In the latest issue of the Journal of Economic Literature, two papers deliver devastating reviews on the Stern Review on the Economics of Climate Change. The reviews are by serious, mainstream economists: William Nordhaus of Yale and Martin Weitzman of Harvard. These are not individuals and articles that can or should be ignored. Of course, they will be ignored by the mainstream media – while at the same time Al Gore’s receipt of the Nobel Prize carries the media day.
The Journal of Economic Literature is the sister publication to the American Economic Review and is put out by the American Economic Association, the leading professional society for economists. Abstracts of the papers, and instructions on how to buy them, are available here.
I have always said that my objections to the prescriptions of the most vocal climate change advocates are on three levels: one, the climate models depend too much on positive feedbacks that are not understood; two, the models have not really been tested, but instead are calibrated to the historical data; and three, even if one accepts the models, one then has to move into the economics of optimal policy, and there the best analysis suggests relatively modest reductions in carbon emissions for the near term. I like to ask environmentalists to summarize their prescriptions with the appropriate tax per barrel of oil: tell me what you think the price of oil should be increased by, in order to recognize the impact of carbon.
But back to the reviews of the Stern Review. So the Stern Review made big headlines when it came out, as it was commissioned by the UK government and was ostensibly a serious analysis of the economics of climate change. Both Nordhaus and Weitzman deliver fatal blows, although they try to temper it a bit. Here is a quote from Nordhaus:
“The central methodology by which science, including economics, operates is peer review and reproducibility. By contrast, the (Stern) Review was published without an appraisal of methods and assumptions by independent outside experts. Nor can its results be easily reproduced…(this) does mean that fatal flaws in evidence and reasoning, which might have been caught in the early stages under normal ground rules, may emerge after the report has been published.”
Weitzman says,
“However, in my opinion, Stern deserves a measure of discredit for giving readers an authoritative-looking impression that seemingly objective best-available-practice professional economic analysis robustly supports its conclusions, instead of more openly disclosing the full extent to which the Review’s radical policy recommendations depend upon controversial extreme assumptions and unconventional discount rates that most mainstream economists would consider much too low.”
Now in the spirit of full disclosure, I recommend everyone look at the papers for themselves. Nordhaus and Weitzman go out of their way to point out the positive aspects of the Stern Review. But the overwhelming conclusion, especially from Nordhaus, is that the extreme policy prescriptions of the Stern Review are way overblown.
To summarize the contrast: The Stern Review calls for a carbon tax of $350 per ton of carbon in 2015. Nordhaus’ model, which has been peer-reviewed many times, calculates the optimal carbon tax in 2015 to be ONE-TENTH of that, or only $35 per ton carbon. I find it useful to put these quantities in terms of something we understand more readily: $350 per ton carbon converts to $1 per gallon of gasoline, while $35 per ton carbon converts to 10 cents per gallon of gasoline. We are talking big differences here.
So what is wrong with the Stern Review’s economics? It is real simple – they use an extremely low interest rate, close to zero. Everything follows from this, and in my opinion, the assumption is crazy.
The essence of carbon policy is that we incur costs today for benefits many years into the future. Changing our energy usage patterns will be costly for us today, and the benefits of lower temperatures come 50, 100 or even 200 years in the future. Any time you are considering investing today for benefits in the future, you have to consider the interest rate. Investments to stabilize climate should yield returns – a rate of interest – in the ballpark that other investments yield. If we can invest in human capital, for instance, and earn 10% per year, why should we invest in climate stabilization if it yields a zero rate of return?
Nordhaus has some great examples to illustrate the unreasonableness of using a zero discount rate for climate policy: “Suppose that scientists discover a wrinkle in the climate system that will cause damages equal to .1 percent of net consumption starting in (year) 2200 and continuing at that rate forever after. How large a one-time investment would be justified today to remove the wrinkle that starts only after two centuries? Using the methodology of the (Stern) Review, the answer is that we should pay up to 56 percent of one year’s world consumption today…In other words, it is worth a one-time consumption hit of approximately $30,000 billion today to fix a tiny problem that begins in 2200…the Review would justify reducing per capital consumption for one year today from $10,000 to $4,400 to prevent a reduction of consumption from $130,000 to $129,870 starting two centuries hence and continuing at that rate forever after.”
Another point in this criticism is the essential inter-generational fairness issue. Per capita income worldwide has been growing at around 1.3% over many decades – and this is the number that the Stern Review uses. At that growth rate, per capital world consumption will grow from today’s $10, 000 to about $130,000 in two centuries. Which generation is the relatively poor generation? Are we so sure that we are impoverishing our children and our children’s children? What about all the new technologies, institutions such as democracy and market economies, physical infrastructure, and knowledge that we are bequeathing them? Do we not think that people 200 years from now will enjoy more leisure, better health, better technology, and generally be better able to pursue life, liberty, and happiness?
Read the articles, they are really convincing. For most of the media, of course, that will be too difficult. Much easier to report on Al Gore winning an Academy Award – oops, I meant a Nobel Prize.
Friday, October 19, 2007
Vinod Khosla and the Invisible Hand
On Monday, October 15, 2007, I saw the invisible hand at Dartmouth College.
Vinod Khosla, a founder of Sun Microsystems and now a venture capitalist focused on renewable energy, gave a talk to Tuck and Thayer students and faculty. It was truly amazing. Khosla laid out his vision of how the world was going to transition away from a petroleum and coal-based energy economy to one that would rely on renewable, low-carbon emitting forms of energy. But more than just the vision, Khosla is part of the invisible hand of market economics, of what I recall so fondly from graduate school as “price theory.” Khosla is playing a fundamental role in bringing together the scientists, entrepreneurs, professional managers, and investors that are needed to form the organizations that will provide us our energy needs of tomorrow.
But the most important part of his talk was his incredible optimism, his beliefs in the power of science, entrepreneurship, and markets. He described some of the truly amazing technologies that he is funding, from designer cells that focus all their internal mechanisms on producing butane, to “sub-critical” nuclear reactors, to cellulosic ethanol, to significant improvements to the mundane old internal combustion engine.
Throughout it all, he focused on the pragmatic, and the scalable. He will invest in projects that may not become huge, but primarily he wants to develop sources of energy that can supplant significant amounts of petroleum and coal. I may disagree with his views on climate change (see my other post of today) but I don’t disagree that we do have to transition away, gradually, from petroleum and coal.
