Tag Archives: poverty

A Helpful Reminder: Environmental Regulations Are Regressive

President Donald Trump promised to loosen energy and environmental regulations during his campaign, and he’s already taken some steps to fulfill this pledge.

Earlier this month, Trump announced that he was reviewing the aggressive auto fuel-economy standards put in place by the Obama Administration. Now, Reuters is reporting that Trump will sign a new executive order this week to relax regulations on the fossil fuel industry.

Even without getting into the details, we all know how the political battle lines will be drawn on this issue. Democrats and progressives will be opposed to the regulatory cutbacks while Republicans and conservatives will be pleased. The left will decry the implications for climate change and the right will cheer it as a boon to economic growth.

But what often goes unmentioned in this debate is the distributive impact of environmental regulations. The fact is that most environmental regulations are economically regressive*–that is, they harm the poorest people more than everyone else.

Defining Regressivity

As a quick primer, regressivity and progressivity are concepts that are generally used in the context of taxes. The terms describe how the tax rate changes for people with higher incomes. For this purpose, the tax rate that matters is the effective income tax rate–which is calculated simply as the amount of tax paid over the amount of income earned.

We would say that a tax is regressive in nature if the effective income tax rate decreases as income rises. A tax is progressive in nature if the effective income tax rate increases as income rises. And if the effective tax rate stays the same as income rises and falls, then the tax would be proportional, also known as a “flat tax”.

Based on these definitions, the US federal income tax system is theoretically progressive in nature–it is designed such that richer people pay a higher share of their income than poor people. (In extreme cases, loopholes might flip this result, but this is the intent.)

Meanwhile, a sales tax on groceries would tend to be regressive in nature. Rich people and poor people both spend a somewhat similar amount each month on groceries, they would also pay a similar amount in sales tax. The richer person may pay more tax in absolute terms. But if we divided the tax paid by each person by their respective incomes, we would find that the poor person is paying a greater share of their income than the rich person. Thus, it’s regressive.

While the terms regressive and progressive are most commonly used for taxes, they can be applied to other policies as well. Any policy that harms poor people more than rich people could be appropriately described as regressive.

Why Environmental Regulations Are Regressive

Environmental regulations are often described in very positive terms: energy efficiency, clean energy, fuel-economy, and so on. At least superficially, these ideas seem silly to oppose. Oh, so you’re against efficiency, huh? What’s wrong with you?

The problem is that these terms obscure the underlying costs to consumers. Let’s take the Clean Power Plan (CPP) as an example. And before we get into details, note that the following economic analysis applies regardless of one’s position on climate change.

The CPP required a 32% reduction in US carbon dioxide emissions through 2030, using 2005 as a baseline year. These reductions were to be achieved substantially through carbon dioxide emission limits on existing power plants.

To the Obama Administration’s credit, the CPP did not mandate, in detail, how states were to achieve this goal. Instead, it gave them flexibility to determine how it would be done–a few suggestions included building more renewable energy, building nuclear power plants, or investing in carbon capture technology, commonly branded as “clean coal”.

The common characteristic of each of these options is that they would cost more money than the status quo. Market costs of renewable energy options like solar and wind have come down recently, but they are still more expensive than carbon dioxide-emitting alternatives. Similarly, retrofitting or rebuilding a coal power plant with carbon capture technology is naturally more expensive than using the plant that already exists today.

It follows that, whatever the CPP’s intention, it would have the effect of making energy more expensive than it otherwise would be. In this way, it has the same net effect as a sales tax that only applies to energy. The way the cost increases is different, but the end-consumer is still paying more.

We can also safely assume that energy usage among different people does not vary as widely as income varies. In general, a family earning $200k a year is not going to use 10 times the energy of a family living off $20k per year. Thus, if we adopt a policy that increases everyone’s energy cost, we have a regressive outcome–poor people get harmed more than rich people as a share of their income.

This same basic analysis would hold for fuel-economy standards, energy efficiency, and others. Boiled down, the mechanism is straightforward. Regulations force businesses to invest additional resources to create a compliant product. Since it costs more to produce, part of the cost will be passed on to the consumer in the form of prices that are higher than they would be otherwise. And since environmental regulations tend to affect the prices of basic necessities where rich and poor alike spend a somewhat fixed amount, the price increase is more impactful to the poor people. So by themselves, environmental regulations are generally regressive.

