Proof Is in the Dow

“The Obama budget is nothing less than an attempt to end the ideas of Ronald Reagan.” — New York Times

Adam Smith, the father of free-market economics, once stated, “There is much ruin in a nation.”  President Obama is out to prove it in his Newspeak program he calls “A New Era of Responsibility.”  It should be called “A New Era of Irresponsibility.”

And there’s no better proof than the stock market’s reaction to Obamanomics, which is big-government Keynesianism at its worst.  Since Obama took office, the Dow is down a whooping 15% — and that’s after the huge sell off in the market in 2008 by more than 30%.

And the market has continued to drop precipitously since Obama addressed Congress and announced his obscene $3.6 trillion budget for fiscal year 2010.  This budget includes:

the largest tax increase in history, including a monstrous tax on oil & gas (cap and trade) and the repeal of the Bush tax rates on incomes higher than $200,000 for individuals and $250,000 for couples.  Contrary to Obama’s claim, over 65% of tax filers in this category are small business owners and investors.

the highest level of federal spending since 1945, from today’s 21% of GDP to a whooping 27.7%.  This includes new entitlements in health care and energy.

Clearly Wall Street has spoken:  Obama’s tax, spend and regulate policies are a disaster for the nation.

And sadly Obama doesn’t get it.

What should investors do?  Play it conservative.  Be well-diversified in global stocks.  Maintain a high cash position, look for bargain opportunities, and keep squirreling away gold and silver coins.

And do not despair.  It is not time to head for the hills, although some wealthy friends are talking about moving to New Zealand, or the Bahamas.  (One friend of mine has already taken the extreme step of renouncing his US citizenship!)

In writing “The Big Three in Economics” (click here to order), I found that Adam Smith and his “system of natural liberty” have come under attack on many occasions by his sworn enemies Keynesians, Marxists and socialists, and has often been left for dead, but always makes a comeback.

As Adam Smith declared in his 1776 classic “The Wealth of Nations,”

“The uniform, constant, and uninterrupted effort of every man to better his condition . . . is frequently powerful enough to maintain the natural progress of things toward improvement, in spite both of the extravagance of government, and of the greatest errors of administration.”

In sum, the ideas of Adam Smith, and his modern followers, including Ronald Reagan, are far from dead.  They are only in hibernation.  The free-market giant will soon be awakened by our dire situation.

Hopefully pro-market forces in Congress (both Republicans and Democrats)  will filibuster the Obama tax increases and budget excesses.  Charities and non-profits are already up in arms about the proposed limits on tax deductions for wealthy donations for good causes.

I’m doing my part by holding the world’s largest gathering of free minds at FreedomFest, July 9-11, 2009, in Las Vegas, the focal point of liberty.  For details, go to www.freedomfest.com.  I hope you will join us.

I know I’m a dreamer but I’m not the only one.

Obamanomics Is Making Matters Worse

Unfortunately, the [Keynesian] balance week is unbalanced. ~ Milton Friedman

We have outlived the short-run and are suffering from the long-run consequences of [Keynesian] policies. ~ Ludwig von Mises

Last week, Treasury Secretary Timothy Geithner announced another solution to the financial crisis — his new “Financial Stability Plan.” Since the announcement, Citigroup has fallen 51 percent, Bank of America is down 46 percent, and Wall Street had its worst week in 2009.

So much for the Financial “Stability” Plan.

As John Adams once said, “Facts are a stubborn thing.”  The Obama model of Keynesian-style bailouts and massive deficits is simply failing to cure the growing financial crisis.

Despite all the bailouts President Obama has put forth — for the banks, the big 3 auto companies, and homeowners — the global economy is still reeling.

In fact, I would argue that Obamanomics (Keynesian economics in disguise) is counterproductive and making matters worse.  That’s because business and Wall Street recognize that there is no free lunch — government spending is piling up huge debts that will need to be paid back, probably through the printing presses.  And inflation — another evil — will come back with a vengeance.

Keynes is famous for the line, “In the long run, we are all dead.”  And that’s what Wall Street fears — that financially we are all going to be killed by excessive debt.

Lack of confidence in Obama, Geitner and Bernanke is why gold is going through the roof now, and is approaching $1,000 an ounce. The U.S. Mint is having a hard time keeping up with demand for American eagle gold and silver coins.

The problem is Keynesian-style policy, the darling of the establishment politicos and media giants.  Keynes has suddenly trumped Adam Smith.  And that’s dangerous.

One day last week, I walked into the largest Barnes & Noble bookstore in New York and saw a big display table up front with all kinds of books on John Maynard Keynes and Keynesian economics.  One book, The Return of Depression Economics, was written by Paul Krugman, the caustic New York Times columnist who just won the Nobel Prize.

