Friday, September 30, 2011

Obama's Tax Proposals

I'm still a bit worked up about how Obama's tax plans were covered in the media.  I just don't feel that Obama's positions were accurately presented or that the objections to them really reflected the plan itself.  Instead, we were given a somewhat fantastical narrative about the plan that adhered more closely to traditional stories about the left and right than it does to actual policy positions that exist in the real world.  Storytelling trumped facts yet again.

So, I'll give my own take on the tax provisions of Obama's plan  (if I get ambitious I may comment on the rest in the future).

First, a bit that I favor but that is neither here nor there narratively.  The plan includes an expiration of the Bush tax cuts on higher income earners.  Looking over the last decade there's no real evidence they did much for growth so good riddance, but I admit this particular provision falls into the traditional story well enough.  The thing is, the rest of the plan really doesn't.

The second thing I'll bring up is a provision I lean towards not liking but that doesn't really fit the traditional narrative.  This is the proposal to limit the value of itemized deductions to 28% for families making more than $250,000.

There's a few notable things about this proposal.  First off, it's complicated, which on its own is a good reason not to like it.  It does weird things, like create a zone where families making $240,000 a year can still get a deduction worth 33 cents on a dollar where deductions for a family making $260,000 a year are worth only 28 cents on the dollar (admittedly ignoring some complications here).  Most likely this won't do anything to alter incentives, a deduction is still worth 28 cents on the dollar and the reduction from 35 cents on the dollar won't make much difference.  This will also balance incentives so that the person facing a 35% marginal rate will now have a similar incentive structure to someone at the 28% marginal rate lessening distortions due to differential impact between brackets.

On the whole, however, this is an ass backwards way of doing this and we'd be better off tackling more deductions so that we don't get as many distorting tax incentives.

Which is what I like about this plan.  Most of the changes involve getting rid of distortionary tax incentives.  This is particularly important because most of the tax literature indicates that most people* don't respond all that strongly to absolute changes in tax rates but respond very heavily to differences between tax rates.  So while behavior won't be distorted a great deal by a change in the marginal tax rate it will be distorted heavily if there is a change in the capital tax rate relative to the income tax rate, in treatment of various income sources, or in deductions for various types of spending.**

A very big piece here is that carried interests/profits will now be treated as ordinary income.  This tax treatment is particularly illustrative of the unfairness of the tax code and how it distorts behavior.  By treating this form of income differently the tax code creates very large incentives for businesses to seek to classify employee compensation as carried interest rather than as ordinary income.  This shifting is likely to be inefficient, businesses are doing this because it brings them a tax advantage, not because of market efficiency.  By eliminating this deduction the plan will not only raise revenue but it will also reduce distortions in the economy.  Eliminating loopholes such as this are pro-market under any definition of the market more sophisticated than market = private sector (which is unfortunately used all too frequently).

There are a number of other rules changes such as this, regarding oil and gas companies, life insurance companies, accounting rules, etc., some of them quite technical.  On the whole, eliminating these loopholes should be efficiency increasing (in my opinion, very, very few loopholes are efficiency increasing and I believe their elimination would almost always benefit growth, the few exceptions can be better dealt with in many cases through spending rather than the tax code, well with some exceptions where the IRS would be more efficient at dispersing the spending but this is mostly for low income individuals rather than the high income exceptions discussed here).  It needs to be more broadly recognized just how much variation there is in the current tax treatment of individuals.  This variation is far more distorting and damaging to efficient allocation and economic growth than the absolute levels of taxation and spending, it is relative tax rates that matter not headline rates.  Obama's plan is surprisingly good, though not perfect, at focusing on distortionary provisions of the tax code.  More could be done, but it's a step in the right direction.

My biggest critique, really, is that there is no provision to cap the home mortgage interest deduction, which is an increasingly necessary reform.  Wealth and the Welfare State referred to the American welfare state as V shaped for the amount of giveaways the rich receive, largely through the tax code. The mortgage interest deduction being the biggest of these, it should have been the first cut.

*Exceptions are basically artists and other who engage in piece work.  High tax rates can and do make these individuals choose not to write another book, act in another movie, or give an additional talk or lecture.  This is a small segment of the wealthy population however.  A factory owner doesn't have the luxury of being able to shut his factory down halfway through the year because too much of his marginal income is being taxed away to be worth it.  While we can argue on some esoteric philosophical plain about the implications of this, as a pragmatic, empirical matter there is little observable change in behavior based on absolute rates beyond those few that engage in high end piece work.

** While people don't change their behavior very much to changes in absolute rates changes in relative rates will cause individuals to hide their personal income as business income if taxes on capital are lowered relative to labor.  This is surprisingly easy to do, though the easiest loopholes have been closed.  It can also be seen in other areas, favorable tax treatment of housing causes people to invest more in housing relative to other assets than they otherwise would.  This does, of course, break down once we are "out of sample," as Lindert said many times in his book.  Truly confiscatory taxes, such as more than half of absolute, not marginal, production does tend to have very significant impacts on behavior.  This, however, is almost never engaged in by states in modern times (it is, however, historically frequently engaged in by powerful private actors and is a recurrent theme throughout history, for instance, in China, taxes were generally set at 1/30 of the harvest in Han times, in additional to pole taxes which could also be problematic, but landlords would frequently take half the harvest, a recurrent historical theme, not just in China but in most agrarian societies, is that peasant revolts worsen as more peasants become beholden to private landowners rather than the state, there's no reason to believe this is unique to pre-modern societies, though we have no recent historical experiences of a modern state weak enough to allow this dynamic to develop over a long time frame).

Tuesday, September 27, 2011

The Ephemeral Nature of Ideology

I sometimes come across references to ideologies that imply that many ideological stances are opposite sides of eternal questions.  Most frequently, this is referenced to class with the old Roman plebian vs. patrician struggles trotted out as an example, never mind that social class in Roman was a legally recognized and created status involving certain privileges and was less than perfectly correlated with material wealth.

On a superficial level this is true enough, there are a range of questions that people tend to divide into two camps on.  Throughout history we see people for and against foreign intervention, for and against economic intervention, for and against harsh laws and punishments, etc.  However, arguing from this that ideology reflects eternal divides is superficial for two reasons.  First, ideology is far more than these questions, it is a narrative that seeks to link them together for purposes of political mobilization as well link multiple issues distinct from more general questions to them for political purposes.  It also fills gaps in our knowledge of issues, whether it is individual gaps or things we don't fully understand as a society.  These extra issues composing an ideology are far too big for me to address meaningfully in a blog post.

The second superficiality is that the big questions addressed by ideologies are not linked together in any consistent way.  While it is easy enough to identify two opposing ideological camps in any society as well as to identify issues that conform to both big modern questions and ancient questions, each society will have the big questions split up by its ideological parties differently.  While ideology can, and does, have a force of its own this is necessarily a force put into motion by powerful actors in a given society, not a natural product of people dividing on either side of eternal questions.

These thoughts were spurred by reading a summary of the modernist and reformist political positions in the Former Han dynasty given in The Cambridge History of China, Vol.1 (p. 188 -189).  If someone is looking for loose ideological similarities between their positions and modern political divisions they can be found.  For instance, the modernists supported state controls (though unlike the American left, though like the socialist left, their justification was to take profits from private hands and bring them into the state), believed that the state iron monopoly helped to give high quality tools to the peasant, sought to stabilize the price of iron goods and salt, and sought to ensure regular production and transport of goods using state labor (it also needs to be noted that economic thought and ideas of individual liberties were far more primitive meaning that the means to achieve these things are not what anyone on the left or right would support today).  The reformists disparaged the idea that the state could earn profits from its monopolies and that these transactions were of no use to the Chinese people, charged that state created tools were of poor quality and that the price was the same regardless of quality, that the state misused the labor it was supplied with, and charged that the government was oppressive and its exactions harsh.

We can also flip the views however.  The modernists also sought to encourage manufacture, trade, and transport, sought to maintain a stable currency, believed that the best means of defense lay in taking the offensive, sought to support trade, and sought to deter crime and support social stability through a strong system of laws and punishments.  By contrast, the reformists complained there were grave disparities between rich and poor, thought that expansion had weakened China and wasted its wealth, sought to restrict trade, and thought that the laws and punishments treated the population unjustly and inequitably.  There were also some ideas that are totally outside of modern debate, such as reformist opposition to money generally and support of taxation in kind and their belief that giving moral lessons were more valuable than punishments and that inculcating moral principles in training government officials was essential to good government.*

Thursday, September 22, 2011

Book Review: Growing Public

Book review of Lindert's Growing Public

Read this book, my copy will shortly be on its was back to Washington state to be available for another interlibrary loan (I'll probably be buying a copy to keep as a reference soon as well).  This is one of the better books I've read on comparative policy history.  There are two volumes, the first is accessible to the general public but still contains a wealth of data, the second contains his model and a great deal of information on the data and calculations.  The second volume is aimed at social scientists but is worth reading for anyone puzzled over why his findings seem at odds with reports of what is supposedly expert opinion found so frequently on the internet.

