$ummers

Larry opines on the falling dollar.

Something for me to think about

Nicholas Carr offers me advice:

Because blogging is such a personal pursuit, with strong and immediate ego-rewards, it can be irrationally seductive, particularly to highly competitive overachievers. The hazard - and this applies as well to disciplines beyond economics - is that extraordinarily talented individuals may end up, like lab mice drinking sugar water, spending more time blogging than they should, even though their comparative advantage is smaller in blogging than it is elsewhere. Distorted by noneconomic but nonetheless powerful rewards, the idea market would become less efficient than it should be, and we'd all suffer as a result. The real danger, in other words, may not be that the "lemons" - the "tolerable bloggers" - will take over as the mainstays of the blogosphere but that they won't.

Please stop blogging, Greg Mankiw. You have better things to do.

Redistribution in the Rangel Bill

The Tax Policy Center has run the numbers to show how different income groups would be affected by the Rangel tax reform proposal compared to the tax law currently on the books. Here is roughly what the numbers (in Table T07-0300) show:

• The bottom three-fourths of households, those making less than $75,000 a year, are not much affected. They each would receive a tax cut of about $100 per year.
• The next 24 percent, those making between $75,000 and $500,000, would receive much more substantial tax cuts. Those in the $200,000 to $500,000 range, who are in the 96 to 99 percentile of the income distribution, would get a tax cut of about $3,600 per year.
• The top 1 percent, those making over $500,000, would pay substantially more in taxes. Those making more than $1 million would see their tax bill rise by an average of more than $100,000.

Thus, as a first approximation, the plan increases the progressivity of the tax code by redistributing income from the very rich (e.g., CEOs, hedge fund managers, superstar athletes and actors) to the upper middle class (e.g., doctors, lawyers, congressmen).

Where have all the oil shocks gone?

Oil prices are near record highs, which raises a fascinating question. In recent years, the U.S. and world economies have typically shrugged off oil price increases. By contrast, oil price increases are a major part of the conventional story of the economic turmoil of the 1970s. Why the difference?

We economists do not have a complete answer, but we have some clues. One important clue is below (via Carpe Diem):

The economy is far more energy-efficient today than it was in the past, in part because economic activity is based more on services and less on manufacturing. As a result, energy prices matter less today.

In their research on the topic, Blanchard and Gali also give credit to more flexible labor markets, better monetary policy, and a bit of luck.

Another hypothesis: The macroeconomic effect of high energy prices may depend on whether the high prices are the result of reduced supply or increased demand. Perhaps in the 1970s high oil prices were largely the result of supply restrictions, whereas in recent years high oil prices are driven more by increased demand from a booming world economy.

One final conjecture: Maybe the recent increase in oil prices has been less sudden, making it easier for other prices and thus the economy to adjust. In particular, it may not have affected the skewness in the distribution of relative-price changes in the same way as previous oil shocks did.

We have no shortage of theories. The definitive study on the macroeconomic effect of oil prices is still waiting to be written.

Update: Lutz Kilian of the University of Michigan has a new paper on the topic.

A Metaphor

From Jinx the Byte:

Lamont Café, the culinary provider of the undergrad library, serves a gargantuan cream puff. It’s as big as the palm of my hand and as thick as Mankiw's Principles of Economics.

Krugman vs Obama

On TV this morning, I heard this exchange:

George Stephanopoulos: Let's bring up the point on social security. Barack Obama, taking advice from pundits and advisers to be tougher on Senator Clinton. Yesterday, he said she wasn't truthful on a number of issues. Social security was his number one issue. He said that senator Clinton has made a mistake to hedge and not say what she would do on social security.

Clip of Barack Obama: Conventional thinking in Washington says that social security is the third rail of American politics. It says you should hedge and dodge and spin -- but at all costs, don't answer. I reject that notion.

George Stephanopoulos: Paul, he rejects it and says he would lift the payroll tax on all income. You shake your head. Does that mean you think he's making a mistake?

Paul Krugman: Social Security, if you go through the federal government, piece-by-piece, and see which programs are seriously underfunded and which are close to being completely funded, social security is one of the best. It's not for certain that social security has a problem. And it's something that the right has always wanted to kill, not because it doesn't work but because it does. And Obama to go after this program, at this time, you have to wonder. All of my progressive friends are saying what on earth is going through his mind to raise this issue.

Maybe Senator Obama was persuaded by this point of view on the topic.

