U.S. government spending is growing at a faster pace than the ability of taxpayers to pay for it. As government spending outpaces economic growth, more resources are redirected from productivity-enhancing functions toward government-fueled consumption without commensurate increases in the ability of workers to pay for a larger government. Excessive government spending also fuels inflation, depresses growth, and lowers living standards.

Congress’ latest debt deal is woefully inadequate for addressing the drivers of growing spending and debt, primarily putting controls on less than one-third of the budget that is already projected to decline further as a share of the economy: discretionary spending.

The Congressional Budget Office’s (CBO) latest long-term budget outlook projects that U.S. government spending will consume nearly 30 percent of the economy by 2053. At 29.1 percent of gross domestic product (GDP), federal spending will be 8 percentage points of GDP or almost 40 percent higher than the historical average.

As the figure above illustrates, interest costs are a main driver of spending increases, alongside expansions in major health care and Social Security spending. Other mandatory spending, which includes various welfare programs, retirement benefits for federal employees, and some veterans’ benefits, is projected to decline as a share of GDP. Discretionary spending growth also flattens out in CBO’s assumptions.

Interest costs are projected to triple as a share of the economy, assuming Treasury 10-year bonds at 4 percent – below average rates recorded over the past three decades. Interest cost increases are due to higher interest rates and the increasing size of the debt to which they apply. Publicly held debt borrowed in credit markets is projected to almost double from 98 percent of GDP in 2023 to 181 percent of GDP by 2053. The best way to address rising interest costs is to stabilize the debt as a share of the economy, which Congress can accomplish by reducing projected spending by at least 10 percent.

The only major category of federal spending expected to grow faster than interest on the debt is federal health care programs. Major health care programs include Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and subsidies for private insurance purchased on the exchanges created by the Affordable Care Act (ACA). According to CBO, two-thirds of the increase in major health care spending will be due to the growth in per-person health care costs, meaning fixing the current subsidy, instead of allowing health care spending to grow ever more generous without budget controls, would fix most of the cost growth problem. Only one-third of the projected increase in total spending on the major health care programs is due to population aging. Unfortunately, President Biden’s initiatives to lower health care costs will be mostly futile, acting primarily as campaign talking points rather than addressing underlying cost drivers. As Jim Capretta with the American Enterprise Institute argues:

“President Biden’s latest plan to lower health care costs for American households…[is] far too trivial to matter much for most patients. If anything, the net effect is more likely to be an increase in overall costs rather than a reduction.”

The two largest federal programs, Medicare and Social Security, will face a fiscal cliff sometime in the next 10 or so years. CBO’s estimates assume that Medicare and Social Security spending will continue as if the fiscal cliff didn’t exist. Were Congress to let scheduled benefit cuts occur, Medicare providers would face 11 percent payment cuts as soon as 2031 and Social Security beneficiaries could see their benefits reduced by 20 percent as soon as 2033. Given the popularity of both programs, waiting until the 11^th hour before the fiscal cliff hits will likely result in legislators adopting a short-term band-aid approach, such as papering over entitlement deficits with additional borrowing and tax increases, while any benefit reductions could be delayed a decade or longer. U.S. workers have the most to lose from this wait-and-see approach as they’ll get hit with the double whammy of higher taxes and a slower-growing economy.

Following current debates in Congress, legislators have moved on from worrying about passing a budget or addressing the debt to arguing over how much to increase recently agreed upon spending levels on defense and non-defense discretionary programs under the guise of emergency needs. Congress should have closed gaping loopholes in the debt limit deal to account and pay for emergency spending if legislators wanted to ensure their agreement held tight.

Unfortunately, raising the debt limit didn’t make the debt issue go away, it merely kicked the can down the road while Americans continue to struggle under the weight of ongoing inflation that’s in no small part driven by excessive government spending. Americans should ask those running for office how they will stop the government from eating up more of the economy. Without public questioning, Congress may just as well try to ignore the debt problem until 2025, when the debt limit suspension comes to an end.

Senators Cynthia Lummis (R‑WY) and Kirsten Gillibrand (D‑NY) introduced an updated version of their Responsible Financial Innovation Act. The bulk of the bill addresses issues around market structure and cryptocurrency exchanges—issues my colleagues Jack Solowey and Jennifer Schulp have discussed at length. Yet, within the bill also lies an interesting section on combatting illicit finance within the cryptocurrency market.

What makes this section so interesting is that Senators Lummis and Gillibrand appear to have largely adopted this section from a separate bill introduced by Senators Elizabeth Warren (D‑MA) and Roger Marshall (R‑KS). In fact, all four senators just joined hands to introduce this section as a standalone amendment to this year’s National Defense Authorization Act (NDAA). As many might remember, the Warren-Marshall bill received a nearly instant wave of criticism from Cato, Coin Center, Bitcoin Policy Institute, Bitcoin Magazine, Filecoin Foundation, and many others when it was first introduced.

Coin Center’s Peter Van Valkenburgh wrote, “The bipartisan Digital Asset Anti-Money Laundering Act, introduced today by Sens. Warren and Marshall, is the most direct attack on the personal freedom and privacy of cryptocurrency users and developers we’ve yet seen.” Filecoin’s Marta Belcher wrote, “The bill would also effectively ban privacy-enhancing technologies in blockchain networks. The bill is a disaster for digital privacy and civil liberties.”

A cursory look at the bill makes it easy to see why everyone was so concerned. The Warren-Marshall bill proposed expanding anti-money laundering (AML) and know-your-customer (KYC) surveillance to self-hosted wallets and cryptocurrency ATMs as well as effectively setting a prohibition on the use of cryptocurrency mixers. The bill also proposed having the Treasury, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC) levy new examination and review processes on the companies they oversee. Finally, the bill proposed a requirement for Americans to report to the Financial Crimes Enforcement Network (FinCEN) if they transact more than $10,000 in cryptocurrency if at least one party in the transaction is outside the United States. As Valkenburgh and Belcher said at the time, it was a direct attack on digital privacy and civil liberties.

