Taxes, Free-riding, and Federation

Check out Adam Smith complaining about the rent-seeking that the UK’s North American colonies were practicing back in 1776:

The expence of the ordinary peace establishment of the colonies amounted, before the commencement of the present disturbances, to the pay of twenty regiments of foot; to the expence of the artillery, stores, and extraordinary provisions with which it was necessary to supply them; and to the expence of a very considerable naval force which was constantly kept up, in order to guard, from the smuggling vessels of other nations, the immense coast of North America, and that of our West Indian islands. The whole expence of this peace establishment was a charge upon the revenue of Great Britain, and was, at the same time, the smallest part of what the dominion of the colonies has cost the mother country. If we would know the amount of the whole, we must add to the annual expence of this peace establishment the interest of the sums which, in consequence of her considering her colonies as provinces subject to her dominion, Great Britain has upon different occasions laid out upon their defence. We must add to it, in particular, the whole expence of the late war, and a great part of that of the war which preceded it. The late war was altogether a colony quarrel, and the whole expence of it, in whatever part of the world it may have been laid out, whether in Germany or the East Indies, ought justly to be stated to the account of the colonies. It amounted to more than ninety millions sterling, including not only the new debt which was contracted, but the two shillings in the pound additional land tax, and the sums which were every year borrowed from the sinking fund.

This comes from Book 4, the third (and last) part (“Part Third”) of Chapter 7 in Smith’s famous book The Wealth of Nations (TWON). (Here is a great link to the whole chapter, courtesy of the Library of Economics and Liberty. I read the Bantam Classics version for my Honors seminar on Liberty in Western Political Thought, led by Andrew Sabl, who is currently a Visiting Professor at Yale, though I don’t have it with me so I can’t cite, let alone remember, the page numbers.)

Let me throw a little bit of historical context for this excerpt at you. Smith wrote TWON before the onset of the first Anglo-American war (TWON was published in 1776, which means it did not influence the American colonists in any way, shape, or form; think about the way information spread back in those days), and the war was largely the result of a quarrel between the UK and its North American colonies over taxation. The taxation, though, was needed in order to pay for a war (the Seven Years’ War) that the colonies had initially lobbied the British government to fight for them. The British colonies in North America had much more leeway than their French, Spanish, Portuguese, and Dutch counterparts, and a number of these colonies wanted to expand westward, into the Ohio Valley, where the French state had made claims that were recognized under international treaties.

To make a long story short: Several colonial factions picked a fight with the French and their Native American allies, and this little schoolyard brawl turned into a global war (with fighting in North America, India, Africa, South America, and East Asia) that saw the United Kingdom become the world’s preeminent imperial power and France lose almost all of its North American colonial possessions.* When the war was over, the British parliament wanted to tax the colonies to pay for their fair share of the war, and the colonists said “No taxation without representation!” Smith summed up the situation as thus:

In order to put Great Britain upon a footing of equality with her own colonies […] it seems necessary, upon the scheme of taxing them by parliamentary requisition, that parliament should have some means of rendering its requisitions immediately effectual, in case the colony assemblies should attempt to evade or reject them […] The parliament of Great Britain insists upon taxing the colonies; and they refuse to be taxed by a Parliament in which they are not represented.

This is quite the conundrum, and Smith put forth a proposal that I found quite novel when I first read it as an undergraduate. But before I get to his proposal, I want to make sure that everyone understands the situation here. The UK fought an expensive war at the behest of its colonies, and the colonies, once the war was over, refused to pay for it. Sound familiar? It should. Today the United States finds itself in this situation often (just replace the word “colonies” with “allies”).

