Hedge

by Nicolas Colin

  The next stage of government intervention is when this social insurance function (or a part of it) is taken over by the state. This provides the whole system with one main advantage: cost reduction. When insurers competing on the market are replaced by a single payer, there are few marketing and distribution costs because there’s only one payer and it’s mandatory for everyone to be insured by it. And so single-payer systems (like those that exist in most European countries and in the US with Medicare) provide the great advantage of making social insurance more affordable.

  Additionally, a single payer can also pressure or regulate providers to make sure the prices of services designed to mitigate losses are commensurate with the premiums paid by the customers. The downside of single-payer systems, obviously, is that the absence of market competition deprives customers of its virtuous effects on the innovation front. As an insurer, the state can lag behind when it comes to covering new risks or inventing new ways of covering old risks. This is especially true in the context of tax revolts and constant fiscal austerity such as we have seen in recent decades.

  Finally, the ultimate stage in the world of social insurance is when the state takes over both insurance and providing services to those who’ve been confronted with a loss—as is the case with the British National Health Service (NHS), which is effectively both an insurer and a care provider. The state’s vertical integration of the two functions makes it easier to make the whole system affordable both for its users and from a fiscal point of view. But as seen in Chapter 9, in the age of mass production this usually comes with a top-down bureaucratic approach, leading customers into a frustrating one-size-fits-all experience[457].

  Now, why go through this tedious social insurance 101 discussion? Mostly it’s because the techno-economic paradigm of the Entrepreneurial Age has a major impact on this whole architecture. State intervention in insurance was originally developed in certain sectors such as healthcare and agriculture to protect individuals against the most critical risks: professional hazard, old age and illness for employees; illness and crop loss for farmers. Because those risks were so critical, it was worth it to deploy the complex mechanism of pooling resources, imposing constraining rules such as a mandate and forbidding selection, and adequately compensating those confronted with a loss. But today technology makes it easier to incentivize the market towards an approach resembling social insurance, this time without the top-down, one-size-fits-all approach.

  One contribution of technology is the possibility to induce network effects. Ubiquitous computing and networks make it easier to create relationships between the customers of a certain insurer, eventually turning them into a multitude. This enables peer pressure so as to prevent moral hazard and free riding, which is one of the major flaws on most insurance markets. It also contributes to virtuous group dynamics when promoting good prevention practices (not smoking is easier done together) or following a loss (groups of patients covered by the same insurer can stick together and help each other as they undergo demanding and painful treatment).

  With more intensive monitoring of user-generated data, technology also provides insurers with the tools to implement better prevention at a much larger scale. It makes it possible to collect more data, which in turn makes it easier to target prevention measures. Data can be used both at the individual level (to know us better and influence our lifestyle in a virtuous way) and at the aggregate level (to assess statistical results and improve the capacity to predict both individual losses and the insurer’s underwriting margin).

  Hence technology provides private insurers with the unprecedented capacity of scaling up to the point of universal coverage in a more beneficial manner. Contrary to a traditional insurer, an entrepreneurial insurer needs as many people as possible, well-behaved or sick. In the presence of technology, a new customer, whatever their risk profile, contributes to maximizing returns on marginal input, which encourages the insurer to welcome as many customers as possible. This is just how Google Search performs better as its application is used by a growing community of individuals, even if most of them don’t click on sponsored links and thus don’t directly generate revenue for Google.

  With the proper infrastructure and legal framework, the Entrepreneurial Age could therefore be conducive to an unprecedented universalization of insurance benefits. It doesn’t mean that everyone will be served the same way. Rather, it means that there will be less incentive to practice adverse selection.

  A traditional approach to health insurance invites selection based on signal, leading to a careful screening of pre-existing conditions and a widespread exclusion process. Conversely, a multitude-driven approach triggers different dynamics. Because each new customer contributes to increasing returns to scale, the insurer has an interest to be more welcoming to the many. In the new world of health insurance, a customer is not only a potential loss that you need to exclude or rob with high premiums so that they cover the cost of future compensation. It’s a new node in a network that over time will create value for the entire community of insurees through aggregated data, behavioral influence, and peer-to-peer work. Overall, the bet is that network effects beat selection effects most of the time.

  Up to now, social insurance systems have been designed and managed under the old rules of top-down bureaucracy. You needed to reach critical mass in order to make an average, standardized experience affordable for the masses. We all count on the healthcare system to be treated when we need it. But we also hate it for the complexity and endless frictions of its user experience.

  Many startups, notably in the US, are trying to change that. A first generation[458], among them Oscar[459], has been lifted by the regulatory disruption of Obamacare. But now that the Democrats have lost power, the new generation will have to be even more radical. Fortunately, it doesn’t look as if the tech industry is avoiding that challenge. Q Bio, an Andreessen-Horowitz-backed startup, is aiming to reinvent preventive medicine in the age of ubiquitous computing and networks[460]. Watsi, an impressive Y Combinator-backed non-profit, is working to deploy the infrastructure to operate universal health insurance in less developed countries[461].

