Hillary Clinton made the news a week or so ago by saying the rich don’t pay their fair share of taxes, echoing statements President Obama has made since his presidential campaign.  But the remedy they recommend is to raise income tax rates on high-income earners.  That’s not taxing the rich, it’s taxing the productive.

Rich people are people who have lots of wealth.  People become wealthy by spending less than they earn, so their incomes can turn into wealth.  But there is a difference between income and wealth.  Someone can be rich — owning substantial wealth — without earning much income.  Someone who has inherited a fortune, for example, but doesn’t have a job, can be rich but low-income.

Meanwhile, someone earning more than $250,000 a year (apparently, President Obama’s threshold for determining who’s rich) might have little wealth.  One could imagine, for example, a heart surgeon who’s just finished her residency starting out with a high income, but little wealth, and maybe even negative wealth if she’s put herself through medical school by taking out loans.

If someone were really serious about taxing the rich, they’d advocate taxing people on their wealth, not on their incomes.  For example, Bill Gates, and Warren Buffett, two people who have advocated higher taxes on the “rich,” both got rich not through earning high incomes, but on capital gains from the increases in the values of their companies.  If Gates and Buffett were serious about taxing the rich, they’d say that rather than paying income taxes they should be taxed a percentage of their wealth they’ve accumulated.

I’m not advocating actually taxing the rich.  I think it’s a bad idea.  What I’m saying is that when people say the rich should pay more, they never advocate policies that actually would make the rich pay more.  They advocate policies that would make high-income people pay more.

People’s incomes (much more than their wealth) come from their productivity, so when people advocate taxing the rich by increasing income tax rates, they’re not really advocating taxing the rich (because they’re not advocating a wealth tax), they are advocating taxing productivity.  It should be obvious that increasing taxes on our most productive citizens is counterproductive.

People in government tend not to recognize how much risk there is in earning high incomes.  They picture high-income individuals earning salaries just like minimum wage workers earn the minimum wage.  They don’t see that those high incomes come from the people who earn them making risky choices.  The entrepreneurship that drives our economy and gives us continual economic progress comes from those high-income risk-takers.  Raising taxes on high income individuals will reduce entrepreneurship and slow growth.

President Obama and Secretary Clinton are not the only ones who confuse high-income people with the rich.  Here’s a piece by the Tax Foundation attacking Clinton’s statement that the rich don’t pay their fair share.  But the Tax Foundation too confuses the rich with high-income earners, noting that people earning more than $212,000 pay more than 40 percent of federal taxes.  We can safely call those people high-income earners, but we have no evidence as to whether they are rich.

What we’re really debating, then, is whether productive individuals are paying their fair share, not whether the rich are.  We need to make the distinction in public debate between “rich” and “high-income,” because they are not the same thing.  The current administration is calling for higher taxes on the productive, not on the rich.

In my earlier post I outlined the way that economics is applied to analyze incentives in the legal system. The most fruitful area of research in this vein, and arguably the most important one, has focused on the behavior of judges. Unlike consumers and producers in market settings, the relevant incentives for judges’ behavior are usually not denominated in money terms. One exception is bribery. Another is to look at judges’ salaries and how their decisions might affect them. But these are relatively specific issues within a broader set of questions about how judges respond to incentives generally. Several chapters in The Pursuit of Justice extend this area of work.

Since judges usually don’t incur direct money costs by ruling one way or another, we have to measure their incentives in another way. This is where public choice theory offers an advantage. Broadly speaking, public choice seeks to determine whether observed outcomes are systematically different when under different institutions. For judges, then, a good starting point is to compare their decisions under different selection methods, such as elected versus appointed judges. Simply put, elected judges might have the incentive to rule in ways that will get them re-elected. Appointed judges, on the other hand, might have the incentive to represent the interests of the political offices that appoint them. Within the elected-versus-appointed dichotomy, we can insert even further institutional details. Elected judges, for example, might be elected in partisan elections where they run on party-line ballots alongside candidates for legislative and executive offices. Or, elected judges might be elected in non-partisan races. The basic premise is that these different institutional environments confront judges with different sorts of incentives, and we ought to be able to observe the effects in the way the legal system functions.

