Department of Economics Honours Programme in Economics 2009

Public Economics
[Module code 11143-771]

Module lecturers:
Mrs. AI Jansen (coordinator) Room 521, CGW Schumann Building Tel: 808-2737 (W) E-mail: ada@sun.ac.za Prof P Black Room 406, CGW Schumann Building Tel: 808-2478 (W) E-mail: pablack@sun.ac.za Mr. FK Siebrits Room 510, CGW Schumann Building Tel: 808-2234 (W) E-mail: krigesiebrits@sun.ac.za

Internal Moderator: Dr P de Villiers

Copyright 2009 University of Stellenbosch All Rights Reserved

MODULE OUTLINE
A. GOALS

The goals of the module are to: develop an understanding of the various views on the role of the government in an economy; study the theories of government expenditure, taxation and loan finance (debt) by the state, and thereby to master the principles of public economics; and study the influence of public sector activities on the economy, both macro- and microeconomically, with special reference to South Africa. B. LECTURE SESSIONS

The module consists of 12 sessions. Sessions are on Tuesdays, 14h00-16h00. The venue is the Jan Sadie Lecture Room (Room 207B), CGW Schumann Building. Attendance of all sessions is compulsory and punctuality is expected at all times. Note that the duration of sessions is two hours. All students are expected to study the literature for each session in advance. The module outline in Section E below contains the minimum study objectives for each session, which may serve as a guideline for individual self-assessment of progress in mastering the study material. The dates, themes and lecturers of the sessions are given below. Any changes in the programme will be announced in advance.
Programme of lecture sessions Topic Introduction to Public Economics and the role of government; Overview of analytical tools The role of government in the economy: market failure, public goods and externalities Public-choice issues Growth / roll-back of government and privatisation Theory of taxation: Efficiency and equity Tax theory and practice in SA: Tax on income, wealth, goods and services Tax reform issues Income distribution and social security issues MID-TERM TEST Project evaluation and cost-benefit analysis Fiscal policy and the national budget Public debt and debt management (Submission of essays) Intergovernmental fiscal relations: theory and practice

Session 1 2 3 4 5 6 7 8 TEST 9 10 11 12

Date 17-Feb 24-Feb 03-Mar 10-Mar 17-Mar 24-Mar 31-Mar 14-Apr 21-Apr 28-Apr 05-May 12-May 19-May

Public Economics 2009 Module Outline

3 C. ASSESSMENT

Assessment is by way of a test, an essay and an examination. The test will take place on Tuesday, 21 April 2009, during the lecture period. Essays have to be submitted during session 11 on 12 May 2009. Assessment marks are as follows: Component Test Essay Examination Total

Percentage of final mark 25 25 50 100

D.

LITERATURE

Various articles, reports and excerpts from publications are prescribed, as listed in respect of each session. Note that additional prescribed material can be made available during sessions, or that additional articles may be prescribed. Students are responsible to ensure that they have a copy of all prescribed material. In Section E full references regarding recommended material are given in respect of each session and students must obtain these sources themselves. The prescribed book is: Black, P., Calitz, E., Steenekamp, T.J. and associates. 2008. Public Economics. 4th edition. Cape Town: Oxford University Press. This book is available at Van Schaik's Bookshop in the Neelsie Student Centre. [Below we refer to this book as Black et al.] The prescribed and recommended literature also include sections from: Rosen, H. S. and Gayer, T. 2008. Public Finance. 8th edition. McGraw-Hill Irwin. The book is reserved for use in the JS Gericke library [Below we refer to this book as Rosen & Gayer.]

Public Economics 2009 Module Outline

4 E STUDY OBJECTIVES AND LIST OF STUDY MATERIAL, BY SESSION This section contains a brief outline of the study objectives of the sessions and the applicable prescribed and recommended literature. Session 1 Introduction to Public Economics and the role of government; Overview of analytical tools Study objectives Once you have studied the prescribed material, you should be able to: 1. give an overview of the study field of public finance; 2. interpret the different views on the role of government in the economy; 3. understand the changing role and composition of the public sector in the South African economy; and 4. describe the different tools of positive and normative analysis Prescribed literature 1. Black et al.: chapter 1. 2. Rosen & Gayer: chapter 1, pp 1-5. 3. Tabellini, Guido. The Role of the State in Economic Development. KYKLOS 58(2): 283-303. 4. World Development Report. 1997. The STATE in a changing world. Washington, DC: World Bank: Overview (pp 1-15); Chapter 1 (The evolving role of the state) (pp 19-28.) Recommended literature 5. Rosen & Gayer: chapters 2, 3 and Appendix (pp 539-560). (Strongly recommended for self-study.)

