Inequality – The State of the Union

President Obama has recently claimed, and reiterated in his state of the union address, that income inequality is the defining problem of our time.  Inequality is more harmful to humanity than terrorism, tyrannical governance, nuclear proliferation, disease, etc.  Yet, even if we agree with Mr. Obama the questions of why there is such inequality and how to create more income equality (assuming this is the goal) seem to be lost on the president.  In fact, Mr. Obama must know that his “solutions” to this problem have much political weight but little hope of a practical impact.

Why is there so much inequality?  Depending on who you ask, the answer is typically some version of the following: Individuals can attain higher incomes via hard work and productivity yet many others don’t have the knowledge or skills to do so, and this is the way it should be OR there is not enough income redistribution.  The U.S. is going to have wealthy people and poor people (no one disputes this), but the question is should government do more to close the gap between these two groups.  If you look at all the developed countries in the world that have more equality than the U.S., they are mainly concentrated in Europe and they all have significant redistribution programs in place.

The irony here is that in the president’s state of the union address this week, despite all the talk about working and work ethic, his solutions to inequality are impotent to actually make a difference.  What’s more, income inequality is not the same as poverty (which he seems to conflate).  Many countries have more income equality than the U.S., but overall they are much poorer.

Yet, even if the President believes we must close the gap so that incomes (he is not claiming wealth should be more equal) are more equal, will his proposals have any affect?  Raising the minimum wage will impact a tiny portion of the labor market.  Extending unemployment benefits will not even make a dent income inequality, and the modest increase in taxes on the rich proposed by the president will lower their income by a few percent.  Mr. Obama seeks to pray on zero-sum thinking.  If one person has a higher income than someone else must earn less, so it is only fair to take from those who have more and give to those who have less.  This is a fundamental economic fallacy that unfortunately many believe.  Wealth is not static, and people who earn high incomes are often creating new wealth.

Maybe the president should focus his attention on how the government can incentivize job growth and not income equalization.  It should be clear to the Obama administration, that without a job Americans have no hope in attaining a more equal income.

The Problem of Healthcare Costs

Many argue that the Affordable Care Act (often referred to as Obamacare), is better for patients.  Those who do not have healthcare will be forced to purchase health insurance.  This mandate provision in the law that requires the uninsured to purchase health coverage gives those under certain income levels a subsidy to buy their insurance, and all others will pay for their insurance out-of-pocket.

The Congressional Budget Office (CBO) recently reported that the number of Americans who will face tax penalty unless they purchase insurance is 50 percent higher than originally estimated when the bill was passed.  One of the unintended consequences of this new law is that many who must purchase health insurance (or face a penalty) are increasingly those in the middle class that President Obama promised to protect.

One question that arises is what criteria determine the best system for patients?  In any country, there will not be enough healthcare to provide all citizens unlimited care.  Healthcare is a scarce resource and must be allocated as such.  Yet, one of the most prominent problems with healthcare allocation is that costs have climbed at a much faster rate than inflation and the rapidly changing technological improvements in healthcare don’t lower costs as in most industries.  Thus, the myriad challenges with government spending and huge deficits for entitlement programs such as Medicaid and Medicare.  Costs continue to rise, and the Affordable Care Act does little to deal with this cost problem and patients suffer because they cannot afford care.

New York University economist William Baumol, recently published the book Cost Disease where he addresses this issue.  The subtitle of the book “Why Computers Get Cheaper and Health Care Doesn’t” gets right to the heart of the issue.  In it, Baumol explains this disease where in the service sector (and particularly in government) productivity tends to stagnate while costs rise over time.  In healthcare for example, it takes the same amount of time for a nurse to perform a basic task, such as bandaging a wound, today as it did 20 years ago.  So, healthcare workers’ wages rise overtime yet productivity tends to remain flat (or flatter).  Presumably then we should experience lower costs in healthcare on the capital intensive/technological side of the industry.

