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Fueled, Ignored, Misdiagnosed in DC, Inflation Broadens

18 Monday Jul 2022

Posted by in Inflation

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Inflation accelerated at the consumer level in June and the advances continued to broaden. That’s confirmed by the median item in the Consumer Price Index (CPI) and a measure of the CPI that “trims” out items with the largest and smallest price hikes (see chart above from the Cleveland Fed). Wholesale inflation also picked up in June. At this point, there’s a very real danger that increasing expectations of future inflation are getting embedded into current pricing decisions. Once that happens, the cycle is very hard to break. And wage rates are not keeping pace, so inflation is reducing real incomes for many workers. The sad fact is that inflation takes its greatest toll on the well being of low income earners.

And why did inflation accelerate from 1.4% in January 2021 to 9.2% in June? Don’t ask Joe Biden, at least not if you want a straight answer. He’s been changing his tune almost every month, with a rotating cast of the characters coming in for blame. First, the story was that higher inflation was just transitory; then too, the Administration said it only hurt the rich, a wholly preposterous assertion; the blame then shifted to the oil companies; then to Putin; and then big corporations generally; more recently, it’s independent gas retailers! Nothing is said about Biden’s early pledge to shut down fossil fuels. Nothing is said about the federal government’s profligate spending and the money printing that paid for it. Nothing is said about the extended payment of unemployment benefits, which pinched labor supply. More generally, nothing is said about the extension of Biden’s pandemic emergency powers, which allows continued Medicaid and food stamp benefits to many who are otherwise ineligible. The federal spigot has been wide open!

So here’s a quick synopsis of events leading to our inflationary surge: demand strengthened as pandemic restrictions were lifted across the country. Unfortunately, businesses were not ready to meet that level of demand. Operations had been sharply curtailed during the pandemic all along business supply chains. Hiring staff was next to impossible for many firms, especially given the Biden Administration’s ineptitude with respect to labor incentives. The Administration also set out to starve the fossil fuel industry of capital and to shut down drilling and refining operations through restrictions and binding regulations. The price of oil began to soar early in the Administration, which has been working its way into the prices of other goods and services, including food and transportation. Reinforcing these ill effects was the broader regulatory onslaught instigated at many agencies by Biden, actions which tend to increase costs while limiting competition in many industries.

Most of the factors just listed were limitations on supply. However, the price pressure was accelerated on the demand side by government stimulus payments. And in fact, none of this inflation would be sustainable without easy monetary policy — and monetization of government debt.

Later, of course, Vladimir Putin’s invasion of Ukraine exacerbated worldwide energy and food shortages. Meanwhile, Democrat efforts to push through additional social spending, née “infrastructure”, were unrelenting. They are still pushing for more climate change regulation, not to mention funding “investments” intended to improve the “equity” of highways! Thank God for Joe Manchin for shutting it down, though even he seems intent on imposing drug price controls. Biden now says he’ll impose green energy policy via executive order.

Until about March of this year, Federal Reserve policy remained extremely accommodative, despite the central bank having completely missed its so-called inflation target rate of 2% well before that. Take another look at the chart at the top of this post. CPI inflation shot above 2% in early 2021. The Fed did not really react until March 2022. The chart below shows that growth in the GDP deflator was slightly more muted than the CPI, but it too was above 2% in the first quarter of 2021 and accelerated from there. It’s as if there had been no Fed target at all!

The story, again, was “not to worry, it’s transitory”. Moreover, the Fed was convinced the inflation was driven entirely by supply problems. In fairness, it’s true that tighter monetary policy won’t stop inflation from supply shocks without great cost in terms of lost output. But monetary accommodation, which is what happened in 2021, simply validates inflation and runs the risk of allowing inflation expectations to become embedded in pricing. And again, that’s hard to undo.

Despite the dominance of supply-side inflation pressures early in 2021, it’s no wonder that a different kind of pressure has cropped up since then. The following chart from David Beckworth is helpful:

We now have primarily demand-side inflation fueled by the earlier accommodation of supply constraints and the monetization of government deficits. Sure, there remain significant supply constraints, whether induced by the actions of Russia, Biden, or lingering pandemic dysfunctions. But supply-side inflation cannot sustain without monetary accommodation. An early reading for the second-quarter GDP deflator will be available in late July, but it may well show accelerating pressures from both the demand side and the supply side.

There is no way to eliminate the inflation surge without curtailing the growth of liquidity. Unfortunately, the risk that monetary tightening by the Fed will induce a recession is already very high, even a likelihood at this point. A fairly reliable signal of recession is an inversion of the yield curve, and we now see two-year Treasury debt yielding 15 – 20 basis points more than 10-year bonds. Again, real wages are declining. Real retail sales are down two months in a row and down from a year ago. Here’s a chart showing the most recent dismal reading on the index of consumer sentiment:

Whether a recession has already begun is not clear, but inflation certainly hasn’t abated, and the Fed is expected to continue tightening, albeit belatedly. Meanwhile, the Biden Administration and key Democrats don’t seem to want to make the Fed’s job any easier. They simply don’t comprehend the reality and their role in fostering the upward price trends we’re experiencing. They still cling to hopes of another big spending package that would add to deficits and the inflation tax, despite contemplating tax hikes on private employers, but so far Manchin has put the kabash on that. Still, we’re nowhere close to putting our fiscal and monetary houses in order.

Fiscal Inflation Is Simple With This One Weird Trick

03 Thursday Feb 2022

Posted by in Fiscal policy, Inflation

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I’ll get to the weird trick right off the bat. Then you can read on if you want. The trick really is perverse if you believe in principles of sound credit and financial stability. To levy a fiscal inflation tax, all the government need do is spend like a drunken sailor and undermine its own credibility as a trustworthy borrower. One way to do that: adopt the policy prescriptions of Modern Monetary Theory (MMT).

A Theory of Deadbeat Government

That’s right! Run budget deficits and convince investors the debt you float will never be repaid with future real surpluses. That doesn’t mean the government would literally default (though that is never outside the realm of possibility). However, given such a loss of faith, something else must give, because the real value government debt outstanding will exceed the real value of expected future surpluses from which to pay that debt. The debt might be in the form of interest-bearing government bonds or printed money: it’s all government debt. Ultimately, under these circumstances, there will be a revised expectation that the value of that debt (bonds and dollars) will be eroded by an inflation tax.

This is a sketch of “The Fiscal Theory of the Price Level” (FTPL). The link goes to a draft of a paper by John Cochrane, which he intends as an introduction and summary of the theory. He has been discussing and refining this theory for many years. In fairness to him, it’s a draft. There are a few passages that could be written more clearly, but on the whole, FTPL is a useful way of thinking about fiscal issues that may give rise to inflation.

Fiscal Helicopters

Cochrane discusses the old allegory about how an economy responds to dollar bills dropped from a helicopter — free money floating into everyone’s yard! The result is the classic “too much money chasing too few goods” problem, so dollar prices of goods must rise. We tend to think of the helicopter drop as a monetary policy experiment, but as Cochrane asserts, it is fiscal policy.

We have experienced something very much like the classic helicopter drop in the past two years. The federal government has effectively given money away in a variety of pandemic relief efforts. Our central bank, the Federal Reserve, has monetized much of the debt the Treasury issued as it “loaded the helicopter”.

