Separation of Economics and State

The ultimate justification for separation of church and state is our need to come to our own, individual conclusions and act accordingly, no matter what any religion says. This need for intellectual freedom applies more broadly to all thought and action, including in our economic lives: producing, trading, and consuming wealth.

As Ayn Rand identified, the liberated rational mind is our basic means of creating the products and services life requires. Men have developed heart transplants, microprocessors, and skyscrapers only to the extent their minds have been free from coercion by criminals and government.

A proper society respects a complete separation of state and economics. Individuals may engage in any voluntary economic arrangement they choose, no matter how controversial.

For example, individuals can start a fully-free, for-profit medical care network or they can start a socialized, “single-payer” network. But participation must be voluntary; they have no right to force their ideas on doctors and patients. To the extent economic decision-making is liberated in this way—whether in health care, finance, or computers—the result is the discovery and spread of the best ideas, and an ever-increasing standard of living.

Q&A with Ayn Rand

What is capitalism?

When I say “capitalism,” I mean a full, pure, uncontrolled, unregulated laissez-faire capitalism—with a separation of state and economics, in the same way and for the same reasons as the separation of state and church.

What is a mixed economy?

A mixed economy is a mixture of freedom and controls—with no principles, rules, or theories to define either. Since the introduction of controls necessitates and leads to further controls, it is an unstable, explosive mixture which, ultimately, has to repeal the controls or collapse into dictatorship. A mixed economy has no principles to define its policies, its goals, its laws—no principles to limit the power of its government. The only principle of a mixed economy—which, necessarily, has to remain unnamed and unacknowledged—is that no one’s interests are safe, everyone’s interests are on a public auction block, and anything goes for anyone who can get away with it. Such a system—or, more precisely, anti-system—breaks up a country into an ever-growing number of enemy camps, into economic groups fighting one another for self preservation in an indeterminate mixture of defense and offense, as the nature of such a jungle demands. While, politically, a mixed economy preserves the semblance of an organized society with a semblance of law and order, economically it is the equivalent of the chaos that had ruled China for centuries: a chaos of robber gangs looting—and draining—the productive elements of the country.

A mixed economy is rule by pressure groups. It is an amoral, institutionalized civil war of special interests and lobbies, all fighting to seize a momentary control of the legislative machinery, to extort some special privilege at one another’s expense by an act of government—i.e., by force. In the absence of individual rights, in the absence of any moral or legal principles, a mixed economy’s only hope to preserve its precarious semblance of order, to restrain the savage, desperately rapacious groups it itself has created, and to prevent the legalized plunder from running over into plain, unlegalized looting of all by all—is compromise; compromise on everything and in every realm—material, spiritual, intellectual—so that no group would step over the line by demanding too much and topple the whole rotted structure. If the game is to continue, nothing can be permitted to remain firm, solid, absolute, untouchable; everything (and everyone) has to be fluid, flexible, indeterminate, approximate. By what standard are anyone’s actions to be guided? By the expediency of any immediate moment.

The only danger, to a mixed economy, is any not-to-be-compromised value, virtue, or idea. The only threat is any uncompromising person, group, or movement. The only enemy is integrity.

Is there a valid argument for limited government intervention?

There can be no compromise between freedom and government controls; to accept “just a few controls” is to surrender the principle of inalienable individual rights and to substitute for it the principle of the government’s unlimited, arbitrary power, thus delivering oneself into gradual enslavement. As an example of this process, observe the present domestic policy of the United States.

If a detailed, factual study were made of all those instances in the history of American industry which have been used by the statists as an indictment of free enterprise and as an argument in favor of a government-controlled economy, it would be found that the actions blamed on businessmen were caused, necessitated, and made possible only by government intervention in business. The evils, popularly ascribed to big industrialists, were not the result of an unregulated industry, but of government power over industry. The villain in the picture was not the businessman, but the legislator, not free enterprise, but government controls.

In view of what they hear from the experts, the people cannot be blamed for their ignorance and their helpless confusion. If an average housewife struggles with her incomprehensibly shrinking budget and sees a tycoon in a resplendent limousine, she might well think that just one of his diamond cuff links would solve all her problems. She has no way of knowing that if all the personal luxuries of all the tycoons were expropriated, it would not feed her family—and millions of other, similar families—for one week; and that the entire country would starve on the first morning of the week to follow. . . . How would she know it, if all the voices she hears are telling her that we must soak the rich?

No one tells her that higher taxes imposed on the rich (and the semi-rich) will not come out of their consumption expenditures, but out of their investment capital (i.e., their savings); that such taxes will mean less investment, i.e., less production, fewer jobs, higher prices for scarcer goods; and that by the time the rich have to lower their standard of living, hers will be gone, along with her savings and her husband’s job—and no power in the world (no economic power) will be able to revive the dead industries (there will be no such power left).

Is it possible to have a mixed economy without corruption?

If parasitism, favoritism, corruption, and greed for the unearned did not exist, a mixed economy would bring them into existence.

Since there is no rational justification for the sacrifice of some men to others, there is no objective criterion by which such a sacrifice can be guided in practice. All “public interest” legislation (and any distribution of money taken by force from some men for the unearned benefit of others) comes down ultimately to the grant of an undefined, undefinable, non-objective, arbitrary power to some government officials.

The worst aspect of it is not that such a power can be used dishonestly, but that it cannot be used honestly.

In a controlled (or mixed) economy, a legislator’s job consists in sacrificing some men to others. No matter what choice he makes, no choice of this kind can be morally justified (and never has been). Proceeding from an immoral base, no decision of his can be honest or dishonest, just or unjust—these concepts are inapplicable. He becomes, therefore, an easy target for the promptings of any pressure group, any lobbyist, any influence-peddler, any manipulator—he has no standards by which to judge or to resist them. You do not know what hidden powers drive him or what he is doing. Neither does he.

Every government interference in the economy consists of giving an unearned benefit, extorted by force, to some men at the expense of others. By what criterion of justice is a consensus-government to be guided? By the size of the victim’s gang.

What principles govern human interaction in the free market?