Why does technological advancement in healthcare fail to reduce costs?  The answer here is not that a MRI scan and a personal computer are fundamentally different in terms of their technological development, but the pricing system for these products and services is profoundly different.  It is estimated by the CBO that half of all healthcare costs are driven by advances in technology, and while patients are the primary beneficiaries of this technology third parties pay for them.  Insurance companies and government programs approve a specific payment for a particular medical procedure and this procedure becomes available at the mandated price.  The supplier now has no incentive to lower its price because there is no competitive pressure to do so, and there is little prospect of increasing sales and market position by reducing prices.

Consequently, in healthcare both the cost disease problem explained by Baumol and the third party payment system create an industry where prices rise unchecked and there is no market-based means of cost reduction.  The Affordable Care Act fails to address the most basic problem with the U.S. healthcare system, which is uncontrollable costs

Runaway Spending

Despite the rhetoric espoused by both party’s during their respective conventions, the Republicans must continually challenge Mr. Obama on the fundamental problem of unsustainable government spending.  Every time a Romney-Ryan policy is criticized, the runaway freight train of Obama spending should be part of the rebuttal.

When the Obama administration claims that the Romney-Ryan Medicare plan will harm the elderly (which is a distortion because those over 55 can keep Medicare as is), the response should be “what do you plan to do about a budget that is 1 trillion dollars in the hole this year?”  Raising taxes on the wealthy is not a viable policy option to solve this spending problem.

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As the chart above demonstrates, the trend shows government borrows approximately 45 cents of every dollar it spends.  This level of imbalance is not only unprecedented historically during peacetime, but it is a problem that more tax revenue cannot solve.  Even when considering one of the most punitive tax increase proposal by the democrats in the House of Representatives, a tax on the wealthy making $1 million or more a year (both income and capital gains tax increases) would actually raise $40 billion to $50 billion a year which is only about 3% of the annual federal deficit.  This increase in revenue is barring an absence of any negative effects on economic growth, which is no certainty when taxes are raised on those who drive economic activity.

The U.S. government has a major spending problem, and both the candidates and the American people need to start acknowledging the disastrous path we are on.

Should We Be Talking About a Flat Tax?

The economy has most certainly become the central discussion point for both the Obama and Romney campaigns during this election year.  With the addition of Congressman Paul Ryan to the Romney ticket in August, discussions of the Ryan Plan have reemerged.  Ryan has largely shied away discussing a flat tax option, although he did suggest a flat tax plan in the past, and found some merit it candidate Rick Perry’s optional flat tax plan last October.  On Tuesday, Ryan appeared on GMA where he argued with anchor George Stephanopoulos that a reduction of tax rates was necessary for economic growth.  With all the tax reform talk, it’s left me wondering if the Eastern European model of flat taxes will affect the political rhetoric before the November elections.

Since 1994, 24 countries (the bulk in Eastern Europe) have adopted a flat tax system.  This spread of the flat tax has been quite remarkable during the past 15 years, and it has contributed to the widespread economic growth throughout Eastern Europe.  Additionally, the flat tax in many of these countries has helped create a simple system of revenue collection that saves millions in implementation and collection costs.

Is the European model the ticket to U.S. financial recovery?  Let’s first consider the complexity of the U.S. tax code.  It is estimated that taxpayers and firms spend over 6 billion hours per year attempting to correctly file tax returns.  Not only does this figure represent the equivalent of millions of workers, but it also pulls billions of dollars out of more productive uses.  According to the IRS Taxpayer Advocates, who reported to Congress in 2010, the complexity of the American tax code is driven in part by the continual changes to the system as the federal government attempts to squeeze more and more out of taxpayers.  In the past decade there have been approximately 4,400 tax code changes resulting in an additional 3.8 million words to document the U.S. tax code.

It is clear that this complexity costs billions of dollars each year just for taxpayers to comply with the laws, yet it also costs the Federal government billions in tax fraud and avoidance.  Again, Eastern Europe provides a lesson here where compliance of Russian taxpayers increased by over 30% after the adoption of a flat tax system.

In addition to the massive waste of resources due to complexity, the American tax code is a drag on economic growth and progress.  U.S. households and firms make decisions with their resources that are based not on market returns but on tax sheltering and loopholes.  Foreign firms weigh the costs of locating in the U.S. based on a tax rate that is the second highest in the world.  Congress and the White House are continually using the tax code to regulate.  The tax code has become the primary means of legislation, and the continual additions and changes imposed on the tax system contribute to uncertainty and fear among firms which eventually lead to decisions that hinder economic development.

