Economist's View

Cash for Clunkers

What do you think about this proposal?:

A Modest Proposal: Eco-Friendly Stimulus, by Alan S. Blinder, Economic View, NY Times: Economists and members of Congress are now on the prowl for new ways to stimulate spending in our dreary economy. Here’s my humble suggestion: “Cash for Clunkers,” the best stimulus idea you’ve never heard of.

Cash for Clunkers is a generic name for a variety of programs under which the government buys up some of the oldest, most polluting vehicles and scraps them. If done successfully, it holds the promise of performing a remarkable public policy trifecta — stimulating the economy, improving the environment and reducing income inequality all at the same time. Here’s how.

Smart Cost Sharing

Robert Waldmann is thinking about how to give insurance companies a long-term stake in the health of their clients. This is an example of the type of policy I had in mind when I said:

...preventative care ... ought to be encouraged, and one way to help with this is ... to forge an unbreakable lifetime relationship between the insurance company and the consumer so that expected lifetime costs are important to the insurance carrier.

Here's Robert Waldmann's plan:

Smart cost sharing, by Robert Waldmann: Ezra Klein writes about smart cost sharing. He wants a committee to decide reimbursement rates.

Oddly, I had another idea about smart cost sharing. Make the doctors pay for the care and pay the doctors based on outcomes. This is based on a Cutler et al result that very small financial incentives to doctors based on their patients' blood pressure, glucose and cholesterol can cause big changes in those outcomes.

Does HUD Need to Be Razed and Rebuilt?

For the urban and regional economics experts - is this argument correct? Does urban development policy as administered through HUD need major restructuring? If so, can HUD be reformed, or would it be best to, as suggested below, eliminate HUD and start over?:

To Fight Poverty, Tear Down HUD, by Sudhir Venkatesh, Commentary, NY Times: ...It might be best to simply close the [Department of Housing and Urban Development] and create a new cabinet-level commitment to urban development.

In 1965, when HUD was created, its mission was to spur growth in and around cities. The agency provided mortgage assistance to veterans and first-time homeowners, it built housing for the urban poor, and the Federal Housing Administration spurred suburban expansion by recruiting developers and home buyers to a relatively new, untested market.

Since its inception, HUD has had a fairly straightforward recipe: develop good relations with mayors and local real estate leaders, then award grants and underwrite loans that affirm local development priorities. ...

But in the last four decades the urban landscape has changed from discrete, independent cities to vast, interdependent regions where people and goods move freely..., cities have no choice but to collaborate on decisions over land use and economic development. ... And for the first time in our nation’s history, poverty is rising faster in suburbs than in urban cores. In this new era, HUD’s each-city-is-a-separate-whole approach is not only too inflexible and short-sighted, it also hinders effective regional growth.

To see why, consider HUD’s most prominent urban development program: Housing Opportunities for People Everywhere (VI). ...

How could a program aimed at curbing inequality and helping the poor end up creating new pockets of poverty? The answer lies partly in HUD’s myopic focus on gentrifying urban cores. The agency ignored studies showing that former project residents would have difficulty finding rental housing in outlying neighborhoods and did not provide assistance for inner-ring suburbs with high rates of foreclosures. HUD resisted calls to slow down housing demolition and to move the poor to areas of high job growth.

By making no effort to ascertain needs and resources on a regional scale, HUD has ended up eliminating poverty in one place while creating distressed, low-income communities in others. If HUD had developed a broader vision, one that tied together inner city and suburb, it could have created policies to help both areas adjust to the modern urban landscape.

In correcting HUD’s missteps, we must first separate “housing policy” from “urban development.” ...

Then, the development needs of our nation’s regions — wide areas like the Northeast corridor or Southern California — could be considered anew. Block grants could provide incentives for municipal and county governments to collaborate. Regionalism must be embraced, even if it tests local officials who fear losing their traditional sources of government financing. ...

Americans live ... spread out, and economic activity is no longer limited to downtowns. Community-based initiatives — from vocational programs to rezoning efforts to designing effective transportation corridors and recreational space — are sorely needed but will be effective only if they tie into a broader vision that anticipates growth on a large scale.

Even our most persistent problems of inequality will require new strategies. A federal agency devoted to regional planning could help the Health and Human Services Department reconfigure anti-poverty programs to aid suburban communities that have so far gone unnoticed but are desperately in need. It could motivate the Labor Department to develop training programs and support the transportation needs of workers.

We need an agency that can work outside old boundaries and design a regional approach to revitalizing cities and suburbs. Dismantling HUD would be a great place to start.

Update: Richard Florida says "He's absolutely right."
Update: Ryan Avent   says "HUD’s mission should be changed, [but] blowing it up probably isn’t necessary."

Why Tyler Cowen is "Not So Crazy about HSAs"

Tyler Cowen:

Health savings accounts, Marginal Revolution: A few readers have written me or asked in the comments why I am not so crazy about HSAs.  From the past, read here and here, and here, or here is an index of previous MR posts on the topic; in any case my take is relatively straightforward:

1. I favor tax-free savings (albeit with some fiscal qualifications), so you can make a case for HSAs on this ground, noting that we do already have other tax-free savings vehicles.

2. HSAs take one market segment -- usually a relatively wealthy and health care-satisfied segment -- and introduce one marginal improvement of incentives.  This doesn't seem to help much in terms of lowering aggregate costs.

3. HSAs introduce greater care into any single medical expenditure by creating a direct private opportunity cost for the spender.  I am less sure it will limit medical expenditures in general; that depends on how people frame withdrawals, once funds are committed to an HSA account, and to what extent they use HSAs for what would have been cash payments anyway.

4. As Paul Krugman says, "too much health insurance" is not the fundamental problem in the health care market.  (Unlike Krugman, I don't see single-payer plans as the solution; I see the incentives of producers, combined with the fear and unreasonableness of buyers, as the key problem on the cost side.)

5. Re Bryan Caplan on Singapore, HSAs might work much better in another setting, noting that the other features of Singapore also might account the difference in performance in health care systems. 

6. Given #1 and #2, it is easy for me to believe that HSAs bring net social benefit.  It is much harder for me to see HSAs as "the one health care idea we would promote if we had one shot at health care reform."  The main beneficiaries are the healthy and the wealthy, and, while I am all for helping those people, surely that is odd, no?

7. I will profess my agnosticism on many health care policy issues, but one of the better plans is Jason Furman's and/or spending more on medical R&D and some public health programs and lots of cost-lowering deregulation while in the meantime getting expenditures and costs under control.  I also recommend Arnold Kling's work.

"What’s Causing Global Food Price Inflation?"

This research argues that India, China, and speculators are not the cause of the food price explosion, the cause is biofuel support policies. Thus, since the "OECD’s recent report on the economic assessment of biofuel support policies has clearly shown that their effectiveness is disappointingly low," the conclusion is that governments should reconsider their biofuel support policies:

What’s causing global food price inflation?, by Stefan Tangermann, Vox EU: Global food prices have exploded since early 2007, causing major social, political, and macroeconomic disruption in many poor countries and adding to inflationary pressure in the richer parts of the world.[1] Concerns about high food prices have been expressed at the highest political level, including during the recent G8 summit on Hokkaido.

What has caused the explosion of food prices? Several culprits have been blamed.

• Newspapers have cited an internal World Bank document as having found that 75% of the price increase was due to biofuels.
• Several governments and commentators see speculation as a major driving force.
• A widely held view has it that rapidly growing food demand in the emerging economies is pushing up global food prices.

Which contributions have these or other factors made to rising food prices?

Fannie and Freddie

Robert Reich says Fannie and Freddie are too big to be allowed to fail:

Fannie, Freddie, and the Pending Taxpayer Bailout, by Robert Reich: Fannie Mae and Freddie Mac, the two giant quasi-public housing lenders that together own or guarantee about half the $12 trillion in home loans outstanding, are heading into insolvency. No surprise. As housing prices continue to drop, more and more middle-class homeowners who got their loans from Fannie or Freddie are under water... And as the economy continues to go south, more and more of them can't meet their loan payments.

