Government Spending and Skin in the Game
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Last time I talked about some ideas from Nassim Taleb’s underrated book Skin in the Game. These were ideas which I believe had been overlooked by most of the people reading or reviewing the book, ideas which I kept coming back to. What I didn’t cover was his central idea, the one that gave the book it’s title.
And I had not intended to talk about it this time either. In fact, If I’m completely honest I didn’t even notice the connection until I was most of the way through with writing this post. (And if it seems unusually delayed, that's part of the reason, that plus travel and book writing.) I had initially organized the post around the idea of inflection points. But once I was nearly done I realized that all of the inflection points I had mentioned were unified by a single phenomena: people no longer have “skin in the game”. In some respects the meaning of this phrase and the effects of this lack probably seems self-evident. In other respects it’s a very subtle idea, and hopefully we will uncover some of these subtleties in the course of the post.
As a first illustration of what I mean, let’s go back to 2012, when Mitt Romney said the following in the course of his campaign for President:
There are 47 percent of the people who will vote for the president no matter what. All right, there are 47 percent who are with him, who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them, who believe that they are entitled to health care, to food, to housing, to you-name-it. ... My job is not to worry about those people. I'll never convince them they should take personal responsibility and care for their lives… These are people who pay no income tax.
Romney did not intend this for public consumption. He was speaking at a private fund-raiser, but as is so often the case, video of the speech was leaked, and this particular statement came across as being especially inflammatory. I don’t think it’s accurate to say that it was singularly responsible for him losing the election, but it certainly didn’t help. However I’ve always thought that buried in this statement lies a very important point, a point about who has skin in the game and who doesn’t.
To begin with, everyone agrees with Romney’s numbers. In 2011 47 percent of people did not, in fact, pay any income taxes. And while it was unfair (not to mention unwise) for Romney to go on to say that these people “believe that they are victims” and also “believe that they are entitled to health care, to food, to housing”. Democracy nevertheless is a numbers game, and to a first approximation, what the majority wants the majority gets. Absent built in protections, like those contained in the Bill of Rights, which to the extent it talks about taxes, is against them, which is why we needed the 16th amendment.
I don’t think it’s outrageous to claim that people don’t like paying taxes, and they do like getting money. If we should therefore find ourselves in a situation where the majority of people don’t pay taxes, i.e. they don’t have skin in the game, then it’s not unreasonable to assume that they will use that majority to prolong that situation indefinitely. And beyond that it is within their power to compel the minority who do pay taxes to pay still more taxes and fund programs which benefit them. This all touches on one of the key things Taleb points out: once people no longer have skin in the game their motives become distorted. He mostly talks about Wall Street investors who don’t suffer the downsides of their bad decisions (see the 2007-2008 crisis) but the same thing applies to tax payers.
Now it is going too far to say that once 51% of people don’t pay income taxes that the system is instantly and irretrievably broken. First off there are other taxes beyond taxes on income. Most of the really big governmental benefits are (supposedly) funded by payroll taxes which are paid by a far greater percentage of people. Also this 51% will not immediately take on the form of a monolithic block with perfect coordination. Some people might vote in such a way to cause them to start paying income tax even if they previously hadn’t. Nor are people very good at accurately assessing and pursuing, to the exclusion of all else, their own self interest. Finally, it’s always possible that their income will rise to the point where they have to start paying taxes.
Nevertheless, in a democracy, whenever you get 51% of the people on one side of the fence something has changed, even if the consequences of that change are not immediately apparent. We have to consider that we might be looking at an inflection point. A democracy where even 47% of people are not paying taxes is potentially a very different one from one in which 51% of people aren’t. Even if, in terms of actual numbers, the difference is not all that great. We passed from a state where some people don’t have skin in the game to where a majority of people don’t have skin in the game.
Fortunately, despite Romney’s ill-considered words, at the time we were still in the 47% world and not the 51% world. We had not yet reached the inflection point. But that was nearly a decade ago. What does the situation look like now? When I started this post I honestly didn’t know, I was surprised to find out that we’re not just a little bit past the 51% mark, we’re a lot past it.
