The Road to Prosperity: How to Grow Our Economy and Revive the American Dream

Table of Contents

Title Page

Copyright Page

Dedication

Foreword

Preface

Acknowledgements

Chapter 1 - Principles of Prosperity

The First Principle: Property Rights—Ownership Is the Foundation of Markets

The Second Principle: Markets Work—Let Them!

The Third Principle: Taxes and Spending—The Lower the Better

The Seen Trumps the Unseen

The Fourth Principle: Stable Money

Where We Go From Here

Chapter 2 - Lessons from History

The Federal Reserve’s Great Deflation

Herbert Hoover Intervenes

Roosevelt’s Role in Prolonging the Depression

The Greatest Story Never Told

How Did This Happen?

Around the World—The Rise of the Celtic Tiger

What Can We Learn?

Chapter 3 - Tax Policy

How Much to Tax

Whom to Tax: The Distribution of the Tax Burden

How to Tax: Be Simple, Transparent, and Neutral

The Reform We Need

Freedom and Prosperity

Chapter 4 - Government Spending

Government Spending Balloons

Earmarks and Rancid Pork

Deficits

Controlling Spending

Chapter 5 - Free Trade Facilitates Economic Growth

Comparative Advantage

The Truth About Trade Deficits

The Problem with Protecting Certain Industries

The Siren Song of Fair Trade

Our Not-So-Hollow Economy

Trade Actually Helps Poor Foreign Workers

Free Trade Works

Chapter 6 - Transforming Social Security

Personal Accounts Mean Personal Prosperity

The Proof is in the Pudding

The Opposition

Chapter 7 - School Choice

The Problem: Monopoly Breeds Mediocrity

The Solution: A Competitive Education Market

Different Kinds of School Choice

Milwaukee Example—Design and Success

Arguments Against School Choice Refuted

Change We Can Believe In

Chapter 8 - The Crash of 2008

Monetary Policy

Greenspan’s Defense

The Legislation and Regulation that Contributed to the Crash

Mark-to-Market

Paulson and Bernanke—Contributing to the Crisis They Were Trying to Prevent?

Writing History Matters

Chapter 9 - The 2009 Lurch Left

Bailouts, Nationalizations, and Asset Purchases

Mark-to-Market Accounting

The Bankruptcy Alternative to Bailouts

Tighten the Federal Belt Instead

Tax Hikes

Cut Taxes Instead

Government-Dictated Industrial Policy Will Fail

Denying Workers’ Freedom

Slouching Toward Protectionism

Cap and Trade (or Cap and Tax)

Conclusion

Epilogue

Notes

About the Author

Index

Copyright © 2009 by Patrick J.Toomey. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Toomey, Pat.

The road to prosperity : how to grow our economy and revive the American dream / Patrick J. Toomey, with Nachama Soloveichik.

p. cm.

Includes bibliographical references and index.

eISBN : 978-0-470-54319-1

1. United States--Economic policy--2001- 2. Fiscal policy--United States.

3. Monetary policy--United States. I. Soloveichik, Nachama. II.Title.

HC106.83.T66 2009

330.973--dc22

2009017154

To my wife Kris, whose love, encouragement and confidence

inspire me to dream great dreams;

and to the sunshine of our lives,

Bridget and Patrick, who have waited patiently for Daddy

to have more time to play with them

Foreword

Barack Obama is moving American economic policy firmly away from democratic capitalism toward a big-government command-and-control philosophy. Obama is seeking nothing less than to undo the principles of the Reagan Revolution, which unleashed the private economy from the shackles of stagflation and malaise and created enormous wealth for a generation of Americans.

As I write this in May 2009, the Republican Party is searching for both a coherent message and a central spokesperson to counter Obama and the Democratic Congress. Polls indicate that the United States remains a center-right country and both the financial industry bailout and the economic stimulus package are unpopular with voters. Republicans have an opportunity to capitalize on public unease and articulate a strong, commonsense alternative to Obama’s government-driven, budget-busting policies.

The Road to Prosperity by Pat Toomey is an important salvo in the fight for traditional American free-market economics against the Obama-led, European-style collectivist policies. In a clear, eloquent fashion, Toomey explains the core principles under-girding prosperity and shows how those principles are systematically being ignored or violated by the Obama administration.

