Archives: February, 2010

The College Earnings Premium — Why It’s Meaningless

The WSJ reports today on the average lifetime earnings advantage conferred by a college degree. This statistic is probably worse than useless. “College” isn’t a single thing, and its benefits will not likely be enjoyed equally by every single student, even those pursuing precisely the same degrees.

For a college earnings premium figure to be of any value to policymakers or prospective college students, it would be necessary to break it down by field and by student characteristics. What’s the premium difference, for instance, between workers who majored in engineering, chemistry, computer science, mathematics, economics, etc., compared to those who majored in communications, art history, social work, multicultural studies, etc.? A similar breakdown of interest would be by SAT score.

These breakdowns would help people to make better informed decisions. An overall earnings premium estimate may well be worse than nothing: leading to great over- or underestimates for the value of a particular college degree to a particular student.

Time to Lose the Trade Enforcement Fig Leaf

During his SOTU address last week, the president declared it a national goal to double our exports over the next five years.  As my colleague Dan Griswold argues (a point that is echoed by others in this NYT article), such growth is probably unrealistic. But with incomes rising in China, India and throughout the developing world, and with huge amounts of savings accumulated in Asia, strong U.S. export growth in the years ahead should be a given—unless we screw it up with a provocative enforcement regime.

The president said:

If America sits on the sidelines while other nations sign trade deals, we will lose the chance to create jobs on our shores. But realizing those benefits also means enforcing those agreements so our trading partners play by the rules.

Ah, the enforcement canard!

One of the more persistent myths about trade is that we don’t adequately enforce our trade agreements, which has given our trade partners license to cheat.  And that chronic cheating—dumping, subsidization, currency manipulation, opaque market barriers, and other underhanded practices—the argument goes, explains our trade deficit and anemic job growth.

But lack of enforcement is a myth that was concocted by congressional Democrats (Sander Levin chief among them) as a fig leaf behind which they could abide Big Labor’s wish to terminate the trade agenda.  As the Democrats prepared to assume control of Congress in January 2007, better enforcement—along with demands for actionable labor and environmental standards—was used to cast their opposition to trade as conditional, even vaguely appealing to moderate sensibilities.  But as is evident in Congress’s enduring refusal to consider the three completed bilateral agreements with Colombia, Panama, and South Korea (which all exceed Democratic demands with respect to labor and the environment), Democratic opposition to trade is not conditional, but systemic.

The president’s mention of enforcement at the SOTU (and his related comments to Republicans the following day that Americans need to see that trade is a two way street – starts at the 4:30 mark) indicates that Democrats believe the fig leaf still hangs.  It’s time to lose it.

According to what metric are we failing to enforce trade agreements?  The number of WTO complaints lodged? Well, the United States has been complainant in 93 out of the 403 official disputes registered with the WTO over its 15-year history, making it the biggest user of the dispute settlement system. (The European Communities comes in second with 81 cases as complainant.)  On top of that, the United States was a third party to a complaint on 73 occasions, which means that 42 percent of all WTO dispute settlement activity has been directed toward enforcement concerns of the United States, which is just one out of 153 members.

Maybe the enforcement metric should be the number of trade remedies measures imposed?  Well, over the years the United States has been the single largest user of the antidumping and countervailing duty laws.  More than any other country, the United States has restricted imports that were determined (according to a processes that can hardly be described as objective) to be “dumped” by foreign companies or subsidized by foreign governments. As of 2009, there are 325 active antidumping and countervailing duty measures in place in the United States, which trails only India’s 386 active measures.

Throughout 2009, a new antidumping or countervailing duty petition was filed in the United States on average once every 10 days.  That means that throughout 2010, as the authorities issue final determinations in those cases every few weeks, the world will be reminded of America’s fetish for imposing trade barriers, as the president (pursuing his “National Export Initiative”) goes on imploring other countries to open their markets to our goods.

Rather than go into the argument more deeply here, Scott Lincicome and I devoted a few pages to the enforcement myth in this overly-audaciously optimistic paper last year, some of which is cited along with some fresh analysis in this Lincicome post.

