Why Jobs Don’t Justify Government Spending

Government jobs aren’t a free lunch.

My colleague, Maggie Anders, recently made an insightful post on X.

As Trump begins to shutter government bureaus (or at least pieces of them), many are highlighting an obvious downside: government employees will lose jobs if you shut down government agencies.

Some articles are calling it the biggest layoff in history, and saying it will have serious, negative economic consequences. Others hedge by saying the impact may not be felt for a long time.

Of course, it is unfortunate when people lose their jobs in and of itself. However, it does not follow that every job is worth preserving.

When any job is created, government or otherwise, it comes with a potential upside and downside. The upside is the value the job produces both for the individual and for the rest of society based on what they produce in their job. The downside is that the individual’s time and the resources they use to accomplish their job cannot be allocated to the production of alternative goods. Economists call these foregone opportunities the opportunity cost of the job.

In private markets, companies compare the upside of a person’s job with the downside by looking at how much the worker produces (in terms of additional revenue generated) and comparing that to how much they cost to employ (in terms of wages, benefits, and so on). If a new job produces more revenue than it costs in terms of resources, the job will be created because it adds to the company’s profitability. If a new job costs more than the revenue it brings in, then this implies that other uses of those resources are expected to be more urgently demanded by consumers. In this case, the company would make a loss, and the new job would not be created.

On the flip side, when the government creates jobs, no such accounting takes place. Since politicians and bureaucrats do not use profit and loss, there is no way to see if the value of the resources used is greater than the value of the services provided. To quote the economist Ludwig von Mises:

A government is not a profit-seeking enterprise. The conduct of its affairs cannot be checked by profit-and-loss statements. Its achievement cannot be valued in terms of money.

The upside of government programs is easily visible—when the government builds a new bridge, you can see people use the bridge. However, the downside is less clear. The money and resources the government took from taxpayers to build the bridge and hire employees could have been used for other things, but since politicians take these resources from voters via taxation, they do not bear the cost and cannot account for it.

In Economics in One Lesson, Henry Hazlitt makes a related point about governments building bridges:

When providing employment becomes the end [of building the bridge], need becomes a subordinate consideration. “Projects” have to be invented. Instead of thinking only where bridges must be built, the government spenders begin to ask themselves where bridges can be built.

But don’t these jobs make society richer? Not so fast. Hazlitt continues:

It is true that a particular group of bridgeworkers may receive more employment than otherwise. But the bridge has to be paid for out of taxes. For every dollar that is spent on the bridge a dollar will be taken away from taxpayers.

The government can create jobs by taking tax dollars. However, some jobs are destructive to the wealth of society. It would be wasteful if some private company used millions of dollars of resources to dig holes in the ground and immediately refill them. The reason we don’t worry about this happening is that a company whose owners chose to do this would make massive losses.

No taxpayer would be happy with the government paying someone a six-figure salary to dig holes and fill them back in. But how can the government be sure that existing government jobs aren’t wealth-destroying? How can we tell if some positions are essentially just hole-digging-and-refilling positions? Without profit-and-loss accounting, we can’t.

The federal government is not fundamentally a jobs program—at least not if we want it to make the lives of citizens better. As such, the claim that cutting government is bad for the economy because people lose jobs does not follow. Those people will go on to find jobs in the private sector, where their new employers are subject to the desires of customers and the forces of competition, profit, and loss.

Maggie’s point here is absolutely correct. The government is not a jobs program.

Additional Reading:

Economics in One Lesson by Henry Hazlitt

Bureaucracy by Ludwig von Mises

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

A Second Working Paper Shows That People Who Receive a Guaranteed Income Tend to Work Less

In October, I reported on the release of the largest research project ever on universal basic income (UBI). The study’s results were disappointing for advocates of the idea. In short, the research showed that many people who received the income reduced their hours working and increased leisure time. Furthermore, people didn’t use their leisure time in any of the productive activities advocates often claim (e.g., self-improvement, entrepreneurship, time with family).

