Oregon Election Results

With the passage of Measure 49 it seems to me that Oregon voters have learned a lesson in externalities and public good and have found that individual rights should not always be advanced at the expense of social objectives. That, in fact, in a market based economy the government has a large role to play to balance the needs of society as a whole and the rights of individuals. It is never an easy line to draw and voters spoke loudly when Measure 37 passed that government had exercised too little restraint. But they also spoke loudly yesterday when they decided that Measure 37 constrained government too much. Perhaps we have found balance, only time will tell. I hope, though, that this can serve as a moment in which most Oregonians can learn to appreciate the delicate balancing act that a democratic government must perform in a market-based economy.

Measure 50 is, for me as an amateur spectator of politics, an extremely interesting litmus test. I have made it clear in an earlier post that I disliked the populist twist of Measure 50 - a sort-of Rube Goldberg device to make it appealing by punishing bad behavior to help kids. I applaud both goals however (trying to reduce smoking and providing health care for uninsured kids) as I think both smoiking and uninsured kids impose heavy costs on society that are born by all of us. However I cannot lament the failure of Measure 50, it just smacked too much of politics and populism. I am also afraid of special taxes that have earmarks, as these do not allow government the flexibility to respond to changing conditions. The real answer is wholesale tax reform in Oregon, a great resetting of government fiscal policy and powers to stop the madness of measure-driven politics and return to representative democracy. I am saddened that the governor has backed away from this just because revenues are up...but I'll leave that for another post.

Is Voting on Taxes for Specific Services a Good Idea?

In addition to voting on Measure 49 and Measure 50, I am also being asked to vote on a measure, 02-64, that would levy $0.90 per assessed $1,000 to support services in Benton County, most notably the County Sheriff's department and justice system. Last year, Corvallis residents were asked to support a levy to support local schools. Measure 50 is, of course, a special tax on cigarettes to support children's health care access. And so, time and again, we see voters being asked to support a tax for a specific public service or infrastructure project.

Some celebrate this type of measure-driven public policy arguing that it gives voters more control over what they want government to do. Economics tell us, however, that this is a poor way to provide public goods - goods that have at least partial non-excludability and non-diminishability. As an example of public goods consider police protection: the fact that I enjoy police protection does not exclude any other person from enjoying it and the fact that I may need police assistance from time to time does not in any substantial way diminish what is available to others. This is true of other services (fire, ambulance, street cleaning, etc.) and infrastructure (roads, bridges, libraries, etc.). The reason that voting for the funding of specific government functions is a poor way to do things can be easily seen in this simple example I have been teaching undergrads for 10 years. The story goes like this: suppose a town beside a river is considering building a bridge over the river. There are only five residents in this town and they each would value having that bridge differently. Suppose their own private valuations for having the bridge are: $800, $600, $300, $200, $100. In other words one person would be willing to pay up to $800 to have the bridge built, the next $600, etc. Note that the total benefit to the town of a bridge is $2000. Suppose that the bridge would cost $1600 to construct. Socially then constructing the bridge would lead to $400 in surplus. But will it be built if an equal tax were to be voted on? No. The proposed tax would be $320 and only the top two valuation residerns would vote yes. The tax would fail a popular vote 3 to 2. What about asking for voluntary contributions? It is likely that each individual would contribute little, hoping that others will contribute more. So, in the end the community is likely to loose the $400 in surplus a bridge would provide. What if the government had a general fund from which it could draw the $1600? Given the $400 surplus, this would be an easy choice to make - build the bridge, everyone is better off.

Now there are ways to make the tax progressive that might help. (But note that I have said nothing about income or wealth - just valuation: so the $800 person might be the poorest but work directly across the river and without the bridge has to travel 50 miles each day) Sill there is a good chance that socially beneficial projects or services will not be provided. A bigger problem arises in the from of free-riders. Since I can enjoy a public good if you pay for it, what is best for me is to enjoy it without contributing (like OPB for example). It is these same motivations that provides the rationale for government provided services in the first place. Allowing voters to decide on them al-a-carte style makes no sense: it makes it likely that public goods will be underprovided. This is why a goverment staffed with skilled beaureaucrats is the model we use - it allows us to escape many of the problems of free market provision of public goods.

