Virtue, Incentive, and Economic Policy

Economics begins, as Rousseau said of political philosophy, by “taking men as they are and laws as they might be” Religion, on the other hand, commands men to “Be perfect, as your heavenly father is perfect” (Mt. 5:48). This creates a tension between the perspectives of the theologian and the economist. Their respective principles can be called, for short, virtue and incentive. These must be reconciled before we can intelligently debate the morality of economic policies like federal welfare.

Both religion and economics are concerned with man’s “goods.” Both recognize a hierarchy of goods which motivates behavior. But economics confines itself to certain temporal goods—exchangeable property—while religion is concerned with temporal goods only so far as their use is ordered to attaining man’s highest good: God.

Catholic social teaching holds that the purpose of private property, the right to which is rooted in man’s very nature, is the moral development of the human person. Property enables every man “to create for himself and for his family an area of true freedom—not only economic, but also political, cultural, and religious freedom.” This freedom is not absolute and may be regulated according to the common good, since social justice requires safeguarding similar rights for everyone. But abuse of moral freedom—lack of virtue—does not diminish the right to private property. Temporal rewards are the same whether people treat them as means for pursuing eternal salvation, or as a final end; but in the latter case, “they have received their [only] reward” (Mt. 6:2).

Economic theory is agnostic about the ultimate validity of a person’s scale of values. It assumes everyone has such a scale: the preferences for goods revealed in economic behavior are among the basic data of economic analysis. But the value scales are assumed to originate beyond the scope of economics, and people’s motives—selfish or altruistic—are simply lumped under the catchall heading of “utility” or “self-interest.” Far from being objectionable, this “agnosticism” for purely economic analysis is necessary to preserve the authority of the (technically informed) theologian to pronounce on the morality of economic policies. Otherwise, economics would fall into utilitarianism, pretending to be a science of final ends instead of means.

However, the order that social scientists find in economic markets (or in any human behavior) is never “value-free.” To understand the relation between markets and social justice it is necessary to avoid several false interpretations of Adam Smith’s “invisible hand”—the famous metaphor describing how each individual is led by self-interest to promote the common good, “an end which was no part of his intention.” Such order cannot arise according to Bernard Mandeville’s principle, “private vices, public benefits;” nor is the market a morally neutral mechanism; nor is it founded on universal altruism, as George Gilder sometimes argues. As St. Augustine explained, any order in human society must result from people acting according to natural law, not violating it; and no matter how much we violate the Golden Rule with respect to others, we expect others to keep it with regard to ourselves: “For what thief will tolerate another thief stealing from him?” So far as it goes, this is right: “When it is said, ‘Thou shalt love they neighbor as thyself,’ it becomes evident that our love for ourselves has not been overlooked.” The three advantages of private property enumerated by St. Thomas Aquinas—productivity, order, and peace—are as important to members of the City of God as they are to members of the Earthly City. Removing self-love, as opposed to inordinate self-love, from one’s motivation would be against natural law and could only reduce any order of social justice that exists: grace builds on nature, it does not destroy it.

However, both faith and reason tell us the correct scale of values: we are commanded to love God about all else and our neighbor as ourselves. Any order that might result from self-love alone is always inferior to the order resulting when people follow the proper scale of values. The main argument for government intervention in markets is the existence of social disorders which economists call “externalities”—costs or benefits of private property which are not fully borne by the owners. Without correction, these result in behavior with harmful “spillover effects” upon others, and insufficient provision of public goods like clean air or equal protection of the laws. Unselfish behavior is by definition sensitive to “externalities,” so it diminishes social disorder and improves the dexterity, as it were, of the “invisible hand.”

In fact, no such thing as a free market—conditions for free exchange of goods—can arise before there is a certain level of respect for the rights of others, whether voluntary or the result of an effective legal system. But the degree of virtue which actually exists is generally a middling one and should not be exaggerated. The German economist Wilhelm Roepke drily observed, “When we speak of ‘service’ to the consumer, we obviously have in mind not St. Elizabeth but the assistant who wipes the windshield of our car at the filling station.”

Given these minimum conditions (and the existing distribution of property), free exchange is the most efficient method of distributing goods according to people’s scales of values. But these values (or the initial distribution of property) may not accord with the objective standards of social justice. If not, there are basically two things to be done about it: either try to change people’s value scales, or else change the consequences of acting according to them: virtue or incentive.

