The Coase theorem’s claim about the domain within which normative analysis of legal rules – whether one set of rules is preferable to another or the reverse – is actually relevant and central to law and economics.

Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler came out with a study using Cornell University mugs, and the results were direct contravention of the Coase theorem. They referred to this as the endowment effect – the refusal to give up an entitlement one holds initially even though one would not have been willing to pay to acquire that entitlement had one not held it initially. The endowment effect showed that Coase theorem’s prediction of equivalent outcomes, regardless of the initial entitlement, no longer holds. This plays an important role in drafting of legal rules.

Law and economics tries to assess the desirability of actual and proposed legal rules. For this purpose, the endowment effect is more suited than the Coase theorem. In the presence of endowment effect, the value attached to a legal entitlement varies based on the initial assignment of the entitlement.

Context plays an important role in the occurrence of endowment effect. Prior to the Cornell University mugs study, there were many studies which concluded that the Coase theorem was empirically robust in a set of domains. In all these studies, the value of each possible outcome was directly specified in dollar terms by the researchers. These studies found that if the transaction costs are sufficiently low and people are told specifically what each outcome is worth to them, they will generally find their way to a value-maximizing outcome. The Cornell University mugs study proved that if people are not told about the value of the outcome, the results of the earlier studies would be different.

The study of behavioral law and economics examines human limits to means-end rationality. The endowment effect plays an important role in behavioral law and economics. Other features of behavioral economics also pay an important role. Unbounded rationality, unbounded willpower, and unbounded self-interest are considered to be normal traits of humans. For studying behavioral law and economics, humans must be viewed as departing from traditional economic assumptions in three distinct manners: bounded rationality, bounded willpower, and bounded self-interest. The legal system can be influenced by the results of such studies. Using behavioral law and economics, courts can adjust legal reasoning and conclusions accordingly and legislators can design more effective laws.

If the consumer does not value a product in the market, the prices of all factors involved in the production of that product including labor will fall and vice-versa. Real wages will also rise if the workers become more productive.

If the government through legislation raises the wages, the demand for labor will fall and some labor will not have any employment. It is more likely that the less experienced and young workers will be the ones at the receiving end. Minimum wage legislation prices the least employable out of the market and makes them unemployable. If an employer feels that a worker is not likely to produce at least the value of the wage paid to him.

Increase in minimum wages pushes up the cost of individual businesses. Most businesses will pass on the increased in the wages to the end consumer.

Minimum wage legislation will inevitably create unemployment. The ones who are most affected are those at the bottom of the economic pyramid. Labor valued by employers at less than the mandated minimum are likely to be unemployed. It increases unemployment amongst the young and unskilled.

The most obvious beneficiary of minimum wages legislation are unions and their members. The median weekly wage for union members is higher than for nonunion workers. How successful an union is depends on its ability to maintain high wages and job security for its members or else it will loose its members. To obtain higher wages, it becomes necessary to exclude some labor from the market. Only a small percentage of the population will be benefited by increase in the minimum wages. This benefit comes at the expense of the least experienced, least productive, and poorest workers.

Supporters of minimum wage legislations claim that without minimum wages employers would drive down the wages to extremely low levels which would make it very difficult for the workers. This is just not true. Many businesses pay higher wages than mandated by law.

Increasing the minimum wages will not result in an increase in the real wages. Although minimum wages have been fixed over the last few years, the average pay in the United States had been increasing steadily. This is not due the efforts of the policy makers in Washington DC. Any attempts to increase the minimum wages would have a negative impact on the economy. It will affect the capacity of the economy to generate prosperity for the less skilled.

Instead of trying to influence minimum wages through legislation, the government could do very well to ensure a booming economy in which lots of businesses are opening and expanding thereby increasing the demand for labor which in turn increases the wages.

Estate tax is nothing but another tax on savings and investments which are already under heavy taxation – income is taxed when it is earned, interest derived from investments and savings is taxed, appreciated value of an asset is taxed (capital gains tax).

A study by well-known economists Henry Aaron and Alicia Munnell concluded that estate taxes are unfair, raise little revenue, impose excess burdens, and have failed to achieve their intended purposes.

Estate taxes reduce the amount of capital available in the economy and thereby reduce the wealth ultimately available to the society. It encourages consumption and discourages savings. It reduces the after-tax return on investment. This causes the capital stock growth to decrease. Capital is vital to economic growth. Estate taxes impede the accumulation of capital. This has a negative impact on economic growth.

