FTPL Videos

 Two great videos just dropped related to fiscal theory. 

The first is an "Uncommon Knowledge" interview with Peter Robinson. We start with fiscal theory and move on far and wide. Peter is a great interviewer, and the Uncommon Knowledge production team put together a great video of it. Pick your link: Video at Hoover (best, in my view); Hoover event page with podcast, links and more info, Youtube, Twitter, Facebook. 

Second, Michael Strain at AEI moderated a great panel discussion on fiscal theory with me, Robert Barro, Tom Sargent and Eric Leeper. Three of the founding fathers of fiscal theory offer thoughtful comments, and Michael had provocative questions. I start with a 20 minute presentation, with slides, so this is the most compact "what is the fiscal theory" video to date. It's at the AEI event page or Youtube 

Mulligan and the demand for opioids

This is another post from an Economic Policy Working Group meeting at Hoover, in which simple undergraduate supply and demand analysis, creatively applied, leads to a surprising result.  

Casey Mulligan presented "Prices and Policies in Opioid Markets." Paper, slides and video of the presentation.  (Updated link now works) 

Once prescription opioids became an evident crisis, the government took steps to restrict the supply, raising the price. Yet opioid consumption and overdoses went up. Explain that Mr. Chicago economist! 

Here's the clever answer: 

There are two ways to buy opioids, 1) legally or semi-legally; i.e. get opioids that come from pharmaceutical companies and are prescribed to someone by a doctor or 2) illegally. 

There is a fixed cost of entering the illegal market. .".Avoiding theft, acquiring self-dosing skills, or overcoming fear of needles. ...establishing a trusting relationship with a drug dealer...." But the cost per dose of illegal drugs is typically less than for legal drugs. 

So, imagine a drug user starting at B. At that price for legal (red) and illegal (black) drugs, the user chooses legal drugs at point B. Now raise the price of legal drugs, as shown by the arrow. If the user stayed with legal drugs, he or she would use less. But now there is an option, incur the fixed cost and buy illegal drugs on the black line. At the higher price for legal drugs that makes sense. But since the marginal cost of illegal drugs is lower, once the user has overcome the fixed cost, he or she uses more. 

Raise the price, and they consume more (of a substitute). 

Short and long run minimum wage

On Wednesday, Erik Hurst presented a lovely paper, "The Distributional Impact of the Minimum Wage in the Short and Long Run," written with Elena Pastorino, Patrick Kehoe, and Thomas Winberry, at the Hoover Economic Policy Working Group seminar. Video (a great presentation) and slides here. 

This is a beautiful and detailed model, which won't try to summarize here. I write to pass on one central graph and insight. 

Suppose there is some "monopsony power," at the individual firm level. Don't argue about that yet. Erik and coauthors  put it in, so that there is a hope that minimum wages can do some good, and it is the central argument made by minimum wage proponents. In the paper it comes because people are uniquely suited to a particular job for personal reasons. Professors don't like to move, they've figured out the ropes at their current university, so the dean can get away with paying less than they could get elsewhere. Why this applies to MacDonalds relative to the Taco Bell next door is a good question, but again, the point is to analyze it not to argue about it. 

"Labor demand" here is the marginal product of labor. (\(f'(N)\) It's what labor demand would be in a competitive market. The monopsnists' demand is lower). Monopsony means that the "marginal cost of labor" rises with the number of employees. There is a core of people that really love the job that you can hire at low cost. As you expand, though, you have to hire people who aren't that attached to this particular job, so you have to pay more. And you have to pay everyone else more too, (by reasonable assumption -- no individually negotiated wages), so the average cost of labor rises. 

Thus, the monopsonies firm chooses to hire fewer people \(N_m\),  produce less, and pay them a wage \(W_n\) below their marginal product.  ("Average cost of labor" is really the labor supply curve, call it \(w=L(N)\). Then \(\max (f(N)-wN\) s.t. \(w=L(N)\) yields \(f'(N)=w+NL'(N)\). The "marginal cost of labor" in the graph is this latter quantity: the wage you pay the last worker, plus all workers times the extra wage you must pay them all. Disclaimer: the equations are me reverse-engineering the graph.) 

