Guest Column: Should we trade emissions rather than tax them?

By Brian Easton.

There appears to be a tendency to pose carbon taxes as the only economic way to address carbon emissions. But tradeable emission permits (TEPs) are a serviceable alternative which have both strengths and weaknesses over carbon taxes. Their greatest strength may be that they are politically more feasible.

TEPs, which permit emission of carbon (and without such permits no emissions are allowed), could be started off by grandfathering in recent levels of emissions so that current emitters got permits sufficient to allow them to emit their last year’s level, say. But each year the allowance attached to each TEP decreases so that at the end of the target period we got emissions down to our international target. This would force each emitter to reduce its level of carbon emissions unless it could acquire TEPs from others that had reduced their emissions more. Since the obdurate polluters are forced to purchase the TEPs from the reducing polluters, there would be a market incentive to seek technologies to reduce emissions, together with some demand side effects as the price of the products of carbon emitters would be forced up.

The scheme requires some development, particularly

1. How to interface with the rest of the world, and
2. How to deal with carbon sinks (one option is for the government to reward sinks with annual TEPs which they can sell to emitters, in effect offsetting the pollution with a sink).
3. Administrative mechanisms.

Typically there would also be an annual resource levy to cover the cost of management, enforcement and R&D in the scheme.

This proposal essentially involves a market mechanism, but it does not involve a tax. (The levy is not a tax but user-pays. However, corporate gains from the market value of TEPs may well be treated as income and thereby taxed.) So the rents do not, on the whole, go to the public purse (which many would think a pity). It is easy to show that there would be some inequities (but a tax-based system would generate them too).

The advantage of TEPs over a tax (other than one can target aggregate emissions with precision) is that the scheme is relatively politically stable. Had it been in place last year, the coalition partners would not have asked for a repeal because they would have been destroying the property rights of the holders of TEPs who, despite any doubts about the scheme, would lobby against its abolition (since the alternative might be worse).

Of course the TEP scheme is clumsy. All impure market schemes are – which is why one only advocates them when the market is failing to deliver (big time in the case of carbon emissions). But a tax-based system is also clumsy. My guess is the TEP scheme is not as clumsy as a tax-based one, although it does not have the advantage of revenue raising.

The point of this note, is that sometimes having lost a policy battle, the losers want to fight again on the same battlefield, so sure are they of the justice of their cause. Thus those concerned with global warming seem to want to return to taxation as the mechanism. But sometimes it makes sense to look around for other policy options which give a reasonable chance of the advocates winning the next bout. As TEPs may do. At worse one learns about the strengths and weaknesses of the previous policy and its resolution.

Guest Column - What Does The 2004 Living Standards Report Tell Us?

By Brian Easton.

The New Zealand Living Standards 2004 report depends entirely upon its "Economic Living Standards Index" (ELSI), first used in the previous (2000) report. At that time I expressed reservations about the index. Many have not been addressed. What I do here is set some down again, and then mindful of the ELSI's problems, and try to draw some conclusions of what the latest survey may be telling us about what happened between 2000 and 2004.

This may all seem a bit tedious. Who cares if the measure does not have any real meaning? Is it not better to use it for whatever (political) purpose we want without worrying about what the measure actually means? Don't we do that all the time? Do we need to have a detailed understanding of the meaning of time or income or whatever? Cant we just trust those who constructed the measures?

Well actually no. Typically scientists have spent much effort in constructing valid indexes. They are usually based on sophisticated theory, while each measure is verified by other scientists and is shown to have a practical significance related to things outside the narrow confines of the data which generates the measure. This is so routine for our authoritative measures that we assume it is true whenever someone proposes a new one. It may not be. Often indexes (i.e. measure of something or other) are not validated and amount little more than the opinions of the proponents.

