Public sector economics:
Week 1:
Lecture 1
Why Study Public Economics? Facts on Government in South Africa and Around the World
The government is a huge part of the economy:
• Government spending represents a large sector of the economy, in RSA and other
countries
• This spending is financed with (1) taxes or with (2) debt, and these impact every
facet of the economy
• Many sectors of the economy are also directly impacted by regulation
Spending, taxes, deficits and debts
Government spending are its outflows, and its inflows are tax revenues
• budget surplus= revenues > spending
• budget deficit= revenues < spending,
• Each Rand of government deficit adds to the stock of government debt. That
is, the deficit measures the year-to-year shortfall of revenues relative to
spending
• The debt measures the accumulation of past deficits over time
• These deficits must be financed by borrowing from either citizens of
the local/ national area, or by borrowing from citizens of other areas /
nations
1
,The personal income tax burden has been steadily increasing since 2010/11. Between
2000/01 and 2008/09 corporate income tax revenue grew strongly in line with economic
growth, the commodity boom, improved compliance and measures to limit tax avoidance.
The corporate tax base was broadened, and the rate reduced.
Personal income tax relief was provided to balance the tax burden.
In recent years, government has not been able to provide full inflationary relief and has
raised the effective personal income tax rate. Continuing to raise the personal income tax
burden over a long period could have negative consequences for growth and investment.
If growth does not accelerate over the medium term, it may be necessary to adjust
consumption taxes. The least economically damaging means of doing so would be to
increase the VAT rate, which is low by global standards. However, this needs to be balanced
against the potential effect on poor households, which can be mitigated through targeted
public expenditure.
Corporate income tax revenue moves in line with the overall economy. Improving economic
growth should result in a higher contribution from this tax. South Africa’s corporate income
tax rate of 28 % is higher than the OECD average of 25%, leaving the fiscus vulnerable to
base erosion and profit shifting – a term describing the channels used by multinational
corporations to shift their reporting of income to low-tax countries.
The 4 questions of public economics:
1. When should the government intervene in the economy?
2. How might the government intervene?
3. What is the effect of those interventions on economic outcomes?
4. Why do governments choose to intervene in the way that they do?
2
, 1. When should the government intervene in the economy?
1st Fundamental Theorem of Welfare Economics= the competitive equilibrium, where
supply equals demand, maximizes social efficiency.
• If markets deliver efficient outcomes, why should government do anything?
• Primary motive for government intervention is therefore market failure.
• Market failure= a problem that causes the market economy to deliver an
outcome that does not maximize efficiency
• Deadweight loss
Negative externalities:
• Suppose person with active TB does not get TB treatment
• Increased risk of passing TB to others
• If others develop active TB, they will have higher medical costs and worse
performance at job
• Total social cost of lack of treatment is higher than individual cost
• MDR-TB and XDR-TB
• Per patient cost of XDR 4x more than MDR, and 100x more than drug-
sensitive
• Drug resistant TB comprises only 2.2% of cases, but about 32% of the total
estimated 2011 national TB budget
From social efficiency to social welfare: The role of equity
2nd Fundamental Theorem of Welfare Economics= Society can attain any efficient outcome
by suitably redistributing resources among individuals and then allowing them to freely
trade
o Difficult in practice to redistribute like this
Social welfare= the level of well-being in society
o Determined by both how much gets produced and how it is distributed
• Even if the market is well-functioning, an efficient outcome is not necessarily socially
desirable.
• Redistribution= a 2nd reason for government intervention.
Redistribution= the shifting of resources from some groups in society to others.
Equity–efficiency trade-off= the choice society must make between the total size of the
economic pie and its distribution among individuals
3
, • Can increased equity increase efficiency?
2. How might the government intervene?
Tax / Subsidise Private Sale or Purchase
o Use the price mechanism, changing the price of a good to encourage/
discourage use
Taxes= raise the price for private sales / purchases of goods that are overproduced
Subsidies= lower the price for private sales / purchases of goods that are underproduced
Restrict / Mandate Private Sale or Purchase
- Quotas restrict private sale of goods that are overproduced
- Mandates require private purchase of goods that are underproduced
Public Provision
- The government can provide the good directly
Public Financing of Private Provision
- Governments pays; private companies produce
3. The effects of alternative interventions:
Interventions have direct and indirect effects.
• Direct effects= the effects of government interventions that would be predicted if
individuals did not change their behaviour in response to their interventions
• Cost of providing health insurance to 84% uninsured in SA
• Indirect effects= The effects of government intervention that arise only because
individuals change their behaviour in response to the interventions
• If the 16% with private health insurance drop their private coverage, how
does that affect the cost?
