Seen versus Unseen Taxation

While taxes may provide some goods which are commonly valued to cities, states, or nations they also provoke visceral reactions from swathes of the population. Public opinion polls reveal 48% of Americans believe taxes are too high. Surprisingly this is not linked to income (Here is a link to the Gallup Poll Data).

Negative attitudes towards taxation appear to stem from lack of consent and the confiscatory nature in which public funds are obtained. But, despite the existence of negative attitudes toward taxation there has been a drop in the disapproval of taxation. I cannot help but think, "What if people knew how much tax they were paying?" Since so many taxes are automatically withheld I wonder how people would behaviorally respond to writing an explicit check for money to the government?

I'm thinking of some different strategies to analyze how reactions change when taxation is seen as opposed to unseen.

Public Goods

In my last post "Why Justice?" I wrote, "Without getting into too much more depth at present a price tag is difficult to place on some goods that people find very meaningful." This post concerns that difficult explanation and explains the case of public goods. Below is a 2x2 diagram of the classes of goods economists talk about. The lower right hand corner provides examples of public goods.

These public goods are difficult to provide because of the non-rivalrous and non-excludable nature of them.

(Non)Excludable: The provider and/or consumer of the good has (does not have in the case of non-excludable) the ability to prevent some people from the consumption


(Non)Rivalrous: The consumption of a good by one person subtracts (does not subtract in the case of non-rivalrous) from another person's ability to consume.

Because each person benefits from a public good regardless of whether they contribute to the cost (and you cannot prevent them from benefiting) there is always an incentive for letting someone else provide the good. Most people have participated in group projects. Each person, regardless of the effort they put forth, will receive the same grade. Or, think of fireworks. People love fireworks but they can benefit from watching them without actually paying for them. Likewise with the examples such as social welfare, knowledge, defense, and public health. People would like to see them provided but do not wish to contribute to the cost. This discussion of the free-riding problem can be characterized by the "Prisoner's Dilemma"

Dilbert does not understand the Prisoner's Dilemma. If two prisoner's are placed in separate rooms and they committed a crime they would like to tell the same version of the story; but, they do not know the story their "partner in crime" will tell. They get a harsher penalty if they lie and the other prisoner does not. Therefore, there is a big incentive for each of them (in the absence of knowing what the other will do) to tell the truth so they can avoid the harsh penalty. Likewise with public goods: Everyone would be better off if the public good is provided but nobody wants to be the sucker that puts forth all the money, time, and effort to provide the public good while others do not contribute anything.

Another notable characterstic of public goods is that often times no individual can unilaterally provide the public good. This need for others to cooperate can be explained by the Prisoner's Dilemma but also by another diagram: Lindahl Taxation. 

The cost of providing the public good is represented by MC or marginal cost. Each of our three people has a demand curve but they do not have a willingness to pay greater than cost; therefore, they have no individual incentive to provide the public good. If we add up all of their demand curves though we come up with a Social Demand curve. Where that Social Demand intersects marginal cost gives us the optimal quantity of the public good. The idea then is to charge each person a tax equal to what they would be willing to pay at that quantity. 

But, can you get people to truthfully reveal their demand curve. This is a point that has been discussed at length in economics. To see this consider the following quote by economic luminary Paul Samuelson,

But, and, this is the point sensed by Wicksell but perhaps not fully appreciated by Lindahl, not it is in the selfish interest of each person to give false signals, to pretend to have less interest in a given collective consumption activity than he really has, etc.

The bottom line is this, society might want certain public goods but people may not truthfully tell their value of those goods because then they would have to pay that price. This means that we cannot charge prices. Thus, we have might have the need for a non-market provision of such goods and services.

It Seemed Like a Brilliant Idea at the Time

Here's a provocative comment from Robert Scheer writing at The Huffington Post:

"It wasn't the students struggling at community colleges who came up with the financial gimmicks that produced the Great Recession, but rather the super-whiz-kid graduates of the top business and law schools.

What nonsense to insist that low public school test scores hobbled our economy when it was the highest-achieving graduates of our elite colleges who designed and sold the financial gimmicks that created this crisis. Indeed, some of the folks who once designed the phony mathematical formulas underwriting subprime mortgage-based derivatives won Nobel prizes for their effort."

I've had a chance to talk to students many times about the danger of ascribing the Financial Crisis to any one factor. From my point of view, there was a perfect storm which included: 1) the pressure from the federal government on the banking industry to make sub-prime mortgages for political rather than economic reasons; 2) an overly long period of easy monetary policy; 3) unintended consequences of the post-Enron "reform legislation" especially a) changes in accounting rules, and b) some worst-of-all-possible-worlds changes in the regulation of securities rating agencies; and 4 ) natural tendencies for the formation of asset bubbles. But I agree with Scheer that the replacement of common sense economics of mortgage lending with mathematical whiz-kiddery was not benign. The unintended damage done by anyone who thinks of himself or herself as an expert in a field has important implications for understanding the idea of a "calling" from God and for how the sin of pride operates in out lives.

* Thanks to instapundit.com for the original tip to the Scheer post.

