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A Two-Tier Plan By Any Other Name?

Posted by Michael Sykuta on May 21, 2012

Paul Fain has an interesting update today on the issue of two-tier pricing for California’s community college system. Santa Monica College rocked the boat in March when it announced plans to start using a two-tier pricing schedule that would charge higher tuition rates for high-demand courses.

Santa Monica–and most all community colleges in California apparently–have been slammed with would-be students looking to take classes that would help prepare them for better jobs or for further education and training (that would prepare them for better jobs).  The problem is that state funding for community colleges has been drastically reduced, thereby limiting the number of course offerings schools can offer at the subsidized tuition rate of $36 per credit hour. Santa Monica had the radical idea (well, radical for anyone that fails to understand economics, perhaps) of offering additional sections of high-demand courses, but at full-cost tuition rates (closer to $200 per credit hour).

Students protested. Faculty at other community colleges complained. Santa Monica College relented. So students don’t have to worry about paying more for courses they will not be able to take and faculty at other colleges don’t have to worry about the possibility of more students wanting to go to their schools because the overflow tuition at Santa Monica drives students to find substitutes. Well, that, and no more worries for those faculty at schools who charge even more than $200 for students to get those core courses that they cannot get into at their community college. It didn’t matter much anyhow, since most agreed that Santa Monica College’s proposal would have violated the law.

Now there is a proposal before the California legislature that would allow schools to implement two-tier pricing, but only for technical trade courses, not for high-demand general education-type courses.

Aside from complaints that “the state should be giving away education–even if they are not” (which are the most inane because they have nothing to do with the issue at hand), there are a few other arguments or positions offered that just cause one to scratch one’s head in wonder:

1) Fain reports that Michelle Pilati, president of the Academic Senate of California Community Colleges, asserted that “two-tiered tuition is unfair to lower-income students because it would open up classes to students who have the means to pay much more.” Apparently, Ms. Pilati would prefer all students have equal access to no education than to open up more spaces (to lower-income students) by opening up more spaces to higher-income students at higher prices. Gotcha.

2) The Board of Trustees at San Diego Community College seems to agree, having passed a resolution opposing the proposed legislation because it “would limit or exclude student access based solely on cost, causing inequities in the treatment of students”. Apparently the inequity of some students getting an education and some not is more noble because explicit out-of-pocket costs are not involved and other forms of rationing are used. And yet…

3) According to Fain,  Nancy Shulock, director of the Institute for Higher Education Leadership and Policy at California State University at Sacramento, asserts “wealthier students have a leg up when registering for courses. She said research has found that higher-income students generally have more ‘college knowledge’ that helps them navigate often-complex registration processes. That means wealthier students could more quickly snag spots in classes, getting the normal price, while their lower-income peers would be more likely to pay the higher rates under a two-tiered system.”

So, community colleges have created overly complex registration systems that disadvantage lower-income students. Yet, all that suggests is that the current system already punishes lower-income students because wealthier students can more easily “snag” the limited number of subsidized sections. Perhaps community colleges could make their enrollment processes less complex?

Regardless the fate of the “two-tier pricing” legislation, there is already a two-tier system in place; only the current two-tier plan prevents people from getting educations at any price.

Posted in Education, higher education, markets, Sykuta | Leave a Comment »

Taxing Regulatory Failure

Posted by Michael Sykuta on May 7, 2012

Last month, the IRS and the US Treasury Department issued proposed rules to implement a new tax on health insurance providers and self-insured groups. The tax is part of the Patient Protection and Affordable Care Act (ACA) and will be used to help fund the new Patient-Centered Outcomes Research Institute (PCORI), which will conduct research evaluating and comparing health outcomes and the clinical effectiveness, risks and benefits of medical treatments. The proposed “comparative effectiveness research fee” will cost insurers $1 for every covered person (including dependents) in the first year and $2 in the following 6 years. The fee is scheduled to end by 2019.

Sounds reasonable on the surface. If the government is going to regulate health care, it makes sense that it would want to do research on what procedures are more or less effective so it can determine what procedures should or should not be covered under different circumstances. If that sounds a bit like rationing, it is. But it would be based on some standard of productivity. However, reasonable on the surface does not reasonable on the whole make.