In effect, this wasn’t an act of monetary policy at all, because the Fed does not have the authority to simply issue new government debt. The Fed can buy other assets (like government bonds) by issuing dollars (as bank reserves). That’s how it engineers increases in the money supply. It can also “lend” to the U.S. Treasury, crediting the Treasury’s checking account. Presto! Stimulus payments are in the mail!

This is classic monetary seigniorage, or in more familiar language, an inflation tax. Here is Cochrane description of the recent helicopter drop:

“The Fed and Treasury together sent people about $6 trillion, financed by new Treasury debt and new reserves. This cumulative expansion was about 30% of GDP ($21,481) or 38% of outstanding debt ($16,924). If people do not expect that any of that new debt will be repaid, it suggests a 38% price-level rise. If people expect Treasury debt to be repaid by surpluses but not reserves, then we still expect $2,506 / $16,924 = 15% cumulative inflation.”

FTPL, May I Introduce You To MMT

Another trend in thought seems to have dovetailed with the helicopter drop , and it may have influenced investor sentiment regarding the government’s ever-weakening commitment to future surpluses: that would be the growing interest in MMT. This “theory” says, sure, go ahead! Print the money government “must” spend. The state simply fesses-up, right off the bat, that it has no intention of running future surpluses.

To be clear, and perhaps more fair, economists who subscribe to MMT believe that deficits financed with money printing are acceptable when inflation and interest rates are very low. However, expecting stability under those circumstances requires a certain level of investor confidence in the government fisc. Read this for Cochrane’s view of MMT.

Statists like Bernie Sanders, Alexandria Ocasio-Cortez, and seemingly Joe Biden are delighted to adopt a more general application of MMT as intellectual cover for their grandiose plans to remake the economy, fix the climate, and expand the welfare state. But generalizing MMT is a dangerous flirtation with inflation denialism and invites economic disaster.

If This Goes On…

Amid this lunacy we have Joe Biden and his party hoping to find avenues for “Build Back Better”. Fortunately, it’s looking dead at this point. The bill considered in the fall would have amounted to an additional $2 trillion of “infrastructure” spending, mostly not for physical infrastructure. Moreover, according to the Congressional Budget Office, that bill’s cost would have far exceeded $2 trillion by the time all was said and done. There are ongoing hopes for separate passage of free community college, an extended child tax credit for all families, a higher cap for state and local income tax deductions, and a host of other social and climate initiatives. The latter, relegated to a separate bill, is said to carry a price tag of over $550 billion. In addition, the Left would still love to see complete forgiveness of all student debt and institute some form of universal basic income. Hey, just print the money, right? Warm up the chopper! But rest easy, cause all this appears less likely by the day.

Are there possible non-inflationary outcomes from ongoing helicopter drops that are contingent on behavior? What if people save the fresh cash because it’s viewed as a one-time windfall (i.e., not a permanent increase in income)? If you sit on such a windfall it will erode as prices rise, and the change in expectations about government finance won’t be too comforting on that score.

There are many aspects of FTPL worth pondering, such as whether bond investors would be very troubled by yawning deficits with MMT noisemakers in Congress IF the Fed refused to go along with it. That is, no money printing or debt monetization. The burgeoning supply of debt would weigh heavily on the market, forcing rates up. Government keeps spending and interest costs balloon. It is here where Cochrane and critics of FTPL have a sharp disagreement. Does this engender inflation in the absence of debt monetization? Cochrane says yes if investors have faith in the unfaithfulness of fiscal policymakers. Excessive debt is then every bit as inflationary as printing money.

Real Shocks and FTPL

It’s natural to think supply disruptions are primarily responsible for the recent acceleration of inflation, rather than the helicopter drop. There’s no question about those price pressures in certain markets, much of it inflected by wayward policymakers, and some of those markets involve key inputs like energy and labor. Even the median component of the CPI has escalated sharply, though it has lagged broader measures a bit.

Broad price pressures cannot be sustained indefinitely without accommodating changes in the supply of money, which is the so-called “numeraire” in which all goods are priced. What does this have to do with FTPL or the government’s long-term budget constraint? The helicopter drop certainly led to additional money growth and spending, but again, FTPL would say that inflation follows from the expectation that government will not produce future surpluses needed for long-term budget balance. The creation of either new money or government debt, loaded the chopper as it were, is sufficient to accommodate broad price pressures over some duration.

Conclusion

Whether or not FTPL is a fully accurate description of fiscal and monetary phenomena, few would argue that a truly deadbeat government is a prescription for hyperinflation. That’s an extreme, but the motivation for FTPL is the potential abandonment of good and honest governing principles. Pledging an inflation tax is not exactly what anyone means by the full faith and credit of the U.S. government.

Inflation: The Leftist “Tax the Poor” Policy

23 Thursday Sep 2021

Posted by in Deficits, Inflation, Redistribution

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Recent years have seen explosive growth in federal deficits along with growth rates in the money supply that would have made John Maynard Keynes blush. It’s no coincidence that a new school of thought has developed among certain “monetary economists”. But as someone trained in monetary economics, I wish I could make those quote marks larger. This new school of thought is known as Modern Monetary Theory (MMT), and it asserts that the money spigot is a perfectly legitimate means of financing government spending and, furthermore, that it is not necessarily inflationary. Here is how Scott Sumner and Patrick Horan describe MMT:

“A central idea of MMT is that a government that issues its own fiat currency can pay its bills in that same currency. These governments need not worry about budget deficits when contemplating additional spending. Thus because the US government has a monopoly on money creation, our federal government does not need to raise all its revenue through tax or bond finance. A government with its own currency cannot go bankrupt because it can always issue more currency to cover any budget deficit. … MMT advocates argue that this why the US government can afford expensive programs such as a jobs guarantee and universal healthcare.”

Spend and Print

Joe Biden’s $3.5 trillion “social infrastructure” package would be just a start, but that’s likely to be more like $5.5T once the budget gimmicks are stripped out. We can be somewhat hopeful, because that initiative looks increasingly likely to fail in Congress, at least this time around. But the tax side of that bill was already $2.6T short of the latter spending figure, and the tax provisions keep shrinking. Now, it’s looking more like a shortfall of $3.5T would require financing. Moderate Democrats may not support this crazy bill in the end, but Dems from deep blue states want to reinstate state and local tax deductibility, which would cut the tax component still more. Well who cares? Print the money, say the brave MMT advocates.

Sumner gets to the heart of the problem in this piece. Progressives, with false assurance from MMT, want loose monetary policy to make their expansive programs “affordable”. As he explains, if this happens while the economy is near its production potential, inflation is a sure thing. These lessons were learned long ago, but have been conveniently forgotten by the political class (or they simply prefer to ignore them), instead jumping onto the MMT bandwagon.

Inflation Is Taxation

No conscientious observer of government finance should ever forget that inflation is a form of taxation. Assets whose values are either fixed or subject to some inertia are devalued by inflation in terms of purchasing power, or in real terms, as economists put it. Strictly speaking, this is true when inflation is unexpected… if it is expected, then lenders and borrowers can negotiate terms that will compensate for these changes in real value. But when inflation is unexpected, the losses to lenders are offset by gains to borrowers. Of course the federal government is a gigantic borrower, so inflation can represent a confiscation of wealth from the public.

It’s not small potatoes. Currently, about $22T of U.S. Treasury debt is held by the public, and its average maturity is more than 5 years. If the Federal Reserve engineers an unexpected 1% jump in the rate of inflation, it shaves over $1T off the real value of that debt before it’s repaid, and it reduces the real interest cost of that debt as well. Of course, the holders of that debt will suffer an immediate loss if they are forced to sell prior to maturity for any reason, since new buyers will be demanding higher yields to compensate for higher inflation if it is expected to persist.

