Spreading the Wealth Around

Over the past few years, I have done some thinking and writing about the distribution of income and optimal tax policy.  I have collected some of my thoughts in this new paper, which later today I will be presenting as my presidential address to the Eastern Economic Association.

More on Ranking CEAs

The Economist takes up the challenge.

An Interview

With my favorite economist.

Financing Healthcare Reform

Today's Washington Post reports:

Obama's proposal takes the more modest Senate bill as his basic framework. But, in what is perhaps his proposal's most notable feature, he scales back the Senate bill's main revenue source, a tax on high-cost insurance that he has strongly supported. Instead, he would impose a new tax on the unearned income of the wealthy.

In my view, this is a step in the wrong direction. The tax on so-called Cadillac health plans made sense as a way to reduce the existing tax incentive toward excessively generous health insurance, which in turn encourages excessive use of healthcare. That reform is, apparently, now gone.  Instead, the current administration proposal is to increase the tax on capital income, reducing the incentive for saving and investment. 

In other words, the new proposal would do less to bend the curve of rising healthcare costs and more to impede long-run economic growth.  This change was probably made to attract more House Democrats.  It will likely make the plan even less attractive to congressional Republicans.

By the way, according to CBO director Doug Elmendorf, the new administration proposal has too few details for the CBO to provide cost estimates.  Perhaps more details will be available in the days to come.

How Not to Stop Healthcare Inflation

The NY Times reports:

President Obama will propose on Monday giving the federal government new power to block excessive rate increases by health insurance companies, as he rolls out comprehensive legislation to revamp the nation’s health care system, White House officials said Sunday.

Very, very strange.  You would think that all those future Nobel-prize-winning economists working for the President would explain to him the history and economics of government price controls.  Imposing price controls certainly wasn't President Nixon's finest hour.

Maybe President Obama should instead follow in President Ford's footsteps and start wearing a WHINE button on his lapel, for Whip Healthcare Inflation Now, Egads!  

Feckless would be one step better than counterproductive.

What unions are getting...

....from the Obama Administration, according to The Economist:

Union leaders such as Mr Trumka and Andy Stern, the leader of the more moderate Service Employees International Union, are regular guests at the White House. Mr Obama has revoked some Bush-era executive orders that unions hate and issued a few they adore. He has appointed union insiders to top jobs, allowed Congress to add “buy American” provisions to the stimulus bill, risked a trade war with China to please tyre-workers, let other trade deals wither and brazenly favoured unions when bailing out car firms.

But his biggest favour has been green, foldable and borrowed. For example, he encourages the use of “Project Labour Agreements” on big federal construction projects, whereby contractors must recruit through a union hiring hall. Such agreements inflate costs by 12-18%, according to David Tuerck of Suffolk University, and were banned under Mr Bush. Even where PLAs are not in force, federal contractors are obliged to pay “prevailing” wages. That actually means something close to the union rates, which is nice for the workers in question but means that taxpayers get fewer roads and schools for their money.

What I've Been Reading

I enjoy good memoirs. At their best, they can give you a sense of what it would be like to lead a different life, to walk in another's shoes. Political memoirs are usually a disappointment, as the writers typically have an agenda, such as establishing a place in history or angling for the next job.  They seem more like spin than truthful self-assessment.  Memoirs by nerdy academics, rare as they are, are among my favorite, in part because I can easily see myself in them and in part because the authors are often brutally honest.

All this is a prelude to a book recommendation: My Life as a Quant: Reflections on Physics and Finance, by Emanuel Derman. I have never been a physicist or worked on Wall Street, but this book gives a good sense of what both career paths are like.

The book was written, by the way, before the recent financial crisis. As a result, one does not get a sense of how the author would put recent events into perspective. But by the end of the book, the author is skeptical enough about the use and abuse of financial models that I suspect he would not be terribly surprised when they went awry.

Fiscal Stimulus, One Year Later

Pro and Con.

Thoughts about the Fiscal Commission

Here is a question I have been pondering.  If you were a member of the fiscal commission, what would you try to achieve?

The answer for liberals is easy: They want to raise taxes to fund the existing, and even an expanded, social safety net, while politically insulating the Democrats as much as possible from the charge of being the "tax and spend" party.  President Obama can then campaign in 2012 that he did not break his no-taxes-on-the-middle-class pledge, but rather a bipartisan group broke it.  That is, the President wants to take credit for fixing the fiscal situation but duck responsibility for having imposed higher taxes.

