Ranked choice voting had a good showing at the polls this month, meeting with approval in eight of the ten cities and counties to consider it, including Seattle, Portland and surrounding Multnomah County, Ore., Fort Collins, Colo., and Evanston, Ill. (Two Washington counties, Clark and San Juan, rejected the idea.) Perhaps most significant, Nevada voters approved Question 3, which would make Nevada the second state to adopt the double reform pioneered by Alaska: replacing conventional party primaries with a universal qualifying round from which the top five candidates (four in Alaska) advance to a general election employing RCV. (Nevada voters will get a second look at the measure, since under state law a constitutional amendment does not get adopted until voters approve it twice.)

Much of the ensuing political chatter has been stirred by conservative complaints that these voting methods somehow tilt toward candidates from the left side of the spectrum. I’m with Eric Boehm in Reason (who also quotes me): conservative losing House candidate Sarah Palin was simply not popular with enough Alaskan voters, who on the same day and using the same rules re-elected moderate Republican Senator Lisa Murkowski and conservative Republican Governor Mike Dunleavy. As I wrote last month,

right‐​leaning parties have done quite well in Australia and Ireland, both of which have used ranked choice voting for a century (and are among the world’s most stable democracies). In August, Canada’s Conservatives used ranked‐​choice to pick Pierre Poilievre to fight the next election against Justin Trudeau’s Liberal Party.

Writing in Vox just before the election, in a piece worth reading throughout, Andrew Prokop reported that many committed progressives are also cool to Final Five, because they see the threat of knocking off Democratic moderates in the primary as currently giving them a lot of leverage to yank those candidates leftward. “Activists really like the current primary system because turnout is low and it’s easier for them to influence the outcome, according to” one progressive he talks to. Under the Alaska rules, by contrast, candidates at odds with their party’s activist core can hope to win anyway if they can appeal to many independents or members of the other party.

That’s not a right-versus-left tilt, although it may count as a normie-versus-political-obsessive tilt. The bottleneck Final Five removes is currently exploited for purposes of control not only by activists of left and right, but also by party machines. Moreover, it isn’t just centrist or technocratic politicians who may be skilled at winning support from voters not registered with their own party — figures as diverse as Donald Trump, Bernie Sanders, and Ronald Reagan have all been known for that. 

Note also that a central and apparently successful theme of Question 3 proponents in Nevada was that Final Five would decisively open up the process to independent voters, putting them for once on the same legal footing as their R- or D‑registered neighbors. With independent voter registration having trended upward for two decades, that’s likely to shape up as a powerful political argument as proponents of the Alaska plan turn to new states. 

President Biden’s handling of immigration is the subject of intense scrutiny and criticism from all sides. Much of this criticism is right, but the president has also implemented many positive policies. While it often acted too slowly and has much more to do, the new administration has already reversed the most important restrictionist policies imposed by the Trump administration.

Major Big Picture Actions

1. Ending the “security” travel bans

On January 20, 2021, President Biden fully rescinded President Trump’s ban on immigration and certain travel for nationals of Iran, North Korea, Somalia, Libya, Syria, and Yemen (the original group from 2017) as well as for Nigeria, Eritrea, Tanzania, Sudan, Kyrgyzstan, and Myanmar (the second group added in February 2020).

2. Rescinding the labor protectionist immigrant visa ban

On February 25, 2021, President Biden fully rescinded President Trump’s worldwide ban on permanent immigration by almost everyone other than spouses and minor children of U.S. citizens. The ban was based on the fear that they would compete for jobs with U.S. citizens.

3. Rescinding the “public charge” rule

In February 2020, the Trump administration implemented a rule that, in effect, banned most family-sponsored and diversity lottery immigrants with low incomes. In March 2021, the Biden administration rescinded this rule.

4. Recovering immigrant visa processing

Overall immigrant visa issuances have recovered to their pre-pandemic level and—for two months—even exceeded the pre-Trump level.

5. Allowing the labor protectionist nonimmigrant visa ban to expire

On April 1, 2021, President Biden allowed President’s Trump’s worldwide ban on most nonfarm temporary work visas to expire on the terms originally set by President Trump. The ban was based on the fear that these workers would compete for jobs with U.S. citizens.