Estate tax liquidates and transfers to government control privately held assets which could otherwise be used for maximizing economic efficiency. Instead they are transferred to consumption-intensive government uses.

Estate taxes discourage entrepreneurial activity, hinders entry into self-employment, and breaks up family-owned businesses – a critical component of the U.S. economy. For people of lower income households to move to higher income groups, entrepreneurship is the key. Estate tax prevents upward income mobility by disrupting the transmission of a family business to succeeding generations.

Studies have shown that the estate tax continues to be a primary reason why small businesses fail to survive beyond one generation. Many heirs have cited the need to raise funds to pay estate taxes as the reason why their family business failed. Planning for estate taxes reduces the resources available for investment and employment. Business owners tend to keep liquid assets available to pay off future estate taxes. Estate tax imposes large cash demands on family businesses that generally have limited access to liquid assets.

In a tax system that is fair, individuals with fewer resources pay less taxes than those with greater resources, and all taxpayers with the same amount of resources pay the same tax. However, the rich can afford to use various estate planning options to reduce or avoid estate taxes, and the poor who cannot afford estate planning end up paying more. There are many tax avoidance options available to the general public. To avoid estate taxes, capital owners shift resources from their most productive uses into less efficient but more tax-friendly uses.

Estate tax is extremely primitive and can result in inefficient allocation of resources. The maximum rate for estate tax is presently 45%. It discourages savings and investments and lowers the after-tax return on investments. Estate tax violates the basic principles of an efficient tax system.

There have been concerns that short sales are behind the big price slides. Short sellers seek to profit from a stock’s decline by selling borrowed shares and replacing them at a lower price. Short sellers have been blamed for the declines in stocks including Fannie Mae and Freddie Mac which were taken over by the Federal government last month.

Concerned about the possible unnecessary or artificial price movements based on unfounded rumors regarding the stability of financial institutions and other issuers exacerbated by short selling, the U.S. Securities and Exchange Commission (SEC) has come out with a new set of rules. The SEC also banned the short selling of nearly 1000 stocks until three days after the $700 billion rescue package is enacted into law.

The new rules require money managers with at least $100 million under management to report short selling if it exceeds a certain percentage of the shares outstanding and is greater than $1 million in value. Short sellers who haven’t added to their positions since the rule went into effect won’t have to report. Mutual funds and exchange-traded funds that short stocks also are subject to the disclosure rules. The disclosures would be made public by the SEC with a two-week delay – due to start in mid-October.

The new rules bring an end to secrecy which short sellers have long held to be one of their dearest tools. Short sellers will have to report which stocks they are short and how their exposure to those stocks changes during the day. The new rules have been welcomed by some who feels that since investors who own 5% of a company’s outstanding shares have to report their stakes, there is no reason for short sellers not to.

The new set of rules has been criticized by many. Forcing such public disclosure would be like asking Coca-Cola to reveal the super-secret formula for its popular fizzy beverage. It could lead to variety of consequences, some of them unintended. Short sellers are already plotting changes in strategy. Short sellers represent a supply of shares when the market is rising and demand for shares when markets are falling. It could affect the liquidity of some stocks if short sellers retreat fearing companies will cut off information flow, investment firms will lock them out of investor conferences and competitors will see who has built what positions. Stocks exposed as targets of well-known shorts could suffer if other investors piggyback on the same companies.

The SEC subsequently modified the disclosure requirement stating that the disclosure will not be made public. This came as a relief to short sellers and other hedge-fund managers worried that public disclosure of their bearish bets might expose them to pressure from the companies they target.

Although the law has noble aims, there is a hug difference between the language and actions of the government. While the law seeks to set high educational standards, the nation’s commitment to wealth to its schools is mediocre. The United States is amongst the least equitable nations when it comes to equality for children. A study by the United Nations Children’s Fund gave the U.S. a low ranking of 21st out of 24 industrialized nations in educational equality. NCLB promised equality for all, but the government has failed to provide funds to meet the cost of turning this promise to reality.

What NCLB has done is that it has raised the standards without providing for the resources. This may have the undesirable effect of setting up many children for failure. While the socio-economic benefits of funding the national educational obligations to the poor and the needy are enormous, the fact is that funding alone will do little to prevent the existing system from randomly denying funds to the schools that need it the most. NCLB holds schools with well educated patents and generous resources and improvised schools to the same standard and does not distinguish between them. The system as it exists today does not recognize that a child with poor parents may not be as focused on education as a child with rich parents.

