Kinky Economics

Romney's True Tax Rate

2012-01-24T19:33:00.000-08:00

Much has been of the release of Mitt Romney's tax returns, and most of it has been misleading at best. The general summary has been that his effective tax rate has been 13.9% based on $3m in taxes and $21.7m in income for 2010. This fits with the argument that he pays a lower rate than his secretary as Warren Buffett likes to claim. However, both men know that that is not the true story. Most of his income (12.5m) was from capital gains which means that it was taxed twice -- once at the corporate level (which is borne by shareholders) and once at the personal level. Not enough information is given to figure the exact amount of pretax income and taxes paid, but let's assume that he made 17.5m before corporate taxes and then paid 5m to leave him with personal income of 12.5m. This would mean that he paid 8m in taxes on 26.7m in income resulting in an effective tax rate of 30%. If you deduct the 3m in charitable contributions he made from his income, then the effective tax rate is 8/23.7 = 33.76% which is much closer to his true tax rate.
If left in charge I would change it to where investment income and carried interest (which resulted in another 7.5m of his income) were taxed as ordinary income. Of course I would also eliminate the corporate tax rate (I'd also eliminate the charitable contribution and mortgage interest deductions). These changes would cancel each other out and wouldn't have too much effect on tax revenue, but at least they would provide an honest representation of the amount of taxes paid by individuals.

America Inc.

2011-11-24T19:59:00.000-08:00

The Occupy Wall Street protestors provide an example of what can happen when thousands of unemployed or underemployed people exist even if those people are fed and housed due to public welfare programs. People weren’t protesting because they were starving or because of police brutality, they were bored and had nothing better to do. Idleness, in addition to poverty, is a Public Bad. One of the arguments for Social Insurance, including Welfare, is that by reducing or eliminating the suffering of others is a Public Good in that everybody’s Utility is decreased by seeing others in poverty. However, the welfare programs that exist today exacerbate the Public Bad of idleness.
Everyone agrees that it would be better if they had jobs, but some claim that there aren’t any jobs out there. Poppycock! To say that there aren’t any jobs is akin to saying that scarcity does not exist. They might not be the jobs that the protestors want (and think they deserve), but there are jobs out there. As long as people have unmet wants, then jobs exist. I wonder how many protestors have volunteered to join the military, pick up trash, or harvest crops.
Unfortunately, our system discourages both workers and employers. Welfare programs are based on income levels. Thus, the loss of government assistance to employed people is effectively an extremely high tax rate. People are better off staying on welfare and working on the black market instead of joining the legitimate labor force.
Employees and employers aren’t allowed to agree on wages below the federal minimum. Frankly, some people aren’t worth $7.25 an hour. The real problem is the asymmetric information. Employers don’t want to risk hiring someone with unknown abilities and people can’t show their abilities without getting hired.
America needs an ongoing employment program to help the situation. My vision is to have government-owned enterprises in almost every sector of the economy – agricultural, manufacturing, construction, services, retail, … The government would own farms, plants, and stores whose primary purpose is to employ people, however, the enterprises themselves could be profitable. These enterprises would replace most welfare programs, and there could be some contribution from government. However, the contribution would be fixed so that more people employed in these enterprises would mean lower wages per worker.
The ultimate goal is to get people into private jobs instead of living off the public sector. Private sector employers would be relieved of the burden of testing out and training unqualified workers. This program gives these people training, experience, and an opportunity.
While this program obviously has some Socialistic characteristics, I am in no way a Socialist. However, turning part of the economy socialist is preferable to turning the entire country socialist. I firmly believe that these programs will narrow in scope as people who want to work and do a good job end up with private sector jobs. Meanwhile, those who don’t really want to work end up off the government dole.

Social Security and Consumer Debt

2011-11-21T12:16:00.000-08:00

Proponents of Social Security like to say that it is the only thing that keeps millions of
seniors out of poverty. Of course that ignores all the taxes that they paid
into Social Security before retiring. I doubt you’d thank a mugger if he give you
twenty bucks back after stealing your wallet. In order to decide whether or not
social security actually benefits people, you have to look at what they would
have done had they not had to pay all those taxes. Proponents implicitly assume
that people would completely waste all that money and it would just be gone by
the time they retire. Thus, any payment from social security is treated as a
pure gain.

If you look at social security as an investment, you can calculate the return to your investment. Social Security returns are higher for low income workers with long lives. The Social Security administration provides numbers here and more analysis is available here. Suffice it to say that the returns are pretty bleak with an average of 1-2% after inflation.

These returns are pretty pathetic when compared to investing in the stock market
where inflation adjusted returns are closer to 8%. When there are discussions
of privatizing social security, they talk about how risky stocks are and they
revel in every dip in the Dow. The real risk is not having enough money during
retirement and social security is at least as risky for this standpoint.

Instead of looking at the stock market, you can look at debt. Americans, especially the poor, are
drowning in debt – from credit cards, auto loans, underwater mortgages, to
student loans. The Wall Street protestors and community activists like to blame
banks and demand principal reductions and loan forgiveness. Simple math will
tell you that it is foolish to earn 1-2% on your savings while paying 10% on
your debt, but that is exactly what Social Security forces people to do.

You ARE the 1%

2011-10-15T14:50:00.000-07:00

The Occupy Wall Street movement has been focusing on the level and growth of inequality in the US with their "We are the 99%" motto. In reality, they are the 1%, and not just because so many of the protestors are college students that come from priviledged backgrounds. They are the 1% because they live in a nation of great wealth, and that great wealth is largely the result of the corporations, banks, and economic system that they are protesting. Even those in poverty in the US are likely to have cell phones, color TVs, and computers -- luxuries that most of the world do not enjoy. We are a country of haves and have-mores instead of a country of haves and have-nots.

The protestors complain that corporations are unfairly shipping jobs overseas. Of course, providing jobs in developing countries helps the poorest people in the world and reduces global income inequality. Apparently, the 1% are supposed to help the poor, but not the really poor. The protestors really only care about their own well-being, just like the 1%.

The protestors complain that the 1% doesn't pay enough in taxes even though their share of the tax burden is even higher than their share of income. The protestors want that money to be redistributed to themselves to reduce inequality. They are just as selfish as the 1% that they rail against, perhaps just not as good at it.

The protestors want bankers to be held accountable for their part in the financial crisis. Do they want to prosecute people who didn't pay back the amounts that they borrowed? Do they want to prosecute people who lied on their mortgage applications? While I too want anyone who acted illegally to be punished, I am not sure the protestors will get the results that they desire.

Good vs. Bad Government Spending

2011-08-17T17:38:00.000-07:00

Paul Krugman believes that the problem with the fiscal stimulus is that it just wasn’t large enough and that we are in need of another one to improve the economy. He even went so far as to suggest that a military buildup to protect us from a fake alien invasion would be a good thing.

