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I gave Trump 50-day grades and 100-day grades, but those were largely speculative assessments.

Now we have a full year of data and that real-world evidence can be used to grade Trump’s first year in office.

But before I get into the details, allow me to start with a broad observation. William F. Buckley famously said that he would rather be governed by 2000 random people from the Boston phone book than by the faculty of Harvard University. Well, one can argue that he posthumously got his wish. The 2016 election was a choice between:

  • Hillary Clinton, a very well-credentialed leftist who would have staffed her administration with other well-credentialed leftists (the Harvard faculty in spirit), who nonetheless was defeated by;
  • Donald Trump, a novice politician who has random-guy-from-the-phone-book opinions (as I described him to a TV audience in New Zealand, he’s “your Uncle who spouts off at Christmas dinner”).

It’s not my role to say whether the American people made the right choice, but I am willing to analyze the economic consequences.

So let’s look at the five major policy areas that determine a nation’s level of economic liberty and see whether Trump is moving America in the right direction or wrong direction.

  • Fiscal Policy – It’s not easy to give Trump a grade because he’s like Dr. Jekyll and Mr. Hyde on the budget. On the tax side of the ledger, he pushed for and ultimately signed a better-than-expected tax bill featuring an impressive reduction in the corporate tax rate and some much-needed limits on the deductibility of state and local taxes. On the spending side of the ledger, however, the first year of Trump has been a disappointment. According to the Committee for a Responsible Federal Budget, he actually approved more than $250 billion (over eight years) of additional outlays. And we haven’t gotten any entitlement reform (though Trump supported the Obamacare repeal legislation on Capitol Hill, which included some reasonably good spending provisions). Trump Grade: B
  • Trade – Trump has moved policy in the wrong direction, though the first year was not as bad as feared. In other words, he been doing a lot of saber-rattling, but fortunately not drawing too much blood. That being said, he is threatening to pull the United States out of NAFTA, which would be a very big mistakeTrump Grade: D
  • Regulation – This is Trump’s best issue area. He’s rolled back some Obama-era regulations, and he’s made some very sensible appointments, which means there’s hope of ameliorating the statist orientation of bureaucracies such as the FDA and the FCCTrump Grade: A-
  • Monetary Policy – Trump hasn’t said much about monetary policy, so we can only grade him on the basis of the people he has appointed to the Federal Reserve. But even that doesn’t allow us much room for analysis since his picks have been very conventional. One hopes a Trump-influenced Fed will support a gradual end to artificially low interest rates, but that’s unclear at this stage. Trump Grade: C
  • Rule of Law – Trump has been aggressive with executive orders, which worries me even if I happen to agree with the underlying policy. The White House hasn’t tried to flout court decisions, however, so that’s a good sign. The appointment and confirmation of Justice Gorsuch also bodes well (assuming he doesn’t “grow in office” like Justice Roberts). Trump Grade: B-

Overall, I think economic policy has moved slightly in the right direction, and I’ll be curious to see whether my back-of-the-envelope grading is confirmed by Economic Freedom of the World.

Here’s some of what I wrote for the latest issues of Cayman Financial Review.

…his first year in office has been a net plus for the U.S. economy. The regulatory state has been curtailed and a semi-significant tax reform has been enacted. …Equally important, Trump has not destabilized global trade. His protectionist rhetoric has not (yet) translated into major anti-trade initiatives. Nor has he implemented any populist policies on immigration or the budget. In other words, we have dodged a bullet. …That is the good news. The bad news (or, to be fair, unsettling news) is that Trump still has at least three more years in office. …The fact that Trump’s first year has been characterized by a “normal” set of Republican policies is besides the point. Almost everyone assumes he is capable of doing something out of the ordinary.

I’ll close by making a second broad observation. The fact that economic liberty increased during Trump’s first year in office does not mean that his presidency will be a net plus. It’s possible that his personal unpopularity will trigger a backlash that makes it easier over time to impose statist policies (just as I suggested that a Hillary victory might have produced desirable long-run consequences).

Check with me in 2021 for a final assessment on whether picking a president from the Boston phone book (metaphorically speaking) was a good idea.

P.S. For what it’s worth, here’s a speech I gave back in Trump’s first month in office. I think my predictions were on target (mostly because I paid attention to what Trump was saying, not because of any special insight).

P.P.S. Whether you’re a left-leaning opponent of Trump or a right-leaning opponent of Trump, remember there’s always the silver lining of mockery.

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To put it mildly, Italy’s economy is moribund. There’s been almost no growth for the entire 21st century.

Bad government policy deserves much of the blame.

According to Economic Freedom of the World, Italy is ranked only 54th, the worst score in Western Europe other than Greece. The score for fiscal policy is abysmal and regulatory policy and rule of law are also problem areas.

Moreover, thanks to decades of excessive government spending, the nation also has very high levels of public debt. Over the last few years, it has received official and unofficial bailouts from the International Monetary Fund and the European Central Bank, and Italy is considered at high risk for a budgetary meltdown when another recession occurs.

And let’s not forget that the country faces a demographic death spiral.

You don’t have to believe me (though you should).

Others have reached similar conclusions. Here are excerpts from some VoxEU research.

Italy will increasingly need to rely on growth fundamentals to sustain its public debt. Unfortunately, the fundamentals do not look good. Not only was Italy severely battered by Europe’s double dip recession (its GDP is lower today than it was in 2005) but when we look at the growth of labour productivity…, we can see that Italy has been stagnating since the mid-90s. …At the end of 2016, Italy’s central government debt was the third-largest in the world…, at $2.3 trillion. …a debt crisis in Italy could trigger a global financial catastrophe, and could very possibly lead to the disintegration of the Eurozone. To avoid such a scenario, Italy must revive growth…a tentative policy prescription is for Italy, to remove those institutional barriers (such as corruption, judicial inefficiency and government interference in the financial sector) that stifle merit and contribute to cronyism.

