It’s increasingly likely that an unpopular war and a teetering economy will bring Republican House and Senate losses in 2006, and throw the 2008 Presidential election wide open. Free market economists, frustrated by the George W. Bush administration, should thus be thinking about ideas to pitch to the potential Democrat Presidential contenders of 2008, who will shortly start scouring the country for campaign money and voter-friendly policies.
Traditionally, free market economists have been closer to Republicans than Democrats. Their ideal President, the last true believer in minimal government, was Calvin Coolidge, although President Ronald Reagan’s tax cuts and deregulation of the U.S. energy and other markets were also attractive. On the other hand, President Dwight Eisenhower’s refusal to cut taxes from extraordinarily high wartime levels, President Richard Nixon’s social programs and President George H.W. Bush’s inability to control federal spending demonstrated to free marketers that their preference for Republicans should not be unconditional. Conversely President John Kennedy’s supply side income tax cut, President Jimmy Carter’s deregulation of the airlines and President Bill Clinton’s sober fiscal policies and government spending restraint (helped by Republican House Speaker Newt Gingrich) all demonstrated that free marketers could also hope for progress under Democrat administrations.
To free market economists, the George W. Bush administration’s record is at best mixed. On the plus side, it cut taxes, albeit with an absurd credit-card-bill mechanism that requires Congress to repeat the cuts over and over again, thus enabling lobbyists to extract additional Danegeld at each extension. It reduced the double taxation of dividends, although it did so in a silly way, minimizing the economic benefits from the move. It supported free trade, albeit rather grudgingly and through a mechanism of bilateral trade agreements that in practice achieved little. Oh, and it avoided controls on domestic oil prices.
On the minus side, the Bush administration increased agriculture subsidies in 2002, instead of abolishing them, it protected steel, until coming to its senses as the steel price soared and it supported a Fed policy of low interest rates that replaced a stock market bubble with a housing bubble and postponed for years the necessary correction.
Above all, the Administration engaged in an orgy of public spending that has permanently increased the size of the federal government. Together with the Republican Congress, it loaded the federal budget with record amounts of pork, federalized airport security and devised an ineffective new bureaucracy for it, increased the federal government’s intrusions into education and devised new entitlements in healthcare. Both education and healthcare “reforms” were put in place without the free market mechanisms of vouchers and pricing that might have made them cost-effective.
On balance therefore, the Bush administration’s record has been uninspiring to free marketers. It may indeed become positively loathsome to them should the deep recession that appears to be looming produce as is likely an Administration reaction of populist “Keynesian” spending programs, economic meddling and protectionism, combined with crocodile tears about how taxes must be raised in the interests of the American people.
If a Democrat President is elected in 2008, it is likely that he (or she) will face an economic background of prolonged recession, astronomical budget deficits, persistent inflation, depressed stock markets and housing markets and severe world economic imbalances (if by some chance this apparently inevitable fate has been avoided, 2008’s winner will probably be another Republican.) The new President will have a theoretical commitment to a market economy, but a much stronger and more urgent desire to do something for the less well off, the unemployed, minority groups and workers in the public sector and traditional unionized industries, who collectively will form the base of his support. He will be torn between the desire to spend public money, bash the rich and reward supporters, and the knowledge that too much of this fun stuff may knock an already fragile U.S. economy on the head.
To a free market economist, the challenge will be to devise policies that are reasonably politically popular, enable a Democrat President to satisfy his ideological and political desires, and yet don’t economically “kill the goose that laid the golden eggs.” In particular, he needs to warn the incoming President which favorite policies are particularly damaging. For example, the Franklin Roosevelt administration’s Glass-Steagall Act of 1933, which split commercial banking from investment banking, de-capitalized the investment banks and removed their appetite for risk – causing new issue volume in U.S. capital markets to shrink to minuscule levels for a decade, thereby paralyzing the economy’s innovation mechanism.
