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Intermediate Public Economics

Intermediate Public Economics

Jean Hindriks
Gareth D. Myles
Copyright Date: 2013
Published by: MIT Press
Pages: 1016
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  • Book Info
    Intermediate Public Economics
    Book Description:

    Public economics studies how government taxing and spending activities affect the economy -- economic efficiency and the distribution of income and wealth. This comprehensive text on public economics covers the core topics of market failure and taxation as well as recent developments in both policy and the academic literature. It is unique not only in its broad scope but in its balance between public finance and public choice and its combination of theory and relevant empirical evidence. The book covers the theory and methodology of public economics; presents a historical and theoretical overview of the public sector; and discusses such topics as departures from efficiency (including imperfect competition and asymmetric information), issues in political economy, equity, taxation, fiscal federalism, and tax competition among independent jurisdictions. Suggestions for further reading, from classic papers to recent research, appear in each chapter, as do exercises. The mathematics has been kept to a minimum without sacrificing intellectual rigor; the book remains analytical rather than discursive. This second edition has been thoroughly updated throughout. It offers new chapters on behavioral economics, limits to redistribution, international taxation, cost-benefit analysis, and the economics of climate policy. Additional exercises have been added and many sections revised in response to advice from readers of the first edition.

    eISBN: 978-0-262-31379-7
    Subjects: Political Science

Table of Contents

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  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-xx)
  3. Preface to Second Edition
    (pp. xxi-xxii)
    Jean Hindriks and Gareth Myles
  4. Preface to First Edition
    (pp. xxiii-xxiv)
    Jean Hindriks and Gareth Myles
  5. List of Figures
    (pp. xxv-xxxii)

    • 1 An Introduction to Public Economics
      (pp. 3-12)

      The study of public economics has a long tradition. It developed out of the original political economy of John Stuart Mill and David Ricardo, through the public finance tradition of tax analysis into public economics, and has now returned to its roots with the development of the new political economy. From the inception of economics as a scientific discipline, public economics has always been one of its core branches. The explanation for why it has always been so central is the foundation that it provides for practical policy analysis. This has always been the motivation of public economists, even if...

    • 2 Equilibrium and Efficiency
      (pp. 13-50)

      The link between competition and efficiency can be traced back, at least, to Adam Smith’s eighteenth-century description of the working of the invisible hand. Smith’s description of individually motivated decisions being coordinated to produce a socially efficient outcome is a powerful one that has found resonance in policy circles ever since. The expression of the efficiency argument in the language of formal economics, and the deeper understanding that comes with it, is a more recent innovation.

      The focus of this chapter is to review what is meant by competition and to describe equilibrium in a competitive economy. The model of...

    • 3 Behavioral Economics
      (pp. 51-86)

      Behavioral economics involves both the introduction and the development within economic theory of insights about behavior drawn from different domains of psychology. It has been widely recognized for a long time (since at least the early contributions of Allais and Ellsberg) that some of the central assumptions of standard economic analysis may reflect an unrealistic representation of human behavior. To be sure, the standard approach can produce wrong predictions on some occasions. Empirical and experimental research has cataloged a wide range of anomalies: observed choices that do not match the predictions of standard analysis. Behavioral economics is an attempt to...


    • 4 Public Sector Statistics
      (pp. 89-118)

      In 1913 the Sixteenth Amendment to the US Constitution gave Congress the legal authority to tax income. In so doing, it made income taxation a permanent feature of the US tax system and provided a significant source of additional tax revenues. Revenue collection passed the $1 billion mark in 1918, increased to $5.4 billion by 1920, and reached $43 billion in 1945. It was not until the tax cut of 1981 that this process of growth showed any marked sign of slowing. This growth in tax revenue was matched by an equal growth in government expenditure. The US experience is...

    • 5 Theories of the Public Sector
      (pp. 119-144)

      The statistics of chapter 4 have described the size, growth, and composition of the public sector in a range of developed and developing countries. The data illustrated that the pattern of growth was similar across countries, as was the composition of expenditure. Although there is some divergence in the size of the public sector, it is significant in all the countries. Such observations raise two interrelated questions. First, why is there a public sector at all—would it not be possible for economic activity to function satisfactorily without government intervention? Second, is it possible to provide a theory that explains...


    • 6 Public Goods
      (pp. 147-190)

      When a government provides a level of national defense sufficient to make a country secure, all inhabitants are simultaneously protected. Equally, when a radio program is broadcast, it can be received simultaneously by all listeners in range of the transmitter. The possibility for many consumers to benefit from a single unit of provision violates the assumption of the private nature of goods underlying the efficiency analysis of chapter 2. The Two Theorems relied on all goods being private in nature, so they can only be consumed by a single consumer. If there are public goods such as national defense in...

    • 7 Club Goods and Local Public Goods
      (pp. 191-222)

      One of the defining features of the public goods of chapter 6 was nonrivalry: once the good is provided, its use by one consumer does not affect the quantity available for any other consumer. This is clearly an extreme assumption. Many commodities, such as parks, roads, and sports facilities, satisfy nonrivalry to a point but are eventually subject to congestion. Although not pure public goods, these goods cannot be classed as private goods either.

