Bastiat’s Bastions

Smoking behavior and its effects of non-smoking is constantly in the news. The latest news is from the mighty halls of Congress where Rep. Tancredo’s (Republican) cigar smoke drifted into Rep. Ellison’s (Democrat) office and a member of Rep. Ellison’s staff called the Capital Police to investigate. The rule on smoking in Congressional offices is that the Congressman decides makes the smoking policy for his own suite of offices. That seems like a decent rule.

Here at Nicholls, things are a bit different.The first edition of the Nicholls Worth in 2007 led with the headline “Smoking ban causes decline in bar sales.” Not only has the Nicholls Worth provided Nicholls economics students with a good example of complementarity of goods (goods that tend to be used together), but other important issues are raised in their editorial on the smoking ban. The editor clearly sees through the smoke that clouded the thinking of our state legislators (surely those guys in

Baton Rouge were smoking something much stronger than mere tobacco when they came up with this one). The editor sees that both smokers and non-smokers have rights and that these rights are reciprocal. If we allow smoking, we grant certain initial rights to smokers that end up harming non-smokers. If we ban smoking, the rights of the non-smokers are upheld, harming smokers. Smoking in a public place, where some innocent by-standers are harmed by the production or consumption of someone else is an example of a general class of problems with not only markets, but all forms of social exchange, a problem that economists term “externalities.” With externalities, costs (or benefits) are imposed on those “external” to the original exchange, someone other than the buyer or the seller, a sort-of innocent bystander problem. In situations of external costs, the buyer gets the good without paying all of the costs of his actions and ends up consuming more than he or she would if he had to pay full cost.

As an aside, note that people are now claiming that those who consume fossil fuels, such as gasoline, are creating external costs through the creation of greenhouse gases, such as CO_{2 .} These greenhouse gases lead to global warming, they suggest, and fossil fuel consumers should (that is a very normative “should” by the way) be forced to pay full costs of their actions via instituting a tax on carbon meant for combustion.

Well, all of this leads us to something called the Coase Theorem. Ronald Coase, in 1960, suggested that there was a problem of this whole notion of externality, which also is called “social cost.” The problem, he said, was due to this reciprocal nature of externalities. We can cater to the smokers, costing the non-smoker, or to the non-smoker, costing the smokers, as was noted by the Nicholls Worth editorial. So, no matter which way we set the “rights,” there will be external costs. Coase suggested that if the very act of trading (making transactions) was costless, it would not matter who had the initial right that the other side would pay to get their way, that either way, we would end up in the same place, further, that we could not improve on that situation without harming someone—which is what economists call “economic efficiency” or “Pareto Optimality.” The idea is that if the non-smoker preferred not to be bothered by the smoke of others more than the smoker preferred to be able to smoke, the non-smoker should be willing to pay the smoker to refrain from smoking. So if there were no costs to cutting a deal with the smoker, we would end up in the same place if we gave the smoker the right to smoke and the non-smoker could buy him out or if we gave the non-smoker the right to have no-smoking to start with, and after the dealing were done, we would be at an efficient position.

One of the main points of Coase’s theorem, and one that is pointed out by law professors Guido Calabresi and Douglas Melamed in their very important work, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral (Harvard Law Review, 1972), is that there are often cases of what Coase called high “transactions costs,” and when these costs are significant, economic efficiency is served by setting the rights in such a way as to arrive at the rights that would occur if there were no transactions costs, because the costs of cutting a deal are just not worth the bother. Transactions costs should be understood as just costs of cutting the deal as separate from what people face with the deal itself. Lawyers’ fees for coming up with terms of the contract would be a form of transactions costs. The opportunity cost of waiting in line to make payment would be another type of transactions cost. Another way, then, of understanding transactions costs is a cost of trading not received by the other side of the exchange.

Here is a little of what Calabresi and Melamed had to say:

The first issue which must be faced by any legal system is one we call the problem of “entitlement.” Whenever a state is presented with conflicting interests of two or more people, it must decide which side to favor. Absent such a decision, access to goods, services, and life itself will be decided on the basis of “might makes right” – whoever is stronger or shrewder will. Hence the fundamental thing that law does is to decide which of the conflicting parties will be entitled to prevail. The entitlement to make noise versus the entitlement to have silence, the entitlement to pollute versus the entitlement to breathe clean air, the entitlement to have children versus the entitlement to forbid them – these are the first-order of legal decisions.

