Economics, Pethokoukis, U.S. Economy

Which country has the most billionaire entrepreneurs? (And how can we get more?)

Magnus Henrekson and Tino Sanandaji

Magnus Henrekson and Tino Sanandaji

While the US has the most billionaire entrepreneurs, both Hong Kong and Israel have more per million residents and thus the highest density of “high-impact” entrepreneurship. This according to “Small business activity does not
measure entrepreneurship” by Magnus Henrekson and Tino Sanandaji. The authors used Forbes magazine’s annual billionaires count from 1996 through 2010 to compile a list of nearly 1000 self-made superrich folks.

These are the creative destruction guys. As the authors see things, the number of billionaire entrepreneurs is a handy measure of a nation’s level of “Schumpeterian entrepreneurship,” referring to the kind of startups that bring new innovations to market, sell new goods and services, and generate lots and lots high-paying jobs as they grow bigger and bigger. And make their founders richer and richer.

Of course, if you care about an economy’s dynamism, higher inequality of this sort is worth it. It is one thing for your 0.01% to be made up entrepreneurs like Steve Jobs or Bill Gates or the Google Guys, quite another if they’re all wealthy scions or CEOs manipulating pliant boards. (Inequality researcher Thomas Piketty apparently thinks it’s pretty much all the latter, a topic Sanandaji is currently exploring.)

Frankly, we could use even more of these high-impact entrepreneurs and the innovative firms they create. How to do that? “Countries with higher income, higher trust, lower
taxes, more venture capital investment, and lower regulatory burdens have higher billionaire entrepreneurship rates,” Henrekson and Sanandaji find. In “SuperEntrepreneurs … and how your country can get them,” also co-authored by Sanandaji along with his brother Nima, the role of capital gains taxes gets a lengthy analysis:

Venture capital is involved in the majority of the highest growth firms in the US, and increasingly in Europe and other developed countries. In their ground breaking research on the venture capital industry, Harvard economists Paul Gompers and Josh Lerner show how sensitive it is to economic incentive and to the return on investments.

One interesting finding is that the return on capital in the venture capital industry is approximately the same as the return on capital in the stock market. This implies that the flow of capital into venture capital is determined by the economic rate of return, and therefore likely to be negatively impacted by high capital gains taxes.

Another important finding is that many of the investors in US venture capital are precisely those who are exempt from capital gains taxes. These so-called institutional investors account for about half of all funding to venture capital and private equity. This shift of ownership is yet another indication that investors are sensitive to taxes. A separate study by Harvard economists Gompers and Lerner has found that capital gains taxes significantly affect the flow of funds to the venture capital industry and the financing of entrepreneurial firms.

Tino Sanandaji  and  Nima Sanandaji

Tino Sanandaji and
Nima Sanandaji

Now that might not be all that matters. As The Economist argues concerning the Henrekson and Sanandaji paper, “the authors have little to say about how to create the network of institutions that they think helps to create entrepreneurship: high-powered universities and dense clusters of activity of the sort that flourish in Boston and Silicon Valley.” Fine, but it doesn’t seem like Washington is giving much concern to any of the above factors as policymakers try to figure how to escape from America’s Long Recession. 

Pethokoukis, Economics, U.S. Economy

‘A gold standard is not practical for a modern economy’

I just ran across this paper by University of Chicago economist John Cochrane (h/t to David Beckworth), “Understanding policy in the great recession: Some unpleasant
fiscal arithmetic.” As I was glancing through it, this jumped out at me:

A gold standard, or even a commodity standard are not practical for a modern economy. Gold and commodity prices diverge too much from the broader measures of inflation that we really care about, and opening a Fed-Mart to buy and sell the entire CPI is not feasible.

However, once we recognize that the fiscal commitment rather than direct purchases or sales of the commodity is the key ingredient for inflation determination a little financial engineering can create the same commitment. If the Fed targeted CPI futures, or the TIP-Treasury spread, it would be targeting the thing it really cares about – CPI inflation or expected inflation – rather than the price of commodities only loosely linked to those measures.

If, say, deflation occurred, the Fed would lose a lot on its CPI futures or TIP-Treasury bets, just as it would lose a lot of money buying gold. If inflation occurred, the Fed would make a lot of money on the same bets, just as money would flow in when buying gold. These measures would communicate and commit the same fiscal commitments as a CPI purchase program, without requiring actual CPI purchases.

Actually, Cochrane makes a pretty good case for the Fed to manage expectations through a different sort of rule: a commitment to keep nominal GDP growing at a constant rate over time, perhaps through a NGDP futures market.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Where are all the startups? A Q&A with Ian Hathaway on the decline of US entrepreneurship



Ian Hathaway is founder and managing director of Ennsyte, a San Francisco-based economics and research consulting firm. He is also a visiting scholar at the Federal Reserve Bank of Cleveland and an advisor to early-stage technology startups.  His current research focuses primarily on technology, innovation, entrepreneurship, and economic growth.


