Tuesday, June 19, 2018

Privileges for some, punishment for others

In case you missed it, Veronique de Rugy’s chart from last week is a must-see (and must-share):

This chart uses two measures of the revenue impact from taxing the rich (blue bars): the FY2013 amount and the 10-year average tax collection. The business and energy tax extenders (red bar) alone take away $67.7 billion from federal revenue in 2013.

Taxes collected from increasing rates on the rich in FY2013 amount to $27 billion, while tax revenue collected based on the average over 10 years is roughly $62 billion. Even in the best-case scenario for tax collection, the increases in revenue are lower than the amount being paid out to businesses and energy subsidies.

If President Obama had let all of the special tax breaks for businesses and energy companies expire, he would have raised more revenue than his tax hikes on high-income earners. The president’s actions contradict his professed desire to ensure that “the wealthiest corporation and individuals can’t take advantage of loopholes and deductions that aren’t available to most Americans.”

Privileges for some, punishment for others

Here is the chart:

revenue-impact-tax-hikes-vs-extenders-chart

(click on the image to see large)

Read the whole post here.

Also, don’t miss Vero’s latest blog post. It addresses a newly-discovered provision in the fiscal cliff deal. The provision reduces Medicare payments for one and only one firm, a company that happens to directly compete with another firm that figures prominently in the Senator Majority leader’s state.

January 29, 2013

Step one in obtaining government privilege is to have a seat at the table

The weekend edition of the WSJ featured an interview with Uber founder Travis Kalanick by Andy Kessler. It offers a nice lesson in how regulatory bodies can get captured by incumbent firms. In city after city Kalanick and his team encountered regulations and regulators intent on privileging the established taxi and luxury limousine industries.

The interview touches a bit on the Uber experience with the DC Council, (which I first wrote about back in July):

…the city tried to change the law—with what were actually called Uber Amendments—to set a floor on the company’s rates at five times those charged by taxis. “The rationale, in the frickin’ amendment, you can look it up, said ‘We need to keep the town-car business from competing with the taxi industry,’ ” Mr. Kalanick says. “It’s anticompetitive behavior. If a CEO did that kind of stuff—you’d be in jail.”

In the end, the city backed away from its proposal, allowing Uber to operate without the requirement that it charge 5 times what its competitors were charging. So far so good. Unfortunately, however, the legislation that gave Uber access to the DC market also mandated that any firm wishing to serve that market be licensed. As I wrote in The Washington Examiner in December, this adds one more chapter to the story:

As tech reporter Ryan Lawler points out, the licensing requirement erects a barrier to entry for other businesses. SideCar, for example, is a West Coast service that, according to its website, “instantly connects people with extra space in their cars with those who need to get from one place to another.” It is, they say, “like a quick and hassle-free carpool.” Since these instant carpoolers are obviously not licensed, they’d be illegal in DC. That’s handy for Uber. The company managed to cross the regulatory velvet rope and, alongside taxis, obtain access to a lucrative market. But once inside, Uber put the rope back up.

The incident raises questions about how much responsibility firms bear for the privileges they enjoy. I honestly don’t believe Mr. Kalanick set out to obtain a privilege for his firm. The problem is that once he had safely passed through the maze of red tape, he hardly had an incentive to ensure that anyone following him got through. And, of course, he even stood to gain if no one did. The simple fact is that when the deal was hashed out, Mr. Kalanick was at the table while the folks at SideCar (and hundreds, if not thousands of other would-be startups) were not. This is how regulatory capture works.

January 28, 2013

A government that hands out privileges can expect corruption

According to the Washington Post, the mafia is heavily involved in Spain’s Italy’s renewable energy market. This is not particularly surprising given that firms in that market compete on a manifestly uneven playing field.

The Godfather Movie in TextIn a market characterized by a genuinely level playing field—one in which no firm or industry benefits from government-granted privilege—the only way to profit is to offer something of value to customers. If you fail to create value for voluntarily paying customers, they won’t volunteer their money. It’s that simple.

But things are different when the playing field can be tilted through government-granted privileges. This is because when the playing field can be tilted, firms have an incentive to find some way to persuade the government to tilt it their way. And the most persuasive techniques aren’t always above board.

The problem is that objective standards for playing favorites are hard to come by. This can corrupt even well-intentioned programs that privilege particular behavior in the name of serving the general good.

Imagine you are a politician and you want to reward firms that specialize in renewable energy. How do you determine who makes the cut? What if you want to reward companies that securitize mortgages for low-income households. How do you decide whom to reward? Or say you want to bailout “systemically important” banks. Where do you draw the line between systemically important and systemically unimportant?

Without objective guideposts, subjective factors loom large: whom do you interact with the most? Whom have you known the longest? Which firms share your ideological perspective? Which are headquartered in your hometown?

Even the most well-intentioned of politicians are susceptible to these considerations because all humans are susceptible to these considerations. That’s why a slew of research has found government-granted privileges are often associated with corruption. For example, in an examination of 450 firms in 35 countries, economists Mara Faccio, Ronald Masulis, and John McConnell found that politically connected firms are more likely to be bailed out than non-connected firms. It’s possible that more deserving firms just happen to be politically connected, but this strains credulity. A more plausible explanation is that in the absence of an objective standard for dispensing privileges, politicians reward those they know.

