Growthology

Where does the Laffer curve peak?*

Ezra Klein asks "Where does the Laffer Curve bend?" but he's really asking where it peaks.  It bends at the origin, of course, a tax rate of 0.1  percent. 

Many experts think the Laffer Curve peaks around 60-70 percent, but I'm confident none of them would recommend this as the target rate.  Maximizing government revenue is a hideous goal, fit for the likes of Kim Il Sung.  The goal, one would hope, is to maximize human welfare.  This starts with considerations of private wealth generation, should include deference to liberty and personal property, and end with careful appreciation of long-term growth.  All of those point to an optimal lower rate which would be lower relative to the preferences of the respondents.  My guess is that even the most ardent social planners would opt for a rate no higher than 50 percent. But it would be pretty easy to argue for a top rate of 15 percent.

It's a shame that very little empirical evidence is known on this question.  I've been working on some experiments, but need to finish up those working papers with the results.  At minimum, this seems like ripe material for the next blogger's survey, no?

My Failed Jobs Program ... from the archives of?

Guess who wrote the following article (quoted in part)?

(a) Brad DeLong
(b) George Will
(c) Michael Kinsley
(d) Amity Shlaes

The government makes it comically difficult for the honest citizen to hire a single employee -- and makes it virtually impossible to do it correctly. I'm fairly bright. My assistant is very bright. Between us we have spent many, many hours struggling over the forms. Yet it is inconceivable that we can have got it all right. Now, as a result of my rash attempt to create a job, neither one of us can ever become Attorney General.

Obeying the rules for a part-time household employee is fairly simple, once you get the hang of it. The government sends you a form every three months. You return it with an easy-to-compute check. Once a year, the government sends you a W-2 form, which you fill out in something like octuplicate.

But hiring a full-time business employee plunges you into an entirely new dimension of complexity. By my count (which undoubtedly is wrong), it takes a minimum of 37 different forms and 50 separate checks to hire a single employee for a year, even if she graciously agrees to be paid only once a month.

Forms. At the federal level, there is the employer-registration form, which gets you your employer number; the W-4, which counts the employee's deductions; the annual W-2, listing all income earned and taxes withheld; the W-3, summarizing all the W-2s (required, even when there is only one W-2); Form 941, "Employer's Quarterly Federal Tax Return"; plus forms with each check you write. The District of Columbia requires its own employer- registration form (with, of course, a different employer number); its own D-4 model of the federal W-4; and the ever-popular FR-900BO, "Annual Reconciliation and Report," plus forms with each check.

Checks. Once a month, one check goes to the employee, and another goes to pay for health insurance. One monthly check goes to the feds and another goes to the District of Columbia, reflecting federal income-tax withholding, federal Social Security and Medicare (employee's and employer's shares), and local income-tax withholding. Separate checks go to the feds and the District of Columbia -- only one a year each! -- for unemployment insurance. (The District of Columbia form is called "Quarterly" but needs to be filed annually. Or so I think.) The chance that all these checks are for the right amounts is slim.

***

Hiring an assistant is a wonderful way to keep an assistant busy -- and to keep busy yourself. It wasn't long after we started sending paperwork to the government before the government started firing paperwork back at us. The IRS wanted to know: Where was my Form 941 for the quarter before my employee was hired? We confidently batted that one right back again -- no Form 941 was due for that quarter, you idiots! -- and got the undaunted response, "We are taking no further action at this time, but we may need to contact you again if other tax issues arise." And indeed they have arisen.

You can find out the answer here, where the essay was originally published in 1994.  Or you can find the author's archives here. This is one of my favorite pundits, fyi, and the archives are a treasure.

Who Declared War on Entrepreneurs?

Nick Schulz over at the Enterprise Blog draws our attention to an apparent crackdown by the IRS on the flexible employment arrangements used by many independent contractors and small businesses. It's not clear what impact this will have but, anecdotally at least, there have been reports that many new and young businesses in this recession have been turning more and more to freelancers and contractors. And we've seen the average size of new companies shrink over the past few years by about two employees--as noted in the story above, this likely indicates increasing use of such flexible arrangements.

Put this together with the anti-angel provisions in the Dodd bill (which I think may have been slightly diluted recently), and it seems as if someone has declared a war on startups. Which is, in other words, a war on job creation and economic growth.

Who's scared of a Value Added Tax?

There's a lot of chatter about the U.S. adding a Value Added Tax (VAT) to solve its looming fiscal crisis.  The Feds need to tax more and spend less to bridge the trillion dollar annual deficits, right?  Here's Bob Carroll and Alan Viard in TaxNotes:

Recommendations that a VAT be considered have been more common than outright endorsements of the tax. The idea surfaced briefly as a possible source of revenue for healthcare reform.6 House Speaker Nancy Pelosi, D-Calif., recently commented that ‘‘it’s fair to look at’’ a VAT, and Senate taxwriter and Budget Committee Chair Kent Conrad, D-N.D., has said that a VAT should be on the table in future tax policy discussions.7 Two former Federal Reserve chairs have made similar statements: Paul Volcker has referred to a VAT as a ‘‘possible approach,’’ and Alan Greenspan has said that it must be considered as a possible way to reduce the deficit.8

The fact is the U.S. is the only advanced economy that doesn't have a VAT. Americans have no appetite for adding another tax.  But they might just be willing to trade for one. So which tax would the pro-VAT crowd be willing to give up?  Corporate is probably the leading candidate, because it raises far less revenue than other major taxes, it is sensitive to recessions (generating half as much during busts as booms), and because it is really bad for growth.

