A Lesson in Tax Incidence

I don’t do Public Finance economics but I did take a course in that subject many years ago. One lesson that I took from that course was that who actually pays a tax or who actually benefits from a subsidy isn’t necessarily those you might think pay a tax or benefit from a subsidy. I saw a press report today that illustrates this point nicely.

Tesla has recently cut the price of one of its cars twice. The article claimed that the first price cut occurred just after a subsidy to the purchase of the car was partially eliminated. If true, and the timing should be easy to verify, then notice who benefitted from the subsidy. Tesla did by charging a higher price than it otherwise would charge. The buyer may also have benefitted but by less than the amount of the subsidy. The same is true of a tax – it usually is paid by buyer and seller.

So the next time a subsidy is thrown your way by government, remember that you aren’t likely to get as much as you may think you are getting.

Gas Prices

I filled up my car’s gas tank the other day and paid $1.83 per gallon. This is the lowest price I paid in a long time so I decided to see if gas prices are lower today, adjusted for inflation, than they were in October 1973 when the first OPEC oil price increase occurred. Economic theory tells us to look at relative, as opposed to absolute, prices when we try to understand the connection between expenditures by households and the prices of goods and services paid so the adjustment for inflation is important to do.

Gas was about $.30 per gallon in October 1973 (regrettably I am old enough to remember those days) and, using the CPI since then, gas prices should be about $1.60 just to keep up with inflation since the first OPEC oil price shock. So gasoline looks more expensive today than it was in the past but it should be remembered that cars are much more gas-efficient now than they were in October 1973. So it seems reasonable to suggest that cars are actually cheaper to fuel today than they were when the first OPEC oil price increase occurred.

This is a big part of the explanation for why auto companies are reducing their production of sedans. SUVs are now much cheaper to operate so consumers have shifted out of sedans and into SUVs. The President seems unhappy with the auto companies for their shifts in production but what else are they to do if market conditions change as they have?

GDPNow Forecast for 2018:3

I pointed out in a previous post that the Atlanta Federal Reserve Bank has a real output forecasting service called GDPNow. This is an advanced warning system which could be useful to individuals and firms about the near-term behavior of quarterly real output in the U.S. The 2018:2 growth rate for real GDP, recently reported by the federal government, was 4.2 percent at an annual rate and GDPNow is predicting a 2018:3 growth rate of 3.9 percent. Thus the economy is still booming but at a somewhat reduced rate according to GDPNow.

The Growing Federal Deficit Updated

Readers of this blog have seen comments about the entitlements crisis and its implications for the federal government deficit. The tax reform recently passed will also have implications for the deficit and so I thought it would be useful to provide some recent data tracking the deficit. The data below is from the Fiscal Service of the U.S. Treasury. The data are in millions of dollars and they report data for the first nine months of 2017 and 2018. A positive entry is a deficit; surpluses are negative numbers. I have updated the data in the following table. The data now includes September 2018. This added month reveals a substantial surplus.

Month	Deficit	Month	Deficit
January 2017	-51,257	January 2018	-49,237
February 2017	192,044	February 2018	215,239
March 2017	176,233	March 2018	208,744
April 2017	-182,428	April 2018	-214,255
May 2017	88,423	May 2018	146,796
June 2017	90,233	June 2018	74,858
July 2017	42,939	July 2018	76,865
August 2017	107,689	August 2018	214,148
September 2017	-7,886	September 2018	-119,116

The data reveal the growing deficit. For the first nine months of 2017, the deficit was about $456 Billion and, for the same nine-month period in 2018, it was just over $554 Billion, an increase of about 21.5 percent. There seems little doubt that the trend that we see in this data will continue, with the likelihood of trillion dollar deficits in the not-too-distant future.

It was not so long ago that we saw the federal government borrow over a trillion dollars and, prior to that point, there was no way to know if the government could borrow such a large amount since it was outside of our range of experience. We now face the prospect of even larger deficits and, again, there is no way to know if there will be a debt crisis, a situation where interest rates on government debt rise sharply and, eventually, the government simply cannot borrow the amounts necessary to continue its operations for an entire fiscal year.

What seems remarkable to me is that there seems no indication that Congress is at all interested in the crisis that is unfolding. Perhaps ignorance really is bliss.

Hidden Taxes

It is sometimes said that politicians don’t get reelected by raising the taxes paid by their constituents. If true, then it makes sense for politicians to raise the taxes paid by individuals in a way hidden from them (that is, unless they read this blog!). Two examples have appeared recently in the media which illustrate this phenomenon.

Health Care

Ever wonder why you paid $500 for tissues during your last hospital stay that was covered by your insurance? Part of the answer is that hospitals are legally required to cover emergency room visits by the uninsured. There are cases where emergency rooms have been closed by hospitals due to the losses incurred by this requirement but another option is to load the costs of the uninsured on patients covered by health insurance. Politicians could have taxed the insured with the proceeds going to the hospitals incurring losses from treating the uninsured but that is visible to the insured (they pay the tax bill). So a hidden tax solves the “problem” of giving health care to the uninsured and it does so with hidden tax payments from insured patients.

Mileage Standards

I just bought an SUV and the price caused in me a serious case of sticker shock. But part of that price covers the losses car manufacturers make on small cars which help to satisfy government mileage standards. It has often been reported that small cars cannot be made profitably by car manufacturers so, if small cars are to be produced, how does the car manufacturer stay in business? The answer is that the company must cover their losses from the sales of other cars, such as SUVs. So part of the price that I just paid is designed to pay for small cars not favored by much of the public. Put differently, mileage standards raise the supply price of SUVs, raising the prices paid for SUVs.

