The economics of the Car Allowance Rebate System (CARS) and the First-Time-Home-Buyer Tax Credit (FTHBTC)

A student in my managerial economics course asked me a very interesting question today concerning the U.S. federal government’s “Cash for Clunkers” (also known as “CARS”, which is an acronym for “Car Allowance Rebate System”) program.  Specifically, she was interested in knowing how to assess the social costs and benefits of government programs like CARS from an economics perspective.

Let’s look at CARS and its cousin, the so-called “first-time-home-buyer tax credit” (FTHBTC).  It’s worthwhile reading the October 28 Edmunds.com article about the economics of CARS.  Apparently the net cost to taxpayers of CARS, per marginal sale, was $24,000.  Coincidentally, MIT economist (and former IMF chief economist) Simon Johnson published a Washington Post article about FTHBTC earlier this week which reports a net cost to taxpayers of FTHBTC of between $43,000 to $80,000 per marginal sale.  Thus the net effect of both policies has been to create a rather muted, temporary, and highly inefficient stimulus at a substantial cost to the taxpayer (the same points could be made about any number of other stimulus measures taken this year by the U.S. government, but I digress).  Professor Johnson notes (and I agree) that “Putting cash in pockets does have a stimulative effect because some of that cash will turn into consumption. But as far as stimulus measures go, it has a low multiplier (the ratio of new economic activity to stimulus spending).” 

In the case of CARS, a social cost of $24,000 provides a maximum net private benefit of $4,500 (note that the clunker would have to be literally worthless in order for the net private benefit to be equal to $4,500!), and in the case of FTHBTC, a social cost of $43,000 – $80,000 provides a maximum net private benefit of $8,000 (note that since the FTHBTC is means-tested, the average net benefit must be less than the $8,000 maximum).  In the case of FTHBTC, Professor Johnson asserts (and I agree), that most, if not all of the private benefit (i.e., additional “surplus”) is enjoyed by the seller of the home in the form of a higher price than she would have otherwise received from the buyer in the absence of the FTHBTC.  With the FTHBTC, the buyer will naturally become less reticent about paying top dollar for owner-occupied housing because up to $8,000 of the price is covered by taxpayers (also note that other public policies such as the tax deductibility of mortgage interest and mortgage securitization by the likes of Fannie Mae, Freddie Mac, the FHA, et al. have similar effects with respect to inflating the value of our nation’s housing stock).  For these very same reasons, I also suspect that much of the “surplus” associated with CARS ended up benefitting sellers by making new car buyers less price sensitive than they otherwise would have been.

Finally, bringing this question “closer to home”, I often think about the economic effect of government subsidies on higher education.  To the extent that the government subsidizes tuition (e.g., in the form of scholarships and below-market interest rates on student loans) this also has the effect of increasing the producer surplus enjoyed by universities by making students and their families less sensitive to price.  I am convinced that an important reason why education costs generally and higher education costs specifically have been increasing faster than overall inflation for some time now is due to the role played by government subsidies.  There’s also an obvious cautionary tale in all of this for health care reform, but I’ll leave that to a future discussion.

Assorted Links (10/31/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Finance and the Financial Crisis

“Neither the rating agencies’ mistakes nor the overleveraging by financial firms was the fault of an academic hypothesis.”

Foreign Policy

“Military experts say that President Obama is intellectually sophisticated, but they do not know if he has the determination needed from a war president.”

“Is there anything he (Barack Obama) hasn’t blamed George W. Bush for? The economy, global warming, the credit crisis, Middle East stalemate, the deficit, anti-Americanism abroad — everything but swine flu. It’s as if Obama’s presidency hasn’t really started. He’s still taking inventory of the Bush years. Just this Monday, he referred to ‘long years of drift’ in Afghanistan in order to, I suppose, explain away his own, well, yearlong drift on Afghanistan.”

