Category Archives: Economics

Don’t Quota Me

Chinese apparel have been slapped with a quota. Quotas are worse than tariffs, but first here’s a little background.

The rash of China bashing is well-timed to keep the Chinese buying dollars according to Yuan Answers? (WSJ, 6/10, subscription required). A triangular trade where US sends dollars and st0ck and title deeds overseas to the rich savers of the world and imports lots of stuff in one way shipping containers from China is not a bad thing. In fact, it can be sustained indefinitely with the US capital st0ck continuing to grow. It is a testament to how our laws are not quite as bad as everyone else’s.

In economics we talk about how tariffs and quotas both imply a “deadweight social loss”. When prices are artificially raised via a tariff, the customer prices rise and the supplier prices fall. The quantity sold also falls. It is this last part that is the first component of deadweight loss. By reducing the quantity sold, profitable trades without the tariff become unprofitable because they are not profitable enough to beat the “spread” between the supplier and customer prices induced by the tariff. All this is Economics 101.

A quota has an additional element beyond this kind of loss. In a quota, the supply price rises too. That means that any supplier who can produce at the new higher price will try to fulfill their quota. Thus suppliers who would have cut back production under a tariff will continue to produce to fulfill their quota. Everyone is cut back pro-rata (or according to some formula, e.g., 7.5% more than last year even if growth would otherwise be 500%) and not according to who is the most efficient. Coase might say that quota shares could be traded, but this entails higher transactions expense than the decentralized trade that occurs with a competitive market price.

The additional inefficiency is happily born by international suppliers who receive a major benefit when a quota is imposed–higher prices. So the quota is a collusive bargain between the Government, the domestic suppliers and the foreign suppliers to raise prices on the consumers at the cost to the economy of two kinds of deadweight social loss. Diffuse harm, concentrated benefit. Can one file a class action law suit against an industry association that lobbies for selfish policy?

Auction H-1B Visas

The limit for H-1B visas is 65,000 this year and next down from 195,000 in 2001-2003 according to US Citizenship and Immigration Services. Since foreign technical service personnel are literally worth their weight in gold, this is detrimental to the US economy. The London fix on gold (according to WSJ–subscription required) was $418.25 per troy ounce Friday. Each troy ounce is 31.1 grams or so. The average weight of a US adult is 177.3 lbs according to CDC. That much gold can be bought for $1.08 million. A technical services worker costs about $47,000/year according to the Federal Reserve of St. Louis. If the relative prices stay the same, 23 years of work will net $1.08 million. Technical services are likely to become more valuable compared to gold over time.

In the New York Times today, John Tierney talks about Julian Simon’s research showing that war has become less lethal over the years as a leading cause of death and the trend has continued. Simon was also a big believer in the value of human capital as am I.

His argument in The Ultimate Resource 2 showed that while more births cost more at first (not counting the joy of parenthood), they resulted in more economic growth when they grew up. There is no delay associated with H-1B visas. The import of human capital will immediately speed US growth. These people were already raised overseas and represent a pure boon to the US economy.

There are individual losers, of course. US technical service workers earn less if people are imported from overseas. But protectionism always results in lower aggregate GDP than free trade. There ought to be a way to compensate US technical service workers for the wage loss they will suffer while still allowing the increase in foreign workers and have a win-win or at least a win/small loss.

My proposal is to have US citizens classify themselves into categories according to proof of training. Then the citizens can get some cash from the proceeds of an H-1 B visa auction if people are being imported in their classification. I also propose that the application process be a short form and that the only reason to reject a form would be the auction price and falsification. That is, any reason to immigrate would be fine as long as the auction price was right. The penalty for falsification would only be to make sure the auction proceeds went to the right people.

I would prefer that they just open the floodgates to a million or more immigrants per year with no evidence of need required. Just set the price so that the benefit of the marginal immigrant exceeds the cost. If Simon did the analysis, we would probably end up subsidizing immigration instead of discouraging it. We should continue to refine our tax code, regulations and improve our environment so the US is the most excellent place to live.

