Let me offer three basic principles that our leaders—and our fellow citizens—should keep in mind in evaluating new revenue options:
It is usually better to broaden the tax base rather than increase tax rates. Why? Because high tax rates create disproportionately large economic distortions and invite widespread evasion. Any effort to increase revenues should therefore focus first on the many special credits, exemptions, and exclusions that undermine our current tax base. Such “tax expenditures” cost more than $1 trillion each year but receive surprisingly little oversight. Some of these provisions generate economic or social benefits, but many are simply hidden ways to help special interests. Reducing or eliminating those tax expenditures could bring in new revenues, improve economic efficiency, and avoid the economic damage that would result from higher tax rates.
Income taxes are usually worse for the economy than consumption taxes. Why? Because income taxes discourage saving and investment, while consumption taxes do not. That is why a rising chorus of experts is recommending that the United States consider a value-added tax, rather than higher income taxes, if it decides it wants to finance substantially higher government spending.
Taxes usually discourage whatever activity is being taxed; as a result, it is better to tax bads rather than goods. Taxes on pollution, for instance, should be preferred over taxes on working, saving, or investing.
I am happy to announce that I will become the director of the Urban-Brookings Tax Policy Center on May 17. TPC has established a remarkable record of nonpartisan research on tax and fiscal policy issues over the past eight years, and I am honored to be joining their team.
Here’s the press release from the Urban Institute announcing the appointment:
WASHINGTON, D.C., April 13, 2010 — Donald Marron, who served as a member of the President’s Council of Economic Advisers and as acting director of the Congressional Budget Office, will become the director of the Urban-Brookings Tax Policy Center May 17.
Marron was a council member in 2008 and 2009. Earlier, he was the deputy director (2005–2007) and acting director (2006) of the nonpartisan Congressional Budget Office.
Marron’s White House experience includes stints as a senior economic adviser and consultant to the Council of Economic Advisers (2007–08) and as its chief economist (2004–05). He was with Congress’s Joint Economic Committee from 2002 to 2004, first as the Senate minority’s principal economist and later as the committee’s executive director and chief economist.
Marron succeeds Rosanne Altshuler, who will be returning to Rutgers University after nearly two years with the Tax Policy Center. The eight-year-old center, a joint venture of the Urban Institute and Brookings Institution, is the nation’s leading nonpartisan resource providing objective analyses, estimates, distributional tables, and facts about the federal tax system and proposals to modify it. Last year, Tax Policy Center researchers produced more than 50 reports and used their state-of-the-art tax model to generate over 500 sets of detailed tax estimates.
“Understanding and helping address the nation’s revenue problems require imaginative scholarship, crisp communication skills, and an insider’s knowledge about how good public policy can be made. Donald brings that and much more to the Tax Policy Center,” said Robert Reischauer, president of the Urban Institute.
Since leaving his White House post, Marron has been a visiting professor of public policy at Georgetown University and an economic consultant.
Marron, who holds a doctorate in economics from the Massachusetts Institute of Technology, was an assistant professor of economics at the University of Chicago’s Graduate School of Business from 1994 to 1998. He is a member of the Bipartisan Policy Center Debt Reduction Task Force and served as a member of the Federal Accounting Standards Advisory Board.
The Tax Policy Center’s leadership also includes two co-directors, William Gale, the Arjay and Frances Miller Chair in Federal Economic Policy at the Brookings Institution, and Eric Toder, an Institute fellow at the Urban Institute.
The Urban Institute is a nonprofit, nonpartisan policy research and educational organization that examines the social, economic, and governance challenges facing the nation. It provides information, analyses, and perspectives to public and private decisionmakers to help them address these problems and strives to deepen citizens’ understanding of the issues and trade-offs that policymakers face.
The Brookings Institution is a private nonprofit organization devoted to independent research and innovative policy solutions. For more than 90 years, Brookings has analyzed current and emerging issues and produced new ideas that matter—for the nation and the world.
P.S. I am also happy to report that I will continue my teaching at the Georgetown Public Policy Institute next year. Should be a fun and busy year.
Last week Spirit Airlines announced that it would start charging fees for carry-on bags this summer. Spirit described the benefits of this move as follows:
“In addition to lowering fares even further, this will reduce the number of carry-on bags, which will improve inflight safety and efficiency by speeding up the boarding and deplaning process, all of which ultimately improve the overall customer experience,” says Spirit’s Chief Operating Officer Ken McKenzie. “Bring less; pay less. It’s simple.”
As I’ve noted in previous posts, carry-on bags have become a problem on many flights. With advances in roll-aboard technology and in the face of new fees for checked luggage, more passengers are bringing baggage on board, sometimes overwhelming the capacity of the overheads. Airlines need to find a solution to that problem. Spirit’s fees are one possible answer.
