Economist's Notebook: On Ronald Coase and Joe Rose

Nobel prize winning economics Ronald Coase passed away recently leading to many eulogies and explanations of his work and, in particular, his eponymous theorem.  I did my part as well.  I have always enjoyed teaching the Coase theorem because it is not obvious until you really think about it and it usually stirs up passions, especially if you use environmental pollution as the example.  But there are many others and one came to mind the other day when reading Joseph Rose's column in The Oregonian about who is at fault when a door opens up an whacks a car or bicyclist (or even, I suppose, a very fast runner).  

Joe explains that it is the responsibility of the opener of the door to avoid whacking people.  This makes sense and is probably uncontroversial, but for me the point is how property rights more or less solves the whacking problem and how it didn't really matter to whom you gave the right - this is what the Coase theorem tells us.  You see you could have given door openers the right to adequate space to open doors and held the bicyclists and other cars at fault for not yielding enough space to do so safely and the same 'efficient' solution would have resulted: folks would be careful not to get too close and no whacking would be done. 

This is just as efficient a solution as giving the cars and bicyclists the right to pass by closely and not be whacked.  Either way the important thing for efficient outcomes is that everyone knows how the property rights are assigned and acts accordingly.  No matter to whom the right was given, efficiency would result from the clear assignment of rights.   

Which is why it is good to have places like the Oregonian and reporters like Joe Rose to make sure people know to whom the right belongs so that efficiency can result.  For it only takes on driver who thinks that they have the right to open their door whenever they want for someone to get whacked.  

NB: This is also why I hate the unsigned intersection which are a plague in Portland. 

Fred Thompson: Cooperating with the IRS to Collect Delinquent and Liquidated Debt

Another dispatch from Fred Thompson:

Yesterday we hosted a National Association of State Auditors, Controllers, and Treasurers webinar on the IRS’ Treasury Offset Program (TOP) at Willamette University for interested state officials. TOP intercepts federal tax refunds and other payments to delinquent debtors prior to their disbursement on behalf of state governments and provides access to the Treasury’s Do Not Pay program. This year TOP has recovered nearly $7 billion in delinquent child support obligations, supplemental nutrition assistance program (SNAP) debts, income tax debts, unemployment insurance compensation debts, and other federal and state debts, including penalties and fines due to the state courts.

Oregon participates in this program, although currently only to collect child-support and personal income tax (PIT) arrears. In FY 2012, Oregon recovered $43.8 million for these programs ($15 million in PIT delinquencies).

Nevertheless, there is a lot more that we could do. Currently, Oregon sits on a backlog of nearly $4 billion in delinquent and liquidated debt. Moreover, this stock is growing at a rate of about $300 million per annum. If we had done no more than collect our fair share of recoveries, we would have grabbed an additional $30 million.

In addition, the state could potentially take advantage of TOP to collect hundreds of millions of dollars in PIT and business taxes that are evaded or avoided when taxpayers file incorrectly or fail to file, especially from those who choose to file in states other than Oregon. Oregon is a big tax exporter (net). Consequently, its taxpayers pay a lot more taxes than Oregon collects, mostly to states with lower PIT and business tax rates. Much of this borderline tax evasion could be preempted if the state had the capacity to monitor and analyze income flows promptly and more accurately.

More than anything else, what’s needed here are information system upgrades at Oregon’s Department of Revenue. As noted in a recent blog, those are on their way.

Indeed, these upgrades are needed to fully participate in TOP. A case in point, where the social security number (SSN) or employer identification number (EIN) of a TOP debtor matches the SSN or EIN of a payee, but the names do not match, the state lacks the capacity verify or falsify the match. Consequently, such offsets aren’t pursued. The situation is even more fraught in the case of non-tax delinquencies.

Centralizing the state’s debt portfolio and payment streams would facilitate working with TOP, not only because TOP accepts only one or two points of connection with a state, but also because duplicating the capacities to pursue delinquencies would be very costly. Finding the funds to upgrade the Department of Revenue’s collections capacity took ten years. It make no sense to try to duplicate this capacity for the courts, DHS, etc.

At the same time, nearly everyone agrees that the legal requirements governing collections programs need a second look. Debt collection laws quite properly require that debtors be given notice prior to intercepting funds owed to them: 60 days notice before a tax refund may be offset, 30 days notice for most other debt collection actions. However, the requirement that notice be given by certified mail seems entirely obsolete. That Federal law requires the IRS to charge a fee to cover its costs of running the TOP program, but does not permit it to pay a fee to the states when the state offsets a payment to collect a federal debt, also appears to be open to question. Possibly these examples are only the tip of the iceberg.