Desmond Lachman of the American Enterprise Institute paints a grim picture.

Italy’s economic performance since the Euro’s 1999 launch has been appalling. …an over-indebted Italian economy needs a coherent and reform-minded government to get the country quickly onto a higher economic growth path. …since 2000, German per capita income has increased by around 20 percent, that in Italy has actually declined by 5 percent. Talk about two lost economic decades for the country. …if Italy is to get itself onto a higher economic growth path, it has to find ways improve the country’s labor market productivity… It has to do so through major economic reforms, especially to its very rigid labor market…being the Eurozone’s third largest economy, Italy is simply too big to fail for the Euro to survive in its present form. However, it is also said that being roughly ten times the size of the Greek economy, a troubled Italian economy would be too big for Germany to save.

Even the IMF thinks pro-market reforms are needed.

Average Italians still earn less than two decades ago. Their take-home pay took a dip during the crisis and has still not yet caught up with the growth in key euro area countries. …a key question for policymakers is how to enhance incomes and productivity… In the decade before the global financial crisis, Italy’s spending grew faster than its income, in important part because of increases in pensions. …The tax burden is heavy…a package of high-quality measures on the spending and revenue side the country could balance the need to support growth on the one hand with the imperative of reducing debt on the other. Such a package includes…lower pension spending that is the second highest in the euro area; and lower tax rates on labor, and bringing more enterprises and persons into the tax net. …together with reforms of wage bargaining and others outlined above, can raise Italian incomes by over 10 percent, create jobs, improve competitiveness, and substantially lower public debt.

There’s a chance, however, that all this bad news may pave the way for good news. There are elections in early March and Silvio Berlusconi, considered a potential frontrunner to be the next Prime Minister, has proposed a flat tax.

Bloomberg has some of the details.

A flat tax for all and 2 million new jobs are among the top priorities in the draft program of former premier Silvio Berlusconi’s Forza Italia party… The program aims to relaunch the euro region’s third-biggest economy…and recoup the ground lost in the double-dip, record-long recession of the 2008-2013 period. …Forza Italia’s plan doesn’t cite a level for the planned flat income tax for individuals, Berlusconi has said in recent television interviews it should be 23 percent or even below that. The written draft plan says a flat tax would also apply to companies. The program pursues the balanced budget of the Italian state and calls public debt below 100 percent of GDP a “feasible” goal. It is currently above 130 percent.

Wow. As a matter of principle, I think a 23-percent rate is too high.

But compared to Italy’s current tax regime, 23 percent will be like a Mediterranean version of Hong Kong.

So can this happen? I’m not holding my breath.

The budget numbers will be the biggest obstacle to tax reform. The official number crunchers, both inside the Italian government and at pro-tax bureaucracies such as the International Monetary Fund, will fret about the potential for revenue losses.

In part, those concerns are overblown. The high tax rates of the current system have hindered economic vitality and helped to produce very high levels of evasion. If a simple, low-rate flat tax is adopted, two things will happen.

  • There will be more revenue than expected because of better economic performance.
  • There will be more revenue than expected because of a smaller underground economy.

These things are especially likely in Italy, where dodging tax authorities is a national tradition.

That being said, “more revenue than expected” is not the same as “more revenue.” The Laffer Curve simply says that good policy produced revenue feedback, not that tax cuts always pay for themselves (that only happens in rare circumstances).

So if Italy wants tax reform, it will also need spending reform. As I noted when commenting on tax reform in Belgium, you can’t have a bloated public sector and a decent tax system.

Fortunately, that shouldn’t be too difficult. I pointed out way back in 2011 that some modest fiscal restraint could quickly pay big dividends for the nation.

But can a populist-minded Berlusconi (assuming he even wins) deliver? Based on his past record, I’m not optimistic.

Though I’ll close on a hopeful note. Berlusconi and Trump are often linked because of their wealth, their celebrity, and their controversial lives. Well, I wasn’t overly optimistic that Trump was going to deliver on his proposal for a big reduction in the corporate tax rate.

Yet it happened. Not quite the 15 percent rate he wanted, but 21 percent was a huge improvement.

Could Berlusconi – notwithstanding previous failures to reform bad policies – also usher in a pro-growth tax code?

To be honest, I have no idea. We don’t know if he is serious. And, even if his intentions are good, Italy’s parliamentary system is different for America’s separation-of-powers systems and his hands might be tied by partners in a coalition government. Though I’m encouraged by the fact that occasional bits of good policy are possible in that nation.

And let’s keep in mind that there’s another populist party that could win the election And its agenda, as reported by Bloomberg, includes reckless ideas like a “basic income.”

…economic malaise is increasingly common across Italy, where unemployment tops 11 percent and the number of people living at or below the poverty line has nearly tripled since 2006, to 4.7 million last year, or almost 8 percent of the population… “Poverty will be center stage in the campaign,” says Giorgio Freddi, professor emeritus of political science at the University of Bologna. …Five Star is a fast-growing group fueled by anger at the old political class. …a €500 ($590) monthly subsidy to the disadvantaged…is a key plank in Five Star’s national platform, and the group’s leaders have promised to quickly implement such a program if they take power. Beppe Grillo, the former television comedian who co-founded the party, says fighting poverty should be a top priority. A basic income can “give people back their dignity,”… The Five Star program echoes universal basic income schemes being considered around the world. …Five Star says the plan would cost €17 billion a year, funded in part by…tax hikes on banks, insurance companies, and gambling.

