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Before I talk about this, I should mention that I am not very knowledgeable about macroeconomics, and this idea may be old.

My friend Nick came up with, what seems to me, an extremely good stimulus mechanism for economic downturns. When economic downturns hit, instead of providing tax refunds, states temporarily cut their sales tax significantly.

The advantage that a sales tax holiday has over an income tax breaks is that sales taxes are consumption taxes, not income taxes. When people get a break in their income taxes, it is rational for them to save the extra income in order to spread the increased consumption out over a longer period. However, when people get a consumption tax holiday, it is rational for them to move future consumption into the present, as well as move the purchase of storable goods into the present. Thus a sales/consumption tax holiday would provide more concentrated stimulus than an income tax break.

A sales tax holiday would be broad based because it would apply to all transactions which are subject to sales tax. I don’t know much about stimulus economics, but this seems desirable as it is in tax economics.

Another advantage of a sales tax holiday is that it would be easy to make automatic, which is important for a stimulus mechanism, because special stimulus plans can take time to move through legislatures. I see two ways using a sales tax holiday as a stimulus mechanism could be automated:

  1. Tie the activation of the sales tax holiday directly to local macroeconomic conditions. For example, the sales tax holiday could be triggered if the unemployment rate falls below some critical threshhold (it could also be graduated).
  2. Tie the activation of the sales tax holiday to a Normative Prediction Market, that predicts what a specific council will, in the future, say should have happened right now (i.e. “There should have been a stimulus in August of 2008”). The committee would be a lot like the current committee that dates recessions, except that it would decide whether a stimulus was a good idea. You could alternatively simply use the committee for dating recessions; InTrade already has similar markets. The sales tax holiday would be whatever the market expectation value is for the recommendation, or when the probability of recession rises above some cutoff like 30%.

A number of states already have regular sales tax holidays, though these seem to me like a bad idea, since it is undoubtable distortionary. Some other people have also suggested using a sale tax holiday, notably the Missouri Lt. Governer called for such a simulus, and some states have extended their regular sales tax holidays.

Update: The Washington Post has noted that regular holidays have provided such a stimulus, though the holiday only applies to certain goods (link).

There are many ideas floating around for reforming existing institutions so that they produce significantly better outcomes. The three ideas for reforming governing institutions that I know of are Predictocracy, Futarchy, and Professional Voting; I am sure there are more, and I know there are a lot more for reforming other institutions. However, there is a noticeable lack of experimentation with type of idea. Does it make sense not to experiment? Let’s do a few back-of-the-envelope net present value calculations to see if it does or not.

Let’s say that we judge Futarchy to have a 1% chance of working. Let’s also assume that if we experimented with it now it would take 30 years for the benefits to appear, that it would save everyone in the country $100/year (a conservative guesstimate, remember this is contingent on Futarchy “working”), and that the total investment would be about $100 million (surely a massive over guesstimation). Using a discount rate of 10%/year, the Net Present Value of a $100/year stream appearing after 30 years is $57 (I did the calculations). There are 300 million people in the country so the total Net Present Value is ( 1% x $57 x 300 million ) – $100 million = $70 million. So even under these calculations, the expected benefit of researching Futarchy is massively positive. Not experimenting is huge loss.

The thing that makes this investment so good is the fact that there are a lot of people in the country. Finding an institutional reform that makes peoples lives better provides a massive public good, but costs a fixed amount to find. In these calculations I have only included the people in the country, the expected benefit is an of magnitude larger if we consider the benefits to everyone in the whole world.

One of the most interesting concepts I learned from Michael Abramowicz’s Predictocracy (which I have mentioned before) is the idea of a “normative prediction market”.

The essential distinction between normal conditional prediction markets (about prediction markets in general) and normative prediction markets is that for a normal prediction market, the contract payout depends on some objective criteria, like whether Barrack Obama wins the Democratic nomination or what the unemployment rate is in 2013, but for a normative prediction market, the contract payouts depend on the the subjective judgment of a person or organization. The subjective judgment could be that acquiring that small startup was a bad idea for Google or that introducing needle exchange programs was a good idea.

The major benefit of using subjective criteria to decide prediction market contract payouts is that the market predictions are more useful because they more precisely target the questions of interest. Normative prediction markets are less biased than normal prediction markets because they do not omit important but hard to quantify effects (which seem commonplace). Normative prediction markets can also do a good job of  aggregating preferences in some cases.