But what if you are conservative?  This is harder.  You can try to stick to your no-tax-increase position.  The problem is that doing so would require spending cuts larger than are politically realistic.  If I were king, I bet I could find sufficient spending cuts.  But I am not expecting to be anointed any time soon.  If the fiscal commission is going to succeed, tax increases will have to be part of the deal.

A reasonable position is, perhaps, that the commission should not succeed.  After all, it is the president's responsibility to put out a budget.  The one he just released is, as I explained in my recent Times column, not sustainable.  He just passed the buck to the fiscal commission.  Perhaps conservatives should not allow him to do that but, instead, should try to force him to put out a sustainable budget on his own.  After all, isn't that Peter Orszag's job?

But let's suppose that you are a conservative and you want the fiscal commission to succeed.  You will have to agree to higher taxes as part of the bargain.  But what should you aim to get in return?  Here is my list.

1. Substantial cuts in spending.  Ensure that the commission is as much about shrinking government as raising revenue.  My personal favorite would be to raise the age of eligibility for Social Security and Medicare.  Do it gradually but substantially.  Then index it to life expectancy, as it should have been from the beginning.
2. Increased use of Pigovian taxes.  Candidate Obama pledged 100 percent auctions under any cap-and-trade bill, but President Obama caved on this issue.  He should renew his pledge as part of the fiscal fix. A simpler carbon tax is even better.
3. Use of consumption taxes rather than income taxes.  A VAT is, as I have said, the best of a bunch of bad alternatives.  Conservatives hate the VAT, more for political than economic reasons.  They should be willing to swallow a VAT as long as they get enough other things from the deal.
4. Cuts in the top personal income and corporate tax rates.  Make sure the VAT is big enough to fund reductions in the most distortionary taxes around.  Put the top individual and corporate tax rate at, say, 25 percent.
5. Permanent elimination of the estate tax.  It is gone right now, but most people I know are not quite ready to die.  Conservatives hate the estate tax even more than they hate the idea of the VAT.  If the elimination of the estate tax was coupled with the addition of the VAT, the entire deal might be more palatable to them.

One thing is clear: The Democrats in Congress would hate the five demands above.  But that is precisely the point.  The fiscal commission is giving the Democrats something of very high value: political cover for a major tax hike.  If Republicans are going to give them that, they should get something very big in return.  If the conservatives on the commission could achieve my five goals above, it might be a deal worth talking about.

An Illogical Attack on the GOP

The Democratic Party is attacking some Republican congressmen for both opposing the stimulus bill and also helping direct some stimulus spending into their districts.

I don't know the facts of the case, but the logic of the Democratic position baffles me.  It seems perfectly reasonable to believe (1) that increasing government spending is not the best way to promote economic growth in a depressed economy, and (2) that if the government is going to spend gobs of money, those on whom it is spent will benefit.  In this case, the right thing for a congressman to do is to oppose the spending plans, but once the spending is inevitable, to try to ensure that the constituents he represents get their share.  So what exactly is the problem?

Let me offer an analogy.  Many Democratic congressmen opposed the Bush tax cuts.  That was based, I presume, on their honest assessment of the policy.  But once these tax cuts were passed, I bet these congressmen paid lower taxes.  I bet they did not offer to hand the Treasury the extra taxes they would have owed at the previous tax rates.  Would it make sense for the GOP to suggest that these Democrats were disingenuous or hypocritical?  I don't think so.  Many times, we as individuals benefit from policies we opposed.  There is nothing wrong about that.

The Buck Stops Where

Click here to read my latest column in the NY Times.

Ranking CEAs

Tino Sanandaji ranks CEAs by their academic accomplishments.  The ranking is based on the total citations of the three members on the Council.

The ERP

CEA Chair Christy Romer blogs about the new Economic Report of the President.  She also provides the link to the report itself.

One of my former staff at the CEA takes note of this sentence:

This past year, the Council has been blessed with staff of a caliber not seen since the glory days of the CEA in the 1960s, when future Nobel laureates Robert Solow and Kenneth Arrow were senior economists and James Tobin was a member.

Really? I am impressed with the current CEA staff as well, but this seems a bit of an overstatement. I wonder who on the current staff is expected to win a Nobel prize.