CBO lists these major revenue sources for the federal government in FY 2009:

• $915 billion ... Individual Income Taxes
• $891 billion ... Social Insurance Taxes
• $138 billion ... Corporate Income Taxes
•  $62 billion ... Excise
•  $23 billion ... Estate and Gift

Based on this paper (HT Marginalrevolution.com), a VAT raises revenue at under half its rate in GDP terms, meaning that a 10 percent VAT historically brings in around 4 percent of GDP in revenue.  Since corporate income taxes raise 1-2 percent of GDP in the U.S., then a revenue neutral VAT replacement would, I think, be roughly a 4 percent tax on consumption. 

But why stop there?  Conservatives (and some liberals) hate the estate tax.  Offer to eliminate it along with the corporate income tax in exchange for a VAT of 5 percent, and everybody's happy.  Right?

But why stop there?  If a grand tax bargain is in the works, why not put a serious gas tax on the table?  Jim Hamilton tells us that the U.S. consumes 12 billion gallons of gasoline in a typical month.  That's a Gross Billion a year (144 for math geeks). A one dollar gas tax would (ceteris paribus) yield $144 billion a year.  Make it six bucks a gallon, and you could kill the form 1040 forever.  I like it.  In fact, I like this little fantasy a lot better than doing my taxes tonight ...

Let us tax work

It's unbelievable, but higher taxes on work are coming to most states in the Union.

The median increase will be 27.5%. And employers in places such as Hawaii and Florida could see levies skyrocket more than ten-fold.

If anyone wants an easy bipartisan job-creating legislative idea, top of the list is to give states the flexibility to modify the Unemployment Insurance (UI)I system. A smart policy would let states opt out entirely, given that UI is proven to prolong joblessness. There are alternative approaches, but they will be left untested so long as one-size-fits central planning from Washington continues (as it has for decades). Or did I hear that everything is on the table?

Why the Media Doesn't Understand the Tea Party

If you added up all the words in the MSM about the Tea Party phenomenon, the snark would outweigh the insights by a 2-1 or maybe 3-1 ratio.  The Tea Party is not some right wing extreme within the Republican party, rather it is an intelligent, if populist, and almost predictable reaction to the failure of the 2-party duopoly to restrain both the growth of big government and the yawning deficit. Unfortunately, the media paradigm is stuck with a binary view of politics in America: Democrat/humanitarian/labor/biggovernment versus Republican/militant/corporate/antitax. It's a false frame, and the Republican party has been especially hypocritical in the last half century.

Look, this quasi-movement could easily start morphing into a third party... "The notion that the Tea Party movement is a vocal minority in the Republican Party may have been put to rest today. A new three-way generic ballot from Rasmussen Reports finds that a Tea Party candidate would fare better than a Republican candidate, 23% to 18%, with the Democratic candidate coming out on top at 36%. The poll also found 22% remained undecided." Wow.

As Rick Santelli, who may have inspired the tea partiers with a famous March 2009 rant said to Chris Matthews, "This isn't a left and right issue." (Seen here in this link to a good Megan McCarlde blog post).

I just wonder why it's so easy for my highly educated friends to dismiss the tea partiers, as if they were rabid. The Rasmussen survey confirms the hunger for a huge swath of Americans - the same kind of folks who backed Ross Perot in 1992 - to return to the limited federal role enshrined in the Constitution. They have been bubbling under the surface because the political system has effectively kept them locked out.

"Debt is the salve on the wound of rancorous politics. It fixes everything! Until the bill comes due" says WaPo's Joel Achenbach in another mini-masterpiece.  Well, not quite. Debt is the result of a broken political process, not a salve or side-effect of a functional process. And deficits will not be fixed without a better politics -- less gerrymandering, fewer election laws that favor incumbents and incumbent parties, and zero restrictions on free speech. Bets on that kind of reform happening?

Every two years we get candidates who promise to change the ways of Washington, to forge a bipartisan consensus. The result? Highly evolved creatures that speak glowing centrist rhetoric and produce hyper-partisan legislation the spends more and taxes less. And it is getting worse.

If you want to understand the anger about "re-using TARP money" to pay for a new job stimulus, just remember this: Americans were promised the $700 billion in TARP funds would be repaid in full. This was investment, not spending. And now? 

Would a Jobs Credit Work? A Response to Pozen

(Bob Litan)

Main Street is impatient with the pace of the recovery. Yes, the stock market has rebounded smartly from its March lows; and yes, government statisticians tell us that total output of goods and services actually increased at an annual rate of 3.5% in the third quarter, most likely marking an official end to the Great Recession. But on Main Street, unemployment has now passed 10%, and many more Americans are discouraged from looking for work, or engaged in part-time jobs unable to upgrade into full-time work.

