ARNOLD HARBERGER ON TAXATION by Ihering Guedes Alcoforado

“ Arnold Harberger: “That is the way I think. If you read the different articles that I have written about taxation: We put on one tax and we get a triangle in its market; now we put on a second tax and we get a triangle in this second market, but we get a new rectangle in the first market, or a parallelogram or a trapezoid. Then we put on a third tax and we get a triangle there, plus two rectangles on the goods with the first two taxes, and so on. This is general equilibrium. As in a reduced-form situation, the instrument that we’re playing
with is the tax rate. We can think of the tax rate as being imposed, like a 10% tax or, more elegantly, squeezed in as in a line integral. You squeeze up a tax rate to generate a triangle in its market, but you can get rectangles or trapezoids in related markets if they have preexisting distortions. As we change the price of beer, we have to look at what happens to the demand for wine. If the beer price is going up, then the demand for wine will go up. At every point in the raising of that tax on beer, the person who jumps over to
wine is just barely indifferent at that point. It’s an elegant, sweet concept, and I think of this as something that people absolutely have to understand in order to understand applied welfare economics well.” [HARBERGER, p.10

“[…] the difference between the partial and the general equilibrium levels is not in the size of the triangle for a given taxed commodity. Rather, it is that
in the general equilibrium case you take account of preexisting distortions that are affected by your move, and if you’re just doing partial equilibrium, you don’t. It’s very tricky. If you look at the tax on telephone calls, you put the tax on telephone calls and look at the telephone call market, and you’ve got this triangle. When I’m teaching a class, and I have that triangle, I’m telling my students, “If the only tax we have is the tax on telephone calls, this is what it looks like; it stands alone.” Another way to say this is, “If this is a general equilibrium situation, and we have a tax that has ramifications in
other distorted markets, for us to be left with just a single triangle, these other ramifications must cancel out.” That’s a perfectly reasonable thing to say to the class at that level.
But that same class should be taken through an analysis that says, “When we put this tax on telephone calls and we have an already existing tax here and another already existing subsidy there, this is how we are supposed to take those ramifications into account.” Then somebody says, “These things can be infinite.” I say, “If you’re a damned perfectionist, you’re probably right because the dXi =dPj are probably not all going to be precisely zero.” But to be practical, you would take into account those places to which people’s demand shifts when they reduce their demand for telephone calls. What
are the three or four most important places? Which of these three or four most important places has a significant distortion? Maybe only one, maybe only two; so we take into account the intersection between the items whose quantities are significantly affected by the tax you’re imposing (or the other disturbance you’re creating) and the set of items with significant preexisting distortions. You don’t need to catch all of them; you only need to deal with those that have significant distortions.” [HARBERGER, 2012:11]

ARNOLD HARBERGER: The monopoly markup as a private tax — “The monopoly markup is really just a private tax […] Life is tough. At one level, there are many, many, many entities that have some degree of control over the prices of their products. That is to say, they face somewhat-downward-sloping demand curves. We know better than to think that they look only at their existing competitors when they estimate the long-run demand curve facing themselves. They consider potential entry, as well as potential expansion of production by existing competitors, in determining the elasticity of that demand curve. If you want to think about monopoly power in the company world, I would say, “Let’s look at profits that are measured. Look at the return to capital. Let’s measure profits — everything, and say how much of that can plausibly be thought of as monopoly profits.” You’re not going to have a technical way to measure that. But I think you can say a lot of things.
You can identify some industries as pretty competitive and figure that the median one of them is earning a competitive rate of return. If somebody’s earning more than that rate of return, the difference is very likely the maximum amount that you would assign as monopoly profits. Then what you want to do is take those monopoly profits and spread them over the whole value of the goods and services produced by the entity, because monopoly profits are not a proper part of the return to capital at all”[HARBERGER, 2012:16]

“ They’re effectively the return of an excise tax, so they ought to be treated as we would an excise tax by spreading them over the whole value of the product. When you do that you get a lot of insights about the economy, and this is somewhat important in deriving our economic opportunity cost of capital for cost-benefit purposes. If we think there’s a lot of monopoly in the economy, we ought to make that spread. In making that spread, you can spread the monopoly markup over the full value of the product, or
you can pretend that materials come in fixed proportions to the product. If you do that, you can spread monopoly profits just over the return to labor and capital, which makes it simpler. In that case, you’re just dealing with two big factors of production, and you can handle the problem more nicely” [HARBERGER, 2012:16/17}

