Bastiat’s Bastions

People have attacked Bush’s tax cuts as tax cuts for the rich. Many people seem to believe that the government helps the rich and disregards the poor. The notion is that some people think that the rich pay too little in taxes and not enough help is given to the poor. The questions of “how much is enough help for the poor?” and how much of the incomes of the rich to be paid in taxes is enough?” never seem to be answered, though. Of course, we should all see that these are just normative questions, questions which cannot be answered objectively.

Often, people have looked at the question what proportion people’s incomes go to taxes and whether that proportion tends to go up or down as incomes go up. The idea is that people with higher incomes “should” (that’s a normative “should”) pay more, and pay a larger share of their incomes, than poorer individuals, an idea sometimes referred to as the “ability to pay” principle of taxation. If we tax a good, say by $1.00 per unit of the good, and that good has an income elasticity equal to one, the percent of the average person’s income going to pay that tax would stay constant as the incomes rose. This is termed a “proportional tax.”

If the income elasticity of demand is greater than one for some good that is taxed, the proportion of incomes going pay that tax increases as incomes go up. A tax on such a good is termed “progressive” and clearly meets the “ability to pay” principle. Luxury goods are generally considered to be those with income elasticities greater than one, and so a luxury good tax seems to meet this “ability to pay” principle. We have be careful about this, because sometimes such taxes affect the sellers more than the buyers because the sellers have a lower elasticity of supply than the buyers’ elasticity of demand. In these cases, we would be concerned about the workers in the luxury good market. And of course, if the income elasticity of demand on some taxed good is less than one, the proportion of the average person’s income going to pay the tax goes down as income goes up. Such a tax is considered to be a “regressive” tax, and clearly violates that “ability to pay” principle.

What we should really be doing though, is instead of looking at taxes in isolation, is looking at the spending that taxes finance and see if the net effect of the taxes and the spending is proportional, progressive or regressive. For instance, what if we taxed the poor a bit more than the rich, but, in the meantime, used those taxes to pay for goods and services that would be extremely beneficial to the poor, such as Head-Start programs?

That is exactly what is done in a newly released study from the Tax Foundation. That site gives an overview of the study, but the entire report can be downloaded from the site. This study is one of several that has looked at both government spending to benefit those in certain income groups and the taxes paid by people in those income categories, together. The study boils things down to a few easy to understand numbers. The study asks the question, “for each dollar paid to government in taxes, how much do people get back?” Alternatively, we can see this as the price of government spending for one’s benefit? The poor get over $8 for each dollar in taxes they pay, while those in the top 20% of incomes get back $0.41 and those in the middle group get $1.30. Based on these levels of benefits for each dollar paid in taxes, is it any wonder that the poor generally vote for more taxes and spending while the rich tend to vote the opposite way? With those in the middle group getting more in benefits than they pay in taxes, why doesn’t the size of government grow at even a higher rate than it has?

MC

I got an email over yesterday that said:  Block this site!  Don’t let your students see this!  This is humor only economists should hear…and no one else!

Well, here is the site:

Oh, and my students, no points for commenting on this one, you still might want to check out the link at http://www.youtube.com/watch?v=VVp8UGjECt4

MC 

One of the classic Econ 211 lessons (it is coming) is how problems are created in markets when buyers and sellers have different sets of information at their disposal. Economists call this situation “asymmetric information”. An important example is insurance markets.

First, the background …

Imagine there are only two types of drivers – “risky” drivers and “safe” drivers. An asymmetric information problem exists in the auto insurance market. Drivers know more about their proclivities to engage in risky activities than do the insurance companies. Consider how often you use your seat belt, cell phone, drive fast, drive drunk, drive not that drunk, or other unmentionable driving distractions. Your insurance company has little information about these activities.

Ignore the legal minimum coverage requirement and imagine an insurance company that charged only one price to all of its customers, one that corresponded to the risk level of the average driver. Would this work out?

Consider the drivers. Risky drivers would find this price to be a good deal. As risky drivers, they should be paying higher premiums that reflects their higher level of risk. As the price they are being given reflects the risk level of the average driver, this price will be attractive to these drivers.

