Tax Reform Not Perfect but Good for All Americans by David Montgomery

If you only watch channels like CBS or CNN or read the Washington Post, you are no doubt convinced that the Republican tax reform bill announced yesterday has the sole purpose of taking money from the poor and middle class and handing it to businesses and the rich. There is a fundamental error behind that thinking. Tax policy is not just a zero-sum game – changes in tax law can make the pie larger or smaller as well as influencing who gets a bigger slice. And increasing the size of the pie is the whole purpose of the proposed tax reforms.

Nancy Pelosi is already complaining that the reduction in the corporate income tax rate from 35% to 20% is the largest reduction ever made in corporate taxes. She does not mention that the 35% rate American businesses now pay is the highest of any developed country, and the 20% rate will put us back into the middle of the pack. But what she and the other Progressives try to conceal is that tax reform will eliminate the incentive that American businesses now have to move their assets, factories and patents overseas, giving jobs and tax revenue to other countries and eliminating them here.

The corporate rate reduction is the most important part of the proposal for encouraging investment in the United States, and without it tax reform would be meaningless. In addition, the proposal will reverse the incentives that have caused American corporations to leave their foreign earnings on the books of their overseas branches in order to avoid taxes. In an arcane section at the end, the proposal will put a one-time tax on all past earnings held overseas, just as if they had been brought back. Thereafter, U.S. companies will be able to bring those earnings back for investment or dividends in the United States without paying taxes, thus freeing up more funds for investment here.

Finally, high corporate taxes have motivated many companies to register patents overseas and charge themselves high royalties that go to their foreign affiliates that pay little or no tax. The proposal will put a 20% additional tax on payments to foreign affiliates to eliminate the possibility of sheltering income from patents and other intangible assets. That provision is not as strong or effective as the abandoned border tax adjustment, but it will be a help to keep R&D at home.

The result of this reform of business taxation is not just higher profits for those companies. It will help everyone who owns shares of U.S. businesses in their 401(k) retirement funds, not just wealthy executives. Possibly more important to businesses on the Eastern Shore, tax reform will also limit to 25% the maximum tax rate that must be paid by owners of small businesses on the earnings of their C or S corporations that flow through to their personal taxes.

The effects of these changes in business taxation have been grossly misrepresented by the opponents of tax reform. The loudest claim by left-wing economists is that the proposals are “just another example of the discredited trickle-down theory.” Contrary to every principle they teach, these progressive true-believers speak as if heavy taxes have no effect on wages or job growth. They also have an odd reading of history. In the past eight years, we have seen an explosion of regulation and higher and higher taxes on business – and still, wage and job growth are stalled. Seems to me that pretty much proves the trickle-down theory – tax and regulate businesses to death and wages and job opportunities will fall. Relieve business of taxes and regulation and wages and job opportunities will grow.

Independent studies of the effects of the Ways and Means proposal show how this would work. First of all, all income groups will benefit from the personal tax reductions. Poorer working people will pay no tax, and every income group will pay less. With the increased standard deduction, most families will no longer need to itemize deductions, and this means more than saving time and money on tax preparation.

There is a great deal of self-interested and deceptive agitation against limiting deductions of state and local income taxes and mortgage interest. These deductions mean a lot to real estate agents and mortgage brokers who get more business from the subsidy to home purchases and to state and local governments that get less pushback against tax increases because they are tax deductible. And most of the increased revenue that would come from limiting these deductions will be paid by those in the highest income groups. With the increased standard deduction and personal exemptions, these deductions become meaningless because the standard deduction is a bigger benefit to most low and middle-income taxpayers. So this is not taking money out of the pockets of the middle class, it is fixing a subsidy to the rich. According to the Tax Foundation, 88% of the benefit of the state and local tax deduction goes to taxpayers with incomes over $100,000. Even the Treasury Department has labeled the deduction a perverse subsidy to the rich.

The Tax Foundation also estimates that the specific reforms just announced by the Ways and Means Committee will increase U.S. employment by about 1 million jobs after 10 years of increased economic growth, increase wages by 3.1%, and make middle-income families better off by about $2500 annually.

Maryland fared even better, with an increase of over 18,000 jobs and increased income for a middle-income family of $3,250. The proposed set of tax reforms are a rare example of a policy that is good for all Americans. Not perfect: keeping the border adjustment, reducing personal taxes on investment income further, and making expensing of all investment permanent would have given about three times the benefits, but good enough to deserve bipartisan support.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

 

 

Semper Fidelis by David Montgomery

My less conservative friends sometimes tell me “how Europeans think about the United States,” usually mentioning that we are obsessed with sex and more recently claiming that we are war-mongers intent on global dominance. The claim about sex (from the French, of all things!) most often refers to the adherence of many American Evangelicals and Catholics to traditional Christian teaching about abortion, divorce, homosexuality, and the nature of marriage. That is true, and the comment is only interesting because of what it reveals about the state of Christianity in Europe.

The European view of America as a militarist society intent on global domination is false and offensive, and therefore deserves a response from all of us who know how wrong it is.

A recent article in the usually level-headed Economist magazine is typical, though it is more personal and offensive than most in its derogation of the character of the men and women who serve in our armed forces. Its author uses the pseudonym “Lexington” (appropriate as the place where British fired on American militia) and claims to have been a war correspondent. To deepen the insult, the title he gave the article in the print edition was “Semper fidelis.”

The article itself is a lengthy recital of the author’s prejudices about American military personnel and the present Administration. “Lexington” accepts uncritically every accusation leveled at American forces or President Trump and invents whatever “facts” his ideology tells him should be true.

“Lexington” makes two idiotic claims: the American public suffers from a romantic illusion about the character of American soldiers, sailors, airmen and Marines, and we irrationally support the intention of our government to dominate the world through military force.

A few excerpts will convey the tone, without subjecting my readers to the sick entirety of the article.

“No soldier expects the beloved chumps back home to understand what he gets up to. He just needs to feel appreciated.”

This based on Lexington’s dismissal of the cards and letters posted on bases in Iraq thanking our soldiers for “being over there to keep us safe.” He calls their senders “chumps” on the grounds that ISIS and Al Qaeda are fighting a defensive war, not threat to us a home. The vulnerability of all of the Levant to jihad, and its meaning for the West, seems never to have occurred to him.

“In 1990, 40% of young Americans had a military veteran for a parent; in 2014 only 16% did. But this dissonance has not, as the general implied, caused Americans to underappreciate the forces. To the contrary, it has encouraged, as [General Kelly’s] remarks also indicated, a highly romanticised view of military service, which is inaccurate and counter-productive at best.”

The romanticized view being that soldiers risk their lives and perform heroic actions for our benefit. Not denying that this is what soldiers in fact do, “Lexington” attacks their motives:

“Members of the armed forces are often patriotic. But many see their service primarily as a way to make a living…”

After all this denigration of the American soldier, Lexington does an about-face to express outrage at President Trump’s (quoted without context) words to the widow of a Special Forces sergeant killed in Niger. What I hear in the now famous phrase that “he knew what he signed up for” is President Trump paying the ultimate compliment to Sergeant Johnson’s courage and sacrifice – he knew that he might die and he went anyway. But Lexington’s bias makes him hear it in the worst possible way.

“Lexington” then claims that what he views as “uncritical soldier worship” and “America’s unthinking reverence for its fighters” lets our generals and politicians plan for global domination:

“Most obviously, it gives the Department of Defence an outsize advantage in the battle for resources with civilian agencies. Today’s cuts to the State Department, whose officers are not noticeably less patriotic or public-spirited than America’s soldiers, are a dismal case in point.” Nonsequitur of the first order, but a nice revelation of bias.

“The fact is, America’s foreign-policy doctrines envisage a degree of global dominance, based on military might….”

Thus a European intellectual looks down on the American public as romantic fools demeans our military as no better than mercenaries, and then plays to the prejudice of his European readers by confirming their suspicion that we aspire to create a new Roman Empire with our mercenary legions.

The Catholic Church is not immune to this disease. A disturbing article recently appeared in the Jesuit magazine La Civita Cattolica, written by its editor and another close associate of Pope Francis. The Jesuits make the same broad accusations about how we start wars and plan to dominate the world, but blame it on an alliance of Protestant fundamentalists and wayward Catholics.

The authors claim that “Religion has had a more incisive role in electoral processes and government decisions over recent decades, especially in some US governments. It offers a moral role for identifying what is good and what is bad” and has led our government into a moral crusade against Islam.

