Washington’s Counterproductive Attack on Stock Buybacks

Back in 2013, I joked that “you get bipartisanship when the Stupid Party and the Evil Party both agree on something.”

That generally means bad outcomes, with the TARP bailout being a prime illustration.

We now have another example since many Republicans and Democrats want to restrict – or even ban – companies from buying shares from owners (i.e., company shareholders).

Known as stock buybacks, these share purchases should be viewed as an innocuous way of distributing profits.

But you’ll see below that many politicians think they be able to dictate how private businesses operate.

First, let’s look at some excerpts from the Tax Foundation’s very useful primer on the issue.

It’s important to understand why stock buybacks occur and the economic role they play. The new tax law lowered the corporate income tax rate… A lower rate also means that corporations will receive larger profits than anticipated on investments they made in the past—it should be expected that companies would share at least some of this unexpected increase in cash with their shareholders. …Stock buybacks are complements to investment, not substitutes for it. Research shows that stock buybacks do not deprive firms of capital that they would otherwise invest, and further, that stock buybacks can facilitate long-term investment by redirecting funds from lower growth firms to higher growth firms. …Limiting the ability of a corporation to return value to shareholders—value which was created by productive investments made in the past—will not improve economic conditions.

Many experts from the worlds of finance, business, and public policy have tried to explain why stock buybacks should not be viewed as controversial.

In a column for the Wall Street Journal, for instance, Donald Luskin and Chris Hynes explain why it’s a bad idea to curtail buybacks.

Sen. Elizabeth Warren would require, among other things, that to receive aid…companies receiving aid be permanently barred from executing share buybacks, even after the aid is repaid. This is an opportunistic mutation of the left’s longstanding claim that buybacks are a uniquely evil form of predatory capitalism. In reality, buybacks create benefits for shareholders large and small… Shareholders must receive a dividend when it’s declared and pay taxes on it. In a share buyback, investors who want cash can sell some shares and pay taxes. If they don’t want cash, they can choose to hold on to their shares. …Some opponents of buybacks…argue that they waste company cash that ought to be reinvested in plant and equipment. But not every company is in growth mode, and even those that are might have more cash than growth ideas. …Paying money out to shareholders frees them to reinvest in new companies with big growth ideas. This is the best way to promote growth for the economy as a whole.

The Washington Post is not exactly a hotbed of libertarian thinking, so it’s noteworthy that its editorial warned that politicians shouldn’t be dictating private business choices.

the practice by which public corporations use spare cash to buy back their own stock has turned into a policy flash point for both Democrats and Republicans. The basic allegation is that profits devoted to stock buybacks…are profits not plowed back into new plants, equipment or higher wages. …Contrary to the concerns about diverting investment funds, U.S. nonresidential investment and job creation have been rising for most of the past decade. When shareholders get cash for their stocks, the money doesn’t disappear; it flows through the economy, often as productive investment elsewhere. …Perhaps a tax change would accomplish something — though companies would still have an incentive to give spare cash back to shareholders as long as there is no clearly superior investment alternative. Critics of stock buybacks are saying, in effect, that elected officials or regulators may know better than companies themselves what should be done with extra cash.

Writing for the Foundation for Economic Education, Ethan Lamb points out why Senator Cory Booker doesn’t understand the economics of buybacks.

Senator Cory Booker…reintroduced the “Workers Dividend Act,” which would mandate corporations match every dollar spent on buybacks with compensation toward employees. …this bill presupposes that stock buybacks are inherently bad for society. …Booker doesn’t understand the function of stock buybacks. …Buybacks are just another mechanism, like dividends, to return money to shareholders. …Booker and company will also argue that stock buybacks come at the expense of investment, whether it be in the form of wages or capital expenditures. …none of that is true. …stock buybacks are a brilliant example of the free-market system offering a win-win to both parties. In other words, when the corporation purchases its own stock, the money from that exchange has to go somewhere. Presumably, the investor that just received the money would re-invest in another company that would be more inclined to use that money on investments in labor, R&D, or capital.