Here are edited excerpts of our recent chat for my Ricochet Money & Politics podcast on the decline of US entrepreneurship:

Now you’ve written a number of papers on innovation, and entrepreneurship, and what’s going on in the U.S. economy, but I want to start with a paper you co-authored.  It came out this summer.  It’s called “The Role of Entrepreneurship in U.S. Job Creation and Economic Dynamism.”  And let me just read a couple of sentences from that:

The United States has long been viewed as having among the world’s most entrepreneurial dynamic and flexible economies.  It is often argued that this dynamism and flexibility has enabled the U.S. economy to adapt to changing economic circumstances and recover from recessions in a robust manner.  But evidence along a number of dimensions and a variety of sources points to a U.S. economy that is becoming less dynamic – of particular interest are declining business startup rates and the resulting diminished role for dynamic, young businesses in the economy.

 What about Google, Facebook, Twitter, Uber, Airbnb? How can you say that there’s a decline in entrepreneurship and business dynamism when we see all this – you know, all this sort of good churn and creative destruction happening if you just pick up the business pages?

The numbers don’t lie. The data show declining business dynamism overall, which is largely a function of the declining firm formation rate, what we’re calling loosely the entrepreneurship rate.  These are very clear trends when looking at economic data over the course of several decades.

Now, you point out the examples of getting pushback because of what’s happening in the technology sector, in particular – and, of course I hear that often myself.  I live in San Francisco, sort of at the heart of all of this dynamic entrepreneurship and growth.

But first I would say that’s a very small portion of the economy.  And secondly, I would also point out that  I think people are just more aware of technology these days.  technology has been around for a long time.  The technology sector experienced substantial growth throughout the ’80s and ’90s, but it’s just that these products like Google and Twitter and Facebook and so on are just very personal and they’re consuming, you know, a larger portion of our personal lives and our day.

So I think people are just more aware of the small set of firms that are – that haven’t been around for that long.  They’ve been around for a decade or half a decade or so but have grown substantially over a very small period of time.

So your key finding is that here aren’t as many startups as there used to be?

So if you look at the startup rate, which we’re saying is – If you look at the number of freshly launched firms in a given year and you take that as a share of all firms, that rate declined from about 15 percent or so in the late ’70s to about 8 percent in 2012, which is our latest data.  We actually just had a data release yesterday.  So the startup rate has declined by about half over that period.

But that tracks exact same period where we saw Silicon Valley get bigger and bigger. How do you sort of reconcile those two things happening at the same time?

So if you talk about tech again, and in the 1980s in particular, if you look at the startup rate for the technology sector on its own, if you just isolate that group of firms, the entrepreneurship rate was actually surging at that time.  And, well, it continues to be much higher than the overall rate, which, of course, includes everything from  dry cleaners and restaurants to tech startups.  It encompasses the entire private sector economy.

So, actually, during that period, the startup rate in the tech sector was a lot higher but some other research that I’ve done and others have done shows that the tech sector also experiences a sharp decline, but it’s – it’s later.  It’s in the 2000s.  There’s a marked change around 2000, following the dot-com bust.

Now, of course there’s been a surge in activity in recent years.  And, unfortunately what we’re getting with accuracy with our data, which is administrative data that’s calculated by the Census Bureau, and it comes from – it comes from actual tax records from the IRS, so encompassing the entire private sector universe – what we’re getting with accuracy – unfortunately, we have a time lag there.  So, as I mentioned, just yesterday, the data for 2012 were released.  And we all know that there’s been a surge in tech entrepreneurship, in particular in the last couple of years.

So while I would expect that rate to have gone up in the two years that have passed, the bigger picture here is that there was a persistent decline for three decades.  So if we’ve experienced a rebound these last few years, and my guess would be that we have, particularly in certain segments of the economy, but we still have a huge hole to climb out of.

If we’ve seen this decline in entrepreneurship and startups at the same time we’ve seen this explosion in tech startups, then maybe that overall decline doesn’t really matter.  Maybe we’ve seen a decline in drycleaners or something, sort of low-tech, low-wage, while we’ve seen a lot more dynamism in the kinds of companies that hire lots of people and create new jobs and new technologies, you know, the gazelles, the fast-growing companies, the companies that are likely to become the next Google.  

And if we’ve seen this decline in tech since 2000, isn’t that just explained because 2000 was a peak in the tech bubble?

So I guess my point is that I’d like to see productivity gains from all sectors of the economy, tech or non-tech.

