Tag Archives: regressive

Mutant Capitalism rears its ugly head in Arlington

Confectionery-giant Nestlé plans to move its U.S. headquarters from California to 1812 North Moore in the Rosslyn area of Arlington in the next few years. This should be great news for the people of Arlington—a world-famous company has decided that Arlington County is the best place to be in the U.S. This must be due to our educated workforce and high quality of life, right?

Maybe. The real attraction might also be the $6 million of state handouts to Nestlé, along with an additional $6 million from Arlington County. Government handouts like these have become a way of life in the U.S. even though the results are often underwhelming.

Federal programs such as the New Markets Tax Credit Program have had at best small effects on economic development, and there is a good chance they just reallocate economic activity from one place to another rather than generate new economic activity. Local programs like Tax Increment Financing appear to largely reallocate economic activity as well. These programs might be good for the neighborhood or city that gets the handout, but it doesn’t help the residents of nearby places who are forced to contribute via their tax dollars.

In the Nestlé case, all of Virginia’s taxpayers are paying for Nestlé to locate in Arlington, which already has a relatively strong economy and is one of the wealthiest counties in Virginia. Why should taxpayers in struggling counties such as Buchanan or Dickenson County be forced to subsidize a company in Arlington? Government handouts to firms are often regressive since companies rarely want to locate in areas with a low-skill—and thus low-income—workforce. Everyone pays, but the most economically successful areas get the benefits.

Government officials often praise the jobs that these deals create and the Nestlé deal is no different: According to the performance agreement, Nestlé must create and maintain 748 new full-time jobs. And even if we ignore the fact that jobs are an economic cost, not a benefit, a closer look reveals that projections and reality usually diverge. For example, Buffalo awarded hundreds of millions of dollars to SolarCity, which promised to create 5,000 jobs. They have since revised that number down to 1,460. There are numerous other examples where the cost per job turned out to be higher than initially projected.

The grant performance agreement also estimates that Nestlé will provide $18.2 million in taxes to the county over the next 10 years, more than enough to offset the grant expenditure. But this doesn’t take into account what would have happened absent the handout. Perhaps some other company would have relocated here for free. Or a local company, or collection of companies, would have eventually rented out the space.

Government grants may also distort the real estate market: There’s a good chance no company had occupied 1812 North Moore because the rent was too high. If so, part of this grant is a handout to the owners of the building, Monday Properties, since now it does not have to lower its rent to attract a tenant. This may lead other property companies to lobby for and expect government handouts to help them find tenants.

Government grants often distort the economy by treating out-of-state companies differently than in-state companies. They encourage relocation by subsidizing it, which discourages expansion. A better strategy is to create a simple, non-intrusive business environment that treats all businesses equally.

Government grants are a characteristic of what my colleague Chris Koopman calls Mutant Capitalism and are antithetical to real capitalism and free enterprise. Capitalism involves businesses competing for consumers on an even playing field—there is no room for government favors that tilt the playing field towards one business or another.

Are state lotteries good sources of revenue?

By Olivia Gonzalez and Adam A. Millsap

With all the hype about the Powerball jackpot, we decided to look at the benefits and costs of state lotteries from the taxpayer’s perspective. The excitement around yesterday’s drawing is for good reason, with the jackpot reaching $1.5 billion – the largest thus far. But most taxpayers will never benefit from the actual prize money, with odds of winning as low as one in 292.2 million for the jackpot. So if few people will ever hit it big, there must be other benefits for taxpayers to justify the implementation of lotteries, right?

Of the 43 states that implement lotteries, the majority of lottery revenues – about 58% on average – go to awarding prizes. A relatively small proportion (7%) is used to pay for administration costs, such as salaries of government workers and advertising. The remaining category, and the primary purpose of implementing state lotteries, is revenue for government services. On average, about one third of state lottery revenues is directed to state funds for this purpose. The chart below displays the state-level breakdown of lottery revenue for the most recent year that data are available (2013).

lottery sales breakdown

It is surprising that such a small portion of state lottery sales actually make it to state funds, especially considering how much politicians advertise the benefits of state lotteries. A handful of states direct more than 50% of lottery revenues towards state funds: Rhode Island, Delaware, West Virginia, Oregon, and South Dakota. The other 38 states allocate significantly less with Arkansas and Massachusetts contributing the smallest percentage, only 21%.

