Relevant and even prescient commentary on news, politics and the economy.

Slow Post Day

I’m still working on my Rawls follow-up, but in the meantime I do have one thing to point out to my readers: Michael Savage is a jackass.

I guess that makes the decision-makers at MSNBC objectively pro-jackass.


Cranky Physicist

Robert Park, a Physicist at the University of Maryland, posts/emails on Fridays. Here’s his take on the plans to eliminated the testing requirements for missile defense:


In April 2000, the APS Council stated: “The United States should not make a deployment decision relative to the planned National Missile Defense system unless that system is shown through analysis and intercept tests to be effective against the types of offensive countermeasures that an attacker could reasonably be expected to deploy with its long-range missiles.” In fact, a law designed to prevent deployment of weapon systems that don’t work was passed in 1983 after Ronald Reagan announced his Strategic Defense Initiative. Now the Bush administration is proposing to exempt the Pentagon’s controversial missile defense from testing. The request is in the 2004 budget. I called my friend Puff Panegyric at the Missile Defense Agency. “You’ve got to admit the law makes sense,” I said. “Maybe it did in 1983,” Puff sneered, “but North Korea has made the world a more dangerous place. We don’t have the luxury of waiting until things work. There are leaders of some countries who would like nothing better than to start a war.” “I see your point Puff.”

I strongly recommend Park’s newsletter, which you can read or have emailed to you at


More Mankiw

Earlier, I gave a piece of advice to Greg Mankiw, incoming chair of the Council of Economic Advisors:

Note: Mankiw has also written a few books, including a Macroeconomics textbook. I advise keeping public pronouncements consistent with theories in the latest editions of those books.

Atrios has the goods on Mankiw’s Principles of Economics. Here’s an excerpt from Atrios’ excerpt:

An example of fad economics occurred in 1980,” Mr. Mankiw wrote, “when a small group of economists advised presidential candidate Ronald Reagan that an across-the-board cut in income tax rates would raise revenue.”

After reviewing the impact of Mr. Reagan’s policies, which included a run of high budget deficits that lasted until the mid-1990’s, Mr. Mankiw wrote that the moral of the experience was that “when politicians rely on the advice of charlatans and cranks, they rarely get the desirable results they anticipate.

In later editions of his textbook, Mr. Mankiw dropped the entire section on “charlatans and cranks” and muted his criticism. But he has not mended his fences with today’s advocates of big new tax cuts.

Now I almost wish I hadn’t said “latest editions”, because this creates some wiggle room for Mankiw to say that the thinking about deficits changed. But in the late 1990s, I can’t think of any new events that would make an economist decide that lowering taxes would increase federal revenue, since the exact opposite had occured (taxes were raised in 1993, the economy boomed, and deficits began shrinking and then turned into surpluses).

Doesn’t the Whitehouse have staffers who can vet for this kind of stuff? I suspect they do, but to find an economist who remained true to Supply Side economics and the Laffer Curve throughout the 1980s and 1990s, the administration would have to go pretty far into the ranks of Republican hack-economists. This would cost the administration much-needed credibility (scroll down to question 10 to see less than half favor Bush’s economic plan and that opposition reached 40%) on the economy.


Still to come: more Rawls, Alterman and Bailey, but as Matthew Yglesias points out, it takes some care and time.


Max Sawicky has another great quote (tying deficits to long term interest rate) from Mankiw’s book here.

Slate’s Daniel Gross also discusses Hubbard and Mankiw here.

And here’s a link to the list of economists opposing Bush’s tax cuts. Even excluding the ten Nobel Laureates, it’s an impressive list.

Three Takes on “The Veil of Ignorance”

Preface: I don’t entirely agree with Rawls’ conclusions, but this is surely true: only a few people in this world are truly irreplaceable, John Rawls was one such person; read one obituary here.

The Three Takes:

  1. The West Wing.

    In the first scene, Will Bailey (the character that replaces Rob Lowe’s character) presents three hypothetical tax-payers: A box unloader at minimum wage (taxed at 15%), a teacher at $41.7k (taxed at 28%), a doctor making $150k (taxed at 36%); later, he adds a fourth box for the “Uber-Wealthy” CEO making $16 million. Will’s plan (and the Bartlett administration’s) is to raise the rate on the CEO by 1 percentage point (to 37%) to finance a tax deduction for college tuition for people making less than $80k/year.

