public finance

1. Public Finance
Instructor: John Hartman
Today: An introduction to Econ 130
Introduction to public finance
The role of government

2. First issue: Crashers
 Current cap: 60 students
 Crash list
 You must be on the department wait list to be
considered for this class if you are not registered
 I will hand out a crash list for you to fill out also
 No add codes distributed until next week
 Enrolled students get priority for seating
 Later option for Econ 130
 This class is usually offered each fall

3. Before we begin…
 Remember that this is a small class  Ask
questions if things are not clear
 The syllabus is posted online  See
http://econ.ucsb.edu/~hartman/
 For most of you, attendance is important if
you want to get a good grade
 If reading this size font is difficult, I urge you to sit near the front

4. Before we begin…
 I expect you to know the following tools
 Calculus
 Derivatives, integrals, partial derivatives
 Microeconomics
 Econ 1, Econ 100A or 104A, Econ 100B or 104B
 Macroeconomics (although not as important for this public
finance class)
 Econ 2, Econ 101 or 105
 If you are lacking on any of these skills, please
make sure you are comfortable with these skills by
next week

5. Structure of learning
 Read first
 Lectures & problem solving in class
 Do more problems on your own
 Prepare for test
 Some time in class to review
 Come to office hours if needed
 Additional office hours will likely be offered close to tests

6. Textbook for this class
 Rosen/Gayer
 Public Finance, 9th edition
 Published by McGraw-Hill/Irwin

7. Reading the textbook
 Main text and appendix is 560 pages
 Too much for a 30-hour class
 Look at syllabus for reading assignments
 Maximum of 50 pages per week
 Maximum of 300 pages overall

8. Office hours and review sessions
 Office: NH 2028
 Office hours:
 Mondays 2:15-3:15 pm
 Wednesdays 9:15-10:15 am
 Additional office hours before test will be in a
larger classroom if demand warrants it

9. Tests
 Three tests, as of now scheduled for:
 Monday, April 26 (in lecture); 65 minutes
 Monday, May 17 (in lecture); 65 minutes
 Tuesday, June 8 (final, Noon-2:30 pm); 140
minutes
 Some problems on tests will be similar to
what we cover in practice problems
 Some questions will require you to learn
material and think your way through

10. Extra credit
 To encourage dialogue and discussion in
class, each student that makes at least one
intelligent question or comment during the
quarter in lecture will receive one percentage
point added to her or his final grade
 In order to receive your extra credit, you will
need to include your name when you state
your question or comment

11. Lecture slides
 I will post a subset of lecture slides on-line
 Usually posted 2 days to a week before lecture
 On-line slides are not meant to be a
replacement to lecture

12. Grading
 If you do not miss a test:
 Two best tests count 40% each
 Lowest test counts 20%
 Exception: If your best test is the final, the final
will count 60% and the other two tests count 20%
each
 If you do miss a test, check the syllabus for
details

13. Grading
 I try to write tests so that the average score is
between 60-80% (of the second best student)
 In other words, don’t worry if everything is not correct
 Previous Econ 130 classes
 20-25% A+, A, or A-
 35-45% B+, B, or B-
 30-35% C+, C, or C-
 Remaining students: D+, D, D-, or F
 Some Econ 130 classes are stronger than others

14. More on this class
 Early on, I will lecture the entire time
 Later on many lectures will be about 50-60
minutes, followed by problem solving
 Most lectures will be devoted to a single topic
 Some topics will require more than one lecture
 A few lectures will cover multiple topics

15. Problems
 Problems have been posted on the class
website for you to practice on
 I will also do some problems at the end of
many lectures
 As we get closer to each test, I will devote
some time to solving problems on the class
website

16. Today
 What is public finance?
 An introduction to Econ 130
 What will we cover over the next 10 weeks?
 Introduction to public finance
 The role of government
 Organic and mechanistic views of government
 Size of government
 Tiebout’s model

17. What is public finance?
 Analyzing government taxation and spending
 Examples
 Preserving the environment
 The roads you drive on
 Health care reform
 Social security sustainability
 Fairness of income distribution
 Taxation of income: Tax evasion versus tax
avoidance

