Tag Archives: Megan McArdle

The Fast Trains That Can’t

17 Sunday Feb 2019

Posted by in Air Travel, infrastructure

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High-speed rail will remain a pipe-dream in the U.S. except for the development of a few limited routes. However, statists continue to push for large-scale adoption. That would represent a triumph of big government, if realized, and it is very appealing to the public imagination. But high-speed rail (HSR) is something of a fraud. Projected fares do not include the massive capital costs required to build it, which must be funded by taxpayers. Like most big public projects, HSR presents ample opportunities for graft by privileged insiders. And apparently it’s easy to rationalize HSR by repeating the questionable mantra that it is environmentally superior to autos or even air travel.

California recently confronted the harsh reality of HSR costs by scaling back its ambitious plans to a single line traversing a portion of the central valley. Now, the federal government has acknowledged that the state has violated the terms of past federal grants, essentially for non-performance. Those grants totaled $2.5 billion, and another grant of almost $1 billion might be withheld. Better not to throw good money after bad.

Megan McArdle wisely debunks the viability of HSR in the U.S. based on four potent factors: distance, wealth, legal obstacles, and cost. Unlike Europe, Japan and even the eastern Chinese seaboard, the distances involved in the U.S. make widespread development of HSR infrastructure quite challenging. Even on shorter routes, the U.S. has too much valuable property in and between population centers that would have to be repurposed for placement of relatively straight-line routes to facilitate high speeds. An authoritarian government can commandeer property, but wresting property from private owners in the U.S. is not straightforward, even when obtrusive bureaucrats attempt to invoke eminent domain. McArdle says:

“… the U.S. legal system offers citizens an unparalleled number of veto points at which they can attempt to block government projects. Any infrastructure project bigger than painting a schoolhouse thus has to either fight out the reviews and court cases for years, or buy off the opponents, or more likely, both.”

Another downside for HSR: the cost of installing and operating U.S. infrastructure is inflated by a number of factors, including high U.S. wage levels, unions, overlapping regulatory agencies, and the distances and other cost factors discussed earlier. Even worse, the extensive planning and lengthy time lines of such a project virtually assure cost overruns, as California has learned the hard way. So high-speed rail has a lot going against it.

Warren Meyer raises another issue: rail in the U.S. is dominated by freight, and it is very difficult for freight and passenger traffic to share the same system. That means freight traffic cannot be used to help defray the cost of installing HSR. Meyer makes an interesting comparison between the efficiency of passenger trains relative to freight: much more energy is needed to pull a heavy passenger train car than to pull the actual passengers inside. In contrast, the cargo inside a typical freight car weighs far more than the car itself. But the efficiency of freight transportation in the U.S. seems to have no allure for many critics of U.S. transportation policy.

“Freight is boring and un-sexy. Its not a government function in the US. So intellectuals tend to ignore it, even though it is the far more important, from and energy and environmental standpoint, portion of transport to put on the rails. … We have had huge revolutions in transportation over the last decades during the same period that European nations were sinking billions of dollars into pretty high-speed passenger rails systems for wealthy business travelers.”   

Comparisons of efficiency across modes of passenger transportation are typically limited to operating costs, including energy costs, per passenger mile. That narrow focus yields a distorted view of the relative advantages of different passenger modes. In particular, the massive incremental capital costs of HSR are often ignored. Moreover, weight must be assigned to the very real economic costs of passenger time, not to mention the external costs imposed on the viability of farmland, nearby property owners, and wildlife.

In the long-term, all modes of transportation have infrastructure costs, but HSR lines don’t yet exist in this country. It is therefore relevant to ask whether the cost comparison is intended to address an ongoing transportation need or an incremental need. HSR is often promoted as a replacement for other modes of transportation, so the lack of an installed base of infrastructure is a huge incremental cost relative to modes already in place.

Air travel has some obvious advantages over high-speed trains. First, it requires much less support infrastructure, and a significant base of that capital is already installed. Again, the massive, up-front infrastructure costs of HSR are incremental. Also, airports tend to be well-integrated with local transportation options. New passenger train terminals would require additional investment in local ground transportation such as light rail or subway extensions, highway access, and the like. In addition, planes require less passenger time than trains over lengthy routes.

How about autos vs. HSR? Autos have the pre-installed base of road infrastructure. They provide hard-to-value flexibility for the traveler as well, but parking costs must be dealt with, and cars have extremely high accident rates. Travel time is a disadvantage for autos relative to HSR, even at moderate distances. In terms of operating costs, however, autos are not necessarily at a disadvantage: they weigh much less per passenger than trains, but that advantage is offset by trains’ low “rolling resistance” and other factors. The best choice for travelers would vary with the value they place on their time, specific plans at the destination, preference for flexibility, and the operating costs of their vehicle relative to the high-speed train fare.

Supporters of HSR contend that it is less costly to the environment than other modes of transportation. That case is easier to make if you focus solely on operating costs and exclude the impact of generating the electricity needed to power trains, which will require emissions of greenhouse gases for many years to come. A second fundamental omission is the environmental cost of the rail infrastructure itself. It’s very existence is disruptive to local environments, but perhaps most importantly, producing and installing the steel, concrete, and other materials needed for HSR will carry a steep environmental cost.

HSR is unlikely to achieve widespread adoption in the U.S. The distances of many routes and high infrastructure costs are obstacles that will be nearly impossible to overcome. Projected fares would be outrageously high were they to cover the full cost of the infrastructure. A typical argument is that taxpayers should fund the infrastructure due to the social benefits that rail is presumed to confer, but that presumption is far-fetched given the impact of producing the infrastructure itself, as well as the power needed to run the trains. I don’t expect adherents of rail to put aside their dreams quickly, however: there is something so romantic about the notion of having the state provide a massive rail network that the idea will never die the death it deserves. And don’t be fooled by Elon Musk’s hyperloop. It remains a distant technological hope and it too will have enormous resource costs along with an attendant call for public subsidies (a call which has already begun). After all, public subsidies are a hallmark of most of Musk’s business ventures.

