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Suppose that every day, ten men go out for beer and the bill for all ten comes to $100…

If they paid their bill the way we pay our taxes, it would go something like this… 

The first four men (the poorest) would pay nothing. 
The fifth would pay $1. 
The sixth would pay $3. 
The seventh would pay $7.. 
The eighth would pay $12. 
The ninth would pay $18. 
The tenth man (the richest) would pay $59. 

So, that’s what they decided to do.. 

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve ball. “Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by $20″. Drinks for the ten men would now cost just $80. 

The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free. But what about the other six men? The paying customers? How could they divide the $20 windfall so that everyone would get his fair share? 

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. 

So, the bar owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.

And so the fifth man, like the first four, now paid nothing (100% saving). 
The sixth now paid $2 instead of $3 (33% saving). 
The seventh now paid $5 instead of $7 (28% saving). 
The eighth now paid $9 instead of $12 (25% saving). 
The ninth now paid $14 instead of $18 (22% saving). 
The tenth now paid $49 instead of $59 (16% saving). 

Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, the men began to compare their savings. 

“I only got a dollar out of the $20 saving,” declared the sixth man. He pointed to the tenth man,”but he got $10!” 
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar too. It’s unfair that he got ten times more benefit than me!” 
“That’s true!” shouted the seventh man. “Why should he get $10 back, when I got only $2? The wealthy get all the breaks!” 
“Wait a minute,” yelled the first four men in unison, “we didn’t get anything at all. This new tax system exploits the poor!” 
The nine men surrounded the tenth and beat him up. 

The next night the tenth man didn’t show up for drinks, so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill! 

And that, boys and girls, journalists and government ministers, is how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas, where the atmosphere is somewhat friendlier. 

David R. Kamerschen, Ph.D. 
Professor of Economics. 

For those who understand, no explanation is needed. 
For those who do not understand, no explanation is possible

Which are you?  How do you think Obama leans?

It appears as though your successor, Mr. Obama, has reinterpreted your most excellent essay on the natural role of government.  Therefore, if you would be so kind, please update your declaration as edited below.

Changes are to the 1st sentence of the 2nd paragraph.

…..

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and, the pursuit of Happiness., public Healthcare, freedom from Mortgage foreclosure, a guaranteed Union auto job and Broadband access.

…..

I understand, that it will be most difficult to obtain signatures from all the founding fathers on this amended version.  However, I’m sure Mr. Obama will be most appreciative of your assistance as he endeavors to re-shape the country you and your friends set forth.

Sincere regards,

Dan Dodson

Trenton, NJ

Crossroads of the Revolution

The economic downturn and subsequent entry of the federal government in to a wide variety of private businesses left me searching for a way to think about this. I picked up my old copy of Ayn Rand’s “Atlas Shrugged” and began re-reading.

Ms. Rand treats capitalists as noble heroes and socialists as evildoers. In the book, socialists, such as Wesley Mouch, use government power to control the economy. She calls these people looters as they don’t  produce anything themselves yet they impose their will through the use of government power. Much of the book echoes the words we’re hearing today such as, “we’re doing this in the public interest”, “the poor deserve the same as the rich”, and “too big to fail”.

President Obama has literally suggested that government should compete with private enterprise to provide health insurance. His rationale is that private enterprise is not doing a good job insuring Americans. He draws the conclusion that only the government can provide low cost (to the consumer) health insurance

President Obama either has not read Ms Rand’s warnings about the slide to socialism or doesn’t care. I assume the man is well read, so I conclude he doesn’t care.

When he says government can compete with private business, what does he really mean?

There’s a fundamental difference between a private enterprise like Cigna and a government enterprise. Cigna’s investors choose to fund an enterprise that perpetuates itself by making money and delivering a return to shareholders. A private enterprise operates on a level playing field, kept level by both market forces and regulation.

A government business has taxpayers as investors who have no choice but to support the enterprise. The business does not need to return a profit. If a taxpayer decides the government business is a bad investment, he has no where to turn. He can be held at gun point until he pays his portion of tax that props up a failing government concern like Fannie Mae or Amtrak. In addition, government businesses can operate on an uneven playing field by the passage of regulations that favor its operation.