And when that is the case, firms make it their business to get to know politicians. Just ask Angelo Mozilo, the politically ensconced former head of Countrywide Financial. Countrywide supplied the loans that were repackaged by the federally backed Fannie Mae. And since Countrywide’s business model depended on the favor of politicians, Mozilo made sure he was in good standing with his benefactors. Under a program known internally as the “Friends of Angelo” program, Countrywide offered favorable mortgage financing to the likes of Senate Banking Committee Chairman Christopher Dodd and Senate Budget Committee Chairman Kent Conrad.

The conventional route to profit is to please one’s customers. But when firms are able to profit by pleasing politicians, they will do whatever it takes to please politicians. Which brings us back to Spain Italy and renewables. The current investigation (known as operation Eolo after the Greek god of wind) first bore fruit in 2010 when eight people were arrested for bribing officials with cash and luxury cars. Armed with more evidence, officials have now arrested another dozen crime bosses.

It is good, of course, to have police who investigate these matters. But a far simpler, equitable, and efficient solution is to create a truly level playing field for business. When politicians cannot tilt the playing field in favor of particular firms or industries, businesses have nothing to gain from bribery and connections.

Put away the honey jar and you won’t have an ant problem.

photo by: labnol
January 25, 2013

Separation between art and state

In Utah, the Sutherland Institute is leading an effort to stop state support for the Sundance Film Festival. On the organization’s blog Derek Monson writes:

Given the amount of sexual promiscuity that Sundance Film Festival regularly brings to Utah, it seems similarly indecent that Utah’s major economic development agencies basically endorsed the event: providing “critical support” to the festival as a “global branding” opportunity, and being listed under the event’s “Corporate Support” banner.

The institute’s president Paul Mero says that the organization is opposed to all corporate subsidies. From an economic position — and one of fairness — this makes sense. As Matt has written, subsidies that favor one type of business lead to inefficient investment thereby decreasing economic growth. When Utah policymakers tout the economic benefits that the festival brings to the state, they are ignoring that the festival would likely be held in Park City for its scenic location without a subsidy and the unseen costs of directing taxpayer resources away from what they would otherwise be invested in.

In this case of subsidized art, however, those receiving the subsidies should be as wary as the taxpayers providing them. No one at the Sutherland Institute has suggested placing restrictions on the content of the films allowed at Sundance, rather they object to their tax dollars supporting supporting a film festival, and one that contains films some may find offensive at that. But in many other cases, public funding for art breeds censorship.

In 2010, the Smithsonian’s National Portrait Gallery famously removed a video by David Wojnarowicz which had been a part of an exhibit called Hide/Seek in response to conservative groups and the Catholic League which described the work as  as “designed to insult and inflict injury and assault the sensibilities of Christians.” Understandably, these groups protested their tax dollars being spent on art they found offensive, but just as understandably artists participating in the exhibit objected to government censorship of their colleague’s work. In reaction, AA Bronson asked the National Portrait Gallery to remove his work in protest, but his request was denied by the museum.

The many examples of censorship of government-funded art and art museums provide compelling reasons for art and state to remain separate, both to protect taxpayers and economic growth along with artists’ freedom of expression.

January 24, 2013

States Aim to Eliminate Corporate and Individual Income Taxes

Although the prospects of fundamental tax reform on the federal level continue to look bleak, the sprigs of beneficial tax proposals in states across the US are beginning to grow and gain political support. Perhaps motivated by the twin problems of tough budgeting options and mounting liability obligations that states face in this stubborn economy, the governors of several states have recommended a variety of tax reform proposals, many of which aim to lower or completely eliminate corporate and individual income taxes, which would increase state economic growth and hopefully improve the revenues that flow into state coffers along the way.

Here is a sampling of the proposals:

  • Nebraska: During his State of the State address last week, Gov. Dave Heineman outlined his vision of a reformed tax system that would be “modernized and transformed” to reflect the realities of his state’s current economic environment. His bold plan would completely eliminate the income tax and corporate income tax in Nebraska and shift to a sales tax as the state’s main revenue source. To do this, the governor proposes to eliminate approximately $2.8 billion dollars in sales tax exemptions for purchases as diverse as school lunches and visits to the laundromat. If the entire plan proves to be politically unpalatable, Heineman is prepared to settle for at least reducing these rates as a way to improve his state’s competitiveness.
  • North Carolina: Legislative leaders in the Tar Heel State have likewise been eying their individual and corporate income taxes as cumbersome impediments to economic growth and competitiveness that they’d like to jettison. State Senate leader Phil Berger made waves last week by announcing his coalition’s intentions to ax these taxes. In their place would be a higher sales tax, up from 6.75% to 8%, which would be free from the myriad exemptions that have clogged the revenue-generating abilities of the sales tax over the years.
  • Louisiana: In a similar vein, Gov. Bobby Jindal of Louisiana has called for the elimination of the individual and corporate income taxes in his state. In a prepared statement given to the Times-Picayune, Jindal emphasized the need to simplify Louisiana’s currently complex tax system in order to “foster an environment where businesses want to invest and create good-paying jobs.” To ensure that the proposal is revenue neutral, Jindal proposes to raise sale taxes while keeping those rates as “low and flat” as possible.
  • Kansas: Emboldened by the previous legislative year’s successful income tax rate reduction and an overwhelmingly supportive legislature, Kansas Gov. Sam Brownback laid out his plans to further lower the top Kansas state income tax rate from the current 4.9% to 3.5%. Eventually, Brownback dreams of completely abolishing the income tax. “Look out Texas,” he chided during last week’s State of the State address, “here comes Kansas!” Like the other states that are aiming to lower or remove state income taxes, Kansas would make up for the loss in revenue through an increased sales tax. Bonus points for Kansas: Brownback is also eying the Kansas mortgage interest tax deduction as the next to go, the benefits of which I discussed in my last post.

