Category Archives: Policy

GDP’s … something?

While the government is shut down, it seems like a good time for a rousing round of Alan Atkisson‘s GDP Song:

The shutdown means GDP measurements are on ice, which is not all bad, though we can expect a 15 basis point drag on GDP per week to include some real harm.

Shutting down our measurement systems strikes me as alarmingly close to turning off the instruments on the flight deck of a plane, due to a route dispute between the pilot and copilot.

Tax time

It’s time* for environmentalists (and everyone else) to give up on a myriad of second-best regulatory policies and push for a simple emissions price (i.e. a carbon tax). The latest reason: green subsidies are unraveling under adverse energy market conditions. There are many others:

All of the above have some role to play, but without prices as a keystone economic signal, they’re fighting the tide. Moreover, together they have a large cost in administrative complexity, which gives opponents a legitimate reason to whine about bureaucracy and promotes regulatory capture.

If all the effort that’s now expended in fragmented venues to create these policies were focused on one measure, would it be enough to pass a significant emissions price with fair revenue recycling and a border adjustment? I don’t know for sure, but I’d like to see us try.

* Actually, I think it was time for a carbon tax at least 20 years ago.

EU ETS on the ropes

The EU declined backloading, a deferral of permit auctions that would have supported prices in the Emissions Trading System (ETS).

This is described imminent collapse to the system, threatening the achievement of emissions targets. Perhaps a political collapse is imminent – not my department – but the idea that low emissions prices threaten the system is a bit odd. The ETS price is a feedback mechanism. Low prices are a symptom, indicating that the marginal cost of meeting targets is extremely low. That should be a cause for celebration (except for traders).

For the umpteenth time, this shows the difficulty of running a system that invites wrangling over allocation and propagates noise from the economy into a market.

Meanwhile, carbon taxes grind away at their job.

Greek oil taxes – the real story

A guest post from Ventana colleague Marios Kagarlis, who writes about the NYT article on Greek heating oil taxes:

The problems in Greece are interdependent and all have their roots at the fact that the model of government that has been the status quo in Greece since WWII isn’t working and needs radical change, but the people who run the system know no other way, so the problems keep compounding with no solution in sight.There used to be two tiers of taxation for oil: one was for heating oil, which was relatively low, and the other was for oil used for all other purposes (e.g. for diesel cars etc) which was taxed at about 100% over the fuel cost.

Because of the inability of the government institutions to enforce the laws in Greece (which on paper are tough but in practice are not enforced because the system is incompetent), there has been widespread abuse of this: from refineries to gas stations, many oil merchants have been branding diesel as heating oil to evade the tax, and then selling at as non-heating oil, doubling their profit and ripping off both the consumers and the government.

The government has for years been attempting (supposedly) to crack down on this, with pitiable results. The international lenders have demanded from the Greek government, as a precondition for the continuation of the bailout installments paid every now and then (essentially going in their entirety toward servicing past debt, as opposed to relieving the economy), to crack down on tax evasion via illegal diesel sales of ‘heating oil’ as non-heating diesel. Because the tax collection system is broken and cannot control the diesel market or collect the taxes due, the Greek government had to do something quickly to meet the lenders’ demands. And this was the best they could come up with…

So they finally decided to do away with the two separate tiers of taxation and tax all oil as non-heating oil. To make up for the huge rise in cost to the end consumer they established obscure and bureaucratic criteria for lower income families to submit applications to the government for partial reimbursement of the extra tax, the idea being that this would deprive the sellers from a means to cheat and would still enable end consumers in need to get reasonably priced heating oil after reimbursements. However this didn’t work and instead people just massively stopped using oil for heating, which is by far prevalent in Greece (another government failure, for a country with no oil resources and lots of sun and wind). There are entire older building blocs in cities that were built without fireplaces (which up until recently in modern city apartments were more of a symbol of affluence than of any practical use – people essentially never using them) that have just turned off heating altogether, and fights amongst tenants are commonplace for disagreements over whether to turn on heating or not (which in older buildings is collective so it’s heating for all or for none). Those who cannot afford it just don’t pay so sooner or later most buildings in working class neighborhoods are forced to abandon central heating and sustain the cold or improvise.

