Monday, December 06, 2010

The 'broken window fallacy' of federal extensions of unemployment

The federal government is debating how to pay for the planned extension of unemployment benefits. While there is much talk in the news about 'whether or not to do it,' the real question is how to pay for it, as it appears many Republicans are very likely to support it if they can make cuts elsewhere to cover the millions of dollars it will cost.

So you're probably wondering where a broken window fits into all of this. Before we get there, it's important to understand how unemployment insurance works in the first place - as that is critical to the discussion.

In Ohio, employers are charged/mandated by the state to pay into a fund a specific amount based upon what they pay their employees. Being 'insurance,' there are actuarial tables and estimates, etc... to determine the rates. The state bases their rates on projections of how many people will be unemployed and for how long. Because they administer the program, the state then processes requests for the insurance payouts based upon an unemployed individual's earnings and length of time employed and pays out for up to 26 weeks.

This expense on behalf of the state is covered by what employers have paid.

The federal government, on the other hand, has no specific income to cover what they have been paying out over and above what the states have given. The federal government has been paying for up to 53 more weeks of unemployment under their Emergency Unemployment Compensation (EUC) program. That's a total of 99 weeks.

But that's not all. Ohio also has an Extended Benefits program which paid out another 20 weeks for people who'd still not found a job after 99 weeks. That program was, according to, 100% funded by the federal government.

So where did the federal government get the money to pay 73 weeks of unemployment to everyone in the country who didn't have a job? That's a good question, considering that the federal government is, essentially, broke. Obviously, they borrowed to come up with the money - which means that we (and our children and grandchildren) are paying the price of today's giveaways.

Of course, the 'logic' in Washington is that this handout is really 'economic development.' Just last week, House Speaker Nancy Pelosi said (again), that unemployment compensation creates jobs.

"It injects demand into the economy, it creates jobs to help reduce the deficit," Pelosi said.

At least she's being consistent in her error as back in October she claimed that food stamps and unemployment insurance will grow the economy and help end the recession.

And here is where the broken window fallacy becomes so relevant. The broken window concept is part of an essay, "That Which is Seen, and That Which is Not Seen," written by Frederic Bastiat in 1850. Lew Rockwell Jr., chairman of the Ludwig von Mises Institute, summarized Bastiat this way:

A kid throws a rock at a window and breaks it, and everyone standing around regrets the unfortunate state of affairs. But then up walks a man who purports to be wise and all knowing. He points out that this is not a bad thing after all. The man fixing the window will get money for doing so. This will then be spent on a new suit, and the tailor too will get money. The tailor will spend money on other items, and the circle of rising prosperity will expand without end.

What's wrong with this scenario? As Bastiat put it, "It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented."

You can see the absurdity of the position of the wise commentator when you take it to absurd extremes. If the broken window really produces wealth, why not break all windows up and down the whole city block? Indeed, why not break doors and walls? Why not tear down all houses so that they can be rebuilt? Why not bomb whole cities so construction firms can get busy rebuilding?

It is not a good thing to destroy wealth. Bastiat puts it this way: "Society loses the value of things which are uselessly destroyed."
So for every dollar the federal government takes from working people to give to non-working people, that is a dollar that is not spent in the economy.

Even if you believe that working people should have their money taken from them and given to those who don't work, you cannot believe that the economy will be better off, since you're not creating any NEW spending - just changing WHO is doing the spending.

And the expense is actually LESS because government has taken a percentage off the top to cover its costs of taking and re-distributing.

Politicians are trying to tie the unemployment extension to ending the expiring tax cuts for the 'rich.' First of all, the claim that those tax cuts 'cost' the federal government is a fallacy in and of itself.

The federal government has nothing that it hasn't first taken from someone. I find it incredulous that federal politicians think it 'hurts' the government to not have these funds but don't care one bit about how it may hurt the person from whom they're taking the funds.

And lest you begin to believe the class warfare distortion, the vast majority of the 'rich' that are impacted by the current proposals are small business owners whose loss of those funds, especially in this economy, will definitely hurt the individual owner and their ability to hire and expand - or even stay open.

Even if you support the idea of the government taking more from some people than others, you cannot escape the logic that it will not improve the economy to move the money from one spender (the current owner of the money - the 'rich') to another (the end recipient - the unemployed).

Is it true that people who are unemployed with spend whatever the government gives to them? Yes. That is true. It is, as Bastiat explained, what is seen.

But it is also true that the people who've had the money taken from them, in order for the government to give out unemployment compensation, will NOT spend. They won't be purchasing items they wanted, so there is no new demand. This is what Bastiat explains is unseen.

The back and forth in Washington over the issue is political posturing. But the basic economics of the idea are irrefutable - and just common sense. You cannot improve the economy by taking from one person, deducting your percentage and then giving to another - nor can you expect that more goods will be produced, more demand will be generated and the economy will grow by taking such action because you've eliminated a corresponding action from the person who had their money taken from them in the first place.

So if the logic is faulty why are they employing it? Because if they tell the truth the American people won't support it.

While it's a declining percentage, a slim majority still pay the bills for everyone else and too many of that majority are hurting themselves. Individuals who've lost jobs and have taken a new one at less pay don't want to foot the bill for those still not working. And they shouldn't have to. Many do choose to help by giving to food banks and other charities, or by helping to support a family member. But that is a choice - not something being forced upon them through penalty of law as taxation is.

So the politicians will twist the words and present fallacies hoping we, the American public, will either be so greedy as to not care who isn't getting money so we can have some - or that we won't be knowledgeable enough to know the truth.

And then they'll come back to us in two or four or six years and tell us how grateful we should be for what *they* did for us. Logic will be trumped by emotion - and the economy, and our own individual situations, won't be any the better for it.

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