In 2020, 61% of people didn’t pay any income taxes. Which is getting really close to two thirds of everyone not paying taxes. This reminds me of the quote, erroneously attributed to Benjamin Franklin, that “Democracy is two wolves and a lamb voting on what to have for lunch.” And it graphically illustrates the point I’m trying to make. The wolves have no skin in the game, while the lamb has not merely skin but everything. Even without such stakes, if a minority has something the majority wants, i.e. their money. And they can get it without inconvenience to themselves. Why wouldn’t they?
As I said I was surprised to find out that we were not only past the 50% mark, but well past it. I would have thought that it would be big news when we passed the 50% mark. Big enough I would have heard about it. But even after searching I couldn’t seem to find out when it had happened, perhaps it just happened in 2020. Maybe the deluge of cash dispensed in response to the pandemic added an additional 11+% to the amount of people who don’t pay taxes. Presumably it will be less that 61% in 2021, and perhaps lower still in 2022, but I’m willing to bet that regardless of what it was pre-pandemic (and if you can find out what that percentage was I’d be grateful) after the smoke clears it will be permanently above 50%. That we have crossed an inflection point and we’re not going back.
All of this might be less worrisome if there wasn’t still another inflection point we appear to have passed recently. The inflection point of worrying about government spending. We’re no longer even pretending to have skin in the game. And while this inflection point is more difficult to assign an exact number to, doesn’t it feel like, between Trump’s profligacy and the firehouse of pandemic money that something has definitely shifted here as well? If nothing else, the sums of money people have been suggesting since the start of the pandemic dwarf those of the pre-pandemic world. I still remember when the $700 billion allocated by TARP was a huge deal. And now the moderate position is to only spend $1.5 trillion rather than $3.5 trillion. (Bernie Sanders was suggesting $6 trillion.) And this is on top of the trillions already spent fighting the pandemic.
Which is not to say we haven’t been on this path for a long time, but not only are the amounts different but lately politicians appear to have abandoned even the pretense that new spending has to be balanced by tax increases or spending cuts elsewhere. Politicians used to at least pretend that there needed to be skin in the game, but now they hardly even mention it. Or if they do, they distort the idea so thoroughly that it ceases to have any meaning.
I am not claiming that 51% of people think the government can spend as much as it wants. Nor do I think it’s 51% of the members of congress. In fact, in a recent survey 52% of people said that the national debt and deficit is the biggest economic problem, above inequality, wage stagnation and slow growth. If true, I think it’s fair to say that the average voter is more worried about things than the average member of congress. And while the debate between $1.5 vs. 3.5 trillion is only happening on the Democratic side of the aisle, it’s not as if the Republicans did any better under Trump.
So how do we reconcile the 51% of people who don’t pay taxes with the 52% of people who think that the debt and the deficit are the biggest economic problems? Or rather out of these two majorities which will get their way? On the surface neither of them have much skin in the game. But I think as we dig deeper it will become apparent which side will ultimately triumph.
To begin with we should look at which way the trends are pointed. As we’ve seen, the trend is for fewer people to pay income taxes. Which already puts us in a situation where it’s not the 51% of people who don’t pay taxes vs. the 52% of people who think government debt is a problem, it’s the 61% who don’t pay vs. the 52% who worry. One imagines that the trend would be for the 52% to increase as well, particularly as the debt grows and there’s more reason for worry. But I’m not sure that’s the case. Back in 2012, 69% of people said the budget deficit should be a top priority. Now these 69% of people were answering a somewhat different question, so it shouldn’t be used in a direct comparison with the 52%, but it does show that a lot of people have been worried about it for quite a while without anything really changing.
Why hasn’t anything changed? Why is the majority who worry about the debt so powerless to translate their preference into actual legislation? This is where it comes back to skin in the game, and specifically what economists call revealed preferences. Or to put it more bluntly: people SAY a lot of things. We’re interested in what they actually DO.