Because the government again hadn’t foreseen any of this, and wood burning was never particularly widespread in Greece, there had not been standards for wood or pellet burning stoves. So the market is flooded with low quality wood-burning stoves which are totally inefficient and polluting. So suddenly from December the larger cities in Greece are filled with smog and particulates for the first time from inefficient wood-burning stoves, and from burning inappropriate wood (e.g. people burn disused lacquered furniture at their fireplaces, which is very polluting). Cases of asthma and respiratory illnesses in the larger cities since December have skyrocketed. In the meantime forests and even city parks are raided daily by desperate unemployed people who cannot afford heating (especially in northern Greece), who cut down any trees they can get their hands on.

It’s hard to see that there can be any short term solution to this, in the middle of the worst economic crisis Greece has faced since WWII.

Marios lives in Athens.

Oil tax forces single cause attribution folly

A silly NYT headline claims that Rise in Oil Tax Forces Greeks to Face Cold as Ancients Did.

The tax raised the cost of heating oil 46%, which hardly sends Greece back to the Bronze Age. Surely the runup in crude prices by a factor of 5 and a depression with 26% unemployment have a bit to do with the affordability of heat as well?  And doesn’t the unavailability of capital now make it difficult for people to respond sensibly with conservation, whereas a proactive historic energy policy would have left them much less vulnerable?

The kernel of wisdom here is that abrupt implementation of policies, or intrusion of realities, can be disruptive. The conclusion one ought to draw is that policies need to anticipate economic, thermodynamic, or environmental constraints that one must eventually face. But the headline instead plays into the hands of those who claim that energy taxes will doom the economy. In the long run, taxes are part of the solution, not the problem, and it’s the inability to organize ourselves to price externalities that will really hurt us.

Update: the real story.

Et tu, EJ?

I’m not a cap & trade fan, but I find it rather bizarre that the most successful opposition to California’s AB32 legislation comes from the environmental justice (EJ) movement, on the grounds that cap & trade might make emissions go up in areas that are already disadvantaged, and that Air Resources failed to adequately consider alternatives like a carbon tax.

I think carbon taxes did get short shrift in the AB32 design. Taxes were a second-place favorite among economists in the early days, but ultimately the MAC analysis focused on cap & trade, because it provided environmental certainty needed to meet legal targets (oops), but also because it was political suicide to say “tax” out loud at the time.

While cap & trade has issues with dynamic stability, allocation wrangling and complexity, it’s hard to imagine any way that those drawbacks would change the fundamental relationship between the price signal’s effect on GHGs vs. criteria air pollutants. In fact, GHGs and other pollutant emissions are highly correlated, so it’s quite likely that cap & trade will have ancillary benefits from other pollutant reductions.

To get specific, think of large point sources like refineries and power plants. For the EJ argument to make sense, you’d have to think that emitters would somehow meet their greenhouse compliance obligations by increasing their emissions of nastier things, or at least concentrating them all at a few facilities in disadvantaged areas. (An analogy might be removing catalytic converters from cars to increase efficiency.) But this can’t really happen, because the air quality permitting process is not superseded by the cap & trade system. In the long run, it’s also inconceivable that it could occur, because there’s no way you could meet compliance obligations for deep cuts by increasing emissions. A California with 80% cuts by 2050 isn’t going to have 18 refineries, and therefore it’s not going to emit as much.

The ARB concludes as much in a supplement to the AB32 scoping plan, released yesterday. It considers alternatives to cap & trade. There’s some nifty stuff in the analysis, including a table of existing emissions taxes (page 89).

It seems that to some extent ARB has tilted the playing field a bit by evaluating a dumb tax, i.e. one that doesn’t adapt its price level to meet environmental objectives without legislative intervention, and heightening leakage concerns that strike me as equally applicable to cap & trade. But they do raise legitimate legal concerns – a tax is not a legal option for ARB without a vote of the legislature, which would likely fail because it requires a supermajority, and tax-equivalent fees are a dubious proposition.

If there’s no Plan B alternative to cap and trade, I wonder what the EJ opposition was after? Surely failure to address emissions is not compatible with a broad notion of justice.

