Justice Antonin Scalia — RIP

I did not know Antonin Scalia, who passed away unexpectedly February 13 at the age of 79.  I did, however, have the opportunity to meet the Supreme Court justice from time to time at Federalist Society events in Washington, but only long enough to shake hands and exchange pleasantries.  More significantly for me in remembering Justice Scalia is the dramatic impact he had on the law.

Largely in the 1980s — and spurred in significant measure by then-Attorney General Edwin Meese — conservative and libertarian legal scholars began to formalize the study and key principles of the judicial philosophy known as “originalism”  Originalism holds that a judge should seek to interpret the Constitution solely on the basis of the meaning that its drafters (including the drafters of amendments) had at the time of the drafting.  Justice Scalia, who took his seat on the Court in 1986, was an originalist, and by dint of his appointment, was in a position to bring that judicial philosophy to bear on actual law.  He did so with great effect over the course of nearly 30 years on the Court.  Today, even those justices and lower court judges who do not subscribe to originalism must be prepared to account for it and be able to defend their constitutional law opinions in the face of it.

Importantly, originalism is not a single idea with firm boundaries.  Over the years, legal scholars have developed various strains of the philosophy.  Justice Scalia self-identified as a “textualist,” by which he meant that he looked principally, if not solely, at the text of the provision of the Constitution that he was interpreting.  In so doing, he looked to the meaning of the words as they were understood at the time that they were written  Although with considerable overlap, another strain of originalism has taken on currency today as well.  This strain holds that, to give proper meaning to the words of the Constitution, one must read them within the context of the natural law and natural rights principles found in the Declaration of Independence.  That is, the natural rights principles in the Declaration informed the Constitution’s drafters understanding of what they were writing, and thus must similarly inform subsequent judges who are interpreting the document.  Some believe that Justice Clarence Thomas represents this originalist perspective.

Significantly, Justice Scalia applied his textualist brand of originalism with equal vigor to statutory interpretation.  Here too he sought to examine only the words within the four corners of a statute to find its legal force.  He considered such things as “legislative intent” — derived, for example, from the record of congressional debate — to be extraneous material and therefore not to be consulted by judges.  One of the more celebrated recent examples of his application of textualism is his dissent last year in King v. Burwellthe case upholding the Internal Revenue Service’s interpretation of the word, “Exchange,” within the meaning of the Affordable Care and Patient Protection Act, i.e., “Obamacare.”  In that case, the Court’s majority, in an opinion written by Chief Justice John Roberts, found it proper to define “Exchange” on the basis of the spirit and intent of the statute.  In stark contrast, Justice Scalia read the words of the statute literally and, in uniquely Scalia-esque language, vigorously critiqued the majority’s departure from those words.  (If readers are interested in more detail, I have written on that case and Justice Scalia’s dissent here.)

Last Friday, along with thousands of others, I was honored to be able to pay my respects to the late justice as he lay in repose in the Great Hall of the Supreme Court building.  As I exited the building, a reporter asked me about my impressions.  The brief interview with me and his story about the day can be found here.

 

 

Economic Libertarians Will Have a Friend in Ted Cruz

[This post was originally published in American Thinker magazine on Feb. 11, 2016]

In considering the current crop of presidential candidates, economic libertarians and others who place a high value on property rights, the right to earn a living, and the right to open a business will find no better friend than Texas Senator Ted Cruz.  Cruz demonstrated his commitment to these values when he was a senior official at the Federal Trade Commission during George W. Bush’s Administration.  Significantly, his work at the FTC established a foundation on which the cause of economic liberty progresses still today.

Leading a team of senior FTC lawyers, Cruz used his considerable advocacy skills to fight relentlessly against state laws conferring privilege on politically and economically powerful interest groups.  Many of these laws do little more than protect entrenched incumbents from small entrepreneurs seeking to open a business and earn a living.  Cruz and his team vigorously opposed unjustified state government privilege in such diverse occupations as attorneys, funeral directors, opticians, and mortgage brokers.  The goal was always to open up markets to entry by anyone with the talent and desire to compete on a level playing field.

