ECO 4113 FISCAL ECONOMICS

COMPETITION AND GOVERNMENT

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COMPETİTİON AND GOVERNMENT

Competition is central to the workings of a market system.

Public finance must consider the relationship between competition and government in a market economy.

Government’s role takes many forms: - actions to encourage or costraint competition- competition between governments- competition among private firms in supplying products and services to the government as buyer, - frequent cases when both government and private producers are supplying similar services to overlapping clienteles.

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ENCOURAGİNG COMPETİTİON Governments have two primary tools with

which to promote competition and restrain the excesses of monopoly

* Antitrust law is a tool ,which defines and imposes penalties for behavior by firms that is intended to limit or destroy competition

* The other tool has been a variety of regulatory agencies empowered to curb the excesses of monopolies that are not within the reach of the antitrust laws.Historically ,these regulated monopolies have included telecommunications, banking,railroads,trucking,airlines,and electric power providers.

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Workable Competition

There is usually enough workable competition. The competitors who generate workable competition may be firms in related industries or workable competition may come about as the result of new technology.

In either case,its main feature is to offer consumers some alternative suppliers or products in order to restrain most of the excesses of what generally proves to be only monopoly power.

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Regulatory agencies tend to develop cozy relationships over time with the industries that they regulate,thwarting the intent of oversight.

As a result ,the capture theory of regulation says that these agencies will come to regulate their industries largely for the benefit of the industries themselves rather than their customers ,who are underrepresented in the regulatory process.

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In recent decades,more emphasis has been placed on positive approaches to encouraging competition.

Some of these approaches include Facilitating technology tansfer(particularly

from universities and government laboratories)

Small business development Business incubators Pooled risk management Other services that enable new firms to get a

start against established competition

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DISCOURAGING COMPETITION

People who invest in physical or human capital have no trouble establishing their property rights to that investment in order to try to earn a fair rate of return.

However for people who invest in intellectual or artistic creations ,protecting property rights is a major challenge.

Governments offer creators of such valuable products and services some degree of protection through

Patents Trademarks Copyrights

These protections allow the creator to sue those who copy or appropriate their work without permission as a way of asserting their property rights and earning a return on their investment

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Patents,trademarks,and copyrights also create some degree of monopoly power for their owners.

To avoid creating long term monopolies ,these intellectual property rights have finite lifetimes.

Every government in a market system has to weigh the trade-offs between ensuring that people have incentive to invent,innovate,and create and the risk of encouraging small,inefficient,unresponsive monopolies.

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A second effect that government has,indirectly, on competition in the private sector is through its procurement practices.

Government purchasing,especially at the federal level,favors large firms.

Because the paperwork is complex,the volume of the order is often very large.

Larger firms are just more connected to the information network through which information about planned government purchases is disseminated.

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A third, indirect but significant effect that government has has on competition has to do with the paperwork burden that firms incur in complying with a host of regulations,such as environmental,disability access,gender equity,and worker safety rules.

As the compliance costs will raise the average or unit cost more for a small firm than a large one,regulations have the effect of putting small firms at a competitive disadvantage.

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Finally,governments have historically been the sole supplier of certain kinds of services because the market was so limited and the economies of scale so substantial that only one firm-or perhaps none-could profitably serve the market.

Public transportation,rural electricity,and solid waste collection and disposal have all been in government hands because the alternative was either a private monopoly or no supplier of the service at all-services that were considered desirable as merit goods or goods with positive externalities but not able to generate a profit as an inducement for a private supplier.

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COMPETITION BETWEEN GOVERNMENT AND PRIVATE FIRMS

One of the defining characteristics of government is that it possesses certain kind of monopoly power.

At a minimum,governments have a monopoly on the lawful use of force,which is reserved to the police.

When the government has monopoly power over the legal use of force ,it is able to compel citizens to submit to its demands.

Those demands include payment of taxes, compliance with the speed limit,registering for the military draft, attending school until age 16,and smoking only in designated places.

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When a government has the exclusive right to provide services ,it can’t force people to use its services but it can prevent others from supplying similar services.

As a result it will be less sensitive to customer concerns and less likely to try to be more efficient,to keep prices down,and to provide better services.

In many areas ,government agencies compete both directly and indirectly with private firms,both for profit and nonprofit

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The direct competition takes place when certain services, such as education, recreation, transportation, health care, are offered by both public and private agencies.