While it's true that most of their home loans were made before 2006 when lending standards were tighter, that doesn't really matter because the rip-tide of this sinking economy is now hitting a much broader group of home owners.

Fannie and Freddie may not be technically insolvent yet, but I'm betting that if their lending portfolios reflected the true market prices of their loans they would be. That's why their own investors are bailing out.

So who gets stuck with the tab? Investors in Fannie and Freddie have always believed that the loans issued by the two giants were guaranteed by the federal government but technically they aren't. The guarantee has always been assumed but has never been put into law explicitly... Yes, the companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, and the two companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed. But these won't keep the two afloat for long.

As a practical matter, we're facing a Bear Stearns squared. Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, and the rest of us have to bail them out.

On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.

What would you do?

Update: Big Picture adds:

"All This Need Not End Horribly"

Ken Rogoff says if we don't hit the brakes on global growth soon, we're headed for a train wreck:

Time to put the brakes on this runaway train, by Kenneth Rogoff, Commentary, Project Syndicate: The global economy is a runaway train that is slowing, but not quickly enough. That is what the extraordinary run-up in prices for oil, metals, and food is screaming at us.

The spectacular and historic global economic boom of the past six years is about to hit a wall. Unfortunately, no one, certainly not in Asia or the US, seems willing to bite the bullet and help engineer the necessary co-ordinated retreat to sustained sub-trend growth, which is necessary so that new commodity supplies and alternatives can catch up.

Instead, governments are clawing to stretch out unsustainable booms, further pushing up commodity prices, and raising the risk of a once-in-a-lifetime economic and financial mess. All this need not end horribly, but policy makers in most regions have to start pressing hard on the brakes, not the accelerator. ...

I am puzzled that so many economic pundits seem to think that the solution is for all governments, rich and poor, to pass out even more cheques and subsidies so as to keep the boom going. Keynesian stimulus policies might help ease the pain a bit for individual countries acting in isolation. But if every country tries to stimulate consumption at the same time, it won’t work. A general rise in global demand will simply spill over into higher commodity prices, with little helpful effect on consumption. Isn’t this obvious? Yes, there is still a financial crisis in the US, but stoking inflation is an incredibly unfair and inefficient way to deal with it.

Some central bankers tell us not to worry, because they will be much more disciplined than central banks were in the 1970 s...

But this time is different. ... The historic influx of new entrants into the global workforce, each aspiring to western consumption standards, is simply pushing global growth past the safety marker on the speed dial. As a result, commodity resource constraints ... are hitting us...

Wait a second, you say... Won’t high prices cause people to conserve on consumption and seek out new sources of supply? Yes... But the process takes time...

The ... current expansion is unusual in that ... labour constraints are not the problem. On the contrary, the effective global labour force keeps swelling.

No, this time, commodity resources are the primary constraint, rather than a secondary problem, as in the past. That is why commodity prices will just keep soaring until world growth slows down long enough for new supply and new conservation options to catch up with demand.

This runaway-train global economy has all the hallmarks of a giant crisis in the making — financial, political, and economic. Will policy makers find a way to achieve the necessary international co-ordination? Getting the diagnosis right is the place to start. The world as a whole needs tighter monetary and fiscal policy. It is time to put the brakes on this runaway train before it is too late.

Let's see if I can play along with the train game, but with a different set-up. In this version of the game, if you hit the breaks too hard, passengers can get injured (workers can lose their jobs). And if the train is riding on a shaky infrastructure (meaning the financial system), perhaps it's on a long bridge you aren't too sure about (you are worried the financial system might collapse and bring the economy, or "train," down with it), then slamming on the breaks may not be the best thing to do, especially if there's a hill (recession) beyond the bridge that will slow the train down in any case, or a long straight section that will allow ample room to slow the train down gently. It depends upon how fast the train is going at the time, how likely it is that hitting the breaks while still on the bridge will cause the bridge to collapse, how many passengers will be injured from slamming on the breaks even if the bridge doesn't collapse, how good the brakes are, and what the terrain is like beyond the bridge (e.g., the magnitude of the expected slowdown).

So even with a train that's going too fast, a level speed for the moment followed by a measured level of braking once the train is on solid ground might be best.

I also think it matters whether the inflation is being driven by relative price changes due to world growth, or by excessive demand from interest rates that are too low and from stimulative fiscal policy. Implicit in the argument above, if I read it correctly, is that it's the latter - it's inflation from excessive liquidity and from stimulative fiscal policy, and if so, I agree that the inflation needs to be moderated as soon as it's safe to do so.

But if the run-up in prices that we are seeing is the result of changes in relative prices driven by underlying fundamentals, then the case for active intervention to slow world demand to "sub-trend growth" is not as clear. While there may be reasons to limit the speed of adjustment and reduce the displacement of labor and other resources to a manageable level, trying to limit price changes that are driven by fundamentals mutes the signals that encourage conservation and the development of solutions to the energy problem (there is also the issue of externalities, but that's a long discussion in and of itself).

This is something that's been on my mind lately because it's very clear that rising prices, even those driven by fundamentals, impose costs on people that they cannot avoid in the short-run, but may be able to absorb better in the long-run, so we don't want to allow the adjustment to happen too fast, or we want to find a way to limit the damage by compensating those who are hurt. Hence, the "sub-trend growth" called for above might be optimal. But it's also clear that high prices and the high profits that come with them serve as the markets equivalent of a prize for innovation - there are big profits waiting for successful innovators that are far, far greater than, say, the amounts McCain is talking about for inventing a better battery - and we don't want to stand in the way of that process. The higher the price, the bigger the prize. So the key is, I think, to allow prices to rise quickly so as to encourage the needed adjustments, but be very aggressive in helping people make it through the transition, those who become unemployed, face high gas and food costs, etc. Unfortunately, however, I don't think it's reasonable to expect that the government will provide such help, at least not enough, not in the current political environment, and that means we'll have to take it a bit slower, and look for other ways to encourage the necessary investment in solutions to the energy problem.

Gorbachev: Will the US Become an Empire or a Democracy?

Mikhail Gorbachev says the candidates need to talk about the "increasing tendency to militarize policymaking and thinking," and to state clearly whether they plan to continue in this direction. I'm pretty sure I know the answer in one case. For McCain, it's a solid yes. I also think I know the answer in the other case, it's no for Obama, but can I be sure?:

Questions for the candidates, by Mikhail Gorbachev, Commentary, IHT: There has been unusual interest throughout the world in the U.S. presidential race. ... Major policy problems today cannot be solved without America - and America cannot solve them alone.

Even the domestic problems of the United States are no longer purely internal. I am referring first of all to the economy. ... [A]s I talk to ordinary Americans, ... I sense their anxiety about the state of the economy. The irony, they have said to me, is that the middle class felt little benefit from economic growth when the official indicators were pointing upward, but once the downturn started, it hit them immediately, and it hit them hard.

No one can offer a simple fix for America's economic problems, but it is hard not to see their connection to U.S. foreign policies. Over the past eight years the rapid rise in military spending has been the main factor in increasing the federal budget deficit. The United States spends more money on the military today than at the height of the Cold War.

Yet no candidate has made that clear. "Defense spending" is a subject that seems to be surrounded by a wall of silence. But that wall will have to fall one day.

We can expect a serious debate about foreign policy issues, including the role of the United States in the world; America's claim to global leadership; fighting terrorism; nonproliferation of weapons of mass destruction; ... the problems caused by the invasion of Iraq..., the size of America's defense budget and the militarization of its foreign policy. I am afraid these two questions will not be asked by the moderators. But sooner or later they will have to be answered.