These plans for reform are as bold as they are novel; no state has legislatively eliminated state income taxes since resource-rich Alaska did so in 1980. It is interesting that the aforementioned reform leaders all referenced the uncertainty and complexity of their current state tax systems as the primary motivator for eliminating state income taxes. Seth Giertz and Jacob Feldman tackled this issue in their Mercatus Research paper, “The Economic Costs of Tax Policy Uncertainty,” last fall. The authors argued that complex tax systems that are laden with targeted deductions tend to concentrate benefits towards the politically-connected and therefore result in an inefficient tax system to the detriment of everyone within that system.

Additionally, moving to a sales tax model of revenue-generation may provide state governments with a more stable revenue source when compared to the previous regime based on personal and corporate income taxes. As Matt argued before, the progressive taxation of personal and corporate income is a particularly volatile source of revenue and tends to suddenly dry up in times of economic hardship. What’s more, a state’s reliance on corporate and personal income taxes as a primary source of revenue is associated with large state budget gaps, a constant concern for squeezed state finances.

If these governors are successful and they are able to move their states to a straightforward tax system based on a sales tax, they will likely see the economic growth and increased investment that they seek.

Keep an eye on these states in the following year: depending on the success of their reforms and tax policies, more states could be soon to follow.

January 24, 2013

President calls for an end to government-granted privilege

As expected, there were a number of beautiful words in the President’s Second Inaugural. In my view, the most-beautiful were:

The patriots of 1776 did not fight to replace the tyranny of a king with the privileges of a few, or the rule of a mob. They gave to us a republic, a government of, and by, and for the people.

(Okay, so the POTUS didn’t provide a hyperlink to my Mercatus paper on government-granted privilege, but maybe the Government Printing Office will one day add one).

cronyismIn any case, one can only hope that this is a signal that the president has decided that the time has come to abandon government-granted privileges. No more bailouts of particular firms like GM (or, more accurately, certain of GM’s creditors but not others). No more expected bailouts that allow firms like Fannie Mae to borrow at significantly lower interest rates than their competitors. No more subsidies to farmers. No more regulations that require consumers to buy certain products such as health insurance. No more tax breaks for manufacturers just because they make things rather than provide services. No more loan guarantees for certain energy firms because they make politically correct products. No more monopoly status for the USPS. No more price supports for sugar producers or tariffs that benefit domestic makers of solar panels.

Hopefully, this signals a new era of non-discriminatory democracy. I won’t hold my breath.

January 22, 2013

Political espionage and government intervention

“To govern is to choose,” John F. Kennedy famously declared. And when governments intervene in markets, they inevitably choose to favor some business forms over others.

Sometimes this is obvious, as when a local government considers a regulation which conspicuously privileges one type of operator at the expense of another. Sometimes this is less-obvious, as when a licensing regime raises barriers to entry, privileging incumbent firms at the expense of those that might enter the market.

Sometimes the privilege is nearly hidden. Last year, I wrote about laws banning old-fashioned incandescent light bulbs. NPR’s Peter Overby had reported that major light bulb manufacturers actually liked the ban and spent money lobbying to maintain it. Why would a firm possibly want to limit its options? After all, it can make curly-Q light bulbs whether the old kind are legal or not. The answer seems to be that the ban benefited large, established firms because it kept customers from buying the older, cheaper alternative bulbs from rivals who weren’t as good at making the newfangled kind.

The point is that it is nearly impossible to formulate an intervention that treats all firms equally. Even a flat rate tax will fall more heavily on small firms because they lack the compliance resources that the big ones have. It goes without saying that this tendency is even greater when interventions violate generality.

When government policy can make or break a business, you can bet that the business will take an interest in policy. Very large sums of money are at stake when a city council considers a new regulation, when Congress considers requiring customers to buy a certain product, or when the FDA considers approving a new drug. It should come as no surprise, then, that some enterprising folks have set up firms that specialize in reading the tea leaves of government policy. These firms help their clients predict what new rules, regulations, taxes, subsidies, etc. might be coming down the pike. And firms are willing to pay pretty hefty sums for these prognostications, especially when policy is difficult to predict (as, for example, when it turns on the arbitrary beliefs of certain regulators).

Brody Mullins and Susan Pulliam write about just such a firm in a fascinating article in yesterday’s Wall Street Journal.

Naturally, lawmakers take a dim view of this activity. Senator Charles Grassley (R-IA) wants these “political intelligence specialists” to disclose their clients, activities, and fees: “We ought to know who these people are that seek political and economic espionage,” he says.

I have another idea. Rather than regulate the firms that are trying to figure out whom government is going to punish and whom it is going to privilege, why not eliminate discriminatory government policy? Why not limit government intervention in the market? And why not ensure that policy turns on predictable rules rather than arbitrary decisions?