As support for this he brings back his argument that World War II brought us out of the depression. The idea that war is good for the economy is absolutely wrong. While it may be true that war (or any fiscal stimulus) increases GDP, a higher GDP does not mean an improved economy. (I will give him the benefit of the doubt and assume that he doesn’t believe that the death of 400,000 military personnel isn’t good because of the higher per capita GDP.)
An economy only improves if people have more of the things they want. War does not do this and neither does wasteful fiscal spending. Professor Krugman also argues that cutting federal spending and austerity is bad which is wholly incongruous with his argument that World War II was good for the economy because the war was a period of tremendous austerity with the rationing of many goods.

Now this is not to say that Krugman is entirely wrong about fiscal spending. Government spending is worth it if the benefits outweigh the costs and this is true whether the economy is in a recession or an expansion. Some spending, such as protection against fake alien invasions, provide no benefits and should not be undertaken. I would also include land wars in Asia, most entitlement spending, and most wealth redistribution efforts in this category of wasteful government. Beneficial government spending would include some amounts of national defense, education, infrastructure, legal and regulatory framework, scientific research, and even some entitlements and wealth redistribution.

I would even agree with Keynesians that federal spending should increase during recessions. Not because it stimulates the economy, but because the cost/benefit tradeoff changes resulting in more beneficial projects. If unemployment is high, then the government can hire people at lower wages. If interest rates are low, then future benefits have a higher present value. Thus, a bad project during expansions becomes a good project during recessions. However, paying people to do nothing and trying to keep wages high completely nullifies this.

The main problem with the economy isn’t the lack of fiscal stimulus, it is the excessive use of bad government spending. If the government were to cut the wages of current employees and cut out a lot of the bad spending, then it could fund spending that actually has benefits.

Social Security does contribute to the deficit

2011-08-07T15:43:00.000-07:00

There are many ways to solve the budget deficit and reasonable people may disagree as to which method is the best. Revenues could be increased through some combination of higher levels of GDP, faster growth of GDP, and higher taxes as a percent of GDP through either higher tax rates or eliminating tax expenditures (such as home mortgage interest deductions). Realistically, there is some limit to the ability to raise revenues because higher tax rates may also limit the level and growth rate. I have posted on the Laffer Curve before as have others with opposing views.

The deficit could also be reduced through spending cuts. There is also a limit here as lower spending could lower the growth rate of GDP (higher spending may also reduce growth if the spending crowds out private investment with greater growth opportunities). For convenience, the US budget can be broken down into four broad areas: health care (Medicare and Medicaid), Social Security, Defense, and discretionary non-defense. Right now, health care, Social Security, and defense are all in the $700-$800 billion dollar range, but health care has the highest projected growth rates and is definitely the biggest threat to the deficit. However, today I would like to talk about Social Security.

Many people, including Nobel-prize winning economists, argue that Social Security does not contribute to the deficit because we have historically raised more in revenues into Social Security than we’ve spent resulting in a large surplus in the “trust fund” that won’t run out for many years. While this is technically true, it ignores the fact that by soaking up such a large portion of US tax revenues, there is less opportunity to raise additional revenue.

Imagine if there were a law that said that 50% of all tax revenues were dedicated to the Department of Defense. If the defense department only spent 20%, would that mean that they are saving us money or that we don’t spend enough on defense? Of course not, the problem would be that we are dedicating too much of our revenue on defense.

That is the problem with Social Security. By dedicating 12.6% of most workers paychecks (including the “employers” portion, another myth), we are crowding out revenues that could be used for better purposes. An individual with an income of $50,000 would pay 15.3% in Social Security and Medicare, another 15% in federal income taxes, and maybe 10% in state and local taxes, sales taxes, property taxes, … No wonder so many people feel that they are Taxed Enough Already.

Collective vs. Individual Bargaining Rights

2011-03-29T16:39:00.000-07:00

We are in the midst of attacks on unions in general and public sector unions in particular. While most critics argue that this unfairly limits workers’ collective bargaining rights, it should also be seen that unions restrict the individual bargaining rights of workers. The value of unions increases with the monopsony power of employers in the hiring process and the similarities among employees. For example, generous health care benefits may not provide as much value to younger, healthier employees and employees who already have coverage through a spouse. Pension plans that reward longevity may not provide as much value to mobile employees. Salaries that are based on experience and degree fail to reward those exceptionally talented teachers. However, these teachers have no voice for their needs. They are stuck with the deal negotiated by the union.

Kinky Health Care

2010-12-15T07:38:00.000-08:00

How should health care be reformed? Well, the Kinky Economist has a plan that provides for both universal health care and the best damn health care that money can buy. The first major component is government provided health care available to anyone. This public plan would be modeled on the VA system where the government owns the hospitals and the doctors and nurses are employees of the government, so members would not be able to choose their own doctor. If you want to choose your own doctor, pay for it yourself (or buy your own insurance). There is no right to choose your own doctor.

The plan would focus on preventative care where annual check-ups are not only free, but you could get paid for a healthy lifestyle. So much of our health care costs, especially diabetes, heart disease, and respiratory problems, are driven by behaviors such as obesity, inactivity, and smoking. By focusing on wellness, these costs can be avoided (although healthier lifestyles do result in higher costs due to increased life expectancy and chronic diseases in old age).

Chronic and catastrophic health care would be rationed by Quality Adjusted Life Years (QALYs). For instance, the government may pay up to $40,000 for treatment that extends a patients life by one year, so the cost per QALY would be $40,000. Yes, health care will be rationed -- it is already rationed. Every scarce resource is rationed. If you don't want the plug pulled on Grandma. then pay for her health care. You shouldn't demand that other people to pick up the tab if you're not willing to pay the costs. If QALYs are used to ration health care, then how much are we willing to pay to save a life? More accurately, how much are we willing to make someone else pay to save a stranger's life? The budget for health care must be limited to a percentage of the total government budget. Once a fixed dollar value has been created, the cost per QALY will depend on how many people are in the government plan and how much health care they need. The government plan is meant for the poor and the sick, not the healthy and the wealthy. If more people get their own insurance, then the available funds can be spread among fewer participants resulting in higher costs per QALY. The plan can also accept contributions from donors that would increase the cost per QALY.Another focus of the plan is positive externalities of health care. The plan could require patients to be immunized resulting in a reduced likelihood that other people will get sick. The plan could strongly encourage organ donation to help save other lives. The plan could be used for research on new medical techniques and drugs. All of these characteristics result in social benefits.

Another focus of the plan is cost containment. Treatments would be based on comparative effectiveness so that costly, ineffective treatments are avoided. Medical malpractice costs would be eliminated or at least drastically reduced by not allowing patients to sue or instituting a program to resolve these disputes. Generic drugs would be prescribed instead of brand names in order to lower pharmaceutical costs. The plan would also use it's size to negotiate better terms for prescription drugs, medical equipment, and other purchases.

There would also be a greater reliance on medical personnel other than doctors such as Physician Assistants and Nurse Practitioners. Additionally, employment in the system could be worked into programs for medical and nursing schools. For example, tuition is free at military academies such as West Point, but students are required to give four years of duty after graduation. The GI Bill will pay for college for soldiers after they leave the service. The federal government could pay for medical school with a requirement that the doctors work in the system after graduation.