No wonder then that policy makers in both political parties are frantically searching for ways to reverse the monthly job losses and start putting more Americans back to work. One idea that has attracted a lot of attention is a temporary tax credit or a partial or total suspension of the payroll tax to encourage employers to begin hiring again.

Robert Pozen, a thoughtful and experienced financial expert, recently provided some useful analysis of this idea, and came up with a highly targeted job creation proposal designed to provide the largest bang for the policy bucks (to minimize the impact on the uncomfortably large federal deficit). The notion is to provide a 15% tax credit, up to $100,000 per employee, for employers making net additions to their payrolls, but require that half of the new workers come from the ranks of the previously unemployed.

However, this proposal would limit the credit only for already established employers – those in business prior to some cutoff date (Pozen suggests September 30th of this year). The rationale for excluding all new firms from eligibility is to prevent existing firms from breaking themselves up or forming new subsidiaries or affiliates simply in order to qualify for the credit.

What sounds like a minor detail – the eligibility cutoff – would actually be a big mistake--for it reflects a fundamental misreading of which firms are most likely to hire new workers and sustain the recovery after the stimulus measures wind down and are eventually withdrawn.

A new Kauffman Foundation study documents that over the past three decades, until this recession, new firms (those one to five years old) have been responsible for much or all of the net new jobs created in our economy. Remarkably, even in the teeth of the recession, through 2008, the number of new business starts, as measured by another Kauffman study, has actually increased modestly. What we don’t know is whether the constraints on business credit or other impediments will deter these new firms, as well as those recently created, from continuing the historical pattern by being the prime source of net job creation now and in the years ahead. What do know, though, is that excluding new firms from receiving any job tax credit will certainly break that historical pattern – hardly the outcome anyone wants.

Fortunately, there is much more straightforward way to prevent the kind of gaming that Pozen worries about: in calculating the employment benchmark for determining whether a firm has added to its payrolls, the tax authorities should include all subsidiaries and affiliates in which a firm has an equity interest above a certain threshold (such as 10% of  an entity’s equity).

Meanwhile, policy makers should continue to look for other ways to boost the formation and growth of new companies, which are not only likely to be source of new jobs but of the next wave of new products and services that will restore optimism about our economic future.

Some examples: Establish a “job creator’s” visa for immigrants who launch new companies and hire workers; fix bank capital requirements so that they are less likely to discourage business lending in economic downturns (by making the requirements less pro-cyclical); allow shareholders to determine whether their companies should adhere to all or a portion of the requirements of the Sarbanes Oxley Act that make it more expensive for high growth companies to go public and thus expand on their rather than to sell out; and encouraging the development of a truly free market in the licensing of technologies developed by our universities using federal research funds, which would accelerate the commercialization of innovations that will reshape our future. (The House Financial Services Committee recently voted to extend the exemption of small companies from Sarbanes-Oxley's section 404(b). The measure still needs to pass the full House and Senate and does not affect the requirement that these companies comply with section 404(a).)

Agree or disagree, as you may, with some of these specifics. But the source of America’s remarkable job growth, our new firms, is not in dispute. As we all seek to dig our way out of our current economic hole, we cannot leave our entrepreneurs out of the solution, because they are the solution.

--Bob Litan

Where Have All the Loans Gone?

Last week the Obama Administration announced the expansion of a few Small Business Administration (SBA) loan programs, raising the cap on 7(a) loans, increasing the size of "microloans," and offering more aid, via TARP, to community banks. Questions will persist about the efficacy of SBA loan programs for new and small companies, as well as the effect of TARP restrictions on community banks, but two things are immediately clear. 

First, business loans have plummeted during this recession (via Econompic):

Worse, they show absolutely no upward trend in recent months:

(Source: John Mauldin.)

Any expansion of capital for businesses, even from the SBA, should theoretically help in some way. Credit is the oxygen line of new firms and they have been courting asphyxiation in this recession. 

Second, new and young businesses are the primary source of net job creation in the United States, yet this fact of economic life has for the most part been lost on policymakers (and media) obsessed with restarting the hiring process at large, established companies. Any recognition, therefore, of the importance of new firms and their access to capital can only be a good thing.

These steps aren't a silver bullet, mind you, and officials in Washington and every state capital continue to cast around for anything that will address (or appear to address) the dire employment situation this country faces. Nonetheless, President Obama's announcement is a step in the right direction and it comes on the heels of the creation within the Department of Commerce of a new Office of Innovation and Entrepreneurship. New firms are the drivers of job creation, and now Washington is finally turning to them.

Cato's Downsizinggovernment.org

DC is filled with hot air about controlling spending, but the think tank CATO takes that mission seriously. Here is the main text from the page of the Dept. of Agriculture:

All agricultural and rural subsidies in the Department of Agriculture’s budget should be abolished to save taxpayers $25 billion annually. In addition, agricultural trade barriers should be repealed. Current agricultural and rural policies are economically and environmentally damaging, and they create unfair transfers of wealth.