6. Reopening most U.S. consulates to process visas

The State Department moved slowly to reopen consulates, but now most U.S. consulates are fully open for nonimmigrant visa processing.

7. Expansion of nonimmigrant visa interview waivers

In March 2021, the State Department waived most nonimmigrant visa interviews for individuals renewing visas expired in the last 4 years, and it authorized interview waivers for many work visa applicants. About half of all nonimmigrant visa applicants no longer need a visa interview. This has helped to partially recover the nonimmigrant visa processing.

8. Ending country-based travel bans

President Trump banned anyone traveling from certain countries during the COVID-19 pandemic. This list included China, Iran, Brazil, and nearly all of Europe. President Biden maintained and even expanded the list in 2021 to include India and South Africa, but finally, in November 2021, he replaced all these bans with a much simpler (albeit still unnecessary) vaccination requirement.

9. Ending the nonessential travel ban with Mexico and Canada

In November 2021, Biden replaced the Trump administration’s nonessential travel ban on noncitizen travelers through the land borders with Mexico and Canada with a vaccination requirement.

Employment-Based Issues

10. Increasing the H‑2B visa cap multiple times

The Biden administration has acted—based on specific congressional authorization—to increase the H‑2B cap in the summer of 2021, the winter of 2021–22, and the summer of 2022, and it has announced plans to use all the visas authorized by Congress for the first time in the winter and summer of fiscal year 2023.

11. Ending the waste of employer-sponsored green cards in 2022

In 2020 and 2021, the government failed to process a significant percentage of employment-based green card cap spots (as a result of the higher cap, intentionally sabotage by the Trump administration, and poor execution by the Biden administration). In 2022, however, it processed the largest number ever and wasted none of the employer-sponsored cap spots.

12. Suspending biometric requirement for certain status renewals

In March 2021, U.S. Citizenship and Immigration Services (USCIS) suspended the requirement to make fingerprint appointments to renew status for various nonimmigrant dependents (spouses and minor children). This Trump rule had caused a massive backlog for those appointments for green card applicants, leading to wasted green card cap spots.

13. Reinstating the prior deference memo

The Trump administration’s USCIS rescinded the policy of deferring to a prior adjudication involving the same facts and parties. This policy meant that it could get to effectively “redo” old H‑1B adjudications when the status came up for renewal, leading to a surge in denials and requests for evidence. In April 2021, USCIS reinstated the prior deference memo.

14. Decreasing H‑1B requests for evidence and denials

The H‑1B denial rate and requests for evidence have both fallen under the Biden administration.

Humanitarian Issues

15. Afghan evacuation parole program

President Biden waited too long to evacuate allies from Afghanistan, but the fact that his administration ultimately managed to bring about 70,000 Afghans to the United States in just a few weeks is unprecedented and far more than what the prior administration contemplated or would have done.

16. Uniting for Ukraine parole program

In February 2021, President Biden announced the intention to admit 100,000 Ukrainians. His administration created an uncapped, streamlined, online-based sponsorship program to grant “parole” (authorization to travel and enter the United States temporarily), and it has already exceeded 100,000 admissions.

17. Venezuelan parole process

In October 2022, in response to rising arrests of Venezuelans crossing illegally, the Biden administration created a new parole program for Venezuelans similar to the one for Ukrainians, but with a cap of 24,000. The government is making approvals very quickly. The cap could be lifted if demand exceeds supply.

18. Haitian asylum processing at ports of entry

In 2022, the Biden administration began to process asylum seekers at ports of entry in a serious way for the first time since the Trump administration had stopped processing in 2022 with a focus on Haitian asylum seekers. This change effectively ended illegal immigration by Haitians.

19. Preserving and expanding Temporary Protected Status

The Temporary Protected Status (TPS) program provides employment authorization and status to people already in the United States when their home country has a situation that makes it unsafe for them to return. The government has used it sparingly, and the Trump administration tried to terminate TPS for about 400,000 applicants. Court cases and President Biden’s election has prevented that from happening, and his administration has opened up the program to twice that many applicants.

