Results for “from the comments”

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I want to comment on a common error in the discussion of my post Nature, Nuture, and Income.  (See for example the comments at Jane Galt, Kevin Drum and also the trackbacks).

Despite my warning, many people thought that graph was saying something important about the average income of adoptees versus that of biological children.  Hence many people argued that "the results" were explained by discrimination against Korean Americans, poor nutrition of the adoptees before being adopted, or low IQ of children given up for adoption.

For the record, Asian Americans in general and the children in this sample have higher income and more education than the average American.  More fundamentally, however, these comments have misunderstood what is to be explained.  It is true that the average income of the adoptees was lower than that of biological children but the adoptees are also younger.  Once you control for this and a few similar factors the mean income difference goes away (think of shifting the adoptee line up).  What remains, and this is the key point, is that the biological line is upward sloping and the adoptee line is flat.

What my post and the paper are all about is the difference in the slope of the two lines, i.e. why is it that child income increases with parental income for biological children but not for adopted children.

Addendum: Suppose we control for age and other factors which in effect will raise the adoptee line then we could phrase the results as ‘adoptees do better than biological children raised in poor households but worse than biological children raised in rich households.’  The explanation is simple from the genetic point of view – adoptees are drawn more or less randomly while high income parents tend to pass on high-income genes and low income parents tend to pass on low-income genes.  It’s going to be very difficult, however, to explain why poor parents treat their adopted children better than their biological children but rich parents treat their adopted children worse.

In 1940 the instructions to the Form 1040 were about four pages. Today they are more than 100 pages, and the form itself contains more than 10 schedules and more than 20 worksheets. The complete tax code totals about 2.8 million words – about four times longer than "War and Peace" (and considerably harder to parse).

That is from a New York Times Op-Ed.  And Andrew Sullivan has been pushing for a flat tax. 

My comments:

1. In a sufficiently wealthy or sufficiently egalitarian society, a flat tax is a no-brainer.  Distributional dilemmas are the main obstacle, whether in reality or the public perception.

2. Much of the complexity of the U.S. tax system stems from the definition of income; the simplification benefits from moving to a single flat rate, while real, are often overrated.  A VAT can be complex as well.

3. If I were spending political capital on reforming a tax system, I would sooner push for a more favorable treatment of capital income.  Similarly, if we were sacrificing revenue or fairness, my priority would again point toward capital income.

The bottom line: My ideal tax system has two or three rates, with slight progressivity.  I would keep the tax privileges of non-profits, but otherwise be reluctant to use the tax system for social engineering.  So I favor a "not quite flat tax."  Tax simplification is worth doing, whether or not it is linked to pure flatness of rates.  That being said, flat tax advocacy remains a good way to hold politicians’ feet to the fire.  All tax systems are too complicated, and moves toward simplification are rarely a mistake.

Addendum: Bruce Bartlett summarizes some tax reform ideas.

Though Alex has already blogged about the Kremer/Snyder paper on vaccines versus cures, there are, I think, a couple of comments worth adding.

According to Kremer and Snyder, monopoly sellers would rather sell cures than vaccines. To get this result, they need some heterogeneity: we all have different probabilities of getting sick (though we all find it equally costly to get sick).

But what if you introduce the opposite kind of heterogeneity? (That is, we all have different costs of getting sick, even though we all face the same probability of getting sick.) Then it’s a nice little exercise for your students to show that the cure and the vaccine are equally lucrative monopolies (ignoring the positive externalities of the vaccine).

A more important observation: In the Kremer/Snyder setup (still ignoring positive externalities), it’s a good thing for sellers to invest in cures rather than vaccines. The reason cures are more profitable is that they in essence allow perfect price discrimination. So with cures, there’s no deadweight loss due to monopoly; with vaccines there is.

The analysis changes if you assume, say, that a vaccine prevents a four-day illness, but a cure only cuts two days off your illness. Then vaccines might or might not be socially preferable to cures—but in that case, willingness-to-pay for vaccines versus cures would double. This gives sellers an incentive to produce vaccines. The incentive isn’t perfect, but it goes in the right direction.

Social security privatization has a little-discussed benefit, done properly it is equivalent to a cut in marginal tax rates. A problem with the current system is that there is little relationship on the margin between taxes paid and benefits received. On average, of course, those who pay more taxes get more benefits (although not proportionately there is a subsidy to low-earners). But because the rules are complex and based on average earnings over a long period of time there is little connection between your social security taxes on an additional hour of work and your social security benefits for that additional hour.

