Why is redistribution of wealth so difficult to achieve in the US?

Jan 28 JDN 2458147

Income and wealth in equality is much higher in the US than in other First World countries. Within the OECD, only Mexico, Turkey, and Chile have higher income inequality than we do. Over 60% of Americans agree that the distribution of wealth in the US is unfair. Furthermore, the majority of Americans support the use of taxes and transfers to directly redistribute wealth from the rich to the poor.

Why, then, is it so hard to actually get any meaningful wealth redistribution in the United States?

Part of it is surely partisan differences: While about 70% of Democrats favor redistributive taxes, about 70% of Republicans oppose them. So one would not expect a move toward redistribution when Republicans control all three branches of government, and indeed we have seen quite the opposite. (Then again, one would also not expect a government shutdown under one-party rule, and yet that is what we have.)

But even most Republicans say they would like to see a much more equal distribution of wealth than the one we actually have. In fact, when I as an inequality economist look at the distribution of wealth people say they want, it looks a little too equal! Even Denmark and Sweden aren’t that egalitarian! I know more or less how to get from here to Denmark; but from here to “Equalden” looks like an awful long way. So if this is really the distribution of wealth people want, we need to be doing a huge amount of wealth redistribution—but we’re hardly doing any at all.

Indeed, we didn’t actually see all that much redistribution of wealth when Democrats more or less controlled all three branches in the period from 2008-2010. We may have seen a little bit shortly thereafter, and tax policy typically does come with a delay of a year or two. But as you can see in this graph, the Great Recession did more to reduce the top 1% income share than any tax policy changes:


The biggest changes made to our tax code under Obama were actually the handling of capital gains; the increase of the top rate on capital gains from 15% to 20%, plus the 3.8% capital surtax from the Affordable Care Act raised the tax bill for the top 0.1% by tens of billions of dollars. Surprisingly, Trump’s tax cuts don’t actually remove these provisions, though they did dramatically cut the corporate tax rate, which will probably have a similar effect on the income distribution.

To be honest, I’m not as disappointed with Trump’s tax cuts as I thought I would be. Some genuinely good ideas (like the reduction of the mortgage interest deduction, tighter restrictions on carried interest, and increase of the personal standard deduction) and some reasonable but debatable ideas (like cuts to the corporate tax rate, switching to a territorial corporate tax system, limits to deductions on corporate debt payments, removal of the deduction of state taxes, and extensions of 529 savings plans to private primary and secondary schools) were mixed in with the absolutely ludicrous and terrible ideas (like eliminating the Obamacare mandate, doubling the estate tax threshold, cutting the alcohol tax, and allowing offshore drilling in Alaska [One of these things is not like the other ones….]). Some of the terrible ideas, like ending the deduction of student loan interest and tuition waivers, were actually removed in the final version of the bill. Of course, you won’t be surprised when I tell you that the overall US tax system became a lot less progressive as a result of this bill. And even if cutting the corporate tax while raising the capital gains tax is probably a good idea (as I and many economists believe), cutting the corporate tax without raising the capital gains tax probably isn’t.

(An aside: For how much they claim to be “tough on crime”, it’s always kind of baffling to see how often Republicans like to cut alcohol taxes and pollution regulations, which are pretty much the only things that have ever been empirically shown to actually reduce crime. There is some evidence that maybe more policing also helps, but if so, it does so in a far less cost-effective way—indeed, the direct cost of alcohol taxes and pollution taxes is negative. Even if they didn’t work at all, they’d still be worth it just because they raise revenue. I begin to suspect that Republicans don’t actually want to reduce crime, because they know they can use the fear of crime to win votes; they simply want to appear tough on crime, and so they press as hard as they can for more policing and incarceration in the country that already has the highest incarceration rate in the world. This may be a more general phenomenon: While Democrats want to actually solve problems, Republicans want to appear to solve problems while actually exacerbating them, thus insuring their own job security. Compare how Bush kept talking about Osama bin laden while invading Iraq, and Obama actually killed Osama bin Laden. Is this too cynical? Can anything be too cynical in the era of Trump? There were 50,000 Russian bots on Twitter trying to tilt our election! Mueller’s FBI investigation is already implicating several of Trump’s top officials! Everything that seemed like paranoia or cynicism just a few years ago is turning out to be entirely true.)

This is what seems to happen: Year after year, we raise some taxes, then we cut some taxes. Then when raise some taxes, then we cut some taxes. The tax system gets a little more progressive for a few years and inequality begins to fall, and then those changes are removed and inequality begins to rise again. Back and forth and round and round we go.

Is there some way to lock in these tax changes for a longer period of time? The only way I can see would be a change in voter behavior: Keep voting in Democrats to all branches of government consistently for 20 years, and then maybe we would see a serious reduction in income and wealth inequality. Or at least stop voting in Republicans; aside from the Democrats, there are some third parties that would also support redistribution, like the Green Party. And yes, it really is about voting behavior: As prevalent as gerrymandering has become, as terrible as the Electoral College is, as widespread as voter suppression has gotten, Trump only won because 63 million Americans voted for him. Even after everything he’s done, Trumps’ approval rating is still about 39%. As long as there are enough people in this country whose partisan loyalty so strongly outweighs any rational assessment of policy, we are going to continue to see such travesties continue.

