No transitional gains traps?

Don Wittman is right: the transitional gains trap is a bit of a puzzle.

Recall first how the transitional gains trap works. One a rent-seeker has a rent conferred upon him, the value of that rent is capitalized into whatever draws the rent: the quota permit for Canadian dairy farmers; the taxicab medallion for New York taxi firms; the liquor licence for permit holders in places where licences are in restricted supply, for example. After that capitalization happens, the owner of the permit earns only a normal return on the total value of his capital, including the capitalized value of his regulatory rents. Permits change hands such that whoever earned the windfall initial gain takes his rent and leaves; eventually, nobody who currently owns the permits has earned any kind of excess return by having owned them. But try to get rid of the regulatory inefficiency that draws the rent and each and every one of these permit holders will scream blue murder as you're wiping out a good chunk of their capital: some permit holders could easily go bankrupt over it if they took out loans to buy the business and both they and the bank were counting on a continuing flow of regulatory rents.

Now, Wittman would rightly point out that if this is really so inefficient, there has to be a move that buys out the losers out of the gains to the winners. If it's Kaldor-Hicks efficient, this has to be the case. If you run the compensation, then the policy switch is Pareto-efficient.

The usual answer is that the transactions costs are too high to prevent the move towards more efficient policy. But in the case of taxis, or the Canadian dairy cartel, that really doesn't seem to be the case. For dairy, as I've suggested many times, all you need to do is put a tax on dairy products in Canada at the same time as you abolish all of the tariffs on imports and abolish supply management. The tax keeps the price to consumers a bit below where it was prior to the shift and is sufficient to pay off the bonds you issue to buy out the quota holders.

But, there's a reason that opaque transfers are preferred. That reason? Voters. Don't believe me? Read the comments section on Stephen Gordon's Globe and Mail piece where he suggests my "tax dairy and buy out the cartel" solution. For example:

professor_x

2:56 PM on November 16, 2011

I read the word screaming clear TAX.

We want to TAX dairy to make it even more expensive to 34 million Canadians who have to pay off $30 billion dollars in outstanding quota values.

Opaque transfers are opaque. Nobody understands tax incidence, never mind this kind of thing.

Add in the generalized worries about trade, insecurity issues about the Americans, and just general weirdness about food, and you wind up with voter support for a policy that makes them worse off. I'd batted back some of these fallacies. Even if Canada gets rid of supply management, Canada will still have a dairy sector; if Canadians want to ban GE milk, or milk where hormones are used in production, they can do it by direct regulation; and, if Canadian dairy farmers want to form a voluntary cooperative to get some efficiencies of scale while avoiding being contract operators for others, Canada has a strong tradition of agricultural cooperatives.

The best counter-argument I've heard is that the government can't constrain itself against bailing out farmers, so the one-off payment is likely to be followed by some additional support down the line. But isn't it better for government to try to come up with some mechanisms for self-discipline? It's a general purpose technology worth developing. And it's hard to believe that the costs of any potential future support package would trump the cost the supply management system imposes every year with certainty.

Martha Hall Findlay, Canadian Liberal Party leadership contender, makes the case for abolishing supply management in combination with a temporary tax on dairy used to fund a transitional support package for dairy farmers. She suggests the main problem is overcoming dairy farmer resistance and points out that dairy farmers are a trivially small proportion of the voting population; there's no reason that the Conservatives, or anyone else, couldn't just abolish the system, lose every single dairy farmer vote, and not expect much difference in the allocation of seats in Parliament.

I love Findlay's proposal. But I worry that the problem isn't the angry dairy farmers voting against incumbents. Rather, it's angry dairy farmers putting up ads on TV scaring voters about imported milk combined with voters really not understanding that a temporary tax on milk, under this system, reduces the cost of milk rather than increasing it.

I expect that the Canadian Dairy Cartel will use the threat of this kind of public campaign to negotiate for a bigger payout. So it's good to see the folks at EconomyLab helping to inoculate voters against the "make voters dumber" campaign that's likely to come. But if Stephen Gordon or Mike Moffatt were to put something up slowly explaining why free trade in agriculture won't mean that Canadian consumers are suddenly forced to drink poisoned milk, that would probably also be pretty useful. I know it's obvious to us, but it isn't obvious to the folks who can veto the play.