Factions and Governance

William H. Young

Thirty years ago, in The Rise and Decline of Nations (1982), Mancur Olson showed that most of the factions endemic to mature democracies seek to redistribute rather than create income and wealth. Further, over time, they impose social and economic rigidities and costs which cause nations to lose vitality and reduce their rate of economic growth. Olson warned that factions drive political life away from considerations of “widespread common interests” and spur “divisiveness” that “can even make societies ungovernable.” The decline of our economic growth rate from about 3 percent per year to less than 2 percent since 2000 and the increased polarization of our politics over that period reflect his prognosis.

In my previous article Factions and Western Civilization, I presented an overall view of factions in America and the features that the Founders incorporated in our form of government to contain them, drawing on Western wisdom. Today, progressive governance and its constituent factions have brought America almost to its knees. Rather than controlling factions, government is dominated by and intertwined with them. Often incoherent policies and legislation almost always reflect a consideration of favored interests, to satisfy the expectations for benefits awarded to factions across the spectrum: plutocrats, crony capitalists, unions, trial lawyers, farmers, seniors, and greens—as well as individuals possessing tax exemptions, preferences, or exclusions.

To show the importance of coming to grips with such preferences as part of tax reform, I will illustrate how just one provision of the federal tax code—the exclusion of employer-provided health insurance or benefits from employee compensation subject to income and employment (Social Security, Medicare, and unemployment) taxes—adversely impacts job formation, economic growth, global competitiveness, non-tradable or public sector productivity, income distribution, and health care costs.

Ironically, this exclusion arose during World War II as a way around wage increases, to keep prices in check. It evolved into a subsidy to encourage employers to furnish health care and cover its costs. Employer-provided health care became a standard benefit in larger corporations until the 1980s, when skyrocketing costs and the changing economy stunted the spread of corporate coverage. Today, more than 60 percent of Americans under age 65 still receive such a tax benefit. It is the largest tax break, and principal distortion, in the federal tax code, foregoing revenue of about $200 billion each year. (Seth Hanlon, “Tax Expenditure of the Week: Tax-Free Health Insurance,” Center for American Progress, January 12, 2011)

Who are the recipients of this tax advantage—the factions who would thwart its change? First, they are employees (and their families) of larger corporations, many of whom are crony capitalists with strong lobbyists. Second, they are the members of private sector labor unions, who have political strength. Third, they are employees of institutions of higher learning and non-profit organizations, who influence elite expectations. Last, they are federal, state, and local government employees, often represented by powerful public sector unions. And most of these factions receive benefits during lifelong retirement, to be paid by our younger generations.

While “tax the rich” is a popular refrain of polls and politicians, the health care tax break is immune to such criticism. Yet the health care exclusion is known as an “upside-down” subsidy, since most tax savings are enjoyed by recipients with higher incomes and more generous insurance plans. Not only do lower paid employees receive fewer benefits, the rapidly increasing number of private sector contingent workers—independent economic individuals and their families—receive no tax benefits to purchase insurance. (See my article Independence) The health care tax exclusion is our most regressive tax provision.

Employer-provided health care increases product costs and makes American companies less competitive in the global marketplace, inhibiting the exports needed to grow the economy. It deters the creation of new private sector jobs and drives the turn to contingent workers. Small businesses and entrepreneurial start-ups, in particular, often cannot afford the cost burden of health care, impeding hiring and expansion. Employer-provided health care is not portable, contributing to job market paralysis. It is a prime reason for low productivity in the non-tradable and public sectors, contributing to a declining standard of living. And the tax increases required to fund benefits have become a major reason for falling public sector employment.

Large-employer health care benefits have continually become ever more generous because they are tax free. Economists generally consider such “Cadillac” plans a major driver of rising health care costs and spending. Such plans both incentivize greater demand for health care not paid for by the individual and set the bar high for the rights others then feel entitled to have in their plans—and medical lobbyists seek. Ironically, when General Electric recently put its white-collar employees on a high-deductible health plan, their use of its imaging devices declined dramatically. (Kate Linebaugh, “GE Feels Its Own Cuts,” The Wall Street Journal, September 17, 2012)

Independent commissions (Simpson-Bowles, Domenici-Rivlin) have recommended phasing down or out the tax exclusion for employer-provided health care benefits, transferring greater payment of costs and subsidies to individuals. Republicans (Bush, McCain, and Ryan) also have offered similar plans, but are reluctant to quantify reductions required in the employee tax exclusion because of demonization of such cuts by opponents to gain short-term political advantage from the factions affected.

For example, when John McCain proposed in 2008 to replace the tax exclusion with a $2,500 tax credit for every individual and $5,000 for families, he was pilloried by Barack Obama for raising taxes on the middle class (which unions now call themselves). (Maeve Reston and Seema Mehta, “Obama assails McCain health care plan,” Los Angeles Times, October 5, 2008) At the same time, Grover Norquist of Americans for Tax Reform castigates any Republican who proposes to increase revenue by reducing tax exclusions. Mitt Romney has run into a political buzz saw for his revenue-neutral tax-rate-reduction proposal to encourage economic growth because of his reluctance to identify tax exclusions to also be reduced, which President Obama promptly charged will “involve sticking it to the middle class.” (Scott Horsley, “Rhetoric Aside, Few Details of Romney Tax Plan,” September 11, 2012)

The Patient Protection and Affordable Care Act of 2010 (Obamacare) does not change the health care tax exclusion, consistent with President Obama’s position in 2008. It levies a new excise tax on Cadillac plans to raise revenue. The Congressional Budget Office’s most recent analysis shows that the law is jammed with $1 trillion in tax hikes and will spend more than $1.7 trillion over the next decade. (Sen. Tom Coburn, “Obamacare: It’s Still a Gateway to Single-Payer Health Care,” National Review Online, September 6, 2012) Obamacare is opposed by small business because it continues the link between employers and health insurance, does little to address the costs of health care, does nothing to rein in costs driven by trial lawyer litigation, and adds new regulations and taxes. The new jobs and economic growth so urgently needed by America will continue to go begging.

Let me offer a suggestion. Rather than mobilizing to reduce inequality through democratic engagement, the American Association of Colleges and Universities and higher education might strike an instant blow against inequality by endorsing elimination of the health care tax exclusion enjoyed by its relatively wealthy members—and improve the economy and reduce the budget deficit at the same time.

In his Farewell Address in 1796, President George Washington warned that “it is indeed little else than a name, where the Government is too feeble to withstand the enterprises of faction.” The Founders chose a republic in which enlightened elite representatives deliberate and collaborate to make hard decisions based on reason, balance, and prudence—to reach compromises. The nation needs a Madisonian “grand bargain” to reign in rewards to all kinds of factions from government, to spur economic growth and avoid insolvency. It is time for our people and their representatives to get on board the reform train rather than the entitlement train that is on a track to impoverish their progeny, the subject of next week’s article.

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This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.

The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).

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