Session 2 The role of government in the economy: Market failure, public goods and externalities Study objectives Once you have studied the prescribed material, you should be able to: 1. distinguish between private, public, mixed and merit goods and services; 2. derive the conditions for the optimal allocation of public goods and services using both partial and general equilibrium analyses; and 3. explain the different types of market failure (e.g. externalities) and the role of government in each case. Prescribed literature 1. Black et al.: chapters 2-5. 2. Agiobenebo, T. J. 2006. On the optimal quantity of public goods and related issues. South African Journal of Economics 74(2): 294-300. 3. Hofmeyr, A., Burns, J. & Visser, M. 2007. Income inequality, reciprocity and public good provision: an experimental analysis. South African Journal of Economics 75(3): 508-520. 4. Black, P. A. 2008. Alcohol taxes versus preventative measures: a theoretical note. South African Journal of Economics 76(4).

Public Economics 2009 Module Outline

5 Recommended literature 5. Brown, C. V. & Jackson, P. M. 1996. Public Sector Economics. Oxford: Blackwell Publishers: pp 54-64. 6. Breier, M. & Visser, M. 2006. Community-based provision of development services in rural South Africa. South African Journal of Economics 74(2):301-314. Session 3 Public choice issues Study objectives Once you have studied the prescribed material, you should be able to: 1. distinguish between different voting systems and explain and compare their efficiency and equity properties; 2. explain the median voter model and indicate its potential strengths and weaknesses; 3. discuss the meaning and importance of Arrows impossibility theorem; 4. explain Buchanan & Tullocks notion of optimal voting rules; 5. explain the different types of government failure; and 6. describe key challenges facing South Africa and how best to deal with them. Prescribed literature 1. Black et al.: chapter 6. Recommended literature 2. Blankart, Charles B. & Koester, Gerrit B. 2006. Political Economics versus Public Choice: Two views of political economy in competition. Kyklos 59(2): 171200. Session 4 Growth / roll-back of government & privatisation Study objectives Once you have studied the prescribed material, you should be able to: 1. discuss salient trends in the size and composition of public expenditure in general and in South Africa; 2. explain and compare different theories on the growth of government and their relevance in the South African context; 3. understand the rationale for, nature of and debate on privatisation; and 4. describe the results of privatisation and the policy implications in developing countries. Prescribed literature 1. Black et al.: chapter 7. 2. Holcombe, Randall R. 2005. Government growth in the twenty-first century. Public Choice 124: 95114. 3. Parker, David & Kirkpatrick, Colin. 2005, Privatisation in Developing Countries: A Review of the Evidence and the Policy Lessons. Journal of Development Studies 41(4): 513-541. Recommended literature 4. Rosen & Gayer: chapters 6 (pp 125-131) and 4 (62-66). 5. Lusinyan, L. & Thornton, J. 2007. The revenue-expenditure nexus: historical evidence for South Africa. South African Journal of Economics 75 (3): 496-507.
Public Economics 2009 Module Outline

6 Session 5 Theory of taxation: efficiency and equity Study objectives Once you have studied the prescribed material, you should be able to: 1. explain the meaning of all relevant tax terminology; 2. discuss the properties of a good tax; 3. analyse tax incidence (shifting) in a partial and general equilibrium framework; 4. explain excess burden, using indifference curve analysis; 5. determine the magnitude of excess burden, using the consumer surplus approach; 6. explain the Ramsey rule and its applicability; and 7. explain the theory of optimal taxation. Prescribed literature 1. Black et al.: chapters 9-10. 2. Rosen & Gayer: chapters 16. 3. Feldstein, Martin. 2008. Effects of Taxes on Economic Behavior National Tax Journal LXI (1):131-139. Recommended literature 4. Rosen & Gayer: chapters 14-15.

Session 6 Tax theory and practice in South Africa: Tax on income, wealth, goods and services Study objectives Once you have studied the prescribed material, you should be able to: 1. define and explain the main tax bases in South Africa; 2. distinguish between different direct and indirect taxes in South Africa; 3. evaluate the different taxes according to the norms of efficiency and equity; 4. describe the impact of inflation on the burden of taxation; 5. explain the effect of direct taxation on the labour supply, saving and investment; and 6. compare the different taxes in terms of their economic impact. Prescribed literature 1. Black et al.: chapters 11-13. 2. Grote, M. & Fletcher, K. 2000. Capital gains tax in South Africa. South African Journal of Economics 68(4): 786-797. 3. Black, P. A. & Mohamed, A. 2006. Sin taxes and poor households: unanticipated effects. South African Journal of Economics 74(1): 131-136. 4. Delfin, S., Kearney, M., Robin, S. & Thierfelder, K. 2005. An Analysis of South Africas Value Added Tax. World Bank Policy Research Working Paper 3671. Washington, DC: World Bank. 5. Koch, Steven F., Schoeman, Niek J. & van Tonder, Jurie J. 2005. Economic growth and the structure of taxes in South Africa: 1960-2002. South African Journal of Economics 73(2): 190-210.
Public Economics 2009 Module Outline

7 6. Nyamongo, Morekwa, E. and Schoeman, Nicolaas J. 2007. Tax reform and the progressivity of personal income tax in South Africa. South African Journal of Economics 75(3): 478-495. 7. Republic of South Africa. 2007. An overview of tax reform since 1994 within the context of the broader tax policy framework. Background Memorandum for the South African Tax Symposium. Pretoria: National Treasury. 17-18 March 2008.

