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Let's Impose Some Transaction Costs on Government

Tags U.S. EconomyValue and Exchange


One of the things I have said to my economics principles students for years is that economists don’t like the letter T. It has been a good way to reinforce an important idea to students, but this year, I am planning on flip-flopping a bit (in honor of the political season) and endorsing T in appropriate circumstances.

Economists’ dislike of the letter T is obvious when we remember that in economic analysis, T often stands for taxes. Between differences in subjective values and differences in opportunity costs of production, economists recognize that voluntary exchanges create wealth and that, therefore, anything that wipes out voluntary exchanges that would otherwise have been agreed to wipes out real wealth.

Higher Costs Imposed by Governments

To illustrate, say you value a widget at $5 of other goods and services and I value it at $3 (or it costs me $3 to make it as a producer). When we exchange, it increases wealth by the difference in our values (and each of us gain some of that wealth as long as it is voluntary). However, what if there was a tax of $2.50 imposed on such transactions? That tax wedge exceeds the potential gains to our exchange (and all others where the net gains are less than $2.50), and the exchange no longer take place, wiping out the wealth that would otherwise have been created.

To the extent that regulatory burdens act like taxes, economists extend their dislike of the letter T to the letter R.

If T stands for tariffs, the same argument applies to international transactions. It also applies to non-tariff trade barriers, which act like tariffs in raising costs, but since we have no standard abbreviation for them, it gives us no particular letter to dislike.

In these cases there is, of course, the question of what the government does with the resources generated out of others’ pockets. However, basic understanding of the consequences of wiping out mutually beneficial trades, as taxes and tariffs must, implies that to advance social well-being, every dollar of government spending must produce not just more than its one-dollar tax cost to society (a criterion seldom met), but also the cost of the wealth destroyed in the process of generating the tax revenue. Government meets this far higher standard, almost never mentioned in political discussions, even less frequently.

There are also other Ts to dislike. Economists do not like transportation costs that are higher than necessary, because that excess wedge between the value to buyers and the cost to sellers destroys trades that would have occurred, just as with taxes. Economists similarly do not like transactions costs that are higher than necessary, for the same reason. And the reasons for both problems can often be traced to the many government-imposed barriers to entry and competition.

These Ts offer lots of reasons to dislike the letter. However, on the same day I discuss those Ts in class, I also discuss the importance of private property rights and the better incentives they provide than other forms of property rights (e.g., government property rights). And providing stable property rights provides a reason to like higher transactions costs in one area — for government acts that undermine private property rights. That is, from the perspective of the individuals that make up society, there is a very good reason to want to place very high T costs in the way of government efforts to destroy the essential building blocks of peaceful, productive cooperation.

Imposing High Transaction Costs on Government

This pro-T extension of my anti-T discussion allows me to introduce a bit of public choice analysis early on in my course. What is the Bill of Rights at heart but a way to impose very high transactions costs on any attempt to erode particular protections against government abuse? What is federalism, but providing a voting-with-your-feet alternative which makes government abuse harder to successfully impose? What is the core issue of “activist” courts but their ability to lower the transaction cost of changing the Constitution through redefinition rather than the high-transaction-cost way Constitutionally specified for such changes? What is the most important goal of separation of powers but to make the transaction costs of government actions higher, in order to restrict government acts to where there is a much higher degree of societal agreement?

I have always thought of “disliking the letter T” as a useful reminder of an important aspect of economic analysis, much like mnemonic devices (e.g., HOMES, for remembering the Great Lakes). But let's extend the analysis to why citizens want a very high transaction cost hurdle for government to change private property rights. This is necessary if low transactions costs are to maintained for our voluntary arrangements. And that is especially so as we face an election where both major party candidates are promising governments that will override their constraints to impose even more harm on Americans.

Gary M. Galles is a professor of economics at Pepperdine University. He is the author of The Apostle of Peace: The Radical Mind of Leonard Read.



Gary Galles

Gary M. Galles is a Professor of Economics at Pepperdine University and an adjunct scholar at the Ludwig von Mises Institute. He is also a research fellow at the Independent Institute, a member of the Foundation for Economic Education faculty network, and a member of the Heartland Institute Board of Policy Advisors.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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