The Poor Losers

Inflation causes redistributions to take place, especially when it is unexpected inflation. We’ve already discussed lenders and borrowers, but similar considerations apply to anyone entering into fixed price contracts for goods or labor. Here’s what Claudio Bario of the Bank of International Settlements (BIS) has to say about these shifts:

“Inflation shifts income and wealth away from those who are least aware of it, or least able to protect against it. These segments of the population often coincide with lower-income groups, which explains why inflation has often been portrayed as a most regressive form of tax. The ‘inflation tax’ takes its toll through the erosion of the value of financial assets and contracts fixed in nominal terms.”

Inflation is a regressive tax! In this respect, economist Noah Smith echos Bario in a recent op-ed in which he discusses “money illusion”, or the confusion of real and nominal income:

“Workers … who are slow to perceive the rise in prices they pay for goods like cars and groceries, won’t realize this, and will be happy with their unusually large raises. But companies, whose accountants and managers certainly know the true inflation rate, will also be happy, because they know they’re not actually paying more for labor.

That information asymmetry between workers and employers may be exactly what keeps wages from rising faster than inflation. If workers take a year to realize how much prices have gone up, they may be satisfied with the raises they got during the time of high inflation — even if that inflation ultimately turns out to be transitory. By then, it might be too late to negotiate for a real, inflation-adjusted raise.”

Inflation taxes and redistributions become more acute at higher rates of inflation, but any unexpected escalation in the rate of inflation will take a toll on the poor. Bario elaborates on the mechanisms by which inflation inflicts budgetary pain on the those at the lower end of the socioeconomic spectrum.

“As regards wealth distribution, the financial assets that are most vulnerable to inflation are cash and bank accounts – the typical savings vehicles held by the poorest segments of the population. This is mostly because the poorest have access only to limited investment options to protect their savings. …

… wages and pensions – the main sources of income for a large majority of households and even more so for the poorest half of the population – are typically fixed in nominal terms and hence vulnerable to inflation. Indexation mechanisms, such as those adopted in many [advanced economies] in the 1970s, are no panacea: they may fail to keep pace as inflation accelerates; …”

In addition to the inflationary gains reaped by government, it’s clear that inflation gives rise to redistributions between private parties: generally from those with lower incomes and wealth to their employers, producers, financial institutions, and pension payers (businesses, state and local governments). An exception is some low income debtors might benefit if they owe long term obligations at fixed interest rates, but low income individuals are often constrained from obtaining this form of credit.

Causing, Then Exploiting, Inequality

Another especially galling aspect of the Left’s focus on money finance is how its consequences fly in the face of their concerns about income and wealth inequality. Inflation is typically manifested in rising equity prices: nominal stock values tend to escalate in an inflationary environment, protecting their owners from losses to the real value of their investments. Stocks are generally a good inflation hedge. Yet we know that stocks are disproportionately owned by those in the highest strata of the income and wealth distributions. Later, of course, the Left will seek to level the burgeoning inequality wrought by their own policies by “taxing the rich”! Apparently, for the Left, consistency is never considered a virtue. This is not unlike another trick, which is to blame “greedy corporations” for the inflation wrought by Leftist policies.

It’s a great irony that the Left, which purports to support the poor and working people, would propose a form of government finance that is so regressive in its effects. To be generous, perhaps it’s just another case of “progressives” unknowingly hurting the ones they love. The expansive programs they advocate will confer government benefits to many individuals in higher income brackets, not just the poor, but those government alms will help to compensate for higher inflation. But this too takes advantage of money illusion, because those benefits might well buy progressives the loyalty of beneficiaries unable to recognize the ongoing erosion in their standard of living, and who are unwilling to come to grips with their increasing dependency.

But Tut, Tut, They Say

Advocates of MMT, in combination with expansive government, also have a tendency to deny that inflation has ever been a consequence of such policies. As Sumner points out, they have forgotten historical episodes that run contrary to the theory, and most “popular” advocates of MMT fail to recognize the important role played by limits on the economy’s production potential. When money growth outruns the economy’s ability to produce real goods and services, the prices of goods will rise.

Infrastructure Or Infra-Stricture? The Democrats’ $3.5 Trillion Reconciliation Bill

16 Thursday Sep 2021

Posted by in Big Government, Central Planning, infrastructure, Uncategorized

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The Socialist Party faithful once known as Democrats are pushing a $3.5 trillion piece of legislation they call an “infrastructure” bill. They hope to pass it via budget reconciliation rules with a simple majority in the Senate. The Dems came around to admitting that the bill is not about infrastructure in the sense in which we usually understand the term: physical installations like roads, bridges, sewer systems, power lines, canals, port facilities, and the like. These kinds of investments generally have a salutary impact on the nation’s productivity. Some “traditional” infrastructure, albeit with another hefty wallop of green subsidies, is covered in the $1.2 trillion “other” infrastructure bill already passed by the Senate but not the House. The reconciliation bill, however, addresses “social infrastructure”, which is to say it would authorize a massive expansion in the welfare state.

What Is Infrastructure?

Traditionally, public and private infrastructure are underlying assets that facilitate production or consumption in one way or another, consistent with the prefix “infra”, meaning below or within. For example, a new factory requires physical access by roads and/or rail, as well as sewer service, water, gas and/or electric supply. All of the underlying physical components that enable that factory to operate may be thought of as private infrastructure, which has largely private benefits. Therefore, it is often privately funded, though certainly not always.

Projects having many beneficiaries, such as highways, municipal sewers, water, gas and electrical trunk lines, canals, and ports may be classified as public infrastructure, though they can be provided and funded privately. Pure public infrastructure provides services that are non-rivalrous and non-excludable, but examples are sparse. Nevertheless, the greater the public nature of benefits, the greater the rationale for government involvement in their provision. In practice, a great deal of “public” infrastructure is funded by user fees. In fact, a failure to charge user fees for private benefits often leads to a tragedy of the commons, such as the overuse of free roads, imposing a heavier burden on taxpayers.

The use of the term “infrastructure” to describe forms of public support is not new, but the scope of government interventions to which the term is applied has mushroomed during the Biden Administration. Just about any spending program you can think of is likely to be labeled “infrastructure” by so-called progressives. The locution is borrowed somewhat questionably, seemingly motivated by the underlying structure of political incentives. More bluntly, it sounds good as a sales tactic!

$3.5 Trillion and Chains

Among other questionable items, the so-called budget reconciliation “infrastructure” bill allocates funds toward meeting:

“… the President’s climate change goals of 80% clean electricity and 50% economy-wide carbon emissions by 2030, while advancing environmental justice and American manufacturing. The framework would fund:
• Clean Energy Standard
• Clean Energy and Vehicle Tax Incentives
• Civilian Climate Corps
• Climate Smart Agriculture, Wildfire Prevention and Forestry
• Federal procurement of clean technologies
• Weatherization and Electrification of Buildings
• Clean Energy Accelerator”

The resolution would also institute “methane reduction and polluter import fees”. Thus, we must be prepared for a complete reconfiguration of our energy sector toward a portfolio of immature and uneconomic technologies. This amounts to an economic straightjacket.

