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Beat the press por Dean Baker

Beat the Press is Dean Baker's commentary on economic reporting. He is a Senior Economist at the Center for Economic and Policy Research (CEPR). To never miss a post, subscribe to a weekly email roundup of Beat the Press. Please also consider supporting the blog on Patreon.

Sometimes random events come together in ways that help clarify our thinking. I had such an event last Friday. I was happy that day because Bloomberg ran a column by me on an idea I’ve toyed with for years: replacing the corporate income tax with a tax on stock returns.

The logic is that this is a simple and largely foolproof method of taxing corporate profits. Since the components of stock returns (capital gains and dividend payments) are public information, corporate tax liabilities could be determined on a simple spreadsheet. And, there is nothing for companies to argue over or contest, we know how much their stock rose and we know what they paid in dividends. If the corporate tax rate is 25 percent, that is what they owe, end of story.

By chance, on the same day, someone e-mailed me a piece from Fortune magazine on how Amazon is offering employees the opportunity to leave Seattle to move to offices in surrounding suburbs or other locations. As the piece indicates, at least part of the motivation for shifting employees out of Seattle is a tax on high-end wages that the city passed this summer.

Under this new tax, mid-size businesses (revenues between $7 million and $1 billion) would pay a tax of 0.7 percent on wages between $150,000 and $399,999. It would pay a tax of 1.7 percent on a worker’s pay in excess of $400,000 a year. Large businesses, with revenue of more than $1 billion a year, would pay a tax of 1.4 percent on wages between $150,000 and $399,999. They would pay a tax of 2.4 percent on a worker’s pay in excess of $400,000 a year.

This means that a mid-size business that pays a worker $1 million a year would pay a tax of $11,950 for that worker. A large company that paid a worker $1 million a year would pay a tax of $14,400. If we carry this out a bit and take a large company (e.g. Amazon) that pays a worker $5 million a year, we get a tax bill of $113,900. If they have ten workers in this category (stock options count as pay) then the tab would be $1,139,000.

I’m not doing this arithmetic to imply that this tax is a huge burden on Amazon. It’s an enormous company and can easily afford this tax hike. It’s also not a problem if this money comes out of the pockets of high-end earners, as would almost certainly be the case over time. Most of the upward redistribution of the last four decades has gone to high-end earners like these Amazon employees, not corporate profits. If these folks at the top see their pay knocked down a couple of percents, that is all to the good in my view.

My reason for pointing out the price tag of this tax is to show how much more it will now cost to keep high-end employees working in Seattle, as opposed to its suburbs, or in other locations around the country. If Amazon can persuade, or force, a worker earning $5 million to switch from Seattle to an office in a nearby suburb, it will save itself $113,900 a year. While Amazon can afford this payment, it is a safe bet that it would rather not make it. The piece in Fortune suggests that they have made this calculation and concluded that it would be a good idea to get much of Seattle’s high-end workforce to move out of the city.   

Whether Amazon’s behavior is typical or exceptional remains to be seen, and we also don’t know what share of their high-end workforce will actually be leaving the city. But clearly it is possible that a substantial portion of the people who were targeted by this tax will be relocating outside of the city.

After all, it is not that difficult for a company to shift the offices of a small number of people to nearby suburbs. We are all used to communicating through the Internet these days and we still have phones. And, nothing prevents people with offices in the suburbs from physically checking in on subordinates and colleagues in Seattle from time to time.

They can do plenty of these in-person visits without violating the law, and even if they did exceed the limits to make themselves a Seattle worker for tax purposes, how would the city enforce the tax law? Would it require logs of hours for Amazon workers who ostensibly don’t even work in the city?

To be clear, I would hope that most employers don’t play games and that Seattle does collect the expected tax revenue. I know several of the people who played central roles in getting the tax implemented. They are long-time friends and political allies. I would hate to see their efforts wasted, but I worry that will be the result.

When it comes to imposing taxes on the rich and corporations, we have to recognize first and foremost, they are not our allies. They do not want to pay higher taxes. There are some civically-minded rich people who will cough up the money they owe, but we should assume that most will do everything they can to try to avoid or evade their tax burden. (Avoiding a tax means using a legal method to get out paying it. Evading a tax means breaking the law by not paying it.)

This is why when we consider tax proposals we have to consider all the ways that they can be circumvented. The rich pay tax lawyers and accountants huge sums to find ways to get them out of their taxes. The arithmetic is straightforward. If we have a tax rate of 60 percent, then the rich will be willing to pay up to 59 cents to hide a dollar of income. Or, to make the numbers more realistic, they would be willing to pay up to $599,999 to hide $1,000,000 of income.

If those of us who don’t spend their lives developing tax avoidance schemes can find a plausible path for tax avoidance in a few minutes, it is a sure bet that the professionals will have the trick perfected long before the tax takes effect. In order to avoid wasted efforts, we have to beat up our tax proposals as best we can to ensure that we are actually raising the expected revenue and not just creating jobs for high-priced tax lawyers.

 

Taxing Stock Returns

This brings me back to the idea of replacing the corporate income tax with a tax on stock returns. Most progressives would like to see the government raise more revenue from taxing corporate profits. The logic is straightforward, the vast majority of stock is held by people in the top 10 percent of the income distribution, with close to half of all shares being held by the richest one percent. If a corporate income tax reduces the money that corporations give to shareholders, either directly as dividends or indirectly through higher share prices, it will be a highly progressive tax.

The problem with the corporate income tax is that we have had considerable difficulty collecting it. Prior to the Trump tax cut, the nominal corporate tax rate was 35 percent. Due to various loopholes, the actual amount of tax paid was typically in the range of 20 to 22 percent of corporate profits.

The Trump tax cut lowered the nominal rate to 21 percent. The reduction in rates was supposed to go along with an elimination of loopholes so that we would collect something close to a 21 percent nominal tax rate. That is not what happened. In 2019 tax collections were just 13.3 percent of corporate profits. That amounts to a cut in the corporate tax rate of close to 40 percent, a pretty nice gift for the richest people in the country.

If instead of taxing corporate profits we targeted stock returns, we could be certain of collecting the tax rate we had targeted. Stock returns are dividends and capital gains, both of which are public information. We could calculate every public company’s tax liabilities on a simple spreadsheet.

In addition to largely eliminating the possibility for tax avoidance, this switch would also put a huge number of tax lawyers and accountants out of business. The tax avoidance industry itself is an important source of inequality since many of these people get lots of money to reduce the tax liabilities of the rich. We would also save the I.R.S. money on collection and enforcement. They could redirect personnel to reviewing the books of privately traded companies or others who might be ripping off taxpayers.

We’ll see if anyone in the Biden administration, or a hopefully Democratically controlled Congress, is interested in actually collecting the corporate income tax. But the point is that we can write laws in ways that are enforceable, and we have to be sure we do.

Sometimes random events come together in ways that help clarify our thinking. I had such an event last Friday. I was happy that day because Bloomberg ran a column by me on an idea I’ve toyed with for years: replacing the corporate income tax with a tax on stock returns.

The logic is that this is a simple and largely foolproof method of taxing corporate profits. Since the components of stock returns (capital gains and dividend payments) are public information, corporate tax liabilities could be determined on a simple spreadsheet. And, there is nothing for companies to argue over or contest, we know how much their stock rose and we know what they paid in dividends. If the corporate tax rate is 25 percent, that is what they owe, end of story.

By chance, on the same day, someone e-mailed me a piece from Fortune magazine on how Amazon is offering employees the opportunity to leave Seattle to move to offices in surrounding suburbs or other locations. As the piece indicates, at least part of the motivation for shifting employees out of Seattle is a tax on high-end wages that the city passed this summer.

