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Chapter 1 Why Study Public Finance?

Why Study Public Finance?

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

Why Study Public Finance?


Chapter 1 Why Study Public Finance?

Controversies about the proper role of the government raise the fundamental questions addressed by the branch of economics known as public finance. The goal of public finance is to understand the proper role of the government in the economy.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.1

The Four Questions of Public Finance


Chapter 1 Why Study Public Finance? public finance The study of the role of the government in the economy.

four questions of public finance When should the government intervene in the economy? How might the government intervene? What is the effect of those interventions on economic outcomes? Why do governments choose to intervene in the way that they do?

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.1

The Four Questions of Public Finance


When Should the Government Intervene in the Economy?
Chapter 1 Why Study Public Finance?

Market Failures
market failure Problem that causes the market economy to deliver an outcome that does not maximize efficiency.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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APPLICATION The Measles Epidemic of 19891991


Chapter 1 Why Study Public Finance? After the measles vaccine was introduced in 1963, measles cases had become relatively rare in the U.S. by the 1980s. Over the period from 1989 to 1991, however, there was a huge resurgence in measles. It is clear that this outbreak resulted from very low immunization rates among disadvantaged inner-city youths.
These unimmunized children were imposing a negative externality on other

children who had received their immunizations but for whom immunization may have worn off. The federal government responded to this health crisis in the early 1990s:
The government publicly encouraged parents to get their children immunized. The government also paid for the vaccines for low-income families.

The result was impressive. Immunization rates, which had never been above 70% before the epidemic, rose to 90% by 1995. Government intervention clearly reduced this negative externality.
2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 5 of 28

1.1

The Four Questions of Public Finance


When Should the Government Intervene in the Economy?
Chapter 1 Why Study Public Finance?

Redistribution
redistribution The shifting of resources from some groups in society to others.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.1

The Four Questions of Public Finance


How Might the Government Intervene?
Chapter 1 Why Study Public Finance?

Tax or Subsidize Private Sale or Purchase


One way that the government can try to address failures in the private market is to use the price mechanism, whereby government policy is used to change the price of a good in one of two ways: 1. Through taxes, which raise the price for private sales or purchases of goods that are overproduced, or 2. Through subsidies, which lower the price for private sales or purchases of goods that are underproduced.

Restrict or Mandate Private Sale or Purchase


The government can directly restrict the private sale or purchase of goods that are overproduced, or mandate the private purchase of goods that are underproduced and force individuals to buy that good.
2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 7 of 28

1.1

The Four Questions of Public Finance


How Might the Government Intervene?
Chapter 1 Why Study Public Finance?

Public Provision
The government can provide the good directly, in order to potentially attain the level of consumption that maximizes social welfare.

Public Financing of Private Provision


Governments may want to influence the level of consumption but may not want to directly involve themselves in the provision of a good.

Introduce Regulation
Governments may want to influence the working of the markets through regulations and legislations.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.1

The Four Questions of Public Finance


What Are the Effects of Alternative Interventions?
Chapter 1 Why Study Public Finance?

Direct Effects
direct effects The effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions.

Indirect Effects
indirect effects The effects of government interventions that arise only because individuals change their behavior in response to the interventions.
2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 9 of 28

APPLICATION
Chapter 1 Why Study Public Finance?

The Congressional Budget Office: Government Scorekeepers


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) provides Congress with the objective, timely, nonpartisan analyses needed for economic and budget decisions. The CBO increasingly plays a critical role as a scorekeeper for government policy debates. Legislative spending proposals that are to become law must first have their costs estimated by the analysts at the CBO. It is not an overstatement to say that the economists who work at the CBO frequently hold the fate of a legislative proposal in their hands. The large price tag that the CBO assigned to the Clinton administrations plan to reform health care in the United States in 1994 is often cited as a key factor in the defeat of that proposal.
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1.1

The Four Questions of Public Finance


Why Do Governments Do What They Do?
Chapter 1 Why Study Public Finance? political economy The theory of how the political process produces decisions that affect individuals and the economy.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

The Size and Growth of Government

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

The Size and Growth of Government

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Decentralization
A key feature of governments is the degree of centralization across local and national government unitsthat is, the extent to which spending is concentrated at higher (federal) levels or lower (state and local) levels.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Spending, Taxes, Deficits, and Debts

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Distribution of Spending
public goods Goods for which the investment of any one individual benefits everyone in a larger group.

social insurance programs Government provision of insurance against adverse events to address failures in the private insurance market.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Distribution of Spending

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Distribution of Spending

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Distribution of Revenue Sources

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Distribution of Revenue Sources

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.2

Why Study Public Finance? Facts on Government in the United States and Around the World
Chapter 1 Why Study Public Finance?

Regulatory Role of the Government


Another critical role the government plays in all nations is that of regulating economic and social activities. The Food and Drug Administration (FDA) regulates the labeling and safety of nearly all food products and bottled water, tests cosmetics to ensure their safety, and approves drugs and medical devices to be sold to the public. The Occupational Safety and Health Administration (OSHA) is charged with regulating the workplace safety of the 115 million Americans employed at 7.2 million job sites. The Federal Communications Commission (FCC) regulates interstate and international communications by radio, television, wire, satellite, and cable. The Environmental Protection Agency (EPA) is charged with minimizing dangerous pollutants in the air, water, and food supplies.
2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 26 of 28

1.3

Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education
Chapter 1 Why Study Public Finance? Social Security, health care, and education are each the subject of debate, with both the liberal and conservative positions holding differing views in their approach to each problem.

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.

Health Care
There are currently 45.8 million Americans without any health insurance, about 18% of the non-elderly U.S. population. Projections suggest that health care will consume almost half of our GDP within the next century.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.3

Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education
Chapter 1 Why Study Public Finance?
It 1980
It 2003
0% 34%
28% 0%

55% 4% 7%

5% 5%

62%

Pension

Family benefit

Labour market

Health

Housing

Pension

Family benefit

Labour market

Health

Housing

US 1980

US 2003

0% 32%
46%

0% 44%

53% 8% 7%
5% 5%

Pension

Family benefit

Labour market

Health

Housing

Pension

Family benefit

Labour market

Health

Housing

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.3

Why Study Public Finance Now? Policy Debates over Invecchiamento della Popolazione Social Security, Health Care, and Education
ChapterPercentuale 1 Why di Study Public Finance? ultrasessantenni
45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
US

NETHERLAND

LUXEMBURG

PORTUGAL

DENMARK

BELGIUM

FINLAND

IRELAND

SWEDEN

FRANCE

GERMANY

AUSTRIA

GREECE

SPAIN

2000

2050

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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ITALY

UK

1.3

Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education
Chapter 1 Why Study Public Finance?

Education
There is an enormous dissatisfaction with our current educational system, highlighted by the dismal performance of U.S. students on international tests.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.3

Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education
Chapter 1 Why Study Public Finance?

Education

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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1.4

Conclusion
Chapter 1 Why Study Public Finance? It is clear from the facts presented here that the government plays a central role in the lives of all Americans. It is also clear that 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.

2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

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