201710

October 19, 2017 3:41PM

Competing Analyses of the Republican Tax Reform Framework

The media’s favorite analysis of the Big Six tax reform framework comes from the Urban-Brookings Tax Policy Center (TPC), which purports to estimate that the plan would increase individual income taxes by $471 billion over a decade (by slashing exemptions and deductions), while cutting business taxes by $2.6 trillion.  Predictably, this generated a tidal wave of outraged editorials and TV ads claiming the plan would do nothing for economic growth and benefit only “big corporations and the top 1%” (which is redundant, because individual taxes aren’t cut and the TPC wrongly attributes nearly all corporate tax cuts to the top 1%).

The Wall Street Journal has offered a powerful corrective to the TPC’s concealed analysis in “Where Critics of Tax Reform Go Wrong”, by Larry Kotlikoff of Boston University. It draws on his working paper with Seth Benzell of MIT and Guillermo Lagarda of the Inter-American Development Bank, which found “The [corporate] tax reform produces enough additional revenues to permit a reduction in personal income tax rates.”

The Tax Policy Center opines there will be “little macroeconomic feedback effect on revenues,” Kotlikoff explains, because they rely on an antique closed-economy model in which (1) investment can only be financed from some domestic “pool” of savings, and (2) higher taxes are equivalent to more savings because they supposedly reduce government deficits without reducing private savings. If government borrows more, this supposedly raises interest rates and “crowds out” private investment.

In reality, U.S. interest rates do not rise and fall with budget deficits, partly because arbitrage ensures the global bond yields move in tandem. Japan ran large chronic budget deficits for decades with super-low interest rates.  

The TPC nevertheless claims that lower corporate tax rates must add to the deficit because they will not raise investment and economic growth. And the reason lower corporate tax rates will not raise economic growth is because they will add to the deficit. Run those two sentences back and forth a few times to appreciate the magnificent circularity of this rhetorical trap for the unwary.

Unfortunately, Kotlikoff’s policy advice is not quite as careful as his analysis. He and his co-authors apparently “share critics concerns that [some unspecified aspect of] the plan would disproportionately benefit the top 1%. One way to rectify the fairness problem and address the country’s long-term fiscal gap would be to add, as the framework foresees, a fourth personal tax bracket for those with very high incomes.”   

Congress might take a clue from the Clinton-Gore campaign, for example, and add a 10% surtax on taxable income above $1 million. That would leave us with a 38.5% tax rate on income reported on individual income tax returns and a 20% tax rate on income reported on corporate tax returns. Contrary to Kotlikoff, that would not raise more revenue (to “address the fiscal gap”) for reasons explained by Kotlikoff himself: “If corporate tax rates are lower than personal income tax rates, people have an incentive to shelter their self-employment income (lower their personal tax bill) by incorporating.”  

In the 1980s, as the top tax rate on individual income fell from 70% to 28%, professionals and owners of closely-held businesses shifted en masse from reporting most of their income on corporate tax forms to reporting it on individual tax returns, as pass-through partnerships, proprietorships, Subchapter S corporations and LLCs.

A 2015 study by five Treasury economists and two Chicago scholars finds, “'Pass-through' businesses like partnerships and S-corporations now generate over half of U.S. business income and account for [41%] of the post-1980 rise in the top- 1% income share.” If we now slam that process into reverse – by cutting corporate tax rate to 20% while leaving top individual rates of 35-40% – that would soon result in massive income-shifting out of pass-through entities back into C-corporations that pay no dividends and compensate owners with tax-free perks, company cars and condos, and lavish expense accounts rather than large salaries.  

In short, the wider the gap between top tax rates on individual and business income (including self-defined pass-through income on Schedule C) the more futile it would become to raise top tax rates on income reported on individual tax returns above 30% much less 38-40%. The fourth tax bracket is a really bad idea based on really bad estimates of who wins and loses from a lower corporate tax rate.

Kotlikoff, Benzell and Lagarda have no basis for evaluating the “fairness” of proposed tax changes for individuals because they explicitly “do not model” such changes – they are exclusively concerned with the corporate tax. But, their model estimates that cutting the corporate tax raises tax revenue and also raises real wages by about 8 percent.

Kotlikoff’s endorsement of a fourth individual tax rate higher than 35% is not because he believes the GOP Framework adds much to budget deficits, but because he apparently accepts the Tax Policy Commission’s static estimates that the top 1% benefits most, as shown in the Table.

TPC Estimated Static Change in Federal Taxes by Income Group from Republican Framework Tax Plan

Lowest Quintile

-10.4%

Second Quintile

-9.3%

Middle Quintile

-7.2%

Fourth Quintile

-5.5%

Top Quintile

-9.6%

     
Top 1%  

-17.6%

The reason the top 1% appears to get the largest tax cut is not because of the plan's trivial rejiggering of individual deductions and taxes (which go up rather than down), but because the Tax Policy Center arbitrarily “assumes” that owners of capital bear 80% of the corporate tax, and most capital is owned by people with high incomes.

