Bananas and Broken Windows

A guy walks into his local grocery. Noting the price of bananas is 89 cents per pound, he complains that the grocery across the street sells bananas for 69 cents per pound. The grocer asks him why he didn’t buy bananas from the other grocery. “They are all out of bananas.” The grocer tells him, “When we’re all out, we sell them for 49 cents per pound.” 

It makes sense, doesn’t it? When Grocer A runs out of bananas, Grocer B can charge more. As the supply dwindles and he continues to raise his price, some customers will switch to oranges. Meanwhile, banana growers, realizing more profit, will produce more bananas. But now there are fewer customers because some converted to oranges, so grocers will lower the price to sell their bananas before they go bad. This shows that profits motivate sellers to adjust prices to meet changing supply and demand.

This is common sense economics, understood since people first began to trade. An “education” in basic economics just gives you the ability to draw graphs about prices, supply and demand. “Advanced economics” gives certain economists like Paul Krugman the ability to baffle the masses with more complicated graphs. We are led to believe that government intervention by politicians, justified by graph-makers, will cause more employment, abundant goods, stable prices, and a chicken in every pot. Common sense flies out the window. 

The economy is so complex that it’s impossible to determine all the effects of government intervention. A 19^th century economist, Frederic Bastiat wrote, “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” Bastiat went on to describe the “Broken Window Fallacy” to illustrate the point. Let’s go back to the grocery. 

While the grocer and customer haggle over bananas, a hoodlum throws a rock through the front window. A crowd gathers and begins to discuss the misfortune of the grocer who will have to pay $500 to have his window repaired. Eventually someone points out that the window repairman will have more money to buy bananas for his family. He’ll also buy a pane of glass, providing income for the glass manufacturer. The glass manufacturer will buy raw materials. Truck drivers will deliver these materials. This stimulus will ripple through the economy. When you consider these benefits, isn’t the hoodlum a hero? 

The broken window and the economic activity it will create are easily seen. What is not seen is what would have transpired had the window never been broken. Prior to the act of vandalism the grocer had a good window and $500. After the repair he only has a good window, but not the $500. What would he have done with the $500? Perhaps Christmas bonuses for his staff, a vacation for his family, a new credit card machine to improve service at the checkout register? The very grocer who earned that $500 gets none of the benefit of it! Five hundred dollars of his wealth has been destroyed. If this were truly an effective economic stimulus, the government could hire hoodlums to break windows everywhere!  

The Broken Window Fallacy has been thriving ever since people first began asking government to improve their lives. It’s all the rage today. A tax levied on one group of people to benefit another group has the same effect as throwing rocks through windows. 

Here are some examples of the Broken Window Fallacy:

• Economic development subsidies (see Gaylord Entertainment)
• Stimulus programs
• War-on-Poverty programs
• Government jobs programs

No economist or politician can tell you what would have been created if the tax was never collected.  But you know what you would have bought with the money. Even if you just buy bananas, it’s best left to the wisdom of individuals who own the money instead of government.

The Anti-Stimulus Program

Politicians often lack a foundation in basic economics, or we probably wouldn’t be facing the possibility of a financial collapse. The average individual has a better intuitive understanding of basic economics than many of our elected officials, or even famous economists. Humans, from the time they first began to trade, have understood supply and demand, pricing, and the use of scarce resources. Billions of people know how to balance spending against income. Our most famous economists, however, are so wrapped up in fallacy that they have forgotten the basics. And history. 

Nobel Prize winning economist Paul Krugman is leading the call for a new WPA-like program. The WPA (Works Progress Administration) was a depression era jobs program. In 1935, just when it appeared that the economy was turning around, President Roosevelt feared that it wouldn’t turn around fast enough. Even though his administration was spending tax money at an enormous rate on public works projects, he created the WPA to give jobs to even more people, lower the unemployment rate, and right the economy. This was a stimulus plan, featuring “shovel ready jobs.” 

Did it work? No. Even the government at the time counted WPA workers as unemployed. Since the private sector could not provide jobs for them, it’s obvious that the economy had not improved.

During the depression, the WPA faced several unanswerable questions that undoubtedly limited its effectiveness. A new WPA program would face similar questions in a more complex world. Nobody can know the right answers. 

1. What wage should be paid? The WPA had a limited budget. They could put more people to work by paying lower wages. But low wages puts downward pressure on wages in general. In the free market, that’s not a problem. Remember basic economics of supply and demand? Labor is a market good. If there are lots of workers available (lots of supply), wages will already be depressed. But government labor is not a free market. It is controlled by unions who spend billions of dollars to elect their bosses. An influx of cheap labor would be bad for unions. Union supported politicians are not likely to do anything to jeopardize union power. 

