Public Finance Instructor: John Hartman Today: An introduction to Econ 130 Introduction to public finance The role of government

First issue: Crashers Current cap: 60 students Crash list You must be on the department wait list to be considered for this class if you are not registered I will hand out a crash list for you to fill out also No add codes distributed until next week Enrolled students get priority for seating Later option for Econ 130 This class is usually offered each fall

Before we begin… Remember that this is a small class  Ask questions if things are not clear The syllabus is posted online  See http://econ.ucsb.edu/~hartman/ For most of you, attendance is important if you want to get a good grade If reading this size font is difficult, I urge you to sit near the front

Before we begin… I expect you to know the following tools Calculus Derivatives, integrals, partial derivatives Microeconomics Econ 1, Econ 100A or 104A, Econ 100B or 104B Macroeconomics (although not as important for this public finance class) Econ 2, Econ 101 or 105 If you are lacking on any of these skills, please make sure you are comfortable with these skills by next week

Structure of learning Read first Lectures & problem solving in class Do more problems on your own Prepare for test Some time in class to review Come to office hours if needed Additional office hours will likely be offered close to tests

Textbook for this class Rosen/Gayer Public Finance, 9th edition Published by McGraw-Hill/Irwin

Reading the textbook Main text and appendix is 560 pages Too much for a 30-hour class Look at syllabus for reading assignments Maximum of 50 pages per week Maximum of 300 pages overall

Office hours and review sessions Office: NH 2028 Office hours: Mondays 2:15-3:15 pm Wednesdays 9:15-10:15 am Additional office hours before test will be in a larger classroom if demand warrants it

Tests Three tests, as of now scheduled for: Monday, April 26 (in lecture); 65 minutes Monday, May 17 (in lecture); 65 minutes Tuesday, June 8 (final, Noon-2:30 pm); 140 minutes Some problems on tests will be similar to what we cover in practice problems Some questions will require you to learn material and think your way through

Extra credit To encourage dialogue and discussion in class, each student that makes at least one intelligent question or comment during the quarter in lecture will receive one percentage point added to her or his final grade In order to receive your extra credit, you will need to include your name when you state your question or comment

Lecture slides I will post a subset of lecture slides on-line Usually posted 2 days to a week before lecture On-line slides are not meant to be a replacement to lecture

Grading If you do not miss a test: Two best tests count 40% each Lowest test counts 20% Exception: If your best test is the final, the final will count 60% and the other two tests count 20% each If you do miss a test, check the syllabus for details

Grading I try to write tests so that the average score is between 60-80% (of the second best student) In other words, don’t worry if everything is not correct Previous Econ 130 classes 20-25% A+, A, or A- 35-45% B+, B, or B- 30-35% C+, C, or C- Remaining students: D+, D, D-, or F Some Econ 130 classes are stronger than others

More on this class Early on, I will lecture the entire time Later on many lectures will be about 50-60 minutes, followed by problem solving Most lectures will be devoted to a single topic Some topics will require more than one lecture A few lectures will cover multiple topics

Problems Problems have been posted on the class website for you to practice on I will also do some problems at the end of many lectures As we get closer to each test, I will devote some time to solving problems on the class website

Today What is public finance? An introduction to Econ 130 What will we cover over the next 10 weeks? Introduction to public finance The role of government Organic and mechanistic views of government Size of government Tiebout’s model

What is public finance? Analyzing government taxation and spending Examples Preserving the environment The roads you drive on Health care reform Social security sustainability Fairness of income distribution Taxation of income: Tax evasion versus tax avoidance

An introduction to Econ 130 This class covers four “units,” each with three to five lectures Unit 1: Introduction and Microeconomic tools Unit 2: Public goods, externalities, and government Unit 3: Health care and income redistribution Unit 4: An introduction to taxation

Unit 1 (begins today) Introduction and Microeconomic tools Chapter 1: Introduction to public finance and government Most of Chapter 2: Empirical tools Part of Chapter 3: Economic theory tools Most of Chapter 8: Cost-benefit tools Part of Chapter 22: The Tiebout model

Unit 2 Public goods, externalities, and government Chapter 4: Public goods Chapter 5: Externalities Chapter 6: Government and political economy Chapter 7 & the end of Chapter 8: Government spending on education

Unit 3 Health care and income redistribution Chapter 9: Problems of insurance in the health care market Chapter 10: Government’s role in health care Most of Chapter 11: The structure of Social Security; stresses caused by the baby boom generation Most of Chapter 12: Conceptual issues of income redistribution Most of Chapter 13: Programs for the poor

Unit 4 Primary and secondary effects of taxes Most of Chapter 14: Taxation and partial equilibrium Part of Chapter 15: Excess burden Part of Chapter 16: Tax evasion & tax avoidance Other taxation topics from Chapters 17 and 18 Basic structure of the United States personal income tax Rate structure of the United States personal income tax Marriage neutrality of taxes Behavioral issues with taxation

Before moving on… If you think that you are weak on your Microeconomics skills, you should read the Appendix at the end of the book or look at an intermediate Microeconomics textbook

Introduction to public finance This class is meant to cover public finance to students that have no direct background in the topic Some knowledge on public goods and externalities is useful, but not required Three topics will be covered today What is studied in a public finance class? What kinds of views do people have about public finance? Tiebout’s model Government will be addressed more in later lectures Size of government will be covered in the next lecture Growth of government will be covered in week 4

