Archive for March, 2012

Ran into Felix Salmon out at the Kauffman Foundation’s economic bloggers confab. His latest Felix TV breaks the contemporary art market down into two simple metrics: $ per spot and $ per stripe.

Feliz says buy spots. But a word of warning: Damien Hirst seems hellbent on flooding the dot market. Somehow I think the price of a dot will plummet when he releases his painting with 2 million dots.

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In a new paper, my Tax Policy Center colleague Eric Toder and I argue that the federal government is larger than conventional budget measures suggest. Why? Because many tax preferences are effectively spending programs. Adding these “spending-like tax preferences” back to federal spending and revenues gives a better picture, we think, of the federal government’s true size.

In 2007, for example, federal spending was officially recorded as 19.6 percent of GDP. If you add in the tax preferences that Eric and I believe are effectively spending (the SLTPs), that figure rises to 23.7 percent. In round terms, the government was one-fifth larger than traditional budget figures indicate:

And that’s not all. We also consider the many user fees and premiums that the government charges for various services, ranging from regulatory activity (e.g., patent fees) to Medicare premiums. Such payments are treated as negative spending in official budget calculations. This is sometimes done as a pure budget gimmick to make the government look smaller. More often, however, it’s done for a good reason: to focus on government activities that are funded collectively. That’s an important thing to measure when budgeting. But it’s not the only one. If you want to know how much economic activity is occurring through government agencies, you should consider the gross size of those activities, not just the net. The third column thus adds back user fees and premiums to get the full size of the federal government: 25.4 percent of GDP in 2007.

Eric and I would be the first to argue that the size of government, by itself, tells you little. Small governments can be dysfunctional, and large ones can be well-run. But government size plays a central role in many political discussions. Given that attention, we think it’s worthwhile to consider whether existing measures fairly capture its true size.

And, as a crucial corollary, whether they fairly capture the implications of potential policy changes. As I will discuss in a subsequent post, our measure of government size has several important implications. For example, some “tax increases” (e.g., closing loopholes and reducing many other tax preferences) actually make the government smaller.

P.S. The figures in our paper are based on information from the administration’s 2012 budget. Some historical figures have changed slightly since then, due to revisions in GDP and budget figures.

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My latest column at the Christian Science Monitor lays out the case for corporate tax reform:

April 1 is often a day for pranks. In the tax world, however, it will mark something more serious. Barring another Fukushima Daiichi-like catastrophe (which delayed its plans last year), Japan will cut its corporate tax rate by five percentage points. That move will leave the United States with the highest corporate tax rate in the developed world: 39.2 percent when you add state and local taxes to the 35 percent federal rate.

The corporate income tax is a particularly problematic way to collect tax revenues. Corporate taxes are often more harmful for economic growth than ones on personal income or consumption, as noted in a recent study by the Organization for Economic Cooperation and Development. Moreover, a high corporate rate is an invitation for US multinationals to play games with their accounting, locating profits overseas while reporting as many tax-deductible expenses as possible here at home.

That’s why there’s a growing bipartisan consensus that the federal rate needs to come down. President Obama recently proposed lowering it to 28 percent. His likely Republican challenger, Mitt Romney, wants to bring it down to 25 percent.

But corporate tax reform can’t just be about lowering the statutory rate. America faces enormous budget challenges and cannot afford to simply cut future revenue. Moreover, the high statutory rate isn’t the only problem with our system. The code is riddled with tax subsidies and loopholes. Those tax breaks, more generous than those in many nations, reduce corporate tax burdens significantly.

That leaves us with the worst possible system. It maximizes the degree to which corporate managers must worry about taxes when making business decisions but limits the revenue that the government actually collects.

One side effect is that the system plays favorites among different businesses. Retailers and construction companies, for example, pay an average tax rate of 31 percent, according to recent Treasury Department calculations, while utilities pay only 14 percent and mining companies (which include fossil fuel producers) pay only 18 percent.

I know of no reason why the tax system should favor utilities and mining while hitting construction and retailers so hard. Far better would be a system in which investors deployed their capital based on economic fundamentals, not the distortions of the tax system.

Another problem is that the system perversely favors debt financing over equity. Interest payments are tax-deductible, while dividends are not. Corporations thus have a strong incentive to finance their investments by borrowing. Given what our economy’s been through, it is hard to believe that the tax system ought to subsidize more debt.

The solution to all this is to reduce the corporate tax rate while taking a hatchet to many corporate tax breaks. Done right, that would level the playing field across different businesses and between equity and debt and maintain revenues.

Mr. Obama and Mr. Romney have proposed reforms along these lines, albeit with much more clarity about the rate-cutting than the base-broadening. That isn’t surprising.

Leveling the playing field (while maintaining revenues) will require that some companies pay more so others can pay less. Politicians would rather focus on potential winners, not losers. But losers there will be.

The US Chamber of Commerce has said that it “will be forced to vigorously oppose pay-fors [tax increases] that pit one industry against another.” But such pitting is exactly what will be necessary to enact comprehensive corporate tax reform.

P.S. You might be wondering what tax breaks I would cut in order to lower corporate tax rates. I haven’t had a chance to put together a complete package, but a starting point would be the domestic production credit (a subsidy for manufacturing), many energy subsidies (the ones for fossil fuel don’t make much sense, and I’d rather we use taxes than tax subsidies to encourage greener energy production), and the benefit of debt finance (e.g., by limiting deductibility of interest). Interest deductibility isn’t usually viewed as a tax break, but it leads to perverse effects when combined with favorable depreciation rules. Many propose rolling back those depreciation rules, but given the overall tax preference for debt, it’s worth considering limiting interest deductibility instead.

