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Public Finance

Purpose of Course  showclose

Learning Outcomes  showclose

Course Requirements  showclose

• Unit 1
• Unit 2
• Unit 3
• Unit 4
• Unit 5
• Unit 6
• Final Exam
• All Units

Unit Outline show close

Unit 1: Introduction to Public Finance and Tools of Analysis  

This unit will begin with an introduction to the tools of analysis that will be used throughout the course.  Most of the models we will use in this course will be extensions of the supply and demand models you learned in your introductory microeconomics courses, which will allow you to evaluate the effects of tax and subsidy policies.  These policies change the relative costs of different activities for the individual decision-makers.  By using rational-choice assumptions—i.e. by assuming that individuals know what they prefer and, given a choice, will choose the happier path—we can graphically illustrate the effects of policy change.  Additionally, you will learn how economists use assumptions about optimality to “add up” individual benefits and costs such that they reflect social benefits and costs. While economists debate the appropriateness of certain assumptions, experience using a given set of tools will help you consider how changes in assumptions might affect the outcome of the analysis. After this quick refresher, this unit will go on to introduce major arguments for and against government fiscal intervention.

From an economic perspective, what is considered “good” government fiscal intervention?  Many economists believe that public goods and externalities exist as market failures and that the government should therefore use fiscal policy to affect the outcome in the marketplace.  Public goods are products or services that economists think are not likely to be provided in ideal quantities because individuals are not motivated to produce them.  If you ask an economist, “What is a public good?”, he or she will invariably respond: “National security.”  In this unit, we will consider the problem of national security, acknowledging that in order for individuals in society to be able to conduct their affairs and accumulate capital, they need assurances that the rule set they are operating under is somewhat stable.  How shall mechanisms for ensuring this space, such as a large military, be provided?  In this unit, we will learn how economists define a “public good” so that we can consider whether the particular subsidies from Unit 3.2 meet this definition.  Does national security meet this definition?

We will also take a look at how the dynamics of voting may fail to overcome the public goods problem when individual voters have different valuations for the public good before studying tax systems (such as the Lindahl tax) that seek to overcome this problem.  Finally, we will consider examples in which private persons have provided public goods despite the existing theory of public goods, which would incline us to believe that these goods do not exist until they are provided by a governmental unit that has the power to tax.  Consider how people provided public goods before the advent of modern governments: if free-rider problems are pervasive, how do public-goods-providing governments ever get started?

We will conduct a similar investigation into the issue of externalities.  Arthur Pigou, an English economist whose career and influence bridged the late 19^th century and early 20^th century, proposed a system of taxation that would internalize externalities by taxing behaviors such that the private value would equal the social value.  His model was widely accepted, until a challenge in 1960 from Ronald Coase demonstrated that Pigou’s model was only a special case. Ronald Coase won the Nobel Prize for refuting the efficiency of Pigou’s system and, in doing so, opened up a wholly new way of considering conflicts of interest.  This unit will take a look at Coase’s theorem and his insight into the difficulty of assigning rights—which often precede our legal understanding of externalities.  We will conclude by considering the possibility of government failure as an externality.

1.1 Tools of Analysis  

1.1.1 Consumer Surplus, Producer Surplus, and Profit  

• Lecture: Tutor2u’s “Consumer and Producer Surplus”

  Link: Tutor2u’s “Consumer and Producer Surplus” (Adobe Flash)
   
  Instructions: Please open and review this presentation in its entirety.
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

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• Reading: Preston McAfee’s Introduction to Economic Analysis: “2.1 Supply and Demand.”

  Link: Preston McAfee’s Introduction to Economic Analysis: “2.1 Supply and Demand”  (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: Access the document above, and read it entirely (10 pages).  This reading is on pages 14-24 of Preston McAfee’s textbook and analizes the importance of the Supply and Demand process.
   
  Terms of Use: The article above is licensed under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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1.1.2 Pareto Principle  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “5.2.8 Edgeworth Box.”

  Link: Preston McAfee’s Introduction to Economic Analysis: “5.2.8 Edgeworth Box” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: Please open the link above to access the reading.  This reading is on pages 187-194 of Preston McAfee’s textbook and will explain the significance of the Edgeworth Box and how and why it relates to Public Finance.
                         
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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1.2 Public Goods as a Definition and as a Theory  

• Lecture: Tutor2u’s “Public Goods”

  Link: Tutor2u’s “Public Goods” (Adobe Flash)
   
  Instructions: Please review this presentation in its entirety.
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

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1.2.1 Definition of a Public Good  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4: Public Goods” and Randall G. Holcombe’s “A Theory of the Theory of Public Goods”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.4: Public Goods” (PDF) and Randall G. Holcombe’s “A Theory of the Theory of Public Goods”  (PDF)
   
  Also available in: (Preston McAfee)
  Microsoft Word Document (Zip File)
   
  Instructions: When reading the McAfee document, pay particular attention to the definition of a 'Samuelsonian Public Good'.  This reading is covered by pages 232-233 of Preston McAfee's textbook.
  For the Holcombe reading, please click on the second link above to access the PDF file.  When it loads, the referenced reading is in volume 10, number 1. 
   
