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Archive for the ‘Government intervention’ Category

A couple of weeks ago, I reviewed the four major candidates running in the French presidential election and expressed general pessimism.

This Sunday, Emmanuel Macron and Marine Le Pen will face each other in the runoff election.

That’s a rather depressing choice. Macron is a former official in the disastrous big-government Hollande Administration and Le Pen is a big-government nativist who wants to preserve the welfare state (though not for immigrants).

Like choosing between Tweedledee and Tweedledum.

Not encouraging since the country needs a Ronald Reagan or Margaret Thatcher.

A column in the Wall Street Journal explains France’s untenable position.

The deeper question is whether French voters accommodate themselves to reality or cling tighter to their economic illusions. …“The French try to erase historical experience,” Pascal Bruckner tells me. The literary journalist is one of a very few classical liberals among French public intellectuals. He says his compatriots “have forgotten the experience of 1989 and only see the bad aspects of capitalism and liberal democracy.” The tragedy of France, Mr. Bruckner says, is that the country never had a Margaret Thatcher or Gerhard Schröder to implement a dramatic pro-growth program. …it wasn’t shadowy globalists who in 1999 imposed a 35-hour workweek to make overtime labor prohibitively expensive. The law was meant to encourage firms to hire more workers, but like most efforts to subjugate markets to politics, it ended up doing more harm than good. Now it’s the main barrier to hiring in a country where the unemployment rate is stuck north of 10%. Nor was it global markets that levied a corporate tax rate of 33% (plus surcharges for larger firms), a top personal rate of 45%, and a wealth tax and other “social fees” that repelled investors and forced the country’s best and brightest to seek refuge in places like London, New York and Silicon Valley. Nor did globalization build a behemoth French bureaucracy that crowds out the private economy.

Yes, France is in a mess because of statism. Hard to argue with that.

The question is whether Macron or Le Pen will make things better or worse.

With pervasive lack of enthusiasm, I suppose Macron is the preferable choice. There’s at least a chance he’ll be a reformer. Let’s look at how some observers view him.

We’ll start with George Will, who is not overly impressed by Macron.

The French…might confer their presidency on a Gallic Barack Obama. …Emmanuel Macron, 39, is a former Paris investment banker, untainted by electoral experience, and a virtuoso of vagueness. …This self-styled centrist is a former minister for the incumbent president, Socialist François Hollande, who in a recent poll enjoyed 4 percent approval. …In 1977, France’s gross domestic product was about 60 percent larger than Britain’s; today it is smaller than Britain’s. In the interval, Britain had Margaret Thatcher, and France resisted (see above: keeping foreigners’ ideas at bay) “neoliberalism.” It would mean dismantling the heavy-handed state direction of the economy known as “dirigisme,” which is French for sclerosis. France’s unemployment rate is 10 percent, and more than twice that for the young. Public-sector spending is more than 56 percent of France’s GDP, higher than any other European nation’s. Macron promises only to nibble at statism’s ragged edges. He will not receive what he is not seeking — a specific mandate to challenge retirement at age 62 or the 35-hour workweek and the rest of France’s 3,500 pages of labor regulations that make it an ordeal to fire a worker and thus make businesses wary about hiring. Instead, he wants a more muscular European Union , which, with its democracy deficit, embodies regulatory arrogance.

Joseph Sternberg of the Wall Street Journal is a bit more optimistic.

Optimistic pundits hope the impending victory of a fresh-faced reformer signals that France’s economy at last can be fixed. But for at least the past decade, France’s problem hasn’t been a lack of understanding in the political class of what the French economy needs. Mr. Macron is not so much a radical change-agent as a photogenic tribune for a political class that is increasingly, albeit belatedly, uniting behind the need for economic overhauls. Formerly of the center left, he won Sunday’s first round on a revitalization platform different more in degree than in kind from that of the main center-right candidate, François Fillon, on matters such as government spending cuts and labor-law reform. The global case of the vapors over Ms. Le Pen obscures how remarkable this pro-reform convergence is. …Margaret Thatcher and Ronald Reagan…remade British and American politics for a generation not through the workings of their legislative programs but through their capacity to shape public opinion. They created a coalition of the optimistic…. If the Macron program is to stick, he’ll have to do the same. He isn’t off to an auspicious start. …His message to those workers—“Take the hit for the good of the country”—lacks a certain Reaganesque resonance.

A columnist for the New York Times offers the most positive spin, portraying Macron as a Reaganite reformer.

