Capital Gains

Income from capital gains - e.g. the increase in the value of assets like stocks - is taxed at a lower rate than wages. In theory, lower taxes on capital income should lead to higher investment, which benefits the entire economy. The idea is to increase the incentive to save - if the taxes on the gains are lower, people will respond by buying more shares (an act of saving, because they forego consuming goods and services to buy shares). If people are more eager to buy shares, it will be easier for firms to raise money in the stock market for investment projects, like new factories and equipment (i.e. capital). A larger capital stock means that workers can produce more, and therefore wages should rise. So, even though the direct benefit of a capital gains tax cut goes mainly to a relatively small group of wealthy people, it may actually have economy-wide benefits.

I'm rehashing the argument for special treatment for capital income because the case against was made last weekend in the Washington Post by Leonard Burman of the Tax Policy Center, and in the Times by Princeton economist Alan Blinder. Writes Burman:

...In fact, the tax break on capital gains does more harm than good. The overall level of saving responds little to tax rates. And enough investment is financed from sources unaffected by individual income taxes -- such as pension funds, insurance companies and foreigners -- that the direct taxation of capital gains of U.S. stakeholders doesn't matter much....
What the low tax rate on capital gains does is spur a huge amount of unproductive tax sheltering. Wealthy individuals invest enormous sums in schemes to convert ordinary income into capital gains, often making investments that would make no sense absent the tax savings. Capital is drawn away from productive investments, hurting the economy. Similarly, the highly talented people who dream up tax shelters could, in a better world, do productive work....

Here's a graph of the effective capital gains tax rate (blue line, from the Tax Policy Center) and nonresidential fixed investment as a share of GDP (red line, from the BEA):
In the data, the relationship is far from clear; the correlation coefficient is actually slightly positive at 0.16! There is a bit of a dip in investment after the Tax Reform Act of 1986, which (temporarily) ended the differential treatment of capital gains income. However, investment is down again lately, despite the cut in the top capital gains rate as part of President Bush's package. Though this is short of a rigorous analysis for sure, it suggests that, although the logic is sound in the first paragraph above, the magnitude of the effect is so small it doesn't matter.

Babylon-icare

As, yet again, we discuss plans for (badly needed) "reform" of the US health care "system," its often useful to look to other countries for ideas. Here's an idea from Babylon (as parts of Iraq were known back in the day). From the Histories of Herodotus (ch. 197):

They have no physicians, but when a man is ill, they lay him in the public square, and the passers-by come up to him, and if they have ever had the disease themselves or have known any one who has suffered from it, they give him advice, recommending him to do whatever they found good in their own case, or in the case known to them; and no one is allowed to pass the sick man in silence without asking him what his ailment is.

Sounds like a good, low-cost way to aggregate information. I suspect the AMA would oppose it, though.
Another Babylonian custom praised by Herodotus was their annual bride auction: the high bids received for the comeliest were used to finance dowries for the homeliest. Is it possible to deplore the sexism and admire the efficiency at the same time?

Have Nobel, Will Travel

The WSJ's Real Time Economics reports that Nobel laureate Vernon Smith is leaving George Mason for Chapman University in California. Hmmmm....

Development Dots in Motion

As we recall from "Sesame Street," it can be very amusing to watch dots move around. Check out Gapminder, which describes itself as "a non-profit venture for development and provision of free software that visualise human development." The "Gapminder World" is a nifty tool that allows you to plot various development indicators (life expectancy, fertility, per capita income) for the countries of the world. Each country's data is represented as a dot proportional to its size, and - this is the cool part - you can set the graph in motion to see how things have progressed (or not progressed) over time. For a dramatic illustration of the AIDS epidemic, choose life expectancy as one of the variables, and follow Botswana's dot.

