By the Editor
Introduction
After months of battering from the coronavirus pandemic and government-mandated shutdowns, our economy and the American people are suffering badly. The response from the federal government has been unprecedented, with over $3 trillion in emergency spending approved so far and Congress contemplating an additional $1 trillion. These outlays will be financed with additional borrowing, pushing the level of federal debt to alarming levels. According to the Congressional Budget Office, government debt held by the public is currently projected to grow to around 101% of GDP, up from about 78% of GDP in 2019. Even more increases are expected in the future as deficit spending continues to exacerbate the problem.
The soaring level of federal debt is a serious long-term problem our country must address, but at least we can easily track it. Perhaps more insidious are proposals for legislative and regulatory changes that would adversely affect the structure of our economy. These ideas are particularly concerning because their negative impact is harder to identify and quantify than a straightforward increase in federal debt, making the consequences more difficult to evaluate and manage. And once implemented, these types of changes can be very difficult to reverse.
This dangerous trend is evident all around us as politicians use the current crisis as a pretext to promote anti-growth initiatives that would never be able to gain support in normal times. We must vigilantly guard against policies that damage the structure of our economy and weaken our country’s ability to return to a growth trajectory. A healthy economy will provide our best chance to pay down the enormous amount of post-pandemic government debt we will face.
The following examples are representative of some of these counterproductive proposals. They include anti-growth regulations, burdensome mandates on businesses, policies that undermine the rule of law, and government interference in the free-market. Unfortunately, this discussion of harmful proposals is not comprehensive, but it provides a sense of the detrimental consequences these policies would have on the economy.
Discriminatory Interference in Markets: Government Picking Winners and Losers
Returning with a vengeance is the old saying popular among the big government crowd: “Never let a crisis go to waste.” This is clearly front of mind for many cynical politicians who see the pandemic as an opportunity for large scale interference in the economy to achieve their partisan objectives or to benefit their favorite special interests. Examples include proposals that would provide tax-payer funded subsidies to certain types of renewable energy while at the same time artificially impeding other less expensive sources of power, including low-carbon alternatives such as natural gas.
These plans can be extraordinarily wide-ranging. The Biden campaign is currently proposing to “enact a national strategy to develop a low-carbon manufacturing sector in every state.” The price tag for these government programs would be massive, adding billions and perhaps trillions to the federal debt. Other costs would flow through to American consumers in the form of higher prices. Not only is this type of government intervention very expensive, it amounts to a politically-driven national industrial policy that will inevitably be less efficient than an economy guided by the operation of the free market. As a result, productivity and growth will suffer. The government should not pick winners and losers in the economy.
Government Relief Programs Creating Disincentives to Work
The pandemic has led to government-mandated shutdowns of non-essential businesses, causing massive job losses unprecedented in their speed and severity. Understandably, the government has responded with various initiatives to support individuals and help them make it through this difficult time. However, it is counterproductive to implement programs with built-in disincentives for laid-off individuals to go back to work.
This dynamic can be seen in the design of emergency unemployment insurance. The CARES Act passed by Congress in March increased the normal unemployment payment levels across the board by $600 per week. This once-size-fits-all program has damaging unintended consequences in large part because prevailing wages vary considerably by region and by type of job. One analysis from the American Action Forum found that 63% of all workers would receive more from this unemployment program than they would earn by returning to their jobs.
Restarting businesses after the disruption of pandemic-driven closures will be hard enough, but it will be made much more difficult if workers are financially penalized for going back to work. Policymakers should explore more effective alternatives. For example, Georgia implemented a temporary program to allow people to return to work and continue to receive the enhanced unemployment insurance payments, with dollar-for-dollar reductions in their unemployment insurance kicking in only to the extent they earn over $300 per week.
Temporary Mandates on Business are Burdensome and Prone to Mission Creep
Recent legislation passed by Congress mandates that certain businesses provide paid time off for coronavirus-related absences, including sick leave and family leave to care for a child if schools or child-care providers close due to the pandemic. Businesses with less than 50 employees may apply for an exemption if these requirements would jeopardize the viability of their business.
While businesses are eligible to recoup the costs related to this mandate through a payroll tax credit, companies will face the additional administrative burden of tracking and reporting these costs and will be out-of-pocket during the time it takes to receive the tax credits.
These mandates are scheduled to expire at the end of 2020. However, many government mandates originally implemented as temporary measures have been extended, expanded, or made permanent. Indeed, the HEROES Act proposed by the House would extend these mandates for paid time off through 2021 and remove the potential for businesses with less than 50 employees to obtain exemptions.
