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.
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.
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.