In a free economy, where no man or group of men can use physical coercion against anyone, economic power can be achieved only by voluntary means: by the voluntary choice and agreement of all those who participate in the process of production and trade. In a free market, all prices, wages, and profits are determined—not by the arbitrary whim of the rich or of the poor, not by anyone’s “greed” or by anyone’s need—but by the law of supply and demand. The mechanism of a free market reflects and sums up all the economic choices and decisions made by all the participants. Men trade their goods or services by mutual consent to mutual advantage, according to their own independent, uncoerced judgment. A man can grow rich only if he is able to offer better values—better products or services, at a lower price—than others are able to offer.

Wealth, in a free market, is achieved by a free, general, “democratic” vote—by the sales and the purchases of every individual who takes part in the economic life of the country. Whenever you buy one product rather than another, you are voting for the success of some manufacturer. And, in this type of voting, every man votes only on those matters which he is qualified to judge: on his own preferences, interests, and needs. No one has the power to decide for others or to substitute his judgment for theirs; no one has the power to appoint himself “the voice of the public” and to leave the public voiceless and disfranchised.

Now observe that a free market does not level men down to some common denominator—that the intellectual criteria of the majority do not rule a free market or a free society—and that the exceptional men, the innovators, the intellectual giants, are not held down by the majority. In fact, it is the members of this exceptional minority who lift the whole of a free society to the level of their own achievements, while rising further and ever further.

A free market is a continuous process that cannot be held still, an upward process that demands the best (the most rational) of every man and rewards him accordingly. While the majority have barely assimilated the value of the automobile, the creative minority introduces the airplane. The majority learn by demonstration, the minority is free to demonstrate. The “philosophically objective” value of a new product serves as the teacher for those who are willing to exercise their rational faculty, each to the extent of his ability. Those who are unwilling remain unrewarded—as well as those who aspire to more than their ability produces. The stagnant, the irrational, the subjectivist have no power to stop their betters. . . .

The mental parasites—the imitators who attempt to cater to what they think is the public’s known taste—are constantly being beaten by the innovators whose products raise the public’s knowledge and taste to ever higher levels. It is in this sense that the free market is ruled, not by the consumers, but by the producers. The most successful ones are those who discover new fields of production, fields which had not been known to exist.

A given product may not be appreciated at once, particularly if it is too radical an innovation; but, barring irrelevant accidents, it wins in the long run. It is in this sense that the free market is not ruled by the intellectual criteria of the majority, which prevail only at and for any given moment; the free market is ruled by those who are able to see and plan long-range—and the better the mind, the longer the range.

All the evils, abuses, and iniquities, popularly ascribed to businessmen and to capitalism, were not caused by an unregulated economy or by a free market, but by government intervention into the economy.

The economic value of a man’s work is determined, on a free market, by a single principle: by the voluntary consent of those who are willing to trade him their work or products in return. This is the moral meaning of the law of supply and demand.

How would government be funded in a free society?

In a fully free society, taxation—or, to be exact, payment for governmental services—would be voluntary. Since the proper services of a government—the police, the armed forces, the law courts—are demonstrably needed by individual citizens and affect their interests directly, the citizens would (and should) be willing to pay for such services, as they pay for insurance.

The question of how to implement the principle of voluntary government financing—how to determine the best means of applying it in practice—is a very complex one and belongs to the field of the philosophy of law. The task of political philosophy is only to establish the nature of the principle and to demonstrate that it is practicable. The choice of a specific method of implementation is more than premature today—since the principle will be practicable only in a fully free society, a society whose government has been constitutionally reduced to its proper, basic functions.

Is it possible for a mixed economy to immediately implement a program of voluntary government financing?

Just as the growth of controls, taxes and “government obligations” in this country was not accomplished over-night—so the process of liberation cannot be accomplished overnight. A process of liberation would be much more rapid than the process of enslavement had been, since the facts of reality would be its ally. But still, a gradual process is required—and any program of voluntary government financing has to be regarded as a goal for a distant future.

What the advocates of a fully free society have to know, at present, is only the principle by which that goal can be achieved.

The principle of voluntary government financing rests on the following premises: that the government is not the owner of the citizens’ income and, therefore, cannot hold a blank check on that income—that the nature of the proper governmental services must be constitutionally defined and delimited, leaving the government no power to enlarge the scope of its services at its own arbitrary discretion. Consequently, the principle of voluntary government financing regards the government as the servant, not the ruler, of the citizens—as an agent who must be paid for his services, not as a benefactor whose services are gratuitous, who dispenses something for nothing.

What makes the economy grow?

Everyone should want the economy to grow. A growing economy puts more money in families’ pocketbooks and charities’ budgets, the poor and unemployed have an easier time finding jobs, and families saving for retirement or their children’s education can see their nest eggs grow.

So what makes the economy grow? You don’t need a degree in economics to answer this, you just need to think carefully. Common sense can help expose some popular but mistaken myths about the economy.

Many think of our economy as if it were a big apple pie with that flaky criss-cross crust on top. You can slice the pie this way or that. You can cut eight or 10 or 12 equal slices, or you can cut some slices thinner than others.

If you cut one of the slices really thick, though, you’ll have to cut the other slices thinner. It’s a trade-off. So it seems unfair that some should have more than others. It seems fairer to slice the pie into equal slices.

But this idea is fatally flawed. First, our economy isn’t like an apple pie sitting on the counter getting cold. With the right conditions, we can create more wealth: That is, we can make the pie grow. Some create more than others and may end up with bigger slices; but in the long run, everyone can end up with a bigger slice than they would have had otherwise. That’s a win-win.

Our economy isn’t like an apple pie sitting on the counter getting cold. We can create more wealth: That is, we can make the pie grow. Some create more than others and may end up with bigger slices; but in the long run, everyone can end up with a bigger slice than they would have had otherwise.

The second problem with the apple pie idea is this: Who’s doing the slicing? Usually that task is assigned to the federal government, but the government didn’t bake the pie in the first place. American work and ingenuity did that. So when government tries to slice the pie into equal pieces, it’s simply spreading income around by taking from some and giving it to others. At best, that’s win-lose. And by picking winners and losers, such a policy distorts the incentives that lead those who produce more to do their best, which means they produce less, they earn less, and the pie shrinks.

Trying to spread income around by redistributing what people have earned through their own efforts actually hinders the creation of new income. And creating more income—growing the pie—is the only known way to increase overall prosperity.

