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Never Accept an Interventionist Premise

Mises Daily: Monday, October 11, 2010 by

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The people who design advertising and political campaigns know that if they can frame the issues, they've already won. In an economics context, I've previously alluded to euphemisms for tax hikes, and how in grad school we actually used the term "social-planner's solution" to denote the ideal use of resources. How can an Austrian economist fight back against the "planning" mentality when every PhD student has had this terminology burned in his or her mind?

We see yet another example of this problem in a recent post from George Mason economist Bryan Caplan. Now Caplan is (famously) no longer an Austrian economist, but nonetheless by mainstream standards he is an extremely radical free-market guy. And yet as we'll see, Caplan casually throws around a suggestion to impose a new tax, simply because that's the analytical framework in which today's professional economists have been trained.

Caplan's Offhand Proposal to Impose a New Tax

Things started off harmless enough. At the popular blog EconLog, Caplan wrote a post explaining that he has several views that are "inconvenient," because his rationale for a given position is not "ideologically clean" or "crowd-pleasing."

For example, Caplan thinks that people ought to have more kids. However, this isn't because children are the future, and parents ought to sacrifice everything for their offspring. On the contrary, Caplan thinks that parents don't really affect how their kids turn out in the grand scheme, and that if they (parents) would just relax, then they could selfishly enjoy having more of the little photocopies of themselves running around. Needless to say, Caplan would not get a standing ovation for expressing this position, whether at a Tea Party or the Grammys for that matter.

But Caplan recognizes that it's not just his views on children that are inconvenient. On the topic of formal schooling, he writes,

A high fraction of education teaches no useful jobs skills; instead, it's largely socially wasteful signaling. Government support for education is like government subsidies for air pollution; they encourage additional production of a good that the free market already overproduces relative to the efficient level. A first-best efficient education policy would actually tax education; but given public choice problems, the wisest course is to eliminate government support and rely on laissez-faire.

Yikes! Recognizing that I am more sensitive than most to claims that a new tax would be "first-best efficient," I asked in the comments for a clarification. Just what exactly was Caplan saying here?!

He graciously gave a follow-up post that only exacerbated my angst. I'll reproduce the whole thing — with Bryan quoting me and then responding — below:

[Robert Murphy:] When Bryan says the first-best solution is to tax education, is he just making a point that there are negative externalities? In other words, does Bryan also think a government tax on pollution is the optimal thing?

[Bryan Caplan:] "Optimal" in the sense of first-best Kaldor-Hicks efficient, yes. Of course there are many background assumptions here, too: That government knows enough to pick the efficient tax rate, that the deadweight costs of collection exceed the deadweight costs of bargaining, etc.

[RPM:] I realize he brings up public choice issues, but the standard libertarian anarchist objection to taxation (even in cases of negative externalities) goes beyond mere public choice arguments.

[BC:] As I see it, the standard libertarian anarchist objection to taxation is moral: Even if a tax is first-best efficient, we shouldn't do it. I discuss my full views on Pigovian taxation here.

[RPM:] So I'm asking, before I get all worked up and perhaps write an article over at Mises.org explaining what's wrong with Bryan's view here, can someone point me to a discussion where he spells out his views on when it's a good idea to tax something?

[BC:] Again, there's "good idea" in the sense of economically more efficient, and "good idea" in the sense of morally right. My approach to economic efficiency is straight out of the textbook (or better yet, Landsburg), though I naturally think that most economists have a big statist bias when they apply the concept. Morally, I don't buy libertarian anarchist absolutism, but the real-world efficiency case in favor of taxation isn't strong enough to overcome the presumption against taking people's property without their consent.

Explaining Caplan's Endorsement of a Schooling Tax

Before explaining why I think Caplan's explanation doesn't work, let's first be clear on where he's coming from. Caplan subscribes to a "signaling" model of education (although really it's a model of schooling, which is different from education) as popularized by the economist Michael Spence in a 1973 article.

In this approach, the reason an employer will offer a higher salary to, say, a Harvard physics major with a 4.0 GPA than he would to someone with a 2.5 GPA and a literature degree from a community college isn't that the job will require knowledge of Maxwell's equations for electromagnetism. Rather, Spence's signaling model says that the type of person who chooses to major in physics at Harvard, and can graduate with a 4.0, is also the type of person who will do well in many jobs. So it's not that college (and graduate school) actually endow students with useful skills, it's just that they provide mental hoops for students to jump through and thereby exhibit their intrinsic abilities to employers.

To the extent that the Spence model is accurate, getting formal degrees is an arms race of sorts. If everyone could agree to spend fewer years in school, then everybody would be better off. However, no individual student can benefit from unilaterally skipping college, because our society is currently stuck in the equilibrium in which productive individuals signal their talent by getting degrees from prestigious colleges.

