Archives: 09/2011

Capital Gains Taxes: Washington Post Omissions

Washington Post reporters write a few thousand words on capital gains taxes today, and they somehow forget to mention the key economic factors in favor of a lower rate.

One factor is that the double taxation of corporate equity under an income tax system creates a serious economic distortion. Corporate profits are taxed at the business level and then again at the individual level by taxes on dividends and capital gains. Providing a lower rate for dividends and gains at the individual level is one way to partly alleviate the distortion.

Another factor is that inflation causes investment returns to be overtaxed in an income tax system without special rules to compensate. If someone buys a stock for $10 and sells it a few years later for $15, some portion of the tax paid will be tax on inflation. The effect of taxing people on inflationary gains is to reduce real returns and distort the tax code against investment.

These problems have led virtually every industrial nation to adopt special rules for taxing long-term capital gains. Most countries have either a reduced individual rate or a partial exclusion. About a dozen advanced economies – for example, the Netherlands and New Zealand – have long-term capital gains tax rates of zero. The Post managed to miss this international reality in its reporting.

The following chart from Global Tax Revolution shows capital gains tax rates in the high-income nations of the OECD. The chart is a little dated now, but it makes the point that our federal capital gains tax rate of 15 percent is pretty average – it is not some sort of unique right-wing giveaway to rich people, as the Post story implies.

Adam Gopnik Fails the Ideological Turing Test

Can people on one side of a political debate understand why others disagree with them? Sometimes it doesn’t seem so. Take Adam Gopnik’s article about “declinism” in the September 12 New Yorker. (Online for subscribers only, alas.) It’s an interesting review of new books about the decline of America and/or the West by Ian Morris, Niall Ferguson, and Thomas Friedman and Michael Mandelbaum. In the course of it Gopnik explains that there is “another side” in American politics from the good and decent side of President Obama and such people as Friedman and Mandelbaum. And that side is “inexorably opposed to these apparently good things.”

The reason we don’t have beautiful new airports and efficient bullet trains is not that we have inadvertently stumbled upon stumbling blocks; it’s that there are considerable numbers of Americans for whom these things are simply symbols of a feared central government, and who would, when they travel, rather sweat in squalor than surrender the money to build a better terminal. They hate fast trains and efficient airports for the same reason that seventeenth-century Protestants hated the beautiful Baroque churches of Rome when they saw them: they were luxurious symbols of an earthly power they despised.

This is the sort of place where it’s a good idea for an author to stop and think: Is that really what advocates of smaller government think? They actually hate the very idea of fast trains and efficient air travel? They’d rather sweat in squalor than pay for better service?

He goes on:

We don’t have a better infrastructure or decent elementary education exactly because many people are willing to sacrifice faster movement between our great cities, or better-informed children, in support of their belief that the government should always be given as little money as possible.

Sure, he’s claiming, we small-government folks would like our kids to learn to read. But not if it means giving up one solitary dime to the predatory state. Gopnik might have added that we crotchety libertarians would rather a hundred guilty men go free than a single innocent be jailed. Or that we’d rather see the people of Iraq suffer under Saddam Hussein rather than send a single American to die in the desert. Except that those are “ideological convictions” that New Yorker writers share. In those cases they understand that there are trade-offs, that benefits come with costs, that the end does not always justify the means.

And having identified those concepts, I wonder if Mr. Gopnik might try again to understand why some Americans oppose an array of government spending programs. Is it really that they “simply” fear good schools and fast trains? Or is it possible that they – we – have actual arguments? That we have actually enunciated those arguments in blog posts, op-eds, essays, and even books? And that few of us have said we’d rather sit in traffic than “give too much pleasure” to liberals?