Next we have a series of generous programs and expansions that would encourage dependence on government:

“• Universal Pre-K for 3 and 4-year old children
• High quality and affordable Child Care
• [free] Community College, HBCUs and MSIs, and Pell Grants
• Paid Family and Medical Leave
• Nutrition Assistance
• Affordable Housing”

If anything, pre-school seems to have cognitive drawbacks for children. Several of these items, most obviously the family leave mandate, would entail significant regulatory and cost burdens on private businesses.

There are more generous provisions on the health care front, which are good for further increasing the federal government’s role in directing, regulating, and funding medical care:

“• new Dental, Vision, and Hearing benefit to Medicare
• Home and Community-Based Services expansion
• Extend the Affordable Care Act Expansion from the ARP
• Close the Medicaid “Coverage Gap” in the States that refused to expand
• Reduced patient spending on prescription drugs”

Finally, we have a series of categories intended to “help workers and communities across the country recover from the COVID-19 pandemic and reverse trends of economic inequality.”

“• Housing Investments
• Innovation and R & D Upgrades
• American Manufacturing and Supply Chains Funding
• LPRs for Immigrants and Border Mangt. • Pro-Worker Incentives and Penalties • Investment in Workers and Communities • Small Business Support

I might suggest that a recovery from the pandemic would be better served by getting the federal government out of everyone’s business. The list includes greater largess and more intrusions by the federal government. The fourth item above, grants of legal permanent residency (LPR) or green cards, would legalize up to 8 million immigrants, allowing them to qualify for a range of federal benefits. It would obviously legitimize otherwise illegal border crossings and prevent any possibility of eventual deportation.

Screwing the Pooch

How many of those measures really sound like infrastructure? This bill goes on for more than 10,000 pages, so the chance that lawmakers will have an opportunity to rationally assess all of its provisions is about nil! And the reconciliation bill doesn’t stop at $3.5T. There are a few budget gimmicks being leveraged that could add as much as $2T of non-infrastructure spending to the package. One cute trick is to add certain provisions affecting revenue or spending years from now in order to cut the bill’s stated price tag.

A number of the bill’s generous giveaways will have negative effects on productive incentives. It’s also clear that some items in the bill will supplement the far Left’s educational agenda, which is seeped in critical theory. And the bill will increase the dominance of the federal government over not only the private sector, but state and local sovereignty as well. This is another stage in the metastasis of the federal bureaucracy and the dependency fostered by the welfare state.

Taxing the Golden Goose

But here’s the really big rub: the whole mess has to be paid for. The flip side of our growing dependency on government is the huge obligation to fund it. Check this out:

“American ‘consumer units,’ as BLS calls them, spent a net total of $17,211.12 on taxes last year while spending only $16,839.89 on food, clothing, healthcare and entertainment combined,”

Democrats continue to dicker over the tax provisions of the bill, but the most recent iteration of their plan is to cover about $2.9 trillion of the cost via tax hikes. Naturally, the major emphasis is on penalizing corporations and “the rich”. The latest plan includes:

  • increasing the corporate income tax from 21% to 26.8%;
  • increasing the top tax rate on capital gains from 20% to 25%;
  • an increase in the tax rate for incomes greater than $400,000 ($450,000 if married filing jointly)
  • adding a 3% tax surcharge for those with adjusted gross incomes in excess of $5 million;
  • Higher taxes on tobacco and nicotine products;
  • halving the estate and gift tax exemption;
  • limiting deductions for executive compensation;
  • changes in rules for carried interest and crypto assets.

There are a few offsets, including the promise of tax reductions for individuals earning less than $200,000 and businesses earning less than $400,000. We’ll see about that. Those cuts would expire by 2027, which reduces their “cost” to the government, but it will be controversial when the time comes.

The Dem sell job includes the notion that corporate income belongs to the “rich”, but as I’ve noted before, the burden of the corporate income tax falls largely on corporate workers and consumers. Lower wages and higher prices are almost sure to follow. This would deepen the blade of the Democrats’ political hari-kari, but they pin their hopes on the power of alms. Once bestowed, however, those will be difficult if not impossible to revoke, and the Dems know this all too well.

The assault on the “rich” in the reconciliation bill is both ill-advised and unlikely to yield the levels of revenue projected by Democrats. Like it or not, the wealthy provide the capital for most productive investment. Taxing their returns and their wealth more heavily can only reduce incentive to do so. Those investors will seek out more tax-advantaged uses for their funds. That includes investments in non-productive but federally-subsidized alternatives. Capital gains can often be deferred, of course. These penalties also ensure that more resources will be consumed in compliance and tax-avoidance efforts. The solutions offered by armies of accountants and tax attorneys will tend to direct funds to uses that are suboptimal in terms of growth in economic capacity.

What isn’t funded by new taxes will be borrowed by the federal government or simply printed by the Federal Reserve. Thus, the federal government will not only compete with the private sector for additional resources, but the monetary authority will provide fuel for more inflation.

Fracturing Support?

Fortunately, a few moderate Democrats in both the House and the Senate are balking at the exorbitance of the reconciliation bill. Senator Joe Manchin of West Virginia has said he would like to see a package of no more than $1.5 trillion. That still represents a huge expansion of government, but at least Manchin has offered a whiff of sanity. Equally welcome are threats from radical Democrats like Senator Bernie Sanders and Rep. Antonia Ocasio-Cortez that a failure to pass the full reconciliation package will mean a loss of their support for the original $1.2 trillion infrastructure bill, much of which is wasteful. We should be so lucky! But that’s a lot of pork for politicians to walk away from.

Infra-Shackles

The so-called infrastructure investments in the reconciliation bill represent a range of constraints on economic growth and consumer well being. Increasing the government’s dominance is never a good prescription for productivity, whether due to regulatory and compliance costs, bureaucratization of decision-making, minimizing the role of price signals, pure waste through bad incentives and graft, and public vs. private competition for resources. The destructive tax incentives for funding the bill are an additional layer of constraints on growth. Let’s hope the moderate Democrats hold firm, or even better, that the tantrum-prone radical Democrats are forced to make good on their threats.

Joe Biden’s Fat Cooked-Goose Tax Plan

03 Saturday Apr 2021

Posted by in Fiscal policy, Taxes

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I recently wrote on this blog about the damaging impact of corporate taxes on workers, consumers, and U.S. competitiveness. Phil Kerpen tweeted the chart above showing the dramatic reduction in the distribution of corporate tax rates across the world from 1980 through 2020. Yes, yes, Joe Biden’s posture as a fair and sensible leader aside, most countries place great emphasis on their treatment of business income and their standing relative to trading partners.

Kerpen’s tweet was a response to this tweet by economist Justin Wolfers:

Apparently, Wolfers wishes to emphasize that Biden’s plan, which raises the statutory corporate rate from 21% to 28%, does not take the rate up to the level of the pre-Trump era. Fair enough, but compare Wolfers’ chart with Kerpen’s (from the Tax Foundation) and note that it would still put the U.S. in the upper part of the international distribution without even considering the increment from state corporate tax rates. Also note that the U.S. was near the top of the distribution in 1980, 2000, and 2010. In fact, the U.S. had the fourth highest corporate tax rate in the world in 2017, before Trump’s tax package took effect. Perhaps Biden’s proposed rate won’t be the fourth highest in the world, but it will certainly worsen incentives for domestic U.S. investment, the outlook for wage growth, and consumer prices.

