Bryan Caplan  

True by Definition: Redistribution and Economic Freedom

PRINT
Obama's War on Coal?... "Some Men Just Want to Watch t...
My main complaint about Scott Sumner is that he still hasn't joined the faculty of George Mason's Economics Department.  But I'm also unhappy about the distinction he frequently makes between "size of government" (or "redistribution") and "market freedom."  The latest example:
Scandinavian economies are some of the most market-oriented on the planet.  Noah is probably confusing two completely separate issues; size of government and degree of market freedom.  For instance, although Denmark has a very high level of government spending on social welfare programs, if you look at the 8 out of 10 categories in the Heritage Foundation Ranking on Economic Freedom that are not related to level of taxes and spending, then Denmark is the most market-oriented country on earth.  Sweden has been very aggressive in privatizing, deregulating, and having a very open policy for international trade and investment.  Every single Swedish child is eligible to use vouchers to go to any school they wish.  Scandinavian voters have quite rationally voted for a very free market regime, and then decided to redistribute the fruits of that system for utilitarian reasons.
The truth is that size of government and economic freedom are inextricably connected.  Any definition of "economic freedom" that doesn't directly incorporate the size of government is a crummy definition.

To illustrate, consider the following hypothetical.  The government of Ruritania allows consenting adults to sell one another anything on any mutually agreeable terms.  Ruritania has no minimum wage restrictions, no hiring or firing restrictions, no licensing, no zoning, and no paternalism.  It even - wonder of wonders - has totally open borders.  Anyone can hire anyone regardless of their national origin. 

Before you packs your bags, I should point out that the government of Ruritania does have one little function.  Namely: It imposes a 100% tax rate on all income, and redistributes that income equally to all.  To enforce this tax rate, Ruritania has an all-pervasive system of surveillance - and punishes tax evasion with torturous death.  Leaving the country counts as tax evasion.

By Scott's standards, Ruritania is a free-market utopia.  But almost no one else - economists, non-economists, or its own citizens - would see it that way.  Ruritania is functionally equivalent to North Korea.  No one can earn an extra dime by his own efforts.  Given these awful incentives, everyone would have to survive on an equal share of virtually zero output - or risk death by earning illegal income or fleeing the country.

The essence of a free market isn't merely that people can buy and sell whatever they want on whatever terms they find mutually agreeable.  Without the right to keep what you earn, freedom of contract is utterly hollow.  A society that redistributes most of what you earn is economically unfree.

My point is not that redistribution, rather than regulation, is The Key to economic freedom.  My point is that economic freedom has Two Keys.  A solid measure of economic freedom wouldn't merely take points off for both redistribution and regulation.  A solid measure of economic freedom would only classify countries as "economically free" if they had low redistribution and low regulation - and would classify countries as "economically unfree" if they had high redistribution or high regulation.

I'm still open to the possibility that Scott's right about Sweden.  Maybe, taking redistribution and regulation into account, Sweden is economically freer than the U.S.  Especially nowadays. 

Yet I'm skeptical.  Swedish school vouchers sound great.  Nevertheless, Sweden's tax/GDP ratio in 2011 was almost double that of the U.S - 47.9% versus 26.9%.  The comparison for spending/GDP isn't quite as lop-sided, but it's still pronounced: 52.5% versus 38.9%.  If you don't think that weighs heavily against Sweden's free market credentials, you're making a big mistake - and abusing language along the way.



COMMENTS (28 to date)
Nathan Smith writes:

While we're talking definitions, open borders includes the right to emigrate.

Ted Levy writes:

Semi-permeable borders?

Ben writes:

I'm reading Sumner to be making a different point than the one you're rebutting, with the difference possibly due to the words "completely separate". I think he means to say there's more to economic freedom than just level of taxation and not that level of taxation is irrelevant to economic freedom.

johnleemk writes:

What Nathan said! How does this hypothetical Ruritania have open borders if they punish emigration/tax evasion with death?

I think Scott's point holds assuming that a country allows emigration. If emigration is a possibility, but people choose to put up with high levels of redistribution, maybe there's more to how the state works than meets the eye. Tiebout sorting/exit over voice and all that.

SteveSpearman writes:

Bryan,

According to your numbers, Sweden's tax and spending level per GDP are much more closely aligned. Our lower spending to GDP numbers are built on a lie: namely that we can spend now and pay for it later. Technically, that may be true, but our political system seems unwilling to make those kind of hard choices.

I don't really disagree with your assessment. All things considered, I would rather live in a system with low levels of taxation and spending. But the second best option is Sweden, agree as a society to lots of distribution and be willing to confiscate the wealth of the nation to fund it. Our system is worst of all, let's pretend that we don't have high levels of redistribution so that we can pretend we don't have to pay for it.

