Regulation Th e C at o Re v i e w o f B u s i n e s s a n d G o v e r n m e nt
Ending Chevron Deference The Supreme Court should make Congress take responsibility for regulation
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Understanding Why Rent Control Hurts Renters P. 22 Is the USMCA Trade Agreement Better than Nothing? P. 12 Regulation Advocates Change their View of Regulatory Procedure P. 8 WINTER 2018–2019 / Vol. 41, No. 4 / $6.95
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Bridging the gap between academic ideas and real-world problems
Volume 41, Number 4 / Winter 2018–2019
CONTENTS
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P. 8
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F E AT U R E S
D E PA R T M E N T S
R E G U L AT O R Y R E F O R M
For the Record
Embracing Ossification With Donald Trump in the White House, pro-regulation forces are changing their view on regulatory procedure. By Stuart Shapiro COMMERCE & TRADE
12 Is NAFTA 2.0 Better than Nothing? Would Americans be better off if their government simply repealed NAFTA rather than replace it with the USMCA? By Pierre Lemieux R E G U L AT O R Y R E F O R M
16 Getting Out of Your Business Cities nationwide are making it a crime to work from home. By Christina Sandefur PROPERTY
22 How Economists Understate the Damage from Rent Controls These policies may lower rental payments, but they hurt the quality of rental housing. By Richard B. McKenzie and Dwight R. Lee E N E R GY & E N V I R O N M E N T
28 The Perils of a Carbon Tax High-minded proposals for a “revenue neutral” Pigouvian tax could result in bigger government, but they could also make it smaller. By Michael L. Marlow L AW
34 From Chevron to “Consent of the Governed” The Supreme Court should link Congress to its lawmaking duties. By David Schoenbrod
2
The VSL Is Not Too High By W. Kip Viscusi
Briefly Noted 4
Would Suspending DACA Withstand Benefit–Cost Analysis? By Ike Brannon and Kevin McGee
6
Wasting Kidneys: The Multivisceral Transplant Conundrum By Ike Brannon
In Review 40 Invisible Countries Review by Pierre Lemieux
52 Suicide of the West Review by Phil R. Murray
42 The People vs. Democracy Review by Dwight R. Lee
54 Can It Happen Here? Review by Pierre Lemieux
45 Regulatory Hacking Review by Sam Batkins 47 The Fed and Lehman Brothers Review by Vern McKinley 49 The Cost–Benefit Revolution Review by David R. Henderson
57 Skin in the Game Review by George Leef 59 The Tragedy of Kabul Bank Review by Vern McKinley 61 working papers Reviews by Peter Van Doren and Ike Brannon
Final Word 64 Guidance on Guidance By Richard A. Williams
COVER:
Illustration by Keith Negley
Regulation, 2018, Vol. 41, No. 4 (ISSN 0147-0590). Regulation is published four times a year by the Cato Institute (www.cato.org). Copyright 2018, Cato Institute. Regulation is available on the Internet at www.cato.org. The one-year subscription rate for an individual is $20; the institutional subscription rate is $40. Subscribe online or by writing to: Regulation, 1000 Massachusetts Avenue NW, Washington, DC 20001. Please contact Regulation by mail, telephone (202-842-0200), or fax (202-842-3490) for change of address and other subscription correspondence.
2 / Regulation / WINTER 2018–2019
FOR THE RECORD
The VSL Is Not Too High
I
n his Spring 2018 review of my book Pricing Lives: Guideposts for a Safer Society (Princeton University Press, 2018), Sam Batkins makes four principal points. First, my estimates of the value of a statistical life and those used by government agencies have increased over time and are too high. Second, the result is that “regulators are employing ever-higher figures for the Value of a Statistical Life (VSL) to justify more stringent regulations.” Third, trial lawyers are using the VSL to push for greater damages. Fourth, these developments may impose a threat to further economic progress. In my book I advocate a $10 million figure for the VSL. This number does not in fact represent any kind of quantum leap in the VSL. By way of history, I introduced the VSL into federal regulatory policymaking in 1982 when I was asked by the Reagan administration to resolve a dispute between the Occupational Safety and Health Administration and the Office of Management
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and Budget over the proposed hazard communication regulation. The $3 million VSL number that I employed then was based on my estimates of the extra pay that workers receive for incurring job-related fatality risks. My estimate was an order of magnitude greater than OSHA’s “cost of death” mortality benefit measure, which was based on lost earnings and medical costs. When converted to 2017 dollars, my 1982 $3 million VSL figure becomes $7.8 million. If we also take into account the increase in real per-capita income and apply an income elasticity for the VSL of 0.5 to 0.6, then extrapolating my 1982 number to current economic conditions produces an estimated current VSL in the $11–$12 million range. My $10 million VSL figure consequently is a bit below the level that would be obtained by taking my 1982 estimate forward. What then are we to make of the substantial increases in the VSL that have been observed at regulatory agencies during this century? Price adjustments and increased societal income levels undoubtedly play a role but are not the whole story. An additional contributing factor is that before agencies used the VSL to value mortality risks, they relied on the present value of lost earnings as the measure of the mortality risk reduction benefit. Because many agencies anchored on their previous earnings loss estimates, they were slow to fully embrace the estimates of the VSL in the economics literature. As a result of this anchoring effect, the VSL estimates used in Department of Transportation regulatory analyses have crept upward from $1.4 million (in 2017 dollars) in 1983 to over $9 million since 2013. Over the past four decades, federal agencies have become increasingly attuned to economic evidence on the VSL, ultimately making their VSL estimates more in line with current VSL estimates from the economics literature. The alarm that Batkins expresses regarding the VSL levels in the United
States and its consequences for regulatory stringency is misplaced. The United States quite correctly has what he terms “one of the highest VSLs on the planet.” Of course we do, and we should. The VSL for the United States should be higher than that in almost all other countries because our gross national income per capita is greater. Setting regulations that reflect the safety preferences of the U.S. citizenry is exactly what we want responsible regulators to do. Outside of the regulatory arena, Batkins fears that higher VSLs will lead to “higher tort damages.” The practice of using the VSL to set compensatory damages for the loss of enjoyment of life is known as hedonic damages. As I indicate in my book, almost all state courts now prohibit the use of the VSL for valuing the loss of enjoyment of life, so this is a non-issue. However, I do propose the use of the VSL to set the total level of damages in the rare instances in which punitive damages are warranted in wrongful death cases. That approach not only will create efficient incentives for safety but also will provide jurors with well-defined guidance for setting punitive damages awards. I have documented over 100 punitive damages awards in excess of $100 million, which I have termed “blockbuster” punitive damages awards. Many of these awards involve wrongful death cases in which the jury has concluded that punitive damages were warranted, but the jury has lacked meaningful guidance for picking the punitive damages number. Providing jurors with an economic structure for assessing punitive damages will foster efficient levels of safety and will have a restraining effect on these outlier awards. The VSL sets the correct price for mortality risks. Because the VSL reflects the average societal tradeoffs between risk and money, its use to establish safety incentives or to set regulatory standards will enhance our welfare. Regulatory standards based on benefit–cost analyses using the VSL are not a threat to economic progress.
W. Kip Viscusi University Distinguished Professor of Law, Economics, and Management Vanderbilt University
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Regulation EDITOR
Peter Van Dor en M A N AG I N G E D I TO R
Thomas A. Fir ey D E S I G N A N D L AY O U T
Dav id Her bick Design C I R C U L AT I O N M A N A G E R
Alan Peter son CONTRIBUTING EDITORS
Sam Batkins, Ike Br annon, Art Car den, Thomas A. Hemphill, Dav id R. Hender son, Dw ight R. Lee, George Leef, Pier r e Lemieux, Phil R. Mur r ay EDITORIAL ADVISORY BOARD
Chr istopher C. DeMuth
Distinguished Fellow, Hudson Institute
Susan E. Dudley
Distinguished Professor of Practice and Director of the Regulatory Studies Center, George Washington University
William A. Fischel
B R I E F LY N O T E D
Would Suspending DACA Withstand a Benefit–Cost Analysis? ✒ BY IKE BRANNON AND KEVIN MCGEE
I
n September 2017, President Trump announced that his administration would suspend Deferred Action for Childhood Arrivals (DACA). The program, launched in 2012 by executive order of President Barack Obama, grants temporary legal status to young adults without a valid visa who had been brought to the United States
Benjamin Zycher
by their parents before the age of 16. To qualify, applicants must have lived in the United States since 2007, be younger than 31 on June 15, 2012, have received a high school diploma, and have no criminal record. Under DACA, participants can attend college (although without access to federal or state financial aid) and obtain legal employment. When Trump announced DACA’s repeal, he claimed the program’s creation through executive order was constitutionally improper and gave Congress six months to pass legislation to extend and perhaps amend the program. Legislators proved unable to do that, but various lawsuits have prompted the courts to suspend DACA’s phase-out until the legality of its repeal can be adjudicated. We are agnostic as to the legality of DACA’s repeal and on the constitutionality of its creation. However, we believe that any major regulatory action taken by an administration should be subject to a stringent benefit–cost analysis. Executive Order 12866, first issued by President Ronald Reagan and honored (more or less) by each of his successors, requires such analysis.
PUBLISHER
Weighing benefits and costs /
Professor of Economics and Hardy Professor of Legal Studies, Dartmouth College
H.E. Fr ech III
Professor of Economics, University of California, Santa Barbara
Robert W. Hahn
Professor and Director of Economics, Smith School, Oxford University
Scott E. Harrington
Alan B. Miller Professor, Wharton School, University of Pennsylvania
James J. Heckman
Henry Schultz Distinguished Service Professor of Economics, University of Chicago
Andr ew N. K leit
MICASU Faculty Fellow and Professor of Environmental Economics, Pennsylvania State University
Michael C. Munger
Professor of Political Science, Duke University
Robert H. Nelson
Professor of Public Affairs, University of Maryland
Sam Peltzman
Ralph and Dorothy Keller Distinguished Service Professor Emeritus of Economics, University of Chicago
George L. Pr iest
Edward J. Phelps Professor of Law and Economics, Yale Law School
Paul H. Rubin
Samuel Candler Dobbs Professor of Economics and Law, Emory University
Jane S. Shaw
Board Member, John William Pope Center for Higher Education Policy
R ichar d L. Stroup
Professor Emeritus of Economics, Montana State University
W. K ip Viscusi
University Distinguished Professor of Law, Economics, and Management, Vanderbilt University
Cliffor d Winston
Searle Freedom Trust Senior Fellow in Economic Studies, Brookings Institution John G. Searle Chair, American Enterprise Institute
Peter Goettler
President and CEO, Cato Institute Regulation was first published in July 1977 “because the extension of regulation is piecemeal, the sources and targets diverse, the language complex and often opaque, and the volume overwhelming.” Regulation is devoted to analyzing the implications of government regulatory policy and its effects on our public and private endeavors.
In 2017 the Congressional Budget Office estimated that allowing DACA recipients to become IKE BR ANNON , a contributing editor to Regulation,
is a senior fellow at the Jack Kemp Foundation and president of Capital Policy Analytics. KEVIN MCGEE is professor emeritus at the University of Wisconsin, Oshkosh.
permanent legal residents would cost the federal government $26 billion over 10 years. To reach that number, analysts assumed the recipients would become eligible for Medicaid, Pell grants, and other federal benefits that they currently cannot receive under DACA. Those benefits were the primary drivers of the estimated cost. This estimate has been used to defend Trump’s repeal decision. However, the CBO analysis does not reflect policymakers’ current decision over DACA. The CBO compared only the alternatives of continuing temporary legal status for DACA participants and permanent legal status for those participants. We believe the status quo is politically unsustainable. Because of that, policymakers should be deciding between a different pair of alternatives: Congress passes legislation that allows DACA recipients to become permanent legal residents, and thus be eligible for most of the benefits conferred to citizens. ■■ The president eliminates DACA, making participants ineligible to work legally in this country. ■■
We performed our own benefit–cost analysis of these two alternatives, essentially asking what the opportunity cost would be to the government, as well as the broader economy, if the nation were to end DACA.
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/ Regulation / 5
lation nonetheless remains in the country. We assumed average annual earnings of $20,000 for these workers. For both the legal-residency and the DACA-terminated scenarios, we assumed that only 75% of the population would be employed, consistent with the BLS’s estimated employment– population ratio for Hispanics ages 25–34.
SAN JOSE MERCURY NEWS /GETTY IMAGES
Blanca Lopez of Union City, CA had been protected under DACA, but she did not receive renewal materials under Trump administration policy. As a result, she is now unemployed.
Under the permanent status alternative, we assumed current DACA participants would pursue employment opportunities consistent with their educational achievements. A significant proportion of these participants have earned or are in the process of earning college degrees. Under the DACA repeal alternative we assumed that most of this cohort would remain in the country—the only country most of them know—and join the informal job market, working illegally for cash in lowpaying jobs and not paying income or Social Security and Medicare (FICA) taxes. To estimate the consequences of legal residency, we obtained data from TheDream. us, a college scholarship fund for DACA recipients, on 2,563 DACA recipients currently enrolled in college. The data identify the college, declared major, and expected graduation date for each of these people. We used the data to forecast each student’s income upon graduation, using data from the FinTech company Payscale. com, which has access to information from over 2 million new college graduates. We assumed their earnings would follow a quadratic-shaped age–earnings profile, initially increasing by 4% per annum but slowing to a 2% growth rate after 20 years. Quadratic age–earnings profiles are com-
monly used for college-educated workers in labor economics. We simulated the full DACA population using 2014 estimates for their educational attainment from the Migration Policy Institute. DACA participants enroll in college at roughly the same rate as U.S. citizens, although their attrition rate once in college is markedly lower. By 2033, we estimate that 36% of the DACA population will have bachelor’s degrees, with another 17% having some lesser level of post-secondary education. We forecasted income over the next decade for three separate DACA populations: those with college degrees, those with some college, and those with only high school diplomas. Forecasted earnings for the latter two groups were based on median 2017 weekly earnings for Hispanics at these two educational levels obtained from the Bureau of Labor Statistics (BLS) and estimated age–earnings profiles for these educational levels. Our resulting income forecasts allowed us to estimate the taxes that the DACA population would pay over the next decade, provided they receive permanent legal residency. We then generated income and tax forecasts for the second outcome, where DACA status is terminated and the DACA popu-
Results / Our calculations indicate that with permanent legal status, current DACA participants would earn around $380 billion from 2020 to 2029. They would pay around $43 billion in federal income taxes and $59 billion in FICA taxes (both the employer and employee shares) over that period, for a total of $102 billion in federal revenue. Without that status, they would earn only about $158 billion over that same decade. It is unclear to us how much, if anything, they would pay in taxes because their employment would be illegal. But if all these DACA workers paid both income and FICA taxes, they would pay around $6 billion in federal income taxes and $24 billion in FICA taxes over the next decade. Comparing the two alternatives, we estimate that eliminating DACA will cost the federal government more than $70 billion in foregone tax revenue over the decade. The upper bound of this loss could approach $102 billion. The lost revenue dwarfs any entitlement increases that may accrue to DACA recipients should they be granted full legalization. We note that providing permanent legal residency to the DACA population would move about a million workers out of lowskill, low-pay job markets, into higher-skill job markets. Roughly half of those workers would move into job markets requiring a college degree. Because we tend to have supply surpluses in the low-skill markets and shortages in the high-skill markets, permanent legal status would have an overall salutary effect on the allocation of U.S. labor. That, in turn, should boost income and resultant tax revenue. Since DACA participants, for the most part, have spent most of their lives in the United States, the program’s continued
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existence is unlikely to have much if any effect on the current size of the U.S. labor force. As we’ve noted, DACA participants are likely to stay here in the country, legal status or not, and any attempt to deport the entire contingent would prove to be both costly and largely unsuccessful. Permanent legal residency would allow DACA recipients to be far more productive and contribute considerably more to the U.S. economy. All DACA recipients necessarily have high school diplomas, and many have post-secondary education and college degrees. Permanent legal residency would allow them to put to use the human capital they have acquired, benefitting both themselves and American society as a whole. It would also allow them to pay considerably more in federal taxes, and in state and local taxes as well.
Our data—as well as other data on the employment patterns of immigrants—suggest that this cohort promises to be much more mobile than the rest of the U.S. labor market. That means they are less likely to remain in communities where unemployment is high and jobs are low, and they can be expected to relocate to where labor shortages have developed. This predilection suggests that granting permanent legal status to DACA participants will in fact benefit U.S.-born workers in rural areas by ameliorating incipient skilled-labor shortages. What’s more, their legalization means they will not be forced to work in low-paid, unskilled occupations where it is easier to pay people under the table. That, in turn, will mean less competition for U.S.-born workers with relatively few labor market opportunities.
Wasting Kidneys: The Multivisceral Transplant Conundrum ✒ BY IKE BRANNON
S
ome 18,000 kidney transplants are performed in the United States each year. People who need a kidney often receive a donor organ from a relative, but people who don’t have that option must turn to an organ transplant waiting list. Prioritization on these lists is based on how long a patient has been on dialysis, his current health,
and how long he has been on the waitlist. The longer the wait and sicker the patient (but not too sick!), the higher he is on the list. However, patients who need a transplanted liver are treated differently. It is fairly common for a liver recipient to also receive one of the deceased donor’s kidneys in a procedure known as a multivisceral transplant. These constitute about 10% of all kidney transplants done each year. It is worth noting that the kidneys that IKE BR ANNON is president of the consulting firm
Capital Policy Analytics and a senior fellow of the Jack Kemp Foundation. He is a Regulation contributing editor.
typically accompany these transplants tend to be especially good organs, coming from young, otherwise healthy individuals, who make for the best liver donors. There are two ostensible reasons for transplanting both organs together. First, people with liver failure typically develop kidney failure concomitantly, a condition known as hepatorenal syndrome. Second, even if the recipient does not have an immediate, urgent need for a kidney, it can be economical to do both surgeries at the same time if doctors believe the patient may one day need a kidney; the dual-transplant surgery would require just
one anesthesiologist, one operating room, and one six-to-eight-hour surgery window. Multivisceral transplant candidates get priority on the kidney transplant list. Someone who recently became afflicted with liver disease and who may not even be on a kidney list will routinely get a kidney along with his new liver, as long as a nephrologist—a kidney specialist—approves the procedure. In these cases, it is the liver transplant list that dictates kidney priority. Here’s the rub: in many cases, the transplant kidney ends up being completely redundant. Liver function greatly affects kidney function, and the successful transplantation of a healthy liver restores many recipients’ ailing kidneys to working order. In other words, for these patients, the Quality-Adjusted Life-Years (QALYs) that the kidney transplant adds is low. Nonetheless, the surgeons proceed with the multivisceral transplant, leaving the original kidneys in place. As a result, many of these transplant recipients end up with three functioning kidneys. These transplants reduce the already tight supply of donor kidneys, harming people who have been on the transplant list for a long time and for whom a transplant kidney may extend their life for decades. Many of these patients will never receive a kidney and, as a result, live only a short time longer. The allocation of kidneys to multivisceral transplants has a very low benefit and extremely high cost in terms of potential lives lost. There is a simple fix to these unnecessarily transplanted kidneys: end the preference given to liver transplant patients for a new kidney. Perverse incentives / Why do doctors who perform liver transplants frequently insist upon transplanting a kidney with the liver? One explanation that is certainly understandable is that the transplanted kidney makes doctors more confident the liver transplant will succeed. However, other factors likely are also at work in these decisions, and those factors are troubling. For starters, liver transplants bring in
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/ Regulation / 7
non-white patients who have been waiting for an organ for years and gives them to patients who, on average, are wealthier, whiter, and have been sick for much less time, and whose gain from the new kidney, as measured in QALYs, is much less.
/ The United States already has a dearth of usable kidneys. There are 500,000 people on dialysis and over 100,000 on a waiting list for a kidney while no more than 18,000 usable kidneys become available in a year. Almost losing their ability to perform such surger- 10,000 people die each year waiting in ies. However, one way for a liver transplant vain for a match. surgeon to avoid the strictures of the liver This shortage is exacerbated by taking report card is to do a multivisceral trans- another 2,000 kidneys out of the system plant. Because they constitute only 15–30% and giving them to liver transplant recipiof all liver transplants—or 1,500–3,000 a ents, many of whom benefit little from the year—there are too few of them to aggre- kidney. The fact that this is encouraged by gate for a reliable report card. Thus, a lower financial incentives, and that it has regressurvival rate brings less opprobrium. sive effects, is a tragedy. Recently, transplant organizations have The optimal solution to our kidney taken steps to limit such gaming of the shortage would be for the federal government to compensate living kidney donors Multivisceral transplants further distort for their donations. an already worrisome racial and class Research suggests that imbalance for transplant organs, paying potential donors shifting organs to wealthier patients. $50,000 would ensure that all who need a kidney could receive one, which would not only kidney transplant list. For instance, trans- save thousands of lives a year but also plant lists place patients who have already save the government over $100 billion over received a liver and now need a kidney at a decade through reduced dialysis costs. the top of the waiting list, a policy that (See “Could PAYGO End the Prohibition helps to deter multivisceral transplants. If a on Paying Organ Donors?” Spring 2016.) hepatologist—a liver specialist—knows her Given the data indicating that a person’s patient can get a kidney later if it becomes health changes little whether she has one necessary, the doctor has less reason to do functioning kidney or two, compensated a multivisceral transplant. living donation would present a very large It is worth noting that multivisceral benefit both for those suffering from kidtransplants further distort an already ney disease as well as the government and worrisome racial and class imbalance the overall economy, and with very little for access to transplant organs. A major- attendant increase in costs. ity of the people on the kidney waiting Failing that, however, we should reduce lists are African Americans, Hispanics, or unnecessary multivisceral kidney transplants Native Americans, yet almost two-thirds and instead direct those kidneys to the sickof all liver transplant recipients are white. est and most deserving patients. Doing this Redundant multivisceral transplants effec- may reduce the income of hepatologists but tively take transplant kidneys from poorer, it would save lives and money.
MORSA IMAGES/GETTY IMAGES
Conclusion
much more money for a hospital than kidney transplants. Hospitals typically charge $500,000–$700,000 for a liver transplant, as compared to $200,000 for a kidney transplant (and much less for some patients, as we will see below). Though I don’t want to assert that doctors callously make these decisions in a crass chase for dollars, the added revenue provides perverse incentives. Exacerbating this disparity is the fact that most kidney transplant recipients are on Medicare while most people receiving liver transplants are on private insurance, where reimbursement rates are much higher. For instance, Medicare only pays a hospital around $70,000 for a kidney transplant. The organ procurement organizations also benefit from multivisceral transplant, as it results in organs being distributed to fewer centers, reducing overhead. Another reason liver transplant doctors prefer to do multivisceral transplants has to do with their evaluations. These days nearly all doctors in all specialties are subject to some sort of report card on their performance. In the early days of these evaluations, transplant doctors could game the system by deferring surgeries on sicker patients with a lower probability of surviving, and instead doing more procedures on healthier patients. However, improved data allow evaluations to adjust fairly well for the health of the patient, so there is less room for gaming these days. The improved reliability of these evaluations has resulted in the profession putting more weight on them, and transplant surgeons with a sub-par grade on their report card for a couple of years run the risk of
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Embracing Ossification With Donald Trump in the White House, pro-regulation forces are changing their view on regulatory procedure.
I
✒ BY STUART SHAPIRO
n 1992, University of Texas law professor Thomas McGarity coined the phrase “the ossification of the rulemaking process” to describe the challenges agencies face in promulgating regulations. These challenges include procedural steps required by law and by executive order, and judicial review of regulations by the courts. Because of the increased difficulty of issuing regulations, McGarity claimed, agencies were turning to nonregulatory means of setting policy. Supporters of government regulation now commonly say that requiring agencies to follow certain procedures when issuing new regulations is stifling government attempts to improve public welfare. Among the requirements they often criticize are the conducting of benefit–cost analysis of regulations, demonstrating the quality of the information used in rulemaking, and virtually any new regulatory reform statute that Congress considers. As McGarity noted, the concerns about ossification extend to judicial review. Regulatory supporters bemoan the lack of deference in the courts to agency expertise. Finally, even the requirement that agencies solicit public comment before finalizing a regulation, which dates back to the 1946 Administrative Procedure Act, has been criticized as disproportionately helping business interests and not living up to its promise of encouraging broader participation in regulatory decisions. Meanwhile, opponents of regulation frequently champion these requirements—particularly judicial review, benefit–cost analysis, and the Information Quality Act—as necessary to ensure that regulatory policy is rational and democratic. The continual efforts in Congress to reform the regulatory process, many of which would add new procedures, are generally sponsored by Republicans concerned about the growth of the regulatory state. NEW FANS, NEW OPPONENTS
These debates have been going on for decades. But in 2017, something dramatic happened: the Trump administration entered the STUART SHAPIRO is the Associate Dean of the Faculty in the Bloustein School of
Planning and Public Policy at Rutgers University.
