Russ Roberts and The Rat Hole Fallacy

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Dan Crawford
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by Eric Kramer

Russ Roberts and The Rat Hole Fallacy

Liberals believe that unregulated markets do not adequately supply public goods like roads, parks, and scientific research, and that government should use its taxing and spending powers to provide these goods.  Conservatives agree that markets fail to provide ideal quantities of public goods, but they emphasize that government spending is often wasteful and inefficient, and they argue that waste and inefficiency justifies limiting government spending.  Market failure is real a problem, but so is government failure, and nothing is gained by shoveling tax dollars down a rat hole.

The belief that government inefficiency justifies reducing the size of government is one of the most common and influential arguments for limited government.  Here is a version of this argument being made by Russ Roberts in a recent episode of his EconTalk podcast:

I have no problem with government taxing at relatively high rates if I thought they would spend the money well . . . I oppose high tax rates not because of market inefficiencies or slowing of rates of growth. Because I don’t think that government allocates that money well. And I think that argument–again, it’s not much of a winner [politically] –but that’s the right way, I think, to think about those things.

The point Roberts is making is intuitively plausible.  The idea that government waste justifies spending cuts is also emotionally appealing, because people deeply resent the idea that their tax money is misspent by incompetent or corrupt public officials.  Not surprisingly, the belief that government is wasteful reduces public support for government programs.  But the claim that government inefficiency justifies limited government is a fallacy.  We can call it the Rat Hole Fallacy.

To see the problem, let’s focus on road spending.  Suppose that government road building and maintenance is unnecessarily costly.  Perhaps the contracting process is not competitive, or too much is spent on new roads relative to maintenance, or there is a prevailing wage law that raises construction costs, or the government sometimes wastes money on “bridges to nowhere“.

One response to wasteful road spending is simply to argue for reforms that would make spending more efficient.  We could advocate for a more professional and competitive contracting process, for a reallocation of spending to maintenance, against prevailing wage laws, or for reforms to the process by which road building projects are selected.  (Whether paying construction workers a premium over a competitive market wage is wasteful is debatable, but put this aside.)  This type of advocacy is, arguably, the right response to concerns about government inefficiency, but this is not what Roberts does.  Roberts’ response to government waste is (apparently) to support lower taxes.

Now, supporting lower taxes might seem like a second-best response to government waste.  Voters can’t be expected to force government officials to make the road building process more efficient, because they don’t understand how it works.  Public choice theory – the application of economic reasoning to politics – suggests that advocating for reform is pointless, because the existing inefficient road building process is (apparently) a stable political equilibrium.  But even if fixing the nuts and bolts of the road building process is impossible, it may be possible to get voters to insist on lower taxes, or to overturn the existing political equilibrium by voting for lower taxes in a referendum.

Let’s assume that this is what Roberts has in mind.  (I can’t imagine what else he thinks arguing for lower taxes while complaining about government inefficiency in a very nonspecific way can accomplish, other than making his listeners more receptive to tax and spending cuts.)

Suppose Roberts persuades voters to insist on lower taxes, perhaps by supporting a referendum that caps spending on roads.  Is this likely to raise the public welfare?  The answer is, not necessarily.  It could be that spending on roads is already too low, even if it is somewhat wasteful, and that cutting spending will just make this problem worse.

Roberts does not even try to justify his opposition to taxes by showing that current spending is too high.  Instead of trying to answer the relevant questions – Is current spending too high?  Will cutting spending promote the public welfare? – he simply trades on the intuitively plausible idea that government inefficiency justifies lower spending.  In effect, Roberts is substituting a theoretical claim about the optimal level of government spending – that the optimal level of spending is lower if government is more wasteful – for a careful empirical argument that shows that actual spending is too high, given the existing level of wastefulness of government spending.

It is conceivable that this theoretical point about the relationship between waste and the optimal size of government is a useful heuristic for thinking about whether actual spending levels are high or low.  For example, if spending is generally set at levels that would be about right if government were not wasteful, then perhaps the claim that government is wasteful and should be cut down to size is a useful rule of thumb for thinking about the level of spending.  Obviously, to make this argument persuasive, Roberts would have to provide some evidence that spending is generally set at a level that would be sensible if government were not wasteful, and he does not do this.  But it turns out that there is another problem.  The theoretical argument is wrong.  It is simply not true that the optimal level of spending goes down when inefficiency goes up.

To see this, assume that we start with efficient road building, and the cost of road construction then goes up 20% due to increased inefficiency.  This increase in the cost of roads has two effects on the optimal level of spending:  1) fewer roads should be built, because fewer will pass a cost/benefit test when costs are higher, and 2) the cost of roads that are built will be higher.  These effects work in opposite directions, and it is not clear whether optimal spending goes up or down.

So, is Roberts right to claim that government spending is too high in some nonspecific, overall sense?  Maybe.  But that claim can’t be evaluated by pointing to the indisputable fact that government is sometimes wasteful.  The only way to show that government spending is too high (or too low) is to look in detail at actual government spending.  If spending is not actually too high, persuading people to cut taxes can lead to harmful cuts in essential government services.

The claim that tax cuts are justified because government is inefficient is intuitively plausible, emotionally appealing, and wrong.  It should be recognized for what it is, a potentially destructive fallacy that diverts our attention from thinking about the important issues in public finance.