I'm off for an outdoor adventure here...

If you guessed that there will be no computers, you're right. But I'll be back and blogging again in four days or so.

Happy holidays and all that jazz!

Traffic accidents and real economic activity

Health Economics has published a paper by Antonio García-ferrer, Aránzazu De Juan, and Pilar Poncela titled, "The relationship between road traffic accidents and real economic activity in Spain: Common cycles and health issues." The authors say that this study has implications for health policy.

Abstract:

This paper analyses the aggregate relationships between traffic accidents and real economic activity in Spain during the last 30 years. Our general approach is based on two basic assumptions: (1) the number of accidents depends on the use of cars and other exogenous variables, and (2) the level of economic activity affects variation in the stock of cars, as well as degree of utilization. We propose a novel turning point characterization for monthly seasonal data that allows to check whether economic and road accident cycles coincide and, to date the beginning and end of their respective cycles. Empirical results from this section are important in establishing posterior causal models and whether or not economic activity and road accidents have a common component in the long run and a varying lead-lag relationship, depending on the cycles. These models will be the basis to check when Spain will achieve the European Union figures in terms of the fatalities/accidents ratio under different scenarios. Empirical results as well as historical experiences from other European countries proved that reducing fatalities is not only a question of diminishing accidents rates.

American Pie

CIBC's Avery Shenfield was feeling a little artsy when he published the bank's latest weekly forecast. Here's an excerpt from his rendition of 'American Pie':

A long, long time ago…
I can still remember, how the data used to make us smile
And I knew that if they had the chance
That stores could make the shoppers dance
And, maybe, they’d be happy for a while.

But housing prices made them shiver
With no more tax cuts to deliver
Bad news on the wealth front
It couldn’t be much more blunt
I can’t remember if I tried
To have my VISA charred and fried
But something hit me deep inside
The day, the house boom died.

So buy, buy, the consumer won’t buy
Leaving Chevys at the levee
And Ford sales running dry
And Wall Street boys were drinking Perrier and rye

Singing this will be the day that I die
This will be the day that I die.

More of that here (pdf).

Tax evasion: lessons from Egypt

In my view, we should be taking a lesson from Egypt when it comes to dealing with tax evasion. I'll explain.

Studies claim that tax evasion among the self employed in Canada is common and the costs are high. What should be done? First, it depends if the government is concerned purely with inefficiency, or if its concern is inequality (which do not need to be trade-offs, as I've argued before here; and I'll point to my view on equality here). I'm going to address the aim of efficiency here, but I'll quickly explain why.

In a welfare state, the objective of an inequality-averse government would be to raise taxes to redistribute incomes, and thus auditing would be useful to protect the tax base. But there are drawbacks to making equality the only major priority. I won't get into the old equality debate again here, but here are a few thoughts: First, when are degrees of inequality aversion sufficient? And, how do we know if such a degree is attainable? Finally, it's worth repeating that, if efficiency is gained, equality does not need to be a trade-off.

My assumption henceforth is that efficiency is the government's concern when it comes to deterring tax evasion.

What actions can the government undertake to increase efficiency? Three possibilities: Do nothing, design an efficient auditing scheme, or cut taxes to a point where the self employed are more willing to pay (and, ultimately, adopt a low flat tax).

Do nothing

If efficiency is the major concern, nothing should be done, claims Simon C. Parker in The Economics of Self Employment and Entrepreneurship (2004: p. 248). Audits are expensive for the government and for the individuals who prepare the tax reports for audits. [edit: My hurried fingers pasted the wrong quote here. Sorry. Intended quote:] "These costs impose deadweight losses on the economy." Parker concludes that a government would be more efficient to not audit.

Design an efficient auditing scheme

Herb J. Schuetze (2002) disagrees. He finds that (at least in Canada) a discriminatory method of auditing would be most effective in reducing tax evasion.

Excerpt from Schuetze's paper "Profiles of Noncompliance Among the Self Employed" (2002, p 19-20) (The entire paper can be found here. Click on "research"):

Even though pre-tax wages will adjust to equalize after-tax wages, too many resources, in terms of efficiency, will be allocated to occupations which provide the greatest opportunities for noncompliance. This result also suggests an obvious strategy for the development of an effective tax audit system. One which targets the self-employed in construction and service occupations is likely to be more effective.

