Chapter 1 - Introduction
Public Finance
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McGraw-Hill/Irwin
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Public Finance Defined
• Public finance is about the taxing and spending activities
of the government.
• Also known as “public sector economics” or “public
economics.”
• Focus is on microeconomic functions of government –
polices that affect overall unemployment or price levels are
left for macroeconomics.
• Scope of public finance unclear – government has role in
many activities, but focus will be on taxes and spending.
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Public Finance and Ideology
• How should a government function in an economic sphere?
• Organic view – community stressed above individual.
Goals of society set by the state.
• Mechanistic view – government is a contrivance created
by individuals to better achieve their individual goals.
Individual, not group, is at center stage.
– This is the viewpoint taken in the textbook.
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Government at a Glance
• Legal framework
– Federal government
• No real constraints on spending in Constitution
• Taxes must originate in House of Representatives
– Equal tax rates across states.
– Income tax came from 16th amendment to Constitution.
• Can run budget deficits
– State and local government
• Can impose spending / taxing restrictions on itself.
• Many states cannot run budget deficits.
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Government at a Glance
• Size of government – how to measure?
– Number of government employees
– Annual expenditures
• Purchases of goods and services, transfers,
and interest payments
• Unified budget – In 2001, $1.6 trillion spent
at federal level, and another $1.3 trillion at
state and local levels.
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Government at a Glance
• These numbers ignore activities that do
not have explicit outlays, but substantial
effects on resource allocation.
– Regulations, for example.
– Conceivably, could construct a “regulatory
budget” to account for these costs, but
difficult to compute.
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Government Expenditure
• Annual expenditures have grown by a
factor of 290 from 1929-2001.
– Inflation, population also changing. Real,
per-capita expenditure still 10 times as large.
– As percentage of GDP, government
expenditure was 9.6% in 1929, and 29.3% in
2001.
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Table 1.1
Government Expenditure
• United States versus other developed countries.
• U.S. public sector is quite small compared to
Sweden or France, and smaller than all the
countries listed.
• Although large, the U.S. government is small in
relative terms. More reliance on private sector.
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Table 1.2
Government Expenditure
• In 1965
• In 2001
• National defense almost
half of federal
expenditure
• Defense was less than
one-fifth
• Social security small &
Medicare non-existent
• Debt payments roughly
constant.
• Social security now
largest spending item,
Medicare large &
growing
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Figure 1.1
Government Expenditure
• Much of the government budget consists of
entitlement programs – programs with costs
determined by number of people who qualify.
– Social Security, Medicare, welfare
• Three-quarters of the federal budget is relatively
uncontrollable, because of these entitlements.
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Government Expenditure
• Federal government responsible for about 51%
of direct expenditure.
• State governments responsible for 21%.
• Local governments responsible for 28%.
– State & local governments primarily responsible for
police & fire protection, education, transportation, and
some welfare programs.
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Government Revenues
• Federal taxes mainly consist of individual
income taxes, payroll taxes, and corporate
taxes.
– Personal income tax 46% of collections.
• State & local taxes mainly consist of property
taxes, sales taxes, individual income taxes, and
grants from federal government.
– Less reliance now on property tax, more on income
tax.
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Recap of Introduction
• Public finance, definition
• Views of government
• Government expenditure
• Government revenue
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