White House and made deregulation a stated priority. Arguably this administration has given the elimination of existing regulations a more significant place in its rhetoric than any previous administration. President Trump has continually emphasized his desire to cut regulations. He has also dramatically exaggerated his administration’s accomplishments in this regard, claiming at one point to have eliminated 22 regulations for every new one the agencies have issued. (See “Deregulation through No Regulation?” Fall 2017.) One of the reasons this claim is an exaggeration is that it counts attempted deregulatory actions as actual deregulation. These actions include proposed repeals that have not yet been finalized, delays of regulations that may or may not be repealed, and announcements of intent to repeal regulations. Most importantly, many of the attempts at deregulation have been found wanting by the courts. Why have the courts held up Trump’s deregulatory efforts? Because the administration has, by and large, carelessly managed the procedural requirements of the regulatory process. This has led to a shifting political dynamic. Groups that customarily support regulation, including the Barack Obama administration’s regulatory efforts, have taken to the courts to stop the Trump administration’s attempts to deregulate. Their arguments before the courts have been myriad, but in many cases they have cited the failure of President Trump’s agencies to follow the strictures of the regulatory process. The Trump administration has tried to delay the implementation of regulations for long periods of time without accepting notice and comment on the delays. Presumably the administration is hoping to repeal these regulations eventually. In numerous cases, however, often at the behest of environmental advocacy groups, courts have ruled that these delays violate the Administrative Procedure Act. In these decisions (e.g., California v. Bureau of Land Management, Becerra v. Department of Interior), courts have told agencies that in order to delay enforcement of a regulation, notice and comment are necessary. As the Trump administration moves from delays to attempts at
SKODONNELL/GETTY IMAGES
WINTER 2018–2019
actual repeal of Obama administration regulations, one can fully expect this litigation to continue. Because the Obama administration spent years building a legal record to support its regulations, attempts to repeal them will need to be similarly constructed and detailed. Repeals will have to meet the standard of not being arbitrary and capricious and the existence of a rulemaking record supporting the original regulation may make that a particularly high barrier to overcome. Initial efforts by Trump’s subordinates cast doubt on whether they are capable of doing this. While the short-circuiting of notice and comment by the Trump administration has been one target for pro-regulation interest groups, it is far from the only one. Allegations surfaced that the Trump Department of Labor had initially conducted a benefit–cost analysis of a proposed regulation designed to repeal an Obama rule that had outlawed the practice of “tip sharing”— employers requiring service-sector workers to pool their tips. The analysis was never made a part of the public record (presumably because it showed the politically unpalatable conclusion that employers would likely profit and workers would lose money) when the proposed rule was made public. Interest groups that
/ Regulation / 9
typically criticized benefit–cost analysis called for the release of the analysis or the withdrawal of the Trump proposal, while traditional supporters of benefit–cost analysis were conspicuously silent. In addition, pro-regulatory plaintiffs have cited benefit–cost analyses in support of lawsuits to stop regulatory delays. (See Earth Justice’s brief in Air Alliance Houston v. EPA.) The Northern District of California cited another regulatory procedure often criticized for hobbling regulation in a decision striking down a Trump attempt to deregulate. The Regulatory Flexibility Act (RFA) requires agencies to assess the effect of their regulations on small businesses. Trump’s Department of the Interior ignored this requirement when attempting to reverse an Obama administration rule to reduce methane emissions from oil and natural gas production on federal lands. The court found that ignoring the RFA (along with other procedural requirements) was sufficient justification to enjoin the deregulatory effort. The Information Quality Act (IQA) directs the Office of Management and Budget, as well as some other agencies, to issue guidelines for “maximizing the quality, objectivity, utility, and integrity” of data and other information used in rulemaking. When implemented early in the George W. Bush administration, there were concerns that it would hobble agency rulemaking. It has turned out that the complaint process that is the primary enforcement mechanism of the act has been rarely used and easily deflected by agencies. Still, the group Democracy Forward made notable use of the IQA to dispute an analysis by the Trump Treasury Department of the tax bills being considered by Congress. Those who supported the IQA have not used it at all to challenge the myriad questionable assertions by the Trump administration in support of its deregulatory policies. HISTORY OF CHANGING SIDES
This shifting dynamic over procedural controls of the bureaucracy has happened before. When Congress began to debate administrative reform in the 1930s, opponents of the New Deal pushed for strict judicial review of agency action in order to curb the flow of power to the executive branch. Not surprisingly, President Franklin D. Roosevelt opposed such efforts. Still, one bill passed in 1940, known as the Walter–Logan Bill, which focused particularly on restricting agency adjudicative processes, then the primary source of executive branch decisions. Roosevelt vetoed the bill and Congress failed to override the veto. As President Harry Truman took office,
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however, the politics of administrative procedures shifted. Supthe current administration; see Table 1. Miles’ Law, “Where you porters of the New Deal became concerned that the president stand depends on where you sit,” appears to apply to ossification. would not win reelection. They also had growing confidence that As debates over regulatory reform continue, this shifting polithe judiciary, now staffed largely with Roosevelt and Truman tics of procedural controls is important. Many of the bills being appointees, would uphold administrative actions. The result of considered by Congress will add procedures to the regulatory these changing preferences for oversight over the executive branch (and deregulatory) process. Arguments about how such bills will was the Administrative Procedure Act, the statute that set the make it harder to regulate should take a backseat to debates about modern standards for judicial review of agency action and created whether the procedures being contemplated can stand on their notice-and-comment rulemaking. own merits. Do requirements for participation increase the likeliSimilarly, in 1984 the Supreme Court handed down Chevron hood of useful information being brought before regulators and v. NRDC, one of the most important decisions in the history of regulatory policy. Table 1: The decision argued for greater deference Should I Favor Ossification? to administrative agencies, particularly citing presidential control of agencies as a President prefers deregulation President prefers regulation reason for such deference. The ruling was Interest group wants Judicial review should be stringent Judicial review should be deferential applauded by conservatives at the time more regulation and procedures are good: and procedures are burdensome: because the president who then controlled pro-ossification. anti-ossification. the agencies in question was Ronald ReaInterest group wants Judicial review should be deferential Judicial review should be stringent gan, and the sentiment was that the deciless regulation and procedures are burdensome: and procedures are good: sion would allow for more flexible regulaanti-ossification. pro-ossification. tory policies (the case itself involved an EPA regulation granting greater flexibility to meaningfully give a sense of involvement to affected parties? Will industry). Now Chevron is regularly a target of conservative advorequirements for analysis lead to demonstrably “better” regulacates who bemoan the deference given to administrative agencies. tions and increase the transparency of the regulatory process? For In a recent paper, Brigham Young University law professor requirements such as formal rulemaking, how will they improve Aaron Nielson coined the term “sticky regulations.” He points the decisions made by regulatory agencies? out that just as it is hard to put regulations in place because of These are all very much open questions. Whether such proceprocedural requirements, it is also hard to remove them. Nielson dures ossify the regulatory process is also an open question. But focuses on the benefits of sticky regulations to agencies looking the deregulatory efforts by the Trump administration have shown to make their work-products permanent and to regulated entities that procedures have similar effects on attempts to deregulate as seeking certainty in the regulatory environment. The reactions to well as on attempts to regulate. Advocates on all sides of regulaPresident Trump’s attempts to deregulate show that those who tory debates should therefore hesitate before using ossification benefit from regulations and the interest groups that represent arguments. Making it harder for agencies to create new policies them also may prefer regulations that are sticky or a regulatory cuts both ways. process that has at least some degree of ossification. The empirical question of whether the regulatory process is READINGS ossified is an open one. Numerous scholars have cast doubt on ■■ “1930s Redux: The Administrative State under Siege,” by Gillian E. Metzger. McGarity’s original hypothesis. (See “What Regulatory ‘OssificaHarvard Law Review 131(1): 1–95 (2017). tion’?” Winter 2015–2016.) Regardless of whether the regulatory ■■ “Deregulation: Process and Procedures that Govern Agency Decisionmaking process has become crippled by the implementation of regulatory in an Era of Rollbacks,” by Bethany A. Davis Noll and Denise A. Grab. Energy Law Journal 38(2): 269–295 (2017). procedures and stringent review by the courts, it is clear that each ■■ “Some Thoughts on ‘Deossifying’ the Rulemaking Process,” by Thomas O. procedure makes rulemaking harder or costlier for agencies. The McGarity. Duke Law Journal 41(6): 1385–1462 (1992). Trump effort at deregulation has shown that the cost of deregu■ ■ “Sticky Regulations,” by Aaron L. Nielson. University of Chicago Law Review 85(1): lating has similarly increased. Procedures enhance the standing 85–143 (2018). of the regulatory status quo. ■■ “Testing the Ossification Thesis: An Empirical Examination of Federal RegulaThis has scrambled attitudes toward judicial review and protory Volume and Speed, 1950–1990,” by Jason Webb Yackee and Susan Webb cedural control of rulemaking. It turns out that these attitudes Yackee. George Washington Law Review 80(5): 1414–1492 (2012). depend not only on one’s sentiment regarding the existing stock ■■ “The Administrative Procedure Act: The Beginnings,” by Walter Gellhorn. Virof regulations (if we have too many, then rulemaking should be ginia Law Review 72(2): 219–233 (1986). harder; if we have too few, then rulemaking should be easier). ■■ “The APA: Past, Present, and Future,” by Martin Shapiro. Virginia Law Review 72(2): 447–492 (1986). They also depend on the direction of regulatory preferences of
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12 / Regulation / WINTER 2018–2019 COMMERCE & TRADE
Is NAFTA 2.0 Better than Nothing? Would Americans be better off if their government simply repealed NAFTA rather than replace it with the USMCA?
L
✒ BY PIERRE LEMIEUX
ate last September, the governments of the United States, Mexico, and Canada announced agreement on the United States–Mexico–Canada Agreement (USMCA) to replace the North American Free Trade Agreement (NAFTA). The standard reaction of free traders to the announcement was that the new deal isn’t as bad as they had feared. A Wall Street Journal editorial put it succinctly: “The new trade deal could have been worse given Mr. Trump’s protectionist beliefs, but that’s about the best we can say for it.” More interesting was the tepid response to the announcement from groups that are not known as free traders. The president of the International Brotherhood of Teamsters, a large American union with a Canadian presence, applauded the USMCA’s “considerable progress on workers’ rights,” but said that more information, notably on enforcement, was required “before the Teamsters can give it our unqualified support.” The United Auto Workers were pleased but not ready to give their blessing until all the details are released. The AFL–CIO, the largest labor organization in America, called the agreement “a good start,” but said they “simply do not have enough information at this time to know whether [it] is in the economic interests of the United States.” In truth, nobody at that time had enough information to make such a judgment. The final language wasn’t set until November 30—after this article went to press—when representatives of the three governments were scheduled to sign the agreement. Until then, analysts made due with a draft “Subject to Legal Review for Accuracy, Clarity, and Consistency.” Even with the formal signing, the proposed treaty will still have to be approved by the PIERRE LEMIEUX is an economist affiliated with the Department of Management Sciences of the Université du Québec en Outaouais. His latest book is What’s Wrong with Protectionism? Answering Common Objections to Free Trade (Bowman and Littlefield, 2018).
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legislatures of the three countries, and it is not certain what the new Congress will do with the deal. The draft agreement is made of a preamble, 34 chapters, 15 annexes, and 33 “side letters”—all of which add up to 2,082 pages. The USMCA is an even more complex piece of legalese than the roughly 600 pages of NAFTA. In comparison, free trade should be simple. Any pair of individuals or their intermediaries or corporate bodies should be free to exchange a good or service on their own terms. The very complexity of the USMCA suggests that it is not free trade. POSITIVE POINTS IN THE USMCA
The USMCA is often described as being very similar to NAFTA, which is why some people are calling it “NAFTA 2.0.” Among the things that have been substantially maintained is the dispute settlement mechanism of the original NAFTA’s Chapters
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19 and 20, which allows each national government to challenge antidumping or countervailing duties before arbitration panels. Much of what the USMCA does not borrow from NAFTA it copies from the Trans-Pacific Partnership (TPP), a trade agreement that the Trump administration abandoned and that the other 11 involved nations then rechristened the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) and signed. One lawyer’s estimate puts at two-thirds the number of chapters of the USMCA that can be traced to the CPTTP. One can find positive changes in the USMCA, but they are small. One such change is a prohibition on currency depreciation intended to produce a trade advantage, although it may be difficult to disentangle such manipulations from ordinary monetary policy. Canadian and Mexican consumers will benefit from a higher threshold for importing small packages without tax or duty and with minimum clearance procedures. Agricultural trade is very slightly liberalized. Trade in digital products like music and e-books will be liberalized (as TPP proposed to do), although the liberalization will be accompanied by new regulations under the guise of consumer protection. Trade in financial services and telecommunications will also ostensibly be liberalized, though they too will be encumbered by exceptions and (as European bureaucrats would say) “harmonization”—that is, regulation.
CREDIT HERE
MORE TRADE REGULATION
Regulation is a general problem in the USMCA, even more than it was in NAFTA. One example is the extension of intellectual property protection (on copyrights and some patents, including “scent marks”), which will be accompanied by strengthened regulations and controls. More significantly, as the Wall Street Journal noted, “The new deal also takes a giant step toward politically managed trade by imposing new rules of origin and labor regulations.” The USMCA tightens the previous rules of origin. These rules make it harder for intermediate goods imported from outside a “free trade” area like North America to stealthily benefit from the zone’s trade preferences when incorporated into final products traded within the zone. For instance, to move across North American borders without tariffs, cars will need to have 75% North American content, compared to 62.5% under NAFTA. North American car and truck manufacturers will also have to purchase 70% of
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their steel and aluminum on the continent in order to avoid tariffs. This will raise costs on North American consumers. We know this because, if manufacturing more parts and materials in America did not increase costs, manufacturers would already be doing it. Costs will thus increase, notably for small cars built in Mexico with large parts such as transmissions and engines imported from the rest of the world. Examples include the Nissan Sentra, the Volkswagen Golf compact, the Honda Fit, the Fiat 500 subcompact, and the small Mazda3. It seems that “fairness”—a term used in one form or another some three dozen times in the agreement—is consistent with hitting consumers who buy small cars. What about the poor and the environment? The USMCA will protect unionized American (and Canadian) workers against competition from poorer Mexicans. North American car manufacturers will be obliged to ensure that about 40% of the value of their cars is produced by labor earning at least
Why did the Mexican government accept these restrictions? One reason may be that the collapse of NAFTA would have impoverished Mexico and presented a political challenge to its government. Another reason is that many people on the left claim that restricting the employment choices of poor workers, as labor regulations do, constitutes a triumph of social justice. If rational ignorance did not exist and all voters read Chapter 23 of USMCA, many would be surprised to learn that the three governments involved “affirm their obligations as members of the ILO, including those stated in the ILO Declaration on Rights at Work and the ILO Declaration on Social Justice for a Fair Globalization (2008).” Aren’t these leftist causes ostensibly in contradiction with the Trump government’s official agenda? The answer is that the populist right, just like the populist left, has no libertarian or classical liberal philosophy, and is as willing to use organized labor for its own power-aggrandizement purposes. Similar observations could perhaps be made about the USMCA’s Chapter 24 on the environment. It states that “a healthy environment is an integral element of sustainable development.” The three governments “recognize that emissions of certain substances can significantly deplete and otherwise modify the ozone layer in a manner that is likely to result in adverse effects on human health and the environment.” The Trump administration believes that? For good measure, the three governments also “recognize the importance of promoting corporate social responsibility.”
The populist right, like the populist left, has no libertarian or classical liberal philosophy, and is just as willing to use organized labor for its own power-aggrandizing purposes.
$16 an hour. That is well below this sector’s wages in the United States and Canada, but above the wages currently paid in Mexico. In other words, the USMCA imposes a minimum wage on a large proportion of Mexican autoworkers. As a post by Stan Veuger of the American Enterprise Institute quips about the USMCA negotiations, “All this for a Mexican minimum wage increase?” It is true that car importers could avoid these new restrictions by simply paying the 2.5% tariff approved by the World Trade Organization. But car parts or unfinished cars crossing borders several times along integrated North American supply chains would presumably be hit by the tariff more than once. Moreover, the U.S. government could then impose the 25% tariff it has threatened, or any amount of a “national security” tariff. The effort to undermine the competitiveness of Mexican workers extends beyond the automobile industry. The USMCA mandates that each member government “shall adopt and maintain statutes and regulations, and practices thereunder, governing acceptable conditions of work with respect to minimum wages.” Iain Murray of the Competitive Enterprise Institute notes that the agreement will force the Mexican government to implement the “core rights” promoted by the International Labor Organization (ILO), including union recognition and mandatory collective bargaining. We can only hope that the Teamsters are right to fear an ineffective enforcement.
A POLITICAL TAKEOVER?
The preamble of the USMCA is interesting in itself. It dutifully qualifies free markets and competition with the fairness ideology as it speaks of “freer, fairer markets” and “fair competition.” It is certainly not a coincidence that environmental and labor regulation will mainly impede Mexican competitors. How is that much different from what Barack Obama or Hillary Clinton would have negotiated? An original and questionable innovation of the USMCA is to practically prohibit any of the three governments (“the Parties,” as they are called in treaty legalese) from concluding a free-trade deal with a non-market economy, which everybody recognizes is aimed at China. Article 32.10, par. 4 decrees: Entry by any Party into a free trade agreement with a nonmarket country shall allow the other Parties to terminate this Agreement on six-month notice and replace this Agreement with an agreement as between them (bilateral agreement).
I have argued before that there is no reason to fear the competition of a non-market country. (See “Peter Navarro’s Conversion,” Fall 2019.) Isolating China imposes a cost to all individuals and
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corporations that would have freely traded with Chinese partners. It also increases the risk of a military confrontation. The USMCA makes continental trade more dependent on politics and more subject to political uncertainty. The agreement includes a 16-year sunset clause if it is not specifically renewed. Neither Canada nor Mexico is seriously protected against future tariffs that the U.S. government could (again) impose under the excuse of “national security.” Although the three national governments will still be able to bring trade disputes before USMCA arbitration panels, a private foreign investor from within the area will not generally be able to do so, as was possible under NAFTA. The Trump administration’s trade war has generated much political uncertainty. One case in point: companies that could move their factories to the United States, as Trump wants, would face “political risk” if they do so. What if their imports (automobile parts, for example) are hit by new American tariffs? Johan Gott, a principal with global management consulting firm A.T. Kearney, notes that “these companies are now seeing an element of political risk to operating in the U.S.” For a country’s residents, the main benefit of free-trade agreements is not so much to save them from foreign governments’ protectionism as to protect them from their own Leviathan—and any state is a potential Leviathan. A free-trade treaty ties the hands of one’s own government, which is a benefit not a cost. Many changes in the USMCA increase the power of the national governments involved—and perhaps mainly the U.S. government—over their own citizens, instead of better circumscribing it. The rechristening of NAFTA as the USMCA betrays the political character of the renegotiations. In his 2016 campaign, Trump called NAFTA the “worst trade deal maybe ever signed anywhere,” which was at best a politician’s exaggeration. The president will now be able to cynically claim that he has repealed NAFTA while, in fact, he has accentuated its worst features.
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There also are arguments to support a negative answer: that no NAFTA would be better than a fake one under the name of USMCA. One problem is that the new agreement strengthens the false ideas that export is the justification of free trade and that the goal is to protect corporations and other producers (including government cronies). Despite occasional lip service to “consumer welfare,” one is hard-pressed to find in the USMCA’s 2,082 pages a clear reference to the benefits to consumers of international trade. Benefits to consumers always seem to flow from regulation and the protective intervention of benevolent governments. But in reality, the state acts on behalf of domestic producers, not consumers. National governments negotiate on behalf of their producers. The USMCA thus deepens the fundamental misunderstanding in debates about free trade. As free traders know, the real benefits of free trade accrue to consumers—most of whom are
Trump called NAFTA the “worst trade deal maybe ever signed anywhere,” which was at best a politician’s exaggeration. Now he can claim he repealed NAFTA when, in fact, he’s accentuated its worst features.
A FUZZY BOTTOM LINE
It is quite clear that the original NAFTA was more favorable to free trade than the USMCA. That the expression “free trade” has been deleted from the latter’s name is not benign. This raises the question whether the USMCA is better than no trade deal at all— that is, better than even a repeal of NAFTA with no replacement. One argument for a positive answer—that NAFTA 2.0 is better than no NAFTA—is the symbolism of the alternative. A repeal of NAFTA by President Trump would have boosted the idea that the world is entering a new age of protectionism. It also would have struck another blow to the international standing of the United States and the idea of liberty that it still represents for many. We cannot know for sure how the USMCA will play out, and it might not be as bad as it seems.
also producers, but they produce in order to consume, not the other way around. Managed or regulated trade, on the contrary, is based on the idea that every freedom to import that a government gracefully grants its citizens must be matched by a “concession” from foreign governments, as if the value of trade resides in exports. Free traders tend to adopt the concession vocabulary in order to persuade the other side, but in doing so they undermine the true economic and ethical arguments for free trade. It would thus be better for the vast majority of people in the three countries of North America if Congress rejected the USMCA and stopped Trump from abrogating NAFTA. Assuming that this is not a feasible option, the preferable alternative between a bad USMCA and no agreement at all is difficult to decide. It seems to me that a supporter of economic freedom and free trade could take either side of the issue. I don’t emphasize the alternative of unilateral free trade because it is not politically feasible now. The question at hand boils down to which of the alternatives on the political table has the best chance of moving us toward—instead of away from—an ideal world where every individual, at least among our fellow citizens, is free to trade as he wishes, to individually make his own deals at home or abroad with whomever is willing and able to trade.
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Getting Out of Your Business Cities nationwide are making it a crime to work from home.
K
✒ BY CHRISTINA SANDEFUR
im O’Neil ran a thriving medical billing business in Chandler, AZ. But that business became a nightmare when local officials discovered she was operating it out of her home. Her firm, KMB Medical Billing, originally had its own office. But when O’Neil’s father became ill, she moved it into her house so she could care for him and keep an eye on her two children. Her business had no signs, no commercial equipment, and she did not sell goods or store inventory. No customers came to her home, so she was not causing any noise, traffic, or parking issues. And though she did employ workers, they did not work out of her house. Most observers would have never noticed that a business was operating in her home. Nevertheless, when city officials learned about the arrangement, they initiated months of tedious back-andforth with O’Neil, with ever-increasing demands and legal threats. First, they told her she had seven days to apply for a special-use permit or face legal action, even though no one had previously told her she needed the city’s permission to work from home. Then they said she needed to construct a commercial parking lot on her property, even though no clients or employees would ever use it. They even demanded she attend monthly meetings with the city. Eventually, she gave up and rented some office space. The ordeal, she said, was “one of the most stressful experiences of my life.” O’Neil’s business helped doctors and patients and provided flexible employment for her and her employees. Rather than praising her for such entrepreneurship, city officials punished her—not because she was causing problems, but simply because she ran a business from her home instead of an office. THE GROWTH OF HOME-BASED BUSINESSES
In recent years, the internet, social media, and smartphones have given entrepreneurs unprecedented freedom to run businesses CHRISTINA SANDEFUR is executive vice president of the Goldwater Institute.
from their homes cheaply and easily. The home-based option gives stay-at-home parents, the handicapped, and others who find it difficult to leave the house new options to earn money for their families. Lawyers, psychologists, furniture repairmen, and data entry technicians are just some of the professionals who can work from their homes. Others make money selling items online. In fact, according to the U.S. Census Bureau, more than half of the businesses surveyed in 2012 were operated primarily from a home. Home-based businesses also grow into larger enterprises, including some of the biggest companies in America today. Amazon, Apple, Disney, Harley–Davidson, Hewlett–Packard, Google, Mattel, Microsoft, and many other major corporations began in peoples’ homes and garages. But they might never have come into existence if they had faced today’s growing local restrictions on home-based businesses. STIFLING ENTREPRENEURSHIP
In a survey of local zoning ordinances published last year, M. Nolan Gray, an expert in city planning who is affiliated with Rutgers University, and Olivia Gonzalez, research associate for the Mercatus Center at George Mason University, found that the perworker costs of complying with regulations are higher for small businesses than larger businesses. That puts many people who work from home out of work or prevents them from getting their businesses off the ground in the first place. People who want to work from home are often unaware of zoning requirements and other restrictions impeding their work until city officials impose stiff penalties or force them to cease operating. Others operate their home-based businesses underground—thereby risking serious civil and even criminal penalties—because the regulations are too confusing or severe. According to Gray and Gonzalez, officials sometimes try to craft reasonable solutions but nevertheless end up thwarting
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home-based businesses. One approach is for cities to explicitly permit specified types of businesses in residential areas. But at best, this approach can only result in allowing existing types of businesses to continue. Government officials cannot possibly predict the innovations that entrepreneurs will make, so such lists quickly become obsolete. Cities also restrict the number of employees and clients who can visit a home-based business. In Nashville, it is illegal to serve a customer in one’s home regardless of the business, meaning that people who unobtrusively cut hair, teach violin lessons, or tutor schoolchildren are outlaws if they do so from home rather than a traditional office. Portland, OR allows up to eight clients to visit a home-based business each day, but only if the homeowner gets a permit and passes a home inspection. In San Francisco, it’s legal to have a group of friends over to watch a movie, participate in a book club, or even sew a quilt, but it’s against the law to invite
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the same people over for business purposes. Surprisingly, officials sometimes prohibit home-based businesses from employing nonresident employees who work off-site. These arbitrary, one-size-fits-all restrictions fail to recognize that the typical home-based business is a quiet, responsibly run operation that neighbors never even notice. Forcing those businesses to comply with outmoded zoning, licensing, and permit requirements deprives people of economic opportunity and punishes responsible citizens. It also empowers meddlesome neighbors to divert limited city resources away from addressing pressing issues, distracting the police from solving genuine crimes. That is precisely what happened to Angie Hall of Phoenix. Hall left her lucrative yet hectic 16-year corporate career to start a business teaching yoga and meditation at a local studio. Some clients expressed a desire to practice in a quiet space outside of the commercial studio setting, so she decided to construct a
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quaint studio in her backyard where she could offer small, more intimate gatherings of just a couple of people at a time—no more than a dinner party. Hall had owned her home for 11 years and during that time had always been a kind and tidy neighbor. For advice on the studio, she consulted with a contractor who lived next door; he had recently finished building a home office in his own backyard and he initially expressed an interest in building her studio himself. Then she consulted the city code, even though she knew that other residents on her street operated businesses out of their homes without a permit. Her neighbors were not doing anything dangerous or bothering anyone, so she did not complain. However, she wanted to follow the rules. She got a building permit for her backyard studio and disclosed her intentions to offer yoga there. She also applied for a business permit and a permit allowing increased traffic, even though she did not think her business would bring extra traffic to the neighborhood. That’s when Hall’s dream became a nightmare. After she decided to use a different contractor, the neighbor who originally offered to build the studio decided he did not want another business in the area. He began campaigning against her request for a permit. A coalition of neighbors began spying on Hall, looking for excuses to object at city council meetings where her permit application would be considered. They photographed cars that parked in her driveway or near her home, as well as guests who entered the house. One neighbor began eavesdropping on her conversations through the fence, stalking her social media accounts, and printing out posts regarding the studio. Angie invested her life savings into the construction of her studio, but when she finally finished, it became clear she might not be able to use it. Unable to move forward with her business, she was forced to hire a lawyer at $500 an hour. At the zoning hearing, she and her lawyer offered a compromise: in exchange for a business permit, she would submit to additional hearings before the city’s zoning board to prove her business was not having an ill effect on the neighborhood. She would only allow three cars to be at her house at any time, and all would park in her driveway, mitigating any traffic concerns. Finally, though she has no plans to move, she would surrender her business permit if she ever sold her house. Those good-faith efforts were in vain. At the hearing, residents were rowdy, yelling and speaking out of turn. It didn’t matter that Hall and her students offered to teach free community classes, do street clean up, and ride bikes to their appointments instead of coming to classes in cars. Client testimonials, letters of her good character, and her lawyer’s best pleas did nothing.
After months of harassment and repeated city inspections (both announced and unannounced), it became clear that the organized campaign against her home-based business would ruin her chances of obtaining a permit. And because she had disclosed her intentions, the neighbors would continue to file complaints anytime they suspected she was conducting business from her home. Emotionally and financially exhausted, she withdrew her request and gave up. Had Hall followed the examples of her neighbors and ignored the law, she could have been living her dream today. Her small, private yoga instruction firm had no observable effect on the neighborhood, so neighbors likely would have never known it existed. But because she tried to abide by the law, she was forced to undergo repeated humiliation and harassment—to be dragged
Home-based business regulations might have been created with good intentions, but they’re often hijacked by NIMBY neighbors and exploited to turn private squabbles into public disputes involving the government.
before the city as if she were a criminal and forced to justify her actions—even though her work had never bothered anyone. Her life was turned upside down because she followed the rules. City permit requirements for home-based businesses might have been created with good intentions, but they’re often hijacked by “not-in-my-backyard” (NIMBY) neighbors and exploited to transform private squabbles between neighbors into public disputes involving the government. That results in government dictating what people may do within the confines of their own homes. A STATE-BASED SOLUTION
Every year, Lee Sepanek’s Christmas display brings joy to Phoenix residents who visit to enjoy the glistening decorations and sip the hot chocolate he serves them. But not last year. Thanks to local bureaucrats, he was forced to cancel the show. The trouble started during the summer of 2017 when the city warned him he was violating its Mobile Food Vending Ordinance, even though he was not operating any kind of “mobile” facility and was not engaged in vending. Sepanek does not charge for the cocoa— he just asks for donations. But the city said its rules are broad enough to prohibit even giving away cocoa from one’s driveway. When Sepanek asked the city what he could do to keep the show going, officials told him he “would need to find a licensed commissary kitchen as a ‘base’ to store, clean and prep” his cocoa and that he would have to get a “special event/seasonal permit,” requiring fees and onsite inspections. City officers also
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complained that he was selling Christmas ornaments, which, they said, violates Phoenix’s rules against having a “home occupation.” After local news reported Sepanek’s story, the city indicated it might back down. But by then it was too late; he could not get the lights up in time for Christmas. Phoenix’s Grinch-like attitude might seem like a small thing, but it’s part of the same problem that doomed O’Neil’s medical billing and Hall’s yoga instruction businesses: outmoded local ordinances that forbid home-based businesses and in the process violate private property rights and hamper economic opportunity. Cities that shut down home-based businesses often complain about traffic or neighborhood parking, but there are already rules on the books that address such concerns. Even more common is the often-unspoken assumption that the presence of a commercial transaction transforms an innocent activity into a business that government must oversee. This makes no sense. If it is legally and morally unobjectionable to do one’s own income taxes at the kitchen table, there is no reason that an accountant should be barred from doing someone else’s taxes in her home office so long as she follows the rules of the profession. If a mother can teach her daughter to play the violin in her living room, it makes no sense for the government to penalize her for teaching someone else’s daughter in the same living room for money. Yet local governments typically draw the line at the exchange of money: cooking a meal for a guest in one’s kitchen is viewed as falling within the almost sacred right of deciding what to do in the privacy of one’s home, but cooking a meal for a guest for money is treated as suspicious in the absence of government supervision. That’s not to say there are no legitimate grounds for regulating home-based businesses. Local governments should have power to prevent traffic problems, noise, threats to public safety, and nuisances. But existing ordinances already address those concerns. And local regulations of home-based businesses are often based on assumptions about the marketplace that are now growing obsolete—and are rarely tailored to address specific concerns. Instead, they’re more often written in broad terms, essentially banning all home businesses on the theory that they might lead to problems. And that approach is increasingly stifling the sharing economy. Some efforts have been made to liberalize local restrictions on harmless home-based businesses. But even those efforts have faced such strong NIMBY opposition that many cities have refused to budge. As a result, some states are taking matters into their own hands, working to create fairer, more uniform rules that give blanket permission to engage in specific home-based enterprises. Colorado recently passed a “cottage food law” allowing people to sell food prepared in small quantities in their homes. Alaska, California, Illinois, and Georgia have similar laws. California also prohibits cities from banning home daycare services. But overall, few states have adopted comprehensive protections for home-based businesses. This year, the Arizona legislature considered one of the most comprehensive reforms yet: the Home-Based Business Fairness
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Act, drafted by the Goldwater Institute and the Arizona Free Enterprise Club. The legislation would put an end to the patchwork of bureaucracy and restrictions that block home-based entrepreneurship. Under the bill, cities could not require home-based businesses to obtain a costly, time-consuming home occupation license or permit unless there was actual evidence that a business would cause disruption to the residential area. It would require that homes be primarily used as residences, so there would be no risk of shopping centers cropping up in residential neighborhoods. But it also provides that if a business has no harmful effect on the community—meaning it does not generate excess parking or traffic, or cause noise or other disturbances, and is not visible from the street—it could operate without government obstruction. This would safeguard families with home-based businesses from lengthy, uncertain, and expensive permitting or rezoning processes that are not designed to mitigate a nuisance but are aimed at a homeowner simply because she works from home rather than a traditional office. The bill would leave local governments to focus on mitigating nuisances through building codes; traffic, parking, and noise ordinances; and other health and safety regulations. Most importantly, homeowners would not have to get a bureaucrat’s permission to run a business that is not causing neighborhood disruption. Unfortunately, thanks to intense NIMBY opposition, the legislation failed. LOCAL CONTROL, OUT OF CONTROL
Several Arizona cities vehemently opposed the Home-Based Business Fairness Act, incensed about what they perceived as a loss of their power and arguing that home-based business regulation is a matter of “local control.” To kill the bill, city officials resorted to fear tactics, raising a number of nonsensical objections and outright falsehoods. They argued that home-based businesses would generate noise, traffic and parking congestion, and other nuisances. Yet the bill expressly addressed those concerns, leaving cities with the same power they already had to enforce existing nuisance rules, fire and building codes, and traffic restrictions. The bill was also narrowly targeted to protect only businesses that did not “generate on-street parking” or create a “substantial increase in traffic.” City bureaucrats nevertheless protested that the bill would make it difficult for them to maintain the residential character of neighborhoods and could lead to an increase in businesses like dog boarding, auto repair facilities, and dental offices—none of which were true, given that the bill allowed cities to ensure home-based businesses were secondary to a property’s use as a home. Nor would the bill have altered any existing laws relating to professional licensing, taxes, or public health and safety standards. In fact, that was the whole point: the bill would have instructed cities to focus on harm to the neighborhood, not on inoffensive activities going on in a home. But the most disturbing argument raised at meetings about the Arizona bill came when city officials argued that their enforcement
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powers would be curtailed because the legislation would make it harder for them to enter and inspect homes. If the bill passed, some claimed, city governments would not have an accounting of the activities people were conducting in their homes. But city officials have no business intruding in people’s private homes. State and federal constitutions provide robust privacy protections against such busybody monitoring. Indeed, even the federal Occupational Safety and Health Administration backed down from its decision to conduct inspections of people’s home offices after widespread outrage that such a move would intrude on individual privacy. If homeowners are causing problems for their neighbors, cities can investigate under the nuisance powers they already possess—and those powers should be enforced the same across the board regardless of whether someone is working from home. But opponents of the bill were quite clear: existing prohibitions on home businesses give them a unique advantage to demand the disclosure of private information—and they were unwilling to give that up. CONCLUSION
City bureaucrats often threaten home-based businesses in the name of “local control.” But while local control is a tool that allows communities to make decisions within the proper scope of their authority, it should not be used as a weapon against individual ww_ad_reg11-10_1/2pg.qxd
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rights. When local control becomes destructive and oppressive, then states have a duty to step in and protect people’s rights. Arizona’s Home-Based Business Fairness bill did not seek to eliminate cities’ powers; it simply sought to end local abuses by establishing an important presumption of freedom: if a home-based business has no harmful effect on a residential neighborhood, a homeowner should be allowed to operate without first seeking permission. Most neighborhoods already have many home-based businesses that operate in secret without disturbing anyone, and those practices deserve protection. Responsible home-based business owners should not be dragged through expensive, tedious, often futile permitting processes that give neighbors a heckler’s veto over what goes on in the privacy of one’s home. The good news is that despite its initial failure in Arizona, the Home-Based Business Fairness Act can serve as a nationwide model giving policymakers the tools they need to strike a fair balance between property rights and public protection from genuine nuisances. States should standardize and modernize their cities’ overly broad and often outmoded regulations. That way, policymakers can refocus local resources where they belong: on addressing actual disruptions while embracing the new economy and empowering people to pursue the American Dream—whether they do so from a corporate office or their kitchen table.
