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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

The job is made easier when readers have a good basic understanding of economics and how cities work.

There’s no point in trying to write Reinvent Trenton articles that provide this basic education when there are best selling books that do it much better than I ever could dream of.

Economics isn’t really about money.  It’s important to understand that.  Rather, economics is the study of causes and effects in human society and the incentives that drive our behavior.  I would recommend a basic textbook on micro and macro economics but why do that when there’s ….

Freakonomics is a fun and provocative book that explores many of life’s conundrums many of which relate directly to Trenton’s issues.  It covers crime reduction, parenting, education, government incentives and even gang life.  In addition, there’s a Freakonomics movie that updates the book and covers the basics in less than 2 hours.  Unless you’re already a PhD Economists you’ll be helped in the way you think about what drives a city by reading the book or watching the movie.

Much of what we’ve been told about cities is wrong.  This is amazing given that one of the seminal books on cities was written almost 50 years ago.  You could probably read a Master’s Degree worth of urban design and policy books and still not get a clearer view of what makes a city vibrant than by reading ….

Death and Life of Great American Cities discusses the impact of short blocks, sidewalks, zoning and government money on how cities stay relevant.  If policy makers in Trenton had read the book we wouldn’t have had the Canal Banks urban renewal, the Rt. 29 cutting off the river and our former downtown walking plaza.  There are small things we can do to fix our city but we have to be on the same page as to what works.  Jane Jacobs’ book is 600 or so pages that all of us need to understand.

There are plenty of books out there but these are the two of the most well known and arguably the best books you can read in their respective areas.    We need everyone in Trenton to be as well educated as possible about urban planning and economics as we help our government wrestle with our problems.  Short of everyone being that well-read, maybe the inquisitive and activist readers of Reinvent Trenton can be.

Eminent domain should be an issue in our 2010 elections as it is front and center in the city’s train station redevelopment plan.  Furthermore it has been used or threatened over the years in many Trenton development projects.  Do we as Trentonians want our new crop of political leaders to wield this weapon?

There are two types of negotiations: successful ones and unsuccessful ones.

A successful negotiation is where a deal is struck.  A deal can only be struck when both parties feel they have profited from it.

We’ll use the example of a developer wanting to buy a property from a homeowner.  The development is large($100,000,000) and will cost the developer $200,000 to change the plan if he can’t buy the house.  The homeowner wants $60,000 but fears it will only be worth $50,000 if he doesn’t sell because there will be a big office building next door.

There is a key concept at play here called BATNA.

• BATNA stands for Best Alternative To a Negotiated Agreement.
• Each party has an implicit BATNA and has it in the back of their mind.
• The BATNA has a certain value to the party.

With no eminent domain on the table the homeowners has the power.

For instance, in the case of a homeowner, not coming to a deal might mean they have to stay in their home.  However, the future value of their home might be diminished in the case where a developer is building around them.  So, although the homeowner might like to sell for $60,000, in the back of their mind, not coming to an agreement is unsatisfying because their properties value will be diminished.  The BATNA would therefore be the perceived value of the property after development has happened around them plus the intrinsic value of not having to move or pay transaction costs let’s say $50,000.

In the same deal, the developer has a very different situation.  He might be happy to buy for $60,000, but if he can’t make the deal bad things will happen.  His “alternative” to striking the deal is to redesign the project or maybe relocate it.  This could be expensive so it’s conceivable that the BATNA could be very high, perhaps $200,000 for a large project.

If the above negotiation is unsuccessful, everybody loses.  The homeowner’s property is de-valued AND the developer gets a big hit in costs.

In this situation you might say the homeowner has all the power, and you’d be right.  Conceptually the developer would pay up to $200,000 for the home in order to avoid change costs.  The savvy homeowner knows this, so he likely won’t settle for just $60,000 and will try to stick it to the developer.  The property is simply worth more to the developer than to the homeowner.

Conceivably they could come to a satisfying deal at very close to $200,000.   The developer can’t economically reject the deal and the homeowner would be crazy not to milk it for everything its worth.

Enter eminent domain.  Eminent domain is the power of government to condemn and force the sale of a property.

City’s and lets be clear about who the “city” is in this case.  Politicians who have an interest in new development either because they’re honest and seek tax revenues or because their dishonest and receive donations from the developers, have big interests in development.

Therefore, they have extended the use of eminent domain, from its traditional use in clearing land for roads and schools to the modern manifestation in preferring developers over small home and business owners.  There is much more tax revenue and/or graft to be had from a $100,000,000 office building than a $60,000 home.

City and state lawmakers in NJ have agreed that eminent domain should be used to tip the balance of power in a property negotiation.

With eminent domain in the mix the power shifts to the developer

The homeowner wants to sell for $60,000 but know that if he doesn’t reach a deal he’ll be forced by the city to sell at a price set by a third party.  Furthermore, he knows that it will cost up to $5,000 in lawyer’s fees to challenge the price offered by the developer.  Let’s say the homeowner spends $500 for an appraisal that says the house is worth $50,000.  The implicit BATNA is therefore $50,000 – $5,000 – $500 = $44,500.  The homeowner’s BATNA is now $5500 worse than without eminent domain.

On the other hand the developer has a different BATNA as well.  Assume the same appraisal and legal costs and the same $50,000 excepted sale price should the government have to step in.  The developer’s BATNA is therefore $50,000 + $5,000 + $500 or $55,500.

If all parties are thinking clearly they will come to a deal  likely at $44,500 because the developer has no reason to go higher than the homeowner’s BATNA.  This is $15,500 worse than $60,000 he wanted.

So what’s the problem here?

There is a gap in value of $155,500 in potential deal price for the homeowner before and after eminent domain.

