It’s obvious: “Government should be run like a business.”

It’s obvious:  “Government should be run like a business.”

This assertion has a corollary, which has a strong form and a weak form:

• Strong form:  “Business leaders should govern.”
• Weak form:  “Government officials, elected or otherwise, should have at least some business experience.”

It also has an analogous assertion:  “Government finances should be managed like family finances.”

First, we should try to understand the phrase, “like a business”.  How is a business “run”, and, to achieve its goals, how is a business structured?  Economists, sociologists and business people propound more than one “Theory of the Firm”, but, this article is a blog post, and I see no need and insufficient space to discuss this entire topic here.

We can, however, point out some salient characteristics of management structures that are found in almost all companies and non-profit organizations.  I don’t claim that these characteristics are essential for effective management, only that they are endemic to it.  I also claim that these characteristics are a product of design, evolution.  They are:

1. Command and Control management structure:  The CEO, with the assistance of his or her small circle of senior lieutenants, determines policy unitarily; members of the organization implement it uniformly throughout the organization.
2. Tightly Restricted speech:  Organization policy determines message content to other organizations (public relations, transaction content, professional and commercial communication) and among the members of the organization (informal and formal speech and writing norms).
3. Non-representative governance:  Leaders at every level are chosen to lead by their superiors or peers within the organization (or its governing Board, a very small circle of “friends”).  Individual producers have no direct influence on the appointments of leaders, nor do policy makers consider their personal life interests or requirements when forming policy (except as an afterthought).
4. Opaque operations, structure and decision processes:  The company attempts to hide its operations and specific intentions about many aspects of operations from competitors, observers (the press, the government, the tax authorities, for example) and employees to gain competitive advantage.
5. The stated goal of for-profit corporations:  to maximize the financial wealth of company owners (shareholders, members, as in LLCs, partners).
6. Singular focus on achieving this goal, i. e., “winning the game by any means ”.

Promised outcomes, accordance to economic theory of the firm, of this structure include:

1. Superior (“economic”) returns to shareholders;
2. Nothing else.

A representative governance structure and management has at least the following salient characteristics:

1. Distributed Power:  Decisions are taken as a result of collective action; the most frequent form of collective action in governments is voting under the principles, one person, one vote and a majority decides the issue in its favor.
2. Loosely restricted speech:  Members of the governing body are permitted to participate in framing, arguing and voting issues equally; they make speak to non-members as they wish about any subject they want to discuss.
3. Constituent representation:  Presumably, representatives express the preferences of their constituents and act on them by voting consistently with them.
4. The stated goals of the government are several and the representatives and their constituents dispute their composition continuously.
5. Transparent operations, structure and decision processes.  Admittedly, no government is completely transparent, but citizens require a significant minimum transparency of their governments.
6. Foci on various means and limitations on means to achieving such goals.

By comparing these lists, item-by-item, it should be obvious that economic entities and political entities differ materially along at least these five dimensions.  Indeed, almost no citizen of any Western democracy would want government according to business principles.  It would be tantamount to wanting governance in the style of Somalia, Syria, Egypt, Saudi Arabia, Senegal, Burma, or any other totalitarian dictatorship that you want to name.  What, then, can one mean by asserting, “Government should be run like a business?”

To run a government like a business means, apparently, that its managers should devise a budget that represents the planned implementation of strategic policy, they should be allowed to deviate from it only by special approval of strategic-level management, and total expenditures should not exceed total operating cash inflow in any single year.  This position is naïve.  The federal and state government have budgets, and expenditures that would exceed budgeted amounts require approval of their legislative bodies.  Private companies do require budgets, and upside deviations from budget do require approval by more senior managers.  But, total expenditures frequently exceed total cash operating cash inflow for companies in a given period and they may do so for several periods (years) without damage to the future viability of the company.  To the argument that this operating cash outflow must turn positive at some time (but no particular time) and over the life of the firm cash inflows must exceed cash outflows, I note that so long as lenders are willing to lend and investors are willing to invest in it, a given company may never achieve positive net operating cash flows during their lifetimes.  Many companies never do achieve positive cash flow.

So, the proposition, “Government should be run like a business,” seems quite dubious to me, at least from the perspective of a citizen of a country with a representative form of government.  No two organizations are structured or operate less dissimilarly than a private-sector company and a representative body.  Representative government is a recent development in the history of civilization; private enterprise is ancient.