And in the same thread, Wolfers said this:

That’s certainly true, but let’s talk about those “loopholes”. First, much of U.S. corporate income is “passed though” to the returns of individual owners, so corporate taxes understate the true rate of tax paid on corporate income. Let’s also remember that the corporate tax represents a double taxation of income, and as a matter of tax efficiency it would be beneficial to consolidate these taxes on individual returns.

Beyond those consideration, the repeal of any corporate tax deduction or credit would have its own set of pros and cons. As long as there is a separate tax on corporate income, there is an economic rationale for most so-called “loopholes”. Does Wolfers refer to research and development tax credits? Maybe he means deductions on certain forms of compensation, though it’s hard to rationalize treating any form of employee compensation as income taxable to the business. Then there are the massive tax subsidies extended for investments in renewable energy. Well, good for Wolfers if that last one is his gripe! The CARES Act of 2020 allowed publicly-traded companies to use losses in 2020( presumably induced by the pandemic) to offset income in prior years, rather than carrying them forward. Did Wolfers believe that to be inappropriate? I might object to that too, to the extent that the measure allows declining firms to use COVID to cloak inefficiencies. Does he mean the offshoring of income to avoid U.S. corporate taxes? Might that be related to relative tax rates?

In any case, Wolfers can’t possibly imagine that the U.S. is the only country allowing a variety of expenses to be deducted against corporate income, or credits against tax bills for various activities. So, a comparison of statutory tax rates is probably a good place to start in assessing the competitive thrust of tax policy. But effective tax rates can reveal much more about the full impact of tax policy. In 2011, a study showed that the U.S. had the second highest effective corporate tax rate in the world. Today, among developed countries, the OECD puts the U.S. roughly in the middle of the pack, close to Germany but higher than Canada, Mexico and Japan, and lower than the UK. This article from 2019 reaches the same conclusion, though the rankings and rates differ from the OECD’s calculations. So it’s not as if the U.S. is the only country to offer tax incentives, or “loopholes” in Wolfers’ preferred terminology.

The corporate tax hikes proposed by the Biden Administration are intended to fund the massive outlays in the so-called infrastucture bill, which of course has very little to do with real infrastructure. Both the tax and spending proposals are bad policy. So far, however, passage of the bill is not a given. Let’s hope all of the Republicans and at least one Democrat senator have the sense to vote it down, but I’m not optimistic. The best hope for resistance among Democrats is Joe Manchin of West Virginia, but even he has signaled his support. Biden’s appointment of Gayle Manchin to a key administration post couldn’t have hurt.

The Fast Trains That Can’t

17 Sunday Feb 2019

Posted by in Air Travel, infrastructure

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High-speed rail will remain a pipe-dream in the U.S. except for the development of a few limited routes. However, statists continue to push for large-scale adoption. That would represent a triumph of big government, if realized, and it is very appealing to the public imagination. But high-speed rail (HSR) is something of a fraud. Projected fares do not include the massive capital costs required to build it, which must be funded by taxpayers. Like most big public projects, HSR presents ample opportunities for graft by privileged insiders. And apparently it’s easy to rationalize HSR by repeating the questionable mantra that it is environmentally superior to autos or even air travel.

California recently confronted the harsh reality of HSR costs by scaling back its ambitious plans to a single line traversing a portion of the central valley. Now, the federal government has acknowledged that the state has violated the terms of past federal grants, essentially for non-performance. Those grants totaled $2.5 billion, and another grant of almost $1 billion might be withheld. Better not to throw good money after bad.

Megan McArdle wisely debunks the viability of HSR in the U.S. based on four potent factors: distance, wealth, legal obstacles, and cost. Unlike Europe, Japan and even the eastern Chinese seaboard, the distances involved in the U.S. make widespread development of HSR infrastructure quite challenging. Even on shorter routes, the U.S. has too much valuable property in and between population centers that would have to be repurposed for placement of relatively straight-line routes to facilitate high speeds. An authoritarian government can commandeer property, but wresting property from private owners in the U.S. is not straightforward, even when obtrusive bureaucrats attempt to invoke eminent domain. McArdle says:

“… the U.S. legal system offers citizens an unparalleled number of veto points at which they can attempt to block government projects. Any infrastructure project bigger than painting a schoolhouse thus has to either fight out the reviews and court cases for years, or buy off the opponents, or more likely, both.”

Another downside for HSR: the cost of installing and operating U.S. infrastructure is inflated by a number of factors, including high U.S. wage levels, unions, overlapping regulatory agencies, and the distances and other cost factors discussed earlier. Even worse, the extensive planning and lengthy time lines of such a project virtually assure cost overruns, as California has learned the hard way. So high-speed rail has a lot going against it.

Warren Meyer raises another issue: rail in the U.S. is dominated by freight, and it is very difficult for freight and passenger traffic to share the same system. That means freight traffic cannot be used to help defray the cost of installing HSR. Meyer makes an interesting comparison between the efficiency of passenger trains relative to freight: much more energy is needed to pull a heavy passenger train car than to pull the actual passengers inside. In contrast, the cargo inside a typical freight car weighs far more than the car itself. But the efficiency of freight transportation in the U.S. seems to have no allure for many critics of U.S. transportation policy.

“Freight is boring and un-sexy. Its not a government function in the US. So intellectuals tend to ignore it, even though it is the far more important, from and energy and environmental standpoint, portion of transport to put on the rails. … We have had huge revolutions in transportation over the last decades during the same period that European nations were sinking billions of dollars into pretty high-speed passenger rails systems for wealthy business travelers.”   

Comparisons of efficiency across modes of passenger transportation are typically limited to operating costs, including energy costs, per passenger mile. That narrow focus yields a distorted view of the relative advantages of different passenger modes. In particular, the massive incremental capital costs of HSR are often ignored. Moreover, weight must be assigned to the very real economic costs of passenger time, not to mention the external costs imposed on the viability of farmland, nearby property owners, and wildlife.

In the long-term, all modes of transportation have infrastructure costs, but HSR lines don’t yet exist in this country. It is therefore relevant to ask whether the cost comparison is intended to address an ongoing transportation need or an incremental need. HSR is often promoted as a replacement for other modes of transportation, so the lack of an installed base of infrastructure is a huge incremental cost relative to modes already in place.

Air travel has some obvious advantages over high-speed trains. First, it requires much less support infrastructure, and a significant base of that capital is already installed. Again, the massive, up-front infrastructure costs of HSR are incremental. Also, airports tend to be well-integrated with local transportation options. New passenger train terminals would require additional investment in local ground transportation such as light rail or subway extensions, highway access, and the like. In addition, planes require less passenger time than trains over lengthy routes.

How about autos vs. HSR? Autos have the pre-installed base of road infrastructure. They provide hard-to-value flexibility for the traveler as well, but parking costs must be dealt with, and cars have extremely high accident rates. Travel time is a disadvantage for autos relative to HSR, even at moderate distances. In terms of operating costs, however, autos are not necessarily at a disadvantage: they weigh much less per passenger than trains, but that advantage is offset by trains’ low “rolling resistance” and other factors. The best choice for travelers would vary with the value they place on their time, specific plans at the destination, preference for flexibility, and the operating costs of their vehicle relative to the high-speed train fare.

Supporters of HSR contend that it is less costly to the environment than other modes of transportation. That case is easier to make if you focus solely on operating costs and exclude the impact of generating the electricity needed to power trains, which will require emissions of greenhouse gases for many years to come. A second fundamental omission is the environmental cost of the rail infrastructure itself. It’s very existence is disruptive to local environments, but perhaps most importantly, producing and installing the steel, concrete, and other materials needed for HSR will carry a steep environmental cost.

