…because I’m an economist and a mom–that’s why!

The Very Picture of a Very Public Problem

May 12th, 2010 . by economistmom


For inside-the-Beltway-obsessed (“DCist”) types, here’s a picture worth at least a thousand words and several billions of dollars that ought to get your attention: the size of the BP oil spill superimposed over the DC metropolitan area.

This is clearly not just BP’s problem or that of any other private interest who could be blamed, and we’re all going to have to pay to clean it up as best we can, as we all should.


Conservative Delusions on Tax Cuts

May 10th, 2010 . by economistmom


There are two main delusions ideological-but-not-thoughtful conservatives have about tax cuts:  (i) they pay for themselves (supply side to the extreme, known as the “Laffer Curve” effect); or (ii) they don’t pay for themselves and so they restrain spending (the “starve the beast” argument).  They obviously can’t both be right, and it turns out that neither are right.

A very thoughtful and brutally honest article by Kevin Williamson in the May 3rd issue of the National Review declares “Goodbye Supply Side”–because there’s just no evidence that at today’s marginal tax rates, cutting rates could spur so much economic growth that revenues would actually rise.  Williamson quotes Arthur Laffer himself confessing:

Arthur Laffer, whose famous (and possibly apocryphal) back-of-the-napkin diagram launched supply-side tax policy, readily concedes that the growth effects of tax cuts are oversold in the political debate. “Does every tax cut pay for itself? No. I think Irving Kristol wrote that, once — and then did a pretty good job of arguing for it. But if some guy running for Congress in Clayton County, Texas, says all tax cuts pay for themselves, what do we want to do? Go after him with a shotgun? Sure, they’re going to cite me, and there’s very little I can do about it. But there’s the same amount of ignorance on the other side, ignoring the economic feedback effects of tax cuts.”

…and Williamson goes on to explain the difference between recognizing that marginal tax rates do affect economic decisions and being delusional about how large those responses are:

[S]uch magical thinking is not the exclusive domain of back-benchers from the hinterlands. The exaggeration of supply-side effects — the belief that tax-rate cuts pay for themselves or more than pay for themselves over some measurable period — is more an article of faith than an economic fact. But it’s a widespread faith: George W. Bush argued that tax cuts would serve to increase tax revenues. So did John McCain. Rush Limbaugh talks this way. Even Steve Forbes has stepped into this rhetorical stinker from time to time…

[I]n truth, nobody really should run for office on the supply-side revenue effects of tax cuts, either. As it turns out, they present a dry and technical question of limited interest to the general electorate. It is true that tax cuts can promote growth, and that the growth they promote can help generate tax revenue that offsets some of the losses from the cuts. When the Reagan tax cuts were being designed, the original supply-side crew thought that subsequent growth might offset 30 percent of the revenue losses. That’s on the high side of the current consensus, but it’s not preposterous. There is, however, a world of difference between tax cuts that only lose only 70 cents on the dollar and tax cuts that pay back 100 cents on the dollar and then some…

And when conservatives can’t rely on the myth that tax cuts raise revenue, they turn to the argument that if they lose revenue, then all the better(!)–to “starve the beast” of government spending.  Kevin Williamson also dismisses that as another delusion about tax cuts:

[T]hat’s one thing the gentleman from Clayton has right: Tax cuts aren’t really the problem. The hot action is on the spending side of the ledger, and nobody wants to touch it. The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending — just keep cutting taxes, the argument goes, and somebody else will eventually have to cut spending. The results speak for themselves: Tom DeLay and Dennis Hastert and Trent Lott and Bill Frist all know how to count, but, under their leadership, Republicans spent all the money the country had and then some. Deficits boomed, and Republicans’ claim to being the responsible britches-wearing adults when it comes to spending got unpantsed. Cutting taxes is easy. Cutting spending is hard.

Bruce Bartlett points out in his latest Forbes column that the “starve the beast” theory is so wrong in practice that tax cuts in fact have had just the opposite effect, ironically feeding the beast of government spending as well as the uglier beast of budget deficits:

["Starve the Beast"] remains a critical part of Republican dogma. On April 8 Rep. Michele Bachmann, R-Minn., told right-wing talk show host Sean Hannity that the Republican response to health care reform would be to “starve the beast” by refusing to fund it. On April 14 Sarah Palin begged her followers in Boston to “please starve the beast” by resisting any tax increase, no matter how large the budget deficit.