I’m sure Spirit expected that some passengers and passenger advocates would object to these fees. I wonder, however, whether the airline ever suspected that it would incur the wrath of Washington?
If you are like me, your first reaction should be to wonder why the Treasury Secretary–rather than, say, the Transportation Secretary–is the lucky recipient of Schumer’s letter. This being the middle of April, however, the answer shouldn’t surprise you: taxes, specifically the taxes that are levied on airline tickets (but not on some other fees associated with flying). The narrow issue is whether the carry-on fees should be subject to the tax. The broader issue is whether carry-on fees should be allowed separate from the ticket price.
Meanwhile, the Transportation Secretary, Ray LaHood, wasted no time in denouncing the proposed fees as well, saying:
I think it’s a bit outrageous that an airline is going to charge someone to carry on a bag and put it in the overhead. And I’ve told our people to try and figure out a way to mitigate that. I think it’s ridiculous.
So watch out Spirit Airlines; your experiment in pricing scarce overhead capacity may not be welcome in Washington, even if it does lead to lower fares and faster boarding.
P.S. The tempest over the baggage fees is temporarily overshadowing a much more interesting and important issue: the transparency and intelligibility of airline fees. Secretary LaHood touches on this in the interview linked to above, as does this article over at Philly.com’s Philadelphia Business Today. Given the panoply of fees and taxes on air travel–thanks both to the government and to the airlines–there’s a real question about whether consumers understand the full costs of flying when they make their purchasing decisions. And some airlines–most notably Spirit with its “penny” and “$9” fares–seem to be playing on that.
My recent post about oil and natural gas prices elicited some very constructive responses from readers (thanks in particular to PJ, MF, and FW, in addition to public commenters on the post). As a result, I’ve rethought my discussion of the relationship between oil and natural gas prices.
I was also inspired to look at the futures markets to see what they are signaling about the relationship between oil and natural gas prices. Here’s my usual chart of the ratio of oil prices to natural gas prices, now showing both history (lighter blue) and futures markets (darker blue):
As noted in my earlier posts, oil and natural prices appear to have disconnected from their historical relationship. For many years, oil prices (as measured in $ per barrel) tended to be 6 to 12 times natural gas prices (as measured in $ per MMBtu). That ratio blew out to more than 20 in late 2009, then receded to more traditional levels, and then blew out again in recent months. At yesterday’s close, the ratio stood at 21.8, far above its historical range.
In my previous posts, I argued that this unusual pricing reflects the sudden (and welcome) increase in natural gas supplies and that we should expect oil and natural gas prices to eventually move back toward their historical relationship as markets absorb the new gas. Of course, I was careful not to say when this would happen.
As shown in the graph, the futures markets are indeed signaling some normalization in the price ratio in coming years, but not a rapid one. Moreover, even after eight years, the ratio would return only to the upper end (12) of its historical range. (Caveat: Futures markets are quite thin that far out, so we shouldn’t place too much weight on those distant prices.)
Let me offer a revised interpretation of the pricing relationship that’s consistent both with the futures data and the comments I received. This interpretation (consider it a theory, really) distinguishes four time periods:
Good Old Days: For many years, the electric utility industry had generating plants that ran on oil, natural gas, or both. The ability to fuel switch (either by changing the dispatch order of oil and gas plants or changing fuels at plants that could use either) limited how much oil and natural gas prices could deviate. If oil prices fell too low, utilities would move from natural gas to oil, and vice-versa. Similar fuel arbitrage occurred, to varying degrees, among other uses as well (e.g., home heating and some industrial uses).
More Recent Days: In recent decades, electric utilities have embraced natural gas and moved away from oil. As a result, there is much less opportunity for arbitrage between the fuels. The same has happened among other fuel consumers as well. Oil and natural gas prices nonetheless remained within their usual historical relationship. For example, oil and natural gas prices rose and fell in tandem during 2008. This suggests that the markets encountered similar shocks during those years (e.g., strong demand or, some would argue, speculation), not that they were linked via arbitrage.
Today: With the decline of traditional fuel arbitrage possibilities, oil and natural gas prices can now move separately if they experience distinct shocks. That appears to have happened with the increase in natural gas supply, for example.
Future: Looking further ahead, however, one would expect some new arbitrage relationships to develop. If we have persistently cheap natural gas and persistently expensive oil, that creates an incentive for ingenious folks to find ways to use natural gas to serve what have traditionally been oil demands. That should eventually limit the degree to which the prices can deviate (although not necessarily in the 6 to 12 ratio range). Two leading candidates for this linkage are using natural gas as a transportation fuel (directly as a fuel and perhaps indirectly as electricity) and increased international trade in liquified natural gas.
Note: The chart uses the spot price for West Texas Intermediate at Cushing and the spot price for natural gas at Henry Hub on a monthly basis through March 2010. For April 2010, I use the closing prices on April 8. The monthly futures are from the CME Group.
