Good Tax Policy

In a recent column posted at Forbes http://tinyurl.com/d3pg4eo, Peter Ferrara argues that President Obama is a socialist.  What label one wishes to place on another is of little importance to me.  Whether you want to call the President a socialist or a liberal is of little importance to me.  I think name-calling is immature.  Someone called me “Big Nose” once.  It hurt my feelings, but it didn’t facilitate an informative discussion of the issues.

But what I want to discuss here is a statement made by Ferrara that illuminates a common error in thinking among many economic hacks.

Tea Party Patriots national coordinator Jenny Beth Martin, right, with Reps. Michele Bachmann, left, and Louie Gohmert this March. (Chip Somodevilla / Getty Images)

 “Good tax policy is not guided by ‘need.’  It is guided by what is needed to establish the incentives to maximize economic growth.”

This is a good illustration of how pop-economics has deteriorated over the years.  This guy thinks that tax policy should be guided on incentives to maximize economic growth.

Tax policy should actually be guided towards allocating the costs of government services to those that benefit from them.  Ideally, all expenses should be matched against the revenue.  If this doesn’t happen, then resources can be misallocated resulting in a net loss to society.  For example, there was a sitcom where a boy was making burritos and selling them to his friends.  He would buy the ingredients at the grocery store and charge them to his mother’s account.  Then he’d sell the burritos for $1 each.  When the expenses were paid by his mom, he thought he was making a profit.  Thus, resources were allocated towards an unprofitable endeavor thereby resulting in a net loss to society.

The same for a business.  Part of the expenses of a business are the roads that the delivery trucks drive on, the cost of the court system to enforce contracts and the CIA agent in Afghanistan preventing terrorist attacks.  A perfect tax policy would allocate the costs of all government services to the individuals and businesses that benefit from them.  A toll booth or a gas tax allocates costs to those that use roads.  An entrance fee allocates costs of public parks to those that enjoy them.  However, a lot of services (like national defense, police protection and cutting the grass on the National Mall) are more difficult to allocate to those that benefit, but the objective should be the same.

But what’s been happening these past few decades is that mom, or perhaps I should say “Mǔqīn”, has been picking up a lot of the bill.  This is where tax policy can establish incentives to maximize economic growth.  The government can establish trade relations with foreign nations, spend billions to protect shipping lanes, build roads and bridges, and provide a judicial system to enforce contracts.  But if these costs are not appropriately passed on to those that benefit (i.e. consumers and businesses), then the costs are not included in the prices of the products and services generated thereby resulting in misallocation of resources resulting in a net loss to society as a whole.

Tell me.  Who should pay for your latte?  Should you pay for it?  Who should pay to protect us from terrorists?  You think you’re paying for it.  Truth be told you are paying for some of it, but a portion of it is being paid by whoever is going to inherit the national debt, most likely your children and grandchildren.

Let’s go back to the boy who was making so much money selling burritos.  Who should pay for the ingredients?  If the boy can convince his mom to make his little sister pay, then the boy can reap profits and enjoy a lavish lifestyle.  Meanwhile the boy’s mom struggles to pay her bills, and the little sister gets screwed.

Another result is that society produces more burritos than it wants.  Suppose it costs more to produce a burrito than a taco.  But because the boy’s mom picks up the costs, the boy can sell the burrito for less than the taco thereby putting the taco boy out of business.

A real world example of this would be transportation.  People want gasoline.  Americans like to drive their cars, and they want the gasoline to be inexpensive.  In addition, gasoline diesel fuel and gasoline are used to ship goods to market.  If the price of gasoline and diesel fuel go up, then the prices of many goods will increase from tomatoes to lumber.  What would cheap gasoline be without roads on which to drive.  Americans want pothole free roads.

The government spends hundreds of billions on securing shipping lanes and making deals with oil producing nations.  Seemingly uncountable amounts of money are spent by federal, state and local governments on road construction, repairs and maintenance.  When Bob Hamilton gets into his car to drive to the Starbucks to get a cup ‘o jo, he pays, let’s say, one dollar for the cost of the round trip in addition to his coffee.  However, if all the costs were included, it might cost, let’s say, ten bucks.  Thus the government is subsidizing this lifestyle.  If Bob had to pay the total cost, he might reconsider his plan.  He might pick up the coffee on the way home from work or combine his daily errands thereby reducing his costs.  To go to his job he might consider taking public transportation.  And he might buy a more fuel-efficient car instead of that Hummer.

Do Americans like their cars?  Yes, they do.  Should the government subsidize it?  That’s the question.  If you want to drive your car, then drive your car.  Get a Ford Excursion or a Hummer and drive just for the fun of it.  But should part of the cost be paid by someone else?