Despite its continuing popularity among Republican politicians, at least a few conservative intellectuals are starting to have misgivings about STB. In 2005 free-market economist Arnold Kling admitted he had been wrong. “Cutting taxes did not help to reduce the size of government,” he conceded.

For some years Bill Niskanen of the libertarian Cato Institute has argued that STB actually increased spending and made deficits worse. His argument is that the cost of spending is ultimately the taxes that will have to be raised to pay for it. Thus fear of future tax increases was the principal brake on spending until STB came along. By eliminating tax increases as a necessary consequence of deficits, it also reduced the implicit cost of spending. Thus, ironically, STB led to higher spending rather than lower spending as the theory posits.

In the latest study of STB, political scientist Michael New of the University of Alabama confirms Niskanen’s analysis. “Revenue reductions by themselves are not an effective mechanism for limiting expenditure growth,” New concluded. “The evidence suggests that lower levels of federal revenue may actually lead to greater increases in spending.”

In effect STB became a substitute for spending restraint among Republicans. They talked themselves into believing that cutting taxes was the only thing necessary to control the size of government. Thus, rather than being a means to an end–the end being lower spending–tax cuts became an end in themselves, completely disconnected from any meaningful effort to reduce spending or deficits.

Why didn’t “starve the beast” work as Bruce explains Milton Friedman and Ronald Reagan once claimed it would? (emphasis added):

On Aug. 7, 1978, economist Milton Friedman added his powerful voice to the discussion. Writing in Newsweek magazine, he said, “the only effective way to restrain government spending is by limiting government’s explicit tax revenue–just as a limited income is the only effective restraint on any individual’s or family’s spending.

By 1981 STB was well-established Republican doctrine. In his first major address on the economy as president on Feb. 5, Ronald Reagan articulated the idea perfectly. As he told a nationwide audience that night, “Over the past decades we’ve talked of curtailing spending so that we can then lower the tax burden. … But there were always those who told us that taxes couldn’t be cut until spending was reduced. Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.

Well, maybe because when you reduce a kid’s allowance, he doesn’t normally just turn around and max out his credit card…

Or as Kevin Williamson puts it (emphasis added):

This we know: Tax cuts don’t get us out of the spending pickle, and growth isn’t going to make the debt irrelevant. Legislative mandates and gimmicks like spending caps and the like will not constrain the spendthrift habits of appropriators — because, if they do, they will be repealed, just like Gramm-Rudman was. You can’t starve the beast if the Chinese and the bond markets keep lending him bon-bons by the ton. And the prospect of enacting a balanced-budget amendment to the Constitution is a castle in the sky.

So these Laffer-curve and “starve the beast” theories are both delusions that only encourage us to keep feeding the debt monster, while our revenue base continues to waste away.

Happy Mother’s Day!

May 9th, 2010 . by economistmom

Happy Mother’s Day to all moms out there, but especially to my own mother–who has been an inspiration and a source of wisdom and strength for me my whole life!  (Sorry to put this up so late in the day, Mom; I know you’re probably going to bed already!)

Two More Reasons to Like a VAT, Other Than for the Money

May 8th, 2010 . by economistmom

Nearly a year ago I posted on Len Burman’s idea of implementing an add-on value-added tax to fund health care reform, commenting on what a good idea it was to combine tax reform and health reform, because tax reform on its own could probably never be enacted if anything more than revenue neutral.  This Thursday I was at a meeting of tax policy experts which included Len, at which he suggested a couple other reasons to like the VAT, besides for the revenue it could raise which we so badly need:

