Gruber4e ch01

Public Finance and Public Policy Jonathan
CopyrightGruber
2012 Fourth
WorthEdition
Publishers
Copyright 2012 Worth Publishers
1 of 32
Why Study Public Finance?
1.1 The Four Questions of Public Finance

1.2 Why Study Public Finance? Facts on
Government in the United States and
Around the World
1.3 Why Study Public Finance Now? Policy
Debates over Social Security, Health Care,
and Education
1.4 Conclusion
P R E PAR E D B Y
Dan Sacks
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers
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1.1
C H AP T E R 1 W H Y S T U D Y P U B LI C E C O N O M I C S ?
The Four Questions of Public Finance

Public finance: The study of the role of the
government in the economy.
Four questions of public finance:
1. When should the government intervene in
the economy?
2. How might the government intervene?
3. What is the effect of those interventions on
economic outcomes?
4. Why do governments choose to intervene
in the way that they do?
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1.1
When Should the Government Intervene in the

Economy?
Economics generally presumes that
markets deliver efficient outcomes, so why
should government do anything?
Primary motive for government
intervention is therefore market failure.
Market failure: Problem that causes the
market economy to deliver an outcome
that does not maximize efficiency.
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1.1
APPLICATION: The Measles Epidemic of 19891991
Measles vaccine introduced in 1963, and

measles cases had become relatively rare
in the United States by the 1980s.
19891991: Huge resurgence in measles.
This outbreak resulted from very low
immunization rates among disadvantaged
inner-city youths.
Unimmunized children imposed a negative
externality on other children.
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1.1
APPLICATION: The Measles Epidemic of 19891991

The federal government responded to this
health crisis in the early 1990s:
o Encouraged parents to immunize their
children.
o Paid for the vaccines for low-income
families.
Impressive results:
Immunization rates never higher than
70% prior to outbreak.
Rose to 90% by 1995.
Government intervention clearly reduced
this negative externality.
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1.1
When Should the Government Intervene in the

Economy?
Even if the market is well-functioning, an
efficient outcome is not necessarily socially
desirable.
Redistribution is a second reason for
government intervention.
Redistribution: The shifting of resources
from some groups in society to others.
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1.1
How Might Governments Intervene?

Tax or Subsidize Private Sale or
Purchase
o Use the price mechanism, changing the
price of a good to encourage or
discourage use.
Taxes raise the price for private sales or
purchases of goods that are overproduced.
Subsidies lower the price for private sales
or purchases of goods that are underproduced.
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1.1
How Might Governments Intervene?

Restrict or Mandate Private Sale or
Purchase
o Quotas restrict private sale of goods that
are overproduced.
o Mandates require private purchase of
goods that are under-produced.
Public Provision
o The government can provide the good
directly.
Public Financing of Private Provision
o Governments pays, private companies
produce.
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1.1
What Are the Effects of Alternative Interventions?

Interventions have direct and indirect effects.
Direct effects: The effects that would be
predicted if individuals did not change their
behavior in response to the interventions.
o With 49 million uninsured, providing
universal health insurance covers 49
million people.
Indirect effects: The effects that arise only
because individuals change their behavior
in response to the interventions.
o If people drop private coverage, many
more people may end up covered by the
public plan.
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1.1
Why Do Governments Do What They Do?

Governments do not always choose efficient
or socially desirable outcomes.
Political economy: The theory of how the
political process produces decisions that
affect individuals and the economy.
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1.2
Why Study Public Finance?

The government is a huge part of the
economy:
Government spending represents a large
sector of the economy, in the United States
and around the world.
This spending is financed with taxes or with
debt, and these affect every facet of the
economy.
Many sectors of the economy are also
directly affected by regulation.
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1.1
APPLICATION: The Congressional Budget Office as

Gatekeepers
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)
scores policy proposals by estimating
their budget implications.
CBO scoring uses the theoretical and
empirical tools of public finance.
CBO scores can determine the fate of
legislation.
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1.2
Federal Spending as a Percent of GDP, 19302011
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1.2
Total Government Spending Across Developed

Nations, 19602013
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1.2
Decentralization
A key feature of governments is the degree
of centralization across local and national
government units.
Centralization: The extent to which
spending is concentrated at higher (federal)
levels or lower (state and local) levels.
In the United States, state and local
spending is about one-fourth of total
government spending.
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1.2
Federal Revenues and Expenditures, 19302011
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1.2
Federal Surplus/Deficit, 19302011
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1.2
Federal Debt, 19302011
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1.2
Debt Level of OECD Nations in 2011
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1.2
State and Local Government Receipts,

