Before Science, treating the symptoms of an illness was all we had. Along our way, using trial and error, we found a few things that worked. The big breakthroughs came when we started to look for the causes of an illness. The association of an illness with toxins was deducible. Then, as we knew more and could see farther, we found that most of our physical illnesses were caused by such other things as bacteria, and viruses.

Still and yet, we see attempts to treat illnesses symptomatically. It wasn’t that long ago President Ford wanted to the nation to deal with the swine flu by treating the symptoms. Only yesterday, President Trump wanted us to treat the symptoms of COVID-19 with whatever occurred to him. At first look, it might seem that this approach could be cost effective. That look was 300,000 dead wrong. The most proximate cause of all these deaths was a Corona Virus, COVID-19. The cause next proximate was the refusal to acknowledge the first. The President didn’t want to acknowledge the reality of the pandemic. The people didn’t want to make the necessary changes to their lifestyles. Those 300,000 and more unnecessary deaths could have been prevented by acknowledging and addressing the pandemic, the cause.

Economics was the reason most often given for not addressing the cause of these unnecessary deaths. But good economics would have mandated the expenditures necessary to quickly produce one-billion N95 face masks, and install needed workplace safeguards. Just as good economics would mandate looking to the cause of our inequities and disparities in income and wealth.

Politics is another area where looking to the cause is of utmost importance. With such matters as the electoral college, the inherently unrepresentative Senate, and qualifications for the office of President; treating the symptoms of these flaws in the constitution isn’t even a short term solution. The Senate impeachment vote is a case in point: 34 GOP senators representing 34% of the Senate votes but just 14.5% of population could have blocked the conviction of a president who tried to violently overthrow American democracy. The flaws in the electoral college, not the people, selected Donald Trump in 2016.

The treating of social ills seems to bring out the worst in us. We are want to treat the consequences, the symptoms, of poverty, disparity, and injustice with increased policing, incarceration, …, when we should be looking to the causes.

If we are to successfully deal with climate change, we must address the causes of climate change.

Today Tyler Cowen posted this:

Remember the proposals for a $15 federal minimum wage?

Employment would be reduced by 1.4 million workers, or 0.9 percent, according to CBO’s average estimate…

That is from the new CBO report.

Here is a bit more context:

In an average week in 2025, the year when the minimum wage would reach $15 per hour, 17 million workers whose wages would otherwise be below $15 per hour would be directly affected, and many of the 10 million workers whose wages would otherwise be slightly above
that wage rate would also be affected. At that time, the effects on workers and their families would include the following:
Employment would be reduced by 1.4 million workers, or 0.9 percent, according to CBO’s average estimate; and
The number of people in poverty would be reduced by 0.9 million.

We can debate whether to raise the minimum wage, how far, whether to use wage subsidies or a negative income tax, etc. But debate is difficult when one side refuses to participate in good faith. Furthermore, when right-wing economists spread obvious half-truths to bolster the case for their preferred but unpopular policies they undermine trust in the economics profession as a whole. This makes it more difficult for economists to get a hearing when they have something important to say. I really don’t know what Cowen thinks he is accomplishing by doing this.

Prior post here.

Angry Bear has been featuring the words of Steve Hutkins and Mark Jamison for a good bit of time now. They are the go-to people outside of the USPS on issues associated with it and the Congress which impacts it. We exchange emails and stories from time to time.

Save the Post Office is edited and administered by Steve Hutkins, a retired English professor who taught place studies and travel literature at the Gallatin School of New York University.

Expected Rate Increases Beyond CPI

On November 30, 2020, the Postal Regulatory Commission issued a 484-page order revising the rate system for Market Dominant products. Under the new system, the Postal Service will be able to raise rates beyond the Consumer Price Index, which it was prevented from doing (aside from the provision for an exigent increase) by the Postal Accountability and Enhancement Act of 2006. (See this previous post for more about the order.)

Last week, the Postal Service gave the PRC its calculations for the two new authorities crafted by the Commission. The Notice of Calculations of Future Rate Authorities indicates that the density-based rate authority will be 4.5 percent, and the retirement-based rate authority will be 1.06 percent, for a total of 5.56 percent.

Those potential increases are on top of the approximately 1.8 percent increase for First-Class Mail and 1.5 percent increase for other categories the Postal Service has already proposed for 2021. If the Postal Service were to exercise its full rate authority, the total increase would thus be over 7 percent. The new system also gives the Postal Service authority for an additional 2 percent increase for products that don’t cover their attributable costs.

