Misconceptions about corporate welfare

There are many distortions in the US economy.  As a result, a decision by a corporation to move to a new area often has important spillover benefits.  Indeed this is also true of many individuals.  California would gain significant net benefits if Warren Buffett were to move here from Nebraska.  These are not good reasons, however, to oppose a national policy that discourages sweetheart deals that try to induce interstate migration.

Here’s an analogy.  The fact that Barry Bonds hit more home runs after using steroids is not a good argument against a major league ban on steroid use.  (There may be good arguments against such a ban–I’m agnostic.  But the effectiveness of steroids for individual players is not such an argument.)

Suppose that California collects $10 billion in revenue from corporate income taxes.  Also suppose that the optimal corporate tax rate is zero.  Now assume that California raises the tax rate on most corporations, in order to cut the rate on a favored few.  Revenue stays at $10 billion.  If you look at the select few beneficiaries in isolation, it might look like the subsidies make sense.  They may add net benefits to the state, even at the reduced tax rate.  But that ignores what Bastiat called “the unseen”.  The negative effect on non-favored companies.

New York may gain net benefits from attracting Amazon.  But how many firms will leave New York as a result of the higher taxes imposed on other companies, as a result of the subsidies provided to Amazon. In my view, states should compete for business and for individuals by offering an attractive economic climate for all people.

I do understand that other approaches are possible.  You could have state officials in California visit billionaires in New York, offering a 5-year income tax holidays if they moved west.  These billionaires would pay more in sales and property taxes than they’d use in public services. Meanwhile, New York officials could do the same.

Does this make sense from a national perspective?  It’s hard to see how—even if you think state income taxes are a bad idea.  For instance, this type of policy regime tends to encourage corruption.  Resources are wasted on the negotiations.  Individuals will game the system by moving around to earn tax holidays.  Companies will do the same.  Politicians are babes in the woods compared to big corporations—look how Wisconsin’s governor got taken to the cleaners by Foxconn.

Just say no.

To summarize:

1. When considering the benefits from attracting favored firms, one needs to consider the indirect effect on non-favored firms.

2. Even in the rare case where corporate sweetheart deals help a given state after accounting for the negative effect on other firms, it’s still probably in the national interest to a have a policy that discourages such deals.  As an analogy, even if monopsony power means that the optimal tariff for big countries is positive, it probably makes sense for the US and the Eurozone to sign a free trade agreement with zero tariffs.

Let’s adopt a policy of treating individuals equally, and also treating companies equally.  That policy is likely to be best in the long run, even if there are occasions where favoring a certain person or company might produce local benefits. Don’t underestimate the value of simple, clear and transparent tax regimes that treat everyone equally.


What can Congress do to improve monetary policy?

This past Friday I visited Capitol Hill, and spoke to staffers for three different senators and one congressman.  In my view, it is not appropriate for Congress to tell the Fed exactly how to do monetary policy—it’s better to set broad objectives.  Thus I do not think Congress should mandate NGDP targeting, although I favor having the Fed adopt that policy.  But I also believe that there needs to be more transparency and accountability in monetary policy.  I gave each staffer a Mercatus policy brief on my views in this area; here’s a short excerpt:

In this paper, I’ll propose an alternative approach to accountability and transparency, which I believe is both more useful and more politically acceptable. In this regime, the Fed would first set specific quantifiable goals, then conduct annual evaluations of past policy decisions. The Fed would then tell Congress whether, in retrospect, the previous year’s policy stance had been too expansionary or too contractionary, and it would also provide specific metrics to justify this appraisal. . . .


While previous proposals to “audit the Fed” have been fiercely resisted by the Fed leadership, this proposal for boosting transparency and accountability is likely to be uncontroversial, with appeal to both political parties. No institution can seriously argue that its performance leaves no room for improvement or that it cannot learn from past mistakes. Indeed, the proposal has several features that might actually be attractive to the Fed chair. First, it will help Congress to better understand the Fed’s motives when unusual policy steps are needed. Second, it will tend to unify the Fed’s own decision-making process. The Fed chair will be less likely to feel like a person “herding cats” with differing views on how to make the dual mandate operational.

Unlike other reform proposals, the Fed will retain its current level of independence under this proposal. It will continue to be free to decide how to interpret the meaning of its dual mandate, to decide which policy instrument settings are best able to implement its vision of the dual mandate, and it will also be given the discretion to decide for itself how to evaluate whether past policy settings were too expansionary or too contractionary. That’s an enormous amount of independence for such a key policymaking institution. As a result, it’s hard to imagine the Fed putting up much resistance to the proposal.

Read the whole thing.

PS.  There’s a “Straussian reading” of the proposal, which would be much more impactful than it might appear at first glance.

Saving regret

Suppose everyone were rational in their saving decisions.  Now assume that a social scientist decides to interview 10,000 people, to see if they regret how much they had saved when young.  Of this group, 8000 are old people who are still alive, 650 are in heaven, and 1350 are in hell.  The average person expresses no regret—they saved the right amount.  However, there is an interesting pattern.  On average, the 8000 living interviewees express regret for not saving more, while the 2000 who are dead express regret for saving too much when young.

