Gruber4e ch01

Why Study Public Finance? 1
1.1 The Four Questions of Public Finance
1.2 Why Study Public Finance? Facts on Government in
the United States and Around the World
1.3 Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
1.4 Conclusion
P R E P A R E D B Y
Dan Sacks
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 2 of 32

C H A P T E R 1 ■ W H Y S T U D Y P U B L I C E C O N O M I C S ?
1.1
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers
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The Four Questions of Public Finance
• Public finance: The study of the role of the
government in the economy.
Four questions of public finance:
1. When should the government intervene in the
economy?
2. How might the government intervene?
3. What is the effect of those interventions on economic
outcomes?
4. Why do governments choose to intervene in the way
that they do?

1.1
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When Should the Government Intervene in the
Economy?
• Economics generally presumes that markets deliver
efficient outcomes, so why should government do
anything?
• Primary motive for government intervention is
therefore market failure.
• Market failure: Problem that causes the market
economy to deliver an outcome that does not
maximize efficiency.

APPLICATION: The Measles Epidemic of 1989−1991
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1.1
• Measles vaccine introduced in 1963, and measles
cases had become relatively rare in the United States
by the 1980s.
• 1989−1991: Huge resurgence in measles.
• This outbreak resulted from very low immunization
rates among disadvantaged inner-city youths.
• Unimmunized children imposed a negative externality
on other children.

1.1
APPLICATION: The Measles Epidemic of 1989−1991
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• The federal government responded to this health crisis
in the early 1990s:
o Encouraged parents to immunize their children.
o Paid for the vaccines for low-income families.
• Impressive results:
• Immunization rates never higher than 70% prior to
outbreak.
• Rose to 90% by 1995.
• Government intervention clearly reduced this negative
externality.

1.1
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When Should the Government Intervene in the
Economy?
• Even if the market is well-functioning, an efficient
outcome is not necessarily socially desirable.
• Redistribution is a second reason for government
intervention.
• Redistribution: The shifting of resources from some
groups in society to others.

How Might Governments Intervene?
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1.1
• Tax or Subsidize Private Sale or Purchase
o Use the price mechanism, changing the price of a
good to encourage or discourage use.
• Taxes raise the price for private sales or purchases of
goods that are overproduced.
• Subsidies lower the price for private sales or purchases
of goods that are under-produced.

How Might Governments Intervene?
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1.1
• Restrict or Mandate Private Sale or Purchase
o Quotas restrict private sale of goods that are
overproduced.
o Mandates require private purchase of goods that
are under-produced.
• Public Provision
o The government can provide the good directly.
• Public Financing of Private Provision
o Governments pays, private companies produce.

1.1
What Are the Effects of Alternative Interventions?
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Interventions have direct and indirect effects.
• Direct effects: The effects that would be predicted if
individuals did not change their behavior in response
to the interventions.
o With 49 million uninsured, providing universal
health insurance covers 49 million people.
• Indirect effects: The effects that arise only because
individuals change their behavior in response to the
interventions.
o If people drop private coverage, many more
people may end up covered by the public plan.

1.1
Why Do Governments Do What They Do?
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• Governments do not always choose efficient or socially
desirable outcomes.
• Political economy: The theory of how the political
process produces decisions that affect individuals and
the economy.

1.2
Why Study Public Finance?
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The government is a huge part of the economy:
• Government spending represents a large sector of the
economy, in the United States and around the world.
• This spending is financed with taxes or with debt, and
these affect every facet of the economy.
• Many sectors of the economy are also directly affected
by regulation.

1.1
APPLICATION: The Congressional Budget Office as
Gatekeepers
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• The methods and results derived from empirical
economics are central to the development of public
policy at all levels of government.
• The Congressional Budget Office (CBO) “scores” policy
proposals by estimating their budget implications.
• CBO scoring uses the theoretical and empirical tools of
public finance.
• CBO scores can determine the fate of legislation.

