Tag: economics

Four Reasons Why Big Government Is Bad Government

A new video from the Center for Freedom and Prosperity gives four reasons why big government is bad fiscal policy.

I particularly like the explanation of how government spending undermines growth by diverting labor and capital from the productive sector of the economy.

Some cynics, though, say that it is futile to make arguments for good policy. They claim that politicians make bad fiscal decisions because of short-term considerations such as vote buying and raising campaign cash and that they don’t care about the consequences. There’s a lot of truth to this “public choice” analysis, but I don’t think it explains everything. Maybe I’m an optimist, but I think we would have better fiscal policy if more lawmakers, journalists, academics, and others grasped the common-sense arguments presented in this video.

And even if the cynics are right, we are more likely to have good policy if the American people more fully understand the damaging impact of excessive government. This is because politicians almost always will do what is necessary to stay in office. So if they think the American people are upset about wasteful spending and paying close attention, the politicians will be less likely to upset voters by funneling money to special interests.

For those who want additional information on the economics of government spending, this video looks at the theoretical case for small government and this video examines the empirical evidence against big government. And this video explains that America’s fiscal problem is too much spending rather than too much debt (in other words, deficits are merely a symptom of an underlying problem of excessive spending).

Last but not least, this video reviews the theory and evidence for the “Rahn Curve,” which is the notion that there is a growth-maximizing level of government outlays.

The Good, the Bad, and the Ugly of the Tax Deal

Compared to ideal policy, the deal announced last night between congressional Republicans and President Obama is terrible.

Compared to what I expected to happen, the deal announced last night is pretty good.

In other words, grading this package depends on your benchmark. This is why reaction has been all over the map, featuring dour assessments from people like Pejman Yousefzadeh and cheerful analysis from folks such as Jennifer Rubin.

With apologies to Clint Eastwood, let’s review the good, the bad, and the ugly.

The Good

The good parts of the agreement is the avoidance of bad things, sort of the political version of the Hippocratic oath – do no harm. Tax rates next year are not going to increase. The main provisions of the 2001 and 2003 tax acts are extended for two years – including the lower tax rates on dividends and capital gains. This is good news for investors, entrepreneurs, small business owners, and other “rich” taxpayers who were targeted by Obama. They get a reprieve before there is a risk of higher tax rates. This probably won’t have a positive effect on economic performance since current policy will continue, but at least it delays anti-growth policy for two years.

On a lesser note, Obama’s gimmicky and ineffective make-work-pay credit, which was part of the so-called stimulus, will be replaced by a 2-percentage point reduction in the payroll tax. Tax credits generally do not result in lower marginal tax rates on productive behavior, so there is no pro-growth impact.  A lower payroll tax rate, by contrast, improves incentives to work. But don’t expect much positive effect on the economy since the lower rate only lasts for one year. People rarely make permanent decisions on creating jobs and expanding output on the basis of one-year tax breaks.

Another bit of good news is that the death tax will be 35 percent for two years, rather than 55 percent, as would have happened without an agreement, or 45 percent, which is what I thought was going to happen. Last but not least, there is a one-year provision allowing businesses to ”expense” new investment rather than have it taxed, which perversely happens to some degree under current law.

The Bad

The burden of government spending is going to increase. Unemployment benefits are extended for 13 months. And there is no effort to reduce spending elsewhere to “pay for” this new budgetary burden. A rising burden of federal spending is America’s main fiscal problem, and this agreement exacerbates that challenge.

But the fiscal cost is probably trivial compared to the human cost. Academic research is quite thorough on this issue, and it shows that paying people to remain out of work has a significantly negative impact on employment rates. This means many people will remain trapped in joblessness, with potentially horrible long-term consequences on their work histories and habits.

The agreement reinstates a death tax. For all of this year, there has not been a punitive and immoral tax imposed on people simply because they die. So even though I listed the 35 percent death tax in the deal in the “good news” section of this analysis because it could have been worse, it also belongs in the “bad news” section because there is no justification for this class-warfare levy.

The Ugly

As happens so often when politicians make decisions, the deal includes all sorts of special-interest provisions. There are various special provisions for politically powerful constituencies. As a long-time fan of a simple and non-corrupt flat tax, it is painful for me to see this kind of deal.

