Wednesday, November 15, 2017

Link to: "Researchers chart rising inequality across millennia"

This link is too good to pass up, especially as our Republican Congress debates lowering taxes for the wealthy.

"Researchers chart rising inequality across millennia

Findings have profound implications for contemporary society"

One paragraph: "Their findings, published this week in the journal Nature, have profound implications for contemporary society, as inequality repeatedly leads to social disruption, even collapse, said Tim Kohler, lead author and Regents professor of archaeology and evolutionary anthropology at Washington State University. The United States, he noted, currently has one of the highest levels of inequality in the history of the world."

The Purposes to Taxation

There are four purposes to taxation.

1: Destroy money. The government doesn’t need to tax to spend money. It just has to write the check. However, money it spends adds to the money supply, and this would cause inflation if an equal amount of money wasn’t taken out of circulation or destroyed. If money is taken out of circulation but not destroyed, as when the government borrows to spend, (which it rarely has any need to,) and this money is accumulated by the financial sector, the potential for inflation remains, and increases as the amount of money in the financial sector increases.

2: Discourage certain behaviors, or, through negative taxes, ie subsidy, (a word for particular forms of spending,) encourage certain (other) behaviors. All spending, of course, encourages the production of what it is being spent on. (Allowing for profits, of course.)

3: Redistribute demand, and therefore wealth. More or less egalitarian societies, such as democracies, cannot survive an excess of economic inequality. Money represents economic rights. That is, economic rights are proportional to wealth and income. Economic rights cannot be completely separated from political rights. An unequal distribution of economic rights results in an unequal distribution of political rights. This phraseology, however, is sort of a contradiction, since political rights may implicitly be regarded as those rights held, and that wealth shared, equally by all citizens in a society. Precisely: The only difference between economic rights and political rights is the method of allocation, and their resulting distribution. A more proper phrasing, then, would be that increasing economic inequality results in an increasing conversion of political rights to economic rights. A sufficiently progressive tax system can prevent this from arising, and so help to maintain a system of political rights. An egalitarian government, therefore, will tax economic rights, so limiting the scope and degree of inequality, and subsidize political rights, so enlarging the scope and degree of equality. The dynamics and stability of this process is itself interesting, but beyond the scope of this question. However, the first goal of every proto- oligarchy is the reduction of the progressivity of taxation to a level insufficient to prevent the increasing of economic inequality.

4: Validate its currency. By requiring that taxes be paid in its unit of money, the use of that money is (very strongly) encouraged in that economy. Since using a single unit of money increases economic efficiency, this increases the quantity of free resources in that economy. This increases both the rate of sustainable consumption, and the rate of wealth accumulation in that economy.

Friday, August 18, 2017

How Misleading are Solar Yeilds?-- A Link

Here is an excellent discussion by Gail Tverberg, over at  How Misleading are Solar Yields?.

While yes the main topic is indeed that named in the title, she also goes into an excellent discussion of Energy Return on Energy Investment (EROEI:  It is the ratio of energy spent to the energy produced. ) and its origins as a measure if energy return on human (and animal) labor.

She also deals with some important social issues when this ratio drops too low. Societal collapse seems alarmist, but others like inability of governments to collect sufficient taxes, seem to describe our current situation.  She refers to this book:

The Upside of Down: Catastrophe, Creativity, and the Renewal of Civilization
Jan 31, 2008
by Thomas Homer-Dixon

Her basic point is that the EROEI on PV Panel is (Probably grossly) overestimated.  She's probably right about that to some degree, since mostly we settle for industry figures. The complementary problem for oil, however, is that domestic oil production is also heavily subsidized which means we don't really know the true cost of extraction, and neither do we know the EROEI on it. 

In any case, the EROEI is certain to be less than we have historically been used to.  This has two implications: The first is that we must devote a larger share of the economy to developing and maintaining our energy supply.  And the second is that we will not be able to live as comfortably as we are used to.  If our unequal society is unable to adapt to this new condition, it will not survive, and this would be catastrophic.

While some of the issues in measurement  of EROEI return on PVs she raises I believe can be addressed, it is an important discussion of these issues, and as I indicated above EROEI issues in general.

Monday, July 31, 2017

Generalizations in Interpreting Supply and Demand Digrams

In a recent post Hidden Benefits of Taxes we argued that while a tax wedge reduced allocative efficiency, it increased productive efficiency.  With a tax wedge,  a portion of the remaining Social Surplus was allocated to the government, the Harberger Triangle in the diagram being discarded since it was no longer being (inefficiently) produced.  Inefficient production is a waste of resources, often irreplaceable ones.  For a very nice post on this issue, see this book review of:  "Capitalism 3.0 A Guide To Reclaiming The Commons" (2006) book by Peter Barnes,over at Portrait of the Dumbass

So.  Consider the situation where the source of a product, the factory or the mine, is far from the consumer, and the cost of transport is significant.
The shipper must cover the cost of transport, so the price the consumer is going to have to pay will be much higher than the shipper pays the producer.  We also observe that the quantity bought from the producer will ordinarily be the same as the quantity sold to the producer.  And we see that if we draw a diagram of the entire process, including the cost of transport, we have an identical diagram as if we had a tax wedge:  The wedge now going to cover the costs of transport, instead of going to government coffers.

