Chapter 4 – The Public Sector

The U.S. Economy: Private and Public Sectors

Can The Market Fail?

• What does that mean?

Production? • When producing a product or service –

whether the government or the market…. Best mix of output required.

What are the factors that make up production?

• Optimal mix of output (inputs to outputs)

• What directs resources from one product or industry to another ????

• Prices

When the market fails… it is a double edge sword

Market Fails if not optimal mix.

* Optimal Mix of Output…… “Most desirable combination of output attainable with existing resources, technology and social values.”

Market Failure

*“An imperfection in the market mechanism that prevents optimal outcomes.”

Output decision- wrong point on PPC

• When market fails- government tends to step in:

Example: Banks fail (govt bails out)

Pollution (govt regulates externalities)

No city parks (govt incentivizes

builders to include in development)

Microsoft has monopoly (govt steps in

The Public Sector:Government’s role.

Questions to ponder:

• What is Public Sector?

• When do markets fail?

• Should government step in? (Too Big to Fail?)

In real words?Overproducing a good with external costsUnderproducing a good that has external

benefits.Not enough public parks…UNot enough care for environment…UNot enough welfare…OToo much separation between top 10% income

earners and median income earners…ONot adequate security within our borders….UToo many immigrants….?

Market FailureIs this evident in today’s market?

***market moves resources from one industry to another. (price directs resources) (demand responds) (price moves the resources then to another demand choice) (at this point (competition begins to prevail to level the prices)

• Changes in market prices directs resources• Question…. Is this movement of resources what

society really desires? Forcing small cars and aluminum trucks…If society does not want this market reallocation… should government intercede?

Market failure = (forces of S & D not leading us to BEST point on ppc… Who decides what is defined as BEST?

Enter…. Government intervention!

Will they perform magic? OR Will it be in worse shape?

How do you know if optimal mix is met?

Optimal mix of ANY GOOD or SERVICE =

MB = MC

(Marginal benefit = Marginal Cost)

If cost > than benefit… the failure occurs.

If benefit > than cost, then market is functioning according to other factors (price, demand, etc.)

Does this apply to our war against terror?

Government Can Enter the Market to correct when market fails…

Question……………….

Does government improve the mix or make it

1. More complicated

2. Less efficient

3. More costly (now to taxpayers)

• Governments Enter the Market to assure:

1. Public Goods

2. Externalities (positive or elimination of negative)

3. Market power

4. Equity

Property Rights must be fully defined in a competitive market to yield correct signals of market failure or success..or externalities are

created.

• (that means… “stuff will be manufactured depleting the environmental commodities (air, water, minerals, etc) because of the profit motive

While…

“stuff will not be produced (parks, flower gardens, etc) because of costs imposed with no direct benefit for those doing the production….. Hence, inefficiency of a market system.

Translation

If government and/or the consumer was not acting as a watchdog…. Would corporations be diligent about utilizing the proper mix of resources…If they are, can they compete?

Does that always mean regulation increased?Could it mean that consumer sovereignty

switches to another desire… BUT… what about things like energy… would we really know if the provider was efficient?

What is the tragedy of the commons?

Lake Michigan… who owns it?No, resources owned in commonDo we maintain our houses.. Own property? If we improve our property (paint, build-on) do we

most often recoup when we sell?No incentive for us to not pollute Lake Michigan.Hence, natural resources are overused and

degraded…(fish die, balance of nature upset)

Continued Concept of Common Assets

Resources, rivers, lakes, oceans, air… all fall into them absorbing pollution.

If manufacturers can dump wastes or discharge smoke without cost… they will do so.

Manufacturers will choose the least-cost combination of inputs and bear only unavoidable costs.

Many individuals avoid trash service if they can burn or dump their garbage.

No incentive for manufacturer to absorb internal costs for being good citizen

Remember the tomato canning factory example

Fallacy of composition applies here… persons and firms reason their amount of environmental destruction is not significant in the total…

Creating a Market for External Rights

Government creates a market for externality rights.