Under this new tax, mid-size businesses (revenues between $7 million and $1 billion) would pay a tax of 0.7 percent on wages between $150,000 and $399,999. It would pay a tax of 1.7 percent on a worker’s pay in excess of $400,000 a year. Large businesses, with revenue of more than $1 billion a year, would pay a tax of 1.4 percent on wages between $150,000 and $399,999. They would pay a tax of 2.4 percent on a worker’s pay in excess of $400,000 a year.

This means that a mid-size business that pays a worker $1 million a year would pay a tax of $11,950 for that worker. A large company that paid a worker $1 million a year would pay a tax of $14,400. If we carry this out a bit and take a large company (e.g. Amazon) that pays a worker $5 million a year, we get a tax bill of $113,900. If they have ten workers in this category (stock options count as pay) then the tab would be $1,139,000.

I’m not doing this arithmetic to imply that this tax is a huge burden on Amazon. It’s an enormous company and can easily afford this tax hike. It’s also not a problem if this money comes out of the pockets of high-end earners, as would almost certainly be the case over time. Most of the upward redistribution of the last four decades has gone to high-end earners like these Amazon employees, not corporate profits. If these folks at the top see their pay knocked down a couple of percents, that is all to the good in my view.

My reason for pointing out the price tag of this tax is to show how much more it will now cost to keep high-end employees working in Seattle, as opposed to its suburbs, or in other locations around the country. If Amazon can persuade, or force, a worker earning $5 million to switch from Seattle to an office in a nearby suburb, it will save itself $113,900 a year. While Amazon can afford this payment, it is a safe bet that it would rather not make it. The piece in Fortune suggests that they have made this calculation and concluded that it would be a good idea to get much of Seattle’s high-end workforce to move out of the city.   

Whether Amazon’s behavior is typical or exceptional remains to be seen, and we also don’t know what share of their high-end workforce will actually be leaving the city. But clearly it is possible that a substantial portion of the people who were targeted by this tax will be relocating outside of the city.

After all, it is not that difficult for a company to shift the offices of a small number of people to nearby suburbs. We are all used to communicating through the Internet these days and we still have phones. And, nothing prevents people with offices in the suburbs from physically checking in on subordinates and colleagues in Seattle from time to time.

They can do plenty of these in-person visits without violating the law, and even if they did exceed the limits to make themselves a Seattle worker for tax purposes, how would the city enforce the tax law? Would it require logs of hours for Amazon workers who ostensibly don’t even work in the city?

To be clear, I would hope that most employers don’t play games and that Seattle does collect the expected tax revenue. I know several of the people who played central roles in getting the tax implemented. They are long-time friends and political allies. I would hate to see their efforts wasted, but I worry that will be the result.

When it comes to imposing taxes on the rich and corporations, we have to recognize first and foremost, they are not our allies. They do not want to pay higher taxes. There are some civically-minded rich people who will cough up the money they owe, but we should assume that most will do everything they can to try to avoid or evade their tax burden. (Avoiding a tax means using a legal method to get out paying it. Evading a tax means breaking the law by not paying it.)

This is why when we consider tax proposals we have to consider all the ways that they can be circumvented. The rich pay tax lawyers and accountants huge sums to find ways to get them out of their taxes. The arithmetic is straightforward. If we have a tax rate of 60 percent, then the rich will be willing to pay up to 59 cents to hide a dollar of income. Or, to make the numbers more realistic, they would be willing to pay up to $599,999 to hide $1,000,000 of income.

If those of us who don’t spend their lives developing tax avoidance schemes can find a plausible path for tax avoidance in a few minutes, it is a sure bet that the professionals will have the trick perfected long before the tax takes effect. In order to avoid wasted efforts, we have to beat up our tax proposals as best we can to ensure that we are actually raising the expected revenue and not just creating jobs for high-priced tax lawyers.

 

Taxing Stock Returns

This brings me back to the idea of replacing the corporate income tax with a tax on stock returns. Most progressives would like to see the government raise more revenue from taxing corporate profits. The logic is straightforward, the vast majority of stock is held by people in the top 10 percent of the income distribution, with close to half of all shares being held by the richest one percent. If a corporate income tax reduces the money that corporations give to shareholders, either directly as dividends or indirectly through higher share prices, it will be a highly progressive tax.

The problem with the corporate income tax is that we have had considerable difficulty collecting it. Prior to the Trump tax cut, the nominal corporate tax rate was 35 percent. Due to various loopholes, the actual amount of tax paid was typically in the range of 20 to 22 percent of corporate profits.

The Trump tax cut lowered the nominal rate to 21 percent. The reduction in rates was supposed to go along with an elimination of loopholes so that we would collect something close to a 21 percent nominal tax rate. That is not what happened. In 2019 tax collections were just 13.3 percent of corporate profits. That amounts to a cut in the corporate tax rate of close to 40 percent, a pretty nice gift for the richest people in the country.

If instead of taxing corporate profits we targeted stock returns, we could be certain of collecting the tax rate we had targeted. Stock returns are dividends and capital gains, both of which are public information. We could calculate every public company’s tax liabilities on a simple spreadsheet.

In addition to largely eliminating the possibility for tax avoidance, this switch would also put a huge number of tax lawyers and accountants out of business. The tax avoidance industry itself is an important source of inequality since many of these people get lots of money to reduce the tax liabilities of the rich. We would also save the I.R.S. money on collection and enforcement. They could redirect personnel to reviewing the books of privately traded companies or others who might be ripping off taxpayers.

We’ll see if anyone in the Biden administration, or a hopefully Democratically controlled Congress, is interested in actually collecting the corporate income tax. But the point is that we can write laws in ways that are enforceable, and we have to be sure we do.

Washington Post columnist Megan McArdle had a piece today arguing that California is taking a big risk if it insists on requiring that Uber and Lyft treat their drivers as employees. The risk is that these companies have threatened to shut down their operations in the state, leaving their drivers out of jobs (actually Uber and Lyft insist they already don’t have jobs). According to McArdle, people then won’t be able to get rides, and restaurants will no longer have access to delivery services. And this comes when the state is suffering through a horrible recession.

While that sounds really bad, fans of the market will be less troubled.  There are actually many cab companies in California that compete with Uber and Lyft. (I’m not sure if they are complying with the state’s law on driver classification.) If Uber and Lyft leave the state, presumably these companies will largely fill the gap. There may also be some new startups who will enter to fill the vacuum.

Since there are not many economies of scale in driving cabs, the reduction in Uber and Lyft rides will be largely offset by an increase in rides by these other companies. They will then need more drivers, which should mean that positions will open up at these companies for the former Uber and Lyft drivers who want to take them.

There may be some drop off in demand, since both Uber and Lyft have been losing money, meaning that investors are effectively subsidizing their passengers’ rides. Profit-making cab companies may charge a higher price and therefore have somewhat less business, but the lost business will be far less than Uber and Lyft’s current business.

It is also worth noting that, while investors may not in general be very smart, they typically hold stock because they expect the company to be profitable, not just because the company is cool.  At some point, Uber and Lyft will presumably raise their prices so that they actually make money. 

The same story applies to restaurants and their delivery services. Many restaurants offer their own delivery service and there are other companies that do pick-ups and deliveries from restaurants. In short, California’s restaurants will not have to worry about not being able to get their food to customers if Uber and Lyft leave the state.

Washington Post columnist Megan McArdle had a piece today arguing that California is taking a big risk if it insists on requiring that Uber and Lyft treat their drivers as employees. The risk is that these companies have threatened to shut down their operations in the state, leaving their drivers out of jobs (actually Uber and Lyft insist they already don’t have jobs). According to McArdle, people then won’t be able to get rides, and restaurants will no longer have access to delivery services. And this comes when the state is suffering through a horrible recession.

While that sounds really bad, fans of the market will be less troubled.  There are actually many cab companies in California that compete with Uber and Lyft. (I’m not sure if they are complying with the state’s law on driver classification.) If Uber and Lyft leave the state, presumably these companies will largely fill the gap. There may also be some new startups who will enter to fill the vacuum.

