Legal Reform As Economic Stimulus

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WASHINGTON-Burdensome paperwork, arcane immigration regulations, convoluted tax laws. It's no wonder that some potential entrepreneurs give up before they begin.

Our legal system has conferred important benefits on our economy, such as enforcement of contracts and patent rights, but how many possible Microsofts and Googles have never seen the light of day due to inefficient, overly burdensome laws?

Far too many, says the Kauffman Foundation, a Kansas City-based non-profit organization focused on entrepreneurship. On Tuesday Kauffman president and CEO Carl Schramm delivered his annual State of Entrepreneurship Address at Washington D.C.'s National Press Club, explaining how legal reform can increase economic growth and generate more jobs.

Kauffman has just published a 494-page book on how the legal system can be reformed to encourage economic growth. Entitled Rules for Growth, the book contains 18 separate proposals on different aspects of the legal system written by university and law school professors and think-tank scholars. It can be downloaded free from Kauffman's Web site,

The object of Rules for Growth, writes Kauffman vice president and Brookings Institution senior fellow Robert Litan, is "to expand our vision of the economic effects of the law and legal institutions to consider how the law has in the past, and how it might in the future, stimulate innovation and economic growth."

Our legal system can throttle economic growth like sediment building up in a water tank. Old laws are rarely discarded, new ones are just added. Some small companies don't even exist because of legal morass, and others don't grow.

Litan estimates that under our current legal and regulatory system our economy generates about 15 new companies a year that are likely to grow to have a billion dollars or more in annual revenue. Litan also predicts that legal and regulatory reform could increase that number to 45 to 75 such new companies, raising GDP growth by a full percentage point. With GDP growth one percentage point higher, from 3% to 4%, the economy would double in 18 years rather than 24, raising real incomes.

One legal reform that would foster economic growth would be to revise our immigration laws to admit more highly skilled immigrants, a goal embraced by President Obama in his State of the Union address. Kauffman vice president John Tyler and Yale University professor Peter Schuck argue that highly-skilled immigrants figure prominently in successful startups, and America needs more of both. If it were easier for foreign-born students and workers to obtain provisional visas to stay and work in America, visas that could transition into green cards later, America would have faster GDP growth and job creation.

Another idea, advocated in a chapter on taxation by American Enterprise Institute resident scholar Alan Viard, is replacing part of our income tax system with a value-added tax. True, it may be more efficient to move to a consumption tax, but one disadvantage of VATs (a form of consumption tax) is that, once in place, they are money machines, used to expand the size of government.

Experience teaches that VATs have a way of rising over time. When imposed in 1967, Denmark's VAT was 10%; it is now 25%, in addition to a top income tax rate of 51%. Germans are more fortunate; their VAT has risen "only" to 19% from 10% in 1968, and their highest income tax rate is "only" 45%.

It's politically unrealistic to expect that a VAT would be a substitute for the income tax, so it would end up being an additional levy, one that enlarges the government's claim on the rest of the economy and discourages entrepreneurship.

More compelling is the chapter on the effects of modern tort law on innovation and economic growth, written by Yale Law School's George Priest. It describes how modern tort law has resulted in the departure of certain products and services from the market. For instance, starting in the 1980s, coinciding with an increase in liability judgments, some pharmaceuticals have been withdrawn. Some may have been harmful, but others could have helped certain patients.

Because tort law tilts towards medical malpractice plaintiffs, doctors abandoned obstetrics for safer practices. Some daycare centers were closed because of fear of tort actions. In addition, some products, potentially useful, never reach the market. The good is tossed out with the bad as companies play it safe.

A slow Food and Drug Administration approval process, as well as liability suits, is having a substantial effect on pharmaceutical companies, reducing their rate of innovation. New York University professor Richard Epstein (not included in Rules for Growth, unfortunately) has proposed eliminating the FDA entirely and allowing doctors to determine what drugs to prescribe for patients.

Rather than reform the FDA, the government has attempted to fill the innovation gap. On January 14, Health and Human Services Secretary Kathleen Sibelius announced that the administration would fund a $1 billion drug development center at the National Institutes of Health to discover new drugs.

This amount is tiny compared with the $45 billion pharmaceutical companies spend annually, and cannot replace lost private-sector innovation. It would be far more effective, and cheaper, to reform the legal system to encourage pharmaceutical companies to develop the drugs, rather than have the government take over the process.

Yet the Administration appears to be taking over an increasing number of sectors rather than reforming the legal system to allow industries to function better. Over the past two years we've seen Government Motors, Government Health Care, Government Student Loans, Government Mortgages, and Government Pharmaceuticals. Such takeovers didn't raise productivity in the former Soviet Union, and they're unlikely to work for us.

With the economy's slow job creation rate - 36,000 jobs created last month, and big deficits - a deficit of $1.4 trillion is projected for this fiscal year - Kauffman's costless proposals to stimulate the economy are worthy of serious consideration.

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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