Bastiat’s Bastions

The Lakers won a title in 2009-2010 in spite of—not because of—Derek Fisher. Fisher averaged 7.5 points and 2.5 assists per game in just over 27 minutes per regular season game. These numbers rose slightly, along with his court time, in the playoffs. Fisher is well-liked by teammates (Kobe Bryant) because he knows how to stay out of the way. Also, he rarely turns the ball over, generates value as a defender, and can knock down open three point shots when an opposing team doubles. He also has become associated with winning, which leads many to believe that he is a “winner” in the sense that he creates wins (If win-association marks a player, then Robert Horry is Michael Jordan’s equal). On a championship team, however, Fisher is underproductive even as a role player and certainly as a $5 million role player. There are more than a few mid-salary NBA point guards who create more shots for their teammates while doing a comparable job on defense. Even when Fisher was routinely making game-winning three-pointers for the Shaq-led Lakers, I couldn’t help but wonder whether the Lakers would have needed as many game-winning shots had they a more than serviceable point guard. Indeed, Derek Fisher is a solidly mediocre starting NBA point guard. That the Lakers have won so many championships with Fisher is a testament not to him but to his teammates, who have carried the load of his mediocrity. I am not attempting to pummel Derek Fisher. To be even a mediocre NBA point guard is a rare and wonderful thing. I’m merely stating my belief that, in terms of receiving his due, he is the beneficiary of a payment error. I bring this up because Kobe Bryant, Pau Gasol, Ron Artest, and Lamar Odom are all well beyond the typical peak performance age of a professional basketball player. The Lakers will not be able to afford Fisher’s slack if their goal is to win another title next year.

And Fisher’s slack can be cut. His contract, which paid him over $5 million dollars this season, has expired. If the Lakers wish to three-peat as NBA champions once again, Jerry Buss must tear Derek Fisher’s card from his rolodex during the free agency season and go shopping, come trade or high water, for a point guard whose salary does not derive from win association but from win creation. Without the burden of Adam Morrison’s $5.3 million contract (If the Lakers are interested, I’m available to sit in a chair for just $5.2 million per year) or the salaries of Fisher and Jordan Farmar (the latter of whom may constitute a value at $1.9 million), the Lakers can make a run for a quality point guard. Finding one might be a different story. The free agent market of 2010 isn’t being called a “bonanza” for its point guards. Moreover, the Lakers don’t have much in the way of trade material (Would anyone like to take a turn employing Luke Walton for the low, low price of $5 million per year?). If there are enough late first round draft considerations in the world, the Lakers should consider a multiple team trade for Baron Davis—who happens to live in Los Angeles and is disgruntled with his current employer. But there probably aren’t enough late first round draft considerations in the world, which is why cash considerations could be a useful tool toward the Lakers trade acquisition of a marquee point guard. The team may come to regret all that money they spent on a parade! If Baron Davis is out-of-reach, the Lakers might try to acquire somebody along the lines of Andre Miller. Though 34 years old, Miller is a few notches above Fisher in overall contribution. Further, his salary ($7 million due next year) is absorbable for the Lakers.

If I were a gambler who was also in charge of the 2010-2011 Los Angeles Lakers (I am only one of these but won’t reveal which), I might dangle Andrew Bynum and see if any team wishes to take a gamble themselves. In exchange for Bynum and some combination of cash and draft picks, I would expect to obtain, through a multiple-team deal, one of two packages: 1) a point guard who ranks near the top-ten in the NBA at his position, such as Miller, and an above average, role playing center or power forward such as Udonis Haslem or 2) a point guard on the level of Baron Davis (Note: These projections of value are based on zero real-world experience in NBA player trading. Then again, it is unclear that experience helps NBA executives make good value projections, as evidenced by the career earnings of Luke Walton, Austin Croshere, Brian Cardinal, and other Great White Dopes).