Since there are not many economies of scale in driving cabs, the reduction in Uber and Lyft rides will be largely offset by an increase in rides by these other companies. They will then need more drivers, which should mean that positions will open up at these companies for the former Uber and Lyft drivers who want to take them.

There may be some drop off in demand, since both Uber and Lyft have been losing money, meaning that investors are effectively subsidizing their passengers’ rides. Profit-making cab companies may charge a higher price and therefore have somewhat less business, but the lost business will be far less than Uber and Lyft’s current business.

It is also worth noting that, while investors may not in general be very smart, they typically hold stock because they expect the company to be profitable, not just because the company is cool.  At some point, Uber and Lyft will presumably raise their prices so that they actually make money. 

The same story applies to restaurants and their delivery services. Many restaurants offer their own delivery service and there are other companies that do pick-ups and deliveries from restaurants. In short, California’s restaurants will not have to worry about not being able to get their food to customers if Uber and Lyft leave the state.

Top Biden adviser, and long-time personal friend, Ted Kaufman was seen in the Wall Street Journal warning that the debt run up by the Trump administration will seriously limit what Biden will be able to do as president. This is wrong big time, and it is the sort of silly thing that no one in a Biden administration should ever be saying.

The government’s ability to spend is limited by the economy’s ability to produce, not the debt. If the government spends too much, it will lead to inflation. When we have a period of high unemployment, as is the case now and almost certainly will still be the case if Biden takes office in January, we are very far from hitting the economy’s inflation barriers.

It takes some very deliberate head in the ground economics to argue that we are somehow limited by the size of the government debt. Japan provides a great model here. Its ratio of debt to GDP is more than 250 percent, more than twice the current U.S. level. Yet, the country is seeing near zero inflation and has a 0.03 percent interest rate on its long-term debt. The interest on its debt is near zero, since much of its debt carries a negative interest rate.

The idea that we would not address pressing needs, like climate change, child care, and health care because we are concerned about the debt burden is close to crazy. As long as the economy is not near its capacity, there is zero reason not to spend to address these priorities, and even when it does approach its capacity, we can impose higher taxes on the economy’s big winners over the last four decades.

I will also throw in one important item of logic that our deficit and debt hawks should be forced to deal with. When the government issues patent and copyright monopolies to pharmaceutical and software and other companies, this is a form of implicit debt. These monopolies are effectively private taxes that the government allows these companies to collect in exchange for their innovations or creative work.

The rent payments on these monopolies run into many hundreds of billions annually and quite possibly exceed $1 trillion a year. They dwarf interest payments on the debt. The debt whiners don’t get to exclude this implicit debt from their calculations just because they like the companies and individuals who benefit from these rents.

If people are having a hard time understanding the logic here, we can go back to pre-revolutionary France. To deal with its huge debt the government would sell off the right to collect specific taxes. I guess Mr. Kaufman and other deficit hawks would say this is fine since the country now had a lower debt burden, but that is not a serious position. It would be good if the economics profession could be united in explaining this simple logic to laypeople, but as is often said, economists are not very good at economics. 

Top Biden adviser, and long-time personal friend, Ted Kaufman was seen in the Wall Street Journal warning that the debt run up by the Trump administration will seriously limit what Biden will be able to do as president. This is wrong big time, and it is the sort of silly thing that no one in a Biden administration should ever be saying.

The government’s ability to spend is limited by the economy’s ability to produce, not the debt. If the government spends too much, it will lead to inflation. When we have a period of high unemployment, as is the case now and almost certainly will still be the case if Biden takes office in January, we are very far from hitting the economy’s inflation barriers.

It takes some very deliberate head in the ground economics to argue that we are somehow limited by the size of the government debt. Japan provides a great model here. Its ratio of debt to GDP is more than 250 percent, more than twice the current U.S. level. Yet, the country is seeing near zero inflation and has a 0.03 percent interest rate on its long-term debt. The interest on its debt is near zero, since much of its debt carries a negative interest rate.

The idea that we would not address pressing needs, like climate change, child care, and health care because we are concerned about the debt burden is close to crazy. As long as the economy is not near its capacity, there is zero reason not to spend to address these priorities, and even when it does approach its capacity, we can impose higher taxes on the economy’s big winners over the last four decades.

I will also throw in one important item of logic that our deficit and debt hawks should be forced to deal with. When the government issues patent and copyright monopolies to pharmaceutical and software and other companies, this is a form of implicit debt. These monopolies are effectively private taxes that the government allows these companies to collect in exchange for their innovations or creative work.

The rent payments on these monopolies run into many hundreds of billions annually and quite possibly exceed $1 trillion a year. They dwarf interest payments on the debt. The debt whiners don’t get to exclude this implicit debt from their calculations just because they like the companies and individuals who benefit from these rents.

If people are having a hard time understanding the logic here, we can go back to pre-revolutionary France. To deal with its huge debt the government would sell off the right to collect specific taxes. I guess Mr. Kaufman and other deficit hawks would say this is fine since the country now had a lower debt burden, but that is not a serious position. It would be good if the economics profession could be united in explaining this simple logic to laypeople, but as is often said, economists are not very good at economics. 

We are really in an unprecedented period where the economy is trying to recover from the shutdowns of April and May while being faced with partial shutdowns due to the resurgence of the pandemic in large parts of the country. We are struggling to make sense of data, which often has a substantial lag. We are still getting data from July even as we are in the last weeks of August. Furthermore, when we have large monthly changes, the picture at the end of July could have been very different than the beginning of the month.

The Opportunity Insights program at Harvard University is trying to help navigate the storm with its Economic Tracker. This provides much more current data on a variety of measures by relying on various industry sources. The latest picture is not good.

Starting with the one I find most troubling, their source on job posting shows a huge falloff in August. Nationally, we are almost back to the lows reached in May.

There is the qualification that these are posting at small businesses, so perhaps the story would look different if we included and mid-sized and large businesses, but still, this picture is not encouraging. Their data on small businesses that are open and revenue are also not good.

The other very disturbing item is their data on consumer spending, which is derived from credit and debit card spending.

The data show a healthy bounce back in June, but then spending levels off in July. Then, spending begins to trail off at the end of the month and start of August. Note that this is just as unemployment insurance supplements are ending.

These are new data sources that I and most other economists are not familiar with. That means that there can be quirks that explain the plunge in job postings and falloff in spending that we do not know about. But on its face, these data suggest a recovery that is stalling, with many businesses closing and millions of workers not being able to go back to their jobs.

That should make the case for a new rescue package more urgent and also again remind us of the importance to the economy of bringing the pandemic under control.

We are really in an unprecedented period where the economy is trying to recover from the shutdowns of April and May while being faced with partial shutdowns due to the resurgence of the pandemic in large parts of the country. We are struggling to make sense of data, which often has a substantial lag. We are still getting data from July even as we are in the last weeks of August. Furthermore, when we have large monthly changes, the picture at the end of July could have been very different than the beginning of the month.

The Opportunity Insights program at Harvard University is trying to help navigate the storm with its Economic Tracker. This provides much more current data on a variety of measures by relying on various industry sources. The latest picture is not good.

Starting with the one I find most troubling, their source on job posting shows a huge falloff in August. Nationally, we are almost back to the lows reached in May.

There is the qualification that these are posting at small businesses, so perhaps the story would look different if we included and mid-sized and large businesses, but still, this picture is not encouraging. Their data on small businesses that are open and revenue are also not good.

The other very disturbing item is their data on consumer spending, which is derived from credit and debit card spending.

The data show a healthy bounce back in June, but then spending levels off in July. Then, spending begins to trail off at the end of the month and start of August. Note that this is just as unemployment insurance supplements are ending.

These are new data sources that I and most other economists are not familiar with. That means that there can be quirks that explain the plunge in job postings and falloff in spending that we do not know about. But on its face, these data suggest a recovery that is stalling, with many businesses closing and millions of workers not being able to go back to their jobs.

