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The Internet media free-for-all

Tomorrow, a host of Silicon Valley firms will visit Trump Tower for a meeting with the President-elect. Last week, AT&T and Time Warner visited Capitol Hill to testify about their proposed merger. These diverse companies build lots of things, from software to networks to original content, but they also have one thing in common. Increasingly they are all vying for bigger chunks of the video market, and in the process they are creating an entirely new media universe.

Too often when policymakers look at these companies, individually or in small sets, they see only what it right in front of them, rigidly defined and static, or even stereotypes of what these companies were a generation ago. But these companies — and the markets in which they play — are changing every day.

Several years ago, in a report called “Life After Television,” we noted that the YouTube and Netflix phenomena were only just the most obvious and earliest manifestations of the Web video revolution. We noted that, yes, the more abundant bandwidth of cable TV and then satellite had been improving the video market for years, but that even bigger changes were coming. This process, we said, would be intense, and messy, and often exhilarating.

Broadband and the Web have now super-charged all these phenomena. We enjoy far more choice and diversity, and the spectrum of quality is broader still. The producers, delivery channels, and business models for video are also multiplying (and in some cases recombining and overlapping in surprising ways). We are only in the middle of the beginning of what will be a decade-long process of sorting out the video content, creation, distribution, aggregation, user-interface, viewing, advertising, and subscription markets.

Here is the graphic we used to describe, in simplified form, the overlapping activities of firms competing in the video market, often approaching from very different angles and starting points.

screen-shot-2016-12-13-at-1-11-54-pm

Graphic describing simplified video value chain, circa 2014, in Life After Television.

The firms pictured are still at the center of the new media tussle. But others have joined the fray, and the battlefield is constantly shifting. Facebook, for example, was not even on our 2014 graphic, but in the subsequent two years it has become a giant player in the Web video (and thus advertising) market. At the time of our report, only Comcast covered the full spectrum, from connectivity to content. But in the meantime Verizon added content via its purchases of AOL and Yahoo, and AT&T is adding content with its Time Warner acquisition. Netflix and Amazon have only expanded as award-winning  production houses of original content. Google and Apple, of course, continue to approach video with distinct business models — Google via advertising and the Web, Apple via a la carte and apps — but each remains a powerful player. And we are still only, perhaps, at the end of the beginning of this media reshuffling.

This new media world is emblematic of an even larger phenomenon of dynamic competition across the technology landscape. I described this even wider playing field in another report called “Digital Dynamism: Competition in the Internet Ecosystem,” which illustrated the multidimensionality of the market. This new market was characterized by intensive innovation, product differentiation, and cascades of competitive and complementary products and services.

The dynamism of the Internet ecosystem is its chief virtue. Infrastructure, services, and content are produced by an ever wider array of firms and platforms in overlapping and constantly shifting markets.

The simple, integrated telephone network, segregated entertainment networks, and early tiered Internet still exist, but have now been eclipsed by a far larger, more powerful phenomenon. A new, horizontal, hyperconnected ecosystem has emerged. It is characterized by large investments, rapid innovation, and extreme product differentiation.

There is both more competition, and more complementarity, than ever before. Which is why policymakers or pundits who are quick to shout “monopoly” in any of these contexts is almost surely wrong. Yes, some of these firms have large market shares in small portions of this overall digital world, but these share are often gained through real innovation, and even then they are often fleeting. These markets are way too fluid to assume anyone has a lock on any part of it, let alone a dominant position overall. So a merger of, say, AT&T and Time Warner, might to some look like “consolidation,” when in fact it potentially provides highly innovative and beneficial new competition in the online advertising business, where at the moment Google and Facebook are the biggest players.

It’s way too early to predict where all this will end up, let alone to dictate and end game.

Zero-sum thinking on zero-rating threatens 5G success

On Wednesday, the Senate Antitrust Subcommittee will take up AT&T’s pending acquisition of Time Warner (the owner of HBO and TBS, not the cable company). Congress has no direct role in merger approval, but the hearing will no doubt highlight the arguments for and against the merger that the Department of Justice, and possibly the Federal Communications Commission (FCC), will hear next year.

As odd as it may sound, I think the AT&T-TWX alliance is chiefly a 5G wireless infrastructure story. Time Warner, combined with DirecTV, will provide a huge amount of popular video content to act as a killer app for a new nationwide wireless infrastructure, not only delivering video to proliferating mobile devices but also competing with cable for residential TV and broadband subscribers.

While video may be the killer app, this 5G wireless network will also serve as the strategic platform for most of the rest of the economy, from connected and autonomous cars to health care to the retail and industrial Internet of Things (IoT). For an incoming administration focused on infrastructure and reviving the lagging sectors of our economy, 5G is attractive. It offers not only tens of billions of dollars of direct infrastructure investment and jobs (at no cost to taxpayers) but also a means to boost productivity and incomes in industries that so far have been left out of the information revolution.

Much of the opposition to the deal takes the vague and familiar form of big-is-bad. Among specific critiques of the deal, however, the most prominent is opposition to “zero rating.” Zero rating, or free data, is the practice of content firms paying for the data consumption of their viewers or listeners. Free data comes in different forms — some are like 1-800 toll-free numbers, other exempt sponsored content from data limits.

Critics worry that AT&T, like Comcast before it, will use zero rating to favor some content over other content, and the outgoing FCC is trying to pick a fight. Last week, AT&T launched its new DirecTV Now service, which delivers bundles of cable-like video channels over the internet and which won’t count against users’ AT&T data limits. You’d think the FCC would be thrilled with this new, attractively-priced, competitive offering. Yet the FCC promptly hit AT&T (and Verizon, which has a similar service) with letters skeptical of their free data programs.

