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Why We Should Scrap Mortgage Interest Deductions

Jason J. Fichtner, Jacob Feldman — Thu, 31 Jul 2014 11:12:49 -0400

Expert Commentary

The mortgage interest tax deduction is often justified as promoting homeownership among the middle class and supporting industries that employ middle-class workers. The deduction also has broad public support: a recent survey found that six out of ten Americans oppose its elimination.

But such support is misplaced. Over 64% of the MID tax benefits go to tax filers earning more than $100,000, according to our new study released through the Mercatus Center at George Mason University. While the upper middle class does benefit from the deduction, the vast majority of the dollar benefits go to higher-income taxpayers. Little to no dollar benefits go to low-income households that purchase a home.

Our study examines the economic effects of the mortgage interest deduction in addition to assessing the tax break’s policy effectiveness. We argue that, considering the political hurdles that full repeal might create, policymakers should instead seek to replace the MID with a fixed $900 credit for all taxpayers with a mortgage.

The purported public policy role of housing-related tax deductions and credits is to increase homeownership. But as currently structured, the MID fails to significantly increase homeownership among its intended beneficiaries, and it encourages greater debt among homeowners. In short, the MID is generally giving a tax break to households that would likely purchase homes anyway and enabling high-income households to buy homes that are roughly 10–20% larger than those they would otherwise buy.

Of the 65.2% of tax filers claiming to make less than $50,000, a mere one in ten claims the mortgage interest deduction. One reason that low-income and many middle-income taxpayers are unlikely to use the MID is that the standard deduction is likely greater than any itemized expenses. Unless annual mortgage interest expenses, combined with any other expenses that are allowed as itemized tax deductions, are greater than the standard deduction, a taxpayer will not opt to itemize deductions. According to data from the Internal Revenue Service, it is only after reaching $100,000 in income that three-fourths of tax filers use the MID.

Other countries also demonstrate an inconclusive relationship between the MID and homeownership. In the case of the United Kingdom, which phased out the MID between 1975 and 2000, the homeownership rate rose from 53% in 1974 to 68% in 2001. While the increase in homeownership may or may not be a direct result of phasing out the MID in the UK, at a minimum, the phase out did not decrease homeownership.

Much of the justification for owner-occupied housing subsidies focuses on encouraging individuals who would not otherwise have sufficient savings to acquire home equity. Yet as Yale economist Robert Shiller points out, other foreign countries such as Switzerland have higher rates of household saving even without high homeownership rates.

The MID could likely be eliminated with minimal effects on low- and middle-income taxpayers. Only a full repeal of tax-favorable housing policies in exchange for lower marginal tax rates for all taxpayers will eliminate economic inefficiencies. Elimination of the MID in exchange for lower marginal rates and a higher standard deduction would represent a general improvement in the standard of living for almost all low- and middle-income taxpayers.

This hypothesis has already been proven by the The Tax Reform Act of 1986, which significantly reduced the value of the MID by reducing marginal tax rates and increasing the standard deduction. The lower tax rates significantly diminished the use of the MID by lower-income households, although the reduction in use was not quite as great for high-income households.

Eliminating the MID may slightly decrease the demand for housing among some low-income households that actually have sufficient mortgage interest to itemize. But this decrease seems relatively small, given that the MID is used so infrequently by low-income households. The bulk of the decrease in the demand for mortgage debt would come from households with large loans that exceed the loan limits of Fannie Mae and Freddie Mac.

A cleaner tax code would also move the housing industry away from its current tax-driven overvaluation. Revenue-neutral tax reform that eliminated the tax bias toward housing might encourage higher-income households to shift some housing investments to more socially productive investments, such as stocks or bonds.

If tax-favored housing must exist, it should, at a minimum, promote homeownership among low-income and middle-income households. A successful tax-favored housing policy would be designed to encourage households at the margin to purchase a home—that is, those homeowners who would like to own homes but would not do so without a federal subsidy. For example, offering a fixed, nonrefundable $900 credit to people who have a mortgage could increase homeownership among low- and middle-income households by as much as 5%, while only decreasing homeownership rates among high-income households by 1%.

By reforming the MID from a deduction to a credit, the purported policy goals of supporting homeownership would be more properly aligned with actual outcomes. A cleaner, simpler tax code brings more equality to investment opportunities and is a step toward greater tax fairness.

This hypothesis has already been proven by the Tax Reform Act of 1986, which significantly reduced the value of the MID by reducing marginal tax rates and increasing the standard deduction. The lower tax rates significantly diminished the use of the MID by lower-income households, although the reduction in use was not quite as great for high-income households.

Social Security is in Crisis

Jason J. Fichtner — Thu, 31 Jul 2014 17:28:41 -0400

Expert Commentary

The 2014 Social Security Trustees report showed a continuation of the current trend toward insolvency of both of its trust funds. As in the previous two years, the Trustees estimate that Social Security's combined retirement and disability trust funds will become exhausted in 2033, less than 20 years from now.

Regrettably, the lack of change in the combined trust funds' insolvency dates will likely lull some into a false sense of security that the program's finances are now stable. But the truth is that Social Security is simply advancing down the path toward insolvency.

In short, the Trustees report underscores that the Social Security crisis isn't only real, it’s already upon us.

The Trustees now estimate that the 75-year financial shortfall for the combined trust funds is $10.6 trillion in present-value terms. That's a lot of money.