How the Two Bills Stack Up

The good news is that the new Lummis-Gillibrand bill did not copy the Warren-Marshall bill entirely. The Lummis-Gillibrand bill would not necessarily expand surveillance to self-hosted wallets, prohibit the use of cryptocurrency mixers, or force Americans to report cross-border transactions over $10,000. The bad news is that the Lummis-Gillibrand bill did pick up other pieces of the Warren-Marshall bill (see Figure 1).

Like the Warren-Marshall bill, the Lummis-Gillibrand bill would require cryptocurrency ATMs to “verify the identity of each customer using a valid form of government-issued identification or other documentary method, as determined by the Secretary of the Treasury.” The bill would also require owners of cryptocurrency ATMs to report the physical location of ATMs to FinCEN every four months. Targeting ATMs may not be as severe as surveilling self-hosted wallets and effectively prohibiting mixers, but it’s important to recognize that requiring cryptocurrency users to have their identities verified is still taking a stance against financial privacy.

The Lummis-Gillibrand bill also adopted the Warren-Marshall proposal to have the Treasury, SEC, and CFTC create new “risk-focused examination and review” processes for the companies they oversee. These examinations would be intended to monitor how companies are complying with anti-money laundering requirements. Considering compliance is already estimated to cost financial institutions $46 billion a year in the United States to stop an unknown amount of crime, it’s unclear what exactly this added burden will contribute, especially since the specifics are left for the agencies to determine.

Where the Warren-Marshall bill would have prohibited the use of cryptocurrency mixers, the Lummis-Gillibrand bill takes a more nuanced approach by instead requiring FinCEN to issue a report to Congress that explains how mixers are used in markets currently and to make recommendations on possible future legislation. This approach is better than the prohibition proposed by the Warren-Marshall bill. However, this approach will require watchful eyes on the part of the public. On the one hand, the report could easily give FinCEN another tool to argue for further expanding its authority over financial transactions. On the other hand, the report could result in essentially kicking a prohibition to a later date.

Beyond Warren and Marshall

The Lummis-Gillibrand bill also makes a few unique additions of its own outside of what was adopted from the Warren-Marshall bill.

Notably, the section on combatting illicit finance opens with an amendment on penalties for cryptocurrency related crimes. By amending 12 U.S.C. Section 1957, the Lummis-Gillibrand bill would make it so violations of financial recordkeeping laws (12 U.S.C. Chapter 21) where cryptocurrency is involved can lead to additional punishments with up to $10,000 in fines and up to five years in prison. It’s possible this provision is partly a response to the fall of FTX given it raises the stakes for keeping proper accounting standards.

The Lummis-Gillibrand bill would also see to the creation of a working group dedicated to crafting proposals to combat illicit finance. The group would include officials from both law enforcement and regulatory agencies as well as businesses working on cryptocurrency technology, financial institutions, and research organizations. Within this theme, the bill would also require the President to issue a separate, public report. Although exchanging ideas in an open manner is commendable, it’s unfortunate that legislation is required to make that happen. (Though, perhaps that’s more so a commentary on politics at large.)

Continuing the theme of opening new dialogues, the Lummis-Gillibrand bill would create an “Innovation Laboratory” within FinCEN. The laboratory would be dedicated to promoting “regulatory dialogue, data sharing between the FinCEN and financial companies, and an assessment of potential changes in law, rules, or policies to facilitate the appropriate supervision.” This idea might sound nice to some, but FinCEN’s history of repeatedly refusing to provide data to prove the effectiveness of anti-money laundering surveillance in general makes it hard to have faith in the agency’s ability to live up to what the senators have in mind. One may be comforted because it’s a statutory requirement, but events earlier this year have shown that statutory requirements have still not been enough to get real answers about the effectiveness of anti-money laundering requirements.

Finally, although it was not in the section on combatting illicit finance, it’s worth mentioning that the Lummis-Gillibrand bill does address self-hosted wallets elsewhere in the bill. When discussing risk management, the bill says that the CFTC and the SEC must create standards regarding money laundering, customer identification, and sanctions compliance for exchanges dealing with self-hosted wallets. This move is not the same assault levied by the Warren-Marshall bill. Yet, at the same time, it is concerning that these rules are being left open for regulators to decide and will require watchful eyes if it comes to fruition.

Conclusion

Taken together, the Lummis-Gillibrand approach may not be as concerning as the Warren-Marshall bill, but that is not to say it is not concerning at all. Although Senators Warren and Marshall sought to take a leap forward for expanding financial surveillance, Senators Lummis and Gillibrand are still creeping forward by pushing forth these proposals. It’s for that reason that the Lummis-Gillibrand and Warren-Marshall alliance should be concerning for advocates of privacy and freedom.

It was only a few months ago that Senator Warren was described as “building an anti-crypto army.” The fact that her proposals spreading, even in limited form, should give people pause to ask if that army isn’t growing. The new bill is not the full assault from last year, but it also isn’t a retreat.

As debates move forward on both this bill and the recent NDAA amendment, it will be important for the public to keep a watchful eye.

A few weeks ago, American Compass released Rebuilding American Capitalism, A Handbook for Conservative Policymakers. This Forbes column (American Compass Points To Myths Not Facts) provided a very brief critique of the handbook’s Financialization chapter, and Oren Cass, American Compass’s Executive Director, released a response titled Yes, Financialization Is Real.

This Cato at Liberty post is the fifth in a series that expands on the original criticisms. (The first four in the series are available here, here, here, and here.) This post discusses the one remaining core argument American Compass relies on – income stagnation. It demonstrates that the evidence contradicts American Compass’s income stagnation story.

The idea that Americans’ income has stagnated is central to American Compass’s argument that American capitalism needs to be rebuilt. The foreword in American Compass’s handbook uses this stagnation story as follows:

What has happened to capitalism in America? Businesses still pursue profit, yes, but not in ways that advance the public interest. Over the past 50 years, corporate profits rose by 185%. Wages rose by 1%. [Emphasis added.]

It connects this supposed stagnation to financial markets as follows:

Financialization shifted the economy’s center of gravity from Main Street to Wall Street, fueling an explosion in corporate profits alongside stagnating wages and declining investment. [Emphasis added.]

