Yup, it’s my Austan Goolsbee Post

You knew this was coming and here it is.

The question of the day is “Who is Austan Goolsbee?” . That’s followed by what will he do in his position of head of the CEA to the president besides tripping the tango with Larry Summers? That’s a link to the WSJ and there are others too. Like most people out there in the business world, the discussion at WSJ is mainly about Goolsbee’s Yale and MIT pedigrees and jobs held. I’m going to do something a little different. I’ve chased down his vitae and his research. You can tell a lot about an academic by their research agenda. It basically tells you what pushes their buttons although when you’re in the heat of the tenure battle, you’ll frequently publish a topic that’s a hot button for the research community. Still, your frames will out.

The professors that taught me theoretical Investments could always tell that I wasn’t interested in markets as income makers but more in finding ways that markets were gamed by the kinds of papers I wrote for them. They also knew I didn’t buy the Fama viewpoint of efficient markets. I was much more interested in the ‘frictions’ or the way the markets became dysfunctional.

This alone made me realize that I wasn’t going to have a future in publishing anything related to derivatives or micromarket structure because I’d never be able to comfortably play to the editorial boards. So, you have to keep this in mind. Especially, when I bring up his publications in the top tier journals. A lot of it is what interests you. Some of it is what interests the editorial boards of the journals where you seek publication. You don’t go to a finance journal with Fama on the editorial board if you intend to rip apart the efficient markets hypothesis. Keep that in mind when you read about Goolsbee who obviously had access to top journals via his pedigrees as well as work.

So, hang on or grab a coffee, I’m about to do an Austan Goolsbee literature review. I’m going to concentrate on some of his publications in the tax arena because I believe you’re seeing his stamp on this latest ‘stimulus’ package. I’m not going to cover the models, only the results. He went to MIT so he certainly knows his math and econometrics. No reason to venture there.

This first paper was submitted in 1997, revised in 1999 and published in the Journal of Political Economy in April 2000. That’s definitely a top tier journal. It’s entitled “WHAT HAPPENS WHEN YOU TAX THE RICH? EVIDENCE FROM EXECUTIVE COMPENSATION”. It’s basically one of his favorite topics. It’s about tax avoidance strategies for those at the highest marginal tax brackets and is basically an empirical test of the Laffer curve which is a darling theory of supply siders. He examines how top CEOs time and exercise their stock options among other things. It also looks at how they take their compensation (i.e. do they prefer bonuses, straight salary, or stock options.) There are a lot of technical estimates of elasticities in this paper so if you venture into it, you’ll get the traditional blurry brain one gets from dealing with greek economics, however, you can read his introductory material and conclusions without looking at the estimation models and tables.

Here’s his conclusion in the abstract.

Breaking out the tax responsiveness of different types of compensation shows that the large short-run responses come almost entirely from a large increase in the exercise of stock options by the highest income executives in anticipation of the rate increases. Executives without stock options, executives with relatively lower incomes, and more conventional forms of taxable compensation such as salary and bonus show little responsiveness to tax changes.

Here’s his conclusion from the paper itself.

They also suggest that taxing the rich can lead to dramatic shifting of taxable income in the years immediately surrounding a tax change. Such changes may allow many to avoid taxation for a short period of time and may wreak havoc on contemporaneous revenue estimates, but after the shifting is done, the total changes in taxable income may be more limited and the deadweight loss of progressivity more modest than previous work has suggested.

His other empirical works on the Laffer curve come from the Brookings Institute and again, another paper presented for the AEA proceedings in 2000. In this last paper, Goolsbee looks at executive compensation in broad terms and considers the gains to CEO portfolios in their stockholdings to be a type of substitute for salary. This is interesting in light that the Bush Tax cuts–and right now any extension of them–treat capital gains differently from ordinary earned income. If the stock market booms, executives will make much more income in an area that receives preferable tax treatment if they are taking compensation in the form of stock options, so, there would be a loss in tax revenues to governments as a result. He doesn’t see the overall progressivity of the tax system as burdening investments, however so the guy’s not a Republican in that sense at all. If anything, this is a first hint at the influence of the “Nudge” concept. One very rich guy at the top changed his behavior but the majority of the CEOs did nothing.

