Category Archives: Economic Freedom

Don’t make us drive these cattle over the cliff

First a brief note: I am now blogging at the American Spectator on economic issues. I invite you to visit the inaugural posts. Last week, I covered the fiscal cliff. Like many others, I also marvel at the audacity of the pork contained therein.

Lately the headlines have given me a flashback to 1990 and those first undergrad economics classes. And not just econ but also U.S. history and the American experience with price floors and ceilings. In this post I’ll discuss the floors.

As I note at The Spectacle one of the matters settled by the American Taxpayer Relief Act is the extension of dairy price supports from the 2008 farm bill. Now, Congress won’t be “forced to charge $8 gallon for milk.” To me, nothing screams government price-fixing more than this threat aimed to scare small children and the parents who buy their food.

Chris Edwards explains how America’s dairy subsidy programs work in Milk Madness. Since the 1930’s the federal government  has set the minimum price to be charged for dairy. A misguided idea from the start, the point of the program was to ensure that dairy farmers weren’t hurt by falling prices during the Great Depression. When market prices fall below the government set price the government agrees to buy up any excess butter, dry milk or cheese that is produced. Thusly, dairy prices are kept artificially high which stimulates more demand.

According to Edwards’ study, the OECD found that U.S. dairy policies create a 26 percent “implicit tax” on milk, a regressive tax that affects low-income families in particular. Taxpayers pay to keep food prices artificially high, generate waste, and prevent local farmers from entering a caretlized market.

Now for the cows. The recession revealed that the nation has an oversupply of them. The New York Times reports that rapid expansion in the U.S. dairy market driven by increased global demand for milk products came to a sudden halt in 2008. Farmers were left with cows that needed to be milked regardless of the slump in world prices. The excess dry milk was then sold to the government but only at a price that was set above what the market demanded.

In other words, in a world without price supports, farmers could have sold the milk for less at market and consumers would have enjoyed cheaper butter, cheese and baby formula. Instead, the government stepped in, bought $91 million in milk powder so the farmer could get an above-market price and keep supporting an excess of milk cows. Rather than downsize the dairy based on market signals (and sell part of the herd to other dairy farmers, or the butcher) farmers take the subsidy and keep one too many cows pumping out more milk than is demanded.

It turns out auctioning a herd is not something all farmers are anxious to do. Some may look for additional governmental assistance to keep their cattle fed in spite of dropping prices, increased feed costs, and bad weather. To be sure eliminating farm subsidies would produce a temporary shock (a windfall for farmers and sticker shock for consumers), but in the long run as markets adjust everyone benefits.Dairy cows in the sale ring at the Warragul cattle sales, Victoria, [2]

New Zealand did it. Thirty years later and costs are lower for consumers, farmers are thrivingenvironmental practices have improved, and organic farming is growing. While politicians and the farm lobby may continue pushing for inefficient agricultural policy in spite of the nation’s fiscal path,as Robert Samuelson at Real Clear Politics writes, “If we can’t kill farm subsidies, what can we kill?”

 

Would You Oppose a Tax Cut on the Grounds that it Only Applied to a Few Firms?

A few weeks ago, Pete Boettke graciously invited me to speak at the Philosophy, Politics and Economics workshop at GMU. During the course of the talk, I extolled the virtues of what Hayek called “generality”—the idea that political action should not (positively or negatively) discriminate against any person or group of persons. (Note: generality goes beyond the 14th Amendment guarantee of equal protection under the law. That only prohibits discriminatory application of laws, but it does nothing to prohibit discriminatory laws such as taxes that apply to one group but not another. A true generality principle says that the laws themselves should not discriminate.)

Near the end of the talk, one of the attendees asked if I would oppose a tariff reduction for one (and only one) industry on the grounds that it violated generality. I believe many free-market advocates would say “No; we should always take any opportunity to expand economic freedom.” Milton Friedman expressed this view when he declared he’d “never met a tax cut I didn’t like”

My answer, however, is that in some circumstances the advocates of economic freedom should oppose such a tariff reduction. This is because I believe those of us who value economic freedom should also value generality. I have four reasons.