Fortunately, we know how to grow the economy—how to make the pie bigger: by individuals working and trading and creating freely, not by government taxing away our income, restricting our economic freedom, and spending our money supposedly on our behalf but really on its own priorities.[1]

Think of a dozen engineers at Apple Computer who invent an easier way to find information on the Web, which Apple then includes on its new, wildly popular iPhone. Millions of people buy and enjoy the new iPhones, providing jobs for Apple employees and money for future research at Apple. New income and wealth has been created.

Similarly, when a farmer tends an apple orchard and then sells the apples, he gets money to buy what he needs for his own use and to sustain his apple business, while customers get the apples, which they prefer to the money they give the farmer. Income has been created by developing products that consumers want. If the farmer saves rather than spends some of the proceeds, he can invest the money and create even more income in the future.

This isn’t rocket science. It’s common sense, and it’s been true for thousands of years. But in Washington, unfortunately, it’s not very common. In an economic downturn, it becomes downright rare. Many lawmakers use temporary downturns to increase their power permanently by taxing, spending, and borrowing rather than supporting policies to grow the economy.

Of course, some of the federal government’s work—such as administering the judicial system and maintaining national security—is vital to society and the economy. But income redistribution and other forms of government meddling often shrink the pie or keep it from growing. They take income away from those who earned it and give it to those who didn’t. In the process, they divert resources to less productive uses and thus impede the creation of new opportunities that would otherwise benefit everyone in the long run.

For instance, when the government imposes a tax and takes income from Apple Computer or the apple farmer and hands it over to somebody else, it is merely redistributing—not creating—income. Total income has not increased by one penny, and the government has discouraged both Apple and the farmer from creating more products of value to others.

So what really does make the economy grow?

The economy grows when individuals and businesses succeed in recognizing new markets and new opportunities and accept the risks involved in pursuing these opportunities in the hope of earning income. Each of these elements is important, like a recipe of many ingredients. The absence of any ingredient would diminish the taste of the dish. For example, the economy grows when someone sees an opportunity to meet a need and can marshal the resources to meet that need. That need may be to supply an existing good to a new market, or it may be to supply something brand-new, like Apple Computer’s iPhone in the example above.

For the supplier to meet the need, however, there must be a marketplace in which the supplier can meet potential buyers and where they can settle on a price. The supplier knows there will be risks involved, and so must have some confidence about a whole range of issues to be willing to accept those risks. For example, he must be confident that his goods won’t be stolen by someone else or confiscated in whole or in part by the government, and he must have some confidence that the customers will be in the market and willing to pay an adequate price.

When these elements are in place, individuals invest in their own abilities through education and training, and so increase their value to the market. When these elements are in place, businesses invest in new production facilities in the hope of expanding the quantity or range of their products and to employ the latest technologies to reduce cost.

Importantly, economic growth is not the consequence of some master economic plan managed by the government. It results from millions of people individually seeking what is in their own interests by providing what is in the interests of others. The collective consequence of their actions, under a stable rule of law, is to increase the number of jobs in the economy, the wages earned by workers, and the income and wealth of the nation.

The economy grows when individuals and businesses succeed in recognizing new markets and new opportunities and accept the risks involved in pursuing these opportunities in the hope of earning income.

But lawmakers rarely admit these realities. The idea of transferring income from families and businesses to government gets repackaged in all sorts of creative but deceptive ways. We hear talk about stimulating the economy, creating jobs, putting people back to work, bailing out allegedly vital industries, and making the rich pay their “fair share.” Though these myths are all variations on the same theme, let’s deal with them one at a time.

Growing the Economy: Separating the Myths from the Facts

MYTH #1: Government spending grows the economy by pumping new money into it.

FACT: Every dollar that government “injects” into the economy must first be taxed or borrowed from families, businesses, or other nations.

In tough economic times, lawmakers often launch new spending programs to rev up growth by “injecting” money into the economy. But this approach does not increase production or create new income; it only moves money around within the economy. In other words, it does not encourage growth in either the overall economic pie or the family bank account.

Think of your family’s savings. If you want to increase your investments in a savings account without earning more money or taking out a loan that must be repaid, then you have to take that money from another part of your savings, such as your checking account. You haven’t increased your savings; you’ve just shifted existing savings around.

The same logic applies to government spending. Governments don’t create new income out of thin air. When Congress funds spending with taxes or by borrowing, it is not creating new income; it is merely redistributing existing income.

Because government must first take or borrow money from people before spending it, the claim that pumping new money into the economy will grow the economy is ill-founded.

MYTH #2: Government spending makes people more productive.

FACT: Government spending often encourages behavior that has bad economic consequences.

Many government programs lead to choices that actually make the economy worse. Welfare programs, for example, generally encourage recipients to rely on government handouts rather than to work. This is why welfare reform efforts that require recipients to find work tend to succeed: They encourage choices that help both the individual and the community. Work gives people dignity because it allows them to become more self-sufficient rather than depending on government assistance. And their work makes the economy more productive.

In another example, federal flood insurance programs encourage people to take undue risks by building houses in flood plains. How many people would actually build on a flood plain without insurance against floods? Some private insurers would accept such a risky venture, but only by charging a far higher premium for the insurance. The government takes on this risk while letting taxpayers foot the bill.

Besides encouraging bad choices, government programs often discourage good economic choices, such as investment and personal savings for the future. For example, government programs that cover retirement (like Social Security and Medicare), housing (the low-income housing tax credit), and higher education expenses (Pell grants) discourage saving. Why should people set aside funds for big-ticket expenses such as college and retirement that government says it will pay for? Other government programs—such as Medicaid, which funds health care for the poor—have eligibility rules that encourage individuals to keep their incomes lower in order to qualify.

Does this mean that society and individual citizens should do nothing to help the poor and unemployed? Of course not. But we have to weigh the real economic costs of government-controlled programs, especially income-transfer schemes, against their real—as opposed to promised or imagined—benefits. If lawmakers actually did this, few of these programs would exist in their current forms, since most do more harm than good.

Instead, government spending should focus on some very specific things that can improve our productivity. In some cases, for example, additional spending on infrastructure can reduce transportation costs and increase productivity within the transportation sector, which then permeates much of the rest of the economy.