...A tax audit scheme targeting groups which have been found to conceal income the most (such as self employed households headed by younger males or those in the construction and service occupations) is likely to be an effective tool in reducing noncompliance.

He acknowledges a disadvantage:

Clearly, such a policy, if continued for a period of time, would lead to the misrepresentation of occupation and other characteristics by self-employed tax filers to avoid being audited. However, if the information from these audits is used effectively, policies can be designed to reduce noncompliance.

Such a well-designed auditing scheme might be attractive, but perhaps its major disadvantage (other than the one pointed out by Schuetze) is that it's not simplistic. Simplicity in self-employed tax treatment, or any tax treatment for that matter, should be an objective within any economy. By the way, The World Bank agrees with this sentiment (link via The Heritage Foundation) :

Complicated tax systems can lead to high evasion, even when rates are low. ... A better way to meet revenue targets is to encourage tax compliance by keeping rates moderate.

Lower taxes

In my mind, the best solution would be to take a lesson from Egypt. That is, lower taxes to a point where the self employed are willing to pay (zero would be the ultimate). By extension, if taxes for the self employed are to be lower, taxes for all business should be lower. A flat tax seems to be the most efficient, but I digress. Let's get back to Egypt.

Excerpt from "TAX: Abrupt halt to haggling." The Financial Times, Dec. 11:

"The existing culture as far as the tax authority was concerned was a story of predation." says Youssef Boutros Ghali, the finance minister. "Anything the tax authority could squeeze out, it did. But now we have affected a fundamental change of attitude. We have given up predation and established a partnership through a law that is transparent rather than fuzzy and through reducing the tax rate to what people would be willing to part with."

The new law set the top rate at 20 per cent for both individuals and companies, down from 42 per cent. It offered a total amnesty to those who had never filed a return in their lives, regardless of how long they had been earning, if they presented themselves before the end of March 2006.

The law also introduced self-assessment, changing at one fell swoop a system based on the assumption that the tax payer is always a liar, to one in which inspectors have to believe properly-maintained records presented to them, unless they can come up with evidence of wrongdoing.

At the same time penalties for tax evasion have been seriously stiffened. Mr Boutros Ghali says the impact in the first year has been dramatic, with 2.6m returns filed, up from 1.7m in 2005.

The finance ministry had been expecting receipts to drop by 12 per cent in the first year and by 7 per cent in the second before climbing back to their original level at the time the legislation was introduced. Instead, tax receipts have grown by 17 per cent - a reflection of both the wider tax base, and the buoyant economy.

....It is still not uncommon for middle class professionals to argue privately that they should not pay tax, citing examples of official corruption or waste, or to justify tax
evasion by saying that they make no use of the subsidized and generally bad health and education services provided by the government and that, instead, they pay exorbitant fees at private schools and hospitals.

Tax inspectors also say that under-reporting is still rife. One cited the example of a doctor who charged him personally $20 when he went for a consultation, but when he filed his return he listed his fee as less than $4.

No one has any doubts that it will take years for a new tax culture to take roots. But there is agreement that new law is definitely a start.

Now Mr Boutros Ghali says that, with an improved computerised system, and freed of the necessity to check the records of every single taxpayer, his 39,000 inspectors will have more time to chase evaders.

Perhaps we could do better to take our complex tax systems to the trash and keep an eye on Egypt.

Income Splitting Among the Self-Employed

Which system of taxation on the self employed evokes the greatest tax distortions?

I) An income-splitting system where individuals may appeal to tax non-compliance; or,

II) A system of individual taxation where individuals may simply not report income.

In an interesting paper forthcoming in The Canadian Journal of Economics, University of Victoria professor Herbert J. Schuetze estimates (with a few caveats) that in Canada’s income-splitting system “…approximately one half of a billion dollars in taxes were avoided in 1998 by more than 90,000 businesses.”