Just because people say they want something doesn’t tell us anything about what they’re willing to sacrifice to get that something. One assumes that there are a lot of people who are on Social Security who are also in that 52% who are worried about the debt. As many politicians have found out, regardless of what people say about government spending, you don’t touch Social Security. And numerous pundits have ascribed Trump’s victory in 2016 to his promise to protect that program. One can quibble about how serious he was, but it was a departure from the Republicanism of Paul Ryan and George W. Bush. The point being, people worry about government spending unless it’s government spending that benefits them, and then it’s off limits. And it’s in this fashion that the 51% (or 61%) people who don’t care about taxes will triumph over the 52% (or 69%) of people who worry about the debt.
You might be under the impression that this problem is limited to concerns about the actual money people receive, but as it turns out even asking people to just imagine that they have more skin in the game dramatically reduces their willingness to sacrifice. As an example I offer up this recent poll on climate change:
According to the poll, 69% of Americans - including 56% of Republicans and 71% of independents - believe the United States needs to take “aggressive” action to fight climate change.
Some 78% believe the government should invest more money to develop clean energy sources such as solar, wind and geothermal, including 69% of Republicans and 79% of independents...
More than half of Americans either strongly or somewhat support the idea of weaning the United States off fossil fuels entirely within 10 years – the central tenet of the Green New Deal - including a third of Republicans and 57% of independents...
Support for such changes dropped off dramatically, however, when poll respondents were asked whether they would be willing to assume certain costs to achieve them.
Only 34% said they would be very likely or somewhat likely to pay an extra $100 a year in taxes to help, including 25% of Republicans and 33% of independents, according to the poll. The results were similar for higher power bills.
This is an excellent example of the difference between having skin in the game and not having it. 69% believe that we need to take aggressive action to fight climate change. I’m not sure what they were imagining when they heard the word aggressive, but apparently for half of them that word meant something less than $100 a year. If I’m aggressively paying down my debt then I would hope that I’m doing it at a faster rate than $100 a year. But of course I have skin in the game with my debt. It’s obvious that when it comes to climate change and government debt that most people don’t feel like they have skin in those games.
And, as I pointed out in the beginning, we’re just asking people to imagine that they have skin in the game, when you get to the actual skin they have in the game it’s presumably even less. Which is to say, out of the 34% of people who said they’d be okay paying $100 extra a year, how many of them are already sending that much to organizations dedicated to fighting climate change? I’m willing to bet the number is a lot closer to “none of them” than “all of them”.
Finally this isn’t an isolated result. Plenty of people have found similar results on a broad range of questions. But if we’re specifically considering replication. The Cato Institute conducted a nearly identical survey which found that 68% of people wouldn’t pay $10 a month more on their electricity bill in order to fight climate change. (The same survey found that 58% of people would pay an extra $1 a month, so that’s something I guess.)
But here we arrive at another mystery. Should the Democrats pass their $3.5 trillion dollar infrastructure bill that would amount to $27,000 per household, which is significantly more than $10/month. And yet most Democrats and even many Republicans seem to be okay with that. Presumably somewhere in that group are people who both support the $3.5 trillion dollar bill and adamantly reject an additional $10/month. How could this be?
Once again the answer is skin in the game. There has always been something of a disconnect between government spending and personal spending, but lately it seems to have really gone off the rails. People can imagine their power bill going up by $10 a month. And having imagined it, decide they don’t want it to happen. They can’t imagine a bill for $27,000 arriving in the mail. People have become completely detached from the actual mechanisms of government. They have no skin in the game.
When you ask progressives what they’re hoping to achieve with this sort of spending, they will talk about a reduction in inequality. They will speak of the good the money might do. They may bring forth an anecdote about someone who had to declare bankruptcy because of medical bills, or who is now homeless after losing their job. On the other side they may speak of the unfairness of Bezos’ billions, and the increasing wealth being accumulated by the 1% as a whole. If you ask them to get more concrete they may mention a wealth tax, or the idea of duplicating conditions in one of the Scandinavian welfare states.