Lindert's basic puzzle is why the relation between social spending and economic growth is close to zero, and according to his empirical estimates possibly slightly positive.  His answer is basically common sense, democracy serves as a check on any excesses so greater public spending tends towards both more efficient taxation and more efficient social policies (with some exceptions I'll mention briefly later).

The general gist of what he is communicating are summed up in 9 conclusions from page 20 of volume 1:
1. There was so little social spending of any kind before the twentieth century because political voice was so restricted.
2. The central role of political voice is shown by an exceptional early case.  Both Britain's relatively high poor relief in 1782 - 1834 and cutbacks in 1834 and 1870 fit the changing self-interest of those with voice.
3.Just noting the interests of those with voice helps explain education puzzles (summarized).
4. The great advance of social spending since 1880 is explained partly by the same political-voice motif, partly by population aging, and partly by income growth...
5. Postwar welfare states developed more fully in countries where the middle and bottom ranks traded places more and were ethnically homogenous
6. The same forces that explain the growth of social spending until the 1990s carry implications for the future of all regions... (greatly summarized)
7.The net national costs of social transfers, and the taxes that finance them, are essentially zero.*
8. That large social programs have cost little in practice is consistent with the rise of European unemployment since 1970... the loss in output was less severe because those who remained out of work tended to be less productive workers anyway.** (summarized quite a bit)
9. Two general principles seem to explain why the welfare state does no net damage to GDP per capita and why welfare states will not collapse.  The first is that high budget democracies show more care in choosing the design of taxes and transfers so as to avoid compromising growth.  The second is that broad universalism in taxes and entitlements fosters growth better than the low-budget countries' preference for strict means testing and complicated tax compromises.

I can't emphasize enough how important this book is to read if you want to understand growth, spending, and optimal policy.  There are bits I could quibble with, and I found other criticisms of small pieces online, but this is inevitable with any book of this scope.  I certainly couldn't find anything that presented a challenge to the conclusions, some of the things I would quibble with would actually reinforce them.

A significant part of this book is that there are tradeoffs on both the tax and spending side.  Neither the optimal tax utopia of the far right nor the high spending utopia of socialism are compatible with either side's preferences on the tax or spending side.  The far right can't get their optimal taxes without high social spending and the far left can't get their high spending without efficient taxes that allow capital to flow freely.  This book just reinforces my conviction that both poles are dead wrong and the state is essentially symbiotic with markets rather than opposed, efficient taxation is not possible without efficient social policy.  Also, it reinforces the idea that many social policies actually are efficient, while it is possible to simply state that the government never does anything useful the empirical data says the opposite.

This isn't to say that Lindert finds all welfare state policies effective.  For instance, he finds that employee protection laws are correlated with both higher unemployment and lower growth.  This isn't surprising but it needs to be mentioned that other works on the subject find that social spending is heavily correlated with the socialist influence that leads to these confrontational policy with business.  It's perfectly consistent with my contention that the standard left-right ideological paradigm fails to grapple with the actual observed effects of policy.

Something I would find interesting is an extension of part of the books argument to look at why US spending and taxing are so inefficient.  One notable possible cause is the very low voting turnout.  It may easily be the case that the lack of democratic participation and knowledge in the US is enabling certain elites to have undue influence in our public policy leading to both inefficient taxation that benefits these groups as well as inefficient social policy which serves to help prevent voter mobilization that would increase spending as well as targeting inefficient tax privileges.  I think this equilibrium may be particularly damaging to small business owners (and the poor), a subject I'll take up in a later post.

A working paper that addresses some of the same issues the books do is available online, though I urge you to read the entire thing to get the full argument.

* While this may seem peculiar to many that are used to hearing about the negative effect of taxation, much of what is written about taxes relies on assumptions that social spending does no good.  Using this assumption taxation can never be anything but a loss so it's basically a meaningless result as far as optimal levels of social spending and taxation go.  Though this assumption can be valid when analyzing trade-offs between various forms of taxation.

** This is something that will be uncomfortable for many to admit.  A lot of policies seek to induce more individuals to work.  However, evidence indicates that those that are dropping out of the labor market are the least productive individuals.  Is it really efficient to be trying to incentivise someone to work whose marginal labor productivity may be below the minimum wage and may even be lower than a subsistence wage?  In this case, it may be more efficient to just provide welfare rather than wasting resources on either carrots or sticks to get this theoretical marginal individual to work.  The choice in this case may be to pay for welfare or for prison.  I won't pretend to have an answer, I just want to raise the question.

Tuesday, September 20, 2011

This is How They Lie to You

I've been absolutely blown away by the speed with which Obama's statements about the "Buffet tax" have been misconstrued.  It's even reached Yahoo News, which is what spurred this post.  I've already linked some other articles on this, but I'll briefly quote Yahoo on the subject.

President Barack Obama says he wants to make sure millionaires are taxed at higher rates than their secretaries. The data say they already are. ...

On average, the wealthiest people in America pay a lot more taxes than the middle class or the poor, according to private and government data. They pay at a higher rate, and as a group, they contribute a much larger share of the overall taxes collected by the federal government.

The problem with this statement is that Obama never claimed that the average millionaire was being taxed less than less wealthy Americans, he simply claimed that some wealthy Americans were paying less.

How about we actually look at Obama's speech.

And that’s why this plan eliminates tax loopholes that primarily go to the wealthiest taxpayers and biggest corporations –- tax breaks that small businesses and middle-class families don’t get.  And if tax reform doesn't get done, this plan asks the wealthiest Americans to go back to paying the same rates that they paid during the 1990s, before the Bush tax cuts...
In fact, I’ve cut taxes for the middle class and for small businesses, and through the American Jobs Act, we’d cut taxes again to promote hiring and put more money into the pockets of people.  But we can’t afford these special lower rates for the wealthy -– rates, by the way, that were meant to be temporary.  Back when these first -- these tax cuts, back in 2001, 2003, were being talked about, they were talked about temporary measures.  We can’t afford them when we’re running these big deficits.
Now, I am also ready to work with Democrats and Republicans to reform our entire tax code, to get rid of the decades of accumulated loopholes, special interest carve-outs, and other tax expenditures that stack the deck against small business owners and ordinary families who can’t afford Washington lobbyists or fancy accountants...  That means that how much you pay often depends less on what you make and more on how well you can game the system, and that's especially true of the corporate tax code.
We’ve got one of the highest corporate tax rates in the world, but it’s riddled with exceptions and special interest loopholes.  So some companies get out paying a lot of taxes, while the rest of them end up having to foot the bill.  And this makes our entire economy less competitive and our country a less desirable place to do business... And we can lower the corporate rate if we get rid of all these special deals.
So I am ready, I am eager, to work with Democrats and Republicans to reform the tax code to make it simpler, make it fairer, and make America more competitive.  But any reform plan will have to raise revenue to help close our deficit.  That has to be part of the formula.  And any reform should follow another simple principle:  Middle-class families shouldn’t pay higher taxes than millionaires and billionaires ...

So far so good, but now we're getting to the tricksy part.  Yahoo, and others, quote this bit:

Warren Buffett’s secretary shouldn’t pay a higher tax rate than Warren Buffett.  There is no justification for it.
It is wrong that in the United States of America, a teacher or a nurse or a construction worker who earns $50,000 should pay higher tax rates than somebody pulling in $50 million.
Without also quoting the most important bit:
They should have to defend that unfairness -- explain why somebody who's making  $50 million a year in the financial markets should be paying 15 percent on their taxes, when a teacher making $50,000 a year is paying more than that -- paying a higher rate.

My key point here being that there is already a massive counteroffensive against the public perceiving things from the Democrat's point of view.  Obama is not, and never claimed to be, talking about the average wealthy individual.  His speech was about a particular set and not wealthy people who are doing their bit under the general provisions of the tax code:

All I’m saying is that those who have done well, including me, should pay our fair share in taxes to contribute to the nation that made our success possible.

So those wealthy people who are making their millions and billions without needing to take advantage of tax shelters and favorable tax treatment are largely irrelevant to Obama's speech.  It doesn't matter that the average wealthy person is paying more in taxes, it matters that a certain large set of wealthy people, such as Warren Buffet, are able to pay far less in taxes meaning that wealthy people that earn their incomes by other means are paying far more in taxes than other wealthy individuals.  It matters even more that many economists think that the particular way in which these taxes are avoided are particularly damaging and distortionary.  It also matters that a sense of what the wealthiest individual's fair share is has been decreasing decade by decade for the last several, with no corresponding increase in general economic growth or growth in income for the rest of society.

