Why Able Abel has to be taxed?

Karl Smith points to this morality tale by Bryan Kaplan,

Suppose there are ten people on a desert island. One, named Able Abel, is extremely able.  With a hard day’s work, Able can produce enough to feed all ten people on the island.  Eight islanders are marginally able.  With a hard day’s work, each can produce enough to feed one person.  The last person, Hapless Harry, is extremely unable.  Harry can’t produce any food at all.
Questions:
1. Do the bottom nine have a right to tax Abel’s surplus to support Harry?
2. Suppose Abel only produces enough food to support himself, and relaxes the rest of the day.  Do the bottom nine have a right to force Abel to work more to support Harry?
3. Do the bottom nine have a right to tax Abel’s surplus to raise everyone‘s standard of living above subsistence?
4. Suppose Abel only produces enough food to support himself, and relaxes the rest of the day.  Do the bottom nine have a right to force Abel to work more to raise everyone‘s standard of living above subsistence?
How would most people answer these questions?  It’s hard to say.  It’s easy to feel sorry for the bottom nine.  But #1 and #3 arguably turn Abel into a slave.  And #2 and #4 clearly turn Abel into a slave.  I suspect that plenty of non-libertarians would share these libertarian moral intuitions.  At minimum, many would be conflicted.

The tale and the conclusions drawn lie at the heart of libertarian opposition to taxation and government intervention. But in the real world, the tale does not end as Kaplan envisions, but goes on. And here is a possible (among many) sequel.

Able Abel knows that he can produce more (of say, dates) and sell it to others and use the money realized to increase the quality of his leisure. He has heard of the neighbouring village island, Fishland, where he can pursue his dream hobby, fishing. So he strikes a deal with his other inhabitants. He offers to transfer a share of his extra production, if they help him with laying a road to transport his produce from the far-off fields to their village. 

Accordingly, the eight marginally able people sell one-fourth of their time to help Able Abel lay the road. However, taking pity on Harry, they also demand that he be provided subsistence feed by Able Abel, who readily agrees. Within three months the road is completed and simultaneously Able Abel has stored enough food for a week to cover his fishing expedition. 

He travels to Fishland and starts fishing. Now the people of Fishland find the dates which Abel eats irresistible and they offer him a deal. If Abel supplies them with ten bags of dates, they will in turn provide him accommodation for his fishing expeditions and also five buckets of fish, which he can take back and sell to his desert island villagers. Abel takes back fish samples to his village. As anticipated, his villagers like the fish and immediately agrees to buy it. 

But again the transportation problem crops up. Abel needs help to lay the road so as to transport dates and fish. Now it is a much longer road and needs help from the people of Fishland too. They all agree to contribute a share of their work in return for a share of Abel's earnings - dates for the people of Fishland and fishes for those from his village, including for Harry. And so the story goes on.

As can be seen, the fundamental issue here is not taxation or other transfers. Able Abel can pursue his economic activity only with help from his co-inhabitants. In the barter-world, this help comes in the form of work-sharing in return for a share of Abel's production. In the modern world, instead of the in-kind transfer, a share of his production or revenues is appropriated, in the form of taxation, to meet the cost of the infrastructure required to carry out that activity.

This help or support required to sustain an economic activity can be in many forms - maintenance of law and order to protect against thieves; mechanism to enforce contractual obligations; infrastructure to transport and store goods, and so on. It is unviable for individual economic agents to establish these support mechanisms. Someone has to co-ordinate the demands of all those needing these support systems and collect the cost required to establish and maintain them. The government steps in to provide them in return for a share in their incomes, in the form of taxation.

As I have blogged earlier, the abler, and consequently those more likely to be rich and well-off, generally benefit greater from these support systems. It is therefore only appropriate that they bear a greater share of the cost required to establish and maintain these systems.

Just as the eight villagers sympathized with Harry and demanded that Abel provide him with a share of Abel's produce in return for their labour to construct the road, there are certain underlying currents of morality in any society. Once social agreement on them break-down, Harry would not be able to rely on society to provide for him. Thankfully, societies today collectively agree on certain minimum moral principles, whose fulfillment they seek to achieve by setting apart a share of the proceeds from the taxation revenues. In simple terms, their willingness to contribute to the establishment of the support systems (which help people like Able Abel disproportionately) is conditional on the fulfillment of these moral obligations. 

To paraphrase Adam Smith, the villagers of the desert island and Harry get a share of Able Abel's produce not because of charity or some moral code or government expropriation, but because his own self-interest encourages Abel to strike the deal.   

Markets in everything - internalizing expenses due to misconduct as the cost of doing business

Since the disastrous oil spill from its Deepwater Horizon oil rig in April 2010, British Petroleum (BP) has apparently spent nearly $30 bn in clean up costs, civil damage claims, and restitution to businesses and residents along the Gulf of Mexico. The incident, which involved a spillage of 200 million gallons of oil, resulted in the death of 11 workers and a massive environmental disaster. However, despite the huge price tag of the oil spill, $30 bn and climbing, BP's commercials appear unaffected. It collected more than $375 billion in 2011, pocketing $26 billion in profits.