They blame this development on “evangelical fundamentalism” to which American Catholics have become allied. Though I am a Roman Catholic now, I was brought up in that tradition, and I can state with confidence that their account of its history and leaders is completely fictional. Nor can I figure out how to reconcile the claimed political dominance of evangelicals and orthodox Catholics like me with our inability to stop abortions, redefinition of marriage, etc.

Nevertheless, the authors go on to describe the terrible effects of our domination of American politics. They accuse us of “stigmatization of enemies who are often ‘demonized’” – in particular, “the migrants and the Muslims.” Further, “Within this narrative, whatever pushes toward conflict is not off limits. It does not take into account the bond between capital and profits and arms sales. Quite the opposite, often war itself is assimilated to the heroic conquests of the “Lord of Hosts” of Gideon and David. In this Manichaean vision, belligerence can acquire a theological justification…”

Here we see two common prejudices of the European intellectual community. First the Marxist view that our military ventures are really being arranged by capitalists to profit on arms sales, and have nothing to do with actual defense of the West against Islamic terrorists and jihadists. The fundamentalists and their Catholic allies help convince the masses to support this military expansion by giving it a religious justification.

The authors in the Jesuit magazine conclude their diatribe with “We must not forget that the geopolitics spread by Isis [sic] is based on the same cult of an apocalypse…. So, it is not just accidental that George W. Bush was seen as a ‘great crusader’ by Osama bin Laden.”

Thus we end with the conclusion that there is no real difference between Islamic terrorists and U.S. foreign policy. Sadly, the liberal Catholic magazine Commonweal endorses the Jesuit’s article, characterizing it as “giving voice to how non-American Christians and Catholics around the world are perceiving the U.S. situation.” Another European point of view is revealed.

Were it not for the position of the authors in the informal hierarchy of the Vatican, the silliness, inconsistency and historical inaccuracy of the article would make it just another example of bad editorial judgment in the world of Jesuit publishing. As things stand, the article serves as another example of the depth and pervasiveness of prejudice against America among the European intellectual elite.

Where for Lexington it was our “uncritical soldier worship” that supports imperial ambitions, for the Jesuit authors it is the power of fundamentalist religious leaders. That smart Europeans could be so deluded about the United States is a staggering thought.

I write on this topic today to urge my readers not to be deceived by these European prejudices or to see European disdain for American values and accomplishments as a sophisticated worldview worthy of emulation. Europe as a whole is in decline, and the moral basis of its decline is clearly apparent in these attitudes toward all things American.

We are an exceptional country, with not only the most effective and disciplined but the most generous fighting forces in the world. Even when misguided, as it may have been to intervene in Vietnam and Iraq, there is no notion of world domination behind our use of military force. Perhaps an unrealistic belief in the power of democracy to improve the lives of citizens of every nation, but not a wish to rule them.

Our military personnel face fear, hardship, and death in order to protect the innocents in the countries where they serve from Islamic terrorists and tribal warlords. They provide humanitarian aid while watching their backs, and must distinguish instantly between whom to protect and whom to kill. And they are our first line of defense against militant and expansionist Islamic movements and countries. European second-guessers who question their motivations and self-sacrifice deserve only our contempt.

We need to celebrate the sacrifices and accomplishments of our Soldiers, Sailors, Airmen, and Marines — and remember them when we stand up for the National Anthem on November 11.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Sport that Unifies by David Montgomery

I do not understand how there can be a shred of sympathy or support for professional football players who kneel during the National Anthem. Leaving aside the vagueness of whatever message they are trying to send, their implicit claim that employees have a right to make personal political statements on company time while acting as representatives of the company is nonsense.

By now, the strength of my political, religious and moral convictions should be pretty clear, as well as my willingness to speak my mind. But I knew exactly what rules I had to obey when I was in front of clients or could be identified with the company that employed me. Any political activity or symbolism was way out of bounds as a matter of principle. I was never to speak about subjects on which I had less than complete professional qualification except in personal and private conversations. The opinions and feelings of my clients were to be treated with respect at all times, as a matter of common decency and of self-preservation. My employers were always adamant about maintaining a considerate and courteous image, and I knew that I had many competitors who would be happy to exploit any distance that I let develop between clients and myself.

I certainly would have been disciplined if I started a public presentation on trends on gasoline prices by praying for the babies that would die in abortions that day. Nor would I ever expect to be invited back. Yet I doubt that the professional athletes taking a knee to publicize “Black Lives Matter” are stating convictions any stronger than mine about abortion.

Nor do I see being unfairly attacked by a political figure as a mitigating factor in perpetuating bad behavior. I have been there. Senator McCain once rose in the Senate to accuse me of being paid off by oil companies to reach the conclusions I published about a bill that he had introduced. But I did not start every subsequent public appearance by repeating that the McCain-Lieberman bill would cost 3 percent of GDP and do nothing to solve climate change. Yet professional football players doubled-down on disrupting the National Anthem in order to get back at President Trump for calling them out about their protests.

If they really cared about the ills they protest, football players might try doing something that actually has a cost. They might, for example, collectively donate their salaries from one game to an organization that does something to create safer communities or to keep black youth from committing the crimes that bring them to the attention of police.

Or, if a player feels so strongly that he cannot play football without expressing himself, he might just refuse to play until the wrong he protests is righted. That, at least, would show more respect for paying customers than acting in a way that diminishes their enjoyment of the game. A game, by the way, that they paid top dollar and possibly waited for years to attend.

I know what it is like to be told to keep quiet. I had an employer inform me that I could not write opinion pieces for a newspaper without prior review and censorship, that anything I said in public belonged to them. I left that company, voluntarily, shortly thereafter. I did not continue publishing and expecting no consequences. Yet professional football players seem to expect their teammates and employers to tolerate whatever they feel like doing.

To be clear, I am convinced that NFL players who “take a knee” or refuse to come on the field for the National Anthem are cheating their fans.

Not long ago, my wife (a Navy veteran) and I attended the Navy-Air Force football game. That was the kind of experience football is supposed to be. No protests, no disruption, everyone standing and veterans saluting while we sang the National Anthem — in tune and with respect, by the way – and everyone present feeling a sense of brotherhood and shared enjoyment. We watched young men, all of whom had the much higher calling of preparing to serve their country, give everything they had to win the game. Navy pulled way ahead by the half, Air Force figured out the Navy offense well enough to stop one or two drives and caught up, then went ahead. Then Navy scored the winning touchdown with 16 seconds on the clock.

The Navy quarterback, by my count, ran for at least two touchdowns and well over 100 yards, and still threw a perfect pass to end the game. He does not expect to sign for $435,000 or $10 million when he graduates, and he comes to the game expecting to do nothing but play the best football he can for his team and the crowd.

While there, I did not think about the difficulties of getting true tax reform, or the polarization of American politics, or any of the other depressing political topics of the day. I did think about this column, I confess, as I was conscious of that day and that game being a time when I was part of the kind of country I remember, one where everyone acknowledged they were part of a bigger whole.

Esther and I were on the Gold side, which those who attend Navy football know put us in the middle of Air Force fans. While others in America are defining themselves into more and more divided identity groups, we felt kinship even with the Air Force fans around us. We knew that we shared interest in football, good feelings toward the teams, dedication to our country and respect for its symbols.

That is what the overpaid NFL players who take a knee are stealing from their fans. They have taken away the opportunity of spending an afternoon enjoying sports and being part of a community with common interests. With all this whining about safe spaces in colleges and searching for microaggressions in every kind of normal behavior, you would think that we could at least watch sports without having political theatrics forced upon us.

And the owners need to acquire the backbone of other employers who insist their employees show respect to their customers and make that a requirement for anyone who wants to wear their uniform.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Better than Baseball by David Montgomery

Although October has been depressingly familiar for Washington baseball fans, it has been just the opposite for political observers. While Congress continues to dither, the President has been moving ahead to reverse the expansion of the Administrative State. And he has done so by using his executive authority to force Congress to do the work assigned to it by the Constitution.

In the case of immigration, the President sent a letter to Congress with a comprehensive plan for strengthening enforcement of immigration laws and screening out those who would be a threat or a burden. And he has been explicit about the message he wants Congress to hear: If you care so much about those who are now in the United States illegally, pass a law to change their status. I do not have the authority to do that on my own. Quite a contrast to President Obama’s “I’ve got a pen and I’ve got a phone. And that’s all I need.”

In the case of Obamacare, the President sent the liberal press all atwitter by terminating subsidies to insurance companies losing money under Obamacare. Again, he sends a message to Congress that they must fix the structural problems in Obamacare and not rely on the public purse to hide them.