It was wonderful when he dismissed an engineer’s criticism of biomass energy on the basis of thermal efficiency. I have always thought that engineers focus way too much on process efficiency, in regard to what percent of some input source (e.g., wattage from the sun) is transformed to the final product. What really matters is the economic efficiency of the process – dollar value of inputs vs. dollar value of outputs. BTUs are not all the same – BTUs in the form of sunshine are not all that useful in economic life, but BTUs in the form of gasoline are valuable.
I left feeling invigorated, and confident that if our politicians do not restrict our freedoms too much, there is little that we cannot accomplish. Certainly my confidence in thinking that my children will be able to enjoy even better forms of heating and cooling, lighting, and transportation was tremendously enhanced.
Vinod Khosla, a founder of Sun Microsystems and now a venture capitalist focused on renewable energy, gave a talk to Tuck and Thayer students and faculty. It was truly amazing. Khosla laid out his vision of how the world was going to transition away from a petroleum and coal-based energy economy to one that would rely on renewable, low-carbon emitting forms of energy. But more than just the vision, Khosla is part of the invisible hand of market economics, of what I recall so fondly from graduate school as “price theory.” Khosla is playing a fundamental role in bringing together the scientists, entrepreneurs, professional managers, and investors that are needed to form the organizations that will provide us our energy needs of tomorrow.
But the most important part of his talk was his incredible optimism, his beliefs in the power of science, entrepreneurship, and markets. He described some of the truly amazing technologies that he is funding, from designer cells that focus all their internal mechanisms on producing butane, to “sub-critical” nuclear reactors, to cellulosic ethanol, to significant improvements to the mundane old internal combustion engine.
Throughout it all, he focused on the pragmatic, and the scalable. He will invest in projects that may not become huge, but primarily he wants to develop sources of energy that can supplant significant amounts of petroleum and coal. I may disagree with his views on climate change (see my other post of today) but I don’t disagree that we do have to transition away, gradually, from petroleum and coal.
It was wonderful when he dismissed an engineer’s criticism of biomass energy on the basis of thermal efficiency. I have always thought that engineers focus way too much on process efficiency, in regard to what percent of some input source (e.g., wattage from the sun) is transformed to the final product. What really matters is the economic efficiency of the process – dollar value of inputs vs. dollar value of outputs. BTUs are not all the same – BTUs in the form of sunshine are not all that useful in economic life, but BTUs in the form of gasoline are valuable.
I left feeling invigorated, and confident that if our politicians do not restrict our freedoms too much, there is little that we cannot accomplish. Certainly my confidence in thinking that my children will be able to enjoy even better forms of heating and cooling, lighting, and transportation was tremendously enhanced.
Sunday, October 14, 2007
Gore Gets the Nobel
OK, let's all give Al Gore due credit for winning much of the world over with his efforts over climate change. It is true, the fellow has been quite relentless on the issue for some time. Now he gets the Nobel Peace Prize.
I still don't quite understand the Peace Prize aspect of this. The original language in Alfred Nobel's will is "to the person who shall have done the most or the best work for fraternity between the nations, for the abolition or reduction of standing armies, and for the holding and promotion of peace congresses." The story with climate change is allegedly that changing weather patterns will cause new strife between nations, especially in regard to migration and fighting over water resources. Maybe. Maybe not. Seems to me like many of the predictions over effects of climate change -- might happen, might not happen, and if it does, might be easier to mitigate down the road than try to prevent right now.
At about the same time that Gore got the Nobel, a judge in the UK ruled that the UK government may send the film to all secondary schools and they can show it to students, but they must note that the film is politically one-sided and is inconsistent with even majority scientific opinion in places. The ruling was in a lawsuit filed by an heroic parent -- who won back 2/3 of his legal costs since the judge ruled that he substantially won the case.
Here is one quote from the "guidance" that teachers in the UK must be given if they are to show the film:
The High Court has indicated that schools can lawfully show AIT to pupils without
breaching ss. 406 or 407 of the Education Act 1996, but that, in doing so they must
bear in mind the following points:
• AIT promotes partisan political views (that is to say, one sided views about
political issues)
• teaching staff must be careful to ensure that they do not themselves promote
those views;
• in order to make sure of that, they should take care to help pupils examine
the scientific evidence critically (rather than simply accepting what is said at
face value) and to point out where Gore’s view may be inaccurate or departs
from that of mainstream scientific opinion;
• where the film suggests that viewers should take particular action at the
political level (e.g. to lobby their democratic representatives to vote for
measures to cut carbon emissions), teaching staff must be careful to offer
pupils a balanced presentation of opposing views and not to promote either
the view expressed in the film or any other particular view.
The entire guidance is available here.
Dr. William Gray, climate change skeptic and a very respected US meteorologist (the two are almost now mutually exlusive, to the detriment of science), has this to say: "We're brainwashing our children."
I still don't quite understand the Peace Prize aspect of this. The original language in Alfred Nobel's will is "to the person who shall have done the most or the best work for fraternity between the nations, for the abolition or reduction of standing armies, and for the holding and promotion of peace congresses." The story with climate change is allegedly that changing weather patterns will cause new strife between nations, especially in regard to migration and fighting over water resources. Maybe. Maybe not. Seems to me like many of the predictions over effects of climate change -- might happen, might not happen, and if it does, might be easier to mitigate down the road than try to prevent right now.
At about the same time that Gore got the Nobel, a judge in the UK ruled that the UK government may send the film to all secondary schools and they can show it to students, but they must note that the film is politically one-sided and is inconsistent with even majority scientific opinion in places. The ruling was in a lawsuit filed by an heroic parent -- who won back 2/3 of his legal costs since the judge ruled that he substantially won the case.
Here is one quote from the "guidance" that teachers in the UK must be given if they are to show the film:
The High Court has indicated that schools can lawfully show AIT to pupils without
breaching ss. 406 or 407 of the Education Act 1996, but that, in doing so they must
bear in mind the following points:
• AIT promotes partisan political views (that is to say, one sided views about
political issues)
• teaching staff must be careful to ensure that they do not themselves promote
those views;
• in order to make sure of that, they should take care to help pupils examine
the scientific evidence critically (rather than simply accepting what is said at
face value) and to point out where Gore’s view may be inaccurate or departs
from that of mainstream scientific opinion;
• where the film suggests that viewers should take particular action at the
political level (e.g. to lobby their democratic representatives to vote for
measures to cut carbon emissions), teaching staff must be careful to offer
pupils a balanced presentation of opposing views and not to promote either
the view expressed in the film or any other particular view.
The entire guidance is available here.
Dr. William Gray, climate change skeptic and a very respected US meteorologist (the two are almost now mutually exlusive, to the detriment of science), has this to say: "We're brainwashing our children."
What Did Israel Bomb in Syria?