Cost savings are an illusion. There is no reason to think a government health insurance business will be any less costly than its private “competitor”. Certainly Blue Cross and Cigna have enough scale to push down costs today. A government business will not affect the fundamental cost of health care at all. Doctors, hospital, pharmaceutical companies and medical malpractice lawyers will still charge too much.

President Obama and his supporters are confusing the public on this issue. They aren’t proposing to change the cost of health care, rather they are proposing to force Americans who pay taxes to subsidize those who can’t afford it.

Why go to all this trouble? Instead why not be honest about it and add a line item on the tax bill called “subsidy for health insurance”.  As Ms. Rand predicts, President Obama and the looters won’t dare do this, for then they’ll be admitting that they are simply common criminals, stealing from tax paying Americans to give to the poor.

I’m well aware that many Republicans have strong opposition to the NEA. But at its root, the NEA is just another union. There is a natural conflict between unions and management as unions attempt to take control away from managers. The Republican party generally shares the sensibilities of managers and therefore doesn’t get much support from the union movement including the NEA.

However I do support a person’s right to form a union and to bargain collectively. It’s a free country.

The education unions just have it all wrong.

My mother and I were having a particularly heated discussion about the NEA when I finally asked her, “You’ve been in the NEA for many years now and you’re still complaining, so how’s it been working for you”. This has pretty much stopped the argument.

Opposition to school-choice has been a central position of the NEA for years. This policy position is bad for students, teachers and even unions.

Of course students are better off through the discipline of competition among schools. One only has to observe the desperate measures parents of children in underperforming districts, like Trenton, will take to sneak their kids into better systems. School systems won’t crumble either, they’ll just get smaller or maybe larger depending on how they perform. What I really want to concentrate on is the argument that choice is good for teachers.

Consider the logic:
If you are negotiating with an employer and it’s the only employer in town, then you have very little leverage because quitting is not an option for you. You would much prefer to have several employers bidding for your valuable services. While there are a small number of private and charter schools operating today, there is essentially only one employer of K-12 teachers since schools are supported by the state.

Naturally you as an employee would unionize in order to increase your bargaining position against this monolithic employer. However, you would also hope like mad that another employer would come into town. In non-governmental industries this almost always happens because a competitor knows it can poach poorly paid employees. This drives up salaries.

Even unions themselves are better off with competition. Think about the AFL-CIO’s negotiations with the auto manufacturers. They pick the most vulnerable company and target it for negotiation thereby setting the contract standard for the industry.

School-choice has been a hot topic for many years and is a key difference between Democratic and Urban Republican viewpoints. Because choice is good for both teachers and the inner-city students they serve, the Democratic agenda is out of touch with the needs of urban America.

Harvard Panel on the Financial Meltdown 9-25-2008

Basically, there are two drivers to the current problem, one of which affects Trenton and the other one, not so much.

First, the one that doesn’t. In the early part of the decade, home prices were bid up due to the ripple effect of the tech bubble. That momentum induced the mortgage industry to relax lending criteria in the face of a rising market. The more lending, the more demand and the higher the prices went. That ponzi scheme eventually collapsed.

At roughly the same time, and especially in 2003, Fannie Mae and Freddie Mac loosened their lending criteria for affordable housing programs. They, along with NJHMFA, poured money into places like Trenton at sub-prime rates, 100% financing and balloon loans. They were bottom fishing, but again, as long as housing prices went up, no problem.

In a very sick and cautionary way, the two root causes are related.  Congress put pressure on Freddie and Fannie to subsidize affordable housing partially in response to higher housing prices.  It’s quite possible that if these lower income buyers had not received subsidization then two things would have happened: 1) Freddie and Fannie wouldn’t have failed, and 2) those same buyers would be waiting on the sidelines to buy up homes when prices fell, thus allowing the financial system to unclog itself and work like it’s supposed to.

