Similarly, business decisions are strongly affected by tax policy. To the extent that businesses allocate resources in order to avoid taxes, that allocation fails to serve consumers in the optimal manner we observed in the free market. The radical distortions stemming from tax policy are another major factor differentiating the current U. S. economy from a free market.

In particular, the income-tax code affects employer-employee contracts, with far-reaching economic implications. If non-monetary forms of compensation, such as medical and life insurance or pensions, are tax-exempt, then the value of these programs to many employees will considerably exceed their free-market value, and employers will find it profitable to provide those benefits in lieu of full monetary remuneration. Small businesses, however, may not be able to afford the administrative and paperwork costs of such programs and therefore are placed at a market disadvantage by such provisions of the revenue code.

In the free market, of course, employees might receive full monetary compensation, and they could then elect to purchase benefits that they considered worth the cost. When employer policies are partly determined by the tax code, however, many workers will receive benefits that have less utility to them than the money expended on those benefits might have provided. For instance, an employee without family or dependents may receive a costly but largely unwanted life-insurance policy. In short, tax regulation encourages less efficient methods of employee compensation.

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