Mystery still surrounds the September 6 strike by Israeli aircraft deep inside Syria. Much of the mystery is that the event was initially hardly noted -- particularly that Syria itself did not even issue a complaint. Slowly now more information is coming out. At the time of the event, one telling comment I heard was that there was an amazing coincidence of interests between Israel and Syria in keeping their mouths jointly shut.
New reports suggest that that telling comment was true. Papers today are reporting that the Israeli fighters hit a partially constructed nuclear reactor -- a Syrian reactor being built, supposedly, with the help of the North Koreans. If this is true, it explains why Syria did not complain too loudly. Israel's silence, of course, needs no explanation.
Also of interest is the ease with which the Israeli planes accomplished their mission.
It may be, however, that the Israeli's acted too fast. Clearer evidence on North Korea helping the Syrians build a reactor would be helpful.
I bet we hear more about this event over the next months. It is one of those things that gets a tiny story at first, and when you read it, you think, like Bob Dylan in Ballad of a Thin Man: "Because there's something happening here but you don't know what it is..."
New reports suggest that that telling comment was true. Papers today are reporting that the Israeli fighters hit a partially constructed nuclear reactor -- a Syrian reactor being built, supposedly, with the help of the North Koreans. If this is true, it explains why Syria did not complain too loudly. Israel's silence, of course, needs no explanation.
Also of interest is the ease with which the Israeli planes accomplished their mission.
It may be, however, that the Israeli's acted too fast. Clearer evidence on North Korea helping the Syrians build a reactor would be helpful.
I bet we hear more about this event over the next months. It is one of those things that gets a tiny story at first, and when you read it, you think, like Bob Dylan in Ballad of a Thin Man: "Because there's something happening here but you don't know what it is..."
Wednesday, September 26, 2007
Lee Bollinger's Unfortunate Remarks: Ahmadinejad at Columbia
There is a speech I would not have looked forward to giving -- "welcoming" President Mahmoud Ahmadinejad to the Columbia campus. Luckily it fell to President Lee Bollinger and not to me. Talk about a no-win situation.
President Bollinger, who was Provost at Dartmouth for a few years, scored about 80% on my grading scale. Unfortunately, the areas where he slipped up were rather serious.
So much of his speech is right on the point. Put most simply, we do need to hear what our adversaries have to say. For all the critics of the Iraq war, one would think that there would be overwhelming support for getting the best information possible on Iran before that comes to war as well. And the US can and will take the high road: let our citizens hear Ahmadinejad out, and let them make political decisions. We have elections coming up (lots of evidence of that in Hanover tonight, with all the Democrats in town) and voters should be seriously considering who will best handle the Iranian situation.
But...why then engage in some pretty nasty name-calling? Why call the President of Iran a "petty and cruel dictator?" Why say "I doubt that you will have the intellectual courage to answer these questions?" Why the scornful "You are either brazenly provocative or astonishingly uneducated?" These are soundbites unbecoming of the President (or even a professor) of one of the world's leading liberal arts universities.
While many seemed to enjoy the sight of Ahmadinejad having to listen to Bollinger's insults, I actually have to hand it to the President of Iran for his response: "In Iran tradition requires that when we in a person to invite to be a speaker we actually respect our students and the professors by allowing them to make their own judgment and we don't think it's necessary before this speech is even given to come in with a series of claims and to attempt in a so-called manner to provide vaccination of some sort to our students and our faculty." (Quoted from the Washington Post transcript, with some obvious grammatical problems.) No doubt, Ahmadinejad is no intellectual light weight. Sparring with him would be a good fight.
I also think that Bollinger should have held back on the long list of complaints against Iran. Get up, say why Columbia is having him speak and why people should at least accept that if not be proud of it, and then give him the podium. Save time for questions -- the real learning was in President Ahmadinejad's responses to questions, not in President Bollinger's prepared remarks.
It was a tough situation to be in, with half of the listeners sure to be ticked off no matter what you did. The job of University President is not an easy one.
President Bollinger, who was Provost at Dartmouth for a few years, scored about 80% on my grading scale. Unfortunately, the areas where he slipped up were rather serious.
So much of his speech is right on the point. Put most simply, we do need to hear what our adversaries have to say. For all the critics of the Iraq war, one would think that there would be overwhelming support for getting the best information possible on Iran before that comes to war as well. And the US can and will take the high road: let our citizens hear Ahmadinejad out, and let them make political decisions. We have elections coming up (lots of evidence of that in Hanover tonight, with all the Democrats in town) and voters should be seriously considering who will best handle the Iranian situation.
But...why then engage in some pretty nasty name-calling? Why call the President of Iran a "petty and cruel dictator?" Why say "I doubt that you will have the intellectual courage to answer these questions?" Why the scornful "You are either brazenly provocative or astonishingly uneducated?" These are soundbites unbecoming of the President (or even a professor) of one of the world's leading liberal arts universities.
While many seemed to enjoy the sight of Ahmadinejad having to listen to Bollinger's insults, I actually have to hand it to the President of Iran for his response: "In Iran tradition requires that when we in a person to invite to be a speaker we actually respect our students and the professors by allowing them to make their own judgment and we don't think it's necessary before this speech is even given to come in with a series of claims and to attempt in a so-called manner to provide vaccination of some sort to our students and our faculty." (Quoted from the Washington Post transcript, with some obvious grammatical problems.) No doubt, Ahmadinejad is no intellectual light weight. Sparring with him would be a good fight.
I also think that Bollinger should have held back on the long list of complaints against Iran. Get up, say why Columbia is having him speak and why people should at least accept that if not be proud of it, and then give him the podium. Save time for questions -- the real learning was in President Ahmadinejad's responses to questions, not in President Bollinger's prepared remarks.
It was a tough situation to be in, with half of the listeners sure to be ticked off no matter what you did. The job of University President is not an easy one.
Monday, September 17, 2007
France Steps Up to the Plate!
What a difference an election makes. On Sunday, French Foreign Minister Bernard Koucher said that "the world must prepare for the worst" in regard to Iran and, when pressed, said that the worst was "war." See the Deutsche Welle's story. (Ah, the Deutsche Welle, that reminds me of when I used to listen to DW on a shortwave radio -- and the BBC, before I lost my trust in that service.)
While backing down a bit on Monday, France stuck to its guns pretty well, saying that since UN sanctions will never happen, a set of EU sanctions similar to those of the US are possible: see the International Herald Tribune.
Le petit Nicolas, as one of my French friends refers to the French President, is making quite a stir on the international scene. What a shame he wasn't around when the US had to serve the world and take out Saddam Hussein.