Emmanuel Macron…attributes the nation’s woes not to outsiders — European officials and immigrants — but on France’s own “sclerotic” and unsustainable welfare state. …Mr. Macron would work to slim down one of the world’s fattest welfare states, rather than build it up as Ms. Le Pen would do. Of course France has attempted welfare state reform before, without success. The latest effort came last year, when Mr. Macron was a minister in the Socialist government, and wrote the Macron laws, opening regulated industries to competition. Those plans set off mass protests, and were watered down, but Mr. Macron says there is a big difference now: Earlier governments were not elected with a mandate to downsize the welfare state, while his could be. …the case for change has grown more urgent. …Georges Clemenceau, who served twice as prime minister between 1906 and 1920, cracked that his country was very fertile: “You plant bureaucrats and taxes grow.” Over the last decade state spending has grown even more… It’s tough to say how much state spending is too much, but France has clearly fallen out of balance, and Mr. Macron is right that the trend is “no longer sustainable.” The public payroll is similarly bloated, and Mr. Macron aims to rebalance the economy by cutting 120,000 public sector jobs, streamlining the pension system and dropping state spending back to 52 percent of G.D.P. Mr. Macron leads an emerging centrist consensus that recognizes that — more than immigrants or the euro — the main obstacle retarding France’s economy is its attachment to a welfare state culture of short workweeks and generous benefits. …In recent years France’s high income taxes have been chasing artists, executives and entrepreneurs out of the country. Last year, 12,000 millionaires emigrated — the largest millionaire exodus from any country by far. Mr. Macron — who once said that stifling taxes threaten to turn France into “Cuba without the sun” — has strong support among young, professional urban voters who would prefer opportunity at home to an expat life in London.

I hope this last column is accurate.

And the chance of Macron being good are greater than zero.

After all, it was the left-wing parties that started the process of pro-market reforms in Australia and New Zealand.

And it was a Social Democrat government in Germany that enacted the labor-market reforms that have been so beneficial for that nation.

Heck, policy even moved in the right direction when Bill Clinton was in the White House in the 1990s.

So I guess we can keep our fingers cross that Macron plays a similar role in France.

By the way, I can’t resist citing Paul Krugman’s assessment. He actually thinks France is in fairly good shape.

…what’s going on. …how did things get to this point? …France gets an amazing amount of bad press — much of it coming from ideologues who insist that generous welfare states must have disastrous effects — it’s actually a fairly successful economy. …It’s true that the French over all produce about a quarter less per person then we do — but that’s mainly because they take more vacations and retire younger… France offers a social safety net beyond the wildest dreams of U.S. progressives: guaranteed high-quality health care for all, generous paid leave for new parents, universal pre-K, and much more.

That’s an interesting spin, but maybe French people would like to earn more, but don’t have the opportunity because of bad policy?

And if things are so good in France, why are so many French people escaping to other nations?

Moreover, to the extent there are problems, Krugman says the blame belongs to the supposed pro-austerity crowd in Brussels and Berlin.

Even though Brussels and Berlin were wrong again and again about the economics — even though the austerity they imposed was every bit as economically disastrous as critics warned — they continued to act as if they knew all the answers

Yet the nations that actually cut spending – such as the Baltics – have recovered strongly. It’s the big spenders in Europe who are dragging down the continent.

And since Macron’s supposed reform agenda would only reduce the burden of government spending to 52 percent of economic output (from about 57 percent today), that’s not exactly an example of vigorous budget cutting anyway.

But it would be nice to add France to my list of nations that have – for a last a couple of years – restrained the growth of the public sector.

P.S. I have a good track record in France. The candidate I “endorsed” in 2012 won the race.

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What federal program is most sacrosanct, even though it delivers poor results?

Those are all good answers, and you could also add housing subsidies, the drug war, and lot of other example to the list of programs that enjoy lots of political support even though they produce bad results.

But I’m guessing that the activity that has the greatest level of undeserved support is government intervention for “pre-K” kids, with Head Start being the most prominent example.

I haven’t written about the failure of that particular program since 2013, which is unfortunate because two of the most compelling visuals about Head Start were released in 2014.

First, this AEI research reveals that the supposed academic consensus for the program evaporates under close examination.

Second, this table from an article in National Affairs shows that the program doesn’t produce long-run benefits.

Yet these empirical results don’t seem to influence the debate. Every year, programs such as Head Start get funded because politicians only seem to care about intentions.

And positive headlines for themselves, of course. After all, we’re supposed to believe that they care about kids because they spend other people’s money on programs with nice goals.

With this as background, now let’s zoom in on a specific example of how supposedly good intentions in this field translate into occupational restrictions that have very bad results for the less fortunate people in society.

The Washington Post reports that the city’s local government has decided that additional regulation is needed to boost the quality of programs for pre-K kids.

More than a decade after Washington, D.C., set out to create the most comprehensive public preschool system in the country, the city is directing its attention to overhauling the patchwork of programs that serve infants and toddlers.  The new regulations put the District at the forefront of a national effort to improve the quality of care and education for the youngest learners. City officials want to address an academic achievement gap between children from poor and middle-class families that research shows is already evident by the age of 18 months.

And what exactly did the city government propose to achieve these nice-sounding goals?

They’ve imposed “new licensing regulations…for child-care centers” that will mandate college degrees.

The District set the minimum credential for lead teachers as an associate degree… The deadline to earn the degree is December 2020. New regulations also call for child-care center directors to earn a bachelor’s degree and for home care providers and assistant teachers to earn a CDA.

Gee, this sounds nice. Don’t we all want the best-trained staff so that we can get the best outcomes for kids?

Yes, but let’s consider costs and benefits. Especially, as noted in the article, costs that are imposed on people without a lot of money who are working at childcare centers.

…for many child-care workers, often hired with little more than a high school diploma, returning to school is a difficult, expensive proposition with questionable reward. …prospects are slim that a degree will bring a significantly higher income — a bachelor’s degree in early-childhood education yields the lowest lifetime earnings of any major.

And poor people without a lot of money who are clients of childcare centers.

