Tag Archives: US

Institutions matter, state legislative committee edition

Last week, Mercatus published a new working paper that I coauthored with Pavel Yakovlev of Duquesne University. It addresses an understudied institutional difference between states. Some state legislative chambers allow one committee to write both spending and taxing bills while others separate these functions into two separate committees.

This institutional difference first caught my eye a few years ago when Nick Tuszynski and I reviewed the literature on institutions and state spending. Among 16 different institutions that we looked at—from strict balanced budget requirements to term limits to “item reduction vetoes”—one stood out. Previous research by Mark Crain and Timothy Muris had found that states in which separate committees craft taxing and spending bills spend significantly less per capita than states in which a single committee was responsible for both kinds of bills. As you can see from the figure below (click to enlarge), the effect was estimated to be many times larger than that found for almost any other institution:

InstitutionsBut as large as this effect seems to be, the phenomenon has largely been ignored. To our knowledge, Crain and Muris are the only ones to have studied it. Their paper was now two decades old and was based on a relatively small sample of years from the 1980s.

As I wrote in yesterday’s Economics Intelligence column for US News:

To get a fresh look at the phenomenon, my colleagues and I consulted state statutes, legislative rules, committee websites and members’ offices. We created a unique data set that for some states spans 40 years. We took a cautious approach, coding taxing and spending functions as not separate in any chambers in which it was possible for a tax bill to come out of a spending committee and vice versa. We found that in 25 states, these functions are separate in both chambers, in 7 states they are separate in one chamber, and in the rest, these functions are separate in neither chamber.

To control for other confounding factors, we also gathered data on economic, demographic, and institutional differences between the states. Controlling for these factors, we found that separate taxing and spending committees are, indeed, associated with less spending. To be precise:

Other factors being equal, we find that those states with separate taxing and spending committees spend between $300 and $450 less per capita (between $790 and $1,200 less per household) than other states.

Our full paper is here, a summary is here, and my post at US News is here. Comments welcome.

Would cutting Ex-Im’s ties to the U.S. Treasury amount to “unilateral disarmament”?

Before winning this year’s World Cup championship, Germany faced a dilemma during its qualifying match against the United States. Both teams could ensure their advancement in the tournament by colluding to do nothing. If they tied, both would advance. If one of them won, the other might not advance. However, neither could ensure that the other would cooperate. And as a result, they were both forced to compete.

This situation, known a “prisoner’s dilemma,” is one that manifests itself in all sorts of situations, frombusiness to politics to World Cup qualifying games.

It also helps explain where we find ourselves with the Export-Import Bank,or “Ex-Im,” a federal agency tasked with subsidizing U.S. exports. The bank’s charter is set to expire in a few months, and some are making the case that it should be reauthorized to help U.S. manufacturers “compete internationally” by“leveling the playing field.” This is simply another prisoner’s dilemma playing out in the real world.

That is my latest, coauthored with Chris Koopman, at US News.

Is American Federalism conducive to liberty?

In new Mercatus research, Dr. Richard E. Wagner, Harris professor of Economics at George Mason University tackles a fascinating question: Is the American form of federalism supportive of liberty?

His answer is a qualified ‘yes.’ Under certain conditions, American federalism does support liberty, but that very same system can also be modified resulting in the expansion of political power relative to the liberty of citizens. The question of what results from the gradual constitutional transformation of the American federalist system is a salient one for not only students of government but also policymakers.

The important conditions that determine which form of federalism prevails (liberty-supporting or liberty-eroding) are rooted in competition among governments. Today we are experiencing a very different kind of federalism than the one instituted by the Founders. For the better part of a century, the US constitution has often been amended in a way to encourage collusion among the states thus undermining a key feature of a liberty-supporting federalism.

Restoring a liberty-supporting federalism first requires a deeper diagnosis of the American federalist system. Dr. Wagner develops that possibility through a very engaging synthesis of public choice theory, Austrian and new institutional economics.  Student of Dr. Wagner may be familiar with many of these concepts, developed in his public finance books including Deficits, Debt and Democracy (2012, Elgar). Rather than summarize the paper in today’s blog post, for now I encourage you to read the piece in full.

The unseen costs of the Ex-Im bank

The great 19th Century French economist Frederic Bastiat had good advice when thinking about economics. Actions, habits, and laws, he said,

[produce] not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

The good economist, he said, “takes into account both the effect that can be seen and those effects that must be foreseen.”

So it is with the US Ex-Im bank.

The independent federal agency helps foreign firms finance the purchase of American-made products. They do this by selling insurance to these foreign purchasers, by directly loaning them money, and by guaranteeing loans that others like Goldman Sachs make to these firms.

