Perverse Incentives and Unintended Consequences
  (September 23, 2010)

The status quo, based on the premise of endless "growth" and debt-based "prosperity," is fatally burdened with perverse incentives.

Already dependent on an impossible model of endlessly rising consumption and debt, the U.S. economy is also burdened by perverse incentives which lead to structurally disastrous unintended consequences.

The U.S. culture, economy and Empire are based on the unquestioned presumption that debt-based "prosperity"--more consumption, more growth, more of everything-- is naturally endless. Thus adding "overhead"--unproductive costs--is subconsciously viewed as painless because "prosperity" will inevitably rise enough to effortlessly pay for the additional expenses.

The status quo is thus incapable of functioning in an environment of structurally declining income, consumption, taxes, debt and "prosperity."

This is how you get public pension plans which are wildly beyond the ability of the local government to pay as tax receipts enter a long period of decline.

In response, the status quo (Central State/Empire, its fiefdoms and financial/cartel corporate partners) imposes increasingly pervasive (and onerous) regulations to force compliance, with the single goal being the maintenance of the status quo Elites.

As noted yesterday, the U.S. has a highly progressive tax system: the bottom 60% pay almost no Federal income tax while the top 10% pays the vast majority of Federal taxes. This aligns with long-standing values of our society: the better-off pay more. Indeed, the U.S. has the highest nominal corporate tax rate of major economic powers, relatively high personal income tax rates, and until recently, estate taxes that were heavy enough to drive all the great fortunes into charitable trusts (Ford Foundation, et al.) lest they be lost to taxes.

As correspondent D.K. noted:

I don't see unearned (business) income as under-taxed. Corporate income is subject to 35% tax - making dividend and capital gain taxes double taxes. Add estate tax as the triple tax. Yes, the wealthy investor/business class is insulated - under-taxed, no.

Despite this steeply progressive tax structure, wealth and power continue to concentrate in the top 1% and top 1/10 of 1%. As noted earlier in the week:

One Year Later, No Sign of Improvement in America's Income Inequality Problem:

Income inequality has grown massively since 2000. According to Harvard Magazine, 66% of 2001-2007's income growth went to the top 1% of Americans, while the other 99% of the population got a measly 6% increase. How is this possible? One thing to consider is that in 2001, George W. Bush cut $1.3 trillion in taxes, and 32.6% of the cut went to the top 1%. Another factor is Bush's decision to increase the national debt from $5 trillion to $11 trillion. The combination of increased government spending and lower taxes helped the top 1% considerably.

Two Americas: The Gap Between the Top 5% and the Bottom 95% Widens (August 18, 2010)

As total household income declines, the wealthiest Americans take home a larger piece of the national income pie. In 2008, Americans reported $8.4 trillion in total income, down 4.6% from 2007. Adjusted for inflation, that is down 8.4%, the sharpest decline in total income since the brief recession that began in 1990.

David Stockman, director of the Office of Management and Budget under President Reagan, recently noted in an editorial that the top 1% of Americans received two-thirds of the gain in national income from 2002 to 2006.

Economists Emmanuel Saez and Thomas Piketty have reported that the top 10% of earners took home about half of all income as of 2007.

If taxes are highly progressive in the U.S., which they clearly are, then how can wealth continue concentrating into the top 1%? It seems that the efforts of the Central State to collect ever higher taxes have created perverse incentives, which have then triggered unintended consequences.

High tax rates encourage gaming the system/offshoring. While some think-tank studies claim that high corporate tax rates do not discourage relocation to lower-tax states within the U.S. (tell that to the film industry in Hollywood, which has been gutted as production moves to states offering huge tax breaks), only the willfully blind would claim high U.S. corporate rates aren't a factor in offshoring. Moving operations overseas and paying much lower rates on the income earned makes perfect sense.