Many states direct their lottery revenues towards education programs. The largest lottery system, New York’s, usually directs about 30% of their lottery sales to this area. Similarly, Florida’s lottery system transferred about one third of their funds, totaling $1.50 billion, to their Educational Enhancement Trust Fund (EETF) in 2013.

The data presented here are from 2013, so it will be interesting to see how the recent Powerball jackpot revenues will affect lottery revenues more broadly in the future, especially since the Multi-State Lottery Association reduced the odds of winning in October of 2015 in the hope of boosting revenues. State officials argue that reducing the chances of winning allows the prize to grow larger, which increases the demand for tickets and revenue.

The revenue-generating function of state lotteries makes them implicit taxes. The portion of revenue generated from a state lottery that is not used to operate the lottery is just like tax revenue generated from a regular sales or excise tax. So even if lotteries are effective at raising revenue, are they effective tax policy?

Effective tax policy should take into account the tax’s ability to generate revenue as well as its efficiency, equity, transparency, and collectability. Research shows that state lotteries fall short in most of these categories.

The practice of dedicating portions of tax revenue to specific expenditure categories, also known as earmarking, can be detrimental to state budgets. Research that looks specifically at the earmarking of lottery revenues finds that educational expenditures remain unaffected, and sometimes even decline, following the implementation of a state lottery.

This result is due to how earmarking changes the incentives facing politicians. A 1999 study compares the results of lottery revenues directed specifically to fund education with revenues going to a state’s general fund. Patrick Pierce, one of the co-authors, explains that when funds are earmarked for education they go to the intended program but, “instead of adding to the funds for those programs, legislators factor in the lottery revenue and allocate less government money to the program budgets.”

Earmarking also affects total government expenditures, even though from a theoretical perspective it should have little effect since one source of funding is just as good as another. Nevertheless, many empirical studies find the opposite. Mercatus research corroborates this by demonstrating that earmarking tends to result in an increase in total government spending while having little effect on the program expenditures to which the funds are tied. This raises serious transparency concerns because it obscures increases in total government spending that voters may not want.

Last but not least, about four decades of studies have examined lottery tax equity and the majority of them find that lottery sales disproportionately draw from lower-income groups, making them regressive taxes. This only adds to the aforementioned concerns about the transparency, collectability, and revenue raising capabilities of lottery taxes.

Perhaps the effectiveness of lottery taxes can be best summed up by the authors of a 1993 study who wrote that “lotteries as a source of funding are neither efficient nor equitable substitutes for more traditional tax sources.”

Although at least three people walked away with millions of dollars yesterday, many taxpayers are not getting any benefits from their state’s lottery system.

Environmental Injustice at the EPA

This past week, the EPA’s science advisory board held a public hearing on efforts to measure the “environmental justice” (EJ) impacts of EPA rules. EJ refers to adverse human health and environmental effects of government policies on minority and low income populations in the US. The EPA has released draft guidance to agency analysts who measure these effects, and this hearing was intended to find ways to improve the guidance before it is finalized.

While holding a public hearing is a sign that the EPA is committed to getting this issue right, significant improvements need to be made to the EJ guidance if the EPA does not want the entire EJ project to backfire. Specifically, closer attention should be paid to the costs EPA rules impose on low income and minority populations. Further, improvements in the transparency of agency procedures will help ensure that those with modest incomes are allowed to participate in decisions that will have significant impacts on their health and well-being.

Currently, the EPA is focusing far more on the benefits of its rules to low income and minority groups than on the costs. As evidence, the 81-page draft guidance document contains only two pages related to costs of EPA regulations. In those two pages, the agency argues that costs are often not relevant to environmental justice issues, saying:

Consideration of the distribution of costs in the context of EJ is not always necessary. Often the costs of regulation are passed onto consumers as higher prices that are spread fairly evenly across many households.

This is a striking statement because regulatory costs are regressive exactly in the instances that the EPA describes in this statement. Any time costs of a policy are spread evenly across all citizens, the dollar amount paid to implement a regulation consumes a larger percentage of a poor person’s income than a wealthy person’s income. This is precisely why sales taxes are regressive.

Additionally, as incomes fall due to the costs imposed on citizens complying with regulations, people have fewer resources available to use toward risk reduction and outlays related to improving health. Meanwhile, there is evidence that private risk reduction can be much more effective than public methods of risk reduction, especially when regulations are addressing very small risks that are dwarfed by the other risks individuals face in their everyday lives.