Objections to a flat tax almost always hinge on fairness rather than economic efficiency or outcomes.  A progressive tax is deemed “fair” because higher income earners pay a higher marginal tax rate, and thus any talk of a flat tax is immediately rejected by those who see unnecessary benefits to the rich.  Yet, with a flat tax the more you earn the more you pay (as with a progressive tax system) and with a true flat tax you no longer have the countless loopholes and deductions to hide behind.  A flat tax system is more “fair” by any economic measure as taxpayers do not have to spend time and resources gaming the system in order to shelter their income (a practice that certainly benefits the rich).

If America wants to move past the stagnation of the previous four years and begin to see consistent economic growth again, tax reform is necessary.  The examples in Eastern Europe demonstrate that flat tax reform is possible and can have a significant economic impact.  What these examples also show, is that strong executive leadership is a crucial component of any successful tax reform.  The Romney-Ryan ticket has a clear opportunity to set the agenda early and champion the necessary reforms to unburden American individuals and firms with an outdated, inefficient, and costly tax system.

Dr. Peter Frank is co-author of a recent study entitled “The Flat Tax: Has its Time Come?” which can be read in its entirety at www.jessehelmscenter.org.  Frank is also the Jesse Helms Free Enterprise Fellow at the Jesse Helms Center and a professor of economics at Wingate University.  You can reach him by email at PeterFrank@jessehelmscenter.org

Obamanomics or Reaganomics?

My newest op-ed was just published by WND.com.  In it, I discuss the ways in which government needs to “back out of the system” in order to stimulate real growth-much as Reagan did during his years of Presidency.  The op-ed is based on my latest Jesse Helms Fellows white paper  “Research on Reaganomics: Past Contributions and the Future of Economic Growth Policy.”

You can read the Obamanomics or Reaganomics op-ed at World Net Daily’s site or you can read it in its entirety below.

OBAMANOMICS OR REAGANOMICS?

Exclusive: Peter Frank advocates reversal
of ‘government is the solution’ mentality

Published: 12/16/2011 at 1:49 PM

http://www.wnd.com/2011/12/378229/print/

Economic growth is of primary concern for policymakers and the Obama administration as the president continues to tout policy designed at stimulating job creation. The mantra continues that in order to get the economy growing again, and move people into the labor force, government needs to spend more. A jobs bill, a stimulus package, a bridges bill, etc. – all that is needed is more government spending. Congress has all but forgotten, or so it seems, about the growing national debt with a $1.3 trillion budget gap this year alone. So the spending proposals continue. To what end? And has this solution proved effective in the last series of major economic challenges of the late 1970s and ’80s?

The Obama administration recently approved a half-billion-dollar federal loan guarantee to an electric-car company that has decided to manufacture its first line of automobiles in Finland. Is this the path to growth and continued prosperity for Americans? The problem here is not a question of intentions. Surely all legislators and the president desire to put Americans back to work. The problem resides in the basic limitations of government. There is no agency, politician, or bureaucrat that has enough information to efficiently direct resources in order to ensure a particular outcome. Decision-making by market participants informed by the specific knowledge of their complex circumstances is the only way forward. Washington lawmakers are unable to predict U.S. tax dollars fleeing to Finland and employing Finish autoworkers.

Instead of pushing spending bills and stimulus packages, instead of inciting protesters to blame American firms for all the evils in the world, the president should shift his focus to policy of which government can actually predict the beneficial outcome. Tax reform is the solution. Ronald Reagan demonstrated in the 1980s that when government gets off the backs of the people economic change will follow. Reagan pursued radical tax reform for two primary reasons: to lessen the burden of government while promoting the founding ideals of economic and political freedom, and to promote incentives that generate economic growth.

Optimal tax policy is not that which maximizes revenue to the federal government. Government has a limited function to perform, primarily a protective one, yet it is clear that for too many in Washington that the reach of government should have no bounds. Thus, when policymakers view government as the first solution to all economic problems, spending decisions are made irrespective of revenue – which leads to the massive deficits.

