The year politicians turned their backs on economics

Illustration: Rachel Mendelson/WSJ, iStock
Illustration: Rachel Mendelson/WSJ, iStock

Summary

Economists routinely advise against price controls, tariffs, discriminatory taxes, and wider budget deficits. Donald Trump, Joe Biden and Kamala Harris are entertaining some or all of them.

It’s too soon to predict the winner of November’s presidential election, but not too soon to predict the loser: economics.

Economists routinely advise against price controls, tariffs, discriminatory taxes and wider budget deficits. Donald Trump, Joe Biden and Kamala Harris are entertaining some or all of them.

Of course, no one expects economic principles to always take precedence over other priorities. And there are times when price controls, tariffs and deficits are actually good economic policy.

But the candidates haven’t just demoted economic principles this year; they’ve jettisoned them altogether. It’s as if they wanted to flip the bird at the economic establishment.

“Doesn’t anyone listen to economists anymore?" asked Columbia University economist Glenn Hubbard, who chaired President George W. Bush’s Council of Economic Advisers. “Economists don’t seem very involved in either campaign or in internal decisions in recent administrations."

Sure, these ideas look politically shrewd. But if implemented, they may come back to haunt a future president who learns just how harmful or impractical they are.

No taxes on tips

Tax policy usually involves a trade-off between equity (treating people fairly) and efficiency (improving growth and consumer well-being). Former President Trump’s proposal to end taxes on tips, quickly adopted by Harris, manages to be both inequitable and inefficient.

It’s inequitable because it would tax people paid mostly via wages, such as cooks, more heavily than similar people paid mostly via tips, such as waiters.

It’s inefficient because it rewards a clumsy and often arbitrary form of compensation. Research finds tips only loosely correlated with quality of service. Tips survive because of social norms and psychological bias: restaurants that replace tips with higher wages have to raise prices, but customers prefer lower posted prices even when the all-in expense is the same.

When tips are no longer taxed, employees and employers will try to take advantage by structuring more compensation as tips. The losers: consumers who already resent proliferating requests for tips, often before a service is rendered. Tax breaks are supposed to encourage things we like, such as children and homeownership; this one does the opposite.

Price and rent controls

The U.S. hasn’t had economywide wage and price controls since the early 1970s, and Harris isn’t proposing them now.

She and Biden are proposing something narrower: taking federal tax benefits away from corporate landlords that raise rents more than 5%, and cracking down on “price-gouging."

In spirit, these are similar to existing federal, state and local laws that regulate prices of insurance and drugs or during natural disasters. Yet as with formal price controls, they short-circuit the essential role of higher prices: drawing in new supply and encouraging substitution toward cheaper alternatives.

Price controls are justified when a few companies enjoy market power, because they are monopolists or oligopolists, or because of an emergency. Those conditions don’t apply to apartments or food.

After apartment rents soared during the pandemic, developers responded by building record new units. Thanks to that flood of supply, new lease rents are now falling, according to the Labor Department.

Alexei Alexandrov, former chief economist of the Federal Housing Finance Agency, said no multifamily developer controls enough of the apartment market to have market power. While some landlords have been accused of colluding, “that’s why we have…antitrust laws already on the books."

A temporary rent cap won’t have much effect given rents aren’t rising much anyway, Alexandrov said. If perceived to be permanent, developers will try to raise rents immediately, screen tenants more tightly, build fewer of the affected buildings (more than 50 units), or convert apartments to condominiums, he said.

Since Harris hasn’t explained how her price gouging ban would work, its effects can’t be predicted. A bill sponsored by Sen. Elizabeth Warren (D., Mass.) would punish companies that brag about price increases, which would certainly reduce bragging, if not price increases.

Trump has branded Harris’s proposals as socialism, yet he too has a soft spot for price controls. As candidate and president he routinely called for Medicare to negotiate drug prices. It finally happened this year, under Biden. Given Medicare’s size, and the penalties for not cooperating, drug companies consider this tantamount to price controls.

Tariffs

Economists have a visceral dislike of tariffs. They’re a tax on imports, and imports are quite useful. In recent years, a more nuanced view has emerged. Trump’s tariffs on China, which Biden continued and Trump now proposes to expand, reduce U.S. vulnerability to a geopolitical adversary.

But Trump’s proposed 10%, or even 20%, “baseline" tariff on every country and product serves no obvious purpose. He claims this will cause American consumers to buy U.S. instead of foreign-made goods, boosting jobs and reducing the trade deficit.

Certainly, if you’re willing to force consumers to pay thousands of dollars extra, you can make them buy domestic instead of imported products. But for what purpose? Factory jobs are not intrinsically superior to other jobs; pay and working conditions are often better in services. Protection can be justified for infant industries such as green tech or products essential to national security, like semiconductors. T-shirts, wine and countless other imported products don’t qualify.

In any case, tariffs alone won’t reduce the trade deficit because currencies, interest rates, savings, and the budget deficit often work in the other direction, boosting imports and reducing exports. Despite tariffs, the trade deficit widened during Trump’s presidency.

Perhaps Trump thinks tariffs give him leverage to force other countries to reduce trade barriers. Some might, but others, such as the European Union and China, will likely retaliate, as they did in his first term. In a May report, Deutsche Bank economists show that manufacturing employment deteriorated in the U.S. after Trump’s trade war began in 2018, with the biggest impact in the most manufacturing-intensive counties. The Tax Foundation estimates Trump’s 10% tariff would shrink U.S. output by 0.7% and cost 505,000 jobs.

The tax giveaway arms race

Harris has proposed a $6,000 tax credit for the parents of a newborn child. Not to be outbid, Trump’s running mate JD Vance has pitched a $5,000 credit for every child, no matter how rich the parents. The fiscal arms race doesn’t stop there; Harris is promising a $25,000 tax credit for first-time home buyers. Trump would end income taxes on Social Security benefits.

These ideas aren’t inherently bad, but boy, they’re expensive. The Committee for a Responsible Federal Budget estimates Harris’s promises, beyond those already made by Biden, cost about $1 trillion over a decade; Trump’s Social Security tax repeal would cost at least $1.6 trillion.

The U.S. budget deficit is already close to a record outside wars and crises, and these plans would make it worse. There are times when it’s OK, even necessary, for the government to borrow more: at war and in crises, and when inflation and interest rates are low. None of those things are true now.

The political types will say not to worry; a few bad ideas are worth electing a good candidate, and besides, many won’t be enacted.

But some will. In December 2020, Trump called for a new round of $2,000 stimulus checks, which even at the time looked excessive. The Democratic candidates in Georgia’s Senate runoff elections picked up the call. After they won, new checks became a centerpiece of Biden’s stimulus and helped fuel the inflation that haunts him, and Harris, now.

Write to Greg Ip at greg.ip@wsj.com

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