This month, a National Bureau of Economic Research (NBER) study on UBI authored by economists Sidhya Balakrishnan, Sewin Chan, Sara Constantino, Johannes Haushofer, and Jonathan Morduch was released.

The study examined 2,097 households in Compton, California. They gave around one-third of the households a guaranteed monthly income of an average of $487 and examined how recipient households acted relative to the non-recipients.

Employment and Guaranteed Income

The most obvious impact of a guaranteed income is going to be on a recipient’s work decisions. Predictably, many people who received the guaranteed income reduced their working hours.

The researchers found that part-time workers (those who worked less than 20 hours per week) reduced their time working by 13 percent. Less time working means less money. How much less? The paper states:

The negative impacts on labor market participation translate into negative impacts on household income. While the average monthly cash transfer amount for the treatment group is $487 … the net impact on total monthly household income over the past 30 days including the cash transfer was just $92 and not significantly different from zero.

This means that these part-time worker households who received a nearly $500 transfer ended up only being $100 richer overall, because they reduced their working hours. Furthermore, this $100 difference was not statistically significant, which means it’s unclear whether the transfer really leaves people with more income than before!

It should be noted that full-time employees did not significantly change their working habits. This fact also does not bode well for UBI advocates. Why?

Ask yourself, why would part-time employees work less, but full-time employees work the same amount? One explanation is that it is generally easier to pick up part-time work than it is to find a full-time job. As such, full-time workers were likely reluctant to leave behind their stable full-time jobs for a temporary guaranteed income. Additionally, an income of $500 per month is likely not enough to make up for the loss of a full-time job. So it’s unsurprising that this program didn’t affect the decisions of full-time employees.

However, if this program were a permanent government program, I would expect that some full-time employees would also leave their jobs or cut back hours. If you expect to get a guaranteed monthly stipend for two years, you aren’t going to quit your job, because you’re going to have to take on the cost of finding a new full-time job when it ends. However, if you’re going to get it forever, you’re more likely to do so.

Other Impacts of Guaranteed Income

Unlike the study I discussed in October, this study did not examine extensively how recipients used their time. However, it examined other impacts of guaranteed income, some positive and some negative.

On the positive side, the monthly stipend appears to “have a strong positive impact on the index of housing security,” but the authors also highlight that it had “no clear impact on the indices of psychological well-being, financial security, or food security.”

The research also found: “The list experiments show strong evidence of relative reductions in IPV [intimate partner violence], weak evidence of reduced alcohol consumption, and moderately strong evidence of relative increases in tobacco consumption.”

So in some of these other areas, we see some positive results. Does this vindicate the idea of a government-provided guaranteed income? Not exactly.

It’s no surprise to economists, or anyone for that matter, that if you give people money, they’ll get some benefits. Adding more inputs leads to producing more outputs in the simplest systems. However, the economic problem is determining which beneficial avenues are best to pursue. For example, instead of giving people a guaranteed income of $500 per month, that money could have been spent on healthcare, education, means-sensitive charity, or research and development of technology.

This gets even more complicated when you think about who the $500 comes from. In a government-run guaranteed income system, the money for the guaranteed income comes from taxpayers.

Do the benefits generated by such a system outweigh the benefits taxpayers would have enjoyed if they were able to keep their own money? How could we even begin to compare the benefits of a government program like this to all the unimplemented, unseen plans of the millions of taxpayers who pay into the system?

What This Means for Basic Income

Overall, the picture drawn by the two recent studies on this policy is underwhelming in my estimation. Looking at both studies together, it seems like when you give people a guaranteed income, they become a bit wealthier and more financially stable, but the gains are small because the policy disincentivizes working relative to leisure. We would expect this problem to worsen if the policy were permanent, and this may cause the benefits to evaporate almost entirely.

On the flip side, such programs on a large scale would be extremely expensive—meaning that taxpayers would have to give up a lot. To give a stipend to every adult would be more than a trillion dollars every year.

