Category Archives: policy

What do Rick Perry and pro sports teams have in common?

They use the same shady economic methodology to promote their policies.

If you follow the news, you’re familiar with “IMPLAN”, albeit indirectly. It’s the software package underlying the studies that pro sports teams, among others clamoring for public favors, use to claim that each new stadium will generate several gazillion dollars for the local economy—supposedly justifying a massive public outlay. Here’s a study using IMPLAN to justify a new Sacramento Kings stadium; here’s another that looks at the proposed Santa Clara stadium for the 49ers and another that attempts to justify a new stadium for the A’s. There are studies looking at the impact of the Mavericks’ American Airlines Center, the Packers’ Lambeau Field, and Oriole Park. And, of course, there are countless others: whenever someone wants to make preposterous claims about the benefits of his pet project, he’ll inevitably turn to IMPLAN or a similar package.

Artist's rendition of the new 49ers stadium proposed for Santa Clara, whose economic impact has been studied using the same highly reliable methodology now applied by Rick Perry's campaign.

There’s an obvious element of pseudoscience to these studies. They use “input-output” models that painstakingly track the path of spending through the economy—a worthy goal, though perhaps an overambitious one. But they fail entirely to model the supply side of the economy, effectively assuming that there is unlimited capacity, and that each additional dollar of “spending” (magically generated by the new stadium) will become an additional dollar of economic activity—even more, in fact, after you account for the multiplier.

Strangely enough, Rick Perry’s campaign is using the same model to analyze his tax plan, in a context where it makes even less sense.

As James Pethokoukis explains, the Rick Perry presidential campaign has contracted with John Dunham and Associates to run a revenue analysis of Perry’s new tax plan. The impact of the plan depends on your choice of baseline policy: it raises $4.7 trillion less than the CBO baseline for 2014-2020 under conventional, static scoring, and $1.7 trillion less under “dynamic scoring”.  Relative to the CBO’s more arguably realistic alternate baseline, the plan does better. But regardless of your preferred baseline, it’s clear that the plausibility of Dunham’s “dynamic scoring” model is key: it provides an additional $3 trillion over only 6 years!

It’s troubling, then, to learn that the Perry campaign’s idea of “dynamic scoring” bears absolutely no relation to what most economists mean by the term. In fact, the Dunham model more closely resembles the shady estimates for the 49ers stadium than any accepted methodology in public finance.

The idea behind dynamic scoring—as economists generally understand the concept—is that we should account for how the incentives created by the tax system affect the economy, and how those effects might feed back into revenue. A income tax cut, for instance, might lead to higher taxable income and a new stream of tax revenue—though certainly not by enough to fully offset the initial revenue loss, as Art Laffer once claimed. In theory, capital tax cuts may to even larger offsetting movements in revenue, though still not enough to recover the loss completely. Greg Mankiw and Matthew Weinzierl provide a short guide here.

Dynamic scoring is controversial: many Democrats believe that in practice it’s a gimmick that obscures the revenue losses from tax cuts. But in principle, it’s hard to deny that dynamic scoring would be the ideal way to evaluate the effects of tax policy: taxes do have real effects, and those effects eventually find their way back into the tax base. The challenge is that the relevant magnitudes are extremely uncertain, and it’s hard to calibrate a model that realistically accounts for the effects of new policy. Moreover, if the overall effect on revenue is negative, to be complete you need a model of how other tax and spending policies will eventually adjust to close the additional deficit—a very difficult task indeed, one that practitioners usually ignore. Some proceed nevertheless; some think it’s better to avoid the issue until we have more accurate models.

But none of this matters to the Perry analysis, because it’s completely unrelated. It doesn’t look at the effect of taxes on incentives at all. Instead, it simply feeds the increased personal income from tax cuts into the IMPLAN model and churns out the same kinds of estimates we typically see for sports stadiums. If you think I’m kidding, read the document:

In order to better understand the effects of the Perry tax proposal on the national economy, a dynamic scoring exercise was conducted by JDA. JDA used an input-output model of the US economy to estimate the true revenue effect of personal income tax proposals, including the feedback effects of taxes on national income.

The dynamic analysis used in this model was based on tax savings (or tax increases) for various income groups in each of the 7 years between 2014 and 2020. These savings were run through the IMPLAN input-output model as increases to income for each group and the resulting change in GDP was fed back through the model for subsequent years. This led to higher GDP growth estimates for each year beginning with 2014 (see Table 6). Based on this analysis, GDP is expected to grow faster than forecast by the CBO, reaching $26.5 trillion by FY 2020 – a 16 percent increase.

Needless to say, this description is a little hazy, but it’s pretty clear what’s going on: they look at tax savings as increases in “income” to each group and feed them through the IMPLAN input-output model, which vastly multiplies the initial impulse and leaves us with an utterly implausible estimate for improvement in GDP. (Sixteen percent? Are they kidding?) There’s no recognition that long-run output is determined by supply constraints, not demand; in fact, this is a completely demand-side analysis trying to pass itself off as supply-side dynamic scoring. Rather bizarre for a Republican candidate, particularly one as hostile to demand-side policy as Rick Perry!

Now, to be clear, there is a place for demand modeling and multipliers like those in the IMPLAN model: when we’re in a demand-constrained recession and monetary policy has reached its limits, tax cuts may provide economic stimulus by boosting aggregate demand, not just improving supply-side incentives. (Though there’s a debate about that.) But this is explicitly a short-to-medium term phenomenon, one that only matters (if at all) in a zero lower bound recession. No one—not even the most fanatical Keynesian—claims that such multipliers provide a foundation for long-term analysis of public finance. And certainly no one is crazy enough to think that the demand-side effects of a tax cut can boost GDP by sixteen percent, as the Perry analysis claims.

In fact, this model makes even less sense in the context of federal tax policy than in its usual, already dubious applications. When we’re looking at a stadium, at least we’re confining ourselves to a particular region: consumers flocking to a stadium can’t boost the productive capacity of the US economy as a whole, but they might encourage labor and capital to relocate around the stadium, delivering economic expansion to the region in question. But this doesn’t apply to the US as a whole: we only have so much labor and capital. Granted, if the model looked at the supply side of Perry’s plan, it might demonstrate how improved incentives lead to an expansion in labor and capital supply, thus increasing potential economic output. That is, however, what the model explicitly does not do: it ignores supply considerations completely, instead assuming that supply constraints are irrelevant and that the income from tax cuts will forever ripple throughout the economy and prompt a demand-led expansion that would put the Clinton era to shame.

I never thought I’d see the day when I had to lecture a Republican presidential candidate on the importance of supply-side analysis, or the dangers of overexuberant demand-side logic. Apparently that day has come!

The truth, of course, is that neither Rick Perry nor his staff have any idea of the analysis behind their numbers. Instead, they hired a consulting firm that specializes in using IMPLAN to create exaggerated estimates for the effect of particular industries (“Meat! Responsible for 5 trillion jobs!”) in order to please its lobbyist clients. The firm evidently knows nothing about tax analysis; it has no credentialed public finance economists on its staff and no experience in analyzing tax policy. When asked to conduct a study, it turned to the only game it knew: IMPLAN, which just happens to be a absurd way to analyze national fiscal policy.

But hey—cut them some slack! It’s not like they’re evaluating the key economic proposal from a major presidential candidate or anything.
 


Update. Lifted from the comment section, from economics professor and sports researcher Donald Coffin:

Nice to see a good take-down of the IMPLAN modelling approach. Those of us who do sports economics and urban economics seriously are almost constantly having to push back against those kinds of studies. The single most disturbing aspect of the IMPLAN model for local economic analysis is the wildly unreasonable values that have for multiplier effects (compared, for example, with the BEA’s Regional Input-Output Modeling System). IMPLAN is exactly what you describe it as, a “model” designed to generate large impact numbers to please a client who wants to lobby someone.

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Insurance against oil shocks: the best idea Bill Frist ever had

Back in 2006, there was a brief stir over the Republican majority’s plan to offer $100 rebates to offset higher prices from gasoline. It quickly became the object of almost universal derision, earning scorn from politicians and bloggers of both the left and right.

Kevin Drum, for instance:

A hundred dollar rebate! It’s bad economics, bad policy, bad optics, and the palpable stink of election-year desperation all rolled into one fetid package. But at least it’s means tested!

On the conservative side, Power Line asked “Wasn’t there a time when Republicans knew something about economics?” and proceeded to demonstrate its own ignorance of economics:

Taxes are a large part of the cost of gasoline. How about if we cut them?

Ironically, the rare proposal that managed to draw bipartisan condemnation was one of the best ideas Congress ever had.

First, why is one of the main alternative proposals—a cut in gas taxes—such a ridiculous idea? Since the US accounts for more than 20% of world oil consumption and the short-term supply of oil is highly inelastic (except when it’s in contango and oil is being hoarded), elementary tax incidence theory tells us that a substantial chunk of the gains from a short-term cut in taxes will go to producers, not consumers. In fact, a very short-term cut in the summer is even worse, since most of the supply is completely fixed, as refineries are already planning to produce as much as they can (which is what made Hillary Clinton’s 2008 proposal so absurd). On top of all this, gas taxes are presumably there to serve some purpose—in particular, to internalize some of the harm from congestion, accident, and pollution externalities—and that purpose doesn’t go away when the price of oil increases.

In short, cutting gas taxes in response to high prices is very bad policy. But that doesn’t mean there shouldn’t be any response from the government.

