Thursday, March 14, 2013

Thinking About the Size of Government

Back in ancient times, when the public good wasn't really seen as part of the role of government, it went without saying that the extraction of income by private individuals with the blessing of the government was part of the revenue of government (even if it ended up in private coffers). Tax farmers, private customs officials, feudal lords, military contractors, and other parasites were obviously seen as being a part of the government even though they often acted primarily in a private role simply having bribed the government with a payment or loan in return for the right to extract rents from people just trying to get by in their day to day lives.

Today, however, it seems that we are supposed to believe that government is only whatever is on book and on budget. Outsourcing government function to the private sector is "privatization," not an expansion of the public sector. But how is the private sector extracting rents from the public materially different from the tax farmers of yore? How does outsourcing Medicare through vouchers, as in Paul Ryan's budget, create a smaller government when the bureaucracies of government adjacent private companies like health insurers taken into account? How are tax deductions, like the home mortgage interest deduction, not an expansion of government into the housing sector? How is the tax preparation industry not a creation of government's desire to make spending not look like spending?

This little outburst is the result of Paul Ryan's really silly budget and the growing evidence of the failure of 401ks as a retirement program. How is outsourcing Medicare to the private sector anything but an expansion of government? Due to higher administrative costs vastly more money will flow into the sector as a result of this action increasing the role of the government in the economy. Sure, much of it will be off books, but so was the excess taken by a tax farmer in the Roman Republic. What difference is there? The same goes for the 401k program. Government tax preference results in savings** going to more expensive private management, rather than to the very inexpensively managed Social Security program. How are the managers of these funds ultimately different from a Roman tax farmer? All these programs achieve is creating an opportunity for private individuals to extract rent from public programs; just like with the ancient practice of tax farming all that is achieved is a nominal reduction in the government's administrative cost but at the cost of greatly increasing the impact of government policy on the ground. The size of government is not simply that captured by government share of GDP, to properly assess the size and role of government leveraged private dollars, whether in housing, health care, retirement, education, tax preparation or other programs also need to be taken into account. Using this more accurate assessments, many programs advertized as reducing government would be seen as expanding it; which they do conceptually even if it is ideologically convenient to ignore this.

Now, I do see there being some sense in arguing if these programs are in some way better from direct government oversight; though as I like to say that is an empirical question. But I disagree that they reduce the size or scope of government, describe these programs in the terms we would use for ancient practices and the continued government role is obvious. Privatizing government functions does nothing to decrease the size or scope of government, it almost always does the opposite. It is simply an accounting trick and one that has significant costs.

*I've written enough on Paul Ryan that I don't feel any need to go beyond an ad hominem in addressing it. The man's an idiot that gives every appearance of being a true believer in his ideology and not really understanding either the empirical data or opposing views.

**While I don't read up a lot on this topic, what I have read indicates that the 401k program does little to increase savings. People don't seem to actually behave according to the economic assumptions these programs are based on; indicating a problem with the theory not people's behavior (I often here a blame the victim approach when people don't act as certain economists want them to, with a social science the purpose is to accurately model observations, if the behavior diverges from the theory your theory is bad, if you think otherwise you're engaging in moralizing, not science).


  1. I am curious about your critique of the 401(k) program. Overheads on 401(k) plans can be extraordinarily low, lower than social security, if the right funds are chosen. It seems a simple matter to mandate the inclusion (if not exclusive offering) of index funds, which have the absolute lowest cost of any 401(k) offering. In addition, the degree to which social security offers real returns is pitiful compared to securities. Even highly successful forced savings schemes such as Singapore's CPF offer higher returns on their retirement portions. Singapore's has a statutorily guaranteed return floor of 4% and is regularly updated. Given the opportunity to choose slightly higher overhead in return for increased ability to expose myself to risk (and presumably, returns), I'd take them, and I don't see how denying someone that choice in a scheme that truly forces people to save more will help.

    1. I have a few different issues with the 401k program.

      My first critique of the 401k program is that the tax advantage is strongly skewed towards the wealthy.

      My second critique is that it doesn't appear to have a large impact on savings, as is well known the US savings rate has declined markedly over time despite the tax advantages. Since 401ks are largely intended to increase savings this has to be seen as a massive failure.

      Then there are smaller issues. Most people lack the sophistication to make good investments. This makes them vulnerable to predatory marketing by firms which target these individuals.* Many firms provide their employees with 401k plan options, if you're HR department isn't very good you may have terrible choices available. It also serves to drive assets into private hands, which is just old fashioned rent seeking. While if value is added this may not be such a bad thing; but I think we should be sceptical of this without contrary evidence.

      Of course, the 401k program is great for sophisticated investors. It certainly aids me relative to a higher statutory forced savings program like Social Security. But this is just rent-seeking on my part, once our student loan debt is paid down both of us will doubtlessly be saving more than statutory maximum to our 401ks and would do so without the program. So my behavior isn't changed, I simply get a large tax deferral from the government as a handout for doing what I was doing anyway; meaning that those less well off than me face higher taxes to compensate for this. What is just or fair about a situation that gives more to those that have and takes from those that don't?

      *I see this as related to a broader issue. The more I read about the industrial revolution and capitalism in general the more convinced I am that the advantages accrue from specialization, the extension of markets to broader groups of people, and the more refined way in which rewards can accrue to people based on the value of their talents/skills to others.

      I see much of this being reversed. Programs like 401ks mean that people who are financially savvier gain larger benefits than people who are less financially savvy, though this may have nothing to do with their ability to contribute to society or what others are willing to pay them. This dissociates reward from ability and pushes us away from a capitalistic society, where specialization is emphasized, and towards the pre-capitalistic state where people needed a broad array of skills just to get by rather than simply needing to excel in one array.

      In short, I see a major tension between personal responsibility, which requires a broad array of skills and is essentially an agrarian virtue, and capitalism, which in theory should reward narrow specialization based on market value.