  Terms of Use: The article above, McAfee’s “Public Goods,” is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here. 
  
  Terms of Use: The article above, Holcombe’s “A Theory of the Theory of Public Goods,” is licensed under a Creative Commons Attribution 3.0 United States License.  It is attributed to the Ludwig von Mises Institute.  The original version can be found here.

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1.2.2 Free Rider Problem, Median Voter, and Taxation Solution  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4.2: Free Riders” and “6.4.3 Provision with Taxation”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.4.2: Free Riders” and “6.4.3 Provision with Taxation” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 233-236 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

  See a broken link? Please let us know!

1.2.3 Tiebout Theory  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4.4: Local Public Goods”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.4.4: Local Public Goods” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 236-238 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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1.3 Externalities and Market Failure  

1.3.1 Externalities as Market Failure  

• Lecture: Tutor2u’s “Positive Externalities” and “Negative Externalities”

  Link: Tutor2u’s “Positive Externalities” (Adobe Flash) and “Negative Externalities” (Adobe Flash)
   
  Instructions: Please read through and review both of these presentations, paying particular attention to the graphical representation of externalities.
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

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• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.3 Externalities”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.3 Externalities” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 219-222 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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1.3.2 Pigouvian Taxes  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.3.2 Pigouvian Taxes”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.3.2 Pigouvian Taxes” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 223-226 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/).
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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1.3.3 Coase’s Theorem and Insight  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.3.5 Coasian Bargaining”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.3.5 Coasian Bargaining” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 226-227 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

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Unit 2: Taxes  

In this unit, we will familiarize ourselves with the different kinds of taxes that exist in policy today, including those that are less frequently used.  This unit will distinguish the elements of a tax: (a) the taxable base, which is the object or activity that the tax payment is calculated on, (b) the person who remits the tax payment by actually cutting a check to the government, and (c) the person(s) who bear the economic burden of the tax.  You will learn that economists distinguish between who pays a tax and whose behavior changes because of a tax.  In ordinary conversations, these are often confused, but our toolset will show that the tax burden doesn’t always fall on the person or company that is explicitly being taxed.  We will also consider the cost of deadweight losses, or welfare that is lost due to the changing behavior of individuals given different policy choices.  Rational choice individuals don’t like to pay taxes, so we will see the different ways that they avoid paying taxes by changing what they invest in, and how much they are willing to work based on the taxation of income.

2.1 Types of Taxes  

2.1.1 Personal Income Taxes  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “The Personal Income Tax” and Tamahome Jenkins’ “A Short History of the Income Tax”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “The Personal Income Tax” (PDF) and Tamahome Jenkins’ “A Short History of the Income Tax” (PDF)
   
  Also available in:
  EPUB
  
  Instructions: Please read the entirety of both readings.  The Wise et al reading is Kurt Wise and Noah Berger's guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: The Wise article is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original version of the Howgate article here.
  
  Terms of Use: The Jenkins article is released by Everything Is History by Steven Durham under a Creative Commons Attribution-NonCommercial 3.0.  You can find the original version of the Jenkins article here.

  See a broken link? Please let us know!

2.1.2 Corporate Income and Business Taxes  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Business Taxes and Corporate Income Tax”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Business Taxes” (PDF) and “Corporate Income Tax” (PDF)
   
  Also available in:
  EPUB
  
  Instructions: Please read both selections from Kurt Wise and Noah Berger’s guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: The article above is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original Wise version of these articles here.

  See a broken link? Please let us know!

2.1.3 Sales Taxes  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Business Taxes & Corporate Income Tax” and Dave Farnsworth’s “Sales Tax”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “General Sales Tax” (PDF) and Dave Farnsworth’s “Sales Tax” (PDF)
   
  Also available in:
  EPUB
  
  Note on the Text: Please read both readings.  The Wise et al reading is Kurt Wise and Noah Berger’s guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: Terms of Use: The article above is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original Howgate version of this article here. Please respect the copyright and terms of use displayed on the web pages above.

  See a broken link? Please let us know!

2.1.4 Property Taxes  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Property Tax” and Roby Smith’s “Understanding Property Taxes”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Property Tax” (PDF) and Roby Smith’s “Understanding Property Taxes”  (PDF)
   
  Also available in:
  EPUB
  
  Instructions: Please read both readings.  The Wise et al reading is Kurt Wise and Noah Berger’s guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: The Wise article is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original version of the Howgate article here. 
  