Given the incentives faced by politicians, it is not hard to believe that such deception is beneficial to them. Regrettably, this form of deception is all too often the way that government does business, one reason, in my opinion, why politicians have so little credibility in the eyes of the public.

The Investment Share of GDP

One critical aspect of the 2017 tax reform was its impact upon investment in plant and equipment by firms. Here is the share of Gross Private Domestic Investment (GPDI) to GDP beginning with 2017:01.

Quarter	Share
2017:01	20.43
2017:02	20.56
2017:03	20.70
2017:04	20.65
2018:01	20.97
2018:02	20.82

The table shows share increases in 2018 when compared to the shares in 2017. But the 2018:02 value is slightly below the value for 2018:01. The values of real GPDI in 2018 were higher than they were in 2017. And 2018:02 GPDI is higher than it was in 2018:01. So the levels of real GPDI suggest that some tax reform effects may have occurred.

Thus the tax reform has not yet produced an obvious substantial increase in U.S. investment activity. But there are lags between policy changes and economic activity as I pointed out in my previous post so I will continue to look at these shares as the year unfolds.

Real GDP Growth in 2018:02

The Bureau of Economic Analysis has released its estimate of real GDP growth for the second quarter of 2018. Their estimate is that the annual growth rate of real output was 4.1 percent which is consistent with other economic data such as the unemployment rate (currently at 4 percent for June 2018) and it is also consistent with earlier forecasts such as GDP Now. The tax reform passed last year is undoubtedly the explanation for the second growth rate.

Notice that first quarter growth in real GDP was much lower, estimated to be 2.2 percent. This reflects the lagged responses of economic activity to policy changes, a well-known feature of industrialized economies. It is important to keep these lags in mind when evaluating the effects of economic policy changes.

I will look further, and report later, at the latest NIPA (Nation Income and Product Accounts) numbers to see if they are consistent with our expectations regarding the economic effects of the tax reform passed last year.

GDPNow

The Bureau of Economic Analysis (bea.gov) is the federal government agency that manages the NIPA (National Income and Product Accounts) for the U.S. Just recently we saw the release of first quarter 2018 real GDP growth but these estimates arrive with a considerable delay after the end of a calendar quarter. Often it is useful for individuals to have some advanced predictions about future real GDP. The Atlanta Federal Reserve Bank has a project which generates such predictions, a project called GDPNow. I provide this link here for those interested in a prediction of future real GDP.

It may also be of interest to readers to know that the current forecast for second quarter real GDP growth from this source is now 4.1 percent which, if accurate, suggests that the recent tax reform has indeed had a very substantial impact upon U.S. real economic activity. This should not come as a big surprise since there are other sources of information (such as statements by the Federal Reserve) consistent with the view that the economy is now in a boom.

The 2018 Social Security Trustees Report

The Trustees for the Social Security program recently issued a report on its financial condition (here is a summary of the report), getting substantial media attention. I thought it might be useful here to discuss for readers the report’s statements about the trust fund. Warning: equations lurk below.

An Accounting Constraint

The assets in the Social Security trust fund obey the relationship

End of Period Assets = Assets at the End of Last Period + Interest Earnings + Social Security Payments from Workers – Social Security Payments to the Public

which describes how assets rise or fall over time. So the equation states that assets at the end of, say, 2018 will be assets at the end of 2017 plus interest received on assets plus funds received from workers paying into the Social Security system less any payments made to people by the Social Security system. The last three items are all for 2018. It is true that in the past

Just Another Day at the California DMV

I follow a blog by John Cochrane who is a Senior Fellow at the Hoover Institution (his blog, The Grumpy Economist, is linked on this blog in the right-hand column). I just read a post that he wrote about going to the California DMV office and, quite honestly, I just stared in disbelief at what I read. Check his full post for all the details but below is a snippet of what he wrote. It speaks for itself. As anecdotes go, this one is a stunner.

I arrived at the DMV yesterday at 9 AM. My number came up at 5:45 — you have to wait anxiously all day as you have 10 seconds to respond to your number. At 6:05, 10 hours after arrival. I was informed it was too late to take my written test so I would have to come back. As usual the place was packed, no food, no drink, two filthy restrooms.

(California has an appointment system but it takes two months to get an appointment, so if you need something now or can’t book a free day two months ahead of time, you wait. 10 hours. Then you still get an appointment to return two weeks later as they won’t get to you.)

Despite 13.2% top income tax rate, 7.5-9.5% sales tax, gas taxed to $3.80 a gallon, California cannot operate a functional DMV. Even Illinois, good old corrupt, bankrupt, Illinois, can operate a vaguely functional DMV. (Direct election of the secretary of state may have something to do with that.)

Estonia, this is not. Piles of paper flow around. Technology is about 1992 — there is a number system, so you don’t stand in line for 10 hours. But no indication where you are in the queue or when they might get to you.

Rebellion was in the air. Most people do not have my time flexibility. The very nice lady next to me had taken the day off work and had to arrange child care, which was going to end at a finite time. This was her second day of waiting. She was ready to start the revolution.

This is not unusual. It’s just a completely normal day down at the DMV.