They go on to point out that once the state picks who has the right to something, such as the right to smoke or the right to clean indoor air, the state must then decide how to enforce those rights. Three methods for protecting people’s entitlements that Calabresi and Melamed suggest are:

Property rules, which involve the law of contracts, where the price is set by the free working of the market system, rather that by government or judicial edict. The terms of trade or the rates of exchange are set through bargaining or through the market.

Liability rules, which involve tort law, where the price or exchange rate is set by a judge or some other dispassionate third party. The terms of trade or the rates of exchange are determined by a judge or uninvolved third party.

Inalienability, which means no exchange of rights can take place at all, no matter how much one side may be willing to pay the other side to get his way.

Largely what Calabresi and Melamed talk about is the balancing of costs to non-smokers of this second-hand smoke and the costs to smokers of not being allowed to smoke. While it might make sense to have such bans in some public spaces, extending the notion of public space to the privately owned bars and restaurant seems to be a stretch because these places are owned by some private citizen(s). We should note that it is exactly these restaurant and bar owners who have the most to gain from setting the smoking or no-smoking rules because they are in a position to balance the costs of smokers not being able to smoke with the costs of non-smokers breathing second-hand smoke. Whether it is ok or banned in their establishments is a decision to be made by the owner with an eye on demand by their customers and the demand lost by making one decision or the other. Banning favors the non-smokers, and restaurants may wish to cater to non-smokers and do away with smoking in their place of business, but they must face what happens to their paying customers. Does the business, on net, gain or lose revenues? Allowing smoking, of course, favors the smoker. Still, if it meant that much to non-smokers, they could always pay smokers to stop. In a competitive environment, some restaurants or bars could always ban smoking in their establishment and gain many of the avid non-smokers as a result, and others could specialize in catering to smokers. With a private ban ordered by the owner of the business, the business owner could still be persuaded into changing his decision if it could be shown to be worth it.

We should note some other conclusions of Calabresi and Melamed concerning where the rights fall.

That economic efficiency standing alone would dictate that set of entitlements which favors knowledgeable choices between social benefits and social costs of obtaining them, and between the social costs and the social costs of avoiding them;

That this implies, in the absence of certainty as to whether a benefit is worth its costs to society, that the cost should be put on the party or activity best located to make such a cost-benefit analysis;

That in particular contexts, like accidents or pollution, this suggest putting costs on the party or activity which can most cheaply avoid them;That in the absence of certainty as to who that party or activity is, the costs should be put on the party or activity which can with the lowest transaction costs act in the market to correct an error in entitlements by inducing the party who can avoid social costs most cheaply to do so; and

That since we are in an area where by hypothesis markets do not work perfectly–there are transaction costs–a decision will often have to be made on whether market transactions or collective fiat is most likely to bring us closer to the Pareto Optimal result the “perfect” market would reach.

However, an out-and-out ban on smoking in bars and restaurants, as our legislature has passed, puts the entitlement protection that Calabresi and Melamed discuss into the realm of “inalienability,” where no one can act to trade to correct errors in entitlements. The law creates prohibitive transactions which make it more or less impossible for smokers and non-smokers in a bar to make any trades that will lower the total costs of smokers not being able to smoke and non-smokers facing second-hand smoke. Who is in the best position to act to reduce these social costs? The owner–just like the Congressmen get to do in their own offices.

In the interest of full disclosure, I should tell you that several times when the issue of cigarette tax increases for the state of Louisiana came up in the legislature, I was asked to testify before the House Ways and Means Committee concerning my research on the effects of state cigarette tax hikes. The Tobacco Industry did pay me as an expert. My main publication on this was “A Note on Estimating Cross-Border Effects of State Cigarette Taxes” RM Coats – National Tax Journal, 1995, where I estimate two crucial tax elasticities of cigarette demand that allowed me to estimate the effect of state cigarette taxation on the change in cigarette demand to and from other states. In my testimony, I noted that I was an avid non-smoker. I should also point out that my research on cigarette taxation has been cited by those on both sides of the issue.

MC

FYI,

Reports of the President’s Council of Economic Advisors were just released. Here was the email I got. If you find something interesting in here, please share it with us in the comment section.

MC
______________________

The Council of Economic Advisers (CEA) today released the 2007 Economic Report of the President. The annual report provides an overview of the U.S. economic outlook and puts into broader context many of the economic issues that underlie the Administration’s policy decisions.
CEA Chairman Ed Lazear conducted a news conference about the report and the transcript can be viewed on-line here:

Fact sheet from the White House communications office:

Full report

Chapter 1: The Year in Review and the Years Ahead
Chapter 2: Productivity Growth
Chapter 3: Pro-Growth Tax Policy
Chapter 4: The Fiscal Challenges Facing Medicare
Chapter 5: Catastrophe Risk Insurance
Chapter 6: The Transportation Sector: Energy and Infrastructure Use
Chapter 7: Currency Markets and Exchange Rates
Chapter 8: International Trade and Investment
Chapter 9: Immigration

Thank you.

