Economic Policy in the Next Administration Should Target Efficiency, Not Redistribution

Tariffs

Tariffs and other trade restrictions force American consumers to pay more for goods and firms to pay more for inputs that they use to produce their products. This means that tariffs harm American consumers and businesses. The overall effects are often worse than the direct effects, since countries targeted by United States tariffs will likely retaliate with their own tariffs on U.S. exports. This is what happened in response to the Smoot-Hawley tariffs of 1930, with predictable, disastrous results. Indeed, the recent trade war with China has harmed U.S. industries.

Proposals to raise tariffs substantially, but so far not forcefully rebutted by Trump or Harris, are thus blatant attempts to curry favor with particular voting blocs, especially workers in the manufacturing sector who are heavily concentrated in swing states. As a political ploy, this may work. But it makes no sense as economic policy.

Immigration

Efficiency considerations suggest substantially expanding the legal avenues for immigration into the U.S. Immigration expands the labor supply, which lowers production costs and thereby allows businesses to expand profitably. Immigration also appears to enhance economic productivity and innovation. Assertions about negative effects—crime, terrorism, lower wages, and fiscal costs—are exaggerated or outright wrong.

Thus Trump’s position, which Harris has recently moved toward, is backwards. Reasonable people can object to the current mechanisms for legal immigration, worrying that they are messy and confusing. And reasonable people can caution that completely open borders might be disruptive if many immigrants arrive within a short period.

The goal must nevertheless be to expand immigration. Trump’s extreme resistance to immigration is disastrous: deporting immigrants en masse will raise labor costs for U.S. businesses (including manufacturing), making them less competitive and rewarding competing firms from other countries. Additionally, deportations would not only be costly but also detract from the net positive fiscal impact of immigration. Money spent on walls is pure waste, since immigrants consistently circumvent virtually any attempt to keep them out. The difference in wages and living conditions between the U.S. and the origin countries of most immigrants are large, so immigrants are willing to incur almost any cost to enter the U.S.

Tax Code

The ideal tax code raises revenue in the most neutral manner possible. This implies taxing similar things at similar rates to avoid incentivizing evasion and avoidance. The ideal code, relatedly, is simple, making it easy for taxpayers to comply and for the government to enforce.

Thus proposals from both candidates to exempt tips or social security income are exactly backwards. They reward certain types of activity for no reason other than to generate political support from that group.

Similarly, proposals to expand the child tax credit are difficult to defend from any efficiency perspective. Having children is a choice, which parents can make on their own. Arguments exist for why privately chosen decisions might not always be socially optimal, but these arguments run in both directions, and little evidence suggests any major inefficiency from either fast or slow population growth.

On the corporate income tax, both candidates have it wrong. Harris supports raising the corporate income tax rate from 21% to 28%. This is backwards from an efficiency perspective: the ideal corporate income tax rate is zero. The usual objection—that corporate income taxation falls mainly on the rich—is at a minimum overstated. The tax falls partly on consumers and employees, who have a range of incomes, as firms will pass on most taxes to these groups in the form of higher prices or lower wages. In some cases, the distributional implications are backwards, since high rates drive corporations overseas, putting U.S. employees out of work. If desired, progressivity in the tax system is best accomplished with progressive rates in the personal income tax system.

Trump’s recent proposal to lower the corporate income tax rate just for businesses that make their products in the U.S. is also backwards from both efficiency and equity perspectives. The tax code should treat all kinds of income the same. Otherwise, it incentives perverse avoidance and evasion behavior. For example, businesses will try to define themselves as “manufacturing” to qualify for the lower tax rate.

Improving the tax code is hard given current levels of expenditure and the looming federal deficits. The fiscal situation pushes many people to support tax increases, but these will be contentious and likely include numerous carve outs and special treatment. The solution is reduced expenditure, which allows simpler tax policies that collect less revenue.

Home Ownership

Politicians across the aisle have long endorsed the “American dream” of home ownership, promoting a broad range of subsidies via Fannie Mae, mortgage interest deductibility, and more. From the efficiency perspective, the government should play no role in encouraging home ownership; no plausible market failure needs to be corrected. Instead, politicians intervene to redistribute: toward people who want homes but cannot easily afford them, and toward others would like bigger homes than they can afford on their own.

That is no basis for policy, however, even if recent economic events have raised housing prices. Policy changes can instead reduce housing prices while enhancing economic efficiency by scaling back state- and local land use restrictions. This would expand supply and reduce prices. Estimates suggest that, in major urban areas, restrictions raise the price of land by as much as typical household income. Proposals from Harris (national rent control, down-payment support for first time home buyers) exacerbate supply issues by discouraging construction of new rental property or increasing demand: both effects would increase housing prices, especially given current land use restrictions.