Steve

david writes:

A fun thought experiment:

It's fairly easy to reduce a 100% tax rate if you have easy contract enforcement.

Observe, trivially, that a organization composing 30% of the country's population would face only a 70% effective tax rate, as an institution, and can simply use contractual enforcement to oblige individual cooperation by demanding an even more negative tax rate - 110% for failure to work, paid out of any savings, say. Then the MTR raises above zero again. On a lifetime, inheritable basis: if you default, you die, and your children inherit your debt. Remember, Ruritania allows you to contract anything!

Therefore, the obvious efficient outcome is "a conditional contract signed by 100% of the population, conditional on such signing, to form such an organization" - everyone gets paid the same, but workers get shot if they don't turn up. Therefore, society remains efficient. Neoclassical reasoning is weird.

Joe Cushing writes:

The tax rate in America is more like 40% when you take all taxes into account.

Kevin writes:

Market freedom and size of government are separate but linked variables, in my mind/ Higher market freedom means that each percentage point of non-governmental ("free") GDP is more free (and probably more productive) than it would be otherwise. That doesn't mean that a country with 30% government spending is definitely more free than one with 31% government spending.

Chris H writes:

David writes:

On a lifetime, inheritable basis: if you default, you die, and your children inherit your debt.

I disagree that this part would be possible. Under a hypothetical purely free market contract system it is NOT possible to force someone else to contract a debt they did not agree to. Thus a person's children would be under no obligation to actually accept their "inherited" debt. If they are forced to do so that is actually a deviation from pure lassiez-faire contracts. The most you could say is that inheriting any accumulated property from your parents is dependent upon inheriting the work debt.

Nate writes:

Can I assume that healthcare is not a part of the US numbers, but is in Sweden? That would certainly narrow the gap.

Aaron writes:

But the rankings he's talking about don't look at just redistribution. An example, let's say you have a government official come to everyone's house, give them a million dollars, then leave. At which point, another official comes by and immediately taxes everyone a million dollars. Both government spending and the tax burden are going to skyrocket, but you cannot say anyone is less free because of this.

ed writes:

I'm not convinced. Yes, 100% taxation would be a disaster, but that's not really relevant to the ranges of real world choices.

One consideration: people care a lot about status.
Basics like food, clothing, other manufactured goods are basically cheap enough for everybody to have enough. Much of the extra income buys status goods: a house in best neighborhood, the best mating partners, slightly higher status clothes and cars, etc. These things are essentially in fixed supply, so the tax rate doesn't matter for incentives.


Mr. Econotarian writes:

An interesting read is KPMG's Individual Income Tax and Social Security Rate Survey 2011.

On $100K income, Sweden comes in with an effective tax rate (including social security payments) at 34.6%, which is lower than Belgium, Greece, Germany, Italy, France, India, Iceland, and Portugal. But still higher than the US at 24.3% (which assumes the income is taxed by New York as well as Federal levels).

At $300K income, Sweden at 49.2% still trails Belgium, France, Iceland, Denmark, and Italy. The US is at 29.8%.

Doug writes:

Tax as percent of GDP is a rather blunt measurement. You have to take into account the deadweight loss associated with the tax.

The US tax code has tremendous amount of deadweight loss for its revenue level, just consider the impact of the 1.1 trillion in tax expenditures.

A country with that raised 50% of GDP through a Georgist tax would be much more economically dynamic than a country with a 25% tax burden that raised most of it through capital gains, corporate taxes with a healthy sprinkling of crazy deductions.

david writes:

@Chris H

Caplan was aggressively defending the libertarianism of inherited contracts earlier, so take that up with him. I don't make the rules, I just point out their absurdities.

Matt C writes:

Many good comments here, you should engage with some of them.

In the U.S.:

Our healthcare market, costing twice or 3x what other developed countries pay, is nominally private, but in practice is a disgusting shambolic mess of regulation, mandates, and market distortions.

Our financial sector is nominally private but in practice gets periodic enormous bailouts from the federal government.

Our higher education sector is quasi private, but even the nominally private part relies heavily on federally subsidized student loans. Again the cost of higher education is going to the moon, though I admit I have not compared against other countries.

I have no problem with the idea that 40% taxes plus a grossly distorted and special interest dominated market could actually be less free than 50% taxes and a more genuinely free market. The details would have to be argued over, of course.

MikeDC writes:

Redistribution IS regulation.

I think it's obvious that a voucher system is better than public schools, but it should also be obvious that either way our consumptive preferences are being highly regulated (toward education away from any other use of our funds).

