A Take on “Gingrichonomics”

A Bloomberg editorial on Wednesday provides an interesting analysis of some of the proposed policies which Newt Gingrich has discussed in his campaign for the GOP nomination.  The article is particularly critical of his proposed reform to tax codes:

“He would make the Bush tax cuts permanent. He would reduce the corporate-income tax rate to 12.5 percent from 35 percent and allow companies to write off most new equipment. He would eliminate taxes on estates, dividends, interest income and capital gains; give everyone a new personal deduction of $12,000; and institute a “flat tax” of 15 percent.”

Additionally, Gingrich has proposed making these “optional” for tax filers, meaning that payers could also elect to continue paying under the current tax laws.  While these policies represent Gingrich’s desire to “simplify” the practice of paying taxes, making it necessary for filers to calculate not 1, but 2 tax payments, seems rather contradictory.  Even worse, the Tax Policy Center estimates that such revisions would reduce government tax revenues by $1.3 trillion.

Though Gingrich’s campaign maintains that this does not account for the increase in economic activity which the revisions would inspire, such a gamble seems particularly risky given the current state of the federal deficit, a shortage he plans to reconcile by ” “by growing the economy, controlling spending, implementing money-saving reforms, and replacing destructive policies and regulatory agencies with new approaches.”

The ambiguity and vagueness of this proposed solution to the federal deficit is hardly encouraging.  As the article notes, if “Gingrich intends to gut one-third of government revenue — and still plans to honor our debts, mount a national defense, pay promised benefits and so on — he’ll need to do a much more convincing job of explaining where the cuts come from.”

Private Equity: What it is and What it Means for a Capitalist Economy

As political tensions rise amongst GOP candidates, many opponents of Presidential candidate Mitt Romney have criticized his time in private equity at Bain Capital, likening him to a corporate raider.  While much is being made of the former governor’s time at Bain, few are truly informed on what function Romney, and similar people within private equity, serve.  Economists Steven Davis and Kevin Hassett, in an editorial for The Atlantic, define and examine some academic work on the role private equity has in a capitalist society.

The piece addresses the principal role of private equity firms, including describing their role in both LBOs and venture capital.  Contrary to critics assertion that such firms are simply interested in buying and looting a company, Davis and Hassett note that “the goal in each case is to create a thriving business so the private equity firm can sell its investment stake at a profit.”  They note that while private equity acquisitions are often associated negatively with employment at the targeted firm, much of the elimination of jobs is a necessary part of restructuring a struggling firm.  Given the high proportion of costs that labor represents, eliminating excessive labor costs can go a far way in making a struggling company successful.

To build a successful and profitable company in the long-term, Davis and Hassett argue that a private equity firm must in fact encourage innovation in their employment efforts.  Evidence suggests that “for manufacturing firms, productivity grows more rapidly at buyout targets compared to otherwise similar firms. In large part, the extra productivity growth reflects a greater tendency by private equity to shift jobs from less productive facilities to more productive ones. Much of this accelerated reallocation activity occurs within the target firms.”

The evidence Davis and Hassett present supports the assertion that private equity is in fact a source of positive, creative destruction.  Private equity has been proven to not only provide positive returns for its investors, but also have only a minimal impact on purchased firms, especially when factoring in the venture capital side of private equity.  By serving as a source of capital for both new and established, but struggling firms, as well as acting as a restructuring force focused on reducing inefficiencies and encouraging innovation, private equity firms, as Davis and Hassett conclude, are a positive force in a capitalist economy.