Here we arrive at perhaps the most interesting place of all. As it turns out one of the features of the Scandinavian welfare state is that there’s a lot more skin in the game at all levels of wealth. The main inspiration for this post actually came from an article by a Swedish doctoral student in economics, and yet somehow despite this article providing the initial inspiration I’m only just getting to it. In this article he mentions several very interesting things:
Sweden doesn’t really tax the millionaires and billionaires—it taxes the poor. In Sweden, it is possible to avoid virtually all capital gains taxes through an investment savings account, which obviously mostly benefits the rich. What about wealth taxes? The Nordic countries have long since moved past them: Denmark abolished its wealth tax in 1997, Finland in 2005, and Sweden In 2007. It’s not about ideological opposition to taxing the rich. It’s that the wealth tax was completely counterproductive and caused capital to flee these countries. In the U.S., the wealth tax is a novel idea. In the Nordics, it’s the 56k modem of taxation.
Instead, the big difference between the U.S. and Sweden, taxation-wise, is how the poor are taxed. Americans who make less than $12,000 per year pay no federal income taxes. Many who make more than that still end up paying a net zero in taxes once deductions are accounted for. In Sweden, the equivalent is about $2,300. On any money you make above that threshold, you pay a tax rate of about 30 percent, plus payroll taxes. What about deductions? In the US, the average tax refund last year was $2,707. In Sweden, it was $821. On top of this, Sweden has a national sales tax of 25 percent on almost everything you buy. As the poor spend a greater share of their income, this tax disproportionally hurts them.
The kind of taxes that the poor are forced to pay in the Nordic countries would be completely unacceptable to the majority of the American public. It does not matter whether polls claim Americans support Nordic welfare programs—it’s utterly meaningless unless you also agree to pay them the only way they can be paid for: By taxing the average citizen. [all emphasis original]
To begin with the author rejects the idea of a wealth tax. (I particularly like the idea that it’s the 56k modem of taxation.) But more tellingly he points out that a far greater share of the tax burden is borne by “the average citizen”. This gives them skin in the game. In more concrete terms, to use the examples already given. You don’t have a situation where a majority of people don’t pay taxes and can therefore raise the taxes which do exist as a strictly democratic exercise. You also presumably have much more engagement with how the government spends the money, given that just about everyone is on the hook for it, not merely the top 39%. All of which is to say, if you’re looking to duplicate Scandinavian welfare states you’re essentially going in exactly the wrong direction. Even The Economist recently pointed out that America will never have a European style welfare state without a VAT.
However, as near as I can tell, there’s been hardly any discussion of a VAT, which is a major pillar of the Scandinavian welfare states, and quite a bit of discussion of a wealth tax, which is something they’ve tried and rejected. There’s also a big push to make the US tax system more progressive, when it’s already more progressive than the European tax codes and in fact according to the OECD it’s the most progessive system in use by any nation. (Something which also surprised me.)
Okay, apparently progressives are going the wrong way on all of these issues if their destination really is a Scandinavian-style welfare state. But despite this the goal isn’t an impossible one, right? Well setting aside the greater percentage we spend on defense, and our differing cultures. The author of the article makes one final point about the need for skin in the game.
Building a welfare state is a boom-time endeavor. The Nordic welfare states were built during the postwar expansion. In Sweden’s case, we got the best of both worlds: We avoided becoming involved in the war, and afterward, demand for our industries spiked. With that, so did salaries. This made building a welfare state easy for two reasons: First of all, as salaries boom, so do tax revenues, even if tax rates are unchanged. This revenue boost allowed the government to add additional safety nets and government programs without raising rates or having to cut any other budgets.
Secondly, it is politically much easier to raise taxes when salaries are rising quickly. Most people don’t pay close attention to their tax rates, but rather to how much they get paid. If taxes are increasing, but real wages are increasing at an even faster rate, then most people will be fine with it because their paychecks keep getting bigger over time and they are able to purchase more stuff. Relative change is king.
Thus far we’ve mostly been talking about the “skin” part of having skin in the game. Here we’re talking about the “game” part. The Scandinavians were playing a much different game than we are. And while I think rising wages was a huge factor, I would argue that it’s something he didn’t mention that mattered even more. The nation was unified. This is easy to do if there’s plenty of money to go around. And I’m sure the fact that the war was over helped out as well.
But the key thing is that they were all playing the same game. I don’t think the various sides in the US are even playing the same sport.
The easiest way to have skin in the game is for there to be money at stake. I’m not entirely sure what game I’m playing, and I imagine neither are you, but if you want some skin in whatever this is, consider donating.