If we indefinitely extend past the 75-year period, the so-called "infinite horizon," the shortfall is a whopping $24.9 trillion. For comparison, our nation's gross domestic product is approximately $17 trillion — and our gross national debt (not including unfunded liabilities) at the end of July is $17.6 trillion .

As I noted in a MarketWatch column last year, the warnings of the Trustees report were largely dismissed, with the venerable New York Times editorial board declaring that Social Security's financial shortfall "isn't a crisis" and "is a manageable problem." My guess is that we'll see similar responses this year from many in Washington and the media.

This complacency creates a false sense that the financial problems facing Social Security are neither serious nor urgent. Please don't be fooled. Social Security faces severe financial challenges that policy makers must soon address if we are to ensure the program remains viable for the most vulnerable in our society.

I know what you're thinking. Every year someone warns that Social Security is in dire trouble, and policy makers must act. But nothing ever happens. Why should I pay attention now? Further, if the retirement program isn't estimated to become insolvent until 2034, why worry about it now?

It's important to understand that there are actually two separate trust funds: One for the retirement program and one for the disability program. For the retirement program, the Trustees estimate that the trust fund can continue to pay full benefits until 2034, one year earlier than estimated in last year's report, at which point the program will only be able to pay about three-fourths of scheduled benefits. For the disability program, the insolvency date is much, much sooner — 2016.

The disability trust fund's financial shortfall is more immediate and, if reforms aren't adopted soon, disability beneficiaries could see almost a 20-percent benefit cut in just two years.

While it is highly unlikely that Congress can muster up the political will to pass reforms to Social Security in a midterm election year (2014) or a presidential election year (2016), there is an option currently being supported by the Obama administration and talked about on Capitol Hill to "save" the disability program. Unfortunately, the proposal is to reallocate a portion of payroll tax revenues — which are dedicated to the retirement program — and redirect it to the disability program. But taking from one Social Security Trust Fund to backfill another is just robbing Peter to pay Paul ; it doesn't fix the underlying problems with the disability program, and it will hasten the insolvency of the retirement program.

A better, if temporary, approach would allow the disability trust fund to borrow from the retirement trust fund. To hold the retirement fund harmless, the disability insurance trust fund would pay back any borrowed money in full and owe interest on the loan to the retirement trust fund at the interest rate any borrowed money would earn if it remained in the retirement trust fund. This interfund borrowing would provide the short-term financial patch necessary to ensure that those receiving disability benefits would continue to receive full benefits. It wouldn't, however, mask the financial shortfall of the disability insurance program or lessen the pressure for policy makers to enact real, necessary meaningful reforms. This interfund borrowing has been done before . In fact, in 1982 the retirement trust fund had to borrow from the disability trust fund to pay full benefits.

I recently testified before the Senate Finance Committee of the U.S. Congress on proposals to strengthen the Social Security program. My testimony focused on the Social Security's incentives — specifically, how the current structure provides disincentives to work and save — and discussed how Social Security reform, if done correctly, can increase U.S. savings, labor force participation, economic growth, and federal revenues. As I testified:

"Social Security faces real and increasingly urgent financial challenges. Reform isn't only the wise thing to do, it is critical to ensure that Social Security remains solvent and fiscally sustainable and can continue to provide retirement security for generations to come. Social Security reform must not only address the program's fiscal solvency issues but also remove the disincentives to working later in life. This means reforms must focus on reining in the growth of program costs, encouraging personal saving and investment, and rewarding those in middle and early retirement age who make the decision to extend their working careers. Finally, Social Security reform must begin immediately...We can reform this critical program, and we can do it in a way that will improve the financial security of all future Americans in retirement."

In short, the Social Security Trustees have once again sent a clear warning that the Social Security crisis is real, and is here now. We can't afford to wait or to become complacent; doing so will only ensure that the changes necessary to shore up Social Security's retirement and disability programs will be far larger and more difficult than if policy makers made the necessary reforms today.

Eli Dourado Discusses the Effects of Technological Innovation on Future Job Prospects on Al Jazeera

Eli Dourado — Wed, 30 Jul 2014 12:00:26 -0400

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Eli Dourado Discusses the Effects of Technological Innovation on Future Job Prospects on Al Jazeera

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Dodd-Frank's Birthday Marred By Its Many Inadequacies

Hester Peirce — Wed, 30 Jul 2014 17:30:46 -0400

Expert Commentary

Financial reform debates rarely dwell long on the purposes financial markets serve. Instead policy debaters move quickly from cursory diagnoses to regulatory remedies. As a consequence, the reforms that these discussions produce often inadvertently impede the proper functioning of the markets. An impaired financial industry can have deep and devastating effects on people far away from Wall Street and Washington.

The financial industry exists to serve consumers and companies that need to manage their risks and finance homes, educations, retirements, production, and innovation. The regulatory framework within which the financial industry operates can affect the industry's ability to effectively meet those needs. Many people simply assume that, on balance, more regulation will make financial markets function better. For example, 60 percent of the respondents in a Better Markets poll from earlier this month want "stricter regulation on the way banks and other financial institutions conduct their business."

The poll results might have been different if the respondents had also seen a June 2014 Goldman Sachs study that asks the important question-"Who Pays for Bank Regulation?" The research found that post-crisis financial regulatory efforts are particularly costly for low-income consumers and small businesses. A subset of consumers who were once able to get credit cards and home mortgages now rely on payday lenders, government agencies, and other nonbanks for credit.