Now the wedge covers all transport costs T so we can consider it as the resources consumed to include those that are necessary to support the capital involved in the transport.  This would as well include any retained surplus. What was actually surplus and what was cost to the shipper is not yet defined by the diagram.  Where the infrastructure costs are zero,  the wedge is merely the costs incurred by the shipper.

We note that high transport costs imply that the productive costs must be low, since only the most eager and wealthy of consumers are willing to pay the high prices for the product. Productive efficiency, per se, must be high.  There is thus a large Allocative loss, but also correspondingly large deferred costs.

Now, where transport costs are low, we see that there is still a market for those goods which are produced at a higher cost, with less efficient processes, among those with a lower inclination to pay.  With a lowering of transport costs, there is an increase in allocative efficiency, a reduction in allocative loss, and a reduction of productive efficiency

However, there is another way of looking at low transport costs.  We can say that lower amount of resources given over to transportation support a smaller infrastructure.

So we can consider a rectangular wedge in any situation where there is a cost between supplier and consumer, and the quantity supplied does not change.

Now we will define a community to consist of consumers and the local businesses to support them. The supplier will input into this community.
The supplier will sell to the local businesses, who sell the input to the consumers.  The difference between the price the businesses pay and the price the consumers pay the businesses, times the quantity supplied by the businesses, is seen to support the businesses.

The interesting thing is that the size of this wedge, that is, the size of the business sector in the community, depends on the inefficiencies involved in the conveyance of the input from the suppliers to the consumers.   A totally efficient conveyance between supplier and consumer would eliminate any business sector in the community.

The point is, while from one point of view this wedge is wasted resources, from another point of view it supports the business sector of the community. And from that point of view it is not wasted at all.  Indeed, let us look at the worst possible alternative to the community.  A more efficient supplier is able to provide inputs directly to the consumer, at just below the price community business would have been able to supply them.  We see that the consumer is marginally better off, but the business sector of the community has essentially been destroyed.  Virtually the entire surplus has been absorbed by the supplier, and the surplus which would have gone into the community to support the business sector are denied the community..

Where the transport costs become low, it may become in the interests of the society to increase the tax wedge, in order to maintain productive efficiency.

Friday, June 30, 2017

Obligations of the Wealthy

What obligations do capitalists have to their society? Any? Or is it only the money?

Consider somebody who works for a living. Family. Wife and children. Hard worker. Maybe overtime. He has time and resources to look after his own affairs. But does he have time to look at the bigger picture? And even if he had the time, would he have the opportunity. Would he have the education?

Probably not. Indeed, in most cases, a person cannot look after larger interests than his own. Yet, each person is as dependent on this bigger picture as he is of his job. Indeed, one of the people he is most dependent on is his boss. His boss can make his job miserable or pleasant. He can fire him, in some places without any cause at all. Just so, his boss is dependent on his own boss, and his boss on his boss. And so on, up to the very wealthy and very powerful. And even the self employed, even the small business owner is dependent on those richer and more powerful than he is in society. After all, they are able to spend vast sums of money, and alter the government and the allocation of resources. Any one of these powerful could destroy him, the worker, the self employed, the small business man, purely incidentally, without thought, or regard. One has only to look at the hundreds, perhaps thousands, of down towns destroyed by Walmart, or the thousands of desolate factories, to know this is true.

We are all dependent on what goes on beyond our horizons. And we look to other people, those above us, those around us, to keep track of what those things are. We have to.

This dependency is a socially necessary thing. Society could not exist without it. A worker who was more concerned with the affairs across the planet simply could not give enough attention to be able to manage his own life. The same for the small business man. He must attend to his business, his community, the people he buys from and sells to. He doesn’t really have the time to spend a lot of it worrying about the larger issues.

And of course there are other dependencies. We are dependent on the behavior of our neighbors, on the politicians who are expected to serve us, on the people who provide the public services in our community. Society is a web of dependencies. So the question is: Do these dependencies carry any obligation beyond the purely economic? Do they carry a moral obligation?

And what do we mean by moral obligation? From “The Free Dictionary:” we have: MORAL OBLIGATION. A duty which one owes, and which he ought to perform, but which he is not legally bound to fulfill.