Bynum’s trade value is certainly diminished by his persistently ailing knees (His knees take turns being hurt. They are very polite to one another). However, the time might be right to unload him. Even when healthy, Bynum gives the Lakers’ frontcourt less than a marquee point guard would give its backcourt. This is not a slight on Bynum (This article seeks to slight only Derek Fisher, Adam Morrison, NBA executives, and Luke Walton). Bynum is a talented frontcourt player in a crowded front court. His contribution, though considerable, diminishes the potential roles of Gasol, Odom, and Artest. If the Lakers could exchange Bynum for a talented frontcourt role player and a point guard upgrade, as in option 1 above, they would be taking a page from the 90’s Bulls, a team in which natural role players supplemented stars. Until this point, the Lakers have acquired big names for big dollars (e.g., Lamar Odom) and broken them into role players around Kobe Bryant (the only Laker who enjoys triangle immunity). This is an expensive manner of operation and one they cannot afford in the present off-season. At a time of slightly depressed revenues, one doesn’t cook with a bottle of Caymus.

I’m not claiming to understand the best route for the Lakers. I only claim to understand that this route involves a) revaluating (devaluating) Derek Fisher not just in terms of age progression and b) subsequently upgrading at point guard.

-SS

The  U.S. Minerals Management Service (MMS) is the regulatory agency in charge of safe operations of our offshore oil industry.   Yes, these are the guys who were supposed to make sure that British Petroleum and others drilling for offshore oil follow procedures to keep our environment safe. This is just one example of what economists call “government failure.”  With the recent oil spill, as with Katrina, we often trust the government to keep us safe.  When we do, however, we are bound to not only be disappointed, but also to be anything but safe.

In class recently, I talked about how regulatory agencies are sometimes captured by the industry they are supposed to regulate.  According to recent news stories, the MMS has gotten very cozy with the oil industry.  Here is a story from Salon (warning: the relationships involved are sometimes sexual in nature, and the story mentions specific acts) about that cozy relationship.  The relationship between the MMS and the oil industry painted in the Salon story and elsewhere is one where the regulatory agency has become the agency’s, well, handmaiden.

Of course, the truth is that BP wasn’t trying to do something its managers thought was particularly risky.  This was the sort of event no one had any experience with.   BP did not think that their efforts would cause a major oil spill with a horrible loss of life of their employees and those of its contracted partners.

Still, the point is that we cannot rely on regulations to get firms or anyone else to do the right thing.   If firms cannot make money by getting around the reglations, they will try to do just that.   And if we cannot trust a firm’s management to have strong moral and ethical character, how can we be so sure that the regulators themselves will have strong moral and ethical character and will be above taking bribes?   If the profits from subverting the intent of regulations are enough to pay the regulators to look the other way, then we are deluded into thinking that the regulators are keeping us safe. 

MC

To many people, requiring difficult licensing exams in order to protect public health and safety sounds like a great idea.  Who would object to requiring an exam to obtain a driver’s license?  We surely do not want those who don’t know the rules of the road or cannot make a proper left turn or have vision problems sharing the road with us and with our children.  We require licenses for so many things we seldom stop to ask why a license is needed.

Recently, Chad Turner penned a post that mentioned a Daily Comet editorial supporting a bill sponsored by Rep. Franklin Foil, R-Baton Rouge before the Louisiana legislature to do away with the testing requirements for the licensing of florists in Louisiana.   How does having one’s floral skills tested before a panel of judges really protect the public?  Professional florists are tested and judged by a far more sophisticated panel of experts, the buying public.  If a florist’s arrangements are not very tasteful or artistic, people stop buying from that florist and the florist turns to a new occupation.  Survival in a competitive market is a good indicator of quality.

Some years ago, a colleague of mine pointed out a “letter to the editor” sent to a New Orleans publication from someone who ran a massage therapy school.  This person was trying to get legislation passed to license massage therapists, requiring, of course, training from a massage therapy school.  That massage therapy school proprietor swore that he would try to make sure that all current massage therapists were grandfathered in and would not have to go back to school to continue in their profession.  If current massage therapists are all qualified to rub people, then why would we need licensing to protect the public?

The real question to ask is “who is such legislation protecting, the public or those in the occupation seeking licensure?”  There was never any evidence that anyone was being harmed by ill prepared masseuses.   It was only Louisiana politicians, not Louisiana masseuses, that rub people the wrong way.  Occupational licensure restricts the number of people entering a profession.  With fewer suppliers pay is pushed up—the laws of supply and demand do not sleep.   If someone is no good at a profession, they lose their job.  When customers can judge quality easily and cheaply either before or after purchase, why would we need someone else to protect us?