  1. Generality is morally intuitive. Kant called it the “categorical imperative,” others more prosaically call it the “golden rule.” Whatever you call it, it seems that lots of humans in lots of cultures value the idea that laws ought to treat us equally.
  2. Violations of generality make us poorer. When government discriminates in the way it taxes or in the way it spends, people change their behavior (note that in traditional public finance, a head tax creates no loss because it doesn’t discriminate between work and leisure or between consumption and non-consumption). And these changes in behavior are costly because they tend to discourage mutually-beneficial exchange. Economists call this the deadweight loss of taxation and these costs are greater when policy is more discriminatory. Thus, a tax that raises $100 million by taxing goods and services equally will involve less deadweight loss than a tax that raises $100 million by taxing only goods. What’s more, the tax rate on goods will have to be higher if the government wants to obtain the same amount of revenue. (I could mention other economic costs under this same heading. For example, knowledge problems and malinvestment, both loom large under discriminatory taxation).
  3. Violations of generality create rent-seeking loss. When government is in the business of privileging some and punishing others, citizens tend to invest resources (time, money, effort) in asking for their own privileges or in asking that others not be privileged. Quite often, these efforts produce no value for society and are a loss.
  4. Violations of generality make it easier to violate economic freedom. In the long run, I believe a norm which permits violations of generality will tend to make it easier to violate economic freedom. Consider a proposal to tax each of three people $10, plus one additional dollar in deadweight loss, in order to turn around and redistribute $10 to each of these same three people. None of our three citizens would be willing to vote for it. But now consider a proposal that costs each of three people $11 ($10 in tax + $1 in DWL) in order to turn around and redistribute $15 to two of the three. Now a majority coalition can easily be formed. The coalition is made viable only by violating generality. What’s more, the coalition will be even stronger if the proposal not only violates generality on the spending side but also on the taxing side. That is, if the proposal is to impose $33 in costs on only one person in order to distribution $15 to each of the other two, then the coalition will be especially strong. In fact, if it can shield itself from the pain of taxation, the coalition will be prone to ask for much more revenue. So in the long run, economic freedom is protected by adhering to generality, even if in the short run the two values appear as a trade-off.

None of this is to say that we shouldn’t also value economic freedom. To put it in terms that economists will quickly grasp, my indifference curves look like this:

 

 

 

 

 

 

Not like this:

 

 

 

 

 

 

Too often, in my view, conservative policymakers are suckered into violating generality because they believe they are advancing economic freedom. They end up supporting tax preferences for manufacturing, ethanol, housing, child bearing, and much else on the grounds that any tax cut is a good tax cut. Many of these tax preferences are the result of cronyism and each entails a host of economic and social costs. The end result is a tax code that is monstrously complex and that, too, is a cost.

The first-best solution is low and non-discriminatory taxation. Beyond that, I think we need to recognize that there are (short run) trade-offs.

 

Eileen Norcross on News Channel 8 Capital Insider discussing Virginia and the fiscal cliff

Last week I appeared on NewsChannel 8’s Capital Insider to discuss how the fiscal cliff affects Virginia. There are several potential effects depending on what the final package looks like. Let’s assume the deductions for the Child Care Tax Credit, EITC, and capital depreciation go away. This means, according to The Pew Center, where the state’s tax code is linked to the federal (like Virginia) tax revenues will increase. That’s because removing income tax deductions increases Adjusted Gross Income (AGI) on the individual’s income tax filing (or on the corporation’s filing) thus the income on which the government may levy tax increases. According to fellow Mercatus scholar, Jason Fichtner, that could amount to millions of dollars for a state.

On the federal budget side of the equation,the $109 billion in potential reductions is now equally shared between defense and non-defense spending. Of concern is the extent to which the region’s economy is dependent on this for employment. Nearly 20 percent of the region’s economy is linked to federal spending. Two points: The cuts are reductions in the rate of growth in spending. For defense spending, they are relatively small cuts representing a return to 2007 spending levels as Veronique points out. So, these reductions not likely to bring about the major shakeup in the regional economy that some fear. Secondly, the fact that these cuts are causing worry is well-taken. It highlights the importance of diversification in an economy.

Where revenues, or GDP, or employment in a region is too closely tied to one industry, a very large and sudden change in that industry can spell trouble. An analogy: New Jersey’s and New York’s dependence on financial industry revenues via their income tax structure led to a revenue shock when the market crashed in 2008, as the New York Fed notes.

On transportation spending there are some good proposals on the table in the legislature and the executive. Some involve raising the gas tax (which hasn’t been increased since 1986), and others involve tolls. The best way to raise transportation revenues is via taxes or fees that are linked to those using the roads. Now is no time to start punching more holes in the tax code to give breaks to favored industries (even if they are making Academy-award quality films) or to encourage particular activities.

Virginia’s in a good starting position to handle what may be in store for the US over the coming years. Virginia has a relatively flat tax structure with low rates. It has a good regulatory environment. This is one reason why people and businesses have located here.

