A Quiz on Public Finance

How well do you understand public finance? Below is a quiz. Answer whether the statements are true or false, and briefly explain why. If you think that the statement is only sometimes true, or true under particular conditions, say “maybe” and explain. My answers follow the quiz, but first write down your own answers.

1. After a high tax on land value is in place, it will impose a burden on landowners and reduce the productivity and efficiency of the economy.
2. The most efficient way to pay for a city bus service is to make the bus riders pay for the full cost.
3. The best way to decide whether a club should have a party is by a yes-no vote, with the majority of those voting deciding the outcome.
4. No decentralized pricing system can optimally provide collective consumption.
5. Subsidies that reduce the price of goods below the cost of production typically have net benefits to society.
6. The best policy for government budgets is always to avoid deficits, hence to finance all spending from current revenues such as taxes and fees.
7. The best way to handle pollution is with restrictive regulations, as these are less costly than pollution taxes or permits.
8. The least worst tax for the USA would be a flat-rate income tax with no deductions or credits.
9. The least worst tax for the USA would be a national sales tax that replaces the income tax.
10. A pure free market generally fails to provide adequate public goods and to efficiently and equitably handle externalities such as congestion and pollution.

Answers

1. False. A tax on land value reduces the price of land and replaces what would have been paid in mortgage interest. A land-value tax pushes land to its most productive use, increasing productivity and efficiency.

2. False. The best way to pay for mass transit is to charge riders only when the service would otherwise be too crowded, and just enough to prevent congestion. The rest of the cost is best paid for from the increase in the land rent generated by the transit.

3. False. The best way to decide on a club party is the method called “demand revelation.” Each member records the most he would pay for the party. The amounts are added up. If the total is greater than the cost, have the party. To keep the members honest, if any member changed the outcome, relative to stating one’s cost, that person has to compensate the group an amount equal to the net loss of everyone else (their stated values minus their costs). This method is better because it measures how much the members want the party, not just whether they want it.

4. False. Collective consumption paid for by land rent can be decentralized, because the rent reflects the demand to be located there, and the land will not flee, hide, or shrink when its rent is tapped to pay for collective goods.

5. False. The social cost of taxes that pay for subsidies is greater than the gain to consumers.

6. False. Government borrowing can be a good policy if the funds are spent for investments that are more productive than if the funds were spent in private investments. Otherwise, the budget should not have a deficit.

7. False. A charge or tax on pollution, based on its damage, is more effective than regulations and permits, and the funds can replace taxes that harm the economy.

8. False. A land-value tax is better for the economy than a flat-rate income tax.

9. False. A land-value tax is better for the economy than a national sales tax.

10. Some textbooks say this is true, but the better answer is, False. Private communities such as homeowners’ associations and shopping centers can and do provide public goods from the site rentals. In a pure market, pollution is trespass that requires compensation. Private transit can have congestion charges. A pure free market would have contractual governance that could adequately provide public goods and prevent pollution and congestion.

6 thoughts on “A Quiz on Public Finance

  1. Just passing by, but some quick comments.

    1. A land tax harms some landowners, but benefits others. It benefits those landowners who already own large amounts of land and can afford to pay the tax because the tax increases the entry cost for new land owners. It harms those land owners who have not yet entered the market.

    2. It’s hard to discern what is meant by ‘efficient’. I for one favor transit as a way to subsidize transportation for the poor and so wouldn’t want to charge them the full price of transit; if it were possible though I’d get rid of transit and just give the poor a minimum income. I agree congestion based pricing is valuable nonetheless.

    7. Disagree. I’m most in favor of allowing cities (or if feasible smaller local authorities) negotiate whether to tax local pollution. Some cities like Detroit might prefer increasing their pollution levels if it attracted businesses to re-enter the area. Other, already wealthier cities, might value a cleaner environment more.

    8 & 9. It all depends on what you mean by ‘USA’. I’m too much of a subjective to believe that a federation can have a meaningful preference. I, as an individual, would favor a single land-tax for the most part.

    • A tax on land value decreases the purchase price of land, so it reduces rather than increases entry cost for land ownership. The tax replaces what would otherwise be mortgage interest, so no harm is done to new landowners. The pollution question is whether it is more efficient to have a charge rather than command-control regulations. The tax questions were about the least-worst taxes for an economy. Good that you agree about a single tax on land.

  2. 10 Very much disagree. Leaving everything to “market forces” has always shown to embed privilege. Most areas of activity should be private, but some, e.g. education, health and welfare, have a whole community benefit, if funded and managed communally. I do not suggest there is no room for private enterprise here, but the embedded inequities within the US health system are a prime example of why health should be run communally.

    • But then, if health was communal, there would have been no “Breaking Bad” and as I am certainly not a fan of the show, that, to me, would have been a good thing.

    • We need to analyze whether the existing iniquities are due to governmental policies, or the market. If not for the income tax and sales taxes, individuals would be better able to afford health care, and have a greater choice about medical services. If the iniquities are due to embedded governmental intervention, then the first remedy is to remove the intervention. Of course folks can’t afford medical care when government takes away half their income.

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