Indirect competition simply means that many government activities could also be undertaken by private suppliers ,in which case the threat of lost jobs and loss of power and prestige can have the same effect as direct competition on bureaucrats and government workers

The threat of competition forces government agencies to be more efficient,responsive,and accountable if they think that service provision might be turned over to a private supplier

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SHOULD GOVERNMENT COMPETE?

When government is expected to compete directly with private suppliers of some services (education for example),what happens to those social benefits or public goods aspects of the service that justified public involvement in the first place?

While government agencies and business firms have some common challenges ,methods,and characteristics,often they are quite different in mission and purpose.

The similarities and differences will vary greatly from one agency to another.

The appropriate standards for evaluating their performance may likewise be very different.

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COMPETING IN THE LABOR MARKET

Private firms and governments at all levels compete in the labor market for the same pool of available workers

The package offered by government tends to be different

Often the wage scale is less attractive,but there is much more job security,often more opportunity for advancement ,and frequently more generous benefits,particularly sick leave and annual leave

Private firms vary greatly,but they tend to rely heavily on salary as an incentive rather than job security or benefits

Even at the local level ,competition between the government and other major employers affects the total cost of labor,labor turnover,and the kinds of workers each side can attract

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COMPETITION FOR RESOURCES WITHIN GOVERNMENT

All government agencies have to compete for resources.

Because government ,like households and firms,faces a budget constraint.

The budget constraint is strongest for local governments,who usually must balance their budgets and have limited ability to raise taxes or tap new revenue sources.

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FISCAL SURPLUS, FISCAL IMPACT,AND ECONOMIC IMPACT Fiscal surplus measures the cost-benefit

calculations made by the industry,potential resident or commercial developer in terms of taxes,fees,and public services

Fiscal impact measures the opposite side of the coin,looking at taxes and fees generated and public services demanded from the governments’ point of view

Economic impact is the brodest of the three measures ,looking at the total change in economic activity in terms of income,employment ,and wealt creation

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FISCAL SURPLUS OR DEFICIT

Add up the value of services received ,and subtract the value of taxes paid (including any fees or other nontax obligations)

If the difference is positive ,the tax payer has a fiscal surplus;if negative a fiscal deficit

While taxes are easy to measure, the value of services received is highly subjective,so that two taxpayers with the same tax burden may have different fiscal surpluses because they value services differently

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Mathematically,the fiscal surplus for the ith individual in the jth location is given by

FSij = ΣSVij-ΣTij

whereFS is fiscal surplus SV is the value of services received from governmentsT represents taxes ,including fees and other forms of nontax obligations

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FISCAL IMPACT

The government compares the cost of providing services for the additional resident to the amount of revenue that resident would be expected to generate

If the new resident or firm will generate more revenue to the government than the cost of providing the additional services,the fiscal impact is positive

The mathematical formula is

(SC):FIij= Σ Tij –ΣSCij

where FI is the fiscal impact ,SC is the estimated additional service costs

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The revenue side is the easier part of the computation.

The cost of serving an additional household may vary greatly according to its size, income level,and location.

Determination of fiscal surplus and fiscal impact is not a zero-sum game,although there are some trade-offs

If the value that the citizens place on the service is higher than the cost of producing it,then citizens can have a fiscal surplus even while the local government has a positive fiscal impact

In the case of a pure public good,where adding another user does not diminish the amount available to existing users ,the service cost of an extra resident is zero while the value of the service remains positive

The government can afford to offer this taxpayer a favorable tax service package because an extra resident will result in a revenue increase,yet expenditures will remain unchanged

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ECONOMIC IMPACT

Economic impact measures not only the effect on/of the public sector but also the impact on the private economy from adding new firms or residents

The key to creating a positive economic impact is some external source of private revenue,which may come from selling goods and services to non residents or from attracting residents that have a source of income from outside the local economy

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Export industries –local firms that sell primarily to buyers outside the local market –are said to have multiplier effects on the local economy in terms of the additional spending and job creation that result from their payroll

Communities need export industries in order to acquire the resources to pay for imports,that is,to make purchases of goods and services produced outside the immediate locality

A manufacturing industry is one way to have that multiplier effect,but so are medical centers,resource based industries(timber,agriculture,oil and gas,minerals) or a “mailbox economy” of retirees receiving pensions and Social Security checks from elsewhere

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INTERSTATE COMPETITION AND TAX/SERVİCE INCENTIVES

States are in competition with one another for industry and high income residents