While criminal prosecution charges were framed against the executives of BP and its contractors, nobody has been prosecuted till date for these damages. This has important moral hazard implications. Though BP has been involved in similar safety failures earlier, when they paid huge fines, they have moved on without addressing the underlying safety related issues. In fact, as Times writes, "without personal accountability, the fines become just another cost of doing business".

Much the same story can be said about the several cases of financial market irregularities, bordering on criminal misconduct, that played a major role in blowing the sub-prime mortgage securitization bubble. Several financial institutions, including its leading lights, have been found guilty of practices that involved making money by betting against their own clients. These firms peddled unsuspecting clients securities that they themselves were betting against (say, shorting). They made money from fees as well as being the counterparty in the trade.

In most of these cases, the financial institutions have settled the malpractice suits and even the criminal prosecution by making huge compensation and fine payments. However, not one top executive has been convicted on criminal misconduct. Most of these institutions have weathered the worst of the sub-prime meltdown, paid their fines, and are back to making profits by indulging in the same practices. They have come to see the fines as another "cost of doing the business".

In his best selling book, Predictably Irrational, Dan Ariely has written about the changed behaviour of parents when a kindergarten moved from a regime of mandatory pick-up as soon as school closes to a regime that charged for additional hour spent beyond the school hours. They found that in the former regime parents generally came to pick-up their children within time, whereas parents preferred to pay and pick up their children at their convenience. He argued that in the first regime, social norms kept parents from tardiness in pick-ups. However, in the second regime, introduction of a penalty increased tardiness. A fine becomes the price (pdf here) of the violation or deviation. The same motivations lie beneath the moral hazard described in the first two examples.

Such trends are not confined to high-finance and business, but pervasive in modern-day lives. Old-fashioned virtues of equality (of people standing in a que to access a service) have given way to opportunity-cost driven conventions (rich people pay to access the service out of turn). The implications of this gradual shift have been far-reaching and is surely a major contributor to the widespread widening of inequality across societies. It is obvious that there is a slippery slope associated with these trends. Traditional mores slowly get replaced with market-based morality, with all its attendant consequences.

In this context, Michael Sandel's new book, What Money Can't Buy: The Moral Limits of Markets, provides an excellent perspective on how pricing human behaviour and responses runs the risk of crowding out other values. Jonathan Last has an excellent review of the book, where he writes,

Today you can purchase your way out of waiting in line for rides at many amusement parks. There are express lanes that allow us to buy our way out of traffic. Many schools now "incentivize" performance, paying students if they read books or do well in school; some schools now sell ads on children's report cards. Cities routinely sell advertising space on public property, ranging from parks and municipal buildings to police cars. In each of these cases, long-held ideas about inherent worth and common ownership have been displaced by the simple morality of the market. 

He quotes Sandel's assessment of market driven morality,

Markets don't only allocate goods, they also express and promote certain attitudes toward the goods being exchanged... When we decide that certain goods may be bought and sold, we decide, at least implicitly, that it is appropriate to treat them as commodities. 

Prof Sandel raises questions about the effect of such marketization on democracy itself,  

At a time of rising inequality, the marketization of everything means that people of affluence and people of modest means lead increasingly separate lives. We live and work and shop and play in different places. Our children go to different schools. You might call it the skyboxification of American life. It's not good for democracy, nor is it a satisfying way to live. Democracy does not require perfect equality, but it does require that citizens share in a common life. What matters is that people of different backgrounds and social positions encounter one another, and bump up against one another, in the course of everyday life. For this is how we learn to negotiate and abide our differences, and how we come to care for the common good.

The issues raised by Prof Sandel have enromous significance for our society today. If the creeping influence of markets and its touchstone of utility maximization crowds-out individual values and social norms, then we are not far from an age where man would move from being a "social" to a "monetary" animal. Its aggregate consequences would be far from benign.

Votes would be bought and sold, criminals would purchase their way out of jails, college seats would be auctioned off, policy decisions would be purchased based on donations made to parliamentarians and ministers, and so on. Further, it would be no longer anathema to let the poor suffer or even die for lack of access to medical care, or keep lowering taxes on the rich, or provide tax concessions to businesses while loathing welfare subsidies to the indigent, and so on. 

America as a conservative outlier among developed economies

The graphic highlights how conservative American society remains despite its modernized society and high national income.

The impossibility of regulating street vendors

The Times reports that many American cities are grappling with the issues raised by an increase in food trucks vending relatively inexpensive and convenient food in its streets.

Opponents of food trucks argue that such food trucks clog streets, eat into scarce parking spaces, pollute the area, annoy neighbours, and cannibalize the earnings of existing restuarants. Therefore, several US cities - Seattle, Chicago, and Raleigh - have sought to regulate food trucks with more restrictions - notifying areas where they could park, types of food they could sell, distance from restuarants etc. Such restrictions are expected to regulate the food truck business without causing much harm to existing business, raising opposition from neighbours, and by minimizing negative civic externalities.