Industrial Policy and Manufacturing

Policies in which governments support specific industries or sectors deemed especially valuable or strategic have a long and disappointing history. Markets make numerous mistakes in choosing winners and losers, but governments make more and rarely correct their bad choices; markets let bad ideas go bankrupt and disappear. Policy should therefore take no stand on the economy’s industrial structure.

A crucial example is manufacturing. This sector has indeed declined as a share of the economy (although many accounts exaggerate the magnitude; in particular, the decline in employment has been greater than that in output, presumably reflecting improved productivity). But protecting or subsidizing manufacturing reduces economic efficiency by shifting resources away from sectors that the marketplace deems more attractive. Politicians obsessed with promoting manufacturing are instead appealing to that voter base.

Entitlements and Fiscal Balance

A necessary condition for a government’s spending plan to make sense is that it be affordable over the long haul, given plausible estimates of how much that government can collect in taxes. The U.S. fiscal plan no longer satisfies this condition. Under current projections, spending relative to the size of the economy will grow without bound, eventually producing fiscal default and economic crisis. Tax hikes can make only a minor dent in this dismal outlook, since at a level not far from current practice, higher taxes will reduce economic growth and therefore lower tax revenue on net.

Promoting economic efficiency over the long run thus requires significant reductions in federal spending. Given the magnitudes of existing programs, which are projected to grow relative to GDP, spending reductions require phasing in substantial reductions in Social Security and Medicare, whether via higher ages of eligibility, higher co-pays and deductibles in Medicare, or slower benefit growth in Social Security (e.g., indexing the initial benefit level to prices rather than wages). Determining the optimal size of these programs is hard, but a necessary condition is that they grow no faster than GDP on average.

Disappointingly but unsurprisingly, neither candidate endorses this perspective. Trump and Harris not only oppose any cuts to Medicare or Social Security; both endorse increased benefits.

Education

Economists have long emphasized that subsidizing education potentially enhances economic productivity. Whether this implies the magnitude or design of current subsidies, however, is less obvious.

In particular, it is hard to give a convincing efficiency reason for federal intervention in education. State governments have long subsidized education to a substantial degree. And since many people who borrow to finance education have difficulty repaying—suggesting the extra education did not substantially enhance their income—the right amount of subsidy is plausibly lower than now. Yet federal intervention appeals to many voters, for redistributionist rather than efficiency reasons.

A prime example is the federal student loan program, which is likely excessive relative to any valid efficiency concerns.

Even if such programs make efficiency sense, loan forgiveness programs do not. Such programs are unlikely to be “one-offs,” since future borrowers will hope the receive forgiveness, and many politicians will want to oblige. If borrowers believe they will not have to repay their loans, they will make bad decisions about whether to take out such loans in the first place. More broadly, interference with loan contracts sends the wrong signals about making thoughtful decisions and will incentivize political manipulation of such arrangements for groups favored by the existing political power.

Climate Policy

Given current scientific understanding, policies that reduce greenhouse gas emissions potentially improve economic efficiency by reducing an economic bad—emissions—by more than any loss of economic goods: GDP. The natural policy is a carbon tax set equal to the marginal social cost of carbon. Thus, Harris’ desire to address climate change is one area where, at first glance, a current political position seems to address efficiency rather than redistribution.

Yet even in this arena, recent and proposed policies are problematic because they use clean energy subsidies rather than carbon taxation. The two approaches sound similar, since they both raise the relative price of carbon-based fuels. Subsidies for clean energy, however, mean reduced energy prices overall and therefore increased energy use, much of which will be fossil fuels for the medium term given the current energy grid. Thus, clean energy subsidies could be counterproductive.

Yet politicians endorse energy subsidies because they cater to a political base—voters who are unwilling to face the higher energy prices implied by carbon taxation—and reward energy companies, consultants, and the like. Similarly, tariffs or bans on solar panels and electric vehicles make no sense from an efficiency perspective; politicians presumably endorse these policies to help the domestic suppliers of such products.

Other Policies

Beyond the specific areas in which the past policies and current proposals from Harris and Trump emphasize redistribution over efficiency, numerous other examples exist where policy should rethink current practice: antitrust, minimum wage laws, union protections, rent control, anti-price-gouging laws, restrictions on peak load pricing of utilities, occupational licensing, land use restrictions, the Jones Act, regulatory barriers to entry, and much more. These harm efficiency with weak distributional benefits at best. The opportunities for better policies are virtually endless.

Conclusion

Politicians propose policies they think will help them win votes. Disappointingly, this seems to mean policies that reallocate the economic pie, rather than policies that expand it. A few redistributionist policies aim to help the most disadvantaged members of society, but the vast majority transfer resources in ways that help special interests, the wealthy, the connected, or the politically influential. These policies fail on both efficiency and equity grounds. Thus, renewed focus on efficiency would promote both productivity and equity.