Links to Yichuan’s LinkedIn Page, his Medium page and to his blog Synthenomics.

Yichuan Wang is my coauthor on two very popular Quartz columns, “After Crunching Reinhart and Rogoff’s Data, We Found No Evidence High Debt Slows Growth” and “Examining the Entrails: Is There Any Evidence for an Effect of Debt on Growth in the Reinhart and Rogoff Data?” along with other posts about Reinhart and Rogoff’s data linked there. Along with Fumio Hayashi and Yoshiro Tsutsui, he is also my coauthor on a (not yet completed) academic paper on the dynamics of happiness. And he is a Quartz columnist in his own right. As an undergraduate at the University of Michigan, he is taking my “Monetary and Financial Theory” class this semester, and has been writing three blog posts a week in that capacity. Yichuan has his own blog, Synthenomics, but I asked him if I could publish this very interesting and sophisticated post as a guest post–the 8th student guest post this semester. Here is Yichuan: 

Critics of Dish’s bidding strategies during the most recent AWS auction need to distinguish the difference between distorting prices and distorting taxpayer intent. While exploiting “small-business” tax breaks is distasteful because it violates the original intent of promoting business by minorities, such a payment subsidy likely increased the revenues from an auction which would have otherwise been dominated by AT&T and Verizon.

First, some background. The Advanced Wireless Services — 3 auction was an FCC auction for wireless spectrum. “Spectrum works like lanes on a highway, and wireless carriers have to buy more of it as they add subscribers and traffic increases.” As such, obtaining spectrum during these auctions is critical for companies who may wish to expand their wireless offerings.

AT&T and Verizon are obvious examples of such companies. But the real surprise was that Dish, a satellite TV company, won $13.3 bn. in spectrum in the auctions. Dish’s strategy relied on coordinating with three other “small business” entities. This had two benefits. First, it allowed a more complex bidding strategy. Because bids were anonymous, this created an illusion of more competition and drove prices higher. Second, it allowed Dish to benefit from a small business subsidy that took $3.3 billion dollars off of the sticker price.

I sympathize with comments from FCC Commissioner Ajit Pai that Dish’s bidding strategy “makes a mockery” of the “small business” part of the tax break. But is this a “distortion”?

In standard auction theory, we are typically concerned about two measures of efficiency. First, is the auction allocatively efficient? Second, does the auction maximize revenue? The first criterion is concerned with whether the spectrum is allocated to the firms who most value the spectrum. The second is concerned with whether the government is extorting — err, raising — the maximum amount of revenue from the bidders.

These two goals are often at odds. For example, suppose you have an auction system that is allocatively efficient, but the firm who values the spectrum the highest has much more wealth than all the other bidders. Think of this firm as AT&T. If AT&T is aware of this, then their optimal bid is much less than their true valuation of the spectrum — why pay more when they don’t have to? This, of course, screws over the FCC. So one possibility is to put in a minimum bid. But if you put this minimum bid too high, then nobody will bid and you lose allocative efficiency. But so long as you’re reasonable, you can raise much more revenue this way.

So did Dish make the auctions less allocatively efficient? On face, the answer seems to be yes. If Dish had a special price advantage due to tax benefits that could have unfairly given it spectrum that it didn’t deserve, then that could mean the spectrum wasn’t given to those who value it most.

But this doesn’t hold if Dish plans on monetizing its spectrum by selling it to other firms. T-Mobile has criticized Dish for hoarding spectrum and treating it more like a trade-able financial security. But if Dish sells its spectrum to another firm, then in the end the spectrum still ends up with a firm that values it most. Admittedly, Dish is engaging in tax-arbitrage — buying spectrum at tax advantaged prices and turning around to sell it to other less subsidy endowed firms. But this is a criticism of how Dish flaunts taxpayer intent, not of how Dish reduces allocative efficiency.

While the effect on efficiency is a wash, it’s clear that giving Dish a tax + strategic benefit in the bidding process dramatically raised revenues for the government. One estimate is that Dish’s actions raised the value of the auction by $20 bn. AT&T and Verizon could not just put in bids that were “big enough” — Dish and its subsidiaries made sure that AT&T and Verizon paid their valuations. In this light, Dish’s tax break could instead be seen as a tool to prevent Verizon and AT&T from dominating the auction.

Given this, it’s natural that AT&T and T-Mobile are crying foul. But in an auction with asymmetric bidders, tax subsidies that seem “unfair” may still be efficient and even revenue increasing.