Every state would like to attract or develop high-quality employers who pay good wages,pay lots of taxes,demand relatively few services,respect the environment, and in general enhance the quality of life in the state

States are looking to create positive fiscal impacts

To do so they must lure the residents and firms with both special amenities and tax/service packages that are competitive with other locations,not merely fiscal surplus

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To balance the desire for a positive fiscal impact with the firm’s (or citizens)search for fiscal surplus ,states increasingly are turning to negotiated agreements with business firms,which is a form of price discrimination

While many firms build large ,expensive physical plants that have a long useful life time,others require relatively little capital investment and can easily pick up and relocate

Because of this risk,some states or local governments have included in their aggrements with new or expanding firms receive such inducements a provision known as clawback

A clawback provison requires repayment of certain benefits if the firm does not stay in that location for some minimum period of time or fulfill the terms of the aggrement in terms of dollars invested and jobs created

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INTERLOCAL COMPETITION AND THE TIEBOUT HYPOTHESIS

Even more intense than the competition between states for residents and industry is the competition between local governments for high-income residents,commercial facilities of various kinds,industry,and even state institutions (colleges,prisons,hospitals)

Making those choices,moving between localities because of the relative attractiveness of the tax and service packages,is called “voting with one’s feet”

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TIEBOUT HYPOTHESIS

The classical description of the workings of interlocal competition was that of regional economist Charles Tiebout in 1956

The Tiebout Hypothesis has been one of the most fruitful ideas in regional economics in that it has led to considerable empirical testing as well as further refinements of our understanding of locational decisions and capitalization of the fiscal surplus into the prices of land and homes

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The Tiebout Hypothesis was based on the assumption that both workers and firms not only engage in the usual informed ,self-interested decision-making processes that lie at the heart of economics,but also that workers and firms are mobile

Communities ,in turn, are trying to attain some optimal population in order to reach an efficient size that will minimize the average cost of providing public services

Under these circumstances,people will tend to cluster in communities in which tastes and preferences for public services and taxes are relatively homogeneous

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This model suggests a monopolistically competitive model of many similar communities differentiated by the offerings of the public sector as well as other amenities that influence people’s locational choices

The Tiebout hypothesis suggests that mobility gives voters much more voice and clout in the decisions of the local public sector

The threat of losing residents or commercial and industrial facilities because of mobility is a powerful device for getting the attention of politicians and bureaucrats,much more powerful

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HOMOGENEOUS COMMUNITIES

The Tiebout hypothesis suggests that market-type forces will result in communities that are relatively homogeneous in terms of preferences for public services and the willingness to pay for them

One conclusion of the Tiebout hypothesis is that there may be some tendency for communities to become segregated by income levels

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FİSCAL CAPITALIZATION The process by which present and future fiscal surpluses are

reflected in the prices of houses is called fiscal capitalization.

Capitalization refers to the process by which a stream of future income flows or expected costs is incorporated into the present value of an asset.

If the fiscal surplus on a property increases,the value of the property should increase by the same amount.

If the fiscal surplus decreases ,either because the expected future tax burden increases or the expected value of services decreases the value of the property should decline.

The change in the stream of future obligations and benefits is incorporated into the value of the property,or capitalized.

An important implication of fiscal capitalization is that any changes in taxes or service levels impact primarily those who own the property at the time,not future owners

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FISCAL ZONING

Another implication of the Tiebout hypothesis is that cities and even countries can attempt to defend themselves against some of the undesirable effects of citizen mobility through zoning designed to limit in-migration of low-tax,high service demand residents.

When zoning regulations set high minimum lot sizes or minimum square footage requirements in order to protect the value of the fiscal surplus of established and higher income residents,they are engaging in fiscal zoning.

The result of fiscal zoning tends to be communities that are homogeneous not only in tastes and preferences but also in income and wealth.

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INTERNATIONAL COMPETITION AND GOVERNMENT

In a global economy,national governments find that competition with other nations puts constraints on their monopoly power.

If the factors of production tended not to move ,then the only source of competition between national governments was the movement of goods,which governments could restrict with tariffs,quotas,and other regulations.

If a single government has lost much of its monopoly power,perhaps it can regain or retain some power by joining with other nations to become one of several oligopolists or”price leaders” in a global society made up largely of very small to moderate-sized nations.

Large nations or coalitions of nations have considerable influence in international negotiations on such issues as working conditions,environmental regulations,fishing rights,and protection of intellectual property rights

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