  Terms of Use: The Smith article is released under a Creative Commons Attribution-NoDerivs 3.0 Unported License.  You can find the original version of the Smith article here.

  See a broken link? Please let us know!

2.1.5 Excise Taxes  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Selective Sales Tax”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Overview of Selective Sales Tax”  (PDF)
   
  Also available in:
  EPUB
  
  Instructions: Please read this selection.  The Wise et al reading is Kurt Wise and Noah Berger’s guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: The article above is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original Wise’s version of this article here.

  See a broken link? Please let us know!

2.1.6 Head Taxes  

• Reading: New World Encyclopedia’s: “Poll Tax”

  Link: New World Encyclopedia’s: “Poll Tax” (PDF)
   
  Instructions: Click on the above link to access the reading.  Please read the text in its entirety.
   
  Terms of Use: This work is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License.  This work was created by contributions from both New World Encyclopedia and Wikimedia Foundation contributors.  The original New World Encyclopedia article can be found here.

  See a broken link? Please let us know!

2.1.7 Standard Criteria for Taxes and Tax Systems  

• Reading: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Standard Criteria for Taxes and Tax Systems”

  Link: Kurt Wise et al’s Understanding Our Tax System: A Primer for Active Citizens: “Five Criteria for Assessing Taxes and Tax Systems” (PDF)
   
  Also available in:
  EPUB
  
  Instructions:  Please read this selection.  The Wise et al reading is Kurt Wise and Noah Berger’s guidebook, which is publicly available under a creative commons license on the Massachusetts Budget and Policy Center’s website (http://www.massbudget.org).
   
  Terms of Use: The article above is released under a Creative Commons Attribution-NonCommercial License 3.0.  You can find the original Wise version of this article here.

  See a broken link? Please let us know!

2.1.8 Progressive and Regressive Taxation  

• Reading: Jason Welker’s Economics in Plain English: “The Role of Taxes in Income Re-Distribution”

  Link:  Jason Welker’s Economics in Plain English: “The Role of Taxes in Income Re-Distribution” (HTML)
   
  Instructions: Click on the above link to access the reading.  Please read the text in its entirety.
   
  Terms of Use: This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 United States License.  This article was written by Jason Welker for Welker’s Wikinomics Blog.  The original version of the article can be found here.

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• Lecture: Harvard University: Michael Sandel’s “Progressive Taxation – Freedom to Choose”

  Link: Harvard University: Michael Sandel’s “Progressive Taxation – Freedom to Choose”  (Adobe Flash)
   
  Instructions: Click on the above link to listen to an introductory lecture on economic philosophy at Harvard by Michael Sandel.  Please watch the lecture starting at 5:30.  When watching this video, ask yourself which side of the argument you find more compelling.
             
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

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2.2 Impacts on Prices and Output  

2.2.1 Incidence of Taxation and Dead Weight Losses  

• Lecture: Tutor2u’s “Indirect Taxes”

  Link: Tutor2u’s “Indirect Taxes” (Adobe Flash)
   
  Instructions: Please review the presentation in its entirety. 
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

  See a broken link? Please let us know!

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.1 Taxes”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.1 Taxes”  (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 201-206 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/).
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

  See a broken link? Please let us know!

2.2.2 Excess Burden  

• Reading: Preston McAfee’s Introduction to Economic Analysis: “6.1.3 Taxes: Excess Burden of Taxation”

  Link: Preston McAfee’s Introduction to Economic Analysis: “6.1.3 Taxes: Excess Burden of Taxation” (PDF)
   
  Also available in:
  Microsoft Word Document (Zip File)
   
  Instructions: This reading is on pages 206-208 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

  See a broken link? Please let us know!

2.2.3 Neutral Taxes  

• Reading: Ludwig von Mises’ Human Action: The Scholars Edition: “XXVIII. INTERFERENCE BY TAXATION: The Neutral Tax”

  Link: Ludwig von Mises’ Human Action: The Scholars Edition: “XXVIII. INTERFERENCE BY TAXATION: The Neutral Tax” (PDF)
   
  Instructions: Click on the above link to access the reading.  Please read the page of text in its entirety.
   
  Terms of Use: This work is licensed under a Creative Commons Attribution 3.0 United States License.  This work is attributed to the Ludwig von Mises Institute.  The original version of this article can be found here.

  See a broken link? Please let us know!

2.2.4 Ramsey Taxation  

• Reading: The Saylor Foundation’s “Handout on Ramsey Taxation” and Preston McAfee’s Introduction to Economic Analysis: “2.4.1 Elasticity of Demand”

  Link: The Saylor Foundation’s “Handout on Ramsey Taxation” (PDF) and Preston McAfee’s Introduction to Economic Analysis: “2.4.1 Elasticity of Demand”  (PDF)
  
  Also available in (Preston McAfe):
  Microsoft Word Document (Zip File)
  
  Instructions: The Saylor Foundation handout will describe the main conclusions of Ramsey Optimal Taxation while the reading in the McAfee textbook will provide a refresher on elasticity of demand, for those who need it.  The McAfee reading is on pages 33-36 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/).  
  