Orthodox Christians are aware that, due to sin, the kingdom of God can never be fully realized within history or identified with any party or program. Salvation is through grace, not the law, which limits the political sphere. But within these limits, St. Thomas Aquinas sums up the twofold nature of public policy in an important sentence: “The human law does not prescribe all the acts of all the virtues, but only those that may be directed toward the common good—either immediately (when some things are done directly for the sake of the common good) or mediately (as when the legislator enacts certain provisions relative to good discipline, through which citizens are educated and accustomed to respect the common good of justice and of peace.” Virtue generally falls, if at all, under the “mediate” influence of the state, working “subsidiarily” through more primary institutions. Economic policy primarily involves “immediate” or direct efforts to affect people’s behavior through incentives and disincentives.

Obviously, virtue is preferable, because it governs internal as well as external acts. But the policymaker is faced with a lack of direct means at his disposal. Leaving aside the role of grace, the most effective ministers even of the moral virtues—which can be acquired by habit and are therefore susceptible to human discipline—are family, church, workplace, school, and other genuine communities which can treat each person as a unique person, recognizing special needs, weaknesses and strengths. A national bureaucracy must be guided by abstract generalities instead of concrete personalities. The national policymaker also usually does not command the most powerful motive for inner conversion: love. The French economist Jacques Rueff observes:

Constraint would be the sole instrument for governing men, if their scales of preference, that is to say their fundamental natures, were strictly unchangeable. It would be a serious error, however, to forget that certain states of love are able profoundly to alter the hierarchy of values in light of which each individual considers the acts he is able to do and chooses those he will perform. Love, in all its forms, love of God, love of country, filial love, is able to substitute for his own scale the one the authority which he reveres commands him to adopt. It is then without constraint, in the ardent desire to obey or to serve, that he does the actions which otherwise would not be the most desirable for him. “If ye are led by the Spirit, ye are no longer under the law” (Gal. 5:18). But for someone led by the Spirit, everything is as if love or faith had really changed his nature, to the point of desiring that which his beloved or his God desires for him.

There are also important differences among direct or “immediate” economic policies. Rueff divided economic policy into two fundamental methods, which he called the liberal and the authoritarian (or socialist). The liberal method is essentially fiscal, employing taxes and subsidies. Rueff called it “liberal” because except for the property acquired by the government, which it spends according to its own scale of values, people may dispose of the rest as they please. The authoritarian method leaves people in possession of all their property, but directs them under penalty to use part of it according to the government’s scale of values. The most common form of the authoritarian method is what we call regulation, but also includes rationing, quotas, price controls, requisitioning and the like.

Viewed in this way, liberalism and socialism are not different programs but different methods of action. The amount of government intervention is a separate question—though toward the extremes of libertarian anarchy (no government) and communism (all property owned by the State) the choice becomes moot. To achieve a given end, the same amount of property must be set aside from private toward common use (e.g., we can have a draft or a volunteer army, but in either case the same manpower must be diverted from private to public service.)

In practice, however, all governments use a combination of both methods, because each is better suited for different ends. Generally speaking, taxation and subsidies are more appropriate for affecting the prices and distribution of physical property. For example, rent subsidies are more efficient than rent controls in increasing the supply of affordable housing. The authoritarian or regulatory method, however, is more appropriate in affecting the “property” people have in their own bodies—their health, safety and personal behavior. For example, setting hours and conditions of work would be unfeasible using taxes and subsidies, short of permitting a kind of voluntary human slavery; this can best be done by regulation.

Having considered the twofold role of public policy concerning virtue and incentive, how can it be applied to the debate over federal welfare? As we have seen, social justice forbids that anyone be completely denied the fruits of property. But this goal of social justice can be accomplished in many ways. Until the Reformation, care of the poor was primarily a function of the Church. (In fact, the Church could be said to have used both the liberal and the authoritarian methods—collecting and distributing tithes, and commanding private charity.) It is probably no accident that the first government poor laws in England were promulgated under Queen Elizabeth I, after the nationalization of Church property. Especially since the industrial revolution, the relief of poverty has been increasingly taken over by the government. This is partly because the industrial revolution changed the nature of poverty—gradually raising the material standard of living of the poor, but also dissolving their traditional social ties and means of support.

In The Idea of Poverty, Gertrude Himmelfarb remarks that since the early 1800s, the often fierce debate over social welfare policy has been more concerned with the moral than the material status of the poor. There have generally been two opposing philosophies. For example, the English New Poor Law, against which Dickens and others raged, ended the fairly recent practice of a guaranteed income or wage and required those who applied for public aid to enter a workhouse. Advocates saw the law as a way of discouraging dependence and integrating those who could remain self-supporting through their labor into the rest of society. Opponents objected that the new law stigmatized those who had to enter the workhouse, thereby cutting off the dependent poor from the rest of society. Many argued for a guaranteed income as a right of the poor.