The legal theories that Cruz and his team developed from 2001 – 2003 continue to pay dividends.  For example, last year those theories helped secure economic rights for small entrepreneurs providing teeth whitening services in North Carolina shopping mall kiosks and similar venues.  These entrepreneurs entered this service market coincident with the growing popularity of teeth whitening in the mid-2000s.  Practicing dentists in the state also offer teeth whitening services, but generally at much higher prices than the small operators.  As a result, the new competitors began taking business away from the incumbent dentists.

In response to this emerging competition, the North Carolina State Board of Dental Examiners (NCSB), a North Carolina state-sanctioned agency controlled and elected by practicing dentists and charged with regulating the practice of dentistry, sent letters to the small operators threatening them with potential criminal liability for the unauthorized practice of dentistry.  The letters effectively closed down the new competitors.  Significantly, North Carolina law did not include teeth whitening in the statutory definition of dentistry, nor was there credible evidence that non-dentists offering whitening services created a significant health or safety hazard.

In 2010, the FTC filed an antitrust complaint against the NCSB charging it with unlawful collusion to exclude the non-dentists from the teeth whitening market.  After an administrative hearing, in 2011 the full Commission found the NCSB’s tactics to violate antitrust law.  Key to that finding was that the NCSB did not conform to proper procedures under North Carolina law and was largely motivated by a desire to protect incumbent dentists’ economic interests.  The FTC ordered the NCSB to stop sending the threatening letters, to send new letters to previous recipients admitting error and rescinding the earlier threats, and to notify prospective non-dentist teeth whiteners that they would not be violating the law.

Relying on a 1943 Supreme Court decision holding that state actions to suppress competition are immune from the federal antitrust laws under the constitutional principle of federalism, which provides for both state and national sovereignty, the NCSB went to federal court arguing that, as a state agency, it had sovereign immunity and therefore was not bound by the FTC’s findings.  Armed with the legal theories that Ted Cruz and his team developed, which were later memorialized in a formal Report, the FTC defended the constitutional legitimacy of its antitrust suit all the way to the Supreme Court.  In an opinion handed down just a year ago, the Court held that, although a creature of the state, the NCSB nonetheless was a non-sovereign body, being controlled by private parties and elected by market participants, and acted without significant state supervision. It therefore did not enjoy state action immunity from the federal antitrust laws.  The FTC’s prior finding of unlawful anticompetitive conduct thus stood, as well as its order enjoining the NCSB from prohibiting non-dentists from competing in the North Carolina teeth whitening market.  In other words, property rights, the right to earn a living, and the right to open a business prevailed.

Without Ted Cruz’s earlier efforts to develop the legal theories used by the FTC to defend the constitutionality of its antitrust suit, it is doubtful that these important values could have been protected in the face of politically powerful local interests.  What’s more, this important clarification of the law has led to increased scrutiny of state-sanctioned boards in other states, thus further securing economic liberty rights against the politically connected.

For example, just last month, relying on the FTC’s 2015 win, an antitrust action was filed against the Nevada State Board of Pharmacy, an administrative agency of the state.  The complaint contends that that the Board exceeded its authority in finding direct shipment of pet medicines unlawful.  The effect was to exclude the plaintiff, a direct shipper, from competing with incumbent pharmacists, allegedly because such competition would mean a loss of business for the incumbents.  Similarly, resting on the NCSB decision, a Texas telemedicine business brought an antitrust suit against the state’s medical board, alleging that the board promulgated a rule for the unlawful purpose of protecting state-licensed physicians against competition from telemedicine providers.  The rule prohibits doctors from treating people over the telephone.  The court issued a temporary injunction requiring the medical board to suspend the rule pending the outcome of the litigation.  In North Carolina, after the NCSB decision, LegalZoom settled a long-running dispute with the N.C. State Bar over whether its online provision of certain legal documents constitutes the unauthorized practice of law.  The settlement permits LegalZoom now to offer these documents, subject to certain conditions.  

What all these developments say is that Ted Cruz’s FTC legacy continues to have positive results in advancing the cause of economic liberty.  Much work, however, remains to be done, as government privilege persists at both the state and federal level.  Contrary to maintaining the status quo, a Cruz Administration will assuredly expand the fight for economic liberty by using all legitimate means to challenge such government privilege.  Based on Ted Cruz’s history, economic libertarians can be confident of that commitment and would do well to support the Texas Senator in his presidential quest.

