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Brooks Wilson's Economics Blog: March 2010

Wednesday, March 31, 2010

The Nanny State: Pet and Human Welfare

We put too many burdens on our neighbors through the state.  Jaya Narain describes the actions of an overweening state protecting society from a 66 year-old woman selling goldfish to a minor in "Pet shop owner fined £1,000 and told to wear an electronic tag... for selling a GOLDFISH to a boy aged 14" published by Mail Oline.
Her offence was to unwittingly sell a goldfish to a 14-year-old boy taking part in a trading standards 'sting'.

At most, pet shop owner Joan Higgins, 66, expected a slap on the wrist for breaking new animal welfare laws which ban the sale of pets to under-16s.

Instead, the great-grandmother was taken to court, fined £1,000, placed under curfew - and ordered to wear an electronic tag for two months.

The punishment is normally handed out to violent thugs and repeat offenders.

The prosecution of Mrs Higgins and her son Mark is estimated to have cost taxpayers £20,000 and has left her with a criminal record.

Mark, 47, was also fined and ordered to carry out 120 hours of unpaid work in the community.
If members of a free society must police the sale of goldfish, is it any wonder that the United Kingdom has budget problems? 

Narain also reported that the police also found a cockatiel with a bad eye and a broken leg which was ironically put down to stop its suffering.  I wonder which metric they used to determine that the bird's future suffering outweighed its future pleasure? 

Did those who designed the law stop to think that pet stores that attempt to sell damaged goods don't sell much? 
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Bittlingmayer, Havenner and Hazlett on the Stimulus

George Bittlingmayer, Art Havenner and Tom Hazlett, three of my professors at U.C. Davis, teamed to write, "They Don't Call It Stimulus No More" for Real Clear Markets.  They argue that the American Recovery and Reinvestment Act has failed to achieve the goals promised by its supporters, the failure of the bill is yet another nail in the coffin of Keynesian economics, and the large deficit produced by the bill will hinder long-run economic growth.  The article is well written.  I quote a few of my favorite paragraphs.
Despite the debate raging over whether the $787 billion "stimulus package" passed by Congress in February 2009 worked, the argument is over: the Obama Administration has capitulated. And it was on display in the President's signing ceremony last week for the next round of federal economic elixirs. No government official dared to call the $18 billion spending package anything but a "jobs bill."

Hello. The spending strategy unveiled a year ago was Keynesian - fatter federal deficits would jolt investor sentiments, igniting capital spending and putting Americans back to work in the private sector. That's the theory.

But now, besieged with prolonged high-level unemployment, the President and his congressional allies have put forward yet another deficit-enhancement plan. The "stimulus" tag has been abandoned; this is a jobs bill. And the rhetoric defending last year's spending binge has been duly adjusted, trumpeting the school teachers and fire fighters who kept their jobs due to credit extended to the states by the Federal Government.

The change is anything but subtle, and is entirely appropriate: massive U.S. deficits aren't stimulating private sector job gains...

President Obama blames the Bush Administration for the high cost of government - a bad situation that existed "when I walked in the door." One need not dwell on the fact that Senator Obama went to Washington in 2004 and proceeded to vote for the spending he now tags as profligate. The point is extremely well-taken: Bush43 did a fiscal belly flop, drenching the national ledger in red ink. For that, he is rightly held in low esteem, and his party swept from office.

Now the Democrats are making Mr. Bush's failures their own. Mushrooming deficits have not saved the economy. Even assuming that job losses have bottomed out, today's optimistic scenario, no post WWII recession has taken longer to turn around. And no recession has suffered employment losses so steep in percentage terms. This might be blamed on a Republican predecessor too, but for the fact that such a debacle was precisely what the Obama Administration forecast would be avoided by the February 2009 "stimulus."

Now, fiscal dereliction poses threats of its own. Economists Carmen Reinhart and Kenneth Rogoff have written the book on financial crises in history, THIS TIME IS DIFFERENT: EIGHT CENTURIES OF FINANCIAL FOLLY (Princeton, 2009). Just as the low-visibility risks taken by Fannie Mae and Freddie Mac appeared to be a free political lunch up until the fateful instant that they proved calamitous, sovereign debt can be a silent killer. The national debt, being pushed substantially higher just as the Baby Boomers retire, only looks harmless. But, "at some point," write the authors, "interest rate premia react to unchecked deficits." Fiscal "stimulus" must be withdrawn; austerity results. And "higher taxes have an especially deleterious effect on growth."...

Like a rain dance that produces no clouds, we are now into our fourth round of federal deficit creation - the automatic "stabilizers," followed by the Bush (2008), Obama I (2009), and Obama II (2010) versions. With each dry day, the deficit dancing intensifies. When the rain finally falls, we will be told that the recovery is a tribute to the Keynesian Gods. But it's already clear that something has gone wrong: the "stimulus" chant has fallen silent. Our dance on a fiscal cliff has lost its theme music.