 

 

Progressives: Paul Doesn’t Want Peter’s Money? What a Hypocrite!

08 Thursday Feb 2018

Posted by in Big Government, Federal Budget

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Red & Blue States

I’ve heard the following assertion over and over: blue states are “doners” of federal tax revenue and red states are donees. In other words, states dominated by Democrats contribute more than they take from the federal budget, while Republican states take more than they contribute. But the facts are somewhat ambiguous. And to the extent that it is true, policies that would improve the net position of blue states would be very unpopular with the progressive Left. Furthermore, progressives expose their confusion regarding the ethics of sound governance by calling the red state opposition to an expansive  federal government “hypocritical”.

The relative positions of red and blue states in terms of federal dollars is the topic of an excellent article by Megan McArdle, whom I haven’t featured on this blog for a while. Originally, the claim that blue states “gave” to red states via the federal budget was based on data from 2005, but a lot of fiscal water has passed under (and over) the bridge since then. Also, the original presentation used state totals of federal outlays minus revenues without accounting for differences in the size of state populations. Many blue states are relatively populous, so some the state rankings may shift when expressed on a per capita basis. McArdle reproduces a chart from a report by the New York State Comptroller using 2013 data:

“… deep-blue New Jersey is the biggest donor state. But red-blooded Wyoming is the next biggest, and North Dakota makes the list too. There is certainly a preponderance of blue states at that end of the spectrum, but it’s not a clear ‘Donor states are blue’ story. And if we match the 2013 data to the closest election (2012) we find that New Mexico, the biggest net recipient, went for Obama in 2012, as did Virginia, Maryland, Maine and Hawaii. What’s driving the net subsidies isn’t anything as simple as political identification.“

Wyoming and North Dakota contributed lots of federal revenue from taxes arising from the fracking boom.

McArdle goes on to consider policies that would reduce the flow of budget dollars to donee states:

“Most of the transfers do not come from ‘red state welfare’ like agricultural subsidies. They derive from Social Security, Medicare, Medicaid, unemployment insurance, food stamps, welfare, the maintenance of the national highway system, the purchase of goods and services for the federal government, and the operation of federal facilities and lands.

If blue state liberals consider this out of whack, what do they want to change?

  • Do they want to move toward a flatter, less progressive federal tax code?
  • Do they want to cut Social Security, Medicare and Medicaid?
  • Do they want to return unemployment insurance and similar entitlement programs entirely to the states?
  • Do they want to hand over the national parks to the states, or privatize them?
  • Would they like to downsize the federal workforce?
  • Should we redistribute military bases from red states to blue? (Those relocations might meaningfully alter the state electorate, making it easier for Republicans to get elected. …)“

Of course not! But like McArdle, I’m of the opinion that many of the policy changes on that list, or at least reforms of existing policies, are in order. Perhaps the allure of steeply progressive federal taxes has faded for blue state Democrats with the new reality of the Tax Cuts and Jobs Act. The law restricts deductions for mortgage interest, a hit on those borrowing against high-end homes. It also limits deductions for state and local taxes, eliminating a federal tax subsidy to high-earners living in states with high taxes. State and local politicians who support high taxes will no longer receive a “discount”, courtesy of taxpayers in  other states, on the natural political liability of high taxes.

The categorization of blue states and red states as federal donors and donees is not quite as unambiguous as most Leftists imagine. Be that as it may, the flows of revenue and spending between the federal government and states is a consequence of demographics, regional business environments, and many other factors, but most of all the set of policies promulgated over the years in Washington DC. An objective assessment of the federal government’s largess indicates that most of those policies are in need of drastic reform, yet statists resist, demand more, and act as if “red states rubes” should be grateful for the dysfunction and the federal cash it brings. To progressives, it is hypocritical to oppose an expansive federal government on this basis. The absurdity of that claim is self-evident, but such is the confused state of progressive discourse. Perhaps a better adjective for red state opposition to federal profligacy would be “principled”.

 

Insurance Subsidies: Taxes vs. High Premiums

16 Tuesday May 2017

Posted by in Health Care, Subsidies, Taxes

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Here’s a question a friend posed: Why do we care whether health care coverage for high-risk individuals is subsidized by taxpayers versus premium payers via common (community) rating in a combined risk pool? For convenience, let’s call those two scenarios T and C. Under C there is no segmentation whatsoever, while T involves a division of individuals into two groups: standard and high risk. Both scenarios involve guaranteed issue, though T assumes that high-risk individuals must purchase their coverage in the appropriate market. I’ll tackle T first because separate treatment of the distinct risk archetypes yields results that are useful as a baseline.

Taxpayers Subsidize Pre-Existing Conditions

Under scenario T, suppose that all standard risks face the same expected outcome in each period. Everyone in that group pays based on their expected health care costs. In the end, some will have greater health care needs than others, but only a few will be truly unlucky, incurring extremely high health care expenses. On balance, the pooling of risk makes the arrangement sustainable. People enter into these contracts voluntarily because they are risk averse. No one forces them; they are capturing value from protection against financial ruin. The paid-in cash can be invested by the plan in the interim between premium and claims payments. The combination of premium payments and investment income must be enough to cover claims and allow the managers of the plan to defray their administrative costs and make a tidy profit. The profit matters because it attracts voluntary resources to bear on the problem of health-expense risk. Therefore, these insurance transactions are mutually beneficial to the insured and the owners of the insurer.