The FCC’s attack on free data is probably legally indefensible, but it is also economically unsound. Opposition to zero rating is based on zero-sum fallacies, where one party’s gain necessarily means another party’s loss. If HBO or ESPN or Netflix or NBC or Spotify subsidize your consumption of their content, then you or other content firms must somehow lose, or so the theory goes.

But the opposite is true. What if most everyone can get more of what they want? This is the way innovation works. In competitive markets like mobile broadband and digital content, free data is additive. It’s positive-sum. By allowing content firms to contribute to the economic equation where they see a benefit, it promotes the consumption of more total data by consumers, their ability to access more third-party non-zero-rated content, and the ability to build faster networks. It’s a win-win-win for consumers, ISPs, and content providers.

Free data is likely to be a widely used business model for connected cars, health care and educational apps, and the Internet of Things. And so proscribing the use of this commonplace business model would not only hurt digital content but also the emerging apps and services we are planning to build using 5G networks.

There’s lots more to say on these topics, but opposing a merger based on refusing free data for consumers is unlikely to be a winning argument.

Google Fiber pull-back shows broadband is difficult. But 5G will make it much easier.

USA Today reports that:

Google Fiber is halting its rollout in 10 cities and laying off staff as its chief executive Craig Barratt steps down, dealing a major setback to the Internet giant’s ambitions of blanketing the nation in super-speedy Internet.

Several years ago, Google Fiber was the darling of both Silicon Valley and most of Washington’s tech policy wonks. It was supposed to bring “gigabit speeds” to supposedly woefully underserved American consumers. The facts were more complicated. It turned out existing broadband firms were already investing hundreds of billions of dollars in wired and wireless broadband, and the U.S. topped the world rankings in the most important measures of Internet performance. Google Fiber’s demise, or pause, or whatever it turns out to be, shows that large scale infrastructure projects are hard. And expensive. And competitive. Especially when deploying fast-changing technologies. And especially when the costs of regulation are rising.

Which points to an ironic facet of this news. At the Wall Street Journal‘s annual WSJ.D conference yesterday, AT&T CEO Randall Stephenson plainly acknowledged Google’s victory in the biggest tech policy debate of the last 15 years: “On neutrality. You guys from Google, you won. It’s done.” Yet the sad irony is that Google’s “win” on policy — the imposition in 2015 of old and voluminous monopoly telephone rules onto modern broadband — made Google’s own broadband deployment efforts even more difficult. We long said that Title II regulation would make broadband less competitive, and Google’s exit of the business is evidence of this effect.

What regulation taketh in terms of innovation and investment, however, technology can in some significant portion often give back. Enter 5G wireless.

Fifth generation wireless, or 5G, is a suite of technologies that will be the foundation of the Internet, and of most of the economy, for the next 20 years. It includes more advanced air interface protocols, new “software defined” network architectures, use of huge new swaths of high-frequency spectrum, and deployment of millions of small cells, all of which will dramatically expand coverage and capacity. But not just for mobile. 5G will also power connected cars and the Internet of Things. It could even become a real competitive offering for fixed residential broadband, delivering both interactive Web video and TV-like high-definition video the way only cable and fiber-to-the-home do today.

It is this facet of 5G that AT&T and Time Warner have emphasized over the last few days since announcing the $85-billion merger of the two firms. Verizon and AT&T over the last decade have built fiber networks into neighborhoods where it made financial sense. But as Google learned the hard way, the business case for fiber is tough even in densely populated urban or suburban areas, let alone exurbs or rural communities. (Google does deserve credit for the progress it made in prying open the local regulatory bottlenecks that too often discourage broadband deployment — things like burdensome infrastructure permitting and local cable franchise rules. Larger broadband firms are now taking advantage of these beneficial bottleneck openings to lay more fiber deeper into communities and neighborhoods across the country.)

A key component of 5G is the opening up of huge amounts of spectrum, at far higher frequencies than are used today for mobile wireless. Today’s mobile devices send and receive signals mostly in the 1-2 gigahertz range. Most Wi-Fi signals are in the 2.4 and 5 GHz bands. But 5G will make use of bands in the 20, 30, and even 70 GHz range. These higher frequencies contain large blocks of mostly unused bandwidth that can transmit more data far faster than today’s mobile cell networks. In a neighborhood setting, fiber-connected small cells could blanket not only hundreds of home receivers but also thousands of mobile devices. But bringing fiber to the neighborhood is far more cost-effective than taking it all the way into the home.

5G could be powerful enough to deliver a video service on par with cable TV/broadband. Satellite will still have an important role for high definition TV, but 5G can overcome satellite’s limited capacity for interactivity (given the latency incurred over the 46,000-mile round trip to space and back).

This new competitive broadband service might be enough to push the AT&T-TW partnership over the line with regulators. And it should also serve as a warning to future market meddlers at the FCC: technology is almost always far more powerful, and pro-consumer, than clever attempts to shape yesterday’s markets.

 

What’s behind the stunning decline in publicly traded U.S. firms?

An underreported story of the last two decades is the sharp decline in the number of publicly traded U.S. firms. In 1996, U.S. stock markets boasted 7,322 listed firms. By 2015, however, that number had dropped by more than half, to 3,200. If we adjust for population, the U.S. had 2.2 public firms per hundred thousand people in 1975, but today that number has fallen to 1.1 public firms per hundred thousand people. The peak in 1996 was 2.7 public firms per hundred thousand.

