Painting features as bugs

I hadn't quite understood New Zealand's carbon emissions trading scheme before I moved to Wellington. The thing seemed a little dodgy with a fair bit of reliance on dubious foreign credits. But then the genius of the thing was explained to me. I've not looked at it properly myself, but the story is interesting, and seems plausible.

It goes something like this.

New Zealand's first preference is for everyone in the world to be on-board for serious GHG reduction. But we can't get to the first best directly. Plenty of countries have dodgy emissions trading regimes with credits of dubious origin. And the worst case for New Zealand isn't doing nothing. Doing nothing is bad, but even worse would be New Zealand taking GHG reduction seriously while other countries don't.

Why is that bad? New Zealand is, relatively speaking, one of the less GHG-intensive producers of milk. Our pastoral systems might not be nice for water, but they're not as bad on methane emissions as barn systems elsewhere. And NZ pushing too hard too fast on GHG abatement, when other places aren't, isn't just bad for the NZ economy. It also risks pushing production away from relatively clean NZ to places where production results in more emissions. Bad for the economy, likely bad for the environment too.

So what's the solution? NZ joins an emissions trading scheme and is happy to accept whatever dubious credits other countries are willing to countenance. Why is that good when dubious credits are, by definition, dubious? It means that New Zealand gets serious about GHG reduction whenever other countries do too. As soon as the international trading systems stop accepting dodgy credits, New Zealand stops using them too. And that means NZ is on board for more substantial climate change action at the same time that everyone else is.

At least that's the potted history I've heard around the Wellington traps. If that's what's going on, it's genius. The dodgy credits are far from hidden and far from a bug. They're a feature that lets New Zealand set up an ETS apparatus that automatically scales to being serious when it's the right time to be serious, and avoids imposing serious costs until the international community is ready to take things seriously.

The Morgan Foundation's report goes through some of this, noting that New Zealand disproportionately makes use of dodgy credits. But it draws a different conclusion than I would. Rather than follow some countries in unilaterally cancelling carry-over credits into the next round, New Zealand should be arguing that all of the trading schemes use a stricter standard on credits. Then everybody tightens up, us included.

Soak the tourists?

Gareth Morgan argues that New Zealand needs to do a better job in extracting all the surplus from tourists.

He first argues that foreigners buying property here would pay a fairer tax share under comprehensive capital income taxation on the value of their purchased property.

A lot here would hinge on relative elasticities.

Suppose that foreign demand for NZ property is completely elastic (there are close substitute countries where rich people might go instead) and that domestic property supply is completely inelastic. Under those assumptions, we would see a one-off drop in property values equivalent to the present discounted value of the future tax flow. Some money currently being paid by foreign investors to Kiwi owners would instead go to the government. If demand for NZ property is more elastic than the supply of NZ property, which seems likely, then the proposal mostly transfers money from current owners to the government. And the more elastic the demand for NZ property among foreigners, the more foreign buyers are deterred by the regime.

He goes on to worry about costs imposed by tourists. In some cases, he's right - but in those cases it points to a problem that's broader than tourists. He points to costs imposed by tourists when they have car accidents; if tourists do have disproportionately more accidents, then ACC car registration levies on cars run by car rental agencies should be higher than those on residents' cars - the problem is one of inadequate premium sensitivity to realised risk than one of tourists per se. And while he's right that the system should charge tourists when they wind up needing costly rescue operations from mountaintops or ravines, the system really should charge whenever there's recklessness - whether from tourists or locals.

Morgan continues:

But we could and should go even further. This season the Great Walks are enjoying record numbers of tourists. Again these are taxpayer-funded facilities so why shouldn’t the taxpayer get a direct return on that investment, at least to cover the track maintenance? We already charge for hut beds so clearly are not allergic to the user-pays ethos, but extending this to foreigners having the right to use of National Parks again seems a no-brainer. Again that levy could be collected at the airport as part of a bundled “taxpayer-provided services levy”.

And it shouldn’t stop here. In instances where there are direct charges for the services provided by central- or local-government funded or part-funded amenities, we could simply have a separate and higher charge for foreigners. Zoos for example could levy that – as the example in the photo illustrates at Darjeeling zoo, foreigners pay 2.5 the entrance fee that locals do.

We already do this at the Waitangi Treaty Grounds, presumably because there is value in New Zealanders visiting this historical site. Why not extend this approach to other sites – such as Te Papa, Zealandia, and the plethora of other Zoos and Museums that receive taxpayer and ratepayer subsidies?

On the other hand, tourists pay 15% GST on everything they buy here and only can reclaim GST on those goods they bring home with them - if they can be bothered to fill in the paperwork. Further, tourists already pay more for facilities like zoos where locals can often profit by purchasing annual passes that pay for themselves after two or three visits.

And where tourists are cost sensitive, tourist-soaking levies on some facilities will reduce the amount tourists spend elsewhere.

Bigger picture, cities like Wellington do pretty well out of tourists. Sure, they can be a bit annoying for locals when Lambton Quay is jammed if two cruise ships are in port at the same time, but we're able to support a better variety of restaurants and bars than we could without them.

Finally, in a world where public facilities are directed to soak tourists, they need a way of identifying locals. That means we'd all need to show our driver's licence for entry to these facilities. But why stop there? Councils fund a lot of art galleries; you might need to bring your power bill or some other proof of local residence to get discounted admission: a driver's licence wouldn't be enough. Or maybe Councils would start issuing special residents' cards. People who sound local would likely not be bothered to pull out their IDs when entering facilities, but folks like me who still have a Canadian accent after being here for more than a decade would have to stump up every time.