Now, add a minimum wage. As the minimum wage rises above \(W_m\), we initially see a rise in the number of workers, and their incomes. The firm moves along the arrow as shown. (\(\max f(N)-wN\) s.t. \( w \ge L(N)\), \( w \ge w^\ast\) gives \(w^\ast = L(N)\) .) 

Keep raising the minimum wage, though. Once we get past the point that labor supply ("average cost of labor") requires a wage greater than the marginal product of labor, the firm turns around and hires fewer people: 

Trust Fund

The Social Security Trust fund is set to run out in a few years. Who cares? Is the total US Federal debt $31,456,554,630,496.28, including Treasury debt held by the Social Security trust fund and other agencies?  or is it "only" $24,629,050,125,670.81 held by the public? (Source.)

I've been mulling these questions over, prodded by conversations with some colleagues. 

The "trust fund" exists because for a while, Social Security taxes were larger than Social Security payments. Social Security used the extras to buy Treasury debt. Now there are fewer workers, more retirees and more generous benefits, so Social Security taxes are smaller than payments. Social Security sells off its "trust fund." And it seems we're in trouble when the "trust fund" runs out.  

But that's not how it works at all. Treasury debt is not an asset like a stock or bond, or Uncle Scrooge's pool of gold coins. Treasury debt is a claim against future income taxes. Cashing in Treasury debt just  means paying for benefits with income taxes. 

The ups and downs of the trust fund just reflect a change in how we finance spending. While payroll taxes > social security spending, which was the case until 2007, then payroll taxes are financing other spending. When payroll taxes < social security spending, then income taxes or increases in debt are financing social security spending, which (graph below) was the case after 2008.* The trust fund just adds up this change over time. But exhausting the trust fund is, in this view, really irrelevant. 

source: CBO

That doesn't mean we can all go to sleep, for two reasons. First, when payroll taxes < Social Security outlays, and the trust fund is winding down, then income taxes or additional public debt must finance the shortfall. The government has to spend less on other things, raise income tax receipts, or borrow which means raising future taxes. And, per the graph, the numbers are not small. 1% of GDP is $230 billion. The extra strain on income taxes, other spending, or debt, happens right now, when the trust fund is positive but decreasing. 

Zero matters only because by law,  when the trust fund goes to zero, Social Security payments must be automatically cut to match Social Security taxes. That's the sudden drop in the graph. The program was set up as if  the trust fund were buying stocks and bonds, real assets, and would not lay claim on income tax revenues. But it was not; social security taxes were used to cover other spending, and now income taxes must start to pay social security benefits. 

What happens when the trust fund runs out, then?  Congress has a choice: automatically cut benefits, as shown, or change the law so that the government can pay Social Security benefits from income taxes, or, more realistically, by issuing ever more debt, until the bond vigilantes come. (Or raise payroll taxes, or reform the whole mess.) I bet on change the law. 

So what's the right measure of debt? It's conventional to look only at debt in public hands. But there is a case to look at the total debt, i.e. including the trust funds. Those are the total claims against the income  tax. Looking at it this way, however, one could also go on and count unfunded future social security benefits as a debt -- the present value of the difference between the two lines above, which leads to immense numbers, per Larry Kotlikoff. 

I have usually not considered the present value of unfunded promises as "debt," because Congress can change the payments at any time. Changing debt repayment to the public is a default, with financial and legal consequences; changing social security benefits is legislation. You can't sell your future social security benefits as you can sell your treasury debt. The trust fund is half way on this scale. What would be the consequence of a haircut or rescheduling of trust fund debt? Would that trigger something like cross-default clauses in corporate debt? I don't know. The event is unlikely anyway. The left pocket defaulting on the right pocket doesn't help pay the bills. The trust fund is certainly unlikely to run, and its debt is not used as collateral in financial transactions. As a somewhat meaningless accounting identity, it's a lot less "debt" than the debt in public hands. 

I think this all goes to remind us that paying off the existing debt is not the US central fiscal problem. The central problem is vast unfunded future promises. Defaulting or inflating away current debt does nothing to fund those promises. 

I look forward to comments on this one, especialy if there are standard views on these apparently simple questions that I'm not aware of. 

*In the end,  

payroll taxes + income & other taxes + increase in public debt = Social Security spending + other spending. 