The present administration, particularly during ... Bush's first presidential term, was bent on trying to solve many foreign policy issues primarily by military means, through threats and pressure. The big question today is whether the presidential nominees will propose a different approach to the world's most urgent problems.

Relieving the Strains on the Economy

Robert Reich and Brad DeLong say more stimulus is needed:

Paul Krugman: Driller Instinct

Mr. McCain’s energy gambit:

Driller Instinct, by Paul Krugman, Commentary, NY Times: Blaming environmentalists for high energy prices, never mind the evidence, has been a hallmark of the Bush administration.

Thus, in 2001 Dick Cheney attributed the California electricity crisis to environmental regulations that, he claimed, were blocking power-plant construction. He completely missed the real story, which was that energy companies — probably some of the same companies that participated in his secret task force... — were driving up prices by deliberately withholding electricity from the market.

And the administration has spent the last eight years trying to convince Congress that the key to America’s energy security is opening up the Arctic National Wildlife Refuge to oil drilling — even though estimates ... suggest that ... would make very little difference to the energy outlook...

But it still comes as a surprise and a disappointment to see John McCain joining that unfortunate tradition.

I’ve never taken Mr. McCain’s media reputation as a maverick seriously,... on most issues, he’s a thoroughly conventional conservative. On energy policy, however, he has ... seemed to show some independence. Most notably, he voted against the really terrible, special-interest-driven 2005 energy bill, which was backed by the Bush administration — and by Barack Obama.

But that was then.

In his Monday speech on energy, Mr. McCain tried to touch all the bases. He talked about conservation. He denounced the evils of speculation... A weird aspect of the current energy debate, incidentally, is ... that many of the same market-worshipping conservatives who first denied that there was a dot-com bubble, then denied that there was a housing bubble, are utterly convinced that nasty speculators are responsible for high oil prices.

The ... news, however, was Mr. McCain’s call for more offshore drilling... This was a reversal of his previous position, and it went a long way toward aligning his energy policy with that of the Bush administration.

That’s not a good thing.

As many reports have noted, the McCain/Bush policy on offshore drilling doesn’t make sense as a response to $4-a-gallon gas: the White House’s own Energy Information Administration says that ... even at peak production its impact on oil prices would be “insignificant.”

But what I haven’t seen emphasized is the broader picture: Mr. McCain has now aligned himself with an administration that, even aside from its blame-the-environmental-movement tendencies, has established an extensive track record as the gang that couldn’t think straight about energy policy.

Remember, they didn’t just insist that the Iraqis would welcome us as liberators;... administration officials were also adamant that regime change in Iraq would add millions of barrels a day to the world oil supply, driving oil prices way down...

So why would Mr. McCain associate himself with these characters? The answer, presumably, is that it’s a cynical political calculation. I’m reasonably sure that Mr. McCain’s advisers realize that offshore drilling would do nothing for current gas prices. But they may believe that the public can be conned...

And Mr. McCain may also hope to shore up his still fragile relations with the Republican base..., many people on the right ... believe that all our energy problems have been caused by sanctimonious tree-huggers. Mr. McCain has just thrown that constituency some red meat.

But I very much doubt that Mr. McCain’s gambit will work. In fact, it’s almost certainly self-destructive. To have a chance in November, Mr. McCain has to convince voters that he isn’t just Bush, continued. Energy policy is one of the areas where he could best have made that case.

Instead, he has ceded the high ground on energy to Mr. Obama, and linked himself firmly to the most unpopular president on record.

"Sue OPEC"

Should we sue OPEC for anti-trust violations?:

Sue OPEC, by Thomas W. Evans, Commentary, NY Times: The president of the United States has the power to attack, and perhaps destroy, the Organization of the Petroleum Exporting Countries, the illegal cartel that has driven the price of oil over $130 per barrel. ... The president need simply allow the states to seek relief in the Supreme Court under our antitrust laws.

The oil ministers of the OPEC countries meet periodically to set production quotas ... and in the process establish an artificially high price for crude oil. Under our antitrust laws, this is illegal. Two years ago, Amy Myers Jaffe, an energy expert at Rice University, estimated that the real production cost was $15 a barrel, at a time when the price was approaching $60. Recently, an OPEC spokesman said the price could be $70 a barrel — a little more than half the current price — if speculation and manipulation could be eliminated.

Despite this illegal conduct, ... “under the current state of our federal laws the individual member states of OPEC are afforded immunity from suit brought for damage caused by their commercial activities when they act through OPEC.” ...

Fortunately, there is another way to sue OPEC. Even if actions by individual citizens fail, a seldom-used provision of Article III of the Constitution grants original jurisdiction to the Supreme Court over lawsuits brought by states against “foreign states”...

The attorneys general of the various states should sue OPEC as ... a foreign state. (A joint action by the attorneys general is the method the states used to collectively sue tobacco companies, Microsoft and health maintenance organizations.) ... If the states won the case, the court could recover substantial damages based on assets and commercial activities of OPEC member nations in the United States.

Still, even though the states are allowed to sue OPEC in the Supreme Court, they might not prevail. There are significant separation of powers issues. ...

That’s where the president ... comes in. If the Supreme Court decided to defer to the policies of the political branches, the states could ask the president to issue a statement permitting the lawsuit to go forward... This pathway was established in a statute passed by Congress in the wake of Cuba’s expropriation of American sugar interests. ...

Moreover, confronted with the likelihood of huge damages and restraint of its illegal conduct, OPEC, or some of its members, might seek a settlement establishing production goals that would provide a price closer to actual costs. The probable reduction in the price of heating fuel and gas at the pump might exceed the amount of the current federal stimulus package.

If the president allowed the states to sue OPEC, his actions would undoubtedly anger political leaders in the Middle East and create the need for diplomatic initiatives to limit the fallout. But how stable is the Middle East right now? And isn’t starting a lawsuit better than starting a war?

And, from the LA Times, Sue OPEC (same title, but different authors, different editorial pages):

As the national average price of gasoline raced toward $4 a gallon and airlines laid off workers by the thousands because of rising jet fuel costs, the House of Representatives took action: It overwhelmingly passed the Gas Price Relief for Consumers Act of 2008. The bill would have ... permitted the U.S. Justice Department to charge the Organization of the Petroleum Exporting Countries with violating American antitrust laws.

Even before the 324-84 House vote last month, President Bush pledged a veto, saying OPEC might retaliate against U.S. interests overseas or cut oil production further. But he didn't have to make good on that promise. Senate Republicans held the line for him, last week threatening a filibuster... That effectively killed the bill and, for now, any hope that the United States would finally start treating oil the same way it does computer chips, vitamins, rubber and all other products. ...

If monopoly power is distorting these markets, then sure, we should fix that just as we should fix other market failures (e.g. not fully internalizing environmental costs into production decisions). However, it's unlikely that this is the factor behind the run-up in prices. Monopoly power explains the level of prices, i.e. why price is $8 rather than $5, but it doesn't explain the change in prices, i.e. why the price would change from $8 to $12. There are ways to tell this story, e.g. a war or some other event giving a cartel the cover it needs to raise prices and blame it on external factors, but I don't think that's what's going on in oil markets today, at least I don't think this is a significant factor behind the oil price increases.

For these reasons, if we fix the monopoly power problem, it's unlikely that oil prices will suddenly plummet. Even if monopoly power is a factor, it's unlikely it's as important as the growth in world demand. And while I don't put a lot of faith in the speculation story, I'd be more likely to believe speculation was the cause of the price run up than I would monopoly power.

I don't mean to downplay monopoly power, I've been frustrated that we seem to have lost focus on this aspect of markets over the last few decades, and we don't worry enough about market power in public policy. And maybe breaking up OPEC would bring down the price noticeably (for now, world growth will continue to put upward pressure on oil prices). If so, then we should eliminate the monopoly power, there's no reason to pay more than is necessary (though if we impose carbon taxes to correct other problems in these markets, the price will go back up again, the difference will be who gets the extra revenue).

