Tax Policy and the Purpose of a House

As much as possible, the tax code shouldn’t bias investment decisions. As it is, the tax code is too heavily weighted in favor of housing… Congress should level the investment playing field by treating capital gains on real estate, stocks, bonds and other assets the same… Doing so would also reduce the incentive for speculative investment in real estate and remove some disincentive to investing in the stock market. My guess is that investors would shift more of their money into Corporate America, especially innovative companies that create the wealth of the future (p. 214).

Upon the initial reading of my economics textbook, the above passage first convinced me that I might have something to say in response to the BusinessWeek perspective on the world. The article complained that the Taxpayer Relief Act of 1997, by eliminating capital gains taxes on real estate profits (under certain circumstances), promoted speculation within the housing market and lead to unsustainable gains in housing costs, which have now lead to a whole host of other economic troubles. This seems to me an extremely narrow vision of the world. First of all, this article ignores the large proportion of the American populace who don’t have any spare wealth to invest in real estate or any other form of investment. Then there’s the even larger proportion of the American populace whose home is their only investment. I would imagine, although I can’t say that I’ve ever spoken with him about this personally, that Bill Clinton was aiming the tax code much more at that middle class voting block than at the small percentage of folks making a fortune from real estate flipping. If that’s the case, then the merits of the Taxpayer Act can certainly be debated, but they must be debated by considering a much wider sphere of influence and possible consequences. People don’t just buy houses to resell them. They buy them to live in, because human beings need shelter. Obvious stuff, but it leads to a different set of questions when evaluating housing policy. Did the tax benefits increase the stock of homes? How about the affordability of those homes? Did it allow people to move up to a better house than they might otherwise have been able to afford, leaving their previous residence available for someone else? Did it create jobs for homebuilders? And, to be fair, how did it affect the likelihood of speculation and price inflation within the housing market?

Then, once we have resettled our perspective to realize that most homeowners who may have benefited from the tax policy were not speculators trying to merely cash in on a profitable investment, we have to ask how much influence was truly wielded by the few who were. Although I do find it plausible that certain investors may have made some clear calculations and decided to invest in real estate due to the particulars of this bit of tax policy, I find it quite implausible that these people could have had such a profound impact. Could those few speculators have really set off the forest fire that swept through the housing market? Or was it more like a thousand campfires of individual homeowners hoping to get in on the heat?

And that leads me to the issue of the susceptibility of any kind of investment market to bubbles and panics and all sorts of other changes in elevation that are much more fun on a roller coaster ride than they are in an economy. But I’ve already grumbled about just how fishy the whole stock market seems to me, so I suppose I’ll just let that rant go for today. I’ll just get back to reading tax code and plotting my next investment strategy.

Christopher Farrell. A Housing Boom Built on Folly. in Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007

GDP and the Measure of a Good Economy

Chapter 12 is entitled “Measuring Economic Performance. (p.185)” It begins by describing Gross Domestic Product (GDP)—a measure of the total goods and services produced in a country in one year. What do we think of this measure?

Many people have lodged many criticisms at GDP. I don’t know the details to judge the merit of their arguments, but they often include something about what is or isn’t counted toward the total productivity of the nation. For instance, many tasks that have been traditionally performed by women such as childcare, food preparation, and community work haven’t been monetized (or at least not as readily) as tasks traditionally performed by men. So work performed in the home has no value, even while the same work performed for strangers could have value. Other arguments center on whether the goods or services produced really contribute to quality of life. For instance, the production of weapons and other items in our vast military budget count toward GDP. But what do they provide for the nation’s quality of life?

But if we step back even further, using GDP as the measure of an economy’s “performance” implies that what we really want an economy to do is produce stuff. Goods and services. Is that really the primary function of an economy? Certainly it is important. And I will admit that I have always had the privilege of living in a society (and a social class within that society) where the ill effects of too much stuff are more obvious than the ill effects of too little stuff. I have never had to stand in a bread line, or wait in a gas line, or really experience a shortage of anything at all. So I probably do take production for granted to some extent.

Even so, aren’t there other things we want an economy to do? If all of us worked in factories producing stuff that only a couple families got to use, would that be a “performing” economy? Does distribution matter? How about employment, for that matter, another way of getting at the same issue? Don’t we want our economy’s performance to be tied somehow to the percentage of our citizenry that is able to earn their living? Later in chapter 12, employment numbers are described as coincident economic indicators (p. 199). Indicators of what? What is this ephemeral “economy” that employment is “indicating?” Isn’t employment the outcome, rather than just a subordinate indicator to some primary economy?