One unanswered question is why the government needs to create an entire new federal agency to conduct comparative effectiveness research. One would think that private health insurance companies would already have an incentive to determine what procedures are most effective. This is also the kind of work that medical researchers engage in all the time (a quick Google Scholar search results in almost a half-million articles on “comparative effectiveness of medical treatment“). So it is quite likely that the federal government is simply recreating the wheel–a very expensive wheel–while adding costs to insurance providers. And when insurance providers’ costs go up, so do prices for healthcare coverage.

Of course, it is possible that the private insurance market is not currently doing this kind of research on comparative effectiveness of treatments and is ignoring the plethora of research in the medical journals. But if having that information could help those companies increase their profits by allowing them to direct patients to more effective treatments that reduce cost of coverage, why would they not use it?  If companies are not using this kind of information, there must be no economic incentive to do so. Which begs the question: why not?

A possible explanation is that the market for health insurance coverage has been protected from competitive pressures by the nature of the regulatory system. Although the market for insurance may seem like a national market, a maze of state-level regulations reduce the effective size of markets and increase the overall costs to insurance providers. Different regulatory processes and standards across states make it more difficult for insurance companies to operate across many states. This reduces competitive pressures between insurance providers. However, it doesn’t seem like a sufficient argument to support the idea that insurance companies regularly ignore information that would allow them to increase their profits, even if they were not competing as vigorously on prices.

Besides the motivation question, there is also a question of what the possible consequences of the new PCORI’s comparative research may be. At a minimum, one would expect that the government would begin dictating what procedures can or cannot be covered by federally-approved health care plans. While such a determination by an individual insurance company may lead to competitive behavior between providers offering different coverages, federally-established mandates will further reduce competition by limiting the margins (coverage options) on which insurers can compete.

It is also reasonable to suppose that a federally-approved list of  procedures will reduce the likelihood of innovation in treatment methods and practices by medical professionals. Reducing incentives to innovate will slow advances (and potential cost reductions) associated with possible new treatments. Having to get federal approval for new treatment options will do for treatments what the FDA has done for introduction of new pharmaceuticals (increasing costs, reducing the number of alternatives that reach clinical trials, and slowing the time to market).

The PCORI is mandated as part of the ACA. The ACA itself is a monstrosity of regulations to correct regulatory failures (part of the economic argument around the controversial mandate provisions now being reviewed by the US Supreme Court). The PCORI tax is just one more element of a regulatory response to regulation-induced market failures that is as likely to reduce health care options as to provide them.

Posted in health care, health care reform debate, markets, regulation, Sykuta | Leave a Comment »

More Bailout Fallout: Non-buyer’s Remorse

Posted by Michael Sykuta on March 12, 2012

An interesting story in the WSJ Online today about American International Group (AIG)’s use of a standard tax write-off and the political firestorm it is creating…all because the Washington establishment thought it could hide behind semantics during the bailout era.

The benefits at issue were accrued by AIG as it amassed record losses amid the financial crisis; the U.S. tax code allows businesses to “carry forward” such net operating losses to offset future tax obligations, in effect saving on future tax bills. But those carry-forwards can vanish if a company is taken over or sold, an exception that prevents healthy companies from avoiding taxes by buying firms with significant losses.

The criticism from the former members of the congressional panel stems from a series of Treasury determinations beginning in late 2008 that said the federal government’s bailout of AIG, General Motors Co. and other firms didn’t constitute a sale.

The US government acquired as much as 90% ownership in AIG during the bailout era. Under most any definition, such a shift would be considered a change in corporate control. However, because the Treasury Dept. wanted to maintain the illusion that government was not taking over large swaths of the US economy, it pronounced that these bailouts were not what any student of financial markets understood them to be: an exchange of equity control and strings on management for access to cash. In short, a sale of control.