Ultimately, democratic capitalism is about ideas—simple, profound ideas about creating an economy that rewards hard work, investment, imagination, and risk taking. History proves that policies of low taxes, currency stability, free trade, and respect for property rights ignite individual ambition and creativity, stimulate economic growth, and increase overall prosperity.

Toomey rightly points out that the Obama administration’s policies threaten a repeat of Franklin Roosevelt’s New Deal, which unnecessarily prolonged the Great Depression.The massive government spending, along with the punitive, antibusiness rhetoric and protectionist trade measures promulgated by the Obama administration echo back to the 1930s. Those types of actions did not lead to a strong, sustained economic recovery in the 1930s; and they will not today.

We are witnessing more spending, deficits, and debt creation than anyone ever imagined. Bailout Nation has run amok. While this started under Bush, Obama has raised the stakes exponentially.

The latest federal budget would double the debt in 5 years and triple it in 10. For some perspective, that debt level is higher than the combined debt levels generated under every president from George Washington to George W. Bush. According to the Congressional Budget Office, federal debt held by the public as a percentage of gross domestic product (GDP) under Obama is projected to rise to 82 percent in 10 years. The budget deficit itself never drops below $670 billion and closes the period at $1.2 trillion. That’s nearly a 6 percent share of the economy.

All of this will certainly lead to large tax-rate hikes that will rob incentive power from entrepreneurs, investors, and small-business owners. Just look at Great Britain, where the top tax rate has been raised to 50 percent from 40 percent.The Thatcher revolution is being repealed over there. Unless current trends are reversed, the Reagan revolution will be repealed in the United States.

This is the wrong direction for economic growth. Instead, business tax rates should be slashed—which, by the way, would repatriate corporate earnings for domestic investment. We need a capital gains tax holiday. We should be flattening individual tax rates across the board. And all manner of loopholes and special-interest deductions should be repealed to broaden the taxable income base.

Nowhere is the Obama vision of government interference more evident than on the banking front. The White House and Treasury are using the Troubled Asset Relief Program (TARP) as a bullying club to force government control on the country’s financial institutions. Exactly how it will end is unclear, although it is near certain that major banks and corporations will remain subject to government control. This reminds one of François Mitterrand, the former socialist president of France. It’s way outside the American economic tradition.

According to Special Inspector General Neil Barofsky, the $700 billion TARP program—which has ballooned to more than $3 trillion in spending, loans, and loan guarantees—is inherently vulnerable to fraud, waste and abuse. Barofsky already has opened 20 separate TARP-related criminal investigations and six audits into whether taxpayer dollars are being stolen or wasted. Rest assured that they are.

In short, Obama is seeking to change the whole relationship between the government and the free-enterprise private sector. It looks very much like a war against investors, businesses, and entrepreneurs. Shareholder rights are being eviscerated. Political decisions are replacing the rule of law, the rule of bankruptcy courts, and free-market principles.

The Road to Prosperity is a much-needed reminder of the principles of prosperity and a warning against the dangerous course that we have embarked upon. It is hoped that people will listen before it’s too late.

—LARRY KUDLOW

Preface

It is ironic that economics is so widely seen as an obscure, complex, highly technical field best left to academics and financial experts. In fact, the most important truths of economics are easily grasped by most people, in part because they are repeatedly demonstrated in daily life.We all know intuitively, from a very early age, that, all else being equal, a shortage of something makes it more precious and an excess makes it less so. We understand without questioning that people respond to economic incentives because, as consumers, we are bombarded with and often take advantage of clearance sales, coupons, volume discounts, and the like. Even an esoteric-sounding idea such as the time value of money is universally understood, if not always by that name.We all prefer to be paid promptly for a service rendered rather than made to wait. Conversely, most of us take advantage of zero-percent financing when it is offered.

Despite the commonsense understanding of economics most of us demonstrate through our mundane, daily behavior, many myths and misconceptions are widely disseminated and too often believed. Special-interest groups and the politicians they support tell us that government subsidies of select industries are good for taxpayers, that wage controls are good for workers, that fewer imported products are good for consumers, that higher taxes won’t slow down economic growth. They peddle these and other pernicious myths by cloaking them in half-truths and populist rhetoric. These economic fallacies are believed by people who have not been guided to see through the smoke and mirrors obscuring the economic truth.The fallacies are promoted by policy makers who seek to ingratiate themselves with the special-interest groups who are seeking their own narrow gains at the cost of the general taxpayer or consumer.

