Contents of the "Inflation Reduction Act"

Please let me know how this so-called "Inflation Reduction Act" reduces inflation.  Here's what's actually in it:

Major items

• Alternative minimum tax for corporations Sec 10101
• This raises the level of business taxation, which reduces real wages.
• IF it reduced the dispersion of business taxation, that would be a force toward increasing real wages to help offset the level effect.  BUT see below on the dozens of IRA provisions that increase the dispersion of business taxation.
• Gives the Treasury Secretary the authority to determine an individual corporation's tax liability!  Sec 10101 (a)(2)(C), (a)(13)
• [I changed my mind: I want to be Treasury Secretary!]
• Close the "carried interest loophole" Sec 10201
• $80B for IRS Sec 10301


• 3 types of drug price controls
• Prices set by HHS for selected Medicare drugs Sec 1191 [I think the Senate typist meant Sec 11091]
• Inflation rate cap for Part B drugs (obtained at hospitals and clinics rather than pharmacies) Sec 11101
• Inflation rate cap for Part D drugs (obtained at pharmacies) Sec 11102
• Medicare Part D (i.e., drug plans for seniors) insurance-benefit floors and reduced subsidy rates Secs 11201-11202, 11401
• Both benefit floors and subsidy-rate cuts will increase Medicare Part D premiums.  The net result could be more subsidy $ and more drug-plan expenses for most seniors.
• One insurance-benefit floor (Sec 11201) requires that enrollees have 100% of their pharmacy bill covered after they have spent $2k for the year.  Another (Sec 11202) does the same on a monthly basis (roughly $150 per month).
• A third insurance-benefit floor is for vaccines Sec 11401
• Zero is a dangerous number for a price!
• The 80% Medicare subsidy associated with these transactions is cut sharply.  This by itself would reduce distortions in the program.
• Remember that Part D premiums are already about 75% subsidized.  At that rate (which will increase -- see below), the government expense for Part D could well increase.  
• Increases in subsidies for Medicare Part D premiums Sec 11404
• Specifically, expanding eligibility for "low-income" premium subsidies
• Budget gimmick courtesy of Alex Azar: repeal rebate rule Sec 11301
• This rule would have prevented drug manufacturers from competing for Medicare Part D business by offering rebates, thereby sharply increasing Medicare Part D premiums and the government's Part D expenses.
• On paper, repealing this rule would reduce the federal deficit.  However, many expect that the rule would be struck down in court (regardless of whether the IRA repeals it), especially now that agencies have less latitude in reinterpreting statutes.  Hence this savings is a budget gimmick.
• I explain in Chapter 10 of yourehiredtrump.com how HHS Secretary Azar concocted this rule.  We warned him and Trump that Democrats would, via a budget gimmick like this, use the rule to "fund" their big-government programs.
• Extend the "temporary" Obamacare expansions that were put in place during the pandemic Sec 12001


• Clean energy tax credits Secs 13101-13802
• 291 pages of the Green Dream!
• Interestingly, Sec 13105 increases credit for nuclear power plants, but just those already built.  Intended to slow down nuke-plant closures?
• Otherwise "clean" refers to the various technologies that are in vogue, including bio fuels and battery manufacturing
• Get a tax credit for purchasing a used Electric Vehicle Sec 13402
• $4K or %30 of sale price
• But only for households with AGI less than $150K and EVs selling for less than $25K
• Must go through a car dealer
• Limit of one credit per vehicle lifetime
• Limit of one credit per taxpayer per 3 years
• As a result, the federal government will be granted EV credits when:
• EVs are produced,
• EVs are sold new, and
• EVs are sold used
• $20B for agricultural conservation programs Secs 21001 and 21002
• Appropriations for clean energy programs ($80-85B total)
• Another 100+ pages of the Green Dream, not to be confused with clean energy tax credits (291pp).
• $2B subsidies for "Electric loans for renewable energy" Sec 22001
• Biofuel subsidies Sec 22003
• $10B for rural electric cooperatives Secs 22004 and 22005
• $15B for Greenhouse Gas Reduction Fund Sec 60103
• $1B for HUD clean energy projects Sec 30002
• $3B for NOAA climate resilience projects Secs 40001-40007
• $10B to subsidize switching from natural gas appliances to electric Secs 50111-50123
• $1B to subsidize zero building energy code adoption Sec 50131
• $14B for DOE loans and grants Secs 50141-50145
• $3B for electricity transmission subsidies Secs 50151-50153
• $6B for the Office of Clean Energy Demonstrations Sec 50161
• $2B various other DOE Secs 50171-50173
• $1B for clean heavy-duty vehicles Sec 60101
• $3B for clean energy programs for ports Sec 60102
• $6B for various pollution-reduction programs Secs 60113-60116
• $3B for Environmental and Climate Justice Grants Sec 60201
• $5.5B for various other clean energy/environment Secs 60502-60506
• $3B for USPS clean fleet Sec 70002
• Taxing fossil fuels
• Increase royalty rate on offshore oil and gas by about 4 percentage points Sec 50261
• Increase royalty rate on onshore oil and gas by about 4 percentage points Sec 50262
• Both royalty rates are expanded to flared gas Sec 50263
• Methane Emissions Charge Sec 60113
• Permanent extension of tax on coal Sec 13901
• Roughly $1 per ton.  For context, coal prices were sometimes below $50/ton before the pandemic

