Can the Private Sector Support What the Public Sector Claims To?

This is the first part in a three-part series.  It raises an issue that I have been thinking about for over three years, and I have finally nailed down some sources and drawn the whole argument together.  I will issue the next two parts over the course of the week.

 

The Problem

With the pending election there has been a resurgence of discussion about privatizing certain industries, e.g. health care, education, etc.  Further, the Democratic Convention suggests that the Democratic party is the party that cares about a shared responsibility for the collective mankind, establishing a suggested radical individualism present among Republican.  More simply put, the Democrats are often portrayed as the party that cares about the poor, while the Republicans are the party that cares only about themselves.  Paul Ryan has maintained that he is fiscally conservative in part because he does care about the poor.  His prudential judgement has led him to believe that the best way to help the poor is through fiscal monetary policies.

However, when the proposal to privatize any government service arises, alongside we find a familiar, and seemingly difficult to overcome, argument.  Just as an example, let’s take education.  Were we to privatize our education system completely, would that not leave several individuals in a position of not being able to afford tuition.  There are, after all, people in tax brackets that pay less in education taxes than it costs for the government to educate their children, just as there are those who pay more in education taxes than the cost of education.  This is the point of taxes for social services: a redistribution of wealth.  It is misunderstood that those who would defend a privatized system are selfishly attached to “my money” and somehow prioritize the individual over the community.  This is a red herring, though; the discussion is not about the priority of the individual or the community, but rather about the best way to serve the community, through tax dollars or private charitable giving.  Those who cannot afford tuition would be helped in the same way that many are now helped who cannot afford other necessities: through freely offered private charitable giving.  Typically, the next objection is that this is overly optimistic about human generosity.  In other words, the amount of freely offered charity will not be able to sustain the need, and hence compulsory giving, i.e. taxes, is necessary.  My aim is to defend that in most cases a privatized system will out-give compulsory giving  via taxation and that freely offered charity enjoys philosophical and theological advantages over dollars extracted through a tax system.

 

The Numbers

My thesis is that private funds will be able to account for the drop in funding by eliminating the taxes that current fund the social service.  To see this, we need to discuss two economic realities.

The first is the efficiency with which the government, and by contrast the private sector, provides social services.  Robert Woodson (1989), in Breaking the Poverty Cycle: Private Sector Alternatives to the Welfare State, has calculated that, on average, 70% of the funds collected through taxes dedicated to social services goes not to the social service itself, but instead to administrative bureaucracy.  This means that for every dollar collected by the government, only 30 cents actually goes towards the service.  Michael Tanner corroborates this 70/30 split through several regional studies in The End of Welfare (1998).  In contrast to this, the same administrative/service split in the private sector is reversed.  Only one-third of privately collected monies goes towards administrative services, and two-third goes towards the actual cause.  According to Edwards (“The Cost of Public Income Redistribution, 2007), 70 percent of newer charities, as rated by Charity Navigator, spend at least 75% of their budgets on the programs and services they exist to provide.  90% spend at least 65%, and the median among all charities in the sample was 90.7%.

The reason for this is basic competition.  Private sector charities are under strong pressure to operate efficiently because donors want to know that a large percentage of their gifts go to support the appointed cause.  Programs that operate inefficiently will cease to attract donors and eventually cease to exist.  True, there are some very unethical charities out there that take advantage of donors’ money, but over time and with adequate exposure, competition solves this problem.  In contrast, government lacks the motivation experienced by private charitable organizations to operate at efficient levels.  There is an ironic turn of events in this: according to Edwards,

“Those operating at levels of inefficiency comparable to the average government agency are often prosecuted – by the government (which never applies the same standards or threat to its own agencies – for fraud.  Pressure on private charities to avoid such prosecution, and the bad publicity and loss of public trust resulting, is strong.”

The contrasting levels of efficiency between the public and private sectors means that the government has to raise over twice as much money in taxes as the private sector would have to raise in donations in order to provide the same service (assuming the private sector operates at a 70% efficiency level).  In other words, if a social service costs 21 million dollars, the government would have to extract 70 million dollars in taxes in order to cover the cost.  The private sector would have to raise only 30 million dollars.  This assumes a generous 70/30 split in the private sector.  As stated earlier, the median is closer to a 90/10 split, and in this case the private sector would only have to raise 23.3 million dollars, only a third what the government requires.