It's that last bit that sounds particularly unappealing. I know Morgan's framing this as being an anti-Winston-Peters thing, but I'd reckon that Morgan's soak-the-tourists proposals have a lot better chance of passing in a world in which New Zealand First has the balance of Parliamentary Power than one in which they don't.

I'd hit on related topics in last week's NZ Initiative "Insights" newsletter.

Gareth's strawman

Fun week.

I posted over at Interest.co.nz about how reducing regulatory barriers to densification and to expansion in the suburbs could reduce housing costs and consequently improve child poverty outcomes, at least some of which are due to high housing costs.

Gareth Morgan posts over at Gareth's World about how I'm kinda evil for being so pro-sprawl and wanting sprawl everywhere and not wanting densification and how free-marketers are hypocrites for only wanting new development not next to them and how the infrastructure costs of sprawl should be borne by developers, and so on.

I posted comment there as follows.

Hi Gareth,

It's a shame you didn't get in touch to ask me about some of this stuff. I'm not sure why you began by assuming some strawman version of my argument, but I'll hit on it here.

First off, I'm more than happy for things to include Epsom. David Seymour and I have had a few disagreements about this. You might even read the parable I had up at Offsetting today as being directly relevant. This one. Is this the kind of thing that an out-only guy would write?

Secondly, why would you think I wouldn't support that new developments bear the infrastructure cost? I've long been a fan of Municipal Utility Districts for such purpose: these load all of the infrastructure costs onto the folks moving into new developments, using a fairly efficient financing structure.

Third, I'm totally a fan of congestion charging. Do that at the same time so that any sprawl congestion costs are internalised.

Finally, I've over and over again posted at Offsetting on how we need to get rid of regulatory impediments to densification. Heck, I've even come up with some political economy solutions to try to buy out the NIMBYs to stop the blocking of densification. Why are you assuming that I only want growth on the fringes? Auckland's done a fair bit already to open up on the fringes, though they could do a lot more. But the big gains would be overturning the avenues for NIMBY blocking of intensification. I even said it in the piece you seem to hate: we need UP AND OUT. Lemmie check...ah yes. There it is. "When land supply, both expansion at the city fringes and land zoned for increased density, is constrained by regulation, the price of zoned land rises." I specifically put that in in case people might misread me as making some argument for sprawl-only. I'm not making that argument. I don't know why you think I'm making that argument.

I agree with you that there are tons of right-wingers who want only development away from them, and that they'd come out of the woodwork were substantial proper reform suggested. I'm not one of those people. I'm one of the ones trying to figure out how we make housing more affordable given the set of political constraints.

I kinda think we're on the same side here. I don't know why you're painting this caricature.

Dunno what Gareth's deal is.

Meanwhile, David Seymour isn't a fan of my post wondering about how we get to consider neighbourhood character to be a property right.

@bernardchickey @EricCrampton reductio as absurdum
— David Seymour (@dbseymour) October 2, 2014

I agree with David on a lot of stuff. Not so much on this one.

Self-control

I read the behavioural literature as a meta form of self-help. Here are some standard ways that people can screw things up; here are some heuristics they use that work on average but can yield failures when applied to the wrong domain; here are some strategies for applying the right heuristic at the right time and for avoiding applying the wrong one; here are some common spots where people need to be extra-vigilant to avoid making errors.

Gareth Morgan tweets a link to a write-up of the standard Wansink findings around food:

Why most people don’t have control over how much they eat http://t.co/Cf6lyT1RHt
— Gareth Morgan (@garethmorgannz) February 23, 2014

Sure, in field experiments, you can induce overeating by making people think that they've eaten less than they have (for example, by surreptitiously filling the bowl from below). But does that mean that they're irrational and always subject to error? Or might it mean that people eat until one of two conditions are met: satiation, or end of current portion? If the latter typically comes before the former, people stop eating at the end of the bowl. If the former tends to come before the latter, they'll leave some behind. What interest would a restaurant have in supplying you with more food than you'd really want when doing so might make you less likely to order dessert and will make you more likely to linger longer at the table?

The linked piece also takes a self-help approach to the findings: Try using smaller bowls or smaller plates; don't go for "value" deals if that isn't what you really want to eat.

And so Matt Nolan replied to Gareth:

@garethmorgannz Control still comes from the fact that people can precommit by purchasing smaller packets/portions http://t.co/eI50VkKJdV
— TVHE (@TVHE) February 23, 2014

Morgan replied,

@TVHE You are assuming perfect information
— Gareth Morgan (@garethmorgannz) February 23, 2014

This kind of line really bugs me; it reminds me of the kind of thing that non-economists will come out with when criticising economics. Imperfect information hardly seems to be what's driving food choices. And, perfect knowledge is hardly necessary to make precommitment viable. You just need to know that you often screw up particular kinds of choices.

Odysseus didn't need perfect information about just how lovely the Sirens' call was in order to have the sailors bind him to the mast; he just needed to know that the temptation had proved too tempting for many others. I've never played World of Warcraft, but that doesn't mean that I've erred in deciding never ever to start playing multiplayer online games. I definitely don't have perfect information about it - I've never played it! But I know that I'd find it hard to avoid spending too much time playing online games if I had the added pressure of friends wanting me to come help them on a raid. So I just don't play. Imperfect information has led me to consume what's likely too little gaming relative to an ideal: you don't need to assume perfect information to get precommitment.

Obesogenic environments?

