Posted by Marc Hodak on June 15, 2009 under Executive compensation, Invisible trade-offs, Politics, Unintended consequences | 
The government, purveyor and practitioner of the most perverse incentives on the planet, is coming down the road with a cart of new remedies for incentive compensation:
“This financial crisis had many significant causes, but executive compensation practices were a contributing factor,” Geithner said in his statement on Wednesday. “Incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage.”
It is, indeed difficult to pinpoint all the potential causes of the financial crisis, and it’s certainly plausible to point the finger at bank compensation. The politicians and media would have us believe that:
A consensus has grown in Washington that compensation incentives based on short-term profit encouraged excessive risk taking at banks and played a major role in creating the financial crisis.
But the manner and degree to which bank compensation is at fault is, in fact, quite speculative. Read more of this article »
Posted by Marc Hodak on May 25, 2009 under Executive compensation, Unintended consequences |
Damn those finance geeks. The government imposed restrictions on their bonuses, and they turned around and increased their salaries. Who could have predicted that?
It’s as if Wall Street has this mysterious knowledge about the ability of value to be transformed into different kinds of financial claims, and that these claims that can be traded across time…and stuff. Where does this mysterious knowledge come from?
Posted by Marc Hodak on May 11, 2009 under Politics, Unintended consequences |
Residents in Greenwood, Ind., planned to widen a road leading to I-69 in hopes of attracting businesses, Mayor Charles Henderson said. Instead, a regional authority gave the city $1.2 million in federal stimulus funds to build a pedestrian trail bridge over a road. “It does not stimulate long-term economic development, but we’re going to take that money,” he said.
Most people admitted that trying to quickly spend $780 billion just to spend it would yield some inefficiencies. One of the many things the bill writers didn’t consider is how the raw amount of money offered in different ways to states and cities would interact to place different hands in the same pocket.
Charlotte received far less than that — about $4 million from the stimulus funding for road refurbishing — only to learn that the state would take back nearly $4 million it had planned to provide to the city in highway funds…
In Rhode Island, Providence Mayor David N. Cicilline, a Democrat, said city schools were happy to get about $10.2 million in federal money. Then the state Legislature cut state school aid by the same amount. “It clearly undermines the intention” of the stimulus legislation, Mr. Cicilline said.
And how are state governments deciding where to give and take these funds?
Pat McCrory, Charlotte’s mayor, charges that states often hand out federal dollars “by politics and not by need.”
Perhaps Charlotte is not exactly Chicago, but c’mon. Mayor McCrory cannot be such a political neo-phyte that he is actually stating this in surprise.
Posted by Marc Hodak on April 26, 2009 under Unintended consequences |
Here’s a simple thought experiment. There are ten people. They have an income distribution and a tax bill that look like this:
# Income Tax Effective rate
1 – 50 15 30%
2 – 20 5 25%
3 – 8 1.5 19%
4 – 6 0.8 13%
5 – 5 0.5 10%
6 – 4 0.2 5%
7 – 3 0 0%
8 – 2 0 0%
9 – 1 0 0%
10 – 1 0 0%
Total 100 23 23%
In other words, our little group roughly represents the distribution of income and income taxes in many developed countries. Now, let’s say that the government wanted to raise additional income by raising the top marginal rate, which would be felt exclusively by the top earner. Let’s say the effect of that increase would raise his tax from 15 to 16, or his effective tax rate from 30% to 32%. That would boost overall tax revenue from 23 to 24, a 4.3% gain.
Now, 4.3% would be considered a huge gain in total income for a government from just a tax rate increase. Here is why they would not be likely to see it.
Wealthy people are sensitive to their effective tax rates as much as the rest of us, and possibly more (they didn’t get wealthy by being indifferent to money). The wealthy and their income are highly mobile in every country except the U.S., Libya, and North Korea. All it would take is a 7% chance of the top earner decamping for, say, Switzerland to make this tax increase lose money for the government on an expected value basis. When things get too far out of whack, high-tax nations have a lot to worry about on this score. And that is before counting any effects on marginal productivity.
