Fiscal Stimulus

I participated in a discussion on the Oregon economy and the government's fiscal stimulus plan this morning on OPB's "Think Out Loud" program so I thought a post that summarizes my thoughts would be appropriate.

The fiscal stimulus plan being proposed by the federal government is based on good old Keynesian theory that in a temporary down turn in the economy, fiscal policy can have a role in stimulating the economy and lessening the blow. Keynesian theory underwent a withering attack from the rational expectations revolution in macroeconomics which suggested that fiscal policy is ineffective as agents in the economy understand that any fiscal spending today has to be paid back in the future so behaviors will adjust immediately. However, assuming this is true, economies do not adjust immediately to behavioral changes - there is wage and price 'stickiness' - which means that, in the short-run, fiscal policy can still be effective. The key with fiscal policy as opposed to monetary policy is that if it appears that consumer confidence is low and present and future consumer spending is and will be low then firms react my lowering investment and employment and wages suffer - further enhancing the low consumer confidence and spending. This leads to the downward spiral that can enhance and lengthen recessions. Cash transfers to those that are likely to spend it will cause a temporary shock in this cycle which, it is hoped will lead to new investment and job recovery - further stimulating consumption - and lessen the extent of the economic downturn.

So two pertinent questions are: does the current situation look like the one I have described, and what is the catch to such a policy?

First, it is not entirely clear that we are in such a cycle and that this is the appropriate policy response and the main reason I say this is that it is not clear we are seeing the big effect on investment and jobs probably due to the very strong export market thanks to the weak dollar. But it is hard to know exactly as data lag the present. I am weakly in favor of the plan broadly conceived (but I think we could do a lot better targeting benefits to those most likely to spend them) - largely because the risk of a severe downturn is real and recessions hurt the most vulnerable hardest, so I generally err on the side of caution.

Second, the catch is that short term stimulus increases the debt which will be a drag on the economy when it returns to sustained positive growth. So, once again, there is no free lunch.

What does this all mean to Oregon? Well, there are two competing facts: one, Oregon has traditionally be a high unemployment state and was hit particularly hard by the last recession, and two, Oregon's housing market is is good shape (so far) relative to other parts of the country. Local conditions matter only partly for the economy so any national recession will be shared by Oregon, but I do think we will not be exceptional like last time. Exports are strong (10% of Oregon GDP), house values have not crashed and there is a chance that tourism (generally down when incomes fall) will remain healthy in Oregon as people substitute Oregon vacations for overseas ones due to the dollar. So I remain cautiously optimistic. The wood products industry and construction industry are already being hit hard by the slump in construction, however, and demand for Oregon's manufactured goods within the US is falling. So, only time will tell.

Econ Job Market: Another Note

Here is a new innovation that did not exist when I was on the market: an econ job market wiki site. This reveals information to both sides of the market which is fantastic - as an economist I generally believe the more information available in markets, the more efficient the outcome.

The Economist's Job Market

I have been a bit lax in posting lately and for that I apologize. One look at the department's seminars list will explain my absence from the blog-o-sphere. The ones in 2008 are all the department's job market candidates that we invited to visit the OSU campus after an initial interview in New Orleans. It is very hard to predict, when you are a job candidate, which institutions are particularly interested in you and way. Each department is made up of a group of faculty members each with idiosyncratic preferences and the department (especially smaller ones like ours) may have particular needs that the new hire is supposed to address. Thus you never really know as a candidate what is going on behind the scenes. The single most important thing a job candidate does is their "job talk," the presentation of the main research paper from their dissertation. This has to go well - a bad job talk can sink a candidate. Amazing, eh, perhaps a lifetime employment opportunity can me made or broken with a 90 minute presentation. The pressure is, therefore, enormous.

[A note: Economics dissertations in the US have almost completely become a bundle of 3-4 separate research papers sometimes having little relation to each other. Mine was exactly like this. This is in response to the incentives of the academic market and publication lags in economics. In economics the name of the game is journal publications and a publishable paper is usually about 30 pages long. Books, book chapters, etc. are almost worthless for getting tenure. So students start trying to write papers for journals from the outset. Also, publication lags in economics are becoming so bad (you often have to wait over a year just to get an initial response from a journal to a submission and it is quite common for a paper to take 3-4 years to 'stick' somewhere) that to get enough research published for tenure in a typical 6 year tenure clock, you have to get papers out even before you leave grad school. Thus the new style dissertations. A friend who is finishing up his dissertation at an august British institution is being forced to do an 'old style' dissertation (in the UK old is often thought of as necessarily better) and this really hurts him - he has to write an entire dissertation on a single subject with parts that are not suitable for journals.]