Wedge furor

Socolow is quoted in Nat Geo as claiming the stabilization wedges were a mistake,

“With some help from wedges, the world decided that dealing with global warming wasn’t impossible, so it must be easy,” Socolow says.  ”There was a whole lot of simplification, that this is no big deal.”

Pielke quotes & gloats:

Socolow’s strong rebuke of the misuse of his work is a welcome contribution and, perhaps optimistically, marks a positive step forward in the climate debate.

Romm refutes,

I spoke to Socolow today at length, and he stands behind every word of that — including the carefully-worded title.  Indeed, if Socolow were king, he told me, he’d start deploying some 8 wedges immediately. A wedge is a strategy and/or technology that over a period of a few decades ultimately reduces projected global carbon emissions by one billion metric tons per year (see Princeton website here). Socolow told me we “need a rising CO2 price” that gets to a serious level in 10 years.  What is serious?   “$50 to $100 a ton of CO2.”

Revkin weighs in with a broader view, but the tone is a bit Pielkeish,

From the get-go, I worried about the gushy nature of the word “solving,” particularly given that there was then, and remains, no way to solve the climate problem by 2050.

David Roberts wonders what the heck Socolow is thinking.

Who’s right? I think it’s best in Socolow’s own words (posted by Revkin):

1. Look closely at what is in quotes, which generally comes from my slides, and what is not in quotes. What is not in quotes is just enough “off” in several places to result in my messages being misconstrued. I have given a similar talk about ten times, starting in December 2010, and this is the first time that I am aware of that anyone in the audience so misunderstood me. I see three places where what is being attributed to me is “off.”

a. “It was a mistake, he now says.” Steve Pacala’s and my wedges paper was not a mistake. It made a useful contribution to the conversation of the day. Recall that we wrote it at a time when the dominant message from the Bush Administration was that there were no available tools to deal adequately with climate change. I have repeated maybe a thousand times what I heard Spencer Abraham, Secretary of Energy, say to a large audience in Alexandria. Virginia, early in 2004. Paraphrasing, “it will take a discovery akin to the discovery of electricity” to deal with climate change. Our paper said we had the tools to get started, indeed the tools to “solve the climate problem for the next 50 years,” which our paper defined as achieving emissions 50 years from now no greater than today. I felt then and feel now that this is the right target for a world effort. I don’t disown any aspect of the wedges paper.

b. “The wedges paper made people relax.” I do not recognize this thought. My point is that the wedges people made some people conclude, not surprisingly, that if we could achieve X, we could surely achieve more than X. Specifically, in language developed after our paper, the path we laid out (constant emissions for 50 years, emissions at stabilization levels after a second 50 years) was associated with “3 degrees,” and there was broad commitment to “2 degrees,” which was identified with an emissions rate of only half the current one in 50 years. In language that may be excessively colorful, I called this being “outflanked.” But no one that I know of became relaxed when they absorbed the wedges message.

c. “Well-­?intentioned groups misused the wedges theory.” I don’t recognize this thought. I myself contributed the Figure that accompanied Bill McKibben’s article in National Geographic that showed 12 wedges (seven wedges had grown to eight to keep emissions level, because of emissions growth post-­?2006 and the final four wedges drove emissions to half their current levels), to enlist the wedges image on behalf of a discussion of a two-­?degree future. I am not aware of anyone misusing the theory.

2. I did say “The job went from impossible to easy.” I said (on the same slide) that “psychologists are not surprised,” invoking cognitive dissonance. All of us are more comfortable with believing that any given job is impossible or easy than hard. I then go on to say that the job is hard. I think almost everyone knows that. Every wedge was and is a monumental undertaking. The political discourse tends not to go there.

3. I did say that there was and still is a widely held belief that the entire job of dealing with climate change over the next 50 years can be accomplished with energy efficiency and renewables. I don’t share this belief. The fossil fuel industries are formidable competitors. One of the points of Steve’s and my wedges paper was that we would need contributions from many of the available option. Our paper was a call for dialog among antagonists. We specifically identified CO2 capture and storage as a central element in climate strategy, in large part because it represents a way of aligning the interests of the fossil fuel industries with the objective of climate change.

