Saturday, August 06, 2011

[bmnabnic] How much of government spending is actual spending?

Government outlays could be classified into two categories: income redistribution and "actual" government spending.

A standard economic assumption states income redistribution is a "mere transfer" and does not affect the economy as a whole, to first approximation.  Money gets taken from one person, then given to another person who then has to spend it efficiently within the same market economy as the first person would have. There is no loss in efficiency.  Second order effects we are ignoring for now include incentive distortions from taxation and the societal friction caused by wealth disparity.

Social Security (minus administration overhead) is pure income redistribution.  Going to war is mostly pure government spending.

But many outlays do not initially seem to fall neatly within either of the two categories.  Take Medicare and Medicaid, for example: the government is giving you money, but the money is restricted to health care.  To assign these, imagine a hypothetical scenario where we sum the value of government funded health care a poor person or old person consumes over the course of the year.  Then we travel backwards in time, and give that money as a lump sum to the person, saying you can spend it on health care, or anything else.  The amount the rational (another standard assumption) person spends of that on health care is the "income redistribution" amount, any excess is government spending.  A more sophisticated analysis would include externalities (e.g., contagious infections).

The government pays for a road.  Trying to break up this outlay into the two components is an interesting exercise, one I have not solved.  I think it involves assuming the "free rider" problem does not occur.

Revisit two assumptions: What if the recipient of the distribution does not spend it efficiently?  My first thought is, economics if not ready for such questions.

Assuming the distortion effect of taxation is not negligible, how should taxes be structured to minimize distortion?  Progressive income tax.

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