Imposing additional government mandates on businesses will increase the cost and complexity of doing business, reducing growth potential. As a result, these types of mandates should be avoided or at least severely limited, and in no case should they be made permanent.
One-Size-Fits-All National Mandates: Increased Federal Minimum Wage
One of the most prominent examples of a damaging government mandate is the proposal from some politicians for an increase in the national minimum wage. Higher minimum wages are a bad idea in general, but it is particularly damaging to impose a mandate that will increase labor costs and discourage job creation during a severe economic downturn. Businesses are already struggling to survive and the imposition of above-market labor costs will create additional strains, causing some businesses to go out of business for good.
Labor costs and living expenses vary greatly across the country. It is very counterproductive and overly prescriptive to institute a national standard across a country with such significant differences in local cost structures. A wage level that makes sense in New York City might be ruinously expensive in Birmingham, Alabama. To allow for a return to growth, we need to keep burdens on businesses low and maintain operating flexibility across geographies.
Attacks on the Franchise Business Model
The ability to own and operate a franchised business is one of the most effective ways for small business people in our country to drive their own success. Many middle-class and working-class individuals have built their livelihoods in this way. Minorities and immigrants, in particular, have benefited from the ability to own and operate franchises.
Some on the left have been waging war on this business model. The primary angle of attack is a standard known as the joint employer rule, which is used to determine when one business is jointly responsible for the employees of another business. The issue arises when a business utilizes the services of another business as part of its operation. A franchise is one example of this type of arrangement. For decades, a business contracting for services from another entity has been classified as a joint employer only if it exercised “direct and immediate” control over the other. Some are attempting to change the joint employer standard to “indirect control” or even “potential control,” making it so expansive that many typical business arrangements, such as franchising, would be captured.
This is important because once a business is classified as a joint employer of another entity, it is jointly responsible for the labor practices of that other entity. If franchisors are legally liable for franchisee employment practices, they will have a strong incentive to take control of the franchised operations. This could make the franchise model largely obsolete.
Why would anyone want to attack such a beneficial engine of economic growth and opportunity? There are several motivations. One key objective is to make it easier to unionize businesses by pushing the independent franchisees under the umbrella of the larger franchisors. In addition, making the bigger franchisor entities responsible for the employment practices of the smaller franchisee businesses would create more sizeable litigation targets with deeper pockets.
But it gets worse. The proposed expansion of the joint employer rule could also impede other standard business practices such as contractor arrangements, temporary staffing, and outsourcing. Inhibiting the flexibility of our economy in this way would be very damaging to our country’s growth potential. The franchise model, in particular, is a powerful tool for individuals to build their own prosperity and it should be vigorously defended.
Inhibiting New Forms of Working Arrangements: The Gig Economy
A similar challenge to flexible employment relationships can be seen in recent attacks on emerging working arrangements, such as the gig economy. Increasingly, technology is being used to match independent workers with customers. A very successful example of this type of innovation can be seen in the ride-sharing platform pioneered by Uber. Customers love the benefits this service provides. Many people are now able to go about their lives much more efficiently without needing to own a car. Drivers are able to set their own work schedules.
A fundamental pillar of this business model is that drivers operate as contractors rather than direct employees. Many progressives have been agitating to prohibit this flexibility and mandate that gig workers such as ride-sharing drivers must be treated as employees of the company they have contracted with. This change would result in a host of costly and burdensome regulations including minimum working hours, minimum wages, the loss of scheduling flexibility, and requirements that gig workers receive paid time off, family leave, and health insurance.
For example, California has recently passed a law to limit the ability of its residents to choose to work as independent contractors such as ride-share drivers. The ride-sharing companies object that these requirements would significantly increase the costs of their services, making them much less attractive to consumers. If widely implemented, these restrictions would result in higher expenses and decreased flexibility so severe as to make some gig economy business models unworkable.
Predictably, California’s new law has resulted in unintended negative consequences, with a wide range of professions caught up in the restrictions. For example, freelance journalists have found that this law limits the number of assignments they can accept from any particular out-of-state publication.
Similar constraints on flexible work arrangements have been proposed in several other states and by members of Congress who see the pandemic as an opening to implement restrictions on the gig economy. There is never a good time for opportunity-killing regulations like these. But given the daunting levels of unemployment we currently face, this is an especially bad time to limit employment options.