The department's food subsidy activities—food stamps, school lunches, and WIC—are properly local and private functions. They should be devolved to the states, with each state determining appropriate policies for its own residents. Such reforms would save federal taxpayers $79 billion annually. Some states may decide to fund food subsidies on their own, but competition between the states would likely result in smaller, more innovative programs.

Forest Service subsidies to state governments and private businesses should be ended. Congress should also explore options to transfer the national forests to the states or to new independent trusts that would be self-funded from forest-related receipts.

The table shows that these reforms would eliminate more than 90 percent of the USDA’s budget, saving federal taxpayers $108 billion annually, or about $923 per U.S. household. Under the proposal, the USDA would retain responsibility for animal and plant health inspections, food safety, grain and packing inspections, and conservation activities.

Check out downsizinggovernment.org.

The site is an impressive piece of work, on substance and style. Makes me wonder what other government related websites have you seen with such an efficient, informative, and clean design?

Strong Words from Jim Hamilton

Jim Hamilton, founder of the blog econbrowser and one of my dissertation advisers, writes in reaction to some University of California professors who suggesting a strike on the first day of class as a protest against the system-wide salary cut:

There are any number of things that happen in life that may not be as I would have wished. But one of my core principles is never to take that out on the students I am asked to teach.

If some of my colleagues perceive that they now have better opportunities than teaching at the University of California, I'd encourage them to resign so that they can take advantage of those opportunities.

If not, they need to stop whining and do their jobs.

And perhaps even be thankful that, unlike many other Americans, they still have one.

Impressive statement.  And yes, a sad situation for the great state of California.  While I strongly oppose bailouts for individual states, I would have preferred a stimulus bill that gave block grants to all 50 states (population weighted, of course).  Alas.

California remains an important story for its lesson in political failure, cousin of the term market failure. Its ambitions overstretched its capacities, and now the government is struggling to find balance with a handful of dysfunctional political institutions in the way. We can only hope they get a constitutional convention in place that establishes a workable government -- and not one that just jacks up tax revenue potential. That way spells brian drain.

Time will tell. But we should be thankful for the government employees who remain committed to service even while paying for the sins of their leaders.

Entrepreneurs (And Everyone Else Who Has Flown Since 1978) Owe a Debt to Ted Kennedy

Guest post by Charles C. Johnson

At the risk of wading into the political weeds, allow me to suggest that entrepreneurs owe Ted Kennedy a debt of gratitude for his work regarding airline and trucking deregulation. (h/t: Nick Gillespie of Reason Magazine.)

And the benefits of airline deregulation? The US Department of Transportation estimates that passengers save $19.4 billion dollars per year, thanks to lower fares due to deregulation. Today, airline ticket prices are almost 40% today than they were in 1978. 

 

Boycotters Call for Whole Foods Founder to Be Removed as CEO

Guest post by Charles Johnson 

The ire over Whole Foods CEO, John Mackey's WSJ op-ed on health care has entered a new phase, with union boycotters calling for him to be removed as CEO and chairman by the Whole Foods board. I quote, 

"Mr. Mackey attempted to capitalize on the brand reputation of Whole Foods to champion his personal political views, but has instead deeply offended a key segment of Whole Foods consumer base," CtW Investment Group's Executive Director Bill Patterson said in a statement. 

Meanwhile, the United Food and Commercial Workers Union, which is part of Change to Win, said it will be giving out information to Whole Foods shoppers about health care reform. The group said Mackey's op-ed was an "attempt to undermine Obama's health-care reform."

First of all, the boycott is clearly failing. Whole Foods's stock hasn't fallen a bit since the boycott began. If anything, it's increased! (Which, incidentally, is welcome news to this Whole Foods admittedly extremely small scale stock owner.)

Second of all, why don't we want entrepreneurs injecting their politics into the national debate? If it is acceptable for entrepreneurs to inject their politics into the debate in favor of increasing marginal tax rate, increasing the gax tax, and removing subsidies on fossil fuels? Why isn’t it okay for one entrepreneur, who by all accounts has helped his employees get some of the best coverage available, to weigh in on the health care debate? 

We should be thanking Mr. Mackey for bringing his expertise to bear on a problem of national import, particularly given his experience insuring his own work force!  

(For those interested in greater detail, be sure to check out Megan McArdle's excellent post explaining why the Whole Foods boycott is really a non-starter.)

Bernanke the Great

Federal Reserve Chairman Ben Bernanke has been asked by President Obama to serve a second term in the current post, which is deeply good news for America. (I do worry if this is good news for the Professor;  can you imagine how many sleepless nights the man endures?)

Changing horses mid-stream is always a foolish risk, but especially now when the horse is doing just fine.

Bernanke will and has endured severe criticism, most of it ignorant. History will reflect that the Fed was the hero in the crisis, in sharp contrast with the Treasury and the frivolous American legislature. Nobody will be surprised if the bulk of the "stimulus" bill is revealed as impotent in future studies, whereas the monetary policies of Bernanke's Fed will almost certainly be shown to be the key to arresting the panic.

