Wednesday, February 27, 2008

Graphs without Explanations

The Times offers this handy graph about that raise you're not getting:

Wage Growth Graph

This depicts year-on-year changes in hourly and weekly real wages. Real, as opposed to nominal, figures are adjusted for inflation. Deflating the earnings allows us to compare historic prices in today's dollars—apples to apples, instead of apples to apples covered in rising oil prices.

From the article:

Since last October take-home pay has been contracting for about 80 percent of the American workforce, including factory workers and non-managers in service businesses.

Although the author allows that the "blame lies with a combination of slower wage growth and higher inflation," the article does not address the data driving the fall—exactly 1% (contra to the graph) or 18 cents (in January 2008 dollars)—which is high inflation to the tune of 4%. Nominal wages grew by 3.7% year-on-year; if we were experiencing inflation more in line with the norm—say, 2007's average of 2.85%—real growth would have been positive. Instead, inflation, particularly over the last three months, has been sufficiently high to cancel out the nominal growth.

Four percent isn't 1974 (11%) or Zimbabwe (66,212%), but there are troubling parallels with the former. Are we looking at a sustained period of both inflation and depressed growth—the dreaded stagflation? My money is on the recession but not the inflation, but there are a lot of unknowns. Zimbabwe's problems are easier: Long-term inflation is always and everywhere a monetary phenomenon, so lay off the printing press.

To the rescue, Chairman Bernanke today signals he is open to more rate cuts. Err, wait. That won't help. Ah, but look over here: The FOMC finally acknowledges via its semiannual congressional report that it has an informal inflation target of 1.5 to 2.0% core over three years and slightly less over the long-run. That should aid in restoring the Fed's inflation hawk credentials. Now is decidedly not a fun time to be Fed Chairman.

For the curious, the data backing this graph and my post is from the BLS report Real Earnings in January 2008. Earnings were deflated using the CPI-W, which includes food and energy.

Monday, February 25, 2008

Moon over Boston

This Gallup Poll is interesting:

"Which one of the following do you think is the leading economic power in the world today?"

China - 40%
United States - 33%
Japan - 13%
European Union - 7%
India - 2%
Russia - 2%

Compare to the actual size of the respective economies: The US economy is five times that of China's. Per-capita GDP is 18 times larger. Even adjusting for purchasing power—which has come under question via-à-vis China—the US economy is 15% larger.

Out my window, long exposure of a full moon over Boston:

Moon over Boston

Elsewhere, our chief economist, Hal Varian, lays out an economic view on Google's success.

Sunday, February 24, 2008

No, February is the Cruelest Month

39°F in Boston and, although beautiful and sunny, I still miss St Lucia.

St Lucia
1440 × 900 wallpaper

That was the view from bed.

Bad Reporting, Great Visualization

From today's Sunday Times, another statistical graphic that will make Edward Tufte proud:

Revenue Graphic
The Ebb and Flow of Movies: Box Office Receipts 1986-2007

At least they get something right.

For those unfamiliar with "The Leonardo da Vinci of Data," I highly recommend all four of Dr Tufte's books: The Visual Display of Quantitative Information, Envisioning Information, Visual Explanations, and Beautiful Evidence. Even if you are not concerned with statistical graphics and other forms of information visualization, I bet you will find his work beautiful, if not enlightening.

Friday, February 22, 2008

Stupid Hawk

At first, we welcomed the hawk. Majestic, balletic, and charitable, Hank became a member of our household. In exchange for keeping the alley that he calls his kingdom vermin-free, I would lay gifts at his altar—a commissioned portrait, for example, or a disabled larger animal he was otherwise unable to kill.


It was a symbiotic relationship in the tradition of Nixon and Kissinger, Lennon and McCartney, Joey and me. My days were brightest when Hank would fly by, wearing the bowtie and monocle I gave him for Erev Yom Kippur, I helping him with his molting plumage or he offering assistance with my taxes. As with any strong friendship, ours was built on shared interests, respect, and admiration. Our relationship was mutually beneficial—until Hank, taking a page from Hugo Chavez, stopped respecting private property.