There’s been an initial public offering (IPO) winter for the last 15 years.  We know that Sarbanes-Oxley, the set of post-Enron financial regulations enacted in 2002, substantially boosted compliance burdens for public companies and, at the margin, discouraged listing publicly. But the drop in total public listings began before Sarbox and was in fact coincident with the late-1990s boom of technology IPOs. The mid-1990s peak of tech IPOs almost assuredly skews the chart, and yet the U.S. still has fewer public firms today than it did 40 years ago.

The mid-1990s peak of tech IPOs almost assuredly skews the chart, and yet the U.S. still has fewer public firms today than it did 40 years ago.

So I still have more questions than answers. For example:

Over the past few decades, the rate of new businesses formed in the U.S. has fallen. Is the plunge in the number of public firms partly a result of the slowing rate of net business starts? Or perhaps just the reverse: Is reduced new firm formation a function of a less healthy public equity market?

Does this represent a benign shift in the way companies are financed? In other words, are private markets – bank loans, venture capital, private equity – now so large and sophisticated that they can replace and compensate for shrinking public markets? Or are weaker public markets starving businesses of funding?

Is the drop a function of slower economic growth overall? Or is it a cause of slower growth? In a similar vein, is the drop a cause or effect of the recent productivity plunge?

Are there a significant number of foreign firms that used to be listed on U.S. stock markets now listed on their home markets?

Is the reduced number of public firms a result of a higher rate of mergers and acquisitions (M&A)? And if so, is higher M&A activity a secular shift in industrial organization? Or is it a response to policies that encourage M&A and discourage firm independence?

Does the knowledge economy, which rewards network effects and scale economies, tend toward a smaller number of winner-take-all firms? In a distinct but related phenomenon, might modern communications tools allow firms to more efficiently integrate than was previously possible? Or might these network and scale effects produce both winner-take-all mega-firms (Apple, Google) and also lots of complementary firms (start-up app developers, graphic designers, etc.), with the problem lying elsewhere?

Are private firms better at investing and innovating for the long term, given the regulatory incentives faced by public firms and investors to focus on the short term? (Sarbox and other “fair disclosure” [FD] rules, for example, are designed to increase transparency and provide a level information playing field for all investors. But in practice the FD paradigm concentrates information releases into discrete quarterly announcements. It thus may contribute to the dreaded “short-termism” – a myopic focus on next month’s earnings rather than long term innovation. Because real information is less available, it also encourages short-term quantitative computer trading over fundamental analysis and long-term investing.) If so, private firms may be a solution to the information desert afflicting public markets.

Is the public firm reduction concentrated in particular industries – manufacturing, retail, health care, finance, technology, etc.? Or is it spread evenly across industries?

Does globalization mean that former U.S. firms now spread around the world just aren’t replaced by domestic firms? The timing with the rise of China suggests perhaps this is a factor. And yet the world economy is not zero sum. Why couldn’t globalization, which allows for more specialization and growth, allow new types of American firms to replace the ones that “moved” abroad?

Is the tax code an important factor? For example, publicly traded firms fell after the 1986 tax reform (after which much income reporting was shifted away from corporate income and toward individual income), rose after the 1993 tax increase, and then fell again after the 1997 capital gains tax reduction. In addition, the U.S. corporate tax rate of 35% has, over time, become the highest in the developed world. We know U.S. firms keep several trillion dollars in retained earnings overseas because they can’t bring it home. Can corporate inversions, in which U.S. firms move abroad, at least notionally, often to escape punitive taxes, explain a significant part of the phenomenon?

How do fewer public firms affect R&D investment and employment? Is the fall in the labor force participation rate related?

What does the investment environment look like in a world of reduced public equity vehicles? How do equity markets behave with fewer domestic public firms but many more investors? How does this change affect individual retail investors, who don’t have much access to private markets, versus sophisticated investors who enjoy many more options, such as venture capital, private equity, M&A, and private credit?

The most comprehensive treatment of the topic comes from a paper by Gustavo Grullon, Yelena Larkin, and Roni Michaely. They attempt to tease out some, but not all, of these questions and focus especially on the market concentration issue. They find that “product market concentration has increased across most industries,” profits have increased because of “increased market power,” and “competition could have been fading over time.”

new report from the White House Council of Economic Advisors picks up this theme and laments higher firm concentration and less competition in the U.S. economy. The CEA says more rigorous antitrust enforcement and agency specific regulation could help promote competition.

And yet the CEA report ignores perhaps the most important factor in falling competition: regulation itself. Dodd-Frank has made the big banks bigger and reduced the number of small community banks. The Affordable Care Act (ACA) accelerated the consolidation of hospitals, clinics, and other health care providers into massive health care systems. The ACA has also reduced product and supplier choice, and boosted premiums, in the health insurance market. Washington is trying its best to shut down private colleges and other non-traditional educational offerings. Its “war on coal” has been successful at killing coal companies and thus reducing energy competition. And the Federal Communications Commission’s new Title II net neutrality rules – which were designed for a monopoly industry! – are likely to discourage new entrants into the wired and wireless broadband arena. I could go on.

If Washington had set out to frustrate entrepreneurship, reduce competition, and discourage public equity financing, it would have enacted policies much like the ones of the last 15 years. The entire apparatus of regulation and taxation, taken as a whole, has slowed the economy and thus the diminished the possibilities for smaller competitive firms to get started, expand, and perhaps go public.

No one knows what the “correct” number of public firms is. But we’d get a much better picture of that number by freeing competitors to compete and allowing the market to fund firms with the best mix of financing.

__________________

This post originally appeared at the U.S. Chamber Foundation blog – https://www.uschamberfoundation.org/blog/post/what-s-cause-and-effect-plummeting-public-firms.