It would certainly help if our voting system were fairer, so that third parties had a better chance at taking seats. But it’s also difficult to see how that could happen any time soon. For now, the best I can come up with is trying to show people two things:

First, most Americans favor redistribution of wealth. You’re not alone in wanting that. It’s not some fringe opinion.

Second, there is a real difference between Democrats and Republicans on this issue. The canard “The two parties are the same” is the most untrue it has been in at least twenty years.

I would even understand if there are other issues you consider more important than wealth redistribution. Ecological sustainability is the most defensible—you can’t eat GNP—though that would push you even harder toward the left. Among things that might push you right, I can understand being concerned about higher taxes hurting economic growth, and while I think the view that abortion is murder is ludicrous, given that as your belief I can understand why you would want to prioritize fighting abortion. (If I thought we were murdering millions of babies every year, I’d be pretty mad too! Of course, you should be glad, then, that the US abortion rate has been falling. Right? You know about that, right?)

What I don’t get, however, is people who thought that voting for Donald Trump would help working people. I don’t understand how you can see someone who epitomizes everything that is wrong with the billionaire rentier class and think, “Yeah, he seems like he’s definitely a populist. That guy who was born insanely rich and made even more mind-boggling amounts of money by lying and screwing people over is definitely going to look out for folks like me.”

If I understood that, maybe I would know where to go from here. But people’s political beliefs can be astonishingly intransigent to evidence. Politics is the mind-killer.

Did the World Bank modify its ratings to manipulate the outcome of an election in Chile?

Jan 21 JDN 2458140

(By the way, my birthday is January 19. I can’t believe I’m turning 30.)

This is a fairly obscure news item, so you may have missed it. It should be bigger news than it is.
I can’t fault the New York Times for having its front page focus mainly on the false missile alert that was issued to some people in Hawaii; a false alarm of nuclear attack definitely is the most important thing that could be going on in the world, short of course of actual nuclear war.

CNN, on the other hand, is focused entirely on Trump. When I first wrote this post, they were also focused on Trump, mainly interested in asking whether Trump’s comments about “immigrants from shithole countries” was racist. My answer: Yes, but not because he said the countries were “shitholes”. That was crude, yes, but not altogether inaccurate. Countries like Syria, Afghanistan, and Sudan are, by any objective measure, terrible places. His comments were racist because they attributed that awfulness to the people leaving these countries. But in fact we have a word for immigrants who flee terrible places seeking help and shelter elsewhere: Refugees. We call those people refugees. There are over 10 million refugees in the world today, most of them from Syria.

So anyway, here’s the news item you should have heard about but probably didn’t: The Chief Economist of the World Bank (Paul Romer, who coincidentally I mentioned in my post about DSGE models) has opened an investigation into the possibility that the World Bank’s ratings of economic freedom were intentionally manipulated in order to tilt a Presidential election in Chile.

The worst part is, it may have worked: Chile’s “Doing Business” rating consistently fell under President Michelle Bachelet and rose under President Sebastian Piñera, and Piñera won the most recent election. Was that the reason he won? Who knows? I’m still not entirely clear on how we ended up with President Trump. But it very likely contributed.

The World Bank is supposed to be an impartial institution representing the interests of global economic development. I’m not naive; I recognize that no human institution is perfect, and there will always be competing political and economic interests within any complex institution. Development economists are subject to cognitive biases just like anyone else. If this was the work of a handful of economic analysts (or if Romer turns out to be wrong and the changes in statistical methodology were totally reasonable), so be it; let’s make sure that the bias is corrected and the analysts involved are punished.

But I fear that the rot may run deeper than this. The World Bank is effectively a form of unelected international government. It has been accused of inherent pro-capitalist (or even racist) bias due to the fact that Western governments are overrepresented in its governance, but I actually consider that accusation unfair: There are very good reasons to make sure that your international institutions are managed by liberal democracies, and turns out that most of the world’s liberal democracies are Western. The fact that the US, France, Germany, and the UK make most of the decisions is entirely sensible: Those are in fact the countries we should want making global decisions.

China is not underrepresented, because China is not a democracy and doesn’t deserve to be represented. They are already more represented in the World Bank than they should be, because representing the PRC is not actually representing the interests of the people of China. Russia and Saudi Arabia are undeniably overrepresented. India is underrepresented; they should be complaining. Some African democracies, such as Namibia and Botswana, would also have a legitimate claim to underrepresentation. But I don’t lose any sleep over the fact that Zimbabwe and Iran aren’t getting votes in the World Bank. If and when those countries actually start representing their people, then we can talk about giving them representation in world government. I don’t see how refusing to give international authority to dictators and theocrats constitutes racism or pro-capitalist bias.

