Democracy’s Death Spiral

On Monday, Puerto Rico missed a payment on $422 million worth of bonds. If the United States doesn’t come to the rescue, this will be only the first of many defaults to come. In all, the island has $72 billion in debt and an additional $46 billion in unfunded pension liabilities—totaling more than the country’s annual GDP. As debt mounts, potential taxpayers are fleeing: 84,000 Puerto Ricans moved to the United States just last year alone.

Puerto Rico is experiencing what I call a “democracy’s death spiral.” The same thing happened in Detroit. And more recently in Greece. It could happen next to the state of Illinois. And even in California.

It works like this: Politicians find it in their self-interest to take from Peter and give to Paul, whenever Paul can offer more political support than Peter—in the form of votes, campaign contributions, get-out-the-vote efforts, etc. But as tax rates rise to pay for these political acts of theft, some of the Peters begin to emigrate to other jurisdictions. As more taxpayers leave, the tax rates needed begin to rise—leading to a greater exodus. Eventually there are no Peters left to tax to pay for all the benefits the Pauls were expecting.

In the United States I associate this general approach to politics with Franklin Roosevelt, who had two important insights.

First, Roosevelt realized that people are far more aware of the impact of public policy in their roles as producers than in their roles as consumers. For example, most consumers of sugar probably have no idea what sugar quotas are costing them (answer: they pay about twice the world price), but sugar producers are very much aware of how important those quotas are to their incomes. Also, the sugar consumers are not organized, they have no trade association and no PAC, while the sugar producers do have all those things.

Roosevelt capitalized on this insight in spades. Had he not been stopped by the Supreme Court, his National Industrial Recovery Act (modeled after Italian fascism) would have allowed every industry and every trade to fix wages and prices, control output and act as a monopolist—at the expense of consumers everywhere. Think of all the reasons why businesses and trade associations pay lobbyists to roam the halls of Congress. Under the NIRA, such lobbying would no longer be needed. Roosevelt would have given them the power to do for themselves everything they wanted from politicians.

Even though the NIRA was quashed, the Roosevelt legacy continued in some major industries. The Department of Agriculture largely acted as a cartel agent for the farmers. The lCC acted as a cartel agent for the trucking and railroad industries. The CAB acted as a cartel agent for the airlines. And so forth.

The general principle is that it is often easy and politically profitable to take from the general public and reward concentrated interests—even when the exercise is harmful for the country as a whole.

Roosevelt’s second insight was that it’s much easier to rob Peter to pay Paul, if Peter isn’t old enough to vote. It’s easier still, if Peter isn’t even born yet. That’s why Social Security and later Medicare and Medicaid’s long term care benefits were organized as Ponzi schemes. Every dollar these programs collect in taxes is spent—the very minute, the very hour and the very day it comes in the door. Promises of future benefits will only be as good as the government’s ability to collect from future taxpayers.

Puerto Rico has taken all these insights and applied them with abandon. How much do you think the electricity would cost to power an ice skating rink in the tropics? It doesn’t cost the city of Aguadilla, P.R. anything. That’s because the government has been giving free electricity to all 72 of its municipalities. It also supplies free power to government-owned enterprises and some for-profit business.

Even though the unfunded pension liabilities are huge, the government has been giving public sector retirees Christmas, summer and medication “bonuses.” Public sector employees can borrow from their pension funds—up to $100,000 for a mortgage on a home and $5,000 to take a vacation. In fact about one-quarter of the pension system’s investment portfolio consists of such loans.

Making things worse, the Puerto Rican government (just like Greece) does a poor job of collecting taxes. The income tax evasion rate is estimated to be 60 percent.

What lesson can we take away from all of this? That’s easy.

When politicians take from citizens generally and give to special interests, they are not promoting the general welfare—something they are obligated to do under the Constitution.

See also my previous post on why the United States enjoys relative political stability, while many other nations do not.