Individuals spending their own money out-of-pocket will tend to under-invest in mental health services. The reason is the same reason why individuals spending their own money will tend to under-invest in education: they cannot capture the full value of the return of that investment.

Most middle-income families are in a 50% tax bracket. In general, one more dollar of income is subject to a 28 percent income tax, a 15.3 percent (FICA) Social Security payroll tax and, say, a 7% state and local income tax. At the margin, government is taking half of each extra dollar of tax earnings.

Now suppose these individuals do something to enhance their productivity, say by investing in education or in mental health. The higher productivity should produce higher income. But the individual will get to keep only half the additional earnings. So if people are making rational calculations, they will make productivity-increasing investments until the marginal cost of those investments equals one-half the marginal benefit (the total marginal benefit minus taxes). But from a social point of view, we want people to invest until the marginal cost equals the full marginal benefit. One could also argue that investments in education and mental health produce spillover benefits that are not captured in a person's market wage.

This is the kind of argument economists sometimes use to justify taxing people and using the proceeds to provide subsidized or free education to those very same people. The argument is: on their own, people will under invest in their own education. So government coercion is needed to move us closer to the socially optimal investment. The same argument can be applied to mental health.

Another reason why individuals will tend to underinvest in their own mental health is that they are unlikely to bear the full cost of failing to invest in mental health. For example, they are likely to be able to rely on free care provided by government or private charity in the case of serious problems. Also, part of the cost of lack of mental health is the discomfort and inconvenience caused for others.

Externalities. The argument developed here relies on the economic concept of "externalities." Briefly, externalities are effects that are external to the market. Hence they are not bought and sold. As a result, relying on the market alone produces suboptimal (non-Pareto Optimal) outcomes.

In the current context, the argument is that mental health has positive spillover effects that are not bought and sold in any market. Conversely, lack of mental health has negative spillover effects that are not bought and sold in any market.

To take an extreme example: my enjoyment of life is much higher if I walk down the street and observe sane, happy people engaging in polite behavior than if the street is filled with banshees engaging in impolite, bizarre behavior.

Note that to a certain extent, people can "internalize the externalities" by choosing to live around other people who are mentally healthy and avoiding the mentally unhealthy. But not all such effects can be internalized - or we would not have a problem left to solve.

So we need an extra-market mechanism (e.g., government) to solve the problem markets cannot solve.

Public Goods. Closely related to the concept of "externality" is the concept of "public goods" and "public bads." A public good is a good for which one person's consumption does not diminish the ability of others to consume it. For example, one could argue that a general condition of mental health has public good qualities. The reason is that my enjoyment from living in a sane society does not take away from your ability to enjoy it. Conversely, one could argue that a mentally unhealthy society is a public bad. And the disability I suffer from living in such a world does not increase or diminish the disability you suffer.

(Note that "public good" and "public bad" are often two ways of describing the same phenomenon. For example, one could say that clean air is a public good. Or one could say that pollution [causing a lack of clean air] is a public bad.)

Public goods have positive externalities. Public bads have negative externalities. For these reasons, markets tend to deal with the production of public goods and bads inadequately. In general, the market tends to under produce public goods (such as clean air) relative to private goods. It tends to over produce public bads (such as pollution) relative to private goods.

• Unlike the third argument, this argument does not rest on the assertion that people cannot appreciate the value of mental health services. Instead it posits that with full knowledge of the value of these services people will under-invest in them because they cannot capture the full benefits.

• The argument from market failure can be used to justify forcing group health insurance to cover mental health services. A version of this attempt is "parity" - requiring insurance contracts to have the same benefits for mental health care as for physical health care.

• The argument can also be used to justify governmental subsidized mental health services.

• Note also: the implications of the argument are not limited to mental health. The argument can also be used to justify mandating that insurers cover certain physical health services - such as vaccinations for childhood diseases and other preventative health services.

Although the "pro" side sounds good in theory, there is no direct evidence that we are under-investing in mental health services. Part of the problem is that - just as it's hard for employers and private insurers to measure the benefits of mental health services, it's also hard for independent, objective researchers to measure those benefits. And of course it may be the case that the benefits are greatly exaggerated. Worse, because of government failure (arguments 5 and 6), even in cases of market failure, the costs of government actions to correct market failure may exceed the benefits.

Links: