Political Fantasies Can Be Costly

By John Hood

RALEIGH — It’s hard not to play along when children come up with cute untruths.

For example, for a time one of my boys used to tell me confidently and matter-of-factly that if he didn’t go to bed, the moon would not rise. It was a reasonable conclusion based on his personal experience at the time (he was around three years old). Later, of course, his bedtime changed, he began to notice the moon in the sky even during the daytime, and concluded differently.

Unfortunately, many politicians have yet to grow out of the toddler phase when it comes to spotting and discarding spurious correlations. The most naïve and destructive examples stem from misusing the concept of the multiplier effect.

A politician will say that for every dollar spent on such-and-such a project, the public will receive multiple dollars back in economic activity and job creation. They cite economic-impact studies that take the amount spent and run it through a model that estimates the local expenditure on labor and materials. While such data can be useful — particularly if you are thinking about going into the business of supplying labor or materials to a particular project, firm, or industry — they don’t speak at all to the net economic benefits of spending those tax dollars.

Getting to the net requires that you estimate the benefit of using those dollars on some alternative expenditure. Economists call this the opportunity cost. Basically, all costs are opportunity costs, whether they are denominated by dollars, time, or some other means. If you spend $10 eating lunch at Jersey Mike’s (highly recommended, by the way) you can’t spend the same $10 on some other meal, or on buying socks at the store after having skipped lunch altogether. More broadly, the resources you consumed getting to and from the sub shop, including the minutes, can’t be devoted to something else. What you didn’t consume — the alternative meal, the socks, the extra time spent at the office — constitute the opportunity cost.

In public finance, the opportunity cost comes at two stages. Certainly the tax dollars you spend on, say, highway construction can’t be spent on public schools or law enforcement. That’s the second stage of opportunity cost. But there is also an opportunity cost to converting private dollars, earned through voluntary means, into tax dollars in the first place.

When people keep more of what they earn, that money doesn’t disappear just because it no longer shows up in the government’s balance sheet. It is devoted either to current private consumption or to net private investment, both of which have economic impacts of their own. When politicians claim huge economic bonanzas from subsidizing sports stadiums, convention centers, or economic-development projects, they typically ignore this lost private expenditure altogether.

The only real justification for a government program is that private individuals, spending a given amount of money through voluntary exchange, won’t get as high a return on that money as the government would by taxing the money away from them and devoting it to some public purpose.

The case isn’t that hard to make when it comes to basic governmental services such as law enforcement and the courts. Beyond that, you have to argue that government policymakers are likely to know better than citizens how best to spend the citizens’ own money. There are such cases, I would submit — public goods where, for technical reasons, private individuals are not presented with the accurate information (prices) they need to make the best decisions. But these cases are rare.

Politicians who assert the magic of multiplier effects to justify their pet programs may be dissembling. But it is my experience that most of the time, they don’t know enough about the matter to be lying. They are just repeating what they’ve heard, or spotting spurious connections on the basis of limited experience.

It’s their business if they choose, Peter Pan-like, not to grow up. But they should keep their hands out of the wallets of the grownups.

John Hood is a Carolina Journal columnist and author of the forthcoming novel Mountain Folk, a historical fantasy set during the American Revolution (MountainFolkBook.com).