20. Rescinding Remain in Mexico and Title 42 expulsion policies

The Biden administration won at the Supreme Court in its long quest to end Trump’s Remain in Mexico policy that had forced asylum seekers to wait homeless in Mexico for the outcome of their cases, making it impossible for them to find attorneys or make an adequate defense. It also has announced that the Title 42 expulsion policy, which also sent asylum seekers back to Mexico but without the chance to apply for asylum, will end on December 21, 2022.

President Biden’s management of immigration has left much to criticize, but although it often took too long or was insufficient, his administration has also accomplished a lot to restore the U.S. immigration system. This list is just a brief overview of the many changes and actions that this administration has taken to improve immigration procedures and processing. These actions have not gone far enough, and the administration is still overseeing record backlogs, but the actions it has taken should be recognized anyway. The situation could be far worse.

Further Reading

Processing Backlogs in the U.S. Immigration System: Describing the Scale of the Problem

Deregulating Legal Immigration: A Blueprint for Agency Action

Reforming the Immigration System: A Brief Outline

In the new Cato Handbook for Policymakers, I propose cutting the earned income tax credit (EITC). I previously critiqued the credit in this study with Veronique de Rugy. While the credit receives support from both parties in Congress, the closer you look the more flawed it appears.

The EITC provides benefits to households with earnings from employment. In 2021, it provided $71 billion in benefits to 27 million recipients. The EITC is mainly a spending program, not a tax‐​cutting program. The credit is “refundable,” meaning that individuals who pay no income taxes receive payments from the government. In 2021, $69 billion of the benefits were refundable.

The EITC encourages some individuals to join the workforce, but it also discourages many individuals already in the workforce from increasing their earnings. The EITC has a high error and fraud rate, and the spending part of the EITC imposes a large cost on the taxpayers who fund it.

There is another problem. To the extent that the EITC boosts labor supply, it pushes down market wages. This effect is usually overlooked by EITC supporters. People complain that some employers, such as fast-food restaurants, pay low wages, but the EITC puts downward pressure on those wages. To an extent, the EITC is a business subsidy helping employers pay low wages.

Michael Keen and Joel Slemrod summarize this unfortunate wage effect of the EITC in their excellent 2021 book Rebellion, Rascals, and Revenue. The book provides a fascinating and nonpolitical history of taxation, with a focus on the underlying economics.

Keen and Slemrod report:

By making work more attractive, the EITC induces an increase in labor supply among low-income workers. Unless the demand for their labor is perfectly [elastic] … this increase in labor supply drives wages down. To the extent that wages fall, the benefit of the EITC to the intended beneficiaries—low-income, often low-skill, workers—is reduced, and some of the intended transfer redounds to employers. Moreover, low-skill workers who do not receive the EITC are hurt even more, because—as they compete with the workers who do receive it—they receive the lower wages but do not get the credit.

… One estimate is that for every dollar that single mothers receive from the EITC, they ultimately lose $0.30 through lower wages. Employers of low-skill labor capture a whopping $0.73 per dollar: $0.30 of this decline coming from those EITC-eligible single workers and another $0.43 from workers who are not EITC-eligible but whose wages nevertheless fall. The net transfer to all low-skill workers, considering both those who get the EITC and those who do not, is, according to this study, just 27 (that is, 100 minus 73) cents per dollar of the EITC.

The authors cite this study by economist Jesse Rothstein for the figures.

“Things aren’t always what they seem,” note Keen and Slemrod in introducing their EITC discussion. With government, the “risk that measures intended to improve the lot of the poor can end up benefiting, maybe even more, the better-off, is a recurrent one.”

In sum, the EITC is not the clear-cut winner for workers and the economy that supporters may believe. Against the modest gains in labor force participation that it may create are numerous damaging effects, including pushing down market wages for lower-skilled workers.

Swiss Medtech, a trade association representing the medical technology industry, issued a press release on November 28 praising the Swiss Parliament for enacting legislation allowing Swiss health care providers and patients to access medical devices approved by the U.S. Food and Drug Administration. Until now, the Swiss government only permitted patients and doctors to access devices that have a CE Marking, which indicates the device meets European Union standards, and the E.U. approves it for marketing among member states. The Swiss Parliament’s action should expand access and increase price competition for medical devices.

