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Posts Tagged ‘Unintended Consequences’

When politicians target “the rich” with class-warfare schemes like wealth taxes, it’s often ordinary people that bear the costs.

For a painful example of how this works in the real world, check out the first 42 seconds of this video.

From an economic perspective, this is a story about secondary or indirect effects. Or, as noted in the video, there are unintended consequences.

In most cases, the fundamental problem with class-warfare taxes is that they penalize saving and investment with double taxation. This is bad for workers because there’s a strong link between the level of capital (i.e., machines, tools, technology) and productivity.

And since there’s also a strong link between productivity and pay, this explains why ordinary people generally don’t enjoy much opportunity in societies with spite-driven tax laws.

Now let’s consider the case of the luxury tax, which was part of President George H.W. Bush‘s disastrous 1990 tax increase.

Rather than being a broad tax on saving and investment, it was an excise tax on a group of products (the levy on expensive boats got most of the attention).

Let’s see what actually happened, and we’ll start with some excerpts from this 1993 column in the Washington Post by James Glassman.

Rich people aren’t happy about paying this extra money. Even if they can afford it, they think it’s unfair. And in some cases, they’re refusing to pay it — simply by refusing to buy new boats and planes. Of course, rich people don’t have to buy a new 90-foot Broward… So the federal government doesn’t get the tax money — and, worse, Broward doesn’t sell its yacht and various boat builders get put out of work. As a result, in its first year and a half, the yacht tax raised a pathetic $12,655,000 for the Treasury. …Meanwhile, the tax has contributed to the general devastation of the American boating industry — as well as the jewelers, furriers and private-plane manufacturers that were also targets of the excise tax… What went wrong with the luxury tax was that, in trying to go after the rich guys’ toys, Congress put the toymakers out of business. The rich guys, meanwhile, bought other toys (including foreign-made ones) not covered by the tax; or they bought used toys and refurbished them; or they simply saved the money, waiting to spend it another day.

The government still collected some money from the tax on the “toys,” but it’s also important to understand that it lost money when the “toymakers” lost their jobs.

So there was a Laffer Curve-type effect.

The great, late, Walter Williams opined on this issue more recently. Here are segments of his 2011 column.

Let’s look at what happened when…George H.W. Bush signed the Omnibus Budget Reconciliation Act of 1990 and broke his “read my lips” vow not to agree to new taxes. When Congress imposed a 10 percent luxury tax on yachts, private airplanes and expensive automobiles, Sen. Ted Kennedy and then-Senate Majority Leader George Mitchell crowed publicly about how the rich would finally be paying their fair share of taxes. What actually happened…In the first year, one-third of U.S. yacht-building companies stopped production, and according to a report by the congressional Joint Economic Committee, the industry lost 7,600 jobs. When it was over, 25,000 workers had lost their jobs building yachts, and 75,000 more jobs were lost in companies that supplied yacht parts and material. …Jobs shifted to companies in Europe and the Bahamas.

Walter explicitly explains why the government lost revenue.

The U.S. Treasury collected zero revenue from the sales driven overseas. …Congress told us that the luxury tax on boats, aircraft and jewelry would raise $31 million in revenue a year. Instead, …job losses cost the government a total of $24.2 million in unemployment benefits and lost income tax revenues. The net effect of the luxury tax was a loss of $7.6 million in fiscal 1991. …Why did congressional dreams of greater revenues turn into a nightmare? Kennedy, Mitchell and their congressional colleagues simply assumed that the rich would act the same after the imposition of the luxury tax as they did before and that the only difference would be more money in the government’s coffers. Like most politicians then and now, they had what economists call a zero-elasticity vision of the world, a fancy way of saying they believed that people do not respond to price changes. People always respond to price changes. The only debatable issue is how much and over what period.

And Walter’s analysis also applies to Joe Biden’s proposed tax increases.

It’s quite possible that the government will collect more money if Biden’s fiscal plan is enacted, but not as much as politicians think. More important, there will be lots of collateral economic damage.

Call me crazy, but I don’t want ordinary people to lose jobs simply because greedy politicians want more money so they can try to buy more votes.