  Terms of Use: Preston McAfee’s text above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

  See a broken link? Please let us know!

2.2.5 Lindahl Tax  

• Reading: The Saylor Foundation’s “Handout on Lindahl Taxation”

  Link: The Saylor Foundation’s “Handout on Lindahl Taxation” (PDF)
  
  Instructions: Please read the entire handout.  When reading, think about how much you might be willing to pay for different public goods.  Is it possible to perceive your own willingness to pay for those goods?  Have you seen the Lindahl solution in action?

  See a broken link? Please let us know!

2.2.6 Income Tax and Labor-Leisure Tradeoff  

• Reading: The Saylor Foundation’s handout on “Income Tax and Labor-Leisure Tradeoff” and Preston McAfee’s Introduction to Economic Analysis: “5.2.2 Labor Supply”

  Link: The Saylor Foundation’s handout on “Income Tax and Labor-Leisure Tradeoff” (PDF) and Preston McAfee’s Introduction to Economic Analysis: “5.2.2 Labor Supply” (PDF)
  
  Also available in (Preston McAfee):
  Microsoft Word Document (Zip File)
  
  Instructions: The Saylor Foundation handout will describe the relationship between taxes and the labor-leisure tradeoff, while the reading in the McAfee textbook will provide a refresher on labor supply, for those who need it.  The McAfee reading is on pages 166-170 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/).  
  
  Terms of Use: Preston McAfee’s text above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

  See a broken link? Please let us know!

2.2.7 The Laffer Curve  

• Reading: Charles Kelly’s “Laffer Curve and Tax Revenue” and Wikipedia’s “Laffer-Curve”

  Link: Charles Kelly’s “Laffer Curve and Tax Revenue” (PDF) and Wikipedia’s “Laffer Curve” (PDF)
    
  Instructions: Please read the Kelly reading in its entirety through the above link.  You can see an example of a Laffer Curve by clicking on the Wikipedia link.
  
  Terms of Use: The Charles Kelly article is licensed under a Creative Commons Attribution-NoDerivs 3.0 Unported License.  You can find the original version of the Kelly article here.
  
  Terms of Use: The Wikipedia article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.  

  See a broken link? Please let us know!

• Reading: Rok Spruk’s “Tax Policy and Laffer Curve” and Liberal American’s “The Laffer Curve Comes Back from the Dead”

  Link: Rok Spruk’s “Tax Policy and Laffer Curve” (PDF) and Liberal American’s “The Laffer Curve Comes Back from the Dead” (PDF)
   
  Instructions: These two readings are optional.  The Laffer curve continues to be an influential theory that is often used in policy debates about determining the level of taxation.  To get both sides of the debate, consider the blogs linked above.  Which side of the story do you believe?
   
  Terms of Use: Rok Spruk’s blog post is licensed under a Creative Commons Attribution 3.0 United States License.  You can find the original blog post here. 
  
  Terms of Use: Liberal American’s blog post is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 United States License.  You can find the original blog post here.

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Unit 3: Subsidies  

Subsidies are expenditures by the government intended to support an activity that politicians or government bureaucrats think society needs more of.  Subsidies are the opposite of taxes; rather than altering individual behavior by making one activity less profitable than another, they make one activity more profitable than another.  Much of the logic that applies to taxes also applies to subsidies—only in reverse.  Generally subsidies are justified on one of three arguments: (i) redistribution of wealth, (ii) national interest, and (iii) to promote positive externalities.  The first justification is a matter of national values, which each country decides on the basis of their beliefs.  Economists can help in this case by considering the economic costs and benefits of this decision.  The second justification is one that is liable to abuse by special interests, and one that does not warrant extended discussion.  The third justification, however, is interesting from an economic point of view, this justification will be considered in the first section of this unit.  We will then move onto considering some empirical evidence of the success that various kinds of subsidies have.  As we move into Unit 4, it will be helpful to remember that both the success and failure of policies can cause an increase in the demand for government expenditure  Do you think that farmers who have been helped by the government will want more or less support in the future?

3.1 Types of and Justifications for Subsidies  

3.1.1 Types of Subsidies  

• Reading: Wikipedia’s “Subsidy”

  Link: Wikipedia’s “Subsidy” (PDF)
  
  Instructions: Please read the entire text, paying particular attention to the section titled “Types of Subsidies.”
   
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

  See a broken link? Please let us know!