Ron Maimon writes:

The analysis of Ruritania is absurd--- of course 100% taxation on all incomes is ridiculous, and would remove all incentives and information signals in pricing. This is a straw man.

What confiscatory taxation and redistribution is used for is to remove _high incomes_. It is a fact of free market theory that all incomes are predicted to be equal to first approximation. The reason is competition--- if someone else is making more money, you go and do what that person is doing. Even if only a small surplus of people can do what you are doing, you lose the ability to demand a high wage.

For example, computer programming, which is by far the most intellectually demanding occupation in the world, the demands on brains it makes is comparable only to research mathematics, used to be a high-paying profession. But because it lacks barriers to entry, a programmer today makes the same salary as a plumber. A very skilled programmer, a skilled assembly language person, who knows how to program embedded systems, can pull in $200,000 a year, maybe a little more. But that's the limit of what competitive jobs can produce as far as salaries go.

Higher salaries are produced by one of three things:

* Sporadic work: actors have high salaries, but they can work only 1 year out of 4, spending the remaining time reading scripts, training, and auditioning, with no results.
* Closed professions with legally enforced barriers to entry: I am not allowed to practice medicine or law, and it is doctors and lawyers that control how many are admitted into the profession in a closed guild fasion, this has the predictable effect of making their wage high, and it is several times market average.
* Entrepreneurship: This is a special case, as it accounts only for a small fraction of high incomes. But it does account for some. It must be noted that income that is reinvested in growing a business doesn't count as take-home, so protecting entrepreneurship is not a good argument against taxing high incomes.
* Politics.

I will focus on the last, because it it the most common source of high salaries. The high salaries in the corporate world are a result of office politics--- individuals get selected to the next level, then the next, in a closed non-competitive way, based on political evaluation of their work at any tier. This is not true competition, since it is closed to outsiders.

Since this is explicitly not a market system, it is a political system, the end result is that there is only competition within each tier among a small number of individuals suitable for promotion--- the 'most likely to succeed' crowd. In order to rise through the ranks, they must learn to make no enemies, have no social ticks or antisocial mannerisms. They must be good at schmoozing and handshaking. Since these skills are useless and time-consuming to acquire, the people that rise through the ranks are among the laziest, stupidest and most incompetent. They never give or hear criticism, since the political process weeds out troublemakers first. This makes them, as a class, the worst equipped to run a large organization.

But as a reward for having maneuvered themselves up, they are given access to corporate profits, which they then divvy up among themselves. The shareholders can't stop them, they have no real say. The market can't stop them, because they are at the top--- nobody can replace them.

So you have a wealthy class of useless moochers at the top of the corporate world, and these people's motivations are not affected at all by taxation. You can tax their income at 100% beyond $250,000 with no effect on anything, since their incomes are politics and not market.

If you do not tax this class of people at high rates, the distortion from their non-competitively siphoning off profits into their pockets lead to a loss of purchasing power for working folks, a situation which predictably ends in catastrophic depression. The depression is a result of the purchasing power of the competing agents in the market falling below that which is required to purchase the sum total of manufactured products, which leads to a cycle of layoffs and further reduction in purchasing power.

The only way to correct this market failure is to tax high incomes and redistribute. Allowences should be made for sporadic workers, of course.

Mike Rulle writes:

Just some potential fact adjustments.

Bankrate.com claims our current nominal GDP is $15.6 trillion. The website governmentspending.com claims total Federal, State, and Local spending is $6.4 trillion (they do not double count their own source numbers).

So Government spending is 41% of GDP in US. I have seen others claim that same total is 36%. But it has been linearly increasing (oddly, it does not appear to be log-linear) for 30-40 years.

Now, one can easily argue that a majority of medicare and SS (certainly not all of it) is just recycling back money people already gave (putting aside the fact we still have gargantuan cumulative deficits---i.e., debt)----so maybe 41% is overstated.

Still, that is a high number. We have so much come to accept this as a national framework, that the two main parties just disagree on the slope of the Debt line. Lower slope is better, but in the grand scheme of things both parties are very similar and have been over time.

This administration really does want to kick it all up a notch (targeted no less)----which to me makes them far worse than the other guys.

I have said for years these are the worst group of so called populists since Willian Jennings Bryan---except the latter never came close to winning.

jean writes:

I think that looking just at the ratio of tax over GDP is a bit misleading.

Sweden has a high ratio of tax over GDP. But don't forget that Sweden has a notional pension system, which represents 13.5% of GDP.

Since the pensions provided by this fund are proportionnal to the contributions, I am not that afraid by the disincentives caused by these contributions.

Old Whig writes:

The Scandinavian welfare states are nothing but forced savings schemes. 80% of taxes paid by an average individual is paid back over that individuals life.

