Instructor'sManualtoaccompanyPublicFinanceSeventhEdition3.3.SuggestedAnswerstoDiscussionQuestionsandSampleExamsbyHarveyS.RosenMarch2004?McGraw-Hill/Irwin2004Someofthequestionshavenosinglecangooffindifferentdirections.Someofthequestionshavenosinglecangooffindifferentdirections.SuggestedAnswerstoDiscussionQuestions“correct”answer-reasonablepeopleInsuchcases,theanswersprovidedheresketchonlyafewpossibilities.Chapter11.a.Putin'sstatementisconsistentwithanorganicconceptionofgovernment.Individualsandtheirgoalsarelessimportantthanthestate.b.Rehnquistmakesaclearstatementofthemechanisticviewoftheb.Rehnquistmakesaclearstatementofthemechanisticviewoftheb.c.b.c.state.2.a.Apersonwithanorganicconceptionofthestatemightreactfavorably,arguingthatevenifanindividualownerisworseoffbecausehemustshowonlyFrenchmovies,thenationisbetteroffbecauseitachievesmoreunity.Alibertarianwouldcertainlyrejectthispolicyandthereasoningbehindit--thereisno“nationalinterest”independentoftheinterestsofindividuals,andpeopleshouldhavetherighttoruntheirlivesinthewaythattheyprefer--including seeingwhatevermoviestheywant.ASocialDemocratwouldtrytobalancethesetwoaims,anditishardtopredicthowheorshewouldcomeout.Mechanisticviewofgovernmentsaysthatthegovernmentisacontrivancecreatedbyindividualstobetterachievetheirindividualgoals.Withinthemechanistictradition,peoplecoulddisagreeontheobesitytax.

Libertarianswouldsaythatpeoplecandecidewhatisbestforthemselves.Theydonotneedproddingfromthegovernment.Incontrast,socialdemocratsmightbelievethatpeoplearetooshortsightedtoknowwhatisgoodforthem,sothatgovernment-providedinducementsareappropriate.4.a.b.Ifthesizeofgovernmentismeasuredbydirectexpenditures,themandatedoesnotdirectlyincreaseit.Costsofcompliance,however,maybehighandwouldappearasanincreaseina“regulatorybudget.”4.a.b.c.Thefederalbudgetwoulddecreaseifgrants-in-aidHowever,ifstateandlocalgovernmentstaxes,thesizeofthegovernmentsectordownasmuchasonewouldhaveguessed.werereduced.5.Theinflationerodestherealvalueofthedebtoffsetthisasawholebyincreasing

wouldnotgoby0.032x￡10.6billion.Thisfigureshouldbeincludedasrevenuetothegovernment.￡332billionorItc.Thefederalbudgetwoulddecreaseifgrants-in-aidHowever,ifstateandlocalgovernmentstaxes,thesizeofthegovernmentsectordownasmuchasonewouldhaveguessed.werereduced.5.Theinflationerodestherealvalueofthedebtoffsetthisasawholebyincreasing

