Five things government does better than you

We know a lot less about how to manage money than we think

Published August 21, 2012 7:57PM (EDT)

This article originally appeared on The American Prospect.

When Wisconsin Congressman Paul Ryan and other hard-line conservatives talk about cutting the government’s budget, their primary rationale is that individuals can make better decisions with their own money than the government can. As Ryan himself said to an audience at Georgetown University, “We put our trust in people, not in government. Our budget incorporates subsidiarity by returning power to individuals, to families and to communities.” It sounds reasonable—of course we want individuals to have power, and of course we want communities to take care of their neediest members. And since conservatives have done a fine job of portraying the government as full of heartless, inept bureaucrats, allowing people to make their own decisions sounds better than the alternative.
The American Prospect
The conservative approach to government stems from a basic tenet of free-market economics: that people always act rationally to maximize their own benefits, and that from this rises a general state of well-being for society as a whole. But this isn’t always true. One of the hottest academic disciplines to arise in the last few decades is behavioral economics, which explores the ways in which people behave irrationally. In addition, easy-predictable problems with certain markets prevent us from achieving the best outcomes. These two facts have consequences for how we should think about government in certain instances. There are many ways in which the government can make better decisions with our money than we can, and there are many ways that the Ryan budget would make society worse off by getting rid of government programs. Here are five.

Retirement Insurance

Since the 1930s, Social Security has protected Americans by providing a cushion against poverty in old age. It taxes workers and employers for every dollar earned and uses that money to pay retired workers based on how much they’ve earned throughout their lives, adjusted for inflation. Ryan’s budget would significantly change Social Security by turning it into private accounts for each American worker, making it operate roughly like a 401(k) retirement plan you’re automatically enrolled in. People would choose how to invest in the private market for their own retirements.

The problem is that, as study after study has shown, people are pretty bad at managing their own retirement savings. Employees routinely invest less in 401(k) accounts than they mean to because, in general, people value money more in the present than they do in the distant future. Even if participation is mandatory, there’s no guarantee that people will invest enough, or choose the right amount of risk. There’s also no way to plan for an economic disaster like the one that hit in 2008, when many private pension plans and 401(k)s lost disastrous amounts of money, and when many suddenly unemployed workers withdrew money from their plans early. Individuals can’t predict what’s going to happen to them in the future, or how accurately how long they’re going to live after retirement. But we are pretty good at planning for what will happen to the population as a whole, which is why a system like Social Security, which pools money collected from everyone and plans for population-level changes, is safer.

Health Care

The same principle that makes Social Security work better than individual retirement accounts—that we don’t know what’s going to happen to us but can reasonably predict outcomes for an entire population—also applies to health care. Not only would a Romney-Ryan administration work to undo the Affordable Care Act; Ryan would turn the perennially popular Medicare system, the government-run health insurance program for the elderly, into a system in which seniors would get vouchers to buy insurance on the private market. Medicaid, the health-insurance program for the poor, would be turned into a state-run system for which the federal government would provide a fixed amount of money.

There are a number of reasons the private market doesn’t work well for health insurance, and they’ve been enumerated many times before. But here’s the heart of it: Even if you buy the idea that people always act rationally, free markets only work efficiently if consumers have the necessary information to make the best choices. But patients know less than doctors; doctors don’t know everything about their patients; and none of us know what accidents might befall us.

In fact, that’s how modern health-insurance programs started. In the 1920s, doctors at Baylor University hospital in Texas found that, without noticing it, people spent more money on cosmetics during the year than they did on medical care—they didn’t squirrel away a few bucks a day in case an unpredictable medical illness befell them, precisely because those things are unpredictable. It worked better for both hospitals and patients if there were systems through which people could pay a little each month to guard against future costs. The plan worked so well that states began copying it in the 1930s, giving birth to the Blue Cross system of nonprofit insurance plans.

But those small plans started to create problems right away. At first, health-care plans were only marketed to people with jobs who seemed likely to stay healthy—this meant that insurance plans could collect reasonable premiums without having to worry about too many big payouts. The problem, of course, is that it leaves the sickest, poorest people without care. In addition, as America became richer during the last half of the last century, many insurance companies shifted to the for-profit model.

Other problems arise in private markets, and they have to do with both rational and irrational behavior on the part of consumers. Private insurance works only if there are some people paying premiums who get lucky and don’t spend as much on health care as they pay so that there’s enough money to cover those unlucky folks who fall off a ladder or wind up with a heart condition. But if you let consumers make their own bets, many will bet that they’ll be one of the lucky people and decide that they don’t want to contribute to a health-insurance plan. This leaves the insurance companies with a pool made up of a larger percentage of sick or risky individuals than they planned for, which will require them to raise their premium rates.