This example is an excellent illustration of the difference between societies like India and the US in using regulations to control such types of activities in our cities. The city councils in the US obviously take for granted that these restrictions are enforceable and the minority of deviants could be forced to toe the line by strict enforcement. In contrast, in Indian cities, practical considerations, as discussed here, makes enforcement a near impossibility.

For a start, most city spaces and corners are already occupied either by squatting hawkers or cart-based vendors. Despite grappling with the problem for several years now and having passed numerous legislations, no Indian city has even remotely succeeded in addressing the problem of regulating street vendors. In simple terms, the challenge is in choosing between depriving tens of thousands (as in the case of any decently large city) off their livelihoods and in the process bringing order and discipline into urban life or leaving cities as stages for vibrant small-scale entrepreneurial activity with all its attendant disorderliness problems.

There are two issues here. Is there enough space to accommodate the demand? And assuming there is enough space, is enforcement of regulations possible? The first question is easily answered. No! The rapid pace of urbanization in recent years has ensured that there is no corner of any city which has been left free from being encroached. The informal market (controlled by local musclemen) in accessing such spaces and the magnitude of its rents is a reflection of their huge demand.

Any rationing would perforce leave massive numbers of people without their livelihoods. This is apart from sucking the government into a highly corrupt and inefficient allotment process, which the informal second-best market is currently administering with reasonable fairness and efficiency. The possible incentive distortions with such an arrangement are unimaginable and hugely counterproductive.

About the second issue of enforcement, as already discussed, it is a non-starter. When deviations and violations are the norm than the exception, enforcement becomes simply impossible. Enforcement works when deviations are at the margins. Strong enforcement signals can get the recalcitrant few at the margins to fall in line. It fails when the majority are deviants or violators.

Given the scarcity and demand for space, actual enforcement would involve uprooting large numbers of street vendors from each area in order to limit, regulate and discipline the hawking activity. Apart from the political impossibility of getting such policies through municipal councils, there is the practical issue of finding out alternative livelihoods for them.

This argument should not be seen as one supporting street hawkers. It is merely outlining the challenges that need to be overcome if we are to regulate street vendors in developing countries. Unfortunately, it is a challenge which does not appear to have been satisfactory addressed anywhere.

The crowds are not always wise!

James Surowiecki's best selling book, The Wisdom of Crowds, popularized the belief that the collective wisdom of a group of people was superior to the individual wisdom of even experts. It has generated considerable interest in the design of systems that seek to channelize the knowledge of large groups of people to say, predict events and prices. See Justin Wolfers' paper on prediction markets here.

It is based on the statistical phenomenon by which individual biases cancel each other out, distilling hundreds or thousands of individual guesses into uncannily accurate average answers. However, it assumes that the members of the crowd have a variety of opinions, and arrive at those opinions independently.

A new study of this phenomenon by Jan Lorenz and Heiko Rahut finds that contrary to conventional wisdom, groups insights could go awry if participants were influenced by the guesses of their peer group. They found that though groups are initially wise, "knowledge about estimates of others narrows the diversity of opinions to such an extent that it undermines” collective wisdom". Moreover, they found that "even mild social influence can undermine the wisdom of crowd effect". In this context, as the Wired article points out, computer modeling of crowd behavior also hints at dynamics underlying crowd breakdowns, with the balance between information flow and diverse opinions becoming skewed.

The authors recruited 144 students from ETH Zurich, made them sit in isolated cubicles and asked them to guess various indicators like Switzerland’s population density, the length of its border with Italy, the number of new immigrants to Zurich and how many crimes were committed in 2006.

At the end of each round of questioning, they were given small payments for coming close to the actual answer (signified by the gray bar). At left is the range of responses among participants who received no information about others. The findings of the study participants who were asked how many murders occurred in Switzerland in 2006 is shown in the graphic below.



The Wired article concludes,

"As testing progressed, the average answers of independent test subjects became more accurate, in keeping with the wisdom-of-crowds phenomenon. Socially influenced test subjects, however, actually became less accurate. The researchers attributed this to three effects. The first they called "social influence": Opinions became less diverse. The second effect was "range reduction": In mathematical terms, correct answers became clustered at the group’s edges. Exacerbating it all was the "confidence effect", in which students became more certain about their guesses."

As the authors claim, such false beliefs are commonplace in society, politics and markets. The herd behaviour of investors in financial markets is driven by excessive confidence generated by social influences. Opinion polls and the mass media largely promote information feedback and therefore trigger convergence of how we judge the facts and potentially create overconfidence in possibly false beliefs. Social fads and beliefs, some of which are of questionable value, become popular for no apparent reason.

In all these areas - markets, society, and politics - there are people and groups with an interest in influencing the beliefs of participants. They are vulnerable to being manipulated to suit the requirements of these vested interests. Such dissonances constitute failures in markets, politics and society.