That said, there are other reasons to think that the World Bank might actually have some sort of pro-capitalist bias. The World Bank was instrumental in forming the Washington Consensus, which opened free trade and increase economic growth worldwide, but also exposed many poor countries to risk from deregulated financial markets and undermined social safety nets through fiscal austerity programs. They weren’t wrong to want more free trade, and many of their reforms did make sense; but they were at best wildly overconfident in their policy prescriptions, and at worst willing to sacrifice people in poor countries at the altar of bank profits. World poverty has in fact fallen by about half since 1990, and the World Bank has a lot to do with that. But things may have gone faster and smoother if they hadn’t insisted on removing so many financial regulations so quickly without clear forecasts of what would happen. I don’t share Jason Hickel’s pessimistic view that the World Bank’s failures were intentional acts toward an ulterior agenda, but I can see how it begins to look that way when they keep failing the same ways over and over again. (I instead invoke Hanlon’s razor: “Never attribute to malice that which is adequately explained by stupidity.”)

There are also reports of people facing retaliation for criticizing World Bank projects, including those within the World Bank who raise ethical concerns. If this was politically-motivated data manipulation, there may have been people who saw it happening, but were afraid to say anything for fear of being fired or worse.

And Chile in particular has reason to be suspicious. The World Bank suddenly started giving loans to Chile when Augusto Pinochet took power (the CIA denies supporting the coup, by the way—though, given the source, I can understand why one would take that with a grain of salt), and did so under the explicit reasoning that an authoritarian capitalist regime was somehow “more trustworthy” than a democratic socialist regime. Even in the narrow sense of financial creditworthiness that seems difficult to defend; the World Bank knew almost nothing about what kind of government Pinochet was going to create, and in fact despite the so-called “Miracle of Chile”, rapid economic growth in Chile didn’t really happen until the 1990s, after Chile became a democratic capitalist regime.

What I’m really getting at here is that the World Bank has a lot to answer for. I am prepared to believe that most of these actions were honest mistakes or ideological blinders, rather than corruption or cruelty; but even so, when millions of lives are at stake, even honest mistakes aren’t so forgivable. They should be looking for ways to improve their internal governance to make sure that mistakes are caught and corrected quickly. They should be constantly vigilant for biases—either intentional or otherwise—that might seep into their research. Error should be met with immediate correction and public apology; malfeasance should be met with severe punishment.

Perhaps Romer’s investigation actually signals a shift toward such a policy. If so, this is a very good thing. If only we had done this, say, thirty years ago.

What about a tax on political contributions?

Jan 7, JDN 2458126

In my previous post, I argued that an advertising tax could reduce advertising, raise revenue, and produce almost no real economic distortion. Now I’m going to generalize this idea to an even bolder proposal: What if we tax political contributions?

Donations to political campaigns are very similar to advertising. A contest function framework also makes a lot of sense: Increased spending improves your odds of winning, but it doesn’t actually produce any real goods.

Suppose there’s some benefit B that I get if a given politician wins an election. That benefit could include direct benefits to me, as well as altruistic benefits to other citizens I care about, or even my concern for the world as a whole. But presumably, I do benefit in some fashion from my favored politician winning—otherwise, why are they my favored politician?

In this very simple model, let’s assume that there are only two parties and two donors (obviously in the real world there are more parties and vastly more donors; but it doesn’t fundamentally change the argument). Say I will donate x and the other side will donate y.

Assuming that donations are all that matter, the probability my party will win the election is x/(x+y).

Fortunately that isn’t the case. A lot of things matter, some that should (policy platforms, experience, qualifications, character) and some that shouldn’t (race, gender, age, heightpart of why Trump won may in fact be that he is tall; he’s about 6’1”.). So let’s put all the other factors that affect elections into a package and call that F.

The probability that my candidate wins is then x/(x+y) + F, where F can be positive or negative. If F is positive, it means that my candidate is more likely to win, while if it’s negative, it means my candidate is less likely to win. (If you want to be pedantic, the probability of winning has to be capped at 0 and 1, but this doesn’t fundamentally change the argument, and only matters for candidates that are obvious winners or obvious losers regardless of how much anyone donates.)

The donation costs me money, x. The cost in utility of that money depends on my utility function, so for now I’ll just call it a cost function C(x).
Then my net benefit is:
B*[x/(x+y)+F] – C(x)

I can maximize this by a first-order condition. Notice how the F just drops out. I like F to be large, but it doesn’t affect my choice of x.

B*y/(x+y)^2 = C'(x)

Turning that into an exact value requires knowing my cost function and my opponent’s cost function (which need not be the same, in general; unlike the advertising case, it’s not a matter of splitting fungible profits between us), but it’s actually possible to stop here. We can already tell that there is a well-defined solution: There’s a certain amount of donation x that maximizes my expected utility, given the amount y that the other side has donated. Moreover, with a little bit of calculus you can show that the optimal amount of x is strictly increasing in y, which makes intuitive sense: The more they give, the more you need to give in order to keep up. Since x is increasing in y and y is increasing in x, there is a Nash equilibrium: At some amount x and y we each are giving the optimal amount from our perspective.

