Money and Our Future
We are fortunate to be living in these times, for we are seeing the unfolding of events long explained and predicted by the Austrian tradition.
Maybe that sounds implausible. What is fortunate about our times? The economy is tanking, stocks have been pummeled, unemployment is rising, and Washington is pursuing the worst combination of economic policies since Hoover and FDR. Nor does the new guy in charge seem to have a clue about the limits of what government can do.
Consider what it means to live through our times in the light of economic understanding. Even in the face of calamity, there is no mystery, and hence fear is reduced.
You look at department stores going belly-up, and you know why. You see parking lots empty, and you know the reason. You have friends losing their jobs, and there is clarity concerning the cause. You see depositors in failing banks lose their money, and you are not surprised. Prices behave in ways that shock and surprise everyone else, but you know what's what.
In many ways, it is like watching the movement of stars and planets with the scientific knowledge provided by astronomy — or observing the effects of a plague with medical knowledge.
Without the understanding, the events look mysterious, like a curse from the gods, and their patterns appear random. With the knowledge, with the understanding, we can make sense of the events. Patterns of cause and effect emerge. You see events before they happen, like turning the page of a script before the movie catches up to you. This gives you a sense of intellectual coherence and inner peace — even in the midst of calamity.
If you read what Mises wrote during the Great Depression and World War Two, you can see firmness of conviction and steadfast calm, even as the whole world was going nuts. Intellectual clarity is the key to seeing the right things and doing the right things. It is a matter of knowing the shape of things even before the things take shape.
Knowledge provides a means of curing the ill. It provides a way out, an answer that gives hope. This is a major reason why people with an Austrian understanding in the midst of financial meltdown keep their wits about them.
Yes, it is more than frustrating to see people in Washington spending trillions in a futile effort to repeal economic law. It is sheer madness that they are creating vast quantities of new dollars by means of the Fed's power, even with evidence from the whole of human history that new money only waters down the value of the old, and does nothing to provide a long-term boost to the economy, and much to further distort economic structures.
It's like watching as barbers bleed patients in the name of curing them, or bringing in the witch doctors to cast out demons from people with the flu. But even if our knowledge of events cannot stop what these people are doing for now, it provides us with a sense of solace in the face of disaster. We can keep our heads, even as others run around as if theirs had been cut off.
In order to understand events, there is no substitute for doing what the media and most economists refuse to do, which is to look at the big picture and the long view, over decades. It is a matter of applying the rule that Henry Hazlitt brings home so clearly in Economics in One Lesson: economics consists in looking at the effects of policies not on one group but on all groups, not only in the short run but also in the long run.
From the long-run point of view, we observe an intriguing illustration of the Austrian warning against ever attempting to bail out an economy that is pushing toward recession. In 2001, the economy wanted to go into recession but the government wouldn't let it happen. It was the first stimulus package in the new millennium, consisting of vast new funding and vast money creation, with the Fed driving down rates and keeping them rock bottom.
If you look at the short run, it seems that it worked. But looking at the long run, we can see that the attempt to forestall recession only ended up creating a bigger disaster down the line.
Something very similar happened in the short recession of 1991. Clinton came to power and shortened the recession, which only created another bubble in financials that broke and so on, until we are where we are today.
Arguably the last time that a recession was permitted to run its course was following the crack-up boom in the end of the Carter years, as a result of Nixon's inflation. Reagan came to power, with Carter's choice of Volcker at the Fed. Reagan ignored the crying from Congress and the press. He let interest rates rise; the federal-funds rate was 20% and prime was at 21.5% in 1982. Unemployment reached nearly 11%. Inflation fell from 13.5% in 1980 to 3.2% in 1983.
If we include the S&L debacle in this, it was a nearly total blowout, and if Reagan had left it at that, it would have been a model for how to deal with recessions. There is pain and suffering. But wait it out and you have a fertile ground on which to build a solid prosperity. Sadly, you also produce a solid financial footing that invites the government to abuse the system, as Reagan did with record spending and deficits.
If we want to look back even further to find better examples of how to handle recession, we can look at 1920 and 1921. The less the government did, the better the results long term. Murray Rothbard's own dissertation on the Panic of 1819 is an interesting case. He took a look at a pure case in which nothing was done to fix a problem. The problem went away. What was notable about this panic is precisely that it never made the history books. It didn't because the government didn't make it worse.
In the months ahead, we are going to witness more of these ridiculously futile attempts to patch up a failing economy, and we are going to pay a big price this time. It won't be like 2001 or 1992. We will be lucky if it ends up like 1978–1982. More likely, it is going to be worse — and how much worse depends on just how stupid the Obama administration is going to be. It is hard to imagine that these people will be worse than Bush, but it could happen.
We all must deal with the possible death of the dollar. Many plans have been proposed through the years that would restore the gold dollar, and many have merit. They all provide a means to go back to gold. While they are not lacking in technical detail, they are lacking in something that they can't provide: the political will to do the right thing. They are all premised on the idea that our leaders might be interested in doing the right thing. But the same people that would be in charge of implementing the reform are the very ones who got us into this mess.
It is hard enough in the course of regular life to get anyone to admit an error and reverse course. In politics, it virtually never happens. Even in the case of egregiously immoral effects, the political class persists in error, mainly because it is more interested in saving itself than saving society. Guido Hülsmann points out in his new book, The Ethics of Money Production, that "governments inflate the money supply because they gain revenue from inflation."
This is hardly a new insight. Hülsmann quotes the 14th-century Bishop Nicholas Oresme as follows:
I am of the opinion that the main and final cause of why the prince pretends the power of altering the coinage is that profit or gain which he can get from it; it would otherwise be vain to make so many and so great changes…. Besides, the amount of the prince's profit is necessarily that of the community's loss.
The techniques are different today, but the incentive and moral result are the same. Hülsmann points to another change: today's princes have "received absolution from the scientific authorities of our day." Princes used to work in secret to do these things, and be disgraced when caught. Now they announce the policy as responsible statecraft that is consistent with the teaching of modern economics — and the economists stand ready to nod their heads in agreement.
In the face of this, it is time to deal with political reality that no one in Washington (except Ron Paul) is even slightly interested in: an orderly plan to restore sound money. And yet the problems of fiat money and financial collapse cannot go unaddressed. What's more, the institutions of fiat money are failing, and this fact will be undeniably obvious to everyone in a matter of years.
We will look back on the end of the Bush administration as an economic disaster, a capstone of many years of horrible foreign policy moved to domestic policy. They will be disgraced, as will the new administration that pursued all the wrong policy measures as a response. The new messiah will face the same reality that the old one did. No amount of bluster, political will, determined speeches, and money flowing from the printing press can get around the problem of economic reality.
