Month: February 2018

One of the things that I like most about economics is that it truly is the driving force behind all of humanity. When you think about economics you may not think of it in this way. You might imagine that it is strictly the study of currency or financial markets, but in reality the true fundamentals of economics are quite different. Economics is in fact largely a social science, and its focus lies at describing the cause for all actions that have ever been taken by humans. At the core of this social science is the study of incentives. Understanding the economic incentive requires awareness of only a few fundamental assumptions. First of all, every person has unlimited wants and needs, and is inherently self interested. Second of all, all resources are scarce, meaning that the limited amounts that exist are not sufficient to fulfill the unlimited wants of each person. And because of this, every action and choice has a cost, meaning that by choosing to do one thing, you give up something else that you could have done instead. An example of this is that by choosing to pay to go to college, you are giving up all of the other potential things you could have done with the time and money you have expended by choosing to go to school. And finally all people are generally rational, meaning that when making decisions, they would always seek to maximize personal gain while minimizing personal losses. And from this structure comes the incentive. An incentive simply refers to an adjustment of either the costs or benefits of a choice with the intent of encouraging a desired action, this can be done through either positive or negative means. If implemented correctly, an incentive will cause the benefit of a desired action to outweigh the costs, or the costs of an undesired action to outweigh the benefits. It is very important to understand that in every single aspect of society, whether it was intentional or not, incentives based on cost benefit analysis are responsible for every action of ever person. People often say that a corporation “should” be doing something or some other sort of normative phrase. In reality it is very clear why people and firms act in the way that they do, it all comes down to a cost benefit analysis and the incentives that surround each situation. It may certainly be true that incentives control each persons actions, but that in no way applies that it is a straightforward task to predict just how an incentive will influence decision making. It is important that we acknowledged how incentives that we create will not always yield the intuitive results that we may expect.

 

An instance in which incentives have backfired can be seen in British Colonial India. At the time the city of Delhi was seemingly infested with venomous cobras. The British governor saw this to be a problem, and sought to end the cobra scourge. In an attempt to incentivize the extermination of cobras, a cash reward was offered to anyone who turned in a dead cobra. The idea was of course that the incentive would increase the benefits of hunting and killing cobras, which would in turn reduce the cobra population and solve the problem. The incentive seemed logical, but backfired in the most counter productive way possible. While the benefits of hunting cobras were increased, the benefits of farming cobras increased on an even higher scale. Citizens began to farm the snakes, and turn in their bodies in exchange for the cash bounty. By the time the British government had caught on, there were excessively higher numbers of cobras within the city than there had been to start with, especially after the farmers released most of their remaining snakes after the bounty was dropped. This idea of an incentive with unintended consequences has since come to be known as “The Cobra Effect“.

The main takeaway of the aforementioned story is not that incentives don’t work. In fact, incentives were the very reason that the Indians farmed the cobras at all. Rather, it is to show that incentives are a powerful, but complex tool, and that there is often more than meets the eye in any given situation. A story such as the Cobra Effect is not an antiquated tale of misfortune, this same concept applies very directly to many areas of modern life and politics. Every year politicians promote policies that they promise will change something for the better. It is important to remember that a great deal of these policies deal heavily with incentives, and are therefore subject to very similar risks as the cobra bounty in colonial India. Though politicians may think they know exactly how they can influence a situation, it is quite likely that they are missing a key detail somewhere. One of my favorite F. A. Hayek quotes summarizes this entire concept beautifully, ” The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”.

Image Source

The part of economics that I like the most isn’t what you’d first think of when someone mentions the field. While typical concepts such as GDP growth and unemployment rates are certainly essential to the study of economics, it is less conventional niches of econ that I find most fascinating. Stephen Dubner is a University of Chicago economist who co authored the Freakonomics series with Steven Levitt, another economist. Their work, which I very highly recommend, seeks to “explore the hidden side of everything” through the lens of economics. The books analyze a wide array of topics, from incentive structures that promote teachers cheating on standardized tests, to the dynamic through which levels of society tend to adopt popular baby names. All of the areas assessed prove to be incredibly interesting, but in this post I will be highlighting an area that has a very significant economic and social effect on society as a whole. Crime is, of course, a constant occurrence that we as a society are constantly trying to suppress. In Freakonomics, Dubner points out the seemingly “out of control” crime rates of the mid 80s and early 90s that had many people concerned. Many scholars and policy makers had championed various, and often conflicting theories of crime reduction. Dubner points out that those who had promoted all sorts of different policies have always asserted that aggressive and deliberate application of their policy would result in a decrease in crime. When crime finally did come down in the 90s, many suggested that this was the result of these same policies. However, Dubner shows that such claims are inconsistent and unsupported by data. He rather suggests that another factor entirely was at play below the surface, one that seemed unrelated, but logically and statistically added up upon deeper inspection.

