Friday, May 03, 2013

Bipartisan Socialism and Subsidizing American Business

-- Posted by Neil H. Buchanan

One of the recurring themes of my Dorf on Law posts over the years has been to expose the logical inconsistencies in standard economic arguments.  Usually, this involves showing that the "neutral," or "objective," or "scientifically required" implications that all too many economists consider to be non-normative are being used (mostly, I think, on purpose) to import a normative agenda into the policy discussion.  Many philosophers of science (and even some economists) have noticed this over the years, of course, and the interesting meta-question is why this obvious fact -- that there is no neutral "state of nature" from which a disinterested social planner could derive efficient rules and policies -- is so frequently ignored by economists and policymakers alike.

This is obviously a big topic, which can be addressed in a rich variety of ways.  Today, I will think small-ish, offering a few preliminary thoughts that might later develop into a larger project.

Politically motivated people in the U.S. (and elsewhere) who try to apply the simplistic lessons of orthodox economic theory take as a matter of bedrock principle that the government should not favor one activity over the other.  Even people who concede that there is no such thing as true neutrality often nevertheless insist that the best approach to policymaking is to "allow the market to work" and thus to adopt a policy that does not "put a thumb on the scale."  That is the core principle behind laizzez-faire economics, and that principle is used to argue against the welfare state, against redistributive taxation, against the regulation of businesses, and so on.  If the government picks winners and losers, we are told, then the market works less well than it could and should.

This makes it especially surprising that both parties in the U.S. -- the far-right Republican Party, which is the heir to a formerly center-right and right party of the same name; and the center-right Democratic Party, which is the heir to a formerly center-left party of the same name -- compete to create incentives for businesses to increase the amounts that they invest in new factories, equipment, and so on.  Historically, Democrats have preferred to subsidize business investment through the tax code, while Republicans have preferred simply to reduce taxes on profits (especially capital gains).

There is both a short-run and long-run aspect to this.  In response to the Great Recession, even the post-stimulus policy responses from Congress have included extremely generous tax provisions designed to increase business investment (especially by small businesses -- the "job creating" darlings of the current Republican Party).  But even when the economy is strong, the tax code has baked-in subsidies for business investment, most prominently in the form of "accelerated depreciation deductions," which are simply nod-and-wink provisions that allow businesses to pretend that their investments are wearing out sooner than they really are.  This increases a business's deductions, and thus reduces the taxes that the business must pay.

These provisions, according to most research, are notoriously ineffective in actually increasing investment above the levels that we would otherwise see.  (This is true of both parties' preferred methods of encouraging investment.)  Let us put that aside, however, and assume that the goals of the policies are met, that is, that businesses spend more of the economy's resources on investment each year than they would otherwise be willing to spend.  Why would a political culture that reveres laissez-faire economics view that as a good outcome?

Or, to put the point more provocatively: Why are Republicans and Democrats alike so interested in defying the free market by socializing business investment?

The only possible answer to that question is that people must be assuming that investment would be too low without the tax incentives.  But compared to what?  Obviously, we do not want to use all of society's resources each year to invest in future production of goods and services, because we have to use some of those goods and services to keep ourselves alive and to enjoy some of the fruits of our labor.  How to balance the tradeoffs?  The standard answer, of course, is to rely on the price mechanism.  People choose between buying diamonds and water, or apples and bananas, or taking a vacation and working overtime, in response to the prices that they face for each choice.

There is, of course, a price that reflects the relative cost of present versus future consumption.  It is called the interest rate, and it tells us how much future consumption we lose by engaging in $1 of current consumption (and thus not investing that dollar in future output).  We are told to reluctantly accept the cold logic of the market when it tells us that financiers are "worth" more than social workers, or that healthy food is more expensive than unhealthy food, so why are we not told to just suck it up and accept whatever level of investment that the free market generates, without trying to subsidize it?

The standard economic model only has one answer to this: market failure.  Despite the deep skepticism inherent in orthodox economic theory to the idea that markets can fail (or that attempts to fix those failures will not be worse than the failures themselves), there is at least a logical case to be made that the present-versus-future tradeoff will not be made in the real world in a way that reflects true underlying costs and benefits.  There might be biases toward present consumption, for example, either through myopia or (for longer time periods) the inability of not-yet-born people to express their preferences.