Long and Variable Lags

are a problem not just in monetary policy, but also for academic economists trying to get research published. The editorial process at a journal can take a really long time, and since rejection rates are high, its often years before a completed paper becomes a publication. My impression (with no real evidence) is that economics is particularly bad in this regard (and unfortunately, what the Fresh Prince once said of parents can also be true of deans: they just don't understand). So I was very interested in the following, from an e-mail I received today announcing R. Preston McAfee as the new editor of Economic Inquiry:

Editor's Announcement: No Revisions Option

Journal time to publication lags have become embarrassing. Many authors have 5 year submission-to-print stories. More insidious, in my view, is the gradual morphing of the referees from evaluators to anonymous co-authors. Referees request increasingly extensive revisions. Usually these represent improvements, but the process takes a lot of time and effort, and the end result is often worse owing to its committee-design. Authors, knowing referees will make them rewrite the paper, are sometimes sloppy with the submission. This feedback loop - submitting a sloppy paper since referees will require rewriting combined with a need to fix all the sloppiness - has led to our current misery. Moreover, the expectation that referees will rewrite papers, combined with sloppy submissions, makes refereeing extraordinarily unpleasant. We - the efficiency-obsessed academic discipline - have the least efficient publication process.

The system is broken.

Consequently, Economic Inquiry is starting an experiment. In this experiment, an author can submit under a 'no revisions' policy. This policy means exactly what it says: if you submit under no revisions, I (or the co-editor) will either accept or reject. What will not happen is a request for a revision.

Update: On a related note, via Dani Rodrik, apparently at Harvard they don't need no stinking journals.

Debunking David Brooks

In a column titled "A Reality Based Economy," the Times' David Brooks writes:

If you’ve paid attention to the presidential campaign, you’ve heard the neopopulist story line. C.E.O.’s are seeing their incomes skyrocket while the middle class gets squeezed. The tides of globalization work against average Americans while most of the benefits go to the top 1 percent.

This story is not entirely wrong, but it is incredibly simple-minded. To believe it, you have to suppress a whole string of complicating facts.

The first complicating fact is that after a lag, average wages are rising sharply. Real average wages rose by 2 percent in 2006, the second fastest rise in 30 years.

The second complicating fact is that according to the Congressional Budget Office, earnings for the poorest fifth of Americans are also on the increase. As Ron Haskins of the Brookings Institution noted recently in The Washington Post, between 1991 and 2005, “the bottom fifth increased its earnings by 80 percent, compared with around 50 percent for the highest-income group and around 20 percent for each of the other three groups.” ...

Sharp-eyed bloggers were all over this one: Economist's View has a roundup of the smackdown. The quote above provides two good examples of how easy it is to deceive with statistics:

1. Brooks uses average wages, rather than median wages - rising incomes of the top few will increase the average, without making people in the middle of the income distribution better off.
   
2. The overall rise in incomes of the poorest fifth from 1991 to 2005 is the end result of an increase between 1991 and 2000, followed by a decline since then.

Lies, damned lies and statistics, indeed.

Roll Over Chairman Mao

and tell Karl Marx the news. Adam Smith probably won't like it either. The state-owned China Development Bank is purchasing a stake in Barclays, a British Bank. Brad Setser responds with a great post on the ironies and contradictions of China's role in the global economy. He writes:

The alliance between the Chinese state – lest we forget, still a (nominally) communist state -- and the high priests of global financial capitalism is close to complete.

Among the ironies he notes:

...Asian and Middle Eastern governments – through their investment funds -- increasingly are playing a role in Western economies that voters do not necessarily think their own governments should play.

China's investment in Barclays is coming from a lender theoretically devoted to "development" -- both domestic infrastructure lending and subsidized lending to Africa. I guess there is more poverty in the City than I thought. Either that or China Development Bank is now more commercial than China's state commercial banks...

...And it increasingly seems like the highest stage of Chinese communism will turn out to be financial capitalism. I am not quite sure that anyone would have guessed back in 1949 that China’s communist government would be invited into Wall Street and City board rooms – or, for that matter, that China's communists would ever have accepted.