Implications

For conservatives and libertarians, the fact that environmental regulations tend to be regressive is just one more reason to keep them at a bare minimum (and getting rid of many that are on the books today).

But for progressives, it is a more complicated picture. The fact that environmental regulations happen to be regressive does not automatically mean progressives would oppose them. There are high-profile cases, such as Philadelphia’s recent soda tax, where left-leaning politicians adopted a plainly regressive tax in pursuit of ostensibly more important goals–funding pre-K education and improving health. For many progressives, climate change might warrant a similar treatment–perhaps poor people will have to bear a lower standard of living in order to cap emissions?

Wherever you come down on that, the key is to recognize that trade-offs do exist. Environmental regulation is a case where two progressive priorities will often come into direct conflict: helping poor people live a better life right now or protecting the environment from climate change in the long run.

As the debate and bipartisan grandstanding around environmental regulation heats up, it’s worth keeping the underlying economics in mind.

*If the environmental regulation in question amounts to the enforcement of basic property rights, this regressive outcome would not hold. For instance, a law that prevents other people people from dumping waste on your property without your consent could possibly be viewed as an environmental regulation, but it would not have the same economic implications explained here.

 

Stop Using Statistical Aggregates for Income Inequality

Income inequality is one of the major issues in this year’s presidential election, and there is no shortage of statistics to convey just how dire the status quo is. Below, I’ve gathered a few examples:

You get the idea. It seems there is almost no way to talk about income inequality (or tax policy) without resorting to the use of statistical aggregates (1%, 10%, etc.). The results of any such analysis can be jarring, and lead to many interesting questions. Is it really fair that 0.1% of population should possess 90% of the nation’s wealth? Should the top 1% really make more than the bottom 50%? Can the government do something to ensure income is more broadly among the population?
While these are all interesting questions, they rely on two very important assumptions:
  • “The Top x%” group contains a consistent group of individuals over time. 
  • Extreme income inequality, among different income brackets, is an aberration.
The problem with these assumptions may not be immediately obvious, but it will become clear if we try out a slightly protracted thought experiment. Using broad statistical aggregates seems to be a reasonable way to describe these issues. However, it breaks down quickly under any scrutiny.
To illustrate this problem with statistical aggregates truly are, I decided to run the numbers on a hypothetical economy–the economy of Equalistan–that is completely equal by design. Here are the key assumptions driving Equalistan:
  • Everyone starts work at age 23 at a starting salary of $40k per year. No one is unemployed after this age.
  • Combining the effects of annual salary increases and promotions, it is assumed that everyone’s salary increases by 5% per year.
  • Each person saves 5% of their income each year, which is added to their wealth
  • Each person earns a 5% return on their accumulated wealth. (And to make the math easy, this is calculated off the wealth at the end of the previous year).
  • Everyone starts off at age 23 without any student loans and without any wealth of their own.
  • Everyone retires promptly at age 65.
Now, it may be correctly argued that the assumptions driving my imaginary society are unreasonable. I would readily agree. However, I hope we can all agree that such a society would be a veritable utopia for those concerned about income inequality.
So let’s see the results:
Note that in this table, all of these calculations are somewhat conservative, because they only include the working population. By assumption, no one is unemployed, and retirees are excluded from these percentages.
In spite of this conservative approach, and the explicitly equal nature of the society imagined, the statistical aggregates still paint a darker portrait. The 1% is well under control it would seem. But it’s still the case that the top 10% owns dramatically more than the bottom 50%, and the top 20% makes almost 50% more than the bottom 50% does. What accounts for this?
Well, the most important fact is that in Equalistan, as in real life, older, more experienced, people tend to make more money than their younger counterparts. Older people are also likely to have accumulated more wealth, which, in the absence of Federal Reserve shenanigans, will generate meaningful returns on their investments each year. This wealth accumulation effect naturally contributes to income disparity, even though it is presumably not a feature of a market economy that we want to eliminate for ourselves
What all of this tells us is that using statistical aggregates like the top 1% or top 10% is deeply unhelpful. Some economists and politicians like this approach because the data is easy to access and it produces neat headlines. And in a very literal way, it does define the extent of income inequality.
But when we talk about income inequality, the inequality at any point in time is not the real issue. What we really ought to care about are poverty and social mobility. If no one was in poverty, it is my contention that we would not care how much the top 5% earned. Similarly, if even people from poor backgrounds had an equal chance to make it to the top, it would matter much less to everyone just how much those people made.
Of course, neither of these features describe the world in which we actually live. Poverty still exists and social mobility is not as strong as we would like. But if we are going to understand and evaluate progress on these issues, a good first step would be to use meaningful data. After seeing the thought experiment above, the bottom 100% of people should agree that mere rhetoric about “top 1%” isn’t sufficient.
Hat Tip: Tom Woods and Bob Murphy at Contra Krugman for highlighting this problem.