The editors of the Wall Street Journal warned about the risks of government intervention.

Stock buybacks are the latest bipartisan piñata, whacked by politicians on the left and right who misunderstand capital markets. …Repurchasing shares is simply one way a company can return cash to owners if it lacks better ideas for investment. …Senators complain that “when corporations direct resources to buy back shares on this scale, they restrain their capacity to reinvest.” But the money doesn’t fall into a black hole. An investor who sells stock into a buyback will save or reinvest the proceeds. …Banning buybacks won’t create better investment options inside companies. Instead CEOs may spend more on corporate jets or pet projects with marginal economic returns. …A recent report from Mr. Rubio floats the idea of raising tax rates on buybacks. …For example: “An increased tax rate on repurchases might raise revenue to finance other incentives for capital investment.” In other words, Mr. Rubio wants politicians to have more leverage to direct how businesses deploy their capital. This would produce less investment, not more, with corresponding damage to workers and federal revenue.

Jon Hartley, in an article for National Review, debunks the notion that there’s some sort of special tax favoritism for buybacks.

Marco Rubio’s plan to tax stock buybacks in the hopes of spurring investment…is heavily flawed for multiple reasons. …the senator seems to be operating under the incorrect belief that buybacks are tax-advantaged, when in fact buybacks are already taxed in the form of capital-gains taxes. Since 2003, when the dividend-tax rate was lowered to remove the tax advantage then afforded buybacks, the tax rates on qualified dividends and long-term capital gains have been the same. …let’s take a hypothetical example: Say an investor bought a stock at $100 and over the period of a year, the stock price appreciated by 10 percent to $110 after the company increased its profits and paid corporate taxes (at today’s 21 percent rate) on its earnings. If the company pays a $2 dividend at the end of the year and the investor sells the stock at $108 (ex-dividend), the investor pays the 23.8 percent dividend tax on the $2 dividend received and 23.8 percent on the $8 capital gain. If the company buys back some of its stock at $110 instead of paying a dividend and the investor sells his shares at $110, the investor pays the long-term capital-gains tax of 23.8 percent on the $10 he made. …Now, let’s imagine that Senator Rubio’s legislation is passed and a tax on buybacks goes into effect. …A transaction that was previously subject to two layers of taxation (corporate and capital-gains taxes) is suddenly subject to three layers of taxation (corporate taxes, capital-gains taxes, and buyback taxes), yielding a higher overall tax bill.

Ted Frank, writing for the Washington Examiner, adds further analysis.

Sen. Josh Hawley, a Missouri Republican, proposed banning buybacks as one of a series of conditions of government relief. Anyone making blanket condemnations of stock buybacks is either confused or otherwise fundamentally unserious — and proposing counterproductive policies that will slow the recovery. …It’s economically indistinguishable from a special dividend, where a corporation pays out money to every shareholder, except it permits shareholders to elect their own tax consequences, unlike a dividend that creates a tax event immediately. …Proposals to ban buybacks are effectively proposals to demand corporations hold such huge stockpiles of cash, depriving shareholders of investment choices. Such proposals will backfire by slowing down the economic recovery when money that could be invested is instead held in corporate bank accounts, doing nothing.

I want to close by sharing two additional columns that argue against restrictions on stock buybacks, but also suggest that there may be some desirable reforms that might – as a side effect – lead to fewer buybacks.

Clifford Asness recently opined for the Wall Street Journal about buybacks and investment, echoing many of the points included in the above excerpts.

Share buybacks are when a company purchases its own common shares on the open market. After a buyback, a company is left with less cash and fewer shares outstanding. Buybacks, along with ordinary dividends, are one of the main ways companies return cash to investors—the ultimate objective of any investment. So why have buybacks become the subject of vitriolic criticism? …The lead accusation against buybacks is that they “starve investment.” …Related to the claims of starving investment, some argue that today’s buybacks are a form of “self-liquidation” in which companies are systematically shrinking away. This ignores that…the net cash outflow from share buybacks has been more than replaced by cash inflow due to new borrowing (think of this as a debt-for-equity swap). Despite buybacks, on net companies have been raising money, not liquidating. …Buybacks…facilitate a movement of capital from companies that don’t need it to those that do. That’s how markets are supposed to work.

