Can governments “create wealth” by using resources to produce goods or services of greater value to society than the resources used? Or does government merely take from some and give to others without any net increase in people’s well-being?
That question came to mind after recent comments by Minnesota Senate Minority Leader David Senjem, R-Rochester. In a discussion about cutting property taxes, Senjem asserted, “Government can’t create wealth. It can collect wealth and it can redistribute it. But it certainly can’t create it.” In one sense, his statement is absolutely correct. In another, it is profoundly wrong. It is important for citizens to understand both senses.
Senjem went on to say, “to cut property taxes … it’s going to come out of income tax, corporate income tax, some other source of revenue.” In that context, his assertion is both correct and important. There is no free lunch. If government cuts one tax without cutting spending, it must increase another tax or pass the burden on to future taxpayers.
But consider another interpretation: Can only the private sector turn resources into more valuable goods and services to meet the society’s needs? Is government merely a zero-sum game in which taxes hurt some and benefit others with no net improvement overall?
That is profoundly wrong. To economists, it is an argument that there are no “public goods.” That term describes goods or services that markets fail to produce at optimal levels. Markets fail because such goods contain benefits that spill over to society as a whole, and the producer cannot charge those who benefit.
Such goods include national defense, police and fire protection and weather warnings. In the absence of government, private firms will not voluntarily provide these services because the benefits flow to society as a whole.
Private retailers can refuse a hamburger or can of paint to any customer who does not pay. But if a private firm provides an aircraft carrier or tornado warnings, it is impossible to force all the beneficiaries to pay. The same goes for most roads, basic education and scientific research. Without government, a society will never get enough such goods to be as well off as possible, given the resources available.
Do fire departments and city streets provide no net benefits to society? Does the amount taxpayers must pay exactly offset the gains to those who benefit from such services?
That is one reading of the “government cannot create wealth” assertion, but history and economic theory argue otherwise.
One can’t explain the theory briefly or without complicated graphs or equations. It is clear, however, that if government does not act to supply public goods, society gets fewer of its needs met. Government spending means taxing, but the benefits to society from the public goods can exceed the loss to society from taxes. Government uses resources to create wealth.
History shows no nation that achieved high standards of living without government providing some goods or services. Big government is not needed, but some government is.
However, the argument that government can indeed “create wealth” by using tax dollars to provide public goods does not mean all government spending provides net benefits for society.
It is hard to see how current farm subsidies, for example, provide any net benefit to society.
Moreover, just because a government program has some element of “public good” does not mean that the net benefits to society necessarily exceed the value the tax dollars might have created if left in the private sector.
Net benefits to society of K-12 education exceed those from nearly any private investment. Post-doctoral grants for economists and basket weavers don’t.
Nor does it mean that because government is needed to produce public goods, the government itself must produce them. Private firms can build and run toll roads. Voucher systems can pay private institutions for educational services that are at least partly public goods.
Nor does it mean that public goods are the only legitimate use of tax funds. Payments to disabled veterans and food coupons for women, infants and children may simply be transfers from one group to another with no net increase in society’s well-being. But many believe these make us a more just society.
Regardless of government, a society cannot be prosperous without an effective private sector. Regardless of its private sector, a society cannot be prosperous without a government that provides at least some public goods. Both sectors “create wealth.”
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.