The public plan is not for everyone and most Americans can and should get their own insurance, just as they do today. However, the health care system does have flaws and room for improvements. The primary downfall of the plans that seem to be bandied about is the insistance on a single level of health care resulting in either reduced levels of care and/or higher costs. By recognizing that everyone deserves basic health care but not necessarily Cadillac care, I believe that the KinkyCare framework has the best potential to improve health care coverage and results.

The Four Hurdles of Global Warming

2010-03-19T08:40:00.001-07:00

After health care, debate over global warming and the environment has been the most raucous over the past years. Before I go into a full discussion of my views, I do want to mention two points worthy of special mention. The first is whether or not global warming is caused by man. Who cares? Suppose we knew that it global warming was real, but not caused by man. Would that make it any less dangerous? The second point is that even if you don’t believe in global warming, fossil fuels are still pollutants that results in negative externalities. As we all know by now, even the most strident anti-government economists recognize that there is a role for government in the regulation and taxing of negative externalities. (Full disclosure: I consider myself a strident, anti-government economist). With that out of the way, I’ll move on by discussing the four questions that should really guide the debate.

Is global warming really happening? This is the question that has the least to do with economics and the most to do with climate scientists. I’m going to have to say yes on this question based on the climate reports. Admittedly, it is fairly easy to massage data to fit your hypothesis and the models have done a very poor job of forecasting the future. What I mean by this is that it is easy to create a model that explains what happened in the past, but if the model can’t predict the future, it isn’t of much use. So even if the Earth has gotten warmer over the past 100 years, I am not confident that it will continue to get hotter even if there are no actions taken to reduce global warming.
What are the positive and negative effects of global warming? It is possible that global warming may cause the ice sheets to melt and sea levels to rise, but it may also lead to longer growing seasons and more temperate conditions elsewhere. There is no reason to believe that the current climate is the optimal climate. It is entirely possible that a warmer Earth is actually better. Realistically, some people will gain and some will lose. It may suck to be a Polar Bear, but there are areas that will benefit from global warming. I have seen reports that the US would be better off with global warming, and not just because California will be under water.
Can human actions affect it? While I don’t think it matters whether or not humans cause global warming, I do think it is important to know whether or not humans can control it. It doesn’t really matter whether or not man caused global warming, what matters is whether or not we can do something about it. What effect will a reduction in carbon dioxide emissions have? Are there other actions that may affect global warming. The book SuperFreakonomics has a chapter devoted to alternative methods of fighting global warming that includes things like huge ocean mirrors and simulated volcanoes. These might be as effective and cheaper than reducing the use of fossil fuels.
Are the benefits of taking action worth the costs? In economics we talk about tradeoffs, and when I say costs I am not just talking about money, I’m talking about lives. Economics is sometimes known as the Dismal Science because it is concerned with Scarcity. It originally got this name due to the work of Thomas Malthus who basically predicted that population growth would outstrip food supply leading to constant famine. The question became one of forced population control (like China’s one-child policy) or natural population control through starvation. The Earth currently has almost 7 billion people. Many people believe that the Earth is overpopulated and a population of 5 billion may be more manageable. Is this a good thing? I’m not even sure if we can define what is good or bad, and if we can’t define an objective, how can we decide what to do? (Side note: Both Global warming and efforts to fight global warming may cause death). Beyond life and death, there is quality of life. If you could go back 100 years and prevent the development of the car or the discovery of oil, would you? By doing so, you may prevent global warming, but you’d also be eliminating the huge strides in our quality of life.

Frankly, I don’t know what to think. I basically support some taxes on fossil fuels due to the negative externality that results combined with some subsidies for greener forms of energy, but there becomes some point where the taxes and subsidies go too far. Just like the discussion of externalities, the tax should be equal to the marginal social cost – no more and no less. The goal is not to have no pollution (or no global warming) the goal is to have the optimal amount, and your definition of the optimal amount may be different from mine.

Coase Elections

2010-02-24T08:22:00.000-08:00

I have become frustrated by government and believe it is badly in need of fixing. This puts me in agreement with about 300 million other Americans. A common complaint is that special interests and lobbyists have too much influence over policy. This complaint only grew in intensity after the Supreme Court ruled in Citizens United vs. FEC that corporations and other entities have the right to fund political activities as free speech. The decision has been openly criticized by the President in the State of the Union address and has been mocked in Congress as leading to the Senator from Exxon. I disagree with the argument that this ruling means that corporations will be able to do whatever they want. Lobbyists tend to fund candidates on both sides of the aisle and there are lobbyists on both sides of any issue. I don’t think that the new ruling will change the type of legislation that government passes (or doesn’t pass), I just think that more money will be wasted by both sides in “rent seeking” activities, and any time money goes to unproductive resources, society is left worse off.
A better solution, I believe, is to redirect the resources used for rent seeking. Under the current system, lobbyists on both sides of an issue spend millions to get legislation passed (or to stop legislation from being passed) or to get a candidate elected. Any money spent on Lobbying is wasted if you don’t get the outcome you wanted (for example, if the other side spends more and gets the outcome that they wanted). The way to reduce the amount of money wasted is for the two sides to decide among themselves which side is willing to pay more for a particular outcome and then for them to pay off the other side. This is the idea behind the Coase Theorem that basically states that under certain conditions, the outcome will go to the party that places the greatest value on the outcome. Suppose two neighbors are arguing about a tree on their property line. One neighbor want to chop it down and the other guy wants to keep it. They decide to go to court to decide who has the rights over the tree. Coase argues that there is no need to go to the courts; the easier method would be to determine which neighbor places a greater value on the outcome. If one neighbor is willing to pay $20 to chop it down, but the other person is willing to pay $25 to keep it, then the second person should pay the first person at least $20, but no more than $25, in order to keep the tree. Both sides are now better off.
What if we used the Coase theory to decide political outcomes? Participants on both sides of an issue raise money and whichever side raises the most money wins, but has to turn at least some of the money over to the losing side. The easiest way to see this is an election. Candidate A is a favorite of business and raises $1,000,000 while Candidate B is a favorite of unions and raises $900,000. Candidate A would win the election, but the people who contributed would have to pay $1,000,000. The people who donated to candidate B get to keep their pledge plus they double their money because they get paid out of the money that Candidate A raised. The extra $100,000 goes to the government.
Just to be clear, not only does the losing side get their own money back, they double their money. Instead of being a system where the “rich” are allowed to buy an election,the Coase election is really a huge means of wealth redistribution from the rich and powerful to the poor and powerless. Instead of keeping power by "buying" politicians, they have to give the money to the people. Also, each candidate would really have two accounts. One account would be used for campaign activities such as commercials, signs, and fund raising. As a donor/lobbyist, you can contribute to this fund, but you won’t get that money back - any money spent on that is lost. This fund is the same campaign fund that candidates currently have. The other fund is a new fund that determines who wins or loses the election. Whichever candidate raises the most money for this new fund wins. There is no actual election where people go vote. The way you vote is by contributing to the fund. Not only must you decide who you want to win, you must decide how much you are willing to pay to get him elected. Any entity could participate in this, including corporations and speculators would also participate. I may not care who wins, but I may contribute $50 to the candidate that I expect to lose. If I’m right and that candidate loses, then I double my money. If my candidate wins, then I lose my $50.
Is this a great idea? Yes. Will it happen? No. Why? Congress. Let’s look at the current system for deciding these matters. People vote to elect Congress, lobbyists from both sides shower congress with favors. Congress does nothing. Repeat. With 90%+ of congress reelected each time, why would they support a system that takes away their influence and the barrage of favors that comes with it? There are also some practical limitations to the Coase theorem. This type of election requires a fairly clear dispute between two sides. As you add more and more possible outcomes, it becomes impossible for both sides to win. However, you could have a series of votes between outcomes until you have a final winner – sort of like November Madness.

