Controversy rages over the Obama administration’s mandate that all employers – including Catholic hospitals and universities — include free contraception in their employee health insurance policies. Catholic officials object that since their church forbids contraception, the decree violates the First Amendment’ s protection of religious freedom. Others have joined in the protest, prudently anticipating that this violation of freedom of conscience could spread to other matters and other faiths.

Those raising the objection have an unimpeachable case. The precedent apparently set in the more than two dozen states that already have similar mandates is irrelevant. What’s immoral does not become moral simply by precedent. The principle that no one should be forced to finance that which he or she finds abhorrent is sound. In fact, it should be generally applied.

Changing the Subject

Defenders of the decree are quite good at changing the subject. Of course they are — what else have they got? To hear them, you’d think someone has proposed that contraception be outlawed. (Well, Rick Santorum does seem to favor that; but he’s pretty much alone.) Obamacare champions would have us believe the controversy is about “access” to certain products and services. All the decree does, they say, is provide insurance coverage for, and therefore access, to free contraception (along with other preventive services) for women who want it. But that just raises another question:

What has this got to do with insurance?

Access does not depend on coverage. We have access to many important things not covered by insurance. Weirdly, some say the decree actually affirms religious freedom. How so? Sens. Barbara Boxer, Jeanne Shaheen, and Patty Murray explained in the Wall Street Journal: “[T]he millions of American women who choose to use contraception should not be forced to follow religious doctrine, whether Catholic or non-Catholic.”

In other words, lack of insurance coverage for contraception is equivalent to being forced not to use contraception. That is some strange argument, but it’s what we’ve come to expect from members of the “world’s greatest deliberative body.”

Well?

So the question remains: What has this got to do with insurance?

“Access to birth control is directly linked to declines in maternal and infant mortality, can reduce the risk of ovarian cancer, and is linked to overall good health outcomes,” Sens. Boxer, Shaheen, and Murray write.

Fine, but what’s it got to do with insurance?

“[B]roadening access to birth control will help reduce the number of unintended pregnancies and abortions, a goal we all should share.”

Fine, but what’s it got to do with insurance?

“Proper family planning through birth control results in healthier mothers and children, which benefits all of us.”

Fine, but what’s it got to do with insurance?

“It saves us money too….”

Fine, but what’s it got to do with insurance?

“It can cost $600 a year for prescription contraceptives.” (That’s a high-end estimate; there are lower cost options, including Planned Parenthood for low-income women.)

Fine, but what’s it got to do with insurance?

“Some 99% of women in the U.S. who are or have been sexually active at some point in their lives have used birth control, including 98% of Catholic women, according to the Guttmacher Institute.”

Fine, but what’s it got to do with — oh never mind. I’ll answer myself: It’s got nothing to do with insurance.

Pooling Risk

Insurance arose as a way for individuals to pool their risk of some low-probability/high-cost misfortune befalling them. It shouldn’t be necessary to point this out, but coming of child-bearing age and choosing to use contraception is not an insurable event. It’s a volitional act. It may have good consequences for the person taking the action and society at large, but it is still a volitional act. It makes no sense to talk about insuring against the eventuality that a particular person will use contraception. Strictly speaking, contraception has nothing to do with insurance.

Unfortunately, we don’t speak strictly about health insurance. One reason we don’t is the tax code. Since World War II compensation for labor in the form of employment-based health insurance does not count as taxable income. (Money spent independently on health insurance does count.) The tax code thus creates perverse incentives to 1) depend on one’s employer for medical insurance, 2) shift income from liquid cash to restricted insurance benefits, and 3) define uninsurable events as insurable. Would someone care to explain how well-baby care can be insurable?

So we have taxation to thank for yet another feature of the modern world: the corruption of language. In the medical realm insurance no long means insurance.

Instead it’s a game by which we get other people to pay for stuff. Well, that’s not quite accurate. It’s actually a game in which we pretend that other people pay for stuff. Look, contraception, mammograms, colonoscopies, and well-baby care are not free. (See my “There’s No Such Thing as a Free Mammogram.”) They require labor and resources for which the owners wish – not unreasonably — to be compensated. Someone has to pay. If employers are compelled nominally to pay for the coverage, does anyone seriously doubt that employees will actually pay through lower cash wages? Employers are not charities. So even without a copayment, we all know deep down that we as workers pay for the coverage. (Which by the way is likely to be more expensive than the services would be in a freed market, since insurance companies will charge overhead and more for their trouble. Also subsidized demand raises prices.) Nevertheless, the truth is so obscured that people can pretend they’re getting something for free.

So the government-generated system treats us like children, and alas most of us seem happy to be treated that way.

Update

Under pressure, the Obama administration was expected to announce a “compromise” under which exempt Catholic employers would not have to pay for contraception coverage. Instead, insurance companies would provide the coverage directly to employees. Since under Health and Human Services rules, this coverage must be free, the Obama administration is in effect directing insurers to eat the cost. But insurers are profit-making companies, not charities, so we may expect them to pass the cost to someone else. But to whom? There’s only one possibility: nonexempt employers, which means in fact employees of nonexempt companies. So the grand compromise shifts the cost from a small minority of employees to the vast majority — all in the name of religious freedom. All workers in nonexempt companies and institutions will take a pay cut.