Ugh. Basic income is a very troubling idea.

I’ve already speculated about whether Italy has “passed the point of no return.” If the Five Star Movement wins the election and makes government even bigger, I think I’ll have an answer to that question.

Which helps to explain why I wrote that Sardinians should secede and become part of Switzerland (where a basic income scheme was overwhelmingly rejected).

In conclusion, I suppose I should point out that a flat tax would be very beneficial for Italy’s economy, but other market-friendly reforms are just as important.

P.S. Some people, such as Eduardo Porter in the New York Times, actually argue that the United States should be more like Italy. I’m not kidding.

P.P.S. When asked about my favorite anecdote about Italian government, I’m torn. Was it when a supposedly technocratic government appointed the wrong man to a position that shouldn’t even exist? Or was it when a small town almost shut down because so many bureaucrats were arrested for fraud?

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The left’s fixation on reducing inequality is misguided. If they really care about the poor, they instead should focus on reducing poverty.

And that means pushing for more growth. We know from U.S. evidence and global evidence that better economic performance is the effective way to boost living standards for the less fortunate (I also recommend a look at the data from China).

Unfortunately, many folks on the left pursue policies that undermine prosperity and actually exacerbate inequality. I put together some examples back in 2015, and now it’s time to expand that list.

A report from the left-leaning Brookings Institution looks at how regulations protect – and enrich – the top 1 percent.

The real cause of elite inequality is the lack of open access and market competition in elite investment and labor markets. To bring the elite down to size, we need to make them compete. …people working in the securities industry (which includes investment banks and hedge funds) earn 26 percent more, regardless of skill. Those working in legal services get a 23 percent pay raise. These are among the two industries with the highest levels of “gratuitous pay”—pay in excess of skill… Using microdata from the Census Bureau, I find that the “gratuitous pay” premium in certain industries has increased dramatically since 1980. …The accredited investor…rules contribute to inequality by giving the richest investors privileged access to the best investment strategies. …If the law was changed to allow mutual funds to offer hedge fund portfolios, hundreds of billions of dollars would be transferred annually from super-rich hedge fund managers and investment bankers to ordinary investors, and even low-income workers with retirement plans. …politicians and intellectuals often champion market competition—but what they mean by that is competition among low-paid service workers, production workers, or computer programmers who face competition from trade and immigration, while elite professionals sit behind a protectionist wall. …For lawyers, doctors, and dentists— three of the most over-represented occupations in the top 1 percent—state-level lobbying from professional associations has blocked efforts to expand the supply of qualified workers who could do many of the “professional” job tasks for less pay.

Matt Ridley, a columnist fo the U.K.-based Times, writes about the pernicious impact of cronyism, licensing, and industrial policy.

The history of industrial strategies is littered with attempts to pick winners that ended up picking losers. Worse, it is government intervention, not laissez faire, that has done most to increase inequality and to entrench wealth and privilege. For example, the planning system restricts the supply of land for housebuilding, raising property prices to the enormous benefit of the haves (yes, that includes me) at the expense of the have-nots. …Why are salaries so high in financial services? Because there are huge barriers to entry erected by government, which hands incumbent firms enormous quasi-monopoly advantages and thereby shelters them from upstart competition. …Why are lawyers so rich? Because there is a government-licensed cartel restricting the supply of them. …Our current “industrial strategy” for energy — to subsidise offshore wind, solar, biomass and nuclear — is responsible for the fact that domestic electricity prices are the seventh highest… Domestic electricity bills are a higher proportion of household budgets for the poor than for the rich, so this policy is regressive; doubly so, because the wind and solar subsidies mostly go to the rich. 

Let’s consider health policy. Folks on the left favor the healthcare exclusion in the tax code because government supposedly should play a role in encouraging health insurance. What’s the impact of this policy? Well, let’s peruse a Robert Samuelson column on health policy and inequality, which is based on a study from the Mercatus Center.

…add health care to the causes of growing wage inequality in America. There’s a largely unknown paradox at work. Companies that try to provide roughly equal health insurance plans for their workers — as many do — end up making wage and salary inequality worse. …It’s simple arithmetic… Paying for expensive health insurance squeezes what’s left for wage and salary raises. Economic inequality increases, because health insurance typically represents a larger share of total compensation for lower-paid than higher-paid workers. Their wages are squeezed the most. …Even though the company raised its compensation package by 5 percent for all workers, the wage and salary gap between the best- and worst- paid workers widened. Pursuing one type of equality (health coverage) inadvertently worsened another type of inequality (wages and incomes). …From 1992 to 2010, about half the increase in wage and salary inequality is explained by rising health costs.

We’ll close with a new study by an economist at the University of Michigan for the National Bureau of Economic Research.

The three major reforms that I will analyze are: (1) the state income tax introduction, (2) the introduction of withholding, bundled with the introduction of third-party reporting, and (3) the intergovernmental agreement between the federal and the state governments for coordinating auditing practices. …the introduction of the income tax raised the Atkinson inequality index by 0.015, which is about 7 percent of the sample mean, statistically significant at the 1 percent level. …The income tax introduction raised the Gini coefficient by 0.014, which is about 3 percent, significant at the 5 percent level. …All of the three reforms raised the Theil index in a statistically significant way, at least at the 5 percent level. The introduction of the income tax and of the withholding raised it by about 0.06… In other words, the fact that the only effect that these reforms had in common was raising the revenues from income tax and making the government bigger and the private sector smaller, suggest that a bigger government, at least in the recent history, had the effect of higher inequality.