Are People the Problem or the Solution?

The debate about humans and the self-destructive deterioration of the environment in which they inhabit is one that has continued since Thomas Malthus started worrying about it in the 18th century.  Malthus famously predicted that humans would quickly overwhelm the carrying capacity of the earth.  Then we had the Population Bomb in which Paul Ehrlich predicted, again, that population increases would soon lead to the end of humanity.  Of course the Green Revolution soon followed the population bomb and completely discredited it - not that it hurt Ehrlich's reputation at all, it seems one is always safe predicting the worst, because every one is happy and ready to forgive if it does not come to pass.

And then we had this ridiculous tautology: that humans themselves were more impactful on the environment than any one individual action.  (This is tautological because humans can be thought of as a collection of actions and thus the sum is greater than the parts).  This is a particularly pessimistic view of humans and the view that humans represent a problem and not a solution to me is dangerous. As birthrates and poverty are closely related, environmental scolds in rich countries are in danger of blaming the world's poor for the world's environmental problems.

Anyway this is all a long lead in to this interesting and (in my mind) quite correct essay on how to think about humans and their place on earth in The New York Times by Earl Ellis. Here is an excerpt:

The science of human sustenance is inherently a social science. Neither physics nor chemistry nor even biology is adequate to understand how it has been possible for one species to reshape both its own future and the destiny of an entire planet. This is the science of the Anthropocene. The idea that humans must live within the natural environmental limits of our planet denies the realities of our entire history, and most likely the future. Humans are niche creators. We transform ecosystems to sustain ourselves. This is what we do and have always done. Our planet’s human-carrying capacity emerges from the capabilities of our social systems and our technologies more than from any environmental limits. 

Two hundred thousand years ago we started down this path. The planet will never be the same. It is time for all of us to wake up to the limits we really face: the social and technological systems that sustain us need improvement. 

There is no environmental reason for people to go hungry now or in the future. There is no need to use any more land to sustain humanity — increasing land productivity using existing technologies can boost global supplies and even leave more land for nature — a goal that is both more popular and more possible than ever. 

The only limits to creating a planet that future generations will be proud of are our imaginations and our social systems. In moving toward a better Anthropocene, the environment will be what we make it.

I think this is quite correct. And as I think about the impact of a new baby on the earth I prefer to think of the possibilities: to invent the next sustainable energy technology, to help solve world poverty, be a leader and lead people forward to a better future. I reject the pessimistic view of humans as only resource-suckers leading us to our doom. Our future is us and we need to figure out how harness the power of human potential rather than dismiss the world's poor as an overly reproductive cause of our problems rather than a symptom of a system that we have created.

Oregon Adds 4,500 Jobs but Unemployment Rate Climbs to 8.1%

Oregon's jobs picture keeps playing the same old song.  Decent jobs growth, but not great.  Unemployment stuck at an unacceptably high rate, though not as bad as the worst days of the recession.  And Oregon's economy showing signs of life but not really springing back to full health.  

So the long slog continues but at least things are still in the positive direction.

Well, I suppose we can rejoice that we are now five years since the financial crisis and thus halfway through our lost decade!

The Gilded Age, Redux

From Emmanuel Saez:

Welcome to the roaring 10s!

Economist's Notebook: Specialization vs. Generalization and the Research University Model

This little article in The New York Times on some research by David Figlio and others caught my eye: it essentially claims that non-tenured instructors do a better job teaching introductory-level university courses than do tenured and tenure-track faculty.  There could be many reasons for this and as an economist I am obliged to talk about incentives first.  Instructors have to be more worried about performance in the classroom than to tenured faculty - although I should throw in a note here about the increasing use of merit-pay and promotion to improve the classroom performance of tenured faculty.

Other reasons could be that research takes time and energy away from a professors classroom performance, or that instructors do not teach as difficult a class, who knows?  What interests me is that the mostly likely reason in my mind is due to specialization: instructors that focus on intro classes become extremely good at it thanks to the time and energy they can devote.  They also have time to experiment with new classroom techniques and teach these classes more frequently so there is no depreciation in their skills.