Now the Treasury Department’s ruling is coming back to bite. Under the US tax code, AIG and its investors have a legal right to carry forward losses from the financial crisis to offset taxable earnings now. But now legal-scholar-turned-bureaucrat-turned-politician Elizabeth Warren, and others, want to change the rules after the fact. Warren is calling on Congress to “end this special tax break”. I’m not sure what exactly is so “special” about this tax break, since it applies to any business, not just those bailed out by the Feds. So is Warren suggesting all businesses should be prohibited from carrying forward losses? Or only businesses whose losses the Federal government wasn’t willing to tolerate in the first place? After all, if the Treasury had let nature take its course, AIG (and many other bailout recipients who are now wondering about their own ability to carry forward losses) would have been bought–albeit likely in pieces–and this whole issue would be moot.

What’s really interesting about this whole argument is that Treasury still holds 70%–a controlling interest–of AIG’s stock. AIG reported their beneficial tax breaks weeks ago. Presumably Treasury is paying attention to their investments and knew about that decision, possibly even before it was publicly released. So why didn’t they exercise their controlling interest and stop management from electing to use the carry forward? More importantly, Treasury is the “owner” that stands to gain the most from this tax benefit. So what exactly is Ms. Warren and others complaining about?

Either way, this is a mess of Treasury’s own making with its semantic gamesmanship on whether the bailout should be named for the government take-over that it was. Seems like we have a bit of non-buyer’s remorse.

Posted in business, law and economics, Sykuta, taxes, truth on the market | 5 Comments »

A Tale of Two Subsidies

Posted by Michael Sykuta on March 5, 2012

Last week’s business news highlighted two tremendous subsidy programs. In one case, the company received no direct payment for product development. None of its suppliers received targeted subsidies to produce parts. But consumers were subsidized to encourage them to buy the product.

In the other case, the company received direct payments to underwrite the cost of product development, one of the company’s suppliers received an even larger subsidy to create critical components, and consumers were given subsidies to encourage them to buy the product.

One of those products is among the best selling products in the world. The other just halted production. The successful one was subsidized through private market transactions. The other was subsidized by the US government using taxpayer dollars.

If you haven’t guessed by now, I refer to the Apple iPhone and the Chevy Volt, respectively.

The irony of these twin tales is that they highlight the problems of subsidies in general, but particularly when the subsidy is used as a tool for the government to pick winners and losers in the market (i.e., industrial policy).

In the case of the iPhone, cellular phone companies subsidize the phone in the hope of being able to recoup those costs in the price of the service contracts that are bundled with the subsidized phones. Basically, the subsidy really amounts to nothing more than a marketing expense for the cell phone companies to expand their market share of (particularly data) service contracts. Cell phone carriers recognize that consumers value the features of the phone and are willing to take a loss on the phone to get the consumers locked into a service contract. The subsidy creates value all the way around, since the cellular companies would not offer the subsidy if they did not believe they could more than recoup the cost on the service contracts.

In the case of the Volt, the government had no concern for being able to break even. The motive was to unlevel the playing field by giving GM an (unfair?) advantage in developing an electric vehicle, whether compared to other electric vehicle manufacturers or to traditional combustion engines and recent hybrids. (Actually, according to the WSJ report, the Feds also subsidized Fisker Automotive’s Nina plug-in, which is also no longer in active production.) The problem is, consumers don’t want the product—even at the whoppingly-low, subsidized price of $40,000 per car. GM sold barely half of its originally target of 15,000 cars in 2011. The company has built up so much excess inventory that it shut down production and laid off 1,300 workers for a couple months, with the hope that consumers will eventually buy up the excess.

This doesn’t mean that private market “subsidies” are necessarily good either. As the WSJ reported, Apple is facing an uphill battle. As the market for contract cell service begins to get saturated, Apple finds itself unable to effectively compete in the non-contract market because it doesn’t have affordably-priced phones for that segment and cellular companies cannot (or simply will not) subsidize the iPhone if they can’t recoup the cost. Some investment fund managers have even grown leery of Apple because they see a rough road ahead as Apple tries to expand into LDC’s where non-contract phone plans dominate and consumers cannot afford the pricy iPhone.

As the WSJ headline indicates, subsidies provide a crutch for producers. In every case, over-reliance on the crutch will inhibit long-term growth and economic viability. The difference between privately-provided crutches and government-provided crutches is that the private sector market has a much stronger incentive to make sure the patient has a realistically good prognosis to begin with, rather than Washington’s knack for picking losers.

