Welfare programs change behaviour

Many people like to envision worlds where the State will tax the rich and help “the needy” – this ranges from free health care to unemployment insurance to disability insurance, etc.

There are many problems with these schemes. One of them is the fact that people respond to incentives. We are not bricks, we are not stones, but men, and being men, we will optimise. When unemployment insurance is offered, people will try less hard to find a job, to acquire skills that will get them a job, to migrate to a place where jobs are more easily found, etc. When health care is free, people are more inclined to be fat or smoke or otherwise take less care of themselves. And so on.

Among economists, it’s considered obvious that people drive in a more rash manner when wearing a seat belt, but in the wider discourse, this raises hackles. When researchers found that drivers pass closer when overtaking cyclists wearing helmets as compared with overtaking bare-headed cyclists, economists were among the few who were not surprised. Laypersons generally recoil from the idea that the presence of a government giving out free open heart surgery increases obesity.

The first element of the behavioural change is lying and misrepresentation by citizens. When a government says it will give out disability insurance, people have an incentive to go to a civil servant and claim that they are disabled. I remember hearing a story from Holland, when a certain set of rules were constructed to give an early pension to the disabled, and policy makers had estimated that 1% of workers would be eligible for those benefits. In a few years, 10% of workers tried to claim these benefits, and front-line civil servants were placed in the difficult situation of having to identify the few genuinely disabled within the large pool that was claiming to be disabled.

The second layer is genuine changes in behaviour. Ljungqvist/Sargent have emphasised the damage caused by European-style welfare programs, which encourage or support withdrawal from the labour market. Some of these problems are now coming about with NREG. Migration out of villages is central to India’s future, but NREG is reducing the incentives of people to engage with the urban labour market and ultimately to leave.

I just came across an example of behaviour distorted by incentives that veers on the fantastical: An unemployed Austrian man sawed his foot off, to avoid being found fit enough to go back to work. We find it incredible that Aron Lee Ralson cut off his right arm (to avoid certain death). But sawing your foot off to avoid going back to work?

This is a colourful story and only an anecdote. The man is most likely a nutcase. It is nobody’s case that such extreme responses will come about on a large scale. The claim of the microeconomics literature is more limited: that on average, fairly significant behavioural changes come about in response to changes in the rules of the game. Through this, welfare programs have unintentional consequences that go far beyond those visible at the surface.

Politicians and bureaucrats in India like to roll out out more welfare programs. It would be useful to bring alternative perspectives on these questions, which are mainstream worldwide but are considered cutting edge in India: about the limited governance capacity of the State, about the fiscal crisis that the State faces, and about the behavioural changes induced by welfare programs. In this field, you may like to see a paper by Vijay Kelkar and me.

Public Goods

Let’s play spot the fallacies:

We do not just have governments in order to rob Peter to pay Paul. We have governments because there are things they can provide that the private sector is either unable or unwilling to provide effectively – courts, police, schools, roads, other infrastructure, etc. Conservatives focus so much on redistribution that they tend to ignore this fact, but if you think about it, you’ll realize public goods are why we have government in the first place. [Emphasis added.]

I will cede that the court system is best administered by the government, given its coercive touch. However, the idea that there is no way the free market can provide policing, education, roads, and other infrastructure is simply foolish.

Regarding policing, consider that private investigators and voluntary constabularies have both played major roles in law enforcement for a decent portion of American history (with the former still in existence). Of course, there is not likely to be any free market policing of victimless crimes, like speeding and drug use, but I don’t see this as a down side, seeing as how the negative externalities of these laws as the relate to property rights are already handled by the law.

Regarding education, it is laughable to claim that the free market can’t provide schooling in light of the present existence of private schools, private universities and colleges, and home schooling. While a free market model would increase the probability that people would have to pay directly for education instead of soaking other people for the costs via taxation, this will encourage more efficiency and lower costs in the long run (and, let’s be honest, the current results of the modern public school system are simply abysmal), and will likely end the public-school-as-free-daycare model of education that currently plagues society today.

Regarding private roads, I will simply note that privatized highways currently exist, and that there have been many cases of privately funded roads. In fact, the modern road system was initially built on private financing from businesses. Furthermore, it is quite conceivable that the free market can provide lots of infrastructure. Sure, it might be more expensive, given the market tendencies of those entities known as natural monopolies, but this will likely help conserve resources and distribute them more equitably over time.

