The Toxic Populism of the Democrats

Richard Epstein*

Richard Epstein

Richard Epstein

As his campaign roars into New York State, Bernie Sanders has been on a roll. He has won eight of the last nine primary contests, most recently the ones in Wisconsin and Wyoming. His impressive performance has emboldened him to take on Hillary Clinton in her adopted home. Sanders has attracted wildly enthusiastic audiences by pushing his program of economic populism. He loudly proclaims that, unlike Clinton, he has never received support from Wall Street or corporate interests—and that his impressive financial support comes from tens of thousands of small contributors, each of whom shares his vision. If elected president, he points out, he would be held accountable to these supporters and will make good on his program that includes massive tax increases largely targeted at the super rich. The effectiveness of his campaign is measured by the extent to which it has forced Hillary Clinton, not a person of deep principle, to veer sharply to the left in order to secure the nomination, after which, if successful, she will have to lurch back to the center in order to gain the presidency. He is the populist hero. She has become his pale imitator.

What is most frightening about their Democratic populism is the manifest weaknesses of its underlying arguments. Any complex political issue will always present a fair share of economic and social trade-offs, which makes it imperative for a serious candidate to see both sides of a given question. That degree of caution, however, is nowhere present in the position papers of either Sanders or Clinton, neither of whom ever addresses the downsides of their proposals. Like most populists, both are far better at denouncing the current state of affairs than in explaining the plusses and minuses of their own plans.

In this regard, income inequality is for both candidates the bellwether issue of our time. On his website, Sanders begins his own treatment of the topic by trumpeting the high level of income inequality in the United States, a point on which Clinton quicklyfollows suit. But there are only two ways in which to reduce the level of income inequality: either by lifting the bottom earners up or by pulling the higher earners down. Both candidates, it seems, are insistent in trying the latter route. But both ignore the simple truth that it is a lot easier to destroy wealth by government fiat, and far harder to create it, given the law of unintended consequences. Sanders and Clinton suffer from the fatal delusion that they can ignore the responses that private parties will take when hit by a new round of taxes and regulations.

To give but one example, the Obama Administration’s Department of Labor has proposed increasing the number of workers covered by the overtime provisions of the Fair Labor Standards Act. It will extend its protections to all workers who earn under $50,440—more than double the current level of $23,660. Needless to say, this proposal gets Clinton’s support as another example of “fair growth.” But as Donald Boudreaux and Liya Palagashvili point out in their recent Wall Street Journal Op-Ed, the most likely effect of this policy is that employers will reduce the base wage of covered workers to offset the increased overtime costs, at which point everyone will be left worse off than before. As is usually the case, “fair growth,” like “fair trade,” turns out to be an oxymoron.

The explanation for this outcome runs as follows. Any shift in required compensation formulas, let alone one that could impact as many as 5 million workers, is costly to put into place, and those compliance costs could require firms to scale down their operations, raise their costs, and ultimately result in them receiving a reduced net income, which also reduces net revenues to the government. But nothing will be gained from these increased costs. Instead, the impacted firms will take steps to reclassify workers in ways that will minimize the brunt of the burdens, or introduce new technologies that will reduce the number of jobs that are subject to overtime wages. The one thing that will not happen is a simple wealth transfer of dollars from firms to lower or middle-income employees. Instead, the size of the pie will shrink and the distribution of those losses will be hard to project in advance, given the many different firm structures to which the rule applies.

Nor is it sensible to justify this sharp bump by noting, as is surely the case, that the number of workers covered by these overtime rules has dropped from about sixty percent in 1975 to under eight percent of workers today. Before that argument can be made, it is necessary to explain why the high level of overtime wages put into place 40 years ago under the FLSA counted as a social benefit when it reduced flexibility in labor markets. From its inception, the Fair Labor Standards Act (FLSA) created a massive interference in the operation of labor markets, to which the proper social response is to slowly shrink via administrative inaction the number of workers who are affected by its provisions. The same argument applies to virtually every proposed labor reform that seeks to provide workers with wages that are not backed by productivity gains, which only free markets, not government mandates, can supply. It is easy for both Clinton and Sanders to lament the fate of the shrinking middle class. But both of them need to recognize that their own aggressive policies that interfere with labor markets will only compound the difficulties that they see.

