Tag Archives: vote

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.

 

Milton Friedman Would Have Been 100 Today

There have already been a lot of great paeans. I’d recommend this article by Thomas Sowell or this blog post by Bryan Caplan or this collection of remembrances by David Henderson. Friedman is justifiably remembered as an excellent economist whose timely and careful research on consumer behavior, money, and economic history literally upended conventional economic wisdom. But he is also remembered as an eloquent and impassioned public voice on behalf of individual freedom.

In that spirit, I think the best tribute is to let him speak for himself. Courtesy of Don Boudreaux, here is Friedman on freedom, government and conformity:

What the market does is to reduce greatly the range of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game. The characteristic feature of action through political channels is that it tends to require or enforce substantial conformity. The great advantage of the market, on the other hand, is that it permits wide diversity. It is, in political terms, a system of proportional representation. Each man can vote, as it were, for the color of tie he wants and get it; he does not have to see what color-the majority wants and then, if he is in the minority, submit.

It is this feature of the market that we refer to when we say that the market provides economic freedom. But this characteristic also has implications that go far beyond the narrowly economic. Political freedom means the absence of coercion of a man by his fellow men. The fundamental threat to freedom is power to coerce, be it in the hands of a monarch, a dictator, an oligarchy, or a momentary majority. The preservation of freedom requires the elimination of such concentration of power to the fullest possible extent and the dispersal and distribution of whatever power cannot be eliminated – a system of checks and balances. By removing the organization of economic activity from the control of political authority, the market eliminates this source of coercive power. It enables economic strength to be a check to political power rather than a reinforcement.

And courtesy of Professor Miles Kimball, here is a collection of Friedman videos. In the spirit of Mercatus’s latest initiative on cronyism, here is Friedman on the government and the power of the industrialists:

 

(HT, Steven Mitchell)

Puerto Rico Secretary of State on Government Reform

On my last post about government reform in Puerto Rico, a commenter pointed out that some of the trends indicating that the territory’s government is shrinking have reversed in the past year. Indeed, the number of government employees increased from 259,000 in December 2010 to 269,000 in December 2011. Likewise, government revenues ticked up in 2010 and 2011 after decreasing in 2008 and 2009.

I wanted to learn more about the reversal of the shrinking central government, so I spoke with Puerto Rico Secretary of State Kenneth McClintock about these trends. He explained, as the commenter pointed out, that the increase in government revenue is in large part due to an excise tax on foreign corporations that went into effect in 2011. This temporary tax is being used to finance broad-based tax reform and is gradually being phased out over the next five years when it will expire in 2016. McClintock explained that a six year plan for tax reform was one of the administration’s top priorities upon Governor Luis Fortuño taking office in 2008.

Reform measures have included cutting corporate tax rates from 39 percent to 30 percent and individual tax rates by 50 percent over the six year period. McClintock said, “Beginning in year one, everybody had more money in their pockets.” These reforms include a unique trigger. If Puerto Rico doesn’t achieve a balanced budget by the end of the six-year reform period, the final tax cuts will not go through. “We wanted to show people that good things happen with fiscal discipline,” McClintock continued.

Regarding the increase in government employees, McClintock said that part of the increase was due to stimulus funds from the American Recovery and Reinvestment Act and hiring by local governments. Additionally,  a negligible number of the initial cutbacks were deemed to be unsustainable and required refilling some positions that were eliminated in the initial round of cuts. Attrition policies are still in place, so longterm cuts should still be expected.

Initially, government job cuts raised Puerto Rico’s already high unemployment rate by about 1.2 percentage points. McClintock said that while hard data is not available on the individuals laid off from government jobs, anecdotally about half of them are now employed in the private sector. The layoffs included a $1 billion severance package which provided $5,000 for each laid off employee that they could use either to go to school or as seed money for a new business.