I am proud of the staff I put together when I was CEA chair, and I am sure other CEA chairmen are as well.  Yet I would venture a guess that the post-1960s peak in the caliber of the CEA came in 1982-83.  I was a junior staffer then, along with University of Chicago economist John Cochrane, but put that aside.  Martin Feldstein was the chair, and the senior staff included Larry Summers and Paul Krugman.  That makes three winners of the John Bates Clark Award--a feat that, I suspect, has not been repeated since.

Here is a project for some ambitious blogger: Go to old ERPs, which list the CEA members and staff, and collate them with data on citations.  That would provide one way to judge objectively (albeit imperfectly) the quality of CEA economists over time.

Update: Here.

Become an Ec 10 Section Leader

Interested in an exciting teaching opportunity?  Become a section leader for ec 10, the introductory economics course at Harvard College. 

The job is open to PhD candidates in economics, master's students in public policy, business, and related fields, and law students.  The only requirements are a good training in economics and a desire to share your passion about the field with some of the best undergraduates on the planet.  Past ec 10 section leaders have included NEC Director Larry Summers, Federal Reserve Governor Kevin Warsh, and CBO Director Doug Elmendorf, as well as the humble proprietor of this blog.

Click here to learn more.  (Access to this link available only to members of the Harvard community.)

Imperfect Information and Aggregate Supply

I have posted a new paper, which Ricardo Reis and I have prepared for the new Handbook of Monetary Economics.  Warning: For econonerds only.

Reading the Budget's Footnotes

From the Commitee for a Responsible Federal Budget:

The Administration is taking two tax provisions from the 2009 stimulus bill -- expansions of the child tax credit and the EITC -- and claiming them as part of the "current policy" Bush tax cuts. And they are doing something similar for Pell grants: assuming that they will receive sufficient funding to pay out the maximum grant level set in the stimulus bill.

The Administration didn't inherit these policies, they created them. And worse, still, they created them as explicitly temporary, under a stimulus bill which they claimed was meant only to help bring us out of this recession.

Yet the White House wants to continue these policies, and they don't want to pay for them. So what do they do? They hide these policies in their baseline, in the hopes that they won't have to.

Austan Goolsbee on The Daily Show

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Austan Goolsbee
www.thedailyshow.com
Daily Show Full Episodes Political Humor Health Care Crisis

Two economists walk into a bar...

Reflections on the Housing Market

An analysis, in verse, from Wellesley economist Karl Case:

For the last few years, we have shed many tears
Living through a recession.
The economy's broke and it's not a joke,
When we talk of another depression.
Fifteen million without a job,
Foreclosures and banks that fail,
401K's became 201K's,
And everything's up for sale.

How can it be? What didn't we see
That led to all of this trouble?
There is little doubt that the proximal cause
Was a bursting housing bubble.
But other than that, who can we blame?
And what do they lament?
Millions of people contributed to
This hundred-year event.

For me, it began in '76
With a house on Cleveland Road.
At fifty-four thousand, I thought it a lot
For a small three-bedroom abode.
But ten years later, that very same house
Would sell for four times the price.
I was glad that I bought...I remember the thought,
"This may not be fair, but it's nice."

In Boston alone, that boom created
$100 billion in wealth.
We spent more, saved less, and I have to confess,
It was good for our mental health.
We had to know that it couldn't go on.
Someday prices would fall.
We knew there were risks -- to ourselves and our fiscs
If those prices were ever to stall.

It all began in 2001,
9/11, the dot.com bubble.
The Fed had to act because of the fact
A recession would mean big trouble.
So the Fed funds rate, sitting just below eight,
Was cut to under two.
And you had to know, with rates so low,
That a refi boom would ensue.

The volume of mortgages written back then
Stunned imaginations.
In a single quarter in 2003,
A trillion in originations!
But something happened late that year
That caused long rates to rise.
And that was the end of the refi boom.
It came as quite a surprise.

With refi's gone, so were big fees,
But banks still had money to lend.
And the search for buyers to fill the gap
Seemingly had no end.
The Fed kept pumping through 2005
To keep short rates very low.
And Greenspan gets a share of the blame;
His halo has less glow.

Of course the key for all to see
Was a robust housing market.
Buyers could borrow lots of cash
And a house was a good place to park it.
A summer home...a new big house,
No one seemed to care.
Homes were made of bricks and land,
The value would always be there.

It didn't matter what rate you paid
Or what you made in a year.
For a while liquidity led to stupidity,
"Just sign and see the cashier."
High LTV's and Option ARMs
Negative AM's and more,
2-28's with teaser rates
And ridiculous Fico scores.