On the other hand, a safe driver would not find that price attractive, and might not buy insurance at all.

From the perspective of the insurance provider, this turns out to be a lousy idea. They will find this price attracts many risky drivers and few safe drivers (called an adverse selection problem). As a result, they will have an incentive to attempt to acquire information concerning what type of driver their customers are. They will charge drivers different prices based on their risk level. Essentially, they try to reduce the asymmetric information problem. This is why they ask you all those pesky questions about how many tickets and accidents you have, your age, the type of car you drive, whether you are a homeowner, or even what your credit score is.

So this is all old hat and found in any textbook – what is interesting to me is that it is quite likely that safe drivers have an incentive to show insurance companies they are indeed safe drivers. Now, anyone could lie and say they were a safe driver. But how can someone credibly show their insurance company they are a safe driver?

Not have accidents for one, but the article provides another answer. Basically, a camera system mounted on the dashboard records what is happening in front of and behind the car, filming constantly. The device only stores the film for the few seconds before and after the car brakes or accelerates rapidly.

Drive safe, avoid sudden starts and stops, nothing is stored. Drive like Bob Huggins or Paris Hilton, there will be a lot of film.

If the costs is low enough, I think this will catch on. It will be interesting to see if the big talkers about how important privacy is will be willing to put their money where their mouth is.

–CT

What if I am right, and these devices do catch on? Suppose you are a risky driver, and thus you choose not to stick the cameras in your car. Is an insurance company learning anything about you?

It seems that New Orleans Mayor, Ray “Willy Wonka” Nagin, is at it again. If you haven’t noticed, he recently told a group of publishers that he believes that there has been some plot to change the racial makeup of New Orleans. Sure, the proportion of the city’s population that is African-American has declined. Let’s take a look at some of what has happened, though. A city that was about 60% African-American was the site of one of the biggest disasters this nation has ever faced, with a month of flooded streets and housing. Hundreds of thousands of New Orleans residents evacuated the city, many after being caught in the devastating floods themselves. Hundreds of thousands of former New Orleans residents have moved elsewhere, many to other states. Some like their new cities better than New Orleans. And with skyrocketing rents, many just cannot afford to move back.

A solution that some have suggested (hear the story on the Free Speech Radio Network, click on Real Audio and go to 5 minutes and 10 seconds into the broadcast to hear the story) is to impose rent controls so that poor people can afford to move back.

There is just one problem: while rent controls will make it more affordable for people to move into New Orleans, it will bring the rebuilding, especially the rebuilding of rental property, to a halt. With no one willing to provide rental housing, the current shortage of housing will only be exacerbated by the short-sighted solution of rent controls. Affording apartments is one thing, finding such apartments available is another thing altogether.

For every rental unit a family moves into, someone else has to build and offer that unit on the market. Transactions are all two sided. If we focus only on one side of the market, the buyers’ side, we tend to forget about the other side, taking the sellers’ activities for granted—to our detriment.

For someone to build and offer housing units for rent, there has to be something in it for them, some profit of some kind. If rents are controlled and set below what they already are, it will only make housing shortages worse, not better. At low rents landlords will be unwilling to rent out their units and will turn to other, more profitable investments. Landlords will turn the few rental units they have into condos and offices. If forced to rent those units, landlords will be slow to fix things, and areas of rental housing will soon be blighted. As George Mason economist Walter Williams has said, “Short of aerial bombardment, the best way to destroy a city is through rent control.”

And, as we have discussed in class, rent controls also invite racial discrimination, favoring whites, and exploitation of the shortages by landlords who then demand payments in non-monetary forms.

The group, The People’s Hurricane Relief Fund, has also complained that renters have been denied the help that property owners have received (this is from the story above on Free Speech Radio). Both owners of owner-occupied housing and rental housing have been slated for help to rebuild their housing. You should be able to explain why it does not matter whether renters trying to come back to New Orleans or the landlords receive the housing subsidies, that ultimately, the rent will be the same no matter who receives the housing subsidy.

Two city councilwomen have tried to impose moratoriums on multi-family housing units. Read Bruce Eggler’s Times-Picyune article about the proposal here.