Hawk flapping wings

One day, out of the blue, the damn hawk started shitting everywhere. He would eat a whole raccoon, or one of the infants I would cripple, and then blast the entire thing out his ass and onto our window. And it wasn't just my home he treated with no regard; soon Hank's altar was also drenched in hawk feces.

Hawk defecating

That beast is a scumbag, a liar. Boorish and repugnant, I cannot imagine another animal with such disregard for people or property. More a jive turkey than a hawk, Hank is no longer welcome in my home or on my window sill. I hope he eats a plague-ridden ferret, catches on fire, and asphyxiates on an American flag. Stupid hawk.

Tuesday, February 19, 2008

Tacking far Left

Obama seeks Ohio’s blue-collar vote:

Barack Obama on Monday made an aggressive pitch at Ohio's blue-collar workers by proposing a "Patriot Employers" plan that would lower corporate taxes for companies that did not ship jobs overseas.

Mr Obama's plan would lower the corporate tax rate for companies that met criteria including maintaining their headquarters in the US, maintaining or increasing their US workforce relative to their overseas workforce, holding a neutral position in union drives among their employees and providing decent healthcare.

Mr Obama's plan met instant scepticism from otherwise sympathetic Democratic economists who said it would require a large regulatory apparatus to put into practice.

No, no, no. Come on!

Is Senator Obama really proposing codifying into law "holding a neutral position in union drives"—whatever that means—as a basis for determining your effective tax rate? On its economic merits, the plan is terrible, but is it even good politics? This puzzling proposal, this refuge of regulation, is surely not implementable.

Update: This speech mirrors a bill introduced this summer, The Patriot Employer Act of 2007, which provides "a tax credit to companies that make a commitment to American workers."

Monday, February 18, 2008

Innovating in Mobile

Andy Rubin on Android:

We're building an open-source platform for mobile phones called Android. The strategy is to provide Web-style innovation and rapid development on the cell phone, which we think is still in prehistoric times. If you have people developing applications at home, one of them will create the next Facebook. That's the idea behind our mobile mashups. Third-party developers get data from one site and overlay it on something like a Google map. We want to deliver thousands of applications to your phone.


Tax Briefing Book

How I know I am a tax wonk: This Tax Policy Briefing Book from the Tax Policy Center (a collaboration by left-of-center Brookings and the Urban Institute) is phenomenally fascinating.

Some random musings on improving the tax code:

  • Eliminate the Alternative Minimum Tax (AMT)
  • Lower marginal rates for middle-class income brackets
  • Simplify the EITC
  • Eliminate the corporate income tax
  • Eliminate every tax deduction and credit that is politically tenable

And my pet cause: Strive toward a consumption tax. I suspect the solution that maximizes efficiency, simplicity, and likelihood is the elimination of the current basket of savings incentive options (IRA, 401k, et cetera) and their replacement with a single, simple program that allows unlimited contribution.

Hedging Risk

I am reading the Sunday Times a day late. On the "arcane market" of credit default swaps:

Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.

The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion—roughly twice the size of the entire United States stock market.

No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.

A credit default swap (CDS) is a financial instrument backed by a contract in which one party agrees to pay a contingent payment to a second party upon a default by a third. In exchange, the second party pays a periodic fee to the first party. Acting as the first party in a CDS is similar to functioning as a reinsurer, taking on risk in exchange for cash. The second party in a CDS is looking to hedge existing risk, transferring risk off the books along with some cash. Because the parties do not have to actually hold the debt in question, trading CDS obligations also allows traders to speculate on the pricing of risk.

The problem: As CDS contracts are not collateralized or otherwise guaranteed, their real value depends on the creditworthiness of the involved parties. Unfortunately, their traded value does not reflect this creditworthiness—in fact, "an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim." The CDS contracts are being marked to market as sizable profit, but if a series of defaults hit, can the reinsuring parties pay the hedgers? Or do we have another contagion stinking up corporate books? This suggests that the market needs better pricing of creditworthiness, along with some contractual standard thereof, into the CDS obligation.

