What do the following things have in common: education, rapid antigen tests, public transport, childcare, and vaccines? They are all things people regularly argue should be free, paid for by the government. With the Greens Party already promising free TAFE and university, we can expect more things to be added to this list as the federal election gets closer.
But making these things free raises some awkward questions. Does it make sense to provide free things to rich people? Could that money be better used elsewhere? What if people were going to buy that thing anyway, does it still make sense to make it free? Can we call something "free" if you end up paying for it through higher taxes or reduced purchasing power via inflation? Is "free" sustainable? Luckily, economics gives us some ideas for how to tackle this thorny issue.
The first is to acknowledge government resources are finite. More government spending in one area means less in another area unless the government is willing to raise taxes or go into deficit.
Raising new taxes has costs: forgone spending, saving, investment or employment that would have taken place had it not been for that new tax - what economists call "the deadweight loss of taxation". Clever taxes minimise these distortions, but they are hard to avoid completely.
Deficits have their own challenges. If inflation is already high (which it is), additional government spending threatens to push prices, and interest rates, even higher. This leads to the perverse outcome where governments give money with one hand while inflation and higher interest rates take it away with the other.
If investors get nervous about Australia's stock of debt, they will charge higher interest rates still. If they stop buying government debt altogether, the central bank needs to buy it instead. This throws more inflation on the fire, hurts confidence and investment, and eventually leads to a currency crisis as investors refuse to lend and trade with Australia in our currency.
The finite nature of government resources means we need to be selective in how the government spends money. So, what should be free? Three criteria help us decide.
First, the government should only make something free if that thing has positive spillovers for the rest of society. It makes little sense for the government to buy me a Ferrari. But there are lots of things that do provide broader benefits to society. Education, healthcare, the elimination of poverty, vaccinations, and rapid antigen tests are all examples. The consumption of these goods benefits both the consumer, and the rest of us. So, should they be free? Not necessarily. This is where the next two criteria come in.
The government should only make something free (or cheaper) if it delivers something that wouldn't have happened anyway. If people were willing and able to buy something, then it makes little sense for the government to get involved.
This is when problems emerge. Most people, after all, would vaccinate themselves regardless of whether the government made vaccines cheaper or free. Rich people are likely to purchase healthcare without any help from the government. And although education has positive spillovers for society, it also has big private benefits to individuals meaning that lots of people would go to university and get apprenticeships without help from the government.
Governments should only intervene when there is a market failure. This is particularly the case for the supply of public goods like national defence - things that anyone can consume without preventing others from doing the same thing. Private individuals have no incentive to supply these goods on their own. Things like defence, infrastructure, and a social safety net won't be supplied without government help. But if something will happen without government help - like rich people sending their kids to university - it makes little sense for governments to get involved. Government money that doesn't change behaviour is government money that is better used elsewhere.
The third criterion is that government involvement needs to be efficient. Most things in life are subject to diminishing returns. Your first university degree is more valuable than your 10th. The government should help people consume things like education, healthcare, and RATs up until the point that the social benefit of that consumption equals the cost. Beyond that, additional spending is not sensible. Making things free will probably lead to over-consumption which, again, means scarce government resources could be better spent elsewhere.
What does all this mean when we think about the cash-splash of election commitments and budget promises over the next few weeks? A few principles stand out.
First, rich people can pay for themselves. Not only do rich people have the capacity to support themselves, they are also less influenced by subsidies that make things cheaper. Government supports should be heavily means tested and targeted to those who need support and those who will change their behaviour because it.
Second, if people will buy something on their own, let them. The government should only intervene if it delivers something better. If people were going to educate and vaccinate themselves anyway, it makes little sense for the government to retrospectively pay them back. If you can't think of better ways to use scarce government resources, you're not trying hard enough.
Third, if it makes sense for something to be free, then make it genuinely free. If inflation is high, giving more money to households is a double-edged sword: government spending stokes inflation which erodes the value of household incomes. Similarly, if people need to pay higher taxes to pay for the money the government gave them, they are no better off. Ensuring the tax system is progressive (where how much tax you pay depends positively on your income) is important. Avoiding handouts when inflation is high is even more important.
Finally, just because something has a public benefit doesn't mean it should be free. It will likely vary between people. RATs will need to be free for some, discounted for others, and should be full priced for the rest. If we can't tell them apart, we need better better government systems. Defaulting to making things free might be simple, but it rarely stacks up against the evidence.
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