If government cannot privilege some and punish others, then insider information will be worth next to nothing. If government interventions are limited, then firms will not live or die at the whim of politicians and regulators. And if policy is predictable and rational, share prices will reflect policy expectations, and there will be no way to profit from insider information.

If to govern is to choose some business forms over others, then sometimes the best option is not to govern and to let people choose for themselves.

January 19, 2013

Apply for the Mercatus MA Fellowship

One of the more rewarding aspects of my job is the opportunity it affords me to work alongside dozens of bright, ambitious, Mercatus MA Fellows. The Mercatus MA Fellowship is a competitive, full-time fellowship program for students pursuing a master’s degree in economics at George Mason University. It is ideal for those interested in pursuing a career in public policy rather than academia (for those interested in the academic route, the Ph.D. Fellowship may be for you). The MA Fellowship includes full tuition support, a stipend, and a research assistantship position with Mercatus scholars. It is a total award of up to $80,000 over two years.

Successful MA Fellows—including my co-blogger and MA Fellowship alumna, Emily Washington—have gone on to do great things. Some have secured public policy positions in federal and state government; others work at prominent research institutions. If you are interested, you better hurry. The application deadline for Fall 2013 is March 1, 2013. Apply here.

January 17, 2013

Economic Freedom and Economic Privilege

Heritage indexLast week, the Wall Street Journal and the Heritage Foundation released their annual Index of Economic Freedom by Terry Miller, Kim Holmes, and Edwin Feulner. I was delighted to contribute a chapter on government-granted privilege. I began by noting that despite the manifest evidence of a strong empirical link between economic freedom and economic prosperity, large numbers of people still lack basic economic freedoms.

In the latest edition of the Index, for example, 92 countries—home to nearly 70 percent of all of humanity—were listed as “mostly unfree” or “repressed.” Even among the freer nations such as the United States, economic freedom in recent years has been declining.

Why? I suggest two answers. The first is that ideas matter and we are currently losing the battle of ideas.

The second answer is more difficult:

Put simply, some entrenched interests benefit from the current lack of economic freedom and are prepared to go to great lengths to maintain the unfree status quo.

If this is not immediately obvious, it may be because the advocates of economic freedom often fail to emphasize it. Too often, those of us who argue for freedom highlight the fact that taxes are crushing, that regulations are burdensome, and that government involvement in the economy is an impediment to progress. While this is typically true, it is also true that tax dollars line the pockets of some well-connected companies, that regulations often allow some firms to profit at the expense of customers and competitors, and that almost every intervention in the market creates both losers and winners.

The chapter, adapted from The Pathology of Privilege, can be found here.

There are other interesting contributions from Robert Barro on “Democracy, Law and Order, and Economic Growth”; James Roberts and John Robinson on how “Property Rights Can Solve the Resource Curse”; and by Myron Brilliant on how “Good Business Demands Good Governance.”

Also, don’t miss Miller’s OpEd from the Wall Street Journal. It offers a nice overview of the latest data and a summary of the chapters. Lastly, be sure to spend some time exploring the data and the website. They’ve done a brilliant job of bringing all of this information together and presenting it in a user-friendly way.

My thanks to Heritage and especially to Terry Miller for the opportunity.

January 15, 2013

Virginia’s transportation plan under the microscope

Last week Virginia Governor Bob McDonnell shared his plan to address the state’s transportation needs. The big news is that the Governor wants to eliminate Virginia’s gas tax of 17.5 cents/gallon. This revenue would be replaced with an increase in the state’s sales tax from 5 percent to 5.8 percent. This along with a transfer of $812 million from the general fund, a $15 increase in the car registration fee, a $100 fee on alternative fuel vehicles and the promise of federal revenues should Congress pass legislation to tax online sales brings the total amount of revenue projected to fund Virginia’s transportation to $3.1 billion.

As the Tax Foundation points out, more than half of this relies on a transfer from the state’s general fund, and on Congressional legislation that has not yet passed.

Virginia plans to spend $4.9 billion on transportation. As currently structured, the gas tax only brings in $961 million. There are a few reasons why. First, Virginia hasn’t indexed the gas tax to inflation since 1986. It’s currently worth 40 cents on the dollar. In today’s dollars 17.5 cents is worth about 8 cents. Secondly, while there are more drivers in Virginia, cars are also more fuel efficient and more of those cars (91,000) are alternative fuel. In 2013, the gas tax isn’t bringing in the same amount of revenue as it once did.

But that doesn’t mean that switching from a user-based tax to a general tax isn’t problematic. Two concerns are transparency and fairness. Switching from (an imperfect) user-based fee to a broader tax breaks the link between those who use the roads and those who pay, shorting an important feedback mechanism. Another issue is fairness. Moving from a gas tax to a sales tax leads to cross-subsidization. Those who don’t drive pay for others’ road usage.

The proposal has received a fair amount of criticism with other approaches suggested. Randal O’Toole at Cato likes the idea of Vehicle Miles Travelled (VMT) which would track the number of miles driven via an EZ-Pass type technology billing the user directly for road usage. It would probably take at least a decade to fully implement. And, some have strong libertarian objections. Joseph Henchman at the Tax Foundation proposes a mix of indexing the gas tax to inflation, increased tolls, and levying a local transportation sales tax on NOVA drivers.