wouldnotgoby0.032x￡10.6billion.Thisfigureshouldbeincludedasrevenuetothegovernment.￡332billionor6.Thefederalgovernmentgrewby$450billion.However,becausethepricelevelwentupby16percent,intermsof2001dollarsthisamountedtoadecreaseof$224billion(=$1.86trillion-1.16x$1.41trillion).AsaproportionofGDP,federalspendingin1993was21.2percentandin2001itwas18.2percent.Hence,bybothmeasures,thesizeofgovernmentfell.Togetamorecompleteanswer,onewouldwantdataonthepopulation6.3.3.sizeofontheChapter2Therealitythatastronomersaretryingtounderstandisnotinfluencedbyany“policies”sizeofontheChapter2Therealitythatastronomersaretryingtounderstandisnotinfluencedbyany“policies”thatastronomersmightimplement.Moreover,parameterswithwhichastronomersmustdealareconstantoverwhiletheparametersineconomicscanchangeacrosstimeandspace.1.thetime,2.ThisAchangeinthemarginaltaxratechangestheindividual 'snetwage.2.Thisgeneratesbothanincomeeffectandasubstitutioneffect.Aslongasleisureisanormalgood,theseeffectsworkinoppositedirections.Hence,onecannottellaprioriwhetherlaborsupplyincreasesordecreases.Onecouldasktaxpayerstodescribehowtheywouldchangetheirbehaviorundertheproposal,butitishardtoimaginethatthiswouldyieldusefulresults.Inasocialexperiment,acontrolgroupwouldconfrontthestatusquo,andanexperimentalgroupwouldfacethenewtaxregime.Thisisclearlyinfeasible.Econometricinvestigationoflaborsupplyseemsthebestapproach,particularlyifdataassociatedwithpastchangesintaxratescanbebroughttobearontheproblem.Generally,economicoutcomesareaffectedbyanumberofvariables.Economistscannotperformcontrolledrandomizeexperiments,whichmakesitdifficulttoassesshowanysinglevariableaffectsagivenoutcome.Similarly,brainimpairmentmaybeduetoanumberoffactors.Ecstasyusersclearlyarenotarandomsampleofthepopulation.Hence,onedoes

notknowwhetherbrainimpairmentisduetoEcstasyorsomevariablethatiscorrelatedwithEcstasyuse.4.Thetextpointsoutthepitfallsofsocialexperiments: theproblemof4.obtainingarandomsampleandtheproblemsofextendingresultsbeyondthescopeoftheexperiment.Participantsinthestudyhadfoundittotheiradvantagetobeapartoftheexperiment,whichmayhaveresultedinaself-selectedpopulationunrepresentativeofthewidergroupofhealthcareconsumers.Further,physicians'“standardpractices”arelargelydeterminedbythecircumstancesofthepopulationasawhole,nottherelativelysmallexperimentalgroup.5.Thereappearstobeaweakrelationshipbetweendeficitsandinterestrates.5.Indeed,itmightappearthatwhenlargedeficitsleadto lowerinterestrates.However,onewouldneedmoredatatoinvestigatethisquestion.OnewouldwanttolookatdeficitsrelativetoGDP.OnewouldliketocontrolChapter31.a.Chapter31.a.Inthisparticularinsurancemarket,onewouldnotexpectasymmetricinformationtobemuchofaproblem -theprobabilityofafloodiscommonknowledge.Moralhazardcouldbeanissue -peoplearetooperatefairlymorelikelytobuildnearabeachiftheyhavefloodinsurance.Still,onewouldexpectthemarketforfloodinsuranceefficiently.tooperatefairlyb.Thereissubstantialasymmetricinformationinmedicalinsuranceandmalpracticeinsurance.consumption,thepricemustbeequaltothemarginalcost,andthethemarketsforForefficient

b.Thereissubstantialasymmetricinformationinmedicalinsuranceandmalpracticeinsurance.consumption,thepricemustbeequaltothemarginalcost,andthethemarketsforForefficienteffectofinsuraneemaybetoreducetheperceivedpriceofmedicalcareconsumption. Thatwouldleadtoconsumptionaboveefficientlevel.Becauseoftherolesofregulation,insuranee,andtheshiftingofcostsfromtheuninsured totheinsured,thereisreasontoexpectthemarkettobeefficient.thelittlec.d.e.f.Inthestockmarketthereisgoodinformation, andthousandsofthelittlec.d.e.f.buyersandsellers.Weexpect,ingeneral,efficientoutcomes.Fromanationalstandpoint,thereisagooddealofcompetitionandinformation. Theoutcomewilllikelybeefficient. However,somefirmsmightexercisesomemarketpower.Student loanmarketsmaybeimperfectbecauseofasymmetricinformation--studentknowsbetterthanlenderwhetherhewillworkhardenoughtorepaytheloan.Carinsuraneemarketsmaybeimperfectbecauseofasymmetricinformation.Driverswhoknowtheyareparticularlyaccidentpronewillbeparticularlylikelytowantcarinsuranee (orpolicieswithgreatercoverage).2.Pointarepresents anequalallocation ofwater,butitisnotefficient2.Pointbecausethereisnotangency.Pointbisanefficientallocation(butnottheonlyone).AD: 1)horizontalaxis.AD: 1)horizontalaxis.Thedashedlineispositioned atthehalfwaypointonthe2)Pointbisatangency3.Themarginalrateoftransformationbetweenforeignanddomesticmovesdependsontherationoftheirpricesbeforetaxesandsubsidies.Becauseofthewedgecreatedbythetaxesandsubsidies,thetwopriceratiosaredifferent.Therefore,themarginalrateofsubstitutionandmarginalrateoftransformationarenotequal,andtheallocationofresourcesisinefficient.