Third, his EPA Administrator has declared that the Clean Power Plan put into effect by his predecessor is illegal, because it goes beyond what Congress authorized EPA to do in the Clean Air Act.

In taking these actions, the President is fulfilling what I saw as the most important of his campaign promises, to stop government agencies from issuing regulations that make new laws never passed by Congress. That is, he is challenging and attempting to rein in the Administrative State.

I admire the subtlety in President Trump’s cancellation of subsidies to insurance companies for many reasons. The subsidies make the insurance companies fat and happy and motivate them to work against his goal of reforming ACA. His action shows that the excessive delegation of authority made by Congress in ACA can be used to reduce as well as increase the administrative state. And he tosses the political problems back to Congress in a way that should send the message that Congress cannot avoid political responsibility for legislation by leaving all the details up to bureaucrats.

The critical flaw in the Clean Power Plan that took it to the Supreme Court is its insistence that electric utilities pay others to reduce emissions on their behalf in order to satisfy regulatory requirements. This is contrary to the explicit language in the relevant parts of the Clean Air Act that such requirements be feasible for the regulated companies to meet on their own.

I am known as an advocate of emission trading where appropriate, but only when applied through Constitutional processes in which its suitability for a particular task is examined openly, not by an agency using legal casuistry to require something prohibited by the clear wording of the law.

Likewise, I fully support the goal of open borders for all who qualify to be future citizens, but equally, strongly opposed President Obama’s refusal to enforce a clear requirement of the law – not to mention his willingness to accept the lazy and criminals along with those who support themselves and obey the law.

There are much broader issues at stake here than just these specific abuses of powers delegated by Congress in regard to immigration, environmental regulation, and Obamacare. It is the growing role of unaccountable administrative agencies in creating rules and regulations that go far beyond anything considered or authorized by Congress. Philip Hamburger calls this the “Administrative State” and describes its influence by saying “Americans must live under a dual system of government—one part established by the Constitution and another circumventing it.” The Trump Administration has been trying to rein in the Administrative State since its first day in office through its deregulation initiatives.

First, the Administration and Republicans in Congress are reversing the flood of regulations issued by his predecessors. Economically significant rules are defined as those with an annual cost of $100 million or more, and during the Obama Administration, almost 500 of these regulations with an estimated burden of $890 billion were issued. The burden of regulation accelerated under Obama, but it has been growing since the 1970s. Between 1995 and 2016, Congress passed 4260 public laws but the Executive Branch issued 88,899 new final rules. Since regulations have rarely expired or been repealed, this adds up to a growing cumulative burden. These regulations proliferate – 27 new regulations for every new law – because Congress delegates its legislative responsibilities to administrative agencies, which have proceeded without hindrance beyond what Congress intended.

In comparison, under President Trump agencies have pulled or suspended 860 pending regulations, and the number of economically significant regulations still in process fell to 58.

One of President Trump’s first actions was to require all agencies to re-examine their past regulations and eliminate two existing rules for each new one they issue. His Executive Order also required agencies to reduce the burden of existing regulations by an amount at least as large as the cost of any new regulations. Some of my colleagues in the field of environmental economics complained about this order on the grounds that costs should be weighed against benefits and not be the sole criterion. Although I agree with the principle, I am unconcerned about the application because among the regulations issued under the Obama Administration there are ample to choose from that do no net good.

This is also an area where Congress has done good, by exercising its authority to disapprove regulations and especially those issued by a lame-duck President. Voting under the Congressional Review Act, which limits debate on disapproval resolutions, Congress repealed 14 midnight regulations issued in the last days of the Obama Administration.

These actions are the beginning of an effort, with a clear populist base, to rein in the Administrative State that has grown in power and size for decades. Visible actions to limit and repeal unnecessary regulations only address part of the problem of the Administrative State. Like the iceberg, most of the Administrative State is hidden. Wayne Crews of the Competitive Enterprise Institute has called this “regulatory dark matter,” which he defines as “thousands of executive branch and federal agency proclamations and issuances, including guidance documents, memoranda, bulletins, circulars, and letters, that carry practical (if not always technically legally) binding regulatory effect.” None of these show up in the counts of regulations in the Federal Register, and they are subject to none of the public comment and appeal processes that apply to published regulations.

This is also a target of the Administration, and a particularly difficult one since decisions behind these memoranda and guidance letters and individual rulings are not made in open regulatory processes. They are made day to day by permanent bureaucrats buried in agencies and often difficult or impossible for their political superiors to reach and control.

One of the reasons for the expansion of the Administrative State before President Trump was the deference of the courts to decisions of regulatory agencies that did the proper paperwork, no matter how vague the facts or casuistical the legal arguments justifying them.

This is the major uncertainty about whether President Trump will succeed. Courts have already shown a willingness to block his Executive Orders that they never showed to his predecessors. Thus the question is whether courts will defer as readily to an Administration that wants to reduce the Administrative state as to one that wants to expand it. As Philip Hamburger put it “The courts often defer to the executive—both to its interpretations of law and to its fact-finding” and he decries this as depriving those who challenge regulations of due process.

What really matters here is the attitude of 5 Supreme Court justices. Some, like Justice Stephen Breyer, have attitudes toward actions of regulatory agencies that appear to go even further and sound more like admiration than deference. Once again, the key to Making America Great Again may be less in what regulations the President abolishes than in whom he appoints to the Supreme Court.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

 

Setting the Record Straight on Tax Reform by David Montgomery

Though I share Rob Ketcham’s concern about the risks of a last minute effort at tax reform, I do so for almost exactly opposite reasons.  My greatest fear is that a tax reform bill will pass with just 50 votes in the Senate, but that it will be so far from the original Brady-Ryan plan to be Tax Reform In Name Only.  If that happens, we will have missed a once-in-a-generation opportunity to complete the process that Ronald Reagan started, of fundamentally changing our tax code into one that encourages Americans to save and invest at home.

This does not seem to be Mr. Ketcham’s concern.  He seems to think that President Trump invented tax reform last Wednesday, when in fact Speaker Ryan spent two years developing the Blueprint for Tax Reform he released even before President Trump won the election.   The President’s message on Wednesday rested on a massive effort by the country’s greatest experts on taxation.

Having read these misrepresentations of tax reform, it appears that I need to try once again to explain the Brady-Ryan plan and why it would lead to substantial increases in investment, wages and economic growth.

The principles that guided Speaker Ryan and Chairman Brady were that tax reform must encourage investment, eliminate incentives for American companies to move overseas, and keep the deficit from increasing.  For personal taxes the goal was to simplify and lower taxes on the middle class.  Every aspect of tax reform in original Brady–Ryan plan that I described earlier this year was carefully designed to serve at least one of those objectives.  

Mr. Ketcham ignores this and singles out two provisions of that plan, elimination of the AMT and the death-tax, as examples of the President Trump’s selfish interest in tax reform.  Contrary to Mr. Ketcham’s allegations, the AMT has unintentionally become a paperwork and financial burden on the middle class and the death tax closes family farms and businesses. And despite the impression Mr. Ketcham creates, these are minor components of tax reform with little revenue effect.

The major parts of the Brady-Ryan plan address the shortfall of investment since the Great Recession.  According to the Bureau of Labor Statistics, growth in labor productivity and output from 2008 to 2016 was lower than for any comparable period of time since 1948.   There are many factors that affect productivity and growth, but investment in new plant and equipment and in R&D are most important.  

In 2010 net private investment had fallen to 1% of GDP, and by 2015 it had struggled back to about 4%.  From 1960 to 2008 net private investment never fell below 5% of GDP, despite Vietnam, oil embargoes, stagflation, and more oil price shocks.   The current lack of investment holds back wage growth as well, because wages cannot increase without productivity growth.  Past cycles in investment and the current low are clearly correlated with increases and decreases in the tax burden on investment.

Jobs and investment have also moved overseas as U.S. companies have moved their headquarters, invested in new factories and R&D centers, and sold themselves to other countries where they pay lower taxes.  This “base erosion” has also moved taxable income out of the U.S. and contributed to growing deficits.

Business pages report on the ballooning Federal deficit nearly every day, so that designing tax reform to avoid contributing to the deficit is an obvious policy goal.  But that is not the only reason it is central to tax reform in the Trump administration.  As long as Democrats make obstruction of President Trump’s initiatives their highest priority, the only way to pass legislation is by using the budget process to move tax reform without their help.