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Tuesday, March 30, 2010

Alabama and the NCAA: Vacating Wins and Common Sense

The University of Alabama was caught providing student athletes with free textbooks and for this sin the NCAA is forcing the Tide to vacate twenty-one wins in football and records from three other sports from 2005 to 2007 ("Alabama's penalty from '09 ruling stands").  The university describes the punishment as "so excessive as to constitute an abuse of discretion."  The penalties were certainly more severe than historical precedents.  The NCAA Division I Infractions Appeals Committee said that the NCAA needed latitude in meting out punishment because no two cases were the same. 

Again the NCAA paints itself into an odd corner.  Top athletes are underpaid and, as this case demonstrates, over regulated.  Under normal circumstances, lowering the cost of education is considered a good thing.  If the student happens to be an athlete, it is bad.  If the regulation changed and all division I programs were able to provide free books, the competitive balance would not change.  Does anyone believe that USC, Texas, Ohio State, or LSU couldn't find free texts for athletes?
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Monday, March 29, 2010

The Stimulus, Crowding Out and Growth

The stimulus (The American Recovery and Reinvestment Act) was sold as a necessary government intervention to restore employment and economic activity.  Such Keynesian plans are fraught with problems including bad timing, spending for political gain, bad economic investments, and permanent increases in the deficit. 

De Rugy (Veronique de Rugy, "Politics: Democrats Stimulus Haul Is Almost Double Republicans") finds that stimulus spending in Democratic districts ($471,533,539) is nearly twice spending in Republican districts ($260,675,663) and that there is no relationship between spending in a district and the unemployment rate in a district.

The stimulus could permanently increase deficits and the national debt and many economists believe that larger permanent debt could raise interest rates for all borrowers both public and private.  The rise in interest rates lowers private investment a phenomenon known as crowding out.  Last week's Treasury three offerings that totaled $118 billion were met with weak demand and interest rates rose.  Both the Wall Street Journal ("Debt Fears Send Rates Up") and the Financial Times ("Supply fears start to hit Treasuries") noted that U.S. Treasuries had yields above that of high quality corporate bonds. 

One week's data does not constitute a trend, but, as James Hamilton suggests ("Interest rates spike up"), the bond market bears watching.  He also offers a rosier explanation based on the simultaneous increase in stock prices and interest rates.  Perhaps investors believe that the economy is improving.  Being an optimist, I like the explanation that the private economy is improving but I worry about rise in Treasury yields compared to corporate bonds and that the poor financial condition of the federal government will limit private sector growth.   
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Wednesday, March 24, 2010

Thoughts on Schumer and Graham's Immigration Reform Outline

Now that health care reform has been signed into law, it appears that comprehensive immigration reform will be the next item on the legislative agenda.  Senators Charles E. Schumer of New York and Lindsey Graham of South Carolina presented an outline of a comprehensive immigration reform bill in "The right way to mend immigration" which was published in the Washington Post and supported by President Obama according to a Washington Times article "Obama backs plan to legalize illegals" written by Stephen Dinan.  Schumer and Graham offer justification for reform.
Our immigration system is badly broken. Although our borders have become far more secure in recent years, too many people seeking illegal entry get through. We have no way to track whether the millions who enter the United States on valid visas each year leave when they are supposed to. And employers are burdened by a complicated system for verifying workers' immigration status.
I am weary of politicians who call for legislation by decrying some part of our economy as "badly broken" and comprehensive legislation to fix these problems.  While the senators do not call their proposal a comprehensive plan, it certainly is.  While the senators correctly observe that the government has difficulty keeping track of people entering the country illegally or overstaying their visas, they do not claim economic damage due to illegal entry.  This damage is harder to find and quantify than many might believe and some researchers find net gains.  For example, Ottaviano and Peri find that the wages of low skilled workers do fall, but that is based on the low wages earned by immigrants.  Low skilled workers born in the experience a 3 to 4% increase in wages ("Rethinking the Gains from Immigration: Theory and Evidence from the U.S.," National Bureau of Economic Research, Working Paper 11672, September 2005.

If illegal immigration does not cause economic or other damage, then the governmental apparatus designed to stop it could be considered an unwarranted expense and intrusion on people's liberty.  The people I refer to are legal citizens who trade with illegal immigrants.  I suppose that I am part of a tiny minority that does not view immigration, particularly illegal immigration as a big problem and if immigration is to be limited rationally, the senators' outline could improve existing laws.  They provide a very broad outline.
Our plan has four pillars: requiring biometric Social Security cards to ensure that illegal workers cannot get jobs; fulfilling and strengthening our commitments on border security and interior enforcement; creating a process for admitting temporary workers; and implementing a tough but fair path to legalization for those already here.
I have a couple of comments on their pillars.  If you wish to limit illegal immigration, some sort of high tech identification will be necessary.  Carrying yet another card is a legal citizen's burden of controlling the border. 