Conceivably, the smaller high-risk group could be handled the same way, as long as their aggregate health care expenses are predictable. Those expenses will be high, however, so the cost of coverage for individuals in such a pool might be prohibitive. One solution is to force taxpayers to subsidize coverage for this group. The transactions in this market are also mutually beneficial to the insureds and the insurers, just as in the market for standard risks. In both cases, the value to purchasers of coverage is no less than the cost of providing it, including compensation for any capital employed in the process.

In the simplified world of scenario T, we have an optimal insurance outcome for both standard and high-risk individuals. The downside is the cost of the subsidies to taxpayers, which distort a variety of incentives, including labor supply, saving and investment. These lead to misallocations, but they are spread across the economy rather than concentrated on the outcomes in a single market. Is this better than simply pooling all risks, as in Scenario C (common rating)?

Common (Community) Rating

Common rating means that all risks are combined into one pool and everyone is charged the same premium. High-risk individuals get to participate just as if they are standard risks. However, because the combined risk pool has greater expected health care costs on average than the standard risk population, the premium must be greater than the one charged to standard risks in Scenario T. Otherwise, the plan could not cover all expenses nor earn a profit. Worse yet, the standard risks now have an incentive to exit the market while high-risk individuals have every reason to leap in. This is called adverse selection, and it leads to the sort of insurance death spiral we’ve witnessed under Obamacare. And not only does the risk pool deteriorate: the incentive to offer coverage is diminished as well. Thus, an entire industry is rendered dysfunctional. Those who wish to pool together voluntarily in order to efficiently hedge their risks are, by law, prohibited from doing so. The next step might well be for government to mandate participation in an attempt to keep the plan afloat.

Those who favor forced redistribution (not my set) might have other reasons to prefer Scenario T, as it creates greater latitude for progressive tax funding of the subsidies. However, the subsidies themselves could be sensitive to income such that the risky but well-heeled pay more.

From a libertarian perspective, Scenario C has obvious drawbacks, starting with the coercion of insurers to provide coverage to the high-risk population at rates that do not compensate for risk. Then, too, the mis-pricing of risk places a burden on individuals of standard risk. With the pooling of all risks, community rating and coverage mandates result in individual and aggregate over-insurance against most types of risk, tying up scarce resources in insurance assets that could be invested more productively in other uses. In addition, resources are absorbed by compliance costs as authorities find it necessary to enforce the many rules made in hopes of proping-up an otherwise unsustainable arrangement.

Then There’s Single-Payer

It’s often argued that going beyond this point in Scenario C to a single-payer system will yield better outcomes at lower costs. Megan McArdle shreds this idea in a recent column: well over 40% of health care spending in the U.S. is paid by government already; the average growth of that share is even higher than private health care spending; the quality of care is often lower in the government health sector, and in any case, single payer systems around the world do not enjoy slower growth in costs. Rather, they started from lower levels of health care costs. Our relatively high level of costs in the U.S. evolved many years ago, before single-payer systems were adopted abroad. We have many more private and semi-private hospital rooms in the U.S., we often have greater availability of advanced technology, and waiting times for care tend to be significantly shorter.

The high standard of living in the U.S., i.e., our level of consumption, explains a lot of the gap in health care spending. Overall, our health care outcomes are good relative to other developed countries. Unfortunately, we’ve also pushed-up costs from the demand side by offering tax subsidies on employer-provided care, and government in the U.S. has had a role in “managing” health care since the time of the Woodrow Wilson Administration, largely to the detriment of cost control. Government control stultifies competition, creating monopoly-like conditions in both insurance and the provision of care. That manifests in higher profits, safer profits, or slovenly performance by organizations and agents that lack accountability to customers and market forces. Costs rise.

Liberty or Coercion

Libertarians will object to the tax in Scenario T, which like all taxation is coerced, but the taxes necessary to pay for adequate coverage for pre-existing conditions is minor relative to the potential costs of distorting the entire health insurance industry, repleat with the costs of government regulation and compliance that entails, and the potential for still more encroachment of government in health care.

Finally, the question posed by my friend about tax subsidies versus common insurance rating was prompted by a presumed “right to health care”. One must ask whether that right is legitimate. Kevin Williamson argues that scarcity interferes with any such claim. More to the point, in a free society, one cannot simply demand health care from another free individual. Our choices for distributing scarce health care fall into one of only two categories: voluntary and coerced. We should always prefer the former, which may take the form of charity or a mechanism under which care is provided via free exchange. The latter works very well when incentives are clear and pricing is efficient. For those who cannot participate in exchange for any reason, including pre-existing conditions that make coverage prohibitive, private charity is an alternative to government subsidies. At a minimum, charity should serve as an important relief valve for the burden on taxpayers. The Left, however, is always quick to condemn private charity as if it is somehow an illegitimate mechanism for solving social problems, but it is often superior to government action.

Trumpist In a Taxpot

06 Thursday Oct 2016

Posted by in Taxes

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The media narrative around Donald Trump’s 1995 tax deduction of a business loss would have you think it had been the crime of the century. Last weekend, the New York Times presented an analysis of a Trump tax return from 1995 showing a loss of $916 million, which was eligible for “carry forward” to reduce taxes on his business income in future years. The Times characterized it as something of a scandal, and the Clinton campaign was quick to jump on board. However, the ability to deduct losses or carry them forward to deduct in future years are basic features of the U.S. income tax code. Hillary Clinton used the same tax provisions as recently as 2015, albeit on a smaller scale than Trump, and the Clinton’s have engaged in other forms of tax avoidance. The point here is that if your business realizes gains from some winning investments, but suffers losses on a few others, a basic and reasonable feature of the tax code is to allow the losses to offset a like amount of gains for tax purposes. Similarly, your winnings at the casino (assuming you report them) are not taxed without first netting out the bad bet you made at the roulette table. So far, so good.

