- It is getting ever harder to do business in the United States, argues Niall Ferguson, and more stimulus won't help: Our institutions need fixing.Not everyone is an entrepreneur. Still, everyone should try—if only once—to start a business. After all, it is small and medium enterprises that are the key to job creation. There is also something uniquely educational about sitting at the desk where the buck stops, in a dreary office you've just rented, working day and night with a handful of employees just to break even.As an academic, I'm just an amateur capitalist. Still, over the past 15 years I've started small ventures in both the U.S. and the U.K. In the process I've learned something surprising: It's much easier to do in the U.K. There seemed to be much more regulation in the U.S., not least the headache of sorting out health insurance for my few employees. And there were certainly more billable hours from lawyers.This set me thinking. We are assured by vociferous economists that economic growth would be higher in the U.S. and unemployment lower if only the government would run even bigger deficits and/or the Fed would print even more money. But what if the difficulty lies elsewhere, in problems that no amount of fiscal or monetary stimulus can overcome?Nearly all development economists agree that good institutions—legislatures, courts, administrative agencies—are crucial. When poor countries improve their institutions, economic growth soon accelerates. But what about rich countries? If poor countries can get rich by improving their institutions, is it not possible that rich countries can get poor by allowing their institutions to degenerate? I want to suggest that it is.Consider the evidence from the annual "Doing Business" reports from the World Bank and International Finance Corporation. Since 2006 the report has published data for most of the world's countries on the total number of days it takes to start a business, get a construction permit, register a property, pay taxes, get an export or import license and enforce a contract. If one simply adds together the total number of days it would take to carry out all seven of these procedures sequentially, it is possible to construct a simple measure of how slowly—or fast—a country's bureaucracy moves.Seven years of data suggest that most of the world's countries are successfully making it easier to do business: The total number of days it takes to carry out the seven procedures has come down, in some cases very substantially. In only around 20 countries has the total duration of dealing with "red tape" gone up. The sixth-worst case is none other than the U.S., where the total number of days has increased by 18% to 433. Other members of the bottom 10, using this metric, are Zimbabwe, Burundi and Yemen (though their absolute numbers are of course much higher).Why is it getting harder to do business in America? Part of the answer is excessively complex legislation. A prime example is the 848-page Wall Street Reform and Consumer Protection Act of July 2010 (otherwise known as the Dodd-Frank Act), which, among other things, required that regulators create 243 rules, conduct 67 studies and issue 22 periodic reports. Comparable in its complexity is the Patient Protection and Affordable Care Act (906 pages), which is also in the process of spawning thousands of pages of regulation. You don't have to be opposed to tighter financial regulation or universal health care to recognize that something is wrong with laws so elaborate that almost no one affected has the time or the will to read them.Who benefits from the growth of complex and cumbersome regulation? The answer is: lawyers, not forgetting lobbyists and compliance departments. For complexity is not the friend of the little man. It is the friend of the deep pocket. It is the friend of cronyism.We used to have the rule of law. Now it is tempting to say we have the rule of lawyers, which is something different. For the lawyers can also make money even in the absence of complex legislation.It has long been recognized that the U.S. tort system is exceptionally expensive. Indeed, tort reform is something few people will openly argue against. Yet the plague of class-action lawsuits continues unabated. Regular customers of Southwest Airlines recently received this email: "Did you receive a Southwest Airlines drink coupon through the purchase of a Business Select ticket prior to August 1, 2010, and never redeem it? If yes, a legal Settlement provides a Replacement Drink Voucher, entitling you to a free drink aboard a Southwest flight, for every such drink coupon you did not redeem."This is not the product of the imagination of some modern-day Charles Dickens. It is a document arising from the class-action case, In re Southwest Airlines Voucher Litigation, No. 11-cv-8176, which came before Judge Matthew F. Kennelly of the