© 2005 Thomson C hapter 29 Government Spending

© 2005 Thomson 2 Gottheil - Principles of Economics, 4e Economic Principles Public goods Merit goods Transfer payments

© 2005 Thomson 3 Gottheil - Principles of Economics, 4e Government Spending and Public Goods Public good A good whose benefits are not diminished even when additional people consume it and whose benefits cannot be withheld from anyone.

© 2005 Thomson 4 Gottheil - Principles of Economics, 4e Government Spending and Public Goods 1. Which of the following offers the best example of a public good: a. Lift tickets sold at ski resorts b. A network of street lights c. Restaurant meals

© 2005 Thomson 5 Gottheil - Principles of Economics, 4e Government Spending and Public Goods 1. Which of the following offers the best example of a public good: a. Lift tickets sold at ski resorts b. A network of street lights c. Restaurant meals

© 2005 Thomson 6 Gottheil - Principles of Economics, 4e Government Spending and Public Goods A private good, such as a lift ticket or a restaurant meal, is exclusively the property of the person who bought it. That person can prevent others from using the good. 2. What does the nonexclusiveness property of public goods mean?

© 2005 Thomson 7 Gottheil - Principles of Economics, 4e Government Spending and Public Goods 2. What does the nonexclusiveness property of public goods mean? Public goods such as street lights are not exclusive, and nobody can be denied the benefits of the lighting.

© 2005 Thomson 8 Gottheil - Principles of Economics, 4e Government Spending and Public Goods 3. What does the nonrival property of public goods mean? It means that use by one person does not subtract from what is available for others. Examples include street lights and public radio.

© 2005 Thomson 9 Gottheil - Principles of Economics, 4e Government Spending and Merit Goods Merit good A good that market demand and supply do not produce enough of.

© 2005 Thomson 10 Gottheil - Principles of Economics, 4e Government Spending and Merit Goods What are some examples of merit goods? Public-supported colleges and universities Public-supported arts and health care Libraries and museums

© 2005 Thomson 11 Gottheil - Principles of Economics, 4e EXHIBIT 1FEDERAL, STATE, AND LOCAL GOVERNMENT SPENDING: 2001 ($ BILLIONS) Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2002).

© 2005 Thomson 12 Gottheil - Principles of Economics, 4e Exhibit 1: Federal, State, and Local Government Spending: 2000 ($ billions) 1. Which level of government (federal or state/local) is the largest purchaser of goods and services? State and local

© 2005 Thomson 13 Gottheil - Principles of Economics, 4e Exhibit 1: Federal, State, and Local Government Spending: 2000 ($ billions) 2. In which category of government spending are Social Security contributions and benefits recorded? Transfer payments

© 2005 Thomson 14 EXHIBIT 2GOVERNMENT SPENDING IN 2001, BY FUNCTION ($ BILLIONS) *The minus figure represents subsidies less current surplus of government enterprises. **Interest paid less interest received by government. Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2002).

© 2005 Thomson 15 Gottheil - Principles of Economics, 4e Exhibit 2: Government Spending in 2001, By Function ($ Billions) 1. What is the largest single functional category of expenditure by the federal government? Income support, Social Security, and welfare.

© 2005 Thomson 16 Gottheil - Principles of Economics, 4e Exhibit 2: Government Spending in 2001, By Function ($ Billions) 2. What is the largest single functional category of expenditure by state and local government? Education

© 2005 Thomson 17 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Over the period , the annual rate of increase in government spending on elementary, secondary, and higher education, measured in constant dollars, was about 3 percent.

© 2005 Thomson 18 Gottheil - Principles of Economics, 4e EXHIBIT 3GOVERNMENT SPENDING ($ BILLIONS) ON SECURITY: 2001 Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2002).

© 2005 Thomson 19 Gottheil - Principles of Economics, 4e Exhibit 3: Government Spending on Security: 2001 Complete the sentence: The two largest security expenditure categories by state and local government were _____ and _____.

© 2005 Thomson 20 Gottheil - Principles of Economics, 4e Exhibit 3: Government Spending on Security: 2001 Complete the sentence: The two largest security expenditure categories by state and local government were police and prisons.

© 2005 Thomson 21 Gottheil - Principles of Economics, 4e Exhibit 3: Government Spending on Security: 2001 The burden of national defense spending exclusively falls upon the federal government.

© 2005 Thomson 22 Gottheil - Principles of Economics, 4e How Much Does Government Spend? The budget for veterans’ benefits and services is dominated by disability and survivor compensation.

