The Unseen Costs of Taxation and Regulation

On a EconLog post about E-Verify, commentor “Jay” writes:

I’m confused, if [E-Verify] poorly enforced and therefore only sparsely followed by employers, how does it raise hiring costs?

Jay’s question is an excellent one, and one that gets down into one of the main reasons we have deadweight loss (DWL) stemming from taxes and regulation.  Taxes and regulations change behavior (if they didn’t, we’d only have a transfer of wealth from consumers/producers to the government and there would be no DWL).  The obvious way they change behavior is when people adopt less efficient use of resources (in the case of E-Verify, hiring a worker who may be less productive over a worker who would be more productive because the first worker will pass E-Verify and the second worker won’t).

But evasion of those taxes and regulations are also a cost.  For example, if an employer hires someone who would not pass E-Verify, and as such goes to lengths to ensure his hiring is not caught (paying him under-the-table, hiding him of INS come looking, that sort of thing), these are all extra costs being paid.  Costs of time, or money, or effort that would otherwise have been spent doing something productive (and that’s not even counting the government’s cost of enforcement!).

These costs, while unseen, are very real.  Employers face evasion costs just like anyone else, and will make decisions based upon them, even if they never show up explicitly as some budget item or in an official government report.  These costs will change their actions, and we are all worse off for it.

Transferring Wealth is Not the Same as Creating Wealth

The Commerce Department has proposed tariffs of up to 20% on Canadian sofwood lumber imports.    These tariffs are phrased by the Administration and supporters as “leveling the playing field” and wealth creating measures.  Ramiyer, commenting on this blog post by Mark Perry, has a typical protectionist scarcityist argument:

Plus [the tariff] saves thousands of jobs who can afford to purchase and go out and eat. These people are real workers. Not some people who just throw their opinions or Wall Street Looters or big cheaters as in case of some CEOs.

It is true that some jobs are ‘saved’.  But that is only half the story: many jobs are lost, too.  Tariffs do not create wealth.  They transfer it.  Tariffs transfer wealth from consumers to producers and the government (for a graphical representation, see my blog post here).  Unlike free trade, no new wealth is created (in fact, tariffs cause wealth to disappear!). The wealth is merely transferred from the consumers and their spending habits to the producers and their spending habits. Therefore, a nation cannot, though tariffs and artificial scarcity, create wealth; it cannot tax itself into prosperity.  It can merely redistribute wealth.

What’s interesting about this is, until very recently, the same people arguing for tariffs now understood this.  They decry welfare and high corporate taxes for the exact same reason I outlined above for opposing tariffs.  I find the hypocrisy nauseating.

Toward a Better World

According to the organizers of Earth Day: “Education is the key to advocacy and advocacy is the key to change.”  I agree.  Toward that end, allow me to explain why free markets, and in particular secure private property rights, help make the world a better, cleaner, and more environmentally friendly place.

Property rights are important because they encourage the owners of that property right to maximize the property’s uses.  Property rights do this by having the owners incur the costs of their property (its upkeep, its development, etc), but also confers the benefits onto its owner; in other words, the greater concentration of costs and benefits means each person’s success is dependent on his/her activities.  As such, the property owner is incentivized to minimize costs and maximize benefits over the life of the property.

While there are many kinds of property rights, the type of right matters for environmentalism.  Contrary to many popular claims, public ownership of natural resources (national parks, nature preserves, and the like) may be counter to the goals of environmentalism; in other words, state-produced environmental efforts may make the situation worse, not better!  The reason for this is the incentive may not be as strong to maximize effort on the part of the property owner.

Allow me to explain by way of paraphrasing an example Armen Alchian gives in his 1965 Il Politico article Some Economics of Property Rights:

Suppose there is a community with 100 people in it, and 10 enterprises.  Further suppose that each person, by devoting 1/10th of his time to some enterprise as an owner, he can generate a gain of $1,000 for the enterprise.  If ownership of each enterprise is divided equally among the populace (that is, all the enterprises are “publicly owned,”), then he will produce a gain of $100 for himself each day (1/100th part owner and 10 firms) and the rest of his product ($9,900) going to the other members of the community.  If the other 99 people in the community act the same way, he will get $9,900 from them, bringing his total wealth gain to $10,000.