Other consumers and small businesses still have access to bank credit, but they pay more than they did before. The Goldman Sachs study estimates that a household earning $50,000-the median annual income-pays an extra $200 a year in interest. With respect to business borrowers, the study estimates that small and mid-sized companies are paying, respectively, 41 and 55 basis points more on bank loans than they did pre-crisis. Larger companies, by contrast, are actually paying less than they did before the crisis to fund themselves.

The study attributes the disparate effects in part to the degree to which nonbank alternative sources of funding are available to different groups of consumers and businesses. As the study authors explain, "consumers and businesses that have ready access to alternative sources of finance are less likely to pay the incremental tax that regulation imposes." Low-income consumers and small businesses don't have many funding options, so they cannot avoid the regulatory tax.

There are a number of steps that regulators can take to preserve and expand funding options for consumers and small businesses. First, the capital markets, which the Securities and Exchange Commission regulates, can be a valuable alternative to bank financing for small businesses. The SEC, using its discretionary authority and the authority granted to it under the JOBS Act, can undertake serious efforts to open up viable funding sources for new and growing businesses. These efforts will fall flat, however, if new capital-raising avenues such as crowdfunding and Regulation A offerings are loaded down with costly obligations that put them out of the reach of small companies.

Second, bank regulators can look for creative ways to limit regulatory obligations on small banks. Dodd-Frank's burdens take a tremendous toll on these banks, which are key to small business lending. A well-capitalized community bank should not have to worry about being second-guessed by a bank examiner for making a loan to a local small business or a consumer with whom the bank has had a long-standing relationship.

Third, the Bureau of Consumer Financial Protection should not lose sight of its statutory objective to ensure that "markets for consumer products and services operate transparently and efficiently to facilitate access and innovation." The Bureau points to its rules, enforcement actions, and consumer complaint database as evidence of its solidarity with consumers, but it has not given sufficient thought to the potential effects of its actions on consumer prices and the willingness of companies to serve consumers. As Robert Clarke and Todd Zywicki wrote in a recent article, "Competition and consumer choice can be powerful vehicles for improving consumer welfare and consumer protection." The Bureau should embrace-rather than tolerate or ignore-its legal obligations to consider the effects its rules will have on small banks and other small businesses.

Fourth, regulators should look back at old regulations to identify those that are particularly harmful to small businesses and consumers. Bank regulators are currently conducting the 10-year review of regulations "to identify outdated, unnecessary, or unduly burdensome requirements" required under the Economic Growth and Regulatory Paperwork Reduction Act of 1996. This process provides regulators a key opportunity to consider whether particular rules or sets of rules are increasing the costs of consumers and small businesses to financing and decreasing their access.

Dodd-Frank's fourth birthday party was marred by talk of its long list of inadequacies. It is unfortunate to have to add the statute's regressive effects to that list. But regulators can do a lot before the law's next birthday to remove uneconomic regulatory impediments to the financial industry's ability to serve the full range of consumers and businesses.

Ex-Im Funds Flow to Few States, but All Bear the Risks

Veronique de Rugy — Wed, 30 Jul 2014 11:14:48 -0400

Publication

This week’s maps use data from the Export-Import Bank and the US Census Bureau to display the effect of Ex-Im Bank financing on each state. The maps show that Washington state, home of Boeing, garners the bulk of the benefits in terms of both Ex-Im Bank disbursements and as a percentage of total state export value, even though taxpayers across the nation are equally exposed to liability.

The first map displays data from the Export-Import Bank’s congressional map tool. The web interface contains more specific details than are presented in the bank’s annual reports; it breaks down all transactions by state (plus the District of Columbia and Puerto Rico) and by small business activity. We extracted data from FY 2007 to FY 2014 for all Ex-Im Bank disbursements for each state along with the proportion of small business transactions reported by the bank. We then summed the total for all states and determined each state’s share of total Ex-Im disbursements. The map displays this proportion for each state on a map of America. Each state is shaded according to the proportion of Ex-Im disbursements that it received.

The first map shows that Washington state is the clear winner in terms of total Ex-Im disbursements, receiving a massive 43.6 percent of all Ex-Im Bank disbursements from 2007 to 2014. Washington is the home of Boeing, one of Ex-Im Bank’s biggest beneficiaries, but the sheer size is nonetheless startling. Larger states like Texas and California only respectively pulled in 10.5 percent and 8.8 percent of total Ex-Im Bank disbursements during the same time. An astounding 42 states received less than two percent of Ex-Im Bank disbursements, with 35 of these receiving less than one percent. While businesses in most states barely benefit from the Ex-Im Bank at all, their taxpayers are just as exposed to Ex-Im Bank liabilities as taxpayers in states that receive the most Ex-Im Bank backing.

The second map uses data from the same Export-Import Bank congressional map tool and the US Census Bureau’s datasets on state exports from 2007 to 2014. In this case, we wanted to see what the impact of Ex-Im Bank financing had on each state as a percentage of that state’s total exports over the same period of time. We extracted Census data on total state exports and calculated the percentage of export value that Ex-Im Bank records claim were backed for each state. The results are displayed on a map of America, and each state is shaded according to the proportion of state exports that are backed by the Ex-Im Bank. States whose exports were more significantly backed by the Ex-Im Bank are darker, while states whose exports received less backing are lighter.

The second map displays a similar pattern to the first. Washington state is again the big winner in terms of state export value supported, with an incredible 22.67 percent of state exports backed by the Ex-Im Bank since 2007. The state percentages drop off quickly from there. While almost four percent of Wisconsin’s exports and about 3.5 percent of Massachusetts’s exports were backed by the Ex-Im Bank, the Ex-Im Bank supported less than two percent of the exports of 41 states for the same time period.

