January 2007

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Redistribution in a Model of Voting and Campaign Contributions

January 22, 2007 in Academic Articles, Taxes | Permalink

On Friday I attended a job market talk by recent Harvad PhD graduate Filipe Campante. Mr. Campante’s job market paper discussed how the equilibrium level of redistribution changes as inequality in a society increases.

The author sensibly assumes wealth is distributed in a according to a Pareto distribution. Individuals choose a tax level in order to maximize disposable wealth:

  • wdi=(1-τ)wi+T
  • T=τW-φ(τ)

The variable wi represents pre-tax wealth and wdi is after-tax wealth. The constant marginal tax rate is τ and the lump sum redistribution amount is T. The convex function φ(τ) represents economic or administrative costs to redistribution. Since the distribution of wealth is pareto, all individuals whose pre-tax wealth is above the mean wealth level, (W), will desire no redistribution (τ=0). Those with wealth below the mean will prefer taxes to be (1-wi/W). In equilibrium, the tax rate will be equal to the desired tax rate of the median voter. Since the wealth distribution is pareto, the median individual’s wealth level is below the mean wealth and thus some redistribution will take place.

Adding campaign contributions to the model

The central proposition Campante makes is that inequality will alter the traditional median voter predictions if we take into account campaign contributions. Consumers are assumed to vote or donate to political campaign because they gain utility from this action. This direct utility from civic participation is needed since a rational individual would realize that their vote has a measure 0 likelihood of changing the election’s outcome. Campante also gives evidence that any one individual’s contributions also will not change the outcome of the election. Some empirical findings are:

  1. Contributions are typically very small and unable to change an election outcomes (the median contribution is around $500)
  2. Contributions are strongly related to personal income
  3. Contributions are strongly related to other forms of political participation, such as turnout
  4. Parties largely use contributions to increase the turnout of potential supporters

The author assumes contributions are proportional to income. Also, there are two parties: one for the rich (R) and one for the destitute (D). Party R favors less redistribution and party D favors more redistribution. A clever theoretical model is developed which finds that as inequality increases from complete equality, the society will favor more redistribution at first. This is due to the fact that when inequality increases, the median voter is relatively poorer and thus favors more redistribution (i.e.: an increase in τ). However, as inequality increases past a critical value, σ*, more and more wealth will fall into the hands of the supporters of party R. Party R will receive significantly more campaign contributions than Party D and thus the voter turnout for the supporters of Party R will be higher than the turnout for Party D. Thus, income redistribution, τ, will decrease as income inequality increases past the critical value σ*.

To summarize, when inequality increases there are two effects: 1) the median voter will prefer more and more redistribution and 2) Party R will receive a higher and higher percentage of the political contributions. Effect 1 dominates when inequality is relatively low and effect 2 dominates when inequality is relatively high.

Empirical Work

While the theoretical section of this paper is interesting, the empirical section is less significant. The author does not test whether redistribution increases with inequality—which is what the model proposes—but only whether campaign contributions increase with inequality. Campante finds that the amount, but not the number, of campaign contributions increases with inequality. This evidence is predicted by the theoretical model developed, but does not prove the theory since the regressions are based on campaign contributions and not redistribution levels.

GoozNews on Bush Health Care Plan

January 21, 2007 in Current Events | Permalink

Check out Merrill Goozner’s early look at President Bush’s health care plan, which will be unveiled on Tuesday during the president’s state of the union address.

The Onion’s take on The Economist readers

January 19, 2007 in Miscellaneous | Permalink

Here’s an article from The Onion which will bring some levity to your Friday. “According to The Economist…“

Manhattan Institute

January 18, 2007 in Current Events, Pharmaceuticals | Permalink

The Manhattan Institute’s Center for Medical Progress has some interesting articles on health care policy.  The Center “…is dedicated to articulating the importance of medical progress and the connection between free-market institutions…”

One paper of note is by Vernon, Santerre and Giaccotto (“Are Drug Price Controls good for your Health“).  The authors examine the Medicare Prescription Drug, Improvement and Modernization Act (MMA) of 2003 and the possibility that the bill could be extended to allow Medicare to negotiate price decrease directly with the pharmaceutical firms.  The authors astutely observe that federal government negotiation with pharmaceutical firms will create a near monopsony.  This will reduce price charged to consumers initially, but at the cost of a reduction in new drug innovation in the future.  To quote from the executive summary:

“…the MMA will dramatically reduce both real drug prices and R&D spending. We estimate that real drug prices will decline by 67.5 percent (or about 49 percent lower than pre-MMA levels) if purchases under the MMA are treated in the same manner as drug purchases under Medicaid and the VA have been treated historically. We further estimate that this decline will reduce R&D spending by 39.4 percent, or $372 billion over the lifetime of the act. This translates into a reduction of 277 million life years. “

Price controls may save money in the short run, but at significant cost in the long run.