Of course, not everyone is as optimistic about the success of the territory’s reform efforts. As a blog produced by Center for the New Economy, a Puerto Rican think tank, reports, the tax reform program is not uncontroversial:

The control and reduction of government spending has stabilized the Commonwealth’s financial position.  Unfortunately, this stabilization is not cost free.  The implementation of this contractionary fiscal policy in the middle of a four year recession may have deepened and prolonged the economic recession in Puerto Rico.  Furthermore, the government’s pro-cyclical fiscal policy has been implemented at the same time that commercial banks in the island are undergoing a de-leveraging process that has significantly reduced the availability of credit.

As the article explains, some aspects of the tax reform plan may not point toward long run stability. The territory’s budget is increasingly reliant on federal funds with $1 of every $4 spent by the central government coming from federal transfer payments. Furthermore, debt service payments are increasing as a percent of Puerto Rico’s GDP.

While siginificant economic growth has yet to be seen coming out of the recession, economic indicators are looking better than when Governor Fortuño took office, despite about 12,500 government layoffs by the central government. Unemployment has fallen from 18 percent to under 16 percent and the Economic Activity Index reached positive territory in 2011 for the first time since early 2006. Some recent reforms will have staying power beyond Governor Fortuno’s term in office. The focus has been on improving Puerto Rico’s business climate relative to the states and neighboring countries by expanding trade and lowering taxes.

Reducing bureaucracy has also been a priority. “So far we have approved 11 of 13 reorganization plans to consolidate and eliminate agencies,” McClintock explained. He also said that many of the barriers to the renewable energy industry have been eliminated, leading the territory to become home to the largest wind and solar farms in the United States.

Puerto Rico is also pursuing an institutional change that could reduce long run spending. In August, Puerto Ricans will vote on an amendment to cut the number of legislators from 27 to 17 in the senate and 51 to 39 in the house of representatives. As research from Jowei Chen and Neil Malhotra demonstrates, state spending is likely to decrease with fewer state senators and with a higher ratio of representatives to senators.

Matt Mitchell and Nick Tuszynski covered their research in a literature review, and Matt estimates that these changes could be expected to reduce spending in Puerto Rico by about $77 per person yearly. The change to the legislature would take place ahead of the 2016 elections. McClintock said that this proposal is the result of “courageous legislators who are thinking from the people’s perspective rather than their own. It’s only natural that after cuts in the administration, people would expect cuts in the legislature as well.”

Many of the changes in Puerto Rico could be implemented in states looking to streamline government, particularly their tax reforms and triggers to provide incentives for voters to act as watchdogs to be sure that fiscal discipline is carried through.

Florida Senate Votes against Privatizing Prisons

Yesterday, the Florida state senate voted down a bill that would have privatized 27 of the state’s prisons. The shift was projected to save $16.5 million in a state with a $2 billion budget deficit. Theoretically, private prisons are projected to save money because they operate under a profit motive, putting them in a better place to find operating efficiencies compared to state run prisons.

While from a budgetary perspective prison privatization may make sense, the issue is not straightforward. Privatizing prisons creates an interest group that stands to profit from higher incarceration rates. The case of two Pennsylvania judges who accepted bribes from private prison interests in exchange for incarcerating 5,000 juvenile offenders, many of whom appeared in court for minor offenses without attorneys, brought light to this issue. Of course this illegal corruption does not represent the typical interaction between the justice system and private prisons, but does demonstrate the danger of crony capitalism in the industry.

In a paper for the Reason Foundation, Adrian Moore points out that prison interest groups are by no means exclusive to private prisons. Public sector employee unions also have incentives to grow their bureaucracy and protect their jobs by seeking harsher prison sentences. In Florida, the International Brotherhood of Teamsters, a union representing public sector prison workers, played an important role in the defeat of the privatization bill. The California Correctional Peace Officers Association is perhaps the most studied public prison lobby. The CCPOA has made extensive contributions to both political campaigns and to groups that fight for harsher sentencing laws.

