Economics, Public Policy, and Whatever Else Interests Me
An indispensable resource in understanding tax policy is the Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute. The Center has a new resource for understanding the work of the President's Advisory Panel on Tax Reform, located here.
See also this earlier commentary.
David Rosenbaum provides an interesting preview of the anticipated November 1 report of the President's tax advisory commission in today's New York Times. He gives us the summary right up front:
President Bush's tax advisory commission indicated on Tuesday that it would not propose replacing the income tax with a national sales tax or a value-added tax, but would recommend limits in the popular tax deductions for mortgage interest and employer-provided health insurance.
To which I say good, good, and really good. I'll take them in order.
No national sales tax or value-added tax. If I were starting a tax system from scratch, I would look to a broad-based tax on consumption rather than income. But I'm not in that position, and the transition from the current system, in which there is deferred income waiting to be taxed, to a consumption-based system in which that income would have no way of being taxed, is too complicated to inflict on ourselves. The best approach now is to keep the income tax, while broadening the definition of income to allow the lowest possible tax rate on that income.
Limiting the home-mortgage deduction. Another fine idea. I wouldn't quibble with a policy like this that is designed to encourage homeownership. (And the White House is genuinely fond of its homeownership talking points.) But making that incentive a deduction rather than a credit and extending it to mortgage amounts that clearly pertain to the margin of "how big a house should I get" rather than "should I own my own house" are bad policy moves. They are not progressive, and they give back tax revenue relative to a pure income tax base that must be made up with higher tax rates elsewhere. So pare them back slowly.
Limit the exclusion of income taken as health insurance premiums from taxable income. I posted about this last December (here, here, and here). The exclusion favors those with high income relative to those with low income, because the latter have lower income tax rates and are less likely to have health insurance. How is that good tax policy?
The common thread in these two items is that look to raise revenue by limiting exceptions to the principle of taxing income that go disproportionately to higher income households. The article mentions the deduction for state and local taxes paid in the same vein. To that, I would suggest the subsidy to saving for college educations through 529 plans as another item that could be pared back.
Why the new focus on ways to raise revenue by broadening the income tax base? According to the article:
At its last meeting, in July, the commission agreed to recommend abolishing the alternative minimum tax for individuals, a step that would cost the federal government $1.2 trillion in lost revenue over 10 years.
The AMT, because it is not fully indexed, will become the default tax system for a growing number of households. Originally conceived as a way to limit the extent that a household with high gross income could reduce its tax bill through use of every exception from a pure income tax (like those mentioned above, and worse), the AMT has a broad base but is not itself a desirable tax system because it allows so few exemptions and deductions. It was designed for extreme cases (particularly in the pre-TRA 86 period when tax shelters were rampant), not for the typical household. Here's a good summary.
What the tax commission is proposing, in essence, is to scrap the AMT as a parallel tax system but to retain some of its elements to improve the tax system that affects most people. Based on the figures shown in the article, they are not quite revenue neutral. But this teaser of a report suggests that the commission has made a heck of an effort.
As for the partisan spin, I expect it to be severe, but I'm not going to pre-judge that either.
Karen Lundegaard has an intereting article today in the Wall Street Journal about new thinking about fuel economy and safety.
The story presents a graph from the EPA showing fuel economy over time for cars, trucks, and then their combination. It makes the point well from an earlier discussion of the CAFE standards (here, here, and here). Even though fuel economy per vehicle may have been flat to increasing for both cars and trucks, the shift of more drivers into the less efficient trucks has caused the overall fuel efficiency to fall.
The main new point in the article is to point out that some new research takes issue with the presumption that improvements in fuel economy would come at the expense of safety:
For decades, whenever the federal government leaned on auto makers to improve fuel efficiency, the industry had a ready response: Research showed that lighter, more fuel-efficient vehicles weren't as safe as their heavier, gas-guzzling cousins. Even shedding as little as 100 pounds could lead to a serious increase in traffic fatalities.
The result has been a virtual standstill in fuel-economy improvements for cars, trucks and sport-utility vehicles over the past 20 years.