  1. The “announcement effect” would be good stimulus for the recovering but still-weak economy. Policymakers worry this is no time to raise taxes, because the labor market is still weak and thus we still need to be in “stimulus” mode–cutting taxes, if we do anything with taxes.  Len explained that of course an add-on VAT would not take effect immediately (heck, let’s face it, it wouldn’t even be enacted any time soon), and as soon as it is clear when the VAT would take effect, the announcement would create the incentive for households and businesses to bring forward in time any consumption they can (such as in durable goods), before the tax takes effect.  Later, after the VAT takes effect, consumption may be depressed (and saving encouraged) beyond what would be the normal “steady state” level, which is a fine thing to happen once the economy is at full employment and we’re back to focusing on increasing our productive capacity (rather than just putting to use our existing capacity).  Thus, the add-on VAT can be good for both short-term stimulus and longer-term fiscal sustainability.
  2. The intergenerational distribution of the burden of a VAT would work to offset the distributional effects of the federal entitlement programs that disproportionately benefit the elderly. Because a value-added tax is a consumption-based tax, it is economically equivalent to taxing the sum of current labor income plus one’s existing stock of wealth or savings (that’s what can be used to purchase goods and services).  Economists like the tax on existing wealth for efficiency reasons, because it amounts to a “lump-sum” tax that doesn’t distort economic behavior (as I explained in my last post on the oil spill and what any fine on BP alone would amount to).  On fairness grounds, there was some debate about the desirability of this lump-sum tax on wealth among the tax experts on Thursday.  A tax on wealth tends to burden the rich more than the poor, which might seem fair, but it also tends to burden the old more than the young, which might not seem fair–in isolation at least.  Tax policy experts have traditionally grappled with this intergenerational burden of consumption taxes in the context of replacing the income tax with a consumption tax–in which case it does seem unfair for a person entering or in retirement, who paid income taxes on his/her labor income over an entire career with the expectation that their income tax burden would go down in retirement (as his/her income would go way down), to suddenly be taxed on his/her consumption (which may remain just as high or higher in retirement compared with in working years).  Tax economists have called this a “transition cost” of switching to a consumption tax, and have often concluded that “transition relief” would have to shield the elderly from this tax on existing wealth, which unfortunately would chop the tax base way down and get rid of its most efficient component.  But in the case of an add-on VAT, this fairness concern seems less concerning, especially given what the VAT would fund (health benefits that disproportionately benefit the elderly) and why that additional revenue is needed (because existing entitlement programs which disproportionately benefit the elderly are on an unsustainable path).  In fact, when this topic was discussed on Thursday, most of the experts seemed to conclude this was an advantage, not a disadvantage, of the VAT (add-on or not)–that it would help alleviate the current intergenerational skewness in the net benefits of federal government programs, as well as which generations (younger ones) bear the burden of the debt.

But the number one reason why to like a VAT is still because there aren’t really any better ideas about how to raise more revenue, and not raising more revenue is not an option.

Who Should Pay the Costs of the Oil Spill? All of Us, Really.

May 6th, 2010 . by economistmom


A story on CNN-Money today by Steve Hargreaves asks “What will BP really pay?”  I think a more fundamental question to ask at this point is “What should BP pay?  And should no one else?”  As the story explains (emphasis added):

NEW YORK ( — The Gulf oil spill is going to cost billions to clean up, a tab BP has publicly pledged to pay in full.

But thanks to the unpredictable nature of the oil slick and the legal maze surrounding maritime law, what BP will pay and to whom is very much an open question…

Start with the costs. Estimates to clean the spill and compensate other parties for the economic damage run from $2 billion to $14 billion. One politician even said it could run into the hundreds of billions

…which is a lot of money, too much for even BP to cover (whose profits were (coincidentally) around $14 billion last year).

BP’s public pledge notwithstanding, there are limits on what the government can make them pay, and the question is what can be done about it.  Policymakers are starting to realize that if the costs are paid through anything more than a simple one-time fine on BP only–which BP would just have to “suck up” (pun intended)–that the burden of those costs will be spread (emphasis added):

BP’s liabilities may be capped by a federal rule that limits the payouts for economic damages stemming from an oil spill to $75 million. Once that threshold is reached, a federal fund kicks in, covering an additional $1 billion. The federal fund is paid for by a 8-cents-a-barrel tax on oil produced or imported into the United States…

To ward off any confusion, lawmakers in the House and Senate have introduced bills raising the liability cap from $75 million to $10 billion, an initiative they’ve dubbed the “Big Oil Bailout Prevention Act.” Lawmakers say there’s precedent for making the law retroactive: Witness the Superfund, which forced polluters to reimburse the government for toxic cleanup.

