© 2005 Thomson C hapter 29 Government Spending. © 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Public goods Merit goods Transfer

© 2005 Thomson

CChapter 29hapter 29

Government Government SpendingSpending

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Gottheil - Principles of Economics, 4e

Economic PrinciplesEconomic Principles

Public goods

Merit goods

Transfer payments

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Government Government Spending and Public Spending and Public

GoodsGoodsPublic good

• A good whose benefits are not diminished even when additional people consume it and whose benefits cannot be withheld from anyone.

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GoodsGoods1. Which of the following offers the best example of a public good:a. Lift tickets sold at ski resorts

b. A network of street lights

c. Restaurant meals

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GoodsGoods1. Which of the following offers the best example of a public good:a. Lift tickets sold at ski resorts

b. A network of street lights

c. Restaurant meals

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GoodsGoods

• A private good, such as a lift ticket or a restaurant meal, is exclusively the property of the person who bought it. That person can prevent others from using the good.

2. What does the nonexclusiveness property of public goods mean?

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GoodsGoods2. What does the nonexclusiveness property of public goods mean?

• Public goods such as street lights are not exclusive, and nobody can be denied the benefits of the lighting.

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GoodsGoods3. What does the nonrival property of public goods mean?• It means that use by one person does not subtract from what is available for others. Examples include street lights and public radio.

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Government Government Spending and Merit Spending and Merit

GoodsGoodsMerit good

• A good that market demand and supply do not produce enough of.

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Government Government Spending and Merit Spending and Merit

GoodsGoodsWhat are some examples of merit goods?

• Public-supported colleges and universities

• Public-supported arts and health care

• Libraries and museums

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EXHIBIT 1 FEDERAL, STATE, AND LOCAL GOVERNMENT SPENDING: 2001 ($ BILLIONS)

Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2002).

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Exhibit 1: Federal, State, and Exhibit 1: Federal, State, and Local Government Spending: Local Government Spending:

2000 ($ billions)2000 ($ billions)

1. Which level of government (federal or state/local) is the largest purchaser of goods and services?

• State and local

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Exhibit 1: Federal, State, and Exhibit 1: Federal, State, and Local Government Spending: Local Government Spending:

2000 ($ billions)2000 ($ billions)

2. In which category of government spending are Social Security contributions and benefits recorded?• Transfer payments

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EXHIBIT 2 GOVERNMENT SPENDING IN 2001, BY FUNCTION ($ BILLIONS)

*The minus figure represents subsidies less current surplus of government enterprises.

**Interest paid less interest received by government.


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Exhibit 2: Government Exhibit 2: Government Spending in 2001, By Spending in 2001, By Function ($ Billions)Function ($ Billions)

1. What is the largest single functional category of expenditure by the federal government? • Income support, Social Security, and welfare.

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Exhibit 2: Government Exhibit 2: Government Spending in 2001, By Spending in 2001, By Function ($ Billions)Function ($ Billions)

2. What is the largest single functional category of expenditure by state and local government? • Education

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How Much Does How Much Does Government Spend?Government Spend?

Over the period 1980-2001, the annual rate of increase in government spending on elementary, secondary, and higher education, measured in constant dollars, was about 3 percent.

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EXHIBIT 3 GOVERNMENT SPENDING ($ BILLIONS) ON SECURITY: 2001


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Exhibit 3: Government Exhibit 3: Government Spending on Security: Spending on Security:

20012001Complete the sentence:

The two largest security expenditure categories by state and local government were _____ and _____.

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20012001Complete the sentence:

The two largest security expenditure categories by state and local government were police and prisons.

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20012001The burden of national defense spending exclusively falls upon the federal government.

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The budget for veterans’ benefits and services is dominated by disability and survivor compensation.

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EXHIBIT 4 FEDERAL, STATE, AND LOCAL GOVERNMENT SPENDING ON EDUCATION: 2001 ($ BILLIONS)


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Exhibit 4: Federal, State, and Exhibit 4: Federal, State, and Local Government Spending Local Government Spending

on Education: 2001 ($ on Education: 2001 ($ billions)billions)1. True or false: Total education

spending is dominated by expenditures on elementary and secondary education. • True. Elementary and secondary education consumes nearly three-quarters of the total education budget.

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Exhibit 4: Federal, State, and Exhibit 4: Federal, State, and Local Government Spending Local Government Spending

on Education: 2001 ($ on Education: 2001 ($ billions)billions)

2. True or false: The federal government provides financial support for higher education, but not for primary or secondary education. • False. The federal government provides some financial assistance at all levels.

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1. What percentage of total government spending goes to international aid:a. 26.2 percent

b. 8.9 percent

c. Less than 1 percent

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2. Which of the following has the larger percentage of total government spending:a. International aid

b. Conservation and natural resources

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2. Which of the following has the larger percentage of total government spending:a. International aid

b. Conservation and natural resources

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Other than telecommunications, there has been relatively little commercial motive for space travel. Federal spending on space exploration was $11.3 billion in 1996.

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3. What common denominator is there for government spending on security, education, transportation, natural resources, energy, and space?• For each of these, the target population of beneficiaries is everyone.

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In contrast, agricultural subsidies are targeted at benefiting farmers, and public assistance programs are targeted at benefiting the poor and needy.

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Welfare

• Government-provided assistance—cash payments and goods and services—to the poor, the elderly, and the disabled. Eligibility is based principally on income and size of family.

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Until recently, eligibility for welfare was linked to single-parent families (Aid to Families with Dependent Children, AFDC) and to the sick or disabled (Supplemental Security Income Program, SSI).