The plan opens up Virginia’s 2013 legislative session and is sure to receive a fair amount of discussion among legislators.

January 14, 2013

James M. Buchanan: Realistic Optimist

This week we mourn the passing and celebrate the achievements of James M. Buchanan. There have already been many moving and informative tributes. Alex Tabarrok offers a nice summary here. I was fortunate to take one of the last classes Buchanan taught. Even though he was well into his eighties, I found him to be sharp, enthusiastic, and more than a little intimidating to this graduate student.

I’m sure people will be debating Buchanan’s contributions and legacy for quite some time. One aspect that seems unsettled is the degree to which Buchanan’s legacy is optimistic or fatalistic. An old exchange I had with Matt Yglesias highlights the optimism I found in Buchanan’s work:

Back in 2011, in a post titled “Against Public Choice, For Public Virtue,” Matt declared: “I don’t really “get” public choice and think I never will.” He argued:

The observation that malgovernment is a major source of human ills is quite correct, but embracing fatalism about it only exacerbates the problem. What’s needed are efforts to push societies in the direction of taking honor and civic obligation more seriously, not less so.

In a post responding to Matt, I made the case that public choice is no more fatalistic about government failure than other branches of econ are fatalistic about market failure:

Consider a problem from normal economics: the tragedy of the commons. Armed with empirical and theoretical reasons to expect that fishermen will over-fish a common pool, we should plan accordingly. We should examine the incentives of fishermen and think of ways to improve or alter these incentives (e.g., assign property rights over the pool, or impose a Pigouvian tax). To my knowledge, few if any economists would council that we ought to spend our time begging fisherman to pretty please stop overfishing. That is likely to be a fool’s errand.

The idea is much the same with public choice. Armed with empirical and theoretical reasons to think that politicians might do bad things, we should plan accordingly by placing some things—such as the establishment of religion—beyond the reach of politicians. I suppose we could ask Congress to pretty please not establish a religion but in my view it is better to make it illegal for them to do so.

James Buchanan, Gordon Tullock, and the other founders of Public Choice and its close-cousin Constitutional Political Economy didn’t stop their analysis after they found that politicians sometimes behave badly. Like James Madison before them, they thought of constructive ways to make political actors behave better, sometimes by placing certain decisions beyond their reach.

There is nothing fatalistic about that.

 

January 11, 2013

Welcome Andrea

NFX readers will notice a new name appearing in their RSS feeds. I’m delighted to welcome my coauthor Andrea Castillo to the blog. When she isn’t coauthoring with me, she’s coauthoring with more eminent scholars such as Florida State’s Randall Holcombe (don’t miss their excellent forthcoming paper on the ways cronyism manifests itself in various economic and political structures). And when she isn’t coauthoring with anyone, she is keeping the Mercatus trains running on time as a program associate. You will soon discover, as did I, that she is a superb writer and a gifted researcher. As exhibit A, see her first post on the mortgage interest deduction.

January 8, 2013

What’s Good for General Motors May be BAD for the Country

Marketplace recently did a segment on the federal government’s announcement that it was getting out of the car business and would be selling off its stake in GM over the next two years. Marketplace reporter Nancy Marshall-Genzer first turned to Cato’s Dan Ikenson who noted that taxpayers would likely “need to assume a loss of $15 to $20 billion.”

Then, she turned to Sean McAlinden of the Center for Automotive Research who believes that taxpayers will break even.

“Is he math-challenged?” she asks. Not when you “look beyond the bailout cost” and consider that the bailout meant government ended up spending less on unemployment checks, that it got more income-tax revenue from auto industry employees, and “Then there’s the trickle-down effect.” To wit:

Without GM, auto parts suppliers would have struggled. Maybe gone under themselves. The carmakers use many of the same suppliers, so assembly lines at Ford would have ground to a halt. Dealerships would have suffered too.

A few things to note:

First, I love that she uses “trickle-down” in the way it should be used: in reference to a top-down government policy that transfers wealth from the taxpayer to well-to-do firms in hopes that the transfer will eventually “trickle down” to the little guy. I’ve long felt that if there were any justice in the English language, policies such as these would be called “trickle-down economics.” More commonly, of course, it is across-the-board tax cuts that don’t transfer wealth but instead abstain from taxing that go by the name “trickle-down.”

Second, as long as we are looking “beyond the bailout cost” let’s also look beyond the “trickle-down” effect (which I find dubious, but I’ll leave that to another day) and consider some additional negative consequences of a bailout. In my paper on government-granted privilege, I catalogue a host of problems that may arise when government bestows favors on particular firms or industries. These include:

  1. Less competition, yielding higher prices for consumers and less economic surplus
  2. X-inefficiency (i.e. higher production costs)
  3. Lower quality goods and less innovation
  4. Rent-seeking (people invest valuable resources asking for bailouts)
  5. Unproductive entrepreneurship (entrepreneurs busy themselves thinking of new ways to obtain bailouts instead of new ways to create value for customers)
  6. Moral hazard (firms are incentivized to make mistakes when they know that mistakes might entitle them to a bailout.
  7. Loss of innovation and diminished long-run economic growth
  8. Increased short-run macroeconomic instability
  9. Increased cronyism, which can erode social trust and diminish the legitimacy of both government and business

You can read my paper for arguments and citations for each of these claims (though this appropriately-titled paper is a good place to start).

