It never ceases to amaze me that the leftists in charge are focusing the health care debate on rationing and redistribution. Lost in all of their histrionics about expanding the role of government is a simple fact. In order to provide more health care services to people who don’t currently get them without taking them away from others, it will be necessary to train more people as medical professionals. Obama is trying to pass a bad plan that won’t take effect until 2013. I propose that one key element of any good plan to improve American health care wouldn’t show any results for SEVEN YEARS. Once someone starts medical school it takes at least seven years for them to become a practicing doctor, a time which is long relative to the news cycle and even election cycles. This probably explains the intransigence of politicians in putting forth proposals to correct these impending shortages.

The liberals propose that we need to provide health care for the speciously quoted figure of 47 million uninsured Americans. If you’re suggesting that nearly a 1/6th of the people in this country are not getting any medical care, then in order to change this, it is necessary to increase the production of medical care by about 20%. Of course, many people are only temporarily without insurance, some of them are affluent enough to be self-insured, and they all still can receive treatment when they show up at emergency rooms. This doesn’t change the fact that people with a good insurance plan will get more and better treatment than someone without money or insurance, but the 20% figure is obviously somewhat inflated.

Unlike The Won, I do not expect that very many doctors perform needless surgeries in order to boost their income. On the other hand, I will point out that the American Medical Association is for many purposes, a guild. Their members sit on state licensing boards that have prevented new medical schools from being opened and existing schools from increasing their enrollments for decades. While the desire to maintain high admissions standards in order to mitigate future rates of malpractice is admirable, it has the obvious consequence of constraining the supply of physicians and raising the fees that they can charge. It also shunts aspiring MDs into academically marginal programs in the Caribbean and schools of osteopathy.

Most medical professionals are overworked. How often do you hear of a competent doctor or nurse who can’t find a job? Who has waited in an emergency room or doctor’s office for hours beyond their scheduled appointment time and thought to themselves that there are too many doctors?

The population of the United States in 1980 was 231 million, and today it stands well over 300 million. (The results to be fudged by for ACORN employees in 2010…) From the election of Ronald Reagan until very recently, the number of MDs graduating from U.S. medical schools has stayed fixed at 17,000/year. Despite the failure of about a third of Americans to finish high school, our top students are excellent. I find it hard to believe that we couldn’t admit the same proportion of the population to medical school that we did nearly thirty years ago without endangering patients to an extent greater than we did back then.

Aside from the increase in our population, we have a demographic bubble facing us. Among adults, the older you are, on average, the more medical care you’ll require to stay alive for an additional year. Another point is that doctors have gotten better at performing surgeries in recent decades. Paradoxically, this results in more surgeries because people are more likely to survive only to inevitably develop a new ailment that requires another surgery. Such is the human condition.

You’ll notice that I said that we need more medical professionals. It’s hard to say offhand exactly which subgroups of providers need the greatest increases in their ranks, but this is how the debate needs to be framed. We need to study how we can most cost effectively improve the availability of medical care by increasing the ranks of MD, PA, and nursing school students. Among the things to consider are where to locate new schools and whether it is better to expand existing schools than to open new ones. Another consideration would be to make it easier for people who are not U.S. citizens or permanent residents to attend U.S. medical schools. We take foreign doctors for our residency programs, but we deny the best foreign undergraduates the opportunity to learn in our medical schools. This is foolhardy.

With regards to the training of specialists, we need to take a close look at how many more people we could train to become highly competent neurosurgeons, cardiologists, and radiologists, and how it could be done. There are fundamental limitations on the availability of people to perform the most heroic operations and design the most complex pharmaceutical treatment strategies, and as a result there are also severe limitations on the availability of competent instructors in these specialties. One readily foreseen consequence of any proposal to increase the ranks of practicing physicians is that it will reduce their ability to charge for their services. The standards for gaining entry to top law schools, banks, and medical schools are very similar. People need to have succeeded in challenging academic programs and thus repeatedly shown that they do their work in order to stand a good chance of getting admitted to any of them, and such people are few and far between. They have choices. We must seek to emulate highly trained and successful specialists, not punish their livelihoods.