Now some of these dependencies are equal exchanges. I depend on my neighbors, and my neighbors depend on me. The sense of ‘duty which one owes,’ seems clear in these cases. It is not so clear in cases of hierarchy. Does a boss owe his employee anything besides his salary? Is not the entire value for both parties of the relationship summed up in the exchange of labor for money? Is not the employee compensated in his wages for all the factors of his employment including, say, the fact that he can be fired at will? If we believe this, then be believe that not only is the labor market efficient, but that it is just. But if we believe a particular market is just, how can we believe that the same market, tilted by external forces, is also just? Is the market produced by a monopoly just? And employment, we have a market defined not only by an asymmetry of needs, as are all markets, but by an asymmetry of information. Can the employee negotiate a premium on not only on what he doesn’t know, but what he doesn’t know he doesn’t know? Not only can he not negotiate such a premium, but it is unreasonable to expect him to. And even were he to, he would be in competition with those who would not demand such a premium.

The point here there is that there is a gap, which cannot be remedied by formal debt and application of law.

And what about the relationship between the wealthy and the rest of us. Let us first admit the obvious. They pretty much control the economy. That is, our welfare, the welfare of the society is dependent on their actions. Even if this were not completely the case, it is very much so. By their actions, should they choose, they can do enormous damage to society.

I am not claiming conspiracy. I merely claim a similar response to similar motivations. There was no conspiracy to outsourcing, nor is there to robotization, but damage was done, though some would say the benefits to society more than compensated for it.

But who got compensated? Did the workers who lost their jobs to outsourcing gain any share of the increased profits enjoyed by those companies who sent their jobs overseas? Were they owed any? Did the companies who fired these workers for greater profit elsewhere have any obligation to these workers, or society in general? Or just to enjoy their increased profits, to divide among the wealthy shareholders?

So do the wealthy owe the rest of us anything? It need not be a matter of owing. A parent has obligation to his offspring. But it is not a matter of debt. And in a very real sense we count on the wealthy to take care of us, to manage the economy for the benefit of us all. Why should society allow them to have and retain wealth, if it were not to the benefit of the rest of society? If the wealthy have no obligation, then they have no obligation to act to society’s benefit. They have no obligation not to inflict damage on the rest of society. So if inflicting damage on society profits them, then we should expect them to do so.

Unless they indeed have a moral obligation to the society which supports them.

Tuesday, May 16, 2017

The Growth Trap (Revised)

Every economy, every self-organizing system which is not also self-limiting within the bounds set by its environment, grows until it exceeds the ability of that environment to support and sustain it.  It then collapses. 

The collapse of our global economy can be expected to be catastrophic.


When an economy first develops, acquiring resources is difficult and expensive. Growth is slow and uncertain, often outstripped by the demands of increasing population.  This is despite the fact that resources are often accessible and plentiful.  The methods of extracting the resources are primitive and inefficient, and there is little surplus.  The demand for and uses for new resources are limited, and efforts at developing new resources are often desultory. This state of affairs, essentially one of economic stagnation while surrounded by plenty, can often last a long time.

Note that there is a maximum benefit to any resource, and the costs of development, extraction, and conversion of that resource to useful form must be subtracted from that maximum benefit. Ideally, the remainder is what is available for use by the rest of the economy, though more often an economy is incapable of extracting the maximum benefit from any resource. There is almost always some degree of inefficiency of use of any resource by an economy and in primitive economies, this inefficiency is very high.

However, as infrastructure is invested in and developed, the relative cost of acquiring and developing resources decreases.  More uses are found for extracted resources, providing motive for ever greater extraction. Since it is easier and cheaper to develop uses for resources, rather than new sources of resources, demand, in general, outstrips supply, keeping the profit margins of producers high. For the producers, this extra profit means more resources are available to invest in expanding extraction and distribution, thus increasing the supply of these extracted resources available to be put to other uses in the economy.   

With the initiation of growth, the economy is able to exploit resources at an accelerating rate.   The economy grows further.  At this stage, the limiting factor no longer is the costs of extraction, but the limitations in demand, which are the final uses for the resources, and the necessary distribution systems, which also must be developed.

So it is necessary to develop an infrastructure, in order to extract, distribute and employ the resources, There is a cost, in resources consumed, to developing this infrastructure, There is also a cost to maintaining this infrastructure, and finally there is a cost to operating this infrastructure.

Since these costs are low, when resources are still plentiful and cheap to extract, the infrastructure grows robustly, This has the consequence that the early infrastructure maintenance systems will not be designed for efficient use of resources.   And this has consequence when resources later become expensive.

For clearly, however, with finite resources, or a finite average density of resources, or even with a finite rate of renewal of resources, the availability of  resources limits any economy’s ability to grow.  And this first shows up as resources become more expensive to find, to extract, and to distribute.

