The Economics of Plush Carpet at the Head Office

It always amuses me when economists go out of their way to claim that economics is a science (more or less true) and that they base what they say on purely on the scientific principles and not value judgments (very often false). It’s especially amusing when they blow the science to get the value judgment they’re looking for. Here’s the latest example I’ve seen. George Mason economics professor Walter E. Williams attempts to explain why for-profit entities sometimes spend on unnecessary luxuries:

You say, “Professor Williams, for-profit entities sometimes have plush carpets, have juicy expense accounts, and behave in ways not unlike non-profits.” You’re right, and again, it’s a property-rights issue. Taxes change the property-rights structure of earnings. If there’s a tax on profits, then taking profits in a money form becomes more costly. It becomes relatively less costly to take some of the gains in non-money forms.

Actually taxes have little to nothing to do with this. There is a real economic reason for this behavior (as well as several psychological and sociological ones, but economists like to ignore those factors so let’s stick to the purely economic for the moment) and it has nothing to do with taxes. While taxes may have some distant, second-order effect on this, the real driver is a disconnect between the needs of the owners on the one hand and the managers on the other. For example, suppose Joe CEO wants a private jet. He can purchase it himself, or he can have his company purchase it and let him use it whenever he wants to. If he purchases it himself, he pays the full cost of the jet. If his company buys it for his use, then they pay and their profits go down a little.

Now Joe is probably a large owner of his company’s stock, so he pays some of the cost of the jet in this scenario, but that cost is spread over all the stockholders. In essence, the other owners subsidize the cost of Joe’s jet. Joe gets his jet at a really steep discount, in effect taxing his coowners.

Do taxes have an effect on this transaction? Yes. Is this effect anywhere close to the main reason companies overspend on lavish accoutrements? No. Of course, pointing that out would eliminate the anti-tax value-judgment Williams wants to make, so he doesn’t mention it.

Advanced question: why is there such a disconnect between owners and managers? There are good economic reasons for it, though I don’t have time to elaborate them here. In brief, markets are not nearly as efficient, players as rational, or information as equally available as they’re assumed to be in most economic models.

This entry was posted on Monday, October 30th, 2006 at 7:33 AM and is filed under Economics. You can follow any responses to this entry through the Atom feed. You can make a comment, Digg this story, or trackback from your own site.