Any health care reform that requires a uniform fee schedule for services while bringing in new members to the profession who are less capable than the existing ones will have a tendency to dissuade talented people from pursuing a career in medicine. If the availability of residency slots in all specialties were increased in proportion to the increase in MD graduates, I’d expect that most of the added MDs who would not have made the cut for admission to medical school in previous years would become general practitioners and that those who would have otherwise become general practitioners would get admitted to specialties. (The prospect of my family doctor performing brain surgery on me is frightening, but what’s the alternative?) Perhaps one way to mitigate the risks of this expansion in the ranks of doctors would be to make the length of time required to complete medical school and residency more variable so that it would be common for about 20% of the students to spend an extra year in either. Of course, if 20% of residents need to take another year to be trained, then this requires 0.2 additional years of instruction per new doctor during which they need to be overseen by an established doctor, so providing the needed training now cuts into the availability of treatment in the present.

I hope that people have some comments on this. I find it ridiculous that we’re fighting over all these details about how to pay for care when our demographics and collective corpulence are causing our demand for health care to outstrip our capacity to provide it. Proposals to train more medical professionals ought to be the centerpiece of any health care plan. I’m not a doctor or an attorney specialized in the medical licensing process, but it seems that this is a partial solution that can revive federalism through trials in our laboratories of democracy. If state legislators and governors can work to streamline and fund the process for expanding medical enrollment with little to no involvement of the federal government, then perhaps we can build a better health care system despite the best efforts of Congress and Obama to destroy it.

So, in my previous diary entry I discussed some details about quantitative easing, and here I aim to show that it is a better alternative to TARP. The chief reasons that QE is better than TARP are 1) TRANSPARENCY and 2) MARKET NEUTRALITY.

Firstly, treasury bonds and government mortgage securities trade in very liquid markets, so fair prices are known at all times. A trader who overpays for a treasury bond by a tenth of a percentage point is going to get massively chewed out by their boss. If the Fed buys a bond, it buys it from the current owner who is willing to part with it for the least money. There’s no situation like I described in a recent comment in which the government official in charge of purchases takes a bribe in order to overpay for a hard to value security. If Martha Kent wants to sell her treasury bond to the Fed’s QE program, she gets to if she’s the cheapest seller.

Next, with regards, to market neutrality, QE may distort the government bond market, but it doesn’t directly pick winners and losers in private markets like TARP. Understanding how this is so depends on the following principle: conservation of financial assets. To the first order, the number of treasury bonds, and private bonds and shares of stock as well, is independent of the amount of cash in circulation. (If you want to argue that QE induces Congress to spend even more wildly and thus issue more treasury bonds, you’d probably have a good case, but that’s a second order effect!) So, if the Fed creates cash to buy a bond from an investor, the investor then has to do something with their money. Aside from stuffing the cash  in their mattress (or taking the advice of ACORN’s Brooklyn office and burying it in the backyard), they have a few basic options: A) they can spend it on real asset or consumption goods, B) they can deposit it in the bank, or C) they can purchase a new financial asset. The Fed doesn’t dictate which of these things an investor will do, so it doesn’t pick winners and losers.

Now, let’s outline how former owners of treasury bonds pursuing options A), B), and C) will repair the economy if left to their own devices.

If an investor chooses to do buy real assets, this means that they are buying things like houses, cars, and equipment in addition to consumption goods and services such as restaurant meals and vacations. This stimulates the economy.

If an investor deposits their money in a bank, this improves the bank’s capital ratio, thus allowing the bank to make new loans. This partially alleviates the banking crisis.