An abstract from “Income Splitting Among the Self-Employed:”

Whether the individual or the household should be the unit of taxation is a long-running debate in the economics literature. One potentially important cost associated with a switch to individual taxation, which has been overlooked in this debate, is the impact of such a move on tax non-compliance. In particular, under individual taxation with progressive marginal tax rates households in which the distribution of income among household members is unequal benefit from attributing income from the higher to thelower income household member. The absence of a third party reporting income enables self-employed households to "split" income among family members to reduce income tax liabilities. Using the Canadian experience as a case study this paper sheds light on the magnitude and nature of this activity by developing a unique estimator of the incidence of illegal income splitting among couples. These estimates provide evidence that the occurrence of income splitting is likely non-trivial and suggest that the costs associated with this activity are potentially significant.

Schuetze draws a comparison between the U.S. and Canada. “The current US tax code, which primarily treats the household as the unit of observation, is such that the distribution of income within the household does not affect household tax liabilities.”

His findings:

…the raw reported employment rates of wives of self-employed men in Canada are significantly higher than those of their US counterparts. …. No significant difference in employment rates are observed among husbands…. I find strong supporting evidence that the employment differential found among wives is indicative of Canadian self-employed men attributing income to their wives.

He concludes:

…the pattern of income splitting found above suggest that countries that have high marginal tax rates, unequal wages across men and women and high rates of self-employment may find a system of joint taxation optimal, while for those with low incentives for income splitting individual taxation may be more appropriate.

Perhaps as equally interesting as his findings (at least to me) is the methodology he uses. He attempts to identify hidden behaviours, taking a lesson from Duggan and Levitt (corruption in wrestling) and Jacob and Levitt (cheating among teachers), among others.

Santas and elves: skilled and unskilled?

Apparently the demand for skilled Santas in Alberta vastly exceeds supply. The problem, says Victor Nevada, headmaster of a Calgary-based Santa School, is that Santas are being paid as though they were unskilled workers. Gasp!

Malls should classify the Santa position as skilled labour, he said, given the job requires skills ranging from acting to psychology.

"Santas encounter stories that cause a lot of emotional distress for Santa and children generally are regarding Santa at that point as psychologist, I suppose," he said. "They're looking to Santa to provide some closure, some comfort and so forth and that's why I say it's a skilled position. If a personal shopper can make $50 an hour I would think that a skilled Santa should also make at least about $50 an hour."

I'm sure it's gruelling, but there must be plenty of elves willing to do the job for less than $50.

That would answer the problem from the supply side, but what about demand? No problem. If malls were to treat elves as subsitutes to Santa rather than complements, perhaps supply will create its own demand, as Says Law goes. After all, elves are small (less intimidating) and often more agile (exciting). They can sell themselves.

Perhaps any one of these small people pictured below would have prefered an elf if only the market existed.

If demand is as low as anecdotal evidence suggests, there's no reason for wages to be as high as $50/hour, and thus Alberta's Santas are right to go work on the oil rigs.

Plenty of anecdotal evidence of weak demand sweeping across North America can be found here.

Link fest

I've made a few discoveries.

1.Bill Goeff's Econ Search Engine (Google Trial III) is a customized search engine that "lets you use Google to search the contents of some 10,000 economics web sites (the URLs are from RFE and EDIRC)." The best part is that you can add his search engine directly to your Google homepage.

How useful is it? Very. For example, if you search for the word "toilet" using Google, you'll find The Home of Toilet Art, Humor, and Fun Facts. But use Bill's Econ Search Engine and you'll be led to worldwide portable toilet sales. Voila. No more humour, fun, and all that crap. Thanks Bill! Log into your Google account, click on Google Gadgets For Your Webpage, and run a search for "Econ Search Engine Google Trial III."

2. I'm really digging the Vancouver Housing blog. Don't let the name fool you. There's a lot to learn here. For example, here, he/she asks if immigration is driving the Vancouver housing boom. And here he/she looks at median family incomes in cities across Canada. And if you need more convincing, it won best Canadian business blog this year. Unfortunately, the author is on a holiday hiatus, but the archives are worth reading for now.

3. I often wish that Canada would catch up to the U.S. and the U.K. when it comes to the frequency in which (some) data is collected, as well as the accessibility of (some) data.