Of course, the US can’t repeal the laws of supply and demand: there’s no way to suddenly turn on the spigot and make oil cheaper in a world market where American producers will never provide more than a few percent of supply. An increase in oil prices will make Americans poorer.

But the problem isn’t just that an increase in prices makes consumers poorer. It’s that they have short-term liquidity problems: most consumers lack any cheap line of credit for when gas suddenly becomes more expensive. Instead, they have to cut other spending, even when the increase in prices isn’t expected to last forever—and that’s a very real inefficiency.

In an ideal, frictionless economic world, consumers would either buy insurance against high gas prices ahead of time or have easy access to credit, to make a sudden price change more palatable. In the real world, this doesn’t happen: the administrative costs of insurance are too high, and there are innumerable agency failures making it difficult to provide credit. When consumers are operating under these constraints, government intervention can be beneficial.

Frist’s $100 rebate proposal, though tiny, was a way to slightly ease the liquidity constraints facing consumers hit by price increases—in a sense, he wanted the government to provide insurance when the private sector could not. Of course, it wasn’t targeted to consumers who used the most oil, but that was unavoidable. Without any preexisting arrangement, the only way to provide targeted relief would be to cut the gas tax, which for all the reasons I’ve already covered would be a horrible idea.

Such relief could be made much more effective, however, if we made it part of a formal insurance system. Imagine the following: every year, taxpayers filling out their 1040s are given the option to purchase a limited amount of insurance against a surprise increase in oil prices. (The insurance is priced by government economists based on data from futures markets—in fact, the government can even take an offsetting position to negate its risk.) Naturally, anyone who is especially susceptible to an increase in prices will want to buy the most insurance—for instance, a commuter from the exurbs, or a New Englander whose house requires heating oil. This way, the government delivers targeted relief without the perverse incidence of a tax cut.

Whenever government intervenes in a market, of course, the natural question is to ask what advantage government has in providing the service. In this case, I think the answer is obvious: since the government already administers taxes, the overhead from offering oil price insurance consists of little more than an extra line on tax returns, some wire transfers (when the insurance is paid out), and maybe some checks in the mail. The government’s scale is so enormous that its cost of conducting trades to hedge the risk is minimal (and next to the size of its budget, the risk is minimal anyway). There are no regulatory barriers to navigate, and no costs to advertise the new program.

I can’t see why this has never been proposed.

In the absence of a more systematic program, however, ad-hoc insurance like Frist’s doomed “gas rebate” is a completely reasonable idea. It’s revealing that the proposal was so roundly mocked as bad policy—lawmakers and pundits relied more on the vague sense that a rebate sounded gimmicky than on any serious economic analysis. Republicans immediately pivoted to the their “real solution” (pretending that domestic supply can change world prices), while Democrats did the same (using CAFE to force consumers to buy efficient cars). And a perfectly valid proposal skidded to failure.

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Means testing and implicit taxes

Often I see proposals for means testing entitlement programs. For instance, Richard Posner writes:

Perhaps some politician will be bold enough to advocate that all entitlements programs, including social security as well as Medicare, be means-tested, as Medicaid is. There is no reason why people who can afford to provide for their retirement should be subsidized by the government, which is to say by the taxpayer. But such a reform does not appear to be politically feasible.

This is a very common sentiment: in an era of impending fiscal crisis, why should the government be paying Social Security benefits to Bill Gates? Economically, however, its logic is questionable.

Means testing is an implicit tax, with all the distortionary effects of ordinary taxes. If $1000 in additional income causes you to lose $100 in government benefits, your effective marginal tax rate is 10% higher than it otherwise would be. It’s strange to see people who would cringe at higher-bracket tax increases suddenly turn around and extol the virtues of means testing Social Security—and it’s hard to attribute this to anything other than a superficial understanding of what “taxes” really are.

But in fairness, the fact that means testing is an implicit tax doesn’t mean that it’s necessarily a bad idea. Two circumstances come to mind.

First, maybe the program in question is highly inefficient. Tyler Cowen, for instance, argues that since Medicare is an in-kind benefit while Social Security is a cash transfer, we should always cut Medicare first. If you believe that Medicare is extremely wasteful, you can make the argument that the benefits from a cutback outweigh the drawbacks of what Greg Mankiw once called “an income tax surchage levied only on old, sick people”. Of course, it’s hard to see how this argument could possibly apply to Social Security, which is as close to a pure transfer program as you can come.

Second, maybe the implicit tax is a relatively efficient one. Under many proposals for Social Security means testing, this is clearly not the case: cutting back benefits on the basis of current ability to pay is a terribly inefficient proposal, wrapping an income tax and a severe capital tax into one. As Scott Sumner once pointed out, this proposal would place the burden of fiscal adjustment entirely on responsible savers like himself, offering continued benefit checks to the former NFL star who blew his savings by his 40th birthday but not to the far lower-income nurse who steadily contributed to her 401(k).