But he then notes that the tax code’s bias for debt could be a problem.

…there are some possible problems with buybacks. If taken to excess far beyond today’s levels and financed with debt, they could lead to too much leverage.

Noah Smith explains for Bloomberg that banning stock buybacks is the wrong response to the wrong question.

Stock buybacks are a fraught and confusing issue. …A number of politicians have decried this practice, and sought restrictions or a ban. …Many observers are mystified by this animosity. …share repurchases are like dividends — a way to return money to shareholders. When companies don’t have any way to invest their money profitably, they might as well give the money back to investors.

But he then suggests other government policy mistakes that could be artificially boosting the level of buybacks.

…many of the concerns people have with buybacks probably could be better addressed by reforming other parts of the corporate system. If executive short-termism is the problem, stock- and option-based compensation should be discouraged. If debt is the problem, tax corporate borrowing more heavily. …instead of attacking buybacks, reformers should focus on fixing other parts of corporate America.

Since I just wrote about the tax code being biased in favor of debt, I obviously am very sympathetic to tax reforms that would put debt and equity on a level-playing field.

Noah Smith raised the issue of whether stock- and option-based compensation arrangements for company executives are artificially encouraging buybacks.

Well, my modest contribution to this discussion is to explain that such compensation packages became more prevalent after Bill Clinton’s failed 1993 tax hike imposed a significant indirect tax increase on corporate salaries of more than $1 million. That tax hike, however, did not apply to performance-based compensation, such as measures tied to a stock’s performance.

So what we’re really looking at are a couple of example’s of Mitchell’s Law in action.

Politicians adopt bad policies (favoritism for debt in the tax code and higher taxes on regular salaries), which lead to unintended consequences (more stock buybacks), which then gives politicians an excuse to further expand the size and scope of the federal government (restrictions and bans on buybacks).

Lather, rinse, repeat.

The Temporary Tradeoff Between Health Outcomes and Economic Outcomes

In the past couple of weeks, we’ve discussed a bunch of coronavirus-related issues, ranging from big-picture topics such as the proper role of government and the catastrophic downsides of excessive bureaucracy to more-focused topics such as how gun control puts families at risk, why laws against “price gouging” are misguided, and how government-encouraged debt makes the economy more vulnerable.

The crisis even led me to unveil a new theorem. And I also shared some amusing cartoons in hopes of lightening the mood.

The latest chapter in the coronavirus saga is that people are beginning to question how much economic damage we should be willing to accept in order to get the disease under control.

Public health experts argue that isolation and lockdown are critical if we we to “flatten the curve” so that new cases don’t overwhelm the ability of the system to treat patients (thus resulting in unpalatable forms of triage, with older and sicker patients set aside to die so that limited resources can be utilized to save others).

But if the economy is put on hold for several months, the economic damage will be catastrophic. At some point, policy makers won’t have any choice but to relax restrictions on people and businesses.

So how do we assess the costs and benefits of various options?

Eline van den Broek-Altenburg and Adam Atherly, both from the College of Medicine at the University of Vermont, explain the necessary tradeoffs.

While a growing number of people are starting to understand the message of the intuitive picture of “Flattening The Curve”, some health economists are starting to wonder how flat the curve should actually be for the benefits to exceed the costs. …how does the economic cost of the flattening fit into the discussion? …we use publicly available data to calculate the cost effectiveness of the flattening the curve. …When considering the value of a healthcare intervention to inform decision-making, benefits are usually measured in terms of life years gained, with the life years adjusted for the “quality” of the life (using standard formulas) to create a “Quality Adjusted Life Year” or QALY. …interventions in younger populations will typically yield more QALYs than interventions in older populations: because younger people have longer life expectancy. …Heath systems then compare the QALYs gained to the cost and calculate a cost per QALY gained. In the United States, interventions that cost less than $100,000 per QALY gained are often considered “cost effective,” although the precise number is somewhat controversial.

