1 Conventional Wisdom versus The Data October 29, 2011 copies of this presentation can be found at .

Conventional Wisdom versus The Data

October 29, 2011

copies of this presentation can be found atwww.antonydavies.org

The Game

Select what price to charge.

Lower price sell more units.

Higher price sell fewer units.

The Game

Goal: Make the most profit possible.

Profit = Revenue – Cost

Price per unit x Units sold $1 x Units sold

Price per Unit Units Sold$1 100$2 95$3 90$4 85$5 80$6 75$7 70$8 65$9 60

$10 55$11 50$12 45$13 40$14 35$15 30

Example

Suppose you charge $3 per unit.

How many units will you sell?90

What is your revenue?

($3) (90) = $270

What is your cost?

($1) (90) = $90

What is your profit?

$270 – $90 = $180

$10 55$11 50$12 45$13 40$14 35$15 30

Example

Suppose you charge $15 per unit.

How many units will you sell?

($15) (30) = $450

What is your cost?

($1) (30) = $30

What is your profit?

$450 – $30 = $420

Example

Suppose you charge$3 per unit.

Profit = $180

Suppose you charge$15 per unit.

Profit = $420

Of these, $15 is the better price to charge.

Round 1

Choose the price you will charge for your product.

Every unit you sell costs you $1 to produce.

Profit = Price x Units Sold – $1 x Units Sold

$10 55$11 50$12 45$13 40$14 35$15 30

Price per Unit Units Sold Revenue Cost Profit$1 100 $100 $100 $0$2 95 $190 $95 $95$3 90 $270 $90 $180$4 85 $340 $85 $255$5 80 $400 $80 $320$6 75 $450 $75 $375$7 70 $490 $70 $420$8 65 $520 $65 $455$9 60 $540 $60 $480

$10 55 $550 $55 $495$11 50 $550 $50 $500$12 45 $540 $45 $495$13 40 $520 $40 $480$14 35 $490 $35 $455$15 30 $450 $30 $420

Round 1

Round 2: Tax the Consumers

In this round, consumers will pay an additional $4 per unit tax.

You choose a price.

The consumers pay that price per unit to you plus they pay another $4 per unit to the government.

$10 55$11 50$12 45$13 40$14 35$15 30

Round 2

In this round, consumers will pay an additional $4 per unit tax.

If you charge $3, how many units will consumers buy?

What is your profit?$210 – $70 = $140

You charge $3.

Consumers pay $3 + $4 = $7.

Consumers buy 70 units.

($3) (70) = $210

What is your cost?

($1) (70) = $70

Round 2

The consumer pays your price plus another $4 to the government.

$10 55$11 50$12 45$13 40$14 35$15 30

Price per Unit Units Sold Revenue Cost Profit$1 80 $80 $80 $0$2 75 $150 $75 $75$3 70 $210 $70 $140$4 65 $260 $65 $195$5 60 $300 $60 $240$6 55 $330 $55 $275$7 50 $350 $50 $300$8 45 $360 $45 $315$9 40 $360 $40 $320

$10 35 $350 $35 $315$11 30 $330 $30 $300

Round 2: Tax the Consumers

Round 3: Tax the Firms

In this round, firms will pay a $4 per unit tax for every unit they sell.

The price consumers pay is the price you charge.

$10 55$11 50$12 45$13 40$14 35$15 30

Round 3

In this round, firms will pay a $4 per unit tax.

Your cost per unit is now $1 (for the unit) plus another $4 (for the tax).

If you charge $3, how many units will consumers buy?

What is your profit?$270 – $450 = –$180

($3) (90) = $270

What is your cost?

($1 + $4) (90) = $450

Round 3

In addition, you pay the government $4 for each unit you produce.

