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US Supreme Court

This morning, the Supreme Court upheld Affordable Care Act’s individual mandate. While the biggest surprise was Chief Justice John Roberts’s siding with the majority in the case, a close second was how the majority interpreted the constitutionality of the of the mandate. They said the mandate is a tax, not an extension of the Commerce Clause.

Confused as to what exactly that means? I asked Thomas Brennan, an associate professor of law at Northwestern with a joint appointment in finance at the Kellogg School, to clarify things.

Brennan said the main question before the Supreme Court was which part of the Constitution allowed Congress to penalize people who don’t get health insurance. There were two main possibilities, the Commerce Clause, which gives Congress the right to regulate commerce between states, and the 16th Amendment, which grants Congress the power to levy taxes without doling it out to the states or basing it on Census results.

That the taxation argument won caught people by surprise. The Commerce Clause has been why many laws enacted by Congress have passed legal muster, including the Civil Rights Act of 1964 and various parts of the New Deal. It was also seen as the part of the Constitution on which the mandate would be either upheld or struck down.

The taxation issue “was not briefed or argued in nearly as much detail as the Commerce Clause issue, and I don’t think that most people thought it would carry the day for the new law,” Brennan said.

Part of that surprise stems from the Commerce Clause’s wide applicability. “Over the years, the nature of what exactly constitutes ‘Commerce’ for this purpose has been broadened considerably,” Brennan said.

In the Affordable Care Act case, “One argument was that the penalty provision now came within its scope as well. Another argument was that this was far beyond the intended meaning of the Commerce Clause, particularly because it charged people a penalty for inaction rather than for action. The Supreme Court decided, essentially, that this latter argument was more correct—the Commerce Clause does not go this far. As a result, today’s opinion can be seen as reining in, to a degree, the expansion of the Commerce Clause to new areas.”

While four of the five in the majority supported the mandate under the Commerce Clause, Justice Roberts did not. Yet even though he didn’t support the Commerce Clause argument, he didn’t invalidate the mandate, either. Instead, he said the mandate acted as a tax on the people who have to pay it, which is within Congresses powers.

But as with many aspects of law, there’s a lot more to this decision than meets the layperson’s eye. “The tricky thing here is that the constitution requires ‘capitations’ and ‘direct taxes’ to be apportioned among the states, which means that the amounts collected need to be pro rata across the states according to the populations of the states as recorded by the Census,” Brennan said.

“There is a critical question here of what a ‘capitation’ or ‘direct tax’ is, and it is murky and complicated,” he continued. “The relevant prior Supreme Court cases that deal with the issue are over 100 years old, and some of them over 200 years old. The answer is not completely clear, but it seemed very plausible that the penalty might be a ‘capitation’ or ‘direct tax’ and thus be subject to apportionment. This would have eliminated the taxing power as a basis for upholding the penalty provision, since apportionment among the states was not what the law was doing.

“What the Supreme Court did today, though, was to really significantly simplify and expand the interpretation of what things are neither ‘capitations’ nor ‘direct taxes’ and thus are things which Congress has the power to collect from people under its taxing power, without apportionment.”

In the last century or so, few Supreme Court rulings have limited the expansion of the Commerce Clause. This ruling went against that trend. “But that was significantly offset by a new door to Congressional power that was opened by reading the taxing power as far more broad than it had previously been understood to be,” Brennan said.

Brennan also noted that while today’s ruling was influential, he’s not sure how it will affect legislation or court rulings in the future. “In principle, it opens up the door to many other things being deemed taxes that are not subject to apportionment and letting Congress collect penalties or taxes from people for all sorts of things,” he said. “For right now, though, it simply means that the penalty provision of the health care law has been upheld.”

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The Supreme Court is expected to rule later this month on a central part of the Affordable Care Act, the individual mandate that would require everyone to purchase health insurance. While the individual mandate is important, health insurance exchanges are another key feature of the legislation. They would allow individuals and small businesses to band together and use strength in numbers to purchase plans at lower costs. The exchanges are to be set up on a state-by-state basis. Some states have been dragging their feet or outright refusing to begin the process, but others have been moving rapidly.

