introduction to public finance - the university of vermontjfarley/pa305/introduction t… · ppt...
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Introduction to Public Introduction to Public Budgeting and FinanceBudgeting and Finance
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Administrative StuffAdministrative Stuff Use of WebCTUse of WebCT
Any problems so far?Any problems so far? Organization of courseOrganization of course
Each session = 4 weeks, with corresponding Each session = 4 weeks, with corresponding number of readingsnumber of readings
Syllabus is rough guide onlySyllabus is rough guide only Not all reading materials will be covered in Not all reading materials will be covered in
lecture, but all should be read carefullylecture, but all should be read carefully Group projects Group projects Homework assignments due by following sessionHomework assignments due by following session Take home final due week after courseTake home final due week after course
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Objectives of the courseObjectives of the course Survey the dominant theories in budgeting and Survey the dominant theories in budgeting and
finance, compare practice and trendsfinance, compare practice and trends Learn how to strategically plan a budget, how to Learn how to strategically plan a budget, how to
manage ongoing activities, and how to control manage ongoing activities, and how to control spending;spending;
Understand the role of public organizations in a Understand the role of public organizations in a market economymarket economy
Understand social security, public health and Understand social security, public health and other major categories of public expenditureother major categories of public expenditure
Understand the theory and practice of the Understand the theory and practice of the redistribution of wealth and resourcesredistribution of wealth and resources
Understand the impact of taxes on social welfare. Understand the impact of taxes on social welfare. Learn from practitioners in the field. Learn from practitioners in the field.
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What is Public Budgeting?What is Public Budgeting? How governments strategically plan How governments strategically plan
a budgeta budget Manage ongoing activitiesManage ongoing activities Control spending Control spending
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What is Public Finance?What is Public Finance? The study of how governments collect The study of how governments collect
and spend money and real resourcesand spend money and real resources How do governments collect/spend How do governments collect/spend
money? Positive analysismoney? Positive analysis How should governments collect/spend How should governments collect/spend
money? Normative analysismoney? Normative analysis We are studying public finance in a We are studying public finance in a
market economymarket economy
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What is the Role of Government?What is the Role of Government?
To maintain and improve the welfare To maintain and improve the welfare of the peopleof the people To protect the people from harmTo protect the people from harm To provide the institutions that allow To provide the institutions that allow
market to function (e.g. protection of market to function (e.g. protection of property rights)property rights)
To provide the essential goods and To provide the essential goods and services that markets fail to adequately services that markets fail to adequately provideprovide
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The Role of Government: IdeologyThe Role of Government: Ideology
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Current TrendsCurrent Trends Reagan tax cutsReagan tax cuts Shrink government “down to the size Shrink government “down to the size
where we can drown it in a bathtub”where we can drown it in a bathtub” Grover Norquist Grover Norquist
““The era of big government is over” The era of big government is over” Bill Clinton Bill Clinton
Bush tax cutsBush tax cuts Free market ideologyFree market ideology
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Organic view of governmentOrganic view of government Society is a natural organismSociety is a natural organism Goals of society set by stateGoals of society set by state Actions of individual are judged by Actions of individual are judged by
the contribution they make to the the contribution they make to the statestate
““Ask not what your country can do Ask not what your country can do for you; ask what you can do for your for you; ask what you can do for your country.”country.”
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Mechanistic view of governmentMechanistic view of government Individuals are paramount, government Individuals are paramount, government
created to meet the needs of individualscreated to meet the needs of individuals Big debate over importance of Big debate over importance of
individual freedomindividual freedom Two types of freedom:Two types of freedom:
Freedom to do as you likeFreedom to do as you like Freedom not to suffer from activities of Freedom not to suffer from activities of
othersothers As society grows more crowded, second As society grows more crowded, second
type of freedom becomes more importanttype of freedom becomes more important
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The Role of Government: Objective AnalysisThe Role of Government: Objective Analysis
Complexity theory and systems thinkingComplexity theory and systems thinking Government in a market economyGovernment in a market economy
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Complexity theory and Complexity theory and Systems thinkingSystems thinking
Bringing together many, many simple Bringing together many, many simple components leads to emergence of components leads to emergence of spontaneous order, complex system: spontaneous order, complex system: 2 H and 1 0 atoms form water molecule, 2 H and 1 0 atoms form water molecule,
molecules form cell, cells form organs, organs molecules form cell, cells form organs, organs make up humans, humans make up societymake up humans, humans make up society
Complex systems greater than the sum of Complex systems greater than the sum of their partstheir parts
Characterized by non-linearities, feedback Characterized by non-linearities, feedback loops, emergent properties, unpredictable loops, emergent properties, unpredictable surprises, etc. surprises, etc.
