Health Care Reform and Supply-side Arguments

Greg Mankiw and Sally Pipes note what CBO director Doug Elmendorf said about the use of a supply-side argument by Democratic proponents of health care reform:

The point is that for employers, health care is merely a part of total compensation: It reduces cash compensation for employees but it does not increase costs of employment. To argue otherwise is to argue for lower total U.S. compensation -- that is, lower wages for U.S. workers. Said Mr. Elmendorf, "the costs of providing health insurance to their workers are not a competitive disadvantage to U.S.-based firms."

If one assumes that the labor supply curve was perfectly inelastic, then any increase (decrease) in the amount of employee health care cost borne by the employer would be fully passed onto employees in the form of lower (higher) wages. The analysis is similar to an analysis of the effect of reducing the payroll tax - a proposal that Greg Mankiw has made. If the labor supply curve is perfectly inelastic, reducing either the payroll tax or the amount of employee health care cost borne by the employer would have no effect on the cost of employment to employers or the amount of workers hired.

But wait a second - I thought moderate supply-siders such as Greg Mankiw (Dr. Mankiw is not one of those lunatic supply-siders like Art Laffer) argue for reductions in the payroll tax in order to induce an increase in employment as if the labor supply curve were not perfectly inelastic. So why wouldn’t a reduction in the amount of employee health care cost borne by the employer have at least modest benefits for the US economy?

Update: CBO provides Elmendorf’s testimony on February 25, 2009. On the last two pages of this 31 page document, there is a brief discussion entitled “Effects on the Economy”. While Elmendorf did make the sensible statement that any cost of employer provided health care would at least be borne in the form of lower wages, this section also begins with:

Proposals that made large-scale changes affecting the provision and financing of health insurance could also have an impact on the broader economy. Because most health insurance is currently provided through employers, proposals could affect labor markets by changing individuals’ decisions about whether and how much to work and employers’ decisions to hire workers.

Glass Houses Alert

by the Sandwichman

Paul Krugman groans about the news media's penchant for one-sided debate

One major sin of news coverage, especially on TV, is the way certain points of view just get excluded from consideration — even if many of the best-informed people hold those views. Most famously and disastrously, the case against invading Iraq was just not heard in the months before the war.

And one major sin of economics education and the public discourse of economics is the way certain points of view just get excluded from consideration. The perspective that work time reduction might be a key part of a progressive economic recovery strategy — as Keynes pointed out, one of three ingredients of a cure and the ultimate solution — is not only excluded, it is ridiculed by economists as a lump of labor fallacy. I’ve researched the alleged fallacy and I’ve found the claim to be fraudulent. The results of my research have been published in the Review of Social Economy as “Why Economists Dislike a Lump of Labor”. I’ve even offered a $10,000 prize if someone could refute my rebuttal and get it published in a leading economics journal. No takers of course.

Meanwhile, Dean Baker has offered a policy proposal for reducing working time as part of an economic recovery package. Just listen to the spirited discussion among economists of Dean’s proposal! What’s that you say? Silence? Oh.

What Would James Tobin Say About Today’s GOP Fiscal Stance?

AP reports:

The top Republican in the House is seizing on the latest spike in unemployment to call for a freeze on government spending and to urge President Barack Obama to veto a $410 billion spending bill. Rep. John Boehner, R-Ohio, said the jump in unemployment to 8.1 percent and the loss of 651,000 jobs in February is a sign of a worsening recession that demands better solutions from both parties. Boehner criticized the spending bill as chocked full of wasteful, pork-barrel projects. The Senate postponed a vote on the bill until Monday amid the criticism. Boehner said he hoped Obama would veto the bill. He urged the president to work with House Republicans to impose a spending freeze until the end of this fiscal year.

Josh Marshall calls this proposal a joke:

I'm not even sure it's fair to say that this is a replay of the disastrous decisions the magnified the Great Depression between 1929 and 1933. It's more a parody of it. When the crisis is a rapid and catastrophic drop off in demand, you handcuff the one force that can create demand (i.e., the federal government) in the throes of the contraction. That's insane.

