A Vast Right-Wing Conspiracy

Economists from the Organisation for Economic Cooperation and Development (OECD) published a study that said property taxes are the best way to raise additional tax revenues since its effects on economic growth are less than other ways to increase taxes. The study concluded that increasing income and employment taxes are the worst way to raise taxes due to its negative impact on economic growth.

This is consistent with the supply-side revolution in tax and economic policies that Ronald Reagan unleashed almost 30 years ago, and keeping tax rates on income low is one of the important ways we can get the economy growing again.

Interestingly, the OECD is a Paris-based organization that works on economic and public policy issues. It is an established member of the many international organizations that influence policy. As such, it is no bastion of conservative thinking. The fact that such a group published a study extolling the virtues of a "regressive" property tax and depicting the problems of a "progressive" income tax illustrates how accepted it is by economists that higher income taxes reduce economic growth.

A Deal Worth Making

Count me as a supporter of the recent deal between the Obama administration and Congressional Republicans to prevent the Bush tax cuts from expiring on January 1 and to resolve absurd state of estate tax law.

The compromise is just that: it reflects many elements which are disturbing. Most importantly, the tax cuts and estate tax are resolved only for the next two years, whereas the positive impact on economic growth from the Bush tax rates would be much more significant if the tax law was permanent.

To reignite economic growth and reduce unemployment, we need individuals, businesses, and investors to take risks on new investment opportunities, and the aftertax rate of return on those investments is the fundamental determinant of whether, and how much, new investment occurs. And since new investments have a return typically measured over many years (often decades), lowering taxes (or more accurately, not allowing tax rates to rise) permanently would raise aftertax returns much more significantly than a two year tax plan with the tax rates scheduled to rise afterward.

But allowing tax rates to rise would be much worse, so two years of lower taxes with the ability to refight the battle later is better than nothing.

The estate tax change is genuinely a good thing, since estate tax law has been subject to the absurdities that John McCain and others inflicted on the nation when the Bush tax cuts were first passed. Estates were not taxed at all in 2010, but death tax rates were scheduled to increase dramatically on January 1. The compromise raises the level at which estates gets taxed, and reduces the tax rate, while preserving the estate tax. I'd much prefer to see estate taxes abolished, since after a lifetime of paying taxes on one's money, it is obscene to take 55% of one's money at death (the pre-Bush tax cut rate that would have taken effect on January 1 without the new law). But a 35% tax rate on estates over $5 million is more equitable than a 55% tax rate on estates over $1 million that would have occurred on January 1.

What is most disturbing in the law are the provisions that pay off various Senators for their support, such as maintaining the ethanol subsidy. It is also disappointing that spending wasn't cut to offset the cost of various provisions to reduce their impact on the budget deficit.

But this is the political reality of divided government: Republicans can't get all they want, nor can Democrats.

It is interesting that a number of aspiring Republican presidential candidates, such as Mitt Romney and Sarah Palin, oppose the deal. While that may or may not be good politics, it is bad economics.

Meanwhile, the Democrat left who oppose the deal, vociferous in their denunciations of the bill and Obama for agreeing to it, demonstrate their belief that the earnings of Americans belong to the government and that a tax cut (or preventing taxes from rising) is "giving" money to the affluent.

Quite the opposite: lower taxes mean people keep more of their own money, while higher taxes means the government confiscates more of your money.

The Pigs at the Trough Have Learned Nothing

While the tax deal Barack Obama negotiated with Congressional Republicans contains many features that will help the economy grow, it also faces added elements ostensibly needed to win the votes of wavering senators.

One such deal is a continuation of ethanol subsidies, which will cost $4.9 billion in 2011. Not only has Al Gore, the green lobby's "star", come out against ethanol on environmental grounds, after championing it for so many years, but it is adding billions of dollars to the budget deficit at a time of staggering deficits.

Even if ethanol had merits, we should be eliminating all business subsidies as one step in improving our awful fiscal situation.

The fact that with trillion dollar deficits projected for years the government can include this $5 billion give away that doesn't even achieve the environmental goals for which it is intended demonstrates the lack of seriousness of our political leaders.

This is how government financial crisis arise, and why tragically it often takes such a crisis to force people to make decisions they otherwise wouldn't.

Audacity of Power

Barack Obama was finally able to use the power of the Democrats' large majority in Congress to get his healthcare legislation passed. For months, many complained of Republican opposition to the legislation as the reason for it stalling, which ignored that the Democrats had it solely within their power to get it passed.

