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Duane Freese makes an eloquent case for tax simplification. He says that if you add up the total amount of work spent on tax compliance, it amounts to

The equivalent of 2,774,000 [full-time workers]...

That is more than the total civilian employment of the federal government. It is twice the active duty military force we have available to protect our shores and fight our wars. It is three times the number of police officers we have going after crooks.

What Freese refers to is one component of what economists call deadweight loss. Deadweight loss is the amount that taxes cost the public that is in excess of the revenue collected by the government.

Discussion Question. Apart from compliance costs, how else do taxes impose deadweight loss?

Over thirty years ago, the late James Tobin gave an address to the American Economic Association in which he offered an explanation for some of the core issues of macroeconomics. The current state of the economy provides an excellent illustration of Tobin's framework.

Think of our economy as having two job markets, one for webmasters and one for home health care assistants. 2-1/2 years ago, we had full employment in both markets, with webmasters making $35 an hour and home health care assistants making $10 an hour.

Next came the collapse of the dotcom bubble, which caused a drop in the demand for webmasters. Eventually, for equilibrium to be restored, the ratio of the webmaster wage to the home health care wage has to fall and on the margin some webmasters have to change careers to become home health care workers.

The fundamental problem of macroeconomics is how this transition takes place. In a zero-inflation environment, the webmaster wage must fall and the home health care wage must rise. In a deflation environment, both wages must fall, with the webmaster wage falling more. In an inflation environment, both wages may rise, with the health care wage rising faster, although in real (inflation-adjusted) terms, the wages of webmasters will fall.

What Tobin argued is that the the relative wage adjustment will occur most quickly in an inflationary environment. He said that it is difficult to reduce nominal wages, so that in a zero-inflation or deflationary environment wages will be sticky in the short term, leading to unemployment. Webmaster wages will remain above their market-clearing level, and unemployed webmasters will remain unemployed hoping to get jobs at those unrealistic wages, rather than taking pay cuts or changing careers.

Discussion Question. How does Tobin's model fit in with the current controversy over whether the Fed should be trying to reduce interest rates?

John S. Irons discusses a CBO report on how much of the larger deficit is due to the faltering economy and how much is discretionary.

roughly one-third of the projected decline in the total surplus between 2000 and 2003 results from "automatic stabilizers" the automatic response of the budget to the business cycle. Most of the remaining two-thirds is attributable to legislative action: primarily EGTRRA [2001 tax cuts], JCWAA, and increases in discretionary spending

In the short run, EGTRRA can be viewed as discretionary policy to fight the recession. And JCWAA was a package of spending to fight the recession, including increased jobless benefits. So, including the discretionary anti-recession component of policy, much of the near-term deficit increase is in response to the economic slump. However, the long-term tax cuts cannot be viewed as an attempt to fight the near-term recession.

Discussion Question. Has the use of fiscal policy been too aggressive or too cautious in fighting the recession?

John S. Irons asks why, if small firms create most of the jobs in the economy, the share of employment in small firms does not go up.

Given these numbers, you'd expect the total employment share in firms with less than 20 people would have been growing over time, and the share of the 500+ group to decline. Right?

Wrong!

I would speculate that one answer could be that although job creation is faster at small firms, job destruction also is faster at small firms. When you net out jobs lost due to firms going out of business or laying off workers, the employment share of small firms may not tend to rise.

The Economist points out,

British house prices are up by over 20% on a year ago. American house prices have risen by more in real terms in the five years to mid-2002 than in any previous period since 1945. The truth is that house prices, like equities, cannot for long outpace the growth of nominal incomes.

It is amazing how much wisdom there is in the simple argument that it is difficult for any one sector to outgrow GDP for a long period of time.

Discussion Question. Why wouldn't all real estate prices, including commercial real estate, rise along with house prices?

Jeff Madrick in the New York Times writes about George Akerlof and behavioral economics.

Mr. Akerlof argues, however, that market bubbles can exist and should be kept under control; that unemployment can often be pushed lower by government without generating inflation; that people will not save enough on their own; and that liberalized global capital flows have been damaging. He argues that monetary and fiscal policies do matter in creating jobs and raising incomes.

This implies that government intervention can improve social outcomes. However, that assumes that government is motivated by the public interest. But James Surowiecki discusses what we might call behavioral political science.

In fact, the Bush economic policy looks a lot like what the political scientist Theodore Lowi called "interest-group liberalism." As Lowi saw it, the rise of government regulation and independent bureaucracies had turned the process of policymaking away from the pursuit of the common good—however imaginary that might be—and toward a divvying up of the spoils by politicians and interest groups. As long as the government is as big and as active as it is in the United States, the incentive for interest groups—like big oil and big steel—to seek succor from it will exist.

Discussion Question. Why does interest-group liberalism make it problematic that government can be counted on to deal with issues that are posed by behavioral economics?

Paul McCulley points out that the Federal Reserve tends to tell banks to tighten credit at exactly the point in the business cycle when the economy most needs a relaxation of credit restrictions.

