In Defense of Ben

Click here to read my column in Sunday's NY Times.

Mark Thoma vs Larry Summers

Mark and Larry discuss whether academic economists should listen more to practitioners.

The discussion is interesting, but unfortunately devoid of much evidence.  Let me note the following fact: If you look at the most influential economics research, you will find that relatively little of it came from interactions between academics and practitioners.  For example, Larry has eight articles on this list of greatest hits (an impressive achievement), but they were all written before his substantial "real world" experiences.

The Rainbow Fish, Revised

If you are familiar with the classic children's story The Rainbow Fish, you might enjoy this revised version. If you aren't, you might click here first to listen to the story in its original version.

A Question About Tax Incidence

A reader alerts me to this story:

The expiration of the FAA reauthorization on Friday means some aviation taxes are no longer being collected. These include a 7.5 percent sales tax on U.S. air transportation and a 7.5 percent sales tax on the purchase of air miles, said fare watcher FareCompare.com. Additionally, taxes on jet fuel are also reduced.

"Friday evening we adjusted prices so the bottom line price of a ticket remains the same as it was prior to the expiration of federal excise taxes, etc.," [said] American Airlines spokesman Tim Smith.

The reader asks how to reconcile this story with the basic theory of tax incidence, according to which consumers and producers share the burden of taxes.

What a good exam question!  Stop and answer the question yourself before proceeding.  If you need help, click through and read the article.  It provides some clues.

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My answer: It appears that the supply of airline seats is perfectly inelastic.  With inelastic supply, the incidence of the tax falls entirely on producers; conversely, all the benefit of the tax cut is enjoyed by producers.

Is the assumption of inelastic supply realistic?  Not generally, but here the situation might be different.  The story goes on to say:

Neidl also said the benefit to airlines would be minimized if Congress reached a deal soon to resolve the partial FAA shutdown.

"It looks to me like it's going to be very temporary," Neidl said. "So whatever effect it has, it's going to be very minor."

In response to a change that is expected to be very temporary, airlines might be reluctant to adjust the quantity of seats supplied.  That is, the assumption of inelastic supply might not be so bad.

If the tax cut were to persist, however, the larger profit margins would encourage a supply response.  In that case, some of the tax cut, perhaps most of it, would be passed on to consumers.

The Light Bulb Ban

Virginia Postrel is making a lot of sense.

Spending in Disguise

Donald Marron on tax expenditures.

The Subprime Mortgage Crisis

Alternative theories, discussed by Boston Fed economists Chris Foote and Paul Willen. (I am told this article will eventually go behind a paywall, but it will be open access for a couple weeks.)

The European Debt Crisis

As seen by economists Francesco Giavazzi and Anil Kashyap.

The Always Quotable Larry Summers

A reader alerts me to this interview of Larry Summers on the Charlie Rose show.  He finds this quotation (starting around 21:50) particularly provocative:

Never forget, never forget, and I think it’s very important for Democrats especially to remember this, that if Hitler had not come along, Franklin Roosevelt would have left office in 1941 with an unemployment rate in excess of 15 percent and an economic recovery strategy that had basically failed.

Size Matters

These may be the least expected sentences I have read lately:

This paper explores the link between economic development and penile length.... The GDP maximizing size is around 13.5 centimetres.

Those are from the abstract.  Click here to read the paper.

The Latest from the Standup Economist

Why aren't businesses hiring?

University of Chicago economist Steve Davis suggests some answers.

Reinhart and Rogoff on the Debt Problem

They write:

In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth.

Why there is no budget deal

Keith Hennessey says that the reason Republicans are rejecting the President's budget proposal is that it is distinctly to the left of the one recommended by the bipartisan Bowles-Simpson commission.

Update: Ezra Klein disagrees.

Spending Hidden in the Tax Code

The blue line is total discretionary outlays of the federal government, and the brown line is the sum of tax expenditures.  Both are in constant dollars.  Note that these two categories of spending are about equal in magnitude.  It is just as important to focus on stealth spending implemented through the tax code as on explicit spending.

Source.

Addendum: David Leonhardt has a related article in the Times today.

GSE Fact of the Day

From Peter Wallison:

Edward Pinto (a former chief credit officer of Fannie Mae, and now a colleague at the American Enterprise Institute) presented the evidence to the commission showing that by 2008 half of all mortgages in the U.S. (27 million loans) were subprime or otherwise risky, and that 12 million of these loans were on the books of the GSEs.

Choices for Greece

Tyler Cowen tells us not to expect much happy news.

The Disappointing Recovery

Rogoff on Inequality

Ken suggests that rising inequality may be self-correcting.

I was scooped

...by Scott Sumner.

A Good Exam Question

Dean Baker endorses and expands upon an idea of Ron Paul's.  I think the idea is crazy, but at least it is crazy in an interesting way.  Here it is, in a nutshell:

1. According to Congressman Paul, to deal with the debt-ceiling impasse, we should tell the Federal Reserve to destroy its vast holding of government bonds.
2. Because the Fed might have planned on selling those bonds in open-market operations to drain the banking system of the currently high level of excess reserves, the Fed should (according to Baker) substantially increase reserve requirements.

This would be a great exam question:  What are the effects of this policy? Who wins and who loses if this proposal is adopted?

STOP READING.  Think about the question yourself for a few minutes.

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DID YOU REALLY ANSWER THE QUESTION?
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Okay.  Here is my answer:

Part 1 is just an accounting gimmick. Since the Fed is really part of the government, the bonds it holds are liabilities the government owes to itself. Destroying the bonds has no direct economic effect. It is just like an increase in the debt ceiling, without any other policy changes attached.

Part 2 is a form of financial repression. Assuming the Fed does not pay market interest rates on those newly required reserves, it is like a tax on bank financing. The initial impact is on those small businesses that rely on banks to raise funds for investment. The policy will therefore impede the financial system's ability to intermediate between savers and investors. As a result, the economy's capital stock will be allocated less efficiently. In the long run, there will be lower growth in productivity and real wages.

Housing Tax Subsidies

Here is something for tax reformers to keep in mind:

Investment in owner-occupied housing faces an effective marginal tax rate of just 3.5 percent. In contrast, investment in the business sector faces an effective tax rate of 25.5 percent. This leads to a tax-induced bias for capital to flow into housing-related uses rather than other types of projects. As a result, businesses are less likely to purchase new equipment and less likely to incorporate new technologies than otherwise might be the case. Less business investment results in lower worker productivity and ultimately lower real wages and living standards. While the housing sector provides employment and has other positive effects on the overall economy and on society, the resources employed in the housing sector displace investment that would otherwise occur in the business sector were it not for the favored tax treatment of housing. The resulting distortion in the allocation of capital likely lowers overall output, because resources are allocated based on tax considerations rather than economic merit. In effect, the United States has chosen as a society to live in larger, debt-financed homes while accepting a lower standard of living in other regards.