Because insurance companies need to make a profit, they’ll try to keep sick people or people who are likely to get sick, like smokers, out. Doing that kind of screening creates higher administrative costs. Estimates on how big a percentage administrative costs are for total health care spending vary, but the average in our employer-based insurance system is about 12 percent, and in the private market—those poor saps who have to try to buy insurance on their own—it’s as high as 30 percent. This is one of the big reasons that the costs of the government-run programs, Medicare and Medicaid, are rising more slowly than those in the private market—government doesn’t have to worry about maintaining profits, so its overhead is much lower. The figure often side for Medicare’s overhead is 2 percent, but Ezra Klein argues that its probably more fair to say it’s 5 to 6 percent, to count for the tax-collection and other costs incurred outside the Department of Health. This is also why health care costs in the United States have risen so much faster than they have in the rest of the developed world, where universal plans that cover every citizen. It’s also why a system like Ryan’s, where seniors would get money to buy plans in a private market without reform, won’t do anything to slow the rise in health-care costs and ultimately leave many seniors paying for their own care.

All of these problems in health-insurance markets boil down to one thing: information problems. For markets to work well, consumers and sellers need to be able to have all the relevant information readily available to them, and because our health, especially our future health, is such a different good than, say, a croissant, the private market just won’t work as smoothly and efficiently as we would want it to work. Health insurance works best, and is cheapest, when we spread risk out over as many people as possible, which is why every wealthy country but ours has decided to spread risk out over its entire populace. The Affordable Care Act works to get closer to a universal system by requiring companies to offer insurance plans to everyone, setting ground rules for how insurance companies cover medical problems and by requiring every person in America to pay premiums, either with help from the government or on their own.

Addressing Poverty

The conservative argument against government spending on the poor through programs like welfare and food stamps is that it de-incentivizes working, and that help for those who can’t work is best left up to communities and charity. While its important that communities take care of their members, and local resources are important to rely on, there are arguments against relying on charity as a basic social safety net.

People don’t give enough. Americans spent about 1.9 percent of their disposal income on charity in 2011. That was up from the year before but generally down from its high in 2005, when Americans gave 2.4 percent of their disposal income to charity. Charitable giving falls in times of economic hardship, which is also when need rises.

Disaster Relief

Conservative arguments against funding FEMA hold that local communities are better at cleaning up after widespread destruction than the government. After tornadoes tore through southeastern Missouri last May, FEMA was facing a funding shortfall and deficit-obsessed House Republicans, led by Ryan’s physical and ideological twin Eric Cantor, argued that lawmakers would have to cut money elsewhere before raising FEMA’s budget. Russ Carnahan, a Democratic representative from Missouri, responded in a way that nicelysummed up the sentiment after Cantor’s comments when he said, “[T]o have that debate in the face of the suffering we’ve seen in Joplin is just plain wrong.”

The problems with disaster insurance is similar to the problems with health insurance: Only people who think their house might be flooded bother to buy flood insurance, so the insurance companies risk going broke paying out all of their customers every time it floods. In general, the federal government has many more resources at its disposal than states and communities do. Damage from catastrophic events runs in the billions of dollars and devastates local economies, so states not only have to step up their spending to help hurting communities, but take a hit in tax revenues as well. Keeping the federal government in charge of disaster relief spreads risk out over the entire country, and ensures that victims in poor states—basically every state in Tornado Alley—get as much help as residents of wealthier states would.

All the Little Things

While I’ve been focused so far on specific things that the federal government can do better than individuals or the private market, there are a number of tiny things that local governments do to create the world in which you live—building roads, taking out the trash, keeping traffic flowing, and turning street lights on at night. Basically, we can call this “running your community.” Where would your nice duplex be if there was no way to get to it, and your yard was full of trash? Yet the sentiment behind plans like Ryan’s to gut government extends to state and local levels. The biggest experiment in gutting local government came from Colorado Springs in 2010. The previous fall, voters had rejected a plan to raise their own taxes to cover a shortfall in revenues. Local officials then warned that they’d have to end certain services, like neighborhood community centers, park maintenance, and streetlights.

Undeterred, local residents decided to chip in to clean up in local parks, and, ultimately, the city decided to privatize some services. The city started an “adopt a streetlight” program after residents were upset about dangerous, darkened streets. This American Life documented life in the town in the year after the city government drastically cut its services, and shared this story from the local mayor, Jan Martin:

[A] gentleman came up to me and actually thanked me for the adopt a street light program. He had just written a check to the city for $300 to turn all the street lights back on in his neighborhood. And I did remind him that for $200 if he had supported the tax initiative, we could have had not only streetlights, but parks and firemen and swimming pools and community centers. That by combining our resources, we as a community can actually accomplish more than we as individuals.

Robert Smith: And he said?

Jan Martin: He said he would never support a tax increase.

Robert Smith: So for him it wasn't the money. He was willing to pay more to turn on the street lights than to pay for all city services.

Jan Martin: That's right. And it's because of a total lack in trust of local government to spend those services, which was part of [local businessman’s] Steve Bartolin's letter. That prevailing sense that government won't take care of our money, that brings somebody to the conclusion that, I'll take care of mine. You go figure out how to take care of yours, because we don't trust government to do it for us.

That’s why Ryan’s budget shows him to be an ideologue. A smart, tough-minded, politically-brave representative would be more willing to preserve the programs that the government actually does run better than individuals could. An ideologue feeds into the conservative-led narrative that’s been prevalent for the past 30 years —that government is never to be trusted.

By Monica Potts

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Healthcare Reform Paul Ryan Poverty Republican Party The American Prospect