Folotyn, The Real Death Tax

“[Peripheral T-cell lymphoma] is a very aggressive disease, and patients right now have no options,” said James V. Caruso, the chief commercial officer for Allos, a 17-year-old publicly traded company based in Westminster, Colo., that has no other drugs on the market.

Mr. Caruso also said the price of Folotyn was not out of line with that of other drugs for rare cancers. Patients, moreover, are likely to use the drug for only a couple of months because the tumor worsens so quickly, he said. So the total cost of using Folotyn will be less than for many other drugs with lower monthly prices.

The drug costs $30,000 per month, and it has not been shown to prolong life, only to shrink tumors.

It has come to this. The makers of cancer drugs want your total willingness to pay for their drugs. This could be pretty high even if the drug only presumptively prolongs life. Regardless, if you are going to die soon, your payment per unit of time has to be high. On a per-treatment basis that means a high price. Drugs that actually work have to be priced less.

"Questioning a $30,000-a-Month Cancer Drug"

This Estate Has A Hall of Mirrors

When does stopping a tax from disappearing cost the government revenue over the long run? When it's the US estate tax.

Did the estate tax make it into SuperFreakonomics? It should have. If there is any policy more super freaky than the US estate tax, I haven't seen it.

According to the Financial Times ("US House Votes to Extend Inheritance Tax"), the House voted to lock in the current estate tax provisions. Roughly speaking, taxable amounts above $3.5 million face a rate of 45%.

This change will bring in additional revenue in 2010. Recall, the tax was going to disappear for that one year. According to the Joint Committee on taxation, the estate tax will now bring in $468 million. Note: you read that right, "million," not "billion." That's pretty thin turkey given the size of the hole in the Federal budget.

And, as they used to say on late night television, but wait, there's more! The freeze is going to cause the estate tax to bring in $234 billion less than it would have otherwise from 2009-2019.

Why is that? Because the exemption and rate in 2011 and future years were going to return to their 2001 levels. Those would bring in much more revenue, to the tune of $234 billion more.

This is a strange piece of legislation. I do not know how our elected officials think it will benefit them. They seem to lose points two ways here--not only do they raise taxes, but they also do not raise revenue. Of course this isn't actual law, it is just an enacted House bill, but how does this make any political (much less economic) sense?

Let's fill momma's pockets with gold and then throw her from the train!

Health Insurance and Missing Markets

In my last post, I highlighted an article on health insurance by Nicholas Kristof ("Are We Going to Let John Die?"). He told the story of John Brodniak. Brodniak developed a cavernous hemangioma, which caused him to lose his job, which caused him to lose his health insurance, which ended his ability to manage his health condition.

I noted last time that a cavernous hemangioma is one of (many) kinds of conditions that health insurance could not induce. That is to say, since you cannot give yourself a cavernous hemangioma, there is no moral hazard from having insurance against the risk of coming down with this condition.

This raises an interesting question: why can't parents buy a health insurance policy for their unborn children against risks with zero moral hazard and zero adverse selection? This option does not seem to exist.

OK, I casually tossed in the "zero adverse selection" assumption. Surely, given the limited state of current knowledge about genetics, there really are a lot of diseases for which there is zero moral hazard and for which no parent could really know more than an insurance company the chances that the unborn child would come down with the disease.

Why doesn't a market for this kind of insurance exist? Under competition, there would be a lifetime policy for one (big) lump-sum as well as an annual policy with low rates that increased over time. Surely some parents have a willingness to pay for this kind of insurance, for their children, that would lead a market to develop.

In light of Kristof's story, I think this is one missing market that is actually missed.

Two Stories of the Times

The Washington Post and the New York Times each had stories this week on two of the main economic issues of our time: housing and health.

The Post tells a riveting story of a woman who ended up buying a home she could never afford ("The $698,000 Mistake"). It has all the elements we have come to expect--a liar loan, wishful thinking, a 40% profit in two years--but the pieces are not assembled in the usual way. I used to think of the buyer as "the" liar in a liar loan. In this case, however, the seller originates the lie to be able to flip the property. The story ends well for the seller (so far...). The losers are the buyer, who lost a growing business and her credit rating, and of course someone on the lending side, although by this point it could be Fannie-Freddie and the American taxpayer. Thanks to the Post for a story that gets beyond the cliches.

While the housing story is sad, the health story is simply outrageous ("Are We Going to Let John Die?"). Why is it so hard to insure all American's against conditions for which there is no possibility of moral hazard? This poor guy has a cavernous hemangioma (read the story). My point here is, no one can give themselves a cavernous hemangioma. It's not like a broken leg or the flu or most other things where your own recklessness can bring it on. If you cannot cause it then there can be no moral hazard.

Of course, this fact alone does not mean that every last American would be willing to pay the actuarial fair cost of this insurance. The absence of moral hazard alone does not make it efficient to tax everyone in order to provide everyone with coverage. That said, I suspect that the cost of insuring against this condition--and a range of similar ones--is so low (for all of them combined!) that a simple mandatory payment scheme would make almost everyone better off.

The real trajectory toward a single-payer system does not begin with the very limited public option we are likely to enact. It begins with good ideas that would make stories like this one a thing of the past.

Resolution That Tony Soprano Would Appreciate

This past Tuesday, the House Committee on Financial Services issued a discussion draft of a bill to overhaul the regulation of the financial sector ("Financial Stability Improvement Act of 2009"). It does a number of things, like abolish the Office of Thrift Supervision (Section 1206) and give the Board of Governors of the Federal Reserve broad powers to manage systemic risk.

