Monday, January 18, 2010
Saturday, January 16, 2010
Friday, January 15, 2010
The Bank Tax
President Obama has proposed a special tax levied on large financial institutions. In general, I am skeptical of narrow-based taxes, as they feed a particularly nasty kind of politics, where the majority gangs up on a minority. And I am turned off by the populist rhetoric coming from the administration, which suggests the issue pits Wall Street fat cats against ordinary Americans. Nonetheless, on the economic merits, there may be a case for the bank tax.
One thing we have learned over the past couple years is that Washington is not going to let large financial institutions fail. The bailouts of the past will surely lead people to expect bailouts in the future. Bailouts are a specific type of subsidy--a contingent subsidy, but a subsidy nonetheless.
In the presence of a government subsidy, firms tend to over-expand beyond the point of economic efficiency. In particular, the expectation of a bailout when things go wrong will lead large financial institutions to grow too much and take on too much risk.
You may recall that I made precisely this argument regarding Fannie Mae and Freddie Mac some years ago when I was CEA Chair. (No, I was not a prescient genius. The potential problem was apparent to anyone who cared to look.) But now the problem of implicit subsidies is far more widespread. We have in effect turned much of the financial system into government-sponsored enterprises.
What to do? We could promise never to bail out financial institutions again. Yet nobody would ever believe us. And when the next financial crisis hits, our past promises would not deter us from doing what seemed expedient at the time.
Alternatively, we can offset the effects of the subsidy with a tax. If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.
Will the tax law in fact be so well written? It certainly won't be perfect. But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.
One thing we have learned over the past couple years is that Washington is not going to let large financial institutions fail. The bailouts of the past will surely lead people to expect bailouts in the future. Bailouts are a specific type of subsidy--a contingent subsidy, but a subsidy nonetheless.
In the presence of a government subsidy, firms tend to over-expand beyond the point of economic efficiency. In particular, the expectation of a bailout when things go wrong will lead large financial institutions to grow too much and take on too much risk.
You may recall that I made precisely this argument regarding Fannie Mae and Freddie Mac some years ago when I was CEA Chair. (No, I was not a prescient genius. The potential problem was apparent to anyone who cared to look.) But now the problem of implicit subsidies is far more widespread. We have in effect turned much of the financial system into government-sponsored enterprises.
What to do? We could promise never to bail out financial institutions again. Yet nobody would ever believe us. And when the next financial crisis hits, our past promises would not deter us from doing what seemed expedient at the time.
Alternatively, we can offset the effects of the subsidy with a tax. If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.
Will the tax law in fact be so well written? It certainly won't be perfect. But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.
Wednesday, January 13, 2010
The Rise of European Leisure
There has been some recent discussion in the blogosphere about comparing the United States and Europe. With the pending passage of the healthcare bill and the more general expansion in the size of government, the United States of the future will in some ways start looking more like Western Europe today. So I thought my blog readers might enjoy this excerpt from my favorite intermediate macroeconomics textbook:
Higher unemployment rates in Europe are part of the larger phenomenon that Europeans typically work fewer hours than do their American counterparts. Figure 6-5 presents some data on how many hours a typical person works in the United States, France, and Germany. In the 1960s, the number of hours worked was about the same in each of these countries. But since then, the number of hours has stayed level in the United States, while it has declined substantially in Europe. Today, the typical American works many more hours than the typical resident of these two western European countries.
The difference in hours worked reflects two facts. First, the average employed person in the United States works more hours per year than the average employed person in Europe. Europeans typically enjoy shorter workweeks and more frequent holidays. Second, more potential workers are employed in the United States. That is, the employment-to-population ratio is higher in the United States than it is in Europe. Higher unemployment is one reason for the lower employment-to-population ratio in Europe. Another reason is earlier retirement in Europe and thus lower labor-force participation among older workers.
What is the underlying cause of these differences in work patterns? Economists have proposed several hypotheses.
Edward Prescott, the 2004 winner of the Nobel Prize in economics, has concluded that “virtually all of the large differences between U.S. labor supply and those of Germany and France are due to differences in tax systems.” This hypothesis is consistent with two facts: (1) Europeans face higher tax rates than Americans, and (2) European tax rates have risen significantly over the past several decades. Some economists take these facts as powerful evidence for the impact of taxes on work effort. Yet others are skeptical, arguing that to explain the difference in hours worked by tax rates alone requires an implausibly large elasticity of labor supply.
A related hypothesis is that the difference in observed work effort may be attributable to the underground economy. When tax rates are high, people have a greater incentive to work “off the books” to evade taxes. For obvious reasons, data on the underground economy are hard to come by. But economists who study the subject believe the underground economy is larger in Europe than it is in the United States. This fact suggests that the difference in actual hours worked, including work in the underground economy, may be smaller than the difference in measured hours worked.
Another hypothesis stresses the role of unions. As we have seen, collective bargaining is more important in European than in U.S. labor markets. Unions often push for shorter workweeks in contract negotiations, and they lobby the government for a variety of labor-market regulations, such as official holidays. Economists Alberto Alesina, Edward Glaeser, and Bruce Sacerdote conclude that “mandated holidays can explain 80 percent of the difference in weeks worked between the U.S. and Europe and 30 percent of the difference in total labor supply between the two regions.” They suggest that Prescott may overstate the role of taxes because, looking across countries, tax rates and unionization rates are positively correlated; as a result, the effects of high taxes and the effects of widespread unionization are hard to disentangle.