American Compass’s very reason for existence is to argue that American capitalism no longer flourishes largely because “globalization and financialization” are “undermining the nation’s prosperity.” The alleged evidence is that the typical American worker’s income has been stagnating for decades. The third sentence of Cass’s 2018 book, The Once and Future Worker, laments that “while gross domestic product (GDP) tripled from 1975 to 2015, the median worker’s wages have barely budged.”

This stagnation story, just as American Compass’s claims regarding talent, profit, and investment, does not hold up to scrutiny. The empirical evidence undercuts American Compass’s stated reason for existing. To be clear: It is true that America has many economic problems. In fact, Cato scholars regularly discuss countless ways to fix many of these problems. Unfortunately for American Compass, though, a broad stagnation (or decline) in Americans’ income is not a problem.

The opening lines of Cass’s book (reproduced above) provide an excellent starting point for this discussion. While it is very easy to verify something like GDP growth for any given period, it is not so straightforward to evaluate “the median worker’s wages” because the median worker can be defined in any number of ways. The term could reference, for example, someone who earns the median wage of all U.S. employees, the median wage of all private employees, or the median wage of all production and nonsupervisory employees (excluding managerial staff). Arguably, the term should exclude all part-time workers or all workers under the age of 16. There simply is no single way to define the median (or typical) worker.

This basic problem is magnified by multiple definitions of income, including total compensation (wages plus fringe benefits, such as health insurance) and household income (both before and after taxes and transfers). Separately, for any given measure of income, adjusting for inflation with different price indices results in large disparities in real income growth over long periods of time. And, of course, choosing different time periods from within the overall length of a series can easily produce a deceptively low (or high) growth rate. These problems are all further complicated because the “typical” household from distant decades is no longer the typical American household – aside from multiple other demographic changes, more household income is now typically spread over fewer family members.

It is straightforward to use Cass’s example to illustrate some of these points. For instance, using the Consumer Price Index (CPI) to adjust average hourly earnings of production and nonsupervisory employees suggests that real wages have grown less than 1 percent from 1975 to 2015, consistent with Cass’s statement. However, adjusting the same earnings data with the Personal Consumption Expenditures (PCE) index indicates that real wages grew 22 percent – obviously not stagnant.

Interestingly, using either a longer or shorter timeframe provides a very different growth figure than Cass’s 1975 to 2015 period. For example, examining the same income series from 1964 – the first year the data is available from the Bureau of Labor Statistics (BLS) – to 2015, while adjusting for inflation with the CPI, shows that real wages grew almost 9 percent from 1964 to 2015. Using the PCE shows that real wages grew a bit more than 39 percent from 1964 to 2015. Separately, using the CPI to examine the same income series from 1991 to 2015 (both 1975 and 1991 mark the end of a recession) shows that income grew almost 15 percent. Using the PCE to adjust for inflation suggests that income grew 27 percent for this period.

As Figure 1 demonstrates, “income growth” is highly influenced by the chosen inflation metric and the starting point for the period of analysis. Figure 1 plots the growth rate in real income – average hourly earnings of production and nonsupervisory employees – with the rate calculated using every year from 1964 to 2000, respectively, as the starting point, and 2015 as the ending year. It shows the analysis using both the CPI and PCE to convert nominal wages to real. (Real adjustments made using the PCE, the Fed’s preferred price measure, always result in a higher growth rate.) Using 1975 as the starting point for this analysis, for CPI adjusted income, produces the lowest possible (positive) growth rate.

Using only this method – the one Cass uses – while ignoring all the others gives the false impression that real income was stagnant.

Similar issues arise using the Census Bureau’s household income figures, but even the basic data, as reported, contradicts the stagnation story. For instance, without making any adjustments for changes in demographics, Census reports that real median household income increased 34.18 percent from 1967 to 2018.[1] That’s hardly stagnant.

Still, because the number of people in each household declined 23 percent from 1967 to 2018 (from 3.3 individuals to an all-time low of 2.53),[2] the Census income distribution figures understate how well individuals have been doing. Larger household incomes are now divided among fewer people, so adjusting for only this change in household size shows that real median household income increased 74 percent, from $14,355 in 1967 to $24,972 in 2018.[3] That’s more than double the increase shown in the unadjusted data, far from stagnant.

While many journalists have let go of the income stagnation story, others have (even if unintentionally) fueled the false narrative. Take, for instance, an article in The Atlantic that discussed the U.S. Census Bureau’s 2018 report Income and Poverty in the United States. The author noted:

Around 13 percent of households made more than $150,000 last year; a decade ago, by comparison, 8.5 percent did. While that’s something to cheer, without a solid middle class, it’s not indicative of an economy that is healthy and stable more broadly.

At best, the author is guilty of a major understatement.

The 2018 Census report shows that more than 5 million households – not individuals, but families – moved into the high-earning category. That shift is undoubtedly something to cheer, but the author still implies that these numbers support a “disappearing middle class” narrative. As Mark Perry from the American Enterprise Institute confirms, the very same Census report shows that the share of households earning between $35,000 and $100,000 fell from more than 53 percent in 1967 to 42 percent in 2018, and that the share of households earning more than $100,000 essentially tripled, from less than 10 percent in 1967 to more than 30 percent in 2018. Moreover, while The Atlantic article largely ignores it, the share of households earning less than $35,000 fell, from approximately 36 percent in 1967 to less than 28 percent in 2018.