Australia began permitting patients and doctors to access FDA-approved medical devices in 2018 and has been allowing them to use E.U.-approved devices for several years. Israel allows devices approved in the U.S., E.U., Australia, and Canada.

U.S. lawmakers have proposed legislation permitting American health care consumers and providers to access drugs and/​or devices approved in other developed countries. Policymakers inaptly refer to the proposal as “reciprocity,” but the reform is not contingent upon the other countries permitting their residents to use FDA-approved drugs or devices in return.

In testimony before the Joint Economic Committee in September 2020, I stated:

Congress should pass legislation giving reciprocal approval to drugs and medical devices (which includes tests) in similar countries. Reciprocal approval already exists among the European Union states plus Iceland, Liechtenstein, and Norway. In July 2019 Senator Ted Cruz (R‑TX) introduced S.2161, the Reciprocity Ensures Streamlined Use of Lifesaving Treatment (RESULT) Act, which would allow for the marketing of drugs approved in certain countries, but not yet approved by the FDA, if “there is an unmet need.” While this is indeed a step in the right direction, in the interest of promoting competition and consumer choice, reciprocal approval should not be contingent on an unmet need.

In Drug Reformation, published later that year, Michael F. Cannon and I wrote:

…at a minimum Congress should eliminate the FDA’s ability to restrict truthful speech by manufacturers about their products and allow American consumers to purchase drugs that have won approval from designated certification agencies, including foreign regulatory bodies. According to one study, recognizing drug approvals by regulatory bodies in Canada and Europe between 2000 and 2010 would have given U.S. consumers quicker access to 37 “novel” drugs for which “no other FDA‐​approved prescription medicine had the same mechanism of action,” including 10 drugs treating mostly orphan diseases “for which no alternative therapy was available in the USA.” Such recognition would have allowed U.S. consumers to access those drugs a median of 13.6 months earlier.

If members of the incoming Congress are serious about increasing access to health care and reducing health care costs, they should, at a minimum, pass a law that allows for drug and device “reciprocity” with other developed nations.

A federal judge in Texas is weighing whether to free consumers nationwide from an unconstitutional ObamaCare requirement that they purchase coverage they do not want, the Wall Street Journal reports. He should do so.

In September, Judge Reed O’Connor of the U.S. District Court for the Northern District of Texas ruled that ObamaCare violates the Constitution by giving the U.S. Preventive Services Task Force (USPSTF) the power to dictate particular types of coverage consumers must purchase. O’Connor ruled that provision unconstitutional because USPSTF members would have to receive Senate confirmation to wield such power. (They do not.)

Maybe you don’t care if those mandates violate the rights of individuals to make their own health care decisions and violate the Constitution. But what if they are also counter-productive? When ObamaCare’s preventive care coverage mandate tried to make contraceptives “free,” prices for hormones and oral contraceptives skyrocketed. (See nearby figure.) How does that promote preventive care or reproductive rights?

The individual consumers and employers who challenged this ObamaCare provision “are asking Judge O’Connor to strike down all preventive-coverage requirements since 2010 that have been recommended by the task force…O’Connor could limit any relief to just the plaintiffs in the case, or he could issue a nationwide injunction that would strike down the requirement that insurers cover preventive services recommended by the task force.”

O’Connor should strike down all such requirements nationwide. The primary purpose of the judicial branch is to ensure the other two branches do not exceed the powers the people granted them through the Constitution. If a statutory provision is unconstitutional, it injures all the people. Not least by eroding trust in institutions. Failing to strike down this provision nationwide would erode trust in the Constitution and the judiciary.

Supporters of broader access to preventive care should demand an end to such mandates — not least because prices for oral contraceptives and other preventive care would likely fall — and demand that Congress and states remove regulatory barriers to preventive care.

A good place to start would be to end the Food and Drug Administration’s power to require prescriptions. In “Drug Reformation,” Jeff Singer and I show that giving the FDA that power blocks access to preventive care and has harmed rather than promoted health.