One of the major claims that Dubner asserts in the book is that “conventional wisdom” is almost always assumed to be true, but is often formed from incomplete or incorrect logic. Conventional wisdom generally consists of the set of assumptions that we as a society have come to consider intuitive. For instance that the logical way to combat crime would be to enact “anti crime” policies such as gun control or increased police presence. While this may seem logical, Dubner argues that a much more definite, yet much less expected variable was the result of the decrease in crime seen in the 90s, and a general means by which crime can be lowered. As counter intuitive as it may sound, Dubner argues that that Roe v Wade supreme court decision in 1973 is what deserves credit for the crime reduction roughly two decades later. It may sound crazy, but the evidence presented actually presents a very strong argument in favor of the theory.

In 1973 the US Supreme Court ruled in in favor of Norma McCorvey, meaning that abortion was effectively legalized throughout the entirety of the United States. This decision on the surface would at first seem to have next to nothing to do with crime, let alone a drop in the crime rate nearly twenty years later. But when you take a closer look, the connection becomes surprisingly intuitive. Demographically, abortions are sought most commonly by low income women. Prior to the decision, abortions were particularly difficult to obtain in many parts of the US, meaning that many of these low income women were unable to have a procedure done. Then suddenly in 1973, abortion becomes widely accessible, meaning that hundreds of thousands of low income women began to have abortions each year following the decision. Its not so much about what began happening at this point, but rather what ceased, that being the birth of hundreds of thousands of low income individuals to mothers who likely couldn’t have afforded to raise them. It also happens to be the case that these low income individuals who are not being born, would also typically be part of the demographic that is most predisposed to committing crime (low income). The decrease in crime experienced in the 90s coincides almost perfectly with when all of the individuals that were not born due to abortion, would have been reaching their peak crime committing years. Thus, as concluded in a much more thorough study co-authored with John Donohue, Dubner reaches the hypothesis that the drop in crime experienced was the result of the Roe v Wade decision. This is further extended into the theory that abortion in general plays a key role in lowering crime rates, and other comparative examples are referenced further supporting the hypothesis. If you are interested in reviewing a more thorough explanation of Dubner’s claims, I would recommend reading Freakonomics or referencing the complete study via the link above. Also check out a list of responses Dubner compiled which address various counter arguments brought against his theory.  

This is of course not in any way meant to be an argument for or against abortion based on moral principles or protection of rights (to life or choice). Rather the goal of this post was to highlight the idea that the conventional wisdom often does not provide adequate answers to many occurrences, and that in order to understand the full picture, it is often necessary to dig a bit deeper than you normally might. As Dubner often asserts, many people will try to explain observed patterns in an over simplified, self interested manner, the true cause is often a variable that may have never occurred to you. It is all summarized quite well in a quote by legendary economist F. A. Hayek, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

Today’s post will of course still be featuring a controversy relating to economics; however, the nature of this issue will require a bit more “normative” analysis than purely quantitative, positive analysis. This is the case because though the issue is heavily economically based, the core arguments are largely based on principle rather than practicality. Nonetheless, it is a very legitimate issue and I feel that it deserves to be understood in its entirety. After all, the study of economics occasionally evaluates somewhat normative concepts such as economic freedom. This post will focus on the controversy of whether or not churches and religious institutions should be exempt from taxation. Currently, religious institutions are not required to pay taxes to the government, a policy that is derived from several principles. However, this policy has been met with opposition as opponents also cite many reasons that the practice is undesirable. It is important that rarely talked about issues like this be fully understood and considered so that as a society we may develop informed opinions and work towards viable solutions to such debates.