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How Economists Understate the Damage from Rent Controls These policies may lower rental payments, but they hurt the quality of rental housing.
R
✒ BY RICHARD B. MCKENZIE AND DWIGHT R. LEE apidly rising rents in the Los Angeles and San Francisco metropolitan areas have once again produced calls for government rent control. This November, Californians voted on Proposition 10, which would have overturned a state law prohibiting local governments from imposing controls on units built after 1995. The measure was defeated, with 61% of voters giving a thumbsdown on the measure. However, rent-control advocates will almost certainly undertake other efforts in the near future, especially given that 39% of Californians favor rent controls, a sizable political base from which to launch another campaign. Rent-control backers’ reasoning is straight-forward: “The rent is too damn high!” Renters are being priced out of economically dynamic big cities, driving them out to the suburbs, out of state, or onto the street. And rising rents and proposed controls seem to be destiny in the Golden State. The backers’ working presumption is that rent control (or its less onerous variant, “rent stabilization”) will benefit a substantial majority of (if not almost all) renters, especially low-income tenants. Conventional economic analysis tends to support this view, at least in the short run: though the controls may discourage the addition of new units, they will benefit current renters by giving them a break on their monthly payments. But this view is too circumscribed and doesn’t recognize that even renters who keep their apartments and houses in the near term
RICHARD B. MCKENZIE is the Walter B. Gerken Professor (emeritus) in the Merage Business School at the University of California, Irvine. DWIGHT R. LEE is the
Ramsey Chair of Private Enterprise (emeritus) in the University of Georgia’s Economics Department. McKenzie and Lee are coauthors of Microeconomics for MBAs: The Economic Way of Thinking for Managers, 3rd ed. (Cambridge University Press, 2017).
and long term will be made worse off by the controls, even with lower rental payments. CONVENTIONAL RENT-CONTROL ECONOMICS
To understand this, we must understand the economics behind landlords’ search for the best combination of rent and unit “amenities” (e.g., carpet, painting, maintenance, cabinets, lights) and “features” (e.g., air conditioning, security systems, balconies, showers, window treatments, upscale appliances) that augment the value and costs of the units they offer for rent. The negative consequences for renters emerge because controls on rents force landlords to reconfigure their units’ combinations, taking away these amenities and features or reducing their quality even though the takeaways are worth more to the tenants than the money saved by rent controls. Even in the short run, landlords can reduce the amount of living space available for, say, tenant storage, limit the number tenants in each unit, and convert units into condos. In the longer run they can let rental units deteriorate at an accelerated rate, reducing the count of rentcontrolled units. Figure 1 captures the supply and demand for basic rental units, which amount to a given square footage with minimal amenities and no features. This is an intentionally simple starting point to draw out the logic of adding features and, concomitantly, determining unit rents. As in conventional rent-control analytics, the market forces in Figure 1 will lead to a monthly rent payment of R1 with U1 units made available—absent rent controls. Under conventional rentcontrol analytics, a controlled rent, R c, will be set below R1. (There is no market effect from a rent control at or above R1.)
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This figure illustrates how rent control alters the market equilibrium of rental housing in troubling ways: The controlled rent leads to a greater number of rental units demanded, U2, than would be demanded if the market rent were allowed to stay at R1. ■■ The supply of units will shrink from U1 to U3 as landlords take their units off the market, convert them to condos, fail to maintain them, and shelve plans to build more rental units. ■■ As a result, a shortage of rental units will grow over time, ultimately equaling the difference between U3 and U2. PIUS99/GETTY IMAGES
■■
Given the shortage, landlords can be choosier in selecting tenants. This means they will be more inclined to discriminate on whatever basis they like, including veiled discrimination for age, race, gender, or sexual orientation. Landlords can use a host of other characteristics to choose tenants, including physical attractiveness, whether the applicant has children or pets (and
/ Regulation / 23
how many), criminal history, and credit scores. In short, rent control will boost various non-price forms of discrimination and will likely lead to an upgrade in the average “quality” of tenants from the landlords’ perspectives. RENTAL UNIT FEATURES AND RENT CONTROL
Rental units typically come with an array of features. Even the most basic units have toilets, sinks, stoves, and carpet. In adding features beyond basic amenities, landlords follow a fundamental economic rule: add features (and/or upgrade their quality) so long as their prospective value to tenants is greater than the costs landlords incur in adding them. Consider the addition of air conditioning to basic units. If tenants value the air conditioning more than it costs the landlord to provide, the landlord has incentive to offer that feature. The demand and supply curves will shift, as represented in Figure 2. Because an air-conditioned unit is more desirable, the demand curve will shift outward from D1 to D2, moving upward the vertical distance ab, which represents how much more in monthly rent
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RENT-CONTROL ANALYTICS REVISED
We can now reconsider the economic consequences of rent control with the help of Figure 2. Let’s start with the market for rental units with air conditioning, settled with a market-clearing rental payment of R2 and with U4 rented units. Let’s suppose that the local government designates R2 an “exploitive” or “immoral” rate for low-income tenants and decides that a reasonable, fair rent is R1 (the monthly payment for basic units). What’s a landlord to do? Conventional economic analytics assume that landlords either can’t do anything other than charge R1, as required, and marginally reduce the count of units. Sup-
Figure 1
Rent Control, Conventional View Monthly rent
tenants are willing to pay for a basic unit with air conditioning. Likewise, the air conditioning will add to the landlord’s costs, which means the supply curve will shift upward from S1 to S2, moving the vertical distance cd. That distance reflects the increase in monthly rent the landlord must charge to recover the cost of the air conditioning. Notice that the outward shift in the demand curve, ab, is greater than the upward shift in the supply curve, cd. This difference reflects the fact that the landlord will not add air conditioning unless it pays to do so, which is to say that ab must be greater than cd. If prospective tenants were only willing to pay $100 a month more for a rental unit with air conditioning but the air conditioning cost the landlord $150 a month, the landlord wouldn’t offer air conditioning (not for long, at least). If, however, the tenants were willing to pay $150 a month more for air conditioning that costs the landlord $100 a month to provide, the landlord would be leaving money on the table by offering only basic units. And even if a myopic landlord failed to exploit this opportunity, some enterprising real estate investor would recognize it, buy the landlord’s units, add the air conditioning, and raise the rent, pocketing the additional $50 (or somewhat less) per unit per month as added profit. This new landlord would also be doing the tenants a favor in two ways. First, the number of units would rise from U1 to U4. Second, the tenants would receive ab in added value on their units but would have to pay less than that in additional rent, R2 – R1. The landlord would follow the same calculations in adding other features—maybe a higher grade of carpet, larger refrigerators, security systems—and would only stop adding features when the added cost exceeds the added benefits to tenants. The general point is that financial forces and market competition will ensure that amenities and features mutually beneficial to landlords and tenants will spread across rental developments in markets. Landlords who, for whatever reason, refuse to add mutually beneficial features will tend to be pushed out of the market. By the same token, one of the reasons many people are priced out of rental markets is that other tenants are willing to pay more for added features. Rent controls are promoted as a means of controlling landlords, but they also control prospective tenants’ demands for amenities and features.
S1
R1 Rc D1 U3
U1
U2
Rental units
posedly the landlords could not see any way to take advantage of the resulting shortage of rental units (U2 – U3) and improve their units’ profitability (or reduce their losses). Rent-control advocates believe that by controlling rent they can magically suppress market competition and actually improve the economic positions of renters. But in fact, landlords can and do react to rent control because of the shortage in housing units that would emerge. They have more tenants seeking their units than units available. Bluntly put, they don’t have to passively take what the local government says they must. Landlords of basic units can engage in discrimination, as described above. For units above basic, they have other options: cut out the air conditioning, or reduce regular maintenance, or take away security guards, or do whatever else results in the greatest cost savings. In Figure 2, the removal of air conditioning will cause the tenants’ market demand to drop from D2 to D1, denying tenants the air-conditioning benefits equal to the vertical distance ab. As can be seen in Figure 2, that cut is more than the drop in the rental price, R2 – R1. The tenants who keep their units are worse off even though they are paying a lower, controlled rent. Put differently, rent-control backers argue that rents are lowered by their control proposal. That is true for the out-of-pocket monthly rent payment, but it isn’t true of the tenants’ effective rent, which is the sum of the rent they pay and the lost value of amenities and features forgone because of rent control. In Figure 2, effective rent is represented by the controlled rental payment, R1,
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Figure 2
Monthly rent
Adding Apartment Features and Rent Control
S2 S1
a
R3 R2
c d
R1 b
D2 D1 U3
U1 U4
U2 Rental units
plus the loss in the air conditioning benefits, ab, which together equal R3. Notice that R3 is higher than the uncontrolled market rental rate, R2. That is, rent control increases, rather than decreases (as backers claim), tenants’ effective rents. At the same time, landlords receive a lower effective rent. Their monthly costs go down by cd, but that cost reduction is less than the decrease in the rent they can charge, R2 – R1. As with the tenants, the landlords are worse off, on balance, because of the controls. Notice in Figure 1 that the decrease in the available basic rental units is U1 – U3. The decrease in available rental units in Figure 2 is much lower, U4 – U1, than would have been the case had landlords not been able to take away features (resulting in a decrease in units to U4 – U3). This is the case because the landlords remove features and thus lower their costs, enabling them to continue to offer more—but less valuable—units to tenants. In this way, price controls do damage in the covered markets. However, landlords, by taking away features, somewhat moderate the damage done: tenants are better off by losing features than losing more units. And it should be noted that landlords’ ability to take away features reduces their ability and willingness to discriminate against prospective tenants on whatever basis they fancy (e.g., race, gender, religion, physical attractiveness, pets). Moreover, landlords must adjust their features, given extant competitive market forces that are at work establishing rental units’ combinations of amenities, features, and rent. Those landlords who are reluctant to remove the air conditioning, or
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curb regular maintenance, or delay the replacement of worn carpet can be expected to be bought out by landlords who are not so reluctant. Again, landlords must heed competitive market forces. Rentcontrol backers seem to think that landlords, whom they chastise for being profit maximizing, will convert their businesses to charities and do the bidding of the rent-control advocates, even when rent-control advocates denigrate the landlords as “capitalist pigs” or other choice slurs. They scold landlords for having “monopoly power,” not realizing that the landlords’ market power will be enhanced by the shortages that rent control generates. But there is more. Landlords, in addition to removing features, can develop an array of “tie-in sales.” For example, under rent controls in New York City decades ago, landlords began charging extra for keys to enter apartment buildings’ front doors. These charges, dubbed “key money,” capitalized the difference between the market rental payment and the controlled rent. The price of the key could be expected to vary with the controlled rent level (the lower the controlled rent, the more key money demanded) and the features removed (the more features eliminated, the less key money demanded). Key money is now illegal, but the effect of that control extension has been to increase the shortage of rental units. Landlords can get even more creative. They can start charging for repainting, use of the pool, and use of provided furniture, as well as providing air conditioning, security systems, and other features. The one silver lining for tenants from these “creative reactions” to rent control is that they can result in landlords taking fewer housing units off the market than would otherwise occur. CHASING THE RENT-CONTROL RAINBOW
Rent-control advocates might respond that, if their rent ceilings result in feature reductions, government can enact additional controls that mandate certain apartment features. But there is a limit to how much control government can exercise over rentals—if government truly wants to help renters. With required features specified, landlords can move to other margins of their apartment “bundles.” They can simply withhold other features or become even more creative in adding tie-in sales. (New York City’s rent regulations are now a legal morass of what landlords can’t do.) Rent controls can push many landlords into progressively withdrawing maintenance as the market rent gradually moves up and the controlled rent remains fixed (or “stabilized” with increases in the controlled rent lower than increases in the market rent). Along the control track, landlords can treat tenants progressively worse by using inconsiderate and unkind, if not outright nasty, comments and actions. Being nice and respectful to customers can be costly, after all. The landlords’ (and their managers’) surliness would reduce the development’s profits absent rent controls, but with rent controls the effect can be limited to causing tenants to go elsewhere (say, into up-market units with
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more features that the renters don’t consider worth the higher rents) but be replaced by other renters in the tight housing market. To the extent that government can extend its regulations over more features (and amenities), landlords can be expected to do what comes naturally in the conventional rent-controlled models: take units off the market (through deterioration, conversions to condos, and scrapping building plans). This means that added controls can lead to more discrimination on several fronts among prospective tenants. Tenants with relatively low incomes and low credit scores (or with dogs and children) can expect their rental options to shrink more than those renters with higher incomes and credit scores. As rent controls are extended, low-income tenants can be expected to crowd ever more densely into basic units, or worse. Of course, rent control advocates may continue to chase their rainbows by prodding government to extend controls ever more broadly over what landlords can do. In essence, government would assume the role of de facto owner—without investing public capital but with the usurpation of developers’ capital, all the while claiming the intent is to help hapless tenants. That would be a neat trick if it could last. But developers would soon catch on to government’s tricks and stop risking their own capital in the jurisdictions where rent controls prevail. Of course, that would exacerbate the shortage of rental units at decent prices—precisely what the advocates oppose. At that point, governments would recognize that the only option for providing affordable housing would be to build basic housing, dubbed “public housing.” Of course, government has long offered public housing, with disappointing results reflected in poorly maintained projects plagued by crime, cyclical poverty, and despair. The end of the rent-control rainbow is not a pot of gold, but a pot of coal.
themselves, many tenants would respond by failing to treat their units with the expected care. They might also sabotage their units by loosening, say, plumbing connections that can lead to leaks requiring repairs. If their landlords repair the problems intentionally created, the burden of the repair is on the landlords, who cannot pass along the repair costs to tenants in the form of higher rents. If the repairs are not made, then the tenants can withhold their rent payments, all very legally. The tenants might
Government would assume the role of de facto owner— without investing public capital, but with the usurpation of developers’ capital, all the while claiming that the intent is to help hapless tenants.
PERVERSE EFFECTS OF RENT CONTROLS ON MAINTENANCE
Landlords’ most immediately attractive line of defense against imposed rent controls might be to allow maintenance to slide, for example, by refusing to repair or delaying repairs on plumbing and electrical networks in their rental developments and by reducing the frequency of grass mowing, trimming shrubbery, and removing litter. Such strategies gradually transform landlords into “slumlords.” Tenants might not like the deteriorating looks of their rental homes but, with the housing shortage that emerges from rent controls, their complaints would be whistles into the wind. The local governments might respond (mistakenly) by passing an ordinance allowing tenants to withhold their rents in the absence of repairs. If so, recognizing an opportunity to better
lose value in the maintenance problems they create, but they still can be expected to create the problems so long as the lost value from the repair problems is less than the rent payments they are able to miss. Through deterioration and withdrawal of units from the covered rental market, rent controls—if pursued vigorously over time by governments—can have effects similar to carpet bombing, with neighborhoods practically destroyed. Economist Thomas Sowell, in his book Basic Economics: A Common Sense Guide to the Economy (5th ed., Basic Books, 2014) observed years ago that New York City’s rent controls have had precisely that effect: Owners have simply disappeared in order to escape the legal consequences of their abandonment, and such buildings often end up vacant and boarded up, though still physically sound enough to house people if they continued to be maintained and repaired. The number of abandoned building taken over by the New York City government over the years runs in the thousands. It has been estimated that there are a least four times as many abandoned housing units in New York City as there are homeless people living on the streets there.
Such are the perverse and unanticipated consequences of rent controls. HOW RENT CONTROL FAVORS THE RICH
Advocates of rent control are concerned for the welfare of the poor and the “near poor.” As such, they should be distressed that the likely (and realized) effect of rent control is to benefit higher-income classes at the expense of others. When rent control only applies to housing for the poor or to rental units that carry rents under some specified monthly rent level (now $2,700 in New York City), the rich benefit. The poor
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get fewer units in their housing markets because landlords will reduce the stock of rent-controlled units by leaving no-longerprofitable rental units vacant, converting their units to condos, or moving their investments to non-controlled units with high rents (and to other industries). Concerning the latter two strategies, as developers move to build uncontrolled high-price condos and rental units with luxury features, the supply of housing units for the rich increases. That, in turn, drives down high-end units’ prices and rents as compared to what they would be otherwise, absent rent controls on housing for lower-income groups. That is, the prices and rents of housing for the rich might still rise but by less than they would otherwise. Despite the lower per-unit prices of these units as a result of stronger competition, high-end residential development further flourishes under these conditions, partially because the demand for those units can be expected to rise. This can be the case because, to obtain housing, some low- to moderate-income renters can be forced to move up-market, paying higher rents for more and higher-quality features that the renters consider not worth the added rents. These supply and demand effects suggest that developers who specialize in converting low-income housing to high-income in wealthy markets (say, New York City) can find themselves build-
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ing personal fortunes of millions and billions of dollars, helped along by rent control. Surely, many New York rent-control advocates would be chagrined to learn that their campaigns over the last 40 years have likely boosted, albeit marginally, the wealth of mega-developers like Donald Trump. CONCLUSION
Conventional economics understates the consequences of rent controls. Its analytics suggest that, though controls can limit the supply of new rental housing, current tenants who keep their units are better off because of the controls. The perspective developed here is decidedly contrarian: even those tenants who stay in their units after the implementation of rent controls are worse off as measured by the difference between ab and R2 – R1, or by the difference between the rent they paid absent the control, R1, and the higher effective rent, R3, that they must pay because of the loss of features. Rent-control advocates’ intentions are laudable: to make rental units more affordable to lower-income households. And they do accomplish this, but not in the benevolent way they think. Rent controls make the units more affordable by making them less desirable. As shown above, that lost value to tenants is greater than their reduction in rent.
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28 / Regulation / WINTER 2018–2019 E N E R GY & E N V I R O N M E N T
The Perils of a Carbon Tax High-minded proposals for a “revenue neutral” Pigouvian tax could result in bigger government, but they could also make it smaller. ✒ BY MICHAEL L. MARLOW
BACKYARDPRODUCTION/GETTY IMAGES
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T
he debate over climate change and the need for government intervention to combat it is often portrayed in “left–right” terms, with the political left claiming that urgent action is required and the right dismissing both climate change’s existence and the need for intervention. However, a 2017 poll by the University of Chicago’ Energy Policy Institute and the Associated Press–NORC Center for Public Affairs Research found that 60% of Americans, including 43% of Republicans, say that government should address climate change. Accordingly, some right-leaning groups have suggested climate change policies featuring a Pigouvian tax on carbon emissions. (Such a tax could be extended to other greenhouse gases, but for simplicity this article will refer to a “carbon tax.”) True to the right’s “limited government” philosophy, many of these proposals would use the tax’s resulting revenue to reduce other taxes that are more economically distortionary, resulting in a “revenue neutral” outcome. Some of these proposals would include the rollback of some costly environmental regulations. Another proposal, by the Climate Leadership Council, would use the carbon tax revenue to fund a universal “dividend” program for U.S. citizens. These ideas are intriguing theoretically, but implementing them would expose them to the machinations of politics. Leftleaning groups, for instance, would likely oppose revenue neutrality and a tradeoff of deregulation, preferring instead to pursue other policy goals. Politicians, who would adopt such legislation, would have their own priorities. The result would likely be something very different from what right-leaning, limited government groups envision. This article develops a harm-reduction strategy for such policy proposals. This would steer the debate toward what tradeoffs would be acceptable in order to mitigate harm from climate change. WILL CARBON TAXES CORRECT EXTERNALITIES?
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Carbon pollution is a negative externality because it imposes external costs on people MICHAEL L. MARLOW is professor of economics at
California Polytechnic State University in San Luis Obispo. This article is based on his white paper “A Carbon Tax That Constrains Government,” produced for the Alliance for Market Solutions.
/ Regulation / 29
who did not create the pollution. The social cost of carbon (SCC) refers to the cost of an additional ton of carbon dioxide pollution. Pricing the correct SCC through a “Pigouvian tax, named after British economist Arthur C. Pigou (1877–1959), internalizes the negative externality so that all costs are accounted for in market prices. Most taxes push resources away from efficient outcomes, but “correct” Pigouvian taxes push resources toward efficient market outcomes. Most economists believe taxes are superior to regulation in efficiently dealing with externalities. In contrast, regulation offers very blunt methods that “command and control” all businesses identically. One-size-fits-all mandates ignore individual characteristics of firms and are inefficient, as some firms reduce emissions by reducing output. Because these regulations dictate what methods should be used to reduce emissions or what emissions levels are acceptable, firms lose incentive to find innovative emissions-reducing alternatives. Critics are correct that a theoretical basis for carbon taxes does not necessarily imply that their implementation corrects externalities. The EPA offers a range of SCC estimates from $14 to $138 per metric ton; that wide range indicates considerable uncertainty on the part of policymakers. Garnering support for “correct” carbon taxes would be difficult because the benefits are uncertain, they may take decades to emerge, and mitigation of climate change is a global public good with many free riders. Even if government knew the “correct” Pigouvian tax, political decisions are rarely based on efficiency grounds alone, as demonstrated in a 2012 paper on emissions pricing by Tom Tieteberg. Still, he found that the predominant effect has been to reduce emissions. Transforming economic theory into practice is clearly imperfect. But it is also naive to believe that perfection is on offer. Regulatory policies exhibit a wide divide between theory and practice, making comparisons of a politically chosen carbon tax to its textbook rendition something of a misplaced debate. Taxation may also be easier to understand, monitor, alter, and is less subject to “crony capitalism” than regulation. DO TAX SWAPS INCREASE WELFARE?
There is a long economic literature indicating that economic growth is inversely related to government size. (See, e.g., Robert Barro’s 1990 Journal of Political Economy article.) This inverse relationship is consistent with distortions to resource allocations stemming from over-regulation and excessive taxation that reinforce commitment to constrained government. Tax swaps focus on substituting taxes with high excess burdens (deadweight loss or welfare cost) for ones with lower burdens. Excess burdens are additional costs that arise when tax policies (beyond simple tax collections) cause resources to be allocated inefficiently. Taxes raise prices and decrease consumption away from efficient allocations. Unlike “correct” Pigouvian taxes that push markets toward efficient outcomes, most taxes push markets in the other direction as government pursues revenues to fund its programs.
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Recent studies estimate that substituting carbon taxes for other tax sources yields significant reductions in excess burdens. A 2015 paper by Donald Marron, Eric Toder, and Lydia Austin summarizes the evidence from separate modeling exercises in five recent academic papers. Estimates differ because of different methodologies, data sets, and time periods, but the studies found that reducing tax rates on capital income was the best choice for reducing the excess burden of our tax system. This result is consistent with standard predictions that lowering taxes on capital income, either through tax rate reductions on all investment or specifically to the corporation tax, raises savings that eventually raise worker productivity and wages as businesses fund more capital investment. Corporation taxes are thus a very expensive method of funding government, resulting in the economy producing fewer jobs, higher prices, and less income for citizens. In fact, a 2007 U.S. Treasury paper estimated that 73% of the corporation tax is borne by workers. This view that carbon taxation yields environmental benefits and a greater tax efficiency is often described as a “double dividend” argument for carbon taxation. However, the soundness of this argument is at best uncertain because taxing carbon is, in effect, taxing factors of production such as labor that push resources further away from efficient allocations. A 2010 review article by Joseph Aldy et al. concludes that most analytical and numerical analyses of environmental tax shifts find that the tax-interaction effect exceeds the revenue-recycling effect, implying no double dividend, and that abatement costs are higher because of the presence of preexisting tax distortions. The tax efficiency gains from revenue-neutral tax substitution are thus uncertain at best, but likely non-existent. Reducing tax expenditures that include tax credits on wind and solar energy and other favored treatments given to “green” industries is another path to reducing excess burden. Tax expenditures are policies that lower, eliminate, or defer tax bills for various activities through reduced tax rates or narrowing of the tax base. Energy-related tax expenditures accounted for 42% (about $12.4 billion) of all financial interventions and subsidies in energy markets in 2013, according to the Energy Information Administration. The three largest tax expenditures represent roughly 90% of nearly $5 billion in annual tax reductions and are unrelated to correcting negative externalities or promoting new technology. Most tax expenditures reflect political favors toward certain industries and clearly enhance employment opportunities for lobbyists and tax accountants. Revenue-neutral carbon taxes coupled with fewer tax expenditures make it harder to “hide” these political favors associated with environmental regulation and complex personal and corporate tax codes. In sum, while tax reform that reduces overall excess burden
raises welfare, it is unlikely that carbon taxation offers a significant double dividend. WILL A CARBON TAX TRULY BE REVENUE-NEUTRAL?
The U.S. Treasury estimated that a carbon tax that started at $49 per metric ton of carbon dioxide equivalent in 2019 and gradually increased until it reached $70 in 2028 would generate net revenues of $194 billion in the first year of the tax and $2.2 trillion over the 10-year period. Some policymakers can’t wait to get their hands on those revenues. Washington Gov. Jay Inslee, for instance, recently admitted that his support for a state carbon tax was partially based on raising $2.1 billion over two years to help fund the state budget. The budget constraint view predicts government spending rises whenever taxes are increased, the “tax–spend hypothesis” often associated with Milton Friedman. He succinctly stated this view as “Governments spend what governments receive plus whatever they can get away with.” There always exists a govern-
Theoretically, substituting a carbon tax for other taxes could be an efficiency gain. But taxing carbon in effect taxes factors of production such as labor, pushing resources further away from efficient allocation.
ment program someone wishes to expand or create. A reasonable assessment of the empirical evidence is that a carbon tax exerts an ambiguous effect on government spending if doubts remain over the viability of the revenue-neutral promise. Major uncertainty would exist if politicians were not legally constrained to act in one way or another when carbon taxes are added to the list of tax sources. That is especially true given the view that constraining government expansion is much easier through tax reduction than through tax increases. Convincing voters that carbon tax revenues should not be used to fund more government would be challenging. Spending proponents are likely encouraged by various surveys of voter attitudes on this issue. A survey of Swiss adults found that a carbon tax could find substantial support on a ballot, but it may not reach the majority without explicit earmarking for environmental spending or climate change spending. Another survey finds that Americans oppose a carbon tax when the resulting revenue’s use is left unspecified, but 60%—including majorities of Democrats, Republicans, and independents—were in support when the money was used to fund research and development for renewable energy programs. A more recent survey of Americans found that most respondents supported using the money to fund clean energy and
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infrastructure. The highest support was associated with using tax revenues to fund clean energy (80%) and infrastructure (77%), with less support for reducing income taxes (59%), returning dividends to households (46%), and reducing payroll taxes (44%). Experience with countries introducing value-added taxes (VAT) fails to mitigate concerns that carbon taxes will fuel government spending. Several studies find that the adoption of a VAT significantly increased the size of government as measured by the tax-toGDP ratio, suggesting that the VAT is a “money machine.” (See, e.g., David Nellor’s 1987 International Monetary Fund paper.) Experience with the Tax Reform Act of 1986 that flattened income tax rates in exchange for the removal of numerous tax expenditures within an agreement of tax neutrality suggests the need for extreme caution. After the legislation passed, politicians quickly began raising rates again, creating more tax brackets, and introducing new tax expenditures, in what has been described as the resetting of a rent-seeking clock that seeks to maximize government revenue. Concerns remain that a similar fate awaits a carbon tax “swap” because politicians would be encouraged to raise government spending given voter support for earmarking carbon revenues for new government programs. Politicians would surely understand that hiking tax rates on those sources whose rates were reduced in the tax swap, as well as on carbon, would deliver more revenue for expanding government.
