…we find that the subsets of consumers who claimed to be switching exclusively for price reasons appropriated only between 26-39% of the maximum gains available through their choice of new supplier. While such behaviour can be explained by the existence of high search costs, the observation that 27-38% of the consumers actually reduced their surplus as a result of switching cannot.

Yes, among people who switched to save money they only saved a third of what was available to them. A third of the people who switched actually increased their bill.  The authors rule out a number of explanations to conclude that these people just got it wrong because figuring out optimal tariffs is quite tricky. And these are the people who are actively switching and evaluating tariffs, so this is what market success looks like!Outcomes like this make us instinctively want to provide some sort of expert assistance or intervention to help these people. Unfortunately, regulating to ‘fix’ problems like this one is exceptionally difficult because every household has different needs. What it might point to is the need for thoughtful default options because, when engaged consumers are this poor at selecting the best option, what hope is there for those who are not actively comparing tariffs?

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.

…but it doesn’t account for everything

Even the CGE model doesn’t include all known effects: commentators have been quick to point out that externalities, such as pollution and congestion, are not included in the model. Nonetheless, it is better than the previous estimates and HM Treasury should be applauded for their efforts. The current, static scoring suffers from the same problems so dismissing the CGE estimates on those grounds would allow the good to be the enemy of the perfect.

John McDermott, in the FT, also criticises the model for ignoring the effects of monetary policy and the current slump, saying that “their absence means we should be sceptical about any attempt to simulate GDP two decades down the track”. This is a tricky question. The absence of money from a long-run model shouldn’t matter because, over a twenty year horizon, monetary policy rarely has much effect. However, a tax can have different effects in a slump than it would in a boom and CGE analysts commonly ignore these subtleties because it is difficult to know their magnitude. But these are minor quibbles since the current, static scoring method also suffers from the same problems.

The counterfactual is crucial

The most telling critique is made by Chris Giles and Simon Wren-Lewis, who claim that the Treasury has modelled the tax cut in manner designed to make it look good. The issue is that when you ask, ‘how much will it save?’ the answer is ‘compared to what?’ A reduction in the fuel duty could be matched by either a cut in expenditure or a rise in taxes elsewhere. The Treasury chose to compensate with extra taxes that change growth by the least amount possible. Chris and Simon’s point is that the overall impact would be far less rosy had the Treasury chosen to hike income taxes instead. That is true but, most likely, the Treasury analysts don’t know what the Government would do to compensate and tried to be as neutral as possible. Ideally, they would model various scenarios to give an idea of the possible range of impacts, but it is quite possible that they did not have the time to do that. Certainly, it would be good to see more scenarios in future work but it is telling that this question is never asked of static scoring. The reason is that static analysis tends to hide these assumptions through omission, rather than making them explicit as CGE analysis requires. The discipline of having to think about, and debate, these questions is a good one and certainly not a reason to favour the current, static techniques.

Conclusion

It’s great to see the Treasury conducting more sophisticated analyses of tax policy and doing so publicly. Publishing the results allows for these discussions and can only improve work they do in future. The analysis of fuel duties has obviously hit a political nerve and commentators have been quick to jump on the difficulties inherent in complex estimation tasks. In the hubbub we shouldn’t lose sight of the fact that the CGE model is still a great advance on what came before.

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.

Following is a comment from UK after the 2013 first home buyer policy was announced (from FT):

Andrew Bridgen, senior economist for Fathom Consulting, a forecasting firm run by former Bank of England economists. Bridgen said: “Help to Buy is a reckless scheme that uses public money to incentivise the banks to lend precisely to those individuals who should not be offered credit. Had we been asked to design a policy that would guarantee maximum damage to the UK’s long-term growth prospects and its fragile credit rating, this would be it.”

Pretty much the same situation here. The predictable outcome is that demand will increase without increasing supply. This will increase house prices.

The borrowing will be done by those who are on low incomes and they will commit a large portion of their incomes to debt repayment. If economic circumstances change (say redundancy) or family circumstances (say an illness or an additional child) could force them to financial difficulty.

This policy also flies in the face of what the RBNZ is trying to do with macroprudential tools – which the government turned into legislation recently. The macroprudential tools are meant to reduce the amount of risk in the financial system by not lending out too much to high risk people (low income, low job security, etc) and high risk debt (low deposit, over-priced asset, etc).

The underlying issues are around debt and supply.

Households are borrowing again and a large chunk of it is in low deposit borrowing (take a look at the bank GDSs). Why do we have such a favoured status for housing, where it can have gearing of well over 80%, but few businesses, including those with commercial property portfolios, cannot? Maybe we should have a grown up conversation about banking regulation.

Planning rules require some work too. Archaic and ossified planning regulations mean that there are many barriers to the supply of housing where it is needed (including bizarre lot size requirements in suburbs even when they are in transport nodes).

