The Wall Street Journal has published a biased news story regarding state budgets. The piece by Kate Davidson and David Harrison reflects only Keynesian thinking, exaggerates the plight of governments, and only quotes analysts in favor of more federal bailouts.

Here are some of the problematic aspects of the piece:

“State and local governments spent or invested $2.33 trillion in 2019.” That statement is false. The $2.33 figure is the state-local portion of GDP (BEA Table 1.1.5). But total state-local spending and investment in 2019 was $3.1 trillion (BEA Table 3.3).

“Michael Strain, director of economic policy studies at the conservative American Enterprise Institute, said Congress should take similar steps to fill the budget hole for state and local governments, which have seen revenues decline by 15% to 20% in some cases.” It is an error to conflate the budget situations of state and local governments. State governments may face a revenue decline of perhaps 10 percent, on average, but most local governments likely face little decline. Almost three-quarters of local tax revenues are from property taxes, and housing values remain buoyant so far during the recession. During the last recession, overall local government revenues did not fall for that reason.

The article cites analysts at liberal think tanks Brookings, TPC, and CBPP. It quotes a GOP senator who is one of the few Republicans in favor of another big state bailout. It quotes a scholar at conservative AEI who has a big-government view on this issue. And it cites Moody’s Analytics, which has a Keynesian economic model programed to show that government spending boosts GDP. Thus, the story cites six people in favor of another bailout and none against.

The article focuses on the most exaggerated estimate of state budget gaps, which is the Moody’s two-year figure of $500 billion. Why do they add two years together other than to produce a big-sounding number? The authoritative source of state budget data, NASBO, reports data on an annual basis.

The article includes a lower budget gap estimate by TPC, but excludes other recent lower estimates by Tax Foundation and economists Christos Makridis and Robert McNab. The Tax Foundation study shows that these three estimates are similar, and lower than the Moody’s outlier estimate highlighted by the WSJ.

The WSJ does not mention that the “gaps” and “shortfalls” it discusses are differences between pre-crisis forecasted revenues and current forecasts. If a state had forecast 2021 revenues to grow 5 percent but now expects 0 percent growth, the gap is said to be 5 percent and translated into dollars. The state would need to keep its 2021 spending flat to keep its budget balanced. That is not a crisis, especially after state general fund spending grew 5.5 percent in fiscal 2019 and 5.8 percent in fiscal 2020.

An alternative way to report budget gaps is to compare expected 2020 and 2021 revenues to actual peak 2019 revenues. That approach shows smaller gaps, as shown in the Tax Foundation study.

The WSJ article highlights Moody’s claim that without more federal aid, state budget gaps will “shave more than 3 percentage points off U.S. gross domestic product and cost more than 4 million jobs.” The Moody’s model reflects the Keynesian view that government spending boosts GDP. But other economists disagree. WSJ reporters might have interviewed Hoover Institution economists whose recent study found that cuts to government spending would boost GDP.

More broadly, Keynesian macro modeling ignores many microeconomic distortions caused by government spending that undermine GDP. I explore such distortions here. At minimum, reporters should note that the supposed stimulative effects that groups such as Moody’s claim are short-term impacts and do not include the longer-term costs of government spending.

The other day, WSJ publisher Almar Latour criticized “agenda-driven reporting” and said his paper’s “news coverage stands as a beacon.” I love the Journal and read it every day, but there is room for improvement in the news department.

Senator Kamala Harris is Joe Biden’s pick for vice president. The vice president could play a more important role on immigration than in prior presidencies, so it’s important to understand Sen. Harris’s plans on this issue. From a libertarian perspective, legalizing the act of crossing borders should be the main focus of immigration reform, not merely legalizing those who have already done so. While she generally agrees with making legal immigration easier, Sen. Harris clearly disagrees with the libertarian prioritization of the issue.

Overall, Harris generally adopts the same pro-immigration agenda of Biden. But in the primaries and now, Biden’s plan was more clearly pro-legal immigration than Harris whose plan barely mentions the subject. Her plan mostly details how she would use executive authorities to allow illegal immigrants to obtain legal status or deferred action. This reflects the majority of her time in the Senate, which has focused mainly on the treatment of illegal immigrants in the United States. This is a reversal from her time as a prosecutor where she worked with ICE to deport juveniles who were not charged with a felony.

