Chapter 22

Public Finance in a Federal System

Multiple Choice

1. When the federal government gives a grant to a state or local government without restrictions on use,
this is known as
A) revenue sharing.
B) block grants.
C) endowments.
D) tax shelter.
Ans: a

2. A circuit breaker is concerned with

A) faulty tax wiring.
B) residential property taxes.
C) corporate tax systems.
D) block grants.
Ans: b

3. A Tiebout model involves

A) completely mobile individuals.
B) governments generating no externalities.
C) perfect information.
D) all of the above.
Ans: d

4. When a tax is based on the difference between the market value of the taxpayer’s assets and liabilities,
it is called
A) a difference tax.
B) a wedge tax.
C) a personal net worth tax.
D) an implied liability tax.
Ans: c

5. For the last 100 years, the level of government that has seen the largest increase in its percentage of
expenditures is
A) local.
B) state.
C) federal.
D) all of the above.
Ans: c
6. When a group of people voluntarily band together to share some kind of benefit, we call this a
A) a gang.
B) a team.
C) a coalition.
D) a club.
Ans: d

7. When did the percentage of federal grants in state and local expenditures reach its peak?
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Ans: c

8. Local property taxes are used to provide

A) education.
B) fire protection.
C) libraries.
D) all of the above.
Ans: d

9. What does foundation aid do?

A) increases shareholders’ net worth
B) ensures minimum level of expenditures
C) ensures a maximum level of expenditures
D) reduces tax liability for the poor
Ans: b

10. _________ percent of Americans have different residences than they did the year before.
A) 30
B) 17
C) 9
D) 22
Ans: b

11. The assessed value of a home is

A) the value that the jurisdiction uses to assign taxes.
B) an annual 6% increase in the value of a home.
C) the annual rate of deprecation of a home because of use.
D) always lower than its market value.
Ans: a

12. The property tax is very popular because

A) it is fairly assigned.
B) it is administered locally.
C) it is very regressive.
D) of all of the above.
E) of none of the above.
Ans: e

13. A local government would not be efficient in providing which of the following services?
A) international aid
B) police protection
C) fire protection
D) roads
Ans: a

14. Which of the following is not a political jurisdiction?

A) Cook County
B) Alabama
C) New York City
D) California research triangle
Ans: d

15. A local public good

A) only benefits members of a particular community.
B) gives higher benefits than regular public goods.
C) requires unanimous voting.
D) has become an integral part of the federal government.
Ans: a

16. Disadvantages of decentralization are

A) intercommunity externalities.
B) forgone scale economies in the provision of public goods.
C) inefficient taxation.
D) the lack of ability to redistribute income.
E) all of the above.
Ans: e

17. __________ explores the roles of different level of government and the ways in which they relate to
each other
A) Federal system
B) Club model
C) Centralization.
D) Fiscal federalism
Ans: d

True/False
18. Property taxes are currently unpopular. In the future, they will be more popular.
A) True
B) False
C) Uncertain
Ans: c

19. The ratio of tax collections to tax capacity is known as tax effort.
A) True
B) False
C) Uncertain
Ans: a

20. The Tiebout model assumes that public services are financed by a proportional property tax.
A) True
B) False
C) Uncertain
Ans: a

21. It is easier to avoid state and local taxes than federal taxes.
A) True
B) False
C) Uncertain
Ans: a

22. The flypaper effect causes money to move from where it initially hits and sticks somewhere down the
bureaucratic chain.
A) True
B) False
C) Uncertain
Ans: b

23. The Tiebout model can be summarized as “voting with the invisible hand.”
A) True
B) False
C) Uncertain
Ans: b

24. Lump sum grants are sometimes referred to as categorical grants.

A) True
B) False
C) Uncertain
Ans: b

25. A federal system consists of one level of government to provide public goods and services.
A) True
B) False
C) Uncertain
Ans: b

26. Local property tax policy generally has a small effect on the property tax base.
A) True
B) False
C) Uncertain
Ans: b

27. Grants as a percent of total federal outlays have been increasing since the 1960s.
A) True
B) False
C) Uncertain
Ans: a

28. The proportion of total direct expenditure made by local governments is called the centralization
ratio.
A) True
B) False
C) Uncertain
Ans: b