Oregon Econ Blog Comments & M50

This blog will be exactly one month old tomorrow. I was nervous about starting it - I spent six years as a professor in a state, Colorado, where the political climate was so toxic that even attempting a neutral blog could invite a barrage of trouble. So it was with much hesitation that I began this one. Part of my goal was expository, especially as a way to get my students thinking beyond the classroom. Part of it was to get people discussing policy in Oregon. I make no claim to have some monopoly on the truth and I am acutely aware of the limits of economic thinking. Nevertheless, I want to push economic arguments and have people dissect and push back with other economic arguments or arguments from other perspectives. However, I didn't really think the reality would live up to my aspirations.

I was wrong.

Though I have only had a few commenters on this blog so far, the comments have been better than good - they have been excellent. Every single comment so far has made me stop and think hard about the comment itself and my original argument. For that I thank all of you. I now have renewed energy and faith in this endeavor I am excited to get more students involved and to have more commenters from around the state sharing their perspectives with me, challenging me and the economic way of thinking, and discussing policy.

Two recent comments about my post on M50 really struck me as so good that I decided to reply in this post rather than in the comments.

First, 'keith' writes:

I don't understand, exactly, how smokers cost the state more than non-smokers -- certainly not the $11. I understand that smoking is associated with illness and a shorter life-span. By contrast, non-smoking is associated with a longer life-span; ending, of course, in illness at some point. I don't mean to be crude, but everybody eventually gets ill and dies; and being sick is expensive, and some of those costs are borne by the state. If smokers' illnesses are more expensive than others, I would think that at least some of these costs would be defrayed by the fact that they are likely to pull for a shorter time on social security, retirement insurance, and in general the social expenses of living old.

This is such an excellent point, I had to mull it over for a long time and I still do not have a good reply. My first response was, 'well yes, but smoking has direct costs associated with it that are not reflected in the price, living well does not.' But then I played devils advocate: if eating whole foods, leafy greens and exercising make you live longer, and if living longer is costly to society (and I agree it is in terms of health care for the aged) then why don't we impose Pigouvian taxes on whole grain bread, lettuce and health club memberships? From a pure economics perspective the answer is that the two are equivalent. A second answer was one of welfare economics: it is socially optimal to have people live as long as possible for this allows the highest 'utility' possible for a society (apologies for the econ-speak, but I have to indoctrinate you all in little doses...). Smoking lowers societal utility by shortening life-spans and is costly on top of that. This argument has some merit but largely fails by the counter argument that smokers are engaging in an activity of which personal costs are well known and yet since they do it, they must be engaging in a utility maximizing behavior including the lost utility from the extra years not lived (N.B. see addiction not below). So finally, I have only one good response (but no good data to back it up): it is very likely that living a healthy and active lifestyle saves as much in societal costs during the prime years as it is costly during the extended old years. Playing the devil's advocate again, maybe you could make an argument that nicotine makes people so extra-productive in their working years, that it compensates the extra costs from health complications in later years - but I personally doubt this very much (but maybe I have stumbles on an interesting research question: do countries that have a high incidence of smokers have higher overall productivity than low smoking incidence countries?).

Second, 'Chris Lowe' asks a more philosophical question about economic thinking:

Your discussion of externalities is interesting but the application to smoking reflects one problem I have with marginal utility economics at times. To me the greatest negative externality about smoking is the premature loss of human lives, not reduced to a balance sheet of income, productivity and costs, but persons and all the human ties that envelop them, cutting of which harms others. I've felt such smoking costs myself, observed it in others, and fear it for certain friends.