Similarly, some years ago, CPAs in Louisiana began to require 150 hours of college, or about 2 semesters of college beyond a bachelor’s degree to even sit for the CPA exam.  They do not even specify what those extra hours of coursework are.  Basket weaving would be fine.  What was the real reason for the stiffer requirements?  New CPAs coming out of college were depressing CPA pay.

With pass rates of about 75% of the examinees, the new supply of florists is currently being cut by about 25% of its potential, boosting the pay for florists, and so, the price of a floral order.   Rep. Foil’s bill encourages competition among florists and will help keep floral prices down, and so he deserves some thanks for his efforts.  Perhaps some flowers would be appropriate.

-MC

First off, a rare editorial on unnecessary regulation of florists from the Daily Comet with which I wholeheartedly agree. This is pretty blatant case of using regulation to limit competition. How has this made it this far, I wonder? Check out the original article from nola.com that outlines what incumbent businesses do to make it harder for new florists to compete with them.

I like the Daily Comet editorial page…

And yet I am fickle…

Check out this editorial, on a proposed law that would revoke the (government provided portion of) pensions of public service officials convicted of stealing from tax payers. Apparently, some Louisiana lawmakers are proposing such a law. And the Daily Comet isn’t completely on board.

Take for example, this quote:

The idea is the product of an understandable sentiment, but taking away so much of a public employee’s pension might be an unfair penalty on top of whatever fine or jail time he or she owes.

Unfair is a normative term — let’s talk positive economics for a moment.

As an example, let us take the case of someone like Tim Whitmer (the now resigned former Jefferson Parish Chief Administration Officer). Mr. Whitmer is under federal investigation — if he is convicted of a crime, he of course will have additional penalties to contend with. But consider that the pension he is slated to receive is in the neigborhood of $150,000 per year. If he received this pension in perpetuity (he won’t live that long), assuming an interest rate of say 8% (I’m being conservative here), the present value of this pension would be rougly $1.875 million.

Economists model criminal behavior as rational — criminals weigh the expected benefits of the crime with the expected costs of crime. Of course, the expect costs of the crime are probabilistic — they consist of the probability the person will get caught multiplied by the penalty if they are caught.

If the law that was being suggested was passed, the penalty, conditional on being caught would increase. This would increase the expected costs of a potential crime. And thus, holding the benefit of crimes constant, would reduce the number of crimes that were rational for criminals to commit.

Further, think of the types of people for which this additional penalty would be particularly costly. Most pensions are a function of time served and the average salary earned. Thus, pensions (and thus the penalty if one lost their pension) would be higher for high earning, long-time politicians. Would it not be nice that those with perhaps the best ability to steal would also have the most to lose?

Back to the editorial. Here is another quote…

Still, the wrongdoers should forfeit only the money that was gotten illegally. For instance, a state employee who works without incident for years before committing a crime should not lose all the state pension benefits he or she earned while doing the job legitimately.

Surely they don’t mean the first part of that. Wrongdoers should forfeit only the money that was gotten illegally?

So say the only I crime I commit is to steal $10 dollars. The expected benefit of my crime is $10.

Suppose when I I am caught, they fine me $10. So long as the probability I get caught is less than one (I get away with it some time), the expected costs of the crime are less than $10. Therefore, the expected benefit is greater the expected costs, and it is rational to commit the crime. In non-econ terms, if you ever got away with one, you’d come out ahead.

Now surely that is not exactly what the editorial means (is it?). They understand there will be jail time and other fines — but I’m back to the the original point? Wouldn’t increasing the penalty be a good thing?

Perhaps the good people at the Daily Comet (and those of my readers who don’t understand the term) should look up the term “treble”.

Now back to the normative. Do you think it is really unfair that people lose their pension if they commit the crime? What is unfair about that?

Am I missing something?

–CT

Hotel room prices vary greatly across time and means of booking. Despite having the same general demand conditions (with peak and off-peak periods), hotel parking fees appear to be a lot less variable. Why is this?

