WH Smith Divisional Incentives

High powered incentives appear to have backfired for WHSmith. In its North American travel retail division, performance evaluation and rewards were tied to aggressive profit targets. These appear to have encouraged managers to recognize income early, particularly from supplier rebates. On paper, the division looked like a strong performer. In reality, profits had been pulled forward, inflating results by tens of millions of pounds. When compensation is tightly linked to a single, measurable outcome like short-term profit, employees rationally focus on maximizing that metric, even if doing so decreases overall profitability.

Managers did not commit outright fraud but made possibly defensible accounting choices. While headquarters wants sustainable profitability, accurate reporting, and long-term relationships with suppliers, division managers are rewarded based on short-term profitability. The result is a predictable reallocation of profitability to where it will enhance compensation. This is a reminder that the problem is not just bad actors, it is often good agents responding optimally to poorly designed incentives.

Profit-Cap Evasion through Vertical Integration

Insurers offering Medicare Part D face a form of profit regulation in which federal reimbursement rates are tied to costs. This provides an incentive to inflate costs. In a new paper, Kakani et al show that firms shifted where they take their profits to an unregulated upstream affiliate. Higher pharmacy prices by affiliated pharmacies represent higher costs to insurers, some of which will be reimbursed through higher insurance prices. Moreover, "We detect larger price increases by insurers that were at greatest risk of exceeding the allowable profit level. More than one-fifth of these higher prices were borne by the federal government." 

The effect of California's $20 minimum wage

From MarginalRevolution:

...prices [of Food Away From Home or FAFH] rose, quantity demanded fell, and that’s what killed the jobs—not robots replacing workers.

In terms of welfare, the bulk of employed workers get an 8% wage increase, a small minority get disemployed. The big transfer was from consumers to workers. California has roughly 39 million residents, all of whom face 3.3–3.6% higher FAFH prices. The transfer is likely regressive — lower-income households spend a larger budget share on fast food specifically. So the policy effectively taxes low-income consumers generally to raise wages for a subset of low-income workers, while eliminating jobs for another subset. Your mileage may vary but I don’t see this as a big win for workers. ...

Changes in top income tax rates over last 20 years

WSJ:  

Democrats warn that tax cuts will slash state revenue and services to the bone, ... Republicans caution that higher taxes will risk an exodus by wealthy residents who create jobs.

Elizabeth Warren's plan to keep poor people in apartments, and out of homes

The Free Press:

...“Warren is deliberately trying to choke off investment in the construction of new single-family rental properties. This is profoundly regressive. Why is it OK for large investors to build and rent out apartments but not single-family homes?” He adds: “Warren’s policy effectively helps rich people keep working-class renters out of their towns.” ...

BOTTOM LINE: More investment increases supply which reduces price.

How Vail changed the economics of skiing

WSJ:

Ski resorts used to be weather-dependent businesses — essentially farmers who grew snow. Bad snow year, bad revenue. In 2008, Vail CEO Rob Katz asked a different question: what if we could sell skiing in advance, before anyone knew how good the conditions would be? The Epic Pass was the answer.

The business model is textbook: bundle access to dozens of resorts onto a single pass, price it attractively, sell it in the offseason, and collect nearly $1 billion in revenue before a single lift spins. Weather risk transfers from the firm to the customer. Cash flow becomes predictable. Vail can now plan capital investments, acquire more resorts, and grow — all without watching the sky.

The tradeoff is equally textbook. To make the pass look cheap, you make day tickets look expensive — some now top $300. That's not accidental; it's price discrimination by design, nudging committed skiers toward the bundle. The side effect is crowded slopes and squeezed independent resorts that can't compete with a bundle their customers already bought.

What happens if we raise our capital gains tax?

Senate Democrats want to raise the top federal capital gains tax rate to 35.8% — which, combined with state taxes, would hit nearly 50% for investors in California or Maryland. That would be the highest rate since 1978. For comparison:

• China has a 20% rate. 
• The European average capital gains tax is 17.9%.

The higher rate will have two effects: 

• Less investment: A higher tax on the returns to investment means that fewer US investments would have a positive NPV.
• Lock-in: since the tax only triggers when assets are sold, investors would hold appreciated assets longer than they should, freezing capital in old uses instead of letting it flow to better ones. 

BOTTOM LINE: Investment and the resulting growth double our standard of living every 40 years.  This tax would change that.    

Benefit-Cost Analysis of California's electric only mandate

Ted Stroll: The Bay Area Air Quality Management District wants to mandate electric water heaters and says it “will avoid an estimated 37 to 85 premature deaths per year.”

The Santa Clara County Association of Realtors surveyed contractors who estimated costs per home at $43,950 to $224,000. Its figures rely on replacing stoves and dryers as well as water heaters and furnaces.

Let’s pick a random lower figure and assume the Bay Area Air Quality Management District ban will cost each home $12,000. If 120,000 homes need a new water heater annually, the cost will be about $1.5 billion every year. That is a lot of money to “avoid an estimated 37 to 85 premature deaths,” assuming there’s a basis for that claim.

What could we do instead with that amount of money?

One answer would be to spend $1.5 billion annually to remediate homeless encampments. Encampment fires are ubiquitous in Santa Clara County. San José Spotlight reported in February that “over the past year thousands of non-structural fires have been sparked by homeless camps, causing toxic fumes and safety problems for people and property.”

Stroll correctly points out that the opportunity cost of the mandates is whether there are better uses for the money.

QUESTION: Why have mortgage interest rates gone up?

CalculatedRisk

CCMBS/Treasury spreads, in contrast, widened significantly last month

One reason CCMBS/Treasury spreads have widened since January is that implied and actual interest rate volatility [a measure of risk] has increased ... Below is a chart of the MOVE index, a measure of implied interest rate volatility from options on Treasury securities across the curve.

Voluntary transactions create wealth, but in Canada there are not enough of them

The Free Press quotes Carleton University economist Vivek Dehejia:

... Canada has long been “the socialist neighbor to the north—an overtaxed, overregulated, overcontrolled economy,” resulting in low productivity and weak growth. ... the prescription is straightforward: lower taxes, less spending, and deregulation.