HSR is unlikely to achieve widespread adoption in the U.S. The distances of many routes and high infrastructure costs are obstacles that will be nearly impossible to overcome. Projected fares would be outrageously high were they to cover the full cost of the infrastructure. A typical argument is that taxpayers should fund the infrastructure due to the social benefits that rail is presumed to confer, but that presumption is far-fetched given the impact of producing the infrastructure itself, as well as the power needed to run the trains. I don’t expect adherents of rail to put aside their dreams quickly, however: there is something so romantic about the notion of having the state provide a massive rail network that the idea will never die the death it deserves. And don’t be fooled by Elon Musk’s hyperloop. It remains a distant technological hope and it too will have enormous resource costs along with an attendant call for public subsidies (a call which has already begun). After all, public subsidies are a hallmark of most of Musk’s business ventures.

 

 

Government Output: Illusions and Handicaps

09 Sunday Sep 2018

Posted by in Big Government

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Building a big government is thought to be a luxury that prosperous nations can afford, but such efforts have a systematically negative effect on their ability to generate income, much as eating the seed corn delivers a farmer to poverty. Daniel J. Mitchell puts it bluntly in a piece entitled “Rich Nations That Enact Big Government Don’t Remain Rich“. This is nowhere more obvious than in Argentina and Venezuela, two nations that were prosperous 50 years ago and are now economically feeble, or in Venezuela’s case, imploding. Government, in the final analysis, extracts resources from the private economy, often contributing negatively to productivity. Yet the idea that government is a tonic for economic growth persists, and it persists even in the face of weakness induced by excessive government.

Government statistics on Gross Domestic Product (GDP) exaggerate the contribution of government to income in at least a couple of ways. To understand why, it’s necessary to distinguish between spending aggregates and income aggregates, which add up to the same total GDP. The former  include consumption, investment, and government spending. Income aggregates are the other side of the GDP “coin”: payments made to factors of production, which represent GDP as a measure of output value.

A dissociation between these alternative views of GDP with respect to government’s contribution is that government payments count as spending and income regardless of the recipient’s contribution to output. Even if nothing is accomplished, nothing is produced, it is measured as income and spending and it is an increment to GDP. Payments to dig holes and refill them contribute to GDP as long as the government does the “job”. By contrast, if a worker in the private sector is paid but produces nothing of value, the firm’s owners suffer a loss of income corresponding to the worker’s pay, and GDP is unchanged! So increased factor payments by government cause an implicit bias in the measurement of output.

A second government bias implicit in GDP statistics is that public spending and government labor payments are often not subjected to a “market test” of value. The activity is “mandated”, so there is no correspondence to a willingness to pay or real value. Public employee unions exaggerate these distortions. There are generally no competitors for government provision of services, few incentives for efficiency, and often little discipline in government procurement processes. So the pricing of government transactions tends to be inflated. And yet when the government gets ripped off by overcharges or cronyist kickbacks, the excess payments contribute positively to GDP. In contrast, when a private firm gets ripped off, its income is correspondingly reduced and the transaction generally will not contribute to GDP.

It takes taxes to fund government, either immediate or deferred, and the taxes are either explicit or implicit in the form of eroded purchasing power. This creates negative incentives that retard private investment incentives, work incentives, and thereby private economic growth. Redistributional efforts retard work incentives as well because welfare–state beneficiaries often face high marginal tax rates on earned income.

Does big government represent a good investment for the wealth of a prosperous nation? In view of the above, one can hardly trust official statistics in rendering a judgement on that question. But despite these distortions, big government and measured economic growth are still negatively correlated. Mitchell provides more detailed analysis of government and economic growth at Heritage, including a set of references to academic papers on the topic.

One important way that government may contribute to economic growth is through the provision of physical infrastructure, which theoretically improves efficiency in private production. However, public infrastructure spending is subject to the same upward cost pressures discussed above, it is often tied to bumbling industrial policy efforts, its utilization by the public is usually mis-priced, and governments are congenitally inept at operating facilities efficiently. It is not clear that private developers could be counted upon to fill the void without some form of partnership with government, however, which has its own pitfalls. There are certainly reforms that could make private and public infrastructure investment and operation more viable, such as eliminating regulatory roadblocks to the installation of new facilities.

Another area in which government may generate a positive economic return is public investment in education, but that return is far from guaranteed. The success of public education investment depends on a wide range of cultural, political, and economic factors. For example, Cuba has the third largest proportion of government education spending to GDP, but the country’s ability to profit from that investment is severely crimped by its totalitarian economic and political system. I have been a frequent critic of public education in general, and I am not persuaded that education is truly a public good, despite some degree of spillover benefit. And while education may be a worthwhile national priority in many circumstances, it is not clear that government should necessarily fund education, let alone “run” education. Public education spending certainly doesn’t automatically translate to effective education outcomes, and it does not guarantee economic growth.

There is great exaggeration regarding the success of certain nations that have allowed government to absorb a large share of resources. That includes many of the European states, for which average incomes are roughly comparable to the Mississippi Delta. Only Luxembourg, Norway and Switzerland have income levels that are respectable relative to the U.S., and Norway relies heavily on oil extraction. Attributing economic power to government in the Nordic countries is especially misleading because the strength of those economies has always stemmed from their fundamentally capitalist underpinnings. Sweden built its wealth on capitalism, but it has cannibalized that strength over several decades with a burgeoning welfare state and high taxes. It only recently has begun attempting to reverse course.

Economic progress is unlikely to be achieved by “investing” in a larger public sector. Instead, encouraging private activity via positive incentives and minimal regulatory interference is a better route to success. The measured economic benefits of government spending are illusory to a significant degree. Even those activities thought to be the most productive avenues for government involvement, like investment in infrastructure and education, are plagued by cost inflation and incompetent execution. Finally, cross-country empirical evidence confirms that a more dominant public sector is associated with lower income growth. And yet there will always be a faction subscribing to the infantile, “free-lunch” belief that big government can deliver growth, and deliver it in excess of the predictable damage it inflicts on the private economy.

Infrastructure: Public Waste & Private Rationality

25 Tuesday Jul 2017

Posted by in infrastructure, Privatization

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The exaggerated deterioration of American infrastructure is the basis of a perfect bipartisan spending coalition. Proposed public spending on capital such as roads, bridges, high-speed rail, locks, dams, and water and wastewater systems is of obvious value to those who would build it, but the benefits for the public are not always beyond question. As Jeffrey Harding notes at the link, the American Society of Civil Engineers (ASCE) rates U.S. infrastructure as seriously deficient, but it is in their interests to do so. The news media finds the kind of horror story promoted by ASCE hard to resist:

“What they don’t tell you is that if you look at transportation issues over time, things have been getting better, not worse. … The Reason Foundation’s studies on state-owned highways (they are widely recognized as being leaders in this field) and other studies on highways and bridges reveal that there have been significant improvements of infrastructure measures like road and bridge quality and fatalities over the past 20 or 30 years. The facts are that, on the state level, overall spending on highways doubled during that period, and overall measures of highway transportation have improved.“

The point of building new infrastructure is the future flow of service it can offer. Creating construction jobs is not the point. If it were, the government could hire workers to dig holes with spoons, to paraphrase Milton Friedman. Nor should the timing of infrastructure investment be dependent on employment conditions. Unworthy projects are not made worthy by high unemployment. Politicians often attempt to sell projects to the public on exactly that basis, yet as Harding points out, increases in public spending on infrastructure seldom happen in a timely manner, and they often fail to create jobs in any case. This is partly due to the regulatory morass that must be navigated to get approval for new infrastructure, and also because the skilled labor required to repair or add infrastructure is usually occupied already, even when the jobless rate is elevated. In addition, expensive infrastructure projects are vulnerable to graft, which is compounded by the many layers of approval that are typically required.

