Government spending has major cost

It’s hard not to play along when children come up with cute untruths.

Back when one of my now-grown sons was just an Opie Taylor-like tyke, for example, he used to tell me matter-of-factly that if he didn’t go to bed, the moon wouldn’t rise. It was a reasonable conclusion based on his experience at the time. Later, as his bedtime changed and he noticed the moon visible even during the daytime, he concluded otherwise.

Unfortunately, many politicians have yet to grow out of the toddler phase when it comes to spotting and discarding spurious correlations. They insist matter-of-factly that without their favorite spending program or regulation, some huge chunk of the economy would cease to be or some favorable social trend would reverse itself.

The most naïve and destructive behavior is to misuse the concept of the “multiplier effect.” A politician will say that for every dollar spent on such-and-such, the public will receive multiple dollars back in economic activity and thousands or even millions of jobs. In most cases, the statement isn’t just invalid. It’s idiotic.

These politicians are citing economic-impact studies that take the amount spent and run it through a model that estimates the local expenditure on labor and materials and the resulting employment implications. While such data can be useful — particularly if you are thinking about going into the business of supplying labor or materials to a particular project, firm, or industry — they don’t speak at all to the net economic benefits.

Getting to the net requires that you estimate the benefit of using those dollars on some alternative expenditure. Economists call this the opportunity cost. If you spend $9 eating lunch at Jersey Mike’s (highly recommended, by the way) you can’t spend the same $9 on some other meal, or on buying socks after having skipped lunch altogether. More broadly, the resources you consumed getting to and from the sub shop, including the minutes, can’t be devoted to something else. These represent the opportunity costs of your Jersey Mike’s excursion.

In public finance, the opportunity cost comes at two stages. Certainly the tax dollars spent on, say, highway construction can’t be spent on public schools or law enforcement. That’s the second stage of opportunity cost. But there is also an opportunity cost to converting private dollars, earned through voluntary means, into tax revenue in the first place.

When people keep more of what they earn, that money doesn’t disappear just because it no longer shows up in the government’s balance sheet. It is devoted either to current private consumption or to private investment, both of which have economic impacts of their own. When politicians claim huge economic bonanzas from subsidizing sports stadiums, convention centers, or economic-development projects, they typically ignore this foregone private expenditure altogether.

The only real justification for a government program is that private individuals, spending a given amount of money through voluntary exchange, wouldn’t get as high a return on that money as the government would by taxing the money away from them and devoting it to some public purpose.

The case isn’t that hard to make when it comes to basic governmental services such as law enforcement and the courts. Beyond that, you have to argue that government policymakers are likely to know better than citizens how best to spend the citizens’ own money. There are such cases — public goods for which, for technical reasons, private individuals are not presented with the information (prices) they need to make the best decisions. But such cases are not the norm.

Those who assert the magic of multiplier effects to justify their pet programs may be dissembling. But it is my experience that most of the time, they don’t know enough about the matter to be lying. They are just repeating what they’ve heard, or imagining spurious connections on the basis of limited experience.

It’s their business if they choose, Peter Pan-like, not to grow up. But they should keep their hands out of the wallets of the grownups.

John Hood is chairman of the John Locke Foundation and appears on the talk show “NC SPIN.” You can follow him @JohnHoodNC.
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