Friday, January 17, 2020

Great Society Review

I just finished Amity Shlaes' Great Society. It's a great book. I warmly recommend it.

The US is debating a fourth great wave of US government expansion. Theodore Roosevelt to Wilson the original progressive era and WWI; Frankin Roosevelt's new deal; and the Kennedy-Johnson-Nixon "great society" of this book came before us.

Plus ça change, plus c'est la même chose, is in many ways the theme of the book. The Great Society offers lots of parallels to our time, and a cautionary tale that it will all end badly once again. But not all is the same, and the many ways our time is different from the 1960s is also good to ponder -- for better and for worse.

Amity is a gifted writer and storyteller. Pay attention to her books also for how they are written. How do you tell the story of an era in a way that is comprehensible and memorable? Amity picks a few central (and now often overlooked) people, a few programs, and a few benchmarks (the Dow, the price of gold), and tells the story of the era through their eyes. It's the Game of Thrones approach to the Great Society.  Do not expect even a comprehensive list of all great society programs, diff in diff regression discontinuity estimates of their causal effects, or even charts and graphs (all curiously packed in an appendix and never referred to in the text) or the customary eyeball-glazing recitations of statistics. This was her approach to the Great Depression in Forgotten Man, equally effective. It complements, but does not substitute for that more structural work.

Introduction

In case you don't get the point, Amity starts right off in the introduction with Michael Harrington who wrote "a then-famous bestseller called The Other America" and who worked for Sargent Shriver, which is one of the main characters of the book (Daenerys Targaryen?)
Why not socialism? The president had been in office three months, and he wanted new ideas to distinguish himself from his predecessor. Could the author bring up socialism at the lunch? The very word “socialism” had been toxic until recently. ... The taboo was weakening, though.
..“socialism” might sound too controversial for the White House. The writer could, however, pitch ideas that took the country toward socialism. ... Laws that backed up organized labor so it might represent a greater portion of the American workforce... Higher minimum wages... Minimum wages that covered more workers, even those who did not work in an office or full-time. A dramatic change in the training of bigoted policemen in the big cities. ... The money was simply in the wrong hands. ... a tax system that captured the elusive wealth of the superrich. The moment had come to level incomes in a systematic fashion. 
..The story sounds like something that could happen today."
The 1960s and early 1970s included a huge expansion of programs. And the results were in the end mostly abject failure.

Today
progressive proposals that bear a strong resemblance to Michael Harrington’s, from redistribution via taxation to student debt relief to a universal guaranteed income, are becoming popular again. Once again, many Americans rate socialism as the generous philosophy. But the results of our socialism were not generous. May this book serve as a cautionary tale of lovable people who, despite themselves, hurt those they loved. Nothing is new. It is just forgotten.
It is also a refreshing reminder of just how old most of the "new" ideas we are being bombarded from on the left are -- and a warning of how long they will pester us, at least as long as we are unwilling to learn.

From an SDS (students for democratic society) manifesto:
"The wealthiest 1 percent of Americans own more than 80 percent of all personal shares of stock"
The capsule stories of the 1960s focus on the civil rights triumph, the remaining politically successul programs such as medicare and medicaid, the vietnam war, and a vague hippy nostalgia. Shales' story, and the central roles of the forgotten (largely)  men she tracks are a novel tonic.

Stories

Walter Reuther, head of United Auto Workers, is a central figure, and the fight between the old-left unions and the new-left students epitomized by Tom Hayden, for the soul of the Democratic party.

Sargent Shriver, and the Office of Economic Opportunity are the stand-in for many ill fated programs. It starts with the predictable story of chaos that results from a flood of federal money.   The flood of federal money  did not stop the cities from burning.  The OEO is the beginning of Federal support for "community action" programs, including political activity.
"Community action programs, the authors [of the Community Action Program Workbook—262 pages on how to apply for and run a federally funded program] wrote, should provide the “stimulation of change.” One marker of a successful community action group was that it “increased competence in protest activities.” The OEO ... welcomed experiments, including those where community action organizers paid by Washington were “facilitating the opportunities for the poor to participate in protest actions.”
That kind of language was enough to send mayors like Dick Daley through the roof.
In the end, the cities went up in flames. The OEO morphed in many ways. One interesting almost afterthought of the original program, legal aid to the poor -- who can obect to that, helping poor people who can't afford lawyers? -- ballooned the way all such programs do,
"the governor [Reagan] was after the lawyers again, assailing California Rural Legal Assistance. The nonprofit should have stuck to individual legal aid cases for rural indigents, Reagan said, but instead had “converted itself into a vehicle for class action lawsuits against various government agencies.” Reagan told the crowd that his staff had reckoned that if the CRLA won all its suits in California, the cost of welfare there would increase by $1 billion—the same amount Johnson and Shriver had first set as the budget for the entire War on Poverty."
Here was where the government started paying lawyers to sue the government for more government.

Amity tracks disastrous housing policies through the life of the Pruitt-Igoe housing project in St. Louis, begun in earnest but remote social-planner hope, though destroying the community where it sat, and ending in controlled demolition.
"In some cases, only welfare families were entitled to the lowest rents at Pruitt-Igoe. And to receive welfare under Missouri’s rules, a family could have only one parent—the mother. So families considering life in the towers had to make a terrible choice: stay together or take the apartment. ..Families who moved into Pruitt-Igoe often lost a father. ...The social workers even policed apartments at night, checking to see if fathers had secretly returned, grounds for eviction. "
The consequences of which are predictable.
"Pruitt-Igoe elevators, which stopped only every few floors, were muggers’ traps. Poor maintenance meant the elevators often jammed, leaving gangs’ victims in with them for long extra minutes. The gangs lurked in the halls and made tenants “run the gantlet” to get to their doors. Young men threw bricks and rocks at windows and streetlamps; the activity was a regular sport..... Because there were no toilets on the ground floor, children had accidents there and in the elevators, and the elevators gradually became public toilets. The community area was a sorry joke... No one seemed able to stop the decay. "
I love this:
"Social scientists were descending on the complex to conduct multiyear investigations, and that irritated the tenants further."
we've been at it a long time, missing the ends of our noses.
"At Pruitt-Igoe, rents were scaled to income. Every time the Straughters’ wages went up, their rent went up, a tax on striving"
Income-capped rent subsidies are with us today.
"After tens of millions and decades of urban renewal spending, Detroit did not look renewed. Detroit looked, Mayor Cavanagh said, like a city that now did need a Marshall Plan, like “Berlin in 1945.” Almost three thousand businesses had been sacked, with damage many times greater than in Watts just two years before. "
In the end
"There was hypocrisy [and I would say a great deal of paternalistic disdain] in the  different treatment of the middle class and poor. For the middle class, the government had aimed to re-create and sustain the world of Alexis de Tocqueville, subsidizing home purchasers for suburban settlers. For the poor, however, the government had operated in the world of Karl Marx: government-sponsored housing blocks with tenants, not owners. Black citizens—Pruitt-Igoe was now all black—had been ripped from their roots when they moved North, uprooted again when they were moved for urban renewal, and then placed in high-rise rentals where putting down new roots was impossible."
"How might neighborhoods like this one have turned out if local companies, local authorities, and local individuals had led in the 1950s and 1960s, building their own Great Society? How might St. Louis have looked if the jobs had stayed? No one knew.  But here in the shadow of
Pruitt-Igoe, Father Shocklee and Pruitt-Igoe tenants had discovered one possibility. With his small housing program, Father Shocklee had shown that “the poor” were more like the middle class than people supposed. They gained from something only when they had a chance to own it."

Daniel Patrick Moynihan is a second central character in Amity's story (Tyrion Lannister?) Moynihan was a Democrat, but wrote the important and controversial "The Negro Family: The Case For National Action," pointing out, among many other things, the perverse incentives of welfare.
"From his work at Harvard and in Washington, Moynihan thought he had learned what was wrong with American welfare. The first trouble was that poverty funding tended to flow to bureaucrats—social workers, not poor people. “Feeding the horses to feed the sparrows,” Moynihan called it.  In many states, those social workers spent their time in perverse endeavors: inspecting apartments at Pruitt-Igoe to make sure no fathers were present, for example. Taxes hit people when they entered the workforce, reducing the appeal of working just as Eartha Kitt said. ...In some states, for example, a welfare mother working at the same job as a family father not on welfare took in 50 percent more than the man, because she was entitled to keep a portion of her welfare. Why not bypass the bureaucrats and send the money to families, regardless of whether fathers were present?"
And then he took a job with Nixon, and became one of Nixon's main advisers. He nearly got passed a negative income tax, the equivalent of today's universal basic income. In his grudging New York Times review, Binyamin Applebaum finds this story "curious," because it did not pass in the end. But it nearly did, which makes it important. Amity covers well the failed attempt to over rule right to work laws, which also nearly passed. Near failures good and bad are equally instructive to our current situation, no matter the flap of butterfly wings that determines their fate.  (The quick review of the UK's longer experience starting p. 335 is well worth it too.)