There is nothing underhanded about using the budget process in this way, but it is not a slam dunk.  The process starts with a Budget Resolution, which sets targets for revenues and spending and contains instructions for the committees that flesh it out.  Once those committees have acted, each House of Congress must pass a reconciliation bill to put the committee actions together into a package consistent with the original budget resolution.  That reconciliation bill requires only a simple majority to pass in each house, and it may contain new legislation if it is germane to the budget.   The Congressional Budget Act was designed from the start to make sure that a budget could not be held up by a minority.

The plan this year was to use reconciliation to pass tax reform.  This is where avoiding increases in the deficit comes in.  First, the House Budget Committee instructed the House Ways and Means Committee, which originates tax legislation, to make tax reform “deficit neutral.”  Second, the Senate budget process is constrained by the so-called “Byrd rule” which prohibits any tax cuts that would increase the deficit after 10 years.   That means that to pass the Senate, tax cuts must either expire after 10 years, as happened with President Bush’s tax cuts, or be designed to maintain or lower the deficit thereafter.

So now we see that tax reform must be deficit neutral over the next 10 years as a goal of budget policy and thereafter as a precondition for passage.  But who decides?

Mr. Ketcham sees all sorts of chicanery here.  According to the rules of the House and the Senate, the Budget Committees decide.  In the normal course of business, they rely on the Congressional Budget Office and staff of the Joint Committee on Taxation for revenue estimates.  Until recently, these estimates were based on a single macroeconomic forecast that was assumed to be unchanged by the legislation being analyzed.  This “static” approach has worked well for the mass of legislation that is not expected to have a major effect on the economy.

This clearly is not true of major tax legislation, especially when it is designed to increase incentives for and remove obstacles to investment in the United States.  Because of this, the Budget Committees decided that they wanted revenue estimates to take into account how changes in taxation would affect growth of the economy and thereby alter the net effect of tax changes on revenue.  

Adoption of “dynamic revenue estimation” was not popular among many revenue estimators, because it is difficult, requires development of new tools, and strains CBO and JCT’s resources.  I have banged my head on how to do it right myself.  But nobody denied the obvious fact that budget policy will be better informed if some attempt at dynamic revenue estimation is made than if it is not.

Having decided that they want dynamic revenue estimates, it remained up to the Budget Committees whose estimate to accept. Neither the JCT nor CBO have a track record or established role in dynamic revenue estimation, because the entire practice is new. Other independent organizations, like the nonprofit Tax Foundation and the Tax Policy Center, have done dynamic revenue estimates for some time, and the Treasury Department and Office of Management and Budget could also provide them.  

As a matter of law and practice, it is up to the Budget Committees to decide what analysis they want to rely on, and always has been. This is a power and responsibility no different than that of an agency head, member of regulatory commission, or judge who must decide which expert opinion on an economic issue to accept.  Neither CBO nor the staff of the JCT at this point have a monopoly on expertise about the new practice of dynamic revenue estimation.

So now to the merits of the Brady-Ryan blueprint for tax reform and how this week’s announcement by President Trump suggests it might be changed, focusing on stimulus for investment and growth.

The Brady-Ryan plan would stimulate investment in 3 ways – lower tax rates for corporations and pass-through businesses, lower tax rates on investment income, and immediate expensing of all types of investment.  Of these three, analysis by the Tax Foundation shows that immediate expensing is by far the most important.  Their analysis shows that full expensing accounts for about 60% of the increased revenues attributable to accelerated economic growth.

And it is the first provision sacrificed in President Trump’s plan.  Instead of full and permanent expensing, the more recent plan is to allow expensing for a 5-year window and then return to the current rules.  This is just foolish.  Most surveys of businesses I know of find that temporary tax cuts do little to change long-term strategies about where to locate new factories and how much to invest.   

Moreover, the revenue loss associated with expensing is greatest in the first 5 years.  Expensing a large investment can eliminate tax liability in early years compared to depreciating it, but after the deduction of investment expense is fully utilized the company will have no depreciation to claim going forward.  Thus its taxes will increase in later years.   The additional economic growth stimulated by permanent expensing will also offset the early revenue loss, so that the Byrd rule’s requirement for deficit neutrality after 10 years is easier to satisfy.  Giving expensing for only 5 years may limit its revenue loss during the 10-year budget window but just makes the Byrd rule problem worse.

Now I will move to the goal of keeping jobs and investment here at home.  Contrary to what Mr. Ketcham believes, the one-time tax on the retained earnings of foreign affiliates of US companies is not intended to provide a stimulus to investment, but rather to provide revenues to offset the effects of rate reductions and expensing.  His mention of the failure of past “tax holidays” to induce corporations to bring back money they were hoarding overseas is a red herring.   A tax holiday offers a carrot of temporarily lower tax rates on overseas earnings that only means something if there is a stick of much higher taxes in the future.  

The Brady-Ryan plan recognized the futility of that effort.  Instead it and the President’s plan would tax all foreign earnings still held in overseas affiliates of U.S. corporations whether or not they are transferred to the U.S. parent’s books.  This one time tax has the sole purpose of raising revenue.  The second part of both the Brady-Ryan and the President’s plan is to make all future dividends paid from foreign affiliates to US parents tax-free.  The whole idea is to make sure that U.S. taxes don’t keep our corporations from bringing back foreign earnings for dividends or investment in the U.S.   

But these two provisions still don’t address the problem of U.S. companies finding it advantageous to move their factories to foreign countries, so as to avoid U.S. taxes on earnings from manufacturing and R&D done here.

The problem is that other countries generally rebate taxes when a company exports goods produced in that country, and impose their Value Added Taxes or other direct taxes on goods that are imported.   We do not do that – U.S. companies pay income taxes on revenue from exports just the same as they pay taxes on revenue from domestic sales, and foreign companies pay no taxes on income they earn from exporting goods to the United States.

The Brady-Ryan plan had an elegant solution to this problem:  exempt all earnings from exports from income tax and eliminate the deduction from income tax for the cost of imported goods.  All of a sudden, there would be no incentive to move overseas to pay lower taxes on income from goods produced for shipment to the U.S. market or for export to third countries.  In addition, since the U.S. is a net importer, this provision would provide revenues needed to offset the effects of immediate expensing and rate cuts.

Even better, a little thought about how this “border tax adjustment” would affect imports and exports leads to the conclusion that it will be paid for by other countries, not U.S. consumers.  All else being equal, the effect of higher taxes on imports and lower taxes on exports would be an immediate drop in the U.S. trade deficit.  But that cannot happen if tax reform is deficit neutral, because it is also an economic fact of life that our trade deficit mirrors our borrowing from overseas, and that borrowing is driven by budget deficits.  To keep the trade deficit from changing, the dollar will appreciate until the entire burden of the border adjustment is born by our trading partners who will get fewer dollars for what they export and pay more in local currency for what they import.

Unfortunately, our elected representatives have chickened out on the border adjustment.  A coalition of retail interests and big contributors convinced many legislators dependent on their support to declare against the border adjustment before they had any explanation of how it would work.  In its place, the President proposes a minimum tax on all foreign earnings of foreign affiliates of U.S. companies.  This is small beer compared to the border adjustment, fraught with difficulties of defining income to be taxed and preventing companies from avoiding the tax, and will leave U.S. corporations at a disadvantage to foreign corporations that operate in those low-tax jurisdictions.

The proposal to eliminate interest deductions for businesses is a “base broadening” measure intended to raise revenue needed for the rate cuts that will stimulate investment.  It also has benefits of its own, by eliminating a subsidy for debt financing that has made corporations more highly leveraged and prone to bankruptcy, and made it harder for small, dynamic firms that need equity finance to compete.   The President’s plan is to narrow eligibility for the interest deduction rather than eliminating it completely.  This change will weaken its good effects and, more importantly, reduce the amount of lost revenue it can offset.

Thus Mr. Ketcham and I have some areas of agreement.  I do not want to see real tax reform derailed by TRINOs for another generation, and I don’t want contrived budget estimates to conceal the inferiority of the latest incarnation of tax reform to the original Brady-Ryan plan.  I am actually a great deal less worried about the second than the first, because I believe there are plenty of good Republican advocates of tax reform to keep the process honest, if not necessarily going in the best direction.  I think many will share and express my opinion that the most recent proposals are not revenue neutral and that they fall far short of the Brady-Ryan plan in what they would do for investment and growth.  

