Tax Season Special

If you still don't quite get the progressive marginal tax system or if you think I've been pulling a fast one, here is a good website to play with, to see how your income tax is affected by a small change in income that "bumps" you into a new bracket (hint: not much).

Market Failures and the Banks

Economists agree that markets work, except when they don't. The philosophical debate starts when markets don't work and people wonder what should be done about it. One side says the government can intervene constructively, and the other says that the government will probably only make things worse. But the debate at this point is not over whether markets have worked well in the financial sector, it's about what to do about it now that they have not. Larry Summers was on the News Hour (audio: HERE, and video: HERE), and explains it much better (his interview starts at 4min, 55sec):
 

GWEN IFILL: At the heart of this plan that Secretary Geithner introduced today is the idea that somehow these assets, which some people call "toxic assets," but which I notice you all call "legacy assets," that they're somehow worth saving. How do you value that? How do you know that it's worth a government investment?

LARRY SUMMERS: Well, our approach is premised on the recognition of a market failure that we have right now. Traditionally and usually these assets trade all the time between people who borrow money in order to finance their purchase.

That market, where they're able to borrow money, what people call "get leverage," has broken down. And as a consequence, the assets have lost a significant part of their value, just as if, all of a sudden there was no mortgage value, houses would lose a substantial part of their value.

And so, by providing the financing that enables that market to work, we enable more realistic valuations of these assets. We enable these assets to trade again. That means that people are in a position to originate loans and sell them into the market, and that gets the flow of credit going.

The point, though, is to create enough liquidity (and, by putting well-trained econ geeks like Summers and Romer out there, confidence) so that scared banks can both retain the higher levels of excess reserves they feel they need, and still keep credit flowing to private businesses. The alternative would be nationalization of the banking sector, which, in a more fundamental way than simple income redistribution or even public health care, would truly be a step in the direction of "socialization" of the private sector. Nobody, (even this administration, contrary to what some folks believe) wants that.

The Economic Definition of "Government Expenditures"

The debate over the various government "bailouts" and "stimulus packages" really glosses over the difference between a "subsidy" (negative tax) versus true "direct expenditures" by the government. The definition is important because the impact of these components of the current legislation have different "multiplier effects." Some of them behave similar to "tax cuts" (even if they are negative taxes) and some of them behave like "government expenditures" in the Keynesian framework. Here is a brief taxonomy:
Tax cuts/Negative taxes:
1. reductions in the tax rates;
2. subsidies to struggling private firms ("bailouts");
3. transfer payments (welfare).
Government expenditures:
1. direct government production (e.g. building/repairing roads);
2. government purchases of final goods and services;
So, in terms of the economic impact (multiplier effects) TARP, the auto bailout, unemployment insurance, subsidies to private clean-energy firms, and explicit reductions in tax rates are in the "TAX CUT" category, and tend to have less impact in the short run, because firms (perhaps rationally, and to the long-run benefit of the economy) might hold back some of that form of "stimulus." The other category only includes things that directly inject expenditures into the economy, such as building a tank, repairing a road, or a direct public investment into the building of new infrastructure, such as a new energy grid. These direct expenditures MIGHT have a larger short-run impact IF AND ONLY IF they occur when the economy has substantial unemployment, and if they are enacted before the recovery. If they are enacted after the recovery begins, they will tend to be inflationary.

The Editors of the Economist should be Flogged

Printing anything that uses the terms "Calculus" or "Second derivative" should be punishable with public beatings, as exemplified by this article in the Economist.

