Monday, April 6, 2009

Liberalism And The Danger Of First-Order Thinking

There are two basic ways to look at the spending priorities of a government institution.

The first is to examine the public's underserved needs to determine where money should be allocated. The second is to consider where the money comes from to pay for it all.

Both perspectives are critical, and both perspectives help to shape the impacts of government policy. But few who analyze policy spend much time on the latter view.

Spending time only on the first part of the equation is the basic flaw in liberalsm. I call it first-order thinking.

To a first-order thinker, the obvious way to meet a need is through spending money on it. This applies to everything -- health coverage, education and pensions to name a few.

Sadly, economics follows its own thermodynamic principal. And, aside from recent actions by the Federal Reserve, the government lacks the power to simply invent money out of thin air and then spend it. By and large, governments must raise money they want to spend through taxation, borrowing or both.

Both taxation and borrowing involve taking money from one set of people and allocating it to the government's spending priorities. Those whose money is taken or borrowed must then adjust their priorities accordingly. This is a second-order effect, and it is not one a liberal is likely to consider.

This effect is the basic reason why the New Deal did little to fix the Great Depression, and Obama's stimulus package will do little to help the present national economy.

In fact, most economists view the negative second-order effect of government spending as more harmful than any benefits derived from the spending itself. This is because those whose money was taken or borrowed probably would have invested it in projects aimed at profitability.

Such for-profit projects are the engine of a capitalist economy. When the government substitutes its judgment for that of the invisible hand of the market, a less efficient outcome is nearly always the case.

So, the stimulus package will probably delay the economy's recovery.

But this is a local blog, so I want to address another second-order effect that is unique to the layers of government below the federal level.

Few probably remember Prop 63, the Mental Health Services tax which passed some years ago. This initiative imposed a 1 percent tax surcharge on Californians whose incomes exceed $1 million per year. It raised the top income tax bracket to 10.3 percent -- by far the highest in the country.

While my income means I have not been burdened with this tax, I opposed it because I suspected its second-order effects would mean more harm than good would come out of it.

My reasoning was based partly on the concept of the Laffer curve -- which says that there is a point in taxation where raising the rate actually nets the government less in revenue. This is because high taxation crowds out profitable investment opportunities. This then lowers the total income of the society, thus lowering the amount of tax to be found.

For Prop 63, the effect is even more pronounced, because these "millionaire households" need only to move to another state to avoid this tax.

And move they have. Since the tax passed, more than 7,000 such households left Los Angeles County. This flight hurts government revenue at every level. It means these people probably sold their houses, depressing property tax revenue. The same kind of thing goes for sales tax revenue.

Worse yet, it means they now pay zero income tax to California. At least $100k in taxes per year per family is gone from the state revenue base. That's $700 million per year, assuming each household makes around $1 million a year, which is a conservative estimate.

What does this analysis mean for places like Oakland, where all three of property, sales and income taxes are at the highest levels in the country?

Well, it probably means tax revenue will continue to fall, in spite of efforts to pass tax after tax. And it means the blight will grow. Why would anyone in their right mind relocate to Oakland or start a business here, knowing the level of taxation they're likely to encounter?

What should the state and local governments do? Lower taxes, and accept the short-term consequences to spending priorities. Doing so will actually increase the long term revenue to the government by drawing in individuals and businesses seeking more reasonable taxation.

It's clear as day to me that if Oakland lowered its ridiculous business taxation, reduced its property tax level to a more normal 1.1 percent (from 1.35 percent) and declared itself willing to do whatever it takes to attract businesses and wealthier residents, every aspect of the city would fare much better over the next decade than it will under the present course.

The problem, of course, is there is no clear constituency to advocate for such policies. The public employee unions will always advocate for higher spending. The anti-gentrification and socialist elements will always clamor for taxing the rich (until they all leave). But who is left to advocate for the right course of action when the second-order effects dictate that higher spending will only leave us with less to spend in the future?

I encourage my readers always to think about second-order effects in any government policy. Don't just consider where the money goes. Consider also where it comes from.