Now a wave of new studies and technologies -- strong, light materials, better airbags and smarter designs -- are beginning to break the logjam. The upshot: A big shift in government thinking that is paving the way for regulators to revamp fuel-economy rules for SUVs and pickup trucks for the first time in three decades.
I'm glad for the use of research on the other side of a long-held presumption, but I'm not sure the article gets the argument right. Later, we have:
For years, the accepted wisdom in the car industry held that, all things being equal, heavier vehicles are always safer when two vehicles crash. New studies highlight how other factors -- including a car's size, body design and advanced technology -- can do much to counteract the weight issue.
The newer studies also have homed in on the downside of weight: While a heavy vehicle protects its occupants in an accident, it inflicts more damage to those it hits. That means reducing the weight of the biggest vehicles could yield dividends in both fuel consumption and safety.
All of this has contributed to a rethinking of the fuel-economy regulations from the National Highway Traffic Safety Administration. Last month, NHTSA crafted new "Corporate Average Fuel Economy" rules, or CAFE, for light trucks that aim to balance safety and fuel efficiency. The old rules set an average weight target for an auto maker's entire fleet of cars or trucks, encouraging car makers to sell lots of small fuel-efficient vehicles at sometimes unprofitable prices, so they could keep selling their more profitable gas guzzlers.
The article fails to recognize two issues. First, there is a big difference in safety risks that a vehicle poses to its own occupants and the risks that a vehicle poses to occupants of other vehicles. There is a compelling reason for the government to be involved in the latter, far more than would exist for the former. Without government involvement, drivers of heavier vehicles would not bear the costs they impose on other drivers. (It's not clear that they do so now, apart from states without no-fault insurance requirements.)
Second, the flaw in the old system is the presence of multiple categories for fuel economy standards, with lower standards for some groups. That remains in the new system and can be expected to have the same consequences for fuel economy. Exactly what has changed that would arrest the slide in fuel economy shown in the graph above? Only the increase in the standard for trucks as a whole--not the presence of categories.
Consumers can make their own choices about how much safety they want in their own cars. The government can confine itself to providing accurate information about safety. The continued commingling of irrelevant own-occupant safety concerns with legitimate concerns about fuel economy makes the policy less useful than an ideal CAFE or a gas tax.
Discouraging news from the President's remarks today:
WASHINGTON (AP) - President Bush on Friday ruled out raising taxes to pay for Gulf Coast reconstruction, saying other government spending must be cut. "You bet it will cost money, but I'm confident we can handle it," he said.
Bush spoke after his advisers warned that Hurricane Katrina relief and reconstruction costs will swell the national debt by $200 billion or beyond. "It's going to cost whatever it costs," he said. "We're going to be wise about the money we spend."
Bush did not put a price tag on the costs or say what government programs will be cut.
Where to begin?
I'll start by noting for the benefit of the folks working on the President's speeches that the sentence, "It's going to cost whatever it costs," gives the audience no confidence in the next statement, "We're going to be wise about the money we spend."
I was a fan of cutting other government spending before Katrina, and I am a fan of it now. I hope that the President is right that "we can handle it." The President will have to sort that out with the Republican leadership on the Hill, who seem to believe (quite counterfactually) that there is no more fat to trim. Leave that aside for the moment, and let's ask the following question:
If we can handle it now, why weren't we handling it before?
Why does rebuilding New Orleans compete favorably with this unspecified set of least useful programs, but not funding Social Security personal retirement accounts? Or the new Medicare prescription drug benefit? Or simply lowering the debt burden on future generations?
But I digress. If we have decided that rebuilding New Orleans to the tune of $200 billion is a national objective (and I haven't seen nearly enough debate on that subject in the Capitol), then we ought to fund it by reducing our consumption of everything else. The simplest way to do that would be to impose an income tax surcharge that funds the rebuilding over a given period. Over the next three years, for example, individual income tax receipts are projected to average about $1 trillion per year. So everyone has to pay a 6.7% surcharge over those years, maybe a bit more, since Katrina's economic impact should lower the projections for taxable income and the surcharge itself will discourage economic activity. Over a four year horizon, the surcharge would be 5%, before those adjustments. These are percentages of the taxpayers' tax bill, not of their taxable incomes.