Validation usually involves two stages. First, there is the underlying theory. Is it rigorous? How does the index relate to it? (Its construction often has to make compromises, but if the theory is well understood one can evaluate the extent to which they matter.) Second is a empirical validation. Does the index relate to anything outside the data from which it was constructed? (Two examples of my trying to empirically validate indexes – sometimes called ‘calibration’ – are at http://www.eastonbh.ac.nz/?p=229 and http://www.eastonbh.ac.nz/?p=460.)

Validating the ELSI Index

The ELSI is based on asking households (strictly an "Economic Family Unit" – EFU) a set of questions about what items they have or have not got, what restrictions there are on their social activities, what economising behaviour they have had to practice, and how they rate themselves. The household responses are then combined to give the ELSI index.

Note there are two stages. The first involves the questions asked. Are they the right questions? The second involves the aggregation of the responses. Has the right weighting (significance) been given to each response? How do we know the selection and weightings are not merely the opinions of those who construct the index, and that another set of "experts" would make different decisions? (For instance, the ELSI doubles the significance of some responses relative to others. Why not three times? Why not half?)

As far as I know, there has been little attempt to validate the ELSI. There is no reference to a satisfactory validation in either the report nor its bibliography. That does not mean the index is necessarily invalid, but we need to be most cautious when using it.

In my view the ELSI is a very poor measure of overall economic living standards (whatever that means). In particular, it is unlikely to be much use discriminating between those who are comfortably off. I should not be at all surprised if Bill Gates and myself would get much the same score, as might someone on the average wage and myself. That is because the questions are not designed to discriminate between the affluent. (There is not even a question on car ownership.)

Thus one can give no significance to the average ELSI for the whole public. (If everyone got a(n extra) car it would have to have no effect on their ELSI score – other than perhaps through changes in self-rated satisfaction.)

The difficulty arises because the researchers were focussing on the circumstances of the poor. So while we should dismiss the ELSI for the population as a whole we cannot be so dismissive of the index for those near its economic bottom. It is important if some people do not have a good pair of shoes (supposing that means "suitable for general purposes", rather than "for dressing up"), which was one of the questions.

So what I am going to focus on are those the authors describe as being in some or greater "hardship". That category includes those in "severe hardship" and "significant hardship". In my judgement their samples are too small and the measurement error too big for one to make comparisons involving them

Comparing 2000 and 2004

Famously, Moser's Law says that if a statistic looks interesting, it is probably wrong. Despite the rise in real incomes between 2000 and 2004 (which the report acknowledges) the ELSI decreases slightly. Which is surely "interesting", (I don't have a feel of the significance of the fall in the ELSI from 40.6 to 39.7 – out of 60. That is one of the consequences of not validating the index.) But given that the index is probably meaningless for the majority – say top two-thirds – of the population measures based on the whole population (such as the mean) are of little value.

What is more disturbing is the evidence that more of the population (that at the bottom) were in the hardship category. The rise in the proportion of the population in hardship rose from 23.6 percent in 2000 to 24.0 percent in 2004.

A useful table (C10) in the report, which gives the proportions for the total and a huge range of sub-populations, shows this difference is not statistically significant – that is it could arise from the vagaries of sampling.

There are a few cases among the sub-populations where there are increases and a handful where the difference is statistically significant (but remember that will happen by accident on occasions, given the way that statistical tests operate). You can pour over the table, and find some example that suits your assumptions. (For instance Labour-committed supporters will mention the decrease in hardship of the proportion of the Maori and two parent families. Those on the other side may draw attention to that there seems to be more employed and more of the elderly in hardship.)

At this point we could drop the whole exercise, concluding the changes in the ELSI over the four years tell us nothing. But there is a really interesting problem – one where the "probability" in Moser’s Law warns us sometimes happen. Sometimes a statistic can be interesting and not wrong.

The problem is this. The four years between the two surveys were ones of economic prosperity by almost all conventional welfare measures – higher real incomes and employment, lower unemployment ... – as well as common sense. Yet there is no improvement in the ELSI. The inconsistency is sufficiently strong to suggest that the ELSI is generally not valid. I have already argued that is true, so I am not surprised. At which point we could end the story.