What’s also ignored in this “analysis” is the crowding effect that the government plays in competition for these services. For example, the government providing education at no cost to it recipients (or, more accurately, their parents) makes it considerably more difficult for other companies to compete since they cannot coerce people to buy their product. Really, once one accounts for the competition-distortive effects of government, it should become readily apparent that the claim that the market is unwilling to provide certain things, and thus the government must is simply wrong. Whether this claim is made in ignorance, malice, or plain stupidity is for the reader to decide.

On Wealth Inequality

Inequality is bad for growth, stability and efficiency. … Inequality peaked both before the Great Depression and before the Great Recession, and it’s not an accident. So basically, when we have a lot of inequality, demand goes down. … All this inequality was offset by creating a bubble. The bubble allowed people to consume more. Now we have the inequality but we don’t have a bubble, and that means that we will have persistent, weak demand, and therefore unless we create another bubble it’s going to be very difficult for us to get back to full employment.

A lot of the inequality that we have in the United States is created by distortions – excessive financial sector, monopolies like Microsoft … giving the oil companies, mining companies resources at a discount. … These things distort the economy, while they create wealth at the top. So it’s not wealth creation – it’s wealth redistribution, which makes the size of the pie smaller.

In a materialist sense, no two people are equal. We each have differing physiques, talents, interests, motivations, limits, and abilities. As such, even if given perfect equality of opportunity, it is reasonable that we would never have equality of outcome. Thus, there will always be some level of inequality among human beings. This is perfectly natural, and entirely unavoidable, no matter how many Marxist revolutions try to say otherwise.

That said, there is something to Joseph Stiglitz’s observation that this degree of inequality is economically detrimental. Stiglitz is undoubtedly better versed on the subject of inequality than I am, but I wonder if his tendency to view these sorts of matter through the mainstream economics lens handicaps him, and so I disagree with his assertion that radical inequality causes economic decline. I theorize that it merely correlates with economic decline. As Stiglitz noted, there are many economic distortions caused by the federal government, and these economic distortions have a nasty habit of benefiting the wealthy, politically connected elite.

As such, there should be an inherent distrust of radical inequality, and it should be coupled with a suspicion that the wealthy are trying to use the government to exploit everyone. This is a fairly common occurrence in the world today, and has been the historical norm. Businessmen,* therefore, are no more deserving of trust than politicians because both groups are human, and are more or less equally susceptible to the vices that have plagued humans for millennia: greed, lust, and hunger for power. Therefore, any time inequality is present to a radical degree, it should be suspected that the wealthy elite are in cahoots with the government to enrich themselves.**

* Caveat no. 1: “businessmen” is not synonymous with “free market.” I fully support the free market because it is an inherently trustworthy process. Even though the market may be an implicitly trustworthy process, it does not follow that its participants are.

** While we should suspect collusion, we should not assume it. We should merely check to see if businessmen are, in fact, colluding with politicians for the purpose of self-enrichment. If they are, we should demand that said collusion be brought to an end. And if they are not, we should get over our envy.

Chuck Moulton: Open Letter to Gary Johnson on the "Fair" Tax

I’m not going to post the whole letter here — you can read it at Independent Political Report. And you should. As a teaser, here’s the opening:

Main libertarian objections to the Fair Tax:
1. The prebate would start a new welfare entitlement.
2. The transition would redistribute from savers to borrowers.
3. There is a danger of getting BOTH an income AND a consumption tax.
4. Advocates disingenuously quote a 23% rate when it is actually 30%.
5. Advocates use protectionist rhetoric to sway populists.

Also well worth a read is Jason Gonella’s open letter to Johnson, which covers some other issues.

And two pieces on the “Fair” Tax by LP presidential nomination candidate R. Lee Wrights (here and here).

And finally, while I don’t by any means claim to be “the father of libertarian opposition to the ‘Fair’ Tax,’” I can claim to have done a bit of writing on it long before it became a football in the Libertarian Party’s 2012 presidential nomination process — see here and here.

Redistributing Wealth

In an axiomatic sense, wealth is always distributed in some way. Likewise, any transfer or exchange of wealth is a redistribution of wealth.

Redistribution of wealth comes in two forms: coercive and voluntary. The former method of redistribution is associated with socialism and, more generally, any statist attempt at transferring the goods or wealth of an individual or group to another individual or group. The latter method of redistribution is associated with capitalism and, more generally, any form of voluntary exchange.

It is obvious, then, that wealth is continuously redistributed. People constantly desire to trade some portion of what they have for something else they desire more. Thus, redistribution of wealth occurs in the free market, and often occurs via the mechanism of exchange. However, there are some instances when wealth is redistributed freely, such as when a parent provides for his child in exchange for nothing. More generally, though, the redistribution of wealth in a free society usually requires exchange.