Twelve Angry People (Part 2)

I chose the title “12 Angry People” deliberately, because I remember the sadness and anger among the jurors of so much destruction in the lives of so many young people. Just a few days earlier, my pastor Bill Bess sent around a letter from a Presbyterian elder in Arizona, asking that, in the wake of the Tucson shootings, that we not let political bickering overcome the deeper issues of dealing with young men like Jared Loughner. I had some disagreement with that letter because I felt that it avoided the toughest issue in the Tucson case --- the identification and potentially involuntary hospitalization and treatment of individuals with severe mental illnesses such as, it is suspected, paranoid schizophrenia. However, in the cases of the young people connected with this trial, I (and I suspect others) kept thinking, was the Church of Jesus Christ in their lives? If not, why not? If so, is there more that could have been done?

This is a personal concern of mine, because it distresses me that the organized congregations of the PCUSA are responding to tough budget times by reducing giving to ministries such as the Presbyterian University Center at Florida State University. What more important mission of evangelism can there be than reaching out to the next generation?

Corn Meal Mush

There's a diagram I want to make sure that I discuss in the Sustainability class on Monday. According to the United States Department of Agriculture, as reported in this morning's Wall Street Journal, since 2006 the proportion of US corn acreage devoted to ethanol production has gone from about 20 % to about 39%. This is madness. This is a totally artificial, politically motivated demand shift driven by the now discredited idea that ethanol was some kind of "green fuel." And the unintended consequences are prices increases for a basic foodstuff. Economic inefficiency plus a transfer of wealth from the poor to the rich. What's not to dislike?

Why Justice?

Student evaluations arrive a couple months after courses are taught and inevitably I will receive some markdowns from students because there is a lack of continuity for the Economics of Compassion course. This is partly because there is no single textbook (which at present I am happily writing) but also because I sometimes do not make explicit some very important points. One student came to me yesterday during office hours and asked me to review the Adam Smith and Justice lectures. Some important points emerged.

The key insight from Adam Smith was that each person pursuing their own self-interest could promote the general welfare of society. To see that this is a true statement consider the supply-and-demand framework below.

Demand (willingness to pay) slopes downward because at lower prices there are more people "willing to pay". Supply (willingness to accept) slopes upward because at higher prices there will be more people "willing to accept" the higher price. The intersection of the two lines represents the market-price.

Willingness to Pay - Price = Consumer Profit,
If we add up all the consumer profits ==> Consumer Surplus

Price - Willingness to Accept = Producer Profit,
If we add up all the producer profits ==> Producer Surplus

"Surplus" is just a fancy way of saying "the value created". We know that trades only occur when both parties receive a positive profit. Therefore, each person, not necessarily looking out for the interest of others will create value when transactions happen. But, this is all based upon price. 

In a market economy priority (who buys and sells the goods and services) is based on willingness to pay being greater than price and price being greater than willingness to accept.

Without getting into too much more depth at present a price tag is difficult to place on some goods that people find very meaningful. Therefore, priority cannot be established through the price mechanism. Instead, we must determine how goods and services are allocated through non-price rationing. Because price is not establishing priority for the allocation of goods and services we must be guided by some other normative principles of justice. This is why I talk about justice in class even though I am no expert in philosophy.

12 Angry People (Part I)

I served on jury duty this week. Not just waiting in the bull-pen, but actually on a serious criminal trial with major life consequences for the defendant. I chose the title for this blog because regardless of how many differences we worked out on the facts of the case, everyone was angry about the waste of so many young lives (this defendant, the witnesses and other involved in the crime). I'm not aware of any of them being older than 30 years of age, and several were in their early 20s.

I'm going to split my comments between the economic and the faith-centered, although the distinction may not be absolute. I've always been somewhat torn between different economic models of the economics of drug policy. I accept that the "war on drugs" has horrible unintended consequences both here and in other countries (Mexico, Columbia, Afghanistan). I am convinced that organized crime thrived in the U.S. during prohibition, and that something similar, or worse, is going on now. But, I've also had discussions with equally good economists who point out that our national memory has focused on the unintended consequences, but we've missed the fact that by driving up the effective price of alcohol, less alcohol was consumed, and that did show in national health patterns. I've spoken with other economists who are completely sympathetic to the libertarian drug legalization arguments, but argue that ONLY legalizing drugs would have its own unintended consequences. Reacting to the same data I discussed above, these economists believe that legalization would lead to more drug abuse (how could an economist think that it wouldn't if the argument is that the effective price would go down) in a system in which we have in so many ways chosen the government as the financial backstop for many of the problems that increased drug abuse would almost certainly entail.

As my assignment as a juror was on a drug trial, I had hoped it would clarify these economic arguments for me. It didn't. Here's the primary reason. Many supporters of drug legalization will argue that "the government can legalize these dangerous drugs but still regulate them for safety reasons." Well, I can assure you that that, by itself, won't work, because all of the squalor and violence that I heard about was brought about by exactly that model: "legal but controlled drugs." So, where do we go? Complete legalization and free access? Certainly the motives for robbery would drop if anyone could buy an oxycodone pill for $2 rather than $70. But, if I told you the occupations that these drug abusers were tending while high, sick, or falling asleep, much less where they were driving around town, you might not want to go out your front door. And those problems would be worse, not better, if demand expanded as the price of the drugs dropped. We would be trading fewer armed robberies for more people in daily life being, for lack of a better term, whacked out. On the other hand, a system (strict government regulation) that drives the cost for one person's habit to $4,000 per month [not to mention costs of such things as this trial, incarceration, etc.] shouldn't exactly win first prize in a high-school mock legislature contest, either. One thought I'm left with is why, if we seem destined to spend public/government funds out of our ears in either of these models, shouldn't we consider trying an alternative in which we try to cure some of these people?