In yet another example of the nanny state getting out of hand, there is a recent movement afoot to ban the sale of caffeinated alcoholic beverages, as if this is a new issue.  This article reports that Utah Attorney General Mark Shurtleff calls them “killer cocktails,” and Maryland Comptroller Peter Franchot says they constitute a “clear public health and public safety threat.”  They have already been banned in Washington state, Oklahoma, and Michigan.

Public safety threat?  Could be.  But rum and Coke has been a popular bar drink since the introduction of Coca-Cola more than a century ago.  If this is a problem, it is not a new problem.  Caffeinated alcoholic beverages pre-date prohibition.

The issue appears to be that the alcohol and caffeine are sold together in one can, already pre-mixed.  Nothing I’ve seen yet suggests that bartenders be prohibited from mixing the two.  Could that be next?

The issue seems to have gained some visibility after a number of college students around the nation ended up hospitalized after drinking these beverages to excess.  But drinking to excess isn’t new on college campuses, and I haven’t seen anything to suggest that drinking an all-in-one caffeinated alcoholic beverage out of a can is riskier than drinking old-fashioned rum and Coke to excess.

Perhaps I could see a potential issue if someone drank excessively and ended up hospitalized with no health insurance.  But Obamacare has solved that one by requiring us all to buy health insurance.

I suppose the next step would be to outlaw mixing caffeinated alcoholic drinks yourself.  Bye-bye rum and Coke.

You have no freedom if you don’t have the freedom to make what other people think are bad choices.

Politicians have been advocating a value added tax (VAT) for decades, and with the huge projected federal deficits interest in a VAT seems to be increasing lately.  Last Spring Paul Volker was suggesting one, and David Theroux recently noted in his blog Paul Krugman’s support.  Alice Rivlin and Pete Domenici suggest a 6.5% “debt reduction sales tax,” probably phrased that way to avoid saying “value added tax.”

I wrote a study on the VAT for the Mercatus Center this year, which can be found here, and have been to Washington twice in the past few months to give talks to congressional staffers in the VAT, based on my Mercatus paper.  My Mercatus paper on the VAT was even referenced in Glenn Beck’s new book, Broke, so the VAT issue appears to be on the radar of lots of people these days.

Will a VAT help reduce the deficit?  The evidence seems to lean the other way.

Greece, Portugal, Spain, Ireland, the UK, and France all have substantial VATs, and those countries also have serious deficit problems that have made the news in the past year.  So, on the surface, it appears that adopting a tax structure like those countries is not the answer to solving the deficit problem.   Look a little deeper, and the reason becomes more apparent.

There is no doubt that the initial effect of a VAT would be to inject major amounts of money into the Treasury.  The VAT is known as a revenue machine.  Over the longer run, the VAT does not add appreciably to revenues, however.

One reason is that the VAT is a very complex tax.  In theory it has the same effects as a sales tax, but in practice the record-keeping required imposes huge compliance costs on taxpayers, and adds substantial administrative costs on government.  These costs are a drag on the economy, and reduce income and economic growth.  My Mercatus paper gives the details of my reasoning here.

Once imposed, VAT rates tend to rise.  I only know of one country (Canada) that has reduced its VAT rate from its initial level; meanwhile, there have been huge increases in country after country.  Denmark initially imposed a 9% VAT; it now has a 25% rate.  The UK started out at 8% and now taxes 17.5%.  Germany started at 10% and now charges 19%.  In fact, the EU now requires its members to charge a minimum 15% VAT rate, which while lower than the rates in the EU countries I listed, is higher than all of their initial rates.

Once the VAT foot is in the door, you can be sure VAT rates will rise.  That 6.5% rate Rivlin and Domenici propose is just the “special introductory rate.”  You can be confident that if the tax were introduced, it would eventually reach European levels.

The burden a VAT would place on the economy would slow economic growth.  I did some “back of the envelope” projections in my Mercatus study — as projections of a US VAT have to be, because we don’t know exactly what one would be like — and figure that once a VAT has been in place 20 years, it would raise almost no additional revenue to fund government expenditures.