Here’s a chart from Professor Troiano’s research. Note how the rich got richer at the point (“0”) the income tax was implemented.

And here’s a look at what happened to various measures of inequality. Again, pay attention to the point (“0”) where the income tax was imposed.

Writing for PJ Media, Simon Constable discusses some implications of the NBER report.

Income taxes don’t reduce income inequality. Instead they do quite the opposite, according to December-dated analysis published by the National Bureau of Economic Research. The paper looked at three major 20th century U.S. tax reforms and found that they did nothing to decrease income inequality and everything to increase it. …Why did income inequality increase when that wasn’t the goal of the reforms? …bigger government ends up retarding the private sector and reducing the size of the wealth pie. Naturally, the poorer come out worst in such a situation, while the well-heeled can get top tier advice to dodge the tax bullet. Hence, the rich get richer and the poor stay skint. …Nobody who believes in liberty, or public choice theory, will be surprised to learn that higher taxes lead to more inequality,” says Robert E. Wright, professor of political economy at Augustana University in South Dakota. The problem is that the elites in any society, including the U.S., control the government and they quite naturally take care of themselves first, he says.

The bottom line is that our statist friends claim that they’re shooting at the rich, but the poor tend to suffer the most damage.

If you want more evidence, look at what happened to income for various groups during the pro-free market era of the 1980s and 1990s compared to what’s happened so far this century.

P.S. The most twisted look at inequality was produced by the IMF, which implied that radically lower living standards would be acceptable if everyone was more equally poor.

P.P.S. The most satirical look at inequality comes from David Azerrad.

P.P.P.S. The most insightful comment on inequality comes from Johan Norberg, who reminds us that we should be upset by unfairness, not inequality.

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I was not optimistic about a Trump presidency. Before the 2016 election, I characterized him as a “statist” and a “typical big-government Republican.”

I’ve also criticized his policies on entitlements, trade, child care, capital gains taxation, government spending, and infrastructure.

But one good thing about being libertarian is that I feel no pressure to spin. I will criticize politicians who I normally like and praise politicians I normally dislike.

So I’ve also applauded some of Trump’s policies, whether they are big reforms like a cut in the corporate income tax or small changes like killing Obama’s Operation Chokepoint.

Today, I’m going to give Trump some credit for what’s happening with regulation and red tape.

Wayne Crews of the Competitive Enterprise Institute measures the change.

The calendar year concluded with 61,950 pages in the Federal Register… This is the lowest count since 1993’s 61,166 pages. …A year ago, Obama set the all-time Federal Register page record with 95,894 pages. Trump’s Federal Register is a 35 percent drop from Obama’s record… After the National Archives processes all the blank pages and skips in the 2017 Federal Register, Trump’s final count will ultimately be even lower.

Here’s a visual that captures what has happened.

Wayne explains that the numbers of rules have dropped in addition to the number of pages.

…the Federal Register may be a poor guide for regulation… The “problem” of assessing magnitude is even worse this year, because many of Trump’s “rules” are rules written to get rid of rules. …There has also been a major reduction in the number of rules and regulations under Trump. Today the Federal Register closed out with 3,281 final rules within its pages. This is the lowest count since records began being kept in the mid-1970s.

Susan Dudley of George Washington University looked at what’s happening to regulation for Forbes.

…what has the administration achieved on the regulatory front in 2017? …President Trump issued Executive Order 13771 directing federal agencies to remove two regulations for every new one they issued, and to cap the total cost of new regulations at zero. …An Office of Management and Budget report…finds that during the first eight months of the administration (through September 30th), executive agencies issued 67 deregulatory actions and only 3 significant regulatory actions. …More meaningful is the report’s estimate that these actions will save Americans more than $570 million per year on net. …This was the year of the Congressional Review Act. Working with the Republican Congress, President Trump has disapproved 15 regulations, most issued at the end of the Obama administration.

She looks specifically at regulations that involve a lot of money.

The pace of new regulation has visibly slowed in the Trump administration. A search of OMB’s database reveals that, between January 21 and December 20, 2017, the Office of Information and Regulatory Affairs concluded review of 21 “economically significant” regulations—those with impacts (costs or benefits) expected to be $100 million or more in a year. As the chart below shows, that is dramatically fewer rules than previous presidents have issued in their first years.

Here’s an impressive chart from her column.

And here’s most impressive part. Some of these “significant” rules are actually designed to reduce red tape.

…a further breakdown of those 21 economically significant actions this year: …Three are classified as “regulatory,” including two from HHS and one from the IRS. …Four are “deregulatory,” including three HHS rules as well as the congressionally-disapproved FAR rule mentioned earlier.

So what does this shift in regulation mean?

Well, as the New York Times has just reported, less red tape is good for the economy.

A wave of optimism has swept over American business leaders, and it is beginning to translate into the sort of investment in new plants, equipment and factory upgrades that bolsters economic growth, spurs job creation — and may finally raise wages significantly. …the newfound confidence was initially inspired by the Trump administration’s regulatory pullback, not so much because deregulation is saving companies money but because the administration has instilled a faith in business executives that new regulations are not coming.

I fully agree with this point.

What seems to be helping growth is that companies are getting some “breathing room” simply because the regulatory onslaught of the Bush and Obama years has finally abated.

