Matt Nolan

Series on tax: Part 4 – A primer on income taxes

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Over at Rates Blog they have popped up part 4 of the series on tax I’m popping together.  Here are the blog posts linking to part 1, part 2, part 2b, and part 3.  I would note this will at least be an eight part series, instead of six now, as I’ve split up this specific article.

Originally I wanted to talk about income tax, consumption tax, and ideas of progressivity and implementation all at once.  Now I realise it will have to be 3-4 articles on these issues.

The main trust of this piece was to ask “why is income tax distortionary when a poll tax is not”.  Given this idea, we can talk about the “relative efficiency” of types of income tax (namely labour and capital) and point out the idea of time – and how this impacts on the “accumulation” of capital, and thereby the “stock” of capital.

Personally, these things make more sense IMO, and are more closely related to our idea of “transfering goods and services” when we look at output taxes – specifically consumption taxes.  Next time, this is exactly what we do!  Originally I couldn’t bring myself to seperate the income and consumption articles … but at 3k words I sort of had to.  As a result, I’d suggest reading next fortnights article as an extension to this.

Also, I plan a “part 4b” for here.  I can imagine some people may get confused why I view the deadweight loss through the “price wedge” – when if we had perfectly inelastic demand we would “sell” just as much but the price would be higher.  Doesn’t this mean there is no deadweight loss, and that this tax is just like our poll tax?  Well no, but to explain this we need to actually dive into some of the economics they do in first year university.  We will look at indifference curves and budget constraints (we are comparing Marshallian and Hicksian demand) – we will introduce the tax, then assume an income transfer that brings our person to the same level of utility (compensating variation).   The reason we don’t see it in the single good case is that we are not considering the impact on income/wealth from the tax – and what “perfectly inelastic demand” means in terms of income and substitution effects (pro-tip – they must be canceling each other out to leave the quantity demanded at the higher price unchanged!).  Anyway, I’ll leave that to the post.

Matt Nolan

Small open economies and trade: The New Zealand example

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Over on the Herald I saw Bernard Hickey discussing how we have been performing relatively well due to China in recent years (Note, this was also on Rates Blog) – and we have to realise that if something went wrong over there it would hurt us.  Fair point, and one that people should be conscious of given the lack of good information we currently have about China!

I then journeyed down into the comments, where everyone was being civil and discussing the issue.  Very nice.  I noticed a comment by Digby Green:

Well said.

I have noticed that our exports to many other countries have fallen in the last few years.

So “we” need to make sure we do not forget them.

And it reminded me of a neat little thing about being a small open economy with relationships with many many other economies.  We are a “residual claimant” for a “homogenous good” in most of the markets we trade in, and as a result if one country is buying less of our produce we can usually ship somewhere else instead for only a slightly lower price.  What this means is that we produce very little of the world output in many of the things we sell, and the things we sell are pretty “similar” to what is sold overseas.  As a result, we just follow around the world price!

Now this isn’t the case for everything.  NZ wine, and chilled NZ meat, gain significant premiums in some markets – and when demand in those countries cools off, NZ producers have to take quite a price cut to sell them.

However, whenever we jump onto the Statistics New Zealand site and look at the Overseas Merchandise Trade figures, this suggest that we will see the “composition” of our trade (in terms of the countries we sell to) change massively over small periods in time – the best example in the past year was Venezuela, where dairy exports have all but disappeared due to changes in South American production and purchases … but of course, we just sold those dairy products to other countries.  During the drought, farmers destocked by killing livestock – and as a result, meat exports to China have gone up … but this will only be temporary.

In this way, the “amount” we sell overseas isn’t really determined by overseas demand – we are such a small fish we can make as much as we want and sell it!  However, the amount NZ farmers and other exporters for homogenous goods want to produce is determined by the return they get from it!  And this price is determined by demand overseas. This is very different than large economies like China and the United States, and as a result they discuss their trade figures in very different ways than we do over here.

So the lesson is we can sell as much as we make, but whether it is worth making depends on how “scarce” (and as a result how high the price is) overseas.

Note:  Indeed there are exceptions, and the more we specialise into “niche” markets the more this is the case.  But for the majority of New Zealand trade, and given the openness of NZ with the rest of the world, this simple little principle is very powerful.

Matt Nolan

Fair point

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From this entertaining discussion of the Rethinking Macroeconomics II conference comes this gem (ht Economist’s View)

8) Can we realistically solve the “too big to fail” problem?

We have to solve it. If we can’t, then nationalize these behemoths and pay the people who run them the same wages as everyone else who work for the government.

Fair call, economists, like most people, despise “socialism for the rich”.  And honestly, if public institutions are always going to backstop them then nationalisation makes a lot of sense – and is how we felt here during some of the financial firm bailouts.

I can’t see the government letting banks fail, which is why I’ve been pro-deposit insurance recently (here, here).  But even down that road, have a deposit levy.  Also ask why we are going down that road, is it because we want a “risk free” rate of return for mum and dad investors no matter the cost … if that is the social preference Bair’s suggestion of nationalisation starts to make a lot more sense right 😉

Matt Nolan

A point from Layton’s electricity market discussion

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Brent Layton at the Electricity Authority wrote this piece (or here if that isn’t working) discussing the Labour and Greens power market policy.