Government is a complex systemGovernment is a complex system
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Government in a market economyGovernment in a market economy Economics is the allocation of scarce resources Economics is the allocation of scarce resources
among alternative desirable endsamong alternative desirable ends What are the desirable ends?What are the desirable ends?
To maintain and improve the welfare of the peopleTo maintain and improve the welfare of the people Government and economics have the same desirable endsGovernment and economics have the same desirable ends
What are the scarce resources?What are the scarce resources? What are the characteristics of the scarce What are the characteristics of the scarce
resources?resources? Whether resources should be allocated by Whether resources should be allocated by
government or the market depends on the physical government or the market depends on the physical nature of the scarce resourcesnature of the scarce resources
Once we agree on the desirable ends, deciding on Once we agree on the desirable ends, deciding on the role of government moves towards objective the role of government moves towards objective science and away from ideology.science and away from ideology.
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Legal FrameworkLegal Framework
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Federal Government: ExpenditureFederal Government: Expenditure
Constitution empowers government Constitution empowers government to “pay the debts and provide for the to “pay the debts and provide for the common defense and general common defense and general welfare of the United States.”welfare of the United States.”
Bills to appropriate expenditures can Bills to appropriate expenditures can be initiated in either house, must be be initiated in either house, must be approved by both houses and approved by both houses and PresidentPresident
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Federal Government: RevenueFederal Government: Revenue Duties, imposts and excises must be Duties, imposts and excises must be
uniform throughout USuniform throughout US Constitutional amendment (16Constitutional amendment (16thth) )
required for federal income taxrequired for federal income tax 55thth amendment– can’t take away amendment– can’t take away
property without due process of law, property without due process of law, compensation requiredcompensation required
Can’t tax articles exported from statesCan’t tax articles exported from states Empowered to borrow moneyEmpowered to borrow money
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State and local governmentsState and local governments States have power not explicitly States have power not explicitly
relegated to federal governmentrelegated to federal government Can’t impose duties on imports or Can’t impose duties on imports or
exportsexports Power of local governments granted Power of local governments granted
by statesby states
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The Size of GovernmentThe Size of Government
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Historical contextHistorical context What was the What was the
highest marginal highest marginal tax rate tax rate Under Eisenhower?Under Eisenhower?
•Under Kennedy?Under Kennedy?•Today?Today?
•Highest tax bracket currently applies to single people earning $54,000/yr
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What has happened to the deficit?What has happened to the deficit?
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What has happened to the size of What has happened to the size of government as a share of GDP?government as a share of GDP?
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How does size of US government How does size of US government compare with other countries (2001)?compare with other countries (2001)?
USAUSA 29.3% of GDP29.3% of GDPAustraliaAustralia 31%31%CanadaCanada 37.4%37.4%JapanJapan 38.3%38.3%UKUK 38.8%38.8%FranceFrance 49.4%49.4%SwedenSweden 53.1%53.1%
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How does the federal government How does the federal government spend its money?spend its money?
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How do state governments spend How do state governments spend money?money?
Miscellaneous (~43%, +)Miscellaneous (~43%, +) Education (~35%, -)Education (~35%, -) Public welfare (~17%, +)Public welfare (~17%, +) Highways (~5%, -)Highways (~5%, -)
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Where does the government get its Where does the government get its money?money?
FederalFederal Individual income Individual income
tax (+)tax (+) Social insurance (+Social insurance (+
+)+) Corporate tax (--)Corporate tax (--) Other (-)Other (-)
State and localState and local Other (+)Other (+) Sales taxSales tax Grants from federal Grants from federal
government (+)government (+) Property tax (-)Property tax (-) Individual income Individual income
tax (+)tax (+) Corporation taxCorporation tax
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How do we Objectively Measure How do we Objectively Measure Government Performance?Government Performance?
