Policy Institutes

There’s a lot to say about the substance of the misguided anti-encryption legislation sponsored by Sens. Dianne Feinstein and Richard Burr, which was recently released as a “discussion draft” after a nearly-identical version leaked earlier this month.  I hope to do just that in subsequent posts.  But it’s also worth spending a little time on the proposal’s lengthy  pre-amble, which echoes the rhetorical tropes frequently deployed by advocates for mandating government access to secure communications and stored data. 

The bill is somewhat misleadingly titled the “Compliance With Court Orders Act of 2016”—which you’d think would be a matter for the Judiciary Committee, not the Senate Select Committee on Intelligence—and begins with the high minded declaration that “no person or entity is above the law.”  Communication services and software developers, we are told, must “respect the rule of law and comply with all legal requirements and court orders.”  In order to “uphold the rule of law,” then, those persons and entities must be able to provide law enforcement with the plaintext—the original, un-garbled contents—of any encrypted message or file when so ordered by a court.

The politest way I can think of to characterize this way of framing the issue is: Nonsense.  Whatever your view on mandates of the sort proposed here, they have little to do with the principle of “the rule of law”: The idea that all citizens, including those who wield political power, must be governed by neutral, publicly known, and uniformly applicable rules—as opposed to, say, the whims and dictates of particular officials.  This formal principle says nothing about the content of the legal obligations and restrictions to which citizens are subject—only that those restrictions and obligations, whatever they are, should be known and consistently applied.  In effect, Feinsten and Burr are pretending that a sweeping and burdensome new regulatory requirement is nothing more than the application of a widely-revered formal principle central to free societies.  We can debate the merits of their proposed regulation, but this talking point really ought to be laughed out of the room.

There are two wholly different kind of scenarios in which technology companies have recently been charged with placing themselves “above the law” by declining to assist law enforcement.  Both are specious, but it’s worth distinguishing them and analyzing them separately.

First, you have the kind of situation at issue in the recent conflict between Apple and the FBI, which has received so much media coverage. In this instance, it is clear that Apple was indeed capable of doing what the FBI wanted it to do: Write a custom piece of software that would disable certain security features on the work iPhone used by a deceased terrorist, enabling the FBI to crack the phone’s passcode and unlock the data within.  Sen. Feinstein condemned the company for fighting that order in court, declaring: “Apple is not above the laws of the United States, nor should anyone or any company be above the laws. To have a court warrant granted, and Apple say they are still not going to cooperate is really wrong.”  A similar view of the conflict was implicit in a slew of lazy news headlines that characterized Apple as “defying” a court’s order.

All of this, however, reflects a profound and rather disturbing misunderstanding of how our legal system operates.  Subpoenas and court orders routinely issue initially in response to a request from the government, with no opposing arguments heard.  But the recipients of those orders, as  a matter  of course, have an essential legal right to contest those orders in an adversarial hearing.  Here, Apple raised a variety of different objections—among them, that the statute invoked by the government, the All-Writs Act, did not actually authorize orders of the sort that the FBI had sought; and that even if the statute could be generally interpreted to permit such orders, that this one imposed an excessive and unreasonable burden on Apple. 

Now, you can agree or disagree with the various legal arguments advanced by Apple, as well as the many legal and technical experts who lined up to back the company.  But this is not Tim Cook standing atop a barricade howling “Anarchy!”—and it is a borderline-Orwellian abuse of language to say that a company puts itself “above the law” by using the legal process to contest the government’s interpretation of the law.  If the case had gone to the Supreme Court, Apple had lost, and still insisted it wouldn’t comply, then yes, they’d be placing themselves “above the law.”  Until then, they’re just working appropriately within the legal system, and it’s frankly chilling to hear elected officials implying there’s anything improper about that.  “The rule of law” does not require that everyone engaged in litigation with the government should surrender and defer to the interpretation of the government’s lawyers—especially given that one judge has already held that Apple has the better argument.

The second scenario the bill aims to address is the one where a company simply can’t do anything to help, because they don’t have access to the cryptographic keys needed to decipher a given message or file.  Now, you can argue the merits of passing a new mandate requiring companies to have this capability. What you cannot reasonably argue is that “the rule of law” is undermined when, in the absence of a mandate, companies cannot comply with orders to decrypt files with user-generated keys.   The rule of law does not mean that every imaginable outcome a judge directs—from decrypting data to flying like a bird—must be achievable by anyone served with a court order.

Consider: It is possible to build cars (and, presumably, laptops or firearms or any number of other consumer goods) with a GPS location beacon and a remote shutoff switch that will disable them until police can arrive in the event of theft.  Some cars are indeed built with such features, which would no doubt be of great help to police in a variety of cases. But most cars are not built with these features, and nobody thinks General Motors—served with an order to locate a stolen car and shut down the engine—would be “defying the rule of law” if they had to reply:  “We have no way to do that; we didn’t build that car with those capabilities.”  Moreover, if a legislator proposed a massive and costly new regulation requiring that all new cars be built with such features, we would rightly gawp incredulously at the suggestion that this was merely an effort to “ensure compliance with court orders,” as though the failure to build a feature useful to police were tantamount to obstruction of a lawful search warrant.  We would, indeed, probably regard such an argument as a rather brazen attempt to downplay the costly new regulatory burden such a mandate would impose on auto makers. 

All sorts of technologies—from document shredders to toilets—may help criminals keep incriminating material out of the hands of police.  As a result, some searches conducted pursuant to lawful warrants will not succeed in turning up the evidence sought.   We can regard that as unfortunate, and we can debate what measures what may be appropriate in aiding police meet with greater success.  But anyone who tried to ratchet up the rhetoric by claiming that toilets therefore undermine the Rule of Law would be laughed out of the room—which is the appropriate reaction here, as well.

So much for rhetoric.  In a subsequent post, I’ll get into why the substantive idea of a “decryptability” mandate is so insanely misguided.

On Sunday night, Brazil’s Chamber of Deputies voted overwhelmingly (367-137) to open impeachment proceedings against President Dilma Rousseff. The Senate will now vote on whether to take the case and try her, which is all but guaranteed. As a matter of fact, barring some unforeseen event, Dilma’s days as president are numbered.

These are Brazil’s most turbulent months since the return to democracy in 1985. Not only is the president about to be removed from office, but the country is also mired in its worst economic recession since the 1930s. It is not coincidence that Dilma’s popularity (10%) stands at a similar level to Brazil’s fiscal deficit (10.75%), the unemployment rate (9.5%), and the inflation rate (9.4%). The economic and political crises are feeding off of one another.

Here are some facts and myths regarding this impeachment process:

“It’s a coup!”

For some in the Latin American left, anything that cuts short a president’s tenure in office —even if it’s an impeachment process stipulated in the Constitution— is a coup. The same narrative was applied when left-wing President Fernando Lugo was impeached by Paraguay’s Congress in 2012.

The impeachment process and the crimes for which a president can be impeached in Brazil are clearly outlined in articles 85 and 86 of the Constitution. Moreover, the entire process has been overseen by the Supreme Court, which has thus far found no fault in how things have been conducted. It’s important to add that 8 of the 11 justices in the Supreme Court were appointed by Dilma and her Workers’ Party predecessor, Lula da Silva.

Tellingly, when the Guatemalan Congress voted last year to strip right-wing President Otto Pérez Molina of his immunity, so he could be prosecuted for corruption charges, no one claimed it was a coup.

“Dilma hasn’t been accused of any wrongdoing”

It is true that Dilma hasn’t been accused of personally being involved in the Petrobras bribing scheme that inflicted loses of $17 billion on the state-owned oil company. Even though she was the chairwoman of the oil giant when most of the corrupt deals took place, her defense is that she was unaware that this was going on; at any rate, not a very good show of competence.

However, President Rousseff is not being impeached over the Petrobras corruption scandal, but over her government’s illegal handling of budgetary accounts. In this regard, it was an independent court —the Federal Accounts Court— that ruled that the Rousseff administration had broken the law. According to article 85 of Brazil’s Constitution, this is a crime for which a president can be impeached.

“Most of the members of Congress are implicated in corruption scandals”

This is actually true. According to an NGO called Transparência Brasil, 60% of members of Congress have been convicted or are under investigation for various crimes, including corruption and electoral fraud. The speaker of the Chamber of Deputies, Eduardo Cunha, has been charged with taking millions of dollars in bribes under the Petrobras scheme.

It is true that Brazilians aren’t simply dealing with a corrupt ruling party, but a crooked political class. Impeachment won’t fix this, but it will certainly set a powerful precedent. However, if the ultimate aim of Brazilians is to clean up the political system, they must be more rigorous in how they elect their political leaders in the future.

Other reforms are badly needed, such as overhauling the rules that grant immunity to members of Congress when they face criminal charges. Brazilians who have taken to the streets demanding the ouster of Dilma should now set their sights on political reform and those who oppose it.

“There is a political vendetta against the Worker’s Party from the Judiciary and the right-wing media”

It is true that Brazil’s judicial institutions, including the federal police, the attorney general’s office, and leading judges have been very active uncovering, prosecuting and convicting politicians involved in corruption scandals. But those implicated thus far have belonged to different political parties, including those of the opposition. As mentioned above, the speaker of the Chamber of Deputies leading the impeachment process against Dilma has been charged with corruption.