What you just read is the theoretical framework.

The authors then apply the model to the current situation.

…is the current “stay at home” and social isolation-policy, with school closed and businesses shuttered, cost effective using the standard health economics framework? …The years of life-gains are relatively straightforward. …statistics on the people who died of COVID19 in China and Italy are the best source of currently available data. …The average 80-year old in the United States has a life expectancy of about 9 years, suggesting that on average, a death averted will “buy” 9 extra years of life. …If we use diabetes as a reasonable proxy for the many chronic diseases, we would adjust the 9 years down to 7.8 years or QALYs. In other words: the average loss per person of quality-adjusted life years is 7.8. …This implies the pandemic, if unchecked, will lead to a loss of between 1.56 million and 13.26 million QALYs. …What, then, is the cost of the intervention of social distancing? One easy estimate would be to use the cost of the current stimulus bill before congress — 1 trillion dollars. This is likely an underestimate of the true cost, but is a reasonable starting place. …the cost per QALY gained from the current approach to be somewhere between approximately $75,000 and $650,000.

So what’s the bottom line?

Here’s a graphic they prepared.

And here’s their explanation.

…the key variable is the expected number of deaths. A pandemic that is likely to lead to 1.7 million deaths can justify the enormous public costs. However, if the pandemic is in the lower end of the predicted range, then the public funds would have been more valuable if spent elsewhere. …Some claim it is impossible or even unethical in times of a crisis, to think about cost when lives are involved. But in a world of finite resources, it’s necessary to make choices. Why not use a framework that has been defended by governments and scientists for decades?

Richard Rahn, former Chief Economist for the U.S. Chamber of Commerce, is very explicit about the downsides of an economic shutdown for future generations.

Some government officials, politicians and commentators keep saying words to the effect, “we need to spend whatever it takes to stop the coronavirus deaths.” They, of course, do not literally mean the government should spend an infinite amount of money to save a life — because, if they did, we would not let people drive more than five miles an hour in order to save more than 35,000 Americans who die on the roadways each year. …What is missing in this discussion is what American taxpayers and workers in terms of job losses should spend to save each life… Such calculations are necessary for insurance companies to price their products correctly, and for all of those government agencies involved in health and safety to determine both the proper form and degree of regulation. …If we learn that a 35-year-old MD has unexpectedly passed away, we are likely to feel far worse about the tragedy than if we hear her 90-year-old grandfather has died.

That’s Richard’s conceptual framework.

Here are his calculations.

Let’s assume that the low-cost measures will result in 50,000 more deaths (which is almost certainly on the very high-side given the experience of other countries). If we value the average death at…$2,000,000 figure… (which is high, because of the advanced age of most of the coronavirus victims), then policies that cost taxpayers, and the hit to GDP, more than $100 billion are counterproductive. Even if you assume that my figures are off by a magnitude of three, the mitigation policies should not cost more than $300 billion — not trillions.

Jeffrey Polet, a political scientist at Hope College, also explores the adverse consequences of an economic lockdown.

A panicking public will produce bad consequences, and we are already seeing its destructive effects on our economy. …While the elderly and infirm are the most vulnerable populations, small businesses, low wage laborers, and less healthy social institutions are the most likely to succumb to the economic consequences of the reaction to the virus. …The result will be, as we already see, a call for more government programs to aid those made destitute by the government’s reactions. …collective overreacting has profound social, economic, and political effects. …Good leadership neither overreacts nor under-reacts but reacts sensibly. …Calling something a “pandemic” excites public fear, even if the majority of the population is unlikely to be either directly or indirectly harmed. …For many people in this country, the prospect of losing their business or their job is far more frightening and harmful than the prospect of getting infected with the virus. An already insolvent government is hardly in a position to get this economy up and running, particularly if its policies create massive economic dislocations. …One of the appeals of utilitarianism is that it actually provides a functioning calculus, however imperfect in implementation.

