Taxation – Page 2 – This Week In Stupid

We turn our attention to Chris Christie, who, in truth, is my kind of Republican. But nobody’s perfect. Back in 2012, he repeated a familiar refrain in the GOP, although he stated it more forcibly than some. In response to Warren Buffett’s revelation that he pays a lower tax rate than his secretary, Christie said that Buffett should “just write a check and shut up.” That is, if Buffett wants to pay more taxes, he can. What Christie resents is that Warren Buffett wants to force others to pay more taxes to support his favorite programs.

William F. Buckley once said something related

Liberals, it has been said, are generous with other peoples’ money, except when it comes to questions of national survival when they prefer to be generous with other people’s freedom and security.

Liberals, including thisweekinstupid, disagree. Once again, an ignorance or underestimation of a basic market failure causes us to talk past one another. Government agencies, including the Department of the Interior, NOAA, the FAA, the CDC, and the SEC, produce what are called “public goods”–goods that you don’t have to own to enjoy. A more thorough discussion of public goods (now featuring math!) is in our first ever thisweekinstupid appendix.

Public goods for non-economists

In brief, Investopedia defines a public good as a product or service that one individual can consume without reducing its availability to another individual and from which no one is excluded.… National defense, sewer systems, public parks and basic television and radio broadcasts could all be considered public goods.

Left to the free market, public goods will be under-produced. That is, the dollars I voluntarily spend on public goods return a benefit spread over a large group, so, I tend to lean toward spending on private goods, the benefit of which I can secure to myself. This is rational and efficient on a personal level, but irrational and inefficient on a societal level. This is known as the “free riders” problem.

An example

Imagine five homes in a cul-de-sac. Each of the homes is for rent by a different landlord. A local landlord’s association reports that a $30 per month lawn service increases the rental value of a property by, on average, $40. Further, $100 worth of landscaping of a median in the middle of the cul-de-sac increases the rent for each of the houses by the same $40. A house with a lawn service and a landscaped median can get $55 more than without any landscaping at all. What should I as a landlord, do? Considering only myself, a lawn service for my own lawn is a good deal, so I sign up. But, if I can get everyone to chip in, landscaping the median is even better. If everyone contributes, we can get the same benefit for only $20 each. Imagine a few of us try to pull the money together for a landscaped median. But, as good libertarians, we’re not going to compel anyone to contribute. Unfortunately, one owner sees the opportunity for a free ride. If she pays only for her own lawn and the rest of us pay for the median, she can make $55 more in rent for only $30 in lawn care. The rest of us are left with a choice. Pay $25 each to landscape the median, or pay $30 to landscape our own yards. The median is still a better deal, but less so than if we had enforced a contribution, for example through home owner’s association dues. Public goods work the same way in a larger community. In the absence of public funding for arts, parks, public highways, defense, etc. the temptation to free-ride causes us to spend less than is most efficient. Failing to properly value public goods and take steps to produce them, wastes resources. Where public goods are concerned, government spending via taxation can lead to more wealth, efficiency and happiness (more in the appendix).

Public good skepticism

Intelligent conservatives know this, of course and still want to spend less than me on many government programs. The disagreement is sometimes rooted in the different value conservatives and progressives assign to public goods. Environmental issues are an easy place to see this. In discussions with Republicans and Libertarians on this topic it becomes quickly clear that, compared to myself, they underestimate the differential benefit between an intact ecosystem and one damaged by oil exploration, air pollution or deforestation. This can be either because, compared with me,

they underestimate the ecological damage; or
they undervalue the things a healthy ecosystem provides.

I find that it’s often a combination of these. Climate change skeptics often don’t think carbon emissions cause warming to a great extent, but even if it did, they don’t think warming is so bad. Connecting it to the lawn care analogy, some owners might doubt that tenants care about a landscaped median. Or they might not trust the community to choose the right landscaper and deliver the promised value. Any one of these factors may cause them to undervalue the public good and reject the cooperative solution.

And so it goes with taxation. Compared with me, Chris Christie underestimates our connectedness. I believe that undereducated or unhealthy children and impoverished families cause great harm to us all and so education, public health care and anti-poverty programs are a public good of great value. Further, I believe we’re economically connected enough that the presence of a public safety net is a great economic benefit to the whole country, and especially to the people with assets to lose. If we removed the public safety net, some of us would put money in the collection plate to cover rent and medical care for the poor, but to get really rich, a better strategy would be to keep your money, buy cheap apartments and rent them to the poor, collecting the charity they’re given by everyone else. Free riders win again.

Role reversal

The other half of William Buckley’s statement concerns the military, which is also a public good. You can’t let someone opt out of funding the military because protecting every third house from the Red Dawn is just as expensive as protecting the whole country. Opters-out become free riders. But, in the case of defense spending, Republicans simply value that public good higher than I do. I think our military is big and strong enough to defend our country from any (terrestrial) enemy several times over. I regard the marginal benefit of an additional dollar in the defense budget to be zero (possibly less). So, I’m quite tired of Chris Christie and William Buckley and their set being quite so generous with my money toward military contractors.