[Full Disclosure:  Senator Cruz and I were colleagues at the FTC from mid-2001 to 2003.]

The Federal Reserve and the Inflation Tax

[This post was originally published in American Thinker magazine on Feb. 6, 2016.]

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens.  No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Just last Monday, speaking in New York to the Council on Foreign Relations, Federal Reserve Board Vice Chairman Stanley Fischer reiterated the Fed’s long-standing position that monetary policy should achieve an annual rate of price inflation of two percent.  This targeted inflation is specifically in consumer prices.  As anyone with common sense understands, such deliberate price inflation amounts to a tax on income earners, savers, and holders of cash assets — essentially all Americans.  Moreover, this two percent tax falls on top of all other properly enacted taxes.  The consequences are severe.  An annual two percent inflation rate means that the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

Under what authority does the Fed have this power to tax? Ostensibly it derives from the so-called “dual mandate” that Congress assigned to the Fed in 1977 when it passed the Humphrey-Hawkins Act.  At that time, Congress told the Fed that its job is to promote maximum employment and stable prices.  To most people, stable prices means, well, stable prices, i.e., no price inflation.  Torturing the English language, however, the Fed defines stable prices to mean its targeted two percent inflation rate.  The Fed holds that maintaining this rate satisfies the price stability prong of its dual mandate.

The economic theory justifying this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianism”). This theory holds that economic well-being and prosperity come about through spending.  Therefore, spending, and especially consumer spending, must be encouraged.  Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective.  People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too.  Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

Another factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately.  By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure.  Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover.  Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate.  This asset inflation, according to the modern thinking, produces a wealth effect that also encourages spending.  That is, stockholders see their investments rise in nominal value, feel richer, and spend more.  In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses.  Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher nominal GDP and full employment.

So goes the modern Keynesian story. The core premises of the story survive despite the historically slow recovery of the economy in the aftermath of the 2008 financial crisis.  In fact, even allowing for fiscal policy failures, the evidence since 2008 is that monetary policy has done little to benefit middle and lower-income Americans by comparison to wealthier Americans with significant holdings of financial assets.  Still, the Fed persists in its desire to tax Americans by boosting inflation through artificially low interest rates and perhaps even another round of quantitative easing.

Nonetheless, there are several grounds on which to question the soundness of the Fed’s inflation tax. First, even taking the Fed’s monetary theory as valid notwithstanding its failures, no prominent economist of which I am aware has explained why two percent is the appropriate inflation rate to target.  Why not three percent?  Or, one percent?  In fact, there is nothing in the analytics of the theory itself that determines this precise rate.  At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the guesswork of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth.  It is the basis for productivity gains in the economy.  Capital accumulation, however, requires saving to finance the new capital.  By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be.  Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a lasting social cost.

Third, according to the Bureau of Labor Statistics, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%.  This means that the value of the dollar has dropped by over 95%.  This record is hardly one to be proud of.  More significantly, it shows just how severe an inflation tax is over time.

Fourth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This result comes about in two ways.  First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year.  Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect.  Second, the inflation tax encourages debt-taking.  Debtors are rewarded by inflation by being able to pay back loans with cheaper money.  As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates.  With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, a court is unlikely to find the Fed’s desired tax on the American people to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Therefore, removing this taxing power will require legislation, a doubtful prospect.  Even so, in this political season, it might not be too much to ask that the presidential candidates weigh in on the topic.  Monetary policy being arcane to most in the media, however, I am not optimistic that the people will get answers.  

