How a Progressive Consumption Tax Works

Yesterday Gary Becker proposed switching to a consumption tax, one which could be made progressive. Since a progressive tax has higher rates for higher incomes, it's a bit hard to think how this is possible. If I buy milk, how will the government (or the store for that matter) know how much I make?

A progressive sales tax is progressive in an indirect way. We know that wealthy people tend to buy certain goods (superior good), middle-class people buy certain goods (normal goods), and poor people buy certain goods (inferior goods). Note in this case, an inferior good is not a good of poor quality. It's just one where people buy more of it when their income falls. College is an example (few wealthy people go to college).

Under progressive consumption taxes, restaurant food should be at a high tax rate, fast food at a moderate level, and little-to-no tax on food bought in a grocery store. Concerts should have a high tax and board games a low rate. The internet should be moderately taxed or not taxed at all.

The only issue with this kind of tax is its implementation. As you can guess, cataloging all these different goods would be incredibly time consuming. It's tempting to divide goods into large segments but selecting something as broad as "cars" becomes problematic. There are luxury cars and basic cars. In some places (e.g. NYC), many low income people don't have cars since public transportation is sufficient to meet their needs. In rural areas or in western states, this is less the case. It gets even more complicated considering some low income people need their car to operate a small business, regardless where they live.

Of course, we will have to accept some imperfections in a progressive consumption tax system. Imperfections are inevitable. But it's worth thinking about how it might work in practice.

Everyone Fires People. Every Day.

Mitt Romney's been under criticism for talking about his love of firing people:

At a breakfast event in Nashua, Romney told an audience that his health care plan would allow them to dismiss insurers and health care providers. "If you don't like what they do, you can fire them," he said. "I like being able to fire people who provide services to me."

Why is this so controversial? Because his critics use it to paint him as a Gatsby-like 1%er, firing his maid or butler just to watch them cry. But he's actually describing how average he is.

We fire people all the time. We do it so much, we don't even think about it. Today I went to Cakelove and had a cupcake. It cost over $3, but it was not worth $3, so I fired them: I won't go there again.

Then I fired the local AFI movie theater. I was going to go see Tinker, Tailor, Solider, Spy there but I kept reading reviews about how confusing it was if you haven't read the books. Not for me. I'll get it on Netflix so I can re-watch scenes, thank you very much.

For lunch I fired Einstein Bagels and Panera Bread. I usually grab something to eat at either of those places but I've grown tired of the limited number of things I like on their menu. Craving something new, I went to Baja Fresh. Will I fire them tomorrow? Probably; I'm thinking about making lunch in-house.

How many times have you fired someone today?

In Praise of AP Credit

Prof. Michael Mendillo doesn't like that high school AP classes can count to general requirements for college.

Lost to these nonscience students is an exposure to cutting-edge science and the methods of science taught by professors active on a daily basis in their exploration of nature. In how many AP classes in high school does the physics instructor say, "At the last American Physical Society meeting, one of my students presented a paper on this very topic"? Or, in an astronomy class, "My upcoming observations using the Hubble Space Telescope will address this dark-energy issue"? Identical scenarios exist, of course, for science and engineering students who miss out on university-level introductions to the humanities and social sciences taught by active scholars in those areas.

From what I remember of all of my introductory courses in college, there was very little "cutting edge" research discussed. And thank goodness for that! It's an introductory course. When I teaching introductory econ I rarely mention any new research and if I do, it is illustrative of some larger point (say an empirical paper on a price control). You don't want to overwhelm the students and, precisely because it's advanced, they probably won't understand it anyway. Imagine having a long discussion of the Higgs boson in Physics 101 when you're still trying to wrap your mind around Newton's Three Laws of Motion.

OK so you stick to offhanded references, not in depth discussions. Big deal. Admittedly, mentioning something cutting edge is cool to do and it can get your students interested in the introductory topic or illustrate where the puzzles in your discipline remain. Disallowing AP credit for college would generate these additional benefits but they are small. They come at a cost of the student not taking a course that's completely new or paying tuition for the semester that can no longer be avoided.

I had a student in introductory econ who didn't have to take my class: he had AP credit. He took it anyway since he'll be taking future courses from me, but I can't help but think that it was largely a waste of his time.

