In its technical paper justifying the awards, the Nobel Committee points out a major problem with using taxes to fund government programs: taxation distorts. The term economists use is “deadweight loss,” a loss that is not offset by a gain to anyone. Economists have estimated that raising $1 in taxes doesn’t cost society only $1; it costs somewhere between $1.17 and $1.56. The extra 17 to 56 cents is deadweight loss. The committee notes that by auctioning off major electromagnetic assets, the federal government avoided having to tax as much.
This isn’t to say that the ideal auction is one that maximizes government revenue. One way to maximize auction revenue is for the FCC to act like a monopolist and hold spectrum off the market. But what matters most is that spectrum gets into the hands of the most-productive users. As former FCC chief economist Thomas Hazlett, now at Clemson University, and his co-author Roberto E. Muñoz of the Universidad Técnica Federico Santa María have pointed out, the gains from efficient allocation swamp the gains in government revenue. The 2017 wireless spectrum auction, for example, redirected spectrum from broadcast television to cellphone companies. If you’re reading this on a cellphone, you can thank Messrs. Milgrom and Wilson.
This is from David R. Henderson, “Thank These Nobel Laureates for Your Cellphone,” Wall Street Journal, October 12, 2020 (October 13 print edition.)
Under my contract, I’m allowed to quote 2 paragraphs from my article. I’ll post the whole thing in 30 days.
By the way, as an economist friend pointed out on Facebook, I was one of the few to note the potential conflict of interest in Milgrom both helping design the auction and consulting to a company that bid in the auction. I responded that I wouldn’t be a good card-carrying economist if I hadn’t noted that. Economics is all about incentives. As I wrote in “Hooked on Economics,” Chapter 2 of The Joy of Freedom: An Economist’s Odyssey, I noted in all my reading of economics while a math major and then in all of my reading post-Bachelor of Science and pre-UCLA graduate school that the unifying theme was incentives.
Here’s the article on “Auctions” in David R. Henderson, ed., The Concise Encyclopedia of Economics.
HT to Alex Tabarrok and Lynne Kiesling for giving a quick read to my draft before I sent it to the Wall Street Journal. Also to my wife, Rena Henderson, for a quick edit. All of them turned it around in less than 25 minutes. Also thanks to Tom Hazlett for checking the paragraph on his findings. He did so while waiting to board a flight.
READER COMMENTS
James
Oct 13 2020 at 3:00pm
Some years back I saw articles opposing spectrum auctions and in favor of letting the spectrum be subject to homesteading. In theory, whoever had the most valuable use for the spectrum would commit the most resources to homestead frequencies.
Is there any principled objection to this besides the lack of government control and revenue?
David Henderson
Oct 13 2020 at 3:27pm
It’s a good question. I’m on deadline with something else today but I’ll plan to answer this in the next 48 hours.
nobody.really
Oct 13 2020 at 4:31pm
Standard caveat: “Deadweight losses” are measured relative to a world with government services (such as enforcement of property rights and contracts), but without taxation. For most purposes, this is a fantasy world. Likewise, most of us walk rather than fly around the house, even if the burdens of walking are “not offset by a gain to anyone”–because most of us live in the real world, not a fantasy.
That doesn’t mean that we should ignore deadweight loss, or the advantages of financing government services in a way that reduces marginal tax rates. An unattainable ideal can still provide a useful benchmark. But the relevant points of comparison are the ATTAINABLE alternatives; the benchmark merely facilitates the comparison.
I merely hope we can avoid certain libertarian stumbling blocks.
Jon Murphy
Oct 13 2020 at 4:57pm
Sort of. Any taxation will result in DWL. That is true whether or not there was taxation before. It may be that the benefits from such taxation will outweigh the losses, but the DWL still exist.
So, if there are multiple ways of achieving a goal, and one causes distortions (taxation) and the other does not (auction), and the desire is to generate as much net benefit as possible, one should prefer the non-distortionary action to the distortionary action. That is irrespective of whether or not other distortions exist.
nobody.really
Oct 13 2020 at 7:00pm
Thank you, Murphy; that was the point I was trying to make: Taxation may result in “deadweight loss,” yet still be an optimal strategy–because we pick our strategies from among real-world options, not among fantasy options.
robc
Oct 14 2020 at 9:47am
But there is a real world option without deadweight loss — the Single Land Tax.
Any time anyone chooses a tax with deadweight loss over it, they need to explain why. And I haven’t heard a good* excuse yet.
*One I hear (Krugman, for example) is that you just can’t raise the amount of money in tax revenue that we do today with the SLT, it would max out at about 1/3 of total US tax revenue at all levels. I consider this a good argument IN FAVOR OF the SLT, not a good one in opposition.
Stéphane Couvreur
Oct 13 2020 at 6:27pm
Hi,
You might mention that auctions are only the second best solution, much better than the “beauty contest” method to allocate the spectrum, but not as good as good old property rights.
Why? Because government sells the right to broadcast with many strings attached, thus stifling innovation or taxing it. Not to mention that there still is a deadweight loss, since the price paid for the licenses far exceeds the policing costs of enforcing them. I think Thomas Hazlett would agree. I guess Coase considered this second best solution only because he knew that the first best was not on the table.
What really happened in the 2017 reverse auction is that the US government bought back frequencies whose license prohibited wireless internet and resold the same frequencies at a profit allowing for wireless internet. It taxed the right to start an innovative business, there is not other way to put it. It was better than the status quo, when these frequencies were wasted on small audience regional TV channels. But these frequencies had been sterilized for years because of the licensing restrictions. This would not have been the case under a “use-what’s-yours-as-you-wish” property rights regime.
So I am moderately enthusiastic about this year’s Nobel prize…
David Seltzer
Oct 14 2020 at 6:31pm
For many years I traded in open outcry auction markets, as a member, on the CBOE, NYFE and American Stock Exchange. The open outcry system was designed to achieve Walras equilibrium. Hence, no dead weight loss. Competing traders, in open outcry, communicated bids and offers as their positions required. To be successful, a trader would immediately arbitrage fleeting information asymmetries. Allocating spectra this way, would culminate in less dead weight loss and more pareto efficiency.
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