P.S. If it’s any consolation, politicians from other nations can be equally foolish and short-sighted. Both France and Italy suffered when governments went after yachts.

P.P.S. You won’t be surprised to learn that pro-tax former Senator John Kerry avoided taxes on his yacht.

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One of the many frustrations of working in Washington is that politicians, when dealing with a problem created by government intervention, routinely propose that the solution is to give even more power to government. And since they are either unwilling or unable to connect the dots, they don’t care that their “solutions” will make matters worse. I’ve referred to this unfortunate pattern as “Mitchell’s Law.”

Of course, this concept isn’t new to me. It’s been around for a long time. I just like the phrase, “Bad government policy begets more bad government policy.”

Other people also have been publicizing this concept. I especially like what Chuck Blahous of the Mercatus Center recently wrote about the 5-step Washington tradition of “doubling down” on policy mistakes. The final step could be called the lather-rinse-repeat cycle of government failure.

Chuck also cites some very powerful (and very depressing) examples from healthcare policy.

He starts with the tax code’s healthcare exclusion.

With the best of intentions the federal government has long exempted worker compensation in the form of health benefits from income taxation.  There is wide consensus among economists that the results of this policy have been highly deleterious.  As I have written previously, this tax exclusion “depresses wages, it drives up health spending, it’s regressive, and it makes it harder for people with enduring health conditions to change jobs or enter the individual insurance market.”  Lawmakers have reacted not by scaling back the flawed policy that fuels these problems, but rather by trying to shield Americans from the resulting health care cost increases.

I fully agree.

He then points out that Medicare, Medicaid, and other spending programs have a similar impact.

The federal government has enacted programs such as Medicare and Medicaid to protect vulnerable seniors and poor Americans from ruinous health care costs.  …it is firmly established that creating these programs pushed up national health spending, driving health costs higher for Americans as a whole.  Consumer displeasure over these health cost increases subsequently became a rationale for still more government health spending, rather than reducing government’s contribution to the problem.  Examples of this doubling down include the health exchange subsidies established under the Affordable Care Act (ACA), as well as its further expansion of Medicaid.

I fully agree.

Chuck also shows how government involvement has created the same unhealthy dynamic in other areas, writing about college costs, Social Security, and Obamacare.

The moral of the story, as displayed by this poster, is that more government is the problem instead of the solution. Which is something Bastiat warned us about back in the 1800s.

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Alex Pollack of the American Enterprise Institute explains how even supposedly benign interventions have negative effects. Using deposit insurance as an example, he explains how the benefits of intervention are often obvious, but the costs are usually hidden and indirect – and generally of a greater magnitude. The politicians get applause for the supposed benefit (in this case, peace-of-mind for despositors) while avoiding any blame for the hidden costs (moral hazard, financial crisis, malinvestment, etc):

On one hand, there is the fervent political desire to make deposits riskless for the public, so that depositors do not need to know anything about or care about the soundness of their bank. But their deposits fund businesses that are inherently very risky, highly leveraged and cyclically subject to much greater losses than anyone imagined possible. The combination of riskless funding with risky businesses is inherently impossible. The attempt is made to achieve the combination through regulation, but this inevitably fails. Governments are therefore periodically put in the position of desperately wanting to transfer losses from the banks to the public, as once again in this cycle. An alternative is to prefund the losses through deposit insurance. But because the losses can get bigger than the fund, it ends up needing a government guarantee, thus bringing the risk back to the public. …Has government deposit insurance “put a premium on bad banking,” as Sen. Bulkley warned it would? Certainly in some cases it did, especially when risky, rapidly expanding real estate-lending banks could fund themselves by rapidly expanding brokered deposits. More generally, did deposit insurance help inflate the real estate bubble, especially in commercial real estate? Without doubt, it did. Leveraged real estate has been the cause of many banking busts. Over the past several years real estate loans of all commercial banks have grown to represent 56% of their total loans. For the 6,500 smaller banks, with assets under $1 billion, this ratio is a whopping 74%. This expansion of real estate risk could not have happened without deposit insurance.

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