I found this amusing
"The crowd at Harvard had held even Hubert Humphrey, and at times Robert Kennedy, in contempt. Any interest in Nixon Harvard rated worse than reprehensible
The schoolmates of Moynihan’s children stopped talking to them. Alan Rabinowitz, a fellow academic, wrote a satirical poem chiding Moynihan for his betrayal, “The Knight Before Nixon.”
Plus ça change in academia, and much Trump-deranged society.

Fairchild semiconductor plays a small but significant role. It's good to remember how different the US economy of the 1950s was. There really were a few very large companies in most industries, and most technology came out of defense. The emergence of an innovative private tech sector is one of those many ways we are not replaying exactly the same song. The slow emergence of Toyota and VW, selling better cars and forcing change in Detroit is another.

Money and gold

A minor story for the book caught my eye, and I pass it on first as many blog readers are interested in monetary issues. One of the themes of the book --  the snow level on the great white wall -- is the price of gold, and the US continuing problems of gold outflow, the emergence of inflation, and the eventual collapse of the Bretton Woods system. This is an event much too little studied by macroeconomists, though my international and economic history friends tell me that shows just how parochial we are and we should start reading their papers.

In macroeconomics perhaps we are too influenced by Milton Friedman's great called home run, the 1968 presidential address, where he forecast inflation would emerge along with unemployment. But Friedman's story was told entirely in terms of the money supply and to a lesser extent interest rate targets, the one too large and the other too low. And that is how the stylized history has come down to us: Fiscal deficits from the Great Society and Vietnam war, combined with too loose monetary policy, set off inflation.

That story leads to the puzzle of our age: If the (by current standards) comparatively minor Johnson-Nixon deficits set off a grand inflation why do our huge deficits have no such effect now, despite many officials stated desire for more inflation?

The story of the book reminds us that the mechanics were quite different then, and leads me to the speculative thought that the gold standard mechanism brought on inflation much more quickly than our current arrangements. In part, it may have been designed to do so -- to force governments to make fiscal adjustments quickly rather than let the problem get so big the fiscal adjustment will be immense, much as Doug Diamond and Raghu Rajan model short term debt and its runs as a disciplining device to managers.

The world was different then. We had fixed exchange rates, and it was difficult to move capital from country to country -- to buy foreign stocks, for example. Bretton Woods was not really set up to handle today's large trade deficits financed by large capital account surpluses. When the US started running trade deficits, other countries piled up dollars, and the main thing they could do with those dollars was to turn them in to their central banks, who in turn used them to drain gold from the Fed. So, it strikes me that open capital markets that allow us to finance large trade deficits are an important reason our system has held up so long.

Amity tells the sad tale of stopgap measures -- bans on using dollars for foreign travel, half-hearted interest rate increases, looney schemes for the Federal Government to mine gold, and of course the tragedy of price controls.

In any case, the remaining gold standard between central banks, not very open capital markets, not very open currency markets and fixed exchange rates were a crucial part of the inflation dynamics in this period, not just bad money supply or interest rate rules.

The episode also raises the counterfactual question why the US did not use the many devices used to defend the gold standard through the centuries. Borrow gold. Temporarily suspend convertibility.

Coda

At the end of a review that had to be negative, though he had to admit the quality of the book, New York Times review, Binyamin Applebaum writes
"Half a century later, in the midst of a revival of interest in ideas like Moynihan’s basic income proposal, readers may find themselves wondering whether the nation’s problem is really too much government — or, perhaps, not enough."
One wonders just what it would take to ever change his mind on that one. Were the 60s riots, the 70s economy, and the evident pathologies of the welfare system not bad enough, or do we have to go full Venezuela first? After all these years, and with the same policies on agenda, with the same predictable disincentives and unintended consequences, could not his call be at least for smarter government, not just more? For a larger government that learns from rather than repeats this sad history?


Thursday, January 16, 2020

Housing hope

There is a tendency in grumpy land to view the world as heading in the wrong direction. But a believer in our system must be optimistic that it is eventually capable of reform, that we will do the right thing in the end if only after we try everything else, as the saying goes.

This thought comes to mind in reading the Horrible Housing blunder in the Economist. The Economist calls housing "The west's biggest policy mistake." And, the ray of hope, even the progressive left in California is beginning to wake up and think about somewhat sensible reform.
 ...just as pernicious is the creeping dysfunction that housing has created over decades: vibrant cities without space to grow; ageing homeowners sitting in half-empty homes who are keen to protect their view; and a generation of young people who cannot easily afford to rent or buy and think capitalism has let them down. ... much of the blame lies with warped housing policies that date back to the second world war and which are intertwined with an infatuation with home ownership. They have caused one of the rich world’s most serious and longest-running economic failures. A fresh architecture is urgently needed.
At the root of that failure is a lack of building, especially near the thriving cities in which jobs are plentiful. From Sydney to Sydenham, fiddly regulations protect an elite of existing homeowners and prevent developers from building the skyscrapers and flats that the modern economy demands. The resulting high rents and house prices make it hard for workers to move to where the most productive jobs are, and have slowed growth. Overall housing costs in America absorb 11% of gdp, up from 8% in the 1970s. If just three big cities—New York, San Francisco and San Jose—relaxed planning rules, America’s gdp could be 4% higher. That is an enormous prize.
To put that into perspective, the worst-case scenarios from climate change, now called the "climate crisis" are 10% of GDP in the year 2100. 4% is a lot!

The economist places much blame on subsidies for (highly leveraged) homeownership, and points out the lack of evidence that it has the civic and political benefits alleged. It does not go on, that highly leveraged homeownership is likely a part of reduced dynamism. People do not get up and move from bad areas, because they own an underwater house there. Renting is a fine contract for mobile people, who change jobs more than in the 1950s, and an economy with shifting opportunities. Landlords also have incentives to keep up property, and often do a better job than indebted homeowners who can send the keys to the bank.
s it possible to escape the home-ownership fetish? Few governments today can ignore the anger over housing shortages and intergenerational unfairness. Some have responded with bad ideas like rent controls or even more mortgage subsidies. Yet there has been some progress. America has capped its tax break for mortgage-interest payments. Britain has banned murky upfront fees from rental contracts and curbed risky mortgage lending. A fledgling yimby—“yes in my backyard”—movement has sprung up in many successful cities to promote construction. 
Yes, even in San Francisco. Of course we are also the land of rent control, subsidized housing, impossible zoning and permitting. But there are cracks in the wall. That the Economist, generally center-left consensus, has caught on is good news.

A chilly Chilean lesson

I have been interested in following the news from Chile.

Most recently, I found this very interesting essay by Avel Kaiser in the Jan 1 Wall Street Journal. An excerpt:
Latin America’s freest, most stable and richest nation—is in free fall. Public order has collapsed, violence is rampant, and populism is the new creed of the political class. 
There is a recession, characterized by capital flight and rising unemployment...
It took a mere 40 days for the Latin American “oasis”—as President Sebastián Piñera called Chile not long ago—to vanish. How a stable and prosperous Chile fell so dramatically in such a short period is a lesson for every Western democracy. 
Coordinated protest groups destroyed almost 80 subway stations, bringing Santiago’s public transportation to a halt. Rioters attacked public and private property. 
...The economic pain started with the antimarket reforms of the previous government under Socialist President Michelle Bachelet, 
The policies result from a profoundly false narrative Chilean elites tell themselves about the country. Over the past 20 years, intellectuals, media personalities, business leaders, politicians and celebrities in this Latin American nation have marketed the myth that Chile is an extreme case of injustice and abuse. It began at the universities, where progressive ideologues spread the idea that there was nothing to feel proud about when it came to Chile’s social and economic record...“neoliberalism” had created a society of winners and losers in which neither group deserved the position in which it found itself. 
... Even Mr. Piñera, a billionaire, accepted the basic premises of the progressive elites’ narrative. In his first term he raised taxes to address what he called one of Chile’s main problems: inequality.  
Chilean elites are waging a sustained war against law enforcement. Many police officers don’t dare act for fear of sensationalist media coverage and punishments by courts under the sway of progressive elites. The same is true for the military. 
The free market didn’t fail Chile, whatever its politicians might say, and the state doesn’t lack the means to restore the rule of law. The central problem is that a large proportion of the elites who run key institutions—especially the media, the National Congress and the judiciary—no longer believe in the principles that made the country successful. The result is a full-blown economic and political crisis. Other nations should take note: This is what elite self-hatred can do for you.
My emphasis, and the central point for today. Societies fall apart when the people who run its central institutions no longer believe them worth defending. Sometimes they're right about that -- Soviet Union. Sometimes they're not. The lessons for the rest of us are obvious. 

