Nine Growth Policies to Improve the US Fiscal and Economic Health
June 10, 2010
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[Note: This article will be posted to my Upward Society Blog in the upcoming days, but I decided to post the text-only version here first.]
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"Nine Growth Policies to Improve US Fiscal and Economic Health"
Sovereign default! Zimbabwe! Weimar Germany! Hyperinflation!
I have seen way too much of the above terms in the past two years. There is a growing belief that the US is on an unsustainable fiscal path and the only end result that can possibly occur is Zimbabwe-like hyperinflation. Not only is this wrong, but it’s so wrong, that we’ll look back on it in 20 years and view it in the same vein as the apocalyptic predictions on Y2K.
Don’t get me wrong --- the US does have too large of a debt-load relative to its GDP. Moreover, the US government desperately needs to reduce defense and entitlement spending. I’d even go so far as advocating phasing out Social Security. These sorts of spending cuts would help balance the US budget and lower our long-term liabilities, but people are ignoring an even better way to lower our debt load:
GROWTH!
And while growth is technically a 6-letter word, you’d think it only had 4 letters given the political aversion to mentioning it. People too often forget that if you lower the deficit, but GDP growth falls, debt-to-GDP could still be rising. On the other hand, if the deficit stays flat, while GDP improves, then debt-to-GDP is falling.
Right now, more than anything, the American public needs to focus on growth. Yet, I’ve seen very few realistic ideas on how to achieve it thrown around. In fact, I see more and more political policies discussed that have the potential to decrease long-term GDP growth.
So here are 9 policy ideas that would allow the US to increase long-term growth potential. Some might be controversial, but they would achieve the ultimate objective of sustainable growth:
(1) Legalize, regulate, and tax marijuana ---
This might seem like an odd idea on how to achieve growth, but it makes a whole lot of sense when you understand the economics behind marijuana prohibition. By making marijuana illegal in the United States, we’ve essentially created an entire underground economy for it, just as we did with alcohol after the passage of the 18th Amendment.
Think of all the consequences of this marijuana criminalization:
(a) Government revenues are decreased because no income is generated for taxation purposes;
(b) Government expenditures are increased because more law enforcement is needed to enforce the laws and more prisons must be created and maintained to house prisoners. Prisoners generate very little real income and become government-dependents. Moreover, being a prisoner limits one’s future income-earning potential;
(c) Crime is increased, which drags down the economic health of neighborhoods associated with the drug trade;
(d) Potential government revenue is destroyed, because the government can not tax marijuana in the same way it taxes cigarette or alcohol sales;
Even after all these negative economic currents, the problem is still not solved. While cigarette usage has declined dramatically over the past few decades in the U.S., there is no similar decline in drug usage.
In general, the “Drug War” is an extremely unprofitable activity for the US government and it harms potential GDP, without actually addressing any of the underlying problems behind drug usage. Legalizing, regulating, and taxing marijuana would be a great first step to solving our problems and it would dramatically reduce the burden on taxpayers. Call it the “low-hanging fruit”, if you will.
There is already a bill in California legislature to legalize marijuana and it is estimated that this action will boost state revenues by $1.3 billion per year and possibly reduce costs by as much as $1 billion. That’s not a bad return on investment for an act that would basically harm us in no way and would change very little, other than to move one cash crop from the underground economy back to the mainstream economy.
(2) Build a high-speed rail network; allow private companies to bid on rights ---
We’ve heard a lot of talk in recent years about the importance of high-speed rail and how America has fallen behind on this. Even China seems to be worlds ahead of the US, when it comes to building a high speed rail network. Why aren’t we doing more?
The answer to that question is complicated. To build a high-speed rail network, the US and state governments will probably have to become involved. This isn’t like developing a major medical technology or advances in computing --- you have to deal with politicians, who endlessly bicker over just about everything and don’t like handing out funds.
The private sector is much better at innovation, but the private passenger rail in America was destroyed from about the 1920s to the 1970s by extremely flawed public policies (including over-taxation). Moreover, the private sector now lacks the resources to obtain the land necessary to build a national or even statewide high-speed rail network.
So what’s left? The best solution would be for the US Federal government or various state governments to start a process of consulting with business leaders, developing a blueprint, acquire the land necessary, and start building the tracks. Then, the rights to the tracks are merely leased out to passenger rail companies that would be able to bid on the rights. The US government could also sell off Amtrak, while it’s at it.
