Minnesota’s Economic News – W/E 4/16/21
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Why do we tax people? Nearly one in every five dollars of income in the United States is taken by the federal government in tax so its a pretty important question. Every once in a while we should reflect on the fundamentals.
Public goods in theory
Probably the most common answer would be ‘To pay for stuff’. But what stuff?
There are what is known as ‘public goods’. In the jargon, these are goods or services which have the characteristics of being both non-rivalrous (my consumption of it does not leave less for you to consume) and non-excludable (if I pay for it it still benefits you whether you pay or not).
The textbook example is the lighthouse. Literally. There was a picture of a lighthouse on the cover of one of my undergrad textbooks, Economics of the Public Sector.
Lets say you have two ships sailing on Lake Superior, the Viking and the Packer. You can even imagine the Viking as a luxurious queen of the waves, and the Packer as a somewhat moth eaten old tug. Either way, the Viking has paid a contribution to a lighthouse construction fund, the Packer has not. But the Packer benefits from the light just as much as the Viking. There is no way the lighthouse can only shine light for the Viking. The beam from the lighthouse is non-excludable. Also, the Packer can see the same beam as the Viking without reducing the amount of light the Viking sees. The beam is also non-rivalrous.
In these circumstances you have what’s known as the ‘free rider’ problem. The Packer benefits from the lighthouse whether it pays for it or not so it is incentivized not to. But so, also, is the Viking and for the same reason. The result is that neither ship pays to build the lighthouse. It doesn’t get built, and ships start sinking.
Here we have an amount of lighthouses which is socially sub-optimal. To remedy this, the theory goes, the government is required to step in and fund the good (or service) out of general taxation.
Public goods go private
In practice, it can often work out differently.
Technology is constantly changing the excludability of various goods and services. For example, sonar does more to keep ships from submerged dangers nowadays than lighthouses do, and the benefits of a sonar device are excludable.*
And the free rider problem may not be as much of a problem as it first appears. Neither the Viking nor the Packer want to sink. While they may be incentivized to free ride, they are also incentivized not to end up at the bottom of Lake Superior. This incentive can lead to cooperation. As economist Ronald Coase wrote, there is, in fact, a long history of private sector lighthouse provision.
The theory of public goods is a common theoretical justification for taxation and government provision. But it’s not the only one. We’ll look at more tomorrow.
John Phelan is an economist at the Center of the American Experiment
* Where something is excludable and non-rivalrous it is known as a ‘club good’.