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Romina Boccia

As the end of fiscal year 2023 approaches on September 30, Congress is planning to roll spending into another short-term continuing resolution that will fund the government likely to early December. This is a bad deal for taxpayers and another example of Congress’ reckless management of the people’s purse.

As I explain in my Cato Policy Report, “Bankruptcy — Gradually, Then Suddenly?” U.S. government spending is on a collision course with economic disaster. Imagine the federal budget as the Titanic heading for the iceberg.

Below are highlights from my report. Click here to read the full report.

U.S. government spending is on a collision course with economic disaster. Legislators need not lift another finger to increase spending any further. The U.S. federal budget is on a Titanic‐​esque voyage that could result in a fatal crash with a massive iceberg of unfunded entitlement obligations. This ship also has no captain. It is racing full steam ahead on autopilot. Failure to grab the helm and change course undermines living standards, technological progress, and the very foundations of liberal democracy. It will take greater constituent or economic pressure to get members of Congress to finally act.

In just five years, publicly held debt — the portion of debt the government has borrowed in credit markets and from the Federal Reserve — will exceed the highest level of debt recorded in U.S. history: 106 percent of gross domestic product (GDP). And in just 10 years, even if one assumes no major wars, recessions, or public health crises occur, publicly held debt will grow to between 120 and 140 percent of GDP. Within 30 years, public debt would exceed 180 percent of GDP.

Even if the current federal government spending trajectory was affordable in the sense that Congress would simply need to raise the taxes to pay for it, the fact that most of the growth in federal spending will go toward subsidizing consumption, rather than toward productive investments, is problematic. This directs resources away from growth‐​enhancing activities and directs them toward political rent seeking, thereby undermining current and future prosperity.

Even when the government makes the case for subsidies to build defense‐​relevant industrial capacity, political bargaining leads to a misallocation of resources toward politically favored outcomes and undermines the stated goals. As my Cato colleague, Scott Lincicome, points out in his commentary “Social Policy with a Side of Chips” in The Dispatch: “Even the most well‐intentioned and theoretically sound plan … can fall victim to legislative sausage‐making, K‑Street meddling, bureaucratic capture, and other facets of public choice economics.”

High Spending and Debt Come at a High Cost
Excessive public debt with damaging consequences is here now. High government debt that grows faster than the economic product of a country has costs. And those costs, whether they are seen or unseen, are significant.

From the obvious seen costs of interest rates consuming an ever‐​larger share of the U.S. federal budget, there are also the too often neglected unseen costs of reduced economic growth. As Jack Salmon highlighted in the fall 2021 Cato Journal, after reviewing 40 studies published from 2010 to 2020 on the relationship between public debt levels and economic growth, the research unequivocally demonstrates that high debt hurts growth.

In looking at studies exploring the existence of a particular threshold where government debt negatively affects growth, Salmon identified that government debt drags down growth when it exceeds 80 percent of GDP in industrialized nations.

As government borrowing rises, it crowds out private investment and reallocates resources from productive endeavors, with the potential for pushing out the technological frontier, toward politically driven spending that all too often has negative growth effects. Higher interest rates on federal government borrowing spills over into higher interest rates in the private sector, making it more difficult for businesses to launch and expand and for individuals to buy homes and cars and to make other major purchases.

The results of excessive government spending and debt are lower economic growth, lower living standards, and an enhanced risk of a fiscal crisis.

A BRAC‐​like Commission to Reform Entitlements
The debt limit has presented [a hard] legislative deadline; yet, thus far, it has failed in forcing reforms to the very programs driving the United States toward fiscal ruin. The culprits are clear: Medicare and Social Security make up 95 percent of long‐​term unfunded obligations. Other attempts at reducing deficits are mainly tinkering along the periphery.

A commission like the Base Realignment and Closure (BRAC) commission carries the greatest promise for elevating the entitlement reform discourse past short‐​term election politics and toward addressing America’s long‐​term unfunded obligations. Such a commission should be composed of independent experts and guided by clear criteria — such as returning public debt as a share of GDP to below 80 percent in less than 30 years and achieving 75‐​year trust fund solvency for Medicare and Social Security.

Commission recommendations should be self‐​executing unless Congress intervenes. This ship may sink if we wait until a majority in Congress is willing to go on the record in support of entitlement reforms.

Avoiding Disaster
America, a nation still standing strong, is on a course toward decline. With peacetime public debt levels quickly growing toward post–World War II highs as old‐​age entitlement programs rack up tens of trillions in unfunded obligations, legislators do not have an enviable task. To steer this ship away from disaster would require the heroic feat of untangling unfunded benefit promises made by legislatures of the past, while current legislators would have to face the inevitable political costs.

The easiest way out for American politicians is to ignore the problem until it can’t be ignored anymore. By that time, sensible policy changes that protect the most vulnerable Americans from harm and avoid economy-crushing tax hikes on innovators and job creators will have likely expired. Unfortunately, it wouldn’t be the first time that a major superpower undermined its own long‐​term prosperity to avoid short‐​term political pain.

It will likely take much greater constituent or economic pressures before politicians will act to avoid further economic decline. Heeding the words of Milton Friedman, “we have to make it politically profitable for the wrong people to do the right thing.” When those pressures take hold, a BRAC‐​like fiscal commission offers the most promising way to overcome the political gridlock that is driving America toward a fiscal crisis.

Today’s politicians do not feel responsible for entitlement promises made by their predecessors, and they’re unwilling to personally sacrifice to course correct. Giving politicians a way — a lever they can pull— to set entitlement reform in motion, without legislators having to personally take the helm, may very well be the only way to steer America out from the rough seas ahead.

Click here to read the full report.

Chris Edwards

With the congressional debate over a new farm bill on the horizon, the Environmental Working Group (EWG) held a conference today to examine farm policies. The speakers included both environmentalists and fiscal conservatives who share views that some farm programs are anti‐​green and benefit wealthy landowners who do not need the money. The EWG has been a leader in calling for farm subsidy reform.

