In-kind Taxation in the News

Russia is now drafting soldiers.  Below is a new economic discussion of in-kind taxes, of which the military draft is a good example.

In-Kind Taxes, Behavior, and Comparative Advantage

In-kind taxes – obligations of citizens owed in goods or services, rather than money – are some of the most important taxes in human history, and even in recent times are used in significant ways.  For example, according to The Military Balance, 59 percent of countries in the world in 1995 obtained military manpower by conscription: forcing citizens into military service.  More than six dozen countries, including the United States, have constitutional provisions for taking private land using the power of eminent domain. Eminent domain is also used to redistribute intellectual property, and may be employed more frequently in the future as that type of property becomes more valuable.  In-kind “public service” labor payments to local governments can be a major part of the tax burden faced by the poor in developing countries.  Another example: two dozen countries compel their citizens to participate in civic elections. 

Although public finance deals extensively with the question of cash versus in-kind transfers, in-kind taxes are almost completely neglected.  For example, neither of the public finance textbooks by Stiglitz and Rosen mentions in-kind taxes in general, or labor conscription in particular.  The purpose of this paper is to examine the efficiency properties of in-kind taxation (hereafter, IKT), with special emphasis on avoidance behaviors.

Behaviors for avoiding the Vietnam War draft are still famous today.  They include entry into protected occupations, obtaining political favors, moving to Canada, or embellishing medical conditions.  Quantitative work on avoidance behaviors has shown that the Vietnam War draft induced a significant increase in college enrollments (Baskir and Strauss 1978).  Desertion by conscripts can be rampant, and draftees are less likely than volunteers to reenlist when their required tour is finished.   Leon Friedman (1969, pp. 1545-6) describes evasion of the Union Army’s draft, “enrolling officers … were frequently lied to, avoided, and even physically attacked… new towns sprang up just across the northern borders in Canada … some men maimed themselves in order to fail the physical requirements for the army.”  Landowners are known to modify their property in order to avoid being targeted for condemnation or other limits on land rights.  Stroup (1997, p. 57) describes how landowners have reacted to the Endangered Species Act by “managing their land … in a way that almost assures that it will not be suitable for listed species.” 

Avoidance activities like these serve to restrict the quality and quantity of supply of resources to be taken, yet the small literature on the economics of eminent domain and military conscription typically takes the supply as given, emphasizing instead the purported tendency of in-kind taxation to distort comparative advantage (i.e., that the public project fails to be supplied by those most suited to do it) while it economizes on treasury revenue.   This paper treats IKT as a price-regulation phenomenon – the public recruiter is a buyer who has coercive power over its suppliers – and explicitly models the social costs, and private benefits, of suppliers’ avoidance behaviors.

In-kind taxation has been implemented in a variety of ways. Supplier compensation is one variable. Another is the granting of an option (if any) for suppliers to substitute a monetary tax payment for their obligation to supply under the IKT.  The price-control framework readily addresses various implementation options, offers new conclusions, and changes some old ones.  Under some conditions, “fairer” IKTs – those that do not accept monetary payments and thereby widely distribute the IKT obligation – are more efficient than less fair IKTs.  These results may help explain where and when various implementation options are exercised.

The IKT implementation options present a tradeoff between avoidance costs and opportunity costs.  IKT’s are capable of realizing many of the gains from comparative advantage, even while controlling prices.  This implication appears to match the reality in which the resources obtained through IKT are far from random.  Even among men born 1950-53 whose military draft eligibility was chosen by a random draft lottery, military enlistment was by no means random.  Angrist (1990, p. 315) refers to “the fact that armed forces selection criteria were not random ...” and reports that more than three-quarters of draft-eligible men in these cohorts did not serve in the military.   At the same time, roughly ten percent of those not draft eligible did serve. Although IKTs distort comparative advantage to some degree,  the price control framework suggests that comparative advantage distortions might enhance efficiency because they can alleviate incentives to avoid the tax.