Given the public outrage over the spill, and the fact that it’s an election year, the bills stands a good chance of passing.

But not everyone thinks it’s a good idea. If the cap is increased, Nelson predicts that it will only raise the cost of buying insurance for all companies producing offshore oil.

“You’re going to pay for that at the gas pump,” he said.

There’s certainly an appeal to covering the costs of cleaning up (or trying to clean up) the oil spill entirely through a fine levied solely on BP, but that’s only on fairness and public-perception grounds.  Such a fine would be an example of what economists call a “lump-sum tax”–a tax which could not be avoided by changing behavior, in this case because it’s based on something that already happened.  (Any tax on anything that happened in the past–any “retroactive” tax–is a lump-sum tax.)  Economists generally like lump-sum taxes, because they don’t distort economic decisions.  And when such a tax cannot be avoided by changing economic behavior, the burden of such a tax is also unable to be shifted to other participants in the taxed market.  In the case of the BP oil spill (perhaps better called an “explosion”?), this probably seems good and “right” on fairness grounds, at least to most of the American public who aren’t directly employed by or invested in BP.

But it turns out that on economic efficiency grounds, the fact that a tax or fine on BP alone would amount to a lump-sum tax that would not get passed along to any of the other participants in the BP marketplace or the oil market more generally is a bad thing.  Because the BP oil spill reveals more than any lack of adequate quality and safety controls in BP’s production operations.  It reveals more generally the risks associated with oil production, risks that translate into large social costs that go unpriced in the oil market.  It is a classic case of a “negative externality,” where the social costs of producing and consuming a good exceed the private costs paid through market prices.  In such a case, economic theory says that intentionally distorting market prices through public policy–in the case of a negative externality, through a tax representing the excess of social marginal costs over private marginal costs–would improve economic efficiency.

The BP oil spill provides us a new and very in-your-face lesson: that the excess of social costs over private costs (the “external costs”) associated with fossil fuels go beyond the “biggie” of global warming via the consumption (burning) of fossil fuels–a very long-term phenomenon that is very difficult to predict the economic and social costs of (and hence is easy for us to ignore).  The BP oil spill reveals that there are more immediate and clear (and very visual and quantifiable) social costs associated with fossil fuels in terms of the risks to the environment on the production/extraction side of the market.  So now there are at least two major reasons why for economic and social efficiency, fossil fuels should be taxed:  (i) because of the external costs associated with global warming resulting from the consumption of fossil fuels; and (ii) because of the external costs associated with the risky extraction strategies used in the production of fossil fuels.  And both these reasons suggest that there is no way that the right policy response to the BP oil spill–from an economic efficiency, maximize social welfare standpoint–is just to “fine the hell out of BP” (alone) and run BP (alone) out of business.  (Even from a fairness perspective, it’s not at all clear that this kind of accident couldn’t have happened with any other company’s well.)  The right policy needs to indeed spread the burden of the costs of cleaning up the oil spill to all participants in the oil marketplace, including those of us who innocently just fill up our tanks with gasoline.  Only when the extra social costs of the environmental risks associated with both fossil fuel production (e.g., risk of offshore drilling mishaps) and fossil fuel consumption (e.g., global warming, pollution) are incorporated into the prices all of us face in the fossil fuel markets we participate in, will we be led to make the correct, or at least better, decisions from a social welfare standpoint, not just from our own selfish standpoints.  These better decisions include the oil companies using safer production methods (which likely means producing less offshore), and consumers buying less gasoline.

Unfortunately, politicians won’t see it that way.  Even pro-environment types in Congress were cold to President Obama’s climate change proposal last year that would have raised gasoline and other fossil fuels prices.  (Psst:  That’s how climate change policy is supposed to work, by the way, and the President’s proposal was a good one.)  See, the U.S. isn’t in the practice of taxing environmentally-harmful activities (besides via our very/too low-by-international-standards gasoline tax); in fact, we’re in the habit of subsidizing the oil and gas industry via tax preferences.  We get that wrong in two ways:  we increase the deficit, and we worsen the economic inefficiencies (and just plain environmental damage) associated with fossil fuels.  Now with the BP disaster to more clearly and immediately remind us that we’ve been getting this all wrong, we should be trying to make those two wrongs two rights.  This should motivate policymakers to implement smart climate change policy–i.e., a policy that would actually raise fossil fuel prices (that all of us pay) and raise revenue for deficit reduction (or to avoid deficit increases)–as soon as possible.