    An intern (qua speechwriter) quips that “the doctor got into medical school, he had to work hard to do that. And presumably the CEO has some skills, the value of which the market has place at 16 million dollars”. Initially, Will replies glibly.

    Later in the show Will says to the same intern “the answer to your question of why the MD should accept a greater tax burden in spite of the fact that his success is well-earned is called the Veil of Ignorance. Imagine that before you are born you don’t know anything about who you’ll be, your abilities, or your position. Now design a tax system.” The intern replies “the Veil of Ignorance”. Will replies “John Rawls”.

  2. Eric Alterman (What Liberal Media, p. 19):

    “Contemporary intellectual definitions of liberalism derive by common accord from the work of the political theorist John Rawls. The key concept upon which Rawls bases his definition is what he terms the “veil of ignorance”; the kind of social compact based on a structure that would be drawn up by a person who has no idea where he or she fits into it. In other words, such a structure would be equally fair if judged by the person at the bottom as well as the top [emphasis mine]; the CEO as well as the guy who cleans the toilets. In real-world American politics, this proposition would be considered so utopian as to be laughable.”

  3. John Rawls:

    In “Social Unity and Primary Goods”, section II, paragraph 1, Rawls describes two “Principles of Justice”

    (i) “Each person has an equal right to the most extensive scheme of equal basic liberties compatible with a similar scheme of liberties of all”

    (ii) “Social and economic inequalities are to satisfy two conditions: they must be

    (a) to the greatest benefit of the least advantaged members of society; and
    (b) attached to offices and positions open to all under conditions of fair equality of opportunity”

    In his book, A Theory of Justice, Rawls asks us to imagine ourselves behind a veil of ignorance. I’m skipping over much material of consequence, but Rawls concludes that from such an original position–having the ability to structure society, but not knowing where in that structure we might fall–rational people would, perforce, design a “fair” society, and that society would be as consistent as possible with the two principles of justice.

More to come.


P.S. I’m posting this before I read more than the beginning of it, but Salon has a feature on “All conservative, all the time: It’s time to bury the myth of the ‘liberal media’ “writes Eric Alterman in his new book. How can progressives find their voice?“. While I’m about to disagree somewhat with Alterman’s take on the Veil of Ignorance, I must reiterate: buy and read his book.

Angry Bear Hits Continue to Grow

Wow, a link from Atrios can really drive a lot of traffic my way. Thanks Atrios, and welcome new readers!

But I wonder…is that too much power for one man or woman to wield?


Coming soon: John Rawls, The Veil of Ignorance, Eric Alterman, Progressive Taxation, The West Wing (in particular, Will Baily), and how they all tie together.

A New Trend?

Maybe this will lead to a First Amendment challenge of the Digital Millennium Copyright Act (DMCA). Here’s the highlight:

U.S. Justice Department said Wednesday it had seized a rogue Web site that offered information on bootlegged video games and movies, as the owner faces sentencing for copyright violations.

Note that the siezed site offers information on bootlegged games and movies, not the actual bootlegged games and movies. This is one of the more egregious consequences of the DMCA, making it illegal to talk about ways that copyrights can be broken. It’s long been legal to say “they sell crack down on 12th street” while being, of course, illegal to go down to 12th street and sell crack. The DMCA makes the online version of this speech illegal. This is problematic on principle (1st amendment) and problematic on practical grounds. A number of activities proscribed by the DMCA are “dual use”. For example, the controversial DeCSS program (code that hacks DVD encryption) was not originally written for piracy purposes, but rather because DVDs could only be played on PCs running MS Windows…a clever programmer wanted to play DVDs that he legally purchased on his Linux computer.

The recent Eldred Decision by the Supreme Court (ruling in favor of the Sonny Bony Copyright Extension Act) may not bode well for a challenge to the DMCA, but my lay opinion is that Eldred was less clearly based in free speech than something like this. (The cynical view of Eldred is that everytime Mickey Mouse is about to become part of the public domain, Congress extends the length of copyrights).

This may also represent a disturbing new trend in the seizure of web sites by the government, which then redirects visitors to a government site. As TalkLeft points out , redirecting visitors likely entails a log of all IP addresses that visit the original site. Nice.