Note: "the City" is London's financial district.
Why is the Chinese government buying everything? A country with a trade surplus is selling more goods abroad than it is receiving in return - the gap is filled by financial assets. That is, China sends goods to the US and receives stocks and bonds in return. China has also been keeping the value of its currency low by selling Yuan for Dollars; in doing so, it accumulates massive Dollar holdings. In the past, this has mainly been invested in US Treasury securities, which has helped keep US interest rates low, but lately China has begun diversifying its investments into other types of assets.

Gordon Brown is Curt Schilling

Slate's "Moneybox" columnist Daniel Gross explains "The Sinking Dollar Also Has an Upside." Although it makes things expensive for Americans in Europe (try to imagine "The Sun Also Rises" if a weak dollar made it too costly to go out drinking in Paris), it makes things cheap for foreign visitors coming to the US, helping out those who sell services (hotel rooms, etc..) to tourists. From an economics perspective, this example was particularly interesting:

Chuck Skelling, manager at Towne BMW in the Buffalo suburb of Williamsville, receives a few calls per day from status-conscious Torontonians inquiring about new Bimmers. Because Canadian car prices are based on old exchange rates, the same BMW 335 convertible that retails for $48,000 in the United States sells for the equivalent of $63,000 in Toronto.

This is a good example of "pricing-to-market" - BMW charging different prices in different national markets - and also suggests low "exchange rate pass through" - that is, the decline in the dollar relative to the euro has not translated (yet) into higher retail prices for European goods in the US. But what really got me thinking was Gross' comment:

Even the Brazilian real and Argentine peso, the Los Angeles Clippers of currencies, are thriving against the buck.

Hmm....

• I tend to think of the Peso as more of a "lovable loser," like the Chicago Cubs. And like the Cubs with the billy goat, the Peso has a curse - the inability to issue foreign debt denominated in domestic currency, which is referred to as "original sin" in the international macro literature. Is Carlos Menem the economic Steve Bartman?
• The Italian Lira was somewhat of a laughingstock in the 70's and 80's, but Italy's foreign exchange gained strength with the establishment of the European Monetary Union in the 90's, at roughly the same time the Cleveland Indians emerged from long mediocrity after the establishment of Jacobs Field.
• The Swiss Franc is a perennial powerhouse/often overvalued like Notre Dame Football or Duke Basketball.
• Detroit's Pistons often complain they're undervalued, just like Detroit's automakers perenially complain the Japanese Yen is undervalued.
• The Zimbabwe Dollar is in free-fall, like the Oakland Raiders (black markets, black uniforms...).
  
• The British Pound is the Boston Red Sox of currencies. There is a considerable, hand-wringing literature on the decline of Sterling from its glory days ($4.86 under the classical gold standard), emblematic of Britain's (relative) economic decline. Arguably, the decline began in the interwar period with an ill-fated attempt to restore the pre-war parity. It was also during the interwar period that Babe Ruth was traded to the Yankees, and the era of Yankee baseball/economic supremacy began. After a tortured history of collapses, reversals and humiliations (e.g. devaluations in '49, '67 and '92, an IMF bailout in '76), the fortunes of the Pound (over $2 now!) and the Red Sox (2005 world champions) have finally reversed. In Britain's case, much of the credit goes to the policies of the Labour government under Chancellor of the Exchequer (now P.M.) Gordon Brown, who established central bank independence. The Red Sox championship is attributable partly to a pitcher who shares a name with a former sub-unit of the British Pound.
  

Presidents Don't Matter?

In the Times, Tom Redburn makes the case that "Executive Power Reaches a Limit at the Economy." Traditionally "the economy" is a central issue in presidential elections, though it seems to be overshadowed at the moment. Redburn writes:

But this lack of focus on the current state of the economy could actually prove to be a good thing. That’s because American presidents, for all their efforts to claim credit for a growing economy or avoid blame for a slump, don’t really have much influence over such ups and downs. Almost none, in fact. Yet the tendency to attribute such God-like powers to the occupant of the White House obscures what Washington can actually do to improve the way the economy performs over the longer run.

