Monday, August 31, 2015

So, about the inefficiency of stamp duties…

Australia’s economic commentariat is now almost unanimously on board with the idea that stamp duties on property transactions are immensely inefficient and should be abolished in favour of land taxes.

I’ve long held the view that land taxes are the best form of taxation. I certainly agree with that. But the idea that stamp duties are exceptionally bad is not clear cut. Key reference points for this belief are the modelling exercises of economists estimating the welfare losses from these taxes.

The main problem, however, is that there are no transactions in equilibrium economic models, so there is no way to model a transaction tax such as stamp duty. Equilibrium models are ‘pre-solved’ by the Walrasian auctioneer to determine the distribution of goods to a single representative agent.

Here’s what the Australia Treasury had to say when they tried to model the welfare effects of stamp duties.
It is inherently difficult to capture this type of capital transaction tax in a model with a single representative agent. The approach adopted here treats real estate services as an investment good which improves the productivity of the firms, including the housing sector. One way of thinking about this is that real estate agents play a valuable role in finding producers that value the capital the most. Therefore a potential owner will be willing to pay a real estate fee equal to the profit they will enjoy over the previous owner. Within this setting the conveyance duty is treated as a tax on the value of investment and subsequent productivity gains facilitated by the transfer of land and structures.
Translated it reads “our model can’t capture transaction taxes so we’ll just assume the tax is something else to fit it into the model we do have.”

The best micro-level analysis comes from Davidoff and Leigh, who find that the main impact of higher stamp duties is to reduce the frequency of home sales, and of those home sales, some will be from people relocating.

Yet it is not clear that the welfare effect of reduced home sales is negative if some of those sales are merely fuelling speculation in the housing market. The basic result of all transaction taxes in asset markets hold-- if some of the transactions are simply speculative churn then there can be positive welfare effects from reducing turnover through transaction taxes. 

So I urge caution about calls to cut stamp duties, even if those calls are accompanied by the proviso that such a change must be accompanied by higher land taxes, and especially if those provisos are likely to be ignored.

Tuesday, August 18, 2015

Nanny state submission

Australia's new libertarian Senator David Leyonhjelm has called for a Senate Inquiry into Australia's creeping 'nanny state' regulations of individual behaviour. The conflicted Senator, who's main claim to fame so far is to agitate for increased regulations on wind farms despite his apparent principles of freedom, is one of those characters who at least shakes up the dreary world of politics. By coincidence I do often agree with him on personal freedoms, though on economic freedoms and issues about the distribution of wealth and social support, we disagree quite starkly. The Inquiry is, however, a useful catalyst for considering the evidence of individual-level harm-minimising regulations.

My submission is reproduced below, and available in full here.

Background
This “nanny state” inquiry is a timely chance to reconsider the relationship between personal choice and legislated responsibilities, and to consider the evidence that exists of the effectiveness nanny state policies in terms of their intended social impacts.

The Terms of Reference for the Inquiry are:
  • the sale and use of tobacco, tobacco products, nicotine products, and e-cigarettes, including any impact on the health, enjoyment and finances of users and non-users; 
  • the sale and service of alcohol, including any impact on crime and the health, enjoyment and finances of drinkers and non-drinkers; 
  • the sale and use of marijuana and associated products, including any impact on the health, enjoyment and finances of users and non-users; 
  • bicycle helmet laws, including any impact on the health, enjoyment and finances of cyclists and non-cyclists; 
  • the classification of publications, films and computer games; and 
  • any other measures introduced to restrict personal choice 'for the individual‘s own good’. 
I respond to each in turn by taking a practical approach informed by research in these areas. An overarching message is this. It should not be okay to ‘do something’ about a social issue without a rigorous assessment of whether that ‘something’ will even address the issue at hand. Many nanny state regulations are a knee-jerk political response and not policy made with clear assessable objectives.

A second message is this. Healthier citizens need not lead to lower health care costs in general as any disease or injury prevention simply allows another disease to cause that person’s death, and it will also have associated health care and ‘end of life’ care costs.