I’ll close with the observation that I want to err on the side of public health in the short run, though I confess I’m not even sure what that means in terms of public policy since we not only need to agree on how much a life is worth (an unpleasant number to consider), but also get a handle on how many lives might be at risk (a very speculative number).

The goal of today’s column is simply to point out that the tradeoffs are real and to applaud the people who have the honesty to write about the issue.

In the long run, we should all appreciate the overlooked point that there is no tradeoff between health outcomes and economic outcomes.

That’s because wealthier societies are healthier societies. Here are a couple of chart from an article I wrote for the Journal of Regulation and Social Costs way back in 1992.

I’ve written about this correlation many times, both as a general concept, and also when addressing specific topics such as the adverse impact of President Obama’s anti-growth policies (and I cited one of Obama’s top economic appointees, Cass Sunstein, who explicitly agrees about the link between health and wealth).

P.S. There’s a very amusing Remy video about health-and-wealth tradeoffs at the end of this column.

Coronavirus and the Seventh Theorem of Government

I wrote yesterday how cumbersome bureaucracies and foolish regulations have hindered an effective response to the coronavirus.

This isn’t because governments are run by bad people. Some of them probably are that way, of course, but the real problem is that politicians and bureaucrats are dealing with a perverse incentive system.

They’re largely motivated by power, money, publicity, staffing, and votes.

And that leads to some very unfortunate outcomes, as Betsy McCaughey explained in her syndicated column.

Landing in the hospital on a ventilator is bad. But worse is being told you can’t have one. …learning that the state’s stockpile of medical equipment had 16,000 fewer ventilators than New Yorkers would need in a severe pandemic, Gov. Andrew Cuomo came to a fork in the road in 2015. He could have chosen to buy more ventilators. Instead, he asked his health commissioner, Howard Zucker to assemble a task force and draft rules for rationing the ventilators they already had. …Cuomo could have purchased the additional 16,000 needed ventilators for $36,000 apiece or a total of $576 million in 2015. It’s a lot of money but less than the $750 million he threw away on a boondoggle “Buffalo Billion” solar panel factory.

For what it’s worth, I’m not blaming Governor Cuomo for a failure to buy more ventilators.

In the same situation, I also may have decided that it wasn’t wise to spend $576 million for an event that most people thought was very unlikely.

But I am blaming him for supporting ever-bigger government in New York and getting ever-more involved in things that aren’t legitimate functions of a state government.

That applies to the solar factory mentioned in the article, and it also applies to other vote-buying schemes such as mass transit boondoggles, expanded rent control, and anti-gun snitch lines.

And when he expands the size and scope of state government, he increases the likelihood that there won’t be the energy, expertise, or resources to address problems where government should play a role.

Such as dealing with a pandemic.

Which motivates me to unveil a Seventh Theorem of Government.

In addition to the example of Cuomo and ventilators, there’s also a story from Belgium that underscores how bloated governments are less capable.

But I’ll close by noting the Seventh Theorem is not driven by anecdotes. There’s plenty of academic evidence showing that smaller governments are more competent.

P.S. As suggested by proponents of “state capacity libertarianism,” there is a possible exception to the Seventh Theorem.

Some of the world’s poorest nations have small public sectors – at least according to official measurements. It’s certainly possible, at least in theory, that such countries would benefit if they had larger governments that were capable of providing core public goods.

Indeed, international bureaucracies commonly argue that these countries should increase their tax burdens to provide “financing for development.”

However, the real problem in such nations is rampant corruption, low societal capital, and inadequate rule of law. Which is why it’s not a good idea to generate more money for politicians in those countries.

P.P.S. Here are my other theorems of government.

• The “First Theorem” explains how Washington really operates.
• The “Second Theorem” explains why it is so important to block the creation of new programs.
• The “Third Theorem” explains why centralized programs inevitably waste money.
• The “Fourth Theorem” explains that good policy can be good politics.
• The “Fifth Theorem” explains how good ideas on paper become bad ideas in reality.
• The “Sixth Theorem” explains an under-appreciated benefit of a flat tax.