Moreover, the temporary nature of the package is disappointing. There will be very little economic boost from this deal. As mentioned above, people generally don’t increase output in response to short-term provisions. I worry that this will undermine the case for lower tax rates since observers may conclude that they don’t have much positive effect.

To conclude, I’m not sure if this is good, bad, or ugly, but we get to do this all over again in 2012.

Words I Don’t Say Very Often: ‘I Applaud Senate Republicans’

Much to my surprise, Senate Republicans held firm earlier today and blocked President Obama’s soak-the-rich proposal to raise tax rates next year on investors, entrepreneurs and small business owners.

I fully expected that GOPers would fold on this issue several months ago because Democrats were using the class-warfare argument that Republicans were holding the middle class hostage in order to protect “millionaires and billionaires.” Republicans usually have a hard time fighting back against such demagoguery, and I was especially pessimistic since every Republican senator had to stay united to block Senate Democrats from pushing through Obama’s plan for higher tax rates on the so-called rich.

But the GOP surprised me earlier this year with their united opposition to higher taxes, and they stayed strong again today in blocking a bill that would raise tax rates on upper-income taxpayers. Here’s an excerpt from the New York Times.

Republicans voted unanimously against the House-passed bill, and they were joined by four Democrats — Senators Russ Feingold of Wisconsin, Joe Manchin III of West Virginia, Ben Nelson of Nebraska, and Jim Webb of Virginia — as well as by Senator Joseph I. Lieberman, independent of Connecticut. “You don’t raise taxes if your ultimate goal, if the main thing is to create jobs,” said Senator John Thune, Republican of South Dakota, echoing an argument made repeatedly by his colleagues during the floor debate. The Senate on Saturday also rejected an alternative proposal, championed by Senator Charles E. Schumer of New York, to raise the threshold at which the tax breaks would expire to $1 million. Some Democrats said that the Republicans’ opposition to that plan showed them to be siding with “millionaires and billionaires” over the middle class.

Not only did GOPers stand firm, but they were joined by five other senators (including four that have to face the voters in 2012). This presumably means Democrats will now have to compromise and agree to a plan to extend all of the 2001 and 2003 tax cuts.

At the risk of being a Pollyanna, I wonder if the politics of hate and envy is falling out of fashion. Obama’s plan for higher tax rates hopefully is now dead, but that’s just one positive indicator. It’s also interesting that both of the big “deficit reduction” plans recently unveiled, the President’s Fiscal Commission and the Domenici-Rivlin Debt Reduction Task Force Report, endorsed lower marginal tax rates - including lower tax rates for those evil rich people. Both proposals also included lots of tax increases, so the overall tax burden would be significantly higher under both plans, but it is remarkable that the beltway insiders who dominated the two panels understood the destructive impact of class-warfare tax rates. Maybe they watched this video.

The Consumer Spending Fallacy behind Keynesian Economics

I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but I think my former intern has an excellent contribution to the debate with this new 5-minute mini-documentary.

The main insight of the mini-documentary is that Gross Domestic Product (GDP) only measures how national output is allocated between consumption, investment, and government. That’s useful information in many ways, but if we want more output, we should focus on Gross Domestic Income (GDI), which measures how national income is earned.

Focusing on GDI hopefully would lead lawmakers to consider ways of boosting employee compensation, corporate profits, small business income, and other components of national income. Focusing on GDP, by contrast, is misguided since any effort to boost consumption generally leads to less investment. This is why Keynesian policies only redistribute national income, but don’t boost overall output.

You may recognize Hiwa. She narrated a very popular video earlier this year on the nightmare of income-tax complexity.

Earmark Donor States

I have an op-ed in Politico about “earmark donor states.” It’s a term I invented to highlight a rarely discussed side of earmarking: public choice economics.

As public choice theory would predict, the earmarking process operates under a system of concentrated benefits and diffuse costs.  Based on an analysis of 2009 data, 16 states receive a disproportionately large percentage of the earmark pie and can be labeled “earmark beneficiary” states. The other 34 states and the District of Columbia are “earmark donors,” as they receive fewer earmark dollars than they proportionally should.