Update II

Perhaps I stopped the movie too soon. The Wall Street Journal writes, yes, there will be cost-shifting at first. But that’s not the last of it. “The balloon may be squeezed differently over time, and insurers may amortize the cost differently over time, but eventually prices will find an equilibrium. Notre Dame will still pay for birth control, even if it is nominally carried by a third-party corporation.”

In a cold and snowy land there lived the people of the North Country.  Some of them made a living by plowing and disposing of the snow that seemed to fall endlessly from the skies between November and March.  Though the work was hard, and often took place in the dark hours of the early morning, they frequently prospered, since the snowfalls came each year and the people of the North Country needed their driveways and parking lots free of the beautiful white flakes.  The Snow Plowers were happy.

But in the winter of 2011-12 the snows seemed to stop.  Oh there was a little ice and some snow, but not really enough to plow: Warmer temperatures quickly melted the little that fell.  The Snow Plowers were not happy.  They gathered the people of the town and complained that the lack of snowfall was devastating the economy of the North Country.  Without the income they earned from plowing, they told their fellow citizens, they would have no money to spend at the local grocery store or bars or restaurants.  And their fellow citizens who owned those fine establishments (and worked there too) would see their income fall, leading quickly to an economic disaster.

Saving the Economy

At first the people of the town nodded along in agreement.  “Yes,” they said, “we must save our economy. But how?”  The Snow Plowers suggested a petition to the Clouds, begging them to bring the snow that would save their business and, through the Magic Multiplier, save their town’s economy.  And so a petition was created.

But then a wise old man stepped forward and declared this was foolishness.  When asked by the townspeople to explain, here is what he said:

It is true that the lack of snow hurts our friends the Snow Plowers, and that is truly unfortunate.  However, just because they have lost income and therefore cannot spend it in the town and beyond, that does not mean the town as a whole is suffering.  Consider your own situation.  Most winters you spend perhaps $300 to pay the Snow Plowers to clear your driveways.  This winter you have spent but $50.  What has happened to that other $250?  You have presumably spent it (or perhaps put it in the bank to be lent to others who have spent it).  And where did you spend it?  On the exact same things the Snow Plowers would have spent it on.  You have been able to eat out a few more times, buy some extra beers, or a nicer steak at the grocery store, or even some candles.  The economy hasn’t been harmed; the flow of spending has just been altered.  You must, in the words of a wise man, “see the unseen.”  And what is unseen is what you have done instead of pay the Snow Plowers.

The Difference It Makes

One young man raised his hand and asked, “If this is true, then what you are saying is that it doesn’t make a difference whether it snows or not to our local economy.  So why should we not ask for more snow and help out our friends the Snow Plowers?”

The wise man responded:

Ah, but it does make a difference.  The rest of us are better off when it doesn’t snow.  Think of it this way: Each time it snows we must spend $25 to get the thing back we value: a usable driveway.  So in snowy winters we give up $300 and have a clean driveway — and that is all.

This winter, by contrast, we have both the clean driveway and the $300.  And we are free to spend that $300 on other things we might want, such as a new flat-screen TV.  This winter we are able to have both a new TV and a clean driveway, while in past years we’ve  had only the clean driveway.  Are we not all better off as a result?   It is unfortunate that our Snow Plower friends are worse off, but would we really prefer a world where we spend $300 to get us right back where we were before the snow?

The people pondered his wisdom, and they understood.  Some of them suggested that if their Snow Plower friends were truly suffering, the rest might use some of the money they saved by not plowing to help them through winter, perhaps by asking them to do some other sort of much-needed work around their homes or around the town.  After all, painting a room or installing new thermal windows would make them better off in a way that unnecessary snow plowing would not.

So the Snow Plowers’ petition to the Clouds was ripped up, and the people of the town rejoiced in the windfall created by the absence of snowfall.

(Thanks to Sarah Skwire for some stylistic suggestions.)

It’s possible to read that statement as being politically neutral. I’ve known ardent libertarians to decry the materialism that dominates so many lives in prosperous countries such as ours.  But the references to “we,” “America,” and “our kids” reflect an attitude I think libertarians would not be comfortable with.  Such sentiments, expressed in that way, tend more to come from the political left.  It’s similar to things people used to say when I was growing up, such as, “If we can put a man on the moon we can end poverty!”  Today you’re more likely to hear, “Americans spend more on losing weight than on solutions to global warming,” whatever those might be.  — which boils down to an ideological dispute over how best to spend “our” money, with the “we” who would be doing the taking and those from whom it would be taken left unidentified.

I can’t tackle all these tradeoffs right now, so I’ll address just the one in status update.  It seems that in addition to interpreting the ideological content, it’s also possible and probably more constructive to examine the statement in two other ways.