Having pointed out some considerable de facto differences between representative governments and private-sector companies, I haven’t addressed the question as to whether governments should be run like businesses or vice versa, i. e., whether businesses should be run like representative governments.  There are successful cooperative private companies that are run and/or owned by their employees in the United States and in Europe.  There was, at least, one in Brazil, documented in two articles in The Harvard Business Review in 1983 and 1985.  The degree of employee (vs. owner) participation in management processes varies among companies and the incidence of companies that include such participation varies from country to country.

One could draw an analogy between the primacy of corporate stockholders and the primacy of the citizenry and claim that as corporations seek to maximize the wealth of their shareholders so should governments seek optimize the well-being of their citizenry.  This analogy only shifts the comparison from goals to methods.  Businesses are managed from the top down with great flexibility and little accountability for any particular actions; governments are managed from the top down according to strict rules developed within the framework of laws passed by their legislative bodies.  The managers of government agencies are accountable to their managers, their legislators and, ultimately, their constituents.

I just don’t see the advantage of business experience versus experience as a professional, non-profit manager or other non-government employee.  I do believe that a political career should be a second career.

It’s obvious: “Guns don’t kill people; people kill people”

It’s obvious:

1. “Guns don’t kill people; people kill people.”  And
2. “If guns are outlawed, only outlaws will have guns.”

Let me say, first, that both of these claims are slogans.  They are simplistic, conceal assumptions critical to understanding them and are intended to appeal to our emotions, in part by concealing such assumptions.  This much is obvious.  But, although they are simplistic, I’ve seen a lot of car bumpers and windows carrying them around for everyone’s reading pleasure.  To many people, they must be meaningful and important and must express some core belief succinctly.  Our first task, then, is to discover this meaning. Statement A points out that guns, being material objects, don’t “intend” anything; people, being conscious and purposeful by nature (a discussion for another context), do “intend” specific outcomes.  Statement A would be clearer, if written, “Guns don’t intend to kill people; people intend to kill people.”  Still, this says nothing about accidental (unintentional) deaths due to gunfire or about gunfire wounds that aren’t fatal. Statement B, as written, is meaningless and owes its impact to the ambiguity and connotation of the term, “outlaws.”  Prescription drugs are “outlawed”, yet, if I take a Percocet for pain after surgery, I am not an outlaw (I have permission from a registered, licensed physician).  Am I an “outlaw” when I exceed the speed limit or “roll through” a “stop” sign?  Are your sixteen-year-old children outlaws, if they see an R-rated film in the theater (or in your house, for that matter)?  Would law enforcement, the military, the National Guard, the Coast Guard or your bodyguard (including the not-so-Secret Service) be outlaws if they owned or carried guns?  When an American gives his 18-year-old son a glass of wine in a restaurant, are he and the son outlaws?  When a Frenchman gives his 18-year-old son a glass of wine in a restaurant, they are not outlaws.  In France, there is no age requirement to drink wine—outlaw in the U.S., law-abiding citizen in France.  Obviously, Statement B uses “outlaw” in two ways.  This use is intentional and is to good effect on those who are disposed to agree with it.  Let’s scrutinize these claims further. Statement A, while true, is silly.  It builds and knocks down the straw man argument that guns are evil because they can kill people.  Nobody believes that argument.  Substitute “strawberries” for “guns” in it.  The result, “Strawberries don’t kill people; people kill people” is comical (to me, anyway).  Or, use “poisons” or “cars” or try “Yorkshire Terriers” or “Bad breath and acne” or, well, anything in that sentence.  The best reply to Statement A is, “So what?”  It can be read as supporting gun control as easily as protesting it.  Should we monitor and proscribe the usage of guns by people, then, instead of guns?  After all, monitoring and proscribing behavior or the use of objects by people is not new.  We have traffic laws and manufacturing standards for cars.  We have building codes.  Even law enforcement behavior is monitored and proscribed.  In fact, virtually every other aspect of human behavior is monitored and proscribed by the societies in which we live.  In some societies, raping, killing or beating disobedient wives are accepted; yet, oral or written expressions of discontent with authorities or institutions are not. Statement B was constructed to exploit the connotation of “outlaws” as “evil people” in the service of resisting firearms regulation.  It’s meaningless because the middle term is undistributed (by changing its meaning, you change the term).  For example,

All trees have leaves.  This plant has leaves.  Therefore, this plant is a tree.