…in the administration and across the business community, there is a perception that years of increased environmental, financial and other regulatory oversight by the Obama administration dampened investment and job creation — and that Mr. Trump’s more hands-off approach has unleashed the “animal spirits” of companies that had hoarded cash after the recession of 2008. …with tax cuts coming and a generally improving economic outlook, both domestically and internationally, economists are revising growth forecasts upward for last year and this year. Even before it became clear that Republicans would pass a major tax cut, capital spending had risen significantly, climbing at an annualized rate of 6.2 percent during the first three quarters of last year. Surveys of planned spending also show increases. …business executives are largely convinced that the cost of complying with rules diverts money that could be invested elsewhere. And economists see a plausible connection between Mr. Trump’s determination to prune the federal rule book and the willingness of businesses to crank open their vaults. Measures of business confidence have climbed to record heights during Mr. Trump’s first year. …The Business Roundtable, a corporate lobbying group in Washington, reported last month that “regulatory costs” were no longer the top concern of American executives, for the first time in six years. …The National Association of Manufacturers’ fourth-quarter member survey found that fewer than half of manufacturers cited an “unfavorable business climate” — including regulations and taxes — as a challenge to their business, down from nearly three-quarters a year ago.

The bottom line is that Trump has out-performed my expectations on this issue.

But I don’t care about that. I’m more interested in a freer and more prosperous America.

So when you’re contemplating the shift in regulatory policy, here are a few factoids.

  • Americans spend 8.8 billion hours every year filling out government forms.
  • The economy-wide cost of regulation is now $1.75 trillion.
  • For every bureaucrat at a regulatory agency, 100 jobs are destroyed in the economy’s productive sector.
  • A World Bank study determined that moving from heavy regulation to light regulation “can increase a country’s average annual GDP per capita growth by 2.3 percentage points.”
  • The European Central Bank estimated that product market and employment regulation has led to costly “misallocation of labour and capital in eight macro-sectors.”

Red tape accounts for 20 percent of a nation’s grade according to Economic Freedom of the World. If the current deregulatory momentum is sustained, the United States will rise in the rankings and Americans will be richer.

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Now that we have a final bill rather than a mere “agreement in principle,” let’s step back and consider some implications of tax reform.

There are three reasons to be pleased and one reason to worry.

Win: Less-destructive federal tax code

There are several provisions of the tax bill that will boost the economy, most notably dropping the federal corporate tax rate from 35 percent to 21 percent. Slightly lower individual tax rates will also help growth, as will provisions such as the expanded death tax exemption and the mitigation of the alternative minimum tax.

How much faster will the economy perform? There are several estimates, with microeconomic-based models predicting better outcomes that Keynesian-based models. Here are some findings from two market-based models.

From the Tax Foundation:

…we estimate that the plan would increase long-run GDP by 1.7 percent. The larger economy would translate into 1.5 percent higher wages and result in an additional 339,000 full-time equivalent jobs. Due to the larger economy and the broader tax base, the plan would generate $600 billion in additional permanent revenue over the next decade on a dynamic basis. Overall, the plan would decrease federal revenues by $1.47 trillion on a static basis and by $448 billion on a dynamic basis.

From the Heritage Foundations:

We project that the final bill will increase the level of gross domestic product (GDP) in the long run by 2.2 percent. To put that number in perspective, the increase in GDP translates into an increase of just under $3,000 per household. Though we only estimate the change in GDP over the long run, most of the increase in GDP would likely occur within the 10-year budget window. …the final bill would increase the capital stock related to equipment by 4.5 percent, and the capital stock related to structures by 9.4 percent. We also estimate that the number of hours worked would increase by 0.5 percent.

And here is an estimate from a partially market-based model at the Joint Committee on Taxation:

We estimate that this proposal would increase the level of output (as measured by real Gross Domestic Product (“GDP”) by about 0.7 percent on average over the 10-year budget window. That increase in output would increase revenues, relative to the conventional estimate of a loss of $1,436.8 billion by about $483 billion over that period. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $55 billion over the budget period. We expect that both an increase in GDP and resulting additional revenues would continue in the second decade after enactment, although at a lower level.*

And here is an estimate from a Keynesian-oriented model at the Tax Policy Center:

We find the legislation would boost US gross domestic product (GDP) 0.8 percent in 2018 and would have little effect on GDP in 2027 or 2037. The resulting increase in taxable incomes would reduce the revenue loss arising from the legislation by $186 billion from 2018 to 2027 (around 13 percent).

For what it’s worth, the market-based (or microeconomic-based) models are more accurate since they are based on the impact of tax-rate changes on incentives to engage in productive behavior.

That being said, proponents of tax reform should not expect Hong Kong-style growth. First, this is only a modest version of tax reform, not a game-changing step such as a simple and fair flat tax. As George Will opined today, “On a scale of importance from one (negligible) to 10 (stupendous), the legislation might be a three.”

Second, keep in mind that fiscal policy only accounts for about 20 percent of a nation’s economic performance. And if taxes and spending each account for half of that grade, policymakers in Washington have positively impacted a variable that determines 10 percent of America’s prosperity.

That may sound discouraging, but even small differences in economic growth make a big difference if sustained over time. As I noted in 2014:

…very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years.

Win: Pressure for better tax policy in other nations

I consider myself to be the world’s bigger cheerleader and advocate of tax competition. I’ve even risked getting thrown in jail to promote fiscal rivalry between nations. And I’ve written several times about how this tax reform package is good because it will encourage better tax policy abroad (see here, here, and here).

I’ll bolster my argument today by sharing some excerpts from a Wall Street Journal editorial.