 

Janet Yellen and the Power to Tax

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens. No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Janet Yellen, Chairwoman of the Federal Reserve Board, evidently has determined that she is a virtual member of the House of Representatives, and, in fact, holds a controlling position. She and the other members of the Federal Open Market Committee have publicly and repeatedly stated their desired intention to use monetary policy to achieve a continuous inflation rate of two percent a year. The targeted inflation is specifically in consumer prices. This means that Ms. Yellen has decided that income earners, savers, and holders of cash assets should be taxed annually an additional two percent. At this rate, the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

The theory behind this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianim”).* The theory holds that economic well-being and prosperity come about through spending. Therefore, spending, and especially consumer spending, must be encouraged. Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective. People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too. Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

A key factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately. By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure. Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover. Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate. This asset inflation, according to the modern Keynesians, produces a wealth effect that also encourages spending. That is, stockholders see their investments rise in nominal value, feel richer, and spend more. In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses. Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher GDP and full employment. So goes the modern Keynesian story.

It is the story that continues to be taught in mainstream economics Ph.D. programs, and it is the story to which most prominent macroeconomists adhere. It is also the story most prevalent in the financial media. The core premises of the story survive despite the continuation of boom and bust cycles. Indeed, even the severity of the 2008 financial crisis and the historically slow recovery in its aftermath have done little to crack the edifice of modern Keynesianism.

Even so, there is a growing heterodox literature attacking this edifice and, in particular, the performance of the “Fed.” Much of this literature focuses on the period since the end of the Bretton Woods gold-exchange standard, which President Nixon jettisoned in 1971. Mr. Nixon’s decision made the dollar a full-fledged fiat currency and opened the door for the Fed to engage in wide ranging monetary discretion. This critical literature is too voluminous to discuss here. I will, however, set out a few reasons as to why I believe the prevailing paradigm should be abandoned.

First, even taking modern monetary theory as valid notwithstanding its failures, I am not aware of any explanation from Ms. Yellen, any of her fellow FOMC members, or any prominent macroeconomist as to why two percent is the appropriate inflation rate to target. Why not three percent? Or, one percent? Or, one and a half percent? As far as I know there is nothing in the analytics of the theory itself that determines this two percent. It seems to be nothing more than a preferred fancy of the monetary policy elites.** At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the whims of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth. It is the basis for productivity gains in the economy. Capital accumulation, however, requires saving to finance the new capital. By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be. Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a severe and lasting social cost.

Third, by most any measure, the Fed has historically performed poorly in taming the business cycle or making booms and busts less frequent. In fact, internal instability is built into modern monetary policy. Two factors, in this regard, are noteworthy. First, because the interest rate is one of the most important prices in any economy, its manipulation by the Fed creates massive price distortions and makes asset price discovery far more difficult. As a result, much malinvestment occurs. Such malinvestment ultimately has to be liquidated during a subsequent bust. Second, even if wages adjust more slowly than prices in the short term, they must eventually catch up to prices as pressures toward economy-wide equilibrium take hold. The boom therefore rests on an unstable platform. It can only persist if prices continue to outpace wages, an unlikely event.   The bust must inevitably follow.

Fourth, it is noteworthy that, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%, meaning that the value of the dollar has dropped by over 95%. (This information comes from the Bureau of Labor Statistics and can be viewed here.) That is hardly a record to be proud of. What is more, it shows just how severe an inflation tax can be over time.

Fifth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This comes about in two ways. First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year. Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect. Second, the inflation tax encourages debt-taking. Debtors are rewarded by inflation by being able to pay back loans with cheaper money. As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates. With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, Janet Yellen’s tax on the American people is unlikely to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Moreover, the Federal Reserve System, although a creation of the government, does not itself operate as a government agency. Therefore, short of amending the Fed’s enabling legislation and taking away its independence to manage monetary policy, there is likely little the people can do to avoid the Yellen tax. Even so, I think it is important that people at least know that the tax exists.

______________________________________

* For simplicity, I will use the term, “modern Keynesianism” herein to mean this synthesis. In so doing, I neglect the fiscal policy side of Keynesianism, which is not relevant to my discussion.

** Incidentally, this whim is worldwide. Mario Draghi, the head of the European Central Bank, similarly has stated his determination to maintain a two percent inflation rate. Not uncoincidentally, Mr. Draghi was American-trained at MIT and is well ensconced in the modern monetary paradigm.

Hello World!

Welcome to Liberty & Markets, my personal blog site.  I hope that you enjoy my commentary on legal, economic, and political issues of the day.  If you would like to know more about me and my background, please click on the About page on the opening screen.  Theodore A. Gebhard.