In addition to promoting liberty, the unprecedented tax reform ushered in by Reagan set a course for economic growth that was unparalleled in U.S. history. Cutting marginal tax rates for all wage earners and for the highest earners by 42 percent in six years, Reagan changed the incentive to work and earn and thus unleashed frenetic economic activity. This type of leadership and this scale of reform is what America needs today.

The solutions offered by the Obama administration to the economic stagnation that persists in the U.S. economy all reside in a failed ideology. Unlike during the 1980s, the belief in Washington today is that government is the solution and the real problem is tax policy that fails to generate enough revenue for the government to spend. Pulling dollars out of the market economy for government to spend on stimulating the market economy is backwards, yet this is exactly what the president is pushing for.

The time has come for politicians in Washington to pursue radical tax reform in the model of Reagan 30 years ago. Incremental changes in marginal tax rates will not provide the stimulus needed to jump start a sluggish economy, and raising rates on any level of income will only increase (albeit temporarily) the ability for government to spend more using the failed approach of “more spending” as the only solution. A complete change of the tax code will usher in a new decade of prosperity as occurred in the 1980s, but this will only happen if new leadership in Washington governs with the conviction that less government will lead to more “public” prosperity.

Markets and Uncertainty: The Uneasy Union of Policy and Free Enterprise

Coming off the heels of the vote to raise the debt ceiling, the U.S. bond rating downgrade and the market volatility that resulted, it’s a wonder investors can keep up with the constant frenetic activity happening on Wall Street.  As result of these uneasy economic times, President Obama has attempted quell jittery investors by claiming the historic strengths of the economy are still intact.  “The United States is still a AAA nation,” argues the President which appears, from the standpoint of investors, to be nothing more than a simple ploy at rhetoric to boost confidence in the market.  The problem is, all President Obama’s talk flies in the face of reality.  The market, made of the millions of daily decisions of individual investors, does not trust the actions of the President’s regime.

As a result, the Federal Reserve stepped in and tried to ease this uncertainty in the market (and lack of trust in the President’s policies) by announcing a two-year rate freeze keeping its key interest rate at near zero until 2013.  The goal: provide the market with the stability it desires in the face of Schizophrenic government policy.  Regime uncertainty is the core problem which destabilizes the market.  When market actors are uncertain in how to plan for the future; business, firms, and individual market participants pull back and act very cautiously.  They simply do not invest in any long-term projects for fear of the unknown and this includes both capital investment (machines, buildings, etc.) and labor investment (they fail to hire).  The Obama administration has firms guessing, which forces the engine of economic growth (the private sector) to take few risks and pull back.  The President’s healthcare legislation is a perfect example of policy that creates this uncertainty, and thus causes businesses to pull back for fear of how policy will impact the future.

So, has the Federal Reserve solved the problem?  Does the certainty of low interest rates provide the stability necessary for the market to flourish?  The answer to these questions is twofold; maybe in the short run but with a significant cost.  Ben Bernanke, the chairman of the Federal Reserve, appears to have a very short memory.  His decision to lock in the Feds key interest rate for two years is one that looks an awful lot like typical public policy.  That is, a focus on short-term impact with a “let’s hope for the best” in the long-run.  The policy process encourages a myopic view of the world because it is so often driven by election cycles.  Hence President Obama’s push for a “Big Deal” in the debt ceiling debate in order to get issue off the table for his 2012 Presidential campaign.

Yet, Fed policy should focus much more on the long-run.  The Federal Reserve is, in theory, insulated from the political process as the chairman serves a 14-year term.  Mr. Bernanke does not have to worry about the economic climate during the 2012 election, yet the move to lock in a two-year interest rate is bound to result in short-run stability but with a serious long-term cost.  One need not go back further than the economic boom of 2003-2007 to see the severe consequences of artificially low interest rates.  The housing bubble which burst to usher in the recent recession and economic downturn was caused in large measure by interest rates that were kept too low by the Fed.  Money was too cheap, lending standards were too generous (also a result of government policy), and economic collapse resulted.  Why does Mr. Bernanke want to put in place similar economic conditions that led to this collapse?