The trouble is, the TPC assumption that labor bears only 20% of the burden of the corporate tax is totally inconsistent with Kotlikoff’s model predicting an 8% rise in real wages from cutting the corporate tax.  It is also totally inconsistent with all recent empirical studies on that issue. Congressional Budget Office economist William C. Randolph, for example, estimated U.S. labor bears 70% of the corporate tax, once we drop the TPC closed-economy fiction and allow capital to gravitate to countries with lower marginal tax rates. For tax-friendly countries attracting U.S. business and investment, Randolph explains, “Foreign workers benefit because an increased foreign stock of capital raises their productivity and their wages. Domestic workers lose because their productivity falls and they cannot emigrate to take advantage of higher foreign wages.”

A Tax Policy Center survey of the evidence likewise concluded that “Recent empirical studies. . . all conclude that wage earners bear most of the ultimate burden of the corporate tax.”  That means everything you have been reading about “Trump Plan Delivers Massive Tax Cuts to the 1%” is just made-up fiction – based on a key assumption the source (the Tax Policy Center) knows to be false.

October 19, 2017 2:46PM

The Myth of Public‐​Sector Unions’ “Free Rider” Problem

Last month, the Supreme Court’s agreed to review Janus v. American Federation of State, County, and Municipal Employees, Council 31 (Cato filed a brief in support of the plaintiffs). The case is a First Amendment challenge to the “agency fees” that must be paid to a public-sector union by non-members. As a matter of existing First Amendment law, no employee may be compelled to join a union or contribute money to fund a union’s direct political activities, such as political ads. In roughly 22 states (the 28 “right-to-work” states outlaw agency fees), unions may compel non-members to pay agency fees that (ostensibly) only reflect the cost of the union’s representational activities, such as bargaining over wages and working conditions. The agency fee is the product of the Supreme Court’s decision in Abood v. Detroit Board of Education (1977), in which the Court prohibited public-sector unions from compelling non-members to support political speech, but allowed for the compelled support of the union’s other “non-political” activities. 

 

The plaintiff in Janus—like the 2015 Friedrichs case that stalemated after Justice Scalia’s death (in which Cato also filed a brief)—claims that, for public employees, the distinction in Abood between “political” and “non-political” is illusory because the terms and conditions of public employment are inherently a matter of public concern. A teachers union negotiates with a school system over salaries and benefits packages, merit pay versus seniority, the standards for teacher evaluation, and the controversial “tenure” provisions that in some states make it nearly impossible to fire even serial abusers. Each of these represents a core, political issue in education policy, and a teacher who believes that, say, merit-based pay systems would improve the quality of teaching in the school system (where perhaps her own children may attend) can currently be forced to fund negotiations against it.

 

Abood upheld the agency fee based, in part, on the “free rider” rationale. The Court reasoned that, since unions are required expend resources for dissenters’ benefit, dissenters may be required to cover that expense because otherwise they would get a free ride on the supposed union gravy train. Recently, in Slate, attorney Daniel Horwitz—drawing on the argument of a pair of law professors—took the issue a step further, claiming that forcing unions to represent free riders is unconstitutional. Horwitz argues that unions should not have to abide by the duty of fair representation—meaning they have to fairly represent the interests of both members and non-members—if non-members are not made to pay (that is, if Mr. Janus wins). But unions aren’t compelled to abide by the duty of fair representation; they choose to when they become the exclusive bargaining representative.

 

There's a mistake Horwitz makes that's even more basic: he seems to think public employees are covered under the federal National Labor Relations Act. But the NLRA covers only private-sector employees, who would be unaffected by Janus. State and local public employees like Mark Janus are not covered by federal labor law at all (federal employees are covered under a separate civil service system). The actual effect on the rights of unions will therefore come in 51 permutations. But most state laws are analogous on the relevant points, so let’s proceed on that simplifying assumption (with the understanding that any particular state may vary).

 

Currently, a union that receives a majority of the votes of the relevant group of employees in an election may be certified as an “exclusive bargaining representative.” This provides the union certain rights, including imposing a duty on the employer to bargain in good faith with the certified union, and excluding competing unions and dissenting individual employees from the bargaining table. In return the union must shoulder a “duty of fair representation,” which requires the union act as a fiduciary to protect the interests of both members and non-members.