Pollution control agency… determines amount of pollutants permitted without upsetting balance of nature (in case of water… quality is maintained).

If say Lake Monroe can tolerate 500 tons of pollutants… then this is the amount permitted.

This is fixed amount. S

Demand for these rights is downsloping as for any other input…

Higher prices fewer rights purchased.. The manufacturer can either stop pollution, reduce pollution, or purchase from another manufacturer.

Higher demand… (more firms bidding, higher the price)

EPA set standards and market bids on rights

Do You Remember?

Collin County was reprimanded by EPA for polluting too heavily.

You saw businesses crop up for State Inspections….. Franchised to catch polluters (cars, emission controls, etc)

Two concepts to remember

• Public goods… can be equally consumed by all… no restrictions

Skateboarding in the park… Terrorists… can also go to the park… Illegal immigrants can go to school… Merit Goods.

• Private goods… consumption by one person excludes consumption by another..

( my doughnut… my car… etc)

Four Broad Categories of Public Goods Health and Hospitals

Indigent have to be treated

County medical centers

Sometimes charged on ability to pay Highways

State and federal government share the cost Education

State, Local and Federal government provide National Defense

National government provides 5 branches of armed services

Fed pays the entire cost!

Public Goods provided jointly to all would also include such things as:

national defense

monetary system

judicial system

Opportunity cost… if government provides health care, private sector cannot compete. Government “crowds” out the private .

**** Remember, the largest opportunity cost of an item supplied by government is the best alternative use that could have been made of the resources required to provide that good.

If government becomes too restrictive… Black Markets crop up.

examples… cigarettes, drugs, bootleggers, diet supplements, prescription drugs, etc.

Government can and does play an important role in markets…

Rule-maker

Umpire

What does that mean?

• U.S. Concept of Freedom for AllJoint consumption……….We all consume federal defense. (If hit by a

terrorist attack in FL… the entire U.S. is protected. (even non-citizens… even those who attack us.) Why? They are “free riders.”

People who pay most taxes actually contribute more for these services that we all enjoy. Many of us “ride free.”

2nd Area where Government Enters the Market - EXTERNALITIES

What are externalities? “costs or benefits of a market activity borne by a third party.”

Spillovers…an action when one individual or group harms the property of others without their consent.

Throwing trash in someone’s back yard Burning ties in the alley Playing your stereo loudly at 3:00 a.m. Businesses dumping wastes, sludge into rivers People trashing the beach or highway. Electric Companies burning phosphorous fuels

Spillover Examples that perpetrate on others

Calling police when loud party of teenagers next door (actions of teens imposing unwanted cost on neighbor)

Living in downstairs apartment.. Having upstairs neighbors doing Tai Bo when they get off work at 4:00 a.m.

Calling the city when a neighbor doesn’t keep his yard mowed on regular basis.

Externalities can be positive or negative

Homeowners keep lawns immaculate (benefits the neighborhood)

Scientific study for polio vaccine (others benefit beyond scientists’ recognition)

Measles Vaccinations. Education……. How would this be a

benefit?

How can spillovers be corrected?Most obvious way is Legislation.

1. To prohibit

2. To heavily tax the specific product and manufacturer. Tax would be derived to allow for off-setting the clean-up cost. (Super Fund is example)

3. Subsidize both consumers or producers

4. ***Tax incentives… if reduction of pollution and compliance adhered to, taxes reduced.

There are actually quasi corporations AND quasi public goods?

Quasi-Public Goods.,,

Any g & s that is provided by private sector,but is not provided in quantities demanded. Government can assist in this allocation of resources.

