Ten Elements of Clear Thinking About Economic Progress and the Role of Government

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Ten Elements of Clear Thinking About Economic
Progress and the Role of Government
Common Sense Economics James Gwartney, Richard L.
Stroup, and Dwight R. Lee CommonSenseEconomics.com
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Some Questions to Consider

• How does a democratic government really work?
• Is it a corrective device? Does it sometimes
  thwart economic progress?
• Will a policy supported by a voting majority be
  productive?
• What are the unintended consequences of
  well-intended governmental policies and programs?
• What is needed to reduce waste and direct
  governments toward productive activities?

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What Role for Government?

• A wise and frugal government, which shall
  restrain men from injuring one another, which
  shall leave them otherwise free to regulate their
  own pursuits of industry and improvements, and
  shall not take from the mouth of labor the bread
  it has earned. This is the sum of good
  government.
• -Thomas Jefferson

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Clear Thinking Proposition 1

• Government promotes economic progress by
• protecting the private rights of individuals and
• supplying goods that cannot be provided through
  markets.

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Governments Protective Function

• Governments protective function includes the
  maintenance of a framework for security and
  order.
• Protect people and their property against
  aggressors through force if necessary.
• Enforce contracts.
• Help avoid restrictions, regulations and
  discriminatory taxes.

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"If men were angels, no government would be
necessary.

• James Madison
• Federalist Paper No. 51
• 1788

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Life, Liberty and the Pursuit of Happiness

• Government promotes economic progress by
  protecting individuals rights to life, liberty,
  and the pursuit of happiness. It can use force
  to protect against loss of life, threat to
  liberty, and damage of property.
• Individuals will use resources efficiently,
  invest and innovate if their rights to benefit
  from doing so are protected. Economic progress
  ensues.

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Governments Productive Function

• Governments productive function includes the
  provision of public goods goods that cannot be
  provided easily in private markets.
• Public goods
• Are available to others once provided to an
  individual.
• Are difficult to provide only to paying
  customers.
• National defense
• Flood control
• projects

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The Case for Public Goods

• The legitimate object of government is to do for
  a community of people whatever they need to have
  done, but cannot do, at all, or cannot, so well
  do, in their separate and individual capacities.
• Abraham Lincoln

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Clear Thinking Proposition 2

• Government is not a corrective device. It can
  and does fail!!!!

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A Democratic Government

• A method of social organization where individuals
  make and carry out choices collectively.

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In a Democratic Government

• Decisions are made at the margin. Voters, elected
  officials and lobbyists support those proposals
  from which they expect to derive net benefits.
• Too often the secondary effects of political
  actions are ignored and/or pushed into the future
  when the elected officials are out of office.
• So there is no assurance that governmental
  actions will be productive.

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CSE Table 3. Benefits and Costs of a Hypothetical
Government Project
 Building a Road or Civic Center  Building a Road or Civic Center Tax Payment Tax Payment
Voter Benefits Received Plan A Equal Tax Plan B Taxed Proportionate to Benefits
Adams 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Brown 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Green 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Jones 3.00 (6 of 50) 12.00 3.60 (6 of 50)
Smith 2.00 (4 of 50) 12.00 2.40 (4 of 50)
TOTAL 50.00 in total benefits 60.00 60.00
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A Democratic GovernmentSome Important Points

• Policies proposed by the government may or may
  not be productive.
• Policies favored by the voting majority do not
  necessarily promote economic progress.
• The benefits and costs faced by voters belonging
  to different interest groups are often
  disproportionate.

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Unlike Democratic Governments, When Markets Are
Competitive

• Producers can not force consumers to buy their
  products.
• They have incentives to undertake only productive
  activities.

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Lets Compare Democratic Governments and Markets

1. The government can use coercion to tax and
   subsidize. Markets can not.
2. Markets can charge high prices but can not force
   people to pay. Governments can and do.
3. Unconstrained political democracy is a system of
   majority rule, while market allocation is based
   on proportional representation. In markets,
   consumers buying one commodity will not interfere
   with the ability of others to buy a different
   one.

