Economics of the Public SectorChapter 4 •Fiscal Finance and government spending 1“We contend that for a nation to try to tax themselves into prosperity is a little like a man standing in a bucket and trying to lift himself up by the handles”Winston Churchill, British statesman“Income tax returns are the most imaginative fiction being written today”.Herman Wouk, author of the Caine Mutiny, Winds of War, and War & Remembrance.“The avoidance of taxes is the only intellectual pursuit that carries any reward”.John Maynard Keynes, economist.“The United States is the only country in the world where it takes more brains to figure out what you owe in taxes than it took to make the money in the first place”.Ronald Reagan, actor, governor, and 40thPresident of the United States.
Economics of the Public Sector- The first day of class I gave you this definition of economics……economicsis a social sciencethat studieshow society allocatesscarce resourcesamong different and competing alternative uses. - Under the topic of allocates I told you that individuals (i.e., consumers and business) respondto both incentives and 2
Economics of the Public Sector- How do we get people to respond to incentives and disincentives? By using the Price System. - If the government wants you to do more of something, they will just give it to you or provide you with a subsidy to get it (which effectively lowers the price). - If the government doesn't want you doing something they 3
Economics of the Public Sector- So to see how taxes affect prices and how they relate to public policy we need some further discussion. - Recall from Chapter 6 that taxes are inefficient. While they allow the government to collect revenue to buy stuff for us (as well as give us subsidies) they create a deadweight loss. - That deadweight loss is what happens when consumers or business have an incentive or disincentive to do something that they ordinarily wouldn’t have done in the market place.4
Market Efficiency•Consumer surplus is above price and below demand•Producer surplus is below price and above supplyDSP1Q1Quantity ConsumerSurplusProducerSurplusPrice Consumer surplus is valueconsumers get that theydidn’t have to pay forProducer surplus is value theproducer didn’t expect to get
Market Inefficiency•If the tax is placed on the business (increase in cost of production)•Creates a deadweight loss of a1 and a2. This is the (surplus) value lost due to the tax. DemandSupply with no taxP1Q1QuantityQ2P2Supply with taxa1a2•In addition to the deadweight loss (a1and a2), consumers also lose t1and producers also lose t2. The t1and t2area is tax revenue collected by the governmentPrice t1t1t2t2
Market Inefficiency•Tax placed on consumer (increase in price sort of like a price floor)DemandSupply P1Q1Quantity Q2P1 + taxa1a2•Same deadweight loss (a1+ a2). In addition, consumers also lose t1and producers also lose t2.