Anyway, imagine now that a candidate has a fly-out and does well at a place she has never seen in a part of the US she has never been. If she is lucky, she may have been given a quick stroll around the campus, perhaps driven quickly around a few parts of town, but in 24 hours really hasn't had a chance to see much of anything. Then the job offer comes through and it is common to have only about a week to respond (in my earlier post I mentioned how fast the market clears, so departments can't wait for a candidate to decide for fear of losing any chance to hire anyone at all). So here she is back at home, perhaps with a significant other and maybe even kids and she has to decide about coming to an institution and a town she may know nothing about but may end up being her home for the rest of her life in a week. The significant other usually does not get to see anything. Fortunately, the stress is reduced a tiny bit by the fact that the economics job market is pretty robust so movement from position to position is quite common, but you can't count on that. So now you see the plight of the poor graduate student in economics. That said, I am keenly aware that what I am describing probably sounds like nirvana to people in other disciplines where jobs are so scarce that a tenure track faculty position seems like an impossible dream, so I don't complain too much.

If you are interested in how the sausage gets made, the job candidate's seminars are open to the public, so come join us ... and introduce yourself.

Econ 101: The Prisoner's Dilemma

[This post was motivated by a question in the comments to my post on self-fulfilling expectations]

One of the most canonical examples in all of modern economics is the game theory story of the prisoner’s dilemma. The reason this has become so well-known and almost always used as the very first example of game theory in economics classes is because of the power of the result. It very simply and elegantly shows how, in strategic situations, the basic efficiency of free markets fails.

A little background: in economics perhaps the most powerful result of all is what is known as the first welfare theorem. The first welfare theorem states that when markets are free and complete (which is a technical term but actually implies some fairly strong conditions), the resulting equilibrium is efficient. This is also related to the invisible hand which states that economic agents, by solely pursuing their own self-interest, will maximize social welfare. Now, there are lots of things that make this not true in reality, the most common are the existence of externalities, public goods and asymmetric information. But, the prisoner’s dilemma shows us that it is also not true in strategic situations. Strategic situations are where the actions of one player determine the ‘payoffs’ of the other players. (NB: you can think of this as a type of externality, but a in a specific and complicated way – more complicated than the standard externality stories) To give a simple example if we are roommates and you are considering purchasing a new iPhone, the joy you get from that purchase may depend on you being the first to own one and show it off to our friends. If I buy one before you, then the enjoyment you get from yours diminishes. So my actions have affected your payoffs from the purchase of an iPhone. We are now no longer in the pure free market case which assumes that others decisions have no affect on your costs or benefits from market transactions.

The Game: there are infinite variations on the same story but they all follow similar lines. Suppose that two people are arrested of a crime. The police put them in two separate interrogation rooms where they cannot see or talk to each other. The police have enough evidence to get convictions only for a lesser charge which would lead to 1 year jail terms, but if one confesses to the crime they can convict the other of the more serious crime and in this case the confessor gets probation only (o years in jail) and the other person gets a 5 year jail sentence. If they both confess then they both get convicted and sentenced to 3 years in jail. It is assumed that they both know all of this and they know the other person knows as well (and technically each knows that the other knows that the other knows, and on, and on, and on…). They also have to make their final decision without knowing what the other has done.

So now consider the choices of each person. If they decide to not confess they get: 1 year in jail if the other does not confess and 5 years if the other confesses. If they decide to confess then they get 0 years in jail if the other does not confess and 3 years if the other confesses. So no matter what one person thinks the other person will do, confess is always the better choice. So they both confess and the result is that they both spend 3 years in jail.

Note, however, that there is a better out come for both, the one where both don’t confess and get only 1 year in jail. So the result of the prisoner’s dilemma game is sub-optimal because both could be made better off by not confessing. But acting in their own self-interest leads to this poor outcome – contrary to the invisible hand in free and complete markets.

So you see the power of the story: in strategic situations, all the efficiencies of free markets are no longer guaranteed. You could easily change the story to my iPhone story or any other more standard market stories and motivate this more obviously, but the essence is always the same.

Economist's Notebook: Getting it Right on Home Prices

This from the pet peeve department. The Oregonian this morning has a front page headline:

"Portland Home Values Tick Up"

But this is an inaccurate statement. It should read "Portland Home Transaction Values Tick Up." You see, median home sales prices don't necessarily tell you anything about appreciation of home values. It does give some information about market conditions - the median value of a home transaction - but that is all. This could decline due to deprecation of home values OR simply because more lower priced homes are being sold relative to more expensive ones than before. This is why the Case-Shiller index is so good, they track same-home sales to track the appreciation of home values. In other words, they look at houses that have sold multiple times, adjust for improvements, and see if prices have increased or decreased.

The first sentence in the article is even worse: "Portland-area homeowners saw modest growth in home values in December..." NO! You cannot draw this conclusion from median home sales data.

The Oregonian is not alone in this, almost every newspaper makes this same mistake. Editors should insist on accuracy.