Ten things I'd like to see in Health Care Reform

2010-01-30T21:07:00.000-08:00

While I am not a fan of the reform plans being discussed, I do agree that health care reform is needed. Many of these reforms would only be applicable to government provided or subsidized insurance, I fervently believe that individuals and insurance companies or health care providers should be allowed to make whatever kinds of agreements they wish in the private market. That being said, here are ten things I would like to see.

1. Cost effectiveness measures. These limit the treatments you can receive, the medicines you can take, and the doctors you can see. A lot of health care that is currently provided has very little benefit. That's fine if you are using your own money, but not if you are using taxpayer money.

2. Substitutes for doctors. If your goal is to cut costs and increase coverage, then this involves increasing the supply of health care. One way to do this is to expand the use of substitutesw such as nurses, practitioners, and physician assistants. Most of my visits can be handled by these people without ever having to see the doctor.

3. Subsidizing medical education. If you can reduce the cost of becoming a doctor, then you can increase the supply of doctors available. My personal preference involves providing payment for med school in exchange for several years of service, just as a West Point education is free with the requirement that the cadet serves in the military after graduation.

4. Focus on preventative care. If someone has government provided health care, then you can require that they come in for an annual check up and actively monitor their situation. This is especially important if we are talking about prenatal care.

5. Health care with externalities. Similar to preventative care, behavior with negative externalities need to be discouraged and positive externalities need to be promoted. This could include things like promoting vaccinations and providing antismoking or diet services.

6. Tort reform. This could cut costs for all customers, not just those with government provided insurance. There could be an explicit ban on suing or a higher cost for policies that include the right to sue.

7. National markets. The market for individual health insurance is really 50 different markets on a state-by-state basis and each state is pretty much dominated by a single provider. Allowing insurers to compete across state lines could cut costs. This would also eliminate the 50 different sets of rules and mandates that currently exist.

8. Doughnuts. It sounds stupid at first, but it actually makes a lot of economic sense. Most people really just need catastrophic insurance that covers major emergencies. These plans may have deductibles of $10,000 for example. This means that people would have to pay for preventative care themselves, and alot of people would go without annual checkups and other preventative measures. Doughnuts provide coverage for preventative care by paying for the first $500 of expenses and they pay for catastrophic care by paying for anything over $10,000, but they don't pay anything in between (the hole in the doughnut). These are really the judgement calls where it is up to you to decide whether or not it is worth spending your own money for the treatment.

9. Innovative insurance offerings. People should be able to buy Health insurance in the same ways that they can buy Life Insurance. You might buy a term plan that holds premiums steady for the next ten or twenty years. You might also buy a whole plan that covers you until you cancel or die and holds premiums constant or at least limits the rate of premium increases.

10. Portability. I don't mind the fact that most people get insurance through their employer, but insurance should not be job-based. However, an expansion of COBRA that allows people to continue their coverage even after employment is terminated doesn't consider the fact that there is a differential tax treatment and that employer-based coverage tends to be way costlier than necessary, at least for healthy employees.

Jurassic Health Care

2010-01-30T20:06:00.000-08:00

As is true with any plan where nothing can go wrong, something will go wrong. I don't know what, if anything, will be passed in Congress, but I see several potential problems regardless of the final outcome. Here now is my top ten list of future problems.

1. If the reform involves expanding coverage either with private or public insurance, then the reimburesment rates paid to doctors under the new plans need to be set. If rates are so low that the newly insured still don't have access to health care because no doctors are willing to accept them as new patients, then what is the point.

2. If reimbursement rates under the new plans are sufficient to entice doctors to accept them, then Medicare members, which have lower reimbursement rates, or people that already have insurance start getting left out.

3. If Medicare increases their reimbursement rates to ensure that members maintain their access to doctors, then this will cause the cost of health care reform to go way beyond the original estimates. I believe that this is a major concern. If health care reform is passed, it will be based on cost estimates that are way below what they will end up being.

4. Private insurers may also increase their reimbursement rates so that their customers can maintain access. Any hope of "bending the curve" is lost.

5. The government steps in to ensure that all patients have equal access to doctors regardless of the reimbursement rates offered. Private insurers will lower their rates since their is now no advantage to offering to pay more. At this point doctors basically become government employees and their offices are jampacked with patients making it harder for everyone to get an appointment and see the doctor.

6. Doctors revolt by no longer accepting insurance and moving to a cash only basis. This may not be a bad thing in terms of reducing the costs of health care as much of the cost goes to unnecessary procedures that people wouldn't pay for if they were paying their own bills.

7. The number of students training to become doctors starts falling as a future of dealing with government red tape doesn't seem so enticing.

8. Another part of cutting the costs of health care is implementing cost effectiveness measures in order to cut the extent of unnecessary procedures. These measures may include things such as less frequent mammograms, new guidelines on transplants, and reduced end-of-life care. The determination of cost effectiveness would be made by experts, also known as death panels.

9. I'm acually a big fan of cost effectiveness and support death panels, but affected parties will cry foul on these measures and demand that they be alowed to receive any care approved by their doctor. Government will no doubt relent and pay for less efficient treatments causing costs to go way beyond original estimates.

10. If insurance reform involving guaranteed issue, community ratings, and individual mandates passes, then premiums for healthy people would rise dramatically. Granted, premiums on sicker people would fall, but you are robbing Peter to pay Paul. I don't think anyone disagrees that this would happen. Some people believe that that is a fair tradeoff and some people don't.

What is and isn't included in health care costs?

