Andrew Sullivan is smitten

A simplified tax code, consisting of a two-bracket income tax with a large standard deduction and a business consumption tax, would pay for a means-tested safety net, and a system of tax credits, risk pools and low-income subsidies would underwrite a free (or, well, somewhat freer) market in health care. In other words, Ryan would balance our books by shifting away from programs that shuffle money around within the middle and upper-middle classes — taking tax dollars with one hand and giving health-insurance deductions, college-tuition credits, home-mortgage deductions, Social Security checks and so forth with the other — and toward programs that tax the majority of Americans to fund means-tested support for the old, the sick, and the poor.

Paul Ryan is my new hero.

There is a lot about Ryan’s proposals to like: incentive based, progressive and in the long run, cost containing. Yglesias and Klein have focused on some of the downsides from a liberal perspective.

There is a potentially large libertarian downside as well: the  creation of extremely high marginal tax rates at low income levels. Ryan suggests that we means test everything. From the point of view of a household though, means testing is no different from marginal taxation. Every extra dollar you earn reduces the amount of government benefits you receive and so the return from working or investing is muted.

Means-testing can be particularly sinister because the tax rate is not obvious. The result is that effective marginal tax rates could climb to 100% or more. I tend to think that the elasticity of labor supply is pretty low and so the effects of marginal taxation can be easily exaggerated. Still, marginal rates approaching 100% are going to have serious incentive effects.

In addition, even more reasonable but very high marginal tax rates can have strong disincentive effects for the poor. High enough effective marginal tax rates and entering the underground economy becomes profitable, investing in education becomes unprofitable, etc.

Mechanically, means-testing lots of credits is little different than giving everyone the credit and then paying for it with high income tax rates. In some ways explicitly high tax rates are preferable because they are transparent.

Further still, there is not much difference between a tax credit and a voucher system. There can be technical details between means tested credits, universal credits funded by marginal taxation, and universal vouchers funded by marginal taxation but the basic incentive effects are all the same.

Under a Ryanesque approach the accounting will show that government spending is smaller and taxes are smaller. Under a universal voucher approach the accounting will show that government spending is huge and taxes are huge. But the basic economic effects are exactly the same. We should not get lost in the accounting and think that we have done something special because we get different numbers for “taxes” and “spending.”  What matters is the effect government has on the economy.

As usual Jeff Miller is indispensible. The money quote:

Anyone who does not understand and discuss the "imputation step" as part of the BLS job creation process is not a true expert.  You should ignore that source.

You don’t want to misunderstand the “imputation step” do you? Read the whole thing.

The New York Times is reporting that Wall Street is sending more cash to the GOP this year than Democrats. It seems that at least one branch of the East Coast Elite is having second thoughts. Perhaps Nancy Pelosi should send them a gentle reminder on the 2008 TARP vote.

Pretty quickly, it seems. According to a new study, schools spent 38% of their stimulus money in the ‘08-’09 school year, 48% this year, and have 14% left over for next year. From a Keynesian perspective, that seems like a pretty decent pace to spend $100 billion. Some states, in fact, managed to spend 100% of their education stimulus money “immediately”. Even better, some of the money that was tied to reforms, like the $4.3 billion Race to the Top program, will probably pay many future dividends as well.

The downside of spending the money so quickly is many states and districts are once again facing a budget crunch, this time without stimulus money to bail them out. If there’s going to be another stimulus bill- oh wait, I’m sorry, that’s “jobs bill”- then it seems like education money tied to reforms could provide good short-term and long-term returns.  How about instead of $4.3 billion out of $100 billion conditional on reforms, the next round could be 100% conditional on reforms. What kind of reforms could $3 billion per state buy?

Over at The Atlantic Business Channel, Daniel Indiviglio tells Virginia Postrel that just because marginal costs of producing e-books is close to zero does not mean that the price should be close to zero. He correctly points out that price only equals marginal cost when markets are perfectly competitive, and the book market is not perfectly competitive. But Postrel didn’t claim price should equal marginal cost, which you can see in her discussion of the importance of demand:

The other side of the equation is consumer response: How many more copies will people buy if the price goes down? Or, in economic lingo, what is the price elasticity of demand?

Her point is that since price elasticity is large the price should be closer to the marginal cost, because you sell a lot more books by lowering the price. What Inviglio seems to miss is that if Postrel thought that the market were perfectly competitive, she wouldn’t be discussing the price elasticity of demand, since in perfectly competitive markets producers are price takers, i.e. the price is set by the market, which means that from the book sellers perspective the price elasticity of demand would in fact be infinite.

Inviglio’s point about price not being equal to marginal cost is an important one to remember though. Even if books could be made at a no cost, the authors would write them for the publishers for free, and there were no uncertainty about which books would be popular,  the price of books would not equal zero.