Politicians will continue to point fingers at mysterious conspiracies, because, it draws attention away from their own poor policies and sometimes even counterproductive policies. Nagin himself had even considered imposing rent controls right after the hurricane (listen to this story on NPR from 2005).

And when politicians start raising the possibility of rent controls and moratoriums, potential investors, those who we rely on to OK rebuilding, will see those policies as being more likely to occur, and will be less likely to invest.

If rent controls are imposed, the city will never be rebuilt, because there will be no rental housing available for renters to move back to. What does it matter what the rent is if there are no units available at that low rate? And the city will remain less African American than it had been. And it will be the fault of some conspiracy–of the mayor, members of the city council, the People’s Hurricane Relief Fund—a conspiracy of dunces.

 

MC

I know this article is old, but I hate it when people write articles about how people don’t understand probabilties when they themselves don’t understand probabilities. Plus, I love Deal or No Deal. If you are not familiar with how the shows work, click here for my first effort on the show.

Here is an article by Chuck Jaffe, printed in the Bayou Business Review, where he laments the choices people are making on Deal or No Deal.

“Take the case of a recent participant, who was down to four possibilities, two under $250, then $50,000 and $500,000. He was offered nearly $140,000 to walk away, and he had a 75 percent chance of leaving with an amount much lower.”

Oh really? I’m not so sure.

Jaffe has made a mistake – or is at least making some very strong assumptions about what the person will do in the future.

If the person were to refuse all future offers, and thus take the contents of their suitcase, then indeed Jaffe would be correct to say there as 3/4 chance the person will walk away with less than $140,000.

But Jaffe is neglecting the fact that the person has the right to take a cash offer after opening the suitcase after each round. The person doesn’t have to play until they open the suitcase.

In fact, if the $140,000 offer is a refused, there are four possibilities. One suitcase must be revealed:

Possibility A = $500K is revealed
Possibility B = $50K is revealed
Possibility C = one of the <$250 is revealed
Possibility D = the other <$250 is revealed

Now, consider what the bank will offer in each case.

Possibility A = $50 K and both small amounts remain, so the offer is roughly $17,000.
Possibility B = $500 K and both small amounts remain, so the offer is roughly $170,000.
Possibility C = $500 K, $50K, and one small amount remain, so the offer is roughly $187,000.
Possibility D = $500K, $50K, and one small amount reamin, so the offer is roughly $187,000.

So if we know the player will stop after one more round, there is a 75% chance the person will end up with more than $140,000.

In fact, as long there is some chance the person will stop upon receiving an offer better than $140,000, Jaffe's statement is inaccurate.

In all fairness, Jaffe does get one thing right...

The point he makes about the hot hand - people seeing patterns where patterns are not - is, for lack of a better term, on point. See my previous post on roulette wheels here.

But another person quoted in the article also gives us this pearl of wisdom.

“The point often depends on someone’s circumstances. A person with a lot of money can take more chances; to them, a few thousand dollars difference is probably not a life-changing event.”

You mean like someone who just “won” $140,000?

–CT

Note: If the player gets past the first suitcase wihout revealing the $500K, and rejects that offer, then person will get a better offer. If that one is rejected, there will be a 2/3 chance the person will receive an offer better than $250K.

At this point, I am reminded of one of my favorite lines from the movie “The Naked Gun”. Nordberg (played by OJ Simpson) is in the hospital recovering from several gunshot wounds. Someone tells his wife there’s a 50/50 chance that he’ll survive, but then adds, but there’s only a 10% chance of that.

Read this article from cnn.com. In the article, the head of the Food and Drug Administration comments on whether the FDA should regulate the amount of nicotine in cigarettes.

In a rare, sensible act from the head of the FDA, he suggests that the FDA should not regulate the amount of nicotine. What is this? A regulator saying he wants fewer things to regulate? This is indeed a very rare breath of fresh air.

The head of the FDA has the following claim – if the amount of nicotine was reduced in a cigarette, consumers would simply respond by smoking more cigarettes. Sounds right to me.

