Monday, October 26, 2015

Economic Growth

An essay. It's an overview of what a growth-oriented policy program might look like. Regulation, finance, health, energy and environment, taxes, debt social security and medicare, social programs, labor law, immigration, education, and more. There is a more permanent version here and pdf version here. This version shows on blogger, but if your reader mangles it, the version on my blog or one of the above will work better.

I wrote it the Focusing the presidential debates initiative. The freedom of authors in that initiative to disagree is clear.

Economic Growth

Growth is central

Sclerotic growth is the overriding economic issue of our time. From 1950 to 2000 the US economy grew at an average rate of 3.5% per year. Since 2000, it has grown at half that rate, 1.7%. From the bottom of the great recession in 2009, usually a time of super-fast catch-up growth, it has only grown at two percent per year.2 Two percent, or less, is starting to look like the new normal.

Small percentages hide a large reality. The average American is more than three times better off than his or her counterpart in 1950. Real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars. Many pundits seem to remember the 1950s fondly, but $16,000 per person is a lot less than $50,000!

If the US economy had grown at 2% rather than 3.5% since 1950, income per person by 2000 would have been $23,000 not $50,000. That’s a huge difference. Nowhere in economic policy are we even talking about events that will double, or halve, the average American’s living standards in the next generation.

Even these large numbers understate reality.

GDP per capita does not capture the increase in lifespan — nearly 10 years — in health, in environmental quality, security and quality of life that we have experienced. The average American today lives far better than a 1950s American would if he or she had three rather than one 1950s cars, TVs, telephones, encyclopedias (in place of internet), or three annual visits to a 1950s doctor.

But even these less quantified benefits flow from economic growth. Only wealthy countries can afford environmental protection and advanced health care. We can afford to worry about global warming. India worries about 600 people per toilet, emphysema from burning cow patties, and easily treatable parasitic infections. Our ability to defend freedom around the world — even if we are wise enough to do it sensibly — depends on robust economic growth. If GDP had grown at 2%, not 3.5%, we would only be able to afford half the military we have today. The immense improvements in the quality of goods and many services we have today are part of the engine of economic growth.

Looking forward, solving almost all our problems hinges on reestablishing robust economic growth. Tax revenue equals tax rate times income, and growth determines how much income there will be. The amount of tax revenue our government has available to pay off debt and to pay the ballooning social security and health care expenses depends almost entirely on economic growth. Larger tax rates can’t come close to raising that much money.

For example, the Congressional Budget Office, making its regular gloomy analysis of the US long-run budget outlook, assumes 2.2% growth from now until 2040.3 But if GDP grew by 3.5% instead, even with no structural reforms at all, GDP in 2040 would be 38% higher, tax revenues would be 38% higher, and a lot of the problem would go away on its own. A 38% increase in Federal Revenue by higher tax rates or a 38% cut in spending are unlikely. Conversely, if GDP only grows 1%, GDP and tax revenues will be 26% lower than the CBO forecasts, which will force a fiscal crisis.

38% more income — or 26% less income — drives just about any agenda one could wish for, from strong defense, to environmental protection, to the affordability of social programs, to the welfare of any segment of the population, to public investments, health, and fundamental research.

And 3.5% is only a return to the post-WWII norm. Pre-2000 economic policies were not ideal. If we achieve 4% or more growth, even greater benefits occur.

The source of growth

Over long periods of time, economic growth comes from one source: productivity, the value of goods and services each worker can produce in a unit of time.

In turn, productivity comes from new ways of doing things. New ideas, at heart; new inventions, new products, new processes, new technology; new ways of organizing companies; new and better skills among workers. Southwest Airlines figuring out how to turn a plane around in 20 minutes, and Walmart mastering supply logistics, are as much productivity growth as installing scanners or ATMs. Workers who know how to use computers rather than shovels produce a lot more per hour.

Higher productivity typically comes from new companies, which displace old companies — and displace the profits of their owners, and the healthy pay and settled lives of their managers and workers. Southwest enters and either displaces the legacy carriers — Pan Am and TWA — or forces wrenching changes for survivors such as American and United. A&P displaced mom and pop stores. Walmart displaced A&P. Amazon may displace Walmart. Nobody likes the process. Everyone needs the results.

Nothing other than productivity matters in the long run. A factor of three increase in income in 50 years, and the much larger rise in income and health since the dawn of the industrial age, dwarfs what unions bargaining for better wages, progressive taxes or redistribution, monetary, fiscal or other stimulus programs, minimum wage laws or other Federal regulation of labor markets, price caps and supports, subsidies, or much of anything else the government can do.

More people working, and working longer hours, can improve income a bit, but soon runs in to an upper limit. Our grandparents worked long hours, but were much worse off than we are.

Saving, investment and capital formation can improve income a bit, but its benefit is limited as well. A 1950 worker working with twice as many 1950 machines produces much less than a modern worker using current technology. Only new ideas, new products, new technologies, new organizations, and new skills produce such huge increases in prosperity.

In this context, the decline of US GDP growth coincides with more worrying changes. Productivity growth is declining. New business formation is sharply down. Mobility of people from job to job has declined.

Restoring growth: a general strategy

A debate rages among economists why America’s growth has slowed. Most commentators advocate one side of that debate, and advocate strong policies according to their favorite theory. Lots of new ideas and grand policy programs are being dreamed up. Someone putting together a policy program might feel they have to choose a side in that debate, or they might wish to let that debate settle, to identify the most important policies.

Either approach is, I think, a mistake, given the urgency and magnitude of the problem, and given the likelihood that such a highly politicized economic debate will come to useful resolution anytime soon.

Let us instead work on the simple, common-sense things that everyone knows are broken, everyone understands are retarding growth, and that when fixed can increase growth. As opposed to looking for big magic bullets, new and clever theories, and ignoring the simple problems staring us in the face.

Will this approach restore 3.5% growth? Will it bring us to 4% or more growth? Well, really, it doesn't matter. When we have a big problem, and we know simple steps will help that problem, we should take those steps. We should do so, especially, because most of these simple steps can be taken at no fundamental economic or other cost.

Our economy is like a garden, but the garden is choked with weeds. Rather than look for some great new fertilizer to throw on it, why don’t we get down on our knees and pull up the weeds? At least we know weeding works! For another metaphor, our economy has become like a hoarder’s house. For a while he could get through the passages and keep life going, but now the junk is closing in. Well, rather than read the architectural magazines about just what the perfect house will look like, let’s get to work cleaning up the mess.


Alas, such a common-sense, weed-the-garden program has little attraction to many ambitious politicians. Many politicians want a big new program, big new laws and initiatives — a New Deal, a Fair Deal, a Great Society. They don’t see cleaning up the mess left behind by their predecessors as the way to getting one’s face carved on Mt. Rushmore, let alone to win an election. Economists like big new ideas and programs too. Nobody got a Nobel prize for saying, let’s take Adam Smith’s 250 year old classics to heart.

But it is a big idea, a big program, and one that needs and will reward the courageous leadership of great politicians. Everybody has to give up their little deal, protection, tax break and subsidy; everyone has to allow their businesses or profession to be open to competition. Each person must understand that the small loss that he or she will experience directly will be more than made up by everyone else giving up theirs. Politically, rather than fall back on “I’ll support your little deal, you support mine,” everyone has to become part of the coalition that supports reform — “no, I’m not getting mine, so I’m not going to support you getting yours.”

Forming such a coalition and keeping it together is hard. It is the essence of what great politicians can achieve.

Cleaning out the weeds also needs a large effort of simple governance. The President has to revisit and rewrite the mass of executive orders and memos. The Congress has to get serious and pass laws that are actually laws, not thousand page instructions for agencies to figure things out. It has to get around to repealing laws everyone understands are bad — the Jones act restricting shipping, the ban on oil exports, and so on — and reforming laws that everyone understands need to be reformed. It needs to actually follow its own budget law. The heads of agencies will have to renew the staff and reorient them to growth-oriented policy, and undertake a sweeping house-cleaning of regulations and procedures. They will have to implement managerial techniques such as pervasive cost-benefit analysis, regular retrospective review, and sunsets.

All of this is hard too. But it is the basic work of competent, growth-oriented government.

It is tempting to cast the question before us as growth vs. redistribution, or growth vs. inequality, as the rhetoric of redistribution and inequality pervades the arguments from those who want to continue the policies that are strangling growth.

But giving in to that rhetoric is a mistake. The US, in fact, has one of the most progressive tax systems in the world. And the relatively minor costs of government assistance to truly poor, needy, mentally ill or disabled people are not major impediments to growth. The weeds choking the economy represent cronyist redistribution to wealthy people, well-connected industries, and other powerful groups such as public employee unions, and large transfers among middle income people (social security and medicare). They are not, by and large, the result of genuine and effective redistribution from rich to needy poor.

When the average person (voter) expresses concern over inequality, what they really mean is that they are concerned that average people are not getting ahead economically. If the average person were getting ahead, whether some big shot CEOs fly on private jets or not would make little difference. Conversely, the average voter, if not the average left-wing pundit, does not support equality of misery. If the average person continues to do poorly, it would bring them little solace for the government to tax away the lifestyles of the rich and famous.

Long-term robust economic growth is the only way to deliver sustained improvements in the lot of average Americans, and the less fortunate in particular. Redistributing Marie-Antoinette’s jewelry did little for the average French farmer.

The golden rule of economic policy is: Do not transfer incomes by distorting prices or slowing competition and innovation. The golden rule of political economics seems to be: Transfer incomes by distorting prices and regulating away competition. Doing so attracts a lot less attention than on-budget transfers or subsidies. It takes great political leadership to force the political process to obey the economic rule.


The vast expansion in regulation is the most obvious change in public policy accompanying America’s growth slowdown. Most recently, under the Dodd-Frank act and the ACA or Obamacare, these two large segments of the economy have seen radical increases in regulatory intervention. But environmental, labor, product, and energy regulation have all increased dramatically as well.4

Sometimes, regulation slows growth in return for public benefits, such as environmental protection or transportation safety. One can argue whether it does so efficiently, but there is a purpose.

Most economic regulation, however, is specifically designed to slow growth. The purpose of most economic regulation is to transfer money to a specific group of people, companies, or industry. It does so by slowing down new entrants, impeding competition, mandating uneconomic actions or cross-subsidies, slowing innovation, turning off price signals, distorting incentives, and encouraging waste. These are the tools of economic regulation, and they all impede economic growth.

People often complain that there are too many rules and regulations, or that the cost of filling out forms is too high, that there is too much red tape, that there are too many lobbyists, or that the direct measurable costs on industry are too large. The economic impact of regulation goes far beyond these standard complaints. The overwhelming cost of regulation is the economic dislocation: companies not started, products not produced, innovations not innovated, people not hired, costs not slashed, prices too high. And growth too slow. Just because it’s harder to measure these costs does not mean that these are not the overwhelmingly more important costs, and the costs that we need to address.

Economic regulation has left behind the rule-of-law framework that many Americans suppose governs their affairs. In the popular imagination, regulation is about rules, and there are just too many of them. In many areas, however, the regulations are so vast, so complex, self-contradictory and so vague, that they basically give the regulators free rein to do what they want. In many cases, there is not a set of rules that you can read and comply with. You need to ask for preemptive permission from a regulator, who determines if your project can go ahead. Delay in getting needed approval is as good as denial in many cases. Projects that cost millions cannot bear years or often decades of delay in getting approvals.

In other cases, vague and expansive laws and regulations give regulators ammunition to pursue a few selected victims, to extort big settlements or send a few examples to jail. And by doing so to frighten the others into following the regulators’ commandments. In many areas just about everyone is in technical violation of some law or regulation.

We are used to the right to see evidence against us, challenge witness testimony, and appeal decisions to an independent and higher court. These rights often do not apply to regulations, where the agency is prosecutor, police, judge, jury, and executioner all wrapped in one. The methods for determining an “abusive” practice or “discriminatory” outcome are not revealed ahead of time so that people could structure their actions in accordance with the rules.

Much of this state of affairs is Congress’ fault, for writing long vague bills which devolve legal power to the agencies. But in an increasing trend, regulatory agencies are going far beyond even the clear limits of their statutory authority and writing rules or commanding outcomes clearly far beyond the plain language of the law. The EPAs expansion of carbon regulation and the definition of wetland are good cases in point.

The popular debate is about “more” vs. “less” regulation. Regulation is not more or less, regulation is effective or ineffective, smarter or dumber, full of unintended consequences or well-designed, captured by industry or effective, based on rules or based on regulator whim, accountable or arbitrary, evaluated by rigorous cost benefit standards or by political winds, distorting economic activity or supporting it, and so forth.

So “de-regulation” is also an inappropriate slogan. “Smart regulation,” or “growth-oriented regulation” are much better descriptors of what needs to be done.


Financial regulation, even more transparently than other regulation, is just about who gives money and who gets money.

Under the Dodd-Frank act, a highly regulated industry has become suffocatingly regulated. The Federal Reserve embeds hundreds of employees at each major bank, who pass judgment on every decision. The justice department and SEC routinely pursue banks and other financial institutions for multibillion dollar settlements, and now will pursue individuals with criminal charges. The fixed costs of running a compliance department are so high that it is nearly impossible to start a new financial company in the US. Just one new bank has been chartered since the passage of Dodd-Frank.

The parts of the financial system that failed and were bailed out in 2008 — Fannie and Freddie, commercial banks — were already among the most highly regulated businesses in America. Regulation did not fail for being absent. Regulation failed for being ineffective.

Alas, the basic structure of the Dodd-Frank act simply doubles down on the same basic design that has failed again and again: The government guarantees a wide swath of debt, by promise (deposit insurance) and by ex-post bailout. An army of regulators tries to keep banks and other financial institutions from exploiting the guarantee and taking too much risk, and clairvoyantly to forecast panics and take action to stop them. That’s like sending your brother in law to Las Vegas with your credit card, but asking his kids to keep an eye on him.

Like much else in America, our government works to cross purposes. It subsidizes debt with tax deductibility, deposit insurance, too big to fail guarantees, regulatory preference for holding short-term assets, liquidity rules, credit guarantees, Fannie and Freddie, the home mortgage interest deduction, community reinvestment act, student loan programs and so forth. And then it tries to regulate against using debt with bank asset regulation, stress tests, consumer financial protection, macro-prudential policy, and so on.

The alternative is clearly laid out in many sources: Risky investments must be largely financed by issuing equity, not by borrowing very short term money. When that happens, the mass of regulation is simply not needed in order to stop financial crises. Then we will “only” face the task of removing needless regulations whose main purpose is to create subsidies and protections for various clienteles.


The ACA, thousands of pages of law, tens of thousands of pages of regulations, and even more decision-making power by newly empowered regulators, such as the thousands of waivers given to individual companies, represents an enormous increase in Federal intervention in the market for health care and health insurance. Like finance, health was already highly regulated. And like finance, most of the ACA simply doubled down on the same basic regulatory structure that had caused so many pathologies before.