Why We Can Literally Tax “Evil Corporations,” But Not *Really* Tax Them

May 4th, 2010 . by economistmom

Donald Marron takes the “throne” at the Tax Policy Center in less than two weeks, and he’s already showing his wisdom on tax policy. Today on his blog he talked about the “bank tax,” aka the “Financial Crisis Responsibility Fee”–from the Administration that can never say “tax” no matter how evil the entity on which said tax would be imposed.  Donald was focused on the issue of whether revenue from the bank tax would actually be used to reduce the deficit/pay back the TARP money owed (as the Administration claims it would), or whether it would be grabbed up by all the other more exciting ways to use the money–for example, more tax cuts!

But I liked the little lesson in tax incidence that Donald gave on the way to posing his budget question (emphasis added):

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

You see, no matter how the tax is literally (statutorily) structured and who would actually be responsible for writing the check to the government (such as an “evil corporation” perceived as deserving of that tax), the true economic burden of the tax must ultimately fall on some real people.  You can say you’re only taxing “companies” and not “people,” but what you’re really doing is indirectly taxing people, rather than directly taxing people.  When a tax is levied on a business rather than on a household, the burden must still be distributed among households based on those households’ roles in the various markets in which the taxed business operates–through their roles as workers for that business, investors in that business, or consumers of the goods or services the business produces.  A tax on a financial corporation, for example, could end up reducing returns to shareholders of that corporation or reducing salaries of the top management, but it could just as well end up raising the cost of loans to households who borrow to pay for their houses, cars, and college educations–or burdening some households by depriving them of such loans altogether.

Policymakers seems to prefer finding these indirect ways of raising taxes, because these policymakers are politicians, too, and they understand that indirect taxes levied on businesses don’t look as obviously burdensome on ordinary, real people.  The irony is that indirect taxes burden real people every bit as much as direct taxes on household incomes do, but the direction of the burden of an indirect tax is harder to control and tailor–because you are literally levying the tax on businesses based on business characteristics, and not on households based on household characteristics.  So in the process of trying to make a tax look like a tax on an “evil corporation” and not a tax on middle-class households (or households with incomes below $250,000), just for example, you get a distribution of the tax burden that is nearly impossible to keep away from those very households you’re trying to avoid taxing–because you cannot exempt (protect) any households directly when you are not taxing any households directly.

This is in fact the problem with the excise tax on high-end health insurance plans levied on (evil?) insurance companies in the health reform bill.  It is a tax limited to high-cost plans because policymakers intended it to look like a tax only on evil corporations but that would ultimately burden only rich households.  But because it is tied to the characteristics of the health insurance plans the insurance companies sell, rather than the characteristics of the households who purchase such plans, it will inefficiently, unintentionally burden some lower-income households who purchase high-end insurance, while exempting from any burden many high-income households who do not purchase high-end insurance.  In contrast, if the tax had been levied directly at the household level through the individual income tax, the tax could be tailored to more comprehensively apply to the employer-provided health plans of only higher-income households–or any subset of households policymakers feel comfortable burdening with the tax.

So that’s tonight’s public finance lesson on “tax incidence.”  Tomorrow I hope to talk about taxes and “externalities”  and the case of the BP oil spill (perhaps better labeled an “eruption”).  Speaking of another potential “evil corporation”…

President Obama Says “Go Blue”!

May 2nd, 2010 . by economistmom

…and a few other things.  Wow! President Obama gave the U of Michigan commencement address this year. And apparently, according to President Obama’s speech, President Kennedy had given the U of M commencement address 50 years ago. Just about halfway in between, the year I graduated from Michigan (1983), I wasn’t so lucky; I got to hear from Lee Iacocca–the chairman of Chrysler.

Besides “Go Blue” the President had a lot to say about the critical role of government in our society. (Why, we should hope that the government can “take over” more of our country when the private sector doesn’t seem to be doing so well — just think of the two companies most prominent in recent/current news:  Goldman Sachs and BP.)