A final hypothesis emphasizes the possibility of different preferences. As technological advance and economic growth have made all advanced countries richer, people around the world must decide whether to take the greater prosperity in the form of increased consumption of goods and services or increased leisure. According to economist Olivier Blanchard, “the main difference [between the continents] is that Europe has used some of the increase in productivity to increase leisure rather than income, while the U.S. has done the opposite.” Blanchard believes that Europeans simply have more taste for leisure than do Americans. (As a French economist working in the United States, he may have special insight into this phenomenon.) If Blanchard is right, this raises the even harder question of why tastes vary by geography.
Economists continue to debate the merits of these alternative hypotheses. In the end, there may be some truth to all of them.
Higher unemployment rates in Europe are part of the larger phenomenon that Europeans typically work fewer hours than do their American counterparts. Figure 6-5 presents some data on how many hours a typical person works in the United States, France, and Germany. In the 1960s, the number of hours worked was about the same in each of these countries. But since then, the number of hours has stayed level in the United States, while it has declined substantially in Europe. Today, the typical American works many more hours than the typical resident of these two western European countries.
The difference in hours worked reflects two facts. First, the average employed person in the United States works more hours per year than the average employed person in Europe. Europeans typically enjoy shorter workweeks and more frequent holidays. Second, more potential workers are employed in the United States. That is, the employment-to-population ratio is higher in the United States than it is in Europe. Higher unemployment is one reason for the lower employment-to-population ratio in Europe. Another reason is earlier retirement in Europe and thus lower labor-force participation among older workers.
What is the underlying cause of these differences in work patterns? Economists have proposed several hypotheses.
Edward Prescott, the 2004 winner of the Nobel Prize in economics, has concluded that “virtually all of the large differences between U.S. labor supply and those of Germany and France are due to differences in tax systems.” This hypothesis is consistent with two facts: (1) Europeans face higher tax rates than Americans, and (2) European tax rates have risen significantly over the past several decades. Some economists take these facts as powerful evidence for the impact of taxes on work effort. Yet others are skeptical, arguing that to explain the difference in hours worked by tax rates alone requires an implausibly large elasticity of labor supply.
A related hypothesis is that the difference in observed work effort may be attributable to the underground economy. When tax rates are high, people have a greater incentive to work “off the books” to evade taxes. For obvious reasons, data on the underground economy are hard to come by. But economists who study the subject believe the underground economy is larger in Europe than it is in the United States. This fact suggests that the difference in actual hours worked, including work in the underground economy, may be smaller than the difference in measured hours worked.
Another hypothesis stresses the role of unions. As we have seen, collective bargaining is more important in European than in U.S. labor markets. Unions often push for shorter workweeks in contract negotiations, and they lobby the government for a variety of labor-market regulations, such as official holidays. Economists Alberto Alesina, Edward Glaeser, and Bruce Sacerdote conclude that “mandated holidays can explain 80 percent of the difference in weeks worked between the U.S. and Europe and 30 percent of the difference in total labor supply between the two regions.” They suggest that Prescott may overstate the role of taxes because, looking across countries, tax rates and unionization rates are positively correlated; as a result, the effects of high taxes and the effects of widespread unionization are hard to disentangle.
A final hypothesis emphasizes the possibility of different preferences. As technological advance and economic growth have made all advanced countries richer, people around the world must decide whether to take the greater prosperity in the form of increased consumption of goods and services or increased leisure. According to economist Olivier Blanchard, “the main difference [between the continents] is that Europe has used some of the increase in productivity to increase leisure rather than income, while the U.S. has done the opposite.” Blanchard believes that Europeans simply have more taste for leisure than do Americans. (As a French economist working in the United States, he may have special insight into this phenomenon.) If Blanchard is right, this raises the even harder question of why tastes vary by geography.
Economists continue to debate the merits of these alternative hypotheses. In the end, there may be some truth to all of them.
Tuesday, January 12, 2010
Renting is cheaper than Buying
The title of this blog post might lead you to think I am talking about real estate. But no. What I have on my mind is something far more important: Textbooks!
Check it out here. Students can now rent my favorite textbook for about half the price of buying it.
Check it out here. Students can now rent my favorite textbook for about half the price of buying it.
Monday, January 11, 2010
Learning from Europe
Here is GDP per capita, adjusted for differences in price levels (PPP), from the IMF, for the United States and the five most populous countries in Western Europe:
United States 47,440
United Kingdom 36,358
Germany 35,539
France 34,205
Italy 30,631
Spain 30,589
Readers of today's column by Paul Krugman might find these figures useful to keep in mind.
Update: See Mark Perry and Tino Sanandaji and Clive Crook.
United States 47,440
United Kingdom 36,358
Germany 35,539
France 34,205
Italy 30,631
Spain 30,589
Readers of today's column by Paul Krugman might find these figures useful to keep in mind.
Update: See Mark Perry and Tino Sanandaji and Clive Crook.
Subscribe to:
Posts (Atom)