Many parents in the District are maxed out, paying among the highest annual tuitions nationally, at $1,800 a month.

And taxpayers who pick up part of the cost.

…government subsidies that help fund care…and generous funding for preschool.

In other words, imposing this kind of mandate will be rather expensive, especially for lower-income Washingtonians who either work at these centers of send their children to them.

That’s the cost side of the equation. Now let’s look at the benefits.

Except there’s no real-world evidence included in the article. Instead, all we get it some theorizing.

…a 2015 report by the National Academies that says the child-care workforce has not kept pace with the science of child development and early learning. From the first days of life, learning is complex and cumulative, the report says. Infants are capable of abstract thought, forming theories about what is happening in the physical world and whom to trust. Scientists concluded that teachers need the skills and insight to offer the kinds of learning experiences that challenge them and make them feel safe. They need tools to diagnose and intervene when they see learning or emotional problems. And they need literacy skills to introduce young learners to an expansive vocabulary, exposure many children do not have at home and are not getting in day care.

Scott Shackford of Reason is appropriately skeptical about this regulatory scheme.

Scientists say that higher education for pre-school child-care workers is a good idea. So of course D.C. is going to make it mandatory that child-care workers get associate’s degrees and completely screw over an entire class of lower-skilled workers. …The news story doesn’t engage in the question of why parents can’t decide for themselves how important it is for their child-care workers to have advanced degrees. Perhaps that’s because early education advocates might not like the answers, once the realities of the likely cost increases get factored in. …such a subsidy plan would not do much for lower-income families. And so not only would poorer families be even less able to afford child care, they’re also going to be locked out of jobs within the industry itself.

Though he does identify one group that would benefit.

To be sure, this D.C. law is a jobs program—it’s a jobs program for people who work in the field of post-secondary education itself. Nothing like using a regulatory mandate to create a demand for your educational services that might not exist otherwise. The story makes it abundantly clear that advocates for increased education of child-care workers—who, wouldn’t you know it, work in the field of education—want to spread this program well beyond D.C.’s borders.

And there’s another group of beneficiaries. The new DC regulations will be good news for childcare workers who already have college degrees. That’s because the city government is using a form of licensing to force competing workers out of the market (as Scott pointed out, the new rules “screw over…lower-skilled workers”). And that means that the college-educated workers will have more ability to extract higher salaries.

Just as unions urge higher minimum-wage mandates in order to undermine competition from other workers.

In other words, this is a classic “public choice” case study of a couple of interest groups using government coercion to unfairly line their pockets.

P.S. Speaking of public choice, here’s the real-world explanation of how a bill becomes law (h/t: Imgur).

Very accurate. I especially like the variation of Mitchell’s Law at the end.

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Donald Trump wants the federal government to subsidize child care. If enacted, this policy is sure to increase costs and lead to inefficiency, just as similar types of intervention have caused problems in both healthcare and higher education.

While Trump’s proposal is misguided, it hasn’t generated much surprise because politicians routinely try to buy votes with other people’s money.

I was surprised, however, when the normally market-friendly American Enterprise Institute began to publish articles starting a few years ago in support of government policies on the related issue of paid family leave. I was even more surprised when I saw that AEI teamed up with the left-leaning Brookings Institution on a joint “Project on Paid Parental Leave.”

This is not an April Fool’s joke.

And I’m not the only one who is perplexed that someone at AEI is pushing one of Hillary Clinton’s favorite policies. In a comment on one of the AEI articles, a reader asks a very pointed question.

…why, exactly, a purported conservative think-tank would like to impose a one-size-fits-all, top-down national policy upon all businesses in all states, regardless of cost, on the flimsy argument that ‘It’s a good thing.’

Aparna Mathur, AEI’s Co-Directors of the Project, has an article responding to the question of whether intervention from Washington can be considered pro-freedom or pro-market.

To her credit, she basically admits that the answer is no.

I see your point that encouraging a federal paid family leave plan goes against the idea of limited government. …we don’t think markets are the end-all solution here… If we don’t intervene, then that’s how it’s going to continue. …I also agree with your point that this will be a burden on businesses. …we have to be open to the idea that in some areas, markets fail or may under-provide a benefit. And in those cases, for the larger good of society…, we need to accept some sharing of costs.

But while she admits the policy is statist, she nonetheless justifies it because there ostensibly is a market failure.

I’m temped to explain why this is nonsense. After all, the fact that we can’t have everything we want because of scarcity and trade-offs is one of the reasons market exist, not evidence of failure.

But I don’t need to explain because one of Ms. Mathur’s colleagues already has done the job. Here’s some of what Benjamin Zycher wrote on this topic.

There are no free lunches, and the mere fact that expanded paid leave in isolation would be very nice for some or many workers says little about the unavoidable tradeoffs.  Would a given worker or group of workers prefer more such leave combined with lower explicit wages, or with fewer other nonwage benefits, or with employer demands for higher productivity? …with respect to the new moms returning to work soon after giving birth: Was that not their choice?  Yes, in almost all cases, and it is not clear from Mathur’s discussion precisely why such costs ought to be “shared across society.” …Whatever “socializing the costs” comes to mean, it is inevitable that the proponents of such a policy, unconcerned with the expansion of government power, will demand that businesses give something up…  So much again, for the free-lunch atmospherics: Such increases in costs will reduce employment… Which brings us to the final assertion: “In some areas, markets fail or may underprovide a benefit.”  Wow.  What does “underprovide” mean?  …there are only two basic approaches to answering that question.  The first: the outcomes emerging from competitive markets, in this case the amount of paid leave employers offer to employees and the amount that employees are willing to accept as part of total compensation, including working conditions defined broadly.  Mathur simply rejects that outcome as too little.  The second: Political determination of the appropriate amount of paid leave, in which majorities impose their will on everyone regardless of individual preferences.  Why stop at paid leave?  Why not have voters determine wages, vacation policies, dress codes, and everything else?  And are voters really qualified to do so?

