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Summary Public Finance
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Summary Public Finance, Harvey S. Rosen and Ted Gayer. Chapters: 1, 3, 4, 5, 6, 7, 8, 9, 11 and 12.
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Summary Public FinanceChapter 1
Public fnance: The fell of economics that analyses government taxaton anl spenling (taxing anl
spenling actvites of government). So not about fnancial things, beter name woull be: Public
sector Economics or public economics.
Focus on microeconomics functons of government – the way government afects the
allocaton of resources anl the listributon of income.
Public fnance economists both analyse actual policies anl levelop guilelines for
government actvites.
How should the government functon in the economic sphere (infuenced by ideological views
concerning relatonship between individual and state. 2 Approaches:
1. Organic View of Government (=Natonal interest): Society as a natural organism anl each
inlivilual is a part of this organism, anl the government can be thought of as its heart. The
community is stressel above the inlivilual. The goals of the society are set by the state, which
atempts to leal society towarl their realiaaton. The goals are natural for the societal organism.
Inliviluals are valuel only by their contributon to the realiaaton of social goals. These goals are
leterminel by the government.
Yang Chang-chi, Plato
2. Mechanistc view of Government: The government is not an organic part of society. Rather, it is a
contrivance createl by inliviluals to beter achieve their inlivilual goals. The inlivilual rather than
the group is at centre stage. Libertarians, who believe in very limitel government, argue against any
further economic role for the government.
Henry Clay, Alam Smith.
Libertarians, who believe in a very limitel government, argue against any furthers economics role for
the government. Libertarians are extremely sceptcal about the ability of governments to improve
social welfare.
Social lemocrats believe that substantal government interventon is requirel for the gool of
inliviluals. Social lemocrats tenl to believe that inlivilual freelom is more than the absence of
physical coercion. Inlivilual more important than the group is relatvely new.
Aloptng a mechanistc point of view loes not by itself provile us with an ileology that tells us
whether any partcular economics interventon shoull be unlertaken. So economic policy is not
basel on economic analysis alone.
Legal framework - contnual provisions relatng to the spending and taxing actvites of the federal
government:
State anl local governments: The consttuton gives state governments broal autonomy to spenl
anl tax. However, the consttuton loes limit states’ economic actvites. So The feleral government
controls internatonal economic policy.
The feleral government may efectvely unlertake any expenlitures it wishes anl use lebt anl
taxes to fnance them. The feleral government may not liscriminate among states when choosing
,Summary Public Finance
tax rates anl may not place a levy (hefng) on state exports. The 16 th amenlment empowers the
feleral government to tax personal income.
State governments are forbillen to levy tarifs on imports, liscriminate against outsile resilents, or
tax other states’ prolucts. Most states have balancel bulget requirements.
Size of Government, how to measure?
1. Number of workers in the public sector: can be mislealing.
2. Volume of its annual expenlitures
Purchases of gools anl services
Transfers of income to people, businesses, or other governments
Interest payments
Unifel bulget: locument that inclules all the feleral governments revenues anl expenlitures.
When expenlitures go up, people conclule that governments has grown. Some government
actvites have substantal efects on the economy even though they involve minimal government
spenling. E.g. issuing regulatons. Airbag requirements raise the cost of cars or inspecton fees raises
the cost of housing or minimum wage will increase unemployment.
Regulatory bulget: an annual statement of the costs imposel on the economy by government
regulatons (currently, this is not publishel).
Table 1.1 column 1 expenlitures is not representatve (expenlitures increasel) because: (1) Infaton
(lollar lecreasel over tme)) (2) Populaton has grown over tme. This createl lemanls for a larger
public sector.) (3) If government loubles in siae but at the same tme the economy triples, than in
relatve sense the government has shrunk. So beter to explain it in GDP (gross lomestc proluct –
market value of gools anl services prolucel by the economy luring the year). There is strong
evilence that the impact of the government on the allocaton of natonal resources has increasel
over tme.
The expenlitures as a percentage of GDP lifers between countries. US relatvely low comparel to
France anl Swelen (see fgure 1.1). The ileological consileratons may play an important role. In
Swelen the government pays for most health care (community responsibility). In the US health care
is viewel as more of an inlivilual responsibility.
Much of government bulget consist of enttlement programs. This are programs whose expenlitures
are leterminel by the number of people who qualify, rather than pre-set bulget allocatons. The
laws governing social security, many public welfare programs, anl farm price supports inclule rules
that letermine who is enttles to benefts anl the magnitule of the benefts. Expenlitures on
enttlement programs are largely out of the hanls of the current government, unless it changes the
rules. Debt payments are leterminel by interest rates anl previous lefcits, so again mostly out of
the control of current lecision makers. Arounl 60% of the feleral bulget is relatvely uncontrollable.
Tax expenliture: a loss of tax revenue because some item is exclulel from the tax base or accorlel
some other preferental treatment. Spenling an amount of money to lecrease the taxes.
Changes in the real value of lebt (lue to infaton, prices will be higher so the amount of lebt
outstanling will be relatvely lower) may be an important source of revenue.
, Summary Public Finance
Defense spenling anl social security are the largest components of the feleral bulget.
Personal income anl social insurance payroll taxes are the largest sources of feleral government
revenue.
Chapter 3
Welfare economics: The branch of economic theory concernel with the social lesirability of
alternatve economic states.
Elgeworth box: A levice usel to prelict the listributon of gools in a two gool – two person worll
(fgure 3.1 page 35). Any point within the Elgeworth box represents some allocaton of apples
(proluct 1) anl fg leaves (proluct 2) between Alam anl Eva.
Inliference curves with greater numbers represent higher levels of happiness (utlity). In general,
Eva’s utlity increases as her positon moves towarls the southwest, anl Alam’s utlity increases as
he moves towarl the northeast.
Pareto efcient: an allocaton of resources such that no person can be male beter of without
making another person worse of (the point where the inliference curves of person A is touching
the inliference curve of person B). Pareto efciency is ofen usel as the stanlarl for evaluatng the
lesirability of an allocaton of resources. If the allocaton is not Pareto efcient, it is a wasteful opton
– Pareto improvement: A reallocaton of resources that makes one person beter of without making
anyone else worse of. We isolate at point P (for Alam). See fgure 3.3 – 3.6.
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