What Are the Facts?

When I saw the update I first wondered if the underlying factual assumption is true:  that corporate advertisers spend so much on Super Bowl advertising that redistributing it toward education would make a material difference in the academic achievement of our children.  Now, in the same way that spending on the military-industrial complex isn’t the same as spending on “defense,” because there’s so much pork involved, spending on the education-industrial complex isn’t the same as spending effectively on educating children.  But let’s put that all to one side.  I ran a quick Google search and came up with the following “facts.”  (I use the scare quotes because I’m not willing to bet my reputation on the results, but I do think they give a sense of the magnitudes involved.)

According to a website called Marketing Vox, in the 20 years between 1988 and 2007 “Super Bowl ads translated into $1.84 billion of network sales from over 200 different advertisers.”  (That figure, if reliable, is five years old, so we can safely assume that the total is now over $2 billion.)  Next I quickly found a website for the National Center for Education Statistics, a federal entity located in the U.S. Department of Education, which says spending on the government’s elementary and secondary schools amounts to “approximately $596.6 billion in 2007–08,” which as luck would have it happens to be the last year of the Super Bowl data.  So it appears that spending on government education in one year was 324 times the amount companies spent on Super Bowl advertising over 20 years.  That pretty much takes the wind out of that particular status update.

But what about the moral sentiment that underlies it?  While I don’t really care to argue over whether Super Bowl advertising is morally superior to educating children (aside from the tax-funding involved), there are three ways I believe that economics can clarify the issue.

The Economics of Advertising

First, in a world of perfect knowledge we clearly wouldn’t need advertising because we’d already know what the best brands were, where to get them, and at what price.  The great Austrian economist Israel Kirzner tells us that not only does advertising convey information about products we already know about, but more fundamentally in a world of imperfect knowledge, advertising draws our attention to the very existence of products, or characteristics of those products, that we may not have been aware of — which helps to explain why commercials try to be so attention-grabbing, especially during the Super Bowl.  So advertising confers benefits.  But how much is enough?

Second, most advertisers probably wouldn’t be willing to change their spending from ads on the Super Bowl, which they typically see as an expensive long-term investment, to funding education, because their comparative advantage is not likely in education but in selling beer, electronic trading, pizza, and cars.  At the same time, viewers are willing to tolerate those commercials, quite apart from their entertainment value (such as it is), because they make it possible for them to enjoy watching a championship football game.  No ads, no game.  My friend may think that’s not important, and it’s fine if she turns off the television and reads to her kids instead.  It does become a problem, however, if she forces her personal preferences on others by political means.

Finally, and most important, the kind of thinking that underlies all these so-called tradeoffs  – football versus education, moon landings versus poverty, and weight loss versus environmentalism – commits a fallacy that economics refuted over 140 years ago.

Diamonds and Water

One puzzle economists had to solve before they could come up with a satisfactory theory of value was the “diamonds-water paradox”:  Why does water, which is more useful in sustaining human life, fetch such a low price on the market when diamonds, which are less useful in that sense, fetch such a high price?  The answer lies in recognizing that the dichotomy is a false one.  No one, at least in a free society, is in a position to decide between all the water in the world and all the diamonds in the world.  It’s not water versus diamonds in general.  Instead, each of us chooses how much water she would be able and willing to trade for a specific diamond at a particular place and time.  How does that apply to football versus education?

From an advertiser’s perspective the choice is not between devoting his entire budget to advertising or to something else.  It’s whether he spends more or less on advertising rather than perhaps plant and equipment, or possibly even on education of some kind.  From the TV viewer’s perspective, the choice is not between spending all her time watching football or all of it teaching her kids.  Rather given her preferences and budget, it’s how she can best spend four hours on a particular Sunday afternoon.

In a free society we can dispose of our time and wealth as we see fit as long as we don’t violate the property rights of others.  Collectivists, however, might like to use political means to impose their preferences on how all wealth should be spent, in which case the decision may very well turn out to be lots more education and much less football.  I’m not saying my friend would openly seek coercion to impose her values.  In fact I’m pretty sure she wouldn’t.  But what is behind her sentiments and language is a collectivist mentality that taken to its logical conclusion would lead to bigger government and less individual freedom.

Fortunately, for now anyway, no single person or group decides whether we get the Super Bowl or … something else.  And at least my friend realizes that in a world of scarcity tradeoffs do exist.  I’m grateful for small victories.

The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system . . . is . . . an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

Columbia University Professor Edmund S. Phelps, who won the 2006 Nobel Prize in economics, and his coauthor, Saifedean Ammous, assistant professor of economics at the Lebanese American University, write that the U.S. economy ceased to be a free market some time ago, yet the free market is blamed for the economic crisis. (The real question is whether the American economy was ever really free.)

Phelps and Ammous condemn corporatism unequivocally.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has [sic] at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

State-Chosen Goals

It’s great that their list includes the corporate state’s declaration of goals. Too many people are willing to accept government-set goals (such as energy independence) so long as the “private sector” is induced to achieve them. Regardless of how the goals are achieved, if government sets them, that’s statism.

