The Times on Taxes

The New York Times' Sunday lead editorial (12/30) is simply breathtaking. The title is "Why the economy needs tax reform." It starts well,

Over the next four years, tax reform, done right, could be a cure for much of what ails the economy...

OK, say I, the sun is out, the birds are chirping, my coffee is hot, and for once I'm going to read a sensible editorial from the Times, pointing out what we all agree on, that our tax system is horrendously chaotic, corrupt, and badly in need of reform. Let's go -- lower marginal rates, broaden the base, simplify the code.

That mood lasts all of one sentence.

Higher taxes,...

Words matter. "Reform" twice, followed by paragraphs of "higher taxes," with no actual "reform" in sight. The Times is embarking on an Orwellian mission to appropriate the word "reform" to mean "higher taxes" not "fix the system."

Let's be specific. What is the Times' idea of tax "reform?"

Benefits trap art

Two charts from the UK, admittedly sprayed with too much chartjunk, but illustrating the poverty trap in Britain. (A previous post  on high marginal tax rates for low income people has more charts like this.)

Most of UK benefits are not time-limited, so people get stuck for life, and then for generations.

Fiscal cliff or fiscal molehill?

Four thoughts, reflecting my frustrations with the "fiscal cliff" debate. 

1. Recession

How terrible will it be if we go over the cliff?

Bad, but for all the wrong reasons. If you, like me, didn't think that "stimulus" from government spending raised GDP in the recession, you can't complain that less government spending will cause a new recession now. The CBO's projections of recession are entirely Keynesian. Pay them heed if you still think the key to prosperity is for the government to borrow money and blow it.

The Fed's great experiment

So now you have it. QE4. The Fed will buy $85 billion of long term government bonds and mortgage backed securities, printing $85 billion per month of new money (reserves, really) to do it. That's $1 trillion a year, about the same size as the entire Federal deficit. It's substantially more each year than the much maligned $800 billion "stimulus." Graph to the left purloined from John Taylor to dramatize the situation.

In addition, the Fed's open market committee promises to

"..keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." [Whatever "anchored" means.] 

This is a grand experiment indeed. We will test a few theories.

ECB dilemma

It was announced yesterday that  Europe will have a new, central bank supervisor run by the ECB, much as our Fed combines monetary policy and bank supervision. Be careful what you wish for, you just might get it.

One big unified central agency always sounds like a good idea until you think harder about it. This one faces an intractable dilemma.

Here's the problem. Why not just let Greece default?" is usually answered with "because then all the banks fail and Greece goes even further down the toilet." (And Spain, and Italy).

So, what should a European Bank Regulator do? Well, it should protect the banking system from sovereign default. It should declare that  sovereign debt is risky, require marking it to market, require large capital against it, and it should force banks to reduce sovereign exposure  to get rid of this obviously "systemic" "correlated risk" to their balance sheets. (They can just require banks to buy CDS, they don't have to require them to dump bonds on the market. This is just about not wanting to pay insurance premiums.) It should do for the obvious risky elephant in the room exactly what bank regulators failed to do for mortgage backed securities in 2006.

Billing codes

A while ago, an acquaintance saw her dermatologist for an annual check. She said, "oh, by the way, take a look at the place on my foot where we removed a wart a while ago." The doctor looked at her foot, said everything is fine, then finished the exam. Checking the bill, there was a $400 extra charge for the wart examination!

This nice audio story from NPRs "third coast festival"  tells the story of billing codes. Answer: As insurers and medicare/medicaid reduce payment for services, doctors respond by writing up every billing code they legally can. There are whole conferences devoted to billing code maximization. It's a lovely unintended-consequences story. Good luck with that "cost control."

The piece quotes the Institute of Medicine that there are 2.2 people doing billing for every doctor, at a $360 billion dollar cost. I couldn't find the source of these numbers. If any of you can, post a comment.

Of course, being NPR, the program leaves the impression that all this will be fixed in our brave new world of the ACA. But it wasn't even that heavy handed on the point. Perhaps experience is gaining on hope.

Buffett Math

Warren Buffett, New York Times on November 25th 2012:

Suppose that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”

Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 percent.” Only in Grover Norquist’s imagination does such a response exist.

MBA final exam question: Explain the mistake in this paragraph.

Truth stranger than fiction?

From the New York Times. I checked, it really is not from the Onion. 

WASHINGTON — House Republicans said on Thursday that Treasury Secretary Timothy F. Geithner presented the House speaker, John A. Boehner, a detailed proposal to avert the year-end fiscal crisis with $1.6 trillion in tax increases over 10 years, an immediate new round of stimulus spending, home mortgage refinancing and a permanent end to Congressional control over statutory borrowing limits.

...In exchange for locking in the $1.6 trillion in added revenues, President Obama embraced $400 billion in savings from Medicare and other entitlements, to be worked out next year, with no guarantees.

