Archives: 03/2018

The IRS Took the Road Less Traveled By, Yet Judges Still Made All the Deference

In 1984, George Orwell famously defined “doublethink” as “holding two contradictory beliefs in one’s mind simultaneously, and accepting both of them.” But even Orwell would blush at claims made by the Internal Revenue Service that one can somehow both follow the law and violate it with the same activity. Amazingly, this seems to be the exact argument employed against Duquesne Light Holdings and subsequently upheld by the U.S. Court of Appeals for the Third Circuit.

In the early 2000s, Duquesne filed a series of consolidated tax returns along with its wholly owned subsidiary AquaSource. Despite initially declining to challenge the company’s deductions in a 2004 audit, the IRS later determined that the losses claimed constituted a double deduction. Even though the company painstakingly followed the tax code and regulations to the letter, the IRS relied on a strained interpretation of an 80-year-old case, Charles Ilfeld Co. v. Hernandez (1934), to disallow $199 million in losses, demanding a $36.9 million payment.

The Third Circuit’s endorsement of this odd use of Ilfeld creates a broad new view of federal agency power. Rather than understanding Ilfeld as a background presumption for evaluating ambiguous agency rules, this new doctrine allows agencies to override their own regulations to penalize those who violate some unarticulated, uncodified policy principle. Duquesne followed the rules, which did not prohibit the deductions it claimed. But rather than allowing deductions that were legally authorized, the court imposed a “triple-authorization requirement” mandating an additional okay, specifically stating that the deductions may be taken together. In other words, the court said that it isn’t enough for the law to say “you may take deduction A” and elsewhere “you may take deduction B”; the law must then also explicitly say “you may take deduction A and deduction B at the same time.”

The court’s decision continues the long march toward unrestrained administrative power via judicial abdication. First came Chevron deference, whereby courts must defer to the statutory interpretation of the agency that enforces the relevant statute. Then came Auer deference, requiring that courts defer to an agency’s interpretation of its own ambiguous regulations. But the Third Circuit has now gone a step further, ruling that an agency can reinterpret its own unambiguous regulations to mean whatever it wants. If Auer deference is a jurisprudential black eye, then the Third Court’s decision here is an ocular enucleation.

The ruling against Duquesne amplifies three particular concerns that are endemic to Auer deference. First, both Auer deference and this case implicate separation-of-powers concerns. While Auer deference allows an agency to interpret the regulations that the agency itself promulgated, this new “Duquesne deference” would enable an agency to create, enforce, and adjudicate while at the same time completely ignoring the rules it previously created in its legislative capacity.

Yi Gang to Head China’s Central Bank

Yi Gang, an American-trained economist who taught at the University of Indiana, will take over as governor of the People’s Bank of China. Since 2008, he has been deputy governor under Zhou Xiaochuan, who became head of the bank in 2002. The unexpected appointment of Mr. Yi will provide continuity at the PBOC and lend credibility to the pledge for financial liberalization.

Following his appointment, Yi Gang declared: “The main task is that we should implement prudent monetary policy, push forward the reform and opening-up of the financial sector, and maintain the stability of the entire financial sector.”

In November 2007, Yi Gang spoke at Cato’s Annual Monetary Conference, and his speech, “Renminbi Exchange Rates and Relevant Institutional Factors,” was published in the Spring/Summer 2008 Cato Journal, which also included an article by Fed Chairman Ben Bernanke. That special issue of the CJ raised important questions about the types of monetary regimes that best protect the value and stability of money while promoting economic freedom.

Small Marijuana Growers Squeezed Out by Legalization and Regulation

It’s often been noted that regulations can impose larger relative costs on small businesses and can serve to protect incumbent firms from new competitors. Goldman Sachs CEO Lloyd Blankfein noted that new regulations created a “moat” around his firm:

That all industries are being disrupted to some extent by new entrants coming in from technology. We, again, being, you know, technology-oriented ourselves, try to disrupt ourselves and try to figure out what’s the new thing, and come up with new platforms, new forms of distribution, new products. But in some ways, and there are some parts of our business, where it’s very hard for outside entrants to come in, disrupt our business, simply because we’re so regulated. You’ll hear people in our industry talk about the regulation. And they talk about it, you know, with a sigh: Look at the burdens of regulation. But in some cases, the burdensome regulation acts as a bit of a moat around our business.