My main point is that I agree with Obama when he says:
Now, we’re already hearing the usual defenders of these kinds of loopholes saying this is just “class warfare.”  I reject the idea that asking a hedge fund manager to pay the same tax rate as a plumber or a teacher is class warfare.
 This reframing of the issue from Obama's point about a minority of wealthy individuals who take advantage of tax loopholes and the need to curb these abuses to framing the speech as instead being about the average wealthy person is class warfare in action.  It distorts the message in order to control and reframe the debate.  I'd bet in a few days we'll see the Conservative chattering class going on about how stupid liberals can't even do math to realize that the average wealthy person pays more in income taxes than poorer individuals.  Which isn't, and never was, the point.

This is how they lie to you and why it is necessary to be careful about what you read, even when you are reading fact checking.

[Update:  For the record, I don't like what I've heard about the Buffet tax so far.  My understanding is that it is simply an AMT for aggregate gross income, rather than just income.  The AMT is highly distortionary and makes the tax code far too complex and burdensome and should be done away with in favor of reducing the number of exemptions.  It would be better to simply raise the capital gains rate closer to the income tax rate (there is a good argument for it being somewhat lower, but it should be close, the current gap seems inefficiently large).  Capping the home mortgage interest deduction would help a great deal as well. The Buffet tax looks mostly to be playing politics, there are better ways of achieving the same result, though this isn't the worst way.  Raising the capital gains tax would probably anger AARP and the financial industry more than the Buffet tax, which is why I think he's avoiding it.  None of this changes my central point of this post though, there is an effort across many platforms to reframe this speech away from the actual issues it addressed and make the popular perception of it something quite different.  It's a bit disturbing to see this happen so quickly.]

Source Your Friggin Data

Now that Obama has come up with a center-left deficit reduction plan instead of his typical center right there's been a hue and cry from everyone vaguely right leaning on the issue.  So far, everything I've found on the plan is vague enough that I have no comment on the overall package, except that I like that he is insisting on vetoing any package that doesn't include some tax increases.  The mix he's calling for I'm not excited about, I'd prefer closing deductions, adding a consumption tax, etc. as well as a millionaires tax (something like an additional 1% at a million followed by another 1% at each order of magnitude on all income sources).

What's annoying me is that every article I click on is giving me different data, and I can't track any of it down.  David Brooks has this:

In reality, the top 10 percent of earners pay nearly 70 percent of all income taxes, according to the I.R.S. People in the richest 1 percent pay 31 percent of their income to the federal government while the average worker pays less than 14 percent, according to the Congressional Budget Office.

Fair enough, but I can't find the specific CBO or IRS reports referred to.

However, according to Fox:

Data compiled by the nonpartisan Tax Policy Center show households pulling in more than $1 million pay about 29.1 percent of their income in federal taxes. By contrast, households making between $50,000 and $75,000 pay about 15 percent. 
Which is it, and where do these numbers come from?  I found the Tax Policy Center easier to find this data on than the CBO or IRS, but that didn't clarify things.  The 29.1% figure looks suspiciously like this, which is from 2000 and doesn't take into account the Bush tax breaks or current tax policy.

Looking around the Tax Policy Institutes site did reveal some other interesting information, for instance from 2010:

And yes, the richest Americans pay taxes, too. Though a tiny minority manage to avoid federal income tax through elaborate tax planning, 99.7 percent of those with annual incomes above $1 million will pay federal taxes this year, surrendering 27 percent of their earnings to the government. The average American taxpayer pays 18 percent.

Or how about:

Also, raising taxes to pay for current spending has proved more effective at restraining spending than allowing the government to finance its outlays with deficits. Every time we have tried to cut spending by restraining taxes, we have failed. In the 1980s under President Ronald Reagan and in the past decade under President George W. Bush, taxes fell, but spending rose. The only time in the past 30 years when spending fell was in the 1990s, under President Bill Clinton, when taxes were also raised.
Even the massive tax increases during and after World War II – amounting to a permanent rise of 10% to 15% of gross domestic product – and the much smaller tax increases in 1990 and 1993 did no discernible damage to U.S. economic growth.
If we are going to raise taxes as part of the fiscal solution, the tax burden on high-income, high-wealth households needs to rise. The recently enacted debt deal contains only spending cuts and has little or no impact on high-income households. Rather, it puts the entire burden of closing the fiscal gap on low- and middle-income households. High-income households should not be exempted from helping resolve the nation's fiscal problem.
Households in the top 1% of the distribution can afford to contribute. They have done enormously well during the past 30-plus years. In 1979, their income accounted for 10% of total income. According to the most recent data (from 2008), their share of total household income more than doubled to 21%. In contrast, real income for middle-class workers has remained roughly constant over the same time frame.

While we're on the topic, an excellent report from the Tax Policy Center written by Leonard Berman (I urge you to read the full report):
The insurance aspect of progressive taxation is less well understood. With taxes, government becomes a kind of partner—albeit an involuntary one. When taxpayers do well, they pay a lot of tax. When things go badly, they pay less (or even get a net subsidy). Even a flat tax reduces the variance of after-tax returns (since the government takes on a fraction, t, of any gain or loss, where t is the tax rate), but a progressive income tax allows for a higher level of consumption when things go badly than a flat tax system that raised the same amount of revenue. Effectively, it provides insurance in the case of bad luck.
 Economist Hal Varian, who developed the theory of taxation as insurance in a seminal paper, argued that this aspect of taxation might argue for especially high tax rates on people with very high incomes—say over $1 million per year. The logic is that incomes that high must have a substantial luck component. It is not plausible that people reach that level of income simply by working especially hard or saving more much than their neighbors. To the extent that very high incomes derive from factors outside taxpayers’ control, taxing those incomes at high rates might have little or no effect on their behavior. ..
 As noted, the obvious downside of progressive taxation is that it weakens economic incentives. However, most economic evidence suggests that taxpayers’ real responses to the individual income tax are small. One might expect high tax rates to deter work and saving, but in fact, the effects are ambiguous... Empirically, the total response appears to be very small or even zero on average.
 As for those with very high incomes, their labor supply is unlikely to be very responsive to taxation. Otherwise, people earnings millions of dollars a year would be working hundreds or thousands of times as hard as people with moderate incomes, which is implausible. (One theory of wage inequality at the top is the “winner take all” model, which suggests that the people at the very top echelons earn many times as much as people who are quite talented, but a rung below. This suggests that the penalty to slacking off, even a little bit, would be much more than could be effected by taxation. Compare the salaries of vice presidents with CEOs, triple-A baseball players with major league starters, summer stock actors with Broadway stars. It seems highly unlikely that top performers would slack off in response to higher taxation. And, as noted earlier, luck plays a larger role in the incomes of the super-rich than the rest of us. Overall, evidence suggests that their labor supply is insensitive to tax rates. ..
 There is an upper bound on productive tax rates—in the sense that higher rates could actually reduce revenue (an effect made famous by Arthur Laffer and his napkin). A new survey by economists Peter Diamond and Emmanuel Saez estimated that the revenue-maximizing federal income tax rate was “conservatively” 48 percent assuming the existing tax base and could be as high as 76 percent if the tax base were much broader. Evidence from other studies also suggests that current rates are safely below the unproductive level...
 The argument for a lower dividend tax rate is that corporation income is already taxed at the company level. Taxing the dividends again corresponds to double taxation. A similar argument is often made to justify lower capital gains tax rates. However, the lower rate is a very imperfect offset. While some corporations pay a lot of tax, some are able to use tax breaks to significantly reduce their effective corporate tax rate.

That's enough.  You should really read the whole report, there are sections quite relevant to what I was writing about regarding capital gains in the last post.

My main point, however, is that if you're going to cherry pick data to support preferred outcomes you should really be careful about linking precisely to the data you've cherry picked lest someone like me come along and actually read the friggin reports which show the objections being expressed to be nonsense.  It's nice for reporters to imagine some magical post-partisan land where both sides are equally right and a straight down the middle compromise is ideal.  However, if you actually read the policy experts, they say this is bullshit.  The rich aren't getting a raw deal, things are already distorted in their favor.  The empirical data tends to point in the direction of higher taxes on the rich.  It also points in the direction of higher consumption taxes and taxes on goods that produce externalities but since no one is arguing for these policies there is no conceivable world in which compromise takes the form of lower than desired taxes on the rich as well as base broadening through consumption taxation and gas taxes.  It's not on the table, what is on the table is a choice between deficit reduction strategies that work, more taxes (economists often express a preference for lowering spending rather than raising taxes based on their models, there are few instances of this actually happening in isolation), and a deficit reduction strategy that only works in models, cutting spending.  Since this is life and not SimPolicyWonk, our choice is between going with what works and believing in unicorns and pixie dust.

The Credit Fairy is unlikely to appear and fix our deficit.