We can get a precise answer if we assume that the amount of the donations is small compared to my overall wealth, so I will be approximately risk-neutral; then we can just say C(x) = x, and C'(x) = 1:

B*y/(x+y)^2 = 1
Then we get essentially the same result we did for the advertising:

x = y = B/4

According to this, I should be willing to donate up to one-fourth the benefit I’d get from my candidate winning in donations. This actually sounds quite high; I think once you take into account the fact that lots of other people are donating and political contributions aren’t that effective at winning elections, the optimal donation is actually quite a bit smaller—though perhaps still larger than most people give.

If we impose a tax rate r on political contributions, nothing changes. The cost to me of donating is still the same, and as long as the tax is proportional, the ratio x/(x+y) and the probability x/(x+y) + F will remain exactly the same as before. Therefore, I will continue to donate the same amount, as will my opponent, and each candidate will have the same probability of winning as before. The only difference is that some of the money (r of the money, to be precise) will go to the government instead of the politicians.

The total amount of donations will not change. The probability of each candidate winning will not change. All that will happen is money will be transferred from politicians to the government. If this tax revenue is earmarked for some socially beneficial function, this will obviously be an improvement in welfare.

The revenue gained is not nearly as large an amount of money as is spent on advertising (which tells you something about American society), but it’s still quite a bit: Since we currently spend about $5 billion per year on federal elections, a tax rate of 50% could raise about $2.5 billion.

But in fact this seriously under-estimates the benefits of such a tax. This simple model assumes that political contributions only change which candidate wins; but that’s actually not the main concern. (If F is large enough, it can offset any possible donations.)
The real concern is how political contributions affect the choices politicians make once they get into office. While outright quid-pro-quo bribery is illegal, it’s well-known that many corporations and wealthy individuals will give campaign donations with the reasonable expectation of influencing what sort of policies will be made.

You don’t think Goldman Sachs gives millions of dollars each election out of the goodness of their hearts, do you? And they give to both major parties, which really only makes sense if their goal is not to make a particular candidate win, but to make sure that whoever wins feels indebted to Goldman Sachs. (I guess it could also be to prevent third parties from winning—but they hardly ever win anyway, so that wouldn’t be a smart investment from the bank’s perspective.)

Lynda Powell at the University of Rochester has documented the many subtle but significant ways that these donations have influenced policy. Campaign donations aren’t as important as party platforms, but a lot of subtle changes across a wide variety of policies add up to large differences in outcomes.

A political contribution tax would reduce these influences. If politicians’ sole goal were to win, the tax would have no effect. But it seems quite likely that politicians enjoy various personal benefits from lobbying and campaign contributions: Fine dinners, luxurious vacations, and so on. And insofar as that is influencing politicians’ behavior, it is both obviously corrupt and clearly reduced by a political contribution tax. How large an effect this would be is difficult to say; but the direction of the effect is clearly the one we want.

Taxing donations would also allow us to protect the right to give to campaigns (which does seem to be a limited kind of civil liberty, even though the precise interpretation “money is speech” is Orwellian), while reducing corruption and allowing us to keep close track on donations that are made. Taxing a money stream, even a small amount, is often one of the best ways to incentivize close monitoring of that money stream.

With a subtle change, the tax could even be made to bias in favor of populism: All you need to do is exempt small donations from the tax. If say the first $1000 per person per year is exempt from taxation, then the imposition of the tax will reduce the effectiveness of million-dollar contributions from Goldman Sachs and the Koch brothers without having any effect on $50 donations from people like you and me. That would technically be “distorting” elections—but it seems like it might be a distortion worth making.

Of course, this is probably even less likely to happen than the advertising tax.

The potential of an advertising tax

Jan 7, JDN 2458126

Advertising is everywhere in our society. You may see some on this very page (though if I hit my next Patreon target I’m going to pay to get rid of those). Ad-blockers can help when you’re on the Web, and premium channels like HBO will save you from ads when watching TV, but what are you supposed to do about ads on billboards as you drive down the highway, ads on buses as you walk down the street, ads on the walls of the subway train?

And Banksy isn’t entirely wrong; this stuff can be quite damaging. Based on decades of research, the American Psychological Association has issued official statements condemning the use of advertising to children for its harmful psychological effects. Medical research has shown that advertisements for food can cause overeating—and thus, the correlated rise of advertising and obesity may be no coincidence.

Worst of all, political advertising distorts our view of the world. Though we may not be able to blame advertising per se for Trump; most of his publicity was gained for free by irresponsible media coverage.

And yet, advertising is almost pure rent-seeking. It costs resources, but it doesn’t produce anything. In most cases it doesn’t even raise awareness about something or find new customers. The primary goal of most advertising is to get you to choose that brand instead of a different brand. A secondary goal (especially for food ads) is to increase your overall consumption of that good, but since the means employed typically involve psychological manipulation, this increase in consumption is probably harmful to social welfare.

