The social welfare functions used in policy evaluation typically put more weight on poorer people, justifying redistribution from the rich to the poor. The reasoning is that the marginal benefit of a unit of money is greater for the poor than the rich. However, people with a greater marginal value of money are more motivated to earn and save, other things equal, so more likely to become rich. In this case, the rich have on average a higher marginal benefit of money than the poor, or a lower marginal cost of accumulating it. If the justification for redistribution is an interpersonal utility comparison, then revealed preference suggests a greater Pareto weight for richer people, thus redistribution in the opposite direction to the usual.
If the marginal utility of money decreases in wealth or income, then people earn until the marginal benefit equals the marginal cost, so the comparison between the rich and the poor depends on their marginal cost of earning, evaluated at their current wealth and income. The cost and benefit of earning may both be higher or lower for richer people. In a one-shot model, whoever has a greater benefit should receive redistributive transfers to maximise a utilitarian welfare criterion. Dynamic indirect effects sometimes reverse this conclusion, because incentives for future work are reduced by taxation.
Those with a high marginal utility of money are more motivated to convince the public that their marginal utility is high and that they should receive a subsidy. The marginal utility is the difference between a benefit and a cost, which determine whether the poor or the rich have a greater incentive to lobby for redistributive transfers. The marginal cost of an hour of persuasion equals the person’s hourly wage, so depends on whether her income is derived mostly from capital or from labour. For example, both rentiers and low-wage workers have a low opportunity cost of time, so optimally lobby more than high-wage workers. If lobbying influences policy (which is empirically plausible), then the tax system resulting from the persuasion competition burdens the high-wage workers the heaviest and leaves loopholes and low rates for capital income and low wages. This seems to be the case in most countries.
A tax system based on lobbying is inefficient, because it is not the people with the greatest benefit that receive the subsidies (which equal the value of government services minus the taxes), but those with the largest difference between the benefit and the lobbying cost. However, the resulting taxation is constrained efficient under the restriction that the social planner cannot condition policy on people’s marginal costs of lobbying.
In places with zoning laws (restrictions on what kind of buildings are allowed at a given address), there is often debate on whether to relax the restrictions. This would allow new construction or enlargement of existing buildings. The renters are generally in favour of more buildings, because the increased supply of housing lowers prices at a given demand. The landlords oppose construction, because it reduces the rents they can charge. These economic arguments are already part of the debate.
Much lobbying effort (that costs time and money and may create corruption) could be avoided if the market price of housing (rents or house transactions) was used directly in the regulations. New construction is allowed if the average rent is above a cutoff and denied below. Zoning laws may be a bad thing overall, but if they are to remain, they could be made more resistant to manipulation by basing restrictions on objective indicators, not lobbying.
The good incentives created by this require interest groups to put their money where their mouth is: if landlords want to prevent new construction, they should lower the rents they charge. Only with average rents low would building be blocked. Similarly, if tenants want more housing, they should pay the landlords more. They may of course decide to pool their money and found a property development firm instead.
Property developers want to get construction permits for themselves, but deny them to other property developers (their competition). The motivation to get a permit by fair means or foul is stronger when property prices are higher. In this case, the above reliance on the market price to regulate permits does not create good incentives. If new housing is allowed when prices are high, developers are motivated to form a cartel and raise the price. Permits reward high prices. A good price-based regulation of property development would require the opposite of the rental market mechanism – a low selling price of new housing should lead to more construction permits.
In many countries, farmers have managed to obtain free insurance from the government – if there is a bad harvest (due to drought, flood or anything else), the government compensates the farmers using tax revenue. On the other hand, if the harvest is unusually bountiful, the farmers do not pay a windfall tax to the government (which would reduce the tax bill of other people or provide more public services). There is thus no premium for the insurance that the rest of society provides to agribusiness.
A thought experiment: the insurance for the agricultural industry is bought from some insurance company who has to pay the farmers if the harvest is bad. The premiums paid to the insurer are taken from the general tax revenues each year. If the insurance company just breaks even (perhaps due to enough competition between insurers, profits are driven to zero), then the movement of money is the same as in the case of “free” insurance by the government.
Agribusiness has managed to pump some money out of other taxpayers with the free insurance. Their success is explained by the classic lobbying theory: if the benefits of lobbying go to a small group, each member of which gets a large sum, then each member of that group has an incentive to put in the effort and money for influencing politicians. If the cost of lobbying is borne by a large group (say the taxpayers), each member of which only pays a small amount, then members of the paying group do not find it worthwhile to make the effort to counterlobby. The savings are too small to be worth the time and money.
If some politician tries to reduce the subsidy to farmers, they are targeted with intense negative publicity. The agricultural industry claims itself to be necessary for “food security” or “feeding the people”. Nevermind that large amounts of food are currently shipped worldwide. Only the import barriers to foreign-produced food are keeping it out of the domestic market. And food security – who takes a country by blockading it into submission these days? A force large enough to surround the country and cut off food import is large enough to take it by storm, which is considerably quicker. Food security really means preventing the rise of food prices. But this is a financial problem and has a financial solution – insurance against a price rise.
If reducing the farming subsidy does not work, a similar effect can be achieved by providing the same subsidy to everyone and raising taxes. Only the administrative costs are higher than in the case of reducing the subsidy. Other industries could argue that they are affected by the weather or other “national emergencies” and deserve compensation from the government. For example, rainy weather reduces ice cream sales and tourism revenues, so the ice cream sellers and the tourism industry could lobby for the same free insurance as the farmers get. If the world price of some natural resource falls, the miners of that could claim an event beyond their control is threatening them with bankruptcy and ask the government for help. If the tastes of the public change so that some form of entertainment is no longer profitable (theatre, opera, classical music), the providers of that can claim to be important for preserving the national culture and the very civilization itself and ask for taxpayer support… wait, that already happens. It is described in the Yes, Minister and Yes, Prime Minister books.
Of course in reality, the subsidies differ across industries, depending on their lobbying prowess. But if the subsidies were proportional to the tax payments of their receivers, they would neatly cancel with the extra taxes levied to finance them. So the government could abolish subsidies by enlarging the set of receivers to include everyone.
By providing free or subsidized insurance, the government is crowding out private insurance – why insure and pay premiums if the government compensates the loss without premiums? This is especially a problem for risks that are common to many voters. For example, a flood is likely to affect the whole neighbourhood, not just one house. In case of flood damage, the people in the neighbourhood can jointly lobby for the declaration of a disaster zone and a public subsidy for rebuilding. So no need to buy flood insurance. With very few buyers, insurance companies stop offering the product.