2. What kind of work should they do? Again, we see a conflict with the unions. They will object strenuously to the government hiring non-union workers to compete with them at their skilled jobs. The WPA jobs will have to be low skilled, or workers will have to be unionized. Republican politicians who are rarely the beneficiaries of contributions from unions are not likely to let union power expand through government spending.  

3. How do you evaluate worker performance? Private sector workers must create value for their employers. The primary purpose of WPA jobs will be to lower unemployment. The longer it takes to complete a particular project, the more employment is created. If creating employment is the goal, the least efficient projects will be the most successful. In the private sector, that’s called waste. In this case, it’s a waste of our tax money. 

4. Who should get the jobs? If the goal is to reduce suffering caused by unemployment, it makes sense to hire the neediest people. Those people may have the fewest work skills. Hiring the least capable workers leads to even more inefficiency. This is more waste of our tax dollars. 

5. The program is ripe for corruption. During the depression, more WPA money went to districts with politicians that supported Roosevelt. WPA workers were pressured to register and vote as democrats and campaign for democrats.  

Now the biggest questions. Who has the wisdom to administer it? How big should it be? How long should it last? The Obama administration told us that the stimulus package would keep unemployment below 8%. They were very wrong. But government has a long history of throwing more money at failed programs. A new WPA would be another example.

The Spending Crisis

Breathe a sigh of relief – the debt ceiling has been raised. 

By and large, it’s pointless. Both parties have raised the debt ceiling time after time.  Its purpose is to limit the national debt, but since it always gets raised, it limits nothing. Often it has been merely a procedural vote – little debate, no Pomp and Circumstance, just a couple of votes, a quick signature, and more debt. 

Let’s talk about the real crisis – spending. The runaway federal spending is cause for concern from both parties. It’s a concern for everyone except President Obama, who wants to raise the debt ceiling so he can continue buying votes with our money, and the money of generations that have yet to exist. Obama wants to raise the limit by $2.7 trillion dollars.  He’s calculating that $2.7 trillion in new debt will last until after the 2012 elections. He doesn’t want to have this debate again before asking for your vote. 

Think about that. It’s 15 months until the election. From 1776 until now, our nation has accumulated $14.3 trillion in debt.  Obama wants authority to borrow and spend 1/5 of that in 15 months. Despite his rhetoric, he has offered no plan to reduce the debt or deficit. Republicans insist that the additional debt limit be matched by spending cuts over the next 10 years. The federal government will be borrowing something like $180 billion each month, and reducing spending only $22.5 billion per month. The spending cuts may not happen at all or may be reversed by future congresses. 

The debt ceiling will be raised. Even so, we still face the very real possibility that our debt will be downgraded. It was threatened before the debt limit debate, not because of a possibility of immediate default, but because of a potential future default. If our economy collapses under the extraordinary spending and debt, America will not be able to pay its obligations. That is the real crisis.

The Strawman Cometh 

I always cheer up immensely if an attack is particularly wounding because I think, well, if they attack one personally, it means they have not a single political argument left. Margaret Thatcher 

I am honored that Senator Lois Tochtrop responded to my columns about unemployment insurance (UI) (go here and here for my articles). Although she called my writings inaccurate, she never actually refuted anything I wrote. She prefers to mislead us with strawman arguments.

She tells us that employers would not forego hiring to avoid paying a payroll tax of $3.29 per week. But that’s per employee. $3.29 times 95 employees is enough to provide a job that’s substantially more than the average $125 per week unemployment benefit. One in five youths (who might like to work for minimum wage) is unemployed. They are sitting by idly while others accrue unemployment benefits. 

Tochtrop states that the Federal Reserve Board says “unemployment benefits are not important factors in the increase of unemployment or the length of unemployment.” I never argued that it does. Quite the contrary, UI is a disincentive to layoffs. If there are additional costs for layoffs, an employer thinks twice before hiring. 

She tells us that unemployment benefits creates more economic stimulus than tax credits for corporations. I’m not certain where tax credits came in to this discussion. I fear that Tochtrop believes that money is something government allows individuals and businesses to keep. She also seems unaware of what truly drives economic expansion and creates jobs – capital investment. An entrepreneur nearly always has to invest money to start or expand a business. This comes from some sort of savings. 

