Tag Archives: standards

State tax refunds and limiting spending growth

This fall eligible Alaskans will be receiving a check of $1,100 from their state government. Although the amount of the check can vary, Alaskans receive one every fall – no strings attached. Other state residents are probably more familiar with IRS tax refunds that come every spring, but this “tax refund” that Alaskans receive is unique. It’s a feature that residents have benefited from for decades, even in times when the government has experienced fiscal stress. Considering the state’s unique and distressed budget situation that I’ve described in an earlier post, I think it warrants a discussion of the fiscal viability of their refunds.

A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that made closing Alaska’s budget gap this year very difficult. It even contributed to pulling down Alaska from 1st in our 2016 ranking of states by fiscal condition to 17th in our 2017 edition. Given this deterioration, it will be helpful to look into how and why Alaska residents receive dividend payments each year. There is no public finance rule that says giving refunds to residents is fiscally irresponsible, but there definitely are better ways to do it, and Alaska certainly hasn’t proven to display best practices.

Another state that we can look at for comparison is Colorado, which has a similar “tax refund” for residents but is structured very differently. Colorado’s Taxpayer Bill of Rights (TABOR) requires that higher than expected tax revenues each year be refunded to taxpayers and acts as a restraint on government spending growth. In contrast, Alaska’s check comes from the state’s Permanent Fund’s earnings that are generated from oil severance taxes each year, and acts more like a dividend from oil investment earnings.

Are distributing these refunds to taxpayers fiscally responsible? I am going to take a deeper look at these mechanisms to find out.

First, Alaska’s refund.

The figure below displays Alaska’s Permanent Fund checks since 2002 overlaid with the state’s revenue and expenditure trends, all adjusted for inflation. The highest check (in 2015 dollars) was $2,279 in 2008 and the lowest was $906 in 2012, with the average over this time period being about $1,497 per person. Although the check amounts do vary, Alaska has kept on top of delivering them, even in times of steep budget gaps like in 2002, 2009, and 2015. The Permanent Fund dividend formula is based on net income from the current plus the previous four fiscal years, so it makes sense that the check sizes are also cyclical in nature, albeit in a slightly delayed fashion behind oil revenue fluctuations.

Alaska’s dividend payments often end up on the chopping block during yearly budget debates, and there is growing pressure to at least have them reduced. Despite this, Alaska’s dividends are very popular with residents (who can blame them?) and probably won’t be going away for a long time; bringing a new meaning to the Permanent Fund’s name.

The Alaska Permanent Fund was established in 1976 by constitutional amendment and was seen as an investment in future generations, who might no longer have access to oil as a resource. Although this may have been decent forward-thinking, which is rare in state budgets, it does illustrate an interesting public finance story.

Alaska is a great example of a somewhat backwards situation. They generate high amounts of cash each year, but because of the way many of their funds are restricted they are forced to hoard much of it, and give the rest to citizens in the form of dividends. If a different state were to consider a similar dividend before dealing with serious structural budget flaws would be akin to putting the cart before the horse.

Luckily for Alaskan dividend recipients, there are many other areas that the state could reform first in order to improve their budget situation while avoiding cutting payments. As my colleague Adam Millsap has recommended, a fruitful area is tax reform. Alaska doesn’t have an income or sales tax; two of the most common sources of revenue for state governments. These are two potentially more stable sources of income than what the state currently has.

How does Colorado’s “tax refund” compare?

Colorado’s Taxpayer Bill of Rights (TABOR) has a feature that requires any tax revenue growth beyond inflation and population growth be refunded to taxpayers. It was adopted by Colorado voters in 1992 and it essentially restricts revenues by prohibiting any tax or spending increases without voter approval.

A recent example of this playing out was in 2014 when the state realized higher than expected tax revenues as a result of marijuana legalization. At the point of legalization, the plan was to direct tax revenues generated from the sale of marijuana towards schools or substance abuse program funding. But because of the higher than expected revenues, TABOR was triggered and it would require voter approval to decide if the excess revenues would be sent back to taxpayers or directed to other state programs.

In November of 2015, Colorado voters approved a statewide ballot measure that gave state lawmakers permission to spend $66.1 million in taxes collected from the sale of marijuana. The first $40 million was sent to school construction, the next $12 million to youth and substance abuse programs, and the remainder $14.2 billion to discretionary spending programs. A great example that although TABOR does generally restrain spending, citizens still have power to decline refunds in the name of program spending they are passionate about.

 

The second figure here displays TABOR refunds compared with state revenues and expenditures over time. Adjusted for inflation, checks have varied from $18 in 2005 to $351 in 1999, much smaller than the Alaska dividend checks. TABOR checks have only tended to be distributed when revenues have exceeded expenses. The main reason why checks weren’t distributed between 2006 and 2009, despite a revenue surplus, was because of Referendum C which removed TABOR’s revenue limit for five years, allowing the state to keep collections exceeding the rule. The revenue limit has since been reinstated, but some question the effectiveness of TABOR given an earlier amendment in 2000 which exempts much of education spending from TABOR restrictions.

The main distinguishing factor between Colorado’s refund and Alaska’s Permanent Fund dividend is that the former also acts as a constraint on spending growth. By requiring the legislature to get voter approval before any tax increase or spending of new money, it implements automatic checks on these activities. Many states attempt to do this through what are called “Tax and Expenditure Limits” or TELs.

