Eco 3630 Public Economics

Spring 2025
About Me
• Name: Bhanu Gupta
• Fields: Public Economics and Development Economics
• Brief Academic Journey:
• Undergraduate and Masters degree from University of Delhi
• Worked at Indian Statistical Institute – Delhi
• PhD from University of Michigan at Ann Arbor.
What is Public Economics?
• Public Economics (or Public Finance or just PF) = Study of the Role of the
Government in the Economy
• Unrelated to Finance (what hedge funds and investment banks do)

• Government pervasive in economic life:

1. Government in charge of huge regulatory structure
2. Taxes: governments in advanced economies collect 35-50% of National Income in
taxes
3. Expenditures: tax revenue funds traditional public goods (infrastructure, public
order and safety, defense) and welfare state (Education, Retirement benefits,
Health care, Income Support)
4. Macro-economic stabilization through central bank (interest rate, inflation
control), fiscal stimulus, bailout policies
5. Government directly employs people. (DoGE??) Indian Railways is one of the
largest employers in the world.
Questions asked in Public Economics
• Four main questions of public economics:

Q1. When should the government intervene in the economy?

Q2. How might the government intervene?
Q3. What is the effect of those interventions on economic outcomes?
Q4. Why do governments choose to intervene in the way that they do?
Two main streams of PF
• Revenue side – Taxes
• Expenditure
Why do we care about taxes
• Taxes affect all facets of modern civilization. Really!!
• Taxes are used to fund all kinds of government expenditure. But they
can affect people’s behaviour.
Taxes affect architecture
• Skinny houses in Poland
…and in Vietnam!
Taxes inspired freedom movements
• Dandi March and Salt Tax
Taxes inspire movies and literature
The phrases “Do Guna lagaan” and “Peeping
Tom”
Some weird taxes throughout history
• Beard Tax
• In 1698, Emperor Peter I of Russia instituted a beard tax to bring
Russian society in line with Western European models.
• Resistance to going clean shaven was widespread with many believing
that it was a religious requirement for a man to wear a beard
• To enforce the ban on beards, the tsar empowered police to forcibly
and publicly shave those who refused to pay the tax
 A Russian beard token from 1705,
carried to indicate that the owner had
paid the beard tax imposed by Peter
the Great
Taxing Bachelors
• In ancient Greece and Rome, there was a tax on unmarried men of a
certain age.
• Why? They have no family to support , so can pay higher taxes. Also,
an incentive to get married.
• In some cases, a bachelor could avoid taxes if he could prove that he
had asked a woman to marry him and been rejected.
• This gave rise to what were called “professional lady rejecters”
women who for a modest sum agreed to swear that they rejected the
man.
Taxes affect timing of death.
• Kopczuk and Slemrod (2006) investigate temporal pattern of deaths
around the time of changes in the estate-tax system periods when
living longer, or dying sooner, could significantly affect estate-tax
liability.
• They find a small death elasticity.
• However, they cannot rule out that what they have uncovered is ex
post doctoring of the reported date of death
Course Overview & Logistics

• Prerequisites: Microeconomic Theory I and Econometrics I.

• Advised: Econometrics II
• Textbook: Gruber, J. Public Finance and Public Policy 5 th edition. Other
editions can be used. However, I will specify chapters according to
edition 5.
• Attendance Policy: Not enforced in first 2 weeks. No documentation
required for missing up to 5 classes. 3 points deduction for every class
missed after that for a maximum of 15 points.
Assignments and Paper
• There are three problem sets. All of them are ungraded. We will track
submission, however.
• Mid term and final exam. Both carry 35% of the grade.
• End-term presentation is worth 10% of the grade. It might be done at
individuals/group level. Max # of students per group will be
announced soon.
• Presentation topic should be a current topic that incorporates the
learnings from this class.
• All the details can be found in the syllabus.
With great fun, comes great responsibility
• I will post the lecture slides on google drive.
• All the material is only for the students enrolled for this class, and
prepared by investing significant time and effort.
• DO NOT distribute the material to anyone without prior permission.
• DO NOT PLAGIARIZE. We will compare the topics with papers
submitted by previous cohorts. If plagiarism is detected, it will lead to
automatic failure for the entire group.
References
• Chapter 1 of Gruber
Questions asked in Public Economics
• Four main questions of public economics:

Q1. When should the government intervene in the economy?

