Download The Public Sector

The Public Sector
Market Failures:
Externalities and Third Party
Costs
Market failures: externalities
• Market prices are supposed to reflect the
benefits and costs received by producers and
consumers involved in an exchange.
• A market failure occurs when the market
prices fail to reflect all the costs and benefits
involved.
• Market failures are called externalities
• Sometimes externalities are called “third
party” costs or benefits
Negative externalities
• Negative externalities are the costs paid by
society for a private exchange.
• For example, a steel plant may produce toxic
emissions while producing steel.
• The air pollution caused by the factory may
lead to the increases in lung cancer and other
respiratory illnesses.
• The medical and hospital costs associated
with the pollution is not a private cost to the
steel manufacturer, but is born by the third
parties who become ill.
Correcting for Negative
Externalities
• The government may step in to correct the
negative externalities by establishing higher
air quality standards.
• It may also tax or fine the steel company. This
tax increases the costs of producing steel and
lowers the supply of steel.
• Finally the government may want to give
incentives (subsidies or tax breaks) to
companies that create steel with less
pollution.
Positive externalities
• There may be positive third party benefits, as
well.(e.g. inoculations benefit public health)
• A positive externality means that a good is
being under produced, therefore the
government may want to finance this good
(e.g. public education)
• The government may also increase the
incentives by giving subsidies or tax breaks to
an industry which creates positive third party
benefits (e.g. alternative energy with nonrenewable resources)
Characteristic of Market
Economy
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Private Property
Free Enterprise
Self Interest
Competition
Markets and Prices
Limited Government
Role of Government in a
Market Economy
• Provide a legal system enforce laws and protect
private property rights
• Provide Public goods that individuals or private
businesses wouldn’t provide
• Correct market failures such as external costs and
external benefits
• Maintain competition by regulating business
• Redistribute income by taxing those with larger
incomes and helping those in need
• Stabilize the economy by reducing unemployment
and inflation, while promoting economic growth
Government Sponsored or
Inhibited Goods
• Our political system determines which goods
are socially desirable. These goods (e.g.
museums, schools, libraries) are called merit
goods or government sponsored goods.
• Conversely our society may designate some
goods as demerit goods (e.g.cigarettes,
gambling etc.) or government inhibited goods.
• Our local, state, and national governments
subsidizes merit goods, and taxes demerit
goods.
Public Goods
• Public goods are consumed jointly and
simultaneously.
• Public goods include national defense, police
protection, and our legal system.
• Private businesses have little profit incentives
to produce public goods, so government
takes on this responsibility.
• Some citizens may benefit from a public
good, but don’t pay for it. This is called the
free rider problem.
The Federal Budget
• The government spends money on
programs and takes in taxes to finances
these programs.
• The Congress has budget authority.
Spending bills begin the House,
although the Senate and the President
may present their budgets.
• Final approval is through the Congress.
Discretionary and Nondiscretionary Funding
• Programs such as Social Security and
Medicare are called non-discretionary
items because they are mandatory
payments to people who have paid in
through the payroll tax.
• The rest of the budget items are
discretionary items, meaning the
Congress may increase or decrease
their amounts.
Funding of the Public Sector
• The Public Sector is funded primarily through
national, state, and local taxes.
• Our different levels of government may also
charge a fee or borrow money as well.
• Each level of government has a tax base.
The tax base is the level of assets, such as
income and property, that can be taxed by
the government.
• For example, wealthier areas have a higher
tax base than poorer ones.
Federal Taxes
• The majority of revenues for the national
government comes from federal income tax,
paid in April.
• The national government also receives
money from corporate taxes and money from
capital gains (money made on the ownership
of financial assets like stocks).
• Funds for Social Security derive from the
payroll tax. The government also has
withholding for Medicare and unemployment
insurance.
Tax Philosophy
• Our national income tax is a progressive tax,
which means higher income groups pay
higher marginal tax rates.
• Our state sales tax is a proportional tax
because all people pay the same percentage
rate (e.g. 8%).
• A tax is considered regressive if it unduly
burdens the poor.
Marginal tax rates
• The marginal tax rate is the tax rate on
the last dollar of income earned
• In a progressive tax system the
marginal rate is higher than the average
tax rate
State Taxes
• States also have a variety of revenue
sources.
• In California the state property tax, paid by
homeowners, provides large sums of revenue
and is used for big programs like schools.
• Our state also has a sales tax and a state
income tax to pay for state government.
• Not all states have state income or sales tax.
Nevada, for example, funds their state
primarily through the taxation of gambling.
Excise Taxes
• Excise taxes are taxes on specific goods and
services. For example, the state of California
levies a tax on gasoline and uses the
proceeds to fund the highway construction
and maintenance in the state.
• Excise taxes on cigarettes and alcohol are
specifically designed to make these demerit
goods more expensive and discourage
smoking and drinking.
• Ok, let’s try this with the handout
• What is the current marginal tax rate for
people making:
• $8,000
• 10%
• $100,000
• 28%
• $500,000
• 39.6%
Average versus Marginal Tax
rates
• Now look at the example of someone
making $100, 000 per year.
• What is their marginal tax rate?
• 28%
• What is their average tax
• 22%
Taxable Income
• Taxable income is that money earned which
the government can tax.
• Typically people can take deductions on their
income. For example, $3650 is taken off
income for each person in a family
• In addition, homeowners received a
deduction on interest paid on their homeloan
for a primary residence
Incentives and Loopholes
• The government uses tax policy to provide incentives
to business as well.
• For example, the new healthcare law gives tax
incentives to small businesses that provide
healthcare plans to employees
• Corporations involved in energy: oil,natural gas, and
green energy receive tax credits
• These incentives are called “loopholes” by critics
who point out that many large corporation don’t pay
their full tax load, and they often lobby Congress for
these special tax breaks.
Limits to the government in
capitalist society
• Market societies limit government from
owning the majority of businesses, as the
government does in a socialist society.In
addition, the government does not decide
what is produced and does not set basic
prices for the production.
• Most capitalist societies are mixed
economies. It is estimated that about 65% of
all economic activity in the US takes place in
the private market, with the remaining 35% of
services and products occurs in all levels of
the government sector.
Imagine
• A person earns $250,000 in income and
$750,000 from capital gains made on stocks.
• Long term capital gains is about 15%.
• What is the overall tax percentage paid by
this individual?
• Is this fair or unfair? What do you think of
Warren Buffet’s proposal that wealthy
American should pay a tax rate at least equal
to middle class Americans?
Opposing Tax Proposals
• Many Republicans are calling for all of the
Bush era tax cuts to remain, including the
current 35% on the top income bracket
• Many Democrats, including President
Obama, are calling for the top brackets (those
making over $250,000) to jump back to the
pre Bush era tax cut rate of 36% and 39%.
This proposal keeps the other tax rates in
place.
PBS Debate on Tax Cuts
What do you think?
• Should the tax cuts expire?
• Should the highest rates be raised, with the
other tax cuts remaining?
• Should all the tax cuts remain, including the
highest rates?
• Should we make our national income tax
more progressive or move it to a proportional
tax rate (or flat tax?)
• What about people who make most of their
income from capital gains (taxed at 15%).
Should this change or stay the same?