And they used that power, despite deep unhappiness in the country over the legislation, as manifested in devastating election losses for the Democrats such as Scott Brown's stunning Senate victory in Massachusetts.

For years, the Democrats scored PR points from the fact that many people do not have healthcare insurance, even though the lack of insurance has often been by choice due to a preference to spend one's income elsewhere and that the lack of insurance is not the same thing as being unable to receive healthcare services due to charity care.

Moreover, the Democrats for a long time fought genuine reforms that would have been very helpful, such as expanding Health Savings Accounts (HSA) and malpractice reform.

Instead, the Democrats wanted their socialized medicine and used their likely temporary large Congressional majority to achieve it.

There is no other way to say it, but many people will die in the coming decades who otherwise could have lived longer because of this law and its consequences.

Fewer new drugs and medical devices will be developed, as denial of coverage by government panels will reduce the willingness of companies and investors to spend the enormous sums of money necessary to bring new medical products to market.

The standard of care will evolve to less aggressive treatment to save money; the decision last fall by panel to recommend delays in getting mammograms will become more common and, in some cases, be driven by the government's desire to spend less on healthcare.

The law includes new taxes and will lead to further new taxes to pay for all the new spending it will entail. These taxes will reduce economic growth, as individuals and businesses will have less capital and incentives to work and invest.

As economic growth is reduced, America will experience permanently higher unemployment. Young adults, fresh from school and eager to begin their careers, will find diminished opportunities. The economic performance of western Europe the past 30 years, with higher unemployment in general and in particular for younger workers, demonstrates where America will head.

Last, but not least, the law is an affront to the founding principles of America. The Declaration of Independence speaks of the inalienable right to life, liberty, and the pursuit of happiness, held equally by all. This means that for something to be a right, it cannot infringe the rights of another person - otherwise there is no equality of rights. The taxes needed to finance, and the government coercion to force people to live by its healthcare dictates, demonstrate why there is no right to healthcare - since some persons' "right to pursue happiness" are denied so others can get their subsidized healthcare.

For all of this, it may very well be the worst piece of legislation in American history.

Expropriation, Global-Style

Recent actions by the U.K. and North Korean governments indicate that the desire to expropriate the assets of people who are politically out of favor thrives in the world.

In the U.K., the Labour government announced its plan to impose a 50% tax on bonuses paid to bank employees above $40,000. The shockingly punitive rate, directed at certain workers but not all, is a disgrace to the nation that has done so much to advance freedom in the world.

North Korea, who can't claim such an honor, has issued a new currency - but limited the amount of money per person which can be converted to the new currency (about $50-75 worth), and the old currency will no longer be legal tender. So anyone with more than $50-75 in cash, and $100-150 in a savings account, will see their entire savings above those amounts wiped out.

It appears this despicable act is directed against those who have earned some money in the limited markets that have sprung up in the heavily socialized nation, and the totalitarian regime is seeking to make the people even more dependent on the government.

While many disregard the relationship between private property, the reality is that the growth of wealth provides the motivation and means to seek to change oppressive government policies.

The dictatorship in North Korea understands this all to well. Do we?

Real Economics

This Wall Street Journal article on the negative impact of political uncertainty on small business activity illustrates the "anti-stimulus" actions that Barack Obama and the Democratic-controlled Congress have taken. Healthcare and global warming legislation suggest that businesses costs may increase in unpredictable ways, while the risk of increasing taxes takes money and incentives for businesses to grow.

On February 1, I laid out my own suggestions in this column for a proper plan to promote economic growth: cutting taxes, barriers to trade, and regulations without PR and legal assaults on businessmen. Instead, Obama and the Democrats have pursued the exact opposite strategy, inducing fear and uncertainty among the very businesses and people we need to feel confident to expand their activities and grow the economy.

Democrats Run Amok

Democrats are anxious to raise taxes to feed their spending dreams, so the latest tax plan is a real doozey: a tax on financial transactions that could raise $100-150 billion per year. The idea is each time a stock trades, a tax is levied on the trade.

Two things will happen with such an obscene tax. Financial transactions will move offshore, destroying high-paying financial services jobs in America. And the value of U.S. companies will decrease, as investors factor into their valuations the tax liability from selling shares.

Lower stock prices reduce American's net worth for retirement and college savings and all the other reasons people save and invest, and raise the cost of capital for businesses seeking to grow - which retards economic growth.