Coronavirus and Big Government

When the current health crisis heated up, I wrote a column on “Government, Coronavirus, and Libertarianism” and made four simple points.

1. Libertarians believe government should protect life, liberty, and property
2. Libertarians correctly warn that a big sprawling federal government means it is less capable of handling the few things it should be doing
3. Other government-run health systems have not done a good job
4. The federal government has hindered an effective response to the coronavirus.

Today, I want to elaborate on point #4 by highlighting an avalanche of reports on how bureaucracy and red tape have been endangering our health.

Readers are welcome to click on some or all of the stories and tweets to learn more about how we’re at risk because of clumsy and inefficient government. Though if you’re pressed for time, this first story is the one to read.

And here are many more reports that confirm how government has largely been the source of problems rather than a solution.

"Where other nations are expediting these deliveries, trusting proven suppliers in their claims that they simply want to get their goods to those who need it… the FDA has resorted to its favorite fetish: bureaucratic lethargy." https://t.co/kdiy9Rssub

— Tom Rogan (@TomRtweets) March 20, 2020

This is sad, but all too predictable. "Stockpiles of masks, hand sanitizer, and other supplies," @TomRtweets reports, "are sitting in warehouses waiting for FDA inspectors to get around to them."https://t.co/pELgHvUSzw

— Philip Wegmann (@PhilipWegmann) March 20, 2020

Shitshow USA: "CDC botched its own test development. It sent testing kits to state public-health labs with a nonfunctioning ingredient. And by then, the virus was already spreading. It was already spreading as the [FDA] held up independent labs that had made their own tests…" https://t.co/ZLO2hysWxL

— Amy Alkon (@amyalkon) March 21, 2020

It’s been maddening to watch coronavirus testing get strangled in red tape from the FDA & CDC pic.twitter.com/ZGhfD8ki2E

— Alec 🌐 (@AlecStapp) March 14, 2020

The risk calculus part is important. Up until this point, the cost of biomedical delay was invisible and deniable.

But what FDA's CDRH division did in terms of delaying EUAs for lab tests has now very publicly cost us trillions of dollars and likely many American lives.

— Balaji S. Srinivasan (@balajis) March 15, 2020

For what it’s worth, the stories I shared above are just a small sampling. I could have shared dozens of additional reports.

But rather than beat a dead horse, let’s focus on the key takeaway from this tragedy. David Harsanyi of National Review nicely summarizes the lessons we should be learning.

…the coronavirus crisis has only strengthened my belief in limited-government conservatism — classical liberalism, libertarianism, whatever you want to call it. Years of government spending and expanding regulation have done nothing to make us safer during this emergency; in fact, our profligate spending during years of prosperity has probably constrained our ability to borrow now. …government does far too much of what it shouldn’t, and is far too incompetent at doing what it should. The CDC, an agency specifically created to prevent the spread of dangerous communicable diseases, has failed. Almost everyone would agree that its core mission should be under the bailiwick of government. Yet, for the past 40 years, its mission kept expanding as it spent billions of dollars and tons of manpower worrying about how much salt you put on your steaks and imploring you to do more jumping jacks. …The CDC — and other federal agencies such as the FDA — haven’t just moved too slowly in tapping the expertise of our academic and private sectors to fight COVID-19; they’ve actively impeded such private efforts. …The CDC didn’t merely botch the creation of a COVID-19 test, it failed to turn to private companies that could have created a test faster and better. …I’d simply like government to do much less much better.

David’s final sentence about a government that does less and does it better deserves to be emphasized. Observers ranging from Mark Steyn to Robert Samuelson have pointed out that the federal government is more likely to do a good job if it focuses on core responsibilities. And there’s plenty of academic evidence in support of this position, though this anecdote from Belgium may be even more persuasive.