Fall 2010 Grade Distribution

Finally got around to do this. It's a distribution of all grades I handed out in the Fall of 2010, treating pluses and minuses as one category of the same grade. I'm 99% sure I removed all the students who dropped. N=64



Grades followed a rough normal distribution, but the low number of Bs is notable. I'm not yet sure what to make of this: could be random, could be that my assessment material is decisive, could be the ability of Bethany students is bimodal and that's reflected here. But the graph is interesting nontheless.

Quote of the Day

Alastair Smith on political tyranny:

But what if you really are trying to work for the common good? Is there no way of doing that?

None. If you’re working for the common good you didn’t come to power in the first place. If you’re not willing to cheat, steal, murder and bribe then you don’t come to power.

Read the whole thing; short and sweet.

Toil and Trouble

Robert Frank's submission for the Post's "2011 in charts" is number 12 and it's a bit strange. It's the toil index: Franks' term for "the effort required to rent a house served by a school of average quality." It shows a steady increase since the 1950s but it leaves out some key variables over the past 60 years. Homes have gotten larger, people per households have fallen, quality of standard household appliances have increased, etc. Some of these things are hard to measure, but median square feet is easy to find.

Below is the correction, with me eyeballing the original values from Frank's chart. My data only goes back to 1973 so I used those numbers for 1970 and excluded 1950 and 1960.



The original toil index is the green line (left axis) and the adjusted is the red line (right axis). You can think of the adjusted line as "the effort required to rent a square foot of space served by a school of average quality." All of a sudden, those numbers are not so severe. The 2000-2005 jump is still quite noteworthy, but general flattening of the curve cannot be denied (and this was just one correction).

The Capitalist Philosophy of the Muppets

The Muppets is about a dilapidated LA Muppet theater, an business tycoon looking to tear it down to drill for oil, and a familiar cast of characters trying to raise the money to save it. Last week Eric Bolling at Fox News claimed the movie is "brainwashing kids against capitalism" because the villain was a business man.

But The Muppets is the most capitalist movies this year. When they found out that their theater was in danger of being torn down they didn't lobby the California Historical Society to outlaw demolition. They didn't threaten to contact the EPA about the (admittedly real) problem of putting an oil well in downtown LA. They didn't head to Washington to seek a subsidy or add to construction regulations. They didn't even engage in California's infamous referendum system. In fact, none of these ideas ever occurred to them.

No, they did what every good capitalist does when someone tries to buy something they want: they outbid him.

Of Causation

MJ Perry posts this graph on his blog yesterday.



Perry quotes Scott Grannis who argues this chart lends support that Keynesian ideas are wrong. Expansion of the government leads to more unemployment and this is because the government is inefficient. It mostly takes money from one group and gives it to others.

But precisely because that's true, we should be suspcious of that interpretation based on this graph. Causation could easily run the other way. When unemployment increases, that puts more pressure on unemployment insurance, Medicaid, and other programs. It also increases the demand for fiscal stimulus.

Causation could also be confounding as well: something that's causing both higher unemployment AND a rise in government spending as a percent of GDP. This seems very likely as the "as percent of GDP" means the value could rise even if all that happens is GDP falls. Which is exactly what you'd expect to see if people are losing their jobs.

As sympathetic as I am to this anti-Keynesian take, this graph doesn't actually tell us anything useful.

Things ARE Getting Better

I end each principles of microeconomics class talking about the future. Historically, innovation does well to solve problems associated with an increasing population and society ends up better off than when it was when fewer people were around.

One of my students was very skeptical, especially about our ability to cure cancer. I hope she finds this article uplifting. We may be closer than you think to a cure.

How Food Stamps Can Send You To Hawaii

PolitiFact rated Gingrich's claim that food stamps can send people to Hawaii as "Pants on Fire," it was so wrong. Food stamps can only be used for food.

Yes, that's true, but that doesn't mean getting food stamps can't result in you being able to afford going to Hawaii. (I doubt that's what Gingrich meant, but it is true nonetheless). Food stamps are basically gift certificates. If I give you a $1,000 gift certificate to Wal-Mart, it will assuredly result in you buying more goods that don't come from Wal-Mart. You will substitute money you would spend at America's biggest retailer and instead spend it on other things. If you get food stamps, the effect is the same. So yes, food stamps can send you to Hawaii, though not directly.

Prices Solve Problems

As I read Naomi Klein's Nation article about climate change, I am once again reminded how little she knows about economics. So little, it is almost not worth pointing why she's wrong. Almost.