The media has also played a critical role in exposing the Petrobras scheme. This is good. Unlike other South American countries where the press has been stifled by their governments, in Brazil there is a vibrant and free press that hold politicians accountable, and not only those that belong to the incumbent party. As a matter of fact, big news outlets considered “anti-Workers’ Party” have exposed the shenanigans of Speaker Eduardo Cunha and pointed out the fact that numerous Congressmen impeaching Dilma are also facing their own corruption charges. This doesn’t look like a cover-up.

The impeachment process is without a doubt a distressing affair for Brazil’s young democracy. But the country will emerge stronger if the right lessons are learned. 

You Ought to Have a Look is a feature from the Center for the Study of Science posted by Patrick J. Michaels and Paul C. (“Chip”) Knappenberger.  While this section will feature all of the areas of interest that we are emphasizing, the prominence of the climate issue is driving a tremendous amount of web traffic.  Here we post a few of the best in recent days, along with our color commentary.

With Earth Day and the grand signing ceremony for the Paris Climate Agreement just around the corner, we thought it apt to highlight some relevant stories from around the web, particularly those critical of the central climate control enterprise.

Recall that we have pointed out the Paris Climate Agreement represents little more than a business-as-usual approach that has been spun to suggest that it represents a collective, international effort in response to a climate change “concern.” Increasing opportunities for riding your bike (etc.) now have been rebranded as efforts to save the world. Right.

We’ve shown that the U.S. pledge under the Paris “Don’t Call It a Treaty” Agreement, while a bit more aggressive than many, turns out to basically be impossible. Putting our name on such pledge seems a bit disingenuous, to put it mildly.

On top of all this comes a new economic analysis from the Heritage Foundation that basically shows that the U.S. intension under the Agreement would be mucho bad news. Here are the Key Points from the report “Consequences of Paris Protocol: Devastating Economic Costs, Essentially Zero Environmental Benefits”:

 

The justifications for all these findings are described in detail in the full report.

Clearly, considering all the negatives stacked up against the U.S.’s commitment under the Paris Agreement, it’s hard to find any justification for signing it that is built upon anything but false premises.

Next up is a notable article (h/t Judy Curry) called “Twilight of the Climate Change Movement” authored by Mario Loyola, Senior Fellow at the Wisconsin Institute for Law and Liberty, that appears in The American Interest. Loyola points out that despite the “fanfare” surrounding the Paris Agreement, “the climate change movement faces big trouble ahead.”  Loyola explains:

Its principal propositions contain two major fallacies that can only become more glaring with time. First, in stark contrast to popular belief and to the public statements of government officials and many scientists, the science on which the dire predictions of manmade climate change is based is nowhere near the level of understanding or certainty that popular discourse commonly ascribes to it. Second, and relatedly, the movement’s embrace of an absolute form of the precautionary principle distorts rational cost-benefit analysis, or throws it out the window altogether.

Lots of good information in this article, including a review of the uncertainties in the science of climate change and how those uncertainties are downplayed, or swept away, in the pursuit of an anti-industrialist agenda—be sure to check out the whole thing.

Extending a look at the dangers of an anti-industrialist agenda, Cato Adjunct Scholar Alex Epstein gave a dazzling performance in presenting testimony before the April 13th hearing of the Senate Environment and Public Works Committee “Examining the Role of Environmental Policies on Access to Energy and Economic Opportunity.” Alex laid out why restricting energy choice—which is the main premise of centralized efforts to mitigate climate change—is a really bad idea:

The energy industry is the industry that powers every other industry. To the extent energy is affordable, plentiful, and reliable, human beings thrive. To the extent energy is unaffordable, scarce, or unreliable, human beings suffer. 

His written testimony is available here.

But we’d be remiss if we left you only with that.

The real fireworks were in his oral testimony and included a tussle with Sen. Barbara Boxer (D-CA), a call for an apology or resignation from Sen. Sheldon Whitehouse (D-RI), and telling the committee that most of them would probably not be alive today without cheap, plentiful, reliable energy. The highlights are available here. It is most enjoyable!

And finally, last, but certainly not least, is the Manhattan Institute’s Oren Cass’s excellent piece in the current issue of National Affairs, titled “The New Central Planners.” The piece critically examines the administrative state’s seemingly unquenchable desire to fix market “failures”—a conceit that is perhaps nowhere more on display than in the climate change issue. Here’s a taste:

By asserting that their frameworks, tools, and data prove government action will enhance market efficiency, economists are engaging in a new form of central planning. It differs in degree from traditional command-and-control socialism, but not in kind. It is less absolute — the market economy provides a baseline until an intervention occurs. It is less totalitarian — plans are executed through rules and incentives that alter the behavior of market actors instead of through the direct assignment of resources. But it is rooted in the same conceit that technical expertise can outperform market forces and deserves deference where applied. It suffers from the same challenges of incomplete information, heterogeneous preferences, and subjective values. It relies on the same refusal to acknowledge the inherent tradeoffs that underlie the allocation of scarce resources. And, as a result, it also reduces democratic accountability, economic efficiency, and total welfare.

The alternative to technocratic planning is not post-modern, nihilistic resignation to the impossibility of evaluating policy. It is an administrative state designed around a recognition that market signals and political preferences provide a better guide than can bureaucratic analysis, that those signals and preferences vary locally, and that optimization requires constant recalibration. Many current efforts at regulatory reform focus on increasing the influence of cost-benefit analysis, but in fact we need to reduce it. Management within the executive, delegation from the legislature, and oversight by the judiciary should all assume that technocratic expertise lies only in designing the specific rules to implement when there is a political demand for intervention, not in determining when such interventions are appropriate.

Oren’s article is so chock-full of good stuff that it’s really hard to decide what to excerpt, so be sure to take the time and read his entire essay. We’ll sure that it’ll be time well spent. The same is true for all of the above articles. You really ought to have a look!

One of the most important elements of contemporary financial regulation is bank capital adequacy regulation — the regulation of banks’ minimum capital requirements.  Capital adequacy regulation has been around since at the least the 19th century, but whereas its previous incarnations were relatively simple, and usually not very burdensome, modern capital adequacy regulation is vastly both more complicated and more heavy-handed.

After I first began research on this subject years ago, I watched the Basel Committee take part in a remarkable instance of mission creep: starting from its original remit to coordinate national banking policies, it expanded into an enormous and still growing international regulatory empire.  Yet I also noticed that no-one in the field seemed to ask why we needed any of this Basel regulation in the first place.  What, exactly, were the market failure arguments justifying Basel’s interventions generally, and it’s capital adequacy regulation in particular?

On those occasions when regulatory authorities make any attempt to justify capital regulations, they typically settle for mere assertion.  The following little gem from a recent Bank of England Discussion Paper on the implementation of Basel in the UK is typical:

Capital regulation is necessary because of various market failures which can lead firms on their own to choose amounts of capital which are too low from society’s point of view.[1]

The authors don’t bother to say what the market failures consist of, let alone prove that they actually are present.  Nor do they even hint at the possibility that banks may choose unduly low levels of capital, not because of market failure, but because they are encouraged to do so by government deposit insurance or central banks’ offers of last-resort support.  Instead, there is a mere appeal to that ethereal entity, “society,” the incontrovertible opinion of which is that financial institutions ought to hold more capital than they would be inclined to hold if left to their own devices.  Policymakers are, furthermore, privy to this opinion, though why they should be so is also left unexplained.

On those rare occasions when genuine market-failure arguments for capital adequacy regulation are put forward, they are less than compelling.  An example was recently provided by my friend, the former Bank of England economist David Miles.  In an appendix to his thoughtful valedictory speech as a member of the Monetary Policy Committee last summer, David sketches out a simple model to “illustrate the tendency for unregulated outcomes to create too much risky bank lending.”

In his model, banks operate under limited liability, which allows them to pass on high losses to their creditors.  They also take risky lending decisions, but depositors do not see the riskiness of the loans that their bank makes.  Miles then obtains an equilibrium in which banks with lower capital are more prone to excessively risky lending, and he suggests that the solution to this problem (of excessively risky bank lending) is to increase capital requirements.

Let’s grant the point that banks with low capital levels would be prone to excessively risky lending. Let’s also agree that the solution is higher capital.  Miles would have this solution implemented by regulators increasing minimum capital requirements.

However, the same solution could also be implemented by depositors themselves.  They could choose not to make deposits in banks with low capital levels.  In a repeated-game version of the model, they could also run on their bank if their bank’s capital levels fell below a certain threshold.  Weakly capitalized banks would then disappear and so, too, would the excessively risky bank lending.

The mistake here — and it is a common one among advocates of government intervention — is to come up with a solution to some problem, but then assume that only the government or one of its agencies can implement that solution.  To make a convincing case for state intervention, they have to explain why only the government or its agencies can implement that solution: they have to demonstrate a market failure.[2]

A more substantial argument for capital adequacy regulation, also by David Miles, was published in the European Economic Review in 1995.  (See also here.)  The essence of this argument is that if depositors can assess a bank’s capital strength, a bank will maintain a relatively strong capital position because greater capital induces depositors to accept lower interest rates on their deposits.  However, if depositors cannot assess a bank’s capital strength, then a bank can no longer induce depositors to accept lower interest rates in return for higher capital, and the bank’s privately optimal capital ratio is lower than the socially optimal capital ratio.[3]  Information asymmetry therefore leads to a bank capital adequacy problem.  Miles’s solution is for a regulator to assess the level of capital the bank would have maintained in the absence of the information asymmetry, and then require it to maintain this level of capital.