Finally, to the virtues of bipartisanship in tax reform.  I do not know of anyone in the White House or Republican leadership who would not be delighted to have a bipartisan, permanent, growth-oriented tax bill.  But it takes two to tango.  Singling out Republicans for blame when Democrats show no more willingness to work together for the good of the country is pure partisanship.

To my eyes, the problem is that Democratic leaders have made it very clear that they care only about redistribution in tax reform, no matter what damage that does to incentives and economic growth.  Indeed, President Trump moved toward Democrats’ wish to redistribute income when he indicated willingness to impose a surtax on the highest incomes.  

I tried in my earlier column to add something to attract moderates in both parties by offering an approach to climate change that they should all like.  That was a carbon tax along the lines proposed by George Schultz and other old-time Republicans.  

Their proposal combined a carbon tax that I thought would provide useful revenues in a tax reform package with legislation to remove all the unnecessary regulatory measures that the Obama Administration imposed in its Climate Action Plan.  A double dividend for growth

But readers of this column have had a preview of the likely reaction of the Democratic leadership.  When I made this proposal, our own Senator Van Hollen immediately contacted the Spy to correct the record and make his position clear: more taxes, great, but less regulation, no way.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

 

No Easy Solutions by David Montgomery

Once again, attempts by the Senate leadership to design an Obamacare replacement that can gain 50 votes are back in the news. It should not be a surprise that this is a hard task. Very few politicians appear willing to admit that there is no way to give every American all the health care that he or she wants without making someone a great deal worse off.

It is not necessary to be an expert on health economics to diagnose the problems with Obamacare itself and every attempt to replace it. Nobel prize-winning economist Kenneth Arrow did so 50 years ago in an article that started systematic economic thinking on the subject. He emphasized the unique character of the doctor-patient relationship and gave names to three fundamental problems of health insurance: asymmetric information, adverse selection, and moral hazard.

Asymmetric information simply means that the prospective patient knows more about his or her health condition than the insurance company. This means that if everyone is offered identical insurance at identical premiums, those that are relatively healthy will decline to purchase insurance, leaving the insurer with only the less healthy as patients. This is the fundamental problem of adverse selection.

To prevent adverse selection, health insurers may require physical examinations, put limits on coverage of pre-existing conditions, and charge premiums that differ by age, sex, and other factors correlated with health status and unchangeable by the insured. It is also the reason that insurers offer a variety of plans, so that those who believe they are healthy can choose plans with low premiums and limited benefits.

A closely related problem is that having insurance leads to greater use of healthcare unless there is some form of rationing or coinsurance. This is the problem of moral hazard, in which the patient (and doctor) are likely to choose more costly and marginally more effective treatment if a patient has health insurance than if he or she does not.

Insurance companies use coinsurance to provide some incentive for the patient to avoid totally unnecessary expenditures, such as visits to the doctor or emergency room for the common cold. This has been augmented by managed care plans, requirements for pre-approval of procedures, and exclusion of certain treatments. Arrow thought that the relationship of trust between doctor and patient that he observed in 1963 would also reduce moral hazard.

Unfortunately, the healthcare system more broadly seems to defeat these efforts to limit moral hazard. When insurance covers a large portion of costs, hospitals cannot compete for patients on price and instead compete on quality by offering the best and newest equipment and the most famous surgeons. This inflates everyone’s costs Moreover, cost-based insurance reimbursement formulas for hospitals can also encourage premature replacement of equipment.

The elephant in the room for moral hazard is, of course, malpractice liability. A noticeable difference between the United States and countries that are claimed to have better and cheaper health care is that no other country allows the kind of lawsuits that have caused the cost of malpractice insurance and defensive testing and treatment to explode here.And those costs are fully reflected in the pricing of medical services.

The fundamental requirement of an insurance system is that it collect enough premiums to pay claims and build a reserve to cover the uncertainty of needs for medical care. Prior to Obamacare, health insurers used the practices I have described to attract enough subscribers to remain solvent. No one was forced to buy insurance so that premiums and coverage were tailored to maximize revenue while exclusion for pre-existing conditions kept costs down, to the extent permitted by regulators in each of the 50 states. The indigent were covered by subsidized insurance through Medicaid or by hospital emergency rooms that spreads the unreimbursed cost through their paying customers.

Obamacare broke this system by requiring everyone to purchase health insurance, requiring coverage of pre-existing conditions, and limiting the ability of insurance companies to charge higher premiums to groups likely to make higher claims. The result made nobody happy, because it ran into the iron law that the less one group pays into the system, the more others will have to pay in order to keep the system solvent. This is true whether the insurance provider is a for-profit insurance company, a non-profit insurance company or the government.

Despite its ironically inaccurate title of “Affordable Care Act,” the clear purpose of Obamacare was to make sure that every American family was covered by health insurance. This includes those who decided they did not need insurance at the premiums offered by insurance companies, those who could not afford insurance (which is another form of deciding not to participate), and those who were excluded due to pre-existing conditions.

The method of getting each group into the system differed.

The young and healthy were required to buy insurance whether they wanted it or not, and minimal coverage plans were prohibited to ensure that they put more than a toe in the water. This made all of that group unhappy.

Those denied coverage were guaranteed coverage, and insurance companies were prohibited from charging premiums high enough to pay for their expected claims.

Medicaid was expanded to increase subsidies to the poor so that they could afford insurance, and insurance companies were granted subsidies. This necessitated the tax increase that went along with Obamacare.

Premiums for all those who were already insured rose to help pay for all this, and premiums for those forced to buy insurance for the first time became even higher than the premiums they had previously declined to pay. This infuriated those who were getting what they wanted from the previous system.

The failure of Obamacare arose from incompatible goals: universal coverage, limits on premiums charged the highest-risk groups, lower rates or free insurance for the poor, limits on taxpayer subsidies, and no increase in premiums to those already insured.

Those goals proved impossible to achieve simultaneously given the current state of the broader healthcare system. To fix Obamacare, Republicans must decide which goal to sacrifice or else address those broader problems. As usual, politicians on all sides are pretending that there are not any hard choices of who to benefit and who to hurt.

If Obamacare continues to be dealt with in isolation, eliminating coverage mandates will just increase the insolvency of the system as those who never wanted insurance to drop out. That makes it necessary to increase premiums, increase taxpayer subsidies or limit coverage, since insurance companies cannot be forced to operate at a loss forever.

Simple repeal of the Affordable Care Act would work, and the politics are clear. Those who do not want the insurance they are forced to buy would be satisfied, and those who had insurance before would see their lower rates return. Those paying higher taxes to support the current system would also benefit from its repeal. Those with pre-existing conditions would face higher premiums or denial of coverage and Obamacare-based subsidies to allow the poor to afford insurance would cease.

Different political and ethical judgments about which of these groups is most deserving will lead to different preferences about how to change Obamacare, and it is clear that Republican Senators do not agree about those judgments. Unwillingness to admit that difficult choices must be made does not help with resolving such disagreements.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Op-Ed: Would Nelson Mandela Remove Statues of Lee and Jackson? By David Montgomery

Those who want to ban or destroy all symbols of the Confederate States of America need to learn from Nelson Mandela. For no particular reason, I put the movie Invictus in my Blu-ray player last night and viewed it for the first time. It is the story of how Nelson Mandela used the national rugby team of the apartheid government as a means of national reconciliation. Their rugby team, known as the Springboks, were hated by Mandela himself and the black majority as a symbol of apartheid, and an opening scene shows white faces rooting for the Springboks and black faces rooting for their opponent England during the first international match after sanctions on South Africa were lifted.

In a later scene, the South African Sports Union votes to change the name and colors of the Springboks to erase what they saw as symbols of racism. Does this sound familiar yet? Mandela intervenes and insists that the Springboks retain their name and colors. He explains that the Springboks and their colors are revered by the Afrikaaners and that preserving them would be a significant gesture of reconciliation toward the white minority. In another notable scene, Mandela attends a rugby match in which many whites were waving the old Union flag of the apartheid regime. When his assistant whispers that they should be banned, he whispers back that “it is their constitutional right, and we decided already not to ban the flag.”

Invictus no doubt exaggerates the success of Mandela’s support for the Springboks, though South Africans of all colors are now Springbok fanatics. Nevertheless, it was a part of Mandela’s much broader policy of forgiveness and reconciliation, a policy that prevented South Africa from descending into the madness of Zimbabwe and made it a more successful multiracial country than any other in Africa.

Unlike Mandela, politicians of both parties in the United States are pandering to uninformed animosity toward any person, thing or symbol associated with Secession or with how the South fought the Civil War. It is particularly galling that the Republican Governor of Maryland, Larry Hogan, approved the midnight removal of statues of Civil War soldiers by the mayor of Baltimore.

