is it time to bury dead-weight loss?
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Is it Time to Bury Dead-Weight Loss?David George aa La Salle University , Philadelphia , Pennsylvania , USAPublished online: 07 Feb 2012.
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Is it Time to Bury Dead-Weight Loss?
DAVID GEORGELa Salle University, Philadelphia, Pennsylvania, USA
ABSTRACT The conventional argument to explain how taxes distort points out that therelative mix of private goods is altered by taxes. This argument breaks down, however,when it is recognized that a lump-sum alters the relative mix of goods as long as goodsdiffer their income elasticities. This paper argues that claims of tax distortion rest onthe assumption that collective decisions to alter consumption do not alter marginalbenefits while private decisions to alter consumption do, and that this assumption isproblematic. The view of government as an external, nondemocratic force is bestunderstood as an outcome of the pre-democratic roots of economic thinking as well asthe skeptical public-choice view of government as comprising self-interested actors.
1. Introduction
Shocks to the economy may be good events or bad events but they are not usuallythought of as creating inefficiencies. A natural disaster results in significant costs,to be sure. But actions following such a disaster are treated as rational responses toan unfortunate event. An increase in the sale of water pumps following a flooddoes not signal an inefficiency; rather, it is an outcome of changed demandbrought about by a change in the marginal utility that water pumps provide. Simi-larly, a shock such as unexpected ideal weather may lead to a rise in spending forvisits to the beach and a fall in expenditures elsewhere; but no inefficiency isinvolved. Rather, the rising utility derived from beach visits means that theefficient level of beach visits changes.
When it comes to government taxation, however, inefficiencies are said tostem from the change in spending patterns that taxes bring about. A tax on every-thing but water pumps would likely raise the relative demand for water pumps but,absent any clear rationale for the different tax treatment of water pumps, an inef-ficiently large number would be produced, according to received economic theory.
This paper challenges the mainstream conclusion that ‘taxes distort’ and that,as a result, public spending projects are more expensive than the money spent onthem. Jules Dupuit (1844) and Fleeming Jenkin (1871–72) are generally cited asthe earliest economists to write about the welfare loss from taxation, but it wasAlfred Marshall (1961, p. 467) who first reached a wide audience with this
Review of Political Economy,Volume 24, Number 1, 1–13, January 2012
Correspondence Address: David George, La Salle University, Philadelphia, Pennsylvania 19141,USA. Email: [email protected]
ISSN 0953-8259 print/ISSN 1465-3982 online/12/010001–13 # 2012 Taylor & Francis
http://dx.doi.org/10.1080/09538259.2011.636595
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idea.1 From Marshall’s classic treatment of the subject, to Frank Ramsey’s (1927)path-breaking work and through Diamond & Mirrlees’s (1971a, 1971b) extensionof the argument, the point that taxes (unlike private expenditures) distort has gonelargely unchallenged.2
Beginning with Arnold Harberger’s (1964) paper, attention shifted towardthe practical task of measuring the actual welfare losses caused by taxation (andother ‘imperfections’). This was not an idle empirical exercise; estimates ofwelfare losses eventually entered the practical world of cost-benefit analysis. AsJames R. Hines Jr. (1999, p. 183) notes: ‘[I]n 1991, the U.S. government modifiedits cost-benefit procedures to assign a shadow cost of $1.25 to every dollar ofexpenditures financed out of tax revenues.’ The policy implications of questioningthe model of dead-weight loss from taxation depends are significant. Many pro-jects currently deemed too costly would no longer be so if the case for anexcess burden caused by tax inefficiency was found to be invalid.
Section 2 provides a reference point for later sections, by considering theeffect of introducing a new product into an economy. It describes how the lossin consumer surplus from no longer consuming a product is assumed to bemore than offset by the gain in consumer surplus from the new product purchased.Section 3 brings government into the discussion, reviewing how the introductionof a public good is treated as non-distorting only if a politically unrealistic lump-sum tax is used to finance the public good. The argument for efficiency loss istraced to the unexamined and highly questionable assumption that while taxeschange demand, they do not change marginal utility.3 Section 4 traces the historicalroots of this idea to the parallels Marshall drew between the actions of a mono-polist and the actions of government. Section 5 explores how the several compet-ing conceptions of government held by economists reinforce the habit ofnot viewing government actions as reflecting citizen preferences. Section 6 sum-marizes the article’s findings.