A step in the right direction would be to ask analysts to identify the distribution of costs of EPA regulations, especially for rules that increase the prices of products that EJ populations purchase (e.g. rent, fuel, food, electricity).

Another important component of EJ is to gather meaningful feedback from low income and minority persons before implementing policies. The notice announcing last week’s public hearing was published in the Federal Register on Christmas Eve, making it unlikely that many in the EJ community, especially those with little political influence and low alertness to EPA actions, will even be aware this hearing is taking place, let alone will participate in the event.

If the EPA’s science advisory board is truly committed to improving the lot of the less well-off, it should tell the EPA to do more to measure the costs of environmental rules on low income and minority persons, and to improve transparency of agency procedures so those with less political clout can participate equally in the democratic process.

What the Affordable Care Act Can Teach Us about Government Failure

Most people probably believe that the recent failures of the Affordable Care Act (ACA) are an anomaly, and that most areas the federal government involves itself in, from education to transportation, operate quite smoothly, or at least adequately well. This belief is misguided, however, and the issues we see from the ACA should not be viewed as anomalies. Problems like unintended consequences of policy, privilege granting to special interests, adverse selection in insurance markets, and other issues, are widespread in countless areas of public policy. It just so happens that we usually fail to associate the pernicious effects of laws with their source: public policy.

First, public policies create many unintended consequences. People will change their behavior in response to altered incentives from policies and when these behavior changes are not anticipated by lawmakers, unintended consequences occur. As an example, the ACA has altered incentives for many employers. Business owners are now likely to cut worker hours and keep their staffs under 50 employees in order to avoid paying penalties imposed by the law. The intention was that people will get insurance through their jobs, while a result is that many people will lose their jobs or work fewer hours.

A similar effect occurred after passage of the Americans with Disabilities Act. This well-intentioned Act of Congress was supposed to level the playing field for disabled workers by requiring that businesses with disabled workers provide accommodations, such as wheelchair access. The Act also sought to prevent discrimination of disabled workers, such as firing someone for having a disability. The reality once the law was in place was very different, however. Economists have found that the law was followed by a steep decline in employment among disabled workers, likely because of increased costs associated with hiring them, exactly the opposite result the law intended. Perhaps the most famous unintended consequence of all is the fact that minimum wage laws actually hurt low skilled workers.

A lot of these effects, while unintentional, are actually quite predictable and any good economist should be able to identify potential unintended consequences before a law is even implemented. So why do these policies get adopted? A big reason is because special interests have enormous influence in shaping policy. The Affordable Care Act literally has provisions allowing handouts to insurance companies to make up for losses they face in the new government health insurance exchanges. Unfortunately, cronyism like this shapes policy at all levels. For example, a recent USDA regulation will require additional food safety inspection of imported catfish. This may sound like a sensible idea, until one finds out there is no evidence of a significant problem from tainted catfish. The new program was actually lobbied for by domestic catfish producers who wanted to hurt their foreign competitors by driving up the price of imports, all at the expense of American consumers.

A final problem created by the Affordable Care Act relates to adverse selection in insurance markets. Adverse selection occurs because of information problems between buyers and sellers of insurance. Healthy people may have trouble signaling that they are a low risk to insurers, and so the healthy drop out of insurance markets when insurers don’t offer them a low priced product that serves their needs. This can lead to mostly sick people signing up for insurance coverage, while the healthy decide to go without coverage. Over time this leads to higher prices, causing more healthy people to decline coverage and the pool of insured to become ever sicker.

The ACA creates this problem through community rating requirements and other regulations, like guaranteed issue, that don’t allow insurance companies to price policies based on the riskiness of the applicant. As insurance premiums rise (because of regulations and because insurance companies must cover many new services), more and more healthy people will find these policies unattractive. The insurance pool will become ever sicker over time. To avoid this problem, the ACA includes a mandate that everyone purchase insurance. However, it is far from clear whether the current mandate is strong enough to prevent adverse selection problems from taking place.

This problem is hardly new. New York State passed extremely strict community rating regulations several decades ago. This led to higher premiums and lots of young, healthy people dropping out of the insurance pool. I should know, I lived in New York and went without insurance for most of my 20s. The prices of policies were simply too high for me to justify paying.