No matter what you think about a historical event or period, erasing the memory of it is always a bad idea. So is destroying symbols that are meaningful to other groups of fellow citizens. It is said that history is written by the victors so that history books say little or nothing about the motivations, conduct or virtues of the losers. We know a great deal more about what the Romans thought of the Carthaginians than what the Carthaginians thought about themselves or the Romans. Our fellow Americans who served the South deserve more of an effort at understanding.

Tearing down statues of predecessors is a universal practice in countries where succession is based on intrigue or coups rather than democratic processes. Stalin and Khrushchev both removed depictions of prior leaders and struck reference to them out of official histories. So does every new dictator who murdered his predecessor along with his supporters or clan.

Surely, no one wants to follow these examples in dealing with the South and the Civil War.

Granted, there are times when seeing a statue toppled is gratifying and consequential – the fall of communism was celebrated throughout Eastern Europe by destroying statues of Lenin, and I cheered as much as anyone at the confirmation that we had won the Cold War. Statues of Hitler and Nazi monuments likewise were eradicated quickly after the Second World War, and Germany banned the Nazi flag just as we seem to be heading toward banning the battle flag of the Army of Northern Virginia.

But not all examples of triumphal destruction of symbols of the previous regime are good ones. Greeks celebrate the soldier who wrapped himself in the Greek national flag and jumped off the Parthenon when forced to desecrate it by Nazi invaders. Muslim victors have destroyed the religious symbols of conquered peoples from the time of Mohammed to the reign of ISIS. The same liberals who were outraged when radical Islamists defaced ancient Buddhist monuments are now applauding the destruction of monuments of the Confederacy.

Unfortunately, some of those who want to remove memorials to Confederate soldiers and leaders and other symbols of secession put the Confederacy in the same moral category as Nazis and see the removal of all signs of the Confederacy as no different from the elimination of Nazi symbols. And they adopt the same triumphalism as ISIS.

That is historically inaccurate, morally indefensible, and an atrocity against civil society. First, let’s take our own example of misdirected outrage. The statue to the Talbot Boys lists the names of men who died in the Civil War. Very few Confederate soldiers owned slaves, and historical accounts that pay attention to who they were and why they fought overwhelmingly to conclude that they fought for the same reasons as all other American soldiers throughout history: to defend their loved ones and communities against aggression and out of loyalty to the men standing next to them. They have been buried side by side by Union troops and given the same recognition as American veterans.

The Southern leaders targeted by Maryland’s governor and the mayor of Baltimore are no less worthy of memory and respect. Robert E. Lee was more conflicted than most. He was opposed to slavery, wanted to work toward its abolition, and tried to prevent secession. It was only after he concluded that Lincoln would not deal peacefully with the South that he took the job offered by his home state of Virginia to lead its army. Stonewall Jackson was one of the greatest tactical commanders in history, and his character and ability need to be recorded and remembered. I honor both men highly and am outraged at seeing their statues removed and names erased. And I am no neo-Nazi or white supremacist.

Granted, there are also statues of evil Southern aristocrats who maneuvered the South into Civil War and scoundrels who benefited from it, but remaining aware of misdeeds and their consequences help us to identify similar acts and politicians today. There are a great many statues of figures not associated with the South or slavery that I would like to see torn down first, not to mention almost all signs naming bridges after politicians.

What I find morally indefensible and a civil atrocity is the accompanying effort to depict anyone who defends the display of the so-called “Confederate flag” or monuments honoring Confederate heroes as a white supremacist or worse. That is at its most innocent a reprehensible form of bullying and name-calling intended to silence anyone who would defend those symbols. In its worse manifestations, it is an incitement to violence, as we have seen in the recent physical attacks by Antifa groups against peaceful citizens of a less left-wing temperament. At most malignant, such name-calling is a predecessor to the kind of laws that let Canadian and German officials jail or fine anyone who flies a prohibited flag or says something offensive to a sensitive group.

Destruction of symbols important to many for innocent reasons is also politically stupid, as Nelson Mandela clearly saw. To paraphrase Mandela’s lines in Invictus, he pointed out to those who disagreed about preserving the Springboks that “we have to live with those who are passionate about this symbol, and destroying it will just alienate them from the united country we want to build. The rainbow coalition contains white as well as other colors.” He could see the difference between symbols of innocent loyalties to teams and the banners of armed resistance to his government. He was also willing to eviscerate the militant arm of his own party.

The destroyers of Civil War heritage do not seem to share Mandela’s understanding. They demonize everyone with a different understanding of the South and its role in the Civil War and pursue a triumphalist strategy that is destined to achieve just the opposite of what they wish. They may frighten many into silent acquiescence with their destruction of treasured symbols, but at the same time, they create much more sympathetic feelings toward the very few true white supremacists who exist today.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Op-Ed: Disaster Relief and Flood Insurance by David Montgomery

President Trump’s economic, political, and moral instincts are right when he calls for $6 Billion in Federal aid for Houston. To take the last first, giving aid to those who have lost much or everything is right for civil society and government as well. The problem both face is how to do it effectively. That requires planning and rebuilding far beyond the scale of clothing drives or even what effective, community based relief organizations like Catholic Charities (a plug for my favorite charity) can do. Hence the role for government and the moral obligation to support that funding.

Offering aid with no strings attached is politically wise, especially because it is not political payback. As another columnist pointed out, Houston was one of the few regions in Texas that Hillary won, so that everyone should understand that this is not generosity motivated by Red-state favoritism. President Trump has not had much time to promote his program of infrastructure spending, which is the one part of his platform with bipartisan support. His unconcern with the budgetary consequences of this relief effort should reassure Democrats that he is sincere in his desire to spend. At the same time, his deference to the governor of Texas and the good things the Governor said about him will please his base and other Republicans. Rarely does a politician get to make both sides happy.

It is on the economic side that questions might be raised about the implications of such an increase in spending, starting with how it will be fit into the Federal budget. Will the increase in Federal spending to rebuild the area of Texas ravaged by Harvey derail plans to reduce taxes? Will it have to come out of defense or other high priority spending? Or will it be added to the already enormous Federal debt?

I will argue that the correct economic answer is to let the additional spending ride directly into the Federal deficit and debt. This is also the most likely procedural outcome. Both these conclusions rest on the unexpected and extreme nature of the event. The whole point of saving and borrowing is to make it possible to minimize unnecessary economic harm from unexpected events. True, we have done a lousy job of saving as nation, but that does not mean that we should not tap into our continuing ability to borrow when an extraordinary need arises.

The problem with the rising national debt is that it is driven by the intended and predictable growth of spending on entitlement programs – a classic case of living beyond our means and passing the problem onto our children and their children. Nevertheless, the United States government remains able to borrow additional funds, and an occasional unexpected expenditure need not alter the timing of policies intended to deal with longer-term problems of national security, economic growth and debt reduction.

The alternatives to additional borrowing are reducing planned spending on other programs or increasing tax revenues. Both alternatives are political minefields, and would forego the long-term benefits that restoring military strength and tax reform are expected to provide. Politically, further cuts in domestic programs would strengthen Democrats opposition to the Trump budget and increase Republican defections, and taking away from increases in defense spending would outrage Trump’s base (and me, to make my preferences clear). Tax reform is already stalled because of lack of ways to offset revenue loss from rate reductions and increases in investment incentives. Its problems would just be made worse if revenue must be raised for Houston as well as offsetting tax reductions.

The most worrisome consequence of this additional borrowing is very arcane: how it will affect the Federal Reserve System’s plan to correct its balance sheet. A great deal of the recent increase in Federal debt was acquired directly by the Fed and put on its balance sheet as an asset, and the Fed has announced a schedule for selling off that debt. A new increase in borrowing by the Federal government could upset the Fed’s delicate calculation of how its selloff will affect interest rates and as a result slow its progress toward a normal balance sheet which puts it less at risk.

Procedurally, there is no obstacle to increasing the Federal deficit to accommodate disaster spending. Anticipation that disasters requiring added Federal spending will on occasion occur is the reason why the Congressional Budget Act allows the budget to be revised through Reconciliation Instructions.

The paramount procedural question is how to deal with the Federal flood insurance program. Economists (including me) have long criticized that program for subsidizing flood insurance in a way that encourages development in vulnerable areas – and even my friends in the Intergovernmental Panel on Climate Change have concluded that the increased economic damage done by tropical storms is due to increased development rather than increased storm activity.

