10. Public Economics

Front 1

Major Economic Functions

Back 1

Macro Management
Redistribution
Public Goods

Front 2

Macro Management

Back 2

- Federal (central) level should be responsible

- Local would find it difficult - effects leak into other regions

Fiscal Policy is inefficient with seperate currencies and interest rate policies (EU is struggling with this atm)

Front 3

Redistribution

Back 3

- Should be responsibility of the centre

-- only central gov can provide horizontal equity among individuals in diff jurisdictions

- Sub-national redistribution would have adverse effects

-- highly redistributive areas attract poor, repel rich

-- state still has a small role (do undertake transfers in kind in AUS)

Front 4

Public Goods

Back 4

- National benefits (defense) provided by central

- Local benefits, provided by local

-- particularly if preference differ within regions

-- sub-national gov have better info re: preferences

-- national uniform provision doesn't take these into account, but CAN internalise externalities.

MORE SPILLOVER=FED, LIMITED SPILLOVER=LOCAL

Front 5

SUBSIDIARY PRINCIPLE (EU)

Back 5

Subject to cost considerations, public services should be provided by the level of government closest to the users of the service

Front 6

Decentralisation Theorum ( OATS 1972 )

Back 6

Decentralisation of public good provision maximizes economic welfare by matching supply to demand

IF preferences varies, there are no economies of scale or externalities

Front 7

Decentralisation Theorum graph

Back 7

DA: Jurisdiction A's demand for good (DB...)

A: Qa supplied for jurisdiction A if provided locally (F: Qb for B)

C: Uniform provision by central gov.

DWL: ABC (A) + CEF (B)

Front 8

Other Market Failures

Back 8

Imperfet competition; Externalities; Environment

- National government handles national market issues (defense)

- Regional gov handles regional market issues (electricity)

Front 9

Optimal Size of Sub-National Governments --- considerations

Back 9

(similiar to that of supply)

- Diversity of preference -> smaller regions optimal

- Cost efficiency (economies of scale) -> larger

- Local gov may ignore externalities

- Scope of redistribution falls with increase of regions!

--- Optimal size may vary by type of public good

--- There's theoretical work but little empirical data

------ Studies cost of services in different sized areas focusing on technical poss over behavioural poss (few studies on effects of area size on demand and preference satisfaction)

Front 10

Optimal Community Size and Service Level GRAPH

Back 10

QQ: Optimal hospital size for various comm sizes

NN: locus (point) of optimal comm sizes for various hospital sizes (MC=MB)

E: Comm size optimal for given size of hosp and vise versa (excluding spillovers)

ACT&NSW spill over - NSW drop in to ACT hospitals

Front 11

Tiebout Hypothesis (1956)

Back 11

If there are many competing sub-national gov and households are perfectly mobile - local regions will efficiently provide local goods demanded and optimal sized regions would form naturally (AS IN USA, PEOPLE CAN BUY INTERSTATE)

-- to hold, requires that there are no externalities associated with migration (there is)

Front 12

Tax w/ Multi-level Government - criteria for good taxation

Back 12

- Distributional / Equity objectives

- Allocative efficiency (minimize DWL)

- Fiscal adequency (adequte funding for each level of gov)

- Accountability (central gov is less accountable)

Central taxes meet first two but create issues for other two - when spending powers are decentralised (subnational left with less power)

- WHO SHOULD TAX WHAT?

--- to be optimal, many taxes must be shared

Front 13

Tax w/ Multi-level Government -fitting taxes to functions

Back 13

income tax is most effective for income redistribution

- redistribution falls to central gov -> they should have access to income taxes

Sub national gov provision of local goods = needs access to a major tax base

Front 14

Tax w/ Multi-level Government - Issues with Subnational Tax:

Back 14

1) Undesirable tax competition on mobile tax bases (possible cause of DWL)2) Externalities/spillovers (causes DWL)---- these push tax base to central level

Front 15

Tax w/ Multi-level Government - Local Taxes on Capital (graph)

Back 15

[highly mobile and supply elastic]

Local capital shifts supply from s1-s2, but return to owners of capital stays at r1 (TAX borne by CONSUMERS)

DWL: ABC

Original equilibrium: B

Taxed equilibrium: A

Optimal tax is 0 when supply is elastic

Front 16

Tax w/ Multi-level Government - Local Taxes on Goods (graph)

