Friday, December 11, 2015

non-recourse unsecured debt

This is one of those ideas that is not at all well thought-out and is probably a bad idea, but is here because it struck me as interesting when it popped into my head and maybe it can inspire a better idea.

The Obama administration (I believe) has implemented an income-based repayment program for federal student loans; even if you have a lot of debt and low income, you don't have to pay more than 10% of your income toward the loans.  Student loans are special in some ways; most notoriously, to some extent on the premise that they're secured by your education which can't be repossessed, they can't generally be discharged in bankruptcy.[1]  In practice (and I assume from a formal legal standpoint) it's unsecured debt, but the ability of the lender to come after your assets if you aren't paying on the original official schedule has been curtailed.

Now, one of the nasty things about the design of our welfare systems, though it's much improved from a generation ago, is the speed at which benefits sometimes "phase out" as income goes up. Under AFDC, from 1935–1996, if you made an extra $3000 in a year, your benefits were cut by at least $2000, and for most of those 61 years your benefits were actually cut by the full $3000; there was no particular point in gaining work experience or making similar investments that might help you ultimately get out of poverty.  The successor program to AFDC is much more variable from state to state, but phase-out rates are (I believe) universally lower than 67%, usually no higher than 50%.  SNAP, however, phases out at a 30% rate, which might not seem too bad, but this means that if you earn an extra $100 and are on both programs, you may lose $50 in TANF benefits and $30 in SNAP benefits.  Some programs, like Medicaid, are even worse, where if you're $1 below the eligibility threshold, making an extra $2 can cost you your health care; Obamacare subsidies, depending on the circumstances, have a similar structure, where they will decrease gradually until you get to a certain point, but drop discontinuously to zero at a particular threshold.  These health insurance cliffs both seem like bad program design, but often even reasonably designed phase-out rules become problematic when they're phasing out together.  I've suggested that one be able to elect to split 50/50 with the IRS any portion of one's income in exchange for having it officially removed from income for all tax and welfare benefit calculations; this would provide something of a safety valve where, if one found oneself in an income range with 80% in aggregate phaseouts or just above the Medicaid cutoff, one could get 30% of the extra earned dollars back or pay a small amount to get your health insurance back.  More importantly, one would be able to take on extra work without worrying that one is risking eligibility for these programs.

My thought, then, is that perhaps there are other debts we would want to treat similarly to student loan debt, but we might want to lump together with it.  Debtors with those kinds of debt could pay 60% off the top to be at a lower income level for purposes of taxes, benefits, and also income-based debt payment plans, with $10 of each $60 earmarked for creditors, but perhaps more than that if the debtor/taxpayer is not in an extensive phaseout income range.  The debts could include student loans, fines, and judgments from courts, including back child support; in all cases, debts that one wants to see paid, but with the understanding that someone with little reason to work isn't going to be paying them off.

[1]I feel better about this rule in Chapter 7 than Chapter 13, where I would at least be inclined to allow them to be reduced, but that's a bit off topic.

Thursday, December 10, 2015

tax incidence

I've been thinking a bit about "value added" taxes, which are a substantial source of revenue in many European countries, but not in the United States.  The "value added" of a company is essentially the revenue it takes in minus the expenses it pays to other companies; equivalently, it is the profits of the company plus the money it spends paying its employees. [1]  The total production of the economy is then the sum of the "value added" by different economic units.  If markets are competitive, the price of a good is the cost of producing it, and a 20% value added tax translates ultimately to a 25% increase in the final price[2] above the other costs of production; for example, if XYZ corp sells widgets for $3 a piece, with $1 in capital costs (including depreciation), $1 in labor costs, and $1 for inputs purchased from ABC corp, and ABC has no suppliers,[3] then (if supply is inelastic) a 20% VAT tax raises the final price to $3.75, of which $2.50 is value added and $1.25 is paid to ABC; XYZ thus pays 50 cents per widget in taxes, and ABC pays 25 cents per widget in taxes.  It is hoped that the reader will see (or trust) that the result is similar when supply is elastic.

Because of the argument given, the VAT is typically viewed as equivalent to a consumption tax; it gets collected along the supply chain, but is equivalent to, in this case, a 25% tax applied at the end.  At the risk of being wrong — and, note, that is well in the spirit of this blog — it seems to me that a 20% tax on corporate profits combined with a 20% flat income tax on the workers is also equivalent.[4]  If corporations are paying a 36% tax and workers are paying a 20% tax, replacing that with a 20% corporate tax and a 20% value added tax with no income tax seems likely to be equivalent.[5]

There is always, with tax policy, the question of true economic incidence of taxes, which especially in the long-run is likely to be independent of legal incidence; one of the reasons a lot of people like corporate taxes, and a lot of wonks don't, is that it is officially paid by companies, and it's not entirely clear who the actual payers are. (Some quick searching pops up this 2005 working paper on the subject; my recollection is that recent research is unable to exclude, insofar as the question is well-defined, the proposition that about one third of it is borne each by the shareholders or owners of the company, the employees of the company, and the customers of the company, though I don't have a source for that; it probably would depend on the industry, and of course over the entire economy consumers and employees and shareholders are not remotely mutually exclusive groups.)  Possibly because of my American bias, or the fact that I'm just not in that sort of literature generally, I haven't to my recollection seen much analysis of how much of a value-added tax actually falls on consumers, ultimately, and how much is absorbed by someone else.