The Federal Reserve’s War on Retirement and Pensions

In spite of the minor interest rate hike last December, interest rates in the US remain at historically low levels. This is not a natural phenomenon, and it is not caused by the “free market”. Rather, it’s a direct and deliberate result of the Federal Reserve’s monetary policy, and its effects on the broader economy are rarely appreciated. It’s bad for banks, which few people are likely to have sympathy for. It encourages government deficits by lowering the costs of government borrowing. And similarly, it encourages everyone else in the economy, from corporations to students, to take on more debt than they otherwise would.

But while all these things are important, the most destructive impact of artificially low interest rates is that it destroys the ability to save and invest. And, like most central planning policies that are designed to stimulate the economy, the people hit hardest by low interest rates are invariably the people who can least afford it–in this case, the middle class, the working class, and the elderly. Many pensions around the country are deep underwater on the verge of bankruptcy in the coming years, and elderly income insecurity and poverty are on the rise. These are real problems, and they are likely to come to a boiling point soon. But to address them, we need to first understand how they came to be. And the answer isn’t greed or unbridled capitalism; it’s one of the most significant distortions of the market system that exists in the economy today–artificially low interest rates.

How It Works
When the Federal Reserve decides to lower interest rates, it has the effect of shifting all interest rates down across the board. This occurs because all US banks have to be part of the Federal Reserve System. If the Fed lowers the main interest rate they control by 1%, we can expect other interest rates in the economy to shift down by about the same amount.

Banks will be willing to offer corporations loans at lower rates, and this in turn means that corporate bonds offered to the public will go for lower rates. Similarly, as banks start offering lower interest rates to borrowers (the banks’ source of income), they will also shift down the already low rates they pay their depositors on savings (the banks’ expense), to preserve a consistent spread. And generally, the Federal Reserve will also make purchases of the US Treasury Bonds (loans to the Government) to help drive down rates there as well. All of this has the practical effect of depressing interest rates across the whole economy for borrowers and savers alike, in bonds, loans, and deposits.

Source: Multpl.com

In this low-interest rate environment, however, individuals are still going to want to save about the same amount of money for retirement. Or if they’re already retired, they need to continue making a decent return on their existing savings to maintain their standard of living. Prior to interest rates being cut, this might have been possible with a high-yield certificate of deposit, a basic savings account, or investments in government or corporate bonds. But as interest rates shift down, all of these options become less attractive. For example, consider how much lower 10-year Treasury yields have become over time, falling from over 6% at the turn of the millennium, to a mere 1.8% today. While it may seem small, that’s a massive difference. At 6%, investors could earn a respectable return that was all-but risk-free. Today, the same security would barely outpace official inflation (and would be unlikely to keep up with real inflation if rent, healthcare were tossed into the mix).

The end result, then, is that individuals can no longer afford to keep their investments in safe assets, because they don’t earn enough to be worthwhile. Now they have to look for riskier assets that have a chance to generate higher returns. (Riskier investments always tend to carry the promise of higher returns, because they have to compensate investors for the risk. This is why poor people or those with bad credit will generally have to borrow money at higher interest rates–to compensate the bank for taking a risk on them.)

At first, the riskier investments may be stocks. But then, as everybody pours into stocks, the earning potential here falls as well–the price of stocks will be driven up (for example, from $20 to $40 per share) even though the underlying profits will remain the same (say, $1.00 per share). In this example, that would mean the effective yield for anyone that buys at $40 would be $1 / $40 = 2.5%, where as it used to be $1 / $20 = 5%.* As more people pour into stocks, which are already somewhat risky, the return is driven down. This necessarily causes people to find the next, even riskier asset to continue trying to get a higher return. And the cycle repeats itself, with people becoming more and more exposed to risk as it progresses, while still struggling to earn a decent return. This process is referred to as chasing yield, and it only gets triggered in a down interest rate environment.