Uses of normative prediction markets

Normative prediction markets can potential help companies make good decisions. A manufacturing company might use a normative prediction market to predict whether some major internal change, like moving one of their manufacturing divisions overseas, would be regarded as a good idea by a judging committee in the future. The company would commit to setting up a committee in the future which would report on whether the change was a good idea. The committee would have a relatively open ended criteria but would likely consist mostly of cost benefit analysis, and prediction market participants would have to predict what factors the committee would think were important.

Normative prediction markets also have a lot of potential in public policy. For example, an executive agency or an interested non-profit could sponsor a normative prediction market to help evaluate whether it would be a good idea to implement some new type of poverty relief program. Prediction market contracts would pay out based on whether a decision judge, a randomly selected agency employee or non-profit board member, would announce that it was a good idea or announce that it was a bad idea to implement the program.

Payout rules

Different rules can be used to select the body responsible for deciding the variables that determine prediction market contract payouts. One method is to determine the payout based on a judgment made by an individual randomly selected from a defined pool. This method would be relatively cheap and the resulting market prediction should be quite stable because prediction market participants must average the expected judgments of the pool of decision makers. This averaging can be useful if one is interested in making decisions partially based on diverse preferences, not just diverse analysis.

Another method is to base the payout on a judgment made by a committee. Committees would generally give payouts with less variance than randomly selected individuals, which would make participating in the market more attractive because it would lower the risk involved. In some cases committees might also produce higher quality judgments; for example, when back and forth argumentation is important for producing good judgments. Of course, committees would also be more expensive since they involve more people and have other potential problems.

Potential problems with normative prediction markets

Shirking by decision judges is an important potential problem for normative prediction markets, because decision judges do not directly influence the final decision (since it has already been made). Thus, they will have lower incentives to make informed and well thought through decisions than traditional decision makers. This would reduce the quality of the predictions made by prediction markets.

Norms about not shirking and monitoring of decision judges could reduce shirking. However, decision judges should in general be harder than monitoring traditional decision makers because market judges do not directly change real outcomes, which eliminates one method of assessing decision quality.

One normative prediction market feature that could be either harmful or beneficial is that decision judges are likely to give much higher weight to higher order principles and ideology than traditional decision makers. Because decision judges who determine the contract payouts do not determine the decision that was actually made, if they care about other prediction market outcomes in the future, they have an incentive influence how market participants perceive the average decision judgment in order to shift that average in the direction they favor. This may include giving more more extreme judgments than they really prefer.

Consider a situation where the government uses a normative prediction market to decide how much it should spend on a new social programs. The prediction market decision judges are randomly drawn from body of liberals and conservatives. For a particular decision, if a liberal decision judge (a judge who’s spending judgments are generally higher than the mean of the group’s judgments) is selected, then they have an incentive to try to move the group’s mean judgment upward as much as they can by announcing a very high spending amount, even if that amount is higher than the amount they would choose if they were the actual decision maker. The reverse would be true when conservative decision judges are selected.

Strong norms pushing people towards giving genuine preferences would mitigate this effect somewhat.

The beneficial aspect potential of this effect is that decisions judges would generally be less tempted than traditional decision makers to trade off reduced rule of law or other high order principles for better immediate outcomes.

Abramowicz emphasizes this second potential, but on net, I think this effect would be more harmful than beneficial.

Over all, I think normative prediction markets are a very cool idea. They definitely deserve experimentation, and I suspect that they will eventually be used to make many types of decisions.

Links: Abramowiczs description of normative prediction markets

I am reading Predictocracy: Market Mechanisms for Public and Private Decision by Michael Abramowicz, about how prediction markets can be used for decision making in various places. Since I talk about governance mechanisms a lot on this blog, I intend to review the book later on.

In the mean time, here is a series of posts that Abramowicz did for The Volokh Conspiracy on prediction markets which I found pretty interesting. It includes some good-back-and-forth with Robin Hanson about Futarchy vs. Predictocracy (which I have discussed before).

I have discussed the theory that the passage of the 17th Amendment was a serious blow to federalism on this blog before, and I have been supportive of the argument. Although I have not seen an explicit public choice theory for why the indirect election of senators institutionally encourages federalism, the implicit logic is obvious enough: rationally self-interested state legislators, interested in their own power and influence, jealously guard and work to expand the power of state the legislatures by voting for national legislators who defer to the states as much as possible.

Initially, I found this mechanism very convincing, and I thought that the passage of the 17th Amendment explained essentially all of the decline of Federalism in the US since 1917, but I have changed my mind, and I want to explain why.