A general principle of economics that has almost universal consensus is the Pigou Principle: If you want less of something, you should put a tax on it. So, what would happen if we put a tax on advertising?

The amazing thing is that in this case, we would probably not actually reduce advertising spending, but we would reduce advertising, which is what we actually care about. Moreover, we would be able to raise an enormous amount of revenue with zero social cost. Like the other big Pigovian tax (the carbon tax), this a rare example of a tax that will give you a huge amount of revenue while actually yielding a benefit to society.

This is far from obvious, so I think it is worth explaining where it comes from.

The key point is that advertising doesn’t typically increase the overall size of the market (though in some cases it does; I’ll get back to that in a moment). Rather that a conventional production function like we would have for most types of expenditure, advertising is better modeled by what is called a contest function (something that our own Stergios Skaperdas at UCI is actually a world-class expert in). In a production function, inputs increase the total amount of output. But in a contest function, inputs only redistribute output from one place to another. Contest functions thus provide a good model of rent-seeking, which is what most advertising is.

Suppose there’s a total market M for some good, where M is the total profits that can be gained from capturing that entire market.
Then, to keep it simple, let’s suppose there are only two major firms in the market, a duopoly like Coke and Pepsi or Boeing and Airbus.

Let’s say Coke decides to spend an amount x on advertising, and Pepsi decides to spend an amount y.

For now, let’s assume that total beverage consumption won’t change; so the total profits to be had from the market are always M.

What advertising does is it changes the share of that market which each firm will get. Specifically, let’s use the simplest model, where the share of the market is equal to the share of advertising spending.

Then the net profit for Coke is the following:

The share they get, x/(x+y), times the size of the whole market, M, minus the advertising spending x.

max M*x/(x+y) – x

We can maximize this with the usual first-order condition:

y/(x+y)^2 M – 1 = 0

(x+y)^2 = My

Since the game is symmetric, in a Nash equilibrium, Pepsi will use the same reasoning:

(x+y)^2 = Mx

Thus we have:

x = y

(2x)^2 = Mx

x = M/4

In this very simple model, each firm will spend one-fourth of the market’s value, and the total advertising spending will be equal to half the size of the market. Then, each company’s net income will be equal to its advertising spending. This is a pretty good estimate for Coca-Cola in real life, which spends about $3.3 billion on advertising and receives about $2.8 billion in net income each year.

What would happen if we introduce a tax? Let’s say we introduce a proportional tax r on all advertising spending. That is, for every dollar you spend on advertising, you must pay the government $r in tax. The really remarkable thing is that companies who advertise shouldn’t care what we make the tax; the only ones who will care are the advertising companies themselves.

If Coke pays x, the actual amount of advertising they receive is x – r x = x(1-r).

Likewise, Pepsi’s actual advertising received is y(1-r).

But notice that the share of total advertising spending is completely unchanged!

(x(1-r))/(x(1-r) + y(1-r)) = x/(x+y)

Since the payoff for Coke only depends on how much Coke spends and what market share they get, it is also unchanged. Since the same is true for Pepsi, nothing will change in how the two companies behave. They will spend the same amount on advertising, and they will receive the same amount of net income when all is said and done.

The total quantity of advertising will be reduced, from x+y to (x+y)(1-r). That means fewer billboards, fewer posters in subway stations, fewer TV commercials. That will hurt advertising companies, but benefit everyone else.

How much revenue will we get for the government? r x + r y = r(x+y).

Since the goal is to substantially reduce advertising output, and it won’t distort other industries in any way, we should set this tax quite high. A reasonable value for r would be 50%. We might even want to consider something as high as 90%; but for now let’s look at what 50% would do.

Total advertising spending in the US is over $200 billion per year. Since an advertising tax would not change total advertising spending, we can expect that a tax rate of 50% would simply capture 50% of this spending as revenue, which is to say $100 billion per year. That would be enough to pay for the entire Federal education budget, or the foreign aid and environment budgets combined.
Another great aspect of how an advertising tax is actually better than a carbon tax is that countries will want to compete to have the highest advertising taxes. If say Canada imposes a carbon tax but the US doesn’t, industries will move production to the US where it is cheaper, which hurts Canada. Yet the total amount of pollution will remain about the same, and Canada will be just as affected by climate change as they would have been anyway. So we need to coordinate across countries so that the carbon taxes are all the same (or at least close), to prevent industries from moving around; and each country has an incentive to cheat by imposing a lower carbon tax.

But advertising taxes aren’t like that. If Canada imposes an advertising tax and the US doesn’t, companies won’t shift production to the US; they will shift advertising to the US. And having your country suddenly flooded with advertisements is bad. That provides a strong incentive for you to impose your own equal or even higher advertising tax to stem the tide. And pretty soon, everyone will have imposed an advertising tax at the same rate.

Of course, in all the above I’ve assumed a pure contest function, meaning that advertisements are completely unproductive. What if they are at least a little bit productive? Then we wouldn’t want to set the tax too high, but the basic conclusions would be unchanged.

