Archive for November, 2011

Here’s the second of two posts inspired by the super-committee’s failure to report any results just before Thanksgiving. Committee members did report that differences over tax reform and tax rates blocked progress on a budget package members of both parties could back. The interesting thing about this debate is that the media did not come to grips with the logic that underlies disagreements about tax reform and tax rates. Republicans believe that lowering tax rates will increase tax revenues, or at least leave revenues largely unchanged. The surest way to reduce revenues, they believe, is to raise rates. Democrats believe the opposite. The surest way to raise revenues for them is to increase tax rates. A reduction in tax rates equals a reduction in tax revenues for Democrats.

The Laffer curve underlies the Republicans’ logic about tax rates and revenues. A single straight line proceeding up and to the right underlies the Democrats’ logic. I have not surveyed the economic literature on this question, and I have to say I would not have that much confidence in economists’ findings if I did. Usually findings in the academic journals find their way into public debate, especially if they are compelling or if they agree with one or another political position. No findings about the Laffer curve or the single straight line have emerged in public debates about taxes. You’d almost think these two models about the relationship between tax rates and revenues don’t exist. These irreconcilable models drive our public debate on this subject, yet we don’t acknowledge them.

The Republicans want to lower rates, whatever the impact on revenues. The Democrats want to raise revenue, whatever the impact on rates. Interestingly, the two parties don’t even agree about whether current tax rates are high or not. Democrats look at income tax rates, and argue that they are historically low. No doubt about that: you go back to the fifties and you’ll see marginal income tax rates so high they would make your hair stand on end. The Republicans look at the overall tax burden that business firms and workers carry, and they see a proportion of money going to governments that is way above the twenty-five percent that has historically marked the threshold between healthy economies and troubled ones.

Republicans want to get us back down to twenty-five percent. Democrats respond that citizens would never tolerate the deficits and benefit cuts that would accompany tax rates that low. In fact, American citizens have tolerated fairly high tax rates in exchange for public benefits. The Tea Party has said, no more. The Democratic party, especially with health care reform, said yes, more – more benefits and more taxes to support them.

Let’s take a closer look at the Laffer curve. Reagan and his revolutionaries embraced Laffer’s logic. The Democrats laughed at it, then ridiculed it. The Kennedy tax cuts in the early 1960s did in fact increase federal tax revenues, however, so ridicule and laughter do not make the Democrats’ case so well. If they want to assault this model, they should do so with some logical rigor. Clear evidence about the relationship between tax rates and revenues is in fact not that easy to collect. We have a lot of governments, a lot of tax revenue streams, a lot of rates, and a long period of history to study. The empirical side of this question is not simple.

Laffer’s logic is simple and compelling. Let’s consider one tax rate and one revenue stream. Think of it as a sales tax on beans if that helps. We know that when the tax rate is zero, revenue is zero. We know that when the tax rate is one hundred percent, revenue is zero. No one in private business would produce, buy, or sell beans if the government took all the proceeds. Lastly, we know that when the tax rate is between zero and one hundred percent, revenue from the tax is some positive number. Therefore the relationship between the tax rate and tax revenue between zero and one hundred had to look like an upside down bowl. Or maybe a two-humped camel. Or perhaps a gun barrel. It could even look like a steady line up and to the right, until it drops back down to zero at 99.9 percent.

That tells you something. The logic behind the Laffer curve is compelling, but we don’t actually know the shape of the curve. Collecting real data to discover its shape is devilishly difficult. You know that’s so because if it were easy and the findings were conclusive, someone in the Republican party would have those findings translated into talking points and we would never hear the end of it. We don’t even know if the shape of the curve depends on what kind of tax we’re talking about. The same person who might buy a house where property taxes are high might quit working if the income tax rate is high, or might quit investing if the capital gains tax rate is high.

Let’s say we can figure out the actual shape of the curve, form fitted to take into account the variations that may exist among different taxes. Suppose revenues max out at a twenty-five percent rate, and decline after that. The Republicans are in heaven. Now suppose revenues max out at seventy-five percent, then decline as you move toward one hundred percent. Now the Democrats are loving it. That shape gives them much more room to pile on benefits and pay for them. You know that Republicans will oppose a rate that goes much above thirty percent, no matter how much revenue it raises. If you try to take their money, they’ll say Taxed Enough Already.