Losing Reserve

I am reading The Ultimate Resource 2 by Julian L. Simon (Princeton, 1996). He makes the point that commodities prices tend to decline over the course of the last couple of hundred years compared to the cost of human labor. The average US wage in 1999 dollars is growing at about 2.1% per year geometric mean from 1900-1999. The real interest rate has been about 1% (in the UK anyway).

This means that if technology were constant and reserves were constant, the real price of a commodity would rise 1%. Otherwise, it would make sense to mine as much oil as possible and put the money in the bank, or leave the oil in the ground and wait for the price to rise.

In fact from 1860-2000 the price of kerosene (see figure 5) has dropped about a factor of 6. If you look at the service kerosene was providing (lighting), it has dropped a factor of 40 from

Thermonuclear Option

The Senate leadership is pondering repealing the cloture requirement of 60 votes to close debate and stop a filibuster for judicial nominees. Cloture would be repealed not through a formal rule change, but through a clever finesse of the rules. The parliamentarian responsible for interpreting how the rules apply would simply invalidate the cloture rule. This would be challenged and the rule would need 51 votes to keep it at that point assuming Dick Cheney is against.

The Senate Democrats have warned that they will bring all business to a halt in the Senate were this to occur. This is credible, but in turn may be finessed with something even more drastic.

Here is a new option–call it a thermonuclear option–that would allow the Senate to switch to a new majoritarian mode and continue to function. A member would call a point of order saying that none of the rules are in order because they had not been approved by a majority of the current members. The parliamentarian would rule that yes, after over 200 years of precedent, the original Senators clearly made a mistake in assuming that Senate rules bound future Senates. The majority could then go on to adopt any rules they want. This could allow it to continue to function without the participation of any Democrats.

Cloture should be an issue that cuts across party lines. If the Senate repealed cloture on all legislation, the House would have equal say in all matters for a change. This would be a big boon to states like California, New York and Texas that are highly underrepresented in the Senate. Democrat Senators from all States that have nine or more Representatives in the House should be in favor.

The flip side of course is that small state Senators should be opposed. There are many more small state Senators than large state Senators. For this reason, cloture is unlikely to ever be repealed without a massive buyout transferring money from large states to small to compensate them for the lost pork in future years. Even cloture removal just for judicial nominations would be a critical weakening of small state power.

While I like supermajoritarianism in general, I have not been a fan of supermajority requirement in the Senate and a simple majority requirement in the House. This systematically bleeds money from big states to small states. While perhaps a sensible policy during colonization, now it is just a pork fest. Arnold Schwarzenegger made that point after getting elected. My question is, “Why has the House not imposed its own 60% cloture requirement to balance the power in the Senate?”

More on legislative power can be found in “The Senate: An Institution Whose Time Has Gone?” in The Journal of Law and Politics, 1997.

Ten Tax Loopholes

Here are some counterintuitive tax loopholes to ponder:

  1. Savers can separate high and low income securities. Pre-tax savings instruments such as 401k, 403b and 529 plans are taxed at ordinary income tax rates when the money is withdrawn. This is great because it avoids double taxation of both income tax and capital gains tax. It is worth considering where it is most beneficial to put different types of securities from a broad portfolio. Even though the accounts are tax advantaged, the tax advantage all comes at the head end when money is put into the account. Once it is in the account, it is tax disadvantaged due to the high rate when it is withdrawn. (529s only avoid this for a few years while the beneficiary has a lower tax rate than the maximum). Thus if a portfolio has some securities with high expected return (like high beta risky securities), they incur lower taxes in a post-tax account so that upon withdrawal only capital gains of 20% are paid. Bonds and low risk securities belong in the 401k, 403b or other pre-tax account because they will pay out 35% (or higher if taxes go up) when they are withdrawn.
  2. Savers can back load non-matched 401k deposits. The tax benefit accrues if contributions to a 401k occur at whatever time during a year. If that all occurs on December 31, then the growth occurring at ordinary income tax rates has on average a half a year less to accumulate. Here is a strategy that compares favorably with contributing to a 401k all through the year. If money is placed in S&P 500 depository receipts (SPDRs) during the year, if it goes up a saver can borrow against it and put that money into a 401k and sell the SPDRs after a year and book the long term capital gain, holding cash in the 401k, then buying SPDRs in the 401k when it is sold in the cash account. If SPDR prices go down, they can be sold, the capital loss booked and the SPDRs rebought in the 401k. The reduction from 35% to 20% tax on the gains can make up for a lot of margin interest.

