Economics by liaoqinmei

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									ECONOMICS 343
   PUBLIC FINANCE
Government and the
     Economy
      LECTURE 1
              Important Links
•   Budget of the United States
•   The Congressional Budget Process
•   Economic Report of the President
•   Internal Revenue Service
•   Social Security Administration
•   Health Care Financing Agency
•   Bureau of Public Debt
•   Public Finance by David Hyman
Role of the Government in the
           Economy
Roles of Government in the Economy


     In the Wealth of Nations, Adam Smith enumerated four
     “justifiable” functions of government:
     the duty of protecting the society from violence and
     invasion by other independent societies;

     the duty of protecting every member of society from
     injustice and oppression of every other member of
     society;
the duty of establishing and maintaining those highly
beneficial public institutions and public works which are of
such a nature that the profit they earn could never repay the
expense to the individuals to provide them and which it,
therefore, cannot be expected that they would be supplied in
adequate quantities; and

the duty of meeting expenses necessary for support of the
sovereign.
Definition of Public Finance
                                 From A.C. Pigou A Study in Public Finance
                                                  PART I
                                         GENERAL RELATIONS
                                               CHAPTER I
                                                  PRELIMINARY


 § 1.IN every developed society there is some form of government organization, which may or may not
represent the members of the society collectively, but certainly has coercive authority over them
individually. As a rule the government organization is broken up into a central government with large
powers and a number of local government authorities with limited powers. The governing authority,
whether central or local, is endowed with functions and duties, the detailed nature of which varies in
different places. These duties involve the expenditure and, consequently, require also the raising of
revenue.
§ 2. In modern conditions these processes are operated almost exclusively through the medium of money.
It is true that on occasions governments make a levy of resources, of which they have need, in kind.
Thus, in most European countries, even in peacetime, the services of soldiers are obtained by
conscription; and it has happened that civilian labour (e.g. in Bulgaria) has been called up in the same
way. In war-time commandeering is apt to be extended over a much wider range. Buildings, motor-cars,
horses, stocks of food and so on may be forcibly taken over. During the later years of the 1914-18 war
the British Government commandeered the whole of the wool crop and the whole of the wheat crop of
the country. During the recent world war women were conscripted for national service as well as men.
Resort to methods of this kind is not, however, really alternative to the use of money. Conscripted
persons are paid money wages and the owners of commandeered goods usually receive money
compensation. What happens is not an abandonment of the money instrument, but a supplementing of it
by compulsion on the public to sell services or goods, and authority
Thus we may lay it down, as a general rule for modern countries, that the spending and the raising of
resources by government authorities are manifested in the form of spending and raising money.
§ 3. To this rule there is one exception that should be noted. A government may decide to take over and
nationalise some large going concern - the Port of London, the railway system, the coal-mining industry or
the liquor trade. In such a case it is certain not to raise the purchase price through taxes and very unlikely
to raise it through the issue of a public loan. It will pay the sellers, not in money, but in interest-bearing
government script. In so far as they retain this script the sellers will in effect, though not in form, have
loaned the purchase price of their concern to the government; in so for as they retain the script on the
market, the buyers of it will have done this. In neither case will the government itself actually disburse
money; it will disburse new securities instead.
 § 4. Though, apart from special cases of this kind, money is practically always the medium of public
finance, it is not the thing in which it really deals. The money is merely a ticket embodying command over
services and goods. It is these, not the money that represents them, which constitute the real object of all
transactions. This is, of course, a truism. But it is a truism the detailed implications of which are complex.
Apart from the special cases referred to in the last paragraph and apart from creations of new money, every
completed act of public finance is alike in form. £100 million are obtained by the government from the
public and are paid over to certain other persons. This money is purchasing power. When it is taken away,
those persons from whom it is taken are constrained to give up other things (including perhaps some
leisure), which they would have had if it had not been taken away. The government then pays out the £100
million. It is evident that there are a great number of different ways in which the providers of taxes or fees
or loans can modify their purchases and activities in order to furnish the £100 million: and a great number
of different ways in which the £100 million can be paid out and in which the output Of different sorts of
goods and services can accordingly be effected. Thus important divergences of substance underlie the
similarities in money form.
          From Public Finance by Charles F. Bastable

