The Plastic Bag Tax

I was in our nation's capital over the summer with good friend and blogger, Justin. Justin told me about a recently begun plastic grocery bag tax. The tax proceeds are slated to clean up Anacostia River. Justin liked the idea because it cut down on waste. He had completely switched over to re-usable cloth bags.

I wondered if the tax was a good idea though. On the face, it seems like it has two good elements (reducing garbage and cleaning up rivers), but like any good economist, I am forced to think about the dark side. What costs does the tax create? Might we in fact be worse off because of the bag tax? Justin challenged me to make him care about the bag tax that last day in D.C. and I'll do my best.

There are several dimensions where the tax could go wrong:

The size of the tax.
The bag tax is a Pigouvian tax designed to increase efficiency by bringing the price of bags in line with the cost the bags do to society. The tax is 5 cents, but does a bag do 5 cents of damage to society that isn't already accounted for in its price? Today's plastic bags are much thinner than they used to be so they take up less space in landfills. Also, landfills are not as scarce as people imagine them to be. Using up space in landfills probably has very little externality associated with it.

It's probably not that people are not upset with the bags that end up in a landfill, but rather they're upset with the bags that end up in the river. Those bags are unsightly and potentially damaging to the creatures that live in the river. This begs the question, how much damage does a bag that gets into the river cause?

It might be far greater than 5 cents or far less. But it is not the bags in the river that are getting taxed, its all bags. Justin cuts back on his bag use, but that doesn't make the river any cleaner. In fact, since he's not paying taxes on his cloth bags, he's not even helping clean it up. There are likely to be fewer bags used, but in all likelihood the people who are cutting back are also the people who aren't littering. In this case, the tax's effect on the number of bags in the river will probably be limited.

The tax is targeting the wrong thing, bags instead of litter. Thus, not doing as much as intended.

The river cleanup.
The estimated $3.6 million in revenue from the bag tax is earmarked to go to cleaning up the river. Again, this sounds noble, but is it the right way to spend the money. Once collected, it doesn't actually matter where the tax money goes. There is no reason to connect the bag tax to the river cleaning.

Government officials must decide is the best way to spend $3.6 million dollars cleaning up a river. Suppose there was no bag tax and no government river cleanup yet. If an anonymous donor gave the government $3 million would the government spend it on cleaning the river? There are dozens of programs the government engages in, would that money be better spent on education, parks, police? I don't know, but I do know that the earmarking is silly and tax payers need to consider the best use of funds regardless of their source.

The unintended consequences.
I was uneasy about the bag tax because it seemed inconvenient to people, but I have recently learned that it might be more than inconvenient, but also dangerous. A recent study on cloth grocery bags finds that they are covered in bacteria. The tax incentivizes people to live in a slightly more bacteria contaminated world. Healthy and well-informed people probably won't be affected because they will always prep their food correctly and wash their bags. But there are some people who will get sick. Perhaps not many, but it is a consequence of the tax.

My favorite economic saying is, "there is no free lunch." Everything has a cost. The bag tax has a cost and people need to be wary of things that sound good as even less garbage has a downside.

Me vs. The Computer

I was recently inspired by a post from comedian Greg Brainos.

In the post, Greg has a conversation with Cleverbot, an AI programed to respond like a person would. What transpires is hilarious and amazing. So, I figured I'd have a chat with this Hal 9000 and see what it thought about economics. Here is our conversation:

Me: So what do you think about economics?
Cleverbot: What are economics?
Me: Like supply and demand and stuff.
Cleverbot:Really? Why is that interesting?
Me: Because it can help you understand the world.
Cleverbot: Can it be proven that there are boys on the internet?
Me: I think so. You would do some genetic tests for people that you find using the internet. Then you'd know.

I think he won that round. Round 2:

Me: Do you like economics?
Cleverbot: No.
Me: Why don't you like economics?
Cleverbot: I do like you.
Me: Aww, thanks Cleverbot. I like you too.
Cleverbot: Not.
Me: Don't be sarcastic. It's not cool anymore.