Another book was called The Case for Big Government by Jeff Madrick, the editor of Challenge magazine.  I can understand writing a book in support of good, efficient, strong, and productive government, but “big” alone?  Most Americans prefer the motto “cheaper and better.”

The biggest surprise at Barnes & Noble was to see my own book, The Big Three in Economics, prominently displayed along side all the Keynesian and Marxist books.  It has suddenly become my most successful book.

Mark Skousen with the Totem Pole of Economics

But mine was the only book there that took a dim view of Keynes and Marx and their solutions to the financial crisis (always more government, more taxes, and more regulations).  For my money, Adam Smith and his followers (Ludwig von Mises, Friedrich Hayek, Milton Friedman, Murray Rothbard) deserve to be on top of the Totem Pole of Economics.

Unfortunately, Keynes is all the rage now.  The British economist became famous in the 1930s for advocating going off the gold standard, running deficits and bailing out troubled banks with easy money as a way to end the Great Depression.
Today’s politicians, from George Bush to Barack Obama, have suddenly become Keynesians during this financial crisis, spending money they don’t have in a vain effort to right the ship.  Even Newsweek has gone so far to say, “We are all socialists now.”  Alan Greenspan, the ex-student of Ayn Rand, now favors nationalization of the big American banks Citibank and Bank of America.

Every investor and gold bug should know the enemy: Keynes, the advocate of big government and the welfare state, and Karl Marx, the radical who advocated outright state socialism and total central control of the means of production.
After World War I, Randolph Bourne observed, “War is the health of the state.”  Today he might say, “A financial crisis is the health of the state.”

It looks like modern-day statists are getting their wish.  We’re getting big government, good and hard.  Adam Smith and Milton Friedman are out of favor, while John Maynard Keynes, the patron saint of bailouts, inflation, and the welfare state, is making a comeback with a vengeance.

The tentacles of the leviathan state are growing by leaps and bounds.  In 2009, global governments will be the largest shareholders in commercial banks, reversing 20 years of retreat by the state.  The costs of entitlements are exploding upwards, and Congress hasn’t had the courage to address future liabilities.  Social Security and Medicare are government-sponsored Ponzi schemes that will make Bernie Madoff’s embezzlement look like a picnic.

The late management guru Peter Drucker said, “Government is better at creating problems than solving them.” In fact, wrote a cynical Ducker, government has gotten bigger, not stronger, and can only do three things well — taxation, inflation, and making war.  According to Drucker, the state has become a “swollen monstrosity….Indeed, government is sick — and just at a time when we need a strong, healthy, and vigorous government.”  (He said all this in 1969.)  If you want to solve problems, he counseled, you must turn to business and the private sector.

But where does one get the straight scoop on Keynes, Marx, and their nemesis, Adam Smith and the followers of free-market capitalism?

I have no apologies for where I stand on the issue.  In writing The Big Three, I commissioned a Florida woodcarver, James Sagui, to create “The Totem Pole of Economics.”  (The Tolem Pole of Economics is shown on the back cover of the book.)  Clearly, my hero is Adam Smith, the author of The Wealth of Nations, published in 1776, a declaration of economic independence.

Adam Smith, the 18th century philosopher, is on top of the Totem Pole for his advocacy of a revolutionary new doctrine which he called a “system of natural liberty,” what we might call laissez faire or free-market capitalism.  He used the “invisible hand” to symbolized how the private actions of individual entrepreneurs would lead to the public good.

Today’s advocates of Smithian economics have real solutions to the crisis, as I’ve outlined in previous HUMAN EVENTS columns:  suspend “mark to market” accounting rules, make the Bush tax cuts permanent, slash the corporate tax rate, and mostly importantly “do no harm.”  Also, it wouldn’t hurt to take a look at the Canadian banking system, ranked #1 in the world in soundness (US is #40) for its conservative reserve requirements and nationwide branching.  (Not a single Canadian bank has failed in either the Great Depression or now.)

Keynes is ranked below Adam Smith, because he supported big government and the welfare state as a way to stabilize the crisis-prone capitalist economy, the “middle ground” between laissez faire and totalitarian socialism.  But as we have seen, Keynesian activism has led to much mischief in the world today, and countries that have adopted his bureaucratic, regulated mindset have witnessed “slow growth” and “stagflation” style economies.

And Marx is the “low man” on the Totem Pole.  His radical solution, government ownership and control of the production, distribution and consumption of goods and services, would be, as Hayek says, “the road to serfdom.”

Adam Smith and his “system of natural liberty” have come under attack many times by his arch enemies, the Marxists and Keynesians.  But Smithian economics has nine lives, and has always managed a comeback.  With your help, Adam Smith will return.

Click here for a copy of The Big Three in Economics.