The worry is that left unchecked, state spending can grow to unsustainable levels.

Tax and Expenditure Limits

A review of the literature up to 2012 found that although the earliest studies were largely skeptical of the effectiveness of TELs, as time has passed more research points to the contrary. TELs can restrain spending, but only in certain circumstances.

My colleague Matt Mitchell found in 2010 that TELs are more effective when they (1) bind spending rather than revenue, (2) require a super-majority rather than a simple majority vote to be overridden, (3) immediately refund revenue collected in excess of the limit, and (4) prohibit unfunded mandates on local government.

Applying these criteria to Colorado’s TABOR we see that it does well in some areas and could improve in others. TABOR’s biggest strength is that it immediately refunds revenue collected in excess of the limit in its formula, pending voter approval to do otherwise. Automatically refunding surpluses makes it difficult for governments to use excess funds irresponsibly and also gives taxpayers an incentive to support TABOR.

Colorado’s TABOR does well to limit revenue growth according to a formula, rather than to a fixed number or no limitation at all. The formula partially meets Mitchell’s standards. It stands up well with the most stringent TELs by limiting government growth that exceeds inflation and population growth, but could actually be improved if it limited actual spending growth rather than focusing on tax revenue. When a TEL or similar law limits revenues, policymakers can respond by resorting to implementing more fees or borrowing. There’s some evidence of this occurring in Colorado, with fees becoming more popular as a way to raise revenue since TABOR’s passing. A spending-based TEL is more difficult to evade.

Despite its faults, Colorado’s TABOR structure appears to be doing better than attempts to constrain spending growth in other states. The National Conference of State Legislatures still considers it one of the strictest TELs in the nation. Other states, like Arkansas, could learn a lot from Colorado. A recent Mercatus study analyzes Arkansas’ Revenue Stabilization Law and suggests that it is missing a component similar to Colorado’s TABOR formula to refund excess revenues.

How much a state spends is ultimately up to its residents and legislature. Some states may have a preference for more spending than others, but given the tendency for government spending to grow towards an unsustainable direction, having a conversation about how to slow this is key. Implementing TEL-like checks allows for spending to be monitored and that tax dollars be spent more strategically.

Alaska’s Permanent Fund dividend is not structured as well as Colorado’s, but perhaps the state’s saving grace is that it has a relatively well structured TEL. Similarly to Colorado’s TABOR, Alaska’s TEL limits budget growth to the sum of inflation and population growth and is codified in the constitution. Alaska’s TEL doesn’t immediately refund revenue that is collected in excess of the limit to taxpayers as Colorado’s TABOR does, but it does target spending rather than revenues.

Colorado’s and Alaska’s TELs can compete when it comes to restraining spending, but Colorado’s is certainly more strict. Colorado’s expenditures have grown by about 55 percent over the last decade, while Alaska’s has grown approximately 120 percent.

The Lesson

Comparing Colorado and Alaska’s situations reveals two different ways of giving tax refunds to residents. Doing so doesn’t necessarily have to be fiscally irresponsible. Colorado has provided refunds to residents when state revenues have exceeded expenses and as a result this has acted as a restraint on over-spending higher than expected revenues. Although Colorado’s TABOR has been amended over time, its general structure illustrates the effectiveness of institutional restrains on spending. The unintended effects of TABOR, such as the increase in fees, could be well addressed by specifically targeting spending rather revenue, like in the case of Alaska’s TEL. Alaska may have had their future residents’ best intent in mind when they designed their Permanent Fund Dividend, but perhaps this goal of passing forward oil investment earnings should have been paired with preparing for the potential of cyclical budget woes.

A public sector retirement plan for Millennials

According to the Center for Retirement Research, about 52 percent of households are “at risk of not having enough to maintain their living standards in retirement” and that the retirement landscape is making “the outlook for retiring Baby Boomers and Generation Xers far less sanguine than for current retirees.” This growing problem for younger generations is highlighted by the Economic Policy Institute’s finding that almost half of households headed by someone between the ages of 32 and 61 have nothing saved for retirement. A confluence of factors has led to a predicament for millennials as they try to prepare for retirement in a drastically changing job market.

The millennial generation has grown to be an integral part of the workforce, and private sector companies are increasing their efforts to understand what they value most a job. A Deloitte survey reveals that a good work/life balance, opportunities to progress/be leaders, flexibility, and a sense of meaning emerge as the most important factors when evaluating job opportunities. What’s more, millennials are not likely to stick around for a job that doesn’t meet this criteria. The same survey found that if given the choice during the next year, one in four millennials would quit his or her current employer to join a new organization or to do something different.

This flightiness appears to be a characteristic of many young people and to be happening in tandem with, if not contributing to, an increasingly transient job market. This phenomenon, corroborated by other surveys, demonstrates that more and more millennial workers are changing jobs at a higher rate than previous generations. It is not as common to stick with your first or second job until retirement, as it once was for Baby Boomers. The “loyalty challenge” facing companies, paired with changes in technology and culture, has in turn been transforming the landscape of retirement options.

As workers become more transient, companies are forced to provide more portable retirement plan options. During the past two decades, the private sector has done just that by transitioning from offering primarily defined benefit retirement plans to offering more defined contribution plans. This change is to be expected in part because of the flexibility it provides for beneficiaries. Defined contribution plans allow for workers to take their benefits more easily with them from job to job.

