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The Public Sector

Economics for Today by Irvin Tucker, 6th edition©2009 South-Western College Publishing

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What will I learn in this chapter?

What decisions public-sector politicians, government bureaucrats, voters, and special interest groups make

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What puzzles will I learn to solve?

How does the tax burden in the U.S. compare to other countries?

How does the Social Security tax favor the upper-income worker?

Should we replace the income tax with a national sales tax?

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What about the size of government?

Since the 1950’s, government expenditures have grown from about one-quarter to over one third of GDP

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10

5%10%

15%

20%

25%30%

35%

40%

45%50%

Total government expenditures

45 50 55 60 65 70 75 80 85 90 95 00 05

Government Expenditures 1940 - 2006

State & Local Gov. Expenditures

Federal government expenditures

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1970 Federal OutlaysOther

International affairs

Veteran's benefits

Agriculture

Transportation

Education and health

Interest on federal debt

National defense

Income security

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2006 Federal ExpenditursOther

International affairs

Veteran's benefits

Agriculture

Transportation

Education and health

Interest on federal debt

National defense

Income security

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1970 State & Local Outlays Other

Civilian safety

Highways

Health & hospitals

Income security

Education

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2006 State & Local Expenditures Other

Civilian safety

Highways

Health & hospitals

Public Welfare

Education

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How do taxes in the U.S. compare to taxes

in other countries?U.S. citizens are among the most lightly taxed people in the industrialized world

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GermanyItaly U.K. U.S.Canada JapanSweden

20

40

60

80

100

France

56%54%

50%

45% 40%

46%

36%34%

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Federal Receipts 2006Other

Excise taxes

Corporate income taxes

Social insurance taxes

Individual income taxes

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State & Local Receipts 2006 Other

Corporate income taxes

Individual income taxes

Property taxes

State sales tax

Federal Grants

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GermanyItaly U.K. U.S.Canada JapanSweden

20

40

60

80

100

France

59%

51%45%

42% 41%44%

32% 32%

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05 1045 50 55 60 65 70 75 80 85 90 95 00

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Total government taxes

Federal government taxes

Growth in Taxes in the U.S., 1935 - 2006

State & Local Gov. Taxes

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What are two types of taxes?Benefits receivedAbility to pay

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What is the benefits received principle?

Those who benefit from government expenditures should pay the taxes that finance their benefits

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What is the ability to pay principle?

Those who have higher incomes can afford to pay a greater proportion of their income in taxes, regardless of the benefits

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Which principle dominates in the U.S.?

The ability-to-pay principle dominates the benefits-received principle

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What is aprogressive tax?

A tax that charges a higher percentage of income as income rises

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What is theaverage tax rate?

Total tax due divided by total taxable income

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What is themarginal tax rate?

The change in taxes due divided by the change in taxable income

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What is aregressive tax?

A tax that charges a lower percentage of income as income rises

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What is aproportional tax?

A tax that charges the same percentage of income, regardless of the size of income

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What is a flat rate tax?Same as a proportional tax

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319,100

5%

10%

15%

20%

25%

30%

35%

Federal government taxes

145,76070,36029,0507,150

10%

15%

25%

28%

35%33%

17% Flat-rate tax

The Progressive Income Tax versus a Flat Tax

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What ispublic choice theory?

The analysis of the government decision-making process to allocate resources

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Who isJames Buchanan?

The founder of public choice theory which applies economic analysis to politics

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What is thebenefit - cost analysis?

The comparison of the additional rewards and costs of an economic alternative

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What is the basic rule of benefit-cost

analysis?A firm will produce additional units as long as marginal benefit exceeds the marginal cost

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Why might government be inefficient in solving

society’s problems?• Majority rule problem• Special interest effect• Rationale ignorance• Bureaucratic inefficiency• Shortsightedness effect

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What is themajority rule problem?Voting can lead to a rejection of projects with marginal total benefits exceeding the marginal cost

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Can majority rule lead to inefficient solutions?

Yes, “one person one vote” cannot measure the intensity of voters’ preferences as well as the market

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What is the special-interest group effect?Special-interest groups can create government support for programs with costs out-weighing their benefits

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Why can special-interest voting be

inefficient?A small group within the society can benefit while the whole society pays the costs

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What isrational ignorance?

The voters choose to remain uninformed because the marginal cost of obtaining information is higher than the marginal benefit from knowing it

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What is bureaucratic inefficiency?

The bureaucracy may become more powerful than elected officials

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What is the shortsightedness effect?

Democracy has a bias toward programs offering clear benefits and hidden costs

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END