Archive for the ‘Tax and Budget Policy’ Category
State Department Spreads Democracy—and Money
A friend points me to a recent article on Foreign Policy’s website written by a career State Department employee who spent a year in Iraq trying to “win the hearts and minds” of the Iraqi people. I’ve pretty much become numb to stories about government failure, but this one left me with my forehead planted on my desk.
Here are some of the ideas that government officials actually gave the green light to, using your tax dollars:
- French pastry classes for Iraqi women.
- A play about a town’s dispute over “the value of shade cast by a donkey.”
- A road constructed to facilitate commerce was instead used by insurgents to carry out attacks.
- A local artist was paid to paint a mural of “oiled, homoerotic Steve Reeves musclemen” on the wall of a gym.
- Bicycles were bought for impoverished children in a Baghdad neighborhood. However, the roads were too damaged and dangerous for the kids to ride their bikes, so the bike wheels ended up being used on wheelchairs for injured Iraqis.
- The creation of a Baghdad Yellow Pages even though only 250 businesses with permanent landlines could be found.
I suspect that some readers will respond that the federal government should instead be using taxpayer dollars to build roads and fund the arts here in the United States. However, as we demonstrate over and over again at DownsizingGovernment.org, the federal government does a lousy job of spending other people’s money at home or abroad—period.
Four Reasons Why Keynesian ‘Stimulus’ Does Not Work
Professor Allan Meltzer of Carnegie Mellon University has a must-read column in today’s Wall Street Journal, beginning with what should be an obvious statement.
Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.
He then asks a rather important question.
Why is the economic response to increased government spending so different from the response predicted by Keynesian models?
Prof. Meltzer gives four reasons, beginning with the threat of higher taxes.
First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing.
I especially like how he highlights Obama’s actions, which clearly show the link between more spending and more taxes. I also would have added the European fiscal crisis, which has made more people aware of the negative long-run consequences of excessive government.
He then lists the negative impact of having the government distort the allocation of resources, a point that is music to my ears.
Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment.
Spending Reform in Rick Perry’s Plan
Texas governor Rick Perry’s “Cut, Balance, and Grow” plan is out. Dan Mitchell discussed Perry’s proposed tax reforms so I’ll offer my take on the proposed spending reforms:
- Perry says he wants to “preserve Social Security for all generations of Americans” but state and local government employees would be allowed to opt-out of the program. Perry says that younger Americans would be able to “contribute a portion of their earnings” to a personal retirement account. I’d like to be able to completely opt-op without having to work in government. I suspect that other younger Americans who recognize that Social Security is a lousy deal will feel the same.
- Other proposed reforms to Social Security include raising the retirement age, changing the indexing formula, and ending the practice of using excess Social Security revenues to fund general government activities. Proposing to put an end to “raiding” the Social Security trust fund might be a good sound bite for the campaign trail, but excess Social Security revenues will soon be a thing of the past anyhow. Bizarrely, Perry cites the Highway Trust Fund as “the model for how to protect funds in a pay-as-you-go system from being used for unrelated purposes.” As a Cato essay on federal highway financing explains, only about 60 percent of highway trust fund money is actually spent on highways. The rest is spent on non-highway uses like transit and bicycle paths. The bottom line is that the federal budget’s so-called “trust funds” generally belong in the same category as Santa Claus and the Toothy Fairy. Perry should just stick with calling Social Security a “Ponzi scheme.”
- As for Medicare, Perry says reform options would include raising the retirement age, adjusting benefits, and giving Medicare recipients more control over how they spend the money they receive from current taxpayers. No surprises there.
- I’m a little confused by Perry’s language on Medicaid reform. On one hand, he says that the 1996 welfare reform law should be used as the model. The 1996 welfare reform law block granted a fixed amount of federal funds for each state. On the other hand, Perry says “Instead of the federal government confiscating money from states, taking a cut off the top, and then sending the money back out with limited flexibility for how states can actually use it, individual states should control the program’s funding and requirements from the very beginning.” I believe that the states, and not the federal government, should be responsible for funding low-income health care programs (if they choose to offer such programs). However, I don’t think that’s what Perry is actually proposing.