Smaller items

• Eliminating cost sharing for vaccines in Medicaid and CHIP Sec 11405
• Changes to Medicare payments for biosimilars (Secs 11402 and 11403)
• Reinstate superfund Sec 13601
• Research credit for small businesses Sec 13902
• $5B for forestry subsidies Secs 23001-23005
• $0.5B to further carry out the 1950 Defense Production Act Sec 30001
• $1B for National Park Service and Bureau of Land Management Secs 50221-50223
• $0.6B various water Secs 50231-50241
• Regulation of offshore wind leasing Sec 50251
• Some kind of extension of offshore leasing program Sec 50264
• Limit encroachment of offshore windmills onto areas under lease for offshore drilling Sec 50265
• Various other DOE and DOI Secs 50271-50303
• Various other EPA programs (less than $1B) Secs 60104-60112
• Small amounts for Council on Environmental Quality Secs 60401-60402
• $4B for Endangered species programs Secs 60301-60302
• $2B for Neighborhood Access and Equity Grant Program Sec 60501
• Various other Sec 70001, 70003-80004

3rd release of Build Back Better: 7 million less employment

Last night a third release of BBB was shown to the public.  Both in pages and overall economics, it is in between the 1st and 2nd editions.

First-release items resurrected yesterday

• Repeal of Trump's terrible rebate rule (Section 139301).  It is likely illegal so repealing it does nothing but CBO probably will credit Dems with cutting about spending by about $200B with this provision.
• Drug "Price Negotiation Program" (Section 139001).
• Rx "Drug Inflation Rebates" (Section 139101).
• Favors to labor unions such as allowing union dues to be tax deductible (Section 138514) and giving the National Labor Relations Board new authority to levy hefty penalties on employers (Section 21006, which was also in previous releases).  
• E-cigarette and tobacco taxes (Section 138520).
• Federal family leave (Section 130001).

Important items maintained from the 2nd release

• Affordable housing (still $150B across various sections such as 40001ff).
• Expanded ACA premium tax credits (Sections 137301ff).
• New federal childcare (Section 23001) and preK programs (Section 23002), including massive hidden taxes on marriage.
• Child Tax Credit expansion (Section 137101ff).
• Partial launch of the Green New Deal (various sections such as 136001ff).
• Medicaid expansions (various sections).
• Privacy regulation (Section 31501).

New item: Increase annual cap for deduction of State and Local Taxes (SALT) from $10K to $72.5K (Section 137601).  About 8 percent of filers are affected by this.  I guess that about 6 percent of filers are workers who would go from a binding cap to a nonbinding cap.   For such people, IF the federal and SALT rates remain constant, the overall marginal tax rate on labor income falls.  This is my assumption for the table below, but I note that lifting the SALT cap encourages states to increase SALT rates (for everyone, not just the 8 percent) and discourages states from cutting rates.  Moreover, the additional SALT revenues from those rate changes may well be spent on programs that pay people not to work.

This table shows 14 BBB provisions with significant hidden effects on incentives to work.  (My earlier post provides more detail on those incentives).  The final column of the table shows an estimated impact of these hidden incentives on FTE employment, allocated among the 14 provisions.  This does not include any employment effects of funding BBB with income taxes on households (Sections 138201ff) and businesses (Sections 138101ff).

White House Attitudes toward "Screening Agencies" (looking at you FDA)

The Food and Drug Administration (FDA) has been part of many conversations in 2020.  To the great frustration of tens of millions, it has to approve COVID tests and arguably applies the wrong (from economic and health perspectives) standards in doing so.  It is also tasked with approving COVID treatments and vaccines.  Vaccine approvals came much quicker than experts expected, although IMO not quickly enough.

With few exceptions, economists have “long been aware that the agency causes unnecessary deaths and suffering by” its “inexcusable delays in approval” (see esp. Klein and Tabarrok's collection).  Judging from 74 years of Economic Reports of the President, the White House has not traditionally given this issue much attention.  When the FDA does appear, the sentiment generally confirms that the approval delays are harmful and need reform.

Alan Greenspan's CEA was the first in 1975, when it included a paragraph about Sam Peltzman's famous study finding that the 1962 amendments were harming consumers.  A sentence of the 1977 ERP lamented further FDA bans.

Ronald Reagan's ERPs gave the issue more attention, and more bluntly.  "Screening agencies can dramatically affect the rate of innovation. A case in point is the Food and Drug Administration" it said in 1989, as part of a three-page section on the subject (pp. 218-20).  A sentence in the 1987 ERP noted how badly FDA regulation was failing cost-benefit analysis: "the average cost per life saved varies across regulations from as little as $100,000 for NHTSA's 1967 steering column protection rule to $132 million for the Food and Drug Administration's 1979 ban on diethylstilbestrol (DES) in cattle feed." (p. 183)

Both Presidents Bush included a sentence on the issue (1993 and 2001).  Consumer harms from FDA regulation was certainly top of mind for Mark McClellan, who was a member of the CEA at the beginning of the GW Bush administration until in late 2002 when he went on to head FDA.