3.1.2 Subsidies in the Case of Positive Externalities (Merit Goods)  

• Lecture: Tutor2u’s “Merit Goods”

  Link: Tutor2u’s “Merit Goods” (Adobe Flash)
   
  Instructions: Please review the whole presentation, focusing particularly on the section entitled “Encouraging Consumption of Merit Goods.”
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

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3.2 Effects of Subsidies: Deadweight Losses  

• Lecture: Tutor2u’s “Producer Subsidies”

  Link: Tutor2u’s “Producer Subsidies” (Adobe Flash)
   
  Instructions: Please review the entire presentation.
   
  Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

  See a broken link? Please let us know!

3.3 Subsidies as Public Policy  

3.3.1 Farm Subsidies  

• Lecture: Robert LeFevre’s “Farm Subsidies and the First Secretary of Agriculture”

  Link: Robert LeFevre’s “Farm Subsidies and the First Secretary of Agriculture” (Youtube)
  
  Instructions: Please listen to the entire recording of the lecture (28:36).
   
  Terms of Use: The video above is licensed under a Creative Commons Attribution 3.0 United States License.  It is attributed to the Ludwig von Mises Institute.

  See a broken link? Please let us know!

• Reading: Thomas J. DiLorenzo’s “Farmed Robbery” and Wikipedia’s “Agricultural Subsidy”

  Link: Thomas J. DiLorenzo’s “Farmed Robbery” (PDF) and Wikipedia’s “Agricultural Subsidy” (PDF)
  
  Instructions: Please read the entire text of both articles.
   
  Terms of Use: The DiLorenzo article is released under a Creative Commons Attribution 3.0 United States License.  It was published by the Ludwig von Mises Institute, and an original version can be found here.
  
  Terms of Use: The Wikipedia article is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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3.3.2 Public Education  

• Reading: Tutor2u’s “AS Market Failure: Merit Goods”

  Link: Tutor2u’s “AS Market Failure: Merit Goods” (Adobe Flash)
   
  Instructions: Read the entire text, paying particular attention to the section on public education and the section describing the welfare gain to the additional provision of the subsidized goods.
   
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3.3.3 Unemployment Insurance and Welfare  

• Reading: Mary B. Larner et al’s “Welfare to Work: Analysis and Recommendations” and The Saylor Foundation’s handout on "Unemployment Benefits and Labor-Leisure Tradeoff.”

  Link: Mary B. Larner et al’s “Welfare to Work: Analysis and Recommendations” (PDF) and The Saylor Foundation’s handout on “Unemployment Benefits and Labor-Leisure Tradeoff” (PDF)
  
  Instructions: Please read both of these texts.  
  
  Terms of Use: The Larner article is published by The Future of Children under a Creative Commons Attribution-NoDerivs 3.0 Unported License.  You can find the original version of the article here.

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Unit 4: Rent Seeking and Other Government Failures  

In this unit, we will discuss the implications of several Public Choice models that relate to raising and spending of government revenue.  We will begin by “rent-seeking.”  Rent seeking refers to lobbying the government for policies that give interest groups above-market profits.  Subsidies and taxes are potential tools for rent-seeking.  If Company A can get the government to tax a competitor (Company B) more heavily or subsidize Company A directly, it can earn “rents” by being able to operate at a lower internal cost.  We will revisit the question of government failure as a result of rent-seeking behavior. 

Next, we will consider how arguments in favor of rent-seeking are framed “in the public interest.”  Bruce Yandle's theory of “Bootleggers and Baptists” tells the tale of how publicly interested persons end up supporting their opponents.  “X-inefficiencies” are those that arise from subsidized industries that need greater and greater subsidies to survive, and thus spend more money to secure those subsidies.  The term “Iron Triangles” refers to relationships of mutual interest that form between special interest groups, bureaucrats, and politicians and effectively block democratic efforts to reduce or remove special subsidies and taxes.  We will then consider several efforts that have been made to get around these problems, including The Grace Commission, the Graham-Rudman Act, and the Base Realignment and Closure Commission.

4.1 Basics of Rent Seeking and Government Failure  

• Reading: MBA651’s “Public Goods & Rent Seeking: Rent Seeking”

  Link: MBA651’s “Public Goods & Rent Seeking: Rent Seeking” (PDF)
   
  Instructions: Please read the section titled “Rent Seeking.”
   
  Terms of Use: The article above is licensed under a Creative Commons Attribution Share-Alike 3.0 License.  It is attributed to contributor's to MBA651 Fall 2007’s wikispaces page, as a portion of the original post titled “Public Goods, Rent Seeking,” and the original version can be found here.

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• Lecture: Tutor2u’s “Government Failure”

  Link: Tutor2u’s “Government Failure”(Adobe Flash)
   
  Instructions: Please review the presentation in its entirety.
   
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4.2 “Pork Barrel” versus General Welfare  

4.2.1 Industry Protection: Bootleggers and Baptists  

• Reading: Wikibook’s “Industry Protection”

  Link: Wikibook’s “Industry Protection” (PDF)
   
  Instructions: Please read the section titled “Industry Protection” in its entirety.  This section begins at the bottom of page 4.
   