Smith proposed the following deal instead of war or civil oppression (such as economic sanctions):

If to each colony […] Great Britain should allow such a number of representatives as suited the proportion of what is contributed to the public revenue of the empire, in consequence of its being subjected to the same taxes, and in compensation admitted to the same freedom of trade with its fellow-subjects at home. [Were British America] to send fifty or sixty new representatives to parliament, […] there is not the least probability that the British constitution would be hurt by the union of Great Britain with her colonies. That constitution, on the contrary, would be completed by it, and seems to be imperfect without it. The assembly which deliberates and decides concerning the affairs of every part of the empire, in order to be properly informed, ought certainly to have representatives from every part of it. That this union, however, could be easily effectuated, or that difficulties and great difficulties might not occur in the execution, I do not pretend. I have yet heard of none, however, which appear insurmountable. The principal perhaps arise, not from the nature of things, but from the prejudices and opinions of the people both on this and on the other side of the Atlantic. […]

Why didn’t the UK just federate with its North American colonies? Smith cited British fears of an unbalanced political constitution that the North American colonies might bring to such a union, and North American fears of being completely dominated by a faraway parliament were they to join such a federation. He countered both fears well, but check out what he predicted would happen if such a federation were to actually take place:

The distance of America from the seat of government […] would not be of very long continuance. Such has hitherto been the rapid progress of that country in wealth, population, and improvement, that in the course of little more than a century, perhaps, the produce of American [taxation] might exceed that of British taxation. The seat of the empire would then naturally remove itself to that part of the empire which contributed most to the general defence and support of the whole.

Interesting, right? Smith argued that the American colonies would become so rich and so populous that the capital of his proposed British federation would “naturally” move from London to somewhere in North America.

Smith was wrong in a general way, but correct in an even more general way. Let me explain.

Smith was wrong because the United States – once separated from the United Kingdom – evolved into the wealthiest, most innovative society the world has ever known. The reason for this is the aristocratic upper house of a legislative institution (“Senate”) that the 13 states had to create in order for all of them to join a federation. If Smith had had his way, the world would have never known the American Senate, and I doubt very much that the 13 colonies would have grown to become as innovative and wealthy as they are today without this vital institution of governance.

Smith was also wrong to make his argument for such a federation to be based on tax revenue rather than principled representation (though see Warren’s infamous post arguing for just such a proposal). The tax revenue argument might be more economically efficient, but it would not give polities seeking federal bonds the guarantee of some sort of equality (two representatives in the aristocratic chamber of the legislative assembly) that they would need to join such a federation. On these two points Smith’s argument was wrong, but what did he and other republicans and federalists get right?

To answer that I think it’s best to ask another question: What would happen if the UK and the US were to federate today?

The UK would be the poorest state in the union (as measured by GDP PPP per capita), if it were admitted as one state.

The stark difference in living standards doesn’t stop there, though. Suppose the SNP finally gets its way and Scotland leaves the UK. Even if England (intl$ 32,669), Wales (intl$ 25,947), and Northern Ireland (intl$ 27,573) were admitted into the US as three separate states, they would all be at the bottom of the living standards barrel. Were Scotland to go along with the other polities in the UK and federate with the US as a separate state, she would rank second-to-last (intl$ 33,791), just in front of Mississippi but behind Idaho. The rankings would look like this:

49. Idaho

50. Scotland

51. Mississippi

52. England

53. Northern Ireland

54. Wales

Smith’s argument suddenly looks a whole lot better, right? At least if you think living standards as they are measured by economists are a good way to gauge the overall health and wealth of a given society.

A federation is basically a huge, actual free trade zone (both capital and labor can move freely) coupled with a binding military pact and some institutions that allow factions to openly argue and contest for spoils that end up in a state’s treasury, but that’s not what the US has with any of its military allies or trading partners. What I find interesting is that the objections to federation between the UK and its North American colonies that Smith listed are essentially the same ones that crop up when such a federation is proposed between the US and its various allies and partners. The difference between now and then, though, is the Senate. Sending representatives based purely on population or tax revenue would most likely contribute to an unbalanced political constitution, but having two guaranteed representatives in a political body that’s heavily aristocratic and lightly democratic would surely guarantee an equality that all sides could eventually agree upon.