What interests me though, is that where the ELSI might thought to better represent living standards – among those in "hardship" – there is no improvement either (indeed, a statistically insignificant deterioration). I find this much harder to understand. The ELSI cannot be that hopeless.

I tried to think of some technical reasons. Perhaps household fragmentation has had an effect. When a poor couple splits up only is one is likely to have warm bedding (one of the questions asked) at best. Perhaps the drift north has had an effect too (they were asked about having a warm winter coat). But such effects are likely to be trivial in the four year period.

The report acknowledges that beneficiaries had no real increase in their standard benefits over the four years, and some had reductions because some assistance (such as for families) was not adjusted for inflation. Would their lower real incomes be enough to increase their hardship and reduce the ELSI? Possibly.

There is also a tricky problem that the sub-populations change over time. Suppose a better-off beneficiary in 2000 joined the workforce by 2004. That would lower the ELSI of the beneficiaries who are left. It may also lower the ELSI scores of the employed since they ex-beneficiaries are likely to be at the lower end of the standard living of the employed. Bother, bother, bother.

There is another phenomenon which the ELSI does not deal with well. In each survey, respondents were asked whether they had a personal computer (for example). Now the options (to simplify a little) is "yes", "no" (because I cant afford it), or "I don't want one". The "don't want ones" are then netted out. Now it seems possible that some people who said "don't want one" on 2000 said "no because I cannot afford one" in 2004. Their ownership has not changed one iota, but the standard of living of the household measured on the ELSI will have decreased. Are there enough of such items in the survey to actually depress the score? Possibly.

What too about the family that has bought a computer because they now want (or think their children need) one and have made other sacrifices to fund the computer? The way the index works might depress the score. Indeed the additional purchase need not even appear in the survey. A household which bought a car (not in the survey) and sacrificed their annual holiday (in the survey) to do so. That would definitely depress the score. (And to complicate the story further, what if the car was necessary to go to work?)

Trickling Down Prosperity?

At this point one might become so uneasy about the ELSI, to judge of it of no value. However I think there is an interesting conclusion from the previous couple of paragraphs. To put it provocatively, during a time of prosperity, expectations may trickle down faster than income.

This proposition brings together two issues. For more than thirty years I have been advocating that we should use a relative poverty measure. This expectation effect illustrates its relevance.

Second, for some groups – the elderly and children – there is no automatic market trickle down effect, and that sharing prosperity requires some active intervention by the government.

The elderly have a trickle down through the (imperfect) indexation of New Zealand Superannuation to wages. Beneficiaries don't, because their benefit is indexed to consumer prices which rise slower than wages.

Children have suffered even more because their public assistance is not indexed at all. (There is a big lift in the incomes of some of them via the Working for Families package.)

I have argued that the benefit of the rising prosperity to those on social security has been to get an income increase from a job (not all of which disappears in the costs of employment and taxes and benefit abatement). Those on low earnings may also benefit from longer hours, higher pay and better working conditions, and upskilling. As pointed out, the ELSI can miss such improvements.

But I have to modify that conclusion. What the ELSI for low income people seems to be saying is that those that have not got a job have not benefited. Even if their real incomes are maintained, they may experience falling "living standards" if prosperity raises expectations but not their incomes.

The Real Issue

We can go on in this sort of speculation, but the first real lesson is not to trust changes in the ELSI which contradict common sense. However the study affirms one old truth, and challenges a more recent one.

We have long known there are some groups in hardship. According to the survey over 35 percent of our children are (compared to less than 25 percent of the population as a whole, including children). Interestingly, the hardship measure suggest proportions similar to those in the income poverty studies – the vast majority of the poor in income terms or in hardship in this study are children and their parents. (See various papers indexed in http://www.eastonbh.ac.nz/?p=152 for more details.) Perhaps this should be no great surprise, although it is satisfying to a researcher to have a rather different method coming up with similar conclusions.