Therefore, what those who clamor for the redistribution of wealth actually desire is an option to acquire wealth by force in exchange for nothing. They may not be inherently opposed to trade, nor may they be totally desirous of charity—particularly if that charity has behavioral strings attached. Rather, they simply desire to have the option to have wealth redistributed to them without having to offer anything in exchange.

Is a Great Big New Tax Such a Bad Idea?

‘Where have you been? Have you been hiding from me?’ I saw it was Jim speaking when I looked up from reading the paper. I hadn’t exactly been avoiding him, but then I hadn’t really missed not seeing him for a few months.

Jim asked me if I could give him a lift home. He gave me some long and convoluted explanation about why he needed a lift, but I thought he was probably just looking for a captive audience – someone to talk to about something that was on his mind.

He certainly did have something on his mind. As soon as we started off he asked me what I thought of the outcome of the Copenhagen climate change summit. I admitted that I thought it was fairly predictable. Given the way western governments were approaching the issue it would have been hard for China and India to accept that they were serious about achieving concerted action even if the science was settled. I said that if governments thought the stock of greenhouse gas emissions was a serious problem they would be focusing on the incentives needed to develop technologies that would reduce the stock of emissions, rather than just attempting to cap the growth of emissions.

Jim said: ‘I thought that emissions trading schemes, like the one Kevin Rudd is proposing were meant to provide appropriate incentives for firms to develop better technologies.’ I responded that in my view Rudd’s ETS stood for Enormous Transfer Scheme. I suggested that the Australian government was attempting to confuse welfare issues with environmental issues in order to smuggle income redistributions into the scheme. I added that it was crazy for Australia to go it alone without concerted international action and that if we are concerned about incentives for developing new technologies we should be thinking in terms of explicit taxes rather than cap and trade systems.

Jim said: ‘Ah, that’s Warwick McKibbin’s view isn’t it.’ While I was still pondering whether I had under-estimated Jim’s knowledge of the topic, he pointed to a house we were just passing. ‘Look at that abomination’ he said. I assumed that he was referring to the solar panels that covered a substantial part of the roof. I said: ‘I don’t think they look too bad, actually’. ‘It’s not how they look’, he replied. ‘Every time I pass that house it reminds me that the government subsidies that encourage people to put those things on their roofs are an abomination. Solar panels are about the most costly method there is of generating electricity. If governments were really serious about climate change they would be spending taxpayer’s money more wisely so we get bigger bangs for our bucks.’

I observed that Jim’s comment must mean that he was obviously not a fan of Tony Abbott’s winner-picking proposals to reduce CO2 emissions. Jim said: ‘I wouldn’t mind so much if Abbott could actually pick a winner to subsidize. The technologies that he has picked so far are either proven losers or have no track record. If he really wanted to pick a technology that had some hope of competing with fossil fuels without huge subsidies he would advocate the nuclear power option.’

I couldn’t help asking: ‘Does that mean that you would support revival of the proposal to build a nuclear power station at Murray’s beach on Jervis Bay?’ When I glanced across to see how Jim was reacting to the idea of a nuclear power station in his own back yard, he growled: ‘Look where you are going!’

After what seemed like a long silence, Jim asked: ‘What do you think of no regrets policies?’ I replied: ‘What, like the federal government’s home insulation scheme?’ Jim replied: ‘I think the government might actually be regretting introducing that scheme with so much haste last year. No, what I meant was a great big new tax on carbon emissions’.

I was dumbfounded. When I asked Jim to explain how this could be a no regrets policy he asked me whether I had supported the introduction of the GST as a broad-based tax to replace less efficient forms of taxation. When I nodded he then asked: ‘Do you think a tax on carbon emissions would be a more efficient way of raising revenue than existing taxes on insurance and stamp duties on property transfers?’ I had to admit that it would probably be more efficient than some other taxes. Jim then said: ‘So wouldn’t it make sense to introduce a great big new tax on carbon emissions as a no regrets policy? If we do this we might even be able to have an impact on global emissions by persuading governments in some other countries that this is a good idea’.

While I was pondering how to respond Jim laughed and said: ‘I don’t expect you to see anything about this on your blog. Judging from what you have written there about climate change I expect that the polar ice caps would need to melt before you would support introduction of a tax on carbon emissions as a precautionary measure’.

Strong Feelings

I’ve been rude to a friend of mine (Simon Phipps) on Twitter. On the one hand, why should I be rude to a friend of mine? On the other hand, if I don’t call him out for quoting stupid things (as if he agrees with them), then how much of a friend do I consider him? If I’m not willing to be harsh with him, then I can’t value his friendship much. If I’m not able to be harsh with him, then he doesn’t value my friendship much.

