Public Finance and Public Policy

Part 1: Introduction to public economics and review of tools
1. Why Study Public Finance?
(Loosely follows Gluber Chapter 1)
Public Economic Lectures
Summer Term 2016
Dina Chhorn (Mr.)
University of Lumière Lyon 2
Royal University of Law and Economics (RULE)
Centre Universitaire de Recherche en Économie et en Gestion (CUREC)
Copyright © 2012 Worth Publishers
Course Outline
Part 1. Introduction to public economics and review of tools – (1st, 2nd, 3rd and 4th Lecture)
World Economic Outlook
1. Why Public Economics?
2. Theoretical Tools of Public Economics
3. Empirical Tools of Public Economics
4. Budget Analysis and Deficit Financing
Part 2. Taxation and redistribution: – (6th, 7th and 8th Lecture)
5. Income inequality, poverty, well-being, taxes and transfers
6. Role of fiscal policy in reducing income inequality
7. How to deal with extreme inequality?: Economist/non-economist debates
Part 3. Role of Government and Market Failures: Public Goods & Externalities – (10th and 11th Lecture)
8. Political Economy and local public goods
9. Public provision of private goods: Education
10. Externalities: Problems and Solutions
1. The Four Questions of Public Finance
2. Why Study Public Finance? Facts on Government in the United States and Around the
3. Why Study Public Finance Now? Policy Debates over Extreme Inequality, Social Security,
Health Care, and Education
4. Conclusion
1 The Four Questions of Public Finance
Public finance: The study of the proper role of the
government in the economy.
1 The Four Questions of Public Finance
The proper role of the government in the economy?
On the expenditures side of public finance, we ask:
- What kind of services should the government provide, if any?
- Why should the government be spending billions of dollars on aid to local schools,
health insurance for the unemployed?
- More generally, why is the government the primary provider of goods and services
such as highways, education, and transfers to the unemployed, while the provision of
goods and services such as clothing, entertainment, and property insurance is
generally left to the private sector?
1 The Four Questions of Public Finance
The proper role of the government in the economy?
On the revenue side of public finance, we ask:
- How much should the government tax its citizens, and how should that amount be
related to the economic circumstances of those individuals?
- What kinds of activities should be taxed or be given tax relief in difficult times?
- What effect do taxes have on the functioning of the economy?
1 The Four Questions of Public Finance
Four questions of public finance:
1.1 When should the government intervene in the economy?
1.2 How might the government intervene?
1.3 What is the effect of those interventions on economic outcomes?
1.4 Why do governments choose to intervene in the way that they do?
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.
• 1st role - Market failure: Problem that causes the market economy to deliver an
outcome that does not maximize efficiency. The government intervention may
improve the situation.
• Even if the market is well-functioning, an efficient outcome is not necessarily socially
desirable. Market economy generates substantial inequality in economic resources
across individuals.
• 2nd role - Redistribution: The shifting of resources from some groups in society to
others. In another word, government intervention may help reduce inequality by
redistributing resources through taxes and transfers.
1.1 When Should the Government Intervene in the Economy?
Efficient Private Market Allocation of Goods
1st Role for Government: Improve Efficiency
2nd Role for Government: Improve Distribution
1.1 When Should the Government Intervene in the Economy?
• Redistribution creates an equity-efficiency trade-off
1.2 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.
o Taxes raise the price for private sales or purchases of goods that are overproduced (ex: carbon tax)
o Subsidies lower the price for private sales or purchases of goods that are under-produced (ex: flu shots
• Restrict or Mandate Private Sale or Purchase
o Quotas restrict private sale of goods that are overproduced (ex: fuel efficiency requirement)
o Mandates require private purchase of goods that are under-produced (ex: auto insurance)
• Public Provision
o The government can provide the good directly in order to potentially attain the level of
consumption that maximizes social welfare (ex: defense)
• Public Financing of Private Provision
o Governments pays, private companies produce. (ex: privately provided health insurance paid for by
government in medicare-medicard)
1.3 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
• 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.