Their plan for stopping illegal immigration does not deal with the problem of anchor babies: foreign parents securing U.S. citizenship for their children by birthing them in the U.S. and then using U.S. law that attempts to keep families intact to secure their own citizenship.  If the senator's plan works at curbing illegal employment, we may find that successfully stopping the parents from gaining employment may be more expensive to taxpayers than allowing them to work illegally.  For example, perhaps the parents will return to Mexico until the child turns eighteen and then return to the U.S.  Their child will have a substandard education, will not speak English, and may not have their parents' drive to succeed.  They will qualify for welfare benefits. 

The four pillars do not separate high skilled workers who wish to work legally in the U.S. from low skilled workers who come illegally, but the rest of their article does make this distinction.  The high skilled workers could certainly be dealt with in an independent, less controversial bill that if more likely to pass.  The economist in me finds it difficult to oppose intelligent, high skilled workers from working in the U.S.  The Grinch in me must point out that if immigration of low skilled workers hurts the wages of American born low skilled workers than the immigration of high skilled workers must have the same impact on the wages high skilled workers. 

Finally, a plan to deal with illegal immigrants should have a path to citizenship.  I am not big on punishment for arriving illegally because I do not believe that the crime is big.  I rate it about like driving ten miles an hour over the limit on the highway and most of us do that or worse on a daily basis.  By coming illegally to the U.S., many guarantee their children better nutrition, health, education and higher standard of living.  While it is illegal behavior, it is also moral behavior. 

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Monday, March 22, 2010

Toyota and Sudden Acceleration

Last week in class, I theorized that the sudden acceleration problem experienced by a few Toyota drivers was not due to the design or manufacture of the cars but a media and political feeding frenzy centered around a normal number of malfunctions experienced by any make of cars.  The media hungers for stories that sell papers, and politicians thirst for a villain to demagogue.  Toyota was just an unlucky victim.  William M. Briggs, a statistics consultant, writing for Pajamas Media in "Sudden Acceleration or Creeping Fear?" proposes the same theory and supports it with evidence.  We both may be wrong, but it is always good to question the media (and economics professors).  I quote the first several paragraphs and recommend the entire article. 
Just look at these headlines!

  • “Inquiry on Auto Acceleration Expanded by U .S.,” New York Times

  • “Cars That Speed Up Mysteriously Spark Bitter Dispute Over Cause,” Wall Street Journal

  • “Runaway Cars,” Detroit News

And how about these?

  • “Car Plows into Park, Killing 3 & Injuring Dozens,” New York Times

  • “Car Kills Woman At Market,” Post-Standard

  • “Sudden Acceleration May Be the Cause of Recent Accidents…,” Corporate Crime Reporter

Boy, doesn’t Toyota have problems?

Maybe not. That first set of headlines was from an earlier “epidemic” of sudden accelerations thought to be caused by Ford automobiles. The second set was blamed on Audi.
These sudden — then called “unintended” — accelerations happened in the mid-1980s to early 1990s. They were so popular that CBS’s 60 Minutes, in a now infamous segment, “televised a sensational demonstration in which a rigged Audi 5000 was coaxed into accelerating without any hint of pressure on the gas pedal.” They later had to issue a “correction.”

Complaints of unintended acceleration to the National Highway Traffic Safety Administration (NHTSA) were not unusual and were associated with cars of almost every make and model. But after the media reported a cluster of accidents involving first Fords, then Audis, more complaints about those cars were subsequently received.

The unintended accelerations were thought to be caused by everything from electromagnetic interference to sticking gas pedals. But the NHTSA investigated and found: “The major cause appears to have been drivers’ unknowingly stepping on the accleratator [sic] instead of the brake pedal.”

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Saturday, March 20, 2010

The Unemployment and Labor-Force Participation Rates

During a recession, the public and media place a great deal of emphasis on the unemployment rate (=unemployed/labor-force *100) as a measure of human suffering, but, like all statistics, it is subject to errors in measurement such as that caused by discouraged workers. These workers become "discouraged" by the bad job market and stop looking for employment. By definition, an adult must be employed or looking for employment to be in the labor-force, and must be an adult without employment but looking for it to be unemployed. An increase in discouraged workers causes an equal drop in the unemployed and the labor force and makes the unemployment rate lower as the labor market worsens. Conversely, a decrease in discouraged workers makes the unemployment rate rise as the labor market improves.








