SEVENTH EDITION

PUBLIC FINANCEA Contemporary

Application of Theory to Policy

David N. HymanNorth Carolina State University

Harcourt College Publishers

Fort Worth Philadelphia San Diego New York Orlando Austin San Antonio Toronto Montreal London Sydney Tokyo

CONTENTS

PART ONECHAPTER 1

CHAPTER 2

The Economic Basis for Government Activity 1

Individuals and Government 3Individuals, Society, and Government 5The Allocation of Resources Between Government and Private Use 5The Mixed Economy, Markets, and Politics 8Government Expenditures in the United States 9International View: How Much Government?: The Share of Government

Expenditure in Modern Economies at the Beginning of the New Millennium 11The Structure of State and Local Government Expenditure in the

United States 19Financing Government Expenditure in the United States 19Market Failure and the Functions of Government: How Much

Government Is Enough? 21Public Policy Perspective: The Graying of America: Implication for the Federal

Government’s Budget 21Summary 26Internet Resources 28Appendix 1: Tools of Microeconomic Analysis 29

Efficiency, Markets, and Governments 49Positive and Normative Economics 50Normative Evaluation of Resource Use: The Efficiency Criterion 52Markets, Prices, and Efficiency Conditions 56Public Policy Perspective: The Tax System and the Birthrate—An Example of

Positive Economic Analysis 61Market Failure: A Preview of the Basis for Government Activity 64Equity versus Efficiency 67Positive Analysis Trade-Off Between Equity and Efficiency 69International View: Agricultural Subsidies, International Trade Restrictions, and

Global Efficiency 70

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Summary 71Internet Resources 74Appendix 2: Welfare Economics 75

CHAPTER 3 Externalities and Government Policy 93Externalities: A Classification and Some Examples 94Internalization of ExternalitiesProperty Rights to Resource Use and Internalization

101

of Externalities: The Coase Theorem 108Public Policy Perspective: Recycling 118Environmental Protection Policies in the United StatesPublic Policy Perspective: Markets for Pollution Rights in Practice:

118

Sulfur Dioxide Allowances 129International View: Global Pollution: Externalities That Cross Borders 126Summary 129Internet Resources 132

CHAPTER 4 Public Goods 133The Characteristics of Public GoodsProvision of Private Goods and Public Goods:

134

Markets and Government 138The Demand for a Pure Public Good 146Efficient Output of a Pure Public GoodPublic Policy Perspective: Defense Spending in the United States

149

and the "Peace Dividend” 154The Free-Rider ProblemInternational View: The Marginal Cost of the Persian Gulf War to the

156

United States and How International Cost Sharing Financed It 159Summary 160Internet Resources 162

CHAPTER 5 Public Choice and the Political ProcessThe Supply of Public Goods Through Political Institutions:

163

The Concept of Political Equilibrium 164A Model of Political Equilibrium Under Majority Rule 169Uniqueness and Cycling of Outcomes Under Majority Rule 173The Political Process 182Political Parties and Political EquilibriumPublic Policy Perspective: Public Choice in U.S. Cities:

189

Do Political Institutions Matter? 190Voting on More Than One Issue at a Time: Logrolling 193

Contents xv

PART TWO

CHAPTER 6

CHAPTER 7

Special-Interest Groups and their Impact on Political EquilibriumInternationa] View Tariffs and Import Quotas on Textiles and

Apparel in the United States: Special-Interest Croups in ActionBureaucracy and the Supply of Public OutputSummaryInternet Resources

Government Expenditures and Policy in the United States:Selected Issues

Cost-Benefit Analysis and Government InvestmentsEconomic Analysis for the Budget Process: Achieving

the Least-Cost Means of Accomplishingand Authorized Objective

Cost-Benefit AnalysisAnalysis of Government Investments: Cost-Benefit

Analysis in PracticeInternational View: Government Infrastructure Investment in

Less-Developed NationsPublic Policy Perspective: A Cost-Benefit Analysis of the Job Corps ProgramThe Role of Cost-Benefit Analysis in BudgetingSummaryInternet Resources