E-Publication

Reforming the Immigration System: A Brief Outline

With the election of a new president, Congress has the opportunity to correct the two fundamental flaws that plague the current U.S. system. First, the system is too restrictive, and second, the system is too inflexible to adapt to new economic or social conditions, allowing small problems to build into national crises. Here is a compendium of 52 reform proposals, both for enforcing the law, and for a less restrictive and more flexible immigration system.

Read the Reforms

On legal immigration, she wrote only that “she’ll reverse President Trump’s Muslim Ban on Day One and fix the family visa backlog.” The family visa backlog has nearly 4 million immigrants in it, but Harris didn’t explain what her “fix” would be. Biden has suggested exempting some categories from the caps and providing temporary visas to those in the backlog so that they can wait in the United States.

She is the lead Democrat sponsoring the Fairness for High Skilled Immigrants Act in the Senate. The legislation—which I have written about in detail—would repeal the employment-based country caps that cause Indian foreign workers to face a near century long wait for a green card. The fact that she was willing to sponsor this bill demonstrates a level of awareness about the problems facing skilled legal immigrants. She was also an original cosponsor of the NO BAN Act (which I have written about here) that restricts presidential authority to ban legal immigrants.

There are some points of concern. Her focus on executive action may imply that she believes a Biden administration should be less willing to compromise with Congress to make a deal. She was also one of just three Democrats to vote against a bipartisan immigration bill in the Senate in 2018 that would have given President Trump congressional appropriations to build his border wall in exchange for a path to citizenship for most immigrants brought to the United States as children. Then-Vox reporter Dara Lind correctly called it the Senate’s “last best hope” for immigration reform. The bill failed by 6 votes.

She has also basically said that she will act on behalf of labor unions, stating a “commitment to fight for organized labor.” This is concerning because labor unions vehemently oppose all forms of temporary worker programs, which are the primary or, for unskilled workers, the only means for foreign workers to enter the United States for work. She led an effort to stop the Trump administration’s only mildly pro-immigration reforms of the H‑2A program and has introduced legislation to require all farmers to pay overtime to farm workers.

On the other hand, Biden’s plan called the current temporary workers “cumbersome, bureaucratic, and inflexible” and promised to protect or expand them (with normal caveats about protecting U.S. workers).

She also advocates an increase in the federal minimum wage to $15 per hour, which the Congressional Budget Office and others have found would destroy 1.3 million low-skilled jobs—disproportionately among immigrant communities. It would price out many future immigrants from being able to come to the United States to work legally. California’s high minimum wage is likely one reason why its share of the illegal population has halved since 1990. 

Harris also advocates for expanding Medicare to include all illegal and legal immigrants—a policy that Biden opposes—in her Medicare for All plan (also opposed by Biden). There is some evidence that expansion of welfare benefits makes no difference to poverty rates among immigrants. There’s also evidence that government health insurance has no significant effects on health outcomes, despite increasing usage. This policy is anathema not only to conservatives, but moderate Republicans and libertarians as well. If she insisted on it, it would doom any compromise on immigration (as a similar health care issue did in the House in 2013).

Harris’s criminal justice record as a prosecutor was also extremely poor from a libertarian perspective, and given the criminalization of various immigration violations, this could be important as well. While she mostly disavows this record today, she still touts her prosecution of employers who—in her words—“exploit” illegal immigrant workers, but often that can amount to simply denying immigrants the ability to work for anyone.

Overall, Harris will likely advocate for the rights of immigrants already in the United States to live and work here without federal interference. She would push Biden to immediately undo all the harm the current president has done to the legal immigration system. But she hasn’t shown much interest in fixing the legal immigration system, and her positions toward guest workers are concerning. Her votes on Dreamers in 2018 indicate an unwillingness to compromise even when her own party wants her to. Her executive action plans and extreme left policies on health care make it uncertain whether she would be willing to compromise with Congress to make permanent changes that benefit immigrants and Americans.

