Month: March 2007

A loyal MR reader asks:

What is currency and what are the potential implications of a
completely digital currency that could have unlimited meta information
attached to it? [Some obvious implications would be tracking
transactions and the government’s ability to enforce taxes, etc., some
more esoteric stuff would be attaching conditions much like covenants,
say that a particular payment could only be used to buy products that
were carbon neutral, possibly down the road having policy implications.]

Higher taxes and carbon offsets we’ve already covered.  More generally, the use of "covenant currency," as I shall call it, would raise prices.  Restricted money simply isn’t worth as much.  It also would lead to a secondary market in currency.  Say you paid with me with money that can only be used to buy corn from Africa.  I’ll try to resell that money to the people who were going to buy corn in Africa anyway.  Of course the supply of targeted covenant money for that end may exceed the demand for it, and then price will adjust; think of this as an extreme form of legal tender laws.

Would it ever be efficient to use covenant money?  I doubt it.  It is a tax — on the holding and use of cash balances — when a simple transfer would do.  Use regular money for your transactions and, if you wish, send some cash to the corn sellers of Africa.

Inflation is also a tax on cash balances, and few people think that is the right or the best fiscal way to finance subsidies to various worthy groups.

#11 in a series of 50.

A loyal MR reader asks:

What are your thoughts on the new dynamic optimal public finance policy models being built and simulated?  Will they yield any new insights applicable for the real world, or are they a fad?

Real insights maybe, real measurements for sure.  I take this paper by Mankiw to be a paradigmatic example.  Through this body of literature we learn, or confirm our previous intuitions, that:

1. Cutting U.S. income tax rates is not, in general, self-financing.  We also get a rough idea of how much revenue we can make up in the long run.

2. Many forms of corporate and capital income taxation are, in the long or even medium run, inefficient.

3. Ideally we should move to a consumption tax.  (NB: Moving outside the models, I am scared that this kind of tax reform will just turn into another tax increase.  We’ll add a VAT to income taxation rather than shift to the VAT.  Yikes.)

These results are the bread and butter of applied public finance.  You can complain all you want about the assumptions, the artificiality, and the use of intuition to throw out unacceptable calibrations, but at the end of the day there is not a better way to do the work. 

A fad, perhaps, but there is nothing wrong with that.  The Beatles were a fad too.

By the way, here is an interesting paper on a different frontier in public finance, namely field experiments.

#10 in a series of 50.

It’s quite surprising that the major consumers of the world’s oil have not been able to agree to an oil tax under the auspices of something like the Kyoto Protocol.  It’s surprising because if the major consumers of oil all increased taxes they would end up bearing very little of the burden. 

The result is a simple application of the theory of tax incidence.  The burden of a tax falls on those who can least afford to escape the tax.  The world’s demand for oil is inelastic but the supply is even more inelastic.  What is Saudi Arabia, for example, going to do with its oil except sell it?  The oil is already fetching a price well above cost so if there is a world tax on oil that’s like a tax on land – Saudi Arabian land to be precise – and a tax on land is born by land owners not by consumers.

Members of the Pigou Club should take note.  For the Pigou Club to work to alleviate global warming the Pigouvian tax must reduce the global consumption of oil (not just say US consumption) but with the supply of oil being very inelastic that’s not going to happen.  A tax could drive high-cost US producers out-of-business but the major world producers are going to keep selling even with a high tax. In other words, membership in the Pigou club has few privileges unless you can put the major producers under (does that advice sound familiar?)

If you want to tax Hugo Chavez, however, please do join the Ramsey Club.