Janet Yellen's CEA had a full chapter about regulation (Chapter 5 of 1998 ERP), especially climate change, which generally expressed the view that more federal regulation is needed.  Interestingly, five pages of that chapter express some sympathy for the view that FDA has overregulated.  It notes (p. 188) that FDA has been biased toward stopping "unsafe drugs that may cause injury or death" at the expense of "preventing sick people from getting more effective treatment."  The bias is especially questionable, it says, in the context of a life-threatening illness.

The historical context may be especially relevant to understanding ERP 1998: Yellen's boss President Clinton was dealing with a Republican Congress led by Newt Gingrich.  Both Republicans and AIDS advocates wanted to reduce FDA approval delays (the FDA review times for the AIDS treatments were still much longer than those under 2020's Operation WARP Speed), sponsoring the 1997 FDA Modernization Act that President Clinton signed.  The FDA would ultimately, as Scott Gottlieb put it, “steadily disregard[] many of the law’s provisions.”

I see only two exceptions in the 74 ERPs.  President Kennedy signed the Drug Efficacy Amendment that Peltman would later find to be so harmful.  The 1963 ERP characterizes the amendment as "protecting public health."

The second exception is the Obama Administration.  The 2012 ERP cites the FDA as a prototype of "a Smart Approach to Regulations."

By comparison to all previous administrations, President Trump's White House was arguably obsessed with FDA harms to medical innovation from the very beginning.  FDA critic Scott Gottlieb was immediately appointed to head the FDA.  The 2018 ERP had a full chapter about the health sector, half of which was about "Improving People’s Health through More Access to Medical Innovations" and "Encouraging Innovation, and Making It Affordable."  The 2019 ERP (p. 18) cites FDA deregulation as one of the highlights of the year, and devotes twelve pages to how FDA reforms increased competition and reduced prescription drug prices.  The same report also looks at the possible negative innovation effects of a proposed Federal ban on for-profit healthcare, which even Vox acknowledged as "a plausible downside."

The 2020 ERP updated the status of the FDA reforms in its chapter about deregulation, its chapter about healthcare, and its chapter about competition policy.  It also cited the new Right to Try law, and regulatory barriers to treating chronic kidney disease.  FDA barriers were part of the discussion we had with President Trump when he was signing the 2020 ERP (see the photo below).  He clearly indicated to us that his experiences with FDA so far would be helping him remove still more barriers.  (That promise was kept within weeks when Operation WARP Speed launched).  

Citing a pandemic vaccine study finished in September 2019 (sic), page 193 of the 2020 ERP estimated that "the cost of delay in vaccine availability in the case of a pandemic is $41 billion per week."  As White House senior staffer Joseph Grogan put it, the September CEA report was “was part of the intellectual foundation to the modernizing pandemic vaccine production executive order that [the White House] did along with Tony Fauci and NIH.”

[For context versus the current pandemic, note that the 2020 ERP went to the printer in early January 2020 and the writing stopped in early December 2019.  In late March 2020, knowing about the COVID-19 pandemic, I estimated that vaccine delay would cost just the U.S. as much as $136 billion per week].

How Economics Helped End a Pandemic

 

Last March Dr. Fauci explained to a Senate committee that “a vaccine … will take at least a year or year and a half” until it is administered to the general public. In his next testimony, he added, “I don’t give advice about economic things.”  If Dr. Fauci had paid more attention to economics, at least what had reached his own inbox in the prior year via the White House Staff Secretary, he would have understood how different vaccine development during a pandemic would be, and should be, from that in normal times.

 

Dr. Fauci was refering to the lengthy process that the Food and Drug Administration (FDA) has for approving drugs, vaccines, and medical devices for use in the United States.  Long ago a wide range of economists had concluded that the FDA process was too cumbersome.  In 1973, the University of Chicago’s Sam Peltzman concluded that the FDA cure was worse than the disease, “consumer losses from purchases of ineffective drugs or hastily-marketed unsafe drugs appear to have been trivial compared to their gains from innovation” delayed or forgone entirely due to the costs of getting FDA approval.

 

M.I.T. professor Peter Temin said that there should be “less [FDA] surveillance at the premarket level” because the approval delays were too long.  Even 25 years ago, as Emory professor Paul Rubin put it, scholars had “long been aware that the agency causes unnecessary deaths and suffering by” its “inexcusable delays in approval.”

 

During those 25 years, Congress took some steps to reduce approval delays, especially in 1997.  However, the FDA “steadily disregarded many of the law’s provisions.”  The tide started to change in the Trump administration, where there were at least some staff who suspected that government regulation is part of the problem rather than the solution.