When you or your business suffers a loss in a given year, the income tax code allows that loss to be carried forward to offset taxable income in subsequent years. Since the Times article, the term “net operating loss” has been thrown around in some circles as if it’s an arcane tax loophole, but it’s simply good tax policy. John Cochrane provides an example of an entity which alternately reaps gains of $1,000,000 in one year and losses of $900,000 in the next, with an average pre-tax income of $50,000. Without loss carry-forward, this entity would be forced out of business in short order by the IRS. The use of this provision is not uncommon, and it prevents the tax code, such as it is, from being even more threatening to enterprises and jobs that are otherwise viable. Suggesting the elimination of this provision leaves tax experts in disbelief. The effects would be punitive to many businesses, not just corporate behemoths, and would be destructive to the economy.

Cochrane also puts the “blame” for this much-maligned deduction where it should be: the existence of the income tax itself! A consumption tax would not be as sensitive to changes in income, as people tend to smooth their consumption levels over time.

Another question related to the Trump tax revelations would be more controversial, if true: that he might have engaged in so-called “debt parking“. That’s unproven, but Bronte Capital Management‘s John Hempton blogged that it’s highly likely that he did. The alleged sequence of events is as follows: Trump borrowed money and invested it in assets that resulted in massive losses. The losses meant the debt held by Trump’s lender was nearly worthless. If that debt had been forgiven and written off by the original lender, Trump would have been forced to report a large gain, offsetting the tax benefit of the loss on his assets. But as Hempton’s story goes, the lender did not write it off. Rather, in the meantime, Trump created an entity that bought the debt from the lender for pennies on the dollar. After the sale, the write-down taken by the lender was not attributable to Trump as income. Trump’s “entity” simply served as a place to “park” the debt, protecting Trump’s tax benefits via loss carry-forward.

Megan McArdle addresses this issue, but she first reinforces the policy wisdom of the loss provisions in the tax code. McArdle ridicules the notion that businesses seek to generate losses in order to obtain tax deductions. She then  debunks the debt-parking theory of Donald Trump’s tax management:

“This theory seemed to have a lot of credibility among folks on social media. Among the tax professionals I spoke to, it had none: the IRS would treat this sort of structure just as it would if a third party had forgiven the debt.

‘Look,’ says [tax attorney Ron] Kovacev, ‘you put a $900 million loss on your tax return, that’s audit bait. The IRS is going to look into it. The notion that you could just move the money and the IRS wouldn’t ask questions?’ There was a sort of incredulous pause before he finally said: ‘That’s hard to fathom.’“

One other question about the 1995 tax return is whether the $916 million loss proves that Trump is a lousy businessman. In fact, there is speculation that Trump’s losses around that time might well have been much larger than that. He suffered staggering failures in his casino business, his airline, and his investment in New York’s Plaza Hotel. It might not be so remarkable, however, to see a few losses on this scale for a developer investing in a variety of large projects. Big risk goes with the territory. Nevertheless, it doesn’t appear that Trump, having begun his business career with large amounts of family money, has achieved tremendous success with that capital over the years, on balance. Rather, it looks more like the kind of success an average investor would have achieved under the same initial circumstances. The losses claimed on his 1995 tax return obviously restrained his overall gains, but they don’t prove he’s a terrible businessman. He’s probably fairly average.

Both Trump and Clinton have exploited a rule in the income tax code that helps smooth after-tax profits and is a basic element of income tax rationality (given that it exists in the first place). It’s rather absurd for anyone to condemn them for it. Even more absurd for either of them to cast aspersions at the other on these grounds. Would Hillary Clinton do anything to restrict the longstanding ability to carry forward losses to deduct against future taxes? I’m thankful that I haven’t heard her say so!

 

 

God Save the Brexit

28 Tuesday Jun 2016

Posted by in Big Government, European Union

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The British might have a bumpy transition to full independence following last week’s Brexit vote, but the European Union (EU) may now face a challenge to its very existence: the outcome of the British referendum amounts to a revolt against overbearing rule by a distant, authoritarian central government. The vote demonstrates resentment by many Brits to absurd regulation of many aspects of life, to the loss of sovereignty inherent in EU membership, and to the EU’s controversial immigration policies. Other members of the EU may face popular exit movements of their own, as sentiment in France and elsewhere is running strongly against the Union. Economist Joel Kotkin writes the following in his assessment of the Brexit vote:

“In the last economic expansion, something close to 70 percent of all the new jobs created went to non-U.K. citizens. …  In the media and polite circles in both parties, opposition to EU immigration has been widely denounced as racist. But, in reality, UKIP’s [U.K. Independence Party] leader, Nigel Farage, has spoken positively about continuing migration, largely non-white, from the Commonwealth, particularly for skilled workers. In contrast, Cameron’s failure to slow down the largely unregulated EU migration may have been the single largest factor behind the Brexit result.“

This was a vote for self-determination and also a vote for cultural identity. The left has been quick to call it racism, but Tyler Cowan, himself in the Remain camp, thinks that label is misleading in important ways:

 “Quite simply, the English want England to stay relatively English, and voting Leave was the instrument they were given. …  Much has been made of the supposed paradox that opposition to immigration is highest where the number of immigrants is lowest. Yes, some of that is the racism and xenophobia of less cosmopolitan areas, but it would be a big mistake to dismiss it as such or even to mainly frame it as such. Most of all it is an endowment effect. Those are the regions which best remember — and indeed still live — some earlier notion of what England was like. And they wish to hold on to that, albeit with the possibility of continuing evolution along mostly English lines. … The regularity here [comparing England to Denmark and Japan] is that the coherent, longstanding nation states are most protective of their core identities. Should that come as a huge surprise?“

Megan McArdle also takes a stab at illuminating the disconnect between those who believe in forging a European “nation” and those who prefer independence:

“Surrendering traditional powers and liberties to a distant state is a lot easier if you think of that state as run by ‘people like me,’ … particularly if that surrender is done in the name of empowering ‘people who are like me’ in our collective dealings with other, farther ‘strangers who aren’t.’ … The EU never did this work. When asked ‘Where are you from?’ almost no one would answer ‘Europe,’ because after 50 years of assiduous labor by the eurocrats, Europe remains a continent, not an identity.“

Those who had hoped for Britain to remain in the EU include elites who stood to gain from crony capitalism that benefits from heavy regulation, as well as collectivists whose naive ideals dictate government planning and a borderless world. Others may have hoped to profit from another upshot of a remain vote: the U.K., unlike other member states, still has its own currency and its own monetary authority (the Bank of England — BOE); as Paul Craig Roberts says, a British commitment to the EU, and adoption of the euro, would have greatly diminished London as a financial center, bringing potentially significant windfalls to major U.S. financial institutions.