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What Is Needed to Encourage Democratic
Governments To Be Productive?

• To reduce the likelihood that people can
  participate in government projects without
  paying, it is important to link benefits
  proportionately to costs.
• A democratic majority vote does not guarantee the
  passage of productive proposals.
• Supermajority support (75 of the voters) will
  increase the likelihood of passing productive
  projects.

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Clear Thinking Proposition 3

• The costs of government are not only taxes.

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Which of the following is true of taxes?

1. Taxes increase the volume of mutually
   advantageous exchanges.
2. Tax increases are the primary cause of inflation.
3. Business taxes generate government revenue
   without imposing a burden on consumers and
   households.
4. Taxes drive a wedge between what buyers pay and
   what sellers receive.

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3 Types of Costs Incurred

• The loss of private sector output that could
  otherwise be produced
• The cost of resources expended in tax collection
  and enforcement of government mandates
• The cost of price distortions caused by taxes and
  borrowing

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Costs of Collection Enforcement

• Preparation, monitoring and enforcement of
  tax law and regulatory legislation require time,
  talent and money.
• These resources could be used elsewhere.
• People will use resources to avoid taxes.

• Government expenditures plus compliance costs and
  mandated private spending represent more than 1/2
  of GDP.

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Lets Review How To Measure Governments Share of
Total Output

• Government expenditures share of total U.S.
  spending on goods and services produced
  represents approximately 35 of total GDP.
• When the costs of regulations are added, this
  share rises to over 50 of GDP.
• Government is big in the U.S.!

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Government Can Distort Prices

• Taxes alter consumption and production
  incentives.
• Consider supply and demand. Taxes increase what
  consumers pay and reduce what sellers receive.
  They reduce the volume of exchanges and squeeze
  out some of the gains from trade.
• Some exchanges will not occur because the tax
  wedge makes them disadvantageous.
• Deadweight loss of taxation adds 9-16 above the
  costs of compliance and regulation.

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Taxes in a Nutshell

• Taxes distort prices.
• Taxes transfer income from individuals to the
  government.
• Businesses do not pay taxes. Instead, they
  collect taxes from customers, employees and
  shareholders.
• Politicians want to conceal the tax costs of
  their programs and make you think businesses
  are paying!

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Do you agree or disagree? Explain.

• Taxing is much like plucking a goose. It is the
  art of getting the greatest number of feathers
  with the least amount of hissing.
• Senator Bob DoleWall Street Journal
• December 16, 1983

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Clear Thinking Proposition 4

• Unless restrained by constitutional rules,
  special-interest groups will use the democratic
  process to fleece taxpayers and consumers.

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A Democratic Government

• Can contribute to economic progress when it fills
  its protective and productive roles.
• However, more than a majority rule and popular
  vote is needed to assure that it restricts itself
  to those roles.
• Why? Incentives matter! Consider the following
  three examples.

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1. Democratic Government Incentives

• Government regulators and legislators may be
  heavily influenced by lobbyists and the
  possibility of securing highly paid jobs after
  leaving government, and so they may focus on the
  interests of the regulated party rather than
  citizens.

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The Power of Special Interests

• Special interest groups will help politicians get
  elected through donations and getting workers to
  vote.
• While the majority of unorganized voters is
  harmed, there is little incentive to act in
  opposition.
• In varying degrees, all politicians cater to
  special interests.

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2. Democratic Government Incentives

• If a small but organized group cares a great
  deal about a certain government policy, while the
  majority is unorganized and apathetic, then the
  special interest often prevail.

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Consider This Sweet Example

• In 2000, the sugar lobby contributed 13 million
  to politicians.
• The government restricts sugar imports into the
  U.S. through quotas.
• The average U.S. consumer pays 20 per year in
  higher sugar prices while sugar growers gain
  about 1.9 billion.
• IS THIS A SOUND GOVERNMENT PROGRAM? DISCUSS.

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3. Democratic Government Incentives

• Log-rolling implicit vote trading among
  legislators
• They vote for programs that benefit the districts
  of other legislators in exchange for votes for
  their pet projects.
• Federally funded dams, highways, housing
  projects, Veterans Administration hospitals, and
  job-training centers are often reflective of
  logrolling.