A good book on derivatives and risk and recent meltdowns, including credit swaps, is A Demon of Our Own Design. For an older but classic look at hedge funds, see When Genius Failed—although LTCM ate it over fixed income arbitrage, not credit swaps.

Saturday, February 16, 2008

Profits v Revenue

The brilliant jurist Luis Villa discusses basing contractual obligations off of profit versus revenue.

St Lucia
30°F in Boston and I miss St Lucia

In the interest of full disclosure, I am that "good friend."

And on the front page of today's Weekend Journal: Democrats' Attacks On Business Heat Up. Significantly more jobs are lost to technological advancement than trade; we should consider a ban on computers and a per-foot tax on conveyer belts, too.

Finally, a sad way to win: The fight over Florida and Michigan's delegates rachets up. Notably, this AP piece covers Harold Ickes arguing to count the delegates, a change from his early position. See also my conjecture that, from the beginning, the Clinton campaign's plan was to silently win both states and then loudly argue for their delegates' convention seat.

Friday, February 15, 2008

Subprime followup

My buddy Dom has a great followup to my earlier post on Senator Clinton's subprime solution.

I believe both lender and borrower are to blame—it was a bubble, after all—but the lending institutions definitely bear a huge burden of responsibility. While borrowers clearly overreached—prices will just keep going up!—mortgage writers have a duty to serve their client. And many lenders certainly danced around the law—encouraging falsified mortgage applications or outright lying about the terms of a loan. Moreover, this discussion does not even begin to get into the mess in the secondary and securitization market, which was the start of the broader macro-crunch and continued source of contagion.

Regardless of where you place the blame, my point is that the economic fallout from the senator's plan is disastrous: It subsidizes a relative-handful of foreclosing loans at the expense of current (via depressed equity) and future (via higher rates) homeowners. It devastates an industry in the name of saving it and is just bad policy.

Flags as Statements

Icaro Doria's Meet the World:

Political commentary on a flag


Senator Clinton's Subprime Fix

The other day, I wrote:

Senator Clinton's proposal to freeze interest rates for five years, for example, is politics-over-policy to the point of being dangerous; Senator Obama's plan is much more sensible.

I've discussed a dislike with Senator Obama's pro-homeownership policies too, but there is huge difference between "not a step forward" and "dangerous"—those are fightin' words, and I should explain, because Clinton's mortgage interest freeze idea is insane.

The New York Senator has campaigned on a glass menagerie of policy prescriptions, tax credits for childcare and installing E85 pumps, tax deductions for broadband and energy efficiency, but her solution to subprime woes is a unique vomitorium:

FORECLOSURE MORATORIUM: Hillary will call for a moratorium on home foreclosures [for] at least 90 days so that a rate freeze can take effect and at-risk homeowners can get financial counseling to help them transition to affordable loans.

FREEZE ADJUSTABLE RATE LOANS: The rate freeze must last at least 5 years, or until subprime mortgages have been converted into affordable loans. A typical subprime adjustable rate loan is raising monthly payments by 30% to 40% for many families, causing a wave of housing defaults across the country.

We have two proposals: First, a ninety day siesta during which we defer foreclosures and, second, the state compelling the revocation and revision of millions of contracts.

There are over ten million adjustable-rate mortgages in the US (and over three million subprime adjustable-rate mortgages, if the senator chooses to constrain her plan). The enormity of such an intervention is unprecedented. What does it say to the mortgage market when the government favors the short-term over the long? What does this action suggest to lenders, foreign and domestic, about the US government's respect for contracts? And what does this plan say to the market about future adjustable-rate mortgages?

The proposal is overwhelmingly biased toward the borrowers; lenders are left shortchanged, with mortgages locked into teaser rates that in many circumstances are lower than fixed prime rates. This is wonderful news if you are a current borrower, and Senator Clinton's plan is sure to appeal to you. Yet, as with everything else in life, there is no such thing as a free lunch.