Rational self-interest does not imply that the indirect election of national legislators strongly encourages federalism because of vote dilution. Like voters, state legislators have only a very small impact on the outcome of the vote and therefore only a very small impact on their own welfare. This means that even though legislators are rationally self-interested, their political action, like that of voters, will be largely sociotropic (perceived “good” or welfare maximizing).

Because legislators face weak incentives to protect the power of state legislatures, they are likely to follow voter preferences in this domain, even if they are weak, and it may be the case that voters increasingly want more involvement from the national government. Communication and transportation technologies continually get better, which makes the world “smaller,” and I would guess that this makes people think on a more geographically broad level.  People also increasingly have a national identify instead of a state level identity, before the union of the states, people often identified with their state, but now most people identify with their country; few people are more loyal to their state than the nation. This may lead people to think of national level instead of the state level as the appropriate level for politics to take place and therefore lead to less federalism. If this is the case, it would lead to reduced federalism no mater the method used to elect the national legislature. Riker’s (1955) account of the passage of the 17th Amendment seems to support the idea that direct election is inherently popular. Before the passage of the 17th Amendment, many states passed laws requiring the legislature to elect the candidate who won the popular vote in the state, in response to the growing trend of state legislators being forced to campaign primarily on who they would vote for for national senate instead of what they would accomplish in state.

However, there are some potential mechanisms that could motivate state legislators to actively protect the power of the state legislatures.

Indirect election of the national legislature could still systemically encourage federalism if people are biased in certain ways. For example, if people are generally cognitively biased towards accepting ideas which are perceived as in their self or group interest, then legislators will have a skewed perception of what is “good for society.” This will lead state legislators will elect national legislators that favor stronger state legislative power than if they legislators were unbiased.

Indirect election of the national legislature might encourage federalism relative to direct election of the national legislature if state legislators have biased cost/benefit information. For example, state legislators have only the viewpoint and experience of state legislators, so they will be far more aware of the costs and benefits to the state legislatures of proposed structural changes than the costs and benefits to the national government. This would lead state legislators to make decisions based about what they support at the national level largely on what the costs and benefits would be to state legislatures. I am aware of a little empirical support for this proposition: some evidence suggests that people avoid gaining information about the impact of their potential choices on others.

In addition, direct election may actively encourage the transfer of political power from the state legislatures to the national legislature because of the incentives that directly elected legislators have in their attempt to appeal to voters. Directly elected legislators (whether they are national or state) have incentives to expand the control of their legislature both “down” into areas already covered by state bodies and “out” into areas not currently regulated. Legislators have an incentive to work to expand the power of the legislature into new areas in order to claim credit for working to resolve real or perceived problems. This incentive will operate even when those areas are already controlled by the state legislatures because voters are generally ignorant of their own state laws. For example: national legislative candidates in a directly elected system might successfully tout their support for stronger national gun laws, even though the states already good gun laws. This would appeal to voters who think that strong gun laws are a good idea that are ignorant of gun laws in their own state.

Under indirect election, however, national legislators do not have the same incentives to expand the power of their legislature “down” and “out” because, state legislators will generally be far more informed about what issues state law already covers and more often realize that the national legislature does not have any advantage in solving the problem over them. Moreover, while state legislators do have similar incentives to expand both “up” into areas regulated by the national legislature and “out” into unregulated areas, the political system usually prohibits them from expanding upward, taking over areas filled by the national government.

I can’t really comment on whether these mechanisms are true or not, because, while they seem intuitively appealing to me, they mostly are empirical questions for psychology, and I have very little knowledge of the relevant literature.

Overall, It seems to me that there are good reasons to suspect that the 17th Amendment eliminated significant forces in favor of federalism, and that, more generally, the indirect election scheme encourages power sharing between national and state governments. There also seem to be few reasons to believe that indirect election of the national legislature would be a bad political institution. However, the 17th Amendment was probably not an all-important force preserving federalism. Therefore, I think that indirect election of the national legislature is overall a good idea. Unfortunately, it seems that it is a challenge to preserve institutional features like indirect elections, even if they have positive effects, when they can be replaced by popular alternatives. If through some magic, the 17th Amendment were repealed, I doubt that it would stay that way for very long because direct election is popular. While indirect election of the national legislature seems like a moderately good feature of a political system, I have trouble seeing it as a permanent one in normal political systems.

