What Should a Federal Social Safety Net Look Like?

>> Joshua D. Rauh: So, that's kind of what the governments are doing, and that leads to one big question. The big question for this talk really is how big should government be? So, you can consider, to start getting at this question, you can ask yourself about two extremes, right? So, let's consider two extremes, and I think we're all gonna be able to agree to that neither of these extremes would be a very good outcome if we had either of these.

So, one of the extremes is no government, no taxes, no spending, zero. Okay, so what are some problems that would occur if we did that if we had no government, no taxes, no spending? Go ahead.

Okay, yeah, so I heard no law enforcement, no defense, that's sort of problem number one, right?

The only way that one could defend oneself would be by arming oneself privately or organizing private defense for yourself. Gonna be pretty tough, so that's thing number one. Yeah, what else, let's list a few things, yeah, go ahead, yeah?

Okay, so great, so who's gonna enforce our contracts, right, who enforces contracts?

If I write a contract with you to make sure that I'm protecting my property, that you're not gonna take my property, say, let's suppose I sign something to buy a house from you, okay, will you sign a contract? And that contract then says that you're gonna leave the house when it's time for me to go in to occupy the house.

If we have literally no courts or no government, there might be actually no way of enforcing the fact that you've said that you're gonna do that, other than that I would have to hire a private army or something to kick you out of the house. So, these are some really fundamental things where if we had no government, no taxes, no spending, we actually couldn't even really protect private property.

So, that's really good, yeah, go ahead.

Right, okay, so all of our roads will become, now, you said something interesting there, and that's we're gonna get into a lot of these justifications for government spending. So, well we'd have to pay a toll on every road. Well, it's true, right now we have to pay the government taxes then we trust them to build the roads or we kind of monitor them and hope that they're building the roads well.

And we look and say, okay, are the roads, are they keeping up the roads, are they spending the money well? So, to your point, we would have to have private provision of a lot of different types of things that are currently provided by government, primary and secondary education.

A lot of the things actually on these slides that we just saw, right, basically all of these things would all have to be provided privately. And the question that you should ask when you think about what is the optimal size of government, the question you have to ask yourself is, is it optimal that the government provides these things to the extent that it does?

And of course, we do have a system where there's some hybrid, not all elementary and secondary education is provided by the government currently, but a lot of it is. Most of it is, some of it is provided privately, but do we have the right balance? And what we're gonna talk about as we go on in this talk is what are some of the considerations that would determine the right balance?

All right, well I'm gonna go through what I think some of the main points are that are usually put forward to justify government intervention, and what are some of the main problems, government intervention? But I wanna hear from some people, okay, what about this government has 100% share in the economy?

So, 100% income tax rate, every dollar that anybody earns, the government's gonna take, and they're gonna pull that money and they're gonna put that to good use, or so they say. Yes, what's the problem?

Right, why would you run a private business if you knew that the government was just gonna take hundred cents in every dollar that you earned, yeah?

Zero incentive for productive activity, also zero incentive to actually try hard in anything because you don't get to keep the fruits of your labors in any way, yes?

No one sent you to innovate, because you're not gonna be able to enjoy the fruits of that innovation, okay, what else, yep?

Right, we're gonna have no price signals on anything because basically there's gonna be no private market for anything. Okay, so that's good enough for now, so I think we see that there are problems with both of these. The question is, where in the middle are we gonna land?

Right now in the United States, 44% of the economy is government spending. Interesting, okay, I mean, I watched a video by a Brazilian journalist who was talking about how he believed that the socialists in Brazil had destroyed his country. I went and looked up what government spending as a percent of GDP was in Brazil was 38%.

So, I think I wanna figure out where we are? Have we struck the right balance or not? So, I'm gonna go through a few things, many of which are things that you brought up in a bit of a systematic way. So, the first thing is rule of law, protection of private property, and the enforcement of private contracts.

And just a really brief bit of political economic history here. You've probably all studied or heard about Hobbes and the state of nature, 1651. Hobbes wanted a certain type of government, or governor, because he noticed that if you have so much chaos in the economy that there's gonna be no place for industry, because the fruit thereof is uncertain.

What kind of governor did he want, what is that? Do you know what this is?

Yeah, absolute monarch, the Leviathan, I guess this is what they thought a Leviathan would look. I always thought of a Leviathan as a sea monster, but this is the kind of classic picture of the Leviathan.

And then we had John Locke come along who had an answer, who said, no, government can actually be much more limited. It can be limited to just basically a few things, protecting natural rights, the rule of law, protection of private property through life, liberty and possessions. Those are the key things that Locke said that people had a right to, and the government's role should be to protect those rights.

And so, Locke is thought of as being, as I mentioned last night, one of the founders of classical liberalism. So, even fairly, libertarian minded people think that the government needs to be doing things to make sure that people can protect their life, liberty and possessions, particularly through protection of private property and enforcement of private contracts.