The second economic reality is what is known as “crowding out.”  The idea is that, as the government collects tax money and budgets it towards a social cause, private donors become less likely to donate their own funds.  In other words, the government support “crowds out” private donations.  Arthur Brooks in “Is There a Dark Side to Government Support for Nonprofits?” (2000) lists four reasons why crowding out occurs.  The most obvious is that a cause that already receives funding from a third source (government or otherwise) is unlikely to appear as “in need” and therefore unlikely to attract additions donations.  Second, “subsidies to non-profit firms may make them appear to private donors ‘non-mainstream’ and, hence, in need of non-market support.”  Third, private donors often want to know they have some control over the organization they choose to support.  Finally, since government support is taxed-based, it decreases the amount of disposable income that private donors can direct towards charitable causes.  (This last effect is compounded by the relative inefficiency with which government social programs operates.)

Crowd out rates are measured as percentages of a dollar that are “crowded out” for every government dollar added.  For instance, a 70% crowd out rate means that for every tax dollar the government collects for a cause, the private donations are reduced by 70 cents.  “Total crowd out” is a dollar-for-dollar exchange, so for every dollar injected by the federal government, exactly one dollar of private donations is eliminated.  Anything less is considered “partial crowd out.”

The literature that measures crowd out rates falls generally into three categories: real world data, theoretical models, and theoretical controlled experiments.  Unfortunately, crowd out rates based on real world data are across the board.  Brooks summarizes some of the studies which quote real world rates anywhere from 1.8% to 66%.

The theoretical models depend in part on the assumptions made about givers.  In one model, charity is determined exclusively by the need of a particular cause, in which case crowd out rates are total (dollar-for-dollar).  The idea is that a cause only needs a finite amount of money and people are willing to pay to see that finite amount met.  If the government steps in and meets part of the requirement, the private donors, sensing the need has been decreased, will decrease their donations dollar for dollar.  If the government decreases their support, private donations step back in and pick up the slack, again dollar-for-dollar.  The crowd out rate in such cases is 100%.  Other models suggest that people give not simply to satisfy a social need, but also for personal satisfaction, a “warm glow” effect.  James Andreoni is a leading expert in this area, and his models predict a minimum of 71.5% crowd out rate (“An Experimental Test of the Public-Goods Crowding-Out Hypothesis,” 1993).  A third model attempts to consider the effect of giving competition.  The idea is that donors are more likely to give at a particular level based on what their peers are giving.  In this case, Alan Krause (“On the Crowding-Out Effects of Tax-Financed Charitable Contributions by the Government,” 2011) predicts that crowding out may be attenuated by such competition, but the situation is highly unstable.  If even a single person has some motivation to drop their giving, others will follow suit in the face of government subsidies and crowding out rate approaches total.

The third category in the literature is controlled theoretical experiments.  Generally this falls into the mathematical area of Game Theory.  Andreoni is again an expert in this field, and his experiments have corroborated his theoretical rates, in one case 71.5% and in another up to 84%.  Another experiment (“An Experimental test of the crowding out hypothesis,” C. Eckel, et. al., 2003) attempted to separate groups into those who knew that third party funds were coming from tax dollars (“no fiscal illusion”) and those who were unaware of the source of the new funds (“fiscal illusion”).  In the case of fiscal illusion, the authors found no evidence of crowding out, but in the case where donors were aware that tax dollars were subsidizing the cause, crowding was almost total.

In the face of these three categories of results, we are forced to ask: which ones are “better”.  In other words, if were are going after actual crowd out rates, would it not make sense to trust those that are data driven?  No, says Andreoni.  The problem with the data-driven results is that they are incapable of separating out a vast range of influences.  In other words, it is nearly impossible to have a “control” in the real economic world.  For instance, “it is impossible to know whether the incomplete crowding-out found [in the literature] is the result of certain institutional features not captured by the model, or whether it is due to individual preferences that are different than those assumed in public-goods models.”  The purpose of the laboratory experiments is to provide such a control.  Keep in mind that the laboratory experiments are not entirely mathematical – they involve real people making real decisions.  It is also telling that the lab experiments are consistent with the theoretical models developed elsewhere in the literature.

All told, the present author is comfortable in making the assumption that average crowd out rates are at least at the 60% level, that is, for every dollar injected by the government into a social cause, 60 cents is taken out in private donations.  Given the theoretical models and the laboratory experiments, which typically come in around 70%, I feel that this is a generous assumption for my purposes.