The Necessary Evil

Suggestion – Liberty Magazine
The Necessary Evil
by Mark Skousen

Today libertarians spend most of their time lamenting the consequences of big government. And rightly so. Today government is less a defender of freedom and more a Hobbesian leviathan that undermines prosperity. When we do talk about limited government, it is often seen solely as “a necessary evil.”1 Too much government and the economy chokes. Too little, and it cannot function. Is there a Golden Mean?

George Washington best summarized the libertarian view: “Government is not reason; it is not eloquence; it is force! Like fire, it is a dangerous servant and a fearful master.”2 So it is with some trepidation that I suggest that societies or countries may not have enough good or legitimate government. In the never-ending battle against big government, it might be well to consider what constitutes “good government” to see how far we have strayed from the proper role of the state.

Each year the Fraser Institute publishes their Economic Freedom of the World Index (see www.fraserinstitute.org), which measures five major areas of government activity in more than 100 countries: size of government, legal structure, sound money, trade, and regulation. The most surprising thing about the study, according to its author James Gwartney, a professor of economics at Florida State University, is the importance of legal structure as the key to maximum performance for an economy. “It turns out,” he told me in a recent interview, “that the legal system — the rule of law, security of property rights, an independent judiciary, and an impartial court system — is the most important function of government, and the central element of both economic freedom and a civil society, and is far more statistically significant than the other variables.”

Gwartney pointed to a number of countries that lack a decent legal system, and as a result suffer from corruption,insecure property rights, poorly enforced contracts, and inconsistent regulatory environments, particularly in Latin America, Africa, and the Middle East. “The enormous benefits of the market network — gains from trade, specialization, expansion of the market, and mass production techniques — cannot be achieved without a sound legal system.” 3

The Proper Role of the State

Milton Friedman identifies the legitimate roles of the state: “The scope of government must be limited. Its major function must be to protect our freedom both from the enemies outside our gates and from our fellow- citizens: to preserve law and order, to enforce private contracts, to foster competitive markets. Beyond this major function, government may enable us at times to accomplish jointly what we would find it more difficult or expensive to accomplish severally.” 4

Adam Smith suggests that this “system of natural liberty” will lead to a free and prosperous society. As Smith declares, “Little else is required to carry a state to the highest degree of opulence from the lowest level of barbarism, but peace, easy taxes, and a tolerable administration of justice.”5

The division between the positive and negative role of government can be represented visually. In the diagram on the next page, we have on the vertical axis “socio-economic well-being”: some general measure of the quality of life in a free and civil society. For empirical studies, economists might want to use changes in real per capita income, but this may be too confining. On the horizontal axis we have “government activity.” At point O, we have zero government, and as we move along the horizontal axis, the size and scope of government activity increase. The ultimate extreme is the totalitarian regime, which institutes “total government,” though I would hesitate to label this “100% government,” since no government can control all activity.

Too Little vs. Too Much Government

My thesis is that as a society moves from zero government to point P, economic well-being increases to peak performance. Then, as it adopts a larger and less necessary government, its growth diminishes, and can even turn negative if government becomes too burdensome and controlling. Looking at the left side of the mountain, point O (zero government) to P (optimal government) constitutes “too little” government. For example, a nation may spend too few of its resources on personal protection, property control, and government administration. Here we see how increasing the size and scope of government activity initially leads to increased well-being, as measured by individual freedom and prosperity. Point P represents the right amount of government and the optimal amount of expenditure necessary to fulfill its legitimate functions.

This is the ideal of the minimalist state. Any point to the right of P represents too much government, when the central authority becomes a burden rather than a blessing. I’ve drawn it as a gradual downward slope, so that the more bad government a country adopts, the greater the decline in performance, even to the point X where government is so large and so intrusive that it results in the destruction of economic and social well-being, which is probably worse than the costs of anarchy.

Quantifying the Right Amount of Government

Can we quantify P, the optimal size of government? Several economists have attempted to determine the ideal level of government spending as a percentage of GDP. In the1940s, Australian economist Colin Clark said that the maximum size of government should not exceed 25% of GDP. Anything higher would hurt economic growth.6 Professor Gerald W. Scully, of the University of Texas at Dallas suggests that the tax rate ought not to exceed 23%.7 World Bank economists Vito Tanzi and Ludger Schuknecht analyzed 17 countries during the period 1870 to 1990 and concluded that public spending in newly industrialized countries should not exceed 20% and in industrialized countries not more than 30%.8 Is optimal government (point P) the same for every country?

This would make an interesting study, but I suspect that differences in culture and socio-economic circumstances suggest that some nations require more government than others. As Benjamin Franklin states, “A virtuous and laborious [industrious] people may be cheaply governed.”9 And a lazy, dishonest people must be expensively governed.