 

Early battles centered on President Trump’s campaign promise to lower prescription-drug prices.  He appointed FDA commissioner Scott Gottlieb, who had been critical of FDA delays.  Trump’s economic team (where I participated as part of the Council of Economic Advisers or “CEA”) predicted that deregulation would reduce drug prices because reduced FDA barriers would result in more new drugs and more manufacturers of existing drugs competing for consumer dollars.  On the other side was Health and Human Services (HHS) Secretary Alex M. Azar II, who proposed a “drug-pricing blueprint” that would add regulations on everything from television advertisements to business-to-business price controls.

 

As Gottlieb’s boss, Secretary Azar had an advantage in that he could exclude Dr. Gottlieb from Oval Office meetings and potentially prevent the president from hearing how well the deregulatory approach was going.  But Larry Kudlow and others invited Dr. Gottlieb anyway and, more important, the data were on Dr. Gottlieb’s side.

 

CEA got the first progress report on January 10, 2019, with the confidential advance release of the Consumer Price Index (CPI) report for December 2018.  It showed that 2018 was the first year since 1972 that retail prescription-drug prices actually fell (even while consumer prices generally were increasing).  We composed a message to be posted on the President’s twitter account the next day.  But this message had to be approved by HHS, which was loathe to release something so contrary to its perceived “need for regulatory action” in the face of [purported] “prices of existing drugs [that] have been rising in the United States much more rapidly than warranted by inflation or costs.”

 

I convinced the President’s communications team that the CPI is reliable and is telling us something important.  The President would brag about the result in everything from impromptu press briefings to his State of the Union address.  Being results-oriented rather than ideological, he was noticing what administrative manuevers could remove FDA barriers to consumer welfare.

 

Although COVID-19 would not arrive in the U.S. for two more years, the National Security Council’s biodefense team asked the CEA to look at the economics of vaccine innovation during pandemics.  CEA concluded that “improving the speed of vaccine production is more important for decreasing the number of infections than improving vaccine efficacy” and emphasized the need for large-scale manufacturing and the possible advantages of public-private partnerships.

 

The CEA vaccine report prompted an executive order, also before the pandemic, noting that “viruses emerge from animals … that can spread efficiently and have sustained transmission among humans.”  President Trump concluded that “vaccination is the most effective defense.”  As two of Trump former senior staff members put it, “when COVID-19 emerged, the White House was ready and expeditiously applied the report's deregulatory and fiscal lessons to streamline FDA approval for vaccines and their parallel manufacturing on a large scale.” 

 

I was in the Oval Office with the president and his economic team in February (when COVID-19 cases were beginning to spread).  His staff was worried that the FDA would not be interested in removing any more approval barriers.  But the President was confident, telling us that “I’ve done it before and will do it again … bring the FDA management in here.”  President Trump initiated his Operation Warp speed, led by HHS, to give many private companies incentives for “speed and scale” of vaccine production and to give all companies the opportunity for streamlined FDA approval.

 

COVID-19 vaccines are now being administered to the general public at least six months earlier than Dr. Fauci expected.  The economists were correct that accelerating medical innovation is both possible and worth trillions of dollars to Americans.

 

 

Show us the fevers

By all accounts, hundreds of millions of us are confined to home despite being perfectly healthy.  The purpose of all of this, we're told, is to make sure that we do not bump into people infected with the coronavirus.

The wise people forcing us to do so owe us some evidence that in fact the virus is out there in sufficient quantities to merit draconian measures.  They point us to deaths in New York hospitals, and growing numbers of positive test results.  But those presumably were infections that occurred weeks ago (perhaps also some false positives).

Smart thermometers suggest that hardly anyone has had a fever for a couple of weeks now.  Perhaps this data is faulty or easily misinterpreted, but the wise people owe at least an explanation to the hundreds of millions of people paying the costs of their policies.

The time to be at home is when there is lots of virus outside.  That does not appear to be now.

30+ million out of a job

A one-size-fits-all policy, even at the state level, has been a mistake from the beginning.  Instead policy should be favoring decentralized mechanisms over direct control and ensuring that the chosen regulations deliver more net benefits than less stringent alternatives.  It is too bad that governments are causing so much harm at this critical moment by ignoring these longstanding principles of government regulation.

Expressed at an annual rate, the shutdown is already costing $7 trillion, or about $15,000 per household per quarter.  Employment had already fallen 28 million by April 1 and continues to fall as the shutdown continues.  Not only is the shutdown costly, but it is a cost-ineffective way of reducing the health harms from the virus.  My recommendation is to achieve close to, but somewhat less, of the mortality reduction at dramatically less cost to hundreds of millions of workers, consumers, and business owners.

Here's why I think at least 30 million are out of work as of today.  First, that's where I expected we would be headed based on the fact that workdays as we know them have been eliminated.  Second, as of the week of March 29-April 4 (hereafter "April 1"), the employment rate of persons aged 18-64 fell from 0.738 to 0.607.  Assuming conservatively that the same percentage decline (17.8%) also applied to persons 16, 17, or 65+ years old, the decline is 28 million people as of April 1.