Suppose, for instance, that the advertising spending adds half its value to the value of the market. This is a pretty high estimate of the benefits of advertising.

Under this assumption, in place of M we have M+(x+y)/2. Everything else is unchanged.

We can maximize as before:

max (M+(x+y)/2)*x/(x+y) – x

The math is a bit trickier, but we can still solve by a first-order condition, which simplifies to:

(x+y)^2 = 2My

By the same symmetry reasoning as before:

(2x)^2 = 2Mx

x = M/2

Now, total advertising spending would equal the size of the market without advertising, and net income for each firm after advertising would be:

2M(1/2) – M/2 = M/2

That is, advertising spending would equal net income, as before. (A surprisingly robust result!)

What if we imposed a tax? Now the algebra gets even nastier:

max (M+(x+y)(1-r)/2)*x/(x+y) – x

But the ultimate outcome is still quite similar:

(1+r)(x+y)^2 = 2My

(1+r)(2x)^2 = 2Mx

x = M/2*1/(1+r)

Advertising spending will be reduced by a factor of 1/(1+r). Even if r is 50%, that still means we’ll have 2/3 of the advertising spending we had before.

Total tax revenue will then be M*r/(1+r), which for r of 50% would be M/3.

Total advertising will be M(1-r)/(1+r), which would be M/3. So we managed to reduce advertising by 2/3, while reducing advertising spending by only 1/3. Then we would receive half of that spending as revenue. Thus, instead of getting $100 billion per year, we would get $67 billion, which is still just about enough to pay for food stamps.

What’s the downside of this tax? Unlike most taxes, there really isn’t one. Yes, it would hurt advertising companies, which I suppose counts as a downside. But that was mostly waste anyway; anyone employed in advertising would be better employed almost anywhere else. Millions of minds are being wasted coming up with better ways to sell Viagra instead of better treatments for cancer. Any unemployment introduced by an advertising tax would be temporary and easily rectified by monetary policy, and most of it would hit highly educated white-collar professionals who have high incomes to begin with and can more easily find jobs when displaced.

The real question is why we aren’t doing this already. And that, I suppose, has to come down to politics.

“DSGE or GTFO”: Macroeconomics took a wrong turn somewhere

Dec 31, JDN 2458119

The state of macro is good,” wrote Oliver Blanchard—in August 2008. This is rather like the turkey who is so pleased with how the farmer has been feeding him lately, the day before Thanksgiving.

It’s not easy to say exactly where macroeconomics went wrong, but I think Paul Romer is right when he makes the analogy between DSGE (dynamic stochastic general equilbrium) models and string theory. They are mathematically complex and difficult to understand, and people can make their careers by being the only ones who grasp them; therefore they must be right! Nevermind if they have no empirical support whatsoever.

To be fair, DSGE models are at least a little better than string theory; they can at least be fit to real-world data, which is better than string theory can say. But being fit to data and actually predicting data are fundamentally different things, and DSGE models typically forecast no better than far simpler models without their bold assumptions. You don’t need to assume all this stuff about a “representative agent” maximizing a well-defined utility function, or an Euler equation (that doesn’t even fit the data), or this ever-proliferating list of “random shocks” that end up taking up all the degrees of freedom your model was supposed to explain. Just regressing the variables on a few years of previous values of each other (a “vector autoregression” or VAR) generally gives you an equally-good forecast. The fact that these models can be made to fit the data well if you add enough degrees of freedom doesn’t actually make them good models. As Von Neumann warned us, with enough free parameters, you can fit an elephant.

But really what bothers me is not the DSGE but the GTFO (“get the [expletive] out”); it’s not that DSGE models are used, but that it’s almost impossible to get published as a macroeconomic theorist using anything else. Defenders of DSGE typically don’t even argue anymore that it is good; they argue that there are no credible alternatives. They characterize their opponents as “dilettantes” who aren’t opposing DSGE because we disagree with it; no, it must be because we don’t understand it. (Also, regarding that post, I’d just like to note that I now officially satisfy the Athreya Axiom of Absolute Arrogance: I have passed my qualifying exams in a top-50 economics PhD program. Yet my enmity toward DSGE has, if anything, only intensified.)

Of course, that argument only makes sense if you haven’t been actively suppressing all attempts to formulate an alternative, which is precisely what DSGE macroeconomists have been doing for the last two or three decades. And yet despite this suppression, there are alternatives emerging, particularly from the empirical side. There are now empirical approaches to macroeconomics that don’t use DSGE models. Regression discontinuity methods and other “natural experiment” designs—not to mention actual experiments—are quickly rising in popularity as economists realize that these methods allow us to actually empirically test our models instead of just adding more and more mathematical complexity to them.

But there still seems to be a lingering attitude that there is no other way to do macro theory. This is very frustrating for me personally, because deep down I think what I would like to do as a career is macro theory: By temperament I have always viewed the world through a very abstract, theoretical lens, and the issues I care most about—particularly inequality, development, and unemployment—are all fundamentally “macro” issues. I left physics when I realized I would be expected to do string theory. I don’t want to leave economics now that I’m expected to do DSGE. But I also definitely don’t want to do DSGE.