- Perry calls for a Balanced Budget Amendment to the Constitution and a cap on total federal spending equal to 18 percent of GDP. Federal spending will be about 24 percent of GDP this year. What agencies and programs would Perry cut or eliminate to reduce federal spending by 6 percent of GDP? He doesn’t really say. That leaves me to conclude that he embraces a BBA for the same reason that most Republicans embrace it: he wants to avoid getting specific about what programs he’d cut. One could argue that his entitlement reforms are sufficiently specific, but compared to Ron Paul’s plan, which calls for the elimination of five federal departments, Perry’s plan leaves too much guesswork.
- Other spending reform proposals don’t make up for the lack of specifics on spending cuts. For example, Perry proposes to eliminate earmarks. That’s already happened. He says he’d cut non-defense discretionary spending by $100 billion, but that’s a relatively small sum and letting military spending off the hook is disappointing. Proposing to “require emergency spending to be spent only on emergencies” sounds nice but would a President Perry stick to it if Congress larded up “emergency” legislation for a natural disaster in Texas or some military adventure abroad?
In sum, there’s some okay stuff here, but I don’t think it’s anything those who desire a truly limited federal government can get excited about. That said, Perry could have done a lot worse.
As You’ll See, Student Loans Hurt Us All
Suddenly, student loans are nearing the top of the nation’s public policy debate. Indeed, President Obama is expected to make a big speech about them on Wednesday. Why the sudden ascendance? Probably because the burden of student loans is one of the few things OWSers are clearly angry about, and that has raised questions ranging from whether such loans should be dischargable in bankruptcy, to whether they help fuel the Saturn V rocket of college price inflation. And last Sunday GOP presidential contender Ron Paul jumped into the fray, suggesting we eliminate the federal student loan program entirely.
Paul is right about phasing out federal student loans. Unfortunately, that’s likely the last thing President Obama will propose.
The first reaction to hearing such a proposal is that it’s Grinch-level heartlessness, stealing a better future from low-income kids. That is almost certainly what the president would say, and such a reaction would likely poll well. That’s why he’s expected to propose lowering interest rates, easing repayment, and other borrower-friendly measures. But as I lay out in a Cato Policy Analysis to be released imminently, by most indications federal student aid and other taxpayer-fueled subsidies aren’t good for anyone. (Well, anyone not employed by a college or university, the ultimate receiving end of all the forced largesse). By artificially—and hugely—boosting consumption, they ultimately lead to massive tuition inflation, encourage millions of unprepared people to take on studies they never finish, and pour H2O into already watered-down degrees. In other words, student aid—including federal lending—is likely a net loss to both students and society.
But I’ve already said too much. If you want to get a lot more on this—and more on the many unintended evils of federal college policies—stand by for the release of my study. And if you’re in DC, come to Capitol Hill Thursday for a briefing on the subject with me and Rep. Virginia Foxx (R-NC). It should give OWSers, libertarians, conservatives, liberals, and anyone else lots to think about.
Everything You Need to Know About Public School Spending in Less Than 2½ Minutes
Neal McCluskey gutted the President’s new “Save the Teachers” American Jobs Act sales pitch a good while back, as did Andrew Coulson here. Thankfully, it seems a lot of senators agree it’s a bad idea.
Last week, a $35 Billion piece of the president’s new “stimulus” plan, which included $30 Billion to bail out government schools—again—went down in the Senate:
Our public education problem is huge; we’re spending far too much and getting way too little. But most people don’t know the basic details. They still think we need to spend more on education.
So, for all of you who want to get the details but don’t have much time, or have family and friends who need to be introduced to reality, I present to you . . . Everything you need to know about public school spending in less than 2½ minutes.
Watch it, “like” it, post it on Facebook, email it around, comment, and generally get the word out . . . because we really do need to get the word out.
Grading Perry’s Flat Tax: Some Missing Homework, but a Solid B+
Governor Rick Perry of Texas has announced a plan, which he outlines in the Wall Street Journal, to replace the corrupt and inefficient internal revenue code with a flat tax. Let’s review his proposal, using the principles of good tax policy as a benchmark.
