Tuesday, April 30, 2019

Highway Funding Part II: The Work of Flawed Economics

If people knew what ridiculous economic thinking goes into an idea such as the miles-based highway tax, and the congestion fee that comes with it, they would think economists have gone crazy. They're right. 

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In the first part of my blog series on highway funding I explained how a miles-based tax on all vehicles in America would
  • necessitate the use of a privacy-violating GPS in every car, 
  • give government access to every detail about our driving, and
  • be combined with an economically destructive congestion fee.
The last point is often overlooked, even by critics of congestion pricing. Here is what I said about it in my first article:
Suppose we apply the congestion fee to the morning rush hours of 7-9AM. In response, some commuters go to work at 6AM instead of 8AM, others at 10AM and a few even at noon. However, here is where things get tricky for the congestion-fee proponents. When people change their behavior, the revenue collected changes as well: if too many people move their commutes out of, say, the 7-9AM window in order to avoid the fee, revenue declines again. Since the revenue was supposed to help out with highway maintenance, government now falls short in its funding. Keep in mind that the volume of traffic has not changed - only its allocation in time.
Here, miles-tax proponents will point to pilot studies showing that some people will use mass transit instead. That's fine so long as we are only talking about pilot studies with very smal samples of individuals. Consider what will happen to mass transit systems once we apply this tax to everyone; as soon as people realize how hopelessly under-capacity mass transit is, especially in the wake of the surge in demand that those pilot studies allegedly indicate, they will run back to their cars and once again crowd the highways.
At times, of course, when the congestion fee does not apply.
Now faced with the conundrum of a largely unchanged traffic volume and far too little congestion fee revenue, government will obviously adapt the fee to when people are driving. After all, that is precisely what theory says government should do. If too many people move their commute from 8AM to 10AM to avoid the congestion fee, the fee will simply kick in for the 10AM commute instead. If too many commuters move their commutes back to 8AM, the fee again applies at that hour.
As people move their commute around to find a time when the congestion fee does not apply, things start unraveling for employers trying to maintain functioning office hours. With some workers coming in at 6AM and leaving at 2, others rolling in at noon while staying to 8PM, scheduling meetings between coworkers becomes a real chore. Just try to predict when you can get hold of someone at the IRS, call your insurance agent or schedule a plumber.
Then imagine if people change their commutes every day in order to try to dodge the congestion fee as it applies from one day to the next.
Absurd? Sure, but not the consequences. As I will explain in Part 2, these repercussions of the miles-based tax and its congestion-fee component are perfectly logical, even expectable under the theory that economists use to advocate this tax. 
Now: why would anybody suggest a tax that would have these obviously ridiculous effects? There are two reasons, the first being that people cannot move their commutes as congestion-tax proponents believe. For precisely the reasons I point to, businesses do not want to have a disorganized day where people come and go depending on whether or not they can afford a congestion fee on their way to and from work. Such a disorganized work day is disruptive to business-client relations, as well as to the efficiency of the business itself.

There are, plainly, good reasons why most people have a nine-to-five style work schedule.

Since people for the most part are not free to move their commutes around, they will simply have to put up with the tax. Some will try to reallocate their travel to mass transit and others might car pool. They will do so, however, out of sheer necessity because their private budgets do not allow them to bear the burden of a congestion tax. 

Overall, though, people will put up with the tax, pay it - and government gets a predictable revenue stream.

Let us also note that because of the understandable rigidity in many people's work schedule, a congestion fee that is sold as an instrument to reallocate traffic in time, is really nothing more than a method for government to permanently collect more tax revenue. It is, in other words, a regular tax on drivers disguised as an instrument to use economic incentives to ease congestion.

As we get to the second reason why a lot of supposedly educated people - including economists - propose this type of tax, let us first return to the point we made about people rearranging their commutes out of necessity. The underlying theory behind this congestion fee is a slice out of standard microeconomics; known as "welfare theory" or "optimization theory", it is based on the erstwhile idea that all prices on all markets ought to be so-called auction prices. I have criticized this theory before, most recently in a conference paper from 2017, simply because it is one of the most unrealistic, detached-from-reality theories alive today in the social sciences.

The gist of the theory - which is also somewhat loosely known as Walrasian price theory - is that people have perfect foresight, they can adjust their behavior instantaneously to changes in prices, and every decision to make such changes is a rational, optimal and for the individual utility-maximizing decision. To work in practice, this theory requires all of us to have full control over all the cost items and schedules in our lives, so that we can make changes to those costs and schedules whenever one price is changed.

This means, e.g., that when the price of our commute goes up, we can make all the necessary changes that are optimal for us; we can make them now; and we will be better off than if we had made any other choice. Every such alteration of our lives in response to a congestion tax is rational, perfectly informed and aimed to maximize our utility.

Yes, this is actually the meaning of the economic theory behind the miles-based tax and its congestion fee. Does it seem unrealistic? That is because it is unrealistic. Its core was developed in the 19th century and was never meant to be used for practical policy solutions (a fact that many microeconomists are merrily unaware of). As my example with rearranging office hours demonstrated, there are structures in place in our economy that prevent people from acting as this Walrasian theory prescribes.

The economist defending the use of this theory will then claim that the rigid office-hour structure is an imperfection in the economy. If only people would give up the office-hour model for doing business, we would all be so much better off. Our economy would be optimized.

From a real-world perspective, none of this is true, of course, and the reason is simple: structures, habits and contracts between people - such as an employment contract stipulating a 9-5 work schedule - fill a useful purpose. They make life predictable. We have a good idea of what we will be doing, when and why. We have a reasonably good idea of what money we will be making, and what our cost of living looks like. 

Contracts, structures, institutions and habits remove uncertainty from life. 

Of course we change our habits and we change our behavior, our habits and our contracts. But we do so in response to needs, wants or necessities as we see them, and our responses are then based on how we prefer to respond. With a congestion fee and a miles-based tax on our driving, government wants to force us to change our behavior in ways that government - not we - want to do it. When we cannot make any changes, such as in response to a congestion fee, then government forces us to alter our private finances to accommodate the fee.

Just like with any other tax.

Even when people do make changes in response to a congestion fee, such as take mass transit instead of driving to work, they do not do it because it makes their lives better. It is not a decision to maximize utility. It is a decision out of simple economic necessity. If it involves longer commutes and more time traveling from door to door (as mass transit often does) then the lost time and increased inconvenience is a price we have to pay for government imposing a new tax on us.

The only point where the theory behind the congestion fee is correct, is in that people will indeed respond economically to the tax. But to use the fact that people reduce spending to cope with a higher tax, or alter their commutes to avoid it, as an indication that the tax is working as intended, is to elevate a trivial observation of human behavior to a scientific fact.

In other words, the economic theory behind the miles-based tax and its congestion-fee appendix is a theory that is unrealistic in its postulates about reality and bound to have consequences that range from the unforeseen to the directly counter-productive. When we add the privacy invasions that come with this proposed tax, it becomes incomprehensible how a libertarian such as Adrian Moore of the Reason Foundation can support it.

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