October 25, 2011 10:35AM

The Euro Crisis in Prose and Poetry

The European debt crisis is inspiring public radio to literary analysis. Last week NPR's Planet Money put the French-German relationship into a "threepenny opera":


Everyone is counting on you
You've got the money
We've got the debt (Oh yes, we've got a lot of debt!)
And do we need a bailout—you bet


Zat's it, I've had enough
Looks like it's time now for me to leave...




Vhy is ze door locked? You must let me out.


Dear when the times are tough
It's better to give zan to receive

Then Monday Marketplace Radio turned to classics professor Emily Allen Hornblower and economist Bill Lastrapes to discuss Greek debt as classical tragedy—Oedipus? The ant and the grasshopper?

Loyal Cato readers will recognize Bill Lastrapes as the coauthor of the much-discussed Cato Working Paper "Has the Fed Been a Failure?"

And then, if you prefer prose and sober analysis to literary analogies, let me recommend Holman Jenkins's perceptive column on why Europe hasn't solved its crisis yet, which unfortunately appeared in the less-read Saturday edition of the Wall Street Journal. (OK, not less read than Cato-at-Liberty, but probably less read than the weekday Journal.)

Neither leader has an incentive to sacrifice what have become vital and divergent interests to produce a credible bailout plan for Europe. To simplify, German voters don't want to bail out French banks, and the French government can't afford to bail out French banks, when and if the long-awaited Greek default is allowed to happen....

There is another savior in the wings, of course, the European Central Bank. But the ECB has no incentive to betray in advance its willingness to get France and Germany off the hook by printing money to keep Europe's heavily indebted governments afloat. Yet all know this is the outcome politicians are stalling for. This is the outcome markets are relying on, and why they haven't crashed.

All are waiting for some market ruction hairy enough that the central bank will cast aside every political and legal restraint in order to save the euro....

And then the crisis will be over? Not by a long shot.

All these "solvent" countries and their banks will be dependent on the ECB to keep them "solvent," a reality that can only lead to entrenched inflation across the European economy. That is, unless these governments undertake heroic reforms quickly to restore themselves to the good graces of the global bond market so they can stand up again without the ECB's visible help.

It's just conceivable that this might happen—that countries on the ECB life-support might put their nose to the grindstone to make good on their debts, held by ECB and others. Or they might just resume the game of chicken with German taxpayers, albeit in a new form, implicitly demanding that Germany bail out the ECB before the bank is forced thoroughly to debauch the continent's common currency, the euro.

October 25, 2011 8:41AM

Grading Perry’s Flat Tax: Some Missing Homework, but a Solid B+

Governor Rick Perry of Texas has announced a plan, which he outlines in the Wall Street Journal, to replace the corrupt and inefficient internal revenue code with a flat tax. Let's review his proposal, using the principles of good tax policy as a benchmark.

1. Does the plan have a low, flat rate to minimize penalties on productive behavior?

Governor Perry is proposing an optional 20 percent tax rate. Combined with a very generous allowance (it appears that a family of four would not pay tax on the first $50,000 of income), this means the income tax will be only a modest burden for households. Most important, at least from an economic perspective, the 20-percent marginal tax rate will be much more conducive to entrepreneurship and hard work, giving people more incentive to create jobs and wealth.

2. Does the plan eliminate double taxation so there is no longer a tax bias against saving and investment?

The Perry flat tax gets rid of the death tax, the capital gains tax, and the double tax on dividends. This would significantly reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories - even socialism and Marxism - agree that capital formation is key for long-run growth and higher living standards, addressing the tax bias against saving and investment is one of the best features of Perry's plan.

3. Does the plan get rid of deductions, preferences, exemptions, preferences, deductions, loopholes, credits, shelters, and other provisions that distort economic behavior?

A pure flat tax does not include any preferences or penalties. The goal is to leave people alone so they make decisions based on what makes economic sense rather than what reduces their tax liability. Unfortunately, this is one area where the Perry flat tax falls a bit short. His plan gets rid of lots of special favors in the tax code, but it would retain deductions (for those earning less than $500,000 yearly) for charitable contributions, home mortgage interest, and state and local taxes.

As a long-time advocate of a pure flat tax, I'm not happy that Perry has deviated from the ideal approach. But the perfect should not be the enemy of the very good. If implemented, his plan would dramatically boost economic performance and improve competitiveness.