The reason for this is that while the VAT itself would raise additional revenues, the slower economic growth it would bring with it would reduce revenues from other tax bases.  Federal income tax collections would be lower because of slower income growth, and state tax revenues would be especially hard-hit because a VAT would tax the same tax base the state sales tax already taxes.

So, to calculate the net addition a VAT would make to revenues, we need to count the VAT revenue, but subtract out the reductions in other taxes at the federal, state and local level to get the amount the VAT would contribute to revenue on net.  By my calculation, after 20 years that would be almost nothing.

Is it reasonable to think that a VAT would slow economic growth?  From 1999-2004 the US had an average annual 3% rate of economic growth, while the Euro Zone countries grew at 2.1%.  In 2009, US GDP contracted by 2.4%, while the contraction was 4% in the Euro Zone, where all countries have a VAT.  No, this isn’t proof of anything, but it is some evidence consistent with the idea that if the US were to adopt a VAT and have a tax structure more like the EU, we might also run the risk of having slower economic growth rates like the EU.

And, back to the VAT, if adopting one slowed our economic growth to EU rates, then projecting out 20 years any additional revenues the VAT brought in would be offset by reduced revenues from other tax bases, so the VAT wouldn’t reduce the deficit at all.  However, by slowing GDP growth, it would make government spending as a share of GDP rise.

A VAT is not a good option for the US, and adopting one would not reduce the deficit.

Proposed law: “Be it enacted, etc. etc. that the total personnel count of the Internal Revenue Service may not exceed 80,000 for the fiscal year 2011 and henceforth.”

As every American knows, and more importantly, feels, the IRS is big brother. The IRS collects private information on every one of us; the IRS pays informers to rat on their neighbors; the IRS compels us to undertake grueling paperwork burdens, and forces us into maddening thousands-of-hours legal disputes. All its horrendous weight of makework, fear, and accusation is upheld by the threat of sending us to jail, and seizing our homes, businesses, and savings if we do not satisfy its demands. The IRS is the repugnant heart of the big government most Americans want to see diminished.

It is not surprising, therefore, that in the laundry list of initiatives to shrink the state, “elimination of the IRS” figures prominently. The problem with this proposal is that it is too extreme. It implies the end of all revenues, and therefore the end of the federal government. Since just about everyone agrees that government should exist to do at least a few things, the proposal dies. In an attempt to rescue the idea, conservatives get themselves into the tangled business of proposing an entirely new tax system—like a value added tax or national sales tax—which would have to be enforced by some new agency, one just not called the IRS. For most people, the idea of exchanging one tax system and enforcement agency for another carries little appeal, so the idea of limiting the IRS dies.

Instead of this dramatic, draconian idea of eliminating the IRS, I propose a more modest limitation: putting an employment cap on the agency. The 2009 employment level at the IRS was 90,000 permanent, full-time workers. Let this be slightly reduced, to 80,000 workers, and fixed there.

It certainly can’t be argued that the IRS needs these extra 10,000 workers to collect taxes. In 1962, the agency had 62,000 workers and got along fine. Since that time, the advent of computers has greatly eased data handling tasks at the IRS, so staff levels should have fallen dramatically. No matter how many workers it has, the IRS will always say that it needs more agents to track down those who don’t pay their full tax burden. Theoretically, the argument is correct. If the IRS put microphones in every bathroom and a tax informer under every bed in America, there would be less tax evasion—but who wants to live in that kind of country? That’s why we fought the Cold War: to defeat the totalitarian surveillance state.

As a way of shrinking big government, in practical terms this proposal is indeed modest. One is cutting only 10,000 government employees, and only marginally reducing the IRS’s burden on Americans. But in symbolic terms, this measure is revolutionary.

The main reason why the public wants big government—Social Security, Medicare, college loans, farm subsidies, and all the rest—it that it has not truly counted the cost of these measures. Most people vaguely believe that government money comes from the sky; they don’t make the connection between government’s nice-seeming giving and it’s ugly and burdensome taking. Until now, political discussion has focused on benefit programs and the nice things they are supposed to do. Understandably, the public tends to approve of them.