Gareth Morgan wanted restrictions on where "fake food" outlets might be located.

Placement of junk food outlets – local communities have a say over the placement of alcohol outlets, but we can’t stop junk food outlets setting up around our schools or clustering in poor neighbourhoods. This could be changed if planners had to take health into consideration in their decisions.

From The Lancet, online version 29 November 2013:

Influence of the retail food environment around schools on obesity-related outcomes: a systematic review
...
This review of the scientific literature found very little evidence for an effect of the retail food environment surrounding schools on food purchases and consumption patterns, but some evidence of an effect on bodyweight. Given the general lack of evidence for association with the mediating variables of food purchasing and food consumption, and the observational nature of the studies included in this review, it is possible that this finding is a result of residual confounding.

Tiki tours and useful idiots

Back during the Cold War, Western intellectuals were given guided tours of the Soviet Block and sent home to heap praise on the wonders achieved by Stalin. They were collectively called "useful idiots": too dumb to see through the Potemkin villages raised, but useful for internal and external state propaganda.

Last week, Liberty Scott started posting and tweeting on Gareth Morgan's motorcycle tour of North and South Korea. He pointed to numerous instances of Morgan's appearance being used in North Korean state media helping to legitimise the regime.

When I visited the DMZ on a USO tour back in 2007, we were given really strict instructions by the American military. Do not smile at the other side. Do not point. Do not do anything that the North Korean agents on the other side could photograph and print in their newspapers as "Westerner points to the Glorious North, admiring the wonders of Juche." I'm not generally all that keen on "do as I say" regs, but these ones made a lot of sense. One of the world's most evil regimes was staring back - literally, guys with binoculars and big-lens cameras - and I was publicity-shy.

But maybe playing the regime-supporting shill while there was needed so that he could have some chance at seeing what was going on.

Matt Nolan at TVHE yesterday pointed to Gareth Morgan's comments on his tour. Morgan wrote:

Having passed successfully through the demilitarised zone Gareth explains to the world’s media why the West’s “beat-up” view of North Korea is completely wrong.

Gareth and Jo and their group were free to set their own route through North Korea, witnessing at first hand the lives of ordinary North Koreans.

What they found surprised them – a people who were poor, yes, but wonderfully engaged, well-dressed, fully employed and well informed. In Gareth’s view, what North Korea has achieved economically despite its lack of access to international money has been magnificent.

He and Jo support active steps towards providing greater opportunities for ordinary Koreans from North and South to interact together – a goal of leaders from both North and South Korea. Hopefully, with enormous interest from the world media, this trip will be the catalyst for such a change.

Unbelievable. I'd thought that he was going to come out claiming that starvation works wonders on reducing feral cat numbers; this is worse.

Maybe there was some case for the tour somehow facilitating better North-South talks. Unlikely, but not impossible. But that the West has a "beat-up" view of North Korea? They have freaking concentration camps! Morgan's next tour could perhaps hit a few of those off-piste highlights. Morgan found the North Koreans with whom he spoke wonderfully well-informed; it's problematic even asking what that means in a place where preference-falsification is a necessary survival characteristic. As Xavier Marquez wrote:

There is a terrific story in Barbara Demick’s Nothing to Envy: Ordinary Lives in North Korea (pp. 97-101), which illustrates both how such control mechanisms can work regardless of belief and the degradation they inflict on people. The story is about a relatively privileged student, “Jun-sang,” at the time of the death of Kim Il-sung (North Korea’s “eternal president”). The death is announced, and Jun-sang finds that he cannot cry; he feels nothing for Kim Il-Sung. Yet, surrounded by his sobbing classmates, he suddenly realizes that “his entire future depended on his ability to cry: not just his career and his membership in the Workers’ Party, his very survival was at stake. It was a matter of life and death” (p. 98). So he forces himself to cry. And it gets worse: “What had started as a spontaneous outpouring of grief became a patriotic obligation … The inmiban [a neighbourhood committee] kept track of how often people went to the statue to show their respect. Everybody was being watched. They not only scrutinized actions, but facial expressions and tone of voice, gauging them for sincerity” (p. 101). The point of the story is not that nobody experienced any genuine grief at the death of Kim Il-sung (we cannot tell if Jun-sang’s feelings were common, or unusual) but that the expression of genuine grief was beside the point; all must give credible signals of grief or be considered suspect, and differences in these signals could be used to gauge the level of support (especially important at a time of leadership transition; Kim Il-sung had just died, and other people could have tried to take advantage of the opportunity if they had perceived any signals of wavering support from the population; note then the mobilization of the inmiban to monitor these signals). Moreover, the cult of personality induces a large degree of self-monitoring; there is no need to expend too many resources if others can be counted to note insufficiently credible signals of support and bring them to the attention of the authorities.

Even if Morgan was away from his handlers, everyone is a handler. That's the point of a totalitarian regime. Any disclosure can get you and your family sent to a concentration camp because somebody else will have purchased an indulgence by dobbing you in. And the safest course is making yourself believe the things you have to say.

Compare Gareth Morgan's visit with a couple other recent Western visits. Here's Neil Woodburn's travelogue. Here's what Curtis Melvin did while visiting North Korea, and subsequently. Melvin's mapping project would let Gareth Morgan check to see which prison camps he missed along his tour. Liberty Scott's update has some useful recommended readings as well.

Can tax and subsidy incidence really be negative?