Now let me add two more problems that are specific to the auto bailout:

  1. In choosing to give the union’s Voluntary Employee Beneficiary Association greater priority than claims by other unsecured creditors such as suppliers and unsecured bond holders, the Administration’s auto bailout overturned a bedrock principle of bankruptcy law (namely that those creditors with similar claims be treated equally). My Mercatus colleague, GMU Law Professor Todd Zywicki, has written about this with the Heritage Foundation’s James Sherk here, and here. It isn’t clear yet at this point what sort of precedent this will set. But if unions were the winners here, generality and the rule of law seem to have been the losers.
  2. The auto bailout seems to have radically shifted the Democratic Party’s position on the relationship between government and business. As Timothy Taylor pointed out in October, there was a time when Democrats openly mocked Republicans who claimed that “what’s good for General Motors is good for the country.” There was a time when Democrats believed that social safety nets were supposed to catch individuals who were down on their luck, not the firms at which these individuals happened to work. As Luigi Zingales points out in A Capitalism for the People, the Democratic Party’s one-time antagonism to business sometimes proved a healthy check on Republicans who too often confused being pro-market with being pro-business. Now that Democrats, too, think that their job is to help corporate America, there is effectively no organized political check on crony-capitalism.
January 8, 2013

The Home Mortgage Interest Deduction: A Bad Deal for Taxpayers

A new policy brief released by the Mercatus Center and co-authored by Jeremy Horpedahl and Harrison Searles analyzes one of the most popular—and therefore one of the most difficult to reform—subsidies in the tax code: the home mortgage interest deduction. This study touches on many of the points that Emily talked about in her op-ed on the subject last month; namely, this policy’s failure to achieve its intended effects and the fact that a lion’s share of the benefits go to high-income homeowners. Despite widespread enthusiasm for the home mortgage interest deduction, the authors argue that the benefits of this policy are overstated and the consequences are understated.

The home mortgage interest deduction is one of the largest tax expenditures in the U.S. tax code, second only to the non-taxation of employer-provided health insurance and pension contributions. Proponents of the home mortgage interest deduction argue that this policy provides needed tax relief to the middle class and encourages the oft-invoked American dream of homeownership. These folks may be surprised to learn, as Horpedahl and Searles point out, that a mere 21.7% of taxpayers even claim this benefit. What’s more, most of these benefits don’t go to the middle class, but rather to households with incomes of over $200,000. Here’s a breakdown of the tax savings from the brief:


The claim that this policy is necessary to encourage home ownership is dubious as well. The authors explain:

Empirical evidence supports the claim that the mortgage interest deduction has little effect on homeownership rates in the United States. Between 1960 and 1997, homeownership rates stayed within a narrow range of 62 to 66 percent, despite the fact that the implicit tax subsidy fluctuated dramatically. During the recent housing bubble, the homeownership rate rose to 69 percent, but it has since returned to the historical range. This rise appears to have been unrelated to the mortgage interest deduction, though it was almost certainly related to other housing policies that encouraged the bubble. More sophisticated analysis suggests that the homeownership rate would be modestly lower without the deduction, by around 0.4 percent.

Ironically, the home mortgage interest deduction likely creates the perverse effect of discouraging homeownership by artificially raising home values. Economic intuition suggests, and empirical studies have supported, that the deduction does not provide much in the way of savings at all since the value of the deduction is simply capitalized into the value of home prices. The artificially higher house prices prevent would-be home owners on the margins of affordability from purchasing a home within their price range. This effect, combined with the low rates of deduction claims and concentration of benefits to high-income earners, likely contributes to the inefficacy of the home mortgage interest deduction to boost homeownership to the degree that its proponents envisioned.

Additionally, countries like Canada and Australia have managed to produce comparable rates of home ownership as the US without the crutch of a mortgage interest deduction.

While the home mortgage interest deduction doesn’t do much for increasing the number of houses, it has a knack for increasing the size of houses, as a study by Lori Taylor of the Federal Reserve Bank of Dallas pointed out. The deduction has had the unintended consequence of directing capital and labor to high-income residential housing projects that might not have been taken without government intervention—and the benefits overwhelmingly go to the wealthy.

This is all before considering the regressive effects of the policy by design: low- and middle-income renters are made to subsidize the increasingly opulent residences (and sometimes the extra vacation homes!) of their more well-off peers while they struggle to make ends meet in a sometimes-inhospitable economy. This injustice, combined with the inefficacy of the tax deduction to increase homeownership in any meaningful way, causes the justifications for the mortgage interest deduction to grow scarce.

In fact, it is becoming increasingly clear that this policy, which evaded the fate of its similar counterpart—the credit card interest deduction—during the tax fight of 1986, continues as law not because of good economics but because of bad political incentives.

Horpedahl and Searles offer three proposals for scaling back the home mortgage interest deduction: policymakers could 1) eliminate the deduction entirely, 2) eliminate the deduction while simultaneously lowering marginal income tax rates to compensate for the virtual tax increase, or 3) stop the deduction and replace it with a tax credit that taxpayers could redeem upon purchase of their first house. Horpedahl and Searles demonstrate that while this deduction is popular with the public and the real estate industry, it is simply a bad deal for most taxpayers.