While backing down a bit on Monday, France stuck to its guns pretty well, saying that since UN sanctions will never happen, a set of EU sanctions similar to those of the US are possible: see the International Herald Tribune.
Le petit Nicolas, as one of my French friends refers to the French President, is making quite a stir on the international scene. What a shame he wasn't around when the US had to serve the world and take out Saddam Hussein.
Sunday, September 16, 2007
An Experiment in Adverse Selection
An article in Friday's Wall Street Journal, written by Chad Terhune, describes new health insurance policies being offered by some insurance companies. I can't give a reference to the WSJ piece, but another paper reports on it here. The ones offered by American Community Mutual Insurance are particularly interesting. They are targeted at the "healthy young" and offer low annual premiums, around $1000 per year. That doesn't get you much, however, as there is a rather small maximum benefit and a large deductible. What it does get you is the option to buy a much larger benefits cap -- up to $5 million -- if you do get sick and want to initiate the higher coverage. "Coverage on Demand," the company says. Of course, that additional coverage is expensive. It HAS to be, because only the ones who buy it will need it! So given the adverse selection that has to happen, is there a price that will allow the company to break even at least, and that will attract some customers into the program? Or at any price, will the only customers who sign up be so costly that the company will have to lose money? The higher the price of the "coverage on demand," the sicker and more costly will be the individuals who sign on. Or, maybe, the individuals who get sick will have enough uncertainty and be so risk-averse that they will buy expensive coverage even when their medical bills will not be all that large.
There is a large market of rational individuals who find medical insurance too expensive and therefore go uncovered, so I can understand the experiments at attracting them. And there are a lot of new plans coming out, especially as some states like Massachusetts require insurance. The fine print is going to lead to a lot of litigation, I predict: what maximum benefits really are, whether they were disclosed, non- covered conditions, etc.
Great case to cover in a class on the classic information economics problems of adverse selection and moral hazard.
There is a large market of rational individuals who find medical insurance too expensive and therefore go uncovered, so I can understand the experiments at attracting them. And there are a lot of new plans coming out, especially as some states like Massachusetts require insurance. The fine print is going to lead to a lot of litigation, I predict: what maximum benefits really are, whether they were disclosed, non- covered conditions, etc.
Great case to cover in a class on the classic information economics problems of adverse selection and moral hazard.
Monday, September 10, 2007
General Petraeus and Ambassador Crocker
A few observations on the testimony today of General Petraeus and Ambassador Crocker. I listened to some, watched a bit on TV, and based on what I saw:
1. If the White House communicated as well as these two fellows (heck, half as well), these hearings would not be happening – because the Democrats would not be in charge of Congress.
2. The moveon.org ad in the NYT brings rational discussion to a new low. To refer to General Petraeus as General Betray Us not only gratuitously insults someone who appears to really care for our country, and obviously works hard at his job, but it demeans the debate over the war. Shame on them.
3. The Democrats are really scared, because they see that if they do indeed win the White House next election and keep control of Congress, any pullout from Iraq will be their decision – and they could well be in a position of explaining to their supporters why we have to stay in even longer. Political posturing is cheap for them now, but they realize that if they were actually in control, they would be making the same decisions.
4. I never understood why “exit” is valued so highly, even if we succeed in stabilizing the situation. I see tremendous value in having, say, a US military base on the Iran/Iraq border – something widely reported today. What, strategically, is bad about having 100,000 well-trained and well-equipped troops on the borders of Iran, Syria, Kuwait, and Saudi Arabia?
1. If the White House communicated as well as these two fellows (heck, half as well), these hearings would not be happening – because the Democrats would not be in charge of Congress.
2. The moveon.org ad in the NYT brings rational discussion to a new low. To refer to General Petraeus as General Betray Us not only gratuitously insults someone who appears to really care for our country, and obviously works hard at his job, but it demeans the debate over the war. Shame on them.
3. The Democrats are really scared, because they see that if they do indeed win the White House next election and keep control of Congress, any pullout from Iraq will be their decision – and they could well be in a position of explaining to their supporters why we have to stay in even longer. Political posturing is cheap for them now, but they realize that if they were actually in control, they would be making the same decisions.
4. I never understood why “exit” is valued so highly, even if we succeed in stabilizing the situation. I see tremendous value in having, say, a US military base on the Iran/Iraq border – something widely reported today. What, strategically, is bad about having 100,000 well-trained and well-equipped troops on the borders of Iran, Syria, Kuwait, and Saudi Arabia?
Apple’s iPhone Price Cut
So no sooner did I write my post below about how Apple rarely has sales, and they promptly cut the price of the iPhone by $200. I did not mean by “sales” the (anticipated) cutting of price after an initial product launch, but instead the kind of sales like “back to school” or “holiday” or “Labor Day.” Cutting of price after an initial launch can often be wise, and I like to refer to it as “temporal versioning.”
Versioning is generally the idea of offering different versions of the same basic product at different prices. If you offer a deluxe version at a high price and a basic version at a lower price, you can effectively price discriminate, with some folks buying the high-priced version and the more price-sensitive folks going for the cheap version.
Critical to this strategy is separation: the two versions have to be kept distinct enough so that the folks who like the deluxe version won’t see the cheap version as almost as good, and at the lower price, a better deal overall.
With temporal versioning, separation is also temporal -- the time between the high price period and the low price period has to be long enough to keep everyone from seeing the sense in waiting for prices to fall.
Apple seems to have not temporally separated its versions well enough. Nice strategy, but off a bit on the implementation. The consumer outcry is pretty good evidence of the error. Interesting, often when discussing price discrimination students will mention the anger when some consumers discover that others are paying a lower price (economists like to walk down an airplane’s aisle asking people what they paid for their seat). My response to this is often: who cares if the consumers are mad? With Apple, and the importance of repeat purchases, consumer anger could translate quite powerfully into lower sales.
Versioning is generally the idea of offering different versions of the same basic product at different prices. If you offer a deluxe version at a high price and a basic version at a lower price, you can effectively price discriminate, with some folks buying the high-priced version and the more price-sensitive folks going for the cheap version.
Critical to this strategy is separation: the two versions have to be kept distinct enough so that the folks who like the deluxe version won’t see the cheap version as almost as good, and at the lower price, a better deal overall.
With temporal versioning, separation is also temporal -- the time between the high price period and the low price period has to be long enough to keep everyone from seeing the sense in waiting for prices to fall.
Apple seems to have not temporally separated its versions well enough. Nice strategy, but off a bit on the implementation. The consumer outcry is pretty good evidence of the error. Interesting, often when discussing price discrimination students will mention the anger when some consumers discover that others are paying a lower price (economists like to walk down an airplane’s aisle asking people what they paid for their seat). My response to this is often: who cares if the consumers are mad? With Apple, and the importance of repeat purchases, consumer anger could translate quite powerfully into lower sales.