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Given those obstacles, deregulation in return for carbon taxes is a tall order. One encouraging sign is President Trump’s Executive Order 13771, which directs agencies to eliminate two rules for each new rule and prohibited an increase in net regulatory costs for fiscal years 2017 and 2018. While the Trump administration has yet to fully meet this pledge, it has slowed the growth of regulations to the slowest pace of the previous six administrations during its first year in office. (See “Deregulation through No Regulation?” Fall 2017.) Of course, this progress did not hinge on carbon taxation and can also be undermined in the future by new administrations. REVENUE NEUTRALITY OR CARBON TAX DIVIDENDS?
The CLC proposal that would disburse carbon tax revenues directly to citizens is the best solution for winning popular and political support for carbon taxes. The CLC believes this would tip the economic scales toward the interests of the “little guy” at the expense of the wealthy who typically will pay more. The CLC also believes that the dividends program serves to protect carbon tax revenues from funding more government. A tax of $40 per ton is estimated to generate $2,000 in the first year for a family of four and rebates would rise with tax rates. But there are reasons to be skeptical of this idea: The dividend program strips the revenue neutrality requirement out of the carbon tax policy. That negates one of the best reasons to support a carbon tax: swapping out taxes with high excess burdens, such as taxes on capital and income. ■■ The dividend program creates an incentive for voters to push for carbon tax hikes in order to increase their rebate checks. This incentive is not aligned with finding the “correct” Pigouvian tax rate; instead it risks promoting excessive tax rates that result in inefficient market outcomes. ■■ The dividend program enlarges the size of government. It is essentially a new government program that taxes those who use more fossil fuels to fund a spending program that sends government checks to citizens. ■■ The dividend program may appear to be “free” to voters, thus ramping up their demands for new sources of tax revenue that will further expand government. Voters may also be more inclined to tax capital, which has a very high excess burden and lowers welfare. These tax rebate promises quickly become entitlements, expand, and are nearly impossible to unwind. Unfortunately, the tax dividend policy appeals to policymakers seeking to expand the pool of tax dollars that government collects. ■■
WILL CARBON TAXATION BE TRADED FOR ENVIRONMENTAL DEREGULATION?
Some right-leaning proponents of a carbon tax propose implementing it in exchange for reduction or elimination of tax incentives for clean energy and such regulations as the U.S. Environmental Protection Agency’s Corporate Average Fuel Economy rules and Clean Power Plan. Despite the theoretical merits of such a tradeoff, it would likely not receive much political support. Citizens may suffer from a cognitive bias, known as opportunity cost neglect, that makes them more receptive to regulation than corrective taxation because they ignore or are unaware of the hidden costs of regulation. Unlike taxation, the opportunity costs of regulation are implicit and thus regulations may be viewed as something of a “free lunch” to achieve policy goals. Still, a recent Gallup poll found that more Americans believe there currently is either “too much” (45%) regulation or “the right amount” (29%), versus “too little” (23%). Yet while somewhat supportive of deregulation in general, citizens appear unenthusiastic about environmental deregulation; another Gallup poll found that about two-thirds of Americans favor increased enforcement of environmental regulations and setting higher emissions standards for business and energy. A large bureaucracy and special interests supporting environmental regulation would be formidable foes of deregulation. Some firms also prefer regulation over taxation because it is easier for them to “capture” regulators than tax authorities and because they want to use regulation to erect entry barriers on potential competitors.
In sum, the dividend program overturns the many benefits to citizens from tax reform, is likely to foster carbon tax rates above optimal externality corrections, and encourages citizens to believe (incorrectly) they bear little to no cost themselves for checks from the U.S. government.
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IS CARBON TAXATION REGRESSIVE?
The incidence of a carbon tax on the poor appears to be a simple matter when viewed as a stand-alone policy without substitution for other taxes and deregulation. Lower-income citizens spend a greater share of their income on energy than higher-income families and thus shoulder larger burdens than higher-income families. Jobs, especially in energy sectors, may also be adversely affected by a carbon tax, hurting the poor. These concerns are exacerbated when carbon taxes are simply added onto the existing structure of regulation and the corporate tax code. Right-leaning carbon tax proposals that are intended to be revenue neutral must take care that lower-income households are not adversely affected by the tax swap. Reductions in personal and corporate income taxes, as well as payroll taxes, will lessen burdens, so they must be compared to burdens on the poor that follow from taxing carbon. These proposals deal with tax regressivity in various ways. Supporters propose to rebate some portion of carbon tax revenues to poor households or simply focus on tax neutrality that swaps carbon taxes for other taxes that reduce job opportunities and income for all citizens. As discussed, the CLC proposes equal tax dividends to all citizens as a way of providing larger payments to lower-income households. Of course, there are always unknowns in the political process. Regulation has also been shown to promote higher consumer prices that exert disproportionately negative effects on low-income households. Thus, the effects of deregulation should be considered in the greater picture of whether carbon taxes are regressive. A carbon tax is likely to be regressive in the absence of tax neutrality or deregulation. CARBON TAX HARM REDUCTION
Various disagreements among those on the political right focus on the difference between the theory and expected application of carbon taxes. Wide agreement exists that, in theory, Pigouvian taxation is preferable to regulation, tax reform should lower excess burden, carbon taxation should not expand government, and the poor should not shoulder undue carbon tax burdens. Valid differences exist on how well the theory will be transformed into carbon tax laws. Allaying concerns that carbon taxation will simply expand government without deregulation requires a clear commitment to a constrained government. Obstructing this are policy advocates who singularly focus on a narrow range of issues such as poverty, obesity, and education. It is not surprising that policy advocates are more interested in their particular issue areas than in exploring how to constrain government growth. Advocates can safely prescribe new extensions that promote their narrow policy focus when they believe they do not compete for resources with other advocates. Government programs are rarely eliminated or improved under this scenario because proposals receive little scrutiny. This situation is ripe for logrolling, whereby politicians support programs that do not directly benefit their con-
stituents in return for support for their favored programs. Trading partners have little reason to view each other as competitors for taxpayer funds. This is a recipe for government growth that goes well beyond allocating scarce public resources to their highest-value uses. Climate change appears to fit this profile. Why would policy advocates be interested in trading their preferred policy—carbon taxation, for an existing policy (e.g., corporate taxation, payroll taxation—environmental regulation) when gaining their policy does not require reduction of those other programs? Steering debate toward improving overall government efficiency lies in insisting that carbon taxation proceed with a commitment to constrained government. This bargain requires economic sacrifices from carbon tax advocates seeking to mitigate harm from climate change. This carbon tax deal jeopardizes the political order that seeks government expansion funded by a “free lunch” to themselves. The political status quo typically fears dismantling of the regulatory state and is committed to expanding tax revenues to fund policymakers’ particular interests. Carbon taxation, in effect, represents a “destructive technology” to the status quo when revenue neutrality and deregulation are non-negotiable. Carbon taxation coupled with revenue neutrality and deregulation represent a potential opportunity to capitalize on a highprofile public issue to promote a more efficient government. It is safe to say that right-leaning groups exhibiting the spectrum of views on climate change believe that current regulatory and tax policies are suboptimal. Using a carbon tax as leverage to deregulate and reform our tax code is worth exploring when climate change policies are likely to happen anyway. Trades are a necessary part of the policy process and refusing to negotiate with an opposition that prefers expanding government makes deregulation and tax reform less likely. Refusing to negotiate and pursuing tax reform and deregulation on their own merits is sensible when facing weak opposition. But fierce opposition to tax reform and deregulation is more likely and reason to design an effective harm reduction strategy for carbon tax legislation. The non-negotiable nature of tax neutrality and deregulation also “tests” the convictions of carbon tax advocates. Proponents unwilling to accept these commitments are probably more interested in growing tax revenue and the regulatory state than decreasing greenhouse gas emissions. These commitments provide a “quid pro quo” whereby trading out “bad” policy (e.g., inefficient regulation, high excess-burden taxes) for “good” makes government more efficient. Bunching the benefits from deregulation and tax reform in one package compensates the public for introducing a carbon tax. Climate change policy advocates may consider this a “win–win” deal because it produces a better economy with less carbon when they believe a double dividend exists. Climate change skeptics are more likely to view it as a “win–loss” that can evolve into a net gain. Revenue neutrality corrals traders into understanding that carbon tax revenues cannot fund new government programs without spending less on current programs. This constraint ideally
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unleashes greater scrutiny of all government programs as policy advocates realize that increased funding of their programs necessitates “raiding” funds from other programs. This constraint raises incentives for policy advocates to search for misused public funds as a funding source for their own programs. Revenue neutrality, of course, will not make government hyper-efficient, but it will provide a fixed pool of funds for policy advocates to draw from. CONCLUSION
Economists always look for perfection. They can devise the perfect tax in theory, but it doesn’t work the same way in the real world. This explains much of the divide on the political right over the carbon tax issue. Carbon tax proponents focus on the gains from a deal that closely follows the script of economic theory and commitment to limited government. Carbon tax opponents are climate change skeptics who remain unconvinced that tax neutrality, deregulation, and double dividends will come to fruition. Both sides make valid points. This article presents the carbon tax within a harm reduction strategy in a world in which both climate change believers and skeptics face growing pressure to enact climate change policies. The non-negotiable nature of tax neutrality and deregulation is critical because, otherwise, carbon taxation will likely lead to a larger and more inefficient government. Much is at stake here and avoiding missteps is a tall order in the real world of how government usually works. The growing focus on climate change offers a chance at steering government toward greater efficiency by forcing policy advocates to better acknowledge that government has an innate ability to over-regulate and waste money. Limiting the pool of funds via tax neutrality and deregulating redundant environmental regulations force greater scrutiny over what government does and will be met with great resistance by the political status quo. Resistance is inevitable, but also signals that opponents understand that such a carbon tax constrains government. The expected escalation of government debt will undoubtedly have policymakers attempting to siphon off carbon tax revenues. The Congressional Budget Office projects that federal deficits will average $1.2 trillion per year and total $12.4 trillion over the 2019–2028 period. As a percentage of GDP, the deficit is projected to increase from 3.5% in 2017 to 5.4% in 2022 and then fluctuate between 4.6% and 5.2% from 2023 through 2028. Much of the spending growth reflects increases for Social Security, Medicare, and interest on the government’s debt. Politicians, interest groups, and many voters can be expected to seek additional tax revenues (or additional debt) rather than cut spending to fund this widening budgetary gap. Raising carbon tax revenues or creating new tax sources will be a solution favored by those believing government under-taxes rather than over-spends. The next step is to develop the specifics of an ironclad plan for trading carbon taxation for tax neutrality and deregulation. Important decisions remain on the proper tax swap and deregula-
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tion that ultimately will be influenced by the bargaining abilities and strength of traders. Another critical component is to develop a credible means of tying the hands of future policymakers from overturning the terms of the deal. Climate change skeptics are correct to emphasize concerns that carbon taxation will lead to a larger and more inefficient government. Skeptics underscore the importance of designing a trade that meets the non-negotiable nature of tax neutrality and deregulation. Carbon tax proponents who truly believe it is essential for mitigating the effects of climate change should be willing to negotiate along these terms. READINGS ■■ “A Conceptual Framework for Measuring the Effectiveness of Green Fiscal Reforms,” by Gilbert E. Metcalf. International Journal on Green Growth and Development 2(2): 87 (2016). ■■ “A Review of the Evidence on the Incidence of the Corporate Income Tax,” by William A. Gentry. Office of Tax Analysis paper 101, U.S. Treasury, December 2007. ■■ “Carbon Pricing: Lessons Derived from Experience,” by Tom Tietenberg. In Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers, edited by Ruud A. De Mooij, Michael Keen, and Ian W.H. Parry; International Monetary Fund, 2012. ■■ “Designing Climate Mitigation Policy,” by Joseph E. Aldy, Alan J. Krupnick, Richard G. Newell, Ian W.H. Parry, and William A. Pizer. Journal of Economic Literature 48(4): 903–934 (2010). ■■ “Environmental Regulation and the Competitiveness of U.S. Manufacturing: What Does the Evidence Tell Us?” by Adam B. Jaffe, Steven R. Peterson, Paul R. Portney, and Robert N. Stavins. Journal of Economic Literature 33(1): 132–163 (1995). ■■ “Government Spending in a Simple Model of Endogenous Growth,” by Robert J. Barro. Journal of Political Economy 98(5.2): S103–S125 (1990). ■■ “Green Taxes: Can We Protect the Environment and Improve the Tax System at the Same Time?” by Wallace E. Oates. Southern Economic Journal (1995): 915–922. ■■ “Jobs Versus the Environment: An Industry-Level Perspective,” by Richard D. Morgenstern, William A. Pizer, and Jhih-Shyang Shih. Journal of Environmental Economics and Management 43(3): 412–436 (2002). ■■ “Potential Linkages Between a U.S. Carbon Tax and the Earned Income Tax Credit,” by Aparna Mathur and Adele Morris. Tax Policy Center, American Enterprise Institute, August 1, 2017. ■■ “Swapping the Corporate Income Tax for a Price on Carbon,” by Catrina Rorke, Andrew Moylan, and Daniel Semelsberger. R Street Policy Study no. 79, December 2016. ■■ “Tax Avoidance and the Deadweight Loss of the Income Tax,” by Martin Feldstein. Review of Economics and Statistics 81(4): 674–680 (1999). ■■ “Taxing Carbon: What, Why, and How,” by Donald B. Marron, Eric J. Toder, and Lydia Austin. Tax Policy Center, Urban Institute and Brookings Institution, 2015. ■■ “The Deeply Flawed Conservative Case for a Carbon Tax,” by Benjamin Zycher. American Enterprise Institute, March 2017. ■■ “The Effect of the Value-Added Tax on the Tax Ratio,” by David Nellor. International Monetary Fund Working Paper no. 87/47, 1987. ■■ “The Impacts of Environmental Regulations on Industrial Activity: Evidence from the 1970 and 1977 Clean Air Act Amendments and the Census of Manufactures,” by Michael Greenstone. Journal of Political Economy 110(6): 1175–1219 (2002). ■■ “The Transitional Costs of Sectoral Reallocation: Evidence from the Clean Air Act and the Workforce,” by W. Reed Walker. Quarterly Journal of Economics 128(4): 1787–1835 (2013). ■■ “The Value Added Tax: Its Causes and Consequences,” by Michael Keen and Ben Lockwood. Journal of Development Economics 92(2): 138–151 (2010). ■■ “Will the Use of a Carbon Tax for Revenue Generation Produce an Incentive to Continue Carbon Emissions?” by Rong Wang, Juan Moreno-Cruz, and Ken Caldeira. Environmental Research Letters 12(6): 064001 (2017).
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From Chevron to “Consent of the Governed” The Supreme Court should link Congress to its lawmaking duties.
T
✒ BY DAVID SCHOENBROD
he word is out: the Supreme Court is poised to roll back the Chevron doctrine. Set out in Chevron v. Natural Resources Defense Council (1984), the opinion states that when Congress has not “spoken directly to the precise question at issue,” a court reviewing an agency action “may not substitute its own construction of a statutory provision for a reasonable interpretation made by … the agency.” Indeed, the agency may change its interpretation. That gives agencies more flexibility in making law by issuing regulations. The Court should ground any modification of Chevron on the constitutional norm that the “lawmakers” elected by the governed—that is, members of Congress—should take responsibility for the laws. As a practical matter, this norm can be enforced only partially— there is only so far into the regulatory weeds that even the most diligent Congress can go. But partial enforcement is far preferable to no enforcement, which is where we are now. “Underenforced constitutional norms,” to use University of Texas at Austin law professor Lawrence Sager’s term, include the Fourteenth Amendment’s equal protection clause and have an honored place in the constitutional firmament. The question is how to navigate various controversies in order to restore congressional responsibility to that firmament. Controversy churns about the “administrative state”—agencies that de facto make laws and have been criticized for breaking free of democratic control. Controversy also churns about the composition of the Supreme Court, in part because some justices have said the Court’s job includes enforcing the constitutional norm that law be made not by agencies but by an elected Congress. Both controversies shape the extent to which we live in a republic: a state controlled by the public rather than a political boss or an elite.
DAVID SCHOENBROD is Trustee Professor at New York Law School and author of DC Confidential: Inside the Five Tricks of Washington (Encounter Books, 2017).
A PERSONAL ODYSSEY
A surprising light is thrown on all this by my experience longago in the 1970s, trying to enforce the Clean Air Act (CAA). I was an attorney for the Natural Resources Defense Council (NRDC), which was on the losing side in Chevron. The members of Congress who wrote the statute said the CAA would “protect health” from all pollutants with “an adequate margin of safety” by the end of the 1970s. But they left almost all the specifics of what that entails—which is to say, the real policymaking—to the Environmental Protection Agency and the states. The legislation benefited plenty of lawyers on both the corporate and environmental side. Speaking personally, I won major lawsuits, got my name in the news, and received foundation grants. The corporate lawyers collected big fees. Yet, because Congress didn’t do the hard work of lawmaking, tens of thousands of my clients died, as I explain below. I left the NRDC and went into academia to understand why the CAA fell so short of the politicians’ promise and to try to do something about it. Try I did. In articles and a book, Power Without Responsibility (Yale University Press, 1995), I argued that the courts should enforce the Constitution’s requirement that lawmakers in Congress must vote for the laws and thereby shoulder personal responsibility for their consequences. Angry at what had happened to my clients, I argued that Congress could have—should have—made the law. However, at the time, I didn’t sufficiently consider the practical and political difficulties of the Court holding unconstitutional statutes that failed to do so. In other articles and a book, Saving Our Environment from Washington (Yale University Press, 2005), I pushed for Congress to adopt a statute that would put responsibility on the elected lawmakers by requiring them to vote on the major agency-made laws . In response to this and other arguments, Congress and President Bill Clinton approved the Congressional Review Act. The legislation was derived from my proposal, but with a perverse change.
DRNADIG/GETTY IMAGES (US CAPITOL), LUCKY-PHOTOGRAPHER/GETTY IMAGES (SUPREME COURT)
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The requirement that lawmakers vote on agency-made laws was turned into an option to vote on them, which they usually don’t take. (See “Cleaning Out the Statutory Junk,” Summer 2018.) Despite these failures, a promising new path to success has recently appeared with the likely modification of the Chevron doctrine. By basing the modification on the constitutional norm, the Court could reveal that members of Congress fall far short of their duty under the Constitution to take responsibility for the laws. This would be politically powerful because polls show that the public strongly prefers Congress—rather than the administration—to make policy. That is why members of Congress cover up their shirking by pretending to want responsibility. To point the way, this article explains the essence of our republic, why it has declined, and in particular how the Court got trapped into participating in the cover-up, and finally the way for the Court to extricate itself and our republic.
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OUR REPUBLIC
With the Declaration of Independence having proclaimed that governments derive “their just powers from the consent of the governed,” the Constitution sought to empower the people to sack key policymakers. Article I vests “all legislative powers herein granted” in a House of Representatives and a Senate legislating in tandem with a president and mandates roll call votes on controversial issues. That requires these officials to take personal responsibility for the hard choices. There could be “no taxation without representation” or, for that matter, regulation without representation. It is no wonder then that school civics courses once taught that it’s Congress’s job to make the laws and that its members are called “lawmakers.” Article I meant that Congress had to make the law itself rather than delegating that job to others. Debate at the Constitutional Convention proceeded on that premise. The power to regulate
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was understood at the beginning of the republic to be the power to make the rules of private conduct. In Federalist 75, Alexander Hamilton wrote, “The essence of the legislative authority is to enact laws, or, in other words, to prescribe rules for the regulation of the society.” Thus, to regulate, Congress must itself state the rules that bind the public in understandable terms, such as a rule limiting the amount of pollution from designated factories. The enacted rule would thus allow voters to hold their representatives responsible for the consequences of lawmaking. That serves the bedrock purpose of Article I. In contrast, a statute like the CAA that tells an agency to make rules to “protect health” states a goal rather than a rule. As such, the legislation conflicts with Article I. Stating goals is insufficient because Congress avoids responsibility for resolving major political controversies that ensue from pursuing the goal. For example, “protect health” is a pleasing goal, but when Congress passed the Clean Air Act of 1970 most pollutants were known to cause some harm to health at almost any ambient level conceivably attainable by end of the 1970s. Sound policymaking would thus require Congress to strike a balance between health protection and feasibility. Further, Congress would have to decide which pollution sources would bear the burden of cutting emissions sufficiently to achieve the desired ambient level. Such decisions entail heavy political cost for members, so they punt them to the agencies. That gives legislators plausible deniability for unpopular consequences of the rules that get announced on agency letterhead. Of course, even a carefully drafted, legislated rule will require interpretation in some cases. Nonetheless, rule interpretation differs from rulemaking. Interpretation is based on evidence of how the legislature that enacted the statute would have clarified the law’s ambiguities rather than on what makes good policy sense to the interpreter. One source of such evidence is the rule itself because, by making clear what’s required in most cases, it reveals the relative weight the legislature gave to conflicting policy goals such as enhancing regulatory protection vs. minimizing regulatory burdens. In Wayman v. Southard (1825), the Court defined Congress’s regulatory job in a way that jives with my Congress-must-statethe-rule idea. The Court held that Congress must deal with “important subjects” that Article I assigns to it, but may allow others to “fill up the details.” Other officials could “vary minor regulations which are within the broad outlines marked out by the legislation in directing the execution.” “Fill up the details” can be understood as either part of a second definition of the constitutional norm or a way to only partially enforce the state-the-rule definition of the norm. Either way, members of Congress would still have to take personal responsibility for the politically salient choices and so serve the purpose of Article I. I will not pause to find the exact words to reconcile the two definitions because, as illustrated by the CAA provision quoted above, Congress now comes nowhere close to complying with either. The point of this article is to show how the Court could begin to bring Congress
closer to its constitutional duty rather than to state the exact perimeters of that duty. OUR REPUBLIC IN DECLINE
For its first 70-plus years, Congress tried to deliver what the Constitution promised: enacting the rules of private conduct. The young nation had administrative officials who did important work, but with rare exception they applied enacted rules rather than themselves imposing rules. The Progressive Movement, which grew strong toward the end of the 1800s, began to unwittingly push the republic down a slippery slope to the administrative state. Many of the Progressives believed in separation of powers, including a Congress that makes the law. They saw their statutes as empowering experts in agencies insulated from politics to use scientific methods to find correct ways to apply statutory law rather than to make law. For example, they thought of the Interstate Commerce Act of 1887 as authorizing such experts to apply a rule on railroad rates that courts had previously applied. Later, however, it began to emerge that the experts were not insulated from politics and science did not provide correct answers to questions of policy. By then, Washington had many such agencies. Unwilling to roll all that back, in Hampton v. United States (1928) the Court held that Congress does its job if it states “an intelligible principle” to guide the agency. That might have been meant to be only slightly looser than “fill up the details.” Yet, the statute upheld in that case gave the president broad rulemaking power on a hot topic—tariffs—and the Court failed to say how closely Congress’s instructions must control the agency’s choices. Whatever the Court meant in 1928, only five years later Congress passed a statute that provided little control but granted vast powers to President Franklin D. Roosevelt to regulate industry in response to the Great Depression: the National Industrial Recovery Act (NIRA). The Italian dictator Benito Mussolini stated admiringly of Roosevelt’s sway under the statute, “Ecco un ditatore”—that is, “Behold a dictator.” In 1935, a unanimous Court, finding that the statute failed to state an intelligible principle, declared it unconstitutional. Roosevelt infamously struck back at the Court by proposing a statute authorizing him to appoint additional justices. Congress did not pass this so-called “court-packing plan,” but the president nonetheless prevailed. With retiring justices replaced by Roosevelt appointees and the emergencies of the Great Depression and World War II, the scolded Court upheld every regulatory statute it saw from then down to the present, including some whose “intelligible principle” was “the public interest.” Whatever the Court meant by “intelligible principle” in 1935, it now means next to nothing. The modern Supreme Court vows to stop Congress from abdicating its legislative power. But the Court trivializes that vow by holding that Congress does not do so when it states an intelligible principle, even if that principle is a vague goal. The justices upheld
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the CAA’s “protect health” provision. The Court, in effect, lets the members of Congress, despite their self-interest, judge whether they have made themselves sufficiently responsible to voters. Thus, “consent of the governed” has become farce. THE COURT’S ERRORS
The Court has erred twice. First, it adopted a meaningless definition of Congress’s job. Second, it does not acknowledge that Congress shirks its responsibilities. Supreme mush / The Court justifies its part in this farce by claim-
ing that judges lack a judicially manageable test of whether Congress violates its duty. Yet, the Court created this problem itself by replacing its early manageable definitions of Congress’s job, both of which served to make the legislators responsible for the politically salient lawmaking choices. It has replaced that with the unintelligible “intelligible principle” test. The Court’s progressive abandonment of its early formulations is, however, understandable because of growing concerns about whether Congress could fully do the job. It became increasingly hard to imagine that Congress could enact all the federal rules as the nation grew in area and population, more activity spanned state boundaries, and the economy grew more complex. Nonetheless, the Court’s abandoning its earlier formulations was still an error because there are many ways to accommodate concerns of practicality other than trashing the Constitution’s norm of legislative responsibility. For example, courts may desist from issuing an order to right a wrong when the order would create an “undue hardship.” Undoing a massive swathe of federal statutes and regulations would massively harm the public. Moreover, many constitutional standards of liability themselves contain carve-outs to avoid impracticality. Governments can act in ways that otherwise would deny equal protection of the laws if, depending on the discrimination, there is a “compelling state interest” or a “rational basis,” which is a notoriously permissive test. For another example, governments can constrain the content of speech if the speech would create danger—the proverbial shouting “Fire!” in a crowded theater. Similarly, the Court might decide to refrain from enforcing Article I where Congress has left issues that are not politically salient to the agency. That could be seen as using Wayman’s “fill up the details” concept to limit enforcement of the state-the-rule norm. If the Court adopted the state-the-rule norm but indicated that it was willing to limit enforcement, Congress could meet the Court halfway by adopting the proposal discussed in the next section. Capital shirking / Lacking any intelligible concept of Congress’s job, the Court fails to acknowledge that Congress could come much closer to discharging it. Anyone who observes Congress knows it shuns responsibility. This section focuses on one example of how it could shoulder
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more. It’s a proposal that came from James Landis, once the New Deal’s leading expert on administrative law and later dean of Harvard Law School. Major new regulations, he urged, should not take effect until Congress votes to approve them. Later, Judge (now Justice) Stephen Breyer published an essay showing that Congress could do such work. A statute could require both houses to vote on whether to approve agency actions by a deadline with limited debate and no filibuster, and then present the approvals to the president for signature. Congress could find the time for this work. Members and their staffs would have the benefit of the agency’s rulemaking record. There are about as many “major regulations,” as defined by the Office of Information and Regulatory Affairs (OIRA) as votes on symbolic public laws such as the naming of post offices. Voting on major regulations would require legislators to shoulder more responsibility, but exercising legislative powers is in their job description while naming post offices isn’t. One might object that this would transfer rulemaking power from expert agencies to politicians. But agencies and their personnel have interests, so both Democratic and Republican presidents have subjected them to control by OIRA within the Office of the President. Meanwhile, regulatory priorities have swung wildly from president to president. Whatever one thinks of presidential control of rulemaking, we don’t necessarily have far-sighted, broad-minded wisdom at the center of it. Although the legislators themselves would spend little time on each regulation and voters would not read them, the legislators would still feel responsibility for their long-term consequences. After all, a challenger in some future election could point out that the incumbent had voted for a rule that now has unpopular consequences. It is recorded votes on rules, not debate and sound bites on popular goals, that make members of Congress responsible for regulations in future elections. Democratic legislators could hardly say the proposal is anathema to good government when it came from a leading New Dealer (Landis) and a Supreme Court justice who is an expert in regulation and was appointed by a Democratic president (Breyer). Nor can Republican legislators say this when their contingent in the House has repeatedly passed a bill that incorporates it—as I discuss below. The errors’ consequences /
By letting the legislators, in effect, judge whether they do their duty and failing to acknowledge that they could do much more, the Court covers up for an irresponsible Congress. The cover-up matters because polling shows voters want Congress rather than the president to “make policies,” as Yale political scientist David Mayhew reports in The Imprint of Congress (Yale University Press, 2017). In 1958, 1977, and 2004– 2005, the margin of support for this position was overwhelming: about three to one. Knowing that, members of Congress pretend to want responsibility but in practice shun it—at a terrible cost to their constituents.