To seriously begin to limit big government, we must shift attention from the giving side of the welfare state equation to the taking. This proposal to limit the size of the IRS accomplishes this change of perspective. It focuses attention on the question: Do you want more or less of the intrusive, burdensome bureaucracy that takes money away?

With the debate over big government posed in these terms, there’s no question in my mind how the American public will answer.

Alan Blinder’s defense of QE2 is as feeble as Mankiw’s defense of “emergency measures” more generally. Blinder’s argument is simply that QE2 isn’t all that different from standard Keynesian fine-tuning (true) and that Ben Bernanke is smarter than critics like Sarah Palin (duh).”To create the fearsome inflation rates envisioned by the more extreme critics, the Fed would have to be incredibly incompetent, which it is not.” This reminds me of Janet Yellen’s unfortunate 2009 statement that “the Fed’s analytical prowess is top-notch and our forecasting record is second to none. . . . With respect to our tool kit, we certainly have the means to unwind the stimulus when the time is right.”

Blinder apparently thinks that the anti-Keynesian backlash is just some quibbles about this little jot or tittle. He cannot grasp that the growing sentiment against monetary central planning, against fine-tuning, against the whole statist monetary establishment, is a rejection of Keynesianism at the most fundamental level. People are tired of the philosopher kings and their pretense of knowledge.

But this is folly to the kings. Consider Blinder’s criticism of Bernanke:

What the Fed proposes to do is neither foolproof nor perfect. Frankly, it’s not the policy I would choose. As I’ve written on this page, I’d like the Fed to purchase private securities and to reduce the interest rate it pays on reserves, even turning it negative. The latter would blast reserves out of banks into some productive uses.

Ah, to think like a king! Sadly for Alan and Ben, the days of the monetary monarchy may be numbered.

[Cross-posted at Organizations and Markets]

In a roundtable discussion on the U.S. National Commission on Fiscal Responsibility and Reform (“Deficit Reduction Commission”), Nobel Prize laureate and hyper-Keynesian economist Paul Krugman came clean on his view on ABC’s “This Week with Christiane Amanpour,” regarding how to reduce the gigantic federal deficit that he has been so supportive in seeing created: death panels and a national Value Added Tax (VAT). Krugman has been among the leading figures in attacking Sarah Palin’s warnings that Obamacare, without the use of free-market pricing, would necessarily include “death panels” to ration medical treatments for the seriously ill and aged. Neglecting to propose any cuts in spending or taxes, Krugman stated the following:

Some years down the pike, we’re going to get the real solution, which is going to be a combination of death panels and sales taxes. It’s going to be that we’re actually going to take Medicare under control, and we’re going to have to get some additional revenue, probably from a VAT. But it’s not going to happen now.

The Obama healthcare plan passed by Congress in 2010 includes government-run healthcare committees with sweeping powers, including the power to engage in competitive pricing and cost analysis, a system Britain uses that has led to rationing of medical care for the elderly.

Later Krugman, in realizing that his remarks would be met with outrage, tried to cover his trail on his blog for the New York Times, “The Conscience of a Liberal,” but in the process, has only dug himself in even deeper:

I said something deliberately provocative on This Week, so I think I’d better clarify what I meant (which I did on the show, but it can’t hurt to say it again.)

So, what I said is that the eventual resolution of the deficit problem both will and should rely on “death panels and sales taxes”. What I meant is that

(a) health care costs will have to be controlled, which will surely require having Medicare and Medicaid decide what they’re willing to pay for—not really death panels, of course, but consideration of medical effectiveness and, at some point, how much we’re willing to spend for extreme care

(b) we’ll need more revenue—several percent of GDP—which might most plausibly come from a value-added tax

And if we do those two things, we’re most of the way toward a sustainable budget.

By the way, I’ve said this before.

Now, you may declare that this is politically impossible. But medical costs must be controlled somehow, or nothing works. And is a modest VAT really so much more implausible than ending the mortgage interest deduction?

So that’s my plan. And I believe that some day—maybe in the first Chelsea Clinton administration—it will actually happen.

