Finance Homework Assignment

Answer all parts of all 4 questions. Limit response to 2 single-spaced pages per question. Submit answers via Canvas in Word or other text formats by the listed due date. Late exams will be marked down by one letter grade (10%) for each day or portion thereof that the exam is late.
If you have any questions or concerns about the exam, please contact me directly.
Grading will consider the following:

Solid use of facts and evidence to prove a point or analysis.
Demonstrates a solid understanding of the issue and its relation to course content.
Ideas are coherently and logically organized with well‐developed paragraphs.
Easy to read and denotes sharp thinking. Sentences are well-constructed.

QUESTION 1 (25 points)
The arrival of the COVID-19 pandemic in the United States in 2020 marked the start of twin economic and public health crises. A patchwork of government agencies at the local, state, and federal levels were called upon to manage the fallout of the pandemic. Responsibility for testing, contact tracing, and enforcement of local stay-at-home orders fell on state and local public health departments. Meanwhile, the federal government was primarily responsible for public outreach (e.g. reporting of caseloads and quarantine protocols), development of treatments and vaccines, and coordination of state and local response efforts.

Analyze the roles of state and local governments and the federal government in supplying public goods related to the pandemic. Is this division of responsibilities justified by public finance theory? (10 points)
What are some potential advantages and drawbacks of this federalist arrangement compared to one that may emerge in a unitary system of government? (5 points)
The federal government has sent out three Economic Impact Payments (stimulus checks) (Links to an external site.) that are aimed to help eligible Americans impacted by the pandemic. Some lawmakers are currently pushing for the fourth round of stimulus aid (Links to an external site.), but others disagree that it would be an appropriate policy for the economy. Discuss whether you agree or disagree with either side. Your answer should be framed around Musgrave & Musgrave’s description of major functions of government. (10 points)

QUESTION 2 (25 points)
In 2016, voters in the state of Washington rejected a ballot initiative aimed at creating a new statewide tax on carbon emissions. The text of Washington Initiative 732 is reproduced below:
“This measure would impose a carbon emission tax on the sale or use of certain fossil fuels and fossil-fuel-generated electricity, at $15 per metric ton of carbon dioxide in 2017, and increasing gradually to $100 per metric ton (2016 dollars adjusted for inflation), with more gradual phase-in for some users. It would reduce the sales tax rate by one percentage point over two years, increase a low-income sales tax exemption, and reduce certain manufacturing taxes.”

Describe the market failure that the carbon tax aims to address. Is it appropriate for state governments to address this challenge given the scope of this market failure? Why or why not? (5 points)
Evaluate the state of Washington’s proposed carbon tax using the six tax policy principles described in Chapters 5 of Lee, Johnson, and Joyce (2021) and Ross (2014). Your discussion should emphasize any trade-offs between one or more principles: (15 points)

Vertical and horizontal equity
Collectability / administrative cost
Economic efficiency
Revenue production / adequacy
Political feasibility

A ‘cap and trade’ system is an alternative scheme for controlling carbon emissions where the government sets an economy-wide limit on carbon emissions each year and holds regular auctions that allow private companies to bid on permits to produce some amount of carbon (e.g. 1 ton). Permits are sold to the highest bidder until they are completely exhausted under the economy-wide cap. Is a cap and trade system superior or inferior to Washington’s proposed carbon tax on any of the tax policy criteria in part (c)? Discuss. (5 points)

QUESTION 3 (25 points)
Last year, almost 75% of Maryland voters decided to support a constitutional amendment (Links to an external site.) that authorizes the Maryland General Assembly “to increase, decrease, or add items to the state budget,” provided that the change does not exceed the total amount submitted by the governor. This will start to take effect in 2024.

You’ve learned about the four major phases of the budget cycle. Describe which phase(s) would be directly affected by the amendment. (5 points)
What are some potential advantages and drawbacks of having greater legislature scrutiny in the Maryland budget process? Your answer should specifically consider the economic efficiency and political accountability implications of this amendment. (10 points)
In 2004, Maryland House and Senate passed the “Managing for Results” legislation. The state law requires state agencies to set measurable goals that are consistent with their respective mission, among other things. How is this provision relevant to the concept of performance budgeting? Do you think performance budgeting–and other “technocratic” budgeting approaches—could ever substitute the role of politics in the budget process? Why or why not? (10 points)

QUESTION 4 (25 points)
The work that is done by bond rating agencies is a key factor in determining the borrowing costs of state and local governments. Assume you are an analyst working for one of these rating agencies.

What factors, typically found in government financial statements (balance sheet, statement of activities, cash flow statement) and/or on public budgets do you think would be most useful to you in evaluating the creditworthiness of a general obligation bond? (10 points)
Assume the bonds fall into two groups: those maturing in one year and those maturing in 25 years. How would your analysis differ for each case? What factors are more important for the former as compared to the latter? (5 points)
Explain why some people might argue that there is a conflict of interest when bond issuers hire rating agencies to give their opinion and rating for a bond issuance? Design one policy solution that might ameliorate this problem. (10 points)

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