So, where does economics come into this? All right, this is political philosophy, but I'm gonna fast forward to how economics has answered the question, how much do we need? And I'm just gonna focus down onto one case which is this gentleman here, who is Ronald Coase, who wrote something called The Problem of Social Cost.

And maybe I'm just somebody who's excessively enamored with the field of economics, but I think this is as important as Hobbes and Locke. So, Coase had just a great example that illustrates what he was talking about in terms of the question of how much protection we need. I think this example just really kind of brings out the question of how much we really need governments stepping in to protect us about things.

So, his example is the following, so suppose that a doctor and a baker share in office buildings, they have neighboring spaces. Kind of funny to think of the baker in an office but the idea is the baker's got his manufacturing equipment in there, right? So, the baker's loud machinery disrupts the doctor, so the doctor cannot treat patients while the machine is running.

All right, so that seems to be a problem, it's what we in economics would call an externality. So, the old solution before Coase was, well, clearly there's a problem here. The baker is doing something bad, they're making a lot of noise, the doctor can't treat their patients, so we need laws.

We need laws to protect, the baker should compensate the doctor, and laws should be passed to protect people. So, that's kind of how they thought about it, now, what did Coase say? Right, Coase's solution was we actually don't need laws. As long as it's legally clear and enforceable who has the right to control the noise level in the building, the parties will bargain to a solution, and it will be an efficient solution.

The only thing you need is you need courts that will enforce private contracts, so let's give an example here. All right, so suppose that the baker could invest in quiet baking machinery, and that machinery costs $4,000, and soundproofing the doctor's office would cost $6,000. Coase would say as long as it's clear who has the right to determine the noise level in the building, the private economy can work this out.

We don't need the government coming in and making ordinances about what times the baker can use his machine, we don't need all these laws that are trying to protect one party or the other. So, let's suppose that the doctor had to write to determine the noise in the building.

Noise level in the building. What would the private market outcome of this be, what would happen? What would the doctor do?

That's right, the doctor would say to the baker, here's $4,000, which way would it go?

Yeah.

Yes, yep, so that's where the other conditions come in, like negligible transaction costs.

You're gonna have to have full information about what's going on, but this is a setting where that's pretty clear, right? So actually, if the doctor has the right to determine the noise level in the building, then what's actually gonna happen is the baker is gonna have to invest the $4,000, okay, because the doctor has the property rights.

If the baker has the rights to determine the noise level in the building, what's gonna happen there?

The doctor will pay the baker $4,000 to invest in the new equipment and then there will be less noise in the building. So, this is just a really simple example of how we often think that externalities in the economy have to be dealt with through laws to protect somebody.

But actually, externalities are often dealt with by private parties, and they're dealt with effectively by private parties when we have enforcement of private contracts that works well in a system of law. So, speaking of system of law, I have another poll for us, all right, so according to the Heritage Index of Economic Freedom, the country with the greatest judicial effectiveness score is.

So, this is a question the Heritage foundation puts together a list of which countries are most effective on which measures, and one of the measures is judicial effectiveness. How effective are the courts as the entire judicial system? So, what do we think, so let's do some votes here, just guess, don't Google.

You could google the answer, sure, I know you can Google, everybody can Google. But just to answer the question, Singapore, Switzerland, the United Kingdom, New Zealand or the United States of America, what do you think? Okay, 90 results in, we're gonna wait till we get over 100, okay, great, all right, good.

So, three, two, one, and we're gonna end it.

Okay, I'm gonna lock them, I've learned my lesson, and then show their responses. All right, Singapore, Switzerland, United Kingdom, New Zealand, USA. Okay, it's kind of all over the place, Singapore got 40%, Switzerland 28%, New Zealand 18%, USA 10%.

For some reason, United Kingdom people aren't very fond of the legal system there. Let's see what actually is the index, so Switzerland gets a 98 on this score, all right? New Zealand 95, United Kingdom around 86, United States, 77 and Singapore 58. So, what are the index determinants, all right, they are asking, is there an independent judiciary?

Is there a due process in civil and criminal matters? Now, what's the perceived quality of contract enforcement and property rights, and so on? And so, some of the things Switzerland's getting a lot of credit for having an independent judicial system that's effective throughout the economy. They're getting a lot of credit for strong enforced intellectual property rights.

The US is getting credit for some of that stuff, but they're getting dinged for politicized appointments. So, we all know that there's a lot of the appointments of the judiciary goes through, the executive branch, and the executive branch tends to do appointments that may be politically motivated. So, we've seen that a lot over the past, and also this growing strength of the unaccountable administrative state, decisions that are being made by agencies of the federal government or state and local governments that weren't really elected entities.

So, they're getting dinged a lot for that, and Singapore got dinged pretty heavily for bias towards the government in politically sensitive cases. So, that if you sue the government in Singapore, you're very unlikely to win, or if the government sues you, then you're also very unlikely to win.