According to the S&P/Case Schiller national house price index, home prices peaked in 2006 and since then have dropped an average of 21% nationally.  In some markets, like Las Vegas, they are down more than 30%.  Oddly, Charlotte NC has seen a small rise in the same time.

Not all markets have been hurt the same.  Perhaps Trenton could have been among the more mildly affected.  Who knows?

The only thing Mayor Palmer could have done to save Trenton people from themselves would have been to revitalize the city so housing prices continued to go up in the face of a national decline.  Of course, he could have discouraged sub-prime and 100% financing for low income residents.  Instead, along with the state government, he encouraged it.  Ooops!

Revitalization remains the only thing Mayor Palmer can do to help going forward.

The facts speak for themselves – cities with high crime rates generally have poor growth rates. Cities that have somehow improved their crime rate do much better.

New York and Washington, DC are great examples of cities that have aggressively attacked their crime issues and have unleashed unprecedented economic growth. Washington used to be the most dangerous city in America and New York was supposed to be leading the country into chaos.

Looking just at New Jersey, two cities, New Brunswick and Newark are overcoming their crime issues and generating positive population growth. Meanwhile, Asbury Park, Trenton and Camden continue to scare their populations away.

Lot’s of people have lots of things to say about crime. The police say they do all they can and blame the courts for a revolving door justice system or the public for not cooperating. Children’s advocates blame lack of after-school programs. Civil rights leaders blame racism. Parents blame everybody and Bill Cosby blames parents.

A different way to look at this is by understanding the economics of crime. In the end, we are all driven by an innate internal calculus that either rationally (due to good information and clear thinking) or irrationally (due to false information and deluded thinking) lead us to do what we do. This is the basis of economic thinking and has a lot more to do with survival of the species than just dollars and cents. For a really wonderful explanation of how the economic mind works I strongly recommend readers of this blog to also read the book Freakonomics by Steven Levitt and Stephen Buner.

Freakonomics famously recounts the story of gang drug crime in Chicago in an essay called “Why do drug dealers still live with their moms”. It explores the motivations behind becoming involved in the drug trade. The analysis compares the likelihood of becoming a wealthy drug lord to the likelihood of becoming an A-List Hollywood star. It also points out that the average street pushers makes less than minimum wage. Meanwhile the risk of death at any level in the gang is higher than any other job in the world, including the military, test pilot or policeman.

What drives these young men is a well oiled system of misinformation and delusional thinking likely driven by not only gang peers but also by the media.

The low level gang member, lacking his own copy of Freakonomics, has made an irrational decision to risk his life to join the drug trade.

Let’s turn this into an example:

John has a vague notion that if he works hard at drugs he’ll almost surely, let’s say with a 75% confidence level become a millionaire drug lord. He knows there are risks, but John thinks he’s pretty tough so his risk of getting shot is no more than 1% and even if he’s arrested, let’s say a 50% chance, the likelihood of doing hard time is no more than 10%. John hasn’t written down these percentages but if you pressed him, this is what he’d come up with.

John’s not completely wrong. He’s about right with his arrest statistics because he has many data points (most of his friends have been arrested and none have done hard time). However, he’s way off on the life expectancy estimate and not even close on the odds of becoming a drug lord.

However, given the probabilities, as John sees them, the risk is worth the reward. This is especially true if he doesn’t have any credible alternatives. That is, he’s not done well in school and doesn’t understand the straight job market anyhow. John doesn’t know that a mid-level corporate manager will make much more in a lifetime than a drug lord especially since that life-time will likely be three times as long.

So what can be done to change the economic equation for John?

Look for a ReinventTrenton blogs where we explore John’s economic model in Trenton. We’ll cover the following exciting topics

Increasing the cost and risk

• The economics of police prevention
• How economic development prevents crime
• How cranky old white guys can save the day

Reducing the profit

• Suing your local drug dealer
• Take the bling, then take her ring

A credible alternative to crime

• Do mentoring programs work
• Are schools the answer
• Jobs won’t help

More clearly communicating the above

• Public humiliation as a weapon
• The Most Wanted earnings list
• Homeboys: where are they now
• Dan’s list