It is distressing to see so much animus among people who have common goals. The message of Steve’s and my wedges paper was, above all, ecumenical.

My take? It’s rather pointless to argue the merits of 7 or 14 or 25 wedges. We don’t really know the answer in any detail. Do a little, learn, do some more. Socolow’s $50 to $100 a ton would be a good start.

this
three 

a. “It
It
time
available
thousand
audience
akin
the
tools
to
get
started,
indeed
the
tools
to
“solve
the
climate
problem
for
the
next
50

years,”
than
disown
any
aspect
of
the
wedges
paper.

b. “The
wedges
paper
made
people
relax.”
I
do
not
recognize
this
thought.
My
point
is
that

the
wedges
people
made
some
people
conclude,
not
surprisingly,
that
if
we
could

achieve
after
our
paper,
the
path
we
laid
out
(constant
emissions
for
50
years,
emissions
at

stabilization
was
only
half
the
current
one
in
50
years.
In
language
that
may
be
excessively
colorful,
I

called
this
being
“outflanked.”
But
no
one
that
I
know
of
became
relaxed
when
they

absorbed
the
wedges
message.

c.
“Well-­?intentioned
myself
contributed
the
Figure
that
accompanied
Bill
McKibben’s
article
in
National

Geographic
emissions
emissions
discussion

2011 Climate CoLab contest – How should the 21st century economy evolve bearing in mind the reality of climate change?

From my friends at the MIT Climate CoLab, a cool experiment in collective intelligence:

To the members of the Climate CoLab,

We are pleased to announce the launch of the 2011 Climate CoLab Contest. This year, the question that the CoLab poses is:

How should the 21st century economy evolve bearing in mind the reality of climate change?

This year’s contest will feature two competition pools:

  • Global, whose proposals outline how a feature of the world economy should evolve,
  • Regional/national, whose proposals outline how a feature of a regional or national economy should evolve.

The contest will run for six months from May 16 to November 15. Winners will be selected based on voting by community members and review by the judges.

The winning teams will present their proposals at briefings at the United Nations in New York City and U.S. Congress in Washington, D.C. The Climate CoLab will sponsor one representative from each of the winning teams.

We encourage you to form teams with other CoLab members who share your regional or global interests. Fill out your profile and start debating and brainstormingIf you would like to join a team, please send me a message.

Learn more about this year’s contest at http://climatecolab.org. Please tell your friends!

Best,

Lisa Jing
For the Climate CoLab Team

Modeling the Ryan proposal

Thanks Pete for pointing out that there is modeling behind the Ryan proposal after all. Macroeconomic Advisers has the kind of in-depth scrutiny of the model results that I love, in The Economic Effects of the Ryan Plan: Assuming the Answer?.

You really should read it, but here are some of the juicier excerpts:

Peek-a-boo

There were actually two sets of results. The first showed real GDP immediately rising by $33.7 billion in 2012 (or 0.2%) relative to the baseline, with total employment rising 831 thousand (or 0.6%) and the civilian unemployment rate falling a stunning 2 percentage points, a decline that persisted for a decade. (This path for the unemployment rate is labeled “First Result” in the table.) The decline in the unemployment rate was greeted — quite correctly, in our view — with widespread incredulity. Shortly thereafter, the initial results were withdrawn and replaced with a second set of results that made no mention of the unemployment rate, but not before we printed a hardcopy! (This is labeled “Second Result” in the table.)

Multiplier Mischief

The simulation shows real federal non-defense purchases down by $37.4 billion in 2012, but real GDP up by $33.7 billion, so the short-run “fiscal multiplier” is negative.[11] As noted above, that analysis was prepared using the GI model of the US economy. We are not intimately familiar with this model but have the impression it is a structural macro model in which near-term movements in GDP are governed by aggregate demand while long-term trends in output are determined by the labor force, the capital stock, and total factor productivity. Obviously we can’t object to this paradigm, since we rely on it, too.