At a minimum, Congress should remove federal prescription requirements for oral contraceptives, PrEP, and other preventive goods and services.

The 2022 Nobel Prize in Economics is to be shared by Ben S. Bernanke, Douglas W. Diamond, and Philip H. Dybvig, “for research on banks and financial crises.”

Diamond and Dybvig are best known for their 1983 article, “Bank Runs, Deposit Insurance, and Liquidity,” in which they claim to have shown that purely voluntary bank deposit contracts cannot achieve the optimal degree of risk sharing in a world of uncertain consumption timing, but that the optimal outcome is attainable with tax-backed deposit insurance. They conclude that “government deposit insurance can improve on the best allocations that private markets provide.” They concede that deposit insurance can give banks an incentive to take excessive risks, but argue that “in this case there is a trade-off between optimal risk sharing and proper incentives for portfolio choice.”

The Diamond-Dybvig result depends on their crucial assumption that the banking system is subject to what they call a “sequential service constraint, which specifies that a bank’s payoff to any agent can depend only on the agent’s place in line and not on future information about agents behind him in line.” In other words, the bank must settle with each depositor at the time that he or she asks to withdraw, with no later adjustments that depend on how many depositors have asked to withdraw early.

In a 1998 article, the authors have shown that Diamond and Dybvig inconsistently apply this “sequential service constraint” to the private banking system but not to their government deposit insurance agency. Without this inconsistency, there is no need for tax-backed deposit insurance in their model.

Already in 1988, Neil Wallace had considered an alternative resolution of the inconsistency inherent in Diamond and Dybvig’s “sequential service constraint”. Our paper complemented Wallace’s, by showing that with either resolution of this inconsistency, tax-backed deposit insurance is unnecessary.

This blog post provides a non-technical summary of our argument, with a few symbols but no equations. The reader is referred to the original article for the full mathematical and technical details.

The Diamond-Dybvig Model

The Diamond-Dybvig (DD) model has three periods, numbered 0, 1, and 2, and a single homogeneous good. Each agent is endowed with one unit of the good during period 0 and none in subsequent periods. All consumption is during periods 1 and 2.

There is a single production process that yields a gross return of R units of the good in period 2 for every unit of the good invested in period 0. The process may be interrupted during period 1, in which case each unit invested may be salvaged on a one-for-one basis. Once interrupted, the process may not be resumed. However, units of the good may be costlessly stored from period 1 to period 2.

All agents are identical as of period 0, so that their common period 0 expected utility is an unambiguous measure of welfare. However, during period 1, some fraction t of them will sequentially find themselves to be “type 1” agents who must consume during period 1. The remaining fraction 1–t of “type 2” agents may wait to consume during period 2, and thereby take advantage of the high rate of return R on the productive process. Whether an agent is type 1 or type 2 is not directly observable by anyone but the agent.

Given t, the optimal values c₁(t) and c₂(t) of period 1 consumption by type 1 agents and of period 2 consumption by type 2 agents may be found by solving the mathematical conditions for expected utility maximization. DD add the special assumptions that both R and the rate of risk aversion are sufficiently high that,

1 < c₁(t) < c₂(t) < R

for all values of t. These special assumptions also imply that it is less desirable to be a type 1 person than a type 2, so that there is the potential for an insurance market, in which type 2’s compensate type 1’s for their bad luck.

Left to themselves without banks or other financial intermediaries, agents would invest directly in the production process to consume either c₁ = 1 in period 1 if they turned out to be type 1 or c₂ = R in period 2 if they turned out to be type 2. DD correctly point out that this “autarky” solution is not optimal, since it does not maximize the initial expected utility under their special assumptions. However, it cannot be improved upon by an ordinary state-contingent insurance contract, since an agent’s “type” is non-verifiable private information.

DD then consider a “bank” that accepts a unit deposit from each agent in period 0, invests these goods in the production process, and gives depositors the option of withdrawing r₁ units in period 1 or waiting until period 2. After it has made all period 1 payouts, it will distribute its remaining resources, if any, in a pro rata fashion to its remaining depositors in period 2.