Saturday, September 01, 2007
The Irrational Allure of Liberal Songwriter/Singers
So Pete Seeger has written a new song, "Big Joe Blues" that recognizes Seeger's earlier errors in overlooking the evil of the Stalin/Soviet empire:
He ruled with an iron hand
He put an end to the dreams
Of so many in every land
He had a chance to make
A brand new start for the human race
Instead he set it back
Right in the same nasty place
I admit to a certain attraction to songwriter/singers like Seeger, Lennon and Dylan. I think it is the pureness of their idealism, no matter how wrongheaded it might be, I just have to admire it. "Imagine there no possessions." Well, I can imagine that, and it is not pretty, but I can understand what Lennon was trying to accomplish.
Steinbeck' stories are similar. A very socialistic message, but one that hits you very hard and that cannot be ignored.
He ruled with an iron hand
He put an end to the dreams
Of so many in every land
He had a chance to make
A brand new start for the human race
Instead he set it back
Right in the same nasty place
I admit to a certain attraction to songwriter/singers like Seeger, Lennon and Dylan. I think it is the pureness of their idealism, no matter how wrongheaded it might be, I just have to admire it. "Imagine there no possessions." Well, I can imagine that, and it is not pretty, but I can understand what Lennon was trying to accomplish.
Steinbeck' stories are similar. A very socialistic message, but one that hits you very hard and that cannot be ignored.
Apple and NBC Disagree on Pricing
The New York Times reports that Apple and NBC disagree over pricing of NBC’s video content on the iTunes site. Apple prices all TV shows at the flat rate of $1.99; NBC wants more popular shows to sell for more and to be able to offer promotional prices.
Such disagreements are not surprising. Both firms have monopoly power, so both want to make a monopoly profit. Of course, from one firm’s perspective, a monopoly profit by the other firm is equivalent to a tax that reduces sales and revenues.
Right now, there is a standoff, with Apple not offering any new shows from NBC. Negotiations are supposedly continuing. Who wins will suggest to me just how important the iTunes site is to the content providers.
The other interesting observation is how little Apple uses promotional pricing. I am thinking of buying a new Mac, and there is really little reason to hope for a “back to school” sale – well, I guess they offered an iPod to college kids this year, but generally you might as well not look forward to any big sales by Apple. Interesting pricing strategy -- and of course there is also the uniform 99 cent per-song price that has also been criticized by some copyright owners. Why not adjust price on the basis of demand for a song? Thoughts, anyone?
Such disagreements are not surprising. Both firms have monopoly power, so both want to make a monopoly profit. Of course, from one firm’s perspective, a monopoly profit by the other firm is equivalent to a tax that reduces sales and revenues.
Right now, there is a standoff, with Apple not offering any new shows from NBC. Negotiations are supposedly continuing. Who wins will suggest to me just how important the iTunes site is to the content providers.
The other interesting observation is how little Apple uses promotional pricing. I am thinking of buying a new Mac, and there is really little reason to hope for a “back to school” sale – well, I guess they offered an iPod to college kids this year, but generally you might as well not look forward to any big sales by Apple. Interesting pricing strategy -- and of course there is also the uniform 99 cent per-song price that has also been criticized by some copyright owners. Why not adjust price on the basis of demand for a song? Thoughts, anyone?
Thursday, August 30, 2007
The Great Quiet
Anyone notice the lack of stories in the press about deaths in Iraq? Or how the decision by Muqtada al-Sadr to have his army take a six month break has hardly been discussed at all?
These are the best signs that "the surge" is working. Those who want to pull out, and those who want to make the Bush war policy look bad, are running scared.
These are the best signs that "the surge" is working. Those who want to pull out, and those who want to make the Bush war policy look bad, are running scared.
Pessimism Runs Rampant
Who can't help but marvel at the obvious attempts by the liberal MSM to cast a negative pall on anything that could be even remotely linked to the Bush administration.
Yesterday in the Valley News there was a lead above-the-fold article with a Washington Post by-line (authors Christopher Lee and N.C. Aizenman). Headline: US Poverty Rate Down .3% in 2006. The second headline: But More Americans Lacked Health Insurance.
The article goes on to offset any positive aspect with a negative counter. For instance: "While median household income rose for the second consecutive year in 2006, the increase appeared to be driven by a jump in the number of people in each household taking on full-time jobs, rather than a rise in wages."
In fact this is the first time this decade the poverty rate has declined, and it was accompanied with an increase in median household income of .7%.
Yesterday in the Valley News there was a lead above-the-fold article with a Washington Post by-line (authors Christopher Lee and N.C. Aizenman). Headline: US Poverty Rate Down .3% in 2006. The second headline: But More Americans Lacked Health Insurance.
The article goes on to offset any positive aspect with a negative counter. For instance: "While median household income rose for the second consecutive year in 2006, the increase appeared to be driven by a jump in the number of people in each household taking on full-time jobs, rather than a rise in wages."
In fact this is the first time this decade the poverty rate has declined, and it was accompanied with an increase in median household income of .7%.
Saturday, August 18, 2007
Record Low Temps Again?
The record low temperature for Lebanon, NH on August 18 is 41 degrees, recorded in 1957, the year I was born.
The National Weather Service forecast for tonight is a low of....41 degrees.
I think I have to build a fire.
The National Weather Service forecast for tonight is a low of....41 degrees.
I think I have to build a fire.
Apple turns the corner
One of the top electronic game makers, EA, has shipped two new Mac games and will soon be shipping two other popular titles written for the Mac (well, maybe not really written for the Mac, but deciphered from the Windows version).
While still not quite matching the release dates of the Windows version of the games, EA's step into Mac-dom is welcome.
One of Apple's weaknesses has always been the lack of certain software, especially in the gaming arena.
With a few more hits like this, the only remaining reasons for not switching to a Mac would be.........ummmmmmhhhh...
Bill, can you help me here?
While still not quite matching the release dates of the Windows version of the games, EA's step into Mac-dom is welcome.
One of Apple's weaknesses has always been the lack of certain software, especially in the gaming arena.
With a few more hits like this, the only remaining reasons for not switching to a Mac would be.........ummmmmmhhhh...
Bill, can you help me here?
Hanover High Cheating Scandal
At the local high school, Hanover High, nine 17-year old students (all males) have been charged with misdemeanor counts of criminal trespass and/or criminal liability for the conduct of others, in connection with the theft of final exams in math and chemistry courses. It sounds as if the kids hatched – and implemented – a plot to steal exams before test day, so as to be better prepared. I believe they also gave other students the exams as a gift, which causes one to further question the kids’ common sense (unless they sold the exams, which raises the old economics question of whether you can profit more from information by using it yourself or selling it).