Saturday, January 11, 2020

Wealth and taxes -- Overview

I thought that "wealth and taxes" would be a short blog post. It turned in to a 5 part series. Here's an overview, or table of contents in case the whole thing looks a bit indimidating. The most important one, really I think is Part V, "it's all political." The others build bit by bit, well, this can't be the answer and that can't be the answer, so what is the answer, and Part V finds it.

In Part I we met the fact that "wealth" is measured as "capitalized income," Y/r. But only some kinds of income Y and with discount rate choices r that blew up measured wealth inequality. I review the  Smith, Zidar and Zwick paper that finds huge overstatements of inequality because wealthy people have a higher r than you and me.

In Part II we learned that a big reason wealth inequality widened is that interest rates fell and asset prices rose.  If r falls, Y/r rises, but it's the same Y.

In Part III  we noted the distinction between consumption, income and wealth inequality. Wealth is beyond badly measured as a measure of lifestyle. The computations ignore taxes and transfers, wildly blowing up measured inequality and rendering it a "problem" that ipso facto cannot be solved. Why concern ourselves with pre-tax wealth inequality, especially given that most wealth is reinvested in businesses that produce things and employ people?

In Part IV, we met the wealth tax. If the question is, how do we raise revenue for the government, either to spend or to transfer it, the wealth tax is a terrible idea, as it distorts the economy and leads to an evasion industry. A consumption tax is a much better idea.

In  Part V I read Saez and Zucman's opeds, which finally tell us what the question is to which the wealth tax is the answer. Saez and Zucman want to confiscate billionaires' wealth, because they think billionaires have too much political power, billionaires all got their money unjustly, and somehow though big government cronyism is the problem, bigger government is the answer.  The wealth tax is not designed to raise revenue -- it succeeds if it raises no revenue (after perhaps a one-time wealth grab) because the wealth it taxes has vanished. Well, at least it is a consistent view, decide if you buy the premises. 

Friday, January 10, 2020

Wealth and Taxes, Part V

Wealth and Taxes Part V -- it's all about politics

(This is Part V of a series. See the overview for a summary of the other four)

So if wealth is not the answer to "how big is inequality," by any sensible measure, and if the wealth tax is not the answer to "what's the best way to raise money, or to redistribute income,"  if in fact wealth and wealth taxes are terrible answers to these questions, what is the question to which the wealth tax is the answer, and alarmist measures of wealth inequality to buttress it the pathway?

It's right there clear as day in Saez and Zucman's  Jan 22 2019 New York Times Oped
Their [high marginal tax rates] root justification is not about collecting revenue...high tax rates for sky-high incomes do not aim at funding Medicare for All. They aim at preventing an oligarchic drift that, if left unaddressed, will continue undermining the social compact and risk killing democracy.
An extreme concentration of wealth means an extreme concentration of economic and political power… Democracy or plutocracy: That is, fundamentally, what top tax rates are about. 
Well, now we have at least an honest question to which confiscatory taxation is the answer.
  • The point of the wealth tax is to destroy the supposed political power of billionaires by destroying their wealth. 
We could have saved a lot of time and effort if we had just started there and not wasted time on phony economic arguments!

Economic distortions are a feature not a bug. In optimal taxation theory we try to find taxes that raise revenue and don't kill the golden goose that lays eggs. The whole point here is to kill the golden goose.
  • The wealth tax is successful when it raises no revenue, when it destroys the wealth subject to tax.  
Even more clearly:
That few people [in the 1960s] faced the 90 percent top tax rates was not a bug; it was the feature that caused sky-high incomes to largely disappear. 
Is your jaw dropping yet?

(The quote is also a... misleading statement. 90 percent tax rates made reported incomes disappear and tax shelters explode.)

In optimal tax theory, the point is to get resources without disincentives -- to tax the rich without discouraging people from becoming rich, so they can get rich and pay the taxes. Here the point is exactly the opposite. They want to tax billionaires to the point that there are no billionaires.

  • The point of the wealth tax is to destroy the incentive to become rich. 

Why? If you view all wealth as ill-gotten, basically criminal, as perversions of democracy then you want to destroy the incentive to engage in those nefarious activities.

Well, no wonder we've been arguing and getting nowhere! As usual we're starting from different premises.

Saez and Zucman are not particularly consistent, arguing in many other places that the wealth tax will raise lots of revenue rather than just destroy wealth. They advise Senator Warren who has made big revenues a central part of her policy agenda. She wants the wealth tax precisely to fund Medicare for all, which Saez and Zucman just said is not the point. I find that sort of inconsistency very annoying, and telling of a political agenda which they're not willing to state honestly in many circles.
  • Will the real wealth tax please stand up? Is it supposed to raise a lot of revenue, or is it supposed to get rid of billionaires, after which it will raise no revenue? Make up your minds, please.  
An amusing aside
"The view that excessive income concentration corrodes the social contract has deep roots in America — a country founded, in part, in reaction against the highly unequal, aristocratic Europe of the 18th century." 
I guess I can forgive two Frenchmen for being a little foggy on American history. Our revolution had a lot to do with paying British taxes, not guillotining the aristocracy. In modern language, Americans wanted opportunity, not redistribution. The Boston Tea Party was not a demand that Britain tax its aristocrats, either to send money instead of tea, or just to tax them out of existence because "inequality" was galling the Americans.  The American Revolution was run by the wealthiest in this country, and was if anything about keeping property, including slaves.

Do billionaires really run the country?

We have left economics long ago, but does this idea make any sense? This is a mantra of the extreme left. John Cassidy, writing in the New Yorker to cheer these ideas
Meanwhile, the Citizens United ruling, the rise of super pacs, and the lurch to the right of the Republican Party and, of course, the Trump Presidency have demonstrated the growing political power of the billionaire class. 
I'm scratching my head here. Just what billionaires are they worried about? Tom Steyer? Michael Bloomberg? George Soros? Bill Gates, devoting his billions to global charities? The Business Roundtable CEOs who endorsed "stakeholder capitalism" as fast as you can say "Warren just passed Biden in the polls?" The readers of the New Yorker? (Look at their ads and the NYT Style section. They don't run ads like that on Fox News!) Pete Buttigieg's wine-cave buddies? It strikes me that the billionaires in this country are by and large achingly progressive coastal elites. (see Ryan Bourne at Cato "Has Wealth Inequality Eroded U.S. Democracy" for numbers showing political preferences of the very rich.)

That billionaires bought Trump the election is simply untrue. Chris Edwards and Ryan Bourne:
not one CEO in the Fortune 100 had donated to Trump’s election campaign by September 2016. His victory did not stem from influence by the wealthy but more from grassroots opposition to wealthy coastal elites. 
The money was on Hilary Clinton, who spent nearly double what Trump did. I perceived Clinton, famous for Goldman-Sachs speeches, as just the kind of candidate one who dislike cronyism should worry about.

Well, dark conspiracy theories are hard to disprove. But at least now you know what worldview leads, logically (at last) from its premises to a wealth tax. You can decide if you buy these premises. It has, by admission, nothing to do with revenue, and little to do with economics.

The argument goes on that billionaires have too much "economic power." Progressives are great with language, and you usually see wealth "controlled" by the 1% not just "owned," or heaven forbid "earned" by the 1%. I will leave to your imaginations just what that means.  If you have a billion dollars in treasury bills and the Vanguard index fund, just what "power" does that give you?

A wealth tax would also be a dandy way to bring billionaires in, with their tax lawyers, accountants, lobbyists, and favorite congresspeople for a once-a-year trip to the confessional, to discuss how the IRS will value various complex entities, along with their twitter accounts, charitable and campaign contributions, and just how their businesses are doing on advancing the green new deal and diversity and equity programs. As long as we are scratching our heads trying to find the question to which the wealth tax is the answer, this is a pretty good one.

Off with their heads!

The world-view is expressed even more clearly by Bernie Sanders:

or perhaps George Bernard Shaw
“The more I see of the moneyed classes, the more I understand the guillotine.”
The point really is decapitation. "Inequality"  is (Saez and Zucman) such a "crisis" that we are better off just getting rid of billionaires, even if that means throwing all their wealth and the businesses that provide their income in the ocean. While it is often pointed out that any concern with inequality means are better off if a rich person loses $100 and a poor person loses $1, this is a pretty extreme version of that view.