Glenn Greenwald, Geoffrey Stone and others participate in a provocative debate at NYU Law. For those defenders of the war on terrorism who believe “the Constitution is not a suicide pact,” it becomes clear that they must also think the First Amendment is a mere technicality.

From Division of Labor:

[JB: One-ply tissue. Please use more to get the job done]

On November 4, an op-ed article written by Ben Bernanke, “What the Fed Did and Why: Supporting the Recovery and Sustaining Price Stability,” was published in the Washington Post. In this article, Bernanke presents an apologia for the Fed’s decision to undertake QE2, the purchase of $600 billion of longer-term U.S. government bonds during the next eight months. I reproduce the text of Bernanke’s article here, interspersed with my running commentary.

Two years have passed since the worst financial crisis since the 1930s dealt a body blow to the world economy. Working with policymakers at home and abroad, the Federal Reserve responded with strong and creative measures to help stabilize the financial system and the economy. Among the Fed’s responses was a dramatic easing of monetary policy—reducing short-term interest rates nearly to zero. The Fed also purchased more than a trillion dollars’ worth of Treasury securities and U.S.-backed mortgage-related securities, which helped reduce longer-term interest rates, such as those for mortgages and corporate bonds. These steps helped end the economic free fall and set the stage for a resumption of economic growth in mid-2009.

This capsule account of the financial debacle, the recession, and the Fed’s related actions strikes me as an exercise in mythmaking—and not simply because it conveniently ignores everything the Fed itself did to cause the debacle and the recession. For one thing, there was no economic “free fall.” Between the fourth quarter of 2007 and the second quarter of 2009, real GDP fell by about 4 percent. This drop is scarcely a free fall. The Fed needs to stop congratulating itself for pulling the economy away from the brink of an apocalypse.

Bernanke describes the Fed’s frantic, flailing, near-panicked actions, especially from September 2008 through the early months of 2009, in calm, measured terms, as “strong and creative measures to help stabilize the financial system and the economy.” This begs the question of whether the Fed’s actions actually did “stabilize the financial system and the economy.”

A strong argument can be made that, instead, the Fed’s actions created immense uncertainty and confusion about which commercial banks, investment banks, and other big firms would be bailed out and, if they were to be bailed out, how they would be bailed out. This uncertainty deterred private parties from undertaking the necessary revaluation of assets and from devising new arrangements, including reorganized post-bankruptcy firms, that would be able proceed on a sounder basis, as a rule under new, more prudent managements. In short, many mortally wounded firms were kept on life support by the Fed, and others clung to the hope that with some creative accounting to carry them for a while, they might ultimately secure a bailout. Think of it as the zombification of High Finance.

Even if I have misinterpreted these actions and reactions, however, we know for certain that what the Fed actually did was to acquire a variety of financial assets of questionable worth (“toxic assets”) in exchange for checks drawn on itself. That is, it engaged in a massive storm of inflation—or at least potential inflation, given that the banks and their customers have been so paralyzed by fear and regime uncertainty that the volume of credit transactions has contracted and the banks have simply accumulated vast excess reserves at the Fed, for which the Fed compensates them by paying a barely-positive rate of interest. Whether this situation can be managed without its breaking loose into inflationary disaster is anyone’s guess at this point.

Notwithstanding the progress that has been made, when the Fed’s monetary policymaking committee—the Federal Open Market Committee (FOMC)—met this week to review the economic situation, we could hardly be satisfied. The Federal Reserve’s objectives—its dual mandate, set by Congress—are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.

This reference to the Fed’s congressional mandate shifts the blame for the Fed’s discretionary actions onto what it represents to be a sort of legal requirement. But, in fact, the Fed has tremendous scope for a variety of actions, as well as for sheer inaction. Yes, it feels political pressures, to be sure. Yet it retains the capacity to undertake a panoply of policies—more now than ever, given its recent emergence as the nation’s financial central planner for credit allocation in general—and the ability to spin its decisions as wholly consistent with its so-called mandate. Bernanke’s crying crocodile tears for the unemployed looks like posturing to me.

Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy—especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.

Bernanke’s obsession with deflation is wholly misplaced. He has drawn the wrong lesson from the early 1930s, when, in addition to deflation, a host of counterproductive government actions helped to plunge the economy into an unprecedented stretch of subpar performance and mass unemployment. The idea that positive inflation may still be “too low” for the economy’s good is one of the many bad ideas that have been fostered by Keynesian and New Keynesian thinking during the past sixty years. The period of fastest economic growth in U.S. economic history, from the War Between the States to the late 1890s, was a period of secular deflation. Indeed, for centuries, in many countries, deflation, not inflation, was the rule in combination with economic growth. Bernanke has become fixated on a misinterpretation of the early 1930s, and, whether his interpretation is mistaken or not, he has accepted that exception as the rule.

Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating.

Like nearly all modern macroeconomists, Bernanke’s focus on aggregates alone prevents him from asking, “spare capacity” for what? He sees unemployed labor and capital, and he concludes that overall monetary stimulus will remedy these apparent wastes. But the effects of expansionary monetary policy will not be felt equally in every part of the economy, nor should they be. He fails to see that the unemployed labor and capital are concentrated in places to which they were drawn as a result of malinvestments made during the (Fed-fueled) boom, especially in housing construction and finance and related industries. When the Fed now creates new bank reserves via QE2, the banks, if they increase their lending at all, may simply finance—directly or indirectly—investments in commodity speculation, stock speculation, or other expenditures that only inflate new asset bubbles.

The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.

This policy-making on the basis of the latest observations of inflation and unemployment not only demonstrates a supremely unjustified faith in the Fed’s ability to micromanage the macroeconomy, but also betrays an obtuseness to one of Milton Friedman’s best-known empirical claims, namely, that between changes in money and changes in macroeconomic aggregates such as output and inflation lie long and variable lags. So, even if the latest observations of aggregate variables were accurate and were all the information that matters, the Fed’s belief in its ability to make successful policy on that basis would be utterly unfounded. When the Fed throws a rock into the lake, the ripples keep spreading, and future changes in winds and water currents affect precisely where and how quickly those ripples spread.

With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

Hallelujah! Let us now simply monetize the government’s galloping debt. After all, it worked in Weimar Germany and Zimbabwe. Why not here, too?

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action.

Again, unjustified conclusions are drawn on the basis of transient and complex market reactions. Moreover, “this approach eased financial conditions in the past” for whom, exactly? I agree, of course, that it came in handy for some of the Big Boys on Wall Street, not to mention the U.S. Treasury.

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

This “analysis” looks like the marriage of Keynesian folly and money crankiness. Just what we need, eh: to pump up the housing sector, where millions of units now sit unsold or teetering on the edge of foreclosure? Fix a malinvestment by adding to it? Not bloody likely, Mr. Chairman. The idea that real inter-sectoral, inter-industry, and interstate economic disequilibria can be cured simply by debasing the currency is snake-oil of the worst kind.

While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.

One cannot help but wonder whose costs and benefits were balanced, and how the Fed went about that exercise. My best guess is that the reference to this “balancing” is public-relations rhetoric to cloak a decision made on a much more subjective basis. Frequent reviews won’t help much, either, for reasons to which I’ve already alluded: the Fed cannot steer the economic supertanker with the same agility that one can display in maneuvering a small speedboat.

Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.

In short, do not worry. Even though our record is replete with policy mistakes great and small, including those that played a central role in bringing about the present dire situation, we have complete confidence in our ability to micromanage the macroeconomy and, via our central planning of credit flows, the microeconomy, as well. The conditions that kept hyperinflation from breaking out during the past two years may be expected to persist indefinitely, allowing us to keep the inflationary Sword of Damocles from breaking its thread and destroying the economy.

The Federal Reserve cannot solve all the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.

The writer is chairman of the Federal Reserve Board of Governors.

Let us pray.

Of course, in practice it will never be this simple.

Click the image to download the high resolution pdf.

HT to Mike Rozeff and LewRockwell.com.