29. In Tiebout Model, the tax can vary across communities.

A) True
B) False
C) Uncertain
Ans: a

Essay

30. Refer to Figure 22.3 in your textbook. Suppose that the supply curve is constant at $10. Suppose
further that the before-tax demand curve DB can be written as B = 20 – P/2, where B is the number of
structures per year and P is the price.
(A) Find B0.
(B) Suppose that the after-tax demand curve, , can be written as B = 20 – P. Find B1 and .
B
D'B Pg
Ans:
(A) Insert $10 into before-tax demand equation, and solve for B, B 0 = 20 – 10/2. B0 = 15
(B) Insert $10 into after-tax demand equation, and solve for B, to get B = 20 – 10 = 10. To find ,
B
Ps
put the quantity 10 into before-tax demand equation, and solve for P
 = 40 – 2B = 20
PBs

31. The town of Little Bohemia has an estimated elasticity of demand for land of 2. What effect would
there be to the quantity demanded from a 10% decrease in the price of land due to a tax increase?
Ans: The formula for elasticity is , therefore, 2 = - (%X) / (-10) = 20. Demand would
%ΔX
ε=−
%ΔP
increase by 20 percent.

32. Refer to Figure 22.5 in your textbook. Suppose that the initial budget constraint AB is given by the
equation G = 150 – c/5, where G is the units of public good and c is consumption. A closed-ended
matching grant up to 100 units of public good is proposed. If the slope of line segment AD is – 2, write
the equation of the new budget constraint after a closed-ended matching grant.
Ans: For quantities of G between 0 and 100, the equation of the line is G = 375 – c/2. Using this equation
at 100 units, c would be 550. In the original equation, 100 units give c to be 250, which is a difference of
300. Therefore, from the kink at D, the equation is G = 210 – c/5 from 100 to 210.

33. Suppose that the demand for housing is given by the equation Xd=8-P/3. If the price of housing is
initially 9, what is the amount of consumer surplus? Suppose now that the price changes to 13. What
happens to consumer surplus? Is there a DWL?
Ans: When the price is 9, the quantity demanded is 5; therefore, consumer surplus is (½)(5)(15) = 37.5.
When the price increases to 13, the quantity demanded is 3⅔. Now consumer surplus is (½)(3⅔)(11) =
20.166666. Yes, there is a deadweight loss of (½)(4)(1 ⅓) = 2⅔.

34. Refer to Figure 22.2 in your textbook. Suppose that the supply of land is constant at L acres, and
Price per acre is $400. In addition, the before-tax demand for land can be characterized by the equation
P = 500 – 2L, where L is the acres of land and P is the price.
(A) What is the constant supply of land (L) in the market?
(B) If the after-tax demand curve, , can be written as P = 400 – 4L, what is , and how much
D 'B P'L
tax revenue is generated?
Ans:
(A) If the price is 400, then the constant acres of land will be 400 = 500 – 2(L), L* = 50.
(B) At the same quantity of 50, the after-tax price will be 400 – 4(50) = 200. Tax revenue will be [(400
-200) * 50] = 1,000.

35. Some cities have a relatively high residential property tax, while others have a low residential
property tax. Give an explanation for this.
Ans: The number of people and their preferences for local public goods affects whether a city’s residential
property tax is high or low. Property values are important in this discussion, also. The cost of living in a
particular area must also be investigated.

36. The Tiebout model offers a quasi-market solution to public good production and community
development. What are some drawbacks to this model?
Ans: Some of the assumptions of the model are rather strong. Assuming that each individual has perfect
information about all communities, taxes, and services is rather strong. In addition, assuming that there
are enough communities for each individual’s preferences for a package of public goods is tough.

37. Property taxes are not very popular. People might dislike other taxes just as much, but feel powerless
to change them. If the assessed value of the property does not rise or, in fact, declines, then this should be
followed by decreases in tax rates. This, however, is not welcomed by property owners, either. Why?
Ans: Although tax rates may be lower, this decrease corresponds to a decreasing value of the property,
which will result in capital losses. The ideal situation would be for the assessed value of the property to
increase with rates staying the same or decreasing.