_____________________________
Part II can be found here.
Part III can be found here.

14 Responses to Can the Private Sector Support What the Public Sector Claims To?

  • Mike Petrik says:

    Excellent post, Jake. One of the best I’ve read in a long time. I am somewhat surprised to find myself in agreement, though not with high confidence. One factor to take into account is the chilling effect that free rider concerns are sure to have on those who consider responsibility for the poor to be a societal one rather than an individual one. These folks, mostly liberals as revealed in Brooks’ research, will resent that some contribute to this social responsibility but not all, and therefore will rationalize a comfort in not giving. In other words the funds paid by liberals as taxes for the needy, once eliminated, will largely stay with those liberals. That said, I don’t think that fact necessarily defeats your hypothesis.

  • bill bannon says:

    Jake,
    You’ll need to factor in as you go: less free will giving by most families were medicaid to be gradually phased out. Medicaid covers 60% of elderly in nursing homes. I saw a media spot which showed a lady who went though all her $300,000 in assets in five years in a nursing home after which Medicaid kicked in to pay $50,000 a year for her since she had gone from middleclass to poverty via the nursing home experience and thus qualified for Medicaid despite working and saving her whole life. Were children of the elderly to be responsible for $50,000 to $70,000 a year for a disabled parent, such children then would not be donating to charities throughout their lifetimes to the extent that they would either be saving much more for the future personally or they would be
    funding long term health insurance for their parents and themselves. Celibates in the world laity would also be obliged for their future to save much more since they have no children to pay for their nursing home…should they need one.
    Catholic old age homes are a private charity of sorts but 60% of their income comes from medicaid. Medicaid’s budget in 2010 was $401 billion dollars.
    The Vatican is thought to have one billion in investments. Were the Vatican to give it all to the things Medicaid covers, it would be a pittance. Catholics at the parish level gave $60 million to
    Haiti after the quake. That is minuscule compared to the Medicaid budget.
    Rupert Murdoch’s billionaire group are pledged to charity giving which again is a fraction of the Medicaid budget which covers by the way 37% of births in US hospitals…in some cases, unjustly so…but the Bishops will be noticing than as Medicaid gets withdrawn from the lower economic classes, abortion will be more likely because it’s cheaper than what Medicaid now pays.
    Withdrawal of the safety net means the middleclass will have to save much more for their own old age or for their parents and that will reduce the urge to give charity.
    Proceed with your paradigm but include the attendant new money pressures on anyone who is not a millionaire because old age can quickly make savings in the hundreds of thousands vanish if illness attends old age and one needs a skilled nursing home for ongoing nursing care. I suspect a minority need it but since no one knows their future, all will have to financially prepare for it.

  • Elaine Krewer says:

    “You’ll need to factor in as you go: less free will giving by most families were medicaid to be gradually phased out”

    That is a significant concern for many older people. Under federal law (the Deficit Reduction Act of 2005), once a long term care resident applies for Medicaid, all their financial transactions for the previous 5 years are subject to scrutiny. Any money given to another person or entity during this “look back” period without receiving something of equal value in return is deemed a “transfer of assets”. Asset transfers that are not exempt under one’s state law MAY incur a penalty period — meaning, you are deemed ineligible for Medicaid for a period equal to the amount of time you could have paid for your own care with the transferred assets. If you’re already broke and in the nursing home when you apply for Medicaid and you get hit with a penalty, this means you either have to move out temporarily, or the nursing home has to go unpaid for a period of time, or you have to go through the process of getting a hardship waiver (meaning more bureaucratic hoops and delay).

    Now, most states do have provisions for exempting charitable gifts and routine gifts to family and friends for Christmas or other special occasions. However, if one’s financial records are not in order, or your state’s law doesn’t have a specific exemption for charitable/family gifts, or the caseworker processing your application is extremely strict, a person COULD end up being penalized for having made large charitable or family gifts during the look back period.

    The DRA rules are based on an assumption that seniors should be saving as much money as they can to pay for their own long term care and not leaving it on the taxpayers. I understand that, and wealthy people shouldn’t be able to dump six- or seven-figure assets on their heirs, plead poverty and get on Medicaid. At the same time, seniors who want to be generous to their community, church, or family shouldn’t have to live in fear of being left out in the cold if they get sick and end up in a nursing home. Consultation with a knowledgeable elder law attorney is essential.

  • “The DRA rules are based on an assumption that seniors should be saving as much money as they can to pay for their own long term care and not leaving it on the taxpayers.”

    That is a truly fantasy assumption. Most people heading to the nursing home have virtually nothing to their name other than social security and their house. People who do have the ability to pay their nursing home bills frequently engage in strenuous efforts to transfer their property prior to entering the nursing home in order to have the taxpayer pick up the tab. (There are ways to legally accomplish this if done long enough prior to entering the nursing home.) If one wishes to retain an optimistic view of human nature, this is not an area of law to have much exposure to. Unfortunately the vast majority of people save little for a rainy day, especially for their old age, and when it does rain the first reaction is to look to the taxpayer to pick up the tab.