Taxes may be bad, but deficits are surely worse. What's the explanation for why future generations should have to pay for this one, too?
Just a few final comments on CAFE, before moving on to other topics. Kevin Drum argues, in a rebuttal to Matthew Yglesias, that the CAFE standards do what they were designed to do.
His evidence is a National Academy of Sciences study that tracks an increase in the average fuel economy of cars in the wake of CAFE. I cannot point out the weakness in this argument any better than a commenter on his site did (here and here)—it appears to ignore the CAFE-induced shift to light trucks with lower fuel economy requirements.
Drum’s article also points out that the NAS study also suggested the use of a tradable credit system, as I suggested in my earlier post. Good to know that this is concept is now accepted by a broad range of the policy community.
I still prefer the gas tax, but I am not as resolute as I was a few posts ago. If we are going to stick with CAFE, I'd recommend that it have the following elements:
Ted Gayer, a former colleague of mine at CEA, an Associate Professor of Public Policy at Georgetown, and a Visiting Scholar at AEI, takes a turn guest-blogging on CAFE:
Since I’ve done some research on light trucks, Andrew has graciously allowed me to throw in my two cents on the new CAFE standards. I’ll take the invitation as an indication that he has forgiven me for any headaches I caused him while working under him at the CEA.
As Andrew pointed out, one of the odd things about the new CAFE standards is that they create six categories of light trucks (based on wheelbase multiplied by track width), with the standards becoming more lax for the larger categories. So now there’s an incentive to build larger light trucks. (To DOT’s credit, by reducing the discrepancy between the CAFE standard for cars and the standard for small light trucks, they did reduce the incentive to make the latter rather than the former.)
Why would DOT want to provide an incentive to build larger light trucks? One reason is because of John Graham, who is the Administrator of the Office of Information and Regulatory Affairs (the OMB office that oversees regulatory matters). John has long argued that increasing CAFE standards leads to down-weighting, and that down-weighting leads to more traffic fatalities (see his 1989 paper with Robert Crandall in the Journal of Law and Economics [link via JSTOR]). The Crandall and Graham paper finds evidence of down-weighting, and they link these findings to work by Leonard Evans [link via ScienceDirect] which suggests lighter cars lead to more fatalities.
All of this is eminently plausible, yet I have a few quibbles with using this work as a justification for the structure of the new CAFE standards. First, the original Evans work (from the early 1980s) was focused on cars of different weights, and did not consider light trucks (there were so few data points back then for light trucks). While it may be true that two light cars crashing results in more fatalities than two heavy cars crashing, this is not directly generalizable to the case of two light trucks (which are heavier and larger) crashing. But my bigger quibble is that the Evans research examines the total fatalities that occur, given that a crash has taken place. In a world of only cars, this type of analysis makes sense, because there is no a priori reason to think that heavy cars are more crash prone than light cars. But given the higher center of gravity of many light trucks, and the different and conflicting sightlines they present, there is some concern that light trucks are indeed more crash prone than cars.
I looked at this issue in my 2004 Journal of Risk and Uncertainty article. First, I confirm the findings of Crandall and Graham as applied to light trucks. That is, given that a crash has occurred, we can expect more fatalities if the crash involves two cars than if it involves two SUVS. (Interestingly, I find that a crash of two pickups is worse than a crash of two cars.) Another way of saying this is that the safety advantage of being in an SUV rather than a car dominates the additional risk that the SUV rather than a car poses to the other driver in the crash.
But then I estimate the additional crash risk posed by light trucks relative to cars. This isn’t an easy task, since one must consider the likelihood that more reckless drivers select into light trucks relative to cars. I address this by using snow depth variation by states. It turns out that states with higher annual snow depth tend to have more annual light truck driving than car driving. I then use this variation to look at relative crash frequencies in summer months (when snow depth doesn’t play a part). I find that, indeed, the additional crash risk of light trucks cancels out the safety advantage they pose when in a crash.
So what’s it all mean? By creating an incentive to build larger light trucks, the new CAFE standards will likely not achieve their goal of protecting drivers’ safety. Aside from this, I should point out that I agree with Andrew: the pertinent regulatory issue is not the total fatalities resulting from the mix of vehicle types. A consumer can decide for herself how much to spend for a safer vehicle. What she can’t decide is how threatening a vehicle other people should buy.