Good News: Cancer rates fall

January 17, 2007 in Current Events, Medical Studies | Permalink

With so much negative news on how ‘our health care system is failing,’ it is nice to see that “failure” may be an overstatement.  According to the USA Today (“Cancer Deaths Drop“), the American Cancer Society reports that cancer rates have fallen for the second straight year.

This is great news.  The National Center for Health Statistic’s 2004 Mortality Data show that cancer is the #2 killer in America.  This table—cancer is listed as malignant neoplasms—shows that cancer causes half a million deaths per year, or 23.1% of all deaths in the U.S.  Let us hope the trend of reduced cancer deaths continues.

Cavalcade of Risk #17 is up

January 17, 2007 in Carnivals | Permalink

The latest edition of the Cavalcade of Risk is up at David E. Williams’ Health Business Blog.

  • Check out an interesting post at InsureBlog which asks why there are so many uninsured when Medicaid supposedly covers most individuals who earn less than 2 times the poverty line.
  • I also enjoyed the clever idea of Bryan Fleming’s million dollar savings club.  My own back of the envelope calculation find that if you save $1/day, invest $1/day and give away $1/day, you will reach $1 million dollars in financial asset in 37 years (with a 4% savings return and an 8% investment return) or in 32 years (with using 5% and 10% returns instead).
  • Finally, if you need some motivation to try something new, Brian Kim’s article explains how an old dog can learn new risks.

Libertarian Paternalism

January 17, 2007 in Academic Articles, Economics - General | Permalink

The latest oxymoron to come across my desk is ‘Libertarian Paternalism.’ Richard Thalar and Cass Sunstein (2003) claim that people often make choices that are not in their best interest. The authors “…emphasize the possibility that in some cases individuals make inferior choices, choices that they would change if they had complete information, unlimited cognitive abilities, and no lack of willpower.” The authors cite the Madrian and Shea (2001) and Choi, et al. (2002) papers that find that 401(k) enrollment rises significantly when the default setting for new employees is automatic enrollment. If individuals were perfectly rational, the default setting would have no impact on the choices made.

A more abstract example is given in the paper:

“Consider the problem facing the director of a company cafeteria who discovers that the order in which food is arranged influences the choices people make. To simplify, consider three alternative strategies: (1) she could make choices that she thinks would make the customers bets off; (2) she could make choices at random; or (3) she could maliciously choose items that she thinks would make the customers as obese as possible. Option 1 appears to be paternalistic, which it is, but would anyone advocate options 2 or 3?”

The article claims that paternalism is inevitable—which is true in a limited sense. Given that a regulation is made, the details of the regulations can, and likely should, be made in a paternalistic manner. One could, of course, not have the regulation in the first place. While the “libertarian paternalism” appears to be a moderate doctrine at first glance, I think it is more or less good old paternalism in new clothes. When should paternalism should be considered of the libertarian variety and when should it be considered invasive government action.

If this paper is seen as call for pragmatism (i.e.: libertarianism should be tempered by the complexities of reality), I think it is a success. Seeing libertarian pragmatism as a cure-all for most policy issues, however, I believe is naive.

Cafe Hayek has more discussion of libertarian paternalism.

Sight for sore eyes

January 16, 2007 in Current Events, Health Care in Developing Nations | Permalink

The Economist magazine (“Pyramid power“) has an interesting article on how to get reading glasses to poor individuals in third world countries. Below are two excerpts:

Government health clinics are understandably preoccupied with life-threatening maladies and urban optical shops typically shun simple reading glasses in favour of costly, high-margin prescription glasses. But this neglect takes a dramatic toll even on illiterates: farmers can no longer identify pests and choose the proper pesticides, craftsmen cannot manage fine handiwork, seamstresses cannot sew. As their sight fades, so does their income.

Unsurprisingly, The Economist looks to a market-based solution to the problem: “micro-franchising.”

“We deliver a ‘business-in-a-box’ to local entrepreneurs, train them and enable them to make money helping people see better,â€? [Dr. Kassalow] says. Each pair of glasses that Scojo provides to these entrepreneurs costs the firm about $1 to make and deliver. The franchisee pays it $2 or so and sells for about $3. Because every step of the value chain is profitable, the business model is sustainable. Profits are reinvested to expand the scheme. Scojo has sold 50,000 pairs of glasses so far and is aiming for 1m pairs by 2010 and 10m by 2016.