  From a regulatory point of view, it’s becoming clearer how the current approach to social insurance should be upgraded. A mandate still seems necessary in every field where individuals are confronted with critical risks. Like in the case of car insurance, this is clearly the key to making insurance more affordable. As for exclusion, more data-driven regulations should be designed to make sure that insurers don’t practice exclusion or eviction through pricing, effectively nudging them into welcoming new customers as part of the multitude and harnessing the related increasing returns to scale rather than selecting their customers based on personal data.

  Beyond that, the key advantages of a single-payer system are effectively replicated by the winner-takes-most dynamics driven by increasing returns to scale. Indeed a major overhaul of the system should be made with regards to bargaining with providers or even having the insurers deliver certain products themselves instead of relying on third parties. Instead of restricting insurers from bargaining with providers, governments should support the superior market power of those lifted up by increasing returns, using this new breed of insurers to force the overhaul of entire industries through full-stack integration (rather than enacting prohibition on Medicare negotiating drug prices).

  Clayton Christensen has worked a great deal on how to make healthcare more welcoming for disruptive innovation[462], which will go through retrofitting the old care providing industry by diversifying the way prevention and treatment are provided. As he wrote, “Hospitals have become extraordinarily capable of dealing with very complicated problems. But in the process of adding all of that capability and its attendant costs, the hospital has overshot what patients with straightforward disorders can utilize when they are admitted”[463]. Like in consumer finance, we can count on entrepreneurs to tackle the challenge of imagining new ways to serve individuals i
n the field of social insurance.

  This vision for social insurance is indeed optimistic. It can only be realized if the right institutions are not only imagined but are actually established for this purpose. Two dangers must be identified and prevented: the first is the temptation to focus on an obsolete approach to social insurance, one that doesn’t account for the radical changes brought about by ubiquitous computing and networks. The other would be neglecting to implement a policy designed to encourage the birth and development of a new breed of insurers and providers. Not taking advantage of the transition in the insurance industry would be a serious industrial policy mistake and a terrible missed opportunity. If we are committed to the principle of hedging people against most risks, then dealing a new hand in insurance must be a key part of building the Great Safety Net 2.0.

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  We should all be taxed like Donald Trump

  During the 2016 presidential campaign, the press was abuzz with information on Donald Trump’s income history — and the conclusions we could derive from his taxes (or lack thereof). According to a widely read New York Times article[464], Trump recorded a net loss of almost $1 billion in 1995, which could have enabled him to offset his income taxes for a very long time afterwards.

  The reason why Trump was able to do so is that he records his income not like any other ordinary citizen or household, but instead as a kind of individual entrepreneurial venture. The net loss was probably generated by various business partnerships that he was part of, notably in real estate and casinos[465], whose expenses that year were (much) higher than income.

  As opposed to a corporation, which is governed by the fundamental rule of limited liability[466], a partnership’s shareholders are usually accountable for both the profits and the losses. When the partnership generates a profit, it can be transferred to the partners and will be taxed at a personal level. But when the partnership generates a loss, it will also be transferred to the partners who, due to the business nature of that negative income, are able to spread the loss across multiple years to cancel out future taxes on earnings. This is called a “loss carryforward”, “an accounting technique that applies the current year’s net operating losses to future years’ profits”[467].

  Assessing a loss on one’s personal tax returns doesn’t necessarily mean that one is a bad entrepreneur (although it clearly appears as if Trump is precisely that[468]). Say that your partnership spends $2 million this year to build a business that begins generating revenues in the coming years, with the corresponding expenses generating a loss for the initial fiscal year. Carrying that loss forward means that the first $2 million generated will be tax-free, as they're making up for the previous ‘loss’ which is actually an investment and the only reason that the partnership was able to generate those future returns. It seems quite normal that the initial investment can be recovered before you start being taxed on the profits, doesn’t it?

  Yet many denounced the Trump tax situation, claiming that we should close those tax loopholes that only profit millionaires and billionaires. And it’s true that no ordinary person, whose sources of income are mostly wages and any interest earned in their savings account, belongs to a business partnership for which they’re accountable for both profits and losses. When ordinary households’ expenses exceed their income, they borrow money and the interest they pay is certainly not deductible from their next tax bill (except if it’s for buying a home, but that’s another story[469]).

  Should someone choose to replace their labor contract with a partnership that bills their employer in exchange for their services and thus claim the right to adjust for the difference between income and professional-related losses? After all, many expenses that are directly related to work (such as transportation, business lunches, devices such as a laptop and a mobile phone, and even some clothing and services like childcare) could be subtracted off their personal income so that, like a corporation, they’re only taxed on their profit instead of their gross income. Why don’t we all do that?