Imagine a country where shoes cannot be imported and furthermore the elasticity of supply of shoes is very low. Imagine that the government in this country subsidises shoes. The person on the street who doesn't understand tax incidence might think that this policy lowers the price of shoes by the amount of the subsidy. An economist, however, would be likely to point out that, because supply is fairly unresponsive to price, the subsidy mostly results in an increase in the before-subsidy price to the seller.    In our jargon, he would be saying that most of the incidence of the subsidy would be on sellers and only a bit on buyers.

So far so good, but what if that economist now explained that removing the subsidy would make shoes cheaper to consumers, by stopping buyers from bidding up the price. This would seem to now be claiming that the incidence of the subsidy on buyers would be negative. Sure removing the subsidy would reduce the price to sellers but it would be a very strange model that would have the price falling by more than the reduced subsidy. In fact, it would seem to require that the supply curve be downward-sloping. 

And now, imagine that the economist further claimed that removing the subsidy would be good, as it would result in investors switching from investing in shoe production to investing in productive assets. This would go beyond strange. Sure the subsidy might have been diverting assets to having too much shoe production and not enough other stuff, but in what sense would we say that producing shoes is unproductive? And, how is it consistent to argue at the same time that removing the subsidy would lead to less investment in shoe production at the same time as arguing that it would result in lower shoe prices for consumers? 

O.K. this country, this policy, and this economist are fictitious. But if we change "country" to "New Zealand", "shoes" to "housing", "subsidy" to "tax exemption", and "economist" to "Gareth Morgan", you pretty much get this blog piece from Gareth on Tuesday. 

Gareth argues, correctly, that owner-occupied housing receives a favourable tax treatment relative to other investment since we are not charged income tax on the implicit rental payments we receive from ourselves. But he then goes on to argue that removing this exemption would "bring affordability within reach of many more families". This is an argument I have commented on before; it really looks like arguing that tax incidence can be negative: If housing is effectively subsidised by the tax system, we can't expect removing the subsidy to make it more affordable. 

And he then says that our tax treatment of housing has "discriminated against productive investment in favour of property speculation". Now if he means that we have invested too much in building houses and other kinds of investment, then we have to ask: In what sense is it unproductive to build houses that provide housing services to people that they value enough to pay for? And, how is it possible that curtailing such investment would "bring affordability within reach of many more families"? If, in contrast, he means diverting investment resources from building new equipment to buying existing houses as speculation, I have my perennial concern that this line or argument fails to note that buying existing houses for speculation or other reasons is not "investment" at all, and the assumptions you have to make to conclude that such behaviour diverts resources away from productive investment are a stretch to say the least.  

One final curious seeming contradiction in Gareth's post. At the start, he notes "When, not if, interest rates increase, this illusion that housing is `affordable' will burst....house prices will adjust". But later he suggests that if we don't remove the tax-favoured treatement of housing, he should "go out and buy another three houses now and just wait for the rest of you to bid the prices up". Why would that be good personal investment advice if, as he says, house prices are sure to fall? What am I missing?

Optimal cats

I'm not sure that you can make a case for the phased abolition of cats from New Zealand within a utilitarian framework, even one counting animals' utility directly, without arguing that you also have to abolish any carnivore elsewhere in the world whose prey is not at the Malthusean fringe.

It's conceptually easy to add animals' utility to utilitarianism; read Peter Singer. Animals utility will be weighted by their self-awareness and capacity for pleasure and pain, but it counts positively and directly in the social welfare function. This interview of Peter Singer by Tyler Cowen is superb, though it doesn't hit this topic directly.

If the marginal increase in terror imposed by cats on their prey*, accounting for that cats may have greater self-awareness and greater capacity for pain and pleasure than do prey species, outweighs the cat's enjoyment of its own life (including all the murder) and the cat owner's enjoyment of the cat, then a Singer framework would support getting rid of cats. If pet owners get particular disutility from the forced euthanasia of their pets relative to not being allowed to get a new one, then it could be consistent with Gareth Morgan's proposed mandatory neutering and non-replacement.

But it's also consistent with other required policies. The proposal above is only optimal where prey animals would otherwise have had happier lives and deaths: trading starvation at the Malthusean fringe for death by cat might not be all that bad. But consider rabbits and mice in Britain that feed on crops and are not at the Malthusean fringe. Foxes that eat them then do harms little different from the harms imposed by cats here. And what of the terrors keas impose on helpless sheep?

Aha, you might say: rabbits and mice are not endangered, while some New Zealand native bats and birds could be. This matters in a Singer setup to the extent that people value endangered species more at the margin than they value rabbits and mice, and to the extent that any extinction may have flow-on effects elsewhere, but we also have to weigh it against cat owners' enjoyment. And given the likely rather large consumer surplus provided by cats, well, I'm not sure the case is obvious.

If you step outside of the utilitarian framework, it's perhaps easier to derive a "abolish cats but leave foxes alone" conclusion. Harry Clarke puts up a biodiversity standard, arguing that biodiversity should be sought for its own sake and regardless of whether people gain enjoyment from biodiversity. But if there's a continuum of policies that could be undertaken to encourage biodiversity, and if some are very costly, we have to draw a line somewhere about trading off biodiversity against other goods. And that puts us back into a utilitarian cost-benefit assessment even if we're adding in biodiversity as a non-preference-related constraint.