 

I will start by addressing the normative, but legitimate arguments posed by those who support tax exemption of religious institutions. It is of course implied by the American constitution, and generally accepted as fundamental American doctrine, that religion be left separate from government. This often referred to as “the separation of church and state” and is generally a straightforward concept. The idea is that the government should not sponsor, punish or otherwise be affiliated with any particular religious organization in order to fully support the ideal of religious freedom in America. This issue forms an interesting contradiction between “sponsoring” and “punishing” religious institutions, in economics these terms often materialize as “subsidies” and “taxes”. Supporters of religious exemptions argue that taxing churches would equate to not only affiliation with religion, but also punishing religious organizations economically. In 1970, during the ruling of the US Supreme Court on the case of Walz v. Tax Commission of the City of New York, Chief Justice Warren E. Burger stated that, “The exemption creates only a minimal and remote involvement between church and state, and far less than taxation of churches. It restricts the fiscal relationship between church and state, and tends to complement and reinforce the desired separation insulating each from the other.”. Essentially, those agreeing with Burger argue that taxing churches infringes on the value of the separation of church and state, and should be avoided for the sake of promoting religious freedom.

On the contrary, those who feel that religious institutions should be taxed cited similar normative principles to reinforce their beliefs. Advocates from this side of the debate interestingly also cite upholding the separation of church and state, using similar logic to those who denounce taxation. The opponents of exemption focus on the “sponsor” side of separation, arguing intuitively that tax breaks for churches are a blatant example of the government economically rewarding religious institutions, also infringing on said values. Following the same aforementioned Supreme Court case, Associate Justice of the US Supreme court, William O. Douglas drafted a dissent statement against the previous stance, stating that, “If believers are entitled to public financial support, so are nonbelievers. A believer and nonbeliever under the present law are treated differently because of the articles of their faith… I conclude that this tax exemption is unconstitutional.” This argument also holds significant credibility. In my perception both arguments have considerable merit and it likely comes down to personal opinion as to whether you support one or the other.

In order to gain a more holistic view of this issue, it is necessary to also consider whatever positive data we can find regarding the economic costs and benefits of deciding one way or another. First let us consider the data in support of maintaining the current policy of tax exemption. As cited by CNSNEWS a Georgetown University Study concluded that the religious sector contributes 1.2 trillion dollars worth of services to the US economy, taking into account both the actions of religious institutions themselves and Americans acting on the behalf of religion. The low estimate from the study was estimated to be 378 billion and the high number estimated to be 4.8 trillion. The variation was caused by different methods of calculation; however, the 1.2 billion estimate was concluded to have been the most reasonable. Advocates use these findings to argue that taxation of religious organizations would severely cut into this valuable sector. They argue that these organizations are much better at allocating the funds to produce these services than the government would be if it were to take these funds via taxation. Though it would be difficult to calculate the effects that taxation would have on these numbers, it can be reasonably assumed that taxation would reduce the aggregate benefit that these organizations contribute to society.

On the contrary, opponents of church tax exemption note that every year the US government loses a significant amount of tax revenue by allowing religious establishments to remain un-taxed. The Washington Post cites that the US government loses, or in their words “awards a religious subsidy”, of about 83.5 billion dollars in revenue each year. The implications of this are obvious considering that that amount in revenue could otherwise be being used to fund various government programs. For reference, the 2017 federal budget included expenditures of 4.2 trillion, with a 503 billion deficit.

The overall issue is very two sided, particularly in the normative sense, but also when considering positive data. Both sides have strong claims when it comes down to pure principle, and in that case it generally becomes a matter of personal belief of preference. The quantitative evidence is telling, but requires vital additional information in order to become conclusive in deciding this debate. In order to decide the debate, the benefits yielded by the revenue gained from taxing religious organizations would need to be shown to outweigh the costs incurred from the lost services provided by the religious sector, or vice-versa. Until this situation is specifically, and thoroughly analyzed, it is very difficult to say confidently which side holds the better “economic” claim, and comes down essentially to estimation. Until then, it is important for us as responsible citizens to take into account all available information when considering issues such as these and work to develop viable solutions so that we may optimize our society and live as prosperously as possible.