All criminals have guns.  I have a gun.  Therefore, I am a criminal.

Or, Statement B is a tautology.

If owning guns violates the law and all violators of the law are outlaws, then all gun owners are outlaws (i. e., violators of the law).

To get an idea where you stand on gun control, try this short quiz: Why is gun regulation bad?  (Choose all that apply) a)    It violates the second amendment to the Constitution of the United States. b)    Being shot is so unlikely that I don’t need to know who probably didn’t shoot me.  Neither do the cops.  32,000 deaths is only 0.01% of the U. S. population.  That one of them is mine is too improbable to care about.  I wouldn’t care about anyone else’s even if the probability were 0.1%–maybe at 1%.  Now, if I lived in El Salvador, I might feel differently about this issue and get myself a gun, even if I had to register it. c)     I want to be able to defend myself against attack, but I don’t want the gun I used traced back to me. d)    I want to be able to shoot someone who looks like he’s going to rob or hurt me, and I don’t want the gun I used traced back to me. e)    It makes it too easy for law enforcement to arrest and convict me for a crime I committed while using a gun.  It’s like hide-and-seek with breadcrumbs for the seeker, which is unfair to the hider. f)     It would make it too easy for law enforcement to find out that I bought a gun for my cousin, who can’t buy his own gun because he’s a convicted felon, so he could defend himself from his competitors, witnesses of his crimes, or other enemies.  If they catch him and he keeps his mouth shut, they may not catch me. g)    The (federal, state, local, circle all that apply) government would know exactly how much and what kinds of firepower I’ve accumulated in the event that I need to participate in or lead an armed insurrection against it.  They could use this knowledge to make their overthrow more challenging (and cost more lives) by reducing my advantage from the element of surprise. h)    The cops could be prepared to defend themselves against or anticipate my possession of firearms when they come to my house.  I would have no advantage in case I wanted to resist whatever purpose I thought they might be there to achieve or in case I want to scare the hell out them so they’ll shoot me and I can sue the department. i)     I don’t want the cops to know and find the guy who murdered my daughter while attempting to shoot someone else.  Why punish incompetence?  It was just an accident. j)      Just in case I’m able to shoot 26 other students at my school without being identified by -witnesses (eye-, ear-, tongue- or finger-, your choice), I can leave my gun behind and go about my business as usual without fear of arrest or reprisal. k)    All of the above. l)     None of the above. m)  Some reason not listed above.  Please provide it here:_____________________________________________________________ __________________________________________________________________.

The Four E’s of Taxation

It’s obvious:  “Federal, State and Local tax law must be reformed.”[1]

If, by “reformed” we mean, “improved”, then I agree with this statement.  As it’s a command, it’s not literally true or false, so, we should consider it’s efficacy rather than it’s veracity.  In my previous posts to this blog, I’ve made the case for tax reforms.  To recap, the federal, state and local tax laws are too complex, insufficiently progressive where they are progressive, regressive in other areas, challenging and expensive to maintain and enforce, and generally ineffective at fulfilling their role in governing.

In general, a tax code must satisfy four properties (the “four E’s”), it must be:

1. Equitable,
2. Effective,
3. Efficient, and
4. Enforceable.

By “Equitable”, I mean, “must affect each taxpayer equally”, to the extent possible.  This notion is the most difficult of the “four E’s” to define or even characterize.  To many, it simply means, “fair”, viz., applies equally to everyone in a single way.  A single tax rate for all is the usual example of this type of fairness.  I’ve argued, I believe persuasively, that the nature of economic needs and wants renders a single tax rate regressive, therefore, inequitable.  In addition, no matter what tax code we adopt, if we apply it to everyone, it meets this standard.  I’ve argued that some income is more valuable than other income and that as annual income, say, increases, it’s marginal value to the earner decreases.  An Equitable tax rate schedule would tax higher marginal income at a greater rate than lower marginal income; the first dollar you earn is more valuable than the millionth dollar you earn.  The current federal tax code satisfies this principle.