I especially like Zycher’s final point. The notion that 51 percent of people should be able to dictate the terms of contracts to both employers and employees is offensive.

Indeed, rejection of untrammeled majoritarianism was one of the main goals of America’s Founders when they put together the Constitution.

And since we’re on the topic of majoritarianism, Professor Don Boudreaux explains that favorable opinion polls for mandated parental leave are both irrelevant and misleading.

Of course that’s what the polls show – which is precisely why such polls are unreliable in cases such as this.  We need take no polls to discover that people generally prefer to get benefits at a cost to them of nothing.  Such ‘information’ is hardly newsworthy.  …I want, for example, a brand new Mercedes-Maybach S600, but because I’m unwilling to pay the hefty price for the benefit that owning such a car would give to me, the correct conclusion is that I do not really want such a car given its cost.

In other words, Boudreaux and Zycher both agree that there’s no free lunch. Paid leave, mandated by government, necessarily imposes a cost.

And what’s really ironic about this issue is that some honest female analysts acknowledge that women will bear a lot of the cost. Simply stated, employers will provide them lower cash wages to offset the liability that is created by the government intervention.

P.S. To the credit of AEI, it employs one of the nation’s best scholars on the faux issue of the gender pay gap (and you know it’s a fake issue because even Obama’s economic advisor dismissed the silly claim that markets deliberately overpay men).

P.P.S. While I wish Ms. Mathur’s support for intervention was just an April Fool’s joke, at least I can share some intentional humor to celebrate the day.

We know all about leftist hypocrites, and here’s another one to add to the list (h/t: Reddit).

Needless to say, I’m not expecting Michael Moore to sell one of his many homes to help the poor, either.

If you like April Fool’s Day humor, I shared some examples back in 2013.

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There are many powerful arguments for junking the internal revenue code and replacing it with a simple and fair flat tax.

  1. It is good to have lower tax rates in order to encourage more productive behavior.
  2. It is good to get rid of double taxation in order to enable saving and investment.
  3. It is good the end distorting preferences in order to reduce economically irrational decisions.

Today, let’s review a feature of good tax reform that involves the second and third bullet points.

Under current law, there is double taxation of corporate income. This means that companies must pay a tax on income, but that the income is then taxed a second time when distributed to the owners of the company (i.e., shareholders).

This means that the effective tax rate is a combination of the corporate income tax rate and the tax rate imposed on dividends. And this higher tax rate is an example of why double taxation discourages capital formation and thus leads to lower wages.

But this double taxation of dividends also creates a distortion because there isn’t double taxation of corporate income that is distributed to bondholders. This means companies have a significant tax-driven incentive to rely on debt, which is risky for them and the overall economy.

Curtis Dubay has a very straightforward explanation of the problem.

In debt financing, a business raises money by issuing debt, usually by selling a bond. In equity financing, a business raises funds by selling a share in the business through the sale of stock. The tax system provides a relative advantage to financing capital expenditures through debt because under current tax law, businesses can deduct their interest payments on the debt instruments, but dividend payments to shareholders are not deductible. Thus, equity is disadvantaged because it is double taxed while debt correctly faces only a single layer of taxation.

By the way, when public finance people write that something is “not deductible” or non-deductible, that simply means it subject to the tax (much as the non-deductibility of imports under the BAT is simply another way of saying there will be a tax levied on all imports).

But I’m digressing. Let’s get back to the analysis. Curtis then explains why it doesn’t make sense to create an incentive for debt.

The double tax on equity makes debt a relatively more attractive way for businesses to finance themselves, all else equal. As a result, businesses will take on more debt than they otherwise might. …This is a serious problem because carrying significant amounts of debt can make businesses less stable during periods when profitability declines. Interest payments on debt are a fixed cost that businesses must pay regardless of their performance. This can be onerous and endanger a business’s solvency when profits fall.

He points out that the sensible way of putting debt and equity on a level playing field is by getting rid of the double tax on dividends, not by imposing a second layer of tax on interest.

…it does not make sense to equalize their tax treatment by eliminating interest deductibility for businesses. Doing so would further suppress economic growth, job creation, and wage increases. Instead, Congress should end the double taxation of income earned through equity financing in tax reform by eliminating taxes on saving and investment, including capital gains and dividends.

Incidentally, what Curtis wrote isn’t some sort of controversial right-wing theory. It’s well understood by every public finance economist.

The International Monetary Fund, for instance, is generally on the left on fiscal issues (and that’s an understatement). Yet in a study published by the IMF, Ruud A. de Mooij outlines the dangers of tax-induced debt.