The Ex-Im Bank yields negligible benefits for the vast majority of state exports. But the concentrated benefits it yields to a few beneficiaries makes the reform necessary to prevent widespread losses that much harder.

Blahous, Fichtner on Medicare and Social Security Trustees Report

Charles Blahous, Jason J. Fichtner — Tue, 29 Jul 2014 14:40:07 -0400

Expert Commentary

The Medicare and Social Security annual report, released today, shows that the insolvency date for the Social Security Old Age and Survivors Insurance (OASI) trust fund is now 2034, one year earlier than estimated in last year’s report, while the insolvency dates for the Social Security Disability Insurance (DI) trust fund (2016) and the combined trust funds (2033) remain unchanged.

Mercatus Center senior research fellow Charles Blahous, a public trustee for Medicare and Social Security, said the following in a letter with fellow public trustee, Robert Reischauer:

“[T]he adverse consequences of delaying necessary corrections in both [Medicare and Social Security] are beginning to be realized. The most immediate financing threat facing either program is the impending depletion of Social Security Disability Insurance Trust Fund reserves in late 2016.

“…Medicare’s financing shortfall, like Social Security’s, remains a reality warranting legislative corrections.”

Please click here to view the full “Message from the Public Trustees,” as well as the full summary of the 2014 Annual Reports of the Social Security and Medicare Boards of Trustees.

Mercatus Center senior research fellow Jason Fichtner, former deputy commissioner and chief economist of the Social Security Administration, said the following in response to the report:

“The projected dates of insolvency for Social Security’s trust funds remain largely unchanged. I fear this news will give lawmakers and the public a false sense that the program doesn't require immediate reform.

“But make no mistake, there is a Social Security crisis. Misunderstanding the critical state of the program's financial health would lead to grave consequences for beneficiaries of both the disability and retirement programs.”

Establishing a Minimum Wage for Contractors

Antony Davies — Mon, 28 Jul 2014 15:12:29 -0400

Publication

The Department of Labor’s (DOL) proposed rule, “Establishing a Minimum Wage for Contractors,”¹ is intended to implement Executive Order 13658. The stated purpose of the Executive Order is to increase efficiency and cost savings in work performed by federal contractors by raising the hourly minimum wage that contractors pay their workers.² The proposed rule establishes standards and procedures for implementing and enforcing the minimum wage protections for federal contractors required by Executive Order 13658.

Review of the research cited in the proposal indicates that the proposed rule is unlikely to achieve its stated goal. The cited research suggests that increased wages do accompany increased productivity. The research does not, however, indicate that the value of the increased productivity exceeds the cost of the increased wage. This comparison is pivotal to the stated purpose of the Executive Order. The proposal suggests that an increased wage causes increased productivity. But the research is either agnostic as to causal direction or indicates that the causality runs in the opposite direction. The direction of causality is pivotal to the estimates of the proposed rule’s benefits; thus, the cited research fails to support the fundamental premise of the proposed rule.

In addition, there are two important unintended consequences of raising the federal contractor minimum wage: first, it can adversely affect the most vulnerable workers; and second, the rule as currently stated could be enforced in a manner so that its impact would extend to far more businesses than originally intended.

DEPARTMENT OF LABOR’S CLAIMS

In seeking to implement Executive Order 13658, the proposed rule states that:

There is evidence that boosting low wages can reduce turnover and absenteeism in the workplace, while also improving moral and incentives for workers, thereby leading to higher productivity overall.³

The proposal, however, misinterprets the research, inappropriately generalizes results, fails to mention important caveats, attributes gains from other factors to increases in the minimum wage, and fails to take into account tradeoffs or evidence from the marketplace. More importantly, the proposal assumes that higher wages cause greater productivity. This is not a common understanding of the relationship. Standard economic theory maintains that higher productivity causes higher wages.⁴ Whether and under what circumstances the causality might run in the opposite direction is a matter for empirical study and is not accepted as a general economic rule.

A. The proposal takes evidence of causality and assumes the reverse causality.

Highly productive workers, on average, command higher wages than do less productive workers. This is because profit-seeking employers see that highly productive workers can contribute more value, and so they compete for these workers by offering higher wages. Productivity causes wages. While higher wages accompany higher productivity, it does not follow that higher wages cause higher productivity. This reverse-causal assumption underlies the arguments laid out in the proposal, yet is absent from the arguments laid out in the research the proposal cites.

B. The proposal misapplies the research results.

The proposed rule states that absenteeism will decline with an increased wage:

Research shows that absenteeism is negatively correlated with wages, meaning that better-paid workers are absent less frequently (Dionne and Dostie 2007; Pfeifer 2010).⁵

Dionne and Dostie find that “the use of incentive pay . . . had ambiguous effects on (workplace) absences . . .” The researchers’ primary finding does not involve the effect of pay on productivity but the effect of work arrangements (work-at-home options, reduced work weeks, shift work) on workplace absences. They found no clear evidence that higher wages accompanied greater productivity.⁶

Does the Minimum Wage Increase Worker Productivity?

Antony Davies — Mon, 28 Jul 2014 13:11:01 -0400

Publication

The Department of Labor (DOL) recently proposed a regulation establishing a higher minimum wage for federal contractors. The stated goal of the proposed rule is to increase efficiency and lower costs in work performed by federal contractors. In its justification for the rule, the DOL cites numerous studies to support its claim that higher wages are associated with higher levels of worker productivity, but the agency gets the causality reversed, among other errors of interpretation.

