On Power and the Constitution, Part 2 - Analyst Blog

(This is the second part of a two-part article, The first part can be found here.)

How Best to Implement Progress

There are also situations where things need to be imposed industry-wide. For example, any individual owner of a paper mill might decide that he liked to fish in the stream, and thus feel that it would be worth spending the money to make his mill pollute less. He, however, would be putting his mill at a competitive disadvantage to the mills that did not decide to control the pollution, and eventually his mill would go out of business, the share would be taken by the polluting mills, and the stream would be no cleaner than when the process started.

A monopolist could unilaterally decide to become an environmentalist, but not a firm that had to compete. Historically, there have been few monopolists that put things like environmental responsibility on the top of their priority list in any case (very notably the State monopolies in the old USSR, which had absolutely awful environmental practices). Monopolies create many other problems, so we sure don't want to encourage them simply in the hope that they might be more environmentally responsible than a fragmented industry would be in the absence of regulation.

However, if the state steps in and says that all paper plants can only emit X amount of a given pollutant, then the playing field is still level and you have a cleaner stream. One problem with that approach is it quickly becomes very heavy handed and inefficient. Cleaning up pollution generally follows a curve where it is relatively easy cleaning up, say, the first 20% of the pollution, but the next 20% becomes more expensive, and trying to get the last 1% out becomes ridiculously expensive.

That sort of command and control method of trying to control externalities has, in practice, led to industries being forced to spend enormous resources trying to control the last 1% from one source, while totally ignoring the low hanging fruit of the first 20% at another. This is why I tend to favor market-based approaches to try to control externalities like pollution. You simply say that you have to pay $x for each pound of this nasty stuff you are putting into the environment, and it is up to you to figure out how to reduce that cost. That way, the low hanging fruit gets picked first.

This can be done either through a direct tax, or a cap-and-trade system. My general preference is for the excise tax approach as it tends to be much simpler and more transparent. Such an approach also has the added benefit of raising revenues for the government, which can be applied to either cutting the deficit, lowering other taxes, or increased spending.

All taxes create some distortions in the economy, but doesn't it make sense to distort the economy in a good way rather than a bad way? Clearly the issue that this is most in the forefront here is carbon emissions right now. However, the logic of doing so is the same as the one for putting excise taxes on cigarettes. While many of those that oppose cap-and-trade or a carbon tax simply deny that Global Warming exists, the overwhelming scientific evidence is that it is real, and is happening even faster than Al Gore laid out in his Power Point presentation.

To my mind, the Global Warming deniers are in the same position as the tobacco executives of yore who claimed that smoking was not harmful to your health. In that case, we have gone the direct excise tax route. A cap-and-trade approach would be to say to Altria (MO) and Lorillard (LO), we will only allow, say, 1 billion packs of cigarettes to be sold this year, now you guys bid for the right to sell each pack up to that limit, then next year to lower the number of packs allowed to go down to 900 million and repeat the process.

In either case the price of the pack would go up, and the government would collect revenues. Thus when opponents of cap-and-trade call it “Cap and Tax,” they have a valid point.  My response is, “So what?" We have to raise tax revenues somewhere, so why not do so by encouraging a decline in either cigarette consumption or carbon emissions? Doesn't that make more sense than taxing (and thus discouraging) say employment through a payroll tax? Or income, through an income tax? After all, jobs and income are good things that we would want to see more of, not less of. 

Next time you get into a conversation with someone opposed to either a carbon tax, or its indirect cousin, cap-and-trade, ask them if they also think that it would be a good idea to have cigarettes sell for just $1 per pack (about what they would cost without taxes on them). Of course if they simply deny that there is a problem, despite the scientific evidence, that argument will not work with them.

A cap-and-trade system was first used to control emissions of sulfur dioxide, and was put in place by the GOP. It has been extremely successful. After all, when was the last time you heard anyone talking about the damage being done by acid rain? When I was in college in the late 1970's, acid rain had the same general spot in the mind of environmentalists as Global Warming does today. The cost to control SO2 proved to be far less than expected, even by the proponents of the cap-and-trade system at the time it was put in place.

Think of the role of the regulator as being that of the referee in a football game, and the regulations being the rules. A football game would rapidly degenerate into something that was no longer recognizable as football without rules. Players have to know when something is in bounds or out of bounds. We don't want defensive ends to be rushing the Quarterback with knives in their hands. Clearly, though, referees can at times become too much a part of the game, so you want them to let the players play to some extent, but you also don't want to let the players get hurt.

When Powers Become Interchangeable

There is also a real danger as political and economic power start to become interchangeable.  The basic presumption should be that political (governmental) power should be more tilted towards the interests of the poor and the middle class, since there are more poor and middle class voters than there are rich voters.

In the 19th century, senators were elected by state legislatures, not by the people directly. The votes of the state legislatures could be bought, and the end result was that the Senate turned into a millionaires club. That was ended by the 17th amendment. Recently, though, the power of money to influence the political process has again increased. This has happened as the cost of running a political campaign has risen dramatically.

