In support of dynamic scoring

Estimating the impact of tax cuts is a tricky business. You can fairly easily calculate how the revenue from current income and spending will change, but that’s just the beginning. The problem is that people don’t stand still: they change their earning and spending habits in response to your tax changes, which changes the revenues from the taxes. The UK government is pretty good at estimating that but economists have long known that there are a couple more stages before you have a full picture of what’s going on. That’s why HM Treasury has begun to use a dynamic, computable, general-equilibrium (CGE) model to estimate the effect of tax changes.

CGE models bring us closer to reality…

The CGE model accounts for the long-term effect on the economy of changing behaviour. In the case of cuts in the fuel duty it accounts for the growth in production caused by a reduction in transport costs. Increasing production generates more road traffic, which yields more fuel duty revenues and partially offsets the cost of the cut. Using the CGE model to ‘dynamically score’ (as the jargon goes) the cost of the tax cut incorporates effects these effects that are not a part of the traditional approach. Read more

First home buyer help – lets repeat others’ mistakes

National has announced policy to support first home buyers to take on more debt. It will have an entirely predictable outcome: higher house prices and higher debt.

The only good thing about this policy is that it is relatively small: $64m over four years. That’s $16m per year and assuming 90% gearing, $160m of house sales. That’s just under 0.5% of $36b of housing turnover in the year to July 2013.

To National’s credit they couch it in terms of a short term response and in the backdrop of other work to look at housing and land supply. But it is still a bad policy that inflames demand for housing even further, before they have tangible impact on increasing supply.

First home ownership subsidy/support policies have been tried in USA, Australia and UK. This led to a high amount of borrowing by those who could not afford it. It was also at the heart of the sub-prime crisis in the USA and the subsequent GFC. Read more

Raising Rivals Costs: Bar Edition

Just read a great post By Dom over at the liquor ladder. Sounds like the Hospitality Association wants to restrict liquor licensing to certain parts of Wellington (Courtney Place and Cuba St).

But the Council, who seem to think the scenes in Courtenay Place late on Fridays and Saturdays represent “vibrancy”, and the Hospitality Association, led by individuals who, I believe, own businesses in Courtenay Place, are planning a regime that will penalise anyone trying to establish a business anywhere else – businesses that might give discerning consumers an alternative to the chaos on Courtenay Place. It may not be what the Council intended, but it’s what’s called an unintended consequence. It’s what happens when you draw lines on a map and create differences between the two sides.
Of course not all the results will penalise businesses outside the strip. If you’re a Courtenay Place property owner learning that your tenants have privileges with respect to liquor licensing, you’re going to put their rent up. I look forward to hearing the Hospitality Association complaining about sky-rocketing rents in the street in about a year’s time.

Now they may be doing this for good reasons. But to put an economics slant on what Dom says, this sounds a lot like what economists call “Raising Rivals Costs” (RRC). i.e., people who already have bars in Courtney/Cuba want to limit the ability of people to operate bars in other ares, thus hindering competition from other ares of the city.

While it may raise the rent of existing tenants, from memory (I live in Auckland now….) the bars on Courtney place at least are all quite big so may be able absorb the higher fixed costs. So in a way this could be seen as shutting out competition by smaller fringe operators (i.e. most craft beer bars) who won’t have the scale to pay high rents. I for one will not be happy to see a reduction in pub innovation!

A technocrat and an economist

Many economists are becoming increasingly technocratic in their desire to shape the economy to fit their favourite theory. However, behind their desire to improve the lot of their compatriots looms the shadow of public choice theory, scorning their efforts to shape public debate. Indeed, many libertarians are so persuaded by public choice ideas that they advocate limited government largely because they have no faith in elected officials. So can one both appreciate the consistency of treating public servants as our theory would treat anyone else, and at the same time believe in engineering a better state?

Dani Rodrik says ‘yes’:

There are three ways in which ideas shape interests. First, ideas determine how political elites define themselves and the objectives they pursue – money, honor, status, longevity in power, or simply a place in history. These questions of identity are central to how they choose to act.