RePEc Blog

Christian Zimmermann informs me of the new RePEc blog, which is focused on the dissemination of economic research.

The Mother of All Tax Reforms

Ways and Means Chairman Charlie Rangel has proposed a bill dubbed "the mother of all tax reforms." It includes repeal of the AMT, a substantial increase in the top marginal tax rate on individual incomes, and a cut in the corporate tax rate.

Jason Furman has nice things to say about it:

The centerpiece of the corporate tax reform is a reduction of the corporate tax rate from 35 percent to 30.5 percent, hardly living up to columnist Robert Novak's warning that Rangel would be unveiling "the most radical left-wing tax revision in half a century." Without adding to the deficit burden, this rate reduction would be fully paid for by a series of measures to broaden the corporate tax base to ensure that different forms of investments are taxed at similar rates. The biggest of these steps is a repeal of a special deduction for manufacturing businesses that was enacted in 2004 over the nearly universal objection of tax experts who warned that the government should not be tilting the playing field in favor of certain types of businesses. (Note that at the new 30.5 percent corporate rate manufacturing companies would still be paying lower tax rates than they are today.)

Alan Viard is more skeptical:

On the corporate side: that is the one part of the bill I thought was going to support the general notion of lowering the rate and broadening the base. It certainly fell short of my expectations. Base broadening is not an end in itself: we want to broaden the base by eliminating ineffective preferences, where some things are getting better treatment than competing activities. Some stuff in the bill does do that. But some stuff does not make sense from an economic efficiency perspective.

The one thing that jumped out at me was the repeal of LIFO . All studies we have of effective tax rates show even with a significant fraction of inventory getting LIFO treatment they are being taxed more heavily than equipment or structures. It encourages firms to hold more equipment and less inventory, it distorts the choices of firms. The bill would aggravate the differences. It’s a significant increase in the tax burden on inventory. The whole notion of this approach to corporate tax reform is you’ll have more of a level playing field across investments. But this provision takes the stuff already being taxed more than everything else and piles more burdens on it.

Another bad provision: the bill would increase the tax on intercorporate dividends, where one corporation holds stock in another corporation [except] if it’s like a wholly owned subsidiary. That makes no sense. It says the tax burden on investment will depend on how many corporate layers there happens to be. There’s no rational distinction, no efficiency gain, no equity gain in taxing that more heavily.

Some of the stuff in here does follow the philosophy that I was hoping to see: [repeal of] this domestic/international sales corporation which tries to promote exports, which is unsound policy. That’s just mercantilism. It’s good to see the bill scrapping that.

For those tax geeks out there who want to read more about LIFO accounting, click here. But trust me: this topic is not for the faint of heart.

Meanwhile, Scrappleface reports:

House Republicans plan to introduce a conservative alternative to the Rangel alternative to the Alternative Minimum Tax.

The GOP measure would repeal the AMT, and make up for the $65 billion in lost tax payments by levying a 4.6 percent surcharge on Americans who download alternative rock music through iTunes.

House Speaker Nancy Pelosi immediately condemned the Republican proposal because, she said, “It places an unfair burden on people who already carry the weight of the world on their shoulders."

Another Member

The Christian Science Monitor joins the Pigou Club.

Can food shortages be far behind?

A headline from Moscow:

Kremlin Secures Price Controls on Food Items Before Elections

The basic economics here is straightforward, but apparently it is not widely enough understood among the general population to make this kind of policy a political loser.

Correlation vs Causation

Glaeser on Buffalo

The city, not the animal, with some broad lessons for urban policy.

The Budgetary Cost of the War

Appropriations for U.S. Operations in Iraq and Afghanistan and for the War on Terrorism (Billions of dollars), according to the Congressional Budget Office.

Middle Class Stagnation, Not

An article by Terry Fitzgerald from the Minneapolis Fed (via Econlog) asks, Has Middle America Stagnated? It does a good job explaining why one should be wary of data on Average Hourly Earnings.

If you don't want to join the Pigou Club...

...you might like this idea:

If we could pour a five-gallon bucket’s worth of sulfate particles per second into the stratosphere, it might be enough to keep the earth from warming for 50 years. Tossing twice as much up there could protect us into the next century.

A 1992 report from the National Academy of Sciences suggests that naval artillery, rockets and aircraft exhaust could all be used to send the particles up. The least expensive option might be to use a fire hose suspended from a series of balloons.

This proposal is well beyond my ken, but I wonder about unintended consequences.