The cost of corporatism is high, and Phelps and Ammous provide a partial list:

dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

Again, kudos to them for noting the increasing concentration of wealth. The corporate state, after all, is a form of exploitation, the victims of which are workers and consumers, who would have been better off (absolutely and comparatively) without anticompetitive privileges for the well-connected and government-induced recessions.

The authors are optimistic that time will work against the corporate state. Young people coming of age in the Internet’s decentralized and wide-open market of ideas and merchandise can’t be expected to show enthusiasm for a system that protects entrenched corporations from the forces of competition. Moreover “the legitimacy of corporatism is eroding along with the fiscal health of governments that have relied on it. If politicians cannot repeal corporatism, it will bury itself in debt and default….”

Capitalism versus the Freed Market

My main beef with Phelps and Ammous’s essay is their use of capitalism to name the economic system that corporatism corrupted. Like many others, they believe that word “used to mean” the free market. To be sure, it was used that way beginning in the mid-twentieth century. But there was an older usage (of capitalist specifically), coined by free-market liberals like Thomas Hodgskin who predated Marx, associating it with government privileges for the capital-owning class. That undertone has never left. (Long-time Freeman writer and historian Clarence B. Carson expressed misgivings about the word here.)

It’s tempting to dismiss this as mere semantics. But we are trying to communicate, aren’t we? Libertarian theorist Roderick Long, however, shows that more than semantics is involved. For Long, capitalism is what Ayn Rand called an anti-concept, a term that confuses rather than enlightens. One kind of anti-concept is the package deal, “referring to any term whose meaning conceals an implicit presupposition that certain things go together that in actuality do not.”

As a thought experiment, Long asks us to consider his coinage of zaxlebax, which he defines as “a metallic sphere, like the Washington Monument.”  Obviously this is incoherent. Nevertheless,

some linguistic subgroup might start using the term “zaxlebax” as though it just meant “metallic sphere,” or as though it just meant “something of the same kind as the Washington Monument.” And that’s fine. But my definition incorporates both, and thus conceals the false assumption that the Washington Monument is a metallic sphere; any attempt to use the term “zaxlebax,” meaning what I mean by it, involves the user in this false assumption.

Long sees capitalism in its common usage as similar.

By “capitalism” most people mean neither the free market simpliciter nor the prevailing neomercantilist system simpliciter. Rather, what most people mean by “capitalism” is this free-market system that currently prevails in the western world. In short, the term “capitalism” as generally used conceals an assumption that the prevailing system is a free market. And since the prevailing system is in fact one of government favoritism toward business, the ordinary use of the term carries with it the assumption that the free market is government favoritism toward business.

Similarly for socialism, Long writes. He thinks most people mean nothing more specific than “the opposite of capitalism.”

Then if “capitalism” is a package-deal term, so is “socialism” — it conveys opposition to the free market, and opposition to neomercantilism, as though these were one and the same.

And that, I suggest, is the function of these terms: to blur the distinction between the free market and neomercantilism. Such confusion prevails because it works to the advantage of the statist establishment: those who want to defend the free market can more easily be seduced into defending neomercantilism, and those who want to combat neomercantilism can more easily be seduced into combating the free market. Either way, the state remains secure.

In sum, the system that most immediately threatens individual liberty is corporatism (with its militarist component) and the word capitalism is too closely associated with corporatism in people’s minds to be useful to advocates of the freed market.

Krugman claims that the Republican argument for the importance of job creation relies too heavily on the “heroic entrepreneur,” rather than recognizing that “successful companies — or, at any rate, companies that make a large contribution to a nation’s economy — don’t exist in isolation.” For Krugman this means there’s plenty of help from government. Although I can’t speak for all Republican politicians, I can say that Krugman’s view of the argument for free markets is utterly mistaken.

The argument for the market is based precisely on the fact that the entrepreneur exists in a social context that helps to determine how effective her actions will be. The most heroic entrepreneur imaginable cannot be very productive if she is shackled by government regulations or is trying to operate in a society with ill-defined or poorly enforced property rights. As Ludwig von Mises recognized as far back as 1920, this is the same reason that successful entrepreneurs fail miserably when they try to run government agencies like businesses: What gives the entrepreneur the ability to succeed are market signals, which are necessary to determine what people might want and how well it was provided. Even the smartest person can’t learn if a teacher uses black chalk on a blackboard in a dark room. No entrepreneur can succeed in isolation.

The Hard Task

More important, though, is that both Krugman and politicians from both parties are much too concerned about job creation when they should be concerned about value creation. Creating jobs is easy; it’s creating value that’s hard. We could create millions of jobs quite easily by destroying every piece of machinery on U.S. farms. The question is whether we are actually better off by creating those jobs — and the answer is a definite no. We want labor-saving, job-destroying technology because it creates value by enabling us to produce things at lower cost and thereby free up labor for more urgent uses.