However, precisely because we are so familiar with the characteristics of such systems, we doubt that the GI model, used as intended, shows a negative short-run fiscal multiplier. Indeed, GI’s own discussion of its model makes clear the system does, in fact, have a positive short-run fiscal multiplier.[12] This made us wonder how and on what grounds analysts at Heritage manipulated the system to produce the results reported.

Crowding Out Credibility

So, as we parsed the simulation results, we couldn’t see what was stimulating aggregate demand at unchanged interest rates and in the face of large cuts in government consumption and transfer payments…until we read this:

“Economic studies repeatedly find that government debt crowds out private investment, although the degree to which it does so can be debated. The structure of the model does not allow for this direct feedback between government spending and private investment variables. Therefore, the add factors on private investment variables were also adjusted to reflect percentage changes in publicly held debt (MA italics).”

In sum, we have never seen an investment equation specified this way and, in our judgment, adjusting up investment demand in this manner is tantamount to assuming the answer. If Heritage wanted to show more crowding in, it should have argued for a bigger drop in interest rates or more interest-sensitive investment, responses over which there is legitimate empirical debate. These kinds of adjustments would not have reversed the sign of the short-run fiscal multiplier in the manner that simply adjusting up investment spending did.

Hilarious Housing?

In the simulation, the component of GDP that initially increases most, both in absolute and in percentage terms, is residential investment. This is really hard to fathom. There’s no change in pre-tax interest rates to speak of, hence the after-tax mortgage rate presumably rises with the decline in marginal tax rates even as the proposed tax reform curtails some or all of the mortgage interest deduction. …

The list of problems goes on and on, and there are others. MacroAdviser’s bottom line:

In our opinion, however, the macroeconomic analysis released in conjunction with the House Budget Resolution is not relevant to the coming discussion. We believe that the main result — that aggressive deficit reduction immediately raises GDP at unchanged interest rates — was generated by manipulating a model that would not otherwise produce this result, and that the basis for this manipulation is not supported either theoretically or empirically. Other features of the results — while perhaps unintended — seem highly problematic to us and seriously undermine the credibility of the overall conclusions.

This is really unfortunate, both for the policy debate and the modeling profession. Using models as arguments from authority, while manipulating them to produce propagandistic output, poisons the well for all rational inputs to policy debates. Unfortunately, there’s a long history of such practice, particularly in economic forecasting:

Not surprisingly, the forecasts produced by econometric models often don’t square with the modeler’s intuition. When they feel the model output is wrong, many modelers, including those at the “big three” econometric forecasting firms—Chase Econometrics, Wharton Econometric Forecasting Associates, and Data Resources – simply adjust their forecasts. This fudging, or add factoring as they call it, is routine and extensive. The late Otto Eckstein of Data Resources admitted that their forecasts were 60 percent model and 40 percent judgment (“Forecasters Overhaul Models of Economy in Wake of 1982 Errors,” Wall Street Journal, 17 February 1983). Business Week (“Where Big Econometric Models Go Wrong,” 30 March 1981) quotes an economist who points out that there is no way of knowing where the Wharton model ends and the model’s developer, Larry Klein, takes over. Of course, the adjustments made by add factoring are strongly colored by the personalities and political philosophies of the modelers. In the article cited above, the Wall Street Journal quotes Otto Eckstein as conceding that his forecasts sometimes reflect an optimistic view: “Data Resources is the most influential forecasting firm in the country… If it were in the hands of a doom-and- gloomer, it would be bad for the country.” John Sterman, A Skeptic’s Guide to Computer Models

As a historical note, GI – Global Insight, maker of the model used by Heritage CDA for the Ryan analysis – is the product of a Wharton/DRI merger, though it appears that the use of the GI model may have been outside their purview in this case.

What’s the cure? I’m not sure there is one as long as people are cherry-picking plausible sounding arguments to back up their preconceived notions or narrow self-interest. But assuming that some people do want intelligent discourse, it’s fairly easy to get it by having high standards for model transparency and quality. This means more than peer review, which often entails only weak checks of face validity of output. It means actual interaction with models, supported by software that makes it easy to identify causal relationships and perform tests in extreme conditions. It also means archiving of models and results for long-term replication and quality improvement. It requires that modelers invest more in testing the limits of their own insights, communicating their learnings and tools, and fostering understanding of principles that help raise the average level of debate.