Fortunately with economics I have a backup plan: I can always be an “applied micreconomist” (rather the opposite of a theoretical macroeconomist I suppose), directly attached to the data in the form of empirical analyses or even direct, randomized controlled experiments. And there certainly is plenty of work to be done along the lines of Akerlof and Roth and Shiller and Kahneman and Thaler in cognitive and behavioral economics, which is also generally considered applied micro. I was never going to be an experimental physicist, but I can be an experimental economist. And I do get to use at least some theory: In particular, there’s an awful lot of game theory in experimental economics these days. Some of the most exciting stuff is actually in showing how human beings don’t behave the way classical game theory predicts (particularly in the Ultimatum Game and the Prisoner’s Dilemma), and trying to extend game theory into something that would fit our actual behavior. Cognitive science suggests that the result is going to end up looking quite different from game theory as we know it, and with my cognitive science background I may be particularly well-positioned to lead that charge.

Still, I don’t think I’ll be entirely satisfied if I can’t somehow bring my career back around to macroeconomic issues, and particularly the great elephant in the room of all economics, which is inequality. Underlying everything from Marxism to Trumpism, from the surging rents in Silicon Valley and the crushing poverty of Burkina Faso, to the Great Recession itself, is inequality. It is, in my view, the central question of economics: Who gets what, and why?

That is a fundamentally macro question, but you can’t even talk about that issue in DSGE as we know it; a “representative agent” inherently smooths over all inequality in the economy as though total GDP were all that mattered. A fundamentally new approach to macroeconomics is needed. Hopefully I can be part of that, but from my current position I don’t feel much empowered to fight this status quo. Maybe I need to spend at least a few more years doing something else, making a name for myself, and then I’ll be able to come back to this fight with a stronger position.

In the meantime, I guess there’s plenty of work to be done on cognitive biases and deviations from game theory.

Influenza vaccination, herd immunity, and the Tragedy of the Commons

Dec 24, JDN 2458112

Usually around this time of year I do a sort of “Christmas special” blog post, something about holidays or gifts. But this year I have a rather different seasonal idea in mind. It’s not just the holiday season; it’s also flu season.

Each year, influenza kills over 56,000 people in the US, and between 300,000 and 600,000 people worldwide, mostly in the winter months. And yet, in any given year, only about 40% of adults and 60% of children get the flu vaccine.

The reason for this should be obvious to any student of economics: It’s a Tragedy of the Commons. If enough people got vaccinated that we attained reliable herd immunity (which would take about 90%), then almost nobody would get influenza, and the death rate would plummet. But for any given individual, the vaccine is actually not all that effective. Your risk of getting the flu only drops by about half if you receive the vaccine. The effectiveness is particularly low among the elderly, who are also at the highest risk for serious complications due to influenza.

Thus, for any given individual, the incentive to get vaccinated isn’t all that strong, even though society as a whole would be much better off if we all got vaccinated. Your probability of suffering serious complications from influenza is quite low, and wouldn’t be reduced all that much if you got the vaccine; so even though flu vaccines aren’t that costly in terms of time, money, discomfort, and inconvenience, the cost is just high enough that a lot of us don’t bother to get the shot each year.

On an individual level, my advice is simple: Go get a flu shot. Don’t do it just for yourself; do it for everyone around you. You are protecting the most vulnerable people in our society.

But if we really want everyone to get vaccinated, we need a policy response. I can think of two policies that might work, which can be broadly called a “stick” and a “carrot”.

The “stick” approach would be to make vaccination mandatory, as it already is for many childhood vaccines. Some sort of penalty would have to be introduced, but that’s not the real challenge. The real challenge would be how to actually enforce that penalty: How do we tell who is vaccinated and who isn’t?

When schools make vaccination mandatory, they require vaccination records for admission. It would be simple enough to add annual flu vaccines to the list of required shots for high schools and colleges (though no doubt the anti-vax crowd would make a ruckus). But can you make vaccination mandatory for work? That seems like a much larger violation of civil liberties. Alternatively, we could require that people submit medical records with their tax returns to avoid a tax penalty—but the privacy violations there are quite substantial as well.

Hence, I would favor the “carrot” approach: Use government subsidies to provide a positive incentive for vaccination. Don’t simply make vaccination free; actually pay people to get vaccinated. Make the subsidy larger than the actual cost of the shots, and require that the doctors and pharmacies administering them remit the extra to the customers. Something like $20 per shot ought to do it; since the cost of the shots is also around $20, then vaccinating the full 300 million people of the United States every year would cost about $12 billion; this is less than the estimated economic cost of influenza, so it would essentially pay for itself.