While advocates may consider more leisure a good thing by itself, that argument becomes a tougher sell when we look at studies that show how the type of leisure people engage in with basic income isn’t of the kind that its advocates usually tout. Furthermore, that increase in leisure by some will simply result in more labor on the part of taxpayers who now must achieve the same standard of living with higher taxes.

When something sounds too good to be true, it often is. Receiving “free money” every month may sound enticing, but the more we study the details, the more we see the real costs and illusory benefits.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

Sorry, Harvard. There’s No Such Thing as a ‘Free’ Grant

 America’s most prominent university, Harvard, is now fighting the Trump administration. This conflict marks the latest episode in what appears to be a new focus of the White House on higher education. Most recently, Columbia University gave in to some of the government’s demands to ensure continued funding.

The confrontation started when the Trump administration contacted Harvard to demand that it institute reforms based (at least partly) on Harvard’s perceived failure to deal with “[discrimination] against Jewish or Israeli students.”

Harvard made some changes but rejected other demands, calling them unreasonable, and in response, the Trump administration has threatened to freeze federal funding.

Now Harvard is fighting back with lawsuits. In its public-facing website about the conflict, Harvard features what sounds like an inspiring message by the institution’s president, Alan Garber:

No government—regardless of which party is in power—should dictate what private universities can teach, whom they can admit and hire, and which areas of study and inquiry they can pursue.

This sounds nice, but when you scroll down the site a bit further, you see what’s really at stake:

Without federal funding, this work [research] will come to a halt midstream, and researchers will lack necessary resources to finish ongoing projects or to finance new ones in the numerous fields Harvard supports…

Do you see the tension here? Harvard is upset that the government is trying to tell them what to say, while simultaneously demanding that it continue sending them money.

Of the $9 billion being threatened, not all goes immediately to Harvard. Some funding goes in grant form to students who then transmit it to the university in fees. Other grants go to researchers who share a portion (often more than half) with the university. But, regardless of the transmission mechanism, this funding is critical to Harvard’s current operations; otherwise, Trump’s threat would be inconsequential.

Is Harvard entitled to receive millions of taxpayer dollars, directly or indirectly? Are the wealthy administrators and faculty the proper owners of taxes paid by Americans of all economic classes?

In my view, no. Harvard has no right to tax dollars; therefore, it’s hardly an injustice for them to lose that funding.

Why is our government funding one of the most powerful institutions in America when it is sitting on a $53 billion endowment and while it receives donations from foreign governments?

It’s hard to feel bad for Harvard here. One of the oldest lessons in human history is that you have to be careful accepting generous gifts, whether directly or through employees or customers. Money comes with strings attached. Federal money is no different. When you tie your institution’s structure to the gifts of politicians, it’s strange to act surprised when the government leaders expect something (even if it’s unreasonable) in return.

Perhaps the court will rule in Harvard’s favor in this case, but if the voters who elected Trump also elect a Congress that votes to defund Harvard, what will the institution do then?

If institutions like Harvard want to live without fear of being defunded, it’s time for them to let go of the federal government’s hand and walk on their own. Other institutions already do this. Hillsdale College in Michigan and Grove City College in Pennsylvania both eschew federal funding explicitly because they dislike the control the funding gives the government over free inquiry.

These organizations are immune to pressure precisely because they turn down the kind of money Trump is now threatening to take from Harvard. They have the freedom to decide their institutions’ path.

Whoever lives by funding will die by funding. There’s no such thing as a free grant.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

It’s Always the Economy, Stupid

Another election has come and gone, and the results have surprised many—especially on the political left. While Trump polled ahead of Harris in most swing states and outperformed her in the prediction markets in the end, the indicators were neck-and-neck. A late poll in Iowa showing a significant Harris advantage convinced many that she was bound to win.

The Harris campaign spent a significant amount of its time on two issues—abortion (as evidenced by this ad campaign) and Trump as a “threat to democracy.”

These issues certainly rated as important, especially with particular demographics of voters, but overall, insofar as Democrats viewed Trump as weak on these issues, those perceived weaknesses were not enough to keep the Electoral College close.

