Archives: 02/2010

Taxes and Small Business

I testified to the Senate Finance Committee today regarding taxes and small business. My testimony is posted here.

President Obama plans to raise the top two individual income tax rates. That will not be good for business or the economy. A little more than half of all business income in the United States is reported on individual returns, not corporate returns. Of the business income reported on individual returns, 44 percent is in the top two income tax brackets.

My testimony pointed out that while Congress cut the top individual rate by 5 percentage points this past decade, the average top rate in the 30 OECD countries also fell by 5 percentage points, as shown in the chart below.

If the top federal rate rises to 40 percent next year, the United States will have the ninth highest top individual rate in the OECD, including state-level taxes. We’ve already got the second-highest corporate tax rate in the OECD.

A nation that has been a relative bastion of market capitalism and individual achievement has a tax code that is becoming very hostile to high-earners, entrepreneurs, and businesses of all types.

You Always Lose with Top-Down Standards

Yesterday, Andrew Coulson and I wrote a bit on President Obama’s little talk with the nation’s governors about potential changes to federal education policy. The root of the President’s proposal – and we’ve probably only seen fragments of what will eventually come out – is a requirement that states adopt common “college- and career-readiness standards” to qualify for large chunks of federal money.

This certainly puts in place the “standards” part of  “standards and accountability” reform, which has dominated education for roughly the last fifteen years. But where’s the “accountability” part?

So far, nowhere. Yes, a state would have to adopt common standards – or, interestingly, somehow work with universities to certify its standards as college- and career-ready – but the administration has offered nothing by way of accountabilty for academic outcomes. Indeed, it has emphasized a move away from the “corrective” actions that No Child Left Behind imposes on laggard schools and has instead pushed getting extra resources (of course!) to those institutions.

This must be alarming to reformers who think the only way to fix education is to have government “get tough” on its schools. And the no-accountability approach certainly doesn’t make much intuitive sense. Without potential punishments or rewards for outcomes, what incentives do districts and schools have to meet standards, national or otherwise?

The answer, of course, is none. But don’t fret: Whether there are accountability measures for performance or not, in government-run schooling the outcome will be the same. Unfortunately, “the same” always means “poor.”

Why inevitably poor? Because the people employed in education – teachers, school administrators, bureaucrats – have hugely disproportionate power over education politics, and hence a tremendous ability to bend the system to their will. And what do they prefer from the system? The same thing you or I would ideally get from our jobs: as much money as possible with no accountability for what we produce. The impotence of NCLB is exhibit A of this.

With that political reality firmly in mind, the final result for any potential combination of standards and accountability becomes clear: No meaningful improvement. The handy matrix below lays it out:

So let’s give this to President Obama: His move to further federalize education authority is very troubling, but at least he doesn’t see the need for the accountability charade. Or so, anyway, it seems for the moment.

Unions, Productivity, and the 2010 Economic Report of the President

I’ve become a fan over the years of the annual Economic Report of the President, released around this time each year by the Council of Economic Advisers. The more than 100 tables in the back of the book provide an invaluable picture of the economy over many decades, covering all the major indicators from output and employment to interest rates and trade. Each report also contains chapters explaining the economic thinking behind administration policies.

Chapter 10 of the latest report focuses on “Fostering Productivity Growth through Innovation and Trade.” For critics of trade, it offers sound economic reasons why trade raises U.S. productivity and, thus, over the long run, U.S. living standards.

One of ways trade promotes growth is “Firm Productivity.” Economists have come to appreciate that firms within an industry will differ in their productivity. Those that are more productive will tend to grow and prosper in larger and more competitive global markets. As a result,

when a country opens to trade, more productive firms grow relative to less productive firms, thus shifting labor and other resources to the better organized firms and increasing overall productivity. Even if workers do not switch industries, they move from firms that are either poorly managed or that use less advanced technology and production processes toward the more productive firms.

The report doesn’t mention this, but one reason why firms differ in their productivity is unionization. As I spell out in an “Economic Watch” column in today’s Washington Times, and explore in more detail in the latest Cato Journal, unionized firms tend to lose market share to non-unionized firms:

The weight of evidence indicates that, for most firms in most sectors, unionization leaves companies less able to compete successfully. The core problem is that unions cause compensation to rise faster than productivity, eroding profits while at the same time reducing the ability of firms to remain price-competitive. The result over time is that unionized firms have tended to lose market share to non-unionized firms, in domestic as well as international markets.

