Patterns in static

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04 January 05. Painted lady beauty contest

People often ask me: Mr. BK of Baltimore, MD, what do you do when you're not pontificating and overintellectualizing? Well, lately, I've been tiling my kitchen floor.

It used to be crappy linoleum, and Ms. DH of Ann Arbor, MI had asked me if she could do something decent with it. She had done several small-scale mosaics in the past, and so had the experience with tile and the enthusiasm to do something better with my floor than linoleum. It turned out that this was a bit larger of a task than she had expected; most notably, she had not thought to lay the backer board which needs to go under the tile---not until we had already spent two days ripping up the linoleum. The floor now consists of the subfloor, the plywood on which the linoleum used to sit, a layer of cement, the backer board, another layer of cement, and then the tile. By the advice of a friend who is a professional in these matters, we didn't lay backer board in the bathroom, which gives the bathroom a centimeter or so drop from the hallway next to it. Further, we went with a mixed medium concept: a ceramic tile border, and then slate in the center. The ceramic is about 3 mm thick, and slate is about 6 mm.

What I'm getting at here is that it's very much a creative, multi-level experience. There's a border of blue tile, which spills into the bathroom (which is all blue), and collects in pools around the edges. Floating in the center of this is the island of slate, which is occasionally interrupted by small mosaics of mirror and tile, which have a sort of river theme.

Below are a few a photos of the kitchen and hallway, just before we placed the grout. The grout leaves a dolorous haze on everything, which I'm still trying to get off so it will be photogenic again.

Reactions to the new tile floor have been mixed. First, all but one person either agreed that it's better than the linoleum, most giving me a quizzical look in the way of `why would you ask me such a question; it's so obviously better'. [The one exception, Ms. RK of Silver Spring, MD, is famously negative.] Some thought the color scheme was a bit dark, and a number of people pointed out `it isn't level', which I take to mean `I don't know how I feel about your design decision to have a multi-level kitchen/bath/hall area'. Some thought the mosaics a bit fancy for a kitchen floor: `I'd expect to find this hanging on a wall, not on a kitchen floor.' I'm relieved to say that my roommate unequivocally likes what is now his kitchen floor.

The painted ladies I don't recall how much I'd told you about the house, dear reader, but maybe I should mention a few things. It's a Victorian-style townhouse, which the City of Baltimore tells me was built in 1900. The whole row was clearly all built at once, by a developer who bought three blocks of a street in Baltimore and worked its way down producing cheap houses. The townhouses are clearly much more sturdy than the average McMansion, but they were nonetheless mass produced and cheap---after all, they all share their side walls with their neighbors. I'm sometimes curious whether the rhetoric around these houses a hundred years ago was the same as the rhetoric people say now about mass-produced people storage solutions. Unfortunately, such information is pre-Internet, so I'll never know. In the present day, now that the house has sat in one place for a century, it's become quaint and valuable.

There's a painted lady contest on the street every year. A painted lady, the neighborhood newsletter defines, is a house whose facade is meticulously painted in three colors. I bring it up because most of the people around here like the look and think it raises the value of the house, while I think it just looks butt. The social norm is to paint right up to your property line, which means that if there is a little arch that crosses between the houses, exactly one half will be painted taupe and the other half will be painted purple.

Y'know, I'm failing to indicate what I'm pontificating about here, and I expect that I'll continue to do so for the rest of the essay, so let me just spell it out right here and leave your neurons to make the appropriate links. Everything here is about my favorite econ question, what I would call the fundamental question of economics: where does value come from?

Beauty contest So a few months ago, I'd written about the two beauty contests I'd run in class; I've run a third, and here are the results. On this one, I reported to the students the means and 2/3rd of the mean for the first and second runs. I'd used my Amazon associate account on the class website, and made $25 from selling textbooks to my students, and I made this the prize for this one, so it's not dumbass points but cold hard cash they were fighting for this time.

1st daymidtermfinal
2/3 mean173.0366.7244.53
% of ones3%25%10.3%

As a group, everybody moved forward exactly one step from where they'd been last time: the winning bid was two-thirds of last time's winning bid. The equilibrium is to bid one, and you can see that the class sort of backslid away from believing that everyone was going to play that. 18% of the bids were between five and twenty.