Consider how people's behavior changes when the government takes a larger share of the economy. Don't just consider one side of the equation, because doing so leads to the sort of short-sighted policies which have sunk Oakland and are slowly drowning California.


  1. I feel like a dope, I am thinking of actually buying a house in OAK. While it is in a nice neighborhood, I wouldn't send my unborn child to the public school Actually EBC I cannot agree with you more and it depresses me. I will have the resolve to bargain hard with the seller! I will have the resolve to bargain hard with the seller!

    Let me just add a little addition to EBC great post- we here in OAK have a large government for our size city:
    Oakland population: 399,484 FTE: 5,265
    Fresno population: 427,652 FTE: 3,466
    Sacramento population: 407,108 FTE: 4,268
    Long Beach population: 461,522 FTE: 5,986
    We all know that these employees are so unmotivated, that the whole structure is rotten to the core, that there is no reason for reform and entrepreneurialism in city government that we will be paying the price - unless we go BK!

  2. Are you crazy? You're using common sense. Common sense has long since vanished from the public debate in Oakland. No seriously, great post. I couldn't agree more.

  3. Don't buy in Oakland until you seriously consider Alameda and San Leandro (Berkeley naturally is out of the question).

    Alameda is more expensive, but has good schools etc. San Leandro is cheap, but has a couple good grade schools at least, and you're paying less in transfer & property taxes.

  4. Well, now I have to chime in. I'm a real estate agent who works mostly in Oaktown... the best deal for house+school is Walnut Creek... as long as you can deal with the tunnel... if you have to. I once saw Milton Friedman castigate suburbanites for voting with their feet so they could have "free" schools... while leaving the rest of us in the lurch... paying out of pocket for quality schools and paying again in property taxes for the sacred cows of the liberal establishment.

  5. Dear sir:

    Thank you for your meretricious and utterly picayune post, one that gives ample support to the dawning realization that there is nothing remotely intellectually supportable in contemporary "Conservatism." You state, and I quote, "most economists view the negative second-order effect of government spending as more harmful than any benefits derived from the spending itself." And who would "most" of these "economists" include, Joseph Stiglitz? Paul Krugman?

    Well, no, you just conjure a phrase divorced from any reality. What you really mean to say is that "most economists I actually read, i.e., solely those who are in the employ of or affiliated with Conservative 'think tanks' and causes.

    In fact, most leading economists at the top-tier universities, including Nobel Laureates Stiglitz (Columbia University) and Krugman (Princeton University) utterly disagree with your tendentious proposition. As the Peter Parker (Harvard University) acidly ripostes the Conservative malarky with the historical facts, to wit, "The effect of all this government intervention was to enhance the country's overall rate of growth," which entailed the creation of an, "educated workforce, build[ing] crucial infrastructure," and providing the investitures in the "scientific and technological research and development" undergirding American preeminence up until the ascension of Conservative politics––and the consequent decline of the United States as an economic, industrial, and moral force in the world (Parker, New York Review of Books, 3/12/09 pg 39) As to the Conservatives anachronistic and uncouthly slavish reliance on Friedman's Wizard-of-Oz ,1970s era prognostications, Jeff Madrick (Director of policy research at the Schwartz Center for Economic Policy Analysis,New School University) eviscerates the belly of Friedman's baloney by revealing that "Friedman offered much ideology but little evidence" that "Big Government" undermined economic growth (Ibid).

    Given the plethora of disasters brought upon the nation by Conservatism's ideology, Conservatism's incompetence, Conservatism's resort to demagoguery, Conservatism's militant know-nothing ignorance, and, ironically, Conservatism's laughably absurd pseudo-intellectualism, it beggars the imagination that you, sir, would deign to attempt to lecture anyone about "Liberalism" and its discontents.

    As for your claims about rising taxes causing businesses to "abandon" California cities, this is nothing but the classic post hoc ergo propter hoc logical fallacy. If you had studied with anything approaching seriousness, you would have long ago learned that all those "low tax" locales (Red States, suburbs, etc.) to which business supposedly flee make up for lost revenue via the distribution of monies taxed from the more progressive, and thus higher tax paying, states, such as New York.