If the Democrats are wrong about their line that goes steadily up and to the right – that is, if revenues go down when we increase taxes – we make a big mistake if we raise rates in the current situation. If the Republicans are wrong about the Laffer curve – that is, if revenues actually do continue to increase when you increase the rate – they may have some ‘splaining to do. I think revenues probably do peak when local, state, and federal governments’ total take is about twenty-five percent. After that taxes begin to eat away at productive activity. Right now we are so far above a twenty-five percent total I don’t care to contemplate it.

It’s just a gut feeling, though. I can’t show that twenty-five percent is the magic number for the total tax rate. Nor can I show how much revenue we are sacrificing because the total tax rate has crept up toward fifty percent over these many years. We know that employers have willingly shed workers in order to shed the financial burden of keeping them on, even though cutting employees generally means cutting profits as well. We know that small businesses have difficulty starting up and expanding in an environment where hiring new workers is so expensive. We can’t measure the amount of economic activity we forego because the total tax rate is so high. We can only lower the rate to see what happens.

We know from a few decades of experience that we are not going to see lower tax rates. We hear about the Bush tax cuts again and again, but that is one modest, temporary reduction in one tax. If you focus on one thing, you wind up distracted from other things. To add up the total tax burden in our economy is one depressing exercise. I stopped doing it a long time ago. The total take by local, state, and federal governments has not subsided since I stopped.

If you feel the super-committee let us down, consider this idea. We are going to have to proceed on principle here. Neither party can persuade the other based on convincing data about the relationship between tax rates and revenues. Even if you consciously rule out the complexity one encounters in  arguments about taxes, you cannot sufficiently simplify the arguments in this case if you try to collect comprehensive data. You cannot hold other variables constant when you try to measure the impact of rate reductions or increases on revenues. Because taxes operate in such a complex environment, conclusions you draw about the relationshp between rates and revenues are open to challenge from some quarter.

Consequently people eventually have to choose between small government with low taxes, or large government with high taxes. We could go for something in between, but no one is talking about compromise right now. From the 1930s on, we have embraced government benefits. We haven’t felt so comfortable about the cost, but we have consistently settled for gradually increasing taxes in order to pay for public benefits. Ask anyone who has voted for a bond issue to fund a local library or a new school, knowing how much it will add to property taxes in the near term. People are willing to pay.

Until now. The tax revolt has begun. The revolt comes when we have big government deficits at all levels. The deficits make people anxious. We want to address them, but we’re not sure how. We want our leaders to address them, and they clearly don’t know how. We need better leaders and better discussions. Where we’ll find better leaders is open to question. Meantime, we can improve our discussions if we’re more explicit about the mental models we use to analyze tax issues.

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Did you know that the super-committee’s recommendations could have passed the Senate with only fifty-one votes? That is, if the super-committee had made any recommendations, they could have passed the Senate without the threat of a filibuster.

Does anyone other than politics junkies or James Stewart fans even know what a filibuster actually is anymore? I Googled when was the last filibuster in the United States Senate. Do you know the answer? It was in 1992, almost twenty years ago. That was shortly after Ronald Reagan left office. Most filibusters last from ten to twenty hours. Strom Thurmond spoke for twenty-four hours on the Senate floor in 1957. A team of Southern Democrats conducted a talkathon in the 1960s that lasted about seventy-five hours, or three days. That’s it. Every senator has an internal timer that will take him off the floor no matter how little water he drinks. Ten to twenty hours is the longest a senator can hold the floor without going to the bathroom – no chamber pots allowed in the senatorial chamber.

So ask a Washington know-it-all why we don’t have filibusters anymore. Why don’t they occur, even though filibusters supposedly explain why the Senate needs sixty votes to pass anything? You’ll get some complicated procedural answer about how Senate rules require a three-fifths majority for a vote of cloture. Don’t you even pause to consider whether the answer is true or not. Every word of it is true, but it doesn’t answer the question at all. The reason you don’t see filibusters in the Senate anymore is that the senators don’t want to filibuster.

