Sunday, October 18, 2015

Escrow for the Common Good

Years ago, when I was teaching finance more regularly, I read The Squam Lake Report and thought its recommendation to improve corporate governance by requiring deferred compensation (in cash) for top management made sense. Why should a manager with significant oversight responsibility be paid in full today if the firm does not survive well into the future? It is a straightforward approach to moral hazard when the consequences of a manager's actions take some years to be fully realized. Put a portion of the payment in escrow, and hold it there until reasonable performance has been demonstrated.

I'd like to propose two other applications of the same basic idea to areas I have been thinking about for teaching and research of late. Consider the payments that are made by the public sector to organizations that operate prisons. Why should a prison be paid in full today to incarcerate an inmate who recidivates shortly after release? One estimate puts the rate of recidvism at 40% within 10 years. The prison operator has considerable control over the inmate's daily activities while incarcerated. That time should be used to help prepare the inmates to stay out of prison upon their release. If it is not used productively, it shouldn't be just the taxpayer who bears the financial cost to re-incarcerate the prisoner. Why not condition a portion of the payment to the prison operator on the released inmate staying out of the penal system for some period of time? Put the payments in escrow, and release them to the prison operator slowly over time, based on the released inmate's law-abiding behavior. The low cost of interventions like prisoner education and job training compared to the relatively high cost of re-incarceration suggests that prison operators have room to do a better job.

The other example is higher education. Policy makers are currently wrestling with the issue of what to do about student debt repayment. By some estimates, 1 in 6 borrowers are severely delinquent. Why should a university be paid tuition in full based on the proceeds of a loan that may not be repaid? The university has every opportunity to convey knowledge and teach skills that increase the likelihood of repayment. But it does not bear the financial consequences of a loan not being repaid. Instead, put a portion of the tuition payment in escrow, and release it only as the student loan is repaid. This arrangement provides a financial incentive for universities to provide a better education and to avoid enrolling students who are unlikely to be able to convert this education into enough earnings to repay their loans. These two issues are at the heart of our student debt repayment problem. The problem is financial -- the solution should also have a financial component.

Wednesday, January 14, 2015

Diversifying the Workforce, Then and Now

Do you remember what you were doing ten years ago today? Larry Summers was at the NBER, making some remarks as president of Harvard University at a conference on "Diversifying the Science and Engineering Workforce." Those remarks, widely misunderstood in real time and even today, are posted here. Larry lays out his thesis in the second paragraph:

There are three broad hypotheses about the sources of the very substantial disparities that this conference's papers document and have been documented before with respect to the presence of women in high-end scientific professions. One is what I would call the-I'll explain each of these in a few moments and comment on how important I think they are-the first is what I call the high-powered job hypothesis. The second is what I would call different availability of aptitude at the high end, and the third is what I would call different socialization and patterns of discrimination in a search. And in my own view, their importance probably ranks in exactly the order that I just described.

It was the second hypothesis that got Larry into so much trouble. Later in his remarks, he was making a point that is illustrated by the following picture:

The point he made was that if you have two distributions of ability with the same mean but with different variances, then if you look at the extreme tails of the distribution -- here, the ability required to compete for a position in the most selective academic departments -- even a slight decrease in variance will result in a vast under representation of the less variable group. (In the picture above, imagine drawing a vertical line right where the arrow from s2 is placed -- no members from the first group are above that ability level.) Larry's second hypothesis was that the variance of the distribution of female ability was less than that of males. Suggesting in the paragraph quoted above that this had more to do with observed under representation of women in academia than his third hypothesis -- more conventional discriminatory behavior within the professions -- is likely what started the trouble stemming from the remarks. (I blogged about them ten years ago here.)

The broader issues to which Larry was speaking have not gone away.  Ignoring the statistical point in Larry's second hypothesis, his first hypothesis focused on factors that don't favor women that exist across society -- that within households, given current laws and regulations, women tend not to get the same support as men to pursue high-powered careers. The third hypothesis focused on factors that don't favor women that exist within a given profession. On this third hypothesis, my own field of economics is in the midst of some constructive reflection. Some good examples are pieces by Noah Smith in Bloomberg View in November, "Economics Is a Dismal Science for Women," and by Miles Kimball and an anonymous female co-author in Quartz earlier this month, "How Big is the Sexism Problem in Economics?"

Noah, who blogs at Noahpinion, refers to a recent article in Psychological Science in the Public Interest that draws the following conclusions about most math-intensive fields:

We conclude by suggesting that although in the past, gender discrimination was an important cause of women’s underrepresentation in scientific academic careers, this claim has continued to be invoked after it has ceased being a valid cause of women’s underrepresentation in math-intensive fields. Consequently, current barriers to women’s full participation in mathematically intensive academic science fields are rooted in pre-college factors and the subsequent likelihood of majoring in these fields, and future research should focus on these barriers rather than misdirecting attention toward historical barriers that no longer account for women’s underrepresentation in academic science.
However, the paper notes that Economics remains an outlier in a few respects, including promotion and compensation.

Miles, who blogs at Confessions of a Supply Side Liberal, goes on to provide a list of the various, sometimes subtle ways, the path to the top of the profession in economics is still steeper and rockier for women compared to men. I don't think there is a mindset within economics that is unfavorable to women. But a neutral mindset does not always lead to neutral behavior, and as a profession, this is an issue that we should all take seriously.