• In any society that has passed beyond the lowest stage of social
  development, some form of governmental organisation is found to
  be an essential feature. The various activities or functions of this
  controlling body furnish the material for what are known as the
  'Political Sciences'. Every governing body or 'State' requires for
  the due discharge of its functions repeated supplies of
  commodities and personal services, which it has to apply to the
  accomplishment of whatever ends it may regard as desirable. The
  processes involved in obtaining and using these supplies naturally
  vary much in the several stages of social advance: they are
  comparatively simple and direct in a primitive community, while in
  a modern industrial society they present a high degree of
  complication, and are carried out by elaborate regulations. For all
  States, however—whether rude or highly developed—some
  provisions of the kind are necessary, and therefore the supply and
  application of state resources constitute the subject-matter of a
  study which is best entitled in English, Public Finance
• The importance of the subject hardly requires much insistence.
  The collection of funds for state purposes and the use of the
  resources so obtained are such vital parts of the political
  organisation, that they are almost certain to receive attention
  from all who are interested in political and social inquiries. But,
  if demanded, abundant evidence is at hand. The citizen of any
  civilised country need only reflect for a few minutes in order to
  satisfy himself of the number and importance of the actions of
  the state on its financial side. His letters are carried by a state
  agency which claims a monopoly, and in some instances
  realises a large profit for the general revenue. The
  commodities that supply his table are in many cases taxed to
  create a fund for the payment of public services. Either his
  income or property or some of their elements is sure to be
  subjected to a charge of greater or less amount, and several of
  the most ordinary avocations are only open to him on obtaining
  a costly licence for permission to engage in them. Nor do the
  claims of the State cease here.
• In addition to the central body, the local authorities
  have to be considered. If the person of our
  supposition be the inhabitant of a town, his house
  may be lighted by public agency, while it is highly
  probable that for one of the first necessaries of life—
  water—he is dependent on his municipality. There is
  little need for further working out of details. The way
  in which the purely financial agencies of the State—
  and still more those which have some connexion with
  finance—affect the members of the society in their
  everyday existence, is being ever illustrated afresh by
  the ordinary course of social life.
• Public Finance deals with the taxing and
  spending activities of various governmental
  units.
• However, the resources for all government
  expenditures ultimately come from the private
  sector.
• So, public sector decisions impact private
  sector decisions in many ways both large and
  small.
• The overall impact of public sector decisions
  must be examined in the context of their
  impact on private sector behavior.
Government as a Decision Unit
• Public finance studies the economic activity of
  the government as a unit.
• In studying this unit in some sense we treat it
  as analogous to a person.
• For example in studying the economic activity
  of a person we would want to know
  – how the person earns their income and how much
    the person earns.
  – how the income is spent.
  – how the individual makes decisions or choices
    among alternatives.
• Similarly, in studying the public economy, we want to
  know
   – how factually the government secures it revenues -- both
     process and amounts --.
   – how the revenues are spent.
   – how the government makes decisions or choices
     among alternatives. Here the analysis becomes very
     complicated because, while for an individual we are
     examining a single mind, for governmental decisions
     we are looking at a collective mind or political
     process. Moreover, an individual’s decision is one
     among many decisions, government decisions can
     impact the behavior of many individuals.
The Field of Public Finance
• Public Finance is the area of economics or
  economic theory devoted to the study of how
  government policy -- tax and expenditure
  policy-- effects microeconomic behavior as
  well as aggregate economic activity.
• Public finance does not concentrate on
  financial arrangements of government but on
  the economic consequences of public policy on
  – Resource allocation: Allocation
  – Income distribution: Distribution
  – Level of economic activity: Stabilization
The Nature of Private and Public Goods:
            An Overview
             PRIVATE GOODS


