Friday, December 15, 2017

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Would You Oppose a Tax Cut on the Grounds that it Only Applied to a Few Firms?

A few weeks ago, Pete Boettke graciously invited me to speak at the Philosophy, Politics and Economics workshop at GMU. During the course of the talk, I extolled the virtues of what Hayek called “generality”—the idea that political action should not (positively or negatively) discriminate against any person or group of persons. (Note: generality goes beyond the 14th Amendment guarantee of equal protection under the law. That only prohibits discriminatory application of laws, but it does nothing to prohibit discriminatory laws such as taxes that apply to one group but not another. A true generality principle says that the laws themselves should not discriminate.)

Near the end of the talk, one of the attendees asked if I would oppose a tariff reduction for one (and only one) industry on the grounds that it violated generality. I believe many free-market advocates would say “No; we should always take any opportunity to expand economic freedom.” Milton Friedman expressed this view when he declared he’d “never met a tax cut I didn’t like”

My answer, however, is that in some circumstances the advocates of economic freedom should oppose such a tariff reduction. This is because I believe those of us who value economic freedom should also value generality. I have four reasons.

  1. Generality is morally intuitive. Kant called it the “categorical imperative,” others more prosaically call it the “golden rule.” Whatever you call it, it seems that lots of humans in lots of cultures value the idea that laws ought to treat us equally.
  2. Violations of generality make us poorer. When government discriminates in the way it taxes or in the way it spends, people change their behavior (note that in traditional public finance, a head tax creates no loss because it doesn’t discriminate between work and leisure or between consumption and non-consumption). And these changes in behavior are costly because they tend to discourage mutually-beneficial exchange. Economists call this the deadweight loss of taxation and these costs are greater when policy is more discriminatory. Thus, a tax that raises $100 million by taxing goods and services equally will involve less deadweight loss than a tax that raises $100 million by taxing only goods. What’s more, the tax rate on goods will have to be higher if the government wants to obtain the same amount of revenue. (I could mention other economic costs under this same heading. For example, knowledge problems and malinvestment, both loom large under discriminatory taxation).
  3. Violations of generality create rent-seeking loss. When government is in the business of privileging some and punishing others, citizens tend to invest resources (time, money, effort) in asking for their own privileges or in asking that others not be privileged. Quite often, these efforts produce no value for society and are a loss.
  4. Violations of generality make it easier to violate economic freedom. In the long run, I believe a norm which permits violations of generality will tend to make it easier to violate economic freedom. Consider a proposal to tax each of three people $10, plus one additional dollar in deadweight loss, in order to turn around and redistribute $10 to each of these same three people. None of our three citizens would be willing to vote for it. But now consider a proposal that costs each of three people $11 ($10 in tax + $1 in DWL) in order to turn around and redistribute $15 to two of the three. Now a majority coalition can easily be formed. The coalition is made viable only by violating generality. What’s more, the coalition will be even stronger if the proposal not only violates generality on the spending side but also on the taxing side. That is, if the proposal is to impose $33 in costs on only one person in order to distribution $15 to each of the other two, then the coalition will be especially strong. In fact, if it can shield itself from the pain of taxation, the coalition will be prone to ask for much more revenue. So in the long run, economic freedom is protected by adhering to generality, even if in the short run the two values appear as a trade-off.

None of this is to say that we shouldn’t also value economic freedom. To put it in terms that economists will quickly grasp, my indifference curves look like this:







Not like this:







Too often, in my view, conservative policymakers are suckered into violating generality because they believe they are advancing economic freedom. They end up supporting tax preferences for manufacturing, ethanol, housing, child bearing, and much else on the grounds that any tax cut is a good tax cut. Many of these tax preferences are the result of cronyism and each entails a host of economic and social costs. The end result is a tax code that is monstrously complex and that, too, is a cost.

The first-best solution is low and non-discriminatory taxation. Beyond that, I think we need to recognize that there are (short run) trade-offs.