To determine which states win and lose in the earmarking game, I looked at the share of taxes each state sends to Washington and compared it to the share of earmarks that each state receives. 

In the op-ed, I use Colorado, one of the biggest earmark donor states, as an example:

Colorado taxpayers contribute about 1.6 percent of total federal taxes, but they receive just over two-tenths of one percent of earmarked funds—proportionally speaking, less than a third of what it should be getting. This works out to more than $200 million dollars that Coloradans are spending to subsidize earmarks in other states – hardly chump change. So while Colorado’s representatives might pat themselves on the back for securing funding for an occasional municipal bus or bioenergy plant, their earmarking rivals in other states like West Virginia and Hawaii obtain funding for larger and more expensive projects and send the bill to the Centennial State.

Below is a table with additional data indicating which states are earmark donors and recipients.  The key column is the “earmark ratio.” The lower the figure, the smaller a state’s share of earmarks is relative to the amount of taxes its residents and businesses pay.  A state with an earmark ratio below 100% is a donor state.  As you can see, Utah is the first state on the table that receives slightly more than its proportional share of earmark funds. Mississippi, the last state on the list, remarkably receives 11 times more than its proportional share. 

 Also note that the most populous states in the country are earmark donors – almost 90 percent of Americans live in earmark donor states.

State TOTAL FEDERAL TAXES % of Total Taxes Proportional Share of Earmarks (millions of $) Earmarks Received (millions of $) % of Total Earmarks Earmark Ratio % of Delegation on Approps
New York 193,446,916 8.2% 1642.75 418.71 2.1% 25.5% 12.9%
Illinois 116,130,852 5.0% 986.18 252.19 1.3% 25.6% 14.3%
Nebraska 16,200,400 0.7% 137.57 41.53 0.2% 30.2% 20.0%
Colorado 38,484,608 1.6% 326.81 106.15 0.5% 32.5% 11.1%
Connecticut 44,684,141 1.9% 379.46 124.83 0.6% 32.9% 14.3%
New Jersey 103,548,696 4.4% 879.34 319.06 1.6% 36.3% 13.3%
Arizona 32,372,226 1.4% 274.91 102.00 0.5% 37.1% 10.0%
Ohio 103,638,344 4.4% 880.10 345.98 1.7% 39.3% 25.0%
Georgia 59,486,251 2.5% 505.16 203.94 1.0% 40.4% 13.3%
Minnesota 67,646,589 2.9% 574.46 233.10 1.2% 40.6% 10.0%
Texas 200,521,512 8.5% 1702.83 695.59 3.5% 40.8% 17.6%
California 264,868,391 11.3% 2249.27 971.05 4.9% 43.2% 14.5%
Indiana 42,108,854 1.8% 357.59 156.44 0.8% 43.7% 9.1%
Massachusetts 70,108,079 3.0% 595.36 265.75 1.3% 44.6% 8.3%
Wisconsin 38,642,363 1.6% 328.15 171.34 0.9% 52.2% 20.0%
North
Carolina
63,348,252 2.7% 537.95 288.11 1.4% 53.6% 6.7%
Pennsylvania 106,613,979 4.5% 905.37 488.57 2.5% 54.0% 14.3%
Tennessee 44,047,939 1.9% 374.06 208.02 1.0% 55.6% 27.3%
Michigan 56,050,689 2.4% 475.98 279.99 1.4% 58.8% 5.9%
Florida 110,156,809 4.7% 935.45 556.55 2.8% 59.5% 14.8%
Delaware 13,683,353 0.6% 116.20 69.38 0.3% 59.7% 0.0%
Oklahoma 24,297,410 1.0% 206.33 123.91 0.6% 60.1% 14.3%
Oregon 21,736,643 0.9% 184.59 111.85 0.6% 60.6% 0.0%
Virginia 58,598,281 2.5% 497.62 312.80 1.6% 62.9% 15.4%
Wyoming 3,833,691 0.2% 32.56 21.33 0.1% 65.5% 0.0%
District of
Columbia
19,487,689 0.8% 165.49 111.59 0.6% 67.4% 0.0%
Missouri 44,310,000 1.9% 376.28 256.45 1.3% 68.2% 18.2%
Washington 48,587,720 2.1% 412.61 287.22 1.4% 69.6% 18.2%
Maryland 44,484,984 1.9% 377.77 304.09 1.5% 80.5% 10.0%
Kansas 20,374,354 0.9% 173.02 141.68 0.7% 81.9% 33.3%
New Hampshire 8,739,838 0.4% 74.22 62.40 0.3% 84.1% 25.0%
Louisiana 34,882,848 1.5% 296.23 272.57 1.4% 92.0% 22.2%
Arkansas 25,727,268 1.1% 218.48 202.37 1.0% 92.6% 33.3%
Rhode Island 10,909,205 0.5% 92.64 87.58 0.4% 94.5% 50.0%
South Carolina 17,806,603 0.8% 151.21 145.36 0.7% 96.1% 0.0%
Utah 14,270,839 0.6% 121.19 131.18 0.7% 108.2% 20.0%
Idaho 6,859,632 0.3% 58.25 63.27 0.3% 108.6% 25.0%
Nevada 13,770,576 0.6% 116.94 129.88 0.7% 111.1% 0.0%
Kentucky 23,313,696 1.0% 197.98 248.74 1.2% 125.6% 37.5%
Maine 6,105,799 0.3% 51.85 73.04 0.4% 140.9% 25.0%
Iowa 17,614,407 0.8% 149.58 336.88 1.7% 225.2% 28.6%
Alabama 20,093,422 0.9% 170.63 424.18 2.1% 248.6% 33.3%
Vermont 3,366,627 0.1% 28.59 81.97 0.4% 286.7% 33.3%
Montana 4,136,011 0.2% 35.12 101.02 0.5% 287.6% 66.7%
South Dakota 4,888,826 0.2% 41.52 135.48 0.7% 326.3% 33.3%
New Mexico 8,188,815 0.3% 69.54 235.09 1.2% 338.1% 0.0%
North Dakota 4,115,943 0.2% 34.95 136.79 0.7% 391.3% 33.3%
Hawaii 6,747,592 0.3% 57.30 270.74 1.4% 472.5% 25.0%
Alaska 4,670,157 0.2% 39.66 227.81 1.1% 574.4% 33.3%
West Virginia 6,332,264 0.3% 53.77 336.92 1.7% 626.6% 20.0%
Mississippi 9,603,121 0.4% 81.55 900.57 4.5% 1104.3% 16.7%