          MARKET FORCES
       CONSUMER SOVEREIGNTY



ALLOCATION     DISTRIBUTION   STABILIZATION
             PUBLIC GOODS


    DEMOCRATIC POLITICAL PROCESS
              VOTING



ALLOCATION     DISTRIBUTION   STABILIZATION
   ALTERNATIVE VIEWS OF
GOVERNMENT’S ROLE IN SOCIETY
1. The state can be viewed as a unitary being or
   organism. The government has a life of its own.
   This is what James Buchanan refers to as the “fiscal brain”
   approach. One extreme of this approach is the society
   ruled by the complete despot, Louis XIV. A more realistic
   example would be government decisions made by a ruling
   elite or clique. The theory of committees or small group
   behavior might be useful in analyzing such a situation.
   The “public interest” is inherent in the government and it
   transcends individual interests.
2. The second concept of government is the state as a
   means of individual action; a mechanism for collective
   action. The “ideal” example of this approach is the New
   England town meeting. However, more realistically we
   are looking at representative government in large political
    units.
ORGANIC VIEW
Society is conceived of as a natural organism.
Each individual is a part of this organism , and the
government can be thought of as its heart and
mind. European socialist countries are based on
this underlying view of the role of government.
Historically, it has taken extreme forms such as
national socialism in Germany in the interwar
years. Individualism is subservient to the
“natural” goals of the state. Government as a
utility maximizing entity or government as a
ruling clique.
For example, Yang Chang-chi, Mao Tse-tungs, ethics
teacher, states that “A country is an organic whole just
as the human body is an organic whole. It is not like a
machine which can be taken apart and put together
again. The individual has significant only as part of
the community and the good of the individual is
defined with respect to the good of the whole.”

In the organic approach, the community is stressed
above the individual.
MECHANISTIC VIEW
The government is not part of the social machine.
It is a contrivance -- another machine-- created by
individuals to better achieve their individual
goals. The individual rather than the group is at
the center of the system. (Government as a
democratic process) The following document
expresses this view in a very concise manner.
           DECLARATION OF INDEPENDENCE
“We hold these truths to be self-evident, that all men are created equal, that
they are endowed by their Creator with certain unalienable rights, that
among these are life, liberty and the pursuit of happiness. That to secure these
rights, governments are instituted among men, deriving their just powers
from the consent of the governed, that whenever any form of
government becomes destructive of these ends, it is the right of the
people to alter or to abolish it, and to institute new government, laying its
foundation on such principles and organizing its powers in such form, as
to them shall seem most likely to effect their safety and happiness.
Prudence, indeed, will dictate that governments long established should not
be changed for light and transient causes; and accordingly all experience hath
shown, that mankind are more disposed to suffer, while evils are sufferable,
than to right themselves by abolishing the forms to which they are
accustomed. “
Important limitations on
the powers vested in
government are defined in
Article I, Section 9, and in
the first ten amendments to
the Constitution, known as
the Bill of Rights. These
limitations are primarily in
the form of general
prohibitions against the
abridgment or destruction
of fundamental rights.
Legal Framework of Public
         Finance
Political Institutions constitute the rules and generally accepted
procedures that evolve in a community for determining what
government does and how government outlays are financed.
                              United States
                              Constitution


Federal Expenditures       Federal Revenues               State and Local
   Article I, Section 8      Article I, Section 8          Governments
                             Article I, Section 7