18. An introduction to Econ 130
 This class covers four “units,” each with three
to five lectures
 Unit 1: Introduction and Microeconomic tools
 Unit 2: Public goods, externalities, and
government
 Unit 3: Health care and income redistribution
 Unit 4: An introduction to taxation

19. Unit 1 (begins today)
 Introduction and Microeconomic tools
 Chapter 1: Introduction to public finance and
government
 Most of Chapter 2: Empirical tools
 Part of Chapter 3: Economic theory tools
 Most of Chapter 8: Cost-benefit tools
 Part of Chapter 22: The Tiebout model

20. Unit 2
 Public goods, externalities, and government
 Chapter 4: Public goods
 Chapter 5: Externalities
 Chapter 6: Government and political economy
 Chapter 7 & the end of Chapter 8: Government
spending on education

21. Unit 3
 Health care and income redistribution
 Chapter 9: Problems of insurance in the health
care market
 Chapter 10: Government’s role in health care
 Most of Chapter 11: The structure of Social
Security; stresses caused by the baby boom
generation
 Most of Chapter 12: Conceptual issues of income
redistribution
 Most of Chapter 13: Programs for the poor

22. Unit 4
 Primary and secondary effects of taxes
 Most of Chapter 14: Taxation and partial
equilibrium
 Part of Chapter 15: Excess burden
 Part of Chapter 16: Tax evasion & tax avoidance
 Other taxation topics from Chapters 17 and 18
 Basic structure of the United States personal income tax
 Rate structure of the United States personal income tax
 Marriage neutrality of taxes
 Behavioral issues with taxation

23. Before moving on…
 If you think that you are weak on your
Microeconomics skills, you should read the
Appendix at the end of the book or look at an
intermediate Microeconomics textbook

24. Introduction to public finance
 This class is meant to cover public finance to
students that have no direct background in the topic
 Some knowledge on public goods and externalities is
useful, but not required
 Three topics will be covered today
 What is studied in a public finance class?
 What kinds of views do people have about public finance?
 Tiebout’s model
 Government will be addressed more in later lectures
 Size of government will be covered in the next lecture
 Growth of government will be covered in week 4

25. Public finance
 Public finance, as defined by R/G (p. 2)
 “The field of economics that analyzes government
taxation and spending policies”
 Public finance, as described by Former
Czech Prime Minister Vaclav Klaus (From
R/G, p. 2)
 “Public finance is nothing else than a
sophisticated discussion of the relationship
between the individual and the state”

26. Public finance
 We will study topics in which many argue that
government intervention is justified
 Public goods and markets with externalities
 Subsidized education
 Health care reform
 Social Security
 Income redistribution

27. Public _____
 There are at least two other terms that mean
the same thing as public finance
 Public sector economics
 Public economics
 Although I may use the three terms
interchangeably to mean the same thing, I
will usually use the term “public finance”

28. What views do people have?
 Different people have different views about
public finance
 Organic view of government
 Mechanistic view of government

29. Organic view of government
 Government treats an entire society as a
natural organism
 Each individual is part of the organism
 The government is the heart
 Although individual goals differ, some goals
are naturally needed for the societal
organism

30. Mechanistic view of government
 Government is needed for individuals to
pursue their individual goals
 “Invisible hand” (Adam Smith)
 Efficient markets under certain sets of conditions
 Property rights and lack of violence needed to have
efficient markets
 How much government beyond this is
debatable
 Libertarian: Small government
 Social democrats: Larger government needed

31. What this class does
 Some analysis is done on a society-wide
scale
 Social costs and benefits
 Cost-benefit analysis on a nationwide scale
 Other topics talk about individual analysis
 Voting theory
 Individual income taxes

32. Determining what is “good”
 What is “good” to one person may be viewed
as bad as others
 Let’s do an activity to illustrate this
 Everyone starts by standing up
 I will show a statement
 Stay standing if you agree with the statement
 Sit down if you disagree with the statement
 There is no “right” answer to any question
 Time to stand up

33. Statement 1
 I believe that reckless driving should be
stopped through government actions (such
as the use of police)
 Remember: Stay standing if you agree, sit down
if you disagree

34. Statement 2
 I think that government should build and
maintain roads and highways

35. Statement 3
 I believe that each baby needs to be securely
buckled into a car seat while riding in a car, to
be enforced by the government