There is, however, a problem at the heart of this analysis.  Consider first that the technology to assess and convey the quality of bank assets either exists or it does not.  If the technology does exist, then the private sector can use it, and there is no particular reason to prefer that the government use it instead.  There is then no market failure.  On the other hand, if the technology does not exist, then no-one can use it, not even the government.  Either way, there is no market failure that the government can feasibly correct.  To assume that the technology exists, but that only the government can use it, is not to demonstrate the presence of a market failure, but to assume it.

Of course, we all know that the technology in question does exist, albeit in imperfect form.  The traditional solution to this asymmetric information problem is for the shareholders (or, more accurately, bank managers acting on behalf of shareholders) to provide externally audited reports.  These reports are made credible by the managers and the auditors being liable to civil penalties in the event that either party signs off on statements that are materially misleading.  If they issue misleading statements, aggrieved creditors could then pursue them through the courts.

A potential objection is that this solution requires a high level of financial competence among depositors that cannot be expected of them.  In fact, it does not.  Instead, all it requires is that there are analysts who can interpret audited reports, and that they, in turn, convey their opinions to the public in a form that the public can understand.  The average depositor does not have to have a qualification in chartered accountancy; instead, they only need to be able to read the occasional newspaper or internet piece about the financial health of their bank and then make up their minds about whether their bank looks safe or not.  If their bank looks safe, they should keep their money there; if their bank does not, they’d better run.

One should also compare the claims underlying any model and the predictions generated by it against the available empirical evidence.  In this case, the claim that depositors cannot assess individual banks’ balance sheets is empirically falsified, at least under historical circumstances where the absence of deposit insurance or other forms of bailout gave depositors an incentive to be careful where they put their deposits.  To quote George Kaufman on this subject:

There is … evidence that depositors and noteholders in the United States cared about the financial condition of their banks and carefully scrutinized bank balance sheets [in the period before federal deposit insurance was introduced].  Arthur Rolnick and his colleagues at the Federal Reserve Bank of Minneapolis have shown that this clearly happened before the Civil War.  Thomas Huertas and his colleagues at Citicorp have demonstrated the importance of [individual] bank capital to depositors by noting that Citibank in its earlier days prospered in periods of general financial distress by maintaining higher than average capital ratios and providing depositors with a relatively safe haven.[4]

The Miles position is also refuted by the empirical evidence on the bank-run contagion issue.  If Miles is right and depositors cannot distinguish between strong and weak banks, then a run on one bank should lead to runs on the others as well.  Yet the evidence overwhelmingly indicates that bank runs do not spread in the way that the Miles hypothesis predicts.  Instead, there occurs a “flight to quality,” with depositors withdrawing funds from weak institutions for redeposit in stronger ones.  The “flight to quality” phenomenon demonstrates the very point that Miles denies, i.e., that depositors have been able to tell the difference between strong and weak banks.

So, once again, there is no market failure.

I should add, in concluding, that I’ve addressed these two arguments by David Miles because they are the best market-failure arguments for capital adequacy regulation that I’m aware of.  I invite readers to point me to stronger arguments if they can find any.

_____________________

[1] Bank of England, “The Financial Policy Committee’s review of the leverage ratio,” October 2014, p. 12.

[2] There are also two other “first-best” solutions in Miles’ model that do not involve government or central bank capital regulation.  The first is where a bank has a 100 percent capital ratio, in which case the risk of loss to depositors would be zero, but only because there would no longer be any depositors.  The “bank” would no longer be a bank either, because it would no longer issue any money: instead, it would become an investment fund.  The second is to eliminate limited liability to prevent bank shareholders walking away from their losses.  In this context, one should recall that limited liability is not a creature of the market, but a product of the limited liability legislative interventions in the 19th century.

[3] The fact that there is a suboptimal equilibrium in which banks maintain lower-than-optimal capital levels is also a little odd, and would appear to reflect the informational assumptions that Miles made in his model.  If depositors are not sure of the quality of their bank’s assets, we might have expected them to insist that their banks maintain higher rather than lower capital levels, or else keep their money under the mattress instead.  I thank George Selgin for this point.

[4] Kaufman, G. G. (1987) “The Truth about Bank Runs.” Federal Reserve Bank of Chicago. Staff Memorandum 87–3, pp. 15-16.

[Cross-posted from Alt-M.org]

A stubborn myth of the pro-tax left (exemplified by Bernie Sanders) is that the Reagan tax cuts merely benefitted the rich (aka Top 1%), so it would be both harmless and fair to roll back the top tax rates to 70% or 91%.

Nothing could be further from the truth. Between the cyclical peaks of 1979 and 2007, average individual income tax rates fell most dramatically for the bottom 80%  of taxpayers, with the bottom 40 percent receiving more in refundable tax credits than paid in taxes.  By 2008 (with the 2003 tax cuts in place), the OECD found the U.S. had the most progressive tax system among OECD countries while taxes in Sweden and France were among the least progressive.

What is commonly forgotten is that before two across-the-board tax rate reductions of 30% in 1964 and 23% in 1983, families with very modest incomes faced astonishingly high marginal tax rates on every increase in income from extra work or saving (there were no tax-favored saving plans for retirement or college).

From 1954 to 1963 there were 24 tax brackets and 19 of those brackets were higher than 35%.  The lowest rate was 20% -double what it is now.  The highest was 91%.

High and steeply progressive marginal tax rates were terrible for the economy but terrific for tax avoidance. Revenues from the individual income tax were only 7.5% from 1954 to 1963 when the highest tax rate was 91%, which compares poorly with revenues of 7.9% of GDP from 1988 to 1990 when the highest tax rate was 28%. 

The graph, from the Brookings-Urban Tax Policy Center, shows how inflation pushed more and more families into higher and higher tax brackets from 1973 to 1981, when inflation averaged 7.6% as measured by the PCE deflator.   Thanks to runaway inflation and escalating bracket creep, from 1973 to 1981 marginal tax rates were rising for everyone at or above the middle income (the 50th percentile shown in light blue). 

Unfortunately, the 1981 tax law waited until 1983 to phase-in a diluted 23% rate reduction (the 1964 Kennedy rate cuts were 30%).   Yet in 1983, as Bloomberg’s Megan McArdle points out, “the individual income tax was still taking in 8.2% of GDP, which was above the average of the 1970s.” 

In 1983-84, only 18% paid no income tax. Today, mainly because of tax laws enacted by Republicans in 1986 and 2001-2003, 45.3% of tax returns pay no tax –with many receiving refundable tax credits that exceed their Social Security taxes.

Despite dramatically lower inflation after 1981, bracket creep continued to impose small but sneaky tax hikes on middle-income taxpayers until 1985 when tax bracket income thresholds were finally indexed. If tax rate are flat, or nearly so, that whole game of pushing people into higher tax brackets is over. That happened to some extent from 1988 to 1990, when the 1986 Tax Reform briefly cut the top tax rate to 28% through 1990.  The worse that could then happen from a raise, promotion or second earner would be to shove you into a 28% tax bracket, which we now consider “middle class.” From 1988 to 1990 the nearly-flat individual income tax brought in 7.9% of GDP (despite overtaxing capital gains) with a top tax rate of 28%.  Ironically, revenues under that 28% top tax were greater than the 7.6% average of 1991-95, despite or because of the Bush and Clinton “tax increases.” 

Since 1988, despite vigorous efforts of the pro-tax establishment (e.g., Treasury, CBO and their graduates at the Tax Policy Center), marginal tax rates at all income levels remained much lower than they were from 1932 to 1981. Thank Presidents Kennedy and Reagan for that, but also Senator Bill Bradley (D-NJ) and especially Congressmen Jack Kemp (R-NY).  But thanks are also due to Congressmen Bill Steiger (R-WI) and Bill Thomas (R-CA) for lower tax rates on capital gains and dividends. Despite all this widespread relief from onerous and punishing taxation, Bernie Sanders seems oddly nostalgic about President Eisenhower’s 19 tax brackets above 35% while Secretary Clinton dreams of resuscitating a disastrous capital gains tax scheme FDR was forced to abandon in 1938. 

Neither the Kennedy tax rate reductions of 1964-65 nor the Reagan tax rate reductions of 1983-88 were enacted “to benefit the rich.”  That is just a worn-out myth. 

In the run-up to President Obama’s visit to Saudi Arabia later this week, two domestic issues which concern the U.S.-Saudi relationship are also gaining attention. Yet these developments – a congressional bill which allows Americans to sue foreign governments for supporting terrorist groups, and growing calls to declassify the remaining 28 pages of the 9/11 Commission’s report - are unlikely to substantially impact the U.S.-Saudi relationship, which is already on a downward trend due to other, more substantive factors.

Certainly, the bill would have major legal implications for relatives of victims of the 9/11 attacks, who have previously tried to sue the Saudi government for their possible involvement. However, their hope that the declassified report would yield a better understanding of the scope of that involvement is unlikely to yield any smoking gun revelations.

Some of the purported revelations are, in fact, already known. It has been long known that Saudi Arabia has had a hand in the spread, through schools and philanthropic endeavors, of a certain kind of extremist Islamic philosophy often described as Wahhabism. That this philosophy is shared by various radical groups including ISIS and Al Qaeda is likewise well-known, but there is no evidence that the Saudi government ever provided material support to either group.