But I'd also hate to see the oil price discussion get diverted by false hopes. Breaking up OPEC might bring prices down some, but it won't bring back the good old days and the longer term problems remain. At some point we have to face that things are changing, that we have to adjust - we can't keep hoping for a return of the low oil prices of the past because those days aren't coming back (no matter how many holes we drill in Alaska or off our coasts). Maybe technology will save us, but that too will require that we face reality and devote the resources and effort needed to fully investigate and develop alternative energy sources.

"A Home Price Firewall"

Martin Feldstein presents his plan to reduce mortgage loan defaults:

A Home Price Firewall, by Martin Feldstein, Commentary, Washington Post: Home prices are down 20 percent from their peak in 2006 and are falling rapidly... Experts predict an additional 15 percent decline during the coming year...

The danger is that home prices could spiral further down, hurting millions of homeowners and pushing the economy into a deep recession. ...

I believe the federal government should create a firewall to prevent too great a fall in housing prices. ... This can best be done through a program of mortgage replacement loans.

Such a program might be structured this way: The federal government would offer all homeowners with mortgages the opportunity to replace one-fifth of their existing mortgage (up to some dollar limit) with a government loan. This loan would carry a substantially lower interest rate than the individual's mortgage (reflecting the government's cost of funds). It would be a full-recourse loan that would have to be repaid regardless of what happens to the borrower's mortgage or home. By law, it would take priority over all non-mortgage debt.

Such a mortgage replacement loan would eliminate the potential incentive to default for almost all homeowners who now have positive equity. In doing so, it would limit the number of foreclosures that could contribute to a downward spiral.

Follow-Up to "This Global Show Must Go On"

In my response to Tyler Cowen's column on globalization, I concluded with:

Telling people they just don't understand how much trade benefits them is just as likely to produce a negative backlash as it is to convince people that their views are wrong.

Brad DeLong comments:

But if their views are wrong, we are under an obligation to try to convince them that their views are wrong--that globalization is at most a bit player in the rise in inequality within the United States, if it is in fact true that it is at most a bit player.

Then he follows up with a lengthy (and well worth reading) discussion of the winners and losers from trade.

Looking at it again, my concluding sentence was sloppy. I meant to say that trying to convince people that trade has helped them when it hasn't is likely to produce a negative reaction. I didn't intend to leave open the possibility that it might have helped the working class on net, they just don't know it (recognizing, as in the original post, that the consequences of technology and globalization are hard to separate so that my definition of the impacts from trade is likely larger than that used by both Tyler and Brad, e.g. is emailing work to a foreign country attributable to technology or increased openness? -- perhaps both, but in what proportion?). Brad's discussion is about whether trade really is "bad for the greater part of the citizens" of the U.S., and he goes through the conditions under which this would and would not be true. His position is that workers may, in fact, be misperceiving costs and benefits from trade and, if so, that economists have an obligation to convince them that they are wrong. The key factor here, and one where there is disagreement among economists, is the net distributional impact of trade and technology on working class households.

(There are actually two debates, one is over the total benefits from trade which I believe are relatively large, though Dani Rodrik would disagree. The second is over the distributional impact, i.e. who the winners and losers are, and I believe this been unfavorable to the working class when all the costs, including reduced economic security, reduced health care coverage, etc. are taken into account. The question I was addressing is the best strategy to pursue is if you want to avoid a backlash and preserve the large overall benefits of gloablization for the U.S. and the world more generally, telling people that they are wrong about the benefits, or finding ways to distribute the gains more broadly.)

Tyler also adds more:

A few further points of note:

1. Virtually all of the "second best worrying" about trade could be applied also -- in fact more so -- to technical progress.  Or to trade across the fifty states. Yet when it comes to foreigners, the worries acquire a more dangerous credibility. That is the real second best problem, not any theorem you might derive about trade and externalities.

2. I don't see the evidence that marginal strengthenings of the safety net will diminish anti-foreign statements.  Yet this has become an article of faith among the globalization "middle roaders." A crude look at the cross-sectional evidence does not indicate a clear pattern.  France and Germany have a strong safety net but they are skeptical about economic globalization; Sweden and the Netherlands are more sympathetic. Switzerland, with a weaker safety net, is pro-globalization for the most part. Like Will Wilkinson and unlike Bryan Caplan, I am for a safety net but often a bigger safety net makes people even more fearful of loss and change. Note it is the Bismarckian welfare state, the world's most advanced at the time, which turned to The Dark Side during the 1930s. I'm hardly suggesting causality here but it didn't halt the process either.

3. Yes I know about Denmark but job retraining programs in the U.S. hardly have a stellar record.

4. When it comes to improving the quality of economic adjustment, the overwhelming priority should be to delink health insurance from having a job. I doubt if that will decrease skepticism about foreigners, however.

5. Most of the world's wealthy economies are, if only because they are smaller and less diversified in terms of resources, more open than is the United States. They do just fine and by no means do they all spend more on social welfare than does the United States.

6. Cite Samuelson and Stolper all you want, here is yet another paper showing that outsourcing has not been placing significant downward pressure on American wages.

7. China is now the world's leading supplier of photovoltaic cells. 

But it is really the first point that is the key.

"A More Effective Stimulus Package: Job Creation"

Me, on Marketplace, talking about employment. The commentary discusses how and why the recovery of employment has been sluggish following the last two recessions, and criticizes policymakers for not anticipating the slow response of employment when putting the stimulus package into place. That is, policymakers are criticized for not implementing policies that are known to increase employment. Here's the concluding paragraph:

Marketplace: ...Have policymakers reacted properly? The Fed has responded aggressively and creatively and that should help. But fiscal policy - the tax rebates the government sent out- was inadequate. Fiscal policymakers should have recognized that employment has tended to recover sluggishly in recent recessions and implemented policies that are known to create jobs. But they didn’t, and it’s too bad that one policy error, the failure of regulators to prevent the problems in the first place will be compounded be another, the failure of fiscal policy to come to the aid of unemployed workers.

[Update: Paul Krugman talks about the slow recovery of employment over the last two recessions here.]

What Should We Do with the Revenues from Cap-and-Trade?

More on cap-and-trade from Robert Reich:

Why Revenues from Cap-and-Trade Should Be Returned to Us As Dividends, by Robert Reich [originally here] ...[To address global warming,] Barack Obama is on record in favor of cap and trade. And so, significantly, is John McCain.

So it's a certainty that we'll have a president next year who wants to address global warming by imposing an overall cap on U.S. carbon emissions, which will drop annually. The "trade" part ... would allow companies finding efficient ways to cut emissions to sell the unused portions of their permits to others. Obama’s proposal is more ambitious than McCain’s in terms of how fast the overall cap would drop.

But the biggest difference between McCain and Obama is how the permits would be allocated. McCain’s proposal would initially give out most of them for free to the nation’s biggest emitters of greenhouse gases. This does have some logic to it: after all, as the overall cap tightens each year, the biggest polluters will face the largest challenges in cutting emissions.

By contrast, Senator Obama has proposed allocating the permits through an auction. Under his proposal, every company ... would have to buy the rights to emit greenhouse gases. As a result, the biggest emitters would have to pay the most - thereby providing them with the greatest incentive to cut emissions right from the start. In economic terms, such a carbon auction is the equivalent of a carbon tax, and it make more sense than a system that allocates permits on the basis of how much greenhouse gas a company or industry already emits. Companies and industries that impose the largest social costs in terms of such emissions should be given the greatest incentives to cut costs right from the start.

Moreover, carbon auctions invite far less political maneuvering. Setting initial allocations by emissions, as McCain wants to do, invites every big corporation and industry to fight for the biggest possible allocation and claim the largest emissions. Despite John McCain’s avowed determination to reduce the influence of lobbyists in Washington, the resulting free-for-all would be a bonanza for K Street. And there’s no reason to suppose the outcome would bear any resemblance to the public interest. ... This is one reason why cap-and-trade hasn't worked very well in Europe so far. ...