The fact that the earth’s atmosphere cannot safely absorb the amount of carbon we are pumping into it is a symptom of a much larger crisis, one born of the central fiction on which our economic model is based: that nature is limitless, that we will always be able to find more of what we need, and that if something runs out it can be seamlessly replaced by another resource that we can endlessly extract.

This is both completely wrong--scarce resources is what defines economics--and deceptively correct--we do assume we will adapt to greater scarcity. We assume this because when prices are allowed to function, we adapt. And we're adapting now. Let prices work, and we'll adapt more quickly.

We do not need to "shred" economic thought. We just need to make pollution more expensive. Right now, it's too cheap. Skeptics say it's not that much cheaper (if at all) than it should be. Believers say it's way too cheap. But regardless where you land, the answer is the same: adjust the price and you'll get the answer you want.

Klein makes suggestions--more public transportation, more planning, fewer coal-burning power plants, produce less pollution, make less stuff--which will all occur if we get the price of pollution right. (Of course planning will occur regardless if prices are right or not, regardless if it centralized or decentralized...the question is planning for what.)

Look: I don't know much about the science of climate change but I know that there's a consensus among people who know more than I that we're a big problem for the environment. The know more than I do: I respect that a lot.

So please respect this consensus from economists: The right prices solve problems.

A Very Interesting Sentence

Greece and the United States are two of the very few countries in the world in which defense expenditures exceed 4 percent of GDP.

From Posner.

Capitalist Environmentalism

People often think of companies as inherently anti-environment. This seems a bit strange, since companies would love to not pollute if it was the cheapest thing to do. After all, pollution means that you bought something and then threw it away. Cutting costs ties at least as much to environmentalism, not against it.

Consider server farms, which are black holes of energy consumption. About 1% of the world's energy goes to powering the computers and cooling them down. And half of that one percent goes to cooling. So companies like Facebook are moving their server farms to the Arctic Circle, where they can use the natural cool air to cut costs. Facebook is now building one in Lulea, Sweden.

Lulea's dry, frigid weather "definitely is a big part" of the company's decision to build there, Facebook spokesman Michael Kirkland said. Using outside air to cool servers is "absolutely beneficial not just from an environmental perspective, but also from a cost perspective."

Analysts agree. There are "overwhelming financial advantages" to building in the far north, according to Rakesh Kumar, an analyst with Gartner.

Utilizing free outside air can result in "tens of millions, if not hundreds of millions [of dollars], of savings per year" for each site, Kumar said.

Full story here.

HT: Tyler Cowen

On the Average Person's Economic Intelligence

Matt Yglesias posted these survey results on how best to create jobs.



This is why I put so little faith in the economic knowledge of the average voter. The third most popular idea to encourage job creation is to simply not fire people.

Know Your Own Argument

From Megan McArdle:

Similarly, a libertarian of my acquaintance recently found himself cornered at an event by a fellow complaining that government spending was far too high and needed to be cut, a proposition for which he offered in support . . . the work of Art Laffer.

"But didn't Art Laffer say that cutting tax rates would raise the amount of revenue that the government collects?"

"Well, sure," said the Lafferite.

"But then wouldn't government spending go up?"

The Lafferite, never having actually connected these two things in his head, fell mute.

Reverse Causality at the Fail Blog

HT: Fail Blog

Myths Are Simple

Robert Reich lists 7 myths of economics. None of them are actual myths. Actually, he's worse than that: he calls them lies. Basically the same as a myth but without the quaintness that comes with gods having sex with animals.

If you're calling something a myth (or a lie), you're saying "this is completely wrong and people who know what they're talking about know this is wrong." There should be a lot of wide-spread agreement that the proposed myth is wrong.

For example, all toxicologists agree that it's the dose--not the substance--which makes the poison. Tiny amounts of radiation won't hurt you at all. But drink too much water and you'll stomach will explode. Too much salt is bad for you, but you need a little salt to keep your body functioning.

Actual myths are simple, so simple they completely miss basic lessons of whatever disciple they pertain to. There's a mountain of evidence demonstrating why these myths are wrong. Anyone familiar with how the discipline works knows about the evidence.

Let's look at each of his proposed myths:

1. Tax cuts for the rich trickle down to everyone else. He points to how the median wage is flat over Reagan and dropped since W. Bush. Setting aside the fact that Reagan raised a lot of taxes, simply comparing median incomes doesn't account for income mobility. If you're getting wealthier as new people enter the labor market (young people, immigrants), median income might fall. (See here, unfortunately also claiming to be dispelling myths.)