The central problem of preexisting conditions was an artifact of regulation. In the ideal form of health insurance, you buy cheap catastrophic insurance when young, but the insurance policy can follow you as you age, change jobs, and move from state to state, and does not radically increase premiums if you get sick.

Why don’t we have that ideal insurance? Because previous rounds of regulation outlawed it. In the 1940s the US government allowed tax deductions for employer-provided group insurance, but not employer contributions to individual insurance or individuals’ contributions to such insurance. By laws, insurance is not portable across state lines. Thus, there is no reason for anyone who might get a job or move to buy long-term individual insurance that protects against the emergence of pre-existing conditions. In response to the preexisting conditions problem, the ACA forces community rating — everyone pays the same price—tries to mandate healthy people to buy insurance, and steps up pressure on employer provided group plans, which are the source of the problem.

Similarly, once insurance was tax deductible, there was an incentive to salt it up. You would not buy car insurance that “paid for” oil changes — especially if you had to deal with insurance paperwork each time. But with a tax deduction it’s worth buying health insurance that “pays for” routine small expenses. Then the government (state and local too) instituted mandates that insurance must “pay for” — and, of course, charge premiums to cover — all sorts of additional procedures, which makes insurance too expensive.

We need to allow simple, portable, largely catastrophic, lifelong, guaranteed-renewable health insurance to emerge. Right now it’s illegal. To the extent that the government wishes to subsidize health insurance — and it should — then it should give straightforward vouchers, which people can use to buy insurance, or to fund health savings accounts. Such vouchers should take the place of Obamacare, Medicaid, and Medicare.

Health care and insurance is not just distorted from the demand side — too many people paying with someone else’s money. The supply side is ossifyingly restricted as well. New hospitals, new clinics that specialize in cheaply providing one service well, new doctors, new nurses, new insurance companies, all find a wall of laws, regulations, and officials blocking their path. For a reason: To maintain the profits of and cross-subsidies provided by the existing incumbents. Non-profit status itself blocks efficiency: you can’t take over an inefficient non-profit, and non-profits can’t issue equity to make important investments. In reducing the cost and improving the quality of health care, efficiency is far more important than trying to avoid a competitive rate of return to owners.

Energy and Environment

There are few places in the American government where one can witness inefficiency and growth-sapping regulatory bungling on the scale seen in our energy and much (not all) environmental regulation.

Like much else in America, our government pursues conflicting aims. It tries to subsidize and drive down the price of energy. And then it tries simultaneously to regulate against our using energy in a hundred different ham-handed ways, from mileage standards for cars, energy efficiency standards for windows and appliances, special parking places for electric vehicles,

$7,500 tax credits to subsidize $100,000 Tesla cars bought by silicon valley zillionaires, hundreds of annually extended tax credits for various energy boondoggles, and so forth.

The poster child for inefficiency may well be the mandate for gasoline producers to use ethanol. Corn ethanol, it turns out, does nothing to help the environment: It takes nearly as much petroleum energy to produce it as it contains, in the form of fertilizer, transport fuel and so on; it uses up valuable land, which directly emits greenhouse gases, and contributes to erosion and runoff; it drives up the price of food. The only thing sillier was the mandate to include cellulosic ethanol, because the government mandated a technology that simply did not work.

If you were wondering why we do this, it should come as no surprise that corn is produced by big companies in Iowa. If you need more evidence, note that the US also has heavy restrictions on the importation of sugar cane ethanol — as we restrict all sugar cane imports — which actually might be of some environmental benefit. The planet, of course, does not care whether corn is grown in Iowa or sugar cane in Brazil. Corn growers and sugar producers do care.

A litmus test for a presidential candidate ought to be the willingness to stand up in Iowa and say, “Ladies and Gentlemen, a huge government subsidy for corn ethanol is a rotten idea.”

Similarly, if you thought that subsidized production of photovoltaics and the various subsidies to putting solar cells on your roof, including the requirement that your fellow citizens buy electricity back from you at retail prices, are about the environment, you will be puzzled by our government’s heavy import restrictions on cheap Chinese made solar cells. Obviously, mother nature cares not where the cells are produced. Mother politics does.

Energy and transportation policy seem to indulge flights of magical thinking. California, facing a drought, and not having built water projects in decades, is going to spend well over $60 billion dollars on a high-speed rail line. This is advanced in the cause of carbon emission reduction. And quite literally, the case has been made that by building the rail line, we will lower global temperatures, and increase rainfall. If on a dollars per ton of carbon saved the rail line fails elementary cost-benefit analysis, on dollars per drop of water created, it fails the magic vs. reality test.

As this example makes clear, the Federal government is not alone. State and even local regulation is partly to blame as well.

Strong zoning laws forbid people from building houses near where they work, and forbid them from building workplaces near where people live, and from building shops near either. An electric car driving 60 miles is much less energy efficient than living in a high-rise apartment, in a mixed residential/commercial neighborhood, and walking!

A growth-oriented, and anti-cronyist energy policy is pretty simple. To the extent that the government wishes to reduce carbon emissions, impose a simple and straightforward carbon tax. In return, eliminate all the detailed mandates, subsidies, quantity regulations, and boondoggle unprofitable projects. If energy costs more, people will quickly figure out on their own what makes sense.

Energy is an economic paradox, as it is so highly regulated, with so much government picking of technologies, but simultaneously has such a flat long-run supply curve and there are so many technological alternatives. A large price of polluting energy is the most efficient way to induce clean energy innovation; far more efficient than massive amounts of federally subsidized research and development to financially unprofitable businesses and bureaucrats picking technologies. And price-induced behavior changes can reduce usage much more easily than mandating fancier technologies. Paying some attention to turning off the lights when you leave the room is more efficient than mandating LED bulbs and leaving the lights on.

If you are serious about carbon, let the words “nuclear power” pass your lips. We have sitting before us a technology that can easily supply our electricity and many transport needs, with zero carbon or methane emissions. New designs, if only they could pass the immense regulatory hurdle, would be much safer than the 1950s Soviet technology that failed at Chernobyl or the 1960s technology that failed at Fukushima. We are now operating antiques. And even with this rate of accident, nuclear power has caused orders of magnitude less human or environmental suffering than any other fuel.

Similarly, the most environmentally friendly way for people to live is in tightly packed cities, fed by genetically modified foods which yield more per acre of farmland and require fewer fertilizers and pesticides, from laser-leveled fields run efficiently by large corporations in the highest productivity locations. Federal policies to the contrary are not just anti-growth, they’re anti-environment too. When Federal policy can say these things in public, it will have a bit more standing to invoke the name of “science.”

Environmental policy at a minimum needs a far more frequent application of cost-benefit analysis!

As important as carbon may be, our environmental policy has become obsessed with this one danger. But slow warming and sea level rise in 100 years are not the only, or possibly the main, environmental danger we face.

Most of the large species going extinct — elephants, rhinos, lions, and so forth, to say nothing of the more numerous and less photogenic — will go extinct from human predation, poaching, and loss of habitat long before climate has any effect on them. Most of the world faces environmental problems far more pressing than climate. And by focusing on climate, our government is spending far too little time, research and money on small but catastrophic dangers such as global pandemics, crop failures, animal diseases, and so on. As in finance, the unexpected and swift dangers are more likely to cause a crisis than the slow moving widely anticipated ones.


Perhaps one economic issue just about every corner of the political spectrum can agree on is that our tax code is a massively complex and broken mess, needing reform.

Practically everyone agrees on the basic structure of a growth-oriented tax reform: Lower marginal rates — the extra amount of taxes you pay on an extra dollar of income determines the disincentive to earning that income. To raise revenue at lower marginal rates, broaden the base, i.e. remove exemptions and loopholes. And massively simplify the code.

Admittedly, not everyone agrees that tax reform should be oriented to growth. The voices for higher taxes argue for redistribution or decapitation — removal of high incomes, even without benefit to lower-income people — freely admitting the growth consequences of high taxes are at least not positive. They just view distributional goals as more important than growth.

Often, however, tax reform proposals sacrifice too quickly the principles of what a good tax system should be with perceived political accommodations to powerful interest groups. Economists should not play politician. We should always start with “in a perfect world, here is what the tax code should look like,” and accommodate political constraints only when asked to. Political constraints change quickly. Economic fundamentals do not.

Herewith, then, a brief reminder of basic principles:

The right corporate tax rate is zero. Corporations never pay taxes. Every dollar of taxes that a corporation pays comes from higher prices of their products, lower wages to their workers, or lower returns to their owners.

Which one, depends on who can get out of the way. While it is politically tempting to suppose that wealthy stockholders bear the burden of corporate taxation, they are in fact the most likely to be able to avoid taxation. While imposing a corporate tax may hurts existing stockholders, by lowering the value of the stock, there is no reason new investors will give the corporation money unless they can get the same after-tax return they can get elsewhere, and in particular abroad. Thus, new investment dries up until the company can pay the same after-tax return to its investors — by raising prices, lowering wages, or reducing scale to generate greater before-tax profits. In addition, these days the owners and investors of corporations are as much your and my pension fund as they are rich individuals.

For all these reasons, eliminating the corporate tax is as likely to be more rather than less progressive. The higher prices a corporation charges hurt everyone. The lower wages corporations pay hurt workers. The income it passes along to its owners is subject to our highly progressive tax system.

A growth-oriented tax system taxes consumption, not income. When we tax income that is saved, or the investment income that results from past saving, we reduce the incentive to save, invest, start companies and build them, vs. enjoy consumption immediately. One of the first theorems you learn in an economics class on taxation is that the right tax on rates of return is zero.

A person-based consumption tax can be progressive. It is useful to collect the basic tax as a VAT. Then people in higher brackets can declare income and receive credit for investments.

The estate tax is a particularly distorting tax on saving and investment. One may sympathize with the the moral judgment that rich kids don’t “deserve” inherited wealth. But the point is on the incentives of the giver. The tax code should not give strong incentives to middle-age people to stop building their businesses, investing their money, spend their money on round the world cruises and their time with tax lawyers. Nor should it force the breakup of privately held businesses to pay taxes. Maybe the kids don’t deserve it, but if people cannot provide better lives for their children, we remove one of the strongest and oldest human incentives for economic activity.

Taxing corporations rather than people and taxing income rather than consumption is behind many complexities of the tax code. For example, right now the corporate and individual tax rates must be at roughly the same level. If we tax corporate income less, then people rush to incorporate themselves. If we tax personal income less, the opposite. But if we tax consumption and not income, then there is no tax benefit to incorporating yourself. As another example, we only need special health savings accounts and college savings accounts because we tax income. If we taxed consumption we would just save for health, college, and retirement as we do everything else.

In partial recognition of the distortions caused by taxing rates of return, our tax code includes an absurdly complex web of ways of getting around capital income taxes, from IRAs, Roth IRAs, 527(b), 401(k), special tax treatment of pension funds and life insurance, lower rates for long-term capital gains, and the various trust shenanigans of the estate tax. Removing the attempt to tax investment income would make all of these complex structures irrelevant. Then they can be removed, greatly simplifying the code.

The economic distortions of the tax system result from the overall marginal tax rate, not each tax alone. The economic distortion due to taxation does not care that there are separate federal, state and local taxes. The economic distortion is the sum of all these. Start by producing one dollar more of value for your employer. Now subtract the corporate income tax, the payroll tax (social security, medicare, etc.), your federal, state, and local income taxes; the investment taxes, capital gains taxes or estate taxes paid between earning and consuming, and the sales taxes, excise taxes, property taxes, gas taxes and so forth that you pay when you buy something, to see how much of value you actually get in return for the dollar of value you provided to your employer. That’s the overall marginal tax rate.

Far too much tax discussion considers federal income taxes alone as if the others did not exist. They do exist. I only half-jokingly suggested an alternative maximum tax.5 Add up all the taxes you pay, including all the taxes companies whose stock you own pay, to any level of government. If it’s above some high number — say, 70% — you’re done and have to pay no more.

When we say broaden the base by removing deductions and credits, we should be serious about that. Thus, even the holy trinity of mortgage interest deduction, charitable donation deduction, and employer provided health insurance deduction should be scrapped. The extra revenue could finance a large reduction in marginal rates.

Why? Consider the mortgage interest deduction. Imagine that in the absence of the deduction, Congress proposes to send a check to each homeowner, in proportion to the interest he or she pays on money borrowed against the value of the house. Furthermore, rich people, people who buy more expensive houses, people who borrow lots of money, and people who refinance often to take cash out get bigger checks than poor people, people who buy smaller houses, people who save up and pay cash, or people who pay down their mortgages. A rich person buying a huge house in Palo Alto, who pays 40% marginal income tax rate, gets a check for 40% of his huge mortgage. A poor person buying a small house in Fresno, who pays a 10% income tax, gets a check for 10% of his much smaller mortgage. There would be riots in the streets before this bill would pass. Yet this is exactly what the mortgage interest deduction accomplishes.

Charitable donations follow the same logic. Suppose Congress proposed to match private charitable donations with federal dollars. Rich people get 40% match, but poor people only get 10%. Not only would that cause riots, but then there would be a much closer eye on just what “charities” mean in today’s America if they received direct checks from the Treasury. We may moan at the complexities of federal expenditures, but there is at least some oversight. Charities spend tax money largely in the dark. The shenanigans of the Clinton foundation are only the most recent visible example of how “nonprofits” are often the latest scam in the American legal system. Notice how every sports star or celebrity has a charitable foundation? They are great ways to escape estate taxes and investment taxes as well as campaign finance laws. Your kids can serve as the executives of the foundation.

Yes, universities (such as my employer) may suffer. Well, I started this essay with the idea that everyone must give up their little subsidy so that the rest will give up theirs. So too must academics.

Americans remain generous. Even without a tax incentive, Americans will give to worthy causes, as they give now to political campaigns. Worthy charities, such as my employer, may even gain by substitution away from tax and political scams.

In sum, the ideal tax system taxes people, it taxes consumption not investment income, and it taxes at a very low rate with a very large base.

The political debate on taxes

Why is this so hard? Because our political debate mixes different goals.

The central goal of a growth-oriented tax system is to raise the revenue needed to fund necessary government spending at minimal distortion to the economy, and in particular minimizing the sorts of distortions that impede the growth process.

A first objection comes from those who want to pair reform of the code with substantial rises in overall revenue. This has been the main stumbling block to tax reform under the Obama Administration.

Second, our tax code mixes raising revenue with a host of special provisions designed to encourage specific activities and transfer income to specific groups or businesses. Objections come from those who what to preserve one or another subsidy, deduction, or exemption.

Third, our tax code mixes raising revenue with efforts to redistribute resources across income and various demographic classes.

The result is paralysis. The answer lies in separating the arguments. One could go so far as to separate the actual legislation.

First, we should discuss the structure of the tax code separately from the proper level of revenues. Let us agree that we will eliminate deductions and exemptions and have three brackets. Start with a revenue-neutral code. But agree that we can separately and much more frequently adjust the rates, which adjust the overall level of revenues.