Now we see why Caplan thinks that it would be more efficient if people spent less time at school: When a high-school graduate opts to go to college, he or she reduces the marketability of everybody else's college degree. Yet the normal individual doesn't take this negative externality into account when deciding whether or not to go to college. Therefore, to correct for this "market failure," Caplan says ideally the government should impose a tax on (formal) education.

The Problem with Caplan

To be fair to Caplan, he is not actually endorsing a tax on schooling. Remember, in the original post he explicitly says that "given public choice problems, the wisest course is to eliminate government support and rely on laissez-faire."

Yet the problems with the proposed tax go far beyond issues of public choice, which have to do with setting up incentives so that we can trust the government to properly apply this taxing power. Indeed, Caplan himself — in his clarification to me — offers a few more things that he didn't spell out originally: "Of course there are many background assumptions here, too: That government knows enough to pick the efficient tax rate, that the deadweight costs of collection exceed the deadweight costs of bargaining, etc."

"The question of the government knowing enough to set the optimal tax rate is a specifically Austrian objection."

These aren't all public-choice issues; the question of the government knowing enough to set the optimal tax rate is a specifically Austrian objection. Beyond that, Caplan has overlooked the possibility that there are positive externalities associated with formal education. After all, this is the reason so many people support government subsidies for schooling: the idea is that an educated person showers benefits on other people, not just himself.

So we see that there is a lot more packed into Caplan's offhand designation of a new tax as "first-best efficient." Besides assuming away the problems of trusting the politicians with such a power — a concern that Caplan explicitly mentions — this designation also assumes that the bias toward too much schooling (to the extent that schooling is a big signaling game) more than offsets the bias toward too little schooling (to the extent that others benefit from students going to school). Moreover, whatever the theoretically optimal nudge from the government should be, Caplan assumed (without mentioning it originally) that the politicians would know it, or at least get close enough so that their intervention would do more good than harm.

At bottom, I think what's really going on here is that Caplan is trying to tell people that he thinks a person's decision to purchase more schooling can negatively impact other people. But instead of saying that, Caplan says, "A first-best efficient education policy would actually tax education."

Yet notice that Caplan could just as easily have written, "An optimal solution to education would actually involve gang members randomly beating up college freshmen." I am not exaggerating. Caplan's statement is literally equivalent to my own suggestion in terms of both the economic analysis and even his own (practical and moral) misgivings.[1]

Surely, nobody in his right mind would endorse my statement. If people accused me of being a monster or a lunatic, I could defend myself and say, "Wait a second, I'm not actually endorsing the plan to set gang members loose on campuses. We obviously couldn't trust them to beat up the optimal number of students, and thereby correct the negative externality of going to school. And sure, now that you mention it, by calling it 'optimal' I have in mind the background assumption that the gang members would have enough information to actually calculate what the optimal number of students to beat up would be. And finally, most people — including myself — would say that the efficiency gains from my idea would not trump the presumption in favor of not beating people up against their will. So don't misunderstand, I acknowledge all of these caveats when I say it would be a first-best outcome for gang members to beat up freshmen at random."

Would anybody be satisfied after I gave such a defense?

Would we be content to say that beating up students is "first-best," but that in reality, we have to settle for the "second-best" solution of respect for property rights and refraining from coercion?

Conclusion

What is so obvious in my silly suggestion of gang violence becomes less so when it comes to proposals to have politicians take people's property against their will. This is yet another fruit of the terminology and models of mainstream economics.

Notes

[1] Purists might object to my analogy, because (they learned in grad school) that a government transfer payment is neutral in terms of Kaldor-Hicks efficiency, whereas a gang beating doesn't seem to be. In other words, if the government taxes a college freshman $500 for going to school, then the freshman is down $500 but the government is up $500, so it's apparently a wash. In contrast, if a gang member beats up that same freshman, then he imposes harms that are not offset by gains to anybody in society. Hence the "efficiency" of the tax, in correcting the alleged market failure. But this analysis is wrong. In the real world, the government doesn't gain $500 in disposable income for every $500 it takes from citizens, if for no other reason than the salaries it has to pay bureaucrats at the IRS. Furthermore, in what possible sense is it "efficient" for the government to have $500 more to spend? Since the US government in actual practice uses its funds to impose all sorts of "negative externalities" on people all over the world, even on Caplan's own terms, it's not at all clear that extra money in the government's coffers should be construed as a "social gain." Finally, for all we know the gang members would be willing to pay more to beat up freshmen than those same freshmen would be willing to pay to avoid the beating. (Maybe the students will get sympathy from their girlfriends or professors and get excused from a hard test.) So we see that, literally, the differences between Caplan's proposal and mine are merely empirical; they are qualitatively equivalent in terms of the mainstream economic analysis.