Modelling Taxation

I just came across a reference to taxing capital as double taxation in a book I'm reading (specifically Lindert's Growing Public which is an excellent book I'll have more to say about later, opening up the taxation assumptions like Batina and Ihori do would only reinforce his points) which proved to me this isn't simply an idea floating around the internet and is something that needs to be addressed.  I'm by no means an expert on taxation, though I do find it a fascinating topic, so I thought I'd get to it while my recent reading on taxation is still fresh (I've currently moved on to public spending).

The basics are that it was a common view that taxation on capital would be double taxation on saving leading to lower capital formation as well as being inequitable.  This is true enough when one is thinking about the economy in the form of a simple two goods model with choices between consumption and investment where investment amounts to little more than deferred consumption.  If there is also a present value discount of future consumption, this effect is even stronger.  In this view, people largely save now because they believe they will be able to consume more later by doing so.

However, more recent literature is skeptical of the strong case in favor of consumption over capital taxation (though I am not aware of it bothering to give a critique of this simple accounting identity regarding taxing saving as double taxing income, nor should it really, economics is a study of human behavior not natural law so if behavior does not match the accounting identity it's the accounting identity that is wrong, not human behavior).  To quote Batina and Ihori's Consumption Tax Policy and the Taxation of Capital Income:

It may be suboptimal to exempt capital from taxation if any of the following conditions hold: government spending is strictly proportional to output; precautionary saving arising from incomplete insurance markets exists; there is productive public spending that enhances private investment; there are liquidity constraints; and negative externalities associated with production exist.  The general case for the consumption tax is very weak in the presence of any of these phenomena.
That's a lot of caveats, all of them realistic.  There are other problems with the idea of exempting capital income from taxation.  For instance, while under the assumption that savings today is the result of expected higher, time discounted consumption tomorrow a capital tax will reduce investment, investment will be increased if I assume savings today is the result of a desired income level tomorrow (such as under a lifetime income hypothesis).  With this assumption, if I want to save $1 million for my retirement I will have to save more today if there is a capital tax than if there is not, the capital tax now has the opposite impact that it did under a separate set of assumptions (though it is potentially still distortionary regarding utility measures).  This is probably closer to how most savers in an economy behave. 

Other assumptions create similar complications.  If we add a human capital term so that an individual has a choice between standard capital investment and human capital investment taxing the income derived from human capital in the form of increased wage income and not capital income derived from capital gains and dividends distorts this choice as well.  Enter in bequest terms and the various bequest strategies that have been found in empirical studies of this behavior and things get even more complex.

Stepping outside of more formal economics and just thinking about savings behavior that we encounter as individuals throws more complications up.  Many people just save excess income, if I have plenty of books on the shelf that I haven't read yet my savings account just gradually increases (assuming my girlfriend doesn't have some more exciting ways to spend money, I tend to be kinda boring).  I only consider the return if enough money is sitting there that I think it would be wasteful not to invest, taxes don't even occur to me.  Saving in case of a rainy day is rather common, things happen and we want money just in case.  Also, it should be noted that studies of this find that alternatives to capital taxation, such as wage and consumption taxes, distort labor leisure trade-offs creating another source of distortions not always mentioned when capital taxes are discussed.  There are strong hints that it is labor supply elasticities and not savings elasticities that are of more importance to capital taxation.

I could go on, but I think the general point is clear enough.  The idea that taxing capital is double taxation is largely the product of the assumptions of certain models used to analyze this topic, use different assumptions and there are different results.  This is something that I think should be emphasized more in undergraduate courses (or perhaps in economics generally, I know I heard this much more in my graduate poli-sci courses than I did in my undergrad economics).  Models are excellent tools for thinking about relationships between the concepts under study.  However, they are also prone to simply spitting your assumptions back out at you, if a simple two good economy involving consumption and investment is assumed then there will be one set of results, if instead human capital vs. physical capital is being modeled or labor market dynamics, different sets of results and policy recommendations will be the product of the model. 

From a policy standpoint however, it is most likely the case that all assumptions are valid to one degree or another, some people will face decisions between human capital and physical capital others will follow a strict lifetime income model while others will make consumption decisions that conform more closely with consumption maximizing behavior.  Which model to use then becomes primarily an empirical question, given current starting conditions which set of behaviors is most accurate for the polity under study.  It is also likely that the answer will vary depending on both location and time, one polity may be capital short and need policies to maximize capital investment even at the expense of human capital another may have labor market problems and need a focus on human capital development.  Dealing with the problems of each of these will require different conceptualizations of how income, savings, and capital are treated.  There is no "right" way to think about these subjects, they are contingent on the situation and on what is being studied.  Optimal policy requires the ability to approach a problem from multiple angles, otherwise disaster awaits.

Monday, September 19, 2011

Some Hard Numbers on the Administrative Costs of Means-Testing

Since I write about it often enough and recently came across some relevant figures I thought I'd share the hard numbers on the relative costs of means-testing vs. universal anti-poverty schemes.  Knowing generally that means-testing is more expensive has always been enough for me, the argument against means-testing involves many relatively small effects balanced against the rather large one of less payments to wealthier people, but it always helps to have numbers.

These numbers come from Public Spending and the Poor and specifically from literature review sections in a few of the individual essays, such as "Two Errors of Targeting."  Studies of the US found that administrative costs of universal programs are 2.5% compared to 12 percent for two means tested programs (367).  Costs for specific programs in 1985 ranged from 13.5% for AFDC), 13.5% for food stamps, 8% for SSI, and 4.8% for Medicaid (Toward Quantifying the Trade Off, 483).  It should be noted that a study on poor country didn't find differences in cost between means-testing and other programs, but this is not necessarily generalizable to richer countries.

My takeaway from this is that administrative costs alone do not justify universal programs over means-testing, of course I never though they did.  Once other costs of means-testing, such as work disincentives, the relatively higher costs of under-utilization (there is a welfare benefit whenever a child gets healthcare, for instance, and a welfare loss if a child doesn't get healthcare that would have prevented a disabling condition that is greater than the cost in raw dollars and cents of providing that healthcare which means there is a relatively greater cost for each person not covered that should be than for each person covered that wouldn't qualify under means-testing), stigmatization, political impacts (there is considerable evidence that universal programs are correlated with other efficient social and economic policies, countries with less means testing than the US are more likely to have more efficient tax systems, for instance, pretending these policies are separable despite the contrary evidence makes for poor policy debate), etc. that all way against means testing.  All of these individual impacts are too small to justify the increased expense of universal provision, taken together they argue strongly against means testing.

Thursday, September 15, 2011

Private vs. Public Transfers, Social Security, and the Market

I've been reading Public Spending and the Poor and came across a particularly interesting section which reminded me of the Social Security debate.  Chapter 12, "Private Transfers and the Effectiveness of Public Income Redistribution in the Philippines" by Donald Cox and Emmanuel Jimenez looks at the income of public anti-poverty spending and the impact this has on private transfers.  It provides a nice review of the subject and some good data and models from the Philippines, including transfers linked to age, retirement spending, transfers to families from workers abroad, etc.

The article finds that there is a significant crowding out effect of public spending on private transfers.  While the poor are still much better off after the public transfers the reduction in private transfers means this is not as large as it would otherwise be.

What I want to focus on though, is to think about the effect this has on wealthier households.  Specifically, I want to think about how private spending to boost the consumption of someone else may be rather inefficient.

To explain, think about two different people that decide to start their own business.  This isn't a new factory but rather something modest that a moderate income person is more likely to do, a restaurant or small retail shop.  They're both from poor backgrounds, say their parents were poor immigrants who worked on the farm to provide their kids with enough to get through school, neither set of parents has any assets.  Shortly after starting the business, the father of one of our burgeoning businessmen is injured and can no longer work.  We're in a world without Social Security, so the businessman feels obligated to chip in to keep his parents out of abject poverty since his mother only has part time work cleaning rooms at a local hotel and at her age is unlikely to be able to work extra hours, especially since she has to spend more time at home caring for her husband.

Wednesday, September 14, 2011

Is Government Contracting More Expensive than Staff?

The New York Times reports on a recent report from the Project on Government Oversight POGO) that finds that contracted out services tend to be more expensive than hiring staff.  This matches up fairly well with what I know about the subject, but with a caveat.  Staff is permanent and many government projects are temporary.  Even more expensive contract workers are a better deal if the choice is between permanent and temporary employment.  I haven't read the report, and may or may not get around to reading it.  I'll wait for something more comprehensive to come out that is peer reviewed.

What I find interesting though is that the New York Times also mentioned Heritage for a contrasting view.  I've blogged about Heritage before, I don't really respect them.  They are an unabashed partisan shop out to find facts that fit their story rather than try to find the best explanation for the available evidence.  Their goal is not to increase our understanding but to push the conversation in the direction their funders want it to go.  While they probably do produce some worthwhile stuff, they get enough cash to afford it, it simply isn't worth the time investment to sort the wheat from the chaff.  If you want more honest right wing work American Enterprise Institute is better.  I've heard Peterson Institute as having some right wing, or at least big business, affiliation as well but have found their contributions to be of generally high quality.  So it isn't really a partisan thing, though I prefer Brookings.

