THE KEY PROBLEM OF OUR ECONOMY: POLITICAL MISALLOCATION OF CAPITAL

If a Republican wins in 2012, and if the economy doesn’t markedly improve by 2016, a Democrat (quite possibly Hillary) will almost certainly win in 2016.

What would it take for the economy to markedly improve by 2016? To understand that, one needs to understand elementary classical (Austrian) economics. The fundamental problem is that governments, both in the US and around the world, have politically misallocated tens of trillions of dollars of capital to economically lower valued uses because these uses were of higher political value.

Wasting so much seed corn year after year, decade after decade, has inevitably resulted in progressively leaner harvests.

Unfortunately, this extensive capital misallocation is being done by many different methods and the misallocated capital is going to many politically favored groups, so there is no one silver bullet that will fix the mess. A partial list:

1) Negative interest rates for the politically favored:  after including inflation, the Fed’s 0-0.25%interest rate means that those who are politically favored with these low rates are being paid by the rest of us to borrow money. As any classical economist will tell you, below market interest rates mean that capital will inevitably be wasted by being misallocated to consumption and to less effective production and to excessively long and complex production — e.g., Solyndra.

2) Capital is being politically allocated by mandates and subsidies — e.g., Perry’s Renewable Portfolio Standards, and Solyndra.

3) Capital is being wasted by innumerable laws, rules, and regulation. The Federal Register publishes about 85,000 pages of new rules and regulations every year – all of which have been created by bureaucrats and given the power of law by simply publishing them – and none of which have been voted on by Congresscrooks, whom the electorate can hold politically responsible (at least in theory).

4) According to an OECD study, the US tax system is more progressive than that of any OECD member, including social welfare states such as France and Sweden, Of course, the more progressive the tax system, the more it removes capital from the hands of those who earned it and who know how to make it grow, and transfers that capital to politically directed consumption and "investments".

5) The US income tax system is almost alone in the world in that it requires business capital expenditures to be depreciated over a period of up to 41.5 years rather than deducted when paid for (expensed).

Allowing unlimited expensing of all business investments would have a huge beneficial effect on the economy because it would immediately increase the return on invested capital. It would fix the housing market, the upside down mortgages problem, enable new factories to be built is the US, and cause a durable capital goods boom.

This is one of the few simple changes that would have a major economic benefit, but class warfare and the politics of envy stand in the way because the most obvious benefits would be for relatively rich investors — the benefits of lower rents and lower other costs for the poor are more difficult to see, though just as real.

A recent (9/30) survey of bank risk managers predicts that there will be no rise in home prices until 2020.  The solution to this enormous drag on household wealth would be to allow landlords to expense their rental housing investments instead of requiring that they be depreciated over 27.5 years. This would make such investments much more profitable, thereby raising the value of all homes dramatically.

Unlimited expensing of all business investments would provide many of the benefits of a pure consumption tax because it would allow the investment of pre-tax rather than post-tax earnings. Unlike the "Fair Tax" which is terribly unfair to those who have savings on which they have already paid taxes by double taxing those savings and investments, allowing unlimited expensing would not transfer 23% of all extant savings and investments to the central government.

Another grave danger of the "Fair Tax" as currently proposed is that it would greatly reduce the value of all rental housing investments (new and old), as it would apply to all rents (even those from old houses) but not to the sale of a used house. This tax law, if implemented, would cause a huge market distortion by favoring home ownership rather than renting.

The magnitude of this "Fair" Tax investment distortion would far exceed that caused by Fanny Mae, Freddy Mac, sub prime and alt-A loans, the mortgage interest deduction, and the Community Reinvestment Act combined. That would be an immense capital misallocation – one even bigger than those that caused the collapse of 2008!

The "Fair" Tax as written would misallocate many trillions of dollars of capital away from rental home investment and towards owner occupied housing. The latter promotes labor immobility and exposes unsophisticated homeowner investors to risks that they are ill equipped to deal with in an adequate manner.

6) Both the US dollar and the Euro are fiat money and are nearing a very ugly tipping point. Worse yet, the large scale use of hard money in competition with fiat money is effectively crippled by tax laws.  Ron Paul’s Free Competition In Currency Act (HR 1098) could solve this problem, which is one of the few with potentially relatively simple solutions.

7) Tens of trillions of dollars of real estate, oil, gas, and minerals are "owned" by the Federalies and rarely put to beneficial use, and even then in a generally grossly wasteful, unresponsive, and unnecessarily expensive manner.

8) Tens of trillions of dollars that would have been saved and invested for retirement have been diverted at gunpoint to politically directed consumption by the Social Security and Medicare Ponzi schemes. Note that there is a relatively simple (though politically radical) solution to both #7 and #8: Cutting Three Gordian Knots (TTP, July 2011).

9) Crony "capitalism" causes more than astronomical misallocation of capital. Read the GAO report on the Fed’s 17 trillion dollar goodie bag – and that is just for 2008 through 2010:  the Fed’s loans, and the GAO Fed audit.

More than astronomical? As Nobel physicist Richard Feynman pointed out, these government expenditures are greater than astronomical because there are only about 100 billion stars in a large galaxy.

For more on crony "capitalism" from a politician with a track record of stomping on it, see here and here.

10) There is far more, but I have to get back to doing the 2010 income taxes for my three businesses which are due Oct. 16.

The 2012 bottom line is this:

If we elect a Republican President who doesn’t understand the political capital misallocation causes of our economic problems and tries to fix them with more of the same, he will become the new Hoover – and Hillary (or worse) will become the new FDR in 2016. Anybody But Obama isn’t a viable plan or desirable outcome.

Skye is the TTP Forum’s resident genius.