Secondly, there was a recent paper put out this summer by some economists at the University of Maryland and the Census Bureau, in addition to a report from the Bureau of Labor Statistics I believe last year, that shows these high-growth firms create a disproportionate amount of jobs, that their share is also declining.  So we’re seeing a decline in high growth entrepreneurship as well.

A related point that I want to make to that is that research that’s been done on who are these high-growth firms, there’s actually a lot more work that needs to be done in this space but it seems a little bit like a random walk.  Yes, technology firms are disproportionately likely to be high growth, but they represent by one estimate only 20 percent of the universe of high-growth firms going back a few decades.  So the point I want to make is that we really don’t know at the outset if a firm is going to explode and create an entire new industry or significantly disrupt the industry they’re in.

So I guess I would argue, and my coauthor, Bob Litan – I’ll use one of his analogies, just that if we want to score more balls, we just have to fire more shots on goal.  So I’m not satisfied with the answer or with the claim that all we need is tech entrepreneurship and everything will be fine.

And the role of the tech bubble in the decline on tech startups?

Definitely some air was let out of the entrepreneurship in tech in the 2000s I expect that future releases will confirm what’s going on now, which is a resurgence in entrepreneurship in the tech sector. And I would also say though that we also know that there’s a lot of consolidation going on in the tech sector.  These companies that people are mentioning as “startups,” in quotation marks, are actually huge companies, and they are innovating in large measure by acquiring other companies at earlier stages.  So while there has been clearly an uptick in tech entrepreneurship in the last couple of years, I believe there’s also some of this hardening and this consolidation that we’re witnessing in other sectors, it’s also appearing in tech.

You’re talking about a multi-decade trend, when we’ve had Democrats, we’ve had Republicans, we’ve had tax rates which have been kind of high, and they’ve been lowered. It’s been a changing macro-environment.  

D.C. policy audience like to latch on to policy explanations, right?  You can just pull a simple policy lever and that will fix things.  I don’t think taxes are actually a factor in this.

And I guess the only thing I’ll say about regulation is that let’s have the conversation about how specifically does regulation impede firm entry and how does it disproportionately advantage, you know, incumbents versus new entrants?  That’s the kind of conversation that I think we should be having.

One example I’ll use from the tech sector in particular – and this has been a hot button issue with immigration – high skilled immigration in particular and H-1B process.  There’s a cap on these on these visas, and there’s a mass surge in April to apply and that pool of H-1B visas is exhausted pretty quickly.  So you have big companies like Microsoft and so on file hundreds and thousands of applications for H-1B visas.  And if they’re allotted let’s say 250, they can say, great.  You know, let’s go hire 250 workers.  But if I’m a startup, this doesn’t work for me.  This process is lengthy, it is expensive, and it’s unpredictable.

So who would you promote more entrepreneurship?

One in the short term is immigration reform.  We know that immigrants are twice as likely to launch new firms, and that’s in all sectors, and in high tech it’s particularly elevated, so we know that’s something that will push the entrepreneurship rate up higher.

Longer term, education – it’s one of the factors that in studies of what drives regional variation, entrepreneurship rates, it’s the thing that keeps showing up.  And this is at a time when a lot of states have had to cut back on education because of balanced budget requirements and things of that nature.  So these are two things that I would advocate for.

Now, going outside of policy for a moment, we’re just kind of kicking the tires on some things that may be linked with the decline in entrepreneurship and as I said, we’re still working on it so don’t hold my feet to the fire too much on this, but I think that there are  some explanations that aren’t very exciting.

So, for example, if we look at metropolitan areas and states, there’s a very strong connection between the level of entrepreneurship rate in a region and it being located in the West and the South.  Now, we know that entrepreneurship rates increase to a accommodate population growth so it’s very likely that these population – that population growth in the West, particularly in the West and also in some areas of the South had driven entrepreneurship to high rates in the 1970s and early 1980s.  There’s also a strong link and decline in entrepreneurship in those regions.  So the very reason they’ve had these high rates which, as I said, there’s a geographic pattern to it also on average experienced the largest declines. As local demand grows, businesses have to grow along with it to meet that demand.

So one explanation, which isn’t very exciting, is just that we experienced high growth, population growth in certain regions, businesses needed to be formed to meet that local demand and after that growth slowed down, the firm entry rates maybe came down with it.

Another explanation has to deal with business consolidation. So economic theory would say that the more consolidated an industry is, the higher the barriers are to firm entry.  There may be a connection there; others have talked about this.  It’s something that we’ve seen in a number of sectors.  I have some more research coming out in the coming weeks and months that will address that issue as well.

So we have a population issue going on.  We maybe have a business consolidation issue.  Anything else? 

Starting your own business is really difficult.  I mean, it’s – look, everyone has heard about the benefits of working at tech companies, at Google and so on —  there’s food and dry cleaning and everything you can ever need.  if I have an offer and a real strong salary, why would I even bother to go start a business?  It’s just really hard.