The public sector has not quite caught up to this trend. Public sector plans have had much more difficulty staying solvent and much of this is because of the prevalence of defined benefit plans. Mercatus scholars, along with many economists, have long criticized the poor incentive structure of these plans. If these aren’t reason enough for policymakers to offer defined contribution plans in their place, then maybe their changing workforces will.

Much of the debate over growing pension liabilities has focused on whether public sector compensation costs are fair either in comparison to other states or to the private sector. But much less has been said about what is fair across generations.

Most pension reform efforts at the state level target changes in benefits for younger employees while preserving the benefits of older workers. Although this is largely the result of legal and political constraints, such changes have the potential to force younger generations of public-sector workers to shoulder a disproportionate share of the cost of reforms, as their retirement benefits become more uncertain, thus violating a crucial criterion of “intergenerational equity” for pension reform.

Pension experts Robert Novy-Marx and Joshua Rauh reveal in a 2008 study that the intergenerational transfer of pension debt could be quite large. They predict a 50 percent chance of underfunding across the states amounting to more than $750 billion, even before adjusting for risk. In other words, if left alone, the pension bills of today are going to be handed to the generations of tomorrow.

A new Mercatus paper uncovers how similar intergenerational equity issues have developed in the state of Oregon. The author, legal scholar Scott Shepard, writes:

“…the system radically favors (generally older) workers who started before 1996 and 2003, respectively – not just in expected ways, like seniority pay bumps, but in deeply structural ways; earlier-hired employees simply get a significantly better pay-and-benefit package for every minute of their climb up the seniority ladder.”

Oregon’s pension system, along with many other states’ plans, started out offering extremely generous benefits, but as this has grown increasingly unsustainable, the state is being forced to deal with reality and reign in benefits for newer workers.

The unfair retirement landscape that this creates is largely the result of many past poor policy decisions and although this difference in benefits between age groups is far from intentional, how Oregon – and other states in similar positions – responds can be. Changing demographic trends may lend reason for public pension officials to consider moving towards defined contribution plan structures, or at least providing the option.

Shepard strongly urges Oregon to make this shift. He describes a number of benefits; from the perspective of the state, taxpayers, and future generations:

“First, payments must be made when due, rather than being shifted off to future generations. This may seem painful to present taxpayers, but the long-term effect is to ensure a more honest government, in that politicians cannot make promises that their (unrepresented) descendants end up paying for generations later, long after the promisors have reaped the political benefits of making unfunded promises, only to have retired from the scene when payment comes due. This inability to promise now and pay later has a corollary benefit of thwarting the impulse to make extravagant pension promises, as the payments come due immediately, rather than being foisted off on future generations.”

Offering defined contribution plans for workers can provide a more sustainable option that would prevent this equity issue from worsening.

In addition to the accountability and savings that offering a defined contribution option provides, like we have seen demonstrated in Utah and Michigan, this also has the potential to lead to higher worker satisfaction.

With millennials looking to save money for retirement through more portable means, policymakers will want to offer benefits packages that match these preferences. Private sector workers and some public – including Federal and public university – workers lie at the forefront of those benefiting from the defined contribution trend. Most state public plans, however, still fall behind, which has continuing implications for public plan solvency and intergenerational equity.

Why the lack of labor mobility in the U.S. is a problem and how we can fix it

Many researchers have found evidence that mobility in the U.S. is declining. More specifically, it doesn’t appear that people move from places with weaker economies to places with stronger economies as consistently as they did in the past. Two sets of figures from a paper by Peter Ganong and Daniel Shoag succinctly show this decline over time.

The first, shown below, has log income per capita by state on the x-axis for two different years, 1940 (left) and 1990 (right). On the vertical axis of each graph is the annual population growth rate by state for two periods, 1940 – 1960 (left) and 1990 – 2010 (right).

directed migration ganong, shoag

In the 1940 – 1960 period, the graph depicts a strong positive relationship: States with higher per capita incomes in 1940 experienced more population growth over the next 20 years than states with lower per capita incomes. This relationship disappears and actually reverses in the 1990 – 2010 period: States with higher per capita incomes actually grew slower on average. So in general people became less likely to move to states with higher incomes between the middle and end of the 20th century. Other researchers have also found that people are not moving to areas with better economies.

This had an effect on income convergence, as shown in the next set of figures. In the 1940 – 1960 period (left), states with higher per capita incomes experienced less income growth than states with lower per capita incomes, as shown by the negative relationship. This negative relationship existed in the 1990 – 2010 period as well, but it was much weaker.

income convergence ganong, shoag

We would expect income convergence when workers leave low income states for high income states, since that increases the labor supply in high-income states and pushes down wages. Meanwhile, the labor supply decreases in low-income states which increases wages. Overall, this leads to per capita incomes converging across states.

Why labor mobility matters

As law professor David Schleicher points out in a recent paper, the current lack of labor mobility can reduce the ability of the federal government to manage the U.S. economy. In the U.S. we have a common currency—every state uses the U.S. dollar. This means that if a state is hit by an economic shock, e.g. low energy prices harm Texas, Alaska and North Dakota but help other states, that state’s currency cannot adjust to cushion the blow.

For example, if the UK goes into a recession, the Bank of England can print more money so that the pound will depreciate relative to other currencies, making goods produced in the UK relatively cheap. This will decrease the UK’s imports and increase economic activity and exports, which will help it emerge from the recession. If the U.S. as a whole suffered a negative economic shock, a similar process would take place.