If a country’s tax rates were at some equilibrium, it would most likely be the equilibrium for maximizing the country’s tax revenues. I don’t know if any country is exactly at that point, but it’s unlikely that any country is on the strongly upward-sloping part of the Laffer Curve. All of which probably explains why overall revenue seems relatively insensitive to individual tax rates.
Posted by Marc Hodak on April 19, 2009 under Unintended consequences |
Nothing can go wrong
A WSJ story begins with two facts that appear in tension:
Hospitals and pharmaceutical companies have been pushing through hefty price increases aimed at bolstering earnings, even as government and private insurers are struggling to rein in healthcare costs.
And includes a fleeting nugget about how they are apparently related:
Credit Suisse’s Catherine Arnold said that drug companies have increased prices so aggressively in recent months to wring sales out of products before any healthcare cost-cutting efforts eat into profits.
“When the government is talking about more aggressive discounts, your start price is going to determine your end price,” she said.
The article is otherwise full of examples of price increases, the problems they cause, and what people think about it, including the obligatory denunciation by a “consumer advocate.” The above quote is one of the few clues about why they are happening.
Maybe it’s just me, but I believe that economically relevant facts help a story. I think it’s informative to look at the underlying causes and not just the effects of things like price increases.
Instead of talking about “hospitals” or “drug companies” as unitary agents, it would be interesting to see how these institutions comprise of thousands of economic agents doing what comes naturally–gaming the system they are familiar with to their personal profit. I think its important to show how most of the counterproductive gaming is driven by increasingly complicated rules established by various third parties, including government agencies. I think it’s relevant that as health care costs get more constrained by public policy, they diverge from costs that would be dictated by supply and demand, and that the market will react accordingly. A story could illustrate this in the form of threatened negotiations from an agent positioning itself to be a monopoly buyer, and how dispersed sellers will react with preemptive price increases or, to the extent they can’t implement them themselves, price increases somewhere else along the chain of treatment delivery.
Of course, all we see are the price increase, and that’s all the average journalist sees, too.
Posted by Marc Hodak on April 13, 2009 under Unintended consequences |
Paper mill
The intent of the law was to encourage alternative fuels, and reduce dependence on products like diesel that result in greenhouse gases. But the paper companies figured out how to get paid to do the opposite:
The origins of the credit are innocent enough. In 2005 Congress passed, and George W. Bush signed, the $244 billion transportation bill. It included a variety of tax credits for alternative fuels such as ethanol and biomass. But it also included a fifty-cent-a-gallon credit for the use of fuel mixtures that combined “alternative fuel” with a “taxable fuel” such as diesel or gasoline.
Enter the paper industry. Since the 1930s the overwhelming majority of paper mills have employed what’s called the kraft process to produce paper. Here’s how it works. Wood chips are cooked in a chemical solution to separate the cellulose fibers, which are used to make paper, from the other organic material in wood. The remaining liquid, a sludge containing lignin (the structural glue that binds plant cells together), is called black liquor. Because it’s so rich in carbon, black liquor is a good fuel; the kraft process uses the black liquor to produce the heat and energy necessary to transform pulp into paper. It’s a neat, efficient process that’s cost-effective without any government subsidy.
The paper companies figured out that if they add diesel to the black liquor, voila, a fuel mixture that qualifies for the mixed-fuel tax credit.
“You use the toilet every day,” said one hedge fund analyst who’s been closely following the issue. “Imagine if you could start pouring a little gasoline into the bowl and get fifty cents a gallon every time you flushed.”
No one in Congress seems to have anticipated this creative maneuver. This past fall the Joint Committee on Taxation computed the cost of extending the tax credit for three months and projected it would cost a manageable $61 million. It now appears that the extension (which was passed as part of the TARP) could cost as much as $2 billion before the credits expire at the end of this calendar year.
And yet, because the paper industry has invested in lobbying, and now has even more incentive to do so, Congress will probably not repeal this law before it expires.
HT: Greg Mankiw
Posted by Marc Hodak on under Executive compensation, Reporting on pay, Unintended consequences |
The NYT provides a good story about how the Wall Street pay restrictions may be having its effect. Some of the remaining glib tropes we’ll undoubtedly to hear:
– “So what? How much can these people have been worth to companies they helped drive under?”
– “They don’t need these people. The industry had to shrink anyway.”