The upfront tax increases in the proposal go beyond what Senate Democrats were able to pass earlier this year. Tax rates would go up for higher-income earners, as in the Senate bill, but Mr. Obama wants their dividends to be taxed as ordinary income, something the Senate did not approve. He also wants the estate tax to be levied at 45 percent on inheritances over $3.5 million, a step several Democratic senators balked at. The Senate bill made no changes to the estate tax, which currently taxes inheritances over $5 million at 35 percent.

Meanwhile, Costco is in the news, for borrowing $3 billion dollars, and paying it out as a special dividend before dividend taxes rise.  Stock rose 6%. Tax arbitrage is so cool.

Experimental evidence on the effect of taxes

Much of our "fiscal cliff" debate revolves around the incentive effects of raising marginal taxes on high incomes. High tax advocates used to say that taxes won't hurt growth that much, and advocated them for other reasons.  Now they are advocating that even a 91% federal income tax rate, on top of state, sales, etc, as we had in the 1950s, (not counting all the loopholes!) will actually be good for the economy and also raise lots of revenue.

This seems to me like magical thinking, and a great testament to how people can persuade themselves of anything if it suits the partisan passion of the moment.  But wouldn't it be nice if someone would run an experiment for us?

Fortunately, Europe has been running a very useful set of experiments on what happens if you address yawning deficits with high income, wealth and property taxes. Which brings me to a report from the Telegraph

Almost two-thirds of the country’s million-pound earners disappeared from Britain after the introduction of the 50p (percent) top rate of tax, figures have disclosed.

Taxes and cliffs

(Update: John Batchelor show radio interview on this blog post)

The whole tax debate is supremely frustrating to anyone who survived econ 1.

The ill effects of taxation -- the "distortions" -- depend on the total, marginal rate including transfers. If I earn an extra dollar, how much more stuff do I get, or how much more of someone else's services can I receive? That calculation has to include all taxes, federal, payroll, state, local, sales, excise, etc. and phaseouts.

And, if you receive a benefit from the government that phases out with income, so every dollar of income above (say) $30,000 reduces your benefit by 50 cents, then you face a 50 percent marginal tax rate even if you pay no "taxes" at all. Taxes and benefits -- both in level and on the margin -- need to be considered together.
 
I've been looking for good calculations of marginal rates.  The CBO has just issued a nice report titled "Effective Marginal Tax Rates for Low- and Moderate-Income Workers" that begins (begins!) to shed some light on the right question.  Here's one important graph, titled "Marginal Tax Rates for a Hypothetical Single Parent with One Child, by Earnings, in 2012";

Happy Thanksgiving

By Eric Cochrane (who also drew the grumpy economist). More here

Health economics update

Russ Roberts did a podcast with me in his "EconTalk" series, on my "After the ACA'' article. Russ also put together a really nice list of readings with the podcast, at the same link.

I also found this very informative editorial "What the world doesn't know about health care in America" by Scott Atlas. It goes a good way to answering the persistent "What about how great health care is in Europe" comments. Some choice quotes:

Affirming 2005’s Chaoulli v. Quebec, in which [Canadian] Supreme Court justices famously concluded “access to a waiting list is not access to health care,” [my emphasis] countless studies document grave consequences from prolonged waits...

I love this little quote, because the deliberate confusion of "insurance" with "access" has long bugged me about the US debate.

Debt Maturity

Another essay, a bit shorter this time, on maturity structure of  US debt. I was asked to give comments on a paper by Robin Greenwood, Sam Hanson, and Jeremy Stein ^* at a conference at the Treasury. It's a really nice paper, and (unusually) I didn't have much incisive to say about it, except to say it didn't go far enough. And, I only had 10 minutes. So I gave a speech instead. (The pdf version on my webpage may be better reading, and will be updated if I ever do anything with this.) 

Having your cake and eating it too: The maturity structure of US debt
John H. Cochrane ¹
November 15 2012

Robin Greenwood, Sam Hanson, and Jeremy Stein ² nicely model two important considerations for the maturity structure of government debt: Long–term debt insulates government finances from interest-rate increases. Short-term debt is highly valued as a “liquid” asset, providing many “money-like” services, and potentially displacing run-prone financial intermediaries as suppliers of “liquidity.” Long-term debt also provides some liquidity and collateral services, (Krishnamurthy and Vissing-Jorgensen³ (2012)) but not as effectively as short-term debt. How do we think about this tradeoff?

Posing the question this way is already a pretty radical departure. The maturity structure of U.S. debt is traditionally perceived as a relatively technical job, to finance a given deficit stream at lowest long-run cost, as Colin Kim eloquently explained in the panel. Greenwood, Hanson and Stein, along with the other papers at this conference, are asking the Treasury’s Office of Debt Management to consider large economic issues far beyond this traditional question. For example, saying the Treasury should provide liquid debt because it helps the financial system and can substitute for banking regulation, whether or not that saves the Treasury money, asks the Treasury to think about its operations a lot more as the Fed does. Well, times have changed; the maturity structure of US debt does have important broader implications. And getting it right or wrong could make a huge difference in the difficult times ahead.

Go Long!