The American states provide a natural laboratory for testing these ideas. In 29 states judges are appointed by the governor and/or legislature. In the other 21 states judges are elected. Thirteen states have non-partisan elections, and the remaining 8 have partisan elections. In Chapter 3, economists Russell S. Sobel, Joshua C. Hall, and Matt E. Ryan present survey-based data on the perceived quality of each state’s overall legal system. Controlling for education of the populace, judges’ salaries, lawyers per capita, and voter ideology, the authors then estimate the influence of selection type on perceived quality of the states’ legal systems. They find that states with elected judges fare systematically worse on the quality survey, and that almost all of this effect is driven by partisan-election states. Similarly in Chapter 8, economist Adriana Cordis empirically models the effect of judicial selection methods on government corruption. Measuring corruption with data from the Bureau of Justice Statistics on federal arrests of state and local government officials, and controlling for a number of factors, Cordis finds that corruption is lower in states with appointed as opposed to elected judges.

The American counties provide even greater institutional variation, which economists Aleksandar Tomic and Jahn Hakes exploit to observe variation in the way judges rule in criminal cases. Using a rich data set of over 70,000 cases in 54 large-population counties, Tomic and Hakes uncover an entirely novel pattern. Elected judges have higher incarceration rates, but appointed judges issue longer sentences. Absent the view that incentives matter to judicial behavior, these results might be puzzling. But elected judges represent local county voters, who capture the gains of being “tough on crime” locally while sharing the costs of incarceration in a statewide fiscal commons. By contrast, appointed judges answer to statewide politicians, who are sensitive to the fiscal impact of prisons and appreciate the fact that longer sentences spread the average cost per conviction onto future administrations.

These three studies are far from mere academic exercises, as demonstrated by the recent controversy over campaign contributors appearing before elected judges who fail to recuse themselves, which escalated to the Supreme Court in Caperton v. Massey (2009).

This November, SC Senator Jim DeMint (GOP) will be facing Alvin Greene (D) in the General Election.  Greene defeated four-term state lawmaker Vic Rawl in the Democratic primary.  Greene got 59 percent of the vote.   Greene was recently booted out of the US Army, does not have a job, lives with his parents, and was arrested in November 2009 and charged with “disseminating, procuring or promoting obscenity.”  Regarding the criminal charges,  video surveillance  indicates that Greene was showing  “obscene photographs from a website” to a female victim on the University of South Carolina campus and trying go to her room without her consent.

So how did Greene pull it off??  Anti-establishment fever??  A well funded campaign?  Nopes.  It does not appear that Greene mounted any campaign at all.    The speculation is that because Greene’s name appeared first on the ballot and “Senator Greene” is catchier than “Senator Rawl” folks pulled the lever for Greene without having a clue about him.   There was little information out there about either candidate because everyone knows DeMint will easily carry the general election.  Hence, Rawl’s campaign was on a tight budget.  Folks I talked with in SC say they never saw a Rawl ad or even a yard sign.  Rawl was simply to be the sacrificial lamb in the race against DeMint.

Yes, this is an embarrassment to South Carolina, the Democratic Party, and democracy in general.  If a voter steps into the booth and does not recognize the candidates’ names, the voter should abstain.  I know I did that on several primary races.  Because of my state’s progressive-era constitution, almost every office in government is elected rather than appointed.  Thus, I often don’t know a candidate or two and thus leave the ballot blank for these offices that frankly should be appointed by the governor.

But I digress.  Should we do away with elections because of Alvin Greene.? No.  The SC Democratic Party simply failed to take the race seriously and educate the people on the two choices.  I still prefer to take my chances with the people voting and the occasional Alvin Greene rather than to leave the decisions up to my “betters” who aren’t much more appealing than Greene.  Democracy is not perfect, can be down right embarrassing, yet it is better than the alternatives.   Armed with information, the people are in a position to make reasonable choices and defend themselves against those in power.  I’ll live with the embarassment of Alvin Greene so long as we retain the power to vote politicians, who act contrary to our best interests, out of office.

This week California voters passed Proposition 14 by a 54 percent to 46 percent margin.  This measure creates a top two primary system where all candidates will participate in a single, open primary.  The top two vote-getters, whether they are both Republicans, Democrats, Greens, etc., will advance to the general election.

I don’t much care for this result.  Now, it will be even harder for pro-liberty candidates to win office.  The first-past-the-post system in place in the U.S. already makes it almost impossible for third parties to compete.  People are afraid of “throwing away” a vote for, say, a Libertarian or Constitution Party candidate with whom they agree with more so than the Republican or Democrat running.  Thus, the people hold their noses and vote for the lesser of two evils.