But carbon auctions raise another problem when it comes to Washington. ... Lieberman estimates that the market value of all permits under his bill would be about $7 trillion by 2050. That sum would go into what Lieberman calls a Climate Change Credit Corporation, which, operating outside the budget process, would invest in various plans for developing alternative energy. You can bet that lobbyists for ethanol, nuclear, and so-called “clean” coal are already salivating...

That's why it's important that all revenues from carbon auctions be cycled back to citizens. And rather than launch another endless debate over how and to whom – a payroll tax cut for people earning under the median wage? a cut in capital gains? – it would be well to agree to the simplest possible formula: Every adult citizen should receive an equal share. If the carbon auction yields $150 billion in the first year, for example, each of America’s 150 million adult citizens should receive a Treasury check of $1000.

Such direct and simple repayments – what analyst Peter Barnes, who has been pushing this idea, wisely calls “dividends” – deal with another problem. Although the balance of economic studies suggest that the cost of a cap and trade system will be modest, ... inevitably some costs will be involved and be passed along to consumers. The cost of doing nothing about climate change will be far higher. But consumers who are already walloped by high fuel and food costs will be in no mood to accept even modest additional price increases. Hence, ... dividend checks will be a welcome offset. ... Our atmosphere belongs to all of us. It seems only reasonable that corporations should have to pay to use it. ...

Rogoff: It's No Time for Oil Currency Hypocrisy from the US

Why is the U.S. sending inconsistent messages on exchange rate pegs?:

It's no time for oil currency hypocrisy from the US, by Kenneth Rogoff, Project Syndicate: Does it make sense for US Treasury Secretary Hank Paulson to be touring the Middle East supporting the region's hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their currencies appreciate faster against the dollar? Unfortunately, this blatant inconsistency stems from the United States' continuing economic and financial vulnerability rather than reflecting any compelling economic logic. Instead of promoting dollar pegs, as Paulson is, the US should be supporting the International Monetary Fund's behind-the-scenes efforts to promote de-linking of oil currencies and the dollar.

Perhaps the Bush administration worries that if oil countries abandoned the dollar standard, today's dollar weakness would turn into a rout. But the US should be far more worried about promoting faster adjustment of its still-gaping trade deficit, which in many ways lies at the root of the recent sub-prime mortgage crisis. The administration's multi-pronged effort to postpone pain to US consumers, including super easy monetary and fiscal policy, only risks a greater crisis in the not-too-distant future. It is not at all hard to imagine the whole strategy boomeranging in early 2009, soon after the next US president takes office. ...

Someone on the Internet is Wrong...

Tyler Cowen defends Robert Samuelson:

Cap and trade vs. carbon tax, by Tyler Cowen: Robert Samuelson writes:

Unless we find cost-effective ways of reducing the role of fossil fuels, a cap-and-trade system will ultimately break down. It wouldn’t permit satisfactory economic growth. But if we’re going to try to stimulate new technologies through price, let’s do it honestly. A straightforward tax on carbon would favor alternative fuels and conservation just as much as cap-and-trade but without the rigid emission limits. A tax is more visible and understandable. If environmentalists still prefer an allowance system, let’s call it by its proper name: cap-and-tax.

Mark Thoma gets upset at this passage, here is Ryan Avent, Brad DeLong and Matt Yglesias, all upset. Avent was the fount of the opposition:

Yowza. As any economist worth his or her salt will tell you, a cap and trade plan with auctioned permits is essentially identical to a carbon tax. That also happens to be exactly what Barack Obama is proposing. So, another way for Samuelson to have written this column would have been to title it, “Barack Obama has a good plan to reduce carbon emissions."

But Samuelson is correct here and Avent is misleading. When there is uncertainty about the location of the social optimum, and uncertainty about elasticities, a carbon tax and cap-and-trade are by no means equivalent. If you see very high costs from setting the binding cap too low and choking off growth -- as Samuelson mentions -- you should prefer the carbon tax. The price of carbon is more certain and you bear less risk from uncertainty about how fast solar power and other technologies will develop. Alternatively, you might say that risk is transformed into price risk rather than "you can't exceed this cap no matter what" risk.

Of course the postulated uncertainties are realistic in this context and you don't have to invoke uncertainty about the science of global warming.

If there is very high environmental risk to having emissions above a certain level, and we are unsure about the relevant elasticities (again, uncertainty about the pace of technological development can drive this), that militates in favor of cap and trade. It is then easier to ensure that emissions do not exceed a particular level.

You can see that we are comparing the "growth threshold problem" to the "environment threshold problem." Samuelson is apparently more worried about the former than the latter. Maybe he shouldn't be so sure he is focusing on the right problem, but on the economics he is on the mark in the criticized passage.

Addendum: Here is Mark Thoma with more on the topic, here is Megan McArdle on same.

I'll let Ryan respond to the parts directed at him (update - see here). My main objection wasn't the passage above, it was Samuelson's claim that environmentalists are deceiving the public, i.e. my objection was to Samuelson's attempt to "bash environmentalists for proposing a cap-and-trade system" when "there's no foundation" to his arguments. For example, Samuelson says:

[C]ontrolling greenhouse gas emissions ... promises to be hard and perhaps futile, but there are good and bad ways of attempting it. One of the bad ways is cap-and-trade. Unfortunately, it's the darling of environmental groups and their political allies.

The chief political virtue of cap-and-trade ... is its complexity. This allows its environmental supporters to shape public perceptions in essentially deceptive ways. ... It would regulate economic activity, but it's promoted as a "free market" mechanism. ...

Samuelson is the one who is being deceiving here. Cap-and-trade is promoted by environmentalists as market based regulation, the term is meant to distinguish it from command and control type regulation. Samuelson seems to think cap-and-trade is command and control type regulation, but the whole point of market-based regulation is to move away from older style command and control policy regimes since market based regulation has better incentive properties. This is one of the reasons I didn't think he fully comprehended the economics underlying these proposals.

Here's more of Samuelson trying to make the case the environmentalists are deceiving the public by claiming that regulation will be painless:

Carbon-based fuels (oil, coal, natural gas) provide about 85 percent of U.S. energy and generate most greenhouse gases. So, the simplest way to stop these emissions is to regulate them out of existence. Naturally, that's what cap-and-trade does. ...

Even better, their disappearance would allegedly be painless. Reviewing five economic models, the Environmental Defense Fund asserts that the cuts can be achieved "without significant adverse consequences to the economy." Fuel prices would rise, but because people would use less energy, the impact on household budgets would be modest. ...

Here's what the EDF actually says:

How would Americans be affected by a carbon cap?

• Total job loss would be minimal;
• The new carbon market would create new jobs;
• The manufacturing sector is projected to see some job losses, but the models show that losses due to an emissions cap would be minimal.
• The effect on household consumption is expected to be one percent or less.
• American households will be most affected by energy costs, but even here the increases would be modest. Overall costs would be small enough to allow us to expand programs to offset the burden for low-income households.

They do tend to minimize the costs in the language used in the write-up, but they don't say there is no cost at all, and the studies they rely upon in their meta analysis are well documented. And it's not exactly clear why the criticism Samuelson is making is specific to a cap-and-trade proposal, which is the case he is trying to make (he's saying that  environmentalists are hiding behind cap-and-trade rather than being honest and proposing a carbon tax). That is, if the EDF provided cost estimates for a carbon tax, how different would the cost estimates be? Probably not very different since most of the same incentives to substitute toward alternatives would still exist, or, according to Samuelson, be even larger. So this point has little to do with using a cap-and-trade proposal to (supposedly) deceive the public.