Public finance Public finance, as defined by R/G (p. 2) “The field of economics that analyzes government taxation and spending policies” Public finance, as described by Former Czech Prime Minister Vaclav Klaus (From R/G, p. 2) “Public finance is nothing else than a sophisticated discussion of the relationship between the individual and the state”

Public finance We will study topics in which many argue that government intervention is justified Public goods and markets with externalities Subsidized education Health care reform Social Security Income redistribution

Public _____ There are at least two other terms that mean the same thing as public finance Public sector economics Public economics Although I may use the three terms interchangeably to mean the same thing, I will usually use the term “public finance”

What views do people have? Different people have different views about public finance Organic view of government Mechanistic view of government

Organic view of government Government treats an entire society as a natural organism Each individual is part of the organism The government is the heart Although individual goals differ, some goals are naturally needed for the societal organism

Mechanistic view of government Government is needed for individuals to pursue their individual goals “Invisible hand” (Adam Smith) Efficient markets under certain sets of conditions Property rights and lack of violence needed to have efficient markets How much government beyond this is debatable Libertarian: Small government Social democrats: Larger government needed

What this class does Some analysis is done on a society-wide scale Social costs and benefits Cost-benefit analysis on a nationwide scale Other topics talk about individual analysis Voting theory Individual income taxes

Determining what is “good” What is “good” to one person may be viewed as bad as others Let’s do an activity to illustrate this Everyone starts by standing up I will show a statement Stay standing if you agree with the statement Sit down if you disagree with the statement There is no “right” answer to any question Time to stand up

Statement 1 I believe that reckless driving should be stopped through government actions (such as the use of police) Remember: Stay standing if you agree, sit down if you disagree

Statement 2 I think that government should build and maintain roads and highways

Statement 3 I believe that each baby needs to be securely buckled into a car seat while riding in a car, to be enforced by the government

Statement 4 I believe that each person in a moving car needs a seat belt on, to be enforced by the government

Statement 5 I believe each driver needs liability insurance, to be enforced by the government

Statement 6 I believe the government has a right to regulate when each person can use the roads, and the route they take, in order to control traffic patterns

Statement 7 I believe that the government has a right to prevent pilots of commercial aircraft from using a cell phone while actively flying

Statement 8 I believe that the government has a right to prevent train drivers from sending text messages while driving the train

Statement 9 I believe that the government has a right to prevent car drivers from sending text messages while driving the train

Statement 10 I believe that the government has a right to prevent car drivers from making calls on a cell phone while driving

Statement 11 I believe that the government should charge a 70% tax rate on all income I earn in my lifetime

Does everyone agree? No Different people have different opinions about what the government should do Experts often disagree about what government should do We will often assume that the experts in other disciplines have gotten costs and benefits right

How do we figure out what is “best?” Models can help However, no model perfectly describes the real world Example: The Tiebout model

Communities and the Tiebout model Many communities form in order to provide a wide array of benefits to the community members Sometimes these communities are in the form of private clubs Other communities incorporate into cities Charles Tiebout, in 1956 published a paper arguing that people shop for the city to meet their tastes for city-offered amenities

The Tiebout model People rarely leave the US due to government policy Mobility in the US due to government policy is substantial Tiebout makes many assumptions in his model Not a perfect description of the real world Gives a good idea of how people decide what community to live in

Tiebout’s assumptions Government activities generate no externalities Individuals are completely mobile People have perfect information with respect to each community’s public services and taxes There are enough different communities so that each individual can find one with public services meeting her demands The cost per unit of public services is constant so that if the quantity of public services doubles, the total cost also doubles Public services are financed by a proportional property tax Communities can enact exclusionary zoning laws—statutes that prohibit certain uses of land

Advantages with the Tiebout model Tailoring outputs to local taxes Each person or family lives in a community they like One size does not fit all Tastes and preferences differ from person to person Fostering intergovernmental competition People in government generally want people to live in their community

Advantages with the Tiebout model Experimentation and innovation in locally provided goods and services States and cities can try new programs These studies often result in statistical studies by economists The analyzed results lead to good information for governments throughout the nation

Main disadvantage of the Tiebout model Not an exact description of the real world Moving costs No one city is a perfect match for someone’s most desired preference Some parents send their kids to private school, despite the availability of public schools

Other issues with the Tiebout model Externalities Both negative and positive Many public goods are not at the local level Scale economies in provision of public goods Per-person cost often decreases as the number of users increases Inefficient tax systems Different states and cities often compete to get large businesses to locate in their area Scale economies in tax collection

Summary: Introduction to public finance Many topics studied in public finance Topics related to government intervention Tax-related topics Different viewpoints about government Organic view Society is an organism Mechanistic view Government used to reach individual goals Tiebout model: Find a community that is a good fit for the amenities that you want

The rest of this week… For Wednesday Wednesday’s lecture Read the syllabus, Chapter 1, and pages 18-28 and 506-512 Wednesday’s lecture Expected value Marginal analysis Empirical tools in microeconomics

Some ground rules at the end of lecture I will always try to be done by 3:15 pm In return, I expect your attention until the final slide If you must leave early: Please do so no later than 3:05 pm Sit near an exit Leave quickly and quietly Example of final slide

Some ground rules at the end of lecture After many of the lectures Problem solving Your questions (especially near test time) Review of old test questions You are welcome to leave after lecture is finished if I do problems Please do so quickly and quietly

With the remaining time today… Issues with crashers Any crashers not on the list? Any administrative issues Other questions

Have a good day