GPI Global Policy Institute

How to defeat crony capitalism and restore a free market

Martin Hutchinson

April 5, 2017

Paul Ryan’s health care “reform” bill was defeated last week without even receiving a vote in the House of Representatives, in spite of the care he had taken to get input from the health insurance industry. That was the problem. In a crony capitalist system, where bad lobbyist-pushed laws and regulations have poured illicit profits into the pockets of oligopolists, the oligopolists are the last people to consult on how to reform those laws. The same dynamic is visible in monetary policy, in bank regulation and in corporate and individual tax policies. We are a long way from true free-market capitalism, and we won’t get there by consulting the current crony “capitalists.”

A lot of money buys little

Healthcare is a classic example. U.S. healthcare costs 18% of GDP, compared to 12% in the next-highest cost countries, France, Sweden and Switzerland, 11% in Germany and Canada, 10% in Japan and 9% in Britain and Australia. Effectively, the U.S. government pays as much for healthcare as Britain’s state-run system, then private American citizens pay the same amount all over again. The U.S. population gets nothing extra in terms of health outcomes for all this expenditure. Indeed, basic U.S. indicators of healthcare results, such as life expectancy, are distinctly mediocre by rich-world standards.

Whatever your political view on who should pay for what, getting the United States’ appallingly high healthcare costs down to those of the level of its developed peers should surely be the top priority, indeed more or less the only priority, in any healthcare system reform.

American Health Care Act would save little  

Paul Ryan’s American Health Care Act achieved essentially nothing in the way of cost control. It claimed to do so, by replacing Medicaid with a system of “block grants” to the states. But that change does not actually reduce the cost of healthcare at all, it merely shifts it from the Federal government to the states and, inevitably, to America’s less wealthy citizens who depend on Medicaid.

Core problems not addressed  

The legislation did nothing about the trial lawyer blight, it kept all Obamacare’s cost-increasing regulations in place. Besides, it did not provide for insurers bidding across state lines and it did not remove the egregious 1986 emergency room mandate, by which hospital emergency rooms must treat indigent patients without limit, and without receiving any kind of compensation from the state that mandates this nonsense. Without proper cost-reducing measures, the legislation was essentially useless; its 17% approval in the polls was probably higher than would have been achieved once the public discovered what a colossal waste of Congressional time it had been.

Interests of the health insurance industry fully preserved  

The reason for the Ryan bill’s poor quality is that it was designed after extensive discussions with the insurance industry and other beneficiaries of the current system. Ryan is a champion fund-raiser and much admired as a “policy wonk”, largely because of the care he takes to consult the special interests before proposing new policies. Thus, the provisions that might make a serious dent in insurance company incomes were missing from Ryan’s bill, as were provisions that would collapse the cost of medical care overall, reducing the economic rents that health insurers, hospital chains, trial lawyers and others could extract.

Expect the same with tax reform  

This is not a problem limited to healthcare. We are likely to get another almost perfect example of it when Ryan unveils his corporate tax reform plan. While it may include some form of “border adjustment tax”, favored by President Trump, which redistributes income from retailers to manufacturers, it’s likely that the main feature of it will be the abandonment of worldwide taxation and a movement to “territoriality” in corporate tax, by which corporations will pay U.S. corporate income tax only on U.S. income.

This is a move in precisely the wrong direction. The economically neutral and efficient means of taxing multinationals would tax all worldwide income, without any deferral of income earned overseas, but with a full tax credit for taxes paid overseas. The United States has never had this system; corporations’ overseas income is deferred from tax until it is remitted to the United States, under “Subpart F” legislation introduced in 1962.

Thus, we have a system in which U.S. corporations have stashed over $2 trillion overseas to avoid taxes, and companies such as Apple are borrowing domestically to pay dividends and engage in economically damaging repurchases of stock, while keeping ziggurats of cash offshore.

Current tax system makes no sense

The current system makes no sense at all. It encourages companies to invest overseas, by giving them the potential to avoid tax on the investment, thus discriminating against domestic investment –precisely the problem against which Trump rightly rails.  It is also grossly unfair to U.S. individual taxpayers, who have only a very limited ability to use this loophole. U.S. taxpayers who earn income overseas, as I did for some years, must pay full U.S. tax (and in some cases, state tax) on that income, with a modest $75,000 foreign earned income exemption. What’s more if they attempt to keep their own money overseas tax free, in a tax haven bank account, the U.S Treasury goes after the foreign banks, with a spurious excuse of finding terrorist funding, and subjects the taxpayers to threats of imprisonment.