Together, these statistics show a broad increase in prosperity. In fact, this increase is even more impressive considering that the number of American households essentially doubled from 1970 to 2018. For anyone interested in additional evidence that typical Americans – and even, in many cases, lower income Americans – have been earning higher and higher incomes during the last several decades, here are a few references:

• William Cline, U.S. Median Household Income Has Risen More Than You Think
• Richard V. Burkhauser, Jeff Larrimore, and Kosali I. Simon, A “Second Opinion” On The Economic Health Of The American Middle Class
• Salim Furth, Stagnant Wages: What the Data Show
• Michael Strain, The Myth of Income Stagnation
• Scott Winship, Stagnationists Are Simply Wrong and What You Need to Know from the New CBO Income Figures
• Gerald Auten and David Splinter, Income Inequality in the United States: Using Tax Data to Measure Long-Term Trends
• Thomas Hirschl and Mark Rank, The Life Course Dynamics of Affluence
• Scott Lincicome, The American Wealth Machine and Its Misguided Discontents and The Annoying Persistence of the Income Stagnation Myth
• John Early, The Myth of American Income Inequality

In 2020, perhaps after recognizing that the basic income stagnation story does not hold up, American Compass began releasing its Cost-of-Thriving Index (COTI) to provide “a better way to understand the challenge for working families.” According to Cass, his COTI is better than looking at inflation-adjusted (real) income:

Economists rely on inflation-based adjustments to compare costs of living over time, but this method measures the cost of buying the same set of things in different eras. Perhaps a family could more easily afford a 1985 quality of life in 2015 than in 1985, but being in the middle class in 2015 means affording a 2015 quality of life.

While it is true that price indices are imperfect, and they tend to make older incomes look larger than they really were, Cass’s description of inflation-based adjustments over time is highly flawed. Adjusting nominal income to “real” income essentially converts the dollar amount to a quantity, such that it indicates how much “stuff” someone can buy. And both the CPI and the PCE account for (as best as possible) the different quality of goods and services available to people over time, as well how people may buy different products (substitute), including those that they were previously unable to purchase.

Setting this flaw aside, American Compass uses its COTI to argue that living standards have declined, supposedly explaining why “America’s working families” are correct to “feel that they have come under increasing economic pressure.” However, as the American Enterprise Institute’s Scott Winship and Jeremy Horpedahl have documented, American Compass’s COTI methodology is just as flawed as its understanding of inflation-based adjustments.

In their new paper, Winship and Horpedahl demonstrate that the American Compass COTI decline is the direct result of its design choices. Specifically, American Compass’s COTI ignores taxes and transfers (which tend to boost lower earners’ incomes), excludes full-time workers younger than 25 years old, and excludes full-time female workers. American Compass’s COTI also includes a very narrow range of goods and services, defining food, transportation, housing, health care, and higher education as “needs,” yet leaving purchases of clothing, home furnishings, utilities, and communications technology out of the COTI.

American Compass’s COTI methodology is consistent with its propensity for selectively choosing data to give the appearance of supporting evidence for its claims. Thus, Winship and Horpedahl reach a reasonable conclusion regarding American Compass’s COTI report:

Against these data, Cass asks us to believe that, in truth, living standards are down by 36 percent. We have shown that this claim bears no relationship to reality.

…

While Cass’s claims are out of line with all plausible estimates by serious researchers, they align neatly with his organization’s view that American capitalism requires “rebuilding.”

It is also worth mentioning that American Compass’s COTI conflicts with other research that uses separate alternative measures of well-being that do not depend on inflation-adjusted income metrics. For instance, Bruce Sacerdote’s 2017 National Bureau of Economic Research (NBER) paper reports that consumption for two-person households with below median income increased as much as 164 percent from 1960 to 2015. The paper points out that spending on food and clothing grew slower than the growth in total consumption during this period, and that this falling share of total consumption for food and clothing is consistent with real income growth being higher than income-based measures suggest.

Another consumption-based measure of well-being is the number of work hours needed to purchase the same goods at two different points in time. Researchers can use this metric to gauge whether, for example, real income stagnated from 1975 to 2015. If the amount of time someone would need to work to buy the same bundle of consumer goods in 1975 is no different than it is in 2015, then real income has stagnated. On the other hand, if the required work time to purchase the same bundle has fallen, then the evidence suggests that real income has increased. Using a sample of 400 consumer products, George Mason’s Don Boudreaux reports that only one good–men’s work boots–costs more in work time in 2019 than in 1975. (In Myths Of Rich And Poor: Why We’re Better Off Than We Think, Michael Cox and Richard Alm use the same method and report similar results.)

The Simon Project, an endeavor of the Cato Institute’s Human​Progress​.org, formalizes these ideas by creating an index based on the time price (how long someone must work to acquire a good) of 50 basic commodities. Their index shows that the average time price of these 50 commodities fell more than 72 percent between 1980 and 2018. In practical terms, this figure means that if it took one hour of work to buy a commodity – such as sugar, coffee, pork, or lumber – in 1980, it took only about 17 minutes of work to buy that same commodity in 2018. Put differently, if it took one hour of work to buy an item in 1980, that same hour of work would buy almost four units of the same good in 2018.

This Cato post has demonstrated that American Compass’s bleak income stagnation story is a false narrative. American Compass selectively chooses its preferred time periods and economic measures so it appears as if the evidence supports its story. Moreover, as previous posts in this series established, American Compass displays this same propensity to selectively pick terms and dates that appear to support its “financialization” narrative. In all these cases, though, the evidence contradicts American Compass’s claims.

This article appeared on SubStack on July 20, 2023.

One argument for the death penalty is that the usual alternative—life in prison without possibility of parole—imposes a financial burden on taxpayers (about $60,000-$70,000 per death row inmate per year, according to a recent estimate).

Yet capital punishment is costly, too:

Contrary to popular misconception, the expense of the death penalty does not lie in the “end less” appeals of death sentences. Although appeals do consume relatively more resources, capital trials also consume more resources than similar trials with a maximum sentence of life in prison. One early study found the additional trial costs exceeded those of appeals by a factor of four (Cook et al. 1993). Estimates of the marginal capital trial cost vary, but Collins et al. (2015) offer a middling figure of just under $1,500,000 (cf. Roman et al. 2009). The reasons for the increase are several. Attorneys spend more time preparing cases, and many states require the appointment of two defense attorneys to any defendant who cannot afford private counsel. Jury selection is more complicated. The process can take days or even weeks, partly because of the need for “death qualified” jurors, i.e., individuals who neither universally oppose nor support the death penalty. Capital cases also produce more hearings and court filings. Expert witnesses are unavoidable. Mitigation evidence, which argues for leniency in punishment, can require a significant travel budget. For these reasons and more, capital trials are uniquely expensive.