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Consider these instances. The year 1970 brought the first Earth Day and sharp criticism, led by Ralph Nader, that people died from air pollution because a string of clean air laws Congress enacted in the 1950s and 1960s left the difficult policy decisions to federal agencies. In response, Sen. Edmund Muskie, who had a hand in several of those earlier laws, authored the 1970 CAA, which he boasted made the “hard choices.” But this statute also ducked the tough decisions, with disastrous consequences. Take, for example, the pollution that came from refiners using lead additives in gasoline. (See “The EPA’s Faustian Bargain,” Fall 2006.) The statute promised that health would be protected from lead completely by 1976. Yet, politicians on the left and right effectively blocked those protections until the mid-1980s—and relented only after the big refiners found that they could save money if the EPA banned lead additives to gasoline. In the mid-1970s, one-half of the children in New York City had blood lead levels of 19 micrograms per deciliter (μg/dL) or above. In comparison, President Barack Obama declared a state of emergency in Flint, MI in 2016 because 5% of the children had blood lead levels of 5 μg/dL or higher. Back in the 1970s, my medical experts told me that, although lead in paint caused tragically high lead levels in many children, the population-wide contamination came primarily from lead in gasoline. The unqualified promise that the CAA would “protect health” was a pious fraud. I began to wonder what would have happened if Congress couldn’t pass the buck on lead in gasoline. Doing nothing on lead wasn’t an option because in 1970 “Getting the Lead Out” was a chief demand. Congress itself, in a singular exception to the statute’s general flight from responsibility, decided that new cars had to emit 90% less of a list of pollutants by 1975, but left lead off the list. If Congress couldn’t have passed the buck on lead, I suspect it would have reduced lead exposure by at least half by 1975. This quicker start on lead would have averted about 50,000 deaths in the United States, about equal to American deaths in the Vietnam War. There should be a monument on the scale of the Vietnam Veterans Memorial to these victims of Congress’s shirking. I suggest locating it on Capitol Hill. Nonetheless, the 1970 CAA was a political bonanza for members of Congress. They got credit for the popular promise of healthy air, yet the blame for the failures and the economic burdens fell on the EPA and the states. Legislators continue to feign a desire for responsibility. For example, Republicans in the House have repeatedly passed the Regulations from the Executive in Need of Scrutiny (REINS) Act. REINS does include the Landis–Breyer proposal, but swaddled with anti-regulatory provisions that ensure it will never pass and so will never inflict responsibility upon them. (See “Cleaning Out the Statutory Junk,” Summer 2018.) One such provision would require agencies to cut the cost of existing regulations to offset the cost of any new regulations. That allows Republicans who support REINS to take credit with their party’s base for wanting to control regulatory costs, but they shift to agencies the blame for limiting regulatory protection. Meanwhile, Democrats who
support existing regulatory statutes can take credit with their party’s base for wanting regulatory protection but shift to agencies blame for the regulatory burdens. This is a perfect recipe for polarization. Democrats, for their part, have introduced no alternative versions of Landis–Breyer stripped of the anti-regulatory sections. They prefer instead to blast Republicans for being against regulatory protection. The upshot is a legislative stalemate in which lawmakers from both parties escape responsibility for the laws. This illustrates in a microcosm how the polarization, brought on by both parties ducking responsibility, produces gridlock. Congress should adopt the Landis–Breyer proposal. If legislators had to vote on major regulations, their responsibility would motivate them to update statutes to allow agencies to promulgate regulations that produce more regulatory protection bang for the buck. That would inflict responsibility on the “Honorables,” but would be win–win for the constituents they claim to serve. THE TRAP
The Court’s errors might suggest that it cares not for the consent of the governed. But it has repeatedly said otherwise and has decided cases insisting that legislatures exercise legislative powers. For example, in Clinton v. New York (1998), justices from the left and right joined to strike down a 1996 statute in which Congress had given the president line-item veto power over budgets Congress had approved. The Court does, however, seem indifferent to Congress doing its job when it comes to delegating to agencies the power to make rules of private conduct. On that, the Court got trapped by history. The Court fell for the Progressives’ conceit that experts in agencies were applying science rather than making law. When that conceit lost credibility, the Court tried to maintain the status quo with the “intelligible principle” test. Then, faced with the exigencies of the Great Depression and World War II, the Court let administrative lawmaking mushroom, except for the NIRA. The Court let this mushrooming continue after the war. To see why, consider what would happen if it strikes down a statute based upon some meaningful definition of Congress’s job. The decision would come as a bolt from the blue. Chaos would ensue because many of the regulatory statutes in the U.S. Code would probably flunk this test. A huge swath of the U.S. Code and the Code of Federal Regulations would be at death’s door. That would leave people in pervasive doubt as to their regulatory duties and protections. In response, Congress could respond by simply passing a brief statute enacting much of the Code of Federal Regulations. But that would make a mockery of congressional responsibility. Besides, it would take time for Congress to decide exactly what to include and what to leave out of the statute. For example, there would be strong arguments to exclude regulations presently undergoing judicial review. Even after the enacting statute passed, Congress and agencies would struggle to meet the ongoing need for changes in statutes and regulations. These prospects mean the Court
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may face an assault on its independence more successful than Roosevelt’s court-packing plan. The Court might make itself a smaller target by stating that the constitutional norm would be only partially enforced, but deciding the scope of enforcement would require a judgment of policy. This would be far more contentious than those in other constitutional decisions because so much of our current regulatory infrastructure is based on the Court’s consent to Congress shirking its duties and many members of Congress would be enraged. Private discussions with former justices from the left, right, and center left me with the impression that they would have liked to push Congress to do its job but were unsure how to escape the trap. THE ESCAPE
In many institutional reform cases dealing with violations whose remedy depends upon policy judgments within the province of a reluctant legislature, lower federal courts and state courts have found that they can succeed by starting a conversation with the legislature about the remedy. My New York Law School colleague Ross Sandler and I discuss this at length in our book Democracy by Decree (Yale University Press, 2004). The legislatures in those cases were at the state or local level, rather than sitting high on Capitol Hill. But the Court has a potential ally that is even more powerful than Congress: public opinion. A conversation is a better starting place than the guillotine of holding statutes unconstitutional. The Court can start the conversation through statutory interpretation. It has long held that courts should interpret statutes to reduce serious constitutional concerns where the statute would bear such an interpretation. So, courts have sometimes interpreted statutes to narrow delegations of lawmaking power, but the extent to which they do so is limited. The Court’s leave-it-to-Congress approach makes it hard to imagine a serious constitutional concern with delegation. Courts would have far more occasion to invoke the nondelegation canon of statutory construction if the Court recognized congressional responsibility for lawmaking as a partially enforced constitutional norm. An appropriate occasion seems near. In a dissenting opinion in City of Arlington v. Federal Communications Commission (2013), Chief Justice John Roberts expressed discomfort with Chevron. He wrote, “Before a court can defer to the agency’s interpretation of the ambiguous terms …, it must determine for itself that Congress has delegated authority to the agency to issue those interpretations with the force of law.” As the American Enterprise Institute’s Peter Wallison shows in his excellent new book Judicial Fortitude (Encounter Books, 2018), five current Supreme Court justices (Roberts, Clarence Thomas, Samuel Alito, Neil Gorsuch, and Brett Kavanaugh) have expressed support for changing Chevron. The Court should. It is a pro-delegation canon of statutory construction. The Court should not only modify Chevron, but do so based on the constitutional norm of congressional responsibility. The norm would raise serious constitutional issues about many if not
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most regulatory statutes and therefore occasion many decisions narrowing the scope of delegations. In so doing, the Court need not and should not decide the extent to which this norm needs to be only partially enforced. It need not because, although it would be impractical to strike down every statutory provision that empowers agencies to make law, the courts could read statutes to narrow delegations of legislative power where the words of the statute would bear the interpretation. It should not because the Court should use such decisions to call upon Congress to decide how to address these concerns of practicality. Switching statutory interpretation from pro-delegation to anti-delegation would not in itself result in Congress taking much more responsibility, but it would result in teachable moments. With many cases in the courts at all levels dealing with statutes in which Congress arguably didn’t do its job, the courts would have plenty of opportunities to show the public that Congress falls short of public demands as well as the constitutional principle that lawmakers set policy. In contrast, the Court now lends its prestige to covering up for Congress. The Court’s refusal to remain a party to the coverup would tend to prod Congress to engage in the policymaking conversation. So, too, would pressure falling on Congress from its bearing more blame for regulatory outcomes. Chevron often allows legislators to plausibly deny responsibility for regulatory protection not granted or regulatory burdens imposed by saying that the agency misused its discretion under the statute. After replacing Chevron, however, the courts would affirm that many interpretations are based upon what Congress previously wrote and, if the legislators don’t like it, they should change it. So many of the hard choices that Congress avoided would return to haunt it. Of course, Congress could continue to avoid taking responsibility—or, worse, it could cede legislative powers to agencies more openly. In response, the Court would need to consider invoking the Constitution to strike down grants to agencies of the power to make rules of private conduct, but do so in a way that is practical. Rolling out the guillotine would be easier after having tried a conversation first. The public having been educated, the Court’s constitutional intervention would not come as a bolt from the blue. Moreover, the Court would have made clear that it would have preferred that Congress had made the policy judgments about how to stop its evasion of the “consent of the governed.” The Court might take practicality into account by, for example, limiting itself to new “major” regulations as now defined by OIRA. This would be an altogether judicially manageable standard. CONCLUSION
The Court has no more supreme duty than judging compliance with the Constitution. None of the Constitution’s goals is more supreme than “consent of the governed.” Yet, in response to claims that Congress frustrates consent of the governed by outsourcing lawmaking to agencies, the Court outsources judgment to Congress. That’s poetic injustice. And it’s time for that to end.
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IN REVIEW
The Cartel of States
gets the impression that Somaliland’s poverty is in large part because its non-state status creates uncertainty for any party REVIEW BY PIERRE LEMIEUX wanting to do business there. Its passports ✒ are accepted by only a few countries, making it very difficult for Somalilanders to hat are “invisible” countries and why is it so hard to create travel. In our statist world, a territory and new, “visible” ones? Joshua Keating tries to answer those its residents are nothing if they are not subject to a recognized state—an important questions in his new book, aptly titled Invisible Countries. lesson from Invisible Countries. Keating is a journalist, currently an editor at Slate and previously at Kurdistan is also invisible but it, too, Foreign Policy. He defines a country as “a piece of land that has been comes close to being a real country. It has separated from the rest of the earth’s trappings of countryhood,” writes Keating. a population of 25–40 million Kurds, and landmass by political boundaries agreed It is a “stable and mostly functional coun- the land they occupy stretches across several upon by the world countries as a whole.” try” and “pretty freewheeling.” “There’s no recognized countries. Iraqi Kurds do have a A country is also a land dominated by a pirate activity along Somaliland’s shores,” semi-autonomous region, Iraqi Kurdistan, recognized state—that is, a recognized he notes, only along the Somalian coast. but the rest of the Kurds have no such stamonopoly of force. Some of these states A USAID news report last tus. The Kurds were promised correspond to nations, a nation being a February said Somaliland’s a country of their own in the “community of sentiment.” As for nation- last presidential election, for 1920 Treaty of Sèvres, but it alism, he quotes philosopher Ernest which the agency provided never happened. They are U.S. Gellner, who says it is the “political prin- assistance, was a success. allies but, as one of them said, ciple which holds that the political and Somaliland was even an indethey are victims of genocide the national unit should be congruent,” pendent country for one week every 10 years or so. “political” meaning organized as a state. Iraqi Kurdistan is a “proin 1960 before its legislature Western, free-market democvoted to unite with Somalia, From Abkhazia to Liberland / Keating racy.” Recognizing the frona decision that most Somalilobserves that some “countries” are not anders seem to regret. tiers of Kurdistan would formally recognized, while others that are follow the policy proclaimed Somaliland cannot recognized do not have “real” states. Some become a real country today Invisible Countries: by President Woodrow WilJourneys to the Edge of the former have all or most of the attri- simply because it is not interson in 1918 that the borders of Nationhood butes of recognized countries: Abkhazia nationally recognized as of countries, and thus states, By Joshua Keating and Somaliland are two examples. should be drawn “along such by other official states, Abkhazia is a Russian-backed enclave including the United States. 296 pp.; Yale University clearly recognizable lines Press, 2018 that fought the government of Georgia in Perhaps instead of providing of nationality.” In general, a bloody civil war in the 1990s. It is now, “voter education, ID cards, though, the “realistic stance” for all practical purposes, an independent and polling equipment,” as of U.S. foreign policy “has country run by its own government. But it the USAID bulletin boasted it had done, traditionally been more attached to the is only recognized by a handful of states. the U.S. State Department should now preservation of the map.” There are other The fact that both Georgia and Russia push for the country’s recognition. complications, sometimes related to Kurdmaintain claims on Abkhazia illustrates Keating, who admits to not being a lib- ish clans. Not all Kurds, notably in Syria, that there is no room in the (political) world ertarian (though he seems to have poten- want an independent state. for a new country. All the land is now occu- tial), likes to tease them: “Libertarians Akwesasne is another example of an pied or claimed by some state, except for curious about what a basically functional invisible country, this time in North “one remote slice of Antarctica” and a small society would look like with a bare mini- America. The small Mohawk territory that number of minor exceptions. Such has been mum of both services and regulations from straddles the U.S.–Canada border meets the accepted world order for a century. a barely functional government should the ethnic criterion but does not have real Somaliland, which broke away from check [Somaliland] out.” The country is political autonomy. According to Keating, Somalia a quarter-century ago, “has all the very poor. Why doesn’t it take off like Hong it is semi-sovereign on the U.S. side, but Kong did when it was a poor British terri- not as much on the Canadian side. FolPIER R E LEMIEUX is an economist affiliated with the Department of Management Sciences of the Université du tory? It may just be a question of time, but lowing an 1832 Supreme Court decision, Québec en Outaouais. His latest book is What’s Wrong with Protectionism (Rowman & Littlefield, 2018). the reader, under the influence of Keating, Indian tribes are “distinct independent
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communities retaining their original natural rights as the undisputed possessors of the soil from time immemorial.” But the Mohawks of Akwesasne have to show an American or Canadian passport when they cross the “border” inside their own territory. The political arrangements of American Indians represent a sort of “nested sovereignty” or “overlapping sovereignty.” The Free Republic of Liberland is especially interesting; Keating calls it his most extreme case. The republic was proclaimed on April 13, 2015 by Czech libertarian Vit Jedlicka on a 2.7 square-mile patch of terra nullius (land belonging to no one) between Croatia and Serbia. Jedlicka “is optimistic that [the Liberland government] can build ties to Donald Trump’s administration,” Keating reports. It would certainly be a coup if the United States agreed to recognize Liberland. To be fair, Jedlicka also said that he “was not sure about [Trump’s] protectionism.” “That’s probably where we differ,” he added. Invisible Countries is full of such little but significant facts and adventures. The book also mentions Patri Friedman’s Seasteading Institute, a proposed floating libertarian nation. Such a country would make sense as it would give libertarians one place in the world where their political preferences would be respected. More broadly, the respect of individual preferences is the fundamental reason why the existence of different countries can be beneficial. One could imagine an ideal world where every individual could choose to live in the country closest to his own preferences. This world is no doubt utopian but, from an individualist perspective, it should serve as the ultimate goal to guide political choices. Virtual countries and statelessness / And then, writes Keating, there are outliers that “[refuse] to be confined by the world map as currently constructed” and, without any territory, claim some sovereignty. The millennium-old Order of St. John of Jerusalem of Rhodes and of Malta, also known as the Knights of Malta, is perhaps the best example. The Catholic lay religious
order is recognized as sovereign by many United Nations member states, but it has only an observer status at the organization. The Order enters into international treaties and issues its own passports (in very small number) and postage stamps. After a recent conflict with the Knights, Pope Francis reaffirmed their sovereignty. Many hoped the internet would be an outlier capable of escaping the sovereignty—that is, the control—of existing states. Instead, states have imposed their own control under the idea of “internet sovereignty,” reaffirming the theory that only the state can be sovereign. The Chinese state is providing an extreme example. In a somewhat similar fashion, President Trump has talked about regulating “our internet.” Perhaps the most extreme outliers are stateless people. They are individuals who have no citizenship and no passport, often because their one-time countries have dis-
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ity, as it deprives them of captive clients. Rise (and fall?) of Woodrow Wilson
/ The
full range of individual preferences is much wider than mere ethnic ones, and many people prefer to live with others who share social and political values rather than ethnic heritage. The Wilsonian ideal of ethnic nationalism generated chauvinism and conflict. Keating notes ironically that, until the 1990s, the map of the world was coming to resemble Wilson’s vision of self-determination: a country for every people and a people for every country. It took only a century of genocide, total war, and stifling totalitarianism to make it happen.
As he also observes, “There’s not a huge ideological leap from ‘Our people deserve a state’ to ‘Our state is only for our people.’” Much of the correspondence between states and nations has been—if only Respect of individual preferences is imperfectly—achieved by the fundamental reason for different ethnic cleansing. Keating countries. People can live in the cleverly notes that, in realcountries closest to their preferences. ity, “there are almost no ‘natural’ borders—people don’t divide themselves appeared (in the case of Yugoslavia, for neatly, and whenever you try to draw lines example) or because the government of between groups of people, someone is going the country they live in doesn’t recognize to end up on the wrong side.” Redrawing borders is thus not necessarthem as citizens. Among the latter, Keating mentions the Bidun of Kuwait. He could ily a solution to ethnic violence or to the have also mentioned the Tibetans who oppression of minorities. In some cases, though, it can help achieve the ideal of have taken refuge in India. Keating does not clearly explain why individuals living in countries that are statelessness is such a handicap. The rea- closer to their own preferences. Required son is that states are now so powerful, so in both cases, it seems, is a minimum dose sovereign, that stateless persons with no of the universal values of tolerance and regular passports experience many problems individual liberty. Why it is so difficult to create a new when they want to travel or outright move to other countries. No government wants these country? From around 1920 until the midpeople because, once they enter a country, 1990s, many were created in the wake of decolonization and following the collapse there is no country where to deport them. On the opposite side of the fence, there of the Soviet bloc. But, writes Keating, “if is a tiny minority of people who have more you hadn’t created your country by the early than one citizenship and more than one 1990s, you were out of luck”; no further passport. Keating only mentions this fact. It nation states were forthcoming. The memwould be interesting to know why a number ber states of the U.N. form a cartel against of contemporary states allow this possibil- potential competitors for their own citizens’
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clientele. U.N. Secretary-General U Thant said in 1970 that he did not believe the organization “will ever accept the principle of secession of a part of its member states.” Since the mid-1990s, only three new countries have been recognized by the United Nations: South Soudan, Montenegro, and East Timor. But Keating suggests that Wilson’s idea may be making a comeback through the superpowers’ foreign interventions and the rise of ethic nationalism. The Russian invasion of Crimea is an example. Keating notes that it is unclear whether this is a good thing. He could perhaps express his ambivalence better by admitting that the satisfaction of individual preferences is the only philosophically acceptable criterion for evaluating breakups and the status quo. Good and not-so-good ideas / Invisible Countries often challenges conventional wisdom, but there is one point where the author seems to incorrectly buy that wisdom wholesale. He gets bogged down in the climate change issue when he wonders what will happen when Kiwibati, a small but real island country in the Pacific, is flooded by rising sea levels. I am not claiming that this will not happen—I am rather agnostic toward “climate change”—but there is certainly a danger in further increasing state power because of this threat. I think that Keating weakens his book by lamenting “the attitude of the world” toward “the places where the effluvium of global capitalism and militarism finally washes up.” Nice sentence but vacuous thought. He should take a lesson from an exaggeration he reveals himself: “The 2005 Intergovernmental Panel on Climate Change report estimated that the world would have to cope with 50 million refugees [from climate change] by 2010, a claim that was obviously premature and was dropped from subsequent drafts.” Keating suggests that the model of overlapping sovereignty practiced in American-Indian nations—different domains of jurisdiction granted to different governments—could help “nations,” by which he means states, take “a less rigid view of sovereignty.” This is a promising
idea, close to the argument for federalism. Leviathan lives by sovereignty—that is, uncontested power—and the less such power there is, the better. To go a bit further, the ultimate goal should be to replace state sovereignty with individual sovereignty. It is dangerous to dream of an angelic international authority (“the international community”) that would solve all problems. This dream ignores the dangers of the state that Keating illustrates throughout his book. The existence of many countries, even if they tie themselves by international agreements, and the capacity to
create new ones are the best way to defend universal values. A world Leviathan, by preventing decentralized experimentation and the creation or maintenance of islands of liberty, would crush the universal values that are central to the Western tradition. (See “A Bridge to Collectivism,” Fall 2018.) With its many virtues and notwithstanding its few weaknesses, Keating’s book leads us to the classical-liberal and libertarian idea of limiting state power. To the extent that this is achieved, nationstates and the adjustment of borders become less dangerous.
A Flawed Theory but Some Interesting Observations ✒ REVIEW BY DWIGHT R. LEE
Y
ascha Mounk, a Harvard University lecturer on government and a senior fellow in the political reform program at the center-left think tank New America, believes liberal democracy is in crisis as “authoritarian populists are on the rise around the world, from America to Europe, and from Asia to Australia.” The result, he argues in The People vs. Democracy, is that “liberal democracy is coming apart,” separating into “two new regime forms.” One of those forms he refers to as illiberal democracy, or democracy without rights, and the other as undemocratic liberalism, or rights without democracy” (Mounk’s emphasis). He provides the following definitions: A liberal democracy is a political system that is both liberal and democratic. ■■ Liberal institutions effectively protect the rule of law and guarantee individual rights such as freedom of speech, worship, press, and association to all citizens (including ethnic and religious minorities). ■■ Democracy is a set of binding electoral institutions that effectively translate
popular views into public policy. Mounk develops his theoretical basis for his pessimism in the book’s first two chapters. Though I share in this pessimism, I think his arguments in those chapters are unconvincing. Despite that, I think he makes some important observations throughout the balance of his book.
■■
DW IGHT R . LEE is the Emeritus Ramsey Chair of Private
Enterprise at the University of Georgia. He is a coauthor of Common Sense Economics: What Everyone Should Know about Wealth and Prosperity, 3rd ed. (St. Martin’s Press, 2016), with James Gwartney, Richard Stroup, Tawni Ferrarini and Joseph Calhoun.
Democracy without rights /
He begins his first chapter, “Democracy without Rights,” by recalling the 1989 protests in his native East Germany. Protesters chanted, “We— not the secret police, not the party elites— are the people.” Beginning in 2015, there has been a new chant in these same cities: “We—not those foreigners who are flooding Germany, nor the politicians who are in cahoots with them—are the people.” Protesters’ anger is now directed at immigrants and ethnic minorities and mistrust is directed at the press and “fake news,”
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and “perhaps more than anything else, the hankering is for someone who would speak in the name of the people.” Italy, Greece, Spain, France, Sweden, Austria, the Netherlands, Finland, Germany, and more recently the United States, have seen populists (both right and left) achieve unexpected electoral success by claiming to support the people. Mounk summaries his explanation of how this populism can lead to democracy without rights as follows:
why can’t they also keep their rights as well as democracy? There is another problem. Mounk’s description of the path to democracy without rights is followed by an example that doesn’t provide convincing support for his argument. He begins with some reasons for growing income inequality in the United States and other affluent Western countries and points out that policies to reduce this inequality are not simple. He then vents his frustration To understand the nature over Donald Trump’s 2016 of populism, we must election as president. He understand that it is both acknowledges that Hillary democratic and illibClinton lacked a compelling The People vs. eral—that it both seeks to political vision but informs express the frustrations of Democracy: Why Our us “that she has a long history Freedom Is in Danger the people and to underand How to Save It of sincere public service and mine liberal institutions. By Yascha Mounk ran on an intricate package of And to understand its policy proposals that would 400 pp.; Harvard likely effect, we must bear University Press, 2018 have made a significant difin mind that these liberal ference on issues as varied as institutions are, in the preschool education and the long run, needed for democracy to battle against Alzheimer’s.” By contrast, survive: once populist leaders have done Trump “has a long history of conning away with all the liberal road-blocks people, … [and most] of the policies he that impede the expression of the popuchampioned were never going to work.” lar will, it becomes very easy for them to Despite warnings by experts, disregard the people when its preferences start to come in conflict with their own. (Mounk’s emphasis.)
There are clear historical examples of populists being elected and doing away with institutions that protected the rights of the people, and then being rewarded with reelection. This is a seldom-stable situation, however, because such populists almost always morph into dictators who quickly eliminate the right to free and honest elections, eliminating both democracy and rights. Mounk recognizes this problem at the end of the chapter when he states, “Unless the defenders of liberal democracy manage to stand up to populists, illiberal democracy will always be in danger of descending into outright dictatorship.” This raises the question: if the broader electorate stands up to populists,
millions of voters saw the simplicity of Trump’s proposals as a mark of his authenticity and determination and the complexity of Clinton’s proposals as a mark of her insincerity and indifference.… [That] is precisely why glib, facile solutions stand at the heart of the populist appeal. Voters don’t like to think that the world is complicated.
This supposedly explains why the willingness of populists like Trump “to offer solutions that are so simple that they can never work is very dangerous.” One doesn’t have to be a supporter of Trump or deny that he is a populist to see that this is a bizarre example of populism leading to democracy without rights. First, a history of conning people, championing policies that don’t work as promised, and
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getting the support of millions of rationally ignorant voters hardly distinguishes Trump from most presidential candidates. A populist politician is commonly defined as one who champions the common person rather than the elite; one wonders how many presidential candidates Mounk believes got elected by promising to favor the elite over the common person. Second, it is difficult to claim that the United States has experienced the destruction of rights and threat of dictatorship that Mounk describes, despite our history that includes such populists as Andrew Jackson and Teddy Roosevelt. This isn’t to deny that our rights have eroded as constitutional limits on government expansion have weakened from the public’s acceptance of less freedom for (purportedly) greater economic security. At times Mounk does a commendable job explaining the importance of the U.S. Constitution in protecting our freedoms and rights, but he ignores that those freedoms and rights have been eroding since at least the Progressive Era. The 2016 presidential election doesn’t seem like the best example of democracy leading to the loss of rights unless Mounk is more interested in exaggerating Trump’s flaws and Clinton’s virtues than in supporting his arguments with a more reasonable example. Rights without democracy / He writes in Chapter 2, “Rights without Democracy,” that the histories of liberal democracies such as Great Britain and the United States show they “were founded not to manifest but to oppose democracy.” James Madison argued that the purpose of elections is to “refine and enlarge the public views, by passing them through the medium of a chosen body of citizens, whose wisdom may best discern the true interest of their country.” Mounk refers to this view as “the founding myth of liberal democratic ideology—the improbable fiction that representative government would facilitate the rule of the people.” He is forced to admit, however, that it “was under the watch [of this myth] … that democracy conquered half the globe.” But he devotes
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much of this chapter to discussing the limits on electoral institutions that have drastically curtailed “the people’s ability to influence politics.” The first limit he discusses is the expansion of bureaucracies and independent agencies that “are now responsible for the vast majority of laws, rules and regulations.” He next turns to central banks, which since the collapse of Bretton Woods are now the key institutions deciding, for example, whether it is more important for a country to minimize inflation or unemployment. As a result, some of the most important economic decisions facing countries around the world are now taken by technocrats.
Judicial review, which entrusts “nine unelected judges with the power to overrule the will of the people whenever it [comes] in conflict with the preservation of individual rights,” is discussed next. Even when legislatures retain real legislative power, Mounk recognizes that “legislators have become increasingly insulated from the popular will.” He laments the private donations to political campaigns and the money paid to lobbyists by large corporations. Both have grown significantly over the past 50 years, but then so has the effect of government decisions on business interests. He offers relatively little about how our rights are affected by government activities that are removed from democratic approval. When he does, he sees our rights as protected by those changes. For example, he writes that judicial review is “justified by the fact that it protects individual rights and the rule of law.” Thus, we are left with “rights without democracy.” He makes no mention, however, of the work on the administrative state by Columbia law professor Philip Hamburger, who argues “that administrative power is denying Americans basic constitutional freedoms and procedural rights, such as due process, jury rights, as well as others.” It is clear that central banks have reduced the ability of legislators to control monetary decisions in an era of fiat currency, with that control being shifted
to unelected technocrats. There is no mention, however, of the freedoms lost from regulations that are imposed on all of us, either directly or indirectly, to protect the currency monopolies of central banks. As far as minimizing a country’s inflation or unemployment, it is not clear that central banks have done much better than the gold standard did or Milton Friedman’s monetary rule would. Regarding the amounts businesses spend on lobbyists, Mounk mentions that this benefits businesses by getting policies passed that improve their ability to compete. What isn’t mentioned is that those policies reduce economic freedoms
that the Constitutional Convention got the balance exactly right, they came up with a Constitution that achieved a far better balance between individual rights and general well-being for far longer than anyone could have reasonably expected in 1787. This does not mean we can safely ignore Thomas Jefferson’s warning that the tendency is for “liberty to yield and government to gain ground.” This tendency remains every bit the threat to our well-being that it was in Jefferson’s day.