Second, we should separate the tax code from the subsidy and redistribution code. Let us agree, the tax code serves to raise revenue at minimal distortion. All other economic policy goes into the subsidy code. And subsidies should be on-budget and explicit. So, you want a subsidy for home mortgage interest payments? Sure, let’s talk about it. But it will be an on-budget expense — we will send checks to home buyers if we do it. You want to give $7,500 to each purchaser of electric cars? Sure, let’s talk about it. But it will be an on-budget expense. We will send $7,500 checks electric car purchasers if we do it.

Yes, advocates will object. Congress is not at all likely to appropriate money in this way! Tax credits and deductions are very useful for hiding things like this. But again, honest political leadership should say, if we have to hide what we’re doing from the American people, then we shouldn’t be doing it. Or, we should structure it in a way that is acceptable.

This discussion reflects another reality: The size of the US government is vastly greater than we think. It looks like Federal spending is only about 20% of GDP. But each deduction and mandate is the same thing as a tax and a subsidy. By bringing each deduction and tax credit on budget, we can correctly see exactly the size of our government, and more wisely vote on that size.

Even if my dream of putting all subsidies on budget fails, they should at least be conceptually separate parts of the tax code, and debated separately. The key is to keep the basic tax code focused on raising revenue at smallest possible economic distortion, and to argue separately about subsidies.

The art of politics is, of course, bundling things in a way to get deals done. But it is clear that the current bundling is producing paralysis. Those on the left that wish to raise revenue suspect that those who wish to reform the tax code will not later allow a discussion on revenue, so they must hold reform hostage. Likewise with those who want subsidies. Rather than produce another bundled mess, a great politician should be able to promise an honest hearing on revenue and unpalatable subsidies to get a clean growth-oriented reform.

Redistribution by our federal government fails because of its similarly chaotic approach. Discussions of progressivity consider redistribution through the federal income tax code forgetting about the smorgasbord of social programs and other taxes. Social security, medicaid, food stamps, unemployment insurance, and so on and so on all overlap to an incoherent mess. These should be condensed into one coherent approach to helping lower-income Americans. You can redistribute, if desired, by checks as well as by differing tax rates.

The central problem is again the tension between economics and politics. When a growth-oriented economist writes about taxes, the most important question is the distortion. What economic decision is distorted by taxes? If you produce $2 for your employer but only receive $1 in value, does that distort your decision to work, to take a job, or to invest in the skills needed for the job? Who gets how much money is really not that important to growth.

When the political system discusses taxes, the only question is who gets how much money, subdivided into minute income, geographic, racial and industry categories. Nobody pays attention to the distortions. But the distortions lower growth, and it is the job of wise political leadership to move the public discussion in that direction.

The current tax discussion understates, I think, the importance of simplicity in the tax code. A simple code makes its incentives transparent. A simple code vastly reduces compliance costs. And most of all, a simple code is much more clearly fair. Americans now look at the tax code and suspect — often rightly — that rich smart people with clever lawyers are getting away with things. Our voluntary tax code depends vitally on removing this suspicion. The Greek equilibrium in which each person cheats because he knows everyone else is cheating, corrosive far beyond its effect on revenue, can break out here too.

Tax lawyers and economists often come up with complex schemes to achieve parts of the principles I advocate, without doing much violence to the current code. I think this is a mistake. People who look forward to late March and early April each year as a time to show their hard-won expertise should remember how much the rest of the country hates the experience.

For example, rather than eliminate the corporate tax, some economists advocate having corporations notify each stockholder how much tax is paid on his or her behalf, and then the stockholder can deduct the corporate tax payments from his or her individual taxes. That achieves the same economic result, if the costs of filling out forms are zero.

But that setup is disastrous for commitment and simplicity. The corporate tax remains, and arguments about just what corporations can and can’t deduct, which income where they pay taxes on remain firmly in place. With the corporate tax system still in place, we are a sneeze away from limiting or removing the pass-through. And one cannot ask for a way that smacks more of a handout to “the rich,” hiding its effect of lowering product prices or raising wages. The code is only simplified if the corporate tax is eliminated. (And, if the government wants to subsidize R&D, energy investments, or other activities, do so with on-budget subsidies, just like for people.)

As another example, it seems politically easier to leave in place cherished deductions like health insurance, home mortgage interest, and charity, but limit the total amount of deductions any one person can take. That achieves the economic purpose.

But this setup leaves intact a perpetual argument. Next year, let’s renegotiate a higher limit. Or let’s exempt my favorite deduction from the limit. As long as each deduction remains in place, so does the constituency in its favor, and so do all the thousands of pages of tax code each entails.

Zero is zero. If you don’t kill a tax completely, it keeps coming back like zombies in a science fiction movie. If you don’t kill a tax completely, you do nothing to simplification of the tax code.

Eliminating whole sections of the tax code, rather than nullifying them with clever schemes, has another important advantage. A growth-oriented tax code operates by incentives, but people have to understand the incentives. Tax economists tend to be ultra-rational, and figure that people will react to the actual financial incentive even if it is quite hidden. Of course, the point of hiding it — of offering corporate tax rebates, say, rather than eliminating the corporate tax, or sharply limiting deductions rather than eliminating them — is precisely to fool people politically into thinking the provisions are still there. Well, people so fooled may not see the economic incentive either. Behavioral economists who argue that only very clear, simple, provisions have the appropriate incentives have a point. And their point argues for a simple code full of zeros rather than a complex code that has the same set of economic incentives once an expert combs through it.

Debt and deficits; social security and medicare

Debt and deficits are a looming threat to growth. Read any one of the nonpartisan Congressional Budget Offices’ long-term budget outlooks.

Our central problem is straightforward: promises to pay social security benefits, medicare and other health care will soon overwhelm the US budget. Hidden mountains of unfunded pension liabilities, state debts, student loan debts, and debts the US will incur if another financial crisis, recession, or war face us, add to the risks.

Growth-oriented policy will do a lot to solve the debt and budget problem. Economic growth raises tax revenues without raising tax rates. Stagnant growth will make all these problems much worse.

Conversely, a looming debt crisis or the extreme taxes that would be needed to pay for an unreformed system will be strong drags on economic growth. So, setting long-run spending in order now is both necessary, and much easier than doing it later.

Indexing social security to price inflation rather than wage inflation takes care of much of the social security problem. Indexing it to the prices of things that old people actually buy helps even more. Changing the nature of health care support to vouchers, and enacting the other health care reforms mentioned above will give both better help to people in need and solve that budget problem. Both of these steps are much easier the sooner they are taken, so that nobody has to receive an actual cut in benefits.

An economist should emphasize the distortions to economic decisions embodied by these programs, not the cost per se. Programs are bad when they require taxes so large that the taxes kill growth, or when the incentives of the programs sap people’s incentive to work, save, and invest. Social security should be converted to private accounts, not so much to save the government money as to ensure that each person knows that an extra hour of work, or extra effort made to learn a new skill or start a company, results eventually in greater resources for him or her, not just greater taxes.

Social programs

From a growth perspective, the most important characteristic of social programs is also not so much their cost, as it is their disincentives and their ineffectiveness.

Most of our social programs phase out as income rises, often with hard steps at which if you earn one extra dollar you lose a large benefit. If you earn an extra dollar, you can lose health care subsidies, food stamps, social security, medicare, disability payments, and a host of smaller subsidies from home heating oil subsidies, child care subsidies, transportation subsidies and even (in my home town) parking permit subsidies.

As usual in our weed-pulling exercise, there are so many programs and they interact in so many ways, that adding them all up is hard. The broad picture though is that for many Americans there is close to a one for one tax rate from zero up to $60,000 per year in the form of reduced benefits.

The answer is not necessarily to be stingier. The answer, as elsewhere, is to design programs with more attention paid to marginal disincentives, and to design programs that fit together rather than assume each one acts in isolation.

One good way to eliminate marginal disincentives is more frequently to condition support on time rather than income. Unemployment benefits work to some extent this way. Yes, you lose unemployment benefits if you get a job, which provides a disincentive. But you can only earn unemployment benefits for a certain period of time.

It is surprising, in fact, that a society as fluid as ours conditions so much of its government activity on income, as if income were a permanent and innate characteristic. Income changes rapidly through time and over the life cycle.

Social programs are so expensive because most of them are middle class subsidies, not help for the truly poor and desperate. We need to spend more is on the truly unfortunate. Schizophrenics in the streets are unbecoming of a great nation, and helping them costs relatively little. They don’t vote.

Labor law and regulation

Our government and politicians keep repeating how much they want to “create jobs” and help Americans to work.

A martian, parachuting down and studying our economy would come to the opposite conclusion. There are few economic activities in which the government throws more obstacles than that of hiring someone.

Start, of course, with taxes: income taxes and payroll taxes are primarily taxes on employment. But the regulatory burdens of employment are larger still, as anyone who has tried to get a nanny legal will attest.

Minimum wages, occupational licensing, anti-discrimination laws, laws regulating hours people can work, benefits they must receive, leave they must be given, fear of lawsuits if you fire someone, and so forth all impede the labor market.

We are swiftly becoming a nation divided, as Europe is, between “haves” with expensive, highly regulated, full time jobs — that are inflexible for people who wish part time work — and often illegal, under the table, part time “gig” work.

Companies have innovated around many of these distortions with contract workers, but the current fight whether contract workers, independent contractors (Uber drivers) and franchisees must be considered employees of the parent company threatens to undo all of that, placing another huge wedge in the labor market and segregation between well paid, hard to get, full time jobs and a larger pool of unemployed.

America needs a vast deregulation of its labor market. I want to work for you, you want to pay me? Good enough.

The usual argument is that workers need protection of all these laws. Well, the supposed protections do cost economic growth, and they do reduce employment. How much do they actually protect workers? The strongest force for worker protection is a vibrant labor market — if you don’t like this job, go take another. The tightly regulated labor market makes it much harder to get a new job, and thus, paradoxically, lowers your bargaining power in the old one. At a minimum let’s revisit just how much protection is actually being given, and just what the cost in growth is, and whether it’s worth it.


“Give me your tired, your poor, Your huddled masses yearning to breathe free, ..”
- Emma Lazarus.
“He has endeavoured to prevent the population of these States; for that purpose obstructing the Laws for Naturalization of Foreigners; refusing to pass others to encourage their migrations hither,..”
- Declaration of Independence.
Not any more.

We can end illegal immigration overnight: Make it legal. The question is, on what terms should we allow legal immigration.

The immigration debate has nothing to do with who is allowed to come to this country. That’s the tourist visa debate. The immigration debate is about who is allowed to work in this country, and, later, who is allowed to become a citizen. Our Federal government has a massive program in place to stop people from working. That is immigration law.

Immigrants contribute to economic growth. Even if income per capita is unchanged, imagine how much better off our social security system, our medicare system, our unfunded pension promises, and our looming deficits and debt would be, if America could attract a steady flow of young, hard-working people who want to come and pay taxes. Aha, we can attract them! They’re beating the doors down to come. But then we keep them out.

Allowing free migration is, by many estimates the single policy change that would raise world GDP the most. If you believe in free trade in goods, and free investment, then you have to believe that free movement of people has the same benefits.

The most common objection is that immigrants steal American jobs. No, they create American jobs, just as a higher birthrate of Americans would do. Every immigrant is as much a consumer of things we produce, a buyer of houses and cars, a starter of new businesses, as he or she is a worker. Immigrants come to do jobs that are available, not jobs that Americans don’t have. They do work that complements those of Americans, and thus make Americans more productive and better off.

There is very little economic argument for keeping immigrants out of California from old Mexico that would not also apply to keeping immigrants to California out of new Mexico. (Or, as Oregonians, Coloradans, and Texans might wish, keeping Californians out of their states!)

We worry about immigrants using social programs. Fine, but why then is immigration skewed to family members, likely to use social programs, and excludes workers, least likely to use them? If the worry is that they’ll go on welfare, why on earth do we forbid them from earning a living? If social program overuse is a worry, charge a $5,000 bond at the border, require proof of $10,000 of assets and health insurance, and anyone who is convicted of a felony goes home. This fear does not excuse our immigration system.

The status of the 11 million already here is a national embarrassment. 11 million people live in this country, work, pay taxes, buy food and cars and houses, and yet are deprived of legal protection, easily exploited by employers, afraid to even take airplanes, let alone not allowed to vote. If this were a racial minority, we would be scandalized.

But immigration law is so dysfunctional that we need not discuss radical programs. Let’s fix the basic growth-killing pathologies that we all recognize need to be fixed.

Start by letting in people who obviously contribute to the American economy and society. Ambitious young people come to the US to get degrees in medicine, engineering, and business.They want to stay, work, buy things from our businesses and pay taxes. They want to start businesses and hire people. We kick them out. The H1B visa lottery should simply be abandoned. Any high-skill immigrant should be able to stay. Any high-wealth immigrant should be able to stay. Immigrants often start small businesses that serve poor areas. Anyone who starts a business should be able to stay. People who came at a young age, have been through American schools, served in the US military, and know no other country should be able to stay.

The immigration discussion is full of more nonsense than any other policy question facing the country. No, immigrants are in fact much less likely to commit crimes than Americans. No, terrorists come on tourist visas. They do not swim the Rio Grande and stop to pick vegetables for a few years before blowing things up. And we already spend more than twice — $13 billion dollars — on the border patrol than we do — $ 6 billion — on the entire FBI. They are “illegal” some say. Well, that’s easy to fix. Change the law, and they will no longer be illegal! Constructing a great Ice Wall on the border with Mexico is a canard. Immigrants come on airplanes and overstay tourist visas.

As with taxation, the immigration debate needs to separate completely separate questions: Who is allowed to enter the country? Who is allowed to work here? These are completely separate issues. Restrictions on work do nothing to address security.

Immigration and growth feed each other. Immigrants help economic growth. But conversely, the lack of economic growth is feeding a misguided but understandable resentment towards immigrants.


How often must commenters on all sides of the political spectrum complain that America’s public schools are awful?

They are particularly awful for people of lower income, minorities and new immigrants. The problem is not money. Study after study shows that America spends as much or more money on eduction than other countries, and experiment after experiment has shown almost no effect of showering money on bad schools.

The culprit is easy to find: awful public schools run by and for the benefit of politically powerful teachers’ and administrators’ unions. (Don’t forget the latter! Teachers account for only half of typical public school expenses.) Education poses a particularly large tradeoff between profits to incumbents and economic growth, since education lies at the foundation of higher productivity. In addition, the costs of awful schools fall primarily on lower-income people who cannot afford to get out of the system. It is one of the major contributors to inequality.

The solution is simple as well: widespread financing by vouchers and charter schools. As with health care, a vibrant market demands that people control their spending, and can move it to where they get better results. As with health care, the government does not have to directly provide a service in order to help people to pay for that service. But as with health care, a healthy market also demands supply competition, that new schools be allowed to start and compete for students.