That being said, there are some questions that need to be answered before giving a final grade to the plan. Based on Perry's Wall Street Journal column and material from the campaign, here are some unknowns.

1. Is the double tax on interest eliminated?

A flat tax should get rid of all forms of double taxation. For all intents and purposes, a pure flat tax includes an unlimited and unrestricted IRA. You pay tax when you first earn your income, but the IRS shouldn't get another bite of the apple simply because you save and invest your after-tax income. It's not clear, though, whether the Perry plan eliminates the double tax on interest. Also, the Perry plan eliminates the double taxation of "qualified dividends," but it's not clear what that means.

2. Is the special tax preference for fringe benefits eliminated?

One of the best features of the flat tax is that it gets rid of the business deduction for fringe benefits such as health insurance. This special tax break has helped create a very inefficient healthcare system and a third-party payer crisis. It is unclear, though, whether this pernicious tax distortion is eliminated with the Perry flat tax.

3. How will the optional flat tax operate?

The Perry plan copies the Hong Kong system in that it allows people to choose whether to participate in the flat tax. This is attractive since it ensures that nobody can be disadvantaged, but how will it work? Can people switch back and forth every year? Is the optional system also available to all the small businesses that use the 1040 individual tax system to file their returns?

4. Will businesses be allowed to "expense" investment expenditures?

The current tax code penalizes new business investment by forcing companies to pretend that a substantial share of current-year investment outlays take place in the future. The government imposes this perverse policy in order to get more short-run revenue since companies are forced to artificially overstate current-year profits. A pure flat tax allows a business to "expense" the cost of business investments (just as they "expense" workers wages) for the simple reason that taxable income should be defined as total revenue minus total costs.

Depending on the answers to these questions, the grade for Perry's flat tax could be as high as A- or as low as B. Regardless, it will be a radical improvement compared to the current tax system, which gets a D- (and that's a very kind grade).

Here's a brief video for those who want more information about the flat tax.

Last but not least, I've already received several requests to comment on how Perry's flat tax compares to Cain's 9-9-9 plan.

At a conceptual level, the plans are quite similar. They both replace the discriminatory rate structure of the current system with a low rate. They both get rid of double taxation. And they both dramatically reduce corrupt loopholes and distortions when compared to the current tax code.

All things considered, though, I prefer the flat tax. The 9-9-9 plan combines a 9 percent flat tax with a 9 percent VAT and a 9 percent national sales tax, and I don't trust that politicians will keep the rates at 9 percent.

The worst thing that can happen with a flat tax is that we degenerate back to the current system. The worst thing that happens with the 9-9-9 plan, as I explain in this video, is that politicians pull a bait-and-switch and America becomes Greece or France.

October 25, 2011 8:33AM

Biometrics Collection = Risk Creation

Why shouldn't the government collect biometric data unless absolutely necessary? Things like this can happen to it:

The stolen database contained the name, date of birth, national identification number, and family members of 9 million Israelis, living and dead. More alarmingly, the database contained information on the birth parents of hundreds of thousands of adopted Israelis---including children---and detailed health information on individual citizens.

It's a good, short write-up from Fast Company. Read the whole thing and pass it along.

October 24, 2011 4:29PM

A Response to Orin Kerr on GPS Tracking

Orin Kerr—easily one of our most lucid thinkers when it comes to applying the Fourth Amendment to new technologies—argues at Volokh Conspiracy that, while it's a hard call whether the installation of a GPS tracking device to a vehicle counts as a Fourth Amendment "search" or "seizure," the Supreme Court should not treat the use of such devices as a search when it decides United States v. Antoine Jones later this term. Rather, he argues, the Court should hew to a bright line test that makes monitoring "inside" protected spaces a "search" requiring a warrant, while "outside" monitoring—as, for example, of a car traveling on public roads—is always permitted, regardless of the technological means by which that monitoring is carried out, or how extensive that monitoring is in scope or duration.  This is in line with Kerr's reasoning in a thoughtful and important article about the application of the Fourth Amendment to the Internet, which I've already written about in this space.

First, it's worth noting that Kerr's core assertion—that the inside/outside distinction is already the one consistently applied by the Court—is at odds with some fairly unambiguous assertions in the very opinions he cites.  Kerr argues:

You get the same results whether you get these results under the “protected areas” test that preceded the 1967 Katz case, or the Katz “reasonable expectation of privacy” test that the Court has adopted since then. The results are the same: A search occurs when the government intrudes upon a private person, house, paper, or effect, but does not occur when the government merely observes something in a public space or in a space where the government is otherwise entitled to be.

