Cap and Trade and Soda

A few days ago, my family and I went on vacation. On the way back, my family and I were discussing various things including some matters of politics. One thing that came up was some of New York City mayor Michael Bloomberg's recent actions. I expressed the view that the ban on soft drinks larger than 16 ounces seemed rather heavy-handed. (After reading a little more about the exceptions for fruit drinks along with sales at grocery stores, I'm a little more happy to see that, but I still feel the ban was heavy-handed.) I then heard the argument that even if it is heavy-handed, it does help combat the obesity crisis by reducing access to drinking 16 ounces of soda at a time, because even if it is still technically possible for someone to fill up an 8-ounce cup twice, human psychology is such that said person would only fill up once, because for many people the convenience of filling up once trumps the desire to have as much as possible. I then wondered what other alternatives could be considered. The simplest alternative would seem to be a tax akin to taxes on cigarettes; if the large sodas are taxed heavily at such venues, people would naturally be discouraged from drinking as much. I have taken the class 14.03 — Microeconomic Theory and Public Policy, though, so I have seen that in many cases a Pigovian tax scheme like that may not achieve the most efficient outcome because it is difficult to adjust tax rates to control quantities precisely. Then I also remembered learning about cap and trade schemes to control quantities. Would that work? Let's take a look after the jump.

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Frictions, Subsidies, and Taxes

One of the things I learned in my high school AP Microeconomics class was that a tax causes the supply curve to shift to the left, making the equilibrium quantity decrease and price increase. Consumer and producer surplus both decrease, but while government revenue can account for some of the loss in total welfare, some part of total welfare gets fully lost, and this is what is known as deadweight loss. I didn't have a very good intuition for how this worked at the time (though I was able to get through it on homework, quizzes, tests, and the AP exam). At the same time, though, I thought that a tax should be fully reversible by having the government subsidize producers, and that as this would be the opposite of a tax, supply would shift to the right, the equilibrium quantity would rise and price would fall, and there would be a welfare gain.

Then, when I took 14.01 — Introduction to Microeconomics, we again discussed the situation with a tax. Then we talked about subsidies, but I was confused because the mechanism seemed to be in providing a subsidy to consumers rather than to producers. My intuition at that point was that taxes were creating deadweight loss because producers who wanted to produce and consumers who wanted to consume near the original equilibrium could not do so after the tax, so some transactions were essentially being prohibited. However, I still didn't quite understand why a subsidy would create deadweight loss, because it seemed to me like consumers who wanted to consume more and producers who wanted to produce more than the original equilibrium quantity could now do so, meaning it seemed to me like more transactions were being made possible. That said, I did understand why the government would never subsidize producers: unless the market is perfectly competitive, producers would rather collude and pocket their subsidies while keeping prices high when they can. On the other hand, consumers prefer consuming, so subsidizing consumers is a more surefire way of increasing the equilibrium quantity, even though the price would go up rather than down.

(In 14.04 — Intermediate Microeconomic Theory, we barely touched on deadweight loss in the way that it is covered in more traditional microeconomics classes.) Now, in 14.03 — Microeconomic Theory and Public Policy, I think I better understand the intuition behind deadweight losses stemming from taxes and subsidies, and why a subsidy is not the opposite of a tax. In a tax, the government might try to target some new equilibrium quantity below the original one, so the tax revenue collected, which increases total welfare, is the difference between the willingness of consumers to pay and the willingness of producers to accept at that quantity multiplied by that quantity. Consumer and producer surplus both decrease, and the tax revenue contribution to the increase in total welfare is not enough to offset these two, so there is an overall deadweight loss. A completely isomorphic way of picturing this is by considering the tax falling on consumers so that the demand shifts to the left; in both cases, the equilibrium quantity drops, the government collects its revenue, surpluses drop, so deadweight losses appear.
Meanwhile, for a subsidy, the government might target a higher quantity than the original equilibrium. The spending on that subsidy is the difference between the willingness of producers to accept and the willingness of consumers to pay at that quantity multiplied by that quantity. Consumer and producer surpluses both increase, but together they do not increase enough to offset government spending which is an overall drain on total welfare, so there exists a deadweight loss.

It's interesting that taxes and subsidies are not opposites. The intuition is that for a tax, the revenue is not enough to compensate for the welfare losses of consumers and producers because the new equilibrium quantity is lower. By contrast, for a subsidy, the spending is too high compared to the welfare gains of consumers and producers because the new equilibrium quantity is higher. It looks like it is not possible to spend money given by tax revenue to undo the effects of a tax; instead, the government can only overshoot and overspend. It reminds me very much of how friction works: moving in one direction on a surface with friction causes energy loss, while turning around to move in the other direction on that same surface most certainly does not cause energy gain. Essentially, in this model, the market is frictionless, and the government introduces friction.

Of course, this essentially contradicts Keynesian models of government taxation and spending and their respective effects. That's why care must be taken when putting microeconomic models in a macroeconomic perspective. This also doesn't consider externalities, less than perfectly competitive market structures, et cetera. Anyway, I hope my musings on this may help give other people some intuition on simple issues of deadweight loss in microeconomic theory.

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On the Current US Deficit and Debt Crises

It's been a long time since I've posted here about straight-up US politics (that doesn't have much to do with technology, technological freedoms, et cetera), but I felt that what's happening now deserved a post.