The trust fund nets out. 

Fair/consumption tax adjustment

The main (vocal) comment on my consumption/fair tax post and oped  has been to complain about retirees who have earned income, paid taxes, saved, and now must pay consumption taxes on what they buy with the proceeds. 

When writing an oped, one tries to anticipate a few objections, but not to overdo it. I left this one out because it surely seemed an easy exercise for the reader. This is a problem easily solved with money. If the consumption tax is 30%, then the government can top up retirement savings by 30%. Done. 

It obviously need not be that generous. First, old savers will benefit by not having to pay capital gains tax and estate tax on their savings. That almost adds up to the consumption tax right there! So at best they need a subsidy only equal to the difference between the new consumption taxes and what they will save from the absence of all other taxes. Second, the market is likely to boom. So, subsidy only to the value of investments on the day before the tax is announced. Third, this only applies to old savers. Fans of wealth taxation should be lining up for the consumption tax as it hits high wealth accumulators most! (There is an interesting question whether the CPI will include the consumption tax or not. If so, social security is immediately indexed and rises to pay the tax, thereby greatly benefiting seniors who no longer pay income taxes on social security.) 

But more importantly, in the big government intergenerational transfer scheme, current old people who have saved money came out pretty well. They get a lot more out of social security and medicare than they put in, and a lot more than young people will ever see. Whatever the benefits of 100% debt to GDP are, they got them and their grandchildren will pay them. If one is arguing on distributive justice, leaving the poker game just after you scored a big hand, and then crying about taxes is a bit unseemly.

And I'm sure that's only the beginning. Every reform has winners and losers. Tax lawyers and accountants are going to do terribly!  I assume some muddy mess will emerge to compensate old savers and other politically organized losers.  Government and politics are about transfers. Economics is about incentives. If every change must be completely Pareto optimal, we might as well go back to subsistence farming. 

Fair tax oped

An Oped in the Wall Street Journal on the "fair tax" proposal. As usual, I have to wait 30 days to post the full version 

The bill eliminates the personal and corporate income tax, estate and gift tax, payroll (Social Security and Medicare) tax and the Internal Revenue Service. It replaces them with a single national sales tax. Business investment is exempt, so it is effectively a consumption tax.

I've been writing about consumption taxes for a while. Some previous posts on these points,  VAT (WSJ), A progressive VAT, Consumption tax, Tax reform, Taxes, Alternative Minimum Tax, also  Wealth and Taxes Convexification and complication Tax graph Economists and Taxes Corporate tax burden Tax Reform Tax reform again (WSJ) Corporate tax reading list Corporate tax (zero) Trump taxes 2 Those address a lot of the what ifs and whatabouts. 

But it's not progressive! (Meaning, better off people pay the same rate, not the same amount, not "politically progressive"). 

Already the "fair tax" proposal adds 

Each household would get a check each month, so that purchases up to the poverty line are effectively not taxed.

Yes, effectively universal basic income from Republicans! One could do more. And as in the above forest of links there are plenty of ways to make a consumption tax as progressive as you'd like. 

But the most important point, with added emphasis: 

the progressivity of a whole tax and transfer system matters, not of a particular tax in isolation. If a flat consumption tax finances greater benefits to people of lesser means, the overall system could be more progressive than what we have now. A consumption tax would still finance food stamps, housing, Medicaid, and so forth. And it would be particularly efficient at raising revenue, meaning there would potentially be more to distribute—a point that has led some conservatives to object to a consumption tax.

RIP Indexed Bonds in Canada

(An oped at Globe and Mail with Jon Hartley) 

Finance Minister Chrystia Freeland recently announced that the government of Canada  will no longer issue inflation-protected “real return” bonds. A kerfuffle erupted.

The government may wish to avoid inflation-protected bonds, because it thinks inflation will get a lot worse than markets do. But betting in markets is not a responsible strategy.

If the government won’t do it, corporations, banks and financial institutions should issue these bonds themselves rather than just complain. Not every asset must be provided by the government.

Real return bonds adjust both principal and interest for inflation. If inflation goes up, you get more money back. Nice. But when everyone expects inflation, you pay a commensurately higher price ahead of time.