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Question Restrictions that limit sugar
imports, subsidies for the construction of sports
stadiums, and federal spending on programs like
the construction of an indoor rain forest in Iowa
all provide examples of government programs that,

1. Are based on careful analysis of benefits
   relative to costs.
2. Are designed to redistribute income from the rich
   to the poor.
3. Reflect the political attractiveness of
   special-interest issues.
4. Promote the general welfare.

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Clear Thinking Proposition 5

• Unless restrained by constitutional rules,
  legislators will run budget deficits and spend
  excessively.

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The Attractiveness of Deficit Spending to
Legislators

• Budget Deficit Government spending that exceeds
  revenues. Deficits are financed by borrowing.
• Spending is attractive to legislators because it
  allows them to take credit for programs that
  benefit voters.
• Taxes are unattractive because they impose
  visible costs on voters.
• Thus, legislators tend to spend more than they
  are willing to tax.

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The National Debt

• The cumulative effect of all past budget deficits
  and surpluses of the federal government.
• Check out the U.S. Debt.
• The U.S. Treasury borrows funds by selling
  securities like U.S. Treasury Bills, Notes, and
  Bonds.
• Borrowing makes the current cost of running the
  government less visible.

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Deficit Spending and National Debt

• Borrowing pushes the visible cost of running the
  government and policies into the future.
• Bottom line. Immediate benefits with deferred
  costs are politically attractive!
• Deficit spending and public debt appear to
  transfer costs into the future when current
  politicians are no longer office.

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Constitutional Changes That May Restrain
Legislators

• Require the federal government to balance its
  budget like most states.
• Require a 2/3 or ¾ majority vote in both branches
  of Congress to fund deficit spending or increase
  its borrowing power.
• Require that Congress only spends an amount equal
  to last years tax revenue.

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Clear Thinking Proposition 6

• Government slows economic progress when it
  becomes heavily involved in trying to help some
  people at the expense of others.

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Production or Plunder?

• A neutral government can help make the economic
  production pie bigger when it protects property
  rights and provides public goods!
• It shrinks the economic pie when it plunders
  the income of one group to satisfy the interests
  of another.

Counterproductive, favor-seeking activities are
a natural outgrowth of unrestrained democracy.
CSE, p97
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Clear Thinking Proposition 7

• The costs of government income transfers are far
  greater than the net gain to intended
  beneficiaries.

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Income Transfers

• It is difficult to improve peoples well-being
  through income transfers when benefits are not
  attached to costs.
• The unintended consequences of secondary effects
  can get in the way.

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The Unintended Consequences of Income Transfers

• Reduce incentives of both taxpayer and transfer
  recipient to earn income
• Free income reduces work effort and innovation
  among transfer beneficiaries.
• Increased tax burdens stifle incentives to
  produce and earn more among persons earning
  income and paying taxes.
• Competition for transfers erodes most of the
  long-term gain of the targeted beneficiaries.
• When qualification requirements must be met,
  resources and potential production are wasted as
  individuals seek to qualify for the transfers.

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Income Transfers (cont.)

• Protection from adversity arising from imprudent
  decisions makes people more likely to increase
  the likelihood of that adversity.
• Consequences of adversity become less severe.
• Potential recipients have less incentive to avoid
  adversity.
• If you subsidize something, you get more of it.
• Transfers directed toward the poor
  unintentionally encourage high-risk lifestyles.
• Charitable efforts are crowded out.

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The War on Poverty IllustratesThese Points
War
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Clear Thinking Proposition 8

• Central planning replaces markets with politics,
  which wastes resources and retards economic
  progress.

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The Man of System

• The man of system is apt to be very wise to his
  own conceit. He seems to imagine that he can
  arrange the different members of a great society
  with as much ease as the hand arranges the
  different pieces upon a chess-board.
• -Adam Smith

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The Fatal Conceit of Central Planning

• Central planning merely substitutes politics for
  market outcomes.
• Subsidies and investment funds disbursed by
  planners are influenced by political
  considerations.
• Old firms tend to be favored over new,
  growth-oriented firms.
• Pork barrel projects are still pursued.