Back 16

happens at USA near borders, AUS: fuel excise NSW/VIC border

Subnational tax on consumption shifts D curve from 1-2

DWL = ABC, borne by local firms - consumers can buy elsewhere

EQ: B->C

Price: P1->P2

P2(1+t) consumers bearing tax but they don't have to

Front 17

Tax w/ Multi-level Government - Vertical Fiscal Imbalance

Back 17

Center appears to be a more efficient taxing agent but local public goods are best provided locally

VFI: Central gov raises more rev than it needs

Local gov raises less than it needs

Central and local gov rev don't match expenditure responsibilities (resolved using grants from centre)

- Some degree of VFI can be classed as optimal on efficiency grounds

Front 18

Tax w/ Multi-level Government - Vertical Fiscal Imbalance --- Centralised Power

Back 18

- High degree of VFI, large transfers - not good.

- Can be overspending by central gov with weak constraints on it's power

- Overspending by sub-national gov when provided with external funds (fiscal illusions: local gov doesn't bear cost of earning = overspend)

- Central conditions on grants may not satisfy local preferences

- Reduced opportunity for beneficial impacts of desirable local fiscal competition

--- AUS state level rev well below needed, gov over. 40% of state spending supplied by central

Germany is closest to equal (state and fed both earn what they spend)

Front 19

Tax w/ Multi-level Government - Equity (Regressive Taxes, HFI)

Back 19

Regressive Taxes: Subnational govs can't tax progressively because they'll lose part of their tax base (attracts welfare migrants)

Horizontal Fiscal Imbalance

- Subnational gov can't provide equal public services due to diff in expenditure needs and rev raising capabilities

*Markets may offset HFI

- Property prices reflect level of public service provided

Front 20

Tax w/ Multi-level Government - Taxing the same base

Back 20

VFI and intergovernmental transfers can be reduced if diff levels of gov share taxbases.

---occurs in USA, Canada - sales tax

Theory: sharing tax base = increased tax rates because externalities are ignored (vertical tax comp)

Front 21

Intergovernmental Transfers

Back 21

1) Revenue sharing - sharing a tax base

2) Intergovernmental Grants

- General Purpose (GST given back to states to share)

- Special Purpose (conditional)

----- Matching (receiver must contribute)

----- Non-Matching (no contribution required)

Front 22

Intergovernmental Transfers - General Purpose Grants --- objectives and effects

Back 22

OBJECTIVE:
- Compensate for VFI (general revenue shortfalls of sub national gov)

- Reduce HFI (difference in fiscal capacities across states)

----- function of local expenditure needs and revenue capacity

EFFECTS:

- VFI allocation may lead to inefficient allocation. May be better to just increase how much states get overall

- HFE allocation may be inefficient as revenue is redistributed from rich-poor states

Front 23

Intergovernmental Transfers - Special Purpose Grants --- objectives and effects

Back 23

Intended to influence local service delivery

- if unmatched grant is less than initial expenditure on service it's effectively an income grant - may affect some service features

- if matched this changes relative prices and creates substitution effect (more likely to increase consumption of a service than similar unmatched grant)

- More likely to have DWL - forced divergences from local preferences

Front 24

Horizontal Fiscal Equalisation

Back 24

all governing bodies on one level have their fiscal capabilities equalised by a higher level

- then they all have same fiscal capacities

AUS - HFE applied to GST and distributed to states

then states apply equalisation to the grants they give locally!

Front 25

HFE - Capacity Differences -- revenue capacities and expense needs

Back 25

Revenue capacities

- Mining royalties (diff natural resources)

- Land Taxes (diff land values)

- Payroll taxes (diff industry mix and size)

Different Expense needs:

- health (population age)

- law and order (youths)

- education

- geography (dispersion, roads, mountains??)

Front 26

Fiscal Equalisations

Back 26

WHY ADOPT?

- Horizontal equity

- Nationhood (one people, one land...)

- Individuals otherwise equal made unequal by gov decisions

- Establishes efficient migration patters (migration to maximize wellbeing)

- HFE supports development of national markets in which all states/citizens compete on equal footing

USED IN: AUS, Canada (rev only), Germany, Switzerland (mountain disability), decentralised China...

NO explicit HFE in USA but there are transfers!

Front 27

Issues in Australian Federalism

Back 27

- High levels of VFI leads to lack of fiscal responsibility (overspending by both levels)

- State tax base is narrow, inefficient, inequitable

- Central gov GST grants may create inefficiency in acheiving equal fiscal capacities

- Excessive number of inefficient specific grants (150+)

- Too many local/state govs

- Duplication/overlap of provisions (education, health...) between center and subnational