Harding questions the ASCE’s insistence that inadequacy of our infrastructure is inhibiting U.S. productivity growth. If there is any truth to this assertion, it is probably more strongly related to how infrastructure is priced to users than to the state of the facilities themselves. For example, road congestion in certain areas is a chronic problem that can only be solved via efficient pricing, not by endless attempts to expand capacity. Not only does efficient pricing ease congestion, it enhances the profitability of improvements as well as other modes of transportation. A proposal to add infrastructure that is destined to be mis-priced to users is a plan to waste resources.

Donald Trump conveniently bought into and re-sold the notion that America’s infrastructure is unsound, and he is likely to garner support for an infrastructure initiative on both sides of the aisle. He would undoubtedly include the proposed wall at the Mexican border as an infrastructural need, but we’ll leave the wisdom (and payback) of that project aside for purposes of this discussion. As I’ve discussed before on Sacred Cow Chips, President Trump has at least learned that infrastructure is not and should not be the exclusive domain of the public sector. Trump’s infrastructure proposal calls for tax credits for “public-private partnerships” (Harding’s acronym: P3s). As Harding says:

“P3s let private companies design, build, and operate new infrastructure projects. According to Bob Poole, the Reason Foundation’s expert on privatization, P3s will result in projects that will be more economically productive (no bridges to nowhere) and would be much more cost effective. … These projects would be based on privatized systems which generate an income stream, and are financed by revenue bonds. Thus, the risks of these projects are shifted to private companies rather than to taxpayers.“

P3s solve several problems: they allocate private resources toward facilities for which developers expect high demand and user willingness to pay; they avoid higher levels of general taxation, instead allocating costs to the cost causers (i.e., the users); they give users a more accurate measure of opportunity costs when considering alternatives; and they avoid overuse. Too often, users of public infrastructure pay nothing, or at most they pay enough to cover operating costs with very little contribution to capital costs. Ultimately, that makes the quality and service level delivered by the infrastructure unsustainable. Private developers are unlikely to invest in such boondoggles as long as taxpayers are not obliged to subsidize them.

The P3 tax credits in the Administration’s proposal would certainly represent a public contribution to the funding of a project, but the incentive provided by those credits helps avoid a much more substantial committment of public funds. Moreover, the credits do not create the degree of forced economic stimulus that publicly executed projects often do. Rather, the availability of credits means that projects will be initiated when and if they are economically viable and profitable to do so. We can therefore dispense with the nonsensical goal of “job creation” and focus on the real problems that infrastructure investment can solve.

Some would argue that many types of infrastructure are too public in nature to be left to P3s. In other words, projects with pure public benefits would be under-provided by P3s due an unwillingness to pay by users of “the commons”. Yet there is no rule limiting the public role in the design of a public-private partnership, whether that refers to physical development, operation, or funding. Presumably, the more “public” (and non-exclusive) the benefits, the greater the share of development and maintenance costs that should be funded by government. Whether a piece of true public infrastructure should be funded is a standard question of public finance. Assuming it should, there is likely to be a significant role for private builders and operators. Finally, P3’s do not eliminate the potential for graft. Public review and ongoing regulation would still be demanded. In a sense, P3s are all formalized corporatist efforts, but a key difference relative to current practice is the use and risk of private capital rather than public funds. Ultimately, that won’t matter if failed developments are bailed out by public “partners”. The assets of a failed infrastructure project must be sold off to the highest bidder, presumably at a steep discount.

The standard narrative is that America suffers from substandard infrastructure is highly misleading. There are certainly needs that should be met, many with urgency, and there will always be a series of worthwhile repairs and replacements that require funding. Using P3s to accomplish these objectives demands recognition that 1) users typically derive significant private benefits from infrastructure; and 2) use is often underpriced, especially with respect to allocating capital costs. Infrastructure development can be encouraged by inducing private firms to put “skin in the game”. High-risk but potentially valuable projects might have trouble attracting private funds, of course, and that is as it should be. Politicians might ask taxpayers to fund such a project rather than shopping it to private developers. It therefore behooves voter/taxpayers to evaluate the benefits and sustainability of the project with the utmost skepticism.

Postscript: The image at the top of this post prompts me to reflect on whether a starship is infrastructure. It is certainly a transportation system. Is it a public good? In a large sense, the diversification offered by spreading humanity across multiple worlds can be viewed as a benefit to mankind in the future. But rides on the starship would offer private benefits, depending on one’s sense of adventure as well as the prospects for the home planet. Those private benefits, and the voluntary payments they induce, just might get it done.

The Renewable Energy Jobs Hoax

30 Tuesday May 2017

Posted by in Renewable Energy, Subsidies, Uncategorized

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James Taylor at Forbes reveals the dishonest math behind the claim that renewable energy generates more jobs than “conventional energy”, i.e., fossil fuels. It’s a simple trick, as Taylor explains:

“… renewable energy advocates create the broadest possible definition of workers ‘supported’ by the solar power industry, falsely claim that the solar power industry ’employed’ all these workers, and then compare that to the narrowest possible definition of just a single segment of workers ‘directly’ employed in the ‘extraction’ component of the much larger natural gas industry.“

Taylor notes that, “In reality, renewable energy isn’t even in the same universe of job creation as conventional energy.” He goes on to cite the report on which these claims are based and picks it apart. The renewable energy job assertions are obviously self-intereseted, as rent seeking lobbyists know that the political class is dominated by easy marks for renewable energy wonder-stories.

Of course Taylor is correct that the claims about renewable energy jobs are false in the aggregate sense. However, it might or might not be true in the marginal sense, and that’s clearly the sense in which the claim is intended to be taken, despite the fact that the data used is not marginal in nature. If true, it’s not a selling point for renewable energy subsidies because “more jobs” represents a greater marginal cost.

And that brings us to an even more critical issue missed by Taylor: public policy should not be based on the objective of direct job creation. Jobs are a cost, not a benefit. We value the finished goods, not the inputs required to produce them. If you don’t quite get that, imagine two bids for the construction of new kitchen in your home. Same plans, same completion date, similarly brilliant customer reviews of the competing contractors. Without knowing the actual bids, if one contractor tells you it’s a three-man job and the other says it’s a four-man job, you’ll be pretty certain which bid you’ll want to accept.

Ah, but you say, that’s not a fair comparison, because I’m paying for it. Yes you are, just as taxpayers (and more generally society) must pay for the subsidies that lobbyists wheedle out of politicians. Or you say, Ah, but we want more renewable jobs because we want renewable energy, ’cause it’s just right. Maybe, maybe not, but if that’s so, then the idea that the cost is higher because more jobs are required per unit of energy is not a good rationale.