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Role of TheoryRole of Theory
Observe, form hypothesesObserve, form hypotheses Test hypotheses through continued Test hypotheses through continued
observation, measurement and observation, measurement and experimentsexperiments
Confirm hypotheses repeatedly and Confirm hypotheses repeatedly and you have theoryyou have theory
Reject hypotheses and you’re back Reject hypotheses and you’re back to the drawing boardto the drawing board
Theory tells us what questions to testTheory tells us what questions to test
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If we fail to test our theories and If we fail to test our theories and their assumptions, or continue their assumptions, or continue to believe them when they fail to believe them when they fail
the tests, they become the tests, they become ideology, not theoryideology, not theory
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Neoclassical Economic TheoryNeoclassical Economic Theory Assumes humans are rational, self Assumes humans are rational, self
interested utility maximizersinterested utility maximizers Empirical studies reject thisEmpirical studies reject this
Assumes perfect market competitionAssumes perfect market competition Empirical studies reject thisEmpirical studies reject this
Assumes in perfect markets invisible hand Assumes in perfect markets invisible hand leads to efficient allocation: greatest good leads to efficient allocation: greatest good for greatest numberfor greatest number
Can’t be tested in practice, because Can’t be tested in practice, because governments always intervene with governments always intervene with perfect functioning of marketperfect functioning of market
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Ecological Economic TheoryEcological Economic Theory Assume economy is subset of Assume economy is subset of
ecosystemecosystem Ecologically sustainable scale is first Ecologically sustainable scale is first
prioritypriority Socially just distribution 2Socially just distribution 2ndnd
Efficient allocation 3Efficient allocation 3rdrd
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Georgist Economic TheoryGeorgist Economic Theory Ownership of land leads to povertyOwnership of land leads to poverty Value of land is created by nature and Value of land is created by nature and
society, not hard work of individualsociety, not hard work of individual Land tax could finance all government Land tax could finance all government
expenditure, prevent land speculation expenditure, prevent land speculation and concentration of ownership, end and concentration of ownership, end povertypoverty
Land tax could be extended to include Land tax could be extended to include all value created by nature and societyall value created by nature and society
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Empirical methods for Testing Empirical methods for Testing theoriestheories
InterviewsInterviews Subjective, hard to interpretSubjective, hard to interpret
ExperimentsExperiments Ethical issues, self selection, etc.Ethical issues, self selection, etc. Sample sizeSample size
Econometrics (statistics)Econometrics (statistics) Torture the data and it will confessTorture the data and it will confess
Theories can be very hard to testTheories can be very hard to test
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Measurement in a complex systemMeasurement in a complex system
Very hard to isolate cause and effectVery hard to isolate cause and effect E.g. feedback loopsE.g. feedback loops
Rarely have adequate baseline dataRarely have adequate baseline data Systems evolve over timeSystems evolve over time Values matterValues matter
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How do we normatively measure How do we normatively measure government Performance?government Performance?
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Why do we need normative Why do we need normative measures?measures?
We need some way to measure social We need some way to measure social welfare, and choose between alternative welfare, and choose between alternative statesstates
Economic theory provides some Economic theory provides some guidelinesguidelines
Theory can be very incompleteTheory can be very incomplete Different theories make different ethical Different theories make different ethical
assumptionsassumptions The most commonly taught approach is The most commonly taught approach is
neoclassical welfare economicsneoclassical welfare economics
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Pareto EfficiencyPareto Efficiency Pareto improvement-- Any change in Pareto improvement-- Any change in
allocation that makes at least one allocation that makes at least one person better off without making person better off without making anyone worse offanyone worse off
Pareto optimum– an allocation where Pareto optimum– an allocation where no further Pareto improvements are no further Pareto improvements are possiblepossible
We always want to be at a Pareto We always want to be at a Pareto optimum optimum
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Indifference curves in Edgeworth boxIndifference curves in Edgeworth box
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Contract curveContract curve
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Marginal rate of substitutionMarginal rate of substitution If you lose one fig, how many apples If you lose one fig, how many apples
would you need to remain just as happy? would you need to remain just as happy? Determined by slope of indifference curveDetermined by slope of indifference curve Pareto optimum occurs whenPareto optimum occurs when
Eveaf
Adamaf MRSMRS
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Production possibilities frontierProduction possibilities frontier
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Marginal costMarginal cost Marginal cost of figs is the number of Marginal cost of figs is the number of
apples you have to give up to get one apples you have to give up to get one more figmore fig
f
aaf MC
MCMRT
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Efficiency demands thatEfficiency demands that
Eveaf
Adamafaf
f
a MRSMRSMRTMCMC
across all goods and all people in the economy
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First Fundamental Theorem of First Fundamental Theorem of Welfare EconomicsWelfare Economics
Assumptions:Assumptions: If all producers receive the same priceIf all producers receive the same price And there is a perfect market for every And there is a perfect market for every
commoditycommodity And people are perfectly rational,And people are perfectly rational,
Then, the free market automatically leads Then, the free market automatically leads to a Pareto Efficient allocationto a Pareto Efficient allocation
If assumptions hold and all we care about If assumptions hold and all we care about is Pareto efficiency, then government is Pareto efficiency, then government should be minimizedshould be minimized
But some Pareto optimums may be better But some Pareto optimums may be better for society than othersfor society than others
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Second Fundamental Theorem of Second Fundamental Theorem of Welfare EconomicsWelfare Economics
We can attain any point on the We can attain any point on the contract curve by changing initial contract curve by changing initial endowments and letting market take endowments and letting market take over.over.
So initial distribution matters, big So initial distribution matters, big timetime
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ConclusionsConclusions If markets functioned according to If markets functioned according to
theory, the major role of government theory, the major role of government would focus on initial distributionwould focus on initial distribution
Markets unfortunately do not Markets unfortunately do not function according to theory, as we’ll function according to theory, as we’ll learn in next lecturelearn in next lecture