Of Free Riders and Forced Riders: America's Cup edition

We're all familiar with the typical free rider problem. If there's some public good, individual incentives to contribute towards its funding are attenuated by non-excludability: if you benefit from the good whether or not you pay for it, why pay? And so we get all kinds of arguments for government provision of various public goods.

A couple of days ago, my former Econ 224 student Brennan McDonald sagely suggested that the America's Cup bid be funded via Kickstarter. Economists know that most of the "economic benefits" case for these things is, as Shamubeel Eaqub so precisely put it, bullshit. What's left then? If the fun from a big party outweighs the cost, fine. Otherwise, not. Brennan then suggests:

If we host the next America’s Cup, Kickstarter or some other sort of crowd-funding is the only responsible choice. We should be forcing these special interest groups to put their money where their mouth is. I’m sure that a non-trivial proportion of Kiwis would donate to such a campaign. The deal with council and government could be that if you reach $XX million in voluntary contributions, we’ll streamline the resource consents necessary.

I think Brennan's largely right here. Kickstarter's pretty well placed for funding things that provide warm glow benefits, though they're not the only one. I gave some money to the Indegogo campaign for SeaSteading's current fundraising initiative; I'll get a polo shirt to wear. Actually, a third identical blue polo shirt with a nice Seasteading crest. I get warm glow and get to show affiliation, they get money, I get some prospect-theory-based utility.

Will Taylor then raises the usual objection:

@EricCrampton @brennansmacro @tvhe agree, though free-rider problems would be an issue.
— Will Taylor (@WillTaylorNZ) September 18, 2013

Yup, free-riding still could be an issue even for a decent Kickstarter. If we don't make payment mandatory, we'll get some free-rider problems from those who enjoy the benefits but refuse to pay. Sure. And I'm certain that Will here is simply raising the theoretical point rather than taking it as an argument for state funding of yacht races. However, others would use this argument as justification for state support: free-riding on a public good can provide reason for funding.

But there's a necessary complement to free-rider problems. If we do make payment mandatory through taxes, we'll get a forced rider problem: lots of people who get epsilon, zero, or negative utility from the yacht race are forced to pay for it through their taxes. I would currently be willing to pay $50 for the America's Cup to simply cease to exist; I'd pay more to abolish the Olympics. I hate the America's Cup. It clogs up tv, the Twitter Stream gets a bunch of unblockable nonsense added into it, radio blather gets worse. The America's Cup is almost intolerable being held a Pacific Ocean away; it would be unbearable in Auckland. At least it wouldn't be held in Christchurch.

Yes, I'm being ornery and maybe I'm exaggerating just a little. But worries about free-riders' benefiting from the America's Cup without paying lead people to force me to pay for stuff I do not want and the abatement of which I would view as a good. I wouldn't really push a button to abolish these things because I can't know that I wouldn't be doing more harm than good. But none of the darned boosters seem to give a hoot about whether they're doing more harm than good when they want to force everybody to pay for their parties. That's why they keep trying to frame this nonsense in "aggregate economic benefit" terms - so that they can pretend that even people who don't like the Cup get some notional benefit from it. And the merits of that argument were succinctly summarised by Shamubeel.

Free-riders can be a reason for government funding of public goods. It's possible for the aggregate true willingness-to-pay for something to exceed the cost of provision but for the payment not to be forthcoming because of non-excludability. But for stuff like the America's Cup, it's entirely plausible* that the losses from impositions on forced riders exceed, by orders of magnitude, the gains from avoiding free-rider problems. Please let's not go about creating political failures that are worse than the purported market failures they seek to solve.



* James Zucollo asks for evidence that forced rider problems will here be greater than free rider problems. I'll confess that I haven't gone around and run surveys on it. But surely the onus ought to be on those who would use force to compel my payment for a yacht race to prove that the thing creates rather than destroys value. And it's not that hard to turn Brennan's suggestion of Kickstarter into something more like Alex Tabarrok's Dominant Assurance Contracts. In that system, everyone who pledges towards the Kickstarter gets some small reward for their pledge whether or not the Kickstarter raises enough money to activate. If the campaign raises enough money, everyone has to pay up for their pledge. But because everyone is rewarded for pledging regardless of whether the project goes ahead, free-riding problems are reduced. Maybe it's not perfect as you still need some high demanders fronting a bit of cash for the up-front payments to supporters, but it's a decent way of reducing free-rider problems while avoiding forced-rider problems. That boosters of major events typically go for compulsion first suggests, to me at least, something about their expectation that individuals have more than notional demand for these kinds of things.

I'm having a rather harder time imagining how you run a Kickstarter for "No America's Cup Bid For New Zealand". Sure, I can imagine a site taking donations. But where a pro-Yacht Kickstarter would actually pay for the event, an anti-Yacht Kickstarter would have to be providing something to the governing coalition in order that they not go ahead with an America's Cup bid. It couldn't just donate to the National Party as too many potential donors would be put off by that and because Parties can't actually be seen to be selling policy. Instead it would likely have to be providing some desirable-to-the-government public good but only in the case that there's no Cup bid.

