Sunday, September 30, 2007

Tax Cuts are O-K-L-A-H-O-M-A

My brother, Mark Shelley, of Oklahoma City told me about a tax cut proposal in the Oklahoma state Senate and I thought it was a great idea. The bill will eliminate state income tax on overtime pay. A write up of the consideration is available at the Red Dirt Political Report.

“The proposal — Senate Bill 1132 — would exempt most overtime pay from state income taxes required by the federal Fair Labor Standards Act (FLSA). “ To show that I’m not just a partisan, State Senator Kenneth Corn, D-Poteau, and Rep. Bud Smithson, D-Salisaw sponsored the bill.

Who will it help?

Generally, those who are overtime eligible do not have high income jobs. Anything from a McDonalds fry cook to a “turn around” technician at an oil refinery. This tax cut would help the working middle class and working poor.

Why is it good?

Sometimes reforms designed to help the poor are just giveaways to anyone with a low income. This bill isn’t like that. This bill rewards WORKING people, and leaves out anyone who is living on the public dole. It rewards work, not just for having a pulse and a low income.

The other aspects of the bill are attractive to the economist in me. First, it will give an incentive for anyone who works an hourly job to work harder and more hours because the pay rate will be higher. While many low income working people already pay very little, if any, income tax, they still have to wait until tax return time to get their money back. Decreasing the withholding on overtime on their check will let them see more immediate returns for their work, giving yet another incentive for harder work.

The other reason why this is a good idea is political. In the press release from the Oklahoma Senate the two Democratic Senators are joined with AFL-CIO President Jim Curry. If the Unions are in support of a tax cut than how could some of the big government supporters on the left be against it. This is a great issue for small government supporters to push for both political and economic reasons.

Thursday, September 27, 2007

Why Free Trade?

Currently in Congress, they are debating free trade bill agreements with Colombia, Peru, South Korea and Panama. I think that most Americans support free trade, but do not really understand why it is a good idea. It is hard to go through an economics education and not support free trade so this week I want to make it clearer why free trade agreements are good for you and good for America. To do this I will explain how the free market works fundamentally.

Imagine if you will, that you are stranded on a desert island with a complete stranger named Bob. Both of you need to survive. Bob makes a spear and heads out into the water to fish. It quickly becomes clear that Bob is not a very good swimmer and is rather uncoordinated. Bob is a terrible fisherman. You take your turn and quickly figure out that you are a better fisherman. You find coconut trees, but you can’t climb them to get the coconuts so you throw rocks. It takes a long time to dislodge them by throwing rocks. Bob has little problem getting to the top and tosses the coconuts down. You are a better fisherman and Bob is a better climber.

If you work on your own, you are likely to have fish to eat, but few coconuts. Bob is likely to have lots of coconuts, but few fish. So you trade. Now you both have a balanced diet. However, this is not the only benefit of trade. Instead of wasting your time throwing rocks at coconuts, you can spend all your time on fishing. Bob can spend all of his time on coconuts. Now, because of trade, both have more to eat than if you tried to do everything on your own. This is specialization of labor.

Now imagine again that there are two primitive villages. One town has rocky soil, but lots of good grass; the other has good soil, but has a weed that can make animals sick. If they don’t trade the rocky village will have to try to grow crops in rocky fields, and the good soil village tries to raise livestock that gets sick. When they trade, each village prospers because they can specialize in what they have a natural advantage just like the island example. The specialization of labor lets both towns excel because they only do what they do best.

However, the transition to trade has a few short-term losers and this is where the criticism comes. The rocky village has a few farmers who will lose business in the trade deal, and the good soil village has a few ranchers who suffer. Thankfully, this problem is not permanent. Human beings are smart enough to figure out how to make a living and the lost jobs are actually good for the village. Because the two towns can now produce more food with fewer workers, the displaced can do jobs that did not exist before because they had to concentrate only on food production. They can dig wells; build sturdier homes, and all sorts of technological progress. Free trade is why humans were able to develop civilizations. Without it, we would all still be hunting mammoths and picking berries.

