Bastiat’s Bastions

In 1944, an Austrian economist, Frederick Hayek wrote the book, The Road to Serfdom. His book was later shortened and released by Reader’s Digest, and even came out in comic book format and distributed by General Motors. Hayek dedicated his book to socialists of all parties. The central idea of the book is that socialism or collectivism has the same result, whether it is the sort we see in the old Soviet Union and China, and now in North Korea and Cuba, or Fascism of the sort we have seen in Hitler’s Nazi Germany, Il Duce’s Fascist Italy. Hayek’s thesis was that collectivism leads down the same road to tyrannical dictatorships by tyrannical dictators, and he has a very intriguing chapter on “why the worst get on top” in socialism. That very same road, of socialism or collectivism, whether the communist or fascist variety, where people surrender their freedom for the good of the country or the good of the universe, and fall under the spell of the idea that somehow something can be good for the country without being good for any particular person in that country.

Hayek put Fascism and the Naziism in the same category of the Marxism of the Russians, incensing political leaders and academicians in the U.S. as well as with our allies.

Why? The Russians were our allies and the Nazis our enemies. Also, many academicians, even academic economists, were taken in by the ideas of the Marxists. Their societies could not possibly be two sides of the same coin. Or could they?

Well, as my title suggests, we are not only on a road to serfdom, but we are speeding down it as fast as we can go, with little to slow us down.

It is not just that we are about to elect a radical left progressive to the White House. It is also not that both houses of our legislature are also going to have heavy progressive majorities.

No, we are not about to get on the autobahn to serfdom, we have been traveling on it awhile. Certainly policies passed under FDR’s New Deal got us on that road. And that was about the time that the real Autobahn in Germany was being built. It was started before Hitler came to power, but much progress was made on the roads under Herr Hitler, and much of it, fittingly, with slave labor.

The lanes widened with LBJ’s “War on Poverty,” a war that we should all agree did nothing to alleviate poverty, but perhaps only entrenched it and made it more durable, more systemic.

The highway was then super-sized, going from four to eight lanes, and all headed in the same direction, with banking of the curves added to keep us from crashing, but only encouraging us to go faster still. This was accomplished this past month with Bush’s gigantic bailouts with equity positions taken in banks worldwide.

Here are a few signposts along this “Autobahn to Serfdom:”

1. Abolition of property in land and application of all rents of land to public purposes.
2. A heavy progressive or graduated income tax.
3. Abolition of all rights of inheritance.
4. Confiscation of the property of all emigrants and rebels.
5. Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.
6. Centralization of the means of communication and transport in the hands of the state.

Notice that # 5 was pretty much taken care of in the U.S. and abroad with the giant bailouts. Both #2 and #3 seem to be well on their way with the next president and the next congress. You should note that these signposts are taken from Marx’s own Communist Manifesto.

Zoom, zoom, zoom!

-MC

In the now-famous incident where “Joe the Plumber” questioned presidential candidate, Barack Obama, over his intentions to raise taxes on individuals earning more than $250,000 per year, Obama said “when you spread the wealth around, it’s good for everybody.” So, what is wrong with that, what is wrong with taking from some to give to others? Let me count the ways that wholesale redistribution should be cause for concern:

1. If the government has the right and ability to take from the rich to give to the poor, or from someone you don’t favor to give to someone you do favor, it also can take from those you do like to give to those you do not.
2. Reducing the incomes of the rich in order to increase the incomes of the poor reduce incentives to save, to invest in further education and to work hard. Certainly, our forefathers saw this in Plymouth when the Pilgrims came to this land. Great harvests, for which our first Thanksgiving was celebrated, came on the heels of starvation. What made the difference? Private property in farm land that gave families an incentive to work on their own lands, and to feed their own families. When everyone shared equally in the harvests, incentives were so weakened that they barely were able to survive. See this 2006 post I penned with my student, Amanda Walker, on Thanksgiving.
3. The third way is one that people often do not see, which is that resources that could be very productive elsewhere suddenly get devoted to fighting to come out winners in redistributive efforts, while other resources fight to keep from becoming losers in the redistribution game. A good indication as to what awaits in the fight over funds to be redistributed can be seen now in the current lobbying competition for the bailout funds in Washington. This wasting of resources in non-productive fights over who gets what and who has to pay is what economists have termed “rent seeking,” the competition for goodies out of someone else’s pockets. Take a look at this article to get an idea of where we are headed. Lobbying is an expensive undertaking and is done by very talented individuals. These resources just tend to cancel each other out instead of producing anything of value. And when resources are diverted from productive activities to non-productive activities, our economy underperforms and grows at a slower rate.