-1.Asfar-1.Asfarassocietyisconcerned,the “util”toAugustusisequivalenttothe“util”toLivia.b.Socialindifferenee curvesarestraightlineswithslopeof-2.Thisreflectsthefactthatsocietyvaluesa“util”toAugustustwiceasmuchasa“util”toLivia.Ul□aUlUa.7.Itmakesnosensetoignoretaxincentiveswhenmakingbusinessdecisions.7.8.Firmswantthetaxauthoritiestoviewtheinstrumentasdebtbecauseinterestisdeductible.Firmswantpotentialinvestorstoviewtheinstrumentasequity,becausemoredebtmakesthefirmariskierAfter-taxreturnsarewhatmatter.8.Firmswantthetaxauthoritiestoviewtheinstrumentasdebtbecauseinterestisdeductible.Firmswantpotentialinvestorstoviewtheinstrumentasequity,becausemoredebtmakesthefirmariskier9.investment.9.Substitutingintotheformula,theusercostis(.08+.01)/[(.65)*(.7)]=.197.Theproject'sreturnishigherthanthis,sothecompanydoestheproject.Chapter181.a.Increases.b.Decreases.c.Noeffect.Regarding(b),saleofStatueofLibertyisjustaswapofassets,andshouldhavenoeffectonthedebt.Regarding(c),partofthepresentvalueoftheentitlementshouldbecountedasacurrentexpense.[Needanswersfordande.Confirmabovesentences.]Montyon'sassertionmakessense.Becausetheexcessburdenoftaxationriseswiththesquareofthetaxrate,itisefficienttospreadtheincreasesintaxratesovertimebyborrowingandthenrepayingthedebtwithtaxrevenue.However,iftherearedistortionsinthecapitalmarketandtheborrowingcrowdsoutcapitalformation,thisresultmaynothold.If1.a.Increases.b.Decreases.c.Noeffect.Regarding(b),saleofStatueofLibertyisjustaswapofassets,andshouldhavenoeffectonthedebt.Regarding(c),partofthepresentvalueoftheentitlementshouldbecountedasacurrentexpense.[Needanswersfordande.Confirmabovesentences.]Montyon'sassertionmakessense.Becausetheexcessburdenoftaxationriseswiththesquareofthetaxrate,itisefficienttospreadtheincreasesintaxratesovertimebyborrowingandthenrepayingthedebtwithtaxrevenue.However,iftherearedistortionsinthecapitalmarketandtheborrowingcrowdsoutcapitalformation,thisresultmaynothold.IftheRicardianmodelholds,suchcrowdingoutwillnotoccur,andtheefficiencycaseforborrowingisstrengthened.Allthisassumesthattheexpenditureinquestionisaone-timeincrease,suchasawar.3.ThisisconsistentwithFriedman'sview--3.ThisisconsistentwithFriedman'sview--when asurplusappeared,thepoliticiansjustspentit.4.Iftheelasticityiszero,hepresenceoftaxesoncapitalincome,crowdingoutButinthecapital4.Iftheelasticityiszero,hepresenceoftaxesoncapitalincome,crowdingoutButinthecapitalmarketwillgenerateanexcessburden.Therefore,usetaxfinance.5.Whilethisisamatterofopinion,oneshouldnotethattheeffectofadebtreductionontheeconomydependsonwhetherthatimplieshighertaxesorreducedspending,aswellastheportfolioofreductionsinspending.Thus,withoutstipulatinghowthedebtreductionwillbeaccomplished,itishardtosaymuchabouttheeffectontheeconomy.5.6.Thebenefitsreceivedprinciplewouldsaythatdebtisappropriatetotheextentthatthebenefitsofthewararereceivedbyfuturegenerations.Anefficiencystandpointwouldsaythatdebtisappropriateiftheexpendituremajorpre-existingdistortionsistemporaryandtherearenotincapital6.Thebenefitsreceivedprinciplewouldsaythatdebtisappropriatetotheextentthatthebenefitsofthewararereceivedbyfuturegenerations.Anefficiencystandpointwouldsaythatdebtisappropriateiftheexpendituremajorpre-existingdistortionsistemporaryandtherearenotincapitalmarkets.Chapter191. ThemarketvalueofMicrosoftisaaflowfigure.ItmakesnosensemakeasensiblecomparisonwouldMicrosoftintoaflow,i.e.,computestockfigure.Grossdomesticproductiscomparethemdirectly.betoconvertthemarkettoOnewayvaluethestreamofincomethatcouldtoofbeChapter191. ThemarketvalueofMicrosoftisaaflowfigure.ItmakesnosensemakeasensiblecomparisonwouldMicrosoftintoaflow,i.e.,computestockfigure.Grossdomesticproductiscomparethemdirectly.betoconvertthemarkettoOnewayvaluethestreamofincomethatcouldtoofbegeneratedannuallyby$500billion10%forconvenience,thisgivesus$50billionperyear,considerablybelowSpain'sGDP.ofwealth.Usingarateofreturnof.4.a.b.c.d.2.3.4.a.b.c.d.ThestatementismisleadingbecauseitignoresthebusinesspartoftheHall-Rabushkatax.Capitalincomesaregeneratedbybusinesses;effectively,theH-Rtaxcapturesthisincomeatitssource.Note,however,thatinvestmentexpendituresareexpensedundertheH-Rproposal.Hence,onlyreturnstocapitalinexcessofnormalreturnsaretaxed.Thereisafundamentalconfusionhere.Thereisnoreasontoassumethattheincidenceofageneralconsumptiontax(aVAT)willbethesameastheincidenceofapartialfactortax(corporateincometax).Forafangivingamillion-dollarballtoMcGwireorSosa,therewouldbeafederalgifttaxliability.Dependingonthefan'scircumstances,itcouldreach$150,000ormore.Thepersonreceivingthegiftowesnotax.Ifthefankeepstheball,thefanwouldowenotaxnow.Buttheballwouldbecomepartofhisorherestate,taxableafterdeathundertheestatetax.Thefancanavoidtaxentirelybygivingtheballtoacharity,sincehecouldentirelydeductthevalueoftheballfromhistaxableincome.Thecharitycouldselltheball;theproceedsfromthesalewouldnotbetaxed.Ifthefansellstheball,thefanowestaxonthenetproceeds,justasthesellerofanypropertywould.Thetransactionwouldputthefaninthehighesttaxbracket,sothatthemarginaltaxrateontheproceedswouldbe39.6percent.e.Ifthefanholdsontotheballforayear,itbecomesalong-termcapitalasset,subjecttothemaximumcapital-gainstaxrateof28percent.Unlessthefanthinksthatthereisgoingtobeasubstantialdropinthemarketvalueoftheball,heorsheshouldholdontoite.forayear.5.a.False,becauseaconsumptiontaxisequivalenttoataxonwages.b.Maybe.Aconsumptiontaxraisesthereturntosaving,butbecauseoftheconflictbetweenincomeandsubstitutioneffects,onecannotknowwhetherornotthiswillincreasesaving.c.False.Evasioncanbeamajorproblemwithretailsalestaxes,especiallyathighrates.6.Inthesimplestcase,thebudgetconstraintispC=wH,wherepisthepriceofconsumption,Cisunitsofconsumption,wisthewagerate,andHishoursofwork.Withanincometax,pC=(1-t)wH.Withaconsumptiontax,(1+)pC5.a.False,becauseaconsumptiontaxisequivalenttoataxonwages.b.Maybe.Aconsumptiontaxraisesthereturntosaving,butbecauseoftheconflictbetweenincomeandsubstitutioneffects,onecannotknowwhetherornotthiswillincreasesaving.c.False.Evasioncanbeamajorproblemwithretailsalestaxes,especiallyathighrates.6.Inthesimplestcase,thebudgetconstraintispC=wH,wherepisthepriceofconsumption,Cisunitsofconsumption,wisthewagerate,andHishoursofwork.Withanincometax,pC=(1-t)wH.Withaconsumptiontax,(1+)pC=wH.Thus,foranyincometaxratet,wecanfindaconsumptiontaxrate, ,thatisequivalentbysolving:(1+)=1/(1-t).7.a. Solve100+75.6/1.08=x+108/1.08,whichimpliesthatx=70.b. Usetheequationfromproblem6tofind=1/3.1,000tinthefirstperiod,