 

But unions can be members only, thus eliminating all the problems that come with forcing people to contribute to a union. In the words of two prominent labor scholars (one of whom is cited by Mr. Horwitz):

Nothing in section 7 [of the National Labor Relations Act]—which grants employees the rights “to self-organization” and “to bargain collectively through representatives of their own choosing”—limits these rights to workplaces where a majority of employees choose one union. Moreover, nothing in section 9 (which provides a mechanism for choosing a union that enjoys the power of exclusive representation) limits the ability of a group to bargain on a members-only basis. The law currently allows members-only representation.

Unions don’t usually pursue members-only representation because becoming the exclusive bargaining representative of all employees grants special privileges, namely an employer’s affirmative duty to bargain. Only a union that is certified as the exclusive bargaining representative must shoulder the burden of non-members. This makes sense. A member of Congress could be thought of as the “exclusive bargaining representative” of his constituency, which means he has a duty to represent both those who voted for him and those who did not. Non-members of a union are like those who voted for the other guy.

 

However, nothing compels a union to become the exclusive bargaining representative. In fact, the “exclusive bargaining” model is an American peculiarity, born of the particular zeitgeist of the 1930s. In Europe, unions are members only, with multiple unions in a given workplace, often tied to a particular political party or identity. Workers therefore gain the opportunity to associate with a union that represents all their interests, and champions the causes they value. And, as any American who has traveled Europe and encountered a transportation strike knows, European unions are pretty powerful.

 

For many workers who dislike unions, compelled support is often their biggest objection. Also, for many libertarians and First Amendment devotees, unions are only objectionable when they’re coercive and non-voluntary. In the long run, a decision for Mr. Janus could help unions move towards a potentially more popular members-only model. 

 

October 17, 2017 6:19PM

Will Everyone Please Cool it on the Protectionism?!

As negotiations on the North American Free Trade Agreement (NAFTA) continue, many proposals seem to run counter to the goal of modernizing the deal, and some industry groups are taking the opportunity to advance their protectionist agenda. A recent op-ed by Mike Schultz, Vice President of R-CALF USA and COOL Chairman, and Martin Rosas, President of United and Food and Commercial Workers (UFCW) Local 2 in Kansas City, argued for the reinstatement of U.S. legislation that required meat products to bear a label that identifies the country of origin of the product, so-called COOL (country of origin labeling) rules. Supporters of this type of labeling scheme argue that it helps inform consumers of the products they are buying, and that consumers are willing to pay more for this information. In addition, supporters tend to claim that NAFTA hurt the U.S. beef industry.  All of these arguments are incorrect.

First, the COOL scheme that was established by the United States in 2008 was a complex set of requirements that set out when particular muscle-cuts of meat would require a label that identifies where the product was “born, raised, and slaughtered.” On its face, this may seem benign, but the way the legislation was crafted discourages U.S. meat producers from sourcing foreign meat because of the costs of tracing every step of the production process, including segregating herds by nationality.

Tracing of a piece of meat’s “nationality” is complicated by the fact that there is a lot of back and forth trade in the beef industry between Canada, Mexico and the United States. And there are additional barriers to tracing, like the fact that Alaska and Hawaii transship their cattle through Canada to get to the U.S. market to avoid the high costs of shipping imposed by the Jones Act.

Furthermore, the claim that consumers are willing to pay more for a country of origin label is not supported by the evidence. A 2013 study in the Journal of Agriculture and Resource Economics found an “absence of an increase in demand by U.S. consumers” for products covered by the COOL scheme, which “suggests that any attempt to maintain [COOL] would result in aggregate welfare loss not only within the United States but also with key trading partners.” Furthermore, a 2004 report by the U.S. Department of Agriculture found that “[t]he infrequency of “Made in USA” labels on food suggests suppliers do not believe domestic origin is an attribute that can attract much consumer interest.”

Finally, supporters of this protectionist measure sometimes claim (as the op-ed mentioned above does) that NAFTA hurt the U.S. beef industry. This is false. First off, barriers to the beef and cattle trade have been very low for a long time and this predates NAFTA. Second, while Canada is a top supplier of imported beef to the United States, it makes up 18.6% of the total share of imports, and just 2.5% of U.S. beef and veal consumption. Third, the U.S. beef industry is actually doing quite well, and expected to grow in 2018. In 2016, the U.S. was the top producer of beef and veal (by thousands of metric tons), totaling 11,507 metric tons, with Brazil coming in second with 9,284 metric tons. It is important to note that the U.S. is also the top importer of beef and veal because it is also the top consumer—Americans like their beef, so we need to purchase foreign beef to meet our domestic demand.