Aside from the complicated issues that special interests bring to the US prison system, it’s important to take a critical look at the alleged budget savings that private prisons provide. While these prisons are privately run, they of course are not really private businesses, but rather government contractors. This means a layer of bureaucracy separates them from their consumers (taxpayers) and the market process is not in play as it is in a competitive industry. Rather than having an incentive to provide the best service at the least cost, private prisons face incentives to fulfill the most lucrative government contracts at least cost.

Some studies, including Moore’s, have attributed substantial cost savings to prison privatization, but other studies have found the opposite. In Arizona, private prisons actually cost more per inmate than public prisons, according to state data, even though they do not typically house the highest security, most expensive inmates that state-run prisons do.

Florida Governor Rick Scott still has the opportunity to use his executive power to increase the role of private prisons in Florida but said he had wanted legislative support for the measure. While the budgetary and policy impacts of privatizing prisons are ambiguous, one policy change would bring certain cost savings to Florida taxpayers. By some measures, Florida currently has the strictest laws against marijuana possession in the country, including potential jail time for possession of misdemeanor quantities of the drug. By reducing sentencing for victimless crimes including possession and distribution of marijuana, the state could certainly save money and potentially improve outcomes for the states youth who face drug charges.

New Research on Immigration Policy

Immigration reform is something that has already surfaced in the recent GOP debates and will certainly receive more attention in the coming months as we make our way further into another presidential election year. The Cato Institute recently released a special edition of the Cato Journal titled “Is Immigration Good for America” in order to influence this debate and help individuals better understand the possibilities for reform.

Each of the 13 articles in this edition of the journal provides a unique insight into a wide variety of issues concerning current immigration policy. Here are a few summaries of some of the arguments I found particularly interesting.

In his article titled “Why Should We Restrict Immigration?” Bryan Caplan explores many of the prominent objectives to the liberalization of immigration policy through a moral lens. He concludes his argument with the following:

there are cheaper and more humane solutions for each and every complaint [against liberalization]. If immigrants hurt American workers, we can charge immigrants higher taxes or admission fees, and use the revenue to compensate the losers. If immigrants burden American taxpayers, we can make immigrants ineligible for benefits. If immigrants hurt American culture, we can impose tests of English fluency and cultural literacy. If immigrants hurt American liberty, we can refuse to give them the right to vote. Whatever your complaint happens to be, immigration restrictions are a needlessly draconian remedy.

In his article titled “Immigration and the Welfare State” Daniel T. Griswold, the editor of this edition of the journal, provides an interesting argument concerning the assertion that immigrants impose extreme long term fiscal burdens on U.S. taxpayers. He concludes with the following:

For those concerned about the fiscal impact of immigration, the goal should be to wall off the welfare state, not our country. As far as constitutionally possible, Congress and the states should deny welfare payments to non-citizen immigrants. This would be good for the immigrants because they could more easily avoid the disincentives to work and family formation caused by welfare payments. It would be good for U.S. taxpayers because it would reduce demand for welfare spending. And it would be good for the U.S. economy because it would remove one of the more potent political arguments against expanded legal immigration.

In our article titled “U.S. Immigration Policy in the 21st Century: A Market-Based Approach,” Joshua Hall, Richard Vedder, and I argue that visas should not be allocated based on arbitrary political criteria but instead through the price system. Our proposal has several components but consists largely of creating an NASDAQ-style international market for visas. From our paper:

The United States is the light of the world, a beacon of freedom and opportunity. Immigration is both a cause and a consequence of this reality. It is obvious that high volumes of immigration can lead to cultural clashes and can challenge our infrastructure. Thus realistically the body politic will insist that limits be placed on it. Let’s allocate access to our great country on the basis of supply and demand, reflecting the intensity of preferences of immigrants themselves and potential employers, rather than on a political process that is simply not as good as the market in allocating resources.

I think these articles, along with the other articles in this edition of the Cato Journal, are definitely worth a read and hopefully we will see these ideas influence the coming debates.

Down With One-Dimensional Politics!