Tochtrop and her colleagues passed a law last year (HB 1128) that “will guarantee the long-term solvency of the Unemployment Insurance program.” Tochtrop is at best misleading. 1128 merely alters the manner in which higher unemployment taxes will be confiscated. Government programs will always be solvent as long as government is willing to extract money from citizens by force.

Gambling With Our Tax Dollars

Fired. Can you believe it? Governor Hickenlooper fired the entire gaming commission board. Their sin? They granted a tax rate reduction for Colorado’s casinos. When Coloradans are facing layoffs, wage cuts, increasing energy and grocery costs; and when the State is short on revenue and struggles to close budget shortfalls, these commissioners granted a tax rate reduction to one industry. Hickenlooper, in a fit of populist rage, appointed a new board that he hopes will reverse the tax cut.

The gaming commission is charged to “encourage business growth and investment in the gaming industry and to permit licensed operations…to realize a fair and just profit.” Isn’t that what the commissioners tried to do? In their judgment, a 5% tax rate cut would help the gaming industry achieve a “fair and just profit.” Keep in mind that statewide gaming revenue dropped an average of 7% during the last three years. 

You might ask, “Where’s the tax cut for all the other businesses in Colorado? What’s fair about that?” That question assumes the gaming industry starts from a fair position. They don’t. The gaming commission sets tax rates for the industry. Whereas other businesses pay 4.63% of their profits, the gaming industry pays a graduated tax on their Adjusted Gross Proceeds. The tax rate can vary from 0% up to 40%. Adjusted Gross Proceeds means the tax is based, not on profits, but on revenue less payouts, which is a higher portion of the same income. Casinos can’t deduct wages, benefits, capital expenditures, interest, depreciation or other normal business expenses. 

This is an industry that asked permission to operate in Colorado.  Colorado said, “Okay, but you’re going to pay dearly for that permission. You will be subject to the whims of an unelected commission. If the Governor doesn’t like what the commission does, you’ll be subject to a whole new commission. You really can’t guess how to budget for Colorado taxes, but rest assured: YOU WILL PAY THEM!” 

Compare that to the tax situation for Gaylord Entertainment’s proposed project in Aurora. We’re not talking quarter slots, this is real money - $300 million in public financing. It’s your money and politicians are gambling with it. 

Gaylord Entertainment wants to open a convention center and hotel with 1500 rooms and 400,000 square feet of conference space. Aurora, Denver, and the State of Colorado are offering subsidies worth over 36% of the projected cost of the project. Governor Hickenlooper, where is your rage? 

They justify this under the premise that it will bring conferences, people, and money to Colorado. The new activity is supposed to generate new tax revenue. According to their website, Gaylord Hotels “strive to make planning easier for you by providing ‘everything in one place.’ From guest rooms and meeting space, to recreation and dining, in a self-contained environment…” Any conventioneers that come to Colorado will not need to visit anyplace other than Gaylord Hotels. 

Reality check: what are the chances that the CEO of a large corporation will say, “Let’s have a convention, hold it in Aurora, and stay inside”? No offense, but…Aurora? Yet that’s what will be required for Gaylord to generate new revenue.  Here are three possible and obvious ways that your tax dollars will fail to generate the predicted tax revenue: 

1. Tax revenue might be diverted from other local hotels, restaurants, and other businesses to Gaylord. Instead of generating new revenue it just relocates it. Businesses that once depended on that revenue could be hurt.

2.  Conferences might very likely continue going to convention centers that are in more exciting locations than Aurora.

3. Gaylord appears to be a healthy, profitable corporation. So did Enron. If Gaylord fails, our tax money has been wasted. 

If it’s a viable, worthwhile project, private investors will invest in it. If it isn’t worthy of private investment, why should government force us to invest? Let’s leave the gambling where it belongs - in Blackhawk, Central City, and Cripple Creek.

Private Sector Jobs - Our Only Salvation

“I will not be satisfied until everyone who wants a good job that offers some security has a good job that offers security”. President Obama said that, speaking recently at an energy-efficient lighting plant.

Whew. I feel better. And more secure. Who wouldn’t want a good job with security? After all, with job security you don’t have to work. You just have to show up. And Obama is setting the bar pretty low - you only have to want the job.  

It seems like a nice sentiment, but it is neither achievable nor desirable. 

There was a time when people had to work to make an effort to get and keep a job. They did that because they had needs and wants.  If you needed food or shelter you got a job that would allow you to pay for food and shelter.  Need a car? Get a job.  Want a better car? Get a better job. Whatever you needed or wanted, working was the way to get it. 

