Risk Markets And Politics

Monday, September 05, 2005

The Changeling

Legislation-linked futures are likely to first make their mark functioning as tax and subsidy insurance. That is, these futures will be used by parties to hedge against the impact of tax and subsidy legislation.

Consider the estate tax repeal bill (H.R.8 / S.420). It is estimated that the permanent repeal of the tax would cost the government $70 billion per year starting in 2011. Even if this estimate is high, there is certainly room for a significant market to develop here, spurred by individuals seeking to lock-in a certain after-tax estate size. (Of course, this is contingent on whether LLFMs gain the blessing of the CFTC and to an important, but lesser extent, whether the specific contracts are deemed to fall under IRC ยง1256(e)(2) and are officially recognized as hedging instruments.)

As it turns out, Katrina has derailed proponents of the repeal for the time being, and this effect should have more traction than market interest rate moves seen last week in response to the disaster. Republican leadership should surmise that it will be infeasible to pursue tax breaks affecting wealthy heirs when there are scenes like this in the newspaper: "But the bodies are everywhere: hidden in attics, floating in the ruined city, crumpled in wheelchairs, abandoned on highways."

Meanwhile, progressives are seizing on Grover Norquist's stated goal of cutting government down to the size "where we can drown it in the bathtub", citing the disaster as a strike against minarchism (small government). Libertarians, et al answer that the flooding situation in New Orleans and the extent of its aftermath was precisely a failure of government. Is there a more constructive way to frame the debate? The focus here should be on making government more efficient by fostering new structures of public and private organization — which is the philosophical basis of legislation-linked futures markets. The key is for legislators to see LLFMs not as a subversion of their powers, but as means to ease political log-jams and get things done. When LLFMs are used with tax and subsidy legislation, this creates an environment where it is much more likely that political opponents will meet half-way. With LLFMs, issues in fact become partially de-politicized as decision-making is distributed to the private sector. Government becomes more efficient as a result.


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