Postscript on Eldred:

Eldred was premised on the idea that “strong intellectual property rights encourage innovation”, but this argument only looks at half the equation, the marginal benefit of innovation. As Isaac Newton remarked once, “”If I have seen far it is by standing on the shoulder’s of giants”. Under a strict intellectual property rights regime, standing on giants’ shoulders becomes a much more expensive proposal (license fees, searches, tort exposure). So such a regime increases both the costs and benefits of creative activity; the net effect on innovation is therefore ambiguous. Given this ambiguity, maybe deference to the language in the constitution would be wise:

The Congress shall have the power. . . To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries]. . .[Art. I, Sec. 8, Clause 8].

I was suprised at the ruling because of the self-proclaimed “strict constructionalist” philsophy of the justices who ruled in favor of copyright holders (Stevens and Breyer dissented strongly). It’s very difficult for me to see life+70 years as satisfying the “for limited times” language.

More on Mankiw

More on Mankiw

Before this announcment, Brad DeLong wondered why Mankiw (and others) signed the “Republican Economists’ Letter”:

I was slightly disappointed, second, to see Greg Mankiw’s, Mike Boskin’s, and Marty Feldstein’s names on the signature list. I don’t think the letter accurately reflects their views–meaning that if I held their views about how the economy works and what a good society looks like, and if I held their political allegiances, I would not have signed the letter.

Besides the economists DeLong mentions, I’d add that the only other economists of academic note that I found in a quick skim of the list are Ed Prescott, R. Hodrick, Allan Meltzer, and Michael Jensen (who I cited here, about 1/2 way down). By “academic note”, I mean their works are likely to appear in at least one first or second year PhD Economics or Business course. I probably missed one or two (apologies), but given the length of the list, the list is most noteable for the lack of signatures of top economists. Again, DeLong beats me to this punch:

Without their [Mankiw, Feldstein, Boskin] names, the signature list of the letter is not all that terribly impressive: the overall impression is of people who don’t know very much about the federal budget, old Republicans who should have known better, young Republicans who I hope will soon learn better, political hacks hoping for government jobs, lobbyists hoping to get their names on lists of people owed favors, and a smattering of True Believers with fringe views (not that there is anything wrong with having fringe views: my views on a number of important questions are “fringe”: truth is not always with the establishment consensus). Keeping Boskin, Feldstein, and Mankiw on board would have been a high priority.


P.S. Here’s the entire text of the letter, what could be more vacuous? There’s no how or why. Nor does it address deficits.

We enthusiastically endorse your economic growth and jobs proposal. It is fiscally responsible and it will create more employment, economic growth, and opportunities for all Americans. Moreover, it will improve corporate accountability and strengthen the nation’s international competitiveness.

Update: Tapped also has some good info on the “economists” signing the letter

Now who do I pick on?

This just came across the wires: Hubbard leaves econ post. My theory: the barrage of critical analysis from Angry Bear became too much to bear. Note that the announcement hit the wires a scant 9 minutes after my More Glen “No connection” Hubbard and Taxes post.

Hubbard’s being replaced by N. Gregory Mankiw from Harvard. Note: Mankiw has also written a few books, including a Macroeconomics textbook. I advise keeping public pronouncements consistent with theories in the latest editions of those books.

Seriously though, Hubbard was a good economist and a reputedly very smart guy for 20 years, then had two rough years that were not 100% his fault, and now should be able to return to a productive career as an economist (rather than a political strategist). Good luck, Glenn.


More Glen “No connection” Hubbard and Taxes

I came across this very recent interview with Glenn Hubbard (chair of the President’s Council of Economic Advisors, in which Dr. Hubbard talks about “The Fundamentals of Tax Reform”. I first mentioned Hubbard and tax reform here, give links to other stories on Consumption and Income Taxes here , and give a more comprehensive summary here. Finally, my three part series on dividend taxes are (in order) here, here, and here.

Here are some quotes from Dr. Hubbard, with comments. Note that I am not familiar with The Library of Economics and Liberty, the organization conducting and publishing the interview, but I do characterize the interview as very sympathetic to Hubbard’s position.

Quote 1: …especially important in the wake of the recent corporate governance scandals, the tax code is biased in favor of retained earnings instead of a more transparent system and greater dividend pay-outs.

Analysis: The second half of the sentence is true, as I explained in the previous post. But it’s not causally related to the antecedent. Hubbard is trying to imply that if there were no dividend taxes then there would not be corporate fraud. I don’t see the mechanism for this. Independent boards, strong oversight, and independent auditors affect corporate scandals. The relationship to dividends is tenuous at best. For example, perhaps the second largest scandal (behind Enron) was Tyco International. As this chart shows, they regularly paid dividends over the last decade.

