Author Archive

Tax and the Unemployment Benefit are not Unemployment Insurance

April 16, 2010

A few people of vastly different world views have been getting annoyed that the Welfare Reform group is going to be examining the option of unemployment insurance – and some think they should choose a better model to examine. I want to examine the reason why it is frustrating those on the left. No Right Turn claims, endorsing Jackson Wood’s analysis on Twitter, that:

We already have compulsory unemployment insurance. It’s called tax.

What we currently have is not an insurance scheme for at least four reasons:

1) Taxing and promising to pay fixed level of benefits is not an insurance scheme because premiums are not risk-related. If someone was in a particularly stable job (say, they worked for the Government), then their risk of needing to collect the unemployment benefit is lower. If it was an insurance scheme, they would pay lower premiums. Since they do not, they are in fact cross-subsidising those who are riskier.

2) Taxing and promising to pay fixed level of benefits is not an insurance scheme because insurance payouts are not related to contributions. If premiums were legally set as a fixed percentage of income, then payouts would adjust to increase for those who had a higher income. However, that is not the case.

3) Insurance schemes build a capital base from which to meet payouts, while the Government collects money in a year and pays it out in the same year. In other words, the sustainability of the insurance scheme is based on the Government’s ongoing right to tax its people. When schemes rely on future payments to meet obligations, they are typically called Ponzi schemes. Economists from the left and the right agree that benefits like Social Security are Ponzi schemes – they just disagree as to whether it is a good or bad Ponzi scheme.

4) If the unemployment benefit were an insurance scheme, then all Government benefit schemes could be classified as such. However, I’d like to see an insurance scheme with this degree of moral hazard survive in the marketplace. I haven’t seen NZ figures for the unemployment benefit, but there’s certainly evidence of the effect of unemployment insurance from overseas.


The Cost of Free Speech

March 10, 2010

This post is slightly different than the usual post here. The main difference is that I am more unsure of the full implications of my current view than usual.

It seems pretty obvious to me that one still has free speech even when the speech will cost. For example, making sexist remarks may mean others judge you and think less of you. If a businessman makes racist remarks, then perhaps fewer of the relevant race will purchase goods or services from him. I do not think anyone would claim that the businessman does not have free speech because its exercise impacts him in a negative way.

Conversely, it seems to me pretty obvious that a Government that refused to grant contracts to businesses on the basis of the political speech of a director or shareholder would be limiting her free speech. The fact that she could speak her mind is technically true, but costs imposed by the Government on those who speak their mind matter – or certainly seem to matter in my opinion. Is this merely picking up on the point that Alan Dershowitz has made that Jono referenced here?

I think the answer must be no, because the implications are much larger. It suggests that a free market is a necessary, but not sufficient, condition of genuine free speech. Am I missing anything?

Gambling and Tax I

March 8, 2010

It is often said that income tax law subsidises gambling. Because there is no income tax on winnings from earnings, there is a “tax expenditure” which subsidises gambling. Philosophically the concept of tax expenditure is difficult – after all, what does it mean to say that an activity should otherwise be taxed? – but the point is pretty clear: not taxing certain activities which are comparable to other taxable activities has the same effect as a direct subsidy to the untaxed activities.

It has been found by the courts on numerous occasions that winnings from gambling “with the motive of making casual gains or merely for sport or amusement” is not taxable [Duggan v Commissioner of Inland Revenue [1973] 1 NZLR 682]. In that sense, the income tax system would seem to subsidise those who casually gamble. However, in a more important sense, a progressive income tax tends to punish those who take much larger and much more serious gambles.

Assume that there are 10 typists, all of whom earn $45,000 per annum. Any one who becomes a typist will earn that much. There are also ten actresses. Nine of those actresses earn $10,000 per annum, and one earns $360,000. Any one who becomes an actress faces the nine-tenths chance that she will earn $10,000, and a one-tenth chance that she will earn $360,000. To the careful observer, it is clear that the expected value of entering into either job – typing or acting – is equal, at $45,000. And yet, the progressive taxation system results in tax treatment that is quite different. The typists will on average pay $9,290 in tax. The actresses will on average pay $14,345.

So, the tax system may subsidise risk taking in one dimension, but in another massively penalises it. By changing the payoffs in this way, the income tax encourages a form of inefficient risk aversion. In Part II, I will consider whether profits from iPredict are taxable.

Ignorant but Rational

March 3, 2010

Don Brash accused the public of being ignorant, and then said that this was caused by “the failure of teachers to teach and politicians to explain some of the basic facts of life.” The claim of ignorance on issues of public policy is certainly correct, but the diagnosis for why this is the case is wrong.

When are people more likely to be ignorant? When the costs of being informed are high, and the benefits of being informed are low. So, being ignorant about how much you earn could end up being very costly – you may accumulate debt, you will poorly assess your preferred consumption bundle, etc. That’s why people tend to know how much they earn.