But the majority in Katz goes out of its way to deny this:

[T]he Fourth Amendment protects people, not places. What a person knowingly exposes to the public, even in his own home or office, is not a subject of Fourth Amendment protection.... But what he seeks to preserve as private, even in an area accessible to the public, may be constitutionally protected. [emphasis added]

It is true, of course, that in general  our reasonable expectations of privacy will track the line between public (outside) and private (inside) spaces. But this is, crucially, a defeasible presumption, as Kerr plainly concedes when he notes that a search does not occur "when the government merely observes something in a public space or in a space where the government is otherwise entitled to be." If you have freely invited a police officer or informant into your home, where they smell marijuana, you cannot claim that any reasonable expectation of privacy has been violated, even though the odor may only be detectable from "inside" this private space. But then, as the majority in Katz suggests, the presumption should be equally defeasible on the other side: There may be cases where what can be observed in public is nevertheless reasonably expected to be private.

Indeed, Katz itself may be just such a case: It involved a bug placed on the outside of a phone booth, picking up only the faint vibrations from the conversation inside that reached the outside of the booth (though, of course, they would not have been audible to an unaided human ear that was not rather conspicuously pressed up against the glass).  We might imagine, instead, that the surveillance had been of the sort shown in the opening scene of Francis Ford Coppola's masterpiece The Conversation, where a series of high-powered boom microphones and sophisticated audio filtering technology are used to capture a whispered exchange between a couple who are walking through a noisy plaza—and constantly checking to ensure that nobody is near enough to overhear. The majority supports its reasoning with the observation that Katz had stepped into a phone booth and "closed the door," but nothing about the logic of Katz depends centrally on the bugged conversation occurring "inside" that closed booth. There's no reason to think the decision would or should have been different if it had involved a scenario like Coppola's, or a cell phone call placed from a desolate beach.

Kerr does consider some situations where monitoring from a public vantage point has been regarded as a search. On Kerr's reading of the ruling in Kyllo, the use of a thermal imaging scanner to observe a house from outside, on a public street was nevertheless a search of the inside of the home. Similarly, the protection afforded to the "curtilage" of the home involves, in effect, expanding the penumbra of protection around the home so that some property literally "outside" is nevertheless "treated" as being "inside."  At this point, it seems to me, the "inside/outside" distinction ceases to be a useful guiding principle and is exposed as a mere tautology.   If some kinds of monitoring are "treated as inside surveillance" even though, literally speaking, they involve only the "outside" of a protected space, "inside" has just become a term of art meaning "protected."

This is even more obvious when we turn to monitoring of Internet surveillance, where Kerr  hopes the "inside/outside" distinction may be usefully employed. Because while one may speak (for instance) of e-mail header information or metadata as "outside," by analogy with a mailed envelope, by contrast with the "inside" message contents, this is pure metaphor.  In a literal sense, they're all just bits. Moreover, Internet communications operate on the Open Systems Interconnection model, which divides each Internet packet not into "inside" and "outside," but rather seven nested layers. Kerr allows that it is sometimes a "tricky call" where the line between inside and outside surveillance falls. But as thinking about Internet communications should make clear, this is a misleading description. There is no "fact" about the inside/outside boundary for the Court to discover as it contemplates Internet surveillance, no independent dividing line that the Court might use to determine which aspects of the communication deserve protection. Rather, the decision about how the physical metaphor ought to apply to a digital communication just is the decision about what should be protected. In considering which parts of the bitstream are "like" the envelope exterior, and which are "like" the letter within—or for that matter, considering whether the right metaphor is a sealed letter or a postcard—the Court would have to appeal to other considerations.

Let's return to the GPS tracking case, applying some of the reasoning from a decision that might seem to support Kerr's "inside/outside" distinction: California v. Ciraolo. Here, the Court held that aerial observation by police of a marijuana garden in the curtilage of the home was not a Fourth Amendment search. Yet their argument for this doesn't turn on a simple inside/outside binary.  Rather, the Court noted:

The observations ... in this case took place within public navigable airspace ... in a physically nonintrusive manner; from this point, they were able to observe plants readily discernible to the naked eye as marijuana .... Any member of the public flying in this airspace who glanced down could have seen everything that these officers observed..... In an age where private and commercial flight in the public airways is routine, it is unreasonable for respondent to expect that his marijuana plants were constitutionally protected from being observed with the naked eye from an altitude of 1,000 feet.