Indeed, as the plentiful and inexpensive resources are consumed, the exploitation of ever more marginal resources, resources which are more costly to extract and process, which are more distant and difficult to transport, becomes necessary to expand and even just to sustain the economy.  And the infrastructure must be expanded to develop these resources, and at an increasing cost.  What is more, this increasing cost of extraction must be passed on, and this increases the maintenance and operating costs of the entire infrastructure, including that already developed and designed around a low cost of resources in order to be efficiently maintained and operated. This older infrastructure becomes disproportionately costly and inefficient to operate when resources are more costly.

So less and fewer resources are available for expansion of that infrastructure.
Eventually, as the availability of resources decreases, and their cost of extraction increases, the cost in resources necessary to develop new infrastructure, and more importantly, the cost in resources necessary to maintain and operate  the infrastructure already built, exceeds the ability of the economy to extract benefits from those resources.

Increasingly, maintenance will be sacrificed to cover the increasing costs of operation. The system will no longer be covering its fixed costs, but only its variable costs. The result will eventually be a stage where the infrastructure can no longer be maintained, when the maintenance budget passes below a critical threshold, but will be subject to increasing catastrophic failure. This threshold is roughly when the budget is no longer able to cover both preventative maintenance and essential repairs. With inadequate preventative maintenance, essential repairs will increase, eating into the budget for preventative maintenance. As the budget for preventative maintenance decreases, the need for essential repairs will increase, in a vicious spiral. This process is sped by increasing costs of operation as a result of the increasing cost of acquiring resources, which the declining quality of the infrastructure also aggravates.

The real increasing costs of maintaining the real economy, (and in particular its infrastructure,) and the increasing real costs of its extraction of real resources from the natural environment, are hidden by the mechanisms of externalization of costs.

In an economy there are many mechanisms for externalizing costs, but they fall into the two broad classes of externalizing real costs, and of externalizing financial costs.  Externalizing financial costs does not alter the real costs of extraction and distribution.  By financial manipulation, these real costs are not reduced, but merely redistributed throughout the rest of the economy, the point being that the extractive industry will appear to be making more of a monetary profit than it really is.  The industry may actually be losing money.  But the appearance of profit leads to the real economy appearing to be gaining greater benefit from the extractive process than it really is.  Real costs appear lower, because financial costs appear lower.   But the financial costs to some of the other sectors of the economy become higher, though, because they must absorb some of the real costs of extraction.  Somebody must pay, and if not the extractive industries themselves, then it must be somebody else.  And all together, the real cost is greater, because resources are consumed in the economically empty endeavor of externalizing costs.

On the other hand, the externalization of real costs does permit the current extraction of resources at a present day lower real cost.  

So two ways of externalizing real costs are pollution and the over exploitation of a renewable resources.  Deferred maintenance is another.  So where externalizing financial costs distributes real costs throughout a present economy, we see that the direct externalization of real costs distributes those costs into the future economy.  Externalized costs distributed over the future also tend to be greater than costs which are internalized in the present.  For one example: The Newfoundland cod fishery:  It collapsed in 1992 due to overfishing, and has yet (2017) to recover.  

 These manipulations of the real economy, as well as the financial manipulations which enable them, enrich the financial and consuming sectors, and impoverish the actual producers of real goods and services.  At this late stage, many productive sectors are deprived of the real resources necessary for them to grow, and ultimately to maintain themselves.

For in the case of the modern economy, there are two relevant systems:  The real economy itself, and the financial economy which feeds off the real economy.  The financial economy produces nothing of substance itself. When useful it serves as a multiplier of production, by increasing the efficiency of allocation of resources. If feeds itself, first, however, before the real economy, and when overgrown it diverts more resources to itself than it saves the real economy by that allocation of resources.  The result is a decline in the efficiency of the real economy, and its ability to grow.
In any case, this happens at a late stage in the development of the real economy, when the resources available to the real economy to mount opposition to the growth of the financial economy are diverted away. Part of this is the result of increasing real costs in the rest of the economy outlined above.  Part is by the increasing diversion of resources by and to the financial sector itself.  (Inter-sectoral competition for resources is seldom considered by business leaders.)  A point is reached when effective regulation of the financial sector fails.  (One part of this process is that one of the consequences of the increasing concentration of wealth is that the value of non-financial rewards offered by the society declines, and become devalued, reducing the cost of corrupting other institutions.) 

Once the financial economy evades the controls set on it by the real economy, it grows without effective bounds. The financial sector then out-competes the real economy for money.  The financial sector is designed around the acquiring of money, and, unregulated, is simply more efficient at this than any sector of the real economy.