While current borrowers are obviously happy, their elation is at the expense of the lenders, who are expecting many of those adjustable-rate mortgages to pay out at the adjusted rate, but instead will have subprime—that is, risky—borrowers frozen into prime or better rates. Most important, this plan is bad news for future homeowners: Mortgage companies will have less money to lend toward new mortgages, since their cash flow is reduced by the frozen interest rates. And mortgagers will be more hesitant to lend, particularly to subprime borrowers, as they just had a bunch of contracts unilaterally rewritten. The net is less money available for home purchases and thus higher mortgage rates for the rest of us. Higher rates will put further downward pressure on home prices, exasperating the consumer credit crunch.

The senator's plan is going to burn down the forest to save a tree. It is a statist shotgun approach to a narrow (although real) market problem. The proposal is awful economics, and I believe the senator agrees. But its big and its bold and Mark Penn says its good politics.

Thursday, February 14, 2008

A Novel Proposition

Newly released transcripts reveal Mao making a "novel proposition" to Secretary Kissinger in 1973:

"You know, China is a very poor country," Mao said, according to a document released by the State Department's historian office. "We don't have much. What we have in excess is women. So if you want them we can give a few of those to you, some tens of thousands."

A few minutes later, Mao circled back to the offer. "Do you want our Chinese women?" he asked. "We can give you 10 million."

After Kissinger noted Mao was "improving his offer," the chairman said, "We have too many women ... They give birth to children and our children are too many."

"It is such a novel proposition," Kissinger replied in his discussion with Mao in Beijing. "We will have to study it."

Well okay then.

Happy Valentine's Day

Anuncio: I shall speak at LugRadio Live in San Francisco this April.

Bob Woodward visited Google for an interesting chat:

In the talk, Mr Woodward announces a new book in his Bush at War series. I recommend all three of the current works, if for no other reason than to read the progression in Woodward's writing from the first book (a positive portrayal) to the third (not so much). Interestingly, I recall that during the 2004 presidential election, both candidates endorsed the second book. Fascinating how folks in the two parties value and discredit (or at least ignore) different aspects of the same story.

Elsewhere, Microsoft replaces Pieter Knook, the head of their mobile phone group, with Andrew Lees. The new Senior Vice President of Windows CE "has spent most of his career in marketing positions in the U.S. and the United Kingdom," the Wall Street Journal reports.

Ten months ago, Steve Balmer said:

Now we'll get a chance to go through this again in phones and music players. There's no chance that the iPhone is going to get any significant market share. No chance.

Microsoft has 12% of the market and the iPhone a rapidly-growing 7%, despite the latter's "limited geographic" availability through much of 2007, according to this Canalys report. Apple shipped 2.3 million phones in Q407 alone. Most importantly, who actually wants a Windows-based device?

Finally, Chavez cutting off oil to Exxon is toddler's play and not, economically, a serious issue—oil is fungible and 50,000 barrels/day is just not that much. But check out The Onion's take.

Wednesday, February 13, 2008

Mankiw on Obama on Trade

Greg Mankiw blogs on Senator Obama's speech after yesterday's primary sweep:

An open question in my mind is whether Barack Obama is going to align himself with the economic centrists in the Democratic party or with the populists on the far left of the party. A key litmus test is trade, and so far it does not look good.

Dr Mankiw quotes the Illinois Senator:

Because at a time when so many people are struggling to keep up with soaring costs in a sluggish economy, we know that the status quo in Washington just won't do. Not this time. Not this year. We can't keep playing the same Washington game with the same Washington players and expect a different result—because it's a game that ordinary Americans are losing.

It's a game where trade deals like NAFTA ship jobs overseas and force parents to compete with their teenagers to work for minimum wage at Wal-Mart. That's what happens when the American worker doesn't have a voice at the negotiating table, when leaders change their positions on trade with the politics of the moment, and that's why we need a President who will listen to Main Street—not just Wall Street; a President who will stand with workers not just when it's easy, but when it's hard.

I hope Obama steers to the economic right if he wins the nomination. But, if he is the man so many hope, I doubt he will waver.

Like a Pair of Wolves

The Android Developers Blog announces the availability of the M5-RC14 release of our SDK.