And so, in some ways, it’s just that it’s the other side of that equation.  How can I compete with Google?  How can I outcompete them with innovating a new product if I can create something and beat them, and earn profit for my company, versus the other side of the equation – why would I want to compete with them when I can just go work there and have a cozy life?

 So to use the sort of Google example. Why should we really care that there’s been this decline?  There seems to be a lot of  innovation in the economy. So do you think it’s actually had an impact on economic growth, on innovation, on jobs?  

The most clear case is job creation.  So we know that without a doubt that young firms are – new and young firms create a lot of jobs.  In fact, I would say that they’re the primary source of net job creation.  So this is not to say that older and larger firms don’t create jobs, but, on net when you take into account the job that are destroyed from contracting older firms or those that close their doors, on net it’s the young firms that create the lion’s share of new jobs.  So that’s a very clear case here.  And this has coincided with a period – well, periods of low employment growth.

the other two cases are more interesting and, of course, the research is a little less clear.  But there’s innovation productivity.  It’s my belief that at least from a couple of lines of research that young firms tend to be more innovative and in particular more likely to create disruptive innovations, life-changing innovation.

I think just our human experience would agree with that, right?  So Apple is a significant outlier, but in general the most life changing and most powerful innovations have come from businesses that were formed with the intention of commercializing those creations, those innovations or those inventions.

The second thing – I guess now it’s a third thing – is the productivity side of this.  And I think that this is less clear.  So, as I mentioned before, although it’s equal, the realloacative process, this dynamism, this churning is really important for productivity.  But I also said, on the other hand, it’s been shown that, overall, the Wal-Mart effect has been productivity enhancing.

We’re getting new firms that are generating revenue and have huge stock market capitalizations — but not many people work for them.  How many people work for Twitter, Facebook versus the old-line industrial companies? What’s your take on that? 

So Nobel economist Michael Spence and UC Berkeley economist Enrico Moretti have two related frameworks for thinking about this.  So Michael divides divides the U.S. economy between the segment that competes globally, it sells goods and services around the world versus those that are located only locally and serve local markets. Tradable/non-tradable – Enrico calls it innovative sector versus non-innovative sector.  And, basically, what they say is, look, there’s one half of the economy that is going to generate the substantial majority of income growth or value and, at the same time, it’s going to employer fewer and fewer people as a share of that income.  And what’s going to happen is that that income is going to get disbursed around local economies and it’s going to support employment.  So there’s going to be very little productivity and income growth from that local segment, but that’s where a lot of the jobs are going to come from, which also explains a lot of this –  this polarization of wages and job growth in labor markets. And I think that’s absolutely dead on.

Not everyone can work at Google or Apple, I would say that folks that are working in local services and so on – and I’m saying all lines of services.  I’m not just saying, you know, barista at Starbucks.  We’re also talking about  lawyers and doctors who are supporting the local community.  I would just say that those people in the Bay Area and D.C. obviously have much greater employment and wage opportunities as a result of those companies that – those innovative companies, those tradable companies that are bringing – that are creating wealth and capturing it from around the country and indeed the world and bringing that to those local economies.

What about more directly trying to teach entrepreneurship, particularly in high school? 

So Bill Aulet at MIT has written a great book on this called “Disciplined Entrepreneurship.”  Some folks say you can’t teach entrepreneurship.   I disagree with that.  And I think Bill’s sort of one of the leaders in this space and has a lot to say on that. And my co-author Bob Litan  has this great idea of instead of just teaching math and science  where students aren’t that engaged, but actually incorporating how that scientific and that mathematical knowledge has been used in the course of business to create goods and services and, teaching the commercial side of this, providing a link to that from young ages so it’s sort of a part of that curriculum and that learning all along throughout the education process.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Something is missing from the Wall Street Journal’s story on SAT scores, affluence, and inequality


From reporter Josh Zumbrun in the Wall Street Journal:

Students from the wealthiest families outscored those from the poorest by just shy of 400 points. Given the widespread use of the SAT in college admissions, the implications are obvious: Not only are the wealthiest families best equipped to pay for college, their kids on average are more likely to post the sort of scores that make admissions easy. Thus the SAT is just another area in American life where economic inequality results in much more than just disparate incomes.

So what, exactly, is the mechanism here? A “confluence of factors,” Zumbrun writes. He is dismissive that wealthier families being more able to afford test prep is much of a factor. More likely, he explains, is that richer families can afford to live in neighborhoods with better schools. And college educated people tend to make more money. Zumbrun: “When the SAT is crucial to college, college is crucial to income, and income is crucial to SAT scores, a mutually reinforcing cycle develops.”