However, within a country this adjustment mechanism is unavailable: Texas can’t devalue its dollar relative to Ohio’s dollar. There is no within-country monetary policy that can help particular states or regions. Instead, the movement of capital and labor from weak areas to strong areas is the primary mechanism available for restoring full employment within the U.S. If capital and labor mobility are low it will take longer for the U.S. to recover from area-specific negative economic shocks.

State or area-specific economic shocks are more likely in large countries like the U.S. that have very diverse local economies. This makes labor and capital mobility more important in the U.S. than in smaller, less economically diverse countries such as Denmark or Switzerland, since those countries are less susceptible to area-specific economic shocks.

Why labor mobility is low

There is some consensus about policies that can increase labor mobility. Many people, including former President Barack Obama, my colleagues at the Mercatus Center and others, have pointed out that state occupational licensing makes it harder for workers in licensed professions to move across state borders. There is similar agreement that land-use regulations increase housing prices which makes it harder for people to move to areas with the strongest economies.

Reducing occupational licensing and land-use regulations would increase labor mobility, but actually doing these things is not easy. Occupational licensing and land-use regulations are controlled at the state and local level, so currently there is little that the federal government can do.

Moreover, as Mr. Schleicher points out in his paper, state and local governments created these regulations for a reason and it’s not clear that they have any incentive to change them. Like all politicians, state and local ones care about being re-elected and that means, at least to some extent, listening to their constituents. These residents usually value stability, so politicians who advocate too strongly for growth may find themselves out of office. Mr. Schleicher also notes that incumbent politicians often prefer a stable, immobile electorate because it means that the voters who elected them in the first place will be there next election cycle.

Occupational licensing and land-use regulations make it harder for people to enter thriving local economies, but other policies make it harder to leave areas with poor economies. Nearly 13% of Americans work for state and local governments and 92% of them have a defined-benefit pension plan. Defined-benefit plans have long vesting periods and benefits can be significantly smaller if employees split their career between multiple employers rather than remain at one employer. Thus over 10% of the workforce has a strong retirement-based incentive to stay where they are.

Eligibility standards for public benefits and their amounts also vary by state, and this discourages people who receive benefits such as Temporary Assistance for Needy Families (TANF) from moving to states that may have a stronger economy but less benefits. Even when eligibility standards and benefits are similar, the paperwork and time burden of enrolling in a new state can discourage mobility.

The federal government subsidizes home ownership as well, and homeownership is correlated with less labor mobility over time. Place-based subsidies to declining cities also artificially support areas that should have less people. As long as state and federal governments subsidize government services in cities like Atlantic City and Detroit people will be less inclined to leave them. People-based subsidies that incentivize people to move to thriving areas are an alternative that is likely better for the taxpayer, the recipient and the country in the long run.

How to increase labor mobility

Since state and local governments are unlikely to directly address the impediments to labor mobility that they have created, Mr. Schleicher argues for more federal involvement. Some of his suggestions don’t interfere with local control, such as a federal clearinghouse for coordinated occupational-licensing rules across states. This is not a bad idea but I am not sure how effective it would be.

Other suggestions are more intrusive and range from complete federal preemption of state and local rules to federal grants that encourage more housing construction or suspension of the mortgage-interest deduction in places that restrict housing construction.

Local control is important due to the presence of local knowledge and the beneficial effects that arise from interjurisdictional competition, so I don’t support complete federal preemption of local rules. Economist William Fischel also thinks the mortgage interest deduction is largely responsible for excessive local land-use regulation, so eliminating it altogether or suspending it in places that don’t allow enough new housing seems like a good idea.

I also support more people-based subsidies that incentivize moving to areas with better economies and less place-based subsidies. These subsidies could target people living in specific places and the amounts could be based on the economic characteristics of the destination, with larger amounts given to people who are willing to move to areas with the most employment opportunities and/or highest wages.

Making it easier for people to retain any state-based government benefits across state lines would also help improve labor mobility. I support reforms that reduce the paperwork and time requirements for transferring benefits or for simply understanding what steps need to be taken to do so.

Several policy changes will need to occur before we can expect to see significant changes in labor mobility. There is broad agreement around some of them, such as occupational licensing and land-use regulation reform, but bringing them to fruition will take time. As for the less popular ideas, it will be interesting to see which, if any, are tried.

More labor market freedom means more labor force participation

The U.S. labor force participation (LFP) rate has yet to bounce back to its pre-recession level. Some of the decline is due to retiring baby-boomers but even the prime-age LFP rate, which only counts people age 25 – 54 and thus less affected by retirement, has not recovered.

Economists and government officials are concerned about the weak recovery in labor force participation. A high LFP rate is usually a sign of a strong economy—people are either working or optimistic about their chances of finding a job. A low LFP rate is often a sign of little economic opportunity or disappointment with the employment options available.

The U.S. is a large, diverse country so the national LFP rate obscures substantial state variation in LFP rates. The figure below shows the age 16 and up LFP rates for the 50 states and the U.S. as a whole (black bar) in 2014. (data)

2014-state-lfp-rates

The rates range from a high of 72.6% in North Dakota to a low of 53.1% in West Virginia. The U.S. rate was 62.9%. Several of the states with relatively low rates are in the south, including Mississippi, Alabama and Arkansas. Florida and Arizona also had relatively low labor force participation, which is not surprising considering their reputations as retirement destinations.