Now it is pretty clear that the extent of subsidization will become politically relevant – when the reserves of the flood insurance program are deleted by claims for damage by Harvey. Since flooding from Harvey is characterized as a 500 year event, it is likely that the reserves of the flood insurance program would have been deleted even if premiums were much higher. That is why additional Federal aid to Texas is justified. At the same time, the magnitude of the loss should signal policymakers that rates for Federal flood insurance should be increased to levels based on an actuarially sound calculation of expected payouts. After all, the definition of “insurance” is pooling of funds to share risks not a free payout for damage.

That premium is still likely to be less than the rate that a private insurer would require, for reasons also made clear by Harvey. Whereas the Federal government can use its borrowing capacity to cover claims in excess of reserves, the ability of even large insurance companies to do the same is limited. Therefore private insurers must include a risk premium to build reserves against the possibility of the “gamblers ruin” while the government does not need to do so. That is why there has to be cap on the amount of coverage provided by the Federal government to avoid driving private insurers out of the market.
Extraordinary disaster relief is another form of risk spreading that is appropriate for unforeseen events, and government insurance spreads that risk over the largest possible pool. But that does not excuse subsidies in the form of premiums that do not generate enough revenue to pay foreseeable claims.

Unfortunately, the political calculus for this most needed reform leads to the opposite conclusion from the economic one. But if predictions of sea level rise and increased storm activity with climate change do turn out to be even partially correct, ending flood insurance subsidies will become more and more necessary and extraordinary relief after the fact will be less justified. There is little reason to believe that the growth of the Houston area was driven by subsidized flood insurance, but that is not true of many other areas that could become increasingly vulnerable to flooding. Including the Eastern Shore.

Therefore, I anticipate comments similar to those made in response to an earlier column in which I defended reduction of Federal funding for Bay cleanup in favor of an interstate compact. My answer is the same, though I will be less colorful. We cannot move toward national policies designed to promote the common good unless some of us are willing to stop taking Federal money for things we could do for ourselves. Because of where I live, I would surely pay a great deal more for flood insurance if I could not get some from the Federal program. My choices of where to live and how to build would likely change if I did bear those costs. That would be a good thing for the economy as a whole, even if it changed the amenities that some of us could afford.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Is Message More Important Than Facts? By David Montgomery

Never have I thought I would write a column about something that was written about me.  The self-referential topic makes my head spin.  Nevertheless, a recent article that claimed I had single-handedly (well, with one colleague) held back progress on climate policy for 25 years makes me think there is something worth sharing.

Since I have a perverse sense of humor, my first reaction was to send a copy of the article to many friends, asking them to help me celebrate one of the finest compliments ever paid to me.  But the column provoked too many disturbing thoughts to leave the matter there.

The article was titled “Unmasking the Climate Deniers.”  Its stated purpose was to “investigate more deeply the forces driving delay” in climate policy.  In itself, that is an interesting and admirable topic.  Political scientists could analyze the dynamics of American politics, the polarization of the electorate, the dominance of constituency service in the US Congress, and the ability of a minority to block legislation.  Experts in international affairs could examine the incentives to join a treaty to manage a global public good and the difficulty of enforcing such a treaty.  Policy analysts could evaluate the actual legislative proposals and regulatory actions to ascertain whether they would achieve their purposes in a cost-effective way.  Public opinion specialists could measure the depth of public support for action.

Instead, the writer knew that the answer was much simpler: “Throughout the 1990s, the American Petroleum Institute…repeatedly relied on economic models created by two economists, Paul Bernstein and W. David Montgomery, to argue that pro-climate policies would be devastatingly expensive.”  The author then cites studies he claims we did in 1991, 1993, 1996, 1997 and 1998, and drives the nail in our coffin by reporting that “the first two authors of the report Trump cited [in withdrawing from the Paris Agreement] are Bernstein and Montgomery.”  He concludes from all this that “The same arguments – and people – used by the fossil fuel industry to block climate policies decades ago are back.  For the sake of humanity, we must not let them succeed again.”

The idea that studies that Dr. Bernstein and I were responsible for the slow progress of climate policy is so absurd that all it deserves in itself is a good laugh.  But if we realize it is a symptom of much deeper problems, it deserves more attention.   Unimportant as this article was, it was a perfect example of four disturbing trends in public discourse: carelessness about facts, unwillingness to listen to the reasoning of those we disagree with, uncritical acceptance and repetition of statements by politically congenial sources, and finally, the wholesale politicization of academic disciplines.

The article reveals quickly how careless advocates are about facts.  We could start with the title of the article, because neither Dr. Bernstein nor I have ever denied that there is a scientific basis for concern about climate.  Continuing down his list of grievances, the author obviously did not read more than the title of my (Dr. Bernstein and I had not yet met) 1991 study, because that is all the hyperlink in his article provides.  Had he even read the executive summary, he would have seen my conclusion that a carbon tax or gasoline tax would be much more cost-effective than fuel economy standards in achieving greenhouse gas reductions.  Hardly a torpedo against carbon dioxide controls, unless any criticism of any climate policy, no matter how bad, makes you a denier.

Sometimes distortion of facts is an intentional effort to deceive, but in this case it may just be intellectual laziness and bias so deep that it eliminates all thought of checking facts.  This tendency shades over into the more deadly disease of unwillingness to confront the actual substance of arguments that reach distasteful conclusions – or even read what those arguments say.  The author calls Dr. Bernstein and me “co-opted scholars” because, among other things, we pointed out flaws in the Kyoto Protocol.   

His citation to our 1996 work on the Kyoto Protocol is a hyperlink to a Greenpeace broadsheet against Exxon, which is also the apparent source of his only criticism of the substance of our work: “they ignored the negative costs of climate change, and suggested that clean energy would never be price competitive with fossil fuels.”

The problem with this criticism is that in the case of Kyoto, there were no benefits to ignore, and we were and are right about renewables.  Our critic either failed to investigate those possibilities or suppressed what he knows.  

The Kyoto Protocol never gained much respect among experts on climate policy.  Researchers at MIT’s Joint Center for the Science and Policy of Climate Change wrote: “Kyoto Protocol … costs are borne by the United States—the U.S. pays almost two-thirds of the global cost …”  

The consensus of climate scientists on the benefits of Kyoto was stated by one of their number: “. . . the long-term consequences are small. . . . The influence of the Protocol would, furthermore, be undetectable for many decades.”

Substantial costs to the United States, as we said, and virtually no effect on global warming.

The problem with attacking us for suggesting that clean energy would never compete with fossil fuels is that we are correct.  According to the Energy Information Administration, even by 2022 the cost of wind and solar will still exceed the cost of natural gas fired generation (and they do not count the amount of additional backup capacity that must be built because wind and solar are not always available when needed).

It is very disturbing that our critic does not seem to care whether what we wrote was right or wrong.  All he needs to know is who funded some of the work and what its conclusions were.  A diatribe by Greenpeace was all he needed to read.  

A short paper I wrote in 1998 is my critic’s last piece of evidence that I am a mouthpiece for the oil industry.  It was based on testimony I gave at a Congressional hearing alongside the chairman of President Clinton’s Council of Economic Advisors, Janet Yellen.  My conclusion was that “Given her assumptions, Dr. Yellen’s analysis is internally consistent and compatible with mainstream economic analysis. However, … Dr. Yellen has assumed worldwide permit trading and very extensive purchases of these permits by the U.S., whereas the Kyoto Protocol includes only limited trading possibilities and may preclude such extensive U.S. purchases.  If these assumptions fail to materialize, the administration’s estimates of permit prices and GDP costs will need to be adjusted upwards by a factor of ten or more.”

I am rather proud of that testimony, and was complimented on it by Dr. Yellen’s staff at the hearing.  Citing it as evidence of my bad faith simply shows that my critic never bothered to read it.

In a previous column, I discussed the false statements made about how my colleagues and I performed the study cited by President Trump, including claims that we failed to account for jobs created by renewable energy and that renewables make electricity cheaper.

Our critic brought to my attention that this is exactly what Greenpeace stated in a broadsheet dated May 2002.  That is not only the only source of our critic’s knowledge of what we did, it makes the same statements as the attacks on our most recent work.

These statements were untrue in 2002 and untrue now.  It appears that the environmental know-nothings have been quoting each other and not bothering to read the works they condemn for at least the past 15 years.  

That is not unusual.  True believers do tend to associate with and believe only one another, but scientists and scholars are expected to consider and evaluate all points of view.  

