The 3 Ways Money is Spent

Posted: December 15, 2011 in Economics, Finances, Freedom
Tags: , , , ,

During my study of Austrian Economics, it has become very clear how government spending is bad economics. However, when I engaged in conversation with someone on the issue, it has always been difficult to have them understand the rational behind the school when they have not themselves studied the work of the Austrian school. This all changed the other day when I found a simple way that is easy for everyone to understand.

To really understand why taxes are bad, I believe it is important to understand how money is spent. I was listening to a CD about freedom called ‘Freedom Isn’t Free‘, in which Bob McEwan (6 term member of the US congress) was giving a speech. Based on everything I’ve read and heard, I’m going to share that information along with some of my own thoughts.

When you spend your own money on your behalf, you care about two things; the price and the quality. Nobody can make that decision for you as good as you can. Let’s take the example of bananas. When you stand looking at the bananas in the market, you look at the price and make a judgement on how long they are going to last. You also consider if perhaps you will have the nephews and nieces over this weekend because they might go bad.  Not only are you considering the price (you are probably buying them here because this store has cheaper bananas, or it’s cheaper than spending gas to drive further for them) but also the quality. You want to buy the banana’s that will bring you the most satisfaction – like not going bad before they are eaten.

It’s also important to remember here the subjective value theory. It basically says that people value things in different ways, and it is impossible for an exchange to be equal between two persons. For an exchange to be made, person A who has item X must value item Y possessed by person B more than he values item X. On top of this, person B must value item X more than item Y. If A & B gave the same value to the items, there would be no exchange as at least one of them was not gaining anything. In the example above, the buyer of the bananas values those particular bananas more than the money he would be spending.

So when you spend the money on yourself, you spend it at its peak value and, again, no one can spend it like you can. You decide whether you need the shoes, the clothes, etc. This is 1st party spending; something for you, using your money.

Now let’s look at someone spending money on your behalf, or when you buy something for someone else. This is 2nd party spending

When you spend money on someone else, you care about the price. You are paying for it, and you don’t want the money wasted. You will however be much more flexible on the quality. Let’s say you are shopping for a sweater for your girlfriend. You see one that is red and say “oh… I’m sure she will like it.” But you might not have bought it for yourself. You are much more flexible on quality when it’s for someone else, although generally you do still care about it.

Think about the subjective-value concept here.  You would value this sweater in terms of the satisfaction you will get from giving it to your girlfriend, and how much you think she will like you for it. She would value the sweater on the use she would get out of it, and how good she believes it will look on her. It is impossible to know exactly how she would value it, so we can’t put the same value on it as her. Thinking in monetary terms, let us say the sweater is priced at $20. You may have been willing to spend up to $30 for it on your value scale, while your girlfriend, based on her values, would have only spent $25. Or maybe you made a better choice than you thought and she values it at $35. Either way, your values are different and we can’t know the exact value someone else will place on something. Maybe she valued it $10 and you made a bad choice!

Now let’s take a look at 3rd party spending.

Let’s say every time you show up late for work at your office, you have to put $5 in a jar. Now, at the end of the month, there is $150 in the jar, and the boss says “hey, you’re going out for lunch, why don’t you use the money raised, buy something and we will raffle it off at the end of the day.” So you go out for lunch and need to spend the money before you get back to work. Let’s say it’s Easter time and you see a 6 foot stuffed bunny sitting in a window with a price tag of $149 taxes included. You think that’s cute, buy it, wrap it up and stick it in the closet until the end of the day. That time comes, and the boss comes out and says “30 people were late this month, which makes $150 so lets put everyone’s name in a jar and see who wins!”  Laurie’s name comes up, unwraps the bunny and thinks it’s really cute. Everyone laughs and goes home.

Another example is what occurred where I work. Whenever someone swore, the cursor put 25 cents in a jar. That money would end up going to office stuff, such as a can of coffee for the coffee machine. But there are some people in the office who don’t like coffee and wouldn’t buy that if it were up to them.

This is 3rd party spending. This is when you buy something not for you, and with someone else’s money. In this case you care neither for the price, nor the quality. Sure, you might care a little as people will see what it’s spent on, and might not appreciate it if you spent it on Boston Bruins gear in an office in Montreal, but there is much more leeway.

Looking at this again from the subjective-value theory, it is quite clear that most people would have been unlikely to spend $150 of their own money on a bunny, when there are many other possibilities, like a water cooler, or a Blu-ray player, or maybe a day at the spa. In the coffee example – instead of spending it on coffee, although the choice is good for some people, the one who doesn’t like coffee would almost certainly have chosen almost anything else with the same price if given the choice.

People are not getting the peak value for the money. The main point is this. By definition, all government spending is 3rd party spending. They care neither about price, nor about quality. It is taxpayer money, not their own. They are not usually spending it for themselves (and if they are it is stealing!), but for certain special interest groups in society.

One can argue that certain things need to be done by government because it can’t be done by anyone else (On most issues I would argue against that, but not all), but that doesn’t change the fact that 1st party spending is always better than 3rd party spending.

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