Freedom, Fairness, and the Transitional Gains Trap

During the many years I have written about liberty, among the most common criticisms I’ve encountered has been that freedom, including a free market, is unfair.

That conclusion always struck me as backward. How is a system fundamentally based on self-ownership and voluntary arrangements unfair? It certainly meets the traditional definition of justice, which is “to give each his own.” Besides, the alternatives unfairly violate self-ownership and individuals’ power to make voluntary arrangements.

How does a system that is fair get tarred as unfair? Gordon Tullock offered an important reason four decades ago, one that also explains why government is seldom able to end even obviously inefficient and unfair programs designed to benefit particular groups at the expense of virtually everyone else. He argued that a “transitional gains trap” undermines the fairness of undoing things that shouldn’t be done in the first place, leaving no fair way out.

Tullock’s main illustration involved taxi “medallions,” or permits. It remains a good illustration, in that current melees about Uber largely originate in his trap. Here’s how it works.

First, suppose only a limited number of medallions were issued. If demand for taxi services then rose, taxi earnings would rise at the expense of taxi riders. That, in turn, would trigger increased competition for the medallions, which would make higher earnings possible. Medallion prices would rise to capitalize the higher expected future earnings. But that price rise would benefit the owners of taxi medallions, not taxi drivers. After financing the inflated cost of acquiring medallions, drivers do not earn abnormally high incomes.

However, the fact that taxi medallions change hands over time makes it impossible to achieve fairness by simply undoing the initial unfair policy.

Whenever Bob sells his taxi medallion to Jim, Bob gets a price that capitalizes the future expected gains from its ownership. Jim, however, earns only a normal rate of return on his investment in the medallion. So if government wakes up and notices that all riders are harmed by the medallion system, how can it unwind the program fairly? It can’t.

Bob keeps his gain, which cannot be undone after the fact. But easing restrictions will punish Jim, who never gained from the program. That gives Jim a valid argument that eliminating the program is unfair. Therefore, easing an unfair-to-riders policy is not fair; it is unfair to medallion owners like Jim. And that unfairness, along with Jim’s political opposition to the harm that will be imposed on him, can trap citizens in restrictive and harmful programs, even when they become recognized as mistakes. There is no fair way out.

The same analysis applies to various government agricultural supports. Those subsidies are capitalized into farmland prices, making the landowners the beneficiaries, not farmers. Consequently, once this land has changed hands, undoing the crop supports would unfairly punish a different group than those who benefitted from the subsidies.

Similarly, special tax treatment for home ownership (e.g., the deductibility of state property taxes, even though they supposedly finance government services to owners) gets capitalized into home prices. Therefore, once such homes have changed hands, undoing or reducing the benefit would harm current owners, who did not benefit from the tax breaks, without changing the windfalls that went to homeowners when the policies were enacted.

A similar analysis applies to entitlement programs such as Social Security and Medicare, which face unfunded liabilities dwarfing the official national debt. At Social Security’s inception, and every time the program was expanded (including when Medicare was added in 1965), those closer to retirement age got benefits far exceeding their “contributions.” That bonus necessarily imposed an extra tab on later generations. Then, as time passed, many net beneficiaries died. Further, retirees argue that reducing what they were promised and are now counting on, would be unfair, especially in view of their limited earning potential. What is left? Unfairness to future generations. But attempts to address that problem are drowned out by unfairness claims made by senior groups, which have created the third rail of American politics, leaving us with a massive and growing pot of IOUs.

The many extraordinarily expensive transitional gains traps that politicians have created are a major reason why reforms that aim for fairness are stymied for being supposedly “unfair.” They aren’t. But once government policy has created restrictions that enable what H. L. Mencken called an “advance auction of stolen goods,” what is left are net losses, impossible to equitably apportion. That’s ultimately why attempting to undo government-created unfairness by reclaiming a bit of freedom is called unfair, even though it is solely abusive government action that can make it so. And until we overcome the false attribution of unfairness’s paternity to freedom, rather than to government, Tullock’s depressing traps are destined to persist and proliferate.

Gary M. Galles is a Research Fellow at the Independent Institute, Professor of Economics at Pepperdine University, and Adjunct Scholar at the Ludwig von Mises Institute.
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