A civil debate over policy

I do not personally advocate Socialism one bit. In fact, I would say that it is a system that is both morally defunct and internally flawed because of the extreme lack of individual incentives it implies. I also believe in markets, and in the idea of capitalism. However, there are a lot of folks out there making wild assertions about what constitutes "socialism" that are just flat wrong. When a politician or other "pundit" says "income redistribution (or public health care) is socialism" they may be trying to somehow voice an opinion that these things are bad and ill-advised, and that is a sufficiently valid point on its merits. Socialism need not be brought into it for two reasons: First, it is poor logic to conclude that because something contains some of the elements of a particular idea, that it creates sufficient evidence to conclude that the broad generalization of that idea is contained wherever those elements are present. Secondly, it brings no progress to the debate over the proper role of government because it is disrespectful to those who might agree, and is, therefore, ultimately unpersuasive.
The key feature of a socialist system of economic organization is shared, collective, or public ownership of the means of production on a national (and international according to Marx) scale. Then, workers are compensated according to the Labor Theory of Value, or their average productivity (not their marginal productivity as market theories suggest). An egalitarian distribution of income is an indirect consequence of that compensation mechanism.
Public provision of certain "public" or "merit" goods does not constitute the breadth or depth of public or shared ownership to constitute "socialism." In the field of comparative economics these systems are characterized as "mixed" economies, which generally includes every democratic industrialized country in the world these days. Public provision of one narrow sector of the economy is no more "socialism" than another. Take defense, or education. It would be false to claim that government-provided defense or a publicly-funded educational system is (by itself) socialism.
With regard to income redistribution, socialism is not the only economic system in which advocates egalitarianism, and economic thinkers (including the fiercely laissez-faire french thinker Frederic Bastiat) showed concern over income distribution well before Marx. As an example, fascism also advocates for equitable redistribution of income as a means toward building a society in which interest groups of all stripes are united by a sense of duty and obligation and a triumph over the individual. Economic organization in Fascism involved a cooperation between the State and corporate interest groups, which, in theory, could avoid the wasteful competition of market capitalism. As in Socialism, an indirect consequence of this cooperation is an egalitarian distribution of income. The key point here is that welfare programs and negative taxes do negatively impact efficiency by weakening incentives, but are not sufficient conditions for socialism.
In an interesting tangent to the role of democracy Joseph Shumpeter predicted that the ultimate demise of individual capitalism was that it led to democracies that were doomed to implementing huge welfare states and collapsing. Market economists also express concern over the tendencey for democracies to foster radical swings to the left whenever people become dissatisfied with harsh economic conditions (e.g. Venezuela).
Whether income redistribution or universal health care evolves from a socialist, fascist, democratic, or other form of political or economic system its ideological origin is not really important. What is important is that we, as a society, are able to have a civil debate over the merits of various policies. Labels and name-calling are ultimately counter-productive. Yet markets, directed by the interaction of many independently-acting agents on both sides seem to be the best starting point in terms of efficient allocation. To quote Adam Smith: "By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good."

Interesting Lecture

I got this lecture on Class Theory and Marx from Division of Labor. It's not pro-Marx, but it's open minded enough to knock the nonsense about "redistribution = Marxist = bad" on its patoot at both "=" links of the chain.

Poking fun at people smarter than me

Paul Krugman and Greg Mankiw are both brilliant. Therefore, I find some of their intellectual sparring over the stimulus and macroeconomy amusing. Anyway, a recent post by Mancow says:

After all, he is an international trade theorist rather than an empirical macroeconomist

I find this hilarious for two very, very nerdy reasons:
1. When was the last time Paul Krugman did International Trade theory?
2. While in grad school I was given the impression by Stephen Parente (who is, himself, a macroeconomist) that "empirical macroeconomist" an oxymoron.

Monetary Base versus Money Supply

Craig Depken, a great guy and former colleague when I was in Arlington, TX, is worried. I was too the first time I saw the chart he posted:

Then, I did some legwork and hopefully we can keep CADII from fleeing to Canada. The monetary base is heavily biased towards bank reserves, and if banks just are not lending, then this would be expected. Try the actual money supply on for size:

Or, try looking at non-borrowed reserves, and you might see why Bernanke went ooooohhh [expletive] around late 2008 (not the big spike into the negative):

We haven't learned a damn thing!

AAAAAAAAAAAAAAARGHHHH!

Making more Ethanol from Less Corn

Another example of technological innovation around the margins (and the institutions that support it) working to keep us from falling into the Malthusian trap. I'm not a big ethanol fan, but things that can be done to make waste byproducts more useful (e.g. the building of the first cellulose ethanol plant) to help in the short run, might just help us get closer to a long-run solution with wind, solar, geothermal, etc.

Market Imperfections & Policy Specificity

Two things I'll never understand about the debate over the current intervention package. One, why are conservatives parroting for nothing more than blanket tax cuts? Two, why are liberals doing little more than ranting about income distribution?

Financial markets are rife with potential market imperfections: asymmetric information, moral hazard, etc. When the whole crisis was getting revved up, I never understood why there wasn't more effort, not to bail out folks who were now sinking, but to secure traditionally-available lines of credit for individuals and businesses who have always been able to get loans. We did amazingly little to target the core problem then, and we're paying for it now.