Keep the tax and regulatory rules fair and non-discriminatory and let the entrepreneurs discover the opportunities. Don’t develop an appetite for debt financing. A tax system  is meant to collect revenues and not engineer individual or corporate behavior. Today, Virginia beats all of its neighbors in terms of economic freedom by a long shot. The goal for Virginia policymakers: keep it this way.

Here’s the clip

What Was Wrong with the Bush Tax Cuts?

Back in April, President Obama had this to say about the Bush tax cuts:

We tried this for eight years before I took office. We tried it. It is not like we did not try it. At the beginning of the last decade, the wealthiest Americans got two huge tax cuts, in 2001 and 2003. Meanwhile, insurance com­panies, financial institutions, there [sic] were all allowed to write their own rules, find their way around the rules. We were told the same thing we’re being told now—this is going to lead to fast­er job growth, it’s going to lead to greater prosperity for everybody. Guess what? It didn’t.

At first blush, the data would seem to be on the President’s side: even if we ignore the Great Recession,  economic growth in the 26 quarters that followed passage of the Bush tax cuts averaged just 2.5 percent while it averaged 3.7 percent in the 26 quarters that preceded the cuts.

So is this experience reason to throw out every microeconomics 101 textbook? Or at least to rip out the sections that cover the deadweight loss of taxation? No. The fact is that the Bush tax cuts were deeply flawed, even from a free-market perspective. In a new paper with Mercatus program associate, Andrea Castillo, we contend:

[T]he Bush tax cuts had a number of problems from a market-oriented perspective: they were phased in slowly, they were set to expire within a decade, they entailed a Keynesian emphasis on stimulating aggregate demand, and—above all—they were undertaken without any effort to reduce spending. In light of these problems, there is no reason to overturn decades of theoretical and empirical research supporting the link between low taxation and growth. The episode offers a cautionary lesson in how not to cut taxes.

Nanny state could save Madrid from EuroVegas

Las Vegas real estate developer Sheldon Adelson selected Madrid as the site of his next proposed casino project, EuroVegas, last month. The project is estimated to create 250,000 jobs in a country with 25% unemployment. On the one hand, this project may look like a good bet for the city, bringing both short term construction jobs and hopefully creating a long-term tourist destination.

However, EuroVegas will not be financed completely with private investment. Instead, Adelson wants to pay only 35% of the projects construction costs, asking the city to finance the rest. Additionally, he requires that the project receive property and business (IAE) tax breaks. Since most of the investment will be taxpayer funded, the risk is borne largely by the public and the project requires Madrid taxpayers to take on even greater debt. The tax-exempt project will not contribute to the tax base for public services. Adelson selected Madrid as the EuroVegas site after receiving better breaks there than Barcelona policymakers offered.

Carlos Ruiz, a retired engineer, heads the group EuroVegas No. He sums up the feelings of some who feel that the project would benefit Adelson at the expense of Spanish taxpayers who already have a high debt burden:

“Citizens from the whole of Europe are lending money to Spanish banks because they are in a bad situation — hoping that someday these banks will start to give credit to small enterprises, to families, to people,” Ruiz says. “But this money is going to go to Mr. Adelson, who is one of the richest men in the world. This is quite unfair.”

Madrid officials seem poised to offer Adelson all of the concessions he seeks, including subsidies, tax breaks, and exemptions to labor laws, except for one. The sticking point in the deal may be that the project requires an exception to Spain’s nationwide ban on smoking in bars and restaurants to go forward. Prime Minister Mariano Rajoy said that lifting the smoking ban for EuroVegas would give the development unfair political privilege over all of the country’s other establishments where smoking is not permitted. He said he thought that making an exception to the ban for EuroVegas would be unconstitutional.

Whether or not EuroVegas will go forward in Madrid remains to be seen. Either way, Rajoy’s approach to a level playing field is worth noting here. As Matthew Mitchell explains in his paper “The Pathology of Privilege,” creating special advantages for projects like EuroVegas tends to benefit well-connected people at the expense of the general interest and limits economic growth as resources are directed according to political favor rather than by the market.

U.S. Economic Freedom: A Short Introduction

On a few occasions I’ve experimented with YouTube videos as a way to make dynamic graphs that move in order to help convey a point.

The latest edition of the Economic Freedom of the World Report offered an occasion to try this again. This time, however, I thought I’d add a voiceover and a little context. Let me know what you think.

On the topic of economic freedom, don’t miss this excellent piece, coauthored by my Mercatus colleague Antony Davies and James Harrigan.

