amazon associates

Amazon kicked me out of their "Associates" program because I am a resident of Connecticut. That state, as have a few others, recently passed legislation subjecting sales through state-based affiliates to the sales tax. Amazon is protesting such bills nationwide by terminating affiliate contracts like the one I absent-mindedly signed up for a week ago. They claim the taxes are unconsitutional, as online traffic is protected by the commerce clause.


I think this is bullcrap.


Internet and catalog sales are already subject to the use tax, the ubiquitous but rarely obeyed companion to all (I think all) state sales taxes. The states are attempting to enforce, where they see legal nexus, i.e. with affiliates, the established use taxes. Given the situation with state budgets, to enforce existing, widely flouted tax laws seems like a reasonable idea.


The moritorium on taxing online sales was established in the 1990s as a way of encouraging an exciting new growth-industry. It seems to have worked. Well, whether or not the moritorium had any role in the explosion of e-commerce, online sales without a doubt have thrived. In fact it's the old-fashioned way of shopping that seems vulnerable today. Blockbuster and Borders are pretty much gone, driven out of business by online rivals, mainly Netflix and Amazon.


It would be a shame if the existence of online shopping continues to diminish oour access to stores. Stores are places to gather. They also offer an effortless way to see what the world offers. Videos are in three dimensions organized by genre, alphabet, and nation of origin. A bookstore table might be heaped with a hundred new novels the staff recommneds. At the moment, Americans are strolling through stores and shopping online. They get the benefit of both. But one business model is profitable and thriving while the other is weak and looking for ideas.


Equalizing the sales taxes we pay in the two ways we shop would be a good place to start. I don't see how that's not fair. Why should someone who buys via internet or catalog pay less taxes than someone patronizing a local store? Given the communal and eductional benefits of stores, you might argue they should pay less taxes than an online merchant, who extracts business from your state's resident without delivering your state a three-dimensional amenity.

But now Amazon, another corporation enjoying the benefit of existing law, has found someone to bully, and twist their arms into helping to preserve their sop. In this case, the victims, of all people, are their affiliates! These are small business people who steer business to internet retailers and earn a small percentage in return. The contrast in the personas of the players involved is almost comical. The thriving internet retailer who is putting bookstores out of business is fighting to withhold pennies from strapped state governments by terminating the tiny business operations of local resellers, the lowest-cost route to entrepreneur status for people with spare time and a desire to work from home.


I say tax Amazon sales and damn their whining!

Regulate Pill Prices

My friend Sudip came up with a public policy idea so simple and logical, I am surprised I haven't heard it before. It's a powerful idea that could make an enormous difference for the American economy and the federal government deficit.

First, observe the anti-dumping laws in our trade regulations, which prevent non-US manufacturers from selling products at a loss in the states. Dumping is considered a predatory practice, an investment foreign companies make with the goal of hurting their American competitors, while they make their profits elsewhere. The US government protects American manufacturers by regulating multi-national pricing practices.

Now take the pharmaceutical industry. It is well established that the multinational pharmaceuticals earn their profits in the United States. In the developing world, people can't afford to pay anything close to US prices. In the developed world, away from the states, governments negotiate with manufacturers and set prices, generally far below US prices. Here in the states, the market determines how much the drug companies can charge. Certainly, health insurers can negotiate more effectively than individuals can, but they don't get help from regulators. In fact, legislators know how important US profits are to the pharmaceuticals, so they protect this industry from regulators who might want to side with consumers. So life-improving or life-saving pills are available here, and often invented here, but we pay fifty times what our friends in India pay.

While the practice of regulating prices and the relative profitability of selling in different countries is well established, it is employed only to protect US business. American consumers are asked to provide big pharma with almost all its profits, while sales abroad clearly prove that pills could be made and sold profitably for much less.