Fifth and last. Not relevant to the USA. Back in the day when US unions weren’t totally feeble, MacDonald and Solow wrote a brilliant paper on collective bargaining and tax based incomes policy.

Imagine a world in which firms must negotiation with unions (for example imagine Europe). The unions have two aims — they want high wages and they want high employment in the sector they represent. This means that a GM&UAW right to manage contract which specifies wages and working conditions and allows management to choose output, investment, and employment is Pareto inefficient. It makes sense to specify wages and the level of production (firms must produce more than the amount that maximizes profits given wages).

If unions have power (hah!) and behave optimally (ha!) representing workers in general and not just workers who have lots of seniority and job security (ha ha ha ha ha) then things are better, but not as good as they could be.

If we collectively really want high employment but don’t care about wages in sectors, then we want to give the rational firms and workers modified incentives. This might be because we really care a lot about the unemployed and don’t care so much how high incomes of the employed are. For MacDonald and Solow it is mostly because they think that higher wages mean higher prices so an equal increase in dollar wages in all sectors has no effect on real wages — that is that real wages are really relative wages — always and automatically.

In any case, the proposal is to reward increased employment and penalize increased wages. This changes the efficient choices for the union and firms. In theory it causes higher employment and lower inflation. In practice it is alleged to have worked on the rare occasions in which it was tried.

I ask why penalize increases in wages. The same effect occurs in the model if one penalizes wages (and rewards employment). The focus on the change of wages was natural back when macroeconomists were worried about inflation (paper published 1984). It follows from accepting the existing inter-industry wage structure. It follows from unions being powerful back then so a proposal which would generally punish unionized workers would not get support from Democrats in congress. That was long ago (kids believe me — I was alive back then — things were different — also they still are that way in Italy).

So in the model as written (and published in a top economics journal the AER) the income tax causes increased efficiency. The proposal is to tax income and subsidize employment (that is have an income tax and an EITC).

In theory this should work. In practice it works.

This is an extended post on the caveat to debt and taxes 1. It is joint work with Brad DeLong and Barbara Annicchiarico. The point is that, in his Presidential Address, Olivier Blanchard notes that the argument that higher debt causes increased welfare is weaker than the argument that it is feasible.

The Treasury can afford to increase debt D_t just by just giving bonds away and can pay interest and principal without ever raising taxes so long as the safe rate of interest which it has to pay is lower than the trend rate of growth of GDP. In that case it is possible to just roll over the debt forever and the debt (including the additional debt) shrinks to insignificance as a share of GDP.

Following Blanchard we assume zero trend growth and an economy which reaches a steady state. This really just simplifies notation a bit. Also Blanchard works with Rf_t which is 1 plust the safe rate of interest, so bonds mature in one period and pay Rf_t times the amount invested. In contrast investing in productive capital K_t gives a risky return R_t (includng the capital one still has so the ordinary notation is return r = R-1).

The time subscripts are there because, in general, both the safe and the risky return depend on D_t and K_t. This is a major nuisance and I will present a super absurdly simple example (due to Brad) here in which the state is constant.

The model is an overlapping generations model — the young work and get a wage W_t. They consume C_t^y and buy the bonds D_t and the capital K_t from the old. The old get capital income and also sell their bonds and capital to the young. They consume all of that so C_t^o = Rf_tD_t+R_K_t

Importantly, there is a technology shock which makes W_t and R_t stochastic. This is a crazy assumption, which is absolutely standard when one wants to put risk into a macro model and also wants to keep it super simple. The point is that bonds are safe and that ownership of capital (stock) is risky.

The way to make the model absurdly simple involves two steps. First assume that the policy is to increase D and to keep it at the new high level. If Rf_t<1 this involves an additional gift of D(1-Rf) to the young each period. Increased debt finances an increase in this universal basic income so long as Rf_t<1. The point of this is to keep things simple. It is not needed for the increase in debt to help all generations not just the first who get the windfall gift (see below).

Then the key extreme very convenient assumption just for a simple example.

Agents choose C_t^y to maximiz

1) C_t^y + beta ln(C_{t+1}^o)

The extreme extraordinary assumption is that utility is linear in consumption when young, so young people are risk neutral. The assumption that utility is logarithmic in consumption when old is fairly conventional but it is not innocent either. Together they make everything simple, because it means that people always save beta

so

2) K_{t+1}+D_{t+1} = beta

Then the assumption that the state keeps Debt constant implies that capital is constant.

This implies that Rf and E(R) and the stochastic distribution of R are all constant and everything is simple.