As the recession during the early 1980’s worsened, one of the calls from certain supply-side types was that we could increase aggregate demand by cutting government spending. In a speech echoing this insane theme by one of the practitioners of a large econometric model of the US economy, James Tobin asked the speaker a simple question. He asks the practitioner to tell the audience the sign of his fiscal policy multiplier. In other words – as Dr. Tobin explained – what would be the predicted effect on output if the model entertained an increase in government spending? The practitioner thought about the question for a moment and replied that the predicted impact on output from an increase in government spending would be positive. To which – Dr. Tobin politely noted that the entire speech made no sense.

Now if Congressman Boehner can point to a credible econometric model of the US economy where the fiscal policy is negative, maybe he can defend his spending freeze proposal. Otherwise, as Josh notes:

DC Republicans are simply not part of the discussion when it comes to repairing the US economy or arresting our slide into deep economic misery. And any reporters who aren't clear about this are just lying to their readers or viewers.

Request for comments on the new intro for my book

I just completed a nearly final version of The Invisible Handcuffs of Capitalism: How Market Tyranny Stifles the Economy by Stunting Workers. I have put earlier versions here, but this one is very different. The second half is totally new.

I would very much appreciate any comments.

This site would not let me upload the file for some reason. I put here:

http://michaelperelman.wordpress.com/2009/03/07/request-for-comments-on-new-introduction-for-my-new-book/

Thanks in advance.

First the "Good" News...

by the Sandwichman

According to the BLS, nonfarm payrolls fell by "only" 651,000 last month. This was "not as horrific as many traders feared."

Meanwhile, back on earth,

The change in total nonfarm employment for December was revised from -577,000 to -681,000 and the change for January was revised from -598,000 to -655,000. Monthly revisions result from additional sample reports and the monthly recalculation of seasonal factors.

Let's do the math. 651,000 + 161,000 = 812,000 (not counting next month's likely upward revision of this month's 651,000). Not as horrific as many traders feared?

Quote of the week

A monetary crisis rapped inside a liquidity crisis; all rapped inside a quality crisis;

All rapped inside a fiscal crisis rapped inside a financial crisis;

All rapped inside a confidence crisis rapped inside a crisis in the dominant growth paradigm;

All rapped inside a contradiction rapped inside an enigma.

Travis Fast

Fujita on Krugman

I have suggested here that Masahisa Fujita deserved to share the Nobel Prize with Paul Krugman. Fujita has coauthored with Krugman in the late 1990s, after Krugman published his 1991 paper that was cited in his prize. However, Fujita has now published a paper with Jaques-Francois Thisse in Regional Science and Urban Economics (RSUE), "New economic geography: An appraisal on the occasion of Paul Krugman's 2008 Nobel prize in economic sciences," March 2009, 39(2), 109-119. The abstract is as follows:

Paul Krugman has clarified the microeconomic underpinnings of both spatial economic agglomerations and regional imbalances at national and international levels. He has achieved this with a series of remarkably original papers and books that succeed in combining imperfect competition, increasing returns, and transportation costs in new and powerful ways. Yet, not everything was brand new in New Economic Geography. To be precise, several disparate pieces of high-quality work were available in urban economics and location theory. Our purpose in this paper is to shed new light on economic geography through the lenses of these two fields of economics and regional science.

The paper provides quite a list of these predecessors, and although the paper does not highlight them too much, they include his paper in 1988 in RSUE that pretty much fully covered what is in the 1991 paper by Krugman, "A monopolistic competition model of spatial agglomeration: a differentiated product approach." The extensive literature he cites includes two important papers in 1980 and 1982 by him with H. Ogawa, as well as highlighting the foundational work in the 1940s and 1950s by the "Father of Regional Science," the still-living at 90 years old, Walter Isard, also one of the founders of "Peace Economics."

Is Brad DeLong Going To The US Treasury?

