| 1. |
Critics of the government argue
that it has failed to find solutions for many problems of society and that it is very
inefficient in its use of society’s scarce resources. This chapter first analyzes
economic decisions made by government from public choice perspective
turns to the issue
of public finance
and then examines the economics of taxation.
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| 2. |
Most decisions about government activity are
made collectively through majority voting
but the procedure is not without problems.
- Voting outcomes may be economically inefficient
in cases where voters reject a public good whose total benefits exceed total costs or fail
to reject a public good whose total costs are greater than the total benefits. These
inefficiencies can be resolved sometimes by
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- the formation of special interest groups that
work to overcome inefficient outcomes
or
- the use of logrolling
in which votes are traded
to secure a favorable and efficient decision
- but logrolling can also lead to inefficient
decisions.
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- The paradox of voting suggests that the public
may not be able to make consistent choices that reflect its preferences.
- Based on the median-voter model
it is suggested
that the person or groups holding the middle position on an issue will likely determine
the outcome from a majority rule election. Public decisions tend to reflect the median
view.
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| 3. |
Public choice theory suggests that the public
sector has failed because the process it uses to make decisions is inherently weak
and results in an economically inefficient allocation of resources.
- The weakness of the decision-making process in
the public sector and the resulting inefficient allocation of resources is often the
result of pressures exerted on Congress and the bureaucracy by special interests and other
groups.
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- There can be a special-interest effect in which a
small number of people obtain a government program or policy giving them large gains at
the expense of a large number of people who individually suffer small losses. This
special-interest effect is also present in pork-barrel politics because a government
program will mostly benefit one constituency.
- Rent-seeking behavior is reflected in appeals to
government for special benefits or treatment at the taxpayers’ or someone else’s
expense. Government can dispense such rents through laws
rules
hiring
and purchases.
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- Those seeking election to public office
frequently favor programs whose benefits are clear and immediate and whose costs are
uncertain and deferred
even when the benefits are less than the costs. Conversely
they
frequently oppose programs whose costs are clear and immediate and whose benefits are
uncertain and deferred
even when the benefits are greater than the costs.
- There are limited and bundle choices in political
decisions. When citizens must vote for candidates who represent different but complete
programs
the voters are unable to select those parts of a program which they favor and to
reject the other parts of the program.
- It is argued that the public sector (unlike the
private sector) is inefficient because those employed there are offered no incentive to be
efficient
there is no way to measure efficiency in the public sector
and government
bureaucrats can join with the special-interest groups to block budget cuts or lobby for
increased funding.
- Just as the private or market sector of the
economy does not allocate resources perfectly
the public sector does not perform its
functions perfectly; the imperfections of both sectors make it difficult to determine
which sector will provide a particular good or service more efficiently.
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| 4. |
The financing of public goods and services
through
taxation also raises an important question about how the tax burden is allocated among
people.
- The benefits-received principle and the
ability-to-pay principle are widely used to determine how the tax bill should be
apportioned among the economy’s citizens.
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- The benefits-received principle suggests that
those people who benefit most from public goods should pay for them.
- The ability-to-pay principle states that taxes
for the support of public goods should be tied to the income and wealth of people or their
ability to pay.
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- Taxes can be classified as progressive
regressive
or proportional according to the way in which the average tax rate changes as
incomes change.
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- The average tax rate increases as income
increases with a progressive tax
it decreases as income increases with a regressive tax
and it remains the same as income increases with a proportional tax.
- In the United States
the personal income tax
tends to be mildly progressive
the corporate income tax is proportional
and the payroll
sales
and property taxes are regressive.
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| 5. |
Tax incidence and the efficiency loss of a tax
are also important in discussion of public finance.
- The price elasticities of demand and supply
determine the incidence of a sales or excise tax.
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- (The imposition of such a tax on a product
decreases the supply of the product and increases its price. The amount of the price
increase is the portion of the tax paid by the buyer; the seller pays the rest.
- The price elasticities of demand and supply for a
product affect the portions paid by buyers and sellers: (a) the more elastic the demand
the greater the portion paid by the seller; (b) the more inelastic the demand
the smaller
the portion paid by the seller; (c) the more elastic the supply
the greater the portion
paid by the buyer; and (d) the more inelastic the supply
the smaller the portion paid by
the buyer.
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- There is an efficiency loss from taxation. This
loss occurs because there is a reduction in output
despite the fact that the marginal
benefits of that output are greater than the marginal cost. Thus
the consumption and
production of the taxed product have been reduced below the optimal level by the tax.
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- The degree of the efficiency loss of a sales or
an excise tax depends on the elasticities of supply and demand. Other things equal
the
greater the elasticity of supply and demand
the greater the efficiency loss of a sales or
an excise tax; consequently
the total tax burden to society may not be equal even though
two taxes produce equal tax revenue.
- Other tax goals
however
may be more important
than minimizing efficiency losses from taxes. These goals may include redistributing
income or reducing negative externalities.
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- A tax levied on one person or group of persons
may be shifted partially or completely to another person or group; and to the extent that
a tax can be shifted or passed on through lower prices paid or higher prices received
its
incidence is passed on to others. Table 31-2 in the text summarizes the probable shifting
and incidence of the personal income tax
corporate income tax
general sales tax
specific excise taxes
and property taxes.
- The overall U.S. tax structure is only slightly
progressive and has little effect on the distribution of income because progressive taxes
are generally offset by regressive taxes; however
estimates of the progressivity of the
tax system depend on the assumed incidence of various taxes and transfer payments made by
governments to reduce income inequality in the United States.
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| 6. |
In recent years
two tax issues have been
discussed in the United States.
- Pressure to improve the performance of the U.S.
economy and industry has resulted in debates over tax changes to reduce consumption
increase savings
and stimulate investment in capital goods. The adoption of a value-added
tax (VAT) on consumer goods and the reduction or elimination of the personal income or
corporate income tax have been considered to achieve these objectives. The VAT penalizes
consumption and should encourage saving. Increased saving should stimulate investment and
economic growth.
- The complexity of the Federal tax code also
contributes to economic inefficiency because it requires time to keep records and
calculate taxes owed. Proponents of the flat tax would simplify the code by having a
single tax rate applied to individuals and businesses; the tax would encourage saving and
investment because it would not tax capital gains or income on saving.
- Critics of the VAT and flat tax contend that
either one is regressive and would reduce the overall progressivity of the Federal tax
system. Critics also cite transition costs to the economy from tax changes: a general
price increase resulting from the adoption of the VAT
and the losses of tax deductions
from the flat tax may alter spending and housing valuations.
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| 7. |
The nature and amount of government activity
and the extent of individual freedom may be related.
- Conservatives argue that the cost of government
entails not only the economic cost from a growing public sector but also a cost in terms
of reduced economic freedom for the individual because government now makes more of the
decisions over economic activity.
- Liberals counter that the conservative position
is subject to the fallacy of limited decisions. If government activity expands
this does
not necessarily mean that there is less private decision making because the range of
choices can be expanded by increased governmental activity.
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