It’s worth noting here that nothing I’ve suggested so far is controversial. Different economists disagree whether low-interest rates are a good thing (with most mainstream / Keynesian types generally believing they are indeed), but the yield-chasing behavior follows naturally from the incentives it creates.

And this is why the Fed’s low-interest policies are effectively a war on retirement and the elderly. People plan to save a certain amount of money in order to live comfortably in retirement–but this plan necessarily assumes they will be able to earn a decent return. The low-interest rate policies diminishes the prospect for earning a healthy return and thereby plunges numerous elderly people into an income insecure situation.

A Practical Example
To see exactly how much more difficult it would be to retire under this low-interest rate environment, it’s useful to see some real numbers. Back when I was in high school, I was obsessed with money to a completely absurd degree (circa 2006-2007 especially). And in particular, I was really focused on being able to have enough money to retire early. At the time, you could get an online savings account that paid 5% interest. And since I lived in the fantastically affordable city of Boise, Idaho, I figured I could live quite comfortably off of just $50k a year. To do that, I needed to save about $1,000,000. It’s a big number of course, but it’s not an insurmountable one. And then I could live off basically risk-free interest income forever.

Fast forward to today, and I’m not nearly as obsessed. That’s a good thing for many reasons, but one of them is that being focused on money or retiring today would be incredibly depressing. If you’re lucky, and willing to lock your money away for some time, you might be able to get a certificate of deposit around 2%. Assuming costs of living are the same, that means I’d now have to save 250% as much as before ($2.5 million) to achieve the same standard of living I had planned on.

For me, that’s not a big deal. I’m in my twenties, and it’s easy for me to adapt to that new reality (and eventually, interest rates will go back up). But imagine how hard this would be if you were nearing retirement age around the time of the financial crisis, when interest rates officially fell off a cliff. People could have already met their goals, only to see the goalposts get abruptly moved out beyond their worst fears. Then they might gamble on high-risk investments to try to catch up, and the end result may be that they fall even more behind.

Pensions As Collateral Damage
In many ways, pension funds, public or private, face a lot of the same challenges as the average saver does in a low-rate environment. They likely have more robust resources to research markets and find decent investments. But at the end of the day, they’re still stuck chasing yield like everyone else. They’re also likely to be based on somewhat aggressive return assumptions to begin with.

You needn’t know the nuances of pension accounting to understand this discussion, but the basic idea is this. Employers contribute money to pension plans and bake in certain assumptions about how much that money will grow over time. Meanwhile, employees are earning more pension benefits over time, and if those benefits include medical coverage, the cost of their lifetime benefits will rise over time. By comparing projected lifetime expenses of the pension (based on how much people are expected to earn, how long they’ll live, etc.) and lifetime assets / returns of the pension, we can determine whether a pension is adequately funded or not. If the pension is not adequately funded (projected expenses exceed projected revenues), we would say it’s underwater. For instance, using this calculation, the Social Security system is deeply underwater currently. That doesn’t mean it will go broke tomorrow, but it means, if nothing changes, things will break down eventually.

Right now, many US pension funds find themselves in an underwater position. Indeed, the pension for the Teamsters Union is so underfunded that it recently filed for de facto bankruptcy protection (to try to cut the benefits it’s supposed to pay to its members), though its petition was denied. These trends are also a direct result of low-interest rate policy. Pensions take money from employers on the assumption they’ll make (for example) 6% a year. Then if they only make 2% a year, the fund becomes underfunded until they manage to catch up. So they chase yields and expose all of their pensioners to more risk and uncertainty in the process. But they have no other options.

We can actually see this chasing yield phenomenon emerge over time. A recent piece at Zero Hedge, shows how the pension of the International Red Cross, has gradually shifted to more and more risky and uncertain assets as the years have rolled by in a historically low rate environment.** Where they once owned mostly standard, well-understood securities like stocks, bonds, and US Treasuries, now their portfolio has shifted toward more complicated, illiquid investments to try to increase returns. They don’t really have a choice, but the consequences for their pensioners could be substantial.