I don’t know enough to comment on the specifics – outside of a recognition that the benefit to consumers being mentioned is real dodge.  All the parties say this sort of rubbish, “you will get $XXX in your pocket with no ramifications” and this vexes me – I don’t take lies and half truths particularly well.  But in terms of the specific impact of the policy, and the policy settings, I am in no way qualified to add to the debate 🙂

Now in terms of the policy, seeing these comments by economic rock stars like Brent Layton, Lew Evans, and Seamus Hogan at Offsetting (*,*) means I have set my priors such that the policy doesn’t sound like a good idea – but compelling research could see me switch sides!  I would note that I don’t use the term economic rock star lightly, so they do have a significant impact on the beliefs I have around the effectiveness of the policy regime. [Note:  I should have placed down the arguments on the other side – although I had thought they were a bit more indirect, I should have still linked to them.  Here we have John Small, and here we have Geoff Bertram – I have a lot of time for these guys but I’m not sold on the historic cost argument].

But there was something I can take out of this that I’d like to say.  Constantly, Brent Layton mentions the “long-term benefit of the consumers”.  This is the true underlying purpose of the Electricity Authority, and the central area of interest for government regulation AS WE SPEAK – economists in these roles are looking at the trade-offs involved with policies, given this underlying target.  Layton is saying that the plan is a bad one because, when he has specifically analysed those sorts of policies in the past they were “detrimental to the long-term benefit of the consumers”.

He was saying, when he’s done detailed analysis in the past – he’s found that this sort of policy actually leaves people worse off, and yet it is still explicitly being sold as offering this magical benefit based on extremely partial analysis.  Economists do this for a reason – as I wrote when I discussed rebalancing:

Economists are supposed to discuss trade-offs, and this involves making the costs to those who don’t have loud interest groups (such as the disparate interests of consumers) apparent

This is an important issue, and I like the way organisations like the Commerce Commission and Electricity Authority are very clear about this.

And deep down, I am sure most politicians, pundits, and people who are interested feel the same sort of way – they just don’t realise that economists are trying to understand these costs and changes in distribution that occur when policy is put in place!  Answers are far from simple, and even when many of these rock star economists have done piles of modeling, explaining the results to people who haven’t invested in the “language and underlying body of knowledge” (virtually everyone) is incredibly hard.

In this way, I just wanted to highlight the focus on consumer welfare, how that is a central part of what economists looking at policy are interested in, and how that is a great way for explaining stuff to people – even other people who have an economics background but aren’t in the specific industry of interest like myself 😉

Matt Nolan

A verdict on NGDP

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Simon Wren-Lewis has been discussing some of the ideas about NGDP targeting, and has reached his (tentative) conclusion:

My proposal is therefore the adoption of a target path for the level of NGDP that monetary policy can use as a guide to efficiently achieving either the dual mandate, or the inflation target if we are stuck with that. NGDP would not replace the ultimate objectives of monetary policy, and policymakers would not be obliged to try and hit that reference path come what may, but this path for NGDP would become their starting point for judging policy, and if policy did not move in the way indicated by that path they would have to explain why.

His proposal and his logic for getting there are things I all agree with.  Note for New Zealanders – we still have a positive cash rate and a flexible inflation target, so we wouldn’t need to adopt it as an intermediate target right now.  But it is a good issue to think about in case we ever get there 😉

Matt Nolan

Careful how we treat the “economy”

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I’m always glad to see people discussing the New Zealand economy with data and discussion.  So good on Lowell Manning for doing that here.

Of course, this doesn’t mean I have to agree – but I will try to disagree with some substance 😉

There are a number of the specifics I fundamentally disagree with, I will discuss that more later in the post.  But I wanted to touch a methodological line to start with.  The “economy” is the aggregate of individual actions, we cannot reach a conclusion on policy by placing value on outcomes without discussing what individual choices are involved. Four things come out of this:

  1. Without knowing why, we can’t really describe what is going on – this isn’t like a business balance sheet.
  2. As a matter of course, without a “why” we can’t figure out causation – there is a risk of getting things the wrong way around! (For the wonkish, we need behavioural relationships as well as identities to get anywhere 😉 )
  3. When we talk about “debt” someone is borrowing for some purpose.  Someone has to borrow – it is not created from the ether.
  4. We should not want to treat the economy like a business balance sheet even if we could – as we want a society that “maximises happiness” or some derivative of … not economic output.  In honesty, the driver of many structural shifts we see is government policy, which is set GIVEN the fact we’ll take lower output to meet some social needs.  Let us keep that in mind please.

This piece ignores this, where are the prices of non-housing goods, where are the determinants of foreigners willingness to loan to us, and our willingness to borrow?  The links related to these things are weak to non-existent, and it makes the other concerns I have even more stark.  Let us move on with those:

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