1. Public Finance
Session1 - Definition

2. Defined
Public finance is about the taxing and spending activities of the government.
Also known as “public sector economics” or “public economics.”
The fundamental issues are not financial but relate to the use of real resources.
“micro” functions : allocation of resources, distribution of income.
“macro” functions : use of taxing, spending and monetary policies to affect overall level or GDP or unemployment.
Focus is on microeconomic functions of government – polices that affect overall unemployment or price levels are left for macroeconomics.
Scope of public finance unclear – government has role in many activities, but focus will be on taxes and spending.

3. What is public finance ?
By tradition (Musgrave), three roles devoted to the public sector :
Allocation: Public good provision
Redistribution : social transfers, progressivity in the tax system
Stabilization : “automatic stabilizers”
Do these 3 objectives conflict ? The answer is yes.
Trade-off efficiency/equity
Room for macroeconomic stabilization

4. Three roles Allocation
Justifications for the State intervention in the provision of public goods are well known: the very nature of public goods, externalities, … justice, defense, security, education, health…but also direct interventions to corporations and individuals.

5. Three roles
Distribution
Social insurance, horizontal and vertical distribution.
Difficult to disentangle from the third function (stabilization): insurance aims at avoiding hysteresis effects in bad times (unemployment insurance, on-the-job training, minimum benefits)

6. Three roles Stabilization
Size and effectiveness of automatic stabilizers
Justifications for discretionary action along the business cycle

7. Public Finance and Ideology
How should a government function in economic sphere?
Ideology influences the way economists think on how the government functions.
Political thinkers distinguish between two major approaches.
Organic view – community stressed above individual. Goals of society set by the state.
Mechanistic view – government is a contrivance created by individuals to better achieve their individual goals. Individual, not group, is at center stage.

8. Organic view of govt
Society is seen as an organism, with each individual being part of the organism.
The govt is viewed as the heart.
The individual is important only as part of the society or the whole.
The objectives of the society are set by the state.
Proponents of the organic view usually argue that certain goals are natural for the societal organism to purse. E.g. pursuing sovereignty.

9. Mechanistic view of govt
Government is not an organic part of society but is a tool made by individuals to better achieve their individual goals.
The individual rather than the group is at the centre stage.
Govt exists for the good of the people.
To protect individuals from violence and invasion.
According to Adam Smith should create and maintain public works and institutions

10. Government at a Glance Legal framework Federal government
No real constraints on spending in Constitution
Taxes must originate in the House of Representatives.
Equal tax rates across states.
Income tax came from 16th amendment to Constitution.
Can run budget deficits
State and local government
Can impose spending / taxing restrictions on itself.
Many states cannot run budget deficits.

11. Government at a Glance Size of government – how to measure?
Number of government employees
Annual expenditures
Purchases of goods and services, transfers, and interest payments
Unified budget – the document which itemizes all the federal government’s expenditures and revenues at state and local levels.
If expenditures go up people conclude that government has grown.

12. Government at a Glance
These numbers ignore activities that do not have explicit outlays, but substantial effects on resource allocation.
Regulations, for example.
Conceivably, could construct a “regulatory budget” to account for these costs, but difficult to compute.

13. Government Expenditure
Some SA numbers
Annual expenditures have grown strong from 28.3% in 2006/7 to 34.1% in2009/2010 as a percentage of GDP.
This was attributed to countercyclical measures to downswings in the economy
Eskom loan
In the medium-term govt expenditure is expected to moderate

14. Table 1.1

15. Government Expenditure
United States versus other developed countries.
U.S. public sector is quite small compared to Sweden or France, and smaller than all the countries listed.
Although large, the U.S. government is small in relative terms. More reliance on private sector.

16. Table 1.2

17. Figure 1.1

18. Government Expenditure
Much of the government budget consists of entitlement programs – programs with costs determined by number of people who qualify.
Social Security, Medicare, welfare
Three-quarters of the federal budget is relatively uncontrollable, because of these entitlements.

19. Government Expenditure
Federal government responsible for about 45% of direct expenditure.
State governments responsible for 25%.
Local governments responsible for 30%.
State & local governments primarily responsible for police & fire protection, education, transportation, and some welfare programs.

20. Government Revenues
Federal taxes mainly consist of individual income taxes, payroll taxes, and corporate taxes.
Personal income tax 43% of collections.
State & local taxes mainly consist of property taxes, sales taxes, individual income taxes, and grants from federal government.
Less reliance now on property tax, more on income tax.