Category: Economics

A Case Study In Why Higher Taxes Hurt People

Minesota has the second-highest business property tax rate in the United States. In a time when the retail sector is already taking a pounding, this additional burden is forcing retailers to abandon the state. World Market, one of my favorite stores, is one of the retailers pulling out of the state entirely.

I’m sure all the wonderful “government services” purchased with those tax dollars will help. Myself, I’d rather that business stay open and those people who work there have their jobs.

The central reason I’m not a liberal is because the idiocy of taxing businesses to death to expand the government dole is so transparent. We need jobs, not handouts, and right now our government is strangling us to death in red tape and drowning us in a sea of debt.

Why Small Government Is Better For The Little Guy

Hardvard economist Edward L. Glaeser has a fascinating and provocative piece on what he calls “small government egalitarianism”:

In the 20th century, President Woodrow Wilson campaigned on a “New Freedom,” opposing Teddy Roosevelt’s big-government Progressivism. While Roosevelt wanted the government to manage monopolies, Wilson wanted trust-busting and less protectionism. Wilson perceptively noted the dangers of too much government: “If the government is to tell big business men how to run their business, then don’t you see that big business men have to get closer to the government even than they are now?”

Wilson’s warning could not be more prescient. Look at the “stimulus” bill snaking its way through Congress. It is positively loaded with pork for special interests, handout for big donors, and only a fraction of it will go to the sort of crucial infrastructure projects that were supposed to be its very purpose. The “stimulus” bill could not be a better example of why Big Government hurts the poor. Even setting aside the issue of whether government spending creates jobs at all, this bill certainly won’t put enough people to work to make even a dent in the skyrocketing unemployment lines. Instead, billions of dollars will go to the politically well-connected and unscrupulous. The difference between Bill Blogojevich and most of Congress is that Blagojevich got caught.

Small government is good government. Small government helps the American worker because it does not allow the kind of concentrations of power that we have now. Why do big corporations spend billions on lobbying Congress to tilt the law in their favor? Because Congress has the power to tilt the laws in their favors. The reason why the Founders deliberately created a limited government of enumerated powers is to prevent the kind of naked interest-buying that we see now. The more power you give the government, the more incentives there are for government to use their power for their own advantage.

With Congress’ approval at a historic low, the idea that the case for small government is no longer worth making seems absurd. If anything, now is the best time to push a vision for a government that is smaller, more responsible, and more accountable. That such a government would ultimately be more equitable is a beneficial side-effect.

Politically, the Republicans should be doing what Sen. McCain threatened to do and “make famous” every single pork-barrel project in the “stimulus” bill. The message here is simple: tens of thousands of Americans are losing their jobs every day and Congress is paying off its campaign contributors with pork. Americans should be disgusted by the performance of Congress right now. The myth that this trillion-dollar boondoggle is anything but a case of Congress acting like robber barons of old should be laid to rest. Congress wants to claim that they’re “creating jobs”, but instead they’re giving more and more cash to the same politically well-connected actors.

This is precisely why small government is so crucial to having a more equitable society. If Congress were only allowed to spend money on truly national projects there would be no ability to send pork to campaign contributors. Big Government does not produce an more equitable society, it rewards those who side with the politically powerful. Small government benefits the people because it doesn’t allow Congress to game the system to benefit their own interests.

Take a simple but common example. When new regulations come down from all the federal agencies, have John and Jane Doe on Main Street had any opportunity to shape that new rule? Of course not, even if they compulsively wade through each daily edition of the massive Federal Register to see what rules are being proposed the most they can realistically do is send a strongly worded letter. Can Washington interest groups shape that rule? They pay lobbyists great amounts of money to do exactly that. Can business interests shape that rule? Absolutely, and they have their own army of lobbyists for just that purpose. So is it any shock that John and Jane Doe are under-represented in the process?

It’s a myth that “big business” and powerful special interests love small government and hate regulation. Why should they? They have the clout in Congress to make sure that the regulation benefits them. They can use their political connections to steer millions of taxpayer dollars to them. They can benefit from the access they have to Congress and even the White House. They know that P.J. O’Rourke’s great maxim is correct: “when buying and selling is legislated, then the first thing to be bought and sold are legislators.” The bigger and more intrusive government is, the higher the barriers to new competitors. Look at the most heavily-regulated markets in this country: they tend to be dominated by a handful of large players who can use their access to lobby government to keep those regulations in place. They benefit the most from the regulatory state, and they have every interest in seeing Big Government stay big.

