Sunday, October 13, 2013

Incentivizing Honest Preference Revelation for Public Goods

You have written elegantly but doesn't address the public good problem. I was hoping more of some link to mechanism design literature that can explain why it's incentive compatible. - urnbabyurn, Reddit Discussion on Public Finance
Let's review.  The reason that taxation isn't voluntary is because people would have an incentive to lie about how much they value public goods.

EPA: How much is environmental protection worth to you?
Erin: Around $400 a year
EPA: Please pay us $400 a year
Erin: Oh, in that case...it's only worth $100 a year

Here it is from the horse's monkey's mouth...
One could imagine every person in the community being indoctrinated to behave like a "parametric decentralized bureaucrat" who reveals his preferences by signalling in response to price parameters or Lagrangean multipliers, to questionnaires, or to other devices. But there is still this fundamental technical difference going to the heart of the whole problem of social economy: by departing from his indoctrinated rules, any one person can hope to snatch some selfish benefit in a way not possible under the self-policing competitive pricing of private goods; and the "external economies" or "jointness of demand" intrinsic to the very concept of collective goods and governmental activities makes it impossible for the grand ensemble of optimizing equations to have that special pattern of zeros which makes laissez-faire competition even theoretically possible as an analogue computer.
And here as well...
However no decentralized pricing system can serve to determine optimally these levels of collective consumption. Other kinds of "voting" or "signalling" would have to be tried. But, and this is the point sensed by Wicksell but perhaps not fully appreciated by Lindahl, now it is in the selfish interest of each person to give false signals, to pretend to have less interest in a given collective consumption activity than he really has, etc. I must emphasize this: taxing according to a benefit theory of taxation can not at all solve the computational problem in the decentralized manner possible for the first category of "private" goods to which the ordinary market pricing applies and which do not have the "external effects" basic to the very notion of collective consumption goods. - Paul A. Samuelson, The Pure Theory of Public Expenditure
"departing from his indoctrinated rules" = lying
"give false signals" = lie

If Erin lies about how much she values the environment...then she can pay less money while still receiving approximately the same amount of benefit.  If everybody else does the same thing, then the EPA would receive far less money than it should.  As a result, people who value the environment would be worse off.

The common solution is to force people to pay taxes.  Unfortunately, the government doesn't just force people to pay taxes...it also spends their taxes for them.  We give our money to the IRS...and the IRS gives it to congress...and congress decides how to divvy up the money among the various government organizations.

The problem is that there's no real plausible way for congress to determine how much Erin values the environment.  Samuelson the monkey tried to get around this by assuming that congresspeople are omniscient.

As a pragmatarian, my argument is that we should drop this fundamentally absurd assumption and allow taxpayers to choose where their taxes go.  How Erin allocates her taxes will reveal how much she values public goods.  If the cost is a foregone conclusion, then it's in her selfish interest to get her money's worth.

It's like going to an all you can eat buffet.  The cost is a foregone conclusion.  It's fixed.  What's variable is the amount of benefit you derive...which depends entirely on the selections you make.  Therefore, it's in your selfish interest to pick the dishes that you find most deeeelish.  In other words, you have an incentive to pick the items that most closely match your preferences.
Under most real-world taxing institutions, the tax price per unit at which collective goods are made available to the individual will depend, at least to some degree, on his own behavior. This element is not, however, important under the major tax institutions such as the personal income tax, the general sales tax, or the real property tax. With such structures, the individual may, by changing his private behavior, modify the tax base (and thus the tax price per unit of collective goods he utilizes), but he need not have any incentive to conceal his "true" preferences for public goods. - James M. Buchanan The Economics of Earmarked Taxes
Yet, as you can see from urnbabyurn, there's still some concern regarding a lack of honesty in a pragmatarian system.  This primarily stems from people's mistaken belief that our system adequately gauges people's preferences for public goods.  It secondarily stems from the fact that few of the goods supplied by the government are actually public goods.  Most are simply private goods with beneficial spillovers (positive externalities).  So some public goods are more collective than others.  Therefore the argument is that people will have an incentive to pay for the individually beneficial public goods while hoping that others will pick up the tab for the collectively beneficial public goods.

