While we have been referring to government as if it were a single entity, in fact Americans face three levels of government: federal, state, and local. This reflects a division of responsibilities among the different levels of government-a’ system known as The boundaries are not always cut, but in general the federal government directs activities that, concern the entire nation-paying for defense, space exploration, and foreign Local governments educate children, police streets, and remove garbage. States build highways, run systems, and administer welfare programs. The amounts of spending by the different levels are shown in Table 16-1. The dominance of the federal role is a comparatively recent , phenomenon. Before the twentieth century, local government was by far the most ‘important of the ‘three levels. The federal government did little more than support the military, pay interest oil the national.debt, and finance a few public works. Most of collection came from liquor and tobacco excises and ~port tariffs. But the combination of two hot wor:ld wan and ‘one cold war-along with the rise of transfer programs such as social security and Medicare-boosted spending, while the advent of the national income tax in 1913 provided a source of funds that no state or locality could match.

To understand fiscal federalism, economists em-‘ phasize that spending decisions should be allocated ‘among the levels of government according to the spillovers from government programs. In general, localities are responsible for local public gOOds, activities whose benefits are largely confined to local residents. Since libraries are used ‘by townspeople ‘and streetlights illuminate city roads, decisions about these goods are appropriately made by local residents.

Many federal functions involve national public goods which provide benefits to all the nation’s citizens. For
example, an AIDSvaccine would benefit people from every ltate, not just those living near the laboratory ,
where it is discovered; similarly, when the U.S. Army waged war in the Persian Gulf, oil supplies were protected
for the entire country. What about global public goods like protecting the ozone la~r or slowing global warming? These are i~ public gootll because they transcend the boundaries of indivi~ua1 countries. An ;t.cient system of fiscal federalism takes into account the waythe benefits of public programs spill over political boundaries. The most efficient arrangement is to locate. the tax and spending decisions so that the beneficiaries of programs pay the taxes and can weigh’ the trade-offs,

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