Presidential candidate Joe Biden is planning large tax increases if elected in November. One proposal would raise the top federal long-term capital gains rate from 24 percent to 43 percent. In the Wall Street Journal, Mark Bloomfield and Oscar Pollock discuss why that policy change would be damaging.

One of their points deserves elaboration. There is a strong behavioral response to changes in capital gains taxes, such that increases in the rate substantial shrink the tax base. A large federal rate increase will shrink the base dramatically, which would undermine both federal and state tax revenues. Bloomfield and Pollock say, “States like New York and California (and some municipalities, notably New York City) rely heavily on realizations of capital gains, which would drop significantly,” under Biden’s plan.

Consider California. The top 1 percent of taxpayers pay half of the state’s individual income and capital gains taxes. Capital gains tax revenues account for about 10 percent of the state’s overall general fund revenues (p. 157). During the recession a decade ago, the plunge in capital gains taxes from wealthy individuals hit the state budget hard.

California is dependent on capital gains tax revenues because of its highest-in-the-nation top tax rate of 13 percent and its dependence on the wealth generated in Silicon Valley. Not only would California state revenues be hit by Biden’s capital gains tax increase, so would the state’s high-tech economy. California policymakers should be lobbying the Biden campaign to rescind his capital gains tax proposal.

The interaction of tax bases in the three levels of government is an underappreciated factor in public policy. Federal, state, and local governments compete as they tax capital gains, individual income, and corporate income. Higher tax rates at one government level shrink the tax bases and revenues at the other levels. Biden’s proposals to raise capital gains taxes, individual income taxes, and corporate income taxes would shrink state and local tax bases and revenues.

Here is a related concern. A general rule in economics is that the harm of a tax rises by the square of the rate, such that a 40 percent tax rate causes four times the economic damage as a 20 percent rate. Federal and state tax rates pile on top of each other, and it is the combined marginal rate that affects taxpayer behavior. Biden wouldn’t be raising the capital gains rate by 20 percentage points starting from zero. Rather, he would be pushing up the top federal rate to 43 percent and the combined federal-state rate to more than 50 percent in California and other high-tax states.

How many high-tech entrepreneurs and angel investors will put their time, effort, and money into long-term, illiquid, and highly risky startup investments if, in the 1‑in-10 chance they hit it big, governments take more than half the return?

I am surprised that Silicon Valley isn’t up in arms with Biden’s capital gains tax proposal. If enacted, American technology industries would suffer major damage.

# # #

There is a caveat. Under section 1202 of the federal tax code, entrepreneurs and angel investors may exempt from tax investment gains from some types of startups that are held for more than five years. It is not clear whether Biden’s proposal would eliminate that benefit or not. Perhaps Silicon Valley leaders think they can retain this break even as the overall capital gains tax rate rises, but that is a risky political assumption to make.

The two parties are far from agreement on another aid package, so President Trump has decided to take tax and spending measures by executive action. Here are a few thoughts:

Unemployment Benefits. Democrats want to extend extra unemployment benefits of $600 per week, and Trump has gone part way by extending them at $400 per week. The benefits create a work disincentive and will undermine the recovery. Even without the extra benefits, regular unemployment benefits cover 30 to 50 percent of prior paychecks. That is the level of benefits workers would expect, and they should have built their personal savings to help cushion the blow from possible unemployment.

When employed, workers at every income level should save. A WSJ piece discussed Ronald Read of Brattleboro, Vermont, who spent his career pumping gas and sweeping floors. His pay was low, but he was frugal and ended up saving $6 million and leaving it to charity when he died. There is no reason why government benefits should cover 100 percent or more of lost wages. When people are working, they should follow Read’s example and save.

Government benefits are not a freebie. Showering cash on people today comes at the cost of higher taxes on people tomorrow. As such, government aid generates ethical problems, not just microeconomic damage.

Payroll Tax Cut. Trump’s action defers payment of some Social Security payroll taxes, with a possible cancelation of the taxes later on. But if government continues spending on the program’s benefits, then the tax costs will simply be pushed forward. Why should politicians be able to impose the costs of today’s spending onto tomorrow’s workers? This year’s crisis has created huge economic damage. Deficit-spending can move costs to the future but can’t make costs disappear. The nation will have other crises to deal with down the road. It is unfair that people in the future will have to pay both the costs of the crises that will hit them and the costs of past crises. Trump and Congress should offset any payroll tax cuts by cutting Social Security benefits or other spending.

