The Economics of Taking and Giving

14 Jan

I often hear, when talking to people about government debt and deficits, that social programs are vital to our society and provide great benefits.  This always gives me pause as I try to break this down in my mind of how exactly government social programs benefit society and what are the costs and benefits.  First, and the most easily recognizable benefit, is that some people receive assistance – food subsidies, healthcare subsidies, housing subsidies, and direct money transfers.  It is good that people who need help can get help, but then I start to brood over how exactly this is accomplished and if they are truly beneficial.

The government can only give what it first must take.  This is the side of social programs people rarely examine in any great detail because the surface level observation is that people are getting help and this makes people feel good.  If the government is to deliver one dollar of assistance, it must first extract that dollar out of the economy.  So how does the government extract money out of the economy and what effects does this have?

Most often, people assume that a dollar can be taken from one person and given to another with a costless mechanism.  That is, there are no costs associated with the gathering, accounting, and delivery of the dollar to be transferred.  According to James R. Edwards, in his essay “The Costs of Public Income Redistribution and Private Charity”…

…public income redistribution agencies are estimated to absorb about two-thirds of each dollar budgeted to them in overhead costs, and in some cases as much as three-quarters of each dollar. Using government data, Robert L. Woodson (1989, p. 63) calculated that, on average, 70 cents of each dollar budgeted for government assistance goes not to the poor, but to the members of the welfare bureaucracy and others serving the poor. Michael Tanner (1996, p. 136 n. 18) cites regional studies supporting this 70/30 split.


If the cost of government delivery of one dollar to a welfare recipient is $0.66, then the actual person in need receives only $0.33.  How can this be possible?  I can drop a dollar in the hands of a person on the street for nothing, yet the government requires $0.66 to operate their form of charity.  So what costs so much to deliver welfare money?  For one, administrative costs:

The HHS investigators said federal administrative costs increased by 43% between 1987 and 1991, while the number of recipients in the three programs (food stamps, Medicaid, cash benefits under the Aid to Families with Dependent Children program) increased on average by 18%…– “Federal Cost of Running Welfare Soars” 


It’s clear that once you start examining the costs of redistribution, it quickly becomes an iceberg, with the tip being the part that makes people feel good about helping the needy while the bulk of the costs lay hidden under the surface.  As you descend down below the surface and pass the administrative costs, other, less obvious costs begin to appear.

Assuming that the cost of collecting the tax revenues to be budgeted to redistributive agencies is zero, then for each dollar delivered to a subsidy recipient, whether in the form of rent subsidy, food stamps, welfare, prescription medicine, or whatever, the taxpayers who had earned that money productively in the market must be deprived of three dollars worth of the things they want.—“The Costs of…


What does this mean to our economy?  Not only is the government redistribution machine absorbing two-thirds of what it confiscates, it must take two-thirds more from the taxpayer in order to deliver the intended amount of assistance.  Instead of you and I being able to buy three dollars of something we want or need and recirculating that money back into our local economy, it is siphoned away to areas unknown with only one of those dollars going to the welfare recipient.  The other two dollars were taken simply to pay for the whole process (labor and overhead costs).

Another cost normally ignored when discussing the economic impact of the redistribution of wealth is that associated with opportunity costs.  An opportunity cost is the value of the forgone option had the first option not been taken.  For example, a person could be hired as a social worker inside the federal welfare system or that person could choose to work on an assembly line for an automotive plant.  If the person chooses to work as a social worker, the opportunity cost is the wages and productivity that could have been earned as an assembly line worker.  James. R. Edwards sums it up like this:

Acemoglu and Verdier (2000, p. 195) recently remarked that the opportunity cost of government intervention is the withdrawal of agents from the productive sector. This is almost right. In order to draw some fraction of our population and other scarce resources into income redistribution agencies, governments must pay market prices and wages for them. The private sector production those people and other resources would have generated in alternate employment is lost, however, as they are employed instead simply to forcibly redistribute a fraction of remaining national output and income, part to subsidy recipients and a large part to themselves. The amount paid for such resources, approximating the dollar value of their private sector production forgone, is termed their resource cost, and this lost production unambiguously makes Americans in general worse off than they otherwise would have been.     

The final cost I would like to discuss is the economic cost of taxation itself.  Taxation creates a deadweight loss to overall production.  The amount lost depends on the amount of the tax and the market in which the tax is being levied, but the loss is a reality.  Not only does the very imposition of a tax place a drag on overall productivity but the tax system itself imposes costs, as Edwards points out:

The time and effort necessary for citizens to comply with the tax laws are substantial, and since they have alternate uses in production, their value can be estimated. In addition, taxes reduce the incentives people have to use resources productively. They work, save and invest less than they they would if tax rates were lower, and ceteris paribus, this reduces total output and income.3 That loss can also be estimated. Other private sector burdens, including enforcement costs, forced collections (such as business withholding costs), and costs of litigation, tax avoidance and evasion, are also significant. Payne (1993) has estimated that the total government and private sector cost of taxation amounts to 65 percent of net tax revenue.

Below the surface level discussions of welfare and its perceived benefits lies the administrative costs which are estimated to be two-thirds of all money collected.  Also, the taxpayers must fund this process and forego the purchase of goods and services within their local community – costing both them and their local businesses.  An “invisible” cost and one very rarely discussed is the vast ocean of unforeseen opportunity costs associated with pulling people out of the productive private sector in order to run the bureaucracy.  Finally, taxes create a deadweight that can never be recovered and the tax system itself costs the private sector billions of dollars to comply with tax laws.  The cost side of the welfare system in America does not make for a great sound byte on television, but the negative economic impacts of the welfare state need to be addressed if we are serious about economic growth and real prosperity.

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Posted by on January 14, 2012 in Uncategorized


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