Excellent overview! If you dig a little deeper though you’d find that there’s a much more superior solution.
In 1954, the Nobel liberal economist Paul Samuelson published the most widely cited economic defense of government… The Pure Theory of Public Expenditure. In his very short paper Samuelson formally described the free-rider problem…
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. — Paul Samuelson, The Pure Theory of Public Expenditure
It’s human nature to want a free lunch (something for nothing). Everybody wants the most bang for their buck. This fundamentally basic but extremely strong desire works wonders for private goods. We all shop around to find the very best deals to spend our limited and hard-earned money on. Our selfish individual efforts help to improve the quality, quantity and variety of private goods at the maximum possible rate. When it comes to public goods though… our selfishness doesn’t work so well. This is because public goods have a different nature. It’s possible to benefit from them without having to pay for them. Which is a problem because it’s in our nature not to buy something if we don’t have to. As the saying goes… why buy the cow when you can get the milk for free? The logical and detrimental consequence of applying human nature to the nature of public goods is that public goods will be undersupplied.
The free-rider problem is the strongest economic justification for taxation.
Nearly a decade after Samuelson published his paper, the Nobel founder of Public Choice Theory, James Buchanan, published a response…
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 Buchanan, The Economics of Earmarked Taxes
Basically… once the cost of contributing to public goods (aka “taxation”) is a foregone conclusion… then the incentive to lie is replaced by the incentive to tell the truth. If it’s a given that, for whatever reason, you’re required to pay $20 dollars for lunch… then you might as well shop around in order to find the lunch that’s going to provide you with the most bang for your buck.
Therefore, the much more superior solution is simply to allow taxpayers to choose where their taxes go (pragmatarianism). This would essentially create a market within the public sector. Taxpayers would be free to demonstrate their diverse preferences for public goods just like consumers are free to demonstrate their diverse preferences for private goods. Pacifists could boycott wars like vegetarians can boycott meat.
The conclusion of your story was that government “must be reduced to its smallest possible form”. A small government is certainly preferable to our current government… but it’s really not preferable to a pragmatarian government.
Reducing the size/scope of government doesn’t truly solve the preference revelation problem, or the free-rider problem or the incentive problem. So even if you limit the government’s scope to defense, courts and police… we’re still going to suffer from things like unnecessary wars, miscarried justice and police brutality. And the private sector would undersupply public goods like cancer research, environmental protection, space exploration and asteroid avoidance.
With pragmatarianism, on the other hand, we’d have the best of both worlds. The public sector would combine the higher levels of funding generated by taxation with the superior productive performance powered by taxpayer choice.
It might be argued that a small government is much more likely to be achieved than a pragmatarian government. I’ll be the first to agree that a bird in the hand is certainly worth two in the bush. However, an argument about likelihoods would be missing the huge point that in order for either system to be implemented… people have to recognize the immense value of having markets allocate more, rather than less, resources. A small government and a pragmatarian government both mean that the market would allocate more, rather than less, resources.
Markets… what are they good for? Well… I think a big part of the answer was supplied by the two most arguably important economists in the area of public finance… Samuelson and Buchanan. The main conceptual thrust in both their papers was the importance of correctly ascertaining people’s true preferences. I refer to this as “clarifying demand”.
Even though Samuelson understood that the optimal supply depended entirely on clarifying demand… for some reason he believed that ascertaining people’s true preferences was a minor detail. It was as if the economy simply boiled down to math and models… rather than consisting entirely of unique individuals in unique circumstances. As a result… Samuelson got a few other minor details wrong as well…
The Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive. — Paul Samuelson, Economics
Buchanan correctly understood that no economy can truly thrive when the allocation of resources has little relevance to the true preferences of all the unique individuals that comprise the economy. This understanding formed the basis of Buchanan’s appreciation for markets. Markets are good for giving people the freedom to demonstrate their true preferences (clarify demand). Except when it comes to public goods… which is simply solved by taxation and individual allocation.
So in order to achieve either a small government or a pragmatarian government… it’s necessary to help people understand the importance of clarifying demand. This isn’t as difficult as it might sound! The fact of the matter is that the public sector really isn’t the only place suffering from demand opacity. Take Medium for example!