At least in the old system, the third parties would appear on the ballot.  Now, in California, that is gone.  Even in the primary, voters will be pushed to choose the lesser of the evils.  Voters will not be able to “send a message” via the primary to the major parties.  Instead, they will pick the candidates with an eye to just getting someone to the right of Karl Marx on the general election ballot.

For more information on Proposition 14, visit Stop Top Two.

After returning home to the United States from a trip abroad, I almost always experience a comforting sense of security. The surroundings look familiar, traffic is relatively sane, and I always know where to find a great burger when I need one. But there is something deeper going on as well. Here in the United States, if I get robbed of my property I can be pretty sure it was not the police who did it. If I am falsely accused of committing a crime, I at least know I’ll have the benefit of due process to prove my innocence. And when I plop down on my sofa with a good book, I know I can relax in the privacy and security of my own four walls for as long as I want. Citizens of most other countries can’t say these same things, and that’s too bad. So I feel fortunate to be a U.S. citizen. I have to admit. When it comes to the relatively well functioning U.S. legal system, I have a bit of a romantic streak in me.

That said, I would be foolish to let my romantic streak go too far. There is just too much evidence that speaks to widespread inefficiency, injustice, and room for improvement. Consider a few objective facts:

• Nearly five thousand wrongful felony convictions occur each year occur from mistakes in fingerprint analysis.
• The U.S. tort system imposes an implicit tax burden to the tune of hundreds of billions of dollars every year.
• Eminent domain abuse results in thousands of properties being taken each year.
• There are 2.3 million people behind bars and another 5.1 million on parole or probation in America, by far the highest incarceration rate in the world, outpacing all other developed nations by several fold.
• Perhaps it is no surprise, then, that public opinion polls consistently show a majority of Americans lacking confidence in their legal system.

What drives these outcomes? As an economist, I know that wishful thinking will never produce solid answers. Yet in reading the literature, I found that the vast majority of legal scholarship and commentary treats the law with fantasy. It pretends that law is a public good that can only be provided by governments, and since it is governments that supply law it must be the case that law serves the public interest. What I found in the literature was deeply inconsistent with what I found in the world.

Romance is no basis for studying the law. So I decided to produce The Pursuit of Justice: Law and Economics of Legal Systems . In this book, readers will find hard-nosed analysis of legal institutions as they perform in practice. Motivated by the tradition of public choice economics, which analyzes incentives in political systems, these eleven chapters all start from the methodological assumption that incentives matter in the legal system. From this perspective are derived testable hypotheses and normative standards against which to analyze the decisions of judges, juries, prosecutors, litigators, police, and forensics experts. These decision makers are people just like you and me. They are neither wizards nor saints. We we must first understand the real-world decisions they make in order to explain the inefficiencies and injustices of the legal system.

In a series of forthcoming posts here on The Beacon, I will draw your attention to some of the the specific content in The Pursuit of Justice: Law and Economics of Legal Systems. While you’ll find the analysis to be hard-nosed (think of this book as law without romance), it is also a hopeful approach. By explaining the effects of incentives in the legal system, we are better equipped to propose beneficial reforms.

A Citizen’s Guide to Surviving the Fear Mongers

Many people make big bucks these days scaring you about what’s happening, or about to happen, in the world. The media folks top the list, obviously: the more frightened you are, the more of their content you watch. There’s a second reason why media people exaggerate: the storyteller’s bias. When someone comes rushing back to the cave to tell about the saber-toothed tiger he just saw, the attention and adoration of his listeners depends on the size and ferocity of the tiger. Tell them it was a small, dead tiger, and everyone goes back to sleep.

Special interest groups have an interest in exaggerating danger: the more frightened you are, the more money you will donate to them to fight the looming evil. And politicians, for their part, can’t let any crisis go to waste. For one thing, they are afflicted with the storyteller’s bias: LOOK AT ME! is coded in their DNA. Furthermore, any danger or disaster is an excuse for another government program, so that the whole system of claiming credit, taxing the rich, and putting cousins on the payroll can be taken to a higher level.

To counter these professional fear-mongers, we need an objective guide to the disasters we are likely to face, a scientific ranking that enables us to gauge the harm in each case. The scale proposed below is based on the number of deaths involved; one can assume a proportional economic and environmental harm.

Category 1: One billion or more people killed. This is the kind of disaster that a medium-sized meteorite might cause, like the one that supposedly wiped out the dinosaurs. (You might say that this really ought to be Category 2, and let Category 1 be the meteorite that wipes out the entire population of the world. But if that happened, there wouldn’t be any politicians left to exaggerate anything, and this guide would be unnecessary).

