Tag Archives: Scott Sumner

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.

COVID Interventions: Costly, Deadly, and Ineffective

14 Monday Dec 2020

Posted by in Coronavirus, Liberty, Lockdowns, Public Health

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What does it take to shake people out of their statist stupor? Evidently, the sweet “logic” of universal confinement is very appealing to the prescriptive mindset of busybodies everywhere, who anxiously wag their fingers at those whom they view as insufficiently frightened. As difficult as it is for these shrieking, authoritarian curs to fathom, measures like lockdowns, restrictions on business activity, school closures, and mandates on behavior have at best a limited impact on the spread of the coronavirus, and they are enormously costly in terms of economic well-being and many dimensions of public health. Yet the storm of propaganda to the contrary continues. Media outlets routinely run scare stories, dwelling on rising case numbers but ignoring them when they fall; they emphasize inflated measures of pandemic severity; certain researchers and so-called health experts can’t learn the lessons that are plain in the data; and too many public officials feel compelled to assert presumed but unconstitutional powers. At least the World Health Organization has managed to see things clearly, but many don’t want to listen.

I’ll be the first to say I thought the federalist approach to COVID policy was commendable: allow states and local governments to craft policies appropriate to local conditions and political preferences, rather than have the federal government dictate a one-size-fits-all policy. I haven’t wavered in that assessment, but let’s just say I expected more variety. What I failed to appreciate was the extent to which state and local leaders are captive to provincial busybodies, mavens of precautionary excess, and fraudulent claims to scientific wisdom.

Of course, it should be obvious that the “knowledge problem” articulated by Friedrich Hayek is just as dangerous at low-levels of government as it is in a central Leviathan. And it’s not just a knowledge problem, but a political problem: officials become panicked because they fear bad outcomes will spell doom for their careers. Politicians are particularly prone to the hazards of “do-somethingism”, especially if they have willing, status-seeking “experts” to back them up. But as Scott Sumner says:

“When issues strongly impact society, the science no longer ‘speaks for itself’.

Well, the science is not quite as clear as the “follow-the-science” crowd would have you believe. And unfortunately, public officials have little interest in sober assessments of the unintended effects of lockdown policy.

In my last post, I presented a simple framework for thinking about the benefits and costs of lockdown measures, or non-pharmaceutical interventions (NPIs). I also emphasized the knowledge problem: even if there is some point at which NPI stringencies are “optimized”, government does not possess the knowledge to find that point. It lacks detailed information on both the costs and benefits of NPIs, but individual actors know their own tolerance for risk, and they surely have some sense of the risks they pose to others in their normal course of affairs. While voluntary precautions might be imperfect, they accomplish much of what interventionists hope will be gained via coercion. But, in an effort to “sell” NPIs to constituents and assert their authority, officials vastly over-estimate benefits of NPIs and under-estimate the costs.

NPI Stringency and COVID Outcomes

Let’s take a look at a measure of the strength of NPIs by state — the University of Oxford Stringency Index — and compare those to CDC all-cause excess deaths in each state. If it’s hard to read, try clicking on the image or turn your phone sideways. This plot covers outcomes through mid-November:

The chart doesn’t suggest any benefit to the imposition of greater restrictions, or more stringent NPIs. In fact, the truth is that people will do most of the work on their own based on perceptions of risk. That’s partly because government restrictions add little risk mitigation to what can be accomplished by voluntary social distancing and other precautions.

Here’s a similar chart with cross-country comparisons, though the data here ended in early October (I apologize for the fuzzy image):

But what about reverse causality? Maybe the imposition of stringency was a response to more severe contagions. Now that the virus has swept most of the U.S and Europe in three distinct waves, and given the variety and timing of NPIs that have been tried, it’s harder to make that argument. States like South Dakota have done fairly well with low stringency, while states like New Jersey with high stringency have fared poorly. The charts above provide multiple pair-wise examples and counter-examples of states or countries having faced hard waves with different results.

But let’s look at a few specific situations.

The countries shown above have converged somewhat over the past month: Sweden’s daily deaths have risen while the others have declined to greater or lesser degrees, but the implications for mask usage are unaltered.

And of course we have this gem, predicated on the mental gymnastics lockdown enthusiasts are fond of performing:

But seriously, it’s been a typical pattern: cases rise to a point at which officials muster the political will to impose restrictions, often well after the “exponential” phase of the wave or even the peak has passed. For the sake of argument, if we were to stipulate that lockdowns save lives, it would take time for these measures to mitigate new infections, time for some of the infected individuals to become symptomatic, and more time for diagnosis. For the lockdown arguments to be persuasive, the implementation of NPIs would have to precede the point at which the growth of cases begins to decline by a few weeks. That’s something we’ve seldom observed, but officials always seem to take credit for the inevitable decline in cases.