4. Why do governments do what they do?
• Governments do not always choose efficient or socially desirable outcomes
• Governments face enormous challenges in figuring out what the public wants and
how to choose policies that match those wants
• Political economy: The theory of how the political process produces decisions that
affect individuals and the economy
Why Study Public Economics Now? Policy Debates over Health Care, Social Insurance,
Education and Covid-19
Many heated policy debates concern the impact of major public programs:
4
Week 1:
Lecture 1
Why Study Public Economics? Facts on Government in South Africa and Around the World
The government is a huge part of the economy:
• Government spending represents a large sector of the economy, in RSA and other
countries
• This spending is financed with (1) taxes or with (2) debt, and these impact every
facet of the economy
• Many sectors of the economy are also directly impacted by regulation
Spending, taxes, deficits and debts
Government spending are its outflows, and its inflows are tax revenues
• budget surplus= revenues > spending
• budget deficit= revenues < spending,
• Each Rand of government deficit adds to the stock of government debt. That
is, the deficit measures the year-to-year shortfall of revenues relative to
spending
• The debt measures the accumulation of past deficits over time
• These deficits must be financed by borrowing from either citizens of
the local/ national area, or by borrowing from citizens of other areas /
nations
1
,The personal income tax burden has been steadily increasing since 2010/11. Between
2000/01 and 2008/09 corporate income tax revenue grew strongly in line with economic
growth, the commodity boom, improved compliance and measures to limit tax avoidance.
The corporate tax base was broadened, and the rate reduced.
Personal income tax relief was provided to balance the tax burden.
In recent years, government has not been able to provide full inflationary relief and has
raised the effective personal income tax rate. Continuing to raise the personal income tax
burden over a long period could have negative consequences for growth and investment.
If growth does not accelerate over the medium term, it may be necessary to adjust
consumption taxes. The least economically damaging means of doing so would be to
increase the VAT rate, which is low by global standards. However, this needs to be balanced
against the potential effect on poor households, which can be mitigated through targeted
public expenditure.
Corporate income tax revenue moves in line with the overall economy. Improving economic
growth should result in a higher contribution from this tax. South Africa’s corporate income
tax rate of 28 % is higher than the OECD average of 25%, leaving the fiscus vulnerable to
base erosion and profit shifting – a term describing the channels used by multinational
corporations to shift their reporting of income to low-tax countries.
The 4 questions of public economics:
1. When should the government intervene in the economy?
2. How might the government intervene?
3. What is the effect of those interventions on economic outcomes?
4. Why do governments choose to intervene in the way that they do?
2
, 1. When should the government intervene in the economy?
1st Fundamental Theorem of Welfare Economics= the competitive equilibrium, where
supply equals demand, maximizes social efficiency.
• If markets deliver efficient outcomes, why should government do anything?
• Primary motive for government intervention is therefore market failure.
• Market failure= a problem that causes the market economy to deliver an
outcome that does not maximize efficiency
• Deadweight loss
Negative externalities:
• Suppose person with active TB does not get TB treatment
• Increased risk of passing TB to others
• If others develop active TB, they will have higher medical costs and worse
performance at job
• Total social cost of lack of treatment is higher than individual cost
• MDR-TB and XDR-TB
• Per patient cost of XDR 4x more than MDR, and 100x more than drug-
sensitive
• Drug resistant TB comprises only 2.2% of cases, but about 32% of the total
estimated 2011 national TB budget
From social efficiency to social welfare: The role of equity
2nd Fundamental Theorem of Welfare Economics= Society can attain any efficient outcome
by suitably redistributing resources among individuals and then allowing them to freely
trade
o Difficult in practice to redistribute like this
Social welfare= the level of well-being in society
o Determined by both how much gets produced and how it is distributed
• Even if the market is well-functioning, an efficient outcome is not necessarily socially
desirable.
• Redistribution= a 2nd reason for government intervention.
Redistribution= the shifting of resources from some groups in society to others.
Equity–efficiency trade-off= the choice society must make between the total size of the
economic pie and its distribution among individuals
3
, • Can increased equity increase efficiency?
2. How might the government intervene?
Tax / Subsidise Private Sale or Purchase
o Use the price mechanism, changing the price of a good to encourage/
discourage use
Taxes= raise the price for private sales / purchases of goods that are overproduced
Subsidies= lower the price for private sales / purchases of goods that are underproduced
Restrict / Mandate Private Sale or Purchase
- Quotas restrict private sale of goods that are overproduced
- Mandates require private purchase of goods that are underproduced
Public Provision
- The government can provide the good directly
Public Financing of Private Provision
- Governments pays; private companies produce
3. The effects of alternative interventions:
Interventions have direct and indirect effects.
• Direct effects= the effects of government interventions that would be predicted if
individuals did not change their behaviour in response to their interventions
• Cost of providing health insurance to 84% uninsured in SA
• Indirect effects= The effects of government intervention that arise only because
individuals change their behaviour in response to the interventions
• If the 16% with private health insurance drop their private coverage, how
does that affect the cost?
4. Why do governments do what they do?
• Governments do not always choose efficient or socially desirable outcomes
• Governments face enormous challenges in figuring out what the public wants and
how to choose policies that match those wants
• Political economy: The theory of how the political process produces decisions that
affect individuals and the economy
Why Study Public Economics Now? Policy Debates over Health Care, Social Insurance,
Education and Covid-19
Many heated policy debates concern the impact of major public programs:
4
