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Brooks Wilson's Economics Blog: February 2012

Monday, February 27, 2012

The Slippery Side of the Laffer Curve?

The United Kingdom increased its top marginal tax rate to 50% for households earning more than 150,000 pounds ($238,000) to attempt to close its budget deficit. Like the political debate in the United States, liberals argue that increasing taxes on the rich produces a more fair tax system. Very early results indicate that the tax increase has decreased tax revenues (“50p tax rate 'failing to boost revenues’”) implying that the United Kingdom is on the wrong side of the Laffer curve named after Arthur Laffer.

The graph plots a possible Laffer curve that is not based on data. It shows tax revenue increasing until the marginal tax rate reaches 57%. The point of maximum revenue does not indicate the best size of government. Raising the top marginal rate beyond that point would punish the wealthy rather than generate more revenues. The maximum revenue level does not suggest the best size of government. It could easily be smaller but not larger.  

Suppose government officials demonstrate that larger government expenditures would increase social welfare. Those expenditures would require deficit financing which may slightly increase the size of government but would soon give rise to unmanageable levels of debt. 

Have the British reached the slippery side of the Laffer curve? Mathias Trabandt and Harald Uhlig suggest they might have given the increase in the top marginal rate in “How Far Are we From The Slippery Slope? The Laffer Curve Revisited” Using date from 1995 until 2007, they conclude that 
 For benchmark parameters, we have shown that the US can increase tax revenues by 30% by raising labor taxes and by 6% by raising capital income taxes. For the EU-14 we obtain 8% and 1%. A dynamic scoring analysis shows that 54% of a labor tax cut and 79% of a capital tax cut are self-nancing in the EU-14….

 However, transition effects matter: a permanent surprise increase in capital income taxes always raises tax revenues for the benchmark calibration. Finally, endogenous growth and human capital accumulation locates the US and EU-14 close to the peak of the labor income tax Laffer curve. 

We therefore conclude that there rarely is a free lunch due to tax cuts. However, a substantial fraction of the lunch will be paid for by the efficiency gains in the economy due to tax cuts. Transitions matter. 
 Trabandt and Uhlig’s work might provide an explanation as to why countries that tax a larger share of GDP than the United States have less progressive tax structures. The rich earn a larger percentage of their income from capital which is inherently more difficult to tax due to the ability of the wealthy to avoid taxes. The United State and the EU-14 may also be much closer to the peaks of their capital Laffer curves than their labor Laffer curves.
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Monday, February 20, 2012

Deregulate the Lunch Box

A second four-year-old girl at West Hoke Elementary School was told her mother’s lunch was not up to snuff (“Exclusive: 2nd N.C. Mother Says Daughter’s School Lunch Replaced for Not Being Healthy Enough”). 

While packing lunches necessitates government supervision, sex change operations for minors do not (“Sex-changing treatment for kids: It's on the rise”). 

CHICAGO (AP) - A small but growing number of teens and even younger children who think they were born the wrong sex are getting support from parents and from doctors who give them sex-changing treatments, according to reports in the medical journal Pediatrics…

Guidelines from the Endocrine Society endorse transgender hormone treatment but say it should not be given before puberty begins. At that point, the guidelines recommend puberty-blocking drugs until age 16, then lifelong sex-changing hormones with monitoring for potential health risks. Mental health professionals should be involved in the process, the guidelines say. The group's members are doctors who treat hormonal conditions.

Those guidelines, along with YouTube videos by sex-changing teens and other media attention, have helped raise awareness about treatment and led more families to seek help, Spack said.

A sex change operation is more consequential for a child than a bad lunch if the lunch were indeed bad.  If parents are competent to decide a sex change, they are certainly competent to pack a lunch.  It is time that home lunch preparation regained the same deregulated status as sex change operations.