The degree to which the government's recent measures to increase family assistance will markedly reduce hardship remains uncertain, because the support has been targeted on working families, rather than all families.

Which leads to a challenge to a more recent "truth". I think it was right in the early 1990s to place some emphasis on beneficiaries finding jobs. The conclusion, dimly seen through this report on living standards, is that after 15 years of doing so, plus a period of employment expansion and prosperity, there remains a rump who are still trapped into hardship. The policy strategy, which has succeeded for many, has failed them. If we are concerned about their hardship, and the often serious and longstanding (even inter-generational) deleterious consequences, we need to think about an alternative strategy which may be more income. It almost certainly is not to intensify a strategy which has failed them in the past.

Guest Column - Building Coalitions: The Banzhaf Index

By Brian Easton.

One of the advantages of MMP is it enables us to think more systematically about the political process (although given much of the nonsense that is being written at the moment, it does not appear to force us to). What this note sets out is a a mathematical procedure which enables us to think systematically about coalitions (although, and as I shall explain, like most mathematical models it has imitations).

However, first a word about its progenitor, John F. Banshaf III, a remarkable professor of law at George Washington University who is known as the 'Ralph Nader of the Tobacco Industry,' 'the Ralph Nader of Junk Food,' 'The Man Who Is Taking Fat to Court' and 'Mr. Anti-Smoking'. (He is also Faculty Advisor for the GWU Volleyball Team.) Earlier he had been an electrical engineer and obtained the first copyright ever registered on a computer program. He also developed a method for measuring the power of parties negotiating coalitions – the Banzhaf Index.

The Banzhaf Index

I use the Banzhaf Index in the current New Zealand political situation. I take the current allocation of seats. The specials may change the numbers but not the principles illustrated here.

There are eight parties vying for power, with a total of 122 seats. Each may be in or out of a coalition, so in total there is the possibility of 2⁸ or 256 coalitions (including the zero when nobody joins). As it happens there are 124 of these in which the coalition has the required 62 votes or more to govern (slightly less than half because 61 votes doesnt give a majority).

Of course not all parties belong to all the possible successful coalitions. Labour with 50 votes is in 68 (or 55%) of the coalitions. The figures for all the parties are shown in column 4 (and column 5) of Table I.

However, this does not discriminate between the importance of a party in a coalition. For instance in the coalition of all parties with 122 seats, if Progressives with their one seat walk out the coalition still has 121 seats, more than enough to govern.

So the Banzhaf index involves counting the number of times of a party to walk out of a coalition with the result that it loses its majority. In the current situation, any party can walk out of the ‘All’ coalition and it would still have a majority. (Were Labour to walk out, there would still have 72 (122-50) votes).

As it happens Labour is required in 68 of the 124 coalitions, while the Progressives are required in only 4 of them. (Column 6). The Banzhaf index adds the number of times this happens for all parties (238) calculates each party’s total as a proprtion of the grand total, and calls the level of power of each party relative to the rest. (So Labour’s relative power is 68/238 = 28.6%).

Table I: Illustrating the Banzhaf Index

Party	Seats		Coalitions		Vetos
Labour	50	41.0%	96	77.4%	68	28.6%
National	49	40.2%	92	74.2%	60	25.2%
NZ First	7	5.7%	80	64.5%	36	15.1%
Greens	6	4.9%	76	61.3%	28	11.8%
Maori P.	4	3.3%	72	58.1%	20	8.4%
U Future	3	2.5%	68	54.8%	12	5.0%
ACT	2	1.6%	67	54.0%	10	4.2%
Progressive	1	0.8%	64	51.6%	4	1.7%
Total	122	100.0%	124	100.0%	238	100.0%

The final column in bold shows the Banzhaf index of the power of each party in coalition forming.