[1]As with many economic concepts, it gets rough around the edges, so that the first definition I gave is not entirely "equivalent" to the second.  The money a company pays to a company providing its employees health insurance wouldn't be subtracted from "value added"; that's part of paying your employees, only in-kind.  Is the money spent on air conditioning for your office an expenditure on externally-produced inputs or an implicit labor cost?  A reasonable argument could be made for the latter, but I'm sure it's never treated that way.  Whatever the definition of "value added", the tax base for the value added tax is typically closer to the former definition than the latter, so that a company pays "value added tax" on exactly that portion of its revenue on which no other company is paying "value added tax".

[2]The age old confusion about percentages rears its head here; the upshot is that the tax is 20% of the cost with taxes and is 25% of the cost without taxes, so e.g. an item that ends up costing $5 includes $1 in taxes and $4 of "other".

[3]To keep things simple.

[4]Here's where perhaps it's worth emphasizing again that in practice the two definitions given previously for "value added" are effectively very similar.

[5]On the corporate side, $1 before taxes becomes .8×.8=.64 cents after taxes, just as without the VAT.

Sunday, December 6, 2015

endowments, public commitment, and coordination

I somewhat avoid the news here, but the news hook here is pretty tangential; Mark Zuckerberg recently announced that he's giving away most of his fortune to an LLC, not a tax-deductible organization.  One of the reasons for that is the 5% rule; most tax-deductible organizations, as part of the terms of their tax classification, have to spend at least 5% of their endowments every year on expenses that are fairly directly relevant to their official charitable purpose.  I don't know whether non-profit universities are typically incorporated differently or are given an explicit exemption, but they are generally exempt; there has been some talk, at the periphery of American political discussion, of removing the exemption.  In all cases, the idea is that an organization that gets some kind of special exemption from tax laws shouldn't be allowed to simply stockpile and invest an ever increasing endowment without substantial ongoing evidence that it is serving a socially beneficial purpose.

Why do universities (and other organizations) build up endowments in the first place?  Imagine two universities, Typical University which establishes an endowment early in its existence and uses some of it over time, in addition to ongoing donations, tuition, etc., to pay for programming, and Paygo University, which happens to receive in donations each year an amount equal to what TU receives in donations plus what TU withdraws from its endowment; each then funds the same programming.  Presumably they do the same social good; the endowment that TU has at any given time is the present value of the amount of donations TU received in excess of those PU received in the past, where the discount rate is the rate-of-return on the endowment.  If TU is simply letting its endowment pile up, then it has received more in donations, while doing less good, but presumably, one hopes, has enhanced its ability to do good in the future; if TU is pulling substantial funds out of its endowment to fund programs, then there is some sense in which it has not so much taken in more donations than PU, but took them in sooner, perhaps largely taking them in at its foundation while taking in less than PU ever since.

The obvious (at least to me) reason to build up a foundation is to smooth variations in both fund-raising and expenditure; often new buildings are accompanied by special fund-raising campaigns, but there will be times (e.g. capital expenditures) when cash-flow expenses are lumpy and times (recessions, or simply random fluctuation) when contributions are lower than usual, and it makes some sense to have an endowment to smooth that out.  Even ignoring the special capital-spending campaigns (and naming rights that are often a part of that), though, this isn't nearly enough to explain the endowments at most large universities.  If they are smoothing over time and saving for precautionary reasons, they are smoothing over generations and protecting themselves from cataclysms.

It may well be that (especially large) endowments are better at investing money than the donors are, in which case it might make sense to accumulate a large endowment for that reason — the donors can be encouraged to give sooner than they would naturally, perhaps discounting at a lower private discount rate than the university's discount rate — and I neglect that possibility, except for this sentence, not because I think it's unlikely to be important but because I don't think it's as interesting as my other idea.  The other idea, though, is that smoothing over generations and cataclysms avoids coordination failures in which the various participants in a university community — donors, students, professors, and quite possibly others — worry that the university could run into trouble in several years, and thereby avoid it, initially to a small degree, but then, as the prophesy begins to fulfill itself, to an ever greater degree.  A large endowment forestalls that possibility in some ways and serves as a coordination device in others; the number itself makes the university look not just sturdy but reputable.  I wonder, in fact, whether university endowments might be an example of the "overhoarding of liquidity" that Tirole has mentioned as a theoretical possibility that is probably of little practical importance in the settings in which we think of it in those terms.