But how can the Fed get banks to re-engage in underwriting corporate default risk when they don't want to, you ask? The answer, it seems to me, is quite straightforward: just tell them to do it! But will they listen, you ask? Yes, they would, I submit, particularly if Mr. Greenspan were to declare that he is also instructing his bank examiners to act counter-cyclically, not pro-cyclically, in evaluating capital and credit-reserve policies. As an additional incentive for banks to unclog their lending pipes, Mr. Greenspan should publicly call for Congressional investigators to call off their find-a-crook dogs.

The time for bank regulators to get tough is when times are good, not when times are bad. They didn't, of course, during the bubble years, but that is not a rational justification for getting tough now. If counter-cyclical is good for Fed funds policy, then counter-cyclical is good for bank regulatory policy, too. Interestingly, famed economist Henry Kaufman applied this logic just this week5 in calling for a cut in margin requirements for stocks, after having been a fellow traveler with me and Bob Shiller in advocating a hike in margin requirements during the bubble years.

Discussion Question. If regulatory policy should "lean against the wind," and if house prices may be in a bubble, should regulators be telling lenders to tighten their rules on granting mortgage credit?

A maddening example of a government program is the Export-Import Bank. As this article points out, both liberals and conservative economists view it as corporate welfare. However, their views have no effect on the bank's ability to maintain political support.

The bank keeps an extensive data bank that breaks down all the deals it has done, Congressional district by Congressional district, subcontractor by subcontractor, and contains the names of 300,000 executives with whom it has met. From it, a lobbyist can get tailor-made information on Export-Import activities going back five years to make the bank's case.

Discussion Question. Will campaign finance reform have any impact on this sort of corporate welfare?

An article in The Economist paints a picture of a future in which Europe becomes one big nursing home.

According to Bill Frey, a demographer at the University of Michigan, the median age in America in 2050 will be 36.2. In Europe it will be 52.7. That is a stunning difference, accounted for almost entirely by the dramatic ageing of the European population. At the moment, the median age is 35.5 in America and 37.7 in Europe.

...The contrast between youthful, exuberant, multi-coloured America and ageing, decrepit, inward-looking Europe goes back almost to the foundation of the United States. But demography is making this picture even more true, with long-term consequences for America's economic and military might and quite possibly for the focus of its foreign policy.

Discussion Question. What policy options do European countries have for maintaining their economies as this aging takes place?

David Reed asks,

Do we really need more "property rights" in "intellectual property"? That's the real question that we should be asking. In fact, we should be asking whether the conceptual basis of "intellectual property" is sound and defensible. Because unlike copyrights and patents, which are very clear and ancient, "intellectual property" is a new legal invention, a new metaphor, proposed by those who benefit from it, and not examined by the majority who might not.

He is responding to some aggressive legal proposals by the entertainment industry, including one which would allow industry vigilantes to hack individual computers in order to locate and disrupt violators of copyrights. I see this as a very ugly transition from a mass media era do a distributed media era. The mass media companies have the law on their side (or at least they have Congress in their pockets). Distributed media, where individual critics and fans play the filtering role once played by record companies or film distributors, has technology on its side. I am confident that the mass media companies will lose, but I think it will take a while for a stable economic model to emerge for a distributed media industry.

Discussion Question. What are the economic issues posed by the concept of intellectual property? Is strong protection of intellectual property as important for society as strong protection of private physical property?

Bob Frankston does not care for a pricing model in which a connectivity provider obtains a share of revenue from business transactions conducted using its service.

What gives ATT the right to grab revenue from a company just because it uses their wires? Imagine if ATT insisted on taking a cut of every transaction done over its phone lines!

In the market, any voluntary contract between consenting adults is legitimate. If a business would rather pay for Internet service by sharing its transaction revenues than by paying a flat rate, then neither Frankston nor anyone else should try to stop them.

I think that what Frankston would say is that no consenting adult would agree to share transaction revenues with an Internet provider, unless that provider were a monopolist that gave you no choice. That may be what is happening here, in which case the challenge is to regulate monopoly profits, regardless of how ATT chooses to extract them--through transaction revenue sharing or simply by charging exorbitant rates.

Discussion Question. Monopolists tend to gain through price discrimination. Why might transaction revenue-sharing help to facilitate price discrimination? Is this form of price discrimination adverse for the economy as a whole?

Brad DeLong sees the silver lining in the cloud of a weak economy.

By late 2002 (according to our projections, at least) real GDP will be some ten percent higher than it was four years earlier. When you reflect that the U.S. economy is running much less "hot" today than it was in 1999--compare the then-unemployment rate of roughly 4 percent to today's unemployment rate of roughly 6 percent--you come up with the consensus guess that the productive potential of the American economy today is some 15 percent higher than it was four years ago, and is growing at about 3.75 percent per year.

Discussion Question. If real growth of 3.75 percent proves sustainable for the next ten years, what implications does this have?

If you look at the Federal Funds rate, then interest rate have not moved since last December. However, long-term real rates have declined. This led me to wonder how much power the Fed really has over interest rates.

Federal Reserve Chairman Alan Greenspan can spin his steering wheel (the Federal Funds rate), but the correlation between those actions and the direction of interest rates in general is weak and inconsistent.

Discussion Question. What are the pros and cons for using the long-term real interest rate as an indicator of monetary policy?