Transcript The Role of Government in the American Economy

CHAPTER
18
Taxation and Redistribution
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
Taxation and Redistribution
Over half the federal budget goes toward
redistribution
 Directly redistributive programs include:

 Social
security
 Medicaid
 Unemployment compensation
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Principles of Taxation and
Redistribution
Taxes pay for public sector output
 Frequently, taxation and spending pursue
income equality
 Goal of redistributive programs

 Use
resources of some taxpayers to improve
welfare of others
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-3
Equality as a Social Goal

Motivations underlying redistributive
programs:
 Create
more income equality
 Improve welfare of least well off

Redistributive programs targeted
domestically
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-4
Equality of Opportunity and
Equality of Results

Equal opportunity
 Everyone
starts with same chance
 Desire for game with fair rules

Fair rules
 Rules
that can be agreed upon
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-5
Goal of Equality
Equality of opportunity is a normative
goal
 Many individuals feel that less than
equitable results of opportunity warrant
income redistribution policies

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Utilitarian Justifications

Social Utility
 Sum

of individual utilities in a society
Maximize social utility
 Transfer
income from high to low income
individuals

Social welfare function
 Utility
function for society as a whole
 Admits possibility that it can be increased by
income transfers
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-7
Utility Maximization of Those
Least Well Off
Focuses on those at bottom of society
 Recognizes disincentives toward earning
income inherent in redistribution
schemes
 Suggests taxing high-income earners and
redistributing to low-income earners until
utility of person with lowest well-being
maximized

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-8
Charity as a Collective
Consumption Good
Will be underprovided if left to private
sector
 Charitable Giving as a Pareto Superior
Move
 Charity increases standard of living of
less fortunate
 Givers and recipients made better off

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-9
Incentive to Free Ride
Charity has some characteristics of a
public good
 Potential givers have incentive to become
free riders
 Role of government to overcome free
rider problem and provide optimal
amount of redistribution

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Redistribution as Insurance
Acts as type of income insurance
 Partially protects people from having low
incomes
 Premiums paid in high-income years
exchanged for payments in low-income
years

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Progressive Taxation and Wage
Adjustment
Market adjustments to wage structure
partially offset redistributive effects of
taxation
 More progressive tax structure raises
pretax income of high-income workers

 Lowers
pretax income of low-income workers
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Progressive Taxation and Wage
Adjustment
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Distributive Government
Shift of government spending toward
redistributional programs
 Increasing proportion of population
dependent on government for their
incomes
 More worthwhile for special interests to
lobby government

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Incentive Structure of
Government Programs
Do government programs do what they
are supposed to do?
 Welfare programs provide incentives to
remain unemployed
 Programs create transitional gains
 Abolishing programs results in transitional
losses

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Incentive Structure of
Government Programs
A Price Floor
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Redistributive Programs and
the Poor

Short run
 Can

reduce income of poor
Long run
 More
difficult to escape poverty
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Incentives to Earn Less
Income

Redistributive income
 Payments
to lower-income individuals
Higher income tax rates for welfare
recipients if benefits lost included in
addition to taxes paid
 Incentive structure encourages people to
remain on welfare
 May create poverty by creating
permanent class of welfare recipients

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Hard-Core Poor and Marginal
Poor

Hard-core poor


Marginal poor




Poor because of injuries, disease, or disability
Poor because of lack of education, pregnancy,
economic downturn
In position to improve economic status
Goal of redistributive programs to help hardcore poor
Help marginal poor in the process
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Growing Dependency on
Government Programs

Welfare dependency
 Marginal
poor who gradually become hardcore poor
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
18-20
Politics of Redistribution

Redistribution programs becoming larger
portion of government’s budget
 Increases
incentives for special interests to
lobby government

Establishment of redistribution programs
creates welfare industry
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Administrator Incentives
Bureaucrats have incentive to maximize
budgets of their bureaus
 Negative effect of government programs
result of rational self-interests of
government administrators
 Political incentives can cause inefficient
programs to be favored over potentially
effective ones

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Goals of Redistribution
In 2000, a family of 4 would have
received $87,000 if transfers equally
divided among poorest 20% of citizens.
 Why does poverty remain?

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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The Politics of Redistribution
Much income redistributed from middle
incomes to middle incomes
 Much redistribution not targeted
specifically to needy
 Redistribution programs subject to
interest group pressure
 Redistribution programs designed through
political process

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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