Now, I haven't heard of POGO before, they could be great.  But I have to admit that simply contrasting them with Heritage makes me suspicious.  This is the problem with the news media's tendency to balance things by simply presenting both sides, not all arguments are equal.  Non-expert readers expect the media to do some of this sorting for them, few have read enough papers to judge quality on their own.  While ideally the media wouldn't have to fulfill a filtering role, fact is, they do.  Does the average reader have a sense of the relative quality of research done by Heritage, AEI, Peterson, Rand, Brookings, or POGO?  I doubt it.  Simply presenting and linking them just isn't enough.

Nice Little Story on Medicaid Fraud

For the record, most studies of Medicare/Medicaid fraud put the actual amounts at quite a low percentage, though raw numbers can look quite large considered that Federal Medicaid outlays were $204 billion in 2008 (not sure what the number would be counting state outlays).  However, one of the most frequently abused aspects of these programs is home health aides.  There was a bit of a scandal regarding NY City payments a few months back.

Back on topic, Fox News has a nice little story about a veteran who investigated and tracked down a multimillion Medicaid fraud.  Just a neat story, no wider implications.  Well, beyond noting that considering that there is a percent or two of Medicare/Medicaid fraud and abuse we obviously can't rely on individuals to report it all since stories like this are uncommon enough to be newsworthy.  Programmatic changes are needed.  Still nice to see an individual making this much of a difference though, even if there are no systemic implications.

The Failure of Ideology to Reflect Reality

I've been reflecting on the last chapter of Alesina and Glaeser's Fighting Poverty in the US and Europe.  I won't review all of their findings here, basically their contention is that politics have shaped attitudes to the poor rather than basic differences.  They find that hours worked by different income quintiles varies among countries, but the US tends to be near the top of hours worked at all income quintiles.  In some countries the poor work more than everyone else, in some less.  There's no clear pattern with actual behavior.  Also, attitudes towards the poor don't vary based on income mobility, their claim is that there is no evidence of greater income mobility in the US, depending on the country compared the poor may be somewhat less mobile hear while the middle class is somewhat more mobile.  There is also no evidence that the US has been more mobile historically than Europe.  Other works I've read on this dispute some of the details, but I'm not sure whether this is different and newer data or different interpretations of the same data (and I don't care enough to compare bibliographies to answer this question).  These accounts differ in claiming the US used to be more mobile but that this has changed in more recent decades, particularly regarding mobility among the poor.

So that's the snapshot picture of what's actually happening.  What's more troubling is the extent to which the reality differs from perception and ideology's role in this.  In the US, this is primarily right wing ideology.  While this ideology breaks down in the universities, we're pretty much taught a story about how hard work is rewarded and sloth punished, comparative international mobility rates and poverty statistics be damned.  In Europe however, the teaching is more Marxist influenced (to some degree my personal experiences bear this out, I do remember a bit more hard work indoctrination in the US than Canada and supposedly Europe is even farther left than Canada in its teaching, mostly though I'm going off what I've read here and elsewhere, I've never set foot in a European classroom).  This Marxist influenced left wing ideology emphasized the permanence of class and that society is based on privilege, one really can't leave behind the circumstances one is born in.

The problem is that neither view comes close to being even an approximation of the available data.  Both are simply dead wrong.  Income mobility is real and fairly common, and has been throughout human history.  However, mobility rates vary and are likely highly dependent on social and economic policy (I don't know if anyone has studied this empirically, I plan to find out), the laissez-faire approach does not maximize opportunity.  This also however, refutes Marxist class ideas, individuals do respond to incentives, capital does not necessarily come to dominate societies (unless institutions are structured to give it advantage and this is met with an enabling ideology), and cross-cutting cleavages dominate considerations such as class (again, contingent upon institutions, the state must be able to dominate sub-state level political alliances that threaten to overwhelm the normal process of group disintegration).  Neither ideology describes a world where socioeconomic change drives society level responses leading to ever higher rates of mobility and participation.  The right wing ideology fails because it can't explain why participation and mobility has increased as the state has, the left wing ideology fails because it fails to explain why class fails to be the major political and economic identity and how a population can be so economically mobile within the current system.  The left wing ideology also fails to explain how continued growth has not resulted in the takeover by privileged interests.

If these ideologies simply led to some idiosyncratic beliefs, there wouldn't be an issue.  However, the flawed perceptions of each lead to actively destructive policies.  On the right, the failure to acknowledge that the myth of pulling oneself up by one's boots leads to the failure to make investments that would promote income mobility and thus greater utilization and specialization of labor. It leaves a great deal of potential opportunities idle and disempowers people who may otherwise be able to engage in a bit of creative destruction, if only the institutions existed to give them access to the resources needed to compete effectively in the market economy.

On the left, we see a number of destructive labor market policies designed based on the false belief in class immobility.  There are too many impediments to entrepreneurship and union and state policies are designed to protect someone where they are, rather than optimize their ability to move and change.

On the whole, what's necessary is to move past ideologies that were designed to explain a changing economic world we had little data on.  We have the data now and could formulate beliefs that are more accurate to our observations.  What is necessary to realize is that opportunity rarely exists spontaneously, it is created via social and economic investment.  But for individuals to act on these opportunities there need to be sufficient incentives to do so, if they see too much downside risk or too little benefit individuals won't act.  Society and the individual are essential complements, no individual can pull themselves up by their bootstraps (just try, pull hard enough and you might fall) but neither will an individual bother to try pulling if they can't move up by doing it.  As with everything, it is balancing the costs and benefits that is necessary, tipping to one side or the other is inefficient and hurts both people and society.

Tuesday, September 13, 2011

Poverty at Highest Point Since 1993

The Census Bureau has released its Income, Poverty, and Health Insurance Coverage:2010 report, it's worth a skim.  The 2010 poverty rate has increased to 15.1%, the highest since 1993.  This isn't an adjusted figure which is important to note.  Raw poverty statistics are used to assess eligibility for government programs so do not include the impacts of those programs or of tax measures designed to assist the poor (something necessary to keep in mind when nonsense comes up about the government not reducing poverty, since the raw figure is used for eligibility it doesn't measure the impact of most government programs, to a large extent the basic poverty measurement is a closer approximation of market failure than government failure, though anti-poverty measures like job training muddy this interpretation).  The decline in real median income also needs to be noted, though I have nothing to contribute to the subject.  Though it is interesting that the Northeast was the only region for which the decline in median income was not statistically significant.

The main thing I wanted to note is that this increase in poverty is pretty much what the liberal critics of the 1996 welfare reform were predicting as the downside.  It also needs to be noted that the percentage of the population receiving less than 50% of the poverty line in income has been increasing as well.  While the 90s welfare reform did a lot to benefit the working poor and to reduce work disincentives, the compromises made with the Gingrich House resulted in some serious gaps in the safety net.  Early papers I had read on the subject had noted that this seemed to be developing as early as 2008 - 2009, now it seems to have become a reality.  The time limit on welfare receipt seems to contribute significantly to poverty in a long downturn, just as predicted.  It remains to be seen what long term impact this will have on the individuals involved (unemployment insurance is a different topic, while I think our welfare system is almost criminally negligent our unemployment insurance is too generous, benefits should be reduced on a fixed schedule as a work incentive to encourage people to settle for jobs worse than they are accustomed to).  States, such as Michigan, that are shortening welfare eligibility terms will only make this tendency worse.

Reflecting on Taxes

I've been doing a lot of reading on taxes and public spending recently.  I had enough of an overview of the subject that this hasn't made me really rethink anything I've written about taxes before, I'm still for relatively balanced forms of taxation between consumption, capital, and labor.  I have changed my view on the incidence of taxation a bit, because of high levels of tax evasion I've had to revise my view that taxing at the individual level is optimal, rather some taxation of corporate profits is necessary to mitigate tax avoidance.  I've also come to favor taxing property relative to income even more highly, but I already tended this way.

But, while my thoughts on the general themes haven't changed much, there were a few real revelations on more specific, particularly methodological aspects.

First of all, I was a bit shocked how sensitive most of this literature is to assumptions.  In any social science there does tend to be some sensitivity to this, but in this literature there are sign changes and not just shifts in relative valuation.

