In a recent three-part essay, the Niskanen Center’s Brink Lindsey acknowledges all that the modern market system has done to incentivize innovation and coordinate the production and distribution of goods and services. He is concerned, though, that the economists who have assumed leadership of the free-market intellectual movement sometimes take the existence of markets themselves for granted. He adds a vital qualification: 

A well-functioning market system is neither self-executing nor self-sustaining. To achieve what they are capable of, markets need to be embedded in and supplemented by supportive legal, political, and social institutions. 

The idea that institutions are important to the proper functioning of a market economy is hardly new. Harold Demsetz’s work on property rights and Douglass North’s writings on institutions and transaction costs are well-known landmarks in the literature. The question of quality of government (QoG) is a somewhat narrower, but still broad question within the study of economic institutions. Bo Rothstein’s 2011 book on QoG provides an excellent overview of the literature and many original contributions. 

The scope of this commentary is much less ambitious than any of these classic works. As a “statistical portrait,” it is more descriptive and exploratory than a rigorous exercise in hypothesis testing. Still, by highlighting some key relationships, I hope to point the way to potentially fruitful topics for further research. And even with these disclaimers, the findings reported here shed light on important questions regarding the relationship of QoG to democracy, personal freedom, and the satisfaction of basic human needs.

New Research Boosts Our Understanding of the Effective Marginal Tax Rates for the Poor

Does the American welfare system adequately encourage the poor to achieve self-sufficiency, or is it a “poverty trap” that locks welfare beneficiaries into a lifetime of dependency? The question has been debated endlessly with no clear win for either side. 

In large part, the dispute turns on a concept known as the effective marginal tax rate (EMTR) faced by poor and near-poor households. The EMTR is the percentage of any additional earned income that a household pays in taxes or loses in government benefits. Critics argue that high EMTRs leave little incentive to work, and even for those who do work, they mean that their efforts do little to help them to lift their disposable incomes above the poverty level. What is the point of getting a job if taxes and benefit reductions are going to eat up 75 percent or more of your earnings, even without figuring in expenses like child care, commuting, or work clothes? Supporters of the existing welfare system argue that punitively high EMTRs are rare. They emphasize that the current welfare system, despite its flaws, does raise millions of families out of poverty.

Recent research revives the longstanding debate over EMTRs. This commentary reviews studies that suggest that despite some changes for the better, critical segments of the low-income population, especially those with incomes close to and just above the poverty line, continue to face weak work incentives. Simply expanding eligibility for existing welfare programs will not fix the problem. As explained in the conclusion, a more effective approach to mitigating the poverty trap would be to cash out and consolidate current welfare programs, replacing them with a combination of universal income supports, universal child benefits, and wage subsidies for the lowest-paid workers.

It's Time to End the Preference and Tax Capital Gains as Ordinary Income

The United States entered the COVID-19 crisis with an unusually large budget deficit for an economy at or close to full employment. Even if employment, output, and growth were to recover quickly to where they were at the end of 2019 (something that is far from certain), the deficit, under current law, will remain large.

The good news is that interest rates are likely to remain well below the rate of GDP growth for the foreseeable future, as they have since the beginning of the century. As long as that remains the case, there is no danger of an “exploding debt” scenario in which a large but constant federal deficit causes debt to grow without limit as a share of GDP. At this point, the greatest danger to the recovery is premature austerity. Still, as the recovery proceeds, we are sure to hear it argued on both economic and political grounds that the deficit should be reduced.

At that point, the search will be on for ways to close the budget gap. Although everyone will roll out their favorite spending cuts, much of the heavy lifting is going to have to come on the revenue side of the budget. As former Trump adviser Gary Cohn put it recently, talking to CNN’s Fareed Zakaria,

Our next Congress, the Congress that sits down in 2021, almost has to sit down and look at our spending and our revenue side. … How we spend money? There are a lot of places where we could cut back. In addition to that, I think they have to look at our tax system and think of ways that we raise revenue.

No area of the tax code is more ripe for reform than the preferential treatment given to capital gains. While incomes from wages and salaries face a maximum tax rate of 37 percent, capital gains on assets held for more than a year, in most cases, are taxed at a maximum rate of just 20 percent.

The benefits of the capital gains tax preference flow predominantly to the rich. Some 70 percent of the benefits go to taxpayers with annual incomes of $1 million or more, who enjoy annual benefits of $145,000 each. Benefits for households with incomes of $50,000 or less average about $10. For years, backers have tried to find broader justifications for this tax break, contending that benefits to the few somehow trickle down to the rest, but their efforts are less than convincing.