Adults 1,000 1,000 1,000 1,000 1,000 1,000
Labor-force 660 657 654 651 653 655
Employed 601 598 595 592 593 594
Discouraged Workers (DW) 0 4 8 12 10 8
Unemployed 59 58 57 56 57 58
Labor-force participation rate 66.00 65.70 65.40 65.10 65.30 65.50
Unemployment rate with DW 8.94 8.83 8.72 8.60 8.73 8.85
Unemployment rate w/o DW 8.94 9.70 10.15 10.61 10.30 10.00

The example contained in the Table demonstrates how the employment rate can fall as the labor market deteriorates from period 1 through period 4 and then rise as it improves from period 4 to period 6. The number of adults who wish to work remains constant at 660. They do not all remain in the labor-force. The labor market deteriorates during the first four periods resulting in a decline in employment of 3 workers each period. As the market deteriorates, the number of discouraged workers increases by 4 each period, one worker greater than the number losing their jobs. Because discouraged workers are not part of the labor-force or the unemployed the labor-force falls from 660 workers in period 1 to 651 workers in period 4 and unemployment falls from 59 to 56 during the same period. Even though employment is falling, unemployment is decreasing because workers are leaving the labor-force. The unemployment rate falls from 8.94% in period 1 to 8.60% as the labor market deteriorates. If these workers had not become discouraged and had persisted in seeking employment, the unemployment rate would have worsened from 8.94% in period 1 to 10.61% in period 4 as should happen in a deteriorating market.

The labor market improves in the last two periods with an unemployed worker being hired each period. Sensing the improvement in the labor market, two discouraged workers rejoin the labor-force each period and are now counted as unemployed. As the labor market improves, the unemployment rate rises 8.60% in period 4 to 8.88% in period 6.

Using the labor-force participation rate in conjunction with the unemployment rate paints a more accurate picture of the labor market. The graph shows the U.S. labor-force participation rate measured on the left vertical axis and the unemployment rate measured on the right vertical axis from September 2007 through February 2010. Initially, the labor-force participation rate remains stable as the unemployment rate increases. Beginning in June 2008, the labor-force participation rate falls as the unemployment rate rises suggesting a rapidly worsening labor market. Between October 2009 and December 2009, the labor-force participation and unemployment rates fall, the exact situation as described in the table. The labor-force participation rate improved from December 2009 to February 2010 as the unemployment rate improved suggesting a strengthening labor market. This analysis rests on the assumption that the labor-force participation rate declined because many workers became discouraged. If correct, it may take many months for the unemployment rate to fall to historical levels as the discouraged workers reenter the labor-force.

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Wednesday, March 17, 2010

PhRMA, Advertising and Competitive Free Speech

People often assume that business leaders support legislation that strengthens markets, but this assumption is usually false.  Business leaders support legislation that increases the profit of the firms they own and manage.  Given the assumption that drug companies Represented by the Pharmaceutical Research and Manufacturers of America (PhRMA) which represents the country’s leading pharmaceutical research and biotechnology companies, are self interested profit maximizers, Chris Frates of Politico provides evidence directly from PhRMA's advertising budgets that their profits will not be harmed by current reform legislation in his informative article ("PhRMA plans $6 million pro-reform ad buy in 38 House districts").
PhRMA agreed Tuesday to fund an initial $6 million ad buy in the districts of 38 wavering House Democrats. The pro-reform ads will come from the industry-funded coalition Americans for Stable Quality Care and could hit the airwaves as early as today, a top industry official said. The deep-pocketed trade group didn’t decide how much it would spend in total on the campaign; officials are waiting to review the bill first. The decision to flip the switch on five or six days worth of advertising will come when the industry is comfortable with the bill’s direction.

The emphasis added is mine.  Presumably, "comfortable with the bill's direction" means that these firms will benefit from the reform legislation.

A recent Supreme Court decision allowed corporations to spend freely on elections.  Many speculated that the decision would allow corporations to buy elections (see "Justices, 5-4, Reject Corporate Spending Limit").  In a blog post, I noted that business interests were not monolithic and that elections would be competitive.  Frates provides evidence that special interest funding would indeed be competitive.
The drug industry is really the only pro-reform group able to match the millions being spent by opponents like the Chamber of Commerce.

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Tuesday, March 16, 2010

The Latest from the White House on Unemployment

Rebecca Christie and Mike Dorning of Bloomberg report in "Obama Aides See Jobless Rate Elevated for ‘Extended Period’" that employment will only improve slowly. 
March 16 (Bloomberg) -- U.S. employers won’t hire enough workers this year to lower the jobless rate much below the level of 9.7 percent reached in February, three Obama administration economic officials said today.

The percent of Americans who can’t find work is likely to “remain elevated for an extended period,” Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer, chairman of the Council of Economic Advisers, said in a joint statement. The officials said unemployment may even rise “slightly” over the next few months as discouraged workers start job-hunting again.