Government spending on basic research can also increase incomes and productivity in the long run. Basic research is often exceptionally high-cost, is highly uncertain, and typically generates returns many years after the initial investment (think of the space program, for example). These factors discourage the private sector from investing adequately in basic research and provide a rationale for government spending in strategic research areas.

MYTH #3: The federal government should bail out faltering industries and states to revive the economy.

FACT: Bailouts harm the economy because they reward reckless private and state spending, leaving it unchecked and effectively encouraging more of the same in the future.

The Greek philosopher Aristotle once said, “If you want to encourage something, reward it. If you want to discourage it, punish it.” His words ring true 2,500 years later.

Bailouts for private companies usually mean that failing businesses receive taxpayer money, while their more successful competitors do not. Does that make any sense? In the real world, investors seek to put their money where it is most valuable; that is, in companies that succeed, not those that fail. In the alternate world of government bailouts in which lawmakers spend taxpayer money rather than their own, failure is rewarded and success is punished.

With the frenzy of bailouts for private companies, states have tried to hop aboard the federal bailout gravy train to close budget gaps that result from their own overspending. After spending beyond their means, they then argue that it would be in the best interests of their taxpaying citizens to get a bailout from the federal government.

A federal bailout of the states, however, would transfer money from families in states that have resisted extravagant spending programs to other states that have spent more recklessly. This makes no sense.

Imagine you have two sons, Peter and Paul, and you give each a weekly allowance. Paul spends his whole allowance on the first day; Peter budgets so that he’ll have spending money throughout the week. Would you take money from Peter, who saved, to pay Paul, who spent? Of course not. That would not only be unjust; it would teach both boys that careless spending will be rewarded.

In the same way, it’s wrong to force families who have elected responsible stewards in their states to pay for the folly of those in other states who have elected irresponsible spenders.

Moreover, such schemes encourage responsible states to be less responsible next time. When they can simply withdraw whatever money they want from the federal ATM—money that has been earned by families in all 50 states—why bother budgeting responsibly? Their attitude becomes one of spend now, bailout later.

Recent history bears this out. Because most states depend on income tax revenues—which vary a lot from year to year—common sense tells us that they should save during booms to cushion the inevitable recessions. Instead, many states keep responding to temporary revenue surges with new permanent spending programs which leave them in the red when the economy slows.

Between 1994 and 2001, for instance, most states were flush with new revenues. But instead of building up rainy-day funds, many expanded their general-fund budgets. Collectively, they increased spending by 6.2 percent annually. All booms eventually end, however, and these free-spending states were unprepared for the 2002–2003 economic slowdown. Rather than paring back their bloated budgets, they demanded and received a $30 billion bailout from Washington in 2003. Guess what happened next? After the 2003 bailout, states went right back to spending—with states’ annual budget hikes averaging 7.2 percent over the next four years.[3] Encouraging such behavior is not only foolish; it is also wrong.

Congress should resist such bailouts and instead leave state governments to set priorities, make trade-offs, and reduce unnecessary spending. And states that insist on deficit spending should not demand that Washington plunder responsible states on their behalf.

MYTH #4: Public works projects stimulate the economy by creating new jobs.

Fact: In the short run, public works projects have no real effect on overall unemployment. They simply displace resources that could be used to create jobs in the private sector and move those resources to the government payroll.

The myth of public works spending can be best explained by looking at highway spending. In order to spend money hiring road builders and purchasing asphalt, the government must tax or borrow that money from other sectors of the economy. This limits growth in those sectors and crowds out job creation.

Again, this should be common sense. Suppose a family is saving money to build a swimming pool. This would, of course, provide work for the contractors and workers who would build the pool. Now suppose the family learns that they are expecting a new baby. They decide that a swimming pool would be too dangerous with a little one around, and what they really need is an addition to their house. So, instead of hiring people to build the pool, they hire people to build the addition. This provides work for laborers on the addition, but it is instead of, not in addition to, the work that would have been done by the pool builders.

Public works schemes are like this, except that they often do more harm than good. That’s because, like state bailouts, public works projects tend to direct resources to less productive, inefficient projects like “bridges to nowhere” (a boondoggle recently proposed by Congress). Public works projects require significant bureaucracy and red tape, and there is often little accountability and motivation for efficient use of taxpayer dollars. This hinders economic growth, which ultimately is about increasing productivity.

MYTH #5: Tax cuts simply pad the pockets of the rich without helping a weak economy.

FACT: Smart tax cuts encourage work, savings, and investment to help stimulate economic growth that benefits people across the board.

Some argue that cutting taxes and tax rates doesn’t help a weak economy and might even make it worse by increasing deficits. This ignores the way in which people at all income levels benefit when the overall economy grows—which happens when taxes are cut and people have more money in their pockets. As we have seen, government spending does not increase income; it merely diverts income from some people to others.

The United States has what is called a progressive income tax. This means that, as a family’s income rises, so does the rate at which their income is taxed. The last dollar earned is taxed more heavily than the first dollar. This is different than a proportional tax in which taxes would increase proportionally with incomes (see sidebar for further explanation). A progressive system does far more damage to incentives that generate economic growth such as working, saving, and investing.

Progressive taxation is problematic because it decreases the incentive for people to be productive and generate wealth for themselves and the economy. For example, suppose a parent pays a child an hourly wage for helping around the house, but the wage decreases after each hour. The child’s motivation will wither along with his hourly wages.

A progressive tax creates the same problem in the adult world. For the economy to grow, businesses must either produce increasing amounts of goods and services or create new ones. This in turn requires consistently higher investment in new production facilities and technologies and a motivated, productive workforce—therefore businesses and individuals must have financial resources to invest. Yet imposing higher tax rates on the last dollars earned shrinks the amount of money a worker keeps as he creates more value. These taxes discourage all of the wealth-creating activities mentioned above, since the last dollars earned are the ones most likely to be saved and invested rather than consumed.

Think of it this way: You spend your first dollars on necessities like food and rent, which everyone needs; but the more you earn, the more of your additional income you can save and invest—but also the more tax you pay. That’s why lower tax rates on those dollars encourage working and saving, which, in turn, grow the economy.