2. Higher taxes on the rich would hurt the economy and slow job growth. Reich points to historical evidence of high tax rates and high growth but this is sloppy. The question is not is it possible to have high taxes with high growth but will higher taxes reduce growth? Unless Reich wants to overturn the law of supply, the answer, at least on the margin, has to be "yes."

3. Shrinking government generates more jobs. Reich points out that government is an employer. And if the goal was jobs, that would be fine. But for economists, the goal isn't jobs; the goal is efficiency. And due to knowledge and incentive problems, more government generally means less efficiency.

4. Cutting the budget deficit now is more important than boosting the economy. I am sympathetic to this view. If we were at full employment, our budget problems would probably be solved. Not only would expenses go down, revenues would increase. It is not clear how we get to boosting the economy, however, but, in general, cutting government at least makes us more efficient.

5. Medicare and Medicaid are the major drivers of budget deficits. Reich blames rising health care costs, which supports the "lie" rather than contradicts it.

6. Social Security is a Ponzi scheme. Yeah, I wouldn't call it a Ponzi scheme, as those are inherently unsustainable, but it's certainly close to it due to demographics. And if it wasn't it's still quite wasteful due to perverse incentives and the opportunity cost of investment.

7. It’s unfair that lower-income Americans don’t pay income tax. I agree with Riech here, especially given the regressive taxes (tolls, fines, sales taxes, fees, etc). But "fairness" is a normative point. How can that be a lie? Normative is about opinion!

Where the Roads Are

A GAO report shows that for each dollar a state contributes in gasoline tax, that state gets more than a dollar in highway funding. That's pretty funny since the whole idea of the tax is a sort of user fee for the roads. Clearly, this Solyndra-style payment scheme isn't what it's cracked up to be.

Here's a chart showing how much each state gets in highway money for every dollar it sends.



Two territories stand out as getting more than $3 for every dollar they contribute. First is Alaska at $4.99 for each dollar (quite a bit more than $3, actually). What's the deal here? My guess is that there's even more space between all the spread out towns. They spend more money on roads than the average state; they have to in order to connect all its disperse pieces. Here the big winners are the rural areas.

The second is DC at an even higher $5.85(!) for each dollar they collect in taxes. My first guess is that it was the politicians making extra sure their roads are in good condition. But I've driven in DC and at that ratio, I'd expect roads which clear themselves of snow and traffic so light, you'd think you're in the country except for all the buildings. Neither are near the case.

No, what makes the most sense is that commuters fill their tanks up outside the city, where it's cheaper. Where Alaska has extra costs, DC has less revenue. Waaay less revenue. Here the big winners are the city folk who get to enjoy their roads 7 days a week even though they are being paid for by motorists who only come in during the weekdays and are gone by the evening.

So while the whole thing is muddled up and it's important not to read too much into this since all the money goes to a big federal pot anyway, it seems like the suburbs are consistently the biggest losers in this deal. They pay for rural areas which are road intensive and they pay for city streets which they use disproportionately less than the city dwellers.

Of course, the city dwellers tend not to have cars so maybe it just comes out in the wash.

HT: Yglesias

From Hope to Despair

Prepping for a lecture on economics and ethics, I stumbled upon this article by Drs. William Harmon and Francis Delmonico about organ transplants in Iran. Iran has a unique approach to organ donation: donors are paid, partly in cash and partly in the form of life-long health insurance. Unsurprisingly, 80% of donors are poor.

The Iranian model also makes evident what has long been anticipated would occur in a regulated market. There is a fundamental unethical construct that cannot be overlooked despite the attributes that we have cited regarding the Iranian system. It is the poor person who bears the burden of being the kidney source for transplantation. That exploitation becomes real in Iran (>80%) as it does in any other regulated market. The poor person is coerced to make this donation decision, as there are no other means available to obtain money for what becomes temporary personal or family support. This coercion violates the dignity of the human person who is used by those who are highly advantaged to undergo transplantation within the same society.

It takes an impressive amount of intellectual gymanstics to turn someone's best option into a source of their despair precisely because it is their best option.

The Indifference Principle

I hope my managerial economics students can answer the following:

14. Briefly describe the Indifference Principle, when the Principle doesn’t apply, and why it doesn’t apply under those circumstances. (In answering this last part, it might be helpful to explain why the Indifference Principle applies under normal circumstances.)