An 'America First' Economy

An 'America First' Economy

Up next: overhauling infrastructure, reforming entitlements and easing regulation.

NOW THAT tax-reform measures have become law, the White House would do well to follow with a truly comprehensive economic-policy agenda. Such an agenda would involve three additional initiatives: financially feasible infrastructure refurbishment, entitlement reform and regulatory relief. A coherent economic-policy effort along these lines might place something persuasive before Congress, and even encourage Washington to engage in the long-neglected debate on economic strategy.

The tax-reform legislation is neither experimental nor radical, as some have claimed. Rather, it draws rather tamely on a long bipartisan legacy. Much like the Reagan legislation of the mid-1980s, it has made efforts to eliminate tax breaks and use the resulting revenue flow to reduce statutory rates. These same principles informed the recommendations of President Barack Obama’s 2010 National Committee on Fiscal Responsibility. Colloquially called Simpson-Bowles after its leadership, former senator Alan Simpson and former White House chief of staff Erskine Bowles, it failed to become law, but Obama tried several times to press some of its measures on Congress. He actually proposed similar reforms in his 2015 budget. Republican reformers made similar basic recommendations. Proposals to eliminate or cap tax breaks and pursue a cut in statutory rates appeared in the plan advanced in Obama’s first term by Dave Camp, then the Republican chair of the House Ways and Means Committee. Republican Congressman Paul Ryan, when he took over the House Ways and Means Committee during Obama’s second term, embraced the same principles in a set of reforms that he referred to as a “better way.”

This latest legislation relies on the same basic reasoning used in all these reforms. Republicans and Democrats have argued that a general reduction in statutory rates would brighten economic prospects by encouraging individuals to work and business to invest more for the future. Lower statutory corporate rates would further enhance growth by promoting greater efficiencies in business, inducing managers to think less about tax consequences and more about the economics of their respective businesses. Lower statutory corporate rates would offer still another benefit by encouraging U.S. companies to repatriate the accumulated earnings they hold overseas, giving the economy a welcome cash infusion for investment.

As in these precedents, this latest reform takes care to promote greater equity as well. No doubt Californians, New Yorkers and other residents of high-tax states see matters differently. This legislation limits deductions of state and local taxes of any kind to $10,000. But most of the country could argue a different line, and with justice. The old code, to make up for the revenues lost to those huge deductions, implicitly forced on all Americans higher statutory rates than they would otherwise have had to pay. People across the country effectively shouldered some of the burdens imposed by political decisions made in Sacramento, Albany and a few other state capitals. This matter disappears in the new law.

In addition to geographic equity, this new legislation takes steps to secure greater equity across the income distribution. Previously, the law allowed people to deduct mortgage interest on loans all the way up to $1 million. Since the biggest mortgages garnered the greatest tax benefit, the wealthy gained the most from the provision. By lowering that cap to $750,000, the new law rectifies some—but only some—of the code’s pro-wealth bias. To even the relative tax burden across the income distribution further, the new law offers much to those at lower income levels. Because these taxpayers seldom itemize, it offers a near doubling in the standard deduction and major increases in child tax credits. Further, it raises the threshold of income before each taxpayer moves into a higher bracket, and makes the biggest relative tax cuts in lower income brackets: those facing individuals who have taxable income below $200,000 a year, and married couples with joint incomes below $400,000 a year.

Even the proposed elimination of the estate tax, though it seems to favor the very wealthy, can make a claim of equity. The current code, though it seems to tax inheritance heavily, falls mostly on the middling rich: those who inherit family farms or small businesses. They frequently have to sell off their inheritance just to pay the tax. Meanwhile, the very rich, many of whom promote high estate taxes, protect their heirs by giving their money, tax free, to foundations of their own making, where they see to it that those heirs have comfortable positions with sometimes lavish benefits. Whatever they may claim for the good their foundations do, they ensure that the benefits of their wealth pass from one generation to the next, tax free. The legislation simply allows the middling rich a break previously open only to the megarich.