As predicted, Senators McCain and Obama sweep the Potomac Primaries. And on the topic of prediction, in today's Times, David Leonhardt on prediction markets and politics:

Intrade has done an excellent job of predicting election results over the last few years. In 2004, President Bush won every state in which Intrade’s contracts—as of the night before Election Day—gave him a better than 50 percent chance of winning. He lost every state where the traders thought Mr. Kerry was the favorite. Late on election night in 2006, while the talking heads on CNN and MSNBC were still saying that the Republicans would hold onto the Senate, Intrade knew better.

On the flip side, however:

Mr. Ravitch has made a nice profit betting against Ron Paul, the libertarian who late last year was, amazingly, given almost a 10 percent chance of becoming the Republican nominee. "If you asked anyone in politics whether there was ever, at any point, a 10 percent chance of Ron Paul being the nominee," Mr. Ravitch said, without finishing the sentence. "That sort of makes my case for me."

You can see this sort of negative bias in other prediction markets, too—including Google's internal market. Techie favorites, such as Senator Obama and Rep Paul, are overvalued. You could argue Paul never had even a one percent, let alone a ten percent, chance at the nomination, but the collective wisdom priced the event otherwise.

Intrade graph for Senator Obama
Senator Obama to win the the Democratic party nomination

Despite flaws, Mr Leonhardt concludes:

I'll be back at Intrade to try to figure out what’s going on [with the 2008 election]. If you have any better ideas of where to look, let me know.

I agree that prediction markets are the best prognosticators we have on the long-run, but their illiquidity means they fail to quickly capture short-run information such as, say, a recently released poll. I have written on this before. The lack of liquidity leads to, in Mr Leonhardt's words, a dearth of "smart money." The markets need more insiders: those on the ground, folks actually caucusing, or campaign staff. Otherwise you just get the miscellany of polls and buzz and hope we see now.

Tuesday, February 12, 2008

Android at GSMA Congress

Wired covers Android at the GSMA Congress:

Several companies at GSMA are showing prototypes running the Google-backed open-source Android operating system (aka the "GooglePhone"), and judging by the crowd reaction, these "phones" are the hit of the show.

Elsewhere, Tyler Cowen and Ha-Joon Chang discuss via podcast the latter's latest book, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism. Suffice to say, Cowen does not subscribe to the unorthodox "free trade is a myth" proposition.

Un recordatorio: I am live-twittering tonight's primary results, per usual. Prediction? Senators McCain and Obama sweep all three contests.

Wednesday, February 6, 2008

Post Mortem

I had fun live-twittering last night's election returns. At the peak, there were over 100 folks following vote2008 and untold number simply refreshing the webpage. The real-time sequential list of small updates works fairly well for Super Tuesday given the abundance of information—24 states, two parties, five (née four) major candidates—and constant, rolling updates.

In contrast, I was surprised just how bad was the presentation and UI of some of my sources. is absurdly unusable, a unique vomitorium, offering a poor experience for both casual visitors wanting a one-time update and for junkies seeking a constant feed of information (although their HDTV station makes great use of the screen real estate with a heads-up display of election statistics). The best view I found was the Times, whose election coverage graphic would make Edward Tufte proud:

New York Times 2008 Super Tuesday Results

Anyhow, I will continue to update @vote2008 with major election news and will likely live-twitter the general election.

So where are we now?

For the GOP, which is a clearer situation, Sen McCain is the frontrunner. The nomination is not yet a lock, but the senator is the obvious favorite. Gov Romney did surprisingly poor while Gov Huckabee did unexpectedly well. Did voters flee from Romney to Huckabee at the 11th hour? Neither have to drop out, given that Gov Romney is self-funding his campaign and has the means with which to continue and Gov Huckabee never really had any money (or a real campaign) to begin with.

The Democratic side is more complicated. Sen Obama's campaign claims a projected delegate lead. He also did well in proportional delegate states where he did not win—why do the networks harp on who wins if its a close race and proportional?—and he has shown an awesome mastery of caucuses. On the flip side, Sen Clinton won both California and New York with impressive margins and, at least by my count, is winning in pledged delegates.