As I think about the choice between long and short term debt, I feel like screaming⁴ “Go Long. Now!” Bond markets are offering the US an incredible deal. The 30 year Treasury rate as I write is 2.77%. The government can lock in a nominal rate of 2.77% for the next 30 years, and even that can be paid back in inflated dollars! (Comments at the conference suggested that term structure models impute a negative risk premium to these low rates: They are below expected future short rates, so markets are paying us for the privilege of writing interest-rate insurance!)

Bloomberg TV interview

A short interview with Bloomberg TV's Betty Liu on the fiscal cliff.  No big news for readers of this blog, but maybe fun anyway.



We were just getting going when it ended. I was ready to say, if you didn't buy stimulus from spending increases, you shouldn't fear lack of stimulus from spending reductions; all government (federal, state, local) and all taxes matter; you need to include taxes and benefits, and then see the huge marginal taxes faced by poor people, and how cutting subsidies that go to rich people counts in the distributional calculus;the growth of regulation and tax chaos matters more than tax rates, Europe just showed us what happens when you try to balance the budget with sharp hikes in marginal rates....Next time.

Gas price contest

As all of you know, New York and New Jersey are having huge gas lines in the wake (still) of hurricane Sandy. Both are enforcing laws against "gouging," and New Jersey's attorney general, apparently having time on his hands, is going after people who listed gas for resale on Craigslist.

Let's start a little comments essay contest. If New York and New Jersey let people charge whatever they wanted for gas, and prices went up to $25 per gallon then...

Here are some ideas to get you started

Diversity in academia

99 percent of donors from Princeton gave to Obama, reports the Daily Princetonian, 157 to 2.  Princeton's one-percenters are a visiting lecturer and a custodian.

As a colleague pointed out, it may be little wonder that Republican politicians distrust academic "studies," whether about the effects of taxes on growth or carbon on the climate.

Dodd-Frank and Stigler's Ghost

The New York Times finally published  Gretchen Morgenson's article, pointing out that Dodd-Frank enshrines rather than eliminates "too big to fail," though systemic "designation" of "financial utilities" such as the exchanges has been underway since the bill's beginning. Needless to say, this has been my opinion all along.

Today let's move on. I'll label the bigger problem, "too big to fail means too big to compete." TBTF=TBTC. There, we can put that on bumper stickers.

As the Ms. Morgenson figured out, the Chicago Mercantile Exchange is now too big to fail, and will be able to borrow from the Fed and get a bailout. But that's not the big issue. The CME is now too big to compete. Who can now start a new exchange, maybe offering more protection against high frequency traders or other conveniences to customers, and threatening the CME's customer base? Not against a protected "financial utility."

George Stigler taught us that regulators are prone to "capture." Over the years, regulators start to sympathize with the industry they're regulating. Next thing you know, the regulations end up being used to protect the industry from competition. Luigi Zingales' great new book calls it "crony capitalism," emphasizing that it, not too much benevolent government or too much ufettered market competition, is the main characteristic of our society.

Predictions

I did a short spot on NPR's Marketplace this morning (also here). The announced topic was what I thought would happen to economic policy after the election. Jeff Horwich, the interviewer wanted to stitch together a story about everyone is going to get together and play nice now, which seemed like a fairly pointless line to pursue. What "I would do" is now off the table, and I didn't think it worth arguing with Jared Bernstein's repetition of Obama campaign nostrums.

But it gave me a chance to put some thoughts together. I usually don't predict anything, because I (like everyone else) am usually wrong. But I'll make an exception today

Forecast in three parts: The sound and fury will be over big fights on taxes and spending. They will look like replays of the last four years and not end up accomplishing much. The big changes to our economy will be the metastatic expansion of regulation, let by ACA, Dodd-Frank, and EPA.  There will be no change on our long run problems: entitlements, deficits or fundamental reform of our chaotic tax system.  4 more years, $4 trillion more debt.

DeMuth on Obamacare

Christopher DeMuth has a nice Oped in the Wall Street Journal. Thesis: Obamacare is the big question for the election.

He makes two points that I haven't seen expressed this well before, including by me despite 25 pages of trying:

Why the electoral college is a great idea

With the election looming, we see the quadrennial complaining about the electoral college. "The electoral college effectively disenfranchises most Americans" complains the New York Times  "Shafted by the electoral college" complains the usually excellent Steve Chapman at the Chicago Tribune.

Here's why I think the electoral college -- with (crucially) winner-take-all selection in the states, which is under attack -- is a great idea. (Even though I live in Illinois.) Look at the map. (Source here, I found it just by google searching, so no endorsement.)

With the electoral college, Governor Romney and President Obama have to get 51% majorities in enough states to get 270 votes, to win the white house.

Suppose we had a popular vote instead. Now, instead of fighting for 51% of Ohio, President Obama could instead try to raise his 60% of New York and Illinois to 70%, even if it meant 45% of Ohio. Or he could try to raise his 80% of New York city and Chicago to 90%, (made up number).  He doesn't need to persuade people, really, he just needs to  encourage more New Yorkers and Chicagoans to turn out.