Let’s say the Democrats want to bring a bill to the floor for a vote, but they have only fifty-nine votes to support it. The Republicans have forty-one votes in opposition. The Republicans say they’re going to filibuster the bill, which means they threaten to take the floor and debate the bill for some indefinitely long period of time, measured in hours. The speaker may read from the Bible or from a cookbook, he may talk about his hometown or he may even talk about the bill. The Democrats can’t stop him because they need sixty votes to cut off debate. One vote shy of a three-fifths majority, they have to listen to the speaker blab.

Why is this matter of Senate procedure even a question? For years now we’ve said the Congress is dysfunctional. What is the main reason we know it’s dysfunctional? Well, you can’t pass anything in the Senate without sixty votes, and the majority party rarely has sixty votes. Why do you need sixty votes to pass legislation in the Senate? Because the minority threatens a filibuster in every case. Since the majority can’t muster sixty votes to force an end to debate, and because it expects the minority to make good on its threat, it backs down.

Have you heard anyone explain why the majority backs down in every case? I haven’t. Perhaps someone thinks it would harm the Senate’s reputation if its business ground to a halt for twenty-four hours. Perhaps they think the mere spectacle of a filibuster would be the type of political theater the Senate’s reputation doesn’t need right now. Get real. The Senate’s reputation is about as low as it can go right now. It has been low since it stopped passing bills. No filibuster will harm a reputation that’s already in the toilet.

The behavior surrounding filibusters has become so institutionalized that the minority doesn’t even have to threaten a filibuster anymore. All the senators assume now that you need sixty votes to pass anything, and that’s the end of the matter. If these sorry creatures took their jobs, their conflicts and their legislative duties seriously, the majority party would force the minority party to carry out its threat. Challenge the filibusterers to hold the floor as long as they can. Give them the satisfaction of making their demonstration, then pass the bill when the opposition party fags out. That’s what happened in the civil rights debates nearly fifty years ago. Southern Democrats tried filibusters to block new civil rights legislation, but the bills passed anyway. A filibuster is a visible demonstration of dissent – it is not a successful parliamentary tool to block legislation over the long term.

Reputations aside, the only other argument in favor of the current practice is the argument to efficiency. You avoid filibusters to keep the Senate’s business going. But the Senate’s productivity is already near zero, partly because the insitutionalized sixty-vote requirement resigns everyone to helplessness. That’s not quite true – the Senate occasionally passes something. Not so long ago, it managed to pass the Dodd-Frank financial reform bill with votes from both parties. I’d say that bill was quite an exception. It was so general and so symbolically important, it couldn’t help but pass.

These arguments also ignore the Senate’s ability to change its own rules. The Senate could easily agree to a change that requires a vote of only fifty percent plus one to end debate. Within the Senate chamber, that option seemed so radical that insiders dubbed it the nuclear option. What is so destructive about changing the rule? Nothing much, except that to change Senate tradition does seem rather apocalyptic to club members. To outsiders, it certainly seems an unnecessary tempest, since the Senate doesn’t allow real filibusters anyway. The institution found itself tied in knots over a rule change that would affect something that doesn’t happen anyway.

All of these reflections return us to the dysfunctionality we alluded to above. The tacit agreement between the parties not to allow filibusters forms an interesting foundation stone in this pattern of dysfunctionality. When partisanship has worn you down, you think: “Well, at least we don’t have to worry about filibusters. Do you know how tiring they are? That kind of theater sucks up a lot of oxygen, even when you’re not the speaker. Thank God we don’t have to go through those.” In other words, stay with the devil you know. Stay with an institutional pattern of behavior that’s discouraging but predictable. Stay with a pattern of behavior that lets you make excuses. When citizens complain, senators can point to their poor reputations and say with still more pessimism, “What have we got to lose? We’re doing our best. Get off our backs.”

You can tell yourself that, but the citizens who gave you this high honor and responsibility know better: you’re not doing your best.