A profitable pharmaceutical industry is a critical player in American health care and we are fortunate to have them as a part of our compelling economic arsenal. And clearly profits drive them to perform research which can lead to newer better drugs with luck and a lot of money. But health care costs in the US are famously unsustainable. Governments, corporations, and individuals who pick up the tab for our health care cannot make their future budgets balance, because health care inflation has been steadily above inflation in other goods. Why should the American consumer, the sick consumer in particular, be asked to shoulder the whole subsidy, while the rest of the world free rides on the latest science?

Pharmaceuical companies that sell drugs in different countries should not be allowed to vary the price as they see fit. Why not say the US price can't be more than, say, 25% greater than the average price in the next five highest-price countries? That's far from "most favored nation," and would still leave a lot of profitability and incentive to do research. The US consumer would benefit, insurance carriers would benefit. US non-pharma business and government would benefit. Other rich countries might see a price increase for their pills. But the pricing would be much more fair.

employment taxes

It seems odd that in this era of the jobless recovery and declining real median income that we are still taxing employment. The 7.5% social security, unemployment insurance, workers comp, though they're all unimpeachable uses of funds, all make it more expensive for businesses to hire people. Health insurance also famously adds to the cost of hiring. In this high-productivity and low-employment growth era, it's high time we found another economic transaction to piggyback on. I'd love to see a federal sales or excise tax, and if it were coupled with a lower tax on employment-based social security who would complain? Another possibility would be catalog and internet shopping. People owe use tax to their home state on those transactions already, but states probably need federal help to enforce those liabilities.

The jobs bill is fine, but we should recognize that the jobs problem isn't temporary. Jobs are disappearing. Since the 1980s, companies have been avoiding hiring and finding alternative ways of responding to growth. I have no doubt that most people will make do perfectly well in their new entrepreneurial / consulting / temp / home office careers. But stable jobs are a good option for most people and for the economy and we should adjust our tax system to promote them.

Wall Street

All this Wall Street pay business is red herring. Changing the salaries of a handful of people at the top of a hadful of firms is a superficial move, pure politics. It's not unfair though. If we're bailing them out, we can tell them what to do with tax payer money.

Here are a few tougher changes that would be good but that don't seem to be in the works, because our political leadership is surprisingly timid, given what we've just been through:

Resurrect Glass Steagall. (Resurrectionism! See the NYTimes piece on Paul Volcker
NYTimes.comwww.nytimes.com/2009/10/21/business/21volcker.html) Split up the super global financial instiutions and force the businesses that get the benefit of the discount window and FDIC insurance to perform the banking services that we actually need, such as lending to small business.

Force interest rate swaps and other derivatives to be traded in an exchange, rather than over the counter. Having these instruments rely on the credit of the counter-parties puts a very difficult to determine amount of risk on thousands of company and government balance sheets, unnecessarily. Standardize agreements, and pool credit.

Bring back the uptick rule on short-selling. Eliminate naked short-selling. The short-sellers effected a self-fulfilling prophecy by causing a run on Bear and Lehman in 2008. The banks were overleveraged, but a soft wind-down would have been more pleasant for all of us. Hey, I'm no defender of bubbles. But making a killing by wiping out a vulnerable big company is unwholesome.

Let shareholders vote on senior executive pay packages.

If a trader's annual profits are contingent on iffy "mark to markets" of illiquid assets, leave some compensation for the future, when the real results are known. You could easily have a situation otherwise, where bankers are gaming their employers because they know how they'll get compensated, and are sticking shareholders with risks they wouldn't want to own themselves.

health care reform

I agree that we should reform the US health care "system."

Here are some of the reasons:

1. Fee for service insurance plans drive up costs of services and of premiums.
2. 48 million cannot afford insurance and don't get healthcare they need.
3. Preventative care should be encouraged.
4. Competitive businesses that must compete with other countries - i.e. manufacturing - compete at a disadvantage if they provide high-cost American healthcare.
5. High cost pushes down quality. We can't buy as much when something is more expensive.
6. Attaching health insurance to employment increases the cost of hiring people and therefore reduces employment.

Here's a simple plan that addresses all of these issues:

The federal government should define a set of services that it wants provided. It should comprise a fairly comprehensive offering, but more importantly be a very well defined list. Once the package is articulated a cost can be estimated. I would take a less ambitious package at this point, because a successful program can be expanded. And a basic program would help the situation immensely.