Posted in business, markets, Sykuta, truth on the market | 3 Comments »

The Magical World of Mandates

Posted by Michael Sykuta on February 10, 2012

It seems President Obama has discovered a magical cure for his contraception controversy: simply force insurance companies to provide free coverage for contraceptive services, but only for women who work for organizations that qualify for exemption from the original mandate that requires contraceptive coverage be part of any respectable (i.e., Obama-approved) health plan. Never mind the whole religious liberty issue. I think that pales in comparison to the economic liberty argument against the mandates to begin with. But the President’s proposed solution should strike fear into the hearts of any person who likes to be paid for what they do.

The underlying premise of the Administration’s decision is that the federal government has the right to force people to give away the products and services they produce. If the government can force insurance companies to “give away” health care coverage to avoid a political embarrassment, what is to prevent the government from requiring other companies or industries to give away their products if such a mandate would be politically expedient? And more importantly, does Mr Obama really believe any company is going to simply write-off the cost of the “free” service and not cover it by raising the cost of other services? In essence, insurance companies will have incentive simply to raise the price of the health plans they offer to exemption-qualifying employers. Either way, the employer will pay for it. It just might not be listed on the receipt.

Or perhaps Mr. Obama plans to make the cost of the “free” contraceptive care a qualifying charitable contribution for health insurers, since it will only apply to non-profits.

What makes the proposed solution even more ludicrous is that health insurance companies neither manufacture nor deliver, in most cases, contraceptive pills. So why should insurance companies even be involved in this great giveaway? A more direct solution would be to require pharmaceutical manufacturers to give the pills away to begin with. Or to require pharmacies to distribute them for free to qualifying individuals.

Regardless of where one stands on women’s reproductive rights, women’s health or religious liberty, we all make our living by getting paid for what we do. The President’s mandate attempts to create something from nothing by forcing insurers to provide services without getting paid for them. That should violate the sensibilities of anyone who works for their pay.

Posted in health care reform debate, politics, regulation, Sykuta | 14 Comments »

Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts

Posted by Michael Sykuta on February 8, 2012

That’s the title of an interesting article by Emmanuel Farhi and Jean Tirole in the current issue of the  American Economic Review. Here’s the abstract (emphasis added):

The article shows that time-consistent, imperfectly targeted support to distressed institutions makes private leverage choices strategic complements. When everyone engages in maturity mismatch, authorities have little choice but intervening, creating both current and deferred (sowing the seeds of the next crisis) social costs. In turn, it is profitable to adopt a risky balance sheet. These insights have important consequences, from banks choosing to correlate their risk exposures to the need for macro-prudential supervision.

Posted in banking, economics, regulation, Sykuta | 1 Comment »

Options Have Value, Even If DOT Doesn’t Get It

Posted by Michael Sykuta on February 2, 2012

Last week Thom posted about the government’s attempt to hide the cost of taxes and regulatory fees in commercial airfares. Apparently Spirit Airlines is highlighting another government-imposed cost of doing business by advertising a new $2/ticket fee that the airline has imposed. According a CNN report yesterday:

Spirit Airlines says a new federal regulation aimed at protecting consumers is forcing it to charge passengers an additional $2 for a ticket.

The fee, which Spirit calls the “Department of Transportation Unintended Consequences Fee,” has been added to each ticket effective immediately, according to Misty Pinson, a Spirit spokeswoman.

The new DOT regulation allows passengers to change flights within 24 hours of booking without paying a penalty. The airline says the regulation forces them to hold the seat for someone who may or may not want to fly. As a consequence, someone who really does want to fly wouldn’t be able to buy that seat because the airline is holding it for someone who might or might not end up taking it.

In short, DOT is requiring airlines to give consumers a real option to change their flight plans at zero cost within a 24 hour window. Spirit rightly recognizes that options have value. Not only is there a value to consumers in ‘buying’ such an option, there is a cost associated with providing the option; in this case, the opportunity cost of selling seats that may be held for someone that will exercise the option to cancel without a fee.

Obviously, DOT head Ray LaHood is unimpressed.