I am sorry for the kids, but it certainly was not a very bright thing to do. And I would have to say that in my ranking of crimes, this is one notch worse than, say, colluding with another student to share answers. These guys not only (allegedly) violated academic integrity by cheating, but they also allegedly criminally invaded school property and stole something. Not good.
But, the most interesting part of this is that, naturally, some of the kids are children of folks we know. I will resist any urge to engage in schadenfreude, for the usual “there but for the grace of God…” reason. However…one of the poor kids is the son of Jim Kenyon, a notorious columnist for the Valley News. This is the guy who never misses a chance to tear into Dartmouth and generally side with the forces of bleeding hearts and evil. His column is one I never miss, and much like Paul Krugman’s, it never ceases to raise my ire. The last one he wrote got me upset because he criticized our local food co-op for having a 60-year old woman arrested for shoplifting (she was later acquitted by the judge). The co-op should have shown mercy on a nice old lady, Kenyon said; my reading was that he has one kind of justice for people he knows and likes and another kind of justice for outsiders and “ne-er do wells”. Nothing like a little discrimination, eh?
Perhaps Mr. Kenyon knew when he wrote that column that his son was being investigated for his own form of shoplifting?
The Valley News had some quotes from Jim Kenyon regarding the incident and his son:
He said Hanover High School’s “high pressured academic culture” leads to widespread cheating.
“The entire community must be willing to take a hard look at how it might have unwittingly contributed to this problem and work together to find solutions.”
Kenyon said the school’s cheating problems “do not begin or end with the final exams now in question.”
Give me a break, please! So we are to sacrifice our academic ambitions because nine kids can’t resist the pressure to steal exams? And this is not mainly the problem of the kids and their families, but of the entire community? Yes, society is to blame, competition is evil, we are not responsible for our own actions, we all have to work together…blah blah blah.
I am sorry for the kids, but it certainly was not a very bright thing to do. And I would have to say that in my ranking of crimes, this is one notch worse than, say, colluding with another student to share answers. These guys not only (allegedly) violated academic integrity by cheating, but they also allegedly criminally invaded school property and stole something. Not good.
But, the most interesting part of this is that, naturally, some of the kids are children of folks we know. I will resist any urge to engage in schadenfreude, for the usual “there but for the grace of God…” reason. However…one of the poor kids is the son of Jim Kenyon, a notorious columnist for the Valley News. This is the guy who never misses a chance to tear into Dartmouth and generally side with the forces of bleeding hearts and evil. His column is one I never miss, and much like Paul Krugman’s, it never ceases to raise my ire. The last one he wrote got me upset because he criticized our local food co-op for having a 60-year old woman arrested for shoplifting (she was later acquitted by the judge). The co-op should have shown mercy on a nice old lady, Kenyon said; my reading was that he has one kind of justice for people he knows and likes and another kind of justice for outsiders and “ne-er do wells”. Nothing like a little discrimination, eh?
Perhaps Mr. Kenyon knew when he wrote that column that his son was being investigated for his own form of shoplifting?
The Valley News had some quotes from Jim Kenyon regarding the incident and his son:
He said Hanover High School’s “high pressured academic culture” leads to widespread cheating.
“The entire community must be willing to take a hard look at how it might have unwittingly contributed to this problem and work together to find solutions.”
Kenyon said the school’s cheating problems “do not begin or end with the final exams now in question.”
Give me a break, please! So we are to sacrifice our academic ambitions because nine kids can’t resist the pressure to steal exams? And this is not mainly the problem of the kids and their families, but of the entire community? Yes, society is to blame, competition is evil, we are not responsible for our own actions, we all have to work together…blah blah blah.
Friday, August 17, 2007
The Fed to the Rescue
The Federal Reserve today singlehandedly created a 2% rally in the stock market and put to rest at least some fears of a credit crunch. I applaud Ben Bernanke and his colleagues’ move.
The critical distinction here is between bailing out investors who made bad decisions versus preventing a classic financial panic, of the “run on the bank” variety. I give my vote to the idea that there was indeed risk of a credit crunch, with a cascade of negative opinion creating feedback that was preventing capital from flowing to positive net present value projects.
The classic bank run occurs when depositors come en masse to a bank, demanding their deposits. These deposits are not, of course, in a vault at the bank but instead have been lent out to borrowers, with only some small percentage kept close at hand. If too many depositors demand their account balances, the bank must begin calling its loans, and therein lies the contagion effect.
In today’s market, the problem is not so much with traditional banks. But consider an investment bank like Bear Stearns. Bear Stearns discloses that one of its in-house investment funds held mortgage-backed securities that has declined in value so much that the fund is worthless – presumably the fund managers had leveraged their investments, so a relatively small decline in value could wipe out the net assets of the fund. Once disclosed, and given the overall worries about mortgage-backed securities, negative sentiment about Bear Stearns increases. In the normal course of business, an investment bank needs to borrow large sums of money to finance its activities. But given the concerns, and lack of knowledge of how bad the problems really are, who will want to throw money into a pot that might turn out to be rather empty? Afraid of being the claimant of lowest priority, nobody wants to lend money to such an institution under almost any conditions. This causes the investment bank to reduce its activity in a whole host of areas, and to sell assets it otherwise would hold, in order to raise funds. The vicious cycle begins, with lower prices in asset markets putting other institutions at risk…
I have been hearing from friends on Wall Street since at least June of the funny conditions in the credit markets. Credit was drying up, in the sense that lenders were just saying no, rather than just increasing prices by a reasonable amount to cover new risks.
It is funny how long it took for those fairly wide-spread debt market fears took to spread to the equity markets. One of those (many) instance where if only I had known for sure, I could have made some money. Ah, but how many times have I suspected some disaster only to see stock markets rise thereafter? Much better to buy and hold.
What the Fed did, in lowering the discount rate, was really quite genious. Very little additional credit will enter the economy as a result, and what does enter can be offset at an opportune time via open market operations.
But the Fed showed investors that they do understand that conditions are unusual and that there is a risk of a credit crunch. Credit crunches, panics, and runs should be prevented, and that is the job of the Fed. Bailing out mortgage bankers who loaned 100% of a home’s appraised value to buyers without verifying income is not the job of anyone.
By the way, I know folks in Hanover who had to pay for private mortgage insurance when they bought a house, and these are people with great jobs and in a great housing market. How is it that people in Florida and California are getting by with 100% loan to value mortgages, no income verification, and no PMI??