What happens next—who wins the Democratic nomination—is going to depend on how the media frames the fight. If they label Sen Obama the Comeback Kid and play up his impressive performance, momentum will carry him to victory. The next few states are favorable to Obama, but Clinton also has an advantage with superdelegates and the party establishment, which you cannot play down once this brawl goes to convention. That advantage will subside if Obama rides a wave of popular support from today through to the convention. Conversely, if the media downplays Sen Obama's victory, I see Clinton maintaining her presumptive nominee title and winning the nomination. Unfortunate to place that power on the media, but an exciting race nonetheless.

Tuesday, February 5, 2008

DeLong on Summers on Stimulus

Larry Summers works to convince Brad DeLong that the stimulus package is worth supporting.

The top two knocks against the stimulus package, Summers contends, are that it will fail to stimulate the economy yet it will further fuel our deficit. As the United States is not about to go bankrupt, Summers argues that the only negative from additional deficit spending is further reduction of national savings. Now, if the stimulus package does not work, it will be because folks saved instead of spent their stimulus check. If they save it, that will offset the incurred debt and national savings remains unchanged. If they spend it, that will stimulate the economy.

Thus, Summers concludes that the argument that the stimulus package will both fail to stimulate the economy and reduce national savings is "incoherent." Either the stimulus will work or it won't work but won't reduce national savings.

His reasoning is not irreproachable. Summers does not address timeliness—delivered too late, or if unneeded, the stimulus could overheat a recovering economy. And Summers does not calculate the relative cost of lowered national savings versus the benefit of economic stimulus, although DeLong writes "few things are worse for national saving[s] than a recession" in argument that the stimulus minus incurred debt will be a net win over a recession. But on the whole it is a solid argument, addressing the largest criticisms. Thus, even if the package is ineffectual or unneeded, as I argued, it won't do much long-run harm.

And don't forget: Hang with the cool kids and follow live Super Tuesday results this evening @vote2008.

Twittering Super Tuesday

Reminder: I will live-twitter election returns this evening at vote2008.

If you are busy or lazy or just can't get enough of my wit, here is a way to follow the results without expending any effort. You can receive the updates via all sorts of media, including IM and SMS.

Monday, February 4, 2008

Super Tuesday Updates

At vote2008, I will live-twitter tomorrow's Super Tuesday results as they roll in.

Thank Joey, who wants SMS updates while attending some Bruins game. Now I know why I was not invited. This and my extreme rancor for hockey.

On The Supply-Side

Another loyal reader emails in response to Saturday's post on Obamonics and tax credits:

Tell me you aren't a supply sider! Usually I welcome your economic posts, but if you buy into the "tax cuts raise revenue" mantra, you're putting politics over economics just as you cut into Hillary for the same.

She is referring to this paragraph, specifically where I have added emphasis:

The fourth and final problem with tax credits is also the most important: Unlike tax reduction through cutting of marginal tax rates, tax credits yield no incentive to increase work—in fact, they act as a disincentive. A decrease in your marginal tax rate is like an increase in your wage: Your income goes up and thus your consumption rises. A tax credit's effects are similar, but the credit differs vis-รก-vis the marginal cut in one important way: A credit does not increase the marginal utility of work but the marginal rate cut does, thus the rate cut encourages work and makes leisure more expensive. A tax credit does not make leisure more expensive with-respect-to work, but it does increase its recipient's income. Some people, happy with their old consumption level but unhappy with their labor-leisure balance, might respond to the tax credit by working less. Certainly, unlike with a marginal rate cut, folks won't work more.

Ah, but I never said that tax cuts raise revenue, and I am no supply-sider. The backlash, particularly in the press, to the "tax cuts raise revenue" argument has taken us so far in the other direction that we forget that tax cuts do increase productivity. If you cut taxes by ten percent, tax revenue will decrease by less than ten percent.

The supply-side argument goes further: It contends that the productivity gains are so large they will pay for the cut. That is a bold (and often ridiculous) claim. Let me be clear: The "tax cuts raise revenue" thesis is not true hic et ubique, it won't be true tomorrow, and it was almost certainly not true in 2001. That said, the argument can be true—logic suggests that, in some form, the Laffer curve exists. Even John Keynes, the demand-sider to Laffer and Mundell's supply, wrote:

Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more—and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.