There are a lot of what I can only call "well, duh" instances in this literature.  For instance, a lot of the  basic parsimonious models find that not taxing capital is optimal.  However, add in terms for human capital or make government spending at least partially a complement to private investment and all of a sudden it becomes optimal to tax capital.  Duh.  If your only source of growth is capital investment and it's simply a choice between capital and consumption then of course you don't want to tax capital, it lets you consume more later.  But, if labor also creates value and not just capital then you don't want to distort the capital labor trade-off, this becomes inefficient.  Similarly, if government does something of value then there is a trade off here and it is optimal to tax capital (or if externalities exist terms change, leisure trade offs matter, time sensitivity and intergenerational responses matter, etc.).  That anyone would take the basic model as a policy prescription is dumbfounding.  Obviously policy requires the extensions of the model that take real-world complications into account.  Keep this in mind when you come across something in the paper vaguely alluding to an economist or a given model, these models are very highly sensitive to starting assumptions and many of them give the unsurprising result that if you assume something to have no value and that something else does have value, your model will confirm this.  Surprise, surprise.

Empirical studies tend to give highly mixed results, this makes me tend to believe that we don't have a good handle on what is optimal.  If empirical results give different answers based on selection and time period choices or based on whether or not human capital terms are used, then we probably aren't at a point where we can make optimal policy recommendations.  This may not be because of a weakness in the theories, there may have been too much economic changes over the past two centuries and longer time frames are necessary.

Another takeaway is that there should be some scepticism regarding results that reach into infinity.  Some models have negative welfare impacts for decades and centuries on the way to optimum paths.  This is obviously nonsensical as a policy approach, there are too many potential catastrophic downsides over this long of a time period for it to be rational to think in this frame, even if perfectly altruistic.  While a small welfare loss may be justifiable for a large increase, any large loss simply isn't justifiable without a great deal more certainty than we have.  Few states survive for more than a few centuries and their collapse tends to bring down the fortunes of most of its citizens, this is not a sensible time frame to use for anything.

The main takeaway though is that when it comes to taxes at best we have a general sense of the tradeoffs involved.  Anyone that claims to have some idea of what an ideal rate or mix of taxes would be is full of shit.  All of these approaches are highly sensitive to starting assumptions and methodologies and the empirical modeling gives answers that are far from robust.  Valuable knowledge is being gained but we're far from where a technocrat can give a valid plan for society.  What has gotten better is that we can understand the menu better and what we're gaining and losing when we commit to a choice.  Doesn't mean that we'll necessarily like the dish served, but at least we'll have only ourselves to blame, rather than fortune, which was the only recourse of the past.

Haven't the Young Always Been Thus?

Brooks has a column in the NY Times today that made me think about the tension between individual and group morality.  Like most things, this is presented as something of a conflict or choice between morality being "revealed, inherited and shared, but now it’s thought of as something that emerges in the privacy of your own heart."  Also like most things, I think this viewpoint is fundamentally wrong.  Morality only exists in the balance between the two, when private searching is met by a social framework.  Frankly, I consider people on either side of the fence to be nuts.

But the main point I wanted to bring up is that I think the moral philosophy of youth used to be just as empty, only on the opposite side of the fence.  It's a bit of a literary trope for youth to be presented as either absolutely sure of their convictions, something that gets eroded with experience, or to be unmoored from any moral anchor, until they learn responsibility.

So I don't think anything new is revealed here, only rather then the unthinking, unyielding certitude of the Victorian age the tendency toward moral drift has come to the fore (though I've seen plenty of the unyielding certitude of youth even today and I bet there were plenty that were morally unmoored at the height of the Victorian age, all that has changed is the frequencies).  But neither of these are moral in any meaningful sense of the word, the rules based certainty of youth doesn't really choose between a relatively enlightened modern morality, the Jacobinism of the French revolution, Bolshevism, or the crazy philosophy of Qin Shi Huang's China.  Following a set of rules blindly doesn't make one any more moral than the kid adrift in moral relativism, if anything, the certitude makes one more likely to be a dupe in grave moral errors, as has tragically happened so often in the past.

 While there is probably more we could do to prepare people for moral decision making, I'm prone to thinking this is a step up from the past.  With time, accumulation of responsibilities will teach just about everyone some hard moral lessons.  While it would certainly help to have more of a shared framework than we do today, the strict inherited codes of the past seem like they would be greater barriers to true moral reflection and understanding than modern relativism, whose very looseness seems to guarantee that an individual will eventually be faced with situations forcing their moral intuition to grow up fast.  Someone with a strict code is less likely to be confronted with situations to make them reflect on on how the individual and society interact, thus stunting their moral growth.

While I have little doubt that few young people display much understanding of moral questions, I would also posit that young people of the past could do little more than make moral sounding noises.  I would also suspect that many young people today will never reach any kind of moral peace with the universe they live in, as I suspect many older people brought up with defined rules and practices never had.  Morality lies in the tension between self and society, desire and obligation, neither relativism nor rules touches morality on its own.

Monday, September 12, 2011

So what do I Think Our Long Run Financial Problems are?

After thinking about it, I think my last post would be clearer if I stated what I believe our long run financial problems to be.  The big three would be:

1. Health Care.  Health care expenses simply aren't something that we're willing to see people go without.  From the bum passed out and rushed to the hospital every few days at the Albany Armory bus stop to Steve Jobs, every American gets urgently needed medical care, if in a more or less timely fashion.  Unless what it means to be American changes enough that we're willing to let bus stop guy freeze to death/overdose, the focus has to be on delivering this care efficiently.  The available data says that for this particular industry private care isn't delivered cheaply, partially due to needing to treat bus stop guy, but as long as we're Americans we won't be letting this particular service be delivered on ability to pay rather than need so the profit motive can't optimize.  While it's easy to find some model that will support individual prejudices regarding the type of health system that's more efficient, the empirical evidence shows that the US is way more costly than everyone else relative to our per capita GDP.  Usually, when someone is doing something better than you, the solution is to learn from their successes, as American manufacturers learned from Japanese lean manufacturing techniques.  When this became only the American way when private concerns were involved and not public, I don't know.

2. Revenue issues.  We don't collect enough in taxes given our changing demographic makeup.  Our old age dependency ratio is going up, this will mean slower growth and higher taxes.  No way around this, demographics impact growth rates and someone is going to have to pay for the benefits.  The question is how do we most efficiently pay for this.  Personally, I like what the economists say, get rid of most tax expenditures, lower corporate tax rates, tax inheritances at the individual level, introduce a small VAT, tax externalities (even if not taxed at theoretically optimum levels undertaxing or overtaxing by some amount is superior to general income or profits*), etc.  Instituting this would take a magic lamp, however.  Still, eliminating some deduction sin return for lower rates is likely possible, both at the individual and corporate level.  Inheritances can be taxed, moving this to an individual level tax rather than an estate tax would probably make it more popular too, not sure why this hasn't been done.  Sooner or later some form of pollution tax will likely be passed, perhaps with lower rates to compensate.  I'm confident in the long run about this getting somewhat better.  What I doubt is that we'll make the tax code more favorable to labor at the expense of capital, which is another direction I'd like to see things go.

3. Defense.  We spend too much on defense and could see this go down.  Mostly, I think the changes we've made to our force structure to meet the challenges of Iraq and Afghanistan have been terrible directions for us to take.  These aren't the wars of the future, these are wars that should have never been fought the way they were (of course, the lack of other options means that they should probably have never been fought at all, both have objectives that are outside the capabilities of military force, every society learns the limits of power sooner or later).  Wars like Kosovo or Libya are the kinds of wars that we should really be able to fight.  They also synergize well with the need to defend our actual territory in addition to complementing NATO forces effectively.  America's strength has always  been on long range force projection and our ability to build and design new equipment.  We've never had great capacities as an occupying force and I don't think we should develop these capabilities, it just isn't us.  Scale back the manpower and focus on the technology and production which has always been our strengths.  We can be the main strike force, let others put the boots on the ground.

Those are the three big ones.  I could also mention international imbalances (which are the opposite direction they should be, we should have a trade surplus right now when we're at our peak workforce and should have a trade deficit when the demographics turn, this will hurt both us and those currently running a surplus with us since when they try to claim what is owed we will have less productive capacity to produce for them, they'll get less than if their timing were different) and Social Security.  International imbalances aren't something that we can fix easily an Social Security just isn't that big of a deal.  The shortfall is more than 20 years in the future and the changes that are needed are pretty much those expected when the program was created.  It needs to keep up with demographic changes.  They didn't know enough to work those in originally, and we probably don't know enough now to come up with the perfect formula.  Like anything that lasts more than 10 years it needs to be tweaked as new information comes in, I'm confident that it will.  The only thing blocking this is the shrillness of the debate which makes it sound like root and branch reform is needed rather than some tidying up due to the progress of time and better information.

* I found it amusing that my browser spellchecker includes overtaxing, but undertaxing is apparently not a word.

Misperception about our Problems

Ross Douthat has a column today on the mistakes Obama made with the stimulus, framed against Congressional testimony from Alice Rivlin.  I agree on the critique of the over rosy projections and while I don't agree with his critique of the policy mix its a plausible critique.