The $2.7 trillion growth gap

I’ve been updating this chart for too many years now. I think it explains a lot.

Growth Gap - 1Q 2016

 

The Indiana Primary

As a native Hoosier, born in La Porte, now living in Zionsville, I feel a responsibility to share my views on the upcoming primary between Ted Cruz and Donald Trump.

The nation is at a crucial inflection point – on the economy, the culture, and foreign affairs. As for the Republican Party, it will be running against a very weak Democratic candidate, and it has a historic opportunity to change the trajectory of the economy and right the dysfunction in Washington. If you are a Republican, or an independent or Democrat who’s dissatisfied with the nation’s current path, this is a big decision. The bottom line is that Ted Cruz would likely win in the fall, while Donald Trump would almost certainly lose in a historic wipeout. Even if Trump were to win, however, he would continue, not revise, Washington’s harmful policy path.

A few considerations:

1. If Indiana votes for Cruz, the nomination will be decided at the Cleveland convention in July. In that scenario, Cruz likely wins the nomination – and likely wins in November. Trump is a historically unpopular candidate beyond his narrow band of supporters. He is today losing to Hillary Clinton in Utah – UTAH! – the reddest of red states. Even his home-state New York victory was unimpressive. Hillary Clinton and Bernie Sanders each got more votes last week in New York than did Trump. Ted Cruz got more votes in Wisconsin than Trump got in giant New York. The idea that Trump puts New York and other blue states in play is thus silly. And he could easily lose traditionally Republican states – a red/blue wipeout. Voters who want to win in the fall should not succumb to the false idea that this nomination is over. Far from it.

2. Cruz has the best pro-growth economic agenda in decades (watch this interview on CNBC). The U.S. economy is stagnating under the weight of heavy taxation and regulation and misguided monetary policy. Cruz’s two chief priorities are (1) replacing the current abominable tax code with a simple flat tax and (2) repealing Obamacare and replacing it with a health system that’s personal, portable, innovative, and affordable – one that’s better for patients and doctors, not for bureaucrats. Combined with a dramatic shrinking of the regulatory state and a sane monetary policy, Cruz’s agenda would likely unleash waves of growth similar to, or even surpassing, the two decade boom of the 1980s and ’90s.

3. Cruz is razor sharp and principled and has effectively challenged Washington’s run-away spending and regulation. He’s selected an equally sharp running mate in Carly Fiorina, a technology executive who understands the economy, is a terrific communicator, and offers a bright and effective contrast with the Democratic nominee.

4. Trump, on the other hand, supports Washington’s run-away spending, taxation, and regulation. He supports single-payer government health care and, to the extent he knows or cares, supports much of the Democratic agenda. If implemented, his views on international trade could crash the economy. Trump is not a serious person. He is a showman without substance. To the extent he believes in anything beyond himself, he’s a big-government liberal progressive.¹

5. Some say Trump is a good businessman, but he’s a good businessman in the sense that Kim Kardashian is a good businesswoman. They are geniuses at grabbing attention with ridiculous and prurient stunts and turning celebrity into dollars. But celebrity is not leadership. Attention-grabbing stunts do not unite people to do big and important things. Any president by definition already has the world’s attention. It’s what you DO with that attention that matters. And Donald Trump has no clue what to do.

6. Voters should not reward dangerously juvenile behavior. Donald Trump insults women, minorities, and disabled people. When challenged, he calls people names and makes fun of their appearances. He rambles on about personalities and inane topics. Why? Because he has no clue about anything of substance. He dissembles (lies) almost constantly – pathologically, in fact. To the extent he can form a declarative sentence, he’ll switch positions three times in five minutes, and does so day after day. He won’t debate on substance because he knows he’ll get clobbered. Most politicians are of course ambitious and self-involved. But the best among them at least aspire to do important things. For Trump, he is that important thing. (For Cruz, surely an ambitious person, those things are reviving the economy, cleansing a corrupt Washington, D.C., and restoring the Constitution.) For Trump, there is nothing beyond himself. His entire life is an exercise in ego inflation. This is Trump’s ultimate self-aggrandizing confidence game. He’s trying to fool people into giving him more fame than ever. Trump is a vile, vain, insubstantial, insecure, dishonest, divisive, dangerously ignorant con artist.

7. Some tactical considerations. If you are interested in winning in the fall, vote Cruz. If you don’t like Trump and think you like John Kasich, I’d suggest you should still vote Cruz. Only two people can win the GOP nomination – Cruz or Trump. A vote for Kasich is thus a vote for Trump.

8. Read this terrific column by George Will, one of our most sober and smartest defenders of liberty. Two excerpts:

Ted Cruz’s announcement of his preferred running mate has enhanced the nomination process by giving voters pertinent information. They already know the only important thing about Trump’s choice: His running mate will be unqualified for high office because he or she will think Trump is qualified . . . .”

“Trump would be the most unpopular nominee ever, unable to even come close to Mitt Romney’s insufficient support among women, minorities and young people. In losing disastrously, Trump probably would create down-ballot carnage sufficient to end even Republican control of the House.”

Let’s finish on a happy note. Despite the bizarre and frustrating election season, the fact is we still have a very good shot to right the American ship . . . If Indiana does the right thing on Tuesday.

______________

¹ I corrected this description to big government “progressive” because of Trump’s authoritarian views on free speech, for example, and other Constitutional and natural liberties.

* Here are my previous ramblings on the genesis of the Trump phenomenon – “My Two Cents on Trumpism.”

** UPDATE: This story from Tuesday, May 3 – “Trump accuses Cruz’s father of helping JFK’s assassin” – reinforces my point about the vast gulf between Donald Trump and reality. He is, as I wrote above, pathological. 