State and Local Aid. Congress has provided $150 billion in flexible aid to the states plus more than $280 billion in other state and local aid for health care, education, housing, transit, and food stamps. That is more than enough, and Trump is right to resist further intergovernmental aid.

Despite media stories to the contrary, local government revenues may not fall much, if at all, this year since property taxes are likely to remain buoyant. State government revenues may fall about 10 percent, but the states can handle that by tapping rainy day funds, freezing worker pay, cutting programs, and privatizing assets. State and local governments have enjoyed a decade of growth, and they should have been ready for the downturn.

Politicians always want to do something—anything—in response to downturns. But usually the best path is to leave the economy alone because markets adjust and resume growth by themselves. Indeed, shrinking the government’s footprint by cutting spending and regulations increases market flexibility and speeds the return to growth.

Federal aid is usually counterproductive because it creates microeconomic distortions that delay needed restructuring. More federal spending will undermine a speedy recovery, not help it.

I discuss distortions caused by government spending here, and Hoover Institution scholars model the growth benefits of spending cuts here.

In the cover story for the July/​August issue of Cato Policy Report, Lee Drutman of the New America Foundation expounds on a theory of the causes of, and solutions to, hyperpartisan polarization, adapted from his book Two‐​Party Doom Loop: The Case for Multiparty Democracy in America. In the past two to three decades, America’s two major political parties have become strongly sorted and polarized in a way that has not been seen since the Civil War. The consequences have become alarming.
 

It’s not just that the political marketplace is broken — it’s that the broken political marketplace is now breaking the fundamental foundations of modern liberal democracy: the rule of law and adherence to constitutional norms. In the constant jockeying for narrow elusive majorities, partisans are putting short‐​term gains ahead of long‐​term stability and disregarding long‐​standing norms in order to win the next election and humiliate the other side. When “winning” becomes everything, and winning means dehumanizing the other side for short‐​term gain, it legitimates increasingly extreme behavior on both sides.

I call this problem the “two‐​party doom loop.” The idea is similar to an arms race, or any self‐​reinforcing feedback loop of escalation. More aggressive actions on one side justify more aggressive actions on the other side. 

This is a problem that should be especially concerning to libertarians. Not only because we perennially struggle for a seat at the table as an ideological minority within both major parties, but because escalating partisan incentives have undermined things libertarians care deeply about: constitutional limits on government power, checks and balances, liberal norms, and an aversion to the tyranny of the majority.



Rep. Justin Amash (L‑MI) noted similar reasons in his decision to leave the GOP last year, writing in the Washington Post that “The two-party system has evolved into an existential threat to American principles and institutions.”



That’s a dire warning that lovers of liberty should take seriously. But luckily, we are not without possible solutions.



The question is in some ways one of public choice, the incentives facing political actors because of systemic design and process choices. It’s also not new territory for political science, with Duverger’s law dating to the 1950s but the underlying observation long predating it. First-past-the-post elections (the only kind then known to the Framers of the Constitution) tend to sort a nation’s politics into two dominant political parties, and nowhere has this effect been seen more strongly than in the United States. Alone among major liberal democracies, the United States has no members of the House of Representatives who were elected outside of the two largest parties. (The Senate has two nominal independents, but both are de facto Democrats).



Libertarians are thus well positioned to draw on an intellectual tradition that stretches from Nobel laureate James Buchanan all the way back to James Madison, who strenuously sought to craft a system of checks and balances that would tame and channel partisan incentives, including through a strong system of federalism and decentralization. Simply put: incentives matter. The rules of the game go a long way toward determining its outcome. Madison’s genius continues to serve us well, but is not beyond improving on with knowledge unavailable to him in 1787.