There are several reasons why some states have more labor force participation than others. Demographics is one: states with a higher percentage of people over age 65 and between 16 and 22 will have lower rates on average since people in these age groups are often retired or in school full time. States also have different economies made up of different industries and at any given time some industries are thriving while others are struggling.

Federal and state regulation also play a role. Federal regulation disparately impacts different states because of the different industrial compositions of state economies. For example, states with large energy industries tend to be more affected by federal regulation than other states.

States also tax and regulate their labor markets differently. States have different occupational licensing standards, different minimum wages and different levels of payroll and income taxes among other things. Each of these things alters the incentive for businesses to hire or for people to join the labor market and thus affects states’ LFP rates.

We can see the relationship between labor market freedom and labor force participation in the figure below. The figure shows the relationship between the Economic Freedom of North America’s 2013 labor market freedom score (x-axis) and the 2014 labor force participation rate for each state (y-axis).

lab-mkt-freed-and-lfp-rate

As shown in the figure there is a positive relationship—more labor market freedom is associated with a higher LFP rate on average. States with lower freedom scores such as Mississippi, Kentucky and Alabama also had low LFP rates while states with higher freedom scores such as North Dakota, South Dakota and Virginia had higher LFP rates.

This is not an all-else-equal analysis and other variables—such as demographics and industry composition which I mentioned earlier—also play a role. That being said, state officials concerned about their state’s labor market should think about what they can do to increase labor market freedom—and economic freedom more broadly—in their state.

Puerto Rico’s labor market woes

Puerto Rico – a U.S. territory – has $72 billion dollars in outstanding debt, which is dangerously high in a country with a Gross Domestic Product (GDP) of only $103.1 billion. The Puerto Rican government failed to pay creditors in August and this was viewed as a default by the credit rating agency Moody’s, which had already downgraded Puerto Rico’s bonds to junk status earlier this year. The Obama administration has proposed allowing Puerto Rico to declare bankruptcy, which would allow it to negotiate with creditors and eliminate some of its debt. Currently only municipalities – not states or territories – are allowed to declare bankruptcy under U.S. law. Several former Obama administration officials have come out in favor of the plan, including former Budget Director Peter Orszag and former Director of the National Economic Council Larry Summers. Others are warning that bankruptcy is not a cure-all and that more structural reforms need to take place. Many of these pundits have pointed out that Puerto Rico’s labor market is a mess and that people are leaving the country in droves. Since 2010 over 200,000 people have migrated from Puerto Rico, decreasing its population to just over 3.5 million. This steady loss of the tax base has increased the debt burden on those remaining and has made it harder for Puerto Rico to get out of debt.

To get a sense of Puerto Rico’s situation, the figure below shows the poverty rate of Puerto Rico along with that of three US states that will be used throughout this post as a means of comparison: California (wealthy state), Ohio (medium-wealth state), and Mississippi (low-wealth state). All the data are 1-year ACS data from American FactFinder.

puerto rico poverty

The poverty rate in Puerto Rico is very high compared to these states. Mississippi’s poverty rate is high by US standards and was approximately 22% in 2014, but Puerto Rico’s dwarfed it at over 45%. Assisting Puerto Rico with their immediate debt problem will do little to fix this issue.

A government requires taxes in order to provide services, and taxes are primarily collected from people who work in the regular economy via income taxes. A small labor force with relatively few employed workers makes it difficult for a county to raises taxes to provide services and pay off debt. Puerto Rico has a very low labor force participation (LFP) rate relative to mainland US states and a very low employment rate. The graphs below plot Puerto Rico’s LFP rate and employment rate along with the rates of California, Mississippi, and Ohio.

puerto rico labor force

puerto rico employ rate

As shown in the figures, Puerto Rico’s employment rate and LFP rate are far below the rates of the US states including one of the poorest states, Mississippi. In 2014 less than 45% of Puerto Rico’s 16 and over population was in the labor force and only about 35% of the 16 and over population was employed. In Mississippi the LFP rate was 58% while the employment rate was 52%. Additionally, the employment rate fell in Puerto Rico from 2010-14 while it rose in each of the other three states. So at a time when the labor market was improving on the mainland things were getting worse in Puerto Rico.

An educated labor force is an important input in the production process and it is especially important for generating innovation and entrepreneurship. The figure below shows the percent of people 25 and over in each area that have a bachelor’s degree or higher.

puerto rico gt 24 education attain

Puerto Rico has a relatively educated labor force compared to Mississippi, though it trails Ohio and California. The percentage also increased over this time period, though it appears to have stabilized after 2012 while continuing to grow in the other states.

Puerto Rico has nice beaches and weather, so a high percentage of educated people over the age of 25 may simply be due to a high percentage of educated retirees residing in Puerto Rico to take advantage of its geographic amenities. The next figure shows the percentage of 25 to 44 year olds with a bachelor’s degree or higher. I examined this age group to see if the somewhat surprising percentage of people with a bachelor’s degree or higher in Puerto Rico is being driven by educated older workers and retirees who are less likely to help reinvigorate the Puerto Rican economy going forward.

puerto rico 25to44 educ attain

As shown in the graph, Puerto Rico actually fares better when looking at the 25 – 44 age group, especially from 2010-12. In 2012 Puerto Rico had a higher percentage of educated people in this age group than Ohio.