Most tax systems today contain a “debt bias,” offering a tax advantage for corporations to finance their investments by debt. …One cannot compellingly argue for giving tax preferences to debt based on legal, administrative, or economic considerations. The evidence shows, rather, that debt bias creates significant inequities, complexities, and economic distortions. For instance, it has led to inefficiently high debt-to-equity ratios in corporations. It discriminates against innovative growth firms, impeding stronger economic growth. … recent developments suggest that its costs to public welfare are larger—possibly much larger—than previously thought. …The economic crisis has also made clear the harmful economic effects of excessive levels of debt… These insights make it more urgent to tackle debt bias by means of tax policy reform.

What’s the solution?

Well, just as Curtis Dubay explained, there are two options.

What can be done to mitigate debt bias in the tax code? In a nutshell, it will require either reducing the tax deductibility of interest or introducing similar deductions for equity returns.

And the author of the IMF study agree with Curtis that the way to create neutrality between equity and debt is by using the latter approach.

Abolishing interest deductibility would indeed eliminate debt bias, but it would also introduce new distortions into investment, and implementing it would be very difficult. …The second option, introducing a deduction for corporate equity, has better prospects. …such an allowance would bring other important economic benefits, such as increased investment, higher wages, and higher economic growth.

And Mooij even acknowledges that there’s a Laffer Curve argument for getting rid of the double tax on dividends.

The main obstacle is probably its cost to public revenues, estimated at around 0.5 percent of GDP for an average developed country. …In the long term, the budgetary cost is expected to be significantly smaller, since the favorable economic effects of the policy change would broaden the overall tax base. And in fact, a number of countries have successfully introduced variants of the allowance for corporate equity, suggesting that it is not only conceptually desirable but also practically feasible.

Another study from the International Monetary Fund, authored by Mooij and  Shafik Hebous, highlights the damage caused by luring companies into taking on excessive debt.

Excessive corporate debt levels are a serious macroeconomic stability concern. For instance, high debt can increase the probability of a firm’s bankruptcy in case of an adverse shock… Given this concern about excessive corporate debt, it is hard to understand why almost all tax systems around the world encourage the use of corporate debt over equity. Indeed, most corporate income tax (CIT) systems allow interest expenses, but not returns to equity, to be deducted in calculating corporate tax liability. This asymmetry stimulates corporations to use debt over equity to finance investment.

We get the same explanation of how to address the inequity in the tax treatment of debt and equity.

Effectively, there are two ways in which debt bias can be neutralized: either by treating equity more similar as debt by adding an allowance for corporate equity (ACE); or by treating debt more similar for taxation as equity by denying interest deductibility for corporations.

And we get the same solution. Stop double taxing dividends.

ACE systems have been quite widely advocated by economists and implemented in some countries, such as Belgium, Cyprus, Italy, Switzerland, and Turkey. Evaluations generally suggest that these systems have been effective in reducing debt bias… Yet, many countries are still reluctant to introduce an ACE due to the expected revenue loss.

By the way, the distortionary damage becomes greater when tax rates are onerous.

A recent academic study addresses the added damage of extra debt that occurs when tax rates are high.

For a country like the United States with a relatively high corporate income tax rate (a statutory federal rate of 35%), theory argues that firms in this country should have significant leverage. …The objective of our study is to estimate how much such variation in tax structure arising from global operations explains the variation in capital structure that we observe among US publicly traded multinational firms. …We employ the BEA’s multinational firm data and augment it with international tax data… Using our calculated weighted average tax rate, we include otherwise identified explanatory variables for capital structure and estimate in a multivariate regression setting how much our blended tax rate measure improves our understanding of why capital structure varies across firms and, to a lesser extent, across time. …Economically, this coefficient corresponds to a 7.1% higher book leverage ratio for a firm with a 35% average tax rate over the sample period compared to an otherwise identical firm with a 25% average tax rate. These results demonstrate that, contrary to some of the earlier literature finding that tax effects were negligible, firms that persistently confront high tax rates have significantly more debt, both economically and statistically, than otherwise equivalent firms who persistently face lower corporate income tax rates. …Irrespective of whether we examine leverage ratios based on book values or market values, whether we include cash or not, or if we alternatively examine interest coverage, we find that multinational firms confronting lower tax rates use less debt. The results are not only statistically significant, but the coefficient magnitudes suggest that these effects are first order

There’s some academic jargon in the above excerpt, so I’ll also include this summary of the paper from the Tax Foundation.

A new paper published in the Journal of Financial Economics finds that countries with high tax rates on corporate income also have higher corporate leverage ratios. …Using survey data of multinational corporations from the Bureau of Economic Analysis (BEA), the authors…find that businesses that report their income in high tax jurisdictions have corporate leverage ratios that are substantially higher than those in low tax jurisdictions. More precisely, they find that a business facing an average tax rate of 35% has a leverage ratio that is 7.1% higher than a similar firm facing an average tax rate of 25%.

By the way, here are the results from another IMF study by Mooij about how the debt bias is connected to high tax rates.

We find that, typically, a one percentage point higher tax rate increases the debt-asset ratio by between 0.17 and 0.28. Responses are increasing over time, which suggests that debt bias distortions have become more important.

The bottom line is that the U.S. corporate tax rate is far too high. And when you combine that punitive rate with a distortionary preference for debt over equity, the net result is that we have companies burdened by too much debt, which puts them (and the overall economy) in danger when there’s a downturn.