Now both points 2 and 3 tell us that economic growth will be slower with substantial redistribution than without it. Now suppose that economic growth over the next 100 years would be 5% without redistribution, but a whole percentage point less, 4%, with it. Think of someone putting aside $1500 a year each of those years, say by making contributions to an IRA. Of course, somewhere in there money passes from generation to generation, but let us suppose that funds are added at the same amount year after year. At the slower rate, the sum grows to a whopping $1.93 million after those 100 years, but at just 1% faster rate of growth, the sum grows to $4.1 million in that same time period. That more than twice the wealth can support more than twice the annual income flow from that wealth. Even with a substantially wider distribution of wealth, the higher rate of growth allows much more to be done in the economy for those at the bottom.

But perhaps the best illustration of mass redistribution to equalize outcomes is from that master story teller, Kurt Vonnegut, in “Harrison Bergeron.”

Be sure to read these few pages by Vonnegut as he portrays a future society that has equalized society in the only way it can truly do this, by handicapping the very talented and the very bright, by bringing everyone down to the same low level. Notice that everyone is made worse off as a result, as even entertainment is reduced to a low level. Spreading wealth around not only fails to make everyone better off, it makes very many of us worse off.

-MC

…Then, the finances.

When I tell someone that I fear the U.S. is going to be completely transformed into a socialist economy, two of the most common responses I get are: (1) No way; and (2) There’s nothing wrong with that. Notwithstanding the validity of the second response, there is mounting evidence that “no way” is completely wrong.

To begin, there is the potential Obama/Bush Treasury/Federal Reserve set of issues. Then, there’s this lovely story (via Best of the Web Today), where we learn of “A plan by Teresa Ghilarducci, professor of economic-policy analysis at the New School for Social Research in New York.”

Ghilarducci actually testified about her plan last week, on Capitol Hill, though I don’t recall her (apparently well-received) testimony making the evening news.

What is the crux of her plan?

…all workers would receive a $600 annual inflation-adjusted subsidy from the U.S. government but would be required to invest 5 percent of their pay into a guaranteed retirement account administered by the Social Security Administration. The money in turn would be invested in special government bonds that would pay 3 percent a year, adjusted for inflation. The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated.

We can call this by any name that we like, but it does not change the end result of the plan: the government will take over private retirement accounts. But why only 3 percent? With the rates the Feds are charging AIG, surely they can do better than 3 percent. I almost wish I didn’t believe this was happening.

NM

My recent post noted that many low-income workers do not need additional tax credits to offset Social Security taxes because of the Earned Income Tax Credit. This afternoon, I was reminded of a related conversation I had with a former president of the National Tax Association (NTA).

The NTA person (I don’t want to name names) let me know that he was tired of “conservatives” saying that low-income people don’t pay taxes. In fact, he let me know, poor people pay social security taxes and sales taxes, both of which are highly regressive. Well, I’ve already posted on one problem with this logic (the EITC). Still there are others.

For one, it turns out that many people do not pay state and/or local sales taxes on food and “necessities,” the definition of which depends on where one lives. These data are very difficult to pin down because so many municipalities have so many different rules. However, there are several papers at the Tax Foundation that provide a good summary.

Beyond that, the claim that Social Security taxes are regressive is simply a farce. The goal of the Social Security program is to provide a safety net for retirement (call it a pension, if you must). More importantly, the system works by providing retirees with benefits based on what they put in.
In other words, if you work more, you pay more in, but you’re eligible for more when you retire.

On the flip side, if you work less, you pay less in, and end up with lower benefits at retirement…precisely because you didn’t work as much. The only way this can be considered a regressive tax is if you believe (a) Social Security is not a retirement program at all; and, (b) people who work more (and thus pay higher payroll taxes) should have their benefits reduced. I can think of a few words for part b.

NM

In today’s Wall Street Journal, William McGurn does an excellent job describing why it is impossible for Obama (or anyone else) to give an income tax cut to 95 percent of Americans. Why? Because approximately 40 percent of Americans don’t pay income taxes.

McGurn writes:

In most parts of America, getting money back on taxes you haven’t paid sounds a lot like welfare. Ah, say the Obama people, you forget: Even those who pay no income taxes pay payroll taxes for Social Security. Under the Obama plan, they say, these Americans would get an income tax credit up to $500 based on what they are paying into Social Security.