History confirms common sense. High tax rates were reduced during the 1920s, 1960s, and 1980s. In all three decades, lower tax rates contributed to increased investment, and robust economic growth followed: The economy grew by 59 percent from 1921 to 1929, 42 percent from 1961 to 1968, and 34 percent from 1982 to 1989.[4]

But lawmakers often reject tax cuts and spending restraint that foster long-term economic growth. Instead they propose stimulus gimmicks to “put money in people’s pockets” and “get people to spend money.” They are counting on taxpayers to notice the check in the mail while markets ignore the borrowing that financed the check.

Take past tax “rebates” as an example. Washington borrowed billions from investors and then mailed that money to families. In 2001, typical families received $600; in 2008, it was $1,200. This simple transfer of borrowed money had a predictable effect: The consumer spending rate went up, while investment spending went down. No new income was created because the so-called rebates did not increase productive behavior: No one had to work, save, or invest more in order to receive a rebate. Does anyone really believe that we can improve our economy by borrowing and consuming more and saving and investing less?

In contrast, the 2003 tax cuts reduced unemployment and helped grow the economy since they encouraged long-term productive behavior.[5] But this success was not well reported. By contrast, there has been much more commotion over fake stimulus schemes that only put money in consumers’ pockets for the short run.

Reporters and lawmakers should ask which policies will best encourage the work, savings, and investment needed to expand the economy’s capacity for growth. Such growth benefits not just the rich, but also those looking for jobs, saving for their kids’ educations, or simply hoping to increase their earnings from hard work.

Opportunity for All

“As they say on my own Cape Cod,” President John F. Kennedy was fond of noting, “a rising tide lifts all the boats.” President Kennedy meant that overall economic growth benefits everyone. That’s why one of his major acts as President was to slash the top income tax rate from 91 percent to 70 percent, helping to trigger the increased prosperity of the 1960s.

Government policies can have a huge effect on the U.S. economy—and on the family bank account. Policies that try to transfer income from one group to another are based on myths, not reality. They do far more harm than good. In contrast, if public officials will pay attention to the lessons of history and common sense, avoid short-term “stimulus” gimmicks, and instead enact reality-based economic reforms, they can put the country back on the road to sustained prosperity.

How the flood of regulations hurts Americans

When Regulations Attack

Over the years, George Norris, an elderly retiree, had turned his orchid hobby into a part-time business run from the greenhouse behind his Texas home. He would import orchids from abroad—South Africa, Brazil, Peru—and resell them at plant shows and to local enthusiasts. He never made more than a few thousand dollars a year from his orchid business, but it kept him engaged and provided a little extra money for him and his wife.

George Norris’s life would take a turn for the worse on the bright fall morning of October 28, 2003, when federal agents, armed and clad in protective Kevlar, raided his home, seizing his belongings and setting the gears in motion for a federal prosecution and jail time.

Trade in orchids, you see, is regulated by an international treaty, the Convention on International Trade in Endangered Species (CITES). Though initially conceived to protect endangered animals, it was expanded to include flora as well. The U.S. Endangered Species Act (ESA) was amended in 1981 to include the species listed in CITES, which put George Norris in violation of federal law.

These regulations make orchid trade really complicated, since there are thousands of varieties, many of which are indistinguishable to all but the experts. Ironically, the trade overall may not even endanger the rare varieties, since traders and collectors have every incentive to artificially propagate the plants. So, not surprisingly, there is a thriving black market in the orchid trade.

Norris, however, had spent years following the mind-numbing procedures to trade orchids legally. Still, some paperwork errors eventually put him in the crosshairs of the U.S. Fish and Wildlife Service. It cost him years of his life, his retirement savings, and his faith in American justice system. To avoid greater costs he eventually pled guilty and was sentenced to 17 months in prison, including 71 days in solitary confinement, followed by two years of probation. He and his wife still owe $175,000 in legal fees.[1]

As Norris’s story shows, bad regulations can be truly harmful. They can cost us our time, our money, our freedom, and our dignity. In some cases, they can even cost us our health, our safety, and our life.

When Rules Violate Rather than Protect Our Freedom

A free society needs the rule of law. As C.S. Lewis once said, “There cannot be a common life without a regula [rule]. The alternative to rule is not freedom but the unconstitutional (and often unconscious) tyranny of the most selfish member.”[2]

The best purpose for government is to maintain the rule of law—to preserve and defend those conditions which allow individuals and families to pursue lives of freedom and virtue. Since I have the right to protect myself and my family from theft, murder, and enslavement at the hands of others, I can delegate the defense of that right to the government. Therefore, when the government protects the life, liberty, and property of my family, it allows me to be more rather than less free.

Thus we have the need for laws against such things as murder, theft, and fraud. They’re not much different from the laws inscribed on the second tablet of the Ten Commandments—don’t murder, don’t steal, don’t lie. The problem comes when the rules begin to violate, rather than protect, my rights to life, liberty, and property.

Even rules with a good purpose—such as protecting the environment or defending us from terrorists—can be ill-conceived, putting in place too many limits at too great a cost. Some even can reduce our safety or health even when they’re meant to protect it.

In addition, many rules are simply beyond the government’s proper role. Rather than just protecting our freedom to live our lives under the rule of law, government often tries to decide for us, in detail, how we should live. Instead of being a fair referee, government starts calling the shots. Such interference can take many forms—from deciding how we can educate our children and what medical care we can receive, to restricting what political views we can hear on the radio. For example, through economic rules, it can limit the cars or the clothes you can buy.

Some may think that these are minor restrictions on our freedom. Others might think of them as, at worst, mere nuisances, like the countless documents we need every time we visit the Department of Motor Vehicles. Still others see them as signs of an ever more intrusive Nanny State.

Balance of Power

“If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself.”

—James Madison, Federalist #51

In any case, somewhere along the line, a government that creates too many regulations actually violates the rule of law. This is obvious when the government destroys your livelihood because you made a couple of mistakes on a form—as it did to George Norris. It’s less obvious with the countless regulations that slowly fill the stage sets of our daily lives, one prop at a time—until we start getting crowded off the stage.

Overcriminalization

Overregulation leads to overcriminalization. Overcriminalization occurs when it becomes almost impossible for ordinary, law-abiding citizens to carry on their daily lives without violating some obscure law, thereby incurring the wrath of the government. Such policies end up not only punishing the innocent, but debasing the rule of law.

As we’ll see, it’s possible to be a victim of too many regulations, a victim of a bad regulation, or both.