The following are my comments at the conference.

Thanks to EWG for assembling an impressive group of farming and budget experts. EWG provides a crucial input to the debate so that policymakers receive a balanced view of farm policies. I will discuss some big picture points about the U.S. Department of Agriculture (USDA) and farm support.

The USDA is a sprawling bureaucracy with 100,000 employees, including 53,000 running agricultural programs. It has about 1,300 employees just in its economics and statistics offices, indicating the large federal micromanagement of this industry.

The department runs about 150 programs for farms and agriculture. It has more than 4,500 locations, with at least 2,300 of those for agriculture. In today’s online economy, do we really need all those brick‐​and‐​mortar government offices?

Agriculture is a uniquely coddled industry. It is true that the federal government is lavishing subsidies on a growing number of industries, including energy, automobiles, and semiconductors. This is a very troubling trend. There are dozens of other industries that could say they also deserve subsidies because of risks, tough foreign competition, or other reasons. Are the politicians going to hook every industry in America on federal subsidies? Unfortunately, that is the direction we are going.

Agriculture is a prosperous industry and does not need subsidies. Back in 1960, farm households earned just two‐​thirds of what other U.S. households earned, on average. But that situation has flipped, and today farm households earn one‐​third more than other U.S. households.

Farming does not appear to be any more risky than many other industries. The business bankruptcy rate in farming is just one‐​half to one‐​third the rate of all U.S. businesses. And farming generally pays a lighter load of income taxes than other industries.

In 2023, USDA outlays for agriculture will be about $48 billion. Roughly one‐​quarter of that spending goes to public‐​interest activities, such as food safety, animal and plant inspections, research, and conservation. The other three‐​quarters goes to private‐​interest activities, that is, subsidies to farmers.

Could the U.S. agricultural industry prosper without subsidies? We can look to New Zealand as an example of farming with very few subsidies. New Zealand is six times more economically dependent on agriculture than is the United States. Nonetheless, New Zealand slashed its farm protections and subsidies in the mid‐​1980s, and today it provides the least producer subsidies of all the OECD nations.

A 2017 New Zealand government review looked back at the country’s reforms. There were difficult adjustments after the policy changes, but a more efficient industry had emerged by the 1990s. The review noted, “Agriculture productivity has quadrupled .… There was also an indirect positive impact on the environment.” And it argued that today New Zealand agriculture is “run as any other business” with “industry being better placed to respond to market demand.”

Other speakers at today’s summit will tackle the main farm subsidy programs—crop insurance and the crop payment programs—but let me point to two other types of subsidy that Congress should reassess.

First, there are the trio of three foreign aid programs—Food for Peace, Food for Progress, and McGovern-Dole—that donate about $2 billion a year of U.S. farm products to poor countries abroad. There has long been tension between foreign aid experts, who favor flexibility on how we help poor countries, and U.S. farming interests who lobby for in‐​kind food aid. One problem with in‐​kind food aid is that it ships with cargo preference rules that unnecessarily raise costs.

There is also bureaucratic overlap in foreign aid between the USDA and the U.S. Agency for International Development (USAID). Congress should consider getting the USDA out of foreign aid and leaving it to USAID. Both the Obama and Trump administrations raised concerns about the value of in‐​kind food aid. The Trump administration proposed eliminating the Food for Peace and McGovern‐​Dole programs.

A second USDA activity that seems dubious is the Agricultural Marketing Service’s Section 32. This program spends about $1 billion a year buying selected farm products (particularly meats, fruits, and vegetables) partly in an effort to boost prices. Created in 1935, Section 32 is old‐​fashioned central planning and out of place in the modern market economy.

Earlier this year, House conservatives pushed for spending restraint, and Congress agreed to the bipartisan debt‐​ceiling deal in May. With the upcoming farm bill, we will see whether House conservatives are actually fiscally conservative and willing to cut farm welfare, particularly for high‐​earning farm households.

Republicans often say that low‐​income welfare, such as food stamps, should be only temporary, and that people should strive to stand on their own two feet. The same should be true of high‐​income welfare—that is, subsidies for farmers.

For more on farm policy, see this new Cato study and the work of EWG.

Jennifer J. Schulp

While much of the world advances regulation for crypto asset markets, the United States has yet to provide a stable and practical framework for U.S. crypto policy.

In addition to the much highlighted Markets in Crypto‐​Assets Regulation adopted by the European Union, crypto‐​specific regulatory frameworks have been put into place in multiple jurisdictions, including the United Kingdom, Dubai, Switzerland, Japan, Singapore, and Hong Kong. While the details of these regimes vary—sometimes significantly—they largely provide the regulatory clarity that many say the U.S. market lacks for entrepreneurs, developers, and users. Such clarity is fundamental to achieving many of these jurisdictions’ goals of growing crypto and blockchain businesses within their borders. Some have even declared an intention to become the global hub for digital assets; for example, web3 promotion is a part of Japan’s national strategy, and Dubai has been actively courting blockchain businesses.

The current regulatory situation in the United States, however, is a stark contrast. While congressional debate on regulatory frameworks for crypto asset markets and stablecoins has intensified, legislative action to provide regulatory clarity remains a work in progress. Meanwhile, the Securities and Exchange Commission (SEC) continues an aggressive enforcement agenda against the crypto industry, and entrepreneurs, developers, and users are left to interpret the tea leaves with respect to guidance from other financial regulators and the Biden administration.

Far from encouraging—or even not discouraging—crypto innovation on U.S. shores, SEC Chair Gary Gensler has been dismissive of crypto, implying that the loss of crypto business in the U.S. is not consequential to American financial markets.