One reason Samuelson thinks the analysis is misleading is that he objects to the assumption that consumers would substitute away as they face higher prices:

The idea that higher fuel prices will be offset mostly by lower consumption is, at best, optimistic. The Congressional Budget Office has estimated that a 15 percent cut of emissions would raise average household energy costs by almost $1,300 a year.

If environmentalists hide all the costs of cap-and-trade like he claims, what motivates the higher prices and substitution in the study? Anyway, he's really contesting the ability of consumers to substitute, the direct costs aren't hidden, they are out in the open as he implicitly acknowledges with his statement about higher prices (and it's technology too, not just cutting back).

And, in any case, the estimates of little change in energy bills that Samuelson ridicules are not without foundation. As the paper says:

To illustrate the fundamental difference between energy prices and energy bills, we can take a look back at actual household spending patterns. The average American household's monthly electricity bill was virtually the same in 1990 as in 2005 (after adjusting for inflation) -- even though the average residential electricity price was 24% higher in 1990 than in 2005. In other words, even though electricity rates were substantially higher fifteen years ago, the average American family spent no more on electricity than they do today.[14] In the same way, looking forward in time, a given percentage rise in energy prices will lead to a much smaller change in energy bills. This principle is evident in the EIA's projections of future household energy expenditures. The EIA projects electricity prices in the year 2020 to be 9% higher than business as usual under the Lieberman-McCain legislation.

Thus, the EDF estimates are evidence based.

As for lower GDP growth, one of Samuelson's worries, I think his discussion misses this:

And this brings me to a final point that is often overlooked by both sides: the economic indicators that we currently use do not measure societal welfare. When many conservatives point out the lost GDP from a cap-and-trade system or a carbon tax, they typically ignore the fact that GDP does not include the lost welfare from environmental damage done by production. And while figures quoting the lost GDP from imposing a cap-and-trade system are useful, they rarely mention, even in passing, the environmental gain. Any first-year student of macro 101 is taught this difficulty when introduced to national income accounting... The purpose of the income earned from GDP itself is to increase consumption and ultimately utility, but GDP does not measure everything that affects one's well-being.

If there was a government policy instituted for 3 months that said every person must work at least 16 hours per day in that time period, GDP would temporarily increase dramatically. But leisure would be essentially non-existent, and actual societal well-being would fall dramatically. The same can be said for the environment. Due to the tragedy of the commons, lower output (as measured by GDP) could actually improve societal well-being because, after all, the tragedy is a result of overproduction from the perspective of society's welfare as a whole.

On the other side of the aisle, we often hear talk of the number of "green jobs" that would be created by such a policy. Such talk is ridiculous too. The purpose of environmental regulation is not to create jobs. It's to improve societal well-being by reducing emissions. Of course, any time a tax (or its equivalence) on one item is imposed, it will alter behavior. (It's nice to see some liberals finally acknowledge that.) But in the short-to-medium-run the number of green jobs added from cap-and-trade would likely be lower than the number of total jobs lost due to the fact that production overall will fall (which as pointed out isn't necessarily bad), although sector-specific changes would depend upon production functions.

So my doubts about the column remain.

Update: Brad DeLong says "I think that Tyler Cowen has misread Robert Samuelson."

Update: Ryan Avent replies.

Carbon Taxes vs Cap-and-Trade

A review of the equivalence of carbon taxes and cap-and-trade:

Carbon taxes vs cap-and-trade, by Stephen Gordon: There are now several plans for reducing greenhouse gas emissions bouncing around the political landscape. ...

It's important to remember that in almost every way that matters, the [carbon tax and cap-and-trade] approaches are equivalent. But..., this point is easy to overlook. So as a public service, here is the Econ 101 explanation of how the two policies work, and why they are equivalent.

Before the policy, the intersection of the supply and demand curves for ghg-emitting products - point A on the graphs - will generate emissions equal to Q₀, and the price will be P₀. Suppose that the government wants to reduce the quantity to Q₁.

• Carbon tax: Suppose that a carbon tax π is added into the price. For a given quantity, the supplier's price will be the old price plus the amount of the tax, and the supply curve will shift up to S*. The new equilibrium is at point B, the quantity is the target Q₁, and the price will increase to P₁. Note that the price increase will be less than the tax, although if the demand curve is fairly steep (i.e., inelastic, or relatively insensitive to changes in price), the increase in the price will be pretty close to π.
• Cap-and-trade: Suppose that the government restricts emissions to a level consistent with Q₁. The new supply curve - denoted by S* - is now vertical at the target: no matter how high the price goes, supply will remain fixed at Q₁. The new equilibrium is again B: the quantity is determined by the cap at Q₁, and the price will rise to P₁.

So as far as prices and quantities go, the two policies are equivalent: as we go from A to B, quantities fall to the target Q₁, and prices rise to P₁. From the consumer's point of view, that's all that matters.

What distinguishes the two is what happens to π - the difference between the price the consumers pay at B and what it costs suppliers to produce at Q₁. In the case of the  carbon tax, the money goes to the government. But if output is capped at Q₁, that difference is pure profit: a permit to produce one unit of output allows its owner to collect a rent equal to to the difference between the selling price and the cost of production. If permits are traded, their price will be bid up so that their price will be equal to π. So where that money goes depends on how the permits are allocated in the first place. If the permits are simply given to existing emitters, then those profits are pocketed by the firms. If the permits are auctioned off, the price will be bid up to π, and the government gets the money.

So if permits are auctioned off by the government, then cap-and-trade and a carbon tax are equivalent: same quantities, same prices, and the government gets revenues equal to the area in the green rectangle in the graphs.

For more, see ECON 101: Carbon Tax vs. Cap-and-Trade by John Whitehead at Environmental Economics.

Update: More on this topic here. Tyler Cowen comments. My reply.

Update: See also How Low Income Consumers Fare in the Senate Climate Change Bill, CBPP.

Update: Ryan Avent responds to (and disagrees with) Pete Davis (see next update) in One Last Thing on Cap and Trade.

Update: Pete Davis at Capital Gains and Games explains why politicians favor cap-and-trade over carbon taxes:

Carbon Tax: How Much, How Soon?, by Pete Davis: The climate change debate began in earnest in the Senate yesterday afternoon. Few are questioning the science anymore... The question is how best to control carbon emissions...?

We economists usually recommend a carbon tax... We like that fact that the tax is explicit, not hidden, that it is efficient, minimizing collateral damage to the economy, and that it is effective, raising the price of greenhouse gas emissions and encouraging alternatives.

I kid my friends that "I formulated three carbon taxes for Bob Dole back in the early 1980's that are still in his filing cabinet." I'd be very surprised if the former Senate Finance Chair really kept them, but the fact that they were formulated at all shows that Senate leaders, then as now, were fully aware of of the advantages of a carbon tax. That none of those proposals saw the light of day is conclusive evidence that:

Political leaders don't want:

"His Readers are Now Dumber for His Efforts"

Brad DeLong is rightly critical of the editors of the New York Times opinion page for running articles that misinform readers. But it's worth noting that the editors at the Washington Post are doing the same thing. Witness this column today by Robert Samuelson. The main intent of the article is to bash environmentalists for proposing a cap-and-trade system, but there's no foundation to Samuelson's arguments, they're based upon an incorrect understanding of how these policies work. Here's Ryan Avent:

Robert Samuelson Drinks Deeply From the Cup of Stupid, The Bellows: Washington Post columnist Robert Samuelson has long impressed me as one of the most hackish economic columnists not associated with the Wall Street Journal and not named Ben Stein, but today’s piece on cap-and-trade is dismally, embarrassingly stupid. Its essential premise is that consumers and producers of energy don’t respond to price signals, something so incredibly, obviously wrong that even the dolt editors of the Post opinion section should have wondered what was up. Samuelson should be ashamed of himself.