During the initial years of the housing downturn, optimists sometimes offered the following argument: “Everyone has to live somewhere. If a family loses their home to foreclosure, they will become renters. Their new residence might be smaller and less desirable than their former home, but from the perspective of housing units it’s a wash: their former home becomes vacant, but a previously empty rental becomes occupied. That should limit downward pressure on housing overall.”
That argument contains an element of truth: many foreclosed homeowners do indeed become renters (some even become homeowners again). But I’ve always wondered how many former homeowners follow a different path and instead move in with their parents, friends, or roommates, rather than getting their own place to live. Similarly, I’ve wondered how many young adults have delayed starting their own households and instead have stayed at home longer.
On Wednesday, the Mortgage Bankers Association released a study by Gary Painter (sponsored by the Research Institute for Housing America) that examines this question. His answer? America lost 1.2 million households from 2005 to 2008, despite ongoing population increases. Oh, and we likely lost even more households in 2009.
Needless to say, that retrenchment contributes to the ongoing overhang of vacant homes and rental properties.
As one piece of evidence about changes in household formation, Painter looked at the fraction of households that were overcrowded, which is defined as having more people than rooms. He found that overcrowding rates increased sharply from 2005 to 2008 (the most recent year for which he had data):
As any frequent flyer knows, the competition for overhead space is tight. As I noted a few months ago (“The Warped Economics of Carry-On Luggage“), the situation has only become worse since airlines started charging fees for checked luggage. Budget-conscious travelers caught on quick and started carrying on more of their luggage.
In economic terms, the basic problem is a lack of property rights to overhead space. Without those rights, there is a tragedy of the commons as travelers try to grab space before their fellow travelers (just as some guacamole eaters compete for appetizers). Particularly egregious? The passenger in row 35 who brings on two over-sized roller bags and stows them in the overheads around row 15. No, I’m not bitter.
One solution to this problem would be to create property rights to overhead space. But that would be hard to operationalize.
Another possibility–which Spirit Airlines announced today–would be to charge for carry-ons. Spirit announced:
In order to continue reducing fares even further and offering customers the option of paying only for the services they want and use rather than subsidizing the choices of others, the low fare industry innovator is also progressing to the next phase of unbundling with the introduction of a charge to carry on a bag and be boarded first onto the airplane.
The carry on fee ranges from $20 to $45, the same or more than the fees for a single checked bag (fees for multiple bags may be higher). Personal items (i.e., the things you put under your seat) remain free.
Note how Spirit frames this as helping the airline reduce fares. In the future, I hope some enterprising economist studies the different bag pricing approaches that the airlines use to see to what extent higher bag fees–checked or carry on–translate into lower fares and either more or less crowded overhead compartments.
Last summer I noted that oil and natural gas prices had diverged to an unprecedented degree. I bravely predicted that this divergence would reverse (unbravely, I didn’t predict when).
As the chart below shows, I was right: the price relationship did move sharply toward normal levels. In the last two months, however, it’s blown out again:
The chart shows the ratio of the price of oil (measured in $ per barrel) to the price of natural gas (in $ per MMBtu). Under normal circumstances, that ratio fluctuates between 6 and 12. A barrel of oil has roughly 6 times the energy content of a MMBtu of natural gas. If the fuels were perfect substitutes, oil prices would thus tend to be about 6 times natural gas prices. In practice, however, the ease of using oil for making gasoline makes oil more valuable. As a result, oil has usually traded higher.
Natural gas closed today at $4.11 per MMBtu. Under normal circumstances, that would imply an oil price of around $25 to $50. But oil actually closed above $85. As a result, the ratio of oil prices to natural gas prices is up at 20.7, well above the usual range and closing in on the peaks of last summer (on the day before I wrote my earlier piece, the ratio reached 24.5).
Where do prices go from here?
Well, history still suggests that the price gap will eventually narrow, through some combination of oil prices falling and natural gas prices rising. But there’s no guarantee that will happen in the short-run. Over the longer-term, however, I feel confident that demand for natural gas will rise to meet the new supply (the prime reason why natural gas prices have been so low recently) and that the oil vs. natural gas price relationship will eventually move back to normal. Natural gas is cleaner than coal and is available in large quantities in the U.S. and Canada. As a result, natural gas is on the short-list of potential responses to climate change and oil dependence, two concerns that aren’t going away anytime soon.
Note: The chart uses the spot price for West Texas Intermediate at Cushing and the spot price for natural gas at Henry Hub. Both series are monthly, except for the prices for today, 4/01/10.
P.S. Note that I have again obeyed the first law of forecasting: I have given a prediction (the relationship between oil and natural gas prices will normalize), but I haven’t given a date.