Deficits Suddenly Matter

In his column “Don't Cave GOP, This Time Deficits DO Matter” posted at Forbes.com on December 14, 2012, Jerry Bowyer argues that deficits do matter.  This is a sudden departure from his previous position.  Let’s take a look.

On page 60 of his book “The Bush Boom” Bowyer argues to forget the deficit.  In the column referred to above, he admits that he has in the past “downplayed the importance of deficits” thinking that a budget deficit is rendered harmless if GDP growth exceeds the growth of the deficit.  The problem was that (except during the mid to late 1990s) GDP growth did not exceed the growth of the deficit.

Bowyer argues that now the debt has grown “to the point where it really is unsustainable”.  He points out that the national debt as a percentage of GDP is “over 100% and rising” and that “for the past few years the deficit has hovered around nearly 10% of GDP”.  So basically the reason for Bowyer’s sudden change in position is that the debt and deficit have gotten bigger.

A little background: A key statistic in evaluating a nation’s financial position is the Debt/GDP ratio which compares the national debt to the nation’s growth domestic product.  Nations with higher incomes are more capable of handling higher amounts of debt than nations with lower incomes.  For the United States, a debt of $1 trillion is a small amount.  For Cuba, a $1 trillion debt would be unmanageable.  A person with an income of $500,000 could easily afford to pay the mortgage on a $1 million house.  But for a person with an income of $25,000 per year… I mean, forget about it.

The U.S. Debt/GDP ratio has historically been much lower than it currently is.  It reached as high as 30% after WWI.  Then after the Great Depression and WWII the U.S. Debt/GDP ratio peaked at 112%.  It was necessary to accumulate that debt to win the war.  But after WWII the nation was responsible and little by little year by year the ratio decreased back to below 30%.

Then along came the supply-siders telling us that deficits don’t matter.  We can grow our way out of it, they argued.  The only problem is that we didn’t grow our way out of it.  The Debt/GDP ratio nearly doubled during the Reagan/Bush years.  The W Bush years returned to increasing Debt/GDP ratio during what Bowyer refers to as the “Bush Boom”.  Debt kept piling on with a brief respite during the Clinton administration.

Bowyer and people like him who kept saying “Forget the deficit,” and “Deficits don’t matter,” are the principle cause of the dire situation that we’re in today.  Spending beyond our means and borrowing to finance the appearance of prosperity for three decades has resulted in this nation going from the world’s largest creditor to the world’s largest debtor nation and being told to “forget it”.  When the financial crisis hit and the inevitable Great Recession, we were not in a financial position to properly address it.  Instead of drawing on savings, we had to borrow even more to prevent the economy from collapsing.

Now suddenly Bowyer wants to change his position, and he does a song and dance to convince himself (he’s not fooling anyone else) that his original position was justified.  But his original position was wrong.  We didn’t grow out of the debt.  Deficits do and always did matter.  Unnecessary irresponsible spending and debt accumulation accompanied by accumulation of off-balance sheet unfunded obligations for three decades is not and never was a good policy.

Thomas Sowell, Clueless on Capital Gains

http://www.nationalreview.com/blogs/print/329110 

A lot of pop-economics writers have little to no education in the field of economics.  Think of Lawrence Kudlow, history major, Jerry Bowyer, accounting major and Bruce Bartlett, also a history major.  Thomas Sowell actually has an education in the field of economics as well as decades of relevant experience which is why it’s so strange that he is so clueless with respect to capital gains.

In a recent column about capital gains, Sowell reveals that he doesn’t even really know what a capital gain is.

Sowell describes a scenario where he spends ten years writing a book thenceforth selling it to a publisher for $100,000.  He argues that this constitutes a capital gain because there is no guarantee that the publisher will pay him after ten years.  In another scenario he describes a builder who spends ten years creating a housing development.  When he sells the houses, Sowell argues that the income constitutes capital gain because of risk.

When you write a book and sell it for royalties, it’s not a capital gain.  It’s compensation for the work you performed.  The fact that there is risk involved doesn’t render it a capital gain.  Yes, I agree that holding an asset with the hopes that the value will increase and thereby reaping a gain on the sale involves risk, but that does not mean that all income subject to risk is a capital gain.  When you build a house and sell it, any income is ordinary operating income.  If you sell the house at a loss, then it’s an ordinary operating loss.

There are legitimate arguments for taxing capital gain income below that of ordinary income.  But for crying out loud, educate yourself with respect to what constitutes capital gain income before you enter into the discussion.