After the jump I will discuss other cases. Here I just note that the extreme assumptions don’t just make all the math simple. They actually matter, because constant Rf_t gaurantees that it stays below 1. In general (and certainly for independent technology shocks) Rf_t is sometimes greater than 1. I will put all this off to the after the jump appendix.

The super simple model shows three beneficial effects of increased debt. First there is the gift to the old at the time D is increased, second there is the gift of (1-Rf) to the young each period. Third debt causes higher Rf which is nice for the citizens so long as the new higher Rf is less than 1.

There is, however, a fourth effect which alarmed Blanchard. In the olg model debt crowds out capital. In the super simple model

3) K=beta-D

The reduction in K causes lower wages W_t and higher returns R_t (still with time subscripts because both depend on the technology shock).

This transfer from the young to the old is risky and it reduces expected welfare so long as the steady state risky rate is greater than 1. In the super simple model that means it reduces expected welfare s long as E(R) >1 when K = beta. Blanchard shows this at some length.

I am now going to do some algebra. I am going to set population + labor supply to 1 just to simplify notation.

With constant returns to scale, perfect competition implies

4) W_t + R_t K = Y_t

taking the derivative with respect to K

5) d W_t/dK + (dR_t/dK)K + R_t=R_t

so

6) d W_t/dK = – (dR_t/dK)K

7) K+D=Beta so dK/dD=-1 so

8) d W_t/dD = – (dR_t/dD)K

Now consider the following policy. D is increased by a small amount deltaD and a small tax on capital income of Tau is introduced so that

9) (1-tau)(R_t + deltaD dR_t/dD) = R_t

That is the tax is calculated so that the after tax income from ownership of risky capital of the old is unchanged.

The revenues tau(R_t + deltaD dR_t/dD)K are given to the workers. Equation 8 implies that their income is unchanged. The tax and transfer policy eliminates the fourth effect of incrased D.

This means that the policy of increasing debt and eliminating the effect on wages and the return on capital by taxing capital income and giving the proceeds to workers makes every generation better off and is a Pareto improvement.

In general in public economics a reform is said to increase efficiency if it is possible to combine the reform with taxes and transfers such that everyone is better off. So in the simple model, the standard use of the term implies that issuing debt and giving the proceeds to citizens would increase efficiency.

This is a very standard analysis of the absolutely standard model used to analyze the welfare effects of public debt. The conclusion really shouldn’t be controversial (but it will be).

There might be such a thing as a free lunch.

There will soon be a Democrat in the White House and Republicans will soon rediscover their hatred of deficits (which were no problem when they were cutting taxes on firms and rich individuals). We are going to read a lot of arguments about irresponsibly burdening our children with debt (which ignore the fact that they will also inherit most of the bonds). We will be reminded that sooner or later we will have to pay.

I am not sure if Milton Friedman will be quoted saying “to spend is to tax”. There will be arguments about how deficit spending creates the illusion of wealth (as consumer/investors we forget that we owe the money as well as owning the bonds just as citizens we forget that we are (most of) the creditors as well as the owners of the indebted Federal Government). There will be arguments about how we can pay now or pay later and it will be more costly if we pay later.

All of this is based on the assumption that the Federal Government’s intertemporal budget constraint is binding. Arguments that you can’t get more now without having less later are arguments about a binding budget constraint. The argument that an increase in spending must be financed by increased taxes in the present or in the future of the same present value is the argument that the intertemporal budget constraint is binding (in fact it is a better explanation of the concept than “the intertemporal budget constraint is binding” the two statements are equivalent and “increased spending … increased taxes …” is written in plain English).

It is true that in standard models, the intertemporal budget constraint is binding (this is called the transversality condition just to type more big words). This is a condition for *optimality* — an aspect of the solution to an intertemporal optimization problem. It is not a given or an assumption about the problem agents face. This is embarrassingly simple. In standard models, you can’t get something for nothing, because if you were in a situation in which you could get something for nothing, then you made a mistake not getting it, and it is assumed that you didn’t make a mistake.

When discussing fiscal policy, Friedman et al assumed that it is optimal while criticizing it as suboptimal. This is a plain contradiction and simple error. All of the discussion of fiscal policy which is used to rule out more deficit spending now assumes that policy is optimal which rules out any change by assumption.

This is not a quibble. The condition for a binding intertemporal budget constraint is that r>n that the interest rate the Treasury must pay is greater than the trend growth of GDP. if r<n then debt can be rolled over forever with new bonds sold to pay interest and principle on the old bonds. The debt to GDP ratio shrinks to zero if r<n and debt is rolled over. This is how the USA handled World War II debt. The US did not pay it off by running primary surpluses. The USA rolled the debt over until it was small and then elected Reagan and began the modern era of huge deficits.