A few days ago, I linked to a paper on Voter Ignorance by Ilya Somin. There are a few points in it that I would like to talk about:

1) Here is Somin talking about retrospective voting (p. 15)

The retrospective-voting argument does, however, possess a kernel of truth. As Fiorina puts it, retrospective voting can impose a kind of “rough justice” on political leaders who have failed badly. If a policy failure is large, highly visible, and easily attributable to a particular set of leaders, it is certainly likely that they will be voted out of office, as the elections of 1932, 1952, 1968, and 1980 suggest. Moreover, the bigger the failure, the less likely it is that the opposing party’s performance will be worse. The ability of voters to punish large and obvious policy failures by incumbents is one of the major advantages of democracy over dictatorship.

This is how I think about it too. Democracy in general gives politicians a weak but significant incentive to work for good policy, because while voters are quite ignorant about politics, they are not completely ignorant; they do generally know when politicians have done an especially poor job. Unfortunately democracy also gives politicians a host of other incentives that aren’t so great.

2) Somin argues that even altruistically motivated voters are rationally ignorant because the chance that they affect the election is vanishingly small. However, as Gelman and others show, altruistically motivated voters do have an incentive to show up to vote, and extending their logic, also to be informed. What Somin forgets is that while the chance that a particular voter changes the outcome of the election is minuscule when the voting population is large, when the voting population at large, the social welfare effects are also large. Moreover, the chance that a voter decides the election and the size of the welfare effect are inversely proportional to eachother, so that when we calculate expected altruistic utility of voting, it is constant.

However, I don’t think that Gelman’s analysis is quite right either because voters aren’t interested in being altruistic per se, they are interested in the psychological rewards of feeling altruistic, and that feeling doesn’t heavily depend on how informed the voter is. I should say that while it seems intuitively obvious to me that the rewarding altruistic feeling from behaving altruistically doesn’t heavily depend on how informed a voter is, I don’t have a good explanation for why that would be the case. I suspect there’s some sort of cognitive bias at work here.

Over at The Volokh Conspiracy, Ilya Somin has a series of four posts on rational political ignorance (the first one is here, and it links to the rest at the bottom) and discuses why it exists and why it is important.

In his last post on the topic, he mentions his 2004 paper covering some recent empirical evidence for rational ignorance, which I find especially interesting because I had been searching for such a survey without much success.

In a comment on my article on Professional Voting, Robin Hanson questions how well the Election Council in a Professional Voting system would work

The obvious question is how well can ordinary voters monitor whether the Electoral Council members are choosing neutral fair test questions.

I have thought about how low levels of monitoring by ordinary voters (due to rational ignorance) would affect the effectiveness of the Electoral Council, and I have concluded that low monitoring levels would not affect Electoral Council effectiveness very much at all. To a large extent, voters do not need to monitor the Electoral Council members in order to give them incentives to do their job well because those incentives are inherent to the job.

Essentially, the only non-monetary rewards more readily available to Electoral Council members than to other people would be small level fame and the ability to pursue sociotropic goals (ideological or otherwise) for example, getting  the minimum wage raised. Electoral Council members would have little opportunity to be corrupt or wield direct power, because the Electoral Council would not control very much public money nor control powerful government functions.  Because Electoral Council positions have a comparative compensation advantage in providing the opportunity to persue sociotropic goals and because sociotropic motivation is quite strong for some people, sociotropic motivation would be especially strong among Electoral Council members because they would self select for being highly sociotropically motivated (I discuss this logic here). Therefore, we should expect Electoral Council members to act mostly to maximize the monetary rewards of being reelected as well as maximize how much they advance some set of sociotropic goals.

The only way to pursue sociotropic goals as an Electoral Council member, however, would be to influence the arguments and facts that voters learn by influencing the questions that appear on the political knowledge test that the Electoral Council would administer. For a Council member to advance their set of sociotropic goals as much as possible, they must ensure that the questions on the test cover the most convincing arguments and facts supporting their sociotropic goals, and to ensure that those questions measure how much individual knows about such arguments as accurately as possible. Luckly, this is exactly the job of the Electoral Council.

Working to include biased questions on the test would not further the influence of individual Electoral Council members because biased questions are very easy to work around. For example, including the question “Are you a Democrat?”, on the political knowledge test would not help Democrats, because non-Democrats can easily claim to be Democrats. Furthermore, even if such biased questions did help the factions which included them, other factions would strongly resist such questions because they would be percieved as unfair. Attempts to include questions biased in favor of specific demographics would be almost totally muted by the weighting of the final voting result by the demographic survey.

