Public Finance Core Concepts

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Questions and Answers

Which of the following scenarios exemplifies a regressive tax system in practice?

A progressive income tax with increasing rates for higher income brackets.
A flat income tax where all individuals pay the same percentage, regardless of income.
A sales tax on essential goods disproportionately affecting low-income households. (correct)
Property taxes that fund local schools, benefiting all residents equally.

The Laffer Curve suggests that increasing tax rates will always lead to increased tax revenue.

False (B)

Define and provide an example illustrating 'tax incidence'.

Tax incidence refers to the actual division of the burden of a tax between buyers and sellers in a market. For example, if a tax is imposed on gasoline, the incidence shows how much of the tax is effectively paid by consumers through higher prices and by producers through lower profits, regardless of who legally remits the tax to the government.

__________ spending refers to government expenditures mandated by law, which includes programs like Social Security and Medicare.

Mandatory Signup and view all the answers

Match the following types of goods with their characteristics:

Public Goods = Non-excludable and non-rivalrous Merit Goods = Beneficial for society and often under-consumed if left to the market Demerit Goods = Harmful to society and often over-consumed if left to the market Private Goods = Excludable and rivalrous Signup and view all the answers

What is the primary distinction between Social Security and Medicare in the context of government spending?

Social Security provides benefits to retired, disabled, and surviving members, while Medicare provides health insurance to those 65 or older and certain younger people with disabilities. (D) Signup and view all the answers

A budget deficit always leads to an increase in the national debt.

True (A) Signup and view all the answers

Explain the concept of the 'debt ceiling' and its potential implications for fiscal policy.

The debt ceiling is a legal limit on the total amount of money the federal government can borrow to meet its existing legal obligations. If the debt ceiling is not raised in time, the government may be forced to delay or default on payments, which can lead to economic instability and a loss of confidence in the government's fiscal management. Signup and view all the answers

A __________ fiscal policy involves measures like tax increases or decreased government spending, aiming to reduce aggregate demand and control inflation.

contractionary Signup and view all the answers

Match each fiscal policy action with its likely effect on aggregate demand:

Tax Cuts = Increase Aggregate Demand Increased Government Spending = Increase Aggregate Demand Tax Increases = Decrease Aggregate Demand Decreased Government Spending = Decrease Aggregate Demand Signup and view all the answers

What is the 'crowding out' effect in the context of fiscal policy?

A decrease in private investment caused by increased government borrowing. (B) Signup and view all the answers

Public Choice Theory assumes that individuals in the public sector always act in the best interest of society.

False (B) Signup and view all the answers

Define 'rent-seeking' and explain how it differs from normal profit-seeking behavior.

Rent-seeking is the use of resources to obtain an economic gain from others without reciprocating any benefits back to society through wealth creation. Unlike normal profit-seeking, which involves creating value and improving efficiency, rent-seeking focuses on manipulating the system (e.g., lobbying for favorable regulations) to extract value from others. Signup and view all the answers

__________ is the practice of exchanging favors, especially in politics, by reciprocal voting for each other's proposed legislation.

Logrolling Signup and view all the answers

Match the following economic concepts with their definitions:

Pareto Efficiency = An allocation where it is impossible to make anyone better off without making someone else worse off Market Failure = A situation where the market fails to allocate resources efficiently Asymmetric Information = A situation where one party in a transaction has more information than the other party Moral Hazard = The risk that one party will engage in undesirable behavior after a transaction Signup and view all the answers

What is 'adverse selection' and how does it manifest in insurance markets?

The tendency for individuals with higher risk to purchase insurance, leading to a disproportionate number of high-risk individuals in the insured pool. (B) Signup and view all the answers

A Social Welfare Function always provides a clear and universally agreed-upon ranking of different distributions of utility across individuals in society.

False (B) Signup and view all the answers

Explain the concept of 'fiscal federalism' and its significance in a country like the United States.

Fiscal federalism refers to the division of fiscal responsibilities among different levels of government (federal, state, and local). In the United States, it involves the allocation of taxing and spending powers, as well as the system of grants-in-aid, to balance national needs with state and local autonomy. Signup and view all the answers

A __________ grant is a payment from one level of government to another that can be allocated to a wide range of services, providing more flexibility to the recipient government.

block Signup and view all the answers

Match the type of grant with its description:

Block Grant = A grant with minimal restrictions, allowing states discretion in its use Matching Grant = A grant where the recipient must contribute a specified amount to receive funding Categorical Grant = A grant designated for a specific purpose, limiting state discretion Revenue Sharing = Distribution of a portion of federal tax revenue to state and local governments Signup and view all the answers

In the context of behavioral economics and public finance, what are 'nudges'?

Subtle interventions that steer people in particular directions while preserving freedom of choice. (C) Signup and view all the answers

Framing effects suggest that the way information is presented has no impact on decision-making.

False (B) Signup and view all the answers

Explain 'loss aversion' and its implications for tax policy.