In particular, I feel very strongly that the wealthy should be responsible for the poor. “Responsible” means several things. First, it means only lending aid appropriately. “Give a man a fish and you have fed him for a day. Teach a man to fish and you have fed him for a lifetime.” It also means charity should only be for the deserving. “Give an ailing man a crutch and you have gotten him back on his feet. Give a healthy man a crutch and you have taken away his ability to walk.”

Responsible also means not using the power of wealth against him. This is a tough one. It’s very easy to look at someone who is not as wealthy as you, and decide how they need to be helped. Everyone who has more than someone else can fall into this trap. Certainly my country does it all the time, sending food aid to countries that can’t use that food, or to countries where their competitive advantage is that food.

And responsible means consistently advocating for free markets (not using the power of wealth) and private property. When my friends harm that cause, I get very upset. I can understand my enemies, and the people that hate me advocating for coercion. But my friends? That cuts me to the quick.

Should We Expect the Rules of a Good Society to be Good for Everyone?

In my view, we should expect the rules of a good society to have the assent of nearly everyone but that does not mean that these rules are good for everyone. In particular, the law of liberty – preventing people from interfering with the protected domain of others – cannot be expected to be good for everyone even though it serves the good of all.

A good place for me to begin to explain the point I am trying to make is with Richard Kraut’s suggestion that under certain conditions norms, rules and laws do not serve the good of all (“What is Good and Why”, p31). The example he gives is of a situation in which our confidence that it is wrong to steal could possibly be diminished because “the property system may make it impossible for some to have the material resources they need to maintain their health …”. Kraut asks: “What objection can be make to taking what is not yours if you need it to sustain the health of your children, and the person from whom you take it has so much that it would do him no good?” The point he is making is that the rule against taking what is not yours “must be evaluated as a component of the social system in which it is embedded”.

I agree that the rule must be evaluated as a component of the social system, but I don’t think we need to be assured that the social system functions in a way that is good for all members before we can endorse laws prohibiting theft. Does Kraut’s example demonstrate that we could expect people to flourish to the same extent in a society with large wealth disparities in which there are no rules against theft as in a similar society where there are rules against theft? I don’t think so. If there were no rules against theft some resources currently devoted to mutually beneficial activities would be allocated to theft and to the protection of property against theft. Those who have a particular aptitude for stealing might benefit, but the costs to other people would clearly outweigh the benefits to thieves.

Some might argue, however, that our disapproval of theft should allow exceptions in circumstances where the thief has great needs and the victim is relatively unaffected. We might approve of such redistributions if we were to choose behind a veil of ignorance about our chances of being in a situation where we might be tempted to steal or of becoming a victim of theft. In the real world, however, how could a potential thief be sure that a potential victim would be relatively unaffected by the theft of any particular item? Even people who wear their wealth lightly can still own items that have great sentimental value.

Such considerations suggest to me that nearly everyone would agree that theft should be prohibited. I think it is likely that support for such a prohibition would be widespread even among population groups whose members have reason to be aggrieved about their treatment under the prevailing social system. In this sense disapproval of theft may be widely considered to be for the good of all, or at least widely considered to be likely to produce better outcomes than would an ambivalent attitude toward theft.

Does it change matters when the redistribution is undertaken by governments rather than by thieves? There are similarities between theft and rent seeking – the competing efforts of various individuals and interest groups to use the use the coercive powers of the state to have income redistributed to themselves at the expense of other groups in the society (for example through government budget allocations, provision of services, trade protection and other forms of industry assistance). The involvement of governments is an important difference, however, because the decision-making processes of governments may be widely viewed as having greater legitimacy than those of thieves. In addition, the information required to implement modest redistributions that might be given nearly universal assent behind a veil of ignorance – for example, provision of a welfare safety net – is available to governments responsible for implementing such redistributions.

The considerations involved seem to be similar when we come to paternalistic interventions to prevent adults from harming themselves. Norms, rules and laws protect individuals from all kinds of interference by other people, including well-meaning interference to prevent people from harming themselves. It is possible, however, to construct examples where our confidence that it is wrong to interfere is diminished. Richard Kraut gives us the example of a person who has fallen into an acute but curable despondency who proposes to kill himself even though he has many good years ahead of him (p 238). The argument that it is wrong to coerce a person for his own good because this is inconsistent with living in peace with him (see my last post) loses some force if the powers of judgement of the person concerned are obviously impaired.