But back to the subject of me, there is the several thousand dollar question: will the tile floor raise the value of the house? This is the beauty contest all over again, since the question is not whether I think the floor looks nice, but whether I think other people think the floor looks nice. In fact, when potential buyers check out the house, they will all have in mind the resale value of the thing, meaning that I need to consider whether other people will think that other people will like the floor.

Ms. RK thought the linoleum worked better because the only safe strategy to selling a house is to make it as boring as possible, removing all features that may indicate creativity. The risk-minimization approach says that only one or two people will like the house more due to a fun feature, but lots of people will be turned off by it. Obviously, the designers of the typical McMansion have taken this advice: those places have only those features which are universally liked, like skylights and giganticness. After all, they're called McMansions because they match the lowest common denominator characteristics of a certain restaurant chain---which had a net income of $1.47 billion in 2003. We may think we're above it, but the lowest common denominator pulls down a lot of cash.

I tend to be less risk-averse myself, and feel that I'm in a different position than the McMansion builders. After all, I have one and only one house to sell. If I turn off a dozen buyers but get two or three who recognize the kitchen floor as a functional work of art, then I'm done.

But this doesn't solve the beauty contest problem: even if people think it's a work of art, they have to think that other people will agree. We have the same problem as before: if they believe that future buyers will be turned off by the floor, then they will decrease their bids accordingly. Since there are going to be so many more buyers who won't get it than buyers who do, the beauty contest reasoning is only going to push sales prices down further.

Notice, further, that many people didn't necessarily hate the kitchen floor per se, but were thrown because it didn't match their expectations. There is the Platonic ideal of the kitchen floor, and it's level and simple and generally pretty boring. It takes cognitive effort to accept and enjoy something that breaks expectations, and further, we generally assume that everybody is dumber than we are. [This has been verified in the lab a hundred times over. Think attribution bias or the Lake Woebegone effect.] So we'll assume that others are less likely to be able to exert whatever cognitive effort it took us to decide we like it---I've already committed this presumption above, and every buyer will probably do the same. The Lake Woebegone effect conspires with the setup of the beauty contest to push us to conform to expectations.

So why'd I do it? I was at a gallery opening at which a friend of a friend had two paintings on display, and the curator offerred a few pieces of advice to a gathered crowd. Never buy from a gallery in an expensive part of town, never buy from dealers who push the investment value of the piece, and more generally, the only reason to buy a work of art is because you like it. In the context here: forget the beauty contest, and go with what you deem to be beautiful.

[link][2 comments]

on Thursday, January 6th, GK said

so what would not qualify as a "McMansion"? You claim your
townhouse is a mass-produced people storage solution,
so what would qualify as a house? Stone walls?
Unique architecture? Your place has lasted a century, which
seems to indicate some degree of quality.

on Wednesday, January 12th, AH said

I like how you use data from your econ class in your blog. The floor does look nice, albeit a bit too labor-intensive. It seems like something that will always be the subject of conversation whenever you have new company. Are you ready for that? Also, how reflective are the mirror bits that you used? There's a reason why mirrors are so seldomly used as flooring...

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11 January 05. The destructive beauty contest

I don't want to imply that it's just about my kitchen floor. [The sudden start should indicate to you that this one won't make sense unless you've read the last item.] There are much more significant things at stake here. For example, black folk lower housing values.

Why? Because, academic studies show, people really are fucking racist. Emerson et al [1] called 1,663 white folk, and asked them about their choices of home. Their focus was race, but they tried to bury race under a long list of other issues: school, race, recent changes in property values, crime, the relative value of your house vs the neighborhood average. It hurts how unsurprising the results are: controlling for those other factors, a primarily Asian neighborhood had no significant effect on choice (a one SD downward shift), a primarily Hispanic neighborhood had no significant effect (half an SD upward), and a primarily black neighborhood had a way significant negative effect (five SDs down). People who currently live in a hispanic neighborhood are more likely to be OK with living with hispanics, and similarly with blacks.

I could find you more citations about how people are fucking racist, but this is one of those deals where academics just confirm the obvious.

[In non-confirmatory news, I'm told that the white flight thing is a bit mis-stated. You don't have to believe me on this one, `cause I don't have a citation and am not in the mood to look it up, but whites are not more likely to move out of a neighborhood that's become racially mixed. However, new residents are more likely to be minority, meaning that in a few decades, the natural turnover makes it look like white flight.]