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Washington Should Follow Laissez-Faire

Things are really a mess economically in the United States and it isn’t really an exaggeration to say it is all Washington’s fault.  I mean through the easy money policies of the Federal Reserve and the legislative and monetary support of Congress and the previous administration many Americans who couldn’t otherwise afford to buy a house bought one.  This coupled with reckless lending policies on the part of primary lenders due to explicit and implicit government loan guarantees set the economy up for a massive failure.  Then, when their low teaser rates readjusted up and many could not afford their new higher payments the housing bubble burst.  And what was Washington’s response?  It was to provide trillions more in easy money and a policy of encouraging Americans to borrow and spend it to “stimulate” the economy.

Now that, that policy hasn’t worked we are facing a massive debt crisis, with real unemployment north of 16 percent and price inflation eating away at the standard of living in America.

If that is not bad enough, last week it was reported that bailout beneficiaries and mortgage guarantors Freddie Mac and Fannie Mae asked the federal government for more bailout funds.  Freddie asked for $6 billion more bringing that GSE’s total bailout figure to $72.2 billion.  Fannie asked for $7.8 billion more bringing its total Treasury draw to over $120 billion.

The main reason why Freddie and Fannie are still losing money and require more federal largess is because of the policies coming out of Washington.  Freddie reported $4.8 billion in derivative losses alone due to declining interest rates.  Fannie’s president and CEO, Michael Williams claims his firm’s woes are due to homeowners paying less interest on loans refinanced at historically low mortgage rates.  So while Washington brought on the original crisis that forced Freddie and Fannie into U.S. conservatorship, its response to that crisis has only made the financial conditions of those entities worse.

At the end of the day, Henry Hazlitt’s words from his famous book, Economics in One Lesson ring prophetic.

“The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”

In both instances, Washington’s policies leading to the financial crisis of 2008 and its policies since have helped some groups ( i.e. bankers) and hurt others (Fannie and Freddie).  Since no mortal man can determine with precision how a given economic policy of government or a central bank will affect every group in a society it is best for government and central bankers to abstain from imposing their will on the economy.  Certainly we would be much better off now because our economy wouldn’t be in the mess that it is in.

Kenn Jacobine teaches internationally and maintains a summer residence in North Carolina

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In our usual legalistic way, we have entered an earnest debate about whether or not protesters have a right to set up tents in a public space to stay there. We hear a lot about health and safety, public nuisance, the First Amendment, how the encampment smells, how to respond, and so on. Before long, we’ve forgotten that the point of the occupations at their inception was to enact a protest that is provocatively illegal. You can exercise your First Amendment rights in a lot of ways. These protesters choose to exercise their rights in ways that are most likely to provoke a response.

How law enforcement responds is the test. The occupiers demonstratively stayed on good terms with the police during the early stages of their protest. They had the right instincts and the right strategy. After these expressions of good will, the police could not move in with force to remove the protesters without harming their own reputations. They had no justification for abuse.

Civil disobedience is hard. It’s hard on the people who practice it. They suffer all kinds of public abuse for the stand they take. It’s hard on law enforcement officials, as it poses problems for them that they don’t normally face. It raises hard questions about public duties and public rights. Lastly, civil disobedience is hard to sustain long enough to have an effect. It requires discipline, good leadership, effective planning, and clear goals. The Occupy movement had not developed these qualities before policemen all across the country moved in with riot gear and disproportionate shows of force designed to deter future public nuisances.

The occupiers have drawn attention to themselves and to their slogans. In that way they’ve been successful. Because they have not articulated other aims, we don’t know yet whether they’ve been successful otherwise. If we base our judgments about the movement on whether or not the protests are legal, however, we’ll certainly miss the occupiers’ point. They could say, “Of course the occupation is illegal: that’s why we did it.” If it were legal, no one would have paid attention to it.

More specifically, you cannot justify disproportionate force with a claim of illegality. A person may trespass on my lawn, he may urinate on my rose bushes, but I cannot set my Rottweiler on him or attack him with pepper spray. The police who attack occupiers act with disproportionate force not primarily because the encampments are illegal, but in order to intimidate and deter. They do not want the occupiers to return. You don’t need riot gear to turn people out of their sleeping bags. You need riot gear to scare people into obedience.