Ill-gotten wealth 

A second argument lies behind the wealth tax: it's all ill-gotten money, or luck. Zucman and Saez again
progressive income taxation... restrains all exorbitant incomes equally, whether they derive from exploiting monopoly power, new financial products, sheer luck or anything else…
Can you think of a few anything elses' that are missing here?

Robert Reich opines that there are only five ways to make a billion dollars
" exploit a monopoly;...get insider information unavailable to other investors,... buy off politicians,...extort big investors,...get the money from rich parents or relatives."
Just who made their iPhones, I'd like to know?

Edwards and Bourne document much more extensively a view more consistent with my reading of the facts,
Most of today’s wealthy are business people who built their fortunes by adding to economic growth, and some have created major innovations that benefit all of us. The share of the wealthy who inherited their fortunes has sharply declined in recent decades
In particular, the Piketty story of centuries old inherited wealth growing at r>g is a fable. The rich are not getting richer. All of today's rich are nouveau. At best, this generation's self-made internet gazilloinaires and hedge fund managers made more money than the last generation's Waltons and bond traders.

There is an element of truth, as in all fables. Edwards and Bourne go on,
...cronyism, which refers to insiders and businesses securing narrow tax, spending, and regulatory advantages. Cronyism is one cause of wealth inequality, and it has likely increased over time as the government has grown.
The really big billionaires -- google, Facebook, apple, etc. -- unquestionably built tremendous products, and pocketed a tiny fraction of the resulting benefit. But there is a lot of cronyism and exploiting government-granted monopolies in the US economy for sure. The epi-pen story is not isolated. Banking, courtesy of Dodd-Frank barriers to entry. Health care. We can grant that Vladimir Putin did not get wealthy from an innovative tech startup.

But to the extent that wealth is amassed by exploiting regulations, regulatory barriers to entry, special favors from the government, tax deals, is more government really the answer? How is it that the politically connected super wealthy can get massive breaks from corporate taxes (how Reich thinks the Koch brothers made their money), but they won't get, well, massive breaks from the wealth tax? If too much government is the problem, inviting cronies to lobby for government to use its power on their behalf, just how is more government the answer? Bloody Marys don't work for a hangover.

Well, at least now we know what we're talking about. If you live on the Saez, Zucman, Reich planet, and you think destroying billionaires' wealth won't ruin your business too or deny you the benefits of economic growth, and you think that their politicians can operate a confiscatory tax regime without opening the same crony Pandora's box that they claim cause the problem in the first place, you like the wealth tax.

At least they should stop the pretense this has anything to do with revenue, economics,  optimal taxation, expanding economic opportunity for the lower end of America, and so forth. As Warren advisers, they might want to inform her before the next debate, ah, this is not about raising revenue. And we should stop falling for this trap as well, and wasting our time on part I-IV arguments.

Bottom line

I want to end on  two positive notes. I started all this with a discussion of  Smith, Owen, and Zwick. As we saw in part I it cleans up some of the egregious thumbs on scale in Saez and Zucman, and taught me just how fraught the whole "capitalization" idea to measure wealth is. It's a good example of an industry of papers that quickly tore apart the Saez Zucman numbers.

But I fault Smith, Owen and Zwick, and most of their fellows, for meekly taking the questions at face value. Their paper  "builds on the pioneering work of Saez and Zucman (2016)." They "follow Saez and Zucman (2016) in defining wealth." They calculate static revenues from a wealth tax. But we just found out that this was all a red herring as the point is to destroy wealth not tax it. They offer nothing to question the idea that if this definition of "wealth" has become more unequal, "policy" should do something about it.   One can at least point to a literature, such as Edwards and Ryan, that do question the question, or Saez and Zucman's own opeds that suggest a very different set of questions.

Thus, I fault this paper, and its companions, for taking the questions at face value. You see the  agenda.  You’re being suckered into a rope-a-dope. The right response is that this is the wrong question, an utterly silly question, and one can at least say that.

This series is really about conciliation. Unlike other economists, I don't want to presume we're all asking the same question and Saez and Zucman are dummies. I want to respect that they are smart, so if they are coming to a different answer, it must be because they have a different question. In today's post, we now have a set of world views that does at last have some logic, which one can debate. In that spirit, I close with a Saez quote which which I agree completely:
"My sense is really that the public will favor more progressive taxation only if it is convinced that top income gains are detrimental to economic growth of the 99%, and that taxation can ameliorate this. In America, people do not have a strong view against inequality per se, as long as inequality is fair. And what does fair mean? As an economist, you would say fair means that individual income and wealth reflect the value of what people produce or otherwise contribute to the economic system. This is why distinguishing between the standard supply side scenario versus the rent-seeking scenario is so important." 
Amen, brother Saez. And, if rent-seeking is the problem, explain to us how an enormous wealth tax will not attract the same rent-seekers who game the obscene income, corporate, and estate taxes today.

In the end, this is all about power. Sure, let's call it "economic power" as well as political power. Saez and Zucman want to transfer power from private hands to the government, and eliminate a potential source of power, a source of competition to the incumbent government.

Whether that is a good idea depends essentially on your view of just how bad private vs. government power is. I'm a (many adjectives) libertarian, and I see even in the worst excesses of private power some discipline of competition or potential competition restraining it. I see most private power as given to the powerful by government in exchange for political support, which is really an expression of government power to suppress that competition.  The defining character of government power is lack of competition and a monopoly of force. The essence of Saez and Zucman is to reduce the competition for power faced by whoever runs the government.  Historically, I see the damage of extreme government power -- Soviet and Chinese Communism, German Nazism -- as orders of magnitude worse than even the worst caricatures of private power, especially of private power that does not derive ultimately from or require support from state power -- perhaps the Victorian dark satanic mills?

I presume Saez and Zucman agree they don't want to hand massive power to this administration, or a Republican Congress, or maybe even to the branch of the Democratic Party that handed out the cronyist goodies to billionaires they decry. So the argument must be that the "good politicians" will take over, will stay in power, will arrange never to hand the reins to a future Trump, and this time they will not misuse a monopoly of power, made ever stronger by lack of private economic or political power to challenge it.  Just put us bien-pesants in charge and all will be well.

I'm dubious of anyone making that claim, made so often in the past. I don't favor a libertarian dictatorship either.

They claim to worry about "inequality." Many government-run states -- Cuba, say, or Soviet Russia -- had much less measured income inequality. But if this is really all about "power," we should not fail to note that those states had much more inequality of power. Stalin may not have reported a lot on his income taxes, but he essentially owned a whole country.

More

Chris Edwards and Ryan Bourne at Cato have a nice series on inequality issues here (study, also pdf)  here (blog post). Ryan also takes on the final question that this series builds to, Has wealth inequality eroded democracy?

The Saez Summers Mankiw debate is informative.  See also Summers and Natasha Sarin on the wealth tax. If you're following politics, this really is about the soul of the Democratic Party and its economic views, Summers vs. Saez-Zucman as it is about Biden vs. Warren, Sanders, AOC.

My Hoover colleague David Henderson wrote a nice blog post on the topic, including coverage of the  debate.
"Emmanuel Saez... made his case for a tax on wealth and claimed that the wealthy have disproportionate influence on economic policy. In a segment that is beautiful to see (from about the 1:07:00 point to the 1:09:30  in this forum), Larry Summers challenged Saez to give an example where reducing wealthy people’s wealth by 20 percent would produce better political, social, or cultural decisions. Summers to Saez: “You’ve been making this argument for years. Do you have one example?” Saez didn’t. Summers went on to make the point that very wealthy people can have large influence by spending a trivial percentage of their wealth. Even heavy taxes on wealth would leave them quite wealthy."
"In his earlier presentation on the panel, Summers made another important point. He considered three activities that wealthy people engage in.  Activity A is continuing to invest it productively. Activity B is consuming it—for  example, by hiring a big jet and taking their friends to a nice resort. Activity C is donating it to causes and, if the causes are political, having even larger influence on political causes than they have now. Both B and C are ways to avoid a tax on wealth; A is not."
Interestingly, in the above oped, Saez did have examples, like the interesting claim that Russia became oligarchic and Japan did not (?) because Russia wasn't taxing enough. I would have been interested to hear Larry's response to that one.

