Quiz 14: Government Spending, Taxing, and the National Debt: Who Wins and Who Loses


Some citizens of the US feel that the government is growing too large, and in political discussions it is often stated that "small government" would be preferable. Historically, such a philosophy has long been held by a political contingent which has preferred for government to avoid interfering in economic affairs. Much of this is based on the belief that the economic system will solve most problems on its own. This doctrine is sometimes referred to by the term "laissez-faire" which means, essentially, "leave it alone" and refers to an economic system allowed to operate free from regulations, tariffs, and taxes (as much as possible). This has led to disagreements over the years about how the government should manage the economic affairs of the US. For example, through much of its early history the US did not have a central bank. There was a First and a Second "National Bank of the United States" but the charter for each was allowed to expire after administrations changed. It was not until 1913 that the Federal Reserve was established to enable the government to influence the direction of the economy. Another example is in the social programs that were established in waves during the mid-twentieth century. This included the "New Deal" series of programs during the early 1930s, intended to mitigate the effects of the Great Depression; Social Security, a few years later; the "Great Society" wave of programs in the 1960s, and Medicare, also around the same time. All of these efforts were highly criticized and the subject of harsh political dispute at the time of their inception, and, for those programs still in effect, to the present day. In general, each expansion of the operations of the government comes at a cost. As these costs increase, more money is required to pay for them, which has to come from an increase in taxes. Throughout the 20 th century, the size of government grew considerably. This lasted until the 1990s, when for the first time, it began to be scaled back. Briefly, in the late 1990s, the government actually had a surplus of funds, with more tax income than spending. However, this was short-lived. After the terrorist attacks of September 11, 2001, a series of military expeditions in Afghanistan and Iraq required a large increase in spending. A few years later, during the 2007-2009 financial crisis, the government spent an even larger sum of money in a series of economic programs intended to ease the effects of the recession. More recently, the budget has further increased in efforts to expand health insurance coverage. Based on the trend in spending levels, it could be argued that fears about the size of government are somewhat justified. It is true that spending as a percentage of the GDP has increased, so the overall tax burden is both increased and growing. At the same time, however, it is possible to point to past examples where the size of the government has decreased. In the 1990s, government operations were scaled back very modestly amid economic growth and it was possible to reduce the level of spending significantly. Indeed, the tax burden of the US is far lower than most other developed countries. While it is not possible to predict how this will trend in the future, the recent past suggests that the preference for less government involvement will persist in the long run and at least limit the growth of, if not scale back, the size of government.

A public good is a type of good or service that has the following properties. • Public goods are available to everyone in a country. There are no groups who are excluded from being able to use the good. Thus, public goods must be free of exclusivity. • Public goods provide the same level of benefits to all of the individuals who use them. There are no groups who would receive more or less benefit. Thus, public goods must be free of rivalry. Private marketplaces are unable to supply public goods because of what is called the free rider problem that arises from the qualities of non-exclusivity and non-rivalry. That is, in order for a private company to be able to offer a good, it must be able to sell it to customers. In order to sell it, it must be able to exclude it (or offer a lower level of service) to non-paying individuals. Otherwise, there is no incentive for anyone to pay for the good, and without money, the private company cannot operate. For example, suppose that a private company were to own all of the roadways in a city. If that company maintains the roads, it must bring in some sort of income. In order to charge individuals for their usage of the road, it must have some way to prevent them from using it if they do not pay; otherwise, there is no reason for the road users to pay and they will not do so. However, if the road has been excluded to some users, it is no longer a public good. Only a government entity possesses the ability to levy taxes to force payment for public goods. Optimality for public goods can be understood in the context of supply and demand equilibration. The supply-demand relationship between private and public goods is explained in the following chart. img In a fully private market, the demand curve represents the marginal private benefits (MPB). The demand and supply equilibrium point is at price P and quantity Q. There may also be marginal external benefits (MEB) that are associated with consumption of this good or service. The total marginal social benefits (MSB) represents MPB and MEB combined. Government policy, such as subsidies, can be used to increase the demand, which would effectively shift the demand curve to the right. The new equilibrium point occurs at price P * and quantity Q *, which represents the optimum quantity. Government policy could achieve this level of production by either directly producing the quantity img to raise the supply to the optimum level, or by providing a subsidy of the amount img to the consuming public, which would effectively raise the price (that is, raising the amount of money that consumers can pay) to the optimum level to achieve the optimum quantity.

The free rider problem explains why public goods cannot normally be provided by a private company. First it is essential to understand what constitutes a public good. The key characteristics of a public good is that it cannot be excluded from anyone and that there can be no rivalry in its use. That is, by the very nature of the good, it is impossible to prevent anyone from using it or from receiving anything less than its full benefits. One example of a public good is a storm siren system that sounds an alarm when a tornado is approaching an area. It is not possible to prevent some members of the community from receiving the alarm when the sirens are activated, and there is no way for anyone to receive more or less benefit from the existence of the system. A private company seeking to earn a profit from a public good would have to somehow charge users for it, but since no one can be prevented from using the service, no one has an incentive to pay for it. Thus it becomes possible for some "free riders" receive the benefit without paying. The ability to keep their money is incentive enough for most users to avoid paying, and the system cannot be maintained without those payments. The only way to "force" users to pay for the system is through taxation-which can only be done by government. This is why public goods are provided by government, because it is the only entity capable of obtaining payment for public goods.