The most questionable aspect of this new law is the break on unincorporated business earnings, the so-called pass-through income. Those pressing for this argued that reductions in the corporate rate would bias the code against small businesses and limited-liability partnerships, which would have to pay at higher individual rates. Matters, however, are not so straightforward. Corporations pay their own tax, and then shareholders pay at their individual rate, or close to it, when they receive any distributions, usually in the form of dividends. The people behind the corporations pay a combined tax at about the individual rate, just as those behind other business arrangements did. Giving a special break to these businesses now offers them an advantage. It is pleasant to think that small-business owners will find relief in this new law, but it raises questions why they should pay less tax than a corporate shareholder or the wage earner who lives next door.

Other parts of the new law also fly in the face of the basic principles behind it. But anyone who seeks perfection in the compromise of any Congress—especially this one—does not live in the real world. The important thing is that this new law improves what was, and so forms a firm foundation for this White House and Congress to take additional steps.

ENTITLEMENT REFORM, of course, presents more intractable political disputes than tax reform or infrastructure spending, and accordingly has a smaller likelihood of success. Signs of these political difficulties clearly stand out in reactions to recent White House plans to attach more stringent work requirements to so-called welfare benefits, such as food stamps, Temporary Assistance for Needy Families and the like. Coming months will see more specificity and more debate around these matters. But welfare ultimately is a small part of the picture. The real burden of these programs lies in Social Security, Medicare and Medicaid. Few, either in Congress or the White House, stand willing to weigh the future of these programs. Still, urgent budgetary imperatives will leave Congress with little choice.

The budget pressure is becoming intense. Spending on these programs has outpaced everything else of significance that the government does to such an extent that entitlements outlays threaten to swallow the entire budget. In just the last thirty-five years, entitlements spending has grown from half the overall budget to three-quarters of it. Congress exercises no control over this growth—at least the way budgeting is done now. The only reason entitlements spending has failed to impose more on most other government programs is that defense outlays, despite all the strains from the country’s Middle Eastern adventures, have grown at an exceptionally slow pace, falling from just under a quarter of the budget in 1980 to about 15 percent today. Relative cuts at the Pentagon have effectively shielded much of the rest of the government from this relentless growth in entitlements. In so doing, they have allowed various politicians, including President Donald Trump, to fool themselves and the public about what they might do with federal dollars that, without entitlement reform, are simply not there.

Since major tax hikes and deeper budget deficits are politically unpalatable, as is continued shrinking in defense spending (at least to the extent done in the past), Washington will soon have its proverbial back to the wall. At current rates of relative growth, entitlements promise to absorb 80 percent of the budget in less than ten years, and 85 percent by 2035. Even in the unlikely event that defense spending shrinks further to a mere 10 percent of the budget, that would leave only 5 percent of the budget for everything else. Matters are probably more urgent, since this simple extension of past trends ignores how Obamacare will accelerate entitlements spending, as will the retirement of the baby boomers. The window that allows the president and Congress to ignore the matter is closing fast.

To be sure, the average citizen cannot quote chapter and verse from the budget, or measure past trends. Voters nonetheless have shown conclusively that they know how little budgetary viability remains. According to a recent Rasmussen poll, only 19 percent of voters are confident that they will receive their full federal retirement benefits. A Bloomberg national poll showed that an even smaller 15 percent are so confident. A recent Roper poll found that only 29 percent of Americans believe their federal benefits will last through their retirement, down from some 35 percent only six years ago. Such feelings will or should drive politicians to action, no matter how much they would prefer to ignore the need for entitlement reform.

It may well be that objections to the Obamacare replacement bills partly reflected just such budgetary sensitivities. To be sure, the Freedom Caucus fought Republican leadership and President Trump on social as well as economic issues. It nonetheless also showed sensitivity to the legislation’s lack of economic viability. The proposal, for instance, might have used tax credits to individuals in place of Obamacare’s more direct subsidies to health insurers, but the net effect would still have burdened the budget. Objections to community ratings also showed recognition of actuarial reality. The replacement legislation did loosen Obamacare’s insistence that premiums for all, regardless of age and health, must remain largely equal. But it failed to loosen them enough to offer the system sustainability. It would seem, then, that any future efforts to replace Obamacare will receive a warmer welcome if they consider broader budgetary ramifications, and would receive still more support if they aimed to deal with the more general entitlements problem.