1. Does the plan have a low, flat rate to minimize penalties on productive behavior?
Governor Perry is proposing an optional 20 percent tax rate. Combined with a very generous allowance (it appears that a family of four would not pay tax on the first $50,000 of income), this means the income tax will be only a modest burden for households. Most important, at least from an economic perspective, the 20-percent marginal tax rate will be much more conducive to entrepreneurship and hard work, giving people more incentive to create jobs and wealth.
2. Does the plan eliminate double taxation so there is no longer a tax bias against saving and investment?
The Perry flat tax gets rid of the death tax, the capital gains tax, and the double tax on dividends. This would significantly reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories – even socialism and Marxism – agree that capital formation is key for long-run growth and higher living standards, addressing the tax bias against saving and investment is one of the best features of Perry’s plan.
3. Does the plan get rid of deductions, preferences, exemptions, preferences, deductions, loopholes, credits, shelters, and other provisions that distort economic behavior?
A pure flat tax does not include any preferences or penalties. The goal is to leave people alone so they make decisions based on what makes economic sense rather than what reduces their tax liability. Unfortunately, this is one area where the Perry flat tax falls a bit short. His plan gets rid of lots of special favors in the tax code, but it would retain deductions (for those earning less than $500,000 yearly) for charitable contributions, home mortgage interest, and state and local taxes.
As a long-time advocate of a pure flat tax, I’m not happy that Perry has deviated from the ideal approach. But the perfect should not be the enemy of the very good. If implemented, his plan would dramatically boost economic performance and improve competitiveness.
That being said, there are some questions that need to be answered before giving a final grade to the plan. Based on Perry’s Wall Street Journal column and material from the campaign, here are some unknowns.
1. Is the double tax on interest eliminated?
A flat tax should get rid of all forms of double taxation. For all intents and purposes, a pure flat tax includes an unlimited and unrestricted IRA. You pay tax when you first earn your income, but the IRS shouldn’t get another bite of the apple simply because you save and invest your after-tax income. It’s not clear, though, whether the Perry plan eliminates the double tax on interest. Also, the Perry plan eliminates the double taxation of “qualified dividends,” but it’s not clear what that means.
2. Is the special tax preference for fringe benefits eliminated?
One of the best features of the flat tax is that it gets rid of the business deduction for fringe benefits such as health insurance. This special tax break has helped create a very inefficient healthcare system and a third-party payer crisis. It is unclear, though, whether this pernicious tax distortion is eliminated with the Perry flat tax.
3. How will the optional flat tax operate?
The Perry plan copies the Hong Kong system in that it allows people to choose whether to participate in the flat tax. This is attractive since it ensures that nobody can be disadvantaged, but how will it work? Can people switch back and forth every year? Is the optional system also available to all the small businesses that use the 1040 individual tax system to file their returns?
4. Will businesses be allowed to “expense” investment expenditures?
The current tax code penalizes new business investment by forcing companies to pretend that a substantial share of current-year investment outlays take place in the future. The government imposes this perverse policy in order to get more short-run revenue since companies are forced to artificially overstate current-year profits. A pure flat tax allows a business to “expense” the cost of business investments (just as they “expense” workers wages) for the simple reason that taxable income should be defined as total revenue minus total costs.
Depending on the answers to these questions, the grade for Perry’s flat tax could be as high as A- or as low as B. Regardless, it will be a radical improvement compared to the current tax system, which gets a D- (and that’s a very kind grade).
Here’s a brief video for those who want more information about the flat tax.
Last but not least, I’ve already received several requests to comment on how Perry’s flat tax compares to Cain’s 9-9-9 plan.
At a conceptual level, the plans are quite similar. They both replace the discriminatory rate structure of the current system with a low rate. They both get rid of double taxation. And they both dramatically reduce corrupt loopholes and distortions when compared to the current tax code.
All things considered, though, I prefer the flat tax. The 9-9-9 plan combines a 9 percent flat tax with a 9 percent VAT and a 9 percent national sales tax, and I don’t trust that politicians will keep the rates at 9 percent.
The worst thing that can happen with a flat tax is that we degenerate back to the current system. The worst thing that happens with the 9-9-9 plan, as I explain in this video, is that politicians pull a bait-and-switch and America becomes Greece or France.
The Downside of Federal Infrastructure Spending
My Washington Post op-ed on federal infrastructure yesterday elicited a large and vigorous response. The comments on the WaPo site and emails to my inbox were about 80 percent in opposition to my views.