The Invisible Hand Gives the Finger to Haiti

The free market is the best economic system we’ve been able to come up with so far. But it’s a mistake to believe that it’s a perfect system. One commentator believes it is a system bestowed upon us by God himself. What an idiot. The free market system is far from perfect, and it is important for us to continue to study it so that its limitations can be identified thereby contributing to a solution to its weaknesses. One area worthy of looking into is health care. There are various aspects of health care that we can consider.

An economic model is a method of allocating society’s resources. Take Snickers Bars as an example: a state controlled economy would dictate how many Snickers Bars are produced and who gets them. In a free market economy the producer would decide how many Snickers Bars to produce based on their estimate of the market. If inventory builds up, then they stop producing Snickers Bars and maybe produce something else like Almond Joys. If they’re flying off the shelves of stores, then they might increase production, add another shift or even build another manufacturing plant. Consumers would determine the distribution. If someone wants a Snickers Bar, then they can use their money to buy a Snickers Bar. If someone would rather have the Almond Joy, then they don’t buy a Snickers Bar. Someone with no money gets no Snickers Bar but is encouraged to work to make enough money to buy said Snickers Bar. It’s a pretty good system of distribution. He who wants a Snickers Bar pretty much gets a Snickers Bar. It works pretty good for Snickers Bars.

But is a purely free market approach the best method of distributing health care? Is it acceptable that wealthy people receive health care and the poor do not? First, let’s consider the distribution of health care. Who gets health care? In a free market system those that get health care are those that can afford it. In the United States with various state run Medicaid programs and Medicare and employer provided insurance not to mention more laws and regulations than one can reasonably digest, the distribution of health care in the United States hardly represents a free market system. The result is that health care is more evenly distributed in the United States. Most poor inner city infants can get emergency treatment if needed.

But consider the worldwide distribution of health care providers. To do this you don’t even have to look very far: my former primary care physician is from Bolivia, my current primary care physician is from the Philippines, my dentist is from Cambodia, one of my students is a certified nursing assistant from El Salvador, etc. There are countless medical professionals trained in poor countries who come to the United States to practice because the money is so much better. This is good for the United States. However, it is not good for the poor countries. Bolivia has one less doctor. Cambodia has one less dentist to treat the impoverished people of that beautiful country.

The question is whether this is the best distribution of society’s resources. Some may dare to submit that this is the best distribution of resources. I curse them. It is outrageous that a third world country like the Philippines use its limited resources to educate and train a person to be a doctor and then have that doctor leave and go to a rich country to practice. It’s good for the doctor. It’s good for me. But it is not good for the people that remain in the Philippines. I submit that this is not the most efficient distribution of health care resources.

What about research and development? The free market model dictates that private interests will invest in research and development with the intention of creating a product that can be sold at a profit that over time exceeds the cost of the research and development. Companies have invested in developing and producing medicines for high blood pressure, high cholesterol, diabetes and erectile dysfunction. Former Vice President Dick Cheney walks around with a heart pump. Artificial knees, hips and other body parts. [Last summer I was visiting my mom. We were at the pool. We were talking about health care, and I mentioned that they’ve got a pill for almost anything that ails you. My mom declared loud enough for everyone to hear that they haven’t yet developed a pill that will cure her diarrhea. Hold on, mom. It’s coming.] Not only have that, but drug companies produce these drugs in enough quantities so that everyone who can pay for it can had it.

But few private sector resources are devoted to drugs to fight malaria and dengue and other maladies that are unique to third world countries. Again the question is whether this is the best method of distribution of medical research. Some may submit that yes, the free market economic model is the best method of distribution of medical research that society has come up with to date. I question whether investment in cosmetic surgery and cholesterol drugs for those who have eaten cheeseburgers and French fries their entire lives is better than investing in producing and distributing drugs for malaria.

How can it be made better? Examples already exist. Government investment in research and development of treatment of AIDS has benefited untold numbers of AIDS patients in third world countries. Former President George W. Bush is rarely given praise for his initiative to fight AIDS in Africa. One estimate claimed that he may have saved as many as a million lives.

Another example is philanthropy. Many doctors donate their time, and many hospitals donate resources to provide health care to the poor in third world countries. Doctors Without Borders is a fine organization the provides medical treatment to people who otherwise would receive none under the free market. Dennis Quaid is a good example of an individual. He has escorted several patients from Central America to the United States and funded needed surgery. He also funded and helped establish the Ruth Paz Medical Center in San Pedro Sula, Honduras.

Another example is Cuba and its production of thousands of doctors. Medical schools in Cuba train doctors from both Cuba and other developing countries to practice in medicine with the intention that these doctors will treat patients who otherwise could not afford treatment. Cuban doctors and Cuban trained doctors can be found in various countries from Latin America to Africa.

The free market economic model is the best economic model that we have. However, it is not the most efficient method of distributing health care. That doesn’t mean that it should be abandoned.