Aggregation Provides Little Useful Knowledge

How Economic Aggregation Hides the Problems of Interventionism
by Gary Galles

I was going through the textbook for my economics principles course recently, thinking about how I could better reconcile the fact that since only individuals choose, the logic of economics is about individual choices facing the fact of scarcity. Yet macroeconomics is generally presented directly in terms of aggregates and how to control them, as if aggregates were the relevant measures.

The Limits of Macroeconomics

Perhaps in over-reaction to the paltry discussion such issues received in my undergraduate and graduate training, I spend a substantial amount of class time on the limitations of macroeconomic aggregates. For instance, I emphasize that not a single macroeconomic variable measures what we would like to know accurately. This is why we often evaluate more than one imperfect measure to see if the “story” they tell is consistent. We do this to estimate how much confidence can be placed in a particular “fact” (like what the official unemployment rate or a measure of inflation-adjusted output did over a given period). This is why I feel the need to drive home problems aggregation can cause more clearly to my students.

With that in my head, I read the textbook’s introduction to “net taxes.” It struck me how “looking behind the curtain” at that category illustrate how aggregation can hide information and distort important conclusions.

“Net taxes” equals taxes paid to the government minus transfer payments from the government to recipients, for the household sector as a whole. It is a useful category for looking at the net effect of government programs on the disposable income of the sector as a whole. But it can paper over massive amounts of income redistribution and substantial supply-side effects on productive incentives.

Say that the government taxes one subset of the population $3 trillion, and provides $2 trillion in transfer payments (food stamps, unemployment insurance, Social Security, etc.) to another subset. The net effect on households’ aggregate disposable income is a reduction of $1 trillion. But to consider only that net number in an analysis is to ignore very important considerations.
What’s Behind The Big Numbers?

Most obviously, the net number ignores what can be vastly different treatment of different households. And that is crucial to any moral or ethical evaluation of the effects. That is particularly true when we want to know the extent to which government offers “liberty and justice for all,” as we say in the Pledge of Allegiance — that is, how much it honors individuals’ self-ownership and their derivative rights to their own production. A state that steals from Peter to pay Paul on a massive scale violates our inalienable rights in ourselves, but aggregating the effects into “net taxes” hides those effects from view.

The adverse supply-side effects that such policies have also disappear from view when we overlook the redistribution. The reason is that when we “tax the rich and give to the poor,” we reduce both parties’ productive incentives. The higher tax rates faced by higher income earners reduces the fraction of the value they produce for others that they take home, so they shelter more and earn less income. That is, they do less for others with the resources at their disposal than they otherwise would have.

Less noticed is that the aid given to the poor is also conditional on them staying poor. For instance, people lose 30 cents in food stamps for each dollar of earnings counted by the program. They, too, therefore keep a smaller fraction of what their efforts produce for others, and will also produce less for others than they would otherwise.

Hiding redistribution — and the extent to which it reduces jointly-beneficial production by focusing on “net taxes” — is not the only way in which aggregation distorts. For example, it is notable that those who back policies such as higher minimum or “living” wages because they will “help the poor,” primarily argue for it because they assert lower income earners, as a group, will have greater incomes.

Now, there are a host of issues involved in deciding whether that is true, but a focus on that question ignores that there will be a substantial number of lower skill workers who will lose their jobs and/or hours worked, fringe benefits, on-the-job training that builds future income potential, etc. They will be worse off. And arguing that the group in the aggregate might have higher incomes, which only means one subset’s increased earnings will be at least somewhat greater than another subset’s decreased earnings, in no way justifies harming large numbers of that group who are also poor, in the name of helping the poor.

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