It boils down to who would lie about your preferences more...you or congress.  If you would lie about your preferences more than congress would...then we'd be worse off in a pragmatarian system.  Here's how I've illustrated this...


If you would place yourself at a 6...but congress would have placed you at a 5...then if this was the only factor, we'd be worse off in a pragmatarian system.

As Adam Smith wrote in the passage in the picture, "every single piece has a principle of motion of its own...".  In a pragmatarian system...how far would you deviate from your own principle of motion?

With our current system pacifists are forced to pay for war.  This is a huge deviation from their own principles of motion.  They wouldn't deviate nearly as much in a pragmatarian system.  The same could be said of people who support the legalization of drugs.  Shutting down the Silkroad would probably be the last thing that they'd want their taxes spent on.

In the current system people are forced to fund things they are diametrically opposed to.  Conservatives are forced to fund liberal public goods and liberals are forced to fund conservative public goods.  In a pragmatarian system however, the forced rider problem would be limited to those who didn't want to pay taxes.  But at least they wouldn't be forced to fund the IRS.  Of course there would be far less people who didn't want to pay taxes, given that studies show that people are more inclined to pay taxes when they actually value what their taxes are being spent on...
We find that allowing earmarks more than doubles both contributions and the likelihood of giving to government organizations. Participants give on average $1.68 from a $20 initial payment for general purposes, compared to $5.52 for cancer research and $4.04 for disaster relief; the likelihood of giving increases from 30 percent for general purposes to 66 percent for cancer research and 61 percent for disaster relief. - Sherry Xin Li et al, Do Earmarks Increase Giving to Government?
The important thing to consider here is that everybody has their own principle of motion.  This means that it's unlikely that any two individuals are going to put exactly the same things in their shopping carts.  When people are free to shop for themselves...the quality/quantity of products/services will reflect the diversity of people's preferences.

In 1978 when Deng Xiaoping started to help China transition from a planned economy to a mixed economy...the quality/quantity of products/services available reflected the fact that people had not been free to shop for themselves.  Their principles of motion were designated by government planners.
Apart from their other characteristics, the outstanding thing about China's 600 million people is that they are "poor and blank". This may seem a bad thing, but in reality it is a good thing. Poverty gives rise to the desire for changes the desire for action and the desire for revolution. On a blank sheet of paper free from any mark, the freshest and most beautiful characters can be written; the freshest and most beautiful pictures can be painted. - Mao Zedong
The people were essentially marionettes.  They were unable to dance to the beat of their own drum.  This homogenization/standardization of preferences invariably prevents the diversification of products/services.

Once people were given more freedom...as some of the strings were cut from the marionettes ...their own principles of motion began to bear fruit.  The quality/quantity of products/services now available in China is infinitely greater than it was 35 years ago.  

If we created a market in the public sector...then in 35 years from now the quality/quantity of public goods available will be infinitely greater than it is now.

So even in the extremely unlikely situation that some collective public goods received less funding than they really should...the greater quality/quantity of those public goods will more than make up for the less than optimal funding.

Basically, it's a given that all government organizations can do far more with significantly less.

The only way to maximize the incentive for government organizations to do better things with society's limited resources is to allow taxpayers to choose which government organizations they give their taxes to.  If the carrot on a stick is not held by consumers...then it's a given that the government will not be a servant of the people.  Nothing limits progress more than having the government be our master. In order to guarantee a government for the people and by the people...in order to ensure maximum responsiveness...people must have the freedom to give their positive feedback (tax dollars) to the most beneficial government organizations.

In closing, here are some supporting arguments in other people's words...