Why? The explanation, I believe, is based on a familiar cliche in American politics (coined by Bill Clinton’s campaign advisor James Carville): “It’s the economy, stupid!”

Election polling consistently found the economy to be the top issue among voters (see these polls from Gallup and Pew, for example). Election Day exit polls found the same. “Economy” was the top issue for voters nationwide according to exit polls by AP VoteCast, along with immigration (a signature Trump issue and one inherently linked to economic issues in the minds of many voters).

The AP’s Josh Boak and Linley Sanders, reporting for VoteCast, found that “[a]bout two-thirds of voters said they were very concerned about the cost of food and groceries. About half had concerns of health care, housing costs and gasoline prices.”

Fortune magazine highlights that two-thirds of voters also said the economy was either not good or poor.

This negative view of the economy seems to have overridden bad feelings toward Trump. Harris likely did not do enough to convince voters that her economic plan would have been much different from President Biden’s plan, with which ordinary people are frustrated. This is probably because Harris, on several occasions, made it clear that she approved of the Biden administration’s activities without much qualification.

Trump, recognizing this frustration, had a heavy focus on economic issues. Points 3–6 on his official campaign website are all about fixing the economy, and the first two issues listed are related to immigration, which is largely an economic issue for his supporters. His campaign slogan became “Trump will fix it!” Fix what, if not the primary thing voters are bothered about with respect to the Biden administration?

Some have argued that the economy can’t be the primary driver because, by many indications, the economy is good. For example, inflation is slowing, so why would people be concerned about inflation?

Except, inflation slowing does not mean the everyman is immediately better off. First of all, a slower rate of inflation does not mean prices have come down. It just means they are rising more slowly. Inflation compounds, and what really bothers those consumers is higher prices.

Second, inflation erodes the value of savings. People save to plan for future projects or to keep a buffer for security. Pre-Covid savings were eroded by inflation which happened under the Biden administration (even if the policies responsible for the inflation began prior to him). Inflation slowing down does not cause eroded savings to return.

Regardless of how we make sense of it with our data or models, people are unhappy with the economy relative to pre-Covid times, and it seems clear that this unhappiness was a key factor on many voters’ minds as they went to the polls.

Trump’s coalition was largely based on low-income, low-education, working-class Americans upset with the economy. On those margins, his 2024 coalition was closer to Obama’s and Bill Clinton’s than Harris’s coalition was. Harris’s coalition ended up being the wealthy and educated.

Is there a lesson here? I believe so. While many will point to interesting trends in voting (such as Trump having historically strong Latino support or flipping terminally blue counties), I think the most important lesson from this election is the boring one: in the end, what matters most in politics is still the economy.

Cultural war issues generate a lot of noise in our political system, but my take-away from this is that all those things are secondary. No amount of noise will distract people from expensive groceries.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

The Student Loan Interest Pause Finally Ends

The last holdouts of Covid-era student loan programs will have their interest reinstated in August 2025.

In March 2020, President Donald Trump announced a pause on federal student loan payments. The economy was about to shut down (mostly due to government policy), so it seemed fair to suspend the obligation on the part of students to repay the government.

Nobody imagined that this would last as long as five years for some borrowers. During the Biden administration, generosity toward student loan holders expanded. One major addition was the SAVE Plan—a very generous repayment plan which capped interest and offered payments as low as $0 per month.

This plan was introduced in August 2023, and over the following months around 8 million people (nearly one fifth of all borrowers) registered, despite a coalition of states filing suit to block it. The courts issued an injunction around March 2024 that paused the implementation of SAVE, but did not remove those already registered. SAVE officially ended with the Trump administration’s takeover of the Department of Education. It remains unclear how borrowers will be transitioned off.

For most borrowers, interest forgiveness continued for about three and a half years, with interest accumulation restarting around September 2023. However, borrowers were given another year without penalties for non-payment (except for the interest accumulation).

