A picture to inform tax policy for closing the deficit

From CBO:

The new HARP might help...

From this morning's New York Times:

The Federal Housing Finance Agency, which oversees mortgage finance giants Fannie Mae and Freddie Mac, said it was easing the terms of the two-year-old Home Affordable Refinance Program, which helps borrowers who have been making mortgage payments on time but have not been able to refinance as home values have dropped...

...To encourage banks to participate in the program, FHFA is revamping it to protect lenders from having to buy back HARP loans if underwriting problems are later found. Banks will only have to verify that borrowers have made at least six of their last mortgage payments and the new rules eliminate the need for appraisals in most cases.FHFA said government-controlled Fannie Mae and Freddie Mac will waive certain fees for borrowers that refinance into loans with a shorter term, such as 15 years, aiming to spur homeowners to pay down the amount they owe at a faster rate.

The elimination of the requirement for an appraisal will make a big difference.  So will the waiver of fees for those who shorten terms.  Lower interest rates and shorter terms will help borrowers get right-side up faster.

Type I error, Type II error, and voting

No matter how our registration laws are set up, we will make errors: either people who are eligible to vote will be prevented from doing so, or people who are not eligible to vote will be allowed to do so.  Type I error falsely rejects a null hypothesis, while Type II error falsely fails to reject a null hypothesis.

If the null is that people who should be eligible to vote should be allowed to vote, then the new voter registration laws  being propagated around the country will produce more Type I error.  Two points here--I suspect that the new laws will create a lot more Type I error than precent Type II error.  Also, to me, Type I error is more serious than Type II error--preventing eligible voters from voting is a more egregious error than  allowing ineligible voters to vote.

Another impediment to short sales?

This morning, I participated in a conference in Lakewood on housing sponsored by Rep. Linda Sanchez.   A HUD representative made me aware of an issue I hadn't known about before: how mortgage insurance is giving lenders an incentive to foreclose, rather than agree to short sales.

Apparently, a number of lenders bought mortgage insurance on particular mortgages from private mortgage insurance companies.  To clarify, the lenders did not require borrowers to purchase the mortgage insurance, but rather bought mortgage insurance (and paid the cost) on their own.

Under the terms of the policies, the lenders get a pay-off from the PMI companies is they foreclose on a property, but not if they modify a loan or allow for a short sale.  Consequently, lenders are better off foreclosing than modifying, even if the foreclosure produces lower proceeds than a modification.

This is yet another perverse incentive that is contrary to the policy aim of stabilizing the housing market.  I have no idea how widespread this is, but if it is common, it is yet another problem.  

Plane and train envy

One of the privileges of my job is I get to travel a lot.  In the past year, I have been to Hong Kong, Seoul and Singapore.  All three cities have great airports, and nice, clean, comfortable, fast rail transportation from their central cities to their airports.

By comparison, many airport terminals in the US--including two of our biggest international airports, LAX and JFK--are embarrassing, and transportation options to them are limited.  Perhaps such things don't matter much to economic performance--it is easy to overstate the wonders of nice infrastructure when the cost is being hidden via subsidies.  Nevertheless, there is something about the ability of Asian cities to do infrastructure well that makes me envious.   

Lucid is the eye of the beholder

Ed Glaeser celebrates Tom Sargent in a recent Bloomberg column (h/t my father).  The following statement really struck me:

Two of his lucid monographs, “Macroeconomic Theory” and “Dynamic Economic Theory,” have long been mainstays of macroeconomic education

I am guessing pretty much anyone who went to grad school in econ in the late 1980s was subjected to "Macroeconomic Theory."  It has indeed become a useful reference to me, but lucid is about the last word I would use to describe it.  Lucid writers (within the realm of their academic work) include Paul Krugman, Milton Friedman and....Ed Glaeser.  Michael Intriligator manages to make dynamic optimization intuitive.  I just don't see how Sargent gets in the same category.

For free trade to fulfill its promise, the national government must redistribute income

As a card-carrying economist, I like trade--overall, it potentially enriches countries that engage in it.  The problem is the meaning of enrichment.

Trade theory says that trade enlarges the pie that people share.  But among the most important contributions to trade theory is the Samuelson-Stolper Theorem, which says that relatively scarce factors of production see their returns fall when trade is introduced.  In the context of an economy like the US, this means that low skilled workers see their wages fall in the presence of trade.  The trajectory of wages in the US over the past 20 years or so is consistent with the predictions of Samuelson and Stolper.