There is no reason to believe that the decline (an average of 1.3 percent per day for two weeks) was finished by April 1.  The stay at home order for Texas and Maine was not until April 2.  FL, GA, MS: April 3.  AL: April 4.  MO: April 6.  SC: April 7.  Even if the decline were only 0.2 percent per day over the two weeks beginning April 5, that would put the cumulative employment decline past 30 million.

Shutdown reduces the flow of GDP by 28 percent

New data from Alexander Bick and Adam Blandin suggest that the flow of real GDP is 28 percent less than it would be under normal circumstances.  Using two entirely different methods, I previously forecasted 25 percent and 26 percent.  Below are the details of my calculations from Bick and Blandin.

Bick and Blandin (2020) find that working hours per working age adult circa April 1 declined 27 percent from February.  Moreover, among those working in February 2020, between 59 and 61 percent are now absent from their workplaces either due to not working or working at home.  If half of the capital in those workplaces is idle and not replaced by utilizing capital located in home offices, then capital utilization has fallen by 30 percent and GDP by 28 percent.

The GDP calculation assumes production-function exponents of 0.3 and 0.7, respectively.

This brings my estimate of the welfare cost of shutdown, relative to a normally functioning economy, of $7.1 trillion per year or $233 per household per workday.  For this purpose I use the average GDP estimate from the "input method" cited above and the output method I used earlier.

What's Wrong with this Reasoning?

1. FACT: the population density of NYC is 27K per square mile
2. FACT: the population density of Indianapolis is 2K per square mile
3. FACT: COVID-19 was able to be introduced and spread in a city with only 2K susceptible people per square mile (Indianapolis is such a city).

Conclusion: COVID-19 will continue to spread in NYC until either (i) the number of susceptible people falls to 2K per square mile or (ii) a vaccine.  i.e., until more than 90% of NYC has contracted and recovered from COVID-19.  [This conclusion says nothing about time frame; i.e., it could be years]

Does the conclusion follow from the three facts?

Is a Shutdown an Overreaction?

60,000 - 80,000 Americans died from the 2017-18 flu, without exceeding the capacity of ICU beds.  This flu was experienced around the world.  Not a single country found it worth shutting down their economies in that situation.

In 2020 the forecast is that about 90,000 Americans will die from COVID-19, including some deaths due to insufficient ICU capacity.  Shutting down "nonessential" businesses is now the norm.

This forecast comes from the Institute for Health Metrics and Evaluation IMHE at the University of Washington.  Unlike me, IMHE are not amateurs with contagious disease time series.  With "about 500 statisticians, computer scientists, and epidemiologists on staff, IHME is a data-crunching powerhouse. Every year it releases the Global Burden of Disease study...."

At what point is a reasonable person allowed to ask why the economic policies of 2017-18 and 2020 are so disproportionate?

Some people will say that the 90,000 would have been much higher without shutting down the economy.  At what point can a reasonable person follow up with "Why were ALL of the 2020 costs, which were in the $ trillions, taken on the economic (and civil liberty) side of the ledger, and essentially NONE on the mortality side?"

The Economic Cost of Shutting Down "Non-essential" Businesses

THE ESTIMATES BELOW WERE MADE CIRCA MARCH 20, 2020.  Updated estimates are available here, complete with additional cost categories and references and based on important new data.

----------------------
We are currently fighting a war against the COVID-19 virus.  The war presents an obvious and massive tradeoff between “guns” – activities whose primary purpose is war production – and “butter,” which refers to the normal activities of households and businesses.  Without any improvement in our techniques for fighting the war, the sacrifices by households and businesses will be staggering and historically unprecedented.

This document enumerates and quantifies the sacrifices using two novel methods.  The results suggest that negative 50 percent is an optimistic projection for the annualized growth rate of U.S. GDP in 2020 Q2 if the nonessential businesses were not allowed to operate during that quarter.  GDP losses, while massive, nonetheless understate the true costs of the sacrifices that households and businesses are making, which I estimate to total almost $10,000 per household per quarter.  This is why better techniques for fighting the war are incredibly valuable.

Government officials around the world have ordered businesses shut and families to stay in their homes except for essential activities.  My purpose here is to enumerate and quantify the real economic costs of fighting the war in this way.  This document estimates the opportunity costs of lockdown relative to a normally functioning economy, which is the relevant comparison for the purposes of policy decisions such as medical innovation (or, possibly, a statistical sampling effort) that could end the lockdown earlier. 

To be clear, the cost-enumeration exercise can be consistent with a conclusion that the war is worth fighting – that depends on quantifying the benefits, which are surely significant given the value that people place on health and longevity.  Although this document does not address the question of whether a lockdown is better than no policy response, it offers some of the essential ingredients for such an analysis.  No policy response would itself involve economic contraction during the period of time in which no treatment or vaccine is available.