Health Care Reform

Here’s how one of my favorite policy wonks (Keith Hennessey) is handicapping the health care reform legislative “process” that is currently going on inside the Beltway…

Math and Statistics

“Real-Estate Developers Factor In Love of 6 and 8, Fear of Unlucky 4 and 13; What Happened to Floors 40 Through 59?”  Mr. Bialik’s blog entry entitled “

Politics

“When I see those in government, both locally and in Washington, spend and tax and come up each day with new ways to spend and tax—health care, cap and trade, etc.—I think: Why aren’t they worried about the impact of what they’re doing? Why do they think America is so strong it can take endless abuse?”

Public Policy

This blog posting by Professor Mankiw shows how the tax burden, expressed in terms of “average marginal” personal tax rates, has changed over time during the period 1912–2006.

“U.S. regulations are too cautious. Europe has adopted a more sensible approach.”

Assorted Links (10/27/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Climate Change

“Global warming might be solved with a helium balloon and a few miles of garden hose …Part of the genius of Marxism, and a reason for its enduring appeal, is that it fed man’s neurotic fear of social catastrophe while providing an avenue for moral transcendence. It’s just the same with global warming, which is what makes the clear-eyed analysis in “SuperFreakonomics” so timely and important.”

Economics

“Easy money from the Fed hasn’t translated into more consumer lending by banks.”

Health Care Reform

“Not long after that, Senate majority leader Harry Reid announced that the Senate bill will include the public option. Here’s how the Intrade contract on passage of a bill with a public option by year’s end moved on the news”:

Politics and Public Policy

“Whenever he must make a difficult decision, Mr. Obama complains it’s Bush’s fault.”

“The effort to cap executives’ compensation is a good example of overconfidence in government to solve everything.”

Assorted Links (10/26/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Behavioral Economics

  • Lessons from an Ad Man

Rory Sutherland wows a TED conference audience with a compelling and highly entertaining sixteen minute talk on advertising and aspects of behavioral economics.  I particularly enjoyed the “market research” segment toward the end of the video on Shreddies, Diamond Shreddies, and the Diamond Shreddies Combo Pack. Hat tip to Tutor2u!

Health Care Reform

“Americans seem to like the idea of broadening health insurance coverage, but they may not want to be forced to buy it. With health care costs high and rising, such government mandates would make many people worse off.”

“The health-care debate is part of a larger moral struggle over the free-enterprise system.”

“In the health care debate, the ‘public plan’ is all things to all people. For supporters, it would discipline greedy private insurers and make health coverage affordable. For detractors, it’s a way station on the path to a single-payer insurance system of government-run health care. In reality, the public plan is mostly an exercise in political avoidance: It pretends to control costs and improve access to quality care when it doesn’t.”

Politics

“Our liberal op-ed writers don’t think a president from Chicago is tough enough.”

“In the health care debate, the ‘public plan’ is all things to all people. For supporters, it would discipline greedy private insurers and make health coverage affordable. For detractors, it’s a way station on the path to a single-payer insurance system of government-run health care. In reality, the public plan is mostly an exercise in political avoidance: It pretends to control costs and improve access to quality care when it doesn’t.”

Public Policy and Finance

“Here’s a hot tip: Want to keep companies honest, make the markets work more efficiently and encourage investors to diversify? Let insiders buy and sell, argues Donald J. Boudreaux.”

SuperFreakonomics

Tonight on ABC’s 20/20 program, the entire show will be devoted to SuperFreakonomics (subtitled “Global Cooling, Patriotic Prostitutes, and Why Suicide Bombers Should Buy Life Insurance”).  SuperFreakonomics is the recently released sequel to Freakonomics (subtitled “A Rogue Economist Explores the Hidden Side of Everything”) which appeared in 2005.  The authors of both books are Steven Levitt and Stephen Dubner.  Levitt is an economics professor at the University of Chicago and the 2003 winner of the John Bates Clark medal (“awarded biennially … to that American economist under the age of forty who is judged to have made the most significant contribution to economic thought and knowledge”; for what it’s worth, roughly 40% of the Clark medalists have subsequently received the Nobel Prize in economics).  Dubner is an award-winning author and journalist who lives in New York.

