Why Higher Taxes Can't Trim the Deficit

Huge federal-government deficits that are financed by borrowing lead to high interest rates and a strong dollar, thus depressing investment and economic growth, right? And if we just raise taxes to cover those deficits—thus keeping the government from competing for borrowed money and consequently driving up interest rates—then everything will be okay, right? That's what big-spending, big-taxing folks in politics are saying these days. But a recently released US Treasury Department study, three years in the making, shows that what really dampens private-sector activity is government spending, no matter how it's financed.

Paul Craig Roberts, a former policy advisor in the Reagan administration, devoted a recent Business Week column to pointing out the significance of the Treasury study. "The study," Roberts reported, "finds that government spending crowds out the private sector regardless of whether the spending is covered by taxing or borrowing." And the conclusion, he noted, is "that the only certain way to curtail crowding out is to curtail government spending." Indeed, the evidence indicates that "the depressing effects of higher taxes on economic growth would widen the deficit" instead of improving the situation.

Roberts also cited another recent study, by University of Chicago economist Roger Kormendi, that supports the Treasury study's conclusions. Published in the December issue of the prestigious American Economic Review, Kormendi's study "finds that government spending and transfer payments result in lower private spending and reduced economic growth," Roberts reported. So "to respond to a budget deficit by raising taxes," Roberts observed, "does nothing to reduce the real problem—the spending itself—but does reduce private savings further."

The significance of the point Roberts and others are trying to convey will surely be lost on—or ignored by—a good number of our public servants. But at least the data are out there and being talked about—and eventually, perhaps, will be reckoned with.

Spelling Relief Privately

It's no secret that many government foreign-aid programs for the Third World do more harm than good. The aid ordinarily comes with political strings attached, it is frequently diverted to repressive local elites, and it is often ill adapted to the recipient nation's culture and economy. It's no wonder that even left-oriented analysts such as Frances Moore Lappe have added their voices to those of such free-market analysts as P.T. Bauer in calling for an end to foreign aid flowing from Western governments to less-developed countries.

But there is an alternative that has been able to avoid the pitfalls of government aid—private foreign-aid organizations. According to a recent New York Times article, there are currently at least 500 nonprofit organizations involved in development assistance for other countries. Because they are relatively free of government constraints, these private voluntary organizations, or PVOs, can be innovative in ways that government programs can't—and they can do it with far less money.

One such PVO described by the Times is Partners of the Americas. Created by the government in 1964 but switched to the private sector in 1970, it fosters partnerships between citizen groups in 46 states in the United States and 28 Latin American and Caribbean countries.

For example, the Utah-Bolivia partnership has built 117 village schools in an Andean plateau, thanks to the labor of Bolivian villagers and a fundraising campaign by fifth- and sixth-graders in Utah. The Vermont-Honduras partnership is teaching 15 Honduran subsistence farmers about contouring, crop rotation, organic fertilizers, and other simple technologies, with each of the Honduran farmers promising to teach the techniques to four neighbors. And the Wisconsin-Nicaragua partnership is sending medical supplies to Nicaragua and sponsoring a food-preservation project that uses low-cost solar dryers.

All told, Partners of the Americas is sponsoring some 1,300 projects annually. In contrast to the lavish appropriations distributed by government bureaucracies, most of the Partners projects operate on grants of $5,000 or less.

PVOs are often able to work in areas where the US government is not welcome. Joseph Curtin of Catholic Relief Services, which operates in Lebanon, told the Times: "As a foreign private organization, Catholic Relief Services can be completely neutral, serving everyone, both Christians and Moslems, and accepted by all. Furthermore, we can provide an American face other than that of the U.S. military and political presence."

In some respects, however, the relationship between PVOs and the government has become uncomfortably close. Because of the PVOs' successes in getting assistance to people who need it most, Congress has in effect contracted out foreign-aid programs for nations such as Haiti and Zaire, channeling aid funds through PVOs. And 1983 reports indicate that 167 PVOs registered with the government's Agency for International Development (AID) were receiving $731 million worth of government support, compared to a little over $1 billion in private contributions.