© 2005 Thomson 23 Gottheil - Principles of Economics, 4e EXHIBIT 4FEDERAL, STATE, AND LOCAL GOVERNMENT SPENDING ON EDUCATION: 2001 ($ BILLIONS) Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2002).

© 2005 Thomson 24 Gottheil - Principles of Economics, 4e Exhibit 4: Federal, State, and Local Government Spending on Education: 2001 ($ billions) 1. True or false: Total education spending is dominated by expenditures on elementary and secondary education. True. Elementary and secondary education consumes nearly three- quarters of the total education budget.

© 2005 Thomson 25 Gottheil - Principles of Economics, 4e Exhibit 4: Federal, State, and Local Government Spending on Education: 2001 ($ billions) 2. True or false: The federal government provides financial support for higher education, but not for primary or secondary education. False. The federal government provides some financial assistance at all levels.

© 2005 Thomson 26 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 1. What percentage of total government spending goes to international aid: a percent b. 8.9 percent c. Less than 1 percent

© 2005 Thomson 27 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 2. Which of the following has the larger percentage of total government spending: a. International aid b. Conservation and natural resources

© 2005 Thomson 28 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 2. Which of the following has the larger percentage of total government spending: a. International aid b. Conservation and natural resources

© 2005 Thomson 29 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Other than telecommunications, there has been relatively little commercial motive for space travel. Federal spending on space exploration was $11.3 billion in 1996.

© 2005 Thomson 30 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 3. What common denominator is there for government spending on security, education, transportation, natural resources, energy, and space? For each of these, the target population of beneficiaries is everyone.

© 2005 Thomson 31 Gottheil - Principles of Economics, 4e How Much Does Government Spend? In contrast, agricultural subsidies are targeted at benefiting farmers, and public assistance programs are targeted at benefiting the poor and needy.

© 2005 Thomson 32 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Welfare Government-provided assistance—cash payments and goods and services—to the poor, the elderly, and the disabled. Eligibility is based principally on income and size of family.

© 2005 Thomson 33 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Until recently, eligibility for welfare was linked to single- parent families (Aid to Families with Dependent Children, AFDC) and to the sick or disabled (Supplemental Security Income Program, SSI).

© 2005 Thomson 34 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Eligibility for AFDC and SSI meant entitlement, with no time limit specified.

© 2005 Thomson 35 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 4. What new welfare program was created in 1996 and abolished AFDC? Temporary Assistance for Needy Families (TANF).

© 2005 Thomson 36 Gottheil - Principles of Economics, 4e How Much Does Government Spend? The new TANF program is not an entitlement. Welfare recipients must participate in work activities within two years of receiving welfare or risk losing it.

© 2005 Thomson 37 Gottheil - Principles of Economics, 4e How Much Does Government Spend? In addition, a family is only eligible for a lifetime total of five years of welfare benefits.

© 2005 Thomson 38 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Food stamp program An aid program that provides low-income people with stamps that can be redeemed for food and related items.

© 2005 Thomson 39 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Medicaid A health care program administered through Social Security that is applicable to low-income and disabled people.

© 2005 Thomson 40 Gottheil - Principles of Economics, 4e How Much Does Government Spend? Social Security A social insurance program that provides benefits, subject to eligibility, to the elderly, disabled, and their dependents.

© 2005 Thomson 41 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 5. Which of the following are true about Social Security: a.It is compulsory. b.b. Everyone receives the same level of benefits. c. Your contributions are saved in an individual account that you can invest in stocks or bonds.

© 2005 Thomson 42 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 5. Which of the following are true about Social Security: a. It is compulsory. True. b. Everyone receives the same level of benefits. False. c. Your contributions are saved in an individual account that you can invest in stocks or bonds. False.

© 2005 Thomson 43 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 6. What is the purpose of Medicare? Its purpose is to reduce the financial burden of illness on the elderly.

© 2005 Thomson 44 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 7. How are Social Security and Medicaid funded? Social Security and Medicaid are pay-as- you-go programs that are financed through payroll taxes. The revenues go in to a trust fund from which benefits are paid out.

© 2005 Thomson 45 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 8. With the proportion of elderly in the U.S. population growing, what are the future prospects for Social Security and Medicaid? As pay-as-you-go programs financed through payroll taxes, they are at risk because benefit demands are growing relative to the pool of working-age people paying the taxes to support the programs.

© 2005 Thomson 46 Gottheil - Principles of Economics, 4e Welfare Reform and Low- Skilled Employment Welfare reform was based on the premise that welfare recipients choose not to work because benefits with no time limits provide a disincentive to find work and leave welfare.