January 8, 2013

Don’t make us drive these cattle over the cliff

First a brief note: I am now blogging at the American Spectator on economic issues. I invite you to visit the inaugural posts. Last week, I covered the fiscal cliff. Like many others, I also marvel at the audacity of the pork contained therein.

Lately the headlines have given me a flashback to 1990 and those first undergrad economics classes. And not just econ but also U.S. history and the American experience with price floors and ceilings. In this post I’ll discuss the floors.

As I note at The Spectacle one of the matters settled by the American Taxpayer Relief Act is the extension of dairy price supports from the 2008 farm bill. Now, Congress won’t be “forced to charge $8 gallon for milk.” To me, nothing screams government price-fixing more than this threat aimed to scare small children and the parents who buy their food.

Chris Edwards explains how America’s dairy subsidy programs work in Milk Madness. Since the 1930′s the federal government  has set the minimum price to be charged for dairy. A misguided idea from the start, the point of the program was to ensure that dairy farmers weren’t hurt by falling prices during the Great Depression. When market prices fall below the government set price the government agrees to buy up any excess butter, dry milk or cheese that is produced. Thusly, dairy prices are kept artificially high which stimulates more demand.

According to Edwards’ study, the OECD found that U.S. dairy policies create a 26 percent “implicit tax” on milk, a regressive tax that affects low-income families in particular. Taxpayers pay to keep food prices artificially high, generate waste, and prevent local farmers from entering a caretlized market.

Now for the cows. The recession revealed that the nation has an oversupply of them. The New York Times reports that rapid expansion in the U.S. dairy market driven by increased global demand for milk products came to a sudden halt in 2008. Farmers were left with cows that needed to be milked regardless of the slump in world prices. The excess dry milk was then sold to the government but only at a price that was set above what the market demanded.

In other words, in a world without price supports, farmers could have sold the milk for less at market and consumers would have enjoyed cheaper butter, cheese and baby formula. Instead, the government stepped in, bought $91 million in milk powder so the farmer could get an above-market price and keep supporting an excess of milk cows. Rather than downsize the dairy based on market signals (and sell part of the herd to other dairy farmers, or the butcher) farmers take the subsidy and keep one too many cows pumping out more milk than is demanded.

It turns out auctioning a herd is not something all farmers are anxious to do. Some may look for additional governmental assistance to keep their cattle fed in spite of dropping prices, increased feed costs, and bad weather. To be sure eliminating farm subsidies would produce a temporary shock (a windfall for farmers and sticker shock for consumers), but in the long run as markets adjust everyone benefits.Dairy cows in the sale ring at the Warragul cattle sales, Victoria, [2]

New Zealand did it. Thirty years later and costs are lower for consumers, farmers are thrivingenvironmental practices have improved, and organic farming is growing. While politicians and the farm lobby may continue pushing for inefficient agricultural policy in spite of the nation’s fiscal path,as Robert Samuelson at Real Clear Politics writes, “If we can’t kill farm subsidies, what can we kill?”

 

January 7, 2013

More money for FEMA does not guarantee improved results

Before Congress passed $9.7 billion in Hurricane Sandy relief spending today, Governor Christie made headlines for his angry response to the House GOP’s delay in approving relief funds. The new spending will provide FEMA with money to pay out claims to those holding federal flood insurance. While the Hurricane Sandy relief effort gives political immediacy to FEMA funding, the Center for American Progress proposes a longer term strategy for dealing with natural disasters:

There must  be a dedicated source of revenue to fund predisaster mitigation programs that is not susceptible to budget cuts or political manipulation. Since the frequency and/or severity of extreme weather events will be exacerbated by climate change, it makes sense to raise revenue for resiliency from the fossil fuels whose combustion emits carbon pollution responsible for climate change.

The perspective that disaster recovery is a core responsibility of the federal government is widely shared, and voices as diverse as Governor Christie to the Center for American Progress express this opinion. However, the Mercatus Center’s Gulf Coast Recovery Project conducted in the wake of Hurricane Katrina demonstrates that funneling federal dollars toward disaster relief does not guarantee positive results for disaster victims. While the FEMA response to Hurricane Sandy went more smoothly than the Hurricane Katrina response, the federal government simply doesn’t have the capability to respond quickly and efficiently to individuals’ needs following a disaster, and channeling more resources to FEMA from any revenue source will not change the this fact.

As Pete Leeson and Russ Sobel write in a 2007 paper (pdf):

Following a natural disaster, on the one side there are “relief demanders”—individuals who desperately need disaster-relief supplies, including evacuation, food, shelter, medical attention, and so forth. On the other side, there are “relief suppliers”—individuals ready and willing to bring their supplies and expertise to bear in meeting the relief demanders’ needs. On both sides of this “market,” information is decentralized, local, and often inarticulate. Relief demanders know when relief is needed, what they need, and in what quantities, but they do not necessarily know who has the relief supplies they require or how to obtain them. Similarly, relief suppliers know what relief supplies they have and how they can help, but they may be largely unaware of whether relief is required and, if it is, what is needed, by whom, and in what locations and quantities.

[. . .]

Government’s informational deficit in the disaster-relief context is an unavoidable outcome of the centralization of disaster relief management when relief is provided by the state. Disaster-relief reforms that leave government as the primary manager of natural disasters are thus bound to fail. Correcting government’s information failure in the context of disaster relief requires eliminating its root cause: government involvement itself.