With extensive reliance on government money, the PVOs face the danger of becoming an appendage of the government's foreign-aid establishment. But so far, the private organizations have an impressive record of independence and accomplishment. Moreover, they provide a valuable lesson in the advantages of voluntary over government-run charity.

Prescriptions for Healthier Markets

Not all ads are created equal. For years, the Federal Food and Drug Administration (FDA) has required that prescription-drug advertisements (unlike advertisements for aspirin, cookies, or parachutes) must include extensive warnings about any possible side effects. Since nearly every drug has side effects, and since listing side effects for even the most useful drugs could well take up a magazine page or 10 minutes of air time, there has been almost no such advertising aimed at consumers (as opposed to extensive, detailed ads aimed at doctors).

Now that may be changing.

The changes are coming about because of old loopholes in FDA rules. An ad can circumvent the requirement to list side effects if it doesn't mention a specific drug by name or if it doesn't give any information about what the drug does.

As narrow as those loopholes may be, a handful of pharmaceutical firms now are creatively taking advantage of them. Business Week reported in May that Pfizer Pharmaceuticals, which manufactures the diabetes treatment Diabinese, has been running television ads suggesting the wisdom of being tested for diabetes. There is no mention of Diabinese in the ads, but since the commercials started running in 1983, it's estimated that Diabinese sales have gone up by 15.4 percent. Meanwhile, Boots Pharmaceuticals has offered a $1.50 coupon for an anti-arthritic drug and, in Tampa, has advertised its relatively low price but not what the drug is for. And Ciba-Geigy has applied to the FDA for permission to advertise an antihypertensive drug.

Interestingly enough, the impetus for change has not come from major American pharmaceutical companies. Although Merck & Co. has made a foray into magazine advertising for one of its products and companies are running ads aimed at professionals, William Castagnoli, president of a New York advertising agency specializing in medical advertising, told REASON that many of the larger firms are reticent to advertise drugs directly to consumers. Indeed, at a Washington conference earlier this year, representatives of Upjohn and Lilly stated outright that they much preferred marketing prescription drugs to "informed third parties"—that is, doctors.

Castagnoli explained that advertising directly to consumers would "revolutionize" marketing practices, and many of the large companies don't want the disruption. "Their marketing machinery is set up for health professionals," he said. "They have highly trained people dealing directly with doctors, and they don't want to shell out another $10 million for ad campaigns to the public." He pointed out that the two companies most eager to go beyond FDA proscriptions are Boots, a British-owned company, and Ciba-Geigy, based in Switzerland.

Federal officials are unsure how to respond to the pressure to open up the advertising market. The FDA is currently trying to devise new guidelines, and in 1983 the agency imposed a moratorium on advertising prescription drugs to the public until the new policy is issued. Moreover, a House subcommittee chaired by Rep. John Dingell (D–Mich.) is planning hearings on prescription-drug advertising—but as of May, no legislation regulating the advertising is in the hopper.

The pressure for giving advertising freer play in the market may be irresistible. Washington will no doubt moan and propose, but it may turn out to be a case of the tail wagging the dog.

Driving Out Taxi Regulation

What's a city to do—or, to be specific, what are New Orleans and Minneapolis to do, now that the Federal Trade Commission has started up legal proceedings against the two cities on grounds that their taxi regulations violate the federal antitrust laws? Tim Muris, director of the FTC's Bureau of Competition, thinks the cities ought to deregulate their taxi businesses—and that other cities with anticompetitive taxi regulations should take heed, as well.

The FTC's action is its first antitrust move against city governments since the 1982 Boulder decision, in which the Supreme Court ruled that local governments are subject to the federal antitrust laws. Over the past two years, private parties have increasingly assailed the anticompetitive and trade-restraining practices of local governments in the courts, but up until recently the FTC had kept its nose out of the fracas.

According to the commission, the governments of both New Orleans and Minneapolis conspired with cab companies to restrain trade. The specific acts of restraint include rate regulation, limits on the number of cabs allowed to operate, and prohibiting suburban-area cabs from operating within the city.

