The “Santa Claus principle” is what Ludwig von Mises sometimes called the use of coercion to redistribute wealth according to someone’s political preferences. But if people don’t create taxable wealth at least as fast as the government redistributes it, sooner or later “Santa” will run out of goodies.
An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole doctrine of interventionism collapses when this fountain is drained off. The Santa Claus principle liquidates itself.
Another way to think about the Santa Claus principle, however, is as a particular combination of two other problems.
The first problem is how to align the incentives of demanders and suppliers. Call this the incentive problem. The second problem is how to enable demanders and suppliers to become aware of what each side has to offer and its value. Call this the knowledge problem.
(I believe Milton Friedman gets the credit for the following formulation.)
Santa Clause: Spending Your Own Money on Someone Else
During the holidays, we typically buy gifts for other people. On the one hand, we’re very careful how much we spend on others because we know how much we value our own money. We have an incentive to limit our spending.
On the other hand, we often don’t care all that much whether the person we’re buying for even likes the gift (incentive problem). But assuming we do, we still have a much fuzzier idea about that than if we were buying the gift for ourselves (knowledge problem). The better we know the person — ourselves, a family member, a close friend — the more successful we can be.
On the recipient’s side of the exchange, then, there is both a knowledge and an incentive problem. That characterizes most forms of charity, especially large-scale development aid.
Those problems plague us in the next situation in a different way.
Rent Seeking: Spending Someone Else’s Money on Yourself
Here, the opposite problem arises, and it’s potentially a great deal more harmful.
You probably have a pretty good idea how you, as the recipient of largess, value what you’re receiving. But this time, the problems lie on the other side.
Indeed, the less you know about your benefactor, the less likely you’ll know (knowledge problem) or even care (incentive problem) about the value she places on the money you’re taking from her and spending on yourself. Moreover, having political power to redistribute wealth from others — essentially redistribution at the point of a gun — means you’re very likely to spend a great deal more on yourself than the other person would want to spend on you were the exchange voluntary. Here, Santa Claus is practicing what economists call rent seeking or cronyism.
The Free Market: Spending Your Own Money on Yourself
But when you spend your own money on yourself, both the incentive and knowledge problems are minimized. You know the value of your own money and have an incentive to limit it. You also know the value of what you want to spend it on — or you have at least as good and probably better an idea than anyone else does — and you have an incentive to get the most bang for your buck. That’s what happens in an unhampered market.
Keep in mind that “spending on yourself” includes investing in or running a business that you believe will improve your situation by providing a valuable good or service to others, who are willing to pay you more than it costs you to provide it to them.
So here you know how much to spend and have an incentive to keep to that limit. You also know what to spend your money on and have an incentive to buy it: nothing more, nothing less.
Redistribution: Spending Someone Else’s Money on Someone Else
Finally, when the government forces Peter to pay Paul, when it practices forced redistribution, it creates knowledge and incentive problems on both sides of the exchange. First, the government taxes Peter without knowing what value he places on what is being taken from him (knowledge problem), nor does it really care to find out (incentive problem).
Second, the government that taxes Peter neither knows (knowledge problem) nor has any compelling reason to care about (incentive problem) what Paul, the recipient of the transfer, really wants. Is it more education or housing or personal security or something else? How much and in what form?
The result is that government authorities tend to take far too much through taxes, borrowing, or inflation and spend it on things and in amounts that most people don’t want, doing a great deal of damage in the process. This describes almost any politico-economic system in the world today.
Government, then, sounds more like Krampus — the demon who punishes naughty children in horrific ways — than like dear, old Santa. Unfortunately, Mises’s Santa Claus principle often results in “Krampus economics.”