"You Lie" Takes on New Meaning

Barack Obama pushed back on George Stephanopoulos' questions by claiming it is not a tax if the government requires people to pay up to $3,800 if they don't buy health insurance.

Stephanopoulos is a former member of the Clinton White House, so is a partisan advocate of Democrats. Even he was astounded by Obama's tax denial, going so far as to say he looked up the definition of "tax" to criticize Obama.

So let's look at various definitions of "tax" from online sources:

Merrian-Webster defines a tax as "a charge usually of money imposed by authority on persons or property for public purposes."

Dictionary.com says a tax is "a sum of money demanded by a government for its support or for specific facilities or services, levied upon incomes, property, sales, etc."

The Cambridge Dictionaries Online say a tax is "an amount of money paid to the government, which is based on your income or the cost of goods or services you have bought."

Google's dictionary says a tax is "an amount of money that you have to pay to the government so that it can pay for public services."

Wikipedia says "to tax" is "to impose a financial charge or other levy upon a taxpayer."

The point is clear: Obama is completely wrong . He is proposing a large tax, directed overwhelmingly on those making below $250,000 - the very group he claimed during the campaign for whom he wouldn't raise taxes.

Atlas Shrugs in England

The Wall Street Journal reports that a number of hedge funds and their employees are moving from England to Switzerland to escape the new, higher taxes the U.K. has imposed.

For those who don't believe people respond to tax regimes by fleeing high tax areas for low tax ones, think again.

And England will be poorer for it.

The Cat's Out of the Bag

Treasury Secretary Timothy Geithner this weekend, in response to questions about whether the Obama administration would increase taxes on the middle class, said that, "We're going to do what's necessary."

Lawrence Summers, Obama's head economic policy coordinator, made similar comments.

Consider this a trial balloon, and a signal that Obama is planning to violate his campaign vow not to raise taxes on the middle class. Instead, it suggests Obama is planning to seek large tax increases to pay for the Democrats spending spree.

For those who wanted change, you should be pleased: such plans would lead us toward the lower growth, higher unemployment world of Europe.

The Tax Man Cometh

Senate Democrats are considering implementing a new excise tax on soda and sugary drinks to help pay for Obama's plans for socialized medicine.

The left has demonized soda and sugar-laden drinks, and while drinking too many of them can be a health issue, singling out specific products for taxation is consistent with the new economic policies of the Obama era: the government picking winners and losers, favoring certain industries, companies, and products over others.

Suffice to say, the government has no role in any of this.

But the tax on soda, if enacted, would violate Obama's tax pledge to not raise taxes on people making below $250,000 per year. Almost all of the soda in the country is consumed by those earning below that threshold.

But this isn't surprising, because the enormous spending plans and budget deficits Obama is unleashing on America is leading to higher taxes, and most of the income in the country is earned by people making below $250,000 per year.

Obama and the Democrats are introducing stealth taxes on lower income groups so it isn't as visible to them. They have already raised excise taxes on cigarettes (see here), and their plans for carbon taxes means products and services will rise in price to reflect this higher cost of doing business (see here).

Excise taxes on soda are more of the same.

Tax Man Cometh

State governments are raising taxes to address the explosion in government spending over the past several years.

The highest tax rate in NJ, already one of the highest in the nation at 8.97%, is likely to go higher if Jon Corzine and his fellow Democrats get their way. Corzine has proposed a "temporary" increase in the top rate to 10.25%.

Just a few years ago, NJ's top tax rate was 6.37%. The new rate would mean a 61% increase in the tax rate since 2004.

This is the direct result of Democratic control of all branches of government and the ensuing spending and tax explosion.

To put this in historical perspective, NJ didn't have an income tax until 1976, and initially the highest tax rate was only 2.5%.

NJ has now joined California as one of the "People's Republics" among U.S. states. But without the beautiful weather.

Promises Made, Promises Broken

During the election, Barack Obama said that no family making under $250,000 will see any form of tax increase.

He has already broken that promise.

Obama's first tax increase is an whopping 159% increase in the federal excise tax on cigarettes.

The Center for Disease Control and Prevention estimates that over half of smokers are low income, so most of the tax burden will fall on the poor and middle class.

Along with the huge tax increase in Obama's budget through the cap-and-trade system which will fall on everyone, Obama will have to raise taxes on everyone to pay for his spending spree.

And continue to break his campaign promises.