By “Effective,” I mean, “results in enough money to fund the associated government”.  Of course this notion depends on prior notions we hold about the functions of government, viz., their nature, their quality and their cost.  Governance in a republic includes an iterative process of clarifying and changing these prior notions and designing tax structures that reflect these notions.

By “Efficient”, I mean, “optimizes the ratio of benefits to costs”.  In the area of tax codes, this means, to me, the ratio of the total cost to determine and collect taxes to the total amount collected in any given year.

By “Enforceable,” I mean, “taxes due from any taxable entity can be determined with precision and collected without use of force or litigation”.  This standard is quite strict (perhaps, a pipedream); it requires the elimination of estimates.  Such estimates as “economic life” of an asset, “depletion basis” of a natural resource (oil field, landfill, mineral deposits), “full cost” of production, “reasonable economic transfer price” and “goodwill” are estimates, the outcomes of which impact the amount of taxes due and when they must be paid.

Only the federal income tax and some state income taxes address any of the four E’s; none of the current tax regimes satisfies any of them.  This criterion is Equity, which they address inadequately.  When Warren Buffet pays taxes that represent 17% of his income and Mitt Romney pays taxes that represent 13% of his income, yet, most taxpayers pay taxes that represent at least 25% of their incomes, it’s clear that higher marginal income is not taxed at higher rates.

In my next post, I’ll outline a tax code that is Equitable, Effective, Efficient and Enforceable.  I will argue that it improves the international competitive position of US companies, reduces the size of the IRS, minimizes tax management, funds all governments, releases resources for more productive deployment elsewhere, offers one mechanism for minimizing “the tragedy of the common” use of shared resources, and never needs to be changed.

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[1] I don’t use “reform” because reform is ambiguous; “reform” means, “change” and doesn’t imply “improve.”  Unfortunately, when we call for “tax reform” or “gun law reform” or any other “reform”, this term connotes improvement

“Federal state and tax law must be reformed.”

It’s obvious:  “Federal, State and Local tax law must be reformed.”[1]

If, by “reformed” we mean, “improved”, then I agree with this statement.  As it’s a command, it’s not literally true or false, so, we should consider it’s efficacy rather than it’s veracity.  In my previous posts to this blog, I’ve made the case for tax reforms.  To recap, the federal, state and local tax laws are too complex, insufficiently progressive where they are progressive, regressive in other areas, challenging and expensive to maintain and enforce, and generally ineffective at fulfilling their role in governing.

In general, a tax code must satisfy four properties (the “four E’s”), it must be:

1. Equitable,
2. Effective,
3. Efficient, and
4. Enforceable.

By “Equitable”, I mean, “must affect each taxpayer equally”, to the extent possible.  This notion is the most difficult of the “four E’s” to define or even characterize.  To many, it simply means, “fair”, viz., applies equally to everyone in a single way.  A single tax rate for all is the usual example of this type of fairness.  I’ve argued, I believe persuasively, that the nature of economic needs and wants renders a single tax rate regressive, therefore, inequitable.  In addition, no matter what tax code we adopt, if we apply it to everyone, it meets this standard.  I’ve argued that some income is more valuable than other income and that as annual income, say, increases, it’s marginal value to the earner decreases.  An Equitable tax rate schedule would tax higher marginal income at a greater rate than lower marginal income; the first dollar you earn is more valuable than the millionth dollar you earn.  The current federal tax code satisfies this principle.

By “Effective,” I mean, “results in enough money to fund the associated government”.  Of course this notion depends on prior notions we hold about the functions of government, viz., their nature, their quality and their cost.  Governance in a republic includes an iterative process of clarifying and changing these prior notions and designing tax structures that reflect these notions.

By “Efficient”, I mean, “optimizes the ratio of benefits to costs”.  In the area of tax codes, this means, to me, the ratio of the total cost to determine and collect taxes to the total amount collected in any given year.

By “Enforceable,” I mean, “taxes due from any taxable entity can be determined with precision and collected without use of force or litigation”.  This standard is quite strict (perhaps, a pipedream); it requires the elimination of estimates.  Such estimates as “economic life” of an asset, “depletion basis” of a natural resource (oil field, landfill, mineral deposits), “full cost” of production, “reasonable economic transfer price” and “goodwill” are estimates, the outcomes of which impact the amount of taxes due and when they must be paid.