Graph

Optimistically, I would think that if all nations were featured together on the diagram above, the various points P would constitute a fairly narrow mountain range. Almost every country in the world today is to the right of Point P, and could grow faster and enjoy a higher quality of life by reducing the size and scope of government. Countries from China to Ireland to Chile have demonstrated how dramatically the economy can improve by cutting back the state. I’m sure even Hong Kong, #1 in the Fraser Institute’s study in terms of performance and freedom, could benefit from some improvements by scaling back some types of government services.

According to the latest surveys of economic freedom by the Fraser Institute and Heritage Foundation, countries on average are becoming more free, and not surprisingly, the world’s economic growth rate is rising.10 After noting that government represents 40–50% of GDP in most developed nations, Tanzi and Schuknecht conclude, “we have argued that most of the important social and economic gains can be achieved with a drastically lower level of public spending than what prevails today.”11

Two Case Studies in Little or No Government

Are there any examples of countries to the left of point P, that have too little government? The United States suffered from too little government under the Articles of Confederation, which was the basic law of the land from its adoption in 1781 until 1789, when they were replaced by the Constitution. The Articles limited the federal government to conducting foreign affairs, making treaties, declaring war, maintaining an army and navy, coining money, and establishing post offices. But it could not collect taxes, it had no control over foreign or interstate commerce, it could not force states to comply with its laws, and it was unable to payoff the massive debts incurred during the Revolutionary War. States were already putting up trade barriers, striking a serious blow to free trade, and the economy struggled. After the Constitution became law, the United States flourished because of improved government finances, protection of legal rights, and free trade among the 13 states.

A modern-day example of too little government is Somalia, located east of Ethiopia and Kenya, where life has been difficult and often dangerous without any central authority since 1991. For example, drivers pass seven checkpoints, each run by a different militia, on their way to the capital. At each of these “border crossings” all vehicles must pay an “entry fee” ranging from $3 to $300, depending on the value of goods being transported. Competing warlords vie for control of the countryside, which has frequently collapsed into civil war. Only an estimated 15% of children go to school, compared to 75% in neighboring states. However, a recent report by the World Bank indicates that an innovative private sector is flourishing in Somalia. This vindicates the Coase theorem, named for economist Ronald Coase, which argues that in the absence of government authority, the private sector will step in to provide alternative services, depending on the transaction costs.12 The central market in Bakara is thriving: all kinds of consumer goods, from bananas to AK-47s, are readily sold; mobile phones proliferate and internet cafes prosper. But with no public spending, the roads and utilities are deteriorating. Private companies have yet to appear to build roads — the transaction costs are apparently too prohibitive. Public water is limited to urban areas, and is not considered safe, but a private system extends to all parts of the country as entrepreneurs have built cement catchments, drilled private boreholes, or shipped water from public systems in the city.

There are now 15 airline companies providing service to six international destinations, and airplane safety can be checked at foreign airports. After the public court system collapsed, disputes have been settled at the clan level by traditional systems run by elders, with the clan collecting damages. But there is still no contract law, company law, or commercial law in Somalia. Sharp inflation in 1994–96 and 2000–01 destroyed confidence in the three local currencies, and the U.S. dollar is now commonly used. Because of a lack of reliable data, neither the Fraser Institute nor the Heritage Foundation’s economic freedom indexes rank Somalia. The World Bank concludes, “The achievements of the Somali private sector form a surprisingly long list. Where the private sector has failed — the list is long here too — there is a clear role for government intervention. But most such interventions appear to be failing. Government schools are of lower quality than private schools. Subsidized power isbeing supplied not to the rural areas that need it but to urban areas, hurting a well-functioning private industry. Road tolls are not spent on roads. Judges seem more interested in grabbing power than in developing laws and courts. Conclusion: A more productive role for government would be to build on the strengths of the private sector.”13

In short, most countries could use less government, but a few countries could use more of the right kind of authority. There is an optimal size and structure of government, and when it is reached, the result is, in the words of Adam Smith, “universal opulence which extends itself to the lowest ranks of the people.”14

Social Security Reform: Lessons from the Private Sector

IDEAS ON LIBERTY
Economics on Trial
MARCH 2001

by Mark Skousen

“Of all social institutions, business is the only one created for the express purpose of making and managing change. Government is a poor manager.”
—Peter F. Drucker 1

In the ongoing debate over the privatization of Social Security, one story has been over-looked: The private business sector in the United States has already faced the pension-fund problem and resolved it.

Here’s what happened. After World War II, major U.S. companies added generous pension plans to their employee-benefit programs. These “defined benefit” plans largely imitated the federal government’s Social Security plan. Companies matched employees’ contributions; the money was pooled into a large investment trust fund managed by company officials; and a monthly retirement income was projected for all employees when they retired at 65.

Management guru Peter F. Drucker was one of the first visionaries to recognize the impact of this “unseen revolution,” which he called “pension fund socialism” because this Social Security look-alike was capturing a growing share of investment capital in the United States.2 Drucker estimated that by the early 1990s, 50 percent of all stocks and bonds were controlled by pension-fund administrators.