The research is quite clear that this is the case, particularly for smokers. The following academic results are typical (my emphasis).
Health care costs for smokers at a given age are as much as 40 percent higher than those for nonsmokers, but in a population in which no one smoked the costs would be 7 percent higher among men and 4 percent higher among women than the costs in the current mixed population of smokers and nonsmokers. If all smokers quit, health care costs would be lower at first, but after 15 years they would become higher than at present. In the long term, complete smoking cessation would produce a net increase in health care costs, but it could still be seen as economically favorable under reasonable assumptions of discount rate and evaluation period.
And from here
Until age 56, annual health expenditure was highest for obese people. At older ages, smokers incurred higher costs. Because of differences in life expectancy, however, lifetime health expenditure was highest among healthy-living people and lowest for smokers. Obese individuals held an intermediate position.
Therefore when making policy decisions in the interests of improving individual health, an informed government should not naively justify such decisions on the grounds of reducing the resource burden of public health care, as this argument rarely holds. Decisions must be made on other grounds, of which there are many legitimate ones, such as externalities (in the case of passive smoking in some public areas), information failures, market or political power of interest groups.

Underlying this inquiry is also a question as to the current Australia legal situation in terms of duty of care. Take as an example children’s playgrounds in public parks. Surely a part of the trend towards excessive padding and safety is the result of legal pressures and past legal cases against “negligent” councils. The same happens with cracked footpaths (see this example, and there are many others), and other personal injuries that seem to overstep the bounds of a common sense duty of care even on private property (see this example). I believe a key part of the process of decreasing ineffective and costly nanny state regulation requires looking abroad, perhaps to Europe, at how the legal interpretations of duty of care are quite different and allows for governments the legal comfort to go without nanny-state regulations.

Tobacco choice
Legislation restricting tobacco sales, purchasing, and smoking location has had a large impact on smoking in the past two decades. As the below graph from the Australian Institute of Health and Welfare shows, smoking is declining in the general population in response to a combination of policy changes intended to have this effect. Now the rise of vaping as a alternative nicotine indulgence has attracted some attention as its growth in recent years is at odds with the continued long run decline in tobacco smoking in traditional forms. 

 
Questions about tobacco choice must centre on externalities of consumption, and information failures. Is smoking impinging on the freedom of others to enjoy a smoke free environment, and are smokers fully informed about the products they are consuming?

On the first question it seems clear that previously introduced limitations on smoking locations have addressed the majority of externalities associated with tobacco consumption. On the second, one could argue that the pubic awareness campaigns of the past decades have addressed this issue as well, and that plain packaging rules and other changes have little claim to be further addressing information failures, though there is a very light argument that it reduces the power of tobacco brands because of lower community awareness.

The rise of vaping must also be considered. Vaping is specifically designed to minimise externalities from consuming tobacco in public and enclosed spaces, and hence any regulation of vaping should focus on ensuring consumers are fully informed of the product being consumed and its personal health effects.

Alcohol choice
There is no doubt Australia, like many countries, has high levels of alcohol related violence and a binge drinking culture. Australia has some shocking ‘alcohol related violence’ statistics
  • 1 in 4 Australians were a victim of alcohol-related verbal abuse 
  • 13 percent were made to feel fearful by someone under the influence of alcohol 
  • 4.5 percent of Australians aged 14 years or older had been physically abused by someone under the influence of alcohol 
But all the scientific research says that alcohol has absolutely no effect on aggression, and in fact impairs coordination.

One must be clear about what social problem taxes on alcohol and other regulations limiting sale are targeting; the binge drinking that arguable creates externalities on others, or drinking alcohol in general? Clearly it is the rowdy culture and late night violence in cities and suburbs that is a problem.

Yet it is not clear that “sin taxes” on alcohol are an effective way to change the binge drinking culture, and in fact might have the opposite effect. Those who choose to drink alcohol may change their patterns of consumption to only drink to get drunk. Why pay so much for alcohol unless you are going to get drunk?