Gary D. Blank
Chief of Staff
Council of Economic Advisers
The White House
(202) 395-5084

Here is a comment I recently posted to a blog post by Don Boudreaux on his blog, Café Hayek.

Read Don’s Nov. 4^th post here.

Don,

Could it be that those who argued against the draft in the 1970s, many good economists, such as Bob Tollison and Roger Miller, were wrong in just not being thorough enough in their analysis? While they correctly noted that the draft was a more costly way to raise an army, they somewhat failed to note the public choice results of the change to an all-volunteer force. In Bob’s case, this means not making a point that he was making over and over again about the nature of public interest legislation. That point is that when benefits of some proposal are concentrated while the costs are spread out rather thinly and evenly, the legislation will see little opposition and is more likely to be passed. The opposite is, of course true as well, that when the costs are concentrated but the benefits are spread out thinly and evenly, the opposition will be tough and it will be difficult to carry. In a way, this is part of the problem that Anshu Sharma noted in his Nov. 4th post. When benefits are widespread, but low to most, people do not “feel” or perceive those benefits and do not favor them, so special interest legislation prevails over public interest or public goods legislation.

When we went from the draft, which unfairly concentrated the costs of war onto those who were being drafted, to a so-called volunteer force or more correctly, a professional force, or a mercenary force, we change it from one where the costs are less concentrated on the soldiers and are spread across all taxpayers, thus decreasing opposition to military involvement.

Still, to the extent that military involvement is defensive (and so, one of the few real public goods) and not mere imperialism, then at least the benefits to military activity are spread out as well, and here voters will be mostly unmotivated either for or against the military activity. In which case, national defense, a public good, will not suffer from this special interest bias against public goods.

So here I am having come full circle. Tollison, Miller and other economists in the 70s who fought against the draft made no errors of omission in doing so. Moving from a draft to a professional force removed the public choice bias against proposals that have costs that are concentrated on a few.

One other point should be made against Reinhardt’s characterization of our troops in Iraq mentioned by one of the other commentators. If Reinhardt thinks that troops now are cannon fodder, under a draft it would be worse. When troops are easy to replace by going back to the draft board and telling them to send more, current troops are not as well treated and are more likely to be thought of expendable. In the 25 or so years since the draft was ended, I cannot think of a single “they were expendable” case, as we had with Iwo Jima or D-Day. When we rely upon paid troops and must pay “compensating differentials” to attract troops, minimizing the human risk of war suddenly becomes more important.

Morris Coats

Kimberly Barrilleaux, a student in my Econ 211 class, sent me this New Orleans Times-Picayune article on a new type of rent control passed by the St. Bernard Parish Council (10/4/2006). As you can see by reading the article, St. Bernard has established a peculiar style of rent controls, not on the level of the rent charged, but instead on who one could rent to. In a parish where 93% of the homeowners are white, establishing an ordinance that denies homeowners the right to rent their homes to anyone but blood relatives (which the ordinance does), clearly keeps most non-whites from being able to rent in St. Bernard, unless they were renting their before the storm. This clearly violates the civil rights of anyone not kin to someone wishing to rent their St. Bernard homes out. The lawsuit charging a violation of the fair housing act and equal protection under the law is surely warranted.

Councilman Mark Madary nails the issue on the head. In the Times-Picayune article, Paul Rioux writes:

Madary…said St. Bernard can’t afford to turn away anyone who wants to invest in rebuilding the parish after virtually all of its 27,000 homes were swamped by Katrina.

“Without an infusion of outside investors to jump-start the recovery, you might be living next to a debris pile for a lot longer than you would like,” he said. “The longer the houses sit empty, the harder it is to convince people to come back.”

He said the ordinance also unduly restricts property rights.

“When you buy property, you buy the rights that go with it,” he said. “To go back retroactively and change those rights is unconstitutional in my opinion.”

This ordinance is a violation of the property rights of all current homeowners. It denies them the right to sell their property to those who would build rental housing in the area (as this potential market for their houses disappears) and to rent their homes out to the renter who would pay them the highest rent.