The relevant r in the inequality is the interest rate the Treasury pays on it’s debt. This is always much lower than many other interest rates and has historically usually been very very low. It is now exceedingly low, and it has been extremely low since 2008. It was also very low until the 70s and, when corrected for inflation, remained very low until Reagan and Volcker began working with each other.

This is well known to economists. A masterful explanation and empirical demonstration was given as an American Economic Association Presidential address by OJ Blanchard in 2019 . Read it if you doubt my claims (also if you don’t — it is very good).

For a while after 2008, it was assumed that this was temporary and things would return to normal (normal meaning as they were from 1980 to 2000 but never were before 1980 nor have been after 2000). Many economists now agree that this is the new normal (same as the old normal and different from the situation of extremely loose fiscal policy combined with extremely tight monetary policy).

Importantly this is *not* entirely a forecast. The yield on 30 year inflation indexed bonds is currently -0.24% — the US Federal Government can borrow for 30 years paying a negative real interest rate. Pessimists think that the trend of real GDP growth has fallen to 2% a year (from 3% historically). But it is definitely growth not shrinking.

It is true that investors might change their minds and interest rates might shoot up. If the US financed it’s spending with 30 inflation indexed bonds, this would not be a problem for the Treasury for 30 years. Investors who bought the bonds would lose money, but the Treasury would still have to pay the same coupons and face value. There is even a discussion of introducing extremely long duration bonds — 50 year bonds to lock in interest rates longer or even consols (bonds which last forever and pay a constant interest rate — obviously a multiple of the CPI because the old 19th century nominal consols are silly collectors’ items now))..

But basically the main hugely important point is that there is every reason to think that the US Federal Government can get something for nothing, because it has a slack intertemporal budget constraint.

Failing to take advantage of that would be failing to solve an intertemporal optimization problem. It is one of the few (very difficult) ways to fail my Macroeconomics course.

Caveat after the jump

This is the third post in a series. I will discuss advantages of income taxation different from the obvious advantage that taking from people with high income hurts them less than taking from people with low income. Here again, I will assume that, in equilibrium, income tax is returned to the people who pay it as a lump sum. I do this to focus on the incentive effects of income taxation.

The first two posts are here and here.

In standard models, these effects are undesirable and amount to a deadweight loss which is second order in the tax rate. However, the standard models rely on standard assumptions which are completely implausible. They are used, because it is guessed that the policy implications don’t depend on the absurd assumptions. The policy implications always, in fact, follow from the assumptions.

In this post, for the third and last time, I will relax the assumption that people are 100% purely selfish and care only about their own consumption and leisure. Instead I will assume that people maximize the sum of their pleasure from consumption and leisure plus a constant far less than one times other people’s pleasure from consumption and leisure.

This is the second post in a series. I will discuss advantages of income taxation different from the obvious advantage that taking from people with high income hurts them less than taking from people with low income. Here again, I will assume that, in equilibrium, income tax is returned to the people who pay it as a lump sum. I do this to focus on the incentive effects of income taxation.

In standard models, these effects are undesirable and amount to a deadweight loss which is second order in the tax rate. However, the standard models rely on standard assumptions which are completely implausible. They are used, because it is guessed that the policy implications don’t depend on the absurd assumptions. The policy implications always, in fact, follow from the assumptions.

In this post, for a second time, I will relax the assumption that people are 100% purely selfish and care only about their own consumption and leisure. Instead I will assume that people maximize the sum of their pleasure from consumption and leisure plus a constant far less than one times other people’s pleasure from consumption and leisure.

Cases in which income taxation is preferable to lump sum taxation with the same ex post net transfers.

The main reason for progressive taxation is that the welfare cost of taking money from wealthy people is lower, because they have a lower marginal utility of consumption. I would like to discuss other advantages of income taxation, that is cases in which it can cause an increase in money metric welfare, or, in other words cases in which a distortionary tax and transfer policy is desirable even if, in the end (in the Nash equilibrium) everyone gets a transfer equal to taxes paid.

The incentive effects of taxation can be desirable for many reasons. I will try to list them in a series of posts. One very simple reason is that lower income is typically obtained by providing a goods and services to poorer people. This means that the signal from the market is not ideal – even if people obtain income by providing useful goods and services, the income depends on the usefulness divided by the consumers marginal utility of consumption.