So now the problem has spread. People are losing their jobs because of the same problem, and it seems to me, the most direct way to deal with that particular problem is to take this opportunity to increase investment in certain types of "public goods" - infrastructure, etc. - that will at least be there for us when we come out of this mess. It doesn't seem like 1-2 percent in business tax cuts are going to keep the private sector in business when they can't secure the tens of thousands, hundreds of thousands, or millions of dollars in short term credit they're used to taking out for day-to-day operations (the timeline for revenue streams seldom match one-to-one with costs).

It's called policy specificity. Credit markets don't work right? Direct policy towards those (not just bailing out the firms that broke those markets either). High unemployment? Direct policy towards that, and don't just give a payout to firms who may or may not need it and may or may not use it to expand production and employment.

Two Stupid Letters

There's this one by a liberal interest group, and this one by a conservative one.

Neither one really does much to add to a constructive debate over the appropriate role for government, because one is just blindly endorsing a (bad) political solution, and one is using a non-sequitor to argue against it.

I did not endorse either one.

Freakout-onomics

I've said several times that as far as "downturns" or "recessions" go, this one actually isn't as bad as it's made out to be so far. It may well get much MUCH worse, but so far it has been relatively mild in terms of changes in actual output and employment and that this particular financial crisis is not all that different or unique in comparison to past episodes in the postwar era, but don't take my word for it: Take theirs, or theirs (cross-posted via Economix). Basic idea: Times are indeed tough, but we've been through worse, and made it out. Hang in there as best you can, folks.

Small Transaction Costs and the Marginal Utility of Cafeteria Food

Trays are making college students fat. University cafeterias (all you can eat) waste about 30% less food when trays are eliminated, which essentially requires students to go through the line getting ONE plate and ONE drink instead of loading up. I like the comments on this one, especially Michael:

As someone who goes to a college that just eliminated trays, it really
isn’t a win-win situation. It might make people eat less food and waste
less, but it substantially increases the hassle when you have to carry
a plate or two plus a drink and silverware. All that isn’t easy to
carry without a tray.

Yeah, that's basically the point, Michael. That relatively small hassle, or cost, is what we call a transaction cost, and its keeping you from eating enough for a small African village for lunch.

Class Size, Practice, and Learning

Universities are starting to work harder to supply a better product to the market. Instead of cramming butts into several-hundred-seat lectures, MIT and others are reducing class sizes to try to improve their product. But the move is not just for class size: the size reduction is geared towards getting students to have a more hands-on experience - to learn by doing and create a peer-collaborative learning environment.

I certainly can't say that I'm not guilty of falling into a lecture trap of the old school, but we need to think innovatively to capture students with different strengths and learning styles, and do a better job of creating a open line of communication between students and instructors as well as among the students so that they can unlock the material for themselves.

Lessons in Opportunity Cost: Immigration

This is an important lesson in opportunity cost, focusing on the allocation of resources to immigration enforcement. As we expend more budgeted resources towards deportation, and quota enforcement, the more difficult it becomes to control the smuggling of drugs, weapons, and criminal activities across the border. Maybe a more sensible policy on quotas and their enforcement will come, say, in the next decade or so.

This is Interesting

I ran into this via the Green, Inc. blog. Basic idea: which states offer tax breaks for housholds that get renewable energy fixtures for their own use? Find your state and see what's out there.

Economic Humor

At some point it had to be done at the AEA meetings. Maybe better to save economic humor for the recovery, though?

International Education

I didn't actually know that the proportion of international students at US universities were fewer in proportion to the total enrollment than it is in other developed countries. But why should universities pay intermediaries to recruit more students, as the article suggests? It seems like many students are being turned away from the best schools, and the students already in the schools (especially foreign-born students) are reasonably well-qualified. It seems that if there is a greater number of applications from qualified students the thing to do would be to price things better, especially for out-of-state and international students, with generous subsidies for highly-qualified in-state students who do not benefit from a mountain of trust-fund wealth. Let the international students come, but also let them pay full price for the high level of enrollment demand.

Taxes and Spending

Note to Hardball: In this segment your Republican and Democratic guests are arguing over an economic point that is theoretically moot. Maybe that's the beauty of it. In terms of economic impact of a tax cut (in both the "liberal" Keynesian and "conservative" neoclassical schools of thought) is the same as an increase in transfer payments (consumption subsidies). Similarly, an increase in transfer payments is the same as a tax cut. Spending is only "spending" (in terms of having different multiplier effects) if it involves a direct government purchase of goods and services, which transfers/tax cuts/negative taxes do not. Even better if those goods and services have some theoretical possibility of being "public goods" or generating "externalities" or "network effects" as investments in education, infrastructure, or even the military and health care, might.

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