A century ago 40 percent of Americans worked in agriculture; today it’s less than 2 percent. The former farm workers didn’t all go unemployed. The wealth created by higher farm productivity and lower prices enabled us to demand all kinds of new products that in turn created many more jobs than were lost in agriculture. This is the story of innovation everywhere.

So rather than talking about job creation, let’s focus on value creation. The case for freeing markets is that such freedom best enables individuals to find ways to use their knowledge and skills to create value for others and thereby create wealth for themselves. The more wealth that value creators can keep, the more likely they are to continue to create it. Even if a value-creating innovation destroys jobs in the short run, the increased wealth will bring a great deal of job creation in its wake.

Ancillary Jobs

Krugman tries to criticize Apple by pointing out that the “heroic” Steve Jobs has only created about 43,000 Apple jobs in the United States (though around 700,000 overseas). But this misses the point: The real job-creation number that matters here are all the ancillary jobs created through the invention of the Mac, iPod, iPhone, and iPad. Those inventions, along with every other technological innovation, have created tens of millions of jobs in programming, web design, app design, hardware maintenance, and more.

Krugman also takes a swipe at fans of Ayn Rand by referring to “the John Galt, I mean Steve Jobs-type ‘job creator.’” But Krugman is blind to the error of his own joke: John Galt’s innovative motor took static electricity out of the air and turned it into useful energy, which would have been a huge job destroyer! Again, the triumph of entrepreneurial innovation is not in creating jobs, but in creating value. Galt’s motor would have freed up a lot of labor to be devoted to new wants made possible by the cheap source of energy. Krugman can’t even see that his own example undermines his argument.

The next time anyone starts talking about job creation, stop listening. Jobs come into existence when entrepreneurs are free to create value. Aiming directly at job creation is a recipe for waste and poverty. Set people free to use their talents to create value for others and the jobs will follow.

Unlike the government, of course, the Red Sox organization is private and has every right to enact this measure. But, that doesn’t mean we should ignore the bad economics in action, especially since it contradicts the exact goal the organization is apparently pursuing.  By restricting the market for these seats in an attempt to make them cheaper, the Red Sox are only going to make them more expensive for most fans and increase the power of incumbent season ticket holders.

If you’re a Red Sox fan without season tickets, you had two choices: Buy a ticket the day of release (January 28) or purchase a ticket on StubHub. Both options got worse this year thanks to the new policy. Since buying the day of release was the only way to purchase $12 upper-bleacher seats, more people presumably lined up on January 28, so the odds of getting a cheap ticket were reduced.

Let’s say the tickets were sold out, and you go to StubHub to buy a ticket. The prices on StubHub will be higher, since the supply of tickets that can be resold has also been reduced. In one act the Red Sox have made it harder to buy the cheapest tickets and made the tickets available for resale more expensive. Neither of these measures helps the average fan.

Likewise, season ticket holders will now have more control over ticket distribution. In Fenway Park only a small portion of tickets are released for individual game sales. Under the model the Red Sox are promoting, these season-ticket holders will act as gatekeepers for ticket distribution. They are more likely to allocate them to close relatives or friends than individual-game ticket holders are. This will create a small group of elites with lots of tickets and make it harder for those tickets to be distributed more evenly.

In effect the Red Sox are promoting a form of a sports-ticket aristocracy. They’re nominating an elite class that gets to distribute a scarce resource by their own whims and desires in the name of public welfare. Sound vaguely familiar?

Occupy Fenway Park.

[W]e need to change our tax code so that people like me, and an awful lot of Members of Congress, pay our fair share of taxes. Tax reform should follow the Buffett rule: If you make more than $1 million a year, you should not pay less than 30 percent in taxes. [Emphasis added.]

And:

When Americans talk about folks like me paying my fair share of taxes, it’s not because they envy the rich. It’s because they understand that when I get tax breaks I don’t need and the country can’t afford, it either adds to the deficit, or somebody else has to make up the difference. . . . [Emphasis added.]

There are lots of claims there that cry out for examination. For example, what’s need got to do with it? Does Obama really favor a tax system that leaves you only what you need — as determined by someone else? And look at that term “tax breaks.” If a burglar decides not to break into your house and take your things, have you gotten a break? Or have you simply kept what is yours? Is Obama really suggesting that how much of your income you retain should depend on what “the country” can afford? What does that even mean?

Buffett Rule

All that aside, I want to home in on Obama’s notion of fairness. “If you make more than $1 million a year,” he says, “you should not pay less than 30 percent in taxes.” How does he know that constitutes fairness? Obviously 30 percent is an arbitrary figure. If he’s concerned that income and payroll taxes take a smaller percentage of Warren Buffett’s income than the percentage they take from his secretary’s income, why not reduce his secretary’s tax rate? It’s certainly not obvious that Buffett should pay more. (For an interesting discussion of the secretary’s tax rate, see this and this.) Obama (like most other politicians) regards government spending growth as inexorable and virtually untouchable, but why? (Proposed “cuts” are merely reductions in the rate of growth.)