Back to the beauty contest: say you're not a racist. You were bit by a radioactive chameleon and are no longer capable of perceiving people's race in any way. But you're still familiar with Emerson et al, and you know that 51% of the country voted for Dubya. As you go house shopping, you do the calculations on the value of a proposed house in a black neighborhood, and you have no choice but to take into account the fact that you're likely to get a lower value for the house when you sell. As long as there are some racists in the market, everyone will price in a racist manner.

Now say that radioactive chameleons secretly sweep the nation, and one day everybody wakes up color-blind. You don't know this, so you still believe that others are racist, and so you will still value the house less. Maybe I overstated the level of racism in Emerson et al's survey: maybe the respondents are not fucking racist; so long as they believe that others are, they may still value a house in a black neighborhood less.

The same is true everywhere that people can agree on dumb assumptions. If we read in books that there are people who think that women are less productive because they're always birthing babies, then it makes sense to offer a lower salary to women. If you know others are offering a lower salary to women (even if you've entirely forgotten the reason why), it makes no sense for you to offer an above-market salary.

Value-by-fiat, or the destruction of value by fiat, is a coordinated equilibrium: when everybody sees the female signal, everybody knows to offer a lower wage. This is indeed a proper Nash equilibrium, where nobody has an incentive to defect.

I'm frankly not sure about the policy implications for housing. But it makes for a tough row to hoe for a black person: if you buy the same house as a white guy, it'll have less value because you're you. What is likely to be the number one largest and most significant investment you ever make just won't get as high a return.

For employment, this is a solid justification for overhiring those who have traditionally been discriminated against---affirmative action. As long as there are racists or sexists anywhere, minorities and women will be paid less, and the market will not correct this. Shifting people out of a bad equilibrium is one of the roles of government; in this case it does so by breaking the significance of the signal used for coordination. Under a proper AA regime, people won't know if others are offering a lower wage when they get the `girl' signal, so it is not necessarily optimal for them to also offer a low wage.

In the mean time, there are still racists and sexists out there who will continue to offer a lower wage just on principle, meaning that even if the affirmative action regime is correctly implemented, there will still be pressure to shift back to the discriminatory coordinated equilibrium.

author="Michael O Emerson and Karen J Chai and George Yancey",
title="Does Race Matter in Residential Segregation? Exploring the Preferences of White Americans",
journal="American Sociological Review",
volume=66, number=6,
month="December", year=2001
[link][a comment]

on Tuesday, January 11th, Andy said

That's good news for me, as a white person -- I can buy a good home for cheap, if I purchase it from a black person. Same with hiring. If I had a company, I would just hire a lot of smart black people, pay them the average black wage + epsilon, and make a fortune! Meanwhile, other people figure this out too and the price/wage gap is fixed. Proof that racist house buying can change? In every "gentrified" neighborhood in America.

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26 September 05. Things I'll never do.

48.7% of survey respondents said they blog as a form of therapy. Me, I'm primarily here to improve my writing skills (28.7% of respondents) and because much of the information I'm presenting isn't easily available elsewhere on the web (3.3%, more or less), But last episode, that was therapy---a means of asking myself where I want to focus in begging for my next contract. The conclusion is that I have a clear, strong preference for places that report confidence intervals. I want to remain on the scientist side of things, rather than the businessy managerial side of things. But this means that I'm choosing to put a limit on how pleasant my life will be, and how much I'll get done between now and when I shuffle off this here mortal coil.

I am good at inventing structures. Give me a topic, a blank page, and an hour, and I'll have a structure and meaning for ya. In such a manner, via black marks filling a blank space, I've produced a dissertation, a book or two, 145 blog entries, a stats library, assorted models of reality, stuff.

I am bad at inventing social structures. Doing so is a two step process: first, one must invent the structure, which I've just bragged that I'm good at, and second, one must convince others that the structure is valuable and worth working toward, and this is something I am supremely bad at.

There are a number of problems at hand here. The first is what I'd kvetched about before and above: I want confidence intervals, and think that people who have absolute certainty in anything (including their theology, by the way) are lying either to me, themselves, or both of us. But obviously, most of the world takes confidence at face value, and feels funny about Bayesian ranges.