Evidence on Sales and Income Taxes on State Economic Growth

A while back I clipped this quote from a survey of academic papers on state taxes:

“The Effect of Personal Income Tax Rates on Individual and Business Decisions - A Review of the Evidence”
By Mark Rider

Andrew Young School of Policy Studies
International Studies Program Working Paper 6-15

“…there is a large body of evidence that high state [personal income tax] rates have a negative effect on business and individual decisions and thus slow the growth of state employment and personal income. Consequently, states must use care in setting state [personal income tax] rates to make sure they are not out of line with those of their neighbors and other competitor states.” (page iv)

This was quite intriguing and so I started a process of tracking down that papers cited to support that claim. I was left a bit disappointed in the results. This argument seems to be based on an assumed causal link that is speculative: high personal income taxes cause higher wages to compensate, higher wages deter new investment and dissuade businesses to locate there, and finally this causes slower growth. Overall, I found the claims in the paper not always accurate or reliable. An example of one dubious claim is this: "Helms (1985) reports evidence that state tax burdens significantly reduce state growth rates." This is not correct. Helms finds this to be true only when states use tax revenues to fund transfer payments, it is not true when states use tax revenues to fund public services.

In general there is a consensus that overall tax burdens matter somewhat to state growth, but the degree to which growth is sensitive to overall tax burden is a matter of some debate, mostly because the problems of really testing this in a meaningful way. Two careful papers, the Helms paper referenced above and a subsequent paper from two U of O economists suggest that when tax revenues are spend on public investment the negative effect of state taxes disappear or even reverses ( Mofidi and Stone, 1990). But what really matters to the discussion about Oregon is the evidence on the composition of state taxes on growth. Here the evidence is scant and scattered. for the purposes of this post I will present a few snippets of what I have found so far from my survey of the literature on state taxes and growth. One paper that is a little old but intriguing tests whether specific taxes (corporate, personal income and sales) has an affect on subsequent employment growth. There are some methodological issues, but the results are provocative:

"JOBS AND TAXES: THE EFFECT OF BUSINESS CLIMATE ON
STATES' EMPLOYMENT GROWTH RATES"

by MICHAEL WASYLENKO AND THERESE McGUIRE

National Tax Journal, Dec85, Vol. 38 Issue 4, pp. 497-511.

"The results here confirm that for the wholesale trade, retail trade and finance industries the size of the personal income tax may have an important indirect effect on employment growth. Moreover, the coefficient on wages is also statistically significant in these three industries. If part of the higher income taxes is borne by firms in the form of higher wages, these personal income tax rates also have a direct effect on employment growth in these three industries." (p. 506)

They also find that corporate and sales taxes have no measurable affect except for sales on employment in wholesale trade.

Three related papers by Carroll, Holtz-Eakin, Rider and Rosen investigate the effect of personal income taxes on entrepreneurship activity in the US, using the 1986 Tax Reform Act as a natural experiment and find that higher personal income taxes suppress investment and employment by entrepreneurial firms. However, this is done in isolation, so again does not specifically address the mix of taxes.

Finally, evidence on out-migration and personal income taxes shows little of what I would consider strong evidence positive correlation, but there does seem to be strong evidence that higher wages compensate for higher tax burdens and there is very good evidence that business location decisions and foreign direct investment decisions are sensitive to local wages.

So what is a lay reader of my blog to conclude? Sadly the received evidence does not say anything too clear about the effect of tax composition. Person income taxes appear to have perhaps a slightly higher correlation with employment growth and lower entrepreneurial activity and less investment from outside the state and country. The extent to which shifting a chunk of that burden to sales taxes would ameliorate the problem is still far from clear. Still, I think there is enough evidence to suggest that we may not be doing ourselves any favors by being an exceptionally high income tax state.

Tax Poll

Just a note: Since I have been lax in posting on taxes, I am extending the poll closing date until the end of the month.

Getting Back to Taxes

Before I get started, apparently Mike Huckabee has a national tax plan that is interesting in that it proposes replacing the national income tax with a national sales tax. Some economists think this is a good idea in theoretical terms. My readers, I think, are already more well-informed about the evidence than is Mr. Landsburg, but he makes an interesting and sometimes very curious argument - one with a lot of holes in my opinion. I am not the only one. This is the same economist who claimed he bawled out a elementary school teacher for suggesting to his child that recycling is a good thing, claiming that he taught his kids not to recycle because he loved trees. His argument was that recycling lowered demand for trees and thus we should expect fewer trees - forgetting perhaps that what most people care about are not commercial tree farms but old-growth and wilderness areas, but I digress. Safe to say that I am not part of the Steven Landsberg fan club - I think he is an extraordinarily lazy thinker.

Now, getting back to my old posts on a state sales tax. I understand that sales taxes may be as volatile in the short-run as income, but income taxes are still more sensitive in the long-run. Does the long-run matter? I argued before that it does, but now I would like to take that a step further and bring in a stylized fact: Oregon is a high unemployment state. Here is a graph from the Oregon Employment Department.