Though lesser-known, it is also the case that many private Saudi citizens have provided funding to extremist groups over the years. And while it did not come from the government, as Ben Rhodes, the president’s Deputy National Security Advisor noted this week, the Saudi government often paid “insufficient attention” to such funding, particularly prior to 2001. The 9/11 Commission report, though likely to be less detailed than many of the studies of this phenomenon conducted over the last decade, may well include data on the extent to which the Saudi government turned a blind eye to terrorist funding.

Comments from those who have read the reports, and previously declassified information, also suggests that junior Saudi officials may even have played some role in the 9/11 attacks themselves. Indeed, perhaps the best known line in the 9/11 report itself is the assertion that the Commission found “No evidence that the Saudi government as an institution or senior Saudi officials individually funded the organization,” an obvious loophole that leaves little to the imagination. Yet, it is worth noting that any such revelations contained in the report would be at best preliminary, based on unvetted and unverified intelligence.

In fact, while the Saudi government has not objected to declassification of the report, it clearly perceives the congressional bill as a larger concern, threatening economic reprisals. The threat to sell-off American assets if the bill passes is likely an empty one, but it certainly underscores the concern Saudi leaders feel about the potential for such lawsuits.

Perhaps the most interesting aspect of this whole episode is that it is happening at all, a development at least partially driven by the deteriorating U.S.-Saudi relationship. President Obama’s trip to Riyadh will not be an entirely pleasant one given all the tensions in the U.S.-Saudi relationship. Indeed, only a few weeks ago, President Obama himself publicly questioned the Saudi alliance in an interview with the Atlantic’s Jeffrey Goldberg.

Ultimately, the Saudi alliance is changing. Once thought unshakeable, common U.S.-Saudi interests such as energy security and anti-communism have diverged or disappeared entirely. Meanwhile, disagreements on regional stability, Saudi involvement in conflicts like Syria and Yemen, and their support for various extreme groups have helped to sour the relationship. Whether or not the 9/11 Commission report is declassified, it is these larger tensions which present the major obstacle to smooth U.S.-Saudi relations in the future. 

A Time article by James Grant warning about rising federal debt has prompted pushback by columnists questioning whether debt is really so bad. At the Washington Post, Wonkblog columnist Matt O’Brien says “there’s no reason to cut the debt today.” Fellow Wonkblog columnist Max Ehrenfreund suggests that Grant’s figure of $42,998 government debt per person overstates the problem.

O’Brien suggests that the only reason to fear debt would be if it was leading to a financial crisis, but it isn’t because interest rates are low. But O’Brien neglects to mention that interest rates may rise substantially in coming years. CBO projects that as rates rise, federal interest costs will triple from $253 billion this year to $839 billion by 2026.

As for Ehrenfreund, he is right that $42,998 overstates the debt problem because it does not take into account our future rising population. At the same, however, $42,998 understates the problem because each year the government adds more debt. Over the next 10 years, the U.S. population will grow 8 percent, but the CBO says federal debt will rise 69 percent. So Grant’s simple debt metric will increase over time.

Other than possibly causing a financial crisis, rising federal debt creates other harms:

  • Raises Future Taxes. Taxes damage the economy by reducing incentives for productive activities, a harm called deadweight losses. With borrowing, the deadweight losses from taxes are moved to the future when taxes are raised to pay the interest and principal on the debt. So the damage from borrowing is imposed on people down the road because that is when the government will use its coercive power to extract the extra money.
  • Reduces National Saving. Rising debt may crowd out private investment, reduce the U.S. capital stock, and thus reduce future incomes. Economist James Buchanan said, “By financing current public outlay by debt, we are, in effect, chopping up the apple trees for firewood, thereby reducing the yield of the orchard forever.” Such a decline in investment may be averted if private saving rises to offset government deficits. But the CBO says, “the rise in private saving is generally a good deal smaller than the increase in federal borrowing, so greater federal borrowing leads to less national saving.”
  • Saps Business Confidence. Rising government debt may also deter private investment through the mechanism of business expectations. Businesses may be reluctant to make long-term investments, such as building new factories, if high and rising government debt creates a fear of tax increases down the road.
  • Siphoned to Pay Foreigners. Some pundits, such as Paul Krugman, tell us not to worry about government debt because we “owe it to ourselves.” But today about half of federal debt is owed to foreigners. So growing debt means that a rising share of the future earnings of U.S. workers will be siphoned off by the government to repay foreign creditors.
  • Distorts Government Decisionmaking. The availability of debt finance may induce policymakers to increase spending excessively. Since borrowing makes programs appear to be “free” to citizens and policymakers, the government has less incentive to be frugal, and is more likely to spend on low-value programs.

Wonkblog’s O’Brien says he “feels fine” about today’s $13.9 trillion of debt. But how about tomorrow’s $24 trillion, as shown in the chart? And what if America has further recessions, wars, and other negative shocks, and it becomes $30 trillion? Surely, in today’s uncertain world, we want our policymakers to err on the side of prudence, and so debt growth measured in trillions makes me feel far from fine.

 

For a brief history of federal debt and why it is a major problem, see this 2015 report.

The conventional wisdom that United States v. Texas would be one of the handful of 4-4 ties in the post-Scalia era looks pretty wise indeed. After an hour and a half of argument and huge masses of demonstrators outside the courthouse – more people than I’ve ever seen – that result would be anticlimactic: DAPA remains enjoined, without a Supreme Court opinion.

That’s a good thing for two reasons:  1) in my view, President Obama’s executive action goes beyond executive power under the immigration (and administrative) laws and 2) because the next president will almost certainly rescind (if a Republican) or expand (if a Democrat) the program – mooting or transforming the case. While the government’s supporters had been hoping that the 26-state lawsuit would be dismissed for lack of standing – perhaps Chief Justice John Roberts could be swayed to that technical solution – there do not seem to be five votes for that solution either.

But even though we aren’t likely to get a real decision, this morning’s argument highlighted the importance of the case beyond the immigration context, raising key separation-of-powers issues. As the Obama administration has taken executive power to heights it has never been before, the U.S. solicitor general at one point mentioned “the change in federal law” that DAPA represents – and, of course, it takes a new law passed by Congress to change an old law. Justice Kennedy thus asked about a limiting principle – echoing past arguments over Obamacare and other battles over federal power – and how to define “the limits of discretion.”

With respect to immigration, Texas’s solicitor general concisely boiled down the case to a matter of transforming deferred action (a non-binding decision not to seek removal) into a grant of legal status. That’s the nub: much as we would want an immigration system that makes sense, that allows peaceful people to be productive members of society, that’s not what we have, and the president can’t just use his pen and phone to fix it.

As Justice Robert Jackson put it in his canonical statement about constitutional structure in the 1952 Steel Seizure Case, courts must be last, not first, in giving up on the separation of powers. Just because we might like a policy or think that its costs outweigh its benefits, doesn’t mean that it’s constitutional.

A new study, published in the journal Circulation, adds to growing doubts about the benefits of skim or low-fat milk, NPR reports this morning: 

“People who had the most dairy fat in their diet had about a 50 percent lower risk of diabetes” compared with people who consumed the least dairy fat, says Dariush Mozaffarian, dean of the Friedman School of Nutrition Science and Policy at Tufts University, who is also an author of the study.

NPR reporter Allison Aubrey notes other recent studies on the possible benefits of dairy fat and then reports:

With all the new evidence that challenges the low-fat-is-best orthodoxy, Mozaffarian says it may be time to reconsider the National School Lunch Program rules, which allow only skim and low-fat milk.

“Our research indicates that the national policy should be neutral about dairy fat, until we learn more,” says Mozaffarian.

And there’s the problem for public policy. Why do we need a national policy on dairy fat? Why do we need national rules on what local schools can serve for lunch? And most specifically, since our understanding of nutrition science is always changing, why should we codify today’s understandings in law and regulation?

As I wrote a few months ago in response to a Washington Post story on the possibility that decades of government warnings about whole milk may have been in error,

It’s understandable that some scientific studies turn out to be wrong. Science is a process of trial and error, hypothesis and testing. Some studies are bad, some turn out to have missed complicating factors, some just point in the wrong direction. I have no criticism of scientists’ efforts to find evidence about good nutrition and to report what they (think they) have learned. My concern is that we not use government coercion to tip the scales either in research or in actual bans and mandates and Official Science. Let scientists conduct research, let other scientists examine it, let journalists report it, let doctors give us advice. But let’s keep nutrition – and much else – in the realm of persuasion, not force. First, because it’s wrong to use force against peaceful people, and second, because we might be wrong….

Today’s scientific hypotheses may be wrong. Better, then, not to make them law.

The New York Metropolitan Transportation Authority (MTA) has formally quit its membership in the American Public Transportation Association (APTA), the nation’s principle transit lobby. In a harshly worded seven-page letter, MTA accused APTA of poor governance, an undue focus on small transit agencies, and having an embarrassingly large compensation package to APTA’s president.

The MTA and its affiliates, Metro North, the Long Island Railroad, and New York City Transit, together carry 35 percent of all transit riders in America. Since MTA’s ridership has been growing while transit elsewhere has declined, this percentage is increasing.

Yet APTA’s focus has been on lobbying for increased funding for smaller agencies, including building new rail transit lines in cities that haven’t had rail transit and extending transit service in smaller cities and rural areas that have had little transit at all. As a result, says the letter, MTA has been short-changed by roughly a billion dollars a year in federal funding that it would have received if funds were distributed according to the number of transit riders carried.