Here are some critiques of my article and my responses:
Critique: My view of devolving infrastructure funding to the states is unrealistic because only the federal government has enough “resources” to do big projects.
Response: The federal government has no magical source of money. All “federal dollars” ultimately come from taxpayers who live in the 50 states. It is true that the federal government can run larger deficits that state governments, but that’s a reason not to give the Feds responsibility for spending activities because they tend to go hog wild.
Critique: Maybe the federal government screws up, but so do state governments and private companies.
Response: Of course. But as the op-ed noted, when the Feds screw-up they botch it for the entire country, often for many decades. The federal government is a monopoly, and monopolies breed inefficiency. By contrast, the states compete with each other and learn from each other to an extent. And when private companies screw up repeatedly, they go belly up.
Critique: Maybe the federal government screws up, but we should just try to make it work better.
Response: The histories of the Corps and Reclamation illustrate patterns of failure for more than a century. And we’ve explored similar patterns with other federal agencies at www.downsizinggovernment.org. Federal problems are often deep-rooted and systematic, and they defy the many well-meaning efforts at reform, such as Al Gore’s “reinventing government” initiative in the 1990s. So it’s time to try something different—like exploring privatization.
Critique: We need the federal government for things like the Interstate Highway System because infrastructure crosses state lines.
Response: Numerous people made this point regarding my op-ed, but I’m afraid they didn’t put their thinking caps on. Private energy pipelines cross state and international borders, and so do the huge systems of the private freight railroads, such as Union Pacific.
Critique: Federal agencies, such as the Corps, often contract-out work to private companies that do the actual construction, so failures like Hurricane Katrina are private failures.
Response: Hurricane Katrina represented a failure of government on many levels, as I’ll address in an upcoming essay on the Corps. The American Society of Civil Engineers concluded that “a large portion of the destruction from Hurricane Katrina was caused by …engineering and engineering-related policy failures.” So that’s the fault of the Corps, not private contractors.
Anyway, the volume of negative, snarky, and knee-jerk responses to my suggesting that the federal government doesn’t work very well is rather depressing. I criticized Rachel Maddow for “thinking big” about federal spending. But the nation is going to have to “think big” about government reforms to avert the looming federal fiscal disaster. Devolution and privatization offer part of the solution both to reduce debt and to revive U.S. economic growth in coming years.
This Week in Government Failure
Over at Downsizing the Federal Government, we focused on the following issues this past week:
- Chris Edwards proposes an alternative to Herman Cain’s 9-9-9 tax reform plan.
- My reaction to Ron Paul’s plan to cut federal spending can be summed up in one word: Hallelujah.
- Chris Edwards wonders if Canada stole the Tenth Amendment to our Constitution.
- Unfortunately, government spending in the United States is 41 percent of GDP.
- The Government Accountability Office throws water on a taxpayer bailout for the U.S. Postal Service.
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State Government Business Subsidies in the News
Federal energy subsidies to business are a hot national topic thanks to the Solyndra scandal. Flying below the radar—and deserving more national media attention—are grants and other targeted incentives given to businesses by state governments. There is little doubt in my mind that there are state-subsidized “Solyndras” waiting to be discovered.
The Wall Street Journal took a step in this direction by noting in an editorial that a struggling lithium-ion battery maker subsidized by the Obama administration also received handouts from the State of Indiana. The editorial chides the administration for having “made a habit of investing your cash in their clunkers.” A series of investigations from WTHR-TV in Indianapolis has demonstrated that the administration of Indiana Gov. Mitch Daniels shares that same bad habit (see here).
The Journal editorial’s concluding lines correctly sum up the problem with government subsidies to businesses:
Better to leave commercial financing decisions to private investors and bankers who are likely to take more care with their own money. Politicians write the press releases first and worry about the taxpayer losses later.
As I’ve previously discussed, it was my experience as a state budget official in the Daniels administration that led me to coin the phrase “press release economics” to describe these subsidies. Indeed, WTHR’s investigations of the Indiana Economic Development Corporation showed that the Daniels administration was adept at taking credit for “creating jobs” that never materialized.