2009-10-05T19:42:00.000-07:00

Much has been made about the fact that Americans on average spend far more for health care than citizens of other countries and that we still lag those countries in measures of health care outcomes. But there are a lot of questions about what should and should not be counted as health care. One example is cosmetic surgery. This is not covered by health insurance, but it is included in calculations of health care costs. We are paying doctors for breast implants instead of providing health care. Mental Health care costs are also included, as are dental care and elective procedures such as in vitro fertilization. These items are legitimate costs, but their inclusion skews the picture of how much we spend on health care relative to other countries.
Another cost is long-term care. I do not mean to diminish it's importance, but costs could be dramatically reduced if multi-generational households were the norm as they are in many other countries. If I pay $20,000 a year to put my mom in a nursing home, then it is a health care cost. If I give up $20,000 in possible earnings to take care of my mom, then it is not treated as a health care cost. These two situations should be treated the same in order to properly compare health care costs.
American doctors are also paid a lot more than their foreign counterparts. One reason for this is the time and money doctors must devote to their education. In many other countries, medical training is provided by the government, or at least subsidized to a greater extent. in the US the cost of education is indirectly included in health care costs through the higher payments to doctors. In other coutries, these costs are not included in health care costs because they are costs of education.
It may be true that we spend more on health care, but the numbers don't tell the whole story.

Universal Health Insurance

2009-10-05T19:16:00.000-07:00

If we really want universal health insurance then we can easily acheive it. I can personally grant every American health insurance right now. It covers anyone at all, there are no restrictions against pre-existing conditions, it is free, it covers anything the doctor and patient want done, and patients can go to any doctor they want. The key is that the plan reimburses the doctor $1 for each patient he sees during the year. So, now EVERYONE has insurance and the problem is solved.
Obviously not. All the talk about the uninsured and the need for insurance reform misses the point that it is health care and not health insurance that matters. No one dies from a lack of insurance, despite the headlines on a recent report, they die from not receiving medical care. There is a difference between health insurance and health care and people would be wise to understand the difference before making reforms.
If doctors won't treat people covered under the insurance plan then no one receives any health care. The government could FORCE doctors to accept patients, which is already occuring with Medicare reimbursement guidelines and will only increase under proposed reforms. The problem with this is that it will lead to a serious shortage of doctors. We alreay have severe shortages in nurses and general practitioners in part due to the reimbursement schedule.
Besides, it is wrong to FORCE doctors to treat patients. Of course, it is equally wrong to FORCE someone else to pay the doctor to treat patients. In both cases, someone is being forced to work without compensation. In one case the doctor is forced to treat patients, in the other case someone is forced to work for free as his wages go to the government in the form of taxes and ultimately to doctors. If you pay 35% of your income in taxes, then you are being forced to work for free 35% of the time.
A fairer system would involve voluntary exchange and would not have to involve government at all. A non-profit health insurance company could be set up that would accept any and all patients and the health care costs would be funded through tax-deductible contributions. If the American public does indeed care about the uninsured and wants to provide health care to everybody, then this is the way to do it.
Will this work any better than my first insurance plan? Probably not. This whole debate isn't about providing health care, it is about power. It is about making someone else do something that people are not willing to do themselves.

Kinky Health Insurance Reform

2009-09-17T21:10:00.000-07:00

In addition to a public plan that covers the basic health care needs of everyone and anyone, Kinky Care also slaps the insurance industry upside the head and directs them back to the risk-sharing purpose of insurance. Although I am opposed to the reforms that turn the insurance industry into a cost-sharing bastard child, the insurance industry is in serious need of reform.

Critics point to insurance companies refusal to cover pre-existing conditions as a problem, but I am fine with the insurance company refusing to insure pre-existing conditions. However, I am opposed to denying legitimate claims in order to cut costs. The denial of claims or cancellation of insurance after a claim is made is referred to as rescission. Rescissions are not necessarily evil because they does have a proper role in combating fraud. If an applicant lies about a pre-existing condition and then makes a claim resulting from that pre-existing condition, then a denial of claim and rescission is proper. Combating fraud helps to hold down the cost of honest customers and the right to rescind a policy is cheaper than requiring a verifiable, complete medical history from each applicant. However, denying a claim due to an honest mistake by the customer should be forbidden. So, how can you tell the difference between an honest mistake and a fraudulent application? First, a rescission can only occur when the claim is related to the error in the paperwork. If you forgot to mention a broken leg when you were a child and make a claim for a heart attack, the insurance company must honor the claim. Second, the rescission must occur within a reasonable amount of time -- I'd choose two years. Even if you have a family history of heart disease that you covered up, if you don't make a claim or if they don't catch you for two years, then you are free and clear. The third issue is intent and this is the hardest to determine. Did the applicant make an honest mistake or was he trying to cover something up? You have a heart attack after 6 months and the insurance company finds out that your estranged father was on medication for high blood pressure. That would be one for the courts or arbitration panel to decide.
An associated reform covers changes in premiums. Even if insurance is not rescinded, premiums could still rise after a customer has a serious illness. The term of an insurance contract and the allowable increases in premiums must be laid out in the initial contract. If you want a ten-year contract with premium increases restricted to 5% per year, then you could get it. A year-to-year contract would also be available with the knowledge that the customer is taking on the risk of premium increases.

The final major reform is the allowance of interstate competition and the removal of federal antitrust exemptions. Insurance companies are currently protected from federal antitrust laws under the 1945 McCarran-Ferguson Act. The supposed reasoning for this exemption is that they are regulated under separate state regulations with a prohibition against interstate competition. This results in individual state markets that are dominated by a single insurance company. Rates among states vary widely largely based on regulations that restrict risk-based premiums or require mandates that customers may not want. A twenty-five year old who doesn't want coverage for mental health care would be charged the same as a sixty-year old who wants his Viagra covered under a state mandate. Moves to repeal the antitrust exemption and to allow interstate competition are already underway and will hopefully pass regardless of the final health care reform.

Health Insurance (as opposed to Health Care) Reform

2009-09-17T20:06:00.000-07:00

Alot of the venom regarding health care in the US has been directed at the insurance industry. Nancy Pelosi singled them out as the top villain, town-hall protestors are labeled as industry shills, and the primary evidence of the failure of the current system is the number of uninsured people in the US. In fact, the overall health care reform drive is largely a matter of health insurance reform. But health insurance is not health care and was never meant to be. The purpose of insurance is to spread risk among a large number of people. Unfortunately, the insurance industry seems to have moved away from that goal and I want to institute policies that direct the industry back towards their original purpose. Reformers, however, want to turn the insurance industry into something it was never meant to be.
The principle idea behind insurance is that bad things will happen to some people, but not to everyone. If there are ten people and each one of them has a 10% chance of having an accident that will cost $100,000, then each person has an expected cost of $10,000 and the insurance company will charge each person $10,000 (plus some profit) for coverage. If some people choose not to buy insurance, then that won't affect the expected cost of the remaining individuals. The main point is that insurance should charge each person their expected cost plus profit and each person has the right to either buy insurance or not to buy insurance.
Reformers want to turn insurance from risk-sharing to cost-sharing. Under cost sharing, people are no longer charged an amount based on their own level of risk, they are charged an amount based on the collective level of risk. Suppose you had ten people again and one person had a 91% chance of having an accident while the other nine had a 1% chance. Risk-sharing Insurance would charge the nine people $1,000 (plus profit) each and the other person $91,000 (plus profit). Cost-sharing Insurance would still charge each person $10,000. If one of the nine refuses to buy insurance, insurance would have to charge the remaining nine $11,000 each (expected costs are now $99,000 divided by nine people). If another person drops out, the premium would by $12,250 (98,000 divided by 8). The expected costs would be divided among fewer and fewer people until the one person has a premium of $91,000 that he can't afford and the other nine have no insurace.
In order for cost-sharing to work, everyone must be required to buy insurance with the low-risk people effectively subsidizing the costs of the high-risk people. That is why the reformers push three primary reforms: mandates that force everyone to buy insurance (or pay a fine), guaranteed issue which says that insurance companies can't refuse high-risk individuals, and community rating which means that everyone is charged the same regardless of their level of risk. These changes would be accompanied by subsidies that help poor people pay for insurance and taxes that force wealthy people to pay for those subsidies.
The primary healthcare reform proposals being debated result in redistributions from the wealthy to the poor through taxes and subsidies and from low-risk individuals to high-risk individuals (from the healthy to the sick) in the form of individual mandates, community ratings, and guaranteed issue. As far as I'm concerned, there isn't a lick of difference if this is done through a single-payer system, a public option, co-ops, exchanges, or reform of private insurance. I can understand some people supporting this type of reform. It might even be better than what we currently have. But it still isn't the best system and I don't support it.
The fundamental characteristic that a health care policy has to have in order for me to support it is the existence of different levels of quality of care with the customer paying more for higher levels of quality.