German economists at the Center for European Economic Research (ZEW) released a study last week finding that U.S. corporate tax reform will sharply improve incentives for foreigners to invest in America—at the expense of high-tax countries such as Germany. …In the ZEW model, U.S. firms needed a return of around 7.6% for an investment to be profitable under pre-reform tax law, compared to an EU average of 6%, and 5.7% in low-tax Ireland. The U.S. reform changes all this. America’s statutory and effective corporate rates will both be near the EU average, essentially even with Britain and the Netherlands and well below France (a 39% headline rate) and Germany (31%). …Companies from low-tax Ireland, high-tax Germany and the EU as a whole would all see their effective tax rates and their cost of capital for U.S. investment plummet under the reform.

Another German think tank reached a similar conclusion.

US administrations have refrained from any major corporate tax reform since that implemented by Reagan in 1986. This passivity has been remarkable in the sense that most industrial countries have put forward considerable corporate tax cuts in the last decades. This long period of inaction has now come to an end. …Without doubt, this far reaching corporate tax reform of the largest economy will change the setting of international tax competition.

And how will it change the setting?

First, a caveat. The German study looked at the likely impact of a 20-percent corporate rate, so keep in mind that updated numbers to reflect the 21-percent rate in the final deal would look slightly different.

Second, the corporate tax burden in the United States is still going to higher than the European average, even after the 21-percent rate is implemented. Here’s a chart from the German study and I’ve highlighted the current U.S. position and the post-tax reform position (“US_20%_Dep” is where we would be if “expensing” had been included).

Third, even though the reduction in the corporate rate is just a modest step in the right direction, it’s going to yield major benefits.

The US tax reform will affect the net-of-tax profitability of both inbound and outbound FDI as well as domestic investments. …in the case of Germany the reduction in the tax burden for German FDI in the US outweighs the reduction of the tax burden for US outbound FDI in Germany by almost factor 3. …FDI stocks in a country increases by 2.49% if the tax rate is reduced by one percentage point. … despite the overall expansion after the US tax reform which is expected to foster FDI in all countries, the US will benefit disproportionally by additional inward FDI. This comes at the cost of European countries which will face increasing outbound FDI flows to the US which are not accompanied with inbound FDI flows from the US in the same amount. …After the implementation of the US corporate tax reform, manufacturing FDI be particularly expanded. The US will attract additional inbound FDI of 113.5 billion EUR from investors located in the EU28. … European high-tax jurisdictions such as Germany will most likely be confronted with a higher net outflow of investments than European low-tax jurisdictions such as Ireland. Ultimately, the European high-tax jurisdictions will lose ground in the competition for FDI.

And here’s another chart from the study. It shows that it will be somewhat more profitable for U.S. companies to compete abroad, and a lot more profitable for foreign investors to put money in America.

Win: Pressure for better state tax policy

As I’ve repeatedly argued, getting rid of the deduction for state and local taxes is a very desirable policy. On the federal level, it’s good because that reform frees up some revenue that can be used to offset lower tax rates. On the state level, it’s good because politicians in high-tax areas will now feel a lot of pressure to lower tax rates.

Or, if you look at the glass being half empty, they’ll feel pressure not to further increase tax rates.

The Wall Street Journal has a new editorial on this topic, asking “how much will they have to cut income-tax rates to retain and attract the high-income earners who finance so much of their state budgets?”

The mere possibility is caused great angst in some circles.

New York Gov. Andrew Cuomo last weekend declared that the GOP bill’s limit on the state-and-local tax deduction will trigger “an economic civil war” between high- and low-tax states. California Governor Jerry Brown has likened Republicans to “mafia thugs” while Mr. Cuomo calls the bill a “dagger at the economic heart of New York.”

Though only a select slice of taxpayers will be impacted, and some of them are in red states.

…the tax math will be tricky for many high-earners in states with the highest tax rates. …high earners in states with top rates exceeding 6.56% could see their tax bills increase. The nearby table shows the 17 states with top income-tax rates exceeding 6.56%. The four with the highest income tax rates have Democratic Governors—California, New York, Oregon and Minnesota—and liberal political cultures heavily influenced by public unions. …Iowa ranks fifth with a top rate of 8.98% that hits at a mere $70,785 for married couples, which is more punitive than even New Jersey’s 8.87% that hits households making more than $500,000. Wisconsin (7.65%), Idaho (7.4%), South Carolina (7%), Arkansas (6.9%) and Nebraska (6.84%) are among Donald Trump -voting states that also make the high-tax list. …This ought to put pressure on high-tax Midwestern states such as Wisconsin, Iowa and Minnesota to reduce their rates.

But the ultra-high-tax blue states are the ones that will really feel the squeeze to lower tax rates.

…limiting the deduction will increase the existing rate divide between high- and low-tax states. New York, New Jersey and Connecticut have been losing billions of dollars each year in adjusted gross income from high earners fleeing to lower tax climes like Florida. Nevada will become an even more attractive tax haven for wealthy Californians. The problem is more acute when you consider that the top 1% of earners pay nearly 50% of state income taxes in California and New York, and 37% in New Jersey. States may experience significant budget carnage if more high earners defect. To head off a high-earner revolt, Mr. Cuomo could seek to eliminate the millionaire’s tax he campaigned against in 2010 but has repeatedly extended. Mr. Brown could campaign to repeal the 3% surcharge on millionaires he championed in 2012.

Loss: Failure to restrain federal spending puts tax reform at risk

Now that we’ve looked at three reasons to be optimistic about tax reform, let’s close with some grim news.

Republicans could have produced a far bolder tax reform plan had they been willing to restrain spending. That didn’t happen.

Instead, they only were able to produce a tax bill that featured a very modest – and temporary – amount of tax relief.

And because they were constrained by the budget numbers, many of the provisions impacting individuals are sunset at the end of 2025.