Data-free Empirics

Recently, I was in downtown Wellesley, in my favorite local bookstore, Starbucks latte in hand, browsing through the new offerings, when I stumbled upon Robert Reich's new book, Supercapitalism. As I stood in the store, I did what every narcissistic Harvard professor (yes, I am being redundant) does: I looked myself up in the index.

To my surprise, I found myself quoted in the book as an authority on the fact that high tax rates are not distortionary. Here is the quotation from me that Reich uses in a footnote:

CEOs are paid what they are worth to their companies, and their high pay reflects the extraordinary value of their talent. But the supply of talent is inelastic, and the allocation of talent would not be affected if everyone faced high tax rates.

The quotation is taken as support for Reich's broader argument that we should increase taxes on high incomes. He mentions that the quotation is from this blog, but he also cites a David Wessel article from the Wall Street Journal as a source.

Do I really believe that the supply of talented labor is completely inelastic? No, I don't. Let's look at the fuller quotation from my blog entry:

In his model, high CEO salaries are pure economic rents. CEOs are paid what they are worth to their companies, and their high pay reflects the extraordinary value of their talent, but the supply of talent is inelastic, and the allocation of talent would not be affected if everyone faced high tax rates.

Notice the key phrase "in his model." That is, I was not describing any evidence on the question, nor was I even giving my opinion. Rather, I was describing a particular model presented at a Harvard seminar by Xavier Gabaix on his joint work with Augustin Landier.

In Reich's defense, Wessel's article does not include the key qualifier either. Wessel's article does note, however, that "Messrs. Gabaix and Landier shudder at this suggestion [of higher tax rates]." Reich omitted that part of the Wessel article from his footnote. A reasonable interpretation is that Gabaix and Landier made the assumption of inelasticly supplied talent to keep their model simple, not because they really believe it.

In short, here is what appears to have happened:

1. Gabaix and Landier make a modelling assumption for purposes of analytic convenience.
2. I describe their model and its implications on this blog.
3. Wessel quotes part of that description in the Journal.
4. Reich reads the Journal and cites me as an authority using the partial quotation.
5. As a result, a modelling assumption morphs into an established fact.

You might call that data-free empirics.

Ten Principles...

...of Feminist Economics.

From the Pluralist Economics Review.

A Dangerous Obsession Redux

A smart economist I know once called international competitiveness a dangerous obsession. In today's NY Times, the paper's editorial goes from that obsession to the need for tax increases and national health insurance:

the meager tax take leaves the United States ill prepared to compete. From universal health insurance to decent unemployment insurance, other rich nations provide their citizens benefits that the United States government simply cannot afford.

The consequences include some 47 million Americans without health insurance and companies like General Motors being dragged to the brink by the cost of providing workers and pensioners with medical care.

Employer-provided health insurance is just a form of compensation that happens to be provided in kind rather than in cash. What the Times seems to be saying is that because companies like General Motors have promised levels of compensation too large to make them competitive in the international marketplace, we should shift the responsibility for some of that compensation from the companies to the taxpayer.

An alternative approach is for the companies to reduce compensation to levels they can afford. One might respond that reduced compensation would be hard on workers. But so would the higher taxes needed to pay for the national health insurance the Times is lobbying for. There is no free lunch here.

Reasonable people can disagree about the case for national health insurance. But in that important discussion, concern about international competitiveness is at best a non sequitur.

Kennedy on Krugman

Stanford's David Kennedy reviews the new book by Princeton's Paul Krugman.

The Shrinking Pay Gap

An Alternative to Foreign Aid

Justin Muzinich and Eric Werker (the latter an assistant professor at Harvard Business School) suggest one of the least politically correct policies I have heard recently:

Congress should provide a 39-cent tax credit for every dollar of American investment in developing countries. If Company X were to build a $100 million factory in Madagascar, its tax bill would be reduced by $39 million....Using tax credits instead of traditional foreign aid also means that the money will be spent more prudently. Because for-profit companies are focused on the bottom line, they will be more protective than government agencies of the money they invest in developing countries.

I appreciate the logic here. They might even be right that this approach would be more effective than traditional foreign aid.

Imagine what would happen, however, if a political candidate of either party were to come out in favor of the proposal. The opposition would quickly lambast it as the "outsource American jobs to third-world sweatshops tax credit."

A Small Accomplishment

Brad DeLong says I am efficient.

Bloomberg Podcasts

Listen to interviews with a variety of great economists, including Ken Arrow, Stanley Fischer, Austan Goolsbee, Paul Krugman, Amartya Sen, V.V. Chari, Tom Schelling, Paul Samuelson, and Drew Fudenberg.