Loss aversion is the psychological tendency to feel the pain of a loss more strongly than the pleasure of an equivalent gain. In tax policy, this means individuals may react more negatively to a tax increase than they appreciate an equivalent tax cut, influencing their behavior and political attitudes. Signup and view all the answers

__________ refer to the pre-set course of action if no decision is made, often significantly influencing choices due to inertia or convenience.

Default Options Signup and view all the answers

Match each behavioral economics concept with its relevance to public finance:

Nudges = Influence choices without coercion Framing Effects = Impact of information presentation Loss Aversion = Greater sensitivity to losses than gains Default Options = Pre-set choices influencing decisions Signup and view all the answers

What are 'user fees' in the context of public finance?

Charges levied for the use of a specific good or service provided by the government. (C) Signup and view all the answers

Government bonds are a form of equity financing, representing ownership in a government entity.

False (B) Signup and view all the answers

Define 'budget authority' and explain how it differs from 'outlays'.

Budget authority is the authority provided by law to enter into obligations that will result in immediate or future outlays of government funds. Outlays, on the other hand, are the actual payments made by the government. Budget authority is the permission to spend, while outlays are the actual spending. Signup and view all the answers

__________ are congressional directives that specify how funds should be spent, often included in appropriations bills.

Earmarks Signup and view all the answers

Match the following budgetary terms with their definitions:

Budget Authority = Legal authority to enter into obligations Outlays = Actual government payments Earmarks = Congressional directives specifying fund usage Fiscal Year = 12-month period for budgeting Signup and view all the answers

What is the 'shadow economy'?

Unreported economic activity that is not subject to taxation or government oversight. (C) Signup and view all the answers

Fiscal illusion refers to the idea that voters overestimate the true cost of government due to complex budgeting processes.

False (B) Signup and view all the answers

Explain 'generational accounting' and its purpose in assessing long-term fiscal sustainability.

Generational accounting is a method for assessing the long-term sustainability of government policies by examining the burdens and benefits imposed on different generations. It aims to show whether current policies are sustainable by estimating the net tax burden each generation will face over their lifetime. Signup and view all the answers

The deficit is the portion of the budget deficit that is due to the business cycle, while the deficit is due to long-term fiscal imbalances.

cyclical, structural Signup and view all the answers

Match each type of deficit with its cause:

Cyclical Deficit = Due to the ebb and flow of the business cycle Structural Deficit = Due to long-term fiscal imbalances Budget Deficit = When government spending exceeds revenue in a fiscal year National Debt = Total accumulation of past budget deficits minus surpluses Signup and view all the answers

What is a 'contingent liability' in the context of government finance?

A potential liability that may occur depending on the outcome of an uncertain future event. (A) Signup and view all the answers

An increase in government spending will always stimulate the economy regardless of the circumstances.

False (B) Signup and view all the answers

Explain the difference between 'on-budget' and 'off-budget' items in the U.S. federal budget.

'On-budget' refers to the part of the federal budget that includes most government revenue and spending, controlled annually by Congress. 'Off-budget' refers to federal revenue and spending items excluded from the regular budget process, like Social Security. This distinction affects transparency and control over certain government activities. Signup and view all the answers

__________ stabilizers are fiscal policy measures that automatically increase or decrease aggregate demand in response to economic fluctuations, such as unemployment benefits and progressive income taxes.

Automatic Signup and view all the answers

Match each fiscal policy term with its function:

Expansionary Fiscal Policy = Aims to increase aggregate demand Contractionary Fiscal Policy = Aims to decrease aggregate demand Automatic Stabilizers = Automatically adjust to economic fluctuations Multiplier Effect = Increase in final income arising from new spending Signup and view all the answers

Which of the following scenarios best illustrates the concept of 'crowding out' in the context of fiscal policy?

Increased government borrowing to finance infrastructure projects drives up interest rates, discouraging private sector investment. (A) Signup and view all the answers

A proportional tax system ensures that higher-income earners pay a larger absolute amount of taxes compared to lower-income earners, but the percentage of their income paid as taxes remains the same.

True (A) Signup and view all the answers

Explain how the Laffer Curve challenges conventional understanding of the relationship between tax rates and tax revenue, and what critical assumption underlies its validity?

The Laffer Curve suggests that increasing tax rates beyond a certain point can decrease tax revenue due to reduced economic activity. Its validity relies on the assumption that economic activity is highly sensitive to changes in tax rates. Signup and view all the answers

The concept of ______ refers to the idea that voters may underestimate the true cost of government due to complexities within the financial system.

fiscal illusion Signup and view all the answers

Match each concept from public finance with its corresponding definition:

Rent-Seeking = Using resources to gain economic advantage without contributing to societal wealth. Adverse Selection = One party having hidden information that disadvantages the other party. Moral Hazard = The risk that one party will act irresponsibly because they are protected from the consequences Logrolling = Exchanging favors between legislators for mutual benefit. Signup and view all the answers

Flashcards

Public Finance

The field of economics that studies the role of the government in the economy.

Government Revenue

How governments raise money (e.g., taxes, fees).