Feeding off the real economy, finance is also a non-self-limiting, self-organizing system.. It too is subject to overgrowth and collapse.  This happens when it exceeds the ability of the real economy to support it. When this occurs, if and only if it occurs before a critical point in the growth of the real economy, the real economy may yet be saved.  This is not because the real economy is self-limiting.  It is only because it has been increasingly organized to service the financial economy, and with the collapse of the financial economy, the real economy may be reorganized into a self-limiting form.  This is not guaranteed.  This may not even be likely.  In 2008, the opportunity for such reorganization arose, and was missed.   And whether or not the real economy can still be saved still depends on whether or not it is already too big to be reorganized into a sustainable form.  (It should be mentioned that capitalism, per se, is organized around efficiency, not sustainability.)

With the financial economy in ascendant, money is pumped out of the real economy almost as fast as government spending can pump it in.  This severely reduces the profit margins of productive industries.  Producers in the real economy would be hurt two ways.  Because of lags in production, prices of final goods are reduced vis a vis the prices of the factors which went into them.  And because of the money diverted into finance, prices for those final goods are also diminished.

Because of the diversion of money to the financial economy, the quantity of various forms of money in the financial economy increases.  This is accompanied by ever greater concentration of wealth.  While all assets become overvalued, consuming assets, in particular the assets of producers of toys for the wealthy, gain the highest profit margins, and so gain the highest valuation. At the same time, the assets of more basic industries, caught between rising costs and more limited demand, have lower profits, and thus a lower increase in value. 

This growth is in the demand, or consuming side of the economy, which conceals a relative decline in the extracting and manufacturing sectors.  GDP, for instance, does not distinguish between growth in basic industries, whose value added is underpriced, and growth in consuming sectors such as retail (High and low end retail.  Retail oriented toward the middle and working classes, as these are the classes from which the wealthy can most efficiently extract money, does not do as well.) and, increasingly, finance.  The economy becomes increasingly skewed, away from production and towards consumption.

This financial extraction becomes ever more difficult and costly, as the real economy becomes progressively impoverished and less productive.  The concentration and availability of extractable community assets also declines.  These assets, historically, because of their low potential for profits, were unattractive to private enterprise, and government was virtually compelled to assume these responsibilities.  Public services become attractive to private monies only due to the combination of being cheaply acquirable capital, the dearth of alternative investment opportunities, and, because of the increasing inability of the undercapitalized public sector to defend itself, opportunities for graft.

This decline in efficiency of financial extraction, means more labor is required for the financial sector to extract wealth from the real economy. Thus, even though most labor is no longer involved in real extraction and production, there results the paradox of an increasing burden on labor in non-productive jobs. This is obscured by the fact that these financial costs are increasingly externalized onto the real economy, ie absorbed by non-financial industries and labor . However, because of the decreasing efficiency, the profit to be made off these jobs is very low, and decreasing, and the pay must be commensurate. 

Meanwhile, since the cost of all maintenance increases, the cost of maintaining the burden of the financial and consuming sectors is also increasing;   the costs required for extraction increase, the actual financial profits decline to zero and even go negative.

The degree of financial exploitation is not reduced, but more resources are devoted to the process.  Even as this happens, fewer resources are available to the real economy. This is both because the financial sector externalizes its costs onto it onto the real economy, (and thus appearing artificially profitable,) and because greater real resources must be expended in acquiring resources from an increasingly impoverished natural environment. 

Combined, these processes render the usual indicators of economic health and prosperity at least useless and even more likely misleading. Much growth occurs in the wrong sectors, and is indicative of impending failure, rather than success. Further, with increasing deregulation, more fraud may be expected, both in production, and in reporting on that production, further corrupting indicators.


Mankind has yet to develop a modern, self-limiting economy. Hunter-gatherer societies existed in ecological equilibrium with their environment, fitting into the limits set by the rate of replenishment of renewable resources.  For pre-industrial economies, the growth trap must be considered as a possible factor in their ultimate decline. Since economies ultimately serve a population, clearly, with unrestricted population growth, no self-limiting economy is possible.  And any non-self-limiting economy will be subject to the growth trap.

More to the present, however, there is no evidence that capitalism is self-limiting.  Indeed, the virtue of Capitalism is efficiency, not sustainability.  Because of its inherent drive for efficiency, it is able to out-compete any sustainable system, and destroy it.  It even out-competes those sustainable systems it depends on, and destroys those.

Only a self-limiting economy can survive the growth trap.  Only an economy which can limit its consumption of renewable resources to some rate less than the rate those resources are renewed, and its consumption of non-renewable resources to some rate less than those resources can be recycled, can be indefinitely sustained.  All other economies will fail. And a failing economy will be incapable of providing sufficient resources for the survival of most of its members.  Indeed, because of the enormous efficiencies brought about by a modern economy, if that economy fails, such a failure will be catastrophic, and only small percentage of the people who depend on that economy can be expected to survive.

There still seems a choice, however, although, judging from their antics, our political class seems either incapable of or uninterested in confronting the issue.