Bad reform ideas

The corporate tax bill Ryan is likely to propose, as favored by corporatist lobbyists from the Wall Street Journal down, would make this economic insanity worse, by allowing all foreign income to be fully exempt from U.S. corporate tax. Of course, the first effect of this would be a “giant sucking sound” of money rushing out of the U.S. into tax havens for spurious foreign investment, doubtless leveraged to the eyeballs by Fed-induced cheap money.

Special interests will prevent sensible financial systems reforms  

There are other examples of this. President Trump’s economic crew, made up largely of alumni of Goldman Sachs, are unlikely to reform the disgraceful Fed funny-money policies that have distorted resource allocation and destroyed productivity growth for the last decade. They are also likely to gut banking regulations that restrict the insane amount of leverage in the system, while retaining those that add cost and bureaucracy, which provide useful barriers to entry against new and smaller competitors.

Individual tax reform plans will continue to benefit the rich

We are also likely to see this problem in the Trump administration’s “reform” of individual taxes. It may well be inspired by President Reagan’s 1986 tax law, which reduced rates of taxation by eliminating deductions. It may well eliminate the deductions relied upon by the upper middle class for home mortgage interest and state and local taxes.

But you can be absolutely sure that, guided as they will be by the billionaires in the political donor class, the tax law’s drafters will not reform the true source of inequality and scams: the charitable tax deduction. This serves the combined purpose of funding a myriad of sleazy left wing agitators and allowing the ultra-rich to finance their lifestyles tax-free through foundations such as the Clintons’ while the merely mega-rich on the two coasts tax-deduct their repulsive social climbing and networking through charity dinners.

Special laws breed crony capitalism

There is an overall principle here, and it should be pretty obvious. Once an economic system has moved away from a free market, usually through legislation drafted by panicky and economically illiterate leftists given license by a war or an economic crisis, it creates crony capitalists. These benefit from the new restrictions and build businesses optimized for the restrictions that the laws and regulations have introduced.

Very often, as in the case of medical care and modern financial services, the new system absorbs a far larger share of GDP than would the equivalent activity in a free market, with the result that new avenues are opened up for crony capitalists to generate extraordinary levels of profits, while the old free-market businesses are squeezed out of existence.

What happened in Britain

This happened most visibly in Britain after the 1986 Financial Services Act, when the merchant banks, which had provided sophisticated financial services worldwide, some of them for as long as 200 years at modest economic cost, were within a decade squeezed out by foreign behemoths. The behemoths were much larger (and so less efficient) because of the compliance costs they were forced to absorb, which increased the economic share absorbed by the financial services businesses and their practitioners, while destroying the quality of service that the merchant banks had provided.

In the U.S. patients pay for huge bureaucratic costs  

Similarly in U.S. healthcare the addition of regulations after 1960 took away the family doctors and small hospitals that had provided good cost-effective services, and pushed the business towards large bureaucratic hospital chains, with teams of lawyers attached to resist shyster lawsuits, plus an entirely new and unnecessary layer of health insurance companies that exist purely to shuffle paper and intermediate between patients and health services providers. As in finance, these new “crony capitalists” have no interest whatever in dismantling the system under which they have grown rich.

How to restore a free market system

Every now and then a government is elected that wants to return, at least partially, to a free market system. To do so, that government must dismantle a host of regulations which in many sectors have destroyed the free market and replaced it with a crony capitalist rent-seeking cabal. The free-market-seeking government will face huge opposition from the crony capitalists, as well as from the myriad of citizens who benefit from heavy regulation, high taxes and government control, or are ideologically in favor of them.

Eliminate regulations favored by special interests lobbies   

To win through a free-market government will need to draft the new laws itself, and not rely on crony capitalist help, however generous the crony capitalists may be as political donors. If Paul Ryan is a major political fund-raiser, he should not be allowed near the drafting of free-market legislation.

Martin Hutchinson is a GPI Fellow. He was a merchant banker with more than 25 years’ experience before moving into financial journalism. Since October 2000 he has been writing “The Bear’s Lair,” a weekly financial and economic column. He earned his undergraduate degree in mathematics from Trinity College, Cambridge, and an MBA from Harvard Business School.

 

This article was originally published on the True Blue Will Never Stain http://www.tbwns.com

 

The views and opinions expressed in this issue brief are those of the authors and do not necessarily reflect the policy of GPI.

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