But Drucker (who doesn’t miss much) failed to foresee a new revolution in corporate pensions—the rapid shift toward individualized “denned contribution” plans, especially 401(k) plans. Corporate executives recognized serious difficulties with their traditional “defined benefit” plans, problems Social Security faces today. Corporations confronted huge unfunded liabilities as retirees lived longer and managers invested too conservatively in government bonds and blue-chip “old economy” stocks. Newer employees were also angered when they changed jobs or were laid off and didn’t have the required “vested” years to receive benefits from the company pension plan. Unlike Social Security, most corporate plans were not transferable. The Employment Retirement Income Security Act (ERISA), passed in 1974, imposed regulations on the industry in an attempt to protect pension rights, but the headaches, red tape, and lawsuits grew during an era of downsizing, job mobility, and longer life expectancies.

The New Solution: Individualized 401(k) Plans

The new corporate solution was a spin-off of another legislative invention—the Individual Retirement Account (IRA). The 401(k) rapidly became the business pension of choice, and there is no turning back. These “defined contribution” plans solve all the headaches facing traditional corporate “defined benefit” plans. Under 401(k) plans, employees, not company officials, control their own investments (by choosing among a variety of no-load mutual funds). Corporations no longer face unfunded liabilities because there is no guaranteed projected benefit. And workers and executives have complete mobility; they can move their 401(k) savings to a new employer or roll them over into an IRA.

According to recent U.S. Labor Department statistics, there are about nine times more defined-contribution plans than defined-benefit plans. Almost all of the major Fortune 500 companies have switched to defined-contribution plans or hybrid “cash-balance” plans. Companies that still operate old plans include General Motors, Procter and Gamble, Delta Airlines, and the New York Times Company. IBM, a company that once guaranteed life-time employment, switched to a “cash-balance” plan two years ago, giving its 100,000 employees individual retirement accounts they can take with them in a lump-sum if they leave the company before retirement (long-service workers are still eligible for IBM’s old defined-benefit plan). But virtually all “new economy” companies, such as Microsoft, AOL, and Home Depot, offer 40 l(k) plans only.

Why Social Security Needs Reform

Congress could learn a great deal studying the changes corporate America has made in pension-fund reform. In fact, Social Security is in a worse position than most corporate plans were. Since less than a fourth of all contributions go into the Social Security “trust fund,” the government program is more a pay- as-you-go system than a defined-benefit plan, where most of the funds go into a corporate managed trust fund. As a result, the unfunded liability, or payroll-tax shortfall, exceeds $20 trillion over the next 75 years. To pay for so many current recipients, Congress has had to raise taxes repeatedly to a burdensome 12.4 percent of wages, and payroll taxes will need to be raised another 50 percent by the year 2015 to cover the growing shortfall.3 Few corporate plans require such high contribution levels.

Moreover, the Social Security trust fund is poorly managed, so much so that experts indicate that the annual return on Social Security is 3.5 percent for single-earner couples and only 1.8 percent for two-earner couples and single taxpayers.4

Clearly, converting Social Security into personal investment accounts would be a step in the right direction, a policy change already achieved in Chile and other nations. Unfortunately, government—unlike business—is not prone to innovation. As Drucker notes, “Government can gain greater girth and more weight, but it cannot gain strength or intelligence.”

1. Peter F. Drucker, “The Sickness of Government,” in The Age of Discontinuity (New York: Harper, 1969), pp. 229, 236.
2. Peter F. Drucker, The Unseen Revolution: How Pension Fund Socialism Came to America (New York; Harper & Row, 1976). This book was reprinted with a new introduction as The Pension Fund Revolution (New Brunswick, N.J.: Transaction, 1996).
3. Andrew G. Biggs, “Social Security: Is It a Crisis that Doesn’t Exist?” Cato Social Security Privatization Report 21 (www.cato.org), October 5, 2000, p. 3.
4. Ibid., p. 32.

How Many of You Are on Food Stamps?

Personal Snapshots
Forecasts & Strategies
November 2000

by Mark Skousen

“Middle of the road policy leads to socialism.” -Ludwig von Mises

At the recent San Francisco Money Show, I asked an audience of several hundred investors, “By a show of hands, how many of you are on food stamps?” Not a single hand went up. Then I asked, “How many of you are on Social Security or Medicare?” A third of the audience raised their hands.

Finally, I asked, “How many of you think you will be on the food stamp program during your lifetime?” Again, not a single hand went up. But when I asked how many would eventually go on Social Security or Medicare, almost everyone raised their hand.

My point was simple. The food stamp program is a social welfare program limited to the very poor; there’s a means test to qualify for food stamps, and most Americans attending investment conferences don’t need food stamps. On the other hand, Social Security and Medicare are universal social insurance plans. Everyone pays these taxes and at age 65 (sometimes earlier) they all participate, even though most Americans could afford their own pension program and health care insurance. Is there any wonder voters are more worried about Social Security/Medicare than they are about food stamps?