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Friday, February 17, 2012

The Volt: Struck Twice by Lightening

The Obama administration is hell bent for leather on placing one million new-tech automobiles on our highways by 2015.  To help accomplish this goal, the administration intends to increase the subsidy on battery-powered vehicles like the Chevrolet Volts, and on natural gas powered vehicles. 

I believe that the policy is bad economics for two reasons.  First, governments are bad at picking market viable technologies.  Michael Boskin recently quoted Larry Summers who was at the time President Obama’s chief economic advisor who said, “the government is a crappy venture capitalist” (“Washington's Knack for Picking Losers”).  Second, the demand for vehicles like the Volt is probably inelastic meaning that it would take a large increase in the subsidy to cause a significant increase in the number of cars sold.  The average Volt buyer earns $170,000 annually and approximately 50% drive a Prius or BMW (“Obama hikes subsidy to wealthy electric car buyers”).  My guess is that the buyers are trying to make a personal statement about their commitment to the environment and this statement is not particularly dependent on price.

The graph of the “Market for the Chevy Volt” provides some important economic details of the Volt market and the impact of the federal tax credit subsidy.  As with my first attempt to describe the possible outcome of a subsidy for the Volt, (“The Chevy Volt”), a lot of guess work went into the shape of the supply and demand curves.  In this graph, I made demand more inelastic; I did try to find a realistic price but not sales volume.  I almost certainly exaggerate sales.  The supply (S) and original demand curve (DO) represent the market for the Volt prior to the federal tax credit subsidy. Without a subsidy Chevrolet sells 38,800 Volts at approximately $42,400 a piece (point E0).  The $10,000 federal tax credit increases demand (D0 to DN).  At the new equilibrium (E1), Chevrolet sells 4,000 more Volts and equilibrium price increases by $2,000 to $44,400.  With the $10,000 subsidy, the buyer’s price falls to $34,400.

The EPA gives the Volt a combined gasoline/electric fuel economy of 60 mpg, or about twice the mileage of a similarly sized car.  Assuming that a typical Volt owner will drive 15,000 miles per year, and that gasoline costs $4.00 per gallon, the Volt will save its owner approximately $1,000 per year in fuel expenses.  If a traditional subcompact costs $20,000, and assuming the buyer does not respond to the lower operating cost by driving more, the Volt will have a fourteen year payback period ([$34,400-$20,000]/$1,000 per year=14.4 years) for the owner.  

The private market has a new partner, the taxpayer—the forgotten man.  The yellow rectangle is the subsidy paid by taxpayers.  It is $428 million dollars ($10,000 times 42,800 Volts).  The government estimates that approximately one third of buyers will not qualify for the subsidy, reducing the taxpayer’s bill to approximately $285.3 million, or approximately $71,300 per additional Volt sold.  To benefit society, the sale of Volts must generate sizeable positive externalities like a reduction in pollution or a more rapid technological development, etc.  I have a hard time believing that there will be a positive return on societal investment.

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Wednesday, February 15, 2012

Ward or Free Women?

(HT: Drudge Report) An employee of an elementary school in North Carolina to a preschool girl that her homemade meal wasn’t healthy enough and replaced that meal with one from the school cafeteria (“Food police reject preschooler's homemade lunch... in favour of chicken nuggets”). The Department of Health and Human Services determines what is healthy and requires students to eat put it on their plates. The girl’s incensed mother responded,
What got me so mad is, number one, don’t tell my kid I’m not packing her lunch box properly…I pack her lunchbox according to what she eats. It always consists of a fruit. It never consists of a vegetable. She eats vegetables at home because I have to watch her because she doesn’t really care for vegetables. 
You can lead a girl to vegetables but you can’t make her eat. She ate the chicken nuggets on the school provided plate but nothing else. The mother was charges $1.25 for the lunch.

Two winners of the Nobel Prize in Economics suggest two problems with the school’s action. The minor issue was that the school action almost necessarily reduced the wellbeing of the girl. Hayek argues that government action lacks local knowledge, in this case the girl’s eating habits, which is needed for an efficient decision.

