I’ve recently, by which I mean for the past 35 years, been thinking a lot about economic policy, and I’ve finally achieved some clarity: indirect policies don’t work very well, if at all. Direct policies are much more reliable.
The best way to explain what I mean is by example, and I’ll provide some below. But the idea is that when we identify a policy goal — jobs for those left behind, higher pay for low-wage workers, more investment, better educational opportunities, health-care coverage — the surest way to meet those goals is by direct provision of the outcome variable. Tweaking taxes or some market mechanisms in the hopes that you’ll start a chain of events that results in the desired outcome is not only often ineffectual policy. It can be a wasteful and dis-equalizing policy, thinly disguised as intended to accomplish something useful.
There are, of course, exceptions. For example, I think Pigouvian taxes (taxing behaviors with negative externalities, such as pollution or cigarettes) work well, and caveats to the direct approach abound. But let’s go through some examples.
Jobs: A healthy, capitalist economy will create a bunch of jobs through the cycle of “derived demand”: people want and need stuff, and a well-structured economy will set up the production processes to meet those wants and needs. Those jobs spin off more income, and the cycle is afoot.
But industries rise and fall, and structural (vs. cyclical, as in recessions) joblessness happens. In fact, it’s under the microscope now as this market failure is believed to have played a role in President Trump’s upset victory.
In response, we hear way too much about how trickle-down tax cuts for “job creators” in the top few percent of the income scale will create the missing jobs for these left-behind workers (to be clear, I’m not just talking about the Rust Belt; urban job deserts have long been with us). That’s the classic indirect approach, with way too many links in the chain, and this experiment has already failed many times over.
The only way to make sure those without work get jobs is to provide them with employment and often, the necessary training to go with it. If that sounds too New Deal-ish, let me remind you that we ran a program something like this in the Great Recession and it was a big success (to be clear, this program mostly subsidized private job creation rather than creating public-sector jobs, but the subsidies went directly to employers who had to use the money on jobs). In fact, a recent, careful review of such programs shows we’ve done a lot more of this than you probably realized, and well-designed, direct-job-creation programs generate a big job-creation bang for the buck.
Wages: The idea that trickle-down tax cuts or investment breaks lead to higher wages just invokes another broken chain. Conversely, the earned income and child tax credits — two potent pro-work, anti-poverty wage subsidies — and minimum wages (when they’re high enough) have great track records of directly raising the pay of low-wage workers. No chain linkages are involved; no fingers must be crossed, hoping tax-cut beneficiaries respond to incentives the way we hope. Under these policies, if you work, you get higher pay.
Health care: This sector may provide the best and most timely example of the advantages of the direct approach. Medicare and Medicaid directly provide coverage to elderly and poor recipients. They guarantee coverage to their beneficiaries, and do so with slower cost growth than the private sector with comparable outcomes. Although the Affordable Care Act directly and successfully expanded Medicaid (in states that took the expansion), where it has had problems is in the nongroup market, where, you guessed it, it’s less direct, depending on private insurers responding to incentives and subsidies.
Conservatives — and this is a key theme of this post — always favor the more indirect route. Their health-care plans want less government, more consumers’ “skin in the game,” more shopping for coverage in a “free market.” As their Obamacare replacement not incidentally revealed, that plan also includes a big tax cut favoring the wealthy, paid for by cutting Medicaid.
In today’s policy environment, we can only be sure that direct health-care provision leads to more health coverage and that, as per the Congressional Budget Office, indirect coverage leads to less coverage and large tax breaks for the rich.
Investment: If you pay attention to the current tax debate, you’ll hear tax cutters blame our high corporate tax rate on weak corporate investment. It’s true our corporate rate is high compared to other countries, but most large companies don’t pay it. Instead, they pay a bevy of tax lawyers to tap the zillions of loopholes in the business code, which, for the record, is truly a hot mess in need of reform.
But the punchline in today’s context is that there’s no correlation between tweaks in the tax code, business or otherwise, and investment. Once again, the indirect method is a bust. After all, the after-tax cost of investment capital has been historically cheap lately, in part because of very low interest rates.
The direct play here is to take advantage of those low (but rising) rates and invest in public infrastructure. That’s the only sure way to boost investment.
There are caveats, of course. Direct measures can generate unintended consequences (as can indirect ones), such as direct job placements that displace unsubsidized workers, too-high minimum wages, wage supplements that subsidize low-wage employers, or wasteful public investment (bridges to nowhere).
But we’ll be much better able to focus on the effectiveness of our direct interventions if we stop screwing around with the indirect ones. It’s time to admit that most indirect policy ideas, such as the conservative health-care plans or the trickle-down jobs plans, are just tax cuts for the wealthy disguised as ways to help less advantaged people.
If we truly want to help people, and I get that this is an “if,” then we just have to do so.