If the fraction t of type 1 agents were known at the beginning of period 1, the bank could simply set r₁ = c₁(t) for the first t depositors who withdraw during period 1, and zero for subsequent depositors who ask to withdraw during period 1. All type 1’s will then withdraw during period 1 and obtain their optimal consumption. Type 2 agents will have no incentive to join them, since they will know they will get higher utility by waiting to period 2. Suspending redemptions after the first t withdrawals is required in order to prevent a self-fulfilling “bank run” equilibrium in which type 2 depositors, fearing a residual period 2 return r₂ that is less than r₁, all rush to withdraw in period 1. If the fraction f of depositors who ask to withdraw during period 1 turned out to be greater than 1/r₁, the bank would entirely run out of resources in period 1 and fail, leaving the remaining type 2’s and perhaps even some type 1’s with nothing at all in either period.

The problematic case arises when t is random and is not publicly observable. If the bank pays a fixed return r₁ = c₁(f*) to only the first f* customers in line in period 1, after which point it suspends until period 2, it will then either be the case that f* is greater than t, in which case type 1’s receive too little, or else f* is less than t, in which case some type 1’s will not be able to withdraw when they need to. On the other hand, if the bank were to pay depositors a variable return that depended on the fraction of depositors that had withdrawn to date, then type 1 depositors who are otherwise identical would receive different returns, once again a suboptimal outcome, according to DD.

DD propose to solve this problem with what they characterize as a tax-backed government deposit insurance program. Under their system, the bank promises a fixed gross return r₁ >1 to depositors who withdraw in period 1. If the fraction f of depositors who ask to withdraw funds in period 1 is greater than 1/r₁, the bank fails, and the insurer pays off the remaining period 1 withdrawals. This insurance is financed with a tax on all period 1 wealth, and is levied whether or not the bank fails. Tax receipts in excess of those necessary to meet withdrawals in period 1 are turned over to the bank to be distributed in period 2 to the remaining depositors. The DD tax rate depends on the value of f that is observed at the end of period 1 in such a way that the after-tax return to period 1 withdrawers is the optimal c₁(f), while that to period 2 withdrawers is c₂(f), both regardless of r₁. Under this DD system, type 2 depositors will always ultimately do better to wait until period 2 to ask to withdraw, so that f will equal t and the optimal risk-sharing will have been attained.

DD conclude from this that “government deposit insurance can improve on the best allocations that private markets provide.”

Our “Contingent Bonus” Contract

In fact, this conclusion derives only from DD’s inconsistent assumption that “a bank … must provide sequential service and cannot reduce [or otherwise alter] the amount of a withdrawal after it has been made,” while the deposit insurance agency is under no such obligation. It may be true that banks traditionally have offered such “sequential service,” and it may even be true that in many countries they are required to do so by regulation or even by statute. However, it is nowhere written in the laws of the “private market” that this must be the case if there is a good reason to do otherwise.

The “banks” DD describe are essentially mutual insurance companies. They attempt to provide insurance against unforeseeable contingencies at the same time that they are mutually owned, in the sense that their participants or “depositors” sooner or later receive all the proceeds from their operations. It is common for mutual life and casualty insurance companies to charge premiums up front that are based on a worst-case scenario and then later to distribute a rebate or “dividend” to their participants that is contingent on the company’s actual experience.

The “banks” in the DD model in fact promise their depositors nothing at all if they leave their money in until period 2. The return r₂ they actually receive then is a function of the bank’s experience in period 1. In particular, it is a function of the value of f observed at the end of period 1. Now if depositors thus trust the bank’s management to faithfully administer the assets, to contain costs, and to calculate r₂ as a function of f, there is no reason they should not trust the management to make r₁ a function of f as well.

To be sure, such a bank would have to observe the final value of f before it could completely distribute this r₁ for withdrawing depositors to consume. But so does the taxation authority in the DD model. In order for the DD tax to work, depositors must first state their intention to withdraw and then pay taxes before being allowed to consume, for otherwise the type 1 agents could simply consume the promised r₁ and then “die” before paying their taxes, leaving behind an uncollectable tax bill. Furthermore, the DD tax must actually be collected in deposits before they are withdrawn, and not in goods, for otherwise there would be an inefficient interruption of the production process on those tax receipts that were plowed back into the bank. Thus, even though depositors learn sequentially during period 1 whether they must consume during period 1, the technology of consumption in the DD world must be such that they can wait until the very end of period 1 to actually consume.

