Monday, February 7, 2011

All views about the levy are political

Some economists stress that Julia Gillard's decision to finance part of the Queensland infrastructure rebuild by means of a temporary tax levy is a "political" choice, not one dictated by the needs of economic management.

It's true. But the economists don't go on to acknowledge that their almost universal opposition to the levy is based not on value-free (or "positive") economic reasoning, but on a political philosophy buried so deep within their model - and so deep in the way economists are trained to think - that many of them don't know they're being just as political as the pollies.

I have to admit that, as I argued in this space last Monday, the sums involved in this exercise are too small to be worth arguing about. Even so, it's worth debating the principles involved in preparation for the time when the sums are material.

The fact is that the economists' basic, neoclassical model doesn't acknowledge the legitimacy of government intervention in the economy. So it's not surprising they're so predisposed to opposing government spending and taxation. The presumption against the legitimacy of government activity comes mainly from the model's unit of analysis: the individual. Economies are made up of individuals. End of story. What individual consumers and producers want is paramount.

The notion that individuals could choose to confer power on elected governments isn't contemplated. Nor is the notion that non-market institutions such as governments could create benefits for society that wouldn't otherwise exist. This is the basis for Margaret Thatcher's famous assertion: "There is no such thing as society: there are individual men and women, and there are families."

The next anti-government element of the model is its assumption individuals are "rational" - they always know their own mind and act in their own best interests. Since each of us is, in effect, infallible, no government can ever know what's in our interests better than we know ourselves.

So how could I ever be better off allowing government to confiscate some of my income via taxation and give it back to me (or worse, to poor people) in government spending programs? The third anti-government element of the basic model is its implicit assumption that markets always work perfectly in maximising our welfare. So who needs governments to put an oar in? This could only ever stuff things up.

All this means neoclassical economics is founded on the political philosophy of libertarianism: maximum freedom for the individual. Now, in principle, all economists accept there can be instances of "market failure". Even the libertarians accept markets can't be relied on to protect the private property rights of the individual. So they support government intervention to provide law, order and defence.

In principle, most economists accept the existence of "public goods", which only governments will supply in sufficient quantity (because the nature of the good or service renders it unprofitable to private producers). But the economic rationalist revival involves a new reluctance to accept instances of market failure.

It's also heavily influenced by a relatively new and highly political line of economic thought - "public choice", which holds that "government failure" is ubiquitous: when governments intervene they almost invariably make matters worse.

All this submerged intellectual baggage explains economists' knee-jerk opposition to using a temporary tax increase to help finance the rebuilding of public infrastructure and their almost universal preference for covering the cost by cutting "wasteful government spending".

Many economists are convinced wasteful government spending abounds. And, once again, they fail to acknowledge how highly subjective, even political, these judgments are.

Like beauty and fairness, wastefulness lies in the eye of the beholder; it's a value judgment, not something that proceeds from value-free economic analysis (which doesn't exist). Many economists refuse to take a position on fairness questions because they're so subjective, while being happy to denounce this or that spending as wasteful.

There wouldn't be many cases where government spending involved significant "deadweight losses" - pure waste, the elimination of which would leave no one worse off. Rather, most government spending involves losses to the taxpayers, who pay for it, and gains to the recipients of the spending.

Non-recipients may well regard a program as wasteful, but you can be sure the recipients don't. Economists in their wisdom may judge a program wasteful, but the recipients will vigorously disagree.

So decisions about how much to cut and what to cut will always be influenced by political considerations. As an example, the Prime Minister announced plans to cut the funding for the building of low-cost rental housing (which would have added to the supply of housing at a time of unmet demand) rather than scrap the first home buyer's grant (which adds to the demand for housing - and thus raises prices - without adding to supply). Why did she cut what I consider to be the wrong one? Because renters are a lot less politically powerful than home owners. So whether spending cuts will actually lead to a reduction of waste is anyone's guess.

Economists oppose hypothecated (earmarked) tax levies on the basis of arguments that would make sense if voters and taxpayers were rational. You need a feel for behavioural economics to see the virtue of taxes linked to certain spending programs.

They're an attempt to deal with the public's chronically asymmetric attitude to governments and budgets: the way we're always thinking of things the government should be doing to fix the world's problems, but are so reluctant to pay the taxes needed to pay for all the things we want done.

I support special levies - including most of the Howard government's levies - because they teach a freeloading electorate the most basic economic lesson: if you want it, you have to pay for it.