Friday, April 17, 2015

Snapshots of Global Military Spending

For an overview of patterns of global military spending, my go-to source is the Stockholm International Peace Research Institute. SIPRI has just published "Trends in World Military Expenditure, 2014," by Sam Perlo-Freeman, Aude Fleurant, Pieter D. Wezeman and Siemon T. Wezeman. Here are some patterns that jumped out at me.

As a starter, here's the overall pattern of global military spending since the late 1980s. Since the Great Recession hit, global military spending has dropped a bit (as measured in inflation-adjusted dollars).

Here's a table showing the 15 countries with the highest level of military spending. US is one-third of all global military spending, or to put it another way, US military spending is roughly equal to the next seven nations on the list combined. Of course, it's worth remembering that military spending doesn't buy the same outcomes in all countries; for example, the pay of a soldier in India or China is considerably lower than that in the United States. It's also interesting to me that US military spending as a share of GDP is higher than for  most of the other countries in the top 15, with the exception of Russia, Saudi Arabia, and UAE. And it's thought-provoking to compare, say, military spending in China to that in Japan and South Korea, or military spending in Russia to that in Germany and France.

Finally, here's a list of the countries where military spending is more than 4% of their GDP.
As the report notes: "A total of 20 countries—concentrated in Africa, Eastern Europe and the Middle East—spent more than 4 per cent of their GDP on the military in 2014, compared to 15 in 2013.
Only 3 of the 20 countries are functioning democracies, and the majority were involved in armed conflict in 2013–14 or had a recent history of armed conflict."
I won't editorialize here, except to note that when countries devote very high levels of GDP to military spending, they are putting their money behind a belief that using or threatening military force is in their near future.

Thursday, April 16, 2015

Natural Disasters: Insurance Costs vs. Deaths

The natural disasters that cause the highest levels of insurance losses are only rarely the same as the natural disasters that cause the greatest loss of life. Why should that be? Shouldn't a bigger disaster affect both property and lives? The economics of natural disasters (and yes, there is such a subject) offers and answer. But first, here are two lists from the Sigma report recently published by Swiss Re (No 2, 2015).

The first list shows the 40 disasters that caused the highest insurance losses from 1970 to 2014 (where the size of losses has been adjusted for inflation and converted into 2014 US dollars). The top four items on the list are: Hurricane Katrina that hit the New Orleans area in 2005 (by far the largest in terms of insurance losses), the 2011 Japanese earthquake and tsunami; Hurricane Sandy that hit the New York City area in 2012; and Hurricane Andrew that blasted Florida in 1992. The fifth item is the only disaster on the list that wasn't natural: the terrorist attacks of September 11, 2001.

Now consider a list of the top 40 disasters over the same time period from 1970 to 2014, but this time they are ranked by the number of dead and missing victims. The top five on this list are the Bangladesh storm and flood of 1970 (300,000 dead and missing); China's 1976 earthquake (255,000 dead and missing),  Haiti's 2010 earthquake (222,570 dead and missing), the 2004 earthquake and tsunami that hit Indonesia and Thailand (220,000 dead and missing), and the 2008 tropical cyclone Nargis that hit the area around Myanmar (138,300 dead and missing). Only two disasters make the top 40 on both lists: the 2011 Japanese earthquake and tsunami, and Japan's Great Hanshin earthquake of 1995.

The reason why there is so little overlap between the two lists is of course clear enough: the effects of a given natural disaster on people and property will depend to a substantial extent on what happens before and after the event. Are most of the people living in structures that comply with an appropriate building code? Have civil engineers thought about issues like flood protection? Is there an early warning system so that people have as much advance warning of the disaster as possible? How resilient is the infrastucture for electricity, communications, and transportation in the face of the disaster? Was there an advance plan before the disaster on how support services would be mobilized?

In countries with high levels of per capita income, many of these investments are already in place, and so natural disasters have the highest costs in terms of property, but relatively lower costs in terms of life. In countries with low levels of per capita income, these investments in health and safety are often not in place, and much of the property that is in place is uninsured. Thus, a 7.0 earthquake hits Haiti in 2010, and 225,000 die. A 9.0 earthquake/tsunami combination hits Japan in 2011--and remember, earthquakes are measured on a base-10 exponential scale, so a 9.0 earthquake has 100 times the shaking power of a 7.0 quake--and less than one-tenth as many people die as in Haiti.

