What income and wealth tax rates do Americans want?

In an interesting new article published in the Journal of Public Economics (appears to be open access, but just in case there is an ungated earlier version here), Raymond Fisman (Boston University), Keith Gladstone (Princeton), Ilyana Kuziemko (Boston University), and Suresh Naidu (Columbia University), investigated how much income and wealth tax Americans prefer.

Specifically, they collected data from several surveys using Amazon Mechanical Turk over the period from 2014 to 2019, plus the Understanding American Survey (UAS) in 2019. In each survey, respondents were presented with scenarios of hypothetical people with different levels of income and net wealth (assets minus debt), and asked how much tax the hypothetical person should pay. Using that data, Fisman et al. are able to extract the income and wealth tax rates preferred by the sample, on average. You can try the survey out for yourself here. 

They found that:

...their chosen tax bills imply a linear tax rate on income of approximately 13–15%, in line with past work...

When we restrict the relationship of the tax bill and wealth to be linear, the implied average tax rate on wealth is about 1.2% in our baseline estimate.

They also find that the source of wealth matters for their research participants' preferences on taxing wealth:

Preferred taxes on wealth from savings are 0.8%, versus over 3% on wealth from inheritance.

The results are reasonably similar across all of the various survey samples (the mTurk sample is of course less representative than the UAS sample, so it was useful that they checked robustness across different samples), including being fairly stable across samples taken four years apart. The results seem sensible enough, and imply that Americans are not averse to wealth taxes. They also imply a preference for trading off somewhat lower income taxes in exchange for a tax on net wealth.

That last point is the one issue I have with this research. Taxing net wealth seems to me to be a little fraught. Should someone with a $2 million dollar house and a 95% mortgage, and a person with no debt but $100,000 in a retirement savings account, pay the same amount of tax on wealth? That's a normative question that is not easy to answer. However, it seems to me that Fisman et al. have shown a sensible way to better understand taxpayers' preferences in terms of these normative questions. It would also be interesting to know whether, if presented with fiscal estimates based on the implied tax rates they chose, their preferred taxes would change. These are useful questions for future research, especially on how people interpret taxes on net wealth differently or similarly to taxes on gross assets (not accounting for debt).

Book review: Mastering 'Metrics

Last year, I reviewed Mostly Harmless Econometrics, by Joshua Angrist and Jorn-Steffen Pischke, where I noted that:

...this is a book that is not for the fainthearted undergraduate economics student...

Fortunately, Angrist and Pischke have a more accessible book that I just finished reading, Mastering 'Metrics. This book is everything for undergraduates that Mostly Harmless Econometrics is for graduate students, and more. I found it incredibly accessible and readable, which sets it well apart from pretty much every econometrics textbook on the market. Angrist and Pischke use real-world econometric examples from the research literature to illustrate each topic in a very applied way. The underlying theory is clearly articulated in the text, as well as explored in more (mathematical) detail in the appendix to each chapter.

The topic coverage is a broad sweep across the main tools in the modern econometrics toolkit: randomised trials, regression models, instrumental variables, regression discontinuity designs, and differences-in-differences, which Angrist and Pischke label the 'Furious Five' of econometric research, with a hat tip to Kung Fu Panda. Like their other book, the key goal the authors have in mind is for budding econometricians to be able to extract causal estimates of relationships from a variety of data.

I think this may be the most enjoyable econometrics book I have ever read. Many of you are probably thinking that statement doesn't set a very high bar, because most econometrics books are drier than a particular arid corner of the Sahara, and almost impenetrable to anyone without high-level mathematics skills. However, there is an astronomical gap between this book and its nearest rivals. If I was teaching undergraduate econometrics, I would not hesitate to use this as the required textbook.

And even if you're not an economics student, but you want to understand the quantitative methods that underlie a large proportion of economics research (including many of the papers that I discuss on this blog), this book would be a great place to start. Highly recommended!