If one visits Brad DeLong's blog, one will find photos he took on Monday while visiting the US Treasury in Washington, including one of his nose, :-). Brad was a Deputy Assistant Secretary of the Treasury in the early years of the Clinton administration. He was also a student of Larry Summers at Harvard and his most famous papers were coauthored with Summers. Summers was reportedly the person who brought him to Treasury under Clinton, and is now reportedly the top adviser to Obama, with Geithner as Treasury Secretary also a protege and presumably knowing DeLong quite well. All of the positions just below the Secretary level are unfilled, with no public reports of who the candidates are: Deputy plus the Undersecretary and Assistant Secretary positions. All this rather looks to me like Brad may well be a candidate for one of these. Of course, if he takes one, that will probably mean at least a temporary end to his widely read blog.

Mankiw’s GOP Talking Points on Obama’s Budget

Greg Mankiw writes:

Rahm Emanuel, the incoming White House chief of staff, has said, “You don’t ever want to let a crisis go to waste: it’s an opportunity to do important things that you would otherwise avoid.” What he has in mind is not entirely clear. One possibility is that he wants to use a temporary crisis as a pretense for engineering a permanent increase in the size and scope of the government. Believers in limited government have reason to be wary.

He precedes this suggestion that President Obama is a big government liberal (at least he did not use the term socialism) with:

Federal Outlays as a Percentage of GDP
Average over the past half century: 20.2 percent
In 2007, the year before the crisis: 20.0 percent
In 2009, from the Obama budget: 27.2 percent
Average 2010-19, in Obama budget: 22.6 percent
In 2019, last year of Obama budget: 22.6 percent

This presentation is misleading in a couple of ways – which is why I’ve presented two graphs (both using data from this source). The first graph shows Federal expenditure (both total and current) as a percent of GDP. Notice that Federal spending as a share of GDP was about as high in 1985 as it is projected to be for 2019. Also notice that Federal spending as a share of GDP fell during the term of our last Democratic President only to rise under that Republican President that Greg Mankiw served. To be fair – much of this variation came from changes in the defense spending to GDP ratio and not from changes in domestic Federal spending as our second graph shows.

Our second graph also show Federal health spending as a share of GDP, which has risen from 0.5% of GDP in the early 1960’s to over 5% in the last few years. Part of this increase is attributable to changes in what the Federal government covers during George W. Bush’s tenure in office but we should also note that total U.S. health expenditure (public and private) as a share of GDP has been rising and is expected to continue to rise. Given this reality – I’m surprised that the projected share for 2019 is not higher than 22.6%.

Update: A New Era of Responsibility - Renewing America’s Promise does show that the projected Federal outlay to GDP ratio for 2019 under President Obama’s proposed changed in the budget will be 22.6% as Greg claims but what Greg did not tell us is that the baseline budget projected Federal outlays to be 23.2% of GDP by 2019. The document has all sorts of details including the projected increases in Medicare and Medicaid as well as the proposals to reduce defense spending relative to what is in the baseline budget.

Reduce consumption says head of IPCC

The 2007 report of the Intergovernmental Panel on Climate Change (IPCC), issued last year, highlights "the importance of lifestyle changes," said Rajendra Pachauri [head of the IPCC] at a press conference in Paris. "This is something that the IPCC was afraid to say earlier, but now we have said it....tame carnivorous impulses". Don't buy things "simply because they're available..." [*]

Also some excerpts from the State of the World 2009 report:
** Approximately two-thirds of the energy fed into the world's power plants is wasted-released into the environment as heat. (p. 142)

** it is technically and economically feasible to reduce greenhouse gas emissions fast enough .

** The process of tilling soil releases CO2 into the atmosphere.

** Perennial crops store more carbon in the soil than annually planted ones.

The report can be downloaded here.


[*] Lifestyle changes can curb climate change: IPCC chief
Jan 15, 2008
http://afp.google.com/article/ALeqM5iIVBkZpOUA9Hz3Xc2u-61mDlrw0Q

Anticipatory Revisionist History

Right now in some of the most important right-wing think tanks of the country, well-paid hacks are churning out definitive histories of the current crash. Obviously, market forces are part of the solution rather than the problem. We can agree with many of them that the Federal Reserve played a role.

This work follows in a long tradition. For example, their forefathers already figured out that the Smoot-Hawley tariff caused the Great Depression.

We know how innovative this school of thought can be. They've already figured out that government mandates to lend to poor people caused the subprime crisis.
Surely, excessive taxes will be part of the story, but I can't figure out how they will spin that.