Higher education has been relatively healthy in the US, but Federal policy is busy making a mess of it. The correlation between more and more subsidy to higher education, the astronomical rise in tuition, and the leftward drift of campus politics towards support of a larger government is hard to miss. The Federal government took over the student loan market, and is busy creating a new debt bomb that will likely end in another mass bailout. Immigration restrictions are making it harder for students to access this, one of our great export successes.

There is a strong correlation between college education and later income. That does not mean that more college education will automatically generate more individual income or more economic growth. To some extent, smart people who will earn more money anyway go to college, and smart people who know they will benefit from a college education go to college. To a greater extent, people who choose science, engineering, math, computer, or business majors go on to earn greater incomes. Those who study other subjects may profit personally from the experience, but generally do not go on to contribute as much to economic growth.

Loans that are forgiven if one does not earn a higher income, or forgiven for students who go in to non-profit, social work, government or other low-paying work, or who do not work at all, are particularly troublesome from a growth perspective.

Sweat the little stuff

Our growth needs to be revived by pulling a thousand little weeds. A selected few reminders and examples follow.

We still have agricultural price supports, tariffs and quotas such as sugar and oranges.

Trade is relatively free, but could be freer. And keeping trade open requires endless effort against the forces of protection.

The opponents of free trade, and immigration, adduce long-standing fallacies, that one must constantly fight. When, say, China, sends us cheap manufactured goods, they take dollars in return. Every one of those dollars ends up buying an American export, or invested in America. Trade is not a “competition,” and our trading partners are not “competitors.” We win in trade when American consumers get to buy things more cheaply. The point of trade is not to increase exports. When Germany sent Greece Porsches in return for worthless pieces of paper, it was Greece that came out ahead in the deal, not Germany.

That much of the nation’s infrastructure is crumbling is a common observation. And infrastructure supports growth. Low interest rates are a particularly propitious time to build infrastructure.

So why is there less consensus for a large program to repair and build public infrastructure, including roads and bridges, but also bicycle paths, parks, airports, ports, and so forth? In large, part, I think, our government has squandered its people’s trust in its ability to carry out infrastructure projects in a cost-effective, well-planned, and timely fashion. Instead, voters are used to reading about bridges to nowhere, high speed trains from nowhere to nowhere, billion dollar cost over runs, decade plus waits for permits, massive consulting fees, and other pathology.

The process of infrastructure investment needs a complete overhaul. To mention just a few, it is no surprise that costs spiral when projects must pay “prevailing wages” and obey set-asides for specific contractors, or when environmental review takes years. It is no surprise that projects are not repaired when federal funds pay for new construction but not repair. Federal funding diverts resources to rail, a charming but very inefficient mode of transport, over freeways, airports, buses, bus lanes or bus rapid transit, or other needed modes. Real time tolling, private toll roads, and congestion pricing are easy ideas, used successfully in other countries, but almost never here.

So, yes, we need a growth-supporting infrastructure program. But our political leadership needs to show us it can construct infrastructure in a more competent, less politicized, way, focused on delivering the needed infrastructure at least cost to the taxpayer.

There is good spending

I close this essay with two areas in which I think our Government could spend some more money, in ways that would enhance economic growth.

Our legal and criminal justice system is clearly becoming dysfunctional. This system is trapping many people already struggling with poor schools and job prospects. That we spend tens of thousands of dollars to house prisoners and next to nothing to train them to succeed when they exit guarantees their return. Even doubling resources, so that crimes in poor neighborhoods are routinely solved, so that people accused of crimes have speedy trials and reasonable representation, not life-destroying years waiting for cases to be heard, so that people who are imprisoned receive some basic help in dealing with the outside world, would cost little compared to the trillions we spend on middle-class social programs.

The war on drugs is a massive failure. Not only is it leading to mayhem in poorer areas of the US, it is causing narco-states, corruption, violence, and poverty in our neighbors, and driving much immigration pressure. Al-Quaeda, the Taliban, and ISIS earn lots of money from drug trafficking. Legalization would drive them out of business far more effectively than war.

The federal government has a role in financing basic research. Yes, 95% of funded research is silly. Yes, the government allocates money inefficiently. Yes, research should also attract private donations. But the 5% that is not silly is often vital, and can produce big breakthroughs. Like the military, there are a few things the federal government must do. We are falling behind on basic research investments.


And FDA approvals take forever. And patent law is a mess leading companies to spend too much time on lawsuits. And anti-trust law is completely outdated, just throwing sand in the gears. And the NLRB and EEOC are making a mess of labor markets. And the FCC is going to turn the internet into the 1965 French telephone company. And... well, this could go on pretty much forever.

There are a lot of weeds. Just turn to the Hoover research website, especially Economic Policy, Education, Energy Science & Technology and Health care tabs. Turn to Cato’s website and browse down the “Research Areas” tabs, especially the Education, Energy and Environment, Finance, Health Care, Regulatory studies, Tax and budget, and Trade and Immigration tabs. I have kept this essay deliberately free of a forest of numbers and citations for easy reading, but the numbers and citations are easy to find.

This essay summarizes some of my own earlier writings on many of these issues, all available on my webpage. For more on regulation, see “The Rule of Law in the Regulatory State.” For more on health care and insurance see “After the ACA: Freeing the Market for Health Care” and “Health Status Insurance.” On financial reform (alternatives to Dodd-Frank) see “Towards a Run-Free Financial System.”

1 John H. Cochrane is a Senior Fellow of the Hoover Institution, Stanford University. This essay is copyright © John H. Cochrane.

This essay was prepared as a contribution to “Focusing the Presidential Debates.” Other essays and information can be found at

This essay may evolve over time, so please post or pass on links to the original pdf file or this webpage rather than pass on copies of the file.

2The numbers are based on real gross domestic product, series GDPCA, and total population, series POP, from the St. Louis Fed FRED database. Growth rates are continuously compounded, i.e. log.

3 Congressional Budget Office, June 2015 Long-Run Budget Outlook, Table A-1 p. 112

4 Technically, “regulation” means rules written by independent administrative agencies, such as the Environmental Protection Agency, the Federal Aviation Administration or the Federal Reserve. Congress delegates authority to these agencies to write the actual rules. These rules have the force of law, and can carry criminal penalties including jail time, even when no intent to violate rules is alleged. Most economic regulation takes this legal form, but a great deal remains actual laws. I will use “regulation” a bit loosely to refer to both legal forms of government intervention in the economy.

5 Wall Street Journal, April 14 2013,


  1. Replies
    1. It doesn't matter that the average American is more than three times better off than his or her counterpart in 1950 and that real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars WHEN THE TOP 1% GOT 90% OF THE INCREASE.

      I have always voted Republican, 3 degrees (including Comp. Sci. pre-engineering) 15 years of experience in software development and it has gotten me absolutely nowhere financially because the brass keep shipping in cheap labor from India and the brass think it's the cheap labor that made the projects so successful and won't pay their American project leaders much more than the cheap India labor and they pocket the huge cost savings, treating me and all the other American team leaders like fungible commodities even though we play by the rules every day of our lives and we voted for the political candidates that the brass promoted and funded. The brass are a bunch of users, and somewhere along the line, we will have an unheaval in this nation that will tear down the users.

  2. No mention of zoning/land use? Maybe it's just because I'm a real estate lawyer but the impact of that seems to dwarf the losses imposed by, say, boneheaded energy policy. Take Manhattan and force everyone to live in single-family homes and you end up with Palo Alto.

    1. But he did mention it: "Strong zoning laws forbid people from building houses near where they work, and forbid them from building workplaces near where people live, and from building shops near either. An electric car driving 60 miles is much less energy efficient than living in a high-rise apartment, in a mixed residential/commercial neighborhood, and walking!"

    2. You're both right. I did mention it, but not enough. restrictions on construction are having all sorts of bad effects, not just environmental.

    3. Zoning laws are a rational way of preventing negative externalities. You learn this stuff in Econ 101. Somehow people forget it later.

    4. Yes, they do, but as with anything they need to be subject to cost-benefit analyses. Zoning to keep a smog-belching factory our of a residential neighborhood? Probably a good idea. Minimum lot size, height restrictions, exclusion of street-level shops, multi-family homes, etc, probably a very bad idea. Most zoning these days is meant to protect vested interests, not to avoid significant negative externalities.

    5. Some zoning laws make sense I'm sure. Trying to fathom the complexity of NYC's zoning is insane. You don't even need to get into size restrictions and architecture boards, why does the zoning law specify whether a particular lot in midtown Manhattan can only be office, hotel, or residential? That seems like something the market can very easily decide, as it does with the vast difference in price per sq foot of each type of building.

    6. @ Peter Schaeffer

      Zoning laws are many things, but "rational" really isn't one of them. And I would strongly disagree that zoning is a response to externalities. If you use your property in a way that harms me, there are very old common law legal doctrines (public/private nuisance, even trespass would cover certain kinds of pollution) that give me the right to seek compensation.

      The irony is that zoning restrictions are almost universally targeted at restricting uses that would *increase* the values of nearby property. Exclusionary zoning is in fact meant to prevent growth, construction, traffic, "gentrification" and "changing character of the community".

    7. ZR, Sam,

      Like it not, but congestion, low(er) quality schools, and high-crime neighbors are the large negative externalities that homeowners (quite reasonably) care about. Of course, a smoke-belching factory would be undesirable as well. However, the threat of a new steel mill being built in Brentwood, CA is rather small. The probability of apartment buildings is considerably greater.

      Rules enforcing minimum lot sizes, height restrictions, exclusion of street-level shops, multi-family homes, etc, are simply rational mechanisms for preventing deep negative externalities. You may not like this, but it is just Econ 101.

      As for a common law alternative to zoning, that’s absurd. The law simply doesn’t allow a home owner to sue a developer over congestion, crime, and public school quality, etc. Zoning is the mechanism that works, which is why it is so popular. Famously, the city of Houston has no zoning. However, it has restrictive land-use covenants that put municipal zoning (elsewhere) to shame. Predictably, the neighborhoods with restrictive covenants are the nicest and most expensive.

      It is certainly not true that zoning (in general) prevents higher-value uses for land. It is probably true, that one homeowner could sell out at a profit to an apartment developer, but then the rest would be stuck with lower, not higher home values.

      Here is a better way of understanding this issue. Opposition to zoning is just cynical rent seeking (using the mask of faux libertarianism) based on exploiting the tragedy of the commons.

      Just Econ 101.

    8. @Peter Schaeffer

      You really think exclusionary zoning is anything but rent-seeking? And do you know the history of zoning? Almost everywhere it's been a racist, elitist segregation tool. Exclusionary zoning increases prices for everyone who is not a homeowner while raising home values. You keep saying Econ 101, but find me a well-respected economist who supports current zoning laws. Hell, most liberal economists support reductions in zoning.

      Height restrictions prevent "deep" negative externalities? Your view of X being blocked is worth driving up home prices for everyone? You keep focusing on the benefit side (lower congestion) without realizing these policies impose large costs. The last major study that looked at the cost-benefit of these policies estimated it costs the US $1.6 trillion per year: Even if these estimates are off by a factor of 10 that's still $160 billion in costs a year.

    9. I think opposition to zoning is rent-seeking pretending to be "free-market" libertarianism, and worse cynical exploitation of the "tragedy of the commons". Let me use a trivial example. Imagine a developer wants to build an low-income apartment building in a single-family, residential community. The building will bring crime, congestion, and lower quality schools to the neighborhood.

      Of course, the development will be profitable for the developer and property owner who provides the land. Rent-seeking usually is profitable. Exploiting the tragedy of the commons usually is profitable. However, it is still unjustifiable (and economically irrational) exploitation.

      What you decry as “exclusionary zoning” is simply logical (and correct) human behavior. Keeping crime, congestion, and lower quality schools out of a community is simply rationale and reasonable. In your worldview, being a “free-rider” in a community is legitimate and appropriate. People who exploit the tragedy of the common always have some excuse for their personal depredations. Rent-seekers always have their pretenses.

      In your worldview, putting thieves in prison is “exclusionary zoning” because it enables non-thieves to enjoy the rents associated with living in a safer, lower-crime society. Clearly, the vast majority of folks don’t agree.

      As for the literature, let me offer

      “An Economic History of Zoning and a Cure for Its Exclusionary Effects”


      “The purpose of this historical inquiry is to offer a test of the thesis of my book, The Homevoter Hypothesis (2001). Its central idea is that the way to understand local government behavior is to see it through the eyes of homeowners — and not renters, developers, business interests, or machine politicians — who are resident in the community. Homeowners have a special interest in their community that helps overcome the free-rider problem in public affairs. For most of them, a home is by far their largest financial asset, and, unlike corporate stock owners, homeowners cannot diversify their holdings among several communities. Fear of a capital loss to their major asset and desire to increase its value motivate owners of homes to become “homevoters.” They vote their homes in local elections and at public hearings.”

      And (from the Supreme Court decision upholding zoning as Constitutional)

      apartments are “a mere parasite, constructed in order to take advantage of the open spaces and attractive surroundings created by the residential character of the district”


      As for professional economists, it appear that they generally strongly support zoning. Let me offer, Robert Shiller as an example. Officially, he not a big fan of zoning. However, he lives in a community zoned for multi-acre lots. I have yet to find an economist who doesn’t live in an “exclusionary” zoned community. Presumably they do exist.

      The phrase here is “revealed preference”.

    10. As I mentioned before, Houston, Texas has no zoning. However, it does have pervasive land use restrictive covenants that accomplish exactly the same thing. Neighborhoods like the Memorial (which is huge) look exactly like zoned neighborhoods in other cities. If it is moral, ethical, and virtuous for restrictive covenants to produce a given result (nice neighborhoods) in Houston, how exactly is it wrong for zoning to produce the same result elsewhere?

      Enquiring minds want to know.

    11. The resulting neighborhoods may appear similar, but the process and the distribution of costs and benefits differ materially. It ain't exactly the same.

      Virtually all restrictive covenants are reciprocal. If the owner of whiteacre wishes to restrict the use of blackacre, the owner of whiteacre must give something of value to the owner of blackacre. The potential deal points are innumerable, but each side must give in order to get. The owner of whiteacre, in effect, pays (with money or reciprocal restrictions) the owner of blackacre to prohibit or limit the use of blackacre for a purpose that the owner of whiteacre finds undesirable or that will generate undesirable secondary effects. Each side must balance costs and benefits: the greater the restrictions on the burdened tract the greater the costs to the benefited tract. The owner of whiteacre must decide how much it is worth to prevent the use of blackacre for an undesirable purpose.

      By contrast, in cities with zoning, the politically powerful (sometimes developers and other times homeowners) seek to restrict the use of other people's land to benefit their own property without regard to the costs imposed on the other landowner. The proponents of restrictions seek to preserve or enhance the value of their own property without regard to the adverse effects on or diminution in value of the other person's property.

