Apples and oranges, governments and markets

Tyler Cowen (and Megan McArdle, and Will Wilkinson) quote Martin Feldstein:

[F]inancing additional government spending by an across the board rise in all marginal tax rates would make the cost per dollar of government spending equal to $1.76.

[This fact] should be central to any consideration of tax policy. And yet it is not.

Megan's bottomline, in a post entitled 'Substantive arguments against tax increases': At the very least, it's the sort of thing you have to factor into arguments that we as a nation can save money via nationalised health care . . .

Tyler's bottomline: Cram all those numbers together into your noggin' and keep them there.

Will Wilkinson's bottom line: It is possible that the state can make its citizens better off by taking $1.76 to spend $1.00, if those very expensive dollar bills are spent on highly valuable public goods folks can’t coordinate to provide privately. But I reckon this kind of bona fide public good is a pretty small part of the existing budget.

A guy likes consuming apples and oranges. You know that each apple adds, say, 3 'units' to his utility, and you have no idea how much utility he derives from an orange. You know that each orange costs 1.87 apples. Is there anything in this setup that suggests that the guy should sell oranges and buy apples to increase his utility?

Citing an estimate of how much a dollar of government spending costs is not an argument, let alone a substantive one, for lower taxes: how much is what it's buying worth? Voting does not produce a welfare maximising result, so it may well be the case that a benevolent, fully informed, infinitely wise dictator would have the government raise way more tax (and spend way more) than it currently does, even at a cost of $17.6 per dollar of government spending. Given the massive scope for disagreement on the societal value of government spending, any disagreements on the dead-weight loss of taxation amount to small change.

In the absence of an estimate of the value of government spending, using the $1.76 to the dollar figure to support the case for tax-cuts would imply that there are cheaper sources of funds for government services, and thus we are overpaying for them. But what other way is there to raise money to finance redistribution (one of the main things government does, via progressive taxation and programmes that are of more value to the poor) or the military?

These are not profit making activities, and thus cannot be financed by raising capital in the market; so tax it has to be.

The above do not imply that Feldstein's estimates are useless. They would be relevant if presented alongside an estimate of the value of government spending, or with reference to government activities that could be financed via means other than taxation - this class of activities could include, for example, building a bridge or operating an airline. If raising a dollar for a 'commercial' venture in the market costs less than raising it via taxation, go for it - this is a point that reasonable people stopped arguing about a long time ago. Government should only do what the private sector can't, not only because 'governments are useless', but also because raising funds via taxation costs more than doing it via the market - when the latter is an option that is.

Postscript: To Megan: A nation ('the economy') saves money via a public system of health care if it costs less than other means that would achieve the same level of redistribution. Because nationalising health care is mainly about redistribution. The resource costs of actually delivering health-care are secondary in importance.

To Will, from one of Tyler's commenters: 'by expenditure, the two biggest programs by far are: Defense (it should be listed as Numero Uno: if you include all defense-related items from other programs, it is close to twice the regular budget figure) and of course Social Security. Put together, if we include the expanded definition of defense spending, that's over half of the federal budget. Add Medicare, Medicaid, and debt service, and you're over 80% of all federal spending.'

And to Tyler: You are treading carefully.


  1. Anonymous Says:

    Spot on there boss