Let me suggest to Mr. Gopnik a few reasons that some us oppose the various spending programs that concern him:

  1. We know that vastly increased government expenditures often don’t achieve their intentions, such as the 190 percent increase in both inflation-adjusted federal education spending and school infrastructure spending that hasn’t budged test scores.
  2. We know that many wonderful things, perhaps including truly fast trains, could be created at massive cost, but that you always have to weigh costs and benefits. Children say, “I want it.” Adults say, “How much does it cost, and what would I have to give up to have it?”
  3. We believe that people spend their own money more prudently than they spend other people’s money. So goods and services produced in the competitive marketplace are likely to be produced more efficiently and with more regard for real consumer demand than goods produced by government, and thus we should try to keep as many aspects of life as possible outside the control of government.
  4. We believe that you’ll get better schools, trains, and planes if they’re produced privately than if they’re created by government. And thus, since we want good schools and good transportation, we want them produced by competitive enterprise.
  5. We believe that the burden of taxes, spending, debt, and regulation is already reducing economic growth, and that our society would have more wealth for more people and better technology if it had a government smaller in size, scope, and power. Try plotting government spending vs. the increase in the speed of human mobility; I think you’d find an inverse relationship, with very little increase in the past generation of massive government spending.
  6. Yes, we have a philosophical preference for freedom. Not freedom at all costs, not anarchy, but liberty and limited government as the natural condition for human flourishing. We believe that liberal society is resilient; it can withstand many burdens and continue to flourish; but it is not infinitely resilient.  Those who claim to believe in liberal principles but advocate more and more confiscation of the wealth created by productive people, more and more restrictions on voluntary interaction, more and more exceptions to property rights and the rule of law, more and more transfer of power from society to state, are – perhaps unwittingly – engaged in the ultimately deadly undermining of civilization.

And you know, when I think about Mr. Gopnik’s point that my Scottish Protestant ancestors “hated the beautiful Baroque churches of Rome [because] they were luxurious symbols of an earthly power they despised,” it occurs to me: Those churches are beautiful. So are the pyramids. But if President Obama or Paul Krugman or the AFL-CIO proposed to tax productive working people to build beautiful churches and pyramids, I would oppose it. Even if I wanted more beautiful churches, I would not be willing to force my fellow citizens to contribute to my satisfaction. And the same principle applies to faster trains between Washington and New York, which I absolutely do want. And which I believe the market would deliver, if we had a market in transportation and if faster trains are in fact a good use of our economy’s scarce resources.

Bryan Caplan recently challenged Paul Krugman and other intellectuals to an “ideological Turing test” – a test to see who could state an opposing view as clearly and persuasively as its proponents could. I think Gopnik would fail that test. Assuming that he has in this article stated as fairly as possible what he actually believes his opponents believe, then he seems far off the mark. Would he like to try again, to explain and then criticize the views laid out above or in books by Hayek, Nozick, Friedman, and Epstein?

In the meantime, I found much of his article interesting, and I agreed with many of his conclusions about the achievements of Western liberalism. But as he wrote, after taking issue with some of Niall Ferguson’s analyses of the French Enlightenment, Darwinianism, and the sixties, “when someone gets the sixties Beatles this wrong you have to wonder how well he really is doing with the sixth-century barbarians.” And when somebody gets the argument for limited government this wrong, you have to wonder whether he’s accurately described the books under review.

You Can’t Patent Thoughts

Doctors and researchers regularly perform blood tests to determine the effectiveness of various drugs. The resulting correlations between the test results and patient health have recently become the subject of numerous “process” patents. That these patents have been upheld by the U.S. Court of Appeals for the Federal Circuit represents a dangerous expansion of traditional patent law.

This expansion threatens to stifle free markets and infringe on individual liberty. In Mayo v. Prometheus, the Court will address the important question of whether someone can patent the process of observing correlations between blood test results and patient health. The primary legal issue here is whether naturally occurring correlations are patentable as “process” patents simply because the methods used to administer prescription drugs and test blood may involve “transformations” of body chemistry.

On Friday, Cato filed an amicus brief, joined by the Reason Foundation and the Competitive Enterprise Institute, arguing that these patents are not “processes” as the term was originally understood in the Patent Act of 1952. We liken medical-diagnostic patents to other abstract-process patents—such as software and business-method patents—that have resulted in financial losses for firms and discouraged innovation, and argue that enforcing these patents “will only serve to further slow the economy, retard technological innovation, distort the free market, and place human health at risk.”

Moreover, upholding the patents at issue will impermissibly restrict public-domain activity because the final step in a medical-diagnostic patent is an entirely mental one that will be violated whenever a doctor performs a previously public-domain medical test after learning about the patented correlation. Our brief thus closes by arguing that the Court should also consider the profound First Amendment implications in allowing processes whose final step is entirely mental to be patented.* “The Court has repeatedly recognized that the First Amendment protects freedom of thought as well as freedom of speech.” Unlike copyrights, patents lack traditional free-speech safeguards (such as exceptions for “fair use”) and, therefore, the Court should reject medical-diagnostic patents as impermissibly restricting the freedom of thought.

