It’s not just GM, United Airlines and the Federal government who have made unsustainable promises to current and future retirees.  State and local governments have also been irresponsible, to the tune of perhaps a trillion dollars in unfunded liabilities.

For years, governments have been promising generous medical
benefits to millions of schoolteachers, firefighters and other
employees when they retire, yet experts say that virtually none of
these governments have kept track of the mounting price tag. The usual
practice is to budget for health care a year at a time, and to leave
the rest for the future.

Off the government balance sheets – out
of sight and out of mind – those obligations have been ballooning as
health care costs have spiraled and as the baby-boom generation has
approached retirement.

…most states and cities have set aside no money to pay for retiree
medical benefits. Instead, they use the pay-as-you-go system – paying
for former employees out of current revenue.

The plethora of discount
rates and taxes obscures the basic point in Feldstein’s argument against
capital taxation.  Here is a bare-bones version.

There are three
goods, labor, apples and oranges.  Assume that the government taxes
oranges at a higher rate than apples.  A tax on oranges is also a tax
on labor since you need labor to buy oranges and if the price of
oranges is high the value of your labor is low.

Now let’s show
that a reduction in the orange tax matched by an increase in the labor
tax to keep total tax revenues constant can make everyone better
off.  The simplest case is to assume a tax on oranges so high
that no one buys any oranges.  Orange tax revenue is therefore zero.
Now we get rid of the tax on oranges and add an equal-revenue tax on labor
(zero).  So long as the consumer cares at all about oranges he now buys
more oranges and is better off (because he now consumes a variety of
fruit and has an increased incentive to work).  The consumer will still be better off even if we replace the zero-revenue orange tax with a
small labor tax which increases government revenues.  The zero-revenue assumption makes the argument obvious but is not at all necessary for the results.

The basic point is that the tax on oranges distorts the labor-leisure choice and the apples-oranges choice.  A tax on labor distorts only the labor-leisure choice and so is preferred.

For Feldstein’s argument rename oranges as savings, apples as present consumption and labor as income.  To see a counter-argument introduce more people into the model and rename oranges as yachts. 

It’s that time of year again, our NPR moment.  Do you enjoy Marginal Revolution’s blend of economic commentary, book reviews, art recommendations and fun ideas?  Please consider making a donation.  You can donate through Amazon or via the PayPal link in the upper left hand corner.  Any amount would be appreciated.  Use the PayPal link for donations over $50.  We are also happy to accept donations via snail mail.  Send to:

Marginal Revolution, c/o Alex Tabarrok
Department of Economics, MSN 1D3
George Mason Universtiy
Fairfax, VA, 22030

For donations of $100 or more we would be pleased to send you an autographed copy of one of our books, your choice (including my forthcoming book Judge and Jury available in February).

If you are in a position to be especially generous and wish to make a larger contribution through a legally recognized non-profit entity (for tax reasons),
please let us know, this can be arranged.

Why are we asking for donations?  MR is never going to be a paying venture but donations help us
to cover our costs.  More importantly, donations help to solve a serious economic problem.  Efficiency says that goods with zero marginal cost should have a zero price but without prices not only is the incentive to produce diminished but so is information about what to produce.  (See Coase’s 1946 classic, The Marginal Cost Controversy, JSTOR).  Donations allow prices to be set at MC while at the same time providing a (noisy) signal about where true economic value lies.  In particular, Tyler and I know that we can appropriate more of our marginal product from professional work than we can from blogging yet it is conceivable that our marginal product is higher in blogging.  Thus, to decide how much to invest in this venture we markup donations to get an estimate of our social value and we put positive weight on social welfare in our utility function.   

Happy Holidays!

I went to Wegman’s less than 24 hours before Thanksgiving and purchased a turkey, yams, cranberries, a pumpkin pie, wine, cranberry cheese, fresh bread, peanut butter and some more wine.  Not a single item was in short supply let alone in shortage.  I give thanks for capitalism.

In 1990 my colleague Robin Hanson wrote:

Imagine a betting pool or market on most disputed science questions, with
the going odds available to the popular media, and treated socially as the
current academic consensus.  Imagine that academics are expected to "put up
or shut up" and accompany claims with at least token bets, and that
statistics are collected on how well people do….

This would be an "idea futures" market, which I offer as an alternative to
existing academic social institutions.

More and more it looks like Robin was right on.  Consider this story from the London Times:

WHEN Ladbrokes teamed up with New Scientist magazine
in August last year to offer odds on five great breakthroughs being made by
2010, it looked like a typical silly-season stunt.

It is now expected to become a very expensive one. As soon as the book
opened, physicists began to put their money where their theories were and backed
themselves to find gravitational waves – ripples in space and time predicted by
Albert Einstein but not yet proven to exist.

Alan Watson, of the University of Leeds, was astounded
to see odds of 500-1 on a discovery that he considered a matter of when, not if,
and promptly wagered £50.

So many other scientists did likewise that by lunchtime Professor Jim Hough,
of the University of Glasgow, who leads a team seeking the waves, was allowed to
stake only £25 at odds that had fallen to 100-1. When his colleague Sheila Rowan
placed her bet in the early afternoon, the odds were down to 5-1, and when the
book was closed they were 2-1.

It’s amazing how far we have come since Robin proposed idea futures, especially given that the idea could have been implemented hundreds of years ago.  But Robin’s vision is even more radical than betting markets.  Robin proposes that betting markets can substitute for many of the funding arrangements that we use today.  Consider the part of the quote I excised above:

Imagine that funding
agencies subsidize pools on questions of interest to them, and that
research labs pay for much of their research with winnings from previous
pools. 

Imagine indeed!  We are not there yet but the odds are increasing in Robin’s favor.