The rise of speakeasy gyms during the coronavirus lockdown

In my ECONS102 class, several of the examples I use to illustrate the supply and demand model involve trading of illegal goods and services (like illicit drugs). It is important to realise that prohibition (making certain goods and services illegal to trade) doesn't eliminate the market, it just pushes the market underground. So, I found this recent NPR Planet Money story interesting:

My friend Evelyn is an immigration lawyer, and she recently had a meeting at a foreign consulate in downtown San Francisco. (Her work makes it hard for her to talk to reporters, so we're not using her last name). As she walked toward the building's metal detectors, the security guards told her she couldn't bring her backpack in, so she had to leave. She worried this would make her late, so she frantically began searching for a safe place to stash it. She walked down the street, and her eyes caught a gym storefront with one of those garage-style, roll-down metal doors. It was slightly open...

"Oh, we're not open," said one of the trainers.

What Evelyn uncovered can only be described as a speakeasy gym. You know, illegal, hush hush, like the underground bars during the Prohibition era. These underground gyms appear to be popping up everywhere, from LA to New Jersey.

One fitness freak in Ann Arbor, Michigan, turned to Reddit to get their fix. "Anybody want a home gym partner or know of a speakeasy gym?" they asked — assuring readers in a follow-up post, "not a cop." "That is exactly what a cop would say," responded someone in the thread.

Welcome to the COVID-19 Prohibition era, when gym rats have gone underground.

Governments can legislate all they want, but prohibiting stuff with eager buyers and sellers is super hard, says Jeffrey Miron, an economist at Harvard University who has spent three decades studying prohibitions. Miron, who these days is legally working out in his basement, says there's a simple lesson that emerges from his studies: "Prohibitions don't eliminate things. They drive them underground." And that comes with a whole host of unintended consequences...

This a textbook example of a classic unintended consequence of prohibition, Miron says. When markets get pushed underground, quality control tends to go down. In the case of drugs, this means potentially finding rat poison in your weed. When it comes to gyms in the COVID-19 era, it means potentially creating fitness environments that are even more likely to spread the virus than if they were legal and regulated. "When you drive something underground, your ability to regulate it goes away," Miron says...

Higher prices are another classic unintended consequence of prohibition. With less competition and higher risks in black markets, entrepreneurs can charge extra. The money-making opportunities of black markets lead to other classic side effects of prohibition: violence and corruption. "Disputes tend to be resolved violently because the participants in an underground market can't sue each other in state or federal courts," Miron says. Mobs and gangs function as quasi-governments that use violence to keep order and enforce property rights. But it's hard to imagine illegal gym operators turning to Tommy Guns and gang warfare to resolve their business disputes.

Putting aside the issue of gang warfare between rival illegal gym operators, let's consider the effects of prohibition on the market for gym services. First, let's assume that there are stiff penalties for gym operators who open during a lockdown, but no penalties for gym members who attend the illegal gym. This situation is illustrated in the market diagram below. Without the lockdown, the market operates in equilibrium with a price of P0, and there are Q0 gym memberships. Penalties for gym owners who operate during the lockdown increases the costs of gym operation, shifting the supply curve up from S0 to S1. This increases the equilibrium price of gym services to P1 (the higher prices noted in the quote above), and the number of operative gym memberships decreases to Q1.

Now consider an alternative, where there are penalties for gym owners (as shown above), but also penalties on gym members who flout physical distancing rules by attending the gym. In this case, not only is there a decrease in supply (from S0 to S1), but there is also a decrease in demand (from D0 to D2), because gym members face the risk of being penalised if they are caught. Assuming that the penalties on gym members are smaller than the penalties on gym owners, then the shift in demand would be much smaller than the shift in supply (as shown below). The equilibrium price of gym services increases to P2, and the number of operative gym memberships decreases to Q2. [*]

It would be interesting to see if this point from the article happens:

The longer gym shutdowns last during the COVID-19 prohibition era, the more likely people will evade them. And keep in mind it's summer. Come this fall and winter, millions of workout fiends in cold climates could have fewer legal options to exercise. Speakeasy gyms could have an even greater demand.

That would raise the price of speakeasy gym services even further. Prohibition doesn't eliminate markets - it just pushes them underground.

[HT: Marginal Revolution]

*****

[*] If the decrease in demand was larger than the decrease in supply, then the net effect on the equilibrium price would be a decrease. However, either way, we can be sure that the number of operative gym memberships will decrease.