This accords with the finding of a Cato policy analysis that found that New York has been shorted half a billion dollars a year in discretionary transit funds. Since discretionary funds make up less than half of all federal transit funds, it is easy to imagine that the nation’s largest urban area is losing a billion dollars a year to smaller cities that are not making effective use of those funds.

The letter observes that APTA’s executive committee, which makes most month-to-month decisions for the group, has up almost no representatives of “legacy systems,” meaning transit systems that had rail transit before 1980. The committee is thus biased towards smaller systems where transit spending is less needed and/or less effective than in big urban areas such as New York, Chicago, and Philadelphia.

The legacy systems, the letter notes, all have “State-of-Good-Repair needs that are an order of magnitude greater than the non-Legacy rail systems.” Yet APTA’s focus has been on building more rail lines rather than funding the maintenance needs of the legacy systems.

MTA’s APTA membership fee of more than $400,000 a year is only about 2 percent of APTA’s annual budget. The transit agency that carries more than a third of the nation’s transit riders could get away with contributing only 2 percent of the transit lobby’s budget because APTA has lots of “associate members” that aren’t transit agencies. Yet even this is a sore point with the MTA, as those associate members are mainly contractors, many of whom make their money from designing and building new rail transit lines, so their influence further dilutes the interests of the MTA and other legacy systems.

The letter concludes with what it calls the “elephant in the room,” the subject of which (it says) was the cause of “acrimonious discussions at the board level” over the compensation for APTA’s president and CEO. APTA’s 2014 IRS report reveals that it paid its president a whopping $892,471 in 2013, not counting another $57,248 in benefits. To many agency officials, this extremely high salary seems incongruous at a time when most transit agencies are having to cut their spending in response to the reduced tax revenues associated with the recent recession. For MTA in particular, this excessive compensation seems particularly galling considering it hasn’t resulted in greater federal funding for MTA at a time when MTA’s ridership is growing relative to that of the rest of the country.

This letter reflects an age-old battle within the transit industry: should the industry concentrate on providing transit in areas where transit usage is highest, or should it focus instead on trying to generate new transit riders in areas where usage is minimal? On one hand, per capita transit ridership is falling almost everywhere, even New York, so if the industry is to grow some efforts must be made in attracting new customers. On the other hand, the industry is clearly subject to diminishing returns: that is, the cost of getting each new customer is increasing.

One reason for that increase is the industry’s questionable strategy of spending huge amounts of money on high-cost infrastructure including light rail, streetcars, and exclusive bus lanes. Far more riders could be gained by spending the same amount of dollars on improvements to basic bus transit. But here is where APTA’s associate members come in, as they have a clear interest in promoting new infrastructure construction rather than expanded operations on existing infrastructure.

To be fair, APTA has to deal with the political environment in Washington, D.C., an environment that favors new construction over maintenance and at the same time favors distributing dollars to as many states and congressional districts as possible. In this environment, it could be argued, the natural outcome is to favor smaller urban areas over big ones such as New York.

But if this outcome is preordained, MTA might ask, then what good is APTA in the first place? The answer appears to be that APTA spends $20 million a year churning out press releases taking credit for decisions and results over which it, in fact, has little or no control. At least some transit supporters think that APTA could have done more to help its members find ways to spend money in ways that would more effectively attract new transit riders, although doing so might have lost APTA some of its associate members.

Since MTA’s annual fee represents such a small part of APTA’s budget, its departure will have little impact on APTA’s funding unless it is followed by similar resignations by other legacy systems. But the dent in APTA’s reputation may be more severe and may force APTA to reconsider its policy of promoting new construction over operation and maintenance of transit systems in the cities that most heavily use transit.

What do you get when you combine family trips to a gardening store and loose-leaf tea in your trash? To Kansas law enforcement, it’s probable cause to get a search warrant and perform a SWAT-style raid on a private home.

In 2011, Robert Harte and his 13-year-old son went to a store for hydroponic equipment to grow tomatoes for a school project. A state trooper had been assigned to watch that store and write down the license plates of any customers (apparently, shopping at a gardening store translates to marijuana production). To follow up that stellar bit of police work, the Johnson County Sheriff’s Office twice examined the Hartes’ trash. They found, both times, an ounce or so of “saturated plant material.”

The Keystone Kops couldn’t tell the difference between tea and tokes using their senses, so they field-tested the substance and the test came back positive for marijuana. (“A partial list of substances that the tests have mistaken for illegal drugs would include sage, chocolate chip cookies, motor oil, spearmint, soap, tortilla dough, deodorant, billiard’s chalk, patchouli, flour, eucalyptus, breath mints, Jolly Ranchers and vitamins,” notes Radley Balko.)

Still, after falsely reading the tea leaves, the deputy sheriffs performed a military-style raid on the family home. At 7:30am, the Hartes were woken up by pounding on their doors; as soon as Mr. Harte answered, an armed team flooded into the room, ordered him to the ground, and rifled through the home for three hours. The officers—once they realized that there was no large-scale growing operation—began searching for “any kind of criminal activity,” a far greater sweep than a warrant to search for “marijuana” and “drug paraphernalia” permits. Moreover, the deputies left the canine units in the house longer than was necessary, to give them “training or just experience”—so the terrifying armed raid was a mistaken fishing expedition that then turned into a training exercise.

Cato has filed an amicus brief in the federal appellate court where the Hartes’ lawsuit against the police is currently pending (after the district court dismissed it). We argue that the police failed to knock and announce their presence in anything but a literal sense—an important Fourth Amendment rule—and also exceeded the scope of their warrant to look for “any criminal activity.” The case thus raises pressing issues of police militarization in society and warrantless police authority. In briefing for an earlier case, Cato noted that “SWAT team deployments have increased more than 1,400% since the 1980s… . SWAT teams and tactical units were originally created to address high-risk situations, such as terrorist attacks and hostage crises. Today, however, these extreme situations account for only a small fraction of SWAT deployments; they’re used primarily to serve low-level drug-search warrants.”

Moreover, the knock-and-announce rule is an ancient one rooted in the English common law dating back to the early 17th century. The rule serves to protect the life, limb, and property of both home occupants and police serving a search or arrest warrant. When officers use the force associated with a SWAT raid, even without literally breaking the door, their pro forma compliance with the knock-and-announce rule converts the Fourth Amendment into a “parchment barrier.”

Indeed, the systemic use of SWAT-style force to execute low-risk drug warrants converts the presumption that people normally peaceably comply with police—central to the knock-and-announce rule—on its head. The police here could easily have investigated their suspicions here without going commando.

Accordingly, we call upon the U.S. Court of Appeals for the Tenth Circuit to send this case back for trial, consistent with the common law underlying the Fourth Amendment. 

This week congressional trade leaders introduced The American Manufacturing Competitiveness Act of 2016 (AMCA), a bill to reform and reinvigorate the stalled Miscellaneous Tariff Bill (MTB) process.  MTBs are legislative vehicles through which Congress temporarily suspends import duties on certain qualified products typically used as inputs in U.S. manufacturing operations. Soon followed the self-congratulatory triumphalism.

House Ways and Means Committee Chairman Kevin Brady (R-TX) said: “This bipartisan bill will empower American manufacturers to compete around the world, create new jobs at home, and grow our economy.”

Ranking Member Sander Levin (D-MI) added: “The MTB is a critical tool that supports American manufacturers and workers, and I’m pleased that we’re finally moving forward with this legislation.”

Senate Finance Committee Chairman Orrin Hatch (R-UT) boasted: “With this legislation, we offer a smart bicameral and bipartisan approach for MTBs — one that improves transparency and allows domestic firms to receive appropriate tariff relief on products that can only be found abroad so that those firms can produce American-made goods here at home.”

Ranking Member Ron Widen (D-OR) moralized: “We need to do everything we can to make U.S. manufacturers more competitive — that includes passing a miscellaneous tariff bill that reduces costs of components we don’t make here in the U.S.”

Let’s unpack this. 

At great expense to producers, consumers, and taxpayers, the U.S. government maintains “protective” tariffs on thousands of imported products, including thousands not even produced domestically.  To mitigate these costs, since 1982, Congress has passed eight so-called Miscellaneous Tariff Bills, which temporarily suspend duties on certain, “non-controversial” products – usually intermediate goods, such as chemicals, electronic components, and mechanical parts – that are not manufactured domestically, but are needed by U.S.-manufacturers in the production of their own output.  Though limited in impact by its temporary nature, the “no domestic production” requirement, and the caveat that the suspended duty not reduce tariff revenues by more than $500,000, the MTB does provide some cost savings to U.S. producers. The last MTB, which expired in 2012, provided an estimated $748 million of import tax relief.

But relief from what? The MTB provides relief from an abomination of Congress’s own making. Why do we even have import duties on products not produced in the United States?  And, if suspending taxes on imported industrial inputs is as good for U.S. manufacturers as the trade leadership jubilantly proclaims (see above), then why not get rid of all duties on industrial inputs – and permanently?  U.S. Customs and Border Protection collected $45 billion in import duties and fees last year.  About $26 billion were taxes on imported intermediate goods. But Congress wants credit for relieving U.S. manufacturers of less than 3% of that cost burden ($748 million/$26 billion) imposed by U.S. tariffs.  