However, the circumstances in we would condone people coercing others for their own good are extremely limited. We might have somewhat more confidence in intervention by government agencies than by individuals whom we have no reason to trust, but substantial moral hazards are involved whoever is permitted to intervene. Regulation might be more permissible than ad hoc interventions.

Behind a veil of ignorance just about everyone might support regulations that restrict freedom to a minor extent in order to protect vulnerable people whose judgement is obviously impaired. But in the real world it is difficult to frame such regulations to achieve the right balance. For example, the Australian Productivity Commission’s has recently published draft recommendations that the maximum bet limit on most gaming machines should be set at one dollar and the maximum amount of cash allowed to be inserted into a gaming machine at one time should be $20. While I claim no expertise in this area I think such limits could significantly inconvenience gamblers who want to minimize the time they spend playing mind-numbing machines, without doing much to protect problem gamblers. No matter how low the limits are set, they will not be low enough to prevent some vulnerable people from harming themselves.

This is true of all forms of regulation designed to protect vulnerable people from making bad choices. The rule that is good for all – the rule that nearly everyone would agree to behind a veil of ignorance about their own particular interests and vulnerabilities – will not be good for everyone. We should not expect the rules of a good society to be good for everyone.

Obamanomics Are An Obamanation

Obamanomics are an Obamanation.

Robin Hood. President Obama.  Are they the same persona?  Based on TV and Obama’s news conferences both he and the media seem to think so.  “Rob from the rich; give to the poor.”  Of course, he uses the words “you should give more, because you have more”.  But the reality of Obama’s accomplishments remain the same.

I do not see the likeness between this man and Robin Hood.  While Robin Hood is a great folklore hero, I contend that Obama has nothing in common with the man.  Let us review some of the finer points of the story.  A tale with which I hope you are already somewhat familiar.

Robin Hood lived in feudal times.  Kings, Lords and Barons ruled the country as the sole land owners.  King Richard departed the country to fight in the crusades leaving Prince John to rule in his stead.  Prince John and the Sheriff of Nottingham decided that they would claim the throne for themselves but they needed the support of the Lords, Barons and similar figures in the surrounding countries.

Their plan required many goods – Gold, Silver, Wine, and Food in order to bribe these leaders to join their cause.  In acquiring this stuff to buy the allegiance of the lords and barons they began taxing the people heavily if not outright stealing their possessions.

Enter a man with the courage and skill to fight such tyranny, Robin Hood.  As a loyal and patriotic man he fought to protect the people and the throne of the king.  He would steal the money/taxes back from Prince John and return it to the poor from whom it was wrongfully taken; establishing the mantra “rob from the rich; give to the poor”.  In doing so he protected both the people and the crown until King Richard’s return.

So I ask you; how in any conceivable way could President Obama be likened to this man?  Recently Obama began to push sweeping legislation to steal (*ahem, sorry tax) from the rich of this country.  One assumes he is doing this to give to the poor; yet somehow all of the money ends up in the hands of banks and automakers.

President Obama performs this redistribution in broad daylight.  The more I stare at his policies; the more I liken the man to Prince John.  He is trying to steal the very life out of people to buy the right allegiances, also known as votes, in order to keep the throne he is guarding.  After all, large portions of bailout money will be distributed in 2011.

Obamanomics, my unoriginal pet name for the “New” new deal, scares me to death. Recent polls suggest that FDR should be considered one of the top 3 presidents in the United States history.  While history books have been favorable I do not understand.

Why is it that no one remembers the perpetual unemployment FDR created with his policies?  How can anyone in today’s time acknowledge ponzi schemes, like Madoff or Social Security, as good ideas?  Eventually FDR did successfully reduce unemployment in this country but it took a war and the loss of a few million good men.

Is this really the direction we want to head?  It is Obamanable to think that World War II was a good thing and that FDR should be praised.  Yet the whole nation is looking to resurrect FDR’s policies.

This time which future generation will be burdened?  Are there even any left unburdened?  We are staring at the greatest redistribution of wealth in our era.  Unless theft is considered “earning” the wealth is going to the people who did nothing to earn it.  By the way, theft income is required to be claimed on your income tax return unless you are a tax eater for the government and are not required to report it.

The hardest part is trying to be Robin Hood in this story.  The Prince has a larger army and superior guns.  Government propaganda attempts to paint tax evaders, like Treasury Secretary Geithner, Senator Daschle, etc. as leeches on society and unpatriotic.  But how does one protect their own country when the nanny state government is attempting to steal it from them?

I anxiously await the return of the king and President Obama is not him either.