But now we have Swivel available to us, which could possibly, maybe, perhaps improve the data accessibility problem as long as people use it, and use it well. Tech Crunch has an explanation (h/t Statistical Modeling, Causal Inference, and Social Science).

Sources of inequality

Recently we saw the release of two interesting reports on household wealth: the Canadian household wealth figures for 2005 from Statistics Canada, and a report from the UN University's World Institute for Development and Economics (WIDE).

The WIDE release and the StatsCan release cover a lot of ground. Incidentally, the StatsCan release is the first of is kind to offer such detailed data on Canada's household wealth distribution since their last such release in 1995 (we're a bit behind the U.S. and the U.K. in the frequency in which we collect this particular type of data). An attempt is made to actually isolate the sources of inequality, which makes for a unique (as far as I know) opportunity for cross country comparisons of sources of inequality.

What can we learn about the sources of inequality of wealth in Canada?

One thing we know is that the middle class holds the majority of their wealth in the form of their principal residence .
Graph via TD
For comparison:

Graph source: WIDE

Secondly, the richest Canadians are likely to hold a greater portion of their wealth in stocks, relative to lower classes.

TD economists Don Drummond and David Tulk offer their analysis on this:

A distinguishing feature of the 1999 and 2005 wealth surveys is the decline in the real value of stock holdings. As the wealthy hold a disproportionate amount of stocks, the decline in the real value is the principal reason why the concentration of wealth in the highest quintile did not increase by more. If investment returns rise the trend towards growing wealth disparities will likely intensify. This could be compounded by sluggish wage gains in the low end and the financial challenge of immigrants – the main source of growth in the younger, less affluent population.

The National Post says tomato differently:

Net wealth -- non-financial and financial assets minus liabilities -- jumped to 640% of annual disposable income in 2005 from 527% in 2000 and just 370% in 1995, when the country was struggling to emerge from a recession.

The surge in wealth in 2005 reflects rising stock markets and once again the positive terms of trade shock where a stronger dollar is making imports cheaper while export prices surge.

That appears to more than offset total debt of 126% of disposable income in 2005.

The point is, the source of household wealth differs across classes in Canada.

I have two thoughts on this. First, equality varies across time and space. Placing countries on an ordinal scale seems bizarre (to me, anyway), likewise to drawing conclusions based on "trends." The richest Canadians hold a high portion their wealth in stocks, which vary in their returns across time, therefore "equality" is not a stationary measure. Further, there's of course often heterogenity in the data across regions. Perhaps one of the key benefits of these studies is that they allow us to examine the nature of sources of wealth, rather than pointing us to "trends," or forcing cross-sectional data into ordinal scales where both are inappropriate beyond very general terms.

Second, there are policy implications. By understanding the sources of inequality we can fight the impulse to redistribute wealth based on "trends." Further, it should be perfectly clear to policy makers that the needs of investors should be accommodated (since we know where household wealth is concentrated). Onay oremay orporatecay axestay. Right? Clear.

There's so much to explore on this subject, but I'll quickly note one of the many interesting aspects of equality: tax shifting, which neither study had anything to say about, unfortunately (but perhaps understandably so in the Canadian context). Alan Reynolds from yesterday's WSJ (h/t Greg Mankiw):

As was well-documented years ago by economists Roger Gordon and Joel Slemrod, a great deal of the apparent increase in reported high incomes has been due to "tax shifting." That is, lower individual tax rates induced thousands of businesses to shift from filing under the corporate tax system to filing under the individual tax system, often as limited liability companies or Subchapter S corporations.

As far as I can tell, this doesn't seem like a big problem in Canada. Jack Mintz and Michael Smart (2001):

Canada integrates corporate and personal taxes by providing a dividend tax credit and excluding a portion of capital gains from taxation. At the small business level, the combined corporate and personal tax rate on equity income is roughly equal to the personal rate on employment and interest income, while for large companies combined tax rates on equity income exceed that of other income. When the small corporate tax rate has been changed in the past, governments have typically adjusted dividend and capital gains tax rates to maintain integration at the small-business level, in order to minimize incentives for shifting between corporate and personal tax bases.