Okay, so that's one reason for government intervention, we need at least some intervention to create courts and a system of property that's gonna work. All right, next one, the social safety net, poverty alleviation. So, the United States has played an increasing anti-poverty role over time. So, this is for your US history, you learned about the New Deal, the Social Security Act, which created Social Security, Unemployment Insurance and so on.

There was another big wave of Social Security net creation in the 1960s with Johnson's war on Poverty and the Great Society. The second Social Security act of 1965, which created Medicare and Medicaid, these public medical programs, Child Tax Credit introduced in 1997 with expansion. So, it's kind of been an ever-increasing Social Security net.

What you have to keep in mind, and what I wanna introduce here is the fact that incentives are an issue. People do consider their marginal tax rates in deciding whether to work or whether to work more. One big example of that is labor force participation has not recovered from the Covid-19 crisis.

I'll show you some numbers in that in a minute, why is that, what role did government play? So, let's look at some of the evidence about the social safety net and its incentive effects on people's decision to work. So, the first piece of evidence is from Casey Mulligan of the University of Chicago, and this is about the global financial crisis.

This is our previous crisis, our previous era, and the big government expansion of unemployment insurance that happened there. And during that time, the federal government increased the number of weeks that you were eligible for unemployment from 52 weeks to 72 weeks, to 96 weeks, so you could take an unemployment check for almost two years.

They also did what's called a modernization of the unemployment insurance eligibility criteria, which is a translation of euphemism for relaxing it to include some quitting of your job. That you can actually quit your job and get unemployment insurance, which you couldn't do before, but now you can under some circumstances.

And they also changed the way that food stamps are given out so that there's no more asset test on food stamps. So, somebody who's got sufficient assets or significant assets in the bank but is not earning an income will be able to get food stamps. And Casey Mulligan calculated that what this did was it raised the marginal tax rate to as high as 60% for low-income workers, so how does this work?

Think about it this way, suppose that you're on unemployment insurance and that unemployment insurance is paying you $200 a week and you're unemployed, and you're sitting there and you're collecting $200 a week. Then suppose someone comes along and offers you a job, and that job pays $400 a week.

Well, you face a 50% tax rate because if you take the job, you're gonna lose your $200. And so, even though it's time limited, in this case it was time limited to as much as two years, you're gonna say to yourself, gee, it may not be worth it for me.

If I'm gonna get a 50% tax on my earnings, that 200 extra bucks that I'm earning each week, man, I'm gonna have to spend money on gas to get to the job. I'm gonna have to maybe buy more food outside of the house rather than cook at home, it might just not be worth it.

And evidence suggests actually that these benefit programs do have a pretty big effect on labor supply. So, this is one of my favorite economics studies, it examines a 16-week reduction in UI benefits in one state that was implemented in 2011. And basically, what you see is that it happened in April 2011.

People who claimed unemployment insurance right before that change, they ended up being unemployed for a much longer time than people who claimed right after that change. And it wasn't just about being cut off at the end, that 16 week cut off. They were more likely to be still receiving or less likely to still be receiving unemployment insurance and more likely to be employed one week, two weeks, ten weeks, 15 weeks, all the additional weeks.

So, that people really do actually respond to these programs when determining whether they're gonna go back to work or not makes you think. Third example of this is what we saw during the COVID crisis, the CARES Act of March 2020. This was passed a couple weeks after I left the Council of Economic Advisors.

The CARES Act created an additional $600 per week unemployment insurance benefit. It also expanded unemployment insurance in a variety of different ways so that people could collect unemployment insurance who otherwise previously were not eligible for it. And some researchers also at the University of Chicago calculated a median replacement rate of 145%.

So, that meant that someone with a job, if they left that job, they would actually get a 45% pay raise just by leaving the job and collecting unemployment insurance. How could that not affect your decision to work? There was a lot of confusing stuff going on at the time because the pandemic was happening, people were saying, well, maybe I don't wanna work, that's all valid.

But how could it not have had an effect that people would be earning 45% more money by just staying at home and not doing anything rather than gonna work? And the macro evidence shows that there was substantial depressed labor force participation. And also, as John Cochrane mentioned, high savings rates during this time.

These graphs just show differences in this replacement rate by different income brackets and also by different professions. So, sales and retail, medical assistance, these people all would earn more by staying home than by working, and substantially more by staying home than working 55% according to this graph. Okay, so as I mentioned, yeah, so here's the kind of the macro data, the personal savings rate spiked up and the labor force participation tanked.

And this is March 2020, exactly when these programs went in. The labor force participation went down is maybe not that surprising, given that a lot of the response to COVID was just people getting frightened and freaked out and the private economy responded. But the savings rate, I mean, look at that savings rate spikes up a lot, and then you see that it's been very slow, the labor force participation rate's been very slow to recover.

We're still nowhere near back to where we were from before COVID, and all these spikes here, this is money that was saved. And so, people are still working through that saving, it suggests that government policy really played a role in keeping people out of the labor force.