The Laffer Curve

2009-09-16T19:40:00.001-07:00

Much has been made about President Obama’s efforts to raise taxes on high income individuals in order to fund additional spending programs such as health care, energy, and the stimulus. Critics cry class warfare and complain that the wealthy shouldn’t be punished in order to provide a welfare state. Defenders say that the rich can afford higher taxes without any big impact on their well-being. The bigger concern to me, and one that isn’t getting the attention that it deserves, is this – it won’t work.
Raising tax rates on high income individuals will not raise as much money as expected and may raise even less money than before. The idea behind this is known as the Laffer Curve and it basically argues that work effort is a declining function of tax rates and that there is some tax rate that maximizes the amount of revenue collected. At low tax rates, people work but the government gets very little tax revenue. As tax rates rise, people will work less so that tax revenues will still rise but at a decreasing rate. At some point, tax revenues will begin to fall as the reduced work effort dominates the higher tax rate. At extremely high tax rates, people won’t work and no money will be collected. If you wish to draw it, the Laffer Curve looks just like an arch.
There is some tax rate that would maximize total taxes, but people disagree on what that rate is. Keynesian economists (Democrats) tend to believe that we are below that point so that higher tax rates lead to higher tax revenues. Meanwhile, supply-side economists (Republicans) tend to believe that we are beyond that point so that raising tax rates actually reduces tax revenues.
In reality, the revenue maximizing tax rate depends on income and you can make a strong argument that high income people should be taxed at lower rates than middle class people. The determining factor is whether or not people have a substitute for working. High income people include business owners, professionals, doctors, lawyers, … and anyone in the highest income levels probably has some control over their career and how much they work. They have the option of taking more vacation, retiring earlier, sheltering income, deferring income, or take some other action that reduces the amount of tax revenue that the government takes in. Any reduction in the amount of work done by these people, and therefore their income, will result in lower tax revenues. Meanwhile, middle class people have less flexibility in their job. Employers expect 40 hours per week with two weeks of vacation – no more, no less. Low income people actually have greater flexibility too in that they can receive state support or work in informal (and untaxed) jobs instead of working in a traditional job.
It is politically infeasible to have lower tax rates on high income people, so the government really needs to determine the tax rate that maximizes tax revenues for this group and then set tax rates for middle and lower income people either equal to or below that rate. So, what rate maximizes tax revenues for high income workers? I honestly don’t know, but I have a feeling we are probably already close to that rate. The highest marginal Federal Tax rates are set to go up to 39% plus state and local income taxes and sales taxes means that we’re probably already at about 50%. I really don’t think that higher rates will lead to higher revenues.

Not everyone agrees with this. Tax rates have been significantly higher than they are today – as high as 91% under Eisenhower – and the economy did just fine. Indeed, there is very little correlation between economic growth and the highest marginal tax rate. There are two reasons for this. First, tax rates should affect the level of income, not the growth rate. When tax rates change, there may be short term effects on growth as people change their work habits, but once these habits are set, there is no reason that the growth rate should be affected. Second, changes in tax rates will only affect a small percentage of tax payers. If you raise tax rates on the highest 2% of workers, then they may cut their effort, but it won’t have a huge impact on the overall economy.
Again, some people disagree and say that the tax cuts just help the rich get richer. As proof of this giveaway they point to the increase in income inequality since the 1950s when tax rates were 91%. In actuality, their argument is self-contradictory and shows the Laffer effect. When tax rates go down on the highest income individuals, they have greater incentives to work and invest which causes their income to go up. Lower tax rates lead to higher before tax incomes. Conversely, higher tax rates lead to lower pre tax incomes. As far as the effect on tax receipts goes, it depends on the strength of that relationship. If an increase in the tax rate from 40% to 50% causes income to fall from $100,000 to $80,000, then tax receipts are unchanged. A smaller impact on income, say a decline to $90,000, would result in higher tax receipts while larger declines in incomes would lead to lower tax receipts. Overall, I think that higher tax rates will do very little to raise revenue, but it might reduce income inequality. This might be a worthwhile objective, but it won’t pay for additional programs.

A brief overview of Kinky Economics

2009-09-04T21:17:00.000-07:00

On this blog I will outline my views on public policy. The basic principles of Kinky Economics are that everyone deserves a basic quality of life while minimizing the restrictions on people who desire a better life. I also sometimes refer to this philosophy as the barbed wire safety net, it can save your life, but it's not meant to be comfortable. The actual name of Kinky Economics comes from the idea of a kinked Aggregate Demand curve for those of you with a familiarity with Keynesian economics. I am currently focusing on the health care debate due to the current national debate. However, I will sprinkle in some other blog posts at times. It is my objective to pull this together into a book, so you will at times see periods where I focus on taxes, the environment, welfare, regulation, and other topics. I look forward to any comments you may have.

A brief overview of KinkyCare

2009-09-04T20:09:00.000-07:00

How should health care be reformed? Well, the Kinky Economist has a plan that provides for both universal health care and the best damn health care that money can buy. Anyone can get health insurance for free through the government. This public plan would be modeled on the VA system where the government owns the hospitals and the doctors and nurses are employees of the government, so members would not be able to choose their own doctor. Employment in the system could be worked into programs for medical school. For example, tuition is free at military academies such as West Point, but students are required to give four years of duty after graduation. The GI Bill will pay for college for soldiers after they leave the service. The federal government could pay for medical school with a requirement that the doctors work in the system after graduation.

The plan would focus on preventative care where annual check-ups are not only free, but you could get paid for a healthy lifestyle. So much of our health care costs, especially diabetes, heart disease, and respiratory problems, are driven by behaviors such as obesity, inactivity, and smoking. By focusing on wellness, these costs can be avoided (although healthier lifestyles do result in higher costs due to increased life expectancy and chronic diseases in old age).