In an essay written at the end of his career, and recently brought back to life by the Mises Institute, F.A. Hayek discusses the only serious means of reform that is open to us. We must completely abolish the central bank. Money itself must be wholly untied from the state. It must be restored as a private good, privately produced for private markets. Government must have no role at all in monetary affairs. Money should be produced by private enterprise alone. Banks must exist only as free-enterprise institutions, with no privileges from the state. This plan has also been advanced by Ron Paul.
What strikes me is how this accords precisely with what Hülsmann writes. His book on the Ethics of Money Production ends with a call for an end to all intervention in monetary affairs. Coinage must be private. Banking must receive no privileges. There should be no legal-tender laws, no guarantees, no restrictions on currency use — a fully laissez-faire system.
What is further striking about the Hayek, Hülsmann, and Paul idea here is that they offer no plan for restoring a gold dollar. It's not that they would disagree with the idea, but they have fully confronted the reality that the idea of converting the existing currency from fiat money to sound money is essentially a 19th-century ideal that presupposes an enlightened class of political managers. This condition is not met today.
But what is the means? It is the same as we propose in every other area of national life: get the government out. Let the people be free to manage their own affairs. Stop interfering with commercial acts between consenting adults. Stop using violence to interfere with economic affairs. Let the people pursue mutually beneficial exchange based on their own self-assessment of the advantages. Let property owners accept the risk and reward for their own decisions.
It is the same with monetary policy and banking policy too. Let failing banks die. Let profitable banks live. Let the people choose to use any form of money. Let the people choose any means of payment. Let entrepreneurs create any form of financial instrument. Law applies only the way it applies to all other human affairs: punishing force and fraud. Otherwise, the law should have nothing to do with it.
What would be the results? We cannot know for sure. But history can be a guide in our speculations. Throughout all time and in all places, precious metals have emerged as the foundation of the monetary system. I think we can have every expectation that the same would be true today. Evidence comes from how people turn to gold in difficult times as a store of value, a safehouse from the machinations of government. Gold, in my view, is destined to be the foundation of a new free-market monetary system.
To this extent, and with this expectation, all believers in liberty can consider themselves advocates of the gold standard. But we must also be careful with this phrase. It is identified with a particular set of policies associated with 19th-century practice. It was a policy choice among many that some favored and some opposed.
A free-market monetary system of the future will not be a policy option in this sense. It is not something we want the government to adopt as its own. In fact, we don't want the government to adopt any particular policy but rather abandon the policy option altogether. There should be no policy at all in the sense that this word is routinely used today.
In this way, a path forward in money and banking is no different from the path forward in agriculture, labor, health care, education, or any other sector. The right policy is no policy. The job of the government is to stop interfering altogether.
Now, I'm aware that this is a big intellectual leap these days. But you only need to consider the myriad ways in which government fails at everything it attempts, whereas the market succeeds. There is nothing about the structure of the universe that confers upon money and banking any special status that requires the government to regulate it, to serve as a lender of last resort, the marker of money, the guarantor of stability, or anything else. A free market in money would work the same as a free market in everything else.
And consider: We are not asking Congress to intervene with a plan. No one is demanding that the Fed adopt this policy as versus that policy. All we are asking is that it not intervene in the attempts by the market to fix the problems that have been created by the central bank and the executive department.
Just imagine what would happen if legal-tender laws were repealed and the government stopped intervention in the market for money. Virtually overnight, we would see the appearance of hundreds if not thousands of new payment systems and alternative monies online. Merchants would be free to accept any means of payment. There would be intense competition among them. Some would be foreign currencies like the Euro. Some would be new currencies based on existing commodities such as gold and silver. I'm certain that we would see a period of wild experimentation take place before the market settled back down again into a standard system that was famed for its reliability and stability and honesty.
Would we be able to endure the process of discovery? Certainly. We do this every day with our shopping online, or searches for good providers of services and products in the physical world, and our habits on how to invest our money. The market is a process of trial and error, one that never stops innovating and changing. We see everyday on the World Wide Web how this process of creation and change create the right balance between chaos and order, experimentation and standardization. This would happen in the field of money too.
In fact, it might have happened already had the feds not intervened to stop the rise of alternative payment systems online. Walmart might have already entered the banking sector. We might have a wide variety of currencies available to us. Google might already have created its own currency based on any number of goods. We might see a more elaborate use of barter in the online world taking shape, and that barter slowly converting itself into currency. This might be based on Google ad points, on PayPal dollars, or some other currency.
Had a free market been permitted to develop over the last ten years, we might have an option today. As it is, we are being forced to stay with a failing dollar system.
What we've been hearing from Washington is that the economy and this country will be patched up by sheer force of will. If we have hope and work together, anything is possible. There is only one thing standing in the way of this wish. It is called economics. Economic reality is more than a brick wall. It is like the sea or the world's tallest mountain, or like the force of gravity itself. Economic forces pay no attention to the wishes of charismatic leaders and their throngs of adoring followers.
However, there is a kernel of truth in the idea that the force of will can make a difference. Transfer this hope and will outside the institutions of government and into the free market — let experimentation and innovation take place under conditions of freedom — and we will begin to see the emergence of an answer. We need the government merely to let the market be free of political violence, and we will begin to see our way out of this mess.
The government today is marshalling every resource and every means at its disposal to prop up a failing system of the past. Meanwhile, we live in completely new times. These new times are characterized by an international division of labor, global capital flows, digital information delivery, and the slow but systematic destruction of the establishment in media, banking, and finances. What is emerging to replace them is something that no government on the planet can stop. Markets will not be crushed and they resist control as never before.
These new times are not the 1930s when a few eggheads in Washington could set most prices and wages and gather the captains of industry to cobble together business cartels. The economic and financial world moves at the speed of light and is so diffuse that no political authority can act quickly enough to control it. The establishment is going down. This is another reason that all believers in freedom have reason to rejoice today.
Twelve to 18 months from now, it will be obvious that there is nothing the new administration can do to patch things up. Obama will be humbled by the market just as Bush and Clinton were before him, but this time the humbling will overwhelm any attempts to patch things up or put a spin on the much-needed upheaval.
Yes, there is suffering, and there will be more to come. But as a student of the Austrian School and a student of the history of liberty, you have the confidence and clarity to see that freedom alone provides the answers.