Our situation is not hopeless and runaway polarization is not inevitable, as much as recent years might have given that impression. There is currently a bubbling movement for electoral reform sweeping the states, which have broad authority to determine the rules of their own elections. Maine has led the way with ranked choice voting, using it for congressional elections in 2018 and applying it to a presidential race for the first time this November. But there are other possibilities. Some states already use multi-member districts for their legislatures, which are especially well suited to many models of multipartisan electoral reform.



Since the Supreme Court’s ruling in Baker v. Carr in 1962, which struck down malapportioned districts that were once common for one or both chambers, legislative bicameralism in many states has struggled to find a purpose. With state senates effectively elected in an identical manner to their lower houses, they are no longer representing any difference of interests or incentives. One possible reform to consider would be making one house elected by a method of party list proportional representation, and thus explicitly multipartisan, and making the other chamber elected in single-winner nonpartisan elections, as the unicameral legislature of Nebraska already is.



But that’s just one idea. The field of possible electoral reforms is rich with possibilities, many of which have long standing examples abroad we can study. The state-level initiative and referendum process provides a key avenue to bypass established legislators entrenched within their two partisan camps. States can and should take the lead with experimentation. Perhaps in no other policy field is the label “laboratories of democracy” more apt.



By chipping away at the foundations of the doom loop at the state level, Americans might be able to find a more diverse and competitive market for political representation. And in so doing, we could find a way out of the toxic escalation of two-party tribalism, which in the long run provides no satisfactory defense of liberty and the Constitution. The American people represent a vast diversity of values, ideologies, and interests. Their elected representatives should reflect that, including building compromise and consensus rather than engaging in a fight to the death for total control built on narrow majorities.



There is strong reason to doubt how long our constitutional traditions and institutions can survive the two-party tug of war, which in its current unbounded incarnation is barely a generation old. We are overdue to do something about it before something breaks, potentially irrevocably. It is a testament to Madison’s vision that he not only attempted to tackle these same problems, but also provided us a workable way to correct and perfect his system, to better meet its goal of preventing the dominance of any one party or faction. 

From Plato on, paternalists have argued that individuals would be better off if they were shielded from lies, disinformation, and “bad speech.” In contrast, liberals think individuals are capable of discerning their own ideals and interests, free from the oversight of “those who know.” For liberals, such restrictions “elevate society and the state to a despotic command and…reduce the individual to the arbitrary control of others.”

In the United States this liberal case for speech enshrined constitutional constraints on government paternalism. Those constraints “do not permit a State to forbid or proscribe advocacy of the use of force or of law violation except where such advocacy is directed to inciting or producing imminent lawless action and is likely to incite or produce such action.” But that power to punish incitement matters less than you might think. People may be shouting “fire,” but they rarely are in a “crowded theatre” and hence, subject to censorship. We thus risk speech causing “harm to others.”

What about expression that might harm its listeners or readers? The religion clauses of the First Amendment mean government may not protect its citizens’ immortal souls. In theory, obscene speech may be censored; in fact, disagreements about the definition of obscenity have hampered restrictions. Thanks to the First Amendment, the government cannot act like a parent overseeing what its children say and hear. Adults have the right and responsibility to speak, to hear, and to discern the truth in a world often filled with uncertain claims and outright lies.

Private forums for speech, like social media, are different. They are not obligated to follow the First Amendment. But why? Here again the individual matters. Individuals want things, others provide them, and consensual agreements bring them together. Those who create businesses seek to maximize their profits; platforms’ tolerance of some sorts of speech would reduce revenue. An individual or individuals own the platform; they may exclude speech that reduces their profits. More generally no one has the right to use other people’s property without their consent. A platform owner, unlike a government official, may suppress speech they find offensive. Indeed, federal law empowers them to do so.

Some see a conflict between property rights and civil liberties. Platform owners may suppress the speech of their political opponents as a danger to the commonweal. The suppressed say in response that speech should be free in “the new public square” of social media. Property rights must give way to “freedom of speech” with government officials the unlikely champion of the latter.

