Topic: Tax and Budget Policy

Alan Reynolds in 1997 on Exchange Rates and Trade

I stumbled on this 1997 talk abut NAFTA by my old friend Roberto Salinas-Leon, making a case for Hillary’s Wikileak dream of Hemispheric free trade (but not for her other dream of “open borders” if that really meant unhindered migration).  

I may be biased, but the following heretofore lost quote from me still seems relevant, but for the U.S. too, not just Mexico. Trump adviser Peter Navarro thinks the dollar is 45% too strong against the Chinese yuan, which supposedly excuses Trump’s threat of a 45% tariff.  (I’m more in the “strong dollar is good for America” camp, though strong doesn’t mean continually rising.) 

As Alan Reynolds has recently explained, “the explicit goal of devaluation is to worsen the terms of trade”-for instance, to make Mexico trade more exports for fewer imports. Reynolds continues: “…even if Mexico wanted to impoverish itself in this way, it does not work. When the peso was devalued at the end of 1994 that did not result in Mexican oil or beer being one cent cheaper in terms of U.S. dollars. After a devaluation, interest rates soar, real tax receipts collapse, and the foreign debt burden increases. This causes a squeeze on the government’s budget, and on the budgets of families, farms and firms. This is no way to make a country “competitive.” Economic growth depends on more and better labor and capital, neither of which are encouraged by a currency of unpredictable value. A weak currency has never produced a strong economy.”

To be sure, concerns surrounding currency revaluation are closely mixed with the fear of generating a substantial trade deficit. Reynolds again explains the misdiagnosis of increased imports as a sign of bad times: “current account deficits have nothing to do with ‘competitiveness.’ They are caused by a gap between investment and domestic savings that is filled by foreign investment (which is good) or loans (which are not so good). To the extent that a devaluation might “fix” such a gap, it does so by slashing investment, not raising savings.”

Farm Subsidy Outlook

An important issue on the plate of the incoming president will be the next farm bill. Current farm programs run through September 2018, and farm bill supporters are already making plans to extend and expand them.

I have posted a new essay on why farm subsidies should be repealed at DownsizingGovernment.org. I describe eight types of farm subsidies and six reasons to repeal them.

The durability of farm programs over the decades encapsulates just about everything that’s wrong with Washington. The programs make no economic or environmental sense. They subsidize higher-income households, including billionaires. They run directly counter to the American ethos of independence and rugged individualism. Farmers should be proud rural businesspeople, but some have become like cattle feeding at a subsidy trough.

Farm programs survive not because they make practical sense, but because Washington’s agenda is controlled by special-interest insiders exploiting a key flaw in our Madisonian system—logrolling. In a recent news story about the next farm bill, a top farm lobbyist basically admits that farm programs don’t have the votes to pass on the merits, so they are packaged in legislation with food subsidy programs to gain the support of urban legislators.

The current farm bill, passed in 2014, is costing more than originally promised, yet farm-state legislators will soon go on “listening tours” to ask farmers how to expand the subsidies even more. Meanwhile, neither of the two main presidential candidates seem interested in reforming the grotesque system.

Nonetheless, there was a lot of talk about Washington corruption and cronyism on the campaign trail over the past year, so maybe the public will get fired up to oppose welfare for the well-to-do in the upcoming farm bill.

See here for more on federal agriculture subsidies.

Money Laundering Laws: Ineffective and Expensive

Beginning in the 1970s and 1980s, the federal government (as well as other governments around the world) began to adopt policies based on the idea that crime could be reduced if you somehow could make it very difficult for criminals to use the money they illegally obtain. So we now have a bunch of laws and regulations that require financial institutions to spy on their customers in hopes that this will inhibit money laundering.

But while the underlying theory may sound reasonable, such laws in practice have been a failure. There’s no evidence that these laws, which impose heavy costs on business and consumers, have produced a reduction in criminal activity.

Instead, the only tangible result seems to be more power for government and reduced access to financial services for poor people.

And now we have even more evidence that these laws don’t make sense. In a thorough study for the Heritage Foundation, David Burton and Norbert Michel put a price tag on the ridiculous laws, regulations, and mandates that are ostensibly designed to make it hard for crooks to launder cash, but in practice simply undermine legitimate commerce and make it hard for poor people to use banks.