This would create a recurring governmental revenue source (i.e. rent), while allowing our transportation system to be dramatically improved. Transportation is the key to a well-functioning economy and much of America’s current prosperity goes back to the Eisenhower Administration’s decision to create a national interstate highway network. Building a high-speed rail network would expand American travel options and improve growth over the long-haul, especially as oil prices continue to rise. If done right, it also creates a revenue source for the government.
(3) Stop raising taxes ---
Many people might tell you that John Maynard Keynes would support increased government spending right now. This is possible, but simplifying Keynes in this manner overlooks a lot of his economic views. It is likely that Keynes would believe that increasing aggregate demand right now is important.
Increasing aggregate demand could be achieved through higher government spending, but it could also be achieved via lower taxes. Given that our economy has become centered around increasing innovation and the government sector is very ill-equipped to create this type of growth, the latter plan (lowering taxes) seems to make vastly more sense to me than the former.
At the very least, we should realize that increasing spending and increasing taxes achieves no net positive gain, since we are simply shifting production over to the government sector and taxing people at higher levels to sustain it. As more capital is shifted out of the private sector’s hands, less capital will be available to fund start-ups. This means less innovation in the American economy. That will result in lower GDP and lesser efficiency in the long-term since the government tends to be less efficient than the private sector, particularly when it comes to innovation.
(4) Eliminate oil industry subsidies ---
Too often overlooked in America’s energy woes is the fact that the oil industry is heavily subsidized. You can see this in the $10 million liability cap for offshore drilling, which is incredulous on many levels with the current fiasco in the Gulf. Not only do these subsidies cost the US government significantly in the long-run, they also decrease economic efficiency and help deter more innovative solutions from emerging. It’s true that eliminating subsidies will increase price-tags for consumers, but it’s not as if we’re not paying the costs anyway; they simply shift over to our taxes.
(5) Repeal Section 404 of Sarbanes-Oxley ---
Personally, I have mixed views on Sarbanes-Oxley. Some would say it’s a disaster. Some say it’s a big success that has been absolutely vital. I’m in between. I can see how it has helped create more accountability and transparency; it has also been very beneficial to investors. At the same time, it has significantly increased costs for many smaller companies and created huge hurdles to becoming publicly-traded. This results in higher capital costs. This reduces innovation and lowers long-term GDP.
There is one provision of Sarbox (as it’s called by us accountants) that absolutely needs to be thrown out the window --- Section 404. Section 404 requires companies to hire an external auditor to determine the adequacy of internal controls. This practice does yield useful information for investors, but it comes at an extremely heavy cost to small companies.
It would be more beneficial to either outright repeal Section 404, or to permanently change the requirements of it, so that it only applies to large-cap companies, where the fixed cost of conducting such a review does not significantly diminish profitability.
(6) Find ways to reduce or eliminate big-city income taxes ---
If there’s one thing that drives me crazy, it’s high big-city income taxes. You can find them in places like New York City, Philadelphia, and Washington DC. DC was even debating increasing those taxes very recently. My reasons for disliking these high taxes are a bit different from most, however.
High inner-city taxes drive people out of the cities and into the suburbs. This creates more sprawl, which reduces economic efficiency. Moreover, it requires more oil, more energy, and more overall pollution to sustain the resulting demographic shift.
While big cities might perceive these high income taxes as being in their best interests, in reality, it’s just the opposite. By driving out the wealthiest people from the city, they are decreasing their overall tax base. Moreover, they are preventing further development that would increase the population and thus, increase city revenues.
As an example, last Saturday, I was walking around in Washington DC near the Washington Convention Center. This is a beautiful area that should theoretically be a prime spot for development. And yet, I see this urban blight right in front of me. Eventually, some developer will come along and build there, but imagine how much more quickly this process would occur if DC had a 5.75% income tax rather than an 8.5% income tax. That would put it on par with nearby northern Virginia and Maryland.
You might think a 2% - 3% tax difference isn’t a huge deal --- and it might not be if you make $20,000. In that case, you are probably exempt from paying income taxes on a certain amount of income and you might pay $200 - $300 more on the rest of it. The benefits of being in the city would probably outweigh the higher taxes. That math radically changes if you make $1 million per year and you’re paying $20,000 - $30,000 per year for the luxury of living in the city. You could pay someone a salary with that kind of dough!