Now suppose that each person owns 1/10th of a single enterprise.  The individual now works to produce $10,000, of which he keeps $1,000 and the other $9,000 goes to the other owners.  If the other owners do the same, all end up with $10,000.

If we go to the extreme end and each enterprise is owned by a single person, then he gets to keep all $10,000 of his own hard work.

As we can see, in each case above, the reward to the property owner depends partly on his own effort and partly on the effort of others (except the last option).  In the first of the cases, the incentive for him to maximize his efforts is minimal: no matter how hard he works, he’ll only get $100 direct benefit from it.  The other $9,900 must come from someone else who may or may not have the same work ethic as him.

So, if a person is most incentivized to act when s/he absorbs the costs and the benefits, how will that help the environment?  Well, it’ll help by incentivizing the person to keep their property in working order.  A person who owns a home will do her best to keep the house neat, to keep the fixed costs (heating, cooling, water, etc) low.  They may, if they have time and money, plant a garden or maintain a yard in order to keep the house pretty.  Larger groups with common goals could pool money to maintain a park.  Firms, seeking to minimize their costs, are constantly looking for ways to reduce waste and increase output.  Owners of farms, of mines, and the like are always looking for ways to extend the life of their sources of wealth.

In short, people will look to take care of their own little plot of the world.  Environmentalists often urge us to “think globally, act locally.”  I can’t think of anything better than property rights to accomplish this task.

There are objections some might raise to the above discussion, and those I will address in another post as this one, at nearly 700 words, is already too long.

The Doctrine of Scarcity

Two brothers, Charles and Joseph, are sitting at home reading the news.  The following is a conversation between the two:

Charles: Joe, did you see the nation of Zimbabwe is facing a terrible drought?

Joseph: Are they?  What fabulous luck for them!

C: Luck?  How is this luck?

J: My dear brother, have you no capacity to reason?  The drought is a blessing for the farmers of Zimbabwe!  First, since it makes the supply of food more dear, the prices rise.  The farmers get more money!  This, they can spend on employing more workers (since the land is now less fertile) toiling all day to get the wheat out of the ground.  The demand for workers will increase their wages, making the Zimbabwean worker better off.  Surely, only good times can follow!  This is just Economics 101!

C: Perhaps, Joe, but this is only because there is less food.  Perhaps, in nominal terms, workers earn more, but they can buy less with their money.  Are they not worse off?

J: My dear brother, have you learned nothing?  Their increased pay will make them richer!  What they can’t spend on food, they’ll surely spend on other things!  That’ll further increase demand for workers, raising wages even higher!

C: But that doesn’t solve the initial problem, Joe.  There is still less food to go around.  Sure, they may have more money, but that doesn’t calm an angry belly.  Would it not be better for the rains to come and have the fields of Zimbabwe overflow with grains?

J: And have the price of food plummet?  Have the workers no longer needed (since the fields are now more productive) be unemployed?  Why, think of the chaos of having all those people unemployed!  You would undo the Zimbabwean worker with your mana from Heaven!

C: Perhaps there would initially be people who no longer need work in the fields, but they’d have more full bellies.  Since they are freed up from the labor, they could do other things (maybe make clothing?).

J: You are simply a theorist!  No, brother, it is far better for the people of Zimbabwe to have drought, to drive up prices, use more resources for less output.  Indeed, it is in scarcity, not abundance, that true wealth lies!

C: But you live with less-

J: So?  The workers have work!  That is all they need!  They have a sense of purpose, a sense of living!  What more could a person want?

C: Food, shelter, clothing, leisure…

J: Bah!  More of your theorizing!  The true strength of an economy is the number of jobs it has!

C: But what good are those jobs if you can’t buy anything?

J: Better than having lots to buy and not enough farm jobs.

C: But there are other kinds of jobs.  They can do something else.

J: “Something else!”  More theorizing!  Such an unsatisfying answer.

C: But true nonetheless.

(The conversation continued in this manner for some time).

