Tag Archives: Katelyn Christ

No, bailouts are not something to celebrate

Robert Samuelson at the Washington Post is celebrating the auto bailout.

Last December I had a piece in the Post in which I argued that “pro-business” policies like bailouts are actually bad for business. I offered five reasons:

  1. Pro-business policies undermine competition.
  2. They retard innovation
  3. They sucker workers into unsustainable careers.
  4. They encourage wasteful privilege seeking.
  5. They undermine the legitimacy of government and business.

Read my piece for the full argument.

But aren’t things different in the midst of a major economic and financial crisis? Shouldn’t we have more leeway for bailouts in exigent circumstances?

No. Here is why:

First, we should always remember that the concentrated beneficiaries of a bailout have every incentive to overstate its necessity while the diffuse interests that pay for it (other borrowers, taxpayers, un-favored competitors, and the future inheritors of a less dynamic and less competitive economy) have almost no incentive or ability to get organized and lobby against it.

Bailout proponents talk as if they know bailouts avert certain calamity. But the truth is that we can never know exactly what would have happened without a bailout. We can, however, draw on both economic theory and past experience. And both suggest that the macroeconomy of a world without bailouts is actually more stable than one with bailouts. This is because bailouts incentivize excessive risk (and, importantly, correlated risk taking). Moreover, because the bailout vs. no bailout call is inherently arbitrary, bailouts generate uncertainty.

Todd Zywicki at GMU law argues convincingly that normal bankruptcy proceedings would have worked just fine in the case of the autos.

Moreover, as Garett Jones and Katelyn Christ explain, alternative options like “speed bankruptcy” (aka debt-to-equity swaps) offer better ways to improve the health of institutions without completely letting creditors off the hook. This isn’t just blind speculation. The EU used this approach in its “bail in” of Cyprus and it seems to have worked pretty well.

Ironically, one can make a reasonable case that many (most?) bailouts are themselves the result of previous bailouts. The 1979 bailout of Chrysler taught a valuable lesson to the big 3 automakers and their creditors. It showed them that Washington would do whatever it took to save them. That, and decades of other privileges allowed the auto makers to ignore both customers and market realities.

Indeed, at least some of the blame for the entire 2008 debacle falls on the ‘too big to fail’ expectation that systematically encouraged most large financial firms to leverage up. While it was hardly the only factor, the successive bailouts of Continental Illinois (1984), the S&Ls (1990s), the implicit guarantee of the GSEs, etc., likely exacerbated the severity of the 2008 financial crisis. So a good cost-benefit analysis of any bailout should include some probability that it will encourage future excessive risk taking, and future calls for more bailouts. Once these additional costs are accounted for, bailouts look like significantly worse deals.

Adherence to the “rule of law” is more important in a crisis than it is in normal times. Constitutional prohibitions, statutory limits, and even political taboos are typically not needed in “easy cases.” It is the hard cases that make for bad precedent.

Would a Permanent Extension of Tax Rates Really Create Certainty?

In the late 1990s, there were typically fewer than a dozen tax provisions that had just a limited lease on life and needed to be renewed every year or so.

Today there are 141.

That is from today’s Wall Street Journal. If speculation is accurate, today’s Congressional vote will only exacerbate this trend. By my count, it creates temporary provisions for:

  • All income tax rates
  • Capital gains tax rates
  • Dividend tax rates
  • The Social Security payroll tax rate
  • The estate tax rate
  • Student loan tax credits
  • Per-child tax credits
  • The Earned Income Tax Credit
  • The tax credit for blending ethanol into gasoline
  • The $1.00 per gallon biodiesel tax credit
  • A tax credit to incentivize alternative fuel
  • A tax credit for maintaining railroad tracks (really?)
  • Expensing of business investments
  • And others (the WSJ refers to “dozens of corporate-tax provisions that already were subject to annual renewal”; some of these may or may not be in my list above). 

As my colleague, Jason Fichtner and his coauthor, Katelyn Christ, have recently written, uncertainty and tax policy are a fatal policy mix.

Previous research suggests that policy uncertainty can be very harmful to economic growth.

But all of this talk about temporary tax provisions obscures an important fact: Even if the Congress were to make current tax provisions permanent, there would still be an enormous amount of uncertainty in current tax policy. This is because, over the long run, government expenditures are on an unsustainable path and by the simple arithmetic of budgeting, taxes will eventually have to go (way) up or spending will have to go down.

If policy makers truly want to generate certainty and create an environment conducive for economic growth, they will need to reform the tax code, make the reforms permanent, and bring spending in line with taxes.

No End in Sight for Government Budget Gaps

Last week, Surprise, Arizona was in the news for questionable accounting practices. This week, accountants in Ohio are expressing concerns about the state’s long run fiscal prospects. Ohio used more than $7 bilion from the American Recovery and Reinvestment Act to close this year’s budget gap, but this gap will reappear in the budget once stimulus funds are gone.

J. Matthew Yuskewich, chairman of the Ohio Society of Certified Public Accountants said in The Columbus Dispatch:

“Every month that goes by that they delay acting on that next budget reduces the options they have available to solve that gap,”  If they wait too long, “the only solution available is going to be a tax increase, and it’s going to be a big tax increase.”

Yuskewich hints at an ongoing problem in public finance — the absence of profit and loss calculation makes government slow to adapt to changing economic conditions.  The article goes on to explain the society’s recommendation for a long-term solution to this deficit:

If taxes are in the works, “sin taxes” on alcohol, cigarettes, soda and high-fat foods should be first in line.

While Yuskewich and his colleagues seem to have correctly identified Ohio’s core budget problem, sin taxes are not likely to represent a valid long-term solution. Katelyn Christ and Richard Williams of the Mercatus Center illuminate the problems with these excise taxes.  They are inefficient, regressive, and distort the basket of goods that consumers would otherwise purchase.

Ohio will have plenty of company in budget shortfalls in the coming years.  The Sunshine Review projects that 42 states will face shortfalls in fiscal year 2010. While states do need to find long term solutions rather than relying on bailout funds, they should focus on creating prosperous states through low, broad-based taxes instead of targeting specific goods that policy makers identify as sinful.