Of course, economists rarely just use one value to describe an entire economy. That would be like trying to describe a climate with only the rainfall totals. But it is worth considering whether our go-to economic indicators truly reflect what we as economic agents really want from our economy. Do we want stuff? Perhaps even distribution of resources? Or would we prefer stratification? How about weighing stability versus mobility? Do we want quality of life and is that measured in dollars? Do we want everyone’s needs met, or do we want rough and tumble individualism? There are many different options for what constitutes a high-performing economy, based on many different economic value systems. So measuring the economic climate requires a full meteorological bag of tricks.

Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007.

Warren Buffet: The Greatest Capitalist??*

Apparently, corporations constitute 19.9% of all American businesses, but account for 88.8% of all sales and 71.4% of all profits (p. 135).* Those are some pretty astounding numbers. Small businesses, considered such a lifeblood of the American way of life, bring in just over 10% of all sales, and less than 30% of all profits. A relatively small number of mega-corps bring in all the rest.

The book describes a crucial difference between the profit earning potential of corporations versus simpler forms of small businesses as the corporation’s seemingly unlimited capacity to raise capital (p. 131). A sole proprietorship is limited by the collateral of its owner as to what money financial institutions are likely to invest. Corporations, by contrast, get to sell ownership shares (ownership without any resulting liability, somehow) directly to whoever wants to purchase them. From there, the corporation gets to keep reinvesting the money virtually infinitely without paying any interest. Sure, there is the theoretical obligation to pay dividends to shareholders. But many companies eternally delay this step, convincing shareholders that the money is better re-invested in the company (or the CEO’s end-of-year bonus) than spent on dividends. And shareholders are usually untroubled with this explanation, because they have more potential to make money in the future by selling their shares of a highly valued corporation than they ever would have received in dividends anyway. (This of course presumes that the corporation continues to be highly valued by the market, and that there is somebody out there with enough capital to purchase the current owner’s shares.)

Does this seem to anyone else like a wink-wink, nudge-nudge house of cards system? If I invest in some shares of a company, all I have really purchased is the hope that down the line somebody else will want my little scrap of paper with hope written on it. That’s the only risk I’ve taken. My likelihood of making money seems to rely more on the winds of public sentiment than actual business performance, so perhaps it’s fitting that my action, my “ownership,” has very little impact on the performance of the corporation I “own,” anyway. And unless I’m purchasing initial public offerings, I’m not even contributing any actual money to the corporation.** So why is this considered the most capitalist of capitalist endeavors? Why is Warren Buffet, who as far as I know is not responsible for producing anything beyond books describing how to be like him, considered the Greatest Capitalist?

I know stock and bond markets are old, pre-dating Adam Smith, pre-dating capitalism itself. I’d like to know more about the history. If this house of cards truly is a flimsy but surviving relic of our aristocratic and mercantile past, why is it held up as the most modern and advanced element of post-industrial, globalized capitalism? Why do we continue to accept this system so susceptible to human frailties like panic, so exclusive in its beneficiaries, so myopically focused only on short term gain, and so obsessively good at creating massive, virtually stateless profit machines that are understood by no one and answerable to even fewer people?

* "It may seem a bit odd that Warren Buffett, one of the greatest capitalists the world has ever seen, resides firmly in the liberal camp when it comes to tax policy. (p. 181) Janjigian, Vahan. Even Buffett Isn't Perfect: What You Can--and Can't--Learn from the World's Greatest Investor. New York: Portfolio, 2008.

** Interestingly enough, the discrepancy between 88.8% of all sales and 71.4% of all profits would seem to indicate that corporations are dollar for dollar less profitable than sole proprietorships or partnerships.

*** Admittedly, my purchase might indirectly benefit the company by indicating demand for its shares and faith in its profit-making potential, which could then increase its capacity to attract capital. But that’s just another layer of wink-wink nudge-nudge.

Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007.

Price Floors Versus Equilibrium and Implications for Globalization

“Is the minimum wage, then, a bad idea? Economists agree that it is not as efficient as a wage set by supply and demand, but some maintain that not all economic decisions should be based on efficiency. They favor a minimum wage because it raises the incomes of poor people. Others believe that a minimum wage actually increases the number of unemployed people because employers do not hire as many workers. Still other economists believe that a minimum wage has little meaning in the real world, because it is often lower than the lowest wage paid in many parts of the country. (p.92)”

Prices, for labor as well as everything else, tend to fall toward an equilibrium price based on interaction between supply and demand. If supply is too high, if there is a surplus of goods relative to demand, then prices will tend to fall in order to increase demand. Producers will eventually cut production so that the surpluses do not continue. On the other hand, if supply is too low, if there is a shortage of goods that people want, then prices will tend to increase, which will prompt existing producers to make more product, or will entice additional producers into the market. Production increases, and prices will return to equilibrium.