On Netflix admission it throttles certain mobile users but not others

Supreme’s take Apple-Samsung case

The Supreme Court today said it will hear the Apple-Samsung dispute over the “total profits” question in design patent cases. Specifically, the Court said it will address only question 2 from the cert petition:

Where a design patent is applied to only a component of a product, should an award of infringer’s profits be limited to those profits attributable to the component?

This is good news. It means the Court recognizes patent law from the 1800s often does not work in the modern high-tech economy. The Court can help clarify the law so we get more real innovation and less clever, predatory litigation. The patent reformation continues.

We wrote about the case here: Will Apple-Samsung Case Help Clarify Patent Law?

The GOP tax debate

Fifteen years ago, Art Laffer, the principal advocate of the Reagan tax reforms, outlined his ideal tax code for the 21st century. In December 2001, I visited Laffer in San Diego and asked him:

What does your perfect tax code look like?

Number one, it should start out on the first dollar you earn. Then take all federal taxes, (except the sin taxes, which are there to discourage behavior not collect revenue) – I’m talking payroll taxes, income taxes, corporate profits taxes, all federal excise taxes, tariffs, telecom taxes – get rid of them all. And have two taxes. One on business value added. And one on personal unadjusted gross income.

Why do you like a value added tax?

Because it’s got a huge tax base. And it’s all value added. You want to tax the value added to the GDP because that’s what you’re getting the resource base out of. You want to tax both unadjusted gross income and business value added because that way you get the whole GDP twice, so you can have half the rate.

What’s the rationale for that?

If you beat a dog, it’s gonna run, but you don’t know which direction. If you feed a dog, you know where it will be. Taxes are like that. People will do all they can to avoid paying taxes. Evasion, avoidance, underground economy, tax shelters, etc. Going out of work. So the theory behind the flat tax is you want the lowest possible rate on the broadest possible base. By having the lowest base, you provide the fewest incentives to evade, avoid or otherwise not report taxable income.

Isn’t there double taxation involved?

Oh, there is. But it’s double taxation of everything the same. There are no distortions. You can tax GDP at, what is it today, 22 percent of GDP. Or you can tax it at 11 percent at the individual level and 11 percent at the production level. I think it makes a lot of sense to tax 11 percent of each because you make the base that much bigger and the rate that much smaller.

If this looks like the tax reform plan of presidential candidate Sen. Ted Cruz, that’s be cause it basically is. Cruz calls the value added portion of his plan a business flat tax and even referred to Laffer’s support for his plan in last week’s debate. Other candidates, however, have attacked this plan as a “VAT” – a value added tax. They assert that this dreaded three letter tax is an obvious menace of high taxation and big government. But why do they say this? Do they really think that Laffer, the economist most widely associated with pro-growth tax policy, and Cruz, a fierce advocate for taxpayers, want to over-tax the U.S. economy?

For the first few days of the debate, the attackers seemed to be emphasizing the semantics rather than the substance – it is too a VAT! they insisted. If they are trying to equate the Cruz flat tax with a European-style VAT, however, I think they are wrong. Most European VATs are sales taxes, applied transaction by transaction. The Cruz/Laffer proposal taxes firms on revenues minus capital investments and payments to other businesses, is based on corporate accounts, and is payable by firms quarterly. It essentially taxes profits and payrolls, not sales. Or as the Tax Foundation put it,

Is It Like A Retail Sales Tax?

No, it’s not.

Most of the GOP tax proposals, regardless of flavor and legal incidence, tax “value added,” so VAT is a much less precise and informative term than the debate this last week would imply. I understand the political incentive for opponents to link the two semantically, but the label matters much less than the  substance. Critics make some plausible sounding arguments, but I’m not sure any of them hold up. Among the criticisms:

VATs are a key reason European taxation and government is so large.

It’s true that many European nations employ VATs, but these sales taxes are almost uniformly imposed on top of payroll taxes, corporate taxes, and progressive income taxes. They are not a replacement for these taxes but an addition to these taxes. Laffer’s outline and Cruz’s plan, however, use the business flat tax and the personal flat tax to replace the current tax code, not to augment it.

Conservatives have been warning against European style VATs for decades. Why would we go down this road?

Again, the key argument against Euro style VATs was that American liberals have wanted for a long time to boost taxation and the size of government, and adding a VAT on top of the current tax code has been one Democratic idea to accomplish this. Conservatives were and are correct to argue against this additional layer of taxation. The Tax Foundation analysis says the Cruz plan would boost economic growth without increasing the tax burden (and in many important ways, reducing the tax burden) – just the opposite of the European experience.

Which gets us to the next argument – that VATs raise too much money.

It’s true that economists of all persuasions think VATs are efficient methods to raise revenue, which conservatives usually say is the purpose of the tax code. Not social engineering, not redistribution. Laffer’s explanation above makes the point: the lowest possible rates on the largest possible economic base, which will minimize distortions, disincentives, unfairness, and noncompliance. One of the foundational insights of supply-side economics and the Reagan economic revival was that some taxes are better than others – that tax complexity and high rates can impose large costs on the economy relative to the revenue they collect, and that we can encourage greater economic activity and collect necessary revenues with a more efficient tax code. An efficient tax just means we can enjoy lower rates and less interference in the economy.

Ah, critics say, yes, but VATs tend to hide the cost of government.