To see why this is important consider the difference between social security and an IRA. If a worker works an additional hour, earns $10 and puts $1 into the IRA he knows the $1 will produce a benefit 30 years down the line when he retires. The $1 contribution to the IRA is not a tax, it’s consumption, a benefit of working extra hours. On the other hand if a worker earns $10 and $1 is taken and paid into social security there is no clear connection to retirement benefits. Social security payments, therefore, are taxes – and like other taxes they deter work effort and create a dead weight loss.

Privatizing social security, or in some other way creating personal accounts, would reestablish a link between marginal payments and marginal benefits and thus would be equivalent to a cut in tax rates.

The insight goes back to my colleague Jim Buchanan and his 1968 paper “Social Insurance in a Growing Economy: A Proposal for Radical Reform.” National Tax Journal, Vol. 21 (December 1968): 386-95

See also Tyler, Arnold Kling, Victor Davis and Brad DeLong who have been discussing the political issues of social security privatization.

This year’s Nobel Prize in economics went to Finn Kydland and Edward Prescott . Kydland and Prescott wrote a famous 1977 piece (Journal of Political Economy) on time inconsistency. Ever wonder why government policy toward prescription drugs is so problematic? Kydland and Prescott had the answer. The optimal policy will first award the drugmakers a patent and allow them to charge a high price. But once the drug is developed, the “rents” will be confiscated. Optimal policy will revoke the patent and lower the price. After all, once you have the drug. why not let everybody have it cheaply? Of course the drugmakers are aware of this danger in advance, and they are correspondingly reluctant to develop new drugs. Alex posted on this logic just days ago.

In more formal language, the optimal policy is not a time consistent policy. This develops earlier ideas from Thomas Schelling on game theory. Schelling’s point was that nuclear deterrence can fail because, once destruction is aimed your way, you don’t necessarily wish to retaliate.

The logic of time consistency is quite general. It applies to regulatory policy issues, tax policy, monetary policy, foreign policy (threaten Saddam, but do you really want to have go to through with it?), and strategic behavior in a wide variety of settings.

Here are my earlier comments on Prescott, which link to other facets of his work. He arguably has enough contributions to win the prize twice. Kydland is less well known but is an important figure nonetheless. And it doesn’t hurt that he is Scandinavian (Norwegian).

Are the pair deserving? Absolutely yes.

Why did they win this year? I’m guessing that in the midst of a partisan U.S. election, the Swedes did not want to pick Paul Krugman or Robert Barro (pro-Bush), for fearing of appearing too political. Note that the economics prize has stood under criticism for some time now, for not being “scientific” enough.

And this pick the betting market got right. Prescott had opened up a clear lead in the betting market some time ago.

Here is new information from the betting market. Ed Prescott has opened up a lead (then Barro, then Krugman), and Thomas Schelling has joined the list. Read my previous comments; the winner will be announced Monday.

As for tomorrow’s literature prize, John Updike, Margaret Atwood, and Philip Roth are the leaders.

Update: Here is the dark horse who won the literature prize, I am not a big fan.

Michael’s post on Charles Manski’s paper challenging prediction markets has been widely discussed. Manski’s paper is difficult and a number of people wrote asking me for further explanation. Luckily, Daniel Davies has done some of the heavy lifting. Michael also offers further comments here.

My take: Manski shows that the market price is not, for example, the mean subjective belief of the market participants. But who said it was? The argument of prediction market proponents is that the market price is a good, perhaps the best, predictor of the future event. Manski does not challenge this argument. In particular, Manski does not show (or try to show) that there is an alternative way of aggregating individual information that results in better predictions. In this sense, I think the Manski paper is something of a red herring.

I would not claim, however, that information markets cannot be improved. Movements in the price of oil tell us something about trouble in the Middle East. But the oil market was not designed to elicit information about the Middle East. The information in markets is an accidental byproduct of trading. It would be a real surprise if the rules that make for good oil trading are the same rules that make for good prediction of events in the Middle East. Sundering information markets from trading markets, therefore, is a big advance and one that is likely to lead to better market design for information revelation, perhaps with help from papers like Manski’s (contra Daniel, who argues that to work well information markets must be tied to trading markets).

Addendum: Victor, a former student of Manski’s, at the Dead Parrots Society adds considerable wisdom to the discussion.