One overall assessment concludes that

In the 32 states in the Union where the death penalty is legal, as well as the federal government, the death penalty has grown to be much more expensive than life imprisonment, whether with or without parole. This greater cost comes from more expensive living conditions, a much more extensive legal process, and increasing resistance to the death penalty from chemical manufacturers overseas. These costs could even become higher, pending the outcome of various lawsuits against various states for their “botched” executions. Each death penalty inmate is approximately $1.12 million (2015 USD) more than a general population inmate.

And in at least one state, the implication of the increased expenditure is ironic:

When a local government bears the expense of trial, it must raise funds or reallocate them from other sources. In Texas, among other states, the cost of trial is borne primarily at the county level. A panel of Texas county spending over the last decade, constructed from audited financial statements, shows counties meet the expense of trial by raising property tax rates and by reducing public safety expenditure. Property crime rises as a consequence of the latter. The death penalty may therefore impede criminal deterrence if its finance is left to local, rather than centralized government.

Thus not only does the death penalty burden taxpayers; it seems to increase certain kinds of crime. Existing evidence suggests executions have minimal impact in deterring violent crime like homicide.

Reasonable people might still support the death penalty, for moral reasons (“an eye for an eye”).

On consequentialist grounds, however, the case for capital punishment is weak.

The Seventh Amendment guarantees the right of trial by jury for “Suits at common law.” But defining when a suit is “at common law” can be surprisingly tricky. More than two hundred years after the Seventh Amendment’s enactment, the matter remains heavily litigated and unresolved.

For the first time in U.S. history, plaintiffs suing an employer for breach of ERISA fiduciary duties resulting in excessive fees have received a jury trial. ERISA, the Employee Retirement Insurance Security Act, requires employers sponsoring retirement plans to behave prudently with plan money. (Full disclosure: This case was litigated by my former firm, and I was at the firm during the trial.) The court held that the 7^th Amendment jury trial right for “Suits at common law,” applies to such claims, despite plaintiffs seeking relief under ERISA’s provision for “other appropriate equitable relief.” The scope of the 7^th Amendment jury trial right is no simple matter, but the court in Yale University got it right, and in so doing protected a vital constitutional right.

The case involves the distinction between suits at “law” and suits at “equity.” Historically, the British courts of law split and shared jurisdiction with the “Chancellor’s court,” which heard equity cases. In law, claims were advanced seeking, predominantly, monetary damages. In equity, by contrast, courts typically awarded such remedies as injunctions and specific performance (in a nutshell, orders for people to take or refrain from taking certain actions). Although the Federal Rules of Civil Procedure merged law and equity into a single form of action, the distinction lives on in some states, most famously Delaware, where corporate law matters go to the Court of Chancery because they concern trusts.

The right to a jury trial depends on both the nature of the action and the nature of the remedy. In ERISA cases, the statutory action is undoubtedly equitable in nature. This makes sense, as Congress was consciously adopting portions of the common law of trusts. As Justice Antonin Scalia has explained, “appropriate equitable relief” means relief that was “typically available in equity” pre-merger. Monetary relief is permitted in such cases because it takes the form of surcharge, an equitable remedy consisting of an injunction requiring a fiduciary (like an employer) to pay for a loss that resulted from his breach. In most cases, plaintiffs sue because, for instance, the employer caused them to pay excessive fees to an investment firm or recordkeeper. But there is no segregated fund from which the funds will be collected; indeed, they are not even in the hands of the defendant. These are historical markers of equitable remedies: recovery from segregated funds unjustly obtained is equitable. Without those markers, the Supreme Court has held that monetary damages are legal rather than equitable, because they were not typically available in equity.

In sum, these cases present an equitable claim for relief, together with a remedy not typically available in equity pre-merger. While both the claim and the remedy sought matter for the 7^th Amendment analysis, the Supreme Court has made clear that the remedy is the more important. So ERISA cases seeking monetary relief against employers for money paid to third parties should be decided by juries; they seek legal relief, albeit under an equitable statutory right.

Until now, all courts before which the matter reached trial have (wrongly) rejected this conclusion. In general, these courts have read the Supreme Court’s precedent holding monetary damages to be legal damages narrowly, because that case dealt with a suit by a fiduciary against a non-fiduciary. These courts have instead applied the “previously available in equity” test strictly, holding that the collection sought in these cases is surcharge, an exclusively equitable remedy. These reeds are too thin, though, for the denial of a constitutional right, as the court in Yale rightly held.

So in Yale, score one for the defendants, who received the jury verdict, but score another for the Constitution, whose 7^th Amendment received some much-needed recognition.

Last Wednesday, July 12, an updated version of the Lummis-Gillibrand Responsible Financial Innovation Act (RFIA) became public. The updated RFIA, like its predecessor, looks to tackle crypto regulation comprehensively, covering in its 274 pages major topics including market structure, crypto exchanges, stablecoins, illicit finance, and taxation.

The proposal confronts the reality of longstanding legal uncertainty for American crypto market participants. Last week’s highly anticipated order in the case of Securities and Exchange Commission v. Ripple Labs, Inc., along with both the RFIA in the Senate and ongoing efforts in the House, all demonstrate that there’s still significant work to be done before the United States can credibly claim regulatory clarity for crypto.

The RFIA takes important steps toward providing more legal certainty to U.S. market participants, but on some of crypto policy’s most nettlesome questions there remains room for improvement. We offer our initial thoughts on the RFIA’s market structure, crypto exchange, and stablecoin components below. (Our colleague Nicholas Anthony covers the illicit finance and taxation portions in additional posts.)

Market Structure

One of the most hotly contested issues in crypto policy is the seemingly endless debate over whether and when a crypto token is properly considered to be a security or a commodity under U.S. law. The RFIA takes a swing at this issue by seeking to establish the concept of a crypto token as an “ancillary asset.” The idea is that while a crypto token may be sold pursuant to a type of securities transaction known as an investment contract, the token itself need not be considered a security.

Under the RFIA, the Commodity Futures Trading Commission (CFTC) would have exclusive jurisdiction over a crypto token that qualifies as an ancillary asset but not the “security that constitutes an investment contract.” To qualify as an ancillary asset, the token must not offer the holder any financial rights in a business, such as to debt or equity, liquidation, or interest or dividend payments.

