Monday, December 28, 2009

Safety nets and whatnot

Over on Felix Salmon's blog, I made the following comment:

I think this is exactly right. If you want people to take more risks, you can either:

A. Increase the benefits they get from successful outcomes (which I view as the generally Republican view, such as reducing capital gains taxes or inheritance taxes)

B. Decrease the costs they bear from unsuccessful outcomes

C. Increase the probability of a successful outcome

I think all of these are plausible goals, but in my eyes if you want me to walk a tightrope, making the wire more stable and adding a safety net is going to jack up the probability much more than adding some gold to the pot on the other side.

As Greg Mankiw or Charlie Munger would say, incentives matter.  But there are often a variety of (changes in) incentives that would induce the same (changes in) behavior.  I left at least one alternative out:
D.  You can make the existing situation (e.g., current job, retirement system) more risky

In any event, it's easy to find examples of people arguing that bigger payoffs encourage more risk-taking.  Some interesting quotes from a 2002 article that does it (not sure why the Hawaii Reporter was the first google result, but who cares?):
President George W. Bush renewed his call for permanent repeal of the estate tax on March 19. "It is unfair, patently unfair, for any entrepreneur ... to develop her own business and have that business taxed twice as she tries to leave her assets to whomever she chooses," Bush told a Women's Entrepreneurship Summit in Washington, D.C. "We must make the repeal of the death tax permanent. I call upon Congress to do this immediately."
 "I do not believe the role of government is to create wealth," the president told last Tuesday's group at the Ronald Reagan Building and International Trade Center. "The role of government is to create an environment that encourages risk taking, an environment that facilitates the flow of capital, and an environment in which people can realize their dreams. ... And that's exactly what I intend to do as the President."

So why is it that I see so much push towards increasing payoffs to investment, but relatively little on enhancing the safety nets for failed outcomes?  I mean, it's understandable to think about the successes, but we can't ignore the "risk" in "risk-taking".  If we truly want to encourage people to take more risks, with the belief that risk-taking promotes economic growth, shouldn't we be using a full mix of incentives?  In other words, why so much "Incentive A" from above, but so little "Incentives B & C"?  Especially since, in my personal view, the likelihood that my future huge estate will be taxed upon my death is an infinitely minor reason for me not to strike out on my own.

One thing I find interesting is that "Incentive D" is in accord with Greg Mankiw's argument for negative real interest rates - make the status quo less desirable to push people into more investment.

Also, as I noted on Felix's blog, I recently saw Man On Wire, which I thought was fantastic.  Hat tip to Tyler Cowen for that.

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