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2012 February 25 Saturday
Will Higher Taxes Provide Cost Effective Services?

Reason Magazine editor in chief Matt Welch points out Warren Buffett thinks he can spend his money better on philanthropy than the government can. Yet Buffett advocates taking money from rich people to give it to the US federal government.

I'm not one who thinks that Warren Buffett needs to write a $10 billion check to the government in order to prove his policy sincerity. But it is worth noting that his big 2006 media breakthrough came not by pledging his fortune to the U.S. Treasury, but to private charity. It's clear which vehicle he finds the most effective use of his personal money.

Money spent on charity has the potential to be more productive than money spent by national governments. But this is by no means assured. Charity giving and philanthropy are by no means assured to deliver a net benefit to society as a whole.

As I argued in my post Gates And Buffett Quest Will Lower Investment Quality, most philanthropy is wealth-destroying because it shifts money away from productive investment toward unproductive activities, shifts talented people away from useful work, and even in some cases encourages activities that are destructive of self or others. Poorly done philanthropy has effects similar to those of the social welfare state in that it lowers the costs and increases the benefits of bad life choices.

As an example of wealth-destroying philanthropy, Bill Gates (and likely with some of Warren Buffett's money) spent billions of dollars to discover smaller class size does not improve educational quality. It was not hard to know in advance that lowering class size was a waste of money. As Virginia Postrel wrote in the New York Times in February 2001 economist Edward Lazear showed as long as disruptive students are separated from quiet and attentive students the sizes of classes for attentive students can be quite large.

To find out how much of the time learning is actually taking place in a given class, you multiply the probability a student is not disrupting by the probability for each other student. In his model, Professor Lazear uses the same probability for every student, which means he can simply raise the probability to the power of whatever the class size is.

The results are striking. If each student behaves well 99 percent of the time, learning takes place 78 percent of the time in a class of 25; if good behavior drops to 98 percent, learning takes place only 60 percent of the time; at 97 percent, learning drops to a mere 47 percent of the time.

So any value of smaller class size is mostly for the more disruptive students so that they do not disrupt the learning of each other.

Money spent to pull larger numbers of people into teaching careers to make class sizes smaller pulls people away from better uses of their time. In his book Thinking, Fast And Slow Daniel Kahnemann points out the Gates Foundation was lured into making a billion dollar mistake by looking at schools with small classes that had great student performance. What the Gates Foundation's advisers missed: with smaller classes comes larger variation. Some of the schools with terrible student performance also had small class sizes. With smaller groups comes greater odds that a small group will deviate from the average of all students.

Philanthropy is very hard to do well. Even with expensive advisors the Gates Foundation still made a very expensive (and therefore wealth-destroying) mistake. On the bright side, at the end of the mistake Bill Gates admitted the mistake and supporters of wasteful educational spending thru smaller class sizes found a powerful person switched against their position. If Gates used those same dollars to fund the IRS he and quite a few observers would not have learned this lesson.

By Randall Parker    2012 February 25 03:18 PM Entry Permalink | Comments (4)
2010 June 16 Wednesday
Gates And Buffett Quest Will Lower Investment Quality

Warren Buffett and Bill Gates are lobbying other billionaires to give away half their wealth. This is a bad idea for a few reasons:

  • If wealth is spread more evenly more of it will go to consumption rather than investment. The effect will be to shift wealth abroad to foreign billionaires as Americans consume more and invest less.
  • Since people capable of accumulating billions are better investors on average the effect will be to shift wealth into the hands of poorer asset allocators and hence slow economic growth. So return on investment will decline as the average quality of investment decision goes down.
  • Philanthropy tends to go to kooky left-wing causes that damage society. Bill Gates' foolish attempt to raise high school student performance is an example of this phenomenon. So are many of the big charitable foundations. The Howard Hughes Medical Institute is a notable contrary example where the money actually goes to very talented medical researchers. But HHMI stands out as an exception.

"I have everything in the world I want, and then I've got all this surplus around - and I give away the surplus," Buffett said.

Buffett waited until his late 70s to give away a "surplus". Okay, question: Did he not have a "surplus" when he was in his 50s? How many billions did he need to have before any of it became a surplus?

I'll tell you why Buffett didn't give it away sooner: He enjoyed making money so much that he wanted to hold on to what he had to use it to make more. He maximized his pleasure by keeping and compounding his billions. He also ensured many corporations with good business plans were well financed and managed.

By Randall Parker    2010 June 16 09:08 PM Entry Permalink | Comments (14)
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