This thought experiment may have some relevance to a study by Axel H. Börsch-Supan, Tabea Bucher-Koenen, Michael D. Hurd, and Susann Rohweddery, linked to by Tyler Cowen:

We define saving regret as the wish in hindsight to have saved more earlier in life. We measured saving regret and possible determinants in a survey of a probability sample of those aged 60-79. We investigate two main causes of saving regret: procrastination along with other psychological traits, and the role of shocks, both positive and negative. We find high levels of saving regret but relatively little of the variation is explained by procrastination and psychological factors. Shocks such as unemployment, health and divorce explain much more of the variation. The results have important implications for retirement saving policies.

This study excluded the dead population, and only interviewed those still living.  Further support for my “survivor bias” hypothesis comes from this finding, on page 29:

A third conclusion is that, by a number of self-assessed measures, a substantial percentage of respondents view their economic preparation to be adequate, yet they nonetheless express saving regret.

I’m unusual in having extremely strong saving regret in the other decision.  I strongly regret saving too much when young, and even when middle-aged.  (I’m now 63.)

Off topic, here’s the county where I live, and where Reagan said good Republicans go to die, in the two most recent elections:

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David Beckworth on the floor vs. corridor system

David Beckworth has a new Mercatus paper that examines the Fed’s decision to adopt a “floor” system for interest rates.  Beginning in October 2008, the Fed began paying interest on bank reserves.  This effectively created a floor on market interest rates, as banks would have no incentive to lend money at rates lower than they could receive on reserves held on deposit at the Fed. Prior to 2008, the Fed controlled short-term interest rates by adjusting the supply of base money, a “corridor system”.  Now they have two independent policy tools, changes in the money supply (open market operations), and changes in money demand (done via interest on reserves.)

David sees several flaws in this new system:

The Fed’s floor system, then, may be a drag on economic growth for two reasons. First, it may weaken aggregate demand growth by setting the target interest rate above the natural interest rate. Second, it may inhibit credit and money creation by removing banks’ incentives to rebalance their portfolios away from excess reserves. If so, the critics are right to be worried about the Fed’s floor system, because it would constitute a Great Divorce for monetary policy.

I worry that deposit insurance biases banks toward too much lending, so at the moment I’m most worried about the first issue.  In monetary history, one recurring theme is central banks misjudging the stance of monetary policy because they focused too much on interest rates and not enough on the money supply.  Thus during late 2007 and early 2008, the Fed wrongly assumed that it was “easing” monetary policy, even as the growth in the monetary base came to a halt.

Admittedly, this excessive focus on interest rates can occur even without IOR.  But the system of interest on bank reserves makes the mistake even more likely to occur, as the quantity of money becomes even less informative.  Monetary policy is seen as being all about changes in interest rates, not changes in the supply and demand for base money.  The Fed’s monetary policy stance during the fall of 2008 would have almost certainly been less contractionary if Congress had not authorized the Fed to pay interest on reserves.

Wasteful interstate competition

Arms control agreements occur when there is a divergence between the interests of individual countries and the interests of countries considered as a group. It’s a way of overcoming the “prisoner’s dilemma”.   Derek Thompson discusses the concessions that Amazon was able to extract from state and local governments, and then suggests that a sort of fiscal competition disarmament is needed:

Why the hell are U.S. cities spending tens of billions of dollars to steal jobs from one another in the first place?

Every year, American cities and states spend up to $90 billion in tax breaks and cash grants to urge companies to move among states. That’s more than the federal government spends on housing, education, or infrastructure. And since cities and states can’t print money or run steep deficits, these deals take scarce resources from everything local governments would otherwise pay for, such as schools, roads, police, and prisons.

I suppose one could argue that tax breaks don’t use up real resources, but they do make the economy less efficient.  And since the location of these investments is roughly a zero sum game, this subsidy competition is wasteful from a national perspective.  If only states could come together and agree to unilaterally disarm.  Thompson suggests several promising approaches:

First, Congress could pass a national law banning this sort of corporate bribery. Mark Funkhouser, a former mayor of Kansas City, Missouri, envisions the law as the domestic version of the Foreign Corrupt Practices Act, which makes it illegal for Americans to bribe foreign officials.

It’s not entirely clear whether that would pass constitutional muster. . . .

Second, Congress could make corporate subsidies less valuable by threatening to tax state or local incentives as a special kind of income. “Congress should institute a federal tax of 100 percent” on corporate subsidies, Jack Markell, a former governor of Delaware, wrote in The New York Times.

PS.  A week ago I said:

The Dems need to adopt a “patriotism, not nationalism” theme.

French President Macron must have been reading my blog, as a few days later he suggested:

Patriotism is the exact opposite of nationalism. Nationalism is a betrayal of patriotism. By saying our interests first, who cares about the others, we erase what a nation holds dearest, what gives it life, what makes it great and what is essential: its moral values.

I like Macron.  Of course if I was French I’d hate him.  The French always hate their presidents.

Speaking of France, here’s an appropriate tweet:

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