Workers who are more productive command higher wages because employers compete for these valuable workers by offering them higher wages; higher productivity causes a higher wage. Raising the minimum wage makes workers more expensive. It does not necessarily make workers more productive.

This chart shows the relationship between the relative minimum wage (the minimum wage as a fraction of the average hourly wage) and unemployment rates for workers with different educational attainments. Historically, as the relative minimum wage has risen, unemployment among college-educated workers has not changed, unemployment among high-school-educated workers has risen slightly, unemployment among workers without high school diplomas has increased moderately, and unemployment among young workers without high school diplomas has increased dramatically.

While employers make hiring decisions on the basis of more than education, it tends to be highly correlated with many of the factors employers consider, including intelligence, experience, training, and work ethic. Ultimately, all of these factors are themselves proxies for the single factor that concerns the employer: productivity.

If it were true that a higher wage increased productivity and the value of the increased productivity exceeded the cost of the increased wage, we would observe federal contractors voluntarily raising wage rates. The absence of such an increase in wages for the lowest-paid workers suggests that raising the minimum wage is unlikely to secure the gains in efficiency or productivity presented as justification for this rule.

Misleading Minimum Wage Statistics

Donald J. Boudreaux, Liya Palagashvili — Mon, 28 Jul 2014 13:15:46 -0400

Expert Commentary

Earlier this month, President Obama seized upon fresh data from the Labor Department to argue for a higher minimum wage. According to the president and a subsequent Associated Press report, the 13 states that raised their minimum wages in January of this year are now enjoying, on average, faster job growth than the other 37 states.

The conclusion that Obama (and each of the many media outlets that breathlessly repeated this finding) wants us to draw is that a higher minimum wage not only does not price some workers out of jobs, it positively enhances workers’ job prospects. As the president theorized, "When … you raise the minimum wage, you give a bigger chance to folks who are climbing the ladder, working hard.”

Not so fast.

Basic economics teaches that forcing up the price of something makes people less willing to buy that something. This reasoning, for example, is behind the administration’s recent hike in tariffs on Korean steel. The president correctly understands that forcing up the price of Korean steel will cause Americans to buy less of it. Contrary to Obama’s suggestion, the same logic holds for labor. Forcing up labor’s price will cause employers to hire less of it (by, for example, supermarkets using self-checkout computers instead of cashiers).

Export-Import Bank Benefits Big Businesses, Not Small Ones

Andrea Castillo — Mon, 28 Jul 2014 11:54:15 -0400

Expert Commentary

Stanford L. Levin’s commentary, “The Export-Import Bank is good for business” (July 18), would be more accurately titled “The Export-Import Bank is good for businesses with friends with Washington.”

It is simply not true that “the St. Louis metropolitan area benefits greatly” from the Ex-Im Bank. In fact, Ex-Im contributed to less than 0.63 percent of St. Louis-area exports from 2007 to 2014. The bank benefited roughly 1.5 percent of all Missouri exports and 1.38 percent of all Illinois exports at the same time.

It is also incorrect to claim that Ex-Im helps small business. The bank’s records suggest that less than 0.4 percent of small-business jobs and less than 0.03 percent of small businesses benefit from its subsidies. The business of Ex-Im is clearly big business.

By subsidizing their competitors, Ex-Im places the over 99 percent of unsubsidized St. Louis exporters and over 98 percent of unsubsidized Missouri and Illinois exporters at a competitive disadvantage.

These businesses should not matter less than recipients of Ex-Im privileges just because they do not have friends in Washington. It is high time to end Ex-Im corporatism.

Dodd-Frank at War with Itself

Hester Peirce — Fri, 25 Jul 2014 16:42:06 -0400

Expert Commentary

A lot has happened in the four years since Dodd-Frank became law. Many rules were proposed, approved and implemented, and many more are on their way. As rules are adopted, however, it becomes even clearer than it was when Dodd-Frank became law that it does not live up to its official name -- the Wall Street Reform and Consumer Protection Act. Dodd-Frank is keeping regulators busy and causing companies to endure costly changes, but the promised reform and protection are not materializing. It is time to admit defeat and rethink our strategy.

Reassessing our approach requires us to answer a fundamental question: What problem are we trying to solve? We certainly do not want to experience another financial crisis, the attendant costs to taxpayers, job losses and home foreclosures. But we are likely to do exactly that if we do not face the problem that got us into that dire situation.

A constant theme running through the problems we saw in the crisis was regulatory distortion of market decision-making. Think about the government policies that drove home construction and purchases, subsidized mortgages and encouraged investors to buy highly rated mortgage-backed securities without regard to the quality of the underlying loans. Banking and securities regulators directed investors to use ratings as a proxy for quality.

Or think more broadly about the effect of past government interventions to prevent firms (and their creditors) that made bad decisions from reaping the consequences of those decisions. As a result of bailout expectations, shareholders and creditors grow careless about monitoring companies. Along those same lines, government deposit insurance virtually eliminates the need for bank depositors — even very large ones — to pay any attention to the safety and soundness of their banks. And tax advantages given to debt encourage companies to rely on borrowed money, even though doing so could impair their ability to weather crises.

In all of these cases, government — through poorly considered regulations, subsidies or guarantees — nudges companies and individuals to act in a way that they otherwise would not. The government pushed companies and individuals in economically unsound directions. A financial crisis resulted.

