Monday, December 5, 2011

Another Way to Cut Taxes

In the current economic climate, policy makers have dual fears of raising taxes, and cutting government spending for fear of corresponding changes in GDP.  At the same time, policy makers are concerned about large and growing national debt totals.  Clearly, both all of these are important priorities and somewhat in conflict with one another.  This is where reducing regulatory taxes can provide an important third way to promote growth even as the federal government begins reconciling deficits.

Philip Howard of Common Good recently wrote a terrific op-ed in the Wall Street Journal “How to Overhaul Regulation” is a very interesting take on what substantive regulatory reform could look like.  He identifies the key underlying problems inherent within most modern American regulations: their complexity and their universality.  Regulation overhauls should be seen as an incredible opportunity for the federal government to effectively offer businesses tax breaks without affecting government income.  Government income would likely increase due to increased efficiency and corresponding general reductions in price levels.
Regulations, at their best, help solve market problems.  These problems might ensure that producers are not damaging shared resources, or if they are that they are, these damages do not become externalities.  That is, that the producer is the one who pays for damages, and prices those damages into their products for consumers to ultimately pay.
All regulations add costs for firms.  The first cost is that of information.  Understanding a regulation’s impact on an individual firm must be borne out before substantial investments are made.  When information costs are high (as they are when regulations become complex), they become a substantial burden on firms.  Large firms are able to employ economies of scale to minimize these costs, but small firms are not.  This is why small firms are dramatically more impacted by this feature.  Howard’s idea of regulating small firms differently is an important idea.  Laws are meant to be evenly applied throughout society, but when regulations that come from those laws are universally used, they affect firms disproportionately.  Then they become unfair to small firms.
Heavily regulated industries can become dominated by large firms as smaller competitors drop out.  These regulations act as barriers to entry which reduces competition and causes consumers to be harmed twice by this regulation.  First the consumer is harmed by the regulatory costs, which are ultimately passed on to the consumer.  Then the consumer is harmed by decreased competition and potential monopolistic market conditions.
As Howard describes, “Regulators try to imagine every possible mistake and then dictate a solution.  The complexity is astounding.”  Regulations should be observed from an information economics perspective.  One way that the federal government could help American firms is by estimating how much time it would take a lawyer or an ordinary business person to read and implement a regulation.  Departments could issue guidelines about what an appropriate range of time for agencies to target, as these should be considered costs for the businesses and as they pass these costs on, consumers.  The reduction in information costs could be seen as a very real tax cut for American businesses and therefore consumers.  Regulations have often been seen in economics as taxes because they incur costs and are compulsory. (Posner)

The Obama administration has made regulatory changes including simplifications, especially through the Office of Information and Regulatory Affairs.  President Obama has made this a priority through Executive Order “Improving Regulations and Regulatory Review.”  This is an important mandate by the President at a time when American market flexibility is needed to meet increasing strong competition from global trade. 

The order stresses that agencies "facilitate the periodic review of existing significant regulations, agencies shall consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned." 

As stated earlier, regulations are useful to correct market failures or behaviors in which completely free markets produce inefficient results.  Many or most regulations are also more complex than they need be to resolve these inefficient results.  Many regulations also inject rules that do not solve market inefficiency, but rather add to it (perhaps where it didn't exist in the first place).  As President Obama pointed out in his executive order, analysing which regulations promote market efficiency, and which aspects merely add to the billable hours of compliance lawyers should be a regular activity in the federal government.

Regulatory tax cuts could be used in concert with either real tax increases or reductions in government services to moderate their impacts on GDP.  The purpose of this would be to attempt deficit reconciliation during a weak economy.  Hopefully 2011 will be a year of regulatory tax cuts for American firms that could become more efficient and therefore more competitive.


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