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Paradoxically, over-regulation brings about under-regulation. Let’s take regulations that govern the trading of securities. The government is supposed to prevent fraud in all business contracts. Its standard mode of prevention is to prosecute and punish people who commit this crime. That deters others from doing the same thing. To prosecute and punish, government has to specify what constitutes fraud. Some types of fraud are easy to specify, but securities fraud is not.

Securities fraud is hard to specify for a lot of reasons. One is that a lot of institutional layers and middlemen generally exist between buyers and sellers. The securities market is more opaque than many other markets. So we tend to regulate what we’re able to regulate, things like insider trading. Insider trading isn’t even fraud, strictly speaking. It is, however, a type of unfairness that we have fastened on in our regulatory regime for securities. The elements of proof for insider trading are fairly clear-cut, so prosecutors are on familiar ground when they bring a case of that type.

Along comes Bernie Madoff, who gives all of us an example of true fraud. Everyone has heard of a Ponzi scheme, and everyone has a general idea how it works. When we observe a skillful, sophisticated practitioner of Ponzi schemes, we know what to do. We prosecute and put the person in jail. We are all angry that Madoff made off with so much money. Widows suffered. Bernie Madoff will die in the prison infirmary.

Now consider credit default swaps. People in the financial industry call these CDSs. Or consider collateralized debt obligations. These are CDOs. Or how about mortgage backed securities, or MBSs for short? We could regulate all of these instruments, and in fact we have tried to regulate them. But how do you separate legitimate trading in these securities from fraudulent activities? How do you distinguish right from wrong in these markets?

I’d argue that fraud is fraud, and that it’s not so difficult to recognize it when you see it. As a well quoted judge said about obscenity, “I know it when I see it.” When you have a regulatory regime that depends on an over-detailed specification of the crime, however, you run into trouble fast. Regulators in the 1960s wanted to say that depiction of female genitals was obscene and not to be permitted. What about Renaissance painters who depicted nude female bodies? Were they all pornographers, and will we destroy all the books that contain images of these paintings? Of course not. Does that mean we can’t regulate obscenity? Of course we can regulate it, but we want to think about how we do it.

The same goes for securities fraud. It’s doubtful that a detailed specification of what counts as fraud in the market for mortgage backed securities would be that effective. You want to craft laws that prevent fraud, no matter what instruments are traded. You want to craft laws that take into account the kinds of difficulties that arise when you regulate obscenity. Lenny Bruce used words in his performances on stage that landed him in jail. Today we regard his prosecution and punishment as absurd. You can say that community standards have changed, or you could say the laws governing obscenity were wrong. Even if both factors are at play, good obscenity laws would not have sent Lenny Bruce to jail.

We want good laws to prevent securities fraud. We want people who commit fraud to be punished for it, and we want people who conduct their business affairs honestly to be free to continue their pursuits for everyone’s benefit. If people who commit fraud go unpunished, that produces both anger and disillusionment. That makes people say, “I play by the rules. Why shouldn’t they? Even more, why should my money go to pay off people who gambled and lost, and gambled dishonestly at that?”

During the recent financial crisis, analysts frequently commented that the people who did this didn’t break any laws. They may have played fast and loose, but we can’t punish them because under our statutes, they didn’t commit a prosecutable offense. Still, fraud is fraud, and we all know it when we see it. If you rely overmuch on detailed regulations, you are going to get into trouble. You will be forced to burn books of Renaissance paintings in order to keep Hustler out of your child’s private stash.

We already know how to prevent fraud, but we have to act quickly and decisively to prevent it when it appears. By 2008, people in the banking industry could rightly claim, “Everyone is doing it.” That is actually a powerful claim, if you believe that scapegoating is not a legitimate legal strategy. Scapegoating singles people out to make an example of them. Scapegoating piles another unfairness on top of the original crime. To avoid scapegoating, prosecutors have to go after criminals early, before the crime becomes organized and established as a widespread and therefore legitimate activity. If criminal behavior does become established, prosecutors don’t have any good choices.