“This is just another example of the disrespect with which too many airlines treat their passengers,” Department of Transportation Secretary Ray LaHood said in an e-mailed statement. “Rather than coming up with new and unnecessary fees to charge their customers, airlines should focus on providing fair and transparent service — that’s what our common sense rules are designed to ensure.”

Perhaps Mr. LaHood doesn’t understand the concept of options and option value. The right, but not the obligation, to undertake an activity (particularly under pre-specified terms) is clearly an economic good.  The very notion that DOT’s new regulation is touted as “consumer friendly” recognizes that it creates additional value for consumers. That is, it’s giving something away that is of value…a property right to change one’s mind at zero cost. However, it is disingenuous of Mr. LaHood to object to the idea that giving away value imposes a cost on the one providing the value (and I don’t mean the DOT, but the airlines who must honor the consumer’s exercise of the option).

A better solution might be to require airlines to explicitly offer the option of a no-penalty change within a 24-hour window. Then consumers could choose whether to pay the fee and airlines might discover the true market value of that option. Spirits’ $2 may be too high. More likely, it’s too low. Many airlines already do offer the option of a no-fee cancellation and the fare differential is much higher than $2, but that option typically has a much longer maturity…any time after booking up until departure. A shorter maturity window should command a lower option value.

Spirit Airlines may be the epitome of nickle-and-diming air travel consumers, something many consumers (myself included in some cases) don’t appreciate. However, there is no denying that Spirit understands the nature of options and their value. And there’s also no denying that, based on its stock price over the past year, Spirit is doing at least as well as industry leaders in providing consumers value for the options they choose. Perhaps instead of casting aspersions, Mr LaHood and his staff should invite Spirit to teach them about this fairly fundamental concept of options and option value rather than imposing regulations with so little regard for their true costs.

Posted in business, consumer protection, regulation, Sykuta | Tagged: , , | 1 Comment »

Municipal extortion and full employment for lawyers

Posted by Michael Sykuta on April 12, 2011

Consider this a venting, especially as one of the few non-lawyers in our blogging group.

Recently one of my lawyer friends posted a Facebook status as “Amending moving violations and saving clients on their insurance” at the local municipal court. This post reminded me of one of my less-than-enjoyable encounters with the Missouri traffic court system, which got me thinking more generally about this issue and it’s negative social effects. I’m led to believe this may be relatively unique to Missouri, so I welcome comments on to what extent this is the ‘norm’ in other states.

But in Missouri, it is common that municipal prosecutors will regularly “amend” moving traffic violations, which incur points against one’s driver’s license and potentially raise car insurance rates, to non-moving violations which do not incur said points and insurance rate hikes. Of course, the prosecutor only does so under two conditions: Read the rest of this entry »

Posted in economics, lawyers, markets, Sykuta | 6 Comments »

Opening the US securities markets

Posted by Michael Sykuta on April 8, 2011

Larry makes a strong argument below for why the proposed SEC rules changes reported today in the WSJ should not be heralded as some great opening up of US securities markets, but that the changes are little more than political posturing to prevent addressing the real problem of the costs imposed by securities regulation more generally. I don’t disagree that the proposed rules changes Larry targets are, at best, window dressing to release some (well-justified) pressure created by innovative market-based solutions to circumvent the rules that lie more at the root of the securities market problem.  So long as the costs associated with “public” placements are so high, investors and issuers will continue to look for ways to expand their access to capital within the “private” placement market, which by definition excludes many (especially smaller) investors.

That said, I will point out that one of the quotes in the article bemoaning this proposal comes from an institutional investor–one of the groups that is more likely to benefit from the current 500 entity cap. If raising the cap would not open up the market meaningfully to new potential investors, I wouldn’t expect to see such negative comments from one of the groups who will face this greater competition in the supply of private equity. So while the proposed changes certainly don’t address the real problem, it seems they may make the market a bit more open (and less subject to contrived and costly work-arounds like special purpose vehicles) than it currently is.

However, among the rules changes being proposed is one that should open up the market to greater access even to smaller investors (up to whatever new cap might replace the current 500 entity rule). And it’s a rule  change that appears a direct response to something Larry blogged about here just earlier this year.

