Chapter 1 Individuals and Government 1 Public Finance

Chapter 1 Individuals and Government 1

Public Finance n Public finance is the field of economics that studies government activities and the alternative means of financing government expenditures. 2

Government n Governments are organizations formed to exercise authority over the actions of persons who live together in a society and to provide and finance essential services. 3

Political Institutions n Political Institutions are rules and generally accepted procedures that evolve for determining what government does and how government outlays are financed. 4

Examples of Political Institutions n n Majority rule Representative government 5

The Allocation between Private and Government Resources n Private n n n Food Housing Cars Clothing Government n n n National Defense Public Schools Police 6

Government Goods and Services per Year Figure 1. 1 A Production-Possibility Frontier C G 2 G 1 B A M X 2 X 1 0 Private Goods and Services per Year 7

Distribution of Government Goods and Services n Nonmarket rationing: n Prices and willingness to pay those prices are not applicable to goods like national defense. 8

The Mixed Economy: Markets and Politics n Pure Market Economy n n n Virtually all goods and services are supplied by forprofit private firms. Supply and demand determine price. Mixed Economy n A mixed economy is one in which government supplies a considerable amount of goods and services and regulates private economic activity. 9

Figure 1. 2 Circular Flow in the Mixed Economy Goods & Services Dollars Households Income Support & Subsidies Taxes, fees, charges Government Services Dollars Resources Output Market Government Input Market Goods & Services Dollars Subsidies Taxes, fees, charges Government Services Firms Dollars Resources 10

Government Expenditures in the United States n Government purchases of n n labor land capital Government Transfer Payments n n Welfare Social Security 11

Growth in Government Expenditures Table 1. 1 (abbreviated) Year GDP Federal Government State and Local Government Total Government Percentage of GDP Total 1930 91. 3 2. 5 7. 5 10. 0 10. 95 1945 223. 0 84. 7 8. 5 93. 2 41. 79 1960 527. 4 85. 8 34. 1 119. 9 22. 73 1975 1635. 2 345. 4 152. 1 497. 5 30. 42 2002 10442. 1 2073. 9 1050. 9 3124. 8 29. 93 12

International Comparisons Country Government Current Expenditures as a Percentage of GDP 2001 Denmark 49. 1 France 48. 8 Germany 45. 1 United Kingdom 39. 4 Japan 38. 1 Canada 36. 7 United States 31. 9 13

Figure 1. 3 Total Government Expenditure as a Percentage of GDP 1929 -2002 14

Structure of Federal Government Expenditures n n Purchases of Goods and Services Transfer Payments Grants in Aid to State and Local Governments Net Interest Paid 15

Federal Expenditure by Category, 2002 Table 1. 2 Category Percentage of Total Federal Expenditures Transfer Payments 44. 9 Purchases 28. 2 Interest 14. 7 Grants to State and Local 10. 0 Other 2. 2 16

Figure 1. 4 The Distribution of Federal Expenditure, 1966 -2002 17

Federal Government Expenditures by Function 18

The Structure of State and Local Government Expenditures in the United States n n n n Education Civilian Safety Transportation Executive, Legislative, and Judicial Income Security Health and Hospitals Recreational and Cultural Activities 19

State and Local Government Expenditures 20

Financing Government Expenditures in the US n Taxes: n n Income (Corporate and Personal) Payroll Excise Customs 21

Federal Revenues 22

State and Local Government Revenues 23

State Budget Crunch of 2002 n n n 37 states were forced to reduce their budgets. Revenues were typically 10% less than anticipated. States with the most severe deficits: n n AK, AZ, CA, NY, NC, OK, OR, VA, and WA Causes n n n Cuts in taxes on business and individuals in the 1990 s No sales tax collections on services Growth in costs of Medicaid 24

Implications of a Graying America n Social Security n n n Medicare n n In 2008 baby-boomers start to retire and collect The ratio of workers to retiree falls Health care inflation is substantially higher than overall inflation Medicaid n Increased use of long-term care for baby-boomers 25

How Much Government is Enough? n The question of how much government is enough is an important one in any society. It is the tradeoff between public and private goods. When government gets bigger, its increased involvement comes at the expense of less private consumption. 26