Implicit in this report is that the labor-force participation rate will improve throughout the year. 
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Monday, March 15, 2010

China: Limited Access Order and Google

In "Violence and Social Orders," North, Wallis, and Weingast argue that economists have under appreciated the importance of controlling violence in establishing social order in which economic activity occurs.  They describe three types of social orders from most to least violent: primitive, limited access, and open access.  China is a limited access order.  The government creates a governing coalition by trading economic favors to groups who will in turn refrain from violence or help control violence. 

Limited access orders not only limit economic rights of the majority of its citizens but are also careful about granting economic entry into their countries by foreign interests.  This lack of freedom limits economic innovation and growth.  China has been growing rapidly by opening access to both domestic and foreign interests, but its growth may ebb if it fails to evolve into an open access order.

China's governing coalition's dealings with Google may signal the limits to the growth of access to its economy.  Recent cyber attacks on Google which may have been initiated by a university with close ties to the Chinese military ("Chinese schools deny Google cyber-attack links").  Those attacks and demands for censorship by the Chinese government may force Google to close shop in China ("Google’s China Advertising Clients Urged to Defect (Update1)").  This will be good for Baidu Inc., China's main Internet company, which will increase its market share, but it will be bad for consumers and technological advance ("CORRECT: Baidu Shares Rise On Reports Google Near Closing China Site".
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Wednesday, March 10, 2010

A Broadband Free Lunch?

(HT to the Drudge Report)  The Federal Communications Commission is considering a plan to allocate spectrum to free or very low cost broadband Internet service nationwide ("U.S. considers some free wireless broadband service").  The Reuters article suggests that the provision of this service is some sort of free lunch by not mentioning tradeoffs.
WASHINGTON (Reuters) – U.S. regulators may dedicate spectrum to free wireless Internet service for some Americans to increase affordable broadband service nationwide, the Federal Communications Commission said on Tuesday.

The FCC provided few details about how it would carry out such a plan and who would qualify, but will make a recommendation under the National Broadband Plan set for release next week. The agency will determine details later.

One way of making broadband more affordable is to "consider use of spectrum for a free or a very low cost wireless broadband service," the FCC said in a statement.
What is the tradeoff?  At a time of imposing deficits, the FCC could auction off the spectrum to the highest bidders lowering the deficit.  Companies with winning bids value the spectrum more presumably because they can repackage it and sell services to end users.  One function of markets is to allocate goods and services to those who value it most.  An auction achieves that goal but a government give away does not.  There is not such thing as a free lunch and this lunch is paid for by taxpayers and consumers who would be happy to buy products utilizing the spectrum that the government plans to give away.  
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Monday, March 8, 2010

Sebelius Plays Two Political Tricks

Last Friday in "A Health-Coverage Tax and Its Burden" I demonstrated that the burden of a tax placed on restaurant owners would be shared between patrons and the owners in the short-run, and exclusively by the patrons in the long-run.  I also claimed that politicians frequently claim that taxes placed on business will not affect employees or consumers.  Two days later Kathleen Sebelius, the Secretary of Health and Human Services, added evidence to my claim in an interview with David Gregory on Meet the Press in which she stated that it is insurance companies will pay the tax on "gold-plated or Cadillac plans."  To give context to her statement I have included the question by Gregory and her response with the pertinent statement highlighted.   
GREGORY: I want to go to just a couple of issues. One has to do with how this gets paid for. That is a tax, an excise tax on so called gold-plated or Cadillac plans. But in the Senate bill that's been put off until 2018.

And the reasonable question comes up which is, do you really think a future Congress which will be under a lot of pressure not to raise $1 trillion worth of taxes, is going to withstand that pressure, or are you going to be left where -- because this Congress won't raise the tax now, they're going to put it off to 2018 so you're going to have all of the spending and not get any of the savings until 2018. Isn't that unrealistic?

SEBELIUS: I think two things happen right away with the way this is designed. First of all, it puts insurance companies who pay the tax ultimately on notice that this is coming. And they can begin to change the kind of policies that are in the market.

But what we want to do is change insurance company behavior which hasn't been very strategic in terms of cutting costs. And in fact, as the Goldman analyst said they are driving up cost, they have a market strategy that they are willing to dump customers and continue to raise costs; so changing their behavior, putting them on notice that this is coming.
Besides claiming consumers and taxpayers will not share the burden of taxes on business, politicians also like to find enemies to justify actions.  Voters should not allow politicians to scapegoat insurance companies; they are no more or less moral than other businesses which also seek profits or consumers who attempt to get the most out of every dollar spent.  Creating enemies out of whole cloth increases tension between consumers and business and undermines business confidence.   

Three questions come to mind.  First, why do we need a complete overhaul of health care if a simple change in tax structure will alter incentives of insurance companies and consumer incentives as well?  While I don't support an overhaul of the health care system, I do support equal tax treatment of income used to purchase health care through employee provided plans and privately purchased plans as I wrote in the above linked post and here, but why limit taxes to these plans?  Wouldn't a broader based tax further alter insurance company and consumer behavior?  