How Costco gets firms to compete with themselves

 In my ECONS101 class last week, we covered pricing and non-price strategy for firms. This is a topic that you wouldn't see in a 'typical' first-year economics principles class, because it covers some very applied business economics and managerial economics - pretty important stuff for business students to understand, but not seen by most principles lecturers as important enough to squeeze out all the excitement of teaching the principles of cost curves (!).

Anyway, one of the strategies that I cover in this topic is situations where a firm finds it profitable to compete with itself. The examples I use are firms like Unilever, which makes several different brands of laundry powder, effectively making its own products compete with each other. However, by crowding the market with its own brands, Unilever makes it more difficult for other firms to compete. There is limited space on supermarket shelves, so if you can fill up those shelves with your own products, then it increases your profits. The supermarkets play along, because it is lower cost for them to deal with one supplier that can supply a range of products (and therefore make it look to the customer like a wide variety), rather than dealing with many suppliers.

So, I was really interested to read this article by Adam Keesling last month, which illustrates something fairly similar:

If you’re anything like the nearly 100 million people worldwide who have a Costco membership, you probably love Costco’s Kirkland Signature. You can get two dozen cage-free eggs for $6.50, or a 1.75-liter bottle of French vodka for $19.99. 

But despite these products’ exceptional prices, their quality doesn’t suffer at all. In fact, the exact opposite is true. Many of their products pass purity tests with flying colors. 

Kirkland also has a passionate and loyal fan base — not something you typically find with a private label brand. One guy even got a Kirkland Signature tattoo on his left arm and held his 27th birthday party at the Costco food court. 

Kirkland’s success defies our intuition and experience. Shouldn’t lower prices lead to lower quality products? How can they offer rock-bottom prices but still have some of the best products around? 

The answer is this: they get the best manufacturers in the world — who already have products on Costco shelves — to make Kirkland products. Yeah, you read that right. While customers might not know it, Kirkland products are often made by the same manufacturers who make the branded products that sit next to them on the shelves. 

Now, we don't have Costco in New Zealand. However, the explanation of the economics underlying how Costco gets its suppliers to compete with themselves is eye-opening:

Shortly after learning that brands would actually manufacture and package Kirkland products for Costco, I wondered how it worked. Why would a brand — say KIND Bars or Jiffy Peanut Butter — create a product for Costco and use the Kirkland brand? And make it 1% better than their own product? 

In a normal Costco purchasing example, a company might sell their product for $0.95 and Costco might retail it for $1.00. This would result in a 5% margin (in reality the margin is a bit lower, but let’s use these numbers for estimates). 

This $0.95 would be the brand's revenue. If we use some industry averages for margins — marketing budgets average 24% for CPG brands, and gross margins hover around 40-50% — then we can estimate their cost profile.

Keesling estimates that the manufacturer earns about 16% profit on selling their standard product at Costco. Then:

What about Kirkland products? As mentioned above, Costco aims to save customers 15-20% on the Kirkland products compared to their branded counterparts. So in our example, retail price would be $0.80 per unit for the Kirkland products. If that’s the only adjustment, the brand would be in a tricky position. Marketing expense is $0.20, non-marketing expense is $0.60 and the retail price is $0.80. That wouldn’t leave much margin for either the brand or Costco. In fact, it would leave none at all. 

But here’s the kicker: with the Kirkland products, brands don’t have to spend nearly as much money on marketing. They don’t need to pay for Facebook ads or run television campaigns. The only remaining marketing expense might be the account reps associated with the Kirkland account. Let’s say this lowered the marketing expense from $0.20 per unit to $0.05 per unit.  

In this case, Keesling estimates that the manufacturer earns about 14% profit on Kirkland products. So, while it's not the same level of profit as for their standard product, if selling the Kirkland product is what it takes to get your standard product on Costco shelves, then many manufacturers would be willing to do so. After all, Costco is bringing in revenue of nearly US$150 billion per year, so the manufacturers know they are going to sell a lot of products if they are on Costco shelves.

And that is how Costco gets firms to compete with themselves.

[HT: Marginal Revolution]