If an investor uses the money to buy a risky financial asset such as subprime mortgage bond, then this drives up the prices of these securities. When the prices of toxic securities that banks own rebounds, this restores their financial health, so that they can lend again without government capital infusions. If they buy something less risky such a bond issued by General Electric, then the seller of that bond has to find something else riskier to buy, such as the aforementioned subprime security. This is basically an instance of the pigeonhole principle in finance!

Does this all seem like a pipe dream? The Fed actually bought around ONE TRILLION DOLLARS worth of treasuries and government mortgage securities this year through QE. Given the increased level of government borrowing due to the Porkulus spending bill and the budget, if the Fed hadn’t done any quantitative easing, it’s pretty plain that $1T fewer dollars would have been available for lending in the private markets. That would have basically meant that no businesses would have gotten any loans. This would have been an utter disaster.

QE isn’t a cure all. It still induces systemic moral hazard because it trains all players in the market to believe that there will be a macroeconomic rescue if everyone loses their shirt. It runs the risk of causing inflation if the money remains in circulation too long. It still seems a heck of a lot better than placing the bailout money directly back in the hands of the banking institutions that made these bad loans in the first place due to a combination of their shortcomings in risk controls, incentive structures, and government meddling via Fannie, Freddie, Ginnie, and the Community Reinvestment Act. It also precludes letting Congress and the White House have slush funds with which to pick other winners and losers, a situation that causes true economic paralysis, as a command economy saps the will of the individual to exert any effort until they know what share of the pie they’ve been allotted. I hope this doesn’t come across as a cheerleading essay for QE, as I really understand the extreme risks to an economy caused by rapid swings in the supply of money, but I surely believe that we’d have been a lot better off with an additional $787B + $700B in quantitative easing instead of Porkulus + TARP.

We live in an age with many trillion dollar elephants in the room and most of them have complexities that are not discussed in widely read publications. The conflation of quantitative easing and debt monetization by the media is one of them. The two activities have very similar effects in the short term, but their effects in the long run are quite different.

The Federal Reserve controls the money supply and Treasury handles government revenues, expenses and borrowing. They are distinct entities. If the Federal Reserve and the Treasury were actually merged, then the Fed could hand bricks of cash/bank account entries over to the Treasury Department in order to directly fund the budget deficit without the issuance of new debt. This would be an example of monetization of the debt. Another way that this could occur would be if the Treasured issued bonds to cover a deficit, the Federal Reserve printed money to purchase them, and then forgave the debt.

This is not how things are currently done.  When the Fed engages in quantitative easing, it creates money out of thin air in order to buy financial assets such as treasury bonds, but it does not cancel the borrower’s obligation to repay. So, does quantitative easing increase the money supply and cause inflation in the long run? That’s really not so clear. Consider the following examples:

The Fed buys $100 billion worth of newly issued 2-year treasury bonds at par that that pay a 1% coupon rate. This results in $100B entering the money supply now, but assuming that the Treasury keeps making the payments, both the principal and the interest will leave the money supply and return to the black hole that is the Fed. This means that if the federal government doesn’t default, then over the life of this trade, quantitative easing will add and subtract $100B in principal and subtract $2B in interest from the money supply, for a net reduction of $2B. If the Fed had instead purchased $100B worth of 30-yr bonds that yielded 4%, the federal government didn’t default, and the Fed held this bond to maturity, then it would suck a net amount of $120B (4%/year*100B*30yrs) out of the money supply.

In the round of quantitative easing that the Federal Reserve began at the peak of our financial crisis, they bought a number of securities other than U.S. Treasury bonds. (Feel free to look at their current holdings here: http://www.federalreserve.gov/RELEASES/H41/Current/) These other purchases primarily consisted of bonds issued by Fannie Mae and Freddie Mac, which are now backed up by the federal government, and mortgage-backed securities issued by them as well as Ginnie Mae. Unlike bonds, mortgage securities have variable times to maturity. If you sell your house or attach and extra $100 to your mortgage payment each month, the loan gets paid off earlier than expected. If the borrower defaults and the house is sold, this also results in an early repayment of the loan, even though not all of the money owed is returned. The result of all of this behavior is that investors in mortgage loans typically expect to get most of their money back substantially sooner than three decades later. In the case of these government agency issued mortgage securities, the risk of default by homeowners is insured against by the agency (and hence the taxpayer), so the Federal Reserve doesn’t really take any risk that they won’t be repaid as long as the federal government doesn’t default.

