client politics

This weekend Globe and Mail Business columnist Derek DeCloet advised us that "it's not all doom and gloom" with respect to management of the US debt burden.

Looking just at the numbers, I have to agree. The numbers indicate that the federal government probably won't be "hitting the wall" until around 2030, when the older boomers will be in their 80s and even the youngest ones retired. Joshua Rauh's paper on state pension liabilities predicts that the day of reckoning on the state level may occur sooner ("many state systems will run out of money in 10-20 years") but it's true that the United States had the superior system 60 years ago and there hasn't been a revolution that has overturned a system that has stood the test of time.

The challenge for America today is that it the competitiveness that ensured an efficient economic allocation in the past has eroded and this erosion is being exposed by inevitable globalization. While US business culture continues to support innovation and competitiveness, it must work within the context of public policy and the US public sector is in need of significant reform.

A large obstacle to reform is the influence of public sector unions; a writer for the Prospect argues that, in fact, federal workers do not receive too much because the average annual compensation of $120 000 is not the wage number: "It's salary, plus the value of health insurance, plus the value of other benefits like pensions." That's purely a marketing argument, of course, because the liability of the taxpayer doesn't change just because that $120K includes a pension element. At the heart of the public sector problem is the fact that, as a public union boss has admitted, "We have the ability, in a sense, to elect our own boss."

The fundamental obstacle to public policy change is nonetheless public opinion in the USA. A commentator to an Economist story titled "America's Deficit: Confronting the Monster" observed:

It is impossible to make [the public] understand that the optimum amount of tax to raise and the optimum way to raise that amount are separate questions. Hence the politician's adage that "the only good tax is an old tax."

The US tax system is so colossally fragmented, it was possible for the deficit commission co-chairs to cut tax brackets significantly and still generate a trillion dollars in revenue just by eliminating tax expenditures. Tax expenditures, as Greg Mankiw explains in this op-ed, are essentially the same thing as subsidies but can be marketed as tax cuts. It's a handout to a politically powerful interest group. Although Republicans are not shy about supporting direct subsidies when it suits them, they generally prefer that handouts be dressed up as (targeted) tax cuts. However one wants to describe it, the phenomenon that created the mess otherwise known as the US tax code is client politics.

The Conservative Party of Canada has imported several US political ideas into Canada, with a notable recent example being the idea that the national census constitutes a violation of privacy. Although the Republicans made an issue out of this just this summer, the real founder of the idea is Michelle Bachmann (R-Minn.), who went after the US census in the first half of 2009. Glenn Beck was left shaking his head but the Harper government seems to have thought the idea was brilliant. There has, however, been times when the federal Conservatives practiced conviction politics, albeit on very rare occasions. An example would be the taxation of income trusts. The move to tax trusts was accompanied with a move to lower taxes on corporations (hence the revenue neutrality of the decision). The tax cut for corporations, however, was much smaller on a per company basis because corporations constituted a far larger proportion of the economy. The stock market impact in a world of rational actors would have been net unchanged, because listed corporations would have risen as much in aggregate as income trusts fell. But the market is not entirely rational and the average voter even less so. The Tories were reminded of the value of client politics and the wisdom of fragmenting the Canadian income tax code (deductions for bus passes, deductions for fees associated with your kids' sports, etc etc).

One could look at the HST uproar in BC through the lens of client politics in two senses. One is that if BC reversed implementation of the tax, Ottawa would presumably get its $1.6 billion incentive back. Yet how many Canadians outside of BC are at all interested in having that $1.6 billion available for spending in their own jurisdictions? There is no meaningful constituency for reversing targeted spending. The other HST reality is that giving a break to corporations is generally giving a break that, by the sheer scale of the number of parties it benefits, is too shallow a benefit to any one of them in particular for any significant number of beneficiaries to lobby for it. It doesn't ultimately just benefit business, of course, since it is a general benefit for the economy, but that benefit is too diffuse to be politically valuable.

In Alberta, besides some "inflation proofing" now and then there has not been any new additions to the Heritage Fund since 1986. The opposition parties have occasionally called for new additions, by having a proportion of energy revenues directed into the Fund. This is an easy demand, because it doesn't address the trade-off of spending foregone. One would think that the more obvious first step would be to just call for a stop to the raiding of the Heritage Fund, with investment returns being retained in the Fund so it could grow (this year alone Finance Minister Morton plans to move close to a half billion from the Heritage Fund to general revenues). But far from demanding that Heritage Fund returns not continue to be directed into general provincial spending, the Wildrose Alliance, which markets itself as "fiscally conservative," has been missing in action. At the annual public meeting last month, MLA Heather Forsyth, who sits on the Heritage Fund committee, had nothing to say. It was left to Liberal MLA Hugh MacDonald to challenge the government on its unwillingness to save. The previous year, Forsyth didn't even show up. The spending that MLA Rob Anderson has challenged concerns not the province's wage bill but the form of spending that is most analogous to savings, namely, infrastructure investment. And why not; - client politics holds that because infrastructure can generally be used a little bit by everyone, the political lobby in favour of it is too diffused to be anything worth worrying about if it's cut.

To return to the political situation in the US, it's apparent that the country is going to have a very hard time improving the competitiveness of its public policy. Amongst the countries with the most efficient tax systems one finds many of the former Warsaw Pact states. This reflects the fact that overthrowing an old system wholesale allowed for the introduction of a new system based on the latest research.

In a perfectly competitive market, there is no "economic profit," there is only "normal profit," because any economic profits are promptly squeezed by out by competitors who instantly appear. In reality, of course, there is a time delay, and the businesses that are truly successful have as their cornerstone an understanding of the temporary nature of economic profits. There is no more reason why the United States should be the dominant global player in 2050 that it was in 2000 or 1950 anymore than the 30 firms that make up the Dow Jones Industrial Average should be the same as 50 or 100 years ago. While the "line workers" of America, Inc. may be as innovative as ever, its management is increasingly unable to adjust.