Specifically, consider an institution whose prospectus requires it to pay depositors who announce a desire to withdraw in period 1 a total return of c₁(f) by the end of period 1, and to distribute the remaining assets to the remaining depositors during period 2. This contract precisely duplicates the payoffs of the deposit contract with government deposit insurance described by DD and therefore prevents runs while achieving the unconstrained expected utility optimum.

In practice, this “bank” could unconditionally promise depositors a base payment of one unit of output per unit deposited, in either period 1 or period 2, since unity is the liquidating value of the bank’s assets. Depositors demanding withdrawals in period 1 could actually be given this base payment at the time they make this demand, with the remainder, c₁(f) – 1, coming at the end of period 1, as a “contingent bonus” to be determined and distributed only after the withdrawal volume is known. Such an arrangement would facilitate using at least the base value of the deposits as a payments medium. Again, the timing of this secondary distribution is no more a problem than it would be with the DD tax-backed deposit insurance program.

At the St. Louis Fed’s Symposium on Deposit Insurance on Dec. 11, 1992, Philip Dybvig raised the objection to an early draft of our paper, that in order to provide perfectly efficient insurance, our “bank” would have to have a representative clientele so that the fraction of each type of agents among its depositors is identical to that of the population as a whole. However, this is no different than the situation of an ordinary mutual life or casualty insurance company, whose pool of members may not perfectly match that of the entire population. In practice, so long as our bank or a mutual insurance company has a sufficiently large random sample of the population as its depositors or members, the law of large numbers will ensure that its experience is close enough to the population’s experience that any inefficiency will be negligible. Or, if a random sample is not feasible, a single bank could serve the entire population with this service.

The reason that the market is able to duplicate the DD government-backed insurance scheme is that their “tax” in fact does not subsidize, or even promise to subsidize, the banking sector at the expense of the nonbanking sector. In reality, all their “tax” does is make a self-financing redistribution between period 1 withdrawers and non-withdrawers; but this is something the bank could do by itself without the government’s general taxation powers.

DD claim that in their model, “Deposit insurance guarantees that the promised return will be paid to all who withdraw.” This claim is true, but only vacuously so, when we consider that their program simultaneously guarantees that the promised return will be entirely taken away as soon as it is “paid,” and replaced with something that may be completely different at the end of period 1.

Charles J. Jacklin (1993) proposed what he calls a “market rate deposit” that at the end of period 1 pays a variable dividend d that is a function of the market price p of the ex-dividend deposit itself. Since the amount agents are willing to pay for the deposit is a function of d, d and p must be determined simultaneously by the market. Although more cumbersome than our “contingent bonus contract,” Jacklin’s “market rate deposit” plan is an equivalent and prior resolution of the DD risk-sharing problem in the case of a random t.

Wallace’s Interpretation

A sequential service constraint such as DD assumed would be necessary in a world in which type 1 agents had to consume as soon as they learned they were type 1, and could not wait until the end of period 1 to consume. Since DD allow their deposit insurance agency to adjust the amount depositors receive at the very end of the period, we assumed in our paper that this is not the case.

In his 1988 paper, “Another Attempt to Explain an Illiquid Banking System: The Diamond-Dybvig Model with Sequential Service Taken Seriously,” Neil Wallace instead “takes sequential service seriously,” by assuming that sequential service is in fact necessitated by the timing of consumption.

Wallace then correctly points out that with such an immediate consumption constraint, the DD insurance scheme would no longer work, since it would be providing consumption goods to type 1 agents too late for them to use them. Wallace then shows that with immediate consumption, the optimal payout of type 1 agents is no longer constant, as DD had insisted must be the case, but rather should be a declining function of their place in line. If a bank were to make payouts according to Wallace’s schedule, it would be run-proof without deposit insurance, since type 2 agents would always do better to wait until period 2 to consume.