$10 55$11 50$12 45$13 40$14 35$15 30

Price per Unit Units Sold Revenue Cost Profit$1 100 $100 $500 ($400)$2 95 $190 $475 ($285)$3 90 $270 $450 ($180)$4 85 $340 $425 ($85)$5 80 $400 $400 $0$6 75 $450 $375 $75$7 70 $490 $350 $140$8 65 $520 $325 $195$9 60 $540 $300 $240

$10 55 $550 $275 $275$11 50 $550 $250 $300$12 45 $540 $225 $315$13 40 $520 $200 $320$14 35 $490 $175 $315$15 30 $450 $150 $300

Round 3: Tax the Firms

No Tax Tax Consumers $4 Tax Firms $4Retail Price $11 $9 $13

Price Consumer Pays $11 $13 $13Price Firm Receives $11 $9 $9

Units Sold 50 40 40Tax Revenue $0 $160 $160

Results

In round 3, the government taxed the firms $4.

Won’t firms just pass the tax on to consumers?

Results

End result: Firms pay $2 of the tax, and consumers pay $2 of the tax.

Retail price up by $2

Consumers pay $2 more

Firms receive $2 less

Results

In round 2, the government taxed the consumers $4.

Won’t consumers be forced to pay the full $4 tax?

Results

End result: Firms pay $2 of the tax, and consumers pay $2 of the tax.

Retail price down by $2

Consumers pay $2 more

Firms receive $2 less

Results

Lesson #1: The government has no control over who ultimately pays a tax.

(even when the firm is a monopoly)

Results

When there was no tax, consumers bought 50 units.

A $4 per unit tax should generate $4 x 50 = $200 in tax revenue.

Results

Instead of raising $200 in tax revenue, the government only raises $160.

Results

Lesson #2: The government determines the tax rate, not the tax revenue.

(regardless of whom it taxes)

Lesson #1: The government has no control over who ultimately pays a tax.

Lesson #2: The government determines the tax rate, not the tax revenue.

Conventional Wisdom #1

The government is financially sound.

Data sources: US Department of the Treasury, CIA World Factbook

Millions, Billions, Trillions

(blah, blah, blah)

$10,000

A stack of $100 bills, ½ inch high.

$1 million

100 packets of $10,000.

$100 million

$100 million fits on a standard pallet.

$1 billion

$1 trillion

About twice the amount of money the U.S. government spends on interest on the national debt in one year.

$14 trillion

The value of all goods and services produced in the United States in one year.Also, the U.S. national debt (as of 2010).

Total Federal debt and obligations (as of 2010).

$65 trillion

The government has a debt problem.

Data source: Bureau of Economic Analysis

The Federal government collects about $2.3 trillion in taxes per year

(all tax revenues combined).

The average U.S. household earns about $50,000 per year.

$2.3 trillion $50,000

Federal tax revenues = $2.3 trillion

Federal spending = $3.8 trillion

Federal debt = $14.6 trillion

Income = $50,000

Spending = $84,000

Debt = $330,000

Deficit

DeficitDeficit

Deficit

deficit

What causes deficit?

Perhaps we have a revenue problem.

Deficit

DeficitDeficit

Deficit

Revenue Spending

SpendingRevenue

revenue

deficit

$1,000

$1,500

$2,000

$2,500

$3,000

Federal Revenue

Federal revenue has risen 6.9% per year (on average).

Data source: US Department of the Treasury

Not fair. Prices have been rising over time.

$1,000

$1,500

$2,000

$2,500

$3,000

Federal Revenue Federal Revenue (adjusted for inflation)

Federal revenue has risen 3.3% faster than inflation per year (on average).

Not fair. The population has been growing over time.

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

$1,000

$1,500

$2,000

$2,500

$3,000

Federal Revenue Federal Revenue (adjusted for inflation) Federal Revenue (adjusted for inflation, per capita)

Federal revenue per person has risen 2.2% faster than inflation per year (on average).

Tax revenue may be rising,

but it isn’t rising fast enough.

To raise more tax revenue, we need to raise tax rates!

