London School of Economics and Political Science (LSE)

Modules

18
Public Sector Economics

Prerequisite – 28 Managerial economics or
66 Microeconomics

The first main subject area is the relation between the state and the economy, and concerns the broad objectives of economic and social organisation, and the extent to which these objectives can be met by a private market. The state may intervene, first, to improve efficiency in the face of various reasons why the market might allocate inefficiently, including information failures, externalities, public goods and increasing returns to scale. The state intervenes also for reasons of equity, in pursuit of distributional objectives. The various definitions of equity are crucially linked to the underlying view of the state; references are given to libertarian, liberal and socialist views of the state. Where the state intervenes, it might itself be inefficient: it is necessary to look at the literature on public choice, which analyses the influences on the behaviour of voters, politicians and bureaucrats.

The second major area is public expenditure. The largest single items of expenditure are cash benefits and health care; there are important efficiency reasons why these expenditures should be in the public sector. The state also intervenes through public enterprises, again in pursuit of efficiency as well as possible equity objectives. Public expenditure can have efficiency as well as equity effects; various reform strategies have been considered to try to increase the effectiveness of cash benefits, and to ameliorate any undesired side effects.

The third major area is taxation. The equity of a tax system is determined by how the burden of taxation is distributed across individuals; one of the insights of public sector economics is that those who end up bearing the burden of a particular tax may be very different from those who are legally required to pay the tax. The efficiency of a tax system is determined by its effects on economic behaviour. Both equity and efficiency considerations play a role in the major issues in the structure of personal taxation; these issues include the taxation of husband and wife, the balance between direct taxes (such as income tax) and indirect taxes (such as value-added tax), and the choice between income tax and expenditure tax. Of course, taxes are also imposed on companies and have important effects upon their investment decisions among others.