On that last point: the Financial Times reported ("Draft Law Gives Fed Sweeping Powers'') something I thought was rather funny, or at least reported in a funny way:

But the draft law goes further than expected, allowing the Fed to require any systemically significant company to "sell or otherwise transfer assets or off-balance sheet items to unaffiliated firms, to terminate one or more activities, or to impose conditions on the manner in which the identified financial holding company conducts one or more activities".

If that does not save a company, the government could seize it and force rival banks that have more than $10bn (€6.8bn, £6.1bn) in assets to repay any taxpayer money used to seize or wind up the competitor.

That last point checks out (this isn't the funny part). In the proposed legislation, you will find:

SEC. 1109. EMERGENCY FINANCIAL STABILIZATION

(d) RECOUPMENT; ASSESSMENT.—Any losses incurred by the Corporation pursuant to subsection (a) shall be recovered from Corporation assessments on large financial companies in the manner provided in section 1609(o)....

****

SEC. 1609 POWERS AND DUTIES OF CORPORATION.
(o) RECOVERY OF EXPENDED FUNDS FROM FINANCIAL COMPANIES.—

ASSESSMENT THRESHOLD AND GRADUATED ASSESSMENT RATE.— The Corporation shall not assess any financial company whose total assets on a consolidated basis are less than $10 billion. The Corporation shall assess any financial company with $10 billion or more in total consolidated assets on a graduated basis that assesses financial companies with greater assets at a higher rate.

Here is the funny part. Look at the FT quote above. Notice the word "force"?

Why "force"?

I should think that financial institutions numbered 2 through 5, for example, would be pleased to pay to take down #1. I can hear it:

"Secretary Geithner, we feel it is our patriotic duty to step up and help you ease Big Co. out of the picture. We all know it is on the edge. We need RESOLUTION.

So, you got a job to do. We know there will be expenses. Hey, we got it covered. We won't yell. This is hard all around. We all know what's right here."

This is the great thing about economics. It makes you look at transactions from both sides. Sometimes, for fun.

Is John Kay Now Quoting Me?

In a post from September ("Lehman Failed: Did the Regulators?"), I wrote:

What we now know about the financial markets is that they sent very messy signals about risk to market participants. Bank reserves were not hard assets in a rainy day fund under Basel II. Over-the-counter trading of credit default swaps hid the exposure of those issuing them. Salt-of-the-earth companies were tied to small casinos with big books.

This is where things get complicated. When asymmetric information allows sellers to dupe buyers--and they were duped, their willingness to pay was based on incorrect beliefs about risk--is this a failure of regulation? Don't be too quick to say "yes."

...

To emphasize that last point: The cops share blame when crime happens, but the failure of the cops does not absolve the criminals.

In Wednesday's Financial Times (" 'Too Big to Fail' is Too Dumb to Keep"), John Kay writes:

Their activities underwritten by implicit and explicit government guarantee, it is increasingly business as usual for conglomerate banks. The politicians they lobby sound increasingly like their mouthpieces, espousing the revisionist view that the crisis was caused by bad regulation. It was not: the crisis was caused by greedy and inept bank executives who failed to control activities they did not understand. While regulators may be at fault in not having acted sufficiently vigorously, the claim that they caused the crisis is as ludicrous as the claim that crime is caused by the indolence of the police.

Just a coincidence?

Alright--probably.

John Kay on Regulation versus Supervision

John Kay had an interesting column in today's Financial Times ("How the Skies Proved the Limits of Regulation"). Here is the punch line:

The airline industry also illustrates the difference between regulation and supervision. Supervision is shadow management with a public interest orientation, its purpose to ensure universal adherence to good behaviour. Regulation is narrowly focused on specific issues of public concern. Supervision demands knowledge of the industry, regulation demands knowledge of the public interest and public concerns. So nine of the 11 members of the board of the Financial Services Authority occupy or recently occupied senior positions in financial services, but only two of the nine-member board of the water regulator have worked in water companies.

History suggests that supervision is rarely a success.

Kay is onto something, but he drew the line at the wrong point. Intelligent regulation does require knowledge of the industry. The "knowledge of the public interest and public concerns" of which he speaks identifies the benefits of regulation. What about the costs? To understand those, you need to know the full effects of regulation on the industry. "Regulation" is as much an exercise in cost-benefit analysis as "supervision. The distinction he makes he just not tenable.

Atkinson and Stiglitz laid out the basic model long ago. Government takes an action in "stage 1." Industry responds in "stage 2." Government will take the industry response into account in deciding what to do in stage 1. But, what does that mean? It means that government uses its knowledge of how the system works in setting the policy.

This knowledge is important whatever the government's objective. It may want to find the highest net benefits. It may want to do something else. Regardless, and whatever you call the action ("regulation," "supervision"), government needs to know, as fully as possible, the effects of the action on the industry.

Having said all that, there is perhaps a distinction to be made between licensing on the one hand and regulation/supervision on the other. Kay focuses on the airline industry in his article and talks about how regulation went astray. No one seriously believes that pilot licensing went astray. This holds for the mechanics and other skilled workers who work for the airlines. I doubt that you can produce "airline engines" without a slew of licenses verifying not only that the production environment is safe but also that the engines are sound.

Why does licensing pass all intuitive cost-benefit tests? Licensing-regulation-supervision form a continuum of control, but licensing is the first step in that continuum. Under standard (and reasonable) assumptions, the benefits will almost surely exceed the costs. Furthermore, licenses tend to be granted according to rules and not discretion (although not always--alcohol is always special and liquor licenses are often granted with a fair amount of discretion). To the extent rules are used, the allocation of licenses is not subject to regulatory capture.

Kay has the right idea. He just did not take it far enough.