Sure, the USTR can bring even more cases to try to force greater compliance through the WTO or through our bilateral agreements.  But rest assured that the slam dunk cases have already been filed or simply resolved informally through diplomatic channels.  Any other potential cases need study from the lawyers at USTR because the presumed violations that our politicians frequently and carelessly imply are not necessarily violations when considered in the context of the actual rules.  Of course, there’s also the embarrassing hypocrisy of continuing to bring cases before the WTO dispute settlement system when the United States refuses to comply with the findings of that body on several different matters now.  And let’s not forget the history of U.S. intransigence toward the NAFTA dispute settlement system with Canada over lumber and Mexico over trucks.  Enforcement, like trade, is a two-way street.

And sure, more antidumping and countervailing duty petitions can be filed and cases initiated, but that is really the prerogative of industry, not the administration or Congress.  Industry brings cases when the evidence can support findings of “unfair trade” and domestic injury.  The process is on statutory auto-pilot and requires nothing further from the Congress or president. Thus, assertions by industry and members of Congress about a lack of enforcement in the trade remedies area are simply attempts to drum up support for making the laws even more restrictive.  It has nothing to do with a lack of enforcement of the current rules.  They simply want to change the rules.

In closing, I’m happy the president thinks export growth is a good idea.  But I would implore him to recognize that import growth is much more closely correlated with export growth than is heightened enforcement.  The nearby chart confirms the extremely tight, positive relationship between export and imports, both of which track similarly closely to economic growth.

U.S. producers (who happen also to be our exporters) account for more than half of all U.S. import value.  Without imports of raw materials, components, and other intermediate goods, the cost of production in the United States would be much higher, and export prices less competitive.  If the president wants to promote exports, he must welcome, and not hinder, imports.

Volcker Rule Misses the Mark

Today Paul Volcker appears before the Senate Banking Committee to argue for the separation of proprietary trading and commercial banking.  In Mr. Volcker’s own works “what we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets.”

Using his own test, the Volcker Rule fails miserably.  Had this rule been in place say five or even ten years ago, we’d most likely be in the same place we are today.  It would have not avoided the crisis, and may potentially have made it worse.

First of all the proposal ignores the fact that those institutions at the heart of the crisis, Bear, Lehman, Fannie, Freddie, AIG, were not commercial banks.  They were not using federally insured deposits to gamble in our financial markets.  Those commercial banks with proprietary trading activities that did fail, such as Wachovia, were sunk not by proprietary trading, but by bad mortgage lending.

Mr. Volcker is correct in arguing for a change in assumptions that institutions and their creditors will not be bailed out.  He errs in believing that the House passed financial “reform” bill achieves that.  One has to wonder if he’s bother to even read the bill.  The House bill explicitly allows for rescuing creditors.  The House bill does not reduce the chance of bailouts, it increases them.

While the Obama Administration may have changed the face of its reforms, sadly the substance of its proposals continue to bear little relation to the actual causes of our financial crisis.  Nowhere in the President’s proposals do we see any efforts at avoiding future housing bubbles.  Perhaps this should come as no surprise given Washington’s continued attempts to re-inflate the last housing bubble.

Taxing the Rich Won’t Work

The new budget reportedly hopes to raise $364 billion over ten years by raising the top two tax rates, plus $105 billion by raising the tax on dividends and capital gains to 20% from 15%, and $500 billion through discriminatory caps and limits on personal exemptions and deductions allowed to other taxpayers.

The $364 billion from raising the top two tax rates pales in comparison to the $2.56 trillion from keeping the rest of the Bush tax cuts in place, including $600 per couple (the 10% bracket) for everyone still rich enough to pay taxes (the Obama plan would exempt half of  U.S. workers from paying income tax).  That contrast between $364 billion and $2.56 trillion is definitive proof that Democrats’ endless complaint about the Bush tax cuts going “mainly to the rich” was one of the biggest big lies of the past decade.