When I asked someone from the Ways and Means Committee today why Congress doesn’t eliminate all tariffs on intermediate goods – since doing so would help attract investment, valued-added activity, and job creation in the U.S. manufacturing sector, the answer I got explains why trade policy is such a tough slog and so poorly understood.  The answer was that we need to keep those tariffs in place so that we have leverage to negotiate foreign market tariff reduction. Get that?  Even though eliminating tariffs reduces cost for manufacturers and makes them more competitive at home and abroad, the position of Congress is that we should keep self-flaggelating until other governments stop whipping their own producers with tariffs.

To be sure, elimating duties – even though temporarily and only on products not made domestically – helps at the margins.  But the self congratulations is a bit much.  And when one considers the reason that the MTB process was derailed, and that AMCA only gets us back to where we were four years ago, the whole episode is just embarrassing.

In 2012, then-Senator Jim DeMint (R-SC) spearheaded an effort to derail the MTB process, declaring duty suspensions to be earmarks, which congressional Republicans took a vow to oppose, because they provide only a “limited tariff benefit” – defined under House GOP rules as benefiting ten or fewer entities. AMCA is an effort to reconcile the MTB process with the Republican ban on earmarks so that duty suspensions can resume.  It presumably accomplishes that by inserting the U.S. International Trade Commission into the process so that duty suspension requests don’t go directly from constituents to Members and Senators, but are vetted first by this disinterested, objective, third-party intermediary.

Although AMCA provides resolution to the GOP quandary, the impasse should have never happened because duty suspensions are not earmarks.  First, duty suspensions will nearly always have more than ten beneficiaries – meaning they defy the earmark definition – because the number of importing entities is likely to increase after a duty is suspended, and the entities in the supply chains of these importers will benefit, too.  The number of beneficiaries is not static.

Second, and crucially, it is the duties – not the measures to suspend them – that are the real earmarks.  Duties enshrined in the U.S. Harmonized Tariff Schedule constitute transfers from consumers and consuming industries to specific, chosen producers.  Those duties were obtained through a process that included earmarking, logrolling, and other forms of backroom dealing.  Efforts to suspend those duties today are intended to return the tax landscape to a state of neutrality.  That objective clearly differs from measures that would channel resources from the national treasury to projects that benefit a limited few in a particular congressional district.

Under the MTB process, the suspension of import duties on qualified products is an outcome available to anyone, and the suspended duties provide benefits to everyone in the downstream supply chain all the way to the final consumer. The fundamental failure to make this connection – to recognize that there are dynamic, but not immediately observable benefits that will accrue to the economy – helps explain why Congress struggles to see the bigger picture.

Given that duty suspension of qualified products is available to all, the only conceivable sense in which one might consider the benefits limited is that not everyone has equal access to the process.  Some import-consuming companies have the wherewithal to make the formal requests – previously to their Members or Senators; prospectively to the USITC – while other companies do not. 

Accordingly, AMCA aims too low.  Why require formal duty suspension requests at all?  Why not make them automatic?  Why not have the USITC do an assessment of the entire Harmonized Tariff Schedule to identify all items that meet the statutory requirements for duty suspension?  Why have such restrictive criteria at all?

If one has low expectations about how Congress can make the United States a more attractive option for manufacturers to establish and maintain operations, then AMCA represents a laudable – though mostly cosmetic – effort to end a GOP semantics battle and restore the status quo.  But Congress should be thinking bigger – much bigger – than the AMCA. 

Rather than celebrate a bill that leaves in place 97 percent of the taxes collected by Customs on imported inputs used by U.S. producers, Congress should commit to working a little harder to eliminate these costly, investment- and production-diverting import duties.

Reportage in The Wall Street Journal on April 3th states that “A fund owned by China’s foreign-exchange regulator has been taking stakes in some of the country’s biggest banks, raising speculation that it may be a new member of the so-called ‘national team’ of investors the Chinese government unleashes to support its stock market.”

Statists and interventionists around the world (read: those who embrace State Capitalism) think “Big Players,” as the academic literature has dubbed them, will protect us from economic storms. While there is a budding and serious academic literature on Big Players – aka Market Disrupters – the financial press virtually ignores the Disrupters’ potential to bury us. Indeed, instead of stabilizing markets, the Big Players disrupt them. They are the purveyors of instability. For those who wish to grapple with the technical literature, I recommend: Roger Koppl. Big Players and the Economic Theory of Expectations. New York: Palgrave Macmillan, 2002.

Big Players have three defining characteristics. Firstly, they are big — big enough to influence markets. Secondly, they are largely insensitive to the discipline of profits and losses, insulating them from competitive pressures. Thirdly, their freedom from a prescribed set of rules affords them a high degree of discretion.

With these characteristics, Big Players are hard to predict. In consequence, they can disrupt. They divert entrepreneurial attention away from the assessment of strictly economic market fundamentals, such as the present value of prospective cash flows. Instead, the focus shifts toward attempting to predict the actions of Big Players, which are inherently political and unpredictable. This reduces the reliability of expectations, replacing skill with luck.

The Big Players’ discretionary interventions render unreliable most market signals about fundamentals. They foster environments that are ripe for herding and bandwagon effects, as well as noise trading, which is subject to fads and fashions. This partially explains why investment groups are spending big bucks to create a thinking, learning, and trading computer — a search for a master algorithm. Never mind. Big Players heighten volatility and create bubbles. They are the disrupters of the universe.

Just who are the Disrupters? Most central banks possess all the characteristics of Big Players in spades. Since the advent and implementation of quantitative easing (QE), they have become bigger players, with the state money they produce making up a much greater portion of broad money (state, plus bank money) than before 2009. Not only have their balance sheets exploded, but the composition of some of their balance sheets has changed in surprising ways. Not so long ago, central bank assets were largely comprised of domestic and foreign government bonds. Well, now you can find corporate bonds on some central bank balance sheets. And that’s not all. Central banks use their discretion to purchase equities, too. Just take a look at the Swiss National Bank (SNB), one of the alleged paragons of conservative central banking. By the end of Q4 2015, the total value of stocks held by the SNB had risen to $106.62 billion. That’s the size of some of the largest hedge funds in the world, and amounts to over 16.7 percent of Switzerland’s GDP.

The Bank of Japan (BoJ) is also openly a big buyer of stocks — namely, Japanese ETFs. The BoJ is authorized to purchase roughly $25 billion of ETFs per year, and the government leans on the BoJ to use its fire power — especially when the Japanese stock markets are “weak.”

The rogues’ gallery of Big Players also includes: sovereign wealth funds, state-owned enterprises, and many other friends who do the State’s bidding. 

We are becoming grossly over-reliant on Big Players. In consequence, fundamental-based investing has been forced to take a back seat and the markets have become less safe. 

The Heritage Foundation’s John Malcolm and I have a new oped where we draw from newly uncovered to documents to show that the officials who bestowed upon Congress its own special exemption from ObamaCare likely violated numerous federal laws. Malcolm is a former assistant U.S. attorney, a former deputy assistant attorney general in the Department of Justice’s Criminal Division, and the current chairman of the Criminal Law Practice Group of the Federalist Society.

First, a little background. The Affordable Care Act threw members and staff out of the Federal Employees Health Benefits Program, and basically says they can only get health benefits through one of the law’s new Exchanges. Under pressure from Congress and the president himself, the federal Office of Personnel Management (which administers benefits for federal workers, including Congress) decided the House and Senate would participate in the District of Columbia’s “Small Business Health Options Program,” or “SHOP” Exchange, rather than the Exchanges that exist for individuals. The reason is that federal law would not allow members and staff to keep receiving a taxpayer contribution of up to $12,000 toward their premiums if they enrolled in individual-market Exchanges. Yet putting Congress in a small-business Exchange isn’t exactly legal, either. Both federal and D.C. law expressly prohibited any employer with more than 50 employees from participating D.C.’s SHOP Exchange. The House and Senate each employ thousands upon thousands of people.

Okay, now here’s an excerpt from our new oped:

Documents obtained under the Freedom of Information Act show that unnamed officials who administer benefits for Congress made clearly false statements when they originally applied to have the House and Senate participate in D.C.’s “SHOP” Exchange for 2014. Notably, they claimed the 435-member House had only 45 members and 45 staffers, while the 100-member Senate had only 45 employees total…

Making a materially false or fraudulent statement as part of a claim against the U.S. Treasury is a separate federal crime, as is wire fraud. Ordinary citizens who violate these laws face fines of up to three times the amount drawn from the Treasury and/or up to 20 years in prison. They might also face prosecution for health care fraud (10 years), violating the Sarbanes-Oxley ban on falsifying documents (20 years), conspiracy to commit such offenses (5 years), and other crimes under federal and D.C. law.

Newly unearthed documents suggest these officials knew they were violating the law.

Those new documents include admissions by officials in Congress and D.C.’s small-business Exchange that the House and Senate are in fact not small businesses. Read the whole thing.

Just as I am once again highlighting how the Obama administration is trying to save this ill-conceived and unworkable law by spending money it has no authority to spend, University of Michigan law professor Nicholas Bagley is once again defending the administration. Bagley agrees with a large part of my account when he writes:

The exchange website in Washington, DC includes a field for the number of employees. If you enter a figure above 50, the website won’t accept the application. That’s because large employers are ineligible to use the SHOP exchange.

Actually, the web site doesn’t include that field any more, which is part of why Bagley is wrong. But I’ll save that for another day.