Jobs in the gig economy are not appealing to everyone. But for people who seek flexibility and autonomy, these jobs can be very attractive. Frequently, these types of opportunities function as a lifeline for individuals in transition between jobs. Regulations that restrict these opportunities do a disservice to the people who want these types of jobs, not to mention the customers who could lose a valuable service. The government is not in a position to predict what type of employment systems will work for its citizens. This should be left to the operation of the free market which is much more able to determine which working arrangements are better suited to workers, employers and consumers.
Undermining the Sanctity of Contracts
The reliability of contractual arrangements is an important pillar of our modern economy. When two parties enter into a contract, they need to have confidence that they can rely on it. From time to time, politicians seek to subvert contractual arrangements to illegally extract value for special interests at the expense of innocent parties. During the pandemic, some have seized on the current economic dislocation as an excuse to do just that.
One example is business interruption insurance. Many non-essential businesses have been required to close due the coronavirus. Some of these businesses want providers of business interruption insurance policies to make payments to compensate them for costs incurred during the crisis, even though the policies were never designed to cover losses related to a pandemic.
Another example is government-mandated payment holidays for mortgages and rent. The CARES Act grants borrowers with federally-backed mortgages the right to payment forbearance for up to a year. About 70% of single-family mortgages fall into this category so this provision has a wide-ranging impact. While this is a unilateral modification of a contract, at least the federal government is bearing the bulk of the cost. The HEROES Act proposed by the House goes further, calling for forbearance and eviction protections for up to a year for all mortgage borrowers and renters, even those not in federally-backed housing.
These proposals would certainly be helpful to borrowers and renters in the near term, but these provisions were not contemplated by lenders when they extended the mortgages or by landlords when they signed rental leases. Other provisions of the HEROES Act propose an additional moratorium on debt collections for certain small businesses and non-profits, along with programs including forbearance options after the moratorium ends (proposed to be in effect until 120 days after the end of the crisis).
When governments retroactively change contracts, one party inevitably benefits at the expense of another party. Not only is this unfair, this type of behavior undermines the ability of market participants to rely on contractual arrangements, making the process of doing business more difficult and inefficient. Ultimately, additional costs will flow through the economic system. In the case of mortgages, imposing payment holidays and foreclosure limitations can be expected to reduce the availability of mortgages and increase borrowing costs as lenders raise rates to compensate for added risk.
Anti-Growth Tax Policies
Given all the recent proposals for increased government expenditures, it is not surprising that politicians with a “tax and spend” approach to fiscal matters are putting forward a range of suggested tax increases. After all, they say we need to pay for all this government spending. Unfortunately, many of these proposed tax changes would suppress the growth potential of our economy.
In general, lower tax levels are more conducive to promoting a healthy economy. As a country, we may decide to increase the overall level of taxation as a percentage of GDP to reduce our debt levels. If this decision is taken, it is important to design the tax code to raise revenue as efficiently and fairly as possible while preserving a pro-growth economic environment.
As we evaluate alternative tax strategies, we should avoid increasing corporate tax rates because this will discourage investment and job creation and put American businesses at a competitive disadvantage to companies operating outside our country’s tax regime. In comparison to other types of taxes, corporate taxation can be a relatively inefficient and regressive way to raise revenues because of the cost is passed on to consumers and employees.
Government Interference in the Allocation of Capital
A healthy economy relies upon the efficient allocation of capital among various investment opportunities. An important part of this process is when companies use dividends and stock buybacks to redeploy capital to more productive uses. The current crisis has encouraged critics of stock buybacks and dividends to advocate for government control of these practices.
This tendency is evident in the HEROES Act proposed by the House. This legislation would prohibit corporations from utilizing tax loss carrybacks if their distributions to shareholders after 2017 exceed 5% of the company’s equity market value. This is an unreasonable and inefficient precondition for access to tax relief. Our system is designed to tax companies over economic cycles, so profits from good years can be grouped with losses from bad years. This allows companies to plan and operate within a long-term context, increasing the overall efficiency of the economy. Bureaucrats should not weaken this important principal, particularly as part of a political effort to meddle in capital allocation decisions driven by free market forces.
In another example, the Federal Reserve’s emergency lending program prohibits certain shareholder distributions by loan recipients for one year after they have repaid their borrowings. A limitation on dividends and stock buybacks is justified while a company owes the government money, but not after repayment. This type of government interference in the capital allocation decisions made by the private market is damaging because it prevents the optimal deployment of capital and reduces the growth potential of the economy.