The Free-Three-Martini Lunch

Over the past two decades, a few states have taken up distillery deregulation with excellent results to show for it. In New York state, for example, craft distilling became legal in 2002 for the first time since prohibition. The change in the legal environment has made it possible for entrepreneurs to start 30 new distilleries in the state in the past 10 years. Aside from creating profit and jobs for these business owners and their employees, this change has permitted the development of a greater variety of liquors than are possible from large companies, benefiting consumers who are now able to enjoy greater variety.

Most public policy decisions create distinct groups of winners and losers. All transfer payments, for example, make one group better off at the expense of another. Deregulation, on the other hand, benefits new businesses, consumers, and contributes to economic growth at the same time. The only group who could suffer from this change is large distillers that have been shielded from competition. Even they could benefit, however, if the novelty of craft liquors gets consumers more interested in trying new spirits generally.

Despite the economic benefits of this type of deregulation, it took nearly 80 years for states to begin unraveling the rules created during Prohibition, designed to protect people from alcohol. Despite some of the good intentions behind this effort, Prohibition clearly created more problems than it solved, and similarly states’ blue laws, like those outlawing small distilleries, have unintended consequences today. While licensing requirements and regulations are typically framed as policies which will help consumers, in fact delicensing typically proves the opposite, showing that increasing competition between businesses is the best way to help consumers.

After having achieved improved regulatory freedom in some states, some craft distillers are looking to public policies that will offer them additional help. Last year some distillery owners worked with Congress to help draft a bill which would have lowered the federal excise tax on craft spirits to $0.43 per 750 mL, 80 proof bottle from the $2.14 tax that larger distillers pay. While this policy would help more small distillers enter the market, it also creates a disincentive for craft distillers to grow to the point where they would have to pay the higher tax. Additionally, it would create a more significant incentive for large distilleries to lobby for regulations to outlaw their smaller competitors. The right policy question isn’t whether small businesses should get a tax break relative to their larger competitors, but whether the excise tax level on spirits is necessary and if so set at the appropriate level.

A Congressional Cookie Jar with Oak Tree Roots: The Economic Development Administration

David Bier of the Competitive Enterprise Institute makes the case in a recent paper for the abolition of the Economic Development Administration. The history of the EDA is tied into the programs of the Great Society which spawned many fiscal and programmatic connections between federal, state and local agencies with the ostensible aim of spurring local economic improvement (e.g.The Community Development Block Grant). Fifty years on and these programs haven’t lived up to the grandiose mission statements of their architects. The EDA is part of the framework through which stimulus dollars flowed and Bier’s article underscores the key objections to the application of federal dollars to local economic development.

Interestingly, the EDA has been the subject of several academic studies over the years. The classic public administration book, Implementation, by Jeffrey L. Pressman and Aaron Wildavsky undertook an early case study of the EDA in Oakland, California with its inaugural goal of hiring long-term unemployed minorities. They conclude that while advocates had “great expectations” the program produced meager results with impulsive project choices and cost overruns. The cause, the authors postulated, was a delay in implementation and cumbersome bureaucracy.

Pressman and Wildavsky seem to have documented a familiar tale of public choice theory: the malincentives present in bureaucracies and tendency toward inefficiency. Their classic book on programmatic breakdown has touched off another debate recently in the literature centered around the question, “What ever happened to the study of policy implementation?” An intellectual dead-end was encountered according to deLeon and deLeon which can be revitalized by considering policy implementation not from the top-down but from the ground-up.

Pressman and Wildavsky sliced into their analysis in keeping with the dominant theories of the time. They view the EDA in a top-down fashion – as a single federal programmatic entity acting on subordinate levels of state and local government. Since their 1973 classic, advances made by Vincent and Elinor Ostrom and others point to the fruitfulness of thinking in terms of polycentric rather than monocentric orders. That is, to consider policies in horizontal instead of vertical terms. Map out the multiple decision nodes that connect government, marketplace and community.

B. Guy Peters in his article, Implementation Structures as Institutions, notes that in the last decade, the public administration literature now strives to make just such connections in understanding how policies are implemented. It’s an important advance which allows for a more complex and nuanced picture of the effects of programs. Such analysis may help answer one perennial question: how is it that small-budget, experimental programs inspired by mid-century economic theories grow deep roots and resist any kind of reform, alteration or pruning for generations?

When we consider federal spending programs and trace their effects we often see the fleeting connections and feel a sense of unease. A former EDA administrator calls the program, “A Congressional Cookie Jar.” From his vantage point the program is an expense account for politicians to sprinkle federal dollars on their districts. But as EDA grants are scattered among municipal governments, what else happens along the way? How do constituencies coalesce? Who benefits and who loses? Where do the dollars go and how are connections forged between private, non-profit and public sector actors. Metaphorically speaking, how did a single-shot grant in the mid-1960s become an oak forest?