Source:
IRS: http://www.irs.gov/taxstats/article/0„id=206488,00.html
Taxpayers for Common Sense
Author’s calculations

Suspecting that the disparity between states is a product of political clout, I calculated the percentage of each state’s congressional delegation serving on the House and Senate Appropriations Committees.  The graph below shows the correlation between this metric and the earmark ratio of each state. The closely tracking trend lines suggest there is a connection between a state’s representation on the Appropriations Committees and earmarks. The correlation between these figures is 0.264, which is especially strong when you consider that earmarking proponents often argue that the process is entirely merit-driven and apolitical.  To be sure, this is a very rough indicator – earmark recipient states like Alaska and West Virginia were long represented by earmark champions Ted Stevens and Robert Byrd, neither of whom is included in the figure.  Also, it should be noted that Hawaii and Mississippi are represented by Daniel Inouye and Thad Cochran who, respectively, are the chairman and ranking Republican on the Senate Appropriations Committee.  As such, they carry significantly more clout than the average appropriator. Additionally, Nevada’s status as an earmark beneficiary state despite its lack of appropriators might be explained by Senator Harry Reid’s influence as Senate Majority Leader.

I also evaluated the correlation between earmark ratios and median income. Based on the arguments of earmark proponents, one would expect a very strong negative correlation here as earmarking is intended to direct federal funds to needy, underserved parts of the country.  The strength of that correlation is -0.255, which is slightly weaker than the political-based correlation.  This suggests that in the earmarking process, political power is more important than financial need.

