The Compliance Cost "Load"

In order for any government spending to be accretive to GDP it must produce a higher economic return than what those resources would have produced if left in the private sector. This in and of itself is a major hurdle, since government's track record on investment is dubious. But on top of that there is an additional hurdle which is seldom recognized, and that is the cost of collecting the taxes from which government spends.

Compliance costs -- that is what it costs the payer to actually pay the tax plus what it costs the government to collect it -- vary depending on the type of tax. Payroll taxes, for instance, have low compliance costs. The amounts are simple to calculate, the law is pretty straightforward and the government doesn't have to spend a lot of money auditing and enforcing the payment of taxes. Not so with the income tax. Both personal and corporate taxes are incredibly complex, which means that the payers have to spend a lot of money figuring out what they owe and making sure that they are not overpaying. The IRS, of course, spends huge sums of money auditing, enforcing and disputing tax payments. The Tax Foundation estimates that these costs top 20% of the revenue collected,  making the income tax a very inefficient revenue source (though not as inefficient as some such as the estate tax, where compliance costs are estimated to be nearly 100% of revenue collected).

This means that the real tax on the economy is more than $1.20 for every dollar that the government derives from the income tax. It's akin to a mutual fund with a very high load -- you give them a dollar, but only 80 cents gets invested. No mutual fund could overcome starting that far in the hole, and neither can the government.

Once you understand that, it becomes pretty obvious why government's investment performance is so poor. And why the more government takes out of the private sector, the lower will be overall economic growth.

Understanding Fair Share

There seems to be a lot of confusion as to what the term Fair Share means. Many people are under the mistaken impression that it is some fixed number that seems reasonable. That would be wrong. The definition of Fair Share is a percentage of the Federal income tax that is some amount higher than what is being paid today. Thus the following.

Percentage of Federal Income Tax Paid by Top 1% Earners

1979    19%  [Not Fair Share]
1989    23%  [Not Fair Share]
1999    37%  [Not Fair Share]
2009    42%  [Not Fair Share]

So for 2013, Fair Share might be, say, 45%. By 2019 it will be 50% . And so on. It's important to understand this definition. Otherwise we will continue to have fruitless arguments over what a Fair Share really is.

Cliff Notes

What are we to make of the Democrats' position on the so-called Fiscal Cliff? It boils down to: Raising taxes is a bad idea --  except on The Rich.  There are only two possibilities here:

A. Raising taxes retards growth when applied to the 98% of the population. For the other 2% it has a positive growth effect (Logically, they cannot be arguing that tax rates don't matter, else they would be seeking to raise them on 100% of the population).

B. We should be willing to sacrifice some economic growth in order to punish those who earn more the $250,000 annually.

Despite the fact that I would pay to see Nancy Pelosi and Harry Reid argue Position A in front of an Economics 101 class, I haven't noticed anyone actually advocating that theory. So, we're down to Position B. That at a time when growth has been falling every year since the "recovery" of 2009, we should pursue policies which dampen growth further -- all for the satisfaction of seeing tax rates increase for high earners. I guess we'll have to call this the "cut off your nose to spite your face" position because it surely doesn't make any sense for the US economy as a whole.

Flight of Fantasy

Yesterday when I got on a plane in Seattle we sat for a very long time at the gate. I asked one of the cabin attendants what the delay was.

She said, "Oh the pilot is having some difficulty figuring out the right control settings for the plane. He says the pilot who flew the plane into Seattle messed everything up, and he has to straighten out everything again. But don't worry, Dan will get us going soon. In fact we just voted him Pilot of the Year!"

"Well that's encouraging", I said. "He must be a very experienced pilot with a superb service record."

"Actually," said the flight attendant, "he's one of the more junior pilots, has one of the worst on-time records in the company, and burns off more fuel per passenger mile than anyone. He's had a couple near misses in the air, and one time he taxied the plane into a fuel truck."

"What?" I said. "How on earth did he get voted Pilot of the Year?"

"Oh," replied the attendant, "that's easy. He's really cool, and we all think he's somebody who really cares about people like us."

