Thursday, October 20, 2011

Opportunity cost

Reader Xerographica comments about opportunity cost. After a lengthy illustration of opportunity cost — the most valuable thing you have to give up to get something else — he (?) goes on:

We can see that the problem with the current political system is that congress has no idea how much public education I would be willing to forgo for improved medicare. Having attended a public university I certainly value public education but I also valued my grandmother's health. Even though my grandmother and grandfather valued both public goods as well, it's very unlikely that our allocations would be the same.

In the private sector every single consumer is forced to consider the opportunity costs of their spending decisions...and every single donor is forced to consider the opportunity costs of their donations. But in the public sector taxpayers are not forced to consider the opportunity costs of their taxes.

Therefore, we can objectively say that with the current system, the public sector is very inefficient.

To greatly improve the efficiency of the public sector we would simple allow taxpayers to directly allocate their individual taxes among the various government organizations at anytime throughout the year. In other words, donations to government organizations should be 100% tax deductible.

In a few of your blog entries I've noticed that you consider yourself to be pragmatic. That's really interesting because I labeled the above concept "pragmatarianism".

Xero is correct on one point: opportunity cost is central to economics. But after that he goes off the rails.

My original post was about efficiency. His first mistake is to say that "objectively... the public sector is very inefficient." Because there are multiple ways to talk about the efficiency of any system (we might, for example, talk about vehicle miles per gallon, passenger miles per gallon, passenger/vehicle miles per hour, accidents per mile, etc.), even if he's correct, concluding that the public sector is inefficient without qualification ignores all the other measures of efficiency. At best, Xero could have shown that the public sector is less efficient at quantifying opportunity cost.

But Xero actually does not show that the public sector is actually less efficient on this measure. He claims that the government cannot quantify opportunity cost, but of course they can and do quantify them. Congress makes decisions at the margin all the time: they explicitly do reduce this program to increase that program, raise or lower taxes to pay for more or fewer programs. Individual taxpayers can certainly evaluate the opportunity cost of their own taxes, and vote for politicians who will tax at the equilibrium level, where the opportunity cost of one less dollar of private spending equals the actual benefit of one more dollar of taxes. Just because it might be the case that a public body such as Congress does not actually consider the population's view of opportunity cost (because it conforms to the perceptions and preferences of the capitalist ruling class) does not mean it cannot do so.

His preferred method — letting individual taxpayers control the allocation of their own taxes — assumes that the opportunity cost associated with production we typically allocate to the government aggregate additively: the "social" opportunity cost of some public endeavor is the simple sum of all the individual opportunity costs. But anyone who has studied macroeconomics knows that not every variable aggregates additively. For example, the aggregate demand function is not the simple sum of the demand functions for each individual product. The microeconomic demand function for an individual product makes the ceteris paribus assumption that the prices for all other products remains the same. The aggregate demand function obviously cannot include that assumption. Similarly, my individual microeconomic opportunity cost of my taxes for some public good is ceteris paribus, i.e. it assumes that everyone else's behavior remains constant while my own contribution increases or decreases. But however, changes in spending on public goods are not ceteris paribus: if we want to have, for example, more public education, we have more public education for everyone at the same time, and either more taxes or less of something else for everyone.

Opportunity cost, while definitely central to economics, is a particularly bad quantity to use for efficiency. An opportunity cost is necessarily counterfactual: it is the value of what we give up, not what we actually have. Although we can often estimate an opportunity cost, because it is counterfactual, it cannot be measured directly. In the sense that I was using it in the original post, efficiency is a post hoc consideration: it tells you how well your theoretical model works, and you can't create a post hoc consideration on theoretical grounds.

Not only is opportunity cost counterfactual, it's also fundamentally equivocal: the opportunity cost can change based on different ways of setting up the counterfactual. Again, the Prisoner's Dilemma shows this equivocation very simply. If you consider the opportunity cost against the Nash Equilibrium, then the opportunity cost of cooperation is always larger than the opportunity cost of defection, regardless of the other actor's move. On the other hand, the opportunity cost of mutual defection is greater than the opportunity cost of mutual cooperation. Neither construction is "more valid" than the other; it's just the case that the opportunity cost is equivocal in many decisions. Since opportunity costs can be equivocal, any measure of efficiency based on opportunity cost can also be equivocal.

Although opportunity cost is indeed central to economics — everything's a trade-off — precisely because it is central we want to use other, more directly measurable variables to evaluate efficiency. We can measure, for example, value obtained (which might be subjective, but is at least real) and hours worked, to obtain a useful measure of efficiency. These real measures of efficiency can give us a better understanding of our economy than trying to estimate a counterfactual, equivocal quantity.

[Update 10/21/11] There are a lot of other reasons why Xero's idea is really bad, not the least of which is that it turns a (at least nominally) democratic institution into an explicitly plutocratic system. That reason is, however, almost entirely political, and I wanted to make a specifically economic critique of the idea.

I strongly suspect that Xero is not part of the 1%, who would, under his scheme, have near-absolute control over government spending and would use that control for their own benefit, not Xero's (or mine). I'm continually astonished at the propensity of people to come up with schemes to not only justify but also intensify their own slavery.


