Topic: Tax and Budget Policy

John McCain: The Good, the Bad, and the Ugly

With his victory in Florida, Sen. John McCain has become the clear front runner for the Republican nomination. It’s worthwhile, therefore, to take a closer look at what kind of president he might be.

The Good: While Rush Limbaugh and Sean Hannity sometimes portray McCain as a virtual clone of Ted Kennedy, the fact is that he is a true fiscal conservative—certainly more of a fiscal conservative than, say, Mitt Romney. He is well known as an opponent of earmarks and pork barrel spending. But perhaps more importantly, he has long been an advocate of entitlement reform. He was early an ardent support of personal accounts for Social Security, and has pushed for serious Medicare reform, including means-testing. Almost alone among Republicans, he opposed the disastrous Medicare prescription drug benefit.

He has offered the best health care reform plan of any of the candidates. While Mitt Romney has embraced the basic tenants of HillaryCare, McCain would change the tax code to equalize the treatment between employer-provided and individually-purchased health insurance. This is a vital step in moving away from our employment-based health care system toward a more consumer-oriented system. And, he would allow the purchase of low-cost insurance across state lines, avoiding regulation and mandates.

During his time in the Senate, he has never voted for a tax increase. While he has taken much heat for voting against the Bush tax cuts, he now calls for making those tax cuts permanent (although he would retain a vestige of the estate tax at a reduced rate and increased exemption). And, McCain is right that cutting taxes has too often become an excuse for republicans to avoid the hard task of cutting spending. Cutting taxes reduces the pain of government spending (at least for now), allowing Congress to avoid difficult choices. While taxes need to be cut—and McCain supports a number of tax cuts including reductions in the business tax rates and capital gains taxes—future tax cuts should be linked with spending cuts. As I argue in my book, Leviathan on the Right, it’s the size of government, stupid.

He is a strong and unapologetic free trader.

The Bad: John McCain frequently makes Dr. Strangelove look like a peacenik. Its not just his desire to remain in Iraq “for a hundred years.” It’s his bellicosity toward every enemy and perceived enemy from Iran to North Korea. He’s a true believer in the neoconservative goal of remaking the world to fit our desires and beliefs. At best on foreign policy he would be a competent Bush. At worst, he appears a recipe for perpetual conflict.

On domestic policy, he has shown a disturbing predilection for elevating every personal pet peeve, from steroids in baseball to airplane service quality, to a federal issue. And, he has embraced heavily regulatory environmental policies and compulsory national service. Like George W. Bush, he tends to support federal power over federalism, executive authority over legislative, and generally leans toward the imperial presidency.

The Ugly: John McCain appears to have little more than contempt for the First Amendment and free speech generally. He is the principal author of a campaign finance bill that severely restricts political speech. Not content with those restrictions on political speech, he has continually sought to expand regulation to other groups. He has said that he “would rather have a clean government than one where, quote, First Amendment rights are being respected, that has become corrupt. If I had my choice, I’d rather have the clean government.” Any candidate who believes that respect for First amendment rights needs to be qualified by “quote,” raises serious concerns. Moreover, his general attitude appears to be that criticism of the government, the war, and in particular himself, is somehow unpatriotic.

Most worrisome of all appears to be McCain’s basic philosophy, which is unapologetically statist, as Matt Welch points out in his new book McCain: The Myth of a Maverick. McCain once said “each and every one of us has a duty to serve a cause greater than our own self-interest.” McCain believes that cause to be the good of the collective, often defined as the nation or the national community.

For believers in individual liberty and limited government, it’s a decidedly mixed bag. But, then again, aren’t they all?

State of the Earmarks

Last night’s State of the Union address didn’t contain much in the way of new policy proposals. As I note in a podcast (Subscribe!), this is largely a reflection of President Bush’s limited political capital because of his lame duck status, low approval ratings, and the Democratic majority in Congress.

But one issue Bush did indicate he will tackle is the rampant earmarking on Capitol Hill. Bush said he would take a couple actions on this front – and while these might be modest steps in the right direction, the results will be far from earth shattering.

First, Bush will “issue an Executive Order that directs Federal agencies to ignore any future earmark that is not voted on by the Congress.” This is good step and one that fiscal conservatives on Capitol Hill have been urging for years. The President can ignore certain earmarks because Congressional appropriators routinely exclude them from the legislative text of spending bills. Instead they “airdrop” many earmarks into conference reports at the last minute. These reports are not technically part of the law, but serve as accompanying documents to inform the Executive Branch of Congress’s intentions. Appropriators do this to circumvent transparency measures and make questionable earmarks immune to points of order or striking amendments by critical members. Because the Executive branch has always played along, it has never been necessary for Congress to act otherwise.

Until now.

With the new Executive Order in place, Congress will presumably be forced to include earmarks in legislative text rather than putting them in nonbinding conference reports. This will likely increase transparency to some degree, but it’s unlikely to have a significant impact on earmarks beyond that. Enough support resides in Congress to continue to earmark funds and easily defeat procedural hurdles along the way. Furthermore, Bush missed a huge opportunity here. He could have applied the Executive Order to the current 2008 fiscal year and wiped out thousands of earmarks in the process.