    There are some disadvantages to this loophole. Note that there are maximums to 401k contributions so the saver probably needs to start earlier. If the saver’s job security is in doubt, it would be wise to start even earlier because some jobs have a waiting period before contributions may start. Finally, the saver may need the help with the will power that contributing every month brings.

    (Note: for matched deposits, the doubling of the principle earning income offsets any savings in taxation so those contributions are not subject to this loophole.)

  3. Savers can actively convert ordinary income into capital gains. If securities prices rise and fall together, then they can be used to induce “spooky action at a distance”. Einstein coined the phrase to talked about quantum entanglement of particles. Suppose instead we have two entangled investments. If a cash (post-tax) account holds a short position in a risky security and the 401k or 403b holds a long position in the same security, one account will rise and the other will fall as an exact mirror image.

    To mix another metaphor from physics, the custodian of the accounts can behave like Maxwell’s Demon who lets energetic particles through a door and sends slow particles back the other way. Dinkin’s Demon is going to close both positions after one year if the price of the risky security falls and keep positions where the risky security rises. There entropy in thermodynamics that makes Maxwell’s Demon expensive. Dinkin’s Demon only costs commissions. The risky security is held both long and short so all the security has to do is oscillate to generate the opportunity for money to flow from the pre-tax account to the post tax account.

  4. Saver’s can actively convert capital gains and ordinary income into Roth IRA appreciation. The previous loophole would be even wider if the post tax account was a Roth IRA, an account where growth is not taxed. Then no tax would be due on the gains. It would also be quicker because the trade could take one day because there would be no waiting period for the long term capital gains. Not everyone qualifies, however, for a Roth IRA.
  5. Earners can take income in alternate years to avoid estimated taxes. The IRS requires that payments be made to the US Treasury that are the minimum of 90% of current year’s tax due or 100-110% of last year’s tax. If money is earned in alternate years, the minimum will always be zero. Since payments are due annually instead of quarterly, six months interest can be earned on taxes.
  6. Earners can backload regular withholding. There are high penalties associated with the following loophole if it is not executed correctly. By changing the W-4 to have lots of extra withholding in December, it is possible to keep and earn interest on most of the earner’s money that would otherwise be withheld about a half a year extra. Having the high month be November is a little safer because it gives time to correct an accounting error (or find a new job) for December.
  7. Earners can form a partnership to earn dividends instead of wages. Dividends are taxed at ordinary income rates. Wages also require Medicare. The economic incidence of Medicare taxes is twice the employee share of 1.45%. That is, by converting wages to dividends, marginal taxes can be cut by 2.9%. Many states have taxes on partnership and corporate earnings that offset this, but not all. IRS does not look kindly on exclusively paying dividends and not wages so they are on to the loophole. But the loophole is still open for a typical division of profits and salary.
  8. Owners can pay out capital gains instead of cash. One of the biggest drivers of the technology economy was the differential taxation between capital gains and ordinary income. By paying very little cash and making it up with stock or stock option compensation, firms could reduce the tax load of their employees. If the money that was being used for salary and benefits was instead put into a share buyback to reduce the number of shares outstanding, the price of the shares would steadily rise even if the value of the firm stays constant or falls.

    For example, suppose a firm is worth $100 million and stays exactly the same total value. Suppose there are 100 million shares outstanding at $1.00 each. Suppose the firm pays $100 million/year in compensation. If employees and management agreed, 25 million options could be issued, cash compensation reduced, and $50 million (and a $49 million loan) could be used to buy up 99% of the outstanding stock at $1.01, then 8.33 million shares resold. (A synthetic 1 for 3 reverse split). The price per share after the buyback would be $3. The employees would have $50 million in capital gains that they would pay $10 million in taxes on if they exercise the options and hold them for a year so they have $40 million in gains post tax. Compare that to the $50 million they receive in cash. The $50 million would be taxed at ordinary income tax rates so the employees would have only $32.5 million if they are in the 35% bracket. If they are in the 25% bracket, they and their employers have to pay social security so take home pay is roughly the same with cash, but lower brackets do even better with capital gains.