Competition was the force
That made the music play.
As long as prices didn't fall
Everything was OK.
People could always sell their house
For more than they had paid.
Defaults and foreclosures stayed quite low
And lots of money was made.

Fannie and Fred were always ahead,
Then Countrywide got in the fray.
Then Lehman and Merrill and Goldman Sachs
Couldn't be kept away.
You can guess that MBS
Helped make the trading brisk.
Investors thought that the paper they bought
Was traunched with well-measured risk.

To that, add leverage and default swaps,
And then when house prices fell,
"Smart guys" got hosed as the risks were exposed,
And that was the closing bell.
Now where do we go? We really don't know.
We've never been here before.
Only time will tell when the markets will clear
And prices will fall no more.

Some of the data suggest a bottom,
While other data conflicts.
Houses are selling at rates not seen
Since back in 2006.
The inventory of unsold homes
Is down, it no longer grows.
And we're not building any new homes.
Starts are at 50-year lows.

A number of problems remain as risks
As the market begins to turn:
The number of loans that still need to be marked
Is making stomachs churn.
Fifteen million who want to work
Don't have jobs today.
And slow is the pipeline of loans in default
Since no one wants to pay.

It could also be that the pick-up we see
Is just from government red.
Lower rates and tax rebates
Buying paper from Fannie and Fred.
All have certainly played a role
And only time will tell.
What will happen when they're withdrawn,
Still empty units to sell?

So now we come to the end of this ode
Without much to say for certain.
I hate to say, that's where we are
Not beginning or final curtain.
The truth of the matter at the end of the day
Is that markets will make you humble.
Just when you think that it's time for a drink
They will turn and fortunes will crumble.

That free markets work to provide what we want
Is a notion that is not in dispute.
The problem is that once in awhile,
Markets overshoot.
Of course there is greed and there is a need
For moral hazard and rules.
You are damned if you do and damned if you don't.
To be "pure" is a game for fools.

Politicians, of course, are starting to shout
That they want more retribution.
It's better, I think, if they used their time
Helping to find a solution.

Economics Comedy

Here.

Defending Jobs Abroad

Analysis from Dartmouth economist Matthew Slaughter.

The Blame Game

Keith Hennessey dissects the Administration's rhetoric.

The Sorry State of Cap-and-Trade

As Donald Marron points out, "At a time of unsustainable deficits, deficit neutrality is a remarkably lame vision for climate policy."  He explains:

Last year, President Obama proposed to raise $500 billion over ten years through a cap-and-trade system that would limit carbon emissions. This year his climate policy raises nothing.

The president still backs cap-and-trade, but he has caved into congressional pressure to give away or spend all that potential revenue rather than use it to help taxpayers. Cap-and-trade has thus become cap-and-spend.

The new policy is described as follows in a footnote to Table S-2 of the budget:

A comprehensive market-based climate change policy will be deficit neutral because proceeds from emissions allowances will be used to compensate vulnerable families, communities, and businesses during the transition to a clean energy economy. Receipts will also be reserved for investments to reduce greenhouse gas emissions, including support of clean energy technologies, and in adapting to the impacts of climate change, both domestically and in developing countries.

I am sympathetic to the idea that the value of some emission allowances should be used to compensate some families, communities, and businesses as the system ramps up. But studies have repeatedly found that such compensation would require only a fraction of the overall value of the allowances. There should still be plenty of room for allowances that are ear-marked for deficit reduction.

President Obama's New Budget

Click on graphic to enlarge.

From Keith Hennessey:

Again, green is last year’s proposal, blue is this year’s proposal, and dotted pink (30-years) and red (50-years) are historic averages.

We can conclude:

1.The President is proposing significantly more spending than he proposed last year: 1.8% of GDP more in 2011, and roughly 1 percentage point more each year over time.

2.Spending is and will continue to be way above historic averages.

At its lowest point in the next decade federal spending would still be 1.7 percentage points above the 30-year historic average. Over the next decade, President Obama proposes spending be 12% higher as a share of the economy than it has averaged over the past three decades.

Job Opening

I have been running the introductory economics course at Harvard together with the very capable economist Silvia Ardagna.  Sadly, Silvia is leaving Harvard next year to take a job in London.  As a result, the economics department is looking for a new person to replace Silvia as head section leader for ec 10.  The head section leader teaches one section of the course and has significant responsibilities for course administration. To learn more about this job opportunity, click here.