McGurn does a very nice job of debunking the notion that, as Obama’s camp suggests, the tax credit won’t really be a payroll tax cut. Still, McGurn misses a larger point called the Earned Income Tax Credit (EITC).

Many low income families qualify for the EITC, which was originally designed to offset some of their payroll taxes. Naturally, the EITC has been expanded through the years. For at least the last seven years, EITC payments more than offset low-income workers’ payroll taxes.
The exact amount of the credit depends on martial status, the amount of income earned, and the number of children in the family.

Here’s an example (using numbers from a couple of years ago):

Single with no children, earning $15,400
- .0765 payroll tax = 1,178; EITC = $2,747
- Federal income tax = $613
- Net Credit: $956

Married with one child, earning $16,849 in wages
- .0765 payroll tax = 1,289; EITC = $2,747
- Federal income tax = $0 (may even get an additional “refund”)
- Net Credit: $2,747 (at least)

Granted, someone in either of these two situations probably is not having an easy time of things, but that is not the point. The point is simply that our tax system already has the type of credits Obama’s plan is calling for and then some. All the more frightening that Obama is quoted as saying: “We’re not going to solve Social Security and Medicare unless we understand the rest of our tax policies.”

NM

In case you haven’t heard, Sen. Clinton and Sen. McCain have each advocated cutting the federal highway-use tax on gasoline from Memorial Day to Labor Day to save drivers (rather, voters) a whole 18.4 cents per gallon, which amounts to about 5% of what they spend on gasoline. Senator McCain suggests making up the difference in the federal highway infrastructure fund with money from the federal government’s general fund, adding about $10 billion to our already blossoming federal deficit. Sen. Clinton, along with Sen. Obama have advocated placing a windfall profits tax on the oil companies . Obama, it should be noted, has opposed the Clinton-McCain gas tax holiday.

Some opponents of the tax holiday (New York Times Blog and Wall Street Journal) have countered that the short-term tax break would not affect prices that consumers pay, and these opponents are correct. Think about the underlying downward-sloping demand and somewhat upward-sloping supply of gasoline. The short-term upward-sloping supply of gasoline, during the summer months, becomes vertical, as the refineries in the U.S. are all operating at their maximum output levels. With a completely inelastic supply of gasoline, all of any tax falls on the suppliers, but all of any tax-cut is enjoyed by the suppliers. If the price to buyers were to decrease at all from their present levels, the quantity demanded would increase as buyers respond to lower prices by buying more, which we know from the law of demand. But with no more units able to be supplied by refiners, there would be a shortage which would push the price up, back up to its original level. This would save nothing for tax payers over the summer and would cut highway infrastructure moneys, money that could build new bridges, like the ones we see we could use after the Minneapolis bridge disaster last year.

A similar disaster for the millions of drivers would occur with Clinton and Obama’s windfall profits tax on oil. The Carter windfall-profits tax amounted to little more than an excise tax on gasoline from domestic oil, raising gas prices for consumers, cutting the profits on domestic oil, cutting domestic production, and raising reliance on foreign oil. Even if a tax were devised that taxed just profits, which is not what happened with the 1980 windfall profits tax under Jimmy Carter, the long-run results of such a tax would be to make refineries less profitable, reducing long-run supply from what it would have been otherwise, and raising the price of gasoline at the pumps from what it would have been. The Obama plan would put a tax on every barrel of oil that sold at a price higher than $80, which would mostly just get passed along to consumers, who have a very inelastic demand for oil, while oil companies could easily sell their oil outside of the US without the tax (elastic supply of oil to the US), reducing the amount of oil supplied in the US and increasing the prices at the pumps for consumers.

But this increase in prices because of the tax is something that consumers never see, never seem to notice, and blame the higher prices on the oil companies, and not on the federal government, just as the high prices from the lack of investment in new refineries is blamed on the oil companies instead of the myriad of federal and state regulations, such as the needed, but ill-designed air pollution regulations.

What Clinton and McCain want is a reduction in gas prices now, but their tax-holiday idea, while popular, would completely fail to do what taxpayer/voters want it to do, cut prices at the pump. What it will do is make them relatively more popular than Obama, from what they would have been otherwise (economists say, “ceteris paribus”), because voters hear the speech and believe what their candidate tells them. All Clinton and Obama’s windfall profits tax would do is to raise prices on gasoline, as a tax would tend to fall on consumers who have a relatively inelastic demand for gasoline, instead of on owners of oil companies, the stockholders of oil companies. Stockholders have many options in the long run and will divert their funds away from oil companies if these companies are forced to pay a profits tax. Cutting supply raises price. Cutting supply to a good that has an inelastic price raises price a lot.