Great Britain has its own economic problems, of course, and there is no guarantee that exit from the EU will pave an easy road to prosperity. The country is attempting to reign in budget deficits, but relatively slow economic growth is making that more difficult. The steep slide in the value of the pound after the Brexit vote will stimulate exports, but it makes imported goods more costly and has inflationary consequences. That makes the BOE’s job of conducting monetary policy tricky. Fears of a post-Brexit liquidity crisis and recession must be balanced against the inflationary impact of the cheaper pound.

Even worse, with or without the EU, politics in the U.K. tends increasingly toward statism. This is from Sohrab Ahmari in his article “Illiberalism: The Worldwide Crisis“:

“Then there is Britain, where the hard-left wing of Labour has taken over the party. Rising to the leadership in the aftermath of last year’s electoral rout, Jeremy Corbyn has broken the party’s peace with free enterprise and individual responsibility—the main reformist achievement of Tony Blair’s New Labour. The party once again longs for socialism and speaks the language of class warfare at home, while anti-Americanism, pacifism, and blame-the-West attitudes dominate its foreign policy. at home.“

From my perspective, the worst-case scenario for Britain is that post-Brexit economic policy will be marked by a continued drift toward government activism, and that “softening the Brexit blow” will be an additional pretext. I believe the British have something to gain from Brexit, but much of it will be frittered away by giving things over to government control. But then again, perhaps homegrown authoritarianism is preferable to imported varieties.

Unfortunately, the exit itself will be a bonanza to the rent-seeking class, as negotiation of its terms with the EU, and implementing the exit, promise to be complex exercises involving an army of technocrats. They should not be too eager to make regulatory concessions to the EU, or anyone else, in order to maintain close ties. The best approach would be to reduce trade barriers unilaterally, blunting the impact of the cheap pound on import prices while enjoying the favorable effect on exports.

My hope is that Brexit will prove to be an economic and cultural tonic for the U.K. in the long run. It would be far better for the country to use its power of self-governance to the good of private individuals, steering clear of government domination of economic activity and excessive regulation. Authorities should cultivate a light touch, allowing markets in the U.K. to do what they do best: promote the general welfare.

 

Costco Labor Productivity Drives Its Wages

26 Thursday May 2016

Posted by in Minimum Wage, Uncategorized

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Buyer beware: various memes promoting a higher minimum wage, or a mandated “living wage” of $15, cite Costco as “proof” that a higher wage floor does not imply that product prices must rise. In fact, Costco pays relatively high wages to its hourly workers and it is a discount retailer, but it is highly misleading to treat these facts in isolation or to suggest that they imply anything about cost-price causality and the consequences of changes in costs. A higher wage floor would add cost pressure to any business employing low-skilled labor and even some employing more skilled workers like Costco. Many of these firms would have to raise prices to remain viable.

Costco says that it pays an average wage of $17 plus benefits. A quick glance at Glassdoor.com shows starting pay rates well below that average, which is no surprise. Costco recently increased its lowest pay rates for the first time in eight years, to $13 and $13.50 an hour from $11.50 and $12. However, there may be some slight-of-hand used to support other quotes of Costco’s average wage. It’s been claimed elsewhere that the company pays an average wage of $20, and President Obama asserted that Costco’s average wage is $21. Typically, quotes of hourly wages do not include the value of benefits. One blogger suggests that these higher figures may have been calculated by averaging across job classifications, rather than dividing the company’s total hourly wage bill by the number of worker-hours. One other qualification is that roughly 10% of the workers in a typical Costco warehouse store dispense free samples but are not employed by Costco. The average hourly wage of “workers at Costco” would likely be lower than $17 if they were included.

Nevertheless, it’s true that Costco pays a relatively high wage rate to its hourly workers. How can they afford to do so? As it happens, Costco has relatively few workers relative to other retail operations, and its average revenue per transaction is high. According to Megan McArdle at Bloomberg, in 2013, Costco’s average square-feet of floor space per employee was almost twice WalMart’s; according to MarketWatch, Costco’s average revenue per employee is now nearly three times the comparable figure for WalMart (enter COST and WMT). Obviously, Costco employees are highly productive in terms of revenue, and that is closely associated with higher wages.

The high productivity at Costco is not an accident. While a good wage is certainly a motivating factor, the productivity of Costco’s work force starts with screening during the hiring process, where the company is known to prefer significant retail experience. They also emphasize the demanding physical requirements of certain jobs, and given their thin staffing, a relatively high level of responsibility for a retail worker. Newcomers are said to be under a watchful eye, and effective performers are rewarded. It takes four to five years to reach the top of the wage scale in a job category. Many of those categories involve specialized skills, such as licensed opticians, butchers, cake decorators, forklift drivers, licensed hearing aid dispensers, and registered pharmacists (these categories drive up the average wage). The company provides training opportunities in various areas, and average employee turnover is low, which reduces costs. The Costco warehouse stores are without typical retail amenities; they are bare-bones with goods sitting on pallets rather than displayed on shelves. This also lowers costs, giving the company additional leeway in shaping its generous wage policy.