“ Definitely, the way I would go about looking for monopoly elements in an economy is: I would look at the business sector of the economy. I would look at their profits and see if they are substantially and repeatedly in excess of what that economy might reveal as a competitive return. If you have an invention or a new product, it’s a monopoly all right, but it isn’t something that you want to fight particularly, like new drugs.”17

For example, in the drug area, we seem to want monopoly profits to prevail for awhile, for we think of them as a good incentive for innovation in the drug and other industries. That doesn’t stop them from being monopoly profits, but it may stop you from doing what you might otherwise want to do about the monopoly profits [HARBERGER, 2012:17]

INDUSTRIA FARMACEUTICA “Absolutely. There you’ve got a real problem (ots of people who could be helped by a particular drug that they can’t get access to because of a 90% profit margin on some patented pharmaceutical). If we wanted to nationalize or internationalize the pharmaceutical industry, would we be getting better results than what we get with what we’ve got? Again, the length of time of patents is another story. It seems to be a very good thing that in the drug industry, these patents do in fact run out, giving us generics all over the place. It seems to be a question of time before
they get to be cheap, and the issue to which you refer is something within this time frame.”

ARNOLD HARBERGER: The Benefit-cost analysis can be applied to taxes and subsidies — “The Benefit-cost analysis can be applied to taxes and subsidies and what not, as well as to projects. From that point of view, I think of our story as centering on a profile of benefits and costs over time. This profile, itself, is the difference between two moving pictures: One is how the economy would have evolved if we didn’t pursue this investment project (or economic policy change), and the other is how the economy is
likely to evolve if we do make such a move. The profile is the difference between those two moving pictures. It doesn’t have to be a dam or a park (project). It can be a change in the law (taxes and subsidies). You can still make those two moving pictures, take their difference through time, and then take the present value. [HARBERGER, 2012:19]

HARBERGER AND THE SOCIETY FOR BENEFIT COST ANALYSIS — “ This association is a current symbol of a degree of professionalization that was not there 15 years ago. We have seen great enthusiasm from people from the
academic world, people from overseas, and people from the national government and even state and local governments who came to our meetings. It’s very heartwarming to me that we have this range of communication among us. That is going to help bring us toward my ultimate ideal, which is more professional consensus on these matters, so that we can be
more like medical doctors.
Yes, there are differences in the quality of doctors, but on the whole, you go to a doctor, and the doctor tells you what’s wrong with you and tells you how to cure it. There’s a range of areas where we can do this, and we need to get over bickering and come to a more solid professional agreement in such areas. [HARBERGER, 2012:20

HARBERGER AND THE CAPITAL RATE OF RETURN — The capital rate of return can build up to a huge sum 100 years from now. Think of it the other way: Suppose that society can benefit by 8%, let’s say, by dumping the money in the capital market. Why should one turn that down, so to speak? The cost-benefit analysis says that if we raise money from the capital market,
we are in fact losing 8% cumulatively per year as we go forward. It’s costs and benefits. We’re measuring the product of the displaced investments that don’t happen.

We’re measuring the supply price of the savings that does happen, and we’re measuring
the marginal costs of the funds drawn from abroad. All of these are genuine costs, and
the project has not paid off unless it covers those costs. To me, it’s that simple” 20/21