The same kind of woolly thinking is behind both of their proposals to deal with the unfair distribution of income through steeper progressive taxation. The typical indictment begins by noting that the ever larger share of wealth that is taken up by the top one percent, or even the top one-tenth of that one percent. But it is quite another thing to supply the explanation for why this has happened. In this regard, no one factor begins to explain the consistently slow rate of growth in the United States. But it is at the very least unnerving that the rise in regulation and taxation have been followed, as the night follows the day, by lagging overall growth and the declining income of Americans clustered in the middle of the income distribution. But it is a far cry from that to say, as Sanders does, that “Wall Street and the billionaire class has rigged the rules to redistribute wealth and income to the wealthiest and most power people of this county.”

If true, these billionaires have not been very good in executing their master plan, given that their share of public expenditures is far higher than their share of income. The top one percent earns 17 percent of the wealth in the United States, but it also pays about 45.7 percent of all individual income taxes, a fact that never made it into the Sanders’s broadside. Yet, just think what would happen if these incomes fell in response to higher levels of taxation. Our entire system of redistribution depends on not killing the goose that lays the golden egg. However, the effort to squeeze a few more percentage points of income from the highly wealthy runs the risk of reducing their income, thereby eliminating the high marginal tax rates paid on their current top dollars of income. At present, there is, if anything, good reason to reduce taxation rates in order to expand the tax base, yielding both higher incomes for current citizens and more revenues for the government.

That is not likely to happen with either the individual tax rates or the U.S. corporate tax rates, which are the highest in the industrialized world. Corporations, like individuals, respond to incentives, making it all too understandable why large American ones like Pfizer are seeking through inversions to set up operations overseas. As Pfizer CEO Ian Read notes, inverting is necessary to allow them to compete on even terms for investments dollars in the United States. Just allowing the tax-free repatriation of foreign dollars already taxed into the United States would put an end to the inversion movement. But no, the fatal miscalculation to tax corporations on their income earned overseas, a policy unique to the United States, is defended by Democratic populists, even as it puts American corporations at a comparative disadvantage in their home court.

More generally, it is a deep danger sign when any country seeks to limit the exit options of its citizens and corporations. Squelching exit options is a sure sign that the domestic scene is out of whack for the United States in 2016, as it was for East Germany in 1961. The point here is no different from that with free trade, and the fear that American corporations will send jobs overseas while unemployment rates are high in the United States. It is not the case that the rules dealing with domestic labor markets—as with the recent change in the FLSA overtime threshold show—are ideal, when they become more dysfunctional with each passing day. It is that all too often, the only way to remain in business at home is to move some jobs overseas, or face the serious risk of bankruptcy or massive contraction.

At this point, we can explain why the enormous appeal of economic populism is also our greatest danger. The constant attacks on the richest and most productive portion of the population insulate the rest of the system from the intelligent criticism that it needs in order to reach higher levels of performance. There is a real fork in the road. The populists believe that the actions of private firms and individuals are the source of our national difficulties, such that another round of regulation or a new set of taxes is the best way to bring the current malaise to an end. And so the Sanders campaign can note the declining median income of both male and female workers, and conclude that all of this is “unacceptable” and “has got to change.” But indignation is not a substitute for intelligent prescriptions, especially when the wrong populist diagnosis will lead to the wrong proposed cure and make the situation even worse.

The populist view of the economic universe is that the United States has not regulated or taxed itself enough to secure the appropriate level of income equality and social justice. Politics aside, the correct view is exactly the opposite. 

*Considered one of the most influential thinkers in legal academia, Richard Epstein is known for his research and writings on a broad range of constitutional, economic, historical, and philosophical subjects.

Why Democrats Could Win In 2016

Richard Epstein*

Richard Epstein

Richard Epstein

With the hotly contested Iowa primaries only a week away, the level of political polarization is higher than it’s been in decades.Hillary Clinton and Bernie Sanders are veering sharply to the populist left as they each champion a brand of democratic socialism. On the Republican side, the rise of Donald Trump and Ted Cruz reveals the rise of a muscular conservatism that appeals to the far right. By November, this political divide will become more pronounced. No one will be able to say, to quote George Wallace’s oft-repeated remark, that there is not a “dime’s worth of difference” between the two parties.