It is the time for calm in the face of a storm that few fully understand. Let us, as advocates of freedom, be steadfast, rational, clear, and focused on the long term. Be of good cheer and never stop pointing to the truth about freedom. The answer is not the Left nor the Right nor the state. The way out of this mess is freedom. It is time we defer to it, and to the revolution in the status quo that freedom implies, and give up pretending as if any politician can finally stop it.
"Do You Austrians Have a Better Idea?"
A lot of people get annoyed with Austrian economists because they tend to be so dogmatic (we prefer the term consistent) and because they cloak their strictly economic claims with self-righteousness (we prefer the term morality). After a good Austrian bashing of the latest call to steal taxpayer money and waste it on something that will make a given problem worse, the stumped critics will often shout, "Oh yeah? Well do you guys have a better idea?"
Now, in truth, someone doesn't have to have a better suggestion in order to point out that a recommended strategy will exacerbate the situation. If an allergic man has been stung by a bee, I don't know what to do except rush him to the hospital and maybe scour the cupboards looking for Benadryl. But I'm pretty sure drawing blood from his leg, in order to inject it into his arm and thus "stimulate his immune system," is a bad idea on numerous accounts — not least of which, is that I'm pretty sure an allergic reaction means your immune system needs to calm down. But the point is, if a bunch of guys hold the man down — he has to be forced to endure the procedure for his own good, don't you know — I feel perfectly qualified in yelling, "Stop!"
If you grasped that analogy, you can understand my feelings about anything Paul Krugman writes.
(All joking aside, I am pretty proud of the above analogy. But to make it even more accurate, let’s stipulate that a blind heroin addict, who has been convicted of manslaughter on three separate occasions, is the one entrusted with making the transfusion. Naturally he will use one of his own needles for the procedure.)
An Austrian Recommendation for President Obama
In one sense, the critics are right when they ask, "Oh, so we should just sit back and do nothing and let the market fix itself?" Yes, that would be a perfectly good idea. The whole reason we are in a recession in the first place is that the capital structure of the economy had become unsustainable due to the Fed's massive credit expansion following the dot-com bust and 9/11 attacks. Resources — most notably, labor — are currently idle, because the economy needs to readjust. Overextended lines such as housing and finance need to shrink, while others need to expand. (And no, I don't know what those understaffed lines are; that's why we have a price system.) Because Americans lived beyond their means for so many years, they now need to live below their means, consuming less while they rebuild their checking accounts and portfolios.
Given the diagnosis, we can be sure that efforts to borrow and spend our way back into prosperity, or massive bailouts of the banks and homeowners, are only pumping air into a flat tire with a gaping hole. And Bernanke's unbelievable injections of new funny money into the credit markets will only ensure that those failed institutions remain afloat, paralyzing true recovery in the loan market, and risking very large price inflation if Bernanke does not soon reverse course.
However, even though "nothing" would be much, much better than all of the alleged remedies being bandied about, the Austrians actually do have concrete proposals for President Obama. The following list includes items that I would have endorsed even before the crisis, but inasmuch as they would definitely help things, I offer them with sincerity to the new administration.
One last caveat: I know there are many purists who read the Mises Daily, and will be aghast at my watered-down recommendations. Yes, yes, I agree that the best thing would be for Obama, Pelosi, Reid, and all my friends to say, "You know, if you look at the history of this company, it always ends up wasting money and getting innocent people killed. I think we should just quit and go volunteer at a church instead."
But, if I said that as an Austrian recommendation, it would be dismissed as "unserious," a very grave charge indeed. Thus, the following list of recommendations are not politically impossible, just exceedingly unlikely:
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Eliminate the personal and corporate income tax. Don't put in a flat tax or a fair tax or a VAT or any other cute name for a very uncute process. To make sure that individuals and corporations realize you are serious, blow up the IRS building. (Have everyone vacate the premises first, of course.) Tell all of the displaced workers that they have 9 months of full pay, plus whatever pension and health-care benefits they had contractually earned to that point. If the workers get new jobs 3 days after being laid off from the IRS, that's fine; they still get their full 9 months' pay. But if they haven't found a new job after 9 months, tough.
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Unfortunately, dismantling the Social Security system will have to wait. (That means some of the IRS personnel would — sigh — have to be retained. But they would move to a different building.) Getting rid of the income tax will knock out much of the federal revenues, and taking out all payroll "contributions" would take us into the realm of "unserious." Note that in 2007, even without the personal and corporate income tax, the federal government still took in more than $1 trillion in receipts.
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The loss of some $1.5 trillion in annual tax receipts sounds absurd, but the actual figure would be lower, because of "supply-side" effects. That is, the true stimulus to the economy from such an enormous tax cut would cause the revenues from other sources to grow. So long as the federal budget were cut by, say, a trillion dollars, within a few years it would be in the black.
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Reducing annual federal expenditures by $1 trillion sounds inconceivable, but it actually could be phased in. The government has many assets that it could auction off into private hands, so that in the first year or two, the government could take certain programs and say, "This will have its budget cut by one-third over each of the next three years." The auction receipts would fill the gap until these phased-in reductions had fully occurred. Some of the obvious auction items would be the oil in the Strategic Petroleum Reserve (current value of about $35 billion at $50/bbl oil), as well as all of the mineral deposits (both onshore and offshore) technically owned by the federal government. It is difficult to come up with an estimate of how much the latter properties would fetch in an auction, since the proposals right now are for leasing extraction rights. But since the Outer Continental Shelf is estimated to have some 86 billion barrels of oil, presumably the government could receive many hundreds of billions of dollars — and possibly trillions — from an orderly and staggered sale over a few years of the most lucrative (and environmentally noncontroversial) lands.
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Eliminate the DEA and the SEC. Since the SEC failed to catch Madoff, despite nine years of warnings, I think its $950 million annual budget is obviously a waste of money. The DEA's $1.9 billion budget in 2007 also strikes me as counterproductive. Beyond the issues of violent gangs and judicial corruption, there is the fact that this is a recession and we need to cut costs. If you're afraid of your kid doing drugs, have a serious talk and then make him watch this movie. And if he's still keen on the idea, I'm not sure the DEA is going to stop him. (By the way, the DEA and SEC employees get the same deal as the laid-off IRS personnel.)
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Cut the Pentagon budget in half. In FY 2008 it was (officially) some $460 billion,
so that cut alone would free up $230 billion per year. This isn't an article about foreign policy, so we won't be specific about how the military could achieve such cuts. But if you're worried that the country would suddenly be overrun by Iranian tanks, the following chart should reassure you: -
Eliminate the Department of Education. That would save $68.6 billion a year, based on its latest budget. Does anyone want to argue that Americans are well educated? And incidentally, I was a college professor for a few years, so I can say from personal experience that there are way too many kids going to college. If you think "everyone should get a college degree," let me ask you this: Should everyone get a PhD? If not, then why a bachelor's degree? The more kids crammed into the school, the harder it is to teach to the truly academic, and the less of a signal the diploma provides. Plus, $68.6 billion is some serious money.