Last Sunday, ABC’s This Week ran a new segment titled “The Great American Debates.” It featured George Will and Paul Ryan debating Barney Frank and Robert Reich on the question: “There is too much government in my life.”

It was a fun and spirited debate with lots of good lines from both sides. In my view, Barney Frank was at his strongest when he was pointing out the inconsistencies in the conservative positions on foreign policy and personal freedom. He noted that while the conservatives are happy to permit greater freedom when it comes to economic matters, they are the first to “tell us that an adult shouldn’t be able to gamble on the Internet” and they are the first to want to regulate personal matters from the bedroom to recreational drug use. Moreover, while conservatives are skeptical of government’s role in the economy, Frank noted that they are often eager to use the government to rebuild other societies, something “we’re not very good at.”

Having pointed out the inconsistencies of conservatives (more freedom in economic matters but more government in personal and foreign affairs), he might have embraced a more consistent approach: freedom in all spheres. Instead, he ended his opening statement by declaring that he, too, was inconsistent:

And so my answer is yes, I want more government involved in economic regulation and environmental cleanup and for reasons of public safety. I want less government telling me what personal choices to make as an individual.

This answer, I believe, highlights the inadequacy of one-dimensional political thinking. Try as we might, it is pretty difficult to describe many peoples’ political beliefs without making them seem inconsistent.

That’s why I think it is much more helpful to think in terms of (at least!) two dimensions. Consider the animation below.

The common positions of “left” and “right” on economic and personal matters seem inconsistent when viewed on a conventional one-dimensional spectrum. But if you allow for a little richer information, you can think in terms of two dimensions: a) more or less economic
freedom as shown on the horizontal axis and b) more or less personal freedom as shown along the vertical axis. You can think of “libertarians” as favoring freedom in both spheres and “statists” as favoring intervention in both spheres. And you can think of “left” and “right” as favoring freedom in one sphere but not the other and vice versa.

Of course, you can take it one step further and think of a third dimension coming straight out of your computer screen. It would show more or less intervention in foreign matters. (Sadly, my animation skills are not yet advanced enough to render such an image).

I understand why U.S. political parties feel the need to conform to the tired, old one-dimensional view of politics. Long ago, the political scientist Maurice Duverger asserted that two and only two political parties are likely to be viable in democracies that employ the type of voting rules the U.S. employs (one member represents each district and that candidate with the most votes is declared the winner). With such voting rules, third parties rarely win and so their financial and political support tends to dry up over time. Conversely, in countries where, say, the top three vote-getters each get a seat in parliament, third parties are much more viable. Given the fact that the U.S. is likely to have only two parties, these two parties must, by default, simplify matters and pretend that politics can adequately be described with a simple dimension.

It is unfortunate, however, that the media and pollsters play along. ABC, for example, could have easily invited guests to defend the libertarian and the statist position. And pollsters could easily make room for two questions. Instead of asking people if they are liberal, conservative, or moderate (how is a libertarian to answer?), they could ask people separate questions about their positions on social issues and economic issues.

There is ample evidence that people are smart enough to think in multi-dimensional terms. According to Dennis Mueller (p. 242):

Most observers of politics outside of the United States identify at least two salient dimensions to the political party space.

He cites research by Budge, Robertson, and Hearl (1987), Budge (1994), Laver and Schofield (1990), Schofield (1993, 1995), and Schofield, Martin, Quinn, and Whitford (1998).

Here is a fun, short quiz to help you think through your own position in multi-dimensional issue space.

What Makes for a Good Balanced Budget Amendment?

Today, the U.S. House will begin debating a balanced budget amendment. This morning, the editorial board of the Wall Street Journal chastised Speaker Boehner for offering a “vanilla amendment that merely calls for a balanced budget, with no spending limitations or supermajority tax requirements.” Their worry is that, “Under Mr. Boehner’s amendment, spending could rise to 25% or 30% or more of GDP, so long as the budget is balanced.”