But let’s take a stroll down memory lane. Over the years, taxes on cigarettes have increased substantially. As with any tax, consumers and producers look for means to avoid the tax. If the tax on cigarettes was imposed by the pack, several options come to mind to implicitly avoid the tax. Producers of cigarettes could increase the number of cigarettes per pack (say to 50 instead of 20), increase the length of a cigarette, or, drum roll, increase the amount of nicotine (the active ingredient) in a cigarette. My students should be having flashbacks to alcohol prohibition and drugs.

Federal legislation explicitly prohibits cigarette manufacturers from increasing the number of cigarettes per pack, and the long cigarette was a flop as well. What does that leave to avoid the tax? Increasing the nicotine content of cigarettes. Over time then, the increased nicotine content of cigarettes is largely a direct result of government policy!

Back to the present day… nicotine is the active ingredient in cigarettes. A reduction in the amount of nicotine allowed in a cigarette is essentially an increase in taxes on cigarettes – or better still an increase in the taxes on nicotine. Why? Even though the tax is imposed per pack, what consumers are interested is in the tax per unit of nicotine. If there were 10 units of nicotine in a pack and the tax is $1 per pack, then the tax on nicotine is $0.10 per unit. If they reduce the amount of nicotine allowed in half, to say 5 units (and the size of a pack and cigarette stay the same, as does the tax per pack), then the tax of nicotine becomes $0.20 per unit. Another way to think of this is that you have to buy two packs to get the same amount of nicotine as before.

Now the problem has just been reduced down to the simple fact that limiting the amount of nicotine in a cigarette is just an increase in the tax on smokes. The price consumers pay will increase, the amount of nicotine consumption decreases (even though people would smoke more packs), and Uncle Sam collects some more tax revenue. As the demand for nicotine is inelastic, people end up spending more on nicotine.

Should we do it? A good thing will be that there will be a small reduction in nicotine consumption and some more tax revenue. The bad things will be that we are again taxing cigarette smokers, a tax which falls disproportionately on the poor. A second side effect is that there would be more overall smoking, and that means more inhalation of all of those other items that cause cancer in cigarettes.

My stance “ hurray for the FDA!

–CT

We know that when crime makes residents feel less safe, they often move away. This has certainly been the history of New Orleans over the last 30 years, with decade after decade of population loss. New Orleans was once a city of about 600 thousand. By 2000, the population had fallen to about 450 thousand.

The mugger in question here is that master thief, Dictator Hugo Chavez of Venezuela. Instead of just losing what they have worked their lives for, wealthier Venezuelans are leaving in droves, and emigrating to safer places, such as the US. Take a look at this article from the AP sent to me by my brother, Paul. (the origina article my brother sent is no longer available, but take a look at this article  later in October of 2007).

Just think where this will leave Venezuela: fewer doctors, fewer businessmen, and fewer educated professionals. Also leaving will be capital — the equipment that workers need to be more productive. Venezuela will go from a society of haves and have nots, to just a society of have nots, and Chavez will have no one left to tax or steal from in Venezuela–then, he will have to resort to attacking his neighbors in the name of exporting his revolution. The Cambodians did the same thing with their “killing fields,” killing off and chasing away all of the talented, the educated, and the professionals — ridding the country of its essential human capital.

But to Chavez, that’s progress, “In death there is equality!”

MC

In case you haven’t heard, NASCAR’s Daytona 500 finished down in Florida this year amid not just flags, but also flames, flips, flats and flying flack. Here is some Youtube footage of the final lap.

What does this have to do with economics, though?

It’s a matter of a certain type of substitution, something that economists call “moral hazard.”

For a very long time, economists have noted that in the presence of insurance, say fire insurance, people reduce their pursuit of safety in other forms. For instance, people with fire insurance are less likely to do the same things to reduce fires that people without fire insurance would do. It’s a matter of substituting one form of danger reduction for another.

One of my own professors in graduate school, Gordon Tullock, told generations of economists about how seat belts endangered others. His story was that once auto drivers felt safer because of seat belts or other devices to protect the driver, they tend to increase their speeds and drive a little less cautiously. While this increased danger from fast driving gets mitigated for others in cars because they would also be wearing seat belts, the increased danger is not mitigated for pedestrians. Pedestrians would be in more danger from cars than before.

