Chapter 4 – The Public Sector
The U.S. Economy: Private and
Public Sectors
Can The Market Fail?
• What does that mean?
Production?
• When producing a product or service –
whether the government or the market….
Best mix of output required.
What are the factors that make up
production?
• Optimal mix of output (inputs to outputs)
• What directs resources from one product or
industry to another ????
• Prices
When the market fails… it is a
double edge sword
Market Fails if not optimal mix.
* Optimal Mix of Output……
“Most desirable combination of output attainable
with existing resources, technology and social
values.”
Market Failure
*“An imperfection in the market mechanism that
prevents optimal outcomes.”
Output decision- wrong point on
PPC
• When market fails- government tends to step in:
Example: Banks fail (govt bails out)
Pollution (govt regulates
externalities)
No city parks (govt incentivizes
builders to include in
development)
Microsoft has monopoly (govt
steps in
The Public Sector:Government’s
role.
Questions to ponder:
• What is Public Sector?
• When do markets fail?
• Should government step in? (Too Big to
Fail?)
In real words?
Overproducing a good with external costs
Underproducing a good that has external
benefits.
Not enough public parks…U
Not enough care for environment…U
Not enough welfare…O
Too much separation between top 10% income
earners and median income earners…O
Not adequate security within our borders….U
Too many immigrants….?
Market Failure
Is this evident in today’s market?
***market moves resources from one industry to
another. (price directs resources) (demand
responds) (price moves the resources then to
another demand choice) (at this point
(competition begins to prevail to level the
prices)
• Changes in market prices directs resources
• Question…. Is this movement of resources what
society really desires? Forcing small cars and
aluminum trucks…If society does not want this
market reallocation… should government
intercede?
Market failure = (forces of S & D not leading
us to BEST point on ppc… Who decides
what is defined as BEST?
Enter…. Government intervention!
Will they perform magic? OR Will it be in
worse shape?
How do you know if optimal mix
is met?
Optimal mix of ANY GOOD or SERVICE =
MB = MC
(Marginal benefit = Marginal Cost)
If cost > than benefit… the failure occurs.
If benefit > than cost, then market is
functioning according to other factors
(price, demand, etc.)
Does this apply to our war against terror?
Government Can Enter the Market to correct
when market fails…
Question……………….
Does government improve the mix or make it
1. More complicated
2. Less efficient
3. More costly (now to taxpayers)
• Governments Enter the Market to
assure:
1. Public Goods
2. Externalities (positive or elimination of
negative)
3. Market power
4. Equity
Property Rights must be fully defined in a
competitive market to yield correct signals of
market failure or success..or externalities are
created.
• (that means… “stuff will be manufactured
depleting the environmental commodities (air,
water, minerals, etc) because of the profit motive
While…
“stuff will not be produced (parks, flower gardens,
etc) because of costs imposed with no direct
benefit for those doing the production….. Hence,
inefficiency of a market system.
Translation
If government and/or the consumer was not
acting as a watchdog…. Would
corporations be diligent about utilizing the
proper mix of resources…If they are, can
they compete?
Does that always mean regulation increased?
Could it mean that consumer sovereignty
switches to another desire… BUT… what
about things like energy… would we
really know if the provider was efficient?
What is the tragedy of the
commons?
 Lake Michigan… who owns it?
 No, resources owned in common
 Do we maintain our houses.. Own property?
 If we improve our property (paint, build-on) do we
most often recoup when we sell?
 No incentive for us to not pollute Lake Michigan.
 Hence, natural resources are overused and
degraded…(fish die, balance of nature upset)
Continued Concept of Common Assets
 Resources, rivers, lakes, oceans, air… all fall into
them absorbing pollution.
 If manufacturers can dump wastes or discharge
smoke without cost… they will do so.
 Manufacturers will choose the least-cost
combination of inputs and bear only unavoidable
costs.
 Many individuals avoid trash service if they can
burn or dump their garbage.