The lockdown method of fighting the war on the virus directly affects how people allocate their time.  That includes what they do, where they do it, and with whom.  Because normal time allocation includes elements of saving and capital accumulation, such as learning skills, the economic effects of the war are felt into the future as stocks of physical and human capital are reduced.  For enumeration purposes, I distinguish market production activities from all other activities, especially because market production is counted in conventionally-measured GDP whereas leisure activities are not.  Although I refer to the non-market activities as “leisure,” they include religious gatherings and forms of effort such as student effort in school and effort put toward housework.  Both market production and leisure activities are significantly affected by lockdown.

A.  Net Costs Associated with Market Production

Lockdown reduces the amount and effectiveness with which people work.  The effects of this can be measured on either the production side of the national accounts, as the value of goods and services not produced, or the income side as reductions in total incomes.  Either approach yields the same result, up to measurement error.[1]  However, the incidence – the distribution of impact across industries, occupations, and income groups – is different from the production and income perspectives.

Momentarily putting aside costs associated with leisure activities, the lockdown can be analogized with a change in the number of holidays and weekends (“nonwork days”).  A well-studied, albeit obscure, element of national income accounting is the adjustment for the fact that the number of nonwork days normally varies from year to year.[2]  A normal year has about 251 working days and about 114 nonworking days.[3]  The national accountants have found that adding a nonwork day to the year reduces the year’s real GDP by about 0.1 percent and have been applying this estimate to both the production and real income accounts.[4]  Adding a nonwork day to a quarter would therefore reduce the quarter’s unadjusted real GDP by about 0.4 percent.

Extrapolating from this finding, removing all of the working days from a quarter is 62 or 63 times this, or 25 percent.[5]  In other words, if seasonally-adjusted GDP 2020-Q2 would have been $5.5 trillion at a quarterly rate (see Table 1), then changing all of that quarter’s working days to the functional equivalent of a weekend or holiday would reduce the quarter’s GDP to $4.2 trillion.[6]  Applying the same approach to 2020-Q1, with a lockdown occurring for one-eighth of the quarter, 2020-Q1 real GDP (in 2020-Q2 prices) would be $5.4 trillion.  The quarter-over-quarter growth rate of seasonally-adjusted real GDP would, expressed at annual rates, therefore be -10 percent in Q1 and -63 percent in Q2.[7]  The Q2 growth rate would be less negative to the extent that a lockdown was in place for only part of the quarter or for part of the country.

[Table 1 contains POINT ESTIMATES, not worst-case scenarios.  If these costs are to be netted against health benefits, then those benefits should be POINT ESTIMATES too.  Worst-case scenario health benefits should be compared with worst-case scenario costs, which far exceed what I provided].

Lockdown is not exactly the functional equivalent of changing workdays to weekends or holidays.  On one hand, a segment of the workforce will engage in telework during lockdown that they would not perform on a normal weekend or holiday.  Other segments or regions will be exempt from shutdown.  This by itself suggests that the $4.2 trillion estimate is too pessimistic.  On the other hand, much of the normal weekend activity such as restaurants, entertainment, and religious activities is not occurring during lockdown.  This by itself suggests that the $4.2 trillion estimate is too optimistic.

A second method uses the production side alone.  Labor is reduced by the number of “non-essential” employees, which has been about 30 percent during Federal shutdowns.[8]  In some of the industries, real capital will continue to be used, albeit by fewer employees.  Other industries will not use their capital, although it may be repurposed, such as a hotel being used as a hospital ward.  To be conservative, I assume that few industries increase their labor-capital ratio.[9]  The reduction in capital input is therefore somewhere between 0 and 30 percent; I assume 15 percent.  History has repeatedly shown that labor is more important in the production process than capital, so that by the second method real GDP is reduced 26 percent.[10]

The estimates above assume no black markets.  But, as seen with border patrol and the war on drugs, any government regulation attempting to block valuable gains from trade will result in black market activity.  Businesses will also work the gray area, lobbying and distorting their operations to have more activities declared “essential.”

Black-market activity is far less productive than legitimate activity, which is why it does not come close to replacing the “non-essential” sales that were banned.  But it still has value, which is why the best welfare effects of shutdown may be less pessimistic than analysis assuming zero black market.[11]  I assume that black markets replace 25 percent of the gains from trade, based on studies of illegal drugs.[12]  However, value generated in black markets is typically not measured as part of GDP.  Indeed, black markets compete with legitimate markets for the factors of production and by this channel would reduce measured real GDP even more than would occur without black markets (Fleming, Roman and Farrell 2000).

Table 1 shows only averages, but the distribution of costs is unequal.  Revealed preference -- that fact that the demand for social insurance increases in these situations -- suggests that the inequality itself is a cost large enough that people are willing to tolerate even further increases in the average costs (i.e., further decreases in GDP) in order to mitigate the costs for those disproportionately affected.

Although the national income accounts were designed on the basis of the principles of welfare economics, GDP growth is not exactly a benefit and GDP reduction is not exactly a welfare cost because valuable activities and assets such as home production, elements of human capital accumulation, and environmental quality are not yet recognized in the official national accounts (Hartwick 1990, Nordhaus and Kokkelenberg 1999, Jorgenson 2010).  However, as discussed further below, the GDP losses cited above prove to reasonably approximate more comprehensive welfare losses.