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Cancel all the pending "stimulus" and other bailout packages. Tell the Big Three that small is beautiful. Tell the banks, "OK your 'short-term' loan from the Fed has expired, here are your mortgage-backed securities back, and we'll be taking our reserves. Good luck to you. This is a capitalist country, where you keep your earnings if you forecast well (we just eliminated the income tax!) and where you go bust if you don't realize real estate sometimes drops. Have a nice day." Yes, this would cause some banks to immediately go bankrupt, but the big banks aren't doing anything now anyway. The dreaded liquidation would actually wipe the slate clean so recovery could begin. As it is, trillions of dollars in capital is now locked up in undead institutions that can't make new loans but won't mark their assets at true values, since they are insolvent. And with the income tax being wiped out, the toxicity of these troubled assets would come way down.
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Allow unrestricted immigration so long as the incoming folks had a secure job in which the employer (a) paid three years in advance on any state and local taxes that would accrue from the employment and (b) bought at least a $100,000 house for the immigrant and his or her family. (Yes, yes, the last point is silly, but it will help sell the package.)
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Abolish the minimum wage. That — coupled with the elimination of the income tax — will take care of unemployment within 6 months.
Now, where to start cutting?
The above steps are incomplete, and I'm sure many readers will email me with snags in them. Fair enough. But I am confident that the above would make a heck of a lot more sense than letting blind heroin addicts borrow an extra trillion dollars to "stimulate" the economy.
Chávez Grabs Again for Life Tenure
Intimidation is on the rise as a referendum approaches.
When Venezuelan President Hugo Chávez last staged a referendum to give himself lifetime tenure, voters turned him down. That was only 13 months ago. Now he's trying again -- in a Feb. 15 referendum -- and this time he's far more desperate.
![[The Americas]](http://s.wsj.net/public/resources/images/ED-AI946_AMCOL0_D_20090130134227.jpg)
APDemonstrators raise their hands in front of police during a protest in Caracas, Jan. 20.
Treasury reserves are dwindling, electricity blackouts are becoming commonplace, public security is deteriorating, and the finances of the state-owned oil monopoly, PdVSA, are in apparent disarray. There is little reason to think that the decline will be reversed any time soon.
If Mr. Chávez hopes to continue governing under the guise of democracy after 2013, when his term expires, he must get the constitution changed now. Cheating at the polls, as he has done in the past, is one thing. But it would be a far too obvious breach of law if he tried to run again in violation of the existing constitutional prohibition. Another referendum defeat would be devastating, which is why his supporters are pulling out all the stops, including a sharp increase in their use of political violence around the country.
When Venezuelans cast their votes on Feb. 15 they will be answering just one question: Do you approve of changing five articles in the constitution so as to allow for the indefinite re-election of the president, legislators, governors and mayors?
The referendum question did not originally include legislators, governors and mayors. But when an earlier proposal asked for indefinite re-election only for the president, it met with widespread skepticism. So Mr. Chávez decided to widen the field in the hope of picking up support. Even so, everyone knows this is a referendum on the president.
The problem for Mr. Chávez may be that a majority of voters have already had enough of him, and this ballot gives them a chance to say so. Current economic and financial conditions do not favor the incumbent.
Venezuela imports most everything it consumes. The bill is paid with the foreign exchange earned through oil exports. But prices for Venezuelan crude are now below $40 per barrel, and the central bank has recently been asked to hand over $12 billion to a government development fund. The bank's international reserve position is now just below $30 billion -- if government figures can be believed.
The bank's position is not in crisis yet, but the rate at which reserves are shrinking is worrisome. If it continues, Venezuela could have trouble paying for its food. Mr. Chávez also has used the bank as his own political slush fund. His "democratic" survival depends heavily on largess for the poor masses and palm-greasing for not-so-poor political backers.
PdVSA dominates the nation's economy, and its problems can't help but bleed into other sectors. Two weeks ago, Dow Jones Newswires' Raul Gallegos reported that PdVSA owed its suppliers some $7.86 billion in September. Since then, things have only gotten worse. The Spanish-language news service Noticias Financieras reported on Thursday that the president of Venezuela's Association of Metallurgical and Mining Industries says 200 companies are affected by the failure of state enterprises to pay their suppliers -- and if the problem is not resolved, it could affect 25,000 to 30,000 jobs.
Humberto Calderón Berti, a former Venezuelan energy minister, put his finger on the source of the difficulties in an interview with the Mexican news service Notimex last week: "PdVSA's debt has gone from two billion dollars ten years ago to $20 billion, its production has fallen from 3.2 to 2.4 million barrels a day, and the refineries are running into operational problems."
PdVSA is but a symbol of the deterioration of Venezuelan competitiveness under Mr. Chávez, and Venezuelans are already feeling the economic hardship that this decline imposes. In the December 2007 referendum, many voters who fit the chavista demographic seem to have abstained, suggesting disillusionment with the Bolivarian revolution. To combat this malaise, Mr. Chávez's United Socialist Party of Venezuela is campaigning frantically. The party has said its workers will go "door-to-door," hold forums, and man subway exits in Caracas to get out the vote. This is in addition to Mr. Chávez's use of the bully pulpit on television.
Yet all indications are that Mr. Chávez doesn't think this will be enough. To his list of "tools" he has added intimidation.
In the past month, Chávez enforcers have been attacking student groups that are trying to rally Venezuelans to vote "no." Tear gas and rubber bullets have produced both physical injuries and rising fears of violence around the country. This could affect voter turnout. It also raises doubts about whether enough opposition observers can be mobilized to guard the vote on election night. If not, and Mr. Chávez "wins," things are likely to get a whole lot scarier.
Driving Mr. Daschle
Tax avoidance and Democratic Party standards.
So Tom Daschle, the erstwhile prairie populist and scourge of multiple Presidential nominees, failed to disclose and pay taxes on hundreds of thousands of dollars of income. He also waited months to pay up and told the Obama transition team about his tax oversights only days before his Senate confirmation hearing to become Secretary of Health and Human Services.
