Public Finance

• Public finance is the field of economics that studies government activities and the alternative means of financing government expenditures.

Allocation of Resources

Resources are allocated between government and private use:

• For government use:- Roads- Schooling- Fire Protection

• For private use:- Food- Clothing

• Units of private goods and services are forgone by individuals so that government can provide goods and services.

Production Possibility Curve

The Mixed Economy

Characteristics of a mixed economy:

• Government supplies many goods and services

• Government regulates private economic activity

• Government expenditures equal ¼ to ½ of GDP

• Government participates in markets as a buyer of goods and services

Government Expenditures in the U.S.

• Government purchases divert productive resources from private use:- National defense

• Steel, labor

• Government transfer payments redistribute purchasing power among citizens:- Social benefits

• Social Security, Medicare

Government Expenditures, 1930 - 2008

Table 1.1 (abbreviated) – Billions of dollars

Year GDP Federal Government

State and Local

Government

Total Government

Percentage of GDPTotal

1930 91.2 2.8 7.9 10.7 11.73

1950 293.8 41.8 19.3 61.1 20.80

1970 1038.5 204.8 107.8 312.6 30.10

1990 5803.1 1301.5 668.1 1969.6 33.94

2008 14264.6 3247.2 1747.2 4994.4 35.01

Government Expenditures in the U.S.

International Comparisons

Country Government Current Expenditures as a Percentage of GDP 2008

France 52.5

Sweden 51.2

United Kingdom 45.4

43.4

Canada 39.6

United States 38.6

Japan 36.4

Germany

Distribution of Federal Expenditures

Structure of Federal Government Expenditure

Structure of Federal Government Expenditure

State and Local Government Expenditures

State and Local Government Expenditures

State and Local Government Comparison

Category State Local

Education 232 593

Health 40 39

Public Safety 12 77

Transportation 90 62

Public Welfare 50 7

Housing 10 40

Interest on General Debt 44 55

Total 863 1232

State and Local Government Comparison

Financing Government Expenditures

• Federal Government—Taxes

Financing Government Expenditures

Financing Government Expenditures

• State and local governments—Taxes, Federal Grants

Financing Government Expenditures

State and Local Government Comparison

Category State Local

Sales Taxes 358 90

Federal Grants 423 58

Income Taxes 278 26

Corporate Profits Taxes 50 7

Property Taxes 13 397

Education 85 25

Utilities 16 122

Total 1067 876

State and Local Government Comparison

Annual Budget Differential (billions)

Annual Budget Differential (% GDP)

Federal Debt (billions)

Federal Debt (% GDP)

Functions of Government

• Provide items we cannot easily make available for ourselves or purchase from others in markets

- Law enforcement and courts

• Redistribute income and economic opportunity- Income support for elderly, unemployed, poor

• Stabilize economic fluctuations- Recession/Inflation

• Regulate production and consumption- For improved health, elimination of excessive

monopolistic control over prices

How much government is enough?

How much should governments do, and how much should be left to private enterprise and initiative through market sale of goods and services?

Aging Populations & Public Finance

• Percentage of U.S. residents age 65 or older: 1950 – 8.3%; 2000 – 12.3%; 2050 – 21.1%

• Significant effects on Social Security and government-funded health care expenditures

• Tax rates to finance programs must increase or benefits to recipients must decline to avoid causing large federal budget deficit

Population Aging

Old-Age Dependency Ratios