Previous work on conscription has debated the nature of the relationship between monetary taxes and in-kind taxes.  Lee and McKenzie (1992), Ross (1994), and Warner and Asch (1996) claim that economizing on treasury revenue, as in-kind taxation is supposed to do, is socially valuable because of the deadweight costs of collecting monetary taxes.  However, these papers do not model the social costs of effort to avoid IKTs; real-world IKTs interact with income taxes, and the former may generate more deadweight costs because they are more concentrated.  Birchenall and Koch (2014) use a mechanism-design framework to look at the two types of taxes simultaneously, and conclude that IKTs may reduce overall efficiency by raising the marginal deadweight cost of income taxes.  This paper does not contribute to the money-versus-IKT debate, and just assumes that in-kind taxation reacts not only to the efficiency considerations noted above, but also to social or political preferences to regulate prices paid to suppliers.  

Section II begins with this paper’s conceptual point of departure: a model of avoidance behavior as a Tullock-style rent-seeking contest.  A simple, but critical, result is that the social  costs of avoidance are convex in the amount of avoidance.  Section III lays out the other dimensions of IKT policies, relates them to empirical observations of military recruitment schemes, and interprets them in an equilibrium context.  Section IV overturns some of the conclusions from the literature.  Section V looks at policy options for the mix of social costs, and suggests that comparative advantage distortions may not be the primary social cost of IKTs.  Section V concludes with some ideas of why the incidence and design of IKT tax policies vary over time, by country, and across policy domains.

Business Experience Is No Cure-All in Government

Because government and business are fundamentally different in their financing and their evaluation, good business practices can make for poor governing.

The election cycle regularly brings forth successful businesspeople who argue that voters should select them for public office over seasoned politicians because of the skills and experience they acquired in the business sector. In 1996, billionaire Ross Perot started his own political party to advance his quest for the presidency of the United States. Financier Mitt Romney was the Republican nominee in 2012. And now Carly Fiorina and Donald Trump are vying with politicians for the 2016 nomination, arguing, as the New York Post put it, that “America is in desperate need of a suave, successful businessperson like Trump — or former HP CEO Carly Fiorina — to solve what ails our economy.”

In their natural habitat, business leaders work with investors, customers and employees to create value. Each of their relationships is typically voluntary in that no investor is forced to provide funds, no customer is forced to purchase the product, and no employee is forced to work rather than pursuing some other opportunity.

The financing of government is unique in that the government can, and primarily does, force people and organizations to provide resources – these are taxes and takings. As a result, those at risk of taxes or takings change their behavior in order to reduce their exposure. A family may work less, in part because of the income tax burden that comes with working more. A business may cease to operate, or operate on a deliberately limited scale, in part because of the sales tax or regulatory burdens it faces while in operation.

Tax and regulatory avoidance behaviors are known in the economics profession as “excess burdens” because the burdens of taxes and regulations exceed the amount of resources that the government is acquiring. The family that pays $10,000 per year in taxes of course loses the $10,000, but it also has lost something in the adjustments it made – maybe working less – in order to avoid paying even more tax than the $10,000 it already pays. It makes tax-avoiding adjustments because it does not voluntarily pay taxes; rather, it pays them to prevent punishment, and it is perfectly legal to pursue less heavily taxed activities.

Some of the lost tax dollars might be recovered if the government spends it wisely – something like the dividend an investor would receive if he invested funds in a wisely managed business. But the losses due to tax-avoiding adjustments are irrecoverable and have no analogue in business, because unlike taxpayers, investors, employees and customers are voluntary contributors. As a result, a government leader ought to be less ambitious with his or her project ideas than a businessperson should, because government projects have their excess burdens.

The employer-employee relationship is also different in the public sector than it is in the business sector. Public-sector employees are five times more likely to be unionized than private-sector employees are. Moreover, the ultimate government employers are the elected officials, who of course cannot persist in their roles without being re-elected. As a result, a number of government employees are “asked” to participate in political activities that support their boss’s continued tenure.

Although past governing success is no guarantee of future performance in office, the next great president will likely have more experience in public office than business triumphs.

Just Compensation for Jurors

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“Jury service is a serious, meaningful and important responsibility,” says Cook County Court in Illinois and many other courts in the United States. Yet the courts pay jurors far less than minimum wage. In Cook County, jurors are paid $17.20 a day; working eight hours at the state’s minimum wage would pay almost quadruple that.