1.4 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.
2 Why Study Public Finance? Fact on Government in US, and around
the World
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.
In brief:
The size and growth of government
Spending, taxes, deficits, and debts
Distribution of spending
Distribution of revenue sources
Regulatory role of government
2.1 Federal Spending as a Percent of GDP, 1930−2011
2.1 Total Government Spending Across Developed Nations, 1960−2013
What explains the growth in government
spending over the 20 century?
2.2 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.
What is the appropriate extent of
centralization and decentralization in
government activity?
2.3 Federal Revenues and Expenditures, 1930−2011
2.3 Federal Surplus/Deficit, 1930−2011
2.3 Federal Debt, 1930−2011
2.3 Debt Level of OECD Nations in 2011
2.3 State and Local Government Receipts, Expenditures, and Surplus,
What are the costs of having larger deficits
and a larger national debt?
Why are state and local government able to
balance their budgets while the federal
government is not?
2.4 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
2.4 Distribution of Federal & State/local Spending, 1960 and 2012
Are large government intervention in insurance markets warranted, and do they
correct or exacerbate market failures?
What is the appropriate type of spending to be done at the federal versus state
or local level?
2.5 Distribution of Federal & State/local Revenue Sources, 1960 and 2011
What are the implications of moving from taxing business and consumption to
taking workers’ earning? (Federal Level)
What are the implications of shifting from taxation of property to taxation of
income at State/Local level?
2.6 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
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
3 Why Study Public Finance Now? Policy Debates over Extreme
Inequality, Social Security, Health Care, and Education
Many heated policy debates concern the impact of major public programs:
• The role of Extreme inequality, 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.
3.1 Why Study Public Finance Now? Extreme inequality in USA
• Even if market outcome is Pareto efficient, society
might not be happy with the market outcome
because market equilibrium might generate very
high economic disparity across individuals.
• Governments use taxes and transfers to redistribute
from rich to poor and reduce inequality .
• Redistribution through taxes and transfers might
reduce incentives to work (efficiency costs)
• Redistribution creates an equity-efficiency trade-off
• Income inequality has soared in the United States in
recent decades, and has moved to the forefront in
the public debate (see Piketty’s 2014 book success)
3.1 Why Study Public Finance Now? Extreme inequality in USA
3.1 Why Study Public Finance Now? Extreme inequality in USA
Is it really matter, current state of income
3.2 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 today’s young workers pay the
retirement benefits of today’s 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.
How large a role should the government
play in mandating or regulating an
individual’s retirement saving?
How can the government best reform the
Social Security system to address its longrange funding shortfall?
3.3 Why Study Public Finance Now? Health Care
• 49 million Americans lack any health insurance, about 18% of the non-elderly U.S.
• The Affordable Care Act (ACA) promises to cover 32 million, using mandates and
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.
3.4 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?
Can more spending solve the problems of the
U.S. educational system?
If not, can competition work in the education
market as well as it has in other markets?
How do we deal with students who are “left
behind” by such a system, in areas where there
are bad schools and insufficient choice?
4 Conclusion
• Government plays a central role in the lives of all countries.
• There is ongoing disagreement about whether that role should expand,
stay the same, or contract.
Highly recommend readings:
Angus Deaton (2013). The Great Escape: Health, Wealth, and the Origin of Inequality.
Princeton University Press, Princeton.
Jonathan Gruber (2010), Public Finance and Public Policy. 3th Edition, New York: Worth
Joseph E. Stiglitz (2013). The Price of Inequality: How Today's Divided Society Endangers Our
Future. W. W. Norton & Company, 1 edition, New York, London.
Lee Kuan Yew (2013). One man’s view of the world. Straits Times Press. Singapore.
Maya B. B. and Florian M. (2006), Le rôle de l’Etat Fondements et Réformes, Edition Bréal.
Thomas Piketty (2014). Capital in the Twenty-First Century. Harvard University Press,