Why I dislike (the effort of) tipping

I believe there are a few things to say about the economics of tipping. (For those who do not know, in US restaurants you must tip 15-20% as waiters have no fixed salary and live exclusively on tips. This practice has permeated all sorts of industries, from taxis to hairdressers. But not supermarkets or grocery stores, for some reason.)

Essentially, the restaurant manager delegates the task of managing their workforce to the customer. Now, when I go to the restaurant, it is either because I have no desire to cook and wash the dishes, or because I want to have fun with friends. The last thing I want to do is the manager's job, deciding to reward or punish the quality of service with the amount I tip.

The argument that the quality of service improves when the waiter is entirely dependent on tips, though not entirely unfounded, is overblown. It is extremely rare not to tip someone because of poor service. The real reason why restaurants rely on tipping and pay no fixed salary is that it is a very convenient way of unloading the risk of fluctuating income on the employees. If a restaurant does poorly one evening, then waiters go home with very little pay, and the bottom line of the restaurant is preserved.

Now, I heard restaurants operate in an extremely competitive environment, so there is a case to be made in favour of variable pay. However, the same cannot be said of other industries. Why is there a tip jar in Starbucks and not at the local supermarket? Is the service provided by the cashier less valuable when you buy groceries than when you buy coffee? I don't think so, as anyone who has waited in a long line because of a slow cashier can testify to.

A few years ago, Starbucks employees went on strike because Starbucks had decided they should share the tips with the store manager. The company argued that managers participate in the effort, and should be rewarded when things go well. The employees argued that Starbucks were using this ploy to keep their managers' wages down. I will let everyone take sides as they wish, but what I dislike is that the act of tipping somehow drags you into salary disputes (especially when you tend to think in economic terms).

The situation is even worse in other services, such as hairdressing or (so I heard) massage, spas, nail, wax etc. How much should you tip there? Employees put strong pressure on you to tip large amounts (20%), which defeats the purpose of many of these services, namely to relax while someone takes care of you. Again, all the arguments made for restaurants apply here. The service should be included in the price. How am I supposed to know the fair price to pay someone? I would have to know what their fixed salary is (if any), how many haircuts they can expect to do per day, how much they need to pay for their healthcare and into their pension, and so on. I don't want to do that. It's not my job.

I have to admit there may be a cultural aspect here. Not having grown up in a tip culture makes me unsure how much to tip, whereas knowing instinctively how much to tip for an array of services can take some of the effort off. Nonetheless, I feel strongly that this whole tipping institution is an easy way for management to avoid doing their job. It is left to customers and employees to work out the friction that all economic transactions entail. This friction should be resolved internally within the company, and the customer should be left to deal with a smiling facade. They could then enjoy what they came for, namely relax and forget about their own day-to-day work.

We are all Icelanders!

In October 2008, amidst the confusion of the financial crisis, the UK and the Netherlands arm-twisted Iceland into taking responsibility for €4bn of British and Dutch depositors’ money presumably lost by Icelandic banks. This amounts to €12,000 per inhabitant, including new born babies and elderly people.

The legal case is complex but muddied. Iceland has a private deposit insurance scheme, clearly too small to cover the losses. According to the relevant European agreement, a country must guarantee depositors at its banks up to €20,000, regardless of nationality. However, there is nothing to say that the taxpayer should cover losses beyond what the insurance scheme can cover.

The moral case is clear. British and Dutch depositors chose to put their money in Icelandic banks to get higher interest rates, ignoring the age old wisdom that there is no free lunch. Greater rewards only come with greater risks. For obvious political reasons, Gordon Brown decided to make British depositors whole, and then turned to Iceland to get the money back.

On Sunday, Icelanders massively voted against a repayment agreement. They need our support. As a European citizen I feel ashamed that European leaders would threaten their tiny neighbour with economic and diplomatic isolation. And if you are a taxpayer, it is likely that your money was used to bail out your country's banks at some point, so you know how it feels to be coerced into paying for bankers' mistakes.

Part of the blame rests on an ill-conceived European agreement and a free-(for-all)-market mood that suited everyone at the time. Sure, Icelanders probably profited from the money that their banks were hauling in. But so did the British. If the bill for those collective mistakes was split evenly among all European citizens, it would amount to €10 per person. Surely that's something we can afford (even babies and grandmothers). And it is the right thing to do.