True, VATs don’t appear as deductions from your paycheck, nor would the business flat tax. But neither do corporate income taxes appear on your paycheck, nor, for most people, do the high-rate income taxes that pay for a huge proportion of the nation’s total tax take. Taxes in the U.S. today don’t reflect the true cost of government for many voters. Let’s give future voters a little more credit. They would quickly figure out that the business flat tax rates are built into the prices of goods and services and affect wages, and would vote accordingly. (The Cruz plan even says that firms would pay the tax quarterly and report the figures to their employees and shareholders, making it transparent.) In fact, one could argue that a low-rate-broad-base tax would better align voters with good economic policy. In the current highly progressive system in which the cost of government is invisible to many, half(+1) the population can essentially vote to tax the other half(-1). With a flat tax’s broader base and single rate, on the other hand, the costs would be more apparent, less unfairly and arbitrarily distributed, and a substantial majority of voters would be likely to oppose tax rate increases. The Cruz plan would still protect low-income Americans with a larger standard deduction and, they say, an improved EITC.

Yes, yes, yes, but the real threat is that future politicians could raise the VAT rate without people noticing.

Politicians have already proved willing and adept at raising (and complicating) today’s taxes! I understand the theory behind this line of argument, but I just don’t buy it. Again, I think most people would understand that voting to increase the flat tax rate is voting to tax themselves. A further irony: the very critics who warn that future politicians will raise the rates in Cruz’s plan themselves support a tax plan with a corporate tax rate nearly twice as high and a personal income tax rate more than three times as high. One could say their favored tax code thus enshrines from the outset what they warn against as a mere possibility for their opponent’s plan. All that said, yes, I’d love to see some additional protections so that any new and improved tax system would be difficult to undo.

Now, one argument I have not heard from critics but that I can imagine is this: Because a flat tax puts everyone basically in the same boat, and better aligns the incentives of all taxpayers/voters, taxes as a political issue may lose their saliency. Presumably, a large and crucial part of the Republican coalition is based upon the group of voters that pays an overwhelming portion of all taxes. Might some anti-tax advocates think inefficient taxes that gouge some taxpayers are good for generating anti-tax voting incentives and holding together the political coalition? With less of a tax split, would this clear cut issue go away, while the parties realign based on other non-tax issues? I have no idea, am no political expert, and am just speculating.

The fact is that the tax proposals of many of the GOP presidential candidates would all improve the tax code and the U.S. economy. I think the Laffer/Cruz proposal is perhaps the most attractive option among many good plans. For good summaries, detailed analyses, and comparisons of the candidates’ plans, see the Tax Foundation.

Why economic growth matters (cont.)

Marginal Revolution University has a good new short video on why economic growth is so important . . .

Samsung, Apple, and a possible date at the Supreme Court

Today, Samsung asked the Supreme Court to review an antiquated component of patent law. My brief take:

“The prevailing interpretation of design patents and penalties is rooted in the 1870s. It doesn’t work in a smartphone world. The Supreme Court should take this case and modernize the notion of damages for ‘total device profits’ for complex products. The Court should continue its good work in rebalancing our intellectual property paradigm away from clever lawyering and in favor of true innovation.”

–Bret Swanson

A little good news for the Net

Surprise: there’s a bit of good news from Washington. The House and Senate just agreed to include a permanent Internet Tax Freedom Act in the Customs and Border Protection reauthorization. Congress first barred states and the federal government from taxing Internet access in 1998. But the measure was temporary, and every few years since then  it’s been in jeopardy of expiring. Applying discriminatory taxes to Internet access would have slowed the rollout of broadband, the uptake by consumers, and the emergence of some of America’s most successful industries. This new measure ensures we continue a successful policy . . . permanently.

Is there a better vision for health care?

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In recent days, the New York Times and Wall Street Journal have reported on the Affordable Care Act’s growing problems. Skyrocketing premiums, more lost coverage, skyrocketing deductibles, narrow networks, dysfunctional health insurance exchanges (more than half of which have now closed shop), and a warning from the nation’s largest insurer UnitedHealth that it may abandon Obamacare altogether. One consumer summed up the dismal situation:

“We can’t afford the Affordable Care Act, quite honestly,” said Cassaundra Anderson, whose family canvassed for Obama in their neighborhood, a Republican stronghold outside Cincinnati. “The intention is great, but there is so much wrong. . . . I’m mad.”

Is there a better way? Yes, there are lots of better ways, and lots of good ideas to “reform health care reform.” In fact, I believe health care is poised to explode with exciting innovations that will slash costs and radically improve care. Just yesterday the venture capital firm Andreessen Horowitz announced a new fund focused on software for biotech. But many of these important medical and economic advancements will only happen to the degree we allow them to happen. And right now, the ACA is exacerbating the worst features of the existing health market while adding new pathologies of its own. Choice is contracting, costs are mushrooming, and innovation is being stifled. The FDA, too, is a big obstacle. Instead of this rigid, top-down, costly path, I’ve laid out what I think is a more hopeful vision for the future of health care in a new report called “The App-ification of Medicine: A Four-Facted Information Revolution in Health.” This revolution is based on:

  • Smartphones and personal technology
  • Big Data, Social Data
  • The Code of Life
  • The app-ification of the business of health care

The report is by no means a comprehensive look at what is a huge sector and a hugely complex topic. But it might spark some ideas and bolster our optimism that if we free the health sector, it can become an economic blessing rather than a burden.

 

Moore’s Law at 50

Here’s a new version of my 50th anniversary assessment of Moore’s Law, just out from the American Enterprise Institute.

