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Policy and Choice

Policy and Choice: Public Finance through the Lens of Behavioral Economics

William J. Congdon
Jeffrey R. Kling
Sendhil Mullainathan
Copyright Date: 2011
Pages: 247
  • Book Info
    Policy and Choice
    Book Description:

    Traditional public finance provides a powerful framework for policy analysis, but it relies on a model of human behavior that the new science of behavioral economics increasingly calls into question. InPolicy and Choiceeconomists William Congdon, Jeffrey Kling, and Sendhil Mullainathan argue that public finance not only can incorporate many lessons of behavioral economics but also can serve as a solid foundation from which to apply insights from psychology to questions of economic policy.

    The authors revisit the core questions of public finance, armed with a richer perspective on human behavior. They do not merely apply findings from psychology to specific economic problems; instead, they explore how psychological factors actually reshape core concepts in public finance such as moral hazard, deadweight loss, and incentives.

    Part one sets the stage for integrating behavioral economics into public finance by interpreting the evidence from psychology and developing a framework for applying it to questions in public finance. In part two, the authors apply that framework to specific topics in public finance, including social insurance, externalities and public goods, income support and redistribution, and taxation.

    In doing so, the authors build a unified analytical approach that encompasses both traditional policy levers, such as taxes and subsidies, and more psychologically informed instruments. The net result of this innovative approach is a fully behavioral public finance, an integration of psychology and the economics of the public sector that is explicit, systematic, rigorous, and realistic.

    eISBN: 978-0-8157-0501-7
    Subjects: Finance, Political Science, Business

Table of Contents

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  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Acknowledgments
    (pp. vii-viii)
  4. 1 Introduction
    (pp. 1-14)

    When should the government intervene in the economy? When do markets fail? How do we craft policies that maximize social welfare? How do we design policies to minimize unintended consequences? Traditional public finance provides a powerful framework to tackle those questions. This framework, however, relies on an overly simple model of human behavior. This book revisits the core questions of public finance but with a psychologically richer perspective on human behavior. We do not merely apply psychology to economic problems; instead, we explore how psychological factors reshape core public finance concepts such as moral hazard, deadweight loss, and incidence.


  5. Part I. Psychology and the Foundations of Public Finance

    • 2 Psychology and Economics
      (pp. 17-39)

      What do people want? Do they even know? How do they make choices, big and small? Answers to questions like these—how individuals form preferences, how they make decisions—guide how economists think about the world. No matter how far removed the immediate questions of study in any particular field—macroeconomics, finance, trade—may seem from matters of individual choice, scratch the surface and the analysis nearly always depends in some part on assumptions or observations regarding how individuals choose and behave. They may be hidden or implicit, they may be ad hoc or unexamined, but there they are.


    • 3 Behavioral Economics and Public Finance
      (pp. 40-66)

      Even with the simplifying assumptions that economics usually makes about how individuals form preferences and make choices—perfect optimization, self-interest, and so on—the rigorous analysis of public policy questions is a challenging endeavor. Frame questions too narrowly, such as by asking whether a particular policy works or not, and the analysis can miss larger issues, such as whether the policy was a good idea to start with. Fail to anticipate the ways that individuals will respond to the incentives that policies create or to anticipate the ways that markets will adjust, and policy design will suffer. And so on....

  6. Part II. Behavioral Economics and Public Finance in Practice

    • 4 Asymmetric Information
      (pp. 69-106)

      The U.S. government has been described, with tongue only slightly in cheek, as “an insurance company with an army.”¹ In terms of dollars spent, that description is not far off. In recent years Social Security, Medicare, and Medicaid alone have accounted for about 40 percent of all federal government spending, and while those programs are far and away the largest social insurance programs, they are not the only ones. Unemployment insurance, for example, protects workers against precipitous declines in income and consumption between jobs. Nor is the federal government the exclusive provider of social insurance. States both finance portions of...

    • 5 Externalities and Public Goods
      (pp. 107-139)

      It has been famously labeled an inconvenient truth: the burning of fossil fuels, along with a number of other activities that modern economies have become accustomed to or depend upon, is contributing to global climate change.¹ If current patterns of use continue unabated, the environmental, social, and economic consequences of global warming may be severe.² As a result, the matter of how to address this issue has been a staple of policy debates both in the United States and around the world for at least the last two decades. Proposals to stem carbon emissions and thereby slow the rate of...

    • 6 Poverty and Inequality
      (pp. 140-172)

      Roughly one in seven Americans, more than 43 million people, lived in poverty in 2009.¹ In the United States, poverty is defined as having a low level of market income in absolute terms—that is, as living below the poverty line. For a family of four, for example, that meant a total family income of less than $21,756. Incomes at that low level both reflect and create undesirable conditions, not only for individuals who suffer directly the hardships associated with poverty but also for societies and economies that allow such conditions to persist. As a result, economic policy often seeks...

    • 7 Taxation and Revenue
      (pp. 173-200)

      Running a government is expensive. Correcting for market failures, providing public goods, guaranteeing social insurance, and redistributing income and sustaining antipoverty efforts—functions of government within the purview of public finance—all involve various expenditures. Increasing the expense are functions of government that are outside the scope of public finance, such as administering court systems, maintaining regulatory bodies, and other endeavors. In a typical year, the federal government’s share of the U.S. economy is about 20 percent.¹ About one-fifth of federal spending is on Social Security; one-fifth on health programs, including Medicare and Medicaid; one-fifth on national defense; and the...

  7. Appendix A Preference, Choice, and Welfare
    (pp. 201-204)
  8. Appendix B Choice, Welfare, and Policy
    (pp. 205-208)
  9. Notes
    (pp. 209-240)
  10. Index
    (pp. 241-247)
  11. Back Matter
    (pp. 248-250)