The bigger issue is the role that citizens should give the state. Milton Friedman addresses this issue by criticizing a much quoted statement by President Kennedy. Upon reading Friedman’s critique, I first disagreed, but on subsequent readings, I have flip-flopped and completely and whole-heartedly agree with it. The following quote is from the introduction to Milton Friedman's 1962 book "Capitalism and Freedom".

In a much quoted passage in his inaugural address, President Kennedy said, "Ask not what your country can do for you - ask what you can do for your country." Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. The paternalistic "what your country can do for you" implies that government is the patron, the citizen the ward, a view that is at odds with the free man's belief in his own responsibility for his own destiny. The organismic, "what you can do for your 'country" implies the government is the master or the deity, the citizen, the servant or the votary.

To the free man, the country is the collection of individuals who compose it, not something over and above them. He is proud of a common heritage and loyal to common traditions. But he regards government as a means, an instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. He recognizes no national goal except as it is the consensus of the goals that the citizens severally serve. He recognizes no national purpose except as it is the consensus of the purposes for which the citizens severally strive.
The free man will ask neither what his country can do for him nor what he can do for his country. He will ask rather "What can I and my compatriots do through government" to help us discharge our individual responsibilities, to achieve our several goals and purposes, and above all, to protect our freedom?
And he will accompany this question with another: How can we keep the government we create from becoming a Frankenstein that will destroy the very freedom we establish it to protect?
Freedom is a rare and delicate plant. Our minds tell us, and history confirms, that the great threat to freedom is the concentration of power. Government is necessary to preserve our freedom, it is an instrument through which we can exercise our freedom; yet by concentrating power in political hands, it is also a threat to freedom. Even though the men who wield this power initially be of good will and even though they be not corrupted by the power they exercise, the power will both attract and form men of a different stamp.
The girl and her mother were no longer free women but wards of the state.
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Monday, February 13, 2012

Santorum on the CPAC Straw Poll

(HT Drudge Report)  Mitt Romney won the Conservative Political Action Conference (CPAC) with 38% of the vote.  Rick Santorum took second with 31%.  Gingrich took third and Paul, fourth.  Santorum dismissed by innuendo Romney’s win claiming that  Romney like Paul in previous years “rigged the straw poll,” and “stacked the deck” by buying tickets for supporters (“Santorum: 'I Don't Try to Rig Straw Polls'”).

“For two years Ron Paul has won those [CPAC straw poll] because he just trucks in a lot of people, pays for their ticket, and they come in and vote and they leave. We didn’t do that. We don't do that. I don't try to rig straw polls.”

Santorum accused Romney of similar tactics at this year's conference. “You'll have to talk to the Romney campaign and [see] how many tickets they bought. We've heard all sorts of things.”

Santorum stopped short of accusing his rivals of dirty politics, saying that stacking the deck is “standard procedure for straw polls” and noting that, “there’s nothing wrong with that.”

“We just don’t think that’s a good use of our resources,” he said. “Governor Romney obviously may have a different idea.”

Even if the accusation is true, winning the straw poll is a legitimate victory for Romney.  Packing the building with supporters is a function of the enthusiasm of supporters, and the ability to organize and to raise contributions to fund the ticket purchases.  Yes, generating enthusiastic supporters is not considered a Romney strength, but management of a campaign is.  Does anyone believe that Santorum would refrain from “stacking the deck” if he had the resources and campaign organization to do so?