It’s often the case that public policy aimed at “creating jobs” is not accompanied by higher output, lower prices, or even… more jobs! For example, tariffs on foreign goods give an advantage to American producers, but at the cost of job losses in import industries and higher domestic prices that harm consumers more broadly, and thereby reduce jobs. When certain industries or firms are subsidized by the government, the taxpayer is harmed directly, not to mention suppliers of alternatives. This is true at the local and national levels: politicians love to talk about job creation when they offer incentives for new facilities or relocations to their jurisdictions, but these subsidies may put other local firms at a competitive disadvantage and leave taxpayers holding the bag for public services supplied to the recipient firm. When government undertakes large taxpayer-funded infrastructure projects, which might or might not boost productivity, the taxes are damaging and the projects are often poorly planned and lack effective cost controls. Jobs are not a reason to support such projects.

Similar points have been discussed in the past here on Sacred Cow Chips, with links to articles emphasizing the distinction between direct jobs created and economic welfare like this one. “Jobs” should never be a policy objective in and of itself. As Tim Worstall explains in a brief review of Mark Zuckerberg’s recent commencement address at Harvard, jobs simply are not the point! Policy must have a better rationale than the high cost of the labor input!

Private Incentives and Infrastructure

10 Tuesday Jan 2017

Posted by in infrastructure, Markets

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motorway-to-hell

 

 

 

 

 

 

 

Material infrastructure is fixed plant and equipment providing services considered basic to the functioning of society. That definition leaves plenty of room for interpretation, however. For example, it does not limit the meaning of “infrastructure” to facilities necessary for the provision of “public goods”, for which benefits are non-exclusive. And it encompasses facilities used by firms in certain competitive markets, such as some forms of telecommunication. The character of infrastructure tends to change over time, as new technologies lead to changes in our way of life (e.g., the cellular network). That’s even more evident when infrastructure is defined more broadly, as Walter Buhr does in “What Is Infrastructure?” His definition of material infrastructure encompasses all facilities enabling “the activation or mobilization of the economic agents’ potentialities.”

Infrastructure ≠ Government

There is a popular fallacy that infrastructure is the exclusive province of government. Infrastructure often does provide some public, non-exclusive benefits, but the willingness of users to pay is the key test of private benefits. As it happens, most infrastructure needs can be met privately and partly, if not fully, supported by user fees. That follows from the high degree of exclusivity of benefits yielded by the infrastructure. Today, privately-owned infrastructure includes communication networks, power generation and distribution, some water and sewer systems, toll roads, ports, and landfills. The presumed monopolistic nature of some infrastructural services probably encourages the notion that infrastructure must be public, but that view is largely unjustified: the services may be “monopolized” only to the extent that the relevant market is defined narrowly, such as road travel, rather than transportation. Indeed, certain kinds of infrastructure functions in markets that are fairly competitive (e.g., wireless networks).

The great thing about most private infrastructure is that owner-operators have an incentive to put it up and keep it up. So it kind of takes care of itself. I say “kind of” because there is always a degree of public involvement, from land use and environmental approval to construction permits, to licensing, to spectrum auctions, to rate regulation, and many other varieties of oversight. Aside from those considerations, if there is a need for infrastructure that is commercially-viable, the project is likely to be proposed by private interests. The funds necessary to pay for construction can be raised from private investors, rather than taxpayers. It’s not at all strange to say that private infrastructure is highly advantageous from a public finance perspective.

There are risks to private infrastructure developers, but those risks are too often borne publicly. A new facility, be it a water treatment plant or a road, might not prove to be profitable once a new revenue stream or reduction in operating costs is realized. Given those circumstances, private interests might seek additional incentives from public authorities to ensure profitbility. To the extent that the shortfall is due to an error in pricing administered by a public regulatory authority, it might be reasonable to make adjustments in the owner-operator’s favor. However, to the extent that demand falls short of the owner-operator’s expectations, it might be better to let the firm fail. That would allow the assets to be sold at a discount to a new operator who can make the cheaper investment profitable. No bailouts!

Trumpian Infrastructure Incentives

The coming Trump Administration is known to have certain steps in mind for encouraging infrastructure development. While the tax plan that has been discussed has a few questionable features, any policy that reduces corporate tax rates would increase the return to existing and prospective private infrastructure, and the profitability of private operation of public infrastructure. In addition, a proposal mentioned explicitly by Trump is a corporate tax credit for infrastructure development.

Here is where a more precise definition of infrastructure would be helpful. Would traditional categories of infrastructure investment by power, telecommunication, and water treatment companies qualify automatically? Moreover, the long timelines required in the planning and installation of most infrastructure might make it difficult to distinguish between new plans and those already in the works. Will the administration establish a bright line between infrastructure investment and run-of-the-mill corporate spending on new plant and equipment? Perhaps any form of corporate investment will qualify. These are questions that remain unanswered as we await Trump’s inauguration.

There is another public-finance dimension of the Trump infrastructure credit. Public infrastructure projects, such as roads, are frequently difficult for governments to fund because they face limits on the debt they can issue. This is emphasized by Randall O’Toole in a recent piece on the Trump credit. Instead of issuing its own debt, a government can take advantage of a large private road builder’s ability to raise funds in the capital market, agreeing to compensate the contractor over time. Thus, taxpayers will be obligated to pay-off the contractor’s debt. The term “Public-Private Partnership” has been invoked in this connection.

Private Incentives Or Central Planning?

I am never averse to reduced tax rates to the extent that taxation always distorts economic incentives. However, selective targeting of tax benefits at certain industries, specific forms of business organization (like corporations), or specific activities like capital investment is overt central planning. Overriding market incentives in this way is not desirable. (Neither are proposals to subsidize exporters and penalize importers. Tyler Cowen at the Marginal Revolution provides some salient quotes from Lawrence Summers on this point.) At this stage, Trump’s tax plan looks like central planning gone berserk.

Ideally, private investment and private infrastructure should be judged on its real merits, not on the prejudices of a central authority. To that end, I believe the Trump Administration’s intent to roll back regulatory distortions is commendable. A case in point is nuclear power generation. Despite the constant outcry against the burning of fossil fuels, there has been little emphasis on encouraging investment in new nuclear capacity. The lengthy approval process and costly regulatory requirements discourage this zero-carbon form of energy production relative to other forms of energy investment.

Users Are the Cost-Causers

I should note that O’Toole speaks favorably of “targeting” certain kinds of public infrastructure, but I think his point is that private operation of infrastructure, if not ownership, will allow markets to do the targeting more efficiently than government ever could. In particular, he notes that politicians tend to prefer new projects to the maintenance and repair of existing infrastructure, independent of the actual merit. Would relying on private operation and user fees encourage better maintenance?

“Unlike infrastructure paid for out of tax dollars, user-fee-funded projects tend to be well maintained because the agencies that manage them know they have to keep them in good shape to continue earning revenues.“

The cartoon above satirizes the consequences of providing free access to a costly facility. User fees encourage more rational patterns of use. For example, it is folly to think that projects like light rail can be financially viable when free alternatives exist. Specific highway routes under high demand must be priced in order for commuters to make rational decisions about the alternatives available to them, and for providers of transportation facilities, whether public or private, to rationally balance the resources dedicated to supporting various modes of travel.

Lower tax and regulatory burdens under the Trump infrastructure plan offer some encouragement for private development and operation of infrastructure projects. As a by-product, the plan might encourage greater reliance on user fees as a method of defraying the costs of infrastructure and promoting a more efficient allocation of resources toward infrastructure needs. However, there are unanswered questions about the details of the plan, and some of its heavy-handy features should be dispensed with.