That’s what happened to George Norris.

The Cost of Regulations

Did you know that for much of its history, the federal government cost every citizen only about $20 a year (in current dollars)? For decades, the only federal employee most people encountered was the mailman. Now the federal government costs each of us about $10,000 a year.

Some 60 agencies have a hand in federal regulatory policy, ranging from the Environmental Protection Agency (EPA) to the Securities and Exchange Commission (SEC) and the Food and Drug Administration (FDA). Together, they enforce over 157,000 pages in the so-called Code of Federal Regulations. Consider that in 1950 this document contained just 9,745 pages. That’s an increase of 1,621%.”[1] To give you a better idea on the amount of paper, think of two stacks of Bibles with really thin pages reaching from the floor to the ceiling in a room with a twelve foot ceiling, and you’ll get the basic idea. But rather than psalms, proverbs, gospels, and epistles, the rules on these pages are meant to protect our health and safety, to protect us from con-men and dangerous jobs, to protect (or suppress) economic competition, and to protect the environment from us.

Some of these regulations are quite helpful. For instance, anti-fraud rules and, arguably, the do-not-call rules for telemarketers[4] actually reinforce individual and property rights. And even while we debate the details, most would agree that we need security rules to protect us against terrorism and environmental rules to keep people from dumping poison on others’ property. Good regulations along these lines, like the rule of law itself, don’t violate our freedom overall. They protect it.

Still, all regulations have a cost. You can think of the total burden of all regulations—good, bad, or indifferent—as a “regulatory tax” imposed on all Americans.

First, there are direct costs. A universal mandate to buy health insurance costs us all the time and money it takes to get the insurance. It also has hidden costs: the extra money we must pay because the government makes us buy it. Since we’re a captive market, insurance companies can charge more than if everyone were free to buy or not buy the insurance.

Then there’s the cost of compliance. Ford Motor Company, for example, has to hire lawyers, accountants, engineers, and other experts simply to fill out paperwork, monitor employees, and so forth, to ensure that it is following the government guidelines. The more regulations, the greater the cost. That cost is money not being spent researching and building better, safer, less expensive cars.

Next is the economic cost on American firms, which now have to compete with foreign firms that are less burdened by regulations.

Finally, there are the “invisible costs.” Even for many economic regulations, the major cost may not be any direct burden placed on consumers or businesses, but constraints on innovation. We can’t assess such losses because we can’t measure the costs and benefits of inventions that never have been invented. We see their value only after the fact. In a high-tech economy, these unmeasurable and unintended costs are perhaps more harmful than the direct, measurable burdens. We’ll talk more about this below.

Of course, there’s no bottom line indicating how much we pay for these regulations. We don’t file regulatory tax forms on April 15. Yet hidden regulatory costs—just the ones we can calculate—are staggering. According to the Office of Information and Regulatory Affairs (OIRA), the White House office responsible for reviewing and tracking federal rules, regulations adopted in the past 10 years cost Americans $34 billion to $38 billion annually.[5] All federal regulations, OIRA states, could be costing Americans 10 times this amount: some $380 billion.

However, these numbers are low compared to estimates prepared by economists for the Small Business Administration.[6] In 2005, they concluded that regulations cost Americans $1.1 trillion. This is almost half of the amount collected in federal taxes and close to the $1 trillion paid in personal income taxes each year.[7] [8] The total cost of regulation is almost a tenth of America’s gross domestic product (a way of measuring the size of our economy) and more than half of the manufacturing sector’s output.

Even these numbers may underestimate the regulatory tax. For instance,
the study by the Small Business Administration does not include indirect costs. A regulation that increases energy costs would also affect other industries that require energy to produce their products.

Now every bill creating new regulations has some appealing name. The “Endangered Species Act” or the “No Child Left Behind Act” are good examples. Who wants to wipe out a species of animal or leave a child behind? Behind the glossy advertising, however, is always a hidden cost. In some cases, the costs of a regulation outweigh the benefit, whether hidden or unhidden. Whenever that happens, we have overregulation.

Economically, overregulation reduces economic growth, slows job growth, and reduces our income. It varies depending on the type of regulation,[9] of course, but the effect is clear. A recent World Bank study of regulation around the world revealed the connection between economic growth and regulation, finding that “[h]eavier regulation is generally associated with . . . more unemployed people, corruption, less productivity and investment.”[10] At the same time, the authors did not find a correlation with better quality of private or public goods.

The costs are not just economic. As we’ll see, regulations can—and often do—reduce our health and safety as well.

How We Get Regulations

The federal government restricts what we do through both legislation and regulation. It all starts when the U.S. Congress writes, debates, and sometimes eventually passes a bill (also called legislation) such as the Endangered Species Act. When the President signs the bill, it becomes law. That law may state broad goals, and then empower various government agencies to create, implement, and enforce various regulations intended to accomplish those goals. A single law, therefore, can lead to hundreds or even thousands of regulations, which may or may not accomplish the goals of the original legislation.

Deregulation: Trying to Trim the Fat

Since even good regulations can become obsolete and since bad regulations do more harm than good, we have to learn to trim the fat.

Risk and Riskier

It’s wise to think through the unintended consequences of a regulation. In the real world, however, there’s no such thing as zero risk—only more or less risk. So the relevant question for any regulation is one of prudence, not perfect safety: Given the likely consequences of a regulation, do its anticipated benefits outweigh the costs? Is the gain worth the risk?

For instance, everyone knows it’s safer for airline passengers flying through turbulence to wear their seat belts. For years, the American Academy of Pediatrics has called on the Federal Aviation Administration (FAA) to mandate that infants under two be belted on commercial flights.[11] So why does the FAA still allow parents to hold young infants—unbelted—on their laps? It’s the product of thoughtful analysis by federal regulators about the unintended effects of mandating seat belts (and so extra seats) for infants. Here’s how the FAA has explained the policy:

Analyses showed that, if forced to purchase an extra airline ticket, families might choose to drive, a statistically more dangerous way to travel. The risk for fatalities and injuries to families is significantly greater on the roads than in airplanes, according to the FAA. [In 2004] nearly 43,000 people died on America’s highways as compared to 13 on commercial flights.[12]

Even the American Academy of Pediatrics admits that “the risk of death or serious injury in an aircraft is exceedingly small.” In fact, from 1981 to 1997, there were only three reported deaths from injuries due to turbulence on commercial flights.[13]

Still, flying with an infant on your lap puts the child at some risk. So mandating infant seat belts on planes might save a few lives. Nevertheless, the unintended cost in lives of such a mandate vastly outweighs the benefits. Therefore, the FAA only urges but does not mandate seats for infants.