That should make the case for a new rescue package more urgent and also again remind us of the importance to the economy of bringing the pandemic under control.

Special Announcement

Hi everyone, this is Dawn, Development Director here at the Center for Economic and Policy Research. I’m hijacking Dean’s Beat the Press post today to ask all of you who aren’t already doing so to sign up to support Dean’s work through his Patreon page. Dean gives all proceeds raised through his Patreon page to CEPR, so not only will you receive early access to content, you will be ensuring that Dean’s work continues to inform the debate, especially his work on patent monopolies and economic recovery.

As loyal fans, I know that you are aware that Dean makes all of his work available for FREE. It is a great and noble thing to do for sure, but it makes my job incredibly difficult! So please, if you haven’t already, consider signing up to become a patron of Dean’s Beat the Press on Patreon.  To everyone who already joined, please accept my sincere gratitude on behalf of all of us at CEPR.

And now back to your regularly scheduled program…

Hi everyone, this is Dawn, Development Director here at the Center for Economic and Policy Research. I’m hijacking Dean’s Beat the Press post today to ask all of you who aren’t already doing so to sign up to support Dean’s work through his Patreon page. Dean gives all proceeds raised through his Patreon page to CEPR, so not only will you receive early access to content, you will be ensuring that Dean’s work continues to inform the debate, especially his work on patent monopolies and economic recovery.

As loyal fans, I know that you are aware that Dean makes all of his work available for FREE. It is a great and noble thing to do for sure, but it makes my job incredibly difficult! So please, if you haven’t already, consider signing up to become a patron of Dean’s Beat the Press on Patreon.  To everyone who already joined, please accept my sincere gratitude on behalf of all of us at CEPR.

And now back to your regularly scheduled program…

Some folks have complained about the loss of GDP over the last five months and questioned whether the shutdowns have been worth the price. While people often toss around huge numbers in the trillions of dollars as the cost of the shutdown, these big numbers are often both inaccurate and misleading.

Measuring Lost GDP

The first place to start is getting a measure of lost GDP. This is fairly straightforward. We can just apply a 2.0 percent growth projection (approximately the projection from the Congressional Budget Office) and apply it to GDP for the 4th quarter of 2019. The difference between this projection and actual GDP for the first and second quarters gives a reasonable approximation of the cost of the shutdown for the first two quarters. There will be continuing costs going forward, but these are at least as much due to fear of the pandemic, as the impact of ongoing shutdowns. (Air traffic has been running at 25 to 30 percent of year ago levels, even though no restrictions prevent people from flying.)

This simple calculation shows a combined loss of GDP for these quarters of $645 billion measured in 2012 dollars, which would be roughly $745 billion in today’s dollars. That comes to a bit less than $2,300 per person.

If this sounds less than the numbers often tossed around, this is because we generally annualize our GDP numbers. This means that numbers show how much production/spending we would have if the economy kept at the same pace for a full year. As a result, our second quarter GDP showed the economy falling a 32.9 percent annual rate in the second quarter, but it actually only shrank by roughly 8.0 percent. To be clear, this is still a very large loss of output, but it is probably considerably less than many people had envisioned.

Source: Author’s calculations, see text.

Next, it is worth getting a better handle on where this drop in output came from. The figure above shows the breakdown between consumption, investment, and government expenditures. The striking part of this figure is the extent to which the decline in spending on consumer services accounts for the bulk, almost two-thirds, of lost output. This sector ordinarily accounts for less than 45 percent of GDP.

Before looking at consumer services more closely, it is worth commenting on the relatively smaller declines in other areas. The drop in investment means that we will be somewhat less wealthy in the future because we invested at a slower rate due to the shutdowns. While that is a loss to the economy, any reduction in future productivity due to lost investment is likely to be swamped by the effective gains in productivity associated with increased telecommuting and other changes due to the crisis. So, as a general rule, more investment is better than less investment, but the enduring reduction in work expenses due to changes made during the pandemic will far more than offset the impact of this lost investment on productivity.

There was very little change in residential investment as a result of the shutdowns. While construction did slow when the shutdowns were in place most strongly in March and April, it has been close to normal in the months since then, as demand for housing has remained strong. This means we will not be seeing any shortages of housing due to the pandemic.

It turns out that there has been little net change in government expenditures as a result of the shutdowns. A modest reduction in federal expenditures was mostly offset by an increase in expenditures at the state and local level. It is important to remember that these data refer to actual expenditures on goods and services by the government. While they would include payments for education and hospital care, they exclude transfer payments such as unemployment benefits or the $1,200 per person pandemic checks.

Turning to consumption, there were modest declines in goods consumption, but much of this is likely linked to work-related expenses. In the case of the decline in durable goods consumption, more than half is explained by reduced spending on cars, jewelry and watches, and luggage. These are mostly expenditures that are work-related. The other major drop was in therapeutic appliances and equipment, like eyeglasses. This is an important issue, that I will come back to shortly.

There was a small drop in consumption of nondurable goods, where a large increase in spending on food purchased for home consumption almost offset sharp declines in spending on gasoline and clothes. These drops are clearly due in large part to lower work-related expenses. (It is worth noting that spending on newspapers and periodicals was more than 20 percent higher in the second quarter than it had been in the 4th quarter of 2019.)

The real story of the GDP plunge is in services and it is not hard to guess which ones. The ones involving work-related expenses all saw sharp declines. Spending on “personal care services,” which involves items like hair salons and dry cleaning, was down by 77 percent from the fourth quarter of 2019 to the second quarter of 2020. Transportation services were down by 41.3 percent, with public transportation seeing a falloff of more than 80 percent.

The second major category involves recreation and entertainment spending. Spending on recreation services, which includes things like amusement parks, concerts, and movies, was down 58.8 percent. Spending on restaurants and hotels was down 40.1 percent.

The third major category was health care, with spending down by 25.3 percent. The sharpest decline was in areas like physicians’ offices and dental services.

How should we think about these areas of lost consumption? The first category of work-related expenses is probably not a big loss. (I know everything is this category is not directly work-related, but most of the decline is.) If people spend less money on transportation because they aren’t driving or taking the bus to work, that is not an obvious loss in their well-being.

The second category involves activities that people enjoy doing. For several months they have not been able to go to restaurants and movies, visit with friends and family members, or engage in other normal activities. It is possible to see these things as frivolous, and that might be right compared to dying from the coronavirus, but we are only alive for so long. If we can’t do the things we enjoy and see people we care about, for six months or a year, that is a big deal.

Finally, we have the category of health care services. Much of this involves things like putting off a checkup or a teeth cleaning. Most of the time, there will not be major consequences from a delay of a couple of months, but in some cases, there will be. A person who has to wait another three months to have a cancer detected or to discover they have a heart problem may suffer serious and lasting health damage.

There is also the issue that fear of the pandemic may have discouraged people from getting necessary treatment or tests. For example, would a cancer patient, whose immune system is seriously compromised, feel comfortable going into a doctor’s office or hospital for tests? This is likely less an issue of shutdowns blocking care as opposed to the pandemic itself.

In fact, as we move into a period where most of the legal barriers have been removed or relaxed, this fear is likely to be the greatest issue going forward. People will not return to their former way of life until they can be sure that it is safe, and that means getting the pandemic under control.

I haven’t touched on the issue of schools thus far. This is huge for both the children and the parents. Undoubtedly, the shutdowns and school closings created hardships for many families, especially for mothers of small children. This may have been the largest cost of the shutdowns, as many families found themselves in cramped living spaces for long periods of time. We will likely get a better picture of the full impact some months down the road, when more data are available, but is likely that the shutdowns have been associated with more incidents of domestic violence. 