![[Review & Outlook]](http://s.wsj.net/public/resources/images/OB-DB181_oj_1da_E_20090201185641.jpg)
APThis one is going to be fascinating to watch, less for what it says about Mr. Daschle than what it will reveal about Democratic standards. Every Republican in America knows that if Mr. Daschle were a Reagan or Bush nominee he'd now be headed back to private life faster than you can say John Tower. That's the way Democrats have treated GOP nominees who were accused of far lesser transgressions than Mr. Daschle's tax, er, avoidance. The question is whether Democrats are going to treat Mr. Daschle according to the standard that Mr. Daschle set when he was running the Senate.
And what standard was that? Well, on taxes, you may recall that Mr. Daschle's Senate Democrats led the campaign against "Benedict Arnold corporations" that earn too much income overseas. The companies do this legally, in part to avoid a U.S. corporate tax rate (35%) that is the developed world's second highest, but that hasn't stopped the Daschle Democrats from comparing them to traitors.
Then there was the assault on legal tax shelters, led in the Daschle Senate by Democrat Carl Levin. The Levin hearings encouraged the Justice Department to prosecute employees who sold tax shelters for KPMG, though no tax court had found them illegal. Most of the KPMG charges were later thrown out of court, but not before careers were ruined and life savings spent on legal defense fees. Under political pressure in 2002, the IRS disclosed the names of users of a KPMG shelter, including William Simon Jr., a Republican candidate for California Governor. Democrats cried that Mr. Simon was a tax cheat, and he had to release years of tax returns to show otherwise.
Now we learn that Mr. Daschle failed to report some $255,000 in income from 2005 through 2007 for a car and driver supplied to him for personal use. The chauffeur service was provided by Leo Hindery, a big Democratic donor who also made Mr. Daschle a bundle by making him a limited partner in InterMedia Partners, a private equity shop.
As a legal tax matter, this isn't even a close call. Mr. Daschle says he used the car service about 80% for personal use, and 20% for business. But his spokeswoman says it only dawned on the Senator last June that this might be taxable income. Mr. Daschle's excuse? According to a Journal report Friday, "he told committee staff he had grown used to having a car and driver as majority leader and did not think to report the perk on his taxes, according to staff members." How's that for a Leona Helmsley moment: Doesn't everyone have a car and chauffeur, dear?
The Senate Finance Committee is also reviewing whether certain "travel and entertainment services" provided to Mr. Daschle and his wife Linda, an aviation lobbyist, should also be reported as income. The Washington Post reports that Mr. Daschle has earned more than $5 million over the past two years, including $220,000 from the health-care industry he's been nominated to regulate. Capitalism is wonderful, but at the very least Mr. Daschle's record strips the veneer from President Obama's moralizing that lobbying and special interest pleading are the root of all evil in Washington. In appointing Mr. Daschle, Mr. Obama is showing that lobbying is fine as long as it is done by people who agree with him.
Some Democrats said on the weekend that Mr. Daschle deserves to be confirmed because they "know" he is "honest." But that isn't the standard Mr. Daschle set for GOP appointees who had no ethical taint. In 2001, he established a new, 60-vote confirmation standard for Eugene Scalia to be Labor Department Solicitor, though Mr. Scalia had been approved in committee and would have won on the Senate floor. He also filibustered Miguel Estrada, a judicial nominee of wide renown, on the trivial grounds that the Bush Administration wouldn't release internal memos when Mr. Estrada had worked as a Justice Department staff lawyer.
We'll be watching in particular to see how Democrats Max Baucus and Kent Conrad handle the Daschle tax mess. Finance Chairman Baucus gave a pass to Treasury Secretary Tim Geithner, albeit for a lesser offense, and Mr. Conrad also voted to confirm Mr. Geithner though not without saying he wouldn't have done so in "normal" times. We assume by "normal" he doesn't mean when nominees are Republican. If nothing else, a vote to confirm Mr. Daschle will expose the insincerity of Democratic tax populism.
If Mr. Daschle were the stand-up guy his fellow Democrats say he is, he'd withdraw his nomination and spare them the embarrassment of confirming someone who thinks the tax laws apply only to other people.
Sunday, February 1, 2009
Risk Communication and the Dynamics of Public Response
Camille Pecastaing offers a number of useful insights in response to my essay and Bernard Finel’s and John Mueller’s comments. He begins by pointing out that what I call fear in my essay is really anxiety. This is a good point, because fear is more visceral but anxiety endures well past the traumatic events. Anxiety and negative affect are closer to the reactions I am most concerned about. He also argues correctly that anger or outrage were common reactions to the events of September 11th. I do object to his use of the word hysteria however; this is a loaded term. I do not think hysteria accurately describes how most Americans responded to the attacks on the twin towers or the Pentagon.
Dr. Pecastaing speaks of a kind conspiracy — dominant winds blowing in the same direction — in which the administration, media, and public together became numb to reason. I believe the public in a state of chronic anxiety ignored the probabilities of future attacks, failed to consider the opportunity costs of going to war, and, being distracted, failed to see other risks that eventually led to the financial crisis. Very puzzling was the media’s lack of serious investigative journalism leading up to the war.
Interesting is the comment pertaining to the Department of Homeland Security paradigm of zero-risk. This fantasy objective, as Dr. Pecastaing calls it, has big implications. If true, it suggests that that no amount of funding is too large in the effort to protect our country. As I indicate above, such focus has large opportunity costs. What do we give up in pursuit of this standard? The public appears to implicitly expect this level of protection as well. There is a sad irony here. The longer we go without being attacked the more pressure there may be for our nation’s leaders to adhere to unreasonable standards to avoid having another attack on their watch.
I agree that there are two primary dynamics that we need to pay attention to if we are to properly understand public reaction. First, there is the reaction of fear, anger, and anxiety that follows a terrorist attack. These emotions tend to amplify the risk causing us to over estimate the event’s impact. In this state of mind we may favor drastic rather than measured response. Second, we also observe that the public tends to self-correct in the months following an attack. This process helps put the breaks on over reaction. Whichever set of feedback loops is stronger will determine the net reaction at any given point after the attack. We would do well to study this balancing mechanism so that we can design risk communication strategies that help mitigate over reaction. Well designed risk communication may have enormous policy relevance in this regard.
The Practicality of Instructing about Terrorism
by Camille Pecastaing
The Conversation
While it is easy to agree on the benefits to better educating citizens about risks from terrorism, there are many paths to enlightenment, some more practical than others. The task would not just be about preparing the people most likely to be exposed to an emergency, namely those in the largest metropolitan areas, but about educating the entire nation so that citizens’ political responses to the next attack will be better calibrated to the risk. It is particularly essential to explain that terrorists are not killers by vocation but provocateurs, and that nothing better serves their purpose than an overreaction.