Returning to the question of pricing, Costco’s example cannot be generalized. First, it might not be such a good example of price restraint in the face of higher wages to begin with. To bolster earnings, Costco is expected to raise its membership fees by about 9% in 2017; undoubtedly there is also room for retail margins to increase. Time will tell. Second, again, Costco’s wage policy works fairly well because its business model rests largely on high labor productivity. Basic economics teaches us that higher productivity drives higher wages. Workers who earn less than Costco wages are, in general, less productive. This is a consequence of more limited skill sets, less experience, and sometimes weak desire. Those earning at the minimum wage are handicapped by an inability to contribute at high levels, or an inability to demonstrate that they can at their hiring date. Thus, they work in jobs that do not require developed skills. For their employers, higher wages are not a path to profitability.

Mandating an increase in the wage floor is not possible without other market adjustments. First, like anything else, the demand curve for low-skilled labor slopes downward, so a higher wage floor reduces the desired labor input. Job losses befall the least skilled in such a scenario. This consequence has greater breadth in a world in which opportunities for automation are plentiful. Another possible adjustment is an increase in the price charged to customers, which might be a reflexive response among business operators. However, they must compromise when confronted with the competitive effects of passing along an increase in costs. There could be other cost-reducing changes in job structure, benefits, break times, and any number of other conditions and circumstances of employment. Finally, some business owners might accept a lower level of profitability, depending on their disposition and the competitive tenor of the markets in which they operate. Some Costco shareholders believe that might be the case, as the company’s earnings have softened recently.

The final outcome is likely to be a combination of the adjustments described above. Unfortunately for proponents of a higher wage floor, the economy cannot and will not transform itself into a community of Costco clones. With limited skills, the motivational power of higher wages goes only so far. All price floors create excess supply, in this context unemployment. Excess supplies tend to consist of the most marginal units, in this case, the least productive workers. Perhaps sheer ignorance causes agitators for wage mandates to overlook this inevitable marginalization. The real minimum wage is zero.

A note on the cartoon above: It reminded me of an amusing passage in Margaret Mitchell’s “Gone With The Wind” when Rhett Butler, in a sardonic moment, suggests to Scarlett O’Hara that she change the name of Kennedy’s General Store in Atlanta to “Caveat Emptorium, assuring her that it would be a title most in keeping with the type of goods sold in the store. She thought it had an imposing sound and even went so far as to have the sign painted….” Later, Rhett learns that she actually had the sign made, but an embarrassed Ashley Wilkes clued her in to the meaning. She is furious, and Rhett laughs hysterically.

Obamacare’s Left-Handed Monkey Wrench

20 Tuesday Oct 2015

Posted by in Central Planning, Obamacare

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ACA Zombies

Distorted overtures celebrating the great success of Obamacare continue, but no one who cares about the facts is buying the blather. Megan McArdle reminds us that even if we stipulate that the 9.9 million now enrolled on the exchanges have gained something, Obamacare has delivered far less than promised. McArdle also notes the high-risk skew of the population within the risk pools. That’s why insurers are losing money on Obamacare coverage, though their losses have been covered via government “risk corridors” thus far. In “Obamacare Bear Market” at wsj.com (links to a Google search result to get around the paywall — or just search “wsj Obamacare Bear”), we hear about the dismal financial performance of the Obamacare coops, which sell plans on the exchanges. The WSJ also reflects on a new working paper from Wharton economists:

“They conclude that, ‘even under the most optimistic assumptions,’ half of the formerly uninsured take on both a higher financial burden and lower welfare, and on net ‘average welfare for the uninsured population would be estimated to decline after the ACA [Affordable Care Act] if all members of that population obtained coverage.’

In other words, ObamaCare harms the people it is supposed to help. This is not a prescription for a healthy, durable program.“

Health economist John C. Goodman gives more detail on the Wharton study in “Obamacare is bad for the middle class“. Even Ezra Klein admits that the health plan is a failure. Whether Klein really gets it or not, the result is just another failure of central planning. Here’s a quote from Michael Schaus from the last link:

“The same people who failed miserably at launching a website will soon be regulating the sophisticated day-to-day decisions of hospitals, insurers and doctors.“

Anticipating another year of disappointing enrollments ahead, the White House now is low-balling its enrollment target for 2016. This an apparent attempt to present a better face to the public when the bad numbers roll in.

Another piece by Goodman explains that “bending the cost curve” with Obamacare was always a fool’s errand. Again, it has a lot to do with the folly of central planning:

“In a normal market, the entrepreneurs wake up every morning and ask themselves: How can I make costs lower, quality higher, and access to my product better today?

But in a bureaucratic system – where revenues are determined not by customer satisfaction, but by complicated payment formulas – they tend to wake up and ask: How can I get more money out of the payment formulas today?“

Goodman explains that an insurance firm providing coverage through Medicare Advantage would have nothing to gain by introducing cost-saving innovations: all of the extra profit would be turned over to Medicare. Incentives matter, but bureaucrats often fail to understand incentives and their power to improve performance. Goodman also describes the poor results of the so-called Accountable Care Organizations, the futile pilot programs and demonstration projects related to the practice of medicine, and the gaming that has taken place within the hospital “pay-for-performance” program. Ironically, the most certain outcome of any attempt to impose central planning on an industry is that there will be unintended and undesirable consequences.

Goodman has written a book proposing an Obamacare replacement, entitled “A Better Choice: Healthcare Solutions For America“. Here is David Henderson’s favorable review, in which he focuses on the negative labor market effects of Obamacare, including poor incentives for employers and work effort, among other things. To close, here’s an excerpt from Henderson’s introduction:

“If you think that the Patient Protection and affordable Care act (ACA, also known as Obamacare) is bad because of its expense, the distortions it causes in the labor market, its failure to provide people what they really want, and its highly unequal treatment of people in similar situations, wait until you read John C. Goodman’s A Better Choice: Healthcare Solutions for America. You will likely conclude that the ACA is even worse than you thought.