(Parks, Zoos, Educational Institutions)

3rd Area where Governments enter the market to assure accessibility to market power

Regulating Economic ActivitiesEnsuring competition- Sherman 1890, Clayton 1914…Antitrust regulation- (FTC)(Microsoft)

Drug Industries (FDA)Congress is investigating at this time -(drugs in Canada)

Regulating working conditions. (EEOC, OSHA)Public utilities (legal monopolies (some states)Controlling social costs: (diseconomies of scale.Cost of ruining seashore by off-shore drilling.)Securities Industry (SEC) (accounting fraud, etc)

4th Area addressed by government is Equity or perhaps better stated as

Inequity.(ensuring market economy)1)Inadequate income (redistribute to have-nots)

2) Merit goods (everyone entitled to some minimum of food,clothing, shelter) In-kind transfers in food stamps, housing vouchers, health clinics)

3)Social Security and unemployment compensation protect people’s economic security by providing money when they retire or are unable to work.

• SOURCES OF GOVERNMENT INCOME

• TAXES

• Why must government tax?

• What is a fair tax?

• Who should pay?

• The primary function of taxes is to transfer command over resources (purchasing power) from the private sector to the public sector.

Income Taxes

• The Sixteenth Amendment to the U.S. Constitution (1915) granted the federal government authority to collect income taxes.

• It is now the largest single source of government revenue.

What Determines a Fair Tax?Very few people think a fair tax? of taxes as

payment for certain services rendered. • When we purchase a new coat, we have chosen an

item in the market system…pay for it… use it.• We don’t think of that when we call the fire

department or the police department…even if we are delinquent on our taxes, they still show up.

• What if the fire department or police left a bill? Ambulance services do…. Should they?

• How should taxes be assessed?---benefits received----ability to pay!

Benefits Received:

Tax the user- gas tax for drivers- fishing license-ramp fees for boats- toll roads-bus and train tickets-

Pay the government for benefits received- can’t pay for welfare received!

Ability to Pay• Should wealthy pay more

regardless of benefits received?

• Should income and family size be assessed?

• Determining fairest principle for a just tax is matter of values rather than economics and is determined by our political process.

• Executive Budget for 2015 wants anyone $665,00 up to pay more.

Other Factors in Evaluating Taxes Total Revenue yielded Effect on Production (destroy incentive?) Bracket Creep (AMT) Moral consequences (sin taxes) Reflection of values shown in taxes imposed Convenience (withholding, quarterly, penalties) Shifting the burden (seller to consumer) Ability to pay (relation of tax base to tax rate)Tax rate= percentage that is taxedTax base = subject on which the tax is levied.

• Types of Taxes

• Progressive = tax rate increases as the tax base increases

• Proportional = tax rate remains the same regardless of the base

• Regressive= tax rate decreases as the base increases. (often cited as unfair because it places heaviest burden on the least able to pay ---sales tax--- social security tax.)

Federal Government Tax System• Federal government gets most of its revenue from

individual and corporate income taxes.• Next largest amount from Social Security tax• Very small portion of revenue from estate and gift

taxes.• Larger share from excise taxes (gasoline, jewelry,

alcohol, cigarettes, motor vehicles, admission to entertainment events,tires)

• Small portion from tariffs.

Where Does All the Money Go?In 2013, the major entitlement programs - Social Security, Medicare, Medicaid, and other health care consumed 49 percent of all federal spending. These programs, and interest on the debt, are on track to consume an even greater share of spending in future years, while the portion of federal spending dedicated to other national priorities will decline.SHARE OF FEDERAL SPENDING IN 2013

                                                                                                                                                                                         

Consumption Tax

Greenspan said 3/3/05 “taxing consumption instead of income would help promote economic growth,” But warned that a “switch” raises a challenging set of transitional issues.

*What is a consumption tax?*Where is it levied?*Who would this hurt the most?

Types of Taxes We PayPERSONAL INCOME TAX

Progressive with marginal tax rates

Marginal tax rates = those assessed on additional income ranging from 10 to 35%

Individuals may deduct: Interest on Home mortgages and

Property TaxesInterest on State and local bonds

Sales TaxAt first glance… sales tax would appear to be

proportional…. Why is it not?Sales Tax is regressive?Larger portion of a low-income person’s income is

exposed to the tax than is a person with higher income.

