If there is one thing about America that inspires the rest of the world, it is its level of economic freedom. Or at least it used to. According to the 2005 Index of Economic Freedom, published jointly by The Heritage Foundation and "The Wall Street Journal," the U.S. is no longer among the world’s 10 freest economies. In fact, the U.S. is becoming uncompetitive in economic freedom.

Reasons for Decline

One reason for this decline is a combination of onerous taxes and increasing government expenditures, which worsens the fiscal burden on businesses. Another reason is that countries like Australia, Chile and Iceland have leapfrogged past America by decisively and repeatedly cutting taxes, privatizing and deregulating, thus creating friendlier business environments. The degree of economic freedom that the U.S. had 10 years ago, when it was ranked the fifth freest economy, is clearly no longer good enough.

A Warning Is in Order

This plunge in the economic freedom ranking is a warning bell. Economic freedom is the foundation of U.S. economic strength, and economic strength is the foundation of America’s high standard of living, military power and status as a world leader. To regain its leadership in this important area, America must cut taxes and government expenditures, eliminate non-tariff barriers to trade and further deregulate some sectors of the economy. A freer U.S. economy will grow faster, and with faster growth, America will have the resources to raise its high living standard and to preserve its military power and status as a world leader.

Falling Behind

Economic freedom measures the opportunity for people to engage in all levels of economic activity—from starting a business, to opening a bank account, to using a credit card; from buying groceries, traveling and fixing their homes, to being able to obtain good health care; from buying a car, sending their children to school and finding a job, to counting on sound law enforcement and courts to protect their personal liberties and private property. The fewer obstacles to these activities, the more people can participate in the economy by working, investing, saving and consuming. The freer the economy, the more people can use their abilities to create wealth, putting money in the pockets of millions of families.

Until recently, America epitomized the benefits of living in a free society. However, in the four years since 2001, the U.S. ranking has fallen sharply from sixth place in 2001 to 12th place in 2005. Meanwhile other countries were opening their markets and improving their economic freedom. During this time, U.S. government spending ballooned, and this continuous expansion of government expenditures has seriously hurt the U.S. ranking.

The U.S. government has blamed the spending binge on the tragic events of September 11, 2001. However, according to Heritage Foundation analyst Brian Riedl, the majority of the government’s spending spree since 2001 is unrelated to 9/11 or national defense.

In other important areas of economic openness—taxes, non-tariff barriers and regulations affecting local and foreign investment—the U.S. has simply failed to keep pace with a changing world.

Should We Worry?

Should the United States, as a large economy, worry that it is losing its freedom “podium” to small economies like Chile, Iceland, New Zealand or Estonia? Absolutely. One can never overestimate the damage caused by continuously poor policymaking.

For example, in the early 1900s, Argentina was the world’s seventh wealthiest economy. Its wealth was driven largely by foreign direct investment from England and strong enforcement of property rights. It took no more than 40 years of continuously poor policymaking, starting in the 1930s, to erode this wealth. Today, with its world leadership lost, Argentina is a poor country mired in crisis, with a currency that moneychangers around the world refuse to handle. Argentina did not become poor overnight. Its road to poverty began when it became blind to the eventual implications of poor policy.

The perception of the U.S. as the most attractive place to do business is changing as the downward trend in U.S. economic freedom continues.

That perception plummets as spending swells the U.S. federal deficit, Congress threatens more trade restrictions and tariffs and passes legislation to expand underfunded transfer programs, tax rates remain among the highest in the world, the U.S. remains one of the few countries to tax the overseas earnings of its corporations, and some in the Administration support corporate welfare programs such as agricultural subsidies.

Four Reforms To Regain U.S. Leadership in Economic Freedom

It is time for America to rediscover the advantages that flow from increased economic freedom. Specifically, America needs sustained economic growth to maintain its high standard of living, military power and leadership in the world. And to foster this economic growth, the United States needs to increase economic freedom by advancing four reforms.