The President’s urge to penalize mature, two-earner educated couples earning more than $250,000 is symbolic populism, having essentially nothing to do with reducing the deficit. Table S-2 of the Budget (p. 147) lists “Upper-income tax provisions dedicated to deficit reduction” as just $34 billion in 2011 — less than 1% of estimated spending of $3.8 trillion. Errors in estimating next year’s deficit have often been much larger than $34 billion, particularly during the early stages of economic recoveries.

Still, the false belief that higher tax rates on the rich could eventually raise significant sums over the next decade is a dangerous delusion, because it means long-term deficits are seriously understated.

Here are just a few reasons why punitive marginal tax rates on high-income families cannot possibly raise even the relatively trivial sums the Budget is counting on:

1.    Professionals and companies who currently file under the individual income tax (including most trial lawyers and hedge fund managers) would form C-corporation to shelter income, because the corporate tax rate would then be lower with fewer arbitrary limits on deductions for costs of earning income.

2.    Investors who jumped into dividend-paying stocks in 2003 when the tax rate fell to 15% would dump some of those shares in favor of tax-free municipal bonds if the dividend tax went up, and keep the rest in tax-free IRA or 401k accounts.   Prices of dividend-paying stocks and funds could be depressed, reducing the yield of the capital gains tax.

3.    If faced with a higher capital gains tax next year, investors would rush to realize taxable capital gains (those not in IRAs and 401ks) later this year.  After 2010, investors would make greater efforts to avoid realizing gains in taxable accounts unless they had offsetting losses, and they would also make fewer investments in assets subject to the capital gains tax.

4.    Many two-earner couples would become one-earner couples, early retirement would become more popular, physicians would play more golf, etc.

That is a small sampling of known behavioral responses which economists call “the elasticity of taxable income” or ETI for short.  What that means is this: When the marginal tax rate goes up, the amount of reported incomes goes down.  As a forthcoming study by Joel Slemrod, Seth Giertz and Emmanuel Saez concludes, “There is much evidence to suggest that the ETI is higher for high-income individuals who have more access to avoidance opportunities.”

I presented a 60-page paper in 2008 full of graphs and tables, many derived from the tax data of Thomas Piketty and Emmanuel Saez, offering undeniable evidence that static revenue estimates (which ignore or minimize the ways in which people react to higher tax rates) greatly exaggerate potential revenue from higher tax rates on individual salaries, dividends and capital gains.

I concluded, “There is a serious fiscal risk in the future that overly-optimistic revenue estimates based on the assumption of zero or 0.25 elasticity of taxable income could lead the federal government to make long-term spending plans on the basis of phantom revenues from higher tax rates, embarking on major new entitlement programs (in the guise of refundable tax credits) in the false hope that these static or nearly-static revenue estimates are realistic.”

Debate: Is Obama Failing?

At the Economist website, I’m debating the question, “This house believes that Barack Obama is failing.” I’m taking the affirmative. Readers are allowed to vote, and the Economist’s typically left-leaning readers are voting for Obama by about the same margin that Americans are rejecting his health care plan. So feel free to mosey on over there, read both sides of the argument, and cast your vote. My bottom line:

When your policies aren’t working, the voters have noticed and your transformative ideological agenda is moving broad public opinion in the other direction, it’s safe to say you’re failing.

Rebuttals and closing statements will follow in a few days. But don’t delay! Visit today!

Tuesday Links

  • What we can learn from Hugo Chavez: “The lesson for all of us, north and south of the border, is watch our presidents closely, and check them when they try to slip their constitutional bonds.”

Globalization: Curse or Cure?

Globalization holds tremendous promise to improve human welfare but can also cause conflicts and crises. How will competition for resources, employment, and growth shape economic policies among developed nations as they attempt to maintain productivity growth, social protections, and extensive political and cultural freedoms?

In a new study, Cato scholar Jagadeesh Gokhale offers policy recommendations for developed nations to reduce globalization’s negative effects and, indeed, harness it for solving economic challenges.