There is also an interesting cultural development to think about as well. The states in Western Europe and East Asia sans China have helped to develop a political culture that is more closely aligned with the one found in the US, Canada, and Australia/New Zealand, one where citizenship trumps ethnic identity. Identity based on citizenship is not as strong as the one found in the Anglo-Saxon world, and ethnic differences do pop up from time to time (largely due to linguistic differences), but the states of Western Europe and East Asia have taken many steps in the right direction to help eradicate the parochial tribalism that has long plagued European and Asian societies and replace it with citizenship. Take a look at the political constituencies of the following three countries:

blog-2013-elections-germany
Germany’s 2013 federal elections (source)
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South Korea’s 2016 legislative election (source)
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Italy’s 2013 legislative election (source)

They are largely based on a Left-Right divide rather than the ethnic ones we find in less economically-developed, less politically-integrated, post-colonial states. This Left-Right divide would fit in perfectly with the Madisonian constitution, as administrative units (i.e. Northern Ireland, Gangwon, Bavaria, or Trentino instead of the UK, South Korea, Germany, or Italy) could be added in a manner so as not to upset the balance between Left and Right currently found in the US. Political coalitions would wax and wane with time, of course, but if we want a world where the East Asians and Western Europeans pay their fair share, and where they are protected from Moscow and Beijing, then federation is as moderately radical as you can get.

Just ask Adam Smith.

Massachusetts to let cabs tax Uber: The seen, the unseen, and the minor nuisance

There’s a simple alternative to regulation: liability. We don’t need to tell companies how to be safe if we make them legally responsible for negligence.

It’s as though Mass’s government decided that back-to-school season calls for creating real-life rent seeking examples for my class. They’re going to start taxing ride-sharing customers $0.20 per ride with five cents of that going to the taxi industry.

“The law says the money will help taxi businesses to adopt ‘new technologies and advanced service, safety and operational capabilities’ and to support workforce development.”

New technologies like an app that gets more use out of otherwise idle cars? Or an app that makes it easy to hail a ride with little wait? Or an app that brings supply into harmony with demand when demand surges? Oh wait! We’ve already got that and it’s the thing that’s being taxed!

There are a few important economic lessons that Massachusetts’ electorate is evidently in need of. Let’s start with taxes.

Taxes don’t stick

“Riders and drivers will not see the fee because the law bars companies from charging them.” They won’t see the fee, but that doesn’t mean they won’t pay it. A business only exists by collecting money from customers and paying some portion of that to suppliers. The government cannot tax a business without taxing that business’s customers and suppliers.

Granted, part of the cost will be reflected in lower profits (although profits aren’t as big as people think) which means Uber’s shareholders will face part of the tax. But what does that mean? It means 1) a little less money in pensions, and 2) potential investment capital is moved from the people who gave us the best version of taxi travel to the people who gave us the worst version of it.

Money is fungible and I don’t know how to run a cab company

Safety, new technology, and workforce development all sound good, but taxi companies (at least those that deserve to stay in business) will already be doing these things. Safety is important because accidents are costly (especially if your fleet size is limited by regulation). New technology is being adopted by every other (competitive) industry without government support. Other companies invest in their employees.*

Supporting workforce development is part of a larger trend of people supporting specific fringe benefits without appreciating the tradeoff between monetary and non-monetary compensation. And all these ideas reflect a faulty logic: just because something is good, doesn’t mean we need to force people to do it.

Voters simply aren’t in the right position to know if some good thing is good enough relative to other options. If you go into the backrooms of any industry you aren’t already familiar with you will surely learn about techniques and tools you had no idea existed before. So why should we expect that cab companies need regulators to tell them what to do? Let them learn from their trade magazines.

But there’s good news. If we mandated that cab companies use this new revenue stream to pay for new tires, they wouldn’t simply waste the money by buying superfluous tires. They’d stop buying tires out of their own revenues and start buying them from Uber’s. Telling someone to pay from their left pocket simply leaves more money in their right pocket for everything else.**

Extra money in cab company coffers could allow them to invest in better service, happier employees, “and help so taxi owners could buy ‘flagship’ vehicles like a 1940s Checker or a Porsche.” But cab companies are already free to reinvest their profits if they think doing so would create value (i.e. greater future profits). The more likely outcome is that they will simply have more money than before.

Competition is not the problem, it’s protectionism

When we see problems in the world we need to look for their root causes if we want to actually make things better. More often we act like a doctor diagnosing cancer is the cause of the cancer. Don’t want cancer? Outlaw doctors!