Session 7 Tax reform issues Study objectives Once you have studied the prescribed material, you should be able to: 1. explain whether and how tax systems between industrial and developing countries (ought to) differ; 2. explain the rationale behind changes to the South African tax system in recent years; 3. explain the contemporary views on tax reform; 4. discuss the major tax issues confronting the South African tax authorities at present; and 5. make substantiated proposals on how to deal with these issues. Prescribed literature 1. Araujo-Bonjean, Catherine & Chambas, Grard 2003. Taxing the urban unrecorded economy in sub-Saharan Africa. Communication for the Hard to Tax conference in Atlanta. May. Available at: http://isp-aysps.gsu.edu/academics/conferences/conf2003/Chambas.pdf. 18 pages. 2. Bird, Richard M. 2008. Tax challenges facing developing countries. Institute for International Business Working Paper no 12. Toronto: University of Toronto. Rotman School of Management. 33 pages. 3. Devereux, Michael P. & Srensen, Peter Birch. 2005. The corporate income tax: international trends and options for fundamental reform. Paper prepared for the Working Party No. 2 of the Committee on Fiscal Affairs of the OECD. Economic Policy Research Unit, Department of Economics, University of Copenhagen. Available at: http://www.econ.ku.dk/eprn_epru/Analyse/analyse24.pdf. 4. Owens, Jeffery. 2006. Fundamental tax reform: an international perspective. National Tax Journal LIX (1): 131-164. 5. World Bank & PriceWaterhouseCoopers. 2008. Paying Taxes 2008: The global picture. Available at: http://www.doingbusiness.org/documents/Paying_Taxes_2008.pdf. 6. Zee, Howell H., Stotsky, Janet G. and Ley, Eduardo. 2002. Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries. World Development 30(9): 14971516. Recommended literature 7. Boshoff, V. 1993. Corporate tax rates and intercountry comparisons. South African Journal of Economics 61(4): 301-316.

Public Economics 2009 Module Outline

8 Session 8 Income distribution and social security issues Study objectives Once you have studied the prescribed material, you should be able to: 1. explain different views on the justification for income redistribution; 2. explain the economic impact of expenditure policy (on the distribution of real income, incentive to work, etc.); 3. explain the rationale for social security and current developments in the South African context; and 4. describe key challenges facing South Africa in respect of income distribution and poverty and how best to deal with them from a fiscal point of view. Prescribed literature 1. Black et al.: chapter 14. 2. Donaldson, A. 2007. Income security, retirement reform and social development. Bureau for Economic Research. Conference paper. 3. Van der Berg, S., Siebrits, F. K. & Lekezwa, B. 2009. Quantifying efficiency and equity effects of social grants in SA. Unpublished paper prepared for the Financial and Fiscal Commission. Stellenbosch: University of Stellenbosch (Department of Economics).

Session 9 Project evaluation and cost-benefit analysis Study Objectives Once you have studied the prescribed material, you should be able to: 1. distinguish between private and public approaches to project evaluation; 2. explain the net present value approach to project evaluation and compare it to the internal rate of return and the benefit-cost ratio; 3. explain the meaning and relevance of shadow prices and the difficulties involved in quantifying benefits and costs; 4. discuss the importance of the social discount rate in determining net present value of a public project; and 5. describe the relevance, usefulness and limitations of cost-benefit analysis. Prescribed Literature:
1. Black et al.: chapter 8. 2. Musgrave, R. A. & Musgrave, P. B. 1989. Public Finance in Theory and Practice. 5th edition. New York: McGraw-Hill. Chapters 6 (Expenditure Evaluation: Principles) (pp 134-160) and 7 (Case Studies in Expenditure Policies: (1) Public Services) (pp167-176). 3. Starrett, D. A. 2001. Foundations of Public Economics. Cambridge University Press. Cambridge. Section 9.4 (Practical rules and pitfalls of benefit-cost analysis) (pp 158-160).