Quote 2: But on the issue of the dividend plan, if companies pay a dividend to a shareholder, the shareholder would not pay tax on the dividend, provided corporate tax had already been paid.”

Analysis: The last caveat is a big issue. A recent paper by a Finance Professor at Harvard Business School finds that the gap between the profit companies report to shareholders (“book income”) and the profits reported to the IRS (“tax income”) increased over the 1990s (for the wonks: well beyond that explained by the increased use of stock options over the same period). In the early 1990s both types of corporate income were pretty close to equal; by 1996, corporations were on average reporting profits 40% higher to shareholders than those reported to the IRS. (The vast majority of this is not corporate fraud, just using existing loopholes).

Quote 3: About ten years ago, the Treasury Department and the American Law Institute both did very significant studies of corporate tax integration, that is, removing the double tax on corporate source income. Both of those studies found quite significant effects on economic activity going forward so that one could raise the economy’s growth rate by a couple of tenths of a per cent over a very, very long period of time.”

Analysis: Great and probably true, but why use 10 year old studies? I’m not saying these studies are wrong, just a bit dated. This raises some skepticism because it excludes 1993 and after. Clinton’s 1993 Tax Plan imposed some very modest tax changes that increased corporate taxes, yet corporate profits went up. This might complicate the analysis. There are surely more recent studies.

Quote 4: We believe that the revenue feedback effects were they to be [dynamically] scored for the dividend piece could be as high as 40%.”

Analysis: Anyone remember the Laffer Curve? Not that the cuts aren’t stimulative, but the would-be cutters always exaggerate the stimulative effect. Remember “dynamic scoring” and the 2001 tax cut? Here’s a funny Bruce Bartlett quote from 1999:

Although dynamic scoring is no panacea for the Republicans’ budgetary problems [the problem being the inability to sell tax cuts to the public], it would make it easier to both cut taxes and still maintain a large surplus.

Quote 5: I’m not a very political person. But I have observed in this President a great concern about long-term growth.

Analysis: On the first part, ask what lead Hubbard to recently deny a connection between deficits and interest rates. For the second, see Alan Greenspan.


Dividend Taxes Part III: Empire-Building

This is long, but hopefully not too boring. If you are in a hurry, skip down to the bold-faced paragraph and read from there. Quoting from an earlier post, dividend taxes “do discourage firms from distributing profits to shareholders. And, as it turns out, when firms don’t distribute profits to shareholders they quite often do very silly things with the money. When this happens, it’s bad for the firm, bad for the shareholders, bad for the employees of the firm, bad for the stock market, and bad for the economy.”

What are these “very silly things” that firms (particularly, their CEO with the advice and consent of the board) do? Almost always, it is excessive acquisitions and unrelated diversification. Simply put, most firms are better when they center their activities around a small set of activities and then do that well. That small set of activities is what MBAs and consultants call a firm’s “core competency”. “Unrelated diversification” refers to a firm moving from it’s core competency—via acquisition or expansion—into areas not in the core.

We might say that, in 1998, AOL’s core competency was making the internet experience easy enough for your grandmother to use (and they were and remain quite skilled in the art of mailing me CDs). Similarly, Time Warner’s core competency was in something like content production and distribution. The important question for the owners of these two firms, the shareholders, is whether these two competencies go better together (the merger involves real “synergies” or “complementarities”) or whether they are best done separately (the merger is “unrelated diversification”).

Coming up with theoretical synergies between the two is not too tough: the web and TV will converge someday, AOL knows the web and Time-Warner knows TV. But watching AOL-TW in the post-merger years there were very few actual examples of synergies (Instant polls? Crawlers on Talkback Live of Instant Messages? Whoopee!). Instead, you had AOL people worrying about the TW business and TW people worrying about the AOL business. TW’s flagship, CNN, gets passed by FOX News. AOL’s growth rate stagnates, and the two are less valuable together than separate. Management’s focus is spread too thin.

An example of the phenomenon in reverse: when Lou Gerstner took over for IBM in the 1993, IBM was in a lot of trouble, business was lagging, and it faced a serious cash crunch. Part of the problem was that IBM was in hundreds of unrelated lines of business and there was no coordination across even the related lines of businesses. So Gerstner came in and sold off non-core businesses, reorganized around product lines instead of geography, implemented incentive pay, and cut costs. Note to Naderites, yes cutting costs means layoffs. In this case the alternatives were probably bankruptcy or a government bailout. By 1996, IBM was back on track .