What other kinds of regulations and interference with the market is responsible for the debacle?

An immoral or evil nature is not implied

“…To suggest that the Forestry Commission’s policy on clearfelling in dry forests is the result of ideologies does not imply any immoral or evil nature in the officers of the Commission since such ideologies are developed in an unconscious manner. If one has ever been present during a hot regeneration burn, however, it is easy to recognize the impact the event has on those involved. The fire-storm and condensation cloud as well as the immense heat are a far cry from just letting the forest grow back by itself. This active involvement that regeneration burning involves also has implications for the size of the organization, a fact that cannot be dismissed too quickly when analyzing the clearfelling decision. Every organization appears to have an inbuilt “desire” to expand.

The nature of bureaucracies and the theory of public policy can explain, in part, why the Forestry Commission employed clearfelling in dry forests. But much of the decision appears to have derived from individuals whose minds simply came made up; these people simply reasoned or justified that decision after the event as justification became more and more necessary.” [1]

Here's how the current Australian Labor Government fobs off attempts to regulate deliberate and unnecessary forestry infernos; by pretending that all biomass burns are acts of nature beyond the Government's control:

“If a country chooses to account for any Article 3.4 activities [Kyoto Protocol forest management], it must include, and report on, all emissions from all land nationwide on which those activities are undertaken. Australia has elected not to include any such activities because of the risk that random natural events, such as drought or bushfire, could result in significant emissions from those sources during a commitment period.... [If] natural events such as drought and fire result in the release of greenhouse gases over much shorter periods...[if they were] counted towards Annex I countries’ targets, then countries subject to natural disturbances would have no control over meeting or exceeding their targets...." [2]


The Federal and State Governments have amended the 'Regional Forest Agreement' to ensure that our law courts are unable to insist on real protection for the environment and people. Watering the RFA down to say "only that regard be given to the assessment of environmental, social, cultural and economic values..." [3] Effectively, that means that 'anything goes' (ie business as usual).

[Pictures of intense industrial forestry burnoffs in Tasmania were taken by Rob Blakers.]

[1] Clearfelling in Tasmania’s Dry Forests: Analysis of a Public Policy Decision
By David Harries.
Chapter 6. ‘Perspectives on Forest Policy in Tasmania’ edited by Aynsley J Kellow. University of Tasmania Environmental Studies Occasional paper 18. Published Hobart 1984. ISBN 0 85901 257 3. Page 140.

[2] Carbon Pollution Reduction Scheme: Australia's Low Pollution Future
White Paper. 15 December 2008. Executive summary
http://www.climatechange.gov.au/whitepaper/summary/index.html

[3] Environmental Defenders Handbook
http://www.edohandbook.org/doku.php?id=ch8#bushfire_damage_and_smoke_pollution

Economist.com Fires Back with Respect to its Alleged Backdoor Employment Tax Cut

When I criticized this, I should have placed the following in bold:

So the total taxes paid to the government do not fall – just who ends up directly paying the government.

The rebuttal goes something like this:

The assumption of highly inelastic labour is important, but I would argue that it does not always apply in typical labour markets, especially with respect to a single employer.

Actually, the assumption as to the elasticity of either the supply or the demand schedule is not important for the experiment described as follows:

One participant, who writes about technology, remarked that it is not unusual for tech firms to fire their employees and rehire them the next week as consultants. This is essentially a backdoor payroll tax reduction for the employer. When a worker is considered a contracter they become responsible for their full tax burden to Social Security and Medicare (and the cost of health and pension benefits).

Let’s do a very simple example of an employer-employee relationship where the employer ultimately pays $10 an hour for the services of the worker but the government collects $1.50 an hour in payroll taxes leaving the worker with $8.50 an hour after taxes. If the initial burden of the tax system were split evenly between the employer and the employee, both pay $0.75 an hour to the government with the employer paying the worker $9.25 an hour. Now if the employee becomes an independent contractor, he ends up paying all $1.50 an hour to the government but his check from the employer is $10 an hour. Notice something – I made no assumption about elasticity of demand or supply.