     Provisions                Provisions                    Provisions
    Welfare Clause            Uniformity Clause              10th Amendment
     Court System         Direct Taxes/16th Amend.         Article 1, Section 10
    Army and Navy                Due Process         City of Clinton vs Cedar Rapids
LEGAL FOUNDATIONS OF
    GOVERNMENT
Expenditure Provisions
•ARTICLE 1, SECTION 8 : Empowers Congress to
“pay the debts (borrow)and provide for a common
defense and the general welfare of the United States
•Bills to appropriate expenditures can
 originate in either House of Congress.
ARTICLE 1, SECTION 9 , no money shall be
drawn from the Treasury, but in consequence of
appropriation made by Law: and a regular
statement and account of Receipts and
 Expenditures of all public Money shall be
 published from time to time
Revenue Provision
• ARTICLE 1, SECTION 8: “Congress shall
  have the power to lay and collect taxes ,
  duties , imposts, and excises.”
• However, ARTICLE 1, SECTION 7 says
  “all bills for raising revenue shall originate
  in the House of Representatives.”
Restrictions
The Constitution has several provisions limiting the
  taxing power of the federal government. (Not
  surprisingly given the enormous dissatisfaction
  with British tax policy during the colonial period.)
• ARTICLE 1, SECTION 8 : “All duties, imposts,
  and excises shall be uniform throughout the United
  States.”
• ARTICLE 1, SECTION 9: “ No... direct tax shall
  be laid , unless proportional to the census or
  enumeration herein before directed to take action.”
• ARTICLE 1, SECTION 9:”no tax or duty shall be
  laid on articles exported from any state.”
• 16th Amendment:” Congress shall have the
  power to levy and collect taxes on income,
  from whatever source derived, without
  apportionment among the several states, and
  without regard to census or enumeration.”
• 5th Amendment: “ No person shall be
  ...deprived of life, liberty, or property,
  without due process of law nor shall
  property be taken for public use without just
  compensation.” (tax and environmental
  issues)
State Governments
• ARTICLE 1, SECTION 10:” No state
  shall without the consent of Congress , lay
  any imposts or duties on imports or
  exports.”
• 10th Amendment: “The powers not
  delegated to the United States by the
  Constitution, nor prohibited to the States
  are reserved to the States respectively or
  to the people.”
• Thus, international economic policy is in the hands of
  the federal government. In addition, various
  constitutional provisions have been interpreted as
  requiring that the states not levy taxes arbitrarily,
  discriminate against out of state residents, or levy
  taxes on imports from other states. For example, in
  1986, the Supreme Court declared unconstitutional
  an Alaskan law mandating that 95 percent of workers
  on public projects be Alaskans.
• States can impose spending and taxing restrictions
  on themselves in their own constitutions.
Municipal Governments
• The power of local governments to tax
  and spend is granted by state
  governments.
• “Municipal corporations owe their
  origins to, and derive their powers and
  rights wholly from, the [state] legislature.
  It breathes into them the breath of life,
  without which they can not exist. As it
  creates, so it may destroy. If it may
  destroy, it may abridge and control.”
  Quoted in Rosen, p. 12 from City of
  Clinton v. Cedar Rapids, 1868.
         GROWTH OF
        GOVERNMENT

“The era of big government is over” Bill Clinton, 1996
To what extent are society’s economic
resources controlled by the public sector?

Has this control over resources been
growing over time?
TOTAL GOVERNMENT OUTLAYS AS PERCENTAGE
             OF GDP IN 1999

  •   COUNTRY      OUTLAYS
  •   U.S.           33.6 %
  •   JAPAN          39.2
  •   U.K.           40.8
  •   GERMANY         47.1
  •   ITALY          49.2
  •   FRANCE         54.1
  •   SWEDEN         60.2
Trend in Federal Budget Receipts
        and Expenditures
Year    Receipts    Outlays     Surplus/Deficit   Outlays % of GDP
1945.   45,159      92,712      -47,553           41.9
1950.   39,443      42,562      -3,119            15.6
1955.   65,451      68,444      -2,993            17.3
1960.   92,492      92,191       301              17.7
1965.   116,817     118,228     -1,411            17.2
1970.   192,807     195,649     -2,842            19.3
1975.   279,090     332,332     -53,242           21.3
1980.   517,112     590,947     -73,835           21.6
1981.   599,272     678,249     -78,976           22.2
1982.   617,766     745,755     -127,989          23.1
1983.   600,562     808,385     -207,822          23.5
1984.   666,486     851,874     -185,388          22.1
1985.   734,088     946,423     -212,334          22.9
1986.   769,215     990,460     -221,245          22.5
1987.   854,353     1,004,122   -149,769          21.6
1988.   909,303     1,064,489   -155,187          21.2
1989.   991,190     1,143,671   -152,481          21.2
1990.   1,031,969   1,253,198   -221,229          21.8
1991.   1,055,041   1,324,403   -269,361          22.3
1992.   1,091,279   1,381,684   -290,404          22.2
1993.   1,154,401   1,409,512   -255,110          21.5
1994.   1,258,627   1,461,902   -203,275          21.0
1995.   1,351,830   1,515,837   -164,007          20.7
1996.   1,453,062   1,560,572   -107,510          20.3
1997.   1,579,292   1,601,282   -21,990           19.6
1998.   1,721,798   1,652,611    69,187           19.1
1999.   1,827,454   1,703,040    124,414          18.7
2000    1,956,252   1,789,562    166,690          18.7
          An Empirical Observation