The most sensible way to get there would be to incorporate a course on risk and probably in the secondary school curriculum, as part of civic education. As it happens, there are abundant risks in the United States — natural catastrophes, industrial catastrophes, epidemics, and human rampages, from killing sprees to terrorism — so it is possible to incorporate education on terrorism into a broader framework of homeland security, and avoid singling it out as an existential threat.
The only problem is that risk alertness is like a vaccine: it needs to be refreshed. You need a few hurricanes, a few earthquake tremors, a few shootouts now and then to remind that the risk is there and that behaviors should be adapted to it. The best efforts to educate citizens about the reality of the risk they face from terrorism may become useless after a long period without incident. And when the incident occurs — 10, 20 years down the road — no one will be prepared, leaving the field wide open for the kind of overreaction we have witnessed.
There is one puzzle with regard the recent experience in the United States. The attacks of the 1990s where characterized by under-reaction — and under-reaction was robust. If we include attacks against American target overseas (twice in Saudi Arabia, in Kenya, in Tanzania) and failed attacks (the bridges and tunnels attack, the Millennium plot) to the attacks that did occur on U.S. soil, the existence of a risk from terrorism was very apparent at the time, even though the risk of exposure for each American was very low.
Then came the overreaction after 2001. There are several explanations possible for the complete reversal of outcome. One is the temperament of the leadership at the time, which influenced the nation’s response. Another is the effect of the unique imagery and pathos of the New York attack, which may have tilted the scales. A third explanation is the nature of the enemy: Americans killing Americans (Ted Kaczynski, Timothy McVeigh, Eric Rudolph) in the United States was a low emotion risk; Islamists killing Americans in Muslim lands was also a low emotion risk. But the possibility of an alien fifth column already in the country and ready to strike may have been overwhelming.
Those powerful emotions died out when it became clear that this fifth column never existed. In the end, the appetite to pursue Jihadists into the slums of Baghdad and in the caves of the Pamirs was limited, and support for Bush’s wars quickly waned. That says something of how Americans envision — and “feel about” — the safety of their homeland. Dr. Finel ventured to explore the national temperament: imperial reach is not part of it.
Don't Push Banks to Make Bad Loans
Contrary to myth, commercial bank lending is up. So are standards.
BERT ELY
There is a widespread belief that banks are now refusing to lend as much as they should, and that Congress should pressure them to extend more credit to consumers and businesses.
In reality, banks as a whole increased their lending during 2008 -- the notion they haven't is based on a misunderstanding of U.S. credit markets. Pressuring banks to lend more could backfire.
Lost in too many discussions of the financial sector is that banks and other depository institutions account for only 22% of the credit supplied to the U.S. economy (down from 40% in 1982). "Shadow banking" -- notably asset securitization and money-market mutual funds -- now supplies 33% (up from 14%). Insurance companies, other financial intermediaries, nonfinancial firms and the rest of the world provide the balance.
As far as commercial banks go, Federal Reserve data released last week show that their lending increased 2.36% during the last quarter of 2008. For all of 2008, commercial-bank lending rose by $386 billion, or 5.63%, even as the economy slid into recession. Over that 12-month period, business lending jumped $152 billion, or 10.6%, real-estate loans were up $213 billion, or 5.9%, and consumer lending rose $73.5 billion, or 9%. Other categories of bank lending such as loans to farmers, broker-dealers and governments, declined $53.2 billion, or 5.4%.
Fed data also show that during the first three quarters of 2008, the total amount of credit supplied to the economy increased $1.91 trillion, or 3.8%, with $540 billion of that amount coming from foreign lenders.
Nevertheless, Treasury recently demanded that the 20 largest recipients of government capital investments start providing detailed monthly reports about their lending and investment activities. This new requirement could lead to government lending mandates. That would not be a good idea.
In the first place, the drop in stock-market and house prices has made millions of families feel poorer and led them to save more than in recent years. It has also encouraged them (especially Baby Boomers approaching retirement) to pay off debt. They don't need more debt.
More broadly, many of the most creditworthy neither need to nor want to borrow right now. Richard Davis, CEO of U.S. Bancorp, recently said that he is seeing the demand for loans diminish at his and other banks "from people and businesses spending less and traveling less and watching their nickels and dimes."
Lenders moreover have tightened lending standards, correcting an excessive laxness that contributed to our financial mess. Zero or very low down-payment mortgages are out, as are "covenant light" corporate loans. Likewise, lenders have trimmed credit-card limits and cut the amount of money available under home equity lines of credit as home values have declined.
And contrary to the "lend more" message broadcast from inside the Washington Beltway, bank examiners are criticizing weak loans and forcing banks to tighten lending standards. Bankers are caught in a vise between politicians and examiners.
A lot of the credit tightness is a reflection of the near-collapse of loan securitization. Recent Fed plans to buy asset-backed securities may help revive asset securitization, but bankers have no control over the fate of that initiative.
The economy is in recession and working off the consequences of a housing bubble fed by excessive mortgage credit. Given that loan demand typically falls during a recession, it's amazing that bank lending increased as much as it did last year. It was essentially flat during the 2001 recession.
Bankers should always lend prudently, as they are now doing. If they are jawboned or worse by Washington into reckless lending, the U.S. will set itself up for another debt crisis, even before the present mess has been cleaned up.
Mr. Ely, the principal in Ely & Co. Inc., is a financial institutions and monetary policy consultant.
The New Poor Tax
The New Poor Tax
Congress's latest money grab will leave you fuming.
Congress is moving so fast and furious that it's impossible to keep up. But we didn't want to miss telling you about the tax increase on the poor and middle class that Congress is about to pass without a whit of media attention.
We mean the tax increase on smokers that is part of the new children's health-care subsidy bill. To finance this $73 billion entitlement expansion over 10 years, the bill imposes an additional federal tax of 61 cents per cigarette pack, from 39 cents today. According to the Bureau of Economic Analysis, 96% of America's 25 million smokers make less than $150,000 a year. The Tax Foundation estimates that 99% of the smokers who will pay the new tax make less than $250,000, which is the income below which President Obama promised would see no tax increase.
"No other federal tax hurts the poor more than the cigarette tax," says the Tax Foundation. These are the same folks the Obama Administration wants to help by raising the amount of the earned-income tax credit, but wait. A 61-cent cigarette tax hike is the equivalent of a 25% cut in that tax credit for some low-income families. So the politicians give these families money with one hand and take it back with the other.