How does all of this relate to dividends? The AOL-TW management expanded their empire, while Gerstner shrunk his empire. Broadly speaking, CEO’s are aggressive, confident, and competitive; they wouldn’t make the top levels of business if they were not. When a company has profits above those required to sustain core lines of business, the CEO and the board have to decide whether to “Empire-Build” in the style of AOL-TW or distribute those profits to shareholders in the form of dividends. If you look at mergers and acquisitions over time, you really do see too much “Empire-Building” and not enough “Value-Creation”. In most cases, the explanation is a combination of hubris and a misguided desire for diversification.

Here’s a nice excerpt from a randomly googled place (Jensen is a Harvard Business professor who spends a lot of time studying this issue):

Jensen believes that most current mergers undertaken to reduce excess capacity and combine related services (such as the recent Chemical/Chase merger in the banking industry) will ultimately be successful. Those associated with growth and so-called synergies – such as the Time Warner acquisition of Turner – will ultimately be viewed as unwise.

Today’s activity, he notes, is more like the “disastrous” merger wave of the 1960s, which saw “large firms run by managers who, with little of their own money at risk, were spending corporate resources on ill- conceived diversification and empire-building campaigns.” “Unfortunately,” Jensen concludes, “too much of the current M&A; activity falls into the latter category.”

A final example: Goodyear (Tires). In 1984, they were very profitable. They decided to take those profits and invest in a pipeline; over the next two years, they spent over $1 billion. They also tried twice to buy into the helicopter business. What possible skills did managers who know the tire business bring to either the pipeline or helicopter business? None. Goodyear never made money on the pipeline and eventually sold it for $420 million in 1995; while they were doing this (the late 1980s) their tire business went bad. No synergies were ever posited by management, only a (misguided, see the postscript) desire for diversification. This is about $1 billion that should have been paid out to shareholders.

What mechanisms exist to discourage empire-building? If a company commits to paying dividends, then there will be less money to spend on spurious mergers and acquisitions.

Hence the logic of eliminating the tax on dividends: Taxing dividends gives managers an incentive, even an excuse, to retain cash rather than give it to shareholders. Then, rather than let it sit, they spend it on acquisitions and diversification. More often than not, these go bad (Next time you see an acquisition announced, look what happens to the buyer’s stock price). If instead, companies pay profits out to shareholders in the form of dividends, those shareholders can invest it where they see fit.

Is eliminating the dividend tax the only way to discourage empire-building? No. Using incentive pay helps a lot because it ties compensation to the company’s stock price, so there’s less incentive for top management to engage in unrelated diversification (there are problems with stock options, but that’s another topic). Another way to limit empire-building is to have independent Boards of Directors—directors not chosen by or involved in any way with the CEO or other top managers. Because the board must approve the CEO’s major decisions, if the board is independent they will act more in shareholders interests. Increasing the independence of boards is one part of the post-Enron, post-crash, set of reforms. But nothing has yet passed on this front, to my knowledge.

Even Bush cited, or at least tried to cite, the empire-building issue:

“We may not be cash-flowing that much, but the sky’s the limit. Well, when you pay dividends, that sky’s-the-limit business doesn’t hunt.”

Translated into English, I suspect that this would be the first salient and accurate statement about dividends that I’ve heard from the President. Of course, given the choice of two ways to limit “sky’s the limit” businesses, one that disproportionately benefits the wealthy (eliminating dividend taxes) and one that benefits all shareholders (corporate governance reform), which do you expect this administration to pursue?

In summary, eliminating the tax on dividend income would improve the performance of companies, by limiting their follies. This would be good for employees, the shareholders, and the economy. And it could be done in a revenue-neutral fashion. I’m sure wiser proposals could be crafted, but here’s one off the top of my head: eliminate the dividend tax and impose offsetting tax increases on those who benefit from eliminating the tax. In this case, an increase in the corporate profit tax and/or an increase in the top marginal tax rates could be imposed to offset the revenue loss from not taxing dividend income. The wealthy lose money (more income taxes) and gain money (no dividend taxes), netting out near zero. But the incentive for corporations to waste money on unrelated diversification is reduced in the process!


P.S. Isn’t diversification a good thing for firms to do? Don’t they reduce the volatility of earnings by operating in different lines of business? Yes, they do, but that is not a good thing for shareholders because shareholders can achieve their own diversification by, for example, buying mutual funds. Let the managers build the business and let the shareholders diversify.