Bagley’s argument is that since OPM determined Congress may participate in D.C.’s SHOP Exchange, those false statements were not “material to the approval of their applications,” and therefore do not satisfy the elements of one of the federal crimes we mentioned. 

If OPM’s interpretation of the statute is lawful, Bagley may be right. But if OPM’s decision is not lawful, the these false statements are what Malcolm and I allege: a material part of a fraudulent scheme “to facilitate illegal, taxpayer-funded gifts to members of Congress.” So a lot is riding on whether OPM’s determination is lawful.

Bagley claims OPM’s determination is lawful because the ACA exempts Congress from the rules requiring SHOP Exchanges to reject employers with more than 50 employees. If he has evidence that such an exemption exists, he should cite it. He doesn’t cite it, however, because it doesn’t exist. If it did, OPM no doubt would have cited it when the agency announced this curious decision in the first place. Instead, the agency just pretended that such an exemption existed, and pretended the statutory requirement it was vitiating, and D.C.’s corresponding statutory requirement, do not. All Bagley offers in support of this claim is a link to a three-year-old post of his that addresses a different issue (about which Bagley is also wrong; but again, we’ll save that another day). Curiouser and curiouser.

In sum, if Bagley can substantiate his claim that “the ACA singles out [Congress] as a special case” where the rules requiring SHOP Exchanges to reject large employers do not apply, he should do so. If not, what does that tell us?

(Two addenda. First, I have twice asked Bagley via email whether, regardless of whether he thinks it would be a good idea, 18 U.S.C. 1001 is broad enough to allow a federal prosecutor to bring charges given this fact pattern. No answer yet. Second, Bagley calls our oped “irresponsible” and counsels us to “try and keep some kind of perspective, for Pete’s sake.” Good idea. Here’s another. Let’s stick to arguing the facts.)

We’ve updated the charting tool at www.downsizinggovernment.org/charts with the latest data. You can plot spending on hundreds of federal agencies and programs in constant, or inflation-adjusted, dollars. The charts cover 1970 to 2016.

Which are the largest federal government agencies, and how much have they grown? The following series of seven charts captured from the charting tool shows the 21 largest agencies in order by size.

The first chart shows that Defense, Health and Human Services, and the Social Security Administration used to vie for top spot as the largest agency. But Defense is now being left in the dust, as the latter two entitlement-dispensing agencies gobble up ever more tax dollars.

The second chart shows that Veterans Affairs, Agriculture, and the IRS have soared in cost over the past decade. And, remember, these charts are in constant dollars. The bulk of Agriculture’s budget is the food stamp program, which should be put on the chopping block. IRS spending has soared due to the cost of “refundable” tax credits, such as the earned income tax credit.

The third chart shows Education, Transportation, and the Office of Personnel Management. The latter agency includes retirement and health care programs for federal workers. The Education budget gyrates widely because of recalculations in the costs of student loans. The line for Transportation shows a solid upward trend, despite all the whining we hear about the shortchanging of infrastructure. Anyway, the proper amount of federal Transportation spending ought to be near zero, for reasons I discuss here.

The fourth chart shows Labor, Homeland Security, and Other Defense Civil Programs. The latter includes spending on military retirement and health care. The spike in Labor was due to the extra long UI benefits passed by Congress during the recession. Homeland spending spiked during the Bush years and remains high.

The fifth chart shows that State department spending has soared under Obama. It also shows a large drop in HUD spending, and that relates to the way that the budget accounts for housing finance subsidies. HUD subsidies for rental aid and community development remain at high levels.

The sixth chart shows Energy, NASA, and International Aid. The recent Energy spike stems from the “stimulus” package passed in 2009.

The seventh and final chart, below, shows Interior, Commerce, and the EPA. The spikes in Commerce surround Census years. You can see this clearly if you go to www.downsizinggovernment.org/charts, click open Commerce, and plot Census separately.

Similarly, use the chart tool to see that the Commerce spike in the late 1970s was for the Economic Development Administration, which by the way is one of the dumbest agencies in the government. Finally, if you click open EPA on the charting tool, you can see that the spike in the late 1970s was due to a surge in grants to state governments.

Which of all these departments and agencies should be cut? I’d suggest starting with these.

I am not a lawyer, and I’m certainly not an expert on California law, but yesterday’s state appeals court ruling in the much-discussed Vergara v. California teacher tenure case seems plausible. While Golden State statutes make it very hard to remove bad teachers, and may lead to the worst teachers being disproportionately assigned to schools serving low-income kids, district administrators could curb that if they really, really wanted to. It would just require very expensive, convoluted dismissal procedures be followed for each unsatisfactory educator. So technically, the law may not violate California’s constitution. But to defend it, in reality, is to defend a system heavily slanted against low-income students.

Vergara has spawned similar cases in other states, and I would guess there is a good chance similar rulings will come down the pike in those places. But there is probably also a good chance of tenure laws being overturned. It doesn’t strike me that, from a legal perspective, either side has a clearly superior case. But again, I am not a lawyer.

What this once again screams is that public policy needs to move away from an education system in which parents are dependent on politicians or courts to protect their children. They need money to be attached to kids and to have the ability to take their children out of schools they do not like and put them into other institutions. And there should be no blanket state seniority or teacher evaluation rules. Educators should be free to get together and set up schools with whatever policies they want, and whether or not those schools survive or those policies are maintained should depend on their ability to attract enough paying customers with the services they produce.

We need to stop making parents and children wards of the state, and instead give them real power.

“We don’t win anymore!” Republican presidential candidate Donald Trump tells us. One of the main reasons, according to Trump, is due to free trade agreements. At a rally in North Carolina he declared: “All this free trade, you know what, it is free trade for them, not for us. We’re losing our shirts.” Trump has proposed imposing various taxes on foreign imports to the US because he believes this will help facilitate bringing back jobs to the US (my colleague Daniel Ikenson has written about this here and here).

Trump’s talk of unfair trade and his proposals to punish importers has resonated with many Americans. In fact, a recent CBS/New York Times survey finds that 61% of Americans agree that “trade restrictions are necessary to protect domestic industries” whereas 29% say free trade should be allowed even if domestic industries are hurt by competition abroad. 

Yet, Americans may not be willing to foot the bill of goods’ higher prices that will result from Trump’s proposed trade restrictions. A recent AP/GfK poll finds that 67% of Americans would rather buy cheaper products made in another country rather than pay more for the same product made in the United States. Thirty percent (30%) say they’d rather pay more to buy American made products. That being said, 71% report that they’d like to buy American made items, but that they are often too costly or difficult to find. Furthermore, only 9% say they hold firm to only buying American made goods even if they cost more.

These poll results give some insight into Americans’ revealed preferences, or their actual consumer behavior. While in theory Americans like the idea of buying items made closer to home by their fellow citizens, ultimately their pocketbook may prove more relevant to their behavior.

When it comes to free trade agreements impact on American jobs and wages, Americans are divided but tend not to be concerned. Fifty-four percent (54%) do not believe that free trade agreements decrease wages for American workers while 43% think these agreements do harm wages. Similarly 51% do not think that free trade agreements cost American jobs, while 46% think they do.

Overall, Americans are quite divided over the general benefits of free trade with a third who believe free trade agreements are good for the economy, 37% who say they don’t make a difference, and about a quarter who think these agreements harm the economy.

Japan is a developed nation that allows little immigration, thus winning occasionalpraise from American immigration restrictionists. If the reason for copying Japan’s immigration policy of almost no immigrants is that it will improve the labor markets, conditions there do not provide evidence for that claim, at least on the surface. 

Japan’s immigrant population is minuscule compared to the United States, as a percent of either country’s population (Figure 1).

Figure 1: Immigrant Stock as Percentage of Population

Source: World Bank.

Although there is little immigration to Japan, real average monthly cash earnings have declined slightly since 1995 (Figure 2). During the same time period, U.S. wages have actually grown, albeit not as fast as many want (Figure 3). If those graphs were unlabeled, my hunch is that most immigration restrictionists would assume the better graph is Japan. Japan’s sluggish wage growth in a low-immigration environment doesn’t match the restrictionist fairytale while American wage growth contradicts it.

Figure 2: Japanese Real Average Monthly Cash Earnings, (2010 Thousand Yen)

Source: Statistics Japan: Statistics Bureau, Ministry of Internal Affairs and CommunicationsWorld Bank Data.

Figure 3: U.S. Real Average Wages, Annual, (2010 dollars)

Source: United States Census and World Bank.

An immigration restrictionist might counter that more Japanese are employed due to a paucity of immigration, thus outweighing (or explaining) the sluggish wage growth. That response doesn’t fit either as labor force participation rates (LFPR) for the entire adult population in Japan has been lower than in the United States for as long as World Bank data is available (Figure 4). Japan’s population is older than the United States which likely explains much of their lower LFPR.

Figure 4: Labor Force Participation Rates (% of total population ages 15+)

Source: The World Bank, http://beta.data.worldbank.org/

However, according to a different ILO estimate of LFPR for those aged 15-64, Japanese workers are more likely to be in the workforce since 2009 but less likely prior to then (Figure 5). 

Figure 5: Labor Force Participation Rate, Modeled ILO Estimate (% of total population ages 15-64)

Source: The World Bank, http://beta.data.worldbank.org/

Prime Minister Shinzo Abe is turning his attention to reforming Japan’s lackluster labor market that is widely blamed for holding back the country’s economic recovery. Immigration reform could be a portion of that reform package. Some Japanese politicians are less satisfied with their immigration restrictions than they used to be. Japanese public opinion toward immigration has softened recently, especially when viewed in an economic context. Regardless of potentially shifting Japanese public opinion, Japan’s labor market experience does not help immigration restrictionists make their case in the United States.      