I do think there was another reason for the structure of the new CAFE standards. U.S. automakers make larger light trucks than their foreign competitors, so a uniform light truck CAFE standard hurts domestic automakers. I think this gets at Andrew’s concern that CAFE standards are not transparent: here’s an example where they can be used for protectionist purposes. So I throw my hat to the politically implausible goal of scrapping CAFE and replacing with a higher gas tax.
Thanks to Ted for guest blogging. When in doubt, consult an expert!
The Environmental Economics blog has a few of posts about CAFE, including a link to this study done by Resources for the Future that purports to estimate an "optimal" gasoline tax of about $1 per gallon. It is based on factors such as air pollution, greenhouse gas emissions, congestion, and accidents. The author is up-front about the uncertainties involved with making such a calculation.
This calculation does not include the "externality" of the impact that our importation of oil from authoritarian regimes has on the welfare of people living in those countries and or the terrorism those regimes may sponsor, the topic that originally sparked this thread. Overall, though, a thoughtful read and an excellent blog. Also of interest is Matthew Kahn's new blog, focusing on Environmental and Urban Economics.
A comment over at Brad DeLong's blog, in his discussion of this earlier post, suggested that my criticism of CAFE standards is off the mark:
Samwick is simply wrong.
CAFE standards, historically, are extremely effective at increasing efficiency.
The amount of tax you'd need to begin approaching the efficiency under CAFE would be pretty steep. While it could be done in principle, as commenter Rob points out above, it's very unlikely the necessary gas taxes would ever be passed.
I suspect we are not writing about the same exact concepts (e.g., efficiency versus usage), but it did prompt me to recall some academic work on the subject. The best paper I have ever seen presented on this topic is by Penny Goldberg, now at Yale. As far as I can tell, it is still state of the art in the economics literature. The full citation is:
Goldberg, Pinelopi Koujianou. "The Effects of the Corporate Average Fuel Efficiency Standards in the US" The Journal of Industrial Economics, Vol. 46, No. 1. (Mar., 1998), pp. 1-33.
And for those of you with access to JSTOR, you can get it here. She's got a pretty slick model of both automobile demand (including the new and used markets) and the non-competitive elements of the automobile supply side. Using data from 1984-1990 to estimate the model, she does some simulations that compare the effects of CAFE (as it existed in 1989) with a gasoline tax. First, she simulates what would happen if the CAFE standards were eliminated:
The results from these calculations ... indicate that CAFE standards lead to approximately 19 million gallons fuel consumption savings per year. This figure can only be interpreted as a one year ahead effect ... a rough idea about the total impact of the 1989 standard can be obtained by calculating the annual savings in the "steady state," after the current vehicle stock has been completely turned over and replaced by vehicles subject to the 1989 regulation. Assuming that there were no further changes in the standard after 1989, and that the total number of cars on the road remained constant ..., the 1989 CAFE standard alone would lead to approximately 400 million gallons of annual fuel savings.
Even thought this figure is much larger than the 19 million gallons estimated for the first year, it still represents only a small fraction of the approximately 130 billion gallons of gasoline consumed in the US every year.
Okay, so 0.4/130 = 0.3%. Not a very big dent in usage at all. But this doesn't mean that a gas tax is much better, as she shows in her next simulation:
[W]e can compute the gas tax increase necessary to achieve the same fuel savings as with the CAFE regulation. According to our results, this increase would have to be 780% or 80 cents per gallon, implying almost a doubling of gasoline prices.
The gas tax at the time was 10 cents per gallon. So this suggests that neither policy, as they have been implemented to date, have generated much of an impact on total gasoline utilization. So we'll give the commenter 1-for-2: CAFE standards have not been particularly effective, but the gas tax required to mimic their effects on utilization would have to be pretty steep.
Paul Mulshine of the Star Ledger "outs" me in his column today for driving an SUV myself, in the sense of a vehicle subject to the lower standards of fuel economy for light trucks under the CAFE regulations. Like many of my liberal friends in rural New England, I drive a Subaru Outback. I had no idea at the time I purchased it that it qualifies as a light truck, which is the focus of Paul's rather amusing article on the new regulations. If it's any consolation, I walk to work most days.