The answer here is the same as what has plagued the uneasy relationship between markets and government for centuries.  The belief is simple, we must do something.  The government must do something, or as Keynes argued decades ago, “In the long-run we are all dead.”  So, use any policy tools available to intervene in the market to ward off calamity.  Thus, the Americans and Europeans are scrambling to use policy in order to stabilize the market.  The reality is all these policy tools have short-run effects and huge long-run costs.  Is the Fed setting up the U.S. economy for another bubble?  It appears that this is a very real cost to the two-year interest rate lock.  Bubbles eventually burst, and when the price of money is artificially lowered an economic bust always follows.

Why Democrats Hate a Balanced Budget Amendment

My latest piece, “Why Democrats Hate a Balanced Budget Amendment” was just published at BigGovernment.com.  You can read my piece about the struggle for a Balanced Budget Amendment at their site or you can read it in its entirety below:

WHY DEMOCRATS HATE A BALANCED BUDGET AMENDMENT

By Peter Frank

http://www.breitbart.com/Big-Government/2011/07/26/Why-Democrats-Hate-a-Balanced-Budget-Amendment

With Sen. Harry Reid (D.-Nv.) leading the charge that killed the Cut, Cap and Balance Act(it apparently was the “worst piece of legislation” he’d ever seen), and a new deal to break the impasse over raising the debt ceiling looming, it’s appropriate to ask why Democrats hate the idea of a balanced budget amendment.

Americans are forced each day to live with a balanced budget – families can only spend more than their income for a short time without ultimately going into default. Firms in a private market must live with a balanced budget or they’ll quickly exit industry.

So, why do Democrats hate the idea of a balanced budget amendment? Such an amendment would force Congress to spend within its means. What’s the problem with forcing expenses and revenue to equal each other? It seems to make sense in the absence of some mechanism (like profits and losses in the private market) to incentivize a prudent use of resources, that politicians should be bound to spend within their means.

It’s not that Democrats don’t believe in fiscal discretion or think there are no consequences to amassing a massive debt for future generations to pay. President Obama has repeatedly stated that deficit reduction is a priority, and he favors a “big deal” to both raise the debt limit and reduce spending by billions. Democrats in Congress have supported these goals of working hard to reduce the deficit over the next decade. Listening to lawmakers speak about their desire to cut spending, one would expect wide-spread bipartisan support for a balanced budget amendment.

Not so fast.

The bottom line for Democrats is that a constitutional law forcing spending and revenue to equate signifies a massive loss of political power. Democrats in Congress claim that a balanced budget will devastate the economy because they will not have the ability to spend discretionary dollars whenever they see fit (i.e. when they deem it necessary for the economy). House minority whip Steny Hoyer (D.-Md.) said they he wouldn’t support it because it would “make it virtually impossible to raise revenue” (i.e. taxes). I’ll let Michelle Malkin handle the fallacies in Hoyer’s reasoning.

Democrats refuse, no matter how fiscally wise, to give up the substantial power that comes with spending taxpayer (and borrowed) dollars. The President and Congressional Democrats want to solve the deficit problem by cutting future program spending while raising the debt ceiling in order to save America from default. Imagine trying to encourage a teenager to pay off his first credit card by increasing the loan limit and telling him that in the future he’ll have to buy fewer clothes. It just doesn’t make sense.

The problem with the Democrats approach is that it fails to force future lawmakers to live within a budget and to provide any long-term incentive to align spending with revenue. The answer is a balanced budget amendment, yet Democrats are unwilling to cede their unmitigated spending power. They’d rather raise the debt ceiling to keep their power safe. The recent financial crisis and the subsequent economic downturn shows exactly how billions of dollars are spent based on congressional “insight,” with little effect.

The problem of knowing where to spend, when to spend, and how much to spend is a problem that is appears unsolvable inside the halls of the U.S. Capitol.

We can expect the many newly elected Republicans in the House to continue trying to limit the power of government (and their power to spend). Limiting power is a tough sell in Washington today, especially when Democrats are looking to swing the election victory pendulum back in their corner.