“ Let’s start with the capacity to predict 100 years ahead. For most
things we are facing a probability distribution that looks as wide as the world, so to speak.
It’s tremendously difficult. My instinct is to say we approach these problems as current
decision-making problems, like putting a price on carbon emissions. If you put a price
that’s enormously high on carbon emissions, all kinds of industries are going to have
to shut down. The whole economy is going to go to hell, but if you put a modest price,
then things seem to go on, and economic progress takes place; maybe people will be
satisfied, or maybe they will decide to raise that price.
In the case of the Kyoto agreement, quantity is the key variable and the price flows
out of the market. That’s fine; there are two ways to do the same thing. In each kind of
case, you might want to think about sensible, plausible, feasible policies to deal with
something that’s going to run out. What do you do? You save some of it, don’t you? The
idea that saving some of this thing that’s supposed to run out will at least extend the
time that you’ll have it. If something is going to run out, you might want to tax it heavily
in order to extend the life of the limited amounts that are available.
But if you’re talking about natural resources, what people are going to say is that —
when I was a kid, the Sunday supplements nearly every year said we had enough oil for
only 10 years. [Then 10 years passed] and they had crude reserves for another 10 years.
Here we are, nearly 90 years later, and we’re still finding more. When I worked on the
Paley Commission, they had the thought that shale oil would come in at a price not too
much higher — maybe double or maybe triple, at most, where the price was then, which
was really quite low.
Shale oil has come, but it took a hell of a lot higher price for it to happen. But it is
happening, and a lot of people have faith that technology is going to run ahead of the
exhaustion of carbon fuels. We’re going to find other ways of getting energy before those
things get to the point of drastically changing our way of life.”22

HARBERGER ON CHICAGO SCHOOL “ We have these two big fields of a modern,
quite stylized, but very professionally valued macro, with Bob Lucas and Lars Hansen,
Nancy Stokey, [John] Cochrane, and so on. Then we have another side, which is more
micro oriented. I call it human resources, with Gary Becker, [James] Heckman, Kevin
Murphy, Steve Levitt, [Robert] Topel, and others in the department, but we don’t have the
same concentration of policy-oriented people. Back in those old days, we had [Milton]
Friedman in policy-oriented money-macro. We had [T.W.] Schultz and D. Gale Johnson
in agricultural economics, policy oriented; myself and [Larry] Sjastaad in public finance,
policy oriented; George Stigler, at least semi–policy oriented; Harry Johnson, Bob Mundell,
and Jacob Frenkel in international trade. In policy economics, it’s hard to see when there
ever was a department that was so thick with people who were so deeply interested in
policy and in applying robust economics to policies. Now that part is no longer an accurate
description of Chicago, which does not stop it from being one of the top three or four
economics departments in the world” [HARBERGER, 2012:24]

“ The strongest force stems from our economics no longer emphasizing the fundamentals in the way that it did when I was a graduate student and an
undergraduate, and probably when you were a graduate student and an undergraduate.
People are not taught to think like economists in the same way that they used to be,
and they are not taught to use their eyes and ears and sense of smell to perceive and
diagnose economic situations.
I see this all around the world: Many young economists can run through mathematical
proofs of something, but they can’t detect its counterpart in the real world and know even less about what to do about it. That is a big lack. You can read my Ely lecture, which
was one of several sermons that I have preached on this subject. I haven’t changed my
opinion at all about that. I think that good, robust economics built on diagnostics and
the application of fundamentals is the way that economics has produced its greatest
contributions in the past. I think this is also the way it will continue to produce if only
we can keep on that track.” harberger, 2012:24/25

HARBERGER, Arnold., A Conversation with Arnold Harberger and Richard Just IN Annu. Rev. Resour. Econ. 2012: 4: 1–26

PESTICIDE INDUSTRY & DISTRIBUTIONAL ISSUE: — “Richard Just: “I’ve done a fair amount of work in the pesticide industry, which doesn’t have quite as great patent protection as do pharmaceuticals, but it’s probably next. There are a number of cases in which pesticides have more longevity in the market than do pharmaceuticals. There are cases where a pesticide has gone seven years past patent expiration and still has a monopoly because of certain ways to manipulate the regulatory process. Those seem like clear questions of a distributional issue that should be corrected. Does that make sense?