(Shortly after the FTC announced its proceedings against Minneapolis and New Orleans, the House approved an appropriations-bill amendment to restrict federal agencies from using funds in antitrust actions against cities. Just days later, the Senate Appropriations Committee approved a similar measure, which is expected to encounter great opposition in a full Senate vote. James Miller, chairman of the FTC, protested the House vote, calling it "an initiative to achieve a special interest exemption.")

If Minneapolis and New Orleans "did not have the challenged regulations," the FTC statement charged, "consumers would have more taxi service at less cost and with less waiting time." Muris estimates that deregulation would save consumers hundreds of millions of dollars and would create as many as 232,000 new jobs.

But there's more than one way to fight city hall on taxi regulation. And in Houston, it's the civil disobedience of Alfredo Santos, a 31-year-old graduate student who has started up an illegal pesero, or jitney service.

Santos uses a leased Yellow Cab to run a five-mile route through Houston, picking up passengers along the way who flag him down, for $1.00 per ride. Because Santos both solicits customers (including some who are waiting for city Metropolitan Transit Authority buses) and disregards the city's rate requirements for cabs, his operation violates Houston ordinances. So city authorities are out to nail him—even though Santos's customers appear to be quite satisfied with his service. The $1.00 fare is twice the city-bus base fare but is significantly lower than what regular taxis charge, and Santos's service is much faster than the bus.

Though MTA officials and Houston transit manager Antonio Montelongo are intent on rounding up the transit outlaw, Santos appears to have an ally in city government—one George Greanias, a city councilman who is pushing to reform the city's transit ordinances to allow, among other things, jitney services like Santos's. Of city officials' announced vow to nab Santos, the civil disobedient told the Houston Post "They can try to stop me if they please, but I have no intention of stopping the pesero voluntarily."

Hollywood Happy Over Hot Vid Biz

Videocassette fever is sweeping America, and it looks as if just about everybody is cleaning up. That includes the Hollywood moviemakers who not so long ago feared that booming video sales would seriously depress movie-theater attendance. Anticipating economic gloom, Hollywood's knee-jerk reaction was to seek (unsuccessfully, so far) legislation to control and regulate the video market. That effort is waning, however, now that the studios are beginning to see soaring dividends from the video revolution.

Just five years ago, movie producers earned only negligible income from selling their own videocassettes (or licensing others to make cassettes of the studios' movies), but last year's income from that source reached $625 million—13 percent of Hollywood's total revenues for the year. The nation's 12,000 video dealers, the storefront shops that both rent and sell cassettes (and that hardly even existed five years ago), also did a bang-up business last year, renting out 150 million cassettes and selling 8 million.

Far from depressing attendance at the theaters, video sales and rentals appear to stimulate the public's movie-going interest, on which consumers spent $3.7 billion last year. Theater owners are still somewhat jittery about the effect of home video viewing on movie attendance—by year-end, home videocassette recorders, the machines that play the cassettes on a TV set, are expected nearly to double in number from the 9 million units now owned by Americans. (VCR sales may have gotten a boost by the Supreme Court's ruling, in January 1983, that home videotaping of TV fare does not violate copyright laws.) But some theater owners are themselves catching the fever and are selling videocassettes in their lobbies (a tactic used by X-rated theaters for years).

Best of all, consumers are profiting from all the hustle of the unfettered video market. Because moviemakers get no cut of video dealers' income from cassette rentals, the studios are instead pushing video sales. And they're going about it in the old-fashioned way: by cutting prices and aggressively marketing their wares. For instance, while the average movie cassette has been going for $80 to $90, Paramount has been selling some of its biggest hits—including An Officer and a Gentleman, Raiders of the Lost Ark, and Flashdance—for $39.95. The studios are making it easier for customers to buy the cassettes by distributing them through supermarket and discount-store chains, as well as through specialty video shops and record stores.

And the competition among video-rental outlets is so keen now that in some places rental fees are as low as $1.00 per night.

There are bound to be some losers in the fight to satisfy consumers—cable movie networks, like Home Box Office, for example, may lose something to the videocassette competition. But, as they say in Hollywood, that's show biz (or, for that matter, any biz).