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. - Adam Smith, The Theory of Moral Sentiments

Within the market society each serves all his fellow citizens and each is served by them. It is a system of mutual exchange of services and commodities, a mutual giving and receiving. In that endless rotating mechanism the entrepreneurs and capitalists are the servants of the consumers. The consumers are the masters, to whose whims the entrepreneurs and the capitalists must adjust their investments and methods of production. The market chooses the entrepreneurs and the capitalists, and removes them as soon as they prove failures. The market is a democracy in which every penny gives a right to vote and where voting is repeated every day. - Ludwig von Mises, Omnipotent Government

There are two basic and diametrically opposed views of taxation.  Those who favor the ability to pay approach view the state as a master, who extracts tribute from its subjects on the basis of how much they are able to pay.  Those who take this first approach often also view the state as a benevolent father figure, who distributes tax benefits on the basis of need.  In Karl Marx's words, "From each according to his abilities; to each according to his needs." 
Those who take the cost-benefit approach view the state as the servant of the people.  Government provides services and taxpayers pay for the services.  Those who benefit the most from the services should pay the most.  And those who do not use a particular government service should not be forced to pay for it. - Robert W. McGee, The Philosophy of Taxation and Public Finance

The fundamental difference between decision-makers in the market and decision-makers in government is that the former are subject to continuous and consequential feedback which can force them to adjust to what others prefer and are willing to pay for, while those who make decisions in the political arena face no such inescapable feedback to force them to adjust to the reality of other people’s desires and preferences. - Thomas Sowell, Intellectuals and Society

The second common feature relates to the joint professional belief that the value asymmetry will disappear in a market-like environment.  A market-like environment will accomplish the role of providing both incentives to accurately state demand and learning opportunities to the individual.  The first important attribute of the market-like environment is the incentive property; specifically, the design of a public good allocation process which provides the greatest possible incentive for truthful revelation of value.  Once truthful values are obtained, any sources of bias which lead to the asymmetry should then disappear. Additionally, the market-like environment is important because recurrent and reversible transactions can take place in a market. The importance of these transactions lies in the fact that attitudes toward losses may change as the individual becomes familiar with the experience of obtaining a public good and then giving it up. After a period of time, what is given up will be perceived as an opportunity cost, rather than a loss. The loss-aversion phenomenon can then be expected to become a less predominant factor in the valuation measurement process. - David S. Brookshire and Don L. Coursey, Measuring the Value of a Public Good

The second argument for the use of market based frames relates to the opportunities provided by markets for repeated choice and learning in an environment where sub-optimal choice is punished (by a failure to achieve maximum utility).  It is a preference-revelation-based argument in that these are usually considered to be exactly the kinds of conditions most likely to uncover preferences.  Consequently the decisions made in markets yield good outcomes in the sense that they are true to any underlying preferences. - Alistair Munro, Bounded Rationality and Public Policy: A Perspective from Behavioural Economics

Individuals express preferences about changes in the state of the world virtually every moment of the day.  The medium through which they do this is the market place.  A vote for something is revealed by the decision to purchase a good or service.  A vote against, or an expression of indifference, is revealed by the absence of a decision to purchase.  Thus the market place provides a very powerful indicator of preferences. - David Pearce, Dominic Moran, Dan Biller, Handbook of Biodiversity Valuation A Guide for Policy Makers

Using dollars in open markets muffles the rhetorical din and forces persons to reveal honestly the strength of their preferences in a common medium understood by all.  "Put your money where your mouth is" is a coarse reminder of a high philosophical truth.  If the tax collector cannot measure utility straight up, neither can the regulator who is all too likely to succumb to the demands of local residents (and voters) and to overlook or undervalue the preferences of outsiders.  Direct political measurements of utility tend to destroy utility itself.  The wealth proxy has a lot to commend it in straight utilitarian terms. - Richard A. Epstein,  Mortal Peril: Our Inalienable Right to Health Care?

The economic approach stresses the fact that any expenditure always has an opportunity cost, i.e. a benefit that is sacrificed because money is used in a particular way.  For example, since biodiversity is threatened by many factors, but chiefly by changes in land use, measures of value denominated in monetary terms can be used to demonstrate the importance of biodiversity conservation relative to alternative uses of land.  In this way, a better balance between 'developmental' needs and conservation can be illustrated.  To date, that balance has tended to favour the conversion of land to industrial, residential and infrastructure use because biodiversity is not seen as having a significant market value.  Economic approaches to valuation can help to identify that potential market value, whilst a further stage in the process of conservation is to 'create markets' where currently none exist. - David Pearce, Dominic Moran, Dan Biller, Handbook of Biodiversity Valuation A Guide for Policy Makers

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