If you’re a little player, like a “Mom and Pop” operation, forget it. The costs of regulatory compliance are too high. If you can’t afford the lobbyists, you can’t play the game, and you get squashed.

That is why we need smaller, less intrusive, and more accountable government. We need to reduce the incentives for the big players to game the system and increase the chances for small players to enter the market. That way the benefits go to the best and the brightest, not the most politically well-connected.

Here is where liberalism fundamentally gets it wrong: government regulation of the market will never produce equality. It will only benefit the big players. If we want a more egalitarian and equitable society we cannot put in place barriers that keep the small players out. Glaeser is right, and the case for small-government egalitarianism is one that needs to be made now more than ever.

Socialism 2.0

Former Clinton-era Secretary of Labor Robert Reich argues in the TPMCafe that the bailout culture is “lemon socialism”:

America has embraced Lemon Socialism.

The federal government — that is, you and I and every other taxpayer — has taken ownership of giant home mortgagors Fannie and Freddie, which are by now basket cases. We’ve also put hundreds of millions into Wall Street banks, which are still flowing red ink and seem everyday to be in worse shape. We’ve bailed out the giant insurer AIG, which is failing. We’ve given GM and Chrysler the first installments of what are likely to turn into big bailouts. It’s hard to find anyone who will place a big bet on the future of these two. …

Put it all together and at this rate, the government — that is, taxpayers — will own much of the housing, auto, and financial sectors of the economy, those sectors that are failing fastest.

He’s right. With the Obama Administration seriously considering the nationalization of a large swath of the banking industry, the government is rapidly heading for a new kind of socialism. Call it “socialism 2.0”, in which the government takes failing industries and buys them out in order to artificially prop up a faltering economy. Injecting capital in a frozen market is not a bad idea. Nationalizing failing industries is not. What the Bush Administration did and the Obama Administration is continuing amounts to little more than throwing good money after bad.

US Debt to GDP Chart
US Debt to GDP Chart

Our economic problem is structural. We have too much debt. This chart says it all: America’s level of debt has simply skyrocketed. That is not only personal debt (mortgages, credit cards), that is government debt (Social Security liabilities, Medicare, government bonds). The current strategy has been to prop up that unsustainable level of debt. In the case of President Obama’s “stimulus” package, the effect is to dramatically increase federal debt in the hopes that we can spend our way out of recession.

The short version is that our strategy is to massively increase our debt to solve the problems created by our massive debt. That hardly seems like the most sane strategy.

If the United States were another country (say Argentina) and we were seeking IMF aid, we’d immediately be put on an austerity plan. Government spending would have to be cut to get the level of debt down. Nationalizing industries would be completely out of the question. Inflation would have to be kept in check to ensure that it didn’t spiral out of control.

The IMF has put other countries on such plans before, with the approval of the U.S. government. Now is a time for a taste of our own medicine. As hard is it is for some to imagine cutting government spending in a recession, we’ve made others do exactly that before. A problem caused by an unsustainable level of spending is not going to get better by spending even more. Getting our government under control is crucial to the long-term success of this country.

Reich is ultimately right on his point: we’re trying a half-assed form of socialism that will simply not work. By incentivizing failure at the same time we punish success with high corporate tax rates, the government is sending exactly the wrong signals. What this country needs is a stronger business climate, and that won’t come about unless there’s a shakeup in the business world.

Every dollar that goes to GM is a dollar that props up a failing regime. If we are to have a 21st Century economy, we cannot be in the business of making sure nobody fails. The process of “creative destruction” is crucial to a healthy economy. Socialism 2.0 is unlikely to be any more successful than Socialism 1.0 was—and until policymakers in Washington realize that, our economic problems are likely to only get worse.

Obama Digs A Hole For The Economy

President-Elect Obama has chosen to embrace some of the worst economic thinking in his recently announced economic recovery plan. The buzzword he’s following is “infrastructure”—and it’s a strategy that is doomed to fail.

Reason‘s Nick Gillespie sarcastically looks at the plan:

When the history of this awful moment of bailout hysteria is written, there’ll be a chapter or 20 on the complete bogosity of what might call “the infrastructure flim-flam”—the idea that government can boostrap the economy out its funk by hiring two guys to dig a hole and a couple more to fill it in.

