A general consequence of government intervention is the distortion in economic decision-making caused by the taxation that pays for the intervention. Taxes on specific goods make consumers substitute to other goods for reasons other than the relative enjoyment they receive. Taxes on income cause individuals to work and save less. Taxes on corporations cause investment decisions based on tax consequences rather than profit maximization.
In principle governments can avoid these distortions by using what economists call lump-sum taxes. These are “levies” that do not depend on taxpayer behavior. For example, a head tax might require payment of $1,000 per person. Since the amount owed is unrelated to anything the taxpayer does, this kind of taxation does not distort behavior.
In practice lump-sum taxation is not politically viable due to equity considerations. Thus, real world tax systems do distort behavior. In addition, taxation generates compliance costs. Individuals spend time and money filling out tax forms. Businesses expend resources collecting and processing sales and employment taxes. Corporations spend effort computing and complying with the corporate income tax. And all these entities expend considerable effort avoiding or evading taxation. Economists disagree over the exact magnitude of tax distortions and compliance costs, but no one doubts these are substantial.
The overall point is that government expenditure of a dollar costs more than a dollar given the necessity of paying for the expenditure. So, even if an intervention generates benefits in excess of direct costs, that is not enough to make it desirable; the benefits must also outweigh the tax distortions and compliance costs that will result from the intervention.
Dr. Miron, I love your posts but why are they so small? They're like fancy candy: good but not very filling.
At least you could try suggesting other texts or resources that expand on the issue.
Posted by: Gabriel Mihalache | July 06, 2006 at 05:34 AM
Let's see some things Jeff left out.
Of course, government is not the only source of distortions. Credit card companies, for example, take a tax-like slice out of purchases. Wouldn't it be nice if you could make your purchase evading those costs? Especially if you're paying in cash: but the store still needs to charge the same price. You could even argue that all rents cause distortion as well.
How much does taxation on income reduce work? According to Does Atlas Shrug, not at all for the rich. Any unnecessary cost can reduce saving: the percentage that goes to the credit card company, for example.
Businesses also have compliance costs: it costs money to collect your money. Customers have to fill out all sorts of paperwork. And of course there's a huge amount of effort expended in comparing products and finding low prices.
So all those negatives aren't unique to government.
But Jeff's conclusion really says that those negatives don't matter if the benefits outweigh the total costs. Does he give us ANY reason to think one way or the other? Nope: as I predicted. "If he makes a claim, it would be nice if he tells us he's just blowing hot air, or backs it with the appropriate numbers."
Posted by: Mike Huben | July 07, 2006 at 09:27 PM
Huben,
Your argument about market based distortions would be more persuasive if you knew one when you saw one. Credit card fees, etc. are not cases of distortion. They are a price. Can you explain the difference?
"But Jeff's conclusion really says that those negatives don't matter if the benefits outweigh the total costs. Does he give us ANY reason to think one way or the other? Nope: as I predicted. "If he makes a claim, it would be nice if he tells us he's just blowing hot air, or backs it with the appropriate numbers.""
All the numbers in the world are useless unless you have some way of decidng what to do with them. Miron is providing the decision rule here, not claiming to offer a cost-benefit analysis of any specific tax or expenditure. In any case, so long as demand curves slope down and supply curves slope up, taxes will have deadweight effects, which is all Miron is referring to here.
The book you linked to looks interesting, but not really relevant. the book deals with the effects of progressivity, Miron's post with deadweight losses. A downloadable paper would have been better. Like this.
Posted by: James | July 07, 2006 at 11:26 PM
James: If government has a sales tax of 5%, you'd say that distorts. If a credit card company takes a 5% slice of a purchase, that will distort too. Please explain to me why one is a price and the other is not.
The "decision rule" (as you call it) is trivial, and agreed upon by pretty much everybody. The body of his message is a one-sided listing of costs with no listing of benefits and no listing of magnitudes of costs or benefits. In other words, he mentions a rule, but gives us innumerate and biased arguments.
It's as I predicted. "If he makes a claim, it would be nice if he tells us he's just blowing hot air, or backs it with the appropriate numbers."
Posted by: Mike Huben | July 09, 2006 at 07:16 PM
Oh, and "Does Atlas Shrug" IS relevant: as progressive taxes increase, you'd expect deadweight losses to increase as well. But they don't see that happening.
Posted by: Mike Huben | July 09, 2006 at 07:18 PM
Huben,
Re: prices and distortions, I asked you first. If you don't know, fine, but I'm dumbfounded as to why you'd so confidently make claims about distortions when you don't even know what distinguishes a distortion from a price. I'm not trying to be cagey, but I want you to answer my question and then I'll explain the difference (or you could hide the fact that you tried to be pursuasive using a term that you didn't understand and look it up or ask someone else). At the time you made your first comment to this post, did you know the difference between a distortion and a price?
"In other words, he mentions a rule, but gives us innumerate and biased arguments."
Do you believe that numbers are needed to justify Miron's conclusion? If not, why did you bother to make an accusation of innumeracy? No matter what, but especially if you are right, such put downs are superfluous. Why do you resort to them? Proving some of Miron's claims to be false would be a much better way to make your case. I'm beginning to suspect that you are just so eager to make negative posts that when you can't actually deny the claims Miron makes, you just toss out insults.
Let me say this as politely as I can. I've never heard or read a professional economist of any stripe call an argument innumerate for lack of quantitative empirical data. I'm trying to decide if that's because they know something about methodology that you don't or if it's because you know something about methodology that they don't.
"Oh, and "Does Atlas Shrug" IS relevant: as progressive taxes increase, you'd expect deadweight losses to increase as well."
Not necessarily. This is a good illustration of the fact that you need to actually know the implications of a theory before you can say that the data fail to support it. Recall that DW losses are proportional to the square of the tax *rate*. If the average rate was falling at the same time that the degree of progressivity was rising, I'd not expect increasing DW losses.
Posted by: James | July 10, 2006 at 03:55 AM
I'm not an economist but I think I can answer this question: "If government has a sales tax of 5%, you'd say that distorts. If a credit card company takes a 5% slice of a purchase, that will distort too."
You have a choice about whether or not to pay by cash or credit. Regardless of which way you choose to pay, the transaction will still occur.
You do not have a choice about whether or not to pay a government tax. In this instance the consumer may decide to not execute the transaction at all. It is the loss of a transaction that is the 'distortion' in the free market.
Posted by: Michael Lomker | July 10, 2006 at 04:14 PM
Michael Lomker, yes. Credit card companies introduce an option and expand the feasible set. When you buy the service the bank provides, it's just another market transaction.
An arrangement where some party external to the transaction tells you to choose between paying him 5%, not consummating the transaction, or being locked in a cage reduces the feasible set. Of course the consequences are the same whether the external party is a government or not, but it's usually just governments that can get away with this kind of thing.
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