The list of government failures likely to result from the Affordable Care Act is too long for one blog post. The ACA also has regressive effects that tend to favor the wealthy at the expensive of the middle class, and the law will add to moral hazard problems in our healthcare system (i.e. people over-utilizing medical services or not taking adequate care of themselves because the costs of their behavior are passed on to others).

The ACA may have serious problems, but it works great as a teaching device. Nearly every day we see another example of government failure in action.  Maybe once Americans see the effects of the ACA, they will look more closely at the effects of other policies as well.

Why Mandating Higher Quality is Regressive

Lately, a lot of attention has been given to the fact that millions of Americans are seeing their health insurance plans cancelled as a result of the Patient Protection and Affordable Care Act (aka Obamacare). Some pundits have gone so far as to argue this is a good thing. The cancelled plans, the logic goes, were lower in quality than the plans being offered in the new government health insurance exchanges. Many people will end up paying more for the replacement plans, but since the new plans cover a wider variety of health services, they are better off, right?

Actually, no. Imagine if the same logic were applied to automobiles. I drive a 2003 Toyota Matrix. Would I be better off if my current model was banned and I was forced to buy a brand new Ferrari instead? The President made a similar comparison in a recent press conference when he said:

We made a decision as a society that every car has to have a seat belt or air bags. And so you pass a regulation. And there’s some additional cost, particularly at the start, of increasing the safety and protections, but we make a decision as a society that the costs are outweighed by the benefits of all the lives that are saved. So what we’re saying now is if you’re buying a new car, you got to have a seat belt.

If the President’s comparison were appropriate, people would be able to keep their current plans, and might only have to add a new feature or two when they buy a new plan. Instead, people are being dumped from their current coverage and forced into the government run exchanges where they are being forced to buy all kinds of options they don’t want or need. Some might get a subsidy to help with the purchase, but this is still like forcing everyone to buy a Ferrari when all they really want is their trusty old Honda Accord.

Sure, if I had to buy a new Ferrari, it might have all kinds of amazing features that my current car lacks. But I would also have a lot less money to spend on other things that I value a lot more, like my monthly gym membership, or taking my girlfriend out to a nice restaurant on occasion. If banning low quality goods and services is so good for consumers, why not extend this logic even further? Why not ban row boats and force people to buy yachts instead? Imagine how much better dressed Americans would be if we banned all of the clothes sold at Target and Walmart and only allowed people to purchase Christian Dior or Armani!

The problem with this logic is that quality is what economists call a “normal” good. A normal good is something people demand more of when their income rises. By contrast, an “inferior” good is something we demand more of when our income falls. Think macaroni and cheese dinners or sneakers from Payless, for example.

There’s nothing inherently “inferior” about an inferior good. Rather, people with lower incomes often prefer to trade off quality in exchange for a lower price. This is a perfectly rational decision. Since people demand more quality as income rises, banning lower quality products, like catastrophic only health insurance coverage, is actually banning the products that lower income people prefer. And it’s not just the poor who make tradeoffs between price and quality. (For example, I know for a fact that one of my more senior colleagues at the Mercatus Center buys most of his clothes at Walmart!). When prices rise in response to the mandated improvement in quality, the preferences of the poor are ignored and their options limited. As such, each individual must decide for him or herself what the right balance is between quality and price.

Once this becomes clear, one has to wonder who a lot of regulations are really designed to serve. For example, the FDA recently announced it will be setting standards for the production of pet food. Are regulations like this designed to cater to the preferences of the poor, who probably opt for the 79 cent can of cat food? Or are they more in line with the preferences of people who already buy organic food for their cats, people who might not mind paying a little extra to ensure that their pet food has met the new standards set by the FDA?

Mandating rearview cameras in automobiles is regressive for the same reason. This item was originally found mostly in luxury cars, but, thanks to market innovation, these cameras are rapidly becoming commonplace features in cars, all without government regulation.

One of the benefits of the market system is that when a new product is first introduced, the wealthy often pay a lot for it. Over time, the kinks in the product are worked out, and prices fall as the new technology becomes more affordable. Eventually, low income people can afford the product as well, but each consumer must decide for herself when the price has fallen sufficiently to make the purchase worthwhile.

Banning low quality items may seem like a noble way to protect consumers, but not when that removes lower-priced options for those consumers who have the fewest resources to spare. Rather than forcing consumers to buy luxury items, regulatory agencies should respect consumer preferences, especially the preferences of the poor.