Creative, decisive, expert, even agreeable. Calm. Independent. These are his traits. And I honestly believe only Bernanke can know the intricate details of the current crisis, the policies in place, and the fragility of the world economy. Obama was very wise to renominate Ben Bernanke, and not to put up a new person who would, however intelligent, face a daunting learning curve.

Next up: higher rates!  (Let's see how many friends of Ben there are in 2012. I'll be there.)

Health Care Reform is Vital for Growth

Everyone at Kauffman is obsessed with the idea of economic growth, and I have become increasingly distressed that without the passage of bipartisan health care reform during this legislative session, the prospects of economic growth in the U.S. will be endangered. I said on June 23 that the current course was a dead end, and I'd like to pat myself on the back here ("The vast machinery of politics and media will trudge on for months, but essentially this is over."), but I am not cheering the current scene. If the administration doesn't move towards an obvious centrist resolution (Wyden-Bennett), the stalemate will endanger the U.S. economy.

The explosion of health care costs in their current form is the danger. If these costs were eating up a larger percentage of income, that alone would be no concern. A wealthy people will shift consumption preferences, and why not shift them towards longevity in an economy that provides basic necessities at ever lower costs? Consider this observation by Martin Feldstein:

Those who worry about too much health care cite the Congressional Budget Office's prediction that health-care spending could rise to 30% of GDP in 2035 from 16% now. But during that 25-year period, GDP will rise to about $24 trillion from $14 trillion, implying that the GDP not spent on health will rise to $17 billion in 2035 from $12 billion now. 

No, the danger is that health costs are invisibly soaking up income because most health insurance is paid in the form of employee benefits, a consequence of distortionary tax rules. (Remember the growthology mantra from 2 months ago: Taxing employer-provided health insurance is not just a way to pay for reform, it is health care reform). Feldstein again: "Like virtually every economist I know, I believe the right approach to limiting health spending is by reforming the tax rules."

Because health insurance costs that would otherwise go into take-home pay, their rise enables the existence of the pernicious Dystopian Myth that middle class incomes are stagnant. The Dystopian Myth is social poison, a fiction shouted by the negative nabobs that convinces voters the American economic system is failing them. And that is dangerous. As a social force, this empowers dystopian politicians and threatens free-market capitalism.

Oddly enough, President Obama made both of these points in his July presser:

• "...even before this crisis hit, we had an economy that was creating a good deal of wealth for folks at the very top, but not a lot of good-paying jobs for the rest of America."

• "It’s about every small business that has been forced to lay off employees or cut back on their coverage because it became too expensive. "

• "And, by the way, it's important for a family's wages and incomes. One of the things that doesn't get talked about is the fact that, when premiums are going up and the cost to employers are going up, that's money that could be going into people's wages and incomes. And over the last decade, we basically saw middle-class families, their income and wages flat-lined."

Liberals should not fear a centrist solution that gives their President a huge victory -- especially one that ends the regressive use of gold-plated insurance for the lucky few. And conservatives should not be cheering if Obama loses on this. It will be a Pyrrhic victory, because the Dystopian Myth will survive and amplify.

Three Cheers for Ignorance

Does our affection for democracy over alternatives require us to believe that citizens are rational and intelligent? The infamous and insightful comedian Bill Maher recently ranted that Americans are "stupid" and joked that legislators shouldn't bother listening to them during the August recess. At marginalrevolution, Alex Tabarrok blogged that Maher was unleashing his inner Bryan Caplan. Clips from the Maher essay first, then my take on why Tabarrok, Maher, and maybe even Caplan are missing the big picture.

I said [on CNN] 'I wouldn't put anything past this stupid country.' It was amazing - in the minute or so between my calling America stupid and the end of the Cialis commercial, CNN was flooded with furious emails and the twits hit the fan. And you could tell that these people were really mad because they wrote entirely in CAPITAL LETTERS!!! It's how they get the blood circulating when the Cialis wears off. ...

And before I go about demonstrating how, sadly, easy it is to prove the dumbness dragging down our country, let me just say that ignorance has life and death consequences. On the eve of the Iraq War, 69% of Americans thought Saddam Hussein was personally involved in 9/11. Four years later, 34% still did. Or take the health care debate we're presently having: members of Congress have recessed now so they can go home and "listen to their constituents." An urge they should resist because their constituents don't know anything. At a recent town-hall meeting in South Carolina, a man stood up and told his Congressman to "keep your government hands off my Medicare," which is kind of like driving cross country to protest highways. ...

And these are the idiots we want to weigh in on the minutia of health care policy? ...

And if you want to call me an elitist for this, I say thank you. Yes, I want decisions made by an elite group of people who know what they're talking about. That means Obama budget director Peter Orszag, not Sarah Palin.

Which is the way our founding fathers wanted it. James Madison wrote that "pure democracy" doesn't work because "there is nothing to check... an obnoxious individual." Then, in the margins, he doodled a picture of Joe the Plumber.

Let's be fair to Maher, who is clearly poking fun and going to extremes for a laugh. He's a comedian, but is he unserious? Maher is sincere in his elitism, but he clearly misunderstands James Madison whose fundamental message is that the danger of pure democracy required limiting central government power. Nevertheless, he is channeling an ancient dialogue.