Only the federal income tax and some state income taxes address any of the four E’s.  This criterion is Equity, which they address inadequately.  When Warren Buffet pays taxes that represent 17% of his income and Mitt Romney pays taxes that represent 13% of his income, yet, most taxpayers pay taxes that represent at least 25% of their incomes, it’s clear that higher marginal income is not taxed at higher rates.

In my next post, I’ll outline a tax code that is Equitable, Effective, Efficient and Enforceable.  I will argue that it improves the international competitive position of US companies, reduces the size of the IRS, minimizes tax management, funds all governments, releases resources for more productive deployment elsewhere, offers one mechanism for minimizing “the tragedy of the common” use of shared resources, and never needs to be changed.

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[1] I don’t use “reform” because reform is ambiguous; “reform” means, “change” and doesn’t imply “improve.”  Unfortunately, when we call for “tax reform” or “gun law reform” or any other “reform”, this term connotes improvement.

Tax Policy is an Effective tool for Managing the Economy

It’s obvious:  “Tax incentives are effective tools for managing economic behavior.”

Investing in the creation of tax breaks is just one among many economic investments in political outcomes.  Others include the usual suspects: market protections and indirect or direct subsidies.  Examples of such outcomes are, respectively, favorable treatment of capital gains (protects securities markets and participants), prohibitions against wine, beer and spirits producers selling directly to consumers (protects middlemen), regulation (or lack thereof) of certain types of financial derivatives (protects money management and participants), or awards of service slots to airlines at public airports (protects airlines and airports), and research or professional education programs at public schools, colleges and universities (subsidizing professions and businesses that hire those professionals; indeed, the first federal earmark for a specific program was for a research institute at Tufts University).  Additional subsidies include expressway interchanges, local development rights, water use rights, roads, railroads, airports, road and rail rights-of-way, and zoning law changes.  Individuals and organizations invest large amounts of money in such outcomes because they pay off.  For example, the location of an expressway interchange may affect the value of a tract of land more than its development.  A farmer may earn more money by leaving his land fallow than by planting it (ask lobster fishermen in Maine, this year).  In this post, I look at how federal, state and local taxation drive economic behavior and whether they are effective tools at achieving desired outcomes.

I doubt that there is any question as to whether tax incentives drive economic behavior.  Investments in favorable tax treatment of income from transactions or work appear to be quite profitable.  Corporations and associations invest billions of dollars each year in lobbying programs to achieve such treatment, and, it’s easy to point to examples of classes of businesses and individuals receiving tax breaks.    The difficult question is whether they achieve the outcomes desired.  First, however, to talk intelligibly about desired outcomes, we must ask, “Desired by whom?” and, “Which outcomes?”

Some outcomes are good for me, some are good for you, some are good for extraction companies (oil and gas, coal, copper, other mining companies), software companies, manufacturers, transportation companies, construction companies, etc.; some are good for homeowners, railroad workers, farmers, the chronically ill, parents of minor children, working parents who pay for child care, and many other groups of people.  Sometimes, however, outcomes that are good for one group are bad for another, or, outcomes that are good for particular groups or classes of people are bad for the population as a whole.  In the state of Florida, for example, the state insures properties in flood plains or on ocean front property, properties for which owners can’t get private insurance, at rates competitive with private insurance rates for properties that are not in flood plains or waterfront.  After every major storm, state and local governments pay to clean up the mess, i. e., the other residents of the state pay most of the cleanup costs.  Polluting businesses are a similar case of subsidized activities.  State and local taxes, which in Florida consist entirely of flat and regressive taxes, subsidize ownership of property whose ownership benefits the owners, but is costly to the rest of the population.  By subsidizing the market for oceanfront property, state government drives prices of that land up to levels above unsubsidized price levels by shifting the cost of this risk to everyone else.  This outcome is good for owners, bad for buyers, and worse for everyone not involved in the transaction, except for the state government officials who are elected from oceanfront districts.  The net effect is to transfer wealth from state residents to owners of oceanfront properties whether their owners reside in the state at all.  These officials receive campaign contributions or other non-monetary benefits from those owners who can afford to buy and own these properties after their prices have been inflated artificially by tax subsidies.[1]