The second is just that I'm crazy. People aren't looking for any old meaning, they're looking for meaning that makes sense to them and internally resonates and makes them feel better. Again, I ain't getting nowhere here. The `how can I possibly dilute my artistic vision' sentiment is honestly not very strong in me; it's more dominated by the `I don't get what everybody else is getting at' sentiment.

Life is a lot easier for people who think like everybody else but just a little faster or further. We like to characterize famous innovators as, um, innovative, but upon scrutiny of the work of all but the most exceptional, if you've heard of them they probably made an incremental improvement. Newton really did just stand on the shoulders of giants. It's not just whether your way of thinking is objectively superior, it's also a question of how many people will adopt it, and people just have limited tolerance for anybody who says `hey, let's try everything in a whole new way!', because 1) it takes effort to think like them and 2) for every person who thinks in a whole new way and makes the world better, there are fifty who think in a whole new way to everyone's detriment.

Have personally been working on this aspect a lot lately. Every time I write a paper, I interrogate the paper to work out how I can make it as boring as possible. How can this paper be turned into a minor, incremental, obvious extension of the existing literature?

But for the sort of reasons above, any hopes I may ever have had about working with lots of people, instead of just sitting solitary at a computer until I go blind, are fast diminishing. Somewhere, back in the mists of my life, I decided to focus on learning stuff---math, machines, et cetera---instead of learning how to better organize other people who have learned stuff, and at this point it'd be a long haul to turn around years of bad habits.

Why, you ask, would I want to become a manager-type despite my obvious bias against? First, there's the simple fact that most of what is worth doing is too big to be done by one person. Apophenia will never become a full-featured library unless it gets contributions from others. I could write a dozen books about how software patents are dumb, but it does nothing for the fact that they're law; fixing that takes organizing people.

Then, there's the reason we all have but most of us won't admit to: we want to be rich and famous.

Rich: Ms. DH of Ann Arbor, MI, points us to Morris & Western, who point out that: "[at the end of the century,] the earnings for professionals in technical/scientific fields stagnated, even in professions closely tied to technological innovation... During this same period earnings increased by 34% for all occupations in the category of office work, an increase that was driven by the nonscience, nontechnical business professionals and managers..." (Citation below). That is, as much as we may praise Mr. Einstein (and see below on that), our modern scientists aren't necessarily seeing the cash money that their counterparts in the insurance industry are seeing. You're still much better off, security and cashwise, using your time and brains for managing an office than doing original research.

Famous: as for those physicists with Nobel prizes, they're a back seat to the real prize---the peace prize---which rewards successful organizational and managerial effort. Even among the big-name celebrities, like the lead singer of your favorite foursome or the biologists who run the most innovative labs, the ratio of personal talent to persuasive talent is often low. You can go through your day's newspaper and count two managerial and organizational celebrities for every one individual innovator.

Sure, there are certain rewards to being talent (to use the Hollywood term). You get to stand outside of class in a number of important senses, and will still be invited to the fancy parties, and get to turn your nose at those mere managerial types, but life will never be as easy for the scientist as for the scientist's manager.

author = "Martina Morris and Bruce Western",
title = "Inequality in Earnings at the Close of the Twentieth Century",
journal ="Annual Review of Sociology",
volume = 25,
pages= "623--657",
url = here

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14 December 06. Taxing value

[PDF version]

The question for the day: when should you count transfers among third parties as part of your taxable income? Here are two examples.

Your pal gives $1,000 to Amnesty International in your name. Gifts are counted as income; since this is a gift to you with a fair market value of $1,000, does this count as income to you?

Instead of giving you a rent check, your tenant sends the rent directly to CitiMortgage, who apply it to the mortage on the house where your tenant is living. You never see the cash, but pay a smaller mortgage. Does it count as income to you?

To the intuition of most of the folks I've spoken with, the gift donation should not count as income, and the sidelong rent payment should be. So that's an easy consensus, but the next question is why one third-party transfer should count and the other shouldn't. Both are a transfer from one third party to another that benefits you, and at that level, are equivalent. The fact that one is a gift is irrelevant: if Grandma slipped a $1,000 check into your birthday card, you would have to claim it like any other income. Amnesty is a charity, but that just means that after you claim the $1,000 gift as income, you can deduct it as charitable giving. I mean no offense to the many people who have tried, but I have not yet seen a reasonable explanation as to why we should treat one of these cases as income but not the other.