Not only do we see Oregon as a high unemployment state but notice how much worse the downturn of 2001 - 2004 was on Oregon's Unemployment than the national average. So if we are worried about significant and sustained shortfalls in the revenues of the state government - you can see clearly why relying so heavily on an income tax was so costly for the state, and why I am pressing the long-run elasticity as a very significant number.

The related question also becomes: how much does Oregon's high income tax rate contribute to this high unemployment rate? I don't know the answer, but I am sure it is not zero. It may well be not terribly significant, but I am a bit worried about the connection and the data suggest a correlation at least. (Remember to be careful about this kind of evidence though, it could be that high taxes come about as a result of poor economic performance as states struggle to fund essential services) I will leave you all with some interesting maps from the Bureau of Labor Statistics. These are Unemployment rates by state, 2000-2006. Darker shading means a higher unemployment rate. Notice something about Oregon? It had higher unemployment, and took longer to recover than almost every other state. This could be purely coincidental, but it is worth further investigation.

Economist's Notebook: Self-Fufilling Expectations

As I was standing in line at security at PDX on my way out to New Orleans, I happened to see Steve Novick, Democratic candidate for the US Senate seat currently held by Gordon Smith, in line ahead of me. I immediately noticed him because of the fact that he is very, very short. Now, we all know intuitively that height has absolutely nothing to do with the ability to be a good senator - or does it? Steve is obviously extremely intelligent, personable and hard working, so I would argue there is nothing innate about his height that lessens his ability to be an effective senator. But suppose I was worried about his ability to be elected not because of any prejudice I had about his height, but because I thought others might worry about the effect of his height. If everyone in Oregon were like me, personally not worried about his height but worried about others holding his height against him, notice what happens: my initial worry would be confirmed. No one would vote for him because of his height, not because they believed it made him less able but because they believed it would make him unelectable, and they would all have been proven right ex post. This is what in economics are known as self-fulfilling expectations: you expect his height to be a problem, so you act that way, and by such action you cause it to be true.

You can make a similar argument about his effectiveness once in the senate. A senator who is considering supporting him on some legislation he is proposing, might worry about his ability to drum up support among other senators, so decides not to - not because of his own ability, but because of how this senator believes others will act towards Novick. This worry causes the senator not to support Novick and thus causes his own worry to be shown to be correct.

So the punch line is that you can quite legitimately be worried about his height without believing that it has any effect on innate ability. But should you be? Notice that if everyone chose not to worry about what others might do, another equilibrium would result. An equilibrium where height played no role either in the election or in the senate. So what is a voter to do with such economic insight? Well, which equilibrium results really depends on how much you think other voters and senators will be influenced by height. Any one voter's marginal contribution to this is so small it is virtually meaningless, so an individual decision to disregard these concerns is not that meaningful in terms of outcomes, but may be meaningful in terms of one's own utility.

Note to the AEA: Don't Schedule the ASSA Meetings the Same Weekend of the National Championship Game

It was a bit amusing when the fans started rolling in, but not anymore. It is hard to move. After the last interview today, I had a hard time getting out of the hotel because the LSU marching band was streaming in. Note to the Oregon State Economics Department: maybe it is not such a good idea to make the interview room in a hotel on Bourbon street. Ooops. Luckily I am no where near, so I will sleep tonight. New Orleans is not unprepared for this, here is a (bad) picture of one of several mobile elevated observation and command posts they set up all around Bourbon street.



Next is a (bad) picture of Ohio State and LSU fans waiting for the street car. Most interactions have been friendly, but things were getting a little edgy when I was walking by about 9pm.



Normally I would go to sessions where new research is presented, but I simply had no time. It is a shame. But I learned a TON about cutting edge macro research and it is really fascinating. When I had macro theory in grad school it was a bit of a bad time and some new innovations (now old but new to me) - heterogeneous agents models, learning, policy rules and new Keynesian theory has really made it quite an exciting field again, in my opinion. Plus, there is no other field where cutting edge academic research has an immediate impact on actual policy. The Fed system has a huge research agenda and is always interacting with academics. Anyway, I can report that a lot of smart creative people are doing macro these days and, for that, we can all be thankful.

Other notes from the big easy: I was recommended and tried Albita Turbodog. Not impressed: dull and watery. They claim to use Willamette hops, I couldn't tell. The AndyGator was worse. Fortunately, the same restaurant has Sierra Nevada Celebration. Now that is a beer. My evening was rescued. Should have thought to ask if they had Rogue. You never know where you will find Rogue. Vic Tremblay had an Anchor Steam and we got into a discussion about whether Anchor was the first microbrewery. Apparently since Fritz Maytag purchased an established brewery some think he does not deserve the title of first. I say, who cares and enjoy the beer - Vic Agreed. But perhaps if you really care about reducing energy consumption, one should not buy beer that has been shipped half way across the country. But I just could not take another Turbodog.

Supply and demand: guy on street offered me a ticket for the championship game, I asked price. Answer: $1000 (but I think he knew I wasn't serious). Hotel rooms tonight going for double and triple regular price. Thought about subletting. Decided sleep was worth more.