    The unreconstructed emptiness of knee-jerk phrases such as "thermodynamics" and the "invisible hand of the market," the "Laffer curve" ( you mean, "laughable nerve") do not erase historical fact, economic truth, or the reality of the world in which we live.

    As a Conservative, you are entitled, indeed, to your benighted, idiotic opinions. But as the cheesy Russell Crowe movie put it, "The time for celebrating yourself is OVER."

    Indeed it is, Monsieur "East Bay Conservative," indeed it is.

  6. I'd find this reply more compelling if it tackled a couple points.

    First, I wonder how paying public employees 50 percent more than equivalent private-sector employees enhances economic growth. The truth is that the argument about infrastructure required for a modern economy is rooted in the government spending of the 1950s. True, we needed highways and airports. But today's spending is largely not on capital improvements -- it's on transfer payments.

    Second, it is simply a fact that millionaire households are exiting California for other locales. It is true that this phenomenon is hampered by geography and climate -- people like living near coasts. But, to argue that taxes make no difference in where people locate seems pretty foolish.

    One need only look at the progression of tax rates and spending priorities in California since 1960 to see the shift away from hard infrastructure toward welfare and giveaways to public employees. It's unsustainable, and economic arguments rooted in past government successes only serve to make the coming crash worse.

  7. After reading "Stranger" I suspect that the Bureau of Prisons has let the Unibomber have access to the internet. He conveniently omits reference to other respected economists such as Von Mises and Friedman... and probably doesn't realize that there is a real world off campus. Government involves itself in "projects", not because it has a superior knack or aptitude for, say, running schools or building roads... but only because it has the power to tax. School vouchers are a compromise between that power and acknowledgement of the utter failure of government to supervise education.

  8. Dear "Stranger", I came to Oakland in 1973 after being an environmental journalist for a start-up that failed. I then, with 2 friends, started a printing company that we ran for 22 years. For the last 11 of those 22 years I was the paymaster and estimator... along with being the guy who repaired all the equipment. I have a degree in anthropology from UCSB. Your exhalations of distain are completely devoid of detail... but rich in adhominem commentary and self-serving assumptions. Since the BOP has let you reach the internet... perhaps a conjugal visit is in your future. Best of luck!

  9. Dear Mr. Ross:

    You decry the ad hominem, which evidently drew blood due to the accuracy of depiction, but you resort to it as first choice in your rather diminished arsenal in both your responses.

    One would have hoped that your curriculum at UCSB would have included literature in general and the specifics of English language, for you seem to have forgotten the meaning of "hypocrisy." Ah, yes, but then you hew to Conservatism, which by definition means that hypocrisy is the modus operandi of your internal reasoning and external debate. Does one really have the need of enumerating the innumerable examples of hypocrisy your chosen wing has engaged in over the past thirty years––not to mention the past eight years?

    No, your petit examples will suffice as instructive. Consider your claim that my riposte trades in "self-serving assumptions" when in fact it is the author of this noisome blog who claimed so tendentiously (and falsely) that, and I quote, So too do your patently false claims that ripostes lacks "detail." In fact, my rebuttals include citations of a noted scholars, of which yours and your fellow travelers do not. You falsely claim that I resort to "self-serving assumptions," when in fact I eviscerated the "self-serving" falsehoods of this blog's very author, to wit: said blogger claimed, and I quote, "most economists view the negative second-order effect of government spending as more harmful than any benefits derived from the spending itself."

    I pointed out that the leading economists, including a number of recent Nobel Laureates, have achieved a consensus that squarely refutes the egregiously "self-serving assumptions" of the author of the aforementioned opinion.

    It is you, Mr. Ross, who have both refused and failed to rebut with anything approaching "detail" and disinterested analysis.

    That you have worked in Oakland as "paymaster and estimator" for a printing company does not, in itself, make you a disinterested analyst capable of discerning historical, economic, and cultural forces shaping Oakland's economic and political dynamics. Your fawning acceptance of Conservatism's bankrupt assumptions in light of said ideologies–––and its practitioners'–––failings proves this point beyond any reasonable doubt.