District Court for the Northern District of Illinois. As the circular explains: "This Action arose out of Southwest's decision, effective August 1, 2010, to only accept drink coupons received by Business Select customers with the purchase of a Business Select ticket on the date of the ticketed travel. The Plaintiffs in this case allege Southwest, in making that decision, breached its contract with Class Members who previously received drink coupons," etc.As often happens in such cases, Southwest decided to settle out of court. Recipients of the email will have been nonplused to learn that the settlement "will provide Replacement Drink Vouchers to Class Members who submit timely and valid Claim Forms." One wonders how many have bothered.Cui bono? The answer is, of course, the lawyers representing the plaintiffs. Having initially pitched for "up to $7 million in fees, costs and expenses," these ingenious jurists settled for fees of $3 million "plus costs not to exceed $30,000″ from Southwest.Canada's Fraser Institute has been compiling an "Economic Freedom" index since 1980, one component of which is a measure of the quality of a country's legal system and property rights. In the light of a case like the one described above, there is nothing surprising about the recent decline in U.S. performance. In 2000 U.S. law scored 9.23 out of 10. The most recent score (for 2010) was 7.12.Such indexes must be used with caution, but the Fraser index is not the only piece of evidence suggesting that the rule of law in the U.S. is not what it was. The World Justice Project uses a completely separate methodology to assess countries' legal systems. The latest WJP report ranks the U.S. 17th out of 97 countries for the extent to which the law limits the power of government, 18th for the absence of corruption, 19th for regulatory enforcement, 22nd for access to civil justice and the maintenance of order and security, 25th for fundamental rights, and 26th for the effectiveness of criminal justice. Of all the former British colonies in the report, the U.S. ranks behind New Zealand, Australia, Singapore, Canada, Hong Kong and the United Kingdom—though it does beat Botswana.The decline of American institutions is no secret. Yet it is one of those strange "unknown knowns" that is well documented but largely ignored. Each year, the World Economic Forum publishes its Global Competitiveness Index. Since it introduced its current methodology in 2004, the U.S. score has declined by 6%. (In the same period China's score has improved by 12%.) An important component of the index is provided by 22 different measures of institutional quality, based on the WEF's Executive Opinion Survey. Typical questions are "How would you characterize corporate governance by investors and boards of directors in your country?" and "In your country, how common is diversion of public funds to companies, individuals, or groups due to corruption?" The startling thing about this exercise is how poorly the U.S. fares.In only one category out of 22 is the U.S. ranked in the global top 20 (the strength of investor protection). In seven categories it does not even make the top 50. For example, the WEF ranks the U.S. 87th in terms of the costs imposed on business by "organized crime (mafia-oriented racketeering, extortion)." In every single category, Hong Kong does better.At the same time, the U.S. has seen a marked deterioration in its World Governance Indicators. In terms of "voice and accountability," "government effectiveness," "regulatory quality" and especially "control of corruption," the U.S. scores have all gone down since the WGI project began in the mid-1990s. It would be tempting to say that America is turning Latin, were it not for the fact that a number of Latin American countries have been improving their governance scores over the same period.What is the process at work here? Perhaps this is a victory from beyond the grave for classical Western political theory. Republics, after all, were regarded by most ancient political philosophers as condemned to decadence, or to imperial corruption. This was the lesson of Rome. Democracy was always likely to give way to oligarchy or tyranny. This was the lesson of the French Revolution. The late Mancur Olson had a modern version of such cyclical models, arguing that all political systems were bound to become the captives, over time, of special interests. The advantage enjoyed by West Germany and Japan after World War II, he suggested, was that all the rent-seeking elites of the pre-1945 period had been swept away by defeat. This was why Britain won the war but lost the peace.Whatever the root causes of the deterioration of American institutions, smart people are starting to notice it. Last year Michael Porter of Harvard Business School published a report based on a large-scale survey of HBS alumni. Among the questions he