Bush also indicated that he would veto appropriations bills that do not reduce the number or cost of earmarks by 50 percent. This might encourage appropriators to cut earmarks per the president’s request. But there is a danger here – rather than shooting for a significant reduction in earmarks, Congressional leaders could instead dole out more money for members’ pet projects in order to build a vested voting block large enough to override a veto. In terms of passing the annual spending bills, this could be an easier path for Congress to follow, as most spending bills already pass with large majorities. The result could be a net increase in earmarks.

Still, President Bush has made a good faith effort toward improving the earmarking process. And by discussing earmarks during his final State of the Union address, he brought a national spotlight to the issue. But few significant improvements will occur until members of Congress stop coveting earmarks and voters stop returning earmarkers to Congress.

My Least Favorite False Note on Trade in Last Night’s SOTU

My colleague Dan Griswold has a post below about some of the good things President Bush said in his State of the Union address last night (transcript here). While the President deserves praise for the remarks he made about the importance of trade to the American economy, he made much of the importance of exports and of opening markets overseas, with only a cursory glance at the benefits of imports.

That mercantilist rhetoric, in my opinion and in the opinion of my colleague Brink Lindsey, has boxed the administration and other lawmakers into a corner: people now erroneously assume that if the exports fail to materialize, or if the trade deficit worsens, then the trade policies have been a failure. The present skepticism about trade deals (even allowing for the fact we are in fully-fledged campaign mode) is a direct consequence of that flawed thinking.

Putting aside my ranting about the general state of public discourse about trade, though, there was one part of the SOTU address that particularly struck me as misguided. In making the case for trade deals, President Bush talked about the negative effects of trade liberalization on some workers and made a pitch for renewing trade adjustment assistance:

for some Americans, trade can mean losing a job, and the federal government has a responsibility to help.

Wrong.

Laffer Curve Video

Working in Washington can be very exasperating, and few issues are as frustrating as the Laffer Curve. Even market-friendly lawmakers frequently misinterpret the relationship between tax rates, taxable income, and tax revenue. The other 90 percent of politicians are even worse. Using straw-man arguments, they defend a revenue-estimating system that is based on the absurd notion that tax policy never has any impact on economic performance. I’ve complained vociferously (see here, here, and here), but that hasn’t worked.

It’s time to try something new. Regular readers of this blog may have seen the videos I narrated on tax competition and the corporate income tax. These videos, produced by the Center for Freedom and Prosperity, will never compete with Pamela Anderson, but they seem to get a decent amount of traffic by public-policy standards. So the Center has now released a video on the Laffer Curve with yours truly (a.k.a., the George Clooney of the free market movement) again serving as narrator. Indeed, this video is the first of a three-part series.

I sent the video to Art Laffer, who was kind enough to say, “This video is a great common-sense tutorial that shows the real relationship between tax rates, taxable income, and tax revenue. I hope it is widely viewed so that more people understand the need for pro-growth tax policy.” But I also want negative feedback. As in previous cases, I would welcome suggestions on how to make these videos more effective. Needless to say, feel free to share all of them with your friends and colleagues.

Despite Losing Business to Flat Tax Neighbors, Hungarian Politicians Clinging to High Tax Rates

The Budapest Times has a feature story noting that many of Hungary’s neighbors have simple and fair flat tax system and wondering whether the nation can afford to retain a system base on high tax rates:

Bulgaria and Albania joined Russia, Slovakia, Romania and nine other Central and Eastern European countries by adopting a flat tax system at the beginning of the year. Four of Hungary’s seven neighbours have already chosen the flat tax option. In fact, flat tax is now the preferred system among the post-communist economies of Central and Eastern Europe. Is Hungary – already suffering the lowest rate of economic growth of the new EU member states – in danger of being left behind? …To western Europeans, this may sound like the utopian stunt of a madman, but in fact flat tax policies – until recently little more than a theoretical notion dreamt up by economists – have rapidly caught on in the developing economies of central and Eastern Europe since Estonia opted for the novel system in 1994.

In addtion to explaining how the flat tax improves tax compliance, the article notes that many companies are relocating in Slovakia because that country’s tax system is much more conducive to productive activity. The Hungarian fiscal system, by contrast, is very punitive:

With a flat rate of tax, regardless of how much a person earns, he pays the same proportion of his wage to the state. With progressive tax, a pay rise can lead to an increase in the percentage claimed by the government. …a simple, low-rate tax which is easy to collect and difficult to evade is likely to raise more money than a high-rate tax system that is full of loopholes and which nobody fully understands. …Compare Hungary with Slovakia. Hungary’s northern neighbour has opted for the purest of flat tax systems. Employers’ and employees’ income tax contributions are fixed at 19%, as is corporate tax and even VAT. Thousands of Hungarian companies have already relocated their headquarters to Hungarian-speaking southern Slovakia – not only are taxes lower, but accounting has been made child’s play. Hungarian employers must pay 16% income tax and 29% social security on payroll, while employees pay between 18% and 36% income tax plus a host of social and other contributions. The net result of this is that the government receives up to double what the employee takes home. 