Defining income is hard. A great deal of title 26 of the US Code is about questions like these. When your employer pays your health insurance for you, is it income? What if they reimburse you for it after you pay for it? Since you sometimes declare your income tax over a year after you earned it, other problems can arise: ¿If you live in Maryland but work in DC, to whom do you pay state income taxes? Hint: only one of these areas has Congressional representation.

We put the Service in Internal Revenue Service
I called IRS's customer help line, because this question actually has some relevance to my own tax situation. This was probably mean. I'm looking for a valid definition of income--a question which is fundamentally hard, as I'll discuss below--and they're armed with a couple of publications on the IRS website that I've already read.

The first, IRS representative #2504624, decided that a mortgage counts as rental expenses. At this point I'm torn. Even I know this is false, but is it rude to call her on her made-up interpretation of tax law?

Her: As you can see from this publication, tenants paying rental expenses count as income.

Me: It also says here that you can deduct the full value of rental expenses, so would that mean that a person could deduct their full mortgage?

Her: No. You can never deduct your full mortgage.

Me: But you declared that it's a rental expense, and those are deductible.

Her: Mortgages can't be deducted. They don't count as rental expenses.

Me: So if it's not a rental expense, then it's not income when a tenant pays.

Her: Yes, it is income. When a tenant pays rental expenses, then it's income.

This went on for a while, as I politely pressed her for a consistent definition of rental expenses, or of income. She eventually hung up on me.

Which is why I'm bucking my normal habit of using only initials and am printing her full name here. That's right, IRS Representative #2504624, every time anybody searches for your name, the first hit will be this post about how you rudely treated a taxpayer after giving him blatantly false, made-up advice.

The second try gave similar results, albeit much more politely:

Him: This counts as income under the doctrine of constructive receipt. Let me transfer you to somebody else who will explain that to you so I don't have to talk to you anymore.

While on hold, I looked up this doctrine. Constructive receipt is about the timing of income. If you get a paycheck on 20 December, but don't deposit it until 2 January, it still counts as income as of 20 December, because there was nothing keeping you from receiving it then. But this doesn't apply to either of the above cases, because there's a whole lot keeping you from receiving money from either Amnesty or CitiMortgage.

The conversation with the third person went about the same, but he had the grace, wit, and courtesy to admit that he had neither the text of 26 CFR nor the wherewithal to interpret it, and wrote out an email inquiry that was to be replied to within 48 hours. [You can't directly email the IRS's service desk--you have to phone in and ask the operator to type out an email for you.] Naturally, I never got a response.

I checked 26 CFR myself and learned an interesting factoid: it doesn't actually define income, beyond the basic `income is money you receive' definition that does not to justice to any of the above.

The root of the problem
My purpose in elaborating on the Service part of Internal Revenue Service is to show how even the full-time professionals have little idea of how to define income. It is a hard problem. On the one hand, there's some intuition that when you gain value from an action, like when somebody pays your mortgage for you, then it is income. Many countries explicitly use this definition and call it a value-added tax (VAT). But on the other hand, we recognize that you sometimes gain value in ways that are not the government's business, like when somebody gives you a nice backrub or gives money to Amnesty in your name.

There are the no-brainer cases--if somebody hands you cash, then it's income--but what if you loaned them fifty bucks that they paid back the next month? Is that $50 income for them in month one and $50 income for you in month two? Nothing is consumed and relatively little value is added, but it's ambiguous whether there's income. The law also considers things like large gifts to be income. Remember when Oprah Winfrey gave her audience members cars, and they then each got a $7,000 tax obligation with the gift? The idea here is that any item that you receive is equivalent to its fair market value. But this opens the door for massive ambiguity: that backrub has a fair market value, after all.

The tax code is a mess because the problem of defining income is fundamentally unsolvable, because it starts with a fundamentally unsolvable question--¿Where does value come from?--and then adds on top another fundamentally unsolvable classification--¿What portion of value should be taxed?