Natural disasters will never go away, but with well-chosen advance planning, their costs to life and property can be dramatically reduced, even (or perhaps especially) in low-income countries. For an overview of some economy thinking in this area, a starting point is my post on "Economics and Natural Disasters," published November 2, 2012, in the aftermath of Hurricane Sandy.

Wednesday, April 15, 2015

How Milton Friedman Helped Invent Income Tax Withholding

[In commemoration of US federal income taxes being due today, April 15, here's a repeat of a post originally published April 12, 2014, about the beginnings of the practice of having income taxes withheld in advance from your paycheck.]

In one of the great ironies, the great economist Milton Friedman--known for his pro-market, limited government views--helped to invent government withholding of income tax. It happened early in his career, when he was working for the U.S. government during World War II. Of course, the IRS opposed the idea at the time as impractical. Friedman summarized the story in a 1995 interview with Brian Doherty published in Reason magazine. Here it is:

"I was an employee at the Treasury Department. We were in a wartime situation. How do you raise the enormous amount of taxes you need for wartime? We were all in favor of cutting inflation. I wasn't as sophisticated about how to do it then as I would be now, but there's no doubt that one of the ways to avoid inflation was to finance as large a fraction of current spending with tax money as possible.
In World War I, a very small fraction of the total war expenditure was financed by taxes, so we had a doubling of prices during the war and after the war. At the outbreak of World War II, the Treasury was determined not to make the same mistake again.
You could not do that during wartime or peacetime without withholding. And so people at the Treasury tax research department, where I was working, investigated various methods of withholding. I was one of the small technical group that worked on developing it.
One of the major opponents of the idea was the IRS. Because every organization knows that the only way you can do anything is the way they've always been doing it. This was something new, and they kept telling us how impossible it was. It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it's a great mistake for peacetime, but in 1941-43, all of us were concentrating on the war.
I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now."

Tax Expenditures

[In commemoration of US federal income taxes being due today, April 15, here is an updated version of a post that appeared on April 15, 2013, with the table and numbers updated to reflect the information in the proposed federal budget released by the White House Office of Management and Budget in February of this year.] 

In the lingo of government budgets, a "tax expenditure" is a provision of the tax code that looks like government spending: that is, it takes tax money that the government would otherwise have collected and directs it toward some social priority. Each year, the Analytical Perspectives volume that is published with the president's proposed budget has a chapter on tax expenditures.

Here's a list of the most expensive tax expenditures, although you probably need to expand the picture to read it. The provisions are ranked by the amount that they will reduce government revenues over the next five years. It includes all provisions that are projected to reduce tax revenue by at least $10 billion in 2015.

Here are some reactions:

1) The monetary amounts here are large. Any analysis of tax expenditures is always sprinkled with warnings that you can't just add up the revenue costs, because a number of these provisions interact with each other in different ways. With that warning duly noted, I'll just point out that the list of items here would add up to about $1 trillion in 2014.

2) It is not a coincidence that certain areas of the economy that get enormous tax expenditures have also been trouble spots. For example, surely one reason that health costs have risen so far, so fast, relates to the top item on this list, the fact that employer contributions to health insurance and medical care costs are not taxed as income. If they were taxed as income, and the government collected an additional $206 billion in revenue, my guess is that such plans would be less lucrative. Similarly, one of the reasons that Americans spend so much on housing is the second item on the list, that mortgage interest on owner-occupied housing is deductible from taxes. Without this deductibility, the housing price bubble of the mid-2000s would have been less likely to inflate. Just for the record, I have nothing personal against either health care or homeownership! Indeed, it's easy to come up with plausible justifications for many of the items on this list. But when activities get special tax treatment, there are consequences.

3) Most of these tax expenditure provisions have their greatest effect for those with higher levels of income. For example, those with lower income levels who don't itemize deductions on their taxes get no benefit from the deductibility of mortgage interest or charitable contributions or state and local taxes. Those who live in more expensive houses, and occupy higher income tax brackets, get more benefit from the deductibility of mortgage interest. Those in higher tax brackets also get more benefit when employer-paid health and pension benefits are not counted as income.