Rich pay no tax on the part of their income that is saved when they can shelter it… poor are unable to save.

It is a % of income that allows it to become regressive

Note in Tax Law effective 2005Now in Texas…. We can deduct from our

gross income the amount of sales tax that we paid in the tax year reporting. Was renewed for 2014, 2015 still not sure.

Can keep all receipts and add up or use the IRS tax table.

Payroll TaxesMEDICARE AND SOCIAL SECURITYRegressive

Medicare Tax…. 1.45 on all wage income Average payroll tax falls (percentage wise) as

income rises.

• HISTORY OF SOCIAL SECURITY

Began in 1937 as OASDHI

Program of compulsory savings financed from compulsory payroll taxes levied on employees and employers.

Social Security is a regressive tax

History of OASDHI Contributions1937-50 -$3,000 1990 - $51,300 2001 - $80,4001951-54 - $3,600 1991 - $53,400 2002 - $84,9001955-58 - $4,200 1992 - $55,500 2003 - $87,0001959-65 - $4,800 1993 - $ 57,600 2004 - $87,900

2005 - $90,000 2006

- $94,200 2007 - $97,500

*1972 - $9,0001974 - $13,2000 1994 - $60,600 1

1995 - $61,2001976 - $15,300 1996 - $62,7001980 - $25,900 1997 - $65,4001985 - $39,600 1998 - $68,400

1999 - $72,6002000 - $76,200

Since 1981- amounts determined under automatic adjustment provisions of the SS Act

Social Security –Wage Base 2015=$118,500The wage base is increased every January as long as the

fund is deficient… which is probably forever now because:

• People live longer, retire earlier, more drawing on fund (disabled, single parents, etc.)

• Ratio of retirees/workers was significantly reduced by year 2010.

• Eighteen year olds in 2002 will pay over a million and a half dollars into SS. Benefits received????

• SS payroll tax today is 7.65 (FICA= 6.2% SS + l.45% Medicare) 6.2% of your wages are withheld. Your employer matches that amount for the required contribution to the SS Fund up to the wage base amount for that year.

Social Security Continued

• The employer also matches the Medicare contribution of 1.45% of your monthly earnings and there is no ceiling on this amount. Hence, this is a continual tax deduction from your earnings.

• if self-employed 15.3 (12.4 SS + 2.9 Medicare) Wage base applies to SS but no limits on Medicare.

As a self-employed person, you get to take a special deduction from your income when it comes time to pay your federal income tax.(l/2 of SS paid goes under deduction for adjusted gross income)

Economics of Transfer PaymentsRedistribution through public sector will

reduce the size of the economic pie:Weakens the link between productive

activity and reward (taxes increased reduce individual reward for hard work-less productive.

As public policy redistributes large share of income,more resources flow into increasing it

Economics of TransferHigher taxes to finance redistribution will

induce taxpayers to focus less on income producing activities and more on income shelters *higher incomes have greater opportunity here

When leakages flow in taxes rather than in savings (money is unproductive)

Money that is productive generates more capital

More capital generates more jobs.More jobs generates more income.

Merit GoodsThe government is called upon to distribute merit

goods when the market does not provide enough.• A merit good is a good or service society deems

everyone is entitled to some minimal quantity . Public goods have two particular characteristics. They are:

1. Non-excludable - once the goods are provided, it is not possible to exclude people from using them even if they haven't paid. This allows 'free-riders' to consume the good without paying.

2. Non-rival - this means that consumption of the goods by one person does not diminish the amount available for the next

• Taxes paid today go to pay benefits for people drawing today.

• Do you think there is a “special fund” where the SS dollars go???

Continued SS Funding• Today 3+ workers for every person drawing.