Coronavirus Humor

I’ve addressed the public-policy implications of the coronavirus, both in general and looking at a couple of specific issues.

Now it’s time for some Gallows Humor about the disease.

We’ll start with this item that’s related to Wednesday’s column about gun ownership and the potential breakdown of civil order.

For what it’s worth, there’s been a significant increase in the percentage of people citing societal breakdown as a reason to support the 2nd Amendment.

I wrote last year about how more than 2 million children are being home-schooled.

That number has skyrocketed with schools being closed, which is giving libertarians an opportunity to pass on important messages to their kids.

I should probably add this to my collection of libertarian humor.

And if you like humor about home-schooling, you’ll enjoy this video.

Next we have a clever meme that a reader sent to me.

This is only the second time that Greta has appeared on this site, which is surprising.

I wrote about potential economic-policy responses to the coronavirus earlier this week.

Here’s a meme about Republicans and Democrats dealing with cognitive dissonance.

Speaking of cognitive dissonance, a lefty friend sent me this very clever bit of Trump-Bernie humor.

Left-leaning readers will also appreciate this and this.

Let’s close with two items that belong in my collection of socialism/communism humor.

It seems we have a second reason to close colleges.

I favor a different approach if we want to cure young people of their infatuation with socialism, but any port in a storm.

Last but not least, there’s a very good solution if you’re running out of toilet paper.

I’m sure Karl won’t mind (though some people at the European Commission will be offended).

If there’s a shortage of this option, I also recommend all ghost-written books from politicians as well as Thomas Piketty’s error–riddled screed, Capital in the 21st Century.

Economic Lessons from Coronavirus: Government-Subsidized Private Debt Creates Macro Vulnerability

There will be many lessons that we hopefully learn from the current crisis, most notably that it’s foolish to give so much regulatory power to sloth-like bureaucracies such as the FDA and CDC.

Today, I want to focus on a longer-run lesson, which is how tax policy (a bias for debt over equity) and monetary policy (artificially low interest rates) encourage excessive private debt.

Are current debt levels excessive? Let’s look at some excerpts from a column in the Washington Post, which was written by David Lynch last November – before coronavirus started wreaking havoc with the economy.

Little more than a decade after consumers binged on inexpensive mortgages that helped bring on a global financial crisis, a new debt surge — this time by major corporations — threatens to unleash fresh turmoil. A decade of historically low interest rates has allowed companies to sell record amounts of bonds to investors, sending total U.S. corporate debt to nearly $10 trillion… Some of America’s best-known companies…have splurged on borrowed cash. This year, the weakest firms have accounted for most of the growth and are increasingly using debt for “financial risk-taking,”… “We are sitting on the top of an unexploded bomb, and we really don’t know what will trigger the explosion,” said Emre Tiftik, a debt specialist at the Institute of International Finance, an industry association. …The root cause of the debt boom is the decision by the Federal Reserve and other key central banks to cut interest rates to zero in the wake of the financial crisis and to hold them at historic lows for years.

Needless to say, Emre Tiftik didn’t know last November what would “trigger the explosion.”

Now we have coronavirus, and George Melloan explained a few days ago in the Wall Street Journal that the “unexploded bomb” has detonated.

The Covid-19 pandemic…will do further damage to the global economy… The danger is heightened by the heavy load of debt American corporations have piled up as they have taken advantage of low-cost borrowing. …Cheap credit brought on the heavy overload of corporate debt. The Federal Reserve has responded to the virus by—what else?—making credit even cheaper, cutting its fed funds lending rate all the way to 0%-0.25% on Sunday. …Rate cuts in response to crises are programmed into the Fed’s software. There is no compelling evidence that they are a solution or even a remedy. …the low interest rates of the past decade have ballooned all forms of debt: government, consumer, corporate. Corporate debt, the most worrisome type at the moment, stands at about $10 trillion and has made a steady climb to 47% of gross domestic product, a record level… But even cheap borrowing and securitized debt obligations have to be paid back. It becomes harder to make payments when a global health crisis is killing sales and your company is bleeding red ink. …the increased political bias toward easy money remains a problem. The Federal Reserve Act of 1913 was political from the day Woodrow Wilson signed it. It has gotten more political ever since, increasingly becoming an instrument for robbing the poor—savers and pensioners—and giving to often profligate borrowers.