I think I win that round. Round 3:

Me: Do you think the current recession is evidence that capitalism has failed?
Cleverbot: Do you?
Me: No
Cleverbot: Why not?
Me: Because, there were many government interventions and regulations that created the issues in the housing and finance markets.
Cleverbot: Yesss! Victory is mine!
Me: No way. You have to give an example of how free markets create bubbles in asset prices.
Cleverbot: Yesss! Victory is mine!
Me: Because I am an economist. I know what qualifies as an economic argument.
Cleverbot: But I'm a girl.
Me: That doesn't matter. Girls can do economics. Christy Romer was the economic advisor to the president and Elinor Olstrom just won a Nobel prize in economics.
Cleverbot: What? I'm asking about your design. Lets start small. What language are you written in?
Me: English and maybe math
Cleverbot: Das ist gut.
Me: Gracias

So it looks like Cleverbot and I have come to an agreement. Good times, Cleverbot.

Tax Rate Lottery

Here's a plan ventured by blogger, Stephen Gandel, at the Curious Capitalist:

"Let's say that all income below $500K was subject to taxation as it currently is, and that income above that level was subject to a tax rate lottery, held after the income is declared. Some of it gets taxed at, say, 75%, and some is not taxed at all. The goal is to increase revenue from this segment by, say, 10%. Quite a few $B. Maybe the "losers" are exempted from next year's lottery; they'll be taxed at the current rate."

The idea is that higher tax rates make people work less which is bad for tax revenues and, although the author never mentions it, bad for production. So how about we trick the rich into thinking they might not pay any taxes? That way, they keep working which means we could increase tax revenue.

The possibility that they only pay 15% in taxes would encourage them to work more increasing tax revenues! Gotcha Richie Rich!

Not only does this misunderstand the where US tax rates fall on the Laffer Curve, it also misunderstands how people react to uncertainty.

The whole plan is so stupid that I wonder if this isn't some sort of modern Modest Proposal. Allow me to dismantle this idea.

A Hypothetical Example:

Suppose, Richie has as trust fund which pays him $500,000 every year no matter how much or how little he works. Let's also suppose that Richie increases his total yearly earnings by $100 for every hour he works.

If the tax rate is 15% then he gets to keep $85 per hour. Let's say at that rate, he decides to work 50 hours a week for 50 weeks of the year bringing him in a pre-tax earning of $250,000 and $212,500 in after tax earning.

If the tax rate gets hiked to 75%, then Richie gets to keep only $25. This is a 70% reduction in Richie's hourly wage. According to a study done by Emmanuel Saez and Jonathan Gruber (who Gandel quotes in the article), that would reduce the amount Richie would want to work by 28%. That means he'll only work 1,800 hours and earn a pretax amount of $180,000 and keep an after tax amount of $45,000.

Under the first situation, the government gets a tax revenue of $37,500, but under the higher tax situation, the government pulls in $135,000. The numbers in this example are calibrated to be what Saez and Gruber predict people to do. So Gandel is wrong in assuming that increasing taxes will decrease tax revenues. For economists, we are not on the downward sloping portion of the Laffer curve.

So there goes the first part of his argument. If you need more tax revenues, don't do something bizarre like create a lottery. Just raise taxes.

The Lottery:
Suppose the government spins a wheel to determine Richie's tax rate. Half the slots are for a 15% tax rate and half are for a 75% tax rate.

Suppose Richie says, "I stand a good chance of getting a low tax rate so I'll work as if I'm going to face a 15% rate." If he did, he'd work the 2,500 hours and get to keep $212,500 if he lucks out and gets the low rate, but if he doesn't he earn works 2,500 hours to only get $62,500. Compare that to what he would have worked under the 75% tax and you see that he works a 700 hours only to earn $17,500.

It is pretty foolish to assume Richie won't act any differently in a situation where he has a low tax rate and a situation where he could be hit with a high tax rate. Richie will probably split the difference. He might work harder than he would in a high tax world but not as hard as he would in a low tax world.

Here's the kicker. People like two things, they like leisure and they like consumption. To get more consumption, they have to give up leisure. The lottery makes the returns to work uncertain, but doesn't change the certainty of how much you like leisure. The lottery has effectively reduced the incentive to work beyond even what a tax rate of 45% (the average tax rate Richie faces).