Anyway, tonight’s 20/20 program will air five segments, all of which can be previewed online: handwashing in hospitals, the effectiveness of car seats, how practice trumps talent, the dirty truth about altruism, and the problems with global warming.  If you’re interested in following the Freakonomics blog, it is located at http://freakonomics.blogs.nytimes.com

Assorted Links (10/23/2009)

Here’s a list of articles that I have been reading today (organized by topic):

The Economy

This webpage features an interactive chart, based upon the 2008 CIA World Factbook, of per capita GDP for the vast majority of countries in the world.  According to this webpage, the average per capita GDP worldwide during 2008 was $15,162; in America, it was $47,000.  Liechtenstein was the highest, clocking in at $118,000, and Zimbabwe was the lowest, at $200.

Financial Crisis

“Don’t be fooled by the bond market. Banks are holding prices down because they can buy Treasurys with free money from the Fed.”

Health Care Reform

 “All of the president’s “fixes” will just create new problems.”

“In the Wrangle Over Health Care, a Low Rating for the U.S. System Keeps Emerging Despite Evident Shortcomings in Study”. Also see Mr. Bialik’s blog posting entitled “The Trouble With Ranking National Health-Care Systems” for a more technical version of this article.

Highly Recommended

I completely agree with Mr. Frakt’s enthusiastic endorsement of EconTalk, Econtalk podcasts follow a “talk show” format; here is a very accurate self-description of Econtalk:

“The talk show features one-on-one discussions with an eclectic mix of authors, professors, Nobel Laureates, entrepreneurs, leaders of charities and businesses, and people on the street. The emphases are on using topical books and the news to illustrate economic principles. Exploring how economics emerges in practice is a primary theme.”

Politics

“The Chamber of Commerce is only the latest target of the Chicago Gang in the White House.”

“And the American people want him to fix it.”

“Rahm Emanuel once sent a dead fish to a live pollster. Now he’s put a horse’s head in Roger Ailes’s bed.”

Executive Compensation Debate

I would like to call everyone’s attention to a formal online debate concerning executive compensation which began on Tuesday, October 20 and is scheduled to conclude on October 30th.  Later in the semester, we’ll discuss how to structure compensation to align incentives between owners and managers of firms.  However, this debate, which is sponsored by The Economistaddresses the ongoing public controversy concerning whether senior executives are worth what they are paid. 

Specifically, the motion reads as follows: “This house believes that on the whole, senior executives are worth what they are paid.”  The person defending the motion is Steven N. Kaplan, who is the Neubauer Family Professor of Entrepreneurship & Finance at the University of Chicago Booth School of Business.  Professor Kaplan may very well be one of the most widely published and prolific scholars on the topic of executive compensation.  The person who is against the motion is Nell Minow, who is Editor and Co-founder of The Corporate Library, which is an organization that bills itself as “…the leading independent source for U.S. and Canadian corporate governance and executive & director compensation information and analysis”.  Anyway, this debate should certainly be interesting to follow!

The economics of the market for swine flu vaccine

I would like to call attention to a short article entitled “Swine flu vaccines and elasticity of supply”.  The author of this article, Geoff Riley, claims that most of the swine flu market is being contested by only four companies: GlaxoSmithKline, Sanofi-Aventis, Novartis AG and AstraZeneca.  He also notes that “For students of the price mechanism it is a fascinating example of many supply and demand concepts at work: the challenge of scaling up production to meet huge levels of demand – this has involved out-sourcing, the relative importance of fixed and variable costs in developing and manufacturing/distributing a new drug, the elasticity of supply of vaccines to meet short term health requirements, the oligopolistic race to win and protect market share, economies of scale in production, the balance of power between the major buyers and the multinational drug suppliers, price discrimination tactics.”  I hope that Mr. Riley will expand further upon these topics in future blog postings.  If he does, I will be sure to pass this information along.