– “These people are just being greedy, looking for other ways to get rich doing useless things.”
In the meantime, we taxpayers will reap the ‘benefits’ of our government’s politically driven HR policies at institutions completely dependent on the quality of their human resources. What we’ve saved from not “wasting” money on compensation, what we’ve cathartically gained from “tough talk” to the bankers, we will lose a thousand-fold from sub-optimal bank earnings and, in New York’s case, crippled tax collections. Hopefully, the NYT will run a story on those items when they happen, as well.
Posted by Marc Hodak on March 25, 2009 under Unintended consequences |
Not for the children
Obama’s new tax bill reduces the amount that the ‘wealthy’ (any couple making over $250K) can deduct for charitable contributions. The intent is, in effect, to net the government more money at the expense of wealthy donors. The predictable effect will be that each extra dollar the government gets will more or less come directly from the charities, leaving the putative donors with the same after-tax wealth. Martin Feldstein does the math.
A substantial body of economic research shows that, on average, each 10 percent reduction in the cost of giving raises the amount that a person gives by about 10 percent…
Suppose someone would give $10,000 to a university if that amount were deductible at 35 percent. That deduction would reduce the individual’s tax bill by $3,500. Limiting the deduction to 28 percent would lower the individual’s tax saving on a $10,000 gift to $2,800.
This is where things get interesting: If the 10 percent increase in the cost of giving caused the person to reduce his gift by 10 percent, to $9,000, his tax savings would be 28 percent of $9,000, or $2,520. The government’s revenue loss would be reduced by $980 (from $3,500 to $2,520). The person’s gift to the university would be reduced by $1,000, almost the same amount. Since this high-income person would pay $980 more in taxes but give away $1,000 less, he would end up with an extra $20 for personal consumption.
In other words, the $980 hit that the government is expecting the wealthy taxpayer to take is likely to be taken entirely by a hospital, church, or school. And that, Mr. Obama, is a lesson in tax incidence.
HT: Greg Mankiw
Posted by Marc Hodak on March 24, 2009 under Invisible trade-offs, Unintended consequences |
Shall we dance?
The market reacted to Geithner’s asset sale plan yesterday the way you would expect, if you expected a massive transfer of wealth from taxpayers to large publicly-traded banks. The banks are basically waiting to sell assets at above-market valuations, and Mr. Geithner is delivering the buyers.
But how good of a deal is this for the buyers of the assets? Consider a casino advertising a new game that pays out 2-1 for a game with odds of 4-1. That’s a lousy game on a straight bet. But this guy with a high forehead and curly hair is offering to loan you money on the bet. And you don’t have to pay all of it back if the bet goes sour. So your willingness to play this game depends on how much Curly is willing to lend you.
Now, Curly seems like a reasonable guy. But standing behind Curly are a couple of big guys who just recently beat the sh*t out of a recent winner, shaking him upside down until his winnings dropped out of his pocket.
Now, how willing are you to play with Curly?
“If it’s structured correctly, it could really be a very attractive opportunity for private investors, but it also could actually have the government get its money back,” Canning said.
The heavy criticism by lawmakers of the compensation at giant insurer American International Group (AIG.N), which was bailed out by the U.S. government, is the reason he would prefer to avoid public-private partnership.
“I don’t need the government’s help in structuring my compensation,” Canning said. “I get all the help I need from my partners.”
…says the partner in a $5 billion fund.
Posted by Marc Hodak on March 19, 2009 under Stupid laws, Unintended consequences |
There are so many unintended consequences that would pop out of the 90 percent tax on bail-out bankers that it could keep this blogger busy for days. Unfortunately, I’ll probably be way too busy helping set up the management companies that will supplant every last employee at a major bank without “assistant” in their title.
One of the first drivers for this won’t be, as many suppose, the people making over $250K. It will be people married to working spouses. The $250K limit applies to household income. So, if your husband or wife is a New York lawyer, your household income is $250,000 before Morgan has paid you your first dollar. Everything above that is gone as soon as it hits your bank account. You may, in fact, owe money on your earnings.
So, sorry honey, I don’t care how much the taxpayers need you to protect what little they have in that big ‘ole bank. Our nanny now makes more than you do, so find another job, or stay home and watch the kids.