Let me add another possible factor to Zumbrun’s “confluence of factors.” The 2014 paper “Marry Your Like: Assortative Mating and Income Inequality” finds a rise in higher educated people marrying those with similar educational attainment. Combined with the rising returns to education, the authors finds assortative mating has increased income inequality: “If matching in 2005 between husbands and wives had been random, instead of the pattern observed in the data, then the Gini coefficient would have fallen from the observed 0.43 to 0.34, so that income inequality would be smaller.”

Assortative mating may also have a role in the correlation between incomes and SAT scores. Here is economist and Nobel laureate Gary Becker, who died last May, in a 2013 blog post in which he cites some of the factors that Zumbrun does but also one the reporter does not:

The combination of assortative mating with higher returns to IQ could have dramatic effects on relative mobility if the effect was to insulate to a significant degree a prosperous family’s children from economic risk. And it may be. The adults in high-IQ families are disproportionately represented in the jobs (professional, managerial, financial, and so forth) that pay well, and their income can and often is used to give their children a boost—for example in the form of payment of tuition to high-quality (and very expensive) private schools, payment to tutors, a variety of other educational enrichments, and entry into high-quality colleges without need for their children to borrow to finance college (or graduate or professional school) and thus assume debt. Colleges like to admit kids from high-income families, seeing such kids as future donors. And high-IQ parents are likely to produce high-IQ children, further enhancing the children’s attractiveness to first-rate colleges. These factors, which loom larger the greater the inequality in the income distribution, because that inequality creates a highly affluent tier of families (a proximed by the income shares of the top 10 percent and within that group the top 1 percent) are likely to reduce relative mobility, by securing a disproportionate number of the top college and university admissions and top jobs for children of the intellectual-economic elite.

Might the assortative mating of people with high academic ability play at least some role here as Becker suggests? As Financial Times reporter Matthew Klein tweets: “This relationship makes a lot of sense if traits that lead to high SAT scores are heritable and connected to income.” It seems like an avenue the WSJ piece should have explored or should explore in the future.

Economics, Monetary Policy, Pethokoukis

The gold standard is fool’s gold for Republicans

Over at, blogger Ralph Benko attacks a recent post of mine that summarizes a Twitter debate about the role of the gold standard and the rise of the Nazi Party in Germany. Here’s the hed: “AEI’s James Pethokoukis Fouls Out With His ‘Nazis and Hitler’ Innuendo.” What hugger-mugger.

Now my only value-added, if you can even call it that, was posting the exchange via Storify and calling it “a really great Twitter debate.” Benko is a gold-standard advocate and apparently doesn’t much like the words “Hitler” or “Nazi” to be in the same area code of any discussion of once again linking the dollar to the shiny yellow metal.

Unfortunately, economic history is what it is. As economist David Beckworth puts it: “So far all the problems WWI created, the flawed interwar gold standard was probably one of the the more important ones. It led to the Great Depression which, in turn, guaranteed the rise of the Nazis and another world war. The big lesson, then, is getting the international monetary system right matters a lot.”  Beckworth then refers to this chart:


Now I have no idea why Benko doesn’t differentiate between the prewar and interwar gold standard. Perhaps advocates are so sensitive to charges that the gold standard played a key role in the Great Depression, that nuance gets lost in their knee-jerk counterattacks. After all, many gold bugs think their moment is approaching once again. As Ron Paul wrote in his 2009 book “End the Fed”: ” … we should be prepared for hyperinflation and a great deal of poverty with a depression and possibly street violence as well.”  And when the stuff hits the fan, nations will again return to the gold standard for stability. Or so goes the theory over at Forbes.

Then again, I don’t want to return to the 19th century gold standard, either. Here is AEI economist John Makin:

The gold standards like those in place during the late nineteenth century can deliver relatively stable prices, and perhaps falling prices if the supply of gold does not rise rapidly enough. But it also delivers high volatility in real output and tends to be associated with more financial crises. Like it or not, the modern world has grown used to central banks that aim at price stability and full employment and provide an elastic currency in an effort to achieve higher growth while avoiding financial crises.

And economist Scott Sumner:

The gold standard got a bad reputation after the Great Depression, when it was seen as contributing to worldwide deflation.  Kurt Schuler points out that the interwar gold standard didn’t follow the rules of the game, which is true.  Central banks hoarded excessive  gold and that contributed to the deflation.  But at the end of the day I still have two major objections to returning to a gold standard.  If a gold standard requires good behavior by governments, then why not adopt fiat money?  And even if the gold standard were run according to the playbook, the recent dramatic increase in Asian gold demand would have inflicted deflation on any country with a currency linked to gold.

Ramesh Ponnuru:

The drawbacks to a gold standard are well known. If industrial demand for gold rises anywhere in the world, the real price of gold must rise — which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.