One area of huge contention is domestic policy. The two Democratic front-runners are responding to a strong anti-market sentiment by pushing for higher taxes, more income redistribution, and more extensive regulation, targeting both large businesses and wealthier individuals. Income inequality is at the center stage. On these issues, though, the Republican candidates offer a more pro-growth agenda, but do so only in muted terms. If Republicans want to win in November, they must boldly articulate an alternative to the policies of Clinton and Sanders.

One of the most interesting political trends of recent years is the rise of progressive populism. These days, the American left uses the term “progressive” much more frequently than the word “liberal” to describe itself—which represents a symbolic shift. The word “progressive” consciously hearkens back to the era between 1900 and the election of Franklin Roosevelt in 1932. The Progressive Movement held that, in an industrial age, markets did not function adequately, that the antitrust laws did not meet the challenges of the modern industrial economy, and that the imposition of a large administrative state, technically expert but politically aware, was needed to contain powerful private sector firms. These are essentially the same claims Democrats make today, even though the economy is more regulated than ever before.

The chief targets of the Progressives were many key Supreme Court decisions that opposed their worldview. The Court’s 1895 decision in United States v. E. C. Knight blocked systematic regulation of the economy by ruling that manufacture, mining, and agriculture fell outside the limits of Congress’s commerce power, so much so that in 1906, the passage of the Pure Food and Drug Act only let the federal government regulate drug manufacture in the territories, even though it could block the shipment of adulterated or misbranded drugs in interstate commerce. Likewise, in the 1905 case of Lochner v. New Yorkthe Supreme Court sharply limited the power of both the state and federal government to impose maximum hours or minimum wage laws on the economy. Three years later, the Court struck down a federal collective bargaining statute in Adair v. United States, and seven years after that it did the same with respect to state collective bargaining law. To top it all off, in Loewe v. Lawlor (1908), the Supreme Court unanimously applied the 1890 Sherman Act to secondary union boycotts. That decision sparked a furious progressive blowback in the 1912 Presidential election, after which Loewe was overturned by Section 6 of the 1914 Clayton Act that explicitly exempted unions from the operation of the antitrust laws.

Each of these decisions contributed to the enormous growth in productivity during the period before the New Deal. But as the ideological battles raged on, the entire edifice of the Old Court was eventually struck down in a series of decisions. Most notable were National Labor Relations Board v. Jones & Laughlin Steel (1937) and Wickard v. Filburn (1942). The two cases expanded the power of the federal government to regulate all economic activities. This meant that the 1938 revisions of the federal drug act allowed Congress to expand its jurisdiction to cover manufacture within the state. In addition, Jones & Laughlin Steel brushed aside all opposition to mandatory collective bargaining at the state and federal level. And any objection to the widespread reliance on administrative agencies to run the new ambitious state was ended by key decisions such as Yakus v. United States, which in 1944 sustained a criminal conviction for a violation of price control laws, and NBC v. United Stateswhich in 1943 upheld the allocation of broadcast frequency under the flaccid standard of the public interest, convenience, and necessity.

The contrast between the progressive and classical liberal views could not be more vivid. Justice Felix Frankfurter blanched at the thought that the Federal Communication Commission could be limited to setting the rules of the road for radio broadcast. He thought their delegated powers allowed them to determine “the composition of that traffic.” A year later in The Road to Serfdom, Friedrich Hayek presented the opposite vision. The genius of a highway system was that it set the rules of the road and allowed private individuals, each in pursuit of their own mission, to enter and exit as they saw fit—a privilege that was denied to commercial carriers under the Motor Vehicle Act of 1935. By the end of World War II, the entire classical liberal synthesis had been decisively rejected.