The IRS only makes things more difficult by refusing to acknowledge that the income tax is a tax on value. But it remains in denial, both in order to sound smart and for political reasons (The VAT is unpopular because Europeans do it, and the IRS doesn't want to admit that the income tax is a botched VAT). If we could use the word value, then the Amnesty-CitiMortgage conundrum is easy: the gift contribution adds a small amount of value to your life, while a $1,000 mortgage payment adds $1,000 in value. As the IRS's service representatives demonstrated, when you can't use the V word, you're stuck making up ad hoc stories about rental expenses and constructive receipt that don't quite work.

First, let me quickly dismiss one faux solution to the conundrum. Under a flat tax, we retain an income tax but lower tax rates on the rich and raise tax rates on the poor so everybody is paying the same tax. The painfully disingenuous justification for this is that it simplifies the tangle of tax forms. But the root of the mess is not in the problem of working out whether to multiply taxable income by 0.3 or 0.18, it's defining taxable income--a problem that the flat tax doesn't touch. A tax form for the flat tax would be exactly as long as the current 1040.

Another, much more effective alternative: the consumption tax. It has some æsthetic appeal: we aren't bothered by the rich for making lots of money, we're bothered by how they buy big yachts and overpriced shoes. We want to encourage savings, which is why there are so many exceptions in the income tax for savings like 401(k) plans (i.e., retirment plans conforming with 26 CFR 1.401(k).). By the simplified equation Income - Savings = Consumption, the current tax code makes you calculate income--already hard, as above--and then excruciatingly subtract every element that could somehow count as savings. The consumption tax just has you total up consumption, by billing you at point of sale like any other sales tax.

The consumption tax also reconciles the Amnesty-CitiMortgage problem. First, we would decide whether either of the above counts as consumption or not right off the bat. Instead of the situation we have now, where we tax your income and then if you contribute to Amnesty then you get to deduct that portion of income (under a number of caveats), you would instead pay tax when you give money to CitiMortgage (depending on how you wanna count buying a house), and then not pay tax when giving to Amnesty.

Second, all those issues about who who is the final recipient just evaporate: tax is paid by the person making the outlay. Oprah pays taxes on the car when she bought them. There's the social problem of whether the tenants should pay the landlord's taxes, but that isn't complicated by the accounting issues.

Sure, there are still questions of how one defines consumption--like whether your house is consumption or an investment. But once we have an arbitrary decision on that question, the accounting is much easier.

We like progressive taxes, where poor folk pay a lower percentage than rich folk. There's intuition behind this, that economists can readily formalize: a dollar to a poor person that buys a loaf of bread is worth much more--has much higher value--than a dollar to a rich kid who uses it to buy a portion of jewellery or other useless items. In formal terms, there is a diminishing marginal value to income, which is evidenced by risk-averse behavior, especially as shown by those who are well past the survival level. A progressive tax on cash terms approximates a flat tax on value terms. McCaffery proposes fixing this via a refund on the taxes paid on the first $20,000 in spending. If the tax rate is 5%, everybody just gets handed $1,000. Those who consumed less than $20,000 are now making a small profit on the tax system, and thus pay a negative rate; those who spent $20,000 last year are paying 0% taxes, and the yacht buyers are paying 4.999%.

So, the consumption tax really is a simplification of the tax scheme, because it takes taxes at the door, replacing the problem of defining income minus savings with the simpler problem of defining cash purchases for consumption. It encourages savings and discourages yacht purchasing. The only problem is that there are several industries built from the ground up around avoiding income taxes. Lindblom explains in his Market as Prison essay Jstor link that the market is the perfect system for preventing change, because no matter the change, somebody will resist it because they are optimized to make money the way things are now. So when you have a massive system like the income tax, no matter how fundamentally screwed up it is, there will always be a chorus of defenders.

So we're stuck with the tax law we have, that attempts to codify the answer to two impossible-to-answer questions. We'll get tax laws that simplify the situation a bit, and tax laws that complicate it a bit, but as long as the law requires a definition of value and a definition of what value is to be taxed or untaxed, the law will remain a mess.

title = "The Market as Prison",
author = "Charles E Lindblom",
journal ="The Journal of Politics",
volume= 44, number= 2, month =may,
year= 1982, pages= "324-336" }

author = "Edward J McCaffery",
title = "Fair not Flat: How to Make the Tax System Better and Simpler",
year = 2002,
publisher = "University of Chicago Press" }

Relevant previous entries:
The one about value, accounting, and economics

[link][a comment]

on Monday, December 18th, Andy said

I am a big fan of the idea of the consumption tax, too, for basically the same reasons that you outlined, although you should ask Bill Gale about this -- he is pretty skeptical. I think one problem of his is that the tax would have to be larger than 5% -- like maybe 30%.