We have the well known phenomenon that smaller parties seem to have power out of proportion to their votes.

Incompatibles

The previous section was highly idealised, assuming that the parties are only interested in power and have no principles (or backers, which is often the same thing). Sometimes parties are incompatible and wont go into coalition together.

So lets add some of those principles as follows:

1. Progressives always go with Labour
2. ACT and the Greens never go with each other
3. The Maori Party wont go with National because it wont entrench the Maori Seat provision.

(I can easily add some more, but this illustration suffices.).

Now there are only 46 viable coalitions, and as Table II shows Labour is in 91.3% of them.

Table II: Banzhaf Index with Some Political Restrictions

Party	Seats		Coalitions		Vetos
Labour + Progressives	51	41.8%	21	91.3%	19	36.5%
National	49	40.2%	14	60.9%	11	21.2%
NZ First	7	5.7%	16	69.6%	10	19.2%
Greens	6	4.9%	10	43.5%	5	9.6%
Maori P.	4	3.3%	6	26.1%	4	7.7%
U Future	3	2.5%	12	52.2%	2	3.8%
ACT	2	1.6%	7	30.4%	1	1.9%
Total	122	100.0%	46	100.0%	52	100.0%

The final column in bold shows the Banzhaf index of the power of each party in coalition forming.

Not surprisingly, those parties which do not rule out partners as a matter of principle generally have a higher proportion of vetos and more power relative to the unrestricted case. Conversely those that rule out some options have a lower proportion of the vetos and less power.

The exception is United Future. Through a quirk of the numbers, 3 seats is not a good number to have in this set of voting patterns. (Peter Dunne would agree. He would rather have 13 seats.)

Minority Government

Banzhaf designed his index for one-off situations. It is usually illustrated in the American literature, by the Electoral College for the US President, which comes together, votes on the sole matter of who is to be the next president, and then dissolves.

The New Zealand situation is different because the parties meet again after every election and, as we shall see, the prospect of that affects how they behave now. Moreover, the coalition process is an ongoing one in the intervening three years, particularly when there is a minority government, as there has been in eight of the last ten years and there is likely to be over the next three (and probably after).

We can adapt the index as follows. Let’s assume that Labour remains a minority government with the Progressives. It has to seek six coalitions of the remaining parties in parliament. There are coalitions available to it for this purpose (that is the government has to raise at least another 11 votes). Table III shows the calculations for the minority parties.

The Labour and Progressive row is deleted. The theory is not robust enough to measure the power of an incumbent minority government, which has a whole range of institutional instruments which enhance the power from their seats. However the Banzhaf Index can be used to measure the relative power of those outside government, as Table III shows.

Table III: Banzhaf Index for Relative Strengths of Outside Parties (assuming Labour and Progressives form a minority government)

Party	Seats		Coalitions		Vetos
National	49	69.0%	32	19.0%	15	35.7%
NZ First	7	9.9%	29	17.3%	9	21.4%
Greens	6	8.5%	28	16.7%	7	16.7%
Maori P.	4	5.6%	27	16.1%	5	11.9%
U Future	3	4.2%	26	15.5%	3	7.1%
ACT	2	2.8%	26	15.5%	3	7.1%
Total	71	100.0%	168	100.0%	78	100.0%

The final column in bold shows the Banzhaf index of the power of each party to influence the minority government.

Table III suggests that while National has more than two thirds of the seats outside the minority government, it has only just over one third of the power to form a coalition to influence the minority government. All the other parties have correspondingly more power.

National Remains Outside

However, this requires cooperating with the government which, for reasons good or bad, National has not done so in the past. Suppose they refuse to join in. Table IV shows the relative power of the remaining parties outside parliament (assuming that ACT is willing to cooperate).

Table IV: Banzhaf Index for Relative Strengths of Outside Parties (assuming Labour and Progressives form a minority government and National is not willing to cooperate).