The critical distinction here is between bailing out investors who made bad decisions versus preventing a classic financial panic, of the “run on the bank” variety. I give my vote to the idea that there was indeed risk of a credit crunch, with a cascade of negative opinion creating feedback that was preventing capital from flowing to positive net present value projects.
The classic bank run occurs when depositors come en masse to a bank, demanding their deposits. These deposits are not, of course, in a vault at the bank but instead have been lent out to borrowers, with only some small percentage kept close at hand. If too many depositors demand their account balances, the bank must begin calling its loans, and therein lies the contagion effect.
In today’s market, the problem is not so much with traditional banks. But consider an investment bank like Bear Stearns. Bear Stearns discloses that one of its in-house investment funds held mortgage-backed securities that has declined in value so much that the fund is worthless – presumably the fund managers had leveraged their investments, so a relatively small decline in value could wipe out the net assets of the fund. Once disclosed, and given the overall worries about mortgage-backed securities, negative sentiment about Bear Stearns increases. In the normal course of business, an investment bank needs to borrow large sums of money to finance its activities. But given the concerns, and lack of knowledge of how bad the problems really are, who will want to throw money into a pot that might turn out to be rather empty? Afraid of being the claimant of lowest priority, nobody wants to lend money to such an institution under almost any conditions. This causes the investment bank to reduce its activity in a whole host of areas, and to sell assets it otherwise would hold, in order to raise funds. The vicious cycle begins, with lower prices in asset markets putting other institutions at risk…
I have been hearing from friends on Wall Street since at least June of the funny conditions in the credit markets. Credit was drying up, in the sense that lenders were just saying no, rather than just increasing prices by a reasonable amount to cover new risks.
It is funny how long it took for those fairly wide-spread debt market fears took to spread to the equity markets. One of those (many) instance where if only I had known for sure, I could have made some money. Ah, but how many times have I suspected some disaster only to see stock markets rise thereafter? Much better to buy and hold.
What the Fed did, in lowering the discount rate, was really quite genious. Very little additional credit will enter the economy as a result, and what does enter can be offset at an opportune time via open market operations.
But the Fed showed investors that they do understand that conditions are unusual and that there is a risk of a credit crunch. Credit crunches, panics, and runs should be prevented, and that is the job of the Fed. Bailing out mortgage bankers who loaned 100% of a home’s appraised value to buyers without verifying income is not the job of anyone.
By the way, I know folks in Hanover who had to pay for private mortgage insurance when they bought a house, and these are people with great jobs and in a great housing market. How is it that people in Florida and California are getting by with 100% loan to value mortgages, no income verification, and no PMI??
Gloom and Doom
It’s really entertaining to read the New York Times, especially Paul Krugman’s gloom and doom editorials. I have a colleague who writes an investment advisory letter that exhibits a similar “longing for disaster” tone. Another example is all the climate change advocates who I detect thirsting for some Atlantic hurricanes this year (hurry up, Dean!).
The politics and world views behind so many pundits’ analysis is just so obvious, and so weakly denied. Krugman’s columns ooze not just gloom and doom, but I get a strong sense that he wants to see things melt down, just to prove that the Bush administration has been a total failure. My colleague’s letters to his clients are very similar. It’s not just that he thinks a real estate crash might come, but one gets a very strong sense that he will be happy and fulfilled if it does happen.
Here is an example. In today’s NYT, Krugman writes, “According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in a free fall…The housing slump will probably be with us for years, not months…Meanwhile, it’s becoming clear that the mortgage problem is anything but contained.”
Free fall, years not months, anything but contained, lowest levels in decade…well, that last phrase is the one factual statement out of all of them. But given what housing has done in the last decade, to say that activity is lower than it has been for ten years really does not sound too bad. And even with housing prices haven fallen of late, has anyone checked the rate of return on owner-occupied housing over recent periods? Some slowing down or even declines is not exactly a crash.
How much you want to bet that Krugman criticizes the Fed for throwing cold water on his dreams? Don’t you share my hunch that many of these Democratic analysts are hoping that the housing crunch does indeed snowball into a recession, so that the Presidency will go to….Hillary? Obama? Edwards?
The politics and world views behind so many pundits’ analysis is just so obvious, and so weakly denied. Krugman’s columns ooze not just gloom and doom, but I get a strong sense that he wants to see things melt down, just to prove that the Bush administration has been a total failure. My colleague’s letters to his clients are very similar. It’s not just that he thinks a real estate crash might come, but one gets a very strong sense that he will be happy and fulfilled if it does happen.
Here is an example. In today’s NYT, Krugman writes, “According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in a free fall…The housing slump will probably be with us for years, not months…Meanwhile, it’s becoming clear that the mortgage problem is anything but contained.”
Free fall, years not months, anything but contained, lowest levels in decade…well, that last phrase is the one factual statement out of all of them. But given what housing has done in the last decade, to say that activity is lower than it has been for ten years really does not sound too bad. And even with housing prices haven fallen of late, has anyone checked the rate of return on owner-occupied housing over recent periods? Some slowing down or even declines is not exactly a crash.
How much you want to bet that Krugman criticizes the Fed for throwing cold water on his dreams? Don’t you share my hunch that many of these Democratic analysts are hoping that the housing crunch does indeed snowball into a recession, so that the Presidency will go to….Hillary? Obama? Edwards?
Saturday, July 14, 2007
Health Insurance Limitations
Someone remarked the other day that if not for the war in Iraq, health care would be topic number one in the presidential race. That might well be true.
How will we devise a system to stop insurance from creating unlimited demand for health care services, creating a non-ending escalation of costs? Somehow we will have to give consumers incentive to limit their demand for services. This is tough, because when you are sick, or a loved one is sick, it is really tough to say that you cannot get treated.
Yet this has been the norm in all other important areas, such as housing, education, transportation, and food. Prices in these cases serve their normal role of inducing people to make choices to go without certain services, or at least to choose lower cost services. Many people routinely choose cheaper schools for their children, less expensive and less safe cars for themselves, and take jobs that are riskier to life and limb but pay more (e.g., fire fighters). Also, throughout history, unlimited health care has not been the norm.
Other countries are to a great extent using some kind of nonprice rationing such as waiting for service. In the US today, we have some rationing due to geography: living close to a major medical center will get you more, and more expensive, health care.
I have always felt that a part of the answer will lie in medical insurance being differentiated by degree of coverage. Some plans will not cover certain services, such as expensive transplants, or will at least have high co-pays for certain services, such as mental health.