Friday, December 4, 2015

market safety

It is moderately well-known — Arrow's impossibility theorem is better known, but the Gibbard-Satterthwaite theorem is probably more apposite — that there's no ideal way to aggregate preferences into a jointly optimal outcome, so we're left making tradeoffs of different features when we design systems for coordinating group decisions, such as voting systems and market systems.  One real-world criterion that isn't even part of the impossibility results is "simplicity", partly because that can be hard to formally define; still, it is certainly the case that people process information in certain ways that work better if they find a system to be simple and intuitive than if they don't.  One of the practical consequences of this is that the revelation principle, even if useful for theoretical understanding of constraints, is in some practical sense not something that can be put into practice; the revelation principle says that the best possible aggregation system is in practice equivalent to some "strategy-proof" system, wherein each agent reports all of its private information and the mechanism is such that it is incentive-compatible for them to do so, but in practice even developing the information to report is too complex for realistic agents, and the resulting direct mechanism is often unintuitive to laymen in certain ways in order to understand the constraint.

A good example, perhaps, is the Myerson-Satterthwaite (same Satterthwaite) result for two agents trying to trade an object.  One of them owns it, and has a value of it between $10 and $20, and the other places on it a value between $10 and $20 as well.  As far as I and the buyer know, the seller's value is uniformly distributed in that range, and as far as the seller and I know, the buyer's value is uniformly distributed in that range, but the buyer and seller each know their own valuations.  How do I design an "efficient" mechanism — determining, as a function of the private values, whether and at what price the buyer buys the object?  "Efficiency" here is just measured as the private value of the agent who ends up owning the object, and I'd like to simply give it to whoever has a higher value, but because the price at which it trades would have to be a generally increasing function of the reported values, the buyer will tend to understate the value (and the seller would tend to overstate it) unless doing so substantially reduces the probability of a profitable trade.  They find a fairly generally applicable rule, even when distributions aren't uniform, and it's a bit complicated, though also elucidating; what's relevant for my purposes now, though, is that with uniform distributions it turns out to be equivalent to the nonfatuous Bayes-Nash equilibrium of the mechanism "each side states a price and, if the buyer's price is higher, trade at the midpoint."  It is not the case, in this latter mechanism, that each agent's stated price will be equal to the private value — the buyer will certainly shade low and the seller will shade high — but strategically sophisticated traders will buy in exactly the same circumstances as in the direct mechanism, and for the same prices.

Realistic agents may not be strategically sophisticated, but it's hard to tell which direction that cuts; there are human subject experiments (Kagel, Harstad, and Levin (1987): "Information Impact and Allocation Rules in Auctions with Affiliated Private Values: A Laboratory Study," Econometrica, 55(6): 1275–1304) in which subjects seem to find it harder to simply report their own value, even when they are given it, than to do the shading they're used to doing in small bilateral trade situations, and that's when they have been given their value — in the real world, agents asking themselves "how much is this worth to me?" are surely less likely to find it easy to give the right number. They aren't used to this task; they're used to (at a supermarket) deciding whether they are willing to trade at a given price or (at a bazaar, e.g. at an arts or crafts fair) to making a conservative bid.  In a lot of these situations one side or the other may gain an advantage from being better informed or more strategically sophisticated, but the gains tend to be small and not to too badly impair the interests of people who are toward the low end in information or sophistication.

Some simple mechanisms, though, do not have this property.  I've noted that my biggest problem with the Borda count is not that the best strategy isn't to list candidates in order of preference — just as I don't think you're "lying" if you offer to pay $10 for an item for which you would willingly pay $20 — but that even if all of the agents in a Borda count vote are unrealistically well-informed about strategic information, near equilibrium, if one candidate's voters are somewhat more informed than others, that candidate will generally win — essentially without regard to the candidate's popularity.  Systems like approval voting might require some strategic awareness, but once most agents are somewhat aware of what other agents' preferences are, being a lot more knowledgeable than the others only helps under exceptional circumstances.  Often it is, in fact, reasonable to expect the agents generally to be somewhat more aware of each others' preferences than the mechanism designer is, or can reasonably take into account; for example, if there are three candidates, one of whom is the last choice of 90% of voters, the Condorcet winner is likely to win a first-past-the-post vote, while an informed mechanism designer might find it awkward to publicly and formally declare the irrelevant candidate to be irrelevant.  This is a situation in which the mechanism works, and does so in part by letting voters use strategic information that the designer cannot use in a more direct fashion.

What triggered this post, though, was the concept of "spoofing" in the financial markets, and whether or not spoofing is bad. My first visceral response is that, if some agents are making inferences from the public bids and offers of other agents, it's on them if the information content of those bids and offers is other than what they think it is — even if it's other than what they think it is by the design of the people placing those bids and offers.  Let the market seek its strategic equilibrium.  With markets, perhaps the best analysis is to figure out whether this impedes the functions of the market — moving risky assets to their highest-value owners, with information discovery as part of the process of doing that — and that end may well be better served by a rule against spoofing that is nebulous around the edges but, in practice, is often not that hard to discern.  One other criterion to consider, though, is whether the strategic equilibrium that the market would find in the absence of such a rule is one in which agents would find it profitable to devote a lot of resources to gaining strategic information (as opposed to fundamental information), which, in the voting context, I consider to be one of the very most important considerations in evaluating a system.