Outrage

The political and media response to AIG's bonus payments, which appear to be contractually guaranteed, is one of the most outrageous and despicable public acts in recent (and not-so-recent) American history.

Morally, the tax plan is pure wealth confiscation. The 90% excise tax, when combined with state, local, and payroll taxes, is likely to produce a tax rate in excess of 100%. Consider this: during the presidential campaign Barack Obama took umbrage with accusations that his tax policies were a form of socialism, and Joe Biden reacted with disbelief during a TV interview when asked if Obama/Biden's policies were a form of Marxism.

And now the Democratic party wishes to impose taxes that make Obama's tax plans look modest by comparison.

Legally, it is a retroactive tax increase - meaning it is a game of gotcha. There is some debate as to whether it violates the U.S. Constitution's prohibition on Bills of Attainers, which prohibition is designed to prevent the government from imposing specific penalties on specific individuals.

Politically, it represents the rule of the mob. The names of the AIG bonus recipients have been disclosed, which has led to death threats and picketing outside their homes by Acorn "activists".

Is this the activism that Barack Obama cherishes so much?

Worse, the mob may be succeeding in its goals. News reports indicate many of the AIG bonus recipients are returning their bonuses. If you think that is a good thing, consider that now that the mob has won a victory, it will be emboldened for the next issue it seeks to pursue.

Economically, it will reduce the willingness of people to work in the financial sector, particularly TARP firms - making it more likely that the government will lose billions on its TARP investments. The government needs the TARP firms to make lots of money to recoup its investment in them, and the firms need the best talent they can attract and retain to increase profits.

Moreover, the Obama administration introduced today its latest plan to combat the problems confronting the financial sector, after its initial plan a month ago lacked specifics and was poorly received. The new plan entails the government partnering with large investors to purchase assets from banks, with the government providing attractive terms to investors to induce them to participate.

The government will now have to make those terms even more attractive to encourage investors to participate, since the risk of doing business with the government is so high - with the investors having to ask: will they be allowed to keep the profits that they hope to earn from such investments, given the frenzy over the bonuses paid to TARPed firms?

The government will lose far far more money, from further losses on its TARP investments and increased subsidies to investors in the latest bailout plan, then the amount of the AIG bonuses.

And Barack Obama has been AWOL in terms of exerting presidential leadership on the issue. For a man who made his political career by not taking hard stands (witness his huge number of missed votes when he was an Illinois state legislature - if you don't vote, then a constituency who doesn't like your vote can't be upset with you), he now confronts making tough choices.

Yes, he has made tentative comments expressing his concern with the tax plan. But real leadership means speaking out, even if it isn't popular.

The silence is deafening, and disturbing.

The Tax Man Cometh

Barack Obama campaigned, and his recently released budget purports to reflect, his commitment not to raise taxes on those making below $250,000 per year.

Aside from the fact that his proposed spending spree can't be funded without much higher taxes than the already higher taxes he has proposed, his budget plan DOES include higher taxes on all Americans.

Obama wants to introduce a "cap and trade" system to reduce greenhouse emissions, in which companies buy permits allowing them emit a certain amount of greenhouse gases. The budget plan envisions raising $646 billion from 2012-2019, or $80 billion a year, from this plan. This amount of money may severely understate the taxes that such a tax can raise, since when Congressional Democrats considered such a tax last year, it would raise $300 billion per year.

Companies will have to raise their prices of energy and energy-dependent products (i.e., everything) to offset the higher cost of doing business.

That's effectively a tax increase, akin to a sales tax but hidden from public view because it is built into a business' cost structure.

The hidden part makes it worse, since it is easier for politicians to claim they didn't raise taxes when in fact they did.

Obama's plan contemplates returning most of these revenues to workers through a tax credit, which is the President will claim is a tax reduction, but reflects a continuation of Obama's efforts to call income transfer payments tax cuts.

Budget Shenanigans

Barack Obama has announced that he wants Congress to mandate across-the-board cuts in spending to offset any new spending programs or tax cuts.

Sounds like touch fiscal discipline? Think again.

Unlike a common sense approach to budgeting, the federal government's budget includes many programs that automatically increase each year due to inflation, demographic changes or rules. Obama is not saying that any increase in spending would be offset by automatic spending cuts - just any new spending program or tax cut. So the budget will balloon due to the automatic growth in Social Security and Medicare, for example, without triggering the spending cuts.