The power of money, and thus the conflating of political and economic power, took a quantum leap upward with the Citizens United decision. Now, not only do corporations (and unions by the way, but the economic resources of corporations are far larger than the economic resources of unions) have the same free speech rights as individuals, they have more rights.  Now a corporation can go to a Senator and say, "Here is a check for $1 billion. It will be spent on the upcoming political campaign. Which side it will be spent on is up to how you vote on this bill we are interested in. Oh, and by the way, we can put it to use without anyone finding out where the money came from."

Seriously, how is that functionally any different than outright bribery? I think it has to be on any top five list of worst Supreme Court decisions ever (on par with Dread Scott, Plessy v. Ferguson and the blatantly political Bush v. Gore decision that even the majority of the court thought was so weak that they said in the decision that it should not be used as future precedent would also make my list of truly awful decisions).

It is not a one-way street, though. The political power is then used to further increase economic power -- to get regulations written in such a way that it favors one company over another, to steer government contracts in one direction or another. The question becomes not why is there so much money in politics, but why is there so little.

“Buying” a politician is almost always the highest ROI investment available. The self-reinforcing cycle continues and undermines the division of power principal that is at the heart of the Founders' genius. What you end up with is “crony capitalism.” Historically (at least in the 20th century) this was mostly associated with third-world countries, such as Indonesia under Suharto. Crony capitalist economies are not particularly strong or efficient economies, and tend to have lots of monopolies.

The TARP Bailout

A good example of firms having excessive political power that is then turned into further economic rewards for the powerful was the TARP bailout. While I agree that it would have been totally irresponsible to sit back and do nothing, the terms on which the financing was offered was exceedingly generous.

Wall Street had to pay no real price for the disaster. This year bonuses on the Street are expected to hit a record $144 billion, or about 1% of GDP. Most (i.e. over 50%) of that money will go to fewer than 10,000 individuals -- out of a population of 310 million -- and about 140 million individual tax returns. That would work out to about an average of $7.2 million for each of those 10,000. If 90,000 or so split the remaining half of the bonus pool, that would work out to an average of $800,000 each.

In other words, Wall Street makes up a very significant fraction of the top 1% that would see their marginal tax rate rise from 35% to 39.6% if the top end of the Bush tax cuts were allowed to expire.

Supposedly the banks are better capitalized now, but that is only if you think that their book values belong on the non-fiction shelf. I don't, since they don't have to mark their troubled assets to market, and can just pretend that they are worth something close to face value.

The financial system would be much better served, and the economy more stable, if most of that bonus pool had been simply retained by the firms and strengthened their capital position. (To the extent that the bonuses are paid in restricted stock, it does help to strengthen the bank's capital position, albeit at the expense of dilution of the non-employee shareholders).

Remember that most of those 10,000 individuals are the same people who screwed up so royally that they had to be bailed out or the entire world economic system would have crumbled. Yes, it now looks like the government will roughly break even on the whole TARP deal, and perhaps make a small profit, but the taxpayer was taking an enormous risk.  We should have gotten returns that were commensurate with the risk.

I should note that I am referring to the TARP program as it was eventually structured, where the government injected capital, temporarily, directly into the banks' balance sheets.  The original plan called for by Treasury Secretary Paulson -- to simply buy up the crap paper at something close to face value -- would have simply been a direct gift from the taxpayers to the shareholders of the banks.

It was perhaps the worst single piece of legislation ever seriously proposed in the history of the U.S. Congress. In addition to being a looting of the Treasury, it would have also been almost totally ineffective in shoring up the financial system. The country owes Chris Dodd and Barney Frank a huge debt of gratitude. They transformed a truly awful proposal into one that was at least effective in stabilizing the banking system, and which ultimately did not cost the taxpayers that much. The net cost of the original plan to the tax payer would have probably been on the order of $650 billion (of the $700 billion authorized).

As amended, we did not come close to ever using the whole amount authorized, and have already gotten most of the money back. Which side of the break even line we ultimately fall on will depend on the ultimate price we get for our remaining stakes in Citigroup (C), GM (GM), Chrysler and AIG (AIG) (Fannie and Freddie are a whole different kettle of fish). In any case, it is going to be a much smaller number than $700 billion.

...But I Digress

Ok, I have digressed and gone off on a bunch of tangents here. I am a big fan of the idea that power needs to be divided and set up so there are competing power centers. I also think that one should not just consider political power, but economic power as well. Government has a legitimate role to act as a counter-weight to concentrated economic power. That is in keeping in the sprit of the Founders' plan to avoid power from becoming absolute and thus absolutely corrupting as is the idea that government power should be limited.

Since power, like greed, will always exist, a successful system will find ways to channel it in the right ways, or set up systems where the power of one group is counteracted by the power of another.

When the Constitution was first written, it was pretty safe to assume that the power not given to the Federal government would go to either the States or to the individual, and that not given to the government at all would stay with the individual. With the rise of corporations as a new source of power, that assumption was no longer valid. It became the role of the government to make sure that the corporate power was similarly dispersed within a given industry through anti-trust laws. The government became a counter weight to the corporate power overall.

There are those who lump the individual and the corporation together as “the private sector” and say that there is no real difference between the power of the individual and the power of a corporation. I disagree.

Dirk
 
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