In this case, monitoring of the curtilage is clearly treated as "outside" surveillance given the method employed—a method that, crucially, is "routine" for members of the public who are not police officers. As the Court makes clear in a footnote, such aerial surveillance might become intrusive enough to qualify as a search if it involved "technology which discloses to the senses those intimate associations, objects or activities otherwise imperceptible to police or fellow citizens."

Let me posit that almost all of us normally expect privacy for communications and activities that, though they occur in a public space, would be "imperceptible... to fellow citizens" whose senses were not augmented by sophisticated technology, and we routinely rely on that expectation in practice. If I am at a crowded party and wish to pull a friend aside for a private chat, I may seek out an empty room and close the door behind us... but I may equally reasonably step outside, like the couple in The Conversation, to talk in hushed tones in the deserted driveway.  And my expectation that this conversation is private may be reasonable even if, of course, someone could overhear us by approaching close enough to pick up our whispers with an unaided ear—at which point we would stop discussing private matters. Indeed, for people of severely limited economic means—people who may lack regular access to "inside" spaces other than thin-walled tenement apartments or even crowded homeless shelters—the de facto "privacy" of isolation in nominally "public" spaces may be the only sort realistically available.

Parallel reasoning applies if we consider movements rather than conversations. A person driving down a public street is subject to observation—but many contextual features determine whether they reasonably expect such observation in a specific case.  Someone who undertakes a long journey along a desolate highway at night will, normally, reasonably believe that they are not being followed or observed if they don't see headlights trailing them.  Two people who rendezvous at a cabin deep in the woods, arriving separately, will not be less shocked that their liaison is being monitored because the dirt road to their meeting point is "public."

A simple, binary "inside/outside" bright line rule for deciding how the Fourth Amendment applies to high-tech surveillance is appealing because of its seeming clarity and straightforwardness. But clarity is not a virtue if it is achieved at the price of the underlying interests the Fourth Amendment protects. After all, "no warrants are ever required" would be the clearest, simplest rule of all.

October 24, 2011 2:18PM

Libertarians, Medical Malpractice and Contract

Last week, as Michael Cannon has noted in this space, Cato published Shirley Svorny's partial defense of the medical malpractice system, and ever since, knowing my interest in the subject, people have been asking me what I think of it. There is of course no consensus view among libertarians on how to weigh the many important empirical factors, disputed and otherwise, at play here. (For example, I am more alarmed than Svorny at the large volume of claims filed against blameless doctors, and less reassured than Svorny that (p.3) "the dollar amounts [in awards and settlements arising from unfounded cases] are smaller than they would be for similar injuries that result from physician negligence."

But the empirical disagreements can mostly await another day. To the extent libertarians have made one durable contribution to the med-mal debate, it is to uphold the role of contract -- a principle advanced by Richard Epstein in his pioneering Medical Malpractice: The Case for Contract and more recently by Michael Cannon in a paper last year. In brief: most medical interactions occur after a point at which the patient, or someone authorized to make decisions on his or her behalf, could have made a contractual election on how to specify compensation if at all in case of medical misadventure. In modern health care delivery, this would mostly not have to take place at the last minute on arrival for treatment ("Could you set this broken arm? I promise not to sue you for more than a half million if something goes wrong, nor for anything short of gross negligence, and yes, I agree to arbitration.") Instead, matters could proceed far more efficiently if negotiated wholesale beforehand through health insurers or other intermediaries: as part of your health plan, you would get a set of rights in case of dispute, pre-negotiated with doctors and other providers, which might involve damage specifications, arbitration procedures, submission of specialized fact issues to expert panels, and so on.

The one signal fact about the American court system is that, paternalistically, it generally refuses to enforce contractual arrangements of this sort. No matter how well spelled out in advance, courts will not enforce the disclaimer of liability or apply the agreed-on damage limit. You will instead get the malpractice coverage that courts and lawmakers deign to prescribe for you, not the coverage you and your medical provider might have chosen yourselves.