This is a misplaced worry. Right now, Congress is able to vote benefits for current voters while putting about 45 percent of the tab on non-voters (our posterity). It doesn’t take a complicated economic model to see that this arrangement systematically biases spending upward. And any amendment that requires current voters to pay for current spending will diminish that bias. As I told the House Judiciary Committee last month, in states where balanced budget requirements are stricter, spending is lower.

Moreover, the editors’ preferred amendment—one that includes some sort of spending limitation—is actually unlikely to achieve its goal. Last year, I examined the operation of various spending limits, using data from 49 states covering 30 years (I wrote about my research in an OpEd in the Journal). I found that those tax and expenditure limits “that limit budgets to some share of income had no statistically significant impact on either state-only spending or on combined state and local spending.” It may be that when states bind themselves with such limits, they make sure that the limit is set so high that it fails to actually constrain.

As far as supermajority requirements for tax increases are concerned, research does suggest that these can limit spending. I guess it is a political call as to whether such a requirement should be tied to a balanced budget amendment. In my view, a balanced budget amendment requires strong bipartisan support for it to be effective. But I don’t do politics.

I do agree with the editors in one regard. There is no need to settle for a “vanilla amendment.” There are many different varieties of balanced budget amendments and some of these have much stronger features than others. In my view, the most-effective amendments are those that:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

There are amendments that have these characteristics. For example, H.J. Res. 81 (which now has 54 cosponsors), has all three.

In other news, the amazing Cord Blomquist has managed to get my testimony on the YouTubes:

Pension Hearings Wrapped up in Rhode Island

The Rhode Island legislature completed hearings on Tuesday on the reform bill proposed by Governor Chafee and Treasurer Raimondo. The proposed reforms, many explained here, include:

  • Freezing COLA increases in benefits for retirees for up to 19 years;
  • Creating hybrid plans for current and future employees with a defined contribution portion, similar to a 401(k) and a smaller, defined benefit portion;
  • Raising the retirement age from 62 to the age when individuals begin receiving social security;
  • Amortizing the remaining defined benefit plan over 20 years.
Now, lawmakers are debating potential amendments to the reform bill, and it could be weeks until they vote on a final version. Among union leaders, eliminating the COLA is understandably one of the most unpopular parts of the bill because it significantly reduces the amount of money retirees will receive over the the course of their retirement. However, this part of the bill is key in saving RI taxpayers about $3 billion and ensuring that the pension fund will remain solvent.
State union leaders suggest that instead of the reforms proposed by the state’s democratic administration, Treasurer Raimondo should adjust the fund’s actuarial assumptions. They support changing the fund’s expected growth rate from 7.5% to 7.75% and adjusting the assumed average life expectancy for retirees. Their resistance to more significant reform is surprising, given the dire consequences that union members suffered in Central Falls, RI. There, the local pension fund became insolvent, leading the municipality to bankruptcy. Now, many Central Falls pensioners are receiving less than half of the benefit that they were promised.
The fate of this bill in Rhode Island is important not only for local employees and taxpayers, but for troubled pension funds across the country. If Rhode Island is able to enact reforms that protect retirement benefits and taxpayers, it will serve as a model for other states.

An Unbalanced Budget: Fiscal Pollution

Yesterday I appeared before the House Judiciary Committee to talk about a balanced budget amendment to the U.S. Constitution. The other witnesses were Former Governor and Attorney General Richard Thornburgh, Former CBO Director and current president of the American Action Forum, Douglas Holtz-Eakin, and Professor Philip Joyce of the University of Maryland.

I began by pointing out the enormity of the problem: CBO projects that absent policy change, the nation’s debt will be 90 percent of GDP in just seven years. This is an important figure because research suggests that when national debt levels get much above this point, their growth rates tend to slow. In the median case, they slow by 1 percentage point and in the mean case, their growth rates are cut in half.

This may not sound like much, but to put it in perspective, I used the following chart.