More informed lockdown proponents have been hanging their hats on this paper in Nature by Seth Flaxman, et al, published in July. As Philippe LeMoine has shown, however, Flaxman and his coauthors essentially assumed their result. After a fairly exhaustive analysis, Lemoine, a man who understands sophisticated mathematics, offers these damning comments:

“Their paper is a prime example of propaganda masquerading as science that weaponizes complicated mathematics to promote questionable policies. Complicated mathematics always impresses people because they don’t understand it and it makes the analysis look scientific, but often it’s used to launder totally implausible assumptions, which anyone could recognize as such if they were stated in plain language. I think it’s exactly what happened with Flaxman et al.’s paper, which has been used as a cudgel to defend lockdowns, even though it has no practical relevance whatsoever.”

The Economic Costs of Stringency

So the benefits of stringent lockdowns in terms of averting sickness and death from COVID are speculative at best. What about the costs of lockdowns? We can start with their negative impact on economic activity:

That’s a pretty bad reflection on NPI stringency. In the U.S, a 10% decline in GDP in 2020 amounts to about $2.1 trillion in lost goods and services. That’s just for starters. The many destroyed businesses and livelihoods carry an ongoing cost that could take years to fade, as this graphic on permanent business closures shows:

If you’re wondering about the distributional effects of lockdowns, here’s more bad news:

It’s possible to do many high-paying jobs from home. Not so for blue-collar workers. And distributional effects by size of enterprise are also heavily-skewed in favor of big companies. Within the retail industry, big-box stores are often designated as “essential”, while small shops and restaurants are not. The restaurant industry has been destroyed in many areas, inflicting a huge blow to owners and workers. This despite evidence from contact tracing showing that restaurants and bars account for a very small share of transmission. To add insult to injury, many restaurants invested heavily in safety measures and equipment to facilitate new, safer ways of doing business, only to be double-crossed by officials like Andrew Cuomo and Eric Garcetti, who later shut them down.

Public Health Costs of Stringency

Lives are lost due to lockdowns, but here’s a little exercise for the sake of argument: The life value implied by individual willingness-to-pay for risk reduction comes in at less than $4 million. Even if the supposed 300,000 COVID deaths had all been saved by lockdowns, that would have amounted to a value of $1.2 trillion, about half of the GDP loss indicated above. Of course, it would be outrageously generous to concede that lives saved by NPI’s have approached 300,000, so lockdowns fall far short at the very outset of any cost-benefit comparison, even if we value individual lives at far more than $4 million.

As AJ Kay says, the social and human costs go far beyond economic losses:

I cited specific examples of losses in many of these categories in an earlier post. But for the moment, instead of focusing on causes of death, take a look at this table provided by Justin Hart showing a measure of non-COVID excess deaths by age group in the far right-hand column:

The numbers here are derived by averaging deaths by age group over the previous five years and subtracting COVID deaths in each group. I believe Hart’s numbers go through November. Of greatest interest here is the fact that younger age groups, having far less risk of death from COVID than older age groups, have suffered large numbers of excess deaths NOT attributed to COVID. As Hart notes later in his thread:

These deaths are a tragic consequence of lockdowns.

Educational Costs of Stringency

Many schools have been closed to in-person instruction during the pandemic, leading to severe disruptions to the education f children. This report from the Fairfax County, VA School District is indicative, and it is extremely disheartening. The report includes the following table:

Note the deterioration for disabled students, English learners, and the economically disadvantaged. The surfeit of failing grades is especially damaging to groups already struggling in school relative to their peers, such as blacks and Hispanics. Not only has the disruption to in-person instruction been disastrous to many students and their futures; it has also yielded little benefit in mitigating the contagion. A recent study in The Lancet confirms once again that transmission is low in educational settings. Also see here and here for more evidence on that point.

Conclusion

It’s clear that the “follow-the-science” mantra as a rationale for stringent NPIs was always a fraud, as was the knee-jerk response from those who conflated lockdowns with “leadership”. Such was the wrongheaded and ultimately deadly pressure to “do something”. We can be thankful that pressure was resisted at the federal level by President Trump. The extraordinary damage inflicted by ongoing NPIs was quite foreseeable, but there is one more very ominous implication. I’ll allow J.D. Tucille to sum that up with some of the pointed quotes he provides:

“‘The first global pandemic of the digital age has accelerated the international adoption of surveillance and public security technologies, normalising new forms of widespread, overt state surveillance,’ warned Kelsey Munro and Danielle Cave of the Australian Strategic Policy Institute’s Cyber Policy Centre last month.

‘Numerous governments have used the COVID-pandemic to repress expression in violation of their obligations under human rights law,’ United Nations Special Rapporteur on Freedom of Expression David Kaye noted in July.

‘For authoritarian-minded leaders, the coronavirus crisis is offering a convenient pretext to silence critics and consolidate power,’ Human Rights Watch warned back in April.