So the obvious solution (beyond simply lowering the corporate rate, which should be a given) is to get rid of the double tax on dividends.

The good news is that Republicans want to move in that direction.

The not-so-good news is that they are not using the ideal approach. As I noted last year, the “Better Way Plan” proposed by House Republicans is sub-optimal on this issue.

Under current law, companies can deduct the interest they pay and recipients of interest income must pay tax on those funds. This actually is correct treatment, particularly when compared to dividends, which are not deductible to companies (meaning they pay tax on those funds) while also being taxable for recipients. The House GOP plan gets rid of the deduction for interest paid. Combined with the 50 percent exclusion for individual capital income, that basically means the income is getting taxed 1-1/2 times. But that rule would apply equally for shareholders and bondholders, so that pro-debt bias in the tax code would be eliminated.

For what it’s worth, I suggest this approach was acceptable, not only because the debt bias was eliminated, but also because of the other reforms in the plan.

…the revenue generated by disallowing any deduction for interest would be used for pro-growth reforms such as a lower corporate tax rate.

Though I can’t say the same thing about the border-adjustability provision, which is a poison pill for tax reform.

P.S. While the preference for debt is quite harmful, I nonetheless still think the worst distortion in the tax code is the healthcare exclusion.

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I’m flabbergasted when people assert that America’s costly and inefficient healthcare system is proof that free markets don’t work.

In hopes of helping them understand what’s really going on, I try to explain to them that an unfettered market involves consumers and producers directly interacting with their own money in an open and competitive environment.

I then explain why that’s not a description of the U.S. system. Not even close. As I noted in Part I, consumers directly finance only 10.5 percent of their healthcare expenses. Everything else involves a third-party payer thanks to government interventions such as Medicare, Medicaid, the healthcare exclusion, the Veterans Administration, etc.

Obamacare then added another layer of intervention to the existing mess. By my rough calculations, that costly boondoggle took the country from having a system that was 68-percent controlled and dictated by government to a system where government dictates and controls 79 percent of the system.

This is very relevant because Republicans in Washington are now trying to “repeal and replace” Obamacare, but they’re confronting a very unpleasant reality. Undoing that legislation won’t create a stable, market-driven healthcare system. Instead, we’d only be back to where we were in 2010 – a system where government would still be the dominant player and market forces would be almost totally emasculated.

The only difference is that Republicans would then get blamed for everything that goes wrong in the world of healthcare rather than Obama and the Democrats (and you better believe that’s a big part of the decision-making process on Capitol Hill).

Yes, the GOP plan would save some money, which is laudable, but presumably the main goal is to have a sensible and sustainable healthcare system. And that’s not going to happen unless there’s some effort to somehow unravel the overall mess that’s been created by all the misguided government policies that have accumulated over many decades.

This isn’t a new or brilliant observation. Milton Friedman wrote about how government-controlled healthcare leads to higher costs and lower quality back in 1977, but I can’t find an online version of that article, so let’s look at what he said in a 1978 speech to the Mayo Institute.

I realize that many people won’t have 45 minutes of spare time to watch the entire video, so I’ll also provide some excerpts from a column Friedman wrote back in the early 1990s that makes the same points. He started by observing that bureaucratic systems have ever-rising costs combined with ever-declining output.

…a study by Max Gammon…comparing input and output in the British socialized hospital system…found that input had increased sharply, while output had actually fallen. He was led to enunciate what he called “the theory of bureaucratic displacement.” In his words, in “a bureaucratic system . . . increase in expenditure will be matched by fall in production. . . . Such systems will act rather like `black holes,’ in the economic universe, simultaneously sucking in resources, and shrinking in terms of `emitted production.'” …concern about the rising cost of medical care, and of proposals to do something about it — most involving a further move toward the complete socialization of medicine — reminded me of the Gammon study and led me to investigate whether his law applied to U.S. health care.

Friedman then noted how this bureaucratic rule operated in the United States after the healthcare exclusion was adopted during World War II.

Even a casual glance at figures on input and output in U.S. hospitals indicates that Gammon’s law has been in full operation for U.S. hospitals since the end of World War II… Before 1940, input and output both rose, input somewhat more than output, presumably because of the introduction of more sophisticated and expensive treatment. The cost of hospital care per resident of the U.S., adjusted for inflation, rose from 1929 to 1940 at the rate of 5% per year; the number of occupied beds, at 2.4% a year. Cost per patient day, adjusted for inflation, rose only modestly. The situation was very different after the war. From 1946 to 1989, the number of beds per 1,000 population fell by more than one-half; the occupancy rate, by one-eighth. In sharp contrast, input skyrocketed. Hospital personnel per occupied bed multiplied nearly seven-fold and cost per patient day, adjusted for inflation, an astounding 26-fold.

Friedman then explained that the adoption of Medicare and Medicaid hastened the erosion of market forces.

One major engine of these changes was the enactment of Medicare and Medicaid in 1965. A mild rise in input was turned into a meteoric rise; a mild fall in output, into a rapid decline. …The federal government’s assumption of responsibility for hospital and medical care for the elderly and the poor provided a fresh pool of money, and there was no shortage of takers. Personnel per occupied bed, which had already doubled from 1946 to 1965, more than tripled from that level after 1965. Cost per patient day, which had already more than tripled from 1946 to 1965, multiplied a further eight-fold after 1965. Growing costs, in turn, led to more regulation of hospitals, further increasing administrative expense.