Consumer Control, the New Prescription

Can consumers make sensible decisions regarding the use of medical drugs? The federal government thinks not, so we have the Food and Drug Administration and a host of controlled-substance laws to see to it that we can't make those decisions for ourselves. But that rationale for drug regulation—if it ever made sense—is looking ever shakier thanks to low-cost computer technology.

In a chapter from Pharmaceuticals in the Year 2000 (published by the Alexandria, Virginia–based Institute for Alternative Futures), James Turner discusses how access to computerized health information enables consumers to make more-informed health decisions, thereby bringing into question the present style of drug regulation. Because such specialized information is increasingly available to consumers, individuals are in a better position to assess the risks of pharmaceutical use and decide for themselves which risks are worth taking. "The more information that is available," writes Turner, "the less need there is for intrusive government regulation." (This is an especially interesting thought coming from the author in 1970 of the "consumerist" work The Chemical Feast: The Nader Report on the Food and Drug Administration.)

Turner predicts a rapid increase in consumer medical software, "precisely because consumers will be able to purchase [these] new technologies without the government approval required for pharmaceuticals or other devices." And if consumers seek more information relevant to making health decisions, product manufacturers will respond to this demand, suggests Turner, and this will push government regulatory efforts toward increasing information and away from product regulation.

"By making it possible for any number of users of a particular drug to be systematically followed," Turner writes, computers can "greatly improve the existing adverse-reaction reporting system" (whereby individuals' bad reactions to specific drugs are reported to a central data bank). And within such an environment, "the government no longer has the authority (if it ever did) and we can no longer afford (if we ever could) to deprive the entire population of access to products or opportunities that might be harmful or less than optimal to some portion of the population."

Describing that approaching environment, Turner envisions an independent organization like Consumers Union that, through an extensive computer communication network, would "report on adverse reactions, do so by brand and type comparison, and also look at drug overlap and drug misuse."

Already there is developing a consumer-oriented network of health and medical information, though not yet as sophisticated as the situation that Turner foresees. In San Francisco, for example, the Planetree Health Resources Center has collected a substantial library of health literature—some 1,500 books and numerous indexed clippings—geared toward the layman. Anyone curious about a specific health problem can mail $5.00 to Planetree, and the organization will send the person an 8- to 10-page packet of information on that particular problem.

And last year, Prevention magazine publisher Richard Rodale started up the People's Medical Society (PMS), a 40,000-member organization that Esquire described as "a medical Better Business Bureau designed to help consumers choose their doctors knowledgeably." The society's goal is to provide its members with information about specific physicians and medical facilities, on a nationwide scale. After every visit to a physician or health-care facility, PMS members fill out a questionnaire and mail it to the society. The society keeps files on these doctors and facilities, and members can call the society for information about a particular doctor (or hospital, etc.).

The society encourages physicians to join, asking them—but not as a membership requirement—to sign a pledge not to prescribe unnecessary treatments and to do everything to help patients take care of their health by themselves. Those physicians who do sign the pledge may display the society's sticker for patients to see.

The computerization of information services like those of Planetree and PMS may ultimately mean that consumers can resort to informed choice, rather than governmental regulation, as their best defense in the medical marketplace.

Shedding Light on Regulation

Economic truths have a way of piercing the myths that insulate them, eventually to reveal themselves—often with a shock. One such truth concerns the follies of electric-utility regulation, an issue that's becoming a real live wire.

In a recent cover story, Business Week charted the emerging debate—and shift in thinking—over the electric utility industry. As financial woes descend upon the utilities—many of which had not anticipated the falling growth rate of electricity demand and consequently over-invested in costly new plants—more and more analysts are pointing to regulation as the real culprit.

Because the regulators set utility rates based on costs plus a specified return on investment (a state-approved and -guaranteed profit, that is), "the only way utilities could add to profits was to add to their rate bases—and that meant build or stagnate," Business Week noted. Typically, then, utilities pushed through multibillion-dollar nuclear-plant projects, proposed and approved before the 1979 Three Mile Island accident, which led to greater regulatory scrutiny—and costly delays and interruptions. But utilities can pass on these costs to consumers, in the form of higher rates, only when the plants go into operation—another incentive to keep projects under way rather than abandon them. Anticipating these perverse effects, Nobel-laureate economist George Stigler told REASON Contributing Editor Tom Hazlett in an interview last year: "The total cost of electricity in the United States is going to be higher 10 years from now than it would be in the absence of regulation."

