The Dismal Political Economy of the House Tax Reform Proposal

I’ve been reading and thinking a fair bit about the new Republican tax plan – currently the Tax Cut and Jobs Act (TCJA) though I personally agree with the President that the “Cut Cut Cut Act” would be far superior branding.  Before the GOP embarked on its ill-fated (so far!) effort to repeal Obamacare I tried to analyze it from a 30000-foot perspective based on existing theories of Congress.  I’ve been trying to look at the TCJA from a similar perspective; in short, the outlook is bad. I do not expect a bill materially resembling the TCJA to be signed into law.

The largest obvious problem is procedural – the bill doesn’t come close to meeting the requirements to pass the Senate.  In order to be ruled in order to pass the Senate with 50 votes, a bill must (among other requirements) not expand beyond the short-run deficit by more than specified in the budget resolution and must not expand the long-run deficit at all.  The TCJA barely meets the $1.5T allowed under the new budget resolution, which leaves the GOP little room to maneuver – but the legislation makes no apparent attempt to comply with the long-run deficit requirement.*  That’s it, game over, death by point of order.  The TCJA can’t be understood as a bill at all so much as an exercise in blame-shifting; this is Speaker Ryan’s opening bid to prod the Senate into putting together an actual bill.

Beyond that – the political economy of this bill doesn’t make a great deal of sense.  The basic structure is a swap of tax burden from corporations** and capital owners on to individuals, under the theory that the corporate rate cuts will increase the return to investment, increase investment and ultimately raise the level of growth.   That’s the policy justification – but you might have noticed something that sounds less-than-particularly popular about the prior sentence.  The TCJA will shift the tax burden on to individuals.

The TCJA will create large groups of winners and losers, in ways that I think are hugely problematic for the bill’s chance of survival.   There are two specific ways it does this – first, it doubles the standard deduction but eliminates the standard exemption.  For households taking the standard deduction this mostly works out to a wash, but it’s a straightforward increase to all households that itemize deductions rather than taking the standard deduction.  Secondly, it wipes out a large number of widely used deductions such as the medical expense deduction and the state and local tax deduction (SALT).  The net results mean that the bill is largely a wash for most of the population but will hit large swathes of the population with tax increases.

The fact that it creates these losers is bad – the specific people it harms are worse.  There are net tax increases both on the poor ($20K – $40K) but also on the merely-affluent ($200K – $500K).  The deduction repeal will particularly harm well-off voters in high-tax high-property-value jurisdictions…such as the suburbs of New York, New Jersey, and California.  That’s right, the Speaker is proposing a bill that would specifically target the most politically active swing voters in his most vulnerable members’ constituencies.  I do not think the SALT repeal survives.

Deduction-subsidized interest groups are gearing up to go to war.  By doubling the standard deduction as I mentioned above, the TCJA would substantially limit the number of households that itemize deductions, and in turn lessen the incentives to engage in behavior that would otherwise be deductible.  The homebuilders’ association is already gunning for this bill, and I do not think charities, universities, and churches are far behind.  This, coupled with the estate tax repeal (the estate tax motivates a lot of estate donations) would do real damage to Big Charity.  I expect the Catholic Church to come out, swinging hard, after they assess what this will do to their finances.

These interest groups could be paid off with one thing – money, of which there is none.  The existing bill bumps up exactly against the short-term deficit allowances and as I mentioned, runs wildly over on the long-run deficit.  You can’t get rid of the tax increases without getting rid of the tax cuts to corporations that are, essentially, the point.  And given that the bill is way over on the long-run deficit the changes required to make this bill Byrd-friendly would create more and bigger losers rather than buy off existing losers.

Finally, while overwhelming public support could overcome interest group resistance this bill is likely to end up somewhere on the spectrum between unpopular to neutral.  Democrats have decided to unify against it, which will put a natural ceiling on its public support.  The essential goals of this legislation – tax cuts for the wealthy and corporations – are quite unpopular.  It should be little surprise that the bill starts off somewhat underwater in popular opinion, and that’s before a lot of voters figure out this is going to raise their taxes.

Also, as a pure policy aside I think the bill’s authors underrate the time-consistency issues posed by the route they’re taking.  Tax cuts for big corporations and rich estates aren’t politically defensible – the next time Democrats take power they will do so on a platform of reimposing those taxes to pay for broadly popular spending programs.  In that context the hoped-for incentive effects will be muted, as people will not necessary expect that these tax incentives will stay in place.

