Economics: public good and taxation by Frank

Economics: public good and taxation by Frank

1. Public Goods and Tax Policy © MCGRAW HILL LLC. ALL RIGHTS RESERVED. NO REPRODUCTION OR DISTRIBUTION WITHOUT THE PRIOR WRITTEN CONSENT OF MCGRAW HILL LLC. Chapter 14

2. Learning Objectives Use the concepts of rivalry and excludability to distinguish among private goods, public goods, collective goods, and common goods. Show how economic concepts can be used to find the optimal quantity of a public good and describe the ways in which private firms can supply public goods. Analyze the types of efficiencies and inefficiencies that are associated with the provision of public goods. Explain why the maintenance of climate stability is an important public good and evaluate the case for using taxation as a means of funding climate mitigation. Describe a cognitive illusion that leads many wealthy voters to oppose higher top tax rates. Describe how international data on determinants of human flourishing inform the debate on how extensive the government’s role should be. 2 © McGraw Hill LLC. All Rights Reserved.

3. Public Goods Public good is a good that is both nonrival and nonexcludable A nonrival good is one whose consumption by one person does not diminish its availability to others ■ National defense ■ Economics lectures A non-excludable good is one that is difficult or costly to exclude non-payers from consuming ■ Over-the-air broadcasts ■ Fireworks displays A pure public good is, to a high degree, both nonrival and nonexcludable 3 © McGraw Hill LLC. All Rights Reserved.

4. Public Goods and Government Pure public goods are provided by government Cost of production are difficult to recover directly Free-rider problem Impossible to turn a profit unless you can compel people to pay for it through taxes MC of public goods is zero Charging for them reduces total surplus 4 © McGraw Hill LLC. All Rights Reserved.

5. Public Goods and Government A collective good is a good or service that, to at least some degree, is nonrival but excludable Digital downloads you have to pay for Sometimes provided by government A good is a pure private good if Non-payers can easily be excluded and Each unit consumed by one person means one less unit available for others 5 © McGraw Hill LLC. All Rights Reserved.

6. Public Goods and Government A pure commons good is a rival good that is nonexcludable Results in a tragedy of the commons Fish in open water 6 © McGraw Hill LLC. All Rights Reserved.

7. Types of Goods Nonrival Nonexcludable Low High High Commons good (ocean fish) Public good (national defense) Low Private good (wheat) Collective good (video streaming services) 7 © McGraw Hill LLC. All Rights Reserved.

8. Government Decisions about Public Goods Cost-Benefit Principle applies to pure public goods, as all others The cost of the public good is the sum of the explicit and implicit costs incurred to produce it Benefits of a public good are different from a private good Benefit of an additional unit of a private good is the highest price someone would pay for it Benefit of an additional unit of a public good is the sum of the reservation price of all people who use it 8 © McGraw Hill LLC. All Rights Reserved.

9. Paying for Public Goods Not everyone benefits equally from a public good or service. Taxing people in proportion to their willingness to pay is equitable … and impractical Example Prentice and Wilson have adjacent properties Fighting zebra mussel infestation New device to control mussels is $1,000 to serve both properties Wilson's income is higher; value for device is $800 Prentice values device at $400 9 © McGraw Hill LLC. All Rights Reserved.

10. Scenario 1: Sharing the Cost Prentice and Wilson negotiate the joint purchase Value is $1,200; cost is $1,000 Cost-Benefit Principle satisfied Some conditions make a private negotiated solution difficult to achieve Suppose there are a large number of parties Communication and negotiation are costly Free rider problem "Fair" sharing of costs may be difficult to agree Government provision could be a solution 10 © McGraw Hill LLC. All Rights Reserved.

11. Scenario 2: "Equal tax" Rule Local government offers to install the device for Prentice and Wilson Equal sharing of costs with a head tax , which is a tax that collects the same amount from every taxpayer Majority of affected parties must agree Result: no new device $500 is more than Prentice's reservation price Prentice vetoes device A regressive tax has a tax rate that varies inversely with income 11 © McGraw Hill LLC. All Rights Reserved.

12. Scenario 3: Proportional Tax on Income A proportional income tax requires all taxpayers to pay the same proportion of their incomes in taxes Majority rule applies Tax Prentice $333 and Wilson $667 Government buys the device Economic surplus: Wilson: $800 - $667 = $133 Prentice: $400 - $333 = $67 Total surplus increases $200 12 © McGraw Hill LLC. All Rights Reserved.

13. Marital Budgeting Married couples usually pool their incomes If each contributed proportionately, consumption would be limited by the lower income Higher income partner would want to spend more on all normal goods Combining incomes allows them to consume at a level appropriate to their combined incomes 13 © McGraw Hill LLC. All Rights Reserved.

14. Private and Public Goods Individuals consume whatever quantity and quality of most private goods they choose to buy Jointly consumed goods must be provided in the same quantity and quality for all People's willingness to pay increases with income Suppose public goods are financed by a head tax Higher income groups will not get the amount of public goods they demand Progressive taxes the proportion of income paid in taxes rises as income rises These taxes support a better outcome for all groups 14 © McGraw Hill LLC. All Rights Reserved.

15. Unfair Taxation A head tax is regressive With a proportional tax, the tax bill, in dollars, is higher for high-income groups Some argue that progressive taxes unfairly burden the higher income groups If public goods are normal goods, the higher income group demands more public goods than other groups Evidence shows that the income elasticity of public goods is substantially greater than 1 15 © McGraw Hill LLC. All Rights Reserved.

16. The Market for Public Goods Problem: How much of a public good should be provided? Cost-Benefit Principle applies Benefit of an additional unit of a public good is the sum of the reservation of all people who use it Vertical interpretation of demand curve Costs are the same as for private goods 16 © McGraw Hill LLC. All Rights Reserved.

