Public finance and public policy (jonathan gruber), Study notes of Applied Economics

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Jonathan Gruber

Massachusetts Institute of Technology

Worth Publishers

Public Finance

and Public Policy

THIRD EDITION

About the Author Dr. Jonathan Gruber is a Professor of Economics at the Massachusetts Institute of Technology, where he has taught since 1992. He is also the Director of the Health Care Program at the National Bureau of Economic Research, where he is a research Associate. He is a co-editor of the Journal of Public Economics and an Associate Editor of the Journal of Health Economics. Dr. Gruber received his B.S. in Economics from MIT and his Ph.D. in Economics from Harvard. He has received an Alfred P. Sloan Founda- tion Research Fellowship, a FIRST award from the National Institute on Aging, and the Kenneth Arrow Award for the Best Paper in Health Eco- nomics in 1994. He was also one of 15 scientists nationwide to receive the Presidential Faculty Fellow Award from the National Science Foun- dation in 1995. Dr. Gruber was elected to the Institute of Medicine in 2005, and in 2006, he received the American Society of Health Econ- omists’ Inaugural Medal for the best health economist in the nation aged 40 and under. Dr. Gruber’s research focuses on the areas of public finance and health economics. He has published more than 125 research articles and has edited six research volumes. During the 1997–1998 academic year, Dr. Gruber was on leave from MIT, serving as Deputy Assistant Secretary for Economic Policy at the U.S. Treasury Department. He was a key architect of Massachusetts’s ambitious health reform effort, and in 2006, he became an inaugural member of the Health Connector Board, the main implementing body for that effort. In that year, he was named the nineteenth-most powerful person in health care in the United States by Modern Healthcare Magazine. He acted as a consultant on several presidential campaigns and is consid- ered by the Washington Post to be one of the “most influential” health care experts in America.

Brief Contents

Preface................................... xxvii

xiv P A R T I I I Social Insurance and

 - 1 Why Study Public Finance?. PART I Introduction and Background - 2 Theoretical Tools of Public Finance. - 3 Empirical Tools of Public Finance. - 4 Budget Analysis and Deficit Financing. - 5 Externalities: Problems and Solutions. PART II Externalities and Public Goods - 6 Externalities in Action: Environmental and Health Externalities. - 7 Public Goods. - 8 Cost-Benefit Analysis. - 9 Political Economy. 