It appears (to me, anyway) that the U.S. is not all that well prepared this time around for either the seasonal flu or the swine flu.  Both types of flu appear to be in full swing, and yet there are pervasive shortages of both types of vaccines.  I can only hope that the situation does not deteriorate as badly as it did in 2004, which was the last time that a major vaccine shortage occurred.  Back then, the U.S. government had contracted with just two companies, Aventis (now Sanofi-Aventis) and Chiron (now a division of Novartis AG), for each firm to supply roughly 1/2 of the entire U.S. flu vaccine market that year.  The problem then was that in early October 2004, the UK’s Medicines and Healthcare Products Regulatory Agency (MHRA) suspended Chiron’s license to manufacture influenza virus vaccine in its Liverpool facility, which in turn prevented the company from releasing any of its flu vaccine product during the entire 2004-2005 influenza season.  In fact, the shortage became so severe in the U.S. that by late October 2004, numerous articles began to appear touting medical tourism to Canada for the purpose of getting vaccinated for the seasonal flu; e.g., see my 10/27/2004 blog entry entitled “Some Canadian Flu Shot Alternatives”.  Considering that (according to the Centers for Disease Control (CDC)) seasonal influenza by itself typically accounts for 140,000 hospitalizations and 40,000 deaths per year in the United States, this demonstrates how hazardous it can be to rely upon such a small number of suppliers.

Assorted Links (10/20/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Economics and the Financial Crisis

“We can solve the too-big-to-fail problem without losing the benefits of a global financial system.”

“The ‘American Recovery and Reinvestment Act of 2009’ (ARRA), was rushed through Congress on the grounds that fast-acting and temporary measures were needed to counteract the recession… All told, the Obama administration’s budget seeks to make at least 37% of ARRA’s spending and tax cuts permanent on an annual basis.”

Game Theory

Miscellaneous

“Checking in with NASA’s Cassini spacecraft, our current emissary to Saturn, some 1.5 billion kilometers (932 million miles) distant from Earth, we find it recently gathering images of the Saturnian system at equinox. During the equinox, the sunlight casts long shadows across Saturn’s rings, highlighting previously known phenomena and revealing a few never-before seen images. Cassini continues to orbit Saturn, part of its extended Equinox Mission, funded through through September 2010. A proposal for a further extension is under consideration, one that would keep Cassini in orbit until 2017, ending with a spectacular series of orbits inside the rings followed by a suicide plunge into Saturn on Sept. 15, 2017. (previously: 1, 2, 3). (23 photos total)”

Politics

“Congress should consider the costs before passing ‘cap and trade.’”

“Human rights “interfere” with President Obama’s campaign against climate change.

Assorted Links (10/19/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Art, Music and Culture

“Michael Moore’s movie, Capitalism: A Love Story, doesn’t pull any punches in its depiction of capitalism as the monster that is destroying America. Moore’s villains range from Wall Street bankers to Wal-Mart to Treasury Secretary Timothy Geithner, while capitalism’s victims include those who are losing their jobs, their houses and, in some cases, their faith in a system that is supposed to reward hard work and playing by the rules. Knowledge@Wharton asked Kent Smetters, a professor of insurance and risk management at Wharton who describes himself as “generally right of center,” to review Capitalism: A Love Story.”

The Economy

From Knowledge@Wharton, this article explains a new economic “…indicator of indicators that purports to measure the overall state of the economy on just about any given day.”

Finance

“Would you be willing to give away 1 percent of your home’s value if it meant not having to worry about losing more?”

Health Care Reform

“Government reliance on medical studies will make it harder to discard false prophecies and dogmas.”

“Middle-income families will face a big marginal rate increase.”

Law

“We tried the first World Trade Center bombers in civilian courts. In return we got 9/11 and the murder of nearly 3,000 innocents.”

Public Policy

“The FTC wants to police book reviews on Twitter.”