Wednesday, October 01, 2014

The Leadership Implications of "Too Big To Fail"

This month, The New York Times in Leadership will be featuring a short post from me with some reflections on what we have learned about leadership in the six years since the onset of the financial crisis. It is based on a session I have done a couple of times for the Rockefeller Leadership Fellows program at Dartmouth. Here's the conclusion:

Ironically, the leadership lesson of “Too Big to Fail” is that we must lead proactively before a crisis so that leaders can remain comfortably on the sidelines when a large financial institution works its way into trouble.

Read the whole thing.

Friday, September 19, 2014

Income Tax Changes and Economic Growth

Policy makers and researchers have long been interested in how potential changes to the personal income tax system affect the size of the overall economy. Earlier this year, for example, Representative Dave Camp (R-MI) proposed a sweeping reform to the income tax system that would reduce rates, greatly pare back subsidies in the tax code, and maintain revenue- and distributional-neutrality.

In a recently released paper, Bill Gale and I examine how tax changes can affect economic growth. We analyze two types of tax changes — reductions in individual income tax rates without any offsetting tax increases or spending cuts — and income tax reform that broadens the income tax base and reduces statutory income tax rates, while maintaining overall revenue levels and the distribution of tax burdens. We do not consider reforms to the corporate income tax (see Eric Toder and Alan Viard’s recent paper) or reforms that would substitute consumption taxes for all or part of the income tax.

We examine impacts on the expansion of the supply side of the economy and of potential Gross Domestic Product (GDP). This expansion could come in the form of a permanent increase in the annual growth rate, a one-time increase in the size of the economy that does not affect the future growth but raises economic output permanently, or both. Our focus on the supply side of the economy and the long run is in contrast to the short-term phenomenon, also sometimes called “economic growth,” by which a boost in aggregate demand in a slack economy can close the gap between actual and potential GDP.

While there is no doubt that tax policy influences economic choices, it is by no means obvious on an ex ante basis that tax rate cuts will ultimately lead to a larger economy. While rate cuts would raise the after-tax return to additional work, saving, and investment, they would also raise the after-tax income people receive from their current level of activities, which lessens their need to work, save, and invest more. The first effect (the so-called “substitution effect”) normally raises economic activity, while the second effect (the “income effect”) normally reduces it. In addition, tax cuts that are not financed by spending cuts or offsetting tax increases raise federal debt, which reduces long-term growth. The historical evidence and simulation analysis are consistent with the idea that tax cuts that are not financed by immediate spending cuts will have little positive impact on growth. In contrast, tax rate cuts financed by immediate cuts in unproductive spending will raise long-term output, but so would cuts in unproductive spending that are not accompanied by tax cuts.

Tax reform is more complex, as it involves both tax rate cuts and base-broadening. In theory, such changes could raise the overall size of the economy in the long-term, although it is unclear how much. One fact that often escapes notice is that broadening the tax base by reducing or eliminating tax expenditures raises the effective tax rate that people and firms face on returns from additional work, saving, and investing, thereby offsetting some of the benefits of statutory tax rate cuts. But base-broadening has the additional benefit of reallocating resources from sectors that are currently tax-preferred to sectors that have higher economic (pre-tax) returns, which should raise the overall size of the economy.

Well designed tax policies may raise economic growth, but there are many stumbling blocks along the way and no guarantee that all tax changes will improve economic performance. Given the various channels through which tax policy affects growth, a growth-inducing tax policy would require (i) the presence of large positive incentive (substitution) effects that encourage work, saving, and investment; (ii) the presence of income effects that are not large enough to offset the substitution effects, (iii) a careful targeting of tax cuts toward new economic activity, rather than providing windfall gains for previous activities; (ivi) a reduction in distortions across economic sectors and across different types of income and types of consumption; and (v) little or no increase in the budget deficit.

Few if any tax real-world tax changes are likely to satisfy all of those conditions. Thus, the justification for sweeping income tax reform changes must rest primarily on objectives other than economic growth.

Cross-posted by Bill Gale at TaxVox. 
Tax Policy Center event video from September 9. 
 Media References:
"Tax Cuts Can Do More Harm than Good," David Cay Johnston, Aljazeera America, September 18.
"Can Income Tax Reform Spur Economic Growth," APPAM, September 15.
"Taxes and Growth," Dietz Vollrath, The Growth Economics Blog, September 12.
"Don't Count on Much Economic Growth from Individual Tax Reform ... Or From Rate Cuts," Howard Gleckman, Forbes, September 10.

Wednesday, June 25, 2014

A Quick Reaction to More Minimum Wage Nonsense

Danielle Kurtzleben of Vox has an interview with Gap's Vice President of Stores Lynn Albright about the company's decision to phase in higher wages for its lowest paid workers. The claim being made is that this decision is good for the Gap, as it will reduce employee turnover (which is costly) and attract higher skilled workers. I have two reactions.

First, good for the Gap for figuring out that it can raise profits by changing a labor practice. Also, good for the higher skilled workers who now have more opportunities in the labor market.

Second, this policy change at one company has absolutely nothing to do with the case for raising the minimum wage in the economy as specified by law. Such legislation affects the opposite labor practice -- when a company figures out that it can raise profits by offering lower wages, acknowledging that it will suffer higher turnover costs and that it will attract less skilled workers. With that labor practice forbidden by law, companies with that production model and the less skilled workers, who now have fewer opportunities in the labor market, are worse off.

The problem that we should be addressing is that low-skilled workers have low skills, not that there are labor market opportunities that pay them in accordance with their low level of productivity.