In Creating Medicare Part D, Republicans Slit Their Own Throats

As a political expedient designed to give George W. Bush a second term in the White House, Karl Rove convinced, cajoled, and browbeat congressional Republicans into creating Medicare Part D, the program’s new prescription drug benefit and the largest expansion of the entitlement state since the creation of Medicare itself. One of the Bush administration’s selling points was that creating a prescription drug benefit in Medicare would allow the GOP to steal the health-care issue from Democrats. Instead, Republicans may have done little more than slit their own throats.

An article in (“Big pharma veers to the left”) discusses how Part D has delivered the pharmaceutical industry – long a supporter of Republican congressional candidates – into the hands of Democrats:

The growth of state and federal health care programs — including President Bush’s prescription drug plan for seniors — means that today about half of the pharmaceutical market is controlled by government.

That got the industry rethinking about how to position itself politically. And the future seems to be in ensuring that the government programs remain robust and generous.

Whereas big-pharma political giving used to run 3-1 in favor of Republicans, it is now running even between the two political parties.

Isn’t the whole point of selling out your principles that you’re supposed to get something in return?

Slow Learner

Newt Gingrich tells the Washington Post, “We have now launched big-government Republicanism.” Referring to the Bush administration’s bailout-and-takeover plan for the financial sector, he said, “If we saw France do this, Italy do this, we would have thought it was crazy.”

He has a point. But some of us identified “big-government conservatism” as the operating system of the current Republican party a long time ago. I wrote about it in the Australian in early 2003 and in the Washington Post in late 2003. Or check out Bill Niskanen’s comments in this 2004 Los Angeles Times article. Of course, Ed Crane saw it coming in 1999. And Mike Tanner wrote a whole book about it – Leviathan on the Right: How Big-Government Conservatism Brought Down the Republican Revolution – in 2007.

Or you could read Mike Tanner’s critique of “Gingrich’s Big Government Manifesto” back in 2006.

Blame Urban Planning

The credit crisis has led to numerous calls for bigger government. Yet the truth is that big government not only let the crisis happen, it caused it.

This truth is obscured by most accounts of the crisis. “I have a four-step view of the financial crisis,” says Paul Krugman. “1. The bursting of the housing bubble.”

William Kristol agrees. His account of the crisis begins, “A huge speculative housing bubble has collapsed.” “The root of the problem lies in this housing correction,” said Secretary of the Treasury Henry Paulson.

So it all started with the bubble. But what caused the bubble? The answer is clear: excessive land-use regulation. Yet while many talk about re-regulating banks and other financial firms, hardly anyone is talking about deregulating land.

The housing bubble was not universal. It almost exclusively struck states and regions that were heavily regulating land and housing. In fast-growing places with no such regulation, such as Dallas, Houston, and Raleigh, housing prices did not bubble and they are not declining today.

The key to making a housing bubble is to give cities control over development of rural areas – a step that is often called “growth-management planning.” If they have such control, they will restrict such development in the name of stopping “urban sprawl” – an imaginary problem – while their real goal is to keep development and its associated tax revenues within their borders. Once they have limited rural development, they will impose all sorts of conditions and fees on developers, often prolonging the permitting process by several years. This makes it impossible for developers to respond to increased housing demand by stepping up production.

In contrast, when cities do not have control of rural areas, developers can step outside the cities and buy land, subdivide it, and develop it as slowly or rapidly as necessary to respond to demand. The cities themselves respond by competing for development – in other words, by keeping regulation and impact fees low. The Houston metro area, for example, has been growing at 130,000 people per year, yet it was readily able to absorb another 100,000 Katrina evacuees with virtually no increase in housing prices.

Before 1960, virtually all housing in the United States was “affordable,” meaning that the median home prices in communities across the country were all about two times median-family incomes. But in the early 1960s, Hawaii and California passed laws allowing cities to regulate rural development. Oregon and Vermont followed in the 1970s. These states all experienced housing bubbles in the 1970s, with median prices reaching four times median-family incomes. Because they represented a small share of total U.S. housing, these bubbles did not cause a worldwide financial meltdown.

In the 1980s and 1990s, however, several more states passed laws mandating growth-management planning: Arizona, Connecticut, Florida, Maryland, Rhode Island, and Washington. Massachusetts cities took advantage of that state’s weak form of county government to take control of the countryside. The Denver and Minneapolis-St. Paul metro areas adopted growth-management plans even without a state mandate. As a result, by 2000, prices of nearly half the housing in the nation were bubbling to four, six, and in some places ten times median-family incomes.