This, of course, points out that the traditional role of a professor at a research university is not how an economist would necessarily design things.  The principle of comparative advantage suggests that the efficient distribution of tasks would have those with a relative advantage in research do mostly research, those with a relative advantage in teaching do more teaching and so on.  The ideal of the tenured research faculty is one who devotes about half their time to research and half their tie to teaching - the very thing David Ricardo suggested was a bad idea!

But this makes two big assumptions: one, that the goal is efficiency; and two, that there are no spillovers - that having to do research does not help teaching and vice versa.  Even if you accept the efficiency goal, I believe strongly that in some classes this latter statement is false.  Perhaps not as much in intro classes though, which would help explain the Figlio, et. al., result.  But I for one have become a better economist from having to teach and continue to think deeply about very basic economic principles and I think my research experience definitely makes me a better teacher of classes that overlap my research areas (and in a big research university the ideal is that professors teach within their research areas) but also in the more intro and intermediate level classes as well.

Despite this, it does make me wonder whether the new model, that almost all universities seem to have gone to, where each department includes a team of instructors working along side the research faculty, isn't perhaps a better model.   Despite it being the subject of much derision, perhaps it has been better all along?

Jobs: National, Local and ... Porno?

The US gained 169,000 jobs in August, something of a disappointment for those convinced that the economy was picking up steam and who expected a larger number.  This is more than the natural growth of the labor force, but not a lot more and is not significantly reducing the unemployment rate.  The rate fell to 7.3% but that drop was due to labor force drop outs as much as new jobs.

The New York Times has a nice discussion about what the Fed does now.  The common wisdom was that the Fed would wind down its stimulus efforts as the economy appeared to be transitioning to full on recovery.  Again, reports of the recessions demise are somewhat exaggerated.  What the Fed does next is a interesting question.  Those like Paul Krugman who have felt the Fed is doing too little in the face of this liquidity trap will no doubt champion even new efforts to stimulate the economy.  Those worried about sparking an inflationary episode appear to be a little off base given that the inflation we really worry about is the inflation that starts working through the labor market.

On the local scene, Mike Rogoway has a nice piece on how high-tech employment is leading the way in Oregon's job market recovery:

Mark McMulen sounds the note of caution that though this is great news there is an element of risk as many of these jobs can be a bit volatile and many are from companies that have outposts in Oregon, not HQ which makes their connection a bit tenuous.

Finally, an article from Britain's Telegraph which cheekily makes the suggestion that the 2 week work stoppage in California's massive porn industry could have caused the unemployment rate drop due to those workers temporarily leaving the labor force.

Have a good weekend.

Ronald Coase

Photo Credit: Steve Kagan for The New York Times

Nobel Prize-winning economist Ronald H. Coase passed away at the age of 102 on Monday.  As usual, the New York Times does an excellent job with his obituary in explaining why, even among Nobel prize winners, his influence is larger than most.

[As an aside, obituaries for persons who managed to reach triple digits are interesting things to encounter for there is an absence of the usual melancholy of a life cut short - rather there is a feeling of satisfaction that this was a life lived to the fullest extent, but I digress]

Most economics students know his name because of the 'Coase Theorem' which explains how well-defined property rights leads to market solutions to externalities that are efficient. This idea is very simple and seemingly obvious once it is explained to you, but of course it is only obvious once it is explained.  This is the way with some of the very best Nobel winning ideas including Akerlof's market for lemons, Nash's equilibrium concept in non-cooperative games, etc.  But what is particularly profound about this idea is the magnitude of its impact among regulators and especially the judiciary. In fact, Coase thought of himself more as a law scholar than an economist.

Fewer people will have heard about his theory of the firm but it is as impactful within economics as is his theorem.  Another simple idea: why do firms do what they do?  For example why do some firms keep R&D and HR and other functions within the firm and others contract them out?  His idea was that it is all about transactions costs.  There are costs to contracting out, it takes time and energy to design and execute a contract, to make sure the outside firm is doing what you want it to and so on.  There are also costs to doing things in house: you have to monitor, manage and add complexity to do so.  The resolution of these tensions, Coase's theory states, explains the limits of the firm.

For a field that is often math-intensive, it is surprisingly often that the simple yet elegant ideas that are the most influential and generally the things that got me and other graduate students the most excited.  Unfortunately, these days, someone like Coase would have a hard time making it in economics which tends to reward technique more than ideas.