Clinton says she is “reluctant to throw her lot in with economists.” I’m even reluctant to throw my lot in with politicians. While corporations that lie in their ads and promotions can be convicted for fraud, it seems that fraud does not apply to politicians vying for our votes.

Two lessons. One, people trying to get elected are to be believed about as much as those emails from the dying wife of the Nigerian Oil Minister who wants to make you rich. The other lesson is that what we have been talking about in class with burdens of taxes and elasticities was to help understand real proposals, and to help us detect BS before we down in it face first.

And here is a little update–other economists weigh in here.

-MC

Big government advocates assert that democratic choice is somehow to be preferred to choices made through market processes. The idea is usually that people in markets act selfishly and have little information and are swayed too easily by advertising dollars, but when those same people get behind the curtain of the voting booth, they are somehow smarter. A lesson comes from Oregon. After his election to the governor’s mansion, Oregon’s Gov. Ted Kulongoski was sure to make some statement about the “people having spoken.” Those same voters, when they voted down a cigarette tax increase to fund children’s health insurance that Kulongoski backed, have suddenly become dullards whose votes can be easily bought by the tobacco lobby. If a tax increase does get passed in Oregon, it will only be the voters coming to their senses. Then, the “right decision” will have been made–because it agrees with the big government advocates. Here is my question: If the votes of the people are to be distrusted, and seen as being manipulatable by special interests when pet projects are voted down, how is it that those same voters suddenly become all wise, all knowing and altrusitic when they vote on how tax dollars are to be spent?

-MC

Here is my offering along the lines of my class’s recent essay assignment.  The main assignment was to write an essay, much like my blog posts here, commenting on some news item using analysis we have developed in class.   

As you know, Congress has offered subsidies for ethanol production, in an attempt to become less reliant on foreign sources of energy.  Those subsidies, along with high gasoline prices, have caused the price of corn (the main crop used for ethanol)  to shoot up.  This article from USA Today (that appeared in the Arizona Republic) conveys one of the most unfortunate, and I would add, disastrous, side effects of high corn prices.   

With higher corn prices, the opportunity costs of growing other grain crops have gone up.  One of the crops that farmers have found easy to switch away from in order to grow corn has been barley.  This may not sound too bad if you are only thinking about putting barley in a soup.  However, think about what the biggest use of barley happens to be—making barley malt, the main ingredient in beer.  As a result, beer prices are expected to rise about 9% or so. 

In early English (and Scottish) folksongs and the poetry of Robert Burns, John Barleycorn is the personification of this great grain, a grain, after malting, that is used to make both beer and Scotch.  In fact the rock band, Traffic, title one of their albums and songs, “John Barleycorn must die” (you can see and hear Traffic perform the song on Youtube). See this article about John Barleycorn in Wikipedia.

In the songs, various people, especially those with addictions to drink, do their best to kill John Barleycorn.  In many versions of the song, people do indeed kill John Barleycorn.  However, Barelycorn comes back from the grave to get his revenge for those who mistreated him.

And Ahmadinejad thinks he is having trouble with riots over gasoline rationing!

–MC

People have attacked Bush’s tax cuts as tax cuts for the rich. Many people seem to believe that the government helps the rich and disregards the poor. The notion is that some people think that the rich pay too little in taxes and not enough help is given to the poor. The questions of “how much is enough help for the poor?” and how much of the incomes of the rich to be paid in taxes is enough?” never seem to be answered, though. Of course, we should all see that these are just normative questions, questions which cannot be answered objectively.

Often, people have looked at the question what proportion people’s incomes go to taxes and whether that proportion tends to go up or down as incomes go up. The idea is that people with higher incomes “should” (that’s a normative “should”) pay more, and pay a larger share of their incomes, than poorer individuals, an idea sometimes referred to as the “ability to pay” principle of taxation. If we tax a good, say by $1.00 per unit of the good, and that good has an income elasticity equal to one, the percent of the average person’s income going to pay that tax would stay constant as the incomes rose. This is termed a “proportional tax.”