/ Mounk’s pessimism regarding liberal democracy can be appropriate even if his prediction that it will break up, at least initially, into either “democRecognizing the popular will and racy without rights” or protecting individual rights are hardly “rights without democparts of liberalism and democracy that racy” is incorrect. can be separated from each other. His third chapter, “Democracy Is Deconsolidating,” discusses several by benefiting some firms by limiting the reasons for pessimism about the future of liberal democracy. He cites evidence that ability of other firms to compete. He concludes this chapter by stating citizens, particularly young people, give “less importance to living in a democracy” that and are “increasingly open to authoritarliberalism and democracy do not go ian alternatives.” He also cites evidence that together nearly as naturally as most democratic norms are eroding. citizens—and many scholars—have While these and other concerns assumed. As the popular will increasexpressed in this chapter are truly troubleingly clashes with individual rights, some, they have little, if any, connection liberal democracy is splitting into its with Mounk’s argument in Chapters 1 and component parts. 2 that liberal democracies are subject to As opposed to Mounk’s analysis, however, splitting up into either “democracy withrealizing the popular will (best thought of out rights” or “rights without democracy.” as our general well-being) and protecting I see this disconnect as a flaw in the book, our individual rights are hardly component though one that I find sufficiently interparts of liberalism and democracy that can esting to devote most of my review to it. be separated from each other. They are Yet, the remaining chapters contain several achieved, or fail to be achieved, together. interesting observations that should be Every liberal democracy reflects a balance considered seriously. between, in Madison’s words, “enabl[ing] Mounk nicely discusses how the early the government to control the governed; optimism about the political effects of and in the next place oblig[ing] it to control social media has shifted to a more pesitself.” Get this balance roughly right and simistic view. It was initially thought to we can protect our individual rights and be a force to “deepen and spread democincrease our general well-being. Get it badly racy” by allowing “many-to-many” comwrong and we lose our rights and diminish munication to provide an alternative to our well-being. While no one would claim the “one-to-many” communication” of Favorable comments
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a few large networks. Now the concern is that instead of “connecting erstwhile enemies and overcoming ancient hatreds … the inverse would come closer to the truth.” Yet he concludes with hope that “once populists capture the government and break many of their promises, they may be rudely reminded of social media’s potential to empower the new outsiders against their rule.” He makes it clear where he stands on free speech when responding to assertions that if “free speech is invoked as a reason to defend a public discourse that is full of overt forms of racism and microaggressions, then this hallowed principle needs to be sacrificed to the cause of racial justice.” He sees such recommendations as reflecting “an understandable impatience with the conservative defense of the status quo,” but then states that they ultimately throw the baby out with the bathwater…. [Such comments go] too far…. They embrace principles that would ultimately destroy the very possibility of a truly open and multiethnic democracy.
Mounk follows this with a sensible discussion regarding the opposition to “cultural appropriation,” or the adoption by members of the majority group of “the cultural practices of ethnic and religious minorities.” Except in cases of cultural appropriation to ridicule or denigrate minority symbols or traditions, he argues that “a wholesale rejection of cultural appropriation ultimately stand[s] in stark conflict with the ideas of a truly liberal and diverse democracy.” He concludes the book with two short chapters containing suggestions—some reasonable and some not-so-reasonable (e.g., tax increases, “restoring basic elements of the welfare state”)—for improving what most of us would recognize as problems with our political process. Despite what appears to me to be a puzzling disconnect between the early and later parts of Mounk’s book, it contains much that people interested in political economy will agree and disagree with.
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A Playbook for Lobbying Government ✒ REVIEW BY SAM BATKINS
S
hould new businesses ask for permission from regulators to employ their business practices, or beg for forgiveness after employing those practices? For countless startups, the product or service they provide may not have clear regulatory guidelines. For others, nascent businesses can often fly under the radar of
government until they get big enough released before Musk’s recent run-in with and profitable enough to draw regulators’ the Securities and Exchange Commisattention. sion.) That might make many libertarians In a hypothetical world of limited gov- reflexively gag, and understandably so, but ernment, small businesses wouldn’t need Burfield and Harrison have a point about to devote nearly the resources Musk’s success as an innovato regulatory compliance that tor. He has built an empire they do in reality. Yet, here in a variety of green induswe are; there is incredible tries that politicians crawl demand for startups to not over themselves to support: only innovate in their market, electric cars, solar homes, and but also ensure they can do space exploration (just in case so with the blessing of reguthe green industry doesn’t lators. work out on this planet). In Regulatory Hacking, Evan Musk built his empire Burfield, CEO of a startup largely on the back of an adorincubator called 1776, and ing press and politicians willJ.D. Harrison, an executive Regulatory Hacking: ing to hand out subsidies to with the U.S. Chamber of A Playbook for Startups entrepreneurs in his business Commerce, describe the gov- By Evan Burfield with sectors, but also because—the ernment obstacles that inno- J.D. Harrison authors argue—he successvative firms face and offer 320 pp.; Portfolio fully followed the “playbook” strategies for how small busi- Press, 2018 for influencing government. nesses can handle the media, This is the crux of their book. regulators, other bureaucrats, Regulatory Hacking is largely and politicians. To partly answer the ques- a “how-to” guide for startups to manage tion on permission or forgiveness, the policymakers at the state and federal level, authors cite the ridesharing service Uber employing the grassroots, “grasstops” (i.e., and argue that, at least in some cities, it opinion-leaders), and common lobbying may have gone about things the wrong to apply political pressure. In the words way by entering first and asking permis- of Burfield and Harrison, “Regulatory sion later. hacking is the application of hacker culThe authors also argue that Elon Musk ture to complex markets that are deeply is the ultimate regulatory “hacker”—the intertwined with government because they guy who figures out how to break through meaningfully impact the public interest.” the regulatory obstacles. (The book was Government and business / When they SA M BATK INS is director of strategy and research at Mastercard. The views expressed in this review are his own. talk of “hacker culture,” the authors
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don’t mean the North Korean or Russian “hacker farm” variety. For many in the business community, “hacking” is defined as a tool that allows progress within a complex market faster or cheaper than the status quo. What the authors don’t directly state is that virtually every market is intertwined with government at the federal and local level. The book highlights key industries like transportation, energy, and health care, but pick any other industry and government probably has a role. Uber gets top billing for its ability to disrupt local transportation options—namely the taxi cab cartel—but even the motorized scooter industry is under mounting regulatory pressure in cities. Other than pedestrians, who don’t exactly have a strong lobby, there are few incumbent interests yearning to regulate scooters. Nevertheless, cities have been banning scooter leasing companies from operating because they didn’t first ask for government permission. Even startup-friendly San Francisco has targeted the scooter business for increased scrutiny recently, while Washington, DC has taken a comparatively laissez-faire approach. For libertarians, the book is somewhat fatalistic about ever-expanding government. With many startups, not paying heed to local and federal regulators is tantamount to small business malpractice. As a function of size, most small businesses are more focused on innovation than regulatory compliance. Meanwhile, incumbent businesses that have spent years greasing palms can often employ the regulatory state to make life far more difficult for startup rivals. Europe’s recent data privacy regulations known as GDPR are one example of a framework intended to protect consumers. Yet, it has disadvantaged small businesses in the information technology sector, as evidenced by initial reports of Google and Facebook’s increasing market share since GDPR went into effect. Many predict similar results from California’s attempt to mimic Europe on privacy. One could argue crony capitalism and regulatory hacking are synonymous, so long as they are done in the public interest. But that term, “public interest,” has many
tive observers draw the line at government subsidies or refundable tax credits? For every business, dealing with regulators is simply a reality. However, scoring a multibillion-dollar tax benefit is the province of true experts like Musk. As evinced by its subtitle, “A Playbook for Startups,” the book functions much like a how-to guide for lobbying government at every level and creating a positive media narrative for one’s business. For folks inside the Beltway, these tools will sound familiar, but there are countless startups that will find the book’s advice helpful. Getting media on Incumbent businesses that have spent your side is one of the years greasing palms can often employ quickest ways to influthe regulatory state to make life far ence policymakers and more difficult for startup rivals. the broader debate. Develop a popular product that gains reporters’ themselves to lure Amazon’s proposed sec- sympathy and chances are they’ll carry ond headquarters, dubbed HQ2, to their your message to voters. And when voters city, and plenty of voters will reward those take notice, policymakers typically folpoliticians who ultimately succeeded. If low. Burfield and Harrison heap praise on the company were worth $100 billion Musk for his ability to charm the media. instead of $1 trillion, would the HQ2 fer- As they write, “His most meaningful invenvor be the same? Would politicians ever do tion is that unique image that we have of the math on tax subsidies appropriated Elon Musk, the narrative thread weaving versus the economic benefit of each new through his entire career and stitching job? Probably not, but Amazon might be together each of his business ventures, another “ultimate hacker” for its ability to because it’s the foundation that has made defeat harmful taxes and receive an endless all of the others possible.” Since there is only one Elon Musk, new businesses that stream of tax breaks for HQ2. want to follow his strategy will likely need Tools of the trade / Broadly, the book to hire a good public relations firm and tell weaves together anecdotes about success- a compelling story. ful startups with strategies and tactics on how to influence government and ensure Lobbying / The naughty portion of the the media is on your side. From innova- book concerns what is often regarded as tive child care solutions (Uber for Kids) the dirtiest part of politics: lobbying. It’s to identification solutions for government somewhat of a testament to the role of and the private sector, Burfield and Har- government and business that lobbying is rison weave plenty of examples of small as much a necessity to business as innovabusinesses working with government to tion and proper accounting. As every business grows and meets the scrutiny of polisurvive and, in some cases, thrive. These stories reinforce the hazy divid- cymakers, it discovers that it must spend ing line between “regulatory hacking” and millions of dollars to influence governcrony capitalism. If a business is able to ment. As the authors note, for the largest change a regulation to allow its model to companies—e.g., Google—annual lobbying innovate, is that political manipulation spending approaches $20 million. In an or a form of deregulation? Should objec- ideal world, the company would likely find different definitions to different people. A subsidy to the right firm providing public goods or services may be deemed to be in the public interest, even if the firm is a fossil fuel energy company or a publicly funded stadium. To some extent, there is a division among Americans over government supporting companies. On one hand, many begrudge the special tax breaks or subsidies that large companies receive, while the average taxpayer receives little. On the other, politicians have been falling over
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better uses for that money. The average citizen shouldn’t necessarily begrudge this figure. In some cases, lobbying is necessary to ensure a business’s very existence. The authors point to the case of the DNA decoding firm 23andMe, which the U.S. Food and Drug Administration shut down for a time, until intensive regulatory outreach allowed the firm to resume its business. However, for the makers of caffeinated beer and liquor (e.g., the brewer Moonshot), their political outreach couldn’t stop government from ending their businesses. What should concern taxpayers is the clout of lobbying heavyweights to push policymakers to erect regulatory barriers that give lobbyists’ clients a comparative advantage. If these moves are pursuant to the “public interest,” do they count as regulatory hacking? If a hack is for me but not for thee, is it benign? These are some important questions not directly answered by the book. Of course, it wasn’t written as a treatise on regulatory capture or the proper role of government, but as a guide for small businesses to survive potentially onerous regulations. As the authors note, the innovation giants of Silicon Valley don’t demand immediate engagement with D.C., but as companies grow, the intersection is inevitable. Conclusion / Those inside the Beltway will
find few surprises in this book, but they are probably not Harrison and Burfield’s intended audience. There are plenty of startups outside the Beltway that will soon be encountering local and federal regulators for the first time. Regulatory Hacking is a step-by-step manual for businesses to navigate those encounters. By incorporating relevant anecdotes about successful—and some not-so-successful—startups, the book tells its story through real-world examples, not just empty rhetoric or rehashed American Politics 101. Small businesses with a limited government persuasion may not like the reality the book paints, but they must operate in that reality. If they don’t heed the book’s advice, they may not be around for long.
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Challenging the Fed on Lehman ✒ REVIEW BY VERN MCKINLEY
A
lot of ink has been spilled in the media, academic journals, and a number of prominent books about why Lehman Brothers was allowed to fail in September 2008, at the depths of the financial crisis. Last year, I reviewed one of the more recent of these books, Oonagh McDonald’s Lehman Brothers: A Crisis of Value (“Is There Value in Revisiting the Lehman Collapse?” Spring 2017). This year, Johns Hopkins University economist Laurence Ball offers his analysis in The Fed and Lehman Brothers. Ball brings considerable expertise to the task. Besides his tenure at Hopkins, he is a research associate at the National Bureau of Economic Research and a consultant for the International Monetary Fund. He has also been a visiting scholar at the Federal Reserve Board of Governors and the Reserve Banks of Boston, Kansas City, and Philadelphia, as well as the Bank of Japan, the Bank of England, and the Reserve Bank of New Zealand. Ball admits that his book does not unearth much in the way of new, earthshaking evidence about Lehman and the Fed. But he has spent years painstakingly compiling and assessing the already-existing evidence. He writes, “I soon discovered something that is not widely appreciated: there is a huge amount of hard evidence on these topics that is easily available to anyone.” He draws heavily from the report of the Financial Crisis Inquiry Commission (FCIC) and the report drafted by Lehman’s bankruptcy examiner, Anton Valukas. He also uses records from the Federal Reserve, Lehman’s financial statements filed with the Securities and Exchange Commission, and research by journalists. Ball did make Freedom of Information Act requests for Federal Reserve Board documents on the V ER N MCK INLEY is a visiting scholar at George Wash-
ington University Law School and coauthor, with James Freeman, of Borrowed Time: Two Centuries of Booms, Busts and Bailouts at Citi (HarperCollins, 2018).
AIG rescue, but the Fed declined to release those documents and, when Ball appealed to the courts, they deferred to the Fed’s opacity. How the Fed’s justifications are flawed / The
book is straightforward. Ball relates the narrative offered by the Federal Reserve and Treasury Department regarding the Lehman Brothers collapse and federal officials’ decision not to bail out the bank. He then aggressively argues that the individual components of that narrative are false. The primary points that he dissects are:
The New York Fed claimed that it had no legal authority to fund Lehman because Lehman lacked supporting collateral. Ball argues that Lehman had sufficient collateral and thus the Fed had the legal authority. ■■ Fed officials claimed Lehman was deeply insolvent. Ball argues that Lehman was merely on the border of insolvency. ■■ Fed officials also said Lehman was too risky to bail out. Ball argues that other rescues, like the one of AIG, were riskier. ■■ Fed and Treasury officials claimed they reached their “Lehman must fail” decision based on an independent technocratic assessment. Ball argues that Treasury Secretary Henry Paulson made the decision based mostly on political grounds. ■■ Fed and Treasury officials said they knew that Lehman’s unwinding would ■■
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be a disaster. Ball argues that the authorities believed the fallout would be limited. ■■ The Fed claimed it did all it could within its power to lessen the effects of Lehman’s failure. Ball argues that some of the Fed’s actions worsened and accelerated the disorder from Lehman.
ruptcy examiner in Decem- to conclude: “Lehman was solvent, or at ber 2009. least close to solvent, when it filed for Ac c o rd i n g to B a l l ’s bankruptcy on September 15. Its assets research, Bernanke is simply were approximately equal to its liabilities, telling tall tales. Ball argues which suggests it should have been able to that “Lehman would have pay its creditors.” needed about $84 billion of Given the uncertainties that go along liquidity assistance from the with valuation in the midst of a financial Fed to stay in business over crisis, I find this conclusion less convincthe four weeks from Septem- ing than Ball’s arguments concerning the ber 15 to October 13,” which Fed’s legal authority. He admits as much: could have been provided “We will never know for sure whether through the Federal Reserve’s Lehman’s equity based on ideal fair-value The Fed and Lehman An assessment of the Brothers: Setting the Primary Dealer Credit Facility accounting was positive or negative.” Yet many narratives Ball advances Record Straight on a (PDCF). He claims that this he insists that “Lehman was near the Financial Disaster and refutes would exceed the would have at least sustained border between solvency and insolvency.” limits of space for this review, By Laurence M. Ball Lehman into mid-October The fact that no acquirers stepped up to so I will focus on just a few. 294 pp.; Cambridge 2008, by which time Lehman fund Lehman and take on the risk of deep University Press, 2018 should have been able to insolvency indicates continued uncertainty No legal basis / Ball dedicates come up with a more perma- regarding its solvency. a significant portion of the nent solution to its long-term book to refuting what I would consider funding difficulties. He examines the fund- Should the Fed have funded Lehman? / Ball the most outrageous of the Fed’s claims: ing side of Lehman’s balance sheet and presents clear evidence that under law the that it lacked legal authority to fund matches the firm’s borrowing needs with New York Fed could have extended credit Lehman. Section 13(3) of the Federal sufficient collateral (about $122 billion). to Lehman. But simply because the FedReserve Act gives the Fed authority to His numbers and conclusion are well-sup- eral Reserve had the legal power to do so undertake such support, provided that ported: “[Lehman] could have avoided its doesn’t mean that it should have done so. any funds advanced to a troubled institu- bankruptcy filing if it had received a suf- Ball argues for intervention by describtion like Lehman must be “secured to the ficient loan from the Fed, and the firm had ing the aftermath of Lehman’s failure: satisfaction of the Reserve Bank.” plenty of collateral to secure such a loan.” “The U.S. financial crisis intensified dramatically after the Lehman bankruptcy.” The lack-of-authority argument was not made contemporaneously with the How deep a hole? / If Lehman was indeed He also cites the justifications for the failure of Lehman in mid-September 2008, solvent, then lending to Lehman would subsequent AIG bailout a few days after Lehman was allowed to but was first advanced by Fed Chairman fail: “One reason was Ben Bernanke weeks later in a speech to The fact that no acquirers stepped up that policymakers had the National Association for Business Eco- to fund Lehman and take on the risk by that time observed nomics. According to Bernanke: of deep insolvency indicates continued the immediate results of uncertainty regarding its insolvency. Neither the Treasury nor the Federal the Lehman failure…. All Reserve had the authority to commit hell broke loose.” public money.… The Federal Reserve’s Ball argues that this loans must be sufficiently secured to have fulfilled the Federal Reserve’s tradi- disorder could have been largely avoided provide reasonable assurance that the tional role as lender of last resort to sol- if Lehman had been propped up like the loan will be fully repaid. Such collateral vent but illiquid institutions. Ball cites Fed and the Treasury did for other instituwas not available in this case. Walter Bagehot on the importance of tions. But given all the turmoil in SeptemHe made similar public statements in this role: “Bagehot’s basic idea was that ber 2008, it is not at all clear that Lehman’s October and December 2008, on CBS’s a central bank can lend to a bank when failure can be blamed for all or even most 60 Minutes in March 2009, at the Fed’s a run has disrupted its usual sources of of the turmoil. There were imbalances and Jackson Hole conference in August 2009, cash, thereby enabling the bank to stay in mal-investment in the financial sector that before the FCIC in November 2009 and business.” Ball pores through the available needed to be brought into balance and again in September 2010, and in inter- financial statements of Lehman Brothers Lehman’s failure—along with the failures or views with the team of the Lehman bank- from May and early September of 2008 near failures during September 2008 of Fan-
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nie Mae, Freddie Mac, AIG, Wachovia, Washington Mutual, and others—was merely a signal of how bad these distortions were. Ball also concludes that a bailout was proper without thoroughly addressing the long-term moral hazard concerns that are at the core of economic arguments against bailouts. Lehman was a poorly managed and possibly corrupt firm that should have been allowed to fail. The U.S. government has been propping up failing individual financial institutions for at least a century and there is evidence that banks and other financial institutions that have benefited from that backstop have taken on greater risk. Ball seems unaware of the fact that
risk-taking will continue to expand because of his policy prescriptions that the Fed should have greater discretion to lend.
/ I agree with one of Ball’s conclusions: during the response to the collapse of Lehman Brothers, the Fed and Treasury were flying by the seat of their pants. The principal policymakers from 2008 have engaged in post hoc rationalizations for what they did, and that rationalizing has continued through this fall’s 10th anniversary of Lehman’s failure. Ball has done his homework and has provided his readers with the contradictions inherent in those rationalizations.
Rationalizing it all
Sunstein Will Be Dancing, But Should He? ✒ REVIEW BY DAVID R. HENDERSON
I
n his preface to The Cost–Benefit Revolution, Harvard law professor Cass Sunstein writes something that readers may not expect: To date, the cost–benefit revolution has had three defining moments. They stem from the work of presidents Ronald Reagan, Bill Clinton, and Barack Obama.
An approving nod to a Republican president may seem surprising for the Democrat-allied Sunstein, but he credits all three presidents for advancing the use of cost–benefit analysis in the executive branch of the federal government. He gives a nice history of that revolution, starting with Reagan. From 2009 to 2012, Sunstein headed the Obama administration’s Office of Information and Regulatory Affairs (OIRA), the part of the executive branch that enforces the requirement for cost–benefit analysis of major government regulations. Seeing DAV ID R . HENDER SON is a research fellow with the Hoover Institution and emeritus professor of economics at the Graduate School of Business and Public Policy at the Naval Postgraduate School in Monterey, CA. He was a senior economist with President Ronald Reagan’s Council of Economic Advisers. He is the editor of The Concise Encyclopedia of Economics (Liberty Fund, 2008).
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fully make his case. To be sure, he makes a strong argument that cost–benefit analysis has the power to be good analysis. He also shows cases in which good analysis overcame political pressure. But for someone who was in his job when “four thousand regulations were under discussion,” he relates surprisingly little about those discussions when, to make his case, he needed to provide more than just some details about a handful of regulations. He also goes too easy on heads of government agencies, not acknowledging their evident bias. He even makes a simple but telling error in one of his examples of cost–benefit analysis, using an annual figure where he should have used a present value. Also, as noted above, he wants cost– benefit analysis to evolve into welfare analysis. But even though he discusses welfare often in the book, he never gives readers a clear idea what it is. To his credit, he deals head-on with some of the major pitfalls in cost–benefit analysis. He devotes a whole chapter, for example, to Friedrich Hayek’s “knowledge problem,” concerning the difficulty governments have in gathering and employing important information that exists in decentralized form in millions of minds. Sunstein seems to think, though, that he has answered Hayek’s objection. I think he hasn’t. Also to his credit, even though I think that his reasoning falls short, he employs cost–benefit analysis in ways that few other advocates dare, including in evaluating the tradeoff between national security policy and civil liberties such as privacy and freedom of speech.
government up close often makes analytic people cynical, but that hasn’t been the case with Sunstein. He emerged from his almost four-year stint in Washington as a strong believer in the power of cost– benefit analysis to lead not only to answers but also to good policy outcomes. In this book, he lays out why and concludes that the cost– benefit revolution “may well turn out to be a transition to something far better, focused more directly on the measurement of human welfare and enlisting unimaginably ambitious strategies to capture and improve the The Cost–Benefit real-world effects of public- Revolution sector initiatives.” When that By Cass R. Sunstein happens, he closes, “There 266 pp.; MIT Press, will be dancing at the revolu2018 tion, and I’m coming.” Unfortunately, he doesn’t
Respecting people’s will / The book has many strengths. The best chapter by far is Chapter 3, titled “Willingness to Pay and the Value of Life.” In it, Sunstein defends the view that measuring people’s willingness to pay (WTP) for something is a good measure
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of value. That won’t surprise most economists, but he argues this case particularly well. Indeed, this chapter would make an excellent reading for a cost–benefit analysis course. Consider, for example, the argument that using WTP biases the analysis in favor of those who are typically willing to pay a lot, namely, the rich. Sunstein shows that’s not true. He points out that instead of paying, say, $90 to eliminate a one-in-100,000 risk of dying, some people might want to use that money for more pressing wants such as food, medical care, or clothing. In that case, he concludes, WTP is a good foundation because “people are hardly helped by being forced to pay for regulatory benefits that they do not believe to be worth buying.” Sunstein also defends WTP on grounds that will appeal to those who favor freedom. He writes, “Government should allow people to make choices about how to allocate their resources, not necessarily because people know best, but because they should be treated as adults rather than as infants.” It’s particularly encouraging to see him write this because his well-known earlier view, expressed in his coauthored book Nudge, was that government should treat people as—well, maybe not infants, but not quite adults either. He has consistently thought that people make bad choices, but his defense of their right to make those choices is more full-throated than in his earlier work. Knowledge problem / Probably the weakest chapter is Chapter 4, “The Knowledge Problem.” In it, Sunstein addresses the issue that Hayek raised in his classic 1945 article, “The Use of Knowledge in Society.” Hayek argued that the information required for an economy to work exists in the minds of the economy’s players and is employed organically in a free marketplace, but cannot be aggregated in a way that would allow even brilliant central planners to run an economy well. This article drove the final intellectual nail into socialism’s coffin, as socialist economist Robert Heilbroner admitted 44 years later.
Sunstein points out that the same problem could hamper government officials’ attempts to get the information they need to make new regulations that pass a cost–benefit test. But, he believes, the American rule-making process mitigates this problem. If he were to argue that getting the information required to make an effective rule is less daunting than getting the information to plan a whole economy, I would agree. But he seems highly confident that the feedback that regulators receive
his time at OIRA. Surely, if feedback from the public helped inform regulators, he would have numerous examples of that. Yet, how many such examples does he provide in the book? Zero. He does, though, provide a good example of regulators—including himself—tripping up on the knowledge problem. On the second-to-last page of the book, he describes how the Affordable Care Act’s incentives for doctors to use electronic medical records have “caused them to spend significantly less time with If feedback from the public helped their patients—and siginform regulators, Sunstein would have nificantly more time numerous examples to report. But the entering information book reports none. into a computer.” He doesn’t tell us whether that provision was open when they put out proposed regulations for public comment, but he does write, “I for public comment solves the knowledge was involved in many discussions of the problem. This process, he argues, helps issue in government, and no one raised them accumulate the knowledge that is the problem.” In other words, there were distributed in many minds. a number of smart people involved in that But it’s hard for me to share his faith in discussion—Sunstein clearly is smart—and the rulemaking process. During the Clin- no one raised what I, an onlooker, thought ton administration, I wrote a comment on at the time was an obvious problem. That’s some restrictions on cigarette advertising breathtaking. proposed by the Food and Drug AdminIn the same chapter, he says that govistration. Apparently—and I’m going from ernments can adjust regulations on the memory here—the comments against the fly, writing: regulation outnumbered the comments With respect to security lines at airin favor. So what did the regulators do? ports, for example, they can make rapid Extended the time limit and got word to adjustments as the number of travelers thousands of teachers to have their stuvaries over time. With respect to traffic dents write comment letters as an assignfatalities, they can test interventions to ment. It’s easy to imagine what side of test what works and what does not. The the issue K–12 students, “encouraged” by sky is the limit here. their teachers, would take. Voilà! The number of comments favoring the regulation Much more likely is that the deadening ended up exceeding the number against. incentives within the bureaucracy are the I’m pretty sure, though, that the regula- limit. Sunstein seems to lack skepticism tors didn’t give much attention to the chilabout the motives and ability of governdren’s comments—or to mine. Perhaps Sunstein could have better per- ment officials. In one paragraph, he refers suaded me and could persuade other skep- to an OIRA study during the George W. tical readers by providing some examples Bush administration that found that fedwhere the comment process uncovered eral government agencies overestimated information that led regulators to change the benefit–cost ratio 47% of the time and their proposals. Recall that he was involved underestimated it 30% of the time. In the in approximately 4,000 regulations during very next paragraph, he concludes that
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“there does not appear to be a large systematic bias in any one direction.” But 47% overestimation versus 30% underestimation suggests a fairly large bias in favor of regulation. Myopia /
As I mentioned, there are some very good sections of the book. One is Sunstein’s demonstration that the “Precautionary Principle” is inherently contradictory, a case he made in Regulation back in 2002. (See “The Paralyzing Principle,” Winter 2002–2003.) There are various versions of this principle. One he quotes is: If an action or policy has a suspected risk of causing severe harm to the public domain (affecting general health or the environment globally), the action should not be taken in the absence of scientific near-certainty about its safety. Under those conditions, the burden of proof about absence of harm falls on those proposing an action, not those opposing it.