This country of origin labeling issue was brought to the World Trade Organization (WTO) by both Canada and Mexico in 2008. In November 2011, a WTO panel concluded that the COOL measure violated the United States’ obligations because it discriminated against imported livestock. This finding was upheld on appeal. Congress eventually repealed the legislation in December 2015 through H.R. 2029. Asking for this legislation would guarantee another dispute, and also disrupt the cattle and beef market again. Using the NAFTA negotiations to ramp up support for this legislation also runs counter to the reality of the beef and cattle trade in North America. Congress should not allow itself to fall prey to this form of regulatory protectionism yet again. 

October 17, 2017 4:59PM

LAPD Drones Threaten Privacy

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Today, the Los Angeles Police Department (LAPD) civilian police commission voted to approve proposed guidelines for a one-year unmanned aerial vehicles (UAVs) pilot program. According to the LAPD's guidelines, UAVs will not be equipped with lethal or nonlethal weapons and will only be deployed in a narrow set of circumstances. The guideline also requires officers to obtain a warrant before using a UAV "when required under the Fourth Amendment or other provision of the law." This looks all well and good, except that the Fourth Amendment and California law provide little protection when it comes to aerial surveillance.

The Fourth Amendment protects "persons, houses, papers, and effects" from "unreasonable searches and seizures." Many Americans could be forgiven for thinking that this constitutional provision would act as a shield against warrantless aerial surveillance. Sadly, this is not the case. California law is similarly of little help. California is not one of the states that require law enforcement to obtain a warrant before using a UAV, with Gov. Jerry Brown in 2014 vetoing a bill that would have imposed such a requirement.  

To the LAPD's credit, routine surveillance is not included in its list of approved UAV operations. However, the LAPD has a history of using new surveillance gadgets, and it's reasonable to be wary of UAVs being regularly used for surveillance as they become an everyday feature of police departments' toolboxes.

Although the Supreme Court has yet to take up the issue of UAV surveillance, it did address aerial surveillance in a few cases in the 1980s. In Dow Chemical Co v. United States (1986) the Supreme Court ruled that the Environmental Protection Agency did not need an administrative warrant when it hired a commercial photographer using a mapping camera to inspect a 2,000 acre Dow Chemical plant from an aircraft.

The same year that Supreme Court ruled in Dow Chemical Co v. United States it also decided another case, California v. Ciraolo (1986). In that case police acting on an anonymous tip took to an airplane and without a warrant used naked eye surveillance to snoop on Dante Ciraolo's backyard, which was unobservable from street level thanks to a couple of fences. The police spotted marijuana growing in Ciraolo's backyard and arrested him. Ciraolo claimed that the police's aerial inspection of his backyard violated the Fourth Amendment, but the Supreme Court ruled that such warrantless surveillance is constitutional.

In 1989, the Supreme Court dealt with another case involving police looking for marijuana from the sky. In Florida v. Riley (1989), the Supreme Court considered whether police had conducted a Fourth Amendment search when they looked into Michael Riley's greenhouse from a helicopter at 400 feet without a warrant. A plurality on the Court found that Ciraolo controlled and that police had not conducted a Fourth Amendment search.

While those outside of courts and law schools might think that the government agents' behavior at issue in DowCiraolo, and Riley, could reasonably be described as "searches," the unfortunate reality is that for fifty years the word "search" has been defined by courts in a very particular way.  

Fifty years ago, in Katz. v. United States (1967), the Supreme Court ruled that the warrantless use of an eavesdropping device on the exterior of a public phone booth violated the Fourth Amendment. In his majority opinion, Justice Potter Stewart wrote that the Fourth Amendment "protects people, not places."

Katz is notable not only because of Stewart's opinion, but also because of a solo concurrence written by Justice John Harlan II. In his concurrence, Justice Harlan codified the two-pronged "reasonable expectation of privacy test." According to the test, police have conducted a Fourth Amendment "search" if they 1) violate someone's reasonable expectation of privacy and 2) that expectation is one that society is prepared to accept as reasonable.

Thanks to current Fourth Amendment doctrine the LAPD's declaration that police will seek a warrant for UAVs "when required under the Fourth Amendment" is hardly reassuring.

In his Florida v. Riley dissent Justice William Brennan took the Court's reasoning to its logical conclusion, using a "miraculous tool" that at the time was a hypothetical but now resembles a tool that will soon be in the hands of the LAPD and other police departments:

Imagine a helicopter capable of hovering just above an enclosed courtyard or patio without generating any noise, wind, or dust at all - and, for good measure, without posing any threat of injury. Suppose the police employed this miraculous tool to discover not only what crops people were growing in their greenhouses, but also what books they were reading and who their dinner guests were. Suppose, finally, that the FAA regulations remained unchanged, so that the police were undeniably "where they had a right to be." Would today's plurality continue to assert that "[t]he right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures" was not infringed by such surveillance?

The LAPD's UAV guidance does include some praiseworthy provisions, including the ban on UAVs being equipped with weapons. However, the guidance doesn't provide the privacy protections needed to prevent warrantless UAV snooping.