If another country’s government begins hoarding gold, the same thing happens. This is not a theoretical concern: It’s what France did in the early years of the Great Depression. Countries were forced off the gold standard, and recovered in the order they left it. Representative Paul’s strategy for dealing with the theoretical and historical arguments against the gold standard in End the Fed is to ignore all of them. All he says is that problems arose in the 1930s because of the “misuse of the gold standard.” But note that the great advantage of the gold standard is supposed to be that governments cannot manipulate it. Concede that they can and the argument is half lost.

And Beckworth:

The breakdown of the inter-war gold exchange standard, the end of the Bretton Woods system, and the high inflation of the 1970s were all the result of U.S. officials’ attempting—and failing—to manage the business cycle. Prior to this era, there was less concern about swings in economic activity, and the sometimes painful discipline of the gold standard could therefore be tolerated. Barry Eichengreen, in his 1992 book “Golden Fetters,” argued that indifference to the business cycle began to wane in the 20th century because people started demanding more from their elected officials. This meant more government intervention in the economy, and therefore an increase in monetary instability. The gradual abandonment of the gold standard over the 20th century was a symptom of these developments, not their cause. There is no turning back the clock on this changed political dynamic—and that’s why it’s unlikely that any country will ever go back to the gold standard.

Thanks to the financial crisis, the rise in the national debt, and the Fed’s novel monetary policy actions, the gold standard is getting a second look on the right and among Republicans. But wrenching economic volatility and monetary instability and deflation open the door to big government policy responses to restore economic security and growth. The Great Depression got us the New Deal. The Great Recession got us the Obama stimulus and Obamacare. There is a better way.

Economics, Pethokoukis, U.S. Economy

Here is the left’s secret plan to turn America into Sweden

Lane Kenworthy

Lane Kenworthy

Just how big do Democrats/left-liberals/progressives want to grow government? And how high are they willing to raise taxes? If only there were a left-wing version of Paul Ryan’s famous long-term budget blueprint that would outline a multi-decade path for taxing and spending (including how to deal with the coming entitlement tidal wave).

Instead, pretty much all you can find are 10-year budgets showing taxes a bit higher here, spending a bit high there. After that, however, it gets pretty fuzzy. It’s almost as if the pols and wonks on the left are avoiding the subject of what’s beyond the near horizon.

But there are clues. Democrats continue to dream up new entitlements. To Medicare, Medicaid, and Social Security, we now have Obamacare.  Next up on the wish list is universal pre-K. After that, perhaps a universal basic income. On taxes, some prominent left-wing economists are arguing the US economy would be just fine with sharply higher top tax rates of at least 70%. Put it all together, and it seems like the left is quietly working toward a future America where government spends more, intervenes more, taxes more. A whole lot more.

One honest, straight-forward  thinker on the left is University of Arizona sociologist Lane Kenworthy. In his recent book “Social Democratic America” he actually outlines a progressive “path to prosperity” modeled on the generous Nordic welfare states. “Over the course of the next half century, the array of social programs offered by the federal government of the United States will increasingly come to resemble the ones offered by those countries,” Kenworthy wrote in a Foreign Affairs essay earlier this year.

And how much will this cost? Kenworthy offers a rough estimate of 10% of US GDP, or around $1.5 trillion a year, raising total government spending from 37% of GDP to 47% of GDP. And here is the payment plan:

1.) As a technical matter, revising the U.S. tax code to raise the additional funds would be relatively simple. The first and most important step would be to introduce a national consumption tax in the form of a value-added tax (VAT), which the government would levy on goods and services at each stage of their production and distribution. Analyses by Robert Barro, Alan Krueger, and other economists suggest that a VAT at a rate of 12 percent, with limited exemptions, would likely bring in about five percent of GDP in revenue — half the amount required to fund the expansions in social insurance proposed here.

2.) Relying heavily on a consumption tax is anathema to some progressives, who believe additional tax revenues should come mainly — perhaps entirely — from the wealthiest households. Washington, however, cannot realistically squeeze an additional ten percent of GDP in tax revenues solely from those at the top, even though the well-off are receiving a steadily larger share of the country’s pretax income. Since 1960, the average effective federal tax rate (tax payments to the federal government as a share of pretax income) paid by the top five percent of households has never exceeded 37 percent, and in recent years, it has been around 29 percent. To raise an additional ten percent of GDP in tax revenues solely from this group, that effective tax rate would have to increase to 67 percent. Whether desirable or not, an increase of this magnitude won’t find favor among policymakers.

3.) A mix of other changes to the tax system could generate an additional five percent of GDP in tax revenues: a return to the federal income tax rates that applied prior to the administration of President George W. Bush, an increase of the average effective federal tax rate for the top one percent of taxpayers to about 37 percent, an end to the tax deduction for interest paid on mortgage loans, new taxes on carbon dioxide emissions and financial transactions, an increase in the cap on earnings that are subject to the Social Security payroll tax, and a one percent increase in the payroll tax rate.