But what are the costs of ignorance in public policy? Well, the cost of voting for a nonsensical idea is pretty low, because the chance of your vote determining the outcome of the election is tiny. If there’s a one in a million chance of your vote affecting the election, and the cost of tariffs for you personally is $5, then the expected cost to you is one ten thousandth of 5 cents if you vote for a party that supports tariffs. Equally, voting for policies that are illogical may have psychic benefits – you might decide to do something because of personal bias.

But if ignorance and irrationality is driven by our current institutions, then institutional change could alter those incentives. As opposed to each citizen getting to vote, we could have a higher level of aggregation achieved by cross-sectional juries of citizens. We could massively decentralise state functions and then allow greater personal choice in jurisidiction, including the possibility of virtual jurisdictions. An easy first step would be to end get out the vote campaigns.

Mobile Termination Rates

February 22, 2010

Many are getting outraged at New Zealand’s high mobile termination rates – the cost of terminating a call on another network. Many of the comparisons made to other countries – in particular those made by Drop the Rate Mate campaign – are false.

New Zealand operates a calling party pays (CPP) regime – the party that makes the call pays for the cost of the call. The examples of countries which have no termination rates (the United States, Singapore, Hong Kong, etc.) operate receiving party pays (RPP) regimes. If you think about it, it becomes very clear why CPP rates are higher than RPP rates.

When I buy a phone, I care about the cost to me of terminating on other networks. But I cannot control that price, because it is charged by other networks. Equally, I care little about the cost of terminating a call on my cellphone – because I don’t pay that – the people that call me pay that. In technical language, under CPP the terminating network has the incentive to exploit subscribers from originating networks due to its monopolistic market power.

RPP has one draw back – sometimes people refuse to answer the phone if they think the conversation will not be worth the price. Equally however, in CPP regimes, some people do not make calls that are worth it from the point of view of the receiving party. Some phone calls which would have net utility are not made under either regime. It is my understanding that regulation required mobile companies to operate CPP regimes. Now we are considering regulation to bring MTRs down (or the threat of regulation, which is forcing the mobile companies to lower rates). The whole regulatory issue of MTRs has arisen by virtue of prior intervention!

This article has a lot more on the interface between calling regimes and regulation.

Advertising and Cost

February 20, 2010

Let us assume that the volume of advertisements help potential politicians win an election.  At what period of human existence would campaign finance restriction be an effective way to “level the playing field”?

Certainly, political advertising two thousand years ago was not all that expensive. This caricature, drawn on a wall in Pompeii, would cost more time than money. Then again, holding a large banquet or putting on a show was quite expensive.  However, this was typically the role of the politician – not the candidates – and was often seen as an obligation rather than a political opportunity.

In many ways, it seems like campaign finance laws are last century’s battle. It is undoubtedly expensive to advertise in National newspapers and on television. But newspaper subscriptions are declining, and many are downloading television shows in order to avoid advertisements.  The cost of advertising seem to me to be declining rapidly, in which case it is difficult to maintain that there’s a barrier faced by certain political parties. Set up a blog, have a weekly podcast, register on facebook and twitter.

Equally, the idea that the influence of money can “drown out” other messages is nonsensical. The diversity of media available is enormous, and people tend to self-select in terms of what messages they are exposed to.


February 19, 2010

Jesse made reference to the fact that I thought it was harder for the Government to deliver benefits to special interests than many people think, so I thought I would expand on the point.

Let’s consider an example. Let’s say that the beef lobby has sought favours from Government through donations and votes, and the Government wants to help their supporters out. Let’s say they decide to give $500 per hectare to every beef farmer. This will, in fact, not help the beef farmer. After all, before the intervention the return to sheep farmer and beef farmers were about equal (otherwise they would switch business), and so the effect of the subsidy will merelylead to many sheep farmers converting their farm to beef farming. In the process, the return on the actual production on beef will drop – and it will ultimately balance out the benefit. You may get $500 per hectare from the Government, but the return on the sale of beef will drop by $500 per hectare.

Or take another example, which leads to one-off beneficiaries. The restriction on entry into the taxi industry is common around the world. Often, taxi drivers have to purchase medallions from the Government. Initially, this will restrict supply, driving up the prices that taxi drivers can charge. However, as those medallions are exchanged in the market, the higher prices you can charge become capitalised into the value of the taxi medallion. The second generation taxi drivers can charge high prices – but that is compensation for the massive price of the taxi medallion.  So, taxi medallions deliver a one-off gain to current taxi drivers, but no ongoing benefit for taxi drivers.

Generally speaking, the more concentrated benefits will occur in those areas where the Government also limits supply – doctors, lawyers, accountants, etc. That’s why the typical first act of lobbying is for registration or other restrictions on entry. Sometimes these restrictions pose as uniform regulations, the fixed cost of which affects more heavily those who engage least in the industry, and who will be dissuaded from competing.  See here.