Mayo v. Prometheus will be argued late this year or in early 2012.  Here again is Cato’s brief.


*Recall Judge Gladys Kessler of the D.C. federal district court, who found Obamacare’s individual mandate constitutional under the Commerce Clause because it regulates “mental activity.”  Combining this theory with the theory of patentability at issue here, federal courts could sustain lawsuits based on a defendant’s making the same “patented” decision (or non-decision) as a plaintiff.

President Obama’s $447 Billion Tax Increase

In his September 8 lecture to Congress, President Obama promised that “every proposal I’ve laid out tonight will be paid for.”  How?  By raising tax rates on “the wealthiest Americans and biggest corporations.” In other words, the President is proposing a $447 billion tax increase.

When the details are revealed on September 19, the President will be proposing large and permanent increases in the highest income tax rates − mainly to “pay for” a small and temporary cut in payroll taxes (which accounts for 54 percent of his $447 billion package).  The plan is likely to contain elements of the September 7 proposal of Congressional Democrats to the super-committee – such as a draconian “super-Pease” phase-out and cap on itemized deductions, and a top marginal tax rate of 48.8 percent in 2013.

Temporary payroll tax cuts and extended unemployment benefits are bait the President set out to trap House Republicans with their own debt ceiling demands.

“The agreement we passed in July,” said the President, “will cut government spending by about $1 trillion over the next 10 years. It also charges this Congress to come up with an additional $1.5 trillion in savings by Christmas. Tonight, I am asking you to increase that amount so that it covers the full cost of the American Jobs Act.”   But the $447 billion budgetary hit can’t be spread over 10 years without triggering another debt ceiling calamity.  Either the debt ceiling has to be promptly raised by an extra $447 billion or tax receipts somehow raised by that amount in fiscal 2012-2013.   Any “modest adjustments to health care” will be too distant and nebulous to help.

Using permanently higher tax rates on income to pay for temporarily lower tax rates on payrolls is no “stimulus” under either Keynesian or empirical economics.  Neither is a tax-financed extension of unemployment benefits, which clearly raises the unemployment rate by 0.8 to 1.8 percentage points.   Yet the one-year extension of payroll tax cuts and 99-week unemployment benefits is being held out as irresistible bait to gullible legislators.

By inviting House Republicans to stumble into this trap, the president is also hoping to preempt the congressional super-committee’s option of reducing deficits by trimming tax loopholes.  President Obama is trying to lay claim to any potential revenues from cutting loopholes (or legitimate deductions) for his own pet projects, which include grants to hire more state and local government workers and extended unemployment benefits for the private sector.

This is no “jobs plan.”  It’s a tax-and-spend plan, and a bad one.

Davis-Bacon Rules Damage D.C.

The Washington Post reports on a Labor Department decision that applies pro-union Davis-Bacon rules to the CityCenter development in Washington D.C. The ruling could push up costs on the project by $20 million by forcing firms to pay artificially high wages.

The paper says that “area real estate developers and construction executives who have partnered with the District say the ruling, if upheld, is likely to inflate costs on a wide range of projects by as much as 15 percent.” In turn, that could have “unprecedented, significant [and] adverse citywide cost impact upon every economic development project in the District’s portfolio,” said a deputy mayor of the city. So while Democrats in Congress are demanding government action to fix the nation’s supposedly crumbling infrastructure, here the Obama administration has thrown up a new hurdle to investment.

Davis-Bacon rules usually apply to federally funded construction, thus pushing up the costs of public projects. Nationwide, economists at the Beacon Hill Institute found that Davis-Bacon rules cost federal taxpayers about $9 billion annually. For example, repairs to National Park facilities cost more than they should, thus reducing the amount of maintenance the agency can do within its budget. However, the D.C. ruling stretches the Davis-Bacon rules even further because CityCenter is a privately funded project.