To deliver the package in the most cost-effective way, it should then hold a bidding process in each of the 438 Congressional districts. The winning bidder would be the enity that can credibly provide the specified service for the lowest price. The price would include a regular payment from the government, based on population covered, plus small co-payments from the users, designed to produce appropriate levels of use.

The cost of the program would be paid for by new taxes. These taxes should be designed to not discourage employment. OK things to tax would be personal income, corporate profits, excise taxes on goods we want people to use less, such as oil.

The entities that I envision bidding would be amalgams of existing hospitals, medical offices, drugstores, etc, depending on the services articulated, but organized under a single managerial umbrella for the purposes of delivering those services.

Each of the resulting regional health providers would be a multi-billion dollar business, but the job wouldn't be so enormous that it necessarily creates an oppressive bloated bureacracy. Think of an entity about the size of a state police force or a county school system. Having multiple providers would lead to a variety of innovations, which would then be copied around the country. The service would be offered to all comers, but would not rope in the entire health industry, so people who wanted to spend more for what they think are better services would be free to do so. But the public package would be subject to renewal every, say, five years, so that the provider would have to perform or one of the other providers would likely win the next time around.

Use Gas Tax to Solve Social Security Concerns

I'll leave health care until tomorrow but the other concerns of our nation can be dealth with a single policy proposal that I call a houseboat with wheels because it can do more than one thing. Here are the objectives:

1. Increase fuel efficiency of cars in order to reduce our economy's dependence on fossil fuels and to reduce carbon emmissions.
2. Overfund social security so that we don't need to raise income taxes significantly in the future when we will have far fewer workers for each beneficiary.
3. Invest in US infrastructure, such as electrical transmission, renewable energy generation, mass transit, high speed rail.

All these things can be done with one new thing. We have a rare political consensus now that we need dramatic change in the way the US economy has been moving. Here's what we should do:

1. Impose a tax on gasoline consumption. The federal excise is low now, about 20 cents a gallon. I would like to see it increased gradually over the course of the next 15 years. Say 10 cents in 2010, 20 cents in 2011, etc. through 2024. This would give the auto industry some time to create more fuel efficient cars. The policy would be good for them because it would encourage people to replace their old inefficient cars.
2. Take the proceeds of the tax and put them into the social security trust fund.
3. Do not buy US treasury bonds with the proceeds. The point of the trust fund is to fund the certain increase in social security costs over a longer time period, by starting now. Using the fund to buy US treasuries just delays the tax consequences, undermining it's raison d'etre.
4. Instead buy municipal bonds with the proceeds. Direct muni purchases to new, clean, sustainable infrastructure projects, such as renewable energy, electric transmission, trains.
5. Structure the muni securities to pay debt service when we need it for social security, 2030 - 2050.

Bob's and Eric's Ideas for the Economy

My friends Eric Weaver and Bob Palmer wrote some good opinion pieces on the current economic troubles in the US. Eric argues that stimulus dollars flowing to banks should include money for commmunity development banks, not just because their work is important, but because they've been fulfilling their mission while the rest of the financial services sector has been buttering its belly. Bob lays out a plan for mortgage relief. Nice job, guys.

http://progressillinois.com/2009/1/16/palmer-six-steps-foreclosure-crisis

http://www.sfbayguardian.com/entry.php?entry_id=7926&catid=4&volume_id=398&issue_id=416&volume_num=43&issue_num=18

I'm not normally an iconoclast or crank, but I can't understand why the land purchase program I have described in this blog is not being taken up. Here's an op-ed I submitted to the NY Times:

I keep reading that a rebound in the housing industry will be a balm for bank and household balance sheets and a potential key to ending the US economic crisis. This formulation glosses over the fact that housing is two competing industries, both sick. Curing both, however, may not be what's best for the economy. The housing industry includes the sales of new and of existing homes. In fact, the credit crisis and the foreclosure crisis both stem from the decline in the price of existing homes. The decline in the new home construction industry hurts homebuilders and their employees, but that pain does not radiate out to the financial system or American homeowners generally. In fact, there are a lot of benefits from a decline in new home construction.