B.  Net Costs Associated with Nonmarket Activities

The nonmarket/home sector is affected by lockdown through two basic channels, as shown in Table 1.  The first channel is discussed above: the nonmarket sector has additional labor that has been forced out of the market sector.  The second channel is that the nonmarket sector becomes less productive, both for the nonmarket time that normally exists as well as the additional nonmarket time coming from the market sector, because even in their nonwork activities people are restricted in terms of where they go and how they associate with others.  The percentage change in the value created in the nonmarket sector combines the two channels and is approximately the sum of the (positive) percentage change in labor input and the (negative) percentage change of nonmarket productivity.[13]

An important example of the second channel is the time allocation of children and young adults who would normally be enrolled in school and now spend their time at home.  Their learning from normal face-to-face interactions with teachers and fellow students is not fully reflected in GDP, but is nonetheless valuable.  In other cases, as with religious gatherings, entertainment, and tourism, lockdowns reduce the value of these activities by limiting how people can congregate and the market inputs that can be used as part of the leisure activity.

Because the national accounts are based on the principles of welfare economics, GDP would ideally capture value created or destroyed in both the market and nonmarket sectors.  Measurement challenges have so far limited the scope of conventional GDP measures to the market sector.  Conventional GDP measures therefore miss the value of additional nonmarket time added by the shutdown (the first channel) as well as the reduced productivity of nonmarket time (the second channel).  This section provides estimates of the two, which can be added to the GDP losses from Section I.B to arrive at a welfare loss of shutdown as compared to normal economic activity.

To estimate the nonmarket value of added labor, I use the short run of the neoclassical growth model, which is essentially a labor supply and demand framework.  The average nonmarket value of time is below the after-tax real wage that would normally prevail, but above the marginal value of time with a shutdown, which I estimate to be 49 percent of the former.[14]   With a 48 percent marginal tax rate (inclusive of implicit taxes on labor income), the total nonmarket value of the extra time is about $7 billion per day (see Table 1), or about 30 percent of the reduction in real GDP.  Simply put, about two-thirds of the $22 billion daily GDP loss is a welfare loss, even without considering any productivity change in the nonmarket sector.

Full-time schooling, where there are normally about 73 million children and young adults enrolled, is the part of the non-market sector’s productivity loss that is easiest to quantify.  Their time and efforts, which are known as “foregone earnings” and not counted in conventional GDP measures, are combined with direct schooling costs such as the education industry’s payroll and capital expenses because the students, their parents, or their community value the results of schooling.  The direct costs were $370 billion in 2018.  Various studies, such as Breton’s (2013) estimate that foregone earnings are about 102 percent of the direct costs, which would be $377 billion in 2018, or about $4.5 per hour that the average student was in school.  Assuming that some schooling will still occur during lockdown, I take the loss of student output attributable to their time and effort to be half, or about $2.25 per hour that they would have been in school.

Learning does not stop at graduation.  Post-graduation workers learn on the job, which shifts the composition of their compensation toward skill acquisition and away from the cash and other fringe benefits that are part of conventionally measured GDP (Rosen 1972).  Although the market sector may be the physical location of this learning, I count the foregone earnings as “nonmarket” because it is usually unmeasured.  I estimate the value of foregone earnings using the cross-section age-earnings profile and the average of two estimates of the age-training profile (Mulligan 1998).  During a shutdown, this learning does not occur for 30 percent of the workforce, although (as with market production) I assume that about one-third of its value is replaced with nonmarket activity.  The net opportunity cost associated with on-the-job training (OJT) is therefore about $107 billion at an annual rate, as shown in Table 1.

The normal population has even more adults not in the labor force than full-time students, not to mention all of the time that workers normally spend outside of work.  If a shutdown also reduced the hourly value of their time by $2.25 for 2000 hours per year for those out of the labor force and for 500 hours per year for those who work, that would be a loss of $767 billion at an annual rate.

C.  The Incidence of the Net Costs

The massive costs of shutting down “non-essential” activities are not shared equally among Americans.  Some workers are still able to draw a normal salary even while their industry is inactive.  Others work in industries such as parts of healthcare that are booming as a result of the pandemic.  Because the aggregate reduction in the value of what is produced must equal the aggregate reduction in total income, the costs of lockdown will fall disproportionately on the remainder of the population that are not in these circumstances.

Public programs are being created and expanded with the intention of helping some of those who are disproportionately bearing the costs.  Redistribution policy may help distribute the aggregate costs more fairly, but in no way can it reduce the aggregate cost.  Even while these policies assist those who are not working because of the pandemic, they do not replace the work and production that the workers would have been doing.  Instead, redistribution itself has its own aggregate costs, for example, by reducing incentives to work and incentives of workers to shift into industries that need them most (Mulligan 2012).

D.  Bibliography

Barro, Robert J., José F. Ursúa, and Joanna Weng. "The Coronavirus and the Great Influenza Pandemic: Lessons from the “Spanish Flu” for the Coronavirus’s Potential Effects on Mortality and Economic Activity." NBER working paper, no. 26866 (March 2020).