Anecdotal evidence across countries suggest that countries with binge drinking cultures also have the more expensive alcohol, such as the Scandinavians and the UK. While in Mediterranean countries where wine is part of the dining culture, cheap enough to consume with most meals, the binge drinking culture is less prevalent. In fact the weight of evidence now points to regular small quantities of alcohol being beneficial to lifetime health.

So what sort of policies would reduce our violent binge drinking culture? I have a radical proposal.
  • Remove taxes on alcohol (revenues can be made up with land taxes) 
  • Reframe the public alcohol messages. 
  • Reduce the drinking age to 16 
  • Allow alcohol to be sold in supermarkets in States where it is not 
  • Remove liquor licensing rules and simply retain responsible serving of alcohol requirements. 
Essentially such changes would make alcohol boring and integrate it into everyday life.

Public health messages might have a grandma drinking Bundy Rum diluted with cold water after dinner, who then falls asleep on the couch. Or we could do a complete reversal and really drill home the point that rowdy drunks are puppets of their social environment and that they can’t blame alcohol. If you are a tool when you are drunk, you are a tool. Embarrass them into less binge drinking.

As anthropologist Kate Fox explains
I would like to see a complete change of focus, with all alcohol-education and awareness campaigns designed specifically to challenge these beliefs – to get across the message that a) alcohol does not cause disinhibition (aggressive, sexual or otherwise) and that b) even when you are drunk, you are in control of and have total responsibility for your actions and behaviour.
Yet at the moment we have alcohol messages that seem to reinforce the message that alcohol is an excuse for disruptive behaviour, with phrases such as “alcohol is responsible for..”. Actually, no. Would you seriously say ‘tea is responsible for…”.

As I have discussed before, culture is often a good explanation of social and economic phenomena. The more we understand culture, and get over our simplistic ‘Pigouvian taxes can fix everything’ mentality, the more we can strategically intervene in highly effective ways to change behaviours that are having negative effects on others.

Marijuana choice
The same arguments discussed above in relation to tobacco smoking and alcohol apply to marijuana. It is mostly through historical happenstance that marijuana consumption is fully prohibited while tobacco and alcohol is not, and certainly prohibition of various types of drugs have a complex social history.

The main comment is that modern experiments with legalisation of marijuana have showed that there is little social disruption to such changes, and that legal and police resource devoted to the current illicit marijuana industry can be much better employed elsewhere.

Bicycle helmet choice
Australia is globally unique in our laws about compulsory bicycle helmet for all riders. As discussed in the background section of this submission, the argument that injured cyclists will be cared for in public hospitals, and as such create externalities on other through the costs of public health care, is rubbish.

Moreover, even if one believed this argument it would also justify helmet wearing for drivers and pedestrians, who on average account for the overwhelming majority of head injury hospitalisations.

As a general observation the helmet laws has been a knee jerk policy without a clear assessable objective, and has for nearly 30 years been an excuse to ignore investing in urban cycling infrastructure because ‘something’ has already been done for cyclists to keep them safe.

Again, the overwhelming research findings are that helmet laws reduce cycling, make cycling less safe for this who do, and decreasing health of those who opt out of cycling. Being a world outlier in this area should be enough of a signal that this law is not achieving any particular goal of reducing externalities or improving information failures for cyclists, and if anything does the opposite by making cycling appear more dangerous that what the statistic show.

Media classifications
Unlike most of the items int he ToR, media classification do serve to address an information failure, in media and games, where viewers are unable to judge the content until after they have experienced it. The simplest way to view media classification is as a type of labelling, similar to that in the food and groceries, which allows customers to easily access additional information about the product.

In an ideal world media classifications would be simple and their design would imply self-evident feature of the media content in terms of violence, sexual content, language and themes. The main use of these classification is for parents of children who are taking responsibility for their child’s exposure to particular types of media, and hence for these parents some form of classification tools appears to address a possible information failure.

Sunday, August 2, 2015

The confused economic orthodoxy


Last year I presented the idea that perhaps an firm objective function of maximising their rate of return on all costs is more consistent with the stylised facts about firm cost curves.

I want to document here two things. First, the two mutually exclusive responses from editors and referees during the reviewing process, which to me reveals the general ignorance of what the core concepts in economics really are (opportunity cost anyone?).