I would note that Will Rogers was also a comedian who made his living with political humor. It is telling how times have changed that Rogers made his mark by mocking the powerful, whereas Maher and his fellow pundits score most of their points off of the public. 

If we take this hostility towards democracy seriously, we have to squarely address the Caplan critique, and in doing so convince Alex why he should be a small d democrat. So let's get started.

For the record, Bryan Caplan is a friend of mine who wrote a great book a few years ago called "The Myth of the Rational Voter" which challenges a bedrock theory of political science. The median voter theory holds that democracy is unbiased in its policy preferences, and Bryan brilliantly exposes that conclusion as failure. This is not the end of the story. The Caplan critique is of great but limited value. It does not imply better alternatives. It affirms the Madisonian caution against mobocracy, and reaffirms the desirability of federalism and mixed government republicanism, the former as a channel for policy experimentation in a biased (imperfectly wise) world and the latter as a buffer against majoritarian populism. In the end, the Caplan critique confirmed my sense that policy discussions in a democracy can seem frivolous; voters ultimately cannot care about policy because of bounded rationality and instead care about pragmatic outcomes. Good outcomes equal re-election, regardless of policy particulars.

In sum, I think the Caplan critique of democracy write large fails (and he might agree). Here's why:

First, Caplan tells us that voters are irrational, not that they are stupid. This is big difference between the wise professor and the devious comedian.

Irrational voters are in some sense ignorant, but ignorance is no sign of stupidity. Many surgeons are perfectly ignorant about "frivolous" skills like gardening, automotive engineering, and probably even the inner physics of X-ray machines. But they know how to read an X-ray machine, and isn't that what matters?

Who prefers the surgeon to know less about anatomy and more about NAFTA, tax progressivity, and the effects of the minimum wage on teenage minorities? The surgeon is a voter, but an irrational one because she has incomplete information about political policies. Is this dangerous? Inefficient? Unjust in some way? If we prefer a society where more citizens live longer lives due to better surgeries, we must prefer an ignorant electorate, no?

Let's agree that the human mind can know one subject expertly, five or six subjects really well, and an additional thousand facts, all this in a world with an infinite amount of subject matter. We can trivially claim that a non-ignorant citizenry is an impossible standard. A utopia, of sorts. And the only way to realize such a utopia is to limit the scope of common knowledge, which hints darkly at Mao's little red book.

Second, a growing society requires more, not less, ignorance. In their new Modern Principles: Macroeconomics textbook, Tyler Cowen and Alex Tabarrok argue that the division of labor due to trade (i.e. scale) is better understood as a division of knowledge. Great point. In Chapter 18, they write

In a primitive agricultural economy in which each person or household farms for themselves, each person has about the same knowledge as the person next door.  In this case, the combines knowledge of a society of one million people barely exceeds that of a single person. A society run with the knowledge of one brain is a poor and miserable society.

Again, the alternative to rule by all is rule by the few or rule by one. And yet here is evidence that a more complicated society is even less governable by elites than a pre-modern society was. I think a cursory glance at comparative political economies shows that oligarchies are negatively correlated with prosperity (with North Korea, most of sub-Saharan Africa, and Cuba at one extreme and South Korea and SE Asia moving towards the other end of the spectrum towards democracy).

Third, democratic "failure" is resolved by more federalism not more elitism. Look, if we believe that rational ignorance is a function of growth, then they are both poised to accelerate in the years ahead. As the division of labor and knowledge accelerates, the democratic challenge will be how to reconcile increasing levels of political ignorance with democracy.

Logically, more power will be shifted toward experts because increasingly ignorant citizens don't want to manage train schedules. People tend to desire more varieties of ice cream, barbers, and books, so why would we expect them to be satisfied with fewer choices in the political sphere? They will want more experts, not more powerful experts, to supply them with public goods. Also, it is far from clear that a technocracy is the pre-ordained outcome generated by political "ignorance." The efficient apportionment of public goods supply among various service providers is not something people will vote on in a booth. More likely, different nations will try different institutions, and there will be an iterative social learning process. But I suspect political markets may have a better chance of success than a coercive technocracy at finding optimal solutions.

An example that Bryan and I have discussed is the Federal Reserve, which has a kind of technocratic control over the money supply. I think money is a special case, so the Federal Reserve is a necessarily technocratic organization much like the Supreme Court is. Quite different are health care, transportation, welfare, crime, and education. It is not at all clear to me that a centralized organization can effectively manage those issues on a national scale. To the contrary, I trust voter choices among competing products (states, cities) far more than expert knowledge.

Congress is increasingly failing institutionally at selecting weapons systems efficiently, let alone managing public education. Congress' failures have been the luxuries of a rich nation without a basic budget constraint, which will soon change thanks to looming international financiers. When the pressures to balance the budget become critical, fixing of the "broken branch" will inevitably involve a devolution of central power. Congress is simply overcommitted right now, and the limits of taxation will prove unyielding.

So in the end big fiscal decisions about the balance of government services and taxation will play out among 50 state alternatives (with voters making choices via the right of exit -- voting with their feet). Voters may be ever more ignorant of the policies of the 50 states, but they will know where the good schools, low taxes, and growing economies are.

