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Chapter 22
The Public Sector
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What is the purpose
of this chapter?
To examine public-sector
decisions of politicians,
government bureaucrats,
voters, and special
interest groups
2
What about the size of
government?
Since the 1950’s,
government expenditures
have grown from about
one-quarter to over one
third of GDP
3
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
Government Expenditures 1935 - 2000
Total government expenditures
Federal government expenditures
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
4
1970 Federal Outlays
Other
International affairs
Veteran's benefits
Agriculture
Transportation
Education and health
Interest on federal debt
National defense
Income security
5
2000 Federal Outlays
Other
International affairs
Veteran's benefits
Agriculture
Transportation
Education and health
Interest on federal debt
National defense
Income security
6
1970 State & Local Outlays
Other
Civilian safety
Highways
Health & hospitals
Income security
Education
7
2000 State & Local Outlays
Other
Civilian safety
Highways
Health & hospitals
Public Welfare
Education
8
Federal Receipts 2000
Other
Excise taxes
Corporate income taxes
Social insurance taxes
Individual income taxes
9
State & Local Receipts 2000
Other
Corporate income taxes
Individual income taxes
Property taxes
State sales tax
10
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
11
50% Growth in Taxes in the U.S., 1935 - 2000
45%
Total government taxes
40%
35%
30%
25%
20%
15%
10%
Federal government taxes
5%
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
12
What are two
types of taxes?
Benefits received
Ability to pay
13
What is the benefits
received principle?
The concept that those
who benefit from
government
expenditures should pay
the taxes that finance
their benefits
14
What is the ability
to pay principle?
The concept that those
who have higher incomes
can afford to pay a
greater proportion of their
income in taxes,
regardless of the benefits
15
Which principle
dominates in the U.S.?
The ability-to-pay principle
dominates the benefitsreceived principle
16
What is a
progressive tax?
A tax that charges a
higher percentage of
income as income rises
17
What is the
average tax rate?
Total tax due divided by
total taxable income
18
What is the
marginal tax rate?
The change in taxes
due divided by the
change in taxable
income
19
What is a
regressive tax?
A tax that charges a
lower percentage of
income as income rises
20
What is a
proportional tax?
A tax that charges the
same percentage of
income, regardless of
the size of income
21
What is a flat rate tax?
Same as a proportional tax
22
What is
public choice theory?
The analysis of the
government decisionmaking process to
allocate resources
23
Who is
James Buchanan?
The founder of public
choice theory which
applies economic
analysis to politics
24
What is the
benefit - cost analysis?
The comparison of the
additional rewards
and costs of an
economic alternative
25
What is the basic
rule of benefit-cost
analysis?
A firm will produce
additional units as long as
marginal benefit exceeds
the marginal cost
26
Why might
government be
inefficient in solving
society’s problems?
• Majority rule problem
• Special interest effect
• Rationale ignorance
• Bureaucratic inefficiency
• Shortsightedness effect
27
What is the
majority rule problem?
Voting can lead to a rejection
of projects with marginal
total benefits exceeding the
marginal cost
28
Can majority rule lead
to inefficient
solutions?
Yes, “one person one
vote” cannot measure
the intensity of voters’
preferences as well as
the market
29
What is the specialinterest group effect?
Special-interest groups
can create government
support for programs
with costs out-weighing
their benefits
30
Why can specialinterest voting be
inefficient?
A small group within the
society can benefit
while the whole society
pays the costs
31
What is
rational ignorance?
The voters choose to
remain uninformed
because the marginal
cost of obtaining
information is higher
than the marginal
benefit from knowing it
32
What is bureaucratic
inefficiency?
The bureaucracy may
become more powerful
than elected officials
33
What is the
shortsightedness
effect?
Democracy has a bias
toward programs
offering clear benefits
and hidden costs
34
Key Concepts
35
Key Concepts
• What has happened to the size of
government?
• How do taxes in the U.S. compare to other
countries?
• What is the benefits received principle?
• What is the ability to pay principle?
• What is a progressive tax?
36
Key Concepts cont.
•
•
•
•
•
•
•
•
What is the marginal tax rate?
What is a regressive tax?
What is a proportional tax?
What is the majority rule problem?
What is the special-interest group effect?
What is rational ignorance?
What is bureaucratic inefficiency?
What is the shortsightedness effect?
37
Summary
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Between 1970 and 2000,
income security became the
largest category of federal
expenditures. During the
same period, national
defense declined from the
largest spending category to
the second largest.
39
Net interest on the federal debt has
grown from 9 percent of the budget
in 1970 to 12.5 percent in 2000.
Therefore, income security and net
interest payments combined
accounted for 60.5 percent of
federal outlays in 2000.
40
The government's share of total
economic activity has generally
increased since World War II ended
in 1945. Most of the growth in
combined government expenditures
as a percentage of GDP reflects
rapidly growing federal government
transfer programs.
41
50% Growth in Taxes in the U.S., 1935 - 2000
45%
Total government taxes
40%
35%
30%
25%
20%
15%
10%
Federal government taxes
5%
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
42
State and local government tax
revenues consist primarily of
sales and property taxes. While
states rely on income taxes for
revenue, they also collect sales
and excise taxes. In addition,
state budgets depend greatly on
charges and revenue-sharing
grants from the federal
government.
43
Local governments collect most
of their tax revenue from
property taxes, but the majority
of their receipts are from charges
and grants from the federal and
state governments.
44
The largest outlays for state and
local governments have been for
education. Between 1970 and
1997, transfer payments for
public welfare’s share of the
budget rose.
45
The taxation burden, measured by
taxes as a percentage of GDP, is
lighter in the U.S. than many other
advanced industrial countries.
Since 1960, federal taxes have
remained a fairly constant fraction
of GDP. State and local taxes,
however, have generally
increased as a percentage of
GDP since the 1950’s
46
The benefits-received principle
and the ability-to-pay principle
are the two basic philosophies
of taxation fairness.
47
The gasoline tax is a classic
example of the benefits-received
principle because users of the
highways pay the gasoline tax.
48
Progressive income taxes follow
the ability-to-pay principle
because there is a direct
relationship between the average
tax rate and income size.
49
Sales, excise, and flat-rate taxes
are examples of a regressive tax
because each results in a
greater burden on the poor than
the rich.
50
Public choice theory reveals the
government decision making
process. For example, government
failure can occur for any of the
following reasons:
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(1) Majority voting may not follow
benefit-cost analysis, (2) special
interest groups can obtain large
benefits and spread their costs over
many taxpayers, (3) rational voter
ignorance means a sizeable portion
of the voters will decide not to make
informed judgements, (4)
bureaucratic behavior may not lead
to cost effectiveness, an (5)
politicians suffer from a short time
horizon, leading to a bias toward
hiding the costs of programs.
52
END
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