Government likes to give to those who have needs. During the Great Depression the government created jobs through the Work Projects Administration (WPA) and gave them to needy people. During its eight years, nearly eight million Americans received paychecks from the WPA. This was part of the “New Deal,” a huge expansion of the federal government that was intended to end the Depression. 

It failed. As Henry Hazlitt writes in his classic and highly recommended book, “Economics in One Easy Lesson”:

For every public job created by [a] bridge project a private job has been destroyed somewhere else. We can see the men employed on the bridge. We can watch them at work. . . . But there are other things that we do not see, because, alas, they have never been permitted to come into existence. They are the jobs destroyed by the $10 million taken from the taxpayers.  

The Depression was prolonged by government-created jobs and excessive government spending. In 1939, Roosevelt’s Treasury Secretary Walter Morgenthau said, “We are spending more than we have ever spent before and it does not work. . .I say after eight years of this Administration we have just as much unemployment as when we started. . . And an enormous debt to boot!” 

As money wends its way through the economy it generally ends up in one of two sectors – government or private. In general, government does not produce. It does not create things and sell them for profit. It does not seek a profit on its employees. It does not save money to invest in a capital project that will generate a profit. Simply put, money that ends up in the government’s coffers does not grow. Only in the private sector does money create more money. Advocates for more government spending claim that each dollar spent by government grows the economy, a “multiplier effect.”  That may be true, but private sector spending has a much greater multiplier. Private spending, savings, and investment turned America into the wealthiest nation in history. Excessive government spending threatens to destroy that wealth. 

Obama will not be satisfied until everyone that wants a good secure job has one.  My fear is that he will keep trying.  The stimulus plan started by Bush and put on steroids by Obama has been an abysmal failure. Obama laughed when he pointed out that stimulus projects were not as “shovel ready” as he thought. His arbitrary and capricious administration has prolonged this recession. Now Obama wants to spend more and tax more. That might work in the short term, but only until the economy collapses further under the weight of an incomprehensively large national debt.  

Government’s role, particularly during this recession, should be to provide the conditions (not incentives) necessary for expansion of the private sector. Get out of the way and leave the wealth and spending to us.

Unemployment Insurance Problems In Your Own Backyard

Did you know that if you hire your neighbor's kid to mow your lawn, you are liable, under Colorado law, for unemployment insurance for that kid?  

The fact is you cannot sell your labor for a price you are willing to accept unless it meets government criteria. As an employee, you must receive minimum wage -- and be covered by Unemployment Insurance (UI), workers compensation insurance, and have taxes withheld. This is how our state and country disrespect individual enterprise. Let's consider how this affects the small businesses that hire most of the people in our land:

In a recent blog I railed against the Unemployment Insurance (UI) system because it reduces private sector jobs.  The system creates a whole slew of perverse incentives, including these:

§       Businesses are more reluctant to hire an employee who might eventually become an unemployment claim that will raise UI tax rates.

§       Employers facing layoffs have an incentive to fire employees for cause so they avoid an unemployment claim.  This damages the work record of the employee, making it harder to find a new job.

§       In 2009, legislation gave The Colorado Department of Labor and Employment (CDLE) expanded powers to investigate businesses for potential “misclassification” of employees.  With the UI trust fund being $500 million in the hole, CDLE has reason not merely to audit for enforcement, but also to coerce businesses into paying taxes they should not owe. 

Employees don’t see a deduction on their paychecks to cover unemployment insurance.  Nevertheless, they pay for it.  In a competitive labor market, a tax paid by an employer is money that could otherwise be used for employee compensation.  Yet few of the employees who pay for UI taxes will ever receive the benefits.  You only get benefits if you become unemployed “through no fault of your own”.  Employers and CDLE both have strong incentives to prevent payment of benefits.  The UI system is of limited benefit and is a drain on job creation and payrolls.  

To me though, the worst part is that the government limits your right to provide labor.  That is exactly NOT the purpose of government.   Government’s role is to protect your property rights, including your right to sell your labor as you see fit.  You might disagree with me about the value of unemployment insurance, but it is indisputable that it restricts liberties. 

There is a class of people who are exempted from these restrictions: independent contractors and business owners.  If you want to mow your neighbor’s lawn for money, or design a software system for him, you can become a business owner.  Your neighbor won’t have to withhold taxes, buy worker’s compensation insurance, or pay UI taxes.   