2. Shifting Consumption Patterns in a Fully Private Economy
As I argue elsewhere (George, 1990), economics textbooks tend to present govern-ment as a late entrant into the economy. With government ‘intervention’ (a ques-tionable word choice) the pristine economic state is changed, as production for
1See Hines (1999, pp. 169–170) for a wider description of the contributions of Dupuit(1844) and Jenkin (1871–72).2A considerable literature has built on the assumption of tax distortion. In addition to thosealready noted, see, for example, Atkinson & Stiglitz (1976), Browning (1976, 1994),Coleman (2000), Debreu (1954), Gradstein (1999), Harberger (1964, 1971), Hotelling(1938), Kay (1980), Lau (1978), Martina (2000), Samuelson (1986), Sandmo (1976),and Stutzer (1982).3Following Marshall’s way of presenting lost surplus, I will usually treat the marginal costas constant and the supply curve thus horizontal. This simplifies the presentation withoutcompromising the basic points I am trying to make.
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private use declines and production for public use increases.4 In exploring thethinking behind the mainstream conclusion that taxes distort, I concede this rhet-orically biased framing of government since it permits a useful contrast (beforegovernment and after government) that will not weaken my argument. In whatfollows, I describe a functioning market economy with no active economic rolefor government; only then do I bring government into the discussion.
As a first step, consider a new product that gets introduced, causing people tocease buying an existing product and to redirect their money toward the new good.Suppose the new product is computers and the old product is typewriters. To keepthings simple, imagine that prior to the introduction of computers, $X was spent ontypewriters per period while, following the introduction of computers, nothing isspent on typewriters and $X is spent on computers.
That people would be willing to pay more than they must for most of whatthey buy was an important insight generally attributed to Marshall. The water-diamond paradox described by Adam Smith was resolved by Marshall’s obser-vation that what a person pays for something is a crude proxy, at best, for thevalue it provides the person. What she would be willing to pay for water consumedover the course of a day better measures its worth to her than what she is requiredto pay. In the case of water, nothing at all is paid (at least in Smith’s time), but thevaluation above the cost (the consumer surplus) is considerable.
When expenditures gravitate away from typewriters and to computers, whatcan we say about the change in the buyer’s well-being? The usual assumption isthat the consumer surplus associated with the product now being bought exceedsthe foregone consumer surplus from what was previously bought. Simply put,buyers in this case prefer spending their $X on computers rather than on typewriters.
Has there been a dead-weight loss? It depends on what is meant by this. If wemean a net overall loss in consumer surplus following the shift (the dominant defi-nition) the answer is no. But if we allow dead-weight loss to refer to any drop in‘typewriter utility’ in excess of the money no longer being spent on typewriters,the answer is yes. To illustrate, suppose the consumer surplus from buying type-writers annually had been $0.25X. The pre-computer world was one in which $Xwere being spent on typewriters, but $1.25X units of utility were gained. In thecomputerized world, typewriters are not being bought. The $X no longer beingspent on typewriters is not a dead-weight loss but is a monetary transfer from type-writer sellers to computer sellers. The $0.25X is not similarly fungible and thusmight be called a ‘dead-weight-loss.’
But, of course, the opposite also occurs since the new item purchased isvalued at more than it costs. In fact, for the shift in spending to have made anysense, this new surplus must exceed the lost surplus. So, for example, if the con-sumer surplus from spending $X annually on computers is $0.75X, then the netoverall gain would be $0.50X, equal to the $0.75X minus the $0.25X former
4In a work in progress, I have uncovered a relative drop in the use of the expression ‘gov-ernment action’ and a relative rise in the use of ‘government intervention’ and ‘govern-ment interference’ over the last century.
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consumer’s surplus that typewriters would have provided. The voluntary shift ofdollars away from typewriters and to computers has left people better off.
Relaxing the assumption that the decrease in typewriter spending exactlymatches the rise in computer spending complicates the analysis but does notaffect the basic conclusions. It may be that more is spent on computers than had pre-viously been spent on typewriters or that less is spent. In either situation, the mix ofother goods purchased will be affected by the introduction of computers.