To return to where I started – for both procedural and political reasons it is very difficult to see anything materially resembling the TCJA being signed into law.  While a lot of popular punditry on tax reform notes that “tax reform is hard”, I think the political obstacles here are actually substantially underrated.  I do think that the GOP will pass something – but the changes required to come up with something passable will require substantially altering the framework to create fewer losers and in turn giving up on some of the biggest giveaways to unpopular interest groups.  Something more like the Bush tax cuts with across-the-board time-limited cuts will be much more practical.  The existing policy framework appears flatly unworkable in the context of a partisan bill passed through reconciliation.

*: The link cited suggests sunsetting the corporate rate cuts after 10 years would solve this issue; I do not think the Congressional Budget Office would agree.  Large corporations have the ability to shift GAAP profits forward to claim the 20% rate, and claim large losses in the out years.

**: Particularly a massive pass-through cut that makes little sense to me, either on a policy or politics level, and might well have been written by the President’s tax lawyer.


The President & His Imagined Community

The New York Times recently touched on the recent, sharp, and unprecedented polarization in partisan views of the NFL.  Until recently the NFL was viewed quite favorably by both Republicans and Democrats – after the President began a pressure campaign against the NFL for tolerating player protests, Republican views on the NFL switched from +40 positive to -20 against.  Merits of the issue aside, the finding will not shock those familiar with John Zaller’s work, or really most of the political psychology literature.  By intervening in an issue – any issue – the President can sharply change the minds of his co-partisans.  For example, by turning them against a once-favored national pastime.
    I’ve recently been reading Tim Wu’s “The Attention Merchants”, on the history of modern advertising.  He dwells at length on Nazi propaganda.  The focus of Nazi propaganda broadcasts was not ideological – instead, it generally featured light fare with popular music and (anti-Semitic) comedy programs.  The focus was on two things – reinforcing the bonds of the national community through shared experiences and on maintaining complete control of the populace’s attention.  The political stuff was slipped in around that, relying less on indoctrination than piggybacking on the created sense of solidarity.
    The political discourse of the Trump era has been dominated by a single stark fact – a single human commanding more concentrated attention than anything since I Love Lucy. Love or hate, nobody is neutral. The Presidents’ endless war on institutions – virtually all institutions, from the courts to the FBI to the NFL – serves as the raw material for building a shared community.  The President’s feuds and vendettas filter down to his supporters, creating a shared community defined by the support of the President against his myriad enemies.  Whether this behavior is strategic or instinctive, I don’t know.  But the effect is clear; to gradually separate Republican rank and file from all institutions that could serve as cross-cutting loyalties or identities.

Congress & The Mundane Scandals to Come

Somewhat to my own amazement, the Krehbelian analysis that Congress will not repeal Obamacare continues to hold up.  It just died in spectacular fashion, on the Senate floor in the dead of night, the type of spectacle that’s not supposed to happen.*  The relevance of McCubbins’ work got me thinking about another sleeping dog that won’t be pretty when it wakes up – Congressional oversight.  McCubbins’ theory is that, basically, Congress acts as a “fire alarm” – it tends to lie pretty much dormant but activates with a vengeance when something goes wrong, blame needs to be laid, and fingers get pointed.

The expanding Russia scandal aside, the Trump administration will create tremendous numbers of scandals.  Think of the Bush-era Minerals Management Services scandal, with Interior workers doing cocaine and cavorting with prostitutes in exchange for contracts, but much much worse.  The criminal negligence the Administration has shown towards ethics, conflict of interests, and staff competency virtually guarantees the next few years will be marked by enormous wrongdoing at virtually all levels of government.  And unlike the Russia scandal, there is little incentive for Republicans in Congress to run interference for the Administration here.

When these inevitable scandals arise, it will provide an opportunity for Congressional Republicans to make themselves look good, at the expense of the President, but without taking him on directly.  When it turns out that some Trump flunky has been accepting bribes from the Chinese in order to rig trade negotiations (choose your own nonsense adventure here), it will be a very big deal.  The President will either have to sit silently by and fume or try to defend these aides/Cabinet secretaries at great political expense, while Republicans get to polish their images as crusaders for good government.  Even if nothing comes close to the guy at the top, it will rightly do enormous damage to his perceived competence.

Who knows – perhaps the President will use his hardheaded business expertise to whip the government into shape.  But if I’m betting money,  I’d bet a fair bit on something going extremely wrong, like Katrina-level wrong, over the next few years, after which minimal scrutiny reveals a virtually endless well of malfeasance tempered only by incompetence.  And I think there’s little chance Trump will find Congress willing to act as his lawyer in the court of law or the court of public opinion.