Melloan’s final points deserve emphasis. There are good reasons to reconsider the Federal Reserve, and we definitely should be angry about the perverse redistribution enabled by Fed policies.

But let’s keep our focus on the topic of government-encouraged debt and how it contributes to economic instability.

It’s not just an issue of bad monetary policy. We also have a tax code that encourages companies to disproportionately utilize debt.

But the 2017 tax bill addressed that flaw, as Reihan Salam explained two years ago in an article for National Review.

…one of the TCJA’s good points…limits that the legislation places on corporate interest deductibility, which…could change the way companies in the United States do business and make the U.S. economy more stable. …By stipulating that companies cannot use the interest deduction to reduce their earnings by more than 30 percent, the law made taking on debt somewhat less attractive compared to seeking financing by offering equity to investors. …equity is more flexible in times of crisis than debt, which means that problems are less likely to spiral out of control.

That’s the good news (along with the lower corporate rate and restriction on deductibility of state and local taxes).

The bad news is that the 2017 law only partially addressed the bias for debt over equity. Companies still have a tax-driven incentive to prefer borrowing.

Here’s the Tax Foundation’s depiction of how the pre-TCJA system worked, which I’ve altered to show how the new system operates.

I’ll close with the observation that there’s nothing necessarily wrong with private debt. Families borrow to buy homes, for instance, and companies borrow for reasons such as financing research and building factories.

But debt only makes sense if it’s based on market-driven factors (i.e., will borrowing enable future benefits and will there be enough cash to make payments). And that includes planning for what happens if there’s a recession and income falls.

Unfortunately, government intervention has distorted market signals and the result is excessive debt. And now the economic damage of the coronavirus will be even higher because more companies will become insolvent.

P.S. Even the International Monetary Fund is on the correct side about the downsides of tax-driven debt.

P.P.S. In addition to eliminating the bias for debt over equity, it also would be a very good idea to get rid of the bias for current consumption over future consumption (i.e., double taxation).

The Bernie Sanders Paradox

While it’s good news for the country that Bernie Sanders has faded in the polls, there’s a dark lining to that silver cloud.

For all his faults, Crazy Bernie at least was open and honest about his desire for socialism (unlike certain other candidates, who have hard-left platforms, but nonetheless are characterized as moderates).

But openness and honesty are not the same as common sense.

Consider, for instance, Crazy Bernie’s oft-stated assertion that we can afford big government because the United States is the richest nation in the history of the world.

There are two problems with what Bernie is saying.

First, we’re not actually the world’s richest nation.

Countries such as Monaco, Luxembourg, Liechtenstein, Singapore, and Switzerland rank above us, whether we’re measuring per-capita annual income or per-capita net wealth.

To be fair, that doesn’t change the fact that the United States is a very prosperous nation. Especially compared to most other western countries.

But that brings us to main point of today’s column.

Second, America is very prosperous because we haven’t followed Bernie’s recipe for bigger government.

That’s true today and it’s been true in the past. Compared to other nations, the U.S. historically has enjoyed very high scores for economic liberty.

Crazy Bernie and his supporters will argue that none of this matters. They’ll simply assert that the United States is a rich nation and therefore politicians should impose higher tax rates and fund bigger government.

But this ignores the fact that rich nations that adopt big government slowly but surely cease to be rich nations.

In other words, there’s a very challenging paradox for people like Bernie Sanders. They want a wealthy society so there’s lots of loot to redistribute, but their policies make it harder for societies to create wealth.

The bottom line is that there’s no such thing as a free lunch. Even the nations that try to minimize the damage of big government, such as Denmark and Sweden, suffer gradual decline.

Which helps to explain why none of my friends on the left have ever been able to successfully answer my two-question challenge.