There’s widespread agreement, then, that government officials around the world are exploiting the pandemic to expand their power and to suppress opposition. That’s the case not only among the usual suspects where authorities don’t pretend to take elections and civil liberties seriously, but also in countries that are traditionally considered ‘free.’ … It’s wildly optimistic to expect that newly acquired surveillance tools and enforcement powers will simply evaporate once COVID-19 is sent on its way. The post-pandemic new normal is almost certain to be more authoritarian than what went before.”

The Federal Reserve and Coronatative Easing

09 Monday Mar 2020

Posted by in Monetary Policy, Pandemic

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Laughs erupted all around when the Federal Reserve reduced its overnight lending rate by 50 basis points last week: LIKE THAT’LL CURE THE CORANAVIRUS! HAHAHA! It’s easy to see why it seemed funny to people, even those who think the threat posed by Covid-19 is overblown. But it should seem less silly with each passing day. That’s not to say I think we’re headed for disaster. My own views are aligned with this piece by Michael Fumento: it will run its course before too long, and “viruses hate warm weather“. Nevertheless, the virus is already having a variety of economic effects that made the Fed’s action prudent.

Of course, the Fed did not cut its rate to cure the virus. The rate move was intended to deal with some of the economic effects of a pandemic. The spread of the virus has been concentrated in a few countries thus far: China, Iran, Italy, and South Korea. Fairly rapid growth is expected in the number of cases in the U.S. and the rest of the world over the next few weeks, especially now with the long-awaited distribution of test kits. But already in the U.S., we see shortages of supplies hitting certain industries, as shipments from overseas have petered. And now efforts to control the spread of the virus will involve more telecommuting, cancellation of public events, less travel, less dining out, fewer shopping trips, missed work, hospitalizations, and possibly widespread quarantines.

The upshot is at least a temporary slowdown in economic activity and concomitant difficulties for many private businesses. We’ve been in the midst of a “flight to safety”, as investors incorporate these expectations into stock prices and interest rates. Firms in certain industries will need cash to pay bills during a period of moribund demand, and consumers will need cash during possible layoffs. All of this suggests a need for liquidity, but even worse, it raises the specter of a solvency crisis.

The Fed’s power can attempt to fill the shortfall in liquidity, but insolvency is a different story. That, unfortunately, might mean either business failures or bailouts. Large firms and some small ones might have solid business continuation plans to help get them through a crisis, at least one of short to moderate duration, but many businesses are at risk. President Trump is proposing certain fiscal and regulatory actions, such as a reduction in the payroll tax, wage payment assistance, and some form of mandatory paid leave for certain workers. Measures might be crafted so as to target particular industries hit hard by the virus.

I do not object to these pre-emptive measures, even as an ardent proponent of small government, because the virus is an externality abetted by multiplicative network effects, something that government has a legitimate role in addressing. There are probably other economic policy actions worth considering. Some have suggested a review of laws restricting access to retirement funds to supplement inadequate amounts of precautionary savings.

Last week’s Fed’s rate move can be viewed as pre-emptive in the sense that it was intended to assure adequate liquidity to the financial sector and payment system to facilitate adjustment to drastic changes in risk appetites. It might also provide some relief to goods suppliers who find themselves short of cash, but their ability to benefit depends on their relationships to lenders, and lenders will be extremely cautious about extending additional credit as long as conditions appear to be deteriorating.

In an even stronger sense, the Fed’s action last week was purely reactive. Scott Sumner first raised an important point about ten days before the rate cut: if the Fed fails to reduce its overnight lending target, it represents a de facto tightening of U.S. monetary policy, which would be a colossal mistake in a high-risk economic and social environment:

“When there’s a disruption to manufacturing supply chains, that tends to reduce business investment, puts downward pressure on demand for credit. That will tend to reduce equilibrium interest rates. In addition, with the coronavirus, there’s also a lot of uncertainty in the global economy. And when there’s uncertainty, there’s sort of a rush for safe assets, people buy treasury bonds, that puts downward pressure on interest rates. So you have this downward pressure on global interest rates. Now while this is occurring, if the Fed holds constant its policy rate, it targets the, say fed funds rate at a little over 1.5 percent. While the equilibrium rates are falling, then essentially the Fed will be making monetary policy tighter.

… what I’m saying is, if the Fed actually wants to maintain a stable monetary policy, they may have to move their policy interest rate up and down with market conditions to keep the effective stance of monetary policy stable. So again, it’s not trying to solve the supply side problem, it’s trying to prevent it from spilling over and also impacting aggregate demand.”