Moore 50 cover 1

 

Key Points

  • Over the last 50 years, exponential scaling of silicon microelectronics “turned a hundred dollar chip with a few dozen transistors into a 10 dollar chip with a few billion transistors,” fulfilling Moore’s Law, Gordon Moore’s ambitious prediction, and propelling the information economy.
  • Information technology, powered by Moore’s Law, provided nearly all the productivity growth of the last 40 years and promises to transform industries such as health care and education that desperately need creative disruption.
  • Shrinking silicon transistors is getting more difficult as we approach fundamental atomic limits, but varied innovations—in materials, devices, state variables, and parallel architectures—will likely combine to deliver continued exponential growth in computation, data storage, sensing, and communications.

The Regulatory Charade

Michael Spence and Kevin Warsh, writing in The Wall Street Journal, highlight the dearth of business investment over the last eight years. (WSJ)

Michael Spence and Kevin Warsh, writing in The Wall Street Journal, highlight the dearth of business investment over the last eight years. (WSJ)

Unless we address the growth of the Administrative State, it will continue to stifle growth in the real economy. As you can see in the chart above, this recovery has suffered, among other maladies, from the weakest business investment of any recent expansion. The weakest by far. A number of factors may be at play — monetary policy, global turmoil, bad corporate tax policy, the nature of the last downturn, etc. But it’s not a stretch to conclude that a major factor in the economy’s underperformance is growing bureaucratic interference with economic activity. One study estimates that regulation costs the economy $1.88 trillion per year, and another study puts the cost to the economy into the tens of trillions of dollars. As bureaucratic excursions into firms and industries grow, and as the costs so manifestly outweigh the benefits, the agencies’ rationales for regulatory control become ever more creative.

A good example comes from Susan Dudley of George Washington University, who studies environmental regulation. She describes a clearly political decision cloaked as “science.”

The Environmental Protection Agency published its final national ambient air quality standard (NAAQS) for ozone in the Federal Register on Monday.  EPA emphasizes that “Setting air quality standards is about protecting public health and the environment. By law, EPA cannot consider costs in doing that.”  The agency did prepare a regulatory impact analysis (RIA) to comply with presidential executive orders 12866 and 13563, but it is explicit that “although an RIA has been prepared, the results of the RIA have not been considered in issuing this final rule.”

The results of the RIA, however, were featured prominently in EPA’s press release.  According to the release, “The public health benefits of the updated standards, estimated at $2.9 to $5.9 billion annually in 2025, outweigh the estimated annual costs of $1.4 billion.”  EPA’s fact sheet relies on the RIA to assert that meeting the new 70 parts per billion (ppb) standard will avoid 320 to 660 premature deaths each year.

Nonetheless, the 480-page RIA suggests that these health benefits pale in comparison to the benefits that achieving a more stringent 65 ppb standard would bring.  According to EPA’s models, a standard of 65 ppb would avoid between 1,590 and 3,320 premature deaths. (This does not include California.)

There are ample reasons to question EPA’s ozone health benefit estimates but the fact is, the agency’s own analysis claims that the more stringent 65 ppb standard would have saved an additional 1,274 to 2,660 lives per year, and avoided an additional 2,670 emergency room visits and almost 1,300 hospital admissions.

If, as EPA says, “the Act requires [it] to base the decision for the primary standard on health considerations only; economic factors cannot be considered,” how can it reconcile setting a standard that leaves so many lives unprotected?

EPA cannot openly admit that its decision was influenced by the enormous costs of achieving the tighter standard.  (Chapter 4 of the RIA acknowledges that no known measures are available to achieve either of the standards EPA considered, but estimates that a 65 ppb standard would impose costs of $16 billion per year – more than 10 times the estimated $1.4 billion per year cost of achieving a 70 ppb standard.)

It’s obvious that EPA did consider the gigantic cost, and Dudley concluded:

It’s time to stop the charade that it is wise or even possible to base NAAQS purely on health considerations.  There are very real tradeoffs involved in these policy decisions that deserve open and transparent debate, rather than the pretense that they can be made by considering only science.

Another example from the environmental arena is the never-ending Keystone XL saga, in which various bureaucracies have for seven years pretended to “study the impact assessments” while blocking the project. Almost no one even argues anymore that this is anything but a political football designed to pacify narrow constituencies and raise campaign money. And yet billions of dollars in potential investment and thousands of jobs are put off.

It is impossible to insulate executive and even independent agencies from all politics. Let’s be realistic. And yet emboldened bureaucrats are increasingly dispensing with even the pretense of expertise, fair play, and the rule of law.

In recent years, the Federal Communications Commission, a nominally “independent expert agency,” has descended into the political swamp. In the most famous case, one year ago, just after the 2014 elections, the FCC collapsed in the face of a subversive White House campaign to write new regulations governing the Internet, one of the most important and innovative sectors of the economy. The FCC had been heading in one policy direction, but at the last second, after years of consideration, a small team of non-expert political operatives in the White House (in cahoots with a few FCC insiders who, it turns out, were also orchestrating outside political activists) twisted Chairman Tom Wheeler’s arm, and the White House got its favored policy. Never mind that all of this was illegal —  Congress had told the FCC 20 years ago the Internet was to remain “unfettered by Federal and State regulation.”

Last week, one of Chairman Wheelers’s senior advisors spoke to an industry group and once again asked them to go on a political campaign in favor of even more regulation of the communications sector. As Light Reading reported,

Ideally, Sohn [Wheeler’s senior advisor] said, the same kind of consumer activism that helped drive the Open Internet rule changes earlier this year — including pickets at Wheeler’s home and the White House, and widespread TV coverage — could be brought to bear on some of the more arcane issues, such as special access and IP transition rules.

So senior staff at “independent expert” agencies, who make economic rules and enforce technology standards in highly technical sectors of the economy, are now urging political activists to go to the home of the agency chairman to bank pots and pans and urge specific policies — invariably tilted toward more regulation.