For example, lawyers income depends on the wealth of their clients separately from the validity of their clients cases. For another doctors income depends on insurance coverage of their patients as well as the effectiveness of therapy and the need of the patience. I will address these issues in the second post in the series. In this post, I will assume that agents sell goods not services and that they sell them for the same price to all customers. Even in this case, there is a difference between the income maximizing choice and the most socially useful choice. Some people obtain more income selling luxuries that no one needs, but for which high income people are willing to pay a lot rather than selling necessities which poor people really want, but for which they can pay little.

People often perceive a difference between maximizing income and contributing as much as they can to society. There is nothing odd about this – it follows from absolutely standard assumptions about market prices and simple utilitarianism – economists most standard approach to welfare economics ( which is an approach to social welfare often considered to underestimate the importance of equality).

So far, there is no hint of any reason why the incentive effects of income taxation might be useful. The novel assumption is that people are not perfectly completely selfish. If you would rather see well fed than starving children, then standard economic theory does not apply to you. It is very important to avoid the false dichotomy between the assumption that people are perfectly selfish and that they are perfectly altruistic. I have often read read proofs that people are not perfectly selfish presented as an argument against the assumption that people are partially altruistic. Before going on, the assumption I need can be that people care 100% as much about their own interests as about anyone else’s. Such people would strike us as extraordinarily selfish, but they are not selfish enough for standard theory.

No one argues that people are selfish. Selfishness is almost always assumed in economic models. I can think of a number of justifications. One is that we should hope for the best but plan for the worst – hope that people are altruistic, but design a system which will work if they are perfectly selfish. I see no merit in this argument. In particular, we don’t have to guess, we know people are partially altruistic. Another is that a system designed on the assumption that people are partially altruistic also works if they are selfish – it just isn’t true that if one fears something might be true, then one should assume that it is. Another argument for assuming selfishness is that economists focus on arms length interaction, and altruism is important in interactions other than buying and selling. This post aims to demonstrate that that argument is invalid. A third argument for assuming selfishness is that altruism has benefits which are separate from the benefits of good policy. The main point of this post is that policies which are optimal if people are selfish and Pareto inefficient if people are partially altruistic.

The key paper in the literature on this topic is “” by Lester Thurow. Thurow’s point is that if people are slightly altruistic, then redistribution from the rich to the poor can make everyone happier, can be a Pareto improvement. Rich person A likes the fact that money is taken from rich person B and given to a poor person. The small loss for person B bothers him a tiny amount, the large gain for person C pleases him a small amount. Person A does not want his money to go to the poor, but in a large society the huge amount of benefit to the poor from transfers from all the other rich people can make up for his (not totally) selfish desire to keep what he has. This means that rich people who support progressive taxation and welfare but don’t give all of their money away are not necessarily hypocrites.

Thurow points out that even partial altruism is an externality and if people are partially altruistic, then equality is a public good. Standard arguments combined with the clearly true assumption that people are not completely 100% selfish imply that redistribution from the rich to the poor can be Pareto improving.

These posts are not simply a reiteration of Thurow’s point. I will assume no net redistribution. The tax and transfers will not help the poor directly, however, their incentive effects may help the poor.

This post will assume that people produce goods and can choose whether to produce a necessity or a luxury good. Caring about the benefit of their product for the consumer, they will prefer, other things equal, to produce the necessity. In equilibrium, other things won’t be equal because they can make more money producing the luxury. By reducing that incentive, income taxation can shift production from luxuries to necessities. This can increase welfare. This, in turn, can please everyone because people are partially altruistic (the last point is exactly Thurow’s point).

A tiny simple model after the jump

Commenter Dale Coberly asked for this particular story to be posted.

Renown Covid Restrictions Defier is Really Asking For A Better Government 

“We got a government that has taken the stimulus money and gave it to special campaign donors and special interests, abandoning me, and putting me in a position where I have to fight back, okay?

You could’ve given me money and I would gladly walk away for sixty days and let this virus settle down. I’m not gonna do it (without help) alone.”

Dave Morris, owner of D&R’s Daily Grind Cafe, is not afraid to say what is on his mind. He is curious though, whether anyone in power cares to listen. Though the Portage, Michigan business owner has garnered a good deal of attention since his impromptu broadside against the government and COVID-related shutdowns went viral, his curiosity remains justified. Because while figures like Tucker Carlson and Matt Walsh implicitly tokenize Morris as some sort-of antigovernmental warrior, it appears the substantive frustrations of Morris and the millions of other people in this country have remain unheeded. In reality, these frustrations stem from the government not serving as a guarantor of adequate material conditions for its people.

“I see the things we’ve lost since I was a young man raising my children. Pensions are almost non-existent for the normal working man and healthcare is non-existent. Twelve years, I can’t afford it, Affordable Care Act – not affordable,”

Morris laments.