The new Massachusetts regime requiring everyone to have medical insurance is moving in this direction. The Blue Cross Blue Shield website for the state lists several different plans at different prices and with different coverages.
What I was not able to find in the online descriptions of the plans is a key feature: lifetime maximum benefit. I think this will be critical. There should be some plans that are cheaper but have lower lifetime maximums, or in some way put a limit on what will be covered in certain situations (heart transplant, long term hospital stays, hip transplants past a certain age, etc). It is interesting that the lifetime maximum is not prominent in the plan descriptions -- indeed it is hidden. I am pretty sure there are lifetime maximums, and that they differ across plans. What will BS BS do with patients who hit that max and still want more coverage? Will our dear friend M. Moore have yet more fodder for another movie?
How will we devise a system to stop insurance from creating unlimited demand for health care services, creating a non-ending escalation of costs? Somehow we will have to give consumers incentive to limit their demand for services. This is tough, because when you are sick, or a loved one is sick, it is really tough to say that you cannot get treated.
Yet this has been the norm in all other important areas, such as housing, education, transportation, and food. Prices in these cases serve their normal role of inducing people to make choices to go without certain services, or at least to choose lower cost services. Many people routinely choose cheaper schools for their children, less expensive and less safe cars for themselves, and take jobs that are riskier to life and limb but pay more (e.g., fire fighters). Also, throughout history, unlimited health care has not been the norm.
Other countries are to a great extent using some kind of nonprice rationing such as waiting for service. In the US today, we have some rationing due to geography: living close to a major medical center will get you more, and more expensive, health care.
I have always felt that a part of the answer will lie in medical insurance being differentiated by degree of coverage. Some plans will not cover certain services, such as expensive transplants, or will at least have high co-pays for certain services, such as mental health.
The new Massachusetts regime requiring everyone to have medical insurance is moving in this direction. The Blue Cross Blue Shield website for the state lists several different plans at different prices and with different coverages.
What I was not able to find in the online descriptions of the plans is a key feature: lifetime maximum benefit. I think this will be critical. There should be some plans that are cheaper but have lower lifetime maximums, or in some way put a limit on what will be covered in certain situations (heart transplant, long term hospital stays, hip transplants past a certain age, etc). It is interesting that the lifetime maximum is not prominent in the plan descriptions -- indeed it is hidden. I am pretty sure there are lifetime maximums, and that they differ across plans. What will BS BS do with patients who hit that max and still want more coverage? Will our dear friend M. Moore have yet more fodder for another movie?
Friday, July 13, 2007
Taxing Private Equity
Not too long ago, I asked an accounting colleague about the tax treatment of someone selling things on an auction site like Ebay. Suppose you are making your living buying and selling collectibles on Ebay. How does the income you make get treated for tax purposes -- is it normal income, or is it capital gains? The difference, of course, is very large, as capital gains are taxed at 15% and normal income at higher rates. Similar analogies came to mind: how about a used car dealer? If I buy and sell cars, is the money I make a capital gain or normal income? It seemed like one of those issues where tax law would draw a somewhat arbritrary line. I can see an argument that if you are essentially a dealer, i.e., making a market in a collectible, then your income could be considered normal, rather than a capital gain, as you are essentially being rewarded for the service of providing a market. But it is going to be a tough call, and in some sense, illustrates the arbitrariness of treating income differentially to begin with.
Now comes the tax issue with the partners of private equity funds. Is the money that private equity fund managers make better considered to be normal income or a capital gain? This is a great topic for discussion. The current law may well make it legal for the managers to use capital gains rate; I suspect if they are doing it, they have had great lawyers look into the legality. So the question is what the right legal tax treatment should be.
But along comes the New York Times yesterday, with a front page story on "Tax Loopholes Sweeten a Deal for Blackstone." The intent of the story is clear -- to raise all kinds of shady questions about the tax fairness of aspects of the Blackstone IPO. The tactics are the usual combination of insinuation, vague claims, and muckraking language. Here are some examples:
"“These guys have figured out how to turn paying taxes into an annuity,” Ms. Sheppard said. “What people don’t realize is
that the private equity managers, the investment bankers, all the financial intermediaries, are in control of their own
taxation."
"The Blackstone partners sold the good will from their left pocket to their right."
"The ability to provide answers to such questions is why tax lawyers can typically charge $700 an hour or more. Just as
fashion designers blend textures, colors and shapes, tax experts mix and match elements of partnerships and
corporations, and bits and pieces of the tax code, securities laws, accounting rules and economics principles."
There are some interesting issues in the Blackstone deal. But this NYT story leaves me clueless as to what actually is going on, and whether it is at all questionable. Some more facts and clear language on what is being done would go SO much further than the kind of language pointed out above. The "annuity" that is referred to seems to be nothing more than the fact that if the goodwill can be written off against income in future years, then of course it creates a tax saving (assuming there is positive income). And to say that private equity managers are in control of their own taxation is really a stretch.
Well, I guess I am in control of my taxation too. If I earn less money, I will pay less tax.
Now comes the tax issue with the partners of private equity funds. Is the money that private equity fund managers make better considered to be normal income or a capital gain? This is a great topic for discussion. The current law may well make it legal for the managers to use capital gains rate; I suspect if they are doing it, they have had great lawyers look into the legality. So the question is what the right legal tax treatment should be.
But along comes the New York Times yesterday, with a front page story on "Tax Loopholes Sweeten a Deal for Blackstone." The intent of the story is clear -- to raise all kinds of shady questions about the tax fairness of aspects of the Blackstone IPO. The tactics are the usual combination of insinuation, vague claims, and muckraking language. Here are some examples:
"“These guys have figured out how to turn paying taxes into an annuity,” Ms. Sheppard said. “What people don’t realize is
that the private equity managers, the investment bankers, all the financial intermediaries, are in control of their own
taxation."
"The Blackstone partners sold the good will from their left pocket to their right."
"The ability to provide answers to such questions is why tax lawyers can typically charge $700 an hour or more. Just as
fashion designers blend textures, colors and shapes, tax experts mix and match elements of partnerships and
corporations, and bits and pieces of the tax code, securities laws, accounting rules and economics principles."
There are some interesting issues in the Blackstone deal. But this NYT story leaves me clueless as to what actually is going on, and whether it is at all questionable. Some more facts and clear language on what is being done would go SO much further than the kind of language pointed out above. The "annuity" that is referred to seems to be nothing more than the fact that if the goodwill can be written off against income in future years, then of course it creates a tax saving (assuming there is positive income). And to say that private equity managers are in control of their own taxation is really a stretch.
Well, I guess I am in control of my taxation too. If I earn less money, I will pay less tax.
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