This ordinance constitutes a “takings” because the property owner is denied the market that was once part of their potential market. By reducing the number of potential buyers and renters, the demand for housing in St. Bernard is kept down, as is the incentive to build such homes for rental or speculative purposes. This ordinance limits housing and the future growth of St. Bernard.

To make matters worse, this ordinance is not a very smart move for politicians who wish to spend money raised through taxes. Rental homes are not given homestead exemptions and are completely taxed and their value is affected by the rental income they generate. Owner occupied housing, which is partially homestead exempt (for the first $75,000 in value), will generate less income as the housing demand is depressed by this ordinance, which reduces the values of all homes.

MC

I know that our democracy is designed to move slowly, but this seems a bit ridiculous. From the April 14th Wall Street Journal:

The Treasury Department, following a series of hostile court rulings on the way it assesses the federal excise tax on phone service, is working on a plan to stop collecting the levy and refund billions of dollars to consumers and businesses, according to people familiar with the matter.

This is one of those taxes that many people probably don't realize they pay. In fact, I would bet even fewer people know that this tax was first instituted in the 1800's. The law was passed to help pay for the Spanish-American "war," and was put in place largely because phones were luxury items during that period. Even though the courts have said the tax must be eliminated, and even though Congress has killed it (at least) once, the tax still gets tacked onto your phone bill. From the same article:

When the tax was enacted in 1898, telephone service was something of a luxury and the levy affected relatively few Americans. As telecommunications expanded to become a fixture of modern life, the tax has become a steady revenue stream that administrations of both political parties have been loath to surrender. In 2000, Congress repealed the tax, at an estimated five-year cost of $24 billion. Former President Clinton vetoed the measure over budget concerns.

Maybe it will be stopped in time for its 110 year anniversary?

NM

I have yet to buy or sell one single item on eBay. My wife, however, frequents the site. Below, I’ve pasted an email that she just received from eBay.

Louisiana sellers – Protect your right to sell items on eBay

Dear Community Member,

If you sell more than two items a year on eBay, the Louisiana Auctioneers Licensing Board wants to force you to be licensed as auctioneers or auction businesses. You may have to pay a licensing fee, obtaining surety bonds, and submit a notarized copy of your voter registration card. All this just to sell a few items on eBay!

Nearly every eBay seller in Louisiana is at risk. One Louisiana seller already shut down his eBay business. Unless we act quickly, thousands more Louisiana businesses may be at risk.

Protect your right to sell items on eBay. Make your voice heard! Write your elected representatives today!

Sincerely,

eBay’s Government Relations team

I would guess this is the result of either (a) competition appealing to the government for help, or, (b) the government trying to increase its tax revenue. Either way, the issue does not seem to have made big news. If anyone has anything on this, I’d love to hear about it.

NM

Here’s a link to a new USA Today article that claims tax “refunds” are on the rise. I have the word refunds in quotes because we have to use the term loosely in this context. The refunds, in this case, are those sent to taxpayers who had too much money withheld from their paychecks over the course of a year.

This phenomenon has always struck me as odd. I’ve heard the argument (and it is repeated in the article) that people simply like the idea of “forced saving.” In other words, people deliberately have too much money withheld from their paychecks because they know they will receive a refund after they turn in their tax forms.

Here’s the last paragraph of the article:

But many people love the forced savings and its reward — the fat refund — no matter how much it costs. “Taxes are so complicated people are just happy to come out ahead on April 15 rather than behind,” says Ellen Katz, editor of the Tax Savings Report newsletter.

The problem, though, is that people are not coming out ahead by doing this. They are losing money. Had they set up an automatic withdrawal from their paycheck into their own savings account, they would have been earning interest throughout the year.

I think I’m going to start a program that encourages people to send me a fraction of their paychecks every week. Then, on April 15th, I’ll give them back every cent they let me have. I’m more trustworthy than the IRS.

NM

It’s funny how quickly some things change. Not too long ago, the AARP and the N.Y. Times were vehemently opposed to fixing Social Security with private accounts. This week, they’ve both decided it’s not such a bad idea (here and here).

A newly released proposal by The Heritage Foundation’s David John and Brookings’ J. Mark Iwry suggests improving retirement security with the “automatic IRA.” The paper only outlines a proposal, but the general idea is this: most employers would have to offer an automatic payroll deduction for individual workers’ private retirement accounts. Individuals would have the chance to opt out of the forced saving program, so it isn’t really “forced” savings.

I suspect that some staunch libertarians will be opposed to a plan such as this on the grounds that the government should not force this cost on employers. But how much of a cost would this really impose on employers? And, assuming that private accounts would eventually eliminate the need for Social Security, what would be the cost of not switching to private accounts?