A Few Thoughts on Tyler Cowen's New Book

[Another guest post from Charles Johnson, one of our summer interns.]

Tyler Cowen's new book, Create Your Own Economy: The Path to Prosperity in a Disordered World is one of the more engaging books I've read recently. It rests comfortably in the niche between books about behavorial economics and social technology. Careful readers of this blog will note that Tyler Cowen was a participant in the Kauffman Economic Bloggers Forum in February. We prepared videos of the participants. You can see him on video discussing blogging here. Cowen is a seasoned blogger at his blog, Marginal Revolution. 

The thesis for Cowen's new book is that technology is allowing many of us to become autistic-like in our processing of information and consumption of entertainment and culture. We've moved into a "bits" culture where we can constantly be orienting and re-orienting our culture. This remix culture is evident in everything from iPods, to blogs, to delicious, and to Facebook. In a way, I took this part of the book as a kind of demonstration that we can all become renaissance men because the costs of such renaissance have plummeted. We don't need Jefferson's library when we have a worldwide web with easy information at our fingertips. 

Cowen's book can be read as an appeal, that, for the sake of society at large and the individuals in particular, we should embrace neurodiversity, or the different ways in which our brain is wired. (You can hear him discuss the book in an interview with John J. Miller of National Review here.)

I was struck by this paragraph about autism and the foundation of companies. We know that dyslexics tend to have high rates of firm creation. (See here for more details). But what about autistics? 

Here Cowen points to the work of Simon Baron-Cohen, who is a researcher of autism at the University of Cambridge. (Simon Baron-Cohen created an AQ test -- or autism quotient -- that you can take here to see if you might have autistic-like tendencies.) Cowen recounts that Baron-Cohen believes that there may be a lot more autistic high achievers than most people realize. On p. 24-25, Cowen writes about some of these high achievers. [The bolding is mine.] 

Craig Newmark, founder of the web forum Craigslist, has written on his blog that his history as a "recovering nerd" is connected to Asperger's. It is perhaps no accident that autistics are known for their attachment to lists as a means of processing, recording, and ordering knowledge. Bram Cohen, creator and former CEO of BitTorrent, also describes himself in terms of Asperger's syndrome. He founded the company at age twenty-nine and BitTorrent has been a pioneer in exchanging digital information over the web; one of his key insights was how BitTorrent could break up files into smaller bits and send through the bits rather than the whole file at once. Cohen mastered three programming languages by the age of sixteen and his work on BitTorrent is regarded as brilliant. The best-known example of an autistic high achiever is Temple Grandin, a woman who has pioneered commonly used improvements in animal treatment and slaughterhouses; her unique cognitive perspective has helped her understand when animals are afraid and how they can be made to feel more secure. 

I've yet to see a scientific paper or serious clinical discussion of the autistics who hold political office, work in Hollywood, start web 2.0 companies, or run major U.S. corporations or hedge funds.

If Baron-Cohen is right that there is the huge reserve of highly successful autistic achievers, I wonder why there hasn't been some kind of online, Craigslist-type sorting website that seeks to place autistic people with the things in which they specialize or some kind of wider texting that seeks to identify and help autistic people find their niches.  

I came upon this idea when I was spending time with my next door neighbor, who has Asperger's. He has an obsession with clocks and with taking them apart and putting them back together. Imagine the societal benefit if he could be placed with a clock making company. 

Indeed, if I could fault Cowen's book for one thing, it's that it doesn't take the ideas he's advocated and move towards policy. Still, perhaps policy is not one of those things for which Dr. Cowen is wired and I ought to respect his neurodiversity. 

Where good ideas go to die

Why has Washington, DC increasingly become the place where good ideas go to die?

On May 12, the Senate Finance Committee held a hearing on health care reform. There was a long table of 13 experts, and a vast majority agreed that ending the tax exemption on employer-provided health benefits should be part of a reform package.

They gave the reasons that experts — on right or left — always give for supporting this idea. The exemption is a giant subsidy to the affluent. It drives up health care costs by encouraging luxurious plans and by separating people from the consequences of their decisions. Furthermore, repealing the exemption could raise hundreds of billions of dollars, which could be used to expand coverage to the uninsured.

Democratic Senator Ron Wyden piped up and noted that he and Republican Senator Robert Bennett have a plan that repeals the exemption and provides universal coverage. The Wyden-Bennett bill has 14 bipartisan co-sponsors and the Congressional Budget Office has found that it would be revenue-neutral.

The Finance Committee’s chairman, Senator Max Baucus, looked exasperated. With that haughty and peremptory manner that they teach in Committee Chairman School, he told Wyden and the world that this idea was not going to happen.

In the World’s Greatest Deliberative Body, senators don’t run things. Chairmen and their staffs run things.

That is David Brooks; read the whole thing here.

Lessons:

1. The big battle over health care is now dead. The vast machinery of politics and media will trudge on for months, but essentially this is over. History will look back at the $1.6 Trillion CBO score and recognize it as the turning point. Why did it happen?