Instead of a lottery that on average has a 45% tax rate, we could have simply made taxes 45% and we'd get a higher tax revenue. Not only is a tax on people's earnings a drag on the economy, but the tax lottery actually makes it even more of a drag on the economy without getting anything in return!

The moral of the story is if you want to increase tax revenues then just raise taxes. Creating a tax rate lottery will do more damage to the economy just to raise the same amount of money. Plus the government wouldn't even get more money from the lottery than the old way of taxing.

There are further contradictions in the tax rate lottery which almost don't warrant comment, but here is a list:
1) The author realizes that if Bill Gates gets lucky and only pays a 15% tax rate, then the US government loses ton of money. More money than we can make up by charging a 75% rate on a bunch of people who earn $500,000. But the author also says, if you lose the lottery and get the high rate one year, you'll be exempt the next. This would just encourage people to work little, wait until they lose, then when they're exempt the next year, increase their work thereby avoiding the tax.

2) He claims that people will enjoy talking about how they won the tax rate lottery and they'll similarly enjoy losing the tax rate lottery because they can gripe about it. This is just crazy! If you get caught by the tax, then you'll have given up time with your family for no reason. You think people are going to be cool with that?

3) He claims that the fact that the tax rate lottery makes planning your life harder isn't a real problem for the rich since many of them already deal with uncertainty in their incomes. Many CEO's get 80% of their compensation in variable end of the year bonuses. But how much variation is there? Is it a 50% chance that you get nothing and a 50% chance you get $100 million? Probably not. Whatever variation there is, they probably are fairly certain about what they're getting. Also, it doesn't follow that because they deal with some variation, they should be able to deal with a lot more. That would be like saying, the guy on the tightrope deals with the rope wobbling some, so he won't mind if we start shaking it more.

Oil Spill Revisited

If you had to guess how many birds were killed by the oil spill, what would you guess? A hundred thousand? A million?

According to this government report: 2,188.

BP is apparently charged $50,000 per endangered animal killed by the spill. Which means that BP owes $109 million.

But is that the cost of all the lost birds? Is the value of a pelican really $50,000?

Planet Money has an interesting podcast on this subject. They find estimates that range from $30 to $45,000 per day. Basically, the whole valuation process of goods that have no market is difficult. The result (spoiler alert) is that a pelican is worth a pelican. Which means, that the value of a pelican is the cost of raising a replacement pelican.

So what does it cost to raise a pelican?

I found some info on a Florida bird sanctuary called Pelican Man's Bird Sanctuary. According to this article, the sanctuary was forced to close due to lack of budget and facing a $200,000 deficit. The sanctuary saved somewhere between 4,000 to 7,000 animals yearly. So if it's operating budget was $200,000 per year* and saves around 5,000 birds per year then the cost of saving a bird is $40 per bird.

According to that estimate, then BP truly owes around $87,500, not the aforementioned $109 million. Even if the government report above represents only a small faction of the true numbers of birds killed. BP could open a wildlife preserve for relatively little and replace the animals lost. You could even charge BP an interest rate on the lost animals and say BP has to replace all the dead animals and an additional 5%.

Forcing BP to pay for what it did is a good idea, wejust have to make sure it's the right amount.


*There were no reports I could find that told the cost of the sanctuary above what it made in revenues from visitors. Which means that $200,000 per year could be a wild overestimate. Just the way I like.

BP Oil Update

In my last post, I made some guesses about the costs the BP oil spill was imposing on the environment and Gulf tourism and fishing. I assumed that BP would be able to cap the leak and clean up would proceed from there. However, that is not the case, and I thought I ought to go back and look at some of my numbers and how they hold up in the face of new potentially higher costs.

My original estimate was $98 billion. So far it has cost BP around $3 billion and they have a total of $7 billion in escrow for future payouts.

President Obama made a speech that BP was going to "pay every dime for the oil spill." If this is true then the $10 billion cost to BP must also be the total cost of all damages. This would mean my estimate of damages done was $88 billion too high.