Yet social media users may want speech paternalism. They might wish to be protected from extreme expression or be told “the truth” in a confusing era when everything seems up for grabs. And social media are multi-sided platforms. Advertisers, who pay social media to target their ads, want users to come and stay on the platforms. They care little why users come and stay. In any case, they do not want ads for their brands near extreme speech. Content moderation by social media may be less a political imposition and more a business necessity. Even if social media managers have no desire to parent their users, they must meet a market test for their shareholders. Perhaps providing a measure of protection is a part of the social media product. And that measure of protection need not be small. People want what they want, and businesses per se are satisfiers, not judges, of those wants.

We should not exaggerate the novelty of such protections. Legacy media big and small often confirmed rather than challenged the views of their readers providing thereby an untroubled path to familiar conclusions. The older gatekeeping was a kind of content moderation offering safety (among other things) to those seeking it. And the power of gatekeepers raised the costs of reaching an audience; many ideas remained at the margin of public debate. Now we have fewer gates and lower costs to reach readers or listeners. More people are called upon to tolerate more “dangerous” or “false” speech than in the past. The supply of tolerance may be falling short of demand, at least from a liberal perspective. That’s an explanation not a justification for the current situation. Those who wish to live in a free society should live up to liberal ideals.

Most political philosophies are often betrayed by realities. Liberals put the individual at the center of society. They also demand much of each individual, not least the strength to sort good ideas from bad and live (and vote) by their results. Individuals may not meet those demands. At times, they may wish for security and protection and for a world of clear enemies and few doubts. Many see content moderators as politically correct censors or abettors of social injustice. But the liberal among them should be seen in another light, as ordinary people struggling with a dilemma created by our failure to live up to liberal ideals. We may hope moderators will resolve this dilemma in favor of liberal ideals. But it is our failure to live up to individualism, rather than the power of social media moderators, that should concern us all.

In response to the crisis, federal policymakers have passed a series of aid packages providing hundreds of billions of dollars to state and local governments. Legislation, here and here, has provided $150 billion in flexible aid to the states plus more than $280 billion in other state and local aid for health care, education, housing, transit, food stamps, and other programs.

Congress and the administration are working on yet another bailout package. The House plan includes $1.1 trillion further aid to the states, while the Senate plan includes $105 billion for schools and colleges.

Federal aid to the states is harmful for many reasons. When tax revenues fall during recessions, state governments should tap their rainy day funds, cut low-value programs, freeze salaries, furlough workers, postpone new initiatives, and sell assets. The federal government can help by repealing rules that block the states from cutting spending on activities that receive federal money. Millions of American businesses are tightening their belts, so why not governments? Today’s lean budget climate is an opportunity to improve efficiencies in state and local agencies.

Even if some crisis aid to the states made sense, further aid would be too much. The aid already passed would mainly cover budget gaps if states were allowed maximum flexibility with the funds.

During the last recession, state tax revenues fell 10 percent from the 2008 peak and then began bouncing back. Recent projections suggest a decline this recession of no more than that. Tax Foundation surveyed current forecasts for a dozen states, and found that tax revenues are expected to fall about 4 percent in fiscal 2020 and 7 percent in fiscal 2021 from the fiscal 2019 peak. Tax Policy Center recently surveyed 27 states and found similar estimated declines, as did a recent study by economists Christos Makridris and Robert McNab. The budget gaps were larger when compared to a no-recession baseline of rising revenues.

In the chart, the red line is Census data showing state tax revenues rising for a decade and peaking at $1.09 trillion in calendar 2019. Then the red dashed line assumes a 10 percent drop in 2020 and recovery in 2021 and 2022. Tax revenues would be down $109 billion in 2020 and $55 billion in 2021 compared to the 2019 level, for a two-year loss of $164 billion. The losses would be somewhat larger measured against a no-recession growth baseline. But either way, the aid handed out already would mainly fill state budget gaps if states were allowed to use the money flexibly.

The blue line in the chart shows total federal aid to state governments. The projection, 2020 to 2022, is based on regular aid growing per the pre-virus federal budget, plus the $150 billion in flexible crisis aid already provided. The media has focused on how much state tax revenues might fall, but even if the federal government provided no crisis aid, the large part of state budgets funded by federal dollars would chug along with steady increases.

Lastly, note that while state-level tax revenues may fall 10 percent this year, local government tax revenues may not fall much, if at all. During the last recession, overall local tax revenues were flat for a while and then began rising again.