One potential problem would occur if the primary cause of disagreement between electoral council members is differences in values and not about what arguments and facts are most true. In this case, Electoral Council members, may devote significant energy towards preventing questions focusing on strong arguments supporting policies which they oppose from appearing on political knowledge test, instead of towards including questions focusing on strong arguments supporting policies which they support. This would obviously be a bad outcome.

This is an interesting potential problem because it means that we should actually prefer Electoral Council members to be be relatively biased towards believing arguments and facts that support what they support and against believing arguments and facts which do not support what they support. However, monitoring of Electoral Council members by ordinary voters (however little of it there is) and Electoral Council members valuation of honesty in general should reduce Electoral Council member’s efforts to keep legitimate arguments that opposing factions support from being covered by the political knowledge test. Additionally, this would not be a potential problem for Professional Voting as a corporate governance institution, because Electoral Council members would value profit almost exclusively and homogeneously, so disagreements would only exist about which arguments are persuasive.

Intrade is apparently starting to include contracts on the future of aggregate economic measures (e.g. GDP growth rate or unemployment rate changes) conditional on political outcomes (e.g. Hillary gets elected) at the suggestion of a research initiative of the Westminster Business School; such conditional prediction market contracts are central to Futarchy. Now, perhaps, we will be able to see if prediction markets can make good predictions about these topics, though they may be too thin to reveal much information.

Looking at the contract prices and volumes on Intrade (Markets->Politics->Impact of Next Pres.) right now, the markets look pretty thin, but perhaps eventually they will have significant impacts on elections.

A month or two ago, I was talking to Chris, and he brought up the idea of a government based on prediction markets. At the time, I dismissed the idea as unworkable, but now I have come across Robin Hanson’s more in depth development of the idea, which he calls ‘Futarchy,’ so I have given the idea some more thought. Hanson summarizes his idea,

In futarchy, democracy would continue to say what we want, but betting markets would now say how to get it. That is, elected representatives would formally define and manage an after-the-fact measurement of national welfare, while market speculators would say which policies they expect to raise national welfare. The basic rule of government would be:

When a betting market clearly estimates that a proposed policy would increase expected national welfare, that proposal becomes law.

Futarchy is intended to be ideologically neutral; it could result in anything from an extreme socialism to an extreme minarchy, depending on what voters say they want, and on what speculators think would get it for them.

Subsidized betting markets would trade idea futures to determine what the results of certain policies will be. I envision the political body used to define the overall measure of welfare as a lot like the Electoral Council I have discussed for Professional Voting, a proportionally elected body which relies on logrolling to make create efficient outcomes. Proportional elections are important in both Futarchy and Professional Voting because the values and perspective of the median voter are unlikely to be the same values and perspective generated by logrolling between parties representing all voters.

I have not finished reading and digesting Hanson’s in-depth paper on Futarchy, but I wanted to offer my initial thoughts. While, I should first say that I am probably biased against this idea because, the way Hanson proposes it, it would be a substitute for my own idea for making democracy produce better outcomes, Professional Voting.

Here are my initial concerns with Futarchy:

  1. Some goals are procedural, and therefore not measurable, i.e. the Rule of Law.
  2. I suspect that it would be very difficult to create an overall measure of welfare that includes basically everything that people care about, no doubt there could be good numerical measures of a lot of what people care about but not everything or close to everything that people care about.
  3. Even though my own values are utilitarian, I strongly doubt that most peoples values are; I suspect that most people’s values are based on ‘fairness’ and other process based concepts, and policies which try to maximize an overall measure of welfare (which would presumably be a state function) would not be very good at furthering those values.

Ideas futures seem most promising to me as an aid to Professional Voting; good policy-futures markets would provide a lot of valuable information to professional voters and elected officials responsible to them about which policies are most likely to further specific goals. Such information could improve the decision making process tremendously, even if the decision of which policies to implement and how were left up to the discretion of the professionally elected legislative body. But perhaps this is just my bias for favoring my own idea.

Still, I would like to see both Futarchy and Professional Voting tried in experimental and small scale governance settings. I think Futarchy, in particular, would work well for making corporate governance decisions because there is essentially one dimension (stock price) on which to evaluate the quality of decisions. I think Futarchy could largely solve principal-agent problems corporate governance experience due to rationally ignorant stock holders. Internal corporate ideas futures could ask, for example, whether replacing the current CEO would boost the stock price, which would give the CEO a very strong incentive to be a good agent for stock holders.

Such experiments would let us evaluate whether and under what circumstances Professional Voting and Futarchy generate better outcomes that more traditional democracy.