Employers are sometimes forced by state law to pay jurors while they serve the court, but that is no help for the self-employed, students and people without jobs.

Jurors are selected randomly from state-compiled lists of residents and forced to participate unless excused by the court for specific circumstances, such as a medical condition that prevents service. People who do not report for duty can be punished at to the court’s discretion, including jail time.

With random selection, low pay, medical excuses and the potential for severe punishment, a jury summons has a lot in common with a Vietnam-era draft notice, although, of course, the skill and activities associated with the service itself is far different for jurors than for Vietnam soldiers.

Many people summoned for jury duty search desperately for excuses. Their efforts increase the burden on the court system, which has to summon and process a large number of people in order to empanel its juries.

The court system might alleviate these problems by following the example of the modern military: recruit people for service by paying them far more than minimum wage. Jurors could still be selected randomly, but with a nice paycheck waiting for them, they would not try as hard (or at all) to be excused by the court.

Critics of a market-oriented recruitment system might say the pool of jurors would not fully represent the population because, among other things, people getting high pay in their normal jobs would be less willing to serve on a jury because of the loss of pay. But let’s not pretend that the conscripted jurors we have today are a random sample of the population.

If jurors were paid at a generous hourly rate, might they deliberate longer? And would that be a good thing or not? If it were desirable to shorten juror deliberation time, jurors could be paid a flat rate for that part of their service.

The Fifth Amendment to the United States Constitution prohibits the taking of private property “for public use, without just compensation.” Did the founding fathers really think that it was much worse to take property without just compensation than to take a citizen’s time?

Taking property and drafting citizens into government service without market compensation have many of the same economic problems: they fail to spread the burden of supporting government activity, they encourage socially wasteful avoidance behaviors, and enforcement runs the risk of special treatment for the politically connected.

The modern military pays soldiers with both appreciation and money. Jurors should be paid that way, too.

Do Economic Ideas Matter? The Case of the All-Volunteer Army

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It is easy to exaggerate the importance of economic ideas in shaping public policy. The United States’ move to an all-volunteer army is a good example.

Public policies change over time, as with the emergence of the income tax early in the 20th century, deregulation of airlines and banking and the recruiting methods of the military. In each instance, economists and other intellectuals offer arguments and research results that help inform the policy change.

But intellectuals often press for policy changes that never happen, and I suspect that a number of interesting and helpful policy proposals are hardly researched or discussed because they are deemed “politically infeasible.” So it’s possible that – for reasons related to new costs, technologies and so on – policies would change even if intellectuals said nothing about their ideas and policy research results. Or that scholars’ ideas are sometimes only a minor force among many that drive public policy changes.

Military conscription is a case in point. Economists were studying the topic in the 1960s. At that time, the United States military had long recruited much of its manpower through conscription, forcing able young men to join or inducing them to “volunteer” to avoid being forced into service.

Economists tended to appreciate an alternative approach: recruiting the entire military through the market mechanism, offering soldiers enough pay and benefits that they willingly give up civilian activities in order to join. But it seemed unlikely that politicians would come around to their thinking, which is why most economists spent their time researching other subjects (the economist Gary Becker wrote an article about how he abandoned his study).

But the late Prof. Walter Oi and a handful of others (some of the work has been collected in “Conscription“) plowed ahead. Professor Oi showed how the Defense Department budget and work-force efficiency would be different if the government eliminated the draft and recruited its personnel on a voluntary basis.

Less than a decade later, the United States did in fact eliminate the draft. It seems, as the economists David Henderson and Steve Landsburg put it, that young men of today should thank Professor Oi and the few other economists whose work helped end military conscription in the United States.

But regardless of what economists were saying, I suspect that the military and the politicians who direct them would have changed the policy anyway, because the costs and benefits of the draft were changing, in large part because of technological progress. By the 21st century, the United States was fighting with more capital intensity and less labor intensity than it ever had.

Both economic theory and evidence on the costs and benefits of conscription suggest that the size of the force is a primary determinant of whether a country uses the draft to recruit any of its military personnel, whatever the state of intellectual debate on the issue.