The contraction in credit markets has led to sharp reductions in investment and consumption and a broad fiscal stimulus is now necessary to sustain businesses and households through the worst of the slow-down. But a targeted plan identifying existing homes as the root of the problem, and protecting or restoring their value might have saved us from this monumental effort. At this point, a targeted initiative increasing the value of existing homes might be one of the most efficient investments of stimulus dollars, and would accomplish a variety of other worthy aims. To achieve this aim, the government should provide dollars to states for the purpose of buying undeveloped land to be set aside for conservation. Removing potential home lots from the marketplace would immediately add to the value of the existing lots, adding to homeowners' wealth and increasing the value of the home mortgages on bank balance sheets.

Homebuilding is an important industry in the United States. Americans prefer newer homes and economic vitality depends on the existence of affordable, appealing places to live located close to desirable jobs. New homes, though, can come from already developed property as well as from forest or farmland. Industrial and commercial property can be converted into lofts and apartments. Old houses can be torn down and rebuilt, remodeled, added to, or just renovated. The fact is, though, the large homebuilding corporations sell new homes on a very large scale. Their business model depends almost entirely on new home construction. The proposal here is to push back on that business model, increase the ratio of reconstruction to new construction, and give existing homeowners some much-needed market power.

New home construction has been too easy for a long time. In addition to the familiar story of the financial encouragement, the regulatory environment has also been helpful in that home-building permits are awarded at the local level. The metropolitan areas we live and work in are ungoverned. Changing land use and traffic patterns have a regional impact, but permitting is handled locally, and the narrow aim of increasing the local property tax base is usually a significant factor. The resulting sprawl strains city and inner-ring suburban economies and tax bases, and leads to longer commutes, more traffic, and more air pollution, while legacy mass transit systems are made less and less relevant.

Buying undeveloped land is a simple solution to a complex problem. Many states and localities have "land banks" in place. Their traditional role is to take temporary possession of blighted properties and eventually resell them to owners who put them to good use. With sufficient funding they, or other land conservation groups, could fight blight before it happens, rather than after a decade or two of disuse and decline. If a homebuilder sells, say, 2,000 acres of land outside a metropolitan area for $30,000,000 and undeveloped land is made more expensive by the program, the builder would dial down new home construction on undeveloped land in favor of investing in existing homes or other properties and transforming them into more desirable properties. The program could make reinvestment along these lines a condition of the sale. This would be a great benefit for the owners of existing homes, who have seen years of price declines and with inventories at very high levels, face difficulties selling their homes at all.

For 10 months in 2008, the inventory level of existing homes for sale in the United States, was more than 4 million, representing more than eleven months of sales, according to the National Association of Realtors. The annual rate of housing starts (new homes) in December 2008, twelve months into the recession and three months into the credit crisis was 550,000, according to the Census Bureau. That's 45% below the rate of housing starts one year ago, but it's still adding to the available inventory. In December of 2008, the inventory of existing homes for sale finally dropped below 4 million, dropping in fact by 490,000 even though only 360,000 homes were sold. The difference must be a result of would-be sellers giving up. That's not surprising as sales prices in December were 19% below the 2007 level.

One could argue that the time to guard against oversupply of housing has come and gone. New construction has slowed down tremendously, and the four million people who want to sell their homes have little to fear from the half a million new homes currently being made. But the question is, how do we turn the problem around? The key may this: home prices reflect expected appreciation in addition to current supply and demand. The home-making machine is humming quietly today, but the volume will certainly get louder if home prices start to stabilize. Home-builders have substantial amounts of land inventoried, have debt service payments to make, and have an incentive to make and sell houses as soon as and as long as the sales price is greater than the cost of construction. Given this possibility, why buy now? A nationally funded land purchase program would give us a tool to steer, to some extent, new home-buying dollars toward much needed home price appreciation and redevelopment of languishing existing property, rather than toward unneeded additional home construction.

buy land?

