Tuesday, April 13, 2010

Economics 101: The Subsidy Rule

Just like all sciences, there are laws and there are theorems. Laws are those things that are known definitively and can be proven. Physics has such a law. It is called the law of gravity.
What goes up must come down.
Actually there is a lot more to gravity than that, but the old idiom does pretty much cover it. Economics also has some laws. There is the law of taxes and subsidies.
If you subsidize something, you get more of it. If you tax something, you get less of it.
It is a law because there is not a single example where the idiom is not correct. If you tax cigarettes, then you will get less smokers. If you tax investment income, then you change the risk/reward formula and you  you will get less investment. And generally, this is the desired affect. The exception is income taxes, which is why there are loop holes and complex rules. Income tax is about revenue generation. They understand that de-incentivizing people to make more money would hurt revenue generation and that is the reason you have a complex set of deductions.

Subsidies work in the opposite way. If you subsidize the price of a crop, you get more people that will plant and sell the crop. If you give people money not to sell that crop (a subsidy) you get more people that won't grow that crop. If you subsidize health care, you'll get more demand for health care procedures.

The Obama administration knows this, yet their agenda seems to ignore the law of economics in exchange for the the cheap pose of the benevolent tyrant. The cheap pose of the redistribution radical. The politics of the sanction of the victim is in play. How do we know this? Because Larry Summers is the administrations economic advisor.

Incentives Not to Work

"The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a 'reservation wage'—the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase [the] reservation wage, causing an unemployed person to remain unemployed longer."
Any guess who wrote that? Milton Friedman, perhaps. Simon Legree? Sorry.
Full credit goes to Lawrence H. Summers, the current White House economic adviser, who wrote those sensible words in his chapter on "Unemployment" in the Concise Encyclopedia of Economics, first published in 1999.

But alas, the easy to amuse and less interested with opportunity and prosperity demographic is growing. The number of people who get subsidies and entitlements from the government is growing beyond the number who contribute to funding those subsidies and entitlements. It's called the tipping point, and we are just about there.
Despite all of this evidence, Democrats seem to think that extending jobless benefits for another 20 weeks is a big political winner. Iowa Senator Tom Harkin recently roared, "Is there any compassion at all left with Republicans for people whose checks are going to run out?" New York's Chuck Schumer calls Republicans "inhumane."
The sanction of the victim. The politics of unicorns, rainbows, and fuzzy bunnies. Everybody wins. Everybody gets a trophy, and we are all 'too big to fail'.
perhaps the Senate should listen to another Obama Administration economist, Alan Krueger of the Treasury Department, who concluded in a 2008 study that "job search increases sharply in the weeks prior to benefit exhaustion." In other words, many unemployed workers don't start seriously looking for a job until they are about to lose their benefits.
While I think the findings are accurate, I would cast the conclusion differently. I think the unemployed do perform a serious search while unemployed. I would characterize the activity before benefits running out as panicked rather than serious. But their point is taken. The subsidy of unemployment benefits merely delays the panicked search.

The take away synopsis is that we are doing no favors to the economy by continually extending unemployment benefits. The expectation that you must make as much as you did before you lost your job is unrealistic. Just like thinking that the price of your house before the bubble burst is what you should expect after the bubble burst is unrealistic.


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