(extra money in fund invested in U.S. Treasury bonds)

• Number of retirees is increasing and number of workers/retiree is decreasing. In 30 years 2+ workers for every person drawing.

• By 2016 - U.S. paying out more in retirement benefits than collecting

• By 2038- the fund is projected to be empty –(spring,2004, released data that said 2052)

• Re-design of system is imperative.

More Grim Statistics Concerning SS70% of SS goes to retirees - avg monthly benefit of

$898.2015% to disabled workers and familiesMay, 2003- avg benefit for disabled workers was

$837.7015% goes to widows, widowers, and families – avg

check of $850.80By 2030-twice as many older Americans 35

million to 70 million. Now there are 3.4 workers for every beneficiary… by 2030 there will be just 2.1 workers for each beneficiary.

“Nobody gets any if their ain’t none!”Incredible Bread Machine, script, 1970

• EXPLAIN

Back to Tax Structure!So… realizing how many poor people there are

in the U.S…………Which of the three types of taxes would you prefer the federal government to use?Which tax for state government to use?Which tax for local government to use?

How would you fund schools if you had a vote?How about taxing wealthy more?Who are wealthy?What is considered “poor?”

POVERTY LEVEL2014 POVERTY GUIDELINES FOR THE 48 CONTIGUOUS STATES

AND THE DISTRICT OF COLUMBIA

Persons in family/household

Poverty guideline

For families/households with more than 8 persons, add $4,060 for each

additional person.

1 $11,670

2 15,730

3 19,790

4 23,850

5 27,910

6 31,970

7 36,030

8 40,090

MORE INTERESTING FACTS• MEDIAN INCOMES in U.S.

1974 = $14,747 According to a separate1978 = $20,428 report from the Census1982 = $27,619 Bureau (last week of Sept1986 = $34,716 2002), American 1990 = $41,451 households had taken a1993 = $45,161 beating during last year’s1997 = $53,350 recession & unemployment2000 = $62,228

Median Continued, 2002 $43,381

2003 $43,318

2005 $46,326

2007 $50,233

2008 $44,389

2013 $52,250

Income Distribution in Fifths

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Lowest Second Third Fourth Top 5%

Income l/5s in 2001Income l/5 in 2002

The first fourth are$ figures at the upperLimit of each 5th $Figure… The top 5% Is not…

Personal income is unequally distributed in U.S. Top

20% of households receive almost 50% incomeTo redistribute equally… all bars on the 20%

0

10

20

30

40

50

60

Lowest Third HighestFifth

%Household incomefifths 2001% Household incomefifths 1997

20011= 3.52= 8.73= 14.64= 23.05= 50.2

19971= 3.6.2= 8.83= 15.04= 23.25=49.4

Income Inequality

Why is the U.S. Economy owing billions of dollars?

“If you subsidize something you get more of it.”

Dr. Milton Friedman, Free to Choose

• Virtually all of the recent growth in federal expenditure has come from increased income transfers, not purchases of goods and services.

So, it all gets back to Joe Q Citizen… Taxes paid to government.

Question is:

What kind of an economy do we Joe Q’s want?

The primary function of taxes is to transfer command over resources (purchasing power) from the private sector to the public sector.

Why from private to public? Why not the other way around?

• Other Resources to Check http://www.brook.edu/

http://www.ncpa.org

http://www.ntu.org/ http://www.cagw.org/site/PageServer

State and Local Tax Sources

STATE TAX SOURCES

Corporate 6%Property 2%

Other9%

Income35%

Sales48%

LOCAL TAX SOURCES

Other 6%

Sales 15%

Income 6%

Property73%

“POWER CORRUPTS AND ABSOLUTE POWER CORRUPTS ABSOLUTELY!”

Lord Acton

“POWER TO TAX IS POWER TO DESTROY”

Chief Justice John Marshall…. McCullough vs Maryland

Who is best equipped to distribute resources?