I doubt the QJE will follow suit

The journal Economic Inquiry has appointed a humor editor.

McCain on Climate Change

John McCain appears confused about the relationship between carbon taxes and cap-and-trade systems to deal with global climate change:

Mr. McCain said in his speech on Saturday that he wanted to push for alternative fuels, but he implied that more needed to be done to protect the environment. One priority, he said, would be to establish “cap and trade,” a system in which corporations are essentially rewarded for deep cuts in harmful emissions. Mr. McCain has written a bill on that and forced two votes, losing both....

The senator opposes a measure that many environmentalists desire, a carbon tax, most likely as another gasoline tax. He told the warming and energy conference that he generally opposed new taxes but that he also believed that poor workers who tended to commute to work longer distances would be disproportionately affected.

Senatator McCain, it seems, has not been fully briefed on the economic impact of cap-and-trade. Like a carbon tax, a cap-and-trade system would put a price on carbon and raise the price of carbon-intensive products.

At least a carbon tax would raise some tax revenue, so other taxes could be cut to offset the distributional impact of the higher prices. A cap-and-trade system would not raise revenue to fund a compensating tax cut, unless the carbon allowances were auctioned, in which case the system would be effectively a carbon tax.

The bottom line: Those poor workers commuting to work are no better off under cap-and-trade than they are under the carbon tax.

The Tax Share

Source: NY Times.

How to be a Redistributionist

Robert Reich, former Labor Secretary in the Clinton Administration, tells us what he would do to the tax code:

What’s fair? I’d say a 50 percent marginal tax rate on the very rich (earning over $500,000 a year). Plus an annual wealth tax of one half of one percent on net worth of people holding more than $5 million in total assets....If the Democrats stand for anything, it’s a fair allocation of the responsibility for paying the costs of maintaining this nation.

I don't agree with the policy, but I appreciate how forthright he is about his policy preferences.

For another point of view, see Gruber and Saez, who say:

the optimal system for most redistributional preferences consists of a large demogrant that is rapidly taxed away for low income taxpayers, with lower marginal rates at higher income levels.

Realistic optimal tax problems don't usually yield solutions similar to Reich's proposal, even for a social planner who has strong preferences for equality. High tax rates at the top generate a lot of deadweight loss for each dollar of tax revenue. In most standard optimal tax models, a more redistributionist social planner would give more to the poor and impose higher marginal tax rates on everyone, but she would not focus disproportionately on the the very top of the income distribution. And she would not add an extra penalty to capital accumulation, as Reich is proposing.

If I were a redistributionist, here is what I might propose: A large fixed payment to every citizen, paid at the beginning of every month, financed by a proportional tax on consumption, such as a value-added tax.

What everyone has been waiting for

My favorite textbook now in Azerbaijani.

More Competition

The IMF research director has a blog.

My Whereabouts Today

Smith College. Click and scroll down for info about my talk.

Update: I had a great time at Smith: smart earnest students, dedicated faculty, beautiful campus, and a charming college town.

Update on the Federal Budget

This graphic, from the homepage of the Congressional Budget Office, shows estimated year-to-year growth rates in federal outlays and receipts.

The figures do not correct for inflation, nor do they take into account population growth or economic growth. A natural comparison is to the growth rate in nominal potential GDP, which is about 5 to 6 percent. For example, in 2005 and 2006, outlays were growing faster than this benchmark, so the government was growing relative to the economy. In 2007, outlays were growing less rapidly, so government's share of the pie was shrinking.

Also, CBO reports,

the federal budget deficit was about $161 billion in fiscal year 2007, $87 billion less than the shortfall recorded in 2006. Relative to the size of the economy, that deficit was equal to 1.2 percent of gross domestic product, down from 1.9 percent in 2006.

For comparison, note that the average budget deficit over the past forty years is about 2.4 percent of GDP.

Of course, there is still a looming long-run fiscal gap. The short-run fiscal picture, however, does not look historically anomalous.

Al Roth

My Harvard colleague Al Roth visits Google and talks about Market Failure and Market Design. The video takes about an hour.

Why Comments are Gone

Some of you have noticed that the comments section is gone. I disabled that feature of the blog. A friend has asked me to explain why.