In the case of “selling” labor, the supply is controlled by the willingness of people to enter the labor market, and demand by the willingness of employers to employ them. So if you imagine a particular job, say toothbrush salesperson, (although the same mechanisms would apply to the “average wage” across the whole economy), you can imagine a supply schedule. At a certain salary, say $20,000 a year, there may be 10 people who would be willing to travel around the city visiting dentists and pitching toothbrushes. Now, if the toothbrush manufacturer were offering $80,000 a year for dental health crusaders, they would probably get a lot more applicants. Of course, at $80,000, the toothbrush people couldn’t afford nearly as large a toothbrush sales force as they could at $20,000 a person, so the demand schedule would show an inverse relationship. Larger the salary, the fewer people employed.

Now the textbook shows a pretty little picture like this one. You can easily see where the equilibrium price ought to be, where the two lines cross. Simple right? *

Now the fun starts if there is a price floor—a minimum price that must be observed regardless of market conditions. The minimum wage is an example of a price floor. The price floor boosts the price above the pretty little equilibrium, so then you end up with a graph that looks more like this:
The second graph shows the ugly green gap between the supply of labor and the demand of labor—representing all the people who would be willing to work but who can’t get jobs because the employers can’t afford to pay them at the higher than equilibrium wage floor. That ugly green gap is the compassionate conservative’s explanation for why the minimum wage is a bad thing. It creates unemployment. The conservatives pose a conundrum to minimum wage advocates: Which would you prefer? More people with lower paying jobs, or more people with no jobs at all?

The book quotes “other economists” as saying that the minimum wage is somewhat of a moot point. And it may be true that most American workers are already paid well above minimum wage, in which case the ugly green gap isn’t worth much consideration because it is either nonexistent or negligibly small. However, if this is true, it is not because the equilibrium price for labor for American companies has risen. Instead, I am quite confident that the equilibrium price of labor has fallen dramatically, for the simple reason that American companies are not just paying American workers anymore. Free trade policies and ever more efficient transportation have ushered in the era of globalization, which has meant that on our pretty little labor supply and demand graph, the supply line has shifted massively to the right, bringing the equilibrium price dramatically down. A global context is thus crucial to the consideration of labor dynamics. Businesses certainly look at labor decisions that way. Shouldn’t macroeconomics as well?

From a global perspective, we can begin to see the other side of the minimum wage argument. Many countries around the world have posed the minimum wage conundrum, and have decided (or had it decided for them) that they prefer more people with lower paying jobs. And is that the right choice? GDPs have certainly risen in some countries. And global sweatshop scandals have led to international pressure for at least basic worker’s protections. But some economists have argued that countries can get stuck in a poverty trap. Without spare income for investment, without imports to balance out exports (which leads to a devalued currency), and without adequate human or technological capital (which tends to get “brain drained” away to more advanced economies with more opportunity), workers in poor countries spend their meager incomes before they’ve earned them, and the economy never gets to a point of self sustaining growth. Sounds like a cycle of dependency on a macroeconomic scale that could be quite similar to that on a microeconomic scale of families at the bottom of the economic ladder in “developed” countries. Would a global minimum wage break the cycle? Or would it just cut developing countries out of any economic activity whatsoever?

Thus we see that the old minimum wage conundrum now can be recast as an interrogation of globalization itself. The minimum wage has always been a fascinating policy argument, either on practical or purely philosophical/ethical grounds. In either mode of argument, however, these days it is crucial to consider a global context.


* The supply and demand curve of labor is a model, so it is by definition a simplified version of reality. But even just considering the behavior of labor supply and demand themselves (leaving alone all the other factors that could influence supply and demand and price for labor), I imagine the graph would be a bit more simplistic. Labor supply is not a very elastic factor, because most people can’t simply decide not to work. So the quantity of available labor is likely to stay quite high, even at low wages, because people have to work for something. Similarly, as the price of labor goes up, the quantity demanded will decrease at an accelerating rate, as incentives to replace labor with technology or other means increase. So I imagine a supply and demand curve would look more like this:


Downey, Matthew. Contemporary’s Economics. Chicago: McGraw Hill Wright, 2007.