What would current national income be if—in 1975—the U.S. had accumulated the sort of debt that we are about to accumulate and the nation’s growth rate had slowed by 1 percentage point? This is indicated by the dashed line in the middle. Today’s GDP would be about 1/3rd smaller than it actually is. And what would national income be if we had grown at half our actual pace? This is indicated in the bottom line. Today’s income would be 45 percent smaller than it actually is. To get a feel for this magnitude, notice the blip in the top right corner of the actual GDP line. That is the Great Recession that began in 2008. As I told the Judiciary Committee:

The most calamitous economic contraction in decades pales in comparison to the lost income associated with persistently anemic economic growth from too much debt.

In my view, the nation’s fiscal problems owe much to the incentives that politicians face. Around 1:27:45 I make this point:

The basic problem here is one of externalities. This is a problem that is familiar to environmental economists.  If a factory…in the process
of making a product for consumers, is allowed to bilge smoke into the air, that’s an externality. And they will make too much of the product unless it is internalized. So here, what’s happening is that this current generation is allowed to externalize the costs of government onto the next generation….The costs of reform, the costs of avoiding this kind of economic contraction that we are staring at will be borne by people like me, the median voter. But the costs of the status quo will be borne by my daughter. She cannot vote. Until we can internalize that externality, I think we are going to continue to make the wrong choice because none of you have the incentive to make the right choice. It’s not your fault; you are all good people, you are servants of the public and you are listening to what your constituents and your median voters are saying. But the incentives that they offer you are not right.

A balanced budget amendment, by internalizing this externality, would correct these misaligned incentives. Simply put, it would “make each generation that benefits from government services pay for the costs of producing them.”

The video is here (my testimony begins at 54:30). Here is my written statement.

Unfortunately, despite the ardent wishes of my 7th grade civics teacher, these sorts of hearings are not, primarily, about weighing the evidence and changing minds. Instead, they have much more to do with scoring political points and solidifying already-hardened positions. Nevertheless, I found that most of the Congress-people who disagreed with me were polite. And I hope that this leads to opportunities for more fruitful exchanges down the line.

D.C. City Council votes to raise taxes on the wealthy

Yesterday the D.C. City Council voted to raise taxes on those earning over $350,000 a year, creating a new bracket and raising the top rate from 8.5 percent to 8.95 percent on high earners. The logic of sponsoring members Mendelson and Cheh is that this tax will allow the council to “swap taxes” and delay the imposition of a tax on interest income on other-than-D.C. municipal bonds, now slated to go into effect in December 2011. Though the income tax hike is being presented as temporary, at least one member is advocating it be made permanent. The 7-6 vote reveals, “a philosophical divide” among City Council members. Council member Muriel Browser notes the city’s budget has grown by $1 billion since 2008. The income tax hike is projected to bring in $106 million over four years.

On the heels of the increase, Moody’s issued a negative outlook on D.C. GO bonds due to possible federal spending cuts that would reduce federal aid and entitlements in the district. Moody’s decision is unrelated to the tax hike.

But perhaps even more worrying than Moody’s assessment are the factors that will increasingly put pressure on D.C.’s fast-growing budgets. Currently, the District’s pension plans appear over-funded, except they really aren’t. Using accurate assumptions indicates that both the teachers’ and the police and fire plans are funded in the 65 percent range, with a total unfunded liability of $2.17 billion. I had the opportunity to testify before the council this spring and offer my assessment of their pension systems, a matter of concern for several Council members.

D.C.’s higher tax rate on high-earners may have unintended consequences: driving out residents or discouraging in-migration, eroding the tax base and leaving D.C. with future obligations that will be very difficult to pay. A recent paper by Davies and Pulito finds that higher state income taxes cause a net out-migration of not only high-income residents, but of residents in general. They find net out-migration also holds at the county-level when the change is to income levels to which the tax rates apply; that is, when a “millionaire’s tax” is really a tax on those earning much less than a million.