The Fed must react appropriately to market rates to maintain the tenor of its policy, as it does not have the ability to control market rates. Its powers are limited, but it does have a responsibility to provide liquidity and to avoid instability in conducting monetary policy. Fiscal actions, on the other hand, might prove crucial to restoring economic confidence, but ultimately controlling the spread of the virus must be addressed at local levels and within individual institutions. While I am strongly averse to intrusions on individual liberty and I desperately hope it won’t be necessary, extraordinary measures like whole-city quarantines might ultimately be required. In that context, this post on the effectiveness of “non-pharmaceutical interventions” such as school closures, bans on public gatherings, and quarantines during the flu pandemic of 1918-19 is fascinating.

 

 

 

 

 

The House GOP Tax Plan’s Disparate Treatment of Income Sources

09 Thursday Nov 2017

Posted by in Taxes

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Update: In writing the following post, I neglected to devote sufficient attention to the rules that would govern taxation of pass-through income under the House GOP tax plan. Those rules significantly alter some of the conclusions below. Those rules are discussed in a later post: Stumbling Through Pass-Through Tax Reform.

Double taxation of corporate income is a feature of the U.S. income tax code that is partially addressed in the tax reform bill proposed by the House GOP. Corporate income is taxed to the firm and again to owners on their receipt of dividends or when a company’s growth results in capital gains. Ultimately, the total rate of taxation matters more than whether it is implemented as single or double taxation of income flows. However, there is an unfortunate tendency to view corporate taxes as if they are levied on entitites wholly separate from their owners, so double taxation carries a stench of politically sneakiness. It also creates multiple distortions in the decisions of investors and the separately managed firms they own.

Non-corporate income taxation is reduced by the House plan even more substantially than the cut in taxes on corporate-derived income. However, the plan does not reduce taxes on high-earning professionals, many of whom are situated similarly to successful business owners and investors from an economic perspective.

Tax Burdens and Distortions

The federal corporate tax is not borne 100% by shareholders, as discussed in the previous post on Sacred Cow Chips. Some part of the burden is borne by labor via reduced wages. It is difficult to correct for this distortion in terms of calculating an effective marginal tax rate on corporate income. For example, suppose a new 35% tax would reduce corporate income from $100 to $65. The firm finds, however, that it can reduce wage payments by half of the expected tax payment, or $17.50. The firm would now earn $117.50 before tax and $76.38 after tax. Relative to the new level of pre-tax income, the tax rate is still 35%. It is no less than that by way of the reduction in wages, though the impact on the firm’s pre-tax income is mitigated.

The discussion here of tax rates, and even double taxation, is not intended as commentary on tax fairness. It might or might not be fair that the burden of the tax is shared with labor. Instead, the issue is the magnitude of the economic distortions caused by taxes. Tax rates themselves are a reasonable starting point for such a discussion, and they are easy to measure. Lower tax rates beget fewer distortions in economic outcomes than high tax rates. Low rates provide greater incentives to save and invest in productive assets, which enhances labor productivity, wages, and economic growth. Indeed, businesses go to great lengths to avoid taxes altogether, if possible, but typically those are non-productive uses of resources, which demonstrates the very distortions at issue.

Current and Proposed Marginal Tax Rates

Under current law, the top personal income tax rate on dividends is 20%. It is 23.8% if we include the Obamacare surtax. Adding that to the corporate rate yields the effective top tax rate paid by shareholders: 23.8% + 35% = 58.8%. The GOP bill does not alter the 23.8% top rate on dividends or capitals gains. By virtue of the corporate tax reduction, however, the plan would reduce the overall top rate on shareholders to 23.8% + 20% = 43.8%.

The income earned by investors in pass-through entities like proprietorships, partnerships and S-corporations is taxed as personal income under current law at rates ranging from 15% to 39.6% (43.4% at the top, including the surtax). Thus, under present law, the owner of a pass-through company is taxed less heavily at the top rate than the owner of a public company (43.4% vs. 58.8%). (I am ignoring the 15.3% FICA payroll tax owed by self-emloyed individuals in proprietorships or partnerships on incomes up to $127,200, and 2.9% above that level. The combined tax rates would be almost equal even if we include the FICA tax.)

The tax on pass-through business income would be reduced under the GOP bill via a cap of 25% on federal business income taxes. Presumably, this cap would nullify the House plan’s “bubble tax” of 6% on personal income between $1.2 million and $1.6 million of income, as well as the Obamacare surtax. Thus, the tax advantage for pass-through entities over corporations would be somewhat wider under the House plan than under current law (25% vs. 43.4%). (The FICA tax on owners of proprietorships and partnerships would not quite equalize the overall marginal tax rates over a certain income range.)

In addition, the House plan rewards the owners of pass-through businesses relative to individuals earning high levels of wage and salary income. If anything, the bill would penalize these individuals. For example, while the owner of a high-earning pass-through would face a 25% tax rate, a high-earning professional or corporate employee would pay the top marginal rate (39.6%) plus the surtax (3.8%) and possibly the bubble tax (6%). This is one reason why Scott Sumner says it looks as if the House plan was designed by Bernie Sanders!

