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Chapter1WhyStudy
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Why Study Public Finance?
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Why Study Public Finance?
Controversies about the proper
role of the government raise the
fundamental questions addressed
by the branch of economics known
aspublic finance.
The goal of public finance is to
understand the proper role of the
government in the economy.
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The Four Questions of Public Finance
1 . 1
public finance The study of
the role of the government in
the economy.
four questions of public finance When shouldthe government intervene in the economy? How
might the government intervene? What is the
effect of those interventions on economic
outcomes? Why do governments choose to
intervene in the way that they do?
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market failure Problem that
causes the market economy to
deliver an outcome that does notmaximize efficiency.
When Should the Government Intervene in the Economy?
Market Failures
1 . 1
The Four Questions of Public Finance
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The Measles Epidemic of 19891991
A P P L I C A T I O N
After the measles vaccine was introduced in 1963, measles cases had become
relatively rare in the U.S. by the 1980s. Over the period from 1989 to 1991,
however, there was a huge resurgence in measles.
It is clear that this outbreak resulted from very low immunization rates among
disadvantaged inner-city youths.
These unimmunized children were imposing a negative externality on otherchildren who had received their immunizations but for whom immunizationmay have worn off.
The federal government responded to this health crisis in the early 1990s:
The government publicly encouraged parents to get their children immunized.
The government also paid for the vaccines for low-income families.
The result was impressive. Immunization rates, which had never been above 70%
before the epidemic, rose to 90% by 1995. Government intervention clearly reduced
this negative externality.
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redistribution The shifting of
resources from some groups in
society to others.
When Should the Government Intervene in the Economy?
Redistribution
1 . 1
The Four Questions of Public Finance
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How Might the Government Intervene?
Tax or Subsidize Private Sale or Purchase
1 . 1
One way that the government can try to address failures in the
private market is to use the price mechanism, whereby
government policy is used to change the price of a good in one
of two ways:
1. Through taxes, which raise the price for private sales or
purchases of goods that are overproduced, or
2. Through subsidies, which lower the price for private sales
or purchases of goods that are underproduced.
The Four Questions of Public Finance
Restrict or Mandate Private Sale or Purchase
The government can directly restrict the private sale or purchase of
goods that are overproduced, or mandate the private purchase of
goods that are underproduced and force individuals to buy that good.
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How Might the Government Intervene?
1 . 1
The Four Questions of Public Finance
Public Provision
The government can provide the good directly, in order to potentially
attain the level of consumption that maximizes social welfare.
Public Financing of Private Provision
Governments may want to influence the level of consumption but
may not want to directly involve themselves in the provision of a
good.
Introduce Regulation
Governments may want to influence the working of the markets
through regulations and legislations.
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What Are the Effects of Alternative Interventions?
Direct Effects
1 . 1
The Four Questions of Public Finance
direct effects The effects of
government interventions that
would be predicted if individuals
did not change their behavior inresponse to the interventions.
Indirect Effects
indirect effects The effects of
government interventions that
arise only because individuals
change their behavior in
response to the interventions.
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The Congressional Budget Office:
Government Scorekeepers
A P P L I C A T I O N
The methods and results derived from empirical economics
are central to the development of public policy at all levels
of government.
The Congressional Budget Office (CBO) provides Congress
with the objective, timely, nonpartisan analyses needed for economic and budget
decisions.
The CBO increasingly plays a critical role as a scorekeeper for government
policy debates.
Legislative spending proposals that are to become law must first have their costs
estimated by the analysts at the CBO.
It is not an overstatement to say that the economists who work at the CBO frequently
hold the fate of a legislative proposal in their hands. The large price tag that the CBO
assigned to the Clinton administrations plan to reform health care in the United
States in 1994 is often cited as a key factor in the defeat of that proposal.
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Why Do Governments Do What They Do?
1 . 1
The Four Questions of Public Finance
political economy The theory
of how the political process
produces decisions that affect
individuals and the economy.
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The Size and Growth of Government
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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The Size and Growth of Government
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Decentralization
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
A key feature of governments is the degree of centralization across
local and national government unitsthat is, the extent to which
spending is concentrated at higher (federal) levels or lower (state and
local) levels.
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Spending, Taxes, Deficits, and Debts
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Distribution of Spending
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
public goods Goods for which
the investment of any one
individual benefits everyone in a
larger group.
social insurance programs
Government provision of
insurance against adverse eventsto address failures in the private
insurance market.
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Distribution of Spending
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Distribution of Spending
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Distribution of Revenue Sources
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Distribution of Revenue Sources
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
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Regulatory Role of the Government
1 . 2
Why Study Public Finance? Facts on Government in
the United States and Around the World
Another critical role the government plays in all nations is that of
regulating economic and social activities.
The Food and Drug Administration (FDA) regulates the labeling and
safety of nearly all food products and bottled water, tests cosmetics to
ensure their safety, and approves drugs and medical devices to be sold
to the public.
The Occupational Safety and Health Administration (OSHA) is charged
with regulating the workplace safety of the 115 million Americans
employed at 7.2 million job sites.
The Federal Communications Commission (FCC) regulates interstate
and international communications by radio, television, wire, satellite,
and cable.
The Environmental Protection Agency (EPA) is charged with
minimizing dangerous pollutants in the air, water, and food supplies.
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Social Security
1 . 3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
Social Security is the single largest government expenditure program. The
financing structure of this program is basically that todays young workers
pay the retirement benefits of todays old.
Health CareThere are currently 45.8 million Americans without any health insurance,
about 18% of the non-elderly U.S. population. Projections suggest that
health care will consume almost half of our GDP within the next century.
Social Security, health care, and education are each the subject of debate,
with both the liberal and conservative positions holding differing views
in their approach to each problem.
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1 . 3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
It 1980
55%
7%4%
34%
0%
Pension Family benefit Labour market Health Housing
It 2003
62%5%
5%
28%0%
Pension Family benefit Labour market Health Housing
US 2003
44%
5%5%
46%
0%
Pension Family benefit Labour market Health Housing
US 1980
53%
7%8%
32%
0%
Pension Family benefit Labour market Health Housing
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1 . 3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and EducationInvecchiamento della Popolazione
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
US
LUXEMBURG
DENMARK
IRELAND
NETHERLAND
UK
PORTUGAL
SWEDEN
FINLAND
BELGIUM
FRANCE
GERMANY
AUSTRIA
GREECE
SPAIN
ITALY
Percentuale
diultrasessantenni
2000 2050
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Education
1 . 3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
There is an enormous
dissatisfaction with our current
educational system, highlighted by
the dismal performance of U.S.
students on international tests.
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Education
1 . 3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
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1 . 4
Conclusion
It is clear from the facts presented here that the government plays a central
role in the lives of all Americans.
It is also clear that there is ongoing disagreement about whether that role
should expand, stay the same, or contract.
The facts and arguments raised in this chapter provide a backdrop for
thinking about the set of public finance issues that we explore in theremainder of this book.