STaylor

Assignment 1
January 31, 2014

WHY STUDY PUBLIC FINANCE?

Questions and Problems

1. Many states have language in their constitutions that requires the state to provide
for an adequate level of education spending. What is the economic rationale for
such a requirement?

Redistribution and Market Failure are economic rationales when the government
intervenes. If the market fails each state should have provision for education. An
individual who receives an education receives benefits and also provides a positive
externality within communities.

2. How has the composition of federal and state and local government spending
changed over the past 40 years? What social and economic factors might have
contributed to this change in how governments spend their funds?

Federal spending has grown from being less than 3% of GDP in 1930 to approximately
25.30% in 2013. Defense spending has declined from representing more than 50% of
total federal spending in 1960 to less than 20%. Social Security and health care spending
now account for a much larger share of the budget.

The social and economic factors are education. It has been, and remains, the largest single
expenditure item in these budgets, but its share of the budget has declined as the share of
spending on health care has increased. If you notice shift of expenditures from the state
and local levels to the federal government reflects greater centralization.

3. Some goods and services are provided directly by the government, while others
are funded publicly but provided privately. What is the difference between these two
mechanisms of public financing? Why do you think the same government would use
one approach sometimes and the other approach at other times?

Local and State Police forces and the military are perfect examples of direct provision.
These services they provide are public goods but would not be efficiently provided by the
market.

Once these services are provided every citizens benefit. If and when the government
provides the same services, it can tax citizens.

The government contracts with construction companies to build freeways and roads.
When there is an existing market or industry for a given good or service, it may be
cheaper for the government to purchase these goods and services than to produce them
itself. Competition in markets encourages private providers to produce goods and
services efficiently, while government may lack the discipline of the market for the
production of goods and services.

4. Why does redistribution cause efficiency losses? Why might society choose to
redistribute resources from one group to another when doing so reduces the overall
size of the economic pie?

It can cause efficiency losses if there are behavioral responses to the redistribution
system. For example, a generous unemployment benefits may induce some who are out
of work to remain unemployed. A very high tax on labor income may cause some
workers to reduce their amount of labor. Some reasons for redistribution are that people
have a taste, or preference, for a certain degree of economic equity.

5. Consider the four basic questions of public finance listed in the chapter. Which of
these questions are positivequestions that can be proved or disprovedand which
are normativequestions of opinion? Explain your answer.

The four basic questions of public finance are:

1. When should the government intervene in the economy?
The word should suggests that this is a question about which opinion will vary,
so it is normative.
2. How might the government intervene?
The wording of this question suggests the government might intervene in
different ways, so this question is normative. A positive question would ask How
does the government intervene? We could answer that question by observing
verifiable evidence or data.
3. What is the effect of those interventions on economic outcomes?
Economic effects can be measured, and thus are not a matter of opinion, so this
question is positive.
4. Why do governments choose to intervene in the way that they do?
This question asks about existing interventions, which we can directly observe.
But can we prove a governments motivation? Economists infer motivation by
observing patterns of choice, so historical data can be used to address this
question. It is a positive question.

6. One rationale for the public funding of higher education is that, by taking this
class, for example, you will cause a positive spillover to the rest of society. If this
rationale is correct, in the absence of governmental support, will people consume too
much, too little, or the right amount of higher education?

We as a people demand these services based solely on our own private expected returns,
we will consume too little education. Self-interested consumers will not be willing to pay
for a benefit that accrues to others.

7. What is the role of the Congressional Budget Office? Why is independence and
impartiality important when conducting empirical analyses?
The CBO provides economic analyses of proposed legislation, particularly estimates of
the cost of proposed projects. To do this accurately, and to provide the best possible
advice to Congress, the CBO must carefully consider all of the economic effects of a
proposal. A politically motivated CBO might be tempted to understate some costs or
overstate others in order to influence legislation.

8. On occasion, when a government implements a policy that provides benefits to

recipients (such as health insurance for the unemployed), it requires a waiting
period before the benefits can be enjoyed. A rationale for doing so is that people may
change their behaviors in order to take advantage of the benefit. Is this a valid
concern? Explain your thinking.

By requiring a waiting period, the government makes it more costly for people to try to
take advantage of the program by changing their behavior because they would then have
to wait longer for the benefits. However, a waiting period also imposes costs on those
who truly need the program. Valuable benefits can be expected to induce some people to
engage in the associated behavior in order to receive benefits.

9. Bill starts out with $100 in his pocket. Suppose that the government redistributes
some of this money to Ted; to do so, it taxes Bill $40 and gives $35 to Ted, expending
$5 in administrative costs. Does this redistribution of wealth raise social welfare?
Explain your answer.

In example of Bill and Ted excellent monetary adventure, it costs $5 to decrease Bills
wealth and increase Teds, which is an efficiency loss on Bill behalf. However, if Bill and
Ted exhibit diminishing marginal utility in wealth, and Bill is wealthy while Ted is poor,
Bills loss in utility from losing $40 may be less than Teds gain in utility from receiving
$35. In this case this redistribution increases total utility, one possible measure of social
welfare.

10. In the United States, the federal government pays for a considerably larger share
of social welfare spending (that is, spending on social insurance programs to help
low-income, disabled, or elderly people) than it does for K12 education spending.
Similarly, state and local governments provide a larger share of education spending
and a smaller share of welfare spending. Is this a coincidence, or can you think of a
reason for why this might be so?

There are fewer regional differences in preferences related to social program; however,
some may be more willing to give up local control over these programs. Another reason
for federal control of social welfare programs is jurisdictional. When social insurance
benefits varied substantially among states, people might move from one to another in
order to avail themselves of more generous benefits. Local control is often considered
more important for education than for other services, because there may be regional
variations in curriculum preferenceswhether to teach the theory of evolution, for
example.
11. The urban African-American community is decidedly split on the subject of
school vouchers, with their leaders comprising some of the most vocal proponents
and opponents of increased school competition. Why do you think this split exists?

Proponents of the voucher system may believe that it will allow them to send their
children to better schools or that competition will encourage their local schools to
improve in order to retain students who would have a choice of schools under the
voucher system. The opposition may view it as a threat to neighborhood schools, fearing
that if students take their vouchers and leave, inner-city schools may become even more
impoverished. Some community contains a disproportionate number of poor families,
with many students attending substandard schools.

12. Many states have constitutional requirements that their budgets be in balance
(or in surplus) in any given year, but this is not true for the U.S. federal government.
Why might it make sense to allow for deficits in some years and surpluses in others?

If you refer to the time-series graphs illustrate one striking reason to allow for deficits:
during World War II the Federal government spent far more than it took in. However, if
the United States been constrained by a balanced budget requirement at the time of World
War II, we can speculate that the outcome of that war could have been very different.

Some government investments yield long term benefits. Surpluses and deficits may also
have beneficial macroeconomic effects.

13. Why might the government get involved in regulating economic and social
activities? How, besides regulation, does government influence these activities?

When companies and social activities incur external costs, the government may wish to
curtail them. Subsidizing an activity or related product tends to increase the activity. The
government might also engage in campaigns to influence behavior without taxing or
subsidizing it. Anti-litter campaigns are an example of this approach. Taxing an activity
or a product consumed as a complement to that activity tends to reduce the activity.