GAO Throws Water on Postal Bailout
The Government Accountability Office has weighed in on the controversy over whether the federal government “owes” the U.S. Postal Service approximately $50-$75 billion in alleged pension “overpayments” made by the USPS to the government’s retirement system. In short, the GAO concluded that the USPS is not owed the money.
The controversy is interesting because it pits government agencies against each other. The USPS, the USPS inspector general, and the Postal Regulatory Commission say money is owed. The Office of Personnel Management, which administers the government’s retirement system, and the OPM inspector general say that money isn’t owed. The GAO is the most neutral party so its findings should carry more weight with members of Congress. Let’s hope as a transfer from the federal government to the USPS would amount to a taxpayer bailout.
The GAO explains:
Any assets that are transferred from the nonpostal to the postal subaccount of CSRS [Civil Service Retirement System] would increase the federal government’s nonpostal CSRS unfunded liability, which must then be paid by the federal government through tax revenue, borrowing, or both. For example, adoption of the recommendation in the PRC report would result in an asset transfer of about $50 billion to $55 billion, which would then need to be repaid by the federal government and taxpayers.
The GAO also notes that a bailout wouldn’t solve the USPS’s long-term problems:
Any change in the USPS’s share of responsibility for CSRS benefits would provide some temporary relief from the pressures USPS faces because of declining volume, revenue, and inflexible costs, but would not by itself address USPS’s long-term financial outlook. Such a transfer of CSRS funds would not be sufficient to repay all of USPS’s debt and address current and future operating deficits related to USPS’s inability to cut costs quickly enough to match declining mail volume and revenue.
See this Cato essay for more on the USPS’s problems and why it should ultimately be privatized.
American Government Spending: 41% of GDP
My good friend Kathy Ruffing at CBPP takes me to task for testifying that government spending in the United States is 41 percent of GDP, which in my view is a very high and harmful level.
Kathy says that recent U.S. spending data is “exaggerated” because of the recession, and indeed, spending has soared not only here, but in most major countries because of the unfortunate popularity of Keynesian pump-priming theories. My point was that the American smaller-government advantage eroded both during the Bush growth years and during the Obama recession years, as seen in Figure 2 of my testimony.
Kathy noted that the OECD data I used are different than U.S. national income accounts data published by the Bureau of Economic Analysis. Well, that’s right. Every country has quirks in the way they do their national income data. The advantage of using OECD data is that the economists at the OECD adjust for these quirks and create spending data that is comparable across countries. If Kathy has more accurate international comparisons, I’d love to see them.
Finally, Kathy says that just because American government spending divided by GDP is about 40 percent, that “doesn’t mean that government controls about 40 percent of the U.S.economy.” I don’t agree. She means that government does not produce 40 percent of gross domestic product, which is true. The broader figure of 40 or 41 percent includes not just government production but government transfers. And transfers do entail government control over resources because both the taxing and spending activities involved in transfer programs distort private sector behavior. Thus, the government misallocates resources both when it “produces” useless solar power activities in its own labs and when it subsidizes failed private solar companies.
Anyway, thanks to Kathy for raising the important issue of the overall size of government because it is something that the policy community should focus more attention on. For data geeks, the OECD has all kinds of cross-country comparison data here. Government spending is Table 25.
Cain 9-9-9: Huge Tax Haul from VAT
The Herman Cain campaign released details of the revenue expected to be collected from his 9-9-9 tax plan. Here are the estimates for 2010:
- $701 billion from the 9 percent personal income tax.
- $753 billion from the 9 percent retail sales tax.
- $863 billion from the 9 percent business VAT.
Yikes! By far the largest tax haul under the Cain plan would be from the business VAT—a tax which would be hidden from most voters.
By the way, the Cain business tax is not a tax on “corporate income,” as some media stories are identifying it. The new revenue data makes it clear that it is a tax on all value added by all businesses in the nation—corporate, partnership, and proprietorship.
Sorry Mr. Cain, I think your tax plan gives the federal government far too much room to grow in coming decades as entitlement cost pressures increase. I’d suggest dropping 9-9-9 and going with my 15-15-15 tax plan. After that, you could move on to proposing a detailed plan for spending cuts, as candidate Ron Paul has delivered.
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