      A good that has some degree of nonrivalry but for which excludability is possible is called aclub good.The name is intended to reflect the...

    • 8 Externalities
      (pp. 223-254)

      An externality is a link among economic agents that lies outside the price system of the economy. Everyday examples include the pollution from a factory that harms a local fishery and the envy that is felt when a neighbor proudly displays a new car. Such externalities are not controlled directly by the choices of those affected—the fishery cannot choose to buy less pollution nor can you choose to buy your neighbor a worse car. This prevents the efficiency theorems described in chapter 2 from applying. Indeed the demonstration of market efficiency was based on the following two presumptions:


    • 9 Imperfect Competition
      (pp. 255-296)

      The analysis of economic efficiency in chapter 2 demonstrated the significance of the competitive assumption that no economic agent has the ability to affect market prices. Under this assumption prices reveal true economic values and act as signals that guide agents to mutually consistent decisions. As the Two Theorems of Welfare Economics showed, they do this so well that Pareto-efficiency is attained. Imperfect competition arises whenever an economic agent has the ability to influence prices. To be able to do so requires that the agent be large relative to the size of the market in which they operate. It follows...

    • 10 Asymmetric Information
      (pp. 297-342)

      A key feature of the real world is asymmetric information. Most people want to find the right partner, one who is caring, kind, healthy, intelligent, attractive, trustworthy, and so on. While attractiveness may be easily verified at a glance, many other traits people seek in a partner are difficult to observe, and people usually rely on behavioral signals that convey partial information. There may be good reasons to avoid a potential mate who is too eager to start a relationship with you, as this may suggest unfavorable traits. Similarly it is hard not to infer that people who participate in...


    • 11 Voting
      (pp. 345-386)

      Voting is the most commonly employed method of resolving a diversity of views or eliciting expressions of preference. It is used to determine the outcome of elections from local to supra-national level. Within organizations, voting determines who is elected to committees, and it governs the decision-making of those committees. Voting is a universal tool that is encountered in all spheres of life. The prevalence of voting, its use in electing governments, and its use by those governments elected to reach decisions, is the basis for the considerable interest in the properties of voting.

      The natural question to ask of voting...

    • 12 Rent-Seeking
      (pp. 387-420)

      TheUnited States National Lobbyist Directoryrecords there to be over 40,000 state-registered lobbyists and a further 4,000 federal government lobbyists registered in Washington. Some estimates put the total number, including those who are on other registers or are unregistered, as high as 100,000. Although the number of lobbyists in the United States dwarfs those elsewhere, there are large numbers of lobbyists in all major capitals. These lobbyists are not engaged in productive activity. Instead, their role is to seek favorable government treatment for the organizations that employ them. Viewed from the US perspective, the country has at least 40,000...


    • 13 Optimality and Comparability
      (pp. 423-456)

      On April 17, 1975, the Khmer Rouge seized power in Cambodia. Pol Pot began to implement his vision of Year Zero in which all inequalities—of class, money, education, and religion—would be eliminated. Driven by their desire to achieve what they perceived as the social optimum, the Khmer Rouge attempted to engineer a return to a peasant economy. In the process they slaughtered an estimated two million people, approximately one-quarter of Cambodia’s population. The actions of the Khmer Rouge are an extreme example of the pursuit of equality and the willingness to accept an immense loss in order to...

    • 14 Inequality and Poverty
      (pp. 457-502)

      A social welfare function permits the evaluation of economic policies that cause redistribution among consumers—a task that Pareto-efficiency can never accomplish. Although the concept of a social welfare function is a simple one, previous chapters have identified numerous difficulties on the path between individual utility and aggregate social welfare. The essence of these difficulties is that if the individual utility function corresponds with what is theoretically acceptable, then its information content is too limited for social decision-making.

      The motivation for employing a social welfare function was to be able to address issues of equity as well as issues of...


    • 15 Commodity Taxation
      (pp. 505-536)

      Commodity taxes are levied on transactions involving the purchase of goods. The necessity for keeping accounts ensures that such transactions are generally public information. This makes them a good target for taxation. The drawback, however, is that commodity taxation distorts consumer choices and causes inefficiency. Some striking historical examples can be found in the United Kingdom where there have been window taxes and hearth taxes. The window tax was introduced in 1696 in the reign of William III and lasted until 1851. The tax was paid on any house with more than six windows (increased to eight in 1825), which...

    • 16 Income Taxation
      (pp. 537-572)

      In 1799 an income tax was introduced for the first time in the United Kingdom to pay for the Napoleonic war. The tax was levied at a rate of 10 percent on income above £60 and survived until it was repealed in 1816 following major public opposition. Part of the opposition was due to concerns about privacy, and this was reflected in the decision of Parliament to pulp all documents relating to the income tax. The tax returned in 1842 as a temporary measure (imposed for three years with the possibility of a two-year extension) to cover a major budget...