      If, for example, the owners of homes in Memorial want to prevent the owner of a previously unrestricted tract from building a large multiplex movie theater next to the neighborhood, the homeowners would have to pay the developer to agree to provide another benefit to the developer in exchange for the restriction.
      In Dallas, when the homeowners in Preston Hollow (a neighborhood demographically similar to Memorial) sought to prevent a movie theater from developing a tract on which a theater could be built as of right, they raised heck at City Hall, the City unlawfully denied the theater owners the right to develop the theater after the developer bought the property, and the taxpayers of Dallas, most of whom far worse off economically than the neighborhood that benefited from stopping the theater development, paid roughly $4 million to settle the developer's suit against the City.
      So, in Houston, the wealthy folks in Memorial must pay to keep undesirable development out of their neighborhood whereas in Dallas, and other zoning infested cities, the influential and wealthy use other people's money (taxpayers) or devalue other people's property by restricting its use to keep undesirable development away from their wealthy enclaves.

      Or, say a developer wants to build a hospital in an under served area in a large city. The agency that issues certificates of convenience and necessity for hospital licenses requires that the applicant obtain the consent of local elected officials for issuance of the certificate and for any zoning changes to accommodate the development. Then the developer goes to the local elected officials who "suggest" that a certain "consultant" would be helpful in explaining the project to the elected official's staff, and that favorable recommendation on the project to the state agency and support before the local zoning commission if the developer hired the recommended consultant to brief the elected official on the project.

      Zoning is like making sausage except the pigs have two legs, the process stinks worse, and the whole thing leaves a bad taste in your mouth.

    12. Uknown,

      “Virtually all restrictive covenants are reciprocal. If the owner of whiteacre wishes to restrict the use of blackacre, the owner of whiteacre must give something of value to the owner of blackacre.”

      That’s completely wrong. Almost invariably, restrictive land use covenants were imposed by developers when (before) community development (housing construction) started. Restrictive covenants were part of the selling proposition, developers used to attract home buyers.

      To be blunt, it appears that you don’t anything about the actual history of restrictive land use covenants.

      Of course, restrictive land use covenants can only (in practice) be imposed at the outset. At any later point, the collective action, free-rider, tragedy of the commons problem makes imposition impossible (which is why zoning is so heavily used instead).

      “By contrast, in cities with zoning, the politically powerful (sometimes developers and other times homeowners) seek to restrict the use of other people's land to benefit their own property without regard to the costs imposed on the other landowner.”

      Not exactly, zoning prevents rent-seeking, exploitation of the tragedy of the commons. What you are asserting is that each property owner has the “right” to be a “parasite”, free-rider, rent-seeker, exploiter, etc. and that the community must pay them not to do so. That basically like arguing that every car owner in the world should have to pay a few to every potential car thief, for the thief not to steal the car. No thanks.

      It is simply wrong to argue that zone has an “adverse effects on or diminution in value of the other person's property”. If that was even remotely true, homeowners would not be enthusiastic advocates of restrictive zoning. Clearly, homeowners regard restrictive zoning (or land use covenants) as a net benefit to them or they wouldn’t be such ardent “homevoters”.

      Basically you are arguing that economic parasites are entitled to confiscate value from other property owners, and they have a right to be paid, not to steal.

      OK, I get it.

    13. So you suddenly disappeared from the debate and then tried to come back almost a month later and sneak in a response, knowing full well that the person you're attacking will likely never see it? Classy move Peter.

  3. Bravo indeed. I fully agree with most of the points raised. I just want to encourage Professor Cochrane to run a simple spellcheck so that minor misspellings do not distract from the message.

    Reading through the list of 'weeds,' one can't help but conclude that the root cause of all these problems are just symptoms of the broken political system. All these ideas, however laudable, seem to be more about treating symptoms, not the disease.

  4. "From 1950 to 2000 the US economy grew at an average rate of 3.5% per year. Since 2000, it has grown at half that rate, 1.7%."

    Simple decomposition: Y = N*(Y/N)

    Take N to be Total Nonfarm Employees (FRED series PAYEMS). Y is real GDP (FRED series GDPC1).

    dlog(Y) = dlog(Y/N) + dlog(N)

    1947 - 1974: 3.67% growth = 2.11% N, 1.56% Y/N
    1975 - 2000: 3.31% growth = 2.03% N, 1.28% Y/N
    2001 - 2015: 1.75% growth = 0.46% N, 1.29% Y/N

    So it looks like output per worker hasn't been growing any more slowly recently (same since 1975). It's all about slow growth in workers.

    This is probably relevant to diagnosing causes/cures.

    1. I was going to make that point too. Thank you.

    2. Labour force participation rates are endogenous to economic growth, no?

  5. "A factor of three increase in income in 50 years, and the much larger rise in income and health since the dawn of the industrial age, pales relative to what unions bargaining for better wages, progressive taxes or redistribution, monetary, fiscal or other stimulus programs, minimum wage laws or other Federal regulation of labor markets, price caps and supports, subsidies, or much of anything else the government can do." Didn't you mean the opposite of this sentence? What the government (unions, progressive tax laws, etc) can do pales relative to what the free market can do?

    1. Fixed. Thanks. I turned the sentence around and forgot to change the verb.

  6. Terrific essay. Unfortunately, the political climate seems to be trending in the wrong direction on several of these issues.

  7. A tour de force! Typo: "radially" => "radically".

  8. Every theoretical analysis of immigration shows that the gains go to the immigrants, not the natives. In other words, the American people don't gain from immigration. The economy does become (theoretically) larger, the greater GDP goes to immigrants, not natives.

    However, the truth about immigration is much worse. Importing poor people is a losing proposition. Everyone agrees that America's native poor people are a burden. Why would anyone think that imported poor people are going to any better?

    Some of the real-world aspects of Open Borders are covered below. Not that fantasy about importing cheap workers who will prop up the welfare state. The real-world where imported poor people make the welfare state even more expensive.

    The key question is what is likely to be the impact of these immigrants on our nation. This topic has been extensively researched and the results are highly negative. A number of references make this point all to clearly.

    1. The 1997 National Academy of Sciences study found that each low-skilled immigrant costs $89,000 over the course of his/her lifetime. Of course, the numbers would be much higher now (thanks in part to Obamacare).

    “The NRC estimates indicated that the average immigrant without a high school education imposes a net fiscal burden on public coffers of $89,000 during the course of his or her lifetime. The average immigrant with only a high school education creates a lifetime fiscal burden of $31,000.”

    2. There is little evidence that the children, grandchildren, and great-grandchildren of illegals will do much better. Samuel Huntington looked at this subject in his book, “Who Are We”. See Table 9.1 on page 234. The bottom line is that educational attainment rises from the first to the second generation and then plateaus at levels far below the national average. For example, even by the fourth generation only 9.6% of Mexican-Americans have a post-high school degree.

  9. 3. The Heritage foundation found that low-skill immigrant households impose huge tax costs on Americans. See “The Fiscal Cost of Unlawful Immigrants and Amnesty to the U.S. Taxpayer”. The summary is

    “In 2010, the average unlawful immigrant household received around $24,721 in government benefits and services while paying some $10,334 in taxes. This generated an average annual fiscal deficit (benefits received minus taxes paid) of around $14,387 per household. This cost had to be borne by U.S. taxpayers. Amnesty would provide unlawful households with access to over 80 means-tested welfare programs, Obamacare, Social Security, and Medicare. The fiscal deficit for each household would soar.

    At the end of the interim period (after the Amnesty is complete), unlawful immigrants would become eligible for means-tested welfare and medical subsidies under Obamacare. Average benefits would rise to $43,900 per household; tax payments would remain around $16,000; the average fiscal deficit (benefits minus taxes) would be about $28,000 per household.

    Amnesty would also raise retirement costs by making unlawful immigrants eligible for Social Security and Medicare, resulting in a net fiscal deficit of around $22,700 per retired amnesty recipient per year.”

    4. Heather MacDonald has written extensively on the bleak realities of mass unskilled immigration. I recommend “Seeing Today’s Immigrants Straight”. Key quote

    “If someone proposed a program to boost the number of Americans who lack a high school diploma, have children out of wedlock, sell drugs, steal, or use welfare, he’d be deemed mad. Yet liberalized immigration rules would do just that. The illegitimacy rate among Hispanics is high and rising faster than that of other ethnic groups; their dropout rate is the highest in the country; Hispanic children are joining gangs at younger and younger ages. Academic achievement is abysmal.”

    5. Edward P. Lazear’s (CEA / Harvard Economics) paper “Mexican Assimilation in the United States” has a wealth of statistics showing the raw deal from south of the border. Summary quote.

    “By almost any measure, immigrants from Mexico have performed worse and become assimilated more slowly than immigrants from other countries. Still, Mexico is a huge country, with many high ability people who could fare very well in the United States. Why have Mexicans done so badly? The answer is primarily immigration policy.”

    See also “Lazear on Immigration”. Money quote

    “Immigrants from Mexico do far worse when they migrate to the United States than do immigrants from other countries. Those difficulties are more a reflection of U.S. immigration policy than they are of underlying cultural differences. The following facts from the 2000 U.S. Census reveal that Mexican immigrants do not move into mainstream American society as rapidly as do other immigrants.”

  10. "The poster child for inefficiency may well be the mandate for gasoline producers to use ethanol"

    Written by someone with no knowledge of petroleum refining. Gasoline has to meet certain octane specifications. Ethanol is a (very) high octane additive. With lead and MTBE banned, ethanol is more or less mandatory at this point.

    1. If ethanol is necessary to achieve octane specifications then there is no reason for it to be mandated. Let the market decide how much is required and get the regulators out of the decision making process.

  11. Unemployment via mass immigration.

    Immigrants quite literally take jobs from Americans. That makes them a direct loss to the American people. The examples below should demonstrate this point. Note that they are all from a period when the economy was doing much better than it is now.

    1. “The Impact of New Immigrants on Young Native-Born Workers, 2000-2005 By Andrew Sum, Paul Harrington, and Ishwar Khatiwada” (

    “Over the 2000-2005 period, immigration levels remained very high and roughly half of new immigrant workers were illegal. This report finds that the arrival of new immigrants (legal and illegal) in a state results in a decline in employment among young native-born workers in that state. Our findings indicate that young native-born workers are being displaced in the labor market by the arrival of new immigrants.”

    “Between 2000 and 2005, the number of young (16 to 34) native-born men who were employed declined by 1.7 million; at the same time, the number of new male immigrant workers increased by 1.9 million.”

  12. 2. “Employment Down Among Natives In Georgia As Immigrant Workers Increased, Native Employment Declined in Georgia” (

    “Between 2000 and 2006 the share of less-educated native-born adults (ages 18 to 64) in Georgia holding a job declined from 71 percent to 66 percent. (Less-educated is defined as having no education beyond high school.)”

    “Native-born teenagers (15 to 17 years of age) have also seen a dramatic decline in employment. Between 2000 and 2006 the share of native-born teenagers holding a job declined from 22 percent to 11 percent in the state.”

    3. “Impact of Immigration In South Carolina” (

    “At the same time that more Latinos are entering South Carolina’s work force, median wages for those at the low-skill end of the spectrum are dropping. According to the USC survey, the median annual earnings for Latinos was $20,400, far below the median earnings for South Carolinians in general. The effects of a larger Latino work force are most evident in specific industries. Construction appears to be the predominant economic activity drawing Latinos to South Carolina: this industry accounts for approximately 38 percent of Latino employment in the USC survey. The survey also found that the median annual wage for Latinos working in construction is $21,840.

    According to U.S. Census data, among construction workers real median earnings for Latinos dropped approximately 12 percent from 2000 to 2005, even as the number of construction workers expanded 181 percent. Black construction labor saw inflation-adjusted earnings fall two percent. It is also surprising to find that total Black employment dropped by 24 percent during the construction boom.”


    “Almost everybody knows that in the past 40 years, the real wages and job prospects for low-skilled men, especially low-skilled minority workers, have fallen. And there is evidence –– although no consensus –– that a rising tide of immigration is partly to blame. Now, a new NBER study suggests that immigration has more far-reaching consequences than merely depressing wages and lowering employment rates of low-skilled African-American males: its effects also appear to push some would-be workers into crime and, later, into prison…..The authors are careful to point out that even without increased immigration, most of the fall in employment and increase in jailed black men would have happened anyway. Nevertheless, the racially disproportionate effects of immigration on employment are striking.”

  14. 5. The Crider “Natural Experiment” (

    “After a wave of raids by federal immigration agents on Labor Day weekend, a local chicken-processing company called Crider Inc. lost 75% of its mostly Hispanic 900-member work force. The crackdown threatened to cripple the economic anchor of this fading rural town. But for local African-Americans, the dramatic appearance of federal agents presented an unexpected opportunity. Crider suddenly raised pay at the plant. An advertisement in the weekly Forest-Blade newspaper blared “Increased Wages” at Crider, starting at $7 to $9 an hour—more than a dollar above what the company had paid many immigrant workers. (January 17, 2007)”

    “The Crider poultry-processing plant in Stillmore, Ga., lost two-thirds of its workforce last year after a federal immigration agency raid. Since then, Crider has scrambled to replace the employees. It has staged job fairs, boosted starting pay and even contracted for Georgia prison inmates to work on its production line. In an unusual experiment, Crider has also recruited a small group of Laotian Hmong refugees to move from Minnesota to Georgia, hoping they’ll start a new community.”

  15. 6. Immigrant Gains and Native Losses in the U.S. Job Market, 2000 to 2010 (

    “Despite an abysmal jobs picture, Census Bureau data collected in 2010 show that the decade just completed may have been the highest for immigration in our nation’s history, with more than 13 million new immigrants (legal and illegal) arriving. What happened during the last decade in terms of employment of native-born Americans is astounding. Even though native-born Americans accounted for the overwhelming majority of growth in the adult working-age population (18 to 65), all of the net gain in employment went to immigrants. Something like that might not be too surprising over a short period like a quarter or even a year. But it is remarkable that over a 10-year period (2000 to 2010) all the net increase in jobs went to immigrants..

    The growth in the native-born working-age population, coupled with their decline in the number working, created a dramatic decline in share of natives holding a job during the decades — from 76 percent in 2000 to 69 percent in 2010.

    Less-educated natives have been especially hard hit. The share of working-age native-born high school dropouts holding a job fell from 52 percent in 2000 to 41 percent in 2010. For those natives with only a high school education, the share working fell from 74 percent to 65 percent.”

    1. Hello Peter Shaeffer - thanks for your posts on immigration. The Trump wave and the "Bern" shows how most voters are now deeply concerned about the damage done to America by uncontrolled immigration and H1B workers. There is much less economic incentive to get an education or if you don't have an education, to hold a job. Almost all economic gain is going to the owners of capital. This is what happened in Europe in the 1800's and I hate seeing America go down the same road. The problem is that the owners of capital have lost their sense of social affiliation with their follow citizens and they are only in it for the money, and having the upperhand in politics and business, are using their superior negotiating position, are dealing a very bad hand to the rest of America, including pushing the political elite to allow lots of cheap labor to work in America, whether the political elite are Republican or Democrat.