October 17, 2017 11:20AM

International Relations at China’s 19th Party Congress

Later this week the Communist Party of China (CPC) will hold the 19th Party Congress, a major political event that happens just once every five years. Domestic issues will take center stage at the Party Congress, and China watchers will watch closely for news on the composition of a new Politburo Standing Committee, the likely inclusion of Xi Jinping Thought into the CPC’s constitution, and the future of economic development.

International relations will take a back seat to internal issues during the 19th Party Congress, but it will not disappear from the agenda entirely. Three important issue areas to follow are the progress of China’s military reforms, Taiwan, and North Korea. All three could come up during the congress, and all have important implications for U.S. strategy in East Asia and the U.S.-China relationship.

 

Military Reforms

Xi Jinping kicked off a massive reform of the Chinese military in late 2015 by cutting 300,000 personnel from the People’s Liberation Army (PLA) and changing its command and control system. Additional notable reforms over the past two years include changing from military regions to theater commands, the creation of a Strategic Support Force for space, cyber, and electronic warfare, and the growing prominence of the PLA Air Force and PLA Navy relative to the army. The overarching goal of Xi’s military reforms is to turn the PLA into a lean, mean fighting machine capable of winning wars on the modern battlefield.  

Some general information about military reform should be mentioned in the work report produced at the beginning of the 19th Party Congress, but before the report is released congress-watchers should pay attention to promotions and demotions within the PLA and Central Military Commission (CMC). In the weeks and months leading up to the Party Congress, Xi removed several high-ranking PLA generals from their posts and replaced them with new commanders. Changes to the CMC could include a reduction in the number of individuals on the commission and new members that are loyal to Xi and want to improve the PLA’s joint warfare capabilities.

The PLA reforms have two important and competing implications for the United States. On the one hand, once the reforms are completed and internalized the PLA should be a much more effective fighting force, which in turn raises the costs of U.S. military commitments in East Asia. On the other hand, these reforms are a massive and difficult undertaking that will take many years to fully implement. American policymakers should not inflate the threat posed by China in the short term, but it would be unwise to ignore the long-term political implications of a more capable PLA.

 

Taiwan

Relations across the Taiwan Strait have been relatively stable since the election of Tsai Ing-wen as president of Taiwan in January 2016. China is steadily applying pressure on Taiwan in response to Tsai’s “incomplete answer” on the 1992 Consensus, but the pressure has not been unusually onerous and it has not significantly escalated since Tsai’s election almost two years ago. Taiwan will be mentioned in the 19th Party Congress’s work report, but this will likely amount to a restatement of long-held CPC positions on eventual reunification and opposition to Taiwanese independence. The work report’s language could end up being more aggressive and it deserves close observation, but Taiwan is a relatively low priority for the Chinese leadership at the moment.

If the Party Congress produces a “steady as she goes” approach to Taiwan, it would behoove the United States to avoid taking high-profile actions that would damage the US-China relationship. One example of a counterproductive U.S. action is language in the 2017 National Defense Authorization Act allowing U.S. Navy ships to make port calls in Taiwan. Advocates for the port calls, which haven’t happened in Taiwan since 1979, argue that the action is essential for shoring up the U.S.-Taiwan relationship and preventing China from coercing Taiwan. However, Beijing will likely see this break with decades of past practice as a major event that worsens U.S.-China relations.

There are better ways to preserve peace in the Taiwan Strait than adopting a high-profile, precedence-breaking policy of restarting U.S. Navy port calls. For example, U.S. arms sales to Taiwan may lead to angry Chinese press statements, but because they are a continuation of long-standing U.S. policy they reinforce the status quo. Restarting port calls to Taiwan would be a high-profile departure from past U.S. policy, which represents a break in status quo behavior that is worse for the U.S.-China relationship than continuing arms sales.

 

North Korea

The final major international relations issue that may come up at the 19th Party Congress is the ongoing nuclear crisis on the Korean peninsula. The growing tension between the United States and North Korea is China’s most pressing foreign policy problem. A war would prompt a massive influx of refugees into China and have serious implications for the security order in East Asia. Moreover, the Trump administration appears convinced that China needs to do more to pressure North Korea and has levied secondary sanctions against Chinese companies to convince Beijing to do more.

While North Korea looms large for China, it probably won’t get much attention in the 19th Party Congress’s work report. Domestic issues will take precedence at the Party Congress, and while military reforms and cross-strait relations have international implications the CPC views both as domestic concerns. However, a dramatic action by Pyongyang during the Party Congress, such as an ICBM test or an above-ground nuclear detonation, could prompt the CPC to issue a statement on North Korea.