Unfortunately, there’s reason to believe that regulatory hostility to the crypto industry may harm the U.S. economy in the long‐​term. Survey evidence has identified a lack of clear rules for crypto, blockchain, and web3 tech as both a top barrier to crypto investment and adoption and a perceived challenge to U.S. leadership of the global financial system: 87 percent of the surveyed Fortune 500 executives say clear rules are important to sustain it, and 92 percent agree that new rules are needed. And some have pointed to the U.S.’s stance as “affecting where capital will go and therefore where talent will go and where companies will form.”

Others worry that, “U.S. government indifference and hostility towards open network blockchain technology is squandering the potential for Americans to benefit from it.” While the use of crypto and blockchain continues to develop—and the market ideally will have the chance to determine which uses are worthwhile—the implications of missing out may span far beyond financial markets. Indeed, 64 percent of Fortune 500 executives familiar with crypto or blockchain surveyed said that investing in these technologies is important for staying ahead of their competition.

And these concerns may not take decades to materialize; the SEC’s enforcement positions have resulted in crypto firms being vocal about looking abroad, and lawyers report regular conversations with U.S. industry participants actively considering moving to new jurisdictions. Some evidence also suggests that the U.S. has already been losing its market share for blockchain developers.

Questions raised by the state of U.S. crypto regulation and American competitiveness are paramount: Does unclear regulation of crypto assets threaten the United States’ position as a financial leader? Will uncertainty drive digital innovation from U.S. shores? Is delay in enacting a fit‐​for‐​purpose regulatory regime harming U.S. entrepreneurs, developers, and users? How should new financial technologies that are designed to be open‐​source and decentralized be regulated?

Join us to consider these questions on September 7 when Cato’s Center for Monetary and Financial Alternatives hosts Staying Ahead of the Curve: Crypto Regulation and Competitiveness. This conference will feature a fireside chat with Senator Bill Hagerty and remarks by Commissioner Caroline Pham of the Commodity Futures Trading Commission. It will also bring together policymakers and experts to discuss important questions about the state of U.S. crypto regulation.

Our program includes:

9:30 — 9:35 AM: Opening Remarks by Norbert Michel, Vice President and Director, Cato’s Center for Monetary and Financial Alternatives

9:35 — 10:00 AM: Fireside Chat with Senator Bill Hagerty (R‑TN), moderated by Jennifer Schulp, Director of Financial Regulation Studies, Cato’s Center for Monetary and Financial Alternatives

10:15 — 11:30 AM: Panel Discussion on Stablecoins, the Dollar, and Regulation

Julie Hill, University of Alabama School of Law
Neel Maitra, Wilson Sonsini Goodrich & Rosati
Jai Massari, Lightspark
Corey Then, Circle
Leo Schwartz, Fortune (moderator)

11:45 AM — 1:00 PM: Panel Discussion on Crypto Regulatory Uncertainty and U.S. Competitiveness

Rashan Colbert, dYdX
Daniel Davis, Katten Muchin Rosenman LLP
Ji Kim, Crypto Council for Innovation
Kathy Kraninger, Solidus Labs
George Leonardo, Cap Hill Crypto (moderator)

1:45 — 2:00 PM: Remarks by Caroline Pham, Commissioner, Commodity Futures Trading Commission

2:00 — 3:15 PM: Panel Discussion on Regulating Open‐​Source Financial Technology

Jessica Jonas, Bitcoin Legal Defense Fund
Bradford Newman, Baker McKenzie
Jack Solowey, Cato’s Center for Monetary and Financial Alternatives
Yesha Yadav, Vanderbilt Law School
Niki Christoff, Christoff & Co. (moderator)

Register here to attend in‐​person or online to join this timely conversation.

Colleen Hroncich

In recent years, there has been an explosion of school choice programs that enable parents to use state education dollars for learning options beyond the local district school. Education savings accounts (ESAs) have become particularly popular for the flexibility they provide: parents can use the funds for a variety of education options like tuition, tutoring, curriculum, and services for children with special needs. It seems like homeschoolers would be prime beneficiaries of ESAs since they often tap into multiple resources to educate their children.

While some homeschoolers support ESAs, more traditional homeschoolers and homeschool groups often fight these programs because they want to avoid government entanglement. In the 1960s and 1970s, parents had to wage legal and legislative battles to secure the right to homeschool their children. Homeschoolers who know this history often want to remain completely separate from the government. These traditional homeschool groups are politically active and will fight against programs that they think will encroach on homeschool freedoms.

As my new Cato Briefing Paper, School Choice Programs Need a Firewall for Homeschoolers, explains, there is a solution that can satisfy both groups. ESA programs can be written to exclude students who are officially registered as homeschoolers while creating a separate category for students who use an ESA for home‐​based education. Because each state’s education laws are different, there isn’t a cut‐​and‐​paste solution. But by looking at the compulsory education requirements and homeschool provisions in a particular state, policymakers can craft language that will work.

As school choice programs continue to expand and spread, it’s important for homeschoolers to be engaged and for policymakers to listen to their concerns. With careful design, education savings accounts can help new families begin their home education journey while protecting those who want to stay independent of the government.

Travis Fisher

At the signing of the Inflation Reduction Act (IRA), President Biden said: “The Inflation Reduction Act invests $369 billion to take the most aggressive action ever — ever, ever, ever — in confronting the climate crisis and strengthening our economic — our energy security.” One year later, the Biden Administration reaffirmed the President’s statement by describing the IRA as “the most ambitious climate action in history.”

President Biden is certainly correct that spending $369 billion on anything is aggressive, even if that level of spending is projected over the next decade. That’s nearly ten times the amount Elon Musk paid for Twitter (now renamed X). However, the cost could be substantially higher than that, and taxpayers could be on the hook to provide that level of subsidy to electricity producers every few years in perpetuity or until the law is changed. That is because the energy subsidies in the IRA are enacted as permanent law, only to expire when specified emissions targets are met. This could mean that some provisions will last well beyond the 10‐​year budget window.