From Nihai Krishan in the Washington Examiner
Larry Summers... has called Saez and Zucman’s estimates for the revenues generated by the wealth tax “naively high.” One possibility is that, instead of paying the tax, the über-wealthy would strategically give their money away to charities, reducing the tax base. "It seems important to account for the fact that the wealthy (and their tax planners) will inevitably be motivated to limit tax liability," Summers and another professor argued in an opinion piece in the Washington Post
Larry and the rest of us need to read the NYT oped and understand that low revenue is the point. Of course, Saez and Zucman could be more consistent about that.

The prevalence of non-profits as a tax-avoidance device, and their increasingly political nature, is a topic worth exploring. There is a reason every billionaire and sports star has a charity, that among other things employs his or her relatives and associates.

Gerald Auten and David Spilinter's analysis is an important recent piece in the data discussion.
"Top income share estimates based only on individual tax returns, such as Piketty and Saez (2003), are biased by tax-base changes, major social changes, and missing income sources.... Our results suggest that top income shares are lower than other tax-based estimates, and since the early 1960s, increasing government transfers and tax progressivity resulted in little change in after-tax top income shares."
Chris Edwards passed along a number of good links. Like me, Chris is worried about cronyism, and has good opeds  here and here  acknowledging that "the democrats are partially right." He points to the logical fallacy though -- just because some people earned money this way does not mean that all rich people did. And, we can agree on the disease but disagree on the treatment. If a government running a complex tax system open to cronyism is the problem, it does not follow that more government running an even more complex tax system is the answer. Chris also has a nice analysis of the wealth and capital income taxes and Alan Reynolds on tax elasticities

Update: Thanks to commenters and correspondents who fixed some little errors.

A good friend passes on a lovely quip:  "If ever there was an example of policy-based evidence-making, the case for the wealth tax is it."

Thursday, January 9, 2020

Wealth and Taxes, Part IV

(This is Part IV of a series. Part III, and Part V. which has the punchline.  See the overview for a summary.)

The Wealth Tax.

So, if arguing about the ill-defined and ill-measured distribution of wealth lies in service of the wealth tax, what is the question to which the wealth tax is an answer?

Revenue and Redistribution -- good and bad taxes

Preamble: Economists have no real professional expertise to object to redistribution, or argue for it. Swallow hard, you may not like it for political, moral or other reasons -- or you may be all for it for those reasons -- but admit economists economists have no special insights to the right amount of redistribution. Economics has one analysis to offer the world: incentives. (OK, and equilibrium.) If it were possible to take money from A and give it to B without creating any adverse incentives, we have no special standing to cheer or to object. Economics can tell us something about tax rates, but not much about taxes. 

Thus the theory of optimal taxation is straightforward: how can the government raise a given tax revenue while generating the least perverse disincentives? The theory of optimal redistribution offers an additional wrinkle: how can the government give money away while generating the least perverse disincentives to recipients as well as payers?

Monday, January 6, 2020

Dudley on reserves

Bill Dudley, ex President of the New York Fed, has an excellent Bloomberg editorial on reserves.

Reserves are accounts that banks hold at the Fed. The Fed used to pay no interest on these accounts. Accordingly, banks held very small quantities, as little as $10 billion in all, and they managed that quantity very carefully against legal reserve requirements, and having just enough around to make payments. To control interest rates, the Fed used to change the supply of reserves, and then watch the Federal Funds rate, the rate banks charge each other to borrow reserves.
"Each day, the Federal Reserve Bank of New York would assess whether to add or drain bank reserves from the financial system to balance the supply and demand to achieve the desired short-term interest rate. While straightforward in theory, the process was extremely complex to carry out. "
Since 2008, the Fed has started paying interest on reserves. The interest the Fed pays on reserves largely determines interest rates elsewhere, and the Fed doesn't have to go through a hoopla every morning to figure out just how many reserves to offer. The banking system is awash in trillions of dollars of reserves. And there has been no hyperinflation, nor indication that the Fed cannot control interest rates if it wishes to.

There has been a lot of controversy within the Fed about keeping the new system vs. the old.

Sunday, January 5, 2020

State support for nuclear power

Tyler Cowen responded with an interesting  post to my query,
"I don’t see just why nuclear power needs “state support,” rather than a clear workable set of safety regulations that are not excuses for anyone to stop any project."
 (Tyler, originally wrote,
"State Capacity Libertarians are more likely to have positive views of infrastructure, science subsidies, nuclear power (requires state support!), ...," 
I interpreted "state support" as  massive subisdies to be added to the massively regulated system we have now, adding nuclear to (say) windmills, rooftop solar, and housing. Tyler had something quite different and interesting in mind:
"in general American society has become far more litigious, and it is much harder to build things, and risk-aversion and infrastructure-aversion have risen dramatically....So the odds are that without a Price-Anderson Act [which starkly limits nuclear company's liability exposure] America’s nuclear industry would have shut down some time ago, with no real chance of a return. "
A society that allows its lawyers to nearly bankrupt Toyota and Audi over non-existent auto defects, and now is shutting down Bayer over completely unscientific claims that Roundup causes cancer, is obviously going to quickly destroy any nuclear company over harms real and imagined.  If we're going to have nuclear, we need some limitation on this kind of adventurism, along with the legal and regulatory knots that make it almost impossible to build any infrastructure in the US today.

I file this in the "lack of state capacity" department. A good (adjective) Libertarian wants clear property rights, and a sensible tort system that pays some vague attention to scientific evidence.  That is part of state infrastructure. When we say "infrastructure" people envision roads, but good courts, laws, regulations, property rights, and so forth are perhaps the most essential state-provided infrastructure.

Tyler went on a bit, to comments that made a bit less sense to me:
I am not sure which level or kind of liability should be associated with “the free market,” especially when the risks in question are small, arguably ambiguous, but in the negative scenarios involve very very high costs.  Which is then “the market formula”? 
The free market does involve property rights and payment for actual damages. Airlines, drug companies, car companies, all can function in a free-market property-rights libertarian view (another good adjective!) Of all the problems of nuclear, especially the promising small scale new technolgy nuclear, properly bonding and paying for actual (as opposed to imagined) harm does not seem impossible.

But now we're falling in to another libertarian trap, that of discussion which cloud of libertarian nirvana is better. We're pretty far away from designing tort law for free-market property-rights society.

Conference announcement

If you're working on fiscal issues, especially fiscal theory of the price level, here is a good conference you should submit to or attend. Don't wait, the deadline is today. Yes, this is self-interested -- I'm going and giving a talk so it's entirely in my interest that the other papers are interesting! The conference website is here

Wealth and Taxes, Part III

(This is Part III of a series.  Part II and Part IV   See the overview for a summary. The punchline comes in Part V. )

So, why do we care about the distribution of wealth? -- Especially,  as we learned in part I that wealth is poorly defined and poorly measured, and we learned in part II that much of the distribution of "wealth" reflects higher market prices for the same assets, which do not increase their owner's ability to consume over a lifetime? Why so much anger, even from commenters on this blog?
  • Why wealth inequality not income inequality or consumption inequality?
There already has been much ballyhoo about income inequality. Why worry, separately, about wealth inequality? Why worry, especially, given that "wealth" is measured as income / discount rate, so it is income inequality? Well, not really -- it is only certain kinds of income inequality, and different kinds of income get multiplied by different large numbers (1/r). But why do we casre about this particular kind of weighted income inequality rather than broad income inequality?

Why do we worry about wealth inequality or income inequality rather than consumption inequality in the first place?  If you're worried about inequality of lifestyle, inequality of who is using the planet's resources, and so forth, you want to think about consumption inequality.

Friday, January 3, 2020

Wealth and Taxes, part II

(This is a continuation of Wealth and Taxes, part IPart III follows.  See the overview for a summary. The punchline comes in Part V.)

A second asset pricing perspective helps us to digest "wealth," its distribution, and whether we should care.   

Here is another Smith, Zidar and  Zwick  graph showing the top 0.1% share of wealth (as they define and measure wealth). (Reminder. The game here is to start with selected income streams, then divide them by a rate of return to produce large wealth numbers. $100 income / 0.01 interest rate = $10,000 of wealth.) The "baseline" case capitalizes realized capital gains, which I argued last time was a pretty crazy thing to do. The bottom line treats only dividends. If dividends are properly measured, the value of the firm is the value of dividends only and repurchases are irrelevant.

The graph makes the obvious point that "capitalizing" capital gain "income" is an important assumption to driving up the appearance of wealth inequality.