Joe’s comments may seem weird to our ears, and yet it is the common claim of those who practice the doctrine of scarcity commonly known as “protectionism.”  Since scarcity, and not “protection” or “abundance”, is the foundation for “protectionism” I propose calling these people “scarcitists.”

The scarcitists have a weird idea that it is from scarcity that wealth arises, not abundance.   It is as if the best thing to happen to Man was to be cast from the Garden of Eden.  It is as if Hell, and not Heaven, is our goal.  Scarcisim is a strange doctrine.

Ruminations on Equal Pay Day

Today is Equal Pay Day, which means two things are certain: 1) some groups will be arguing that the pay gap is very real and must be addressed and 2) some groups will be arguing the pay gap is a myth and should be dismissed.  Both groups are simultaneously right and wrong.  It is true that, adjusting for various economic factors, much of the pay gap goes away (Group 2 is correct).  However, it is also true that there is some gap that remains which could be due to discrimination (Group 1 is correct).

But economics is limited in this story.  We can provide economic explanations, but there are other factors that other fields could provide insight into as well.  For example, why is it that there is an unadjusted 80-cent gap to begin with?  Are women encouraged to avoid the higher-paying fields?  Sociology could help answer that.  Are women just worse negotiators then men?  Psychology could help answer that.  Are the biological differences that could account?  Biology could help answer that.  Is there legislation that encourages discriminatory hiring practices?  Legal studies can help answer that.  These various disciplines could provide valuable insights.

A mistake I think many economists make (myself included) is sometimes thinking the economic way of thinking is the only way of thinking.  It is powerful, to be sure, but it is not alone.  We can help provide some answers (like on the pay gap) but not all the answers (nor should we.  Division of labor).

My two cents on the pay gap: Is discrimination an explanation for the difference between men’s and women’s pay?  It’s probable; the size of the effect is difficult to know.  Unlikely responsible for a large portion.  Is government the solution?  Possibly.  If the issue is poor incentives from legislation, then government would have to repeal such legislation.  If there are other causes, governmental interference would likely cause more harm than good.

I think the pay gap deserves more thought than many economists are willing to give it, and it especially deserves thought from the sociologists and legal scholars (my gut feeling is that is where we will find much of the gap explained).

Warts and All

Yesterday was Opening Day for the Washington Nationals at Nationals Park in Washington, DC.  Some 40,000 people made their way to the Waterfront to see the Nationals take on the Miami Marlins.  At the corner of N and First Streets, SE, the traffic and pedestrian crossing was a nightmare.  People were flooding out from the Metro headed to the Park.  The crossing guards could barely keep order, and both cars and pedestrians were getting frustrated (this effort was compounded by the fact the traffic lights were still on, often contradicting the guards’ orders).  It was, in short, a charlie-foxtrot.  One might even say it was a government failure.

Although the government’s solution to the pedestrian issue was less-than-ideal, it would be incorrect to immediately jump to the conclusion that a laissez-faire approach would automatically be better; that a “free-market” approach would be better than the government approach.  The free-market approach would come with its own set of problems (perhaps, for example, since pedestrians have the right-of-way, tens of thousands of people would have crossed the streets and no car would have been able to move for hours).  It’s indeed possible that the free-market approach would have generated a worse outcome than the government approach.

Harold Demsetz (among others) warns us against the Nirvana Fallacy; that is, assuming a different (often preferred) method would not contain the same flaws (or flaws at all) from the current method.  We see this very often in politics (eg socialism), but free-market supporters can run aground of the fallacy, too.  Markets, just like governments, are populated with humans with the same foibles.  The incentives are different, to be sure, but markets can fail, too.  One mistake I think far too many market supporters is to assume that markets are not only perfectly efficient (the “efficient market hypothesis”), but also they instantly adjust.  That is not the case.  By arguing, as many do (especially many anarcho-capitalists) that the market solution is always the superior solution is incorrect for the exact same reasons that socialists arguing the government solution is always superior to the market solution.

Markets are extremely powerful.  Generally speaking, they provide excellent results.  But markets are just one of our institutions, and they function best when search and transaction costs are minimized.  For certain problems, there may be other institutions out there that would perform better.