Clear Thinking Proposition #2 Allocation through political voting is fundamentally different from market allocation, and economic analysis indicates that the latter is more consistent with economic progress.

The Political Process Is merely an alternative form of social organization Is not a corrective device that can consistently be counted on to provide a sound remedy when problems arise

Free Markets and Democracy? Democracy does fail. Majority rule while protecting minority rights is difficult Many people argue that all we need to do is export democracy and free markets and we’ll make the world a better place. This may not be true when we set up opportunities for the tyranny of the majority.

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.

Benefits and Costs of a Hypothetical Government Project  Building a Road 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 $60) Brown Green Jones $ 3.00 (6% of $50) $ 3.60 (6% of $60) Smith $ 2.00 (4% of $50) $ 2.40 (4% of $60) TOTAL $50.00 in total benefits $60.00 Project costs $60 but only provides $50 in benefits Use to illustrate that the democratic process can be used to pass an unproductive governmental proposal. Aggregate benefits are less than the aggregate costs. Reference CSE, Table 3. Reference: CSE, pages 84-85. If the benefits are linked proportionately to the taxes paid, the proposal will not pass. However, a voting majority could pass Plan A which is unproductive. Jones and Smith must participate and pay.

A Democratic Government: Some 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. 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.

“Government is the great fiction through which everybody endeavors to live at the expense of everybody else.” Frédéric Bastiat (1801 – 1850)

Let’s Compare Democratic Governments and Markets The government can use coercion to tax and subsidize. Markets can not. Markets can charge high prices but can not force people to pay. Governments “can” and “do”. Majority rule provides the basis for government action, while market activity is based on mutual agreement and voluntary exchange. The political process imposes the same option on everyone, while markets allow for diverse representation. 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. Instructors may want to elaborate on the meaning of proportional representation. Consumers buying one commodity will not interfere with the ability of others to buy alternatives. For example, 20% of all auto consumers can purchase Chevrolets and 15% can buy Fords. And their consumption decisions will not interfere with the choices of others to buy different models. 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.

What Is Needed to Encourage Democratic Governments To Be Productive? Need 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. Linking benefits proportionately to the costs reduces the likelihood that people can participate in government projects without paying

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 Other than Taxes 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.

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.

In 2004, the Small Business Administration Finds That The annual cost of federal regulations in the United States increased to more than $1.1 trillion in 2004. This sums to $8500 per household, or 11 percent of national income. W. Mark Crain and Thomas D. Hopkins, “The Impact of Regulatory Costs on Small Firms,” (Washington, D.C.: U.S. Small Business Administration, 2001), p.24. Available online at http://www.sba.gov/advo/research/rs207tot.pdf. The updated and extended report, by W. Mark Crain, "The Impact of Regulatory Costs on Small Firms," (Washington, D.C.: U.S. Small Business Administration, 2005), p.4, also available online at http://www.sba.gov/advo/research/rs264tot.pdf.

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.

Government Can Distort Prices Taxes distort incentives. 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.

Deadweight loss Loss of economic efficiency that occurs when equilibrium for a good or service is not achieved or is not achievable.

YOU'RE WRONG!!! DO THE MATH 75 cents + $1 = If I told you that the equilibrium price of SNICKERS was 75 cents. And that the government is now imposing onto sellers an EXCISE TAX of $1 per snickers sold WHAT WILL THE NEW EQUILIBRIUM PRICE BE??? YOU'RE WRONG!!! DO THE MATH 75 cents + $1 =

Taxes are a resource cost, which shifts the Supply Curve New Equilibrium Prices are then formed from an interaction of SELLERS and BUYERS together

The Supply curve is the MINIMUM amount a seller would accept at a given quantity At any given quantity, sellers now take the minimum amount PLUS the tax ST P S TAX Price buyers pay = PB PE Govt Revenue = PS Price sellers get Deadweight Loss D Q

$1 TAX P Q Cigarette Tax ST S D Consumer pays $0.86 Seller pays $0.14 Price buyers pay = $5.13 $1 TAX $4.27 Consumer pays $0.86 Seller pays $0.14 = $4.13 Price sellers get D Q

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. The political attractiveness of budget deficits, money creation, and various indirect taxes stems from the desire of politicians to conceal the costs of government programs.

~ Senator Bob Dole Wall Street Journal “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 Dole Wall Street Journal December 16, 1983