Don’t you see? It’s the perfect plan!, as Batman’s Riddler might exclaim. In fact, one only wonders why they don’t hire three guys to fill the holes, thereby cutting unemployment to negative-something.

There are so many flaws with Obama’s plan that one hardly knows where to begin. For one, there’s no way to “create” 2.5 million jobs through infrastructure improvements alone. Unless Obama wants to pave over Iowa, there isn’t going to be enough work to make a significant dent.

Then there’s the issue of the utility of taking a bunch of unemployed stockbrokers and autoworkers and having them pour concrete or lay cable—they’re not trained for either, and it doesn’t help them build the skills they need for the future. It’s busy-work, and it’s economically counter-productive. Something like job retraining would be valuable, not more government-run “public works” projects.

There’s also the fact that if you believe that government is more efficient at allocating goods and services than the private sector, you probably missed the whole “collapse of the Soviet Union” thing. Who will decide what “infrastructure” gets built where? A bunch of Washington nomenklatura? That creates a system where superhighways get built in places where politically powerful Congresscritters live while real needs go unmet. Government is simply not designed to do what Obama wants it to do, and as much hyperbole is there is about Obama being a “socialist” in this case his policies are the sort of thing we’d see from the leader of some banana republic. Economic troubles? Just round up some plebs and have them start digging ditches.

The Obama plan is not a viable solution. We do need better infrastructure, but not through wasteful, inefficient, and crude make-work programs. There is no future in the American economy if we start making our workers dig ditches or pour concrete rather than innovate in nanotechnology, alternative energy, or space. We need an economy for the 21st Century, and Obama keeps playing from the dusty playbook of the 1930s.

What should Obama do? What we need in this country is a high-tech economy. We need more civil engineers to design all those bridges. We need more innovation, more risk-taking, and more entrepreneurialism. What can government do? It can incentivize innovation and risk-taking. If you’re a college student and you want to be a civil engineer? Graduate in engineering and go into government service for 5 years, and you get your college loans forgiven. Obama should direct NASA to give a $1 billion prize to the first company that can demonstrate a workable prototype for a replacement for the Space Shuttle. (Limited versions of such a prize system are already in place, and helping generate high-tech jobs.) Instead of another government make-work project to lay fiber-optic cable, Obama should incentivize companies to develop wireless technologies that can help remove the need for physical connections. These are just a few examples of what would be a, dare I say it, progressive approach to this economic crisis.

But Obama, listening to the radicals of his party, is not really a “progressive” in this sense. He has picked up the failed FDR playbook and seems hell-bent on making the economy worse by embracing the same failed plans as before. We cannot bootstrap a modern economy through government spending. If that were true, the Third World wouldn’t be the Third World. Government spending always comes with prohibitively high administrative costs that creates a severe dead-weight loss on the economy. It is always less efficient than a market-based approach.

Government has a role, but it is a limited one. It can incentivize innovation, but it shouldn’t be in the business of picking winners and losers. It can support the development of a healthy economy, but it cannot create one by fiat. It can help regulate the marketplace, but it can also stifle the entrepreneurial spirit. It is a tool, like a hammer, but you shouldn’t use a hammer to fix a watch.

Obama’s economic plan is based on a fundamentally flawed view of government and the economy. No matter how well thought-out it may be, it will never achieve its objectives because of that basic flaw. Now, more than ever, we need to embrace what actually has worked, not reach back to the failures of the past. The process of economic transformation can be painful, in what the great economist Joseph Schumpeter called the process of “creative destruction”—but without that creative destruction we cannot move forward. Obama wants to move us back to the socialized economy that devastated Britain in the 1970s. If he wants to give us the “change we need” then he must realize that change cannot come from a government program, but from allowing ordinary men and women the opportunity to take risks, innovate, and succeed.

Black Monday

The financial services bailout bill just failed to pass the House with a bipartisan rejection

The bailout bill was a turd sandwich, but it was a necessary one to keep the markets from going into an absolute freefall. Which, coincidentally, is what’s going to happen now that the bailout is unlikely to happen.

I can understand the class warfare motives for the rejection, but when companies can’t get the money they need to make payroll, the people who were demanding Congress do nothing will face the consequences.

We are looking at a quadruple-digit drop in the Dow and a major credit contraction./p pHow bad could this get? I get the sinking feeling that we will soon find out.

UPDATE: The Dow plummeted 778 points today, the worst single-day drop in history. Yes, people don’t like the idea of bailing out large corporations. If that’s their position, then they should not be surprised when those large corporations can’t afford to pay them their payrolls.

