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    A Big VAT

    Nov 14 • Government, Households, Macroeconomic Measurement • 427 Views

    Dating back to the 18th century, the Chinese vase that a brother and sister found “in a dusty attic” sold for $69.5 million at a London auction. The NY Times called it a “treasure-in-the-attic” story. For us economists, it is a VAT story.

    According to the OECD (Organization for Economic Cooperation and Development) the U.K.’s value-added tax rate is 17.5%. Typically, taxing “value added” means a tax is added to each stage of production. But, for this 16 inch, mostly yellow and sky-blue vase that was probably fired near Shanghai, the only value-added stage was the auction. With the VAT, the price of $69.5 million became $81.7 million. (I am not sure why the NY Times says that with the VAT and a 20% buyer’s premium, the final price was $85.9 million.)

    If the same vase had been sold in NYC to a local resident, maybe an 8.875% sales tax would have applied. On the sell side, perhaps the IRS personal income tax obligation would soar.

    You can see where this is going. Depending on where you are, because tax systems vary, so too do incentives. A VAT, as a consumption tax, is supposed to encourage saving. With the deficit commission proposing a vastly simplified tax system, we might see incentives change in the U.S.

    The Economic Lesson

    The OECD tells us that VAT revenue for close to 150 countries is approximately 20% of their total receipts. The United States is the exception. In the U.S., for FY 2009, the personal income tax generated 44% of all tax revenue while social insurance taxes accounted for 42%. Corporate income taxes were a distant third at 7%.

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    What Should Government Pay For?

    Nov 13 • Economic Debates, Economic History, Government, Macroeconomic Measurement • 297 Views

    Topping its front page with “CUT, RAISE, RAISE, LOWER, REPEAL, SCRAP, CUT, CUT,” The Wall Street Journal told readers some of the new deficit commission’s proposals. 1) For defense spending, the cut would be $100 billion. 2) The Social Security age would rise to 69 by 2075. 3) The gas tax would go up 15 cents. 4) The corporate tax rate would go down to 26%. 5) The alternative minimum tax would be repealed. 6) There would no longer be deductions for mortgages over 500k. 7) The federal work force would be cut by 10%. 8) Farm subsidies would drop by $3 billion.

    For each proposal, already, a mountain of pro and con opinions is building. For example, just for changing the Social Security retirement age, the list of arguments on both sides is long because affluence, health, job history, and gender all relate to how Social Security impacts you. Supporters point out that when Social Security was passed in 1935, the average life span was, at 61.7, 3.3 years less than the retirement age. In 2035, 20% of the U.S. population is projected to be 65 or older. Responding, economist Paul Krugman says, “working until you’re 69…is a lot harder…for…Americans who still do physical labor.” Also, he says that high earners live longer.

    The Economic Lesson

    Defined on Planet Money, a public good is “something that we all need that will make our lives better, but the market will not and cannot provide.”  Podcast examples included lighthouses and autopsies.

    Should government pay only for “public goods?” We would not have a deficit problem.

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    Free Trade

    Nov 12 • Developing Economies, International Trade and Finance • 400 Views

    KORUS has been in the news. The Korea-U.S. Free Trade Agreement, negotiated in 2007 but not ratified by Congress, was in trouble. One reason was Ford.

    With a 1% share of the South Korean car market, U.S. automakers want more. One of the bigger sellers of Ford vehicles in South Korea complained about import taxes that make his vehicles so much more expensive than Korean made cars. Ford also said that unfairly high South Korean emissions and safety standards on imports prevent them from competing.

    I guess all of this reminds me of China and our chicken feet and Italy and Pecorino cheese. When we put a tariff on their tires, China retaliated against our chicken feet. When the EU unfairly treated our bananas, we taxed their cheese.

    The significance? Free trade agreements increase U.S. exports. They stimulate our economic growth. Also, though, whether in South Korea or the U.S., they challenge specific domestic producers and can eliminate domestic jobs. Free trade is one of those issues that has been debated for centuries and will remain controversial.

    The Economic Lesson

    Combining Adam Smith and David Ricardo, we can see why most economists support free trade. In a factory, Adam Smith says specialize through division of labor. When each worker has a specific task, output multiplies. Increasing output requires bigger markets in order to sell what has been produced.  As mass production enables us to move from local markets to regional specialization to free world trade, as David Ricardo explained, the world benefits.

    In a 2006 survey, 87.5% of all PH.D members of the American Economic Association said yes to free trade by agreeing that “the U.S. should eliminate remaining tariffs and other barriers to trade.”

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    The Cost of a Corn Flake

    Nov 11 • Businesses, Demand, Supply, and Markets, International Trade and Finance • 359 Views

    Telling us that corn prices are soaring, NPR asked, “Why Not Corn Flakes?” After all, approximately 13 ounces of an 18-ounce box of corn flakes is corn. The corn, though, only adds close to 4 cents to the price. So, even if corn prices continue to soar, a 33% increase means less than 2 cents more for our flakes.

    As we have heard from Michael Pollan, corn touches our food supply in countless ways. We might see skinnier animals being sold by farmers who are paying more for corn feed and higher prices for beef, pork, and chicken. It is also possible that Coke and Pepsi will substitute sucrose for high-fructose corn syrup. Citing higher commodity costs, McDonald’s just announced it was raising menu prices.

    The Economic Lesson

    A classic economic scenario, drought in Russia and too much rain in some U.S. corn fields shifted the corn supply curve to the left. Meanwhile, congressional ethanol mandates and some panic buying from Asia are shifting the demand curve to the right. Supply down. Demand up. The resut? Higher prices.

    You know what follows. Through the wonder of the market, the invisible hand tells farmers to plant more corn. 


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    Venezuela’s Prices

    Nov 10 • Businesses, Demand, Supply, and Markets, Regulation • 344 Views

    You might find it interesting to ponder the implications of the sign in a Venezuelan shopping mall which I saw on Harvard’s N. Gregory Mankiw’s blog. Called Mercado Bicentenario, the store was a part of a chain that had recently been nationalized by the Venezuelan government. The sign said the following:

    Description of the product: Diana oil

    Fair Price: 4,73 Bfs

    Capitalist Price: 7,00 Bfs.

    % of Savings: 32%

    The Economic Lesson

    Please consider for a moment what you think when you hear that a t-shirt is $10. What if the price is $50? As market determined prices, $10 and $50 convey a message to sellers and buyers.

    Market (or as stated in Venezuela, “capitalist”) prices provide crucial information. They tell us about value and efficiency and affordability. They let consumers and businesses and government decide what to do, what not to do, and what they can do better.

    A government established price conveys no signals to sellers and buyers. The supply side can no longer determine a connection among price, profits, and using resources efficiently. On the demand side, consumers can neither assess quality nor indicate what they want and do not want. 

    The long lines, pajama tops without buttons, and grouchy salespeople that characterized the former Soviet Union are perfect examples of what happens in a centrally controlled economy.



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