 

Quick note:

Due to difficulty in finding Japanese data I had to rely on average wage rates and use the CPI as an inflation benchmark.    

 

In the April 13, New York Times an article discusses developments in the civil proceeding between an owner of shares in Fannie Mae and Freddie Mac and the federal government over the latter’s decision in August 2012 to revise the terms of its conservatorship of Fannie Mae and Freddie Mac.  The original agreement stated that the U.S. Treasury would receive a 10 percent dividend on its 189.5 billion dollar injection of capital.  The revised terms gave all positive cash flows from Fannie and Freddie to the Treasury leaving little for the firms’ shareholders.  Granting a request from the government, materials produced under discovery in the case have been under seal.  Responding to a request by the New York Times the judge in the case has released two depositions.  In one the former chief financial officer of Fannie Mae said that she told Treasury officials before their 2012 decision that Fannie Mae would soon earn profits again and that she believes her briefing played a role in the government’s decision to alter the terms governing the conservatorship. 

For some background on this issue you should read my Working Papers column in the Fall 2014 issue of Regulation in which I discuss two papers relevant to the issue.  In “Stealing Fannie and Freddie,” Yale Law School professorJonathan Macey argues that the decision by the Treasury to take all of the profits now earned by Fannie and Freddie erodes the rule of law and violates shareholder rights.

In “The Fannie and Freddie Bailouts Through the Corporate Lens,” Adam Badawi, professor of law at Washington University, and Anthony Casey, assistant professor of law at the University of Chicago argue that in the third quarter of 2012, when the federal government changed the financial arrangements to take all future positive cash flows, the value of shareholder equity in Freddie alone was negative $68 billion.  That is, for the shareholders to earn anything, Freddie would first have to earn $68 billion, which was more than Freddie had earned in the 19 years prior to its financial difficulties (1988–2006). But if Freddie lost only $4 billion more (which is the amount of losses per week in 2008–2009), the senior preferred Treasury shares would be worthless.  The data for Fannie were even worse: it would have to earn $114 billion before common shareholders would earn anything, which is more than it had earned in the 27 years prior to the financial crisis.  The authors argue that when equity’s real value is negative, the directors’ duty to maximize the value of the firm is the practical equivalent of a duty to creditors and not shareholders.  The authors argue that the government’s actions are consistent with what we would expect from a private creditor and do not violate shareholder rights.

I think both papers may be relevant.  As my colleague Mark Calabria has argued the Treasury may have violated the spirit if not the letter of the law.  And in a commentary written at the time he argued creditors were advantaged rather than taxpayers.

But similar to the decision in the AIG case in which a judge ruled that the federal government exceeded its authority in its takeover of AIG but that the government owed no damages to shareholders, the damages to Fannie and Freddie shareholders also may be zero because at the time the firms had negative net worth and would continue to have negative net worth for the foreseeable future.

In the April 13, New York Times an article discusses developments in the civil proceeding between an owner of shares in Fannie Mae and Freddie Mac and the federal government over the latter’s decision in August 2012 to revise the terms of its conservatorship of Fannie Mae and Freddie Mac.  The original agreement stated that the U.S. Treasury would receive a 10 percent dividend on its 189.5 billion dollar injection of capital.  The revised terms gave all positive cash flows from Fannie and Freddie to the Treasury leaving little for the firms’ shareholders.  Granting a request from the government, materials produced under discovery in the case have been under seal.  Responding to a request by the New York Times the judge in the case has released two depositions.  In one the former chief financial officer of Fannie Mae said that she told Treasury officials before their 2012 decision that Fannie Mae would soon earn profits again and that she believes her briefing played a role in the government’s decision to alter the terms governing the conservatorship. 

For some background on this issue you should read my Working Papers column in the Fall 2014 issue of Regulation in which I discuss two papers relevant to the issue.  In “Stealing Fannie and Freddie,” Yale Law School professorJonathan Macey argues that the decision by the Treasury to take all of the profits now earned by Fannie and Freddie erodes the rule of law and violates shareholder rights.

In “The Fannie and Freddie Bailouts Through the Corporate Lens,”Adam Badawi, professor of law at Washington University, and Anthony Casey, assistant professor of law at the University of Chicago argue that in the third quarter of 2012, when the federal government changed the financial arrangements to take all future positive cash flows, the value of shareholder equity in Freddie alone was negative $68 billion.  That is, for the shareholders to earn anything, Freddie would first have to earn $68 billion, which was more than Freddie had earned in the 19 years prior to its financial difficulties (1988–2006).  But if Freddie lost only $4 billion more (which is the amount of losses per week in 2008–2009), the senior preferred Treasury shares would be worthless. The data for Fannie were even worse: it would have to earn $114 billion before common shareholders would earn anything, which is more than it had earned in the 27 years prior to the financial crisis.  The authors argue that when equity’s real value is negative, the directors’ duty to maximize the value of the firm is the practical equivalent of a duty to creditors and not shareholders.  The authors argue that the government’s actions are consistent with what we would expect from a private creditor and do not violate shareholder rights.

I think both papers may be relevant.  As my colleague Mark Calabria has argued the Treasury may have violated the spirit if not the letter of the law.  And in a commentary written at the time he argued creditors were advantaged rather than taxpayers.

But similar to the decision in the AIG case in which a judge ruled that the federal government exceeded its authority in its takeover of AIG but that the government owed no damages to shareholders, the damages to Fannie and Freddie shareholders also may be zero because at the time the firms had negative net worth and would continue to have negative net worth for the foreseeable future.

A number of House Republicans have testified to the Ways and Means Committee about their ideas for overhauling the tax code. Rep. Roger Williams testified about his plan this week. And Reps. Michael Burgess, Devin Nunes, and Robert Woodall presented their plans a couple weeks ago.

Here are a few notes:

Michael Burgess Flat Tax. Rep. Burgess testified in favor of a classic Hall-Rabushka flat tax, which is the plan that has been supported by Steve Forbes and Dick Armey. The tax is named after economists Robert Hall and Alvin Rabushka, who is an adjunct scholar at Cato.

The Burgess plan would have a 19 percent rate (dropping to 17 percent), a large standard deduction ($32,000 for a married couple), and large child deductions ($7,000 per child). My preference would be for a lower rate with a smaller standard deduction, but the Burgess plan is generally excellent.

The flat tax would vastly simplify the tax code. Individuals would be able to file their tax return on a postcard because the plan would abolish nearly all deductions, exemptions, and credits, and individuals would be generally only taxed on their labor income. All capital income would be taxed at the business level at the same 19 or 17 percent rate.

Business taxation would have a simplified cash-flow structure, and companies would immediately write-off capital investment. Complex income tax concepts such as depreciation, amortization, and capital gains would be abolished.

The Burgess tax would eliminate the current tax code bias against savings and investment, which is a key weakness of income taxation. With an economically neutral base and a low rate, the Burgess flat tax would be very pro-growth.

Devin Nunes Business Tax. The Nunes proposal is essentially the business part of the Hall-Rabushka flat tax, but with a 25 percent rate. This is a cash-flow tax, meaning that accrual accounting and noncash concepts such as depreciation would be scrapped. Business investment would be expensed.

Rep. Nunes may have been inspired to pursue his proposal by my 2003 Cato study on replacing the corporate income tax with a business cash-flow tax. Alan Viard at AEI has also written about the idea.

Politicians love to rail against corporate tax avoidance. But the way to actually solve the problem would be to slash the tax rate and replace the current business tax base—which relies on the imprecise concept of “income”—with the easy-to-measure base of net cash-flow, as under the Nunes plan. The current system has so many “loopholes” partly because Congress is taxing the wrong base.

The Nunes plan would be territorial, meaning that the earnings of foreign subsidiaries would not be taxed by both foreign governments and the U.S. government. The plan would encourage multinational corporations to locate their headquarters and their factories here in America, and that would be a boon to U.S. workers. 

Robert Woodall FairTax. Rep. Robert Woodall proposes replacing federal income and payroll taxes with a national retail sales tax called the FairTax. I appreciate the radical spirit of this proposal, and if it were enacted, it would simplify taxation and boost economic growth. However, there are risks to this sort of reform.

One risk is that Congress enacts a national retail sales tax and the income tax is either not repealed or it comes back down the road. The last thing we need is for the overgrown government to have multiple huge tax bases. The Woodall bill would repeal the 16th Amendment, but I don’t think that would be sufficient protection to prevent resumption of income taxation. After all, Congress enacted the corporate income before the 16th Amendment was adopted by claiming that it was an “excise” tax, and today this “excise” tax is the most damaging part of the income tax. Presumably, a liberal Congress could decide that it wanted to impose a similar “excise” tax on America’s more than 20 million small businesses.

Another concern about the FairTax is the plan’s rebate mechanism that would provide families a check each month to offset part of the sales tax burden. That would be a large and redistributive entitlement program, and it would surely become larger and more complex over time as politicians expanded and manipulated it.

All that said, kudos to the sponsors and cosponsors of these bills for their support of a dramatic tax overhaul. Let’s hope that their support can be translated into major tax reform moving through Congress next year.  

For more on the flat tax, national sales tax, and other reforms, see here.

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