But it makes a deeper point, my focus today. The top graph is pretty much the graph of the S&P index. This illustrates visually a deeper point:  
  • A lot of the rise in "wealth," and "wealth inequality," even properly defined and measured as the market value of net assets, consists of higher market prices for the same underlying physical assets. In turn, higher asset prices stem almost entirely from lower real interest rates and lower risk premiums, not from higher expectations of economic growth. 
This raises a deep "why do we care" question. Suppose Bob owns a company, giving him $100,000 a year income. Bob also spends $100,000 a year. The discount rate is 10%, so his company is worth $1,000,000. The interest rate goes down to 1%, and the stock market booms. Bob's company is now worth $10,000,000. Hooray for Bob!

But wait a minute. Bob still gets $100,000 a year income, and he still spends $100,000 a year. Absolutely nothing has changed for Bob! The value of his company is "paper wealth."

We compare Bob to Sally, who earns $100,000 per year wages and has no assets. The distribution of income and of consumption is entirely flat. But the distribution of wealth was already concentrated: Bob had  $1,000,000 of wealth, because we ignored Sally's human wealth, the present value of her salary. Now wealth inequality is 10 times worse, because we also ignore the higher capitalized value of Sally's human wealth.

But why should we care? Bob and Sally are both marching along unchanged.

Well, you say, I just assumed Bob didn't change consumption. He should sell some stock and go out on a round-the-world private jet tour. Or, what gazillionaires really do, he should start a foundation and give it away. But Bob won't do that for a simple reason. Originally, he wanted to spend $100,000 per year. Originally, if he sold his company for $1,000,000 and invested it at 10%, he could spend $100,000 per year. Now if he sells his company for $10,000,000, he can only invest that at 1% per year so the most he can spend is still $100,000!

People don't want to consume in one big spurt. They want to spread consumption out over their and their heirs lifetimes. When the interest rate goes down, it takes more wealth to finance the same consumption stream.
  • Consumption should not respond (much) to increases in wealth generated by lower discount rates for the same cashflows.  
The present value of liabilities -- consumption -- rises just as much as the present value of assets. This is a rather deep point that gets lost all too often in the static Keynesian consumption function thinking about "wealth effects of consumption" that still pervades macroeconomics.

If the rise in asset value is because people expect the income stream to grow a lot in the future, at unchanged discount rates, then indeed Bob is truly more "wealthy" than before. But that is emphatically not the situation of today's market value of wealth in the US, at least on average. If you think internet companies have enormous stock values because their profits will continue to grow at astronomical rates, I have some 1999 dot com stock to sell you.

(A refinement: lower real interest rates do generate a "substitution effect." You should rearrange consumption to be earlier in time rather than later in time. But the central point is that the lower interest rate does not have a "wealth effect." Though the asset is worth more, you cannot consume more in every year than you could before. The original flat consumption path is still just affordable.)

Now there are good questions to be asked about the distribution of consumption, and in particular lifetime consumption. If Bob averages $100,000 consumption over his life, and Sally only $10,000 that's an interesting observation about our society and we might want to think about the economics, politics, justice if you wish and so forth of the situation. But why should we worry about an increase in mark-to-market "wealth" that has no implications for the overall command over resources that "wealthy" people have?

Is this a big effect? Yes. Here is a simple plot of real interest rates, computed as the 10 year bond rate less the university of Michigan inflation survey. It declines from nearly 10% to negative numbers. (If you want to make "wealth distribution" look bad, start capitalizing incomes dividing by zero and then negative numbers!)





In sum, much of the increase in "wealth inequality," to the extent it is there at all, reflects higher market values of the same income flows, and indicates nothing about increases in consumption inequality, or if you prefer "command over resources."

Just why should we carte about wealth inequality?  Obviously, many smart people are very animated by it, including apparently about half the job market candidates on this year's PhD market. What is the question to which wealth inequality is the answer? Stay tuned for part III..

(Note: As a commenter on the last post pointed out, Larry Summers made this point in the excellent
Saez Summers Mankiw debate about wealth and taxes.)

On to Part III


Thursday, January 2, 2020

Wealth and taxes, part I

(This is Part I of a series. See the overview for a summary. The punchline comes in Part V.)

Last November I had the pleasure of discussing "Top Wealth in the United States: New Estimates and Implications for Taxing the Rich" a very nice paper by Matthew Smith, Owen Zidar and Eric Zwick at the NBER asset pricing meetings, presented by Eric. The paper prompts a series of blog posts on wealth distribution and wealth taxes. I'll try to stick to points that haven't been made a hundred times already.

The paper mostly examines  Saez and Zucman's 2016 QJE paper on wealth inequality.  As many others have found, the Saez Zucman numbers are, ... let's say somewhat overstated.


Their bottom line is to cut Saez and Zucman in half. As I read the paper I think this is conservative -- and when we ask the obvious questions that the whole enterprise begs to be asked (which Smith et al don't do, but I will) a chasm of emptiness opens up, and the questions end up emptier than their answers.

The first thing you have to understand is the nature of wealth. Here is most people's impression of what wealth is:


That's not it at all. As Zwick et al say,
“Less than half of top wealth takes the form of liquid securities with clear market values”
So, the question is how do we measure the "wealth" that is not liquid securities with clear market values, like the profits of privately owned businesses? And, given that there is not US data on wealth (yet, thank goodness), even the part that is a security is hard to measure. 

Enter "capitalization." The main idea in Saez and Zucman, reexamined by Smith et al., is that we measure "wealth" by measuring income, and then translating that income to wealth by assuming it will last forever and discounting it at some rate. In equations 

Wealth = Income / discount rate

We have data from the IRS on income. So, let's follow along on Zwick et al.'s best story, how we find wealth invested in bonds from IRS individual interest income data and total bonds outstanding data: 
“In 2014, the aggregate flow of [taxable] interest income was $98B, and the stock of fixed income wealth was $11T. The ratio gives the average yield, r = $98B/$11T   = 0.89%. Using this yield to capitalize income amounts to multiplying every dollar of interest income by 1/0.89% = 113 to estimate fixed income wealth. … Implementing equation (4) for fixed income gives an estimate of top fixed income wealth of $42B × 113 = $4.7T of fixed income wealth held by the top 0.1%. The bottom 99.9% estimate is $56B × 113 = $6.4T .
My emphasis.

You may have wondered, if we're just going to mulitply income by a number and call it wealth, why are we bothering to measure the wealth distribution at all? Let's just use the income distribution! You get one answer here -- if you call it wealth you get to multiply by 113! Since only some kinds of income get this treatment, kinds that are more likely to be held by wealthy people, that makes the numbers look much more unequal.

Smith et al's point though is not this basic one. Rather they look carefully at the calculation. This calculation assumes that all "fixed income" assets pay the same, low, rate of interest. Another well established fact is that rich people get better rates of return on their assets.


 Here is Smith et al's plot of the actual rate of return that people earn on their fixed income investments. The uber wealthy earn 6% on their fixed income investments. This is not a small effect. In our capitalization factors, wealth = income / discount rate,

1/0.01 = 100
1/0.06 = 16.7

Changing from a 0.01 discount rate to a 0.06 discount rate pulls the wealth estimate per dollar of income down from 100 to 16.7. That's a lot. Smith et al:
“the adjustment reduces the top capitalization factor—and thus estimated top fixed income wealth—by a factor of 4.7, or 80%”
This is huge, to say the least.

(Note the irony. People who worry about wealth inequality are usually bemoan the fact that rich people earn higher returns on average than not so rich people, as it apparently will make inequality worse over time.  But the same higher average return must mean a lower multiples for converting income to wealth. You just can't have it both ways.

Higher returns are not some evil plot. The largely come from the fact that rich people buy riskier assets, like stocks and  junk bonds, and less rich people buy safer but lower yielding assets like bank accounts.  OK, It is to some extent a plot. Lots of regulations prohibit lower income people from buying the kinds of assets that make rich people richer in the name of consumer protection. The SEC is loosening some of these regulations.)

Beyond fixed income, the capitalization game gets even muddier, in both papers. What income flow are you going to capitalize?
“In the case of C-corporation equities, the income flow is dividends plus [realized] capital gains."
I think that's an accounting mistake, common in this literature. You cannot take the realized capital gains as an "income" flow for capitalization purposes. Suppose you buy a stock for $1, and it grows to $100. You sell $10 of the stock, but now you only have $90 left. You can't keep doing this forever, as the capitalization assumes.  That's fundamentally different than the company is worth $100, makes a $10 profit and gives you a $10 dividend. I'll be curious to hear from better accountants than I whether you can sensibly capitalize realized capital gains. Onwards...
For S-corporation equities, the income flow is S-corporation  income. For proprietor and partnership wealth, the income flow is the sum of proprietor income and partnership income  [ “capital” income?].  In the  case of real estate, property tax is capitalized to estimate housing assets ….”
Ok, that's income, what is the discount rate?
“Private business returns are harder to estimate than fixed income returns because private business wealth is harder to observe than fixed income wealth…We focus on multiple-based valuation models”
So we go from multiples to estimate a multiple... This all seems rather circular.

