Business and Public Policy
January 18, 2022
Marina Azzimonti
Today’s Agenda
1. A few remarks about the organization of class
2. Quick intro of BPP
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On the organization of the class
I Flipped model
I Interaction between instructor and students
I Feedback
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What is the role of the government?
The government is instrumental in most aspects of economic life:
1. Government in charge of huge regulatory structure
2. Taxes: governments in advanced economies collect 30-45% of GDP
in taxes
3. Expenditures: tax revenue funds traditional public goods
(infrastructure, public order and safety, defense) and welfare state
(Education, Retirement benefits, Health care, Income Support)
4. Macro-economic stabilization through central bank (interest rate,
inflation control), fiscal stimulus, bailout policies
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Three key questions
1. When and how should the government intervene in the economy?
welfare economics
2. What is the effect of those interventions on businesses?
3. Why do governments choose to intervene in the way that they do?
political economy/public choice
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When should the government intervene?
I Economics generally presumes that markets deliver efficient
outcomes, so why should government do anything?
I Primary motive for government intervention is therefore market
failure.
• Market Failures: Market economy sometimes fails to deliver an
outcome that is efficient ⇒ Government intervention may improve
the situation
• Example: COVID-19 pandemic!
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Main Market Failures
1. Externalities: (example: greenhouse carbon emissions) ⇒ require
govt interventions (Pigouvian taxes/subsidies, public good provision)
2. Imperfect competition: (example: monopoly) ⇒ requires
regulation
3. Imperfect or Asymmetric Information: (example: adverse
selection in health insurance may require mandatory insurance)
4. Individual failures: People are not always rational. This is analyzed
in behavioral economics, field in huge expansion (example: myopic
people may not save enough for retirement)
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When should the government intervene?
I Welfare economics is a sub-field of economics that tries to figure out
“optimal policies.”
I Given an objective function, such as ‘alleviate poverty’ or ‘end a
pandemic’, we try to evaluate how different policies get us as close
as possible to that objective.
I What is the most efficient way (or the ideal way) to achieve a given
economic outcome?
I By construction, welfare economics is normative (How Things
Should be).
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When should the government intervene?
I Even if the market is well-functioning, an efficient outcome is not
necessarily socially desirable.
I Redistribution is a second reason for government intervention.
• Redistribution: Market economy generates substantial inequality in
economic resourcesacross individuals ⇒ Government intervention
may help reduce inequality by redistributing resources through taxes
and transfers
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How Might the Government Intervene?
1. Tax or Subsidize Private Sale or Purchase: Tax goods that are
overproduced (e.g. carbon tax) and subsidized goods underproduced
(e.g., flu shots subsidies)
2. Restrict or Mandate Private Sale or Purchase: Restrict the
private sale or purchase of overproduced goods (e.g. fuel efficiency
requirements), or mandate the private purchase of underproduced
goods (e.g., auto insurance)
3. Public Provision: Gov’t provides a good directly to attain the level
that maximizes social welfare (e.g. defense)
4. Public Financing of Private Provision: Governments pays for the
good but private sector supplies it (e.g., privately provided health
insurance Medicare-Medicaid)
5. Market Regulation: defines the “rules of the game” for businesses.
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Key Facts on Taxes and Spending
1. Government Growth: Size of government relative to National
Income grows dramatically over the process of development from
less than 10% in less developed economies to 30-50% in most
advanced economies.
2. Government Size Stable: in richest countries after 1980.
3. Government Growth is due to the expansion of the welfare state:
(a) public education, (b) public retirement benefits, (c) public health
insurance, (d) income support programs.
4. Govt spending > Taxes: Most rich countries run deficits and have
significant public debt (relative to GDP), particularly during Great
Recession of 2008-10 and Covid 2020-21
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Total tax revenues as % national income
60%
50%
Figure 10.14. The rise of the fiscal State in rich countries 1870-2015
Sweden
France
40%
Germany
Britain
30%
United States
20%
10%
0%
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Interpretation. Total fiscal revenues (all taxes and social contributions included) made less than 10% of national income in rich countries
during the 19th century and until World War 1, before rising strongly from the 1910s-1920s until the 1970s-1980s and then stabilizing at
different levels across countries: around 30% in the U.S., 40% in Britain and 45%-55% in Germany, France and Sweden.