From the standpoint of children, it seems clear that the lack of in-school instruction will further exacerbate the education gap between the children from lower income families and children from the upper middle class. The latter group is likely to have the resources to ensure that their kids receive adequate instruction. That is not the case with children from poorer backgrounds, where parents may be forced to work outside the home and they may not have access to computers or reliable Internet.

This could mean that these children will face lasting consequences in the form of lower graduation rates, lower rates of college completion, and lower incomes during their working careers. There is no easy short-term fix here. We can talk about programs to try to make up the lost ground for students from low- and moderate-income families, but realistically, this is not going to happen. We have failed miserably at trying to equalize educational opportunities over the last sixty years, we are not suddenly going to be able to turn things around in the next decade or so for the children currently in school.

To my view, the more promising route is to try to reduce the huge wage gaps we see now so that it matters much less who got the better education. If we had a minimum wage of $24 an hour and CEOs got paid $2-$3 million a year (with corresponding pay cuts for other top execs), the differences in opportunities would not condemn today’s children to a life of hardship. Unfortunately, few people in high level policy positions want to have this discussion.

 

Getting the Virus Under Control

While the cost of the shutdowns this spring were substantial, the cost of not shutting down much of the economy would have been enormous. When the country began to shut down in mid-March, the rate of infection was exploding. It was doubling every three or four days, and the reported rate was almost certainly a gross of understatement of the actual rate since testing was very limited. By early April, the pandemic was causing more than 2,000 deaths a day. The number peaked around 2,300 in mid-April and then began to fall gradually until early July when it was just over 500 a day. It since has risen again to more than 1,200 a day.

Had it not been for the initial lockdown in mid-March, it is almost certain that the infection would have continued to spread exponentially and the number of deaths would have grown along with the number of infections. There can be little doubt that the shutdowns saved many hundreds of thousands of lives in the United States, and quite possibly well over a million.

It is also important to recognize that many of the people who get the virus but don’t die, suffer lasting effects. There have been a number of accounts of people who have recovered from the disease but have enduring cognitive and/or physical problems. At this point, we do not have good data on the percentage of the people who get sick who will suffer lasting effects. But it would be wrong to ignore the consequences of the disease for people who get sick but don’t die.

Also, when we consider possible costs for restrictions in the United States going forward, it is important to realize the extent to which we are an outlier. Most other wealthy countries have largely succeeded in bringing the pandemic under control. The European Union (EU), in spite of a recent upsurge, has been averaging less than 7,000 cases a day. That compares to 60,000 in the United States, in spite of the fact that the EU’s population is 20 percent larger.  The EU has been averaging around 150 deaths a day, compared to well over 1,000 in the United States.

Other wealthy countries generally had stricter shutdowns and smarter re-openings. As a result, the cost to their economies is likely to end up being considerably lower than in the United States. So, even if we decide that the benefits to public health may have been worth the cost to the economy, that doesn’t mean that we could not have had the same or larger benefits at a lower price, with good planning.

Some folks have complained about the loss of GDP over the last five months and questioned whether the shutdowns have been worth the price. While people often toss around huge numbers in the trillions of dollars as the cost of the shutdown, these big numbers are often both inaccurate and misleading.

Measuring Lost GDP

The first place to start is getting a measure of lost GDP. This is fairly straightforward. We can just apply a 2.0 percent growth projection (approximately the projection from the Congressional Budget Office) and apply it to GDP for the 4th quarter of 2019. The difference between this projection and actual GDP for the first and second quarters gives a reasonable approximation of the cost of the shutdown for the first two quarters. There will be continuing costs going forward, but these are at least as much due to fear of the pandemic, as the impact of ongoing shutdowns. (Air traffic has been running at 25 to 30 percent of year ago levels, even though no restrictions prevent people from flying.)

This simple calculation shows a combined loss of GDP for these quarters of $645 billion measured in 2012 dollars, which would be roughly $745 billion in today’s dollars. That comes to a bit less than $2,300 per person.

If this sounds less than the numbers often tossed around, this is because we generally annualize our GDP numbers. This means that numbers show how much production/spending we would have if the economy kept at the same pace for a full year. As a result, our second quarter GDP showed the economy falling a 32.9 percent annual rate in the second quarter, but it actually only shrank by roughly 8.0 percent. To be clear, this is still a very large loss of output, but it is probably considerably less than many people had envisioned.

Source: Author’s calculations, see text.

Next, it is worth getting a better handle on where this drop in output came from. The figure above shows the breakdown between consumption, investment, and government expenditures. The striking part of this figure is the extent to which the decline in spending on consumer services accounts for the bulk, almost two-thirds, of lost output. This sector ordinarily accounts for less than 45 percent of GDP.

Before looking at consumer services more closely, it is worth commenting on the relatively smaller declines in other areas. The drop in investment means that we will be somewhat less wealthy in the future because we invested at a slower rate due to the shutdowns. While that is a loss to the economy, any reduction in future productivity due to lost investment is likely to be swamped by the effective gains in productivity associated with increased telecommuting and other changes due to the crisis. So, as a general rule, more investment is better than less investment, but the enduring reduction in work expenses due to changes made during the pandemic will far more than offset the impact of this lost investment on productivity.

There was very little change in residential investment as a result of the shutdowns. While construction did slow when the shutdowns were in place most strongly in March and April, it has been close to normal in the months since then, as demand for housing has remained strong. This means we will not be seeing any shortages of housing due to the pandemic.

It turns out that there has been little net change in government expenditures as a result of the shutdowns. A modest reduction in federal expenditures was mostly offset by an increase in expenditures at the state and local level. It is important to remember that these data refer to actual expenditures on goods and services by the government. While they would include payments for education and hospital care, they exclude transfer payments such as unemployment benefits or the $1,200 per person pandemic checks.

Turning to consumption, there were modest declines in goods consumption, but much of this is likely linked to work-related expenses. In the case of the decline in durable goods consumption, more than half is explained by reduced spending on cars, jewelry and watches, and luggage. These are mostly expenditures that are work-related. The other major drop was in therapeutic appliances and equipment, like eyeglasses. This is an important issue, that I will come back to shortly.

There was a small drop in consumption of nondurable goods, where a large increase in spending on food purchased for home consumption almost offset sharp declines in spending on gasoline and clothes. These drops are clearly due in large part to lower work-related expenses. (It is worth noting that spending on newspapers and periodicals was more than 20 percent higher in the second quarter than it had been in the 4th quarter of 2019.)

The real story of the GDP plunge is in services and it is not hard to guess which ones. The ones involving work-related expenses all saw sharp declines. Spending on “personal care services,” which involves items like hair salons and dry cleaning, was down by 77 percent from the fourth quarter of 2019 to the second quarter of 2020. Transportation services were down by 41.3 percent, with public transportation seeing a falloff of more than 80 percent.

The second major category involves recreation and entertainment spending. Spending on recreation services, which includes things like amusement parks, concerts, and movies, was down 58.8 percent. Spending on restaurants and hotels was down 40.1 percent.

The third major category was health care, with spending down by 25.3 percent. The sharpest decline was in areas like physicians’ offices and dental services.

How should we think about these areas of lost consumption? The first category of work-related expenses is probably not a big loss. (I know everything is this category is not directly work-related, but most of the decline is.) If people spend less money on transportation because they aren’t driving or taking the bus to work, that is not an obvious loss in their well-being.

The second category involves activities that people enjoy doing. For several months they have not been able to go to restaurants and movies, visit with friends and family members, or engage in other normal activities. It is possible to see these things as frivolous, and that might be right compared to dying from the coronavirus, but we are only alive for so long. If we can’t do the things we enjoy and see people we care about, for six months or a year, that is a big deal.

Finally, we have the category of health care services. Much of this involves things like putting off a checkup or a teeth cleaning. Most of the time, there will not be major consequences from a delay of a couple of months, but in some cases, there will be. A person who has to wait another three months to have a cancer detected or to discover they have a heart problem may suffer serious and lasting health damage.