After the IRA was passed, the estimate of $369 billion for energy credits over a decade was revised upward. Now we have higher estimates of the cost of preserving the IRA credits for ten years. An April 26, 2023 estimate by the Joint Committee on Taxation (JCT) was $515 billion. An April 2023 Goldman Sachs report estimated that the IRA “will provide an estimated $1.2 trillion of incentives by 2032.”

Why the disparity? It depends on what’s included in the estimates. The report by Goldman Sachs estimated much higher spending on tax credits for electric vehicles than the JCT in part because it projected that more electric vehicles (EVs) would be eligible for the full credit. That is a theme throughout the IRA—eligibility for different amounts of credits depends on several factors (like labor requirements and thresholds for domestic content, etc.). The subjective nature of modeling the IRA’s fiscal cost highlights how little we know about what these energy credits will cost the taxpayer.

Time is Money (a lot of it)

Consider another variable: the amount of time the federal government (i.e., federal taxpayers) will continue to pay subsidies. If we limit estimates of the cost of IRA tax credits to a 10‐​year window (standard practice in budget assessments), we get a total of about $515 billion to $1.2 trillion. That is already a wide range, but it’s a lower bound because it fails to account for substantial costs down the road. If we look beyond the 10‐​year horizon, the cost of the IRA credits could increase and remain high for years, perhaps indefinitely.

The tax credit for producing electricity from non‐​GHG‐​emitting sources begins to phase down only when total GHG emissions from the electricity sector fall to 25 percent of the 2022 level (see PDF page 169 here):

(3) APPLICABLE YEAR.—For purposes of this subsection, the term ‘applicable year’ means the later of—

(A) the calendar year in which the Secretary [of Energy] determines that the annual greenhouse gas emissions from the production of electricity in the United States are equal to or less than 25 percent of the annual greenhouse gas emissions from the production of electricity in the United States for calendar year 2022, or

(B) 2032.

To be clear, a 75 percent reduction in GHGs from the electricity sector could take a very long time, especially since the IRA uses 2022 as the baseline year rather than a higher‐​emission year like 2005. The U.S. Energy Information Administration (EIA) analyzed electricity sector GHG emissions in the IRA reference case (and in the no‐​IRA case) and found neither case to bring electricity sector emissions down to 25 percent of the 2022 level by 2050.

So how long are taxpayers stuck with this tab, and what’s the final tally? One estimate that accounted for the cumulative cost of the IRA credits over a longer period came from the consulting firm Wood Mackenzie. In fact, a Wood Mackenzie blog post is the only source I have seen that explicitly stated that IRA energy credits could be indefinite. It said:

Based on the language in the IRA, our view is that these tax credits will be extended for substantially longer than 2032 – perhaps even 30–40 years. Absent IRA repeal, this means that instead of several hundred billion dollars in tax credits for new renewables and storage through 2032, the real money on the table is on the order of trillions of dollars over multiple decades.

With an expanded time horizon, Wood Mackenzie found the cumulative cost of IRA energy credits could reach $2.5 to $3 trillion, most of which would go to utility‐​scale solar energy projects. Of course, if EIA is right about the trajectory of GHG emissions from the electricity sector (that emissions will not fall to 25 percent of 2022 levels, even by the year 2050), the cumulative cost could be even higher.

In a forthcoming policy brief, I will analyze the total taxpayer liability in the IRA as established in the statute, and I provide a sensitivity analysis taking into account the key variables involved: 1) the level of the credits based on eligibility criteria, 2) the volume of credit‐​eligible electricity generation, and 3) the applicable time horizon (when the electricity sector reaches GHG emissions at or below 25 percent of 2022 levels, which itself depends on many variables such as growth in electricity demand).

Conclusion

The total cost of energy credits in the IRA is an unstable number with no reasonable cap. The energy credits are subject to a wide range of variables, and they could persist for decades. Understanding the implications of the IRA for tax and budget policy requires going beyond the typical 10‐​year budget window, as the IRA itself does. Did policymakers mean to subsidize low‐​GHG electricity production to the tune of $50–100 billion per year, ad infinitum—easily $2.5–3 trillion or more when all is said and done? Maybe not, but we’ll find out if policymakers want to keep accruing them when these costs start piling up.

Colleen Hroncich

Today’s education entrepreneurs are as unique as the learning environments they create. Many are parents seeking a better fit for their own children or teachers wanting the autonomy to teach the way they think is best. In the case of Dragonfly Academy in Las Vegas, it was a grandmother who stepped up to create a place where neurodivergent children could learn and thrive.

Anita Williams is a licensed clinical mental health therapist whose grandchildren have been diagnosed with Asperger’s Syndrome and ADHD. Because of her professional background, Anita was able to help her daughter find the right specialists. But even with her knowledge, it was difficult to navigate the system and get her grandchildren the help they needed. When Anita and her daughter met with her grandson’s teacher and principal, Anita could tell they weren’t equipped to meet his needs.

They decided to try homeschooling, which was difficult but did relieve some of the stress of dealing with the school district. Anita began learning more about autism and the autism spectrum. She and her husband eventually decided to open a learning center specifically for neurodiverse individuals. At Dragonfly, Anita says, “an individual education plan is actually an individual education plan. It’s not a copy and paste from one child to another. It’s giving them what they need and focusing on their interests.” If a child has speech therapy, occupational therapy, or any other therapies that the family is happy with, those therapies can take place right at Dragonfly.

Anita initially planned for Dragonfly Academy to be a private school, but after bumping into bureaucratic red tape she reconsidered her options. She’d met Don and Ashley Soifer of the National Microschooling Center, and they told her about microschools. “I’ve been sold on this innovative, non‐​traditional education movement ever since,” she says. Students who attend Dragonfly must register as homeschoolers with the state of Nevada.

Using the homeschool/​microschool model gives Anita a lot of autonomy and flexibility with Dragonfly Academy. This is essential because her goal is to create a learning environment that appeals to a variety of neurodiverse children. By incorporating play therapy, sandtray therapy, art, and music therapy, Dragonfly students can learn, develop, and thrive with their peers.