Breton, Theodore R. "Were Mankiw, Romer, and Weil right? A reconciliation of the micro and macro effects of schooling on income." Macroeconomic Dynamics 17 (2013): 1023–1054.

Christian, Michael S., and others. Human capital accounting in the United States: 1994 to 2006. BEA, 2010.

Council of Economic Advisers. Mitigating the Impact of Pandemic Influenza through Vaccine Innovation. Executive Office of the President, September 2019.

DiMasi, Joseph A., Henry G. Grabowski, and Ronald W. Hansen. "Innovation in the pharmaceutical industry: new estimates of R&D costs." Journal of health economics 47 (2016): 20–33.

Eichenbaum, Martin S., Sergio Rebelo, and Mathias Trabandt. "The Macroeconomics of Epidemics." googlegroups.com. March 23, 2020. https://fb8280a8-a-62cb3a1a-s-sites.googlegroups.com/site/mathiastrabandt/home/downloads/EichenbaumRebeloTrabandt_EpidemicsMacro.pdf?attachauth=ANoY7coRODwA_z1gJoSLHsTEXF0IQcWOQbFP5bfX9cHSypuO2NuwJPyq7T2A4p2wdppOl0jWVgmAzN4-16-irT7vZqkwvBs8_8PNb3hs0ZJmZtr.

European Central Bank. "The impact of the number of working days on euro area GDP in 2004." Monthly Bulletin, June 2004: 51-63.

Fleming, Matthew H., John Roman, and Graham Farrell. "The shadow economy." Journal of International Affairs, 2000: 387–409.

Hartwick, John M. "Natural resources, national accounting and economic depreciation." Journal of Public Economics 43 (1990): 291–304.

Jaffe, Sonia, Robert Minton, Casey B. Mulligan, and Kevin M. Murphy. Chicago Price Theory. Princeton University Press (ChicagoPriceTheory.com), 2019.

Jorgenson, Dale W. "A new architecture for the US national accounts." Review of Income and Wealth 55 (2009): 1–42.

Jorgenson, Dale W. "Human capital and the national accounts." Survey of Current Business 90 (2010): 54–56.

Katz, Eric. "Agencies Paid Federal Employees $3.7 Billion Not to Work During Recent Shutdowns." govexec.com. September 17, 2019. https://www.govexec.com/pay-benefits/2019/09/agencies-paid-federal-employees-37-billion-not-work-during-recent-shutdowns/159936/.

Mulligan, Casey B. The Redistribution Recession. New York: Oxford University Press (redistributionrecession.com), 2012.

Nordhaus, William D., and Edward C. Kokkelenberg. Nature’s Numbers. National Academy Press Washington, DC, 1999.

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[1] Adding the opportunity costs of production to the reductions in incomes would be double counting.

[2] Leap years also create variation in the total number of days.

[3] A year has 52 weeks plus an additional one or two days, for a total of between 104 and 106 weekend days.  There are ten Federal holidays.

[4] European Central Bank (2004).  Note that 0.1 percent is much less than 1/251; the estimate implies that the average nonworking day has two-thirds the GDP of a working day.

[5] The exact number of working days that 2020 Q2 would have normally had is irrelevant for this calculation because the national accountants adjust for its deviation from 251/4.

[6] This is the sum of Table 1’s first row with its addendum row.

[7] This assumes a baseline annual growth rate of 2 percent and applies it one for one.  The formula for the annualized growth rate in Q2 is . 

[8] Katz (2019).  The non-essential share has not yet been measured for government-mandated private-sector shutdowns, which is why the holiday-weekend method should receive more weight.  Given that I obtain almost the same result for the two methods, their weighting is not critical to the analysis.

[9] Using their labor is different than keeping the labor on the payroll.  An unused worker still on the payroll does not contribute to current output.

[10] Barro, Ursúa and Weng (2020) estimate that, if the COVID-19 epidemic were a scaled version of the 1918 Spanish Flu, real GDP would fall less than eight percent.  The authors note that the current pandemic is unique in that “countries have been pursuing a policy of lowering real GDP,” which are the lockdowns that are the subject of this document.  Looking at the current pandemic, Eichenbaum, Rebelo, and Trabandt (2020) estimate that aggregate consumption and GDP (their model has no investment) will fall up to 20 percent.

[11] But government regulators can hardly defend their shutdown regulations on the grounds that they will not be obeyed!  Moreover, black markets add another social cost by eroding respect for law and order.

[12] The war on drugs increases the retail price (and unit cost to suppliers) by a roughly a factor of four and reduces the quantity consumed by a factor of two (Jaffe, et al. 2019, Figure 12-1).  Illegal drug sellers have had many years to accumulate organizational and other capital that lockdown violators did not.  On the other side, drug war enforcers have had many years that lockdown enforcers have not.

[13] The approximation is exact when the changes are measured in logarithms rather than percentages.

[14] This assumes a wage elasticity of labor supply of 1/2 (0.49 = 0.7²).