    • 17 Tax Evasion
      (pp. 573-606)

      It is not unusual to be offered a discount for payment in cash. This is almost routine in the employment of the services of builders, plumbers, and decorators. It is less frequent, but still occurs, when major purchases are made in shops. While the expense of banking checks and the commissions charged by credit card companies may explain some of these discounts, the usual explanation is that payment in cash makes concealment of the transaction much easier. Income that can be concealed need not be declared to the tax authorities.

      The same motivation can be provided for exaggeration in claims...

    • 18 The Limits to Redistribution
      (pp. 607-632)

      In this chapter we step back from the specific models used in chapters 15 and 16 in order to consider taxation from a broader perspective. We have already stressed that the role of taxation is to allow the government to achieve an allocation of resources that is preferred to that which would arise in the absence of intervention. The mixed economy approach we have adopted, by which is meant the combination of competitive trading alongside intervention by the government, is not the only means of organizing economic activity. Many alternatives exist, such as the command economy with direct government resource...


    • 19 Fiscal Federalism
      (pp. 635-664)

      Fiscal federalism is the division of revenue collection and expenditure responsibilities among different levels of government. Most countries have a central (or federal) government, state or county governments, town councils, and, at the lowest level, parish councils. Each level has restrictions on the tax instruments it can employ and the expenditures that it can make. Together they constitute the multi-leveled and overlapping administration that governs a typical developed country.

      The central government can usually choose whatever tax instruments it pleases, and although it has freedom in its expenditure, it usually focuses on national defense, the provision of law and order,...

    • 20 Fiscal Competition
      (pp. 665-702)

      What is the role of competition among governments? If competition is the fundamental force for efficient economic performance in the private sector, why should it be different for the public sector? Why cannot the same disciplining effect of competition be applied to the public sector as well? In the private sector, competition will promote efficiency because firms that best satisfy consumers’ preferences will survive and prosper while others will lose customers and fail. Extending this argument to the public sector, competition among governments and jurisdictions should induce them to best serve the will of their residents. If they fail to...

    • 21 Issues in International Taxation
      (pp. 703-748)

      The recent explosion of globalization has followed a reduction of institutional barriers to the free movement of goods, services, and factors of production. The effect that this has had on trade between nations is dramatic: world GDP has increased by a multiple of five since 1960 but the volume of world trade has increased by a multiple of eleven. It has also become easier and cheaper to move production facilities and corporate headquarters between countries. This in turn allows taxable profits to be shifted between tax jurisdictions. The political landscape has changed as well, with national governments having to accept...


    • 22 Intertemporal Efficiency
      (pp. 751-774)

      Time is an essential component of economic activity. The passage of time sees the birth and death of consumers and the purchase, depreciation, and eventual obsolescence of capital. It sees new products and production processes introduced, and provides a motive for borrowing and saving. Time also brings with it new and important issues in public economics such as the benefits from the provision of social security (pensions) and the effect of government policy on economic growth. This chapter and the two that follow are devoted to exploring these issues.

      The competitive economy described in chapter 2 provided a firm foundation...

    • 23 Social Security
      (pp. 775-808)

      A typical social security system provides income during periods of unemployment, poor health or disability, and financial support, in the form of pensions, to the retired. Although the generosity of systems varies among countries, these elements are present in all developed economies. The focus of this chapter is the economic implications of financial assistance to the retired. The overlapping generations economy proves to be ideal for this purpose.

      In economic terms, the analysis of the part of the social security system that provides assistance during unemployment or poor health is concerned with issues of uncertainty and insurance. Specifically, unemployment and...

    • 24 Economic Growth
      (pp. 809-844)

      Economic growth is the basis of increased prosperity. Growth comes from the accumulation of capital (both human and physical) and from innovation that leads to technical progress. These advances raise the productivity of labor and increase the potential for consumption. The rate of growth can be affected by policy through the effect that taxation has on the return to investments. Taxation can also finance public expenditures that enhance productivity. In most developed countries the level of taxes has risen steadily over the course of the last century: an increase from about 5 to 10 percent of gross domestic product at...


    • 25 Cost–Benefit Analysis
      (pp. 847-894)

      The Flood Control Act of 1936 established a commitment by the US federal government to protect people and property on approximately 100 million acres of land. The act required that the US Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project exceed the costs of that project. Subsequently the US Congress has authorized the Corps of Engineers to construct hundreds of miles of levees, flood walls, and channel improvements and approximately 375 major reservoirs. According to Arnold’s 1988 history of the 1936 Act, these projects “have saved billions of...

    • 26 Economics of Climate Policy
      (pp. 895-946)

      Climate change caused by human activity is possibly the most critical threat that the world economy has ever faced. The continued accumulation of carbon dioxide (CO2) and other greenhouse gases in the atmosphere is predicted to cause a significant increase in global temperatures and disruption to weather patterns worldwide. Rising temperatures will melt polar ice caps and low-lying areas will be flooded due to rising sea levels. Changing rainfall and snow patterns will cause widespread drought, particularly in important agricultural regions. The shortage of food and water will lead to major displacements of populations and civil unrest. Extreme weather events...

  15. Index
    (pp. 947-980)