    Likewise that you have earned a degree in anthropology from University of California Santa Barbara invites the proverbial "pissing contest" to match Twain's Calaveras county nonsense. So be it. You have your success at UCSB.

    I took my degree from Columbia University, with honors, in a double specialization. But with respect to this exchange, only one of us, sir, has used the analytical tools his education has provided him.

    It isn't you.

  10. Economic activity is not captive to economic theory... it is a manifestation of common sense. I once gave an employee a raise, for which he was grateful... until his next check was generated, showing the dreaded "bracket creep." I was coughing up more money for each hour he worked and he was taking home less. Thus we have a ground level example of supply side economics... and how craven politicians and their demented accolytes constantly try to subvert it. In the early 80s we capitalized a whole new factory... and productivity skyrocketed, and thus employee benefits. Greenspan credited growth in productivity as a suppressant for inflation (he is currently, however, on the defensive). My education did not end with graduation... nor did that of my partners, one of whom went to Harvard.

  11. Dear Mr. Ross:

    You contradict once again the author of this blog's "essay ––-the very article with which you registered your strong accord––and his attempt to right his listing ship in claiming, falsely, that "most economists" agree with his Conservative falderal. Now you say that "economic activity is not captive to economic theory."

    How good of you to undermine your own ludicrous support of "supply side economics, to wit; Ronald Reagan signed in 1981 tax cuts that cut marginal tax rates from 70 percent to 50 percent on the "economic theory" that said cuts would actually bring about budget surpluses. The decade's grotesque budget deficits disprove this foolishness quite handily (i.e, cutting taxes while raising military expenditures cannot result in a balanced budget).

    You remind the discerning reader that this bit of economic "the-moon-is-made-of-green-cheese" nonsense remains sacrosanct to the Conservative/ GOP alliance, as you yourself recite it in your latest missive.

    This is the very missive in which you hand your opponent the gun and bullets to shoot you in the foot, as shooting yourself in the foot is obviously your desire but above your current capabilities: "economic activity is not captive to [CONSERVATIVE] economic theory."

    Indeed, Monsieur le Ross, indeed.

    You go on to mistake continuing "education" with Conservative indoctrination. They are not the same thing, sir.

    That your partner went to Harvard is irrelevant to the exchange at hand. After all, he is not the one making absurd claims in support of insupportable shibboleths redolent of Conservative group "think." You are.

    By the way, Harvard is a very fine institution, and had Columbia University not accepted my application to attend, Harvard would have made a fine second choice to commence my studies.

    That said, let us remind you that the current economic crises has utterly discredited your "expert" of choice, Alan Greenspan.

    Greenspan...Greenspan, ah, yes, the very same nincompoop who expounded that "self-interest" would "regulate" Wall street institutions instead of the rule of law and its enforcement. Greenspan apparently never bothered to avail himself of the lessons of history (you do remember Santayana's dictum, right?), the wisdom of political and social philosophers, not to mention untold millennia of human greed, self-delusion, stupidity, and avarice.

    Just as likely that as a Conservative, you could not bring yourself to watch Greenspan's deer-in-the-headlights performance before Congressman John Conyer's questioning, you know: the event during which Greenspan gulped like the deer upon which the Mack truck's headlights bear down on him, uttering in sheepish surrender to the oncoming oblivion that yes, indeed, his theory of "self-regulating" business didn't quite pan out.

    You might want to force yourself to witness the hapless Greenspan being made into so much historical roadkill before you resort to him and his ilk for "intellectual" and academic "support." History, like that Mack truck, has sent Alan Bambi Greenspan's shibbeloths to a better place (the curb). Your slavish reliance on that which reality has run over puts your arguments–––not to mention your dignity–––in same path of truth's oncoming headlights.

    And that which results provides an "education" that demands ever so much higher a price per course credit than ever would UCSB, let alone "Harvard."

  12. zzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzz

  13. Dear Mr. Somnolent Ross:

    Well, thank you for clarifying as to what you actually did during all of your classes at UCSB, and I quote: "zzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzzz"

    It shows, dear alum, it shows.

  14. Great site. This is my first time here so I wanted to say thank you for everything.