Sunstein points out the obvious problem. Efforts to limit or reduce risk can create risk. For that reason, “the very steps mandated by the Precautionary Principle violate the Precautionary Principle.” But there are also other bad sections. One of the worst is an illustration of Sunstein’s that contains not one, but two serious errors. He gives an example of a fuelefficient car that saves its owner $2,000 annually versus a less fuel-efficient car that costs $500 more upfront. He claims the difference in cost is $1,500. See the problem? In a telephone conversation, he quickly admitted to me that for his example to work, he should have said that the more fuel-efficient car costs $500 more upfront. But I pointed out a much bigger problem: his assumption implies that the car dies after one year—he considers only one year’s worth of fuel savings. The fueleconomy savings in his example, using a reasonable interest rate and a car life of 10 years, should be over $15,000 over the life of the car. That mistake didn’t bother him, he said, because he was looking for a num-
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surely knows, that in 2013, national intelligence director James Clapper perjured himself before the Senate Intelligence Committee when he said that the National Security Agency did not “wittingly” collect data on millions of Americans. Clapper later admitted that his categorical denial was the “least untruthful” statement he could make. He was never held to account for uttering something that was nonetheless untruthful. In a chapter that deals seriously with surveillance, and in a book by someone who seems to have enormous confidence in federal bureaucrats, I would have expected Sunstein to at least confront the issue of lying government officials. In his second-to-last chapter, he applies cost–benefit analysis to the issue of free speech. He points out that the whole What of liberty? / As mentioned earlier, idea of limiting speech only when there Sunstein subjects the issue of national is a “clear and present danger,” to use the security versus privacy, and even freedom words of Supreme Court Justice Oliver Wenof speech, to a cost–benefit analysis. Con- dell Holmes Jr., isn’t really consistent with cerning privacy, he argues against what a cost–benefit test. Even though Holmes he calls “Snowdenism,” a term he coined used the language to justify the convicfrom whistle-blower Edward Snowden, tion of someone speaking out against U.S. who exposed the massive and arguably ille- involvement in World War I—hardly a case gal gathering of Americans’ telecommuni- of a speaker presenting a clear and present cations data during the Obama admin- danger to the nation—Sunstein notes that the court in Brandenburg v. Ohio, which has now Shouldn’t Sunstein, of all people, become the standard way have admitted that he himself courts look at this issue, was guilty of the myopia that he read “clear” to mean ascribes to the car buyer? “likely.” What if the danger is not in the present but in the future with a istration. Snowdenism, writes Sunstein, high probability? That’s a good question, reflects enthusiasm for “aggressive precau- and I was pleased to see Sunstein wrestling tions against risks” of oppressive govern- honestly with a tough problem. ment and is an instance of detrimental use One of the arguments against relying of the Precautionary Principle. He argues on cost–benefit analysis to decide whether that the government might simply want to allow free speech is what Sunstein calls to engage in surveillance that saves lives, “institutional bias.” When government not to malevolently snoop through Amer- officials invoke a risk of harm, he notes, icans’ communications. But did Snowden “they are often trying to insulate themargue against surveillance? I don’t recall selves from criticism.” He thinks that the his doing so. Instead, he blew the whistle “clear and present danger” test protects on federal government surveillance without speech too much but “is incalculably prefwarrants. Sunstein doesn’t mention that erable to what would emerge from openimportant fact at all. ended balancing by unreliable balancers.” Nor does he mention, although he His bottom line is that the clear and presber that the car buyer could compare to the $500 in added cost. Although I left the conversation satisfied by that explanation, I am now rather stunned by it. Sunstein, as noted earlier, coauthored the book Nudge. In it, he and economist Richard Thaler argued that consumers are often myopic, tending to look at the numbers right in front of them and not thinking about implications for the more-distant future. Shouldn’t Sunstein, of all people, have admitted that he himself was guilty of the myopia that he ascribed to the car buyer? By the way, evidence from the used car market shows that consumers do take account of gasoline costs over much more than a year. (See “Working Papers: CAFE Standards,” Winter 2015–2016.)
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ent danger test hasn’t caused much mischief in the last 50 years but it might do so in the next 50. I should point out one especially disturbing sentence in the book. In reading it, remind yourself that Sunstein has taught constitutional law at some of the top law schools in the country and, thus, has surely read the U.S. Constitution many times. In discussing the idea of having a cost–benefit agency that is independent of the president, he writes, “True, no president is likely to love that idea; it takes control away from the commander-in-chief.” The U.S. president is commander-in-chief of the U.S. military, not of the executive branch. Sunstein offers no discussion of the military. So is this simply
a slip-up, or are we getting a little insight into the amount of power he thinks the president should have? I hope the former, but I don’t know. Conclusion / Throughout the book, Sunstein argues that cost–benefit analysis is simply a step toward what is really desirable: namely, welfare analysis. The term “welfare” comes up again and again, but not once does he explain what he means by it. He seems to have a feel for it, but he doesn’t share it. So, when the revolution comes, maybe only Cass Sunstein will know it has arrived. He will be dancing, but will he be dancing alone? Should he dance at all?
decreased both relatively and absolutely—an incredible feat, given massive increases in population.” The book’s appendix documents the many ways in which life has been improving over the long run.
The Miracle / Goldberg borrows the term “the Miracle” to refer to the Industrial Revolution and ongoing human progress. He primarily aims to convince the reader that the Miracle is happening. Why it is happening is a lower priority, though he offers two possible answers. The first is English author and politician Daniel Hannan’s view that, as Goldberg puts it, “England did it.” That is, the English people’s “weirdness” or “exceptionalism” produced democratic capitalism. According to Goldberg, Hannan sees five English characteristics that set the stage for political and economic progress. Of those five, “common law” is paramount. ✒ REVIEW BY PHIL R. MURRAY Goldberg quotes Hannan to define “common law: a unique legal system that made n Suicide of the West, National Review senior editor and American the state subject to the people rather than the reverse.” Goldberg shares what HanEnterprise Institute scholar Jonah Goldberg diagnoses America’s nan writes about common law and adds current political, economic, and cultural condition. He aims to that “English common law recognized the persuade the reader of four points: rights of all Englishmen, which made all ■■ The citizens of the world are experiencas of 2008” (measured in “1990 Interna- the difference.” ing booming economic success. tional Dollars”). The second view is offered by Univer■■ This success is fragile. Humanity’s success is not just material. sity of Illinois at Chicago professor Deir■■ “Human nature” is real and stubborn. It also appears in human life’s quality and dre McCloskey. Prior to the 19th century, ■■ Even though the dark side of human quantity. Infant mortality is plummeting people spurned technological progress. nature cannot be excised, it can be and life expectancy is rising. Although our But that suddenly changed; people began controlled. Failing to do so will doom numbers are greater, we do not live at a sub- to appreciate and employ innovations us to cultural, economic, and political and respect innovators, failure. unleashing capitalism on Goldberg aims to convince the reader the production of goods. that the Miracle of human progress is Goldberg likens democratic capital- real. Why it is happening is a lower Goldberg acknowlism to a goose that lays golden eggs. He edges that various influpriority, though he offers two answers. presents a graph of the world’s gross ences combined to cause domestic product from the year 0 to capitalism. His greater 2000. Viewing the graph, one cannot disconcern, however, is tinguish the world’s output of goods and sistence level. Rising productivity increases whether the good times will continue to services from zero for the first 18 centu- our standard of living. Goldberg relays Brad roll. He is pessimistic. ries. Thereafter, production grows expo- DeLong’s estimate that, from the dawn of While the capitalist economy is nentially. In numerical terms, “Global the Industrial Revolution to today, average dynamic, “human nature” is static. GDP has soared, from an estimated $150 income in the world rose “from $180 per Human nature comprises the “baser billion in A.D. 1 to more than $50 trillion person to $6,600 per person.” Concern- instincts” that we all share. There are ing global poverty, Goldberg reports, “The seemingly positive aspects such as “coopPHIL R . MUR R AY is professor of economics at Webber International University. number of people considered poor has eration,” “compassion,” and a desire for
Corrupting the Miracle
I
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“admiration.” Consider human history is “a school of rebellion against the unnatas far back as you know. Throughout it, ural nature of the Enlightenment and all of people cooperated because they could see the Enlightenment’s offspring: capitalism, that more could be accomplished by coor- democracy, natural rights, and science.” He dinated effort. Out of that grew such vir- invokes one of America’s founders to help tues as compassion and such sentiments us understand: as the desire to be admirable. Compassion As Jefferson warned, “The natural seems to be timeless and universal; people progress of things is for liberty to yield, at different times and in different cultures and government to gain ground.” My tend to feel sorry for the less fortunate. only quibble with Jefferson here is that Seeking “admiration” means wanting to he chose the wrong word. The be liked. Goldberg quotes dynamic he was describing Adam Smith, “Man naturally was not progress but decay, or desires, not only to be loved, corruption. but to be lovely; or to be that A good example of conthing which is the natural temporary corruption is the and proper object of love.” administrative state. The The negative aspects roots of the administrative of human nature include state in America go back a “greed,” “violence,” and hundred years to the Pro“romanticism.” Some people gressive Era. Progressives think greed is an aspect of aimed to use government to capitalism. They are wrong, make society better. Goldat least to the degree that Suicide of the West: berg quotes Princeton ecogreed predates capitalism. How the Rebirth of nomic historian Thomas C. Some also think violence is a Tribalism, Populism, Nationalism, and Leonard’s description of the modern phenomenon. They Identity Politics Is progressive mindset: “First, too, are wrong; Goldberg cites Destroying American modern government should several scholars on this mat- Democracy be guided by science and not ter. Here’s McCloskey again: By Jonah Goldberg “Conquest, enslavement, rob- 453 pp.; Crown Forum, politics; and second, an industrialized economy should be bery, murder—briefly, force— 2018 supervised, investigated, and has characterized the sad regulated by the visible hand annals of humankind since Cain and Abel.” To recap, human nature, of a modern administrative state.” Progressives trust “experts.” Goldberg whether an inclination to cooperate or be greedy, is natural. The good must be knows how progressives think. “If you encouraged and the bad must be discour- have the ‘scientific’ facts on your side, why aged. Human nature must be “channeled” would you put the question before the toward good ends. Goldberg maintains voters?” He is no fan of President Woodrow Wilson. Among his reasons: “Wilson that we are now failing at that task. believed that the science of administration Corruption and the state / He writes of could elevate man above his nature and “corruption,” by which he means some- the people he serves. The old dream of the thing other than the standard public offi- perfectibility of man would be achieved in, cial taking a bribe. “I argue,” Goldberg of all types, the bureaucrat!” Thus, we have elaborates, “that political ideas and move- the administrative state. ments based upon the romantic idea of The core of the administrative state is following our feelings and instincts can big government. He defines it as “a vast best be understood as corruption.” complex of bureaucrats and regulators— To him, romanticism is not a movement and the rules they work by—outside the in any subject of the humanities. Rather, it constitutional order.” For example, the
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2010 Affordable Care Act granted overwhelming authority to the secretary of health and human services. Some government agencies tax at their discretion, without authorization from legislatures. Citizens find themselves afoul of regulations issued by the Environmental Protection Agency, the Equal Employment Opportunity Commission, the Internal Revenue Service, and so forth, and their cases are adjudicated by an administrative law judge, not a jury of their peers. This form of government is unconstitutional, Goldberg protests. He quotes Columbia University law professor Philip Hamburger to explain why: “The administrative regime consolidates in one branch of government the powers that the Constitution allocates to different branches.” That is, the administrative state violates the separation of powers, combining legislative, enforcement, and judicial powers in the federal executive branch. One danger of this type of governance is that it will not reflect the will of the people, but of government bureaucrats. Unlimited government is another danger. Goldberg frames it this way: “There is no limiting principle inherent to the idea that a caste of experts should be empowered to do whatever they think is right.” Although agents of the administrative state may have good intentions, they will err. Goldberg recalls the case of the EPA attempting to remove polluted water from mines in Colorado and unintentionally releasing it into the Animas River. Evidently no EPA personnel were fired for that, though the agency was guilty of perpetrating the very harm it was supposed to prevent. Without a check on incompetence, expect more of it. Administrative law is not just unconstitutional; it produces bad economic outcomes. Goldberg introduces the idea of “regulatory capture,” or “guild economics” as he calls it. In general, established practitioners dominate bodies that grant occupational licenses and they block upstarts from entering those occupations. Local governments in particular act to preserve the status quo for taxi cab companies at
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the expense of Uber and its drivers. Regulatory barriers that thwart new businesses also harm consumers. Guilds have existed for hundreds of years and occupational licensing has been covering an increasing number of occupations for decades. The standard of living has nevertheless increased. One might thus reason that technological progress will trump regulatory barriers in the future, but Goldberg is skeptical of that idea. “For every ‘disruptor’ [like Uber] that puts a crack in the façade of the regulatory state, allowing us to see what might lie on the other side, there are a dozen examples of how that façade is getting thicker and more impenetrable.” In other words, he doubts that entrepreneurs and their innovations will continue to save us. Besides government and the market, other institutions are weakening. Take marriage and the family. “Approximately half of the children born to married parents in the 1970s saw their parents part, compared to only about 11 percent of those born in the 1950s,” Goldberg observes. He concedes that “the transformation of ideas about marriage had some benefits”; no one would deny the abused wife’s right to exit, for example. Yet he emphasizes research indicating the negative effects of parental separation upon children. For instance, he relates, “The Brookings Institution’s Isabel Sawhill—no Bible-thumping right-winger—found that 20 percent of the increase in child poverty since 1970 can be attributed to family breakdown.” Goldberg exalts the family. “By any measure,” he claims, “the most important mediating institution in any society is the family.” He infers that if we lose families, we will lose capitalism and civilization itself. Conclusion /
Society is at a critical juncture. The left argues for a larger role of government in the economy and in cultural affairs. The right is turning to tribalism, populism, nationalism, and identity politics. Goldberg generally disapproves of these trends. Obamacare was an awkward interven-
tion into health care markets. The Trump administration’s tariffs are likewise a bungling attempt to benefit some American producers at the expense of American consumers and other American producers. Populism, nationalism, and identity politics may be born of group solidarity, but if taken to their limits they become toxic. If the left goes too far with socialism, we’ll get statism. If the right goes too far with nationalism, we’ll also get statism. He borrows from his National Review colleague Yuval Levin to state the problem. Statism, which is essentially too much bad government, weakens the institutions between individual autonomy and coercive authority. Without “mediating institutions” such as the family, the church, volunteer organizations, etc., we cannot effectively deal with the destructive side-
effects of capitalism such as unemployment in the wake of technological progress. Goldberg does not close with a list of policy recommendations. Instead, he recommends putting God back into our lives. Without God, he contends, we seek “fulfillment, belonging, and meaning in tribes and crowds.” He overlooks that religiosity can also descend into tribalism. “The only solution to our woes,” he concludes, “is for the West to re-embrace the core ideas that made the Miracle possible, not just a set of policies, but as a tribal attachment, a dogmatic commitment.” Going tribal can apparently be a good thing. Goldberg speculates that “under the right circumstances, our tribal nature can be grafted to a commitment to liberty, individualism, property rights, innovation, etc.” Is that the libertarian movement?
You Didn’t See It Coming ✒ REVIEW BY PIERRE LEMIEUX
“C
an it happen here?” ask 19 different contributors, most of them law professors, in this interesting book edited by Cass Sunstein. “It” is tyranny or, as they say more discretely, “dictatorship” or “autocracy,” which is further laundered as “authoritarianism.” This is a crucial question that must be answered squarely. The book gives many good but incomplete— and sometimes question-begging—answers. Sunstein is a well-known law professor, now at Harvard University, who headed the White House Office of Information and Regulatory Affairs during Barack Obama’s first term as president. A prolific author, he has also written in the field of behavioral economics, sometimes trying—and failing, according to some—to reconcile regulation with the idea of consumer sovereignty and economic efficiency. (See “Paternalism and Psychology,” Summer 2006.) With economist Richard Thaler, he helped to originate the idea of government “nudging” individuals toward the presumed best PIER R E LEMIEUX is an economist affiliated with the
Department of Management Sciences of the Université du Québec en Outaouais. His latest book is What’s Wrong with Protectionism (Rowman & Littlefield, 2018).
choices without actually forcing them to choose. (See “A Less Oppressive Paternalism,” Summer 2008.) Prudent optimism / Some of the book’s contributors are optimistic that the United States can avoid authoritarianism. University of Chicago law professor Eric Posner as well as Sunstein himself argue that fascism and dictatorship are very unlikely to happen here because of the United States’ diversity, decentralized power, and legal and constitutional protections. But Sunstein includes a caveat: “If the American project is to be seriously jeopardized, it will almost certainly be because of a very serious security threat.” What quickly becomes apparent as one reads the book is that the authors
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are specifically concerned about right- were small by today’s standards. wing fascism. None of the contributors This is an interesting theory, but it defines fascism, but we understand that suggests that we can’t fall under fascism it is something like Mussolini’s Italy. The because we already have it. In light of the danger of Donald Trump is frequently Trump experiment, we may concede that, mentioned, but left-wing authoritarian- up to a certain point, the administrative ism is not discussed. state, however close we may think it is to Psychologist Karen Stenner and New soft fascism, is still better than the whims York University business proof a strongman. But other fessor Jonathan Haidt argue contributions in the book that authoritarianism “is no cast doubt on the theory momentary madness. It is a that a heavily interventionist, perpetual feature of human apparently too-big-to-mansocieties.” In their estimate, age state cannot be co-opted one-third of individuals have by an authoritarian. an authoritarian personality. It could happen stealthily (Many will question the measure they use to determine / Most of the book’s contributors are pessimistic or this, related to a survey quescautious about the countion about preferred child try’s prospects of avoiding education.) They develop Can It Happen Here? authoritarianism. If it hapa model in which both Authoritarianism pens here, it would probably “authoritarian personality” in America happen slowly. University and “threats to social one- Edited by of Chicago law professor ness” explain populism (of Cass Sunstein David Strauss writes: “There the right) and provide some 496 pp.; Dey Street will have been no single, empirical verification for this Books, 2018 cataclysmic point at which model in Trump’s America, democratic institutions were Marine LePen’s France, and the United Kingdom’s Brexit vote. They demolished. For the same reason, the steps venture that some adjustments may be towards authoritarianism will not always, required to liberal democracy in order to or even usually, be obviously illegal.” Like avoid authoritarianism, such as avoiding other contributors to the book, Strauss gives the impression that the state should too much diversity from immigration. Their model doesn’t consider whether a do everything he thinks is good (like the policy of “live and let live” would be better New Deal) and nothing he believes is bad. than more regulation. Perhaps authoritar- Still, his article provides an interesting ians would be tamer if they were left alone? introduction to constitutional law. Tumur Kuran, an economist and politi“No, it can’t happen here,” writes George Mason University economist cal scientist at Duke University, develops Tyler Cohen. “Not anytime soon.” This an interesting model of cascading intolerwould make him an optimist if it were ance that builds a road to serfdom difnot for the reason he gives. A takeover of ferent from the one that Friedrich Hayek the American government by fascists or foresaw. Trump, he says, is more a sympany other radical group is impossible, he tom than a cause. The problem is the clash argues, because government “is so large between two “intolerant communities”: and unwieldy”: “Big government is useful “identitarians,” who define individuals precisely for (among other reasons) helping to in terms of politically correct minority keep government relatively small” (Cowen’s groups; and “nativists,” who define indiemphasis). Fascists were able to take over viduals as part of the majority. Without a Germany and South American countries, moderate middle and “a return to policies for example, because their governments based on mutual respect and willingness
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to seek common ground,” the system may reach a hatred-filled equilibrium or else produce a demagogue offering to one of the intolerant communities the means of crushing the other. The difficulty of collective action undermines the organization of a moderate middle. One big step toward authoritarianism would be the proclamation of a state of emergency in the face of a real or fabricated security crisis. As noted by Yale law and political science professor Bruce Ackerman and by University of Chicago law professors Tom Ginsberg and Aziz Huk, the U.S. president’s power to make war and declare a state of emergency, possibly followed by the mass arrest of individuals on government watchlists, is less constrained than in many Western countries. Under the title of “How We Lost Constitutional Democracy,” Ginsberg and Huk’s chapter describes how the United States is vulnerable to “the most prevalent form of democratic backsliding: the slow and tortuous descent in partial autocracy.” Except for the difficulty of amending it, the U.S. Constitution is not exceptional from the point of view of preventing democratic backsliding: it can be sidestepped, in some cases more easily than in other countries. Current or recent examples in other countries—Hungary, Poland, Turkey, Venezuela—show that each power grab may be legal in itself up to a certain point, but eventually no resistance to the strongman is feasible. They write, “We would, in short, do well to reject feel-good talk about American exceptionalism and embrace some of the founders’ bracing and necessary trepidation about the future.” Many contributors to Can It Happen Here? use the term “democracy” to mean free elections and individual freedom. But we must realize that democracy itself can lead to authoritarianism. Ginsberg and Huk point out how populist leaders claim to embody “the authentic voice of the people.” They quote Trump who, in a May 2016 campaign rally, expressed his fuzzy organicist conception of the volk: “The only thing that matters is the unification of the people—because other people don’t mean
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anything.” As “other people” are often (but not necessarily) foreigners, a national security crisis is an ideal opportunity to fuse the leader and his people. One of the most important messages of the book: most people will realize that they are living under a dictatorship once it is already well entrenched. It happened before /
Columbia University political scientist Jon Elster provides a historical example of how, in a sophisticated country, an autocrat can grab power in a few steps, each of which is not decisive except for the last one. Within just one year in 1848, Louis Napoléon Bonaparte rose to dictatorship despite three distinct branching points where he could have been stopped legally. His political opponents, including Alexis de Tocqueville and the poet Alphonse Lamartine, failed to do so because of wishful thinking, lack or organization, and political ambition. One strong point of the book is its discussion of how, as University of Chicago law professor Geoffrey Stone puts it, “It would be a grave mistake to think that ‘it can’t happen here.’” In some ways, it has already happened in America. These precedents cast a long shadow. Stone reviews the following events:
Against the backdrop of an undeclared war with France, John Adams’s Federalists adopted the Alien Act and the Sedition Act of 1798. Matthew Lyon, a congressman from Vermont, criticized Adams’s “ridiculous pomp, foolish adulation, and selfish avarice,” a charge deemed to bring the president into “disrepute.” For that, Lyon was prosecuted and sentenced to prison. ■■ During the Civil War, Abraham Lincoln suspended habeas corpus and imposed martial law. Between 13,000 and 38,000 civilians were imprisoned, some for simply criticizing the war. ■■ During World War I, “aggressive federal prosecutors and compliant federal judges soon transformed the [Espionage] Act [of 1917] into a full-scale prohibition of seditious ■■
utterance.” The Justice Department prosecuted more than 2,000 individuals under the act. ■■ The Sedition Act of 1918 was even more restrictive of free speech. During the Red Scare of 1919–1920, “more than five thousand people were arrested on suspicion of radicalism,” including “Eugene V. Debs, who had received almost a million votes as the Socialist Party candidate for president in 1916.” ■■ During World War II, against the advice of the Justice Department, Franklin D. Roosevelt ordered the internment of 120,000 men, women, and children of Japanese descent, of which 70,000 were American citizens. ■■ During the McCarthyism period, the leaders of the American Communist Party were prosecuted. The Supreme Court approved, with only one justice dissenting.
of socialism.” (See “A Coherent Authoritarian,” Winter 2015–2016.) Strangely enough, Can It Happen Here? nowhere mentions the eugenic tyranny that gripped America in the Progressive Era and eventually led to the involuntary sterilization of 30,000 persons. (See “Progressivism’s Tainted Label,” Summer 2016.)
Hope and weak links / One of the contributors, Harvard law professor Martha Minow, analyzed the Japanese internment episode in more detail, asking whether mass detentions without process could happen again in the United States. A Japanese-American, Fred Korematsu, challenged his internment order in court. He took his case all the way to the Supreme Court, where he lost in 1944. Despite the subsequent rehabilitation of Korematsu, to whom Bill Clinton awarded the Presidential Medal of Freedom in 1988, the Supreme Court had never overturned this Throughout American history, Stone infamous decision. Minow expressed the writes, the government has often been fear that Korematsu v. United States could be busy stifling dissent. During the Vietnam used as a precedent, including in public health scares. That was true until It would be a grave mistake to think very recently. Minow that authoritarianism can’t happen published her chapter in America, because at various times before the 2018 decision in history it already happened. in Trump v. Hawaii, where the Court finally and forcefully repudiated War, however, individual rights were bet- Korematsu. Wrote Chief Justice John Robter protected. At last, the Supreme Court erts in the majority opinion, “Korematsu stood firm in defense of the First Amend- was gravely wrong the day it was decided,” ment. But that did not prevent National and “has been overruled in the court of Guardsmen from firing into a crowd of history.” That’s a point for the more optistudent protestors at Kent State Univer- mistic contributors to Can It Happen Here? sity one month after California governor It is not a little ironic that what led the Ronald Reagan was reported saying about Court to revisit and repudiate Korematsu campus militants, “If it takes a bloodbath, was Trump’s travel ban—though the Court let’s get it over with.” Nobody is perfect, did ultimately allow a watered-down verbut politics has a way of making most sion of the ban to take effect. people worse. A ray of light is not the sun. Some of Fascism came to America under other the legal scholars who contribute to Sunforms. Slavery was fascism, but it could stein’s book show a naivety that does not also be seen as socialism. Is there a real bode well for the future. Yale law profesdifference between the two systems? Slav- sor John Balkin is correct when he writes ery defender Hugh Fitzhugh argued that that “Trump is merely a symptom … of “slavery is a form, and the very best form, a serious problem with our political and
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constitutional system.” The 45th president is “straight out of central casting for demagogues: unruly, uncouth, mendacious, dishonest, and cunning.” But Balkin’s article is in large part a succession of clichés typical of the sort of establishment thinking that dutifully prepared the terrain for Trump: for example, the government is at the service of the “[political] donor class” and has been unable “to reconcile globalization with democracy,” the implication being that the former must yield to the latter and the individual to the collective. New York University law professor Stephen Holmes also offers a disappointing chapter. He makes some interesting points against gerrymandered elections and polarized primaries, the danger of temporary democratic majorities, “competitive overpromising” (Holmes’ emphasis) by politicians, the opaque security state, and the power of government to control dissent by using government agencies. But his grist is buried under the shaft of bad economics and pure clichés or contrivances such as “the weakening of the welfare state,” “the puppets of global finance,” economic insecurity, the disappearance of the citizen-soldier and its power to bully the rich, and so forth. Add a few meaningless or confused mantras such as “memory loss at the collective level” and “society’s sense of future possibility.” For good measure, Holmes evokes “a society where a loaded firearm is just another household appliance.” Unwittingly, he demonstrates one reason why one-third of the American electorate voted for Trump. Holmes exemplifies the statist elite suddenly surprised that the vast power they advocated for, and granted to, the state is being used by politicians not of their own tribe. They don’t realize that tyranny, not nirvana, is what happens when people put all their hopes in government, as Anthony de Jasay argues (notably in his 1985 book The State). How can these elites complain so much about government’s actions and yet not question its power? They had taken over the government and were pushing their brand of soft fascism when Trump displaced them.
Government power /
It is remarkable that virtually none of the contributors to Can It Happen Here? mentions government power as a major reason for the danger of authoritarianism. What about reducing that power, regardless of whether it is the Democrats or the Republicans who would hold it? Chain Leviathan! Most of the contributors, on the contrary, seem to love government power, provided it is used to impose their own preferences. (I interpret Tyler Cohen’s argument about why authoritarianism can’t happen in America as the mere empirical hypothesis that the more power government gets, the less it can use that power in arbitrary ways.)
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It is true that government power may result from people’s authoritarian tendencies. But statecraft, if such a thing can be beneficial, should include preventing these tendencies from expressing themselves in police and military actions. If the state is justified, it must be to temper, not amplify, mob clamors. Despite its failings and establishment biases, Can It Happen Here? presents interesting theories about the possible roads and obstacles to tyranny. Some of the chapters are remarkable. And even the book’s failures and biases can teach something. It is by eliminating error that we approach the truth.
Minding the Consequences ✒ REVIEW BY GEORGE LEEF
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had heard about Nassim Nicholas Taleb for years, going back to his 2001 book Fooled by Randomness, which Fortune named one of the 75 “smartest books we know” in 2005. Taleb followed that with The Black Swan in 2007 (probably his most famous work), The Bed of Procrustes in 2010, and Antifragile in 2012. But I had not read any
of his books until his latest, Skin in the Game. For reasons that aren’t explained, he calls these five books “The Incerto” and describes the whole project as “an investigation of opacity, luck, uncertainty, probability, human error, and decision making when we don’t understand the world.” That’s quite an undertaking. Taleb currently holds a part-time post as professor of risk engineering at New York University’s Tandon School, but he began his career as a market trader who faced risk every day. He was very good at that, making enough money that he was able to devote increasing amounts of his time to reading, thinking, and writing. His views are shaped by his distinctive career path. He maintains that “the knowledge we get by tinkering, via trial and error, experience, and the workings of time—in other words, contact with the earth—is vastly GEORGE LEEF is director of research for the James G.
Martin Center for Academic Renewal.
superior to that obtained through reasoning, something self-serving institutions have been busy hiding from us.” (Emphasis in original.) Ignoring long-term consequences
/ The
book’s principal concern is that decisions are often made by people who don’t stand to directly gain if the decisions prove right or lose if they prove wrong. That is, these decision-makers have no “skin in the game.” For Taleb, this is not just an incentive problem but also a moral one because he believes decision-makers are obligated to be “sharing in harm, paying a penalty if something goes wrong.” His first example of a disastrous decision made by people without skin in the game is the Obama administration’s 2011 intervention in Libya. Encouraged by intellectual “interventionistas” who claimed that Muammar Qaddafi had to be removed from power because he was a
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dictator, the United States helped Qaddafi’s enemies overthrow him. The result has been an even worse regime in Libya that tolerates slave markets. The trouble with allowing people who have no skin in the game to make such decisions, Taleb argues, is that they think only about the immediate effect of their decisions and not the subsequent effects, that they don’t distinguish between multidimensional problems and their single-dimensional understandings, and that they don’t learn from feedback. Another case where the lack of skin in the game led to ruin was the housing bubble and subsequent banking collapse. Here is Taleb’s analysis of the crisis: Because of the accumulation of hidden and asymmetric risks in the system, bankers, master risk transferors, could make steady money from a certain class of concealed explosive risks, use academic risk models that don’t work except on paper, then invoke uncertainty and a blowup … and keep their past income.