Moreover, note that Obama proposes this after securing passage of the biggest budget busting bill in history, our "stimulus" bill. So the baseline budget is now higher, so much easier to promise spending restraint after this spending spree.

Last, the plan would also mean tax cuts will never happen to any meaningful degree or without offsetting tax increases. Just as spending grows automatically, tax revenues are also on auto pilot to increase faster than inflation and growth in the economy due to their steeply progressive nature.

Since taxes and spending will continue to rise significantly even with no new programs, Obama's "get tough" approach on the budget is mostly about PR and laying the groundwork for tax increases.

Tax Follies

The Wall Street Journal recently reported, based on 2006 data, that the top 400 taxpayers in the nation paid the lowest tax rate since the recession year of 1991. The article does mention that the driver of the low tax rate is that most of the income for taxpayers is in the form of capital gains, which are taxed at a maximum rate of 15% versus 35% for ordinary income.

The implication of the article is that there is something wrong or inappropriate with such low tax rates for people with such high income.

There is one critical fact that the article doesn't discuss, which is overlooked by critics when discussing the capital gains and dividend tax rates. Shareholders of companies face double-taxation on the same underlying earnings. First, companies pay taxes of up to about 39% on their U.S. income. Then individuals pay taxes on either dividends or capital gains, which when including state taxes can add another 24%.

As example, imagine a company earns $100 in the U.S. before taxes and pays all of its net income to shareholders as a dividend. The company will typically pay $39 in corporate taxes, leaving it with net income of $61. Shareholders will then pay about $15 in taxes on the receipt of dividends, leaving them with a net of about $46 - resulting in an all-in tax burden of 54%.

So the low tax rates on individual tax returns only captures one layer of the tax burden such income effectively pays. That is the underlying economic reality.

It gets complicated by the fact that some corporate income is earned overseas at lower tax rates (meaning U.S. tax rates are higher than overseas), some shareholders aren't taxpayers (such as pension funds) or pay taxes at lower rates, and capital gains and their realization occur over time.

The U.S. is unusual in that it engages in this double taxation; many European countries don't. That's a comparison to Europe the left doesn't make, and for good reason. We tax capital at very high rates, notwithstanding the claims of the left.

Madoff's Inspiration

The cartoon below amusingly depicts a serious problem: the Social Security systems shares similarities to a Ponzi scheme.

Unlike private pension plans, Social Security does not take the taxes paid into the system on your behalf and create a dedicated account which grows in value by earning a rate of return from which future benefits are drawn.

Instead, the payments you receive in retirement come from taxes paid by current workers. If those workers stopped paying taxes (hypothetically), then you couldn't receive your payment.

Moreover, based on the rate of return implied from taxes paid and benefits received, Social Security proved to be a "good deal" for the initial recipients. But to overcome this initial deficit, in recent years the rate of return on Social Security has become terrible, on average well below that which could be earned on U.S. Treasury bonds.

So here are the Ponzi scheme elements of Social Security: a lack of assets which therefore can't earn a genuine rate of return, requiring that Social Security benefits must come from the payments of future contributors - and a good deal for initial contributors but a worse deal for later ones.

Social Security differs from the Madoff scheme in a couple of important ways. Future contributions to Social Security are mandatory since they are a tax liability. Even though returns on Social Security are well below what could be earned in a private retirement plan (even if you conservatively just invested in Treasury bonds), you can't opt out of Social Security in the face of these poor returns and demand your money back.

So the collapse that must come eventually to all private Ponzi schemes, when either returns don't live up to their promise and/or investors demand their money back which doesn't exist, is not a problem for Social Security.

Correspondingly, private Ponzi schemes work because of the promise of high returns, or more cunningly in the case of Madoff, decent returns consistently "delivered". Social Security has dealt with this problem by simply reducing the rate of return going forward, and since it has the taxing power of the government to ensure the inflow of new cash to pay benefits to retirees, it doesn't have to worry about contributors fleeing due to the new, lower return expectations.

Instead, we all lose, slowly but surely.

Stimulus that Actually Stimulates

With the House of Representatives passing a pork-laden and special interest satisfying spending spree that is being called stimulus, it is important to realize there are genuine alternatives that can help the economy.

The Cato Institute ran a full-page ad in the Washington Post this week which contradicts President Obama's assertion that there is widespread agreement on the need for massive government spending to stimulate the economy, with hundreds of economists including Nobel laureates signing the statement. Even more economists have added their names to the statement since it was published (here).

