poor, and other public goods for everybody to consume in some sort of way. While the federal

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1 William Dare Final Exam Paper May 10, 2016 Economics of the Public Sector To determine the economic rationale of government expenditures, we have to know the role that the government has in our everyday lives and what commodities they provide. In the United States, the government provides the citizens a judicial system, a national defense, roads and highways, education, a system of public order, transfer payments for the old, disabled, and poor, and other public goods for everybody to consume in some sort of way. While the federal government would be more inclined to spend more on health care, national defense, and social security payments, it is the state s responsibility to provide its spending with more emphasis on education, public order and safety, and health care. These public goods are not able to be allocated through a private market as well because it is impossible to provide some of these commodities to help only one consumer. For example, to have roads in a city, it is impossible to regulate one road to a single driver because others would have to use it as well. So to say if us as a nation did not have a central government, there would be no rationale to have any of these public goods. We must also know that government expenditure is a key component to a nation s gross domestic product. According to the Federal Reserve of St. Louis (FRED), the sum of current transfer payments for social benefits to citizens and the government purchases was 29.5% of the gross domestic product in Without the spending of these programs then a huge portion of the gross domestic product would be lost, not to mention the jobs and productivity lost as well.

2 Public goods are the opposite of private goods due to the fact public goods can t exclude any citizen from using a good and that there is an unlimited supply of the good or service that is being used. That statement is most of the time true, but there are some exceptions that happen that make a good either more rival or more excludable, and even mimics characteristics that a private good has. For a pure public good, the marginal cost for adding another consumer is zero; however, there are some goods that reach a certain threshold to how many consumers there can be until the marginal cost starts to increase. These goods are called congestible public goods. An example of this would be a busy highway. Most of the time during the day, a typical driver would not have a problem with travelling at the posted speed, but towards the end of a typical work day there may be increased traffic that would increase the opportunity cost to travel that highway due to slower speeds and higher risk of getting in an accident. Price-excludable goods are the other way in contrast to congestible goods, where there is an explicit cost to attain the good or service, but that good is not rival in the consumption. An example of this would be a country club, to where people pay for a membership for the club and the wait for a tee off time at the golf course would be at a minimum. Education is a public good that has some private good qualities to it. It is a public good in the sense that teachers have to share their knowledge to every kid in the classroom and that the amount of knowledge that the classroom receives is the same. On the other hand, each kid is different in the aspect of how much knowledge that he or she can actually retain and the extra effort they may put in to have a one on one learning experience with the teacher. Also each classroom varies in size, for example a classroom with only five people will allow the teacher to focus on the strengths and weaknesses of an individual student better than a lecture hall with 300 students.

3 For each person, there is a unique demand, or marginal benefit, that they have in regards to how much of a public good they want to receive. When determining what would be an efficient quantity of a public good to produce, all the marginal benefits of the participants into the good or service has to be added up, and the point where the marginal social benefit is the same as the marginal social cost, which in this case is the average cost of the good, then that is the efficient quantity of the good that should be produced. For a community to do this, they would have to volunteer some of their income to contribute in paying for a public good. With this method, member of a community could be able to purchase the use of a public good they wouldn t have been able to afford in a private market. The volunteering method is more effective in smaller communities than in larger ones because the costs are higher in larger communities and may be too high for the marginal social benefit to reach. There is also the freerider problem, which is when one person, the free-rider, will understate their willingness to pay for the public good, and be able to achieve what they preferred at a lower cost to them. The other type of government goods and services are transfer payments, which are payments to assist with income support for the poor, retired or disabled and do not require any services for them. One major for of transfer payments used in the United States is the Social Security program. The Social Security program is an income support program to help citizens that have reached the retirement age and have worked a set number of years of their life, and if a citizen decides to work past their retirement age then the benefits that they receive would be higher than if they decided to retire at the retirement age. The United States uses an adjusted pay-as-you-go system, to where the taxes that are paid in the current year by citizens who are employed are used for the pensions received by the retirees. The adjustment is that there is a trust fund that is in place in case of a financial crisis and the taxes couldn t be used for pensions.