What’s the summary of all of this? Through quantitative easing, the Fed temporarily increased the money supply with a built in mechanism to reduce it as the crisis abates by simply holding the bonds it purchased to maturity. They can also potentially speed up the process of reducing the money supply by selling the bonds back to the market, but most of the bonds that they bought are going to be largely repaid within a few years anyways. Is it possible that if the Fed leaves too much money in circulation as the recovery (HOPEFULLY) picks up steam that we’ll see a rise in inflation? Yes, that’s certainly a possibility, but Japan engaged in QE and they saw deflation happen, which shouldn’t be surprising given that QE reduces the money supply in the long run, so the evidence would suggest that fears of runaway inflation are probably overblown.

Let’s examine a few different tiers of government destruction of economic activity.

The first level involves negative marginal multipliers on spending. Government taxation takes money away from private projects that have higher multipliers. Perhaps both of these options have multipliers greater than one, but the private activity is still clearly a better use of funds.

The next level involves government spending on a boondoggle with no physical benefits. People dig holes in the ground and fill them. They get paid for the work and spend their paychecks, but there is no discernible benefit resulting from their efforts. There’s some waste of resources since they drive their cars to work and have to buy new shovels to do the job, but they’re relatively negligible.

The 3rd level involves government destruction of real assets. Imagine the government killing 6 million pigs in order to raise pork prices and thus offset deflation. (See FDR, http://en.wikipedia.org/wiki/New_Deal, under Farm and Rural Programs) The multiplier is negative since there are fundamentally fewer resources for use. The same will be true of federal dollars spent on enforcement of carbon emissions limits, collective bargaining agreements, bank bailouts, and government health care.

Given that climate change is an international leftist pretext for the redistribution of wealth, it should come as no surprise that spending on carbon inspection and other green jobs programs will carry negative economic multipliers. Every dollar that they spend preventing more plant food from entering the atmosphere reduces the availability of electricity and plants! It causes metal to be improperly allocated to the construction of windmills and their necessitated power collection grids, thus taking it away from more productive uses.

Labor is a scarce resource. Collective bargaining causes a reduction in labor output. Restrictive work rules result in pay for idleness. Protection against layoffs make companies disinclined to hire during times of high demand. Consider the rubber rooms run by the automakers. Also, a lack of merit-based raises and terminations puts a damper on personal efforts. Aside from this, union organizers disrupt work sites. Employees are busy contemplating how to get a bigger share of the pie for less effort instead of how to do their jobs better. Spending on federal mediators who will impose outcomes favorable to unions should strikes be protracted will result in longer strikes and reduced production.

Bank bailouts may have been necessary to prevent another Great Depression, but this need was only induced by flaws in our corporate tax policy and our bankruptcy code. Giving fresh money to those investors who have shown historic levels of ineptitude in its deployment is very likely to result in a repetition of historical performance. Let’s also not forget that every dollar spent on enforcement of the Community Reinvestment Act resulted in a negative multiplier since it forced these banks to make bad loans.

The centrally planned reimbursement rates for Medicare and Medicaid already induce physicians to train for certain specialties at different frequencies than they otherwise would. The same is true for malpractice laws that have resulted in a dearth of obstetricians across the country. Just wait for the comparative effectiveness research to be politically gerrymandered. Kids don’t vote now. Dead kids never will. ACORN members vote early and often. We’ll see funding for leukemia cut while abortion funding is increased. That’s how the crooked politicians will shortchange our future, both morally and economically.