The Upshot

The tax system should be neutral across different sources of income. Divergent effective tax rates on owners of corporations, pass-throughs, and high wage-earning individuals is undesirable and introduces arbitrary elements into private decision-making. If anything, the House GOP tax plan exacerbates those differences. By cutting marginal tax rates, it would reduce the magnitude of business tax distortions both for corporate and pass-through organizations and their owners, but the relative advantage of pass-throughs would increase relative to corporations, and owners of corporations and pass-throughs benefit relative to high-earning individuals. Let’s hope this is fixed as the bill evolves, but more balanced reductions in rates would require higher rates on business owners than contemplated in the current plan.

Our Homicidal Drug War

17 Tuesday Oct 2017

Posted by in Prohibition, War On Drugs

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Drug prohibition and the war on drugs are destructive policies and most burdensome to communities that can least afford it: impoverished and often minority neighborhoods. Drug laws and their enforcement likely account for the bulk of homicides that occur there, directly or indirectly. A post on SacredCowChips last week discussed the violence that frequently beleaguers communities that are home to unassimilated minorities. Drug prohibition compounds the tragedy in several ways: deadly rivalry among supplier organizations; violent confrontations with law enforcement; user criminality; drug-related incarceration; degraded user productivity; and tainted supplies that exacerbate health risks for users.

Ultimately, bad laws are distinguished by their failure to achieve broad compliance. The thing is, people who want to do drugs will do so regardless of their legality. Most recreational users are sufficiently imbued with a survival instinct and the self-control to govern their use effectively, without ostensible harm. Nearly all recreational users believe they are engaging in a harmless activity, and most of them are right. That is, quite simply, why the drug war just doesn’t work, and it won’t ever work. It doesn’t work for pot, LSD, cocaine, or anything else, including opioids and heroin. (Also see this.)

Prohibition, however, delivers the drug trade into the hands of gangs and mobsters. The supply side of the business attracts individuals having few legitimate market opportunities, who happen to be concentrated in economically depressed neighborhoods. The drug trade’s illegality transforms it into a risky and violent enterprise, and efforts to enforce prohibition magnify those dangers and expose law enforcement to great risk as well. Then, there are the effects of mass incarceration on individuals and their home communities. The situation is self-reinforcing, adding to the instability of these struggling areas.

There is ample evidence that drug prohibition is a driver of crime and responsible for a large number of homicides in the U.S. A Chicago prosecutor was quoted by HuffPo in 2013 as saying that 80% of homicides in the city were gang-related, and therefore primarily drug-related. Economist Jeffrey Miron has linked drug prohibition to international differences in violent crime rates. Scott Sumner has this take on the drug war and crime rates, including a brief analysis of the drop in homicides (40%) after alcohol prohibition was repealed. In 1991, Milton Friedman stated that the repeal of drug laws would eliminate about 10,000 U.S. homicides every year, which at the time would have been about a 40% reduction. And here is Yale’s Dan Kahan on the subject of drug laws and homicide:

“The weight of the evidence pretty convincingly shows that drug-related homicides generated as a consequence of drug prohibition are tremendously high and account for much of the difference in the homicide rates in the U.S. and those in comparable liberal market societies.“

In my last post on the U.S. homicide rate, I drew on Britigne Shaffer’s On the Banks blog post entitled “Michael Owen Nails the Gun Debate“. As log as we have prohibition and a drug war, the U.S. homicide rate is likely to exceed most other industrialized countries:

“We have a system in place where the government subsidizes poverty in urban areas, imposes economic blight in those same areas through heavy taxes and regulations, renders the residents permanently unemployable via the ‘criminal justice’ (sic) system, and creates a lucrative black market in drugs by restricting supply (not to mention increasing demand as people are desperate to escape their circumstances by getting high), meaning the only game in town is often entering the drug trade. The drug trade is violent because those in it have no access to courts to settle disputes. Powerful industries lobby to keep the drug war going; the top spenders are law enforcement unions, the prison industry, big alcohol, tobacco, and pharma.“

The CATO Institute‘s Handbook for Policymakers, Issue #23, advocates the following: repeal of the Controlled Substances Act; allowing states to pursue their own initiatives without federal interference; complete repeal of mandatory minimum sentences; and termination of the Drug Enforcement Administration (DEA). These actions would allow the federal government to focus its resources on real threats, rather than fighting an unending war with an underworld empowered by those very laws, and with Americans who wish to exercise freedom over their use of drugs for medicinal or recreational use. From the CATO Handbook:

“Repeal of prohibition would take the astronomical profits out of the drug business and destroy the drug kingpins who terrorize parts of our cities. It would reduce crime even more dramatically than did the repeal of alcohol prohibition. Not only would there be less crime: reform would also free federal agents to concentrate on terrorism and espionage and would free local police agents to concentrate on robbery, burglary, and violent crime. … The war on drugs has lasted longer than Prohibition, longer than the Vietnam War. Prohibition has failed, again, and should be repealed, again.”

