Some Perspective on the President’s Budget Request

The White House has been spinning reporters all day with the claim that the new budget holds non-defense spending down, and in some cases even cuts some domestic spending from 2006 budget levels. 

To test the claim, I’ve compiled below the proposed fiscal 2008 inflation-adjusted growth rates for spending in the non-defense Cabinet-level agencies compared to the 2006 budget:

Real Proposed Change in 2008 Non-Defense Cabinet-Level Agency Budget vs. 2006 Budget Level
   
Agriculture -9.2%
Commerce 5.9%
Education -40.2%
Energy 6.1%
Health and Human Services 8.5%
Housing and Urban Development -0.2%
Interior 10.8%
Justice -1.7%
Labor 15.6%
Transportation 6.3%
Treasury 7.7%
Veterans Affairs 13.8%
EPA -10.9%
Total
4.1%

All told, there are five agencies that receive a cut in real dollars: Agriculture, Education, HUD, Justice, and the Environmental Protection Agency. Yet even by the White House’s own numbers, all of these programs combined will still grow beyond the 2006 levels by 4 percentage points above inflation. 

Still, we need to wonder: What does this standard really tell us? 

Not much. The 2006 budget levels were already bloated after a six-year Republican spending spree. What’s actually interesting to see is how much these agencies would grow — after adjusting for inflation and assuming Congress rubber-stamps the president’s new budget — when compared to budget levels on the day Bush assumed office: 

Real Proposed Change in 2008 Non-Defense Cabinet-Level Agency Budget vs. 2001 Budget Level
   
Agriculture 8.0%
Commerce 16.8%
Education 36.2%
Energy 10.7%
Health and Human Services 35.6%
Housing and Urban Development 8.3%
Interior 12.0%
Justice 7.7%
Labor 8.8%
Transportation 12.4%
Treasury 11.7%
Veterans Affairs 52.7%
EPA -12.8%
Total
22.4%

To put it another way: Bush’s new budget still does next to nothing to strip away most of the massive budget increases in domestic programs he signed into law since 2001. It’s the fiscal equivalent of a recovering alcoholic patting himself on the back for merely drinking six beers a day instead of eight.

Rule-of-law and U.S. Competitiveness

Policies such as Sarbanes-Oxley are reducing America’s competitiveness, but an equally worrisome problem is the erosion of the rule-of-law.

Stability and equal treatment are among the characteristics of an advanced legal system. Unfortunately, America’s legal system is now riddled with uncertainty, since investors and companies have no way of predicting outcomes.

The New York Sun has a column noting how America’s justice system is now an obstacle rather than an inducement to international investment:

[T]he American share of global initial public offerings declined to 5% from 50% in the last five years. Foreign companies are being scared away in part, both reports conclude, by soaring costs of American law.

The highwater mark for securities lawsuits was reached in 2005, with over $9 billion in class action settlements. The zeal of American prosecutors in corporate scandals is also of a different order of magnitude. In 2004, government fines in America totalled $4.74 billion, over 100 times more than in Britain, which had a total of $40.48 million. Sarbanes-Oxley, the federal law that imposes higher accountability standards on corporate boards, has almost tripled auditing costs for small public companies.

Perhaps the most chilling parts of the Bloomberg-Schumer report are the surveys of foreign business leaders who suggest, overwhelmingly, that they no longer trust American law. For most of the last century, trust in American commercial and securities law was one of our greatest competitive advantages. Investors flocked to our markets because securities laws guaranteed transparency and honesty. American contract law was the gold standard for world business, in part because of a long tradition of judges rigidly applying guidelines of liability and damages.

Economist Douglass North received a Nobel prize in part for his work on the vital role of legal stability in economic prosperity. An “essential element of the concept of justice,” legal philosopher H.L.A. Hart observed, “is the principle of treating like cases alike.” That’s why law is the foundation of freedom — people know where they stand. They can act freely instead of looking over their shoulders all day long.

But that trust has now capsized. Companies are afraid that if a few employees out of thousands do something wrong — even if not material to the bottom line — the company faces the prospect of ruin. An indictment, not a conviction, could put a company out of business. Why roll the legal dice in America when legal systems in Britain and elsewhere focus on punishing the individual wrongdoer, not shooting everyone in sight?