• 10 State and Local Government Expenditures.
• 11 Education.
• 12 Social Insurance: The New Function of Government. PART III Social Insurance and Redistribution
• 13 Social Security.
• 14 Unemployment Insurance, Disability Insurance, and Workers’ Compensation.
• 15 Health Insurance I: Health Economics and Private Health Insurance.
• 16 Health Insurance II: Medicare, Medicaid, and Health Care Reform.
• 17 Income Distribution and Welfare Programs.
• 18 Taxation in the United States and Around the World. PART IV Taxation in Theory and Practice
• 19 The Equity Implications of Taxation: Tax Incidence.
• 20 Tax Inefficiencies and Their Implications for Optimal Taxation.
• 21 Taxes on Labor Supply.
• 22 Taxes on Savings.
• 23 Taxes on Risk Taking and Wealth.
• 24 Corporate Taxation.
• 25 Fundamental Tax Reform.
• Glossary G-
• References R-
• Name Index NI-
• Subject Index SI-
• CHAPTER 1 Why Study Public Finance? Preface xxvii
• 1.1 The Four Questions of Public Finance
  • When Should the Government Intervene in the Economy?
    • Application: The Measles Epidemic of 1989–1991
  • How Might the Government Intervene?
  • What Are the Effects of Alternative Interventions?
    • Application: The Congressional Budget Office: Government Scorekeepers
  • Why Do Governments Do What They Do?
• States and Around the World 1.2 Why Study Public Finance? Facts on Government in the United
  • The Size and Growth of Government
  • Decentralization
  • Spending, Taxes, Deficits, and Debts
  • Distribution of Spending
  • Distribution of Revenue Sources
  • Regulatory Role of the Government
• Security, Health Care, and Education 1.3 Why Study Public Finance Now? Policy Debates over Social
  • Social Security
  • Health Care
  • Education
• 1.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 2 Theoretical Tools of Public Finance
• 2.1 Constrained Utility Maximization
  • Preferences and Indifference Curves
  • Utility Mapping of Preferences
  • Budget Constraints
  • Putting It All Together: Constrained Choice
  • The Effects of Price Changes: Substitution and Income Effects
• Supply Among Single Mothers 2.2 Putting the Tools to Work: TANF and Labor
  • Identifying the Budget Constraint
  • The Effect of TANF on the Budget Constraint
• 2.3 Equilibrium and Social Welfare
  • Demand Curves
  • Supply Curves
  • Equilibrium
  • Social Efficiency
  • Competitive Equilibrium Maximizes Social Efficiency
  • From Social Efficiency to Social Welfare: The Role of Equity
  • Choosing an Equity Criterion
• The TANF Example Continued 2.4 Welfare Implications of Benefit Reductions:
• 2.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• APPENDIX TO CHAPTER 2 The Mathematics of Utility Maximization
• CHAPTER 3 Empirical Tools of Public Finance
• Correlation and Causality 3.1 The Important Distinction Between
  • The Problem
• Randomized Trials 3.2 Measuring Causation with Data We’d Like to Have:
  • Randomized Trials as a Solution
  • The Problem of Bias
  • Randomized Trials of ERT
  • Randomized Trials in the TANF Context
  • Why We Need to Go Beyond Randomized Trials
• Observational Data 3.3 Estimating Causation with Data We Actually Get:
  • Time Series Analysis
  • Cross-Sectional Regression Analysis
  • Quasi-Experiments
  • Structural Modeling
• 3.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• APPENDIX TO CHAPTER 3 Cross-Sectional Regression Analysis
• CHAPTER 4 Budget Analysis and Deficit Financing
• 4.1 Government Budgeting
  • The Budget Deficit in Recent Years
  • The Budget Process
    • Application: Efforts to Control the Deficit
  • Budget Policies and Deficits at the State Level
• Alternative Approaches 4.2 Measuring the Budgetary Position of the Government:
  • Real vs. Nominal
  • The Standardized Deficit
  • Cash vs. Capital Accounting
  • Static vs. Dynamic Scoring
• A Long-Run Perspective 4.3 Do Current Debts and Deficits Mean Anything?
  • Background: Present Discounted Value
  • Why Current Labels May Be Meaningless
  • Alternative Measures of Long-Run Government Budgets
  • What Does the U.S. Government Do?
    • Application: The Financial Shenanigans of
• Fiscal Position? 4.4 Why Do We Care About the Government’s