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Wednesday, February 8, 2012

Biblical Support for a Progressive Tax

President Obama said at the National Prayer Breakfast
If I'm willing to give something up as somebody who's been extraordinarily blessed, and give up some of the tax breaks that I enjoy, I actually think that's going to make economic sense," he said. "But for me as a Christian, it also coincides with Jesus's teaching that “for unto whom much is given, much shall be required [Luke 12:48].”
The president misses the mark in his biblical justification of a biblical justification for a more progressive tax structure because the verse is about personal responsibility and not tax structure.  A similar verse about personal responsibility could be used to suggest that Jesus preferred regressive taxes.
For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.
And cast ye the unprofitable servant into outer darkness: there shall be weeping and gnashing of teeth [Matthew 25: 29-30].
Leaving behind the appropriateness of using the National Prayer Breakfast as a forum to defend the administration’s economic initiatives, the New Testament can be combined with economic theory to justify a government that aids the poor through a progressive tax structure.  Jesus taught to feed the hungry, cloth the naked and visit the sick and afflicted (Mark 12 34-40).  The poor, at least to some extent, cannot feed or cloth themselves so it must be done by those who are not poor. 
The primary lesson of the parable of the widow’s mite (Luke 21:1-4) is that the poor widow who gave only a small amount to the treasury gave more than the rich who gave out of their abundance fits well with the economic theory of the declining marginal utility of money.  The more wealth or money a person has the less a new dollar of wealth or income adds to their wellbeing.  By transferring resources from the wealthy to the less wealth the resources are placed with those who value them more.
The parable of the good Samaritan told of two men who knew that they should have helped another who had been robbed and wounded but did not and a third man who did not have an obligation but did (Luke 10: 30-36).  A progressive tax may force wealthy free-riders who believe that aiding the poor is their social responsibility to meet the obligation that they believe they owe but wish to avoid.  Combining the admonition to care for the poor, the declining marginal utility of money and the free-rider problem, a Christian could build the case for policy to help the poor paid for by a progressive tax system. 
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Saturday, February 4, 2012

January 2012 Unemployment Report.


The Bureau of Labor Statistics released the “Employment Situation Summary” for January.  It was an encouraging report.  Unemployment fell .2% to 8.3%.  Total nonfarm payroll employment increased by 243,000.  The labor-force participation rate did fall from 64.0% to 63.7% because the number of adults not in the labor-force increased by 1.18 million largely because of the aging of the population; 1.07 million people 65 and older dropped out of the labor-force. 

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Wednesday, February 1, 2012

Candidates, Money, Votes and Reverse Causality

Political pundits often err discussing the role of money in politics arguing that money buys elections for candidates when the opposite is true, good candidates win elections and that attracts money.  In an otherwise excellent article David Paul Kuhn (“Will Romney's Strengths Prove Moot Against Obama?”) makes this error writing

Mitt Romney is winning the GOP race for two reasons: big money and weak competition. That should distress Republicans…In the general election, Republicans will face a more practiced, more disciplined and equally financed opponent. Gingrich should be the easy part. Yet it will remain hard. Gingrich is not going away. On money and performance, we have seen how one Republican after another can lose the race. Romney still has to prove he can win it.

Research by Steven Levitt convinces me that the candidate is the important issue and not the money.  Levitt and Dubner describe Levitt’s research in Freakonomics: A Rogue Economist Explores the Hidden Side of Everything.

…picture two candidates, one intrinsically appealing and the other not so.  The appealing candidate raises much more money and wins easily.  But was it the money that won him the votes, or was it his appeal that won the votes and the money?

That’s a crucial question but a very hard one to answer.  Voter appeal, after all, isn’t easy to quantify.  How can it be measured?

It can’t, really—except in one special case.  The key is to measure a candidate against…himself.  That is, Candidate A ran against Candidate B in two consecutive elections but in each case spent different amounts of money. Then, with the candidates’ appeal more or less constant, we could measure the money’s impact.

As it turns out, the same two candidates run against each other in consecutive elections all the time—indeed, in nearly a thousand U.S. congressional races since 1972.  What do the numbers have to say about such cases?

Here’s the surprise: the amount of money spent by the candidates hardly matters at all.  A winning candidate can cut his spending in half and lose only 1 percent of the vote.  Meanwhile, a losing candidate who doubles his spending can expect to shift the vote in his favor by the same 1 percent.  What really matters for a political candidate is not how much you spend; what matters is who you are. 

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