Raising tax rates increases tax revenue.

Federal Revenue as a % of GDP

21%13%

Data sources: Internal Revenue Service, Bureau of the Census

21%13%

Top Federal Marginal Income Tax Rate

Average Marginal Income Tax Rate

Data sources: Internal Revenue Service, Bureau of the Census, Barro and Redlick (2009)

Average Marginal Income Tax Rate

Data sources: Internal Revenue Service, Bureau of the Census, Barro and Redlick (2009)

Capital Gains Tax Rate

Average Effective Corporate Tax Rate

If revenue is a fixed 18% of GDP, then the debt problem must really be a spending problem.

Deficit

DeficitDeficit

Deficit

Revenue Spending

revenue

deficit

spending

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Average Price Level

Data sources: Bureau of Labor Statistics, Bureau of Economic Analysis

The average price level has risen 700% since 1954.

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Average Price Level Cost of Federal Government

Data sources: Bureau of Labor Statistics, Bureau of Economic Analysis

The per-person cost of the Federal government has risen 3,000% since 1954.

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Average Price Level Health Care Cost of Federal Government

Data sources: Bureau of Labor Statistics, Bureau of the Census

By comparison, the cost of health care has only risen 2,000% since 1954.

The per-person cost of the Federal government has risen 3,000% since 1954.

Government spending is rising, but it’s because of wars, NASA, subsidies to oil companies, [fill in your

favorite evil]…

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

Federal Spending Federal Revenue

Data source: The President’s Budget for Fiscal Year 2011, Office of Management and Budget

2011 Federal Budget

Entitlements

Net Interest

Other Mandatory

Defense

Everything Else

Mandatory Spending

Discretnary Spending

Social Security, Medicare, Medicaid

Food stamps, unemployment, child nutrition and tax credits, supplemental security for disabled, student loans

Departments of Agriculture, Commerce, Education, Energy, HHS, HUD, Interior, Justice, Labor, State, Transportation, Treasury, Veteran Affairs, plus independent agencies, plus Legislative branch, plus Judicial branch, etc.

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

Federal Spending Federal Revenue

Data source: The President’s Budget for Fiscal Year 2011, Office of Management and Budget

2011 Federal Budget

Entitlements

Net Interest

Other Mandatory

Defense

Everything Else

Eliminating all discretionary spending would still leave a $230 billion deficit.

GDP grows!

Reconsider revenue

We only get 18% of GDP in revenue, so let’s stimulate GDP!

Spend more!

Government spending stimulates the economy.

TARP = $356 b.

Stimulus = $578 b.

Federal Reserve = $1,500 b.

Financial Initiatives = $366 b.

Housing Initiatives = $130 b.

Data source: money.cnn.com/news/storysupplement/economy/bailouttracker/

Total (net) stimulus = $3 trillion

Unemployment Rate: 6%7%8%9%10%

Total (net) stimulus = $3 trillion

Historically, how has the economy reacted to stimulus spending?

-6% -4% -2% 0% 2% 4% 6%

Change in Federal Outlays as % of GDP

Stimulus Spending and Economic Growth

If stimulus spending worked, we should see a relationship like this.

-6% -4% -2% 0% 2% 4% 6%

Data source: Bureau of Economic Analysis, National Income and Product Accounts

Increased government spending does not appear to increase economic activity.

Stimulus Spending and Economic Growth (1954.1 to 2011.1)

Maybe stimulus spending doesn’t have an immediate effect. What is the effect over time?

-6% -4% -2% 0% 2% 4% 6%

Increased government spending does not appear to increase economic activity one year in the future.

Maybe stimulus spending’s effects are cumulative. What is the cumulative effect?

-1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0%

Change in Federal Outlays as % of GDP (4Q Moving Average)

Increased government spending appears to have a negative cumulative effect over 4 quarters.

We have to do something! The rich are getting richer and the poor are getting poorer!

The rich get richer while the poor get poorer.