  • Short-Run vs. Long-Run Effects of the Government on the Macroeconomy
  • Background: Savings and Economic Growth
  • The Federal Budget, Interest Rates, and Economic Growth
  • Intergenerational Equity
• 4.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 5 Externalities: Problems and Solutions
• 5.1 Externality Theory
  • Economics of Negative Production Externalities
  • Negative Consumption Externalities
    • Application: The Externality of SUVs
  • Positive Externalities
• 5.2 Private-Sector Solutions to Negative Externalities
  • The Solution
  • The Problems with Coasian Solutions
• 5.3 Public-Sector Remedies for Externalities
  • Corrective Taxation
  • Subsidies
  • Regulation
• to Addressing Externalities 5.4 Distinctions Between Price and Quantity Approaches
  • Basic Model
  • Price Regulation (Taxes) vs. Quantity Regulation in This Model
  • Multiple Plants with Different Reduction Costs
  • Uncertainty About Costs of Reduction
• 5.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• Externalities CHAPTER 6 Externalities in Action: Environmental and Health
• 6.1 Acid Rain
  • The Damage of Acid Rain
  • History of Acid Rain Regulation
    • Empirical Evidence: Estimating the Adverse Health Effects of Particulates
  • Has the Clean Air Act Been a Success?
• 6.2 Global Warming - Application: The Montreal Protocol
  • The Kyoto Treaty
  • Can Trading Make Kyoto More Cost-Effective?
  • What Does the Future Hold?
    • Application: Congress Takes on Global Warming
• 6.3 The Economics of Smoking
  • The Externalities of Smoking
  • Should We Care Only About Externalities, or Do “Internalities” Matter Also?
• 6.4 The Economics of Other Addictive Behaviors
  • Drinking
  • Illicit Drugs
    • Application: Public Policy Toward Obesity
  • Summary
• 6.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 7 Public Goods
• 7.1 Optimal Provision of Public Goods
  • Optimal Provision of Private Goods
  • Optimal Provision of Public Goods
• 7.2 Private Provision of Public Goods
  • Private-Sector Underprovision
    • Application: The Free Rider Problem in Practice
  • Can Private Providers Overcome the Free Rider Problem?
    • Application: Business Improvement Districts
  • When Is Private Provision Likely to Overcome the Free Rider Problem?
• 7.3 Public Provision of Public Goods
  • Private Responses to Public Provision: The Problem of Crowd-Out
  • Measuring the Costs and Benefits of Public Goods
  • How Can We Measure Preferences for the Public Good?
    • Empirical Evidence: Measuring Crowd-Out
• 7.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• Goods Provision APPENDIX TO CHAPTER 7 The Mathematics of Public
• CHAPTER 8 Cost-Benefit Analysis
• 8.1 Measuring the Costs of Public Projects
  • The Example
  • Measuring Current Costs
  • Measuring Future Costs
• 8.2 Measuring the Benefits of Public Projects
  • Valuing Driving Time Saved
    • Application: The Problems of Contingent Valuation
    • Empirical Evidence: Valuing Time Savings
  • Valuing Saved Lives
    • Application: Valuing Life
  • Discounting Future Benefits
  • Cost-Effectiveness Analysis
• 8.3 Putting It All Together
  • Other Issues in Cost-Benefit Analysis
• 8.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 9 Political Economy
• 9.1 Unanimous Consent on Public Goods Levels
  • Lindahl Pricing
  • Problems with Lindahl Pricing
• 9.2 Mechanisms for Aggregating Individual Preferences - Application: Direct Democracy in the United States
  • Majority Voting: When It Works
  • Majority Voting: When It Doesn’t Work
  • Arrow’s Impossibility Theorem
  • Restricting Preferences to Solve the Impossibility Problem
  • Median Voter Theory
  • The Potential Inefficiency of the Median Voter Outcome
  • Summary
• 9.3 Representative Democracy
  • Vote-Maximizing Politicians Represent the Median Voter
  • Assumptions of the Median Voter Model
  • Lobbying
    • Application: Farm Policy in the United States
  • Evidence on the Median Voter Model for Representative Democracy
    • Empirical Evidence: Testing the Median Voter Model
• of Government Failure 9.4 Public Choice Theory: The Foundations
  • Size-Maximizing Bureaucracy
