Public Goods, Taxes & Income Distribution Chapter 11

Public vs. Private Goods Public Goods Goods that are neither excludable nor rival in consumption Private Goods Goods that are both excludable & rival in consumption Excludable- consumer who can not pay are excluded Rival- consumption by one reduces quantity for others Public Goods: clean air, police protection, radio signals, national defense Private Goods: Food, Coffee, airline tickets

Problems with Public Goods Free-rider- a person who receives the benefit of a good but avoids paying for it Examples: “Slacker” in group work at school Volunteer money for neighborhood cleanup Fundraising for Fire Department

Public Good Efficiency When goods are available free of charge => market forces will not allocate resources efficiently Government should collect taxes & provide public goods when: Total Benefits ≥ Total Costs Examples: National Defense Basic Research Fighting Poverty Fireworks on 4th of July

Tragedy of the Commons Common Resources – “commonly” owned resources rival in consumption but nonexcludable Example: fish in ocean, the environment Tragedy of the Commons- the absence of incentives to prevent “overuse” & depletion of a common resource

Types of Taxes Progressive Tax- Regressive Tax- Tax Incidence: Income ↑ => Average Tax Rate ↑ Example: U.S. Federal Income Tax Regressive Tax- Income ↑ => Average Tax Rate ↓ Example: Sales Tax, Gasoline Tax, Bridge Tax Proportional Tax Income ↑ or ↓ => Average Tax Rate stays the same Example: Flat Income Tax, Corporate Taxes Excise Tax Flat fee per unit, paid at purchase Example: Cigarettes, Gasoline (both are also regressive in tax incidence) Tax Incidence: Who Pays?

} Progressive Income Tax Tax Brackets Example: If you Earn $100,000   Total:   $ 22,746 Actual Tax Rate: 22.7%

Income Distribution & Lorenz Curve Egalitarian Society- equal society How to best measure Inequality: Average Income: incomplete measure often inaccurate Distribution of Income more precise measure of inequality Lorenz Curve illustrates income distribution

Gini Index Summary Measures the distance from line of “perfect equality” to Lorenz Curve Gini Index ranges from Zero to 1 An index of 0 (zero) means perfect EQUALITY (on line) As the Gini Index moves from 0  1 inequality increases

Practice Test: Public Goods

U.S. Gini Index Comparison U.S.A. .46 Japan .26 Germany .32 France .33 Bolivia .58 Brazil .59

Tax Cut Controversy