Category 2: One hundred million people killed. The Black Death in Europe in 1330-1351 is estimated to have killed some 75 million. World War II, if you combine all the different wars and genocides taking place in that period, would perhaps fall in this category.

Category 3: Ten million killed. World War I, with 16 million military and civilian deaths, falls in this group.

Category 4: One million killed. An earthquake in China’s Shensi province in 1556 is estimated to have killed 830,000. The 1980-88 Iran-Iraq war claimed around one million lives.

Category 5: One hundred thousand killed. Many recent earthquakes fall in this category, including one in Tangshan, China in 1976 (255,000) and the 2010 Haitian one (170,000). The 2004 Asian tsunami falls here (225,000), as do major hurricanes (cyclones) that hit low-lying Asian regions. A 2008 hurricane in Maynamar killed an estimated 140,000 people.

Category 6: Ten thousand killed. An example is the Galveston hurricane of 1900 that killed an estimated 8,000.

Category 7: One thousand killed. Disasters of this magnitude are rather common, happening more or less every year around the globe. American examples include Hurricane Katrina of 2005 (1,800 killed), the 1889 Johnstown Flood (2,200 killed), and the 1906 San Francisco earthquake and fire (3,000 killed). The Twin Towers attack of 9/11 also falls in this category with 3,000 killed.

Category 8: One hundred killed. These happen practically every week, and include plane, train, and bus crashes, landslides, floods, and industrial accidents and explosions.

Category 9: Few or no people killed, but some harm, or possible harm, to industry, tourism, or the environment. Weather is one cause of these events. Storms, droughts, flooding, freezing and heat waves can have impacts on industries like agriculture, transportation, and tourism. And these same droughts and floods can kill wildlife by the millions. Forest and grass fires can engulf thousands of homes—and slay millions of nature’s creatures. Government actions—taxation, regulation—can produce income loss, unemployment, and crippled industries. Plant closures can impact cities and regions. 

The BP oil spill is one of these category-9 disasters. It involves economic damage, potential job losses, wildlife loss, and spoiled scenery on a scale experienced many times a year around the country. For example, the Nashville flood, which took place at about the same time, involved billions of dollars in damage and killed 31 people. The BP oil spill is not a reason to despair, to go off your diet, or jump off a bridge. The United States will survive and apple pie will be available for sale again when it’s over.

Why is it being treated like a category-3 disaster (which, in case you’ve already forgotten, is a tragedy on a par with World War I)?

Because, as I said, lots of people these days have a vested interest in scaring you to death.

Businesses—especially small businesses—that have managed to survive the ongoing depression face an even steeper uphill battle as Obama’s regime uncertainty continues to play out. They’ll now have to find the time and money to file an average—for small businesses—more than 200 additional tax forms annually, as explained by CNNMoney “Stealth IRS changes mean millions of new tax forms“:

The massive expansion of requirements for businesses to file 1099 tax forms that was hidden in the 2,409-page health reform bill took many by surprise when it came to light last month. …

The result: A blizzard of new tax forms that the Internal Revenue Service will begin rolling out next year.

… All business payments or purchases that exceed $600 in a calendar year will need to be accompanied by a 1099 filing. That means obtaining the taxpayer ID number of the individual or corporation you’re making the payment to—even if it’s a giant retailer like Staples or Best Buy—at the time of the transaction, or else facing IRS penalties.

As Tom Henschke, president of the Pennsylvania-based SMC Business Councils, which was one of the first organizations to call attention to the health care amendment, points out:

“Just with business travel it would include hotels, rental cars. Phone service: 1099. Computer service: 1099. Whoever does your postage meter: 1099. You do a little advertising, Yellow Pages: 1099. Your landlord: 1099. You might as well just keep them in your pocket and hand them out as you go around every day.”

At an estimated half-hour to complete each 1099, this means more than 100 hours of labor for the entrepreneur already doing his or her own books in the evenings or weekends. And with 1099s due to recipients by Jan. 31 each year, small business owners will now have to devote a considerable part of the first of their year doing nothing but 1099s. Adding an additional estimated in excess of $6,000 to the cost of filing a tax return, small businesses will find it even harder to hire or expand.

As champions of the “little guy,” Obama and Pelosi sure look increasingly like Greeks bearing gifts.