…what troubles me is when I hear people say that all of government is inherently bad.  One of my favorite signs during the health care debate was somebody who said, “Keep Your Government Hands Out Of My Medicare” — (laughter) — which is essentially saying “Keep Government Out Of My Government-Run Health Care Plan.”  (Laughter.)

When our government is spoken of as some menacing, threatening foreign entity, it ignores the fact that in our democracy, government is us.  We, the people — (applause.)  We, the people, hold in our hands the power to choose our leaders and change our laws, and shape our own destiny.

Government is the police officers who are protecting our communities, and the servicemen and women who are defending us abroad.  (Applause.)  Government is the roads you drove in on and the speed limits that kept you safe.  Government is what ensures that mines adhere to safety standards and that oil spills are cleaned up by the companies that caused them.  (Applause.)    Government is this extraordinary public university -– a place that’s doing lifesaving research, and catalyzing economic growth, and graduating students who will change the world around them in ways big and small.  (Applause.)

The truth is, the debate we’ve had for decades now between more government and less government, it doesn’t really fit the times in which we live.  We know that too much government can stifle competition and deprive us of choice and burden us with debt.  But we’ve also clearly seen the dangers of too little government -– like when a lack of accountability on Wall Street nearly leads to the collapse of our entire economy.  (Applause.)

So, class of 2010, what we should be asking is not whether we need “big government” or a “small government,” but how we can create a smarter and better government…

And President Obama also described how extreme partisanship and even “demonization” crowds out compromise and any serious, thoughtful development of policies:

…we can’t expect to solve our problems if all we do is tear each other down.  (Applause.)  You can disagree with a certain policy without demonizing the person who espouses it.  You can question somebody’s views and their judgment without questioning their motives or their patriotism.  (Applause.)    Throwing around phrases like “socialists” and “Soviet-style takeover” and “fascist” and “right-wing nut” — (laughter) — that may grab headlines, but it also has the effect of comparing our government, our political opponents, to authoritarian, even murderous regimes.

Now, we’ve seen this kind of politics in the past.  It’s been practiced by both fringes of the ideological spectrum, by the left and the right, since our nation’s birth.  But it’s starting to creep into the center of our discourse.  And the problem with it is not the hurt feelings or the bruised egos of the public officials who are criticized.  Remember, they signed up for it.  Michelle always reminds me of that.  (Laughter.)  The problem is that this kind of vilification and over-the-top rhetoric closes the door to the possibility of compromise.  It undermines democratic deliberation.  It prevents learning –- since, after all, why should we listen to a “fascist,” or a “socialist,” or a “right-wing nut,” or a left-wing nut”?  (Laughter.)

It makes it nearly impossible for people who have legitimate but bridgeable differences to sit down at the same table and hash things out.  It robs us of a rational and serious debate, the one we need to have about the very real and very big challenges facing this nation.  It coarsens our culture, and at its worst, it can send signals to the most extreme elements of our society that perhaps violence is a justifiable response.

The President’s advice on how to avoid “closing the doors” to compromise and what’s best for our country?:

[I]f we choose to actively seek out information that challenges our assumptions and our beliefs, perhaps we can begin to understand where the people who disagree with us are coming from.

Now, this requires us to agree on a certain set of facts to debate from.  That’s why we need a vibrant and thriving news business that is separate from opinion makers and talking heads. (Applause.)  That’s why we need an educated citizenry that values hard evidence and not just assertion.  (Applause.)  As Senator Daniel Patrick Moynihan famously once said, “Everybody is entitled to his own opinion, but not his own facts.”  (Laughter.)

Still, if you’re somebody who only reads the editorial page of The New York Times, try glancing at the page of The Wall Street Journal once in a while.  If you’re a fan of Glenn Beck or Rush Limbaugh, try reading a few columns on the Huffington Post website.  It may make your blood boil; your mind may not be changed.  But the practice of listening to opposing views is essential for effective citizenship.  (Applause.)  It is essential for our democracy.  (Applause.)

That’s some very good advice–not just for the U of M grads, but for all of us.  Now pardon me while I tune into Rush…

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