The subject of "equality" often makes me want to rip my hair out, but there are surely thousands of useful, interesting ways to look at it, as StatsCan and WIDE have proven. What a thick and intriguing subject. Please, let's stop dissing it.

Defaults and donations

It's been a news-heavy week on the personal front, but I'm attempting to get back into some kind of routine, which would include catching up with my reading (a futile task) and blogging more regularly.

Here's just a small thought I've been pondering: How can we encourage individuals to commit to donating, including the donation of their money to charity, or the donation of their organs when they die? Maybe we shouldn't. (edit: At least not on an individual level).

First, consider organ donation.

The Edmonton Journal reports, “Health Canada has identified a shortage of organ donors in Canada, noting Canada has one of the lowest rates of organ donation in the industrialized world.”

Consider the ways we can encourage organ donation.

The government can commit to ad campaigns to attract the so-called "altruistic donor." It could also offer a tax deduction of, say, $5,000 or $10,000 off the estate of an organ donator.

The first option can be costly and ineffective. And, a tax deduction? Well, I happen to think that there shouldn't be an estate tax, so I'm not quite on par with this solution either.

Then there are financial incentives beyond tax deduction. Alex Tabarrok explains (2004):

In the minds of many, financial incentives for organ donation means rich people buying up kidneys being hawked on eBay by the desperately poor...Two distinctions are especially important. First, financial compensation for cadaveric donation and for living donation are different ideas and it is quite possible to have one without the other. Indeed, the primary cause of so-called organ tourism—rich people flying to poor countries like India to undergo a transplant from a poor, living donor—is the shortage of organs in the West. By allowing compensation for cadaveric donations we’ll increase the domestic supply and reduce the demand for people to fly to poorer countries for living donation. Financial compensation for cadaveric donation, in other words, is a substitute for both paid and unpaid living donation.

Second, organs are currently allocated according to a point system which is based on factors such as the quality of the match between donor and recipient, the length of time the potential recipient has been on the waiting list, the health of the potential recipient and so forth. It is not necessary to change these criteria in order to make use of financial compensation. Financial incentives can be used to increase the supply of organs without using finance to determine who will receive an organ.

The solution that has my attention is this: change the default. Andrew from “Statistical Modeling, Causal Inference, and Social Science” explains:

Over 99% of Austrians and only 12% of Gernans consent to donate their organs after death. Are Austrians so much nicer than Germans? Maybe so, but a clue is that Austria has a "presumed consent" rule (the default is to donate) and Germany has an "explicit consent" rule (the default is to not donate). Johnson and Goldstein find huge effects of the default in organ donations, and others have found such default effects elsewhere.

What does this have to do with financial charity donations? Andrew goes on:

Lots of research shows that people are likely to take the default option (see here and here for some thoughts on the topic). The clearest examples are pension plans and organ donations, both of which show lots of variation and also show people's decisions strongly tracking the default options.

....My hypothesis, then, is that the groups that give more to charity, and that give more blood, have defaults that more strongly favor this giving. Such defaults are generally implicit (excepting situations such as religions that require tithing), but to the extent that the U.S. has different "subcultures," they could be real. We actually might be able to learn more about this with our new GSS questions, where we ask people how many Democrats and Republicans they know (in addition to asking their own political preferences).

Does this explanation add anything, or am I just pushing things back from "why to people vary in how much they give" to "why is there variation in defaults"? I think something is gained, actually, partly because, to the extent the default story is true, one could perhaps increase giving by working on the defaults, rather than trying directly to make people nicer. Just as, for organ donation, it would probably be more effective to change the default rather than to try to convince people individually, based on current defaults.

I'm not quite sure how changing a default would work with regards to giving money to charity, or giving blood, without infringing on people's freedoms (I don't consider Austria's "presumed consent" rule to be such an infringment), but I like how Andrew is thinking and I'll be pondering his idea more.

The Art of Controversy, Verizon style

Prof Greg Mankiw points to a recording that “takes a while, and it is not at all edifying.” Go ahead and laugh at the math skills held by a couple of Verizon call center employees, but notice the skill they present on other fronts. Namely, they are natural masters of controversy.