No incentive for manufacturer to absorb
internal costs for being good citizen
Remember the tomato canning factory
example
Fallacy of composition applies here…
persons and firms reason their amount of
environmental destruction is not significant
in the total…
Creating a Market for External Rights
 Government creates a market for externality
rights.
 Pollution control agency… determines amount of
pollutants permitted without upsetting balance of
nature (in case of water… quality is maintained).
 If say Lake Monroe can tolerate 500 tons of
pollutants… then this is the amount permitted.
S
 This is fixed amount.
Demand for these rights is downsloping as
for any other input…
Higher prices fewer rights purchased.. The
manufacturer can either stop pollution,
reduce pollution, or purchase from another
manufacturer.
Higher demand… (more firms bidding,
higher the price)
EPA set standards and market bids on rights
Do You Remember?
Collin County was reprimanded by EPA for
polluting too heavily.
You saw businesses crop up for State
Inspections….. Franchised to catch
polluters (cars, emission controls, etc)
Two concepts to remember
• Public goods… can be equally consumed
by all… no restrictions
Skateboarding in the park… Terrorists… can
also go to the park… Illegal immigrants can
go to school… Merit Goods.
• Private goods… consumption by one
person excludes consumption by another..
( my doughnut… my car… etc)
Four Broad Categories of Public Goods
 Health and Hospitals
Indigent have to be treated
County medical centers
Sometimes charged on ability to pay
 Highways
State and federal government share the cost
 Education
State, Local and Federal government provide
 National Defense
National government provides 5 branches of armed
services
Fed pays the entire cost!
Public Goods provided jointly to all would
also include such things as:
national defense
monetary system
judicial system
Opportunity cost… if government provides
health care, private sector cannot compete.
Government “crowds” out the private .
**** Remember, the largest opportunity cost
of an item supplied by government is the
best alternative use that could have been
made of the resources required to provide
that good.
If government becomes too restrictive…
Black Markets crop up.
examples… cigarettes, drugs, bootleggers,
diet supplements, prescription drugs, etc.
Government can and does play an important
role in markets…
Rule-maker
Umpire
What does that mean?
• U.S. Concept of Freedom for All
Joint consumption……….
We all consume federal defense. (If hit by a
terrorist attack in FL… the entire U.S. is
protected. (even non-citizens… even those
who attack us.) Why? They are “free
riders.”
People who pay most taxes actually contribute
more for these services that we all enjoy.
Many of us “ride free.”
2nd Area where Government Enters the
Market - EXTERNALITIES
What are externalities? “costs or benefits of a market
activity borne by a third party.”
Spillovers…an action when one individual or group
harms the property of others without their
consent.
 Throwing trash in someone’s back yard
 Burning ties in the alley
 Playing your stereo loudly at 3:00 a.m.
 Businesses dumping wastes, sludge into rivers
 People trashing the beach or highway.
 Electric Companies burning phosphorous fuels
Spillover Examples that perpetrate on others
Calling police when loud party of teenagers
next door (actions of teens imposing
unwanted cost on neighbor)
Living in downstairs apartment.. Having
upstairs neighbors doing Tai Bo when they
get off work at 4:00 a.m.
Calling the city when a neighbor doesn’t
keep his yard mowed on regular basis.
Externalities can be positive or negative
Homeowners keep lawns immaculate
(benefits the neighborhood)
Scientific study for polio vaccine (others
benefit beyond scientists’ recognition)
Measles Vaccinations.
 Education……. How would this be a
benefit?
How can spillovers be corrected?
Most obvious way is Legislation.
1. To prohibit
2. To heavily tax the specific product and
manufacturer. Tax would be derived to allow for
off-setting the clean-up cost. (Super Fund is
example)
3. Subsidize both consumers or producers
4. ***Tax incentives… if reduction of pollution
and compliance adhered to, taxes reduced.
There are actually quasi corporations
AND quasi public goods?
Quasi-Public Goods.,,
Any g & s that is provided by private
sector,but is not provided in quantities
demanded. Government can assist in this
allocation of resources.