4) These tax expenditures offer one possible mechanism to ease America's budget and economic woes, as I have argued on this blog before (for example, here and here). Cut a deal to scale back on tax expenditures. Use the funds raised for some combination of lower marginal tax rates and deficit reduction. Such a deal could be beneficial for addressing the budget deficit, encouraging economic growth, raising tax revenues collected from those with high income levels, and reducing tax-induced distortions in the economy You may say I'm a dreamer, but I'm not the only one. After all, a bipartisan deal to broaden the tax base and cut marginal rates was passed in 1986, when the president and the Senate were led by one party while the House of Representatives was led by the other party.

When Government Pre-Fills Income Tax Returns

[In commemoration of US federal income taxes being due today, April 15, here's a repeat of a post from April 15, 2014, on the subject of government filling out your taxes for you.]

As Americans hit that annual April 15 deadline for filing income tax returns, they may wish to contemplate how it's done in Denmark. Since 2008, in Denmark the government sends you a tax assessment notice: that is, either the refund you can receive or the amount you owe. It includes an on-line link to a website where you can look to see how the government calculated your taxes. If the underlying information about your financial situation is incorrect, you remain responsible for correcting it. But if you are OK with the calculation, as about 80% of Danish taxpayers are, you send a confirmation note, and either send off a check or wait to receive one.

This is called a "pre-filled" tax return. As discussed in OECD report Tax Administration 2013: Comparative Information on OECD and Other Advanced and Emerging Economies: "One of the more significant developments in tax return process design and the use of technology by revenue bodies over the last decade or so concerns the emergence of systems of pre-filled tax returns for the PIT [personal income tax]." After all, most high-income governments already have data from employers on wages paid and taxes withheld, as well as data from financial institutions on interest paid. For a considerable number of taxpayers, that's pretty much all the third-party information that's needed to calculate their taxes. The OECD reports:
"Seven revenue bodies (i.e. Chile, Denmark, Finland, Malta, New Zealand, Norway, and Sweden) provide a capability that is able to generate at year-end a fully completed tax return (or its equivalent) in electronic and/or paper form for the majority of taxpayers required to file tax returns while three bodies (i.e. Singapore, South Africa, Spain, and Turkey) achieved this outcome in 2011 for between 30-50% of their personal taxpayers. [And yes, I count four countries in this category, not three, but so it goes.] In addition to the countries mentioned, substantial use of pre-filling to partially complete tax returns was reported by seven other revenue bodies -- Australia, Estonia, France, Hong Kong, Iceland, Italy, Lithuania, and Portugal. [And yes, I count eight countries in this category, not seven, but so it goes.] Overall, almost half of surveyed revenue bodies reported some use of prefilling ..."

For the United States, the OECD report notes that in 2011, zero percent of returns were pre-filled. Could pre-filling work in the U.S.? Austan Goolsbee provided a detailed proposal for how prefilling might work for the United States in a July 2006 paper, "The Simple Return: Reducing America's Tax Burden Through Return-Free Filing." He wrote:

"Around two-thirds of taxpayers take only the standard deduction and do not itemize. Frequently, all of their income is solely from wages from one employer and interest income from one bank. For almost all of these people, the IRS already receives information about each of their sources of income directly from their employers and banks. The IRS then asks these same people to spend time gathering documents and filling out tax forms, or to spend money paying tax preparers to do it. In essence, these taxpayers are just copying into a tax return information that the IRS already receives independently. The Simple Return would have the IRS take the information about income directly from the employers and banks and, if the person's tax status were simple enough, send that taxpayer a return prefilled with the information. The program would be voluntary. Anyone who preferred to fill out his own tax form, or to pay a tax preparer to do it, would just throw the Simple Return away and file his taxes the way he does now. For the millions of taxpayers who could use the Simple Return, however, filing a tax return would entail nothing more than checking the numbers, signing the return, and then either sending a check or getting a refund. ... The Simple Return might apply to as many as 40 percent of Americans, for whom it could save up to 225 million hours of time and more than $2 billion a year in tax preparation fees. Converting the time savings into a monetary value by multiplying the hours saved by the wage rates of typical taxpayers, the Simple Return system would be the equivalent of reducing the tax burden for this group by about $44 billion over ten years."
Most of this benefit would flow to those with lower income levels. The IRS would save money, too, from not having to deal with as many incomplete, erroneous, or nonexistent forms.