On this matter of tax fairness, no one tops Murray Rothbard’s discussion in his classic Power and Market: Government and the Economy (online in PDF format here). Rothbard starts by noting that for many years people thought products had a “just price.”

It is clear, even to those (like the present writer) who believe in the possibility of a rational ethics, that no possible ethical philosophy or science can yield a quantitative measure or criterion of justice. . . . Economics, by tracing the ordered pattern of the voluntary exchange process, has made it clear that the only possible objective criterion for the just price is the market price. For the market price is, at every moment, determined by the voluntary, mutually agreed-upon actions of all the participants in the market.”

Rothbard of course is talking about a market unblemished by government monopoly privilege and other interventions.

He goes on next to ask: “If the search for the just price has virtually ended in the pages of economic works, why does the quest for a ‘just tax’ continue with unabated vigor? Why do economists, severely scientific in their volumes, suddenly become ad hoc ethicists when the question of taxation is raised?”

We might also ask why a president makes ethical pronouncements about levels of taxation without first laying out his moral philosophy plainly for all to judge.

Canons of Justice in Taxation

Thus the “canons of justice” in taxation must not be taken for granted. Calling something just does not make it so. Rothbard writes:

The prime objection to these “canons” is that the writers have first to establish the justice of taxation itself. If this cannot be proven, and so far it has not been, then it is clearly idle to look for the “just tax.” If taxation itself is unjust, then it is clear that no allocation of its burdens, however ingenious, can be declared just.

A few pages earlier Rothbard defined taxation, uncontroversially, I hope, as “a coerced levy that the government extracts from the populace.” Pulling no punches, he quotes his mentor Frank Chodorov, once an editor of The Freeman:

A historical study of taxation leads inevitably to loot, tribute, ransom — the economic purpose of conquest. The barons who put up toll-gates along the Rhine were tax-gatherers. So were the gangs who “protected,” for a forced fee, the caravans going to market. The Danes who regularly invited themselves into England, and remained as unwanted guests until paid off, called it Dannegeld; for a long time that remained the basis of English property taxes. The conquering Romans introduced the idea that what they collected from subject peoples was merely just payment for maintaining law and order. For a long time the Norman conquerors collected catch-as-catch-can tribute from the English, but when by natural processes an amalgam of the two peoples resulted in a nation, the collections were regularized in custom and law and were called taxes.

“Why do not economists abandon the search for the ‘just tax’ as they abandoned the quest for the ‘just price’?” Rothbard asks.

One reason is that doing so may have unwelcome implications for them. The “just price” was abandoned in favor of the market price. Can the “just tax” be abandoned in favor of the market tax? Clearly not, for on the market there is no taxation, and therefore no tax can be established that will duplicate market patterns.

So let’s hear no more about tax fairness, unless it’s to point out that fairness is approached as tax rates move toward zero.

The answer is that the call for privatization does not get at the real reason the private sector works better than the political sector.  The great advantage of the private sector is not private ownership per se but that private owners compete with one another.  Classical liberals would do better to contrast not the “private” and “public” sectors, but the “competitive” and “monopolistic” sectors.  If the goal is efficiency in delivering the goods, private ownership is a necessary but not a sufficient condition.  Instead of calling for the “privatization” of government services, classical liberals should be calling for “de-monopolization.”

Private Monopoly

Suppose a local government decides to privatize trash collection.  This often means that rather than running the trash collection organization itself, the local government offers the monopoly right to collect trash to the highest bidding private firm.  Although the interested firms compete in bidding for the contract, they nonetheless end up with a monopoly privilege in the locality.  From the consumer’s perspective, a political-sector monopoly has been replaced with a private-sector one.

Private monopolies might be marginally more efficient than political ones, if only because they have a bottom line and presumably have to do the job well enough to get the contract renewed.  Those incentives may be stronger than those that flow from the public’s ability to complain or vote out local officials in the case of government provision.  However, notice that the private monopoly ultimately has to please the politicians who dispense the monopoly privilege, not the consumers.  How much the public really gains from swapping a government monopoly for a private one is not at all clear.

Imagine instead that the local government simply opened up trash collection to any firm that wished to sell the service to consumers.  This “de-monopolization” would lead to actual competition among (potential) providers, forcing trash collectors to serve consumers well, instead of just local politicians who hand out monopoly privileges.  Competition drives firms to provide better quality, lower cost goods to consumers rather than political benefits to government agents.  Yes, you can’t have competition without private ownership, but private ownership alone is not enough.  You need de-monopolization to generate the competition that is at the core of the private sector’s effectiveness.

Several Property

In some of his later writing, F. A. Hayek recognized a similar point when he suggested that it was problematic to talk of “private property” and that we should talk instead of “several property.”  The distinction is not merely semantic.  His point is that the important thing about “private” property is not that it is private, but that it is divided among “several” owners who then compete to make the best use of it.