In a possible silver lining, the assertiveness of regulatory and expert agencies is exposing fundamental flaws in the Administrative State. So egregious is the behavior, so overt and obvious is the politicization, so damaging is the impact on the economy, that the agencies — long political tools but not recognized as such — are earning the scrutiny that could lead to a revolution of sorts.

Steven Davis of the University of Chicago describes the size of the problem — a Code of Federal Regulations now 175,000 pages long, for example — here. Charles Murray describes the nature of the regulatory charade and a possible political solution  here. John Cochrane of UChicago and the Hoover Institution outlines the impact of regulatory insanity on economic growth here. I’ve looked at the impact on economic growth here and suggested that, in the cases where regulation is needed, it’s imperative to “Keep It Simple.”

John Cochrane on Economic Growth

We’ve been hammering for years on the importance of reinvigorating economic growth, and John Cochrane of the University of Chicago has put lots of the key ideas, big and small, in one new paper. Enjoy.

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Finally, a robust discussion of economic growth

I’m delighted to see the robust discussion breaking out over the urgent need to reignite the U.S. economy. The impetus seems to be Jeb Bush’s call last week to implement policies that would boost the U.S. growth rate to 4%, at least for several years. A number of economists and journalists said Bush’s 4% goal was impossible. But others say nonsense; of course we can do much better than we have over the last decade. See Glenn Hubbard and Kevin Warsh, for example, in The Wall Street Journal today. Jon Hartley follows up here. Michael Solon wrote an excellent piece back in February. And John Taylor has been urging the same here and here.

Here’s a selection of my own research and commentary on the topic over the last five years:

THE GROWTH IMPERATIVE — Forbes — May 27, 2011
The Growth Imperative — Slides — Presentation to U.S. Chamber — May 24, 2011

More evidence against Internet regulation: the huge U.S.-European broadband gap

In its effort to regulate the Internet, the Federal Communications Commission is swimming upstream against a flood of evidence. The latest data comes from Fred Campbell and the Internet Innovation Alliance, showing the startling disparities between the mostly unregulated and booming U.S. broadband market, and the more heavily regulated and far less innovative European market. In November, we showed this gap using the measure of Internet traffic. Here, Campbell compares levels of investment and competitive choice (see chart below). The bottom line is that the U.S. invests around four times as much in its wired broadband networks and about twice as much in wireless. It’s not even close. Why would the U.S. want to drop America’s hugely successful model in favor of “President Obama’s plan to regulate the Internet,” which is even more restrictive and intrusive than Europe’s?

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Broadband facts: GON with the wind

See below our post from TechPolicyDaily.com responding to President Obama’s January 14 speech in Iowa. We’ve added some additional notes at the bottom of the post.

Yesterday, President Obama visited Cedar Falls, Iowa, to promote government-run broadband networks. On Tuesday, he gave a preview of the speech from the Oval Office. We need to help cities and towns build their own networks, he said, because the US has fallen behind the rest of the world. He pointed to a chart on his iPad, which showed many big US cities trailing Paris, Tokyo, Hong Kong, and Seoul in broadband speeds. Amazingly, however, some small US towns with government-owned broadband networks matched these world leaders with their taxpayer-funded deployment of gigabit broadband.

I wish I could find a more polite way to say this, but the President’s chart is utter nonsense. Most Parisians do not enjoy Gigabit broadband. Neither do most residents of Tokyo, Hong Kong, or Seoul, which do in fact participate in healthy broadband markets. Perhaps most importantly, neither do most of the citizens of American towns, like Cedar Falls, Chattanooga, or Lafayette, which are the supposed nirvanas of government-run broadband.*

The chart, which is based on a fundamentally flawed report, and others like it, deliberately obscures the true state of broadband around the world. As my AEI colleagues and I have shown, by the most important and systematic measures, the US not only doesn’t lag, it leads. The US, for example, generates two to three times the Internet traffic (per capita and per Internet user) of the most advanced European and Asian nations. (more…)

Commissioner Pai’s Netflix letter exposes fundamental flaws of Internet regulation

Combatants in the Net Neutrality wars often seem to talk past each other. Sometimes it’s legitimate miscommunication. More often, though, it arises from fundamental defects in the concept itself.

On December 2, Commissioner Ajit Pai wrote to Netflix, Inc., saying he “was surprised to learn of allegations that Netflix has been working to effectively secure ‘fast lanes’ for its own content on ISPs’ networks at the expense of its competitors.” Commissioner Pai noted press accounts that suggested Netflix’s Open Connect content delivery platform and its use of specialized video streaming protocols put video from non-Netflix sources at a disadvantage. Commissioner Pai concluded that “these allegations raise an apparent conflict with Netflix’s advocacy of strong net neutrality regulations” and thus asked for an explanation.

In its reply of December 11, Netflix made four basic points. Netflix (1) said it “designed Open Connect content delivery network (CDN) to provide consumers with a high-quality video experience”; (2) insisted “Open Connect is not a fast lane . . . . Open Connect helps ISPs reduce costs and better manage congestion, which results in a better Internet experience for all end users”; (3) said it “uses open-source software and readily-available hardware components”; and (4) applauded other firms for developing open video caching standards but “has focused” on its own proprietary system because it is more efficient and customer friendly than the collaborative industry efforts.

Three of Netflix’s four points are reasonable, as far as they go. The company is developing technologies and architectures to improve customer service and beat the competition. The firm, however, seems not to grasp Commissioner Pai’s central point: Netflix relishes aggressive competition on its own behalf but wants to outlaw similarly innovative behavior from the rest of the Internet economy.

(more…)

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