In the meantime, Congress gave the Department of Housing and Urban Development (HUD) oversight authority over Fannie Mae and Freddie Mac. While this was supposedly aimed at protecting taxpayers, Congress knew that HUD’s main mission is to increase homeownership rates, and Congress specifically pressured HUD to increase homeownership among low income families. So HUD responded to the housing bubble by directing Fannie and Freddie to buy increasingly high percentages of mortgages made to low income families, eventually setting a floor of 56 percent. This led Fannie and Freddie to significantly increase their purchases of subprime mortgages, which legitimized the secondary market for such mortgages.

Though everyone knows that the deflation of the housing bubble is what caused the financial meltdown, few have associated the bubble itself with land-use regulation. Back in 2005, Paul Krugman observed that the bubble was caused by excessive land-use regulation. Yet nowhere in his current writings does he suggest that we deregulate land to prevent such bubbles from happening again. Such suggestions have come only from the Cato Institute, Heritage Foundation, and a few other think tanks.

We know that if the regulation is left in place, housing will bubble again – California and Hawaii housing has bubbled and crashed three times since the 1970s. We also know, from research by Harvard economist Edward Glaeser, that each successive bubble makes housing more unaffordable than ever before – and thus leaves the economy more vulnerable to the inevitable deflation. This is because when prices decline, they only fall about a third of their increase, relative to “normal” housing, before bottoming out.

Thus, median California housing was twice median family incomes in 1960, four times in 1980, five times in 1990, and eight times in 2006. In the next bubble, it will probably be at least ten times. This means homeownership rates will decline (as it has declined in California since 1960), small business formation (which relies on the equity in the business owners’ homes for capital) will decline, and education will decline (children of families that own their homes do better in school than children of families who rent).

Worse, more states are passing growth management laws. Tennessee passed a law in 1998, too late to get into the recent housing bubble but enough to participate in the next one. Legislators in Georgia, North Carolina, and other fast-growing states are being pressured to also pass such laws. Naturally, the planners who promote such laws deny that their actions have anything to do with housing prices.

Even worse, the Environmental Protection Agency has proposed to “integrate climate and land use” – effectively using global warming fears to impose nationwide growth management. Supposedly – though there is no evidence for it – people in denser communities emit fewer greenhouse gases, and growth management can be used to impose densities on Americans who would rather live on quarter-acre lots. The California legislature recently passed a law requiring cities to impose even tighter growth restrictions in order to reduce greenhouse gases – and its implementation will be judged on the restrictions, not on whether those restrictions actually reduce emissions.

Instead of such laws, states that have regulated their land and housing should deregulate them. Congress should treat land-use regulations as restrictions on interstate mobility, and deny federal housing and transportation funds to states that impose such rules. Otherwise, hard as it may be to imagine, the consequences of the next housing bubble will be even worse than this one.

Big Victory for Economic Liberty

Amid a financial crisis that has pundits playing the game of who can come up with the most nationalization and re-regulation—and a presidential campaign where neither candidate seems to have much coherent to say about the economy—one bright ray of light shone through.

And it came from San Francisco, no less.

On September 16, the U.S. Court of Appeals for the Ninth Circuit delivered a blow against unfair economic regulation in the case of Merrifield v. Lockyer. Pacific Legal Foundation lawyer and Cato adjunct scholar Tim Sandefur argued on behalf of Alan Merrifield, a businessman prevented from building structures to keep out pests by a bizarre licensing regulation. The California law in question required people who do not use pesticides to undergo years of training and take an examination testing their knowledge of chemicals and insects before they can use pest control techniques that involve neither chemicals nor insects.The law only applies to pigeons, rats, and mice, however, so putting spikes on a building to keep seagulls off it does not require a license. But the same activity aimed at deterring pigeons does. Moreover, the record showed that the rule was designed for the sole purpose of protecting people who have licenses from having to compete in the marketplace against upstart businesses like the one operated by Merrifield.

Circuit Judge Diarmuid O’Scannlain, writing for the panel majority, succinctly explained the problem with California’s rationale:

The possibility that non-pesticide-using pest controllers might interact with pesticides or will need the skill to suggest pesticide use when it would be more effective is the very rationale that government’s counsel proffered, and we relied upon, in upholding the requirement that Merrifield obtain a license under due process grounds. We cannot simultaneously uphold the licensing requirement under due process based on one rationale and then uphold Merrifield’s exclusion from the exemption based on a completely contradictory rationale. Needless to say, while a government need not provide a perfectly logically solution to regulatory problems, it cannot hope to survive rational basis review by resorting to irrationality.” (Emphasis in original)

That is, “economic protectionism for its own sake, regardless of its relation to the common good, cannot be said to be in the furtherance of a legitimate governmental interest.”