Since the 1970s, Presidents of both parties have tried to control the growth of new regulations, creating various agencies and initiatives to weigh their costs and benefits.[14]

In some cases, entire industries, such as the airline and telecom industries, have even been “deregulated.” Still, overall, these efforts have met with only limited success.[15]

Even when the government tries to look at the trade-offs of current and proposed regulations, the regulatory state has a way of growing anyway. That’s because legislators have a bias toward overregulation.

Why? Regulations, especially mandates, look cheap or even “free” from a budgetary standpoint, in contrast to programs that must be funded. Making everyone buy health insurance, for instance, seems less extravagant than taking over the entire health care industry, and attaching a huge payroll tax to pay for it all. The mandate isn’t free of course; it’s just moved from the federal budget to the budgets of individuals and families.

What is Seen and What is Not Seen

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

“Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”

—Frédéric Bastiat[16]

More generally, the problem is the unseen cost of regulation. With regulations, the political focus is most often put on the “seen” effect, and the “unseen” costs are hidden from the public eye.

People see fuel shortages, pollution, and rising fuel prices, for instance. These evils may inspire legislators to force automakers to improve fuel standards. But the legislation may unintentionally lead to the deaths of thousands of people, as car companies make smaller cars that have better fuel economy but lower safety standards.[17] The legislators still get political points for “protecting the environment,” as long as voters don’t see the connection between the new regulation and the increase in deaths.

A Brief Miscellany of Bad Regulations

A quick Google search of “bad government regulations” can provide weeks of disheartening reading. Let’s consider just three bad regulations, as a sort of representative sample.

Withholding Treatment: Approving New Drugs and Medical Technology

The dilemma of the seen and unseen is especially acute when it comes to medical regulations.

One of the most spectacular achievements of American ingenuity over the past 50 years has been the development of medical devices and drugs that prolong life and improve health. From pacemakers to self-monitoring blood glucose kits and insulin pumps, new medical technology has saved the lives and improved the health of millions.

In the U.S., cardiovascular disease is the leading cause of death and disability. In recent years, though, new drugs and improvements in medical technology have improved survival rates significantly. Among the key innovations for treating heart disease are medical devices like implantable cardiac defibrillators that can treat deadly [irregular] heart rhythms and lower the risk of dying by up to 50 percent in some patients who have heart disease.

Stroke is the third leading cause of death in the United States and the leading cause of adult disability; in just the last 20 years, though, deaths from strokes have dropped from 36 percent. The major sources of improvement are new drug therapies as well as advances in brain and vascular imaging technology, which allow doctors to diagnose and treat patients more quickly.

The benefits from advances in health technology are clear. From 1980 to 2005, the annual death rate declined by over 23 percent while life expectancy from birth increased by 4.1 years. And from 1980 to 2000, disability rates for Americans over 65 declined by almost 25 percent.[18]

As in other areas, with medical regulations, unintended consequences can be hard if not impossible to see. Legislators and voters see the deaths resulting from complications with a drug, for instance, even if there’s “only” one death for every one million people who take the drug. So, in response to a few tragic deaths, legislators may push through new regulations that make it much more difficult to bring life-saving new drugs to market.

Pharmaceutical companies spend years on research and development, and hundreds of millions of dollars to get just one drug through the regulatory maze of the Food and Drug Administration (FDA). One estimate puts the cost at $806 million and 12 to 15 years for just one drug to go from conception to the drug store.[19] Well-meaning regulations can delay release and discourage risk and innovation with tragic consequences. One study followed the journey of Misoprostol, a drug designed to prevent gastric ulcers caused by aspirin. After years of logjams, the FDA finally approved the drug in 1988. In some other countries, in contrast, Misoprostol was available in 1985. Using the FDA’s own numbers, Sam Kazman of the Competitive Enterprise Institute determined that the delay of this one drug cost more than 20,000 American lives.[20]

Why do such things happen? Counterproductive, even deadly regulations persist in part because legislators, regulators, and activists get credit for the few visible lives saved, but don’t get the blame for thousands of lives lost. From a regulatory perspective, the thousands of deaths are invisible. A few deaths from an “unsafe” drug will make national headlines, and someone will get the blame. Few notice the thousands of otherwise preventable deaths from overregulation.

Let’s Throw a Little More Gasoline on that Fire: The 2008–2009 Financial Crisis

The 2008–2009 financial crisis has led many pundits and politicians to blame deregulation of the banking industry. What solution do they propose? More regulation. No doubt some regulations need to be reformed.[21] But many of these simplistic calls for “more regulation” are wrongheaded and potentially devastating.

First of all, banking is already one of the most regulated industries on the planet. Second, one of the many causes of the financial crisis was misguided government policies, that is, bad regulation.

The details are complicated, but the basic outline is pretty straightforward.[22] For years, government policies encouraged lenders to lower their standards for people qualifying for mortgages. The reason for these policies was to make home ownership more affordable for lower-income families.

A couple of government-sponsored enterprises, Fannie Mae and Freddie Mac, fanned the flames by purchasing risky housing loans with the (sadly correct) expectation that if they got into trouble, government would bail them out. That encouraged lenders to be lax in lending since they could easily sell their risky loans to someone else. A freer market would have discouraged such risky behavior.

This amounted to a government subsidy for risky home loans. And just as passing out vouchers to buy cars will drive up the cost of cars, this government subsidy for home loans inflated the cost of housing and encouraged many to buy homes that they could not afford.

There’s more to the story than this, but one thing is clear: Deregulation did not cause the 2008–2009 financial crisis. Bad government policy did.[23]

“Shoot, Shovel, and Shut Up”

The Endangered Species Act (ESA), which became law in 1973, is often credited with saving many species of animals and plants. But of the more than 1,200 plant and animal species designated as “endangered” or threatened, only 15—such as American alligators and gray wolves—have ever been “delisted.” Why this lack of success in bringing species back from the brink? One reason may be that the act unintentionally drives landowners to destroy habitats for endangered species rather than preserve them.