That’s the bad news. The good news is that Goodman … proposes reforms that would do more for the uninsured than the ACA does, and at lower cost, and also would make things better for the currently insured. and it would do all this while avoiding mandates, creating more real competition among insurers, and making the health care sector more responsive to consumers….“

Government Wants To Gut Your Gig

24 Friday Jul 2015

Posted by in Big Government, Regulation

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Big government is an inherently conservative enterprise when it comes to protecting  the economic status quo. It frequently acts on behalf of entrenched interests by quashing innovation and competition. This is well illustrated by resistance to the “gig economy” (or “sharing economy”) and companies like Uber and Taskrabbit. The gig economy is growing rapidly because it is often more affordable than traditional channels and it offers tremendous convenience. Enabled by the internet, customized tasks or “gigs” can be performed anywhere for anyone demanding them. My son in New York City just found a talented carpenter through an on-line app, who stopped by his apartment in the evening and mounted a big-screen TV on the wall. The service he provided was not new, but the deal was facilitated and even enhanced by technology in a way that in some cases is reordering economic relationships. The competitive pressure this can create is drawing resistance with the aid of government power.

In St. Louis, there is an ongoing conflict between the Taxicab Commission and Uber, which has not yet gained entry to the market. Three of eight members of the commission own cab companies. They have succeeded in keeping Uber and Lyft out of the market for over a year. A resolution might be possible soon, but the commission is still haggling with Uber over insurance coverage levels, fingerprints and background checks.

On the national stage, the biggest issue surrounding the gig economy is the formal relationship between workers and any company they might represent. Should those workers be treated as independent contractors or employees? Companies like Uber insist that their drivers are independent, but the government would prefer that they be treated as employees. In some cases, that would oblige employers to offer certain benefits. Erik Sherman covers this issue in “How the U.S. Just Knee-Capped the ‘Gig Economy’“. According to Uber, most of its drivers are part-time and like it that way, so it’s not clear that the government can force Uber (under current rules) to pay for extra benefits, or how many of its drivers that would affect. Still, it is instructive that the government is applying pressure in this area, potentially undermining competitive forces and voluntary relationships formed between innovative businesses and their working partners.

Big government advocates are extremely uncomfortable with the gig economy, but there are a fair number of progressives who place a high value on their ability to transact with “gigsters”. Politicians such as Hillary Clinton, who “skewered” the gig economy last week, risk fracturing their own base by advocating steps that could threaten innovative enterprises like Uber. In another statist attack on Uber, New York Mayor Bill De Blasio recently proposed to “cap” the company’s growth while the city studied its impact on traffic. Fortunately, he has backed down.

Progressives should love the value that the gig economy brings to segments of society whose members otherwise can’t afford or can’t access traditional services. For example, residents of low-income neighborhoods often find themselves living in “taxi deserts” when forced to rely on the entrenched cab companies. Megan McArdle makes this point in “Uber Serves the Poor by Going Where Taxis Don’t“. Aside from the technology angle, this is basic capitalism in action. When government steps in to restrict the conditions under which services may be offered, and raises the cost, it lends a degree of monopoly power to the entrenched providers and blocks the diffusion of services to all segments of the market. This should be seen as antithetical to the progressive agenda, but politicians and cronies don’t always see it that way.

The advantages of the gig economy have been made possible by technology, but another key element is that it has unleashed a flood of voluntary activity to fill gaps that were heretofore inadequately addressed. There have been some principled objections to the business practices of Uber and other gig sponsors, which often involve details regarding the splitting of revenue. Despite these concerns, there are benefits to workers who choose to participate, including a great deal of flexibility in choosing working hours and conditions. Second guessing their motives and the opportunity costs they face is a purely speculative and presumptuous exercise. Furthermore, on other fronts, government has been engaged in a seemingly intentional effort to make only part-time work available, as with recent changes in overtime rules and Obamacare regulations; at least the gig economy fits into that framework.

Traditional service providers, some of whom enjoyed government-enforced monopolies, have reacted to new competition by calling for protection. This rent-seeking behavior is typical in the history of regulation, which has often taken root under strong pressure for protection by entrenched interests. Progressives should reject this perverse form of economic conservatism.

Medicaid and Value Mislaid

12 Friday Jun 2015

Posted by in Obamacare

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Medicaid-Agency-Cartoon

A new paper on the MIT Econ department web site finds that the “welfare benefit to recipients from Medicaid per dollar of government spending range from $0.2 to $0.4, depending on the framework ….” Those estimates are from “The Value of Medicaid: Interpreting Results from the Oregon Health Insurance Experiment” by Amy Finkelstein, Nathaniel Hendren, and Erzo F.P. Luttmer (Hat Tips: Marginal Revolution, John Crawford). A major share of the increase in the number of insured individuals under Obamacare stems from Medicaid enrollments, so the efficacy of the program is of great interest as the nation considers possible changes to the health care law.

The value of Medicaid to recipients is low in part because the coverage is incremental to the uncompensated medical care they would have received without coverage. So perhaps it’s not too surprising that if “… Medicaid recipients had to pay the government’s average cost of Medicaid, they would rather be uninsured.” That’s why I think some of the commentary on this result is a little unfair, such as the way it’s presented by Megan McArdle. There are clearly other reasons why Medicaid receives a low valuation by recipients, however. For example, the authors find that the program entails substantial costs of moral hazard, which may mean that recipients are in poor health relative to reimbursement levels, take risks that they would avoid in the absence of coverage, or simply over-utilize services for which they would be unwilling to pay, even if the cash were made directly available. While it doesn’t receive much focus from the authors, low reimbursement rates discourage providers from accepting Medicaid patients. That would certainly reduce one’s willingness to pay for the coverage.