But consumers have wised up and are agitating against both new utility investments and the system of passing costs on to customers automatically. As a consequence of these mounting financial and political troubles, investors and lending institutions are shying away from the utilities.

Moreover, some critics of the cost-plus system are probing further into the regulatory structure, calling into question the long-established practice by which regulators grant utilities monopoly status based on the idea that electricity production and distribution is a "natural monopoly"—that is, the idea that within a specific market (a city, for instance), only one company can provide the service profitably, so the state must grant one provider an exclusive franchise and then regulate its rates.

"Just as technological breakthroughs made it possible to break up the telephone monopoly," Business Week reported, "some experts believe the technology is now available to begin ending the monopoly of the electric industry, at least at the power generation stage." Indeed, William Berry, chairman of Virginia Electric & Power Co., told the magazine: "We ought to consider the idea of a deregulated industry."

To test the waters of at least partial deregulation, the Federal Energy Regulatory Commission in December approved a two-year experiment in which four utilities may shop the market for wholesale power. They're allowed to keep a quarter of any savings they thereby make.

Dismantling a regulatory system that's been around since the '20s will certainly be more than an overnight task. But at least some of the players are beginning to see the light.


• Worth a try. Notwithstanding its employment of the Orwellian notion that a tax break constitutes a "subsidy," the New York Times sensibly suggested in a recent editorial that enterprise zones "deserve a test." An enterprise-zone bill has already passed the Senate and must make its way through the House to become law.

• Higher taxes axed. Cleveland and Cincinnati voters defeated measures to raise their cities' income-tax rates from 2 to 2.5 percent.

• Myth demolition. Gentrification—upper-and middle-class families moving into depressed neighborhoods, renovating homes, and boosting property values—again comes off well, this time in a study by the New York City Planning Department. In two Manhattan neighborhoods where extensive gentrification has occurred, the study found housing conditions had improved, deterioration had been reduced, and the city's tax base had increased through strengthened commercial districts. Moreover, while there was some displacement of poor residents because of gentrification, other poor residents moved because of not enough gentrification—their part of the neighborhood was continuing to decline.

• Threadbare union suit. In April, the Supreme Court ruled unanimously that when a union collects compulsory dues, it may not use a member's dues to pay for general organizing efforts if the member objects. Moreover, the union may not use the money, over the member's opposition, for litigation costs unrelated to bargaining.

• The ICC man cometh. Some powers of the Texas Railroad Commission, which has refused to cooperate with federal railroad deregulation, are being derailed. The Interstate Commerce Commission announced in April that it is displacing the state agency's regulation of intrastate railroads in Texas.

• Letter perfect. Rep. Bill Green has proposed that the Postal Service monopoly be ended in districts where mail service has been particularly lousy. "Surely, if it cannot deliver, the Postal Service should not object if we seek someone who can," the Manhattan Republican wrote in the New York Times. The Green proposal would, of course, permit free-enterprise mail for his constituents in Manhattan.

• Bluenoses broken. On May 1, Indianapolis mayor William Hudnut, a professional minister, signed an ordinance making pornography a violation of women's civil rights. An hour later, the ordinance was challenged in federal court. And on May 9, a federal district judge issued a preliminary injunction prohibiting enforcement of the ordinance until the suit is resolved.

Global Trends

Creeping Privatization of Social Security

BRAZIL—The government-run social security system in Brazil is supposed to provide both health insurance and retirement pay. But the near-bankruptcy of the system is encouraging entrepreneurs to carve out a new market for themselves in both areas.

Since 1977, several banks, insurance companies, hospitals, and a host of smaller companies mostly owned by groups of physicians have offered health-insurance plans to individuals and groups. Practically all large and medium-sized enterprises have contracted with these private companies to provide medical care for their employees, and smaller enterprises are gradually adopting similar plans. By last year, 3 million Brazilians—2.3 percent of a population of 128 million—were covered by private health insurance. In addition, several hundred thousand individuals who are not satisfied with their company's insurance plans or wish to supplement them, or who are self-employed, have bought private plans.

