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    Taxing Decisions

    Aug 16 • Demand, Supply, and Markets, Economic History, Government, Households, Innovation, International Trade and Finance, Labor • 459 Views

    According to The Atlantic’s Megan McArdle, all of us should know about the Fallacy of Chesterton’s Fence before we decide how we feel about taxes.

    Picture a fence extending across a road. 2 people approach it. The first says, “I don’t see the use of this; let us clear it away.” A second person answers, “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.” Chesterton’s point? Assuming that a reasonable person built the fence, we should know why before we decide we have a better reason for removing it.

    This takes us to Warren Buffett. After reading his NY Times Op-Ed column, “Stop Coddling the Super-Rich,” the sound bite that sticks is “Warren Buffett should pay more taxes.” But McCardle logically tells us that instead of focusing on one very affluent individual, we should ask why he and other high earners benefit from the current tax code. Only then can we support retaining or revising it.

    The Economic Lesson

    McCardle lists the issues we should consider when debating tax rates.

    1. The tax code should not diminish economic growth.
    2. People earning more should pay a higher proportion of their income than those earning less.
    3. Tax incentives for desirable activities should be retained.
    4. Tax laws should affect everyone; they should not be directed at any individual.

    She then asks, does this mean we should or should not retain charitable deductions? Home ownership mortgage deduction incentives? Encourage capital investment? If your answer is yes but you believe the affluent should pay more, then your position is potentially contradictory.

    An Economic Question: Please add the following to Ms. McArdle’s list.

    1. Fair
    2. Raising sufficient revenue
    3. Administratively simple

    Then, decide your priorities for a tax system:



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    Too Big To Fail

    Aug 15 • Businesses, Money and Monetary Policy, Regulation, Thinking Economically • 488 Views

    Imagine for a moment that you are the CEO of a large bank. Offered the opportunity to participate in a risky business deal, you say, “Yes.” If the venture succeeds, you benefit. If it fails and threatens your bank’s survival, the government is there to experience the loss because your bank is “too big to fail.”

    In a 2009 econtalk podcast, Gary Stern, past head of the Minneapolis Fed said that “too big to fail” distorts markets.  Explaining why, he said that once creditors expect that an institution will be rescued, no matter how risky its behavior, its demand curve shifts lower than it should be for that institution’s securities.  The result is “mispricing.” With borrowing less expensive, bankers have the incentive to engage in the risky behavior that creates systemic calamity.

    Agreeing, Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City said, “…Without this market discipline provided by creditors willing to withdraw their funds when they suspect a bank of being unsafe, banks have an incentive to take excessive risks.” To people who say Dodd-Frank provides a solution, Dr. Hoenig disagrees. Instead, he believes that the only answer is breaking up large institutions.

    Here, in a previous post, more is discussed about the problems of breaking up large banks.

    The Economic Lesson
    Whenever banking is discussed, someone always refers to Glass-Steagall as a benchmark.  Passed in 1933, Glass-Steagall is primarily associated with creating the FDIC and requiring banks to spin off their investment banking activities as separate firms. Repealed in 1999, actually, Glass-Steagall had gradually been unraveling since 1980.

    An Economic Question: Economist Sam Peltzman once suggested that a solution to a problem sometimes creates the results you are trying to prevent. For example, seatbelts might lead to more accidents because drivers become careless. Might “too big to fail” be an example of the Peltzman Effect?

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    Municipal Rivalries

    Aug 14 • Government, Thinking Economically • 442 Views

    Called the Tappan Zee, there is a bridge that extends across the Hudson River just north of New York City. It could have been a mile long or 2 but instead, politicians selected a spot where the river was 3 miles wide. The result was a more complex and pricey structure.

    NPR’s Planet Money reporters were curious about why New York’s Governor Thomas Dewey supported an apparently illogical decision. The reason was money. If the bridge had been positioned any closer to NYC where the Hudson was narrower, then New York State would have been prohibited from keeping the toll revenue. And New York State, in 1955, needed the money to complete the NY Thruway.

    Frequently, municipalities compete. For the Tappan Zee, it was New York State versus the Port Authority of NY and NJ. Had the bridge been closer to NYC, the Port Authority would have had the right to the toll money. When Honda and Mercedes contemplated locating in Alabama, they were offered generous tax breaks that enabled Talladega County to compete against other municipal bidders. Similarly, Los Angeles is trying to lure the Chargers away from San Diego through a deal for a new sports arena.

    The Economic Lesson

    This is all about revenue. Bridges, businesses and sports teams generate revenue for states, cities, counties. The revenue could be used for rebuilding roads or school budgets or pension obligations to municipal workers.

    An Economic Question: In this sluggish economy with many states and cities facing budget difficulties, would you support tax breaks for foreign investment.

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    “Boomerangers,” the Recession and the Family

    Aug 13 • Behavioral Economics, Households, Thinking Economically • 503 Views

    The “boomeranger” has returned. A Pew Research Survey found that 13% of all households are composed of parents with adult children who moved away and then returned home. Pew’s respondents say the economy was the reason these “boomerangers” moved back.

    In addition, there are fewer newlyweds, delayed babies, and for some, a postponed or canceled divorce. Again, the reason appears to be the Great Recession.

    The Economic Lesson

    Nobel prize winning economist Gary Becker tells us that marriage is about a lot more than love. Instead, we can better understand marriage by looking at a utility function, a graph that represents fluctuations in satisfaction.

    People marry because they expect to, “raise their utility level above what it would be were they to remain single.” (The Essence of Becker, p. 273)

    An Economic Question: Thinking of Becker’s reference to utility levels, how might the Great Recession have affected the attractiveness of marriage?

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    Sole Rights?

    Aug 12 • Businesses, Demand, Supply, and Markets, Economic Debates, Innovation, Regulation • 742 Views

    Suddenly, a red sole has become much more than the bottom of a shoe. The trademark of designer Christian Louboutin, his red soles are supposed to represent glamour, luxury and hidden status. Or, as stated by Mr. Louboutin, “A shoe has so much more to offer than just a walk.”   

    Agreeing, fashion house Yves Saint Laurent (YSL), designed its own line of luxury shoes with colored soles and wound up in a Manhattan courthouse. Louboutin claimed trademark infringement. Saying a red shoe sole is “ornamental and functional,” the court supported YSL.

    In a TED talk, Johanna Blakley explains that a jacket and most other clothing cannot receive intellectual property protection because they are “utilitarian”. A logo on the jacket can be protected but not the jacket or shoe. Contrary to what I would have expected, she believes that the industry is helped by the absence of protection. Copying begets trends; copying stimulates innovation. The threat of copying makes people repeatedly move onward to newer, better, and more unique designs.

    Here and here in past econlife posts, you can read more about fashion copycats.

    The Economic Lesson

    Shoe designers compete in monopolistically competitive markets. The characteristics of monopolistic competition include many sellers with a similar product, sellers creating an individual, unique identity, and sellers having some control over price. The competitive behavior of beauty salons, supermarkets, and clothing manufacturers is also shaped by a monopolistically competitive market structure.

    From most competitive to least competitive, the four basic competitive market structures are: perfect competition, monopolistic competition, oligopoly, monopoly.

    An Economic Question: In a monopolistically competitive market, why have Louboutin’s red soles been valuable?

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