For the U.S., the main practical difficulty that prevents a move to pre-filling is that with present arrangements, the IRS doesn't get the information about wages and interest payments from the previous year quickly enough to prefill income tax forms, send them out, and get answers back from people by the traditional April 15 timeline. The 2013 report of the National Taxpayer Advocate has some discussion related to these issues in Section 5 of Volume 2. The report does not recommend that the IRS develop pre-filled returns. But it does advocate the expansion of "upfront matching," which means that the IRS should develop a capability to tell taxpayers in advance, before they file their return, about what their parties are reporting to the IRS about wages, interest, and even matters like mortgage interest or state and local taxes paid. If taxpayers could use this information when filling out their taxes in the first place, then at a minimum, the number of errors in tax returns could be substantially reduced. And for those with the simplest kinds of tax returns, the cost and paperwork burden of doing their taxes could be substantially reduced.

Tuesday, April 14, 2015

Moore's Law at 50

So many important aspects of the US and world economy turn on developments in information and communications technology and their effects These technologies were driving productivity growth, but will they keep doing so? These technologies have been one factor creating the rising inequality of incomes, as many middle-managers and clerical workers found themselves displaced by information technology, while a number of high-end workers found that these technologies magnified their output. Many other technological changes--like the smartphone, medical imaging technologies, decoding the human gene, or various developments in nanotechnology--are only possible based on a high volume of cheap computing power. Information technology is part of what has made the financial sector larger, as the technologies have been used for managing (and mismanaging) risks and returns in ways barely dreamed of before. The trends toward globalization and outsourcing have gotten a large boost because information technology made it easier

In turn, the driving force behind information and communications technology has been Moore's law, which can understood as the proposition that the number of components packed on to a computer chip would double every two years, implying a sharp fall in the costs and rise in the capabilities of information technology. But the capability of making transistors ever-smaller, at least with current technology, is beginning to run into physical limits.  IEEE Spectrum has published a "Special Report: 50 Years of Moore's Law," with a selection of a dozen short articles looking back at Moore's original formulation of the law, how it has developed over time, and prospects for the law continuing. Here are some highlights.

It's very hard to get an intuitive sense of the exponential power of Moore's law, but Dan Hutcheson takes a shot at it with few well-chosen sentences and a figure. He writes:
In 2014, semiconductor production facilities made some 250 billion billion (250 x 1018) transistors. This was, literally, production on an astronomical scale. Every second of that year, on average, 8 trillion transistors were produced. That figure is about 25 times the number of stars in the Milky Way and some 75 times the number of galaxies in the known universe. The rate of growth has also been extraordinary. More transistors were made in 2014 than in all the years prior to 2011.
 Here's a figure from Hutcheson showing the trends of semiconductor output and price over time. Notice that both axes are measured as logarithmic scales: that is, they rise by powers of 10. The price of a transistor was more than a dollar back in the 1950s, and now it's a billionth of a penny.

graph showing transistors by the numbers

As the engineering project of making the components on a computer chip smaller and smaller is beginning to get near some physical limits. What might happen next?

Chris Mack makes the case that Moore's law is is not a fact of nature; instead, it's the result of competition among chip-makers, who viewed it as the baseline for their technological progress, and thus set their budgets for R&D and investment according to keeping up this pace. He argues that as technological constraints begin to bind, the next step will be for combining capabilities on a chip.

I would argue that nothing about Moore’s Law was inevitable. Instead, it’s a testament to hard work, human ingenuity, and the incentives of a free market. Moore’s prediction may have started out as a fairly simple observation of a young industry. But over time it became an expectation and self-fulfilling prophecy—an ongoing act of creation by engineers and companies that saw the benefits of Moore’s Law and did their best to keep it going, or else risk falling behind the competition. ... 
Going forward, innovations in semiconductors will continue, but they won’t systematically lower transistor costs. Instead, progress will be defined by new forms of integration: gathering together disparate capabilities on a single chip to lower the system cost. This might sound a lot like the Moore’s Law 1.0 era, but in this case, we’re not looking at combining different pieces of logic into one, bigger chip. Rather, we’re talking about uniting the non-logic functions that have historically stayed separate from our silicon chips.
An early example of this is the modern cellphone camera, which incorporates an image sensor directly onto a digital signal processor using large vertical lines of copper wiring called through-silicon vias. But other examples will follow. Chip designers have just begun exploring how to integrate microelectromechanical systems, which can be used to make tiny accelerometers, gyroscopes, and even relay logic. The same goes for microfluidic sensors, which can be used to perform biological assays and environmental tests.