Discussion on the North Korea problem will probably happen during the Party Congress, but absent a significant escalation on the peninsula North Korea will likely not be featured prominently in the official documents produced by the congress. Instead, Xi and the Chinese leadership will likely wait until Trump’s visit to Asia in early November to issue any adjustments to China’s policy toward North Korea.

October 17, 2017 10:59AM

Pruitt: No More Regulation By Settlement at the EPA

Welcome news from the Environmental Protection Agency: Administrator Scott Pruitt is curbing often-collusive deals ("sue and settle") by which the agency, sued by outside groups, agrees to adopt new policies or enact new regulations. (It also usually agrees to pay the outside groups handsomely in legal fees.)  As The Hill puts it, the new policy (full EPA release here) focuses especially on transparency:

“We will no longer go behind closed doors and use consent decrees and settlement agreements to resolve lawsuits filed against the agency by special interest groups where doing so would circumvent the regulatory process set forth by Congress,” Pruitt said, adding that he is also cracking down on attorneys’ fees paid to litigants.

Under Pruitt’s new directive, the agency will post all lawsuits online, reach out to affected states and industries and seek their input on any potential settlements.

The EPA is pledging to avoid settlements that would make for a rushed regulatory process, or that obligate the agency to take actions that the federal courts do not have the authority to force.

Cato adjunct scholar Andrew Grossman discussed the issue in 2015 Senate and 2017 House testimony, noting that "The EPA alone entered into more than sixty such settlements between 2009 and 2012, committing it to publish more than one hundred new regulations, at a cost to the economy of tens of billions of dollars."  He observed that judicially enforceable consent decrees create "artificial urgency" for bulldozing through new regulations quickly, give favored outside organizations an added channel of influence not available to many of those directly regulated, and tie the hands of later administrations. And as I pointed out in this space a few years back, the issue is by no means confined to the EPA or environmental regulation, but serves as a way to expand government agency power while seeming to constrain it in education, social services, and many other areas.

But the next administration's EPA chief could reverse Pruitt's directive with the stroke of a pen. That's one reason the U.S. Department of Justice -- which has been doing its own welcome housecleaning of settlement practices lately -- should continue to monitor and regularize litigation practices of this sort, and why Congress should proceed to consider legislation to curb sweetheart pacts on a more lasting basis. 

October 17, 2017 9:24AM

Monetary Freedom: Lessons from the Western Han Dynasty

During the Western Han Dynasty (206 B.C. – A.D. 9), the question of monetary freedom was vigorously debated. There were as yet no banks or paper money in China — money consisted solely of coin.  Private mints competed with government mints, either in the shadow market or legally. In 81 B.C., the issue of whether the state or the market would be the best guardian of sound money came to a head in the famous “Discourses on Salt and Iron,” which were compiled by Huan Kuan in his book Yantie lun. The relevant chapter for our study is chapter 4, “Cuobi” (“Discordant Currencies”).

In this article, I provide some background for the debate between the Confucian scholars who favored private (competitive) coinage and the statesmen, particularly Sang Hongyang, who defended the government’s monopoly on coinage. I then consider the arguments of those engaged in the 81 B.C. debate over the role of government in coinage and the lessons learned.

Background

The first emperor of the Western Han Dynasty, Gaozu (202–195 B.C.), banned   government minting, legalized private mints — most likely because of the severe shortage of coins that impeded trade — and adopted the Qin Dynasty’s standardized bronze coin, the banliang (or “half ounce” = 12 zhu).[1] Its relatively heavy weight (about 8 grams) made it unsuitable for widespread use. The demand for lighter coins to facilitate trade led private mints to produce a large quantity of lighter “elm-seed” coins that weighed 0.2 to 1.5 grams. Those coins retained the conventional banliang inscription, making their face value much greater than their intrinsic value.[2]  Of course, merchants would not accept them at face value.

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Banliang 4 Zhu Coin

In 186 B.C., Empress Lü reinstituted the Imperial Mint with the hope of gaining control over the monetary system. The first coin brought out by the government was a banliang coin weighing 8 zhu. Next, in 182 B.C., a new banliang coin called the wufen, which weighed only 2.4 zhu, was circulated. The demonetization of the 8 zhu coins, which allowed bronze to be restruck into a much larger nominal stock of money, led to inflation.  Consequently, in 175 B.C., Emperor Wen of Han increased the metallic content of the banliang to 4 zhu, and once again allowed private mints the freedom to coin money provided they complied with the standard weight of 4 zhu and produced only bronze coins. The see-saw between government and private mints continued when, in 144 B.C., Emperor Jing of Han ended competitive coinage and reinstituted the government’s monopoly. Private coining was made a crime and those convicted could face the death penalty.[3]

The substantial difference between the face value and intrinsic value of banliang coins during the early Han period provided fertile ground for counterfeiting.  However, money exchanges developed to discover the true value of banliang coins, adjusting their nominal value to reflect their weight (or intrinsic value), rather than passively accepting the fictitious value of 12 zhu. Eventually, in 120 B.C., a new bronze coin, the 3 zhu cash coin, replaced the old 4 zhu banliang coin — and its face value was made equal to its intrinsic value. Finally, in 119 B.C., Emperor Wu of Han introduced the wuzhu (or 5 zhu) bronze coin, which was extensively used until the 7th century.

