Chapter 1 Introduction Public Economics 1 Public Finance

Chapter 1 - Introduction Public Economics 1

Public Finance Defined • Public finance is about the taxing and spending activities of the government. • Also known as “public sector economics” or “public economics. ” • Focus is on microeconomic functions of government – polices that affect overall unemployment or price levels are left for macroeconomics. • Scope of public finance unclear – government has role in many activities, but focus will be on taxes and spending. 2

Public Finance and Ideology • How should a government function in economic sphere? • Organic view – community stressed above individual. Goals of society set by the state. • Mechanistic view – government is a contrivance created by individuals to better achieve their individual goals. Individual, not group, is at center stage. – This is the viewpoint taken in the textbook. 3

Government at a Glance • Legal framework – Federal government • No real constraints on spending in Constitution • Taxes must come originate in House of Representatives. – Equal tax rates across states. – Income tax came from 16 th amendment to Constitution. • Can run budget deficits – State and local government • Can impose spending / taxing restrictions on itself. • Many states cannot run budget deficits. 4

Government at a Glance • Size of government – how to measure? – Number of government employees – Annual expenditures • Purchases of goods and services, transfers, and interest payments • Unified budget – In 2001, $1. 6 trillion spent at federal level, and another $1. 3 trillion at state and local levels. 5

Government at a Glance • These numbers ignore activities that do not have explicit outlays, but substantial effects on resource allocation. – Regulations, for example. – Conceivably, could construct a “regulatory budget” to account for these costs, but difficult to compute. 6

Government Expenditure • Some numbers • Annual expenditures have grown by a factor of 290 from 1929 -2001. – Inflation, population also changing. Real, per-capita expenditure still 10 times as large. – As percentage of GDP, government expenditure was 9. 6% in 1929, and 29. 3% in 2001. 7

Table 1. 1 8

Government Expenditure • United States versus other developed countries. • U. S. public sector is quite small compared to Sweden or France, and smaller than all the countries listed. • Although large, the U. S. government is small in relative terms. More reliance on private sector. 9

Table 1. 2 10

Government Expenditure • In 1965 • In 2001 • National defense almost half of federal expenditure • Defense was less than one-fifth • Social security small & Medicare non-existent • Social security now largest spending item, Medicare large & growing • Debt payments roughly constant. 11

Figure 1. 1 12

Government Expenditure • Much of the government budget consists of entitlement programs – programs with costs determined by number of people who qualify. – Social Security, Medicare, welfare • Three-quarters of the federal budget is relatively uncontrollable, because of these entitlements. 13

Government Expenditure • Federal government responsible for about 51% of direct expenditure. • State governments responsible for 21%. • Local governments responsible for 28%. – State & local governments primarily responsible for police & fire protection, education, transportation, and some welfare programs. 14

Government Revenues • Federal taxes mainly consist of individual income taxes, payroll taxes, and corporate taxes. – Personal income tax 46% of collections. • State & local taxes mainly consist of property taxes, sales taxes, individual income taxes, and grants from federal government. – Less reliance now on property tax, more on income tax. 15

Recap of Introduction • Public finance, definition • Views of government • Government expenditure • Government revenue 16