Dodd-Frank is an understandably intense response to the crisis -- but in light of the problems' source, it is also a puzzling response. Rather than eliminating government distortions, Dodd-Frank and its regulations add new ones. Dodd-Frank doesn't touch Fannie Mae and Freddie Mac, and new mortgage regulations favor the loans these companies guarantee. Instead of cutting back deposit insurance, Dodd-Frank expands it. Rather than unblocking market incentives to conduct sound underwriting before making any loan, one title of Dodd-Frank directs government to subsidize certain uneconomic loans. Rather than making sure the bankruptcy code is workable for any failing firm, regulators were given the power to identify financial firms that will never be allowed to fail.

Dodd-Frank attempts to counterbalance its bad government incentives by providing regulators with additional powers to prevent companies and individuals from using them. The Financial Stability Oversight Council was created in part to identify any unhealthy risk-taking. The Federal Reserve Bank got more authority over strategic decision-making by banks and non-bank financial institutions. The Volcker Rule enables financial regulators to draw lines between acceptable and unacceptable trading activity by banks. The new regime for over-the-counter derivatives directs regulators to impose very prescriptive clearing, trading and business conduct rules on transactions between sophisticated parties.

The implementation process is teaching us just how tricky it can be to offset bad government incentives with more regulatory discretion. Major rule-making projects are plagued with difficulties. As the regime for clearing and trading formerly over-the-counter derivatives comes online, people worry — quite legitimately — that a big, central clearinghouse could fail with disastrous consequences. Regulating away the possibility of such a failure is no easy task in the face of the regulatory push for clearing. The Financial Stability Oversight Council's attempts to single out certain firms for special regulation fuel concerns that some firms enjoy a government guarantee of perpetual survival.

The multi-regulator attempt to draft a reasonable Volcker Rule was protracted and difficult because regulators realized that how they drew lines would have direct effects on how particular securities trade, and therefore, on their value to investors. As the Securities and Exchange Commission expands the regulatory framework for credit rating agencies, investors are likely to feel even more secure relying on their ratings with no questions asked. And because the Fed is regulating more kinds of financial institutions with a heavier hand, concerns are rising over whether homogenization of the financial system undermines its stability. The FDIC struggles to craft a credible resolution regime that does not simply intensify the too-big-to-fail problem.

Rather than hope in Dodd-Frank’s hyper-regulatory solutions, we should look for ways to eliminate government distortions. We should craft simple rules that force financial institutions — under the watchful eyes of their creditors, shareholders and counterparties — to make prudent choices about their size, structure, funding sources and assets. Reforms might include rooting government guarantees and subsidies out of the housing finance system; strengthening the bankruptcy regime so that creditors know which rules will apply should the firm run into trouble; eliminating risk-weighting from our capital regime; and curbing shareholders' risk appetite with the prospect of additional losses if things go badly at their firms. These rules would be less costly from a regulatory perspective, but many financial institutions would dislike them because the price for that lower regulatory compliance bill would be an elimination of government subsidies and incentives for taking risky actions that do not make economic sense.

The difficulty of Dodd-Frank implementation is not primarily the regulators' fault; the problem comes from Dodd-Frank’s determination to rely on government regulation as a cure for government policy distortions. Instead, let’s work on getting rid of the distortions that encourage people to behave foolishly at the peril of our financial system.

David Primo Testifies before the House Judiciary Committee on Constitutional and Budgetary Reform

David Primo — Tue, 29 Jul 2014 16:47:51 -0400

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David Primo Testifies before the House Judiciary Committee on Constitutional and Budgetary Reform

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Social Security Disability Insurance's Effect on Labor Force Participation

Keith Hall — Fri, 25 Jul 2014 10:09:13 -0400

Expert Commentary

The labor force participation rate for the prime working-age population — those between 25 and 54 years old — has been declining in the U.S. since 1997. One of the big reasons is a rise in the disability rate, which hit a record 5.2 percent in 2013. Since the start of the Great Recession, the withdrawal rate due to disability has accelerated. In fact, 90 percent of the labor force decline for those who were in their prime working ages for the entire six-year span was from disability. Most of this — three quarters — was from those receiving Social Security Disability Insurance (SSDI) benefits.

In 2007, 83 percent of the prime working-age population was in the labor force and accounted for over two-thirds of our total labor force. Today, after six years of recession and weak recovery, labor force participation by this group has plummeted. Nearly five million out of the 125 million of them dropped out of the labor force. But why? How much of this is due to retirement? What else contributed to this decline?

For those who aged out of their prime working years — those now between 55 and 60 years old — about 2.4 million dropped out of the labor force. As you might expect, most (about 70 percent) moved into retirement. The rest exited the labor force due to disability. An underappreciated aspect of baby boomer retirements is the fact that they have not reduced their participation as much as prior generations. In fact, for those aged 55 and above, the participation rate was below 30 percent just 20 years ago — yet for the past five years, it has been higher than 40 percent.

For those who remain in their prime working years — now between 31 and 54 years old — the story is different. As with the older workers, the decline in participation has been significant — over 2.5 million have dropped out of the labor force. But while some moved into retirement, a shocking nine out of 10 individuals of the younger group report that they exited the labor force due to a disability.

In fact, overall the number of Americans removed from the labor force because of a reported disability is at a record 14 million — up from about 11 million just six years ago. What appears to have enabled so many of the prime working age population to exit the labor force has been a single program: SSDI. For those who were in their working prime in 2007 and remain there today, there was a 1.7 million increase in those taking SSDI. This one program alone accounts for three-quarters of the disability exits and therefore, for most of the decline in labor force participation by the prime working-age population.