At first, the wuzhu was minted by both the central government and the prefectures, but in 113 B.C. minting became the sole responsibility of the Imperial Mint.[4]

The 81 B.C. Debate Over Monetary Freedom

When Emperor Wen of Han legalized private mints in 175 B.C., Jia Yi, a former official, argued that competitive coinage would lead to debasement, a plethora of cash coins that would confuse the public, and result in the manipulation of money exchanges. He therefore recommended restoring the state monopoly on coinage and controlling the supply of copper.[5]  His advice was rejected but the debate over private coinage reemerged in 81 B.C.

The Main Arguments

Sang Hongyang, a statesman who had been a key advisor to Emperor Wu, took the lead role in arguing against private coinage and in support of government monopoly.  Meanwhile, more than 60 Confucian scholars (literati) from across China made the case for monetary freedom as the best way to provide sound coinage.

In his argument against monetary freedom, Sang Hongyang contended: “If the currency system is unified under the emperor’s control, the people will not serve two masters [the state and the market].  If coin issues from the ruler, the people will have no doubts about whether it is genuine or not.”[6]

The literati, who favored economic freedom, as opposed to the interventionist policies initiated by Emperor Wu, disputed that argument:

In high antiquity, numerous forms of currency existed, wealth circulated, and the people were happy.  Later, when the old types of currency were replaced with silver coins inscribed with tortoises and dragons, the people became deeply suspicious of the new coins. The more often the currency system changes, the more suspicious the people become.

Subsequently, all the old currencies circulating throughout the realm were demonetized and sole authority to mint coin was vested in the Three Officers of the Intendancy of Natural Resources. Officials and artisans alike steal from the profits of the mint. Moreover, they fail to ensure that coins are made to exact standards; some coins are too thin or too thick, too heavy or too light. Farmers are not expert at perceiving the qualitative differences between different coins. When comparing one coin to another, they trust the old coins but harbor suspicions about the new ones, without really knowing which is genuine and which is false. Merchants and shopkeepers pass off bad coins in exchange for good, taking in coins worth double their face value while fobbing off debased ones.  . . . If people must discriminate between different types of coin, then trade will be harmed, and consumers in particular will suffer.

Therefore, the sovereign provides for the people’s welfare by not restricting the use of natural resources . . . [and] he facilitates the use of currency by not prohibiting people from freely minting coins.[7]

It is clear from these passages that the literati based their case for monetary freedom on sound economics and the positive consequences competitive coinage was expected to have on human welfare.  As Richard von Glahn, an eminent historian of Chinese monetary history, notes,

The Confucian scholars arrayed in opposition to Emperor Wu’s policies of state intervention in the economy rejected the contention that a state monopoly on coinage is the best defense of sound money.  The market, they suggested, will compel private coiners to maintain proper standards of size, weight, and purity.  A state monopoly on coinage, in contrast, allowed the state to debase its own coin with impunity.[8]

They also thought that, from an ethical view point, a government monopoly is unjust, because it prevents free competition and allows officials to use their power to debase the currency for personal gain.

Although the literati had ethics, history, and logic on their side, they were unable to end the state monopoly on coinage.  Government officials’ inclination to abuse their power by manipulating the monetary system for fiscal purposes and their own profit was simply too strong. Consequently, “the court debate in 81 B.C. marked the last serious challenge to the principle of a [monopoly] sovereign currency.”[9]

A Catallactic View of Money

The proponents of competitive coinage held a catallactic (i.e., exchange) view of money. They held that money, as a medium of exchange, evolved from commodities that had an exchange value in barter economies. The literati argued: “The ancients had marketplaces but no coinage.  Everyone exchanged what they had for what they lacked . . . .  In later ages, tortoise and cowrie shells, gold, and bronze coins emerged as the media of exchange.”[10] They did so because those commodities had a nonmonetary value, were scarce enough and durable enough to serve as money, and engendered the people’s trust—not because the sovereign mandated their use as money. In Mengerian terms , they had wide “marketability” — not just personal use value.[11]