Final note: when a horde of people in purple start yelling GO (or more accurately, GEAUX) at you, the proper response is: TIGERS. Now you know.

The ASSA Meetings: Notes from the new PhD job market

So somehow I found myself on the macroeconomics search committee and have spend the last two days in a hotel room for 11 hours both days interviewing job seekers. I am tired. But not as tired when I was on the other side of the room as a new PhD myself, running from hotel to hotel, interview to interview not knowing anything about my future (would I get any job offers at all, will I have any choice, will I WANT to live in any place I am offered a job?). These were huge worries and huge implications for the rest of my life - all from a series of 30 minute interviews that barely scratch the surface of who I am. Anyway, I am glad that is all over.

So now I have to sit in judgement of others, come to quick conclusions about them and most particularly how well they fit the specific needs of the department. This is what is so frustrating for job seekers, in my opinion, because you have no control over that and generally have little specific knowledge of what these needs are. So how do you know if you did a poor job impressing of if you did a good job but are just not quite as good a fit as the next one? You don't. I have already seen many very impressive new PhDs but quite a few I already know we won't go after because of fit. I wish I had ten jobs to offer.

But I digress. What strikes me the most after two days is that macro, which is divided into a number of different 'camps' based on different specific topics in terms of research, seems to have this division now in the graduate core theory classes. I am surprised how little these students know about the other areas of macro. I think this is reflective of the incentives of the academic economics profession: it pays to start working in a specific niche and now this has reached the training itself. Why? Well I think it may have a lot to do with the increasing publication lags in economics. These days in economics it can easily take over a year to hear back from a journal after you submit a paper. If lucky you may get an opportunity to revise the paper and resubmit it which may take another year until acceptance (or eventual rejection). More commonly it takes 2 or 3 rounds of submission to get a revise and resubmit offer. So if you have a paper it may take easily 3 to 5 years to publish it. Considering the fact that most tenure clocks are 6 years in length (meaning you have to go up for tenure in your 6th year on the job), and tenure expectations are often at least 5 or 6 publications, it is becoming more and more important to start this process while still a graduate student. These publication lags are much, much worse than 20 years ago apparently. So you can see why now, graduate students specialize earlier - because specialization means you can 'master' the material easier, you can make a name for yourself easier, and you can become known to the community of researchers that will end up 'refereeing' your papers. But I think in macro it has gone too far. Many students just don't know the 'field' and are thus very constrained by this and have a hard time commenting about other lines of research. I can't imagine what it will be like in 10 years when all of these people are leading the macro profession.

Other notes: there are a TON of football fans here now all decked out in purple and red. And they are all very, very drunk. Generally the interaction is quite friendly (much to the amazement of my English friend who is used to a bit more partisanship found in English football). But I find this all very amusing: hordes of straight laced economists (many in suits and sporting name tags) and hordes of drunken football fans comingling in the streets. The economists are definitely the ones out of place. Sigh. We are so uncool - Freakonomics or not.

Beeronomics: Cereal Boxes and the Honest Pint

Brewers are not the only ones facing higher ingredient prices these days - cereal manufacturers are too. So what to do? Well, you can raise prices or you can shrink the box and hope that consumers won't notice. Cereal manufacturers seem to be successfully doing the latter. So will brewers be tempted to start shrinking servings of beer at their pubs? Would you know if they did? Maybe it is time to get on board with the honest pint.

By the way, anyone know any good brew pubs in New Orleans?

Strike Up the Band

Lousy cell phone picture, but here is a New Orleans Jazz Band playing in the baggage claim area of Louis Armstrong International Airport tonight to welcome thousands of economists to the Big Easy. Note the logo on the Tuba (see below).

I am staying just off Canal, close to the French Quarter and didn't think I would notice any difference here from when I was last here in 2001. Boy was I wrong. Half the buildings and storefronts here are vacant - in the center of New Orleans. I haven't been over to the French Quarter yet, but I suspect it will be better there. Sad.

Oh, and apparently there is something going on here on Monday that has brought in a bunch of Ohio State and LSU fans. Good thing I am out of here on Monday morning.

Economist's Notebook: The US Economy

Three things prompted this post. The first was a letter to the editor in today's Oregonian from a Englishman, Clayton Jolly, who recently visted Portland and write the paper to tell everyone how much he liked it. I chuckled to myself thinking "I bet you liked it, everything was pennies to the Pound." The British Pound has been trasding for about two dollars for some time now, making jaunts in Portland seem like tremendous bargains to the Brits. The second was the return of my mother from a quick stay in Spain where she stayed in hostels, ate on the cheap and still managed to burn $1500 in less than a week. The third, and most interesting, thing however was this graph from Paul Krugman:

The blue line shows residential investment as a share of GDP (left scale). It has plunged impressively. The red line shows exports as a share of GDP (right scale).

