Author Archives: Jack Butler

Rethinking the War on Drugs

Is the war on drugs a war worth fighting?  As Gary Becker and Kevin Murphy wrote in a 2013 Wall Street Journal piece, “The direct monetary cost to American taxpayers of the war on drugs includes spending on police, the court personnel used to try drug users and traffickers, and the guards and other resources spent on imprisoning and punishing those convicted drug offenses.”  At the time the article was written, those direct monetary costs amounted to over $40 billion a year.  Additionally, that figure doesn’t take into account the indirect harmful effects of the war on drugs, such as increased dropout rates, more attractive profit margins for successful (and violent) drug operations in the U.S. and abroad, and the perpetuation of crime, all of which are more difficult to trace and quantify.  On the other hand, at a time when overdose death rates are rising in all 50 states, it’s clear that doing nothing isn’t an option.

There are many who believe that the possession and use of drugs should remain a criminal offense because drugs are harmful and/or immoral, and that the law must act as a deterrent.  I argue, however, that such laws are unjust if their benefits in reducing the amount of people with harmful drug addictions do not outweigh the immense monetary and social costs they impose.  People on both sides of the debate call for the continued criminalization or legalization of drugs based on self-supporting moral premises, but these categorical arguments are of little use because they by definition place too much importance on the sanctity of the principles themselves.  I would argue that virtues like liberty are desirable as means rather than ends, and that the ultimate end, or test, for determining whether a law is just should instead be whether the law will increase or decrease the aggregate level of happiness in society.

Considering a drug policy based on maximizing the utility (i.e., helping the maximum amount of people while imposing the least costs to their liberty to pursue property and happiness) of each taxpayer dollar spent, rather than one largely based on moral principles, will allow for both greater success in helping people avoid or escape drug addiction while at the same time freeing up public funds to be put to better use.  Studies and comparable examples in places like Portugal have shown that treating drug use as a public health issue rather than a criminal issue makes greater economic sense and results in much better outcomes for addicts needing treatment.

Focusing on reducing demand for narcotics through programs that, for example, help abusers of prescription painkillers get over their addictions before they progress to using heroin would be both less costly to taxpayers and more helpful to individuals with drug problems.  Additionally, instead of criminalizing recreational users of marijuana, which imposes significant costs on the justice system and turns otherwise normal people into criminals, redirecting marijuana demand toward legal sources of the drug would help erode the power of the drug cartels.  As Tom Wainwright argues in a February 2016 Wall Street Journal article, “A dollar spent on drug education in U.S. schools cuts cocaine consumption by twice as much as spending that dollar on reducing supply in South America; spending it on treatment for addicts reduces it by 10 times as much.”  If cutting spending on the war on drugs, legalizing recreational use of marijuana, and putting the funds saved toward public health initiatives to treat addicts will create net utility for society, Congress should take action and do so.

Sources:

http://wgno.com/2016/09/23/this-is-america-on-drugs-a-visual-guide/

http://www.wsj.com/articles/how-economists-would-wage-the-war-on-drugs-1455895053

http://www.wsj.com/articles/SB10001424127887324374004578217682305605070

Leave a Comment

Filed under Mill

The Utility of Carried Interest

Do millionaires and billionaires who run private investment firms really deserve to pay a lower tax rate on the slice of returns they generate?  My answer – who cares whether they deserve to?  The highest principle we should adhere to in determining public policy is that of maximizing utility, or the aggregate “net happiness” experienced by everyone in our society.  Laws exist to protect rights so long as the protection of those rights is desirable, and those laws are “just” simply because they are desired by the many as a means to happiness.

Armed with this principle of maximizing happiness, let us examine the question of how carried interest should be treated by the tax code.

Private investment firms, which include private equity and venture capital funds, make long-term investments in businesses using capital raised from “limited partners,” hopefully allowing the businesses to grow and become more profitable so that years later the funds can sell their ownership in them and realize substantial profits. Top-level investment managers at these funds, also called “general partners,” typically both put some of their own capital on the line and make the majority of their salaries in the form of a share of their company’s profits called carried interest.  Carried interest is essentially the share of their investments’ return (say, 20%) that fund managers get to keep in exchange for setting up deals and doing a ton of due diligence and research on target investments.  The limited partners don’t do any work at all – they simply invest their capital with the fund managers in the hopes of growing their wealth.

pe-explained

The amount that each general partner takes home out of this amount of carried interest is currently taxed at the lower capital gains rate (maximum of 20%) rather than the higher income tax rate  (maximum of nearly 40% at the federal level).  Many argue that this constitutes an unfair loophole in the tax code.  Additionally, the Treasury Department has estimated that taxing carried interest as income will raise about $1.8 billion in additional tax revenues each year, revenues that can be spent on public services.  I argue, however, that doing so would violate the principle of maximizing utility.

Even if the tax code is inconsistent in the way it treats carried interest (which is itself debatable), such inconsistency is only worth remedying through legislation if the $1.8 billion increase in annual tax revenue would benefit society more than the resulting decrease in private investment (and potential outflow of competent fund managers) would harm it.

Private equity and venture capital funds are critically important to business development.  When the infusion of capital into a business allows it to survive and expand, everyone is better off for it – a better business will be more valuable and provide its investors with a greater return while at the same time bringing new products and services to market and creating jobs.  Additionally, specialized investment firms are often the only option for smaller or distressed companies who need to raise capital but cannot go to traditional lenders like banks because they’re deemed too risky.  The capital gains tax rate is lower than the income tax rate to encourage productive investment and economic growth.  Extending this tax break to general partners who risk both their own capital and their time and expertise in such ventures is critical to ensuring that the most skilled managers in the industry have the maximum incentive to work to identify potential “diamond in the rough” businesses.

$1.8 billion a year could pay for a lot of social services, services that would undoubtedly make a lot of people happier.   Yet while it is difficult to quantify, the encouragement of successful capital allocation and meaningful risk-taking likely generates far more widespread and lasting happiness by fostering entrepreneurial innovation and creating new jobs, products, and markets.

Sources:

http://www.nytimes.com/2016/07/16/business/dealbook/the-carried-interest-loophole-what-loophole.html

http://www.ibtimes.com/what-carried-interest-tax-loophole-2100059

Leave a Comment

Filed under Mill