Sources and series: see piketty.pse.ens.fr/ideology.et
Figure 10.15. The rise of the social State in Europe, 1870-2015
Uses of fiscal revenues as % national income
60%
Other social spending
Social transfers (family, unemployment, etc.)
Health (health insurance, hospitals, etc.)
Retirement and disability pensions
Education (primary, secondary, tertiary)
Army, police, justice, administration, etc.
50%
40%
47%
6%
5%
9%
30%
11%
20%
6%
10%
1%
2%
8%
0%
10%
6%
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Interpretation. In 2015, fiscal revenues represented 47% of national income on average in Western Europe et were used as follows: 10%
of national income for regalian expenditure (army, police, justice, general administration, basic infrastructure: roads, etc.); 6% for education;
11% for pensions; 9% for health; 5% for social transfers (other than pensions); 6% for other social spending (housing, etc.). Before 1914,
regalian expenditure absorbed almost all fiscal revenues. Note. The evolution depicted here is the average of Germany, France, Britain and
Sweden (see figure 10.14). Sources and séries: see piketty.pse.ens.fr/ideology.
Different levels of governments
I US Federal govt raises about 20% of GDP in taxes (can run
deficits).
I State+Local govts raise about 10% of GDP in taxes (cannot run
deficits).
I Decentralized govt = a larger fraction of taxes/spending are decided
at local level => additional power to individuals and firms who can
“vote with their feet.”
I Decentralized govt can tailor policy to local views (CA has more
liberal policies than TX).
I Redistribution through taxes and transfers harder to achieve at local
level (rich/big corps can leave local jurisdiction if local taxes are too
high)
⇒ Local govts tend to do less redistribution
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CHAPTER 1: THE BUDGET OUTLOOK
ADDITIONAL INFORMATION ABOUT THE UPDATED BUDGET AND ECONOMIC OUTLOOK: 2021 TO 2031
Figure 1-3 .
Total Outlays and Revenues
Federal goverment only (state+local excluded)
Percentage of Gross Domestic Product
40
Projected
30
Average Outlays,
1971 to 2020
(20.6%)
Outlays are projected to
drop from recent highs as
pandemic-related spending
wanes and then trend
upward, as they did before
the pandemic. Revenues
are projected to hover
around their historical
average as a share of the
economy.
Outlays
20
Average Revenues,
1971 to 2020
(17.3%)
10
0
1971
1981
1991
2001
Revenues
2011
2021
2031
Data source: Congressional Budget Office. See www.cbo.gov/publication/57263#data.
When October 1 (the first day of the fiscal year) falls on a weekend, certain payments that would have ordinarily been made on that day are instead made at the
end of September and thus are shifted into the previous fiscal year. All projections presented here have been adjusted to exclude the effects of those timing
shifts. Historical amounts have been adjusted as far back as the available data will allow.
1
Distribution of taxes
I US Federal govt raises about 2/3 of total taxes, State+Local govt
raises 1/3 of total taxes.
Main Federal taxes: (1) Individual income tax (40% of Fed tax
revenue), (2) payroll taxes on earnings (40%), (3) corporate tax
(15%).
Main State taxes: (1) real estate property taxes (30% of state+local
tax revenue), (2) sales and excise taxes (30%), (3) individual and
corporate state taxes (30%).
Key questions: what impact do they have on the economy?
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45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Average tax rates by income group in 2018
(% of pre-tax income)
Estate tax
Individual income taxes
Payroll taxes
Consumption taxes
Source: Saez and Zucman (2019)
Corporate & property taxes
Regulatory role of the government
Another critical role the government plays in all nations is that of
regulating economic and social activities. Examples:
1. Labor market policy: Minimum wage laws, Occupational Safety
and Health Administration (OSHA)
2. The Food and Drug Administration (FDA) regulates the labeling
and safety of nearly all food products and approves drugs and
medical devices to be sold to the public.