Ex-Im’s activities produce some seen benefits and these are widely touted by the bank and it’s boosters, such as the National Association of Manufacturers. These seen benefits are:

The gains to foreign purchasers

Since most foreign purchasers are sub-prime borrowers (what could go wrong, right?), the bank’s assistance allows them to obtain credit that private lenders would otherwise be unwilling to extend. At least in the short run, this helps these foreign purchasers.

The gains to U.S. manufacturers

Ex-Im’s loans, loan guarantees and insurance all increase demand for some domestic manufacturers’ products. This allows them to sell more stuff and to sell it at higher prices than they otherwise would. The bank boasts that, on average, “87% of transactions benefit small business exporters of U.S.-made goods and services.” Note the use of the words “transactions” and “small.” The bank is slicing the data here in a way that isn’t entirely honest. More on which below.

But as Bastiat would tell us, these seen benefits are less than half the story. There are also a host of less-conspicuous effects, and all of them are bad. These include:

Excessive risk

Rational lenders are unwilling to finance risky bets unless they are compensated with higher rates of return. These higher interest rates, in turn, make risky borrowers think twice about undertaking bad investments. This is a feature of a well-functioning financial system, not a bug.

Like all goods, capital is scarce and this feature helps ensure it isn’t wasted, steering it to the projects where it can do the most good for people. Ex-Im’s activities, on the other hand, steer capital—at artificially low interest rates—to sub-prime borrowers so they can buy big, expensive products. This is bad for the world economy because it misallocates capital. But in the long run it’s bad for many of the borrowers themselves because it encourages them to take on risks they can ill-afford (which is why I hedged above when I said they gain “in the short run”). Another great French economist, Veronique de Rugy, highlighted this fact in a recent post. As she points out, this isn’t just a hypothetical concern:

In the 1990s, the Ex-Im Bank was so excited to “support” the people of the Republic of Nauru by extending financing assistance to Air Nauru to purchase some, you guessed it, Boeings. When Air Nauru defaulted in 2002, the Ex-Im Bank seized Nauru’s only jet straight off of the runway — leaving the country’s athletes stranded on the tarmac after the Micronesian Games.

Higher prices for manufactured products

Next consider the unseen effect on domestic purchasers. Like Air Nauru, domestic airlines such as Delta, United, Southwest, and dozens of others also buy Boeing aircraft. Unlike Air Nauru, these firms don’t receive loan subsidies. This hurts all of them once, and some of them twice.

First, the international carriers among this group like Delta lose market share to Ex-Im-privileged firms like Korean Air and Emirates Air. This explains why Delta has filed a lawsuit against Ex-Im.

Second, all US carriers—even those like Southwest that only serve the US market—end up paying higher prices for planes because Ex-Im privileges increase the demand for, and therefore the price of, airplanes. As Vero notes in this piece, this has many air carriers worried about a jet plane bubble. Simple economics, of course, predicts that some of this cost will be passed on to consumers in the form of higher ticket prices.

Privileges for banks

Presumably, many of the legislators who routinely vote to reauthorize Ex-Im do so because they want to subsidize domestic manufacturers. Unfortunately, the laws of economics dictate that the actual beneficiaries of a subsidy need not be the intended beneficiaries.

In the case of Ex-Im, a large chunk of the benefit is captured by privileged banks instead of by manufacturers. Thanks to Ex-Im’s loan guarantees, banks are able to make loans to foreign buyers while unloading most of the risk. This is yet one more way in which banks, “privatize gains and socialize losses” (to borrow a phrase used by Nobelist Joseph Stiglitz at an Occupy Wall Street rally).

This privilege sits on top of a pile of other privileges. The IMF recently estimated that in most years the biggest of these privileges—the too big to fail subsidy—is larger than bank profits!

Few gain at the expense of the many

Consider, again, the bank’s assertion that 87 percent of its “transactions” benefit “small business” exporters. Why focus on transactions? Wouldn’t it be more transparent to focus on the size of these transactions? When you break it down this way, as Vero does in this piece, you see that 81 percent of the value of Ex-Im assistance goes to “big businesses” as the bank defines them.

And just how do they define big and small business? Answer: not in the same way others like the Small Business Administration do. Ex-Im’s definition of “small” manufacturers and wholesalers is three times larger (by number of employees) than the SBA’s definition and it includes firms with revenues as high as $21.5 million a year.

A host of pathologies

As I emphasize in the Pathology of Privilege, these favors to a select few domestic manufactures and banks come with a host of problems. In short, privilege “misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.”

But Ex-Im and its beneficiaries don’t want you to see that.