We know now that Wall Street firms committed fraud. I commented to people after reading The Big Short by Michael Lewis, no matter how bad you think the financial dealings that led to the crisis were, it was worse. It was a lot worse. The fraud was so massive by the time the bubble burst in 2008, no regulatory regime or legal proceeding would have done much to end it by then. The only way to end it was what actually happened: a complete collapse of the bubble. The institutional fraud ended at the same time.

A proper end to these comments would be to suggest some well crafted regulations to prevent securities fraud. I’ll demur on that. It’s a hard job, best undertaken by people who know more about banking than I do. Certainly banks themselves do not like to endure what they endured during the recent collapse. We can also be confident that bubbles will occur from time to time no matter what regulatory actions we undertake. Whatever the future brings, though, we know one more thing with certainty. If people who commit fraud not only escape punishment, but receive compensation from the public treasury, the people who paid that compensation will want to know how that could happen.

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Romney’s Foreign Policy would be Disastrous for America    November 1, 2011

Even though he continues to dwell in the “top-tier” of Republican candidates for president, former Massachusetts’s Governor Mitt Romney continues to draw the distrust of many Republicans primary voters.  Questions continue to surround his positions on the high priority conservative issues of abortion, gun control, taxes, federal spending, and socialized medicine.  Many conservatives are just not sure they can trust Romney given his previous actions and statements on these issues.

But as governor of Massachusetts, Mitt Romney has a relatively blank slate of positions when it comes to foreign policy.  However, his foreign policy appointments to his presidential campaign and recent statements he has made are more than enough to please conservative voters in the Republican Party.  As a matter of fact, they make it hard to determine if Romney is running for President of the United States or prime minister of Israel.

Take Romney’s appointment of Walid Phares to chair the Middle East and North Africa working group of his Foreign Policy and National Security Advisory Team.  Mr. Phares currently serves on the board of ACT! For America, a lobbying group that Politico described as being part of an “effort to transform anti-Islam crusading into a mainstream lobbying effort”.  He has stated that global jihad is already in progress and within a short period of time jihadists will have ten million suicide bombers ready to wreak devastation on the West.  To beat jihadists he is a strong proponent of preemptive strikes and “putting our allies’ forces on existing and new battlefields.”

The problem with Walid Phares is that he sees the world in black and white.  You are either for us or against us.  This of course has been proclaimed before and the consequences of this mentality have been disastrous for America – trillions spent on the War on Terror, two almost decade long wars, and erosion of our civil liberties.  Phares’ anti-Islam/pro-Israel positions will certainly help Romney with neoconservatives.  But, an advisor with such extreme views on Romney’s staff should raise red flags for the rest of us.  Phares’s positions would be great if he was advising a candidate for Israeli prime minister, but he is not.  He is advising Mitt Romney.

Now, if Romney’s appointment of Walid Phares isn’t bad enough, the web site Think Progress Security reports that Romney has admitted that if he becomes president he will leave his foreign policy decisions as they relate to Israel to Israel.  Specifically, when questioned by an Israeli reporter if he would consider moving the American embassy in Tel Aviv to Jerusalem Romney responded, “The actions that I will take will be actions recommended and supported by Israeli leaders. I don’t seek to take actions independent of what our allies think is best, and if Israel’s leaders thought that a move of that nature would be helpful to their efforts, then that’s something I’ll be inclined to do. But again, that’s a decision which I would look to the Israeli leadership to help guide.”

Two points need to be made.  First, Jerusalem is an incredibly sensitive issue.  Every American leader has understood that moving our embassy there was out of the question because it would lend legitimacy to Israel’s claim over that city and immediately squash any hope for a peace settlement between Jews and Arabs.

Secondly, what leader of a country would give up his authority over policy to leaders of another country?  That is called a dereliction of duty and certainly violates the confidence of American voters that their president will advocate for their interests 100 percent of the time.  Romney is running to be our president, not the de facto prime minister of Israel.
At the end of the day, Romney’s appointment of Walid Phares to his campaign staff and his comments on his policy towards Israel are indications of what we could expect from the foreign policy of a Romney Administration.  At the very least, it would be a continuation of Bush/Obama foreign policies. At the worst, it would be an escalation of those policies.  American can ill afford either.

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