Second, ideas determine political actors’ views about how the world works. Powerful business interests will lobby for different policies when they believe that fiscal stimulus yields only inflation than when they believe that it generates higher aggregate demand. Revenue hungry governments will impose a lower tax when they think that it can be evaded than when they think that it cannot.

Most important from the perspective of policy analysis, ideas determine the strategies that political actors believe they can pursue. … Expand the range of feasible strategies (which is what good policy design and leadership do), and you radically change behavior and outcomes.

Cigarette prices and subjective well-being

We’ve written a lot previously about cigarette taxes as a precommitment device that can increase welfare. However, while those models fit the stylised facts, it’s hard to know for sure if people are better off. For that you’d need to make a prediction about their increase in subjective wellbeing and test it. Now a couple of European researchers have done just that and the results are ‘mixed’. By which I mean that the evidence contradicts the theory!

They conclude:

…we find that smoking bans, on average, neither increase nor decrease people’s subjective well-being to a sizable and statistically significant degree. Higher cigarette prices are related to overall lower reported levels of satisfaction with life, ceteris paribus. The partial correlation is, however, measured with a large standard error. Still, the effect is economically meaningful (and corroborated by our differential analysis for people with different smoking propensities). For a fifty percent price increase, we estimate a reduction in average life satisfaction of 0.02 points (on a four point scale). This is about one tenth of the effect of being unemployed rather than employed or equivalent to the effect of a 2.4 percentage points higher rate of unemployment on the population at large. This finding does not lend support to the effectiveness of cigarette taxes as an internalization strategy. Higher cigarette prices at least have overall negative short-term effects.

Additionally, smoking bans turn out to be beneficial to smokers who would like to stop smoking (or not start again). For those smokers who are most likely to find themselves in a situation where they have recently tried to give up smoking but have relapsed, life satisfaction increases between 0.03 to 0.08 points with smoking bans (depending on the specification). This is evidence that supports the idea that smoking bans can serve as a self-control device. Interestingly, the same group of people does not benefit from higher cigarette prices. Rather to the contrary, these people seem to suffer to the same extend as other smokers do who have not recently tried to stop in response to higher prices. The negative effect of higher cigarette prices on smokers, particularly those who are likely to have self-control problems, runs counter to the prominent finding by Gruber and Mullainathan (2005) for the United States where positive effects of higher cigarette taxes on the well-being of smokers are identified.

Update: Eric comments.

More on slippery slopes and nudges

In a follow up post about nudges and shoves Eric recommends a piece by David Friedman on slippery slopes that argues:

An optional charge where the default choice is to pay it is the sort of thing Sunstein and Thaler propose, a nudge in the direction of doing what those responsible believe, possibly correctly, that most of those nudged would want to do if they took the time to think about it. But the people constructing the choice architecture know what result they want to get, they believe they are doing good and so not constrained by what they themselves would consider proper principles of morality and honesty in a commercial context, so it is very easy to make the “wrong” choice more and more difficult and obscure until what is optional in theory becomes mandatory in practice.

Essentially, the argument is that once you start meddling with people’s choices it’s very hard to avoid imposing your own views of the world. The idea behind nudges is that you help people to make the best choice from their own perspective, not yours, but that’s very hard to do in practice.

As far as it goes, that sounds very sensible and Friedman is probably right that people trying to nudge others are likely to stray in paternalistic territory. However, what the argument is missing is a plausible counterfactual. The choice architects will still need to frame people’s choices in some way. If they use nudges as their guiding principle then they will attempt to frame the choice to maximise the expected benefit to the person making the choice. As Friedman cautions, the architect may not be very good at divining the preferences of others and may end up being more paternalistic than they intended. But the alternative is not that the choice disappears, or that it is not framed in some way. The alternative must be some other guiding principle for framing the choice.

One possibility is randomisation, but there are many instances in which that will result in terrible choices for most people becoming the default. It seems hard to justify that position. A more likely alternative is that the framer will use their own preferences to guide the framing of the choice. The outcome is likely to be rather paternalistic and not at all to Friedman’s liking! It’s all very well to suggest imperfections in the mechanism for framing choices but imperfection doesn’t mean it’s not the best of the bunch.