deliver more value per dollar they will get more business. If not, people will go elsewhere.
An employee’s service is of value to the employer because it helps the business to meets the needs of its customers more effectively. In addition, as the employee has more disposable income, they are then able to purchase more goods and services. The businesses that people purchase from are able to generate more revenue, and thus are able to purchase more goods and services, hire additional employees, or distribute the additional funds to their owner who can now purchase more goods and services. In short, it is a classic win-win situation where everyone does better. The economy grows.
The problem for government is that it does not provide goods and services in this fashion. Many people can think of stores they like to shop in, or businesses they like to deal with. But who likes to deal with the government? When was the last time you heard somebody say they wanted to go to the DMV or to the IRS when they were not being forced to go by government itself? While government does provide goods and services they do not compete in the marketplace for business, but rather, often require people to be their “customers.”
A business charges for its services based on people’s willingness to pay. This is how a business gets its money. From these monies the business must pay for its costs such as raw material, labor, taxes, etc. What is left over, if anything, is profit for the owner(s).15 Again if there is a lot of profit, the owner(s) will probably want to invest back into the business, so that it grows even larger. If there is not enough profit, the business fails. As a result there is a strong incentive for businesses to provide services that people want, and at a price they are willing to pay. Even when they are doing so successfully, they must be on guard for others who may come along and do it better.
No such incentive exists for government. Most people deal with the government only when they have to, and avoid it as much as possible. When people do deal with government, the service is generally not good.g This is not because the people who work for government are not as smart or as talented, but because they operate in a different system with different incentives and objectives.
If government revenues were based on a willingness to pay, government would cease to function very quickly. In a few areas, such as the National Parks, people probably would still go because they wanted to, but the vast majority would ‘go out of business’ very quickly. After all, how many people would want to go to the DMV and pay to have their car registered because they liked the services they provide and the way they provided them? As such, government services must be mandated and paid for in the form of taxes or required fees.
A classic example of how this leads to different approaches can be seen in the area of transportation in which there are both government and private choices. When privately run modes of transportation, such as the airlines, don’t have enough money, their approach is to try to attract more customers by providing better service, or by cutting fares. Lower fares mean more riders, more riders means increased revenues.h
When government run means of transportation such as local bus systems or subways have similar problems, their normal response is to raise rates. The reason for this difference is that they have different incentives, and therefore they have different responses.
Be it a private business, or a government office, both are focused on satisfying those who provide the money to pay the bills. In a private business, that is the customer. If the customer is not happy, they will take their business, and their money, elsewhere. But for a government office while the person coming into the office could be deemed the customer they are not the one who provides the money to pay the bills, except in the general sense that they are taxpayers. But even as individual taxpayers they have very little say in how the government spends tax dollars. In addition, most of the time they cannot take their business elsewhere. For a government office, the ones who provide the money to pay the bills are the politicians who appropriate the funding for the program. They are the ones that must be kept happy.
Ultimately the problem with taxes is that they act as a burden on the economy. As we saw earlier, a business or an employee can get increased revenue by providing additional value for a lower cost and the net effect grows the economy. Taxes have the opposite effect; they reduce the spending ability of those being taxed while not providing any direct additional value, or at least a value that is less than the amount paid. If your taxes increase, your ability to spend is reduced.
I am not saying that nothing government does has value, it does. However, this is an issue of value in relation to cost. Given the competition in the marketplace, a primary concern for business must be providing the best value for the lowest cost, lest customers go elsewhere. For government there is no competition and as a result government tends to be very wasteful.
Thus there is little incentive to keep costs down, and in fact for most of government, the incentive is reversed. An agency or department that works hard to reduce costs and save money, will be “rewarded” by having their budget cut, while those that waste money will often have their budgets increased. This is why so much of government spending occurs at the end of the fiscal year, as large amounts of moneys are spent to demonstrate that they were really “needed.” Furthermore the government budgeting process often has built in automatic yearly increases, which further insulates government from any pressure to cut costs.
Thus government does not “price” their services based on a willingness to pay in the market place but instead based on how much money they think they will need. Because of these different incentives, and ways of thinking, any value provided by government will come at a greater cost, often a much greater cost than that provided by private business.i Taxes are then set accordingly.
While getting a better job has a net positive effect on the economy, taxes, because of the inefficiencies, act as a burden on the economy that will slow economic growth.
Taxes in Action
This effect has been demonstrated time and time again when tax increases depressed the economy and thus failed to bring in the expected amount of revenue as a result. While many examples of this effect could be given, one clear example of this occurred in California during the early 1990s.
Like many states California spent freely during the good times of the 1980s. During the decade, economic growth was strong and as a result revenues to the state increased at a very healthy eight percent per year. With all that money flowing in, politicians spent freely, so freely in fact that, as often is the case, the increases in spending outstripped the increases in income. While income increased at an average rate of eight percent per year, spending increased at about eleven percent per year. As a result the state budget grew from $32.8 billion in 1980 to $72.6 billion by 1989, an increase of 121 percent.
Now while the economy was strong, California could get away with this. The problem was that such economic growth can’t last forever. When the economy eventually did begin to slow, so did revenues and California ended up with a huge budget deficit of $8 billion, the largest state budget deficit in the country at that time.16
In response to the deficit, California did what governments tend to do when there is a shortage of money; they ‘asked’j the taxpayers to give them more. While in this case they did make some ‘cuts’ in the state budget the majority of the shortfall in revenue was to be made up by new taxes. Thus California passed a mixture of sales tax and income tax increases on ‘the rich,’ i.e., on those in the upper tax brackets, and these tax increases were supposed to produce $7 billion of the $8 billion needed to close the deficit.
While it may have looked good on paper what the politicians failed to take into account was the negative effect that taxes have on the economy. Rather than bringing in the expected $7 billion in new revenues and thereby closing the budget deficit, the increased taxes caused the economy to slow even more. In fact it slowed so much that not only did the state fail to increase revenue by the expected $7 billion, revenues actually went down by $1 billion per year over the subsequent two years.17
To make matters even worse, while the rest of the nation was recovering from the recession that had initiated the problem in the first place, the burden from the 1991 tax increase slowed California’s recovery such that real per capita personal