17. Quantity (units/day) Price ($/unit) 24 Quantity (units/day) Price ($/unit) D 1 18 24 D 2 36 Market 2 Market 1 9 18 Q = Q 1 + Q 2 Price ($/unit) 24+36 = 60 D = D 1 + D 2 Total Market 24 9 18 Private Good Demand 17 © McGraw Hill LLC. All Rights Reserved.

18. Public Good Demand 18 Price ($/unit) D 2 18 24 Quantity (units/day) Price ($/unit) 36 D 1 24 Quantity (units/day) 8 24 Market 1 Market 2 18+24 = 42 36 Total Market Price ($/unit) Quantity (units/day) D = D 1 + D 2 8 24 © McGraw Hill LLC. All Rights Reserved.

19. The Optimal Quantity of Parkland 19 Acres of parkland Price ($1,000s/acre) A * 140 200 A 80 Demand Marginal Cost © McGraw Hill LLC. All Rights Reserved.

20. Government Provision of Public Goods Government provision has advantages Low cost to collect additional revenue Expedient: no negotiations over distribution of costs Only feasible provider for nonexcludable goods Government provision has disadvantages One-size-fits-all Some pay for goods they don't want Some don't get goods they would pay for Taxation is coercive 20 © McGraw Hill LLC. All Rights Reserved.

21. Private Provision of Public Goods Alternative ways to raise revenues Funding by donation Volunteer action and funding (dot-orgs) Exclude non-payers (turn a public good into a collective good) Scrambled TV signals Private contracting Gated communities and homeowners’ associations Sale of by-products Advertising on TV, Internet 21 © McGraw Hill LLC. All Rights Reserved.

22. Sunday Night Football vs. Masterpiece Show funded by advertising Advertiser values the largest audience Sunday Night Football wins Masterpiece is the efficient outcome Funding public goods through advertising does not assure maximum total surplus 22 Sunday Night Football Masterpiece Market Share 20 percent 18 percent Willingness to Pay $10 million $30 million © McGraw Hill LLC. All Rights Reserved.

23. Making Advertising Work Subscriptions to video streaming service avoid the inefficiency of advertiser's choosing public goods Viewers register preferences Willingness to pay measures strength of preferences Marginal social cost of watching a program is zero Charging introduces inefficiencies Measure size of inefficiencies to select the optimal approach 23 © McGraw Hill LLC. All Rights Reserved.

24. Providing Public Goods Delivery by public or private sector varies Technology influences choices Can non-payers be excluded? Funding mechanism Tax, donation, private contracts, advertising People's preferences 24 © McGraw Hill LLC. All Rights Reserved.

25. Pay-Per-View Market Subscription fee is free Marginal cost of an additional viewer is zero Audience is 100 million Subscription fee $12 Audience is 60 million households Lost surplus from Netflix is $240 million The more elastic the demand, the greater the loss in total surplus 25 Consumers (millions) Subscription fee ($/month) 30 100 60 12 Lost surplus from $12 subscription fee © McGraw Hill LLC. All Rights Reserved.

26. Additional Functions of Government Two roles of government Regulation of activities that generate externalities Increase market efficiency Examples: pollution, education, vaccinations, driving on the right Defining and enforcing property rights Example: regulating access to fishing waters and public forests Regulation entails costs Regulation costs may be greater than the inefficiency created by the externality 26 © McGraw Hill LLC. All Rights Reserved.

27. Which Government? Advantages of local and state government Better communication and responsiveness to citizens' preferences Reflect the unique preferences of the area Residents consider public goods when choosing a home Advantages of federal government Economies of scale when capital costs are high Positive and negative externalities may be nationwide 27 © McGraw Hill LLC. All Rights Reserved.

28. Climate Mitigation: The Ultimate Public Good? The cost of achieving the Paris Agreement’s goal of net zero emissions by the year 2050 would be a global investment of $3.5 trillion annually beyond current levels According to the U.N.’s Intergovernmental Panel on Climate Change (IPCC) suggest we must also remove large quantities of CO 2 already present in the atmosphere Reforestation can help but not enough Direct air capture cost could exceed $1.5 trillion per year in addition to the estimated $3.5 trillion © McGraw Hill LLC. All Rights Reserved. 28

29. Paying for Climate Mitigation The private sector has already begun to undertake a significant share of the investment Costs of solar and wind power, renewable sources are a more attainable Pigouvian taxes are taxes levied on pollution but could be applied to activities that generate negative externalities (progressive consumption tax) Possible solution: a carbon tax that is revenue-neutral, which means periodically rebating the resulting revenue to taxpayers © McGraw Hill LLC. All Rights Reserved. 29

30. The Mother of All Cognitive Illusions The demonstrably false belief that higher top tax rates would require painful sacrifices Checker-shadow illusion example The top marginal tax rate in 1966 was 70 percent, it is now 37 percent Higher taxes reduce all income in tandem False belief that others’ incomes would be unaffected Emotions and memory © McGraw Hill LLC. All Rights Reserved. 30

31. Does Government Policy Matter? Conflicts between individual and group interests arise whenever activities entail side effects on third parties The 2022 World Happiness Report , higher happiness scores are closely linked to country characteristics known to promote human flourishing: income per capita, healthy life expectancy, social support, freedom, generosity, and the absence of corruption © McGraw Hill LLC. All Rights Reserved. 31 The World’s Five Happiest Countries, 2022 1. Finland 2. Denmark 3. Iceland 4. Switzerland 5. The Netherlands

32. Public Goods and Tax Policy 32 Tax Policy and Efficiency Optimal Quantity Public Goods Types of Goods Role of Government Size of Government Who Provides? © McGraw Hill LLC. All Rights Reserved.