  • bill bannon says:

    Elaine,
    Just so your readers know….Medicaid is a Federal-State partnership for which the Ryan budget
    would cut the Federal part by $800 billion over ten years starting immediately if he were able to get it passed. The states then would have more say but would have to come up with more money or reduce coverage but within court ordered mandates that forbid certain cuts. On our property tax statement and perhaps on yours, it will show how much your property taxes were reduced by state funding of same. That funding would decrease as states pick up the medicaid funding cut from the Fed. That means…property taxes would “levitate” if I might give it a mystical term….another pressure on non millionaires that would militate against charity donations…along with proposed elimination of the deduction for mortgage interest. Would federal tax decreases cover the new state exactions? We can only pray to St. Matthew…the patron saint of tax collectors.

  • Jake Tawney says:

    As I proceed through this reflection, it is critical to note that I am not presenting a recipe for how to transition from a State where public funds are used to fund social causes, be they wealth redistribution programs or health care programs, to a State where such causes are funded through private charitable giving. Such a transition is way beyond my pay grade, to quote our illustrious leader. I am presenting evidence that merely favors the existence of charity State over a welfare State. Most of the arguments above, particularly those about Medicaid, have, I think, more to do with the transition than the possible existence. In that sense, they are quite valid. What would various members of society do if they were suddenly put in the position of having to fund large expenses that were previously funded by tax redistribution? This is an important question, but not the one I seek to answer in this series of posts.

    The question I seek to answer is whether or not a charity State is possible. In that light, the objections about the dissolution of Medecaid are not relevant. By this I mean no disrespect to the commentators – merely to clarify the question I am addressing. The argument is that medical expense, like other living expenses, can in fact be funded through purely private means. (Again, transition issues aside.) On the surface, there is nothing special about health care funding compared with other social industries … except …

    The one thing that makes health care funding a bit different is the way the government to some degree controls the prices. It seems, then, that the crowd out/efficiency arguments won’t work. In fact, I seems to recall reading some studies that suggest that government health care is actually more efficient. Yet even this is an illusion. The government does not control how much medical expenses cost, only how much people charge for them. In this way, the government is guilty of currency manipulation (subtly). In the end, this effects the economy and will eventually expose the inefficiency for what it is. Remember, every time the government spends money it is a tax, whether that tax dollar is collected directly or not.

  • Art Deco says:

    People who do have the ability to pay their nursing home bills frequently engage in strenuous efforts to transfer their property prior to entering the nursing home in order to have the taxpayer pick up the tab. (There are ways to legally accomplish this if done long enough prior to entering the nursing home.) If one wishes to retain an optimistic view of human nature, this is not an area of law to have much exposure to. Unfortunately the vast majority of people save little for a rainy day, especially for their old age, and when it does rain the first reaction is to look to the taxpayer to pick up the tab.

    At the rates prevailing in my home town, a pre-mortem stay in a nursing home of mean duration (about 11 months) will set you back about $95,000. Having that amount in liquid assets lying about likely is fairly atypical. Here in New York, liquidating a first residence is not necessary as long as the spouse resides therein.

    They would actually have to anticipate their entry into a nursing home by a minimum of five years in New York and have a set of trusted relations with which to park assets. One, the other, or both are commonly absent. Also, nursing homes commonly want proof from a private-pay patient that they have the means to pay one year’s worth of charges. Most admitted to nursing homes do no last that long. Social Security, pensions, and income from testamentary trusts must be applied unless there is a surviving spouse. Also, comprehensively dumping your assets on proximate relations precludes the use of institutions short of nursing homes, such as supervised apartment buildings and assisted living centers unless you have ample retirement income.

    People do not commonly save for disasters, and the necessity of making use of long term care is in fact a disaster. They make use of insurance. The trouble is, the purchase of long term care insurance has not been a cultural habit, it is expensive, and a surprisingly large share of the population are deemed uninsurable risks under current underwriting standards. There is a reason that two-thirds of the charges for long-term care in this country are met by public expenditure.

  • “At the rates prevailing in my home town, a pre-mortem stay in a nursing home of mean duration (about 11 months) will set you back about $95,000. ”

    About half that in my part of Central Illinois.

    “They would actually have to anticipate their entry into a nursing home by a minimum of five years in New York and have a set of trusted relations with which to park assets. One, the other, or both are commonly absent.”