(Parks, Zoos, Educational Institutions)
3rd Area where Governments enter the market
to assure accessibility to market power
Regulating Economic Activities
Ensuring competition- Sherman 1890, Clayton
1914…Antitrust regulation- (FTC)(Microsoft)
Drug Industries (FDA)Congress is investigating at
this time -(drugs in Canada)
Regulating working conditions. (EEOC, OSHA)
Public utilities (legal monopolies (some states)
Controlling social costs: (diseconomies of scale.
Cost of ruining seashore by off-shore drilling.)
Securities Industry (SEC) (accounting fraud, etc)
4th Area addressed by government is
Equity or perhaps better stated as
Inequity.(ensuring market economy)
1)Inadequate income (redistribute to have-nots)
2) Merit goods (everyone entitled to some minimum
of food,clothing, shelter) In-kind transfers in food
stamps, housing vouchers, health clinics)
3)Social Security and unemployment compensation
protect people’s economic security by providing
money when they retire or are unable to work.
• SOURCES OF GOVERNMENT
INCOME
• TAXES
• Why must government tax?
• What is a fair tax?
• Who should pay?
• The primary function of taxes is to transfer
command over resources (purchasing
power) from the private sector to the
public sector.
Income Taxes
• The Sixteenth Amendment to the U.S.
Constitution (1915) granted the federal
government authority to collect income
taxes.
• It is now the largest single source of
government revenue.
What Determines a Fair Tax?
Very few people think a fair tax? of taxes as
payment for certain services rendered.
• When we purchase a new coat, we have chosen an
item in the market system…pay for it… use it.
• We don’t think of that when we call the fire
department or the police department…even if we
are delinquent on our taxes, they still show up.
• What if the fire department or police left a bill?
Ambulance services do…. Should they?
• How should taxes be assessed?---benefits
received----ability to pay!
Benefits Received:
Tax the user- gas tax for drivers- fishing license-ramp fees for
boats- toll roads-bus and train ticketsPay the government for benefits received- can’t pay for
welfare received!
Ability to Pay
• Should wealthy pay more
regardless of benefits
received?
• Should income and family
size be assessed?
• Determining fairest
principle for a just tax is
matter of values rather
than economics and is
determined by our
political process.
• Executive Budget for
2015 wants anyone
$665,00 up to pay more.
Other Factors in Evaluating Taxes
 Total Revenue yielded
 Effect on Production (destroy incentive?)
 Bracket Creep (AMT)
 Moral consequences (sin taxes)
 Reflection of values shown in taxes imposed
 Convenience (withholding, quarterly, penalties)
 Shifting the burden (seller to consumer)
 Ability to pay (relation of tax base to tax rate)
Tax rate= percentage that is taxed
Tax base = subject on which the tax is levied.
• Types of Taxes
• Progressive = tax rate increases as the tax
base increases
• Proportional = tax rate remains the same
regardless of the base
• Regressive= tax rate decreases as the base
increases. (often cited as unfair because it
places heaviest burden on the least able to
pay ---sales tax--- social security tax.)
Federal Government Tax System
• Federal government gets most of its revenue from
individual and corporate income taxes.
• Next largest amount from Social Security tax
• Very small portion of revenue from estate and gift
taxes.
• Larger share from excise taxes (gasoline, jewelry,
alcohol, cigarettes, motor vehicles, admission to
entertainment events,tires)
• Small portion from tariffs.
Consumption Tax
Greenspan said 3/3/05 “taxing consumption
instead of income would help promote
economic growth,” But warned that a
“switch” raises a challenging set of
transitional issues.
*What is a consumption tax?
*Where is it levied?
*Who would this hurt the most?
Types of Taxes We Pay
PERSONAL INCOME TAX
Progressive with marginal tax rates
Marginal tax rates = those assessed on
additional income ranging from 10 to 35%
Individuals may deduct:
 Interest on Home mortgages and
Property Taxes
Interest on State and local bonds
Sales Tax
At first glance… sales tax would appear to be
proportional…. Why is it not?
Sales Tax is regressive?
 Larger portion of a low-income person’s income is
exposed to the tax than is a person with higher
income.
