People hate taxes. This is actually just a special instance of a more general law, which is that people hate paying for stuff. But the fact that taxes get singled out in this way, and are capable of provoking such deep-seated anger and resentment, is something that constantly amazes me.
What sets the issue of taxation apart is the notion, popularised by generations of economists, that taxes are not just a personal inconvenience to the taxpayer but are also objectively bad for the economy. As a general claim this is simply false (despite the fact that there are specific instances in which it is true). It is, however, a typical consequence of a surprisingly pervasive error that I refer to as the "government as consumer" fallacy.
The picture underlying this fallacy is relatively straightforward. Government services, such as health care, education, national defence, and so on, "cost" us as a society.
We are able to pay for them only because of all the wealth that we
generate in the private sector, which we transfer to the government in
the form of taxes. A government that taxes the economy too heavily
stands accused of "killing the goose that lays the golden eggs" by
disrupting the mechanism that generates the wealth that it itself
relies upon in order to provide its services.
Thus the government gets treated as a consumer of wealth, while the private sector is regarded as a producer. This is totally confused. The state in fact produces exactly the same amount of wealth as the market, which is to say, it produces none at all. People produce wealth, and people consume wealth. Institutions, such as the state or the market, neither produce nor consume anything. They simply constitute mechanisms through which people coordinate their production and consumption of wealth.
A lot of errors in economic reasoning arise from the tendency to treat economic institutions as though they were people. This shows up often in the way that we think about both corporations and government. A surprisingly large percentage of the population does not understand that "making the government pay" for their problems is equivalent to "making your friends and neighbors pay". (I’ve always thought it would be helpful, on this front, if newscasters would occasionally substitute the term "us all" for "the government", in headlines.) In the same way, many people think that having corporations pay taxes represents some sort of an alternative to having individuals pay taxes (rather than being simply an indirect way of taxing individuals).
Both of these errors can be overcome simply by "following the money" to see where it ultimately comes from, or where it ends up. Yet it is also important to have the right sort of "picture" of what these institutions are and what they do. Management theorists have, in recent decades, taken to referring to the firm as a "nexus of contracts". The firm is nothing more than a mechanism for organising a very complex set of transactions between individuals.
The state should be thought of in exactly the same way, at least with respect to its economic role. The primary difference between the state and the corporation is simply that membership in the former is universal and compulsory, while in the latter it is not. Because of this non-voluntary aspect, it would be misleading to call the state merely a "nexus of contracts", even though that is, in a sense, what it is. For now, let’s call it a "nub of transactions".
The state, as people on the right never tire of reminding us, grew spectacularly over the course of the 20th century as reflected by increased spending on welfare, unemployment, pensions, health, and housing, as a percentage of GDP. As far as the economy is concerned, the state went from being a bystander to being the single most important actor.
The standard way of distinguishing this new state-as-economic-behemoth from its precursor institution is to call it "the welfare state". This is not a great term, insofar as it suggests that handing out welfare cheques is one of the major functions of modern government, which typically is not the case. A better idea would simply be to rebrand it as something else, like "the public goods state".
This term reflects an idea, expressed canonically by Paul Samuelson in a 1954 Review of Economic Studies paper, that the reason the state has grown so large is because it is uniquely situated to provide a type of good that markets alone will never deliver, namely, a so-called public good. Samuelson defined public goods as ones that were nonexcludable (you couldn’t prevent anyone from enjoying them) and nonrival in consumption (one person’s consumption did not diminish the quantity or quality of anyone else’s). The sort of thing he had in mind was a lighthouse, the services of which were available to all ships in the vicinity without distinction and without any diminution from increased usage.
There are, in fact, almost no public goods in Samuelson’s sense — even something like national defence, which benefits all citizens without distinction and regardless of their numbers, does not qualify, since it benefits only citizens (or those who find themselves within the borders of the state). More importantly though, Samuelson made it sound as though there was a special and distinct class of goods that by its very nature could only be delivered by the state. In fact, many of the goods provided by government are of exactly the same kind as those provided by the private sector. The question is only how we, as consumers, choose to organise our purchases.
Despite the agreeable homophony between "public good" and "public sector", most of what governments are in the business of providing is not public goods, but rather what economists call club goods. This term was introduced in 1965 by the economist James M Buchanan to bridge what he described as "the awesome Samuelson gap between the purely private and the purely public good".
Every good, Buchanan pointed out, has what might be referred to as an "optimal sharing group". Your toothbrush, for instance, probably has an optimal sharing group of one, making it a good candidate for treatment as a purely private good. But other things are not like this. For instance, it’s not a great idea to spend too much money on exercise equipment. While it is convenient to have an elliptical trainer in the basement so you can work out in the privacy of your own home, this very expensive piece of equipment is likely to sit unused 362 days of the year. If your neighbour has an equally unused StairMaster, and someone else a stationary bike, then there are obvious efficiency gains to be had from sharing exercise equipment. One could organise a complicated rotation scheme among neighbours, or one could do what most people do, which is simply to take out a gym membership.
A "gym" is basically an arrangement through which individuals collectively purchase and share a variety of different types of fitness equipment. Such an arrangement is advantageous because use of this equipment is relatively nonrival. The equipment is quite durable, and so is not noticeably eroded in the short term through multiple use. Furthermore, the amount of time that any one person wants to spend using it represents a relatively small fraction of the day, which makes it well suited for sharing. Thus the way that we typically organise consumption is by charging people a flat fee for access to the club, which then gives them "free" access to all the machines within.
There are a couple of things worth noting about this arrangement. The first is that the use of a flat fee for payment can have the unfortunate effect of obscuring the nature of the underlying economic transaction. For instance, people who join a gym often don’t realise that they’re paying for everything — the treadmill, the sauna, the swimming pool — regardless of whether they actually use it. They think the fee goes to the club, and the club buys the equipment (along with the services of those who work there). They don’t realise that the club is just an intermediary, and that it is really the members, collectively, who are doing the purchasing.
The second important point is that club purchasing often involves a significant reduction of consumer choice. When I join a club, the fee structure usually ensures that I have to pay for a share of everything, regardless of whether I use it. This is why people who like to swim usually get a better deal out of gym memberships than anyone else. Since the swimming pool is by far the most expensive item to maintain, there is almost always cross-subsidisation among members of clubs that have a pool — an effect that clubs sometime seek to diminish by imposing a surcharge, such as a towel or locker fee, on those who use the pool.
This cross-subsidisation among members is clearly one of the disadvantages of many club-purchased goods. It is partially attenuated by the fact that different clubs will arise that offer different mixes of goods, and so consumers can shop around for one that most closely caters to their preferences (for example, someone who doesn’t like to swim should not join a club with a pool). Although in theory one could get perfect efficiency here, in practice the amount of variety on display is fairly limited (as anyone who has compared fitness clubs can attest). This shows that the efficiency gains arising from the collective purchase (that is, the formation of an optimal sharing group) are sufficiently great that they outweigh the losses caused by the bundle of goods being less tailored to the needs of the individual consumer.
This is an edited extract from Filthy Lucre: Economics For Those Who Hate Capitalism by Joseph Heath (Scribe).
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