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The Fatal Conceit of Central Planning

• The incentive of government-operated firms to
  keep costs low, be innovative, and supply goods
  efficiently is weak.
• Boosting efficiency or lowering costs generate
  little political gain.
• Per-unit costs rise as increased inefficiencies
  get built into the political allocation.

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The Fatal Conceit of Central Planning

• Investors risking their own money will make
  better investment choices than central planners
  spending the money of taxpayers.
• Private investors bear the consequences of poor
  decisions directly but central planners do not.
• Private investors have a strong incentive to
  increase productivity and keep costs low. In
  contrast, political rather economic
  considerations are more important for central
  planners.

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The Fatal Conceit of Central Planning

• There is no way that central planners can acquire
  enough information to create, maintain, and
  constantly update a plan that makes sense.
• Market prices generally channel information
  quickly and accurately to both producers and
  consumers. On the other hand a political
  process, particularly one with checks and
  balances like those found in the U.S., will
  respond slowly and often in a contradictory
  manner.

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Clear Thinking Proposition 9

• Competition is just as important in government as
  in markets.

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Government Competition

• Leaders of public sector firms have little
  incentive to cut costs or boost performance when
  there is little competition.
• Inefficient programs are permitted to linger.
• Failure to achieve goals is often rewarded by
  increased funding. Consider increased funding in
  police departments with higher crime rates.
• In the market economy, profits and losses
  register performance. Inefficient producers are
  weeded out and efficient ones are rewarded.
  There is no parallel in the centralized
  government.

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Government Competition

• 3. Increased competition among decentralized
  government units or between the government and
  private sector creates incentives for government
  officials to work productively, seek efficiency,
  cut costs and innovate.
• 4. Citizens with differing preferences and views
  about government activities can vote with their
  feet in a decentralized system a centralized
  system does not permit this.

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Clear Thinking Proposition 10

• Constitutional rules that bring the political
  process and sound economics into harmony will
  promote economic progress.

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Constitutional Checks

• The scope of government must be limited.
• An unrestrained government results in the
  fleecing of citizens.
• Constitutional checks
• 10th Amendment
• 5th Amendment

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A Positive Program for Prosperity

• List the seven constitutional constraints
  presented by the authors.
• Explain the purpose of each constraint.
• Indicate why you think it will be either
  effective or ineffective.

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A Positive Program for Prosperity 7
Constitutional Suggestions

1. No government shall use its regulatory powers to
   take private property, either partially or in its
   entirety, for public use without paying the owner
   the full market value of the property taken.

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A Positive Program for Prosperity 7
Constitutional Suggestions

• 2. The right of individuals to compete in a
  business or profession and/or buy and sell
  legally tradable goods and services at mutually
  acceptable terms shall not be infringed by
  Congress or any of the States.i

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A Positive Program for Prosperity 7
Constitutional Suggestions

• 3. Congress shall not levy taxes or impose quotas
  on either imports or exports.
• 4. A three-fourths approval of both Houses of
  Congress shall be required for all expenditure
  programs of the federal government. At least
  two-thirds approval of the legislative branches
  of state government shall be required for the
  approval of expenditures by state governments.

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A Positive Program for Prosperity 7
Constitutional Suggestions

• 5. A three-fourths approval of both Houses of
  Congress shall be required before the federal
  government is permitted to borrow any funds to
  finance a deficit in its annual budget.

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A Positive Program for Prosperity 7
Constitutional Suggestions

• 6. A three-fourths approval of both Houses of
  Congress shall be required for the federal
  government to mandate any expenditures by either
  state governments or private business firms.

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A Positive Program for Prosperity 7
Constitutional Suggestions

• 7. The function of the Federal Reserve System
  (Fed) is to maintain the value of the currency
  and establish a stable price level. If the price
  level either increases or decreases by more than
  4 percent annually during two consecutive years,
  all Governors of the Federal Reserve System shall
  be required to submit their resignations.