There is also the issue that fear of the pandemic may have discouraged people from getting necessary treatment or tests. For example, would a cancer patient, whose immune system is seriously compromised, feel comfortable going into a doctor’s office or hospital for tests? This is likely less an issue of shutdowns blocking care as opposed to the pandemic itself.

In fact, as we move into a period where most of the legal barriers have been removed or relaxed, this fear is likely to be the greatest issue going forward. People will not return to their former way of life until they can be sure that it is safe, and that means getting the pandemic under control.

I haven’t touched on the issue of schools thus far. This is huge for both the children and the parents. Undoubtedly, the shutdowns and school closings created hardships for many families, especially for mothers of small children. This may have been the largest cost of the shutdowns, as many families found themselves in cramped living spaces for long periods of time. We will likely get a better picture of the full impact some months down the road, when more data are available, but is likely that the shutdowns have been associated with more incidents of domestic violence. 

From the standpoint of children, it seems clear that the lack of in-school instruction will further exacerbate the education gap between the children from lower income families and children from the upper middle class. The latter group is likely to have the resources to ensure that their kids receive adequate instruction. That is not the case with children from poorer backgrounds, where parents may be forced to work outside the home and they may not have access to computers or reliable Internet.

This could mean that these children will face lasting consequences in the form of lower graduation rates, lower rates of college completion, and lower incomes during their working careers. There is no easy short-term fix here. We can talk about programs to try to make up the lost ground for students from low- and moderate-income families, but realistically, this is not going to happen. We have failed miserably at trying to equalize educational opportunities over the last sixty years, we are not suddenly going to be able to turn things around in the next decade or so for the children currently in school.

To my view, the more promising route is to try to reduce the huge wage gaps we see now so that it matters much less who got the better education. If we had a minimum wage of $24 an hour and CEOs got paid $2-$3 million a year (with corresponding pay cuts for other top execs), the differences in opportunities would not condemn today’s children to a life of hardship. Unfortunately, few people in high level policy positions want to have this discussion.

 

Getting the Virus Under Control

While the cost of the shutdowns this spring were substantial, the cost of not shutting down much of the economy would have been enormous. When the country began to shut down in mid-March, the rate of infection was exploding. It was doubling every three or four days, and the reported rate was almost certainly a gross of understatement of the actual rate since testing was very limited. By early April, the pandemic was causing more than 2,000 deaths a day. The number peaked around 2,300 in mid-April and then began to fall gradually until early July when it was just over 500 a day. It since has risen again to more than 1,200 a day.

Had it not been for the initial lockdown in mid-March, it is almost certain that the infection would have continued to spread exponentially and the number of deaths would have grown along with the number of infections. There can be little doubt that the shutdowns saved many hundreds of thousands of lives in the United States, and quite possibly well over a million.

It is also important to recognize that many of the people who get the virus but don’t die, suffer lasting effects. There have been a number of accounts of people who have recovered from the disease but have enduring cognitive and/or physical problems. At this point, we do not have good data on the percentage of the people who get sick who will suffer lasting effects. But it would be wrong to ignore the consequences of the disease for people who get sick but don’t die.

Also, when we consider possible costs for restrictions in the United States going forward, it is important to realize the extent to which we are an outlier. Most other wealthy countries have largely succeeded in bringing the pandemic under control. The European Union (EU), in spite of a recent upsurge, has been averaging less than 7,000 cases a day. That compares to 60,000 in the United States, in spite of the fact that the EU’s population is 20 percent larger.  The EU has been averaging around 150 deaths a day, compared to well over 1,000 in the United States.

Other wealthy countries generally had stricter shutdowns and smarter re-openings. As a result, the cost to their economies is likely to end up being considerably lower than in the United States. So, even if we decide that the benefits to public health may have been worth the cost to the economy, that doesn’t mean that we could not have had the same or larger benefits at a lower price, with good planning.

Some folks may have seen articles reporting that the United Kingdom’s economy shrank by 20.4 percent in the second quarter. While this number is accurate, it is reporting the quarterly rate of decline.

We typically report GDP changes as annual rates, which implies taking the quarterly growth rate to the fourth power. In the case of the UK, its second quarter pace of decline would imply a drop of 59.9 percent at an annual rate.

It is worth making this calculation for comparative purposes. Readers may recall that the US economy contracted 32.9 percent in the second quarter. This is an annual rate of decline. The contraction in the UK was actually far worse than the contraction in the United States. 

Some folks may have seen articles reporting that the United Kingdom’s economy shrank by 20.4 percent in the second quarter. While this number is accurate, it is reporting the quarterly rate of decline.

We typically report GDP changes as annual rates, which implies taking the quarterly growth rate to the fourth power. In the case of the UK, its second quarter pace of decline would imply a drop of 59.9 percent at an annual rate.

It is worth making this calculation for comparative purposes. Readers may recall that the US economy contracted 32.9 percent in the second quarter. This is an annual rate of decline. The contraction in the UK was actually far worse than the contraction in the United States. 

Most might think that when Donald Trump proposes a tax break for the rich it is because he wants to give more money to the rich. Fortunately, the NYT has a staff of mind readers who can keep us better informed. Therefore we are told:

“Mr. Trump and his advisers have regularly considered unorthodox tax maneuvers that they believe would spur economic growth, including reducing the taxes that investors pay on profits earned from selling assets like stocks or bonds (emphasis added).”

There is a large body of research indicating that lowering the capital gains tax rate would have a minimal impact on growth. The evidence would suggest that lowering capital gains taxes, which will almost exclusively benefit the rich, is not a good way to boost growth, but the NYT knows that Trump and his advisors believe otherwise. (It is worth mentioning that most middle class people have their stock holdings in retirement accounts, which would not be affected by a reduction in the capital gains tax.)

Most might think that when Donald Trump proposes a tax break for the rich it is because he wants to give more money to the rich. Fortunately, the NYT has a staff of mind readers who can keep us better informed. Therefore we are told:

“Mr. Trump and his advisers have regularly considered unorthodox tax maneuvers that they believe would spur economic growth, including reducing the taxes that investors pay on profits earned from selling assets like stocks or bonds (emphasis added).”

There is a large body of research indicating that lowering the capital gains tax rate would have a minimal impact on growth. The evidence would suggest that lowering capital gains taxes, which will almost exclusively benefit the rich, is not a good way to boost growth, but the NYT knows that Trump and his advisors believe otherwise. (It is worth mentioning that most middle class people have their stock holdings in retirement accounts, which would not be affected by a reduction in the capital gains tax.)

We are still very much in the middle of the pandemic, with the U.S. seeing tens of thousands of new infections daily, and the world experiencing hundreds of thousands of new infections. However, it is not too early to look at areas where we need to reevaluate public policy, most importantly in financing the research and development of new drugs and vaccines.

The accepted wisdom in policy circles has been, that while the government can finance basic research, we need to rely on government-granted patent monopolies to pay for the actual development and testing of new drugs. The argument is that we want private companies to compete to develop new and better drugs, with the rents earned from their patent monopolies compensating them for the cost of research and testing, as well as compensating them for the risk that they will not develop a marketable drug.

The logic of this position relied on the claim that somehow government financing of the later stages of research and testing is essentially the same thing as throwing money in the toilet. The industry acknowledges the value of the research funded by the National Institutes of Health (NIH), and in fact, is the biggest lobbyist for it. But they say that if NIH were to move downstream and actually finance the development of drugs and do clinical trials, they would turn into a bunch of bureaucratic bozos who couldn’t do anything right.[1]

The behavior of the government in this pandemic seems to indicate that this is not the case. The government, through Operation Warp Speed, is directly funding the research on vaccines, as the research takes place. This is most visible with Moderna, the country’s leading contender to develop a vaccine. The government paid $483 million to Moderna for pre-clinical research and Phase 1 and 2 testing. It then coughed up another $472 million to cover the cost of phase 3 testing.   