Cab companies aren’t as successful as they previously expected and the apparent culprit is Uber. But they only exist because an inefficiency in the market created a profit opportunity. Cab companies are doing poorly because they don’t provide as much value per dollar. And that’s largely because of regulation that prevents competition. Much of it was put in place specifically to protect incumbents from competition.

A lot of these regulations sound nice enough, but they still created the market niche that Lyft and Uber filled. And they protected cab companies from competition right up until ride-sharing became feasible.

Regulation is not the answer

Let’s give cabbies the benefit of the doubt for a minute. Let’s assume that they aren’t really in it for the cash-grab and that they just want to help people get around safely and conveniently. Let’s even assume that NYC’s medallion system is about congestion rather than competition.

If that’s the case, then there are better ways to address the root causes of the problems cabbies tell us to worry about. We don’t need to address each of these problems individually if we can find a few key causes at the root of each of them.

never-half-ass-two-things-whole-ass-one-thing

Cabs have medallions but civilians don’t, so congestion will still be a problem in cities until congestion fees are implemented that balance the demand for road access with its limited supply. Safety is important, but mandating extra inspections for only some types of cars is a half-assed way of dealing with it.

There’s a simple alternative to regulation: liability. We don’t need to tell companies how to be safe if we make them legally responsible for negligence. This is an important lesson for how we think about regulation in all industries. The basic logic is also why economists vastly prefer pollution taxes to specific regulations; it’s usually better to name the outcome we want and create a cost for failure to meet it rather than mandate specific behaviors.

Perhaps this means we should modify the laws that require all drivers to be insured so that some drivers have higher minimum liability coverage. That would be far less invasive and do far more to alleviate the concerns Uber’s critics raise than mandating specific behaviors.

Concentrated benefits dispersed costs

Okay, so maybe this is too small an issue to be concerned with. If that’s not by intentional design, then it at least reflects an evolutionary logic. This policy is likely to survive because the people it taxes will face a cost so small it isn’t worth doing anything about. Yes, Uber and Lyft have incentive to lobby against it, but it’s so close to invisible that they’ll probably be able to pass it almost entirely on to drivers and passengers.

This is going to cost millions… with a tiny little m. At first I read it as a 5% tax and quickly realized that Uber rides are so cheap that I won’t even notice it. And 20 cents a ride is even less than 5%.

So why worry? Precedent. The problem with death by a thousand cuts isn’t any one cut.


*Of course we can argue about whether they do enough of that. There may be a tragedy of the commons if there’s asymmetric information between people looking to make human capital investments and businesses looking to gain access to specific human capital. Such a situation might create an opportunity for government to do some good by investing in public goods or subsidizing on-the-job training. But if that’s the case, it calls for very different programs (education reform, etc.) than taxing successful companies to subsidize their competition.

**Why is this good news? Because if cab companies did change their behavior it would imply they’re doing something where cost exceeds benefit. It would destroy value. Remember those stories of WWII rationing? Imagine that situation but with cab companies buying twice as many tires and just storing extras in the garage. It would clearly be a bad thing. Scarcity isn’t so urgent nowadays, but the basic logic remains the same.

National Economic Systems: An Introduction for Intelligent Beginners – 2

Part Two: Taxing the Rich.

I argue in Part One of this essay that the stimulus package could not possibly stimulate the economy the way a stimulus package is supposed to do. That is, the present stimulus package cannot shorten or lessen the current recession by stemming the growth of unemployment and by jump-starting the national economy, the way Keynesian economics has it. I suggested there had to be another agenda for this massive spending of public money.

Recessions – two consecutive quarters when the national economy contracts instead of expanding – are common under capitalism, in market economies. They wane, whether or not anyone does anything about them. This fact makes if difficult to assign credit to government measures designed to lessen or shorten recessions when economic indicators do look good. Economic indicators don’t look good right now, although some of the press is announcing the beginning of the beginning of the end of the recession.

At any rate, the recession will end eventually. That is, economic growth will resume. I would bet on it but I don’t know when. When growth resumes, we will be left with the second economic crisis facing us. That second crisis is less routine, more extraordinary, and more worrisome than the first crisis, the recession itself. It’s massive public indebtedness. I have to go into the reasons why the Federal Government is even able to incur massive debt. Continue reading