The Washington Post reports on a new example: the legalized marijuana market in California. Libertarians have long urged the legalization of marijuana and other drugs. Certainly I expect better results from a legal regime where people are not arrested for buying, selling, or using marijuana. But governments can’t just repeal laws and stop arresting people; instead, they prefer to set up a regime of taxes and regulation. And that’s having an effect on the small marijuana growers in the state’s “Emerald Triangle.” As Scott Wilson reports in the Post:

Humboldt County, traditionally shorthand for outlaw culture and the great dope it produces, is facing a harsh reckoning. Every trait that made this strip along California’s wild northwest coast the best place in the world to grow pot is now working against its future as a producer in the state’s $7 billion-a-year marijuana market.

A massive industry never before regulated is being tamed by laws and taxation, characteristically extensive in this state. Nowhere is this process upending a culture and economy more than here in Humboldt, where tens of thousands of people who have been breaking the law for years are being asked to hire accountants, tax lawyers and declare themselves to a government they have famously distrusted. 

Wilson estimates that “Fewer than 1 in 10 of the county’s estimated 12,500 marijuana farmers are likely to make it in the legal trade….Less than 1 percent of the estimated 69,000 growers statewide have received a permit to farm marijuana since the beginning of the year.”

Hospitalized Patients Are Civilian Casualties in the Government’s War on Opioids

A recent story by Pauline Bartolone in the Los Angeles Times draws attention to some under-reported civilian casualties in the government’s war on opioids: hospitalized patients in severe pain, in need of painkillers. Hospitals across the country are facing shortages of injectable morphine, fentanyl, and Dilaudid (hydromorphone). As a result, trauma patients, post-surgical patients, and hospitalized cancer patients frequently go undertreated for excruciating pain.

Hospitals, including the ones in which I practice general surgery, are working hard to ameliorate the situation by asking medical staff to use prescription opioid pills such as oxycodone and OxyContin instead of injectables, when possible. But many patients are unable to take oral medication due to their acute illness or post-operative condition. In those cases, we are often asked to use injectable acetaminophen, muscle relaxants, or non-steroidal anti-inflammatory agents. But many times those drugs fail to give adequate relief to these patients—which is why they are not the first line of drugs we use.

The shortage is uneven across the country. Some hospitals are feeling the shortage worse than others. According to the American Society of Anesthesiologists, the shortage is so severe in some hospitals that elective surgeries—such as gallbladder and hernia operations—have been postponed.

Some hospitals have resorted to asking nursing staff to manually combine smaller-dose vials of morphine or other injectable opioids that remain in-stock as a replacement for the out-of-stock larger dose vials. Dose-equivalents of different IV opioids vary and are difficult to accurately calculate. This increases the risk of human error and places patients at risk for overdose, as was explained in a letter to the U.S. Drug Enforcement Administration by representatives of the American Hospital Association, American Society of Anesthesiologists, American Society of Clinical Oncology, American Society of Health-System Pharmacists, and the Institute for Safe Medication Practices. The letter asked the DEA to adjust its quota on the manufacture of opioids to help mitigate the shortage.

As part of the effort to address the opioid overdose crisis—which is really a fentanyl and heroin overdose crisis—the DEA, which sets national manufacturing quotas for opioids, ordered a 25 percent reduction in 2017 and another 20 percent reduction this year.

National shortages of drugs are not confined to injectable opioids. Over the years, various drugs in common use have gone on national “back-order” and health care practitioners have had to develop workarounds. The causes of these recurring shortages, not unique to the US, are complex and multifactorial.

Topics:

Economists Fail at Forecasting and Micromanaging

In a new study, economist Mickey Levy included a chart illustrating the inaccuracies of Federal Reserve economic forecasts. Levy is with Berenberg Capital Markets and a member of the Shadow Open Market Committee.

The chart shows the Fed’s year-ahead projections for real GDP (gray bars) and actual GDP (red bars). The projections are often way off, which is remarkable since the Fed has hundreds of skilled economists and access to unparalleled statistical and anecdotal economic data. The Fed generally overestimated growth until 2016, but for 2017 it underestimated.