My last question: What is in this proposal that would make the AARP and NY Times, just months after trashing any similar idea, endorse it?

Happy Mardi Gras Everyone.

NM

Everyone knows that Democrats are against tax cuts and Republicans are for tax cuts, right? Well, think again.

One of the more amusing (if your cynical) aspects of tax policy during the last couple of years has been the squirming of New York Democrats over the alternative minimum tax, the dreaded AMT. There’s been all sorts of congressional horse trading over this tax, but I think we’re finally about to reach the pinnacle of absurdity.

For more than one year, insiders have known that Republicans might try to renew the 2003 tax cuts (JGTRRA) by linking their extension to (another) one-year fix for the AMT. Why? Because the AMT hits individuals in high-tax states particularly hard…..states such as New York….with two Democratic U.S. Senators.

Normally, Democrats loathe any sort of tax cut, but when a particularly egregious tax is aimed directly at their constituents, well, that’s another story. Which brings us to the funny/sick part of the story.

New York Senator Charles Schumer and Maine’s Republican Senator Olympia Snowe want to institute a windfall profits tax on major oil companies. The tax would only last one year. Right. (We’ll be posting more on this “tax” in the coming weeks.)

I don’t suppose Schumer’s aggressive stance could have anything to do with wanting to offset the “cost” of extending AMT relief one more year? And, I guess it could just be a coincidence that the new profits tax is supposed to raise around $4 billion and the AMT relief for one year would “cost” about $6 billion? Feel free to make up your own mind.

(For Wall Street Journal subscribers, see “The Max Baucus Speed Bump,” February 9, 2006, and also see Chuck Schumer’s letter to the Journal, “Big Oil’s Reported Profits Are Kept Artificially Low,” December 7, 2005.)

-NM (I’m just following Chad’s lead.)

Late last week, U.S. Treasury Secretary John Snow took to the pages of the Wall Street Journal to praise the 2003 tax cut package. According to Snow, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) was one of the main reasons the slow recovery (from the 2001 recession) picked up steam. Perhaps Snow is correct.

One of the main components of JGTRRA was a reduction in the tax rate on capital. Specifically, JGTRRA lowered the maximum tax rate on individuals’ dividend income. Prior to JGTRRA, dividend payments from a C corporation to an individual would have been taxed at the individual’s top personal income rate. The bill reduced the tax rate on such income to 15 percent (for most dividend recipients).

So, the story goes, JGTRRA made it easier for a corporation to provide a return to its shareholders, thus lowering corporations’ “price” of investing in projects. Naturally, when the price of something decreases, we expect to see a higher quantity demanded. Therefore, JGTRRA should have resulted in corporations investing in more projects (new plants, new equipment, new buildings, etc.).

Why am I writing about this now? A recent post on Café Hayek discusses whether the upward trend in the corporate investment data started before JGTRRA was passed. If so, we would have to conclude that the law had very little to do with the quicker pace of the economic recovery.

The post on Café Hayek really doesn’t offer an explanation as to why the law may not have worked as designed, so I’ll offer one plausible explanation: phase-outs. To sign JGTRRA into law, Congress had to allay the fears of the federal deficit hawks. They did this by writing a law that would expire (phase out in beltway language) after 2008.

As a result, all of the pre-JGTRRA capital tax rates return after 2008. This somewhat unseen part of the bill (it certainly has not been focused on by many journalists) could have a serious impact on the way corporate managers estimate their cost of capital. For starters, corporate managers had, at most, a four-year window for which they could be certain of having a lower cost of capital.

To make matters worse, it was widely believed by the time JGTRRA passed (May 2003) that the 2004 presidential election promised to go down to the wire. Candidate John Kerry’s promise to repeal JGTRRA, therefore, would have provided an excellent reason to put off investing in some projects. If most corporate managers were still, in 2004, planning which projects to invest in, then none of the 2003 corporate investment data would include much of a behavioral response to JGTRRA.

The success of JGTRRA’s capital tax reduction depends on a behavioral response, and the bill’s phase outs certainly provided a disincentive to responding quickly. To answer the question of whether these capital tax cuts worked, I would argue we have to start our investigation after 2003. Sorry Mr. Snow.

For discussion: Can anyone think of additional reasons that the investment response to this tax cut would not show up in 2003? At least one should be rather obvious.
Also, for anyone interested, here’s a short summary of two empirical studies that looked at this issue.

Norbert Michel