In Sweden the equivalent to the FICA is roughly plus 40%.
-Healthcare fee 8%
-Sickness leave/disability fee 6%
-Social Security fee 25%
On top of that union contracts proscribe an additional fee of 5-15% for other benefits on top.

A ordinary Swede before take home pay pays 1/3 in fees pre tax. Local county tax is 30-35% and the federal tax is 20-25%. VAT (sales tax) 25%. Special punitive taxation on small business owners with less than 10 shareholders.

Even the most low income earner pays some 65% of income in tax and fees.

That large government lowers growth has been studied and verified in Sweden because if our functional socialist experiment 1968-93. Sweden fell from #4 to # 17 in BNP growth. The State topped out at 70.% of GDP in 1993 when Sweden went into state bankruptcy. Interbank over night rate 500%, Swedish government 5 year bond had a yield of 25%. Greece hasn't been even close.

For those that is interested in research on the Swedish welfare state and the impact of large government policies on growth I recommend:

"Economic Growth with the Swedish model (with Lars Jonung and Joakim Stymne). June 2004.
http://www.ifn.se/eng/people/research_fellows/mh/file_archive_1/english_articles/economic_growth_and_the_swedish_model

"The Rise, Fall and Revival of the Swedish Welfare State: What are the Policy Lessons from Sweden?" by Andreas Bergh :: SSRN
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1884528

Another study has shown that the growth of government with 10% decreases growth by 0.5-1% co-authored by Andreas Bergh

What Sumner et al forgets what the disaster functional socialist policies were. They only see the aftermath of the rescue Scandinavians had to do in the 90s. Scandinavia is because of these harsh remedies the best economies in EU but hadn't it been for the large expansion of the state in the 70-80s all Scandinavian countries would have been richer and more wealthy than Switzerland and the US today.

[bit.ly urls changed to full urls. Please do not use bit.ly urls on EconLog. They will only cause your comments to be moderated. Our readers want to see their food before they eat it.--Econlib Ed.]

James Law writes:

Aren't these comparisons to european tax rates failing to take into account state and local taxes we have in the US? Our effective tax rate is not simply our federal tax rate. When adding local property taxes, state sales and income taxes are we really that far from Sweden?
Thanks for your insight!

Lars P writes:

Comparing tax rates in an era of huge budget deficits is quite misleading. You need to compare actual spending.

The US has lower taxes than Sweden, but it spends about $14 for every $10 it takes.

Meanwhile, Sweden runs a 2% budget surplus on general principle to pay off its debt.

Drewfus writes:

I agree with Bryan.

Is it possible someone here could do a post that outlines government spending as a percent of GDP for as many countries as possible, but also comparing this to the old Soviet bloc countries?

Apparently Great Britain is currently spending around 55% of GDP, which is not much less than the ~60% spent by Soviet countries (when they were part of the USSR). That is, GB spends almost as much as countries we used to be effectively at war with.

Chris H writes:

David:

@Chris H

Caplan was aggressively defending the libertarianism of inherited contracts earlier, so take that up with him. I don't make the rules, I just point out their absurdities.

If you've got a link or quote so that I can be sure I know precisely what I'm arguing against I'd greatly appreciate that. Accepting a contract or debt as a condition of accepting the rest of an inheritance is permissible, but if Dr Caplan argues a child can be compelled to accept an inheritance against his/her will I do have a bone to pick with him!

Paul writes:

"The essence of a free market isn't merely that people can buy and sell whatever they want on whatever terms they find mutually agreeable. Without the right to keep what you earn, freedom of contract is utterly hollow. A society that redistributes most of what you earn is economically unfree."

This may be valid as a moral argument, but is it valid as an analysis of how the world works? That is to say, would calling a country that had high taxes and complete freedom of contract "economically unfree" lead us to make correct predictions about the behavior of citizens in that nation? Or about the state of its economy, or how its economy operates? I have a suspicion that the position Caplan is taking is morally satisfying to libertarians but does not help one understand how the world works.

James A. Donald writes:

You neglect the tax on profits, which is higher in the US than anywhere else.

Robert Bell writes:

Bryan: "The truth is that size of government and economic freedom are inextricably connected. Any definition of "economic freedom" that doesn't directly incorporate the size of government is a crummy definition."

This may seem like a silly question, but suppose there is a large redistributive program that is supported by 95% of the population who pay 95% of its costs, and opposed by 5% who pay 5% of the costs. Is that an equivalent impingement on economic freedom compared to a program supported by 5% but paid for by 95% (e.g. a tariff favoring a certain industry).

Do you score those two programs the same if their share of GDP is the same?

Comments for this entry have been closed
Return to top