Very similar arguments are made today in the United States. The current federal welfare system is a complicated array of “categorical” programs—providing various kinds of cash or in-kind (housing, medical care, etc.) benefits according to specific “categories” of need. Generally speaking, two-parent families are not eligible for welfare, but single-parent families are. Charles Murray argues that federal welfare to the able-bodied promotes dependence and should be abolished in order to reinforce self-reliance and preserve the dignity and independence of the working poor. On the other hand, the first draft of the Catholic bishops’ economic pastoral letter rejects the idea that welfare causes dependence and argues for an unconditional minimum guaranteed income as a matter of human dignity.

This debate has a long history among welfare experts. Virtually all accept in theory that a guaranteed income can promote dependence by creating a double disincentive against self-help efforts. First, the ability to receive a higher income without extra labor trends to induce recipients to work less than otherwise. Economists call this the “income effect.” Second, targeting aid to the poorest people means taking away welfare benefits as their total income rises. Between giving up welfare benefits and paying taxes, would-be workers face marginal tax rates—the bite out of an additional dollar of pre-tax income—that typically approach or exceed 100% at around the minimum wage: one loses net income or gains very little by staying off welfare. For example, Arthur Laffer calculated the implicit marginal tax rate for a single-parent family of four in Los Angeles, which availed itself of all federal, state and county cash and in-kind welfare to which it was entitled. Laffer found that the net income gained by increasing gross wages from zero to $19,200 was only $69 per month, or $828 a year. Between wages of $8,400 and $14,400 per year, the family loses $46 per month, or $208 per year. Economists call the response to such relative costs the “price effect.”

Thanks to extensive experiments over the past two decades, there is also surprising agreement about the size of work disincentives from cash assistance. According to Henry Aaron of the Brookings Institution, the tests suggested “that for every $100 provided to male-headed families, earnings would fall $25 to $50,” with larger effects for female-headed families, wives, and young single adults. In other words, each $100 of welfare increased the before-tax income of recipients only $75, $50, or less, because of the tendency to work less. Aaron concludes: “The experiments established that the extension of welfare to two-parent families adversely changed their work patterns enough to matter” [his emphasis].

The difficulty with major federal welfare reform, as many experts have pointed out, is the following dilemma. We could make working relatively more attractive by phasing out welfare benefits more slowly as income rises—say, 33 instead of 50-75 cents lost for each dollar of earnings; but this would make millions more working families eligible for benefits, reducing their incentive to work and substantially raising the total cost of welfare. This was the approach of President Carter’s unsuccessful reform proposals (and of the intermediate proposals in the first draft of the bishops’ economic pastoral draft). On the other hand, we could phase out benefits more rapidly, restricting the work disincentives of welfare eligibility to those below the poverty level and reducing program costs; but this further raises the marginal tax rates on wages for those still eligible for welfare. This has been the gist of reforms enacted under President Reagan.

It is interesting that the two extremes of welfare reform—abolition, or replacement with a guaranteed income—both represent the “liberal” approach, which, as we have seen, is the method generally less likely to affect people’s behavior in matters like work habits. Both Murray and the bishops’ first draft base their argument on the dignity of the poor. But the one upholds the dignity of work without the dignity of an adequate income; the other, the dignity of an adequate income without the dignity of work. Both would replace the current array of programs which seek, however inadequately, to discern individual human needs, with the “naked cash nexus” of either wages or welfare.

One largely untried solution is the “authoritarian” method of imposing work requirements for able-bodied recipients of federal welfare. President Reagan proposed such requirements during his first Administration, but Congress agreed only to limited and voluntary local experiments, which have barely begun to be assessed. The bishops’ oppose “workfare” as demeaning. Aaron asserts that

If work does not pay, a work requirement in most places and times would be ineffectual and inoperative, a costly and largely futile effort to compel the poor to behave in ways contrary to their own self-interest. It is unimaginable that a large bureaucracy would be capable of sifting millions of individual cases, each fraught with special problems, needs, and ambiguity, all requiring judgment if not wisdom. To inspire hard work is a laudable goal, but one not likely to be achieved through a work requirement without more authoritarian administration than most Americans are likely to accept.

Because of all these problems, welfare experts from left to right are pessimistic about the possibility of significant federal welfare reform. Advocates  and opponents of a guaranteed income agree that there is little popular support for the idea, while Murray concedes that there is also little public support for his own proposal.

Before deciding whether this pessimism is justified, we should note that there is a similar, usually overlooked problem concerning the people who ultimately pay for relief of the poor. Economic policy tries to increase contributions from the non-poor in basically two ways—compulsory redistribution through the income tax and welfare systems, and tax-deductibility of voluntary charitable contributions.