Nor would reformers lack for proposals. On the contrary, there is much on offer to move this critical process forward. This is hardly the place to itemize, much less assess the many schemes that would control the growth of entitlements spending, but a sketch might indicate how many options exist. Social Security’s trustees have placed their own on the system’s website. Among them is the suggestion to raise the age for full retirement benefits. A shift from today’s limit of sixty-seven years old to seventy would do much to make Social Security actuarially sound, and hence lift its burden on the rest of the budget. It would also reflect a national demographic reality in which people live longer than in the past, and remain vital until older ages. Other reforms advocated by the trustees and others would, for instance, change how the system calculates cost of living adjustments or, alternatively, how it determines the benefits paid to high-income beneficiaries.

With healthcare, whether Medicare, Medicaid or, for the time being, Obamacare, matters are less clear cut. Nonetheless, here, too, prospective reformers would have much material with which to work. Allowing insurers to sell across state lines, for instance, would introduce new levels of competition that should hold down premiums. Of course, such a move would force Washington from its clear preference to care more for the bottom lines of insurers than for those paying premiums, but the option exists. Reforming the way in which the Federal Drug Administration tests new drugs offers a way to reduce prescription costs. Block grants to states for Medicaid could unleash a raft of cost-saving schemes that would slow spending with no loss of services. Already, state efforts have yielded more effective ways to deliver health services (the use of clinics, for instance, instead of emergency-room calls, has not only cut immediate costs but, by improving prevention, has held down costs over time). Similarly, if employers simply offered employees block payments for premiums, they would introduce further competition into insurance markets, impose spending disciplines and hold down premiums accordingly.

Legislation might make progress if Congress would change the terms of debate. For a long time, a tedious moralistic posturing has interfered with rational discussion. A more technical approach would allow representatives and senators much more room to compromise. So-called budget hawks could then seek expense relief for the public at large without having to fend off accusations of heartlessness. Those who worry from the other side about the quality of life among those less capable could embrace the virtue of putting support systems on a more secure and durable footing. Though a portion of the moralizing, and the animosity it fosters, would inevitably remain, any movement to minimize it would relieve bad feelings in Washington and among the public generally. At the same time, a turn to honesty by representatives and senators about matters of budget viability, something the public already sees quite clearly, might well defuse the ever-growing distrust of Washington. Difficult as the initial effort at such reform no doubt will be, it is essential, and promises to pay considerable dividends.

ON THE final part of this program—regulatory relief—the White House has reasonably claimed that many of the regulations in place in this country interfere needlessly with business and daily life, slowing the pace of economic growth and unreasonably infringing on private decisions. To the extent that the administration proceeds judiciously, it can not only improve the country’s economic prospects but also remove some major irritants among large groups in society.

The White House has made a start. When, right after his inauguration, Trump issued Executive Order 13771, requiring agencies to eliminate two regulations for each new rule they make, all in Washington and beyond expressed skepticism. But it seems to have had an effect, as has White House insistence that all agencies abide strictly by established procedures and allow time for public comment. Neomi Rao, head of the White House Office of Information and Regulatory Affairs, has noted that through the end of September 2017, the efforts resulted in sixty-seven deregulatory actions (ninety at an annual rate) and only three new regulatory actions. It has also resulted in the withdrawal or delay of 1,500 planned new rules. The Federal Register over this time added 45,678 pages of new rules and changes. That would come to some sixty-one thousand a year, but is still minimally invasive compared to the 95,894 pages added in 2016.

No doubt these measures have contributed to businesses’ increased interest in expansion, as shown in their spending surge on new equipment and technology. But this White House could do more by altering the culture of U.S. regulatory bodies, or at least beginning to do so. Aside from an aggressive agenda under the last president, much of the economic harm done by regulators in this country stems from their legalistic and adversarial approach. These, if they serve public interests at all, do so inefficiently and in ways that create considerable animosity toward government—as well as distrust.