    In my county Art, homes or farm land is normally what is protected, and the transfers usually occur eight to six years prior to the entry into the nursing home, assuming they live long enough to be a nursing home patient.

    “Also, nursing homes commonly want proof from a private-pay patient that they have the means to pay one year’s worth of charges.”

    No such requirement exists with nursing homes in my locale.

    “Also, comprehensively dumping your assets on proximate relations precludes the use of institutions short of nursing homes, such as supervised apartment buildings and assisted living centers unless you have ample retirement income.”

    That assumes the relatives will not use the transferred assets for the benfit of the individual who transferred the asset. I find that is normally not the case here where there is usually a parent child relationship. A bigger problem is an asset becoming involved in a child’s divorce or bankruptcy.

    “People do not commonly save for disasters,”

    Many people do not save for anything at all. In regard to nursing home care you have the same problem as you do in regard to wills and powers of attorney. Thinking about it causes people to consider their own mortality, and many people simply do not wish to do so and so avoid even the simplest of planning until an emergency arises, such as a stroke or a heart attack.

  • Art Deco says:

    By the way, by ‘rates prevailing’, I mean Medicaid re-imbursement rates. For private pay, add about 25%.

    Here in New York, if you have transferred assets at any time in the previous 60 months, you had best not apply for Medicaid. The period of time during which the state will refuse to re-imburse the nursing home is calculated on the basis of the quantum of assets transferred in the previous 60 months. The people with whom you parked the assets will have to liquidate them until the clock is up. In some states (New York is not one), children of nursing home residents have legal obligations and can be the subject to lawsuits by the state or nursing home operators. The way the rules are structured, it requires a goldilocks set of conditions for the wealthy to avoid paying six figure sums of money toward their care.

    About families, I can tell you a couple of stories, one about a good family and one about a hopelessly messy one.

    I should mention that the case of successful and lawful asset dumping of which I am personally familiar involved a very ordinary couple who transferred ownership of their house to their only child. Their daughter was employed as a secretary in my office. It is not just the wealthy who do this.

  • Art Deco says:

    When I say ‘people do not commonly save for disasters’, I am not referring to their prudence but to the means they can reasonably employ to prepare for certain contingencies. Very few people can save to pay for cancer treatments, which is why alternate means such as risk pooling (insurance) are utile. The thing is, a private market for long term care insurance can provide workable solutions for many individual households, but not for the society as a whole.

  • Elaine Krewer says:

    “the case of successful and lawful asset dumping of which I am personally familiar involved a very ordinary couple who transferred ownership of their house to their only child.”

    The federal DRA specifically permits this kind of transfer if the child lived in the home giving care to one or both parents that can demonstrably be shown to have prevented or delayed the parent(s) entry into a nursing home for at least 2 years. I don’t know whether the woman you refer to did this, but if she did, I wouldn’t call it “asset dumping”; I would call it fair recompense for doing everything she could to keep her parents from becoming public charges as long as possible.

  • Elaine Krewer says:

    Maybe to get back on topic, we need to consider a broader question than just Medicaid planning for seniors. The question is: if the public sector stopped providing assistance to persons in need and left it to the private sector, would charitable giving increase, or would it decrease because most people of modest or lesser means would have to be more preoccupied with saving money to take care of themselves?

  • Jake Tawney says:

    Elaine,

    I am happy to see this get back on topic. This was the very question I seek to ask, and I would direct folks to not only read this, but the follow up piece as well. The evidence is actually fairly clear. When you piece together crowd-out rates and efficiency ratings, most causes can be taken care of by private charitable giving. We can discuss until we’re blue in the face whether or not we *think* this may or may not happen, but the actual research in the field suggests strongly that it will. *Why* is another question altogether. And I made the point in a previous comment that the transition would not be an easy thing. But on the theoretical level, the case for private giving is quite clear. Keep in mind, when we talk about these things, one cannot look at an individual case and generalize. It is clear that average Joe, who will now potentially be responsible for this or that cause, may not have the funds to do it. On the other hand, there will be those that experience a lot more dollars in pocket due to lower taxes, and the numbers suggest that they will give more generously because of this. History is full of several examples. I would point more modernly to the Christo Rey schools as an example for where education can be provided for out of private giving. The social organizations of the early 1900′s (Knights of Columbus being one of them) where doing a fine job of providing all sorts of insurance and aide to those financially in need.

    Again, it may be difficult to imagine that this or that cause could be funded if government gets out of the picture, but this is exactly the issue I am addressing in this and the following post. This first post only raises the question and defines some terms. The second one actually makes the mathematical argument.

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