The New Deal victory ushered in a period of consolidation and retrenchment. The Republicans swept back into power in 1946, and that year saw the passage of the Administrative Procedure Act, still very much alive today, to rein in the widely perceived excesses of administrative power under the earlier New Deal statutes. One year later, Congress passed, over a Truman veto, the Taft-Hartley Act that limited the scope of the original 1935 Wagner Act, but which by no means undid the earlier law. And so the stage was set for a longish period of American legal scholarship where the major task of academic lawyers was to make sure that the new administrative state operated with dispatch and good sense. The enterprise should not be belittled today, given the vast difference between an administrative state that tolerates corrupt union elections and one that seeks to give union members a fair shot at appointing the leaders whom they prefer.

Yet, what was notable about this activity was that Congress set the major parameters of regulation, and the courts took the faithful implementation of the law as their task. The mood of the time was captured in the famous mid-twentieth-century course entitled The Legal Process, led by Harvard professors Henry Hart and Albert Sacks, which taught students the virtues of an incremental adjustment of the legal system to the new challenges that it faced. Moving back to first principles was decidedly second-tier. Instead, both left and right made peace with the major innovations of the New Deal, which they sought to rationalize and understand.

Yet the turn away from theory could not last. Even with the apparent mid-century serenity, the rising pressure on race relations, culminating with the 1954 desegregation decision in Brown v. Board of Education, forced questions of theory to the fore on matters of race. And it was only a short time thereafter that this more reflective mode of inquiry made its way into other areas. The rise of the law and economics movement in the 1960s and 1970s was important because it provided various intellectual tools that mounted a challenge to the unquestioned sway of regulation over large swathes of the economy.

Thus in 1959, Ronald Coase wrote the Federal Communications Commission, which had the temerity to argue that the market could do a better job in allocating spectrum use than the FCC, which never created coherent administrative criteria for frequency allocation. In 1962, James Buchanan and Gordon Tullock wrote The Calculus of Consent, which showed how easy it was for majoritarian institutions to fall prey to faction and intrigue. Writers like Henry Manne stressed the importance of the market for corporate control, which was inconsistent with the cozy relationship between big government and big business exemplified by the legal protection afforded to AT&T before its monopoly was broken up in 1982. And so it happened that competition, not regulation, became the new watchword for the overall legal system.

Today, the classical liberal challenge to the New Deal view of the world is stronger than ever. Underneath any piece of New Deal legislation lays the grubby reality of cartel formation in labor and agricultural markets. Fortunately, the high court is taking halting steps to return to the pre–New Deal state of affairs now that Friedrichs v. California Teachers Association may well undermine coerced union contributions and Horne v. Department of Agriculture has already punctured the invulnerability of the raisin cartel.

Yet the progressives have simultaneously revived New Deal principles by advocating for greater regulation to jump-start the flagging economy. In addition, the rise of “critical legal studies” and an ever-greater concern with race, gender, and inequality has moved much of the legal community further to the left. At the same time the law and economics community fractured, giving rise to strong pro-regulatory movements.

None of this conceals the vulnerability of the progressive agenda. Of course, the economy is in vast need of prompt and powerful improvement. But in order to prescribe a cure, it is necessary to diagnose the underlying ailment. Back in 1935, it was hard to find any coherent intellectual opposition to the ever-greater surge of government power. It was all too common then to confuse the size of a firm with its market power, and to assume that any restriction on the contractual freedom of the employer necessarily improved the position of the employee. Anyone who reads the Findings and Policies of the NLRA should be struck by its misguided and outdated argument that its vast administrative apparatus could increase the efficiency of the economic system or the real income of employees.

The tragic feature of today’s populist revival is that it uses obsolete economic and political philosophy to propel the case for additional layers of regulation. These are likely to prove more counterproductive than the initial New Deal blunders because the second round of regulation comes off a diminished economic base. The current slow growth environment and the reduction of labor market participation only compound the miseries of the poor and the vulnerable, whom the progressives want to protect. Yet as long as the Republican candidates fail or refuse to address this challenge, the odds will only increase that the next president will be deeply committed to policies that will cement the Obama legacy of economic stagnation and political turmoil. The intellectual tools to combat these false hopes are available. Let us hope that the Republican nominee will deploy them to maximum advantage. 

*Considered one of the most influential thinkers in legal academia, Richard Epstein is known for his research and writings on a broad range of constitutional, economic, historical, and philosophical subjects.