Despite the destructive effects of prohibition, a great many Americans—and politicians—base their opinions about drug laws on flawed moral reasoning that somehow it is more “wrong” or more “dangerous” to do drugs than to drink alcohol, itself a drug posing great danger to abusers, but a legal one. Responsible drug use, like responsible drinking, is a victimless act, or would be without the engagement of underworld suppliers. But it’s clear that President Donald Trump and Attorney General Jeff Sessions are committed to a continuation of the failed drug war, as are a majority of both Democrats and Republicans in Congress. The drug-related killings will continue, as will the ongoing damage to so many American families and communities. The refusal to end the drug war is a tragedy of many tragedies past and future.

Dynamism and Punishment

20 Wednesday Apr 2016

Posted by in Income Distribution, Taxes

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The “squeeze” on the U.S. middle class is a fiction. If you don’t believe it, take a look at the “gif” above. It first appeared in The Financial Times (FT) with a misleading description about how “…technological change and globalization drive a wedge between the winners and losers in a splintering US society.” It’s obvious that the middle class, as statically defined by the FT, is shrinking only because it is moving up to higher real income levels (i.e., adjusted for inflation). Mark Perry uses this and other supporting charts in noting that “…so many middle-income households have become better off“. Some of these gains are related to an aging population, but the gains are not remotely consistent with FT’s dramatization. One point of emphasis that the chart should make obvious, but doesn’t quite, is that groups appearing to remain within a particular income range over time are never comprised of the same individuals. There is always movement up and down across all of these groups from year-to-year.

There is a stagnation story here, but it’s more limited than suggested by FT’s narrative. It is twofold: first, the financial crisis in 2007-2009 put a temporary stop to the upward income migration, and its resumption during the Obama presidency has been less robust; second, the very lowest-income segment, $0 – $10,000 of annual income, has expanded in each time interval shown since 1991, from just above 1% of adults to roughly 2.5%. A primary reason for the tepid growth of the U.S. economy since the recession’s trough in 2009, and the weaker migration, has been weak physical investment in the productive economy from its recession lows. That form of spending usually takes a lead role in economic recoveries. A number of observers have attributed the poor performance this time around to “regime uncertainty“, or the risk that regulatory and tax regimes could take an even more destructive toll in the future, essentially devouring returns to capital. As for the increases in the lowest-income sliver of the chart, Scott Sumner says:

“It could be due to expansion of the welfare state, the break-up of the traditional family, or perhaps growth in the underground economy. Nonetheless, it is cause for concern. But it has nothing to do with the mythical decline in the ‘middle class.’“

A related fiction is that the U.S. tax system is unfair to the middle class, and that higher income groups do not pay their “fair share”. This is put to rest in an “Issue Brief” from the Peter G. Peterson Foundation (PPF), using data from the Tax Policy Center and the Congressional Budget Office. The analysis shows that while high-income taxpayers benefit from tax breaks, those breaks offset high marginal tax rates and do not diminish the fact that the tax system is highly progressive:

“The Tax Policy Center estimates that 69 percent of taxes collected in 2015 will come from those in the top quintile, or those earning an income above $138,265 annually. Within this group, the top one percent of income earners — those earning more than $709,166 in income per year — will contribute over a quarter of all federal revenues collected.“

Apparently, the PPF analysis does not account for the impact of transfer payments on progressivity, which make average effective tax rates negative at low income levels. However, PPF does acknowledge that the tax system is unnecessarily complex and creates a web of distortions and poor incentives that limit economic growth. It’s a wonder that the dynamic of upward migration in real income was possible at all.

 

The Government Inequality Machine

17 Wednesday Jun 2015

Posted by in Big Government

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Some perceive the government as an ideal agent of redistribution, but they fail to apprehend the many ways in which government policy undermines equality. Scott Sumner and Kevin Erdmann have written an excellent essay on this point entitled “Here’s What’s Driving Inequality” at National Review. They focus on three areas of government action with the unavoidable side-effect of upward redistribution: housing policy (at all levels of government), regulation, and excessive protections for intellectual property.

Sumner and Erdmann briefly cover Thomas Piketty’s controversial view that wealth becomes increasingly concentrated under conditions of secular stagnation. However, they note that over the past few decades:

“... almost the entire change in the share of domestic income going to capital in major developed economies was explained by rising rents on residential real estate. Non-rental capital income (including the corporate sector) still has a fairly stable share of domestic income.“

Housing policy has driven rents upward in myriad ways. For example, restrictive zoning laws, environmental regulation of new building and regulation of bank lending have all made homeownership less feasible and renting more expensive. If you’re already in your own home, you’re safe! If not, welcome to the have-nots! Here’s a story on government insurance programs that offer massive subsidies to wealthy homeowners. All these redistributional effects are compounded by a tax code that has inflated housing prices through the home mortgage interest deduction, and at the same time inflated rents via the incidence of higher taxes on rental income and real estate capital gains.