  9. Taxpayers can start a schedule C business. There is a 2% limitation on miscellaneous tax deductions. There is no minimum on schedule C deductions which can be deducted from the first dollar.
  10. High tax payers can renounce citizenship before making too much money. The United States has a mean streak. It has evolved beyond ‘love it or leave it’ to ‘if you leave it we want your money’. If taxpayers pay more than $122,000 in taxes, they may be liable for 10 years of additional taxes if they decide to renounce their citizenship. This way of avoiding taxes will probably become less popular if estate taxes are reduced or eliminated.

The National Debt Is Too Small

Borrowing to build physical and human capital is a way to finance growth. Can you imagine the quality of education and the number of college educated people if there were no student loans? Can you imagine the house you could get without a mortgage? They would not be nearly so nice as if you get a generous loan at a low interest rate. The same is true of our nation’s capital investments. Can someone tell me if we are carrying on our books assets such as the following: the nation

Capital Surplus Not Trade Deficit

Hand wringing: An excessive expression of distress: handwringing by some experts over the state of the economy.

There is a lot of hand wringing about the trade deficit. We are shipping people slips of paper and they are shipping us cool stuff to use. Sounds like a decent trade to me.

But even if we are worried that the celebration will end some day, here are some good reasons not to worry about the flip side of the trade deficit, the capital surplus.

We have an economy in the United States that is well capitalized. We also attract skilled workers from around the world. One estimate of world capital concludes that the human capital stock exceeds the physical capital stock.

If you take the 60% more that college educated people earn at midlife and multiply it by the number of college educated people, the 40 million college educated people in the United States are worth $1T a year to the US economy. They would cost us a lot more if we could not import them from overseas because they very much increase the returns from other assets in our economy. They are so cheap to rent because they are so common.

This puts the value of the college education portion of the human capital stock at about $20T or about twice annual GDP. This fraction of GDP is similar to the number another researcher gets for the total human capital stock in Chile.

Of the 160 million people 25 and over, about 25% have a college education up from 5% in the mid 1950s. If we continue at that 0.4% increase per year, that gives us an extra $300B/year in extra human capital stock.

If you look at another component of capital, the housing stock, there are about 72,000,000 homes in the US worth an average of $290,000 including the land or another $20T in capital stock. That average price appears to be growing at about $8,000/quarter or about $2T/year. That is just the single family housing stock, not commercial and industrial real estate, not multi-family, not equipment and not environment and infrastructure.

If you add all the human capital growth to the growth and appreciation of physical stock in the United States, you can quickly see that we can sell capital stock forever at a $666B/year rate and still continue to grow our capital stock by trillions per year. If we have $200 trillion in human and physical capital (using the envelope theorem to invert our domestic product by one over the interest rate) in the US almost all held by US citizens, selling 0.33% of it every year even as we grow it by many times more than that is no big whoop.

Whoop: Equal to the word

We Aren’t Doomed

David Levey and Stuart Brown have an antidote for global gloomsaying about the US economy in the latest issue of Foreign Affairs.

The U.S. dollar will remain dominant in global trade, payments, and capital flows, based as it is in a country with safe, well-regulated financial markets. Provided U.S. firms maintain their entrepreneurial edge — and despite much anxiety, there is little reason to expect otherwise — global asset managers will continue to want to hold portfolios rich in U.S. corporate stocks and bonds. Although foreign private demand for U.S. assets will fluctuate — witness the slowdown in purchases that precipitated the decline in the U.S. dollar in 2002 and 2003 — rapid growth of world financial wealth will allow the proportion of U.S. assets held by foreigners to increase….

…Only one development could upset this optimistic prognosis: an end to the technological dynamism, openness to trade, and flexibility that have powered the U.S. economy. The biggest threat to U.S. hegemony, accordingly, stems not from the sentiments of foreign investors, but from protectionism and isolationism at home.