Federal Bailouts for States and Localities Without Requiring Budget Reforms
As part of its initial emergency response, Congress passed the CARES Act which included $150 billion for healthcare-related aid to state and local governments to assist with the costs arising from the pandemic. As the crisis continues, there are calls for much more in federal aid to state and local governments.
To be sure, the pandemic has hit state and local governments hard with increased health care costs and contractions in the economy causing severe reductions in tax revenues. But this crisis should not be used as an excuse to funnel bailouts to states that have engaged in irresponsible fiscal practices for many years. Doing so would be a drag on the economy by enabling continued bad fiscal behavior and would be unfair to states that have made difficult budgeting decisions. No further federal aid should be provided to states unless they commit to common sense fiscal reforms that will put their budgets on a more sustainable path.
The most prominent issue that should be addressed at the state and local level is unfunded public pensions. This problem varies significantly by state. According to a recent report from the Hoover Institution, South Dakota reported that its public pensions are 100% funded while Illinois calculated its public pensions are less than 50% funded. Significant unfunded public pension liabilities are evidence that states are not capable of responsibly managing their defined benefit pension plans. As a precondition for any further federal aid, states should be required to reform their public pension plans to put them on sounder footing. For example, in exchange for additional federal bailouts states should be required to transition public pensions from defined benefit plans to defined contribution plans.
Restructuring Global Supply Chains and Requirements for Domestic Production
As the pandemic spread and countries around the whole shut down their economies, governments and businesses scrambled to obtain medical supplies and other critical industrial inputs. Global trade was disrupted and it became apparent that the U.S. and many economies were overly dependent on other countries for a variety of vital medical supplies and key industrial components. In response, some voices in this country are advocating for requirements that “strategically critical” items should be manufactured domestically.
Certain inputs may be genuinely “strategically critical.” In these cases, it is prudent for our government to maintain emergency inventories and to develop a reliable plan for sourcing these items in a crisis. The danger is that politicians will adopt an overbroad definition of what is “strategically critical” in designing the requirements for domestic production. Over time, global supply chains have developed to maximize efficiency. Unravelling these arrangements will inevitably reduce productivity. Ultimately, higher costs will be passed on to consumers and taxpayers.
Our leaders may conclude this is a price worth paying to prepare for future health crises, but we should require rigorous analysis before imposing domestic sourcing requirements and limit the scope of such mandates to what is absolutely necessary. We should also consider other approaches that could improve the resilience of our supply chains without increasing costs unnecessarily, such as geographically diversifying the sources of our global supply chains to make them less susceptible to problems arising in particular areas.
Suppressing Accurate Credit Information
For credit markets to function efficiently, it is important that accurate information on counterparties is available. Lenders need to understand the creditworthiness of borrowers to provide the best possible loan pricing and terms. In difficult economic times, some politicians are tempted to suppress credit information in an attempt to help borrowers. The HEROES Act proposed by the House includes a provision to suspend negative credit reporting during the pandemic and to prohibit the introduction of new credit models that would result in lower credit scores for as long as the emergency continues. In addition, the HEROES act would permanently ban the reporting of medical debt arising from Covid-19 illnesses. These proposals are very ill-advised because suppressing information on potential borrowers will result in reduced credit availability and higher prices as lenders respond to a lack of reliable data by erring on the side of caution.
Conclusion
The federal response to the current crisis will leave our country with daunting levels of government debt. But perhaps a more dangerous risk is that politicians use this emergency as an opportunity to implement changes that will damage the structure of our economy. This can be particularly problematic for two reasons. First, once imposed these types are changes are very hard to reverse as they become imbedded in the political system and create constituencies that benefit from their continuation. Second, structural changes that are harmful to the economy result in costs that are difficult to quantify and burdens that are opaquely dispersed throughout the economy in ways that are challenging to track. As a result, taxpayers don’t personally experience the adverse impact the way they would feel an increase in their own taxes. This lack of transparency is one of the main reasons politicians use these types of indirect and veiled strategies to dispense political favors and advance partisan agendas.
In responding to the current crisis, it is imperative that our policymakers do not create new laws and regulations that will hinder the economy’s ability to flourish in the future. There is no one solution to building a robust economy. Rather, economic growth and jobs are created by the free market in thousands of different places in millions of different ways. We need to recognize and respect this complex reality and guard against every assault on the dynamism of our economy. More than ever, nurturing the flexibility of our economy is critical to developing a pathway back to an environment that provides opportunities for Americans.