The Securities and Exchange Commission (SEC), however, would have a role to play: where the average daily aggregate value of transactions in the ancillary asset exceeds a certain threshold and where the issuer engaged in “entrepreneurial or managerial efforts that primarily determined the value of the ancillary asset,” the issuer would be required to file detailed disclosures with the SEC. (Where the issuer certifies—and the SEC does not reject—that those efforts have ceased, disclosures are no longer required.) When the issuer complies with the disclosure requirement, ancillary assets owned by the issuer or affiliates will be “presumed” to be commodities and not securities. This presumption could be overturned by a court finding that an ancillary asset does confer a financial right.

Required disclosures to the SEC hinge on whether the issuer is engaged in relevant entrepreneurial or managerial efforts. This “efforts” language is familiar; the third prong of the Howey test for investment contracts asks whether the purchaser “is led to expect profits solely from the efforts of the promoter or a third party.” This element is frequently key to thinking about whether a crypto token should be treated as a security. One reason is that crypto technology allows token projects to develop such that the issuer’s efforts are no longer essential to the functioning or benefits of the project—in other words, projects can become decentralized.

The RFIA does not explicitly invoke decentralization when it comes to classifying crypto tokens as securities or commodities, but it implicitly grapples with the concept to some extent by incorporating the third prong of Howey. Perhaps for that reason, the RFIA’s co-author Senator Kirsten Gillibrand (D‑NY) told Yahoo! Finance that, at least in general, decentralization is relevant in determining a token’s legal character: “If it meets the Howey test, then it’s a digital security. If it does not, and it is fully decentralized and has the hallmarks of a commodity, then it’s a digital commodity.”

One benefit of the “ancillary asset” approach is that it potentially streamlines the token classification process. Nonetheless, as the RFIA’s effort to implement the approach demonstrates, it remains difficult in practice to avoid the “efforts of others” concept given the realities of existing (and convoluted) capital markets regulation and the characteristics of crypto. And in incorporating the idea of entrepreneurial or managerial efforts without further defining it—such as by more explicit reference to and definition of a decentralized token network—the current version of the RFIA leaves important questions unanswered.

Fortunately, one place to turn for such a definition—in addition to other proposals—would be the RFIA itself, which defines a decentralized crypto asset exchange (DEX). The RFIA largely defines DEXs as software where no person, or group of people agreeing to act together, can unilaterally control that protocol, including by altering transactions or functions. That’s a sound place to begin defining a decentralized token network as well.

In addition, distinguishing the token from the investment contract “arrangement or scheme” through which the token is offered or sold can leave questions about the investment contract itself. As noted above, under the RFIA, the SEC would retain jurisdiction over the investment contract. Yet the bounds of that jurisdiction are not clearly circumscribed. For example, would SEC jurisdiction over the investment contract be strictly limited to primary market token sales between the issuer and the counterparty, or could the SEC also extend its investment contract jurisdiction to secondary market token sales on theories related to the overall arrangement or scheme? Nothing about the SEC’s recent crypto enforcement activity suggests anything other than a willingness to aggressively assert, or expand, its jurisdiction. And the recent Ripple opinion, while containing important implications for secondary markets in crypto assets, expressly left open the question of whether secondary market token sales constituted offers and sales of investment contracts. If the RFIA envisions SEC crypto jurisdiction as covering only primary—not secondary—market token sales, it should say so unequivocally.

Exchanges

The RFIA contains provisions addressing both centralized and decentralized crypto asset exchanges. The bill requires any trading facility offering a market in crypto assets or stablecoins to register with the CFTC as a crypto asset exchange. Registered exchanges must both confirm that ancillary assets meet applicable disclosure requirements before they’re listed, as well as comply with core exchange principles, including safeguarding systems and customer assets, monitoring trading to provide an efficient market and prevent manipulation, and providing price and trade volume information.

While making important strides to define decentralized exchanges, as described above, the RFIA leaves somewhat uncertain their ultimate regulatory obligations. On the one hand, some sections regulate DEXs only indirectly by imposing risk management requirements on the centralized institutions that interact with DEXs, not the DEXs themselves. That registered crypto asset exchanges are subject to specific requirements regarding their interactions with decentralized crypto asset exchanges also suggests that the former (registered exchanges) does not necessarily include the latter (DEXs). Similarly, the RFIA defines a crypto asset exchange to expressly include a “centralized or decentralized platform” only for purposes of a tax provision, implying that the term crypto asset exchange is not generally meant to cover both centralized and decentralized platforms when used elsewhere in the bill.

On the other hand, by amending the Commodity Exchange Act’s definition of “trading facility,” which excludes systems that allow for bilateral transactions, to clarify that decentralized crypto asset exchanges that allow for multiple bids and offers to interact are distinguishable from such excluded systems, the RFIA suggests that at least some DEXs could be considered trading facilities subject to crypto asset exchange registration requirements. How exactly a DEX that enables trading pairs of crypto assets would mesh with this provision is perhaps open to interpretation.

Given these questions, the RFIA should make more explicit that disintermediated crypto exchange protocols are not subject to inapt requirements designed for centralized intermediaries.

Stablecoins

The RFIA would only permit “depository institutions,” such as banks, credit unions, and savings associations, to issue payment stablecoins (tokens redeemable on a 1‑to‑1 basis with instruments denominated in U.S. dollars). Notably, the RFIA would amend the definition of depository institution under the Federal Reserve Act to incorporate a category of “covered depository institutions” that includes non-banks exclusively engaged in issuing payment stablecoins and approved to operate by the Office of the Comptroller of the Currency (OCC) or a similar state authority. Under the RFIA, such OCC-authorized payment stablecoins would not be required to maintain federal deposit insurance.

It’s welcome when a bill allows for the operation of stablecoin issuers beyond federally insured depository institutions. Nonetheless, in giving federal banking regulators discretion to reject applications of prospective stablecoin issuers on the basis of subjective and open-ended criteria beyond basic reserve and disclosure requirements, the RFIA risks further constraining future payment services competition.