Another perverse incentive is rarely noted: high tax rates encourage the financialization of the U.S. economy to the detriment of industry. A few years ago I recall reading that a major U.S. manufacturer (I think it was Whirlpool) paid the full 35% tax on their income, which resulted in a tax in the $100+ million range. In contrast, various financial firms (or firms like GE which have financial divisions) paid zero corporate tax, due to the multiple opportunities for gaming the system offered by finance.

If we consider an industrial corporation as an organism, then we have to ask why the organism would choose to pay 35% tax rate when other much more profitable options are available.

This helps explain why finance has come to dominate the U.S. economy, and why U.S. companies have embraced offshoring of production with such enthusiasm: they would be irresponsible not to.

The unintended consequence of high corporate taxes in a global economy is the gutting of U.S. industry and the ascendance of finance--and very possibly lower total taxes collected. Take away the perverse incentives for gaming-the-system and offshoring by lowering the corporate rate to a flat 10%, and perhaps total taxes paid by corporations would rise substantially.

The rising costs of political campaigns has opened the door to the concentration of power by the super-wealthy. The nation's inability to set any meaningful limits on campaign financing has led to the escalation of campaign costs to the point that serious status quo candidates must raise millions of dollars to win elections. This has made them beholden to "major donors" and their lobbyists.

This mechanism explains how a handful of Financial Power Elites managed what Simon Johnson identified as "The Quiet Coup" during the 2008 global financial crisis.

In other words, the exploding costs of maintaining political power has led to concentrated wealth holding concentrated political power. As a result (the unintended consequence), high taxes are burdening the top 19% but leaving the top 1/10 of 1% free to increase their share of the national income and wealth.

Thus it was not accidental that the vast majority of the Bush-era tax cuts flow to the top 1/10 of 1%.

In another example of perverse incentives, correspondent Julie W. noted that volunteer "work" is forbidden to those collecting unemployment:

Thank you for another thoughtful essay on the state of our nation and, more specifically, our economy. While I agree that it would be beneficial for both the unemployed and non-profit organizations for people collecting unemployment to volunteer for these organizations, let me tell you what the reality is here in New York State (N.Y.S).

I was laid off from my job a little over one year ago. As you mentioned, I spend about 2 to 3 hours a day reading the paper and surfing the internet for paid work of which there is precious little. However, the worst part about being unemployed is that I actually had to GIVE UP VOLUNTEER WORK in order to be eligible! Unbelievably, the politicians in N.Y.S would rather pay me to sit at home and watch Maury Povich Show re-runs than allow me to assist with the organization of a community garden or volunteering to help the elderly or sick. Apparently, doing volunteer "work" while collecting unemployment insurance in NYS is considered a form of fraud. Here is the "Fraud Warning" from the Claimant's Handbook:

Claiming unemployment insurance fraudulently is a serious offense. It can lead to severe penalties, including CRIMINAL PROSECUTION and imprisonment. You may be guilty of fraud if you hold back information from or give false information to the Department of Labor. You must report the true reason you were separated from employment. You may be committing fraud if you work while receiving benefits and do not report that employment. This applies even if it is part-time work, operating or starting a business, providing services for yourself or others, no matter how brief, or whether you got paid. Protect yourself. If in doubt, report it. You must report all full-time and part-time employment to the Labor Department or you risk criminal penalties. (Their emphasis).

So, in NY State the politicians believe that it actually IS A GOOD IDEA TO PAY PEOPLE NOT TO WORK!

Rather than encourage productive labor, the status quo punishes it. This is symptomatic of the entire status quo, which is riddled with "fixes" and regulations which actively discourage thrift, productive labor, industry, and enterprise, while perversely encouraging gaming the system, offshoring, financialization and the further concentration of financial and political power.

Thank you, D.K. and Julie W. for your comments. The more laws the State imposes, the more lawbreakers it creates. The more it tries to squeeze from the citizenry, the more citizens slip through its grasp.

That's how you get economies in which 40% of the activity is "black market"/"unofficial" business (example: Italy), as only State enterprises and a few cartels can afford to function in the official economy.

I am slowly catching up on correspondence after several weeks away from my desk --your patience is appreciated.

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