“Federal government expenditures as a percentage
of national income in the United States were only
1.4 percent in 1799. They rose to double that figure
by the end of the nineteenth century, but were still
only 3 percent of GNP in 1929. Starting in the
1930s, however, federal expenditures took off,
rising sevenfold as percentage of GNP over the next
50 years.” (Mueller, Public Choice II, p.320)
       Explantions for the Size and Growth of
                      Government
•   Dennis Mueller in “The Growth of Government”
    list five explanations for public sector growth.
•   The government as provider of public goods and
    eliminator of externalities
•   The government as redistributor of income and
    wealth
•   Interest groups as a cause of government growth
•   Bureaucracy as a cause of government growth
•   Fiscal Illusion
SOME HISTORICAL SPECULATION ON
  THE GROWTH OF THE PUBLIC
            SECTOR
• Law of Ever Increasing State Activities
   •Wagner’s Law
   •Engel’s Law
•Baumol Unbalanced Growth Model

• Displacement, Inspection, and Concentration
  Effect

• Critical Limits Hypothesis

• Theory of Bureaucracy
WAGNER’S HYPOTHESIS OF INCREASING
        STATE ACTIVITIES
As per capita income and output grow in
industrialized countries , the public sector of
these countries necessarily grow as a
proportion of aggregate economic activity.
Wagner indicated this was a natural law of ever
increasing state activity.
     WHY SHOULD THIS BE THE CASE ?
• Economic growth and social progress lead to an
  increase in governmental functions.
• The increase in necessary functions leads to
  pressure for absolute and relative growth of
  government activities .
              WHAT FUNCTIONS ?
• Provide Law and Order: The need to provide a
  stable framework for economic activity.
• Greater economic growth or industrialization
  leads to greater labor specialization causing
  increased complexities (e.g., in the contracting
  process) and interdependencies in economic
  and social life.
• Greater interdependencies foster the need for
  government resolution of conflicts and the
  need to maintain continually more specialized
  services ( e.g.., regulating derivative financial
  claims and mediate cultural conflicts as well).
• Need for Government Participation in the
  Production of certain Goods and Services
  – produce public and quasi-public
  For example,
     – Goods requiring large fixed investment: infrastructure
       projects
     – Natural monopolies and externalities
     – Communications, education, and banking / payments
       industries
     – Goods with a degree of publicness
                                 pg2
                   Engel Curve         High Income Elasticity
  Per capita
                   for Public
  output of
                   Goods
  public goods
                                             Low Income
(Consumption                                 Elasticity
of Public Goods)
                                                 Real per capita
                                                 income
                                           (Income)
          PERCENT OF TOTAL OUTPUT
PUBLIC
SECTOR                               Remember the Wagner
                                     effect takes place over
                                               time
                    PERIOD 2
    33%



                                 PERIOD 1
   10%


                                                  PRIVATE
              67%              90%                SECTOR
                                         Post-Industrialization
         Subsistence Wagner’s Law        Falling Relative Public
Per      Stage                           Sector
                     Period of
capita                                            pg1
                     Industrialization
output     Falling                                    pg2
                     Rising Relative
of         Relative  Public Sector          Third Wave
public     Public
                     Second Wave            Society
goods      Sector
                     Society
                                         Society Resists Too
         First Wave                      Large A Public Sector:
         Society                         Cultural Preferences
                                         for Market Activity;
                                         Individual Freedom


                  3000                         Per Capita Real
                                    15000
                                               Income
Baumol’s Theory of Unbalanced Growth
• Public sector expenditures will tend to grow faster than
  the rest of the economy.
• All economic activity can be grouped into two
  categories – those that are technologically progressive
  and those that are not.
• Output per worker is greater in one sector than the
  other, however, the wage tends to be the same.
• Thus, unless labor markets are sealed off, cost in the
  less productive have to rise.
• If market demand is inelastic or if there is a strong
  political demand for the goods in the less productive
  sector then labor will shift to this sector and the level of
  expenditures in this sector will rise.
• To the extent that the public sector is the less
  productive sector, expenditures in the sector will rise
  relative to the private sector.
• That is, if we assume:
   – a low price elasticity for government services
   – improvements in productivity as more likely in the private than
     public sector
   – Relatively uniform wage rates between the public and private
     sectors
• Then, it would be reasonable to expect that cost would
  rise in the public sector relative to the private sector
  and that governmental expenditures would rise at a
  faster rate than the GDP.
Peacock and Wiseman Approach to
   Growth of the Public Sector
DISPLACEMENT, INSPECTION, AND
   CONCENTRATION EFFECTS
The relative growth of the public sector is
“steplike” rather than continuous.
Public Sector   New fiscal
Revenues        plateau
and
Expenditures
as a %                  Increase due to social disturbance
of GDP