Borrowers on the SAVE Plan, however, were allowed to remain in interest-free forbearance, where they still are, until next month.

This series of decisions has been extraordinarily expensive. According to the American Enterprise Institute, the interest pause alone cost the government nearly $250 billion. That means money that would offset federal debts must now come from somewhere else, likely taxpayers.

The US already has several legal pathways to loan forgiveness. Perhaps the largest is Public Service Loan Forgiveness (PSLF). If, after graduation, a borrower works for the government or a qualified non-profit, he can enroll in PSLF. After making 10 years of student loan payments, the remainder of his balance is forgiven.

Other programs, like Income-Driven Repayment (IDR), are available to those with lower incomes and require 20 to 25 years of payments.

This matters because during the Covid student loan repayment pause, the non-payments counted towards the timers of PSLF and IDR. If you were enrolled in one of these programs, you’ve essentially had three years of payments removed from your obligation. Assuming these programs continue, the Covid pause will have eradicated about 30% of PSLF debt for affected borrowers. Like the interest pause, this lower revenue for the government likely means higher taxes.

On August 1, the pause on interest will finally end for the SAVE Plan holdouts, who at this point have had their loan payments paused for about five years. What the future holds for student loans remains unclear. The Trump administration has signaled a willingness to chip away at programs like PSLF.

A CBS story on the budget reconciliation bill notes:

The new law also does away with Grad PLUS loans, which help people finance higher education degrees… Those seeking unsubsidized federal loans for professional degrees, such as law or medicine, will be restricted to $50,000 per year and a $200,000 lifetime cap. Those seeking advanced degrees in nonprofessional areas, such as history or philosophy, will be subject to an annual borrowing cap of $20,500 and a lifetime limit of $100,000.

This change likely targets the regressive nature of loan forgiveness—programs that often benefit doctors, lawyers, and others earning high salaries in the nonprofit or government world.

The cost of Covid student loan programs will be with us for a long time. But with the end of SAVE interest forbearance, it seems that Covid-era loan policies are finally behind us.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

How Political Prediction Markets Cut Through Partisan Spin

One of the most interesting developments in political analysis over the past decade has been the rise of online political prediction markets. What are prediction markets? The idea is pretty simple.

Participants will put money on their prediction of how an event (for example an election) will turn out. Sports prediction markets where you can bet on the winners of games or point spreads have been popular throughout history. Now these markets have made their way into our political environment.

If you predict the outcome correctly, you get paid out some amount based on when you made your prediction and what other participants predicted. The market provides a win-win for predictors and onlookers. Predictors who have developed more accurate prediction techniques or knowledge stand to gain money by beating their competitors. Furthermore, onlookers will have access to the information of those willing to put their money on the line.

For example, if someone were to develop a new statistical model which more accurately predicts voter turnout, and he is confident in his model, he will be willing to put a lot of money on the line. When he does this, the odds in the prediction market shift, so onlookers can see the impact of this new statistical model without knowing anything about it.

You don’t have to look far to find websites that either offer political betting or keep track of the odds. But while the money-making and information-sharing features of prediction markets are kind of neat, what really makes these markets fascinating is how they can be used as a tool for political analysis.

Put simply, political prediction markets are a powerful way to gauge who is winning the election. They are imperfect tools—but no tool is perfect. Let’s talk about why they are likely the best among second-best options. I’ve compiled some data from ElectionBettingOdds.com from this year’s cycle which I’ll discuss throughout the piece. Here it is:

Image Credit: Custom image by FEE

1) Talk Is Cheap

The major reason I trust prediction markets over polls is simple—talk is cheap. Imagine you go to a grocery store and there is only one bag of apples available, but you and four other customers want it. Imagine the owner of the store says he’ll give the bag to the person who wants it most. He tells you to rank your desire on a scale from one to ten.

What do you say? Likely, you, and everyone else, would rate your desire a ten. Why? Talk is cheap! Saying ten is no harder than saying nine, and saying ten makes you more likely to get the apples.