There is a lot to unpack in all of that, of course.  Much of it harkens back to my work on generational justice, for example.  Here, let me simply pose a slightly different question.  Suppose that one believes -- truly believes -- in the Invisible Hand, but that one is also realistic about the possibility that market failures exist.  If we could correct the market failures, then we would not need to do anything further to subsidize or penalize any particular choices.  In addition, we can always point to particular government policies that arguably cut in the wrong direction on specific goals, so that the second-best choice is to undo the damage that previous decisions have inflicted on society.

This would suggest, however, that we can justify taking any action, so long as we can say, "This is only contingent on the correction of market failures, especially including unwise government policies that have pushed us in the wrong direction."  If that is the justification, however, then why do we consider the laissez-faire approach to be our default at all?  The assumption, after all, is now that avoiding action does not bring us back to the state-of-nature default position, but rather to a state of the world that is tainted by other bad policies and market failures.

One could imagine a believer in hands-off policies saying that, sure, the government has mucked up the world, so we have to be pragmatic and sometimes choose to undo the damage by deviating even further from laissez-faire.  But, this true believer would insist, that must be done as infrequently as possible, so that we do not mess things up even more.

Which brings us back to socialized business investment.  Most of the people who are gung ho for business investment incentives/subsidies are horrified at the idea of rough-and-ready approaches to fixing other social problems.  Why should we subsidize business investment but not worker retraining?  Why divert resources toward businesses, rather than toward retirees who under-saved during their working years.  Why do some problems get the "tough luck!" back of our hand, while others are worthy of policy intervention?

I suspect that any current politician who was even minimally capable of comprehending this question might respond by saying, "But investment increases future economic growth!"  That, however, merely restates the question, because it is simply not a given that more growth is always better.

Obviously, I am not expressing shock that politicians are logically inconsistent.  The question is why the logical inconsistency always seems to point in the same direction.  Even the people who claim to be consistent in their belief that government should not intervene in the economy have (to my knowledge) never expressed dismay that we have socialized business investment.  That is a choice, not the result of applying neutral principles to analyze the world.


egarber said...

I’m always fascinated when I have a conversation like this with conservative / libertarian friends

Me: Healthcare and education should be considered infrastructure (physical and social); those investments supplement the wider free market.

CL: But that’s socialism, and it puts us on the “road to serfdom.”

Me: (not surprised that Hayek is thrown at me). But aren’t say, oil subsidies the worst kind of socialism, since the government is choosing and determining an industry winner, in this case a preferred energy source?

CL: No. Taxes are too high, so companies need that “relief”.

Me: But if tax relief is targeted, it’s no different than direct payments to certain players, no? Further, would you please actually read “Road to Serfdom”? In it, Hayek *supports* a social safety net, but vehemently opposes government efforts to pick winners and losers in the open markets.

CL: That’s not true.

Me: Please read the book and we’ll discuss it. But if I’m right – and I am, btw – my infrastructure supplements-the-market paradigm is completely consistent with what Hayek wrote, while supporting oil subsidies stands in direct opposition.

Lots going on here, of course. But what stands out to me is the lack of even baseline understanding going in. I mean, I’m cool if somebody correctly cites something and we agree to disagree on the conclusions. But throwing out “proof” without understanding it is pretty lame.

It’s like the Laffer Curve arguments. Folks love to prop it up as “proof” that tax cuts always augment revenues, but that’s not even what the theory postulates. Instead, it says there is a point where cutting taxes can increase revenues via growth (for example, maybe if rates were 90%), but there is also a threshold on the other side -- where cutting taxes reduces revenues.

I’m amazed at how many commentators with the “economist” label jack this sort of thing up.

Michael said...

Egarber, I think your conservative/libertarian friends are ill-informed and do not understand what a free market entails.

Opposition to crony capitalism is common in libertarian circles, especially at the top, but less so with conservatives.

By the way, the oil "subsidies" are often tax breaks geared toward American manufactures - something I oppose as all libertarians should.

Also, the Laffer Curve does not say tax cuts always pay for themselves. It says in some (limited and rare) circumstances tax cuts can pay for themselves.

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