Concluding Thoughts

Providing clarity to crypto entrepreneurs, developers, and users in the United States remains a work in progress. Even with important case law evolving in the courts, Congress ultimately must provide a stable and practical framework for U.S. crypto policy.

A few weeks ago, American Compass released Rebuilding American Capitalism, A Handbook for Conservative Policymakers. This Forbes column (American Compass Points To Myths Not Facts) provided a very brief critique of the handbook’s “Financialization” chapter, and Oren Cass, American Compass’s Executive Director, released a response titled Yes, Financialization Is Real.

This Cato at Liberty post is the fourth in a series that expands on the original criticisms outlined in the Forbes column. (The first three in the series are available here, here, and here.) This post demonstrates the evidence does not support American Compass’s claims regarding investment. It also further documents American Compass’s failure to clearly specify terms and dates, as well as its selective use of examples that appear to support its positions.

To recap, the American Compass handbook states the following:

American finance has metastasized, claiming a disproportionate share of the nation’s top business talent and the economy’s profits, even as actual investment has declined.” [Emphasis added.]

As with profits, the “Financialization” chapter does not specify a single preferred measure of investment or any time frame for analysis. It simply complains that “In recent decades…actual investment has declined.” [Emphasis added.] The original critique stated, “The claim that investment has declined is also easily verified as false,” and then used National Income and Product Account (NIPA) data to show “investment in fixed assets has been steadily increasing since 1970, a trend that holds even if the data is adjusted for inflation.”

Cass takes issue with the original critique’s use of absolute investment dollars rather than investment as a share of GDP. Cass’s response states:

Of course, investment rises in absolute dollars as the American population grows and economy expands. Who would claim otherwise? The question is what has happened relative to GDP.

Yet, American Compass uses the term actual investment in the introduction to the “Financialization” chapter and purposely uses aggregate data in levels when doing so suits its purpose. But importantly, American Compass fails to settle on any definition of investment.

Here’s a list of direct quotes describing investment from the “Financialization” chapter:

• Unfortunately, in the United States, productive business investment has been in long-term decline and the financial industry now specializes in trading assets around in circles. [Emphasis added, no dates given.]
• Economy-wide, business investment has fallen significantly as a share of GDP. [Emphasis added, no dates given.]
• They instead become savers themselves by acquiring financial assets, effectively deferring the earthy and material work of productive capital investment to others. [Emphasis added, no dates given.]
• Statistically, this transition began in the 1980s, as the share of corporate investment in tangible assets declined and the acquisition of financial assets climbed. [Emphasis added.]

Despite this ambiguity, Cass’s response insists that readers should know exactly what investment data American Compass’s handbook is referring to because “the Rebuilding American Capitalism handbook is a synthesis of our analysis and recommendations and provides copious references to further reading alongside each proposal.” So, here’s a list of direct quotes from two other American Compass reports, none of which provide a clear answer:

• Actual-investment, by which I mean the allocation of capital toward the development of new productive capacity—the building of structures, the installment of machines, the creation of intellectual property—has been weakening in America for decades now. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• As non-investors have overrun the banks and markets and taken control of corporations, actual-investment has slowed. The nation’s capital base is smaller by literally trillions of dollars as a result, representing untold enterprises never built, innovations never pursued, and workers never given opportunity. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• Net non-residential fixed investment as a share of GDP has fallen by almost half, from 4.1% in the 1970s and 80s to 2.5% in the 2010s. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• The classic categories of investment, structures and equipment, account for 87% of the nation’s capital base and the rate of investment there has been declining in both gross and net terms. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• Net investment as a share of value-add averaged 4.3% during 1998–2000 and then 0.5% during 2002-04. During 2000–17, the average was 2.2%, leading to a $1.0 trillion shortfall over the period, relative to the 1970–99 rate. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• As we have seen, the cumulative gross investment shortfall during 2009–17 as compared to 1970–99 amounted to $3.4 trillion. [Found in “The Rise of Wall Street and the Fall of American Investment“ – emphasis added.]
• Nationwide, net investment as a share of GDP has fallen sharply, and the shortfall since the Great Recession totals roughly $3 trillion (equivalent to the excess outflow from public companies). [Found in “Confronting Coin-Flip Capitalism“ – emphasis added.]
• This creates a vicious cycle in which business leaders pursuing promising opportunities become harder to find, further encouraging the financial sector to develop strategies for deriving profits disconnected from actual investment. [Found in “Confronting Coin-Flip Capitalism“ – emphasis added.]
• From 2009 to 2017, the nation needed $22.9 trillion in gross investment to match the average growth rate of the capital stock during 1970–99 (3.8% of GDP annually). Instead, investment totaled only $19.6 trillion. [Found in “Confronting Coin-Flip Capitalism“ – emphasis added.]
• Even the market fundamentalists—indeed, especially the market fundamentalists—recognize that higher investment levels would be beneficial. [Found in “Confronting Coin-Flip Capitalism“ – emphasis added.]

Setting aside American Compass’s failure to explain whether any of these versions of investment is its single preferred measure of investment to study “financialization,” it is true that there are many ways to describe investment. Indeed, there are even many different time periods, inflation adjustments, aggregation issues, and sub-components of investment that influence how an aggregate investment series behaves.

Moreover, if investment (however defined) declines, or declines slower than some metric, that fact alone would not be evidence that investment is less than optimal. While many American Compass reports imply investment is suboptimal, American Compass has not provided evidence that investment is less than what it should be.

Take, for instance, American Compass’s claim that “Net non-residential fixed investment as a share of GDP has fallen by almost half, from 4.1 percent in the 1970s and 80s to 2.5 percent in the 2010s.” If American Compass believes that that 4.1 percent was the optimal share in 1970, and a 1.6 percentage point lower share in the 2010s “threatens our future prosperity” and requires America to rebuild capitalism, then the least it can do is state a clear hypothesis and make an empirical case. Such critics cannot simply argue that a lower number is less than optimal. (For what it’s worth, American Compass’s “The Corporate Erosion of Capitalism“ also fails to provide such evidence – it is merely an accounting exercise without any economic analysis of the optimal levels of real investment individual firms need to sustain their own operations.)