(I don’t know the answer. I’m asking you.)

Oftentimes, Subway restaurants run specials in which a different type of sandwich is discounted on each day of the week.  Such specials constitute price discrimination in that an individual’s bill is based partly on his or her willingness to eat the sandwich on special.  “Picky eaters,” those who go specifically to Subway for a specific type of sandwich, pay a relatively high price for a Subway sandwich on most days.  That is, they take advantage of the special only when it applies to their favored sandwich.  “Flexible eaters,” those who will eat anything at any restaurant, are charged a relatively low price.  This type of consumer always takes advantage of the special when eating at Subway. 

 Such specials are beneficial to Subway in that they allow the restaurant to draw in additional customers without sacrificing much profit from “picky eaters.”  The specials allow Subway to maximize the sum of profits from two market segments.

-SS

One of my students raised an interesting point when we discussed international trade and comparative advantage.  It seemed that all he had heard was that the U.S. no longer made much  anymore.  Now his point was more that we consume beyond what we produce, borrowing too much to pay for the trade deficit.  Still, many have the view that since manufacturing employment in the U.S. continues to decline (it peaked in 1979), that the U.S. is no longer making much stuff to sell.  Of course, part of what has been going on is that the U.S. has been increasing its services production.  Below is a link to a CBS news video along with links to a few articles on what has been going on with our production and trade in both manufacturing and in services.

First, is the rather misleading video of the CBS report by John Blackstone that aired 2/16/2010 on manufacturing in the U.S.  Note that the declines mentioned are measured in jobs rather than in output.

Now here is an article by Dan Ikenson of the Cato Institute that appeared in National Review Online in August, 2009 where he busts the myth that “We don’t [make things] any more — at least, not like we used to.” 

Along the same lines is a little longer is another article by Ikenson, “Thriving in a Global Economy: The Truth about U.S. Manufacturing and Trade,”  from 2007.

In an email (via a list I am on) from Ikenson I got Feb. 17^th, Ikenson writes:

The manufacturing jobs number (which, by the way, peaked in 1979 and has been on the same downward-sloping trajectory since then) masquerades as a barometer for the health of manufacturing, which has been setting all kinds of records with respect to output, value-added, revenues, profits, return-on-investment year after year (with the exception of the recent recession, which affected all sectors of the economy similarly). 

American manufacturing remains the world’s most prolific manufacturing sector accounting for 20-24 percent of global value-added; China accounts for about half that.  People ask: How can that be when most shelves in retail stores are loaded with products made in China, and ”Made in USA” labels are nowhere to be found?  Part of the explanation is that products labeled made in China are only 35-50%, on average, Chinese value-added.  (Apple iPods, which each register in our trade stats as a $150 import from China, contains about $4 of Chinese value-added–that’s only 3%!)  “Made in China” often means “snapped together in China” from components made in Japan, Taiwan, Singapore, Korea, and the United States.  Another part of the explanation for the dearth of “Made in USA” products on retail shelves is that U.S. manufacturing doesn’t make a lot of products sold on retail shelves.  Pharmaceuticals, chemicals, sophisticated componentry, airplane parts, and technical textiles aren’t sold through retailers, and those are some of the high-value products made in America.

Michael McKee writes this article at Bloomberg.com (Bloomberg News) from November, 2009, also busting the myth of U.S. manufacturing declines.

Finally, take a look at this February 17, 2010 op-ed article from the New York Times by W. Michael Cox , director of the Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business.  Cox writes here on the huge and growing size of U.S. production and exports of services.  I should point out that Dr. Cox is the former chief economist of the Dallas Federal Reserve, and even though I never had a class with Dr. Cox (he arrived my second year of graduate school), I still learned a good bit from him in our twice-a-week seminars at Virginia Tech.

 -MC

(A note to my students looking to get comment points–you will need to show that you looked at the video and have read the articles linked and cited above, or have done other reading on the subject–and link to your sources.)

What got my attention this week was something I heard this past Sunday on Fareed Zakaria’s Global Public Square (GPS) program on CNN.  Zakaria states point blank, that the Bush tax cuts are the single largest part of the deficit.