For this school year, Dragonfly Academy will meet Monday through Thursday from 10:00 a.m. until 2:30 p.m. Learners can attend all four days or just two days per week (Mon/​Wed or Tue/​Thu) with tuition adjusted accordingly. They plan to have field trips one or two Fridays a month. Parents can volunteer for 10 hours a month at Dragonfly in exchange for a lower tuition rate. Limited financial assistance is also available.

An occupational therapist who leases a room from Anita for her private practice also works with Dragonfly students. Each morning there is an optional 30‐​minute “Movement with Miss Mallory” session at 9:30. Then the kids have some self‐​directed time before they get together for a morning meeting. Anita wants the students to be active participants in their learning journey, so she gives them several options throughout the day for group activities in addition to the self‐​directed time.

“Therapeutic schools are not new; I haven’t reinvented the wheel,” Anita says. “But this model has a unique twist to it because a lot of times therapeutic schools are boarding schools—children may stay there months or weeks or Monday through Friday and go home on the weekends. My concept is for these needs to be met on a daily basis and then for the children to go home with their families.”

Anita wants to keep the learning environment at Dragonfly Academy small so she can continue to provide truly individualized learning for each student, but she can see having two or three locations so she can help more kids. Because while her motivation was initially to help her own grandchildren, Anita is passionate about taking what she’s learned and using it to help other neurodiverse children as well.

Jack Solowey

Washington policymakers are consumed with AI concern. Fears run the gamut from existential threats to humanity to chatbots fibbing. In recent weeks, AI entrepreneurs and policy thinkers have helped to frame one of AI’s principle risks as the possible threat posed to political stability and continuity. In a thoughtful multipart series on “AI and Leviathan,” for example, Samuel Hammond (senior economist at the Foundation for American Innovation) argues that “[d]emocratized AI is a much greater regime change threat than the internet” and “[t]he moment governments realize that AI is a threat to their sovereignty, they will be tempted to clamp down in a totalitarian fashion.”

It’s wise to expect that the prospect of dizzying changes threatening the established order will incline states toward aggressive counterreactions. Indeed, we already see early signs of this in financial regulators’ response to autonomous and self‐​executing financial tools (e.g., smart contracts on cryptocurrency blockchains). Notably, smart contracts and certain AI models share a common feature that, when paired with the ability to operate with limited human intervention, can be particularly disruptive to existing regulatory methods: open‐​source code that is freely reproducible.

Even if open‐​source AI models constitute the minority of key foundation models, the fact that enough relatively advanced AI models are readily copyable (not to mention portable and storable) poses a clear challenge to governments looking to exert control over AI. Consequently, there’s an emerging policy battle over the desirability of open‐​source AI.

Unfortunately, financial regulators have led the way in cracking down on novel, open‐​source technologies. In doing so, they risk creating dangerous precedents for the use of open‐​source software—AI-based and otherwise—in both financial applications and in tech innovation more broadly. Before continuing further down this fraught path, policymakers must carefully consider the potential benefits of open‐​source software development that will be lost to knee‐​jerk policy reactions.

Fundamentally, open‐​source software is an intellectual property question: whether the code’s authors will license the free use, copying, modification, and distribution of their software without the need to seek those authors’ permission (the authors themselves typically disclaim liability in the process). Open‐​source licenses facilitate creatively remixing software, as well as ecosystems that foster iterative improvements.

Importantly, open‐​source licenses also give code something of a life unto itself, as it can continue—through the work of developer communities—to evolve and multiply beyond the reach of the original authors.

Open‐​source software therefore can pose a challenge to government agencies accustomed to regulating products and services by regulating their providers. If the government has a problem with OpenAI’s software, they haul in OpenAI. But if they have a problem with any of the tens of thousands of open‐​source AI models, who (or what) gets named and blamed?

Open‐​source AI critics fear that averting and remediating any harms associated with AI models will be seriously hampered by a lack of namable and blamable developers with end‐​to‐​end control over the code or, in the financial services context, human professionals holding out a shingle and visibly shouldering a fiduciary duty. Yet others take precisely the opposite position on open‐​source AI, arguing that the ability to freely use, modify, and distribute AI models will be essential to tackling AI “safety” and fallibility problems. One way in which this could play out is open‐​source licenses simply allowing more minds to work on these challenges and, in turn, make the fruits of their research freely available.

Notwithstanding these hard and high‐​stakes questions, the financial regulatory leviathan already has charged headlong into criminalizing the use of certain open‐​source software when the existence of a sanctionable provider is, at the very least, contestable. The Treasury Department’s Office of Foreign Assets Control (OFAC) has been breaking new ground in sanctioning—i.e., prohibiting transactions with—open-source software itself.

Specifically, in August 2022, the OFAC added the Ethereum blockchain addresses of Tornado Cash—a tool for enhancing cryptocurrency transaction privacy—to the sanctioned persons list in connection with the tool’s alleged use by North Korean state‐​sponsored hackers to launder funds.

Tornado Cash users sued the Treasury Department to vacate the sanctions designation. They contended, among other things, that the Tornado Cash developers and token holders were not properly considered a sanctionable “entity” and that the decentralized, open‐​source, and immutable Tornado Cash software was not properly considered sanctionable “property” under relevant law. On August 17, 2023, the court found in favor of the Treasury Department on these issues.

Regardless of whether one thinks the court got it right in the case before it (plaintiffs faced challenging deference standards on interpretive questions), Tornado Cash shows an emerging government suspicion of open‐​source software, with financial regulators at the forefront.

For regulators to continue down this path would risk creating further dangerous precedent. Indeed, the Tornado Cash plaintiffs noted the chilling effect the sanctions designation had on software development. Policymakers should be wary of this chilling effect and the potential lost benefits when it comes to open‐​source financial technology, as well as open‐​source software more broadly.