He calls this “the Bob Rubin Trade,” after the former treasury secretary who has been criticized for protecting derivatives from stronger regulation, and then watched as derivatives played a key role in the housing bust. The bankers’ avoidance of a harsher reckoning is grating, but that is not the worst legacy of the collapse. He writes, But the worst casualty has been free markets, as the public, already prone to hating financiers, started conflating free markets and higher orders of corruption and cronyism, when in fact it is the exact opposite: it is government, not markets, that makes these things possible by the mechanism of bailouts.
That’s exactly right. He likes markets because they don’t only create incentives for actors to think hard about the risks they take, but also have the wonderful feature of removing those who keep making mistakes. Support systems evolve when participants
have skin in the game, but they don’t Attack of the IYIs / Taleb’s writing is often when actors can transfer risks. The book acerbic. One example is his branding of is loaded with pithy sayings and the one some people as IYIs (Intellectuals Yet he employs in this discussion is, “You’ll Idiots). They have scant practical experinever fully convince someone that he ence with the world but are brimming is wrong; only reality can.” Reality here over with credentials and find their way means suffering losses. into positions where they can dictate to The author’s love of the symmetry the rest of us without any risk to their of markets leads him to own material well-being. espouse what he calls the “The IYI pathologizes othSilver Rule: Do not treat others ers for doing things he the way you would not like them doesn’t understand without to treat you. Under this more ever realizing that it is his robust version of the Golden understanding that may be Rule, people are instructed limited,” Taleb writes. to mind their own business Among those he brands and not try to compel othIYIs are Ben Bernanke, Paul ers to do what is good for Krugman, Cass Sunstein, them. This rule works at all Tim Geithner, and Thomas scales—family members, your Piketty, whose book Capital in barber, nations. Taleb approv- Skin in the Game: the Twenty-first Century Taleb ingly quotes Isocrates, an Hidden Asymmetries eviscerates. (See “An UninAthenian orator of the fifth in Daily Life tended Case for More Capicentury B.C.E., who said, By Nassim Nicholas talism,” Fall 2014.) Sadly, “Deal with weaker states as Taleb despite that book’s errors, its you think it appropriate for 279 pp.; Random argument that government stronger states to deal with House, 2018 must do more to redistribute you.” The First Amendment, income caught on with IYIs he observes, also embodies and the larger class of people Silver Rule thinking: I can practice any who want wealth without taking any risks. religion I want, but I must allow you the Academia also suffers Taleb’s scorn. In same freedom; I may contradict you, but his telling, there is a vast class of univeryou may equally contradict me. sity administrators who hold sinecures There is danger any time we depart and professors who don’t have skin in from such symmetry. The greatest threat the game (when tenured, anyway), which to democracy, he argues, “is the slippery gives them license to engage in parasitic slope in the attempts to limit speech behavior. Of the latter, he writes, “If you on grounds that some of it may hurt say something crazy you will be deemed people’s feelings.” Obviously, he knows crazy. But if you create a collection of, say, what is happening on many of our col- twenty people who set up an academy and lege campuses. say crazy things accepted by the collective, Similar considerations lead him to you now have ‘peer-reviewing’ and can start argue that common law is superior to a department in a university.” Research, regulation. The fundamental rule of the particularly in the social sciences, devolves former — if you harm me, I can sue you into a pointless game where academics — has led to a balanced, adaptive legal pursue their own agendas “at variance with system that grew from the bottom up. what their clients, that is, society and the Government regulation, in contrast, is students, are paying them for.” not very adaptive, often unbalanced, And speaking of education, Taleb offers and prone to being captured by interest an observation that is sure to make him groups that can use the system to transfer enemies in the education establishment. costs to others. The level of wealth in a nation, he states,
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is not a result of the level of education. It’s the other way around. Countries that have become wealthy (thanks to the efforts of risk-takers) can afford to squander lots of money on a risk-free class of teachers and administrators who provide formal (but often useless) education. They do little to enhance the production of wealth but they absorb a great deal of it. Politicians and education insiders who want Americans to believe that the path to greater prosperity is for more of us to attend college have a resolute opponent in Taleb. In the field of medicine, both doctors and patients have skin in the game. But in recent decades, another class of people—hospital administrators—has become much more powerful. Administrators are addicted to metrics that measure the supposed efficiency of the hospital. Unfortunately, their obsession with metrics can put doctors’ skin in the wrong game. Trying to boost certain numbers while reducing others can lead to decisions that are less than optimal for the patient. Conclusion /
Everywhere Taleb looks, he sees damage and waste resulting from the actions of people who don’t have skin in the game. He’s trying to teach us a lesson of the utmost importance. Readers should be prepared, however, for his writing style. At turns, it is funny, brash, and self-absorbed. While we’re learning about the problems caused by people who don’t have skin in the game, readers also learn of the author’s aversion to pricey restaurants where the presentation is far more important than the food, his disdain for fancy exercise equipment (good old barbells are more to his liking), his debates with elitists, and much more. Readers will also find interesting excursions into religion, history, and philosophy that sometimes seem rather tangential. Most problematic of all is Taleb’s way of tossing out sharp insights but then doing little to develop them. Nevertheless, I find myself looking forward to his next book. The man understands how the world works and is eager to take on the IYIs who don’t.
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Not Your Typical Bank Collapse ✒ REVIEW BY VERN MCKINLEY
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ince the beginning of the global financial crisis in 2007, dozens of books have been written about the collapse of individual financial institutions. Many of these have focused on large institutions in the United States such as Lehman Brothers, Bear Stearns, and AIG. Fewer books have been written about banks that collapsed
in other advanced markets, such as the to an end when the Taliban took power in United Kingdom. Fewer still have been 1996: “Tens of thousands of people fled written about banks in emerging markets. Kabul by cars, trucks, motorcycles, and Kabul Bank in Afghanihorse-driven carts; people stan was one such institution even fled on foot.” that failed in the aftermath The overthrow of the Taliof the September 11, 2001 ban allowed him to return terrorist attacks, the ensuing to DAB as first deputy goverU.S. invasion of Afghanistan, nor in early 2002. This would and the subsequent “nation lead a few weeks later to his building” exercises by U.S. first meetings with Afghani forces. Its story is the subject President Hamid Karzai just of The Tragedy of Kabul Bank. after Karzai ascended to the The book’s author is Abdul presidency. In that meeting, Qadeer Fitrat, the former govKarzai pleaded with Fitrat to ernor of Afghanistan’s central The Tragedy of Kabul stay in Afghanistan: “Please bank, Da Afghanistan Bank Bank do not go back; we will put (DAB). After graduating with By Abdul Qadeer Fitrat you in a good position. It a degree in economics from 496 pp.; Page would be better to serve your a top university in Pakistan, Publishing, 2018 nation here.” Fitrat pursued a Master’s Fitrat would again become Degree at Wright State Unithe leader of DAB in early versity in Ohio. I am particularly interested 2008, this time as the official governor. His in his story because I worked in Afghani- task was monumental as he describes it: stan intermittently from 2004 to 2009 and “When I started work at the Central Bank met Fitrat on a few occasions. in January 2008, I felt it was in serious need After some chapters tracing his dif- of fundamental reforms almost in every ficult upbringing in northeastern rural direction.” Afghanistan and his time in Pakistan and the United States, Fitrat discusses Instability begins / By November 2008, the his early career when he led Banke Millie, Afghani banking system was showing a small Afghani bank, beginning in 1993. initial signs of severe stress. A tiny bank He began his first stint leading DAB as named Development Bank of Afghaniacting governor in 1995, during a period stan (DBA) was running low on cash to of triple digit inflation. That stint came pay for deposit withdrawals. As told by Fitrat, the circumstances behind the creV ER N MCK INLEY is a visiting scholar at George Washington University Law School and coauthor with James ation of DBA could be found in a Mission Freeman of Borrowed Time: Two Centuries of Booms, Busts and Bailouts at Citi (HarperCollins, 2018). Impossible script:
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Mr. Sergey Tsoy, the chairman of the bank, who was a Russian citizen with some Ukrainian connection, had established another bank in Uzbekistan called Business Bank, which had failed earlier, most probably due to fraud and mismanagement. He apparently fled to Afghanistan and established another bank in Kabul with help received from some local influential Afghans and relatives of some Afghan parliamentarians…. These individuals turned out to be part of a wider Russian mafia network. To date, the circumstance of how these individuals with such mysterious backgrounds came to Afghanistan has remained very murky.
Not surprisingly, DBA management denied any pending doom, but after an investigation it was clear that “Tsoy had defalcated more than $21 million of people’s deposit funds from the bank.” This sum was small potatoes compared to what was to come. The next domino to fall was predictable: “Hundreds of depositors … were queuing in front of the DBA’s offices and DAB, and soon they were threatening to resort to protests and violence.” Bigger problems / Problem loans were beginning to build at the largest private bank in Afghanistan, Kabul Bank. Fitrat explains, “The Bush Administration was eager to present some success stories in Afghanistan at a time that its intervention in Iraq went badly wrong with growing chaos all around.” An application for an operating license from Kabul Bank in December 2003 was part of the booming banking sector. Fitrat explains that this was at a time when the capacity of personnel at the central bank was “extremely low.” Before long, Kabul Bank was growing rapidly, with branches proliferating across the country, “some without approval of DAB,” and advertisements filled the airwaves to attract depositors. Growth accelerated when Kabul Bank became an agent bank for the government, a designation that Fitrat says may have been driven by graft. New shareholders joined the bank,
including Mahmood Karzai, the brother of the president. Fitrat explains that funds were loaned by Kabul Bank for these investments. After the collapse of DBA in 2008, a number of troubling items came to light involving Kabul Bank. Perhaps the most troubling was that the bank’s management “got very close to President Karzai through massive election campaign donations and other kickbacks” during his 2009 reelection. By February 2010, a Washington Post article exposed many of the details of corruption at Kabul Bank, including investments by bank insiders close to Karzai in
in the United States” began on September 1, 2010 when a run on Kabul Bank started and DAB took control of the bank. Stories were published on August 31st in the New York Times, Washington Post, and London’s The Telegraph setting out the details of the closed shareholders meeting, and Fitrat summarized, “Tens of thousands of Kabul Bank depositors queued in front of its branches all over the country, demanding nothing less than all their deposits.”
Lying for Karzai / A press conference to reassure the Afghani public was convened on September 1st. President Karzai instructed Fitrat to lie about the forced resignations and Karzai told Fitrat to lie about the forced the condition of Kabul resignations and the condition of Kabul Bank. Fitrat describes Bank, but the effort failed because, this as “a CommunistFitrat writes, “nobody believed us.” style cover-up to simply calm down the wary customers.” The press conference had the oppoluxury villas in the building real estate bub- site effect because, Fitrat admits, “nobody ble of Dubai. Fitrat quotes the Post article believed us.” Karzai, in discussions with Fitrat, extensively: “The close ties between Kabul Bank and Karzai’s circle reflect a defining blamed the American Embassy for leakfeature of the shaky post-Taliban order in ing the information to reporters that trigwhich Washington has invested more than gered the run: “Kabul Bank was another $40 billion and the lives of more than 900 conspiracy created by the West against him U.S. service members: a crony capitalism to destabilize his grip on power.” Meanthat enriches politically connected insiders while, according to Fitrat, “the president’s brother added to the panic by asking the and dismays the Afghan populace.” The obvious next step for DAB was to U.S. Treasury to intervene and provide [an] get a handle on the extent of the problems immediate bailout to Kabul Bank.” Deputy uncovered by the Post. There followed a treasury secretary Neal Wolin immediately direct plea from Fitrat to U.S. treasury rejected this request, vowing, “No Amerisecretary Timothy Geithner asking for can taxpayer funds will be used to support help in investigating both Kabul Bank Kabul Bank.” The Afghan government and another smaller bank: “I am writing would later bail out depositors. Subsequent reviews revealed that the to seek technical assistance for a forensic audit and a comprehensive on-site exami- resulting losses were enormous. Writes nation.” The topic of the audit was placed Fitrat: on the agenda for a meeting between KarTeams unearthed massive fraud that zai and Geithner in May 2010, and Fitrat shocked the national and the internaconvened a meeting of shareholders to tional community alike: they found remove the bank’s chairman and chief that $912 million in loans had been executive officer. extended…. Most of this amount was Those efforts were far too late, though. fraudulently issued to owners and Fitrat explains that a crisis “similar in shareholders of the bank and their impact to the Lehman Brothers collapse
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close associates and relatives [between] 2004 and 2010.
Meanwhile, Fitrat struggled to punish the insiders who were responsible: “Most of [the] Kabul Bank suspects were the president’s closest friends from whom he received significant kickbacks before, during, and after the rigged 2009 elections.” His relationship with Karzai deteriorated after the run on Kabul Bank: “I was in a dilemma regarding how to reconcile those experts’ findings and recommendations with those irrational and sometimes stupid views of my president.”
Fleeing Afghanistan / After Fitrat delivered
a very sobering public speech on Kabul Bank, his relationship with Karzai deteriorated so badly that Fitrat feared for his life. Following a business trip to Dubai, he flew to Virginia instead of returning to Afghanistan. He was treated as an outcast by many of his former colleagues in the U.S. government and at the International Monetary Fund, and has had severe financial difficulties, coming close to bankruptcy at times. The Tragedy of Kabul Bank is an easy and interesting read, given the twists and turns in Fitrat’s life and in particular the
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Kabul Bank episode. Disappointingly, there are many grammatical and spelling errors throughout the book. English is not Fitrat’s native language, so this is understandable, but the American publisher should have done a more thorough job of editing the book. It is difficult to say how accurate Fitrat’s account is, but at least one author (Washington Post’s Joshua Partlow) comes to many of the same conclusions regarding the deepseated corruption within the Karzai family. What is clear is the enormous challenge of supervising banks in deeply corrupt emerging markets.
Working Papers ✒ BY PETER VAN DOREN AND IKE BRANNON A SUMMARY OF RECENT PAPERS THAT MAY BE OF INTEREST TO REGULATION’S READERS.
Expensing “Information Sets and Dynamic Scoring,” by Aaron Betz. SSRN, forthcoming.
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or most people, the debate over depreciation schedules for investment is soporific. But for tax policy cognoscenti, the topic is incredibly contentious. There are two broad approaches for the tax treatment of investment. One way would be to require companies to incrementally deduct an investment over the life of the asset. For instance, if a company buys a $100,000 truck that it expects to be in service for 10 years, then it would deduct $10,000 of expenses from its income each year for a decade. We call this “straight-line” depreciation. The other approach would be to allow the company to fully deduct (or expense) the investment the year the company purchases the truck. We refer to this as “full expensing.” For C corporations, the U.S. government has typically done something between these two extremes. Since 2001, the United States has had some version of “bonus depreciation,” whereby companies can immediately deduct some proportion (typically 50%) of new investment. Between 2008 and 2017, Congress extended or altered bonus depreciation eight times. The 2017 tax reform implemented full expensing through 2025, although the authors of reform hope that a future Congress makes that permanent. Full expensing effectively reduces the cost of capital investment because firms receive the tax break sooner. For the $100,000 truck and a company paying an effective tax rate of 25%, full expensing provides $25,000 tax savings at once,
PETER VA N DOR EN is editor of Regulation and a senior fellow at the Cato Institute. IKE BR A NNON , a contributing editor to Regulation, is a senior fellow at the Jack Kemp
Foundation and president of Capital Policy Analytics.
rather than the $2,500 a year for the next decade. Companies would rather have their tax savings up front and put that money to work right away. However, we do not know how much depreciation schedules matter. If we believe firms are fully rational, then the fact that expensing makes investment less expensive should mean that we would see more investment when bonus depreciation effectively reduces its cost, and even more if we allow full expensing. After all, that is the rationale for full expensing. However, Betz argues that the data suggest bonus depreciation does not have much of an effect. If he and others who have made similar observations are correct, then we should focus our efforts on reducing the tax burden on business activity via lower corporate rates rather than maintaining and expanding bonus depreciation. Betz gives two broad explanations for why we may not see the results we would expect from a move to bonus depreciation. The first is that the investment multiplier—that is, the effect on economic activity from any investment—varies across the business cycle. Alan Auerbach and Yuri Gorodnichenko have found that that the effect of bonus depreciation is countercyclical, so that we get a bigger bang for the buck when the economy is going poorly than when it is growing. If companies perceive this to be true, then we should see more investment when economic growth slows, which is generally when the government tends to implement bonus depreciation schemes, at least until the 2017 tax act. That implies that companies see a higher payoff for capital investment, ceteris paribus, when the economy is going poorly, so they are more inclined to invest already when the tax incentives for investing go up. That makes it difficult to discern precisely how much bonus depreciation matters to investment.
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But a larger problem—one articulated by University of California, San Diego economist Valerie Ramey—in discerning how investment incentive schemes matter is that firms’ expectations of future tax policy matter. If companies know that bonus depreciation will definitely last only a couple of years, then they will make a concerted effort to push new investment—or accelerate already-planned investment—into the bonus depreciation window. However, if companies know there is a chance that a bonus depreciation scheme will be extended into the future, the urgency of increasing investment today disappears. That perception would be regrettable because bonus depreciation has historically been the wrench in Congress’s toolbox in combating a recession. To look more closely at this issue, Betz constructs a model with “monopolistically competitive” (some market power, but not much) firms, a central government levying taxes, and an economy in which 18% of firms can take advantage of bonus depreciation when offered—the low fraction being another reason why bonus depreciation may not be terribly effective. He finds that expectations of bonus depreciation have a huge effect on its effectiveness at stimulating investment. His findings do not necessarily negate the importance of more generous depreciation schedules, but they do suggest that, for the policy to work as an effective stimulus, it is necessary for Congress to credibly commit to keeping it a temporary change, which is easier said than done. Failing that, it may make more sense to simply leave depreciation alone and settle on the optimal long-run strategy for the tax treatment of capital. Betz’s paper suggests that it’s not entirely certain what that would be these days; if we assume that a more generous bonus depreciation necessitates a higher corporate income tax rate, it may be the case that we’d rather give up the former for a lower rate. Robert Lucas famously told an interviewer that eliminating the tax on capital income is the closest thing to a free lunch that there is in the economy. Given the collective preoccupation with income inequality, it is hard to see us ever eliminating capital taxes. But it may be worth reminding Congress that using capital taxation to achieve social goals comes at a high cost. —I.B.
Consumer Inattention and Tax Incidence “Hidden Baggage: Behavioral Responses to Changes in Airline Ticket Tax Disclosure,” by Sebastien Bradley and Naomi E. Feldman. August 2018. SSRN #3234195.
I
n previous columns, I described regulations intended to improve outcomes for consumers or job applicants that had unintended perverse results. Payday lending restrictions prevented soldiers from smoothing their consumption with no measurable reduction in excessive debt (Spring 2017). “Ban the box” laws prohibiting employers from asking about criminal history on initial job applications reduced black male employment
(Fall 2016). And bans on the use of credit checks by employers in hiring decisions reduced job creation relative to trend by 12% (Summer 2018). But sometimes regulations enacted to assist consumers can have unexpected benefits. This paper describes one such case. A 2012 U.S. Department of Transportation rule required quoted airline ticket prices to be tax inclusive in an effort to make pricing more transparent. Under conventional economic analysis, the degree to which the taxes were “hidden” would not affect the ultimate incidence of the tax, e.g., how much of the tax is passed on to consumers and how much is “swallowed” by the airlines. The paper demonstrates that prior to the rule, when advertised fares did not have to include taxes, airline ticket taxes were almost entirely passed onto consumers. After the rule, only 25% of the ticket tax was paid by consumers. The regulation resulted in “substantial transfer of surplus from airlines to consumers.” —P.V.D.
Fiscal Rules “Can Fiscal Rules Constrain the Size of Government? An Analysis of the ‘Crown Jewel’ of Tax and Expenditure Limitations,” by Paul Eliason and Byron Lutz. April 2015. Journal of Public Economics 166: 115–144 (October 2018).
T
o the extent that state and local governments impose taxes that have diffuse costs and enact programs that have concentrated benefits, standard economic analysis would predict excessive taxing and spending. A standard political remedy to this tendency has been statutory or constitutional limits on taxation and expenditure. The “gold standard” of such limitations is the constitutional amendment approved by 54% of Colorado voters in 1992. The Taxpayer Bill of Rights (TABOR) requires voter approval for all state and local tax-rate increases and limits real per-capita revenue growth to either 0% or the increase from construction in local taxable property. Did TABOR constrain public tax and expenditure behavior in Colorado? This paper compares the state’s expenditures and revenues with those in other states using the synthetic control method, a recent development in econometrics. The idea is that a linear combination of states that minimizes differences on expenditures and taxes between Colorado and the synthetic “states” prior to the implementation of TABOR is a superior control than the actual states themselves. Prior to the invention of synthetic controls, the change in Colorado outcomes would have been compared to the change in other states, allowing for unobserved differences across states that are constant and do not vary with time (difference-in-differences with fixed-effects research design). The synthetic control method allows for unobserved differences across states to vary over time. Relative to the synthetic control, TABOR appears not to have
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reduced taxes or spending in Colorado. The main reason for this, according to the authors, is that after the passage of TABOR, voters approved overrides of its restrictions. Amendment 23 (passed in 2000) mandates that expenditures for K–12 public education increase by 1% above inflation annually. At the local level, overrides of the expenditure limits have been common. Through 2011, 523 overrides on expenditure limits have appeared on local ballots and 87% passed. Some 699 votes were held to increase local tax rates, and 55% of them passed. The TABOR process insures that voters consent to increases in taxes and expenditures. The sponsors of TABOR assumed that voters would not consent, but they have done so much of the time. Thus, outcomes in Colorado are not dramatically different from other states. —P.V.D.
Mortgage Lending and the Housing Crisis “Villains or Scapegoats? The Role of Subprime Borrowers in Driving the U.S. Housing Boom,” by James Conklin, W. Scott Frame, Kristopher Gerardi, and Haoyang Liu. August 2018. SSRN #3240413.
A
standard explanation of last decade’s financial crisis blames “loose” lending standards by mortgage originators, particularly for lower-income borrowers, combined with the repackaging of mortgages into securities sold to investors falsely informed by misguided AAA ratings. In previous columns (Spring 2011, Fall 2012) I discussed papers presenting evidence inconsistent with this argument. Those papers compared default rates in census tracts that barely qualified for low-income housing goals with default rates in those tracts that didn’t qualify. The papers found no differences or worse outcomes among the tracts whose incomes were too high and did not qualify. In the Fall 2018 issue, I discussed a paper that found that the cumulative losses (through 2013) on all subprime residential mortgage-backed securities (MBS) issued between 1987 and 2008 were dramatically lower for subprime AAA-rated MBS (0.42%) than all AAA-rated MBS (2.3%). This paper examines whether credit expansion to marginal borrowers was associated with housing price appreciation. The authors examine subprime mortgages (defined as mortgages to borrowers with FICO credit scores below 660) issued between 2002 and 2006. The annual share of purchase mortgages originated to high-quality borrowers (scores above 720), mediumquality (between 680 and 720), and low-quality (below 660) are remarkably constant over the boom period. Write the authors, “Counties in the top two house-price-appreciation categories actually experienced slight declines in the share of purchase mortgages to subprime borrowers, while modest increases in the subprime share of purchases occurred in counties with slower house price appreciation.” The narrative that a reallocation of credit to subprime bor-
/ Regulation / 63
rowers was responsible for the boom in house prices requires a positive correlation between house price growth and the share of purchase mortgages to subprime borrowers. The analysis in this paper uncovers a robust negative correlation. —P.V.D.
Renewable Electricity “Setting with the Sun: The Impacts of Renewable Energy on Wholesale Power Markets,” by James Bushnell and Kevin Novan. August 2018. University of California, Berkeley Energy Institute Working Paper #292.
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ecent trends in electricity production have altered prices in wholesale markets and thus the economics of traditional generation. Historically, coal and nuclear plants had high capital costs and low marginal costs. They operated continuously and their output could not vary easily to match the daily demand cycle. Smaller plants fueled by natural gas or oil had lower capital costs and higher marginal costs, and their output could vary to follow demand during the day. The smaller plants’ higher operating costs were reimbursed by higher wholesale prices during the daytime and those higher prices also contributed revenue for the higher capital costs of nuclear and coal plants. The addition of subsidized and mandated solar to this generation picture has altered the economics of electricity production. Prices in the California market are now lower during the daytime than they were several years ago. University of California, Berkeley energy economist Catherine Wolfram noted last year that prices in the Southern California market were negative during the midday for 19 days during March and April 2017. As energy economist Jonathan Lesser argued in these pages (“The High Cost of LowValue Wind Power,” Spring 2013), those lower prices reduce the returns to traditional baseload coal and nuclear generation. Wolfram has expanded this idea to natural-gas combined-cycle plants. She reports that, in 2017, revenues were insufficient to cover their average costs in 17 of 20 locations in PJM, the regional transmission organization that covers much of the central Atlantic and some Midwest states. The result of these lower revenues is either retirement of such plants or subsidies for them as enacted by New York and Illinois. This paper documents an ironic twist to the returns to traditional electricity producers in California. The increased role of solar in California has increased the demand for and thus profits of natural gas turbines. Those plants are less efficient and more polluting than natural-gas combined-cycle plants, which use waste heat to produce steam and more electricity but whose output cannot be altered quickly. The demand for turbines has increased because their production can be increased and decreased quickly at sunset and sunrise. Write the authors, “Nimble generation with low capital, but high marginal, cost is complimentary to renewable energy, while high capital cost baseload plants are not.” —P.V.D.
64 / Regulation / WINTER 2018–2019
Guidance on Guidance MEMO To: All Americans From: Federal Regulators RE: Guidance We thought it was time we provided some guidance on guidance. As you know, we have thousands of guidances, although some of them supersede other guidances and it’s really up to you to know which ones represent our current guidance. Let us be absolutely clear about one thing: draft guidance is not current guidance. Draft guidance only represents our current thinking about what our guidance might be. Now, many of you have been wondering how our current thinking could represent what all of us are thinking. Let us clear up that confusion right now. Our current thinking is actually done by one person—not the same person each time, of course—but it represents “our” current thinking in the sense that we, or at least some of us, believe at that particular moment that the person appointed to think for us is the best choice to do our current thinking for us. Get it? You might wonder what are you supposed to do with guidance? Good question. Let’s clear that up. The short answer: do absolutely nothing. You are not required to do anything with guidance. It’s not a regulation; it’s just guidance. However, if you don’t follow the guidance, you will get a warning letter for not following our guidance, and boy you sure don’t want to receive one of those. Your boss will ask you why you didn’t follow the guidance and you will reply, to his disgust, that you didn’t have to follow the guidance because R ICH AR D A. W ILLI A MS was formerly director for social sciences at the Center for Food Safety and Applied Nutrition at the U.S. Food and Drug Administration and vice president for policy at the Mercatus Center at George Mason University.
it says so right in the top paragraph of the guidance. In fact, we don’t have to follow our own guidance, as we make perfectly clear in every guidance that we put out. And it’s true, we don’t follow our guidance. In fact, we resent anyone telling us what to do, particularly us. Well, not us exactly, but the person who wrote our guidance. Just who does he think he is? Telling us what we can and cannot do and then immediately following that up with saying we will not be bound by this guidance. The nerve. That covers guidance pretty well. Now how about that draft guidance? If you are not required to follow guidance, then for God’s sake please never, ever, ever follow draft guidance, as that is only our current thinking. In fact, it expires the very second we write it because we are constantly in a regulatory fever and we have already thought of making you do something else. In fact, what kind of an idiot would act on draft guidance when it is perfectly obvious that we are (or rather the appointed person to think for us is)
already thinking something different? In fact, we have already appointed someone else to do our current thinking for us. What’s wrong with you? You may think that acting on guidance gives you a “safe harbor” from regulations. Nope, it doesn’t because we are not bound by guidance, by draft guidance, by Congress, or by any deity that we don’t recognize. In fact, the Supreme Court has ruled, in godlike fashion, that we deserve deference. Of course, we deserve deference—we are “We.” Whether you call us an agency, a bureau, or whatever, we are the Alpha and Omega of government. One kind of safe harbor that we absolutely love (laughing about) is “enforcement discretion.” We often write about it in guidance or, better yet, draft guidance. You are bound by force of law to comply with our regulations unless we exercise enforcement discretion. And we love enforcement discretion meetings. We do want to be clear that this memo is what we are thinking about guidance today, but it is only a draft. It is our current thinking and we would like comments on it, as we do on all draft guidance. But please don’t bother commenting on it because we are already drafting a new draft guidance. If you do comment on it, know that you are only bothering us, you idiot, and you will pay dearly for it.
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