 Rich pay no tax on the part of their income that is
saved when they can shelter it… poor are unable
to save.
 It is a % of income that allows it to become
regressive
Note in Tax Law effective 2005
Now in Texas…. We can deduct from our
gross income the amount of sales tax that
we paid in the tax year reporting. Was
renewed for 2014, 2015 still not sure.
Can keep all receipts and add up or use the
IRS tax table.
Payroll Taxes
MEDICARE AND SOCIAL SECURITY
Regressive
Medicare Tax…. 1.45 on all wage income
Average payroll tax falls (percentage wise) as
income rises.
• HISTORY OF SOCIAL SECURITY
Began in 1937 as OASDHI
Program of compulsory savings financed from
compulsory payroll taxes levied on
employees and employers.
Social Security is a regressive tax
History of OASDHI Contributions
1937-50
1951-54
1955-58
1959-65
-$3,000
- $3,600
- $4,200
- $4,800
*1972 - $9,000
1974 - $13,2000
1990 - $51,300
1991 - $53,400
1992 - $55,500
1993 - $ 57,600
2001 - $80,400
2002 - $84,900
2003 - $87,000
2004 - $87,900
2005 - $90,000
2006 - $94,200
2007 - $97,500
1994 - $60,600
1
1995 - $61,200
1976
- $15,300
1996 - $62,700
1980 - $25,900
1997 - $65,400
1985 $39,600
1998 - $68,400
1999 - $72,600
2000 - $76,200
Since 1981- amounts determined under automatic adjustment provisions of the SS
Act
Social Security –Wage Base 2015=$118,500
The wage base is increased every January as long as the
fund is deficient… which is probably forever now
because:
• People live longer, retire earlier, more drawing on fund
(disabled, single parents, etc.)
• Ratio of retirees/workers was significantly reduced by
year 2010.
• Eighteen year olds in 2002 will pay over a million and a
half dollars into SS. Benefits received????
• SS payroll tax today is 7.65 (FICA= 6.2% SS + l.45%
Medicare) 6.2% of your wages are withheld. Your
employer matches that amount for the required
contribution to the SS Fund up to the wage base amount
for that year.
Social Security Continued
• The employer also matches the Medicare contribution of
1.45% of your monthly earnings and there is no ceiling on
this amount. Hence, this is a continual tax deduction from
your earnings.
• if self-employed 15.3 (12.4 SS + 2.9 Medicare) Wage base
applies to SS but no limits on Medicare.
As a self-employed person, you get to take a special
deduction from your income when it comes time to
pay your federal income tax.
(l/2 of SS paid goes under deduction for adjusted
gross income)
Economics of Transfer Payments
Redistribution through public sector will
reduce the size of the economic pie:
Weakens the link between productive
activity and reward (taxes increased reduce
individual reward for hard work-less
productive.
As public policy redistributes large share of
income,more resources flow into increasing
it
Economics of Transfer
Higher taxes to finance redistribution will
induce taxpayers to focus less on income
producing activities and more on income
shelters *higher incomes have greater opportunity here
When leakages flow in taxes rather than in
savings (money is unproductive)
Money that is productive generates more
capital
More capital generates more jobs.
More jobs generates more income.
Merit Goods
The government is called upon to distribute merit
goods when the market does not provide enough.
• A merit good is a good or service society deems
everyone is entitled to some minimal quantity .
Public goods have two particular characteristics.
They are:
1. Non-excludable - once the goods are provided, it is
not possible to exclude people from using them even
if they haven't paid. This allows 'free-riders' to
consume the good without paying.
2. Non-rival - this means that consumption of the goods
by one person does not diminish the amount
available for the next
• Taxes paid today go to pay benefits for
people drawing today.
• Do you think there is a “special fund”
where the SS dollars go???
•
•
•
•
•
Continued SS Funding
Today 3+ workers for every person drawing.
(extra money in fund invested in U.S. Treasury
bonds)
Number of retirees is increasing and number of
workers/retiree is decreasing. In 30 years 2+
workers for every person drawing.