Revised and expanded Sep 7,2016, Nov7, 2016, Feb 17, 2017, May15, 2017

Thursday, May 4, 2017

Hidden Benefits of Taxes

Hidden Benefits of Taxes  A revision of the Social Benefits of taxation                                   
A large tax wedge can lead to a dramatic increase in economic efficiency. The market share of 'deadweight loss' produced by a tax wedge consists of inefficient producers and indifferent consumers.  The high costs in resources involved in production of the relatively small quantity of 'deadweight loss benefits' can be much more efficiently applied elsewhere in an economy.  Because of this increase in efficiency, we find a substantial government sector and its services may be maintained with very little net cost to a society.

Historically, taxes have been considered to be a burden on the productive capacity of an economy.  Many of us have at least little bit of a feeling that they’d be better off without them.  Even critical services such as police and fire protection are suspect expenditures to some. Spending tax money on infrastructure, like roads, public water supplies, in some countries health care and retirement, some claim to be an imposition on their liberty.  Some say all taxation is theft. We will not arguer these philosophical points, we will merely argue that an economy, a society, is materially better off with taxes, almost irrespective of what those taxes are spent on.  This is because some of the most important benefits of taxes are not in what they provide, but in how they can shape an economy. Here they can provide a massive increase in economic efficiency, a much higher amount of goods and services for a given amount of resources consumed.

Let us look the standard Econ 101 supply and demand diagram of a free market, and see what happens when we impose a tax.  We will look at the market for that commodity familiar to economics students everywhere: Widgets. Sure, it could be  a market in anything, but most markets have unique characteristics, and we want to talk generalities.  So we’ll use widgets.


In a supply and demand diagram for the market of widgets, the quantity of  widgets bought and sold is plotted against the price.  The more money is offered for widgets, the more producers are willing and able to make, so the supply curve slopes upward.  The demand curve slopes downward because the higher the price for widgets, the fewer widgets consumers are willing to buy.  Where they come together  (at the equilibrium point e)  is that price where consumers are willing to buy as many widgets as producers are willing to make and sell.

The green and blue triangles are the benefits (welfare) society gets from widget production. The benefits are divided between the producers and the consumers.  The blue is what the producer gains from producing widgets.  This includes his profits. The green is the net benefits consumers get from using their widgets. Not all consumers derive the same benefits.  Some need their widgets more.  Some may just have more fun with them.

The price is the market price, and is the same for all producers and consumers.  The quantity of widgets produced, and the price they are sold at on the market, are determined from where the supply and demand curves come together.  (At e.) Looking at the diagram, we see the widget producers on the left are able produce at a lower cost than producers on the right, so they are able to make higher profits.  They get more benefits than the less efficient, more marginal producers.  Similarly, the consumers on the left get more benefit from the use of the widgets they buy. This is shown by their willingness to pay a higher price along the demand curve.  The difference between what they are willing to pay for widgets and what they actually have to pay is the net benefit they derive from what they are buying.

To the right of the equilibrium point, the cost to producers for making widgets is greater than consumers are willing to pay for widgets.  The cost of production per widget goes up, but with more widgets produced than consumers are willing to pay so high a price for, the price goes down.  So producers don’t make more than quantity Q  widgets, because consumers won’t buy more than Q at that price. 

So what  happens when we put a tax on widgets?  Here we put a production tax T on every widget.  This results in a price difference between P’, the price consumers pay, and  P*, the price producers collect, on every widget produced. This is called a tax wedge.  It effectively increases the cost of production for widgets.  So it shifts the supply curve up by that amount, as shown in the following diagram.


Since the  price P’ paid by consumers is higher, they don’t want to buy as many widgets as before. Instead of wanting to buy Q widgets at price P, at the higher price P’ they only want to by Q’ widgets.  Meanwhile, at the quantity Q’ of widgets that consumers want to buy, producers can only receive P*.  The difference between the prices P’ – P*, times the quantity Q’ produced and sold, is the revenue received by the government.  So we have three regions of benefits, Producer Welfare and Consumer Welfare are both reduced.  Much of this welfare lost by consumers and producers goes instead as Government Welfare.  For their loss in taxes, consumers and producers gain the benefit of government services. The remainder is the region of deferred welfare, benefits which society does not receive, because the tax makes the production of more than Q’ widgets unprofitable to producers, and too expensive for consumers. So the combined benefits to society with the tax are less than the benefits which accrue to society without the tax.

However, this region of lost benefits, the region of so called ‘deadweight loss due to taxes,’ consists of benefits which are both costly to produce, and therefore of low benefit to producers, and of low benefit to consumers, because the remaining consumers in the market are unwilling to pay much more than what the market price would be without taxation.  In fact, with taxation, they are unwilling to pay the price for widgets at all.  They just don’t want widgets that badly. The resources spent in producing these small benefits, now, could be more efficiently spent elsewhere in the economy, as we show in the next diagram.