It’s impossible to measure how much distrust of law has contributed to declining competitiveness. But the evidence is all around us. Just talk with foreign business leaders.

The main victims of this trend, however, are employees and their pension plans. Drying up of markets means that countless people lose job opportunities and that innovation moves offshore. Trust, once lost, is hard to regain.

Tort reforms limiting damages don’t get close to the heart of the problem. American justice has a deeper flaw — it no longer reliably distinguishes right from wrong. Instead, decisions are made on an ad hoc basis, jury by jury, without predictable boundaries.

Hong Kong to Lower Flat Tax?

Thanks to strong growth, which is in part due to a tax system that minimizes the burden on productive activity, Hong Kong leaders are considering reducing the flat tax to just 15 percent.

Tax-news.com reports:

Donald Tsang has pledged to cut Hong Kong’s individual and corporate income taxes if re-elected as the Special Administrative Region’s Chief Executive next month. Tsang officially announced that he would seek election to a second term of office last week and said that one of his key policies would be to return some of Hong Kong’s fiscal surplus back to the population through a “gradual” reduction in salary and profit taxes to 15%.

Dutch Tax Haven Pressures Greedy Governments

The New York Times has a thorough article today detailing how both individuals and companies are using the Netherlands as a haven for productive activity.

This is good news for all taxpayers. The rich directly benefit, since greedy politicians are unable to seize as much of their money. And the rest of us benefit, since this puts downward pressure on tax rates as governments try to keep the geese that lay the golden eggs from flying away.

[L]ast August, according to details disclosed in documents maintained by the Handelsregister, the trade registry of the Netherlands, Promogroup helped the three [Rolling Stones] performers set up a pair of private Dutch foundations that will allow them to transfer assets tax-free to heirs when they die. Other Dutch shelters that Promogroup has arranged for the three have already paid off handsomely; over the last 20 years, according to Dutch documents, the three musicians have paid just $7.2 million in taxes on earnings of $450 million that they have channeled through Amsterdam — a tax rate of about 1.5 percent, well below the British rate of 40 percent.

The rock powerhouse U2 has transferred lucrative assets to Amsterdam, as have other pop singers and well-known athletes….

While old-school, offshore tax havens — the warm ones with tropical fish, off-the-shelf holding companies sporting post-office-box addresses, and scant regulation or transparency — still attract money, they are largely patronized, tax lawyers and entertainment bankers say, by hedge funds and private equity firms looking to protect lush trading profits from taxes. But for earnings derived from intellectual property such as royalties, the Netherlands has become a tax shelter of choice.

Many of the world’s multinational corporations, like Coca-Cola, Nike, Ikea, and Gucci, have set up holding companies here in recent years to take advantage of tax shelters nearly identical to the ones that the Rolling Stones and U2 use.

The Netherlands is home to almost 20,000 “mailbox companies,” Dutch shorthand for corporate shells set up by foreign companies and wealthy foreigners who use them to relieve taxes on royalties, dividends and interest payments….

Globally, some 1,165 companies use Dutch tax shelters to reduce or eliminate taxes on royalties and patents.

Not surprsingly, international bureaucracies and left wing groups despise tax havens — precisely because tax competition makes it more difficult to increase the size of government. The story in the Times elaborates, including completely unsubstantiated accusations that low taxes somehow facilitate dirty money:

Some experts see a darker side to the emergence of the Netherlands as a sought-after tax shelter. In 2000, the Organization for Economic Cooperation and Development, based in Paris, black-marked the country as one of the world’s top five industrialized tax havens for promoting “treaty shopping” for low-tax jurisdictions.

…In its report last fall, SOMO, the research group, said…that “tax haven features of the Netherlands also facilitate money laundering and attract companies with a dubious reputation.”