The rhetoric of “privatization” may turn people off who might otherwise be more sympathetic to classical-liberal ideas if we were to frame them as opposition to monopoly rather than as support for shifting resources from “public” to private hands.  It’s also worth mentioning that the “public” sector is far more “private” than the private sector.  Compare how little we know about what “public sector” organizations like the CIA or the Fed do versus how much we know about Apple, Google, or other public corporations, which regularly open their books and provide annual reports to the public.  If we believe that the benefits of de-monopolization will go to “the public” as consumers, then let’s drop the talk of “privatization.”

Private ownership is not a goal but a means to an end.  What really matters is what best serves the public in its role as consumers.  Private ownership only does that if it’s within an institutional context that promotes competition. We classical liberals need to shift our rhetoric from promoting privatization to promoting competition by ending government monopolies wherever possible.  That is the path to lower prices, higher quality, and more freedom.

The first is from the textbook I’ve used for many years in my introductory microeconomics class by Heyne, Boettke, and Prychitko:

(1) …the demonstration by modern political economists of the tendency within democratic governments to concentrate benefits and disperse costs within policy-making has been one of the most important contributions to our intellectual understanding of why good politics is not necessarily good economics (331).

Political Manipulation

For example, it would be grossly inefficient to implement a government project that costs $3 million but only provides a total benefit of $1 million.  But if through political manipulation you could make everyone in a community of one million pay an equal share of the cost and at the same time hand over the benefit of the project to say 1,000 people, it may well be enacted.  That’s because the no one would pay more than $3, while beneficiaries would be getting $1,000 each.  The gainers would fight a lot harder to pass the project than the losers would to fight it.

Now, this from Friedrich Hayek’s The Road to Serfdom:

(2) Against the innumerable interests which could show that particular measures would confer immediate and obvious benefits on some, while the harm they caused was much more indirect and difficult to see, nothing short of some hard-and-fast rule would have been effective (71).

Hayek is talking here about why sometimes a dogmatic resistance to all government intervention has been helpful in preserving liberty.  But I would like to point out that the kinds of measures he has in mind are things such as minimum-wage laws that appear to benefit workers at the bottom of the wage scale but, as is well established in the economics literature, actually price lower-skilled workers out of the market over time.  Currently in the state of New York it is illegal for anyone to work in most jobs for less than $7.25 an hour, which means if your labor is worth less than that to employers, as is likely the case if you are young, you will not be hired.

At first glance these two statements appear to be saying more or less the same thing.  Both identify a source of systematic government failure: concentrated benefits versus dispersed costs; or immediate/obvious benefits versus harm that is indirect/difficult to see.  Both identify interventions that benefit only some while the consequences fall elsewhere or elsewhen.  And both imply that the outcome of these interventions will tend to be undesirable to someone.

Contrasts

The Heyne et al. statement (1) is in terms of “benefits” and “costs” while the Hayek (2) talks about benefits and harm.  Perhaps you could interpret “harm” as the “cost” that is dispersed in the first statement, although “harm” has a more general meaning that may not be easily quantifiable, such as undermining the norm of preserving the free market.

Furthermore, (1) focuses on concentrated benefits, while (2) on the immediate and obvious benefits.  Beneficiaries of the government project get $1,000 while only some under the minimum-wage benefit at all.  Now beneficiaries in both cases can see immediately what they are getting, but there is a certain sense in which those proposing the minimum-wage law (mistakenly) believe it will benefit everyone, not just a few, while people in the concentrated benefits approach are fully aware that only a few will indeed benefit from the intervention.

The costs in (1) are dispersed while the harm in (2) is indirect and difficult to see.  The $3-per-person cost of the government project is certainly not indirect or difficult to see; rather everyone, both gainers and losers, do see it but it’s too small an amount for most to bother with.  Few have an incentive to do anything about it.  However, the harm of the minimum-wage law is indeed indirect and difficult to see.  Acquiring that knowledge is hard.

Time is not necessarily an element in (1) but it is in (2), in fact it’s because some time has to pass before you can see the full consequences of an intervention that they are often difficult to see.

Inefficiency and Error

Finally, the nature of government failure in (1) is based on inefficiency: the total costs exceed the total benefits.  Government failure in (2), on the other hand, is based on error.  (1) implies that inefficiency is systematic because the political rules of the game make people follow perverse incentives, while (2) implies that error is systematic because of a failure to learn.  And (1) suggests that people can manipulate the system with full knowledge of all the consequences so that they can effectively concentrate benefits on themselves or their cronies and disperse the costs among taxpayers; while (2) suggests that the harm that a policy causes is largely unintentional and the result of ignorance.

The first approach emphasizes incentive problems, the second knowledge problems.  Neither is necessarily better than the other, but there are occasions when one or the other might be more appropriate.  Often both are applicable to the same intervention.  For example, some political economists argue that labor unions say they favor raising the minimum wage to express solidarity with their non-union brothers and sisters but really support it because it insulates its members a little more from unskilled workers.  One author has even characterized the approach to political economy that emphasizes “concentrated benefits, dispersed costs” as “a proposition about inferring intentions from outcomes” (47).  I would not go that far.