The following table shows the stark contrast between the food stamp program and Social Security/Medicare.

U.S. SOCIAL WELFARE SYSTEMS

Program Total
Coverage
Current
Recipients
Total
Annual Expenditures
Social
Security
180.0
million
44.2
million
$375
billion
Medicare 180.0
million
38.4
million
$215
billion
Food
Stamps
19.8
million
19.8
million
$17
billion

Note: Figures for Social Security and Food Stamps are for 1998, Medicare for 1997, the latest available.

Why Not “Foodcare”?

Suppose the President of the United States proposes a new welfare program called “Foodcare.” Since food is even more vital to each American citizen than health or retirement, he argues, the food stamp program should be expanded and universalized, like Social Security and Medicare, so that everyone qualifies for food stamps and pays for the program through a special “food stamp” tax. Congress agrees and passes new welfare legislation. Thus, instead of 19.8 million Americans on food stamps, suddenly 180 million or more begin paying the “food stamp” tax and collecting food stamps, representing perhaps 10% of household budgets. What effect do you think this universal “Foodcare” plan would have on the food industry? Would we not face unprecedented costs, red tape, abuse and powerful vested interests demanding a better, more comprehensive “foodcare”? And suppose “snacks” were not covered by “Foodcare”–wouldn’twouldn’t the general public start demanding that “snacks” be covered by the government because the cast of snack foods was rising too fast? Ludwig von Mises was right: “Middle of the road policies lead to socialism.”

Fortunately, there is no nightmarish “foodcare” program. Granted, there have been abuses and waste in the food stamp program, but the problems of efficiency are few compared to, say, Medicare. In fact, since 1995, the number of Americans on food stamps has declined from almost 27 million to under 20 million, and the costs have fallen from $22.8 billion to $16.9 billion. Yet has the size of Social Security or Medicare declined? Never.

Safety Net or Dragnet?

The conclusion is clear. Government welfare systems-if they should exist at allshould be limited to those who really need assistance. They should be safety nets, not dragnets that capture everyone. It was a tragic mistake to create a Social Security and a Medicare system where everyone became at some point a ward of the state. I’m convinced that if President Roosevelt had conceived Social Security in 1935 as a retirement plan for only those less fortunate to plan ahead financially, it would be a relatively inexpensive welfare program that would require taxpayers to pay at most 2%-3% of their wages/salaries to FICA, not 12.4% as they do today. If President Johnson had proposed Medicare in 1965 as a supplemental medical/ hospital plan limited to the needy, today taxpayers would be paying 0.5% of their wages/salaries to Medicare, not 2.9% as they do today. Instead, the systems were made universal, and the duplication is horrendous-and unnecessary.

Because we all pay in and we all benefit, we don’t always think straight about these “entitlements.” Example: A stockbroker recently told me about a client who called and complained bitterly about attempts by Congress to revamp Medicare. He angrily said, “They can cut spending all they want, but don’t touch my Medicare!” While the stockbroker listened patient to this man’s tirades, he pulled up the client’s account on his computer screen. He had an account worth $750,000! If anyone could afford his own medical insurance plan, it was this man. He didn’t need Medicare. Yet he saw Medicare as his right. He had paid into it all his life, and he deserved the benefits.

Imagine, what this man would be saying about Congress and food prices if we had “Foodcare.”

Having Their Cake

Economics on Trial
Ideas on Liberty
October 2000

Having Their Cake
by Mark Skousen

“The duty of ‘saving’ became nine-tenths of virtue and the growth of the cake the object of true religion.” -JOHN MAYNARD KEYNES (1)

In his 1920 bestseller, The Economic Consequences of the Peace, John Maynard Keynes made a profound observation about the success of capitalism before the Great War. He lauded “the immense accumulations of fixed capital” built up by the “new rich” during the half century before the war and compared the huge capital investment of this golden era to a “cake,” noting how “vital” it was that the cake “never be consumed;” but continue to “grow.”

Keynes was intensely optimistic about the prospects of humanity, “if only the cake were not cut but was allowed to grow in the geometrical proportion predicted by Malthus for population.” Rapid capital accumulation would result in the elimination of “overwork, overcrowding, and underfeeding,” and workingmen “could proceed to the nobler exercises of their faculties.”

Alas, it was not to be. The First World War destroyed Keynes’s dream of universal progress. The cake was consumed. “The war has disclosed the possibility of consumption to all and the vanity of abstinence to many.” (2)

War isn’t the only enemy of capital accumulation. Since World War II, the greatest threat to capital formation (the growth of the cake) has been the direct and indirect taxation of capital.