Q2. How might the government intervene?
Q3. What is the effect of those interventions on economic outcomes?
Q4. Why do governments choose to intervene in the way that they do?
Q1. When should the government intervene in the
economy?
A. Market Failures : market economy may deliver an outcome that is
inefficient ⇒ government intervention may improve the situation.
This is contrary to the result of First Fundamental Theorem.
• Ex: When we drive to work, we don’t take into account the
negative impacts on others. We would all be better off if we all
drove less.
B. Redistribution : market economy generates inequality in economic
resources across individuals ⇒ people willing to pool their
resources (through government taxes and transfers) to reduce
inequality
Think of an example which is efficient but not equal!
Efficiency
Equity
Market Failures
A1. Externalities (example: greenhouse carbon emissions) ⇒ require
govt interventions (Pigouvian taxes/subsidies, public good provision)
A2. Imperfect competition (example: monopoly) ⇒ requires regulation
(typically studied in Industrial Organization)
A3. Imperfect or Asymmetric Information (example: adverse selection
in health insurance may require mandatory insurance)
A4. Individual failures People are not always rational. This is analyzed
in behavioral economics, field in huge expansion (example: myopic
people may not save enough for retirement)
• Introductory economics often focuses on how well markets can
work; and they are often a good way of organizing things
• But replacing social institutions with markets is not always good
• Ex 1. Education is mainly government funded: student loans sound good, but
in practice discourage education become a lifetime burden
• Ex 2. Health care relies heavily on government/community support
everywhere, for good reasons that we will explore
• Ex 3. Saving for your own retirement is economically rational but in practice
most people unable to do so without help
B. Redistribution
Even if market outcome is efficient, society might not be happy with the market
outcome because market equilibrium might generate very high economic disparity
across individuals

Governments use taxes and transfers to redistribute from rich to poor, reducing
inequality

Redistribution through taxes and transfers might reduce incentives to work

(efficiency costs)
⇒ Redistribution creates equity-efficiency trade-off .
Example : Higher income tax for wealthy will help in redistribution but
disincentivize the wealthy from working.

Income inequality has soared in the India/United States in recent decades, and has
moved to the forefront in the public debate
According to Oxfam:
1. There are 119 billionaires in India. Their
number has increased from only 9 in 2000 to
101 in 2017. Between 2018 and 2022, India is
estimated to produce 70 new millionaires every
day.

2. It would take 941 years for a minimum wage

worker in rural India to earn what the top paid
executive at a leading Indian garment company
earns in a year.
 Q2. How Might the Government Intervene?
• Tax or Subsidize Private Sale or Purchase: Tax goods that are
overproduced (carbon tax); subsidize under produced goods (Covid
vaccine)
• Restrict or Mandate Sale or Purchase: Restrict the private sale or
purchase of overproduced goods (fuel efficiency requirements), or
mandate private purchase of underproduced goods (auto insurance)
• Public Provision: The government can provide the good directly, in
order to potentially attain the level of consumption that maximizes
social welfare (example is National Defense)
• Public Financing of Private Provision: Government pays for the good
but private sector supplies it (e.g., viability gap funding of
infrastructure projects)
Q3. What Are the Effects of Alternative
Interventions?
• Direct Effects: the effects of government interventions that would be
predicted if individuals did not change their behavior in response to
the intervention
• Direct effects are relatively easy to compute.
• Indirect Effects: the effects of government interventions that arise
only because individuals change their behavior in response to the
interventions (sometimes called “unintended effects”)
• Empirical public economists estimate indirect effects to inform policy

Remember the example of Death elasticity.

 Q4. Why Do Governments Do What They Do?
• Political Economy: The theory of how the political process
produces decisions that affect individuals and the economy
• Example: Understanding how the level of taxes and spending is set through
voting and voters’ preferences
• Public Choice is a sub-field of political economy from a Libertarian
perspective that focuses on government failures
• Government failures = situations where the government does not act in the
benefit of society
• Normative Public Economics: analysis of how things should be
• Should the govt provide health insurance? How high should taxes be?
• In practice, economists rarely use an unqualified “should”
• This is the study of how to think about what we should do
• Positive Public Economics: analysis of how things really are
• Does govt provided health care crowd out private health insurance?
• Do higher taxes reduce labor supply? To what extent?
• Positive Public Economics is a required first step before we can complete
Normative Public Economics and prescribe policy
• On the other hand, Normative Public Economics tells us what we need to measure in
Positive Public Economics
• Positive analysis is primarily empirical and normative analysis is primarily
theoretical (not a perfect dichotomy)
So Why Study PF?
• Interest in improving economic welfare ⇒ interest in PF
• Practical relevance to contentious policy debates:
• What should be the size of the stimulus package to jumpstart economy?
• Should India decrease the corporate tax rate?
• How to curb evasion under GST?
• Bringing rigorous evidence to these debates has great practical value because
of large stakes
Public economics is also just fascinating; I hope you agree by the end of
this course
Notes