introduction chapter 5 -...
TRANSCRIPT
1
Chapter 5
The Public Sector and Public Choice
Slide 5-2
Introduction
Should a computer operating system be considered a public good?
Economic theory offers some insight into the special characteristics of public
goods.
Slide 5-3
Learning Objectives
� Explain how market failures such as externalities might justify economic functions of government
� Distinguish between private and public goods and explain the nature of the free-rider problem
� Describe the political functions of government that entail its involvement in the economy
Slide 5-4
Learning Objectives
� Distinguish between average tax rates and marginal tax rates
� Explain the structure of the U.S. income tax system
� Discuss the central elements of the theory of public choice
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Slide 5-5
Chapter Outline
� What a Price System Can and Cannot Do
� Correcting for Externalities
� The Other Economic Functions of Government
Slide 5-6
Chapter Outline
� The Political Functions of Government
� Paying for the Public Sector
� The Most Important Federal Taxes
� Spending, Government Size, and Tax Receipts
� Collective Decision Making: The Theory of Public Choice
Slide 5-7
Did You Know That...
� The 1986 tax act was said by Congress to be a reform that would persist over the long term, yet more than 80 additional tax laws have been enacted since then?
� The amount of revenue the federal government collects in the form of an income tax exceeds $1 trillion annually?
Slide 5-8
What a Price System Can and Cannot Do
� A perfectly competitive price system can allocate resources efficiently through the interaction of markets.
� Market Failure– A situation in which an unrestrained
market economy leads to too few or too many resources going to a specific economic activity
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Slide 5-9
What a Price System Can and Cannot Do
� Market failure prevents economic efficiency.
� Market failure prevents individual freedom.
� Public policy (government) is often called upon to address market failure.
Slide 5-10
Correcting for Externalities
� Market efficiency occurs when individuals know the true opportunity cost of their actions.
Slide 5-11
Correcting for Externalities
� Market failure: an example– Assume
• No government regulation against pollution• A town with clean air• A steel mill opens and emits smoke that
causes:– more respiratory diseases– dirtier clothes, houses, cars, etc.
Slide 5-12
Correcting for Externalities
� Market failure: an example– Market failure occurs:
• Steel mill does not pay for the clean air• Costs of production have “spilled over” to the
residents (third parties)• Lower production cost
– More steel is produced than would otherwise be the case
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Slide 5-13
Correcting for Externalities
� Externalities– Occur when the consequence of an
economic activity spillover to affect third parties
� Third Parties– Parties who are not directly involved in a
given activity or transaction
Slide 5-14
Correcting for Externalities
� Externalities are examples of market failures.
� Pollution is an example of a negative externality.
Slide 5-15
External Costs and Benefits
Figure 5-1, Panel (a)
S2
S1E1
EA
Q2 Q1
P1
P2
Pric
e of
Ste
el p
er T
on
Quantity of Steel per Year
Panel (a)
D
Slide 5-16
External Costs and Benefits
Figure 5-1, Panel (b)
S
Q2Q1
P1
P2
Pric
e of
Inoc
ula t
ion
Quantity of Inoculations per Year
D1
D2
Panel (b)
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Slide 5-17
The Other Economic Functions of Government
� Providing a legal system– Enforcing contracts
– Defining and protecting property rights
– Establishing legal rules of behavior
Slide 5-18
The Other Economic Functions of Government
� Property Rights– The rights of an owner to use and to
exchange property
Slide 5-19
The Other Economic Functions of Government
� Promoting competition– Market failure may occur if markets are
not competitive.
– Monopoly power
– Antitrust legislation
Slide 5-20
The Other Economic Functions of Government
� Monopoly– A firm that has great control over the price
� Antitrust Legislation– Laws that restrict the formation of
monopolies and regulate certain anticompetitive business practices
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Slide 5-21
The Other Economic Functions of Government
� Providing Public Goods– Goods to which the principle of rival
consumption does not apply
– In contrast, private goods can be consumed by one individual at a time.
