Tag Archives: Bruce Yandle

The farm bill: a lesson in government failure

As a consumer and as a taxpayer, the farm bill is a monstrosity. But as someone who teaches public finance and public choice economics, it is a great teaching tool.

Want to explain the concept of dead-weight loss? The farm bill’s insurance subsidies are a perfect illustration of the concept. They transfer resources from taxpayers to farm producers; but taxpayers lose more than producers gain.

Want to illustrate the folly of price controls? Sugar supports which force Americans to pay twice what global consumers pay are a fine illustration.

Want to explain Gordon Tullock’s transitional gains trap? Walk your students through the connection between subsidies and land prices: much of the value of the subsidy is “capitalized” into the price of farmland, meaning that new farmers have to pay exorbitant prices to buy an asset that entitles them to subsidies. This means new farmers are no better off as a result of the subsidies. As David Friedman puts it, “the government can’t even give anything away.” The only ones to gain are those who owned the land when the laws were created. But those who paid for the land with the expectation that it would entitle them to subsidies would howl if politicians tried to do right by consumers and taxpayers and get rid of the privileges.

Want to illustrate Mancur Olson’s theory of interest group formation? Look no further than sugar loans. Taxpayers loan about $1.1 billion to producers every year. Spread among 313 million of us, that is a cost of about $3.50 per taxpayer. And who benefits? Last year just three (!) firms received the bulk of these subsidies, each benefiting to the tune of $200 million. As Olson taught us long ago, the numerous and diffused losers face a significant obstacle in organizing in opposition to this while the small and concentrated winners have every incentive to get organized in support.

Want to show how a “legislative logroll” works? Explain to your students that members representing dairy and peanut interests are statistically significantly likely to vote in the interests of peanut farmers and vice versa.

Want to explain Bruce Yandle’s bootlegger and Baptist theory of regulation? Note that catfish farmers want inspection of “foreign” catfish in the name of safety (the Baptist rationale) when the real reason for supporting additional inspections is self-interested protectionism (the bootlegger motivation).

This week’s lesson is on the power of agenda setters to block even modest reforms. Buried in the dross of privileges to wealthy farmers, both the Senate and the House versions of the bill contained a small glimmer of reform. Both included language capping the amount of subsidies that farmers and their spouses receive at “only” $250,000 per year. Right now, House and Senate conferees are working to reconcile the two versions of the Farm Bill passed this summer. And according to the latest reports, they plan to strip these modest reforms that were agreed to by both chambers.

Unfortunately, kids, this is how modern democracy works.

Do More Revenues Lead to More or Less Spending?

This, I think, is (literally) the trillion dollar question.

As you can see from the animated chart below, ours really is a spending problem in the sense that revenue is set to remain fairly constant while non-interest spending is set to skyrocket.  That, in turn, causes interest payments to skyrocket, adding to the amount we spend and causing the whole thing to go to…you get the drift.

One hopes that at least some of the members of the Super-Committee recognize this. If so, they will draw a hard line in the sand demanding meaningful spending reforms in the entitlement programs that are at the heart of the long-term problem.

But a question remains: should they also draw a hard line in the sand against any and all revenue increases?  I believe this question turns on the one above: do more revenues lead to more spending?

If the answer is yes, then a hard line in the sand against revenue increases may be warranted.  But if the answer is no, then negotiators would be wise to focus all of their energies on reforming entitlement spending and should perhaps be willing to give some ground on revenue if it buys more support for spending cuts.  Interestingly, there are good “free market” economists on both sides of this debate.

Milton Friedman exemplifies the view that more revenue will only encourage more spending (see “The Limitations of Tax Limitation,” 1978; I wasn’t able to find a link).  Those who subscribe to his view may point to Reagan’s 1982 “TEFRA” deal with Democrats.  The president agreed to raise some tax revenue, mostly by closing loopholes, in exchange for spending cuts.  But, say critics, the tax increases materialized while the spending cuts never did.

On the other hand, James Buchanan, another Nobel-laureate with free market bona fides, takes the opposite view.  He argues that the ability to deficit spend biases policy makers to favor more spending.  He believes that if you make policy makers charge current taxpayers for what they spend, the current taxpayers will demand less spending.  Ironically, this leads to the conclusion that revenue increases will lead to less spending.  Advocates of this view might point to the 1990s.  Then, revenues as a share of GDP rose while spending as a share of GDP actually fell for the first time in post-WWII history.