This blog started on a lark. It was originally set up for my students in ec 10. After a few weeks, however, the existence of this blog became more widely known, and the readership started to grow. One day last week, more than 20,000 visitors stopped by. This is now one of the top economics blogs, and it is one of the few that are free of advertising (well, almost free of advertising). The blog is sometimes even quoted in the mainstream media (such as in this recent NY Times article).

All that is gratifying, but it is also time-consuming. In addition to this blog, I have classes to teach, students to advise, papers to write, textbooks to update, and three children to raise. Oh, yeah, my wife likes to see me now and then, too. It is fair to say that among all those activities, this blog ranks as my last priority.

To put it simply, this blog is a hobby. My late colleague Zvi Griliches collected coins; I blog. As far as I can tell, Zvi never let his hobby interfere with the rest of his life. I am trying to do the same.

The comments section has been, for me, a source of both fun and frustration. Originally, I had hoped that it might provide a way for my students to debate one another on economic issues. It never quite worked out that way. Some of my current and former students did participate (and shared with me, privately, their sometimes odd screen names). But a vast majority of the commenters fell outside this category.

The growth in the comments section was fine with me, as long as the discussion remained civil. Mostly it was, and I learned a lot from the comments. But unfortunately, a few (usually anonymous) commenters too often crossed the line.

I just don't have the time to police comments and enforce good behavior, especially since some posts were generating more than 100 comments. And I don't want to host a party in which a small vitriolic minority consistently tries to ruin the event for everyone else. So I decided to turn the comments feature off.

The absence of comments may deter some readers from coming by. I hope not. But if attendance falls off a lot, I will start looking for another hobby. Maybe golf.

Explaining Mechanism Design

GMU economist Alex Tabarrok offers his take.

Personal Taxes as a Percent of GDP

Source. Click on the above graph to enlarge.

Data note: According to the BEA, "personal current taxes are tax payments (net of refunds) by persons that are not chargeable to business expense and certain other payments that are made by persons to government agencies (except government enterprises) that are treated like taxes. Personal taxes includes taxes on income, including realized net capital gains, and on personal property. Contributions for government social insurance is not included. Personal current taxes are used in the derivation of disposable personal income, which is calculated as personal income less personal current taxes."

Greenspan on Data and Models

Michael Kinsley reviews Alan Greenspan's book (which I have not yet read). This passage from the review caught my eye:

You gotta love a guy whose idea of an important life lesson is: “I have always argued that an up-to-date set of the most detailed estimates for the latest available quarter is far more useful for forecasting accuracy than a more sophisticated model structure.” Words to live by.

Mike thinks Alan is being hopelessly geeky here. But I think Alan is talking to geeks like me, and also those who used to work for him on the staff of the Federal Reserve.

Modern macroeconomists have spent a lot of effort trying to develop better models of the economy for forecasting and policy analysis. Just look at any issue of the Journal of Monetary Economics or the Journal of Money, Credit, and Banking. Alan seems to be saying that our efforts have, to some degree, been misdirected. Better monetary policy, he suggests, is more likely to follow from better data than from better models. Relatively little modern macro has been directed at improving data sources. Perhaps that is a mistake.

Bernanke on Financial Turmoil

Ben gives a talk on The Recent Financial Turmoil and its Economic and Policy Consequences.

From the Campaign Trail

"I have a million ideas. The country can't afford them all."

- Hillary Clinton, explaining why she has backed away from her baby bonds idea

When to Refinance

Most economic research is not terribly useful for making better decisions regarding personal finance. Here is an exception.

In a new paper, Sumit Agarwaland, John Driscoll, and David Laibson provide a relatively simple closed-form solution to the problem of when to refinance one's mortgage to save on interest payments, taking into account uncertainty and the option value of waiting. They also provide an online calculator to make it easy for people to use the new method.

The Envelope Please

This year's Nobel Prize in economics goes to Leonid Hurwicz, Eric S. Maskin, and Roger B. Myerson.

Eric used to teach economic theory at Harvard and was a great teacher and colleague. If my recollection is correct, when he moved from Harvard to the Institute for Advanced Study in Princeton, he bought the house Albert Einstein used to live in. I wonder if there are any other houses that can claim two (unrelated) Nobel laureates.

Update: A theoretical physicist emails me:

Just a comment on your blog posting about Laureate housing: Frank Wilczek (2004 Physics Laureate) also used to live in Einstein's house. I think he moved to MIT a couple of years before getting the Prize, though.

If all this is true, that house should command quite a premium among local academics. I am going to ask Eric if, next time he is on vacation, I can house sit just to soak up the karma.