36. Statement 4
 I believe that each person in a moving car
needs a seat belt on, to be enforced by the
government

37. Statement 5
 I believe each driver needs liability insurance,
to be enforced by the government

38. Statement 6
 I believe the government has a right to
regulate when each person can use the
roads, and the route they take, in order to
control traffic patterns

39. Statement 7
 I believe that the government has a right to
prevent pilots of commercial aircraft from
using a cell phone while actively flying

40. Statement 8
 I believe that the government has a right to
prevent train drivers from sending text
messages while driving the train

41. Statement 9
 I believe that the government has a right to
prevent car drivers from sending text
messages while driving the train

42. Statement 10
 I believe that the government has a right to
prevent car drivers from making calls on a
cell phone while driving

43. Statement 11
 I believe that the government should charge
a 70% tax rate on all income I earn in my
lifetime

44. Does everyone agree?
 No
 Different people have different opinions about
what the government should do
 Experts often disagree about what
government should do
 We will often assume that the experts in other
disciplines have gotten costs and benefits
right

45. How do we figure out what is “best?”
 Models can help
 However, no model perfectly describes the
real world
 Example: The Tiebout model

46. Communities and the Tiebout model
 Many communities form in order to provide a
wide array of benefits to the community
members
 Sometimes these communities are in the form of
private clubs
 Other communities incorporate into cities
 Charles Tiebout, in 1956 published a paper arguing that
people shop for the city to meet their tastes for city-
offered amenities

47. The Tiebout model
 People rarely leave the US due to
government policy
 Mobility in the US due to government policy is
substantial
 Tiebout makes many assumptions in his
model
 Not a perfect description of the real world
 Gives a good idea of how people decide what
community to live in

48. Tiebout’s assumptions
 Government activities generate no externalities
 Individuals are completely mobile
 People have perfect information with respect to each
community’s public services and taxes
 There are enough different communities so that each
individual can find one with public services meeting her
demands
 The cost per unit of public services is constant so that if the
quantity of public services doubles, the total cost also doubles
 Public services are financed by a proportional property tax
 Communities can enact exclusionary zoning laws—statutes
that prohibit certain uses of land

49. Advantages with the Tiebout model
 Tailoring outputs to local taxes
 Each person or family lives in a community they
like
 One size does not fit all
 Tastes and preferences differ from person to person
 Fostering intergovernmental competition
 People in government generally want people to
live in their community

50. Advantages with the Tiebout model
 Experimentation and innovation in locally
provided goods and services
 States and cities can try new programs
 These studies often result in statistical studies by
economists
 The analyzed results lead to good information for
governments throughout the nation

51. Main disadvantage of the Tiebout model
 Not an exact description of the real world
 Moving costs
 No one city is a perfect match for someone’s most
desired preference
 Some parents send their kids to private school,
despite the availability of public schools

52. Other issues with the Tiebout model
 Externalities
 Both negative and positive
 Many public goods are not at the local level
 Scale economies in provision of public goods
 Per-person cost often decreases as the number of
users increases
 Inefficient tax systems
 Different states and cities often compete to get
large businesses to locate in their area
 Scale economies in tax collection

53. Summary: Introduction to public finance
 Many topics studied in public finance
 Topics related to government intervention
 Tax-related topics
 Different viewpoints about government
 Organic view
 Society is an organism
 Mechanistic view
 Government used to reach individual goals
 Tiebout model: Find a community that is a
good fit for the amenities that you want

54. The rest of this week…
 For Wednesday
 Read the syllabus, Chapter 1, and pages 18-28
and 506-512
 Wednesday’s lecture
 Expected value
 Marginal analysis
 Empirical tools in microeconomics

55. Some ground rules at the end of lecture
 I will always try to be done by 3:15 pm
 In return, I expect your attention until the final
slide
 If you must leave early:
 Please do so no later than 3:05 pm
 Sit near an exit
 Leave quickly and quietly
Example of final slide

56. Some ground rules at the end of lecture
 After many of the lectures
 Problem solving
 Your questions (especially near test time)
 Review of old test questions
 You are welcome to leave after lecture is
finished if I do problems
 Please do so quickly and quietly

57. With the remaining time today…
 Issues with crashers
 Any crashers not on the list?
 Any administrative issues
 Other questions

58. Have a good day