                                     Time
• DISPLACEMENT EFFECT: War and depression
  create a displacement effect by which previous
  (lower) tax and expenditure levels are replaced by
  new higher budgetary levels. New levels of tax
  tolerance ( deficit tolerance ) support a new fiscal
  plateau where tax burdens are higher. On the new
  plateau some old expenditures by government are
  eliminated and new ones are substituted for them.
  Some of the substitutes may have been produced
  by the private sector in the past. Perhaps R&D or
  retirement benefits.
• INSPECTION EFFECT: War and other social
  disturbance force people and their government to
  seek solution to important problems which
  previously had been neglected or perhaps
  unnoticed. For example, the need for an interstate
  highway system or re-engineering of the hospital
  system.
• CONCENTRATION EFFECT: This effect notes
  the tendency for central government economic
  activity to become an increasing proportion of
  total public sector economic activity when a
  society is experiencing economic growth.
Clark’s Approach to the Growth
     of the Public Sector
CRITICAL LIMITS HYPOTHESIS
The critical limits of public economic
activity is set by the rate of inflation. The
critical limit hypothesis as originally
expressed is that inflation necessarily occurs
when the government sector, as measured in
terms of taxes and other receipts, exceeds
25 percent of aggregate economic activity.
BASIS OF THE HYPOTHESIS
• When taxes collected by the government
  reach the critical limit of 25 percent,
  incentives are harmed and people become
  less productive; thus aggregate supply is
  reduced.
• People become less resistant to various
  inflationary means of financing
  government; thus aggregate demand is
  increased. The diagram below illustrates the
  implications of this conclusion.
Price
Level                 AS1


        P2


        P1                       AD1




                            Quantity
             0   Q1
The New Agenda
                          I remember
Post-Industrial Age       1980, don’t
and Controlling the   ?   you?

Size of Government:
Some Observations
CONTROLLING THE SIZE OF
     GOVERNMENT
• CHANGE BUREAUCRATIC
  INCENTIVES
 – Base salaries of bureaucrats on their success in
   reducing their agency’s budget.
 – privatize governmental functions.
• CHANGE THE BUDGET PROCESS
 – Congressional Budget and Impoundment
   Control Act of 1974.
    • Created Congressional Budget Office ( CBO )
    • Formed special budget committee in each House.
  – GRH established a set of steadily declining deficit targets.
    If Congress failed to reduce the deficit to the target level
    before the start of the fiscal year, the excess deficit was
    automatically removed by cutting budget outlays--
    basically across- the- board. The process of making
    automatic cuts was referred to as a sequester. However,
    under GRH when the deficit became too large to handle
    with accounting tricks, legislators simply changed the GRH
    targets.
• INSTITUTE CONSTITUTIONAL
  LIMITATIONS
  – Add a balanced budget amendment to the
    constitution.
• LINE ITEM VETO ( Signed into law by
  President Clinton)
• Passage of the Budget Enforcement Act of
  1990 (BEA)
• 1997 Balanced Budget Agreement- Summary
  Outline of Agreement
• Balanced Budget Reconciliation Act of
  1997
Government Bureaucracies
• As Mueller notes government bureaucracies are an
  independent force explaining the growth of the
  government sector. (Peacock-Wiseman Approach)
• Empirical studies in this area have usually reasoned
  as follows.
• The larger the bureaucracy, the more difficult it is for
  outsiders to monitor its activity, and the more the
  insiders there are who are working to increase the
  size of the bureaucracy.
• Thus the growth of bureaucracy is likely to depend
  on its absolute size.
• Studies have found that growth in the size of a
  bureaucracy's budget is expected to increase
  with the absolute size of the budget.
• As Mueller indicates this result is broadly
  consistent with the pattern of growth of
  government expenditures observed in the U.S.
  over the past two centuries: slow but steady
  initial growth, gradually shifting into more rapid
  rates of growth. (Note: Mueller’s study
  summarized works up to the late 1980s.)
• The idea that bureacracatic power increases the
  size of government presumes that the
  bureaucracy can deceive the legislature about the
  true costs of supplying different levels of output.
• The fiscal illusion presumes that the legislature
  can deceive the citizens about the true size of
  government.
• The fiscal illusion explanation for the growth in
  the size of government assumes that citizens
  measure the size of government by the size of
  their tax bills.
• To increase the size of government beyond
  what people want, the tax burden has to be
  disguised so as to create an illusion that the
  government is smaller than it actually is and
  so the government can grow beyond the level
  citizens prefer.
• The fiscal illusion has been empirically tested
  in various forms.
  1 A tax structure is more difficult to judge the more
    complex the tax structure.
  2 Renters are less able to judge their share of
    property taxes in the community than are
    homeowners.
  3 The implicit future tax burdens inherent in the
    issuance of debt are more difficult to evaluate than
    equivalent current taxes.
  4 Built-in tax increases because of the progressivity of
    the tax structure are less clearly perceived than are
    legislated changes.
• Mueller, quoting a review of the empirical
  literature by Oates, concludes that “ the fiscal
  illusion provides plausible hypotheses, none of
  which have very compelling empirical support.
EXPANSION OF SUFFRAGE:
REDISTRIBUTION FACTOR
• Meltzer and Richard suggest that one explanation for the
  secular growth in government in the United States and
  around the world over the past two centuries has been
  expansion of suffrage.