(If you’d like to read a lengthier treatment of this topic check here.)

Obviously the income tax is a tax on people’s income-generating activities. What this means is that it penalizes these activities relative to activities that do not generate income. In a market setting, income-generating activities are those that lead to the production of goods and services. So the income tax penalizes work relative to leisure, and saving and investment relative to consumption. It is the latter that tends to be least understood and therefore will be the focus of this essay.

Consume or Invest?

The broad choice facing an individual in choosing to allocate his or her income is to either spend it or save and invest it. This consumption/saving choice is distorted by the income tax in favor of consumption.

Using the traditional terminology, the income tax double-taxes saving relative to consumption. It should be noted that this terminology is somewhat misleading. As will be demonstrated, the tax does not explicitly double-tax saving but reduces the returns to saving twice, while reducing the returns to consumption just once.

This can be shown with a simple example. Start with an individual who has $100 of pretax income. In the absence of taxation this person has $100 for either consumption — the purchase of goods and services — or saving. If the interest rate is a simple 10 percent per year, then the person can decide whether he prefers to spend $100 or save the $100 and have $110 available for spending a year from now. The decision will be based on his preference for satisfaction now relative to satisfaction in the future. This is what economists call time preference.

Now assume that the individual faces a 10 percent income tax. His $100 is reduced to $90, cutting the amount available for consumption by that rate. Likewise, the tax implicitly reduces his returns to saving by 10 percent. In other words, by taxing the principal the government is simultaneously reducing the entire stream of returns from the investment. So if he saves the $90, because of the tax his interest income is reduced from $10 to $9.

The Returns to Waiting

In the absence of further taxation the individual’s choice is between spending $90 now or waiting a year and having the opportunity to spend $99. Returns to consumption spending and returns to saving have both been reduced equally by the tax. But under a standard income tax, the returns to saving are reduced yet again. The $9 in interest also is taxed 10 percent, leaving $8.10.

So the tax reduces the returns to savings twice: first from $10 to $9 when the initial $100 is taxed, and second from $9 to $8.10 when the interest is taxed.

Note that the return from consumption is only reduced once, from the level of satisfaction that could be obtained with $100 to the level that could be obtained with $90. The tax on interest or other returns to investment, including dividends and capital gains, biases decisions against saving, investment, entrepreneurship, and business expansion, and in favor of consumption spending.

In addition the government, at both the federal and state levels, further punishes investors with a separate corporate income tax. The corporate tax, which at the federal level is 35 percent, adds a third layer of tax on both dividends and capital gains.

Exempt Returns from Saving

The most straightforward way to remove the bias is to exempt from taxation all returns from saving. This is the approach that has been taken by those who advocate the flat tax, for example, Steve Forbes. From this perspective, saving and consumption are treated symmetrically.

An alternative way of remove this bias is by eliminating all saved income in the current time period from the tax base, taxing it only when it is withdrawn for consumption purposes. A tax that deals with the bias against saving in this way is called a “consumed income tax.” The idea would be to treat all savings and investment in the same way that IRA and 401k retirement investment plans are treated, except that there would be no penalties for withdrawing funds before any legally specified age.

In reference to our example, if the person decided to spend his $100 in pretax income, he would be subject to the 10 percent tax immediately and would have $90 available for consumption. If instead he decided to save or invest the $100 for a year, he would not be taxed on it until it was taken out of savings and used for consumption. At the end of a year, if he chose to withdraw the money from savings or to cash in his investment, the original $100 and the return of $10 would be taxed 10 percent. This would leave him with $99 for consumption, or the equivalent of a full 10 percent return on $90. The point here is that only income that is used for consumption is taxed, hence the name “consumed-income tax.” It should also be noted that this gives the same result as the flat tax, which would exempt the interest income from the tax base. The individual would save $90 ($100 minus the 10 percent tax) and earn $9 in interest.

Full Exemption of Expenses

The consumed-income tax suggests that all expenses incurred to generate future income, which is the definition of investment, should be eliminated from the tax base. This implies that all work-related expenses, including commuting expenses, educational expenses incurred to enhance future income, and day-care expenses, should be excluded from the tax base. These expenses are analytically equivalent to saved income. They represent forgone current consumption in an attempt to generate future income. This approach also implies that all business expenses (labor, plant, and equipment) should also be deducted in the year they are incurred rather than depreciated over time. This insures that the full cost of the investment, rather than a time-discounted cost, is realized in the tax deduction.

A word of warning is in order. It needs to be made clear that there is no such thing as a tax that does not damage productivity and economic growth. To invoke a term often used by economists, a “neutral tax” does not exist. At the very least, all taxation transfers the control of productive resources from the free market to government control, that is, from an institutional setting that will generate a more efficient use of resources to one that will generate a less efficient use of resources. What this means is that overall the economy, and therefore human welfare, always suffers as a result of taxation.