When it comes to setting up a health insurance exchange, states face three main challenges, said Leemore Dafny, an associate professor of management and strategy and expert on health insurance exchanges. (Dafny will be on leave from the Kellogg School next year to serve as a deputy director at the Federal Trade Commission’s Bureau of Economics.) The first is “developing a governing authority, and identifying leadership for that entity,” a process that can be fraught with politics. Next the state has to determine how prescriptive it will be regarding plan specifics. “Do they emphasize the quality? The lowest bid? A combination of the two?” she said.

Finally, states have to determine how risks will be spread across participating insurers. Since insurers have no choice in customers—preexisting conditions are not grounds for denial—one could become overloaded with sick people. For the exchange to function properly, other insurers would compensate that company for its outsize share of the risk burden, Dafny said.

Once an exchange is up and running, states can still tweak their approach. “Massachusetts has been refining theirs regularly—most recently, by constraining the proliferation of plan variations to reduce overwhelming choice and to facilitate price comparisons,” Dafny said. That removes some of the pressure to create a perfect exchange from the start.

Health insurance exchanges will likely have a significant impact on how people shop for health insurance. Their scope is limited for now, since current exchanges are aimed toward individuals and small businesses. Employees of large firms, which typically provide health coverage, are welcome to apply, but likely won’t—they would probably pay more than they currently do through their employer.

But in the future, new exchanges could be geared toward just such people. Dafny explored the idea in a recent research paper. She discovered that employees of large firms participating in an exchange would give up at least $1,240 in employer subsidies for the opportunity to select the plan of their choosing. In this case, employers would benefit by saving money, Dafny noted, and employees would be happier by gaining access to a plan that they feel suits them better.

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Most observers were predicting a tight race in the Iowa caucus, but few could have predicted the slimness of Mitt Romney’s lead. He edged Rick Santorum by just eight votes and narrowly led Ron Paul by just 3 percent of the vote.

Paul’s third-place finish perhaps wasn’t the result for which his campaign was hoping—he had surprising support in Iowa polls running up to the caucus—but his margin of loss was small enough that he’s still strongly in the race. I spoke with Mehmet Ekmekci, a political economist, about Paul’s prospects a few days ago and followed up with him on the outcome of the Iowa caucus. Ekmekci is particularly interested in divided electorates like Iowa’s and has developed a model to study them in depth.

“My model studies precisely such situations when the electorate is highly divided,” Ekmekci told me. “The vote difference between Romney and Santorum is just eight, and Paul is trailing with 3 percent. That’s really tight.”

“Now that some more noise is gone—Bachmann is out of the race—the real contenders are becoming more clear,” he continued. Other primaries may hold a surprise or two—say if Huntsman or Perry win or place well—but realistically, the field is down to Romney, Paul, and Santorum, Ekmekci said. Who comes out on top is a matter of endorsement, according to his research. “The nominee will be the one that gets the strongest endorsement from the establishment. So I would expect the candidates to tailor their speeches and platforms slightly to the Republican base.”

While Romney’s win may indicate that Republicans are willing to put aside their doubts about Romney to field an electable nominee, the degree of division in the vote leaves the door open to a nominee who is less palatable to the general public. “The candidate with the least chance of winning the general election may become the nominee, since the voters may divide their votes among the remaining two candidates,” Ekmekci said.

“In my view, Santorum has the least chance of winning a general election, but he has a significant chance of being the nominee. If either Paul or Romney gets to be the nominee, I think they will not be adversely affected in the general election from the tight primary race. Romney has proven to be a flexible politician and can tailor to the median voter, and Paul can attract new voters who are independents and even Democrats.”

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Ron Paul at CPAC 2011

The nomination process for the 2012 Republican presidential candidate is finally beginning to draw to a close. It’s been a long and turbid race, with the fortunes of candidate after candidate rising swiftly then collapsing. Michele Bachmann won the early Iowa straw pole, only to wane when Rick Perry entered the race. Next up was Herman Cain, who polled high with conservatives on the basis of his 9-9-9 plan and then plummeted amidst a flurry of scandals. And now Ron Paul, who is running for the second time, seems to be surging at just the right time.

To political economists like Mehmet Ekmekci, Ron Paul is a particularly interesting candidate. Though Paul enjoys a good deal of popular support, he faces an uphill battle based on his “electability”. “Electability in the general elections comes up as a big issue” among Republicans, said Ekmekci, an assistant professor of managerial economics and decision sciences. “The Republicans seem to be more concerned about ‘beating Obama’ than simply picking a good candidate whose policies are closer to them.”

