Public Finance 5530

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Public Finance 5530

• Introduction
• Topic One Market Failure

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What is Public Finance?

• the field of economics that studies government
  activities and the alternative means of financing
  government expenditures (Hyman, 1999)
• the taxing and spending activities of
  government (Rosen et al, 2003)
• how the revenue raising and expenditure
  decisions of government impact on the
  distribution of income, the pattern of resource
  allocation and both price stability and
  employment (Auld/Miller, 1982)

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Canadian Governmental System

• The basis is found (of course) in the
  Constitution
• It shall be lawful for the Queen, by and with
  the consent of the Senate and House of Commons,
  to make laws for the Peace, Order and Good
  Government of Canada, in relation to all matters
  not coming within the classes of subjects by this
  act assigned exclusively to the Legislatures of
  the Provinces

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This is the POGG Clause

• Things were done for the common good
• Think of how this made us different from
• m the Americans
• Life, liberty and the pursuit of happiness
• Individual versus communal
• Have we changed?

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Role of the Federal Government

• Federal Government has specific taxing powers
• The power to raise money by any system or mode of
  taxation
• Early taxes focused on imports excise
• With power to tax went responsibility
• Defense, navigation, trade, justice, banking,
  currency, and other areas

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Balancing Responsibilities

• Even in 1867, the Feds provided statutory
  subsidies to the provinces
• They were not expected to grow!
• Corporate (1916) and personal (1917) income tax
  came with WW1
• Initial personal rate was ½
• As time went on, the Feds assumed more spending
  control
• Conditional grants, CPP, EI.

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Provincial Level

• Originally restricted to direct taxation
• A direct tax is one imposed on the individual
  expected to bear the tax
• Now both levels occupy all major tax fields
• Major areas of provincial spending are health,
  education and welfare
• Transfers from the Feds help pay for these

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Municipal Government

• Only authority comes from that legislated to them
  by their provincial government
• Ex City of St. Johns Act
• Role of counties/regional governments?
• Currently there is an effort to change this
• Big City mayors coalition
• Municipal empowerment at the federal level
• Dominant source of revenue is property tax

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Where is the spending?

• Social welfare
• Health
• Education
• Infrastructure
• Transportation, communication, sanitation
  services
• Defense
• Debt servicing

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Market Failure

• Why do Governments need to be involved in the
  economy?

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Three Economic Questions

• Every economy must address
• What should be produced?
• How should it be produced?
• Who gets what is produced
• In our economy, we turn to the competitive market
  model to answer these questions

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The Joy of Competitive Markets!

• We can go to the store and get whatever we want,
  even if it comes a great distance!
• Link is supply and demand goods are available
  at a price the market is willing to pay
• Market activities are conducted out of self
  interest
• Not common good!
• When it works, markets are said to be efficient

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Efficient Markets

• In efficient markets, self regulation determines
  prices and quantities
• the invisible hand
• Certain assumptions are necessary (P. 4)
• Usefulness/enjoyment is derived from present and
  future consumption
• Established and enforceable property rights exist
• Markets exist for all goods
• Firms behave competitively (no impact on prices)
• No transaction costs to market participation
• Participants have complete information

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Fundamental Theorems

• Under the conditions necessary for efficient
  markets, there is no better allocation of
  resources than that generated by competitive
  markets.
• The government can foster equity by transfers
  from the advantaged to the disadvantaged

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What does this mean?

• The first theory refers to something called
  pareto efficiency
• For every winner, theres a loser (zero-sum game)
• While this is efficient, its not necessarily
  fair
• More individual than communal

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Can it be fair?

• The second theorem addresses fairness
• Fairness can be achieved by the redistribution of
  of income and wealth
• Gee, sounds like From each according to his
  abilities, to each according to his needs.
• Anyone know who said this?
• The redistribution of income/wealth is a
  legitimate role of government.

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When Assumptions are Violated

• If the assumptions underlying efficient markets
  are violated, we have a condition known as market
  failure.
• An example of this is what is known as a Public
  Good
• A good whose consumption benefits more than one
  person or group

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Public Goods

• Characteristics
• Non-rival in consumption providing the good to
  one person allows it to be provided to all at no
  additional cost
• Lighthouse
• In some cases, goods may also be non-excludable.
  This means that if they are provided to one
  person, they are automatically provided to all
  people
• Goods that are both non-rival and non excludable
  are referred to as Pure Public Goods.

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Public Goods

• In some cases, public goods are said to be
  congestible, in that the quality of the benefit
  for each person goes down as the number of users
  increases
• Park bench
• In these cases, market failure occurs as the
  first assumption (and the second for pure public
  goods) is violated.

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Who will provide?

• So who will provide a public good?
• Competitive firms would not be interested as
  pricing would be impossible
• Would have to be voluntary
• Free riders
• Too much common good here so society (through
  the collective action of their government) must
  provide them

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Externalities

• Market failure resulting from the violation of
  assumptions 1 and 2
• Occurs when anothers utility is affected through
  either consumption or production by another
• For example, pollution is non-rival property
  rights (ownership) is not enforceable.
• No market exists for pollution

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Common Property Resources

• Lack of ownership (property rights) means there
  is no economic incentive to keep a sustainable
  fishery
• Government has not created property rights
• The environment has the same issue who owns the
  environment? If theres no ownership, what
  incentive is there to act on the issue of global
  warming

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Imperfect Competition

• Types of imperfect competition
• Monopolies
• Some utilities (high entry costs)
• Companies holding special patents (Microsoft)
• Oligopolies
• Oil companies
• Monopolistic competition
• Sellers of unique products (sports teams)
• In all cases, firms can affect price given
  certain conditions

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Asymmetric Information

• It is assumed all market participants have
  perfect information
• Is this realistic what if you bought insurance
  and had the ability to influence the probability
  of the magnitude of a loss.
• The insurance company wouldnt know
• This is referred to as a Moral Hazard

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Role of Government

• Market failure can be addressed by government
• Regulation of natural monopolies
• Anti-trust laws
• Regulation/protection of common ownership
  resources
• Laws to regulate the impact of externalities