By 2016 - U.S. paying out more in retirement
benefits than collecting
By 2038- the fund is projected to be empty –
(spring,2004, released data that said 2052)
Re-design of system is imperative.
More Grim Statistics Concerning SS
70% of SS goes to retirees - avg monthly benefit of
$898.20
15% to disabled workers and families
May, 2003- avg benefit for disabled workers was
$837.70
15% goes to widows, widowers, and families – avg
check of $850.80
By 2030-twice as many older Americans 35
million to 70 million. Now there are 3.4 workers
for every beneficiary… by 2030 there will be just
2.1 workers for each beneficiary.
“Nobody gets any if their ain’t none!”
Incredible Bread Machine, script, 1970
• EXPLAIN
Back to Tax Structure!
So… realizing how many poor people there
are in the U.S…………
Which of the three types of taxes would you
prefer the federal government to use?
Which tax for state government to use?
Which tax for local government to use?
How would you fund schools if you had a
vote?
How about taxing wealthy more?
Who are wealthy?
What is considered “poor?”
POVERTY LEVEL
2014 POVERTY GUIDELINES FOR THE 48 CONTIGUOUS STATES
AND THE DISTRICT OF COLUMBIA
Persons in
Poverty
family/household guideline
For families/households with more
than 8 persons, add $4,060 for each
additional person.
1
$11,670
2
15,730
3
19,790
4
23,850
5
27,910
6
31,970
7
36,030
8
40,090
MORE INTERESTING FACTS
• MEDIAN INCOMES in U.S.
1974 = $14,747
1978 = $20,428
1982 = $27,619
1986 = $34,716
1990 = $41,451
1993 = $45,161
1997 = $53,350
2000 = $62,228
According to a separate
report from the Census
Bureau (last week of Sept
2002), American
households had taken a
beating during last year’s
recession & unemployment
Median Continued
,
2002
2003
2005
2007
2008
2013
$43,381
$43,318
$46,326
$50,233
$44,389
$52,250
Income Distribution in Fifths
180,000
160,000
140,000
120,000
100,000
Income l/5s in 2001
Income l/5 in 2002
80,000
60,000
40,000
20,000
0
Lowest Second
Third
Fourth Top 5%
The first fourth are
$ figures at the upper
Limit of each 5th $
Figure… The top 5%
Is not…
Personal income is unequally distributed in U.S.
Top
20% of households receive almost 50% income
To redistribute equally… all bars on the 20%
60
50
40
%Household income
fifths 2001
% Household income
fifths 1997
30
20
10
0
Lowest
Third
Highest
Fifth
2001
1= 3.5
2= 8.7
3= 14.6
4= 23.0
5= 50.2
1997
1= 3.6.
2= 8.8
3= 15.0
4= 23.2
5=49.4
Income Inequality
Why is the U.S. Economy owing billions of
dollars?
“If you subsidize something you get more of it.”
Dr. Milton Friedman, Free to Choose
• Virtually all of the recent growth in federal
expenditure has come from increased
income transfers, not purchases of goods
and services.
So, it all gets back to Joe Q Citizen…
Taxes paid to government.
Question is:
What kind of an economy do we Joe Q’s
want?
The primary function of taxes is to transfer
command over resources (purchasing
power) from the private sector to the
public sector.
Why from private to public? Why not the
other way around?
• Other Resources to Check
 http://www.brook.edu/
 http://www.ncpa.org
 http://www.ntu.org/
 http://www.cagw.org/site/PageServer
State and Local Tax Sources
Corporate 6%
Property 2%
Other 6%
Other
9%
Sales 15%
Sales
48%
Income
35%
STATE TAX SOURCES
Income 6%
Property
73%
LOCAL TAX SOURCES
“POWER CORRUPTS AND ABSOLUTE
POWER CORRUPTS ABSOLUTELY!”
Lord Acton
“POWER TO TAX IS POWER TO
DESTROY”
Chief Justice John Marshall…. McCullough vs Maryland
Who is best equipped to
distribute resources?