Since then, however, Puerto Rico’s percentage declined slightly while Ohio’s rose, along with Mississippi’s and California’s. The decline in Puerto Rico was driven by a decline in the percentage of people 35 to 44 with a bachelor’s or higher as shown in the next figure below.

puerto rico 35to44 educ attain

The percentage of 35 to 44 year olds with a bachelor’s or advanced degree fell from 32% in 2012 to 29.4% in 2014 while it rose in the other three states. This is evidence that educated people in their prime earning years left the territory during this period, most likely to work in the US where there are more opportunities and wages are higher. This “bright flight” is a bad sign for Puerto Rico’s economy.

One of the reforms that many believe will help Puerto Rico is an exemption from compliance with federal minimum wage laws. Workers in Puerto Rico are far less productive than in the US, and thus a $7.25 minimum wage has a large effect on employment. Businesses cannot afford to pay low-skill workers in Puerto Rico such a high wage because the workers simply do not produce enough value to justify it. The graph below shows the median individual yearly income in each area divided by the full time federal minimum wage income of $15,080.

puerto rico min wage ratio

As shown in the graph, Puerto Rico’s ratio was the highest by a substantial amount. The yearly income from earning the minimum wage was about 80% of the yearly median income in Puerto Rico over this period, while it was only about 40% in Mississippi and less in Ohio and California. By this measure, California’s minimum wage would need to be $23.82 – which is equal to $49,546 per year – to equal the ratio in Puerto Rico. California’s actual minimum wage is $9 and it’s scheduled to increase to $10 in 2016. I don’t think there’s a single economist who would argue that more than doubling the minimum wage in California would have no effect on employment.

The preceding figures do not paint a rosy picture of Puerto Rico: Its poverty rate is high and trending up, less than half of the people over 16 are in the labor force and only about a third are actually employed, educated people appear to be leaving the country, and the minimum wage is a severe hindrance on hiring. Any effort by the federal government to help Puerto Rico needs to take these problems into account. Ultimately the Puerto Rican government needs to be enabled and encouraged to institute reforms that will help grow Puerto Rico’s economy. Without fundamental reforms that increase economic opportunity in Puerto Rico people will continue to leave, further weakening the commonwealth’s economy and making additional defaults more likely.

 

 

Why regulations that require cabs to be painted the same color are counterproductive

A few weeks ago, my colleagues Chris Koopman, Adam Thierer and I filed a comment with the FTC on the sharing economy. The comment coincided with a workshop that the FTC held at which Adam was invited to speak. Our comment, our earlier paper (forthcoming in the Pepperdine Journal of Business Entrepreneurship and the Law), and a superb piece that Adam and Chris wrote with MA fellows Anne Hobson and Chris Kuiper, have been getting a fair amount of press attention, most of it positive.

I want to highlight one piece that seems to have misunderstood us. I highlight it not because I blame the author, but because I assume we must not have described our point well. Paul Goddin of MobilityLab writes:

Their argument seems valid, but an example they use is New York City’s rule that taxicabs be painted the same color. They argue this regulation is a barrier to entry, yet neglect to mention that Uber also requires its drivers to adhere with automobile standards (although these standards have been loosened recently). As of this article, Uber’s drivers must possess a late-model 2005 sedan (2000 in some cities, 2007-08 in others), with specific color and make restrictions for those who operate the company’s Black car service.

A rule that requires everyone in an industry to use the exact same equipment, branding and paint color is, I suppose, a barrier to entry. But that isn’t why we raised the issue. We raise it because—more importantly—it is a barrier to signaling quality.

It is a good thing that Uber and Lyft require their drivers to adhere to standards, just as it is a good thing that TGI Fridays and CocaCola set their own standards. Walk into a TGI Fridays anywhere in the world and you will encounter a familiar experience. That is because the company sets standards for its recipes, its decorations, its employee’s behavior, its uniforms, and much else. Similarly strict standards govern the way CocaCola is packaged, and marketed. Retailers that operate soda fountains are all supposed to combine the syrup and the carbonated water in the same way. If they don’t, they may find that CocaCola no longer wants to work with them.

These practices ensure quality. And they help overcome what would otherwise be a significant information asymmetry between the buyer and the seller. But notice that these signals only work because they are tied to the brands. Imagine what would happen if Chili’s, Outback Steakhouse, and Macaroni Grill were all required by law to adopt the same logos, the same decor, the same recipes, and the same uniforms as TGI Fridays. Customers would have no way of distinguishing between the brands, and therefore the companies would have little incentive to provide quality service in order to protect their reputations. Who cares about cooking a T Bone properly if the other guys are likely to get blamed for it?

So here in lies the problem with taxi regulations that require all cabs to offer the same sort of service, right down to the color of their cars: If every cab looks the same, no one cab company has an incentive to carefully guard its reputation.

Strong words from the SEC on Public Sector Pensions

As state and local governments begin to pull back the curtain on the true value of their pension liabilities with the implementation of GASB 68, Daniel Gallagher, Commissioner of the SEC issued an important statement last week, noting in plain terms that how governments measure their liabilities would have serious repercussions in the private sector. Here’s part of the remarks worth considering:

 …for years, state and local governments have used lax governmental accounting standards to hide the yawning chasm in their balance sheets…

The riskiness of a pension obligation depends on state law.[32]  If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate.[33]  Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability:  specifically, the Treasury zero-coupon yield curve.[34]  This would result in a discount rate in the low 3% range.