One good question is what to do about retired people who paid income taxes their whole lives and are now living on fixed incomes and would have trouble dealing with a large increase in prices?

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30 April 07. Pricing information

[PDF version]

Since it's interesting, we'll begin with extradition. Extradition is not trivial. It's an infringement upon a state's sovereignty to forcibly remove a person, so there are treaties that allow extraditions only under certain conditions. The Australia/USA treaty lists 29 types of crime for which a person can be extradited, and they ain't pretty:
1. Murder [...].
4. Unlawful throwing or application of any corrosive or injurious substances upon the person of another.
5. Rape; indecent assault, including unlawful sexual acts with or upon children.
6. Illegal abortion.
7. Procuring, or trafficking in, women or young persons for immoral purposes; living on the earnings of prostitution.
9. Bigamy.
10. Kidnapping; child stealing; abduction; false imprisonment.
13. Larceny.
14. Embezzlement.
17. Extortion.
18. Receiving any property, money or valuable securities knowing the same to have been unlawfully obtained.
22. Arson.
25. Piracy, by statute or by law of nations; revolt on board a vessel against the authority of the master of the vessel.
29. Dealing in slaves.

So your average shoplifter is safe; we're talking about people who are selling women and children into slavery or are true and honest pirates (a breed which still exists in the seas between Australia and Asia). Major financial affronts like 17 & 18 are in there too.

Mr. Hew Raymond Griffiths is a UK citizen living in Austalia, and as far as I understand it, he's never been to the Western Hemisphere. But he's just won himself a `round the world ticket with accommodations for up to ten years, because a court in Virginia found him guilty of copyright infringement, and the Australian government has agreed to extradite him.

I'm not sure if the Australia/USA treaty applies here, since the guy's a UK citizen, but you get the gist.

As you can imagine, this guy wasn't just making mix tapes for his pals. He was running a warez site with heaps of software free for the taking. If you're not familiar with warez sites, they're one of the dark corners of the web, mostly inhabited by adolescents trying to prove their abilities by cracking security codes, hosting big files (like an operating system or Photoshop), or just putting up lots of porn. This is where `leet-speak came from, and everything about warez sites and their denizens is a turn-off. They also tend to pick black backgrounds and tiny fonts.

So let this be a lesson for any of you who have CSS that specifies less than a ten-point font for your body text: the courts have no sympathy at all. It's an easy win for the prosecution, because warez site are so unattractive to normal folk like judges and juries.

Pricing nothing
But as above, extradition doesn't happen for being a punk--it takes big money crimes, with dollar figures up around seven or eight digits. And here we run in to a problem. How do you evaluate intellectual property?

Let me give you another example: my think tank is a 501(c)3 nonprofit, so contributions and donations are tax deductible. Microsoft, Inc. donates server software to the think tank, which is one factor in why we have a famously slow and messy web site. At the maximum, it cost Microsoft maybe $100 to send us the software, what with the jewel cases and little holograms on the licenses and the bubble wrap. Given that, how much do you think they're deducting from their taxes for mailing us those CDs?

I'm not in the mood to check right now, but last time I looked at Microsoft's annual report, their intellectual property was one or two percent of their assets, where one percent of Microsoft is more than I'll ever be worth. How did they come up with that? They are reporting to shareholders, the SEC, and anyone else who cares that their asset base is 1% larger than their physical plant. There are accountants over in Redmond right now trying to work out how they can claim as large an asset base as possible, and intellectual property (IP) is just a gimme for them.

And not to pick on Microsoft, there are companies where IP is up there around 50 or 90 percent of their asset base.

IP is not the first thing in the world where evaluation is difficult. I had a job that involved evaluating infrequently-traded options for a brokerage firm, and there were yelling matches over it. The equations require an estimate of the volatility of an asset's price, and there are several ways to make that estimate. But at least there are generally-accepted methods to do it, albeit a few too many.