      Sorry for posting as anonymous, I don't have an account with any of the listed selections.

  16. "How often must commenters on all sides of the political spectrum complain that America’s public schools are awful?"

    Actually, American schools are rather good. See "The amazing truth about PISA scores: USA beats Western Europe, ties with Asia" (

    The U.S. does have serious student quality problems. Problems that would get much, much worse if the U.S. adopted the immigration ideas advocated here.

  17. One thing I didn't see in the post was discussion of which good policies increase levels, and which increase growth. Getting rid of sugar import quotas, for example, would raise national surplus flow, but I don't see any way it would increase the growth rate of national surplus flow: it would be a one-time bump-up in the flow of surplus. To get increases in growth, we need to improve incentives for innovation. That's tied up with improving incentives for investment, but is not the same thing.

    1. Eric,

      To improve long term incentives for innovation would require long term commitments by the Federal Government.

      Those type of commitments come in two varieties - political party domination or long term contracts.

      I don't foresee either political party dominating the federal government any time soon and so that leaves long term contracts.

      In the case of debt contracts sold by the federal government, U. S. Treasury has tried to extend the maturity of the government's outstanding debt, the central bank has tried to shorten the maturity of debt held by the public.

      Perhaps long term government equity is the solution?

    2. Hello Frank - how about this for an idea "to improve incentives for innovation": Require owners of large investment portfolios to put a % of their capital in small tech startups. I have been involved in a number of small tech startups for the last 10 years and have seen a lot of market opportunity go wasted because investors just refuse to put money in small companies.

  18. I know the main point of this post is your recommendations, but the notion that current growth is unusually slow or sickly is just not true. We’ll have about 2.2%-2.3% real growth per working-age adult this year, better than every year of the last cycle except 2004 (~2.5%) and better than the average of ~2% in 1970-2000.

    1. How are you defining "working age?" There are currently just under 9 million people age 65+ who are in the labor force, a number that has been rising rapidly. This may skew those numbers, at least to a certain extent.

  19. 1. Get rid of the home mortgage interest tax deduction.
    2. Get rid of the VA.
    3. Outlaw licensing of the law profession.
    4. Outlaw single family detached zoning districts.
    5. No more FDIC deposit Iinsurance.
    6.Run for your lives.

  20. Sad that that list is so long.

  21. I actually agree with the thrust of this post.

    But one could ask---why were the 1950-60s so boom-boom-boomy-boom-boom?

    1. The top marginal tax rate was 90%
    2. There was rate regulations in airlines, trucking and railroads.
    3. Stockbroker commissions were fixed by law.
    4. Financial institutions were heavily regulated, including Reg Q.
    5. Big Labor was, well Big Labor.
    6. Big Steel, Big Auto, Big Aluminum
    7. Much less international trade
    8. Much less immigration
    9. Retailing was stodgy, no Internet. Sears was king.

    Yet--from 1950 to 1970, per capita incomes rose by more than 60%!

    And the Fed printed a lot of money too.


    Why won't facts conform to my theories!

    1. 1. Actual payments received were the usual 20%, even among high earners. The tax code then was full of loopholes.
      2. We just came out of the great depression and WWII, and the rest of the world was destroyed. You can do a lot of catch up growth
      3. Sears and A&P were driving out mom and pop.
      Do you really want to go back to 1 1950s car, 1 black and white TV, 1950s health care, and a rotary phone? Levels matter. Unscrew things up and levels rise. That's called growth.

    2. He is not talking about fixing growth from 1950-1970. He is talking about fixing growth now, when it's low.

    3. BC,

      The real story (of the 1950s) is not about taxes, regulation, unions, etc. The real story is that the period from 1945-1970 were the apogee of the industrial revolution that started (in some respects) around 1500. If you want to understand this, go read Robert Gordon. For a short version, look up just one word, "Ghawar".

    4. Ben,

      You forgot about a big one in terms of economic policy making:

      U. S. House of Representatives

      Controlled by the Democratic Party - 1933 thru 1995, with one term Republican control in 1947 an 1953

      U. S. Senate

      Controlled by Democratic Party - 1933 to 1981, again with one term Republican control in 1947 and 1953

      And there is nothing coming from either party that convinces me that one or the other can hold onto power for very long to implement meaningful long term policy changes instead of lobbyist fueled adhoc band aids.

    5. All good cooments.

      I will say this: if all the structural impediments I mentioned that defined the 1950s and the 1960s were eliminated and GDP growth rates rose, economists would point to that.

      In fact most of those structural impediments have been eliminated, and GDP growth rates declined.

      My own opinion is that the structural impediments are important, but the Fed has been suffocating in the economy in its 30 year war on inflation. Now that the Fed has won the war, we have to see what happens next.

      I advise the Fed to let it rip, let's shoot for Full Tilt Boogie Boom Times in Fat City.

    6. Ben,

      One of those "impediments" was the Bretton Woods agreement.

  22. "Actual payments received were the usual 20%, even among high earners. The tax code then was full of loopholes."

    Life for the factually challenged. From "1950s Tax Fantasy Is a Republican Nightmare" (Bloomberg)

    "Or lower. Marc Linder, a law professor at the University of Iowa, has shown that a more comprehensive interpretation of income that includes capital gains suggests the real effective tax rate for millionaires was 49 percent in 1953. The effective rate dropped throughout the decade, reaching 31 percent by 1960. That 31 percent is just slightly higher than the 29 percent level a Congressional Budget Office report figures the average effective tax for the top quintile will be in 2014. And that number for 2014 doesn’t include taxes in Obama’s health-care law."

    Note that the effective corporate tax rate (actual tax rate) was 50+%.

    1. 1. Your comments are unnecessarily snarky.

      2. I looked up the Bloomberg article you're quoting. It doesn't have any link or citation to that law professor's numbers. Do you have a direct link to his data?

      3. The effective corporate tax rate was over 50%? Where are you getting that from? I don't see that anywhere in the article you reference. Considering the top marginal rate on taxable income was "only" 52% in those years, that seems hard to believe.

      4. Looking at total taxes paid as a percentage of GDP, it's clear that in the aggregate, taxes were not generally higher in those years.

      In FY2015, total tax receipts are estimated at 17.7%, and are projected to be over 19% in the next few years after that. Outside of three years during the Korean War, they were never higher than 17.8% from 1946-1968.

    2. Zack,

      "Your comments are unnecessarily snarky"

      The low quality of the debate at this site doesn’t inspire subtle, nuanced arguments. That said, since you appear to be after substance, let me try to offer some.

      “I looked up the Bloomberg article you're quoting. It doesn't have any link or citation to that law professor's numbers. Do you have a direct link to his data?”

      Bloomberg is not what I would call a “high-quality” source. Nor is Amity Shlaes. I used them because they constitute (in this context) an “argument against interest”. However, since we are seeking substance, let me try. The link for Linder’s article is Linder is a polemicist (at best). However, the Congressional Research Service did a study of this topic. See “Taxes and the Economy - An Economic Analysis of the Top Tax Rates Since 1945 (Updated)” by Thomas L. Hungerford. Figure 1 shows that average tax rates were in the high 30s for the 0.1% (of taxpayers) and around 50% for the top 0.01%.

      “The effective corporate tax rate was over 50%?”

      Several sources confirm this. The data is from the BEA, OMB, etc. See and and “Corporate tax in the United States” (Wikipedia). Actually, Wikipedia shows the effective corporate tax rate reaching (but not exceeding) 50%.

      “Looking at total taxes paid as a percentage of GDP, it's clear that in the aggregate, taxes were not generally higher in those years.”

      That’s mostly true. Taxes were more progressive so the tax burden on lower income folks (relatively) was lower. However, remember that the original claim was “Actual payments received were the usual 20%, even among high earners”. The first part is more or less true. The second part is not. Professors of Economics are not supposed to make trivial factual errors. Keynes supposedly said “Everyone is entitled to his own opinion, but not his own facts” (the origins of this quote are obscure and complex).

    3. Alright, that's a lot to go through. My thoughts on the Linder paper:

      1. Looking through it, it reads more like a historical paper documenting arguments about tax policy. It’s pretty light on actual data analysis and it’s rather convoluted at times.
      More to the point, the "effective" rates referenced appear to be nothing more than taking taxes paid as a percentage of Adjusted Gross Income. The problem is that the definition of AGI has changed significantly over the years, particularly in 1986. By simply using AGI for historical comparisons, one is completely leaving out the very "loopholes" John Cochrane was presumably referring to above- real estate tax shelters, passive losses, corporate expense accounts etc. I don’t see how this is particularly useful for comparisons to recent years.

      From what I can tell, the Hungerford paper is using the same methodology. In any case, I don't know if the rate paid by .01% of the population is really all that important one way or another.

      2. He laments the increase in pre-tax income at the top during the Reagan years, ignoring the obvious- the tax reform expanded the definition of income, and removed several loopholes and shelters that the rich used to lower their paper incomes. Marginal rates at the top were also cut sharply, which logically would have also reduced the incentive to use those maneuvers.

      3. The CBO publishes estimates for a more comprehensive definition of income and tax burdens. Their latest numbers show that effective total rates were in fact more progressive in 2013 than in 1979 (the year they started). To believe that taxes are less progressive today than in the 50’s, there must have been some sharp increase in progressiveness between then and 1979. I’m not sure if there's any evidence of that, but I could be wrong.

      4. I am curious as to what John was referencing when he said those at the top were paying 20% effective rates in those years. At first I thought maybe he was just referencing the fact that total taxes were not any higher then, which is easily found when looking at total receipts as a share of GDP. I don’t really know how one could get accurate numbers for real rates paid at different points on the income distribution from back then relative to today.

      5. Corporate tax rates are tougher and I don’t claim to be an expert on the issue. There seems to be a lot of variance in estimates you get from different groups. Some of the same issues as above may exist with historical comparisons, but I’m not as sure. They may well have been quite a bit higher in the past.

    4. Zack,

      This thread started with a purported factual claim.

      “"Actual payments received were the usual 20%, even among high earners. The tax code then was full of loopholes."”

      This is factually incorrect, based on all of the data I have seen. The tax code was full of deductions. However, rates were so high, that even with the deductions, average effective rates at the top were well above 20%. I argued previously that “Linder is a polemicist (at best)”. My view on this point hasn’t changed. Since your opinion of Linder appears comparable, we can drop Linder.

      However, the Hungerford paper and others do appear to be substantive. Yes, the Hungerford paper and some others do use AGI. However, the historical deductions and loopholes appear to be post-AGI (reducing taxable income below AGI, not reducing AGI). At some level this has to be (have been) true. Everyone recognizes that effective tax rates were well below nominal tax rates. If the historical loopholes and deductions were pre-AGI (reductions to AGI itself), then nominal rates and effective rates would have been much closer.

      A few more specific notes. Take a look at “Average and Marginal Tax Rates, 1980 Individual Income Tax Returns” (by Charles Hicks of the IRS). In 1980, 4,414 returns reported income of over $1 million. Total AGI was $9.21 billion. Taxable income was $7.018 billion. Income tax was 47.9% of AGI. Note that large gap between AGI and taxable income.

      Piketty and Saez have also tried to compute tax rates at various income levels over time. They come up with astonishingly high effective rates for high earners in 1960 (70%). However, they include the corporate income tax as a tax on individual incomes and estate taxes. Note apples-to-apples. Still there paper is worth reading. See “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective Thomas Piketty and Emmanuel Saez”.

      Another source gives tax rates for the top 1%. See “The Obsession with Nominal Tax Rates or the Twinkie Romanticism”. The graph only starts in 1966. However, the effective tax rate is above 30%. Is it really plausible that top 1% effective tax rate was lower 10 years earlier?

      To be continued...

    5. You state

      “In any case, I don't know if the rate paid by .01% of the population is really all that important one way or another.”

      There are actually several points here. First, tax rates were much higher than 20% on the 0.01%, the 0.1%, and the 1%. For better or worse, much of the “supply-side” right is obsessed with tax rates on high incomes and corporations. It would appear that this blog holds to that view. Second, the “supply-side” types engage in a sort of “bait-and-switch” here. Generally, they tend to obsess over top-end marginal tax rates. If anyone points out that history top-end rate were rather high and the economy prospered anyway, they switch to the “it’s the overall tax burden that counts” theme. Of course, the overall tax burden (income tax burden) has been rather flat over time.

      “The CBO publishes estimates for a more comprehensive definition of income and tax burdens. Their latest numbers show that effective total rates were in fact more progressive in 2013 than in 1979 (the year they started).”

      Not really. It somewhat depends on how you define “progressive”. See “The Distribution of Household Income and Federal Taxes, 2011” (CBO November 12, 2014). In this report the average tax rate on the top 1% falls from 35% in 1979 to an estimated 29% in 2013. Could the average tax rate on the top 1% been higher than 35% in the 1950s? Quite possibly. However, even if it was only 35% (or 30%) we are still far above 20%. Note that tax rates on all groups fell from 1979 to 2013 (more at the bottom than at the top).

      There are lots of sources for corporate tax data going back rather far. The BEA NIPA tables seem reasonably reliable to me. Another source would be “The Federal Corporate Income Tax Since WWII” from the Tax Foundation. Figure 2 shows an effective corporate tax rate of almost 50% in the early 1950s. The notable point is that all sources shows effective corporate tax rates of around 50% for this period.

    6. As I said, the definition of income itself has gone through several changes, particularly in 1986 but also at other times. I'm not talking about deductions (although there were changes in that area, as well). I'm talking about well-known tax shelters and loopholes that legally allowed the rich to reduce their paper incomes compared to what would be reported under today's rules. I didn't think there was anything particularly controversial about that claim.

      As for the CBO numbers, two things:

      1. In 1979, the top 1% paid an average total rate of 35.1%, the middle three quintiles paid an average rate of 19.1%, and the bottom quintile paid 7.5%.

      In 2013, they estimate that the top 1% paid an average total rate of 33.1%, middle earners paid 13.3%, and those at the bottom paid 2.9%. That certainly looks more progressive to me.

      2. Those numbers are for total tax burdens- income, payroll, corporate, excise. The statement made at the beginning of this thread was about income taxes. If you look solely at the income tax rate paid by the top 1%, it was 22.7% in 1979 and 20.3% in 2011, before the recent increases on high earners took effect.

      Also keep in mind, FY79 and 80 were a little on the high side in terms of total taxes as a share of GDP compared to the historical trend.

      And with all due respect, I took the time to go through that 138-page paper you cited to begin with- the same paper you now seem to be telling me to forget about. I really don't have time to search for and read every other paper and article you keep listing. Unless any of them found an accurate way of quantifying and adjusting for the changes I’ve listed, the same criticisms would apply.

    7. Zack,

      This thread started with a purported factual claim.

      “Actual payments received were the usual 20%, even among high earners. The tax code then was full of loopholes.”