Obviously, the higher the discount rate, the lower the present value of the liability.  The difference between a discount rate in the range of seven percent and one in the range of three percent is in large part responsible for the hidden $3 trillion in unfunded liabilities that are currently going unreported.

This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees,[35] or not to make the promises in the first place.

In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games.  And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions.  We should not treat municipalities any differently.”

GASB 68 asks that sponsors use a high- yield, tax exempt 20-year municipal GO bond only on the unfunded portion of the liability. This will reveal bigger funding gaps in public sector pension plans. But it does not reveal the full value of the liability since it allows sponsors to continue using the higher discount rates on the funded portion of the liability.

 In addition to using the new GASB standards, Commissioner Gallagher advises that governments should also disclose their pension liabilities on a risk-free basis. This would have the effect of showing the value of these promises on a ‘guaranteed-to-be-paid’ basis. Commissioner Gallagher’s suggestions are extremely sensible and a call to basic transparency in public sector liability reporting.

Ignoring the value of pension benefits is not going to make them cheaper to fund, and the longer a state waits to accurately measure the liabilities and payments, the worse it gets. Just ask New Jersey –  which is struggling to balance its budget and meet a fraction of a fraction of the required annual pension contribution to its state pension system. The situation is so dire that it could trigger yet another downgrade for the Garden State.

 

Profiles in Privilege

  1. When powerful politicians give no-bid construction contracts to their friends, you get Olympic bathrooms with two toilets to a stall. Thank god we don’t have those sorts of problems here in the West, right?
  2. Sheldon Adelson, owner of one of the largest (off-line) gambling ventures in the world, is really worried about on-line gambling. And, apparently, he “can sound surprisingly like a Southern Baptist preacher.” Bruce Yandle probably saw this coming.
  3. Remember that time when the D.C. City Council tried to side with the local taxi monopoly to keep out an innovative new competitor that was wildly popular with customers? Remember how Council members backed down after they were inundated with protests from angry constituents? Politicians in Pittsburgh, Chicago, Milwaukee, and Paris (France) don’t.
  4. In an effort to catch up with the private sector, the Obama Administration wants to move more government business from paper to the web. The paper industry is not a fan of this. In Bastiat’s telling, candlestick makers didn’t like competition from the sun either.
  5. Makers of maple syrup want more exacting grading standards for maple syrup. In other news, I would like a law saying that only economists who attended ASU and GMU can call themselves economists.
  6. Soccer star and aspiring (unproductive) entrepreneur David Beckham is trying to get a stadium built. He says “We don’t want public funding…We’ll fund the stadium ourselves. It’s something where we have worked hard to get this stage, to fund it ourselves.” In other reports, however, “Beckham’s group has hired prominent Tallahassee lobbyist Brian Ballard to help seek a state sales-tax subsidy similar to what other professional sports teams across Florida have received for building stadium facilities.”
  7. Elsewhere in privileged Floridian soccer news, the city of Orlando plans to use eminent domain to seize a church in order to tear it down and build a parking lot for Orlando’s new soccer stadium.
  8. WAMU’s Patrick Madden tweets that Mayor Vincent Gray has assured voters they will not be paying for soccer team D.C. United’s stadium….Voters will, however, pick up the cost of the land at $150,000,000 and then rent it back to the team for $1.00 per year. Sounds too crazy to be true? Read the terms here (to be fair, it looks to me like taxpayers will only be paying $140,000,000).
  9. Pat Garofalo writes: “In a move its protagonist, Vice President Frank Underwood, could be proud of, the studio that produces Netflix’s “House of Cards” is all but attempting to extort tax dollars out of the state of Maryland. As the Washington Post reported, Media Rights Capital has threatened to move production of its show about an absurdly corrupt Washington elsewhere if it doesn’t get a new slew of taxpayer money.”
  10. According to this report, FBI agents posed as film executives to bribe a California state senator to expand film tax credits. This sort of film subsidy corruption scandal will likely sound familiar to those in Iowa. And Massachusetts. And Louisiana. Makes you think that P.J. O’Rourke was right: “When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.”

When Regulatory Agencies Ignore Comments from the Public

A few days ago, the Department of Energy (DOE) finalized a rule setting energy efficiency standards for metal halide lamp fixtures. Last October I wrote a public interest comment to the DOE to point out several problems with the agency’s preliminary economic analysis for the rule. As part of the Administrative Procedure Act, agencies are required to solicit, and respond to, comments from the public before finalizing regulations. Unfortunately, the DOE failed to even acknowledge many of the points I made in my submission.

As evidence, here are some of the main takeaways from my comment:

1)      The DOE claims consumers and businesses are acting in an irrational manner when purchasing metal halide lamp fixtures because they forgo modest long term energy savings in order to pay a low upfront price for lamp fixtures. Yet the agency offers no convincing evidence to support the theory that consumers act irrationally when purchasing metal halide lamp fixtures. At the same time, roughly 70% of the estimated benefits of the rule are the supposed benefits bestowed upon the public when products people would purchase otherwise are removed from the market.

2)      The DOE is currently adding together costs and benefits that occur in the future but that are discounted to present value using different discount rates. It makes no sense to add together costs and benefits calculated in this manner.