$20 isn’t a lot of money for most people; but then, like I said, the time and inconvenience of a flu shot aren’t that large either. There have been moderately successful (but expensive) programs incentivizing doctors to perform vaccinations, but that’s stupid; frankly I’m amazed it worked at all. It’s patients who need incentivized. Doctors will give you a flu shot if you ask them. The problem is that most people don’t ask.

Do this, and we could potentially save tens of thousands of lives every year, for essentially zero net cost. And that sounds to me like a Christmas wish worth making.

The Irvine Company needs some serious antitrust enforcement

Dec 17, JDN 2458105

I probably wouldn’t even have known about this issue if I hadn’t ended up living in Irvine.

The wealthiest real estate magnate in the United States is Donald Bren, sole owner of the Irvine Company. His net wealth is estimated at $15 billion, which puts him behind the likes of Jeff Bezos or Bill Gates, but well above Donald Trump even at his most optimistic estimates.

Where did he get all this wealth?

The Irvine Company isn’t even particularly shy about its history, though of course they put a positive spin on it. Right there on their own website they talk about how it used to be a series of ranches farmed by immigrants. Look a bit deeper into their complaints about “squatters” and it becomes apparent that the main reason they were able to get so rich is that the immigrant tenant farmers whose land they owned were disallowed by law from owning real estate. (Not to mention how it was originally taken from Native American tribes, as most of the land in the US was.) Then of course the land has increased in price and been passed down from generation to generation.

This isn’t capitalism. Capitalism requires a competitive market with low barriers of entry and trade in real physical capital—machines, vehicles, factories. The ownership of land by a single family that passes down its title through generations while extracting wealth from tenant farmers who aren’t allowed to own anything has another name. We call it feudalism.

The Irvine Company is privately-held, and thus not required to publish its finances the way a publicly-traded company would be, so I can’t tell you exactly what assets its owns or how much profit it makes. But I can tell you that it owns over 57,000 housing units—and there are only 96,000 housing units in the city of Irvine, so that means they literally own 60% of the city. They don’t just own houses either; they also own most of the commercial districts, parks, and streets.

As a proportion of all the housing in the United States, that isn’t so much. Even compared to Southern California (the most densely populated region in North America), it may not seem all that extravagant. But within the city of Irvine itself, this is getting dangerously close to a monopoly. Housing is expensive all over California, so they can’t be entirely blamed—but is it really that hard to believe that letting one company own 60% of your city is going to increase rents?

This is sort of thing that calls for a bold and unequivocal policy response. The Irvine Company should be forced to subdivide itself into multiple companies—perhaps Irvine Residential, Irvine Commercial, and Irvine Civic—and then those companies should be made publicly-traded, and a majority of their shares immediately distributed to the residents of the city. Unlike most land reform proposals, selecting who gets shares is actually quite straightforward: Anyone who pays rent on an Irvine Company property receives a share.

Land reform has a checkered history to say the least, which is probably why policymakers are reluctant to take this sort of approach. But this is a land reform that could be handled swiftly, by a very simple mechanism, with very clear rules. Moreover, it is entirely within the rule of law, as the Irvine Company is obviously at this point an illegitimate monopoly in violation of the Sherman Antitrust Act, Clayton Antitrust Act, and Federal Trade Commission Act. The Herfindahl-Hirschman Index for real estate in the city of Irvine would be at least 3600, well over the standard threshold of 2500 that FTC guidelines consider prima facie evidence of an antitrust violation in the market. Formally, the land reform could be accomplished by collecting damages in an amount necessary to purchase the shares at the (mandatory) IPO, then the beneficiaries of the damages paid in shares would be the residents of Irvine. The FTC is also empowered to bring criminal charges if necessary.

Oddly, most of the talk about the Irvine Company among residents of Irvine centers around their detailed policy decisions, whether expanding road X was a good idea, how you feel about the fact that they built complex Y. (There’s also a bizarre reverence for the Irvine Master Plan; people speak of it as if it were the US Constitution, when it’s actually more like Amazon.com’s five-year revenue targets. This is a for-profit company. Their plan is about taking your money.) This is rather like debating whether or not you have a good king; even if you do, you’re still a feudal subject. No single individual or corporation should have that kind of power over the population of an entire city. This is not a small city, either; Irvine has about three-quarters of the population of Iceland, or a third the population of Boston. Take half of Donald Bren’s $15 billion, divide it evenly over the 250,000 people of the city, and each one gets $30,000. That’s a conservative estimate of how much monopolistic rent the Irvine Company has extracted from the people of Irvine.

By itself, redistributing the assets of the Irvine Company wouldn’t solve the problem of high rents in Southern California. But I think it would help, and I’m honestly having trouble seeing the downsides. The only people who seem to be harmed are billionaires who inherited wealth that was originally extracted from serfs. Like I said, this is within the law, and wouldn’t require new legislation. We would only need to aggressively enforce laws that have been on the books for a century. It doesn’t even seem like it should be politically unpopular, as you’re basically giving a check for tens of thousands of dollars to each voting resident in the city.

Of course, it won’t happen. As usual, I’m imagining more justice in the world than there actually has ever been.