As an empirical matter, I don’t think this is settled.  James Payne (2003) has studied the issue at the state level and has concluded that, at least in a plurality of states, spending does seem to respond to revenue, corroborating the Friedman view.  Thus, he concludes that, “any policy to reduce budget deficits via revenues may not result in deficit reduction.”

On the other hand, Andrew Young has studied the matter at the federal level and concludes:

Perhaps counter-intuitively, the findings suggest that tax increases—even temporary—may serve to decrease expenditures by forcing the public to reckon with the cost of government spending.  The findings suggest that the electorate has to be clearly presented with the bill to recognize the cost of government, rather than being allowed to run up a tab.

It makes some sense that the Friedman view would be corroborated at the state level while the Buchanan view would hold at the federal level.  Most states have an obligation to balance their books (more or less), while the Feds have no obligation whatsoever.  Thus, current state taxpayers tend to be the ones to pay for current state spending while current federal taxpayers can more-easily foist their costs onto the next generation.

If you do subscribe to the Buchanan view, what sort of revenue increases should be on the table?  The answer is almost certainly not rate increases on those who are current taxpayers.  They, presumably, are already resistant to more spending (we also know that these are the most inefficient sorts of tax increases).  Instead, revenue increases ought to be focused on closing loopholes and broadening the tax base (about half of all Americans have no income tax liability).  In a new Mercatus working paper, economists Jody Lipford and Bruce Yandle examine what happens to spending when large numbers of Americans have little or no income tax liability, leaving the rest (and future generations) to pick up the tab.

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Update: Josh Barro rightly noted that large numbers of Americans don’t have an income tax liability; they still pay other taxes including payroll taxes.

Proposition 19, Bootleggers, and Baptists

It was nearly 30 years ago that Bruce Yandle penned his influential “Bootleggers and Baptists” essay. The unintuitive thesis is that some government interventions endure because of an unusual (and often unrecognized) agreement between two distinct groups. On the one hand are those who want to see the intervention continue for moral reasons (he calls them “Baptists” in reference to the Baptists who supported the prohibition of alcohol). On the other, are those who benefit from the artificially high price that results from prohibition (he calls them bootleggers).

NPR reports today that California’s Proposition 19—which would legalize and regulate marijuana for recreational use—has generated some unlikely political alliances. As Yandle would predict, many police and mothers are against decriminalization. Surprisling, however, some moms are for it. Skyla Chapman, for one, argues:

When it’s regulated, then it’s no longer in the drug dealers’ hands. It’s in respectable businesses’ hands. They’ll card or ID you.

Consistent with Yandle’s thesis, some stoners are skeptical of decriminalization. They worry that the regulations may be more burdensome than the current regime which permits pot use for medical purposes. They also worry that the decriminalized price will plummet, hurting current sellers. One seller, (appropriately) named Jay, opposes Prop 19. Jay skirts the current law, selling to people for recreational as well as medical use. He worries:

Everyone’s really scared of the prices going down….We all have invested money here, we all live here. I have a daughter here, my wife’s a teacher. Everyone’s scared because we don’t know what the prices are going to be. Already, the prices have gone down and down. It’s harder to sell it.

The story illustrates an important point that my progressive friends rarely acknowledge. Many of them would like to think of regulation as a sort of brake system on the Indy-car that is the market. They imagine prudent well-informed regulators applying the brakes when the cars get going too fast, saving them from veering off the road.

Seen through the bootleggers and Baptists model, however, the story is different. Under this model, cheaters (Bootleggers) actually support the application of the braking system. They, of course, dismantle their own brakes so that regulators can’t apply them. But they are all-too-happy to see the brakes applied to their competitors’ cars. And like the current sellers of pot, they are disapointed to see the brakes removed.

Tax Cuts, or Hikes, Are a Sideshow

Washington State is considering implementing a personal income tax. Much like the federal debate over extending or expiring the Bush tax cuts, this debate is a sideshow to the real issue. In our recent Capitol Hill Campus course, Dr. Bruce Yandle laid out these two charts which point to the real problem in state and federal budgets; spending.

First, this chart tracks the top marginal tax rates versus federal revenue as a percent of GDP.

The government’s take of the economy has remained relatively constant since 1960, despite wild fluctuations in how we “soak the rich”. Washington’s proposed tax would only affect those house-holds making more than $200,000, so one should expect this pattern, or lack thereof, to hold for Washington’s gross state product.

The second part of the story is this; as government spending increases, there is a measurable decline in the economy.