However, he also says:

Finally, instead of pivoting from the Recovery Act to deficits and entitlement reform, the Democratic majority spent all of its post-stimulus political capital trying to push both a costly new health care entitlement and a cap-and-trade bill through Congress. Both policies were advertised, intermittently, as deficit reduction, but neither came close to addressing the real long-term drivers of the nation’s debt.
 Bullshit.  Health care is THE problem with our budget.  While the PPACA is far from perfect, it is better than anything else that has been on offer for more than a decade.  Getting health care right will get us more than half way to getting our finances right.  Less distortionary taxes such as cap and trade will get us a good chunk of the rest of the way (I've been reading a lot of tax literature recently, as long as it is not assumed that market failure is impossible pollution taxes become an optimal way to tax capital, and taxing capital is necessary for efficient taxation as long as labor supply responses are included in the model, of course, many studies exist that don't include these factors, which give the unsurprising result that taxing capital is not optimal, don't include potential theoretical downsides to a policy and guess what, there won't be a downside in your model, surprise, surprise).

My question really, is what Douthat means by, "prioritize Medicare reforms over a more comprehensive health care overhaul."  During negotiation over the PPACA many of the cost control provisions were stripped.  What exactly does Douthat have in mind?  Raising the Medicare age?  Privatizing the entire program and drawing magic graphs, like Heritage did for Paul Ryan*?

Simply privatizing people's health expenses will of course help the Federal debt, but it will just weigh even heavier as a cause in stagnating increases in real living standards and on corporate balance sheets.  It would just be another instance of socializing losses on the American people, while likely privatizing gains among those that benefit most from lowered taxes.

What exactly are these long term drivers of America's debt that haven't been addressed?  I don't think these issues have been addressed optimally, but both the PPACA and cap and trade were strong steps in the right direction.  What is Douthat's plan, getting a think tank to draw a magic graph about the wonders of privatization?

* I don't think it can be pointed out often enough just how absurd the assumptions are behind some of the critiques of Obama's policy. The fact that anyone takes this guy seriously is appalling.

Friday, September 9, 2011

Social Security, Welfare, and Interest Groups

I'm going to confess that they only reason I'm writing this is because a good metaphor ran through my head while staring off into space because of the dullness of the book I'm reading on consumption tax policy and the taxation of capital income (a real thriller).

Anyway, much of the debate about interest groups seems to either take it for granted that interest groups are preexisting or that interest groups are created by government policies, and often always created whenever the government spends money.  Neither of these perspectives are really anywhere close to accurate.  Some interest groups exist based on other sources of power, others come into existence because of rumored changes in government policy, some become coordinated in response to external events, and some do come into being mostly as a result of government spending.  There's nothing uniform about this.

Regarding just the government spending bit however, contrast Social Security with other anti-poverty programs, particularly Temporary Assistance for Needy Families (TANF or welfare).  Social Security is just about politically inviolate, while some politicians will attack it reforms are generally minor and along the lines of what those designing the program intended (SS always required economic growth to pay for it, it was meant to maintain someone's relative income after all rather than be a pension scheme, they also knew that over 60 life expectancy was increasing, however they had poor data on it and it would have been impossible to design a workable formula with that data, still is really, so it was expected that tweaks would be made as necessitated to keep it functioning, reforms to things like retirement age is the program working as designed).  In response to SS, a number of previously weak organizations combined or became organized becoming a very powerful lobby.  There are a lot of reasons behind this, including program design, an easily identifiable minority it pertains to, once in the minority people stay there, and the fact that this minority is one that the majority eventually fall into.  Thus, one of the most powerful lobbies on capital hill was born.

TANF looks a lot different.  Its funding is smaller, but there has never been a comparable consolidation of interests to make for a coherent lobby.  The weakness is overdetermined, there are a lot of differences among the groups it covers, funding streams are highly fractured, most people are only in the relevant minority for a short period of time, etc.

The differences in treatment are stark however.  While SS is nearly untouchable, TANF is basically a pinata that gets beat with a rhetorical bat until the money comes out whenever a politician thinks they need money.  And usually, more people join in with only a few lonely academics calling for the beating to be stop.  This difference illustrates how government spending on its own does little to form interest groups, the characteristics of the potential group makes a big difference.

Thursday, September 8, 2011

My First Reaction to the Jobs Speech

My reaction is basically, meh.  The payroll tax cut hasn't proved very effective so far, I'm sceptical of tax measures at this time.  If we're going to act through taxes an increase in the standard deduction seems more effective because it would give proportionally more back to the very poorest who will spend more and are fairing particularly badly while giving everyone something back.  I never really understood why this part of the tax code doesn't get mentioned much in the US, after college and having a fairly low wage job I really noticed the difference between the US and Canadian tax codes (Canada has about double the amount for the roughly equivalent basic personal amount $10,320 vs. $5,800).  It would be much better targeted for stimulus than the payroll cut (which incidentally is paying for our supposedly Ponzi scheme Social Security).

The employee hiring tax holiday provision seems unlikely to make much difference to me, the cost per employee seems so much higher than the part of this in taxes that I just don't see it making a big difference.  Public spending and preventing more firing in the public sector seem like more effective means (though linking this to something like foregone or reduced COLA in the next contract seems like a good trade off here, job security vs. salary seems fair and it would put off reductions in employee spending to the future as well as give better long run budget numbers).  Anyway, this might be the best possible given current politics, but that doesn't make it impressive.

[Update: Read a bit more about the plan this morning.  There's more direct stimulus than I thought, which makes it slightly better.  I remain very sceptical about temporary stimulus through tax cuts, while permanent tax cuts work as stimulus what I've read about temporary cuts is very mixed.  If cuts are targeted towards income constrained individuals they work, but people who do not suffer these constraints tend to act closer to a lifetime income model and there will be little change in their spending.  The payroll tax cut is better than some, but any stimulus that gives the most to the people least likely to use it seems badly targeted.  Why simply maxing the first $12,000 of income or so non-taxable isn't ever mentioned or considered is beyond me (with the current standard deduction of $5,800 this would effectively give everyone with an income over $12,000 $795 and it seems like an easy sell, saying we'll make your first X amount of income non-taxable sounds straightforward to me, a payroll tax deduction however would only give $400 to someone making $20,000 and $2,000 to someone making $100,000, admittedly, going the income exclusion amount would mean making this a refundable tax credit instead [wrote too fast here, though a tax credit of the size of the rebate would work, our tax system makes any simple changes difficult because there will be odd interactions with other taxes and exemptions, I'm sure that someone that knows more about the tax code than I do could make this work without too much trouble], since EITC and other tax credits/deductions leave many poor people having no income tax after adjustments (or a tax exclusion could be imposed on the payroll tax instead of a rate deduction), but it can still be sold in such a straightforward manner that popular support would probably be with it, it is just insane to be giving $2000 to someone who is unlikely to spend it when the person who will spend it only gets $400).

Looking at the NY Times columnists, Krugman seems happy about it, but it sounds like a story of low expectations to me.  Brooks makes a rather curious comment about Reinhart and Rogoff:

The general lesson I take from this history is that policy makers stuck in a financial recession should probably think about the long term. You’re going to be stuck with a lousy economy anyway. Anything you do to try to boost the growth numbers next month or next quarter is going to be overwhelmed by the underlying forces

Which baffles me because Reinhart and Rogoff say:

Policy makers must recognize that banking crises tend to be protracted affairs.  Some crisis episodes were stretched out even longer by the authorities by a lengthy period of denial... Our extensive coverage of banking crises, however, says little about the much debated issue of the efficacy of stimulus packages as a way of shortening the duration of the crisis and cushioning the downside of the economy as a banking crisis unfolds.

Brooks is seeing what he wants to see here, I certainly didn't end up with that takeaway from Reinhart and Rogoff.  An important thing to note with crises is that prior to the Great Depression there was a substantial subsistence economy propping up demand even during the crisis.  Even during the Great Depression "about half the poor during the Depression years grew some of their food, 30 years later about 85% of poor people lived off the farm.  For them, nothing was free." (Patterson 42)  There was also a large pool of tenants and sharecroppers, particularly in the South, that were largely outside the broader society and that lived at subsistence level.  The point being, Reinhart and Rogoff's data set has very few post WWII banking crises, it is very hard to draw conclusions from the data set regarding the modern economy when we don't have a parallel small farm economy creating an island of demand in the midst of depression operating by its own rules.  By the Great Depression this had become to small to do much, and is even smaller now, in previous crises however, the farm economy was larger than the rest of the economy.  Regarding stimulus, all Reinhart and Rogoff can really say is we don't know.]