I'm not against this kind of messy pluralism; it's close enough to my own messy pluralism, where I invoke liberty side-constraints on utilitarianism rather than biodiversity side-constraints. But isn't it worth weighing up the shadow prices of the incremental gains? You have to put ridiculously high weight on the side constraint to reckon we shouldn't even consider cat owners' forgone enjoyment. And I'm not sure that there isn't a fundamental underlying anthropocentrism even to biodiversity standards where at least some of it seems to require choice among equilibria, and a lot of weight put on particular ex ante status quos. If many of New Zealand's species arrived here long after separation from Gondwanaland, and then evolved here, how far back should we go in turning back the clock? Sure, there was a stable equilibrium here before the arrival of Maori. But there would have been a stable equilibrium before the arrival of bats and buttercups too. And if the pre-human equilibrium was the 'best' one because it included some best stable set of creatures that didn't exist elsewhere, and we should invest resources in maintaining that set of creatures at the expense of other ones, why shouldn't we also invest resources in developing new creatures that do not exist elsewhere? There are lots of ways of increasing biodiversity.

* Every animal dies of something, eventually. If the cat kills an animal that otherwise would have died a painful death of Malthusean starvation, it has done no harm and may have done good. If the cat kills an animal that otherwise would have had a long and happy life because the environment is well below carrying capacity because there are too many predators, then it has done harm. If it kills an animal that otherwise would have soon been eaten by a weasel, rat, stoat or possum, then it's done no harm. See discussion of vegetarianism and eating fish in the Cowen-Singer discussion above-linked.

Kill all the kittens

Gareth Morgan wants to eradicate cats from New Zealand. His campaign website does a good job in describing the various evils cats perpetrate upon our ridiculously pacifistic native wildlife. But it's missing the first thing I'd have expected in a policy campaign coming from an economist: a cost-benefit analysis.

First, how much consumer surplus is generated by cats? It has to be pretty big. The New Zealand Companion Animal Council claims* that the 48% of NZ households owning at least one cat spend on average $838 per year on their cats. 1.419 million cats at $466 per cat is about $660 million spent on caring for cats. I don't know what the price elasticity of demand for cat ownership is, but aggregate surplus seems awfully likely to be big.

Second, how elastic are wildlife numbers to cats' presence? Cats kill a lot of things; they're awfully murderous. But if they weren't there, would native wildlife rebound, or would the population of other predators expand with the reduction in competition?

Finally, how much value do we really place on native wildlife? Sure, we get some existence value from the birds and lizards that cats eat, and it's nice seeing them and hearing them. But is it enough to trump the consumer surplus that people get from cat ownership? I don't know and neither does Gareth. But I'm not the one wanting to kill all the kittens.** Shouldn't we have to run a cost-benefit analysis before considering kitty genocide?

Gareth does recommend a few potentially useful things, like belling cats. I doubt that the cats who do the most damage would be the ones that are belled, but the proposal at least doesn't seem likely to do much harm. Another option: make your next cat a Persian. Our last one was so ridiculously over-bred*** that she could barely eat kibble, much less do any harm to, well, anything other than furniture, carpets, clothing, and my dignity.



* I have no clue how reliable their survey is.

** Ok, he isn't really saying we should kill them all, just that we should phase them out over time. But, still, I'm pretty sure that every time you drink a Coke, Gareth Morgan kills a kitten.

*** We got her from the Cat Protection League's cattery. Long story there. After we moved to New Zealand, Susan insisted we get a cat. I asked that it please please please not be another long-haired one. She sent me to the bank machine to get cash to pay the Cattery after we'd been looking at a nice short-haired one. When I got back, she'd signed all the paperwork for a defective Persian with a substantial underbite. The cat was lost eight years later consequent to the earthquakes.

More on Housing Affordability: Supply versus Demand

Over at TVHE, Matt has followed up on my post here on Gareth Morgan versus the Productivity Commission, arguing that we shouldn't view supply and demand explanations as mutually exclusive. Now I think Matt and I are pretty much in total agreement, but slight differences in language might make our posts seem at cross purposes, so I thought a couple of clarifications are in order.

First, the interesting question is not whether the cause of house-price inflation in New Zealand is supply, demand, or some combination of both. Obviously, since house prices are set by mutual agreement between buyers and sellers, prices are always and everywhere the result of both supply and demand. Rather the issue is, to the extent that house prices are inappropriate for some reason, whether the source of the inappropriateness is acting through supply or demand. Matt frames this by asking whether something is pushing demand for housing beyond what is "socially optimal" (or, by extension, restricting supply below what is socially optimal). Another way of saying this is to ask whether the policy response to high house prices would work by increasing supply (say changes to zoning or consent processes) or demand (say, changes in the tax treatment of housing).

The second clarification is that saying that supply and demand are not mutually exclusive is more than just saying that influences on both sides can contribute to the final effect. In the case of tax policies, the purpoted cause of house-price inflation only makes sense if there is an underlying problem with supply. To illustrate, consider Matt's statement

The key point against supply side issues will be fact that rental growth hasn't gotten as scary at any point -- if there are "too few" houses, then we should really see the cost of housing services/rent pick up.

The idea here is that if house prices are going up faster than rent, then the opportunity cost of owning a rental property must be rising faster than the direct income derived from it, so the only motivation must be the expectation of capital gain. This is true, but the expectation of capital gain only makes sense if the underlying trend is for the demand for housing for non-investment purposes to grow faster than supply. That is, to explain house inflation today as driven by tax-favoured investment, we need to assume a problem with restrictions on supply in the future.

Furthermore, consider what we would observe if there were no favourable tax treatment for owner-occupied housing or income derived from capital gains, but still an expectation of demand growth outstripping supply growth in the future. As long as the capital gains tax rate were not set at 100%, it would still be the case that expectations of future house price inflation would drive inflation in house prices today, there would be a positive after-tax return from capital gains, and hence a slower rise in rents, exactly the observations that Matt suggests might imply the problem is not exclusively on the supply side.