Now imagine the store owner has you bid for the apples. In this case, it’s clear the person willing to pay the most will come out on top.

Money eliminates cheap talk. You may say you urgently want apples, but if you’re only willing to pay $5 for a bag, it must not be that urgent.

The same thing operates in politics. After a bad debate performance, people affiliated with the losing candidate will often try to spin the performance as “not that bad.” However, when people put money on the line, they don’t worry about optics for their candidate. They just want to win the bet, so they report accurately about how they think the debate performance will affect things.

For example, Harris’s longest sustained margin over Trump in the prediction market began after she debated with him. On September 9, the day before the debate, Trump was up 50.5% to 46.8%. The next week he fell to 47.1%, and Harris rose to 51.6%.

On the flip side, the VP debate seemed to pull Trump back into the race—Harris’s margin fell from 4 points to 1. Partisans on both sides were no doubt spinning these debates in their favor. But wouldn’t it make far more sense to trust the combined judgment of people who are putting their hard-earned money on the line?

2) Lagging Polls

Another reason to favor prediction markets is that they move in real time, whereas polls lag. When poll results are released, they are potentially already outdated in volatile election seasons like this one. Poll aggregators make this even worse, aggregating poll results that are several weeks old.

3) Using All the Information Available

It’s also important to remember that prediction markets include and discount poll results appropriately. Bettors also look at polls, so all that information is included in the prediction market results. Not only that, but bettors have an incentive to discover reasons for poll failure and discount partisan polls insofar as they are unreliable.

4) Insider Information

A final reason to trust prediction markets over polls is that prediction markets have the advantage of giving people access to insider information. Insider trading is illegal, but that doesn’t mean that insiders abide by the rules or that secondhand rumors don’t make an impact.

While it would be hard to know for sure that insider information makes its way into prediction markets, we may have an example from this very election cycle.

Joe Biden dropped out of the election on July 21, but if you look at the above graph, you’ll notice markets had Harris overtake Biden the week of July 8. Just the week before, Harris only had a 4.3% chance. What happened?

Some might say that it was Biden’s abysmal presidential debate on June 27, but this doesn’t quite explain it. Even on July 1, three days after the debate, Harris was still below Biden. It wasn’t until July 3 that Harris catapulted over Biden. Why then?

Well, one possible answer is that prediction markets just took a few days to decide the debate was bad enough to oust Biden. We can’t rule out this possibility, but the change is very sharp for there to be no inciting incident. On July 2, Harris was at 5.2%. The next day, she was up over 20%.

Here’s my guess as to what happened. Some of the big names of the Democratic Party got together on the 2nd or 3rd and made the decision to transition to Kamala. This decision was made before Joe was on board himself, and bettors took advantage of the political rumors.

We can’t say for sure whether insider information was the cause, but we can say that bettors decided Joe was out before he did. In other words, the prediction market accurately predicted a major event before it happened.

We’ll see if that level of accuracy holds for the election itself.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

High Interest Rates Are an Opportunity for Education

For most of my adolescence, interest rates were near zero. In fact, even certificates of deposit (CDs), which boast higher interest rates than typical savings accounts, were generating returns below 1%. This was an anomaly. For most of recent history (especially the end of the 20th century), interest rates were much higher.

Investors in the 1960s could reasonably expect at least 5% annual returns from their banks. From the mid-’70s to the mid-’80s, many savers were getting a 10% return. But for those of us who came along after that, such rewards for saving have been impossible.

This was no market accident. When the real estate market collapsed in 2008–09, the US Federal Reserve (the institution responsible for determining US monetary policy) made a series of policy decisions intended to lower the interest rate. Although the Federal Reserve does not directly determine the interest rates, it has a variety of tools to push interest rates up or down.

The leadership of the Federal Reserve saw low interest rates as desirable because lower interest rates mean that it is less costly to borrow money. If businesses want to begin long building projects, for example, lower interest rates would make the projects more financially feasible—all else held constant.