What sort of medical liability coverage would the market furnish were people free to contract for it? A very different sort, I believe, than the pseudo-insurance package now foisted on the parties. While a genuine private insurance market does indeed exist to furnish coverage against accidental injury, it virtually never provides unlimited payouts. Instead, it specifies a maximum -- the "policy limits" -- even though that means some unlucky claimants predictably will not recover their full losses. It also tends to avoid coverage triggers whose subjective or scientifically open-ended nature leaves many cases open to dispute (could obstetricians have avoided this case of cerebral palsy?) And, significantly, private insurance markets virtually never promise financial payouts for pain and suffering, as distinct from lost wages and other out-of-pocket expense. Indeed, if there is a single example from any fully private insurance market of a contractual promise to provide cash compensation for pain and suffering, I am unaware of it. Even in cases where health buyers have enormous negotiating clout -- say, in dealings between the UAW/Big Three and Detroit-area health providers -- I believe one has not seen contract coverage for negligence-based pain and suffering. And that points to an important empirical truth: the ex post cost of providing that kind of insurance greatly exceeds the ex ante value of the coverage to consumers, who quite rationally prefer to negotiate instead for other sorts of coverage expansion, lower copays and so on.

Like others, I grow impatient with lawmakers as they struggle with inevitably arbitrary lines on whether the pain-and-suffering component of their obligatory med-mal "insurance" should top out at $500 thousand, $1.0 million, or $1.5 million. Were they to step back and allow a market to work, I think we would soon see a distinctly un-arbitrary figure emerge: $0.00.

October 24, 2011 1:20PM

Vicente Fox on Legalizing Drugs

Last week, former Mexican President Vicente Fox spoke at a Cato forum on the need to legalize the consumption, production and sale of all drugs. (You may also see C-Span’s coverage of the event.) President Fox took time to do a BBC interview below on the same topic.

By calling for an end to the drug war, he joins prominent figures from around the world—including former Brazilian President Fernando Henrique Cardoso, former Mexican foreign minister Jorge Castañeda, former U.S. Secretary of State George Shultz, and many others—who are calling for policies that treat drug abuse as a social problem, rather than a criminal one. Join us for a major Cato conference, “Ending the Global War on Drugs,” on November 15, where the above opinion leaders will address the harm of prohibition and realistic policy alternatives.

October 24, 2011 11:22AM

The Downside of Federal Infrastructure Spending

My Washington Post op-ed on federal infrastructure yesterday elicited a large and vigorous response. The comments on the WaPo site and emails to my inbox were about 80 percent in opposition to my views.

Here are some critiques of my article and my responses:

Critique: My view of devolving infrastructure funding to the states is unrealistic because only the federal government has enough “resources” to do big projects.

Response: The federal government has no magical source of money. All “federal dollars” ultimately come from taxpayers who live in the 50 states. It is true that the federal government can run larger deficits that state governments, but that’s a reason not to give the Feds responsibility for spending activities because they tend to go hog wild.

Critique: Maybe the federal government screws up, but so do state governments and private companies.

Response: Of course. But as the op-ed noted, when the Feds screw-up they botch it for the entire country, often for many decades. The federal government is a monopoly, and monopolies breed inefficiency. By contrast, the states compete with each other and learn from each other to an extent. And when private companies screw up repeatedly, they go belly up.

Critique: Maybe the federal government screws up, but we should just try to make it work better.

Response: The histories of the Corps and Reclamation illustrate patterns of failure for more than a century. And we’ve explored similar patterns with other federal agencies at www.downsizinggovernment.org. Federal problems are often deep-rooted and systematic, and they defy the many well-meaning efforts at reform, such as Al Gore’s “reinventing government” initiative in the 1990s. So it’s time to try something different—like exploring privatization.

Critique: We need the federal government for things like the Interstate Highway System because infrastructure crosses state lines.

Response: Numerous people made this point regarding my op-ed, but I’m afraid they didn’t put their thinking caps on. Private energy pipelines cross state and international borders, and so do the huge systems of the private freight railroads, such as Union Pacific.

Critique: Federal agencies, such as the Corps, often contract-out work to private companies that do the actual construction, so failures like Hurricane Katrina are private failures.

Response: Hurricane Katrina represented a failure of government on many levels, as I’ll address in an upcoming essay on the Corps. The American Society of Civil Engineers concluded that “a large portion of the destruction from Hurricane Katrina was caused by …engineering and engineering-related policy failures.” So that’s the fault of the Corps, not private contractors.

Anyway, the volume of negative, snarky, and knee-jerk responses to my suggesting that the federal government doesn’t work very well is rather depressing. I criticized Rachel Maddow for “thinking big” about federal spending. But the nation is going to have to “think big” about government reforms to avert the looming federal fiscal disaster. Devolution and privatization offer part of the solution both to reduce debt and to revive U.S. economic growth in coming years.