Compared to equivalent non-unionized competitors, unionized firms are associated with lower profits, less investment in physical capital, and less spending on research and development. By exposing an industry (say, automobiles) to more vigorous international competition, trade accelerates the shift from less competitive unionized firms to more competitive non-unionized firms.

Economists serving a Democratic administration would be understandably reluctant to say such a thing explicitly, but it is certainly there between the lines in Chapter 10 of the new Economic Report of the President.

Tuesday Links

  • Price controls have failed in the past and there is no reason to think they will work now. So why is the president proposing price controls on health care? Michael Tanner: “Attempts to control prices by government fiat ignore basic economic laws – and the result could be disastrous for the American health-care system.”

DC Shouldn’t Subsidize Parking Garages

The District of Columbia is providing tax incentives for a parking garage at a new Harris Teeter grocery store.  This follows a District subsidized parking garage boondoggle that opened at a Columbia Heights mall in 2008.  Whether it’s a parking garage, bike rack, or any other commercial transportation activity, government should remain neutral. If Harris Teeter believes a 150-car parking garage is in the best interests of the company’s bottom line, it should pay for it itself. Taxpayers shouldn’t be on the hook.  If the District or any other city wants to encourage economic development, it should seek lower taxes across the board, and remove costly regulatory barriers.

H/T Chris Moody

Government Program Competes with First-Time Home Buyers

If there should ever be a great time to be a first-time home buyer – it should be now.  Mortgage rates are at historic lows.  Prices have fallen almost 30% across the country since the peak.  Builders continue to add supply into already saturated markets.  Yet, as the Wall Street Journal reports, potential first time home buyers are facing stiff competition from investors…and from the government.

Congress has appropriated about $6 billion to local and state governments to buy foreclosed properties.  President Obama is proposing to add another $1.5 billion that could be used for similar purposes.   The argument is supposed to be that these funds would eliminate the negative impact of foreclosures on communities, while also providing shelter to needy families.  Part of the program’s rationale is that local governments’ will select a better group of tenants and purchasers that would private investors (the history of public housing should rebut that assumption).

With the exception of cities like Detroit, Cleveland and Buffalo, many of the country’s boom areas still have significant population and other amenities (like sunny weather).  Many people would continue to choose to live in these areas, if only they were more affordable.  After all these years of massive subsidies for home-ownership, there seems a great irony in having the government now be one of the largest barriers to families achieving home-ownership – by using tax dollars to bid up and compete away existing homes.

Europe: Either Bismarck or the Euro, but Not Both

The Maastricht Treaty requires countries in the eurozone not to exceed a public debt of 60% of GDP. Well, now almost all of them have an official debt exceeding that ceiling. But the situation is immensely worse because European states also have huge, and largely hidden, unfunded liabilities arising from their pension and health systems. According to a 2009 study by my colleague Jagadeesh Gokhale, the true debt of the 25 European countries is, on average, 434% of GDP. And the treaties that underpin European integration do not say a word about such debt.

Greece’s true debt is 875% of GDP and its current problems are just the first act of the coming fiscal bankruptcy of Europe. In my 2004 essay “Will the Pension Time Bomb Sink the Euro?”, I concluded that Europe would end up facing a critical crossroads: either leave the Euro or abandon the Bismarckian welfare state paradigm. As it turns out, the DNA of the pay-as-you-go system allows for political manipulation and the consequent inflation of pension and health “rights.” This, exacerbated by falling fertility rates and increasing life expectancy, will lead to increasing fiscal deficits, unpayable debt, state insolvency, defaults, covert age wars, and the failure of the Eurozone project.

The welfare state has really become an arbitrary “entitlement state,” where everyone uses the state to rob someone else, and politicians from the right and the left play the transfer game to win elections. This crisis may serve to reveal the true nature and enormous flaws of the welfare state. Sooner or later, Europe will have to dismantle it and move toward a paradigm of personal responsability – that is, a system of personal accounts for pensions, health and unemployment benefits.