It’s not just a question of not doing the right thing. Republicans are actually making matters worse on the spending side of the budget. They are busting the budget caps and doing a lot of so-called emergency spending.

All this will come back to bite them when it’s time extend (or, better yet, make permanent) the provisions that are scheduled to expire. The bottom line if that it’s impossible to have a good tax code with an ever-growing burden of government spending.

* The Joint Committee on Taxation estimate is for the House-passed version of tax reform. An estimate of the final bill hasn’t been released, though it presumably will be similar.

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Adopting tax reform (even a watered-down version of tax reform) is not easy.

  • Some critics say it will deprive the federal government of too much money (a strange argument since it will be a net tax increase starting in 2027).
  • Some critics say it will make it more difficult for state and local governments to raise tax rates (they’re right, but that’s a selling point for reform).
  • Some critics say it will make debt less attractive for companies compared to equity (they’re right, though that’s another selling point for reform).
  • Some critics say it will cause capital to shift from residential real estate to business investment (they’re right, but that’s a good thing for the economy).

Now there’s a new obstacle to tax reform. Senator Marco Rubio says he wants some additional tax relief for working families. And he’s willing to impose a higher corporate tax rate to make the numbers work.

That proposal was not warmly received by his GOP colleagues since the 20-percent corporate rate was perceived as their biggest achievement.

But now Republicans are contemplating a 21-percent corporate rate so they have wiggle room to lower the top personal tax rate to 37 percent. Which prompted Senator Rubio to issue a sarcastic tweet about the priorities of his colleagues.

Since tax reform is partly a political exercise, with politicians allocating benefits to various groups of supporters, there’s nothing inherently accurate or inaccurate about Senator Rubio’s observation.

But since I inhabit the wonky world of public finance economics, I want to explain today that there are some adverse consequences to Rubio’s preferred approach.

Simply stated, not all tax cuts are created equal. If the goal is faster economic growth, lawmakers should concentrate on “supply-side” reforms, such as reducing marginal tax rates on work, saving, investment, and entrepreneurship (in which case, it’s a judgement call on whether it’s best to lower the corporate tax rate or the personal tax rate).

By contrast, family-oriented tax relief (a $500 lower burden for each child in a household, for instance) is much less likely to impact incentives to engage in productive behavior.

Most supporters of family tax relief would agree with this economic analysis. But they would say economic growth is not the only goal of tax reform. They would say that it’s also important to make sure various groups get something from the process. So if big businesses are getting a lower corporate rate, small businesses are getting tax relief, and investors are getting less double taxation, isn’t it reasonable to give families a tax cut as well?

As a political matter, the answer is yes.

But here’s my modest contribution to this debate. And I’m going to cite one of my favorite people, myself! Here’s an excerpt from a Wall Street Journal column back in 2014.

The most commonly cited reason for family-based tax relief is to raise take-home pay. That’s a noble goal, but it overlooks the fact that there are two ways to raise after-tax incomes. Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important.

Now let’s put this in visual form.

Let’s imagine a working family with a modest income. What’s best for them, a $1,000 tax cut because they have a couple of kids or some supply-side tax policy that produces faster growth?

In the short run, compared to the option of doing nothing (silver line), both types of tax reform benefit this hypothetical family with $25,000 of income in 2017.

But the family tax relief (blue line) is better for their household budget than supply-side tax cuts (orange line).

But what if we look at a longer period of time?

Here’s the same data, but extrapolated for 50 years. And since there’s universal agreement that the status quo is not good for our hypothetical family, let’s simply focus on the difference between family tax relief (again, blue line) and supply-side tax cuts (orange line).

And what we find is that the family actually has more income with supply-side reform starting in 2026 and the gap gets larger with each subsequent year. In the long run, the family is much better off with supply-side tax policies.

To be sure, I’ve provided an artificial example. If you assume growth only increases to 2.4 percent rather than 2.5 percent, the numbers are less impressive. Moreover, what if the additional growth only lasts for a period of time and then reverts back to 2.3 percent?

And keep in mind that money in the future is not as valuable as money today, so the net benefit of picking supply-side tax cuts would not be as large using “present value” calculations.

Last but not least, the biggest caveat is that these two charts are based on the example in my Wall Street Journal column and are not a comparison of the different growth rates that might result from a 20-percent corporate tax rate compared to a 21-percent rate (even a wild-eyed supply-side economist wouldn’t project that much additional growth from a one-percentage-point difference in tax rates).

In other words, I’m not trying to argue that a supply-side tax cut is always the answer. Heck, even supply-side reform plans such as the flat tax include very generous family-based allowances, so there’s a consensus that taxpayers should be able to protect some income from tax and that those protections should be based on family size.

Instead, the point of this column is simply to explain that there’s a tradeoff. When politicians devote more money to family tax relief and less money to supply-side tax cuts, that will reduce the pro-growth impact of a tax plan. And depending on the level of family tax relief and the amount of foregone growth, it’s quite possible that working families will be better off with supply-side reforms.

P.S. A separate problem with Senator Rubio’s approach is that he wants his family tax relief to be “refundable,” which is a technical term for a provision that gives a tax cut to people who don’t pay tax. Needless to say, it’s impossible to give a tax cut to someone who isn’t paying tax. The real story is that “refundable tax cuts” are actually government spending. But instead of having a program where people sign up for government checks, the spending is laundered through the tax code.

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Whenever I discuss education policy with one of my leftist friends, it usually follows the same script.

They’ll ask whether I want good education for kids. I’ll say yes. They’ll then say we should devote more money to government schools.

I then show them this powerful chart and point out that we’ve been following their approach for 40-plus years and that it hasn’t worked.