From Arnold Kling:

Take a look at the top ten countries in the economic freedom index. Then look at the top ten countries by population. The United States is the only country in both lists, and at the rate things are going we will not be in the top ten in terms of economic freedom much longer.

My reading is that there are serious diseconomies of scale in governance. The larger the polity, the worse the ability to govern.

What do the citizens of the state of Massachusetts gain by being a part of the United States? My guess is that the sovereign nation of Massachusetts would greatly outperform the U.S. in policy and economic growth.

The authorities do not know exactly how many people have been killed warbling “My Way” in karaoke bars over the years in the Philippines, or how many fatal fights it has fueled. But the news media have recorded at least half a dozen victims in the past decade and includes them in a subcategory of crime dubbed the “My Way Killings.”

That is from a very entertaining and interesting story in the New York Times today that is ostensibly about the “My Way Killings” in the Philipines, but really covers the worldwide phenomenon of karaoke related violence and also the culture of the Philipines, and all in an amazingly short space of words too.

It goes without saying these murders are all very sad and tragic, and that these crimes are all disturbing… But you can’t help find some twisted humor in the absurdity of John Denver driving someone into a murderous rage:

Karaoke-related killings are not limited to the Philippines. In the past two years alone, a Malaysian man was fatally stabbed for hogging the microphone at a bar and a Thai man killed eight of his neighbors in a rage after they sang John Denver’s “Take Me Home, Country Roads.” Karaoke-related assaults have also occurred in the United States, including at a Seattle bar where a woman punched a man for singing Coldplay’s “Yellow” after criticizing his version.

In previous post on the efficient market hypothesis, I sympathized with Scott Sumner’s overly demanding definition of identifying a bubble, because his definition prevents people from taking credit for spotting a bubble an implausible number of years before it popped. The example I gave was Dean Baker, who I recalled as predicting the current housing bubble in 1948. Dean corrected me in the comments, reminding me that it was in fact 2002 when he “called” the bubble, and he links to the paper where made the call.

I strongly suggest that anyone who harbors a notion that Dean called the bubble read his paper, from August of 2002, and consider whether he was calling the housing bubble that popped in 2006, or whether he was calling a housing bubble that hadn’t begun in any appreciable way.

Why don’t I think Dean actually called the bubble? First, in his paper Dean specifically refers to the period of time before we can expect prices to fall as “months”. In his conclusion, he sums up his predictions like this:

..it is likely that the HPI will follow the rent index in the months ahead, first showing considerably slower growth. In later months, it is likely that that the HPI will fall in real terms, and possibly in nominal terms, until it is back near its pre-bubble position relative to the rent index.

He is referring here to slower growth in the “months ahead” and a fall in the house price index in “later months”. In fact, house prices didn’t peak until the second quarter of 2006, four years or 48 months after Dean wrote this paper. From his choice of words here he makes it pretty clear that he did not have anything like that in mind.

Another problem is that national house prices are still above where they were when Dean spotted a “bubble”. According to the most recent Case-Shiller house price indices, the U.S. national house price average is now where it was in late 2003, a year after Dean claimed that house prices were going to fall 11% to 22%. Prices falling well below where they were when you cried bubble is a bare minimum requirement for calling a bubble. Dean has not met this very minimal requirement.

You might think prices are going to fall another 25% and prove Dean right, but prices would need to fall much more than that. If Dean was correct that there was an 11% to 22% bubble in 2002, then after the huge buildup in housing supply that occurred from 2002 to 2006, you’d expect the eventual fall in prices to bring us much lower than 11% to 22% below the 2002 price level. To put it simply, if I said “the supply of gold right now is too high to support the prices we are seeing, prices are going to fall 10% from here”, and then the supply of gold quadruples, prices need to fall more than 10% to prove me correct. This is even more true when you consider that the popping of a huge housing bubble is more destructive than the popping of a small housing bubble, so prices should be lower than Dean forecast due to a much larger destruction of wealth than he expected.

Dean’s a nice guy and all, but I think it really is inaccurate to characterize him as having called this bubble.

Bryan Caplan notices that during a blizzard the name brand items sell out ten times faster than the same item from a generic brand. This puzzles him:

Of course the most popular stuff sells out first.”  But that’s a feeble explanation.  After all, if X is ten times more popular than Y, then you’d expect stores to simply carry ten times as much X as Y.  Why would X sell out faster in a blizzard if stores have already taken its greater popularity into account?

The underlying question seems to be, why doesn’t shelf allocation better reflect actual demand? I can think of a couple reasons that this is the case.