The bottom line here is that the favourable-tax-treatment story simply implies that problems due to insufficient supply will bite a bit earlier than they otherwise would have done. If there is no problem with supply being unable to keep pace with underlying demand, the tax-treatment issue is irrelevant.

Gareth Morgan on Housing Affordability

Gareth Morgan takes aim here at the Productivity Commission, for emphasising land supply as the major determinant of the high cost of housing in New Zealand. He notes that

[t]here are cities in the world with five times Auckland's population, living in an area no larger than Auckland's, and with housing prices lower as a percentage of income than in New Zealand.

Gareth, in contrast, points the finger at the Reserve Bank for directing banks to emphasise mortgage lending (for prudential reasons), and the tax code for favouring housing. He says that as a result of this "toxic duo" we have

driven the price of housing from twice the average household income to six times.

He restates his call for a capital tax (not a capital gains tax) to remove a distortion in favour of housing. Now, as I wrote here, I think that a capital tax has some really horrible properties that would swamp any benefits, but this is secondary to why I don't agree with this analysis of the NZ housing market.

First, explanations don't have to be either-or. Even if we agree that there are problems in New Zealand capital markets that contribute to house inflation, surely it would be the case that those problems are going to be more acute the lower is the elasticity of supply of land for housing?

Second, one of Gareth's concerns about the tax advantage given to housing is that it encourages people to buy housing as a path to prosperity, which presumably means that it is based on expected capital gain. Now this either means that house prices have been pushed up by a bubble, which will eventually burst without any change in the tax system, or that the fundamental price of housing is rising, and speculation is just bringing those price increases forward. If that is the case, then removing any favourable tax treatment on the capital gains from home ownership might cause a one-time drop in house prices now, but a faster increase in those prices in the future.

Third, Gareth's other concern about the favourable tax treatment given to housing--and the one that motivates Gareth's call for a capital tax--is the familiar fact that the implicit income earned from selling housing services to oneself in owner-occupied housing is not subject to income tax (although the transaction is implicitly subject to GST). This distortion will indeed cause the demand for housing to be higher than it otherwise would have been. But it will not cause the after-tax price of housing services to be higher, so again, it is hard to see how removing the tax distortion would be a solution to the problem the Productivity Commission are addressing.

Finally, if looking to the tax code to explain the change in house prices over time, or differences between countries in the fraction of income devoted to housing, one needs to identify time-series or cross-section differences in the tax code. Pretty much all countries have a tax code that favours owner-occupied housing and always have done. If anything, we have moved the tax code away from favouring housing in recent years with changes in the treatment of investment properties, and a switch from income tax to a higher rate of GST. And we don't have policies like the mortgage interest rate deduction that are seen in other countries, particularly the U.S.

Ultimately, it just comes down to ECON 100 supply and demand. The New Zealand population has been rising, and land-use policies have been preventing supply from keeping up with demand. Maybe those policies are a good thing, and we should be moving away from urban sprawl to high-density living. But it is hard to counter that the cost of such policies will be a steady increase in the price per square metre of housing.

The impossible trifecta

Kevin Milligan says a Guaranteed Annual Income cannot simultaneously satisfy three goals. Instead, you have to pick two among the following:

1. low tax rate
2. high benefit
3. balanced budget*

Treasury here in New Zealand modelled a GAI for New Zealand on the request of the Welfare Working Group (HT: Lindsay Mitchell). What did they find? A GMI paying $300 per week - the mean benefit income among those on benefits - would cost $44.5 billion, or $52.6 billion if we extended it to superannuitants as a replacement for NZ Super. The former could be covered by a flat personal income tax rate of 45.4%; the latter, 48.6%. But full fiscal neutrality would require tax rates of 50.6% and 54.4% - the lower tax rates would be just enough to cover the transfers, but income tax revenues are currently also used to fund more than just transfers.

If we recognize that most parents are beneficiaries via Working for Families and compensate them for the loss of our version of EITC with a $86 per child per week payment, we get a $57.1 billion fiscal cost and a personal tax rate of 50% (or 55.7% for fiscal neutrality).

And, even this rather expensive system leaves the worst off worse off, as it kinda has to. Treasury notes:

Although the Gini coefficient improves under all models, many beneficiaries (including the disabled, carers and sole parents) currently receive more than $300 per week and would be made financially worse off under a GMI scheme. Therefore the GMIs considered could distribute money away from those most in need of government assistance and toward those who have choices and opportunities but choose not to work.

Treasury also warned about potential adverse labour supply responses to the necessary personal tax rates. And, the induced gap between company and personal tax rates would increase IRD's enforcement costs.

Treasury concludes by reiterating Milligan's impossibility:

From the international examples it is apparent that the more equal a society is in the beginning, the lower the returns to a GMI scheme. That is, a New Zealand specific GMI would either be at a level of income too low to reduce poverty, or a level of income that is high enough to reduce poverty but is therefore expensive and hence distortionary through higher tax rates. 

I don't think Gareth Morgan's Big Kahuna scheme is able to escape the trifecta by imposing new taxes on capital or land. Why? Because those aren't free lunches either. If it's worth having a land tax, it's worth doing it regardless of whether we have a GAI. So in the first stage we set the optimal tax structure - and I'm completely unconvinced that a capital gains tax is all that hot an idea anyway (see Seamus's posts here here and here.) But whatever the optimal tax structure, we implement it in stage one. Then, we still have to increase all the tax rates by enough to pay for a GAI if we're going to have a GAI. And the impossibility reasserts itself.