The country’s present regulatory approach should, of course, hardly come as a surprise. Washington is, after all, the land of lawyers. Regulators have grown up in the law’s adversarial culture. They can hardly think in other ways. In their scheme, regulators write reams of rules that aim at the impossible job of covering every eventuality. They then approach those they regulate with the presumption that they are evading those rules. The regulated naturally become wary of their would-be prosecutors, stick strictly to the letter of the law and withhold as much information as they can, worried that the regulators will somehow use it against them. Meanwhile, those who would uncover wrongdoing are loath to expose their objectives, lest the regulated use that knowledge to conceal their evasions. This hide-and-seek approach creates considerable and unnecessary expense. It can cause regulators, eager to punish wrongdoing, to lose sight of the original purpose of their oversight, and can sometimes lead them to destroy or downsize industries—needlessly throwing people out of work—even though management might willingly have cooperated with cost-effective means to accommodate public interests.

Because few firms and people seek to break laws, the way is open for a more cooperative approach. Canada and Australia might serve as a model. There, regulators see themselves less as the adversaries of those they regulate and more as partners who consider the needs of stakeholders otherwise neglected by markets and common practice. The matter of pollution might serve as an illustration: since the market charges the polluter nothing, the public interest in clean air and water would seem to demand a government presence. Firms have long since reconciled themselves to this need. Understandably, they would prefer to comply at the lowest possible cost. But they have little means to work with regulators on such solutions. Instead, they face reams of explicit rules that seldom consider cost and anyway cannot take every possible situation into account. A more cooperative interaction could do both. Similarly, those who would protect minority rights, such as the LGBT community, might do better at lower cost and with less animosity if they worked with schools, parks and the like to protect the safety and dignity of that community, while also considering the needs and dignity of others. Such efforts multiplied across business and daily life would save money and ease tension.

Glimmers of such desired arrangements have appeared. The Consumer Financial Protection Bureau (CFPB), for one, has come to recognize that rules have stifled desirable technological innovation in the financial industry. Firms simply will not take the risk of spending millions on systems and practices that the CFPB or some other regulator will not only summarily disallow, but also penalize them for even trying to implement. In an uncharacteristically cooperative move, CFPB regulators have promised to issue what they call a “no-action letter” that will allow firms to experiment with new practices without the risk of regulatory retaliation. It does not save managers from the gamble of squandering resources on business models that fail in the marketplace. That is a risk that a business takes with any new approach. Nor does a no-action letter offer a guarantee of regulatory approval. It does, however, save firms from incurring penalties just for making the effort. It is a small step—but it shows a willingness to set aside the adversarial culture, albeit in a very narrow way.

There is no reason why the CFPB or other agencies could not build on such steps to work with those regulated. Business then could proceed aware of public objectives, and offer ways to accomplish them at minimum cost to all involved. Such a system would, of course, dispense with today’s legalistic reliance on rules, and trust regulators’ judgments of what best serves public needs. (There is admittedly a risk here of what is called regulatory capture, when regulators, instead of focusing on public interest, become the allies of those they otherwise oversee. If that remains a risk, it is not as if the present adversarial approach has stopped regulatory capture in the past. Indeed, reliance on regulators’ judgments and objectives, instead of voluminous rules, might do a better job of guarding against regulatory capture than today’s system, in which the regulated are often the only people with detailed enough industry knowledge to write the rules to which the regulatory lawyers plan to hold them.)

No doubt such an approach would require a way to review regulatory judgments. That review would inevitably have a political dimension. The entire effort to develop an effective review process and alter the culture of the regulatory bodies in this country would take a long time. Initial efforts by this administration could, at most, start this long process. But it would pay handsome dividends in lower costs, both in the regulatory process and to the economy, and by disarming hostility to government—in business, certainly, but also with the general public. It would certainly make Washington look less ridiculous than it does, with rules demanding, for instance, wheelchair access to the fire brigade’s sleeping quarters. Combined with tax and entitlement reform, as well as improvements in the nation’s infrastructure, the entire effort would create a more responsive and responsible policy environment that would promote economic growth and relieve much of the bitterness between the public and the government, as well as political tensions generally.

Milton Ezrati is a contributing editor at the National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and consults as chief economist for Vested, a New York–based communications firm. His latest book is Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live.

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