None of them has ever had an effective or coherent response.

I then point out that the United States spends far more than other developed nations, on a per-pupil basis. Yet our national test scores are dismal compared to other developed nations.

Once again, none of them has ever had an effective or coherent response.

The simple reality if that giving more money to government schools is a foolish gesture.

Today, we’re going to look at some additional evidence.

Research from the World Bank pours cold water on the notion that more money for teachers leads to better outcomes for students.

…countries sometimes implement large increases in public-sector salaries to attract higher-quality applicants to government jobs and to better motivate existing employees. …understanding the extent to which unconditional pay increases make incumbent public-sector workers more motivated and productive is a key consideration in evaluating the cost effectiveness of such salary increases. …In this paper, we provide experimental evidence on the impact of a large unconditional salary increase on the effort and productivity of incumbent public employees. Our study was conducted in the context of a policy change in Indonesia that permanently doubled the base pay of eligible civil-service teachers… The reform moved teacher salaries from the 50th to the 90th percentile of the college-graduate salary distribution. Civil-service teachers in Indonesia also enjoy generous benefits and high job security, and quit rates were very low even before the pay increase. Thus, the teachers in our study are typical of public-sector employees in many low- and middle-income countries, who hold highly coveted jobs and enjoy a significant wage premium relative to their private-sector counterparts.

So what were the results of this experiment? The good news, as you might expect, is that teachers were quite happy.

The experiment significantly improved measures of teacher welfare: At the end of two and three years of the experiment, teachers in treated schools had higher income, were more likely to be satisfied with their income, and were less likely to report financial stress.

But for those of us who actually want better education for children, the results were not very satisfactory.

…despite this improvement in incumbent teachers’ pay, satisfaction, …the policy did not improve either their effort or student learning. Teachers in treated schools did not score better on tests of teacher subject knowledge, and we find no consistent pattern of impact on self-reported measures of teacher attendance. Most importantly, we find no difference in student test scores in language, mathematics, or science across treatment and control schools. …Finally, we use the school-level random assignment as an instrumental variable for being taught by a certified teacher in a given year, and find no improvement in student test scores from being taught by a certified teacher (relative to students in control schools taught by similar “target” teachers). These effects are also precisely estimated…our results are consistent with other studies finding no correlation between teacher salaries in the public sector and their teaching effectiveness (Muralidharan and Sundararaman 2011, Bau and Das 2017), and with studies finding that contract teachers who are paid much lower salaries than civil-service teachers are no less effective (Muralidharan and Sundararaman 2013, Duflo, Dupas, and Kremer 2015, Bau and Das 2017).

Indonesia is not similar to the United States, so some people will want to dismiss these finding.

But the authors note that U.S.-focused studies have reached the same conclusion.

Our results are consistent with prior studies finding no correlation between in creases in teacher pay and improved student performance in the US (Hanushek 1986; Betts 1995; Grogger 1996).

If giving teachers more money doesn’t work, is it possible that spending more money on facilities will help?

Let’s look at another academic study, published in the Journal of Public Economics, for some insight. Here’s the approach used by the scholars.

In this paper we provide the most comprehensive assessment of achievement effects from school facility investments initiated and financed by local school districts. The first part of the analysis examines the impact of nearly 1400 capital campaigns initiated by 748 school districts in the state of Texas over a 14-year period. …We examine the impact of capital campaigns on student outcomes using information on all tested students in the state over this time period, which includes all 3rd through 8th graders and 10th or 11th graders that take the state’s high school exit exam.

And here are the very disappointing results.

…the second part of the study directly measures the effect of capital investment on students actually exposed to it by analyzing more than 1300 major campus renovations. Controls for lagged individual test scores permit us to address changes in student composition resulting from capital investment, analogous to “value-added” models of teacher effectiveness. With or without this adjustment, we find no evidence of achievement effects of major campus renovations, even for renovations that appear to have generated large improvements in school facility conditions. Our estimates are sufficiently precise such that we can rule out positive effects larger than about 0.02 for math and 0.01 for reading for the first four years following a campus renovation.

By the way, I’m not arguing that pay and facilities are irrelevant. I think the takeaway from these studies is that more money doesn’t help when the underlying structure of the education system is faulty. So long as we have a centralized monopoly, more money isn’t going to help.

Unfortunately, American politicians are part of the problem.

Under President George W. Bush, the federal government spent more money on education and grabbed more control of the sector as part of the so-called No Child Left Behind initiative. That didn’t yield good results.

Under President Barack Obama, the same thing happened. Thanks to Common Core, the federal government spent more money on education and grabbed more control of the sector. That didn’t yield good results.

Indeed, a report last year for the National Center for Policy Analysis notes the dismal impact of the federal government.

Over the years, federal funding of primary and secondary education has increased, while students’ academic performance has flatlined. For instance, the high school reading and math scores on the National Assessment of Education Progress show that student performance has remained flat for the past 20 years… education reform initiatives by several administrations produced, at best, minimal improvements in student performance at a high price to taxpayers. Given its track record, the federal government should get out of the education business. Federal education reforms have failed to achieve their goals and failed to have a positive impact on education performance.

Amen. The Department of Education in Washington should be eliminated. It’s part of the problem.

Let’s close with a Reason video that looks at some absurd examples of how taxpayer money is wasted by the government school monopoly.

P.S. Let’s close with a bit of humor showing the evolution of math lessons in government schools.

P.P.S. If you want some unintentional humor, the New York Times thinks that government education spending has been reduced.

P.P.P.S. And you’ll also be amused (and outraged and disgusted) by the truly bizarre examples of political correctness in government schools.

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