Editing, Macro & Micro economics

| June 19, 2015

Editing, Macro & Micro economics

1. Using an appropriate diagram, show why politicians interested in reducing spending on public assistance (welfare) programs would prefer a block grant program to a

matching grant program. Explain. Relate to the “flypaper effect”. (Graph need not be computer generated.)

As we showed in class, Block grant programs and matching grant programs both increase local spending on the programs targeted by the grant. However, a matching grant

program encourages even more spending on a certain program, as the matching grant effectively reduces the opportunity cost of spending an additional dollar on the

targeted program.
As for the “flypaper effect”, we can define it as an effect that results when a dollar of exogenous grants-in-aid leads to significantly greater public spending than

an equivalent dollar of citizen income: Money sticks where it hits. From the figure above, you can see that the matching grant leads to a significantly greater

increase in spending on welfare than the block grant.

2. In your own words, summarize and describe the Tiebout model/hypothesis. Explain how and why the Tiebout model implies that people will sort into relatively

homogenous communities based on income or some other characteristic.

Under certain assumptions- such as perfect information and mobility, no inter jurisdictional spillovers, no scale economies, and a head tax that finances a local

public good, then each household will move into a jurisdiction such that they get the optimal bundle of local goods in their jurisdiction. This will continue until

households have optimally sorted themselves, and this will be an equilibrium. This implies that communities will be segregated b income, class, race, etc. This is

because these tasted for local public goods generally vary directly with income levels and other characteristics.

3. Explain why some might consider property taxes regressive. Might this have been one reason for the implementation of Proposition 13 in 1978 in California?

Whether a property tax is considered regressive depends on how one views the property tax. Zodrow (2001) posits “the incidence of the property tax- the critical issue

of who ultimately bears the burden of the tax- is still one of the more controversial issues in state and local public finance. The “traditional view” of the property

tax argues that the property tax is fully shifted forward to consumers in the form of higher housing prices. In contrast, the “benefit view” of the property tax

concludes that the property tax is simply a payment for local public services received.

The Property tax is borne by homeowners in terms of higher property values, which, in turn, inefficiently reduces the size of the local housing stock, and its burden

is in proportion to housing consumption.

Tiebout “head tax” is equivalent to a “benefit tax”. In this case, consumers are paying for services that they are receiving from their local jurisdiction, so the tax

is not regressive. Perfect capitalization converts the property tax into a benefit tax.

As for Prop 13, which capped property taxes, if one believes in the traditional view of the property tax, then, yes, this regressive tax was reduced, thereby helping

consumers. If one believes in the benefit view, then all Prop 13 did was to make certain homes more expensive in the long run.

4. The objective of the state of Egalitaria is to equalize educational opportunity (defined
as the same average achievement level in every school). Comment on the following: “To
achieve its objective, the state must equalize educational spending (spending the same
amount per student in every school).”

The answer to this rests on the equity VS equality distinction. Equality in dpllar amounts, assuming all districts face the same challengers, student populations and

other constraints would be fair. However, in reality, these assumptions are not met. Suppose there are two identical school districts, A and B, except that one happens

to have a higher proportion of special education students. Equalizing spending between districts A and B is not going to be optimal.

5. Distinguish between foundation grants and guaranteed tax base grants in education finance. Why might foundation grants be more popular in practice?

A foundation grant guarantees a minimum amount of aid to each school district, while a guaranteed tax base ensures a minimum tax base per student, via which grant

amounts are subsequently computed. In general, foundation grants do not have the “flypaper effect”, as, relative to a GTB plan, more of the grant money goes to

spending on other local goods.

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