In the financial context, increasing the risks of publishing open‐​source tools undermines privacy‐​enhancing technologies and the broader use of autonomous financial services that mitigate traditional intermediary risks. In addition, where the suppression extends to open‐​source AI, the potential foregone benefits include the ability of both financial institutions and individuals to run open‐​source AI models on their own hardware to improve processing speed, maintain the confidentiality of personal data, and achieve greater interoperability and customizability.

Notably, the use of more bespoke open‐​source AI models in finance could help to address regulators’ fears of herding behavior due to mono‐​models. Moreover, leveraging experimental tools for autonomous task performance (e.g., an AI agent that could help to organize one’s financial life) thus far is largely a matter of using open‐​source projects. None of this is to say that open‐​source software is always the right tool for the job, and there may ultimately be market forces that make open‐​source models less competitive. But that’s no reason for regulators to put their thumbs on the scale.

As for cutting‐​edge software more broadly, policymakers should consider the role that open‐​source software development may play in discovering and disseminating standards for better aligning AI models (i.e., averting existential risks like civilizational collapse, or worse). Policymakers must steelman the arguments for an open‐​source approach to alignment, including the example of high security standards achieved by community vetting in other open‐​source ecosystems, such as that of the Linux operating system. And even if after careful analysis it’s found that the risks of open‐​source tinkering on sufficiently advanced AI models exceed the benefits at a given moment (given the limits of alignment knowledge at that point), policymakers should not parlay that into a reason to blanket ban open‐​source AI models including those short of the technological frontier.

There are good reasons to expect advances in AI to have transformative impacts on society, including states themselves. And it should come as no surprise that incumbent authorities will react aggressively when perceiving threats to business as usual; indeed, we’ve already seen this in financial regulators sanctioning disintermediated financial tools. But fear of disruption does not justify overreaction in the financial regulatory context or elsewhere.

Notably, when Hammond identified democratized AI as a “greater regime change threat than the internet,” he highlighted that the Chinese Communist Party is already proceeding on that basis. Liberal democracies can and must do better and should have greater confidence in their adaptability to technological change. Reactive policy that targets open‐​source software development carries its own risks. And tilting against open‐​source software without careful deliberation on where that leads is one of the riskiest options of all.

If you’re interested in further discussion on these issues, please join the Cato Institute’s Center for Monetary and Financial Alternatives for a conversation on open‐​source financial technology and broader questions of crypto regulation and competitiveness next Thursday, September 7, 2023.

Scott Lincicome

These days, much of Official Washington has turned its back on freer trade, and China is their reason why. According to the Washington Post, for example, President Biden has “reject[ed] the trade liberalization doctrine that held sway for nearly three decades after the Cold War’s end,” and when asked about the president’s motivations, an anonymous “senior U.S. official” pointed to a Reuters/​Ipsos survey showing that “66 percent of respondents said they were more likely to back a presidential candidate in 2024 who favored ‘additional tariffs on Chinese imports.’ ”

On the other side of the aisle, the Wall Street Journal reported this week that China has motivated several GOP presidential candidates’ turn against new trade agreements and their nationalist support “for boosting domestic manufacturing, even through government subsidies.” Former President Trump has even gone so far as to propose a tariff “ring” on all imports.

As my Cato colleague Clark Packard and I argued in a recent paper, there’s surely a better approach to U.S.-China relations than the clumsy bellicosity both political parties have recently embraced. But it’s especially wrongheaded for U.S. policymakers to let China — which does raise unique challenges — dictate overall U.S. trade policy, given that the vast majority of U.S. trade is conducted with people in countries other than China.

In particular, the latest data from the U.S. Bureau of Economic Analysis show that less than 11 percent of all U.S. trade — imports and exports, goods and services — was with China in 2022.

The numbers for goods trade (i.e., what would get caught up in a global tariff war started by Trump’s “ring”) are a little different, but tell the same general story: China is a big U.S. trading partner but the vast majority of U.S. trade in goods in 2022 involved non‐​China countries.

Even for just U.S. imports of goods, these other countries accounted for more than 83 percent of the total last year:

As I explained in a new column at The Dispatch, Trump’s global tariff is a bad idea for lots of reasons, and the starting point for that analysis is the fact that it would mainly hit countries other than China. (If recent experience is any guide, in fact, a global tariff could give Chinese imports a leg up in the U.S. market.) The same goes for broad‐​based protectionism that President Biden and other policymakers are pushing, which is no more “China policy” than Trump’s (very bad) tariff idea.

Daniel Raisbeck and Gabriela Calderon de Burgos

When we published our Cato Institute Policy Brief (“Argentina Should Dollarize, Pronto,”) on July 27, few outside of Argentina were paying attention to the dollarization debate. This changed on August 13, when Javier Milei, the only pro‐​dollarization candidate taking part in the primary elections, won a surprise victory, thus unleashing a barrage of commentary about the supposed dangers of dollarizing the Argentine economy. Many commentators, however, appear to rely on theories that do not reflect the actual experience of dollarization in three Latin American countries: Panama, Ecuador, and El Salvador. In this post, we attempt to refute some of the most salient myths about dollarization in Latin America.

1. Dollarization leads to a loss of competitiveness and weak growth.

False: The main advantages of dollarization are a) it ends currency devaluation / depreciation b) it prevents the political class from monetizing the debt and causing high inflation à la Argentina.

Those advantages do not take away from a dollarized country’s ability to be economically competitive and maintain above‐​average growth. See the case of Panama, which dollarized in 1904. In recent decades, Panama’s economic growth has been among the highest in the region, and its current level of per capita GDP far exceeds those of non‐​dollarized peers such as Brazil and Colombia.

Source: World Bank

While some argue that Panama’s success is due to the Panama Canal, the proceeds from the Canal’s activity as a percentage of GDP has been less than what other countries in the region obtain by exporting a single commodity. Rather, Panama’s economic strength is based on its open, internationalized banking system, which allows the country to attract foreign capital and guarantees liquidity in the economy.