This analysis is focused narrowly, I agree.  There’s a lot going on here; no economic behavior is isolated from broad outcomes.  That’s part of my point:  Economic outcomes and other behavior due to tax policy are never influenced by tax policy alone and the outcomes are difficult, in not impossible, to predict.  At a minimum, each rule benefits someone at an economic cost to someone else or to everyone else.  In addition, the nature and extent of outcomes are impossible to foresee well enough to manage them in any robust way.  In our example of Florida’s subsidized insurance company, we don’t know the costs to beachfront environments of oceanfront development, of its effects on wildlife or the cost to the public of restricting access to beaches and estuaries.  We do know that hurricanes destroy buildings or damage them seriously.  We do know that oceanfront development accelerates beach erosion.  We do know that wildlife is affected radically by habitat destruction.  Their costs are hard to assess, especially over long periods.  To assess the net costs of ocean front development, we have to identify and assess the benefits and alternatives to it, too.  These tasks are by no means easy.

Tax policy, as an instrument of behavior and outcome management, looks attractive.  The causal links between policies and outcomes appear direct and obvious.  To stimulate construction of single-family homes and home ownership generally, just exempt interest expense on mortgage loans from taxation.  A greater portion of income is, thereby, available for debt service; so, a prospective borrower can borrow more money with which to buy a home.  Demand for homes rises, land purchases and development and construction rise to meet this new demand.  Former landowners become wealthier and their wealth is more liquid and less expensive to deploy.  This newfound liquidity takes the form of deposits in demand deposit accounts in banks, which then lend it to new borrowers (including homebuyers, car buyers, businesses, etc.).  The money supply increases because banks need to keep only a small percentage of deposit obligations on hand in cash[2].  Voila! A tax exemption for mortgage interest payments stimulates borrowing and demand for construction, which in turn stimulates job growth and the money supply, etc.

However, there is no free lunch…-L.  As people buy houses and move out of rentals, rents decrease and, guess what, home prices increase.  To what price do home prices increase?  They increase to the price at which the monthly cost of home ownership equals the monthly rent you would pay for equivalent space, after tax.  Typically, to determine whether to buy or rent, prospective home buyers estimate their long-term top marginal tax rate and estimate their expected mortgage payments by multiplying their expected monthly loan payment by 1 – marginal tax rate, then compare it with their expected cost to rent an equivalent property.  The effect of this calculation is to increase the purchase price of the home by the present value of the savings due to the mortgage interest deduction.  The net effect of the mortgage interest deduction on the wealth of individuals and on the wealth of the population is zero, except to transfer wealth from buyers to sellers.  Home prices may be higher than they would be without this deduction, but, when the loan principal is deducted from the value, the equity remains unchanged.  The advantage in buying a home is supposed to lie in its long-term price appreciation.  But, real estate prices are cyclical and the long-term rate of appreciation of real property equals the rate of inflation.  So, here we are in 2012, with housing prices that have collapsed after a period of ridiculous optimism and price inflation, some of which is due to the availability of the mortgage interest deduction.

The upshot of this analysis is that tax policy rewards some people some of the time, punishes other people at the same time, benefits society as a whole some of the time, and costs society as a whole some of the time.  Although it appears to be applicable surgically, it cannot.  We just don’t know enough to predict enough of the ramifications to assess the reasonableness or desirability of probable outcomes.  Tax policy is a blunt instrument; when we use it to effect outcomes, we always get run over by a train we never saw coming.  Before I started thinking about this issue, I assumed that homeownership was just another tool of wealth accumulation.  After living through three boom and bust cycles in different geographies around the U. S., I know better from experience and from analysis.

Okay, we shouldn’t use tax policy as a behavior management tool, i. e., as a tool to manage our economy.  How, then, should we raise taxes in an equitable manner that will fund the federal, state and local governments?

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[1] Of course, this subsidy drives such prices up to artificial levels, but some of the benefit of subsidized insurance is captured by elected officials in the form of monetary and non-monetary compensation for their cooperation in creating and sustaining this subsidiary.  There are other benefits to other groups, such as construction and design firms, too.

[2] The money supply increases in a geometric series, , where r < 1, a = original deposit amount and r = the percentage your bank can lend.  For example, if banks can lend 80% of your $100 deposit on hand, then the money supply increases by a multiple of .