  • Problems with Privatization
    • Application: Contracting Out with Non-Competitive Bidding
  • Leviathan Theory
  • Corruption
    • Application: Government Corruption
    • Empirical Evidence: Government Failures and Economic Growth
  • The Implications of Government Failure
• 9.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 10 State and Local Government Expenditures
• 10.1 Fiscal Federalism in the United States and Abroad
  • Spending and Revenue of State and Local Governments
  • Fiscal Federalism Abroad
• 10.2 Optimal Fiscal Federalism
  • The Tiebout Model
  • Problems with the Tiebout Model
  • Evidence on the Tiebout Model
  • Optimal Fiscal Federalism
    • Proposition Empirical Evidence: Evidence for Capitalization from California’s
• 10.3 Redistribution Across Communities
  • Should We Care?
  • Tools of Redistribution: Grants
  • Redistribution in Action: School Finance Equalization
    • Empirical Evidence: The Flypaper Effect
    • Tax Limitations in California Application: School Finance Equalization and Property
• 10.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• CHAPTER 11 Education
• in Education? 11.1 Why Should the Government Be Involved
  • Productivity
  • Citizenship
  • Credit Market Failures
  • Failure to Maximize Family Utility
  • Redistribution
• 11.2 How Is the Government Involved in Education?
  • Free Public Education and Crowding Out
  • Solving the Crowd-Out Problem: Vouchers
  • Problems with Educational Vouchers
• 11.3 Evidence on Competition in Education Markets
  • Direct Experience with Vouchers
  • Experience with Public School Choice
    • Empirical Evidence: Estimating the Effects of Voucher Programs
  • Experience with Public School Incentives
  • Bottom Line on Vouchers and School Choice
• 11.4 Measuring the Returns to Education
  • Effects of Education Levels on Productivity
  • Effect of Education Levels on Other Outcomes
    • for Screening Empirical Evidence: Estimating the Return to Education and Evidence
  • The Impact of School Quality
• 11.5 The Role of the Government in Higher Education - Empirical Evidence: Estimating the Effects of School Quality
  • Current Government Role
  • What Is the Market Failure and How Should It Be Addressed?
• 11.6 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• of Government CHAPTER 12 Social Insurance: The New Function
• 12.1 What Is Insurance and Why Do Individuals Value It?
  • What Is Insurance?
  • Why Do Individuals Value Insurance?
  • Formalizing This Intuition: Expected Utility Model
• and Adverse Selection 12.2 Why Have Social Insurance? Asymmetric Information
  • Asymmetric Information
  • Example with Full Information
  • Example with Asymmetric Information
  • The Problem of Adverse Selection
  • Does Asymmetric Information Necessarily Lead to Market Failure?
    • Application: Adverse Selection and Health Insurance “Death Spirals”
  • How Does the Government Address Adverse Selection?
• in Insurance Markets 12.3 Other Reasons for Government Intervention
  • Externalities
  • Administrative Costs
  • Redistribution
  • Paternalism
    • Application: Flood Insurance and the Samaritan’s Dilemma
• How Much Consumption Smoothing? 12.4 Social Insurance vs. Self-Insurance:
  • Example: Unemployment Insurance
  • Lessons for Consumption-Smoothing Role of Social Insurance
• 12.5 The Problem with Insurance: Moral Hazard - Compensation Injuries Application: The Problems with Assessing Workers’
  • What Determines Moral Hazard?
  • Moral Hazard Is Multidimensional
  • The Consequences of Moral Hazard
• 12.6 Putting It All Together: Optimal Social Insurance
• 12.7 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• of Expected Utility APPENDIX TO CHAPTER 12 Mathematical Models
• CHAPTER 13 Social Security
• 13.1 What Is Social Security and How Does It Work?
  • Program Details
    • Application: Why Choose 35 Years?
  • How Does Social Security Work Over Time?
    • Application: Ida May Fuller
  • How Does Social Security Redistribute in Practice?
• of Social Security 13.2 Consumption-Smoothing Benefits
  • Rationales for Social Security
  • Does Social Security Smooth Consumption?