Remember, Friedman wrote this article back in 1991. And the underlying problems have gotten worse since that time.

So what’s the bottom line? Friedman pointed out that the problem is too much government.

The U.S. medical system has become in large part a socialist enterprise. Why should we be any better at socialism than the Soviets?

And he explained that there’s only one genuine solution.

The inefficiency, high cost and inequitable character of our medical system can be fundamentally remedied in only one way: by moving in the other direction, toward re-privatizing medical care.

Some readers may be skeptical. Even though he cited lots of historical evidence, perhaps you’re thinking Friedman’s position is impractical.

So let’s fast forward to 2017 and look at some very concrete data assembled by Mark Perry of the American Enterprise Institute. He looks at medical costs over the past 18 years and compares what’s happened with prices for things that are covered by third-party payer (either government or government-distorted private insurance) and prices for cosmetic procedures that are financed directly by consumers.

As you can see, the relative price of health care generally declines when people are spending their own money and operating in a genuine free market. But when there’s third-party payer, relative prices rise.

Perry explains the issue very succinctly.

Cosmetic procedures, unlike most medical services, are not usually covered by insurance. Patients paying 100% out-of-pocket for elective cosmetic procedures are cost-conscious, and have strong incentives to shop around and compare prices at the dozens of competing providers in any large city. Providers operate in a very competitive market with transparent pricing and therefore have incentives to provide cosmetic procedures at competitive prices. Those providers are also less burdened and encumbered by the bureaucratic paperwork that is typically involved with the provision of most standard medical care with third-party payments. Because of the price transparency and market competition that characterizes the market for cosmetic procedures, the prices of most cosmetic procedures have fallen in real terms since 1998, and some non-surgical procedures have even fallen in nominal dollars before adjusting for price changes. In all cases, cosmetic procedures have increased in price by far less than the 100.5% increase in the price of medical care services between 1998 and 2016 and the 176.6% increase in hospital services.

In other words, a free market can work in healthcare. And it gives us falling prices and transparency rather than bureaucracy and inefficiency. Maybe when they’ve exhausted all other options, Republicans will decide to give freedom a try.

P.S. If you want to get a flavor for how competition and markets generate better results, watch this Reason TV video and read these stories from Maine and North Carolina.

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It’s relatively easy to demonstrate how certain regulations make our lives less pleasant (inferior light bulbs, substandard toilets, inadequate washing machines, crummy dishwashers, etc).

Furthermore, it’s also simple to highlight examples of foolish and preposterous regulations.

And it’s a straightforward exercise (at least conceptually) to argue that regulations should pass some sort of cost-benefit test.

What’s not so easy, however, is getting folks to grasp the overall impact of red tape on growth and living standards. After all, most normal people don’t want to learn about wonky concepts such as the production possibilities frontier. And I also doubt there are many people who are interested in the technical challenge of how to measure the aggregate impact of thousand of rules and restrictions.

But these issues matter. A lot. According to Economic Freedom or the World, the regulatory burden is just as important as the fiscal burden when determining a nation’s competitiveness and economic outlook. Simply stated, our living standards are determined by productivity, which is determined by how wisely labor and capital are combined to generate output.

With this in mind, a new study from the European Central Bank helpfully examines the degree to which regulation hinders the efficient allocation of those factors of production.

The focus of this paper is on the…misallocation of labour and capital in eight macro-sectors (which include manufacturing and services) for five large euro-area countries (Belgium, France, Germany, Italy and Spain) during the period 2002-2012. …The paper then investigates the potential determinants of changes in input misallocation by looking at traditional structural determinants, namely restrictive product and labour market regulations. …regulations that shelter firms from competition might result in poor allocation of resources because low productive firms will keep operating instead of downsizing or exiting. Similarly, stringent labour market regulation, in the form of high hiring and firing costs, might also thwart resource allocation.

For those who are interested in such things, the study looks at what drives improvements in productivity. Is it firms becoming more efficient because of competition, or is “reallocation” as weak companies vanish and dynamic new firms emerge?

The short answer, as illustrated by the table, is that both play a role.

Here are some of the issues considered in the ECB study.

In our full empirical specification, as well as initial conditions in misallocation, …we first examine the role of two structural factors, i.e. changes in both product and labour market regulations. In the presence of high barriers to entry, unproductive firms are able to survive and therefore retain productive resources which are not shifted to the most efficient firms in a given industry (Schiantarelli 2008; Restuccia and Rogerson 2013; Andrews and Cingano 2014). Furthermore, more stringent employment regulation might prevent firms from adjusting their workforce to optimal levels, therefore hampering the efficient reallocation of workers across firms (Haltiwanger, Scarpetta and Schweizer 2014; Bartelsman, Gautier and de Wind 2011). Moreover, in the labour misallocation regressions we also include an interaction term between the changes in product and labour market regulations.

Here are their estimates of both product market regulation and labor market regulation for selected nations.

It’s good to see that there’s a slight trend toward less regulation of product markets. A few nations have modestly reduced regulation of labor markets, but the most interesting observation is that this is an area where the United States has a major advantage. Only Germany is even close to America in allowing markets to operate with a high level of freedom.