You see, just as US vacations are incredibly cheap right now for Europeans, so are US goods and services. The law of demand tells us to expect increased demand with lower prices and so we see in this graph. What is equally interesting is this surge in demand for US exports has countered the fall in investments in housing that woudl have otherwise, most likely, plunged us into recession already.

So thanks Clayton Jolly!

Have You Ever in Your Life Seen So Many Economists...?

I'll get back to taxes soon, but I have been too busy to do much reading of the literature partially because I am preparing for a trip to New Orleans to attend the Allied Social Science Association's (ASSA) annual conference. This is primarily a conference for the American Economics Association (AEA) and it is huge. I was completely astounded the first time I attended it, back in 1999 when it was held in New York City. Apparently, for some unknown reason, attendance for this year's conference is much bigger than normal. So if you have ever wanted to find yourself in a crowd with literally thousands of economists (the horror....the horror...), get thee to the Big Easy January 4, 5 and 6. Or just keep tuned to this space, as I hope to do just a little bit of blogging from there. For you OSU students thinking of possibly pursuing a career in academics - here is a little inside look at how the sausage is made.

The reason I am going is because the Economics Department at OSU is hiring for two replacement positions and the main job market for mew economists is at the ASSA meetings. It works like this. By mutual agreement, all jobs for economists are listed in the AEA's Job Openings for Economists. The main ones (the ones with all most of the new jobs for a given academic year) are published in September, October and November. Newly minted PhDs (or those anticipating their PhDs by September) apply for jobs and, if selected, have initial interviews at the ASSA meetings. These are usually 30 to 45 minute meetings, in hotel rooms, where the candidate gets a brief opportunity to talk about their dissertation research, their teaching experience and themselves, and the department gets to tell the candidate a little bit about the wonders of life there. So, on top of thousands of regular attendees at the ASSA meeting, there are hundreds of (mostly) 25 to 35 year-olds running around looking anxious and stressed. You can tell who they are because they are the ones wearing the brand-new suits. I had 36 interviews in a four-day stretch when I was coming out of grad school and it is one of the worst experiences of my life. The interviews themselves are usually cordial and friendly, but the process is grueling: you are constantly stressed, tired from running from hotel to hotel and trying to keep your thoughts straight. You feel like a piece of meat being poked and proded and evaluated.

After the meetings are over, departments usually invite their top 3 to 5 candidates out to the campus for 'campus visits.' These are also gruelling: lots of travel in winter, all day interviews, hotel rooms and more travel. A typical visit starts before dawn for breakfast, meetings with faculty and deans, lunch, more meetings, a presentation of some part of your dissertation and then dinner. I had seven of these in a row and kept getting stuck with weather. Finally, top candidates are made offers, most of which expire in about a week.

Many economists are very proud of this market, considering it highly efficient. But you have already probably spotted the problem: with so many departments and so many candidates, finding the right matches is often confounded by the quick timing of it all. I had an offer that expired before another very attractive job was even making an offer, so I had to decide if I should take it or leave it in hopes the other place would make me an offer (I took it and it was a good thing: the other place decided not to make any offers). I had another offer on the table, however, that I didn't really want because of location - it turns out there was a woman from U of Virginia who really wanted the job and may have well been offered it if I had turned them down straight away, but I did not and she had to take another job. So the outcomes are decidedly not efficient.

So here I go off to sit in a hotel room for three days and interview 32 people. Though the stress is gone (whew!) the process is no less exhausting. And the worst part is if I even have the energy to go out and find a nice place for dinner - inevitably the place will be filled with economists loudly conversing about the marginal gain from spending the extra $10 for the better bottle of wine and the Pareto optimal allocation of hors d'œuvres. Oy.

Portland Home Prices: Update

Here is the latest Case-Shiller monthly home value index for Portland. The local media are still on the 12 month overall appreciation story of Portland home prices, but the recent trend is not looking good, October is again lower than September. Home prices continue on the downward slide that they began after peaking in July. Part of this is seasonal for sure, a depreciation happened last fall and winter as well, which is why the 12 month figures are considered a better index, but this microtrend is troubling. The key will be whether the spring market corrects this - we shall see.

Long-Term Stability of Sales Taxes - An Example

As I have said, the empirical evidence on sales tax volatility has shown sales taxes to be not significantly less volatile than income taxes in the short-run. These estimates come from deviations around a trend. So sales tax revenues seem to stray from their long-run trends about as much as income taxes do. Income taxes have steeper trends though, meaning they tend to rise faster then do sales tax revenues as aggregate incomes increase. The best estimates I have seen are about a 1.8 long-run elasticity for income taxes and a 0.8 elasticity for sales (see this post). Many public economists argue that short-run volatility is what we should be focusing on - how quickly to the revenues crash due to a sudden downturn in the economy - and I agree that this is an essential component. However, I also think the long-run elasticities are very important as well and have said so, but perhaps have been not as clear as I would have liked as to why. The basic point is that since income tax revenues grow faster in the long-run, they will slow down faster as well when income growth slows down.