  1. Your economic argument against taxpayers directly allocating their taxes is...well...perhaps more interesting if we look at it as a defense of the status quo.

    Why are you defending the status quo? It was really difficult for me to fully appreciate why so many people had such strong "faith" in the current system...until I realized that people paying taxes to a political party in exchange for a desired outcome is nothing more than the modern equivalent of primitive people sacrificing to a deity in exchange for rain.

    We constantly switch parties because neither party can produce the outcomes it promises any more than a deity can make it rain. Of course, when Elijah's sacrifice to god was followed by rain then people's faith in god was quickly restored and they immediately killed all the leaders of the "opposite party" (the prophets of Baal).

    Even a broken clock is right twice a day.

    Should we all be coerced into contributing to the common good? Sure. Do we all have common goods that we value? Yes. Are we all capable of identifying and addressing shortages of the public goods that we value? Definitely. Should the supply of public goods be determined by the demand for public goods. Of course.

    Here's my blog entry where I look at this concept in more detail...Is The Tax Allocation Disparity Divine or Delusional?

    Intensify my own slavery? If you're worried about 1% of the people having control of 40% of the taxes how come you're perfectly fine with .0002% (535 people) of the people having control over 100% of the taxes? You sure must have strong faith that our elected representatives are guided by a divine hand.

    My say over how my taxes are allocated is vanishingly small...meaning it rounds to 0%. In a pragmatarian system I would have 100% control over how my taxes were allocated.

    That being said, I would be really interested to hear your thoughts on which public goods those billionaire bastards are going spend their taxes on in order to control us. Are they going to control us with too much public education or too much infrastructure or too much national defense or too much border security?

    It was a very progressive step when control of taxes was passed from a king to parliament and it will be a progressive leap when control of taxes is passed from parliament to taxpayers. But based on your's and others' responses I doubt it will happen in our lifetime...religion truly is the opium of the masses.

  2. Your economic argument against taxpayers directly allocating their taxes is...well...perhaps more interesting if we look at it as a defense of the status quo.

    I'm a revolutionary communist. It would seem an exercise of the most uncharitable perversity to choose to read any of my posts as a defense of the status quo. There are more possibilities than the black and white alternatives of your ideas and the status quo.

    If I am actually (and unintentionally) defending the status quo, you need merely quote me and demonstrate how I am indeed doing so. But to uncharitably choose the interpretation that's the easiest to rebut is just an exercise in intellectual dishonestly.

    I haven't read any of your other work, and I'm not yet motivated to read any of your other work. I'm judging you only on what you chose to present to me in your comment, and I'm doing my best to address and analyze what you've actually said, no more, no less.

  3. Also...

    My say over how my taxes are allocated is vanishingly small...meaning it rounds to 0%. In a pragmatarian system I would have 100% control over how my taxes were allocated.

    You are being inconsistent, comparing apples to oranges. In your ludicrous "pragmatarian" system, the rich, who do in fact pay most of the taxes (and who most everyone believes should pay even more taxes), would have near-complete direct control over the government's budget. The would not even be forced, as they are now, to try to indirectly influence the public will by media and propaganda.

  4. A revolutionary communist? When you say "communist" I think of Mao Zedong leading the "Great Leap Forward" which directly resulted in 20-30 million people starving to death.

    In other of your posts you referred to yourself as pragmatic...which makes me think of Deng Xiaoping...the guy who immediately followed after Mao. Deng Xiaoping was truly amazing...he went around saying that he didn't care whether a cat was black or white...what mattered was whether it caught mice. As a direct result China has since truly leapt forward.

    Most of my life I've been a limited government libertarian and extreme ideologies like anarcho-capitalism and socialism gave me the heebie-jeebies. Now that I'm a pragmatarian I don't feel the slightest need to try and disprove anarcho-capitalism or anything more liberal than limited government libertarianism.

    Pragmatarianism is system that allows taxpayers to directly support results. If the results should lead to anarcho-capitalism then so be it. If the results should lead to socialism then so be it.

    We can never go in the wrong direction when each and every taxpayer follows the results. Mao Zedong promised results while Deng Xiaoping followed the results.

    In my comment I said that I'd be really interested to hear your thoughts on how the rich would use their taxes to control us. In your reply you only repeated your concern without explaining it in further detail.

    In my opinion, there's just as much correlation between wealth and morality as there is a correlation between religion and morality. To imply that "the rich" all have the same evil agenda to enslave us is as hasty a generalization as saying that atheists are all amoral.

    As I also mentioned...there are no "bad" public "goods". Public goods by their very definition are non-excludable. We all benefit from any public goods that the wealthy help fund with their taxes.

  5. A revolutionary communist? When you say "communist" I think of Mao Zedong leading the "Great Leap Forward" which directly resulted in 20-30 million people starving to death.

    First, we're already figuring out that you're dishonest and probably stupid, so what you think of when you hear anything is probably not particularly relevant.

    Second, it's completely unproductive to trade insults. You're an asshole; you don't like me; yay. Fuck off.


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