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Knife-shaped money

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Spade-shaped money

The Confucian scholars who participated in the 81 B.C. debate over coinage no doubt were familiar with the writings of Sima Qian (c. 145–86 B.C.), the “Grand Historian,” who wrote: “When farmers, artisans, and merchants first began to exchange articles among themselves, manifold forms of currency — tortoise and cowrie shells, gold and bronze coin, and knife-shaped and spade-shaped money — came into being.”[12]

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Sima Qian, the Grand Historian

According to von Glahn, Sima Qian and Confucian scholars “evoked an image of a spontaneous emergence of the market as a reproof of meddlesome rulers who manipulated the currency system for their own profit.”[13]  However, while Sima Qian criticized government intervention, he did not favor private coinage, which he thought could be disruptive.[14]

The catallactic (market-based) doctrine of the origin of money was not widely shared. Most authorities rejected it in favor of the long-held chartalist view that money originated from rulers who sought to improve the welfare of their people. As expressed in the Guanzi (a book by Guan Zhong, a 7th century B.C. statesman): “Tang [mythical founder of the Shang Dynasty] used the metal of Mount Zhuang, and Yu [founder of the Xia Dynasty] took the metal of Mount Li, to cast money, which they employed to redeem the children from bondage.”[15]

Lessons

A study of the monetary history of the Western Han Dynasty is instructive in showing the tension between state power and private initiative in meeting the demand for currency as the economy and population grow.  Government officials’ inclination to abuse their power when they have a monopoly on coinage is evident during the early Han Dynasty, as is the monetary chaos that can occur when there is a lack of a genuine rule of law.

The court debate in 81 B.C. shows that there was support for competitive coinage and that the literati from across China believed that, under just laws that were enforced, private mints could bring about monetary harmony. The debate also shed light on the importance of market forces in understanding the origin (or early history) of money. They thus give us another bit of evidence in the long-standing controversy over the state theory of money (chartalism) and the exchange (catallactic) theory of money, also known as “metallism”.[16]

_________________

[1] Nishijima Sadao, “The Economic and Social History of Former Han,” p. 586; in The Cambridge History of China: Volume 1, The Ch’in [Qin] and Han Empires, 221 B.C.–A.D. 220, edited by Denis Twichett and Michael Loewe, New York: Cambridge University Press, 1986.

The Han banliang was effectively a monetary unit, the actual metallic equivalent for which tended to change over time, while the zhu was a stable weight unit, equivalent to so many grams. Thus coins that bore a banliang value were given a nominal rating equal to12 zhu/banliang. The difference between the nominal and actual value was the difference between that rating and the coins actual weight in zhu.  For an excellent history of coinage during the Qin and Western Han Dynasties, see http://www.calgarycoin.com/reference/china/china2.htm.

[2] Nishijima, p. 586.

[3] Ibid.; see also Richard von Glahn, Fountain of Fortune: Money and Monetary Policy in China, 1000–1700, p. 35, Los Angeles: University of California Press, 1996.

[4] Nishijima, p. 587; Walter Scheidel, “The Monetary Systems of the Han and Roman Empires,” Princeton/Stanford Working Papers in Classics, Paper No. 110505 (February 2008), p. 8.

[5] Jia Yi’s commentary was preserved in the Hanshu (History of the Former Han) compiled by Ban Biao,  Ban Gu, and Ban Zhao. It appeared in 111 A.D.  See Scheidel, p. 8.

[6] Huan Kuan, Yantie lun, 4, “Cuobi,” p. 16; English translation in von Glahn, p. 36.

[7] Yantie lun, pp. 16–17; in von Glahn, pp. 36–37. “Currency” refers to so-called cash coins, not to paper currency.

[8] Von Glahn, Fountain of Fortune, p. 36.

[9] Ibid., p. 37.

[10] Yantie lun, p. 16.; in von Glahn, p. 27.

[11] See Carl Menger, Principles of Economics (1871), chap. 8, “The Theory of Money.” Translated by J. Dingwall and B. F. Hoselitz, with an introduction by Friedrich A. Hayek. New York: New York University Press, 1981.

[12] Sima Qian, Shiji (Records of the Grand Historian), 30.1442. Beijing ed.; von Glahn, p. 26.

[13] Von Glahn, p. 27.

[14] Ibid., p. 35.

[15] Guanzi, 75, “Shanquanshu,” III: 73 (Guoxue jiben congshu edition); in von Glahn, p. 26.  Accordingly, von Glahn (p. 28) notes: “By the late imperial times, the Guanzi version of the origin of money prevailed over catallactic theories.”

[16] On the case against chartalism (also known as cartelism), see Lawrence H. White, “Why the ‘State Theory of Money’ Doesn’t Explain the Coinage of Precious Metals,” Alt-M (August 24, 2017), and George Selgin, “‘Lord Keynes’ Contra White on the Beginnings of Coinage,” Alt-M (August 30, 2017).

[Cross-posted from Alt-M.org]