To make this point more clearly using a real recent episode in Oregon's economic history, I did a quick little back-of-the-envelope calculation based on the actual State of Oregon quarterly personal income figures from the Bureau of Labor Statistics. First off, understand that, in general, aggregate personal incomes increase over time due to inflation, population increases, productivity improvements, etc. So long-run trends in incomes are always positive as are tax receipt growth figures. But in 2001 and 2002 Oregon experienced a very significant slow down of income growth, so I decided to see what receipts of the two types of taxes would look like using those national estimates of elasticities. Based on the average growth rate over the period 1987 to 2007 we could have expected personal income to grow by about 9.2% over that two year span (2001-2002), in reality it grew 3.6%. So from the estimates elasticities we find that based on these expectations v. reality figures, income tax revenue would have fallen about 10% below 'normal', while sales tax revenue would have fallen 4.5% short of 'normal'. This seems quite a significant difference. Of course you can make the opposite argument as well, that once personal incomes started growing at normal rates again the income tax would have more quickly regained the lost revenues than would a sales tax. But, it would have more ground to make up anyway. So though I think the short-run is quite important, I think this long-run differential is important too.

Finally, two comments on the previous post. First, a few people, I think, misunderstand the quote from the Feldstein and Wrobel paper. It does not say anything about whether a progressive tax structure is good or bad - it simply says that the US job market is quite fluid and so employers have to compensate for high taxes. Full stop. So if your aim is to reduce inequality in a state through a highly progressive income tax, it won't work. It has nothing to say on whether inequality reduction is a good goal, or on who should or shouldn't pay tax, or whether the relatively wealthy should pay more, etc. I found this an absolutely fascinating paper - who would have thought that the US job market is that fluid, or that employees respond so strongly to net incomes, not just gross? Wow. But I guess the fact that I find this so fascinating is why I am an economist that does not get invited to many parties...

Second, if you care about poverty and unemployment you should care deeply about economic growth.

Some Snippets of Economic Research on Taxes

Sure to enlighten and enrage, I offer them without comment at this point. Food for thought.

“The Effect of Personal Income Tax Rates on Individual and Business Decisions - A Review of the Evidence”
By Mark Rider
Andrew Young School of Policy Studies
International Studies Program Working Paper 6-15

“…there is a large body of evidence that high state [personal income tax] rates have a negative effect on business and individual decisions and thus slow the growth of state employment and personal income. Consequently, states must use care in setting state [personal income tax] rates to make sure they are not out of line with those of their neighbors and other competitor states.”

Page iv.

“Tax Policy and Entrepreneurial Entry”
By William M. Gentry; R. Glenn Hubbard
The American Economic Review, Vol. 90, No. 2 (May, 2000), pp. 283-287.

“While progressive taxation could in principle encourage entry via insurance for risk-averse entrepreneurs through the tax system or through offering greater incentive to avoid taxes on self-employment income, we find no evidence to support such channels. Our empirical results imply a significant increase in entrepreneurial entry when tax rates are less progressive; whether such encouragement is efficient (that is, stimulating the most talented entrepreneurs) is a topic for future research.”

Page 283


Can state taxes redistribute income?
By Feldstein, Martin & Wrobel, Marian Vaillant
Journal of Public Economics, Vol. 68(3), (June1998), pp. 369-396.

Abstract

“The evidence presented in this paper supports the basic theoretical presumption that state and local governments cannot redistribute income. Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust until the resulting net wage is equal to that available elsewhere. The current empirical findings go beyond confirming this long-run tendency and show that gross wages adjust rapidly to the changing tax environment. Thus, states cannot redistribute income for a period of even a few years. The adjustment of gross wages to tax rates implies that a more progressive tax system raises the cost to firms of hiring more highly skilled employees and reduces the cost of lower skilled labor. A more progressive tax thus induces firms to hire fewer high skilled employees and to hire more low skilled employees. Since state taxes cannot alter net wages, there can be no trade- off at the state level between distribution goals and economic efficiency. Shifts in state tax progressivity, by altering the structure of employment in the state and distorting the mix of labor inputs used by firms in the state, create deadweight efficiency losses without achieving any net redistribution of income.”


“The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross
Section Approach”
By L. Jay Helms
The Review of Economics and Statistics, Vol. 67, No. 4. (Nov., 1985), pp. 574-582.

Abstract

“Results based on pooled time series and cross section data are presented, which indicate that state and local tax increases significantly retard economic growth when the revenue is used to fund transfer payments. However, when the revenue is used instead to finance improved public services(such as education, highways, and public health and safety) the favorable impact on location and production decisions provided by the enhanced services may more than counter balance the disincentive effects of the associated taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes.”

