To restore competition in America, a bold, three-pronged agenda borrowing from left and right.
ON A recent episode of The Ezra Klein Show, an interview-based podcast, the venture capitalist Bill Gurley postulated, “I have this theory that democracy and capitalism will destroy one another if you give them enough time. Our most regulated industries are ones that are least open to disruption—so health care, finance, telecom. And what ends up happening is … industries get more regulated and the incumbents write the regulation.”
The second in a two-part series on America’s economy and how to fix it.
Mr. Gurley has the right diagnosis but the wrong conclusion. Industry incumbents do indeed have a heavy hand in the writing of favorable regulations which edge out competitors. But this does not mean that democratic capitalism has had its decay and collapse predetermined. Instead, democratic bodies must promote capitalism and resist institutional atrophy through a continuous process of self-assessment and reinvention.
But Mr. Gurley’s remarks underscore the extent to which the American democracy has impeded its own reinvention. Bold economic pursuits like the New Deal and the Reagan tax reform program have given way to a Congress whose budgets are scrapped together in a last-minute flurry of continuing resolutions and omnibus measures. Partisanship and brinksmanship have hamstrung both the legislature and executive—the internecine gamble of budget sequestration comes to mind. At the same time, an ever-increasing demand for ideological purity on both sides discourages collaboration on meaningful policy-making and reform. If you believe, as this blog does, that there are good ideas on both left and right, then America needs to put bipartisanship back on the agenda.
As our Thursday editorial makes clear, America’s economy is in dire need of competition. What follows is a policy platform to revitalize the American economy by restoring competition, with special attention paid to the political cleavages across which legislation must be built.
Combat consolidation.
The Federal Trade Commission (F.T.C.) and Department of Justice (D.O.J.), who oversee corporate mergers and acquisitions (M&A), need a harder tack on anti-trust measures. Eliminating future competition by narrowing the field, as was Facebook’s objective in purchasing WhatsApp and Instagram, should be met with intense scrutiny by regulators.
Greater attention must be paid to overarching trends within an industry as well. To see why, consider the case of the airline industry, in which no single M&A was individually responsible for the industry’s massive consolidation (see: graphic in Thursday’s editorial). Nonetheless, the totality of multiple M&A would eventually result in a more consolidated market. Since M&A are approved on a case-by-case basis (i.e. asking if, in isolation, an individual merger creates an anticompetitive market), the F.T.C. would be wise to assign more weight to the extent of pre-existing consolidation within a given industry.
This chart shows values for a common measure of market concentration, the Herfindahl-Hirschman Index (HHI), for the airline industry up until 2013.
One way lawmakers could empower the F.T.C. and D.O.J. to beat back the onslaught of industry consolidation is through an amendment to the landmark Clayton Antitrust Act. There have been a number of these throughout the decades—including the Celler-Kefauver Act, which expanded the F.T.C.’s authority in blocking the formation of conglomerates—each of which have afforded regulatory agencies more leverage in discouraging anticompetitive practices. Like Billy Joel’s “Piano Man,” it’s always worth revisiting (or, in Mr. Joel’s case, never being able to forget about) an old hit.
Reduce red tape.
As Thursday’s editorial explains, a complex regulatory regime favors big industry players—who, as Mr. Gurley suggested, write the rules—by increasing “barriers to entry.” Such rules should be systematically reviewed; evaluated; and, if deemed necessary, repealed.
To slow down regulatory creep, future regulations should also be, well, regulated. Donald Trump has an intriguing idea for how to do this. Mr. Trump’s opening salvo on regulatory reform was to implement a “one-in, two-out” policy, which would “knock out two regulations for every new regulation.” This would compel regulators to review and eliminate the lowest-priority regulations within the 180,000-page-long federal regulatory code.
However, Mr. Trump’s executive order has some shortfalls. For each new rule imposed, Mr. Trump’s order would work by culling two other regulations which, in sum, incur a net cost to businesses equal to that of the new regulation. Britain experimented with a similar “one-in, one-out” policy before eventually upping it to two-out and then, later, three-out. As the Cato Institute’s Ryan Bourne points out, the U.K.’s attempts at this policy highlight the importance of focusing on the comparative costs of regulations—rather than the raw number alone. Mr. Bourne suggests that instead of removing two equal-cost rules for every new one, Mr. Trump’s one-in, two-out policy should concentrate on nixing unneeded regulations worth double the cost of a new regulation, irrespective of the number removed.
Given the limitations of his executive order—and the administration’s distaste for serious policy work—it may be better for Mr. Trump to create a new federal agency fully committed to the systematic review of regulations new and old. Currently, regulatory review is conducted at the behest of the relevant agency—environmental regulations by the E.P.A., financial by the Treasury Department. But this generally means that diligent review of old regulations falls by the wayside. A new federal department with regulatory review as its singular objective and staffed with a broad range of expertise would massively expedite efforts to tidy up the regulatory code.
Another barrier to healthy competition is licensing laws and requirements. Such laws mandate lengthy and often unnecessary accreditation processes in order to obtain a license. One commonly cited (and highly illustrative) example: African-style hair braiders, most of whom acquired their training through family tradition, are required in some states to obtain a general cosmetology license before practicing their craft. Licensing laws also vary between states, creating a legal regime wherein a licensed professional in one state is considered under-qualified in another. This superfluous system edges out highly skilled, yet unlicensed, individuals from the market. Basic checks on safety and hygiene are important, but for the cosmetology industry, market forces are a better determinant of which specific skills ought to be required.