The housing debate and ‘solutions’ are about the next election. It will have the entirely predictable outcome of higher prices and more debt.

Pop over to these guys if you want to get more info about buying a first home.

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!

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.

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.

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.

I’ve come to the conclusion that the main beneficiaries of the big events politicians subsidise at our expense are the cost-benefit analysts hired to justify the expenditure in the first place.
…
The cynical take on the process is that the whole cost-benefit palaver was introduced by politicians to put a veneer of neutrality on the decision-making on pet projects.
…
That doesn’t worry me that much [but if] politicians … are going to support certain events and projects, despite the evidence of the cost-benefit analyses, why is so much public money wasted commissioning these expensive reports?

I’m a bit torn on the subject of CBAs of major projects. On the one hand, I think they should be extremely useful for informing political decisions. On the other hand, there’s plenty of evidence that politicians don’t pay any attention to them.

In terms of informing political decisions, I think Rudman’s rather missed the point. The choice is not between treating the CBA as binding gospel or eliminating altogether. The CBA serves as a complete description of the trade-offs that are required and informs the politician’s decision. In that respect, the report is potentially very useful and can significantly improve the quality of the final policy.

CBAs also produce a benefit-cost ratio that purports to give a criterion for the overall worth of the project. While useful, it should be treated as the normative judgement that it is. As Reinhardt reminds us

The problem with welfare analysis is not so much that ethical dimensions typically enter into it, but that economists pretend that is not so. They do so by justifying their normative dicta with appeal to the seemly scientific but actually value-laden concept of efficiency.

The benefit-cost ratio of a CBA is laden with normative judgements and can only be the final arbiter of a project’s value if one agrees with those values. As a test, ask yourself whether you agree with the following statement: “When Jack gains $10 and Jill loses $5 that is unambiguously good”. For most people that is not true. If we were to take $5 from a poor family and give $10 to John Key then that might not be an ethically good thing. Yet a CBA treats that statement as always true. That is why the CBA should only inform the politicians’ decision, rather than make it for them. They should be making their own normative judgements on the basis of the facts presented in the report, rather than letting the CBA do both the science and the moralising.

Of course, in order to make judgements, they need all of the relevant facts in front of them. That is where the reports commissioned for major projects are invaluable: they collate vast quantities of information and condense it into the few facts that politicians need to make an informed decision. Without the reports, politicians would be simply guessing at the effect that their proposed policy might have. You might think of the CBA as analogous to an AA inspection on a car: it can tell you which bits are broken but it can’t tell you whether you should buy it. Much as a car has value to you over and above its mechanical fitness, policies can have social value that isn’t necessarily reflected in a CBA.

Unfortunately, the evidence shows that CBAs are often mere window-dressing for the policy decisions that have already been made. That is where Rudman’s argument has more traction. If politicians are not using the reports to inform their decisions then is it worth commissioning them in the first place? The work done by most scholars in the field points to the remedy being better use of the CBA and greater understanding of its usefulness, rather than its elimination. A starting point is to improve the quality of the analysis. Rudman’s examples show that quite clearly: when the government asks for a CBA to be re-done with vastly different conclusions then it is hard to trust the analysis. If the politicians feel they can’t trust it then they are unlikely to rely on it. In New Zealand the government is pushing hard to improve the quality of policy advice, so perhaps it will one day become more than a handy rock to throw at the opposition!

First, there’s nothing wrong with a local government body raising funds for the services it provides. It needs to do that but the question is how it does it. Rates are the most common revenue raising tool, but are not a particularly efficient one since they don’t correct any market problems. Now, parking obviously has an implicit price so it makes sense to raise some revenue from parking fees by setting the price optimally. That allows either lower rates or more service provision, depending upon electors’/ratepayers’/councillors’ (delete as you like) preferences.

DPF and the Dom Post contend that parking times are already optimal because they’re controlled by time limits in addition to the charges. However, there’s no reason to believe that the upper time limit is the optimal stay from a social viewpoint. In fact, if the council has done a good job setting the limits and charges, the average stay should be shorter than the upper limit. If it weren’t, then people who REALLY need to use the park for a long time wouldn’t be able to and there would be a huge deadweight loss. So it is quite plausible that the optimal parking fee is higher than the current level, although we’d need some empirics to figure out if that’s actually the case. Hopefully WCC have done the number crunching on that one.

Finally, stores in Wellington are complaining that the high parking fees deter shoppers, who can drive half an hour to another town and find free parking. If that’s true then Wellington City Council is really transferring benefits from the shop owners in Wellington central to the people who want to park but can’t find a spot. It’s not necessarily wrong, but it does favour one group over another. I can only imagine the uproar if they were pricing the parks down to favour local businesses over consumers! Oh, wait…