So, is this level of economic malaise the new normal? It sure could be if the leftists get their way. Don’t let them get away with their Keynesian hogwash justification for giving themselves unlimited power or the consequences will be most severe.

In a speech he gave 45 years ago, Ronald Reagan explained that the only way to achieve peace tomorrow is to surrender today. By that measure, Barack Obama has excelled beyond even the expectations of the Almighty.

He abandoned fledgling democracies in Eastern Europe to Putin’s grand designs for a renewed Soviet empire. He left all of Europe bereft of defenses against small numbers of ballistic missiles by scrapping plans for systems that could in no way change the balance of power between the USA and Russia. In thanks for this concession, the Kremlin continues to aid Iran’s nuclear development through trade across the Caspian Sea in addition to blocking sanctions by invoking its veto power on the U.N. Security Council.

Without even challenging the facts or invoking a lengthy, albeit flawed invocation of international law, he seeks the return to office of a former Honduran president who was attempting to install himself as a dictator by using ballots flown in courtesy of Hugo Chavez. For these prostrations he won praise from despots around the world who wish him a lifetime tenure in office.

He apologized for our alleged sins and ignored true travesties against humanity.  He failed to understand that American exceptionalism is not an ignorant belief that we are a perfect or chosen people, but rather it reflects the original declaration of our founders that our Creator endowed all of humanity with the same rights, and that though they may be abridged throughout the world, no one is less entitled to seek their natural freedoms than anyone else.

Fundamentally though, he has engineered our surrender not through his international speeches slighting our allies and licking the boots of our mortal enemies, but rather through the pursuit of a domestic agenda so profligate as to preclude our continued ability to maintain our military forces. Although we might, for a limited time, experience no direct attacks within our borders as the enemies of freedom choose to first consume emerging pockets of it as we abandon them, we will certainly suffer the guilt of knowing that we have reversed the emancipation of our fellow man.

Perhaps a lucky confluence of events that flies in the face of history will grace the world with a cessation in wars between nations despite the falsely credited efforts of our apologist in chief, but obtaining peace without freedom is at best an incomplete result. Although we may not reasonably expect that the force of American arms, or even any device of human creation, may result in a permanent state of liberty on this planet, there is something decidedly ignoble about turning our backs on those who merely want their freedom in order to curry favor with the thugs who oppress them.

We really need to fight against Obama’s leftist national anti-health and anti-energy bills, but here’s one of the next nuggets of excrement in the pipeline. I honestly expect this to not come to fully fester until after the 2012 election, but I’ve been surprised at how quickly he’s been trying to move everything. I had figured that he would do everything to change America into Europe over the next 20 years or so. His hubris may well be his downfall. Instead of gradually boiling a frog starting from a cold pot, he’s trying to make changes on so many fronts at once that he can’t help but tickoff the majority of a center-right, albeit temporarily gullible nation.

So, here’s one of the future government programs that you have to look forward to after medicine is socialized: the nanny state, well, literally acting as a nanny! I’m really not joking.

http://www.childcare.gov/

Once everyone is used to the government running health care, we’ll be fighting elections over the income cutoff to qualify for free* government daycare. If you don’t want your children to grow up under the amoral supervision of federal childcare workers training them to help the president, appease terrorists, feast on organic government cheese, and generally become red diaper doper babies, you need to stop them in their tracks now.

We’ve always known that Obama would select plausible enough cabinet members and real loons for his czars and assistant secretaries. I’d really like to know who Carmen Nazario, the new Assistant Secretary for the Administration for Children and Families, is, and what sort of indoctrination curriculum for federal child care she is planning. They got $2B from porkulus that they’re spending.