Second I want to spend a moment showing the incoherent ways profit-maximising is used in economics, and reiterate Joan Robinson’s critique of profit-maximisation as it is still highly relevant.

Part 1: Challenging the scriptures

The basic idea of my alternative objective function is that maximising the absolute value of something is universally a stupid thing to do. We need a denominator in a world where what matters at an individual or firm level is relative performance.

I’ve had both the following responses. First is the more common response that the paper is wrong because it doesn’t look at profit maximising firms. Basically, this response involves re-explaining the standard result of profit-maximisation. To borrow Steve Keen’s favourite analogy, we are like Copernicus explaining what a model of the Earth revolving around the Sun predicts, and the response is to explain the predictions of the Ptolemaic orthodox model where the Sun revolves around the Earth. The comments on my first blog post about the paper were mostly along this line.

The second response from editors and reviewers is the opposite. We’ve also been told that return-seeking is natural and implied in the standard model of profit-maximisation.
Your paper argues that firms do not maximize instantaneous profit but instead choose to allocate resources in a way that maximizes return on investment. I don't think that this assumption would surprise or bother anybody.
Actually, yes, it surprises and bothers all your economics colleagues. Maybe you should sit down together and interrogate your own models with some objective clarity and see what they really say.

Even if you dismiss this bizarre series of responses as the outcome of time-poor editors looking for excuses to reject papers they don’t like the look of, you’ve just revealed an acceptance of the non-scientific nature of economics and the lack of openness to anything outside the accepted scriptures (and yes, this is a general social science problem).

Part 2: Sticking with inconsistent beliefs

This is my main problem with economics. Despite a long history of critiques of the core models from inside the discipline, including the impossibility of a representative agent (and it’s full information), the conflation of uncertainty with risk, the Walrasian auctioneer, the impossibility of aggregating capital quantities, and many others, somehow the core survives.

So let me add to this long history of critiques with another of my own.

Consider the short-run profit maximising model, where profits are revenues minus costs. By definition the short-run has a fixed factor of production, usually called capital, which can be any arbitrary set of inputs. What that implies is that the short run profit maximising output actually is more generally represented as

profit = (revenue - costs) / fixed capital amount

Magically we have an implied denominator, which we might consider sunk costs. But then we have another different set of costs in the numerator, the variable costs. Exactly how is this distinction between types of costs made in practice? More importantly, where do the funds come from to pay these variable costs?

Consider the standard short-run price-taking model in equilibrium. Demand then increases. Increasing output requires the imposition of greater costs for each additional unit (being on the upward-sloping part of the ATC), the firm must conjure these costs from somewhere. If they require a new investor (or the same investors to reinvest earnings), they are diluting the rate of return on all the other investors.

As I have explained before, no current investor would allow the rate of return on their share of the firm to be diminished by adding additional investors. Essentially the core short-run profit-maximising model is one of maximising profits per capital owner.

But then we have a long-run profit maximising model which typically looks like this

profit = quantity * price - (labour units * labour unit cost + capital units * capital unit cost)

The denominator has disappeared. All of a sudden firms don’t care how much it costs to make a profit. If there is a choice between spending $100 to make $40 in profit, and spending $200 to make $41 profit, you choose the latter as a profit maximiser.

But as a return-seeker you first take the $100 investment. You don’t ignore a 40% return because a 20.5% return is available elsewhere. Never.

There is much more to this story, particularly around the ability to leverage. But the biggest story is about how value is gained from high return investments. If I can get my 40% return on costs, I can later sell that firm based on the discounted value of net cash flows. If that discount rate is, say, 10%, then my $100 investment gains $27 in value immediately. I can then sell my firm for $127.

In any case, the point here is that profit-maximisation is, in the words of Joan Robinson, meta-physical doctrine. The empirical record is against it, yet it persists as a signal of membership to the economics tribe. And what is worse, it seems that very few economists at the top of the discipline are clear about the crucial and often hidden underlying assumptions of their models, and continue to teach a fairy-tale view of the core models.