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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

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.