Oh, and these rules also are inconsistent with a free society. Here are the principles they say should guide the discussion.

The United States Constitution’s Bill of Rights, particularly the Fourth, Fifth, and Ninth Amendments, together with structural federalism and separation of powers protections, is designed to…protect…individual rights. The current financial regulatory framework is inconsistent with these principles. …Financial privacy can allow people to protect their life savings when a government tries to confiscate its citizens’ wealth, whether for political, ethnic, religious, or “merely” economic reasons. Businesses need to protect their private financial information, intellectual property, and trade secrets from competitors in order to remain profitable. Financial privacy is of deep and abiding importance to freedom, and many governments have shown themselves willing to routinely abuse private financial information.

And here are the key findings about America’s current regulatory morass, which violates the above principles.

The current U.S. framework is overly complex and burdensome… Reform efforts also need to focus on costs versus benefits. The current framework, particularly the anti-money laundering (AML) rules, is clearly not cost-effective. As demonstrated below, the AML regime costs an estimated $4.8 billion to $8 billion annually. Yet, this AML system results in fewer than 700 convictions annually, a proportion of which are simply additional counts against persons charged with other predicate crimes. Thus, each conviction costs approximately $7 million, potentially much more.

By the way, the authors note that their calculations represent “a significant underestimate of the actual burden” because they didn’t include foregone economic activity, higher consumer prices for financial services, lower returns for shareholders of financial institutions, higher financial expenses for unbanked individuals, and other direct and indirect costs.

And what are the offsetting benefits? Can all these costs be justified?

Ending the Tax Breaks for Real Estate

The release of a snippet of Donald Trump’s tax return from 1995 showing a net operating loss of nearly $1 billion, potentially allowing him to legally avoid paying taxes for an 18 year period, has given us another reason to condemn Donald Trump and the complicated provisions in the tax code pertaining to real estate that allow Trump and others like him to pay much less in taxes than the rest of us. One tax professional told me that there’s no reason for a big real estate concern to ever pay income taxes of any kind to the government if they have an accounting firm that knows what it’s doing.

A few people have expressed a hope that, should Trump lose, Congress would begin to look at some of the various real estate tax loopholes that allow such legal tax evasion. I would wholeheartedly agree with such sentiments, and humbly suggest that the purge begin with the most egregious and expensive real estate tax break of them all–the mortgage interest deduction. 

The MID costs the government $80 billion a year in lost revenue and is one of the most expensive tax breaks in the code. It may also be the least effective–because it’s a deduction (as opposed to a credit, or direct subsidy) that means that only the wealthiest homeowners (the top 30% or so) can actually take the deduction.

Why All the Labor Force Dropouts?

The distinguished Stanford University economist Robert Hall, co-architect of the famed Hall-Rabushka flat tax, once described himself to me as a [Bill] Clinton Democrat. Bob Hall wrote one of the most serious studies trying to figure out why the U.S. economy has remained so weak for so long. He concluded that much of the explanation lies in the ways in which recent marginal tax and transfer incentives discourage work.

In an analysis similar to that of Casey Mulligan of the University of Chicago, Hall attributes much of the startling drop in labor force participation to the expansion of federal transfer payments. Disability benefits and food stamps, in particular, are quickly phased-out if nonworkers take a job, or part-time workers switch to full-time work, or single-earner families become two-earner families. In other words, higher tax rates on work and more generous subsidies to leisure leave the economy with fewer people seeking work and therefore less production, lower tax revenue and greater federal spending on transfers from those who earn income to those who instead rely on government.

As Hall put it,

Labor-force participation fell substantially after the crisis, contributing 2.5 percentage points to the shortfall in output. The decline showed no sign of reverting as of 2013. Part is demographic and will stabilize, and part reflects low job-finding rates, which should return to normal slowly. But an important part may be related to the large growth in beneficiaries of disability and food-stamp programs. Bulges in their enrollments appear to be highly persistent. Both programs place high taxes on earnings [emphasis added] and so discourage labor-force participation among beneficiaries. The bulge in program dependence …  may impede output and employment growth for some years into the future.