NAFTA was sold to the US public as something that would make everyone better off.  And in principle, it could have done so, had some of the gains to those who benefited from NAFTA been redistributed to those who lost as a result of it.  Instead we got the NAFTA but not redistribution.  This likely explains the widening disparity of incomes.

Why Einstein was wrong about being wrong

Why Einstein was wrong about being wrong

h/t Mark Thoma. The piece is a lot of fun.

Urban Population Share and Carbon Footprints

I am teaching Ed Glaeser's Triumph of the City to my undergrads right now; he has a chapter called "Is there anything greener than blacktop."  Just for fun, I plotted urban land share by state (source Demographia) against CO2 emissions per capita by state.  Here is what you get:

The regression line is log-linear.  An R2 of .28 on a bivariate relationship is not awful.  One should never make claims based on such things, but they are kind of fun to look at.

A couple of thoughts on the passing of Steve Jobs

(1) I wish we could have a tax code that could somehow discriminate between the truly productive rich and the, well, rich.  While I agree with Elizabeth Warren that no one gets rich by himself, there are rare people who really do know how to spend their own money better than the government.  The social returns to Steve Jobs must be remarkable.

(2) When politicians (and others) pay fealty to a market economic, their implicit assumption is that markets are competitive and exhibit, among other things, industrial (if not firm specific) constant returns to scale.  But successful enterprises like Apple often exhibit increasing returns to scale, at least for awhile, and certainly do not produce commodities sold into a competitive market.  Apple's innovation gives ii market pricing power, which is why it is so successful.  Without that pricing power, there might never be an Apple.  Yet the fact that success often requires market power implies that policies based on an assumption of a competitive equilibrium might be misplaced, perhaps disastrously so.

My testimony to Senate Finance Committtee on Housing and Tax Reform

I testified today.  Here is how the written testimony opens:

Chairman Baucus and Ranking Member Hatch, I want to thank you for the opportunity today to present my views on the issue of housing and tax reform.  My name is Richard Green, and I am a professor in the School of Policy, Planning and Development and the Marshall School of Business at the University of Southern California.  I have published extensively on the issue of the Mortgage Interest Deduction, and in particular published a paper co-authored with Dennis Capozza and Patric H. Hendershott on housing and fundamental tax reform for the Brookings Institution[1].

My general philosophy is that the tax code should be as broad-based and efficient as possible, while maintaining vertical and horizontal equity to the best extent possible.  I find many of the ideas proposed by Robert Hall and Alvin Rabushka to be quite appealing, and to me, in an ideal world, we would have something quite similar to the tax code they propose, albeit with an earned income tax credit added.  That said, we are manifestly not in an ideal world, and issues of transition matter.  As I wrote in 1996, a rapid change in tax policy could have a traumatic impact on the economy, so it is important that congress phase in any major changes to tax policy involving housing.

That said, I have long thought that the Mortgage Interest Deduction is a residual of the 1913 tax code, accomplishes little that its supporters claim for it, pushes capital away from plant and equipment toward housing, and benefits high income (although perhaps not very high income) households more than the remainder of the country.

I will divide my remarks into 8 parts; (1) I will argue that the Mortgage Interest Deduction is a residual of the 1913 tax code, and was not created to encourage homeownership; (2) that those on the margin of homeowning get little-to-no benefit from the Mortgage Interest Deduction, and that the policy therefore does little to encourage homeownership; (3) that the Mortgage Interest Deduction does encourage those who would be homeowners anyway to purchase larger houses than they otherwise would; (4) that even in the absence of the Mortgage Interest Deduction, owner-occupants receive a large tax benefit; (5) that phasing out the Mortgage Interest Deduction would encourage households to pay down their mortgages more quickly, and would therefore encourage households to rely less on leverage; (6) household deleveraging would lead to greater market stability, but would also mean that the revenues generated by the elimination of the deduction would be smaller than static estimates suggest; (7) at a time when the housing market remains quite weak, it is important that the Mortgage Interest Deduction be phased out carefully; (8) that if we do wish to encourage homeownership via tax policy, a targeted, refundable credit would be more effective than the current Mortgage Interest Deduction.

---

[1] Dennis Capozza, Richard Green and Patric Hendershott (1996), Taxes, Mortgage Borrowing and Residential Land Prices in H. Aaron and W. Gale, ed. The Economic Effects of Fundamental tax Reform, Washington, DC Brookings Institution Press: 171-210

There is no reason to be upset with BofA for its new debit-card fees.