This really seems like a golden opportunity to do something about sprawl. Land is cheap. Sprawl causes increased driving and pollution, undermines the fiscal health of towns and cities, and undermines the property value of existing homes. Buying exurban land would address all these very important issues, and address falling home prices at the same time.

The only possible argument in opposition is that increasing land prices would hurt the new home construction industry. But homebuilders are not buying land in this environment. They would much prefer to sell it. If any homebuilders holding land are recapitalized with money instead, and undeveloped land was being bought at above market rates by land banks backed by the federal government, the homebuilders would turn their attention to existing homes, to buy and improve. A fine, non-polluting activity, and one that would help out the owners of those existing homes, a large group of people who have been getting socked with declining equity for about 4 years. I don't think the banks would mind seeing a rise in home prices either.

Proceed with Bailout and have Toll Brothers rebuild North Philadelphia

I'm very disappointed that the bailout failed. What I think many Americans don't understand is that we have nothing approaching a free market in the United States. We have a regulated, mixed economy in which government agencies provide many services, enfranchise businesses to provide many services, regulate businesses in an enormous variety of ways, and step in and save businesses when deemed necessary. Obviously, the size of this bail-out shows that huge mismanagement has occurred. Placing blame for it will be a fun parlor game for many years. But the credit crisis can be solved with this bold dramatic step. If the government also takes steps to improve the real estate market, they would not have to deploy the full face amount of the bailout and the investments they do make might well be pretty good ones. But the success of the legislation will itself have significant ameliorative effects on the credit market.

To improve the real estate market they should read my entry of January 26, 2008. I'd like to see the government buy some land and shrink new home development in overbuilt places like Las Vegas and Phoenix. That would be hugely helpful to existing homeowners and their creditors. Even if they bought the land someone like Toll Brothers has on inventory. I'd like to see them put Toll Brothers to work re-building North Philadelphia.

Glass Steagall is not the Issue. Economic Fundamentals are the real story.

There's a lot of talk now about how John McCain is particularly ill-equipped to lead the country out of the current financial melt-down because he and Phil Gramm were proponents of deregulation and deregulation, including Gramm's dismantling of the Glass Steagall act that separated commercial from investment banking, is what got us into this mess. There are two main problems with this argument. First, Wall Street has been highly regulated in the last decade. Eliot Spitzer's prosecutions, Sarbanes Oxley, regulation FD, have left the business neck-deep in red tape. For example, communications between different functions of the firms are tightly constricted, and employees need permission to make personal investments or accept positions on corporate boards. Second, Glass Steagall might have made things worse. Bear could not have jumped into the arms of JPM had Glass Steagall been in place, nor could Merrill have merged with Bank of America. Past mergers may have been responsible for averting other potential crises as well. Could Citi's or UBS's investment banking arms have weathered the storm without their banking parents?

So regulation and oversight sound good (and appear to have worked in the case of commercial banks), but their application doesn't necessarily protect us, as illustrated by the recent crisis.

The problem this time around was really pretty similar to what happened in the dot-com bubble. Investors had a great appetite for a particular category of investment, in this case structured finance including mortgage-backed securities, and so Wall Street provided a great amount of it. The bizarre twist in this case was that a lot of what turned out to be rubbish was not equities, bets on promising technology, but AAA-rated debt. That made this bubble more toxic than the last one. Another realization that didn't really come up in the dot-com era: broker-dealers hold a lot of inventory and can suffer significant losses as a result.

The problems occurred in the unregulated "structured finance" realm rather than in the regulated world of corporate finance. One response would be to demand the kind of transparency and disclosure of structured entities that is demanded of public corporations. After all, if billions of dollars are being invested in them, the cost of disclosure might be worth the benefit. This might help, and we should probably do what we can, but it's safe to say it won't solve the problem. When investor appetites are in play, securities will flow and when the good stuff is gone, the junky stuff will be conjured up. The problems were flawed science, hopeful investing, and old-fashioned spin-meistering. These things can't be stopped.