Morgan squares things with a cheaper GAI paying $11k instead of Treasury's $15k. But I have a hard time believing that's a stable political equilibrium. Could NZ politicos really avoid the temptation of adding targeted benefits for the many folks currently on benefits totalling well over $15k? If not, how quickly do we wind up having a GAI on top of a targeted benefit system?

* Update: Milligan's updated this in a more recent tweet. I think there are a few possible impossibilities here.

@EmmMacfarlane Again, the impossible trinity: choose two of:

* low phaseout rate
* Big basic benefit
* same cost as current system.

— Kevin Milligan (@kevinmilligan) February 5, 2016

Morgan and Guthrie’s Modest Taxation Proposal

Gareth Morgan and Susan Guthrie have proposed a radical shake-up of New Zealand’s tax and welfare system, summarised in this article in the Herald last week. The main features are as follows:

• an “unconditional basic income” (UBI) of $11,000 for every adult, applying to everyone and replacing all other benefits including superannuation;
• a flat income tax rate of 30% applying to all income earned by individuals, trusts, or companies; and
• a “comprehensive capital tax” (CCT), which effectively imposes a minimum tax on all capital excluding financial assets equal to the tax that would apply if the capital earned a rate of return of 6%.

I assume also that they assume maintenance of a broad-based GST, and full dividend imputation of corporate tax.

Some things in their proposal I like. Having a single system implementing transfers and income taxes is long overdue. I wouldn’t go so far as to have a single minimum income that is the same for every adult, irrespective of need, as the level that would be needed to guarantee an acceptable income to the most needy would be unaffordably high if given to all. An integrated tax and transfer system, however, needn’t be as hands off as in their proposal; there could still be a role for a body like WINZ to adjudicate on levels of benefits according to need, and provide other support services; the most important thing is to integrate the systems so that the impacts of policy changes on horizontal equity and effective marginal tax rates are transparent.

Aligning the corporate tax rate, tax rates on trusts, and the marginal rate of income tax for the majority of taxpayers is also long overdue. I wouldn’t have a single rate all the way down to zero income, in order to allow differences in the guaranteed minimum income based on need to be phased out at higher incomes. Again, the point of difference here is small relative to the main point. A system in which there was a common rate applying to corporate income, trusts, and the income above, say, $30,000 would probably achieve almost all of the benefits of a single rate in terms of eliminating the distortions and compliance costs that multiple rates can bring.

On the other hand, the comprehensive capital tax has me flabbergasted, for a number of reasons:

First, the contrasting motivations for the UBI and CCT seem incongruous. Under the UBI, an able-bodied pre-retirement adult with no dependents would be entitled to choose to not work and still receive the UBI, and pay no tax. Their justification for this is that “[w]e are a rich society so to compel people to opt for paid work or face the stigma of qualifying for a benefit has no logic.” At the same time, however, their CCT does not regard it as a matter of personal choice how people should invest their savings; instead it implies a moral imperative to earn a return of at least 6%. There seems to be an underlying value judgement that earning a high return on capital is a social obligation, but one that only applies to those who choose to save at all.

Second, an effective minimum tax represents a massive deviation from the admirable principle of having a common rate of tax on all income, and brings with it the distorting effects of multiple rates. As an illustrative example, consider someone choosing whether to invest in an asset with a guaranteed return of 6%, or one with even odds of returning either 0% or 15%. The risky asset has a higher expected return to the economy, but under the non-linear tax system it would have a lower expected after-tax return. This is a strange incentive structure for a proposal designed to better allocate capital.

Third, a CCT seems likely to have some quite insidious properties. The proposal calls for the CCT to be applied to all non-financial assets including the family home. They don’t specify in the article how the capital value of the asset is to be determined. Is it the purchase price or the current market value? If it is the purchase price, then the tax would create the same sort of distortion as a capital gains tax applying only to realised gains—an incentive to hold on to appreciated assets in order to avoid the tax rather than choosing a portfolio because of their underlying value. If it is on the market value, then homeowners would be subject to large fluctuations in their tax liabilities from year to year independent of their income streams, at the whim of property valuers. This, of course, is already an issue with local-body rates, but the amount levied in rates each year is trivial compared to a 30% tax on 6% of the valuation of a house.

Finally, a CCT would bring about a one-off capital loss on the value of houses, as future purchasers would have to consider their ability to pay the tax when calculating how large a mortgage they could afford. That is, the shift to the proposed tax system from the status quo would start with a massive takings from property owners. This needs to be borne in mind when thinking about the benefits of a system with a high UGI and low marginal tax rate: Of course, we can have low taxes and generous benefits, if the government can fund its activities from an initial property theft. But I’d rather have a clunky and inefficient tax system coupled with a respect for property rights.

Rot at the centre of New Zealand economic commentary

Matt Nolan over at TVHE takes issue with Gareth Morgan's latest NZ Herald column.

Matt hits some of the problems in that piece. But he's probably pulling his punches out of professional courtesy. As I'm in the academic world instead of the consultancy world, mostly, I don't have to. And so I'm going to smack Morgan around a bit on his history of economic thought.

In particular, Morgan name-drops J.S. Mill in favour of redistributive spending. Morgan writes:

It was during the industrial revolution that grotesque disparities in wealth and intensified impoverishment of the workhouse poor led the economist philosophers of the "enlightenment period" to conclude the purpose of taxation was, as John Stuart Mill put it, to "favour the diffusion rather than the concentration of wealth".