Here, in Market W,  S’ is the new Supply curve brought about with the increase in costs imposed on widget producers from taxation.  The marginal benefits (green striped triangles) otherwise attained by marginal producers at higher cost are forgone, the resources which would have been spent to obtain those marginal benefits are instead available, and here allocated, to be expended more efficiently in Market T of the economy, the market for thingbobs,.  Market T can be similarly taxed, the resources applied still elsewhere in the economy. Eventually, of course, the entire economy is made more efficient, as a portion of the otherwise inefficiently used resources in other markets are distributed to other markets, are some even eventually returned to more efficient use in the markets for widgets and thingbobs.  

Now the freed resources are not actually re-allocated by government.  Private enterprises, rather than trying to inefficiently compete in an unprofitable market, simply choose to place their resources in other markets where they can be used more efficiently.  One can argue, of course, that they should do this anyway.  But it is simply the fact that every market has marginal and inefficient producers, trying to make a dollar.  The tax provides them with additional incentive to enter markets where their use of resources will be more socially efficient, where for lesser cost they provide greater welfare.

To be sure, the difference is harvested by the government. And if we examine the diagram with two markets, we see that the net benefits to the private sector are smaller, with the tax, by about the welfare society would gain from the inefficient producers.  The diagrams are generic, and results will vary.  However, in the example sketched, with a tax wedge in place transforming the inefficient producers in one market into efficient producers in another, for the same cost, society gains government welfare in amount about 4 times the total welfare provided by the inefficient producers. (The direct gains in government welfare from taxing widgets replaces some of the welfare society would gain if the market in widgets were untaxed. So, for the cost of expensively produced widgets, we gain efficiently produced thingbobs, and a total of government services of value more or less equal to the value of the combined social value of the production of both widgets and thingbobs.    .

Under judicious taxation, as a result of this increase in efficiency in the use of resources, most of the services of government can be provided for for free.  That is, resources which would be applied in some inefficient productive process, and so largely wasted, may be applied more efficiently in providing economically useful government services. And many of the services provided by government, by eliminating many of the costs of transaction and overhead that producers would otherwise bear, also act to increase the efficiency of the private productive economy.  Inadequate taxation, and the necessary reduction in economically useful services purchased with these taxes, far from increasing the competitiveness of an economy, decreases it, and nations with an inadequate public sector are at a competitive disadvantage with respect to foreign producers in countries with more robust public sectors. Further, even with the light tax burden, the citizens of countries with small public sectors are less provided for, and are a greater burden to the industry of that country, than countries with a larger government service sector. 

In the example illustrated by the diagram, without taxation the total social welfare is about twice the cost of resources expended. (  The size of the green plus the blue triangles compared to the pink triangle in the first diagram.) With the tax wedge as illustrated, the total social welfare is almost 4 times the real cost to producers.  (The size of the solid green and blue regions in both markets of the previous diagram compared to the solid pink regions.)

Although we have drawn the diagram for two particular and identically composed markets, it is apparent that for a wide variety of supply and demand diagrams, and thus, for a wide variety of economic sectors, the application of a tax wedge will result in a large increase in economic efficiency.

By implication, the opportunity costs of the small amount of marginal benefits forgone are huge. The benefits forgone would be obtained by essentially wasting resources in producing them, and are a small fraction of the benefits produced by allocating these resources more efficiently.  Indeed, we may expect this improvement to be even better than it initially appears, since we would expect the most marginal producers to be those most eager to externalize their costs in order to remain competitive.  Pressure to externalize costs is thus also reduced on the more efficient producers. The economic results from failing to apply a tax wedge in a market are, apparently without exception, far inferior

The very pejorative “deadweight loss,” has been used by those ideologically opposed to government intervention in an economy as a justification for their position. However, they, and the economics profession as a whole, have totally over-looked the high opportunity costs involved in the creation of these marginal benefits.  Taking these costs into consideration inverts the conclusion:  The gain in freed resources, in almost any reasonable scenario, far outweighs any gain involved in wastefully spending these resources for these relatively small benefits.  Indeed, in the scale of economic activity, these resources are much more wisely spent elsewhere.  And the tax wedge causes this to happen.  Far from being a burden, taxation in a market, and at what is traditionally considered a rather high level of taxation, can yield much closer to optimal economic results. .

I leave it to those ideologically opposed to government intervention to find exceptions to the tax wedge increasing efficiency. I do observe that the apparent requirement for monotonicity in the supply and demand curves would seem to make finding these exceptions difficult. 

One interesting argument, though, which remains, is the argument from liberty.  This argument would seem to suggest that the wanton destruction of scarce resources is, somehow, ‘liberating.’ And indeed, acquiring the ability to squander society’s resources seems to be one of the primary motives for becoming wealthy, and indeed the ability, and under capitalism the right, to squander society’s resources is the very defining characteristic of wealth. And this would seem, for example, to be the argument against higher gasoline taxes in the United States. The case shown here is that a higher gasoline tax, even with money spent (more efficiently) on public transit, would free up resources for everyone, as the European experience seems to show.  To be sure, there would be less joyriding, and tickets to NASCAR events might become more expensive.