With only one outlier in fifty-four years of data, this strong correlation indicates that spending cuts pay for themselves with a growing economy. In turn, that should produce more overall revenue with reasonable tax rates. If you live beyond your means, the problem isn’t your income, it’s your spending habit. Sometimes it’s better to take a small slice of the pie, but make the pie itself bigger.

Tax Foundation attorney Joe Henchman put the incentive mechanics this way:

Yes, such taxes will generally raise revenue in the short term without a sudden exodus of wealthy people fleeing to the state next door… . But over the medium term, the taxes will negatively impact location decisions. People expanding old businesses or creating new ones will incorporate the higher cost of doing business into their decision-making, and steer clear of the state.

States and the federal government need to break this destructive cycle.

Yandle Redux

Yesterday I contra-posed Greg Mankiw’s view of stimulus spending against economic realities explained by Bruce Yandle. Last night I noticed this new video, from Reason.tv, in which Dr. Yandle explains in his own words the bootleggers and baptists theory, and talks about it in the context of other regulatory schemes.

The video shows both the depth and breadth of Dr. Yandle’s knowledge and insights, but also captures his gentle humility. It’s a privilege to work with him.

Like Taking Cyanide For A Headache

Greg Mankiw has a long article in National Affairs on the proper way to align incentives and stimulus spending:

Economists will no doubt long debate whether Cash for Clunkers passed a cost-benefit test. (Some early results, from Burton Abrams and George Parsons of the University of Delaware, suggest not.) But the fact that people responded to the incentive as they did — nearly 680,000 cars were purchased — suggests that a broader, more comprehensive program of incentives, such as an investment tax credit, might have stimulated spending even more.

Of course, not all tax cuts or credits are created equal, just as not all direct government spending is. One popular idea in recent years, for instance, has been a tax cut for businesses that make new hires. Indeed, the jobs bill signed by President Obama in March put in place a targeted payroll-tax exemption for some small businesses that hire people who have been unemployed for two months or more; several members of Congress have proposed broader tax cuts for businesses that hire new employees. The premise behind these policies is that, because unemployment is so high even as the economy begins to recover, we should create incentives for businesses to place unemployed workers into jobs.

There is a case to be made for a broad-based payroll-tax cut that might have this effect, but a narrower tax cut for new hires suffers from some major flaws. The basic problem is that we do not know how to properly define — or enforce a definition of — a “new hire.” Presumably we do not want a business to hire Peter by firing Paul and to then call Peter a new hire; this would cause a great deal of inefficient churning in the labor force (not to mention a great deal of unpleasantness for all the Pauls).

In this video from Mercatus’ Capitol Hill Campus, Dr. Bruce Yandle, Dean Emeritus at Clemson University’s College of Business and Behavioral Sciences, points out the faulty premise that stimulus spending increases demand. Instead, he shows that cash for clunkers and the recently expired first-time home-buyer credit simply shifted demand in time.

In short, for an incentive to actually stimulate an increase in demand, it would have to cost significantly more than the benefit created by increased economic activity. Mankiw himself explains that uncertainty is a recurring problem in economic planning:

The negative effects are even more challenging to trace. For example, if people observe the government issuing substantial debt (required to finance a stimulus), they may anticipate higher future taxes and therefore cut back on their current consumption. Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today. Obviously, recovery.gov has no way to take account of these consequences, either.

Dr. Yandle presents the counter-point that economic uncertainty is not just an unfortunate side-effect of directed planning and incentives. Uncertainty is a prime driver of economic stagnation, both fiscally and psychologically. When economic rules and incentives change rapidly, private investors and business owners have to question their entire rational decision-making process.

Suddenly, planning a business is like building a house on quicksand. The point of stimulus spending is to offset a drop in aggregate demand, and hope that economic growth offsets the cost of the spending.

However, aggregate demand drops, as it did in 2008, because asset values become skewed. Aggregate demand needs time to reset, while consumers and producers determine the appropriate level of supply and demand under new conditions. The market seeks to correct uncertainty. By introducing new rules and incentives, stimulus spending time-shifts this realignment, but doesn’t supplement it. It adds more uncertainty to an already infuriatingly complex puzzle. That’s why such massive spending hasn’t had any noticeable effect on unemployment; it’s probable that Washington, with the best of intentions, has made hiring people more difficult for a longer period of time. It’s the same reason cash-for-clunkers was such a dismal failure, and the home-buyer credit shows the same symptoms.

Far from being a momentary side-effect of stimulus spending, uncertainty is a systemic problem with interventionist economic policy. The poison is worse than the medicine.