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Friday, March 5, 2010

A Health-Coverage Tax and Its Burden

Ed Perkins, a travel writer for the Chicago Tribune, sniffs out a scam but I believe attributes it to the wrong party in "New charge on dinner tab is in bad taste."  Perkins believes that restaurateurs are scamming customers by adding a charge to their bill to cover the new tax on owners for the "Healthy San Francisco" health-coverage system.  I agree that someone is running a scam, but it is politicians who sold the tax as a new business tax that was somehow independent of prices consumers pay.  The restaurants are engaging in a political protest and economic education.  Perkins writes 
Nothing succeeds in the travel industry like a bad idea. The latest hidden mandatory add-on is a "health" charge added to restaurant bills. As far as I know, this scam cropped up first in San Francisco, but you can count on it to spread.

The rationale for this one is to cover the employers' mandatory contribution to the City's "Healthy San Francisco" health-coverage system. The charge actually is levied on employers, but at least some restaurants are adding a few dollars or percentage points to each customer's bill to cover this charge.
The economic impact of the tax is relatively straight forward involving three steps.  First, San Francisco restaurants become somewhat less competitive losing a little business to restaurants in surrounding communities. 

I will explain the second step with a graph.  The numbers are fictional but the direction of the movement of equilibrium prices and quantities are predicted by widely accepted economic theory.  As pictured in the above graph, the original equilibrium before the tax results in an equilibrium price of $22.50 dollars per meal with 32,500 meals per week consumed.  The city government imposed a tax of $5.00 per meal.  The restaurateurs added the tax to their cost structure which helped determine their supply of meals.  Supply shifted inward from S1 to S2.  The vertical distance between the two supply curves is the $5.00 tax.  The new equilibrium shown by the intersection of S2 and demand is at a price of $25.00 per meal with 27,500 meals per week consumed.  Consumers now pay $2.50 more per meal than they paid prior to the tax.  That is their burden of the new tax.  The restaurateurs receive $25.00 per meal but must subtract out the $5.00 tax.  Net the tax, they receive $20.00 per meal, $2.50 less than they received prior to the tax.  In my simple model, the burden of the tax is shared evenly between the restaurateurs and their consumers.

The long-run outcome shifts the burden to the tax entirely or almost entirely to the consumer.  This is because restaurants compete in something close to a perfectly competitive market.  As they adapt to new costs, including the tax, their supply curves becomes perfectly elastic, or something approximating a perfectly elastic.  Without the tax, the long-run equilibrium price was $22.50 per meal as determined by the intersection of demand and S1.  With the tax the new equilibrium is at $27.50 per meal as determined by the intersection of demand and S2.  The consumer pays $27.50 per meal and the restaurants receive $22.50, the price they received before the tax.  But the restaurateurs still have good reason to oppose the new tax.  Prior to the tax, they were selling 32,500 meals per week, after the tax, sales fall to 22,500. 

I did not pay attention to the political debate surrounding the implementation of the health-coverage tax, and I am assuming that politicians used an age old tactic of telling consumers that a tax will be paid for business and not them.  Maybe politicians are more honest in San Francisco.  If my assumption is incorrect, I apologize to these politicians.   

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Thursday, March 4, 2010

Fever on the Health Care Bureaucracy

A guest, Fever, wrote in a comment titled, "No new bureaucracy will be necessary"
I don't care which cost savings idea you decide to back, if you create a massive new entitlement there will be bureaucracy and the entitlement will come at an additional cost. Furthermore, the reason the Democrats won't support your tax plan is because the people that pay out-of-pocket for healthcare are rich.
I thank Fever at for the comment and acknowledge some common ground: we both want a smaller government.  He wants to starve the machine and I would like to see it at least skip a few meals. 
As in my previous post, I am attaching a proviso to remarks.  My information source is the governor of Indiana who instituted the plan and his presentation of the program may be biased, but if his information is approximately correct, I stick by my statement that no new bureaucracy will be necessary to offer health savings accounts to all workers as a optional replacement of traditional preferred provider plans, Medicare and Medicaid.  These bureaucracies already exist and Indiana's experience demonstrates that it is less expensive to provide health care and manage payments with health savings accounts than traditional preferred provider plans.  In 2010, the state will save $20,000 or about $950 per state worker enrolled in a health savings account (70% of 30,000).  Health care costs are growing faster than the rate of inflation elsewhere.

A health savings account gives the insured a financial interest in rationally reducing costs as demonstrated by the experiences of Indiana state workers.  Comparing the gradual replacement of Medicare and Medicaid with health savings accounts to current reforms before Congress is a no brainer.  I trust people to make better decisions about their health care than a government committee.  I also trust people to spend their money more carefully than the government would spend it for them.  The real beauty of markets is that health care providers will adapt products to price conscious consumers. 