The article offers a nice comparison of the current recovery with the previous one, and some nifty graphics. I completely agree with Redburn that the influence of the President on short-run economic fluctuations is often greatly exaggerated, and yet:

Average annual real GDP growth
Eisenhower (1953-60) - 2.87
Kennedy-Johnson (1961-68) - 4.73
Nixon-Ford (1969-76) - 2.72
Carter (1977-80) - 3.20
Reagan-Bush (1981-1992) - 2.93
Clinton (1993-2000) - 3.64
Bush (2001-2006) - 2.51

Republican (34 yrs) - 2.79
Democratic (20 yrs) - 3.99

That's a (economically) significant difference. Ok, so maybe the performance of the economy really has more to do with decisions taken the previous year, so, for example, 2001 should be attributed to Clinton, rather than Bush. Shifting everything by 1 year raises the Republican average to 2.84 and lowers the Democratic average to 3.83, still leaving a Democratic advantage of 0.99.

Tycoons!

In a fascinating NY Times feature, Louis Uchitelle examines the "New Gilded Age." He writes:

These days, Mr. [Sanford I.] Weill and many of the nation’s very wealthy chief executives, entrepreneurs and financiers echo an earlier era — the Gilded Age before World War I — when powerful enterprises, dominated by men who grew immensely rich, ushered in the industrialization of the United States. The new titans often see themselves as pillars of a similarly prosperous and expansive age, one in which their successes and their philanthropy have made government less important than it once was.

Some of the new tycoons naturally try to justify their position at the top of an increasingly unequal distribution of income and wealth:

Other very wealthy men in the new Gilded Age talk of themselves as having a flair for business not unlike Derek Jeter’s “unique talent” for baseball, as Leo J. Hindery Jr. put it. “I think there are people, including myself at certain times in my career,” Mr. Hindery said, “who because of their uniqueness warrant whatever the market will bear.”

He counts himself as a talented entrepreneur, having assembled from scratch a cable television sports network, the YES Network. “Jeter makes an unbelievable amount of money,” said Mr. Hindery, who now manages a private equity fund, “but you look at him and you say, ‘Wow, I cannot find another ballplayer with that same set of skills.’ ”

Derek Jeter, of course, is vastly over-rated. As are, perhaps, the new super-rich:

“I don’t see a relationship between the extremes of income now and the performance of the economy,” Paul A. Volcker, a former Federal Reserve Board chairman, said in an interview, challenging the contentions of the very rich that they are, more than others, the driving force of a robust economy.

Of course:

The new tycoons oppose raising taxes on their fortunes.

Fairness is in the eye of the beholder, but the US economy actually grew faster when top marginal tax rates were higher. Here is the annual average growth in real GDP and the average annual top marginal tax rates for the US, by decade:

1951-60 - 3.42 - 91.2%
1961-70 - 4.11 - 78.4%
1971-80 - 3.14 - 70.0%
1981-90 - 3.21 - 44.5%
1991-2000 - 3.22 - 37.9%
2001-2006 - 2.51 - 36.2%

Accompanying the article is a nifty interactive graphic with the top 30 all-time richest Americans. Bill Gates is the one in the pink polo shirt (he really should consider a top hat). [Tax data are from the Urban-Brookings Tax Policy Center]

Welcome to Twenty-Cent Paradigms

Welcome to my new "blog." I'll be posting various links and tidbits, mostly economics-related, gathered from the internet, with some commentary of my own. I hope it will be at least moderately entertaining and useful.

Don't I have anything better to do? I know that I'm cavalierly disobeying Mankiw's advice for new junior faculty (see the second to last point), but if you've ever been to Oxford, Ohio, you know the answer to the question.

Anyway, I hope you enjoy (and do comment, politely)!