Government Subsidies and Income Support for the PoorPoverty in the United StatesPublic Policy Perspective: Changing the Poverty Threshold:

When Are People Really Poor?Government Programs to Aid the Poor: The Basis

and the Trade-OffsGovernment Programs of Assistance to the Poor

in the United StatesSubsidies and Transfers to Individuals: Economic

Analysis of Their EffectsSubsidies to Housing and FoodInternational View: Food Subsidies in Less-Developed CountriesThe Impact of Government Assistance Programs for the

Poor on the Work Incentive of RecipientsPrograms with No Status Tests: The Negative

Income Tax and Subsidies to the Working PoorPublic Policy Perspective: Wisconsin Gets the Poor to Work

198

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The New Welfare Law: The Emphasis on Work and Limits to Eligibility

Programs to Aid the Poor and the Distribution of277

Money Income in the United States 281Summary 283Internet Resources 286

CHAPTER 8 Social Security and Social Insurance 287Social Security in the United StatesInternationa] View: Social Security Throughout the World: Trends Toward

289

Privatization 290The Social Security Retirement SystemPublic Policy Perspective: Social Security and the Family:

293

Some Anomalies in the Modern AgeThe Return to Workers: How Do Pension Benefits

298

Compare with the Taxes That Workers Pay? 302Demographic Change and the Future of Social Security Proposals to Reform Social Security: Maintaining

304

Benefits Versus Partial Privatization 309The Impact of Social Security on Savings and Work Incentives 312Health Insurance for the Elderly: Medicare 321Unemployment Insurance 322Summary 325Internet Resources 328

CHAPTER 9 Government and Health Care 329Characteristics of the U.S. Market for Health Care 330Other Features Contributing to Inefficiency and High Cost 339Governments and Health Care: Compensating for Market Failure 341Public Policy Perspective: Why Worry about Growth in Health Care Costs? 342Health Care Reform: Issues and Policies 356Universal CoverageInternational View: National Health Insurance and

362

Health Services in Great Britain and Canada 366Summary 370Internet Resources 373

PART THREECHAPTER 10

Financing Government Expenditures 375

Introduction to Government Finance 377The Purpose and Consequences of Government Finance 378

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Principles of Taxation 379International View: Taxes and Tax Rates Throughout the World 381How Should the Burden of Government Finance Be Distributed? 386 Criteria for Evaluating Alternative Methods of

Government Finance 390Alternatives to Taxation 394Public Policy Perspective: User Charges and Efficient Allocation of

Resources to Transportation Infrastructure 398Government Enterprise 403Public Policy Perspective: State Lotteries—A Government Enterprise

with a Hidden Regressive Tax on Gambling WtSummary 405Internet Resources 408

CHAPTER 11 Taxation, Prices, Efficiency, and the Distribution of Income 409Lump-Sum Taxes: A Benchmark Standard for Comparison 410International View: The Lump-Sum Tax Takes Its Lumps in the

United Kingdom WThe Impact of Taxes on Market Prices and Efficiency 414Public Policy Perspective: Using Excise Taxes on Alcohol in the

United States to Internalize Externalities HE1!Further Analysis of Tax Incidence 425General Equilibrium Analysis of the Excess Burden and

Incidence of Taxes 432Taxes, Government Expenditures, and the Distribution of Income 436Summary 441Internet Resources 444Appendix 11 The Excess Burden of Taxation: Technical Analysis 445

CHAPTER 12 Budget Balance and Government Debt 453The Federal Budget Balance 455Economic Effects of the Federal Budget Balance 461The Government Debt 470Borrowing by State and Local Governments 473Public Policy Perspective: Social Security and the Deficit Burden of the Debt 476International View: The Euro, Government Budget Balance and

Government Debt in the European Union 378Should the Federal Government Continue to