• Those added to the voting rolls are more often than not
  those with incomes and productivity below the median.

• Thus the median voter changes to someone more prone
  toward the redistribution of income by the government.

• Meltzer and Richard gave increased inequality of income as
  well as increased suffrage
• as the primary causes for the growth of government and
  presented some empirical support for their hypothesis.

• Peltzman has also presented an explanation for the
  growth of government that depends on the shape of the
  distribution of income.

• Peltzman did not however makes use of the median voter
  theorem in developing the argument.

• Rather, he envisioned a form of representative
  government in which candidates competed for
• votes by promising to redistribute income for those voters
  or groups of voters that agreed to join the candidates
  coalition of supporters.

• Peltzman reasoned that the more equal the distribution of
  income among the potential supporters of the candidate,
  the more bargaining strength they would have.

• Thus the candidate must promise a greater amount of
  redistribution the more equal is the initial distribution of
  income among voters.
• Peltzman pointed to the spread of education as an
  important factor increasing the equality of pretransfer
  incomes and thus leading to a growth in the size of
  government.
• What about redistribution ?

• Mueller concludes that ― it is difficult to suppress the
  impression that an important component of the explanation
  for the growth of government lies in government’s
  redistribution activities, so substantial has been the growth in
  the transfer component of government budgets.‖

• ―However, to explain the growth of government in simple
  redistributional terms is inadequate.‖
INTEREST GROUPS
• Mueller and Murrell presented empirical evidence that interest
  groups effect the size of government.

• They described a political process in which parties supply interest
  groups with favors in exchange for the interest groups support.

• When these favors take the form of goods targeted to specific
  interest groups, but with spillovers for other groups, government
  grows larger.

• The number of organized interest groups in a country was shown
  to have a positive and significant effect on the relative size of
  the government sector in a cross sectional sample of OECD
  countries.
Famous Old Quote
• “But apart from this contemporary mood, the ideas
  of economists and political philosophers, both when
  they are right and when they are wrong, are more
  powerful than is commonly understood. Indeed the
  world is ruled by little else.
• Practical people, who believe themselves to be quite
  exempt from any intellectual influences, are usually
  the slaves of some defunct economists.
• Madmen in authority, who hear voices in the air, are
  distilling their frenzy from some academic scribbler
  of a few years back.
• I am sure that the power of vested interests is vastly
  exaggerated compared with the gradual
  encroachment of ideas.
• Not, indeed, immediately, but after a certain interval;
  for in the field of economic and political philosophy
  there are not many who are influenced by new
  theories after they are twenty-five or thirty years of
  age, so ideas which civil servants and politicians and
  even agitators apply to current events are not likely
  to be the newest.
• But, soon or late, it is ideas, not vested interest,
  which are dangerous for good or evil.”
• John Maynard Keynes, The General Theory
  of Employment, Interest, and Money, 1936,
  pp.383-384.

								
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