Bad-mouthing the Economy

Critics of the Bush tax cuts used to complain that America had a so-called jobless recovery. That’s no longer a tenable assertion, so now they argue that wages are stagnant or that people don’t save enough.
The Wall Street Journal certainly does not give credence to any of these claims:
[T]he current expansion was derided right through 2004 as a “jobless recovery.” We now know the economy has created 7.4 million new jobs since mid-2003, as revisions by the Bureau of Labor Statistics have added hundreds of thousands to its original monthly estimates. Thus the hand-wringers have had no choice but to move on, turning their laments to allegedly “stagnant wages.” Well, that’s now vanishing too.
As for real (inflation-adjusted) wage growth, it averaged 0.6% annually for non-farm workers in the first half of the 1990s compared with 1.5% a year so far in this decade. “This cycle as a whole has witnessed twice the average real wage growth than the first 64 months of the previous expansion,” Mr. Darda writes. For the last 12 months, real wages have risen even faster, at a 1.7% clip.
So moving right along, this week’s bad news is said to be the U.S. “savings rate,” which according to the official measure was “negative” for a whole calendar year for the first time “since the Great Depression,” as Martin Crutsinger of the Associated Press helpfully put it.
As a statistic, however, the official “savings rate” is nearly as useless a guide to prosperity as the trade deficit. In the government accounts, what is called the savings rate is literally income less consumption. But the government defines income too narrowly and consumption broadly. For example, “income” doesn’t measure capital gains (whether realized or not), the rising value of your home, or even increases in your retirement accounts.
…[T]hese columns long ago began to watch a far more instructive figure known as “household net worth.” That number, released by the Federal Reserve, includes all assets (tangible and financial) held by individuals less their liabilities (mortgage and other debt). At the end of last year’s third quarter, U.S. household net worth had climbed to $54.1 trillion. That was an increase of more than $3 trillion over the previous four quarters.

Endorsing the U.S. Trade Complaint Against China

On Friday, the U.S. Trade Representative initiated a formal challenge of various Chinese tax programs within the dispute settlement system of the World Trade Organization. It was only the third formal challenge of Chinese policies since that country joined the WTO in 2001.

Specifically, the United States alleges that Chinese tax policies that encourage production for exportation and that discourage the use of imported materials and components in the production process constitute subsidies that harm U.S. interests and violate the obligations China undertook when it joined the WTO in 2001.

I have been critical of the administration’s various trade policy errors of commission and omission over the years. Last week I lamented U.S. trade representative Susan Schwab’s failure to articulate the broad case for trade.  Today, I have only kudos for the USTR. Not only was the United States well within its rights to bring this case, it was the right thing to do, politically and economically. 

Free trade purists might disagree, arguing that if China wants to subsidize its exports to the United States, Americans should write the Chinese thank you letters for financially supporting our consumption. And accordingly, we shouldn’t intervene if the Chinese want to squander their resources that way. I think that argument holds water up to a point — a point that we are well beyond and where the costs of the status quo outweigh its benefits. 

Yes, we benefit as consumers from subsidized Chinese production, but only until the consensus for a liberal trading order collapses. At that point, retrograde protectionism threatens not only the benefits of that subsidized consumption, but the benefits of trade more generally, and the conditions that make relatively freer trade possible. Furthermore, the U.S. trade relationship with China is wealth-creating in both countries without need of subsidization. Safeguarding continuation of the flow of the benefits of trade to both countries by expecting China (and the United States) to play by the established rules seems a reasonable compromise to me.

The rules-based trading system has been remarkably successful at promoting trade and investment, and its continued success depends upon adherence to its rules and respect for its institutions — particularly by the world’s large economies.

China has demonstrated that it doesn’t respond well to bilateral threats — if for no other reason than its desire to avoid the appearance of being bullied. China knows what its obligations are. But it also knows that one of the many benefits of its membership in the WTO is that its policies are above board unless and until the dispute settlement body of the WTO finds against them. If China wants to drag its feet with respect to compliance and reform, bringing cases against China within the WTO might become fashionable.  

We are already witnessing a deterioration of support for trade and its institutions in the United States precisely because of perceptions that policymakers are doing too little to enforce the existing rules. I don’t advocate knee-jerk invocation of our rights to dispute settlement — there is plenty of room for deliberation and consultation (which is perpetually in play under the radar). 

To the extent that Friday’s actions serve as a release valve for some of the political pressure that has been building in Congress for unilateral actions against China, it is already a success. By bringing the case through formal WTO channels, Congress will see that there are, in fact, alternatives to dangerous, unilateral sanctions. In that sense, this case could reduce the likelihood that Congress intervenes and mucks everything up and it could actually improve long-term prospects for the U.S.-China trade relationship.