Let’s go to the videotape:

The Economics of Parental Leave Policies

I didn't know that parental leave policies are associated with  lower post neonatal infant mortality rates and with higher employment rates for women. This interview with Christopher Ruhm also explains how market failure can prevent the private sector from offering parental leave, and how government intervention can overcome the suboptimal outcome [another part of the interview discusses his research on early childhood education]:

Interview Christopher Ruhm, by Chris English, Region Focus Winter 2008, FRB Richmond: ... RF: Tell us about your research into what sorts of economic effects you find abroad in relation to mandated parental leave policies.

Ruhm: My work on parental leave policies has led to a lot of my other work on health topics. How I got into it was a fluke. I was doing work on advance-notice provisions — the mandate [passed in 1988] that requires firms to tell their workers in advance if management is planning a mass layoff. That issue got me interested in mandated benefits more generally, and what happens when the government tells a firm it has to do something.

When I got interested in the role of parental leave mandates, there weren't many in the United States. There were some states that had mandates and, of course, later the Family and Medical Leave Act was passed as a federal mandate. But even with all that, the entitlements to parental leave are quite weak in the United States relative to other countries. So, what I did was go to European data...

Then I looked at the effects of labor market outcomes for women. Men were the control group in this research, because at the time men almost never took parental leave. What I found was that in the presence of parental leave requirements, women were more likely to be employed. There are a lot of reasons why you would expect that to be true. The most obvious one is the notion of job protection. If you don't have to quit your job to take leave, careers outside of the home become more attractive to women.

Greg Mankiw: The Problem With the Corporate Tax

Greg Mankiw wants a cut in the corporate income tax:

The Problem With the Corporate Tax, by N. Gregory Mankiw, Economic Scene, NY Times: At this point in the presidential campaign, Senator John McCain is the candidate of ideas on issues of tax policy. Too many ideas, in fact. While some of his ideas are great, others are almost laughable. The one that has received the most attention recently — a gas-tax holiday — falls in the second category. ...

Lost in this hubbub, however, is a bigger idea that Mr. McCain and his economic team have put forward: a cut in the corporate tax rate, to 25 percent from 35 percent. It is perhaps the best simple recipe for promoting long-run growth in American living standards. ...

A cut in the corporate tax as Mr. McCain proposes would initially give a boost to after-tax profits and stock prices, but the results would not end there. A stronger stock market would lead to more capital investment. More investment would lead to greater productivity. Greater productivity would lead to higher wages for workers and lower prices for customers. Populist critics deride this train of logic as “trickle-down economics.” But it is more accurate to call it textbook economics. ...

Compared with other ways of funding the government, the corporate tax is particularly hard on economic growth. A C.B.O. report in 2005 concluded that the “distortions that the corporate income tax induces are large compared with the revenues that the tax generates.” Reducing these distortions would lead to better-paying jobs.

Of course, a corporate tax cut would affect the federal budget. ... Cutting the rate to 25 percent would seem to cost the Treasury about $100 billion a year.

Part of that revenue loss, however, would be recouped through other taxes. To the extent that shareholders would benefit, they would pay higher taxes on dividends, capital gains and withdrawals from their retirement accounts. To the extent that workers would benefit, they would pay higher payroll and income taxes. Increased economic growth would tend to raise tax revenue from all sources.

Some economists think that these effects are strong enough to make a corporate rate cut self-financing. A recent study by Alex Brill and Kevin A. Hassett of the American Enterprise Institute, looking at countries in the Organization for Economic Cooperation and Development, supports exactly that conclusion. But even if that turns out to be too optimistic, both theory and evidence make it reasonable to expect a significant discount from the sticker price. In the end, the net budgetary cost of the tax cut might be, say, $50 billion a year.

Senator McCain wants to fill that hole in the budget by restraining spending. If he can stop bloated legislation like the recent $300 billion farm bill from becoming law, more power to him.

But in case that quest proves quixotic, I have a back-up plan for him: increase the gasoline tax..., a gas-tax increase of about 40 cents a gallon could fund a corporate rate cut, fostering economic growth and reducing a variety of driving-related problems.

Indeed, if we increased the tax on gasoline to the level that many experts consider optimal, we could raise enough revenue to eliminate the corporate income tax. And the price at the pump would still be far lower in the United States than in much of Europe.

Don’t laugh. I’m serious.

I think a 50% recovery rate on tax revenues is far too optimistic, and I'm disappointed that Greg would even hint that the tax cut would be self-financing.

[He also discusses the distribution of the tax burden, but the 70% figure he cites as the amount of corporate taxes paid by labor relies upon an assumption of perfect capital mobility (and other assumptions), and he doesn't include how the burden of paying for the corporate tax cut would be distributed, i.e. how the gas tax or any other means of paying for the tax cut would be distributed across households. So the analysis of the tax burden is a bit incomplete and relies upon some fairly optimistic assumptions. I'm not opposed to either change, but the distributional consequences need more consideration. Predictions about the distributional consequences of policies that rely upon trickle down arguments have not been accurate in the past, and we should be wary when they are used to justify further cuts in taxes.]

From comments:

Corporate Tax Declines and U.S. Inequality, By John Irons, April 9, 2008: Over the last 60 years, the U.S. tax code has dramatically shifted away from corporate taxes and toward taxes on individuals, especially through the payroll tax, the financing backbone of Social Security and Medicare. In the 1950s, the corporate income tax brought in, on average, one of every four dollars in federal tax revenues. By the 2000s, however, it raised just one of every 10 tax dollars.

The shrinking share of corporate taxes was made up by an increase in payroll taxes to fund social insurance and retirement programs. Excise and other taxes—such as fuel taxes, phone taxes, etc.—shrank as well over the last 60 years, while the individual federal income tax rose slightly, from an average of 43% of total federal revenue in the 1950s to 46% in the 2000s.

This shift is important because of who pays these different taxes. The corporate income tax is significantly more progressive than other taxes. Those with incomes in the top 20% of the income distribution (those making more than about $86,000 a year in 2007) pay four times the average tax rate on corporate income than the middle 20% (those making between $27,000 and $48,000); while, for the payroll tax, those in the top 20% actually pay less than those in the middle as a share of their income.

This shift has been one of the factors leading to the drop in average federal tax rates for the very highest earners. Between 1960 and 2004, the average tax rate has fallen by about 14 percentage points (from 44.4% to 30.4%) for the top 1% of earners (those making more than $435,000 in 2007), while it has increased slightly (from 15.9% to 16.1%) for those in the middle 20%. 

Without offsets, further erosion of corporate tax revenues—either through lower statutory tax rates or through special preferences—would expand the already wide and growing income inequality in the United States.

Stephen Gordon makes the point that the countries with larger social insurance programs generally have lower corporate taxes than the U.S., but they also do much more redistribution after taxes are collected so that the net tax burden is fairly progressive even when they rely on fairly flat tax collection mechanisms such as a value-added tax. These redistribution programs are an important part of those systems.

Update: Brad DeLong comments on the article here.

Socially Unacceptable Externalities

David Beckworth:

Which Externalities Should Be Internalized?, by David Beckworth: Robert Frank's NY Times column on using Pigovian taxes as an "efficient" way to deal with the negative externalities of gas consumption ... points to an important question that has been bugging me for some time. But first ... Gabriel Mihalache ... points out an important assumption in Frank's analysis:

...A Pareto improvement [from imposing a Pigovian tax on gas consumption] means that afterwards, everyone is at least as well off (subjectively) as before and some are better off. ...

The implicit, unstated, assumption of Frank’s article is that we could compensate the losers from the new energy policy from the gains of others.., there exist potential transfers to compensate the losers and still leave the winners better off.

When supporters of free trade point out that the net losers from the full opening of borders could be compensated with transfers from the net winners, the common criticism is that those transfers are both politically and institutionally unfeasible. There’s no mechanism we can trust that would identify the correct transfers (from whom, to whom, how much?) and make it in a way that’s politically acceptable.

