Wednesday, August 31, 2011

anti-trust law, incentives, and coordination problems

When two companies merge, they sometimes achieve efficiencies of scope or of scale, but where they were previously competitors, the merger may reduce competition. If the former effect dominates the latter, the merger may benefit consumers, but if the latter dominates the former, consumers will be harmed, and frequently the net harm to consumers is likely to exceed the net benefit to other parties (e.g. stockholders). Even where this last inequality does not hold, it is frequently within the ambit of regulators only to consider the effect on consumers, and this may be a defensible principle. Regulators may, however, have less knowledge about the likely effects of the merger than industry sources. It would be nice if there were a way to induce industry sources to reveal useful information to the regulators.

Mankiw pointed out a couple years ago that, where a merger is likely to benefit consumers, it will do so by lowering prices and raising quality for consumers, while where it hurts consumers, the opposite will be true. Regardless of how it plays out, competitors of the prospective merger partners will be helped or harmed exactly inversely to the effect on consumers, thus, in this narrow context at least, the anti-business instincts of certain populists are actually well-justified; if competing businesses are lobbying in favor of a merger, Mankiw suggested, block it, while if they lobby against it, approve it. He noted, though, that it is necessary to keep such a policy quiet; if the companies know their lobbying actions have these perverse effects, they will no longer lobby in a way that reveals the relevant information. The policy is not, in this sense, incentive compatible.

On the other hand, what just occurred to me is that one might well be able to, openly and publicly, follow the evolution of the stock prices of competitors that are publicly traded. A potential shareholder in a competitor to the prospective merger partners will wish for the regulator to see a drop in share prices on the announcement of the potential merger when the merger would in fact benefit the company, but he still finds it in his own interest to buy ahead of other potential shareholders; similarly, if he would like regulators to see an increase, he may still wish to sell before others do. If all buyers and sellers in a particular stock could form a cartel, they would jointly find an advantage in acting to confuse the regulator; what they might narrowly view as a "tragedy of the commons" may in fact serve, in this case, to enhance the public good.

While there is a tendency to think of coordination problems as a bad thing, in fact they are frequently quite useful, if usually in combating the effects of other coordination problems (or private information problems). Most of forensic accounting, in fact, involves asking different parties to keep track of essentially redundant information; while a single agent might be able to forge all of its own records in a consistent way, getting all of its business associates to forge their records in the same way is more difficult, such that accountants can subpoena everyone's records and find inconsistency in the combined dataset. Indeed, perhaps the most famous illustration of a coordination problem, with the possible exception of the aforementioned tragedy of the commons, is the prisoner's dilemma, in which a mechanism designer has, according to the usual story, explicitly designed the coordination problem in order to turn the agents against themselves.

In the case of two agents, cooperation is more likely to obtain, especially where they know each other, than it is with multiple, anonymous agents; "incentive compatibility" as it is usually treated in the literature requires only that each agent find it unprofitable to unilaterally deviate from the prospective equilibrium supposing that nobody else does so. In actual practice, it seems likely that this condition is insufficient as long as the sets of agents required to coordinate to block such an outcome are both small and in a variety of senses are known to each other in such a way that they can solve their internal coordination problems — possibly creating what manifests itself as a coordination problem on a larger scale.

Friday, August 26, 2011

stimulative corporate tax policy

Last month I turned 35, and noted that I am now old enough to be President. I was asked my platform, and gave sarcastic responses. I do have a couple of ideas of things I think would be worth trying to stimulate* the economy, though; one of these is price-level targeting, which I've mentioned before. The others relate to corporate taxes.

The first has been badly garbled by blogger, but involves increasing corporate tax rates to 40%, but with a credible commitment to then lower rates by 2 percentage points each year until they drop to 30%.  (How to make this credible is left unspecified.)  The idea, though, is to induce firms to shift profits from the present into the future; if they can find a way to move $10,000 of pre-tax profit from next year to the year after that, they save $200 in taxes.  The next proposals give the firm a way to do that.

The second idea is to allow companies to expense all investment for two years, and half of it in the third. Approximately, if a company spends $10,000 on a piece of equipment that will last ten years, it lists $1,000 as an expense each year for ten years; that is what it subtracts from revenue to calculate taxable profit. I'm suggesting that we allow companies to front-load the deductions; if you spend $10,000 on a piece of equipment this year, subtract the whole thing from your revenues. (You would then carry it at 0 value on the books; you would not deduct $1,000 per year in future years, and, if you sell it, the amount for which you sell it would be taxable revenue.)

The third idea is to cap each company's payroll tax contributions at, say, 80% of its level from some recent previous year; this provision, too, would hold for a few years. A company that is already paying less than that would, of course, not be affected; for a company that is affected, decisions related to changing payroll are now changed by the fact that another $1 in salary paid does not cost the company $1.075 (or thereabouts). Creating a new $30,000 job costs the company $2,250 less per year than it would have otherwise; creating a new $40,000 job costs $3,000 less; laying off a $40,000 worker will save $3,000 less than it otherwise would have. Further, again because of the declining corporate tax rate, a company that thinks it will want to hire two or three years from now has a bit more incentive to bump up its payrolls now.

Finally, while I view as a feature that the third idea encourages companies to create higher-paying jobs to some extent, we can also allow the wages of any hourly worker to be deducted as though they were $10 per hour; e.g. if a company pays an employee $7.50 for 20 hours, it lists an expense of $200 on its taxes rather than $150. This creates a little bit more incentive to create a job at the low end of the scale rather than not to create it, but it also means that raising the employee's pay to $9 per hour will not benefit the company through a lower corporate tax. This one is accordingly a bit dangerous, and is kind of intended to offset any harm done to especially low-skilled worker by recent increases in the minimum wage.

I should note that the second and third ideas in particular are not entirely my own idea; expensing investments is naturally what one would do in a more consumption-based tax system, and Mankiw has recently noted that temporary pro-investment tax provisions, such as an investment tax credit, would in many ways lower the effective interest rate that is used in investment decisions, thus giving a way around the zero-bound on nominal interest rates. Singapore actually uses a countercyclical employment payroll tax, reducing the employer's share of payroll taxes when unemployment is high (to reduce the cost of hiring) and raising it when unemployment comes down (to raise the necessary funds over the long-term). I've essentially taken the marginal rates all the way to 0, but with the 80% offset designed to mimic proposals by people who seek to raise more nearly the amount of revenue that is raised by current levels of payroll taxes.

* I want to emphasize that "stimulate" is supposed to indicate an emphasis on short-term; I'm not discussing here ideas that would focus on creating a good climate in the long-run for sustained growth. The ideas presented, though, should not do great violence to long-run growth, either, and are partly constructed with them in mind.