Our paper therefore complements Wallace’s, by showing that with either resolution of the DD inconsistency about the nature of “sequential service,” tax-based deposit insurance is unnecessary.

Conclusion

Our article showed that the potential market failure Diamond and Dybvig had modeled can easily be rectified without taxpayer-backed government deposit insurance, simply by resolving the inconsistency of their “sequential service constraint” and by instituting what we call a “contingent bonus contract.” This contract is self-financing and does not require either potential or actual taxpayer assistance. It involves no more stringent timing requirements than does the DD governmental insurance plan.

Banks and financial intermediaries serve many important functions not modeled by DD, including the clearing of payments, the transformation of loan denominations, the diversification of default risks, and the economization of information. By focusing in our article on the consumption-insurance function DD had postulated, we did not mean to imply that this is an important real-world function of banks, nor do we advocate that banks actually attempt to implement our contingent bonus contract. Our purpose was merely to lay to rest the notion that the DD model constitutes a theoretical case, as they put it, that “government deposit insurance can improve on the best allocations that private markets can provide.”

The reader is also referred to George Selgin’s far more entertaining post, “Modeling the Legend, or, the Trouble with Diamond and Dybvig, Parts I and II.” Alt‑M, Dec. 17 and 18, 2020.

***

REFERENCES

Douglas W. Diamond and Philip H. Dybvig (1983): “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, 91: 401–419.

Charles J. Jacklin (1993): Market Rate Versus Fixed Rate Demand Deposits,” Journal of Monetary Economics 26: 361–384.

J. Huston McCulloch and Min-Teh Yu (1998): “Government Deposit Insurance and the Diamond-Dubvig Model.” The Geneva Papers on Risk and Insurance Theory 25 :139–149.

Neil Wallace (1988): “Another Attempt to Explain an Illiquid Banking System: The Diamond-Dybvig Model with Sequential Service Taken Seriously,” Federal Reserve Bank of Minneapolis Quarterly Review (Fall), 3–15.

In many cities, a shortage of housing supply has led to high housing prices. One problem is that strict zoning rules have undermined the construction of multifamily housing.

Property taxes are another barrier to increased housing supply. The Wall Street Journal has an interesting piece suggesting that taxing buildings as much as, or more than, land induces landlords to hold onto land undeveloped, rather than pushing ahead with building projects.

The article highlights land in New York City near the U.N. that is zoned for construction of 1,500 apartments but has been empty for 17 years while the “owner has paid relatively little in taxes on the property because it doesn’t contain any buildings.” Apparently, “U.S. cities are littered with vacant or sparsely built sites like this one. New York City alone has more than 77,000 lots that are either vacant or have a building that is less than half the size of what zoning allows.”

All taxes distort, but the argument is that property taxes on land distort less than property taxes on buildings. The article continues:

Some economists and housing advocates say there is a common factor behind all this vacant land: a property tax system that combines low taxes on land with high taxes on buildings.

Lawmakers in Detroit, Philadelphia and Richmond, Va., have proposed reforms that would fundamentally change the way property taxes are calculated. When Andrew Yang ran for mayor of New York in 2021, he called for a higher tax on vacant land.

“There can be no doubt that if you shift the tax off of buildings and onto land, you will encourage buildings and discourage land speculation,” said Nicolaus Tideman, a professor of economics at Virginia Tech.

Perhaps shifting tax costs onto land and away from buildings would boost investment. But I would point to two other tax problems. First, many local governments—such as New York’s—are bloated and inefficient, thus requiring excessive taxes overall. Second, most governments impose higher taxes on apartment buildings than single-family homes, thus tilting investment toward lower-density housing development.

The Lincoln Institute of Land Policy publishes a comparison of effective property tax rates by property type in the largest city in each state. Across the cities, the institute finds that the effective property tax rate on apartment buildings is 36 percent higher, on average, than the rate on owner-occupied residences (p. 40). New York City has one of the largest gaps between its high taxes on apartments and lower taxes on owner-occupied residences.

I’m not an expert on urban issues, but I think we want lean local governments funded by uniform property tax rates on all residential, commercial, and industrial real property. There should be no carve-outs for particular industries or companies, and the single tax rate kept as low as possible.