*: The majority party doesn’t call votes it’s going to lose. Citation: all Congress scholars, though I suppose Cox & McCubbins most prominently.

Policy change & the empty Presidency

It’s June 19, 2017, and the Senate is hurtling towards a vote next week on a major healthcare bill written in secret that most Republican Senators haven’t even seen.  In what would normally have thrown a giant wrench in the gears, last week the President castigated the initial House bill (AHCA) as “mean” and “coldhearted” and exhorted the Senate not to sharply cut coverage.  Instead the Senate is ignoring him and moving ahead seemingly careless of the President’s policy preferences. I wrote a few months ago that I found the passage of Trumpcare unlikely – I still do!  I think it’s worth digging into some of the odd behavior of the actors involved and putting down a marker on why I’m skeptical of the AHCA’s chances.

Republicans were apparently stunned when the President dragged the AHCA despite touting it two weeks before, but they shouldn’t have been.  The President has no real ideological orientation or commitment to internal consistency, which he views as a positive.  I viewed this as presenting a major problem for crafting legislation – legislators wouldn’t go out on a limb for someone who would have no compunction sawing it off after him.  I thought Republican Congresspeople would think through the game a few moves ahead, but apparently was too optimistic:

In the House Ways & Means Committee markup today, there was discussion among a couple of Dems and Republican members, with a Democrat saying: “See, we told you your health care bill was mean. Now the president agrees with us.”…A number of members of Congress have told Axios that Trump and Pence lobbied the bill like nothing they’d ever seen, using superlatives such as calling it a “great bill.” Members who Trump urged to take a risk and pass the bill are now seeing him turn his back on them. One member said Trump was on the phone urging people to support it, and “for him to turn around and do this, it’s stunning. I can’t believe it.”

So this incident is both why the Senate is ignoring his policy demands and why legislating will be difficult.  Senator McConnell rightly sees that there’s no reason to make policy concessions to the President’s stated demands, as his statements today don’t necessarily indicate anything about his preferences tomorrow.  At the same time, moderates facing tough re-election campaigns are likely very anxious about the prospect of a President who might easily turn on them.  They can (also correctly!) see that giving him a concession with a vote here will likely earn them nothing.  Now, the Senators may still be muscled into it the way the House was, but there’s an additional risk – Trump might actually veto the bills.

It only seems insane if you think that the President cares about policy!  It would likely result in a burst of positive press if he told them to “come back with a better deal” and means he wouldn’t have to defend an unpopular bill at political cost to himself.  It would be entirely on-brand. Furthermore, he could count on friendly media to defend his decision and the substantive policy would win some support from Democrats.  I don’t think this is likely, but his general disengagement from the process means it’s certainly an imaginable outcome.

Traditionally theories of Congress depend on spatial ideal points or party cartels but if anyone involved in this game thinks that the President’s utility function depends on moving policy closer to his policy ideal point or protecting the GOP majority, they are playing with fire.

The Empty Presidency

The President of the United States just unprecedentedly intervened in a spat between two American allies…via Twitter.

Secretary of State Rex W. Tillerson and Defense Secretary Jim Mattis initially tried on Monday to smooth over the rift, with Mr. Tillerson offering to play peacemaker and Mr. Mattis insisting it would have no effect on the campaign against the Islamic State.

Less than 12 hours later, however, Mr. Trump discarded that approach by putting his thumb on the scale firmly in Saudi Arabia’s favor. His tweets, which a senior White House official said were not a result of any policy deliberation, sowed confusion about America’s strategy and its intentions toward a key military partner.

The most interesting thing about this isn’t actually the intervention, which appears to be firmly in line with the new administration’s reflexive pro-Saudi leanings.  It’s the question of credibility this raises.  The President seems to almost be going out of his way to ensure that statements from the Secretary of State & Defense are not taken seriously, as they cannot speak for the administration.

On the other hand, the President cannot plausibly claim to speak for the administration either.  The White House is very likely to execute an embarrassing climb-down from the President’s tweet-rant against Qatar*, leaving in place…what, exactly?  Any future policy pronouncements that have gone through deliberation and the inter-agency process are just as liable to be contradicted by the President.  And any future Presidential pronouncements are likely to be rejected by his own staff & bureaucracy.   If push comes to shove, the US stance on this and other commitments like, say, NATO’s Article V, are completely unclear.

In a real sense, no one can credibly claim to speak for the position of the US government.  Which is an interesting challenge that I think is under-rated relative to the actual “policy positions” held by the President.