HT: Ken Barnes

I recently read the revised edition of Thomas Sowell’s excellent The Housing Boom and Bust. One of the most striking things about the role of housing in the financial crisis is the resonance of the “villains, victims, and valiant government” narrative that goes as follows: greedy bankers exploited everyone while the regulators were asleep at the wheel, and the valiant government must ride to the rescue. It makes for a good set of talking points, but it’s wrong (or, at the very least, lacking). Sowell ably traces the distorted and perverse incentives that emerged in the housing market to (seemingly worthy) political goals. As he puts it on page 31,

Like many disasters, this one began with good intentions, or at least intentions that sounded good politically. At the heart of those good intentions was the quest for “affordable housing,” another way of expressing the crusade for more home ownership among a wider range of people.

Political pressure in pursuit of this goal meant that financial institutions could make risky loans and enjoy all of the benefits while other people bore the risk, and borrowers could (sometimes fraudulently) borrow money they couldn’t pay back on terms they didn’t understand to buy houses they couldn’t afford.

Sowell illustrates some of the fundamental differences between politics and markets. When politicians make decisions and implement policies that turn out to be disastrous, they bear no personal cost and if anything, they are often rewarded by voters for “working to increase affordable housing” or “fighting for the poor” or something like that. Disastrous policies are not produced by having the wrong people in office. They are the product of the incentives in place. In F. A. Hayek’s Law, Legislation, and Liberty, he suggested that politics be dethroned. The Housing Boom and Bust shows us why Hayek was right.

Few books have had the scale of impact on a public policy debate more than has More Guns, Less Crime: Understanding Crime and Gun Control Laws, by John R. Lott, Jr. Now a decade after its first release and the raging debate it launched, the book is available as a less expensive paperback in an expanded and updated third edition from the University of Chicago Press. Relying on comprehensive data analysis of crime statistics and right-to-carry laws, the book challenges common perceptions about the relationship of guns and violent crime. For this third edition, Dr. Lott draws on an additional ten years of data—including provocative analyses of the effects of gun bans in Chicago and Washington, D.C.—that brings the book up to date and further bolsters its central theme.

In the aftermath of the U.S. Supreme Court’s landmark 2008 decision for the Second Amendment pertaining to the D.C. gun ban and federal jurisdictions overall in Heller v. District of Columbia, the Court is about to rule in the case of McDonald v. Chicago regarding the Chicago gun ban on whether the Second Amendment applies to States and localities as well.

In this regard, the Independent Institute will be hosting a very timely event regarding the McDonald case at our conference center in Washington, D.C., on June 8th, “The Supreme Court and the Battle for Second Amendment Rights.” This program will feature presentations by Independent Institute Research Fellow Stephen P. Halbrook and Nelson Lund (Patrick Henry Professor of Constitutional Law, George Mason University). To be moderated by our Research Director Alexander Tabarrok, the program will also be covered by C-SPAN, and we will be featuring Dr. Halbrook’s widely acclaimed and authoritative book on the issues directly pertinent to the McDonald case, Securing Civil Rights: Freedmen, the Fourteenth Amendment, and the Right to Bear Arms.

Stanford economics professor John Taylor has an excellent article on this topic, here, in the Federal Reserve Bank of St. Louis Review.  Professor Taylor is a highly-respected economist, writing in a Federal Reserve System publication, so it would be hard to argue that his analysis is outside the mainstream, or the writing of some fringe radical critic whose ideas don’t deserve a hearing.

With regard to monetary policy, Taylor argues that the Fed has held interest rates too low for too long, and it also did so after 2001, contributing to the housing bubble and current financial downturn.  He also criticizes the Fed for doing too much fine-tuning, rather than pursuing a policy designed to control inflation and stabilize the economy.  We’d be better off if the Fed would take Taylor’s advice, in addition to publishing his article.

With regard to fiscal policy he gives a nice summary paragraph: “For fiscal policy, this means avoiding further debt-increasing and wasteful discretionary stimulus packages, which do little to stimulate GDP.  Ten years ago there was a near consensus that such programs were ineffective.  Fiscal policy should focus on reducing the deficit and the growth of the debt-to-GDP ratio.  Reforming existing entitlement programs to hold their growth down and limiting the creation of additional entitlement programs are essential.”

If you are interested in economic policy matters, and especially monetary policy, the article has lots of facts and sound, easy-to-follow, policy arguments.  This critique of recent macroeconomic policy isn’t published by some wacko fringe group; it’s a publication of the Federal Reserve System.  (Hmm… Even as I’m putting up this post, I’m re-thinking that last sentence…)