      Assuming your reference to a 35% tax rate for the top 1% (from the CBO) is correct, the issue is closed… Unless someone can credibly claim that top 1% tax rates were drastically lower in the 1950s. Since the data points in the other direction, the 20% rate for high earners (in the 1950s) is erroneous.

      Your reference to “I'm talking about well-known tax shelters and loopholes that legally allowed the rich to reduce their paper incomes compared to what would be reported under today's rules.”

      Essentially this amounts to a debate about whether AGI is (actually was) a reasonable estimate of high-end incomes. It turns out that there is an extensive literature on this subject (which took me a while to find). The literature is derived from comparisons of BEA income estimates and IRS income estimates. These different sources of income data have been compared (in detail) since the in 1950s. The BEA income estimates and the IRS income estimates are never the same because they use different definitions and methodologies. Of course, the comparisons explain the differences.

      It turns out that AGI has always been defined as taxable (completely or partially) income. That means that AGI excludes non-taxable income. Non-taxable income includes transfer payments and non-taxable interest income (municipal and state bonds). Of course, transfer payments are not significant for top-end incomes. However, non-taxable interest probably is material at the top-end. Of course, non-taxable interest is derived from tax-exempt municipal bonds, that offer (offered) lower yields (a different kind of taxation if you will). See “The Municipal Bond Market, Part I: Politics, Taxes, and Yields” (The New York Fed). The 1-year yield ratio (Figure 2) suggests very high marginal tax rates.

      It turns out that Piketty/Saez also use AGI (with minor adjustments) to estimate historical top-end incomes. See “INCOME INEQUALITY IN THE UNITED STATES, 1913-2002*” ( Since we can presume that Piketty/Saez had/have no intent of minimizing top-end incomes, we have another data point suggesting that AGI is a reasonable metric.

      continued below

    8. A typical definition of AGI is contained in “Comparison of BEA Estimates of Personal Income and IRS Estimates of Adjusted Gross Income”. The definition is

      “AGI is the Federal income tax concept closest to net income. It approximates income less the costs of producing income. In general, gross income for Federal income tax purposes includes all income that is received in the form of money, property, and services that is not explicitly exempt from taxation. Explicitly exempt income includes the cost basis of pension, annuity, or individual retirement account distributions; tax-exempt interest; part of social security and railroad retirement benefits; part of qualified foreign earned income; and part of the gain from sale of principal residence. For 2000, the allowable adjustments to gross income to derive AGI included the deduction for one-half of self-employment tax, contributions to self-employed retirement plans, contributions to individual retirement accounts, alimony paid, and other adjustments.”

      And “Personal Income and Adjusted Gross Income, 1984-1986”. Quote

      “Adjusted gross income estimated by IRS is the total income from all sources that is subject to the individual income tax, less certain deductions. The total income subject to tax includes wages and salaries; a portion of dividends, interest, and pension income: net business and farm income; net capital gains income; and other miscellaneous items. Deductions allowed in the calculation of AGI include various expenses considered necessary in earning income, certain allowances for capital gains and losses, and statutory adjustments [6).”

      The IRS “STATISTIC OF INCOME… 1960” provide some more data points. Table 1 shows that 306 returns reported an AGI of $1 million or more with a total AGI of $611.273 million and a taxable income of $455.501 and taxes of $280.525 million. As you can see, taxable income was 74.52% of AGI and taxes were 61.58% of taxable income (but only 45.89% of AGI). Note that for taxes to be 20% (or less) of actual income, actual income would have to have exceeded 1.402 million (2.29X AGI).

      Even if you don’t accept AGI has a good estimate of top-end incomes before 1961, it should be obvious that actual top-end tax rates were well in excess of 20%.

    9. You wrote

      “I looked up the Bloomberg article you're quoting. It doesn't have any link or citation to that law professor's numbers. Do you have a direct link to his data?”

      You asked for a link. I provided it. I also went through the long and tedious Linder paper and wasn’t impressed. I never recommended it. You will note that I specifically said

      “Bloomberg is not what I would call a “high-quality” source. Nor is Amity Shlaes. I used them because they constitute (in this context) an “argument against interest”. However, since we are seeking substance, let me try. The link for Linder’s article is Linder is a polemicist (at best).”

      Not exactly a recommendation.

      The CBO numbers show top tax rates well above 20%. It is certainly true that the tax system was progressive in 1979 and 2013. Was it more progressive? The CBO has a specific comment on this in “Trends in the Distribution of Income”. Quote

      “Government Transfers and Federal Taxes Became Less Redistributive

      Although an increasing concentration of market income was the primary force behind growing inequality in the distribution of after-tax household income, shifts in government transfers (cash payments to individuals and estimates of the value of in-kind benefits) and federal taxes also contributed to that increase in inequality. CBO estimates that the dispersion of market income grew by about one-quarter between 1979 and 2007, while the dispersion of income after government transfer and federal taxes grew by about one-third.

      Because government transfers and federal taxes are both progressive, the distribution of after-transfer, after-federal-tax household income is more equal than is the distribution of market income. Nevertheless, the equalizing effect of transfers and federal taxes on household income was smaller in 2007 than it had been in 1979.”

      It is conceivable that tax law changes (and other policy changes) from 2007 to 2013 might have reversed this conclusion. However, the data from “The Distribution of Household Income and Federal Taxes, 2011” (CBO) doesn’t show this. What you are apparently observing is that income tax rates on all groups (top 1%, quintiles, etc.) fell from 1979 to 2007 with larger declines at the bottom. However, as the CBO points out, that is not enough to make the system more progressive in 2007 vs. 1979.

    10. "Assuming your reference to a 35% tax rate for the top 1% (from the CBO) is correct, the issue is closed"

      I’ve tried to be as polite as possible, but this is getting ridiculous. Did you even read my last comment? I just corrected you on this. Again, that 35% number is for combined income, corporate, payroll, and excise tax estimates. The average income tax rate for the top 1% was 22.7% in 1979.

      And yes, taxes are clearly more progressive now than in ‘79. You’re trying to mix taxes and government transfers now, which is a completely different subject. That CBO report explicitly says that progressivity of tax payments has increased. Government spending (i.e. social security checks, Medicare, Medicaid etc.) is irrelevant to this discussion.

      You started this with a rather condescending remark citing AGI-based numbers. My only argument has been that AGI was a considerably narrower concept back then, so comparing those numbers to today’s is not even close to an apples to apples comparison.

      You referenced the Tax Foundation earlier, right? Look at the disclaimer they put on their own historical tables in 1986: "Tax Reform Act of 1986 changed the definition of AGI, so data above and below this line not strictly comparable"

      Then again in 2000:"IRS changed methodology, so data above and below this line not strictly comparable"

      If you don't like that, how about this from the left wing Urban Institute: "Tax law amendments had changed this definition of AGI somewhat in the previous 15 years, generally expanding it. The most significant revisions came in the Tax Reform Act of 1986 (TRA86)."

      Also as you sort of alluded to, certain forms of tax-free interest did not even have to be reported on a tax return prior to the 1980's. And of course the reductions of top marginal rates would change incentives to use various avoidance maneuvers.

    11. Like I said before, I have no idea if it would even be possible to accurately quantify all of these things for historical comparison, but there are a few things I can say for sure:

      1. When looking at the CBO comprehensive income/tax numbers, tax rates have clearly become more progressive since 1979.

      2. The rate paid by the top 1% has fluctuated, but their average income tax rate has been around 20%, give or take, since 1979, with the total rate generally in the high 20’s or low 30’s. For the 96-99th percentiles, they’ve ranged from roughly 15-18% and 24-27%, respectively.

      3. When looking at total receipts as a share of GDP, it's clear that, in the aggregate, taxes were not particularly high in the 50’s and 60’s. Remember 1979/80, when the CBO individual numbers above start, was actually on the high side compared to most of those decades.

      Interpret all of that how you may, but this is probably getting a little long for a debate about a single sentence in a blog post comment that someone else made a week ago.

  23. "We just came out of the great depression and WWII, and the rest of the world was destroyed. You can do a lot of catch up growth"

    Two problems with this argument. First, the U.S. exceeded its long-term GDP potential during the war (quite reasonably so). GDP fell right after the war as the U.S. returned to its long-term GDP growth path. Second, the ROW rebuilt with astounding speed after the war. Reconstruction in Europe and Japan was more than complete by 1955 (actually much sooner). There is no way reconstruction can account for fast growth from 1955 to 1970 (or really after 1950).

  24. In summary, policy issues are less important than fundamental shifts in the technological basis of human civilization. The rate of technological change back in the 1950s was very high and it shows up in economic growth.

    As for immigration in the 1950s, yes it was a low immigration period. Of course, low immigration tends to produce a labor scarcity that favors productivity enhancements. The reverse is true. Open Borders creates a low-productivity, low wage economy. From Slate "What the history of the electric dynamo teaches about the future of the computer."

    "David showed that World War I, which led to immigration controls and choked off the supply of cheap but untrained immigrant workers, was one of the spurs to make these changes. U.S. productivity growth eventually leapt in the 1920s, four decades after the commercialization of electricity. Productivity growth rates in U.S. manufacturing in the 1920s were more than 5 percent per year, a rate that makes the "new economy" look laughable, at least for now."

  25. And not a single word about increasing aggregate demand - - -

  26. Oh I forgot: legalize push-cart vending!

    Seriously, any visitor to many nations becomes aware of thriving industries of pushcart vendors. These people are self-employed running their own businesses! They are (nearly) universally outlawed in the United States.

    Of course, doing away with single -family detached housing districts and doing away with laws against push cart vending...

    Well, let me put it this way: I am for those regulations and tax codes that benefit me and I'm against those regulations and tax codes that do not. That is my bedrock principal from which I will not waver.

  27. "There is very little economic argument for keeping immigrants out of California from old Mexico that would not also apply to keeping immigrants to California out of new Mexico."

    If politics and economics were separate that might make sense. Leaving economic theory behind and looking at reality, California has become, largely through immigration, a monolithically Democratic state which has had the not unexpected effect of virtually every growth killing pathology the rest of the essay decries becoming enshrined, immutable public policy.
    Milton Friedman made the oft cited observation that you can't entertain open borders and a generous welfare state simultaneously without dire consequences.

    "Allowing free migration is, by many estimates the single policy change that would raise world GDP the most. If you believe in free trade in goods, and free investment, then you have to believe that free movement of people has the same benefits."

    Again perhaps true theoretically if men were simple economic models, but they are not. Culture matters. Many parts of the world are not prosperous because they do not accept culturally or politically the free markets, free trade and free thought that produce those benefits.
    Europe is discovering to its dismay what difference culture makes. Many very large wars have been fought over these things economists try to ignore and they will continue to be in the future. Political and cultural suicide over economic theory is not a recipe for growth but conflict, very often violent conflict.

  28. Professor,

    Great essay! I really enjoyed the specific policy solutions and agree with you in many ways.

    So paraphrasing you, what you’re saying is, (And let me know if I’m off base), “look, the system works, but we need to make it much more efficient.” And that efficiency is everything you talked about, from Healthcare to Taxes to Debt. Essentially, it is all efficiency of the current system.

    Assuming this is indeed what you’re saying, I have one concern which I’ll phrase from two different perspectives.

    First, what do you say to specifically those economists who argue in the “Secular Stagnation” debate? (

    Second, what do you say to a general person who says “look all that stuff about efficiency is great, but I think the system itself is fundamentally broken, and making the system more efficient isn’t going to solve the problem.” ?

    As for me, I’m split between your and Summers’ argument. On one hand I completely agree with you on inefficiencies in our current system; I live in San Francisco and get to experience the city’s inefficient and horrid zoning laws every day. On the other hand, I’m also very sympathetic to Summers’ position and am deeply concerned about the long term economic trends we see today across the globe.

    What do you think?

    And again, great essay!

    1. "Secular stagnation" combines an observation, that growth has slowed remarkably, with a diagnosis and cure: lack of "aggregate demand" and a need for much more "stimulus," large public works projects in particular. On the former, I agree. On the latter, this essay is intentionally its diametric opposite. No, do not add fertilizer, weed the garden. Fix zoning, regulation and so forth -- rather than build a second high speed train on borrowed money, this time from, say Chico to Colusa, and count on "demand" and "multipliers," while leaving the weeds alone.

  29. Beyond brilliant, bravo. Should be distributed to every ECON101 student and maybe even every citizen

  30. Monetary reform to produce a stable dollar would be the most important pro-growth economic reform of all. There is no hope of getting to 3.5% growth without a stable dollar.

  31. Excellent, my Professor. Lets hope World remain peaceful place.
    Challenges: Migrations in EU; 2. Disturbances in South China Sea 3. Apocalypse ATB

  32. I greatly appreciated this essay. Would you be willing to assign tentative numbers for the relative contributions that each of these measures could give towards achieving the 3.5% growth goal?

  33. We may think fondly of the 1950's even though wages were 1/3 of what they are now, but it is the growth rate that I think people feel, not the relative wage level. If one can imagine that someone making $15K/year is analogous to some one travelling at 15K miles/year that what we feel is differences in accelerations (growth rates) whether in our speed and/or direction. And in the 1950's we were accelerating faster than we are currently. Acceleration feels good, we are going somewhere and at a faster rate - like takeoff in a jet airliner. But when you reach 540 miles/hour you plane off and don't feel any accelerations other than directional changes (up/ down, left/right) -bumps.

    To keep the same acceleration rate going from 10mph to 60 mph in 6 seconds would mean the rate of going 100 mph to 600 mph would be constant at 6 seconds. Just keeping the mass constant would require an accelerating increase in energy. Cars cannot accelerate forever, nor can jets, but it is the accelerations (+ or -) that we feel. Living beings go through different growth rates during their lifetimes, as my four month old granddaughter has doubled in size since birth, and trees don't accelerate to the moon. Absolute size and big numbers do matter.

    But as behavioral finance has taught us is that losses hurt more than gains make us feel good. So we hire government to even out the business cycle and eliminate depressions, but what if that's not correct? We just spent a lot of resources to eliminate the pain of our most recent financial crises based upon what we learned from the Great Depression, but is the tradeoff slower future growth rates?

    To increase engine output so we can go faster at a faster rate one would not want to put a "regulator" or "governor" on an engine. Look up "government" and "stimulus" in the dictionary and see if you find the term "government stimulus" to be an oxymoron. We use "government" to slow down and regulate our society to conserve our resources, - so we don't over rev our engine and blow the whole thing up (depressions) and start over again. -Blue-collar economist, Mike McCune

  34. Nice essay indeed. I'd be interested to see your comments on
    (1) A shift from income and other transactions taxes to property taxes (

    (2) Should tax exemptions for non profits and churches be ended?

    (3) What about publishing standardized tables performance for municipal utilities (and other legal monopolies) as a means of benchmarking/pushing for improvement.

    (4) We need to call carbon taxes (and other Pigouvian taxes) "fees" or otherwise, as they are AIMED at changing behaviors, not raising revenues:

    1. 1) Consumption tax, not property tax. Reasons too long for this note. 2) And universities too. And political action committees. And foundations. 3) Don't know enough to comment. 4) Excellent suggestion.