Andrew Huang makes the intriguing claim that a slowdown in Moore's law might be useful for other sources of productivity growth. He argues that when the power of information technology is increasing so quickly, there is an understandably heavy focus on adapting to these rapid gains. But if gains in raw information processing slow down, there would be room for more focus on making the devices that use information technology cheaper to produce, easier to use, and cost-effective in many ways.

Jonathan Koomey and Samuel Naffziger point out that computing power has become so cheap that we often aren't using what we've got--which suggests the possibility of efficiency gains in energy use and computer utilization:
Today, most computers run at peak output only a small fraction of the time (a couple of exceptions being high-performance supercomputers and Bitcoin miners). Mobile devices such as smartphones and notebook computers generally operate at their computational peak less than 1 percent of the time based on common industry measurements. Enterprise data servers spend less than 10 percent of the year operating at their peak. Even computers used to provide cloud-based Internet services operate at full blast less than half the time.
Final note: I've written about Moore's law a couple of times previously this blog, including "Checkerboard Puzzle, Moore's Law, and Growth Prospects" (February 4, 2013) and   "Moore's Law: At Least a Little While Longer" (February 18, 2014).  These posts tend to emphasize that Moore's law may still be good for a few more doublings. But at that point, the course of technological progress in information technology, for better or worse, will take some new turns.

Monday, April 13, 2015

Documenting the Investment Slowdown

There's a bubbling controversy over the "secular stagnation" hypothesis that investment levels are not only low, but likely to remain low. I've posted some thoughts on the controversy here and there:

I'm sure I'll return to the disputes over secular stagnation before too long, but for now, I just want to lay out some of the evidence documenting the investment slowdown. Such a slowdown is troublesome both for short-term reasons, because demand for investment spending is part of what should be driving a growing economy forward in the short-run, and also for long-term reasons, because investment helps to build productivity growth for increasing the standard of living in the future. The IMF asks "Private Investment: What's the Hold-Up?" in Chapter 4 of the World Economic Outlook report published in April 2015. Here's a summary of some of the IMF conclusions: 

  • The sharp contraction in private investment during the crisis, and the subsequent weak recovery, have primarily been a phenomenon of the advanced economies. For these economies, private investment has declined by an average of 25 percent since the crisis compared with precrisis forecasts, and there has been little recovery. In contrast, private investment in emerging market and developing economies has gradually slowed in recent years, following a boom in the early to mid-2000s.
  • The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump. ...
  •  The overall weakness in economic activity since the crisis appears to be the primary restraint on business investment in the advanced economies. In surveys, businesses often cite low demand as the dominant factor. Historical precedent indicates that business investment has deviated little, if at all, from what could be expected given the weakness in economic activity in recent years. ... Although the proximate cause of lower firm investment appears to be weak economic activity, this itself is due to many factors. ...
  • Beyond weak economic activity, there is some evidence that financial constraints and policy uncertainty play an independent role in retarding investment in some economies, including euro area economies with high borrowing spreads during the 2010–11 sovereign debt crisis. Additional evidence comes from the chapter’s firm-level analysis. In particular, firms in sectors that rely more on external funds, such as pharmaceuticals, have seen a larger fall in investment than other firms since the crisis. This finding is consistent with the view that a weak financial system and weak firm balance sheets have constrained investment. 
I'll just add a couple of figures that caught my eye. Here's the breakdown on how much investment levels have fallen below previous trend in the last six years across advanced economies. The blue bars show the decline relative to forecasts made in spring 2004; the red dot shows the decline relative to forecasts made in spring 2007. These don't differ by much, which tell you that that the spring 2004 forecasts of investment were looking fairly good up through 2007. The dropoff in investment for the US economy is in the middle of the pack.

It's also interesting to note that the cost of equipment has been falling over time, driven in substantial part by the fact that a lot of business equipment involves a large does of computing power, and the costs of computing power have been falling over time. Indeed, one of the arguments related to secular stagnation is that the decline in investment spending might in part be driven by the fact that investment equipment is getting cheaper over time, so firms don't need to buy as much of it. An alternative view might hold that as the price of business equipment falls, then firms should be eager to purchase more of it. Again, I won't dig into those arguments here, but the pattern itself is food for thought.