Having examined the issues covered by the study, let’s now consider the results.

All discussed capital misallocation results are robust to the inclusion of market distortions, i.e. to regulatory and credit constraints. …The general decline in PMR over the period considered dampened capital misallocation dynamics… Stricter product market regulation is found to have led to higher labour misallocation growth. But we also find that more stringent labour market regulations positively correlate with labour misallocation growth, particularly in sectors characterized by more stringent product market regulations. Thus, these results support the idea that the positive effect of the tightness of PMR on labour misallocation growth is amplified if also EPL becomes more restrictive. Seen from an inverse perspective, the gains in the allocative efficiency of labour are larger if both kinds of regulation are jointly loosened.

Here’s the bottom line.

Our results therefore suggest that in order to foster a more efficient within-sector allocation of inputs across firms structural reforms, such as those lowering entry barriers for firms, removing size-contingent regulations that prevent firms from reaching their optimal size and enhancing bankruptcy regulations that facilitate the exit of unproductive firms, would be warranted. The loosening of PMR and EPL in recent years in some countries has proven to dampen misallocation dynamics, yet there is still room for further reductions, as shown for example when comparing the level of regulation with that in the U.S.

Unfortunately, I don’t expect that this study will have any sort of impact on the debate. The people who already understand the negative impact of regulation now have more evidence about the value of unfettered markets and creative destruction.

But the politicians and interest groups won’t care. They are interested in accumulating power and obtaining unearned benefits. To the extent that they would even bother to read the study, they would conclude that they should fight extra hard to preserve the status quo since they will realize that there are fewer favors to distribute when genuine capitalism is allowed to operate.

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I don’t have strong views on global warming. Or climate change, or whatever it’s being called today.

But I’ve generally been skeptical about government action for the simple reason that the people making the most noise are statists who would use any excuse to increase the size and power of government. To be blunt, I simply don’t trust them. In Washington, they’re called watermelons – green on the outside (identifying as environmentalists) but red on the inside (pushing a statist agenda).

But there are some sensible people who think some sort of government involvement is necessary and appropriate.

George Schultz and James Baker, two former Secretaries of State, argue for a new carbon tax in a Wall Street Journal column as part of an agenda that also makes changes to regulation and government spending.

…there is mounting evidence of problems with the atmosphere that are growing too compelling to ignore. …The responsible and conservative response should be to take out an insurance policy. Doing so need not rely on heavy-handed, growth-inhibiting government regulations. Instead, a climate solution should be based on a sound economic analysis that embodies the conservative principles of free markets and limited government. We suggest…creating a gradually increasing carbon tax…, returning the tax proceeds to the American people in the form of dividends. And…rolling back government regulations once such a system is in place.

A multi-author column in the New York Times, including Professors Greg Mankiw and Martin Feldstein from Harvard, also puts for the argument for this plan.

On-again-off-again regulation is a poor way to protect the environment. And by creating needless uncertainty for businesses that are planning long-term capital investments, it is also a poor way to promote robust economic growth. By contrast, an ideal climate policy would reduce carbon emissions, limit regulatory intrusion, promote economic growth, help working-class Americans and prove durable when the political winds change. …Our plan is…the federal government would impose a gradually increasing tax on carbon dioxide emissions. It might begin at $40 per ton and increase steadily. This tax would send a powerful signal to businesses and consumers to reduce their carbon footprints. …the proceeds would be returned to the American people on an equal basis via quarterly dividend checks. With a carbon tax of $40 per ton, a family of four would receive about $2,000 in the first year. As the tax rate rose over time to further reduce emissions, so would the dividend payments. …regulations made unnecessary by the carbon tax would be eliminated, including an outright repeal of the Clean Power Plan.

They perceive this plan as being very popular.

Environmentalists should like the long-overdue commitment to carbon pricing. Growth advocates should embrace the reduced regulation and increased policy certainty, which would encourage long-term investments, especially in clean technologies. Libertarians should applaud a plan premised on getting the incentives right and government out of the way.

I hate to be the skunk at the party, but I’m a libertarian and I’m not applauding. I explain some of my concerns about the general concept in this interview.

In the plus column, there would be a tax cut and a regulatory rollback. In the minus column, there would be a new tax. So two good ideas and one bad idea, right? Sounds like a good deal in theory, even if you can’t trust politicians in the real world.

However, the plan that’s being promoted by Schultz, Baker, Feldstein, Mankiw, etc, doesn’t have two good ideas and one bad idea. They have the good regulatory reduction and the bad carbon tax, but instead of using the revenue to finance a good tax cut such as eliminating the capital gains tax or getting rid of the corporate income tax, they want to create universal handouts.

They want us to believe that this money, starting at $2,000 for a family of four, would be akin to some sort of tax rebate.

That’s utter nonsense, if not outright prevarication. This is a new redistribution program. Sort of like the “basic income” scheme being promoted by some folks.

And it creates a very worrisome dynamic since people will have an incentive to support ever-higher carbon taxes in order to get ever-larger checks from the government. Heck, the plan being pushed explicitly envisions such an outcome.

I’ve made the economic argument against carbon taxes and the cronyism argument against carbon taxes. Now that we have a real-world proposal, we have the practical argument against carbon taxes.

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