Look at Canada:

http://www.universalchildcare.ca/eng/home.shtml

Look to Australia:

http://www.fahcsia.gov.au/Internet/FAO/fao1.nsf/content/payments-ccb

Someone explain how I’m crazy to think that this is where we are going. Or, help me flesh out exactly how I’m NOT crazy. I suggest that we start digging here.

http://www.acf.hhs.gov/programs/ccb/initiatives/arra/index.htm

Watch these brief remarks by Barack Obama and then consider the consequences.

I realize that this is not a recent development, but we can’t forget about it. Obama’s tax changes will limit the charitable tax deduction to 28% as they raise the top tax bracket to 39.6%. To give an example of what this could mean for a wealthy donor, consider this. A philanthropist earns ten million dollars in taxable income from their business activities and they decide to GIVE ALL OF IT AWAY. Under the existing rules, they will pay no taxes. Once we are living under Obama’s rules, this donor will owe over a million dollars in federal taxes (nearly 11.6% of $10,000,000, but slightly less due to some earnings subject to lower tax brackets)!!

Does the prospect of this sound fair? Does this degree of munificence seem implausible? It certainly shouldn’t since Bill Gates and Warren Buffett have pooled their fortunes in order to give them away. Throughout the history of our nation philanthropy has enhanced our civil society. Those who built great industries bequeathed art collections and named universities. What doubt do we have that, on average, those who have grew fortunes through free exchange and the inventive harnessing of the synergies of nature can compose plans to advance the state of their fellow man superior to those dictated in the halls of Congress? Even when these eminent men should err in judgment, or have malicious intent (see Soros, George), almost none of them possess budgetary discretion of the magnitude of the key players in our federal government, so their mistakes are more easily contained, and swamped by their successes through the law of averages.

Indeed, a true irony here is that we have no comprehensive national research university, that virtually all of our top campuses are private, and that even public universities are replete with institutes and professorships named after donors targeting perceived needs in society. Despite all of this, it is within these halls of academia that we witness the beneficiaries of these ‘malefactors of great wealth’ pontificating about the need for the diversion of private capital to the hands of those who by their own rankings of scholarly prestige use it least ably.

Let us also not forget certain branches of the non-profit sector are heavily favored by the current administration over others. Although I do not recall single gifts to traditional religious institutions of the same magnitude as to those entities mentioned above, works of charity executed by non-secular groups are vital to the fabric of society. Their local nature affords them a sensitivity to the needs on the ground unobtainable by a distant state agency. The donors are humble, typically anonymous, and often offer their elbow grease and ethical oversight to the causes they support financially. It is also these groups which are most threatened by Obama’s limitations upon charitable deductions, for while the diversion of direct bequests to universities may well be replaced by federal largesse, religious charities will not see this circuitous path to funding. Indeed, it isn’t much of a stretch to infer that redistributive philosophy in academia is actually self-serving.

This is not accidental. You are witnessing the opening of an economically strategic front in the culture war. The reduction of this tax deduction is designed to diminish the influence of our non-governmental safety nets, thus creating chaos and providing an opportunity for federal men of action to come to the rescue and remake society in their own foolish image. The eradication of civil society by leftists is truly dangerous. For although we can love our neighbors, the government is incapable of love, and a society whose needy are left wholly dependent upon an entity that cannot love them will have no hope of restoring their ability to independently prosper.

If these tax ‘reforms’, purportedly introduced out of ‘fairness’, are implemented, then a person who could have donated $10,000,000 to the charity of their choice will now only be able to donate about $8.9 million. The rest of it will go to Uncle Obama’s pet projects. They won’t get their name on a mail truck, packages of government cheese, or section 8 housing vouchers. (They may, however, be thankful that the Palestinian media will not give them a credit as a co-producer on whatever children’s video is the next successor to the Farfour series!) The beneficiaries of these federal gifts will not know how the industry and generosity of man have provided them. They will attribute their bounty to the providence of President Obama, their local pork barreling legislator,  and his redistribution czars, and it is this ignorance that will leave them forever infantile in their outlook and dependent upon the growing welfare state.