The driving factor here is that the amount of shelf space devoted to a product has an impact on it’s sales. In marketing science they refer to this influence as space elasticity. One reason this occurs is because of exactly what Bryan observed: the more space you have, the less likely a product is not going to be there when you want it. More important than this though, is that more product space gets peoples’ attention, and probably signals something about the demand for that product. If there’s a lot of space devoted to a product that means a lot of people buy it, which influences people via social proof. There’s an interesting behavioral story here about why space influences demand, but for now suffice it to say that it does.

This explains why shelf space matters to sales of individual products, but why would a grocery store, who is concerned with overall sales, care about relative sales of name brand vs generic products? One reason is that many grocery stores have their own generic brands that they want to sell. Another reason is that manufacturers care about how their products are on the shelf, and often make explicit agreements about such things, including paying the grocery store for better shelf space allocation. In some sections of some stores, I am told they let the manufacturers determine how their products will be displayed on the shelf, so that manufacturers are essentially leasing shelf space.

The overall reason why demand alone does not determine shelf space is that shelf space influences demand, so that manufacturers have incentive to bargain to influence shelf space.

Much of the disagreement about the truth or falsity of the efficient market hypothesis seems to stem from a disagreement about what constitutes identifiable. Scott Sumner, and a lot of other EMH proponents, define bubbles as identifiable only if the method of identification can reliably be profited from. Ryan Avent, Andrei Shleifer,  and other EMH critics, argue that because of the risk in betting against a bubble, and the lack of perfect capital markets, one could have a relatively certain belief that a bubble exists but not be able to profit from it.A third route is to agree with Sumner that are identifiable and the fact that you profit from them reliably proves it, thus EMH is false.

I think this is part of the reason Sumner is frustrated by the anti-EMH crowd:  he isn’t distinguishing between those that identify profitability as sufficient proof from those who don’t, so he is faced with some people arguing that “people reliably profit off of bubbles, therefore EMH is false!” and others arguing that “market irrationality prevents reliably profiting off of bubbles, and EMH is still false”. There may be people who hold both of these contradictory points at the same time, and they are wrong. But the existence of two separate arguments against EMH that happen to contradict each other is not evidence against either theory or for EMH.

Aside from the insistence of profitability, the other problem I have with Sumner’s definition of identification is the claim that identifying one bubble is not enough, you must also  able to identify them. This is a very econometrician-centric way of thinking of identification: you get a particular model of asset prices and  estimate a set of parameters, which you can then use to forecast. If your forecast is not reliable, then your model or your parameters are wrong, and your identification is false. But why should a model that can identify a housing market bubble be capable of identifying a tulip bubble or a tech bubble? For that matter, why should an individual with a particular set of knowledge that has allowed him to idenfity a bubble in one market be held to the burden of proof of identifying the next bubble, which will likely be in a completely different market of which he has no knowledge?  Take Calculated Risk, for instance. He clearly and specifically identified the housing bubble using his extensive knowledge of the entire housing industry- from realtors to securitizers. Are we really going to demand that he identify the next bubble in gold, oil, Beanie Babies, or some other market he knows nothing about until we accept that he identified the housing bubble? I see no reason to expect this to be true. Nor do I see any reason to expect that all bubbles be equally identifiable. Using Sumner’s criteria, I’m not sure how you tell the difference between a world in which 1/5 bubbles are identifiable and a world in which 0/5 bubbles are identifiable.

Look, I’m not coming down strongly on one side of this debate- my instinct actually tends to be that, in general, you can’t beat market prices, and we should have humility about disagreeing with them. I also understand why a definition of bubble identification that does not include a higher burden of proof is unsatisfactory; it lends itself to people like Dean Baker claiming they identified the current housing bubble in, I think, 1948. Nonetheless, I’ve obviously got disagreements with the way Sumner and other EMH proponents define bubble identification. I’m still open to persuasion on this.

Cowen and Douthat comment on vouchers. Kling chimes in

In my view, the question is not whether you like vouchers are not. Vouchers are inevitable, given the alternatives. Alternative 1 is to keep what we have, which is an open-ended commitment to reimburse health care providers for all procedures performed on people over the age of 65. That is not feasible–the budget blows up. Alternative 2 is to have government impose strong rationing of medical services to seniors. I think that is an unlikely alternative. It’s not just that I think that government would do a poor job. When it comes down to it, do politicians really want to be put in that position?

I am strongly sympathetic to this view. On one level vouchers do seem like the most realistic form of rationing. But, I wonder whether they are politically stable.

Are we not just committing to a regime in which voucher sizes are constantly raised? Won’t political ads in 2050 simply say: “The biggest problem facing America today is the failure of vouchers to keep up with insurance rates, leaving millions of hard working seniors without life saving care”

I just don’t see how the government can credibly commit to low voucher levels. The government can’t even credibly commit to lower reimbursement rates for MDs. Some way or another we have to cut off excess price growth at the source and I am unconvinced that vouchers will do it.