I will unashamedly yield the same critique against Frank. He wants to seduce us with Pareto improvements but he only tells us half the story, less that half really… he mentions introducing the carbon tax but he remains strangely silent on the ways he’d use to compensate the losers.

Gabriel suggests we avoid resorting to the Pareto efficiency argument and say up front there may be net losers. Josh Hendrickson, meanwhile, also questions the usefulness of invoking Pareto efficiency and goes on to stress that the proper use of a Pigouvian tax requires a Herculean ability to properly assess social costs:

The problem inherent in any such analysis is the view of societal benefit and societal loss that is assumed to be easily calculated and dealt with through Pigouvian taxation. The ability to identify the social cost of a particular action is extremely difficult as each individual has his or her own subjective valuation. The problem is communicating each of these preferences in aggregate form to some central authority. This is a distinct problem in terms of both Hayekian knowledge and a neoclassical framework (Arrow’s Impossibility Theorem). In the absence of this ability, setting the tax rate is extremely difficult.

In short, both of these commentators suggest we should be more humble about our ability to (1) rigorously justify and (2) precisely implement a carbon tax. As noted above, Frank's column also points to another important question that I have been wrestling with for some time: exactly which externalities should be internalized? There are so many negative externalities in society so why stop at those created by gas consumption? Frank alludes to this in his article:

Gasoline is one of a host of goods whose production or consumption generates costs that fall on outsiders. Noisy goods, like leaf blowers, for example, can jolt whole neighborhoods from calm. And goods that don’t biodegrade readily, like many plastic bags, can generate costly waste streams. The list goes on.

Okay, then, why not tax noisy leaf blowers (noise pollution) or billboards along the highway (sight pollution) or rancorous, smelly, ugly people (noise, sight, and smell pollution)? Conversely, should we subsidize quiet neighbors, firms that do not advertise on highway billboards, and beautiful, well-kept people?

Now I am not advocating we tax or subsidize the above items. However, this list does illustrate the fact that society does choose to correct only certain externalities. So what is the decision criteria used in this process? Presumably it involves equating some margins; I am just not sure which one they are though. Any thoughts?

In closing, let me refer you to Peter Klein who, in the context of applying a Pigouvian tax to negative externalities, makes the following statement:

But my main beef with today’s Pigouvians is that they cherry-pick a case here and there — taxes on gasoline, primarily — without fully pursuing the implications of the analysis. If increasing gasoline taxes is efficient, why stop there? What other market failures should the state be empowered to remedy? Here’s my question, specifically:

Please name the activities you believe deserve Pigouvian subsidies. For each activity provide the efficient subsidy amount, explain how this was calculated, and say how the revenues should be raised.

Maybe someone has thought about this more than I have, and your comments are welcome and encouraged, but a couple of quick reactions. It seems to me that one way societies solve this problem is to define which externalities are actionable and which are not through the political process, and then prohibit them by decree rather than through incentive mechanisms such as taxes. Whether you care about the noise from leaf blowers or not, loud music, etc., so long as it's before 10 p.m., you are stuck no matter how much it bugs you - nothing can be done. But after 10 p.m., there are exact restrictions in terms of decibels on how loud music, etc. can be. If someone violates that rule, police will enforce it if asked to do so. For barking dogs, the rule is equally explicit, if it barks continuously for more than a half hour (you are supposed to record it), it is actionable - you can call and have animal control do something about it. Many externalities are like this, the community decides what is and isn't acceptable, whether you like it or not. Some externalities can be stopped, others you are stuck with (though you can still negotiate on an individual level, but the response "there's no law against it" is always available to the person being asked to be more considerate). This isn't the most efficient solution, but it is practical (and given how hard it would be to do individual calculations, it may be the best solution available) - it defines community preferences through the political process and forces adherence to them. This notion works at the local level - e.g. neighborhoods that enforce how houses are painted for example - but I'm having a harder time fitting it into national issues such as global warming, and to issues where taxes are used to discourage behavior rather than issuing blanket prohibitions. But I guess it's the same. If all nations but one decide that polluting the atmosphere with greenhouse gases is just fine, little can be done, it does not violate community standards. If one country really cares about the issue but others don't, it can turn down its music voluntarily at 10 pm to be courteous, i.e. try to fight the problem on its own, but it's only when the majority of nations agree that it is a problem that effective enforcement can begin. Anyway, I've pushed this far enough - thoughts?

"Minimum Wages and Firm Profitability"

With all of the recent discussion about the minimum wage (e.g.), I thought this paper was worth noting. It finds evidence that the minimum wage transfers income from owners to workers, i.e. that it reduces profit and increases wages, but it does not change the probability of a firm going out of business, and it does not reduce employment. Thus, this paper raises the possibility that an increase in the minimum wage reduces inequality without having much of an impact on aggregate activity or employment:

Minimum Wages and Firm Profitability, by Mirko Draca, Stephen Machin, and John Van Reenen, NBER WP 13996, May 2008[Open Link]: I. Introduction In debates on the economic impact of labour market regulation, much work has focused on minimum wages. Although standard economic theory unambiguously implies that wage floors raise the wages of the low paid and have a negative impact on employment (Borjas, 2004; Brown, 1999), the existing empirical literature is not so clear. Whilst many studies have shown that minimum wages significantly affect the structure of wages by increasing the relative wages of the low paid (e.g. DiNardo et al, 1996), empirical evidence on the effect on jobs is considerably more mixed (see the recent comprehensive review by Neumark and Wascher, 2007). Some studies have found the expected negative impact on employment[1], yet others have found no impact or, in occasional cases, a positive effect of minimum wages on jobs.[2]

In the light of this, one may wonder how firms are able to sustain the higher wage costs induced by the minimum wage. One possibility is that firms simply pass on higher wage costs to consumers in the form of price increases. However, there is scant evidence on this score (exceptions are Aaronson, 2001, and Aaronson and French, 2007).[3] An alternative is that the higher wage costs are not fully passed on to consumers and the minimum wage eats directly into profit margins.[4] Since there is a complete absence of any study directly examining the impact of minimum wages on firm profitability, this is the focus of this paper.

Our identification strategy uses variations in wages induced by the introduction of the national minimum wage (NMW) in the UK as a quasi-experiment to examine the impact of wage floors on firm profitability. The introduction occurred in 1999 after the election of the Labour government that ended seventeen years of Conservative administration. There is evidence that the NMW increased wages for the low paid, but had little impact on employment[5] and so this provides a ripe testing ground for looking at whether profitability changed. We use the fact that the intensity (or “bite”) of the NMW is higher for firms with many low paid workers relative to firms with fewer low paid workers in order to construct treatment and comparison groups. We then compare outcomes in terms of wages, profitability and firm exit and entry using difference in differences methods.

Our work does uncover a significant negative association between the minimum wage introduction and firm profitability. This association is robust across two very different panel data sources, namely a specialized UK data source on workers in residential care homes (a very low wage sector) and an economy-wide firm level database FAME (Financial Analysis Made Easy) that covers all registered firms in the UK.[6] In both data sets, firm profit margins fall in relatively low wage firms following the introduction of the minimum wage. These effects correspond to about a fifteen percent fall in profit margins for the average care home and an eight to eleven percent reduction in profit margins for the average affected firms in FAME.  ... Finally, we could not find any evidence that low wage firms were forced out of business by the higher wage costs resulting from the minimum wage. Our analysis of an industry level panel dataset suggested that there was some fall in net entry rates following the minimum wage, hinting at a longer run negative effect on the number of firms. These results were rather imprecise, however, and not significant at conventional levels.

"The Scars of Losing a Home"

Robert Shiller explains why the president should sign the mortgage relief bill:

The Scars of Losing a Home, by Robert Shiller, Economic View, NY Times: Across the United States, there were 243,353 foreclosure filings in April alone, nearly three times the total in the same month just two years ago... The trend is unmistakable, and suggests that, without government intervention, many millions of American families will be losing their homes before long. ...

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