    2. David,

      Property taxes can create a situation of forced liquidation. There is also the problem of valuing property that has a low turnover rate.

  35. John, had you been asked to be a CNBC debate moderator for the last Republican debate, what would you have asked each of the candidates? Do you think they would hate you for asking it?

  36. I am intrigued by the notion that demand deposits should not be used to finance risky investments. However, the solution of increasing the amount of equity is no solution at all since all but a majority equity stake represents too much leverage that is susceptible to a bank run. Since banking has been defined as taking short term deposits and lending it out in longer term loans. It would be useful to think of how to restructure banking to maintain the lending function while honoring the need for customers to have access to non-negative demand deposits. My thoughts are that a lot of lending consists of self-liquidating loans. The fact that a lot of the principal comes due on a daily basis should provide a source of liquidity in the event that demand deposits are recalled in a sudden and extraordinary basis. A substantial percentage of demand deposits should be held in the form of reserves which could be short term treasury debt. Another percentage of demand deposits can be tied to self-amortizing loans. However the majority of lending should be done on the basis of a riskier equity or bond type product. How about an ETF that provides exposure to auto loans, credit card debt, mortgages and student loans? I'd love to have that kind of option in my Vanguard account, one that is extremely liquid with low fees. Such a product could be diversified enough to provide a substantial dividend - paid out at a rate of close to 100%, and yet be subject to losses as in any risky investment. The only way to get your money back would be to either trade the ETF or if it is in the form of a bond or CD, wait until its maturity.

  37. Terrific essay, but I tend to think of proposing exponential growth on a finite planet as an indicator of psycho-pathology. Maybe there could be an asterisk defining "growth". Or move the growth part to the end of the essay. Exulting over current growth may be premature in the overall complete debt cycle. It is at least partly the spending down of our amazing fossil fuel capital windfall. Or let an ecology professor colleague criticize the growth idea, it's possible I am wrong.

  38. What's your thoughts on phasing out the fractional reserve banking system as well and returned to a full-reserve banking system?

    Given the fact that the fractional reserve banking system creates money out of thin air and creates such money as debt that must be owed back.

    1. John,

      That depends what the underlying asset that backs reserves is. I don't think we can go back to full reserve banking under a gold standard. However, an energy backed standard ($1 always buys 10kWH of energy) has some merit.

  39. "The average American is more than three times better off than his or her counterpart in 1950. Real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars."

    Confuses mean and median. Haven't median incomes grown slowly for quite some time now?

    1. And total debt (public and private) has risen from $2,890 per person in 1952 to $184,000 per person today.

      You really think that is sustainable? Income rises 312% but debt rises 6,360%?

    2. liberals don't count debt...they assume it is someone else

  40. Allowing foreigners to participate in our markets provides increased wealth via increased specialization. However, allowing them to become citizens isn't necessarily conducive to long-run growth. It depends on whether they embrace our political institutions which have given rise to Western economic wealth---private property, open markets and limited government. If large numbers of immigrants holding beliefs inconsistent with our basic economic arrangements become voters, they then have the ability to alter the prospects for long-run growth. Witness the consternation arising in several European countries over immigrants believing in the supremacy of Shariah Law becoming a majority of voters.

    1. Anonymous,

      "Allowing foreigners to participate in our markets provides increased wealth via increased specialization."

      If the only markets were the markets for goods - that might be the case. U. S. is very good at producing widgets, China is very good at producing thingamajigs. Both benefit from trade.

      Capital markets change things significantly.

      "However, allowing them to become citizens isn't necessarily conducive to long-run growth."

      How about just subjecting them to taxation via tariffs? If foreigners can invest in securities that are paid from U. S. tax revenue (government bonds), then they can surely contribute to U. S. tax revenue.

  41. "including the requirement that your fellow citizens buy electricity back from you at retail prices,"

    Quick, what's the retail price of green electricity produced mostly on a hot sunny summer day? If I were paying retail for brown electricity produced at night and selling back green electricity produced during the day, I'd be turning a profit. I don't remember PG&E sending me a W2 form or something similar so that I can pay taxes on those profits...

    Maybe instead of paying people who install solar panels on their roofs for electricity, we would prefer to pay for new transmission lines. You do, of course, realize that solar panels produce most electricity precisely when transmission lines have both their lowest capacity and highest demand, right?

    Given that you clearly don't know Jack about solar electricity in California, why should we believe you know Jack about anything else?

  42. From post above:
    There is little evidence that the children, grandchildren, and great-grandchildren of illegals will do much better. Samuel Huntington looked at this subject in his book, “Who Are We”. See Table 9.1 on page 234. The bottom line is that educational attainment rises from the first to the second generation and then plateaus at levels far below the national average. For example, even by the fourth generation only 9.6% of Mexican-Americans have a post-high school degree."

    There is plenty of evidence to the contrary.

  43. This is an excellent essay. Kudos.

    I would add to it the solution to obtaining the good policy you advocate. We have to restructure the political system to wring cronyism out of the system. Good policy changes - which necessarily means changing the status quo - is blocked by cronies who benefit from the status quo. They protect their position by financing and staffing the campaigns of politicians who bend government policy to protect their sinecures.

    The solution? Take away the power of the funders. How? Make campaign contests so tiny that money is not powerful.

    How? Subdivide the current legislative districts in CA into 100 tiny ones. Those 100 caucus and elect a Working Committee member from that large district. Result? Still 120 representatives in Sacramento. But because they are elected first in tiny districts (5-10,000 persons) they don't need money or staffs or full time campaigning to win.

    They go door to door in their tiny districts, meeting each constituent. They then caucus with the 99 others similarly elected, none of whom needs campaign financing or staffing.

    Result? Legislators are elected based upon meeting their constituents, demonstrating their character and knowledge of issues. There is genuine competition in such small races. And funders - who want to protect the status quo and their profits - lose their overwhelming power.

    Please investigate this idea. You can reach me through that site.

  44. No offense to your thesis but in regard to regulations, I believe Congress is powerless to remove regulations. Here's why. I'm self employed and to further my business I use a small airplane. Since aircraft are usually made of aluminum instead of steel they don't rust away like old cars and thus, as a practical matter they last indefinitely. For example, my Beechcraft was made in 1954 (at a time when Boeing was still rolling out brand new B-52s). Just as the Stratofortress (also made of aluminum) remains the backbone of bomber command, antique airplanes (like mine) are still in active use - while flying as fast, as far, and as high as a brand new versions.

    Here's the rub; upgrading antique aircraft to use the exact same GPS map, autopilot, instrument, or even switches as those used in many brand new aircraft is not allowed by the FAA. Why? It's because bureaucrats have developed categories based on who supplied the labor for building the aircraft. Pointless because most 4-place airplanes fly 150-180mph, go about 700 miles on a tank of gas, and do so while sharing the exact same airspace.

    Absent these regulations I'd book the avionics shop for $20,000 worth of new gizmos immediately and because antique airplanes (more than 25 years old) outnumber those produced in the last 10 years by a factor of 20:1, that's a lot of airplanes disallowed form purchasing some of the latest avionics (almost exclusively made in USA, by the way). Multiply me by hundreds of thousands of aircraft owners and we're talking real money but worse, because many of these new electronic devices actually make flying safer, it could be argued the FAA is actually increasing the risk of flying. This is nuts!

    Since there are thousands of similar examples of government regulations, is anyone still wondering why the US economy is stuck in neutral? My favorite analogy is this; just like sending American sprinters to the next Olympics while saddled with 100lb sacks of concrete would mean no gold medals, our bureaucrats weighing down US business hurt the economy. However, the travesty is this; Congress can do zero about FAA-regulations like these because the bureaucrats are in control.

    Here's the proof (again using the FAA). In 2012 the US Congress provided for aeromodeling in the FAA Modernization and Reform Act. Within Section 336 (of the act) they prohibited the FAA from promulgating any new rule or regulation regarding model aircraft. Yet in defiance of Congress, the FAA just promulgated new rules forcing modelers to register (if they fly a model airplane weighing more than 1/2 pound). Note, it's the modeler, not the model which is registered.

    Why? It's due to the explosion in interest in drones. That, plus the fact airline pilots have reported seeing them flying nearby. Seems reasonable the FAA would take an interest, doesn't it? Here's the rub. Since pilots see drones, they also see birds . . . millions upon millions of birds. Birds often weighing more than 10 lbs (Canadian geese easily go to 14 lbs). Since I've dodged buzzards at more than 10k feet, I'm far more afraid of them than toy airplanes flown a few hundred feet off the ground.

    Yet considering Congress specifically exempted modelers from new regulations and the FAA issued new ones anyway, I interpret this to mean the bureaucrats are running amok and Congress is powerless. Since complaints without solutions are pointless, here's my idea; let's repeal 'all' the regulations. Sicne regulations are necessary, next have the bureaucracies submit every single proposed regulation to a vote by affected citizens. Not an NPR where we can comment and are routinely ignored but a genuine vote. If they can't get a win, the regulation goes away. Then let's watch the U|S economy really grow!

    John Beech

  45. Source of Growth


    In your article you focused on productivity of the individual worker. While you mentioned growth in the workforce and availability of investment capital, they were given a minor role in growth.

    The key is the interplay between those three factors.

    Growth related to the workforce comes from the domestic birthrate and immigration (or the negative: emigration, state to state or country to country) and the labor participation rate. New entrants provide competition and new skill sets, if we're doing immigration right. Many of these immigrants are highly motivated and entrepreneurial.

    Investment is key to growth, whether it be in education of existing workers in new methods of operation, automation, or the seed money to launch a new venture.

    Any moves by government should consider the impact on these three factors. The 21st century worker must deal with a dynamic economy and periods of unemployment, whether instigated by his employer or by his own volition. We want to encourage quick re-entry and personal flexibility.

    Obviously, we want to improve the quality of immigrants. The best way to do that is to allow immigrants to self-select, by offering opportunity to succeed but no free ride.

    Finally, we want to encourage investment by domestic and international sources. An attractive tax profile is just one of the factors, in a package of economic freedom designed to attract investment. Accelerating growth is another factor that attracts investment, because it improves the likelihood of rapid success.

  46. John:

    Late comer to your blog from a recent link in John Mauldin's "Outside the Box".

    My full name is Nedland P Williams, a businessman and author of "Fixing Everything: Government Spending, Taxes, Entitlements, Healthcare, Pensions, Immigration, Tort Reform, Crime..."

    Really enjoyed your article and while I agree with most of it, I will make additional comments on the various sections. I also have enjoyed the comments, and while some of them were "snarky", most were excellent.

    I hope that others will continue to comment positively or negatively on my offerings.

  47. Restoring Growth

    While I agree that we should do what we can do, in pulling out weeds; when you have briar patches like the tax code and the welfare system and the Br'er Rabbits (lobbyists/welfare queens) are thumbing their noses at us, it may be time to plow those fields under and start fresh.

  48. A consumption tax makes good common sense without question. However, VAT rates are far less visible than the income tax rates. This has allowed those governments that employ the VAT to raise these taxes without direct consequence. The result has been VAT rates in Europe that stifle investment and economic growth, for example. As such, they become more destructive than the income tax alternative. Sophie

  49. Taxes - Basic Principles

    Almost all current taxes are consumption taxes paid by the ultimate buyer of the product or service, in the final price paid.

    Income taxes are not paid by the employee, but rather by the corporation who pays gross wages, who in turn is paid by consumer. Taxes paid on components are paid by the corporation, who in turn is paid by the consumer.

    Therefore, the difference in theory between various tax programs that generate the same total amount of tax is when and where tax collection occurs.

  50. Yogi Berra had it right:"in practice, it's different."

    Gross salaries currently have provision for taxes included. If you were to switch to a FairTax or all in VAT, gross salaries would not be reduced and taxes would be calculated on the much bigger cost base. Those in high income brackets would see a tremendous boost in take-home pay, where those at the bottom, not so much. "FairTax, the Truth" on a note on page 143 estimates this would result in cost push inflation nationally of 24.8%.

    There is an additional complication that states might see the FairTax windfall to high earners as an opportunity for increasing state income taxes, which would not increase the price of the item.

    So you are correct that earned income should continue to be taxed.

    Whether businesses are taxed with a corporate income tax or a VAT makes little difference, as long as gross salaries become a deduction from the VAT tax base. If not double taxation occurs. Politicians (Ted Cruz/Rand Paul) seem to like the idea of the double tax since it allows them a "lower" tax rate that hides the true level of taxes.

    1. To qualify the above: the tax on "gross salaries" should "become a deduction from the VAT".

  51. Taxes - Political Considerations

    It is estimated that tax compliance requires 6.5 billion man-hours, which translates into 3.25 million man-years. Eliminating half that time would be the equivalent of adding 1% to the national workforce, possibly boosting the nations growth rate by 1% annually. The people released into productive efforts include some of our smartest people. It is also quite possible that the leaders of major businesses spend way too much time developing tax strategies.

    The simplest earned income tax would be a flat tax. Businesses would take accurate withholding on gross income. There should be no need for employees to even file annual tax forms. However, without some mechanism to make such a tax progressive for the bottom quintiles the flat tax is a political loser.

    My recommendation is to fix the "safety-net" at the same time, with an Unconditional Basic Income (UBI) that would go to all citizens monthly, regardless of income. Distribution would be severed from tax collection.

    The amount of the UBI would be 100% of the poverty line. Less and you cannot eliminate federal welfare and financial poverty for citizens. [States and charities would be free to provide additional support.] Unemployment and disability benefits would be reduced dollar for dollar. This would eliminate many of the disincentives against employment.

    Medicaid, Social Security, and Medicare would also be reduced dollar for dollar, so there would be no net change. However, because the UBI would replace 1/3 of Social Security and Medicare with a government guaranteed payment, it would open the door for future replacement with private retirement accounts.

  52. Taxes - Political Considerations

    For more on this subject, I have several YouTube videos. Here's the link:

  53. "If you don’t kill a tax completely, you do nothing to simplification of the tax code." --Life would be so much simpler if private earners knew a little about the income tax law, as written. The salient parts (amidst tons of obfuscating legalese) are available at In a nutshell, the first IRCode of 1862 clearly states that it is an excise, that is: voluntary tax- if you testify that you (are a taxpayer) had gross income: "earnings derived from the exercise of federal privilege" -IRC definition, then you make yourself liable. If you testify that you had private earnings (non-taxpayer) then you are not liable for the tax. Your testimony "must be accepted as the fact" (IRC 1862) unless rebutted by your payer: federal govt as interested second party to the transaction. The govt, as a disinterested third party to private payments, cannot rebut your testimony. What does happen, only since 1942 with the Victory Tax withholding scheme, is that the IRS coerces non-taxpayers into perjuring themselves and testifying to be taxpayers on the 1040. Result: self incrimination guarantees 100% tax court victories for the IRS. --Pat Palmer, Tucson AZ

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