Would Goldman Sachs have survived had AIG been allowed to fail? Probably not.

In the run-up to the crisis, AIG had sold enormous amounts of insurance to banks in the form of CDS contracts. In exchange for a yearly fee, it agreed to pay the bank a nominal amount if the company covered by the contract failed. When Lehman failed, AIG found itself unable to honor these contracts, and the taxpayer had to step in. (The desk selling the insurance contracts had been too busy collecting fees and paying themselves huge bonuses, and had forgotten to set aside sufficient capital to cover losses.) When taxpayers bailed out AIG with $85 billion (and much more later), Goldman Sachs received a $13 billion payment, and Societe Generale and Deutsche Bank $12 billion each, to mention only the largest beneficiaries.

Goldman Sachs (GS) once declared that they would have survived AIG's collapse, as they had taken insurance (entered CDS contracts) on AIG with other institutions. This argument is either naive, or self-serving.

For simplification, say GS had taken $15 billion worth of insurance on AIG with Societe Generale. It is quite possible that Societe Generale would have failed without the $13 billion bailout payment, and would have been unable to honor its contract with GS. Of course, you can imagine that GS had taken insurance on Societe Generale, or that Societe General had taken insurance on AIG with Deutsche Bank. You get the point: The chain reaction may have been longer and more complex, but at that moment, there was a real chance of a systemic collapse of the financial system. And in that case, even if it had been the last standing giant among the ruins of the system, Goldman Sachs would have failed eventually.

Just because banks are repaying the TARP doesn't mean they are off the hook

I have read lately that the fact that US banks are repaying the TARP (the emergency facility set up during the crisis to rescue the banking system) means that all is now well. Taxpayers should be happy that they made a profit, as banks have repaid capital and interest. Well, things are not that simple. Rather, it's like saying: had I bet that Lehman would fail, I would be a millionaire. In this fancy world, everyone would be a millionaire by now.

The mistake comes from judging things knowing the outcome. Taxpayers were forced to enter a deal with banks under the threat of financial collapse, assuming unknown (and potentially huge) risk in exchange for an interest payment. The fact that the outcome was favourable to the taxpayer doesn't mean it was a good deal. Things could have ended very badly. You cannot say that it was obvious things would turn out for the best. Only people who are now millionaires following Lehman's bankruptcy are allowed to say that (and even so).

This is why Obama's proposal that banks should pay an insurance fee sounds fair.

Were money market funds a beneficial financial innovation? No.

Robert E. Litan has recently made a laudable effort at assessing the merits of financial innovations. However, I would like to take issue with his classification of money market funds as a beneficial innovation. On the contrary, I believe they are a typical example of innovation meant to benefit not ordinary individuals but financial institutions.

I always found it extraordinary that anyone would invest in money markets, as they offer returns that are both low and uncertain. In Europe, savings accounts pay a reasonable interest rate (not the paltry 0.25% offered by high street banks in the US). They are the savings instrument of choice. In offering these, the bank does its job: it bears risks it is equipped to manage as an institution.

By contrast, money market funds dump all risks on the investor, and collect a fee for doing nothing much. And this "innovation" ended up costing (or almost costing) taxpayers a lot, as money market funds had to be insured in a rush by the Treasury when Lehman Brothers failed.

In the end, money market funds conveniently avoided paying an insurance fee to the FDIC, yet taxpayers had to come to the rescue of investors regardless. Of course, managers got to keep their comfortable (and to some extent unearned) management fees.

A taxpayer's comparison of tax systems

As the tax season approaches, I offer an employee-oriented comparison of the three tax systems I have personally experienced: France, the UK, and the US.

1. The winner: The UK

I simply loved filing taxes in the UK. A pay slip has two lines only: one for the NHS contribution (health) and one for the income tax.

Some find it unfair that your tax liability does not decrease with, say, the number of children you raise. I am usually very sceptical of well-intentioned but complex tax rules. The income tax does not have to be the place where the state helps you raise children (think child benefits instead). The leaner the income tax process, the better. There are other and less costly means of implementing public policies.