In the face of these looming disasters, Senator and presidential candidate Bernie Sanders, proposed a bill that would apparently require the federal government to provide more assistance (that is, bailout) to underfunded pension funds to protect the workers. But a more pragmatic and sustainable solution is to begin by asking why so many pension funds are failing in the first place. And the answer is that the Federal Reserve’s interest rate policies made it so.

Why Keep Interest Rates Low?
Given all the calamities associated with artificially low interest rates, you might be wondering exactly why they’ve become the dominant policy. The best answer seems to lie in economists’ and politicians’ unholy focus on gross domestic product (GDP) as a metric of overall economic health. To you and me, GDP is completely meaningless. Other than academic curiosity, it obviously doesn’t matter to me what the total net value of all goods and products produced in the US was over a given year. I care whether I have a good job, whether my company still has customers, and whether I can still buy the things I need at reasonable prices. But to economists that love statistical aggregates, GDP is the gold standard, if you’ll pardon the expression.

The trouble is that it’s really easy to mess with. To be counted in GDP, goods and services basically have to be sold to an end-user, and government spending counts as part of that. Thus, in some ways, it’s basically a measure of total spending. And if all we’re measuring is spending, it’s easy to see how low-interest rates help that goal. Low-interest rates decrease incentives to save money (as discussed) and make it easier for me to borrow extra money and spend that. It also makes it easier for the government to borrow and spend more money. Therefore, it should be no surprise at all that lowering interest rates can have the effect of increasing GDP. However, it should be equally obvious that this is not an automatic social good.

To see this, we just need to ask the following question. Which is likely to be more important for economic health: The amount of money spent in any given year or quarter (i.e. GDP) in total, or whether people have a reasonable ability to save and invest for their future? That is not a hard question. But unfortunately, most economists and politicians have agreed on the wrong answer for years.

Summing Up
It’s entirely appropriate for people to be concerned about the plight of the working class and the elderly as the economy continues to struggle along. Many people see expanding the role of government as a means to help address these problems, while people like me would be deeply skeptical of the incentives for government to do things correctly. But before we debate the potential for government to do more to help these people, we should begin by considering the ways that current policies are actively sabotaging them. Artificially low interest rates should be near the top of that list. It’s also a great example of an issue where partisanship can be cast aside. Whether you lean left, right, or libertarian, the case against manipulated interest rates, as outlined here, should be compelling.

*In effect, this model assumes that the company pays out all its profits as dividends. That’s unlikely to be the case in reality. But since theoretically, the value of a stock is really based on its underlying earnings and earnings potential, this is a good enough calculation for our present purposes.

**Not at all important, but I can’t stand when people put an “an” before a word beginning in “hi-“. Anyway, I’m aware that this is not technically correct, and I’ve decided prevailing grammar rules just got this one wrong, and I don’t abide by it.