What is important to note at this point is the following: if it is private agentsresponding to the introduction of new products by shifting their mix of purchases,standard analysis assumes that efficiency will prevail. The economy will be on itsPareto frontier, with no changes possible that will improve the well-being of somewhile decreasing the welfare of none. In short, if a new product changes the rela-tive mix of old products, there is no inefficiency as long as individual choice led tothat result. To accept this conclusion raises an important question—why does theconclusion not generalize to the introduction of government spending funded bytaxes?
3. The Government as Cause of Shifting Consumption Patterns
Suppose now that it is government, rather than the computer industry, that is therecent arrival, and that to fund a public good, say roads, it chooses to tax certainthings but not others. As one example, the government may place a tax on pur-chases, but not on savings. As another, it might tax certain products, but notothers. As a third example, it might tax earnings progressively, so one’s hundredthdollar earned is taxed less than one’s millionth dollar earned.
The message from mainstream economists has been that such taxes result in adistortion. To tax consumption rather than savings causes an inefficiently smalllevel of consumption, according to such thinking. To tax entertainment ratherthan food leads to too little entertainment being consumed. And to tax incomewill lead to inefficient disincentives to work. All these examples share the samebasic message that taxes distort by causing a mix of activities that is non-optimal. This is not to say that the roads are not worth having; rather, theycreate a reallocation of resources that is less than ideal.
How can this ideal be achieved while still having public goods? Supposedly,by an equivalent payment from every citizen to the government—generallyreferred to as a ‘lump-sum tax’ or a ‘head tax.’ Under such a tax policy, CEOs,fast food workers, and the unemployed would each pay an identical amount, aswould those simply unable to work and those approaching death. All would beincluded, because to allow certain conditions to lessen one’s tax liability wouldcreate a bias toward meeting that condition. In short, the tax must not create abias that favors redirection of energies away from what they would have beenin the absence of taxation.5
5As discussed below, as reasonable as this summary of a neutral tax may sound, it is notquite correct. Because of the income effect, any imaginable tax will cause a change in therelative mix of goods consumed.
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No one would seriously propose attempting to implement a lump-sum taxsince it would be next to impossible to get everyone to pay and, even if achievable,it would both offend most people’s sense of fairness and cause hardships for thepoor that would likely create social costs for all. In the real-world, somethingother than a lump-sum tax must prevail.
Economics textbooks continue to suggest that these real-world taxes necessarilylead to distortions. For example, Otto Eckstein (1979, p. 72) asserts that taxingsome activities but not others results in ‘the private economy [being] misledinto producing the wrong combination of goods, underproducing those heavilytaxed’. However, he does not explain how the mix of goods following theactions of a democratically elected government is ‘wrong’ relative to the mix ofgoods that would prevail in the absence of government. As another example, inthe first edition of his Public Finance textbook, David Hyman (1983, p. 383)claims, ‘It can easily be shown that individual taxpayers are better off underlump-sum taxes than they are under distorting taxes which influence relativeprices.’ In a later edition (Hyman, 1999), no such praise of the lump-sumappears. Perhaps it was brought to Hyman’s attention that the lowest earningquarter of the population would see their living standard drop dramatically weresuch a tax implemented. A more interesting word choice than ‘lump-sum tax’or ‘head tax’ has been made by J. Richard Aronson (1985, p. 312, emphasisadded), for whom ‘A tax that does not distort people’s market choices is calleda neutral tax.’ The use of ‘neutral’ can be traced to the belief that such a tax isdistortion-free, but there is the other sense of ‘neutrality’ that relates to motivesand even suggests ‘fair’ or perhaps ‘middle of the road.’ It is, in fact, impossibleto think of the lump-sum tax as neutral in this sense, since no one could with anyseriousness defend such a tax as ‘fair.’ The wealthy would pay much, much lessthan at present, and the poor much, much more.
Notice that imposing a lump-sum tax would not cause the consumption of allgoods to fall by equivalent percentages. To illustrate, imagine someone spending20% of her income on food prior to the lump-sum tax and 25% after. Such a shiftis in keeping with what empirical evidence suggests, since the income elasticityof demand for food is less than one. More generally, any lump-sum tax that mightbe required to finance a modern government would lead to a drop in the relative con-sumption of all those goods and services having income elasticities exceeding oneand a relative increase in the consumption of ‘necessities’ with income elasticitiesless than one.