Fred Thompson: Taxes Don't Collect Themselves

Fred Thompson checks in again!  

Wednesday morning I attended the Interim Revenue Committee meeting in the Oregon State Capitol. The headline topic was the September economic and revenue forecast presented by Mark McMullen, State Economist, and Josh Lehner of the Department of Administrative Services’ Office of Economic Analysis (they predicted more lackluster growth). But I was there primarily for the update on the Department of Revenue’s (DOR) core-system replacement project, presented by agency director Jim Bucholz, and project manager Eric Smith.

This project, which has been in the works for several years, was finally authorized at the tail end of the legislative session and is scheduled for kickoff in October. Over the next four years, it will replace DOR’s thirty year-old information systems and processes and promises to upgrade DOR’s performance materially. Arguably modern IT systems would use artificial intelligence algorithms to determine how best to process each account and do so on a just-in-time basis, thereby minimizing discrepancies between processing time and cycle time and maximizing collections.

This spring, a group of my students looked very carefully at the DOR’s processing of past-due accounts (so called liquidated and delinquent accounts). They estimated that a one percent reduction in processing cycle time would increase past-due accounts collections by >.5 percent. They observed that obsolete information technology substantially retards the speed and the accuracy with which the DOR identifies failures to file, filing errors, and payment delinquencies, impedes execution of the collections process, and slows decision making almost to a standstill. The current collections process operates like a series of fallible filters. Accounts receivable are processed more or less in their order of arrival to a revenue agent’s (RA) in-basket. Processing follows a series of prescribed steps in which the account moves from RA to RA, often spending far more time awaiting processing than being processed. Only when these steps fail, is the account subjected to additional scrutiny and assigned to the next higher level of collection effort. Paradoxically, these procedures appear to subject the most difficult accounts to the greatest delay. As a result my students concluded that if core systems replacement reduced processing cycle time by only 20 percent, it would pay for itself in seven years (or less) from increased collections alone, which is really quite remarkable given that the project won’t generate substantial operational improvements prior to its completion.

Jim Bucholz and Eric Smith did not make their case for the core-systems replacement project in terms of improved performance. Indeed, they very careful to make no performance-related promises. Instead, they emphasized the need to upgrade (replace) antiquated systems and equipment (COBOL programs and green screens) and sought to reassure the committee that this project would not be Oregon’s next information technology disaster. They noted that they were buying an off-the-shelf system that had been successfully installed in 16 other states for a firm fixed price.

Two issues that did not come up in this forum were DOR’s choice of a contractor and overall performance of the DOR. Frankly, I think they made a pretty canny choice of a contractor. Fast Enterprises is relatively small company, but it is the leading supplier of integrated tax-processing systems to state governments. Its principal competitor, CGI, works with fewer than half as many states and, largely based on word-of-mouth, is growing much more slowly. Moreover, Gen-Tax is Fast Enterprise’s main business; tax, revenue and government collections management is a sideline for CGI.

Both the legislators and most of the folks present at the hearing seemed pleased with the overall job DOR is doing. Mostly this assessment seems to be based on the fact that Oregon spends thirty-to-forty percent less than the average state to collect a dollar of revenue. But this fact probably has very little to do with the DOR’s operational excellence and a lot to do with the state’s tax structure. Unlike most states Oregon relies on a single revenue source, the personal income tax (PIT), which means it needs only one administrative apparatus to collect its revenue. Every tax type requires its own collection organization and every one of those organizations costs money. Moreover, to the extent that our PIT and business taxes are aligned with the U.S. tax system, we can piggy-back on the efforts of the IRS to combat tax evasion and excessive avoidance.

Arguably, however, we carry that virtue to excess, relying on the good people of the state to pay what they owe more or less voluntarily; most do, some don’t. One way to assess the performance of a tax system is to look at the difference between net revenue (revenue less the cost of collection) and potential revenue (given the tax base and rate structure). We call this difference the revenue gap. Oregon’s PIT revenue gap is quite a bit higher than the national average and its business tax gap one of the largest. An additional reason our collection-cost per revenue dollar is low is that we spend less than other states to combat tax evasion and avoidance; consequently, we probably do a poorer job of identifying non-filers and under reporters. This is especially likely where our statutory rates are higher than those of other states or where our tax code deviates from the federal tax code. Each of these factors calls for greater investment in collecting taxes and that investment has been put off for far too long. The core-system replacement project is a timely down payment on what needs to be done.