Why I am also skeptical about corrections for market failures

Jon Murphy recently posted explanation why he is skeptical about using taxes to compensate for market failures. His reasoning was that the use of tax policy will inevitably be distorted by political incentives, and that such incentives may be completely out of line with what is socially beneficial.

I agree that this is a big problem. One of my favorite recent explanations for this problem came from Scott Alexander. Alexander used the example of how taxes and subsidies could theoretically be used to encourage people to eat healthier. But Alexander then notes:

After providing numerous examples of the types of subsidies and restrictions that arise from the political process as it actually exists, Alexander concludes: “Given our existing government, these should not be allowed within a light year of establishing one’s diet. To speculate that the people administering the program might be virtuous, competent individuals acting for the good of the public is to say that what has already happened will not happen.

But there’s another reason I’m skeptical of this approach, one that holds even if we remove all the concerns about political incentives. But first, here’s a (seemingly) random digression: What is the impact of time-restricted feeding on people’s weight?

Time-restricted feeding (also called intermittent fasting) is a somewhat popular method that people use to lose weight. Time windows vary, but the most common method is called the 16:8 method, where one goes 16 hours between eating and consumes all food during the remaining 8 hours. Someone who does this may skip breakfast, wait until noon before consuming anything with calories, and then eat between noon and 8 p.m. They then waited until noon the next day before eating again.

Diet and nutrition studies are notoriously difficult to conduct and often have widely varying findings. But there was a very interesting meta-analysis that looked at the effect of time-restricted eating among Muslims who observe Ramadan. This is the practice of fasting between sunrise and sunset, which, as the study notes, can be a fast of between 9 and 22 hours, depending on how far one lives from the equator. It is also a practice observed by hundreds of millions of people, providing a much better sample size than most nutritional studies.

What effect does this have on people’s weight? The answer is ‘all’. It has all possible consequences for people’s weight. Some people who observe fasting during Ramadan lose weight, others maintain their weight, and some even gain weight. Some people lose weight because limiting the time available to eat causes them to consume fewer calories than they otherwise would. On the other hand, some people nearing the end of their fasting period find themselves in a physical state known, to use a technical term, as “insanely hungry” and will stuff themselves when their eating period begins, eventually consuming more total calories than they would have if they had just eaten all day. And for others, these two effects are actually balanced and their total calorie intake remains unchanged. Such as the meta-analysis put down It: “The effects of fasting during Ramadan on weight vary from person to person, ranging from weight loss to weight gain, depending on whether the energy intake during the non-fasting period compensates for the lack of energy intake during the fasting period. whether or not compensated. .”

What does this have to do with using taxes and subsidies to compensate for market failures? Well, the use of such taxes and subsidies implicitly assumes that people will respond to taxes or subsidies in a specifically predictable and desirable way – and people can in fact respond to taxes and subsidies in many different ways, just as the total calorie intake of People can respond to time-restricted feeding in all kinds of ways.

A well-known example of this is the cobra effect. As I described it for:

It was judged that culling the cobra population would produce positive externalities, and thus the market was judged to be undersupplied. Policymakers subsidized cobra killing because they expected it would lead to an increase in cobra hunting, offsetting the market failure by increasing cobra culling to socially optimal levels. But people responded differently than policymakers expected. Instead of hunting cobras, people started breeding cobras. So the attempt to use subsidies to reduce the cobra population had the opposite effect.

But is this just an isolated case? Or is there reason to believe that the inability to predict the specific ways in which people will respond to taxes and subsidies is the rule rather than the exception? In my comprehensive review of Jeffrey Friedman’s book Power without knowledgeI sketched one argument Friedman argued that this issue is the rule rather than the exception, and why this undermines the arguments of economists with technocratic aspirations who think they can skillfully guide behavior across society just by using taxes and subsidies to get the “right” create incentives. Friedman argued that “incentives alone cannot actually lead to behavioral predictions, and therefore not to policy advice.”

This is, Friedman argues, because ‘knowing that the perceived incentive will influence the behavior of these actors is useless – for predictive purposes – if the economist does not also know exactly How it will affect it. But this requires knowing exactly how agents will interpret their situation in light of the perceived stimulus. Only if they interpret their situation as the economist does will the incentive matter. in a way that the economist will be able to predict.But as Friedman takes great pains to argue, different people see things in different ways and think in different ways, which means that the way people will respond to any given stimulus will be variable and unpredictable. As a result, economists (and policymakers in general) “lack the ability to predict future actors’ subjective interpretations of how to behave under future circumstances.” the agents themselves will perceive and interpret them.”

A book-length demonstration of this topic is Scott Hodge’s recent book Taxocracy: What You Don’t Know About Taxes and How They Shape Your Daily Life. It’s a fairly fun and light read. Over the centuries, Hodge outlines many examples where people’s responses to taxes—reactions that were unforeseen by the policy makers who levied the tax—have led to all kinds of unexpected outcomes. Some are just funny, like the way some old houses in France are built like mushrooms: relatively small and narrow first floors with wider floors above. Houses were built this way because “property taxes were based on the square footage of the land a house occupied. So people cheated the tax collector by designing a small ground floor with wider floors above.”

But other times the results are less funny and more disastrous. King William III introduced a tax on windows, on the assumption that homes and buildings with many windows would likely be owned by the wealthy, and so this could serve as a way to tax the wealthy. However,

Admittedly, in none of these cases were taxes introduced as a means of correcting market failures. But the fundamental problem—that people will respond to taxes (or cuts) in many ways that you can’t predict—is equally true whether the taxes (or subsidies) are intended to correct market failures or are simply for the economy. more generic monetization goal.

Friedman argues that this undermines the arguments in favor of technocratic policies – including the use of taxes and subsidies to change behavior in ways that correct market failures. Friedman wrote: “If we have reason to think that we cannot accurately know the results of some action (such as a specific technocratic action), then our knowledge of the beneficial outcome of taking that kind of action cannot be taken as the basis serve. reasoning for that, as technocracy demands, because we lack such knowledge. Likewise, if the defender of technocracy admits that it is likely to have unintended consequences, but also admits that she does not know what they are likely to be, then her perceived knowledge of technocracy’s beneficial outcomes (preventing, alleviating, and preventing solution of social problems) cannot serve as a reason for this, because she has no knowledge of what lies on the cost side of the ledger.”

So even without politically misaligned incentives (a very real problem in itself) there is another problem with attempting to use taxes and subsidies to correct market failures. Because, to paraphrase Friedman, if we have reason to think that we cannot accurately know the specific ways in which people will change their behavior in response to Pigouvian taxes or subsidies, and I think we do indeed have good reason to think this , then the claim that taxes or subsidies will alleviate a market failure cannot serve as a rationale for that policy.