Okay, most of that is not true. The pilot's name was John. He was in his late 50s. Looked sort of nerdy. We had an smooth flight to Tucson and arrived 10 minutes ahead of schedule. But I could tell the flight attendants didn't love him. He'll never be Pilot of the Year.

The Rational Debt Voter

During the recent election run-up, I often heard some version of the following:

"We're more than $16 Trillion in debt.  How can you vote for a president who is adding a trillion dollars a year to that and, essentially, has no plan to repay the debt?"

Sounds like a rational position. But is it?

$16 Trillion is a lot of money. In fact, it so much money it's hard to imagine. So let's make the numbers easier to relate.

Imagine your family has an income of $100,000 annually.  Imagine, also, that you find yourself $500,000 in debt. Fortunately for you, your debt has a low interest rate, so you're able to just barely meet the interest payments.  But not only can't you make any principal payments, you're adding $30,000 a year in new debt.

So you go to two debt counselors -- Ron and Dan. Ron says:

Look. You have to stop spending. You can't afford to live the way you have been. Stop sending your kids to expensive schools. Stop taking vacations. Stop eating out so much. Turn in your cellphone and pull the plug on your cable TV. Stop shopping. If you really cut back, you'll at least be able to stop incurring more debt. You might even be able to pay down a little of it someday. Sure it won't be fun, but it's the responsible thing to do.

Dan says:

Look. Let's be honest. There's not a chance in hell that you're ever going to be able to repay this much debt.  The smart thing to do is to spend even more. Take on even more debt. Enjoy yourself while you can. Sure, eventually your credit will get cut off, but then you'll just tell your creditors that you can't pay them. You'll declare bankruptcy, stiff them for 20 cents on the dollar, and start all over. It's done all the time. Yes, you'll be embarrassed, but what's the better alternative? Austerity for the next ten years trying to pay back what you borrowed? Don't be the sap. Let your creditors be the saps. you deserve it.

Which counselor would you follow? Ron might be touting the moral High Road, but it sounds like a lot of work. Would it be irrational to follow Dan? Neither one is claiming that you'll ever be able to repay your debt. Why not enjoy life while you can. Vote for Dan. FORWARD!

Election Reflection

After the 2008 election, many of us felt that the electorate had been duped, mesmerized by a charlatan of hope who would, like the Wizard of Oz, ultimately have his true nature revealed. That happened exactly as predicted. What didn’t happen was the presumed reaction of the populace. We presumed they would react like Dorothy and the citizens of Oz to send the Wizard away. After all, past Wizards of the Left like George McGovern, Walter Mondale, and Mike Dukakis had been banished once their redistributionist , anti-business, anti-growth plans had been publicized. Especially in an economy as bad as ours has been over the past four years, President Obama should have been driven out decisively, as Jimmy Carter was. Shouldn’t he have?

It turns out that American has changed – fundamentally and most likely permanently. Listen to the Talking Heads, and they will tell you it’s about demographics. It’s about blacks and Hispanics. That’s not what this change is about. It’s not about ethnicity. It’s about mindset

There have always been two types of people in this world. One type wants to do things.  The other type wants to receive things. Anyone who has been a parent will tell you that they can see some of these difference at very young ages.

The first type is driven by accomplishment and respect. They are the sorts who, as children, run up to Mom and Dad saying , ”Look what I can do!” Smart parents nurture this spirit with support , but also with challenges. They reward real successes (keeping score at Little League games) and punish bad behavior. They provide allowances in exchange for chores around the house. These are the children that grow up to be independent adults. As adults these children believe that, in the words of our constitution, they have a right to pursue happiness.

The second type is driven by fear and security. They are the sorts who, as children, run up to Mom to have their boo-boos kissed and to have Dad look in the closet for monsters. They get allowances just for being children. Their parents often make excuses for failures (not keeping score at soccer games) and give out “participation ribbons”. As adults these children believe that they have a right to happiness.