Occupational Licensing Could Meet an Overdue End in California

Good news from California this week suggests that the state may consider ending or reforming occupational licensing laws. And if you care about poverty or limiting wasteful government spending, this is important, especially since California often sets an example for other states to follow.
Now, I know this sounds like fantastically uninteresting topic. The name itself seems designed to induce boredom: Occupational (i.e. work) and  Licensing (waiting in line at the DMV). What could be worse?
But this issue is actually a great one because it’s something where libertarians, liberals, and even conservatives can all wholeheartedly agree–even if they might do so for different reasons. The only people that support these laws are special interest groups, which again, every political camp defaults to hating. So let’s start with the basics.
What are occupational licenses?
Exactly what their name implies. They are licenses granted by a government body that gives the person the right to legally practice a particular profession. Typically, practicing these same professions without a license is illegal and is punishable mostly through fines, but can also result in arrest and/or minor criminal charges.
A surprising array of professions require occupational licenses in the US. And they cover a broad spectrum from licenses that seem conceivably important (doctors, paramedics, etc.) to ones that are obviously silly (barbers, florists, interior designers, etc.). In keeping with our quest for common ground here, we’ll keep focus on the most preposterous ones in this article.
What are the economic consequences?
These rules have different effects depending on which group you consider. We’ll break it down for each:
New Service Providers
In order to get these licenses, individuals often have to go through specialized education or work as an apprentice for many hours. This increases the upfront cost and the time required before they can get a job, and it’s likely to have a disproportionate impact on poor people.
If you have money or can be supported by your parents, these rules aren’t a big deal. You could live at home until you finish 1600 hours of Cosmetology school, and your parents could help finance your education and support you until you can actually earn a living. But if you start out poor, and maybe even have a family to feed, you don’t have this luxury. You would need to start earning a living now. As a practical matter, that means many professions that require an occupational license would basically become off-limits, thereby limiting your employment and earning opportunities.
Established Businesses and Service Providers
If you already have an occupational license, however, this system works pretty well. The higher the requirements are, the harder it is for anyone else to open a new business and compete with you. That means there are fewer choices in the market for your particular service, and you get to charge higher prices.
Thus, it will not surprise readers to know that industry groups are typically the ones that fight hardest to keep such licensing regulations around. It’s not because they are concerned about the public’s interest in having a good haircut. It’s because regulations help their own business. This kind of behavior is what you’ll hear economists describe as rent-seeking–when businesses try to improve their position not by providing a better product, but merely by getting favorable laws passed.
Consumers
Consumers lose out in this system for the same reason the established providers win. Fewer choices means higher prices and well, fewer choices.
Consumers also lose because some portion of their tax money is necessarily being used to finance the regulatory and enforcement infrastructure of the government. So not only do they face higher prices, they also get taxed to keep those prices up. That’s a bad deal.
What are the legal consequences?
As bad as the economic consequences are, the political and law enforcement implications might even be worse.
We mentioned above that these rules occasionally result in arrest. One particularly horrifying example occurred in Orlando, Florida a few years back, when the local police department conducted a series of aggressive raids on barber shops. And you probably won’t be surprised to learn that the shops raided in that case were mostly run by minorities.
But even when these policies don’t result in gratuitous police raids, the consequences still matter. The fines stipulated in California are not incredibly extreme; it’s $1,000 for being an unlicensed barber. But if you’re a poor person, and you very well might be if you’re trying to pay for 1600 hours of education, this could clearly be a significant sum of money. What if you can’t pay? Well, then you might get hauled to court and could even receive a jail sentence. Admittedly, I don’t know how frequently this course of events actually occurs, but the fact that it is possible is bad enough. For the unspeakable offense of cutting hair with someone else’s permission, but without the proper paperwork, an individual could go to jail. No reasonable person would support that kind of system, but that is what we have.
Ultimately, this whole system creates a lot of minor, victimless violations. The transaction between the barber and his customer is consensual, and presumably mutually beneficial. Yet the government can intervene to punish one of them for it. It makes no sense. And again, because there’s no real victim here, that means neither customer nor service provider is going to report the violation. This, in turn, means regulators and law enforcement have to use discretion to seek out the problems. So which neighborhoods do you think they’ll go to first?
What’s the solution?
Many of these licenses should be dispensed with entirely. There’s absolutely no reason why the government should feel the need to insist on a certain number of hours of education to become a florist.
But on the off-chance that some consumers actually could get value out of some of these licenses (perhaps for plumbing or general contracting), there’s a great intermediate option. Just make the licenses optional. If plumbing consumers find the licensing requirements important and helpful, they will choose to only use licensed plumbers. These licensed plumbers will then get to charge a higher price than unlicensed plumbers. Thus, some plumbers would find the license helpful for their business, and would be sure to stay licensed.
In businesses where the licenses are unquestionably silly, however, many customers will choose providers regardless of whether they have a license or not. Thus, barbers will probably forego renewing their licenses, customers won’t care, and the whole regulation regime will naturally become obsolete.
This is a great solution because it’s almost impossible to argue against. If customers find the licensing regulations valuable, then they will continue to exist. If customers do not find them valuable, then what possible reason is there for the government to keep enforcing them anyway? Unless you’re a business that stands to benefit, the answer is none at all.
Summing Up
Final decisions haven’t been made in California just yet, but it’s great news that occupational licensing reform is under serious consideration. If you care about poverty, free markets, limiting the size of government, or all three, then this issue should matter to you. And it’s one of many issues where we can all be on the same team.