The delusional revenue side of the Ryan budget proposal

I think the many chapters of health care changes in the Ryan proposal are actually a distraction from the primary change. It’s this:

  • Provides individual income tax payers a choice of how to pay their taxes – through existing law, or through a highly simplified code …
  • Simplifies tax rates to 10 percent on income up to $100,000 for joint filers, and $50,000 for single filers; and 25 percent on taxable income above these amounts. … [A minor quibble: it's stupid to have a stepwise tax rate, especially with a huge jump from 10 to 25%. Why can't congress get a grip on simple ideas like piecewise linearity?]
  • Eliminates the alternative minimum tax [AMT].
  • Promotes saving by eliminating taxes on interest, capital gains, and dividends; also eliminates the death tax.
  • Replaces the corporate income tax – currently the second highest in the industrialized world – with a border-adjustable business consumption tax of 8.5 percent. …

This ostensibly results in a revenue trajectory that rises to a little less than 19% of GDP, roughly the postwar average. The CBO didn’t analyze this; it used a trajectory from Ryan’s staff. The numbers appear to me to be delusional.

For sub-$50k returns in the new 10% bracket, this does not appear to be a break. Of those returns, currently over 2/3 pay less than a 5% average tax rate. It’s not clear what the distribution of income is within this bracket, but an individual would only have to make about $25k to be worse off than the median earner, it appears. The same appears to be true in the $100k-200k bracket. A $150k return with a $39k exemption for a family of four would pay 18.5% on average, while the current median is 10-15%. This is certainly not a benefit to wage earners, though the net effect is ambiguous (to me at least) because of the change in treatment of asset income.

The elimination of tax on interest, dividends and capital gains is really the big story here. For returns over $200k, wages are less than 42% of AGI. Interest, dividends and gains are over 35%. The termination of asset taxes means that taxes fall by about a third on high income returns (the elimination of the mortgage interest deduction does little to change that). The flat 25% marginal rate can’t possibly make up for this, because it’s not different enough from the ~20% median effective tax rate in that bracket. For the top 400 returns in the US, exemption of asset income would reduce the income basis by 70%, and reduce the marginal tax rate from the ballpark of 35% to 25%.

It seems utterly delusional to imagine that this somehow returns to something resembling the postwar average tax burden, unless setting taxes on assets to zero is accompanied by a net increase in other taxes (i.e. wages, which constitute about 70% of total income). That in turn implies a tax increase for the lower brackets, a substantial cut on returns over $200k, and a ginormous cut for the very highest earners.

This is all exacerbated by the simultaneous elimination of corporate taxes, which are already historically low and presumably have roughly the same incidence as individual asset income, making the cut another gift to the top decile. With rates falling from 35% at the margin to 8.5% on “consumption” (a misnomer – the title calls it a “business consumption tax” but the language actually taxes “gross profits”, which is in turn a misnomer because investment is treated as a current year expense). The repeal of the estate tax, of which 80% is currently collected on estates over $5 million (essentially 0% below $2 million) has a similar distributional effect.

I think it’s reasonable to discuss cutting corporate taxes, which do appear to be cross sectionally high. But if you’re going to do that, you need to somehow maintain the distributional characteristics of the tax system, or come up with a rational reason not to, in the face of increasing inequity of wealth.

I can’t help wondering whether there’s any analysis behind these numbers, or if they were just pulled from a hat by lawyers and lobbyists. This simply isn’t a serious proposal, except for people who are serious about top-bracket tax cuts and drowning the government in a bathtub.

Given that the IRS knows the distribution of individual income in exquisite detail, and that much of the aggregate data needed to analyze proposals like those above is readily available on the web, it’s hard to fathom why anyone would even entertain the idea of discussing a complex revenue proposal like Ryan’s without some serious analytic support and visualization. This isn’t rocket science, or even bathtub dynamics. It’s just basic accounting – perfect stuff for a spreadsheet. So why are we reviewing this proposal with 19th century tools – an overwhelming legal text surrounded by a stew of bogus rhetoric?