Update: I've been informed that if New Zealand wins the racing, the next America's Cup will be held in New Zealand. While I still think this is better funded by Kickstarter if it does go ahead, it's seeming increasingly likely that there might be me and maybe two other people in the country who might be annoyed by having to pay for a yacht race. A lot of people seem to be getting utils out of this thing. And while I think that this makes it way more likely that you could get a million people each shelling out $10 - $15 to support the cup in exchange for exclusive supporter t-shits, it also means that Zucollo could be right: losses from forced riders could be low. Bread and circuses are popular.

Other people's money

When you're playing with other people's money, you have different incentives. Take Corporate Social Responsibility, for instance.

Suppose that there's a trade-off between profitability and CSR mandates. Why might this be the case? Any CSR initiatives that increased profitability would have already been adopted under normal profit-seeking strategies.

Managers want to think themselves good people and enjoy doing CSR things. They get approbation from others for doing so. They'll get in trouble with shareholders if profitability drops too much, so they won't do the nuttiest things. But they'll take some CSR as consumption.

NBER points to some relevant evidence. From the abstract of Cheng, Hong and Shue's new paper:

We find support for two key predictions of an agency theory of unproductive corporate social responsibility. First, increasing managerial ownership decreases measures of firm goodness. We use the 2003 Dividend Tax Cut to increase after-tax insider ownership. Firms with moderate levels of insider ownership cut goodness by more than firms with low levels (where the tax cut has no effect) and high levels (where agency is less of an issue). Second, increasing monitoring reduces corporate goodness. A regression discontinuity design of close votes around the 50% cut-off finds that passage of shareholder governance proposals leads to slower growth in goodness.

In short, the more skin that decision-makers have in the game, the less they go for CSR policies. And the more that those with skin in the game can monitor the decision-makers, the less they go for CSR policies. It's slack in the principal-agent relationship that allows managerial consumption of "do-good" benefits.

Sometimes, we need Larry the Liquidator.

Ladies and Gentlemen... the Greens' would-be Finance Minister

Russel Norman, recently ruled out as Finance Minister in any Labour-Green coalition by Labour, tweets from the Finance Committee:

Sitting in Finance Cttee listening to Treasury officials describe tax as a 'burden'. Right wing political ideology runs deep in Treasury!
— Russel Norman (@RusselNorman) September 17, 2013

Tax is price we pay to live in a civilised society. If Treasury thinks it's a 'burden', perhaps they'd suggest abolition of public health.
— Russel Norman (@RusselNorman) September 17, 2013

Taxes are a bad, public services are a good. Saying the first doesn't mean denying the second.

More importantly, economists use the word 'burden' in a particular way. A few useful notes about Principles-level (maybe intermediate) economics for someone who thinks himself qualified to be finance minister:

• 'Burden' measures the total cost of a tax. The 'excess burden' is the amount by which the cost of a tax exceeds the amount collected. Treasury tends to reckon that excess burden is around 20%: it costs us about $1.20 to raise $1.00 in tax. The $1.00 raised is a transfer from the public to the government; the $0.20 is pure loss due to distortions in economic activity consequent to increases in our current mix of taxes.
• Tax incidence theory is important: it tells us who bears the burden of any particular tax. Suppose we wanted to add another 5% compulsory Kiwisaver contribution. The 'burden' of the tax would fall on both workers and on employers with the precise mix depending on how employers and employees change their labour demand and labour supply with changes in wages: it doesn't much matter whether we say that employers have to pay it or whether employees have to pay it. Regardless of statutory incidence, economic incidence - the burden - will remain the same. Meteria Turei understood this when she said that the accommodation supplement paid to tenants is largely a subsidy for landlords. Alas, public understanding of such things is imperfect, allowing for shenanigans where measures imposing burdens on one group are framed as costing somebody else instead.
• If a genie appeared able to provide public health services, for free, this would be a good thing, right? It's impossible, but it would be good. The services paid for by taxes are good, the taxes are bad. We need to be sure that the value delivered by services are greater than the burden imposed by the tax. At current measures of excess burden, a project must return at least $1.20 for every dollar in spending. 

Russel Norman suggests only "right wing" economists talk about tax burden. Here is a JSTOR search on "tax burden". There are 61 pages of search results with 100 results per page. Item number 177 on a date-sorted list is famous Right Wing Economist John Maynard Keynes discussing the Colwyn Report on Natinoal Debt and Taxation. Item 398 is rabid right-winger Nicholas Kaldor's call for wage subsidies to reduce unemployment (1936).

Burden is just the term used by economists to describe the cost of the tax and to help sort out the difference between statutory and economic incidence. Like "While X writes the cheque to IRD, the burden of the tax falls on Y and Z." That's it. It's the standard term used in the main texts to describe this thing. Richard Musgrave (centre, maybe centre-left) uses it. James Buchanan (right) uses it. Pick a random public finance text, you'll find "tax burden" or "excess burden" somewhere in it.