Politicians are happy to raise corporate taxes because they can get applause from leftist supporters for doing so. Your typical leftist cheers for corporate taxes out of fairness. Their willful ignorance of the nature of ownership blinds them to this simple fact: corporations are owned by individuals who are subject to personal income taxes and tax-exempt institutions, such as their beloved Harvard University. It’s pointless to tax corporations out of fairness because any desired distribution of the tax burden can be achieved by taxing the personal income of the owners of a corporation. There’s no reason to tax Exxon because you can just wait for them to declare a dividend and tax John Q. Greedy at a higher rate on a dividend that is larger because the corporation didn’t have to pay any taxes. If you think that Harvard is an angelic institution, then you should have no objections to them receiving increased income once the corporations in which they are shareholders are no longer taxed. If you think it’s unfair that rich Harvard University pay no taxes itself while it coddles its limousine liberal law students in the lap of luxury as it trains them to shred the Constitution, then this is a good reason to consider changing the standards for qualifying as a tax-exempt institution.

A previous posting, Who Pays Corporate Taxes?, discussed quite a few consequences of corporate taxation. Most people are not aware that corporations can deduct interest expenses from their taxable income. Unlike individuals, who cannot deduct interest payments to credit card companies and are limited in the extent to which they can deduct mortgage interest, corporations are not subject to any limitations on the size of this deduction. Consequently, corporations issue massive amounts of debt in order to take advantage of this. The Harvard endowment doesn’t have to wait for an enterprising member of The Club for Growth to repeal corporate taxes. It can simply buy bonds issued by Wal-Mart and enjoy the interest payments as if they were dividends on tax-exempt corporate income. This pressure to avoid corporate taxes isn’t just exerted by non-profit endowments. The total rate of taxation on a dividend is calculated based upon what is left after both corporate and personal income taxes ((1-(1-0.35)*(1-0.15) = 44.75%, 35% corporate rate and 15% through 2010 at the federal level). The total rate of taxation on interest is just a given person’s marginal tax rate, currently topping out at 35%.

(Scroll down to the U.S. dividend table. http://en.wikipedia.org/wiki/Dividend_tax)

It’s pretty clear that investors would rather only pay 35% tax rates on the operating profits of a corporation than 44.75%. An individual in the top tax bracket who gets a dividend only gets 55.25% of the operating profits as income after federal corporate and individual income taxes). It is this rightful desire to avoid taxes that induces corporations to leverage themselves so that investors might extract their operating profits without subjecting them to intermediate taxation.

So, what does all of this have to do with the banking crisis? As demonstrated above, the deductibility of interest causes the owners of corporations to leverage until their operating profits are completely covered by interest payments. Of course, sensible corporations don’t do this because if they owe too much money, then there’s a good chance they’ll miss a bond payment and then the shareholders and creditors will fight it out in bankruptcy court, and end up collectively losing because they will have to pay a lot of attorneys while alienating suppliers, customers, and employees. Of course, how much debt is too much depends on the business. Some companies have extremely predictable results, and can sustain a very high ratio of interest payments to operating profits. Quite often, however, this perceived stability is illusory, and a minor cold in the economy can send highly leveraged companies to the morgue.

This was a partial cause of the banking crisis. Banks were highly leveraged in order to minimize the taxes indirectly paid by their investors. Of course some investors prefer to own bonds instead of shares because they prefer less risk, but the desire to minimize taxes greatly inflates leverage. If corporate taxes were lower or non-existent, banks would be less leveraged, so they would be able to absorb greater losses before requiring federal bailouts to prevent failure.

Take a look back at the Wikipedia article on dividend tax rates. In 2011, the top personal tax rate is scheduled to rise to 39.6% and dividends will once again be taxed at ordinary income rates. This will mean that the total federal taxation rate on corporate operating profits will be 1 – (1-.35)*(1-.396) = 60.74% versus the new tax rate on interest income of 39.6%. If you thought that our businesses were levered with a 9.75% differential in aggregate taxation, just wait until you see the effects of the increase to 21.14%!