So what ought to be done? First, a litle more diagnosis.

The root of the problem is the distribution of income. Wealth was quickly accumulating in the newly global investor class and it wound up spilling into these instruments that looked conservative, but in fact relied on a healthy American middle class. This group didn't exist anymore.

The US response to anemic economic growth was to keep interest rates really low. Growth was anemic because the American consumer saw no growth in earnings. Low interest rates permitted borrowing and grew asset prices in real estate, as well as sustaining politically presentable levels of consumption growth. Beggars can't be choosers, and this debt-based economic growth was all the US could muster.

Can anything be done about the skewed distribution of income which is essentially a technological phenomenon? Well, the appropriate public policy response is to recognize that economic growth as well as the basic health of a society depends on broad-based prosperity. If the dollars are flowing to corporations and the wealthy, tax them and make the middle class better off with free popular services that benefit everyone such as education, health care, infrastructure.

Historically, societies marked prosperous times by building great, lasting things, like universities, city boulevards, museums, skyscrapers. The prosperity of the 1990s and the more narrow prosperity of the mid-2000s didn't yield much public manifestation. I think that's the root of the problem here. The wealth wasn't shared. And as Obama says, the poverty trickled up.

The Right Stimulus Package

In the United States we have built too many houses in the last five years. The culprit here, in part, is a group of big public corporations like Lennar and Toll Brothers, with plenty of access to capital. Mom and pop construction companies would have had the capacity to slow down when demand tapered off after 2005 or so. But public companies need to keep up their sales in order to keep their stock price up.

The first couple years of the millennium were great for them, because demand for new houses was very strong. There was a notion afoot at the time that a single family residence was a great place to park your money. And if a $500,000 home was a good investment, why not build a million dollar one? Farms and other undeveloped properties two hours outside of major cities were subdivided a fresh batch of 3000 square foot colonials was harvested. The boom lasted longer than expected, and when demand for new houses started to peter the construction boom was sustained by the pernicious financing experiments we've heard so much about. Prices weren't going up anymore but houses were still getting built and the developers had to find a way to sell them. Why not partner up with mortgage providers and work out some way to get somebody's name on the deed. The mortgage banks needed to keep things moving too. Credit standards came down, and the houses got sold.

The economic consequences of this run-amok home construction are manifold. One direct victim is the new home construction industry, which is clearly in a deep recession. An indirect consequence of the excessive construction is a declining price for existing homes. A plethora of empty houses and uncertainty about the direction of prices make this an awful time to sell any house. When people can't sell things they want to sell, a lot of potential transactions are unconsummated. Geographically wider metro areas make for more traffic and longer commutes. Oh and by the way our transportaion "system" is emitting increasing amounts of carbon dioxide into the atmosphere and warming the earth.

Can the government do anything to help the market for existing homes? It can and it should. Home prices could be supported by taking some developable land off the table. The numbers are not easy, but I think you could make a difference by pouring fifty billion dollars into state land conservation programs, using matching grants, and letting the states aggressively acquire land around overbuilt metro areas, in an effort to concentrate development. The "downside" here is that new home construction will not be helped by less land and higher land prices. But the downside is an upside in my view: sprawl is terrible for the environment! New home construction on the outskirts of huge metro areas like Phoenix is a terrible idea, and public policy should discourage not encourage it. Conserving land will put dollars in the wallets of owners of existing homes and believe me, they could use a hand, as could our planet.

Merit Goods Inflation Part IV

Part IV

Kids would work hard to get these scholarships, increasing the academic focus of high schools, but those who don’t make it would not be shafted with the monumental price tags they face in the present system. Scholarships for low-income students who don’t get merit scholarships should continue as well. These programs would be greatly benefited by the program described above because it gets at the problem of price. The amount of tuition kids need to scrape together would become a little more manageable. It would also take people in the middle, who aren’t rich but who could swing $20,000 for four tough years—less if their kid goes to a public university—out of the financial aid pool, allowing those programs to focus on the applicants who are truly needy.

