CHAPTER 1 WHY STUDY PUBLIC FINANCE?

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spending and revenue sources is also evolving over Public finance is central to many of the policy
time as governments move away from being providers debates that are active in the United States today,
of traditional public goods (such as defense) to being such as those over the Social Security program,
providers of social insurance (such as Social Security health care, and education.
and health insurance).
Governments also affect our lives through regulatory
functions in a wide variety of arenas.

QUESTIONS AND PROBLEMS

1. Many states have language in their constitutions 7. What is the role of the Congressional Budget
that requires the state to provide for an adequate Office? Why is independence and impartiality
level of education spending.What is the economic important when conducting empirical analyses?
rationale for such a requirement? 8. In order to make college more affordable for stu-
2. How has the composition of federal, state, and dents from families with fewer resources, a gov-
local government spending changed over the past ernment has proposed allowing the student of any
40 years? What social and economic factors might family with less than $50,000 in savings to attend
have contributed to this change in how govern- a public university for free. Discuss the direct and
ments spend their funds? possible indirect effects of such a policy.
3. Some goods and services are provided directly by 9. The country of Adventureland has two citizens,
the government, while others are funded publicly Bill and Ted. Bill has a private legal business. He
but provided privately. What is the difference earns $50 per hour. At a tax rate of 0%, Bill works
between these two mechanisms of public financ- 20 hours. At a 25% tax rate he works only 16 hours,
ing? Why do you think the same government and at a 40% tax rate he works only 8 hours per
would use one approach sometimes and the other week. Ted works a manufacturing job. He works
approach at other times? 20 hours per week and earns $6 per hour, regardless
4. Why does redistribution cause efficiency losses? of the tax rate. The government is considering
Why might society choose to redistribute resources imposing an income tax of either 25% or 40% on
from one group to another when doing so reduces Bill and using the revenues to make transfer pay-
the overall size of the economic pie? ments to Ted. The accompanying table summarizes
the three possible policies. Does either tax policy
5. Consider the four basic questions of public finance raise social welfare? Are either of the policies obvi-
listed in the chapter. Which of these questions are ously less than optimal? Explain your answers.
positivethat is, questions that can be proved or
disprovedand which are normativethat is, ques-
Effects of Redistributive Policies in Adventureland
tions of opinion? Explain your answer.
6. One rationale for imposing taxes on alcohol con- 0% 25% 40%
sumption is that people who drink alcohol Bills pre-tax income $1000 $800 $400
impose negative spillovers on the rest of society Bills taxes 0 $200 $160
for example, through loud and unruly behavior or Bills net income $1000 $600 $240
intoxicated driving. If this rationale is correct, in Teds pre-tax income $120 $120 $120
the absence of governmental taxation, will people Teds transfer payment 0 $200 $160
tend to consume too much, too little, or the right Teds net income $120 $320 $280
amount of alcohol?