Whether using monetary policy to drive down interest rates is a good idea is its own question. The fact of the matter remains: the Federal Reserve kept interest rates down near zero for a decade. Now that they’ve risen, there is a good opportunity to teach the next generation an important lesson about saving.

One of the major downsides of the decision to keep interest rates near zero is that a generation of Americans never got a chance to learn about the value of savings.

Saving is an integral part of human development. In order to take on big projects, someone must be saving. For example, when you start a business, it often can take months or years before your business makes a profit. How can you pay for workers or materials if you aren’t making a profit? Well, you have to draw from your own savings or someone else’s (the latter would be a loan).

This same logic underlies the decision to go to college. College costs money, and the benefits come later. How can you pay for something that doesn’t deliver a return until much later? Again, you have to leverage savings. Students either have a college fund or they borrow (from the savings of others).

Saving is necessary for the development of a modern economy.

When interest rates are normal, the value of savings is easy to teach because it literally pays to save. If you put $1,000 in a savings account when interest rates are 4% (annual), you end up earning $40 over a year.

This might not sound like a lot, but it can be a great teaching tool for kids for two reasons. First, it’s hard to earn any money as a kid, so any opportunity to earn feels like a big opportunity. Second, the miracle of compound interest can start to produce some truly tangible rewards.

Interest builds on itself, so a $40 gain this year doesn’t mean a $40 gain next year. The interest you earn each year also accumulates interest. This can be hard to visualize without a spreadsheet. To overcome this, the Rule of 72 can help you understand how important interest compounding is.

I’ve discussed this rule writing for FEE before in the context of inflation. The main idea is straightforward. If you divide the number 72 by the annual interest rate, that tells you how many years it will take for your money to double.

For example, let’s say you have $1,000 in your bank account, and the annual interest rate is 6%. Divide 72 by 6, the answer is 12. In 12 years, your balance will grow from $1,000 to $2,000.

Now we can see the importance of our changed interest rates. If savings account interest rates are 0.1% (as they were most of my adolescence), it would take 720 years for your bank account balance to double. Today with interest rates closer to 4%, it would still take about 18 years for an account balance to double. This number, 18, will have clear significance for any parent. This is the perfect amount of time to show your kids the benefit of savings.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.

New Study Shows Why ‘Taxing the Rich’ Isn’t So Straightforward

 A common rallying cry on the left is that we can fund our social programs if we just “tax the rich.” While popular, this slogan is far from a real solution for the country. As has been pointed out elsewhere, if you confiscated all the wealth of every billionaire in the US, you wouldn’t even have enough money to run the government for a year. Our fiscal problem is a spending issue, not a revenue issue.

However, this isn’t the only problem with the proposal. It turns out that “tax the rich” is easier said than done.

A new working paper put out by the National Bureau of Economic Research (NBER) examines the impact of a tax system targeted at the rich. Researchers Nicolas Ajzenman, Guillermo Cruces, Ricardo Perez-Truglia, Darío Tortarolo, and Gonzalo Vazquez-Bare examine a new progressive property tax in Tres de Febrero (a city in Argentina), a system that effectively increased taxes on the rich while decreasing taxes on the poor.

How does this study show an issue with tax-the-rich sloganeering? To understand, we’ll have to consider the work of economist Art Laffer.

The Real Political Economy of Taxes

It’s simple to say, “I want to increase taxes on the rich.” Art Laffer’s work highlights how that desire may be easy to hold but hard to implement.

Laffer was famous for plotting a curve (famously called the Laffer curve) that showed the relationship between tax rates and tax revenues. Laffer’s insight was simple: as tax rates increase, tax revenues increase—at first. However, once tax rates go high enough, people are increasingly incentivized to avoid paying them, with the result being that tax revenues might actually start going down as rates go up. In other words, a tax rate of, say, 40 percent, might bring in more money to the government than a rate of 60 percent.