A country does not become competitive via currency devaluation or depreciation. Were that the case, Argentina today would be extremely competitive, but it is not. Conversely, if an economy became competitive by devaluing its currency in real terms, then Japan would have become significantly less competitive while its currency appreciated by 176 percent versus the U.S. dollar between 1960 and 2004. However, the Japanese economy enjoyed an export boom during said period. On the other hand, the Colombian peso depreciated by 48 percent between 1960 and 2004, yet its exports grew half as fast as those of Japan.

As Manuel Hinds, a former finance minister in El Salvador, explains, Japan succeeded not by devaluing its currency, but rather by “shifting from lower‐ to higher‐​value‐​added production when the currency appreciated in real terms. Germany did the same [in the post‐​war period]. That is true competitiveness.” Hinds adds that devaluation merely favors the profitability of current, lower‐​value‐​added production and deters a shift towards higher‐​value‐​added production.

2. Because growth has been slow in Ecuador and El Salvador, dollarization has not succeeded there.

False: Ecuador has not put in place the right supply‐​side policies to generate Panama‐​like economic growth, and El Salvador has backtracked in this respect since the 2000s. Dollarization is not a silver bullet. It needs to be accompanied by other pro‐​growth policies that have been absent in Ecuador and El Salvador, thus their mediocre growth since they dollarized in 2000 and 2001 respectively.

Nonetheless, dollarization has succeeded in both countries because their dollar regimes prevented fiscally profligate, hard left‐​wing governments from de‐​dollarizing, re‐​introducing weak currencies, and monetizing the debt (Rafael Correa in Ecuador and the FMLN in El Salvador).

As a result, both Ecuador and El Salvador have faced fiscal crises in the last few years. However, said problems have not affected the average citizen, who has maintained a sound currency and some of the lowest inflation levels in Latin America.

Also, as citizens of dollarized countries, Ecuadorians and Salvadoreans benefit from far lower interest rates and longer loan periods than under “monetary sovereignty” regimes. Plus, dollarization imposes an intrinsic hard budget constraint on both their governments and parliaments. Hence, those countries’ fiscal situation likely would have been much worse under a national currency.

3. Dollarization failed in Argentina in the 1990s.

False. In the 1990s Argentina had a currency board that exchanged dollars for pesos, a system and that is sometimes confused with dollarization. In fact, equating that exchange‐​rate system with dollarization is misleading. As Professor Steve Hanke explains, “There are three distinct types of exchange rate regimes: floating, fixed, and pegged—each with different characteristics and different results” (see the table below).

Source: Steve H. Hanke, “A Money Doctor’s Reflections on Currency Reforms and Hard Budget Constraints,” in Public Debt Sustainability: International Perspectives, eds. Barry W. Poulson, John Merrifield, and Steve H. Hanke (Lanham, MD: Lexington Books / Rowman & Littlefield, January 2022), pp. 139–69.

Given the differences between exchange rate regimes, it is incorrect to ascribe the main characteristics of dollarization to a currency peg, which can be changed or done away with. This is not the case with dollarization, whereby a country replaces its currency with the U.S. dollar at a given rate and grants the latter legal tender (de‐​dollarization is most feasible under a totalitarian regime such as Robert Mugabe’s in Zimbabwe). A peg also leaves a country with monetary policy faculties, a partly domestic source of the monetary base, and, hence, the possibility of a balance of payments crisis. None of these factors are present under dollarization.

An orthodox currency board provides an alternative version of a fixed exchange rate regime. Once in place, it sets the exchange rate but carries out no monetary policy, so that the foreign‐​based monetary base remains, as Hanke writes, “on autopilot.” Under a currency board—as with dollarization— the balance of payments determines the monetary base as it moves “in a one‐​to‐​one correspondence” with any changes in foreign reserves. This prevents monetary policy and exchange rate policy from colliding, thus precluding balance of payment crises (as is the case in floating rate systems).

Had Argentina implemented an orthodox currency board in the 1990s, it would have carried out a fixed exchange rate policy but no monetary policy (such a currency board acts as a straitjacket on the local monetary authorities). Under official dollarization, the dollar would have had legal tender, the peso would have ceased to circulate, and the central bank would have become obsolete in terms of monetary policy. Neither was the case.

As we explain in our policy brief, Argentina’s convertibility system of the 1990s, which fixed the peso to the U.S. dollar, had several characteristics that made it, in Professor Hanke’s terms, an “unorthodox currency board.” Namely, the central bank still controlled the impact of capital inflows and outflows on the money supply (through sterilization and neutralization), it carried out monetary policy, and it acted as a lender of last resort. The convertibility system even came under a dual currency regime, with different official exchange rates for imports and exports. Each of these features made the convertibility system incompatible with both an orthodox currency board system and official dollarization,

Despite its inherent defects, Argentina’s convertibility system did cause the inflation rate to drop from over 2,600 percent in 1989–1990 to less than 1 percent in 1998. Due to its design flaws, however, the Argentine peso began to lose parity with the dollar in 2001, when currency market speculators smelled blood. In January 2002, Argentina carried out a chaotic exit from its fixed exchange rate.

4. The loss of monetary sovereignty leaves a country at a disadvantage due to the inability to counter external shocks with monetary policy.

False. As Hinds writes, Panama, Ecuador, and El Salvador have all “calmly endured the 2008 and COVID-19 crises with much lower interest rates than in the rest of Latin America.”

Besides, dealing with a crisis by devaluing the local currency might bring the mirage of (very) short‐​term relief, but this is offset by the necessary consequences of devaluation: the loss of purchasing power, higher inflation and interest rates (than in a dollarized scenario), and the strong incentive to maintain low‐​value‐​added production.

In extreme circumstances, finance ministers of developing countries—both formally dollarized and non‐​dollarized— head to Washington looking for the same thing: a loan in U.S. dollars from the IMF, the repayment of which becomes more onerous with a weakening currency. As Hinds explains, the IMF’s power lies in its ability to allow developing countries to access dollars, particularly in times of crises and when the market shuts out funding for particular governments.