2. Second place: France

The French tax system tends to be complicated, with many ad hoc taxes created by successive administration. Payslips have at least a dozen cryptic lines. However, filing taxes as an employee is a breeze. You can do it online in one minute: just confirm the amount pre-filled by the system, and you're done.

3. The loser: the US

Any normal person will inevitably get lost in the maze of lines you have to fill and questions you have to answer. This is why even employees with a salary as their only income will usually hire an accountant, just to be sure that their forms have been correctly filled, and enjoy the peace of mind that the IRS (the tax administration) will not come haunting them for who knows what mistake.

It is easy to understand why this situation endures. Too many people have a vested interest in it: tax lawyers, accountants, tax advisors etc. The system is skewed in their favour, and not only because of complexity.

First, in the US you cannot file electronically as an individual. You have to go through an accredited company. True, the service they offer must be free if you earn less than a certain threshold. I guess I see where this is coming from: the idea that private companies will run things more efficiently than the government. Well, I'm sorry, it just adds to the horrible complexity of the whole thing.

Second: In the US taxes are withheld, and oftentimes the IRS will pay you back some amount. All companies that file your taxes will offer to advance this amount to you, i.e. pay you now and collect the IRS payment on your behalf a month or so later. Many people are not aware that a sizeable interest rate is charged for this advance. As a result, every year, billions of dollars are transferred from taxpayers to tax companies. I'm not sure where the efficiency of that is.

The myths (and realities) of economic growth

Growth is overrated. Growth does not matter so much as employment. They are two sides of the same coin, yet I believe a semantic shift would help focus minds.

The economy grows as productivity increases. Consider a fixed population size for now. If productivity increases and yet the economy does not grow, this reflects the fact that people have gone jobless. What matters here are the individual tragedies of people loosing their jobs (and not finding another one), not the headline growth figure.

This distinction matters. A politician's short-term aim should be to oil the wheel of the economic machine, helping people adjust and find new jobs when productivity increases put them out of employment. (I believe this adjustment is always more painful than economic science allows for.) Take care of employment, and in the short term growth will follow, mechanically.

Regarding population size: Comments tend to focus on headline growth figures for countries, and forget about per capita income, the true measure of wealth. In 2004, The Economist ran an excellent article demystifying European and American growth figures. Yet they themselves sometimes loose sight of such subtle distinctions in their editorials.

Growth rates can also be misused when looking at developing countries. Think of the high growth rates of emerging economies: China now, Asian tigers in the 90s, Japan in the 80s, Germany in the 60s etc. Sometimes people forget that these countries are catching up. (Not that catching up is easy, some countries seem to never do so.) It is however much easier to catch up, following an established model, than to explore uncharted economic territory and innovate.

Think of the Soviet Union. Back in the 60s, Khrushchev boasted that, based on current growth rates, the USSR would catch up with the US at some point in the 70s. As Krugman showed, growth in the USSR was not so much based on increasing productivity as on resource mobilisation (forcefully putting people to work, producing capital goods rather than consumer goods). Of course, once the country ran out of resources to mobilise (literally ran out of peasants to send to factories), growth slowed, and we all know the end of this story.

Back to growth: There are indeed a few reasons to seek growth per se. One is the miraculous dynamics of debt accumulation. In an expanding economy, if growth rates are higher than the interest rate paid on the debt, the level of debt can be kept under control without ever repaying it. Another significant benefit of economic expansion is military (or diplomatic) expansion. In a world where countries seek military power (our world, last I checked), the larger your economy is, the more you can spend and invest in the military.

Therefore, governments do have an interest in the absolute size of their economy. And indeed, I do not know of a single government that is not actively involved in matters such as productivity (innovation) and population size. However, remember that what matters for well-being are per capita income and employment rates. And if emerging economies are growing at much higher rates, it is because their per capita income is much lower. At least in theory, you are better off living in a rich country with a low growth rate than in a poor country with a high growth rate.

At least in theory, because last but not least, growth seems to have a soothing social effect. A growing economy gives people a sense of purpose, gives them hope of a better future for their children. It seems that human minds as well as economic systems are better equipped to cope with growth than stagnation.