asked was where the U.S. was "falling behind" relative to other countries. The top three lagging indicators named were: the effectiveness of the political system, the K-12 education system and the complexity of the tax code. Regulation came sixth, efficiency of the legal framework eighth.Asked to name "the most problematic factors for doing business" in the U.S., respondents to the WEF's most recent Executive Opinion Survey put "inefficient government bureaucracy" at the top, followed by tax rates and tax regulations.All this should not be interpreted as yet another prophecy of the imminent decline and fall of the U.S., however. There is some light in the gloom. According to the most recent United Nations projections, the share of the U.S. population that is over 65 will reach 25% only at the very end of this century. Japan has already passed that milestone; Germany will be next. By midcentury, both countries will have around a third of their population age 65 or older.More imminently, a revolution in the extraction of shale gas and tight oil, via hydraulic fracking, is transforming the U.S. from energy dependence to independence. Not only could the U.S., at least for a time, re-emerge as the world's biggest oil producer; the lower electricity costs resulting from the fossil-fuel boom are already triggering a revival of U.S. manufacturing in the Southeast and elsewhere.In a functioning federal system, the pace of institutional degeneration is not uniform. America's four "growth corridors"—the Great Plains, the Gulf Coast, the Intermountain West and the Southeast—are growing not just because they have natural resources but also because state governments in those regions are significantly more friendly to business. There are already heartening signs of a great regeneration in states like Texas and North Dakota."In America you have a right to be stupid—if you want to be." Secretary of State John Kerry made that remark off the cuff in February, speaking to a group of students in Berlin. It is not a right the founding fathers felt they needed explicitly to enshrine. But it has always been there, and America's leaders have frequently been willing to exercise it.Yes, we Americans have the right to be stupid if we want to be. We can carry on pretending that our economic problems can be solved with the help of yet more fiscal stimulus or quantitative easing. Or we can face up to the institutional impediments to growth I have described here.Not many economists talk about them, it's true. But that's because not many economists run businesses.
- Take a great ape escape to southwestern Uganda to catch a glimpse of the endangered mountain gorilla in the wild.
IRS Puts Brakes on Corporate Push to Capture Real-Estate Tax Break
By A.D. PRUITT and AMOL SHARMA
The Internal Revenue Service is stepping up its scrutiny of companies that are looking to avoid some corporate taxes by converting their operations into real-estate investment trusts.
The Wall Street Journal
On Friday, outdoor-billboard company Lamar Advertising Co. LAMR -4.22% and data-center operator Equinix Inc. EQIX -5.54% disclosed that their plans to become a REIT could be delayed as the IRS launches a review to define what type of companies can qualify as real-estate firms to become a REIT.
The tax regulator has formed an "internal working group" to study its current standards, according to regulatory filings by the companies. Document storage operator Iron Mountain Inc., IRM -15.84% which since last July has been awaiting IRS approval to convert to a REIT, made a similar disclosure late Thursday.
In trading Friday, concerns that the IRS could strip some companies of their favorable tax status prompted a sell off among the hopefuls. Shares in Boston-based Iron Mountain fell 16%, Equinix, of Redwood City., Calif., lost 5.5% and Lamar, of Baton Rouge, La., dropped 4.2% despite a broad market rally that boosted the Dow Jones Industrial Average by about 1.4%.
The move by the IRS comes as an increasing number of companies, including many that aren't traditionally viewed as real-estate firms, have converted to REITs or are lining up to become a REIT.
Earlier this year, prison landlord Corrections Corporation of America, one of the nation's largest private prison operators, completed its REIT conversion. The list of companies using the REIT structure in some way includes casino operator Penn National Gaming Inc. PENN -0.05% and CBS Corp., CBS -1.66% which plans to spin off its outdoor advertising business in North and South America into a REIT.
The IRS declined to comment.
REITs were established in the 1960s as a way to give small investors an opportunity to invest in income-producing real estate, typically office buildings, shopping malls, apartment buildings and hotels. In recent years, the tax advantages of such trusts have attracted a wide variety of companies and investors.