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Rhetoric matters in economic policy debates. Would allowing people to purchase health insurance from the federal government be a public option, a government plan, or a public plan? Would investment accounts in Social Security be private accounts, personal accounts, or individual accounts? (See my post on the rule of three.) Are tax breaks really tax cuts or spending in disguise? Is the tax levied on the assets of the recently departed an estate tax or a death tax?

In an excellent piece in the New York Times, Eduardo Porter describes another important example, how we characterize differences in income:

Alan Krueger, Mr. Obama’s top economic adviser, offers a telling illustration of the changing views on income inequality. In the 1990s he preferred to call it “dispersion,” which stripped it of a negative connotation.

 In 2003, in an essay called “Inequality, Too Much of a Good Thing” Mr. Krueger proposed that “societies must strike a balance between the beneficial incentive effects of inequality and the harmful welfare-decreasing effects of inequality.” Last January he took another step: “the rise in income dispersion — along so many dimensions — has gotten to be so high, that I now think that inequality is a more appropriate term.”

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Over at the Atlantic, Mark Bowden tells the tale of Don Johnson, who managed to win $4 million playing blackjack at Caesars in Atlantic City, $5 million at the Borgata, and $6 million at the Tropicana.

How’d he do it? By negotiating favorable odds:

Johnson is very good at gambling, mainly because he’s less willing to gamble than most. He does not just walk into a casino and start playing, which is what roughly 99 percent of customers do. This is, in his words, tantamount to “blindly throwing away money.” The rules of the game are set to give the house a significant advantage. That doesn’t mean you can’t win playing by the standard house rules; people do win on occasion. But the vast majority of players lose, and the longer they play, the more they lose.

Sophisticated gamblers won’t play by the standard rules. They negotiate.

Johnson started negotiating.

Once the Borgata closed the deal, he says, Caesars and the Trop, competing for Johnson’s business, offered similar terms. That’s what enabled him to systematically beat them, one by one.

In theory, this shouldn’t happen. The casinos use computer models that calculate the odds down to the last penny so they can craft terms to entice high rollers without forfeiting the house advantage. “We have a very elaborate model,” Rodio says. “Once a customer comes in, regardless of the game they may play, we plug them into the model so that we know what the house advantage is, based upon the game that they are playing and the way they play the game. And then from that, we can make a determination of what is the appropriate [discount] we can make for the person, based on their skill level. I can’t speak for how other properties do it, but that is how we do it.”

So how did all these casinos end up giving Johnson what he himself describes as a “huge edge”? “I just think somebody missed the math when they did the numbers on it,” he told an interviewer.

Johnson did not miss the math. For example, at the Trop, he was willing to play with a 20 percent discount [i.e., you get 20% of any losses back] after his losses hit $500,000, but only if the casino structured the rules of the game to shave away some of the house advantage. Johnson could calculate exactly how much of an advantage he would gain with each small adjustment in the rules of play. He won’t say what all the adjustments were in the final e-mailed agreement with the Trop, but they included playing with a hand-shuffled six-deck shoe; the right to split and double down on up to four hands at once; and a “soft 17” (the player can draw another card on a hand totaling six plus an ace, counting the ace as either a one or an 11, while the dealer must stand, counting the ace as an 11). When Johnson and the Trop finally agreed, he had whittled the house edge down to one-fourth of 1 percent, by his figuring. In effect, he was playing a 50-50 game against the house, and with the discount, he was risking only 80 cents of every dollar he played. He had to pony up $1 million of his own money to start, but, as he would say later: “You’d never lose the million. If you got to [$500,000 in losses], you would stop and take your 20 percent discount. You’d owe them only $400,000.”

Just another illustration that everything’s negotiable, at least if you are a big enough whale. The whole article is worth a read.

h/t: Longreads

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My recent post on “tribes” inspired some thoughtful reader comments about natural selection and stereotyping, and two book recommendations to steel yourself against your brain’s instinctive us vs. them wiring:

I’ve added both to my aspirational reading pile (if electrons can be piled).

Of note to readers in New York, reader Roger K. also noted the apposite opening of Nina Raine’s latest play:

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NPR aired an interesting trio of segments this morning about inconsistency and flip-flopping. I particularly enjoyed Alix Spiegel’s report on Jamie Barden, a psychology professor at Howard University. Barden’s work considers how “tribal” affiliation affects our perceptions of inconsistent behavior by politicians. In one experiment, Barden asked students their view of a hypothetical political operative named Mike who crashed while driving drunk and then, a few weeks later, gave a speech against drunk driving:

Now obviously there are two possible interpretations of Mike’s actions. The first interpretation is that Mike is a hypocrite. Privately he’s driving into poles. Publicly he’s making proclamations. He’s a person whose public and private behavior is inconsistent.

The other interpretation is that Mike is a changed man. Mike had a hard experience. Mike learned. Mike grew.

So when do we see hypocrisy and when do we see growth?

What Barden found is that this decision is based much less on the facts of what happened, than on tribe.

Half the time the hypothetical Mike was described to the students in the study as a Repubican, and half the time he was described as a Democrat.

When participants were making judgments of a Mike who was in their own party, only 16 percent found him to be a hypocrite. When participants were making judgments about a Mike from the opposing party, 40 percent found him to be a hypocrite.

I suspect this is the same phenomenon that leads sports fans to systemtically disagree with referee decisions against their favorite team.

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