He also has a later finance paper (extremely technical)with Harvard’s Mihir A. Desai entitled “Investment, Overhang, and Tax Policy”. This uses the q model of investments which you’re undoubtedly not familiar with but it really doesn’t make much of a difference for our purposes. It’s basically a paper that corrects for econometric mistakes in estimations in earlier papers that evaluate the effectiveness of the Bush tax cuts on investment. Tobin’s Q is a proxy variable used to represent a variety of characteristics in an empirical model and it looks at investment returns. You can Google it if you want your eyes to blur over or you’re suffering from insomnia. It’s the bane of first year graduate students in investments and corporate finance every where.

So, first let me tackle the idea of capital overhang for you which is important. It’s a problem that we’re seeing right now so, let me just define it for you. It’s basically “the huge amount of money raised by private equity funds that remains uncalled”. That depresses stock returns in the market. Stock that is not bought sits out there like excess inventory if you will but it still part of the ROE calculation so it makes returns for people that hold the stock lower as a result.

“The private equity industry faces a number of significant headwinds, and investors who are considering locking their equity up for a decade or more should set a high bar. Manager selection has never been more important,” said co-author Andrea Auerbach, Managing Director and Head of U.S. Private Equity Research at Cambridge Associates. “Of all the asset classes that went parabolic from 2004 to 2008, PE, or leveraged buyout, funds may have done the best Icarus impression. After attracting record amounts of money for three years starting in 2005, the number of buyout transactions plummeted as cheap financing dried up. Much of the money raised remains uncalled, which will probably impact returns for current and future investors for a long time.”

This problem in the investment market makes it complex for fiscal policy (tax policy and government spending policy) to impact and stimulate private investment. It’s like there’s too much capacity out there and not enough activity so any stimulus won’t bring any new activity to businesses buying machines or buildings etc because they’re already not using what they have available.

Here’s the conclusion in the abstract from Desai & Goolsbee (2004) which is from the Brookings Institute.

First, in keeping with the “new” view of dividend taxation, the evidence suggests that dividend taxes do not influence marginal investment incentives. This evidence indicates that the dividend tax cut, with forecast revenue cost of more than $400 billion from 2003-2008, would have had little if any impact on investment. Second, the partial expensing of equipment provisions (revenue cost of approximately $130 billion from 2002-2004) did have an effect on investment but were too small to counteract the large aggregate investment declines stemming from market movements. The results put the investment increases resulting from the tax policies of 2002-2004 at only one to two percent.

The last tax paper I examined was from 2002. It’s entitled “The Impact and Inefficiency of the Corporate Income Tax:Evidence from State Organizational Form Data”. It presents evidence that a change corporate tax rates will cause a firm to change its organization form. This has more to do with if the firm because a partnership, sole proprietorship or some form of corporation to deal with tax liability. It tries to estimate the probability a firm will become a corporation given a tax rate.

Again, this basically attacks another premise of supply side economics that it’s government tax policies that block new investment and by simply giving businesses new tax cuts, you’ll revive business investment. Given the conclusion here, it’s odd that we’d see the Obama administration suggesting what it is suggesting at the moment (i.e. more business tax incentives). However, if you look at this stuff in terms of the nudge concept, it makes sense. You can nudge some companies into different choices by changing tax structure.

From these papers alone, I think we can safely say that Goolsbee does not appear to be a supply-sider. Most of this works basically pulls apart some of the central tenants of “Reaganomics”. It appears he doesn’t by the macro effects of that ill-fated set of hypotheses.

He also has an interesting paper from 2004 called “Taxes and the Quality of Capital”. This more of a macroeconomic study in that it looks at choice of capital as a portfolio choice. This is a portfolio in the sense that you can chose one or many in various combination to get a desired result. Goolsbee (2004) looks at how tax treatment effects the choice. Again, this is a highly technical paper dealing with growth rates of price vectors so just look at the abstract, motivation and conclusions and stay out of the appendix completely.