Aside from the fact that the House plan is mostly about satisfying a leftist wish list of pet projects and causes than it is about stimulus, the very premise that government spending will solve the problem is in question. This plan shares a key premise with the stimulus plan passed in early 2008, which comprised tax rebates: if the government puts money in people's pockets, it will stimulate economic activity.

The problem with such efforts is that the money has to come from somewhere. Specifically, the additional spending or tax rebates are paid for with additional government borrowing, which means there is less money available for other forms of investment or spending. So the impact is not nearly as great as it seems.

Instead, an economic stimulus plan can be crafted that can change the behavior of individuals, businesses, and investors to increase economic activity. An across-the-board cut in all income tax rates, including corporate, capital gains, and dividend tax rates, increases the incentives for everyone to make new investments, start new ventures, and in general work harder - since the payoff from all such efforts is now greater.

Yes, such a tax cut puts money in taxpayers' pockets like a tax rebate or infrastructure spending, but it does much more by encouraging effort and risk-taking - which is the key to stimulating real economic growth.

John McCain did a poor job in the campaign explaining why his plan to cut corporate tax rates was so beneficial. The reason such a tax cut promotes economic growth is simple. When companies make decisions to build a new factory or R&D facility, they compare many variables, all with the goal of maximizing their after-tax income from the investment. If corporate tax rates are reduced for investments in the U.S., then companies (both domestic and international) will be find investments in America more profitable and hence more likely to make such investments in America.

Ireland has experienced dramatic economic growth by using a low corporate tax rate to induce companies to locate operations there. And since the U.S. corporate tax rate is now among the highest in the world, cutting that rate will make investing here more competitive. That will mean more jobs, and more tax revenue, generated in the U.S.

A 30% cut in all such tax rates would cost the government approximately $500 billion, before any stimulating effects of higher economic activity are considered. For individual taxes, the 15% tax bracket would be 10.5%, the 25% tax bracket would become 17.5%, and the 35% tax bracket would be 24.5% - all dropping by 30%. The corporate tax rate of 35% would be 24.5%, which when adding in state taxes would make it about 29% - higher than many countries but much more competitive than today.

A second important element of a pro-growth stimulus plan is to expand free trade globally, rather than threaten to reduce trade as Barack Obama did during the campaign by suggesting he would change the terms of NAFTA or refuse to approve free trade agreements with Colombia, South Korea, and Panama as the Democratic Congress has done. Approving these trade agreements and in general seeking to expand free trade will send a strong signal of America's commitment to expanding trade - which will encourage economic activity as businesses seek new opportunities that more open trade permits.

A third element of a pro-growth stimulus plan is to look to cut regulations that impede economic activity. The auto industry has long been hamstrung with fuel efficiency standards and limits on rationalizing its dealer network. Reducing or eliminating those restrictions won't immediately solve the auto makers deep woes, but will help - and are an example of the type of constraints that limit business activity throughout the economy. Naturally, instead President Obama and Congress want to increase the constraints on the auto industry which will only make economic recovery harder.

Lastly, pro-growth government policies would not include attacking businesses and Wall Street to score PR points. President Obama has resoundly failed in this regard with his recent bashing of Wall Street: if Wall Street didn't pay bonuses to its employees, as the President suggested, then these firms would wither as employees left to work for other firms (existing or new ventures) that haven't received TARP funds.

The key to reviving the economy is having people willing to take risks by investing money and time in new ventures and investments. Lowering taxes, increasing free trade, and reducing regulations all help create incentives for such risk-taking. Criticizing businesses will discourage risk taking by creating an atmosphere of fear - better to hoard cash since you don't know when the next assault will occur or to what restrictions your business will be subject.

All of the above suggestions stand in sharp contrast to the policies pursued during the Great Depression, when taxes were raised significantly; free trade was devastated with high tariffs; new regulations were unleashed; and business leaders were subject to verbal and legal assault.

Contrary to the popular mythology of the New Deal, all of these policies exacerbated the crisis of the 1930's and prevented a full recovery from occurring for over ten years. After six years of the New Deal in 1939, unemployment was about 19% - down from 25% in 1933 but still at depression levels. Note that today's unemployment rate is 7.2%.

Let's not repeat the same mistakes again. Pro-growth policies, consistent with our capitalist heritage, give us the best chance to begin a sustainable recovery.