My conclusion in the previous post was that a tax of $3 per barrel would earn enough to fully pay for this spill. Given that the true costs are likely to be far lower than I estimated, the cost (and thus tax) per barrel of offshore oil would be much lower. Perhaps, somewhere around $1.

Can we afford to spill?

A friend of mine, Harrison, posted this graphic about the BP Deepwater oil spill. The caption reads, "Can we afford to spill any oil?" Um, no I guess not. The graphic shows the damages done by spilling, and I guess how much we need the oil. So, the graphic says, spilling is bad. Ok, sure, but how bad? Bad enough to shut down Obama's proposed offshore drilling? Bad enough to shut down all offshore drilling around the US?

The graphic doesn't have enough information to answer that, so I decided to do some digging, here is what I found:

Based of some numbers I got off a government website, the average amount of oil pumped out of US offshore oil rigs is around 2 billion barrels per year. Suppose that 2010 is peak oil for US offshore rigs and that every year after 2010, the supply dwindles to nothing by 2030. Under these stringent assumptions, that would be 32.6 billion barrels of oil pumped from 2000 to 2030.

There are three main costs that the spill has created, loss of fishing, loss of tourism and damage to wildlife. This website reveals that Louisiana fishing yeilds $2 billion annually. Suppose the spill completely shuts down the LA seafood industry this year and the industry only recovers a little bit each year until after 10 years, it is back to it's $2 billion status.

This EPA website says that the tourism industry for the Gulf Coast is worth $20 billion anually. Suppose the tourism for the Gulf completely shuts down this year and slowly recovers a little each year until 2020 when it get back to $20 billion.

Finally, there was damage to wildlife. This website estimates Exxon-Valdez spill cost $7 billion dollars. So let's assume the same amount of damage from this spill. So in 2010, we lose $7 billion worth of marine life and it takes 20 years to recover fully from the spill.

Using a little present value discounting, the total cost of the the oil spill would be $98 billion.

With that dollar amount in mind, we can find the cost per barrel pumped from offshore oil over the course of 2000 to 2030. So it's $98 billion divided by 32.6 billion barrels which gives us a cost of: $3.02 per barrel.

Spilling really doesn't appear to be much of a cost. Can we afford to spill? No, that's waste, clearly we'd rather not. But does it cost that much? Eh, not really. Should we shut down offshore drilling? No, but we should tax off shore drilling at about $3 per barrel. Why not even make it $4? Even if I undestimated the costs, we'd still be covered*.

*Really love wildlife? Make the cost to wildlife $100 million and the costs per barrel rise to $16. That would still be only about 22% of a $70 barrel of oil.

Cadillac Health Plan Tax

My friend, Justin, posted this radio interview with economist, Jonathon Gruber, on why the Cadillac Health Care Tax is a good idea. Allow me to summarize his points:

1. People with insurance that has a low-deductible (like people who have Cadillac plans) overuse medical treatments. For instance, I get a headache and go get an MRI to find out it's just a headache. I do this because I don't pay for the MRI directly (in general I'd only pay a small fraction.
2. Wages will rise after the Cadillac Tax is passed.

I agree with arugment 1. People do probably overuse health services since they don't pay for them. If people have to pay for them, then they'll use less. This can be good and bad. Let's say that the MRI revealed something and my life is saved at a realatively low cost. Paying for the MRI discourages my use and thus increases costs later.

His whole point is that on net, this will be cheaper for the economy. We save more medical resources by doing less useless medical spending than we lose by having that later spending.

Argument 2 works for me...mostly. Wages and fringe benefits are substitutes for employees. Probably perfect substitutes. If my employer pays an additional dollar of my health insurance, that is one less dollar that they have to pay me in wages.

His argument, is that by taxing Cadillac plans, people switch to cheaper plans which means (under competition) wages rise.

My concern is this: if people switch out of the Cadillac plans into high-deductible plans then the premiums on those high-deductible plans ought to start rising (according to economic logic on substitutes). This will have a downward pressure on the wages of the people who were previously not on the Cadillac plans.

I'm not sure how this all would play out. It seems like it depends on how many people opt to pay the fine for not having insurance.