Both require income tax rates to be substantially higher than they would otherwise be. Here the “income effect” and the “price effect” work in opposite directions. The charitable deduction encourages voluntary donations by reducing the after-tax cost of a contribution; but reduced after-tax income also leaves people less to give to charity. The loss of disposable income may cause people to earn more to compensate; but the higher tax rates diminish the marginal reward for doing so. It is not immediately obvious whether people contribute more to the poor than they would otherwise. One effect may even be perverse: the burden tends to shift toward those who would contribute anyway, because they are less likely to try to avoid the disincentives.

In fact, welfare disincentives are only a special case of a general problem. A purely incentive-oriented federal policy cannot effectively distinguish the “virtuous” from the “reprobate” middle class, any more than it can tell the “deserving” from the “undeserving” poor. Such decisions require “dividing the soul from the spirit” (Heb. 4:12). Social justice cannot be achieved without a government role, but it also cannot be fully achieved by relying on direct federal policy alone. As T.S. Eliot put it, it’s impossible to design a system so perfect that no one has to be good.

Economic recovery has reduced poverty somewhat from its peak, and initiatives like enterprise zones and properly designed tax reform can offset a part of welfare disincentives. Otherwise, as far as direct federal economic policy is concerned, the welfare experts are probably right: we are nearing the limit of what can be done about the poverty dilemma.

But if we do not accept the idea that nothing more can be done to help the poor, then realism must necessarily bring us to the notion of subsidiarity—a “preferential option” for social institutions of a human scale. This is not an aesthetic preference; the realm of “mediate” policy is the only frontier of action which has not been pushed near its limits. Moreover, to refuse this avenue is to surrender to the premise that society consists only of the individual and the state.

It is time to move beyond the seemingly endless debate’ about the proper size of government, and to discuss the even more important question of the proper kind of government. To have an economic policy, the government, like an individual, requires a scale of values or ends. But because different policies have different implications for the way people live, there must also be a hierarchy of preferred policy means. Nearly 30 years ago, Wilhelm Roepke suggested such a policy hierarchy, based on the natural law principles of Catholic doctrine. “If we think it through carefully, we live in times of need by consuming what someone else produces and does not consume,” Roepke wrote. “By what title the needy draw on the current flow of production is quite another question.” Saving means drawing on claims previously accumulated by consuming less than one has produced. Insurance is paid out of premiums based on calculations of pooled risk. Private charity is a voluntary transfer from those in surplus to those in need. Finally, there is compulsory redistribution, through either the local or national government. If we consider all their effects on both donors and recipients, this is the proper scale of preferred policies, in descending order.

The main valid argument for compulsory government provision is that true need cannot be satisfied at a given time through the more desirable methods alone. However, this argument is often used by those who for various reasons really prefer government provision over self-reliance and voluntary mutual aid. Since these are largely substitutes for one another, such defeatism tends to be self-fulfilling.

However, recognizing welfare disincentives does not necessitate following Charles Murray’s advice and simply abolishing federal welfare. Reducing direct federal intervention is sometimes a necessary but never a sufficient condition for social justice. The least of evils is always the morally right choice. As Roepke observed:

We cannot, nowadays, do without a certain minimum of compulsory state institutions for social security…. [T]here must naturally be room for all these in our concept of a sound social security system in a free society, however little enthusiasm we may feel for them. It is not their principle which is in question, but their extent, organization, and spirit…. This assistance should be subsidiary only, to help out where the individual’s own resources or voluntary aid prove inadequate; it should not become the normal form of satisfying the need for security.

For the moment, merely facing up to the choice—either accepting or openly denying the hierarchy of policies—is sufficient to begin progress toward improvement. In addition to an array of policies for a given moment’s conditions, a social strategy informed by Christian social doctrine requires a long-range plan to shift toward a more humane “mix” of policies as soon as possible. There are lasting principles, but there is no permanent “ideal” set of policies for all societies or even for all time in a single society. Appropriate policies depend on the specific conditions present, including the moral and religious development of the people as a whole.

Just as there is no enjoyment of rights without institutions to support them, there can be no long-term vision without an institution to support it. Neither government policymakers nor individual citizens, absorbed as they are in daily emergencies, can be the keepers of that vision. To some degree the universities and political parties can contribute. But for consistency and moral force, it falls especially to the Church—both clergy and expert laity—to develop that vision, to articulate it, and to maintain it over time. If the Church accepts and executes this challenge, it will contribute substantially, as the bishops desire, to the economy of salvation.

  • John Mueller

    John D. Mueller is the Lehrman Institute Fellow in Economics and Director of the Economics and Ethics Program at the Ethics and Public Policy Center. Mr. Mueller specializes in the relation of modern economic theory to its Judeo-Christian and Greco-Roman origins, its practical application to personal, family, and political economy, and the interaction of economics, philosophical worldviews, and religious faith. When he wrote this article, he was economic advisor and speechwriter to Rep. Jack Kemp.

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