Regulation of private business activity is often viewed naively as a necessary, protective function of government, but regulation acts in perverse ways:

“Unfortunately, many government regulations tend to favor larger firms. In recent years we have seen the passage of some extremely complex regulations involving thousands of pages of rules, such as Sarbanes-Oxley, Dodd-Frank, and the Affordable Care Act. The Food and Drug Administration, the Department of Defense, and the public health-care complex tend to create opportunities for uber-firms within industries, which act as clearinghouses for public contracts and regulatory demands.”

Large firms tend to pay higher wages and salaries than small firms. By favoring large firms, regulation in turn favors their relatively high-income workers. In addition, regulation such as occupational licensing, labor regulations and local wage controls damage the health and growth potential of small firms and the mobility of individuals at the bottom of the economic ladder.

Finally, Sumner and Erdmann discuss the often bizarre extension of intellectual-property (IP) rights and the way it favors large firms:

“Copyright protections once lasted for 14 years, applied only to maps and books, and could be renewed once if the author was still alive. Now they’ve been extended to many other products, extend for 50 years after the death of the author, and last for at least 95 years for corporations. These extensions are widely seen as reflecting the lobbying power of companies such as Disney. In the high-tech sector, patents are often granted for seemingly minor and obvious innovations.“

Sacred Cow Chips featured a piece on IP several months ago called “Is The Patent a Perversion?” The Libertarian view of IP is skeptical, to say the least, and favors limited protection at most. In that post, I quoted Jeffrey Tucker of the Beautiful Anarchy blog:

“Through intellectual property laws, the state literally assigned ownership to ideas that are the source of innovation, thereby restricting them and entangling entrepreneurs in endless litigation and confusion. Products are kept off the market. Firms that would come into existence do not. Profits that would be earned never appear. Intellectual property has institutionalized slow growth and landed the economy in a thicket of absurdity.“

There is little doubt that economic mobility is not well served by excessive grants of IP rights that extend monopolies indefinitely.

Government fosters inequality in many other ways. The mere existence of a confiscatory mechanism for legal revenue collection, and a complex bureaucracy in charge of distributing the spoils and making rules, will always attract high-powered rent-seeking resources and encourage cronyism. It is a graft machine. The very complexity of the tax code creates fertile ground for transfers via obscure breaks and carve-outs, while higher tax rates on others are required to fund the exceptions. Here’s another: the Export-Import Bank, which subsidizes exports for large corporations. A nice run-down of some of the many areas of “Welfare for the Rich” was provided a few years ago by Robert P. Murphy in The Freeman.

Unfortunately, direct efforts by the government to help the poor are often mere palliatives. At the same time, many of these programs are notorious for destroying work incentives, which undermines equality and economic mobility.

Government is simply not as well-suited to promoting equality as well-functioning markets, free of government meddling and government grants of monopoly. Profits in such markets attract new resources that compete away excess returns and bid prices downward, actions that tend to promote equality. The opportunity to compete without restraint not only vitiates artificial or permanent claims to profits; along with strong property rights, it encourages invention, economic mobility and growth.

Strangling By Stimulus

01 Sunday Feb 2015

Posted by in Government

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Will more government spending fix a weak economy? That is certainly a common refrain heard from economists and other pundits, including prominent members of the private business community. The historical record suggests otherwise, however, and there are practical reasons to doubt the efficacy of this sort of “fiscal stimulus.” Some of these are explored in “‘Timely, Targeted and Temporary?’ An Analysis of Government Expansions Over the Past Century“, from the Mercatus Center. In particular, countercyclical spending efforts have violated the “three Ts” often said to be required for successful demand-side policies. These efforts have been systematically late, badly targeted, and have resulted in permanent expansions in the resources absorbed by the government sector.