REITs don't pay corporate income taxes on the taxable income they distribute to shareholders as a dividend, and they must pay out at least 90% of taxable income to qualify. Because of those hefty payments, REITs are popular with individual investors seeking higher yielding securities.
Typically, the IRS considers a real estate company any firm that receives rental income and is a landlord. But some analysts argue that some companies are stretching the definition of landlord.
Iron Mountain, for example, stores documents on racks for a fee. Still the company is proceeding with its plans as it awaits the IRS's answer.
"Given that the foundation of our business is storage, we believe conversion to a REIT is the best structure under which to execute our strategy and deliver sustainable value to our stockholders," the company said in a statement.
CBS submitted a private letter ruling request with the IRS to gain REIT status for its Americas outdoor business earlier this year. The company is preparing to file a registration statement with the Securities and Exchange Commission for a planned initial public offering of shares in its outdoor ad business, which operates billboards and has ad space in malls, buses and subway stations.
Several Wall Street analysts said CBS is likely to win approval to convert its outdoor business into a REIT, but the process could be delayed because of the agency's wider review. CBS would lose some tax benefits if the REIT conversion didn't go through.
Davenport Research estimates that the REIT conversion will shift roughly $145 million in 2014 cash taxes back to CBS—a sum that would grow annually. But analysts expect the company to move ahead with a separation of its outdoor business next year, as planned, even without REIT approval.
If the IRS decides that certain nontraditional real estate companies no longer qualify for REIT status, it would be a significant departure from its past practice.
The IRS decades ago defined as real estate sectors including cell towers, prisons and billboards.
But now, "they are being more deliberative," John Rayis, a REIT tax attorney with Skadden, Arps, Slate, Meagher & Flom LLP said of the IRS. He believes the IRS has been and will remain consistent on what constitutes real property.
"The IRS has not expanded the definition of real estate. The only thing that's occurred is that companies with real property who were always eligible to become REITs have now decided to become REITs," Mr. Rayis said.
"It is probably good for certain companies to think twice before seeking REIT status," adds Joel Beam, a REIT investor.
The IRS review comes as other government agencies are scrutinizing REITs. In April, the House Ways and Means Committee indicated that the REIT tax structure was among the many areas it was examining in its effort to raise tax revenue.
The Federal Reserve recently rankled the industry by noting that certain mortgage REITs, which buy and sell mortgage-backed securities, could poise a risk to the financial system. Last summer the SEC questioned whether certain REITs should be regulated as mutual funds rather than real estate companies.
Write to Angela Pruitt at angela.pruitt@dowjones.com and Amol Sharma at amol.sharma@wsj.com
Cleta Mitchell: How to Investigate the IRS
Cleta Mitchell, the attorney who helped expose the tax agency's abuses, has a road map for identifying the culprits. It doesn't stop in Cincinnati.
By JAMES FREEMAN
Washington
The woman who helped expose IRS abuse of conservative activists has more news to share: The abuse continues, and she sees no evidence that the White House, the IRS or the Justice Department is doing anything to end it. "This is not in the past tense. This is still going on," says Cleta Mitchell, perhaps the country's pre-eminent expert on campaign-finance and political tax law.
In 2012, Ms. Mitchell worked to persuade members of Congress that reports of IRS harassment of conservative groups were credible. GOP lawmakers demanded information from the IRS and triggered the internal audit that finally forced the agency last month to acknowledge abuses it had previously denied. Now Ms. Mitchell is determined to end the abuse and identify the culprits.
Don't bet against her. A partner at elite international law firm Foley and Lardner, Ms. Mitchell is sketching out a road map to uncover the truth and force reform—whether or not the Obama administration cooperates.