Researchers on the Gulf Coast Recovery Project found that non-profits, civic organizationsprivate firms, and individuals were more successful at providing the goods and services needed for recovery than the federal government.

Aside from the inherent challenges facing federal disaster response, funneling federal tax dollars to coastal areas prone to flooding leads to moral hazard. Because residents of flood-prone areas purchase federal insurance, taxpayers subsidize those who choose to live in these high-risk areas. Eli Lehrer of the R Street Institute explains this aspect of the Hurricane Sandy Relief Bill to Climate Wire:

“The mitigation piece of it is problematic,” said Eli Lehrer, president of the R Street Institute, a conservative organization that works with environmentalists and insurers to reduce subsidies in public insurance programs. “I think the bill should be drastically scaled back overall.”

He suggests that the disaster supplemental package could be cut in half. That would save taxpayer money, he says, now and in the future — by reducing incentives to develop coastlines. Lehrer also proposes cutting the federal share of post-disaster rebuilding costs to 50 percent. Currently, the government pays for 75 percent of recovery efforts, and Obama is asking Congress to increase that to 90 percent for Sandy survivors.

Politicians and activists who support a large role for the federal government in responding to disasters may have the best of intentions, but these intentions cannot circumvent the knowledge problems that government faces in disaster relief. By reducing the cost of developing in flood plains, greater reliance on the federal government for disaster mitigation and relief will be a costly effort unlikely to provide an adequate response when the next disaster strikes.

January 4, 2013

More money for FEMA does not guarantee improved results

Before Congress passed $9.7 billion in Hurricane Sandy relief spending today, Governor Christie made headlines for his angry response to the House GOP’s delay in approving relief funds. The new spending will provide FEMA with money to pay out claims to those holding federal flood insurance. While the Hurricane Sandy relief effort gives political immediacy to FEMA funding, the Center for American Progress proposes a longer term strategy for dealing with natural disasters:

There must  be a dedicated source of revenue to fund predisaster mitigation programs that is not susceptible to budget cuts or political manipulation. Since the frequency and/or severity of extreme weather events will be exacerbated by climate change, it makes sense to raise revenue for resiliency from the fossil fuels whose combustion emits carbon pollution responsible for climate change.

The perspective that disaster recovery is a core responsibility of the federal government is widely shared, and voices as diverse as Governor Christie to the Center for American Progress express this opinion. However, the Mercatus Center’s Gulf Coast Recovery Project conducted in the wake of Hurricane Katrina demonstrates that funneling federal dollars toward disaster relief does not guarantee positive results for disaster victims. While the FEMA response to Hurricane Sandy went more smoothly than the Hurricane Katrina response, the federal government simply doesn’t have the capability to respond quickly and efficiently to individuals’ needs following a disaster, and channeling more resources to FEMA from any revenue source will not change the this fact.

As Pete Leeson and Russ Sobel write in a 2007 paper (pdf):

Following a natural disaster, on the one side there are “relief demanders”—individuals who desperately need disaster-relief supplies, including evacuation, food, shelter, medical attention, and so forth. On the other side, there are “relief suppliers”—individuals ready and willing to bring their supplies and expertise to bear in meeting the relief demanders’ needs. On both sides of this “market,” information is decentralized, local, and often inarticulate. Relief demanders know when relief is needed, what they need, and in what quantities, but they do not necessarily know who has the relief supplies they require or how to obtain them. Similarly, relief suppliers know what relief supplies they have and how they can help, but they may be largely unaware of whether relief is required and, if it is, what is needed, by whom, and in what locations and quantities.

[. . .]

Government’s informational deficit in the disaster-relief context is an unavoidable outcome of the centralization of disaster relief management when relief is provided by the state. Disaster-relief reforms that leave government as the primary manager of natural disasters are thus bound to fail. Correcting government’s information failure in the context of disaster relief requires eliminating its root cause: government involvement itself.

Researchers on the Gulf Coast Recovery Project found that non-profits, civic organizationsprivate firms, and individuals were more successful at providing the goods and services needed for recovery than the federal government.

Aside from the inherent challenges facing federal disaster response, funneling federal tax dollars to coastal areas prone to flooding leads to moral hazard. Because residents of flood-prone areas purchase federal insurance, taxpayers subsidize those who choose to live in these high-risk areas. Eli Lehrer of the R Street Institute explains this aspect of the Hurricane Sandy Relief Bill to Climate Wire:

“The mitigation piece of it is problematic,” said Eli Lehrer, president of the R Street Institute, a conservative organization that works with environmentalists and insurers to reduce subsidies in public insurance programs. “I think the bill should be drastically scaled back overall.”

He suggests that the disaster supplemental package could be cut in half. That would save taxpayer money, he says, now and in the future — by reducing incentives to develop coastlines. Lehrer also proposes cutting the federal share of post-disaster rebuilding costs to 50 percent. Currently, the government pays for 75 percent of recovery efforts, and Obama is asking Congress to increase that to 90 percent for Sandy survivors.

Politicians and activists who support a large role for the federal government in responding to disasters may have the best of intentions, but these intentions cannot circumvent the knowledge problems that government faces in disaster relief. By reducing the cost of developing in flood plains, greater reliance on the federal government for disaster mitigation and relief will be a costly effort unlikely to provide an adequate response when the next disaster strikes.

January 4, 2013

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