The growth of private health insurance is understandable. The government system is a fiasco, and although everyone pays into it, large sections of the middle and upper-middle class say they never use it.

The social security system was created by fascist dictator Getulio Vargas, "the friend of the working man," who ruled Brazil between 1930 and 1945. It was later expanded by conservative and social-democratic governments. Employees' "contributions" to the system have risen from 6 to 10 percent in the last decade, with another 10 percent coming from employers. Calls for raising this level even higher have fallen on deaf ears. But when economist Paulo Rabello de Castro, a former student of Milton Friedman's, proposed total privatization of social security, his suggestion was violently condemned. Still, the system as it has been in the past is withering away.

Its decline is accelerated by the fact that since 1981, several banks and insurance companies have offered a variety of retirement plans, partially spurred by the growth of Individual Retirement Accounts (IRAs) in the United States and private opting out of social security in Britain. These Brazilian retirement plans have become "the mother lode of financial groups," according to one publication. So far, over 300,000 Brazilians have bought such plans. The potential market is estimated at 1.5 million initially and about 8 million total, or 20 percent of the employed population.

The main reason for the growth of private retirement plans seems to be that regardless of the amount "contributed," the social security system's retirement check will be a meager 39 percent of a worker's average income in the year before retirement. This 39 percent is further reduced by constantly manipulated government statistics, "correction" for inflation being sometimes as much as 43 percent below real inflation levels. The market, on the other hand, is offering flexible plans with contracts guaranteeing a specific monthly amount paid after x years of contributions, fully corrected for inflation and lasting until death.

In spite of the fact that Brazil's problematic distribution of income—a legacy of decades of massive government intervention in the economy and restrictions on market entry—has reduced the number of people who can afford private social security, the present trend may whittle away political and ideological opposition to further privatization, not only in social security but in other fields, as well. Indeed, a trend in that direction is already apparent.

—Jose Italo Stelle

Dutch Treats

THE NETHERLANDS—The queen's birthday here is always a grand occasion. The celebration takes place at the end of April, the birthday of the present queen's mother, Princess Juliana.

In Amsterdam, as in several other Dutch cities, one of the important features of the celebration is the traditional vrijmarkt, "the free market." On the queen's birthday, anyone may set up shop on the sidewalks of the city without being subject to taxes or regulations. The whole of Amsterdam becomes the equivalent of a flea market, carnival, and neighborhood party all rolled into one.

In the center and in many other quarters of the city during this year's celebration, the sidewalks were lined with people selling old clothes, toys, books, and miscellaneous items. A great number of food stands and bands playing every imaginable kind of music lent a festive air to the occasion.

Some residents of Amsterdam have complained about the increased commercialization of the festivities in recent years, a far cry from the times when many of the street merchants were youthful entrepreneurs in the lemonade-and-baked-goods business. But the flurry of economic activity might well serve as a lesson to those who see the answer to economic problems in higher taxes, greater regulation, and bigger government.

Over the Royal Palace in Amsterdam is a statue of Atlas, holding the world on his shoulders. Celebrations such as these may show that, deep down, the Dutch are indeed conscious of who it is that sustains the world.

—Paul St. F. Blair

Global Roundup

• Turkey: state under siege. Since his election as Turkey's prime minister last December, Turgut Ozal has moved swiftly to fulfill his promises to cut back the state and implement more market-oriented policies throughout the nation (see Global Trends, Feb., page 22). Though the head Turk hasn't actually sold off the Bosporus Bridge, his scheme to sell revenue bonds in the profitable span—as well as in other state-owned enterprises—made it through parliament. Among his other reforms have been the deregulation of interest rates, abolition of certain import barriers, formation of tax-free zones, and reduction of the minimum income-tax rate from 36 to 30 percent.

• Bank on freedom. In a May referendum, voters in Switzerland voted 3 to 1 against a Socialist Party proposal to do away with the traditional secrecy of Swiss banks. The proposal would have required banks to open their customers' records to Swiss and foreign tax authorities. On the same day, Swiss voters rejected a right-wing party's measure banning sales of residential property to foreigners.