I don’t much like economic hyperbole, but this time it’s true: we could be staring into the maw of a crippling economic depression. It won’t necessarily be like the Great Depression, but it could be the worse downturn in most of our memories. If Obama gets elected and follows his policy instincts, it will probably get worse.

Bernanke Wisely Holds The Line

BloggingStocks congratulates Ben Bernanke for not lowering the Fed prime rate today. He deserves it. It would have been easy to cut rates and hope that a shot of liquidity would help the markets.

It wouldn’t. Instead, it would have created an even bigger inflationary threat than we have now. Cutting the interest rate would further threaten the weakened dollar, making things even worse for the economy. Our current problem stems from too much money being unwisely given out. Making it easier to hand out more loans is like giving an alcoholic a little hair of the dog to cure a hangover.

Like any good hangover, the only real cure is time, and the markets are going to be reeling for a while now. Then again, one of the purposes of a hangover is to remind us not to drink too much—and the markets need to learn that lesson if we’re to move forward and get our financial house in order. More bailouts, like a Fed bailout of AIG or New York’s idea of letting AIG borrow against its own subsidiaries will only exacerbate the situation. The Fed could ruin that recovery by subsidizing risky behavior—and thankfully the Fed doesn’t seem inclined to do so.

Could The Financial Meltdown Have Been Avoided?

Megan McArdle has an excellent piece on how the current financial crisis developed, going beyond the spin to get to the real issues that precipitated yesterday’s sell-off. The sort of regulation that would have prevented the subprime meltdown—regulating Fannie Mae and Freddie Mac like private companies—were never seriously considered. Both Fannie Mae and Freddie Mac were allowed to grow into politically powerful quasi-governmental institutions free of the rules that should have prevented their collapse. Democrats who want to blame Republicans have no real argument—neither do Republicans who want to pin this all on Democrats. This was a bipartisan failure through and through.

Neither McCain nor Obama have given any real policy positions on this issue. That’s not surprising, as there aren’t any. Short of building a time machine, the only real solution is to let the market adjust. In a free market there has to be a penalty for failure of some kind. There’s no such thing as a riskless economy, only the mitigation of risk.

The calls for a “9/11 Commission” and more regulation from McCain are nearly as misplaced as Obama’s calls for higher taxes and more regulation. The solution to this mess will not come from the same governmental over-breadth that precipitated it. The market has already given the ultimate corporate punishment to firms like Lehman Brothers—the financial death penalty. Passing more regulations did not stop the subprime crisis. Passing more regulations will not prevent the next one. The only way to prevent these sort of things from happening is to ensure that the markets are transparent, assets are not being hidden off-book, and that bad decisions are punished as they were here. Government can and should play a role in all that, but as Ms. McArdle astutely points out, most of the suggested solutions are politically, economically, or socially untenable. We could mandate 20% down payments on home sales—that would prevent another crash like this one. It would also hurt millions of poor people. We could increase capital reserve requirements, but Spain already does that and they have a home market as unstable as ours.

There aren’t any easy solutions, but politicians will try and give us easy solutions that will end up causing the next crisis when they run headlong into the wall of reality. The saying goes that doing the same thing over and over again and expecting different results is the definition of insanity. It might as well be the definition of politics as well.

Oh, You Have GOT To Be Kidding…

The Fed is going to bail out AIG.

Scratch pretty much everything I’ve written—apparently the price of failure is now a nice government bailout. This is a phenomenally bad precedent, even if it saves the markets some short-term pain.

UPDATE: Jim Cramer was pushing for an AIG bailout tonight. If AIG had gone down, would the financial markets have gone down with it? Would the Dow have dropped another 1,000 points? Perhaps.

The problem is that by buying AIG, the damage is still going to be done, it’s just the taxpayers and AIG shareholders who end up holding the bag. Perhaps that’s the best that can happen here, but that doesn’t mean that anyone should like it. The U.S. government should not be in the business of bailing out insolvent corporations. That creates a major problem with moral hazard that can’t be ignored.

What we’ll get out of this (regardless of who wins in November) is more regulation—and not necessarily better regulations. We’re still capitalizing profits and socializing risks, and that’s exactly what got us into this mess.

Saving AIG might have saved the Dow from crashing below 10,000—or it might have set the stage for more problems in the future. Sometimes avoiding short-term pain produces long-term sickness.