There are schools that need to make changes in order to improve the performance of their students. Most of these are schools that do not have the resources that other schools in more wealthy communities have. While the schools meeting NCLB receive more funds, the schools which fail are denied the very funds they need to improve. These schools are labeled as failing. Most schools that have been labeled as failing are in poor or diverse neighborhoods.

To improve the education system, the funding must be adequate. There must be new investments, particularly in poor, rural, and inner-city environments not because it is the law but because it is the need of the hour. The major obstacle to funding is not the lack of funds but the lack of political will. As things stand today – tax cuts, sluggish economy, and the wars in Iraq and Afghanistan – the federal government is unlikely to provide funds for improving the education system. From a legal perspective, the federal government cannot be sued to provide adequate funds under NCLB.

NCLB is therefore nothing but a very good example of a law passed with noble intent but not followed in its spirits to achieve its goals.

Estate tax legislation was first passed in 1916 as a response to the excesses of the Gilded Age. The objective was to shift the tax burden from the Midwestern and Southern states to the rich Northeastern states. The tax burden in those days was mainly in the form of tariff duties and excise taxes. The legislation was recognition that democracy was at risk if too much wealth and power was concentrated in the hands of a few.

One cannot deny the contribution of estate tax to the progressivity of the tax system. The estate tax is the most progressive of any of the federal taxes. The main objective of estate tax is to reduce inequality of wealth and income. It basically applies only to the rich.

Only the super rich stand to benefit from the repealing of estate tax. Without estate tax, billions of dollars in revenue would be lost. The revenue loss over the next decade could be over a trillion dollars. This, at a time of record deficit, could impose an unconscionable burden on future generations. The trade deficit is at a historic high of $61 billion and growing. There are no plans or methods to repay it. This can plunge the U.S. into a drastic economic depression at any time. To make up for this, the government will have to increase taxation or cut Social Security, Medicare, environmental protection and many other government programs which are essential for the overall development of the nation. Any cut or decrease in these programs would be unfair and life-changing to middle class Americans and to the needy, children, elderly, and disabled.

Estate tax also encourages contributions to charity. The present system of estate tax afford the affluent a way of reducing the size of their estates by making contributions to charity. In fact the system operates as an incentive to contribute to charity.

Opponents of the estate tax system harp that it has led to many middle-class Americans losing their estate because of the taxes owed. This has been proved wrong by a study conducted by an organization called United for a Fair Economy. When the exemption increases to $3.5 million in 2009, the share of estates taxed will be about 0.16%. Rest of the estates will pass to the heirs tax free.

Another favorite argument of the critics is that estate tax is a form of double taxation – the estate holder has already paid income taxes and property taxes. Estate tax is not a tax on the estate-holder. It is a tax on the heirs who inherit the estate as an unearned gift.

Repealing of the estate tax will only benefit the rich. Middle class Americans will end up paying more taxes to make up for the revenue deficit.

One cannot accuse the government of being a mute spectator. But what everyone wants to know is will these efforts and the rescue plan succeed?

No doubt everyone wants it to succeed. At the heart of the rescue plan is an effort to keep the credit crunch from sending the economy into a tailspin. The economic downturn is going to be much worse if the financial system doesn’t get working again.

Somewhere in all this, one thing seems to be forgotten – the rescue plan and efforts doesn’t directly address the root cause of the crisis: falling home prices. It was the falling home prices that ultimately resulted in the present crisis. According to the National Association of Realtors, home prices are off 12 per cent from their peak and are expected to fall an additional 10 per cent to 15 per cent between now and mid-2009. Much needs to be done to stimulate demand for homes and to reduce mortgage delinquencies and foreclosures.

The steps taken by the government so far does not do anything to stop the spiral in home prices. This is reducing net worth and creating a falloff in consumer spending. To stimulate demand for homes, the federal government could offer low-interest loans to replace 20 per cent of homeowners’ mortgages. It is unlikely that the crisis will be resolved without addressing falling home prices.

Falling home prices leads to an increase in mortgage delinquencies and foreclosure. Many homeowners end up owning more on homes that their current worth. They then default on their mortgage payments causing foreclosures. The rise in foreclosures results in a negative market psychology. It is a vicious cycle.

The supply of homes on the market remains stubbornly high, while demand for those homes remains relatively weak. The $7,500 tax credit passed by Congress in July has failed to jump-start home sales.