Indeed, for at least the top brackets, the Kennedy and the Reagan tax cuts likely moved the marginal rate from the right-side to the left-side of the curve. But once or twice does not prove universality. The dishonesty is the insistence that marginal rates are always on the right-side of the curve and thus taxes should always be lowered and that said reduction will always increase revenue. Wrong and wrong, Mr Bueller.

Laffer Curve
Martin Gardner's Rendition of the Laffer Curve, licensed cc-by

There are, however, benefits to lowering marginal tax rates that do not rely on supply-side arguments. The productivity gains from marginal rate cuts are welcome in and of themselves. Lower effective rates lower the incentive to evade taxes. On the short-run and if enacted quickly, marginal rate cuts funded by debt are an effective form of fiscal stimulus. And there is the Nozickian take: The government should transfer to itself as little of your income as possible.

That said, cutting taxes to the point of incurring a long-run structural deficit is a rape of my generation by my parents'. As Chairman Bernanke recently put it:

So as I've said on a number of occasions, the law I'm most in favor of is the law of arithmetic—you know, what comes in at least has to equal what goes out at some point. And if you think about the various alternatives that the Congress has over the longer period, I hope the law of arithmetic will be part of your consideration.

Sunday, February 3, 2008

Golden Nonsense

The Wall Street Journal on gold:

Chart of Gold's Price, inflation-adjusted

From the sidebar:

Still, in the long-term, the precious metal has been a horrible hedge against inflation. To keep pace with inflation going back to 1980, gold futures would need to be above $2,228 today.

Hear that, Rep Paul?

On Incentives and Cap Gains

In response to yesterday's post on tax credits, a loyal reader asked via email:

I enjoyed your entry on tax credits and have a question.

You said, "If a choice is bad without a tax credit, commonsense suggests its likely also the wrong preference with a tax credit." Why isn't this true for the capital gains tax, which I imagine you don't like?

Good question. It is a subtle difference. My statement does apply to the capital gains tax—the situation is just inverted.

A tax credit—such as, say, the mortgage interest credit—is a subsidy in favor of mortgages. The credit makes mortgages cheaper, thus encouraging homeownership beyond where it would be in an unperturbed equilibrium.

The tax on capital gains is a burden on investing. The tax lowers the returns on investment, thus discouraging investment below where it would be in equilibrium (how much depends on certain elasticities and is an open research question).

In both cases, we have deadweight loss, where the optimal quantity supplied or demanded is not met. In and of itself, we want to avoid deadweight loss, but the capital gains tax is particularly bad as we want to encourage, not discourage, personal savings and investment.

For exactly this reason, I support lowering or even eliminating the capital gains tax.

Saturday, February 2, 2008

Float Up Economics

Four years from now, when we are all talking (hopefully positively) about Obamonics, remember who coined the phrase that started it all.


David Leonhardt in today's Times on Senator Obama's economic views:

Mr. Obama praised the Clinton administration for reducing the deficit and setting the stage for the ’90s boom. But he said Mr. Clinton had failed to halt a long-term increase in income inequality that had left the middle class feeling squeezed.

If elected, Mr. Obama said he would to try to forge a popular mandate for policy changes that could reverse a generation of slow wage growth and outlast any one administration. At the top of his list would be shifting the tax burden more toward the wealthy and making investments—in health care, alternative-energy research and education—that would cost a significant amount of money but could ultimately lift economic growth.

Leonhardt's is a high-level and laic overview, but it provides a good preview of what to expect: Lots of spending. Among themselves, the Democrat candidates differ very little, but the article goes for drama:

But the two candidates offer strikingly different strategies for achieving their economic agendas.

To be sure, where Senators Clinton and Obama do differ is nontrivial. Senator Clinton's proposal to freeze interest rates for five years, for example, is politics-over-policy to the point of being dangerous; Senator Obama's plan is much more sensible. Perhaps the biggest difference is Clinton's preference for small, directed tax cuts (microcuts in response to microtrends) compared to Obama's favoring of simple and broad measures that have a decided Chicago School feel. As Austan Goolsbee, Obama's senior economic adviser, described the heterogeneity:

Clinton is offering "a collection of relatively narrowly targeted tax credits," he said, while Obama "has a pretty significant middle-class tax relief."