In an essay at www.DownsizingGovernment.org, economist Charles Baird notes that passage of Davis-Bacon in 1931 was motivated by the faulty economic idea that the government should try to keep wages high during an economic downturn. But Baird describes another reason why Davis-Bacon was misguided from the start—the racist intentions of the bill’s supporters:

Congress wanted to keep black workers from competing for jobs that had hitherto been done by white unionized labor. The racist motivation behind the legislation is plain when reading the Congressional Record of the debate in 1931.

Kinks in Obama’s Home Refinancing Plans

In the president’s electioneering lecture to Congress, Mr. Obama said, “To help responsible homeowners, we’re going to work with federal housing agencies to help more people refinance their mortgages at interest rates that are now near 4 percent… . I know you guys must be for this, because that’s a step that can put more than $2,000 a year in a family’s pocket, and give a lift to an economy still burdened by the drop in housing prices.”

Unfortunately, it is not quite that simple. Because using the leverage of Fannie Mae, Freddie Mac, or the Federal Housing Administration to promote riskier standards for refinancing would benefit only those homeowners who stay put in houses they already own, the unintended effect on sales of new or existing homes could be negative.  Moreover, gains to borrowers would be offset by potentially larger losses to investors in mortgage-backed securities (MBSs) – the “toxic assets” that provoked so much financial mischief in 2008.

As it happens, the Congressional Budget Office just released an “An Evaluation of Large-Scale Mortgage Refinancing Programs” by two CBO staffers and Deborah Lucas, a first-rate economist on loan from M.I.T.

Here are some key points:

We analyze a stylized large-scale mortgage refinancing program that would relax current income and loan-to-value restrictions for borrowers who wish to refinance and whose mortgages are currently insured by Fannie Mae, Freddie Mac, or the Federal Housing Administration. The analysis relies on an estimate of the volume of incremental refinancing that would occur and an estimate of how future default and prepayment behavior would be affected by such refinancing. Relative to the status quo, the specific program analyzed here is estimated to cause an additional 2.9 million mortgages to be refinanced, resulting in 111,000 fewer defaults on those loans and estimated savings for the GSEs and FHA of $3.9 billion on their credit guarantee exposure, measured on a fair-value basis. Offsetting those savings, federal investors in MBSs, including the Federal Reserve, the GSEs, and the Treasury, would experience an estimated fair-value loss of $4.5 billion… .

We also discuss the impact of this program on various stakeholders, including homeowners, non-federal mortgage investors, mortgage lenders, mortgage service providers, private mortgage insurers, and subordinated mortgage holders. For example, non-federal investors would experience an estimated fair-value loss of $13 to $15 billion; most of that wealth would be transferred to borrowers… .

In aggregate, the fair-value loss to both federal and non-federal investors is equivalent to the gain experienced by borrowers from the decline in their interest payments… Nevertheless, because a significant share of investors is composed of foreigners and the U.S. government, and because private investors would be expected to reduce spending in response their losses by less than the increase in spending by borrowers in response to their lower interest payments as well as their lower mortgage principal payments, the net effect would be an economic stimulus … but it is likely to be small relative to GDP.

With respect to the housing market, the overall impact of the program is also small; the 111,000 homeowners saved from foreclosure by virtue of lower monthly mortgage payments will have a minor impact on the path of future home prices. Because this program is directed toward current homeowners, it would do little to alleviate the tighter underwriting standards and increased credit pricing for purchase loans. In addition, it would not create much demand for homes, because all of its participants would already have at least one property.

Do People Pay for These Forecasts?

The forecasting firm Macroeconomic Advisers said in a report that Obama’s plan — the American Jobs Act — would boost economic growth by 1.3 percentage points in 2012 and lead to 1.3 million new jobs….

Mark Zandi, an economist with Moody’s Analytics, was even more enthusiastic about the plan. He said the jobs package would increase economic growth by 2 percentage points in 2012 and add 1.9 million jobs.

Washington Post, September 10, 2011

Obama’s program received generally favorable reviews from economists.

“Is it worth doing?” wrote Nigel Gault, an economist at IHS Global Insight. ”Yes, it is a bolder-than-expected attempt to inject fiscal stimulus to support an ailing recovery.”

Washington Post, September 10, 2011

Here’s another view of the Obama proposal. Here’s a critique of these forecasts. And here’s a graph reminding us what happened after President Obama predicted that his first stimulus would actually stimulate the economy.