Avoiding that kind of unintended consequence must be the new President’s #1 priority when considering any structural reforms to the U.S. economic and financial systems. After the collapse of the current funny money bubble, there will be plenty of crooks to throw in jail, notably from the hedge fund sector, which will please the Democrat voter base. Structural changes in the markets, on the other hand, should be undertaken only with great care, though abolishing hedge funds’ exemption from regulation would seem politically irresistible and economically harmless.
The most urgent need following the new President’s inauguration will be new revenue sources for the federal budget. The new President’s supporters certainly aren’t going to stand for him balancing the budget by spending cuts, and the profligate outgoing Bush administration will have cleaned out the cupboard, making rapid action necessary to avoid serious economic damage.
Reversing the Bush tax cuts will certainly help raise revenues, but probably not enough to fill the gap. Further, two of the Bush tax cuts are economically beneficial enough that they should be modified rather than reversed. The repeal of Estate Duty is unnecessary, but the duty will raise more revenue than it does at present, and put a lot of unproductive estate planners out of work, if it is reduced from existing rates of 45-50 percent to a rate of around 20 percent, with a high exemption of about $5 million and as far as possible no loopholes for farming, small business etc. By such a move, estate planning will become unnecessary, and the government will get 20 percent of actual estate transfers rather than 45-50 percent of estate transfers that have been minimized by legal and accounting chicanery.
Similarly, the Bush dividend tax reduction to 15 percent should be removed (with appropriate “red meat” rhetoric about increasing taxes on idle rentiers) but full tax-deductibility of dividends should be introduced at the corporate level, along with a corporate alternative minimum tax (more “red meat” for supporters) of 25 percent of reported profits net of dividend payments (so that manipulating pension contributions, depreciation and stock option schemes to show one profit to shareholders and a lower one to the taxman becomes counterproductive.)
This combination will close down the corporate tax shelter industry, while at the same time the net dividends received by investors and the value of common stocks (whose prices will probably be depressed in 2009) will increase. Since pension funds pay no tax, the funding of defined benefit pensions, likely to be a huge problem in the depressed stock market of 2009, will be correspondingly improved. Unlike the estate tax change, this tax change may cost revenue, but closing corporate tax loopholes should make that cost modest.
On individual taxes, experience has shown that very high nominal tax rates on top incomes are at least moderately damaging to the economy, cause huge increases in tax avoidance and produce very little revenue. In any case, the more go-ahead billionaires are among the largest Democrat donors – better not to alienate them. Increased taxes on the generally Republican suburban upper middle classes are much less of a problem, so “saving social security” by increasing the contribution limit from around $90,000 to say $150,000 will produce a lot of revenue and not hurt the new President’s supporters much.
We can obtain a further revenue boost by restricting the home mortgage interest tax deduction to interest on the first $250,000 of principal. To avoid increasing the cyclicality of housing, interest rates above 6% even on larger mortgages should also be deductible – this avoids the British situation of 1990-93, when housing suffered from a period of 15 percent non-deductible mortgage interest rates. Thus a taxpayer with a home mortgage of $400,000 at 7% would deduct the full 7% on the first $250,000, plus 1% on the remaining $150,000.
This change would not directly affect most middle income voters, and would provide a brake on house price inflation, keeping housing affordable for middle income families. It would also divert wealthy people’s resources away from housing and into stocks, a thoroughly healthy development. Finally, it would produce a lot of revenue; with $1.2 trillion of “jumbo” (more than $333,700) mortgages outstanding in 2004, tax revenues from this source should be at least $40-50 billion per annum. The housing industry would object, but except for Fannie Mae and Freddie Mac, who would be largely unaffected, they are a primarily Republican money source.
Environmentalist supporters will want to do something about oil usage, but tightening Corporate Average Fuel Economy regulations still further would damage the US automotive industry and cost money rather than yielding it. Much better, if gasoline prices are still high, to give the Federal government a “put” option on them, by introducing a Federal gas tax that applies only when gas prices are below say $2.50 per gallon, but is then 50 percent of the amount by which the net price drops below $2.50 – thus 5 cents per gallon if it is $2.40, 50 cents per gallon if it is $1.50, etc.