4 The importance of Social Security is the massive poverty that would happen if it didn t exist. 67% of the participants in Social Security receive half of their income this way, and households with a lower income receive four-fifths of their income from Social Security. Transfer payments are also half of the governments expenditures, which means without Social Security our government expenditures, and in turn gross domestic product, would decrease drastically. To be able to utilize these public goods and services, they have to be financed through taxes because these taxes have to pay for the maintenance, the actual project taking place, and the jobs associated with distributing each of these goods. In order to be able to tax someone fairly and efficiently as possible, you have to think about the incentives for both consumers and producers when being taxed. If the consumers are being taxed too much then they would not have an incentive to buy any of the product from the producer, as the producer would not produce as much product if they were being taxed more. Much of the taxes received by the government is from income and payroll taxes on both federal and state levels. Corporate income taxes are also a large part of the taxes received by the federal government as well. There are also sales taxes and property taxes that make up about 40% of the revenue for state and local governments on average. In the United States, the rate of taxes taken out from a person s adjusted gross income is divided into brackets to ensure more equity. Taxes also depend on if you file as a single independent taxpayer, a head of household, dependent, or filing jointly or separately with a spouse. For example, single taxpayers that have an annual income of $8,700 or lower only have to pay a ten percent income tax compared to a 35% tax for a person making over $388,350. In corporations, the profits earned by the corporation are divided up and given to shareholders.

5 These profits are then subject to a corporate tax and an income tax based on the percentage of the stock that the shareholder has. The corporate tax is also divided up into two categories, those being the federal corporate tax and the state corporate tax. The federal corporate tax is a bracketed tax rate structure similar to income tax. When the taxable income for a corporation is under $50000 then it is taxed 15% of that income and if they make over $10 million then it is subject to being taxed 35% of its income. Government goods and services do have benefits when being implemented, but we also need to take into account the costs that come with the construction, the lifetime maintenance, funding, use of capital, and potential land losses. When government agencies are going to provide the citizens a public good whether it is health care or highways, the projects used for the implementation of these goods and services are subject to cost benefit analysis. There are two different types of benefits that can be accrued from a project. Any increases in output or efficiency that are a direct effect from the project itself are direct benefits. Spillover benefits are any positive unforeseen qualities that take place after the project is finished but are not directly due to the project. Two types of costs exist as well, direct costs are the costs directly associated with the project, such as input costs, and external costs are those that occur as a harmful effect from the project. When evaluating the costs and the benefits, only direct benefits can be used but all costs need to have a monetary value in order to accurately determine the value of the project itself. Projects also have to take into account how much inflation will change the real value of a dollar and the project. For example, if a project was to take place over six years, and in the first year the project was worth $100 but the last year the project was worth $150 nominally, at a certain inflation rate, or social discount rate, the future worth of the project could be worth less

6 than the $100 in the first year. Projects that have a depreciating value over time are rarely approved by the government. In conclusion, the economic rationale for spending in government activities such as national defense, Social Security, education, health care, and other programs is due to the fact that without these programs the productive and technological progress of the nation would not exist if we didn t have spending for such program. Also another reason for the spending in these programs is that government expenditures is a large portion of our nation s gross domestic product today, and without government expenditure, our nation could perhaps still be a developing nation instead of a developed one. For the use of the public goods that are provided by these programs, a community s demand, or marginal social benefit, has to equal the average cost of the good that is being provided. Transfer payments, such as Social Security, are essential to our economy s well-being because without the income support to retirees, the poor, and disable, the level of poverty in our country would increase and our gross domestic product would decrease. To have the funding for government projects and the services they provide, they have to have revenue collected through taxes, mainly from income tax. When a project is taking place a dollar value has to be established for the costs and the benefits of the project, and if the project has a depreciating value over time then most likely it won t be approved.