© 2005 Thomson 47 Gottheil - Principles of Economics, 4e Welfare Reform and Low- Skilled Employment Cutting off welfare after a fixed length of time is supposed to serve as a much-needed “kick in the pants” to get easily employable people into jobs.

© 2005 Thomson 48 Gottheil - Principles of Economics, 4e Welfare Reform and Low- Skilled Employment A 1992 survey found that 44 percent of mothers on welfare (AFDC) had not completed high school. Another survey found that most AFDC recipients are at the lowest two levels of literacy.

© 2005 Thomson 49 Gottheil - Principles of Economics, 4e Welfare Reform and Low- Skilled Employment Consequently the problem is that there is a huge gap between the skills that most welfare recipients have and the skills that most employers require.

© 2005 Thomson 50 Gottheil - Principles of Economics, 4e EXHIBIT 5SOCIAL SECURITY EXPENDITURES AS A PERCENTAGE OF GDP FOR SELECTED ECONOMIES: 1996 Source: World Labour Report 2000 (Geneva: ILO, 2000), p. 313.

© 2005 Thomson 51 Gottheil - Principles of Economics, 4e Exhibit 5: Social Security Benefits as a Percentage of GDP for Selected Economies: Among the other rich industrialized countries listed in Exhibit 6, how does the U.S. rank in terms of Social Security benefits as a percentage of GDP? Social Security as a percentage of GDP is 2nd lowest (among those listed) in the United States.

© 2005 Thomson 52 Gottheil - Principles of Economics, 4e Exhibit 5: Social Security Benefits as a Percentage of GDP for Selected Economies: What conclusions might one draw from Exhibit 6? Social Security is much less of a burden on the U.S. economy relative to many comparable industrialized countries.

© 2005 Thomson 53 Gottheil - Principles of Economics, 4e How Much Does Government Spend? As of 1996 the U.S. paid $277.1 billion in interest on the national debt. 9. How much does the U.S. spend each year as interest on the national debt, and how did this figure change during the 1980s?

© 2005 Thomson 54 Gottheil - Principles of Economics, 4e How Much Does Government Spend? 9. How much does the U.S. spend each year as interest on the national debt, and how did this figure change during the 1980s? Both the size of the national debt and the annual interest payments it creates grew considerably in the 1980s.

© 2005 Thomson 55 Gottheil - Principles of Economics, 4e Is the Level of Government Spending Too High? After learning about the different elements of government budgets, it becomes evident that wholesale cuts in government spending are difficult to advocate.

© 2005 Thomson 56 Gottheil - Principles of Economics, 4e EXHIBIT 6GOVERNMENT SPENDING: 1970–2001 ($ BILLIONS) Source: Economic Report of the President, 1997 (Washington, D.C.: U.S. Department of Commerce, 2000); Survey of Current Business, October 2003.

© 2005 Thomson 57 Gottheil - Principles of Economics, 4e Exhibit 6: Government Spending: ($ billions) What has been the trend in the ratio of total government spending to GDP since 1970? It has more than tripled.

© 2005 Thomson 58 Gottheil - Principles of Economics, 4e Exhibit 6: Government Spending: ($ billions) What has been the trend in the ratio of total government spending to GDP since 1970? The ratio of total government spending to GDP was 31.6 in 2001.

© 2005 Thomson 59 Gottheil - Principles of Economics, 4e EXHIBIT 7GOVERNMENT SPENDING AS A PERCENTAGE OF GDP: 1981–99 Source: Organisation for Economic Co-operation and Development, calendar year data.

© 2005 Thomson 60 Gottheil - Principles of Economics, 4e Exhibit 7: Government Spending as a Percentage of GDP 1. Of the countries shown in Exhibit 7, what has happened to the percentage of government spending to GDP since 1993? All have gone down slightly.

© 2005 Thomson 61 Gottheil - Principles of Economics, 4e Government Spending and Resource Allocation A key distinction between government spending and transfer payments is that government spending takes resources away from production of private goods.

© 2005 Thomson 62 Gottheil - Principles of Economics, 4e Government Spending and Resource Allocation In contrast, transfer payments shift spending from one group of people to another, and do not take resources away from production of private goods.

© 2005 Thomson 63 Gottheil - Principles of Economics, 4e Government Spending and Resource Allocation The purchase of private goods and services funded by transfer payments substitutes for the taxpayers’ purchase of private goods and services.

© 2005 Thomson 64 Gottheil - Principles of Economics, 4e Government Spending and Resource Allocation Aside from transfer payments, government spending represents approximately 15 percent of GDP.