Chronic and catastrophic health care would be rationed by Quality Adjusted Life Years (QALYs). For instance, the government may pay up to $40,000 for treatment that extends a patients life by one year, so the cost per QALY would be $40,000. Yes, health care will be rationed -- it is already rationed. Every scarce resource is rationed. If you don't want the plug pulled on Grandma. then pay for her health care. You shouldn't demand that other people to pick up the tab if you're not willing to pay the costs. If QALYs are used to ration health care, then how much are we willing to pay to save a life? More accurately, how much are we willing to make someone else pay to save a stranger's life? The budget for health care must be limited to a percentage of the total government budget. Once a fixed dollar value has been created, the cost per QALY will depend on how many people are in the government plan and how much health care they need. The government plan is meant for the poor and the sick, not the healthy and the wealthy. If more people get their own insurance, then the available funds can be spread among fewer participants resulting in higher costs per QALY. The plan can also accept contributions from donors that would increase the cost per QALY.

Another focus of the plan is positive externalities of health care. The plan could require patients to be immunized resulting in a reduced likelihood that other people will get sick. The plan could strongly encourage organ donation to help save other lives. The plan could be used for research on new medical techniques and drugs. All of these characteristics result in social benefits.

The final focus of the plan is cost containment. Treatments would be based on comparative effectiveness so that costly, ineffective treatments are avoided. Medical malpractice costs would be eliminated or at least drastically reduced by not allowing patients to sue or instituting a program to resolve these disputes. Generic drugs would be prescribed instead of brand names in order to lower pharmaceutical costs. Finally, the plan would use it's size to negotiate better terms for prescription drugs, medical equipment, and other purchases.

The public plan is not for everyone and most Americans can and should get their own insurance, just as they do today. However, the health care system does have flaws and room for improvements. The primary downfall of the plans that seem to be bandied about is the insistance on a single level of health care resulting in either reduced levels of care and/or higher costs. By recognizing that everyone deserves basic health care but not necessarily Cadillac care, I believe that the KinkyCare framework has the best potential to improve health care coverage and results.

Is US Health Care Broken?

2009-09-04T19:36:00.000-07:00

One of the arguments made by proponents of health care reform is that the US system of health care is clearly broken because we pay so much more than other countries for health care and have worse results. Indeed, the overall statistics bear this out. We spend twice as much per capita and have lower life expectancies and higher infant mortality rates. Is this not proof of the need for change? Perhaps not if we look at individual results instead of averages. Suppose both Rich and Joe are dying. It would cost $100,000 in medical costs to extend Rich's life by one year while it would only take $50,000 to extend Joe's life by two years. From an overall statistical perspective, it would make more sense to save Joe's life. But what if Rich has $100,000 and Joe is broke. Rich might prefer to spend his money to save has own life, and the only way to save Joe is to forcibly take Rich's money from him through taxes in order to pay for Joe's treatments. While this might benefit Joe, Rich is now dead and out $50,000.
So, is this reflective of our current situation? Evidence indicates that this does play a role. While our overall spending is high and our overall results are low, if the results are broken down into subgroups the picture changes. Life Expectancy of Whites and Asian-Americans are inline with European and Asian averages while the life expectancy of African-Americans is lower than the life expectancy of other ethnic groups in the US, it is higher than the life expectancy in African nations, although this is not necessarily a fair comparison.
This is the health care debate in a nutshell. Many people I know and respect believe that health care should not be determined by how much money a person has and that it is fair and preferable that health care should be allocated on the basis of need while the costs of those resources should be borne by the people who can pay. Such a system would indeed lower costs and improve overall results. I would take the opposing view that it is an individual's right to allocate their wealth in a manner of their own choosing.

The Utility of Wealth Redistribution

2009-03-11T10:44:00.001-07:00

How much happiness can someone receive from $100? If you are poor and that $100 is the difference between eating for a week instead of starving, then that $100 might make you very happy. A wealthier person, on the other hand, might receive utility from spending that money on a new pair of shoes. Higher levels of wealth or income are generally assumed to lead to greater utility, but there is also an assumption of diminishing marginal utility in that each additional $100 provides less and less utility. This would suggest that an additional $100 matters more to a poor person than it does to a rich person. That is the basic argument in favor of welfare – that the decine in the rich person’s utility is less than the gain in the poor person’s utility. However, there are many factors associated with utility, and it would be wrong to assume that wealth redistribution would always lead to greater total utility.

The first critique involves the fallacy of interpersonal utility comparison. Money has different effects on different people. Some people don’t care about money and prefer a minimalist, almost monastic, lifestyle. These people may smugly scoff at other people who receive great utility from their conspicuous consumption. Some people are very proud and would lose more utility from accepting a handout than they would receive from accepting that money and spending it. Other people are miserly and greedy and feel the loss of every penny. A transfer of wealth from the miserly and the greedy to the proud and monastic would reduce total utility. I think it’s fairly safe to assume that wealthy people are more likely to place a great value on money in the same way that you assume that someone with a lot of cats probably likes cats. Thus the total utility associated with a transfer of wealth depends on both the level of wealth and the attitude of the giver and the receiver.

Some people could make more money, but they would rather have a life or equate wealth with being a sell-out. Suppose you have two equally able people but one goes into banking because she is materialistic and the other writes poetry because it nourishes his soul. Is it really fair to take money from the banker and transfer it to the poet? Would it be fair to take some of the poet’s soul and give it to the banker? Maybe you think it would be good if the banker had some more soul, but it wouldn’t last. She’d probably just waste the soul to make more money anyways.

The process by which the exchange occurs will also affect utility. Some people may be very charitable and receive greater utility from donating $100 than they would receive from either spending or keeping the money. In the best of both worlds, a wealthy person might gain utility from giving money to a poor person while the receiver gains the utility of $100 worth of food. Now suppose the poor person steals the $100 from the rich person. This has the exact same wealth effect as the charitable donation – the rich person is $100 poorer and the poor person is $100 richer. The utility effect, however, is completely different. The poor person has $100 but may also have the disutility associated with guilt (assuming that the poor person has a conscience). Meanwhile, the rich person has not only lost $100, they’ve lost their sense of security, their power, their independence. In short, they feel violated. Government enforced redistribution of income presumably falls in between the two extremes of theft and charity.
Wealth distribution may also have negative incentive effects. As long as the redistribution involves the fortunate helping out the less fortunate, then it probably increases utility. However, as soon as it crosses that line into punishing the people who made good choices and sacrificed for the future in order to support people who wasted opportunities and ended up poor, then redistribution becomes a utility-reducing activity. Furthermore, it could exacerbate the problem if people become less likely to make good choices and more likely to make bad choices.