Today, free trade works the same way. Some countries are poor so they are better at making labor-intensive products like clothing. However, these same countries often have unreliable infrastructure (water, electricity, education, etc…) and poorly developed legal institutions so they are not as good at making high tech products as we are here. Every country has some kind of activity in which they excel. This is called a comparative advantage. It is not that we can’t make the same products that they make; it is that they can make them cheaper.

This helps explain why free trade is good for America, but it doesn’t answer why free trade is good for you and me.

The main benefit that we receive is lower prices. Because there is more competition, free trade lowers prices. We import the products and services they can perform cheaper and we export the products and services we can perform cheaper. If these four trade bills were enacted and lower the overall price level by 1% that means you and I get a 1% raise.

You probably hear complaints about America’s trade deficit and that this is bad for the economy. According to

An examination of annual changes in the current account balance compared to economic growth since 1980 shows that a "worsening" deficit is typically associated with faster economic growth, and an "improving" deficit with slower growth.

You have probably also heard that free trade encourages outsourcing of jobs to other countries. Even the AFL-CIO, who is very against free trade and outsourcing and is apt to exaggerate, believes that:

According to most estimates, American workers have lost hundreds of thousands of white-collar jobs to outsourcing over the past few years.

Since 2002, the U.S. has created almost 8 million jobs and the unemployment rate has fallen from 5.8 to 4.6 in 2006. It doesn’t look like it is hurting us that much.

So remember: Free trade strengthens the economy and lowers prices. New free trade agreements can cost people jobs temporarily, but this simply avails them for more productive tasks elsewhere.

As always, tell me what you think.

Monday, September 17, 2007

Updates on Education, Principles, and Health Care

Just a few updates to the posts I had over the last couple of months, but first, I read a quote recently that I thought was great.

Robert Murphy – PhD in Economics – “If the press ignored advances in other scientific fields as much as they do in economics, we'd see weathermen advising readers to offer sacrifices to the rain gods.”

On Education –

According to a study by the Independent Women’s Forum (8/13/2007)

“Overall, private-school teachers are nearly twice as satisfied as public-school teachers with their working conditions.”

“At 82 percent, overall satisfaction rates among charter-school teachers are twice as high as their private counterparts and more than three times as high as their district counterparts. Two-thirds of charter-school teachers report high levels of satisfaction with the influence they have over curricula, student discipline, and professional development, as well as school safety, collaboration with colleagues, and their schools' learning environments. On those same measures, slightly more than half of private-school teachers and slightly more than one-third of public-school teachers report high levels of satisfaction.”

On August 9th I wrote and predicted for teachers at independently run schools a whole four days before the study:

“Increased pay, improved discipline, and being in demand should help these teachers feel more respected.”

On Principles and Pachyderms -

Alan Greenspan has written a new book entitled "The Age of Turbulence: Adventures in a New World". In the book, he reveals that he is a libertarian Republican. Here are his thoughts on where the Republicans went wrong:

"They swapped principle for power. They ended up with neither. They deserved to lose."

Here are my thoughts on the same subject from July 19:

“The conservatives lost power because they became convinced that winning elections was all that mattered.”

“What they failed to do was establish a core set of principles so that America could accept the downsides because of the goodness of the purpose.”

Save the money and just read my newsletter and blog :)

On Health Care -

Apparently, John Stossel did a report this Friday on ABC’s 20/20 about private health insurance versus socialized medicine in Canada. I say apparently because I did not watch it and it was not made available in it’s entirety on the internet as far as I can tell. There are snippets on their website however. My father did watch it and related some of the stories of eye-popping wait times that occur under Canada’s government run health care plan that John Stossel used in his piece. Two of the stories were originally from the website that I mentioned back on July 26. They usually run a lot of repeat stories on 20/20 so I can hopefully catch it again sometime in the future.

I highly recommend keeping a nose out for stories by John Stossel. He is one of the few journalists who do actually keep up with Economic science.

Thursday, September 13, 2007

A Tax Cure All?

During a Presidential debate, Gov. Huckabee referred to the “Fair Tax”, and I didn’t know what it was so I looked it up. I came across, which has done research for its plan to make the tax code more efficient and fair.