It turns out, though, that the long-term trend in most of these investment measures is not decreasing. The only way to show that “investment” has declined is to selectively define the measure and period for analysis. Otherwise, it is impossible to say that investment has declined.

Regardless, there is no inherent economic reason that investment, whether in absolute amounts or relative to GDP, whether net or gross, or real or nominal, must constantly increase. A developed economy with evolving working patterns, for instance, would not need to constantly invest more in new corporate structures.

Similarly, the rate of growth of investment does not have to constantly match or exceed GDP (or profit) growth in any historical period. The mere fact that some metric of investment grows slower than some other economic measure – even for an extended period – does not indicate that the economy will be harmed much less that “financialization” caused the “slow” growth.

Our analysis now turns to the actual time series of real investment and real GDP, respectively (see Figure 1 and Figure 2). Contrary to what Cass claims in his response, the right question is not always “what has happened [to investment] relative to GDP.” (Even if it was the correct question, simply dividing investment by GDP would not adequately account for confounding factors such as population growth, the cost of investment, productivity, feedback loops, etc.) Bluntly, it is not at all clear that using a relative measure is the “right” way to look at investment.

For starters, nobody invests in amounts relative to GDP, and even American Compass often refers to levels of investment. Regardless, there are some basic mathematical issues that suggest, at the very least, researchers must be very careful drawing inferences from relative investment measures.

As Figure 1 and Figure 2 show, real (gross private domestic) investment and real GDP both display a sharp upward trend. However, the two series exhibit an enormous difference in size and volatility – the standard deviation of investment growth is five times greater than for GDP growth. A 20 percent year-to-year decline in investment is normal, but it would be highly unusual for GDP. Moreover, any decline in the ratio can easily mask the causal relationship between investment and economic growth.

Put differently, GDP is stable but one of its components – investment – fluctuates rapidly. This stability arises as investment accounts for only 13 percent of GDP on average and fluctuations in investment can be offset by counter-cyclical fluctuations in other components of GDP, such as consumption or fiscal spending. Consequently, measuring investment relative to GDP can give the appearance that something dreadful has happened even though such deviations may be the result of a perfectly normal economy, even one with optimal decision making.

Investment’s high volatility is a commonly known macroeconomic fact. Benchmark macro models dating back to the start of macroeconomic modeling itself have highlighted investment’s significant volatility in comparison to the rest of the economy. Successes of models since then are measured (at least in part) by whether their simulated time series can match the observed volatility of macro indicators such as investment.

Leaving the appropriateness of using levels aside, we now examine nominal investment relative to nominal GDP (i.e., the investment-to-GDP ratio), as well as several of its component measures. (See Figure 3.) These nominal metrics are available from 1929, but in fairness to American Compass, we only present the data from 1950 onwards. The series exhibits high volatility between 1929 and 1950 and starting the graph in 1929 biases the data toward a steeper increasing trend for investment and its component measures. (Incidentally, replicating Figure 3 with real investment and GDP figures also shows the ratio exhibiting an increasing trend.[1])

As Figure 3 shows, the investment-to-GDP ratio exhibits variation around a very mildly increasing trend for all of modern U.S. economic history. As for component measures, non-residential investment has grown significantly as a share of the economy, offsetting the decline in the share of residential investment. Finally, net private domestic investment has declined over time. From this set of investment measures, focusing only on net private domestic investment to argue “actual investment” has declined equates to selectively using a sub-component of investment while ignoring others.

Of course, there are still many other ways to describe investment. Assume, for example, that net nonresidential (or business) investment is the “right” measure to analyze, as Cass’s response suggests. Figure 4 presents real net business investment and its subcomponents from 1967 to 2021.[2] It shows that net business investment exhibits a sharp increasing trend. (Figure 3 showed that nonresidential investment as a share of GDP exhibits an increasing trend.) While the trends are not as steep for the subcomponents, Figure 4 shows that net investment in business equipment and intellectual property also display increasing trends. However, net business investment in structures exhibits a decreasing trend. (Interestingly, in The Rise of Wall Street and the Fall of American Investment, American Compass groups structures and equipment together to demonstrate that investment in “Structures & Equipment” is declining.)

Obviously, it would make little sense to argue that “actual investment” is declining by focusing only on the decline in the net structure subcomponent, or any other component of investment for a shorter period. Put bluntly, American Compass is incorrect to use declines in any of these subcomponents to argue that there is some kind of broad decline in investment.

Still, the trends in these subcomponents on Figure 4 are even more problematic for American Compass. Not only do the trends contradict that investment is in a general decline, but American Compass’s story requires an explanation for: (1) why the highly developed U.S. economy needs constantly increasing growth in structures; and, (2) how “financialization” is responsible for a decline in structure investment and a simultaneous increase in equipment and IP investment.

It is also worth noting that while there’s nothing inherently wrong with using net investment figures, as American Compass sometimes does, neither the Bureau of Economic Analysis’s depreciation estimates nor accounting depreciation perfectly coincide with economic depreciation. In other words, even when someone fully depreciates a piece of equipment for tax or accounting purposes, it does not mean that the equipment is no longer useful and must be immediately replaced.

More generally, from a macroeconomic perspective, there is no reason to distinguish between different sub-components of investment. The primary macro indicator of economic health is real GDP growth away from trend (or similar metrics such as output gap and unemployment). Investment is a means of facilitating capital accumulation and it is not immediately clear why one component of it is necessarily better than any other. This is why seminal empirical economic papers always focus on investment as an aggregate. Even highly cited papers that explicitly model net investment don’t bother to include it in their results, instead focusing again on aggregate investment.

Overall, aggregate investment in the United States is not in decline. Yet, American Compass relies on a wide array of investment descriptions, in various time periods, to argue that American investment is in a general decline and below optimal levels. American Compass’s error is only compounded by its imprecise definition of financialization. This combination of errors leaves American Compass with little more than a set of stories that appear to provide evidence financial markets threaten American capitalism.

In the next post, we will conclude this series by discussing American Compass’s flawed characterization of Americans’ income.