According to the WSJ report, the SEC “is considering relaxing a strict ban on private companies publicizing share issues, known as the ‘general solicitation’ ban.” The current regulations are currently under Constitutional scrutiny as a potential violation of 1st Amendment speech rights, as a result of a case by Bulldog Investors that Larry discussed in his earlier post.  Again, how far will the ‘relaxing’ go and will it be a substantive change in the underlying problem, or just another hanging of curtains? But there should be no doubt that more open communication about private equity investment opportunities should further open the market to smaller investors.

All this to say, I believe Larry is on point for the big picture, but the proposed regulation changes don’t seem to be all bad. Of course, the devil is in the details–so we’ll have to reserve judgment until the specifics are revealed before having more confidence in that conclusion.

Posted in disclosure regulation, IPOs, securities regulation, Sykuta | 1 Comment »

Small Business Financing Post-Crisis

Posted by Michael Sykuta on March 9, 2011

Tomorrow I will be attending a symposium on small business financing sponsored by the Entrepreneurial Business Law Journal‘s at the Moritz College of Law at the Ohio State University. I’m on a panel entitled “Recessionary Impacts on Equity Capital,” which is a bit misleading–or at least a bit different that the topic I offered to speak on, which is the effect of the recession and recent financial crisis on small business financing more generally. The rest of the day includes presentations governmental and policy responses to the crisis and practical implications of constricted capital. A copy of the schedule and list of speakers is available. I’m not very familiar with any of the other panelists, but the luncheon address will be given by Al Martinez-Fonts, Executive Vice President, U.S. Chamber of Commerce.

I’m going to focus on a few basic points and highlight some of the myths around small businesses and small business financing that drives poor policy. My first objective is to lay out a simple framework for thinking about financing deals, or any deal for that matter. Namely, the idea that every transaction involves allocations of value, uncertainty and decision rights; and the deal itself provides structure on those allocations by specifying the incentive systems, performance measures and decision rights that address both parties’ interests. How those structures are designed determine the nature of risk exposure and incentive conflicts that may affect the ex post value and performance of the deal.

In a sense, there is nothing new in small business financing post-crisis.  The fundamentals are the same. There is a multitude of contractual terms to address the various kinds of incentive issues and uncertainties that exist in the current market environment. To the extent there is anything truly unique about the current context, they are less about the financial market itself than about broader regulatory and economic issues. For example, much of the uncertainty affecting credit-worthiness have to do with economic and cash flow uncertainties stemming from upheavals in the regulatory landscape for small businesses, including health care. Uncertainty concerning implementation of financial market reforms passed in July 2010 create uncertainties for lenders. These uncertainties exacerbate the usual economic uncertainties of new and small businesses during an economic recovery period.

During the recession itself, “stimulus” spending distorted the credit-worthiness of small businesses in industries that were more directly benefited by government handouts and by the security provided small businesses that supply large, publicly-administered and guaranteed businesses (such as in the auto industry).  Thus, federal and state economic policy to “create jobs” in some sectors distorted the incentives to lend to different groups of small businesses, likely reducing employment in other sectors.

Finally, I’m going to suggest that talking about “small business” financing is a misnomer if we are truly motivated by a care of job creation. A recent paper by John Haltiwanger, Ron Jarmin, and Javier Miranda illustrates that business size is not the key determinant of job creation in the US, as is often argued in the media and policy circles. (HT: Peter Klein at O&M) They find that it is young firms, which happen to be small, not small firms in general that provide the job creation. Ironically, these young firms are also the ones for whom financing is most difficult due to the nascent stage of development and uncertainty. Thus, policies directed to firms based on size alone further distort capital availability from other (larger) companies that are equally likely to create jobs. Since this distortion is not costless, the policies are not welfare-neutral by simply switching where jobs are created, but likely to reduce welfare overall.

So now you don’t need to rush to Columbus, Ohio, to hear what I’ll have to say–unless you want to see the fireworks in person. But now you’ll know what’s going on in case there is news of more upset around the horse shoe in Columbus.

Posted in financial regulation, markets, regulation, Sykuta | Comments Off

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