This decision is thus a tremendous blow against the various licensing advantages granted by legislatures to the few at the expense of the many. As Sandefur put it in PLF’s press release, “This is a victory for free enterprise and for the Constitution’s safeguards for entrepreneurship.”

The battle for economic rights remains an uphill struggle, however, because the invalidation of California’s pernicious legislation rested not on the basic right to earn an honest living but on the state’s “irrational singling out of three types of vertebrate pests” to the economic benefit of some exterminators as against others.The case necessarily turned on an “equal protection” violation, instead of constitutional protection of any substantive rights. Without that arbitrary listing of pigeons, rats, and mice, the pesticide/insect requirements would have withstood Merrifield’s challenge. Judge O’Scannlain implicitly recognized that reaching the correct result in this manner was intellectually unsatisfying, but that his hands were tied by the Supreme Court’s 1873 Slaughterhouse Cases (which eviscerated the Fourteenth Amendment’s Privileges or Immunities Clause). So long as the Supreme Court shies from revisiting the twisted logic of that precedent, the Constitution will offer precious little defense against legislation that restricts the ability of individuals to freely exchange goods and services.

Nevertheless, in establishing the legal principle that mere protectionism is not a legitimate state interest, the Merrifield case is a major victory for economic liberty—and the first time the Ninth Circuit has taken up this issue.

Congratulations to Tim and to Pacific Legal!

An Alternative to the United States of Permanent Receivership

If you have not seen this essay [.pdf] already, it is well worth your time. Zingales ends the essay:

The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded? For somebody like me who believes strongly in the free market system, the most serious risk of the current situation
is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.

The next 50 years? Perhaps. Markets deal with risk through deterrence. Individuals and firms take risks and gain or lose from their decisions. The gain or loss comes after the decision. If individuals and firms are protected from losses through taxpayer interventions, deterrence against bad risks cannot work. Risks are dealt with prior to a decision rather than afterwards. The government is charged with preventing unwise risk-taking before any decisions are made. Government officials come to have a veto over choices by private actors.

In this way, the United States of permanent receivership becomes in theory, and more and more in practice, a state of control over private decisions.

Fear of Sharia? Oh, Please.

Reviewing the new bills in Congress for my side-project, I come across some interesting stuff — and some dumb stuff.

Very dumb is how I would characterize a new bill introduced this week. H.R. 6975 would require aliens to attest that they will not advocate installing a Sharia law system in the United States as a condition of their admission to our country.

On the blog, I assessed it thusly:

First, there’s the simple bureaucratic nonsense of administering this thing: We’re going to ask every Christian, Catholic, Zen Buddhist, and Hindu not to advocate traditional Islamic law? What an utterly stupid waste of time. I don’t want a penny of my money going to pay for this.

But more importantly, a law like this communicates precisely the wrong thing to new immigrants and the world at large. It tells the world that we’re a weak, fearful country, and that we believe Sharia law is possible in the United States. It tells the world that we’ve come off our traditional moorings and that we no longer believe in free speech and tolerance of all opinions, no matter how wrong.

Let’s talk substance, just in case one or two of you out there are weak and fearful: There is no possibility — none — that Sharia law will be established in the United States. Not by any government body at any level. This country can stand to have Sharia advocated by whatever tiny minority might want to — without any risk. In fact, allowing such discussion will help dispel whatever small demand there could be for Sharia, because it would be so obviously incompatible with our way of life.

It’s embarassing that a strong, free country like ours would even consider an idea like this.

When to Worry about Moral Hazard?

In three different, recent op-eds, I’ve read that only during boom times should we worry about moral hazard — the idea that some actor will engage in overly risky behavior because he believes that he’ll be bailed out if the risk goes bad. The most recent op-ed to say this is Charles Goodhart’s, in today’s FT

OK, I did worry about moral hazard in 1998 when stock prices peaked. And again in 2006 during the housing price boom. 

Question: Instead of worrying, when is it time to “do” something about moral hazard? 

It seems the answer is never. During boom times, no one asks for government to play Good Samaritan. And during a bust — like now — when there’s opportunity to tell negligent investors to “go swim in the lake,” we’re told, well, the time to worry about moral hazard is during boom times! 

That’s another reason to call moral hazard the ”Samaritan’s Dilemma.”