The ATM Debit-card fee is transparent and easy to understand.  This is far preferable to the spate of fees (such as overdraft insurance charges) that were opaque and confounding.  If Bank of America wants to charge for a service, they should be free to do so. 

Will the private market step in?

Conforming loan limits in San Berardino and Riverside Counties in California will drop from $500,000 to $417,000 tomorrow; in LA and Orange Counties it will drop from $729,750 to $625,500. 

So we have a natural experiment in "crowding in."  Will the private lending sector fill the gaps?

Austerity is a problem, but so is fear

Paul Krugman this morning argues that fear of fear is phony.  He is almost certainly correct that fear is not the number one problem at the moment--if I had to pick a number one issue, it would be austerity measures at the state and local levels of government.  Tracy Gordon of Brookings has a nice picture:

 Cuts in state and local government jobs (police officers, school teachers, firefighters, DMV workers) are putting a drag on employment growth.  Moreover, this picture understates the problem, because total compensation to many state and local workers has been cut.

But I do think fear is part of the problem, at least in one sector of the economy.  It seems to me that there are business opportunities in lending that are going unanswered.  The pendulum for underwriting has swung so far to caution that according to the Flow of Funds Accounts, net lending declined in the second quart of 2011.  More specifically, net bank lending dropped by $181 billion on an annualized basis in the first quarter and by $129 billion in the second quarter.  Net lending is the difference between volume of new loans and volume of repayment of old loans. I do find it plausible that one of the sources of the tight lending environment is a fear of regulators.

One more point.  if it weren't for lending by the monetary authority, net lending in the second quarter would have fallen by $860 billion on an annualized basis.

My friend (and co-author) Andy Reschovsky wins Steve Gold award

It was nice to read about it this morning:

University of Wisconsin–Madison economist Andrew Reschovsky will be honored in November with the 2011 Steve Gold Award, which recognizes a person who has made a significant contribution to public financial management in the field of intergovernmental relations and state and local finance.

The Association for Public Policy Analysis and Management, the National Conference of State Legislatures and the National Tax Association give the award each year in memory of Steve Gold, an active member of all three organizations whose career and life tragically were shortened by illness.
"I knew Steve Gold, which makes receiving this award even more meaningful," says Reschovsky, a professor of public affairs and applied economics in UW–Madison's La Follette School of Public Affairs. "As a public finance economist, Steve believed his role was to communicate to policymakers about research and analysis. His emphasis on the link between scholarship and practice and on policy-oriented work on public finance has very much influenced my career."

Boston Fed President Eric Rosengren on the need to facilitate refinances (h/t Kurt Paulsen)

He says at a meeting in Stockholm:

There are several proposals that attempt to facilitate refinancing for homeowners who have been negatively impacted by the drop in housing prices. These proposals do face hurdles, including how to address private mortgage insurance and second liens. However, a program that made it possible for many homeowners to refinance, even if they were upside down, would likely provide significant reductions in mortgage payments to individuals who are likely to have a relatively high propensity to consume. Clearly getting more money into the hands of homeowners who would spend it could help to fuel GDP growth. This would reduce one of the impediments to a more significant effect from the monetary policy actions taken to date.

I hasten to add that there is already a government program to allow underwater borrowers to refinance, the Home Affordable Refinance Program (HARP). This program allows underwater borrowers with Fannie Mae or Freddie Mac loans to refinance at lower rates. Unfortunately, the program has helped fewer borrowers than was originally hoped. Fed Governor Betsy Duke outlined some of the potential reasons why, in the talk I mentioned earlier. They include loan-level price adjustments (LLPAs) that raise interest rates for many borrowers and thereby reduce the benefit of refinancing; originator worries about “buybacks” forced on them by Fannie Mae and Freddie Mac; junior lien-holder resistance to re-subordinating their loans; and mortgage insurance policies.

The Federal Housing Finance Agency (FHFA) is now investigating whether there are ways to enhance the program to benefit more borrowers.[Footnote 15] As this work proceeds, I hope the FHFA considers dropping or reducing LLPAs in cases when a GSE loan is refinanced into another GSE loan. Such a refinance actually reduces the GSE’s credit risk (they already guarantee the existing mortgage and the homeowner will be able to take advantage of lower rates, freeing up cash flow).

