The Burden of Spending

Today’s “big headline” is the cost of Presidential contender Bernie Sanders’ policy proposals, estimated by the Wall Street Journal at about $18 trillion over 10 years – enough to increase Federal spending from 20% of GDP to 30% within one year. It would represent the highest government spending, as a fraction of national product, outside of World War II.

What’s remarkable about this story isn’t the numbers, or even the policies. It’s the way both sides are completely losing sight of what ought to be basic economic principles.

In the conservatives’ telling, this expansion of government spending will be catastrophic; the socialists correctly note that the $18 trillion figure is misleading because it doesn’t fundamentally change what is purchased, only how things are. Accordingly, the policy proposals should be viewed as a change to the institutions through which we obtain services, not the services themselves. As the socialists observe, “almost all of it is on things we’re already paying for; he just wants to change how we pay for them.” It’s a mistake to treat (some of) this spending as new: $1 of health services paid via taxation is the same as $1 purchased through markets, and if our objective is people’s welfare, the source of the spending should be irrelevant.

On this, they’re both right and wrong. It’s true that government spending displaces private spending in the same area. However, the socialists fail to acknowledge the real crux of the matter, which is that this kind of institutional change affects incentives, and therefore behavior at the margin.

When we pay for health care ourselves, we care deeply about how efficiently it’s used; when we don’t feel the cost of our decisions, we care less about those costs – which is the problem with private insurance just as surely as entitlements. Moreover, we can make tradeoffs between health care and other goods. When we pay for things via taxation, we lose the private, individual vigilance about efficiency as well as the ability to make tradeoffs according to the particular circumstances of time and place. We become inclined to consume more, and less efficiently. The only check on this is deliberate regulatory action – but bureaucrats are rarely as invested in making the right decisions as individuals. In some ways the bureaucrats have the advantage owing to greater bargaining power, but they are simultaneously confronted with the challenge that creating a solution that works for most – to say nothing of everyone – is a problem that is much bigger than bureaucracies can ever hope to overcome. This is because policymakers’ tools are broad rules affecting broad categories of people; someone will inevitably be left out in the cold. Individuals may have less power acting as individuals – which they can mitigate by organizing as collectives – but have the advantage in the ability to tailor their decisions to their own unique circumstances.

And it is precisely this last point that creates additional hurdles for regulation: even when working at its best, regulatory imposition creates a mismatch between economic reality and individuals’ perceptions of it. One of the most important functions of the price system is to ration scarce resources voluntarily. When spending is hidden and then controlled by a gatekeeper, people tend to grow dissatisfied because the information that’s visible to them – the price – no longer signals the relative value or scarcity of a good. The individual has strong unmet desires, and without the ability to negotiate in the market, must instead attempt the Herculean task of negotiating with a faceless bureaucracy convinced of its own wisdom. “Frustrating” is the understatement of the century.

Beyond this, there’s essentially no way to pay for any of the proposed spending. These costs cannot be met by shifting spending priorities. Even eliminating 100% of the military budget would free up less than a third of the proposed costs.

Sanders’ policy advisers note that the proposals will require heavy taxation of the middle class. Aside from being politically untenable – the history of taxation in the US is the shifting of tax burden from the public to the wealthy – the imposition of taxes creates its own problems. Like spending, taxation distorts incentives, particularly the incentive to save and invest. Each dollar taxed comes with the deadweight losses of collection, evasion, avoidance, and reduced productivity. Those who believe that the government could pay for these programs via increased taxation are invited to look at a time series displaying US tax revenues as a percentage of GDP. Despite nominal rates ranging from 40-90%, revenue has been a stable 18% or so, hitting an all-time peak at 19% in 1969. There is no obvious way to push past this barrier, because people’s behavior shifts in response to taxation, both in the form of increased tax avoidance and reduced output. Levying a wealth tax might generate some revenue – a 100% rate on billionaires would cover the spending for a year – but nothing destroys an economy quite like retroactive confiscation of legitimately-earned wealth.

On the one side, we have conservatives who don’t acknowledge that moving line items in a ledger doesn’t affect the bottom line, and on the other, socialists who don’t acknowledge that incentives matter.

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