2. President Obama made the same vague mistake that President Bush made. Rather than specify a solid framework for legislation (on immigration, on Social Security, take your pick), the new way to kill your own agenda is to talk up general principles and leave Congress to craft actual legislation. Without clear leadership (and not just behind the scenes), the modern result is acrimony. Inside the beltway, the Clinton health care experience remains a searing lesson in the "wrong way" -- overly strong presidential specificity. But the lesson has been overlearned. What the Clintons did wrong was to hijack the legislative process with a massive semi-secret commission. That wasn't leadership. Somewhere between being a control freak and a mere rhetorician is the golden mean of presidential leadership.

3. It's not too late. Despite lesson #1 above, Obama and key Senators could skip the whole kabuki dance of failure. Announce the old approach dead. Admit you lost, and explain why. And then restart by working with a new coalition, a truly bipartisan one this time (hint Wyden-Bennett). It's been done before. Tax reform in 1986 died and was reborn many times, as recounted in The Showdown at Gucci Gulch.

Stimulating Fewer Jobs

In another strike against government effort to create jobs, the NYTimes excellent "You're The Boss" blog (which we should have on our blog roll) observes how the extension and modification of unemployment insurance is undercutting small businesses. This is an old saw, but research backs it up: legislation that tries to protect workers will chill hiring instead. When will they ever learn?

It gets even worse when the employee files for unemployment. A lot of people — including a lot of business owners — don’t understand how this works. Because the government cuts the unemployment check, it is widely assumed that it’s the government that pays the unemployment benefits. In reality, those benefits are funded by employer taxes. And here’s the killer: The more unemployment benefits your former employees collect, the higher your taxes go.

It works like insurance. If the government pays a claim, your rates go up. In fact, if your former employee collects $10,000 in unemployment payments, you can expect to pay close to twice that in increased premiums. At least that’s how it works in my state, Illinois.

Thus, this becomes another cost of doing business that smart owners attempt to control. How do you control it? By making as few hires as possible, by making sure that those hires you do make are as strong as possible, and by combining documented rules with good management.

And now, thanks to the stimulus package, unemployment insurance has been extended as much as an additional 20 weeks. If you’ve had to lay off 10 people, this could easily result in additional taxes of $10,000, $50,000, or even $100,000. It’s a time bomb that won’t go off until after employers get their contribution-rate increase in November, but it will go off.

And therein lies the final irony: Even after the economy improves, I’m going to think long and hard before I hire anyone. Thanks to the stimulus package — the stimulus package — the costs, paperwork, and legal exposure associated with hiring employees is on the rise. I’m not saying the package is all bad, but it does make it less appealing for small businesses to hire more people, or even to offer health insurance, for that matter.

Uncompetitive Ohio?

A fundamental part of any period of rapid growth or decline is movement. Creative destruction plus a large, open, continental economy yields massive shifts in population. Rural moves to cities. Old cities give way to new. I like to say that a downturn is more of a restructuring than a recession. It's not as if when the economy grows back, all the saggy parts will inflate again.

Michigan, California, we know about those states. But did you know Ohio is on the downswing as well? The Dayton Daily News reports:

NCR will move its corporate headquarters from Dayton to Duluth, Ga., taking with it more than one thousand jobs from here. ... In the memo sent to employees, Nuti wrote, “The decision to consolidate functions in Georgia and build a corporate headquarters campus focused on innovation is in line with our business strategy to drive growth, improve our innovation output, increase productivity and continually upgrade our focus on the customer. In addition, we will decrease time-to-market for innovative solutions, improve our internal collaboration, deliver next generation employee education programs and lower our current operating costs.”

Somewhere in that lies the truth. Or part of it. The full article digs deeper and identifies the direct international flights that go direct to and fro Atlanta. From Dayton, it's 60-90 minutes just to get to one of the regional hubs in Columbus or Cincy. But I wonder. 

The article makes no mention of taxes, so I turned to the handy-dandy Tax Foundation's 2009 State Business Tax Climate Index. So guess which state is ranked 47th out of 50?  And guess which state is ranked 27th? Nothing to see here, folks. Move along.

Is the U.S. becoming a command and control economy?

The Washington Post's editors think so (HT Virginia Postrel). The cap-and-trade bill seems to have a million points of tyranny hidden in the footnotes. If you can read this and see how federalism (that system of 50 entrepreneurial states) lives, let me know. And keep in mind, I've come out in favor of taxing carbon, specifically the cap-and-trade approach.

With those targets in mind, the bill expects organizations that develop model codes for states and localities to fill in the details, creating a national code. If they don't, the bill commands the Energy Department to draft a national code itself.

States, meanwhile, would have to adopt the national code or one that achieves the same efficiency targets. Those that refuse will see their codes overwritten automatically, and they will be docked federal funds and carbon "allowances" -- valuable securities created elsewhere in the bill that give the holder the right to pollute and can be sold. The Energy Department also could enforce its code itself. Among other things, the policy would demonstrate the new leverage of allocation of allowances as a sort of carbon currency -- leverage this bill would be giving to Congress to direct state behavior.