Slide 5-22
The Other Economic Functions of Government
� Characteristics of public goods– Indivisible– Additional people can use public goods at
no additional cost– Additional users of public goods do not
deprive other users– Difficult to charge for a public good based on
consumption—the exclusion principle
Slide 5-23
The Other Economic Functions of Government
� Free-Rider Problem– Arises when some individuals take
advantage of the fact that others will take on the burden of paying for public goods
� Question– How much national defense did you
consume last month?
Slide 5-24
The Political Functions of Government
� Merit Goods– Goods deemed socially desirable through
the political process• Museums• Ballet• Concerts• Theater
– Provided through subsidization
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Slide 5-25
International Example: Free Rider Problems and Terrorism
� Political groups that can provide security and public services for residents are often given free reign to operate in a region.
� This was the case with the Taliban in Afghanistan and Hamas in the Palestinian territories.
Slide 5-26
International Example: Free Rider Problems and Terrorism
� Because these groups collected funds through the threat of force, they were better financed than were the official political entities in the region.
� Their coercive tactics is collecting financial support allowed them to avoid the free rider problem.
Slide 5-27
Paying for the Public Sector
� Marginal Tax Rate– The tax rate on the last dollars earned
� Average Tax Rate– The proportion of total income paid in
taxes
Slide 5-28
Paying for the Public Sector
� Tax Bracket– A specified level of taxable income to
which a specific and unique marginal tax rate is applied
Marginal Tax Rate = change in taxes due
change in taxable income
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Slide 5-29
Paying for the Public Sector
� Taxation systems– Proportional Taxation (flat-rate tax)
• Marginal tax rate = Average tax rate• Everyone pays the same percentage of their
income in taxes
Slide 5-30
Paying for the Public Sector
Proportional Taxation
Proportional Tax Rate = 20%
Taxable Income x Tax Rate = Tax Liability$10,000 20% $2,000$100,000 20% $20,000
Marginal Tax Rate = 20%Average Tax Rate = 20%
Slide 5-31
Paying for the Public Sector
� Taxation systems– Progressive Taxation
• Marginal tax rate > Average tax rate• As a person’s taxable income increases, the
percentage of income paid in taxes increases
Slide 5-32
Paying for the Public Sector
Progressive Taxation: Income Tax
Taxable Income Tax Rate Tax Liability0–$10,000 5% $500
$10,001–20,000 10% $1,000$20,001–30,000 30% $3,000
$4,500
Income = $30,000Marginal Tax Rate = 30%Average Tax Rate = 15% or $4,500/$30,000
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Slide 5-33
Paying for the Public Sector
� Taxation systems– Regressive Taxation
• Marginal tax rate < Average tax rate• As a person’s taxable income increases, the
percentage of income paid in taxes decreases
Slide 5-34
Paying for the Public Sector
Regressive Taxation: Social Security Hypothetical Example
Taxable Income Tax Rate* Tax Liability$5,000 10% $500
$100,000 ——— $5,000*Tax Rate = 10% on first $50,000 of income; no tax on additional income
Income = $5,000Marginal Tax Rate and Average Tax Rate = 10%Income = $100,000Marginal Tax Rate = 0%Average Tax Rate = 5% or $5,000/$100,000
Slide 5-35
The Most Important Federal Taxes
� The federal personal income tax– Accounts for 46% of all federal revenue
Slide 5-36
Federal Marginal Income Tax Rates
Table 5-1
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Slide 5-37
The Most Important Federal Taxes
� Arguments for the progressive tax– Redistribution of income– Ability to pay– Benefits received
� Question– Does the income tax system redistribute
income?