The result is a muddled set of laws and regulations that restrain the American economy. We have the biggest, strongest economy in the world by far. But we still have fewer jobs, slower growth, and less prosperity than we could have if our policies better reflected the economic truths that, upon reflection, most of us know to be true.

This book does not present any new economic theories or novel mathematical proofs. Its purpose is to remind us of the simple economic truths and the corresponding policies that lead to prosperity. The ideas that underpin prosperity can be understood by noneconomists today just as they have been understood in the past.They were discovered centuries ago and have been thoroughly explained since at least the eighteenth century. They have been successfully demonstrated throughout the twentieth century. They are available to us today and, if pursued, would usher in an unprecedented era of economic growth and prosperity in the United States.

Patrick J.Toomey

May 2009

Acknowledgments

Special thanks to the following people:

Gary Blank

Kevin Commins

Mike Ford

JD Foster

Meg Freeborn

Dan Griswold

Howard Hall

Chris Jacobs

David John

David Keating

Mary Ann Leonardo

Jon Lerner

George Mitchell

Chuck Pike

Jan Reardon

Andy Roth

Dan Smoker

Kris Toomey

Mary Ann Toomey

Patrick Toomey, Sr.

Richard Vetter

Brian Wesbury

Brian Wild

Chapter 1

Principles of Prosperity

Our Economy:The Sum of

Many Voluntary Transactions

On my way to the office each morning, I stop to buy a cup of coffee. The coffee costs me $1.49. I buy it for one reason: The cup of coffee is worth more to me than the $1.49 in my pocket. If this were not the case, I’d keep the $1.49 and forgo the coffee.The owner of the coffee shop has the opposite view.To him, the $1.49 is worth more than the cup of coffee, so he sells me the cup. The two of us have exactly opposite views regarding the value of the cup of coffee and therein lies the opportunity for our mutual gain from a single transaction. I gain the coffee that I value more, he gains the cash that he values more, and, most importantly, we are both better off for having made the trade.

This example may seem too ordinary to be noteworthy. In fact, it is exemplary of the most important principle of economics. That is, both parties to any voluntary exchange gain from the transaction. That is why they enter into it. No one is able to determine the value of a transaction better than the people engaged in it. No one knows better than I do how much I value the cup of coffee I buy each morning. No one knows better than the coffee shop owner how much he values producing and selling that cup of coffee in the morning.We each know our own self interest better than anyone else possibly could.

Thus, in a free society in which transactions are honest, purely voluntary, and absent fraud, every transaction is an economically good one¹—benefiting both parties to it. Buying or selling a cup of coffee, a sweater, a stock, a movie ticket, or a life insurance policy; renting a car or a vacation home; or placing a deposit with a bank—every voluntary transaction between people, businesses, or any combination thereof, is an economically good transaction in that it benefits all parties involved. Otherwise they would choose not to be a party to it.

The economy is nothing more than the sum total of all of these transactions. The more economic activity, the larger the economy, and the more people improve their lives. The most important and constructive thing the government can do in the economic realm is to ensure that people are free to engage in these mutually beneficial transactions and to resist policies that hamper these transactions. There are several ways in which governments can facilitate exchange. Unfortunately, there are an almost unlimited number of ways in which governments can impede exchange.

Four fundamental principles, if adhered to, maximize the opportunity for voluntary exchange and thus for prosperity. Whether we are talking about complex exchanges like a major corporate merger, or simple ones like my daily cup of coffee, these four principles of prosperity provide the indispensible preconditions for the vibrant exchanges that enable economic growth. They are: private property rights; a relatively unfettered free market; low tax burden and government spending levels; and a stable currency.

When governments follow these four principles, people spontaneously cooperate, innovate, and elevate their individual and collective well-being. Prosperity is inevitable. Conversely, without these principles, a free and vibrant economy as we know it would cease to exist. There have been plenty of communist and socialist countries that demonstrate just how true this is.The extent to which governments adhere to these principles generally determines the level of prosperity countries achieve.