Oh, and there's another problem. The number of smokers keeps falling, but health-care costs keep rising. So paying for the biggest new health-care expansion in years with a declining revenue source is a guarantee of future red ink that will increase pressure for higher income taxes too. Just ask the politicians in Maryland, who doubled their cigarette tax two years ago to finance a new health-care program. That has led to 25% less tobacco revenue than expected because of declining sales, so the program is already in the red after its first year. But hey, it's the thought that counts.
How Government Prolonged the Depression
How Government Prolonged the Depression
Policies that decreased competition in product and labor markets were especially destructive.
HAROLD L. COLE LEE E. OHANIAN
The New Deal is widely perceived to have ended the Great Depression, and this has led many to support a "new" New Deal to address the current crisis. But the facts do not support the perception that FDR's policies shortened the Depression, or that similar policies will pull our nation out of its current economic downturn.
![[Commentary]](http://s.wsj.net/public/resources/images/ED-AI950_ohania_DV_20090201191451.jpg)
CorbisA man selling apples during the Great Depression.
The goal of the New Deal was to get Americans back to work. But the New Deal didn't restore employment. In fact, there was even less work on average during the New Deal than before FDR took office. Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between in 1930-32.
Even comparing hours worked at the end of 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933. And it wasn't just work that remained scarce during the New Deal. Per capita consumption did not recover at all, remaining 25% below its trend level throughout the New Deal, and per-capita nonresidential investment averaged about 60% below trend. The Great Depression clearly continued long after FDR took office.
Why wasn't the Depression followed by a vigorous recovery, like every other cycle? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936. Similarly, Nobel Laureate Robert Lucas and Leonard Rapping calculated on the basis of just expansionary Federal Reserve policy that the economy should have been back to normal by 1935.
So what stopped a blockbuster recovery from ever starting? The New Deal. Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles by suppressing competition, and setting prices and wages in many sectors well above their normal levels. All told, these antimarket policies choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s.
The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA), which tossed aside the nation's antitrust acts and permitted industries to collusively raise prices provided that they shared their newfound monopoly rents with workers by substantially raising wages well above underlying productivity growth. The NIRA covered over 500 industries, ranging from autos and steel, to ladies hosiery and poultry production. Each industry created a code of "fair competition" which spelled out what producers could and could not do, and which were designed to eliminate "excessive competition" that FDR believed to be the source of the Depression.
These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment. Following government approval of each industry code, industry prices and wages increased substantially, while prices and wages in sectors that weren't covered by the NIRA, such as agriculture, did not. We have calculated that manufacturing wages were as much as 25% above the level that would have prevailed without the New Deal. And while the artificially high wages created by the NIRA benefited the few that were fortunate to have a job in those industries, they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth.
These policies continued even after the NIRA was declared unconstitutional in 1935. There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.
The downturn of 1937-38 was preceded by large wage hikes that pushed wages well above their NIRA levels, following the Supreme Court's 1937 decision that upheld the constitutionality of the National Labor Relations Act. These wage hikes led to further job loss, particularly in manufacturing. The "recession in a depression" thus was not the result of a reversal of New Deal policies, as argued by some, but rather a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.
By the late 1930s, New Deal policies did begin to reverse, which coincided with the beginning of the recovery. In a 1938 speech, FDR acknowledged that the American economy had become a "concealed cartel system like Europe," which led the Justice Department to reinitiate antitrust prosecution. And union bargaining power was significantly reduced, first by the Supreme Court's ruling that the sit-down strike was illegal, and further reduced during World War II by the National War Labor Board (NWLB), in which large union wage settlements were limited by the NWLB to cost-of-living increases. The wartime economic boom reflected not only the enormous resource drain of military spending, but also the erosion of New Deal labor and industrial policies.
By 1947, through a combination of NWLB wage restrictions and rapid productivity growth, we have calculated that the large gap between manufacturing wages and productivity that emerged during the New Deal had nearly been eliminated. And since that time, wages have never approached the severely distorted levels that prevailed under the New Deal, nor has the country suffered from such abysmally low employment.
The main lesson we have learned from the New Deal is that wholesale government intervention can -- and does -- deliver the most unintended of consequences. This was true in the 1930s, when artificially high wages and prices kept us depressed for more than a decade, it was true in the 1970s when price controls were used to combat inflation but just produced shortages. It is true today, when poorly designed regulation produced a banking system that took on too much risk.
President Barack Obama and Congress have a great opportunity to produce reforms that do return Americans to work, and that provide a foundation for sustained long-run economic growth and the opportunity for all Americans to succeed. These reforms should include very specific plans that update banking regulations and address a manufacturing sector in which several large industries -- including autos and steel -- are no longer internationally competitive. Tax reform that broadens rather than narrows the tax base and that increases incentives to work, save and invest is also needed. We must also confront an educational system that fails many of its constituents. A large fiscal stimulus plan that doesn't directly address the specific impediments that our economy faces is unlikely to achieve either the country's short-term or long-term goals.
Mr. Cole is professor of economics at the University of Pennsylvania. Mr. Ohanian is professor of economics and director of the Ettinger Family Program in Macroeconomic Research at UCLA.
The optimum government
Richard Rahn
COMMENTARY:
If you knew economic growth and new job creation begin to slow when total government spending is larger than about 25 percent of the economy, and you knew total government spending in the United States is about 36 percent of gross domestic product (GDP), would you propose policies to make government larger or smaller to create more jobs and boost economic growth?
Over the last few decades, many economists have done studies on the "optimum" size of government. A new study just completed shows the optimum size of government is less than 25 percent of GDP.
Optimum is defined as that point just before government becomes so large as to reduce the rate of economic growth and job creation. Governments are created to protect people and property. A government too small to establish the rule of law and protect people and their property from both foreign and domestic enemies is less than optimal.
The American Founding Fathers also believed government had public health functions (as contrasted with spending on private health), such as draining swamps where malaria-infected mosquitos thrived; and some public works functions (e.g. building and maintaining roads, and ensuring basic education - but not necessarily state-operated schools).
The American Founding Fathers also understood that government could easily become too large, which would diminish the liberties of the people and discourage them from engaging in productive activity. The socialist utopians were in denial of the basics of human nature, which scholars like Adam Smith and the American Founders well understood.
Nevertheless, countless socialist schemes to enlarge the size of government have been sold to naive people. After two centuries of experimentation and the unnecessary loss of hundreds of millions of human lives, most of mankind now understands that pure socialism leads to tyranny and economic stagnation.
The question remains: Between the extremes of virtually no government and a pure communist state, how much government is necessary and desirable, and when does it become a drag on both liberty and economic well-being?