 

Levy’s study concludes:

“The clear pattern of the Fed’s forecasting errors reflects the Fed’s tendency through 2016 to over-estimate the stimulative impact of extending its unprecedented monetary ease well after the recovery was self-sustaining, and tendency to under-estimate the economic impacts of the government’s fiscal and regulatory policies and other nonmonetary factors.” By the latter items, Levy means “the government’s tax and regulatory policies that increased business operating costs, raised uncertainties and dampened business confidence.” 

More recently, “There has been a marked change in regulatory and tax policies that have changed the economic landscape, and the Fed’s perspective on the economy seems to be lagging behind. The Fed’s forecasts understated the dampening impacts of tax policy and growing web of burdensome regulations through 2016, and those policy thrusts have now reversed. The pickup in economic growth—both business investment and consumption—beginning in 2017 has been supported by the shift toward deregulation and the associated sharp rise in confidence.”

I have noted that CBO economic projections are also pretty bad. The agency missed the onset of the last recession, and over a recent 15-year period its projections of real growth for the following year were 1.7 percentage points off, on average. That indicates huge errors given that the average growth rate during the period was 2.1 percent. (Discussed here.)

If the government cannot predict the future, it won’t be able to successfully micromanage the future through interventionist monetary and fiscal policies. That is especially true because government is such an inflexible institution and has trouble changing course. I discuss these themes in this study on government failure.

What then should policymakers do? Economist Adam Smith advised them to adopt the “simple system of natural liberty.” By removing government interventions “the sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society.”

Levy penned a recent study for Cato Journal here.

Local Taxes: Death by “Special Revitalization”

At the Washington Post, Rachel Chason reports on how the Washington, D.C. suburb of Seat Pleasant, Md. has just levied an eight-fold tax hike on five local businesses, with one seeing its $5,991 tax bill jump to $55,019. Several of the owners are suing, but the town says it went through the proper procedures needed to adopt a special tax, which is supposed to be predicated on the provision of amenities such as sidewalk improvements that are of special benefit to the taxed properties. One business owner says he and others didn’t learn about a hearing on the measure until it was too late.

Whoever wins in the court challenge, the episode symbolizes a wider problem. Specialists in local and state government policy are full of ideas for business-by-business and location-by-location tinkering with tax rates, both downward (as part of incentive packages to lure relocating businesses) and upward (to finance special public services provided in some zones, such as downtown revitalization). But there is a distinct value in terms of both public legitimacy and the rule of law in having uniform and consistent taxation that does not depend on whether a property owner or business is on the ins or on the outs with the tax-setting authorities. It is not necessarily wrong for your tax bill to vary based on services rendered—but it should not vary based on political clout.

Ominous Trends in China

On March 11, China’s National People’s Congress made official what had been rumored for more than two weeks, voting to abolish the two-term limit on the presidency. Current president Xi Jinping is now able to serve in that post indefinitely. That decision is merely the latest in a series of ominous developments that have occurred since Xi took office in 2013. 

Ending term limits significantly alters China’s political system. Deng Xiaoping, the architect of the country’s radical economic reforms beginning in the late 1970s, also implemented that crucial political reform. He and his followers did so to guard against a repeat of the horrid abuses committed during the long, tyrannical rule of Mao Zedong. And the restriction did achieve a limited success. China hardly became a democratic state, but within the context of a one-party system, Deng’s successors served more like chief executive officers, with other members of the party elite acting as a board of directors that could, and did, serve as a check on the president’s power. Removing the limit on presidential terms means that an incumbent now has abundant time to accumulate more and more personal power. The threat of strongman rule, with all its potential abuses, has returned.

As I point out in a recent article in Aspenia Online, Xi was exhibiting troubling behavior even before pushing through the legislation ending term limits. Under the guise of combatting corruption (admittedly a very real problem in China), he systematically purged officials who showed signs of independent views. There has been a troubling hardline ideological aspect to his rule as well. Xi initiated a campaign to revitalize the Party, aiming at achieving a renewed commitment to Maoist principles. Even pro-market academics felt the chill of the new political environment, with crackdowns directed against several prominent reformers, including economist Mao Yushi, the 2012 recipient of the Cato Institute’s Milton Friedman Prize for Advancing Liberty.