Another factor which led to the present crisis is the total breakdown in the integrity of asset valuations. The government efforts do not address this. The government has not yet disclosed the pricing logic on which the US government will purchase bad debt from faltering financial institutions. It now appears that the prices will be determined on a case by case basis.

While some lawmakers want the government to exert influence over private companies in which taxpayer money is invested while some are calling for a ban on lobbying activity, bonuses and perks among the companies that have been bailed out by the government, nobody has suggested taking remedial action to rectify either the impaired status of asset valuation techniques.

Lawmakers are probably aware of the need to revamp asset valuation methodologies but they lack the will and fear the explosive political impact of any efforts that will directly challenge the qualifications of real estate brokers, appraisal specialists, bank managers, certified accountants, project engineers, corporate monitors and financial analysts.

This fund is the world’s largest, beating the $600 billion sovereign wealth fund of the oil-rich emirate of Abu Dhabi in the United Arab Emirates.

The fund has many characteristics of sovereign wealth funds. It endorses the latest trend – the most powerful financial entities are not risk-happy investment banks but state-sponsored investment entities that are more cautious.

So far, the United States government has stayed away from investing in the markets. The fund presumes that the government must play a crucial role in deciding how best to deploy a nation’s investment capital.

Critics have long argued that sovereign funds be allowed the privilege of holding positions in public companies when the U.S. government did not do so. When the fund was approved by Congress, it took the sting out of this argument. But there is a difference between this fund and sovereign wealth funds. Sovereign wealth funds invest surplus funds, and in many cases they are doing so abroad for the purpose of financial diversification. The money for this fund has to be borrowed by the Treasury: $700 billion. It will only be investing in the United States. It will make no investments abroad.

The mandate to the fund is clear - avoid further financial collapse by extending a lifeline to U.S. institutions hobbled by their exposure to toxic mortgage assets. This is similar to the goal of sovereign wealth funds – advancing national economic goals. The only difference is that sovereign wealth funds openly state that their goals are political. This fund on the other hand seeks the best prices for the assets it buys.

There are some who feel that the fund does not resemble a sovereign wealth fund, but some sovereign wealth funds are beginning to look like the fund. The present credit crisis is not restricted to the U.S. alone. It is having a worldwide impact. There is tremendous pressure of many of the sovereign wealth funds to come to the rescue of home markets that have wobbled in recent months.

The U.S. Treasury fund’s mandate will run out after two years. But the government might have other ideas if, at the end of two years, it has more than $1 trillion in assets - it has the benefit of starting to buy at what may well be the rock bottom. It could become a permanent fund, and its mandate could be broadened to allow it to invest abroad. It would then become a full-fledged sovereign wealth fund.

The banks actually competed with one another to dream up complex transactions for foreign hedge funds to avoid taxes. The probe also found that some of the internal communications show that the bank officials were concerned that they could run into trouble with the Internal Revenue Service (IRS).

The results of the probe clearly highlight the failure of the IRS and Treasury Department to enforce the law. The banks entered into agreements to give the hedge funds the economic value of dividends, without actually triggering a withholding tax on dividend payments. The foreign hedge funds would sell their stock to an U.S. investment bank just before a dividend was to be paid and simultaneously enter into a swap arrangement with that bank to retain the economics of stock ownership. The U.S. bank paid the foreign hedge fund a dividend equivalent but did not withhold any taxes. The funds technically didn’t own the shares. A few days later, the hedge funds would repurchase the stock from the U.S. bank.

The $32 billion special dividend by Microsoft in 2004 is said to be the trigger that spurred the investment banks and brokerage firms to sell products that would allow their hedge fund clients to avoid paying the associated taxes.

The investigation had some effect. Merrill Lynch & Co stopped doing some of the deals after the committee began its investigation although the investment bank claimed that it acted in good faith when it advised its clients – foreign hedge funds – and it acted appropriately under existing tax law. Citigroup voluntarily approached the IRS and paid $24 million in withholding taxes after an internal audit.

One of the beneficiaries of such transactions – Maverick Capital Management – estimated that such deals helped it avoid $95 million in taxes over an eight-year period.

The result of the probe raises one very important question – where does the loyalty of these investment banks and brokerage firms lie? They are American companies who have reaped all the benefits of being American companies. They have openly helped foreign hedge funds flout U.S. tax laws. Is there something called patriotism or is it profit at any cost?