Now I am not judging whether this vision, whole or in part, is a good idea or would make America a better place. Rather, this post is plea for candor and transparency. Americans deserve know where both parties want to take America in the 21st century.  Demographics, globalization, and automation will prompt big changes in national economic policy. And those changes should be made within the context of broader vision — forthrightly presented — about the next stage of the American Project.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis, Taxes and Spending

Can the US raise much revenue by raising taxes on the 1%?

Image Credit: Wikipedia

Image Credit: Wikipedia

Not really, according to a new analysis by Nezih Guner, Martin Lopez-Daneri, and Gustavo Ventura in VoxEU. Using a model that mimics the tax distribution characteristics of the US economy, the researchers find a revenue-maximizing federal rate of 37% for the top 5% and 43% for the top 1%. The current top marginal tax rate is 39.6% (but is effectively closer to 45%).

From the study:

The message from these findings is clear. There is not much available revenue from revenue-maximising shifts in the burden of taxation towards high earners – despite the substantial changes in tax rates across income levels – and that these changes have non-trivial implications for economic aggregates.

1.) Left-of-center economists such as Peter Diamond and Emanuel Saez have been arguing that top rates of 50% to 70% or higher would raise plenty of tax revenue without damaging the economy. Inequality researcher Thomas Piketty has called for top rates of 80% on income and wealth. The Guner/Lopez-Daneri/Ventura study suggests those rates are too high and would cause great economic harm. (Of course, some want high tax rates for punitive reasons, not redistributive or budget-balancing ones.)

2.) This study also seems to support the finding’s of the UK’s Independent Fiscal Oversight Commission, which determined that cutting that nation’s top rate from 50% to 45% was revenue neutral, implying the revenue maximizing rate is in that range.

3.) Keep in mind these Laffer Curve effects are all about short-term economic impacts. But economists agree that long-term effects are important, too. America benefits greatly from people who take risks and make career choices in hopes of striking it rich. As Aparna Mathur, Sita Slavov, and Michael Strain argue in a 2012 analysis: “Significantly reducing that possibility by hitting those individuals with extremely high income taxes is of first-order importance in determining the optimal top tax rate.” Again, Guner, Lopez-Daneri, and Ventura:

To conclude, it is important to reflect on the absence of features in our model that would make our conclusions even stronger. First, we have abstracted away from human capital decisions that would be negatively affected by increasing progressivity. Since investments in individual skills are not invariant to changes in tax progressivity, larger effects on output and effective labour supply – relative to a case with exogenous skills – are to be expected. Second, we have not modelled individual entrepreneurship decisions and their interplay with the tax system.

4.) At the same time, this study is the latest in modern tax research to suggest that cutting top tax rates to historically low levels — certainly below 30% — would be a huge revenue loser.

5.) If the left wants to deal with rising government spending from entitlements (or to pay for new programs) through higher taxes rather than deep structural reform, they are going to have to support a value-added tax on the 99%.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


A really good and understandable explanation of why net neutrality is a bad idea

Net neutrality is an important economic policy issue, but one many people find abstract and confusing. As the Mercatus Center’s Brent Skorup points out, advocates have been successful in coining a few simple, clever catchphrases and explanations  – “all online data is equal” and  “the Internet has always been neutral” — to give the impression they’re on the side of fairness and freedom. But net neutrality regulation risks locking in a “net neutral world” that does not exist and never existed — and in the process risks limiting new investment and innovation. More from Skorup on why it is unwise to regulate the internet by applying “monopoly-era telephone regulations” to today’s providers:

A few milliseconds of delay for an email is unnoticed but it makes, say, a video chat with a doctor unusable. As the Massachusetts Institute of Technology computer scientist and early Internet developer David Clark said, the Internet is not neutral and has never been neutral. Network engineers and computer scientists in academia and industry for decades have prioritized certain online tasks and services.

These misunderstood and demonized “fast lanes” are increasingly used in the broadband provided to businesses and homes. Special treatment is afforded to phone calls, for instance, so that a phone call to grandma over broadband works even when junior is watching YouTube upstairs on the same line.

Many of those who understand the complex nature of networking are open to the widespread use of fast lanes. President Barack Obama’s former chief technology officer, Aneesh Chopra, recently explainedwhy “fast lanes” – managed services in FCC-speak – are consistent with net neutrality and good for consumers.

As broadband networks increasingly serve as a single source for telephone, television, Internet, home security and Internet of Things services, more prioritization of certain traffic is needed and perhaps inevitable. The regulator’s job is not to freeze current network practices in place for perpetuity but to determine which network practices harm consumers and which are beneficial.