The electability issue is part of the reason why the Republican establishment has not thrown its weight behind Paul. Yet given Paul’s high polling in Iowa among Republicans, they may be forced to change their stance, Ekmekci said. “Given the circumstances that the Republican base wants to beat Obama so badly, I think it’s very likely that if Paul wins, then he will get the classic Republican base.”

Should Paul win, he could do so as a Condorcet loser, or a candidate who wins an election without a simple majority of the vote. That Paul could win without gaining support of the majority of Republicans “seems to create a form of ‘anxiety’ ” among conservative media outlets like Fox News, Ekmekci said. “For instance, suddenly the credibility of the first primary is questioned,” he said. “One hears phrases such as, ‘If Paul wins Iowa, then this means Iowa is not that important anymore.’ ”

Up until now, Fox News and other establishment Republican media outlets do not seem worried by Paul’s poll numbers, in part because they have not been implicitly endorsing another candidate by giving him or her more airtime or coverage, Ekmekci said. That may change, though, if Paul wins or does well in the Iowa caucus. “We may expect the media to start picking their favorite candidate and push him or her through more airtime, supportive interviews, etc.,” Ekmekci added.

According to a model Ekmekci developed to study the phenomenon of the Condorcet loser, if the Republican establishment does not want Paul to win the nomination, they need to throw their weight behind a single candidate to make sure that the vote is not too divided.

Regardless of what happens, Paul’s presence in the race could shake up the Republican party. “It looks like we may be experiencing one of those moments in history when, if the Republicans embrace Paul, they can reshape their party and ideas in part because he is polling better than other Republican candidates among Iowa independents and Democrats,” Ekmekci concluded. “Whether the new shape is for better or worse, of course depends on the power dynamics in those social groups.”

Photo by Gage Skidmore.

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A Chinese high speed train

China’s gleaming new high-speed rail network suffered a tragic accident near Wenzhou on July 23 when a moving train plowed into a stationary one. Official reports blame a signal malfunction caused by a lightning strike, but many in China are doubting this explanation. Public suspicions were stoked when images got out showing the damaged train cars being buried before inspectors had a chance to investigate the scene. Then late on July 29, the Communist Party sought to bury negative coverage of the accident, telling media outlets to refrain from running stories or commentary unfavorable to the government’s accident response or the Railway Ministry.

Such heavy-handed decrees restricting freedom of the press are common in China. The Communist Party has effectively used control of the press and, in more recent years, the Internet to maintain its grasp on power. But China may do well to loosen that grip a tad, especially in response to such disasters as the Wenzhou train crash, where shoddy construction due to corruption is suspected.

For all the control a single party can exert over a country, it also has its limitations, especially when it comes to assessing its own workings. To maintain power, most dictatorships and single party regimes keep a tight leash on the press, much as China does. But in the process of restricting criticism, they also lose an important feedback mechanism. Inefficiencies and corruption can run rampant.

In resource rich countries, this may not be a problem. Georgy Egorov, a professor of managerial economics and decision sciences, looked at the relationship between resource availability and control of the press. What he and his co-authors found was that press freedoms were restricted in countries with more resources, like oil, but less so in countries without substantial resource bases. Higher resource countries can afford to import goods and services to placate their citizens and make up for any waste lost to corruption and inefficiency. Dictatorships with few natural resources, though, had to loosen their grip on the press to reign in corruption and determine how their policies were received by the people.

Despite unprecedented economic growth over the past few decades, China is not particularly resource rich. Though the country may have wide coal reserves, it’s numerous factories and rising standard of living mean it has to import the fuel to supplement domestic mining. China’s rapid economic growth has kept its populace happy, but there are signs that people are beginning the question growth at the expense of things like safety. Should those sentiments grow, the Communist Party would be wise to allow the press greater autonomy.

Further reading:

Abundant Resources, Yet Little Freedom: Why dictators of resource-rich countries muzzle the pressKellogg Insight

Chinese anger over alleged cover-up of high-speed rail crashThe Guardian

Media Blackout in China After WreckNew York Times

Chinese Media Resist Curbs on Coverage of Train CrashWall Street Journal

Photo by stchou.