Should the government expand health care insurance to cover every citizen?  Given the massive size of the deficit and national debt, and the projected increase in these accounts due to unfunded government liabilities, I believe this is an odd time to ask this question.  Let's try to control costs before we increase enrollment. 

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Wednesday, March 3, 2010

Llosa on Paulson and the Fear Factor

Alvaro Vargas Llosa of the Independent Institute reviewed former Treasury Secretary Henry Paulson's memoirs, "On the Brink," on the bursting of the housing bubble, the ensuing financial crisis, and government response in, "Paulson and the Fear Factor."  I quote a three paragraphs of his insightful review.  The remaining review is very much worth the time and effort to read.
WASHINGTON—There is a moment in former Treasury Secretary Henry Paulson’s memoirs when—during a Capitol Hill discussion over a financial rescue plan—he succumbs to stress and suffers an attack of dry heaves in front of a U.S. senator.

This episode is symbolic of what was happening in the country—the panicked spasms of government action to save big banks from going under that Paulson narrates in On the Brink, his inside account of the U.S. financial catastrophe. It is punctuated with episodes of fear; at one point he tells his wife: “Everybody is looking to me, and I don’t have the answer. I am really scared.” The entire government was scared. The result was that between the rescue of Bear Sterns in March 2008 and the rescue of the auto companies in December of that year, an array of bailouts, takeovers and money-pumping acts of desperation gave the U.S. government near-dictatorial control over much of the world’s foremost economy.

We think of statism as born out of altruism or megalomania. But here a third cause transpired: naked, primeval fear. The notion that people could be left to sort themselves out in the biggest financial crisis since the 1930s was terrifying even for Paulson, a true believer in free markets who keeps repeating in his book that he disliked what he was doing. The fear was so overpowering that Paulson, his colleagues and Wall Street decided to put unconditional faith in the very institution, the federal government, that the author tells us was responsible for the conditions under which the housing bubble occurred: easy money, political incentives for homeownership and regulatory incompetence.

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Tuesday, March 2, 2010

Indiana's Health Savings Accounts

I have often expressed the opinion that much of our nation's high cost for health care is the result of bad tax policy that allows taxpayers to make tax free payments for health care through an employer provided health care plan but forces them to pay taxes on out-of-pocket expenses for the same services(see here or here).  People rationally responded to incentives and made payments through their group plans.  As out-of-pocket expenses fell, consumers paid less attention to price. 

Employees also have little incentive to minimize health care payments made through their employers.  In essence, the group plan adds up all health care purchases made by members of the group, divides the sum by the number of members of the group, and charges each member the quotient.  The third party payment system through a group plan turns medical expenditures into a public good which theory tells us is overused and underfunded.  As an example, if 100 people belonged to a group that ran up an annual bill of $240,000, each member would be charged $2,400 ($240,000/100).  Suppose an average member of the group who ran up a medical tab of $2,400 this year were able to cut expenses in half the next, but everybody else maintained their original expenditures.  The frugal group member would decrease group expenditures by $1,200 or $12 per member per year.  Why would anyone cut their annual health care expenditures by $1,200 for a $12 savings?  
Mitch Daniels, the governor of Indiana, implemented health savings accounts that restore individual incentives to limit medical expenditures.  He describes the plan and its consequences in "Hoosiers and Health Savings Accounts," which was published in the Wall Street Journal
When I was elected governor of Indiana five years ago, I asked that a consumer-directed health insurance option, or Health Savings Account (HSA), be added to the conventional plans then available to state employees. I thought this additional choice might work well for at least a few of my co-workers, and in the first year some 4% of us signed up for it.

In Indiana's HSA, the state deposits $2,750 per year into an account controlled by the employee, out of which he pays all his health bills. Indiana covers the premium for the plan. The intent is that participants will become more cost-conscious and careful about overpayment or overutilization.

Unused funds in the account—to date some $30 million or about $2,000 per employee and growing fast—are the worker's permanent property. For the very small number of employees (about 6% last year) who use their entire account balance, the state shares further health costs up to an out-of-pocket maximum of $8,000, after which the employee is completely protected.
Because the plan is elective, it will only be chosen if it is better for state workers than alternatives.  Daniels writes
The HSA option has proven highly popular. This year, over 70% of our 30,000 Indiana state workers chose it, by far the highest in public-sector America. Due to the rejection of these plans by government unions, the average use of HSAs in the public sector across the country is just 2%...

State employees enrolled in the consumer-driven plan will save more than $8 million in 2010 compared to their coworkers in the old-fashioned preferred provider organization (PPO) alternative. In the second straight year in which we've been forced to skip salary increases, workers switching to the HSA are adding thousands of dollars to their take-home pay. (Even if an employee had health issues and incurred the maximum out-of-pocket expenses, he would still be hundreds of dollars ahead.) HSA customers seem highly satisfied; only 3% have opted to switch back to the PPO.