What makes me most unhappy is the author’s biography: “… a former research fellow at … the Harvard Kennedy School of Government, [he] is a doctoral student in the history of science at Stanford University, where his research focuses on climate politics and the manipulation of science “ A topic that does not even pretend to weigh the evidence for whether its hypothesis is true or false.  

My own PhD is from Harvard; I have taught at Stanford and participated from 1980s to the present in Stanford’s Energy Modeling Forum, where the models the author of this diatribe dismisses as “co-opted” were presented, peer-reviewed and published.  To me the most disturbing aspect of all this is that those two institutions are turning out graduates with so little capacity for logical thought and such careless research practices.  To put it more simply, how can you claim to be doing a PhD when you never learned to do your homework?  

I truly hope that some historians getting PhD’s at Stanford learn how to do more than write propaganda, but perhaps that is how far the liberal arts have fallen.  Being rewarded for careless and politicized scholarship, this young man may well join the ranks of professors who have abandoned all pretense of rigor or objectivity and perpetuate the views they taught him on another generation.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

Climate Policy Lessons from California by David Montgomery

California was the first state to enact comprehensive legislation to reduce greenhouse gas emissions, and a key part of that plan – the emission trading system – will sunset in 2020. Paradoxically, environmentalists are leading the opposition to California Governor Brown’s effort to extend and improve the cap and trade system, and businesses are supporting it. This conflict serves as an illuminating case study of the difficulties that states face in making climate change policies work.

The cap and trade system has been hailed as the great achievement of California’s climate strategy but it has been hamstrung by the proliferation of regulatory measures. Although Governor Schwarzenegger highlighted emissions trading in his Executive Order that introduced the strategy, he made the colossal error of turning design of the strategy over to California’s existing bureaucrats. As a result, the “Scoping Plan” that emerged was 80% regulation and at best 20% cap and trade. The bulk of the emission reductions would come from fuel economy standards, mandates for alternative fuels and renewable electricity generation, efficiency standards, regulations on shipping and trucking, industrial process standards, etc. listed in a 198 page appendix to the Scoping Plan. The cap and trade system would clean up around the edges to achieve the remaining reductions.

As a result, the ability of the cap and trade system to achieve certainty in emission reductions while minimizing cost was destroyed. The proliferation of command and control regulations (known in California as “complementary measures”) made the cost per ton of emissions avoided in the transportations sector several times higher than the cost per ton of emissions avoided in the electricity sector, and doubled the overall cost of achieving California’s goals.

There were several reasons for this failure to rely more heavily on cap and trade, and they are still in play. One is clearly bureaucratic incentives and inertia. The Air Resources Board was given the lead, and its approach to air quality regulation has always been heavily command and control. Every other state agency was invited to submit its ideas on how to reduce emissions, and naturally every one suggested more regulations that it could issue and administer.

There is also simple arrogance. The California Air Resources Board has a long history of asserting that it has a better understanding of technology and economics than the industries it regulates, and has not hesitated to tell them what technologies to develop and adopt. Cap and trade means leaving these decisions up to individual businesses, and the ARB has never been willing to relinquish that power.

Although one environmental organization, the Environmental Defense Fund, was from the start a strong supporter of cap and trade, many environmental organizations preferred strict command and control regulations for the ostensible reason that they gave greater certainty that reductions would be achieved. Underneath this rationale, which is entirely specious with a cap and trade system that puts a strict limit on the total number of emission permits that may be traded, is their desire to use regulation to achieve purposes beyond its ostensible objective of reducing greenhouse gas emissions.

In particular, these environmental organizations and allied trade associations prefer the regulatory approach because it promotes specific fuels and industries that would not survive if a cap and trade program were used exclusively. Thus California’s low carbon fuel standard mandates use of ethanol and other biofuels, creating a market and increasing profits for their producers. California’s renewable portfolio standard requires utilities to buy solar, wind and other “renewable” energy sources no matter how their cost compares to natural gas. California’s electric vehicle program creates a market for battery manufacturers and car-makers like Tesla. And so on to creation of smaller and smaller market niches for favored “Green” industries that could not exist otherwise. Relying solely on cap and trade would be at least equally likely to achieve California’s climate goals, but cap and trade would direct investment to the most cost-effective approaches and in the process leave behind more costly but politically favored fuels and technologies.

The so-called Environmental Justice movement took this opposition to cap and trade even further, though the fact that greenhouse gases are no more concentrated near their sources than half the world away should have kept climate policy off their radar. Nevertheless, EJ activists raised specious concerns about cap and trade allowing factories and powerplants to continue polluting poor neighborhoods. They then demanded increased funding for unrelated policies or programs benefiting their constituents as the price for moderating their opposition.

Willful ignorance has been encouraged by the California press which panders to the Environmental Justice movement with misrepresentations of how cap and trade works combined with horror stories about how it would allow industries to continue to pollute poor neighborhoods. Some news articles characterize cap and trade as allowing businesses to pay to pollute, without mentioning that the overall cap guarantees that emission targets will be met. Others moan about how the greenhouse gas cap and trade program failed to solve pollution problems unrelated to climate change.

Some real problems with the California climate strategy were raised by businesses concerned about how the system could damage to their ability to compete with out-of-state suppliers. For some products and regulations, this is not an issue and for others it is critical.

For example, all suppliers of fuels into California, no matter where they are located, must comply with the low carbon fuels standard, and likewise suppliers of electricity. But oil refiners outside California are subject to neither California’s regulations of emissions from the refining process nor its cap and trade program.

These costs are borne only by California refiners, and since gasoline is a fungible commodity easily shipped to California from other states, tighter regulations or high prices for emissions allowances could cause California refiners to shut down. If this were to happen, there would be no reduction in global greenhouse gas emissions, just a shift in those emissions from California to other states. And since those emissions do no local harm, the result would be costs to California with no benefit for global warming.

To deal with this problem, it is necessary to identify industries that are vulnerable in this way and to modify how they are treated under both regulations and cap and trade. This is an unavoidable problem when states attempt to go it alone in dealing with the global phenomenon of climate change. But it also invites rent-seeking by industries and accusations of caving in to big business or big oil.

All of these obstacles to adoption of a sensible and cost-effective policy can be seen in the controversy over renewal of authority for a cap and trade program. The specific bill supported by Governor Brown deals with some of industry’s concerns, by restricting the authority of state agencies to issue new regulations on greenhouse gas emissions covered by cap and trade and by limiting both how high and how low the price of emission allowances can go.

All of this makes perfectly good sense. The legislation would prohibit the Air Resources Board from issuing new regulations requiring additional reductions in emissions from refiner processes. This provision has been attacked as caving into big oil, when in fact it does nothing but reduce the chances that California refineries will shut down and be replaced by refineries from outside the state with even higher greenhouse gas emissions. It has no effect on California’s total emissions, as the overall cap under cap and trade takes care of that. And if additional emission controls at refineries are cost-effective at the price of carbon established by cap and trade, they will be undertaken anyway.

Likewise setting upper and lower limits on carbon prices is a balanced and useful step. Many environmentalists complained about how low carbon prices were in recent auctions by the state of some permits. By setting a lower limit on carbon prices, the cap and trade system gives a more consistent incentive to reduce emissions, and by setting an upper limit it gives businesses more certainty about future regulation. In this the cap and trade system comes to resemble a carbon tax. In typically inconsistent fashion, the same Environmental Justice organizations that oppose Governor Brown’s approach have come out in favor of the carbon tax that it emulates (https://www.bna.com/carbon-tax-next-n57982086840/ ).

Nevertheless, Governor Brown’s proposal has aroused the ire of all those opposed to cap and trade in the first place, and the Environmental Justice movement has already been offered its pound of flesh. In companion legislation, existing industrial facilities are required to install the best available controls to reduce their other, non-greenhouse gas emissions.

No wonder other states are slow to emulate California’s lead in establishing a cap and trade system. What governor wants to take on the headaches now plaguing Governor Brown as he faces interest groups that want to distort the cap and trade system, weaken its ability to achieve cost-effective emission reductions, keep provisions that weaken in-state businesses, or just demand payoffs in the form of additional unrelated programs to benefit their constituencies? California has provided more enlightenment about how difficult it is to construct an efficient, market-based program than about how to do it well. It will be instructive to see who wins in the current battle to reauthorize cap and trade.

Editor’s Postnote: The voters of California approved the continuation of the state’s Cap and Trade program for ten years. Read a full accounting of the election results here

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.