Run Budget Surpluses and Use Them to Pay Off thePublic Debt of the U.S. Treasury? 481

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PART FOURCHAPTER 13

CHAPTER 14

CHAPTER 15

SummaryInternet Resources

Taxation: Theory and Structure

The Theory of Income TaxationComprehensive Income: The Haig-Simons DefinitionA General Tax on Comprehensive Income: Economic

Effects of a Flat-Rate Income TaxInternational View: Treatment of Capital Gains Under the Income TaxLabor Market Analysis of Income TaxationPublic Policy Perspective: The Incidence of Payroll Taxes in the United StatesTaxation of Interest Income and Its Effect on SavingMarket Analysis of Taxation on Interest and Investment Income Public Policy Perspective: The Supply-Side Tax Cuts of the 1980sSummaryInternet Resources

Taxation of Personal Income in the United StatesThe Tax Base: Basic Rules for Calculating Taxable Income

and Why Much of Income Is UntaxedPublic Policy Perspective: How Progressive Are Federal Income Taxes? Effective

Average and Marginal Tax RatesTax PreferencesTax Preferences Under the U.S. Income Tax SystemMinimum Tax on Preference Income: The Alternative

Minimum Tax (AMT)Issues in Income Tax PolicyThe Taxpaying Unit: Does The Tax System Discriminate Against

Married Couples?International View: Income Taxes and Economic GrowthSummaryInternet Resources

Taxation of Corporate IncomeThe Tax Base: Measuring Business IncomeSeparate Taxation of Corporate Income: Issues and Problems International View: Tax Treatment of Multinational CorporationsThe Tax Rate StructureShort-Run Impact of the Corporate Income TaxLong-Run Impact of the Corporate Income Tax

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State and Local Government Finance

Public Policy Perspective: A New Way to Tax Corporate Income—The Corporate Cash Flow Tax 576

Incidence of the Corporate Income Tax 578Summary 580Internet Resources 583

CHAPTER 16 Taxes on Consumption and Sales 584Consumption as a Tax Base 585Direct Taxation of Consumption: The Expenditure Tax 586A Comprehensive Consumption Tax Base 591A General Tax on Comprehensive Consumption 594Impact of Efficiency in Labor Markets 596Sales TaxPublic Policy perspective: Origins, E-Commerce, Destinations,

598

and Issues in Collecting Sales Taxes 602Turnover Taxes 604Value-Added TaxesInternational View: Current Use of the VAT in European Nations

604

and Prospects for Its Use in the United States 608Summary 609Internet Resources 612

CHAPTER 17 Taxes on Wealth, Property, and Estates 613A Comprehensive Wealth Tax Base 614Assessment of Property Value 617A Comprehensive Wealth Tax 618Selective Property TaxesInternational View: Wealth Taxes and Investment Incentives in an

622

Open Economy 623Tax Capitalization 626Capitalization and the Elasticity of Supply of Taxed Assets 628Property Taxation in the United States 630Public Policy Perspective: Capitalization of Property Tax Rate Differentials 631Land Taxes 636Property Transfer Taxes 639Summary 642Internet Resources 644

645PART FIVECHAPTER 18 Fiscal Federalism and State and Local Government Finance 647

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Fiscal Federalism 648Centralized versus Decentralized Government 651Citizen Mobility and Decentralized Government 653International Vieux The Modern Global Economy and Its

Challenges to Federalism 65HInterjurisdictional Externalities and Locational Choices 655The Theory of Taxation Within a Decentralized System 656Variation in Fiscal Capacity 660Public Policy Perspective: Interstate Tax Exportation in the United States 661 Intergovernmental Fiscal Relations 663The Theory of Grants 667Matching Versus General-Purpose Grants: An Application

of the Theory of Collective Choice Under Majority Rule 668Impact of a Nonmatching General-Purpose Grant

on the Political Equilibrium 671Education Finance 673Summary 678Internet Resources 681

Glossary 682

Index 690