In this case, we as citizens would have sanctioned the right of the developer through the power we have vested in our government to use force in such matters, to overcome that $145,000 difference.  We have said to the homeowner that his land isn’t really his to sell, it’s ours and the politicians that represent us, to do with as we please.  This legal concept has been upheld as being consistent with property rights from our days as English colonies when the King literally controlled the use of all property.

In Trenton, we can choose to use eminent domain or not.  The same is true for NJ.  However, we as Trentonians have the opportunity to decide whether our neighbors will be forced to negotiate with the effect of having a gun to their head or not.  We can choose to take eminent domain off the table or not. City council can resolve to deny eminent domain requests.

The effect of this decision will be that smaller development projects will be more likely in Trenton because large ones have the bigger requirement to acquire large parcels of land.  The overall cost of development for large projects will necessarily go up.

The negotiated deal price without eminent domain isn’t as dire as I have left it.

Remember the BATNA for the homeowner was $50,000 and for the developer it was $200,000.  There is therefore a wide range of prices, from $50,000 to $200,000 that will make both buyer and seller happy.  Studies show that more often than not (and depending on all sorts of negotiating tactics) the price will be exactly in the middle of the two BATNAs or $125,000.

The homeowner will be ecstatic and the developer will be OK.

There will certainly be homeowners that will stand in the way of progress no matter how much money they are offered.  And yes we as citizens will be held hostage to what is often a deranged approach to negotiation.  It happens.  However, we all have our reasons for loving and wanting to hold our property.  The city can wait until we’re over it.

For such a drastic action to be taken against homeowners the Train Station committee should have shown some benefits. They have a lot of questions to answer.

• Will the new buildings pay taxes? How much and when?
• What is the likelihood of long term success?  Please show your work and assumptions.
• What impact on income in Trenton will the development have?  Won’t most white collar workers commute to Trenton?  Again, show your math and be prepared to explain why secretaries in the new buildings from Trenton will simply changing jobs for the shorter commute.
• How would income levels rise?  Are these new white collar jobs going to Trenton’s unemployed?
• What costs will the city bear in upgrading infrastructure?  Be honest and include everything.
• If all we’re doing is creating secretarial jobs in Trenton so some folks can have a shorter commute then don’t we feel silly asking our neighbors to give up their homes.

There are many policy choices a city can make short of taking away peoples homes that will favor development.

• We can limit eminent domain to abandoned properties
• We can change our tax system to favor dense development (i.e. the land tax)
• We can reassess property in Trenton to force older homes to pay their fair share and put old and new development on an equal tax footing
• We can clean up our neighborhoods making them more attractive for investment
• If it’s really important to us, we can sweeten the deal for a developer (though let’s make sure the property will pay taxes)

Finally and well beyond the economics of the situation …

• Ask yourself who in the current and future crop of politicians has an interest in any aspect of the development
• Are they associated with development of any part of the project including Hope VI?
• Have they received campaign contributions from any entity involved?
• With so much money involved and so much pain likely to be caused, are we doing it for the right reasons?
• Hopefully, our journalists, competing candidates and bloggers will be able to uncover any hidden truths.

Which are you?  How do you think Obama leans?

I suspect none.

I know plenty of entrepreneurs (some successful) but not one has started a successful industrial, much less “green”, company. One can argue that the U.S has regulated all industrial production green or otherwise out of the country.

The fact is that there just aren’t that many new industrial scale companies including “green” companies making solar panels, electric cars and alternative energy production equipment.

And yet politicians at all levels of government have the arrogance to suggest that they are smart enough to prefer “green” companies over all of the other endeavors that men can set their minds to. Why so arrogant? Well, because the public buys it.

Most of us aren’t sophisticated enough to know that new business formation is extremely risky. We typically don’t understand that even when things seem obvious that they’ll work they won’t. We don’t understand the depth of investment and commitment a new industrial scale business takes. That’s why forming a successful business, needs to be very rewarding. Because, more often than not, they fail.

Yet politicians at federal, state and local levels continue to champion “green” over all other businesses. Do they know something that the rest of us don’t? Yep they know that the public will eat up their rhetoric and doesn’t understand the underlying economics of business formation. “Green” is the darling of moment and talking about it is like using candy to entice a child.

The Obama administration has perhaps taken it further than even the most arrogant politician could imagine. They are putting “green” patent applications ahead of all others. Effectively this means that a process for increasing fuel efficiency in lawn mowers will step ahead in the already long line for other patents. Fuel efficient lawnmowers could beat out a process to cure cancer. How warped. How arrogant.

Trenton has its share of arrogance. There are politicians running in the 2010 municipal elections who are touting green jobs in Trenton. Really? Are those politicians prepared to invest their own money in a solar panels or electric cars? Not likely, it would be far too risky an investment given the uncertainty of the underlying technology and the scale of worldwide competition chasing an industry that survives on government subsidies.

Instead they are counting on us to think they are singlehandedly finding jobs for the unemployable and combating global warming with just their words. If anything they’ll look for ways to use our money (tax dollars) to fund risky investments that they’ll claim are beneficial.

It’s a con.

Really, is Trenton so picky that it would turn down “non-green” business investment?

As an alternative, Reinvent Trenton suggests you pay attention to politicians who propose to create a better overall business climate in Trenton. Short of bribing businesses to locate here, how will they improve the investment atmosphere?

Today’s Trenton business atmosphere is toxic. Development is hard and cumbersome. The tax rate is high. There are few wealthy residents living here that might invest. There are few educated workers. And, Trentonians are generally hostile to industry.

Yet, in the face of these hurdles, Trenton’s politicians are talking about “green” jobs. Who do they think they’re kidding?

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