Here are some of the many issues raised by the capital gains tax preference, and the many reasons why its elimination should be at the top of the list in the search for additional sources of federal revenue.

How Household Debt Threatens the Recovery

The COVID-19 pandemic is having a disproportionate impact on the health of low-income Americans, but even those low-wage workers who avoid the disease itself are likely to suffer grave economic distress. 

In part, that is because workers with lower incomes have been more likely to lose their jobs than those who are better paid. The Pew Research Center reports that 32 percent of upper-income adults say that someone in their family has lost a job or taken a pay cut due to the outbreak. That compares with 42 percent of middle-income households who report lost jobs or pay cuts, and 52 percent of low-income households.

But pay is only part of the story. To fully understand the disparate economic impact of the pandemic, we need to look also at household wealth, or more exactly, net worth. The margin by which assets exceed household liabilities is crucial to a household’s ability to weather a job loss or a pay cut without catastrophic effects. And household net worth is not only less equally distributed than income — it is also frighteningly fragile for those in the bottom half of the population. That fragility is a major threat to hopes for a speedy economic recovery, as we will see.

COVID Pandemic Highlights Need for Reform of US Healthcare

The COVID-19 pandemic has highlighted longstanding weaknesses of the U.S. healthcare system. In a May 20 webinar sponsored by the Niskanen Center, I examined three key issues:

• Where has our healthcare system failed?
• What can be done to make it work better?
• Is healthcare reform as we know it even relevant any more?

By "healthcare reform as we know it," I mean the kinds of reforms discussed endlessly during 2019 Democratic primary campaign and before that, during Republican efforts to "repeal and replace" the Affordable Care Act. I highlight three reform models:

• Democratic candidate Joe Biden's proposal to expand Obamacare
• Republican Representative Bruce Westerman's Fair Care Act
• Universal catastrophic coverage, a nonpartisan alternative put forth by Niskanen Center.

I explain how each of these can at least partially address problems raised by the pandemic, including loss of employer-sponsored coverage by tens of millions of job-losers and inadequate provision for testing, treatment, and supported isolation. I also discuss some problems that existing reforms do not adequately address.

My slideshow from the webinar is available here. A link to the complete video, including comments by Jeff Flier and additional Q&A by participants, will be available soon. 

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A Social Safety Net for the Pandemic and Beyond

America's social safety net has been severely strained by the COVID-19 pandemic. Although the virus has affected people in all walks of life, the burden of illness and lost jobs has fallen most heavily on people in the lower half of the income distribution.

As the chart shows, those in the bottom half are the households whose financial condition is most fragile. They suffered the greatest economic harm in the 2008 financial crisis. Unlike their wealthier peers, they have not yet recovered, and they will experience even greater financial stress this time.

To cope with the economic effects of the pandemic, we need a social safety net that is fast, fair, and work-friendly. Federal efforts to provide income support in this crisis are commendable, but they have not reached everyone in timely fashion, and they have often been poorly targeted.

The safety net needs top-to-bottom reform. A reformed system would place more emphasis on cash assistance, with less in-kind and means-tested welfare. It would be "always on" in the sense that everyone would be automatically pre-enrolled for the minimum level of support needed in good times, so that aid could be quickly ramped up when a crisis strikes. It would provide adequate pay for essential workers and encourage others to return to work when the crisis has passed.

All of this and more was discussed in a webinar presented jointly by the Niskanen Center and the Center for Ethics, Economics, and Public Policy at the University of San Diego on May 14, 2020. You can view a slideshow presented during the webinar at this link or watch a complete video of the webinar, including Q&A, here.

Ozzie Zehner is at it again: Green Illusions, and Planet of the Humans

Are solar, wind, and other alternatives the magic bullets that will solve the world’s environmental and energy problems? Take a closer look, wrote Ozzie Zehner in his 2012 book,  Green Illusions. He is still saying much the same thing, in a new movie, Planet of the Humans, despite the great strides renewables have made in the past eight years.

My Niskanen Center colleague Nader Sobhani has reviewed the movie, and finds it wanting. I'll let you read his movie review. Here is a repost my own 2012 review of the book:

Zehner not only argues that green energy has technological, environmental and economic limits, but also that without an appropriate policy context, some forms of alternative energy could do more harm than good.

The dirty secrets of clean energy

The first part of Zehner’s book—by far the best—is devoted to explaining why neither photovoltaic, nor wind, nor biomass, nor any of the other alternatives to fossil fuels will be able to deliver a future of abundant, cheap, clean energy. Chapter by chapter, he brings out the environmental and economic limitations of each technology. Among the highlights—