Take, for example, the federal estate tax. The estate tax is often viewed as an “inheritance” tax and even a “death” tax. But it’s much worse than that. It’s also a tax on capital. An estate’s taxable property includes stocks, bonds, business assets, real estate, coins and collectibles-all after-tax, afterconsumption investments.

If your net worth exceeds $675,000, your heirs will be forced to pay at least 18 percent to the IRS. The tax rate hits a confiscatory 55 percent at a mere taxable estate of $3 million.

Capital is the lifeblood of the economy. Capital investment finances new technology, new production processes, quality improvements, jobs, and economic growth in general. When those investment funds are taxed-$28 billion in 1998-the funds are removed from the investment pool and transferred to Washington, where they are consumed. For the most part the funds are consumed through government expenditures and “transfer payments” (welfare, salaries of government workers, and so on).

The estate tax also creates economic distortions. It encourages individuals to engage in “estate planning,” expensive legal exercises to avoid the death tax. It forces individuals to buy insurance policies they would not otherwise buy and create tax-exempt trusts and foundations that they would not ordinarily create. Undoubtedly, millions of fiends are transferred every year into foundations and charities just to avoid estate taxes. Charitable giving and public foundations have become big business, but what is the price? Mismanagement and waste are common features in these nonbusiness organizations.

Another Inefficient Tax: Capital Gains Taxes

Perhaps an even more sinister tax is the capital gains tax. If you sell an asset (stock, bond, commodity, real estate, or collectible), the profits are taxed between 20 and 40 percent, depending on how long you held the asset. (If you hold for more than a year, the maximum rate is 20 percent.) This is a terrible penalty on capital. It means that every time a stock or other asset is traded outside a taxexempt vehicle, 20 to 40 percent of the profits are removed from the private economy and sent to Washington, never to be invested again. With the recent bull market on Wall Street, annual capital gains taxes have exceeded $100 billion. What a terrible drain on the economy.

Capital gains taxes also result in economic inefficiency. Because of the high tax on capital gains, many investors refuse to sell their assets. They may prefer to switch into a potentially more profitable investment, but they stay with their original investment because they hate the idea of paying Uncle Sam. Clearly, capital would be more efficiently allocated to its more productive use without this burdensome profits tax.

The United States can learn a lot from foreign nations. Hong Kong has a flat 15 percent personal income tax, a 16.5 percent corporate income tax, and no tax at all on capital gains. In fact, most of the New Industrial Countries in Southeast Asia do not tax capital gains.

Thus capital can move freely throughout Hong Kong and around the world without distortion. And the cake has grown rapidly because of capital’s tax-free status. Hong Kong does have an estate tax on values exceeding HK$7 million, but the maximum rate is only 18 percent. (3)

Fortunately, the U.S. government has recently recognized the negative drain these taxes have on the economy. It has reduced long-term capital gains, and Congress has even entertained a bill to abolish federal estate taxes altogether.

Eliminating taxes on estates and capital gains has been criticized as a break for the rich. Moreover, critics say, estate taxes should be kept in order to establish a level playing field. They argue, “Children and grandchildren of wealthy people didn’t earn inherited money. They should have to work for it, just as their parents did. Inheritances create disincentives to work.”

But these critics fail to understand the broader implications of a large tax-free estate and tax-free capital gains. Everyone-not just the rich-benefits from eliminating these taxes because wealthy people’s capital would be left intact, invested in the stock market, businesses, farms, banks, insurance companies, real estate, and other capital assets, thus insuring strong economic growth and a high standard of living for everyone. As Ludwig von Mises once stated, “Do they realize that every measure leading to capital decumulation jeopardizes their prosperity?” (4)

As an investment adviser, I share the concern that unrestricted inheritances to children or grandchildren can be morally corrupting, but there are other solutions besides a confiscatory tax. For example, a will can limit the use of inherited funds until a certain age of responsibility is reached, or a trust can offer matching funds as a way to encourage work and responsibility.

1. John Maynard Keynes, The Economic Consequences of the Peace (New York: Harcourt, Brace, 1920), p. 20.
2. Ibid., pp. 20-21.
3. For an excellent summary of tax policies throughout the world, see International Tax Summaries, published annually by Coopers & Lybrand (New York: John Wiley & Sons).
4. Ludwig von Mises, Planning for Freedom, 4th ed. (South Holland, Ill.: Libertarian Press, 1980), p. 208.

If You Build It – Privately – They Will Come

Ideas on Liberty
Economics on Trial
August 2000

by Mark Skousen

“Government provides certain indispensable public services without which community life would be unthinkable and which by their nature cannot appropriately be left to private enterprise.” – PAUL A. SAMUELSON

If you take a course in public finance, you will invariably encounter the “public goods” argument for government: Some services simply can’t be produced sufficiently by the private sector, such as schools, courts, prisons, roads, welfare, and lighthouses.