Under the ESA, the federal government can restrict landowners’ use of their property if a listed species’ habitat is discovered there.

Imagine a struggling Ohio corn farmer who discovers a certain wild lupine plant growing on the edges of his farm, populated by a few pretty blue butterflies. He decides to do a little research online and discovers that the Karner Blue butterfly, which is a designated endangered species, will only eat lupine like that growing in his field. With a little more searching, he finds that the government could designate his land a “butterfly habitat” and restrict him from farming on a large part of his land. Given the incentives, how likely is he to report his discovery to the U.S. Fish and Wildlife Service? Not very. And probably neither the lupine nor the pretty butterfly will make an encore appearance on his land.

One Texas cattleman put the matter plainly:

A landowner in his right mind would sooner welcome flesh-eating zombies onto his property than endangered species…. A man takes real good care of his land, some endangered species moves on there, and what’s his reward? The federal government coming in and restricting his ranch operations, that’s what.[24]

Obviously he’s much more likely to “shoot, shovel, and shut up.” In the summer of 2006, citizens implemented a variant of this policy, “saw, shovel, and shut up,” on a large scale in Spring Lakes, North Carolina. Audubon magazine described an epidemic of “chain-saw fever,” which launched the area’s “otherwise laid-back citizenry into a paroxysm of clear-cutting that reduced miles of shady, wooded lots to stumps and scorched white sand.” Who caused the frenzy? The U.S. Fish and Wildlife Service, when it announced its plan to update maps of trees in the area. Those trees happened to be the preferred nesting areas for endangered red-cockaded woodpeckers. Upon hearing the news, the landowners decided to make sure their pine trees did not get “’infested’ with wood-peckers,” which would bring down the regulatory zeal of the feds.[25]

This is a shining example of a bad regulation. Intended to protect endangered species, its real world outcome is sometimes just the opposite.

Fixing the Problems

There are often market-based solutions that work as well or better than a regulation. Often called “deregulation,” market-oriented solutions harness competition, better access to information, consumer choice, and market prices to shape desirable outcomes. Unfortunately, these solutions often take more thought, restraint, and political will than simple regulations, even if the regulations do the opposite of what they’re supposed to do.

As mentioned above, in the past we have successfully deregulated entire industries, such as telecommunications and the airlines.

The telecommunications industry was basically a government-enforced monopoly at one time (90 percent of long-distance revenues went to AT&T in 1984.) From 1984 to 1996, equipment and local and long distance service were all deregulated to one degree or another. Critics warned that chaos would ensue. In contrast, scores of start up companies emerged to compete with the monopoly, and we now have many more choices, much better service, and much lower prices.

The airline industry also was heavily regulated until 1978. Routes and prices were set by a government agency, not by consumer choice. Despite warnings of danger from opponents of deregulation, introducing market competition led to more choices and lower prices. Travelers today can buy an airline ticket for about half the price that they could in 1968 (adjusted for inflation).[26] And airlines have not become less safe as a result. Such is the power of the market.

In still other cases, transforming the role of regulatory agencies may be in order. To solve the problems resulting from delays in FDA drug approval, economist David Henderson offers this suggestion:

Pare back the FDA’s powers to that of an information agency. Require that any drug marketed without FDA approval tout that fact in big letters. And let us make our own trade-offs. Then those who want to avoid all drugs not certified by the FDA can do so; the rest of us can rely on the American Hospital Formulary Service or other private certifiers and thus have wider choices. Those who stuck with FDA certification would be no worse off. Those who tried non-FDA-approved drugs would be, by their standards, better off.[27]

Policy experts have proposed all sorts of creative ways to fix bad regulations. But politicians probably won’t implement them until we citizens—that includes you—hold them accountable not just for visible benefits of regulations, but for their invisible costs as well.

To read more on these topics, see:

• James L. Gattuso, “Reining in the Regulators: How does President Bush Measure Up?” Heritage Foundation Backgrounder No. 1801, September 28, 2004, at http://www.heritage.org/research/regulation/bg1801.cfm.
• James L. Gattuso, “Red Tape Rising: Regulatory Trends in the Bush Years,” Heritage Foundation Backgrounder No. 2116, March 25, 2008, at http://www.heritage.org/Research/Regulation/bg2116.cfm.
• James L. Gattuso, “Meltdowns and Myths: Did Deregulation Cause the Financial Crisis?” Heritage Foundation WebMemo No. 2109, October 22, 2008, at http://www.heritage.org/Research/Economy/wm2109.cfm.
• David C. John, “The Obama Financial Regulatory Reform Plan: Poor Policy and Missed Opportunities,” Heritage Foundation WebMemo No. 2545, July 15, 2009, at http://www.heritage.org/Research/Regulation/wm2545.cfm.
• Thomas Sowell, The Housing Boom and Bust (New York: Basic Books, 2009).
• Andrew M. Grossman, “The Unlikely Orchid Smuggler: A Case Study in Overcriminalization,” Heritage Foundation Legal Memorandum No. 44, July 27, 2009, at http://www.heritage.org/Research/LegalIssues/lm0044.cfm.
• John D. Graham, “The Perils of the Precautionary Principle: Lessons from the American and European Experience,” Heritage Foundation Lecture No. 818, January 15, 2004, at http://www.heritage.org/research/regulation/hl818.cfm.
• Brian M. Riedl, “Ten Myths About the Bush Tax Cuts,” Heritage Foundation Backgrounder No. 2001, at http://www.heritage.org/Research/Taxes/bg2001.cfm.
• Bill Beach, Rea Hederman, and Tim Kane, “The 2003 Tax Cuts and the Economy: A One-Year Assessment,” Heritage Foundation WebMemo No. 543, at http://www.heritage.org/Research/Taxes/wm543.cfm.
• Daniel J. Mitchell, “The Impact of Government Spending on Economic Growth,” Heritage Foundation Backgrounder No. 1831, at http://www.heritage.org/Research/Budget/bg1831.cfm.
• Jay W. Richards, Money, Greed, and God: Why Capitalism is the Solution and Not the Problem (HarperOne, 2009), chapters 3 and 4.
• The Heritage Foundation’s 2009 Index of Economic Freedom, at http://www.heritage.org/index/.