I have an interesting (and I'm going to guess very unsatisfactory) answer to this, again from an economist's perspective: I agree that there are deep emotional and I guess I'll say 'human' costs associated with smoking, especially for those who are close to someone who has smoked and then is stricken with a debilitating illness. But economists would call this an additional social 'cost' associated with smoking and as such should be included in the Pigouvian tax calculation. Of course it is impossible to measure (the thought experiment would be for an individual: how much would I be willing to pay to not have this person I care about stricken...). But the thing is, these costs are, I believe, internalized by smokers themselves, meaning a tax is unnecessary. To put this in personal terms, my father has smoked all my life and I worry constantly about what this will mean in the future in terms of my own pain and suffering (as well as his, of course). If I could put that into monetary terms (I can't) and if that could be reflected in the price of cigarettes through a tax, then his decision to smoke would be a decision based on how much enjoyment he gets from smoking versus the cost of the cigarettes plus the cost of my suffering. But of course he (I hope) already internalizes how much his loved ones will suffer from the increased likelihood of serious illness when he decides to buy that next pack of cigarettes - so the tax is, in a sense, there.

As a final note: there is a whole economic literature on addiction and 'time-inconsistent preferences' that argues that people start smoking making rational marginal benefit versus marginal cost calculations but fail to understand or fully internalize the nature of addiction (do any of us really know what it is like until you are there?). And so ex ante rational choices become quite irrational ex post. If this is true of many smokers than Pigouvian taxes do an even better job of leading to a socially optimal level of smoking.

Election Special: Measure 50

The November special election is coming up in Oregon and in it Oregonians are being asked to vote on two measures, 49 and 50. 49 amends measure 37 and is something I will address in the coming days. Today I am going to give an economist’s perspective on Measure 50. Measure 50, if passed, would increase the state tax on tobacco and dedicates the new revenue to provide affordable health care for uninsured children in the state. Measure 50 brings up a host of economic questions, questions to which the answers are not at all clear. As a result, and I’ll say this at the outset, I remain conflicted about this bill.

Let’s begin by outlining the economic issues that I see as pertinent to this measure. First is the nature and size of the externality that comes with smoking. Second is the price elasticity of demand for cigarettes. Finally, and complicatedly, is the issue of the uninsured in society and what should be done. Now I’ll address these in order.

Externalities are the costs and benefits of an activity that are not born or enjoyed by the person (group, agent, firm, etc.) engaging in the activity. When externalities are costly we call these negative externalities and when they are beneficial, we call them positive externalities. To give an example of both, I can relate a story from my graduate student years. When I was in the first year of my Ph.D. studies at Cornell (the first year in economics programs are notoriously intense) I lived in an apartment house directly above a couple who were physics Ph.D. students. (In other words, wicked smart and slightly deranged) Anyway, the woman was an accomplished violinist and many evenings as I was studying furiously, the wonderful sounds of classical music from her violin could be heard clearly in my apartment. It was beautiful and soothing and if there had been such a market, I would have gladly paid her some small sum to keep it up longer. Her music, therefore, was a positive externality something that imparted benefits to non-participants and for which there was no remuneration. In the absence of remuneration she played less music than was socially optimal. In stark contrast her highly erratic boyfriend would sometimes, inexplicably, late at night turn his stereo up to eleven and blast the most god awful goth rock so loud you would have though it was coming from my own stereo. His was most definitely a negative externality and one which he did not have to pay the cost of my discomfort (save for the fact that I screamed at him once – and that was the last time it happened). Thus, since he did not have to pay the price of others discomfort, he played his music too loud and too often relative to the socially optimal amount. I make this long digression to point out that externalities are not just factories belching toxic smoke, but are often individuals undertaking some activity that imposes a cost on others. (By the way, as I write this, an OSU groundskeeper is blowing leaves around under my window with the loudest leaf blower ever conceived)