If any policy types thought this direct government funding of the research and development of a vaccine was just throwing money in the toilet, they have not been very visible in expressing this view over the last four months. It is true that Moderna will also get a patent monopoly, allowing it to collect even more money for its effort, but the direct funding from the government is clearly the key here. This funding paid for the research and testing. It also meant that the government took all the risk. If Moderna’s vaccine turns out to be ineffective, the government will be out of the money, not Moderna.

Since policy types can apparently accept that when the federal government directly pays for the development and testing of new drugs and vaccines it is not the same as throwing the money into the toilet, maybe we can move forward and ask the next question as to how efficient direct public funding is relative to patent monopoly financed research. The issue here is how much the government would have to spend on advanced funding to get the same results as we see with patent monopoly financed research.

Before considering what the ratio of relative effectiveness might be, it is worth getting some idea of what is at stake. We will spend over $500 billion in 2020 for drugs that would almost certainly cost us less than $100 billion in a free market without patent monopolies or other forms of exclusivity.[2] It is rare that drugs are actually expensive to manufacture and distribute. The drugs that sell for tens of or even hundreds of thousands of dollars for a year’s treatment would typically sell for just a few hundred dollars if they were sold in a free market without patents or related protections. The potential savings of $400 billion a year come to more than $3000 per household.

In exchange for this $400 billion in higher drug prices, we get around $90 billion in research spending by the industry. These numbers are shown in the figure below, along with the $40 billion annual budget (pre-pandemic) for the National Institutes of Health. This is an understatement of federally funded biomedical research since we spend several billion more through the Biomedical Advanced Research and Development Authority (BARDA) and other government agencies. 

These figures are shown below along with the $60.4 billion that we spent on food stamps (SNAP) in 2019. The food stamp budget is included as a point of reference since many people in policy debates seem to believe that our spending on food stamps is a really big deal.

Source: Author’s calculations: see text.

 

Anyhow, the basic story is that we come out ahead with publicly funded research if it is at least one quarter as productive as patent monopoly supported the research. In other words, if four dollars of direct publicly funded research is at least good as one dollar of patent supported research, we would be better off switching to a system of publicly supported research.

There are actually good reasons for thinking that on a per-dollar basis government funding would be more efficient. First and foremost, the government could make it a condition of funding that all results are posted on the Internet as quickly as practical. This would allow researchers to quickly learn from each other’s work, building on successes and not wasting effort pursuing dead ends. This was the practice with the Bermuda Principles in the Human Genome Project. This sort of open-research in the early days after the coronavirus was first discovered led to much more rapid progress than would ordinarily be the case.

The other major reason why publicly funded, open-source, research is likely to be more efficient on a per-dollar basis is that there would be no incentive to develop copycat drugs as a way of sharing patent rents. While it is often desirable to have more than one drug to treat a specific condition since some patients may respond poorly to an initial drug or it could have harmful side effects, trying to engineer around a patent will generally not be a productive use of resources from a social standpoint. If research funding was being paid upfront, with no patent rents to compete over, there would be no incentive to develop a duplicative drug, except where there was a medical reason. 

This raises another reason for believing that direct funding of research will lead to better health outcomes than our current system of patent monopoly financing. When drug companies can sell their drugs at patent monopoly prices they have an enormous incentive to promote their drug even in circumstances where it may not be the best treatment for a specific medical condition. This means that they have a reason to conceal evidence that their drugs may not be as effective as claimed or could even be harmful.

We saw this story with the opioid crisis, where several major pharmaceutical companies are alleged to have misled doctors and the public about the addictiveness of their new generation of opioids. Unfortunately, this is not an exception. There have been many instances where drug companies paid large settlements over allegations that they deliberately misled doctors and patients about the safety and effectiveness of their drugs.

In the absence of patent monopolies, no one would have any substantial incentive to make misleading claims about the quality of drugs. Furthermore, since all the research and test results would be fully public, they would likely not be able to get away with false claims even if they tried.

There is one additional source of waste that would be eliminated if we directly funded the research and allowed drugs to be sold at free market prices. We would not need insurance to cover drug costs. When drugs can cost, hundreds, thousands, or even tens of thousands of dollars, people need insurance to cover this potential expense. However, if most drugs sold for ten or twenty dollars per prescription, insurance would not really be needed. (Lower-income people would still need assistance in paying for drugs.)

Since insurers take on average 20 to 25 percent of health care spending to cover their administrative costs and profits, having drugs sell at free market prices would save us tens of billions annually on insurance costs. This also has to be factored into any comparison of the relative efficiency of direct public funding and patent monopoly financing.

If we do consider direct public financing of research, the Trump administration has not provided us with the best model. We don’t want companies selected through a closed door process with no clear criteria. My ideal model would be to have companies contracting for large sums to pursue research in specific areas for a substantial period of time. For example, a company may get a contract for $20 billion over a twelve-year period to pursue research for new drugs to treat liver cancer.

This sort of long-term contracting should insulate companies for political pressure, since once a contract was granted, they could not lose the funding, barring outright fraud or other serious forms of malfeasance. The awarding and renewal of contracts would be based on clear and fully public criteria. (This system is described more fully in chapter 5 of Rigged.)  

It will be a long jump from where we are now to a system of open-source publicly financed biomedical research, but we opened the door for this switch with the financing of treatments and vaccines for the coronavirus. Once we acknowledge that direct public funding of the development of new drugs is not the same thing as throwing money into the toilet, then we can start asking questions about the relative effectiveness of direct public funding and patent supported research.

This seems to raise uncomfortable questions for many people in policy debates. They, and their friends and family, tend to be among the group of people who benefit from patent and copyright monopolies in drugs and other areas. However, if we want to have serious policy discussions, and not just protect existing patterns of inequality, government-granted patent and copyright monopolies have to be on the table.

[1] This view persists in spite of the fact that many important drugs have actually been developed on NIH grants and the agency has financed hundreds of clinical trials.

[2] There are a variety of mechanisms other than patent monopolies that allow drug companies to have exclusive rights to sell a drug. The most important of these is data exclusivity, which prohibits generic manufacturers from relying on the test data from a brand drug to show that a chemically equivalent drug is safe and effective.

We are still very much in the middle of the pandemic, with the U.S. seeing tens of thousands of new infections daily, and the world experiencing hundreds of thousands of new infections. However, it is not too early to look at areas where we need to reevaluate public policy, most importantly in financing the research and development of new drugs and vaccines.

The accepted wisdom in policy circles has been, that while the government can finance basic research, we need to rely on government-granted patent monopolies to pay for the actual development and testing of new drugs. The argument is that we want private companies to compete to develop new and better drugs, with the rents earned from their patent monopolies compensating them for the cost of research and testing, as well as compensating them for the risk that they will not develop a marketable drug.

The logic of this position relied on the claim that somehow government financing of the later stages of research and testing is essentially the same thing as throwing money in the toilet. The industry acknowledges the value of the research funded by the National Institutes of Health (NIH), and in fact, is the biggest lobbyist for it. But they say that if NIH were to move downstream and actually finance the development of drugs and do clinical trials, they would turn into a bunch of bureaucratic bozos who couldn’t do anything right.[1]

The behavior of the government in this pandemic seems to indicate that this is not the case. The government, through Operation Warp Speed, is directly funding the research on vaccines, as the research takes place. This is most visible with Moderna, the country’s leading contender to develop a vaccine. The government paid $483 million to Moderna for pre-clinical research and Phase 1 and 2 testing. It then coughed up another $472 million to cover the cost of phase 3 testing.   

If any policy types thought this direct government funding of the research and development of a vaccine was just throwing money in the toilet, they have not been very visible in expressing this view over the last four months. It is true that Moderna will also get a patent monopoly, allowing it to collect even more money for its effort, but the direct funding from the government is clearly the key here. This funding paid for the research and testing. It also meant that the government took all the risk. If Moderna’s vaccine turns out to be ineffective, the government will be out of the money, not Moderna.