The SSDI program is the largest federal insurance program for lost income from a disability. To qualify, someone must have a minimum work history and a physical or mental condition that prevents them from engaging in any "substantial gainful activity" for at least 12 months. Use of the program has grown significantly — generally over 4 percent per year. Although it was never meant to be an unemployment insurance program, both the applications and acceptances into the program follow the unemployment rate.

Many have expressed concerns over the sustainability of the growth in spending on SSDI, and the Social Security Administration projects the program to be insolvent in just two years. One aspect of this is concern over whether the incentives of the program are encouraging people with disabilities to substitute SSDI benefits for labor market participation. If this is happening, more may be at stake than viability of the program. It may be undermining one of the important purposes of the Americans with Disabilities Act that tries to make sure people with disabilities access the same employment opportunities and benefits as everyone else.

In the Matter of Amendment of the Commission’s Rules Related to Retransmission Consent, Report and Order and Further Notice of Proposed Rulemaking

Brent Skorup — Thu, 24 Jul 2014 13:59:32 -0400

Publication

The FCC proposes to repeal its syndicated exclusivity and network nonduplication rules,¹ which the Commission first devised in the 1960s and 1970s. The rules were intended to limit cable television growth and to protect the growth of fledgling UHF broadcast stations.² We agree with commenters³ that these rules are vestigial and potentially anticompetitive interventions into television markets from a bygone era.⁴

Television rules from the past are increasingly socially costly as technologies and business models change—particularly as content moves online—and it is time to start repealing old regulations. Experts view television regulations as “a Rube Goldberg regulatory structure,” a complex system that performs simple tasks in indirect, convoluted ways.⁵ The Copyright Office characterizes the FCC’s network nonduplication and syndicated exclusivity rules as “highly complex” and “a paradox” because FCC rules both encourage and discourage importation of distant broadcast transmissions.⁶ The Congressional Research Service similarly has said that “the negotiations between programmers and distributors, although private, are strongly affected by statutory and regulatory requirements and cannot be properly characterized as free-market.”

Every television industry segment has received some regulatory favors though the decades. However, the Copyright Office notes that there is “a thicket of communications law requirements aimed at protecting and supporting the broadcast industry.” ⁷ This thicket arises largely because the FCC has aspirations for broadcast—namely localism, free television, competition, and diverse voices—that are often in tension with each other.⁸These conflicting goals also tend to disadvantage pay-TV providers, particularly smaller operators.⁹

The existing rules have prevented a freer media market for forty years and should be repealed. As the Commission has said, “If the [exclusivity] rules should ultimately prove unnecessary or need modification in light of the passage of time, congressional action or other factors, they can be modified or rescinded.” ¹⁰ Repealing the rules would not be a panacea for what ails television markets, but as one operator noted, eliminating these rules at issue “would be an important step in the right direction . . . .” ¹¹

Municipal Fiscal Emergency Laws: Background and Guide to State-Based Approaches

Eric A. Scorsone — Thu, 24 Jul 2014 12:34:00 -0400

Publication

Beginning with the Great Recession in 2008, hundreds of cities across the country have suffered from fiscal emergencies, with some even declaring bankruptcy. Detroit filed last June, and Michigan's response–forcing the the city to cede control of some of its functions to the state government–was not surprising.

The use of emergency state financial intervention in struggling cities has become increasingly common. In sixteen states ranging from Michigan to New Jersey, governments have developed legal approaches to take over municipalities in crisis.

Given the increasing frequency of this measure, it is crucial for journalists and policymakers to understand the background and effectiveness of state takeovers. In a new Mercatus Center at George Mason University paper, “Municipal Fiscal Emergency Laws: Background and Guide to State Based Approaches,” Eric Scorsone provides an overview of the process, including:

What constitutes a local fiscal emergency
Relevant state laws implemented in recent years
Factors explaining why states assume one strategy over another

Key takeaways for policymakers include:

Laws should acknowledge the importance of institutional factors within cities rather than focusing exclusively on poor management and policymaking.
Policymakers should consider new tools to dissolve or merge municipal corporations, new revenue options, strategies to address the significant burden of pension and retiree health care costs, and reductions in state mandates.

Export-Import Bank Subsidies Benefit Very Few Exports and Export Jobs

Andrea Castillo — Thu, 24 Jul 2014 09:49:52 -0400

Expert Commentary

Sabrina Eaton's July 16 article, "Boon or boondoggle? Congress to decide fate of Export-Import Bank," provides a fair description of the Export-Import Bank debate. However, some of the claims made by the Bank's defenders should be put into context so Ohioans know what's at stake.

Lobbyists at the Chamber of Commerce and National Association of Manufacturers, who represent some of Ex-Im's largest corporate beneficiaries, claim Ex-Im supports more than $37 billion in U.S. exports and 200,000 jobs. In Ohio, they say the Bank supported $2 billion in exports since 2007.

That sounds impressive — until you compare this to non-subsidized exports and jobs. Ex-Im subsidies only benefited 1.8 percent of the total $2.3 trillion in U.S. exports and 1.6 percent of the total 11.3 million export-related jobs last year. Similarly, Ex-Im subsidies only benefited 0.73 percent of the $330 billion in total exports from Ohio since 2007.

In other words, over 98 percent of all U.S. exports and export jobs, and over 99 percent of Ohio exports, receive no subsidies from Ex-Im.

Subsidized firms undoubtedly enjoy their government privileges — but we must remember the other 98 percent of us who do not have friends down at the Export-Import Bank.

