Common Sense Economics 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

Some Questions to Consider: Why do political results so often differ from what was promised? Why do all governments seem to have a tendency to expand? What are the secondary effects of government policy? Each of these questions, as posed in the text, can serve as great discussion starters for students either pre- or post-reading. For more small group discussion questions, see the accompanying document.

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

Clear Thinking Proposition #1 Government promotes economic progress by protecting the rights of individuals and supplying goods that cannot be provided through markets.

Protective vs. Productive Functions Government’s protective function includes the maintenance of a legal framework. Government promotes economic progress by protecting people against loss of their lives, liberties, and properties. Note that the protective function also includes the provision of national defense (a public good) and local police protection, not just a formal legal system. The importance of contract law, however, should also be emphasized here.

Protective vs. Productive Functions (cont.) Government’s productive function includes the provision of public goods. Public goods are not easily provided by markets because they are non-rivalrous and characterized by shared consumption. Ask students to generate examples of other public goods. Some examples might include K-12 education, national defense, many infrastructure systems, etc. Once examples have been generated, ask student if each should be provided by the public sector, or whether the private sector might have any advantages in their production. (Note: This discussion is continued later in this section, especially with the Matrix of Production and Payment.)

Clear Thinking Proposition #2 Government is not a corrective device.

Government as Social Organization Policies favored by majorities do not necessarily promote economic progress. The benefits and costs faced by voters belonging to different interest groups are often disproportionate. It may be useful to provide a brief description of public choice economics here. Lessons on logrolling and voter models are also very useful in emphasizing to students the variance between differing groups’ benefits and costs in pursuing public policy.

Markets & Democracy The fundamental difference between democracy and markets is the government’s coercive power to tax. When goods and services are financed by coerced payments, there is NO assurance that they are valued more than they cost. Point out to students that no such coercive power (i.e., as the government’s power to tax) exists in the private sector. Markets are analogous to a system of proportional representation, whereas political democracy is a system of majority rule, where a slim majority can impose its will on a nearly equal sized segment of the citizenry. Ask students to generate examples of goods or services that seem to actually be valued LESS than what they cost. Answers will vary, but any publicly-financed product which students believe is “not worth it” will do.

Clear Thinking Proposition #3 The costs of government are not only taxes. The amount of revenue a government collects in taxes is often misconstrued to represent the total costs of the institution, its services, and policies. Nothing is further from the truth…Tax revenue figures fail to account for the opportunity costs associated with tax policy decisions.

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 As always, the concept of opportunity cost is extremely relevant here. Federal budget simulations may be useful here. Just one example of such a simulation is found at http://www.econedlink.org/lessons/index.cfm?lesson=EM306. Such simulations tend to demonstrate to students that it is easy to decide on expenditures, until you begin to consider the alternative uses of these same funds.

Loss of Private Sector Output All funds have alternative uses. Public sector production is not entirely financed by tax collection… Ask students to come up with examples of products produced by the public sector which are at least partly financed through the private sector as well. Just one type of such product is one which users pay a fee for, such as a toll road or perhaps a park.

Costs of Collection & Enforcement Preparation, monitoring and enforcement of tax law and regulatory legislation must be funded. $843 BILLION in 2000 $8,200 per household Total government burden represents more than ½ of GDP. The White House estimates that it takes a total of 3 billion hours to comply with the tax code, or about 27 hours per taxpayer. Estimates of the cost of complying with the U.S. tax code top the $200 billion mark, not inclusive of enforcement and regulation. In other words, U.S. citizens spend nearly $200 billion in man hours essentially preparing their taxes. The U.S. tax code is up to nearly 55,000 PAGES in length.

Price Distortions Taxes distort incentives. Some exchanges will not occur because the tax makes them no longer advantageous. Deadweight loss of taxation adds 9-16% above the costs of compliance and regulation.

Clear Thinking Proposition #4 Unless restrained by constitutional rules, special-interest groups will use the democratic process to fleece taxpayers and consumers.

The Power of Special Interests Special interests will help politicians get elected (money and workers). While others are harmed, there is little incentive to act in opposition. Thus, politicians cater to special interests. Ask students if they have ever engaged in activism for a cause that required political (hence fiscal) action. Have they ever argued for such action based on the “look how little it costs you to save/do/better ____”? Have they ever heard such a ply being used on behalf of other causes? How effective is this strategy?

A Sweet Example WHO WINS???? $1.9 billion in sugar subsidies disbursed annually. The average consumer pays $20 per year in higher sugar prices. $13 million contributed to politics by the sugar lobby in 2000. WHO WINS????

Clear Thinking Proposition #5 Unless restrained by constitutional rules, legislators will run budget deficits and spend excessively.