This paper puts forward the idea that tax policy can change the relative price among capital varieties and thus lead to shifts in the quality composition of investment demand. Using data on mining, construction, and agricultural machinery, the cross-sectional evidence indicates that when the cost of capital falls, the sales of higher quality (i.e., more expensive) capital varieties disproportionately increase and the reverse when it rises. This effect is not a general feature of investment but rather appears to be somewhat specific to tax policy.
The paper then establishes a means of aggregating the micro-data to shows that the overall effect of tax induced quality change is large. The entire increase in investment caused by tax subsidies comes about from an increase in the quality of the machines, not the number of machines as in the conventional literature. Prices rise, as well, supporting the idea of an upward-sloping supply curve for these products.
Finally, the paper presents calculations suggesting that the quality distortion created when tax policy differs from full expensing generates an additional deadweight loss which has been neglected in previous work and that this efficiency cost may be quite large.

So, this paper has some hints that tax policy can change individual company’s choice of capital and implies that tax policy can be used to nudge an industry to make one choice over another. That’s given the industry has no excess capacity and will be in the position to invest in something.

A lot of his recent research is on topics related to internet infrastructure, although there is one traditional microeconomics paper out there on the airline industry that looks at oligopoly market structure and barriers to entrance.

So, what can I see from this? His later research on taxes appear to be in the ‘nudge’ vein (see Thaler and Sunstein’ pop book). I don’t think he buys into supply side economics per se, but seems to think that corporate and rich individual’s decisions can be influenced by carefully designed tax policies if ever so slightly. So, there are ‘micro’ impacts but not so much ‘macro’ impacts.

I do think that his appointment may explain why the President appears to be pushing a tax package as some form of stimulus. While, I haven’t see the details of the package, it appears to be in the vein of what tickles the intellectual fancy of Dr. Goolsbee.

Again, if you look out on the web, you’re likely to find a lot of anecdotal stuff on Goolsbee. I’m not sure if it’s helpful or not in understanding what kinds of things he’d place on the policy table. Here’s one of his most famous ‘mispeaks’.

Though he denies it, Goolsbee allegedly misspoke once during the presidential campaign. A Canadian government report said he had told Canada’s Chicago consulate that Obama’s anti-NAFTA campaign stance was “more about political positioning than a clear articulation of policy plans.”

The gaffe may have cost Obama the Ohio primary, but since then Goolsbee has joked about the incident.

“Don’t believe anything the Canadians say,” Goolsbee told Stephen Colbert on “The Colbert Report” last year.

Here’s something popular press says about his economic philosophy inclinations.

While the University of Chicago has a reputation for conservative economic thought, Goolsbee is known as a liberal economist. But, Ezra Klein writes “that’s more a byproduct of his populist rhetorical style than actual populism. He’s a serious free-market guy…”

On an international scale, Goolsbee says that globalization isn’t to blame for much of the country’s income disparities, according to Will in the Washington Post, because “60 to 70 percent of the economy faces virtually no international competition.” Globalization and the free trade that comes with it are often believed to effect American workers by providing companies with greater access to cheap labor.

At home, he says the country’s staggering unemployment will be the last nasty recession byproduct to disappear.

“The jobs crisis is the hardest to fix in the immediate term because job growth is a lagging indicator,” he said, according to Politico. “Even once we have laid the groundwork for financial recovery, economic recovery, housing recovery – all of those things – it still takes time to turn the job market around because ultimately that’s a slow-moving process. That’s the big boat to turn around.”

Goolsbee fought Larry Summers, the director of the National Economic Council, over whether or not to bail out Chrysler. Goolsbee said no, Summers said yes, Summers won the day.

My bottom line comes from that last sentence. “Summers won the day.” Right now, everything coming out of Obama is basically what comes out of Summers. I’m not sure Goolsbee will have any kind of real influence as long as Summers is still in the West Wing. Bullies will out.

Well, I think I’ve bored you enough for one afternoon!! You can go grab your rug and take a nice nap! You deserve it if you made it through this post! I know reading this papers makes me want to go for the gusto but that’s against my Windsor Rules, so ice tea it still is for me! Hope I explained some of this without being technical. Questions or just asking for clarification on something I didn’t explain well are encouraged!!