Pigovian taxes - drunk driving edition

Greg Mankiw links to some research that shows that the increase in the federal alcohol excise tax in 1991 may have save 7,000 lives because of less drunk driving.

Externalities in energy production

OK - today a slightly non-finance post.

There has been much hand wringing recently over the Solyndra Solar scandal in which it is alleged that the solar company received government support without proper controls.  Solyndra filed chapter 11 and is now being investigated by the FBI.

In the same way that I don't think subsidies for agriculture make sense, I don't think that subsidies for certain industries make sense either.  The government shouldn't subsidize solar power.  But it also shouldn't subsidize fossil fuels either.  Turns out that fossil fuel subsidies are a lot larger than the solar subsidies.  A whole lot larger.  This of course, doesn't get Solyndra, its management or the government off the hook in the current scandal.

(graphic from the Environmental Law Institute )


But the Solyndra case is a distraction to the bigger issue.  Even ignoring federal subsidies of fossil fuels, these industries are able to provide low cost energy because they impose negative externalities on other parties.  These externalities are primarily airborne pollution which have a very significant effect on the economy overall.   A recent paper published in the American Economic Review (the very top journal in Economics) finds that the magnitude and costs of these externalities are huge.  If the article is a bit dense, Paul Krugman gives a nice summary of the article.

The solution is to impose a Pigovian Tax - a tax on carbon.  A carbon tax works by raising the cost of carbon fuels towards a point that more accurately reflects their true cost (externalities included).  The key element of such a tax is that it is revenue neutral.  This means that all proceeds are rebated back to tax payers.  The most obvious way of doing this would be to reduce payroll taxes.  Greg Mankiw, the noted Harvard economist, who will admit to being on the opposite side of many debates to Paul Krugman, is a huge fan of a Pigou Tax.

With such a tax in place, and the removal of federal fossil fuel subsidies, the playing field would then be fully leveled for alternative fuels to compete based purely on their merits.

Fix the Federal Budget

Reposted from Greg Mankiw - go ahead and see if you can fix the budget hole.

A few interesting posts from the blogosphere

Rolf Winkler talks about last night's frontline documentary on for profit education.
http://blogs.reuters.com/rolfe-winkler/2010/05/05/frontline-exposes-for-profit-education/
The frontline documentary is well worth a look.

Greg Mankiw posts a graphic of what the federal budget will look like in 2020.
http://gregmankiw.blogspot.com/2010/05/federal-budget-in-one-picture.html
Bottom line, after you take out defense, social security, medicare, medicaid and interest expense you're left with 23% that goes to "other". The clear reality, that perhaps the tea party crowd have not appreciated is that if you want to cut the government debt you need to make cuts in these four areas.

Mankiw also talks about price gouging. http://gregmankiw.blogspot.com/2010/05/in-defense-of-price-gouging.html
Apparently there has been a water shortage in New England leading to spikes in the prices of bottled water. Politicians are crying foul and accusing vendors of price gouging. Further evidence of how clueless politicians are when it comes to Econ 101.

Finally, Steve Allen talks about how GM paid back its TARP to the government by borrowing money from the government. Ultimately tax payers are likely to take a $30bn hit on GM. http://stevenallenblog.blogspot.com/2010/05/truth-about-gm-repaying-its-tarp-loan.html

Is high inflation around the corner?

Probably not. We talked about the spread between TIPS and Long Government bonds in class this week and in particular how this spread is only about 250 basis points. This spread represents the market's expectation of inflation embedded in bond prices.

Greg Mankiw makes the same point in his article tomorrow (Sunday) in the New York Times. You can read it here.

Moral hazard and health care

Moral hazard is the term generally given to a situation where an individual does something that they normally would not do if they bore all the risk. There are many cases of moral hazard: For example, banks that lever up and take excessive risks but have implicit government guarantees are engaging in moral hazard.

The new health care plan that is making its way through the house prevents insurers from denying coverage based on a pre-existing condition. This is a great idea, but with it comes a moral hazard problem. Healthy people have the incentive to not get insurance until they get sick. Then they are guaranteed that they will be accepted into a plan. This doesn't just include the currently uninsured either. I have health insurance, but maybe I should drop my coverage and wait until I get really sick before reinstating it? I could save a huge amount. The economist, Martin Feldstein talks about the problem here.

The writers of the bill thought of this problem. Well sort of. They decided to impose a tax penalty on anyone who didn't get insurance. Brilliant! Except that the penalty is significantly less than the actual cost of insurance, so the problem does not go away.

I don't really want to get political here, but it seems to me that the problem with politicians is that they didn't take enough (or any) economics in school. In fact, if they had just read the book "Freakonomics" they would have seen an example of a very similar situation. I don't recall the exact details, but the basic story recounted in the book was that a day care center had a problem with parents being late to pick up their kids. To try to discourage this behavior, the day care center imposed a fine for each 30 minutes that the parents were late. The problem was that the fine was too low - well below the actual cost of child care. So instead of discouraging the behavior, more parents chose to be late and just pay the fine.

The solution to the health care moral hazard is simple. Make the penalty as much as the cost of insurance and force the non-insurers into a plan.

HT: Greg Mankiw's blog

What do economists think?

Greg Mankiw posts a link to "what economists believe". Take a look and see if you agree!

Mankiw also mentions the recent tire tariffs imposed by President Obama on Chinese tires. Most economists think tariffs are a very bad idea (me included). It does make you wonder though why new Presidents are so quick to levy tariffs. For example, GWB did a similar thing in 2002.

Did Lehman's collapse start the crisis?

Two very reputable economists from Chicago, John Cochrane and Luigi Zingales suggest that the true cause of the crash probably has more to do with the TARP authorization...as they eloquently state...

In effect, these speeches [about TARP] amounted to "The financial system is about to collapse. We can't tell you why. We need $700 billion. We can't tell you what we're going to do with it." That's a pretty good way to start a financial crisis.

HT: Greg Mankiw

Textbook Economics

Ever wondered what goes in to the price of a text book? Greg Mankiw's econ book gets the once over here. And a little more here.

HT: Newmark's door

stocks for the long run?

Greg Mankiw blogs on a recent article in the WSJ about some of the problems with the thesis that stocks are for the long run - i.e. that they consistently beat other asset classes.

Turns out, some of the data for the first 100 years or so was perhaps a little shaky.

Cap and Trade

Greg Mankiw points out that the cap and trade plan now in the works has been greatly watered down. It appears we are repeating the mistakes of the EU. Shame.

Unfortunately there is slim hope for a pigou tax.

Overview of the credit crisis

How did it all happen? A nice summary here .

HT: Greg Mankiw

Indexing wins, again.

From Greg Mankiw... Indexing wins again.

Whether you should be in large cap stocks or not is based on your risk tolerance and overall asset allocation. But what is clear, time and time again, is that you should not pay anyone to actively manage your large cap portfolio. Just index, or buy and hold.

Stay the course...says Malkiel

Burton Malkiel author of a "Random Walk Down Wall Street", advocates very clearly that we should stay the course. Don't try to market time.

It is very tempting to try to time the market. We all have 20/20 hindsight. It is clear that selling stocks a year ago would have been an excellent strategy. But neither individuals nor investment professionals can consistently time the market.

I agree. Right now is the time to be shoveling money into stocks. They look cheap. Very cheap. (except GM and Ford that is).


HT: Greg Mankiw's Blog

Further opinions from economists

For more great insights into the current mess check out Greg Mankiw's blog...