  Terms of Use: This wikibook is licensed under the Creative Commons Attribution-ShareAlike 3.0 License.  The original version of this wikibook can be found here.

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4.2.2 The Iron Triangle: Bureaucracy, Politicians, and Special Interests  

• Reading: NMcBeth’s “Synopsis of Interest Group Theory” and Wikipedia’s “Iron Triangle”

  Link: NMcBeth’s “Synopsis of Interest Group Theory” (PDF) and Wikipedia’s “Iron Triangle” (PDF)
  
  Instructions:  Please read both texts in their entirety, paying particular attention in the NMcBeth reading to how interest groups are able to overcome the free-rider dilemma.
   
  Terms of Use: The article by NMcBeth is licensed under a Creative Commons Attribution-NoDerivs 2.5 Generic License.  The original version of the NMcBeth article can be found here.
  
  Terms of Use: The Wikipedia article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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4.2.3 Examples of Rent Seeking Behavior  

• Reading: Rent Seeker Watch’s “Premium Tobacco Seeking Tax to Hurt Generic Brand” and “Sleezy Realtors Stop Rent Seeking;” People's World’s “Military Bases Are No Solution for Jobs, Economy”

  Link: Rent Seeker Watch’s “Premium Tobacco Seeking Tax to Hurt Generic Brand” (PDF) and “Sleezy Realtors Stop Rent Seeking” (PDF); People's World’s “Military Bases Are No Solution for Jobs, Economy” (PDF)
   
  Instructions:  Please read all of these articles in their entirety, identifying what the “rent” is in each case, and what strategies the “rent seekers” are taking to gain this benefit.  Do you think these represent a justified use of public resources?
   
  Terms of Use: The articles from Rent Seeker Watch are licensed under a Creative Commons Attribution-NoDerivs-NonCommercial 1.0 Generic License.  The original versions are no longer available. 
  
  Terms of Use: The article from People's World is is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 United States License.  The original version of the People's World article can be found here.

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4.3 Efforts to Combat Rent Seeking and other Government Failures  

4.3.1 The Grace Commission  

• Reading: Wikipedia’s “The Grace Commission”

  Link: Wikipedia’s “The Grace Commission” (PDF)
   
  Instructions: Please open the link above and complete the reading about The Grace Commission in its entirety.
  
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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4.3.2 Gramm-Rudman Act  

• Reading: Wikipedia’s “Gramm Rudman Hollings Balanced Budget Act”

  Link: Wikipedia’s “Gramm Rudman Hollings Balanced Budget Act” (PDF)
   
  Instructions: Please complete this reading in its entirety.
  
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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4.3.3 Base Realignment and Closure Commission  

• Reading: Wikipedia’s “Base Realignment and Closure Commission”

  Link: Wikipedia’s “Base Realignment and Closure Commission”(PDF)
   
  Instructions: Please complete this reading in its entirety.
  
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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4.3.4 Decentralization  

• Reading: IMF.org: Daniel Treisman’s “Decentralization and the Quality of Government”

  Link: IMF.org: Daniel Treisman’s “Decentralization and the Quality of Government” (PDF)
   
  Instructions: Please read the text in its entirety.  To access the reading, follow the above link and click on the link to “Decentralization and Quality of Government:” 
   
  Note on the Text: This reading was presented at Conference on Fiscal Decentralization sponsored by the IMF in November 2000.  If you have further interest in the topic, feel free to read some of the other readings contained in the site.
   
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4.3.5 Privatization  

• Reading: Dimitar Dimitrov’s “The Potential Benefits of Privatization and the Political Issues”

  Link: Dimitar Dimitrov’s “The Potential Benefits of Privatization and the Political Issues” (PDF)
   
  Instructions: Please read this text in its entirety, paying particular attention to the potential benefits of privatization.
   
  Terms of Use: Terms of Use: The article above is released under a Creative Commons Attribution-NonCommercial-NoDerivsatives License 3.0.  It is attributed to (Dimitar Dimitrov) and the original version is no longer available.

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4.3.6 Public-Private Partnership  

• Reading: Wikipedia’s “Public-Private Partnership”

  Link: Wikipedia’s “Public-Private Partnership” (PDF)
   
  IInstructions: Please click on the link above to access the document.  Complete this reading in its entirety (7 pages).
  
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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• Web Media: Democracy Now’s “The Privatization of Education: How New Orleans Went from a Public School System to a Charter-School City”

  Link:  Democracy Now’s “The Privatization of Education: How New Orleans Went from a Public School System to a Charter-School City” (Youtube)
  
  Also available in:
  RealVideo
  RealAudio
    
  Instructions: Please watch through the whole video (11:43).  While watching, consider whether the solution of charter schools is a good one.  Might this model be used in other contexts with other state services?
   
