Incentives Matter

I thought it would be useful to make explicit one of the central themes that runs through many of my columns, namely that incentives matter.

This means that the incentives people, institutions, governments, and countries face heavily influence what they will do.

For example, if a person has a health insurance plan in which all or almost all costs are paid by the insurer, and no costs or almost none are paid by the consumer, then the consumer has an incentive to seek additional health care and no incentive to minimize spending. The result: health care spending explodes.

Likewise, if that person has an Health Spending Account, they do have incentives to keep costs down, and the result is lower health care spending.

If the government raises taxes, people have an incentive to work less and shift income to lower taxed areas. If taxes are lowered, the incentive to work increases. The empirical evidence shows this is true.

If consumers reduce their purchases of paper products, such as paper towels, then forestry owners have an incentive to sell their land, currently devoted to growing trees to be harvested and re-seeded for new growth, for other uses such as housing developments, golf courses, or industrial facilities.

So buying less paper products means there will be fewer trees in the world. That is not what the advocates of reducing paper consumption hope for, but since incentives matter, that is what will happen.

All collectivists run into this problem. Try as they might to direct people to act or live as the collectivist desires, people will be influenced by the incentives they face.

So tax-free health insurance leads to exploding health care costs; higher taxes leads to less work and economic growth; and reduced demand for paper leads to fewer trees. None of these outcomes are what the collectivist seeks. But it is what they create.