Notice that Mr. Zakaria thinks he has Greenspan and Paulson in a “gotcha moment,” claiming that they fail to live up to the ”courage of their convictions”  by not supporting immediate repeal of the Bush Tax Cuts.  The problem is that Zakaria is a poor listener.  We face two problems, the recession, which is short term and acute, and the deficit which is long term and chronic.  Notice that Paulson says that the deficit is a long-term problem.  Zakaria is missing a vital point in this discussion.  Reducing deficits, either by raising taxes or cutting spending, during downturns are widely thought to exacerbate recessions.  Paulson and Greenspan both suggest that now, because of our current recession, is not the time to be raising taxes, but they never rule out raising them at some time in the future.

Zakaria later points listeners to a Feb. 4, 2010 article in Time by Jeffrey Sachs, a leading economist at Columbia University, whose work on something called the “natural resource curse” has captured my recent research attention.

The current budget deficit runs about 10% of our national GDP (US  tax receipts are currently at 15% of GDP while spending is at 25%).  Sachs writes in his article that closing up the Bush tax cuts on the rich would only amount to .4% of GDP, which means that the Bush tax cuts account for only 4% of the deficit.  Sachs states: “even with rollbacks of tax cuts for the rich, the fiscal gap will remain enormous.  The Bush cuts in rates hardly account for the biggest part of the current deficit, as Zakaria claims.  Zakaria is not only a poor listener, he is also a poor reader.

Take a look at this picture of Federal Spending and Receipts in millions of dollars:

Here are those same figures but as percentages of GDP:

I should point out that there were actually two Bush Tax Cuts, one enacted in  2001 after 9/11 and the other in 2003.

Note that tax revenues rose faster after the 2nd Bush tax cuts than they did in the Clinton era, with the tax revenue growth coming to an end in 2007 at the beginning of the recession.

More importantly, notice that starting in 2001, public spending as a percent of GDP started to grow again after shrinking, as it had over the Clinton era.  While we should avoid post hoc thinking, we should also note that while the  tax cuts may have led to revenue declines, there were also large increases in government spending that started at the beginning of the Bush era.  The Bush spending programs included a generous pharmaceuticals program for the elderly, an increase in Homeland Security spending, an expensive war in Iraq in 2003 and allowing Republicans in Congress to spend heavily in their districts to increase their reelection chances.

It is the growth of entitlement spending that is at the heart of our future deficit problem, and in the very near future, growth in entitlement spending, from Social Security to Medicaid to Medicare, will be the drivers in our deficits.  Driving these spending figures are an aging population and rising health care prices.  One of the biggest reasons for the rising health care prices is that we have an aging population, boosting the demand for health care goods and services.  Increasing entitlements, through the health care bills that have gotten approval in the House and the Senate are destined to push projected deficits even higher.

A more realistic, as well as more pessimistic, view of the growing defict is reported in this ABC article.  The article reports the findings of the Peterson-Pew Commission on Budget Reform.  One of the commission’s publications is the testimony of Alice Rivlin.  Rivlin, an economist who was appointed by Johnson, Carter and Clinton to various government posts, recently testified before the Senate Budget Committee.  In her testimony, she states “In the next decade and beyond, federal spending, driven by the impact of an aging population and rising health care costs on Medicare, Medicaid, and Social Security, will rise substantially faster than the whole economy can grow–faster than the GDP.  Revenues, at any likely set of tax rates, will grow only slightly faster than the GDP.  The gap between spending and revenues will keep widening.” Obviously, repealing the Bush Tax Cuts, as Zakaria suggests, will do little if “revenues, at any likely set of tax rates,” will grow more slowly than the promised spending from Medicare, Medicaid, and Social Security.

Recently, my daughter and her roommate drove from Natchitoches, LA to Monroe, LA and followed her roommate’s global positioning device.   The car’s GPS routed them through Shreveport, doubling the usual time through Winnfield and Ruston.

As bad as the advice my daughter and her roommate got from the auto GPS, it did get her to her destination.  Zakaria’s suggestion that repealing the Bush tax cuts, or allowing them to expire, would put us much closer to erasing the deficit is just seriously misleading.   Zakaria’s GPS does not even set us on the right path.  Perhaps if Zakaria would listen more carefully and read the articles he suggests to his listeners, he might be worth listening to.