Constitutional Solutions to Our Escalating National Debt: Examining Balanced Budget Amendments

David M. Primo — Fri, 25 Jul 2014 10:01:33 -0400

Publication

Chairman Goodlatte, Ranking Member Conyers, and members of the committee: Thank you for inviting me here today to discuss the need for a constitutional amendment to help achieve credible and sustainable fiscal reform.

I am an associate professor of political science and business administration at the University of Rochester, where I hold the Ani and Mark Gabrellian professorship. I am also a senior scholar at the Mercatus Center at George Mason University. I have written a book, Rules and Restraint (University of Chicago Press, 2007), and several articles regarding budget rules and fiscal policy.¹ I testified before this committee’s Subcommittee on the Constitution on May 13, 2011, on the same subject, and it is an honor to be asked back to address the full committee.²

My three-part message today is simple.

First, the United States’ current fiscal trajectory must change.

Second, the short-run focus in politics, combined with Congress’s institutional prerogatives, make achieving this change—in the form of durable, long-term reform—an elusive goal.

Third, a constitutional amendment, if properly designed, can create the pathway for Congress to do what’s needed to place the United States government’s finances on firm fiscal ground.

THE STATUS QUO MUST CHANGE

We have made promises to current and future generations that we have no hope of fulfi lling given current revenue streams. The US Treasury estimates that the national debt will approach 250 percent of GDP by 2080 (see figure 1).³ For the record, I do not believe this estimate. It’s not that I dispute the Treasury’s calculations. The problem is that the economy or the US government’s fi nances—or both— will implode long before then. This estimate, along with long-term projections from the Congressional Budget Offi ce (CBO) and others, sends a clear message: the current path is not sustainable.

Big-Business Bias

Veronique de Rugy — Tue, 22 Jul 2014 15:03:04 -0400

Expert Commentary

In your July 14 editorial "Closing the Export-Import Bank would hurt the economy" you wrongly claim that the bank extends assistance "when the private sector is unable or unwilling to do so."

First, South Carolinians should know that less than 15 percent of the value of Ex-Im-financed exports in their state went to small businesses. The data clearly show that the business of Ex-Im is big business.

These giant corporations that Ex-Im serves - such as the mining group Hancock Prospecting (which is owned by the richest woman in Australia) and Pemex, Mexico's government-owned oil company - would have no problem arranging financing without Ex-Im. They simply would not get a government-granted discount courtesy of U.S. taxpayers.

The bank's top beneficiary, Boeing, already has a large and capable financing arm to support aircraft exports, as do most of the giant manufacturers that Ex-Im benefits.

The data show that many Boeing jets are already sold without any Ex-Im assistance. In June 2012, Emirates Air bought two Boeing 777s using Ex-Im financing, which lowered the cost per plane by $20 million.

It also bought four Airbus A380s using private financing. In other words, Ex-Im unintentionally financed the purchase of foreign Airbus products by lowering the cost of the Boeing transaction.

This also goes to show that Emirates Air, like many other Ex-Im-backed borrowers, can certainly secure financing for worthy projects from private lenders.

What's more, a recent S&P report predicts that Boeing could find sufficient private financing for their jets without Ex-Im for the next few years.

Your editorial failed to consider the unfairness of a system that grants cheap loans to some companies at the expense of other non-subsidized companies. This is the fundamental debate.

Ex-Im Bank Does Little for Small Businesses

Veronique de Rugy — Tue, 22 Jul 2014 14:28:41 -0400

Expert Commentary

In the July 7 guest column "Re-authorize Ex-Im Bank to Grow Economy," Export-Import Bank beneficiary Michele LaNoue claims that critics want to shut the bank without regard for small and medium-sized Texas businesses. The opposite is true.

According to the Bank's own data, the vast majority of Ex-Im beneficiaries in Texas are large, politically connected firms like Bechtel and Nobel Drilling. From 2007 to 2014, less than 30 percent of Ex-Im's portfolio in Texas went to small businesses.

The data also reveal that most of Texas exports take place without the bank's help. The same is true on the national level: Over 98 percent of all U.S. exports occur without any help from Ex-Im at all.

What is good for LaNoue's company is not necessarily what's good for Texas. It certainly is not good for other firms in the state, such as Texas Valero Energy, which claims that its business and employees are hurt by Ex-Im subsidies.

The vast majority of Texan firms are put at a competitive disadvantage by their own federal government so that favored firms can enjoy political privileges.

After Dodd-Frank: The Future of Financial Markets

contact@mercatus.org (Mercatus.org) — Wed, 23 Jul 2014 22:07:34 -0400

Video

Four years after the Wall Street Reform and Consumer Financial Protection Act (Dodd-Frank) was signed into law, there are many open questions about what the Act has achieved and what lies ahead for the U.S. financial system. This two-day conference, hosted jointly by the Mercatus Center at George Mason University and the Cato Institute, explores some of the most hotly debated aspects of financial regulation and policies to improve financial markets in a post-Dodd-Frank world.

Daniel Rothschild and Dino Falaschetti Deliver Welcoming Remarks

John H. Cochrane Delivers Opening Keynote Address

Economic Analysis: Improving Transparency, Accountability, and Expertise in the Regulatory Process

Featured Roundtable Discussion: The Future of Financial Markets: A Conversation with the Regulators

The Meta-Regulators: Creating a Resilient Financial System

Keynote Address: Rep. Jeb Hensarling (R-TX), Chairman, House Financial Services Committee