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1.2
Federal Spending as a Percent of GDP, 1930−2011

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1.2
Total Government Spending Across Developed
Nations, 1960−2013

1.2
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Decentralization
• A key feature of governments is the degree of
centralization across local and national government
units.
• Centralization: The extent to which spending is
concentrated at higher (federal) levels or lower (state
and local) levels.
• In the United States, state and local spending is about
one-fourth of total government spending.

1.2
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Federal Revenues and Expenditures, 1930−2011

1.2
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Federal Surplus/Deficit, 1930−2011

1.2
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Federal Debt, 1930−2011

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1.2
Debt Level of OECD Nations in 2011

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1.2
State and Local Government Receipts,
Expenditures, and Surplus, 1947−2008

1.2
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Distribution of Spending
• Public goods: Goods for which the investment of any
one individual benefits everyone in a larger group.
o Example: Defense spending
• Social insurance programs: Government provision of
insurance against adverse events to address failures in
the private insurance market.
o Example: Health insurance
• Over time, spending has shifted dramatically toward
social insurance, especially health insurance.

1.2
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Distribution of Federal Spending, 1960 and 2012
Category: 1960 2012
National defense 49.4% 19.1%
Social Security 13.4 15.9
Net interest 9.7 7.6
Unemployment, disability 8.6 9.1
Education, welfare, housing 4.0 11.0
Health (including Medicare) 2.9 25.2
Other 12.0 12.1

1.2
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Distribution of State/Local Spending, 1960 and 2012
Category: 1960 2012
Education 38.8% 33.4%
Transportation 11.7 5.9
Public order and safety 10.2 12.9
Welfare, social services 10 6.6
Health 8.2 22.3
Other 21.1 18.6

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1.2
Distribution of Federal Revenue Sources, 1960 and
2011
Category: 1960 2012
Income taxes 44% 42%
Corporate taxes 23 35
Social insurance contributions 17 13
Excise taxes 13 7
Other 3 3

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1.2
Distribution of State/Local Revenue Sources, 1960
and 2011
Category: 1960 2012
Property taxes 36% 21%
Sales taxes 27 22
Federal grants-in-aid 9 24
Income taxes 6 14
Other 22 19

1.2
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Regulatory Role of the Government
The government regulates a wide range of economic and
social activities:
• The Food and Drug Administration (FDA): food,
cosmetics, drugs, and medical devices.
• The Occupational Safety and Health Administration
(OSHA): workplace safety.
• The Federal Communications Commission (FCC): radio,
television, wire, satellite, and cable.
• The Environmental Protection Agency (EPA): pollution
of air, water, and food supplies.

1.3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
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Many heated policy debates concern the impact of major
public programs:
• The role of Social Security, health care, and education
are all contentious subjects.
• “Liberal” and “Conservative” positions hold differing
views on how to approach these major policy issues.

1.3
Why Study Public Finance Now? Social Security
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Social Security is the single largest government
expenditure program.
• The financing structure of this program is basically that
today’s young workers pay the retirement benefits of
today’s old.
• As the population ages, it is increasingly difficult to
fund.
• Liberals argue that we should raise necessary
resources through higher payroll taxes.
• Conservatives argue that, rather than transfer from
young to old, we should encourage people to save.

Why Study Public Finance Now? Health Care
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• 49 million Americans lack any health insurance, about
18% of the non-elderly U.S. population.
• The Affordable Care Act (ACA) promises to cover 32
million, using mandates and subsidies.
o Supporters argue that the ACA corrects serious
market in the insurance market.
o Opponents charge that it represents an enormous,
expensive, unwarranted expansion of government
power.
1.3

1.3
Why Study Public Finance Now? Education
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There is an enormous dissatisfaction with our current
educational system.
• In 2009, the United States ranked 17th in reading,
23rd in science, and 35th in math skills in a study of 65
countries.
• Will more spending improve educational outcomes?
• Or might competition among schools help?

1.4
Conclusion
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• Government plays a central role in the lives of all
Americans.
• There is ongoing disagreement about whether that
role should expand, stay the same, or contract.
• The facts and arguments raised in this chapter provide
a backdrop for thinking about the set of public finance
issues that we explore in the remainder of this book.

Gruber4e ch01

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