  Terms of Use: The video above is released under a Creative Commons Attribution-NonCommercial-NoDerivatives 3.0.  You can find the original Democracy Now! version of this video here.

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Unit 5: Macroeconomic Considerations in Public Finance  

When market forces were unable to swiftly resolve the economic devastation brought on by the stock market crash in 1929, economists began to look for explanations of why the economy did not behave as the traditional models had predicted.  One of the schools of thought that emerged from these debates was the structural Keynesian school.  This new school of thought posited that in time of economic crisis, investors do not respond to a fall in interest rates due to an irrational pessimism on their ability to make a profit.  This leads to unemployment, which in turn leads to low consumption, which reinforces the investor’s belief that they cannot make a profit.  Keynes suggested that active government policy could be used to stimulate demand in times of recession.  This became known as countercyclical fiscal policy; that is running deficit spending when a country is in a recession, and repaying the accumulated debt in boom times. 

Since the Great Depression and FDR’s New Deal, this school of thought has become a part of American fiscal policy.  The first few sections of the reading will introduce the major aspects of this “macro” approach to fiscal policy.  This approach is not without limits, however, and countries cannot continually run deficits.  Thus, the issue of fiscal sustainability will be the subject of the last sections of this unit.

5.1 Macro-effects of National Policies  

• Lecture: Tutor2u’s “Fiscal Policy”

  Link: Tutor2u’s “Fiscal Policy”(Adobe Flash)
   
  Instructions: Please review the presentation in its entirety.
   
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5.1.1 Keynesianism and Fiscal Stimulus  

• Reading: Wikipedia’s “Keynesian Economics”

  Link: Wikipedia’s “Keynesian Economics” (PDF)
   
  Instructions: Please complete this reading in its entirety.
  
  Terms of Use: The article above is released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of this article here.

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• Web Media: YouTube: Professor Ron Wientraub’s “What Would Keynes Do?”

  Link: YouTube: Professor Ron Wientraub’s “What Would Keynes Do?” (YouTube)
   
  Instructions: Please watch the entire video (1:56), which considers how Keynes might respond to current economic conditions.
   
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5.1.2 Fiscal Sustainability  

• Guest Lecture: TED talks: “John Gerzema: The Post-Crisis Consumer”

  Link: TED talks: “John Gerzema: The Post-Crisis Consumer” (YouTube)
  
  Instructions: This is an optional lecture and not a requirement of the course.  After listening to this lecture (15:07), consider the different ways in which changes in the macroeconomic systems come about, especially in times of economic crisis.
  
  Terms of Use: This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License. It is attributed to TED and the original version can be found here. 

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• Reading: Citizendium’s “Fiscal Policy Tutorial: Fiscal Stability”

  Link: Citizendium’s “Fiscal Policy Tutorial: Fiscal Stability” (PDF)
   
  Instructions: Please read the entire article.  Pay attention, in particular, to the fiscal dilemma.
   
  Terms of Use: The article above is licensed under the Creative Commons-Attribution-ShareAlike 3.0 Unported license.  The original version of this article can be found here.

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Unit 6: Public Finance Trends and Debates in the United States  

This unit applies the public finance concepts you have learned throughout the course to the example of the United States Government.  It begins by familiarizing you with some background information on the U.S. government's aggregate taxation and expenditure over the last 100 years.  You will learn that both taxes and expenditure have grown steadily over this period by taking a look at publicly-available measures of these taxes and expenditures and discussing the types of taxes and expenditures we should expect to find at different levels of government.  The unit will go on to review some of the major contemporary debates in US government spending and taxation, including: (i) the Bush tax cuts, (ii) the stimulus bill, and (iii)proposed constitutional limits on spending.

6.1 The Growth in Public Financing as Public Policy in the United States  

6.1.1 Growth of Taxes and Expenditures  

• Reading: Visualizing Economic’s “Tax Rates and Government Spending”

  Link: Visualizing Economic’s “Tax Rates and Government Spending” (HTML)
   
  Instructions: Please read the entirety of the linked article.
   
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• Web Media: Bankrupting America’s “VIDEO: Is Washington Bankrupting America?”

  Link:  Bankrupting America’s “VIDEO: Is Washington Bankrupting America?”
  
  Instructions: Please watch the entirety of the video (2:21).  While you are watching, ask yourself: “What might be the root of the increase in spending?”  Please use the data with caution, as the data on household income is controlling for inflation, while it is does not appear from the notes that the spending per household controls for inflation.
   
  Terms of Use: This work is licensed under a Creative Commons Attribution 3.0 United States License.  It is attributed to Bankrupting America.

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6.1.2 US Taxation System  

• Reading: EOEarth.org: Brian Roach’s “Taxation in the United States”

  Link: EOEarth.org: Brian Roach’s “Taxation in the United States” (PDF)
   
  Instructions: Open the link to the reading above. Please read the article in its entirety.
   