*: This is all so weird, for the record.

Flexibility vs. Credibility in Strategy

Sometimes the key ingredient in equilibrium is trust.

One under appreciated aspect of the current administration is how much outcomes can change without policy change. The current dispute over the Obamacare CSR payments is an excellent case study – the Trump administration says it will continue to make the payments but vacillates between pledging to make them and threatening to withhold them as a lever for negotiation with Democrats.  This seems implausible, since a lot of people would lose health insurance and the Administration would rightly be blamed.  It’s a bit of a dead man’s switch.  The actual desired end state – what the Administration wants to happen with the payments – is totally unclear.

So – if you’re an insurer whose profitability depends on the payments coming in, what would you do?  You certainly can’t count on the payments coming in, certainly.  If the payments are large enough to present a very substantial upside or a major part of your business, you might gamble – but if the downside risk is high you’d get out and not expose yourself to an unquantifiable uncertainty.  The last thing an insurance CEO wants to tell her shareholders is that she incurred major losses due to a Republican President cutting Obamacare subsidies; after all, what else would she expect?  And so while the policy remains in place, the outcome changes.

Trump says that he likes to be unpredictable – and this has some upsides.  He has a genuine point that his complete unpredictability and lack of ideological commitment offers a lot of flexibility.  By constantly changing his positions on policy issues, it allows him the freedom to do whatever seems most advantageous today without worrying too much about path dependence in the future.  This is a big strength for obtaining his goals, particularly if they change over time. However, he makes a grave mistake when he says that it offers him total flexibility.

There are many policy outcomes that can only be obtained with a credible commitment – the CSR payments are one, and NATO is another.  Even though the NATO policy is currently nominally the same as under Obama, Trump’s lack of credibility on the issue substantially weakened the deterrence value of the alliance.  Constant ambiguity on the issue doesn’t offer the US the choice between “no NATO commitments” vs. “a strong NATO deterrent”, it offers the US the choice between “No NATO commitments” vs. “a weak NATO deterrent”.

Total lack of credibility is not a completely insane choice, but requires the principal to put a very high value on the option value vs. a less-flexible choice with higher expected value.  It’s certainly notable that no other US President has ever gone this route, as it has a lower payoff than picking choices and sticking with it – but that is under the assumption that the principal’s utility function is the same from day to day.  If you don’t know what outcomes you’ll favor tomorrow, chaos might be a rational choice!

Complementary and Contradictory Economies of Scale

The odd thing about economies of scale is that they operate on both the revenue and the cost side, and the two do not have to coincide.
I’ve been digging into some of the literature on network effects, which can drive positive economies of scale – e.g., Facebook is a lot more valuable because all your friends are on it.  This is common in many current-generation software companies based around networks, and the promise pitched to innumerable venture capital investors.  Many competitive spaces based around networks are natural monopolies for this reason, in that the value proposition to the largest player is naturally higher than its competitors.  The rich get richer.
In traditional industries, positive economies of scale are ubiquitous on the cost side. As your brand gets bigger, you can e.g. shift from expensive contract manufacturing to more inflexible but lower-cost in-house manufacturing.  For many traditional industries the economies of scale are highly positive on the cost side but next-to-nothing on the revenue side – the value of Tide is unaffected by whether your neighbor uses Tide.  For consumer brands that are big enough, the revenue economies of scale can turn negative due to reasons of market saturation, fashion, and taste.
A bit of a novelty are businesses with the opposite problem – strongly positive economies of scale on the revenue side and negative economies of scale on the cost side.  For example, a two-sided marketplace where an app mediates physical activities.  As the business gets bigger, issues like liability (legal and PR) become commensurately bigger.  For businesses where the profit model is based on externalizing internal expenses, e.g., shifting insurance and maintenance costs from the service provider to the service operator, that becomes less practical as the firm gets too big.
It strikes me that many of the current-generation sharing-economy companies fall into this category of wrong-way-round economies of scale.  When there are network effects to drive growth but difficult physical realities to work around, it could turn out to be easy for a company to outgrow its economics.  For example, if there are positive cost economies of scale for operating a car-dispatch service, why were there no globe-straddling car-service companies beforehand?  The contradictory economies of scale suggest a natural boom-and-bust cycle where operating cash flow plummets inexorably while revenue (and need for operating cash!) explodes.
Also a fun question – on a conceptual (not accounting) level, is paying to acquire a competitor in a marketplace business a capital or marketing expense?