Arnold Harberger: It seems to. The question is: Why doesn’t somebody get in there and take advantage of the freedom to produce this good? You’re saying that maybe it isn’t real freedom. Maybe something is impeding this freedom. What is that, and what can be done about it?[HARBERGER, 2012:17]

HARBERGER AND POLLUTION EXTERNALITIES: A Law-and-Economics Problem

“ I know that pollution externalities exist, and I have seen them firsthand in cement factories. The dust goes into the air, and it ruins the agricultural industry for miles around. We have externalities in the water area all the time — people are grabbing water that they somehow ideally would not be grabbing, but they do it, and impose serious costs on downstream users. I certainly think that we can have a lot to say about this. In the water issue, we can have regulations having to do with the water table and
usage that draws down the water table.
In the stream-flow irrigation, we have a big problem connected with how you enforce upstream users to leave enough water for downstream users. It’s easy to say but maybe not easy to do. I did an evaluation of the Ullum Dam in Argentina in the middle or late 1960s. They had strict rules about leaving enough water for downstream uses on the San Juan River in Argentina in the 1960s. I don’t know how well that was enforced, but I have seen other places where there doesn’t seem to be any rule at all, and the upstream users just grab this water and screw the downstream guys. It obviously is an interesting economic problem, but I think even more it’s a law and-economics problem. How do you find some reasonable solution for this problem — not a perfect solution, but a reasonable one?[HARBERGER, 2012:17]

HARBERGER: The difference between applied welfare economics and benefit-cost analysis

“ Cost-benefit analysis is a subbranch of applied welfare economics,
and I was involved in the tax side of things early on, as well as agricultural price support analysis. Approximately a decade after I came out of Chicago, I got more and more involved in discount rates for cost-benefit analysis, in the measurement of costs and benefits for that purpose. We have a coherent, rigorous (in its own way) system of benefit cost analysis with assumptions, and our system builds on a tradition that goes back to Ricardo, [J.S.] Mill, Marshall, [Eugen] Slutsky, and [James] Meade. Our system is not full of quizzical innovations that say we’re revolutionizing something. We’re not revolutionizing; we’re building further on a very elegant structure that
was made by people like those mentioned — people smarter than ourselve.

HARBERGER AND INTERTEMPORAL PROBLEMS: Welfare economics vs.
benefit-cost analysis — “ […] (My) work in applied welfare economics has not involved this intertemporal story, but in benefit-cost analysis, because
of the way it deals with profiles over time, the intertemporal aspect is utterly essential. When we derive the economic opportunity cost of capital, we do so in a way that, to me, makes perfect sense to be shifted to almost any applied welfare economic problem.
The issue is that when you’re dealing with an economic opportunity cost of capital, you absolutely must say where that capital is coming from.[HARBERGER, 2012: 18]

There are infinite reasons why the capital market of a country is the most sensible point at which funds are extracted. Then when you extract funds to make an investment or other expenditure, you displace investment, you may stimulate a bit of savings, and you draw some capital in from abroad. Those are the natural sources, and the economic opportunity cost of capital is a weighted average of the marginal costs associated with those three sources. If somebody comes to me and says, “I am going to have a country in
which the government never gets money from the capital market and always gets it from the value-added tax,” then I’ll say, “I would use a similar weighted average here — but with weights determined by how resources are freed up by the same three sources when
the value-added tax is raised.” There’s nothing God given about the capital markets.[HARBERGER, 2012: 18]

It’s both realistic and sensible, but if somebody has a specific thing, then you have the other kind of story: What does a country do when it gets a cheap loan from abroad? We say we don’t use the interest rate on that loan as the opportunity cost. We at least pretend you could dump that loan on the country’s capital market and get the country’s rate of return.
Therefore, we would want to evaluate any projects using that loan, using the standard procedure, and using the country’s standard economic opportunity cost of capital.”[HARBERGER, 2012: 18]

HARBERGER AND THE SOCIETY FOR BENEFIT COST ANALYSIS — “ This association is a current symbol of a degree of professionalization that was not there 15 years ago. We have seen great enthusiasm from people from the
academic world, people from overseas, and people from the national government and even state and local governments who came to our meetings. It’s very heartwarming to me that we have this range of communication among us. That is going to help bring us toward my ultimate ideal, which is more professional consensus on these matters, so that we can be
more like medical doctors.
Yes, there are differences in the quality of doctors, but on the whole, you go to a doctor, and the doctor tells you what’s wrong with you and tells you how to cure it. There’s a range of areas where we can do this, and we need to get over bickering and come to a more solid professional agreement in such areas. [HARBERGER, 2012:20]

BIBLIOGRAFIA

HARBERGER, Arnold., A Conversation with Arnold Harberger and Richard Just IN Annu. Rev. Resour. Econ. 2012: 4: 1–26