Consider, moreover, the effects of devaluation. As Andrei Levchenko and Javier Cravino found in the case of Mexico’s 1994 “Tequila crisis,” “the consumers in the bottom decile of Mexican income distribution experienced cost of living increases about 1.25 times larger than the consumers in the top income decile” during the two following years. Hence, the authors conclude that the distributional effects of large devaluations are “anti‐​poor”. In Professor Hanke’s words, “when the currency loses value, you import inflation.”

Maintaining a weak national currency might appeal to certain central bankers, who would remain employed and could still act as protagonists in times of crisis, when, according to theory, currency devaluation or depreciation is in the national interest. The very rich are largely unaffected, not least because a large portion of their assets tends to be held already in U.S. dollars or other hard currencies.

For the bulk of the population, however, maintaining purchasing power is of the utmost importance. In fact, as we have seen, a sharp loss in a currency’s value is most detrimental to the poorest segments of the population.

5. Dollarization can lead to very high unemployment levels because of external shocks, while flexible exchange rate regimes can withstand such shocks far better.

False: Panama and Ecuador have proved that dollarized countries in Latin America can maintain low unemployment levels compared to non‐​dollarized peers, even those with independent central banks such as Brazil and Colombia.

Source: World Bank

A depreciating currency hinders economic growth in the long term, all things being equal. While a weakening currency might reduce the price of labor, thereby stimulating growth and employment in the short term, it raises the cost of capital in the form of higher interest rates. This discourages investment, which is the source of job creation in the long run.

6. The Federal Reserve oversees all monetary policy for dollarized countries.

False. Although dollarization does take away a country’s ability to set its own interest rates and print its own national currency, while dollarized countries’ inflation rates tend to merge with those of the United States, liberalization of the banking system can grant an important degree of independence.

As economist Juan Luis Moreno‐​Villalaz argued in the Cato Journal in 1999, Panama’s banks, which have been integrated to the global financial system after a series of liberalization measures in the 1970s, allocate their resources inside or outside the country without major restrictions, adjusting their liquidity according to the local demand for credit or money. Hence, changes in the money supply—which arise from the interplay between local factors and the specific conditions of global credit markets—and not the Federal Reserve, determine Panama’s monetary policy. Fed policy affects Panama only to the same extent that it does the rest of the world.

7. Dollarization is a U.S. imperialist policy.

False. No official institution in Washington supports or promotes dollarization. The White House and the U.S. Congress are usually disinterested in the monetary policy of Latin American countries. On the other hand, the large multilateral organizations, namely the World Bank and especially the International Monetary Fund (IMF), tend to oppose dollarization initiatives. For instance, when former Ecuadorean president Jamil Mahuad dollarized in early 2000, he did so against the express wishes of the IMF and the World Bank. Unsurprisingly, current and former IMF economists now oppose Argentina’s potential dollarization.

In part, the IMF’s resistance to dollarization can be explained from a public choice perspective. As part of its mission, the IMF provides member countries with “capacity development, which is technical assistance and training of government officials” in different areas, including “monetary and exchange rate policies.” If a country dollarizes, it no longer carries out such policies. Nor does it employ central bank officials for the IMF to train in terms of monetary and exchange rate policies. This is problematic not only for the IMF. In Latin American countries, economists have strong incentives to work for the local central bank. As Professor Hanke argues, a stint at a Latin American central bank has become the equivalent of holding an advanced university degree. Moreover, central bank economists in Latin America often aspire to an eventual post at the IMF itself. In a dollarized country, no such career path exists for economists. In part, this also explains the opposition to dollarization that is often voiced by local macroeconomists.

Another frequent argument against dollarization is that it is economically harmful due to the loss of seigniorage, the price paid to a currency’s issuer. As we explain in our policy brief, however, the so‐​called loss involved is small and, ultimately, a minimum price to pay for an end to high inflation. Especially in countries with poor monetary policy, the cost of giving up seigniorage is the equivalent of an insurance premium paid for protection against the higher risks of maintaining a local currency.

Jeffrey Miron

This article appeared on Substack on August 31, 2023.

Many policies have good intentions and aim to address real problems in the economy or society. A standard concern, however, is that government attempts to fix such problems generate backlash, meaning heightened antipathy toward an intervention’s goal. Affirmative action or sexual harassment policies, for example, might increase resentment toward minorities and women.

A recent paper provides evidence of backlash in a different context:

The 1965 Voting Rights Act (VRA) paved the road to Black empowerment. How did southern whites respond? Leveraging newly digitized data on county‐​level voter registration rates by race between 1956 and 1980, and exploiting pre‐​determined variation in exposure to the federal intervention, we document that the VRA increases both Black and white political participation. Consistent with the VRA triggering counter‐​mobilization, the surge in white registrations is concentrated where Black political empowerment is more tangible and salient due to the election of African Americans in county commissions. Additional analysis suggests that the VRA has long‐​lasting negative effects on whites’ racial attitudes.

And, backlash seems to occur widely:

Do laws affect the beliefs and attitudes held by the public? Using data from [American National Election Surveys], the [General Social Survey], and Gallup …, I find robust evidence that virtually every major U.S. social policy law of the past half‐​century has induced significant backlash. That is, the public moved in the opposite ideological direction of each law.…

The Civil Rights Acts of the 1960s, the legalization of abortion in the 1970s, the relaxation of gun control beginning in the 1980s, the Defense‐​of‐​Marriage Acts of the 1990s, the legalization of marijuana beginning in the 2000s, the legalization of gay marriage in the 2010s, and more – across various categories of social policy and across the ideological spectrum, backlash has time and time again been the consequence.

The fact that laws can generate backlash does not, by itself, make them undesirable; benefits might still exceed costs. The possibility of backlash, however, should give pause about imposing “good things” on the citizenry. Sometimes the treatment is worse than the disease.