And this just in, President Obama has created a bi-partisan commission to come up with ways to deal with the deficit crisis.  From what I understand, the commission’s proposals would come before Congress to be voted on, yes or no, without amendments.  Unlike Zakaria’s suggestion of dealing with the Bush Tax Cuts (which should be on the commission’s table), President Obama has put us on course to effectively dealing with the long-term deficit problem, looking at both the spending and the revenue side of the deficit problem.

-MC

Firms are very clever in their ability to extract willingness to pay information from customers. For example, brokerage firms likely use price discrimination to maximize the number of orders on which they receive commission. They do so by allowing clients to place “limit orders.” A limit order asks the broker to buy so many shares of a stock, on behalf of the client, at no more than a particular price. Limit orders are convenient in that they allow the client to opt out of an order should a share price rise dramatically before a buy order is executed. This is especially useful if the client possesses a limited amount of tradable funds. However, limit orders can hurt the client in that they ask him to express his spot willingness to pay for shares of the stock. The broker can (and likely does) use this information to maximize the number of commissioned trades he can execute.

For example, suppose that a stock begins the day at a price of $1.01 and rises steadily throughout the day to a closing price of $1.10. A brokerage firm has 10 limit orders, each of which asks to buy one share of the stock. One order places an upper-limit of $1.01 on the purchase price. Another order places an upper-limit of $1.02. This pattern continues such that there is one order at each of the following limits: $1.01, $1.02, $1.03,…, $1.10. Suppose that trading for this stock opens at $1.01 a share, and the brokerage has an opportunity to fill one of the orders at this price (Assume that the market for this particular stock is thin or low-volume in nature.). Which order will the broker fill first? Will he choose randomly? Will he fill the first order placed? A price-discriminating broker who wishes to fill the most commissioned orders will begin with the $1.01 limit order. Such a broker will do so because he may be able to fill any of the other orders at a later time should the share price subsequently rise. However, he does not have this luxury with respect to the $1.01 limit order. If he does not execute this order in the first round of trading and the share price then goes up, the order will go unfilled. Thus, one might pay a hidden cost for the convenience of a limit order. Market orders, on the other hand, are less convenient but betray no information to the broker as to one’s spot willingness to pay for a particular share of stock.

-SS

Once again, the idea of introducing a Value-Added Tax (VAT, better termed the “Stealth Tax”) to curb our mushrooming deficits is being discussed. This time, in a Feb. 4, 2010 article in Time magazine, Columbia University economist Jeffrey Sachs suggests the use of a new tax in America, the VAT, stating “Both sides could agree, for example, on a value-added tax (VAT) – a sort of national sales tax – combined with closing loopholes and reducing some marginal tax rates, including the corporate tax rate….”

Suggesting that we use a VAT instead of a straight-up sales tax to finance anything in this country, even a reduction in the corporate income tax, signifies either a lack of understanding of basic public finance or a willingness for the federal government to increase taxes on American buyers in ways unperceived by most voters.  While a VAT would be more visible than running deficits, which is another form of unperceived taxation, a regular sales tax would be far more visible by tax payers and works better in other respects, as well.

Sachs is right that a national VAT is sort of a national sales tax. With the VAT, instead of charging a flat rate on every dollar of retail sales, that same rate is collected from producers on the difference between the cost of the goods that they sell and their sales revenues, that is, on the value that they add to goods at each stage of production, from raw materials producer to manufacturer to wholesaler to retailer. Take the case of a loaf of bread that sells for a dollar. In the process of making the bread, a wheat farmer sells wheat to a mill which sells flour to a bakery which sells bread to a store which sells it to the final customer. The wheat that went into the flour that went into a loaf of bread sold for a quarter, while that much flour sold for a half dollar while the baker sold the bread to the retailer for 75 cents. Each producer adds a quarter at each of the four stages of production. If each producer is charged a 10 percent VAT, each of the four pays a tax of 2 1/2 cents, which adds 10 cents to the cost of the bread. The price of the bread ends up going up by 10 cents, the same amount as it would if there were just a national sales tax of 10 percent. Who ends up paying for this tax? It is the same person who ends up paying the sales tax, mostly the consumer.