Why does this work out this way? In fact, we had a tax cut for the employer and an equivalent tax increase for the worker. Since the government tax bite has neither increased nor decreased, there is no net effect for either the before-tax wage paid by the employer or the after-tax wage paid by the worker.

To be fair, this demand equals supply model assumes that the labor market clears. I would hate to be accused (again) of “selective quotation” so let me note the following:

In an extremely loose labour market the employee will bear the full tax burden because his labour supply becomes more inelastic. Enough so an employer has the leverage to make that burden explicit and shift it entirely to his employee.

Since we are in a recession, maybe the whole use of demand and supply curve models is a bit misleading. But if one wishes to use such models, maybe one should start off the comparative statics exercise by first noting that the overall tax bit has not changed in the experiment being discussed.

While it is true that the effective wage for workers is likely to fall during periods of weak aggregate demand, this occurrence is not due to some reduction in the tax bite. Maybe the mechanism becomes the shifting of the tax burden without an offsetting increase in the before-tax wage. But the same effect could have been accomplished by simply reducing the wage rate. I guess one could postulate that wages are somehow sticky so employers look for ways around this fact by cutting compensation through some other means – as was once argued by Walter J. Wessels in Minimum Wages, Fringe Benefits, and Working Conditions. But to say that changing the primary incidence of who pays for an unchanged tax bite is the same thing as a tax cut is highly misleading.

Herbert Hoover Democrats

If we were at full employment, I might agree with what Evan Bayh wrote for the Wall Street Journal:

The Omnibus Appropriations Act of 2009 is a sprawling, $410 billion compilation of nine spending measures that lacks the slightest hint of austerity from the federal government or the recipients of its largess. The Senate should reject this bill. If we do not, President Barack Obama should veto it. The omnibus increases discretionary spending by 8% over last fiscal year's levels, dwarfing the rate of inflation across a broad swath of issues including agriculture, financial services, foreign relations, energy and water programs, and legislative branch operations. Such increases might be appropriate for a nation flush with cash or unconcerned with fiscal prudence, but America is neither.

Bayh later notes that we are in an “economic downturn” noting that this fact requires that we need “new policies”. Is Bayh saying we should excuse fiscal irresponsibility during periods of strong aggregate demand but then turn all Hoover-ish when aggregate demand is weak? As Manu Rasu reports, Bayh is not alone:

Moderate and conservative Democrats in the Senate are starting to choke over the massive spending and tax increases in President Barack Obama’s budget plans and have begun plotting to increase their influence over the agenda of a president who is turning out to be much more liberal than they are. A group of 14 Senate Democrats and one independent huddled behind closed doors on Tuesday, discussing how centrists in that chamber can assert more leverage on the major policy debates that will dominate this Congress. Afterward, some in attendance made plain that they are getting jitters over the cost and expansive reach of Obama’s $3.6 trillion budget proposal.

I can understand the desire to restrain the growth of Federal spending over the long-term, but I do not understand the call for fiscal austerity now.

Does Economist.com Understand Incidence of the Payroll Tax?

Backdoor Payroll Tax Cut lays out a silly argument:

One participant, who writes about technology, remarked that it is not unusual for tech firms to fire their employees and rehire them the next week as consultants. This is essentially a backdoor payroll tax reduction for the employer. When a worker is considered a contracter they become responsible for their full tax burden to Social Security and Medicare (and the cost of health and pension benefits).

So the total taxes paid to the government do not fall – just who ends up directly paying the government. Not to praise anything from the Heritage Foundation, but even Stephen Entin can explain the standard view with respect to who bears the incidence of the payroll tax:

The relatively elastic demand for labor, coupled with the assumption of a highly inelastic supply of labor, means that labor bears most of the initial economic incidence of taxes on labor income. It has become common to assert that all taxes on labor income fall on the worker, including the employers’ share of the pay¬roll tax, the employees’ share of the payroll tax, the unemployment compensation tax, and the portion of the income tax that falls on wages and salaries.

As the primary burden on the employer for paying this tax has been shifted to the worker, the standard model says that the wage rate being paid by the employer to the worker rises in an exactly offsetting fashion.