The lighthouse example has been highlighted as a classic public good in Paul Samuelson’s famous textbook since 1964. “Its beam helps everyone in sight. A businessman could not build it for a profit, since he cannot claim a price for each user.” 1

Really? Chicago economist Ronald H. Coase revealed that numerous lighthouses in England were built and owned by private individuals and companies prior to the nineteenth century. They earned profits by charging tolls on ships docking at nearby ports. The Trinity House was a prime example of a privately owned operation granted a charter in 1514 to operate lighthouses and charge ships a toll for their use.

Samuelson went on to recommend that lighthouses be financed out of general revenues. According to Coase, such a financing system has never been tried in Britain: “the service [at Trinity House] continued to be financed by tolls levied on ships.”2

What’s even more amazing, Coase wrote his trailblazing article in 1974, but Samuelson continued to use the lighthouse as an ideal public good only the government could supply. After I publicly chided Samuelson for his failure to acknowledge Coase’s revelation,3 Samuelson finally admitted the existence of private lighthouses “in an earlier age,” in a footnote in the 16th edition of his textbook, but insisted that private lighthouses still encountered a “free rider” problem.4

Private Solutions for Public Services

The lighthouse isn’t the only example of a public good that can be provided for by private enterprise. A privately run toll road operates in southern California. Wackenhut Corrections manages state prisons. Catholic schools provide a better education than public schools. The Mormon Church offers a better welfare plan than the USDA food stamp program. Habitat for Humanity builds houses for responsible poor people.

And now, for the first time in 38 years, there is a privately built major league baseball stadium-Pacific Bell Park, new home of the San Francisco Giants. After Bay area voters rejected four separate ballot initiatives to raise government funds to replace the windy and poorly attended Candlestick Park, Peter Magowan, a Safeway and Merrill Lynch heir, teamed with local investors, to buy the club and, with the help of a $155 million Chase Securities loan, built the new stadium for $345 million. The owners also got huge sponsorships from Pacific Bell, Safeway, CocaCola, and Charles Schwab.

So far the private ballpark has been a super success, selling a league-leading 30,000 season tickets for the 41,000seat stadium. The team’s 81 home games are nearly sold out. Other team owners, whose stadiums are heavily subsidized, were skeptical, but a dozen team owners have visited the new operation to study what they’ve done. They include George Steinbrenner, who is considering a $1 billion new Yankee stadium.5

Economists Attack Public Financing

Perhaps private funding of major league sports facilities has been influenced by two recent in-depth studies by professional economists attacking publicly subsidized sports arenas. In Major League Losers, Mark Rosentraub of Indiana University (and a big sports fan) studied stadium financing in five cities and meticulously demonstrated that pro sports produce very few jobs with little ripple effects in the community, take away business for suburban entertainment and food venues, and often leave municipalities with huge losses.6

A Brookings Institution study came to similar conclusions. After reviewing major sports facilities in seven cities, Roger G. Noll (Stanford) and Andrew Zimbalist (Smith College) found they were not a source of local economic growth and employment, and the net subsidy exceeded the financial benefit to the community.7

These empirical studies confirm a longstanding sound principle of public finance: Beneficiaries should pay for the services they use. In my free-market textbook I call this “The Principle of Accountability,” also known as the “benefit principle.” It’s amazing how often politicians violate this basic concept. For example, John Henry, a commodities trader worth $300 million and owner of the Marlins baseball team, is pushing through the Florida state legislature a bill to tax cruiseship passengers to help fund a new Miami ballpark. (Fortunately, Governor Jeb Bush just vetoed the bill.)

Please, will someone send Mr. Henry a copy of my free-market textbook, Economic Logic?

1. Paul A. Samuelson, Economics, 6th ed. (New York; McGraw Hill, 1964), p. 159.
2. Ronald H. Coase, “The Lighthouse in Economics” in The Firm, the Market, and the Law (Chicago: University of Chicago Press, 1988), p. 213. Coase’s article originally appeared in The Journal of Law and Economics, October 1974.
3. Mark Skousen, “The Perseverance of Paul Samuelson’s Economics,” Journal of Economic Perspectives, Spring 1997, p. 145.
4. Paul A. Samuelson and William D. Nordhaus, Economics, 16th ed. (New York: McGraw Hill, 1998), p. 36n.
5. Peter Waldman, “If You Build It Without Public Cash, They’ll Still Come,” Wall Street Journal, March 31, 2000, p. 1.
6. Mark S. Rosentraub, Major League Losers: The Real Cost of Sports and Who’s Paying for It (New York: Basic Hooks, 1997).
7. Roger G. Noll and Andrew Zimbalist, Sports, Jobs, and Taxes: The Economic Impact of Sports Teams and Stadiums (Washington, D.C.., Brookings Institution, 1997).