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Eligibility for AFDC and SSI meant entitlement, with no time limit specified.

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4. What new welfare program was created in 1996 and abolished AFDC?• Temporary Assistance for Needy Families (TANF).

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The new TANF program is not an entitlement. Welfare recipients must participate in work activities within two years of receiving welfare or risk losing it.

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In addition, a family is only eligible for a lifetime total of five years of welfare benefits.

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Food stamp program

• An aid program that provides low-income people with stamps that can be redeemed for food and related items.

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Medicaid

• A health care program administered through Social Security that is applicable to low-income and disabled people.

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Social Security

• A social insurance program that provides benefits, subject to eligibility, to the elderly, disabled, and their dependents.

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5. Which of the following are true about Social Security:

a. It is compulsory.

b. b. Everyone receives the same level of benefits.

c. Your contributions are saved in an individual account that you can invest in stocks or bonds.

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5. Which of the following are true about Social Security:

a. It is compulsory. True.

b. Everyone receives the same level of benefits. False.

c. Your contributions are saved in an individual account that you can invest in stocks or bonds. False.

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6. What is the purpose of Medicare?

• Its purpose is to reduce the financial burden of illness on the elderly.

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7. How are Social Security and Medicaid funded?• Social Security and Medicaid are pay-as-you-go programs that are financed through payroll taxes. The revenues go in to a trust fund from which benefits are paid out.

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8. With the proportion of elderly in the U.S. population growing, what are the future prospects for Social Security and Medicaid?• As pay-as-you-go programs financed through payroll taxes, they are at risk because benefit demands are growing relative to the pool of working-age people paying the taxes to support the programs.

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Welfare Reform and Welfare Reform and Low-Skilled Low-Skilled EmploymentEmployment

Welfare reform was based on the premise that welfare recipients choose not to work because benefits with no time limits provide a disincentive to find work and leave welfare.

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Cutting off welfare after a fixed length of time is supposed to serve as a much-needed “kick in the pants” to get easily employable people into jobs.

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A 1992 survey found that 44 percent of mothers on welfare (AFDC) had not completed high school. Another survey found that most AFDC recipients are at the lowest two levels of literacy.

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Consequently the problem is that there is a huge gap between the skills that most welfare recipients have and the skills that most employers require.

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EXHIBIT 5 SOCIAL SECURITY EXPENDITURES AS A PERCENTAGE OF GDP FOR SELECTED ECONOMIES: 1996

Source: World Labour Report 2000 (Geneva: ILO, 2000), p. 313.

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Exhibit 5: Social Security Exhibit 5: Social Security Benefits as a Percentage of Benefits as a Percentage of

GDP for Selected Economies: GDP for Selected Economies: 199619961. Among the other rich

industrialized countries listed in Exhibit 6, how does the U.S. rank in terms of Social Security benefits as a percentage of GDP?• Social Security as a percentage of GDP is 2nd lowest (among those listed) in the United States.

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Exhibit 5: Social Security Exhibit 5: Social Security Benefits as a Percentage of Benefits as a Percentage of

GDP for Selected Economies: GDP for Selected Economies: 19961996

2. What conclusions might one draw from Exhibit 6?

• Social Security is much less of a burden on the U.S. economy relative to many comparable industrialized countries.

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• As of 1996 the U.S. paid $277.1 billion in interest on the national debt.

9. How much does the U.S. spend each year as interest on the national debt, and how did this figure change during the 1980s?

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9. How much does the U.S. spend each year as interest on the national debt, and how did this figure change during the 1980s?• Both the size of the national debt and the annual interest payments it creates grew considerably in the 1980s.

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Is the Level of Is the Level of Government Spending Government Spending

Too High?Too High?After learning about the different elements of government budgets, it becomes evident that wholesale cuts in government spending are difficult to advocate.

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EXHIBIT 6 GOVERNMENT SPENDING: 1970–2001 ($ BILLIONS)

Source: Economic Report of the President, 1997 (Washington, D.C.: U.S. Department of Commerce, 2000); Survey of Current Business, October 2003.

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Exhibit 6: Government Exhibit 6: Government Spending: 1970-2001 ($ Spending: 1970-2001 ($

billions)billions)What has been the trend in the ratio of total government spending to GDP since 1970?• It has more than tripled.

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Exhibit 6: Government Exhibit 6: Government Spending: 1970-2001 ($ Spending: 1970-2001 ($

billions)billions)What has been the trend in the ratio of total government spending to GDP since 1970?• The ratio of total government spending to GDP was 31.6 in 2001.

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EXHIBIT 7 GOVERNMENT SPENDING AS A PERCENTAGE OF GDP: 1981–99

Source: Organisation for Economic Co-operation and Development, calendar year data.

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Exhibit 7: Government Exhibit 7: Government Spending as a Spending as a

Percentage of GDPPercentage of GDP1. Of the countries shown in Exhibit 7, what has happened to the percentage of government spending to GDP since 1993?• All have gone down slightly.

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Government Government Spending and Spending and

Resource AllocationResource AllocationA key distinction between government spending and transfer payments is that government spending takes resources away from production of private goods.

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Resource AllocationResource AllocationIn contrast, transfer payments shift spending from one group of people to another, and do not take resources away from production of private goods.

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Resource AllocationResource AllocationThe purchase of private goods and services funded by transfer payments substitutes for the taxpayers’ purchase of private goods and services.

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Resource AllocationResource AllocationAside from transfer payments, government spending represents approximately 15 percent of GDP.

Documents

© 2005 Thomson C hapter 29 Government Spending. © 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Public goods Merit goods Transfer