So, finally to the point: Cigarette smoking produces two main negative externalities. The first is the smoke that is potentially harmful to non-smokers in the vicinity. The second is the smoking related illnesses whose costs are often partially (or fully) covered by the state and federal government. These are both costs that do not accrue fully to the persons partaking in the activity. So, for this reason I have absolutely no sympathy for ‘smokers rights’ arguments, just as I have no sympathy for those that would argue liberty in support of no helmet laws, for example. Prove that you are fully self-insured and I’m happy to have people do all of the life threatening things they want. But if your going to do something that potentially imposes a cost on me and I (or my agent, the state) have a right to intercede. Given that these externalities exist, there is a very good economic argument for state intervention. The state regulates tobacco and taxes it. In fact there is even a theory of optimal taxation given externalities, it is called Pigouvian Taxes. The idea is pretty simple. Suppose we knew that each pack of cigarette imposed a sum total of $1 in external costs. By taxing cigarettes at $1 a pack, we would align the private costs of cigarette consumption with the social costs of cigarette consumption and the result of the market would be efficiency. In addition, the revenue raised from this tax can be used to defray the costs of the harmful effects of the activity.

But the rub is, of course, that we do not know exactly what these costs are. The “Economic Fairness Coalition of Our Oregon” (an advocacy group the supports the measure) claims that, all tolled, the true ‘cost’ of a pack of cigarettes is $11.16. Suppose this is true, then the proposed tax is wildly inadequate. What if it is a lot less? Is the tax potentially too high? I think common sense dictates that the $11.16 figure is probably pretty extreme, but that (given the rising costs of health care) $2.025 that is being proposed is probably not enough to make it truly in line with actual costs. But true evidence is so hard to come by that any attempt at a true Pigouvian tax is really a shot in the dark. Still, on this score I would have to score one for the measure, I think it doubtful it is too high and it is a step in the right direction. Oh and one little side note that observant readers will notice: the real cost of an individuals smoking depends on many things, so the cost we are looking for is an average and thus some will pay ‘too much’ and some ‘too little’ if a Pigouvian tax were enacted.

The next issue is how much revenue will be raised by an increase in taxes. Yes, the per-pack tax will rise, but the number of packs consumed will thus fall. Consumers will stop smoking or smoke less. They will switch to substitutes (nicotine gum?). They may start purchasing more cigarettes when on vacation or in duty-free shops. Whatever the cause, to estimate the reduction in sales of packs of cigs in Oregon, we need to know the price elasticity of demand for cigarettes. This is simply, in percentage terms, by how much the quantity of cigarette packs will fall, given a 1% rise in price. I looked the economics literature and, surprise, surprise, estimates vary widely. I would say that about -0.50 overall is about average (or even a bit overstated) and it is a bit higher for youngsters. So this means we should see about a 1% decline in cigarette consumption for a 2% raise in price. Since Oregon’s tax increase would raise prices roughly 20%, we should see a 10% drop in sales. So revenues should increase by roughly 10% (though equilibrium price should settle even higher) of which the states share has increased 71% so tax revenues could be expected to increase by about 61%. This looks like about an extra $162 million. So my extremely crude back-of-the-envelope calculations are pretty close to what I have seen is the state’s projections (though I am not sure why this is supposed to rise dramatically after the first biennium as they predict).

Finally, the last issue is a population without adequate health insurance. This is not really related to smoking and is probably the reason I have so much trouble with this bill. Perhaps I am hopelessly naïve, but this bill is pure populism: let’s tax smokers (boo) and give kids health insurance (yeay). If smoking and its affects are the point of concern than create policy that deals with this. Use tax revenues to support health care for uninsured sufferers of emphysema and lung cancer. If uninsured children are a concern than create a new plan that is funded from general revenues. This creating and ear marking of specific taxes is troubling to me. I don’t like the ends-justify-the-means arguments and I don’t like it in policy either. ‘Sin’ taxes are a political expedient, but are not necessarily good policy (see the beer tax debate from the last legislative session).

But in the end I’ll probably vote for it. What the hell? I don’t smoke!