Ok, let's go back and have a look at what Mill advocated then. Mill definitely supported redistribution for the alleviation of absolute poverty and starvation. But he also worried that if the provision of relief made relief more attractive than work, "the system strikes at the root of all individual industry and self-government." Let's go back to source:

In so far as the subject admits of any general doctrine or maxim, it would appear to be this—that if assistance is given in such a manner that the condition of the person helped is as desirable as that of the person who succeeds in doing the same thing without help, the assistance, if capable of being previously calculated on, is mischievous: but if, while available to everybody, it leaves to every one a strong motive to do without it if he can, it is then for the most part beneficial. This principle, applied to a system of public charity, is that of the Poor Law of 1834. If the condition of a person receiving relief is made as eligible as that of the labourer who supports himself by his own exertions, the system strikes at the root of all individual industry and self-government; and, if fully acted up to, would require as its supplement an organized system of compulsion, for governing and setting to work like cattle, those who had been removed from the influence of the motives that act on human beings. But if, consistently with guaranteeing all persons against absolute want, the condition of those who are supported by legal charity can be kept considerably less desirable than the condition of those who find support for themselves, none but beneficial consequences can arise from a law which renders it impossible for any person, except by his own choice, to die from insufficiency of food.

What did Mill favour? Indoor relief in workhouses that was always less desirable than working for wages but preferable to starvation. So far from favouring heavily redistributive income taxation to alleviate the problems of the workhouse poor, Mill favoured the workhouse.

So it isn't just the modern amoral mathematization of economics that leads to opposition to Morgan's preferred policies.

Further, as West points out, Mill opposed progressive taxation. Here's West:

The fact moreover that Mill made it quite clear to the Select Committee on income Tax that he was not in favor of a progressive income tax, separates him from most modern advocates of a negative income tax plan. Mill's objection to the progressive income tax was based partly on his demand for "social justice," and partly upon his concern for incentive effects, not at the lower end of the income scale but, again, at the upper. He objected that "to tax the larger incomes at a higher percentage than the smaller is to lay a tax on industry and economy; to impose a penalty on people for having worked harder than their neighbours."

And what do we find when we go back to source? The line immediately prior to the one West quotes reads:

Both in England and on the Continent a graduated property tax (l'impôt progressif) has been advocated, on the avowed ground that the state should use the instrument of taxation as a means of mitigating the inequalities of wealth. I am as desirous as any one that means should be taken to diminish those inequalities, but not so as to relieve the prodigal at the expense of the prudent.

So Mill favoured using taxes to mitigate inequality but not if it punished the prudent in favour of the prodigal. So all of this hints that maybe, just maybe, Morgan does violence to the Mill quote he initially presented. Let's check. Here's the source, in a fuller context. The initial italicized portion forms the question posed Mill in his testimony before Parliament:

I quite understand the force of your argument as between one portion of the upper classes, and the other portion, that is to say, the distinction that you have so clearly and admirably stated between the owners of permanent and terminable incomes, and the owners of precarious and certain incomes; but then I wish to draw your attention to quite another division, the next division of society, not according to the source of income, nor according to the tenure of income, but according to the quantity of income relatively to the wants of human nature for subsistence and for comfort, and to ask whether it did not appear, that upon the whole, the adoption of this principle, that savings are not to be taxed (setting aside the degree in which you may be able to give it a precise application), and the attempt to frame a law upon that principle, would not be a change in our law favourable to the condition of the poorer classes of society as compared with the wealthier? 

I think it would be favourable to the saving classes, whether poor or rich, compared with the spending classes; and that consideration I think is even paramount to the other. If the rich are to be subject to a greater proportionate amount of taxation than the poor, I think it ought to be done in some other way. A succession duty is the most unobjectionable mode of doing it, because in that way it is confined to hereditary wealth. I think you must allow people to retain the full advantage for their lives of what they have acquired; but the State may deal with it on the occasion of succession. I certainly do think it fair and reasonable that the general policy of the State should favour the diffusion rather than the concentration of wealth, but not, I think, by taxing people twice on the same portion of their income, or by taxing people for the fact of their saving. Taxing people on what they save, and not taxing them on what they spend, or taxing people on a larger proportion of their income, because they are better off, does not hold the balance fairly between saving and spending; it is contrary to the canon of equity, and contrary to it in the worst way, because it makes that mode of employing income which it is public policy to encourage, a subject of discouragement. [emphasis added]

So the line after the one Morgan cites specifically cuts against capital gains taxes and progressive income taxes in favour of progressive estate taxes. In other work, Mill argues in favour of a proportional tax on expenditure above a minimal threshold. Sure, this generates average progressivity, but it's hardly a progressive marginal tax schedule. Morgan can go read Kurer in HOPE.

I'm not a history of thought scholar. But I took enough history of thought in grad school to know that Mill favoured indoor relief. In other words, he worried like hell about "welfare bludging". The debates we're having today over welfare aren't all that different from the ones had a century and a half ago over the British Poor Laws. We can read arguments today about whether women have an incentive to have kids out of wedlock so as to get on the DBP. A hundred and fifty years ago, Mill advocated that the poor in workhouses observe strict separation of the sexes to avoid the Malthusian problem. There is nothing new in current welfare debates. And yet Morgan calls today's debates about incentives facing the poor in the face of relief "dumbed-down".

Like Matt, I'm really frustrated by the article. I'm really sympathetic towards arguments for a guaranteed minimum income in place of the current welfare system. But I sure would know better than to cite Mill as support.