There does remain the issue of determining the balance between efficiency and quantity of production in any particular market required for the proper functioning of an economy.  Considerations of scale indicate that, contrary to what is shown in the diagrams, the first unit of anything is seldom the most efficiently produced.  Rather, there is an optimum scale of production, that which minimizes the average cost, (This ignores issues of demand, and thus actual profit.) and we must consider this to be true for an entire economy as well as for a particular production process.  While with this consideration the improvement in economic efficiency would not be as great, it must still be expected to be impressive.

Also, it should be easier to tax economic wants as opposed to economic needs.  (Although see problem three, below.) A more efficient economy, however, needs less to sustain its function, and so has relatively more resources available for the servicing of wants. 

 “Deadweight loss” is also found in other market situations.  Regulated markets, markets with price controls, and markets restricted by private actions such as monopoly formation and oligopoly usually also involve deadweight loss. Increases in efficiency should also be expected in these situations, so It would seem that these other situations also, at the least, need to be re-examined.

Now direct consumer benefits per se are also much less under taxation, the same as under monopoly, and the producer surplus is also much less. However, the government spreads much of its income widely. It is, in its way, both a consumer and a producer. It re-distributes consumption, and capitalizes production, both directly, through capital investments, and indirectly, through subsidy of production, and creation and maintenance of infrastructure. And all of its expenditure, purported to be for the public benefit, does, one way or another, enrich the diverse sectors of the economy.

One problem with the tax wedge, however, because it favors the more efficient producers, it also favors the economic drift toward concentration of ownership, and the creation of oligopolies and eventually monopolies.  We will address this issue here shortly.

Narrowly held monopolies cannot be expected to spread their profits.  Neither can monopolists be expected to spend their profits to provide services which increase the efficiency of the larger economy.   Monopolies once formed, and where not widely owned, further to aggravate the natural tendency of economies to concentrate wealth and power, a concentration which leads to economic instability and collapse. This is especially so because the power concentrated in monopolies tends to translate into political power.  And the monopolist must be expected to use this power to further his power, and mitigate the impact of a tax wedge on his revenue. 

A second problem is that producers which escape taxation will eventually displace those producers which are subject to taxation. The result will be a reduction in both taxes collected and in economic efficiency.  This problem must be considered especially acute in open economies, where tax paying domestic producers can be expected to be displaced by non-taxpaying (and these producers which can often be less efficient) foreign ones The interesting implication here is that, while a nation’s economy may be producing less and consuming more, as an increased share of what is consumed is imported, (much of what is considered production actually either enables consumption, or is a form of consumption,) that economy need not be any better off for this increase in consumption.  Because of the decrease in economic efficiency, fewer consumables will be efficiently used, and more of this consumption will be squandered.  A country running a deficit is essentially externalizing costs, and these costs may in reality be greater to the country than if the country were to internalize them.

A third problem is, of course, the politics of taxation.  Nobody likes to be taxed, and the powerful, more than others, are capable of avoiding it. (This also bears on the second problem.) This first suggests that the markets which serve the wealthy will be the least efficient, even though these are the markets where an economy can most easily bear the loss of marginal producers.  (Marginal producers may be needed in the production of an economy’s necessities.)  And this further suggests that a disproportionate share of an economy will be dedicated to servicing the wealthy, even at the expenses of the necessities of that economy, such as maintenance of infrastructure.  For instance, a recent study has shown that in the United States today, essentially no policies are enacted by the government which are not also approved by the wealthy elite.  An implication of this is that the tax burden upon this elite can only be expected to diminish, and thus that the burden of taxation on the rest of economy and the population can only increase.

One final note.  As an economy increases in efficiency, it inherently becomes less stable, and more vulnerable to collapse. An efficient economy becomes dependent on its efficiency in order to be productive enough to sustain itself.  The greater the efficiency, the greater its dependence.  A reduction in efficiency will result in a reduction of production, perhaps sufficient enough that that economy can no longer sustain itself. 

A particular consideration regarding improvements in efficiency brought about by regulation and a tax wedge, where a wedge and/or regulation is already established, is that removing or even merely reducing these factors will result in a reduction of that efficiency, and a resulting reduction in the productive capacity of that economy.  That economy may no longer be able to sustain itself. With a critical reduction in production, cascades may result, and the possibility of sectoral and even general collapse.  Great care, therefore, should be exercised in the reduction of the size of tax wedges, or the elimination or alteration of any significant regulation. 

Given the tightly coupled world economy, the efficiency of production of any  major economy is a concern for all other nations.