Unless you've been living under a rock, you probably know that the US has a pretty big deficit and a whopping debt. The debt is so high that the US is rapidly nearing the debt limit; if it doesn't raise the debt ceiling, it will default, and the US credit rating will probably be downgraded from 'AAA' to 'AA'. Of course, this will have catastrophic consequences for the economy, which until recently I didn't really understand, but now I sort of do. Many government workers, probably including myself (in my summer internship at NIST) and someone in my direct family will be laid off at least for a while. Interest rates will shoot up. Elderly people will stop receiving Social Security and Medicare, at least until this whole thing can get straightened out again. And the reason why this hits home is because if government workers do get laid off, I may not be able to attend college again until my family has income again to pay for my education. It's a scary and saddening thought, and it's certainly not something I thought I would ever have to worry about in my four years of undergraduate education.

Just for a quick rundown of what's happened so far, President Obama has been trying to bargain and compromise with Republicans in the House of Representatives and Senate in order to actually raise the debt ceiling. These negotiations stalled thanks to Republicans, especially House Majority Leader Eric Cantor, repeatedly walking out of these talks. Obama has moved steadily to the right to try to court Republicans, promising $5-6 in spending cuts, even in things like defense and entitlements that traditionally haven't been touched, for every $1 in tax increases. Recently, House Speaker John Boehner seemed to be agreeable to such deals, but that all fell apart, probably under pressure from Cantor.

Just this week, Senate Minority Leader Mitch McConnell came up with a last-resort plan to raise the debt ceiling, if all else failed. This would involve Congress passing a resolution against raising the debt ceiling, which Obama would veto in order to raise the debt ceiling. For the veto to stand, 1/3 of the representatives and senators would need to block attempts to override the veto. This would happen in all likelihood, and this would have the effect of Obama unilaterally raising the debt ceiling without Congress's help. This would be done in conjunction with trillions of dollars in spending cuts, and this would be repeated 2 or 3 times, once every three months. Most people in Congress have supported it as a last-resort measure, yet Cantor still opposes it, despite it coming from a Republican senator.

There are so many problems with this whole thing, it's unbelievable. Leaving aside the mechanics of the actual debt and deficit reduction plans for a moment, let's just focus on the behavior of the people in DC. Obama and Boehner have been the most agreeable people here for actually seriously considering solutions to the problem, even risking disapproval from members of their respective parties. Cantor has been the No-Man here, saying no to any deal here. In fact, Cantor has had the gall to say that even choosing to negotiate with Obama and the Democrats is itself a compromise. Hello? Last time I checked, negotiation is a prerequisite for compromises to be made. If your idea of sticking by your principles is sticking your fingers in your ears and screaming, people are probably going to give up trying to reason with you. Sadly, you're endangering the economy at the same time by choosing to do absolutely nothing.

And the McConnell plan strikes me as almost as ridiculous as Cantor's stance. It's obvious this is done so that Republicans can place the full blame of raising the debt ceiling on Obama. (As if saving the economy from survival is now supposed to be a shameful act...) This is in response to Obama rightly calling out Republicans on refusing to do/going back on things like closing tax loopholes, ending subsidies for ethanol, and ending tax breaks for toys for very wealthy people. In effect, this also places the blame on Republicans should the US default due to Republican obstinacy. Yet Republicans, more focused on staying in power than actually serving their country and constituents, would rather not act to prevent the US from defaulting by putting the whole burden of raising the debt limit on Obama. I suppose it's marginally better than no plan at all, but the overtly political nature of the stunt is frankly disgusting.

(All for what? To please a guy named Grover Norquist, who has never himself been elected, and who said on The Colbert Report that grandmas should die at the hands of terrorists before taxes can be raised. Yes, he really said that, and judging from the genuinely taken-aback expression on Stephen Colbert's face upon hearing that, Norquist was serious. So really, it's Norquist holding the economy hostage so that his whims may be pleased. What's worse, people paying small portions of their income for the public good, or people losing their jobs, possibly to never get them back? It's insane, but I slightly digress...)

It's sometimes amusing to watch the antics of politicians, and to watch them act like screaming 4-year olds. It's no longer fun when the economy, my college education, and loved ones' jobs are on the line. I think I'll stop before I puke repeatedly and before I get a prescription for hypertension medications.

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Chickening Out on the Chicken Tax

I was reading an article in the New York Times about the proposed overhaul of the New York City taxi fleet; all of the finalists in the selection process are minivans targeted at small business owners (Ford Transit Connect, Nissan NV200, and Turkish company Karsan's entry). Just for fun, I searched all three on Wikipedia (and got no results for the last one). While reading the article about the first, I saw that it goes through a rather ridiculous shipping/manufacturing process just to avoid the "chicken tax". I then clicked that article.
Apparently, this tax was put into place in the 1960s in response to France and West Germany's tariffs on goods like chicken. Since then, all the terms of the tax have been lifted except for the tax on light trucks. What this means is that automakers must build light trucks and minivans like these in the US to avoid this rather excessive (and needless) tax. This doesn't just apply to foreign automakers; as you can see, this applies to Ford as well with its Transit Connect. To get around it (because Ford's US plants aren't capable of building the Transit Connect (yet)), Ford imports these vehicles with windows and rear seats (thus qualifying as a passenger vehicle and thus making it exempt from the tax) and then rips out the seats and seatbelts and replaces the windows with metal panels once in the US.
Isn't that ridiculous and ridiculously wasteful (both of materials and money, which goes to show that quite a few taxes create real waste)? (Granted, the seats and windows are recycled, but it would still probably be less wasteful to just not use the materials at all as opposed to processing these materials at a recycling center after the fact.) Also, isn't it ironic that domestic companies that are supposed to be helped by these tariffs are actually being directly hurt by them? The Cato Institute, a libertarian think tank, calls this tax a "policy looking for a rationale". It may have made a little sense 50 years ago, but now, I wholeheartedly agree with them. Will common sense please stand up?

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