Micro-franchising may be successful when there are supply chain issues or individuals in third world countries are ignorant of new technologies available to them. These issues often occur in the health care industry. In other sectors, however, which need to be more responsive to local consumer demand, centralized micro-franchising may not be as successful.

Universal Health Insurance in Wisconsin

January 15, 2007 in Current Events, Health Insurance | Permalink

Over the past week, I have discussed California’s proposal to extend health insurance to all individuals. Today, I will examine—in my mind—a superior plan developed by former Republican Rep. Curt Gielow. According to a concept paper from the Wisconsin Health Plan website, the reforms will have the following impact:

“All eligible Wisconsin residents receive a “Premium Credit,â€? which the participant uses to purchase health insurance from competing, qualifying health insurance plans. In addition, all adults (age 18-64) also receive a Health Savings Account (HSA), funded at $500 each year.”

Eligible residents include all individuals living in Wisconsin for six or more months except for those eligible for Medicaid (BadgerCare), government employees and those incarcerated. In comparison to the California proposal, this “The Wisconsin Health Plan” is truly a universal entitlement in that there is no means testing.

Having some form of health insurance is seen by many as an important goal for an equitable society. On the other hand, giving away free health care—which in essence defines full insurance—will lead to spiraling costs and overuse of medical services. I applaud the Wisconsin plan for attempting to use some market-based mechanisms to contain costs. The Tier 1 plans set a $1200 annual deductible, a 10%-20% coinsurance rate with an out-of-pocket maximum of $2000 per person or $3000 per family. The child benefit package is more generous with the same coinsurance rates but an annual deductible of $100 and a maximum out of pocket expense of $500. Tier 1 insurance is free to residents but those who wish to have more comprehensive insurance (which is subdivided into Tier 2 and Tier 3 coverage) can purchase this type of insurance at an increased premium level. It is wise to give consumers some choice in their insurance type; having the default coverage include higher deductibles and coinsurance rates will create more efficient medical care allocation.

The Milwaukee Journal Sentinel also reports (“Big, Bold Plan?“) regarding another of the plan’s purported cost saving innovations:

“The Wisconsin plan would wisely make use of market-based incentives to control rising health care costs and save money. This would be accomplished by putting everyone in a state health insurance purchasing pool, patterned after the successful pool that already exists for state employees…Due to the sheer number of people in the plan, the pool would seemingly have the purchasing clout to convince health care providers and insurers to bid to provide high-quality care at competitive prices.”

‘Wisely’ is not the word I would use. The single payer system will reduce prices in the short run, but without competition between plans, hospitals and doctors will face a monopsony. This will likely decrease prices in the short-run but reduce the quantity and/or quality of services provided in the long run. The true value of a service will be unknown in a single buyer system and thus over-purchasing of inessential services and under-purchasing of more valuable—especially newer, more innovative—medical services will occur.

Critics assail the plan’s high cost and the increased payroll taxes as major obstacles to the plan. A study by M. Scott Niederjohn and Mark C. Schug claim that “payroll taxes assessed on Wisconsin businesses and employees would need to be more than 17% instead of the proposed nearly 13%.” Also, the plan states that “Any insurer (for example, HMOs, PPOs, or indemnity carriers) licensed to sell health insurance in Wisconsin — and that meets specified financial, coverage area, and disclosure standards — is qualified to compete to provide insurance coverage.” If the state, and not the insurers, is the entity negotiating prices and services with providers, then insurer competition will become very minimal.

I applaud the Wisconsin Plan, especially for allowing some consumer choice, for forcing consumers to face some of the cost of their medical services through coinsurance and deductible payments, and by making the program universal. The regulatory tiers should not be necessary; a simple minimal level of coverage would suffice with households paying extra for any type of insurance they required. I do not believe that the single-payer system proposed by the state will be cost-saving in the long-run. While the Wisconsin Plan is not optimal, it is a major step forward towards providing health care for all residents in a (relatively) affordable and efficient manner.

Manpower

January 12, 2007 in Current Events, Economics - General | Permalink

For Labor Economists, the Economist magazine has an interesting story (“The world of work“) of the Manpower corporation. Manpower is a global corporation with their headquarters located in my hometown of Milwaukee. If you look at the Fortune 500 list, Manpower can be found at number 136. Below is an excerpt from the beginning of the magazine’s piece:

“Manpower was founded in 1948 when two Milwaukee lawyers, spurred by their failure to find extra administrative help for an urgent legal brief, started a business to provide temporary staff. Today, as is clear from the many national flags that fly, somewhat incongruously, United Nations-style outside its otherwise nondescript headquarters off a suburban Milwaukee highway, the firm is truly global. It has 27,000 full-time employees working in 4,400 offices in 73 countries. It is from those countries that a picture of the changing world of work emerges.”

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