  • Social Security and Private Savings
  • Living Standards of the Elderly
• 13.3 Social Security and Retirement
  • Theory
    • Security on Savings Empirical Evidence: Measuring the Crowd-Out Effect of Social
  • Evidence
    • Application: Implicit Social Security Taxes and Retirement Behavior
  • Implications
• 13.4 Social Security Reform
  • Reform Round I: The Greenspan Commission
    • Application: The Social Security Trust Fund and National Savings
  • Incremental Reforms
  • Fundamental Reforms
    • Application: Company Stock in 401(k) Plans
    • Application: Mixed Proposals for Social Security Reform
• 13.5 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• Insurance, and Workers’ Compensation CHAPTER 14 Unemployment Insurance, Disability
• and Workers’ Compensation Insurance, Disability Insurance,
  • Institutional Features of Unemployment Insurance
  • Institutional Features of Disability Insurance
  • Institutional Features of Workers’ Compensation
  • Comparison of the Features of UI, DI, and WC
    • Application: The Duration of Social Insurance Benefits Around the World
• of Social Insurance Programs 14.2 Consumption-Smoothing Benefits
• 14.3 Moral Hazard Effects of Social Insurance Programs
  • Moral Hazard Effects of Unemployment Insurance
    • Empirical Evidence: Moral Hazard Effects of Unemployment Insurance
  • Evidence for Moral Hazard in DI
  • Evidence for Moral Hazard in WC
    • Empirical Evidence: Moral Hazard Effects of DI
    • Empirical Evidence: Krueger’s Study of Workers’ Compensation
• 14.4 The Costs and Benefits of Social Insurance to Firms
  • The Effects of Partial Experience Rating in UI on Layoffs
  • The “Benefits” of Partial Experience Rating
    • Application: The “Cash Cow” of Partial Experience Rating
  • Workers’ Compensation and Firms
• 14.5 Implications for Program Reform
  • Benefits Generosity
  • Targeting
  • Experience Rating
  • Worker Self-Insurance?
    • Application: Reforming UI
• 14.6 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• APPENDIX TO CHAPTER 14 Advanced Quasi-Experimental Analysis
• and Private Health Insurance CHAPTER 15 Health Insurance I: Health Economics
• 15.1 An Overview of Health Care in the United States
  • How Health Insurance Works: The Basics
  • Private Insurance
  • Medicare
  • Medicaid
  • TRICARE/CHAMPVA
  • The Uninsured
    • Empirical Evidence: Health Insurance and Mobility
• 15.2 How Generous Should Insurance Be to Patients?
  • Consumption-Smoothing Benefits of Health Insurance for Patients
  • Moral Hazard Costs of Health Insurance for Patients
    • Application: The Problem with McAllen, Texas
  • Insurance Experiment How Elastic Is the Demand for Medical Care? The RAND Health
    • Empirical Evidence: Estimating the Elasticity of Demand for Medical Care
  • Optimal Health Insurance
  • Why Is Insurance So Generous in the United States?
    • Application: Health Savings Accounts
• 15.3 How Generous Should Insurance Be to Medical Providers?
  • Managed Care and Prospective Reimbursement
  • The Impacts of Managed Care
  • How Should Providers Be Reimbursed?
• 15.4 Conclusion
• Highlights
• Questions and Problems
• Advanced Questions
• and Health Care Reform CHAPTER 16 Health Insurance II: Medicare, Medicaid,
• Mothers and Children 16.1 The Medicaid Program for Low-income
  • How Medicaid Works
  • Who Is Eligible for Medicaid?
  • What Health Services Does Medicaid Cover?
  • How Do Providers Get Paid?
• 16.2 What Are the Effects of the Medicaid Program?
  • How Does Medicaid Affect Health? A Framework
  • How Does Medicaid Affect Health? Evidence
    • Program Effects Empirical Evidence: Using State Medicaid Expansions to Estimate
• 16.3 The Medicare Program
  • How Medicare Works
    • Application: The Medicare Prescription Drug Debate
• 16.4 What Are the Effects of the Medicare Program?
  • The Prospective Payment System
  • Empirical Evidence on the Move to the PPS
  • Problems with PPS
  • Lesson: The Difficulty of Partial Reform
  • Medicare Managed Care
  • Should Medicare Move to a Full Choice Plan? Premium Support
    • Application: A Premium Support System for Medicare
  • Gaps in Medicare Coverage