The bottom line? The game, as announced by Saez and Zucman is this: We start with the  pretax value of “capital” income, including asset income, proprietor income and partnership income, but not labor income (wages, bonuses, etc) or social security income. We multiply by various huge 1/r numbers to call them "wealth".  By doing that and using low r numbers, the "wealth" distribution looks much more extreme than the income distribution. As you can see the 1/r assumption allows great latitude in how this calculation is going to come out.

****

I spent a lot of time in asset pricing, and this paper was presented at an asset pricing meeting, so let me offer a little bit of what asset pricing has to say about these kinds of procedures.

The real capitalization formula is

P/D = 1/(r-g)

the price - dividend ratio is equal to one over the difference of the discount rate and the growth rate of dividends. Shhh! If the wealth inequality crowd realizes they can subtract g their multipliers will explode! (Joke. Of course we always use the right numbers) 



The function 1/(r-g) is very sensitive to r and g, especially for low discount rates like the 1% we were using for bonds. Going down from 2% to 1% doubles the value. So, if you want to fiddle with values, fiddle with discount rates.

The right discount rate is much higher for risky assets than risk free assets. Lots of people discount things with stock market risk using interest rates, and get absurdly too high values.

If you put the 20 best financial economists in the world together in a room, gave them all of a company's cash flow information, they could not come within a factor of 3 of the actual stock market value.  "Valuation" mostly consists of fiddling with discount rates to get the "right" answer. Maybe "multiples" isn't so bad after all.

In short, capitalizing income to get any sense of "wealth" is an inherently... absurdly imprecise game.

***

I don't mean to sound critical of Smith et al. They're doing the best they can given the Zucman and Saez rules of the game. But a little peek into this sausage factory should leave you wondering, just why are these the rules of the game? Why do we care (should we care) so much about the distribution of something that is essentially impossible to measure or define? If you are making money was a partner in an LLC you help to run, why should anyone care about a fictitious accounting "value" of that partnership? You can't sell it!

Why start with pretax income? If you pay half your income in taxes, does that not halve the value of the asset?  Why does "wealth" include the value of proprietor and partnership income but not labor income or social security income?

These are good questions for the next few blog posts. Stay tuned.

On to Part II


Wednesday, January 1, 2020

(Adjective) Libertarianism

Libertarianism consists of many different ideas, and is clearly in need of some adjectives. Tyler Cowen, in an interesting new-Year's reflection, offers "State-Capacity Libertarianism."  The guts of it is, I think, that the State must exist, and do competently and effectively its crucial tasks.

The best bit, I think:
5. Many of the failures of today’s America are failures of excess regulation, but many others are failures of state capacity.  Our governments cannot address climate change, much improve K-12 education, fix traffic congestion, or improve the quality of their discretionary spending.  Much of our physical infrastructure is stagnant or declining in quality.  I favor much more immigration, nonetheless I think our government needs clear standards for who cannot get in, who will be forced to leave, and a workable court system to back all that up and today we do not have that either.
A nice observation on the left:
9. State Capacity Libertarians are more likely to have positive views of infrastructure, science subsidies, nuclear power (requires state support!), and space programs than are mainstream libertarians or modern Democrats.  Modern Democrats often claim to favor those items, and sincerely in my view, but de facto they are very willing to sacrifice them for redistribution, egalitarian and fairness concerns, mood affiliation, and serving traditional Democratic interest groups.  For instance, modern Democrats have run New York for some time now, and they’ve done a terrible job building and fixing things.  Nor are Democrats doing much to boost nuclear power as a partial solution to climate change, if anything the contrary.
I don't see just why nuclear power needs "state support," rather than a clear workable set of safety regulations that are not excuses for anyone to stop any project.  Democrats have also run California for some time now, and are apparently trying to see just how quickly the golden goose can be convinced to pack up and move to Nevada. In a show of bipartisanship Tyler might have added just how quickly small-government, free-market, individual-liberty local-government philosophies evaporate among many Republicans when inconvenient.

Another good but flawed, I think, observation
2. Earlier in history, a strong state was necessary to back the formation of capitalism and also to protect individual rights (do read Koyama and Johnson on state capacity).  Strong states remain necessary to maintain and extend capitalism and markets.  This includes keeping China at bay abroad and keeping elections free from foreign interference, as well as developing effective laws and regulations for intangible capital, intellectual property, and the new world of the internet.  (If you’ve read my other works, you will know this is not a call for massive regulation of Big Tech.)
I agree with the principles, but "keeping China at bay" seems like a poor goal for our foreign policy, "foreign interference" seems to me vastly overblown compared to domestic interference. The decay of rule of law and property rights seems vastly more important.

While I like the basic idea, I think "State Capacity" is a poor adjective because it isn't that self-explanatory. Libertarians have awful marketing skills, as evidenced by the fact that such demonstrably correct ideas have so little traction.

Adjectives I like in front of "libertarian" include constitutional, rule-of-law, practical, empirical, globalist. Too often though adjectives like these just define a set of ideas as antitheses of their opposites.

Update: Like a commenter, I like the adjective "conservative" appended to Libertarian as well, in the sense that we live on ages of legal and social development that should be respected for encoding a lot of wisdom, and "conserved."

Monday, November 25, 2019

Childbirth and crime

Family formation and crime is the title  of  a very nice new paper by Maxim Massenkoff and Evan K. Rose. (HT Alex Tabarrok at Marginal  Revolution, which also has great commentary.)

The graphs speak for themselves. Go to the paper to look at them all. A few select ones:

Arrests fall by half, starting when mothers know they are pregnant:




(The paper presents  more  accurate but less interpretable event study coefficients.  If you know what that means, go look at  the paper.)

Father's crime drops too:


This decline isn't as steep. But first of all note it's all fathers, married or no, and second third and more kids. Then  look at the huge difference in vertical scale.  Women  go from 3 to 2 economic offenses per 10,000. Men go from 20 to12 economic offenses per 10,000. This is a huge reduction in crime rates.

Wednesday, November 20, 2019

Capital market freedom

I gave a presentation on "capital markets" at the Hoover Centennial series on Tuesday.  Caroline Hoxby gave a clear  presentation on human capital, and George Shultz told  some great  stories  from his time in government. Judging from the questions, Caroline was the star and  I put them to sleep. Finance always does that. The  video:



Here is the text of my  presentation

Hoover  stands for freedom: ideas defining a free society is our motto.  And economic is a central freedom: You can’t guarantee political freedom, social and lifestyle freedom, freedom of speech and expression, without economic freedom.

Economic freedom applies to capital; to financial  freedom, as much as to goods, services, and labor.  Freedom to buy and sell, without a government  watching every transaction. Freedom to save, and invest your capital with the most promising venture, at home or abroad, or to receive investment from and sell assets to anyone you choose — whether the investments conforms to a government’s plans or not.

But freedom is not anarchy. Economic and financial freedom depend on a public economic infrastructure. They need functioning markets, property rights, an efficient court system, rule of law; They need a stable and efficient money, and a government with sound fiscal affairs  that will not inflate, expropriate, or repress finance to its benefit, and freedom from confiscatory taxation.

Here lies our conundrum. The government that can set up and maintain this public architecture can restrict trade and finance. Businesses, workers and other groups can demand protection. The government can control finance for political ends and to steer resources its way. And that ever-present temptation is stronger for finance. Willie Sutton, asked why  he  robbed banks,  responded   “that’s where the money is.” Governments have noticed as well.

Ideas matter. People care about prosperity, too. Citizens and voters must understand that their own freedom, and that of their neighbors, is the best guarantor of their and the common prosperity. 250 years after  Adam Smith, most of US still really does not trust that fervent competition is their best protection, not extensive regulation. See our rent control and labor laws. That necessary understanding remains even more tenuous in financial affairs

Can a more free financial, payments, monetary, and capital market system work? How? It is our job — ours, the ideas-defining-a free-society people  —  to put logic and experience together on this question. And the answer is not obvious. Finance paid for our astonishing prosperity. But the history of finance is also full of crashes, panics, and imbroglios. Government finance won wars, but also impoverished nations.  Economic freedom does  not mean freedom to  dump garbage in neighbor’s back yard. Just where this parable applies to financial markets is an important question.