Perhaps more vigilant regulators and fear of another crisis will keep the leverage of the banking system moderated, but I fully expect there to be a lot of leveraged recapitalizations and buyouts of major non-financial institutions in order to shield them from taxation. It’s all well and good that private enterprise will act within the law to maximize its profits, but isn’t it time that we asked ourselves if it makes sense for our tax code to incentivize corporations to increase their risk of bankruptcy?

The Build America Bonds program is a wolf in sheep’s clothing. It’s a catchy name. Who could be against building America? It replaces the market-based defense of federalism with a direct federal subsidy of interest payments to state and local issuers. It is beyond doubt that there are going to be federal strings attached to this federal money, and that these terms of endearment will become more restrictive as they are consecrated by the passage of time and the abrogation of local responsibility.

This nugget of a program, which is a part of the Porkulus bill, has Uncle Obama provide 35% of the interest payments for state and local bond issues as direct subsidies to the issuers of the bonds. This program ostensibly has an end date in 2010, but as we know, federal programs as the closest thing to immortality.

As it currently stands, state and local governments can choose to participate in the BAB program, or to issue tax-exempt debt under the existing rules. As I have stated in my prior piece, it should come as no surprise that the disruption in the municipal bond market has resulted in the arrival of federal help. How long will it be before this help becomes mandatory and municipal bonds no longer qualify for federal interest income tax exemptions? There have already been rumors of such a change in a recent CBO study, as referenced by the link to BusinessWeek.

http://www.businessweek.com/investing/insights/blog/archives/2009/08/could_municipal.html

Will these interest subsidies sometimes become larger than 35%? Will special subsidy rates be offered for favored communities and ‘green building’ projects? Will communities that choose to use non-union labor for their projects not qualify for a subsidy? What if they want to issue bonds to buy a fleet of police cars? Will they have to buy hybrids to qualify for a subsidy? The ability to issue debt to fund local needs without federal meddling is vital to the survival of local governance. Do you want federal bureaucrats or members of Congress telling your local elected officials what they can and cannot build? Do you want them to feel no sense of responsibility because they just expect to be bailed out by the federal government if they fail? The answer here should be a resounding NO!!

If state and local governments are neither allowed nor able to raise their own funds or suffer their failures, then federalism will be dead, and we will become nothing more than a unitary state.

http://www.treas.gov/press/releases/docs/BuildAmericaandSchoolConstructionBondsFactsheetFinal.pdf

http://www.investinginbonds.com/learnmore.asp?catid=8&subcatid=92

I fully agree that the Laffer curve for recurring revenues collected each year versus the tax rate on a given activity has a maximum at some rate of government expropriation below 100%.

Despite this, I think that the way we discuss the Laffer curve hinders our ability to make sensible economic decisions. The goal of a taxation system for an economic conservative is not to maximize the revenues available to the government. As conservatives, we rarely exclaim how much we enjoy federal spending, so why do we try to espouse the development of a tax system that maximizes the food for Fedzilla?

A better goal would be to seek a tax system that maximizes the aggregate size of the economy, not the federal government. I find it very hard to believe that maximal economic activity occurs at the Laffer maximum for government revenues. In all likelihood, economic activity is maximized at tax rates lower than those that maximize federal revenues. We should be pushing for tax cuts even if they cause drops in revenue and we should be cutting wasteful spending.

I tend to expect that Obama’s planned increases on tax rates will not just result in a drop in federal revenues as our rates are already at or near the Laffer maximum, but will most likely remove incentives for work and investment, causing a larger aggregate drop in economic activity than the loss in federal revenues. This isn’t a mathematical stretch. If federal tax receipts drop despite an increase in the tax rate, then this means that the underlying activity rate dropped to a greater extent than the increase in the tax rate.