Under Obama, Moving On Up May Be A Thing Of The Past

David Bernstein notes that the effect of the Obama tax plan would be to raise marginal tax rates above 50% and in some states it could be as high as 60%.

Obama is playing to his liberal type by exploiting the politics of envy to try and “soak the rich,” but in terms of actual policy, to do so would be economic suicide. It would encourage people to either A:) work less and be less productive or B:) shield their assets from taxation. (Or perhaps a combination of the two….)

The fact is that $250,000 is hardly filthy rich these days. The people that Obama will hurt with this punitive taxation will be the small business owners that employ 50% of the American workforce. They will be less inclined to grow their businesses and less inclined to hire new workers—because the marginal utility of the extra work just went down dramatically. If the benefit of working 10% harder is a 2% increase in income after Uncle Sam takes his bite, it makes little sense to work harder. Because of that, we lose the benefits of that extra labor.

The bottom line is this: it will become much more difficult for people in the middle class to move up the socioeconomic ladder. For Warren Buffet or Bill Gates, an army of lawyers and accountants can shield income while the boss pats themselves on the back for their “social responsibility.” For the average owner of a small flower shop or coffee house who can’t afford those kind of tax shelters, it means that moving to that next level is more of a curse than a blessing. For an economy that is based on the promise of upward mobility, such punitive taxation is anathema.

Obama’s plans make no economic sense. Instead of shoring up entitlements, he would dramatically expand them. For all of the talk about how McCain is a clone of Bush, Obama seems to want to take the worst policy ideas of the Bush Administration (Medicare Part D, steel tariffs, more government spending) and do more of it.

Obama is running as a doctrinaire Michael Dukakis-style tax and spend liberal. Even though this is unquestionably a Democratic year, a lot of voters will be smart enough to see that Sen. Obama seems to want to punish those with the audacity to hope to build themselves up economically.

Clinton’s Fictional Gas Tax Plan

Sen. Hillary Clinton is pushing her own version of a summer “gas tax holiday”—except that her plan would end up doing absolutely nothing to help consumers. Sen. Obama has been attacking her plan (and McCain’s) as an effort to “pander:”

On ABC’s “This Week with George Stephanopoulos,” Sen. Hillary Clinton, D-N.Y., was asked repeated to name an economist who supports her plan to suspend the 18.4 cent federal gas tax. Either she could not or chose not to. “I’m not going to put my lot in with economists,” she said, presenting her tax hike plan as a way to life the burden of soaring gas prices off middle class Americans.

Rival Barack Obama has called the plan, which is also backed by Republican presidential nominee-in-waiting, Sen. John McCain , “a pander” that won’t solve the high cost of gas. Asked about the gas plan in his interview with Tim Russert on NBC’s “Meet the Press”, Sen. Obama, D-Ill., framed the proposal as a “classic Washington gimmick.” “You’re looking at suspending a gas tax for three months. The average driver would save 30 cents per day for a grand total of $28,” claimed Obama.

Although Clinton did not offer her own estimate as to how much relief the holiday would provide, she did try to distinguish her plan from McCain’s. “Senator McCain has said take off the gas tax, don’t pay for it, throw us further into deficit and debt. That is not what I’ve proposed. What I’ve proposed is that the oil companies pay the gas tax instead of consumers and drivers this summer.”

So, what Sen. Clinton proposes is that the oil companies pay the gas tax instead of consumers—and somehow those costs won’t end up getting passed right back to the consumers in the form of higher oil costs. No wonder Sen. Clinton doesn’t want to listen to the advice of people who actually understand economics.

Sen. Obama’s criticisms over the tax aren’t too far off—it is questionable how much a gas tax holiday would actually help consumers, and from a policy standpoint it’s also questionable whether we really want the government encouraging people to use more gasoline than they might this summer.

The Clinton gas tax plan takes the flaws of the McCain plan and magnifies them. At least the McCain plan would actually lower gas prices, while the Clinton plan would just pass the costs right back to consumers. The Clinton plan is definitely a pander—it panders to consumers by pretending to lower gas prices and it panders to anti-corporate sentiment by pretending that the oil companies will take the costs.

Clinton keeps demonstrating that when it comes to economic matters, she’s absolutely clueless—and the fact that she doesn’t want to listen to economists when she formulates economic policy should serve as a reminder why she and the other Democrats not qualified to be deciding this nation’s economic policies.