There have always been these two types of people in this world. What has changed is the mix. In the past, a sort of social Darwinism prevailed. The Type Ones were rewarded both tangibly and intangibly. They got “stuff”, but only if they earned it. They received approbation, not just for being good people, but for achievement. The Type Twos were punished both tangibly and intangibly. They didn’t get much “stuff”. They were ostracized for being school drop-outs or having illegitimate children (those being the two highest correlations with not getting “stuff”).  As a result, the Type Ones tended to outnumber the Type Twos. But then we changed. Achievement is now portrayed as much a matter of luck or connections as of effort. High-level achievers are regarded with suspicion and resentment. Rather than lauding achievers, we tell them “you didn’t build that.” College students are told by our President that rather than go into the business of producing things that others want to buy, they should consider a “higher calling” in government or the arts. Behaviors that correlate negatively with success are portrayed as “choices” that are just as valid as any other choice. “Judgmental” is now a pejorative word of the first magnitude. Everyone is entitled to feel good about themselves. Everyone is entitled not to be offended. Feelings trump results. But there is an iron rule in economics: That which you subsidize, you will get more of. As a result, Type Twos now outnumber the Type Ones

The Talking Heads tell us that the Type Twos believe that “the system” is stacked against them. It’s not for the most part. What is stacked against them is reality. They desire a shield from reality, and they look to governemnt to provide it for them.

Reality says that economic resources are scarce; that choosing more of something means getting less of something else. Shielders say that unpopular limitations can be removed by legislation that simply declares a “right” to get things.

Reality says that borrowing money for projects that don’t produce cash flow leads to bankruptcy. Shielders say that if a project has a worthy goal, the cash flow can be ignored.

Reality says that diverting resources from high-return activities to  low return activities will results in a lower rate of growth for your portfolio. Shielders say growth will just happen anyway.

Reality says that not finishing school and having children without marriage is highly correlated with being poor. Shielders say you should not be unduly punished for those choices.

Reality says that income is determined largely by how valuable your work is to customers and employers. Shielders say that your income should be determined by “comparable worth standards”.  A degree in women’s studies should be just as valuable as a degree in computer science.

Reality says that when technology expands the accessible global labor supply, wages will fall. Shielders say that they can prevent that through trade protections.

Reality says that if you increase the cost of hiring people (e.g. by mandating more costly benefits), employers will find ways to employ fewer people. Shielders say that they will simply increase unemployment benefits, food stamps and “disability” eligibility.

Reality says that structuring retirement plans so that benefits are paid by the contributions of new participants rather than from invested earnings creates unsustainable Ponzi schemes. Shielders say that they will simply extract more and more money from new participants.

Reality says that the essence of producing wealth is risk taking. Shielders say that they can produce wealth by protecting you from risk.

For most of American history work was highly valued in itself. You were expected to prioritize it over your personal and family life . Parents made sacrifices so that their children would have better lives than they did. You didn’t get paid if you didn’t work. Work was a moral understanding. Enter the “Millenials” (people in their 20s and 30s today).  They are willing to trade higher pay for less overtime, flexible schedules and a better work/life balance. The idea of “paid leave” becomes an entitlement. Work is expected to be “meaningful”, not simply remunerative. They believe that employers should seek to meet their needs as much as the needs of their customers. They judge a leader less by his accomplishments than by how much he “cares about people like me.”

At least half of our populace would read these observations and say, “Yes, and I think these changes are for the best. Isn’t shielding people from risk a good thing? Isn’t paying people who can’t or won’t work a compassionate thing to do? Shouldn’t people be entitled to choose a lifestyle that feels right to them without penalty? Why should some people have so much more “stuff” than others?” In the abstract, some of these things do sound appealing, but we do not live in the abstract. In the abstract "turn the other cheek" is an appealing outlook. In the real world, it may land you in the hospital. The very definition of a Utopian is “someone advocating an impractical scheme for social improvement.”

In the real world of economics, when you tax and stifle activities that create wealth while subsidizing and lauding behaviors that consume wealth, you end up with less wealth. We have chosen an economic path in which a decreasing number of productive, self-sufficient wealth-creators are expected to provide more and more things for the majority. In the abstract this produces a bright new world of "fairness". In the real world, it produces a much darker world of stagnation. America will not founder because Obama was reelected. Obama was reelected because America has already set a course for the shoals.