The only method for pricing intellectual property is by current market rate. This is common enough in asset pricing, but it's problematic in this case, because the distance between market rate and cost of production is so large. If Microsoft sent the think tank ten copies of the server software instead of one, it'd be sending ten times the market value, so it should be able to deduct ten times the amount from their taxes. Gosh, why not just send a case of CDs and take the year off from paying taxes.

Our intuition is that the recipients value the items at less than full retail cost. Maybe they'd buy the first copy for full price, but the willingness-to-pay falls precipitously from there. But now we're back to unobservable value, since we can't ask the recipients what a second or third license is worth to them. But it also seems unfair to say that Microsoft can only deduct the price of printing and shipping.

The standard for damages in cases like that of Mr. Griffiths, as I understand it, is to claim full retail price for downloads, which is why Mr. Griffiths's web work is sufficient to merit extradition proceedings usually reserved for child molestors: the plaintiffs claimed $50 million in damages. The nice people at the RIAA often cite lost sales figures that assume full retail price for every downloaded CD when arguing that the Department of Justice should allocate its scarce resources to enforcing copyright laws. Especially with the losers on the warez sites, this is a false assumption. If a kid who makes a few thousand a year from part-time at the Seven-Eleven can't get a free copy of Photoshop, he wouldn't buy it retail (it's very pricey). He'd just get Linux.

This is not to say that none of the people who downloaded from a warez site would ever buy retail. Sales were surely lost, but there is really no way to know whether lost sales make up 1% of the downloads or 99%.

By the way, the operators of warez sites rarely make any money. They just do it to be a leader among maladjusted adolescents. But, you figure, this has nothing to do with whether the thief profits--if a gent steals some jewels to give to his gal, it's still theft. The Supreme Court commented on this very argument in its ruling in Sony v Betamax, which was a case over whether recording a TV show was theft of intellectual property. Since it is mostly applicable to the situation at hand, here is footnote 33 in full (minus citations; VTR = video tape recorder):

It has been suggested that “consumptive uses of copyrights by home VTR users are commercial even if the consumer does not sell the homemade tape because the consumer will not buy tapes separately sold by the copyrightholder.” Furthermore, “[the] error in excusing such theft as noncommercial,” we are told, “can be seen by simple analogy: jewel theft is not converted into a noncommercial veniality if stolen jewels are simply worn rather than sold.” The premise and the analogy are indeed simple, but they add nothing to the argument. The use to which stolen jewelry is put is quite irrelevant in determining whether depriving its true owner of his present possessory interest in it is venial; because of the nature of the item and the true owner's interests in physical possession of it, the law finds the taking objectionable even if the thief does not use the item at all. Theft of a particular item of personal property of course may have commercial significance, for the thief deprives the owner of his right to sell that particular item to any individual. Time-shifting does not even remotely entail comparable consequences to the copyright owner. Moreover, the time-shifter no more steals the program by watching it once than does the live viewer, and the live viewer is no more likely to buy prerecorded videotapes than is the time-shifter. Indeed, no live viewer would buy a prerecorded videotape if he did not have access to a VTR.

Pricing IP at market rates is based on metaphor to physical goods, but as our intuition and the Supreme Court observe, this metaphor doesn't really work out, partly because consuming information without paying does not prevent the owner from continuing to sell that information elsewhere, while the owner can't sell stolen physical goods.

As usual, I have no conclusion. You can decide for yourself whether running a warez site is on par with throwing acid on a person. But be aware of the huge open question that is the pricing of IP, and there's a small industry built on trying to come up with a passable (but self-serving) number.

On behalf of the IP experts of the world, let me say: we have no idea how to price intangible assets. But despite our cluelessness, the number eventually made up matters to us humans. After Enron, there have been many volumes written on how to tighten accounting standards so companies can't do what Enron did, even on a smaller scale--but then IP gives companies an exception big enough to drive a truck through. By tricks like the one above, the US government loses what is no doubt tens or hundreds of millions in tax revenue. Market pricing of IP is sending Mr. Griffiths around the globe, and market pricing allows media producers to have so much pull in Congress that they can use the USA's finite political capital to initiate extraditions.

[link][a comment]

on Wednesday, May 9th, Angelique said

Very interesting! Sadly, I think it's true that in general crimes against someone with money to prosecute are more likely to be prosecuted. The poor guy who had acid thrown on him doesn't have a chance.

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