Compare 1971 (during the Vietnam War), when the armed forces totaled about one-sixth of the male population 15 to 24 years old, with 2003 (a time of wars in Iraq and Afghanistan), when armed forces were only one-fifteenth of the male population that age and an even lesser share of the total population (because by then large numbers of women were serving in a wide range of military occupations). Prof. Andrei Shleifer and I found that the change in United States policy between 1971 and 2003 lines up well with international country patterns of military recruitment, suggesting that costs and benefits may have been behind the policy change, rather than economic research.

(This is not to say that conscription ever makes sense, only that its net costs are less when the fraction of men to be recruited are greater.)

Economists may hope that their ideas matter. Perhaps ideas help accelerate policy changes that would eventually occur because of the costs and benefits, or help prevent nations from slipping back into old policy mistakes. (I suspect that another of Professor Oi’s important ideas – that full-time work can be more efficient than part-time work – will be policy-relevant in the coming years as the Affordable Care Act distorts hiring toward part-time positions.)

Nevertheless, economics ironically predicts that actual costs and benefits probably drive more policy changes than economic ideas do.

Survey Respondents: Mercenaries of Slaves?

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Economic data is valuable, which is why survey respondents should be paid for their efforts.

Several members of Congress have proposed to eliminate the American Community Survey (a survey of households with special attention to geography and housing), or at least change how the survey is conducted, because it is too intrusive. In particular, the American Community Survey mandates that, with little or no compensation, randomly selected individuals assist the Census Bureau in their data collection by answering a number of questions about how they live.

Economists and business people have recently spoken out on the significant value of the American Community Survey data for their research. The economists Emi Nakamura, Jon Steinsson and Nicolas Vincent explained how the Census Bureau data “provide researchers and the public with a trove of information on everything from the size of families’ mortgage payments in Boise, Idaho, to the nation’s median annual income.”

I agree that economic survey data are valuable, and have used them many times in my own research. But in documenting the value of those data, economists have so far failed to address legislator concerns about survey burdens.

The survey for households consists of 30 pages of forms and instructions. The Census Bureau estimates that the survey takes an average of 38 minutes for each household to complete (including time for reading instructions), which is a total of 1.31 million hours per year for the 2.06 million survey participants in 2010.

But a few economists insist that the survey burdens are absolutely necessary: “Making census-type surveys voluntary … can actually increase costs because the sample size would need to be increased to offset biased response rates.” Processing data from a voluntary collection scheme, they believe, would be too difficult and would take away from some of the value provided by those surveys.

This episode reminds me of debates about military manpower during the Vietnam War. Before 1973, our government would require randomly selected individuals – draftees with low draft lottery numbers – to assist the Department of Defense by acquiring military skills and joining troops in the battlefield. President Nixon appointed the Gates Commission in 1969 to consider whether military manpower could instead be acquired in a normal labor market – that is, on an all-volunteer basis.

At first, military leaders were opposed to an all-volunteer system, referring to volunteers as “mercenaries” and insisting that an all-volunteer system would be less effective. (Gary S. Becker also tells the story that his paper “The Case Against the Draft” was rejected by the Air Force-supported Rand Corporation because Air Force leaders were convinced that the draft was beneficial.)

It was also believed that a draft is cheaper because it allows the military to recruit manpower without paying market wages. But as Milton Friedman persuasively explained to fellow members of the Gates Commission, the cost of the military is not limited to the Department of Defense payroll but also includes the burdens imposed on those drafted and their families. By paying market wages, the all-volunteer system helps shifts some of that burden from the families with unlucky draft numbers to taxpayers generally.

For the same reason, I don’t believe that the randomly chosen American Community Survey respondents should be asked to bear the burden of the survey collection. Rather, taxpayers should bear it by compensating survey respondents for their voluntary participation.

Although the official survey budget does not include an “expenditure” for the time of survey participants, survey participants’ time amounts to a social cost of about $54 million per year (valuing hours answering survey questions at the national average labor compensation per hour of about $41.50).

As the University of Chicago economist Tomas Philipson’s research suggests, using incentive-based compensation for survey participants — similar to that used in many other labor markets — could make government data not only more plentiful but also of better quality, compared to compelling people and businesses to take part at no pay.

Economic data would be of better quality if supplied, as Milton Friedman put it, by mercenaries rather than by slaves.