What are the best arguments against film subsidies?

The Academy Awards are nearly upon us, and that means long-winded acceptance speeches from actors and directors, filled with thanks for all the people who have helped them along the way. Listen closely to those speeches. Because they should really be thanking you.

That’s because each of the nine films up for Best Picture this year received some sort of government-granted privilege at your expense. “Captain Phillips,” for example, got a $300,000 grant from Virginia taxpayers, while the “Wolf of Wall Street” got to skip out on some $30 million in New York taxes.

And so, in the spirit of the Oscars, I now present my own awards for the best arguments against these privileges.

That’s me, writing at US News’s Economic Intelligence blog. Click here to read on.

Farm bill replaces conspicuous subsidies with inconspicuous subsidies

From consumers and taxpayers, the farm bill taketh. But to economics teachers, it continues to giveth.

The latest lesson comes courtesy of Ailsa Chang of NPR:

Also getting criticism is the newly-reformed crop insurance program. Now the idea was to protect farmers during bad seasons. The new bill expands that program with money saved from ending a system of direct cash payments to farmers. These are payments farmers would get regardless of their actual profits or even if they planted any crops. The payments amounted to about $5 billion a year. Democrat Debbie Stabenow who chairs the Sen. Agriculture Committee says now farmers will have to first incur losses before they get paid.

“With crop insurance, farmers don’t get a check. They get a bill. They may pay tens of thousands of dollars in premiums and never get a check in a year.”

But critics say farmers are just getting subsidized in a different way.

Ms. Chang is absolutely right to call crop insurance a subsidy in disguise.

Think of it this way:

Imagine that you make donuts and that in order for you to make donuts, you need to buy sprinkles. Now imagine that the government tells you that they will pick up 60 percent of your sprinkle bill. Yes, you still get a bill for sprinkles, but it is a much smaller bill than you would otherwise get. A normal person would call that a subsidy. Similarly, it only seems reasonable to say that when the government picks up 62 percent of a farmer’s insurance premium bill, it offers him (and his insurer!) a generous subsidy.

In many respects, however, crop insurance premium subsidies are worse than donut sprinkle subsidies because they encourage risk; they incentivize farmers to plant crops in flood or drought-prone fields. This is a lesson in moral hazard.

It’s also a lesson in political economy. Why are farm bill authors phasing out direct payments in favor of insurance subsidies and other complicated schemes like the “shallow loss” subsidy program that Professor Vincent Smith writes about? The answer is that direct payments are too conspicuous.

Nobel Prize winning economist Douglass North explained the logic in this piece from 1990:

[T]ransfer payments aside, unabashed redistribution is rare precisely because of its transparency. Farm price support bills in the US policy that simply paid the farmer not to produce never succeeded for just the reason that they were too transparent. And most legislation is not of this type. In most legislation redistribution is either concealed or a by-product of other objectives. In either case, not even the bill’s author may know all the consequences; much less the constituents.

 

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.

9 Farm Bill Figures

In my last post, I made the case that the farm bill (which has now emerged from conference committee and just passed the House) makes an excellent teaching tool.

Many students, of course, are visual learners. So I thought I might suggest a few farm bill figures.

Let’s begin with farm subsidy outlays. These are the most conspicuous privileges afforded farmers. As Veronique de Rugy’s figure below shows, these were around $13 billion per year in the late ‘90s, then surged up to $28 billion in 2000, then settled into annual levels that were about twice their pre-surge levels after that (readers of Robert Higgs will recognize this as a “ratchet” pattern in government growth).

farm-subsidies-chart-original (Click on any image in this post to enlarge it)

The last bar in Vero’s chart shows projected subsidies of about $29 billion in 2014. Another of Vero’s charts, however, suggests that this figure may be optimistic. The chart below shows projected and actual farm bill spending for the last couple farm bills (note: these figures include the entire bill not just subsidies, which is why the numbers are so much larger than those in the previous chart). 

farm-bills-cbo-score-chart-1000

Though subsidies are the most conspicuous privilege afforded to farmers they are by no means the only or even the most important. In addition to cash outlays, farmers also benefit from an assortment of trade barriers (some of which have gotten us into trouble with the WTO), various marketing programs, and artificial price supports. My chart from last week shows how active farm assistance programs have grown over the years (along with farmer incomes):

The chart below by Vero shows how one of these price support programs drives up the price of sugar:

sugar-subsidies-original

As I write in my Mercatus on Policy piece: 

This might seem trivial, but sugar isn’t the only item that is more expensive because of agricultural price supports. The House version of the farm bill imposes artificial price floors on wheat, corn, grain sorghum, barley, oats, long and medium grain rice, soybeans, oilseeds, peanuts, dry peas, lentils, chickpeas, sugar, and dairy products.