Unable (or unwilling) to see their mathematical error, they've wisely armed themselves with Stratagem XXII, Stratagem XV, and Stratagem XXXVI from Arthur Schopenhauer's Art of Controversy. That is, “Petitio principii,” “Use Seemingly Absurd Propositions,” and (the powerhouse) “Bewilder Your Opponent by Mere Bombast.” Their strategies are classic, and painful to listen to (their greatest strength perhaps). Real slick.

George, their opponent, was left with few options. He thus pulled out Stratagem XXVIII: “Persuade the Audience, Not The Opponent.” Brilliant counter attack. The public release of his phone conversation has surely left the blogosphere entirely persuaded (and amused).

A couple more days of hibernation and I'll be back (with less fluff).

To anyone who still returns this blog, I really appreciate you being so patient with my increasingly relaxed blogging habits. I'd prefer to be posting more often and I have a few ideas that I'm eager to run past anyone who will listen. The frequency will pick up here again in a week when I return to trying to earn your love (or at least your readership).

Sometimes I think Stanislaw Lec wasn't being so terribly peculiar when he said, "People find life entirely too time-consuming."

Economic growth or flat labour productivity?

I don't see sunshine and lollipops going into Q4, but November's labour figures make me slightly less bearish than Marc Lee. The fact is, hours worked increased by 1.6% since the end of the last quarter and labour growth still looks healthy (even though much of the net growth in employment was in lower-paying, part-time positions, unlike what we saw from October's net gain in employment of 51,000). Further, as we know, people with jobs spend money.

When October's employment figures came out, I asked why job growth is so out of sync with GDP growth. This still puzzles me, but I'm comforted to know that I'm in good company. TD Economist David Tulk asks a good question:

With just a single month yet to be revealed, 2006 is shaping up to deliver the labour market’s best performance in three years with the expected addition of near 300,000 net new jobs. This stands in contrast to yesterday’s GDP report which shows that economic growth has slowed markedly over the middle quarters of 2006. However, an encouraging development for the final quarter is the pick up in hours worked. Over the first two months of Q4, hours worked have increased by 1.6%, reversing the 0.1% fall observed in Q3. The puzzle is to sort out whether this indicates more economic growth momentum though the fourth quarter of 2006 than suggested by the 0.3% decline in September’s real GDP or a flattening of labour productivity.

Really, the increase in hours worked shouldn't be too surprising, nor should the fact that it hit the right regions in just the right sectors. In October we saw full-time employment rise by 50, 500, putting labour-starved Alberta out of its misery. Well, not quite -– demand is still there -- but Alberta and British Columbia did gain 70 per cent of those new jobs, and November's employment figures tell us that Alberta's woes continue to improve.

Perhaps a productive workforce throughout Q3 and Q4 will be enough to partly offset the economy's bleaker qualities (eg. our less than pretty exports choking on the strong dollar -- which has since improved), and give us less to be bleak about after we witnessed a Q3 GDP growth rate of 1.7%.

In fact, never mind the labour report, maybe the Q3 GDP figure isn't so bad on its own.
Tulk again:

...the details are not as discouraging as the headline number would suggest. While some of the weakness can be traced to the second consecutive quarterly decline in residential investment, the main cause of the deceleration in real GDP growth was a combination of more moderate government spending and falling inventory investment – two of the more volatile components of real GDP. For example, part of the deceleration in government spending from 4.9% in the second quarter to 0.7% in the third was due in part to the one-off effect of the conclusion of the 2006 Census. Meanwhile, the fall in inventory investment likely reflects some unwinding from the significant accumulation in the previous quarter.

As long as firms refuse to fire workers until a recession is in sight, labour growth is a poor indicator of things to come; however, in sum, here's my guesstimate: A slowdown is inevitable, but Q4 has a cushion of labour productivity that some aren't seeing.

Random notes

1.'The latest jobless rates and what's behind them.'
CBC has updated its nifty interactive tool to reflect November's employment figures.
The west wins again.

2. I'm burning to relieve myself of this. Why does at least one Canadian journalist insist on mirroring U.S. journalists by over-emphasizing the housing market figures when housing is such a smaller influence on Canada's CPI? I'm going by memory, but I believe that housing has a weight of 3.5% in Canada and 30% in the U.S.