3. Externalities: The Environmental Protection Agency (EPA) is
charged with minimizing dangerous pollutants in the air, water, and
food supplies.
4. Trade policy: barriers to imports, trade treaties, etc.
5. Competition policy: should we break up monopolies? Restrict
certain M&A? (“killer acquisitions”)
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Why Do Governments Do What They Do?
I Government actions are not only the result of welfare economics’
prescriptions.
I Votes shape politicians incentives.
I Businesses actions also affect government choices
1. Campaign contributions
2. Lobbying efforts: activities whose objective is to affect policymakers
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Why Do Governments Do What They Do?
I Political economy: It is the academic discipline that studies how
collective decision making affects economic outcomes.
Example: Understanding how the level of taxes and spending is set
through voting and voters’ preferences
I Economic outcomes are the actual payoffs – in terms of scarce
goods and services – deriving to businesses, individuals, as well as
groups (as large as countries). Examples
• For businesses: Sales, profits
• For households: Wealth, consumption, leisure
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Why Do Governments Do What They Do?
I Political economy: It is the academic discipline that studies how
collective decision making affects economic outcomes.
Example: Understanding how the level of taxes and spending is set
through voting and voters’ preferences
I Economic outcomes are the actual payoffs – in terms of scarce
goods and services – deriving to businesses, individuals, as well as
groups (as large as countries). Examples
• For businesses: Sales, profits
• For households: Wealth, consumption, leisure
Marina Azzimonti
Why Do Governments Do What They Do?
I Political economy: It is the academic discipline that studies how
collective decision making affects economic outcomes.
Example: Understanding how the level of taxes and spending is set
through voting and voters’ preferences
I Economic outcomes are the actual payoffs – in terms of scarce
goods and services – deriving to businesses, individuals, as well as
groups (as large as countries). Examples
• For businesses: Sales, profits
• For households: Wealth, consumption, leisure
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On Political Economy - continued
I What’s in Political Economy but not in Economics?
• In Economics, public policies are taken for granted
• The subfield of Welfare Economics is an exception – However it does
not study how actual policies came about, but rather how policies
should look like in an ideal world
I What’s in Political Economy but not in Politics?
• Politics studies how collective decision making gives rise to policies
• It does not consider how policies contribute to shaping economic
outcomes
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On Political Economy - continued
I What’s in Political Economy but not in Economics?
• In Economics, public policies are taken for granted
• The subfield of Welfare Economics is an exception – However it does
not study how actual policies came about, but rather how policies
should look like in an ideal world
I What’s in Political Economy but not in Politics?
• Politics studies how collective decision making gives rise to policies
• It does not consider how policies contribute to shaping economic
outcomes
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Public choice
I It is a sub-field of political economy that focuses on government
failures
government failures = situations where the government does not act
in the benefit of society.
I Discussed in detail in this class!
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What is in BPP?
I We focus on the interaction between businesses (any type) and
government (any level)
I Government policies that impact businesses: Taxation, expenditures,
regulation
I Businesses’ actions that impact government decisions: Contributions
electoral campaigns, lobbying
I The key learning objective is to gain valuable insights into
• How the collective decision-making process generates policies
• How policies affect businesses’ bottom line
• How businesses affect the collective decision-making process
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A poster child for BPP: Uber
I Largest occupation in the company: Government affairs specialist
I Uber currently operates in over 10,000 cities across 69
I Challenges: Enters (and disrupts) well established and generally
heavily regulated markets, each with its own peculiarities
I Think just of three countries
• United States
• Germany
• Sweden
Marina Azzimonti
A poster child for BPP: Uber
I Largest occupation in the company: Government affairs specialist
I Uber currently operates in over 10,000 cities across 69
I Challenges: Enters (and disrupts) well established and generally
heavily regulated markets, each with its own peculiarities
I Think just of three countries
• United States
• Germany
• Sweden
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Outline of the course
1. The normative approach: Welfare Economics
2. The positive approach: Public Choice
3. When businesses meet government
•
•
•
•
•
•
•
Labor markets
Regulation
Competition policy
Externalities
Patents
State aid
Trade policy
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Deliverables
1. Quizzes
2. Homework
3. Presentations
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