Tax Reform in Oregon: A Research Agenda

So far I have discovered that revenue stability may be aided marginally by a sales tax during extended downturns in the economy, but that short-term volatility is generally not much better and may even be worse than income tax revenue. So I am now pretty well convinced that if decreasing volatility it the main motive, sales taxes don't appear to be much of an answer. I do believe they can add, largely through diversification, slightly more stability to the tax structure, but this is not likely to reduce overall volatility significantly. Also, sales taxes are regressive and even with exemptions of things like food and medicine they remain recessive. The only way to preserve a non-regressive tax structure is through the implementation of other methods like tax credits or graduating the income tax. I certainly don't believe, and never have, that a sales tax should replace the income tax. My working hypothesis is that a lower income tax with a sales tax is beneficial to Oregon and I am trying to see how that hypothesis fares.

My goal here is only to explore the economic aspects of tax reform, not political aspects, so I will not digress into questions of political motives, political viability, etc. I wish only to see if economic theory and empirical evidence supports the notion that tax reform could be potentially beneficial to the Oregon economy. Though I started this series of posts with the statement that I thought sales taxes would be a good addition to the tax structure, I have no particular bias, and if, after subsequent research, I find that the supporting case is weak, I am just as happy with that conclusion as any other.

Now that my toe is wet, it seems I have a lot more work to do. Here are a list of pertinent economic questions that seem important to explore, to the extent possible, to help figure out what is best in terms of tax reform (in no particular order):

-How sensitive are personal and business location and investment decisions to high income taxes and high sales taxes?

-How big a portion of sales tax revenue would be generated from tourist dollars as opposed to 'domestic' spending (i.e. is there a free lunch)?

-Is there a relationship between tax progressivity and economic growth?

-Is there relationship between tax systems and overall tax rates and economic growth?

-Is there a dead weight loss associated with the difficulty of consumers and businesses having to deal with transactions with sales taxes?

More questions will arise, but if there are others you can think of in the interim, do chime in. 'Tis the holiday season, but I shall try to start delving into the research soon and shall report on what I find whenever I have something of any importance.

Sales Taxes: Lessons Learned so Far...

I had been avoiding posting about Oregon's revenue system for quite a while now because I have a real job and spending time digging into the evidence on tax systems was not a high priority. However, the opinion piece in the Oregonian by Scott Bruun finally prompted me to make a first foray into the debate and I considered a kind of commitment device to finally get my hands dirty. So I decided to start a discussion and over the next month or so I could start to see what the evidence was. After all I have only three readers and they are all pretty patient. Then comes Jeff, who throws gasoline on my nice slow burning fire, and here I am, spending half the night looking at income/sales tax revenue elasticities! Thank you and curse you Jeff Alworth!

So first lesson: a blog is a public forum and so you had better be prepared to engage the public.

But, now that I have looked at a number of studies and have updated my knowledge from my policy student days (gosh, can it really be 15 years ago already?) I am left with two conclusions about the variability of sales taxes.

Second lesson: sales tax revenue is not significantly less volatile than income taxes in the short run and may, in fact, be more volatile.

In a number of studies, short run volatility is actually greater for sales than income tax revenue. Its volatility can change depending on the exemptions and other specifics of the tax, and for some states it is quite stable while in others it is quite volatile, but overall the evidence is simply not there to support the lower volatility claim. What this means is that is the case of short-run income shocks the state is potentially as bad off or worse off with a sales tax.

There is, however strong and consistent evidence that the long-run income elasticity from sales taxes is lower than income. This is not questioned anywhere in the literature, but the interpretations differ. The evidence cited in a previous post show a a fairly significant difference between long-run elasticities for sales and income taxes. This is argued to be largely reflective of the growth rates of the two taxes as incomes in general grow and does not tell us that much about stability. (Which, by the way, is one reason fiscal conservatives don't like income taxes as they grow too fast in their view) In other words, it is argued that this is mostly an indication of a trend and not about variability around that trend. But I am not entirely convinced: it does inform us about, for example, the effects of an extended recession - suppose a three year span of low state income (sound familiar?) - a sales tax should fall less severely in that case.

Third lesson: a sales tax might mitigate the downturn in government revenue during an extended downturn in the economy.

So what does this tell us? Well, it probably says that volatility itself should not be a determining factor in choosing a sales tax. How likely are short-run fluctuations v. long-run downturns and how much each matter seem to be pertinent questions. Oregon has been severely hurt by extended slowdowns of the economy but has also struggled with more short-term economic variation as well.

Forth lesson: with whatever revenue source you have, excepting somewhat property taxes, there is going to be significant volatility.

Whether income or sales are more or less volatile in the short- and long-runs, the essential fact is that they are both volatile and mechanisms for smoothing, rainy-day funds if you will, are necessary if the government really wants to reduce volatility significantly. Sales taxes will not do it. A rainy day fund requires restraint when revenues are high and a reserve to draw on when times are good.

So finally what I am left with is a belief that diversification of revenue sources may help somewhat but that volatility is simply not a particularly compelling case for sales taxes.