  Terms of Use: The article above is licensed under a Creative Commons Attribution-ShareAlike 2.5 Generic License.  The original version of this article can be found here.

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6.1.3 The US Federal Budget  

• Reading: Wikipedia’s “Government Spending” and “2010 United States Federal Budget”

  Link: Wikipedia’s “Government Spending” (PDF) and “2010 United States Federal Budget” (PDF)
   
  Instructions: Please read both articles in their entirety.  To get a better look at the graphs and tables, click on them to enlarge.  Try to identify the most important parts of the Federal Budget.  How easy will it be to make cuts in these areas?  Do you think this type of spending is the result of rent seeking?
   
  Terms of Use: The articles above are released under a Creative Commons Attribution-Share-Alike License 3.0.  You can find the original Wikipedia version of these articles here and here.

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6.1.4 State Budgets: The Example of California  

• Reading: Dave Johnson’s “How does California Develop the State’s Budget?” and California’s Legislative Analyst’s Office’s “Cal Facts 2006: State Budget”

  Link: Dave Johnson’s “How does California Develop the State’s Budget?” (PDF) and California’s Legislative Analyst’s Office’s “Cal Facts 2006: State Budget” (HTML)
   
  Instructions: Please read both articles in their entirety.  Much of the country’s spending on social services and education are executed through individual state budgets.  As California is the most populous state in the US, it has one of the largest and most comprehensive budgets.  Although each state has its own process, these readings will illustrate some of the complexities of the state budgeting process.
   
  Terms of Use: The Johnson article is licensed under a Creative Commons Attribution-NoDerivs-NonCommercial 1.0 Generic License.  An original version of the Johnson article as posted on Seeing the Forest can be found here. 
  
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6.2 Contemporary Issues  

6.2.1 Bush Tax Credits: To Extend or Not to Extend  

• Reading: Economics in Plain English’s “Obama versus the supply-siders – to extend the Bush tax cuts or not? That is the question…”

  Link: Economics in Plain English’s “Obama versus the supply-siders – to extend the Bush tax cuts or not? That is the question…” (PDF)
   
  Instructions: Please open the link above to read the article in its entirety, and consider the discussion questions at the bottom of the page.
   
  Terms of Use: The article above is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 United States License.  The original version of this article from Welker's Wikinomics can be found here.

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6.2.2 The Stimulus Bill: American Recovery and Reinvestment Act of 2009  

• Reading: Ron Paul’s “On More Stimulus Spending” and Dustin Ensinger’s “Stimulus Package has Created Jobs, Boosted Economy”

  Link: Ron Paul’s “On More Stimulus Spending” (PDF) and Dustin Ensinger’s “Stimulus Package has Created Jobs, Boosted Economy” (PDF)
   
  Instructions:  Please read both articles in their entirety.  These readings take opposite viewpoints on the usefulness of stimulus spending in the most recent recession.  Which arguments appear to be the strongest?  Have you seen positive effects of the stimulus spending in your community?  Do these temporary measures warrant the additional government spending?  Is there a risk that temporary spending will become permanent? 
   
  Terms of Use: The Paul article is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License. 
  
  Terms of Use: The article by Dustin Ensinger is licensed under a Creative Commons Attribution-ShareAlike 3.0 United States License.  An original version of Ensinger's article can be found here.

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6.2.3 Constitutional Limits on Taxes and Spending?  

• Web Media: C-SPAN’s “The New Spending Limit Amendment.”

  Link: C-SPAN’s “The New Spending Limit Amendment” (YouTube)
  
  Instructions: Please watch the entire interview (4:21).  If you would like further information, look up the op-ed they reference in the Wall Street Journal. The following reading is a response to this interview and OP-ED.  Consider which argument you find more persuasive.
   
  Terms of Use: The material above was produced by C-SPAN, with permission granted for non-commercial use with no modifications to the material.  The original version can be found here.

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• Reading: Bruce Bartlett’s “A Dopey Budget Idea from Jeb Hensarling and Mike Pence”

  Link: Bruce Bartlett’s “A Dopey Budget Idea from Jeb Hensarling and Mike Pence”  (PDF)
   
  Instructions:  Please read this blog entry in its entirety.  This reading is a response to this interview and OP-ED mentioned in the web media above.  Consider which argument you find more persuasive.
   
  Terms of Use: The article above is licensed under a Creative Commons Attribution-Noncommercial-Share Alike 3.0 United States License.  The original version of Bruce Bartlett's article can be found here.

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Final Exam  

• Final Exam: The Saylor Foundation's “ECON305 Final Exam”

  Link: The Saylor Foundation's “ECON305 Final Exam”
  
  Instructions: You must be logged into your Saylor Foundation School account in order to access this exam.  If you do not yet have an account, you will be able to create one, free of charge, after clicking the link.

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