Expenditures, and Surplus, 19472008
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1.2
Distribution of Spending
Public goods: Goods for which the

investment of any one individual benefits
everyone in a larger group.
o Example: Defense spending
Social insurance programs: Government
provision of insurance against adverse
events to address failures in the private
insurance market.
o Example: Health insurance
Over time, spending has shifted
dramatically toward social insurance,
especially health insurance.
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1.2
Distribution of Federal Spending, 1960 and 2012
Category:
National defense
1960
49.4%
2012
19.1%
Social Security
Net interest
Unemployment,
disability
13.4
9.7
8.6
15.9
7.6
9.1
Education, welfare,
housing
4.0
11.0
Health (including
Medicare)
2.9
25.2
12.0
12.1
Other
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1.2
Distribution of State/Local Spending, 1960 and 2012
Category:
Education
1960
38.8%
2012
33.4%
Transportation
Public order and safety
Welfare, social
services
11.7
10.2
10
5.9
12.9
6.6
Health
Other
8.2
21.1
22.3
18.6
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1.2
Distribution of Federal Revenue Sources, 1960 and

2011
Category:
Income taxes
1960
44%
2012
42%
Corporate taxes
Social insurance
contributions
23
17
35
13
Excise taxes
13
Other
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1.2
Distribution of State/Local Revenue Sources, 1960

and 2011
Category:
Property taxes
1960
36%
2012
21%
Sales taxes
Federal grants-in-aid
Income taxes
27
9
6
22
24
14
Other
22
19
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1.2
Regulatory Role of the Government

The government regulates a wide range of
economic and social activities:
The Food and Drug Administration (FDA):
food, cosmetics, drugs, and medical
devices.
The Occupational Safety and Health
Administration (OSHA): workplace safety.
The Federal Communications Commission
(FCC): radio, television, wire, satellite, and
cable.
The Environmental Protection Agency (EPA):
pollution of air, water, and food supplies.
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1.3
Why Study Public Finance Now? Policy Debates over

Social Security, Health Care, and Education
Many heated policy debates concern the

impact of major public programs:
The role of Social Security, health care, and
education are all contentious subjects.
Liberal and Conservative positions hold
differing views on how to approach these
major policy issues.
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1.3
Why Study Public Finance Now? Social Security
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.
As the population ages, it is increasingly
difficult to fund.
Liberals argue that we should raise
necessary resources through higher payroll
taxes.
Conservatives argue that, rather than
transfer from young to old, we should
encourage people to save.
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1.3
Why Study Public Finance Now? Health Care
49 million Americans lack any health

insurance, about 18% of the non-elderly
U.S. population.
The Affordable Care Act (ACA) promises to
cover 32 million, using mandates and
subsidies.
o Supporters argue that the ACA corrects
serious market in the insurance market.
o Opponents charge that it represents an
enormous, expensive, unwarranted
expansion of government power.
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1.3
Why Study Public Finance Now? Education
There is an enormous dissatisfaction with our

current educational system.
In 2009, the United States ranked 17th in
reading, 23rd in science, and 35th in math
skills in a study of 65 countries.
Will more spending improve educational
outcomes?
Or might competition among schools help?
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1.4
Conclusion
Government plays a central role in the lives

of all Americans.
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 the remainder of this book.
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Public Finance and Public Policy Jonathan

Why Study Public Finance?

1.1 The Four Questions of Public Finance

The Four Questions of Public Finance

When Should the Government Intervene in the

APPLICATION: The Measles Epidemic of 19891991

Measles vaccine introduced in 1963, and

APPLICATION: The Measles Epidemic of 19891991

When Should the Government Intervene in the

How Might Governments Intervene?

How Might Governments Intervene?

What Are the Effects of Alternative Interventions?

Why Do Governments Do What They Do?

Why Study Public Finance?

APPLICATION: The Congressional Budget Office as

Federal Spending as a Percent of GDP, 19302011

Total Government Spending Across Developed

Federal Revenues and Expenditures, 19302011

Federal Surplus/Deficit, 19302011

Federal Debt, 19302011

Debt Level of OECD Nations in 2011

State and Local Government Receipts,

Public goods: Goods for which the

Distribution of Federal Spending, 1960 and 2012

Distribution of State/Local Spending, 1960 and 2012

Distribution of Federal Revenue Sources, 1960 and

Distribution of State/Local Revenue Sources, 1960

Regulatory Role of the Government

Why Study Public Finance Now? Policy Debates over

Many heated policy debates concern the

Why Study Public Finance Now? Social Security

Social Security is the single largest

Why Study Public Finance Now? Health Care

49 million Americans lack any health

Why Study Public Finance Now? Education

There is an enormous dissatisfaction with our

Government plays a central role in the lives

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