So far it looks like the administration will not. Ms. Mitchell represents nine conservative organizations that, beginning around 2010, were subjected to unusual delays, in many cases unlawful demands for information, and in some cases unlawful releases of their confidential data. But she reports that despite filling out the paperwork required by law and regulation, only one of the nine has received the customary IRS approval letter to operate as a tax-exempt group. She says another client received a new letter from the IRS with "very bizarre questions" as recently as three weeks ago.
The Justice Department is allegedly conducting a criminal investigation of the IRS abuse. Has anyone from Justice contacted her or her clients to gather evidence? "Not about this. The FBI's contacted some tea party leaders about their meetings and who comes to their meetings," she says. "I guess they viewed the tea party as domestic terrorists." She is puzzled that the feds aren't asking about IRS targeting: "You'd think that they would, wouldn't you?"
Terry Shoffner
They should, and perhaps the Securities and Exchange Commission ought to start a case file as well. Ms. Mitchell says she learned this week that the IRS even intervened in the business dealings of a donor to conservative causes. "There were two public companies that were in the process of trying to do a merger and somehow the IRS stepped in and demanded all this information and said, 'If you don't give it to us we'll stop this merger,' " she says. "But I cannot get [the donor] to come forward . . . 'Look I've been through this hassle with the IRS. I don't need any more.' People are really afraid and the donors are the most afraid."
She has heard "a number of reports" of conservative donors "having been audited or hassled," but she doesn't have a sense of how many cases there might be. "I hear about them all the time, but so far they've been the most reluctant of all to talk."
Ms. Mitchell, on the other hand, shows no fear as she talks strategy in Foley's Georgetown office overlooking the Potomac River. Maybe that's because this Oklahoma native has already overcome her share of daunting challenges.
"I was raised by a single mom. My dad was kind of a no-account," she says with a chuckle. "But my mother made up for it. She was a very strong woman. Raised six kids." And she demanded excellence from all of them. After Ms. Mitchell's first term at the University of Oklahoma, "I made one B and my mother went around telling everyone that I hadn't done very well but she hoped I'd do better the next semester." She graduated with high honors and a Phi Beta Kappa key.
Like many of her classmates, she also developed a love for the school's famed football team and proved to be as demanding about the Sooners as her mother had been about grades. Shortly after the team's current coach, Bob Stoops, was hired in 1999, she met him at a Washington reception. "You know, coach," she recalls telling him, "the good thing for you is you only need to win three games a year"—against powerhouses Nebraska, Oklahoma State and Texas. When Mr. Stoops responded that Nebraska wasn't on the schedule that year, she replied: "Well, lucky you, you only have to win two games."
These days, winning for her clients doesn't necessarily mean collecting big damage awards. She says the harassed conservative groups are more focused on getting the truth out and ensuring that the IRS's appalling conduct is stopped and never repeated. But the lever of potential monetary penalties could be useful in persuading senior government officials to come clean. Ms. Mitchell is hopeful that, even if the Justice Department sits on its hands, a combination of private lawsuits and congressional investigations can help ascertain who gave the order to target conservatives.
She has filed a lawsuit in federal court on behalf of an organization called True the Vote that names the IRS as well as previous and current IRS officials as defendants. She promises more lawsuits, including one on behalf of the National Organization for Marriage that had its documents leaked to its antagonists at the Human Rights Campaign.
Ms. Mitchell credits attorney Jay Sekulow for his suit on behalf of other conservative organizations and is encouraged by the work of lawmakers like Sen. Orrin Hatch (R., Utah) and Rep. Darrell Issa (R., Calif.). "They're just getting started to get to the answers. The first round is the IRS dissembling, denying, deflecting. And now hopefully we're beginning to get to some real information," she says.
Thus far, senior IRS officials in office when the abuses began have often provided untruthful answers, first by telling Congress in 2012 that the IRS wasn't targeting President Obama's ideological opponents and more recently by suggesting that low-level employees were to blame. Sometimes they've been unwilling to provide any answers at all, such as when Lois Lerner, the head of the IRS unit overseeing tax-exempt organizations, asserted her Fifth Amendment privilege to avoid self-incrimination, but not before proclaiming her innocence at a congressional hearing.