Slide 5-38
The Most Important Federal Taxes
� The treatment of Capital Gains (Losses)– Positive (negative) difference between the
purchase price and the selling price of an asset
– Capital gains are not indexed for inflation
Slide 5-39
The Most Important Federal Taxes
� The corporate income tax– Accounts for 12% of federal tax revenue
Slide 5-40
Federal Corporate Income Tax Schedule
$0–$50,000 15%$50,001–75,000 25%
$75,001–10,000,000 34%$10,000,001 and up 35%
Progressive Taxation: Income Tax
Corporate Taxable Income Corporate Tax Rate
Source: U.S. Department of Treasury
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Slide 5-41
The Most Important Federal Taxes
� Double taxation– Corporation pays taxes on its profits
– Corporation declares a dividend on after-tax profits
– Dividend income is taxed
– Retained earnings may increase the value of the stock
Slide 5-42
The Most Important Federal Taxes
� Who really pays the corporate income tax?– Tax Incidence (the distribution of tax
burdens among various groups in society)• Consumer• Stockholder• Employees
Slide 5-43
The Most Important Federal Taxes
� Social Security tax– Social Security rates today are imposed
on earnings up to about $80,000
OASDI Medicare* Matched by Employer6.20% 2.90% 6.20%
*Medicare matched by employer
Slide 5-44
The Most Important Federal Taxes
� Unemployment tax– 0.8% of first $7,000 of wages for
employees earning more than $1,500
– Paid by employer
– States levy an additional tax up to 3% based on record of the employer
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Slide 5-45
Spending, Government Size, and Tax Receipts
� Government receipts– The federal government
– State and local government
Slide 5-46
Total Government Outlays Over Time
Figure 5-2Source: Facts and Figures on Government Finance
and Economic Indicators, various issues
Slide 5-47
Sources of Government Tax Receipts
Figure 5-3
Source: U.S. Department of Commerce, Bureau of Economic Analysis
Slide 5-48
Federal Government Spending Compared to State and Local Spending
Budget of the United States Government; Government Finances
Figure 5.4
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Slide 5-49
Collective Decision Making: The Theory of Public Choice
� Collective Decision Making– How voters, politicians, and other
interested parties act and how these actions influence non-market transactions
Slide 5-50
Collective Decision Making: The Theory of Public Choice
� Theory of Public Choice– The study of collective decision making
Slide 5-51
Collective Decision Making: The Theory of Public Choice
� Similarities in market and public-sector decision making– Individuals motivated by self-interest– Scarcity and opportunity cost– Competition– Similarity of individuals and incentives
• Incentive Structure– The system of rewards and punishments individuals face
with respect to their actions
Slide 5-52
Collective Decision Making: The Theory of Public Choice
� Differences between market and collective decision making– Government (political) goods at zero price
• Goods (and services) provided by the public sector
– Use of force
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Slide 5-53
Collective Decision Making: The Theory of Public Choice
� Differences between market and collective decision making– Voting versus spending
• Political system versus market system– Political System
» Run by majority rule– Market System
» Run by proportional rule
Slide 5-54
Collective Decision Making: The Theory of Public Choice
� Majority rule versus proportional rule– Majority rule
• Group decisions are made on the basis of 50.1 percent of the votes
• Whatever more than half of the electorate votes for, the entire electorate must accept
– Proportional rule• Actions are based on the proportion of the
“votes” cast and are in proportion to them
Slide 5-55
Collective Decision Making: The Theory of Public Choice
� Differences between market and collective decision making – Voting versus spending
• Spending of dollars can indicate intensity of want
• Votes cannot; each vote counts with the same intensity
Slide 5-56
Issues and Applications: Computer Software as a Public Good
� Does a computer operating system fit the definition of a public good?– It is possible for more users to be added
at no additional cost.
– But an operating system does not satisfy the exclusion principle. It would be possible to prevent people from using the system if they had not paid for it.
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Slide 5-57
Summary Discussion of Learning Objectives
� How market failures such as externalities might justify economic functions of government– Market failure is a situation in which an unhindered
market allocates too many or too few resources to a specific economic activity.
� Private goods versus public goods and the free-ride problem– Private goods are subject to rival consumption– Public goods are not subject to rival consumption– Free-rider problem
Slide 5-58
Summary Discussion of Learning Objectives
� Political functions of government that lead to its involvement in the economy– Defining merit and demerit goods– Redistributing income
� Average versus marginal tax rates– Average tax rate: the ratio of total tax paid to total
income paid in tax– Marginal tax rate: the change in tax payment
induced by a change in income
Slide 5-59
Summary Discussion of Learning Objectives
� The U.S. income tax system– Progressive tax: marginal tax rate > average tax rate– Proportional tax: marginal tax rate = average tax rate– Regressive tax: marginal tax rate < average tax rate
� Central elements of the theory of public choice – The study of collective decision making
End of Chapter 5The Public Sector and Public Choice