Economists have tried to quantify the question by looking at the experience of countries (and economic/political entities) over time as the size of their government grew or contracted, and by making comparisons of governments of various sizes. Most studies measure the size of government as a share of GDP (realizing it is an imperfect measure because it does not measure counterproductive regulation, restrictions on liberty and other factors, but is a reasonable approximation).
Wise observers have well understood that free markets and uncontrolled prices do a far better job in allocating resources (labor and productive investment) than politicians, who tend to resort to deciding what they believe is best for other people and, of course, rewarding their friends.
Most of the studies of the optimum size of government made by reputable scholars in recent decades have indicated that total government spending (federal plus state plus local) should be no lower than 17 percent, nor larger than about 30 percent of GDP. In a just completed paper, economists at the Institute for Market Economics in Sofia, Bulgaria, have provided new estimates of the optimum size of government, using standard models, with the latest data from a broader spectrum of countries than had been previously available. Their conclusion is that there is a 95 percent probability that the optimal size of government is less than 25 percent of GDP.
Because most governments are - and have been for many years - larger than the optimal, there are insufficient data to give a point estimate as to the best size, other than it is less than 25 percent. Other studies have shown small-population homogeneous countries, such as Finland, may have slightly higher optimal government sizes than heterogeneous countries, such as Switzerland and the United States.
The ramifications of this study and previous ones are important for the current debate going on in the United States and many other countries, about having the government spend more to "stimulate" the economy - i.e. create jobs and increase growth rates.
Rather than increasing the size of government, the empirical evidence shows that sharply reducing taxes, regulations, and government spending down to at least 25 percent of GDP would do the most to spur economic growth and create more jobs over the long run.
There is virtually no empirical evidence - in the United States or anywhere else - to support the belief of economists of the Keynesian school that a big increase in government spending will make matters better, rather than worse. Economists of the Austrian school have, in general, supported smaller government as a way to achieve higher levels of both prosperity and individual freedom, and the empirical evidence shows them to be correct.
In the United States, periods of rapid economic growth, such as 1983-89 and 1992-99, have been associated with a reduction in the total size of government. During the 1970s and much of the last decade, total (federal, state and local) government spending grew to a post-World War II record (36 percent), and these periods were associated with lower economic growth. In recent decades, many European countries have greatly increased government spending as a percentage of GDP, and as a result most of them experienced lower growth rates and much higher rates of unemployment than the United States.
Those members of Congress and parliamentarians in other countries who vote for a "stimulus package" that increases the size of government will be voting for slower economic recovery and higher rates of unemployment over the long run, based on both solid empirical evidence and theory.
Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.
The Trouble With Harry
Will President Obama resist the tax-and-spend Congress?
PETE DU PONT
Article I of the Constitution gives Congress broad public policy powers, and Article II defines those of the president.
Congress fully understands that its constitutional powers are more or less equal to and fully independent of those of the president, and the president--every president--had better understand that truth. So one of the greatest challenges of our new president, with both houses of the legislature controlled by his own party, is persuading its members to follow his leadership.
All of which comes to mind as President Obama understands that the sagging American economy needs some strong government stimulus. The new Congress agrees with him but wants even greater government spending and control, and while the president said in his Inaugural Address that those "who manage the public's dollars" must also "spend wisely," Congress, wisely or not, wants to spend a great deal more money on most everything.
So the House Appropriations Committee, chaired by Rep. Dave Obey of Wisconsin, last week passed a significant portion of what will be an $825 billion stimulus bill. It contains $275 billion in tax cuts but substantially increases government spending on some 150 existing federal programs. Some increased spending programs make sense, for in our recession we do indeed need more money to fund unemployment benefits, food stamps and Medicaid.
But other spending increases are pure politics, involving a substantial expansion of the federal government's policy role. Four billion dollars to help hire, equip and pay state and local police forces won't stimulate the economy, but it will give Washington some control over police spending. Nor will $50 million for the National Endowment for the Arts, $2.1 billion for Head Start, or $16 billion more for Pell grants stimulate the economy; they are all standard congressional preferences but no help at all in economic stimulation, which is supposed to be the objective of the bill. In short, the House bill has no broad strategic vision, merely a bigger government spending goal.
Nor would much of the legislation have an immediate economic impact, for only a small portion of its funds would be immediately spent. Of the $18.5 it contains for renewable energy, only $3 billion would be spent by 2011. Similarly, of the $30 billion for highways, only $4 billion would be spent by 2011, and less than half of the $14 billion additional school construction money would be promptly spent.
Of the $80 billion in assistance to state governments for Medicaid and welfare benefits, it is estimated that only $30 billion would be spent by 2011, but we can be sure that the states would promptly maximize their use of these funds. Which leads to another thought: The bill also contains the previously mentioned $4 billion in federal funding so that states can continue to employ police, and $87 billion for Medicaid which Mr. Obey claims could also be used to avoid cutting teachers, police, and firefighters. Once in place, every state would argue that the federal funding must continue--"we need the money; we haven't recovered yet; without it teachers will be laid off"--so perhaps the federalization of state programs will become permanent as well.
One more troubling aspect of the Obey legislation is that it contains no sunset provision. If the bill's spending helps and the economy begins to recover (or if it recovers on its own), there is no limit on new government spending, which makes one think that the objective of the bill is to permanently increase the size, scope and spending of the federal government. And that, of course, would lead to higher taxes of various kinds to feed the government's appetite.
In short, the Appropriations Committee bill is not fresh thinking, but the old 1930s government thinking in the style of FDR adviser Harry Hopkins, who was said to have advised the president to "tax and tax, spend and spend, elect and elect!"
Far more sensible would be tax rate reductions. Each time past presidents have cut taxes--in the 1920s, '60s and '80s, as well as George W. Bush's 2003 tax cuts (which generated $785 billion in additional tax receipts)--the economy has expanded. As Investors Business Daily noted earlier this year, former White House economist Greg Mankiw cited data showing that every new dollar spent by the government expands the economy from $1 to $1.40, but in a study of tax cuts going back to 1947, each $1 in tax cuts generated $3 in additional GDP. Add to that making the economy stronger by pledging to extend the Bush tax cuts, create no government run health care, no climate bill with its costly and job-suppressing mandates, and no limits on free trade.
All of which raises the most important opportunity of the first month of the new administration: Now is the time for President Obama to step up, improve the Appropriations Committee's bill, and set a sound economic course for the coming years. Will our new president back up his pledge to "spend wisely" and force Congress to limit its spending increases, or will he allow it to substantially increase spending to support the core belief that government should be bigger today, tomorrow and always?
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