If the income elasticity of demand is greater than one for some good that is taxed, the proportion of incomes going pay that tax increases as incomes go up. A tax on such a good is termed “progressive” and clearly meets the “ability to pay” principle. Luxury goods are generally considered to be those with income elasticities greater than one, and so a luxury good tax seems to meet this “ability to pay” principle. We have be careful about this, because sometimes such taxes affect the sellers more than the buyers because the sellers have a lower elasticity of supply than the buyers’ elasticity of demand. In these cases, we would be concerned about the workers in the luxury good market. And of course, if the income elasticity of demand on some taxed good is less than one, the proportion of the average person’s income going to pay the tax goes down as income goes up. Such a tax is considered to be a “regressive” tax, and clearly violates that “ability to pay” principle.

What we should really be doing though, is instead of looking at taxes in isolation, is looking at the spending that taxes finance and see if the net effect of the taxes and the spending is proportional, progressive or regressive. For instance, what if we taxed the poor a bit more than the rich, but, in the meantime, used those taxes to pay for goods and services that would be extremely beneficial to the poor, such as Head-Start programs?

That is exactly what is done in a newly released study from the Tax Foundation. That site gives an overview of the study, but the entire report can be downloaded from the site. This study is one of several that has looked at both government spending to benefit those in certain income groups and the taxes paid by people in those income categories, together. The study boils things down to a few easy to understand numbers. The study asks the question, “for each dollar paid to government in taxes, how much do people get back?” Alternatively, we can see this as the price of government spending for one’s benefit? The poor get over $8 for each dollar in taxes they pay, while those in the top 20% of incomes get back $0.41 and those in the middle group get $1.30. Based on these levels of benefits for each dollar paid in taxes, is it any wonder that the poor generally vote for more taxes and spending while the rich tend to vote the opposite way? With those in the middle group getting more in benefits than they pay in taxes, why doesn’t the size of government grow at even a higher rate than it has?

MC

Read this article from cnn.com. In the article, the head of the Food and Drug Administration comments on whether the FDA should regulate the amount of nicotine in cigarettes.

In a rare, sensible act from the head of the FDA, he suggests that the FDA should not regulate the amount of nicotine. What is this? A regulator saying he wants fewer things to regulate? This is indeed a very rare breath of fresh air.

The head of the FDA has the following claim – if the amount of nicotine was reduced in a cigarette, consumers would simply respond by smoking more cigarettes. Sounds right to me.

But let’s take a stroll down memory lane. Over the years, taxes on cigarettes have increased substantially. As with any tax, consumers and producers look for means to avoid the tax. If the tax on cigarettes was imposed by the pack, several options come to mind to implicitly avoid the tax. Producers of cigarettes could increase the number of cigarettes per pack (say to 50 instead of 20), increase the length of a cigarette, or, drum roll, increase the amount of nicotine (the active ingredient) in a cigarette. My students should be having flashbacks to alcohol prohibition and drugs.

Federal legislation explicitly prohibits cigarette manufacturers from increasing the number of cigarettes per pack, and the long cigarette was a flop as well. What does that leave to avoid the tax? Increasing the nicotine content of cigarettes. Over time then, the increased nicotine content of cigarettes is largely a direct result of government policy!

Back to the present day… nicotine is the active ingredient in cigarettes. A reduction in the amount of nicotine allowed in a cigarette is essentially an increase in taxes on cigarettes – or better still an increase in the taxes on nicotine. Why? Even though the tax is imposed per pack, what consumers are interested is in the tax per unit of nicotine. If there were 10 units of nicotine in a pack and the tax is $1 per pack, then the tax on nicotine is $0.10 per unit. If they reduce the amount of nicotine allowed in half, to say 5 units (and the size of a pack and cigarette stay the same, as does the tax per pack), then the tax of nicotine becomes $0.20 per unit. Another way to think of this is that you have to buy two packs to get the same amount of nicotine as before.

Now the problem has just been reduced down to the simple fact that limiting the amount of nicotine in a cigarette is just an increase in the tax on smokes. The price consumers pay will increase, the amount of nicotine consumption decreases (even though people would smoke more packs), and Uncle Sam collects some more tax revenue. As the demand for nicotine is inelastic, people end up spending more on nicotine.

Should we do it? A good thing will be that there will be a small reduction in nicotine consumption and some more tax revenue. The bad things will be that we are again taxing cigarette smokers, a tax which falls disproportionately on the poor. A second side effect is that there would be more overall smoking, and that means more inhalation of all of those other items that cause cancer in cigarettes.

My stance “ hurray for the FDA!

–CT