Since policy types can apparently accept that when the federal government directly pays for the development and testing of new drugs and vaccines it is not the same as throwing the money into the toilet, maybe we can move forward and ask the next question as to how efficient direct public funding is relative to patent monopoly financed research. The issue here is how much the government would have to spend on advanced funding to get the same results as we see with patent monopoly financed research.

Before considering what the ratio of relative effectiveness might be, it is worth getting some idea of what is at stake. We will spend over $500 billion in 2020 for drugs that would almost certainly cost us less than $100 billion in a free market without patent monopolies or other forms of exclusivity.[2] It is rare that drugs are actually expensive to manufacture and distribute. The drugs that sell for tens of or even hundreds of thousands of dollars for a year’s treatment would typically sell for just a few hundred dollars if they were sold in a free market without patents or related protections. The potential savings of $400 billion a year come to more than $3000 per household.

In exchange for this $400 billion in higher drug prices, we get around $90 billion in research spending by the industry. These numbers are shown in the figure below, along with the $40 billion annual budget (pre-pandemic) for the National Institutes of Health. This is an understatement of federally funded biomedical research since we spend several billion more through the Biomedical Advanced Research and Development Authority (BARDA) and other government agencies. 

These figures are shown below along with the $60.4 billion that we spent on food stamps (SNAP) in 2019. The food stamp budget is included as a point of reference since many people in policy debates seem to believe that our spending on food stamps is a really big deal.

Source: Author’s calculations: see text.

 

Anyhow, the basic story is that we come out ahead with publicly funded research if it is at least one quarter as productive as patent monopoly supported the research. In other words, if four dollars of direct publicly funded research is at least good as one dollar of patent supported research, we would be better off switching to a system of publicly supported research.

There are actually good reasons for thinking that on a per-dollar basis government funding would be more efficient. First and foremost, the government could make it a condition of funding that all results are posted on the Internet as quickly as practical. This would allow researchers to quickly learn from each other’s work, building on successes and not wasting effort pursuing dead ends. This was the practice with the Bermuda Principles in the Human Genome Project. This sort of open-research in the early days after the coronavirus was first discovered led to much more rapid progress than would ordinarily be the case.

The other major reason why publicly funded, open-source, research is likely to be more efficient on a per-dollar basis is that there would be no incentive to develop copycat drugs as a way of sharing patent rents. While it is often desirable to have more than one drug to treat a specific condition since some patients may respond poorly to an initial drug or it could have harmful side effects, trying to engineer around a patent will generally not be a productive use of resources from a social standpoint. If research funding was being paid upfront, with no patent rents to compete over, there would be no incentive to develop a duplicative drug, except where there was a medical reason. 

This raises another reason for believing that direct funding of research will lead to better health outcomes than our current system of patent monopoly financing. When drug companies can sell their drugs at patent monopoly prices they have an enormous incentive to promote their drug even in circumstances where it may not be the best treatment for a specific medical condition. This means that they have a reason to conceal evidence that their drugs may not be as effective as claimed or could even be harmful.

We saw this story with the opioid crisis, where several major pharmaceutical companies are alleged to have misled doctors and the public about the addictiveness of their new generation of opioids. Unfortunately, this is not an exception. There have been many instances where drug companies paid large settlements over allegations that they deliberately misled doctors and patients about the safety and effectiveness of their drugs.

In the absence of patent monopolies, no one would have any substantial incentive to make misleading claims about the quality of drugs. Furthermore, since all the research and test results would be fully public, they would likely not be able to get away with false claims even if they tried.

There is one additional source of waste that would be eliminated if we directly funded the research and allowed drugs to be sold at free market prices. We would not need insurance to cover drug costs. When drugs can cost, hundreds, thousands, or even tens of thousands of dollars, people need insurance to cover this potential expense. However, if most drugs sold for ten or twenty dollars per prescription, insurance would not really be needed. (Lower-income people would still need assistance in paying for drugs.)

Since insurers take on average 20 to 25 percent of health care spending to cover their administrative costs and profits, having drugs sell at free market prices would save us tens of billions annually on insurance costs. This also has to be factored into any comparison of the relative efficiency of direct public funding and patent monopoly financing.

If we do consider direct public financing of research, the Trump administration has not provided us with the best model. We don’t want companies selected through a closed door process with no clear criteria. My ideal model would be to have companies contracting for large sums to pursue research in specific areas for a substantial period of time. For example, a company may get a contract for $20 billion over a twelve-year period to pursue research for new drugs to treat liver cancer.

This sort of long-term contracting should insulate companies for political pressure, since once a contract was granted, they could not lose the funding, barring outright fraud or other serious forms of malfeasance. The awarding and renewal of contracts would be based on clear and fully public criteria. (This system is described more fully in chapter 5 of Rigged.)  

It will be a long jump from where we are now to a system of open-source publicly financed biomedical research, but we opened the door for this switch with the financing of treatments and vaccines for the coronavirus. Once we acknowledge that direct public funding of the development of new drugs is not the same thing as throwing money into the toilet, then we can start asking questions about the relative effectiveness of direct public funding and patent supported research.

This seems to raise uncomfortable questions for many people in policy debates. They, and their friends and family, tend to be among the group of people who benefit from patent and copyright monopolies in drugs and other areas. However, if we want to have serious policy discussions, and not just protect existing patterns of inequality, government-granted patent and copyright monopolies have to be on the table.

[1] This view persists in spite of the fact that many important drugs have actually been developed on NIH grants and the agency has financed hundreds of clinical trials.

[2] There are a variety of mechanisms other than patent monopolies that allow drug companies to have exclusive rights to sell a drug. The most important of these is data exclusivity, which prohibits generic manufacturers from relying on the test data from a brand drug to show that a chemically equivalent drug is safe and effective.

The NYT had a piece on how the private equity company, Cerberus, is unhappy with the operation of the German bank Commerzbank. Cerberus has a major stake in the bank and, according to the piece, is unhappy that it has not moved more aggressively to cut costs, meaning firing people.

According to the article, Cerberus forced the resignation of two top executives at the bank. It then tells readers that it is unhappy with plans to replace them:

“But then, on Monday, the supervisory board nominated Mr. Schmittmann’s replacement: Mr. Vetter, former chief executive of Landesbank Baden-Württemberg, which is owned by state and local governments in southwestern Germany. Cerberus did not regard him as having the experience to fix Commerzbank.”

It is not clear how the paper determined that Cerberus’ objections were based on Mr. Vetter not “having the experience to fix Commerzbank.” Given what is reported in the rest of the piece, it seems at least as plausible that Cerberus is unhappy with Mr. Vetter’s selection because he might be reluctant to engage in large-scale layoffs. That may be what Cerberus regards as “fixing” Commerzbank, but that is not the standard definition of the word. 

The NYT had a piece on how the private equity company, Cerberus, is unhappy with the operation of the German bank Commerzbank. Cerberus has a major stake in the bank and, according to the piece, is unhappy that it has not moved more aggressively to cut costs, meaning firing people.

According to the article, Cerberus forced the resignation of two top executives at the bank. It then tells readers that it is unhappy with plans to replace them:

“But then, on Monday, the supervisory board nominated Mr. Schmittmann’s replacement: Mr. Vetter, former chief executive of Landesbank Baden-Württemberg, which is owned by state and local governments in southwestern Germany. Cerberus did not regard him as having the experience to fix Commerzbank.”

It is not clear how the paper determined that Cerberus’ objections were based on Mr. Vetter not “having the experience to fix Commerzbank.” Given what is reported in the rest of the piece, it seems at least as plausible that Cerberus is unhappy with Mr. Vetter’s selection because he might be reluctant to engage in large-scale layoffs. That may be what Cerberus regards as “fixing” Commerzbank, but that is not the standard definition of the word. 

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