But there’s a catch. Colorado law has a list of nine criteria that you must meet to be a valid independent contractor. If you don’t meet all nine, your neighbor will be liable at least for UI taxes.  It is solely the judgment of the auditors from CDLE that determines if you have met those criteria.   

In a recent audit, the auditor interpreted the rules to mean that if an independent contractor gets more than 50% of its revenue from one business, it could be reclassified as an employee and be subject to back taxes, interest and penalties. Such a ruling, were it applied universally, would be totally impractical.  A new contractor could not go into business until it had secured at least two contracts, each for half of its business.  An enterprise would be precluded from doing more than 50% of its business with its best customer.  

The criteria are vague and arbitrary. They lead to abuse by the CDLE who are empowered by the 2009 legislation to enforce the criteria in any way they see fit for the purpose of supporting a UI system that reduces job creation, damages resumes, and robs individual liberties.   

The legislature must change the law to loosen the restrictions on independent contractors. There is only one criterion that is not arbitrary and open to interpretation by unelected and unaccountable bureaucrats: the willingness of an individual to become subject to the risks of business ownership. By expanding the definition of independent contractor, more people will be able to opt out of the failed unemployment insurance system.

Who Pays For Unemployment Benefits?

Imagine you just interviewed for a new job. The employer tells you “You’re a great match for our company, and we’d be excited to have you work for us. We offer good pay, flexible hours, a comfortable work environment, and great benefits.” 

You say, “Great! When can I start?”

“Unfortunately, our benefits are so great, that we can barely afford them for the people we already have. So even though we’d love to have you work for us, we can’t afford to hire you.” 

You reply, “I don’t need all the benefits. I really need the job.” 

“Unfortunately, the benefits are mandated by government, so our hands are tied. Best of luck to you with your job search.” 

In Colorado (as of October, 2010, the latest information my research team (me) could find) every 95 people that receive wages represent one job that won’t be created because of unemployment insurance (UI) taxes.  That means those taxes potentially increase unemployment by 1%. And those taxes are increasing rapidly, so 95 people may soon become 75 or 65, and 1% becomes 1.3 or 1.5%. 

During this recession, Colorado’s Unemployment Insurance Trust Fund (UITF) has been bankrupt since January, 2010. Colorado pays $1.51 in benefits for every $1.00 it receives in UI taxes.   Despite our state constitution’s ban on deficit spending, the UITF has been borrowing money from the federal government since then.  We are currently $500 million in the hole.  Unemployment Insurance taxes are going up to cover the deficit, and with fewer businesses and employees to tax, the rates are skyrocketing. 

Our unemployment system creates huge problems. First is the incentive not to hire. Every new hire is a potential unemployment claim against the employer. Claims raise rates.  It’s better not to hire someone you may later have to lay off.  Second, employers are inclined to fire “for cause” if layoffs are necessary, so that the employee will not be able to make a claim against the company. This damages the resume of the new job seeker. 

But aren’t the benefits worth it? The Congressional Budget Office (CBO) says of the options it studied for government programs to stimulate the economy, UI is the most effective.  It also says that every dollar spent on unemployment generates up to $1.90 in economic growth.  This is preposterous on its face.  If it were true, we could all quit work and the economy would not just recover, it would flourish.

One option the CBO ignored is not taxing employers and not borrowing money to pay for the benefits.  If a dollar taken from an employer by the State and then redistributed to a beneficiary (who spends valuable but unproductive time to meet the State’s requirements) can generate positive economic growth, then a dollar left in the hands of an employer surely would generate more growth.  

Contrary to popular opinion, employers do not pay UI taxes. Sure, they write the checks. But the money comes from you and me, the workers, consumers, shareholders, etc.  UI taxes (as well as any other tax) are a cost to the business, and the business passes those taxes on.  If they don’t or can’t, that leads to fewer profits, business failures, and lost jobs. But if the business you work for fails, you’ll get unemployment benefits! That should make you feel better – you’ll be a beneficiary of the tax that added to the burden that led to the failure of your employer! 

And who gets the benefits?  The government and business both have incentive to deny claims to unemployed people.  Claims increase the experience rate of companies, and that raises their tax rates. Businesses will do their best to terminate for cause so that claims will not be paid.  Colorado government wants to display their “fiscal responsibility” by running a sound program that doesn’t run out of money and eliminates fraud and abuse.  So a relatively small percentage of those who lose their jobs actually receive the benefits.  Even now, only 37% of the unemployed receive benefits. 

So when you go to that next job interview, look at the employees.  Every 95 of them represents the job you won’t get, courtesy of your government.