This leads to the question of what is done with the money. If the money helps the poor individual get their life on track and eventually out of poverty, then the money is well spent. However, if the money allows them to continue along their current failed path, then the money is wasted.This is not to say that all wealthy people worked hard for their wealth and all poor people are lazy and irresponsible. Some people clearly have better opportunities than others and some people clearly take better advantage of whatever opportunities are given to them. I would personally rather help someone who ended up poor even though they made the most out of their minimal opportunities rather than someone who ended up poor because they wasted the opportunities they had. Unfortunately, it is difficult for government programs to make that distinction. People qualify for help based on their present state, not based on how they got into their present state. Private charity is better able to distinguish among potential beneficiaries in order to determine who most deserves help and who can benefit the most.

Overall, I think these factors cause the utility effects of wealth redistribution to be about half of what a straight analysis would suggest. Basically, you would want to compare the utility loss of $100 of a wealthy person to the utility gain of $50 to a poor person. I have no scientific data to back up this statement, but I’m going to use it as an approximation unless I find reason to change.

The Primacy of Voluntary Exchange

2009-03-06T11:20:00.000-08:00

In discussing the role of government in our lives, I am of the opinion that government should try to increase the general happiness (in economic terms we call this utility) of its citizens. But what makes people happy. The government doesn’t know what makes you happy and therefore can’t provide you with happiness. Only you can determine what makes you happy and you display your preferences with your actions. Everything you voluntarily choose to do, you do with the expectation that it will make you happier. Otherwise you would not do it.
Sometimes you make mistakes and take actions that fail to make you happy. Sometimes the actions have both positive and negative consequences. Sometimes the action benefits others as well as making you happy. And sometimes the action harms others while making you happy. Regardless, people voluntarily act in ways that they expect to make themselves happier.
This idea, this Primacy of Voluntary Exchange, is the Hippocratic Oath of Kinky Economics – First, leave people alone. Therefore, any restriction on voluntary behavior, including requirements of involuntary behavior, must be clearly justified, which leads us to the role of government in maximizing utility.
Government, what is it good for? Absolutely nothing. Well, maybe not nothing, but government is the very antithesis of voluntary exchange. It restricts what you can do through laws and regulations and enforces your involuntary support through taxes. Perhaps I am being too harsh. Not everything government does is wrong. Laws that prohibit murder may restrict the voluntary behavior of killers, but they increase the happiness of would be victims. I may not like paying taxes, but I also want services that only the government can provide (or that they can best provide).
Although government does not know what makes you happy, there are some things that government can do to increase overall happiness. Certain responsibilities are clearly the role of government as even the most ardent libertarian will agree. National defense is a government responsibility, although there are differences in regards to the optimal amount of national defense. The legal infrastructure is a government responsibility including both criminal and civil disputes among individuals and legal entities. There is an economic role in providing public goods, adjusting for externalities, and even wealth redistribution. The difficulty is in finding the right role.

Scarcity and the Laffer Curve

2009-03-06T11:15:00.000-08:00

The Mortgage Shuffle

2009-03-05T09:32:00.000-08:00

The current housing market is a mess, at least it is in California, Nevada, and Florida. One in five homeowners owes more than their house is worth and one in eight are either in foreclusure or behind on their monthly payments (a total of 5.8 million homeowners). However, the housing plan currently proposed by President Obama has several flaws, not the least of which is that it rewards people and banks who acted irresponsibly. Banks are "encouraged" to accept lower payments equal to 38% of the homeowners income while borrowers only have to pay 31% with the government stepping in to make up the difference. This ignores how much the house is worth originally or how much it is worth today.
The justification for the plan is that not stepping in will result in further declines in home value for people that are paying their mortgages. Preventing foreclosures and forcing rescheduling of payments through cram-down bankruptcies is not the only solution. A better solution matches owners with homes that they can afford and encourages homeowners to increase, or at least maintain, the value of their home.
There are really two issues involved: how much are homes worth and how much home can a person afford. Both of these factors are important and we must distinguish between them. Homes sell in an illiquid market and it is difficult to measure home values unless there is activity in the housing market. The second issue is how much house someone can afford. Traditional measures suggest that housing payments should be no higher than 31% of income, although that may be adjusted for the amount of other debt and the level of wealth.
One in five homeowners are upside down in that they owe more than the house is worth. This results from some combination of putting little to no money down on their house, having an interest-only loan, and declining home values. Upside-down (or underwater) homeowners that can still afford their house by conventional measures must be encouraged to keep making their payments – any plan that encourages default will only lead to more problems. They also need to have an incentive to maintain the value of their home through general upkeep and maintenance.
If they can’t afford the payments, then they will have to sell the property. Foreclosed homes lose value both for themselves and their neighbors. However, the problem is not the foreclosure, it is the vacancy. Empty homes fall into disrepair, become an eyesore in the community, and discourage current and potential residents. Home values are not independent of the homeowner. Taking care of their property, making needed repairs, and putting on a good face (Sweat Equity) may not turn a home rightside up, but it can keep it from sinking further. Instead of foreclosing on the house, the bank needs to encourage the upkeep and selling of the house, perhaps by hiring a realtor or contractors to assist in repairs. If a $10,000 investment can bump the home value up by $20,000, then everyone wins.
But who is going to buy the house and what is going to happen to the current homeowners (a term I am using loosely)? To a large extent, that depends on how much the homeowner can afford. Suppose a homeowner buys a house for $500,000 that is only worth $400,000. Unfortunately, the homeowner can only afford the payment on a $300,000 loan. The solution is to let the homeowner pay $200,000 (resulting in negative equity of $100,000) for a house that used to be worth $250,000 but was recently vacated by a homeowner who could only afford a payment on a $150,000 house.
Clearly there is a downsizing effect going on here as homeowners leave expensive houses that they can’t afford for cheap houses they can afford. After the fall out, there will admittedly still be expensive houses that remain unsold and poor people left without a home. Some of these losses will be tabsorbed by banks, some by, homeowners, and some by taxpayers. This is much more viable for the government to step into those situations and help out than the massive undertaking it is currently taking (and which will ultimately fail).
Government can assist in this plan by supporting these negative equity loans as long as they conform to the payments are less than 31% of income. I realize that government support of subprime loans through Fannie Mae and Freddie Mac helped to create the situation in which we find ourselves, but a market for these loans can help get us out. The government can go even further in offering loans directly at a fixed rate of 6.5% (or at the current rate) through their soon to be nationalized banks.
A second change is to allow homeowners and or banks to realize a capital loss on the sale of their homes. Currently home sales are considered personal assets and losses are not tax deductible (and gains are generally tax exempt). In reality, homes are the single largest investment for most homeowners and a tax deduction for losses would relieve some of the current pain. Whether or not to change the exclusion on gains is a separate issue.
This solution achieves a few desirable outcomes that are preferable to the current proposal. First and foremost it matches people with homes they can afford. In doing so it creates a market for homes so that they can be fairly valued. It also encourages the maintaining of home values by encouraging people and banks to put in sweat equity in selling their homes as opposed to just walking away or having banks foreclose on the home. Losses are primarily distributed among homeowners who made bad investments and banks who made bad loans with taxpayers only having limited exposure.