This will prevent gas prices to the consumer from dropping to the levels seen in the late 1990s, thus encouraging gas conservation, reducing carbon emissions and providing a contra-cyclical revenue source that tends to increase when the world economy is in recession and oil prices drop. With U.S. gas consumption around 120 billion gallons per annum, this tax would yield $30 billion per annum at a $2 ex-tax pump price. The oil companies will squeal, but why should a Democrat President care about that?
On the expenditure side, there are some obvious economies to make in agriculture subsidies (affecting primarily “red states” that rarely vote for a Democrat President) Republican-generated pork, military expenditures (no more international adventures) and corporate subsidies in general – most large corporations that are recipients of subsidy have redirected their giving to Republicans since the 2000 election.
A Democrat President will need the money for social programs, but should bear in mind one overriding caveat: money spent creating a bureaucracy distorts the economy, since it causes purchasing decisions to be made by bureaucrats rather than beneficiaries. On the other hand, money handed out in welfare distorts the economy less, since the recipient chooses how to spend it. Thus in 1932 President Herbert Hoover should have paid the Veterans’ Bonus in cash, but sharply restricted the volume of reconstruction loans to favored industry – precisely the reverse of the policy he chose. If you must undertake Keynesian reflationary spending, do it through cash handouts.
Economically, an incoming Democrat President in 2009 will face a situation of relatively high unemployment, increasing inequality, and widespread unrest about jobs disappearing overseas. Conventional Chamber of Commerce conservatives will tell him that he should do little about any of these, because of potential damage to the economy.
Being a Democrat, the new President will be resistant to the Chamber of Commerce message. He will recognize that the twin problems of unemployment and inequality are vital to his voting base, more important and threatening than any other economic factor, and capable of swamping at least temporarily any enthusiasm for social issues, foreign policy or entitlement programs. He must address the problems, but how?
This is where a free market economist can help. Outsourcing is far less threatening to the jobs and welfare of working people than immigration, particularly illegal immigration, which attacks their employment directly, allowing employers to drive unskilled wage rates down to levels that do not allow even a minimal version of the American Dream. Although legal immigrants typically vote Democrat, illegal immigrants do not have the right to vote, and hence even allowing for a certain amount of electoral fraud do not form a significant part of a Democrat President’s voter base. On the other hand, liberal Democrat voters would not react kindly to an aggressive program of physical repatriation.
The solution is simple: do not resort to protectionism or to draconian immigration enforcement but instead achieve the desired employment-protecting effect by enforcing aggressively the laws against employing illegal immigrants. Raise the penalties sharply, so that top management of companies persistently employing illegal immigrants receives substantial jail sentences (more “red meat” for the faithful!) This is not a political problem; employers of illegal immigrants are not the investment banks or the tech sector, natural parts of the Democrat donor base, but big retailers, construction companies and providers of personal services to the rich, all overwhelmingly Republican sectors. Cut off demand for illegal immigrant labor and the huge current flow of illegal immigrants will reverse itself.
At the same time as making it impossible for companies to employ illegal immigrants, raise the minimum wage sharply (ideally with a differential between big city areas and the heartlands, reflecting their differing costs of living) so that employers have to pay the immigrants’ domestic replacements at a rate that allows a decent working class standard of living. The result will be a certain amount of inflation, but a decrease in inequality and an even greater decrease in crime and social pathologies in general – not primarily from the departure of the illegal immigrants, but from low-skill domestic youth that is now able to settle down in modest comfort into a job, a home and a family.
The suddenly more expensive jobs will in certain cases disappear, but they will not be outsourced – retailing, construction and personal services are almost entirely un-outsourceable. The higher minimum wage’s unemployment effect will be felt by the illegal immigrants, who will return home. The retailing and construction sectors will be hit, but the overall economy will benefit from a rebalancing against those sectors, swollen in recent years.
This combination will bring the immigration issue, highly salient in the minds of voters, squarely into the Democrat column, thus giving one-time Democrat voters a tangible reason to continue voting that way.
A Democrat President who follows these policies will achieve triumphant re-election. Compared with the currently available Republican alternative, he will deserve to.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.