Am I posting this because I agree with it?  Yes. 

Hard Choices

Los Angeles (and other large cities) have food deserts--places with limited access to fresh, healthful, relatively inexpensive food.  Low-income people living in food deserts are at a particular disadvantage, because they can't afford cars, and therefore often do not have access to supermarkets. A common hypothesis is that poor kids eat unhealthy food because they don't have access to healthy food.  (I think this is only partially true--kids also eat unhealthy food because they like it.  For that matter, I still love McDonald's fries, I just try to limit my intake, and am in part able to because I have access to better alternatives).

Tesco's Fresh and Easy, a chain that develops and operates small grocery stores that feature fresh fruit and vegetables at reasonable prices, has decided on a business strategy of locating in food deserts.  This is potentially a great thing for kids who live in these places (especially if Fresh and Easy can figure out how to take WIC vouchers).  But this begs the question of how they are able to sustain such a business model.  Two answers present themselves--they are a non-union shop, and they rely heavily on automation.  Specifically, Fresh and Easy features self check-out, and so the store doesn't have to hire checkers.   Self check-out also makes it hard for Fresh and Easy to accept paper certificates, such as WIC vouchers, as payment.

So the cost of Fresh and Easy is that it may drive down wages for grocery workers a bit, and it may reduce employment for grocery workers.  The benefit is that it gives low-income children access to reasonably priced, good quality, fresh foods.  My personal social welfare function says to me that feeding kids inexpensively and well dominates most other considerations, but let's not pretend that there isn't a trade-off.

Michio Kaku on CERN's Challenge to Relativity

In this morning's WSJ:

Reputations may rise and fall. But in the end, this is a victory for science. No theory is carved in stone. Science is merciless when it comes to testing all theories over and over, at any time, in any place. Unlike religion or politics, science is ultimately decided by experiments, done repeatedly in every form. There are no sacred cows. In science, 100 authorities count for nothing. Experiment counts for everything.

A reminder: Ronald Reagan raised capital gains taxes

The Tax Reform Act of 1986 actually did two things that required the affluent to pay higher taxes: it raised the effective tax rate on long-term capital gains from 20 to 28 percent, and it eliminated the ability to write passive losses against ordinary income.  This meant that after 1986, Warren Buffett's taxes would have been at least as high as his secretary's.  

Read Taylor Branch's Atlantic Piece on the NCAA

Let me pull out two paragraphs from the powerful story:

Educators are in thrall to their athletic departments because of these television riches and because they respect the political furies that can burst from a locker room. “There’s fear,” Friday told me when I visited him on the University of North Carolina campus in Chapel Hill last fall. As we spoke, two giant construction cranes towered nearby over the university’s Kenan Stadium, working on the latest $77 million renovation. (The University of Michigan spent almost four times that much to expand its Big House.) Friday insisted that for the networks, paying huge sums to universities was a bargain. “We do every little thing for them,” he said. “We furnish the theater, the actors, the lights, the music, and the audience for a drama measured neatly in time slots. They bring the camera and turn it on.” Friday, a weathered idealist at 91, laments the control universities have ceded in pursuit of this money. If television wants to broadcast football from here on a Thursday night, he said, “we shut down the university at 3 o’clock to accommodate the crowds.” He longed for a campus identity more centered in an academic mission.

and

“Scholarship athletes are already paid,” declared the Knight Commission members, “in the most meaningful way possible: with a free education.” This evasion by prominent educators severed my last reluctant, emotional tie with imposed amateurism. I found it worse than self-serving. It echoes masters who once claimed that heavenly salvation would outweigh earthly injustice to slaves. In the era when our college sports first arose, colonial powers were turning the whole world upside down to define their own interests as all-inclusive and benevolent. Just so, the NCAA calls it heinous exploitation to pay college athletes a fair portion of what they earn.

I love college athletics (I am thrilled that I have gotten to attend three Rose Bowls in which Wisconsin played) and admire many college athletes.  I not only envy their athletic prowess, I am amazed at the varsity athlete who can manage a B average in a difficult major while playing a sport.

But the NCAA system gives these athletes a raw deal.  Among other things, the system makes it difficult for athletes in revenue generating sports to get a real college experience--practice and games can leave students too tired to focus on class (yes, I know some athletes have no interest in class to begin with, but in my experience they are a distinct minority).  If the "pay" is supposed to be an education, the least we as colleges and universities can do is make sure athletes get one.