Health Insurance 101

Since health care promises to be a major policy debate in an Obama administration, I plan to write a number of posts on the subject. This first one discusses insurance, one of the most fundamentally misunderstood parts of our health care system.

The first thing to understand is how insurance is priced. Because of its relative simplicity, annual term life insurance provides a good example of insurance pricing. Let's say you purchase a $100,000 term life insurance policy. This means that if you die in the next year, $100,000 is paid to your beneficiaries; if you don't pass away, you get paid nothing.

If actuarial studies suggest someone with your age and other relevant characteristics has a 1% chance of dying in the next year, the expected value of the payment to you is $1,000 - where the expected value is the total payout ($100,000) times the probability of the payout occurring (1%).

So the insurance company needs to charge you at least $1,000 for this insurance policy, to cover their expected insurance payment to you. But they also have to pay administrative costs and earn a profit, so the cost to the consumer needs to be greater than $1,000 - let's say $1,200.

Health insurance, and all insurance, share this basic fact: the cost to the consumer needs to be greater than the expected insurance payment, otherwise the insurance company will lose money and won't offer the policy.

In some ways, insurance is a bad deal for consumers. In the example above, you pay $1,200 to be paid $1,000 on average, for a "loss" of $200. But the key is "on average". You get either $0 or $100,000, and presumably your beneficiaries will need the $100,000 if you pass away (let's say to replace your lost income). Because people are generally risk averse, most are probably willing to lose money on average (the $200 "loss") in order to protect against the risk of a large loss (the income your family no longer has if you die).

Because of this, you ought to buy insurance to protect against large, unexpected losses. For example, although light bulbs burn out at uncertain intervals, their cost is sufficiently low that it doesn't make sense to buy insurance to protect against their demise. Likewise, although an apartment dweller's monthly rent is a very large cost, it is a certain cost. In both cases, you don't want to pay the insurance company's administrative costs/profit for either variable, small losses (light bulbs) or certain large costs (rent).

Another key concept in insurance is moral hazard, which means that a person with insurance may behave differently than if they didn't have insurance - and create more insurance costs than otherwise. While this is a small problem for life insurance and is addressed by preventing payouts for suicide, it is a much bigger problem in health insurance.

For example, if you had to pay the cost of emergency room or doctor's visits out of your own pocket, depending on the nature of your health problem you might choose to see your doctor than go to the more expensive emergency room. If you had an insurance policy that paid 100% of all your costs (as an extreme example), you would bear no direct cost for choosing to go immediately to the emergency room - so you might do so when you wouldn't have without insurance.

Because of this, insurance companies might actually assume that you will incur higher health care spending merely because you have insurance. For example, imagine a health insurance policy that cost $15,000 and paid 100% of all health costs - so the total cost of health care is $15,000 no matter what. Now imagine a second policy that costs $4,000 and has a $10,000 deductible, beyond which insurance pays 100% of all health costs.

This second policy is far better than the first. Why? At most the person pays $14,000 in health care costs ($4,000 for insurance and $10,000 in deductible costs) and very well may pay less (if there are only $2,000 of claims, the total cost for the year is $6,000) - in all cases paying less than $15,000 of certain costs with the first policy.

While my example is hypothetical, the pricing of actual insurance policies can exhibit these characteristics. This can result because of the lack incentives that the first, no deductible policy provides for the insured to minimize health spending.

So here is the point of all this: most health insurance for much of the past 50 years violates these basic principles of insurance. While covering large unexpected costs, health insurance has also typically covered many routine expenditures that may not be both large and unexpected. In doing so, this has given consumers an incentive to over-utilize health care, since if you bear a small portion of the direct cost of providing desired health care, you will use more health care than otherwise.

The solution to this problem is to purchase high-deductible health insurance policies. Such policies have only recently started to gain traction due to changes in the tax code.

Why does the tax code enter this discussion? Because the entire discussion above assumes there are no tax benefits between choosing one type of insurance policy over another. But that hasn't been the case. The tax code allows health insurance to be a tax deductible business expense but is not taxable income for the employee, unlike wages/salary/bonus which is a business expense but is taxable income for the employee.

So this means we have had an incentive to take more of our income in the form of tax-free benefits like health care, with the greater the cost of insurance, the higher the tax savings. As we have seen, greater insurance cost corresponds to health insurance with low deductibles and low co-pays - which is the same insurance policy that reduces significantly the incentives of the consumer to minimize health care spending.

And now you have one of the key elements behind skyrocketing health care costs in America.