Because America has observed these principles more consistently and to a greater extent than most other countries, we have become one of the most prosperous countries in the world. But there is plenty of room for improvement in America’s commitment to these principles. Because our government often strays from them, America is not as prosperous as it could and should be. For reasons political, ideological, and intellectual, government policies sometimes run diametrically opposed to these principles, and we pay the price for these mistakes with less prosperity. We will discuss a number of these policy errors at length in later chapters because these flaws can be remedied.When government policy encourages and ensures private property rights, a free market, low tax burden and government spending levels, and a stable currency, the result is stronger economic growth, more opportunities, higher wages, and a better living standard for our society. This goal is well worth striving for.

The First Principle: Property Rights—Ownership Is the Foundation of Markets

Private ownership of property is the foundation upon which a free economy is built. Because most economic transactions involve the exchange of property, clearly defined ownership and relatively unfettered rights attached to ownership are necessary preconditions to a free and vibrant economy.

Property takes many forms. The word first brings to mind real estate—land, buildings, houses—also called real property. But it also includes personal property, sometimes called chattel in the common law tradition. Personal property is, generally speaking, things that are not permanently affixed to land and thus movable. Goods, clothes, money, and my morning cup of coffee are all considered personal property. Finally, intellectual property refers to the result of personal creative effort, like songs, books, and the design of a commercial product, machine, software, or logo.

In all its forms, the ownership of property must be clearly established in order to maximize its availability for use or exchange. There is not much doubt that the coffee shop owner owns the cup of coffee he sells to me each morning just as he is confident that the $1.49 I give him belongs to me. If either of us is wrong, the consequences are not very significant. After all, it is only $1.49, and the coffee ceases to exist as such within fifteen minutes of my buying it.

But it is a very different matter if the property in question is a substantial piece of land. A buyer with plans to build on the land will not make the purchase if he cannot be sure the seller is the rightful owner. If ownership were in doubt, the buyer risks substantial loss should the legitimate title holder one day demand the return of the property. The same is true of a car, a plane, jewelry, or anything else of value. In order to facilitate the voluntary exchange of property, a prudent government must establish clearly defined rules regarding private property ownership. These rules vary depending on the nature of the property and the manner in which it is acquired.

For instance, real property ownership is usually registered in public documents kept by local governments. Ownership of cars, planes, and boats is typically documented by state governments, which issue titles, while securities ownership is registered by federal government agencies. These are examples of the constructive role governments can play in establishing and documenting the unambiguous ownership of private property, thereby facilitating their use and exchange.

Government helps to establish rightful ownership of property in another way. Since property can be acquired or transferred in many ways, it is helpful to have clear, universally accepted rules for establishing legitimate transfers. Property can be legitimately acquired when it is purchased, traded for, inherited, found, invented, created, or received as a gift. It can be obtained illegitimately by theft or fraud. It can be taken in bankruptcy or seized by the state for a number of reasons. In all of these examples, well-defined laws, especially laws that protect owners from illegitimate loss of property through theft or fraud, are conducive to economic growth.

Finally, it should be noted that property can be privately owned through many different vehicles. People often chose to own and deploy property jointly with others through partnerships, corporations, or trusts. It is very important that these forms of ownership receive the same government recognition and protection as individual ownership. As long as the property is acquired legitimately, there is no reason why they should not.

Without the protected right to own private property and engage in the exchange of property, we would have no real economy to speak of. To see just how true that is, consider the alternative. The opposite of privately owned property is communally, or collectively, owned property. One ideal of every communist state is to restrict the ownership of all property to all people jointly, with the government controlling its usage. Many states have attempted this system to varying degrees. All such experiments have resulted in impoverishment and often tyranny.

The Rights of Ownership

Just as important as establishing lawful ownership of private property is respecting the rights of property ownership. Here government’s record is much less constructive. Real ownership means the exclusive right to do as one wishes with one’s property, provided one is not harming another person or another person’s property.This includes the rights to use, alter, exchange, give away, or destroy one’s own property. Unfortunately, governments too often succumb to the temptation to restrict the rights of property owners. When they do, they invariably diminish prosperity by impeding the voluntary exchanges that enhance wealth.

The New Jersey Highlands Water Protection and Planning Act is a perfect example of the harm government can do when it unduly restricts an owner’s use of his property. Passed by the New Jersey Legislature on June 10, 2004,