If a change in relative consumption patterns would follow from a head tax,why is this not regarded as a ‘distortion’? Introductory textbooks create theimpression that by altering the relative mix of production, taxes distort. Yet thisis misleading, since a head tax similarly changes the product mix. A morecareful consideration shows that something else is at work here. To have achanged mix of goods following taxation is not a sufficient condition for conclud-ing that distortion has occurred, since a changed mix follows any sort of taxsystem. At this point, we must look more closely at why the particular changein the mix following differential taxation is alleged to be inefficient.
Beginning with introductory microeconomics, students are taught the neo-classical condition for efficiency—production of a given good must expand as
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long as the marginal benefit the good creates exceeds its marginal cost. Herein liesthe clue to why private decisions to change one’s relative product mix following ahead tax is said to lead to a more efficient outcome than private decisions follow-ing differential taxation of any kind. Let a tax be placed on a single product. Themainstream argument is that this will then lower the equilibrium quantity (regard-less of who bears the tax burden) and that this lessened output level is less efficientthan the preceding output level.6
In essence, any change in demand or supply due to taxing a particular productor activity is assumed not to be at the same time a change in marginal benefit ormarginal cost. This assumption is the source of the efficiency error; to see this,consider again the lump-sum tax. As noted above, if the government were totax everyone the same monetary amount, then the relative quantities of goodswould change as long as goods differ in their income elasticities. According toreceived theory, these changes in quantities would have been caused bychanges in demand and be viewed as simultaneous changes in marginal utility.So, if prior to the tax, the demand curve intersected a horizontal supply curve ata price of $1 and quantity 100, and if after the lump-sum tax the new lowerdemand curve intersected supply at a price of $1 and quantity 75, we wouldtreat the marginal utility as having correspondingly changed, with the 100thunit providing a marginal utility of $1 prior to the lump-sum tax, but the 75thunit providing this marginal utility after. In other words, when changes indemand follow changes in income, the marginal benefit curve and thus the efficientamount of the good are assumed to have changed as well. In contrast, when a taxraises the price of a single commodity, it is said to do so without in any way chan-ging the real marginal benefit curve. As any introductory text illustrates, an excisetax on buyers of a particular product lowers demand but not marginal benefit.
Is there something inherent in government that results in its decisions havingno effects on the marginal benefit and marginal cost curves? With a dictatorship, itis easy to see why the government is truly an outsider, giving orders that do notreflect popular opinion in any way. But if the government is representative,why don’t mainstream economists treat the decision to tax some goods but notothers as causing not just changes in demand, but changes in marginal benefitas well, done collectively rather than through individual decisions? Tax policyoccurs in the context of elected officials and their appointees expressing what issupposed to be the desires of its citizens. If a change in tastes expressed privatelyacross all individuals leads the socially optimal quantity of a good to change, whydoesn’t a change in tastes expressed publicly through government action do thesame? I would suggest that an answer might be provided in a generally negativeview of government’s economic activity and by a failure of economists to dis-tinguish between democratic and nondemocratic governments, and that weshould thus not be surprised to see government actions characterized as not speak-ing for the people the government is supposed to represent. But to explain is not to
6This assumes that the taxed good is not one generating spillover costs. Were there to bespillover costs associated with the good being taxed, mainstream economics sees suchdifferential taxation not as distorting, but as welfare enhancing.
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justify. A look at the reasoning that figures in the less than laudatory view of gov-ernment is needed.
4. The Roots of Dead-Weight Loss
For reasons that were mainly pedagogical, Marshall (1961, ch. 13) closely linkedexamples of dead-weight loss from taxation with examples of dead-weight lossfrom monopoly.7 It is easy to see certain similarities. While there may be somecompetition between the different levels of government (e.g., national, state,municipal), for the most part there are distinct functions that are the exclusive pre-serve of each. There is evidence of a strong shift over the last 80 years towardassociating government with monopoly. Looking at data from The New YorkTimes, the ratio of appearances of ‘competitive industry’ relative to ‘monopolizedindustry’ has gone from five prior to 1980 to 15 since. Over the same time, theratio of ‘government competition’ to ‘government monopoly’ has actuallyfallen nearly five-fold.8 The conservative shift in favor of markets has apparentlybeen partly manifested by associating monopoly ever more with government andever less with the private sector.