Update: egads, it gets worse. Lance Wiggs tries explaining that it's just a word we use. Russel Norman replies:

@lancewiggs Taxes do change behaviour. To call it a burden or distortionary does buy in to general equilibrium model w all its problems
— Russel Norman (@RusselNorman) September 18, 2013

Update 2: this is way too funny. A Twitter correspondent points me to two press releases by Russel Norman.

First:

"It's not fair to expect income-earning New Zealanders to carry a disproportionate share of the tax burden while some of New Zealand's wealthiest individuals pay none," said Green Party Co-Leader Russel Norman.

Second:

Unlike the National Government that has chosen to shift the tax burden on to the lowest paid New Zealanders, our tax changes would focus on those not currently paying their fair share.

Some advice for David Cunliffe.

Dear David,

Congratulations on winning the leadership of your party. Now the hard work begins. By that, I don’t mean uniting your party; I mean persuading the electorate that you are offering a coherent alternative to National, particularly on economic policy. Now I am an economist not a political commentator, but it seems to me that there are a few principles you need to follow that have been missing from your party over the past five years:

1. Ask yourself in private, what do you really stand for? Politics is the art of the possible. But this should mean asking what desired outcomes you have to give up on in order to be in a position to implement the ideas that really matter to you. Too often in recent years, it has seemed like your party has based its manifesto purely on what it thinks would maximise its chances of winning an election without any thought about why it wants to win.
2.  You will need to sacrifice some principles for populism; that is the nature of democratic politics. But you should aim to form a government that can win more than one election and will be judged well by posterity and so resist the temptation to cynically promote policies you know to be damaging. Your party’s 2011 promise to remove the GST from fresh fruit and vegetables was an example of such a policy.
3.  As a corollary of point 2, minimise your use of bad economics. Regrettably, bad economics can often be good politics, but too much—in particular excessive promising of free lunches—will be seen as non-credible by the electorate.
4.  In particular try to appear to be operating from consistent principles, not just offering to scratch the latest political itch. Your colleague, Clayton Cosgrove, recently and quite correctly in my view, castigated the government for paying a subsidy to Rio Tinto to keep the Tiwai Point aluminium smelter open. Three days earlier, you gave a speech as part of your leadership race in Dunedin in which you castigated the same government for “gutting” the Hillside Workshops in Dunedin. Campaigning against National’s corporate welfare could be a strong election plank for you, but not if you simultaneously criticise National for not having enough of it.
5. This means, you should take economics seriously. Don’t take your advice from courtiers seeking to flatter or consultants prepared to provide any answer you are prepared to pay for. Your party’s recent fiasco in which you repeatedly cited the Wolak report as justification for your electricity policy only to have Frank Wolak repudiate your claims, was an entirely predictable outcome of your not having sought to understand the report before citing it.

Follow these points, and you could be leading a party that operates with a few core principles and with policy proposals that follow logically from those principles. And that would certainly be a way to distinguish yourself from your political opponents!

The scream test

Imagine two policies.

Policy A would have government nationalise all liquor companies and distribute their product, for free, for anybody who wants some, with costs borne out of general taxation. There would be no compensation of the liquor companies.

Policy B would strengthen alcohol intervention programmes for prisoners with alcohol abuse problems. They'd spend a fair bit on it and work hard with prisoners, both while in prison and during their re-integration back into the community, to help them to avoid falling back into substance abuse.

Now Alcohol Action NZ proposes a "scream test" to tell whether some proposed policy would reduce alcohol harm. In their model, industry profits are increasing in the harm imposed by alcohol, and industry screams when profits are threatened. Anything that reduces harm reduces profits, so the scream test tells us which policies are likely to reduce harm.

I suggest instead that industry would scream a lot about Policy A, and would likely support Policy B. I also suggest that Policy A would increase harm and Policy B would reduce harm. Note further that National is already implementing something like Policy B - kudos to them. I've yet to hear screams from industry.

The scream test is a bad one. Profits are perhaps increasing in total consumption, but they're likely decreasing in alcohol's harms not only because of the policy reaction function but also because moderate consumers' consumption is likely decreasing in perceptions of harm.

The one spot where Sellman's scream test could be right would be policies potentially hitting the very heaviest consumers. There are discrepancies between median reported consumption figures and total alcohol available for consumption suggestive of that there is a small group consuming booze by the barrel. Policies disproportionately hitting that group could potentially reduce both harm and profits. But I hardly expect that mandatory 1 am bar closing times fit the bill.

TANSTAAFR

Ladies and gentlemen, the Owlbear song.

Geek cred to the first commenter explaining my cryptic title and the problem in Marcotte's song to which it alludes.

Marcotte's D&D works are up on Spotify (and here and here). Listen to them during your next campaign.

HT: my search on Spotify for the word "Owlbear". This is the only song that came up. If you need to ask why I'd have searched Spotify for Owlbears, you've not been reading me long enough.