3)      The DOE is using a new value of the Social Cost of Carbon (SCC), a way to measure benefits from reducing carbon dioxide emissions, that may be of questionable validity since the analysts who arrived at the estimate ignored recent scientific evidence. Additionally, the DOE is using the new SCC in its analysis before the public has even had a chance to comment on the validity of the new number.

4)      In its analysis, the DOE is including benefits to foreign countries as a result of reduced carbon dioxide emissions, even while the costs of the metal halide lamp fixture regulation will be borne largely by Americans.

Regarding #1 above, the DOE provided no direct response to my comment in the preamble to its final rule. This even though #1 puts in doubt roughly 70% of the estimated benefits of the rule.

The DOE also failed to respond to #2 above, even though I cited as support a very recent and relevant paper on the subject that appeared in a reputable journal and was coauthored by Nobel laureate Kenneth Arrow.

Regarding #3 and #4, the DOE had this to say:

On November 26, 2013, the Office of Management and Budget (OMB) announced minor technical corrections to the 2013 SCC values and a new opportunity for public comment on the revised Technical Support Document underlying the SCC estimates. Comments regarding the underlying science and potential precedential effect of the SCC estimates resulting from the interagency process should be directed to that process. See 78 FR 70586. Additionally, several current rulemakings also use the 2013 SCC values and the public is welcome to comment on the values as applied in those rulemakings just as the public was welcome to comment on the use and application of the 2010 SCC values in the many rules that were published using those values in the past three years.

In other words, the DOE is committed to continuing to use a value of the SCC that may be flawed since the public has the opportunity to complain to the Office of Management and Budget. At the same time, the DOE tells us we can comment on other regulations that use the new SCC value, so that should reassure anyone whose comment the DOE ignored related to this regulation!

All of this is especially troubling since the DOE is required by statute to ensure its energy efficiency rules are “economically justifiable.” It is hard to argue this rule is economically justifiable when roughly 94% of the rule’s benefits are in doubt. This is the proportion of benefits justified on the basis of consumer irrationality and on the basis that Americans should be paying for benefits that will be captured by citizens in other countries. Without these benefits, the rule fails a benefit-cost test according to the DOE’s own estimates.

The requirement that agencies respond to public comments is designed to ensure a level of democratic accountability from regulators, who are tasked with serving the American public. A vast amount of power is vested in these agencies, who are largely insulated from Congressional oversight. As evidence, Congress has only used its Congressional Review Act authority to overrule major regulations once in its history. If agencies ignore the public, and face little oversight from Congress, what faith can we have that regulators will be held accountable for any harms that inevitably arise from poorly designed regulations?

A New Year’s Gift from the Department of Energy

On New Year’s Eve, the Department of Energy (DOE) announced it will be denying a petition brought to the agency by the Landmark Legal Foundation. The petition had requested the DOE reconsider a regulation related to energy efficiency standards for microwave ovens on the grounds that the Energy Department used a new, much higher, estimate of the social cost of carbon (SCC) in the final analysis of the regulation than had been used in the proposed version of the rule. The SCC is a number the Department uses to estimate benefits to society from reductions in greenhouse gas emissions. The public was denied the opportunity to comment on the higher estimate of the SCC since the new estimate was not used until after the time the public was allowed to comment on the regulation.

Here’s some of the DOE’s reasoning for denying the petition:

In the microwave oven rule, the SCC analysis did not affect DOE’s decision regarding the standards that were published in the Federal Register at either the proposed rule or final rule stage because the estimated benefits to consumers of the standard exceeded the costs of the standard, even without considering the SCC values. [emphasis added]

However, as I and others have stated before, these “benefits to consumers” are not benefits at all, and should be excluded from consideration when determining whether the DOE’s energy efficiency standards produce benefits in excess of costs. In a comment I wrote to the DOE as the agency considered this petition, I said:

The preponderance of the rule’s benefits, nearly 80 percent, are not related to reductions in carbon emissions, or even to any environmental effects at all. Instead, these benefits are based on the assumption that consumers behave in an irrational manner when purchasing microwave ovens and that the Department will be able to “fix” this behavior by issuing a regulation, thereby resulting in benefits to consumers. These “savings” should be excluded from the agency’s final analysis of benefits resulting from the regulation.

So the DOE is partly right. The new SCC really doesn’t make a difference in this particular case. However, this is because the regulation produces net costs to society with or without the higher estimate of the social cost of carbon. Thus, the rule can’t be justified on a cost-benefit basis even with the new social cost of carbon number the DOE uses. As I explained in my comment:

Given that the primary estimate of the total benefits resulting from this regulation is estimated at $294 million per year (2011$), and total costs are estimated at $66.4 million per year, subtracting the consumer “irrationality” benefits of $234 million produces net costs to society of $6.4 million per year (2011$).12 If DOE used a lower value of the SCC, like the estimate used in the proposed version of this regulation, that net cost figure would be even higher. The problem is further compounded if benefits to other countries are excluded from the estimates.

The DOE made no effort to respond to this particular critique in its response to the Landmark Legal Foundation petition. The agency does not view the questionable nature of its estimated benefits to consumers as within the scope of the issue it sought comment on. Perhaps this is so. However, there will be more such regulations in the future where this controversial technique is employed by the DOE. Indeed, at Mercatus we have already commented on such regulations. Additionally, the agency’s decision to slip this notice out on New Year’s Eve leads one to question the degree to which the agency is committed to transparent practices. As a result, an inefficient regulation will be implemented and Americans will be made worse off.