Farm privileges are often justified on the common assumption that farming is unprofitable. But this isn’t so. The figure below, taken from Vincent Smith’s paper on the 2013 bill, shows that both median and mean farm household income has exceeded median and mean US household income for more than a decade. Today, the average farm household makes 53 percent more than the average US household:

Farm income

Farm supports are also often justified on the basis that farming is uniquely risky. As Smith explains, though, the business failure rate of the typical American business is 14 times greater than the failure rate of the typical farm. Moreover, as the figure below from his report demonstrates, the agriculture sector’s debt-to-asset ratio is lower than that of other sectors and has been falling for two decades:

Though the average farm has done quite well, it is not the average farm that receives privileges. As demonstrated by Smith’s chart below, since 1995, 83 percent of subsidy payments have flowed to the largest 15 percent of farms:

As I put it in my piece, “Given that these subsidies and price supports distort free market signals and transfer wealth from the relatively poor to the relatively wealthy, one would think they would face bipartisan opposition.” Why, then, do they persist?

This chart by Vero, showing annual lobbying expenditures by the sugar industry is one explanation:

Finally, this chart from my piece shows that political donations tend to be concentrated on those who actually write the bill:

Can Democrats and Republicans Agree on Anything? Yes! (At least in principle)

Wouldn’t it be nice if we could look back one year from now and say that 2014 was the year in which Democrats and Republicans discovered substantial areas of ideological common ground? We’d laud them for putting aside their partisan prejudices, for simultaneously advancing economic freedom and social justice and for turning their collective backs on special interests in order to serve the common good.

With the parties so far apart on so many issues, you might think that no such common ground exists. But it does. It lies in the sugar beet fields of Florida and in the dairy farms of Wisconsin. This untrod common ground is U.S. farm policy and it is overripe for reform.

Valley Farm, West WrattingThat is me, writing at the US News Economic Intelligence blog.

I have a short new piece on farm policy called Ending Farm Subsidies: Unplowed Common Ground.

Pension reform from California to Tennessee

Earlier this month Bay Area Rapid Transit (BART) workers went on their second strike of the year. With public transport dysfunctional for four days, area residents were not necessarily sympathetic to the workers’ complaints, according to The Economist. The incident only drew attention to the fact that BART’s workers weren’t contributing to their pensions.

Under the new collective bargaining agreement employees will contribute to their pensions, and increase the amount they pay for health care benefits to $129/month.  The growing cost of public pensions, wages and benefits on city budgets is a real matter for mayors who must struggle to contain rapidly rising costs to pay for retiree benefits. San Jose’s mayor, Chuck Reed has led the effort in California to institute pension reforms via a ballot measure that would give city workers a choice between reduced benefits or bigger contributions, known as the Pension Reform Act of 2014. Reed is actively seeking the support of California’s public sector unions for the measure that would give local authorities some flexibility to contain costs. Pension costs are presenting new threats for many California governments. Moody’s is scrutinizing 30 cities for possible downgrades based on their more complete measurement of the economic liability presented by pension plans.  In spite of this dire warning, CalPERS has sent municipalities a strong message to struggling and bankrupt cities: pay your contributions, or else.

Other states and cities that are looking to overhaul how benefits are provided to employees include Memphis, Tennessee which faces a reported unfunded liability of $642 million and a funding ratio of 74.4%. This is using a discount rate of 7.5 percent.  I calculate Memphis’ unfunded liability is approximately $3.4 billion on a risk-free basis, leaving the plan only 35% funded.

The options being discussed by the Memphis government include moving new hires to a hybrid plan, a cash balance plan, or a defined contribution plan. Which of these presents the best option for employees, governments and Memphis residents?

I would suggest the following principles be used to guide pension reform: a) economic accounting, b) shift the funding risk away from government, c) offer workers – both current workers and future hires – the option to determine their own retirement course and to choose from a menu of options that includes a DC plan or an annuity – managed by an outside firm or some combination.

The idea should be to eliminate the ever-present incentive to turn employee retirement savings into a budgetary shell-game for governments. Public sector pensions in US state and local governments have been made uncertain under flawed accounting and high-risk investing. As long as pensions are regarded as malleable for accounting purposes – either through discount rate assumptions, re-amortization games, asset smoothing, dual-purpose asset investments, or short-sighted thinking – employee benefits are at risk for underfunding. A defined contribution plan, or a privately managed annuity avoids this temptation by putting the employer on the hook annually to make the full contribution to an employee’s retirement savings.