Armed with an understanding of public goods and free riders, liberals are not naive enough to remove public services, cut taxes, and wait for libertarians to plow their tax savings into private programs to keep the water clean, track diseases, make sure the planes don’t crash, get the mentally ill off of the street, monitor trading of securities and pay the rent and medical bills of the elderly poor. On the contrary, sensible economic thinking says the market will be far too profligate with other people’s health, air quality and safety.

Instead, I propose the libertarians go first. As soon as there’s a private program tracking the evolution of new diseases, we can defund the CDC. When private charity clinics provide the medical care for all the poor, there’ll be no need for Medicaid. And the great thing about some of these programs is that no one need “go first.” Shriners Hospital provides all kinds of free medical care to children. Every surgery in a Shriners Hospital is one that doesn’t have to be done elsewhere. If the child being treated is covered by Medicaid, that’s savings and deficit reduction right there. In a very organic way, private charities could take over for public services. As I’ve detailed above, I have my own reasons for believing it wouldn’t happen that way, but I’d love to be proven wrong. And this is certainly no less reasonable than the opposite proposition–defunding these programs without a viable replacement and blithely hoping one will appear.

So, Governor Christie, if you want smaller government, call up the Shriners, “write a check, and shut up.”

Our discussion of public goods seemed incomplete without at least a little math to back it up. But no one wants to alienate the mathophobes, so we parked this tidbit in the “appendix.”

Let’s analyze a few public goods. Imagine, again, 5 farmers. Last year, one farmer contracted with a beekeeper to manage a hive of bees near his field. He paid $2500 for the year. The next year, his harvest increased by $4500. A farmer in a nearby neighborhood paid for even more hives and boosted his profits even more, although the first $2500 is the most effective in this regard.

But he’s not the only one who benefits. Each of this neighbors also increased their crop yields. After doing some research, he discovers that, in a community such as theirs, for each of your neighbors hiring a $2500 bee hive, you can get $1500 more crop even without spending a cent on your own bees. Mathematically, let’s conjecture that the value of the increased yield is

[latex]\sqrt{\alpha S_0 + \sum \beta S_i}[/latex]

and the profit from that extra spending is

[latex]\mbox{Profit}= \sqrt{\alpha S_0 + \sum \beta S_i} – S_0[/latex]

where $latex S_0$ is the amount I spend on bees and $latex S_i$ are my neighbors’ spending. The constant (exogenous) parameters $latex \alpha$ and $latex \beta$ control just how much benefit I get from my own and from my neighbors’ spending, respectively. The reason for the square root is the idea of “diminishing marginal utility.” Spending $6000 on bees is still better than spending $3000, but something less than twice as good. Your first dollar is more important than any subsequent dollar. That said, the utility curve does not have to be a square root.

Now, if all of the neighbors are equally interested in their property values, they might agree to all spend the same on bees, perhaps in a written agreement. If we constrain all of $latex S_i$ to be the same value, we have a formula of just one variable and can plot the profit function:

From the plot, we can see that, if the neighbors all cooperate, they can each get $6000 more crop from spending just $3000 on bees. This is the most efficient level of spending. But here we run into the free rider problem. Suppose the neighbors do not cooperate and one of the neighbors does the calculation without considering anyone else. If everyone else continues spending $3000, how much should I spend to maximize my profit? When we fix $latex S_i$ at $3000 and allow just $latex S_0$ to vary, the new plot looks like this:

The neighbors cooperating can make a $3000 profit, but from the blue curve we see that the selfish neighbor can spend just $500 on bees and make a $3500 profit. In this situation, the self-interest of the individual hinders the prosperity of the community.

The situation gets even worse for goods which are more public. Perhaps the road leading between the town and the farms needs fixing and they’re freestaters, so the government won’t do it. They’re on their own. This fix will reduce wear on the trucks that take crops to the markets, etc.. Mathematically, $latex \alpha = \beta$. In that case the plot looks like this:

A free-rider, in this case, would have almost no incentive to contribute. That’s not exactly true since even the free riders understand they’re gaming the system and that others will be inclined to seek the same deal. When you incorporate this, you find that, in fact, neighbors are willing to spend just $200 on paving, leaving $3200 of profit on the table. (For more details on this aspect, check out the appendix to the appendix, Galt-ifying Public Goods.) The problem only gets worse as the community grows. If you’re paving a street that benefits 20 people with the same utility function, people are willing to contribute just $47 and will miss out on more than $20,000 profit.

Public goods are not always so easily quantified and it’s usually there that disagreements arise, but a little math goes a long way toward appreciating that opinions about public spending are a continuum and that pretending the market is always right (or always wrong) has real consequences.

Not enough math yet? Check out the appendix to the appendix, where we ask the mathematical question, how much more efficient would John Galt’s community (from the novel Atlas Shrugged) have to be to make up for refusing to subsidize public goods.