To give another example, foreign-trained immigrant doctors are forced to undergo redundant testing and licensing procedures. One in four practicing physicians in the U.S. are trained abroad but can find that upon coming to the U.S. the reset button is pushed on their professional medical careers. It is also notable that America is suffering from an acute doctor shortage, resulting in bloated hospitals and lengthier wait times. Hospitals, rather than the private nonprofits currently in charge of doling out licenses, would be better equipped to weed out under-qualified doctors, allowing skilled, qualified candidates who merely lack the proper piece of paper to enter the medical system. This entire system of licensing could be streamlined by establishing federal parameters for which licenses count nationally, which would allow qualified professionals in Arkansas to remain qualified professionals in California.
Tone up the tax code.
Some significant tweaks to the tax code could create more competitive market conditions and give the economy a much-needed jolt. We suggest the following changes.
Bernie Sanders and the Koch brothers hate this!
Cut the corporate rate to 25%
Close tax loopholes for corporations and individuals
Increase the top rate from 39.6% to 42.5%
Increase the estate tax
While it might play well among readers of The Huffington Post, there is not a particularly compelling case for taxing companies at the current rate of 35%, one of the highest rates in the world. Businesses are the engine of the economy; they create jobs and provide opportunities for vertical mobility. Private sector investment is a potent force for expanding the U.S. capital stock. Many U.S. companies are at the forefront of global innovation, especially in technology, pharmaceuticals, and the auto industry. Thus, it makes sense to lower the corporate rate from 35% to 25%, as Mitt Romney advocated during the 2012 election. Barack Obama proposed a similar rate of 28% in that election, underlining the bipartisan interest in this sort of tax cut.
But cuts in the corporate rate should be accompanied by higher taxes on the wealthy, who would overwhelmingly benefit from subsequent increases in dividend and private-equity income. Additionally, a round of tax loophole closures would minimize the economic distortions caused by oversights in rule-writing. For instance, America’s system of international taxation, under which taxation on the foreign profits of U.S. firms can be “deferred” indefinitely, should be replaced with a territorial tax system, in which taxes are levied based on where profits are made. As one 2012 report by the Tax Foundation notes, 27 out of 34 countries in the O.E.C.D., a club of developed nations, have a territorial tax system. Particularly nefarious loopholes—like “corporate inversions,” where a firm merges with a foreign firm to relocate the company headquarters in a different, low-tax country—should be altogether ended.
Economists love this!
Remove the deduction for state and local taxes
Remove the business deduction for interest expenses
Remove the mortgage interest deduction
Remove the employer-sponsored health insurance exclusion
It might be an understatement to characterize the above tax deductions as politically popular yet economically irrational. That there is always a constituency for these deductions—in the case of the mortgage interest deduction, a relatively niche one: all American homeowners—means academic economists are the only real, unified opposition to the inefficiency they create.
To briefly address the underlying economics, federal deductions for state and local taxes act as an effective subsidy for high-tax states like New York and California. The business deduction for interest expenses makes racking up debt a preferable funding mechanism to raising equity, distorting the market for corporate bonds and encouraging reckless borrowing practices. The mortgage interest deduction is riddled with problems; it is highly regressive, promotes overleveraging by subsidizing borrowing, and sets the stage for bubbles by artificially driving up housing prices. Moreover, there is some evidence to suggest that the mortgage interest deduction does little to boost home ownership. Lastly, the employer-sponsored health insurance exclusion encourages firms to provide better health-care benefits instead of raising wages, which creates faux demand for health-care services and depresses wage growth.
While there are countless other inefficient deductions and exclusions, these four notoriously inefficient ones should be abrogated.
For companies attempting to break through in digital advertising, defense, or technology, the economies of scale (i.e. lower long-term costs for established firms) enjoyed by industry behemoths act as a barrier to entry for potential disruptors. While innovation can sometimes allow ambitious startups to uproot such firms—these days, the only company saying “Yahoo!” in the search engine business is Google—fresh ideas are more often stifled by the weight of the corporate titans.
For this reason, providing tax incentives for startups in capital-intensive industries would create a more competitive environment and promote innovation. Yes, this may result in some misallocation of resources toward firms with some less-than-earth-shattering ideas, but some minor inefficiency is a worthy trade-off for more robust markets in the long run.
Bold, market-oriented economic reform is the best way to undercut the dangerous argument of those who would have democratic capitalism crumble to dust.
This agenda is a bipartisan one. Liberals would be enticed by higher taxes on the wealthy to fund education, research, or health care. Conservatives would delight in a more reasonable corporate tax rate and deregulation.
Although corporate fat-cats would howl, boosting competition helps everyone in the long term. Firms do more with what they have, wages rise as companies strive for the best talent, and prices fall. Profits are aggressively reinvested instead of being sat upon. A rising tide lifts all boats.
Some concerns linger vis-à-vis environmental sustainability. This is a crucial issue worth addressing but largely falls outside the scope of this agenda. A dividend-paying carbon tax would be a good place to start. Also, efforts to deregulate should be done responsibly and should not amount to, as The Economist puts it, “a crude cull of environmental rules.”
It is critical to recognize the enormity of the task before America, its economy still reeling from the financial crisis. But bold, market-oriented economic reform is the best way to return the U.S. to growth—and to undercut the dangerous argument of those who would have democratic capitalism crumble to dust.