Tullock offered, as the ultimate safety device for the protection of pedestrians, a simple dagger mounted in the steering wheel column facing the chest of the driver. With such a device, you can be sure that few accidents would occur. Of course, there would be very few cars on the road as well.

Russ Sobel (WVU) and Todd Nesbit (Penn State at Erie) are authors of “Automobile Safety Regulation and the Incentive to Drive Recklessly: Evidence from NASCAR,” forthcoming in the Southern Economic Journal. We were lucky to have Dr. Nesbit present this paper in a seminar here two years ago. What Sobel and Nesbit show is that after Dale Earnhardt died in a NASCAR crash and NASCAR responded by increasing the safety devices required to protect drivers, the number of NASCAR accidents went up by more than what could be accounted for by mere chance. In other words, as is expected from the theory of moral hazard, the tough rules NASCAR adopted to increase driver safety was met by offsetting risky driving behavior resulting in more accidents.

Is the recent wreck in that final lap at Daytona just because of Moral Hazard and the extra safety equipment required after the Earnhardt tragedy? That really can’t be determined. All we can say is that the recent NASCAR wreck is part of a lot of wrecks in NASCAR and this higher rate of accidents can be attributed to the increase in the safety of drivers from the new regulations.

Some other places in sports where we might see this type of offsetting behavior is in contact sports such as football after pads and helmets were worn routinely. Imagine how different football would be played if there were no pads or helmets used. I doubt the hitting would be nearly as hard. I would bet that there are certain types of injuries that have increased along with the degree of protective equipment.

I thought I would end this on the lighter side by sharing with you a joke that was sent to me by an excellent commenter on this blog, a real critical thinker. Remember when reading this that seat belt laws have increased our sense of safety when driving. So, here is the joke Steve W. sent:

 

The National Transportation Safety Board recently divulged they had covertly funded a project with the US auto makers for the past five years, whereby the auto makers were installing black box voice recorders in four-wheel drive pickup trucks in an effort to determine, in fatal accidents, the circumstances in the last 15 seconds before the crash. They were surprised to find in 49 of the 50 states the recorded last words of drivers in 61.2 percent of fatal crashes were,

“Oh, SH*T!”

Only the state of Louisiana was different. There, 89.3 percent of the final words were:

“Hold my beer and watch this.”

MC

I received this from Gary Blank yesterday.  I wish I had time to look over the administration’s energy proposals right now, but I have a meeting to go to in the morning.

Today Edward P. Lazear, Chairman of the Council of Economic Advisers, testified before the Subcommittee on Energy and Air Quality of the House Committee on Energy and Commerce at a hearing on “A Review of the Administration’s Energy Proposals for the Transportation Sector.”

You can view Chairman Lazear’s prepared remarks on-line here: http://www.whitehouse.gov/cea/lazear20070228.html

Thank you.

Gary D. Blank

Chief of Staff

Council of Economic Advisers

The White House

 

MC

A progressive measure that came to modern democracies in the last part of the 1800s was the secret ballot. If employers, landlords and others who held power could see how you voted, then they could retaliate if you did not support “their guy.” Imagine what it would be like if the local elected sheriff or district attorney could easily tell if you voted for them or not. Well, it looks like the Dems want to end the secret ballot in union elections and let intimidation rule once more.  Remember, that the secret ballot protects the workers from intimidation by the unions, but also by employers.  See this story from Fox News (yeah, yeah, I know, but this is the kind of story that is hard to lie about). 

Added comment 3/3/2007:  I heard this comment on NPR’s “Marketplace” (read it or click on “listen to the program”) program, a comment by Bob Moon, while driving to beautiful Hattiesburg, MS for the Louisiana and Mississippi Political Science Association, to, as coincidence would have it, present a paper on the secret ballot and bribed votes in England.