This does not mean that there is no difference between these sales taxes and the VAT. Since most areas of the country already have some sort of sales tax, a national sales tax would cost little extra to collect. With a VAT, we would have to add a huge bureaucracy of accountants to check the cost of goods sold and the sales at each stage of production. This is a very costly tax to collect. With a sales tax, however, we could, in most states, piggyback collection and enforcement efforts on state and local government efforts.

Another difference is that the burden of a sales tax on the poor can be eased by putting exemptions on certain classes of goods, such as groceries, utilities or medicine, because the poor spend a larger portion of their income on these items than wealthier citizens. With a VAT, producer groups can be excluded, not consumer groups. Instead of easing the burden on certain consumers by exempting certain items such as groceries and medications from the sales tax, the VAT can only exempt certain producers.  This not only makes it difficult for the tax to be eased on the poor, but also makes it more likely that many producer groups will be lobbying in Washington to get their group excluded from the tax. Special interests do not lobby as much for exemptions from sales taxes because it is harder for consumer groups to organize than it is for producer groups. For Sachs, who rightly complains of the influence of special interests in Washington, to give special interests a greater incentive to lobby in Washington means that he does not understand the political incentives posed by certain forms of taxation.

A national VAT differs from a national sales tax in another important way. With a sales tax we see what we pay in these taxes at the cash register. The consumer never sees the bill for a Value-Added Tax, though the consumer ends up paying for the tax since it is mostly passed forward to the buyer. The lack of visibility of the VAT has prompted some critics of this tax, including me, to call it the Stealth Tax, because it hits the taxpayer/voter before she ever sees it coming. If there is a tax increase to pay for some new spending program, the tax increase is passed on as a price increase, and the buyer tends to blame the seller instead of the government.  But when the taxpayer/voter sees the bill for big government, she starts to question whether the spending is necessary. But when we don’t perceive the costs, we seldom question the value of the spending program.

The problem of the lack of visibility of a tax was first pointed out in 1903 by the Italian economist, Amilcare Puviani (as we see in this Richard Wagner paper), and then popularized among English-speaking economists by one of my professors, Jim Buchanan, a problem that has been called “fiscal illusion.” As voters, we are more likely to ask for new spending programs if we never notice how much it costs.   Importantly, Buchanan and others have noted that tax cuts and deficits fail to “starve the spending beast” of government, as many conservatives have proposed to deal with government spending, and instead reduce the visibility of the cost of spending to voters. Voters, then, become more supportive of almost every new spending program that comes along.  If the problem we are tackling with the VAT is the deficit, a very visible national sales tax makes a better weapon against the deficit than the stealthy VAT.

Sachs is quick to remind us that the VAT is widely used in Europe. This is true. And the Europeans have tackled the regressivity of the VAT buy introducing many spending programs to help the poor.  If we are facing a deficit problem, it would seem that additional programs to help alleviate tax regressivity unnecessarily add to the deficit by increasing spending on uncontrollable entitlements.

We should also note that the Europeans arrived at their VAT by their own peculiar history. Their VAT evolved from their former business tax, a tax on gross receipts at each stage of production. In our bread example, a 10 percent tax would collect 2 1/2 cents from the farmer, a little more than a nickel from the miller, about 8 cents from the baker and about eleven cents from the retailer, adding up to more than 21 cents. The Europeans quickly found that businesses could avoid the tax by combining the various stages of production into one business which would lower their taxes considerably, giving vertically integrated firms an advantage over those there are not.  It should also be pointed out that the Europeans already had a system in place to tax at each stage of business sales rather than a retail sales tax bureaurocracy.

So, if we are to go down the road of a new national tax on spending, we should note that a true national sales tax is superior to a VAT at every step, from being more visible and more of a deterrent to federal spending sprees, to being better suited to being shaped to help protect the poor from tax regressivity, to being less prone to being shaped to the liking of special interests, to being cheaper to administer.

-MC

(Note: I have written more than once about the Value-added tax, or VAT, and have repeated some of my own words from past articles, especially see “Vat for financing health care proposals still a bad idea.”)