Diffuse Costs, Concentrated Benefits

In a principles of economics class, I have to spend a lot of time explaining why the government puts into place policies that create inefficiencies in markets, or policies that don’t seem to make much sense. In a situation where you’re already faced with disseminating large amounts of information, I tend to emphasize one factor above all, the principle of concentrated benefits and diffuse costs. When we examine very simplistic market-changing tools like a price floor or a quota, we can clearly identify the winners–generally a really small group of people that benefits greatly–and the losers–generally a large group of people that loses out, but usually just a small amount. So even if the losses of the larger group outweigh the benefits to the smaller group, it’s hard to get the losers to rally around a cause to change things because what they’re losing is not quite worth the time to push for a change. Those who are winning have a strong incentive to make sure the policy stays in place to ensure their continued winning.

The press around the Occupy Wall Street protests is beginning to take form with a small twist on this outcome. Instead of just losing out a little bit, those who are losing out are losing out a lot. And though those who are winning still have a vested interest in maintaining the power structure, but even that is coming unraveled a bit. Warren Buffet’s offering to pay more taxes and in today’s Washington Post, Ezra Klein says there are a lot of people bitter at the fact that “You did everything you were told to do, and it didn’t work out.”

Maybe we’ve gotten far enough along the inequality path that the diffuse costs are big enough for individuals that they’re asking for change. That they don’t know what kind of change yet is definitely something that needs to be worked out, but perhaps not all that surprising. We had to know this wouldn’t last forever.

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A slipperly slope argument for more taxes

I have to admit that this whole debt ceiling debate makes me want to tear my hair out. If I had my druthers, I’d sit down every member of Congress. pry their eyelids open and make them read a few economic history books. Because, you know, cutting spending in a deep recession worked so well the last time, *cough* *cough* (Great Depression!) *cough*. But the politics of it all, it’s just maddening is what it is. A bunch of idiots who don’t even know what their constituents want holding this country’s–and possibly the world’s–economy hostage. I honestly (and naively) expected to come back from my Green River rafting trip and the thing would be solved, over, done with. But no, it’s like no time passed at all.

Twitter brought me two great pieces over the last few days that sent my writing juices flowing again after a few days off. The first, which I believe came from @ezraklein (correct me if I’m wrong), said something to the effect of “The US is the only country in the world with the luxury to create an economic crisis where there is none.”

Just dwell on that one for a minute.

The second was a question retweeted by the official White House twitter account (@whitehouse for the #WHChat) asking why those who are already paying the most taxes should be asked to pay more, invoking the  “it’s not fair” argument. The question of who pays more and how much is a sticky one, one that made heavy press a few months (weeks? I don’t know what’s happening to time right now) when it was announced that only 50% of Americans paid any taxes (really, federal income tax in one year with record-high unemployment; you’d be hard pressed to find someone who actually pays zero taxes). I don’t know what segment of the population the question-asker was referring to, but it got me thinking about who pays taxes and why.

From an practical standpoint, we have many different types of taxes; income taxes, use taxes, sales taxes, estate taxes, property taxes, etc. From an economic standpoint, we split taxes into bigger groups. One of those distinguishing factors of how we group comes down to who pays. From the simplest, principles of economics perspective, we have taxes that are based on use and those based on ability to pay. Use taxes are designed with the idea that the people using the service should be the ones taxed. Use taxes are often sales taxes, they’re associated with things that we use. Take a simplistic example like gasoline, which we tax, and much of the taxes go to repaving roads. If you buy gasoline, you pay tax on it based on how much you buy. If you don’t buy gasoline, you don’t pay tax on it, simple enough. Consequently, you also don’t contribute much to upkeep of roads. If you’re not buying gasoline, you’re probably not using the roads much (or your form of using them is much less destructive or limited than if you went by car), so, you don’t pay for roads.

The ability to pay principle says that those with the greatest ability to pay should pay more taxes. By this logic, a person who makes $200,000/year should pay more in gasoline taxes than a person who makes $20,000/year. Of course, creating a taxation system like that creates all sorts of incentives to lie and cheat and would be incredibly difficult to manage, but it is interesting to think about how use and ability to pay are actually interconnected, particularly at a federal level. Without any numbers to back me up, I’m certain that those with more money not only have a greater ability to pay, but also use more services. I’m going to distinguish here between services and transfers. There’s no doubt that people who make no money receive more transfers–e.g. food stamps, welfare payments, unemployment assistance–than wealthy people. But even though wealthy people may not be applying for food stamps or welfare, their money is being protected by banking laws, their consumer interests are greater because they buy more, they use the courts more for lawsuits (if not perhaps criminal defense), they’re greater users of health care (even more so if they have insurance). I of course have nothing to back this up, and realize fully that the argument could be made in precisely the opposite direction for public assistance. But then, the ability to pay part kicks in; if you’re requesting TANF funds, you have very low ability to pay.

The other reason I don’t like this argument, of course, is that it creates a slippery slope in terms of demanding to pay taxes only on the things we use. If a poor person keeps all their money stuffed in their mattress, they’re not ‘using’ the SEC or the FDIC or other federal banking institutions, and we might find dissenters trying to discount such expenditures from their taxes ala Maggie Gyllenhaal in Stranger Than Fiction. Talk about a nightmare. I think our tax code is complicated enough as it is.

With that rant being done, and regardless of whether paying taxes is fair or not, I’ll share another gem adapted from twitter. Just because you want to order a hamburger next time doesn’t mean you don’t have to pay for the filet mignon you already ate. It does appear that something is going to happen tonight, though, so we’ll see.

I think Greece could do with a little social norms marketing on taxes

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Greece has a serious problem with paying its taxes. It’s a self-reinforcing problem because when people see the system as corrupt, they think their money will be wasted and they won’t face consequences, so they cheat more.

I liked this quote from James Surowiecki in the New Yorker:

According to a remarkable presentation that a member of Greece’s central bank gave last fall, the gap between what Greek taxpayers owed last year and what they paid was about a third of total tax revenue, roughly the size of the country’s budget deficit. The “shadow economy”—business that’s legal but off the books—is larger in Greece than in almost any other European country, accounting for an estimated 27.5 per cent of its G.D.P. (In the United States, by contrast, that number is closer to nine per cent.) And the culture of evasion has negative consequences beyond the current crisis.

It seems to me that Greece needs a serious infusion of social norms marketing (among several other things). I can see the billboards now: “People in our community think it’s good to pay your taxes.”

Okay, back to dissertating. So close.