Generally, this approach is a consumption tax. The “fair tax” charges a sales tax of 23% on all final goods and services. Used items would have no sales tax. There would be no income tax or any other kind of federal tax. Each person would receive a “prebate” (an early rebate) each month so that all spending up to the poverty line would be tax-free. If the poverty line were set to $15K, the prebate checks would total $3,450 during the year.

Supporters claim the plan is more efficient than the current tax code, which I believe is true. Obviously, if the tax code shrank from over 9,000,000 words down to the 130 pages they suggest this would save a lot of money on tax compliance. The group also states that this plan could eliminate the IRS, and end Congress’ love affair with lobbyists. Unfortunately, the devil is in the details.

A glaring problem is crossing borders to buy big-ticket items in Canada and Mexico. I live several hours from Mexico, but if I were going to buy a $25K car that had a 23% tax on it ($5,750), I would definitely buy it in Mexico. People living further away from the border could still save thousands by flying there to purchase a car, boat, jewelry... Only a fool would buy any big-ticket item inside the U.S.

The phrase “final goods and services” may be short, but the definition of “services” could run as long as the current tax code. The definition of “services” is vague and left up to interpretation. A link to their definition is here.

Would a company that currently provides services now have to pay a 23% tax on all the services it performs? Let’s say ABC Services Inc. earns $10 million in revenue per year, and makes $1 million profit. Currently they would pay 35% tax on $1 million, which yields $350K in taxes. If they had to pay 23% tax on their services that would mean $2.3 million in taxes ($1.3 million more than their profits). This means a whopping 757% tax increase that would drive the company into bankruptcy. Maybe this type of “service” does not count as a taxable service, but that would be up to Congress and an army of helpful lobbyists to decide.

Because of the high tax rate, every industry would constantly be lobbying to remove all or part of their output from the definition of “Final Goods and Services”. The “FairTax” would not end the IRS nor would it end lobbying.

This is not to say that a simple tax code is not a noble cause. The Tax Foundation projects that tax compliance for 2007 in the United States will cost around $305 Billion. A study by them on a Flat Tax proposal by then Texas Congressman Dick Armey in 1996, predicted it would reduce tax compliance costs by 94%. Adding up all the government workers, private tax accountants, and the corporate attorneys who work to calculate and avoid taxation it adds up to hundreds of thousands of workers. All of these people could be doing much more productive things.

However, this presents the last and greatest problem with enacting a simplified tax system. The massive upheaval of changing the system would cause many problems. Those whose entire career depends on a complicated tax code do not want to see it go away overnight. If you were 50 years old and all you knew how to do was give advice on the tax code what other kind of job could you hold? Would people give to charity as much if they did not have that pull of a tax deduction? Our current tax code affects our behavior in many ways and completely dropping it might change it in ways that we do not like.

Even though I am a big fan of the Flat Tax, the move to a simplified tax system should be a gradual one. We should have a series of what I dub “Tax Switches”. Those in the highest income brackets who own most corporate stock indirectly pay corporate taxes, which is a 35% tax on profits made by corporations. This tax should be eliminated and switched to an increase in the marginal income tax rates.

If done right, the average person would be no better or worse, and it is one less tax to have to fool with. The countless hours companies spend coming up with ways to reduce taxes are less productive for society as a whole. By doing it slowly and in one sector of the tax code, mass layoffs are avoided.

This may be oversimplified and if someone sees some holes in my logic let me know. I am suggesting this general idea.

Over say ten to twenty years, other taxes would be eliminated in the movement towards a flat tax. Tax deductions would also be eliminated while lowering the marginal income tax rates across the board.

A radical switch in the tax structure sounds good, but it is not feasible when everyone starts to realize how much stress it will cause in the short run. It is also not enough to complain about the size of the tax code and hope Congress does the right thing. We need specific policies that will help us take steps towards a simplified tax code like a Tax Switch.

Thursday, September 6, 2007

The Tyrant Next Door

“I’m all for capitalism, but not in my neighborhood!”

This has become the unspoken creed of many a do gooder. While most Americans support the free market at the state and national level, they don’t seem to be quite so keen on it at the local level.