Reform #1: Cut Tax Rates

One area in which the top 10 economically freest countries in the world distinguish themselves is through low corporate tax rates.

The U.S. must find a way to slash its corporate tax significantly in order to be more competitive and provide businesses with better opportunities for increased production.

Reform #2: Cut Expenditures

Rising government expenditures are imposing a burden on American families and future generations that will be hard to remove. According to David Walker, Comptroller General of the United States, the official debt of the United States government today is $7 trillion.? If the “promises” that the U.S. government has made to retirees and users of government health care services are added, “the real debt is $42 trillion,” which amounts to “18 times the current federal budget, or three-and-one-half [times] the size of the current Gross Domestic Product.” In per capita terms, this obligation represents “over $140,000 for every person in America.”

Just to pay this debt, the U.S. economy would have to grow an average of 3 percent annually for the next 45 years or 6 percent annually for the next 23 years and incur no further obligations. These growth targets illustrate the extent to which current government actions have already affected the future of children born this year, who most likely will have to endure higher tax rates, higher interest rates, a much more difficult business environment, and a lower standard of living.

To reduce the unfunded debt burden on American families, the Administration should immediately advance proposals to reform Social Security, Medicare and Medicaid. Also important, the Administration should stop supporting corporate welfare programs like the farm subsidies.

Reform #3: Support Free Trade, Especially at Home.

The Bush Administration has decisively advanced free trade agreements with other countries. It should continue to do so with others.

The U.S. record is dubious, though, when it comes to removing domestic barriers to trade, such as protectionist tariffs and antidumping laws. One of the worst cases is the stubborn protectionism of U.S. sugar growers. At the current level of protection, sugar sells in U.S. supermarkets at three times the world market price. Moreover, U.S. protectionism is just as bad in other industries, such as orange juice, peanuts and dairy products.

Even worse are the U.S. antidumping laws. In principle, these laws give U.S. producers the right to request protectionist tariffs when a foreign producer sells products in the U.S. at a lower price than in the producer’s home country. In practice, this creates incentives for industries to seek ridiculous protections at the expense of taxpayers.

It all starts with the government’s requirement that 25 percent of the industry making the product must support such a claim. To assess the level of support, the Department of Commerce surveys the industry with a form that producers must complete. Here the Byrd Amendment—in effect the most distorting antidumping law—comes into play. Under the amendment, once the antidumping duty is approved, the producers that support a dumping case are eligible to receive a portion of the duties collected. This obviously creates a strong incentive to support a petition, and approval of every antidumping investigation is virtually guaranteed. A flawed methodology for identifying instances of dumping and the accompanying protection margins—a methodology that is usually biased against foreign producers—further compound the problem.

The damage does not stop there, though. With antidumping laws, producers have a mechanism for requesting protectionist tariffs where no tariff actually exists. In other words, no matter how many free trade agreements the U.S. makes or how many tariffs Congress tears down unilaterally, as long as the antidumping laws exist, U.S. producers will have an avenue they can use to pursue protectionism. Since success breeds imitation, many countries around the world now use antidumping laws as well. The U.S. government must repeal its antidumping laws, not just to preserve the interests of millions of U.S. consumers, but also to advance effectively free trade throughout the world.

Reform #4: Deregulate

The flow of new regulations continues unabated. This problem must be addressed in order to ease the regulatory burden on businesses. For example, foreigners should be allowed to invest in certain sectors that are off limits. In addition, many regulations (e.g., some health and product safety standards, food and drug labeling requirements, or corporate-governance regulations like Sarbanes-Oxley), although well-intentioned, can be particularly burdensome to small and medium-size businesses and should be removed.

Ana Isabel Eiras is Senior Policy Analyst for International Economics in the Center for International Trade and Economics at The Heritage Foundation. This article appeared in Impact Analysis, September-October 2005.

Ana Isabel Eiras
About The Author Ana Isabel Eiras
Ana Isabel Eiras is Senior Policy Analyst for International Economics in the Center for International Trade and Economics at The Heritage Foundation.

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