Our friend the Minuteman has picked up the topic, focusing on the increase in the light truck requirements but the odd coupling of this change with lower standards for larger vehicles within the group. Okay, let's think this one through. With a separate standard for light trucks over the past years, we've seen more SUVs in the light truck category and fewer cars in the other category. Anyone want to bet that we won't simply see more quantity in the less fuel efficient categories over time?
I think the CAFE standards are lunacy as currently conceived, and I'll cite three issues. The first issue, as I've alluded to earlier, is that the problem we care about is total usage of gasoline. Total use is the amount of miles driven divided by fuel economy. CAFE standards, at best, address fuel economy, but they provide no incentive to economize on the number of miles driven. This is why a gas tax is better--it allows people to decide how they want to conserve on fuel usage, fewer miles or fewer gallons per mile.
The second issue is that the CAFE standards operate at the level of a fleet of vehicles produced by one manufacturer. I have never heard of a rationale for regulating a company's whole product line. The more economy cars a company makes, the more fuel-inefficient cars it can make without penalty. Why provide an incentive for Toyota to make larger cars just because it happens to make good small cars? If the objective is to regulate the average fuel economy of all cars on the road, then there ought to be a tradable permit system established. We would get a better variety of cars on the market, though not at any one particular dealer. Pure welfare gain.
The third issue is that the CAFE standards operate in a hidden fashion, and as a result there have been plenty of abuses. CAFE standards are negotiated behind the scenes with a few entities (the manufacturers). They lobby for complexity and then exploit loopholes, like the different standards for cars and light trucks or, as I fear, all these new flavors of SUV. Lack of transparency is the enabler of bad policy. Is there anything more transparent than a gas tax at the pump?
Keep it simple. Scrap CAFE, set a higher gas tax, and return the aggregate revenues from that gas tax through lower income taxes in a progressive fashion.
Linked at Outside the Beltway's Traffic Jam.
Andrew Sullivan returned from his bloggatical this week and picked up the thread of SUVs and terrorism, referencing a generally good column by Fareed Zakaria in Newsweek.
Andrew is also soliciting suggestions for bumper stickers to express the frustration that many feel about conspicuous consumption of gasoline that helps support non-democratic regimes. I haven't seen anything that compares to Tom Friedman's:
There is actually a cottage industry of anti-SUV bumper stickers, some that are intended to be placed on SUVs by someone other than their owner. Start here, or just use Google.
My libertarian streak prevents me from getting into the business of micromanaging what car people drive or how much they choose to spend on gasoline or any other private good. (Though I do confess that this chart makes me wonder why people would want to drive a fuel inefficient SUV unless they absolutely filled it to capacity.) The aspect of SUVs that does annoy me is that I believe that they impose a safety risk on the rest of us for which the owners bear no cost. Consider this fascinating paper by Michelle White of UC, San Diego. Quoting from the abstract:
The main result is that when drivers replace cars with light trucks, 3,700 additional crashes per year involving fatalities of smaller vehicle occupants, pedestrians and bicyclists occur, while only 1,400 crashes involving fatalities of light truck occupants are avoided, i.e., the ratio of negative external effects to positive internal effects is [over] 2 to 1. The paper argues that none of the existing traffic laws or institutions forces drivers of heavy vehicles to take account of their negative external effects.
You can read a digest article summarizing the paper here. If you are going to drive an SUV, you should have to drive better than if you drive a lighter car. I would support a special driver's license for people driving SUVs. Some of the possible reforms discussed in the paper and listed in that summary also make sense: "lower speed limits and more stringent driving rules for heavier vehicles, requiring that all vehicle owners in all states buy liability insurance, raising the minimum required levels of liability insurance coverage, and replacing no-fault liability systems for motor vehicle accidents with fault-based systems."
On the broader issue of excessive gasoline consumption and what that does in the wider world, I reiterate my basic point that a simple gas tax is the best policy. The mullahs don't care whether they get their money from someone driving an SUV 15 miles or a hybrid 45 miles--it's the same gallon of gasoline. So tax that directly and let cost drive behavior.