Here is a story about voter intimidation and bribery from one of the earliest democracies, that of the Roman

Republic about 100 years or so before the rise to power by Julius Caesar. This is an excerpt from a paper I did several years ago with Gary Pecquet (U. Central Michigan) and Tom Dalton (U. Arizona), titled, “The Secret Ballot in Rome as a Threat to the Political Oligarchy: A Seeming Exception to the Heckelman-Yates Rule.” No need to go into the Heckelman-Yates story (as you probably don’t care), but the point is that the Roman “good ole boys” had plenty of room to intimidate voters, and they often had plenty at stake. The politicians could declare war, especially war against a rich and poorly defended adversary. Without the secret ballot, voters were not free to vote how they wished, because they could get beaten or worse, because the stakes were often very high. Well, here is the excerpt:

4.6 The Secret Ballot in

Rome

A key turning point in the political evolution of Roman politics was the adoption of the secret ballot for candidate elections in 139 B.C. and legislation 131 B.C. (Linderski 1985, 91). Before the adoption of the secret ballot, “new men” must have had a very hard time outbidding patrons for votes because the voters would remain at the mercy of their landlords after the election. The secret ballot weakened the barriers to entry and allowed “new men” to compete more freely in Roman politics. The secret ballot did not need the support of established politicians, as those voting on the secret ballot were the voters themselves, it only needed one Tribune to propose the secret ballot.  Incumbents and established candidates may favor laws against bribery because they expect that the costs of gaining office may be reduced, increasing the rents of elective office. However, if the laws are interpreted unequally, incumbents or established candidates may not favor a law that reduces that unequal treatment, as the secret ballot makes it equally difficult for challengers and established politicians to pay for votes expecting to receive them.   The Tribute Assembly adopted secret ballot laws for candidate elections in 139 B.C., judicial assemblies in 137 B.C. and legislative Assemblies in 131 B.C. (Linderski 1985, 91). After this, voters would inscribe the initials of their choice on small clay tablets, and drop these into large voting urns. At first, a broad approach to the voting urn compromised the secret ballot because it allowed observers to stand by voters and intimidate them as they passed in the line to deposit their ballots. In 119 B.C., Marius, acting as Tribune, enacted a law that narrowed the passage to the urns securing the integrity of the secret ballot. (Botsford 1968, 389 and Yakobson, 1999, 130) The secret ballot, not only released the voter from the contractual agreements of the patronage system, but in a military society the ballot protected voters from any reprisals by the potential commanding officers (Yakobson 1995, 427). Moreover, the Roman voter enjoyed more anonymity than modern voters. Roman votes were never recorded below the tribal level. There were no reported results by smaller voting units such as precincts for politicians to reward or punish. Even so, powerful Roman nobles and cliques fell short of the power that modern ruling parties now possess. (Yakobosen 1995, 434) Yakobson (1995, 438-439) contends

The secret ballot allowed the voter to take bribes from the different candidates and be free to vote the way he liked. The voters would no doubt often reward “the highest bidder,” though it should not be assumed that this was the sole consideration that determined his choice. The voter could not be held to his promise or penalized for failure to keep it; nor could he be asked—or pressured—to vote for a candidate upon a promise (which might not eventually be kept) to pay him later, but he had to be paid, in advance, a sum large enough to compete with the bribes likely to be offered by other candidates.

Following the adoption of the ballot laws, bribery, actually increased. While it is unknown to us which form of bribery increased, the direct or indirect payments, that is, the private good or the group public good, our model suggests the latter. Divisores collected bribes from all candidates and distributed them throughout their tribes. Bribery became a form of advertising that voters expected from all serious candidates. Lintott (1990, 14) summarized the democratic nature of Roman political bribery, “When ambitus (bribery) begins to appear in the second century, it is as a disruptive intrusion for those who have the established power, but for the electorate itself it was not only profitable but liberating, as it created the assumption that their votes were on the open market.”  Before the secret ballot, unequal enforcement of the campaign spending laws, then, produced a large differential between the costs of voting for the established candidate and a “new man,” putting the challengers to a decided disadvantage. In effect, the unequal enforcement of the campaign spending laws had the effect of establishing a tariff on votes for challengers, erecting a large barrier to entry for challengers.

In elections, we will either use the secret ballot in some form  or voters will suffer some form of intimidation.  Which do we prefer?

MC