In the civil lawsuits, government defendants will still enjoy their Fifth Amendment rights, but the truth may come out anyway. Ms. Mitchell notes that "civil discovery is much broader and doesn't allow for as much opportunity to refuse to answer. There's a magistrate who is appointed to oversee" and resolve disputes on specific questions. And if a person is forced to answer a question during a deposition, "the perjury statutes apply."
But even if officials find ways to remain silent, they might not be able to contain the relevant information. Ms. Mitchell adds that "we are most interested in seeing documents," and that includes emails. Such documents have hardly been examined, because while the IRS's internal audit recently forced the agency to acknowledge abuses it had previously denied, the inquiry consisted mainly of interviews of staff with a supervisor present.
After denying for a year that IRS employees were targeting conservatives, IRS brass were forced by the imminent release of the audit last month to change their story. But they settled on another inaccurate claim: that the problems centered on a few misguided employees in a Cincinnati office. This was contradicted by a Wall Street Journal report this week that Cincinnati workers were being directed and even "micromanaged" by Washington, according to what one IRS employee told congressional investigators.
"I think the press has done a good job of exposing that it wasn't just in Cincinnati," Ms. Mitchell says. "I knew it wasn't." One of her clients has been waiting for approval for nonprofit status since 2009, she says, and for all that time the application was being considered in Washington. "I was told by the agent in Cincinnati, 'Oh well, you send this stuff to us, but we have to send it all to Washington.' " She says that some unusual information requests to conservative groups have also come from the IRS office in Ogden, Utah.
She adds: "I just want to know who did what and when, and I want them to issue the letters and I want them to stop targeting and go back to the process" that prevailed before the current era of abuse.
This current era appears to have begun sometime after the 2008 election of Barack Obama as president, though the Obama campaign itself offered something of a preview. As the Journal's Kimberley A. Strassel has noted, in the summer of 2008 Obama campaign General Counsel Bob Bauer urged the Justice Department's criminal division to investigate the officers and donors of a group called the American Issues Project after it ran a negative ad about Mr. Obama.
The organization was a client of Ms. Mitchell's, so she learned firsthand about the tactics of the Obama campaign and Mr. Bauer: "He would send a letter to the Justice Department demanding that my clients be criminally prosecuted for exercising their First Amendment rights. And then I would write a response, and then he'd write another letter, and I'd immediately write a response."
Mr. Bauer was named White House counsel in late 2009, shortly before the IRS appears to have begun its harassment of conservatives. Now in private practice, he seems like the kind of former official that conservatives might want to question under oath. Could it happen?
"We'd have to find that there was some communication between him and the IRS or something like that," says Ms. Mitchell. Though much may remain to be discovered, she says, the targeting of conservatives in recent years has been remarkably open: "The communications were all pretty public. That's one of the things that I don't think has gotten enough attention, is the use of the IRS as a political tool. There are 17 Democratic senators who will literally sign anything put in front of them going after conservative organizations."
She is referring to letters sent during the last election cycle by various Democrats urging IRS investigations, some of the letters even referencing specific conservative organizations. But Ms. Mitchell might just as easily mention the many speeches in which Mr. Obama has vilified groups opposing his policies and denounced them as threats to democracy or foreign-backed front groups.
All of this history inspires skepticism that the Obama Justice Department will make the abuse of conservatives a high priority for prosecution. So the job may fall to private attorneys like Cleta Mitchell. If she is intimidated at the prospect of taking on the IRS, she is showing no signs of it. "Where I come from in Oklahoma," she says, "the wide open spaces are not just geography. It's a mentality. You can be whatever you're hoss enough to be."
Maybe it's the IRS's turn to worry.
Mr. Freeman is assistant editor of the Journal's editorial page.
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