burdenis1,000tinthefirstUnderanincometax,Amy'sburdenisand.08t(800)inthesecondperiod.Shirley'speriod,and.08t(700)inthesecondperiod.Amyhasahigherlifetimetaxburden.Underaproportionalconsumptiontax,theyhavethesamelifetimetaxburden,1,000Chapter201.a.Totheextentthatautostendtobeusedwithinagivenjurisdictiononly,itwouldmakesenseforstatesorlocalitiestocontrolpollutionregulations.Totheextentthatagivencarisdriveninmanystates,orthatpollutioncreatedinonejurisdictionaffectsresidentsanother,itwouldmakesenseforthefederalgovernmenttobecharge.ininb.Totheextentthatthenegativeexternalitiesofalandfillaffectonlypeoplewholivenearbythem,thenappropriate.localorstateregulationisc.ProvisionofweathersatelliteswouldChapter201.a.Totheextentthatautostendtobeusedwithinagivenjurisdictiononly,itwouldmakesenseforstatesorlocalitiestocontrolpollutionregulations.Totheextentthatagivencarisdriveninmanystates,orthatpollutioncreatedinonejurisdictionaffectsresidentsanother,itwouldmakesenseforthefederalgovernmenttobecharge.ininb.Totheextentthatthenegativeexternalitiesofalandfillaffectonlypeoplewholivenearbythem,thenappropriate.localorstateregulationisc.Provisionofweathersatelliteswouldmakemostsenseforthefederalgovernment.d.Publicrefusecollectionseemsnaturalfunctionforlocald.Publicrefusecollectionseemsnaturalfunctionforlocalgovernment.e.Externalitiesdoesn'tjurisdictions.arepresenthere--ifhavegoodsecurity,itAfederalroleseemsappropriate.anairportcanaffectinonejurisdiction

individualsinothere.Externalitiesdoesn'tjurisdictions.arepresenthere--ifhavegoodsecurity,itAfederalroleseemsappropriate.anairportcanaffectinonejurisdiction

individualsinother2.Yes.DavidboretheburdenofthetaxincreasewhileJonathandidnot.Becausethefuturetaxpaymentsareincorporatedintothepriceofthehouse,Jonathanwasabletopurchasethe(same)houseatalowerprice.Thepreviousownereffectively “pays”thetax.0000d.d.d.d.4.5.Thetheoryoffederalismindicatesthatoneofthemainpurposesdecentralizationistoallowpeopletoselectbundlesofpublicservicesandtaxesthatsuitthem.Themorediversetheirtastes,thegreaterbenefitsofbeingabletopickdifferentbundles,andhence,thegreaterthebenefittodecentralization.Hence,thefinding isconsistentwiththeory.oftheourThefigurelooksessentiallylikeFigure20.6(withoutsegmentJH).Whatactuallyhap