While there are certainly some similarities between a private monopoly andgovernment, when it comes to assessing inefficiencies associated with each, twomajor differences tend to be overlooked. To see this, it is necessary to comparewhat can be said about the welfare effects of a competitive industry thatbecomes monopolized and the welfare effects of a strictly private economy thatcreates a public sector.
When an industry becomes monopolized, consumers pay more for thenumber of units they now choose to purchase than they paid for that number ofunits when the industry was competitive. It is not possible to conclude with cer-tainty what the welfare effects of this monetary transfer are. The consumersurplus previously associated with spending this money may or may not bematched by the producer surplus now going to the monopolist spending themoney. The usual hunch is that consumers lose more than the producer gainsbut, again, no predictions can easily be made.
Assuming a reasonably well-functioning representative government, suchwelfare uncertainty does not occur when money is transferred from taxpayers togovernment. The lost consumer surplus would be less than the surplus from thenew public spending, which might be called, by analogy, a ‘citizen surplus.’Government has both incentives and moral responsibilities to see that this istrue. A monopolist has neither.
7In Marshall’s (1961, p. 467) words, ‘[C]onsumers’ surplus will be diminished by morethan the increased payments to the producer; and therefore . . . by more than the grossreceipts of the State. For on that part of the consumption of the commodity, which is main-tained, the consumer loses what the State receives: and on that part of the consumptionwhich is destroyed by the rise in price, the consumers’ surplus is destroyed; and ofcourse there is no payment for it to the producer or to the State.’8This is based on The New York Times’s database.
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The second major difference between the money transfer due to monopolyand the money transfer due to government has to do with the efficiency issueaddressed previously in this paper. The efficiency loss due to monopolization iswell known. With imperfect competition driving a wedge between price and mar-ginal revenue, the price that maximizes profit is greater than the price at whichmarginal benefit is equal to marginal cost; thus there is the well-known welfareloss that monopoly creates. In contrast to this, any decision to tax some goodsmore than others or some individuals more than others reflects choices intendedto represent the interests of those being taxed, not the interests of those doingthe taxing. Representative governments are supposed to do on a collective levelwhat is difficult to do individually—namely, change relative prices to matchhow constituents wish to see them changed, and would themselves change ifprivate actions could succeed while delivering the public goods.
A look inside the large modern corporation suggests still another inconsis-tency in the assumptions behind the dead-weight-loss taxation model. Corpor-ations, whose spokespersons tend to strongly support markets, are themselvesdevices for substituting central control for market forces (Berle & Means, 19321991). Even accepting the view that only stockholders can properly be viewedas members of this collective, the fact remains that management actions mightbe understood as having inefficiencies much like government actions on behalfof constituents.
For example, management ultimately decides how much firm earningsshould be distributed to stockholders and how much should be retained. Suchactions apply to all stockholders, who have differing opinions about how greatthe retained earnings should be. It would be reasonable to think of retained earn-ings as a ‘tax’ on dividends, which can affect share-buying behavior, as well asaffecting both current and prospective stockholders. It is true that the analogywith government taxation is imperfect. It is easier for stockholders to ‘vote withtheir feet’ by selling than for citizens to ‘vote with their feet’ by movingoutside of a government’s domain. In addition, the consequences that followfrom retained earnings affect all stockholders, while consequences of governmentspending are more selective. But if the practice of setting forth lump-sum taxes asa normative ideal is followed in the political realm, shouldn’t the literature at leastmention seeing a fixed amount of money withheld per shareholder rather than pershare to avoid the otherwise distorting effects of retained earnings? Not only issuch an ideal never offered, but no attempts are made to subtract any dead-weight losses when attempting to quantify corporate contributions to output.
Consider three different contexts in which the issue of dead-weight loss israised, and consider where the ideas I have raised fit into them. First, there isthe type of situation, discussed in Section 2, where consumers transition fromthe purchase of typewriters to the purchase of computers. There was a loss of con-sumer surplus provided by typewriters, measured by the degree to which typewri-ters were valued over what they cost. But in this case, typical of any voluntarychange in consumption habits, the gain in consumer surplus from computersmore than made up for it.
Second, at the other extreme lies such net social inefficiencies as monopoly.In this case the dead-weight loss to consumers exceeds the surplus gains to mono-
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polists, and there is a net social loss, or overall dead-weight loss, since less than theoptimal quantity of the monopolized product is being produced.