The last 100 years have been a great  ebb and flow of freedom in financial and monetary affairs. The immediate future is cloudy, suggesting more ebb, but offering some hope for flow

Hoover scholars have been and are in the midst of it. Milton Friedman spent a quarter century here, advancing free exchange rates, free trade, open capital markets, sound money, and sound fiscal policy. John Taylor took up that baton. Allan Meltzer, author of the magisterial history of the Federal Reserve, was a  frequent visiting fellow here.  George Shultz spearheaded the transition to floating exchange rates and free capital movement, fought valiantly against price controls, and anchored the Reagan Administration’s effort to eliminate inflation and fix  the tax code. Many others contributed, and Hoover is just  as alive  today.

We  could  spend  an afternoon on the financial history of the last 100 years. I’ll just focus  on three pivotal stories.

Bank and financial panics have been central to the ebb and flow of financial freedom for all of the last hundred years. The banking  panic of 1933 was surely the single event that made the great depression great. It was centrally a failure of regulators and regulation. The Federal Reserve was set up in 1914, to prevent another panic of 1907.  And it promptly failed its first big test.  Micro-regulation failed too. Interstate banking and branch banking were illegal. So, when the first bank of Lincoln, Nebraska failed, it could not sell assets to JP Morgan, who could have  reopened the bank the next day. The bank could not recapitalize by selling shares.  So the people who knew how to make loans were out selling apples.

As usual, the response to a great failure of regulation was... more regulation. Deposit insurance protected depositors. But offering insured deposits to bankers is like sending your brother-in-law to Las Vegas with your credit card. So the government started extensively regulating how banks invested, and forbade banks to compete for deposits. But people in Las Vegas with  your credit card, for 20 years, get creative. From Continental Illinois to the savings and loan Crisis, to the Latin American and Southeast Asian crises, to LTCM, and Bear Stearns, and finally the great crisis of 2008, we repeated the same story: bailout larger classes of creditors, add regulations to try to stop more creative risk taking, add power to regulators who really really will see the next one ahead of time, promise it won’t happen again. Dodd Frank, and today’s “macroprudential” policy are not new, they are just the last logical patch on the same leaky ship.

An alternative idea has been around since the  1930s. Financial crises are runs, period. Runs are caused by a certain class of contract, like deposits, which promise a fixed value,  first-come first-served payment, and the bank fails if it cannot pay immediately. Then, if I hear of trouble at the bank, I run  down to get my money before you do, and the bank  fails. The solution is simple —  let  banks get their money largely by issuing equity and long term debt.  Such banks need no asset regulation, and no protection  from competition, as  they simply  cannot fail. Run prone short term debt financing is the garbage in the neighbor’s back yard, and eliminating it is the key to financial freedom — and innovation.

Many of us at  Hoover have been advancing this idea, adapted to modern technology, along with reform of the bankruptcy code so that large banks can fail painlessly, a lesson we should have learned from the 1930s. It is slowly gaining traction in the  world  of ideas, though not  yet in the world of policy. A lot of vested interests will lose money in this free world, not the least of which the vast regulatory bureaucracy and economists who serve them more welcome ideas.

Second, let’s talk about international trade and capital flows.  Financial freedom includes the right to buy and sell abroad as you see fit, and to invest your money or receive investment from wherever you wish, even if that crosses political boundaries. As always that freedom leads to prosperity.

The world learned a good lesson from the disastrous Smoot-Hawley tariffs of the 1930s. So, the  postwar order built an international system aiming for free trade and free capital markets.  Now  free trade and capital should be easy. They take one-sentence bills, ideally that start “Congress shall make no law…” But each government faces strong pressure and temptations to protect its weak industries, and their employees, and to redirect its citizens’ savings to pet projects, favored sectors, and to government coffers, mixed with frankly xeonophobic fears of “foreign ownership.” So the postwar order was a long hard slog, with international institutions, long international agreements that are more managed mercantilism than free trade, and consistent US leadership.  Capital  freedom took even  longer than trade freedom. As recently as the 1960s, US citizens were not allowed to take money abroad. Many people around the world still fact such restrictions.

This time, a crisis helped. The Bretton Woods system of 1945 envisioned free trade but little net trade, so it wanted fixed exchange rates and allowed capital controls to continue. The US deficits and inflation of the early 1970s blew that apart, leading to floating exchange rates and open capital markets.

By the 1990s, the world entered an era of vastly expanded trade and international investment, strong economic  growth. The last 30 years  have seen the greatest decline  in poverty around the globe in all human history. Now much-maligned “globalization” and “neo-liberalism” was a big  part of it.  I think we shall remember it nostalgically alongside the free-trade and free-capital pax Britannica of the late 19th century.

But crises often lead to bad policy in international finance as  well. The Latin American and Southeast Asian crises of the 1990s, even before the great financial crisis of 2008 unsettled many nerves. To me the stories look  familiar: Latin American governments borrowed too much money, again, and US banks found a way to leverage their  too-big-to-fail guarantees around the supposedly wise oversight of  risk regulators, again. East Asian governments were on the hook for their banks' short term borrowing and big American banks were lending again.

But the policy community, and countries wanting cover for bailouts and expropriations, convinced themselves that dark forces were at work, “hot money” “sudden stops,” and that all foreign capital — not just short-term foreign-currency debt — is dangerous and must be controlled. Now even the IMF, formerly the bastion of free exchange rates, free capital flows, and fiscal probity, advances capital controls, exchange-rate intervention, and government spending on solar cells and consumer subsides, in the name of climate and inequality, even in times of crisis.

Moreover, I think the world of ideas failed really to understand what it had created. For a generation economists scratched their heads that countries seemed to invest mostly out of their own savings rather than borrow from abroad, and called this a puzzle. When the world started to look like our models, and huge trade and capital surpluses and deficits emerged, economists pronounced “savings gluts” and “excessive volatility” needing “policy-makers” to “manage flows,” and lots of  clever economists  to  advise them.  Time-tested verities do not get you famous in economics.

Let me close by speculating a bit about the future. It will be an… well an exiting time for those of us who value ideas in defense of a free society and who think about money, finance, and capital.

Sooner or later, if  our path does not change, the western world will confront a sovereign debt crisis. Our governments have  made  promises they cannot keep, buttressed  by economists bearing the singularly bad idea  that  debts do not have to be repaid.  Since government debt is the core of the financial system, most of which counts on a bailout of borrowed money, the subsequent financial crisis will be unimaginably awful.

Payments,  technology and financial  innovation will force some fundamental  choices.

We are headed to a world of  electronic rather than cash transactions.  But cash has one great freedom-enhancing virtue: anonymity. If the government  can watch everything you buy and sell, or exclude people from the ability to transact, all sorts of freedoms vanish.  Now Governments have good reasons to monitor transactions  to better collect  taxes, and to make life difficult for criminals, drug smugglers, and terrorists. But governments have many bad reasons: to impose capital controls and trade barriers, to prop up onerous domestic regulations, and to punish political enemies, foreign and domestic.

So a great battle of financial freedom will play out. Will the emerging electronic payments  system work on the Chinese social credit model? Or  will innovation undermine leviathan — and  undermine even basic law enforcement efforts? Can we reestablish a balance between anonymity, freedom, and optimally imperfect enforcement of often ill-conceived financial laws and regulations?

In a larger sense, Silicon Valley is trying  to do to finance what Uber did to taxis. Will the Fed and Congress  allow narrow banks, electronic  banks, payments networks like Libra, and internet lenders to compete and serve us better? Or  will they continue to defend by regulation the oligopoly of banks and credit card companies?

Larger questions hang over us. On one political side seems to lie business as usual — unreformed, highly regulated banks, the usual subsidies  such as Fannie and Freddy, student loans, and so on, with increasing restrictions on international trade and investment. On the other side lies a large increase in bank regulation, direction of credit to green new deal projects and favored constituencies, and extreme levels of capital taxation. From the Fed, central banks, IMF, OECD, BIS, CFPB, and so on, I hear  only projects for ever larger expansion  of their role in directing finance.

I do not hear many voices for patient liberalization. Ideas defining a free society will be sorely needed.

********


The Q&A was interesting. John Raisian wisely preempted  the usual "what about inequality?"  question. My main regret was not answering cogently enough the questioner who asked (paraphrase) "Now that unions are gone, who will speak for the little guy (or gal)?" What I should have said, in addition to what I did say:

The little guy or gal voluntarily dropped out of unions, and voted against pro-union politicians, because they felt unions did not speak for them. If you're a Republican, a Libertarian, a fan of school  choice, concerned about pension debt, unions do not speak for you. A lot of formerly union people voted for Trump. Unions became government-supported advocates  for  one wing of one political party, and their members left in droves. Political  parties "speak for" you if you  wish someone to do that.  Not unions.