4. Muchapondwa, E, Carlsson, F & Kohlin, G. 2008. Wildlife management in Zimbabwe: evidence from a contingent evaluation study. South African Journal of Economics 76 (4). Recommended Literature: 1. Rosen & Gayer: chapter 8. 2. Coningarth Economists. A Manual for Cost Benefit Analysis in South Africa with Specific Reference to Water Resource Development. Pretoria: Water Research Commission.
Public Economics 2009 Module Outline

9 Available at:
http://www.wrc.org.za/downloads/report%20lists/web%20rpts/integrated/TT305-07.pdf.

Session 10 Fiscal policy and the national budget Study objectives Once you have studied the prescribed material, you should be able to: 1. define fiscal policy and describe fiscal goals and instruments at macro, sectoral and micro level; 2. discuss the effectiveness of fiscal policy with reference to different schools of thought, lags and uncertainty, and rules and discretion; 3. critically assess the arguments for and against budget rules; and 4. describe salient features of fiscal policy in South Africa against the backdrop of international experience and aspects of the performance of the economy. Prescribed literature 1. Black et al.: chapter 15. 2. Calitz, E. & Siebrits, F. K. 2003. Fiscal policy in the 1990s. South African Journal of Economic History 18 (September): 50-75. 3. Du Plessis, S.J. & Boshoff, W. 2007. Fiscal rule to produce counter-cyclical fiscal policy in South Africa. Stellenbosch Economic Working Papers: 13/07. 38 pages. Available at: http://stbweb02.stb.sun.ac.za/economics/3.Research/WP-13-2007.pdf. 4. Republic of South Africa. 2009. Budget Review. Pretoria: National Treasury. 5. Siebrits, F. K. & Calitz, E. 2004. Should South Africa adopt Numerical Fiscal Rules? South African Journal of Economics 72(4): 759-783. Session 11 Public debt and debt management Study objectives Once you have studied the prescribed material, you should be able to: 1. explain and compare the merit of the different theories of public debt; 2. compare the relative merits of tax and debt as source of finance for government expenditure; 3. explain the nature and objectives of public debt management; 4. give an account of salient features of contemporary debt management in South Africa; and 5. discuss the nature and criteria of fiscal sustainability with reference to developing countries. Prescribed literature 1. Black et al. 2005. Public Economics. 3rd edition. Cape Town: Oxford University Press: chapter 16. 2. Mendoza, Enrique G. & Ostry, Jonathan D. 2007. International evidence on fiscal solvency: is fiscal policy "responsible"? NBER Working Paper Series Working Paper 12947. Cambridge, MA: National Bureau of Economic Research. 42 pages. 3. Perotti, Roberto. 2007. Fiscal Policy in Developing Countries: A Framework and Some
Public Economics 2009 Module Outline

10 Questions. World Bank Policy Research Working Paper No. 4365. Washington, DC: World Bank. 46 pages. 4. Republic of South Africa. 2009. Budget Review. Pretoria: National Treasury (Extracts).

Session 12 Intergovernmental fiscal relations: theory and practice Study objectives Once you have studied the prescribed material, you should be able to: 1. explain the economic rationale for sub-national governments and compare the merits of fiscal decentralisation and centralisation; 2. discuss the Tiebout model and its relevance; 3. describe the assignment of expenditure functions and revenue sources to national, provincial and local spheres of government in South Africa; 4. understand the issues in respect of borrowing powers and debt management at subnational level; 5. distinguish between different kinds of intergovernmental grants and explain the conditions under which each could be used. Prescribed literature 1. Black et al.: chapter 17. 2. Bird, Richard M. & Smart, Michael. 2002. Intergovernmental Fiscal Transfers: International Lessons for Developing Countries. World Development 30(6): 899-912. 3. De Mello, Luiz R. 2000. Fiscal decentralization and intergovernmental fiscal relations: a cross-country analysis. World Development 28(2): 365-380.

F.

ESSAY

Each student must write an essay on one of the topics provided (one essay topic per student). Students may propose their own topics, which need to be accepted by the lecturer. Essays are to be submitted at the beginning of session 11 on 5 May 2009. The essay topics are as follows: 1. 2. 3. 4. 5. The case for a much reduced public sector in South Africa On the optimal supply of a public good: recent challenges Tendering for the South African public sector: what should be the criteria? Should the government finance Eskom? Why and how? The South African government should rely much more on indirect taxation as revenue source 6. Strengthening the social security net in South Africa: basic income allowances or wage subsidies? 7. Should zero-rating of VAT be scrapped? 8. What should fiscal policy do to reduce economic inequality? 9. An agenda for future tax reform in South Africa 10. Are intergovernmental fiscal relations in South Africa becoming more centralised? 11. Should South Africa budget for a low or zero budget deficit? 12. Conditions for fiscal sustainability
Public Economics 2009 Module Outline

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Public Economics 2009 Module Outline