Finally, there is the loss associated with differential taxation. This shares withthemonopolycasetheallegationofanefficiencyloss,butshareswith thetypewriter–computer case the conclusion that there is still a net overall gain that follows theexpenditure of tax money. The loss in surplus is not an overall loss that followsfrom such taxation, but is an offset to the gain from the redirecting of resourcesfrom private to public use. The perception that there is an efficiency loss requiresthe questionable assumption that taxes shift supply and demand without also shift-ing marginal benefit or marginal cost. Does something in the attitude toward gov-ernment help explain this problematic characterization of taxation inefficiencythat follows from the troublesome assumptions?
5. Competing Views of Government
The mainstream economic vision of government can shed some light on how it hasbeen possible to confuse the act of monopolizing an industry with the governmen-tal act of placing a tax on a single industry. Three competing visions of govern-ment have dominated mainstream economists at different times—one ratheroptimistic, the other two quite pessimistic.
The earliest vision of government was generally pessimistic and prevailedamong Western economists prior to the Progressive Era that began at the turnof the 20th century. From the time of Adam Smith through the century that fol-lowed, government was often treated as a vehicle by which the privilegedbypassed market forces, and by so doing gained power and avoided the levelingforces of the market. Such a vision saw government mainly in its predemocraticor highly limited democratic forms. As A. Allan Schmid (1989, p. 212) pointsout, government of this sort ‘implies that taxes represent a kind of tribute andproduce no utility’. In this case, any loss of consumer surplus would not beoffset by surplus from the spending of the tax recipient, since the recipient isseen as wholly external to the society bearing the tax.
A more optimistic view was held by the progressives whose ideas dominatedthe early 20th century, following the influence of John Maynard Keynes. A certainnoblesse oblige attached to this vision, as government stood as the more powerfuland knowledgeable force that was driven by overall good intentions. Hence, thegovernment was seen as capable of acting in the best interest of the broadersociety when it engaged either in social legislation or in monetary or fiscalpolicy aimed at stabilizing the overall economy.
A pessimistic and conservative reaction to Keynesian thought can be associ-ated with the public choice school that has flourished over the past 30 years.9
These thinkers criticized Keynesians for imagining government actors driven todo what was economically wise rather than what might best lead to their re-election.
9The public choice school has mainly focused on government inefficiency caused byelected politicians pandering to informed voters. For a recent argument that severe pro-blems can also be attributed to uninformed voters, see Caplan (2007).
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The two most recent views of government carry a legacy that can shed somelight on why economists of nearly all stripes are prone to miss the connectionbetween the actions of government and the wishes of its citizens. The institution-alist tradition that was manifested in the ideas of progressives, as well as Keyne-sians, encouraged a view of government as an ‘actor unto itself.’ From amethodological standpoint, such a view was consistent with the critique of meth-odological individualism that the progressives directed at orthodox economic thin-kers. While such a focus on the government acting against the people who electedit does not lead to specific welfare conclusions, it can only contribute to the failureto see government actions as expressions of changes in citizens’ individual mar-ginal benefit and marginal cost curves.
The failure of public choice thinkers to see the connection between govern-ment and citizens is due to a very different constellation of factors. Public choicetheorists are unmatched in their allegiance to methodological individualism. Asproblematic as such an allegiance might be in certain circumstances, it wouldseem to be at an advantage in treating government actions as manifestations ofthe tastes of those who vote. To the contrary, the public choice thinkers look atthe self-interest of the government actors themselves rather than the interestsof the voters as being the determining factor in governmental decisions. Whilethere may be a link between any government action and the well-being of somevoters, any attempt to characterize government actions as simple reflections ofaggregated citizen tastes is rejected.
With government actors treated as being ‘outside the market place,’ itbecomes easier to understand what lies behind the distortion view of taxation.The ostensibly neutral tax that would require equal amounts from eachcitizen—though having effects on income distribution that are radically regressive(and unsustainable politically)—is treated as a tax that would not ‘distort’ output,hence carrying no dead-weight loss with it. All shifts in supply and demand wouldarise from the actions of legitimate economic actors only, and would thus amountto bona fide shifts in marginal costs or marginal benefits. In contrast, a tax on con-sumers or producers of particular goods would shift supply and demand while notchanging marginal benefit or marginal cost in the least. These shifts would beinterferences by government, not shifts by collectively arrived at changes inutility or cost.