Still, it’s conceivable that we could design a means testing scheme that worked more effectively. For instance, we could means test on the basis of lifetime income. This would mean an effective hike in income taxes—which makes you wonder why we shouldn’t just enact a direct increase instead—but at least there’s a glimmer of an argument as to why it would be efficient. After all, a progressive tax on lifetime income is more distributionally accurate than a progressive tax schedule on year-to-year income: your earnings across several decades are a better indicator of your ability to pay than your earnings in any single year, and there’s no reason to let a millionaire pay at a low rate because he happened to have a bad year.

Moreover, given the current system for calculating benefits, at the margin means testing would be easy to implement. Right now, the Primary Insurance Amount formula for Social Security offers benefits at a rate of 15% for average indexed monthly earnings over $4,517 (and a higher rate for earnings below that). We could easily lower this percentage to 0%, or even a negative rate at sufficiently high levels. Making the PIA formula more progressive is, in fact, one of the recommendations of the much-maligned deficit commission:

The Commission recommends gradually transitioning to a four-bracket formula by breaking the middle bracket in two at the median income level ($38,000 in 2010, $63,000 in 2050), and then gradually changing the replacement rates from 90 percent, 32 percent, and 15 percent to 90 percent, 30 percent, 10 percent, and 5 percent.

But regardless of the specific proposal, there’s one fact we can’t escape: means testing is a marginal tax increase. As such, it ought to be given the same consideration as any other tax increase, and we shouldn’t let a highly distortionary change in incentives slip by just because we’re not officially calling it a “tax”.

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Why do voters care most about the prices politicians can’t change?

Every day, there’s a new story about the political importance of gas prices. Apparently, voters jump to blame their leaders (especially the President) whenever they’re facing high prices at the pump.

Of course, this is complete nonsense. There is virtually nothing that American politicians can do to change the price of oil. Mitt Romney talks about the need to keep “supply” in line with demand, but he neglects to mention that the relevant quantities are world supply and world demand, and that the US has nowhere near enough oil to make a dent in world supply. Although producing more oil would be financially beneficial for the US, this is only for the very simple reason that selling oil earns money, not the tiny impact that higher US production would have on prices faced by consumers. (Norway has probably managed to figure this one out by now.)

At the same time, however, there is an even more important price that politicians around the country can change: the price of housing. Especially in major cities like New York, San Francisco, Washington and (gah!) Boston, a tangle of zoning and building restrictions makes housing far more expensive than the direct costs of supplying it would suggest. Changes in population from state to state are dominated by a general trend of moving to where housing is cheaper. The costs of shelter account for more than 20% of consumer expenditures. Clearly this a very, very important issue for consumers’ well-being—yet we don’t see a popular response that comes close to matching the ferocity of the reaction to gas prices.

To be fair, there is some response, and it usually takes the form of misguided measures like rent control or top-down efforts to provide “affordable housing”. But I think it’s fair to say that housing is, most of the time, much less salient as a political issue than energy.

Why is this? The obvious explanation is that richer and older people—the ones who vote—are disproportionately more likely to be homeowners. According to the Consumer Expenditure Survey, 89% of the top quintile are homeowners, compared to 40% of the bottom quintile. If we look at the data by age, roughly 80% of households led by people 55 and older own their own home, versus 14% for households led by someone under 25. Homeowners, of course, generally benefit from an increase in housing costs: they own an asset whose price reflects both housing costs today (which they have to pay whether or not they own a home) and housing costs in the future. Since most homeowners are going to die long before their houses or land become uninhabitable, an increase in those future housing costs leads to a direct increase in their real wealth. (Unless, of course, they care about their great-grandchildren’s wealth just as much as their own.)

Perversely, their incentive is to choke off the housing supply as much as possible, not look into ways to create affordable housing. And now, in a world where higher house prices are (mistakenly or not) viewed as essential to economic recovery, this manipulation even acquires an air of legitimacy.

With energy prices, on the other hand, there’s an element of politicians creating their own reality. Since energy encounters price spikes so frequently, it’s an obvious target for popular anger, and thus an easy target for political pandering. Even if there’s absolutely nothing they can do on the issue, politicians are forced to say something about it. And since politicians talk about energy prices so much—and those prices become perceived as a legitimate topic of political debate—voters assume that government must be able to have some impact.

Meanwhile, hardly anyone in the US—save for Alaskans and investors piling into Exxon Mobil stock—benefits from high energy prices. It’s hard to imagine anything less politically risky than complaining about the price of gas. And so we’re left with a bizarre distribution of political attention: massive coverage of a less important price that we can’t change, but relatively minor interest in a more important price that we can.

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