“Fiscal stimulus efforts going back to the 1930s consistently fail to meet the three Ts objective:

  • Improper timing. Policymakers have consistently struggled to properly time fiscal stimulus spending. In every postwar recession in the 20th century where stimulus spending was attempted, government spending peaked well after the economy was already in recovery. Policy lags—recognition, decision-making, implementation, and impact—are largely responsible for this fact.
  • Inefficient targeting. Going back to the New Deal, policymakers have targeted stimulus funds on the basis of politics rather than what delivers the most bang for the taxpayer buck. Further, individual policymakers cannot possess all the collective knowledge required to allocate and direct economic resources in the most efficient and effective manner, as markets do.
  • Permanent expansion of government. Stimulus funding has almost always led to permanent expansion in the size and scope of government. Indeed, the alleged need for immediate stimulus opens the door for expansions in government that might not have occurred under normal circumstances. On the rare occasions that the increased spending has been temporary, the costs have generally outweighed the benefits.“

As for inefficient targeting, I often hear that our nation’s infrastructural needs clinch the argument for stimulus spending. But those needs should be the focus of long-term planning and addressed on a continuing basis, not in bursts dictated by the state of the business cycle. Good projects should not be neglected in good times or bad, and there is no justification for undertaking a project if is not worthwhile on its merits. If increased spending can stabilize a weak economy, government should simply do something it does well: write checks. Who does infrastructure spending  help in those bad times? It certainly fails to address the basic human needs left unmet in a weak economic environment; it may or may not add high-paying construction jobs. (An aside: in the last recession, the stimulus program didn’t so much add construction jobs as it did accelerate certain “shovel-ready” projects.)

Proponents of government stimulus always have a culprit in mind for the economy’s ills: weak demand or under-consumption. They say government can lead the way out with more spending. This post on Sacred Cow Chips, “Keynesian Bull Chips“, disputes this point of view and provides some links on the topic, including this post by John Cochrane that is now ungated on his blog. Stimulus efforts are usually billed as temporary but rarely are. The expanded budgets always seem to remain expanded, and government absorbs an increasing share of the nation’s spending. Meanwhile, the value of government’s contribution to output is overstated, since most of the output is not subject to a market test or valuation.

The growth of government increasingly burdens private sector. Apart from tax distortions, the resources available to the private sector are gradually crowded and squeezed by the growth of public spending. Private investment is curtailed as government deficits absorb a growing share of private saving. Increasingly detailed regulation diminishes the private sector’s productivity. Robert Higgs at the Mises Institute asks: “How Much Longer Can the U.S. Economy Bear the Burdens?” That’s a very good question.

The opposite of expansionary fiscal policy is fiscal austerity: lower spending, and lower deficits. The budget sequester, originally passed in 2011, is a good example. Keynesians typically contend that austerity will weaken the economy, but the evidence often suggests the contrary. Here is a Scott Sumner post on that point. For robust economic growth, cut spending broadly, cut taxes, and deregulate.

Fractured Fiscal Fairy Tales: Moot Multipliers

03 Wednesday Sep 2014

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Scott Grannis asserts that the multiplier associated with fiscal stimulus is roughly zero, and evidence over the past few years suggests that he may be right. He appeals to a form of the classic “crowding out” argument: that debt-financed increases in government spending absorb private saving, leaving less funding available for private capital investment. In the present case, federal deficits ($7.4 trillion since 2009) have soaked up more than 80% of the corporate profits generated over that time frame. Profits are a major source of funds for private capital projects, risky alternatives against which the U.S. Treasury competes.

There are other reasons to doubt the ability of fiscal policy to offset fluctuations in economic activity. Transfers, which have grown dramatically as a percentage of federal spending, can create negative work incentives, thereby diminishing the supply of labor and adding cost to new investment. The growth of the regulatory state adds risk to privately invested capital as well as hiring. Government projects also offer tremendous opportunities for graft and corruption, at the same time diverting resources into uses of questionable productivity (corn, solar and wind subsidies are good examples). Many federal programs in areas such as education fail basic tests of success. Federal bailouts tend to prop up unproductive enterprises, including the misbegotten cash-for-clunker initiative. Even government infrastructure projects, heralded as great enhancers of American productivity, are often subject to lengthy delays and cost overruns due to regulatory and environmental rules. Is there any such thing as a federal “shovel-ready” infrastructure project?

In recent years, research has found that spending multipliers are small and often negative in the long run, contrary to what statists and old-time adherents of Keynes would have you believe. Empirical multipliers tend to be smaller in more open economies and under more flexible exchange rate regimes. Of growing importance to many developed economies, however, is that spending multipliers tend to be zero or even negative in the long run when government debt is high relative to GDP. This is broadly consistent with the classic crowding-out explanation for low multipliers, whereby public debt burdens absorb private saving. U.S. government debt-to-GDP is now well above 60%, an empirical point of demarcation separating high and low-multiplier countries. Finally, some economists believe that fiscal stimulus is frequently offset by countervailing monetary tightening under an implicit policy of nominal GDP targeting. Scott Sumner describes this as the story of the past few years, as neither the fiscal expansion of the 2009 stimulus plan nor the contraction of the fiscal cliff and sequestration had much if any observable impact on economic growth.

Politicians, the mainstream press and eager Keynesian economists are seemingly always ready to pitch fiscal policy and higher federal spending as the solution to any macroeconomic problem. Sadly, that is unlikely to end any time soon, because the story they tell is so simple and tempting, and they are blind its insidious nature.