Washington DC is one of the highest in-demand population centers in the nation --- the fact that so much of its theoretically prime real estate is still in the dumps is a testament to the negative affects of high city/state taxation. If anything, DC should be thinking of every way possible to lower their tax burden and attract businesses and people into Anacostia and other economically depressed areas. Other cities should be doing the same. Cut costs, lower income taxes, and reap the rewards of a wealthier and more sizable tax base.
(7) Create expanded mass transit networks; allow private companies to bid on rights
Déjà vu! This sounds exactly like #2 and indeed, it is very similar. I’ve been on the fence as to whether public or privately managed mass transit would be more efficient. The more I see inter-state struggles as I do here in the DC Metro area (between DC, VA, and MD), the more I start to believe that mass transit would do much better if states simply built the infrastructure and then sold off the rights as a continual revenue source. The states would have an incentive to do this since it would create revenue. These mass transit companies could be regulated similarly to utilities --- moreover, unlike electric utilities, they would have competition, since we already have an extensive road network.
My biggest problem with the nature of American public transit is that it seems like it’s almost impossible to find the necessary funds to pay for capital expenditures. As a result, they end up extremely underdeveloped, with DC being a classic case. Metro ridership is at record highs in spite of having the nation’s most exorbitant fees.
(8) Don’t go overboard on banking reforms; they cut credit and lower GDP ---
As politicians desperately try to find ways to fix the problems that created our economic crisis, they seem to be overlooking the fact that they can easily exacerbate by the problems by going overboard. The Institute of International Finance has concluded that proposed banking regulations could cut GDP by 3.1% in the US, Europe, and Japan.
Regulators are proposing higher capital requirements in many cases. While higher capital levels are undoubtedly needed by many banks, there might be better ways to deal with the problem. A lot of problems in the US could be solved if FDIC is allowed to pursue disproportionately high bank fees for Too-Big-To-Fail (TBTF) institutions and those that take on excessive credit risk. This will create a market mechanism that will help fix the problems, without undermining the basic structure of our commercial banking system.
The FDIC is highly beneficial to Americans, as it has eliminated the former time-honored tradition of massive bank runs during a credit crisis. But it does provide a public backstop to very large banks with excessive risk profiles, so the fee structure should reflect this more. Either way, we should be careful to not start enacting hard-and-fast banking rules that dramatically curtail credit and lower GDP.
(9) Redesign inner-city property tax schemes ---I might sound like a broken record at this point, but a lot of our economic efficiency (and inner city woes) have been created by poor economic policies that ignore the realities of wealth. The American cities were alive and well in the early 20th Century; many of them slowly withered in the latter half of the century, only to regain some steam in the 21st Century. This trend probably would’ve occurred without poor public policies, but even if it did, it’s certainly been exacerbated by flawed policies.
One problem I see with modern property taxation schemes is that they are based exclusively on property values. This seems to create negative incentives for denser, upwards, inner-city developments. After all, those developments create the highest property values. Instead of recognizing that denser urban development creates economic efficiencies, decreases energy usage, and reduces overall pollution, we instead chose to punish those who pursue this sort of urban development.
Perhaps we should be exploring different ways to tax inner-city properties. We could tax based exclusively on land value (so any added-value is not punished). Or perhaps we could continue taxing based on property values, but allow those who build multi-unit, multi-story, energy efficient developments to be taxed at a lower rate. Regardless, it’s an issue that public policy wonks and urban planners need to start examining more closely.
Don’t take my list as a dogmatic one. Rather, my goal here is to redirect discussion on how to improve America’s fiscal and economic situation. Raising taxes and eliminating government funding in vital areas isn’t the solution. This could only make the problem even worse, as it did in the Great Depression.
There’s a much better case to be made for enacting growth policies, seeking out new sources of revenue, lowering taxes, and reducing or eliminating expenses associated with long-term entitlement programs. Moreover, we should also be searching for ways to create a more sustainable long-term economic infrastructure, through green policies. These nine policies I have recommended should help move towards these goals; but there are many other ways to improve our situation out there.
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