A different story emerges if we allow the government to be treated as anagent of its citizens.10 With unanimity on funding a public good via a non-lumpsum tax (be it on a particular product, many products, or income), wouldn’t itbe reasonable to see the government as simply an agent of its citizens? Had thegood been private, each citizen could have behaved as described earlier, shiftinghis or her demand curves to achieve a better mix. With the public good, it makesmore sense for each citizen to reallocate expenditures only on a conditional basis.Each will devote a certain amount toward the public good only if all others agreeto do likewise. With government mediating the process, there is no reason to
10For an attempt to see government as more than just an agent, but as an entity representinga collective with a will comprised of the wills of its citizens, see Schmid (2006).
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believe any distortion occurs. The new demand curve each citizen would facewould be a new marginal benefit curve, just as was the case when a citizen ‘indi-vidually’ undertook a similar act of taxation. Government would be, not an outsi-der, but just a facilitator of action following taste changes experienced by itscitizens.
The issue becomes more complicated when collective actions are not basedon unanimity or consensus. Those not in the majority see money being used inways that are ‘not worth the cost’ or that might be rejected even if they were cost-less. There are thus ‘dead-weight losses’ that everyone can point to.11 But assurely as going accident free does not mean that one has suffered a loss byhaving insurance, seeing money spent in ways that one doesn’t support hardlymeans that these are losses associated with democracy that reflect badly upon it.They are simply the costs of democratic choice mechanisms.
6. Concluding Comments and Summary
The consumer surplus lost due to monopoly, or the loss represented by the taxwedge when a tax is enacted, or the lost surplus experienced by an individualwho changes her mix of purchases, can be referred to as ‘dead-weight’. Theseare costs not exactly and immediately matched by freed-up revenue. However,it is easily overlooked that in a robust economy, alive with changing technologyand tastes, there must be costs that we may, with caution, call ‘dead-weightcosts.’ The problematic nature of this label follows from the fact that the gainin consumer surplus more than compensates for these costs. Gains in surplus, inshort, usually exceed losses in surplus as long as the losses and gains are theresult of rational reactions to changes in the broader economy.
The ‘dead-weight loss’ label is most understandable in the case of monopolysince it is easy to show that surplus gains enjoyed by the firm cannot make up forthe loss in surplus elsewhere. In short, although the triangle that is useful in partialequilibrium analysis may fail to properly measure the extent of the dead-weightloss, there is some real loss that would remain even after a full general-equilibriumaccounting.
In the case of taxation, however, the notion of a dead-weight loss is seriouslymisleading. When government takes action to redirect spending from the privateto public realm, it might be compared to an individual redirecting her expendi-tures, but not to a monopolist choosing to raise price in its own self-interest.
The formal error that has led to the assumption that dead-weight loss is some-thing to be overcome rather than just an inevitable cost of improving the distri-bution of resources is the insistence that government actions shifting demand orsupply curves are not at the same time actions that shift marginal benefit or mar-ginal cost curves. All actions by individual people and private institutions that
11This argument was made by Downs (1960, p. 562) as providing one reason for believingthat government spending is too low, an argument rarely heard today. As he states in thefirst sentence of his conclusion, ‘In a democracy, information costs tend to make govern-ments enact budgets that are smaller than they would be if such costs were absent.’
Is it Time to Bury Dead-Weight Loss? 11
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result in a redistribution of resources are assumed to be actions motivated bychanges in desire or changes in cost (often with change in desire itself being acause of the change in cost). For whatever reasons, government has beentreated as neither having desires nor representing the desires of its constituents.For this reason, the shift in resources brought about by any differential taxationhas come to be seen as having the inefficiency characteristics of shifts in resourcesdue to monopolization.
Summing up, it is one thing to note that the money raised through a differen-tial tax is more costly than the actual money paid. It is quite another to interpretthis additional cost (the lost consumer surplus) as a sign of inefficiency and as adead-weight loss. To recognize that the loss of surplus is as true for privatedecisions that take dollars from use and allocate dollars to another, as it is truefor government that does so, has the potential to change our thinking about gov-ernment taxing and spending.
Acknowledgment
The author would like to thank J. Tucker Taylor, Steven Pressman, and two anon-ymous referees for helpful comments.
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