What people want from their broadband differs greatly and technology should be permitted to respond to changing consumer demands. Some people will want high-quality Netflix. Some will want high-definition teleconferencing ability. Those in rural areas may desire uninterrupted telemedicine applications, and gamers may want games that don’t freeze. Prioritization makes this possible.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, International economy, Pethokoukis

When the euruzone crisis returns …

Image Credit: shutterstock

Image Credit: shutterstock

More alarming analysis from AEI’s Desmond Lachman:

Sticking to the failed policies of the past is particularly unfortunate at this stage of the European economic cycle. Europe as a whole is now on the cusp of price deflation, while the highly indebted countries of the European economic periphery are already experiencing outright price deflation. If Europe’s deflationary tendencies take root, it is difficult to see how the highly indebted countries of the periphery will be able to restore public debt sustainability. It is also difficult to see how Europe will not be exposed to another and more virulent round of its sovereign debt crisis once the U.S. Federal Reserve starts hiking interest rates and once global liquidity conditions are not as favorable as they are today.

Equally disturbing is the all-too-likely further deterioration in Europe’s political landscape should its economy continue to languish. Since the onset of the European debt crisis in early 2010, the European public has progressively lost faith in its political elite in response to years of economic recession, budget austerity and high unemployment. This has spawned the emergence of extremist parties on both the left and the right of the political spectrum, from Greece to Spain and from Portugal to Italy. It has also given rise to a veritable backlash against sticking to a policy recipe of budget austerity and structural economic reform.

It has to be of the deepest concern that Europe’s political fragmentation has not been confined to its periphery. Indeed, the most troubling recent political developments have to be those in France and Germany. In France, Francois Hollande has now lost control of the Senate, which has to throw into question his political ability to reinvigorate the French economy. This is especially the case with Marine Le Pen’s National Front Party breathing down his neck. Meanwhile in Germany, the rapid rise of the Alternative for German Party (AFD) is bound to limit Chancellor Angela Merkel’s room for policy maneuver. This is particularly the case with respect to her scope for adopting an easier fiscal stance or for giving the green light to the ECB to go ahead with full-bodied quantitative easing.

Shorter: the status quo is not sustainable. You have a bunch of no-growth economies that have not recovered from the 2008 recession, stuck with high debt levels and a hog-tied central bank. Oh, and growing political instability.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

Study: The Small Business Administration does more harm than good

Government should be judged by results not intent, outputs rather than inputs. The goal of the US Small Business Administration is, according to the SBA itself, to ensure small businesses “have the tools and resources they need to start and expand their operations and create good jobs that support a growing economy and strong middle class.” Sounds great. But the result of SBA lending programs may be creating a very different result.

From “The Direct and Indirect Effects of Small Business Administration Lending on Growth: Evidence from U.S. County-Level Data,” a new NBER working paper by researchers Andrew Young, Matthew Higgins, Donald Lacombe, and Briana Sell:

The Small Business Administration is a federal government agency charged with promoting the interests of small businesses; in large part by encouraging financial intermediaries to extend loans to them. An important part of that encouragement is the provision of government-backed guarantees on the loans, often for up to 75%-90% of the principal.

In this paper we examine the relationship between SBA lending and income growth at the U.S. county-level. Based on a sample of 3,035 counties that covers the years 1980 to 2009, we find little evidence to support the desirability of the SBA loan programs. A spatial econometric analysis suggests that an increase in SBA loans per capita in a county is associated with negative effects on its own rate of income growth; also the growth rates of neighboring counties. For the average county in our sample an increase in a per capita SBA loans of $3.43 is associated with a cumulative decrease in annual growth rates of a bout 2 percentage points. (The average county in our sample has $34.27 in SBA loans per capita.)

The largest part of this decrease is in the form of indirect effects on neighboring counties. In addition to including period and state-level fixed effects and a large number of other controls, we also check the sensitivity of the results to (a) examining income levels rather than growth rates and (b) examining a subsample of only metropolitan area counties.

The results are largely robust and, perhaps more importantly, we never find any evidence of positive growth effects associated with SBA lending. Even when the estimated effects are statistically insignificant, the point estimates are always negative. Our findings suggest that SBA lending to small businesses comes at the cost of loans that would have otherwise been made to more profitable and/or innovative firms. Furthermore, SBA lending in a given county results in negative spillover effects on income growth in neighboring counties. Given the popularity of pro-small business policies, our findings should give reason for policymakers and their constituents to reevaluate their priors. 

Government is a lousy venture capitalist. And, apparently, a lousy small biz lender, too. Perhaps the SBA would be better suited to run programs on entrepreneurship education or something — but surely at a cost less than its annual billion-dollar budget and lending authority. For more, I refer you to this 2006 AEI paper, “Why the Small Business Administration’s Loan Programs Should Be Abolished.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.