The connection between political power and earmarking prowess is hardly surprising. More startling is the disparity between the shortchanged earmark donor states and the earmark beneficiary states. Perhaps politicians from donor states are unaware of the extent to which their constituents subsidize out-of-state projects. More likely, most congressmen are successfully pulling off a political sleight of hand – trumpeting their occasional earmark project and hoping it distracts their constituents from the disproportionately large number of earmarks in other states.

After all, the vast majority of Americans would be far better off if Congress stopped earmarking and removed itself from spending decisions that should be made by local governments and private entities.  

I must acknowledge several of my colleagues who helped with this analysis – many thanks to Kurt Couchman and Andrew Mast.

Will the Federal Reserve’s Easy-Money Policy Turn the United States into a Global Laughingstock?

Early in the Obama Administration, there was an amusing/embarrassing incident when Chinese students laughed at Treasury Secretary Geithner when he claimed the United States had a strong-dollar policy.

I suspect that even Geithner would be smart enough to avoid such a claim today, not after the Fed’s announcement (with the full support of the White House and Treasury) that it would flood the economy with $600 billion of hot money. Here’s what my colleague Alan Reynolds wrote in the Wall Street Journal about Bernanke’s policy.

Mr. Bernanke…believes (contrary to our past experience with stagflation) that inflation is no danger thanks to economic slack (high unemployment). He reasons that if people can nonetheless be persuaded to expect higher inflation, regardless of the slack, that means interest rates will appear even lower in real terms. If that worked as planned, lower real interest rates would supposedly fix our hangover from the last Fed-financed borrowing binge by encouraging more borrowing. This whole scheme raises nagging questions. Why would domestic investors accept a lower yield on bonds if they expect higher inflation? And why would foreign investors accept a lower yield on U.S. bonds if they expect exchange rate losses on dollar-denominated securities? Why wouldn’t intelligent people shift their investments toward commodities or related stocks (such as mining and related machinery) and either shun, or sell short, long-term Treasurys? And if they did that, how could it possibly help the economy?

The rest of the world seems to share these concerns. The Germans are not big fans of America’s binge of borrowing and easy money. Here’s what Finance Minister Wolfgang Schäuble had to say in a recent interview.

The American growth model, on the other hand, is in a deep crisis. The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies. …I seriously doubt that it makes sense to pump unlimited amounts of money into the markets. There is no lack of liquidity in the US economy, which is why I don’t recognize the economic argument behind this measure. …The Fed’s decisions bring more uncertainty to the global economy. …It’s inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money.

The comment about borrowed money has a bit of hypocrisy since German government debt is not much lower than it is in the United States, but the Finance Minister surely is correct about monetary policy. And speaking of China, we now have the odd situation of a Chinese rating agency downgrading U.S. government debt.

The United States has lost its double-A credit rating with Dagong Global Credit Rating Co., Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy. Dagong Global on Tuesday downgraded the local and foreign currency long-term sovereign credit rating of the US by one level to A+ from previous AA with “negative” outlook.

This development shold be taken with a giant grain of salt, as explained by a Wall Street Journal blogger. Nonetheless, the fact that the China-based agency thought this was a smart tactic must say something about how the rest of the world is beginning to perceive America.

Simply stated, Obama is following Jimmy Carter-style economic policy, so nobody should be surprised if the result is 1970s-style stagflation.

Free Deirdre McCloskey E-Book from University of Chicago Press

Every month, the University of Chicago Press offers a free e-book from its catalog of thought-provoking titles. This month it’s Deirdre McCloskey’s The Bourgeois Virtues: Ethics for an Age of Commerce (2006).

We discussed her follow-up volume, Bourgeois Dignity: Why Economics Can’t Explain the Modern World (2010), in last month’s Cato Unbound. Back in 2006, Cato Policy Report gave a short summary of McCloskey’s argument in The Bourgeois Virtues.

Her argument as I understand it is that commerce and virtue can be mutually reinforcing. Obviously they aren’t always so, but this positive feedback loop has governed much of world history in the modern era, helping to create the world we see around us today. I’d encourage anyone who takes interest in the intersection of markets, virtue, and modernity to take a look. And best of all, it’s free.