This also explains why the Government has a tendency to deliver services rather than goods. Goods can be exchanged easily – recipients can sell them. If you deliver goods in a discriminatory way (i.e., don’t give them to certain races or income groups), there will be an incentive to trade them to those who value them the highest – i.e., those who would have got them in the absence of intervention. However, services are typically non-transferable, and so it provides an effective way for the Government to discriminate.

The Ectopic Nature of Electoral Finance Law

February 18, 2010

Professor John Prebble has a theory that the incomprehensibility of tax law is caused by the misalignment between “natural law” and “the laws of men and women.”  There exists, he argues, an ectopia (or dislocation) between the economic concept of income and the legal concept of income that essentially cannot be solved.  This ectopia is the result of physical facts such as geography (e.g. where someone is resident) and time (e.g. income is earned on an annual basis) that the law is unable to treat neutrally.

I believe that the same thesis applies to electoral finance law.  It is a law of nature that people will try to convince others of their beliefs.  Trying to convince others will always have a cost – sometimes it will cost money, sometimes it will cost time – but it will always cost.   However, the laws that we design to try to deal with speech are necessarily contrived.  Electoral finance laws have to target particular kinds of speech (it cannot regulate what I say to my neighbour), and have to target a particular type of expense (typically money, not time).  That’s all you need for the entire system to start to represent a nonsense.

As an example, consider the initial Government position to cap expenditure of political parties, but not parallel campaigners.  The obvious flaw – as pointed out by Metiria Turei – is that parties will merely use parallel campaigns to advertise beyond the legislated limits.  In order to maintain the effect of limits on political party expenditure, they have to prohibit parallel campaigners from supporting a party.  The implication of this is an increase in the amount of negative campaigning by parallel campaigns.  Negative campaigning is not per se problematic, but when it arises by virtue of a distortion in the advertising market, then we are decreasing human welfare. 

Starting down the road of electoral finance law leads inexorably to arbitrary decisions you wish you did not have to make.  No matter how many times you compile an Issues Paper, seek comments on a Proposal Paper, or send potential laws to a Select Committee, there is no real way to avoid the ectopia of electoral finance law.

Whenever the debate over electoral finance laws becomes circular, I am reminded of a quotation from Marla Daniels to Cedric in The Wire:  “You cannot lose if you do not play.”

The Mischief Rule

February 17, 2010

With the release of Power’s Cabinet Paper on Electoral Finance Reform, many commentators are beginning to weigh in on the implications of lifting spending limits on third parties.  Given that some of the coverage has been negative, the Minister is now saying he’s willing to consider imposing spending limits on third parties, if that is what is required to achieve “broad support” (i.e., agreement from political parties).

It’s important to return to basics and ask the question: what is the mischief or defect that the law is trying to prevent through spending limits?

There is simply no firm evidence that an absence of spending limits illegitimates an election.  The United States and Australia do not have spending limits, and yet the integrity of their elections cannot seriously be called into question.

Part of the reason why high levels of electoral spending does not impugn the outcome of an election is because there is very little evidence that spending influences voting patterns. The fact is that if a politician is highly succesful at soliciting votes, he is highly likely to be succesful at soliciting donations (the same is true of a third party – if third parties are effective at securing votes for their favoured platform, then they are more likely to receive money from the supporters of that platform).  Hence, correlation between spending and electoral outcome proves little.

What you need to do is adjust for confounding factors.  When such adjustments are made, there is very little evidence that spending is a major causal factor in how people vote.  One such study found that “campaign spending has an extremely small impact on election outcomes.”  In fact, some studies have even found that incumbent wealth can harm a political cause.

It seems then that prima facie there is no concrete harm that can be demonstrated from a liberal approach to campaign finance.  But, let us assume that higher levels of spending did in fact cause people to support a particular party of platform.  Would this be a bad thing? Some people may choose to vote for a party because of a charismatic leader, because they are bigots, or any other number of questionable reasons.  It is odd to say that someone should not change their mind on the basis of advertising paid for by people who think their cause justifies such sums of money.

Even if the people who change their vote are doing so in response to the volume rather than the content of the advertising, and such voters have real influence, then there is little that limits on spending will do to cure such shallow voters.  As Robin Hanson argues:

Many folks mistakenly assume that distortions from shallow voters stop if [third parties] are silenced.  But not only would that hinder non-shallow voters from getting info from [third parties], the total distortion by shallow voters is not obviously reduced!  Shallow voters who believe whatever side shows the most ads would either be bought by [third parties]  more indirectly, or by other deep pockets more directly.  And the many other kinds of shallow voters, who believe whoever has the funniest ads, or the coolest spokesfolks, or the prettiest candidates, would still cause distortions.