Finkelstein, Hendren and Luttmer estimate that 40% to 80% of Medicaid’s welfare value derives from “a transfer component, as opposed to its ability to move resources across states of the world.” The transfers go to providers who, in the absence of Medicaid coverage, would offer “implicit insurance” in the form of uncompensated care. As noted above, that’s a good thing. Providers should be compensated rather than relied upon as a charities, though there are strong indications that compensation is inadequate.

The authors also estimate the value of Medicaid as a “redistribution tool” relative to the earned income tax credit (EITC). At best, they find that recipients would slightly prefer Medicaid cuts to equivalent reductions in the EITC (though the comparison suffers from some conceptual shortcomings). Unsurprisingly, the outcome depends upon how highly the “transfers” to health care providers are valued by enrollees. So the program seems to do poorly in the eyes of recipients, who would likely prefer outright transfers of cash. I would speculate that many recipients would prefer a voucher with which they could purchase coverage levels of their choice, retaining any excess not spent.

The “Value of Medicaid” study suggests that the program is unsuccessful in delivering value to recipients and taxpayers. Obamacare reform should include fundamental changes to the Medicaid program, measures that restore individual choice and the private market for health coverage, and provisions to increase competition in the health care and insurance markets. Eliminating prohibitions on the sale of health insurance across state lines would be a good start. Reforms should also combat excessive regulation of health care providers, such as eliminating the electronic health records mandate and reforming the inflexible system of compensation based on relative value units. Market-oriented reforms and competition can reduce costs and make health care more affordable, aiding in the delivery of greater benefits to all segments of society.

The Dire Wolf’s Collectivist Dues

24 Saturday Jan 2015

Posted by in Taxes

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Inequality does not imply poverty for anyone, and inequality is a reasonable outcome of voluntary economic interactions between individuals who vary in their ability to create value. But inequality arising from artificial advantages conferred by the force of government and cronyism is indefensible. Sheldon Richman draws this useful distinction between the market’s distribution of rewards, which is a consequence of an unequal distribution of value-creating energy, ingenuity and talent, as opposed to the unequal rewards of a system of centralized control in which subsidies flow to cronies, monopolists are protected, barriers to activity are erected and political elites enjoy the fruits of value-destroying privilege. Here’s a sample from Richman’s post:

“Unlike market inequality, political-economic inequality is unjust and should be eliminated. … How? By abolishing all direct and indirect subsidies; artificial scarcities, such as those created by so-called intellectual property; regulations, which inevitably burden smaller and yet-to-be-launched firms more than lawyered-up big businesses; eminent domain; and permit requirements, zoning, and occupational licensing, which all exclude competition. …

Instead of symbolically tweaking the tax code to appear to be addressing inequality—the politicians’ charade—political-economic inequality should be ended by repealing all privileges right now.”

And yet we get fatuous rants from Obama about the ravages of market inequality and more tweaking of the tax code. Tweaking is too kind a word. The State of the Union address last week was a collectivist’s wet dream, replete with visions of central planning and a long list of non-neutral incentives and favors for the president’s base. He did his best to stoke the flames of class division and envy. One must ask: how long can the surviving market economy and a shrinking share of actual taxpayers support the growing dependent class and the nonproductive state apparatus?

In “Uncle Sam Is Coming After Your Savings?“, Megan McArdle warns of the dire wolf waiting at the door of every hopeful saver and middle class taxpayer. She cites Obama’s proposed tax on college savings plans (529s) as one piece of evidence, and asks “How would you feel if they did this to Roth IRAs”?

“… the very fact that we are discussing taxation of educational savings — redistributing educational subsidies downward — indicates that the administration has started scraping the bottom of the barrel when seeking out money to fund new programs. Why target a tax benefit that goes to a lot of your supporters (and donors), that tickles one of the sweetest spots in American politics (subsidizing higher education), and that will hit a lot of people who make less than the $250,000 a year that has become the administration’s de facto definition of ‘rich’?”

Then there’s the proposed elimination of the stepped-up tax basis at death, covered a few days ago at this blog, and the increase in the tax rate on capital gains and already double-taxed dividends from 24% to 28%. Of this, and the more general issue of investment incentives and efficient revenue generation, McArdle says:

“… we don’t try to tax the bejesus out of capital income, much as many would like to; old capital flees, and new capital doesn’t get formed, as savers decide it’s not worth it.”

No we don’t, for now, but that lack of capital formation is a dire implication of heavier taxes for the economy. It is an achilles heal of the redistributionist policy agenda, as a lack of new capital undermines productivity, income growth and opportunity across the board. Middle-class economics? Please, no. Glenn Reynolds has some additional thoughts on McArdle’s column:

“The truth is, in our redistributionist system politicians make their careers mostly by taking money from one group of citizens that won’t vote for them and giving it to another that will. If they run short of money from traditional sources, they’ll look for new revenue wherever they can find it. And if that’s the homes and savings of the middle class, then that’s what they’ll target.

For the moment, Americans are safe. With both houses of Congress controlled by the GOP, Obama’s proposals are DOA. But over the long term, the appetite for government spending is effectively endless, while the sources of revenue are limited. Keep that in mind as you think about where to invest your money … and your votes.”

Statistics on inequality are brandished by progressives as if to prove the existence of a great market malfunction, but as Richman points out at the link given above, an extreme form of inequality is an inevitable outcome of privilege conferred by the state. On the other hand, market inequality is no tragedy for humankind. It is an artifact of the most peaceful, productive system of social coordination ever devised. Market inequality is not related in any way to the absolute welfare of the median earning family or the least fortunate, as Robert Higgs explains in this interesting essay:

“Probably no subject in the social sciences has created so much unnecessary heat. Yet, at the same time, economists actually know a great deal about it and can dispel the public’s confusion about it if they try.” [Emphasis added]