If Social Security is a Ponzi Scheme, so is Society

The line about Social Security being a ponzi scheme annoys me.  It is in the sense that it requires new workers to pay for old workers.  But in this sense, so is a family, a corporation, or society itself.  All organizations require constant infusions of new blood to work.  The difference between these things and a ponzi scheme is that they have actual value, they do something.  A Ponzi scheme involves a shell investment with no intrinsic worth, which is not the case with Social Security.  Just because it requires new workers to pay for it doesn't mean we don't gain value.  Does anyone really want to face the prospect of not being able to move because we might have to take care of mom and dad in their old age, or go back to having an extra bedroom in the house for when our parents are to old to work?  I don't think so.  We get value from it, just like we get values from organizations.  The inter-generational transfer aspect is shared among all social institutions pointing this out shouldn't be perceived as a gotcha.  It really shows how much damage has been done to our society that pointing this out seems like a gotcha to so many people.

Misconceptions about the Poor

So, the radio show this morning picked up the topic of Michigan's cut in maximum time on welfare to four years.  My opinion on this is simply that it isn't going to save much money (very few people reach lifetime limits as is and welfare is quite cheap) but it is going to hurt some people quite badly.  That said, most of the people that are being hurt are the ones that would have hit the five year mark anyway, so it doesn't change all that much.  I just can't get excited about it.

What I do find interesting though is hearing the opinions first hand of what people who have no idea what they're talking about think of welfare.  I already know the far right stereotype, people sponging off the system who refuse to get jobs, and I was pretty sure this was widespread.  But I spend too much time on political sites to be sure of this, hearing it today on the radio confirmed this.

So, what are the misconceptions I was hearing?  First, welfare fraud.  Apparently, we know know welfare fraud is rampant.  Depending on how welfare fraud is defined, this is either true or completely false.  It is true in the sense that most people on welfare have some unreported income, most people on welfare do some under the table work or get some help from family members.  This often amounts to about a third to a half of total income and they are supposed to report it.  Most don't.

However, listening to callers, this isn't what people think of when they hear welfare fraud.  They think of people gaming the system to get multiple checks and using welfare as their sole source of income.  This form of welfare fraud is rare, and newsworthy when it happens.  It does happen, but rates of fraud involving multiple checks, false identities, or receiving a check when well above the poverty line are in the low single digits.  Hardly rampant.

The second myth is that these people are receiving assistance instead of working for long periods of time.  Most people on welfare are only on for a few months.  Only about a fifth are on it for more than a year.  However, someone who has received welfare once is quite likely to have another short spell on welfare within five years.  This is because most welfare recipients are marginally employable and are in sectors that have high turnovers.

This makes them unsympathetic but leads to the problem of what to do with these people.  They have few skills but how are they supposed to get any if receiving welfare, which gives them far less than the poverty line and has asset limits, seems like a good option?  You can't save up for college at a minimum wage job, it just isn't enough money.  Training programs are inadequate and often have conflicting goals.  While long term studies are unfortunately rare, what I've read on the subject generally seems to agree that there is a trade off between two program designs.  One, aims at teaching job search skills and tends to have the higher rate of immediate employment and gets people off the rolls.  The second is longer term and skills focused, rather than focused on training people to just get a job, any job.  This kind of program tends to do very little to get people off the rolls or to get them jobs after graduating the program.  But studies that follow individuals more than five years out finds that the second kind of program leads to higher employment, more wages, and less likelihood of welfare after that time.  Training people in skills works, but not quickly and not on any politicians time frame.

  Especially if you have kids, which people on welfare probably do.  It's true that most of these people made their own mess but this doesn't mean that we have other options.  If the kids are consistently deprived because the parent's can't earn enough to give them proper nutrition then we just end up with another generation of welfare cases.

It's easy to complain about them buying beer and cigarettes, but these things aren't that expensive.  Studies show that welfare recipients spend about 6% of their income on entertainment (Jencks, Rethinking Social Policy, from memory so I may be off by 1 to 2%, single digits is correct though).  If they were perfectly responsible and never spent this money needlessly they'd probably be better off, but very few of us are perfect in our habits, why would the poor be any better than most of us?

Then there is the issue that many people on welfare have a lot of problems.  It's easy to say that cases will be examined to make sure the truly needy (what would have been called deserving a generation ago) continue to receive assistance but these groups are quite restrictive and don't include a lot of people who are going to chronically need some form of welfare if they function at all.  It's easy to say that we'll cover people who can't work at all, but this is just about nobody.  The people on welfare are mostly people who can't work regularly.  Health issues, especially mental health issues are common.  Someone might be fine and hold a job for a couple of years, then they have an episode and lose their job.  Welfare is what gets them by until they can work again.  But these people aren't picked up by work rules that tend to have a simple can work/can't work dichotomy which matches poorly with how health, and other kinds of, problems actually effect people (though it matches well with people's prejudices who tend to think that those that could work at one point still could if they tried).  These are the kinds of people on long term welfare, people that have a lot of trouble functioning in regular society.

None of this is to say welfare is a great thing.  It pays below the poverty line, it must be supplemented by work for someone to lead a decent life.  The problem with shortening or trying to get rid of welfare is when the question of what the alternatives are.  They don't simply go and get jobs when the welfare check runs out, being on welfare really sucks, these people are either trying to get jobs or thoroughly discouraged.  A greatly discouraged person is hardly going to be encouraged by being told they no longer even qualify for assistance.  Putting someone out on the street is hardly going to end dependency for someone with, at best, minimal levels of skills.  It's hard to get a job with no residence (not to mention the people on welfare who don't have a home, it really isn't enough to cover shelter in many areas without additional assistance).  Taking care of homeless people costs money, both for police who have that much more work to do and for the health care costs they rack up with every visit where they are treated for exposure.  Then there's always incarceration, which costs a fortune.

In the end, welfare isn't a great program and it's hard to like, but it is cheaper than the alternatives and cash assistance leads to less long term problems.  It's not great, but it is better.

Friday, September 2, 2011

Causal Misatribution, Markets Did This, Not Government

David Brooks has a very wrong-headed column this morning.  My primary problem with it is his usage of the culture of dependency argument, if not the term.  As I've said before, there is very little proof in favor of this argument and a great deal against it.  Let me explain.

According to Brooks:

The Republicans, and Rick Perry in particular, have a reasonably strong story to tell about decline. America became great, they explain, because its citizens possessed certain vigorous virtues: self-reliance, personal responsibility, industriousness and a passion for freedom.

But, over the years, government has grown and undermined these virtues. Wall Street financiers no longer have to behave prudently because they know government will bail them out. Middle-class families no longer have to practice thrift because they know they can use government to force future generations to pay for their retirements. Dads no longer have to marry the women they impregnate because government will step in and provide support.

Let's examine this piece by piece

First of all, financiers.  I shouldn't need to explain in detail that financiers have never behaved prudently without heavy government regulation.  The prudent simply aren't the ones that get rich in this industry.  This goes back centuries to the Amsterdam and London Exchanges.  Tulip mania didn't happen because Dutch investors thought the Republic would bail them out.  It happened because there was money to be made, until there wasn't.  It seems absurd to credit government with something that was happening regularly for centuries before government got in the business of bailing people out.  This is all on the market.

There is something to the middle class thrift argument but there are a few details that have to be noted.  First of all, even during the early years of Social Security there was a very high incidence of poverty among the aged, about 40 - 50%.  (Patterson 78)  So it doesn't seem that even the middle class were saving adequately for retirement before Social Security, there's little reason they would do so today if it were cut.

But market forces and the ensuing cultural changes had more to do with the institutionalization of Social Security than poverty fighting  did.  By the 1920s market rewards had begun to erode the old way of life.  Before then, it was quite normal for at least one son to stay on and take over the farm or the family business and be in a position to take care of elderly parents.  As poverty statistics show, this didn't always work out.  As a result of the growing prosperity linked to markets however, fewer and fewer Americans wanted this.  They wanted to move to new job opportunities and pursue a career different from their parents.  Markets meant that there were opportunities that previously never existed.  These opportunities required individuals to move into a market economy where they generated wealth through their own individual efforts rather than relied on past accumulation by their parents of land and other assets.  People were eager to generate wealth on their own rather than depend on their parents and later have their parents depend on them in turn.  To quote from Patterson (73):

With economic progress in the 1920s, the middle classes had begun to get accustomed to better life-styles.  They had fewer children, and they frequently moved away from their parents.  They did not want to lose what they had by being forced to take in the old folks.  For these people, the allure of old-age insurance was not the benefits they would ultimately receive themselves, which few Americans calculated carefully.  Rather, it was the assurance that they would not have to take care of their parents in the here and now.
In case that wasn't clear enough the changes in American society that brought rise to the pension movement were not some kind of top down change by government, it was a bottom up movement created by changing market opportunities.  We have Social Security because it became increasingly necessary as people transitioned from a local, subsistence economy into an integrated market economy and were exposed to new opportunities.  The government response was a result of not cause of these changes.

Of course, aside from the historical factors, it can also be noted that savings rates are higher in Europe where old age pensions are much more generous than in the United States (the most recent evidence I have for this is the charts in Alesina and Glaeser).  While it may still be arguable that government policy is to blame the policies involved are not those that make current workers pay for retirees.