Even though Hungary’s growth rate is sluggish and the nation is losing jobs and investment to other nations with better tax systems, the politicians are stubbornly refusing to join the flat tax revolution. This is bad news for Hungary’s workers:

The small, conservative opposition party the Hungarian Democratic Forum has long been calling for the adoption of a flat tax model. Party leader Ibolya Dávid argued last year, when the Czech Republic chose to follow its southern neighbour Slovakia into the flat tax world, that Hungary risks losing out in the battle for foreign investment and lagging behind if it does not follow suit. …Earlier this year, it was reported that two of four possible alternatives included the adoption of a flat tax model. However, last week Magyar Hírlap reported that the cabinet working group had ruled out any such move.

Will the UK Chase Away the Geese with the Golden Eggs?

Allister Heath has an excellent column in the Spectator explaining how Gordon Brown’s class-warfare policies will discourage successful foreigners from moving to the United Kingdom.

London will be hit particularly hard because the attack on “non-domiciled residents” will be augmented by higher capital gains taxes and policies to discourage British expatriates from spending too much time (and money) in the city.

But some people will benefit. Swiss realtors are probably delighted with Brown’s self-destructive proposals, since many highly-productive people will now be looking to relocate to tax-friendly jurisdictions:

[T]he Treasury now admits that 3,000 non-dom expats will leave Britain in April, when the changes, including a £30,000 annual poll tax, are due to kick in. This is a truly remarkable admission, of which far too little has been made. Given how hard all economies, including Britain, strive to attract high-net-worth investors and the highly skilled these days, it is difficult to fathom why any government in its right mind would wish suddenly to begin penalising those it has sought to woo for so long. What is most absurd about this is that the Treasury readily acknowledges, in the very same document laying out its tax hike plans, that ‘in an increasingly globalised economy it is crucial for the UK’s competitiveness that the UK continues to attract international talent to this country’.

…[T]he assault on the non-doms is going hand in hand with a hike in capital gains tax, a rise in corporation tax on small companies, and a crackdown on the 29,000 non-residents who commute most weeks from Monaco or the Isle of Man. All of these changes add up to a simple message to the skilled, hard-working and above all footloose international talent to which today’s Britain owes so much of its success: don’t bother coming here, we don’t value you any longer.

…Tax lawyers are starting to warn their clients seeking to relocate to Britain that the current volley of tax hikes is likely to be merely the thin edge of a much more punitive wedge. Brown’s attack on the non-doms could easily become Brown’s very own Sarbanes-Oxley, the ultra-onerous piece of post-Enron legislation in America which chased away hundreds of companies to more welcoming shores. But what is most distressing to non-doms currently based in the City, and to many of those considering moving here, is that the Tories support an almost identical policy.

Stimulus: Kindergarten Keynesianism

It is very curious that some top economists are pushing the Bush/Pelosi $100 billion stimulus giveaway.

  • For years, these same economists told us that more savings is good for the economy. Now they are saying that more consumption is good.
  • For years, these same economists have lambasted the budget deficit. Now, they support blowing a new $100 billion hole in the federal budget.
  • Finally, many economists have long complained that Americans are shopoholics and have far too much credit card debt. Now stimulus-supporting economists are demanding that Americans spend, spend, spend!

It is surprising that anyone takes economists seriously anymore.

Anyway, stimulus proponents say that mailing $100 billion of cash to families will cause the nation’s output to grow. Yet this simple Keynesian chart illustrates that the result will be higher prices, not more output.

The stimulus causes the aggregate demand curve to shift to the right, as proponents suggest. That moves us along the aggregate supply curve, which I believe should be drawn vertically in this case. The result is that prices jump up from P1 to P2, but output does not rise.

Stimulus proponents would argue that the aggregate supply curve should be sloped, at least in the short run. In that case, the figure would show a temporary bump upwards in output.

But that seems unlikely to me. Keynesian theories about why output might increase usually rely on imperfections in markets or information. Producers get fooled into increasing their output for a while, before the errors are worked out and output falls back to its long-term level.

But that wouldn’t seem to be the case here. Let’s say the rebate checks get mailed out in May and June. A U.S. cigarette producer may notice a slight uptick in sales in those months as smokers spend their government checks. But cigarette producers probably watch the news and they will know that this is just a temporary blip. As such, they won’t add any new workers or buy any new machines.

So output would stay pretty fixed, while prices would adjust upward slightly to clear markets. But I don’t claim to be a Keynesian expert, so if one of our Keynesian readers wants to tell me where I’m wrong, I’d be happy to hear it. Until then, I remain convinced that the Bush/Pelosi scheme is crack-pot.