Merit Goods Inflation Part III

Part III

What about education? The federal government should announce that 43,500 boys and girls, one thousand from each of our Congressional districts, will get a merit scholarship every year, to pay for four years of college. In any particular year, four times that number, 174,000 men and women, will be going to school for free on this program. The amount of the award should be based on the government’s judgment of the cost of educating a student—it could vary by category of school. Let’s keep things simple by using one number, say $20,000 per person. The total cost of the program? $2.6 billion per year. No big deal, it wouldn’t get noticed in our trillion dollar budget. But here’s the reason it makes economic sense. The dollars would get paid directly to the schools the kids decide to go to, but in order to qualify for the program, the schools must lower their tuition—for all the undergrads—to $20,000. So that the millions who don’t win the scholarship will get a benefit too. You think Yale would turn up their noses at all the scholarship winners? I don’t. Not with their endowment. So the Yale tuition comes down to $20,000. Columbia, Penn, Cornell would all want those kids too. Some schools might stick it out, hoping to get big fat tuitions from those rich enough not to care, but even their tuitions would respond to the increased competition.

Merit Goods Inflation Part II

Part II

So how do we get out of this mess? Simple. Government shouldn’t augment demand, it should augment supply. One of the best performing companies in America in the last 20 years has been Federal Express. What do they do? Exactly what the US Postal Service does. They must do it pretty well, because the Post Office isn’t half bad, and yet they stay in business. That’s my model for how health care should work. Federal and state government should collaborate (federal dollars, state implementation and accountability) to provide free or very inexpensive health care to all comers. The free market, the remaining private system, would have to compete and provide value (low cost as well as high quality) in order to survive. Everybody would have access to good quality care. Those who felt superior to the government service would be free to buy the good stuff privately, and they would probably get a decent deal on it.

Merit Goods Inflation Part I

I have a few thoughts to share on price inflation in health care and private college education.

Part I

My theory is that inflation in these areas results from solving the problem in the wrong way: by giving more purchasing power to the customer, rather than by providing the service directly.

We want people to be able to afford health care and education, so we help them to pay for it. We subsidize health insurance through the tax code and actually give free health insurance to a portion of the population through Medicare and Medicaid. As for education, we provide Pell grants and subsidize student loans. As a result, people can go to the doctor, get cared for and get some help with the bill. Or they can apply for assistance and loans, go to college and graduate, usually with tens of thousands of dollars in loans. If only a handful of people got these benefits and there were no effect on the market for the goods, the only inefficiency would be the time and effort spent applying to these great programs. But millions benefit and there is a pronounced upward impact on price and a very positive effect on supply. In response to the dollars, we make and sell some great stuff to customers with a lot of dollars to spend, albeit dollars designated for these particular goods. Our education system is top-heavy with Cadillacs; tuition at top private colleges comes with a price tag of $50,000 or more, and we have the finest health care in the world, as long as we focus just on the quality of the product. Americans have access to MRIs, Viagra, arthroscopic surgery, plus all the research from MD Anderson, the Harvard Medical School, the Mayo Clinic, and so on.

The supply response to the increased buying power of patients and students is a great thing and a pernicious thing. It’s great because health care and education are unalloyed goods for our society. We all benefit when these goods are broadly distributed. But the high cost of medical care has become a disadvantage for American business and a big hit on the wallet of individuals paying for their own insurance or for health care directly. In addition, health insurers have become so cost-conscious, their greatest focus is on selection, having become extremely choosey about who they are willing to insure, making life very hard for unlucky people with pre-existing medical conditions and creating an adverse selection bias for the governmental entities that sometimes pick up those left behind.

On education, here’s an odd fact: the majority of students at most private college are on financial aid. Most come from relatively privileged families, but who can afford to spend $200,000 on tuition? The system is hardly fair for the lucky few who can afford it, and it’s not much fun for the majority, who are stuck with a decade of paying off debt. Many view top private colleges as an investment, and consider whether the additional earning power after graduation will offset the debt burden. Somehow it’s not supposed to work this way.