The Laffer Curve | Image Credit: Bastianowa via Wikimedia | CC BY SA 2.5

Avoiding taxes comes in many forms. One way is simply to earn less income. If you get taxed at an extremely high rate, such as losing 80 cents of every dollar you earn, you’re unlikely to work as much as if you only lose 20 cents for every dollar. If tax rates are pushed high enough, tax revenues will fall because people will engage in less income-generating activity.

Economic laws are simple. If you tax something, you get less of it. If you tax work, people will work less.

Another way to avoid taxes is to minimize your taxable income. This can happen legitimately or illegitimately. A legitimate way to lower your taxable income is to take advantage of accounting maneuvers like deductions. An illegitimate way to lower your taxable income is by not reporting income to the government. We can think of this as “non-compliance” with tax laws.

As tax rates increase, people will invest more resources into avoiding their taxes both legally and via non-compliance. Thus, when tax rates go high enough, this leads to lower tax revenue. This is the fundamental insight of the Laffer curve.

Non-compliance and Fairness

With this in mind, we can understand the results of the study of the Argentinian city. The authors report, “We find that reducing taxes for poorer households increases their compliance while increasing taxes for richer households decreases their compliance.” The logic behind the Laffer curve holds up. Higher taxes means lower compliance.

Specifically, they find that “a 1% reduction in the tax rate for the poor increases their compliance by 0.17% … Conversely, a 1% increase in the tax rate for the rich reduces their compliance by 0.36%.”

Interestingly, in the conclusion of the paper, the authors refer to this as an asymmetric response between the rich and the poor:

Our analysis reveals asymmetric responses to tax rate changes across income groups: tax reductions for lower-income households significantly increase their compliance rates, while tax increases for high-income households lead to decreased compliance.

However, there is nothing asymmetric about this from the perspective of economic theory. Both the rich and the poor households’ behaviors are perfectly consistent with the economic logic that underlies the Laffer curve. As you increase the tax burden on people, they have a larger incentive to avoid taxes. As you decrease tax burdens, the risk of non-compliance becomes larger relative to the benefits.

The authors go beyond examining compliance alone. Another part of the working paper is what people do when they are informed about the effect of the tax change.

As you’d expect, not all taxpayers in the study are politically informed enough to know that there has been a change. So the researchers examine the effect of informing voters that the new tax system is progressive. The results are interesting.

First, both rich and poor households claim to recognize the change as one that improves the fairness of the tax system. Furthermore, being informed of this change in and of itself appears to improve the tax compliance rates of poor households. However, the same is not true of rich households.

According to the paper, the authors found no significant increase or decrease in rich-household tax compliance upon receiving information about the progressive nature of the new tax system.

Taxing the Rich Is Harder than It Looks

The study’s findings are interesting for a few reasons. First, they highlight that talk is cheap when it comes to taxes, and this highlights one major issue with progressive tax policies. Many supporters of taxing the rich in theory will increase their non-compliance when the bill comes due. In fact, it may be the very richest of the group who are most able to do so.

This last point highlights a major issue with the plan to bring prosperity to the masses by taxing the most well-off. Ultimately, the government can decide the rate at which they want to tax rich households, but they can’t determine the revenue they collect from them.

Presented with these facts, it’s likely that the tax-the-rich crowd will just argue that we need to crack down on the rich to ensure compliance. But this is no silver bullet. Cracking down is expensive, so any attempt to increase revenues by increasing compliance is going to be offset (at least to some degree) by the associated expenses.

Furthermore, even if you eliminate some forms of non-compliance, others will arise. When you impose costs on people, there is a profit opportunity for those who find a way around the costs.

Finally, even if you could close off all avenues at low cost, the last method of tax avoidance is unstoppable. People can always stop working—and rigorous enforcement will push more people to take that option. As such, there will always be a tax rate beyond which you lose tax revenue. The Laffer curve lives.

Article by: Peter Jacobsen

Peter Jacobsen teaches economics and holds the position of Gwartney Professor of Economics. He received his graduate education George Mason University. His research interest is at the intersection of political economy, development economics, and population economics.

This article was originally published on FEE.org. Read the original article.