The Illinois senator's preference, Goolsbee said, is for what he called "iPod government," which he described as "simple to use, easy for people, makes their life better."

This "spirit of simplicity is in a bunch of policies," he added.

Their policy distinctions, however, are more than just packaging; Senator Obama's economic plans are worth much more than a sound-bite. Simple, broad, and market-based always wins over complicated, narrow, and directed. Moreover, there are real economic concerns with tax credits and deduction.

My first problem with targeted tax credits is that they distort behavior. If a choice is bad without a tax credit, commonsense suggests its likely also the wrong preference with a tax credit. Note this is not a refutal of Pigovian taxes, such as a carbon tax, which price-in otherwise-unpriced negative externalities. The goal of a carbon tax is to incorporate the costs of carbon emissions—pollution—into the price of carbon. The goal of a directed tax credit is to encourage people to make choices that, presumably without the credit, were suboptimal or inefficient. Enter deadweight loss.

In reality, however, most of Senator Clinton's proposed tax credits won't cause huge changes in behavior because folks are already making the choices she hopes to encourage. Thus, the net result is to reward existing behavior (cf. the mortgage interest tax credit) at the expense of Federal revenue. In other words, a second issue with tax credits is that they pay people to do things they would do anyway. And in the rare examples where this is untrue, tax credits distort behavior. You cannot win with these things, even if you are the Clintons.

A third complaint with tax credits is that they are complicated, and both compliance and administration is costly. A simpler tax code is a better tax code and given that we already have a horribly-complicated tax system, sprinkling myriad small credits and deductions around is the exact opposite of the tax simplification for which we should aim.

The fourth and final problem with tax credits is also the most important: Unlike tax reduction through cutting of marginal tax rates, tax credits yield no incentive to increase work—in fact, they act as a disincentive. A decrease in your marginal tax rate is like an increase in your wage: Your income goes up and thus your consumption rises. A tax credit's effects are similar, but the credit differs vis-á-vis the marginal cut in one important way: A credit does not increase the marginal utility of work but the marginal rate cut does, thus the rate cut encourages work and makes leisure more expensive. A tax credit does not make leisure more expensive with-respect-to work, but it does increase its recipient's income. Some people, happy with their old consumption level but unhappy with their labor-leisure balance, might respond to the tax credit by working less. Certainly, unlike with a marginal rate cut, folks won't work more.

Put another way, a revenue-neutral replacement of tax credits in favor of marginal tax rate cuts will increase productivity. Our policy preference should be for marginal tax rate cuts, targeting the middle-class if that is the goal. In fact, it would be a great exercise to tally up the cost of every tax credit and deduction, ditch them all, and decrease marginal tax rates accordingly.

Of course, Senator Clinton (or at least her advisers) know all this. But telling seniors that they get a tax credit for robot insurance and beat farmers that they get a deduction for subsurface agriculture, while bad economics, is good politics. Identify the microtrend and provide the microcarrot—I get it, I read the book. Those who rise higher, to do not what is popular but to do what is right, those who don't capitulate to uneducated demands but instead aim to raise the level of public debate, they are the politicians who deserve your vote.

I largely judge presidential candidates based on their economic and foreign policy advisers. This approach is approximate—who knows who will be around in two years, let alone who has the President's ear on the first—but it gives a good idea about the ideologies and theories that will craft the policies in any given administration. To that end, Dr Goolsbee is good. As is Senator McCain's senior economic adviser, Douglas Holtz-Eakin.

Plan of Attack

A third undersea cable is now severed and Iran is eating heavy packet loss (there are reports that the state is off the grid, but IUST is reachable).

This is happening far too often, but I am as incredulous as Paul Krugman on this one:

OK, this is weird.

At this point, three undersea cables providing Internet access for the Middle East have been cut in the last few days. How often does this sort of thing happen?

The relevant parties continue to blame ship anchoring, which is entirely believable modulo the three-cut-in-as-many-days part.