In many suburban areas, deed restrictions have become a way of life. We want our neighborhoods to look nice and we want our neighbors to maintain their property about as well as we maintain our own. A couple of years ago I received a nice little letter explaining that if I left my empty trash can in the front yard again that I would receive a $75 fine. After the trash truck came by my visiting mother-in-law had placed it on the side of the house where I can’t see it when I pull my car into the garage. Oddly enough while I received a scolding for my trashcan, no rules exist to stop the new neighbor across the street from cutting down four 50-year old live oak trees.

Neighborhood enforcement boards have earned a bad reputation in recent years by letting a select few go on power trips. A man in my neighborhood was cited for parking a boat on the street for a mere 4 hours between midnight and 4 a.m. en route to a fishing tournament. You have to wonder what kind of psycho is goose-stepping around the neighborhood at the wee hours of night looking for infractions. It is annoying, but we were all given the rules when we moved into the neighborhood. Nobody forced us to buy a house there.

In some old neighborhoods, there are no deed restrictions. In Houston, there is no zoning either. For decades, this wasn't an issue. The residents just went about their lives and the neighborhoods maintained their modest appearance. However, over the last decade interest in living in the center of the city has grown dramatically. Old and small houses are being replaced by townhomes packed onto the old lots. The Not-In-My-Back-Yard (NIMBY) crowd now wants the city to allow new deed restrictions to prevent other property owners in their neighborhoods from building townhomes. Some have been successful, so more are trying. They want to keep their neighborhoods the way they have always been. Well, at least since the last time a developer came in and tore up an old family farm to build the neighborhood, and the time before that when the farmer tore up unspoiled wilderness.

In Bellaire, a close in suburb of Houston, they have had restrictions to prevent townhomes on the books for years. The unforeseen consequence was that old homes were still torn down and monster homes took their place. You cannot afford to tear down a house to build another one unless you have a lot of money. If you have a lot of money, you probably are not going to build a small house. Of course, the NIMBY crew doesn’t like these either because the new homes tower above their small homes. In Austin, they have now made restrictions to prevent townhomes and “McMansions”, effectively preventing redevelopment in large swaths of the city.

This means that there are fewer areas for redevelopment. This drives up the prices of available land and prevents those with modest means from moving into the city. This also gives a bigger incentive for developers to seek easier targets, like poor areas with little neighborhood organization. This has consequences as well. Low-income neighborhoods often have unbelievably cheap rents in old buildings that cannot be replicated by new construction.

What is the answer? More regulation and government programs of course. All across the U.S. government organizations are building or subsidizing “affordable housing”. In San Francisco, every new home is required to give money towards affordable housing, increasing the cost per home between $22K and $44K according to a recent article from San Francisco is already one of the most expensive places to live in America and now they have added even more costs on top of that. However, another sticky problem arises when deciding where to build the affordable housing. The NIMBY crowd gets fired up again using our courts to make sure it’s not in their back yard.

Yet another consequence from preventing denser development is “Urban Sprawl”. Ironically, the same anti-development people are against urban sprawl. The opponents of urban sprawl believe that having cities more spread out leads to more pollution and loss of open space. What’s their answer to urban sprawl? That’s right. More regulation and government programs. Cities like Portland, Oregon have instituted growth boundaries around their cities, outside of which development is very restricted. These boundaries force density and limit the supply of land for development.

Economics 101, when you limit supply, what happens to price? It goes up. Is it any wonder why a house in Houston, which has no zoning and little land use regulation, costing $200K goes for $850K in San Francisco, which has stringent development restrictions? Not all forms of restrictions are bad, but the untended consequences of excessive regulation have driven the price of homes in some cities beyond what the average person can afford.

The fundamental problem is that we cannot regulate our way to paradise. Every regulation is going to have an unforeseen side effect, prompting the “need” for more regulation. Everyone has different preferences for how they would like to live and what they want their city to be like. When property rights are taken away our cities become dominated by those who yell the loudest or have the most money. Even though I may look like a curmudgeon from time to time, I feel safe in erring on the side of property rights.