Politicians and Spending Caps

Budget experts worried about the growth of federal spending and deficits have proposed various statutory and constitutional restraints to get the budget under control. I favor a simple cap on the percentage growth in annual total outlays.

Many state governments have spending, deficit, and debt restraints on the books, both statutory and constitutional. The restraints do help to tame state fiscal policy, but there is lots of cheating by the politicians.

Researching Cato’s new Governors Report Card, I came across an illuminating story about Connecticut’s spending restraint mechanism. I quote here at length:

The 1991 General Assembly tried to temper outrage over enactment of the state income tax by drafting a statutory spending cap. Voters would add the cap requirement to the state Constitution one year later by adopting the 28th Amendment.

The cap is supposed to keep spending increases in line with the annual growth in personal income or inflation, whichever is larger. For most of the cap’s history, the legislature has relied on personal income.

The cap system uses an average of personal income growth over the previous five years. That means that the sluggish growth years immediately following the last recession — which ended in 2010 — will continue to limit spending growth under the current cap system.

That makes sense to me—citizen income is stagnant in slow-growth Connecticut, so government growth should be limited so that it doesn’t squeeze people more when they can least afford it.

But that’s not how Connecticut politicians see it:

Both political parties have looked for ways around the cap over the past decade. The governor and legislature can exceed the cap legally if they agree and take special steps.

That happened in 2005 when Gov. M. Jodi Rell, a Republican, signed a declaration of fiscal exigency — declaring a budget emergency. More than 60 percent of the Democrat-controlled House and Senate voted to approve the plan.

Two years later, Rell and lawmakers used the same approach, this time approving a biennial budget that shattered the cap by a record-setting $690 million in the first year.

Since in 2011, Malloy has refused to declare a budget emergency. But that doesn’t mean he hasn’t bent to the cap’s weight.

The governor has proposed or approved moving spending outside of the cap – in large quantities …

The Democrat-controlled Appropriations Committee stunned the Capitol in April 2015 when it proposed a budget that moved billions of dollars in spending for pensions and other retirement benefit costs out from under the cap — for the first time since the spending control was established in 1991.

Both Rell and Malloy have been awarded “F” grades from Cato for their fiscal irresponsibility. It’s a shame that politicians of both parties in Connecticut aren’t abiding by a sensible constitutional restraint passed with the support of 80 percent of voters

Governors Fiscal Report

Most state governments are in an expansionary phase, as revenues are growing at a steady clip. Some governors are using the growing revenues to expand spending programs, while others are pursuing tax cuts and tax reforms.

That is the backdrop to this year’s 13th biennial fiscal report card on the governors, which Cato released today. It uses statistical data to grade the governors on their taxing and spending records since 2014—governors who have cut taxes and spending the most receive the highest grades, while those who have increased taxes and spending the most receive the lowest grades.

Five governors were awarded an “A”: Paul LePage of Maine, Pat McCrory of North Carolina, Rick Scott of Florida, Doug Ducey of Arizona, and Mike Pence of Indiana.

Ten governors were awarded an “F”: Robert Bentley of Alabama, Peter Shumlin of Vermont, Jerry Brown of California, David Ige of Hawaii, Dan Malloy of Connecticut, Dennis Daugaard of South Dakota, Brian Sandoval of Nevada, Kate Brown of Oregon, Jay Inslee of Washington, and Tom Wolf of Pennsylvania.

The report describes the record of each governor and discusses the outlook for state budgets. Medicaid costs are rising, and federal aid for this huge health program will likely be reduced in coming years. At the same time, many states have high levels of unfunded liabilities in their pension and retiree health plans.

Those factors will create pressure for states to raise taxes. Yet global economic competition demands that states improve their investment climates by cutting tax rates, particularly on businesses, entrepreneurs, and skilled workers.

News reports about the states often focus on policymaker efforts to balance their budgets. Balanced budgets are important, but policymakers should also be running their governments in a lean and frugal manner, reforming tax codes to spur growth, and generally expanding fiscal freedom for state residents.

Cato’s new report helps to sort out the governors who are moving in that direction from those who are not. An oped describing the main results is here.