Party	Seats		Coalitions		Vetos
NZ First	7	31.8%	26	23.2%	18	34.0%
Greens	6	27.3%	24	21.4%	14	26.4%
Maori P.	4	18.2%	22	19.6%	10	18.9%
U Future	3	13.6%	20	17.9%	6	11.3%
ACT	2	9.1%	20	17.9%	5	9.4%
Total	22	100.0%	112	100.0%	53	100.0%

The final column in bold shows the Banzhaf index of the power of each party in coalition forming.

The outcome is that the power of the remaining parties is close to their numbers of seats. Moreover, their power is higher than if National was a player. In effect National not joining in gives the others more power, for three or so years anyway.

Conclusion

The above has tried to clarify the current state of the coalition discussions using the Banzhaf index of power. It shows that if there is a minority Labour led government, and National does not join in the coalition making on a one policy basis, the role of the minor parties is strengthened.

There are at least two further caveats in this assessment. The theory is really about a series of one night stands. Coalitions, even those between those inside and outside government, often have more of a marriage element, insofar as one party may compromise against its immediate interests in order to get overall gains in the long run.

Second, while National will not join in the public glare of the House, it is well known that Select Committees are considerably more cooperative. No doubt the coalition principles explored here are relevant, although the caution about the ‘one night stand’ assumption applies here too.

Notes

More about the the theory of the Banzhaf index at http://www.cs.unc.edu/~livingst/Banzhaf/.

A computational algorithm is available at http://www.math.temple.edu/~cow/bpi.html. This makes some assumptions which results in estimates not quite as as precise as those given here, which are derived from a spreadsheet. This more tedious procedure gives the user a better feel of the underlying theory, and also allows the introduction of the incompatibility restrictions.

You can read more about John F. Banzhaf III at http://banzhaf.net/. Its enough to make someone need a hamburger.

Easton on tax cuts

Brian Easton has an interesting paper on "what the tax debate is really about" up on Scoop. He begins by comparing Labour and national's plans, and concludes that a) Labour's targetted assistance, while close to the edge, is "probably within the acceptable fiscal parameters", while National's $10 billion splurge is not; b) borrowing will be much higher under National, as it struggles to cover the shortfall; and c) that this will lead to higher interest rates:

[I]ncome tax cuts will increase household’s incomes. Consumers will spend most of the additional income. But with unemployment as low as 3.7 percent (apparently the lowest in the word) , the economy cannot produce much more. That means that either there will be severe inflationary pressures, or that the extra consumption will be provided by imports or – and this is the most likely – both. Second, there is the additional government borrowing.

The two sides lead to the same prediction. Domestic interest rates will have to rise. They will have to rise as the Reserve Bank takes measures to restrain an overheated economy. They will have to rise because the government will have to persuade overseas investors to hold more New Zealand government debt. Both ways New Zealand borrowers will be hit by higher interest rates. That means mortgage holders will have higher mortgage repayments, and businesses will pay more for their borrowing and defer productive investment.

(Original emphasis) This will in turn cause the exchange rate to rise, and lead us straight into the high interest rates - high exchange rates trap that strangled economic growth in the 80's. In other words, National's plan would lead to a severe economic crisis. So why is Brash - a former governor of the Reserve Bank who knows very well the consequences of is actions - pushing it? Easton concludes

I can't help thinking that National’s underlying agenda is the oft stated right wing strategy of giving substantial tax cuts and then forcing public expenditure cuts to rebalance the budget.

The strategic deficit, in other words - with the end goal of savage but "necessary" cuts to social services, just as Ruth Richardson did in 1991.

The silver lining in this cloud is MMP. Any government is highly likely to be dependent on other parties in order to push its policies through, and this means that

It is possible that the economic individualists could find themselves in office without the power to implement their policies.

Given the noises Winston is making about National's tax plans, I regard that as highly likely. But it's better not to take the risk.