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President Barack Obama and Vice President Joe Biden meet with House Speaker John Boehner and Senate Majority Leader Harry Reid in the Oval Office to discuss ongoing budget negotiations on a funding bill, April 7, 2011. (Official White House Photo by Pete Souza)

Posturing and positioning during negotiations has always been part and parcel in politics, but the recent impasse over the debt ceiling negotiations in the U.S. has thrust those maneuvers more into the public view. Whether it be a press conference held by the President or a PowerPoint presentation by the House Majority Leader to his party members, each action during a negotiation influences the outcome.

Perhaps the simplest way to begin analyzing any negotiation is to establish who is negotiating from a position of power. “In negotiations, there’s a couple of things that determine the power,” said Adam Galinsky, a professor of management and organizations and expert on negotiations. “One is, what are your alternatives? If they don’t reach a deal, what does the world look like for you tomorrow versus today? In this case, clearly one of the considerations is politics…Who needs a deal reached more, Republicans or Democrats?”

In the case of the debt ceiling negotiations, Galinsky said there are three main factors at play—politics, principles, and prosperity. Each is of differing importance to the different parties involved in the negotiations. How an issue plays with the electorate is always on a politician’s mind, but some are more concerned than others. President Obama is very much focused on prosperity, Galinsky said, in part because it is his role as president to be the “steward of the economy.” Plus, “the prosperity issue may have downstream political effects because as we know from many elections that how people feel about their daily livelihood is a big determinant of whether they vote for an incumbent.” John Boehner, the Speaker of the House, is concerned with a mix of politics, principles, and prosperity, he added.

Eric Cantor, being the House Majority Leader, is focused on a hybrid of principles and politics. As the leader of the House Republicans—many of whom were elected on a tea party platform and are more concerned with principles of budget cuts and lower taxes than re-elecetion—his political aspirations are tied to the support he receives from fellow GOP representatives. Cantor hews to the principles in part because they are key to his political power, Galinsky pointed out.

Much has been said about Eric Cantor’s role in the process. Regardless of whether you think he’s a wrench in the works or a principled advocate, he has been attempting to bolster his position both within the negotiations and within his own party. By revealing the goings-on of the negotiations to the press and his party, Cantor was trying to “get an upper hand in the negotiations by letting the rank and file know exactly what was going on.” Cantor knew many conservative Republicans would not like some of the compromises being floated during the talks, and he felt that raising their ire would give him more strength at the bargaining table.

Should things go his way, it could strengthen his position within the GOP. The Republicans, as a group, have shown little interest in offering concessions in the negotiations, in part because they don’t feel that they will suffer much politically if a deal isn’t reached. “I think a lot of Republicans don’t believe it’s going to have the catastrophic effect of going into default that many economists and Democrats feel,” Galinsky said. “That’s making them more resistant to reaching a deal.” From that perspective, their strategy makes sense because in negotiations “the party that’s going to be less hurt by not reaching an agreement is the one who is going to be most resistant to reaching a deal that doesn’t fit their precise interests,” he added.

While the President’s talks with Republicans seem to have stalled out, a new plan floated by the bipartisan “Gang of Six” may meet with some success precisely because it hasn’t been front page news until very recently. Negotiations between President Obama and the Republicans have been “complicated with trying to find situations where they have room to talk with each other” without details being leaked to the press, Galinsky said. The new plan hasn’t shared the same spotlight, allowing its architects to hash out the difficult details before presenting it to the press and their respective sides.

Photo by The White House.

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barricaded Greek Parliament

As Greece tumbles headlong and seemingly inevitably into bankruptcy, I’ve been wondering what the mood in the country is like. The string of protests, riots, and frank man-on-the-street interviews give a good glimpse at how the public feels, but the temperament of economists close to the crisis has been less publicized. Fortunately, Sergio Rebelo, a professor of finance, is currently attending the 10th Conference on Research on Economic Theory and Econometrics in Milos and sent in this report after sitting in on a panel session about the Greek debt crisis.

The mood was generally somber. Some economists hope that the crisis will force Greece into reforming its inefficient state and oligopolistic market structure. Others stress that there is still little public support for these reforms and worry about a scenario in which Greece has to leave the European Union. Everybody agrees that some form of debt restructuring will have to occur. Many economists hope that some form of debt forgiveness can be made contingent on the reforms that are implemented.

Photo by underflowR.

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