The state is saving, too. In a time of severe budgetary stress, Indiana will save at least $20 million in 2010 because of our high HSA enrollment. Mercer [an independent health care consulting firm] calculates the state's total costs are being reduced by 11% solely due to the HSA option.
Costs were lowered because people responded to incentives by reducing expenditures with no adverse consequences to their health.
Most important, we are seeing significant changes in behavior, and consequently lower total costs. In 2009, for example, state workers with the HSA visited emergency rooms and physicians 67% less frequently than co-workers with traditional health care. They were much more likely to use generic drugs than those enrolled in the conventional plan, resulting in an average lower cost per prescription of $18. They were admitted to hospitals less than half as frequently as their colleagues. Differences in health status between the groups account for part of this disparity, but consumer decision-making is, we've found, also a major factor.

Overall, participants in our new plan ran up only $65 in cost for every $100 incurred by their associates under the old coverage. Are HSA participants denying themselves needed care in order to save money? The answer, as far as the state of Indiana and Mercer Consulting can find, is no. There is no evidence HSA members are more likely to defer needed care or common-sense preventive measures such as routine physicals or mammograms.
Currently, I am nibbling at the bait that Daniels is offering, but I would need questions answered before I bought into this type of plan hook, line and sinker as a way to reform Medicare and Medicaid.  Is it actuarially sound?  Are the savings in Indiana due to young people signing into the plan who currently have low needs signing but who will eventually need to make health care expenditures that exceed their savings balances?  How would such a plan protect retirees and those near retirement?

With those provisos, such reform of Medicare and Medicaid, and altering the tax structure to treat out-of-pocket expenses the same as those made through a group plan should go a long way to ease future deficits and assure quality medical care. 

Eventually, health care providers will respond to frugal, price sensitive consumers and the real benefits of market driven reform will spontaneously materialize.  No new bureaucracy will be necessary.  Because the provision of good health will cost less, universal health care will be cheaper if majority of voters desire it. 

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Monday, March 1, 2010

Warren Buffett As General Bullmoose?

Li'l Abner was a comic strip that ran from 1934 through 1977.  One of the characters was General Bullmoose, the epitome of a greedy, ruthless businessman, based on Charles Wilson, a former head of General Motors and Secretary of Defense under President Eisenhower who quipped before the Senate, "What is good for the country is good for General Motors, and what's good for General Motors is good for the country."  General Bullmoose's tag line was, "What's good for General Bullmoose is good for the USA."

Warren Buffett, a very smart man and our country's most successful investor in the past 50 years, and comparing him to a cartoon character is not fair, but his recent statement on health care reform captures a Bullmoose like quality.  AP Business writer, Josh Funk, reports on Buffett's statement ("Buffett says health care costs hurt US economy").
OMAHA, Neb. (AP) -- Billionaire Warren Buffett says health care costs are a major drain on U.S. businesses and act like an "economic tape worm."

The head of the holding company Berkshire Hathaway Inc. said Monday on CNBC that America's health care system needs fundamental reform to attack costs because it's not practical to continue devoting roughly 17 percent of the nation's gross domestic product to health care.

Buffett says much of the rest of the world is paying about 9 percent of their GDP on health care and have more doctors and nurses per person.

He says he hopes Congress will develop a new health care reform proposal that will restrict costs more than any of the current plans would.
First and foremost, if markets are functioning well, it is none of his business, or the business of anyone in the government, how much of a worker's wage he or she chooses to devote to health care.  If markets are not functioning well, the government may have a role in improving market structure.  Given that one element of that structure, tax benefits for health care payments made through an employer, causes distortions and reduces consumer incentives to monitor costs, it seems straight forward where reform should begin.  The payments should lose their tax benefits or all health care payments should be granted the same advantage. 

Second, I would like to see evidence that the portion workers' wages are "an economic tapeworm" eating at our nation's competitiveness.  If the reference is to unionized rust belt manufacturers, the government again has some responsibility having granted unions cartel like privileges during the Great Depression.  Many American firms that pay high salaries are prospering, take Google or Microsoft as examples.  I would bet that these firms and most our successful firms pay high salaries with generous benefits. 

Finally, the health care reform before Congress does not cut costs, it reduces payments.  If the reform passes, and a committee is used to ration health care, it will still cost as much for a procedure but fewer people will meet the committee's guidelines.  If the government attempts to pay less for the procedure, the supply of doctors willing to provide the service at that price will decline and a shortage will ensue. 

Many people mistakenly believe that rich business executives must like markets, but this is only conditionally true.  They like whatever makes them richer; if that's bailouts, other types of corporate welfare, taxes on competitors, or markets, it's all good.  Buffett did tell us something important.  The health care reform is corporate welfare as well as consumer welfare.  Because there is no such thing as a free lunch, we have to ask, who will pick up the tab?

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