Deficits & Reckless Spending Remnants of the Keynesian “revolution” Spending is much more politically attractive than taxing. Debt pushes the visible cost of government into the future… Immediate benefits with deferred costs are hard to defeat! Remind students that the Keynesian “revolution” suggested that government spending (and subsequent deficits) could be effective macroeconomic stabilization tools. There are many national debt clocks available for students to look at on the web. Just two examples are http://www.uwsa.com/uwsa-usdebt.html and http://www.worldnewsstand.net/history/your_debt.htm. Such sites help to bring home to students just how rapidly our national debt is on the rise, and assists them in thinking about the trade-offs that come with financing the present with the future.

Spending Watchdogs Little incentive to be spending “watchdogs” exists. eg. splitting the bill at dinner Will increased tax revenue control spending inclinations? Press students on why the inclination to spend seems only to increase with increased revenue? Why can’t policy-makers ever settle on “enough’s enough” in terms of government expenditures? What does this suggest about the ease with which tax reductions can be accomplished?

Clear Thinking Proposition #6 Government slows economic progress when it becomes heavily involved in trying to help some people at the expense of others.

Production or Plunder? Only a neutral government can protect its citizenry from plunder. “Lost” resources directed at favor-seeking are proportional to their efficacy. Ask students is a “neutral government” (or individual policy-maker) is even a real possibility? Stress that this does NOT mean that policy-makers are inherently bad, wasteful, uncaring, etc., but rather that the incentives to spend are unavoidable in our political system. “Counterproductive, favor-seeking activities are a natural outgrowth of unrestrained democracy.”

Clear Thinking Proposition #7 The costs of government income transfers are far greater than the net gain to intended beneficiaries.

Wars on Poverty Difficult at best to improve people’s well-being through income transfers. The unintended consequences of secondary effects get in the way.

Ineffectiveness of Income Transfers Reduced incentive of both taxpayer-donor and transfer recipient to earn income “Free” income reduces work effort and innovation. Increased tax burdens stifle the incentive to produce and earn more. Competition for transfers erodes most of the long-term gain of the intended beneficiaries. When qualification requirements must be met, resources and potential production are wasted as individuals seek to meet them. Ask students if the above claim about diminished work effort is controversial. Why or why not? If the claim is true, why does it not influence the politics of transfer payments?

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. The moral hazard problem is useful to introduce to students here. Using car and/or health insurance as policies that encourage riskier behavior is a non-controversial way to introduce the concept. That is, ask students to explain why insured drivers might be more likely than uninsured drivers to take risks/drive aggressively. Then you may be able to connect easier to the moral hazard issue in terms of income transfer programs.

Clear Thinking Proposition #8 Central planning replaces markets with politics, which wastes resources and retards economic progress.

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

The “Fatal Conceit” of Central Planning Central planning merely substitutes politics for market verdicts. Subsidies and investment funds disbursed by planners are still influenced by political considerations. “Old” firms tend to be favored over “new”, growth-oriented firms. “Pork barrel” projects are still pursued. The incentive of government-operated firms to keep costs low, be innovative, and efficiently supply goods is weak. Little is to be gained from efficiency gains and/or lower costs. Higher per-unit costs are the norm as budgets expand and efficiency gains are not realized.

The “Fatal Conceit” (cont.) 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 investments directly. Since little personal wealth is realized by planners, there exists little incentive to increase productivity and/or conserve resources. There is no way that central planners can acquire enough information to create, maintain, and constantly update a plan that makes sense. Markets are most adept at channeling information to both producers and consumers via the price system.

Clear Thinking Proposition #9 Competition is just as important in government as in markets.

Government & Competition Leaders of public sector firms have little incentive to cut costs and/or increase productivity. The profit rate is an index of performance for firms in the private sector. Poor performance is often an argument for increased state funding instead of the stricture of bankruptcy. Citizens hold differing views on appropriate public expenditures; a centralized system cannot accommodate multiple viewpoints. Ask students why private firms are penalized for incurring losses while the public sector is not (and in fact, may even see budgetary INCREASES if losses are sustained). What effect does this have on the overall productivity of the economy?

Clear Thinking Proposition #10 Constitutional rules that bring the political process and sound economics into harmony will promote economic progress.

A Pipe Dream? The scope of government must be limited. An unconstrained government results in lost productivity as people fight over their “pieces of the pie”…so the pie never gets any bigger. Constitutional checks: 10th Amendment 5th Amendment Please note that the text includes a proposed “Economic Bill of Rights” as suggestions for accomplishing the objectives above. A separate Power Point presentation on this “Bill of Rights” is also included.