  Two reasons, mostly. First, we still live in a world of settlers rather than hunters. For most of us operating like Donald Trump would mean losing a lot of benefits that are attached to being an employee[470], notably health insurance, the right to a pension, and the security that is generally provided to an employee under labor law. Unlike some salaried workers, a contractor can always be fired without cause and is solely responsible for anything related to covering risks such as illness and old age. For that reason, people usually prefer a labor contract as opposed to structuring their work as a partnership. (And moreover up until now most employers would probably refuse to hire someone as a contractor instead of an employee.)

  The second reason why we don’t all use tax loopholes like Donald Trump is that it is too complicated at the small scale of a middle-class household to account for all the needed information related to income and expenses. Anyone wanting to do that would have to perform double-entry accounting on all their personal finances so that they’re only taxed on what more or less corresponds to their savings (the amount available for future personal investments).

  Yes, that would allow individuals to subtract expenses as well as interest and depreciation from income so as to calculate their personal profit. But it is awfully hard to keep track of all those tiny expenses in their everyday life in the world of what Venkatesh Rao calls “paperware”[471]. The tax authorities could simply refuse their accounting since an ordinary household wouldn’t likely have the robust information system, accountants and auditors to certify that they’re providing a true and fair view of their finances and operating results. Right now, you need to be wealthy to deploy the necessary infrastructure and hire the accounting and law firms that keep track of your personal finances.

  Donald Trump wasn’t punished by voters for his tax situation—not during the campaign[472], nor, obviously, on election day. Meanwhile, many among his opponents and critics called to close that tax loophole[473]. But allow me to play the contrarian here. Instead of closing that particular loophole that is so well exploited by billionaires, why not expand it for everyone else? After all, in the Entrepreneurial Age more individuals are seeing a growing porosity between household spending and professional expenses, for the simple reason that there are more and more self-employed workers and entrepreneurs who have to buy equipment and draw on their savings to finance daily expenses when they start a business.

  As we’re converting to the hunting way of life, shouldn’t we all be allowed to subtract more expenses from our personal income—expenses that in a broad sense are directly linked to our professional life? In the Entrepreneurial Age, aren’t we all confronted with a more unstable professional life that, at various points, will see us dedicate a substantial part of our resources to personal training or founding a startup? As Peter Drucker once wrote, the “entrepreneurial society” is one “in which innovation and entrepreneurship are normal, steady, and continuous”[474].

  It’s true that there are already some mechanisms that favor that approach. There’s the 401(k) account, which enables individuals to exempt income set aside for retirement from taxation with the potential for matching by employers. And there are tax credits to pay for tuition if you go back to school. But those mechanisms don’t really account for the radical paradigm shift of the Entrepreneurial Age. For hunters, retirement doesn’t happen only once in today’s life: it happens many times, every time you switch jobs. As for learning, as we’ve seen in the previous chapter, it can’t be reduced to going back to school—in fact, it could simply involve watching videos on YouTube, joining a learning community on Facebook, or giving gigs a try on a platform.

  In the Entrepreneurial Age, we should have a hunter-friendly tax system that allows for a broader interpretation of earnings and losses over time. We need a system more like the one that's used by Donald Trump, not one designed for people who generally have a stable income from one year to the next throughout an entire career.

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bsp; This would have been a crazy idea in the world of “paperware”[475], in which fraud and mismanagement would surely be widespread. But in the world of software, every transaction can be tracked and documented in the cloud, as illustrated by Intuit’s solutions for the self-employed[476] or, in a more un-Western way, by the intriguing Chinese system of government-sponsored social credit[477]. In most cases it will become ever easier to separate business-related expenses from personal ones, thus opening the possibility that we all use that famous loophole: we wouldn’t pay taxes, and would even be able to spread potential losses out over multiple years, if our business-related expenses exceed our income in a given year. On the other hand, taxes would be due when our personal “startup of you”[478] becomes profitable over the long term.

  Overall, my sense is that the vast majority of people are under the illusion that the tax system is a given. But like is the case for many institutions, this is far from being true. Most components of our modern tax system were imagined as recently as in the twentieth century, in line with the specificities of value creation in the age of the automobile and mass production. Personal income tax was invented to account for the rise of salaried work, which made it easy to assess what people earned in a given period and then apply a tax rate to it. Its proponents were progressive politicians like Woodrow Wilson in the US, who helped pass the 16th Amendment to the US Constitution in 1913, and finance minister Joseph Caillaux in France (one of my inspecteur des finances predecessors in the French government).

  Corporate tax levied on corporate profits was then tailored by economists working for the League of Nations following World War I. The idea was to support the development of multinational enterprises while making sure that their profits wouldn’t be taxed more than once by the various countries where they had a permanent establishment. As for value added tax (VAT), now a major source of fiscal revenue, it was invented in 1951 by French senior civil servant Maurice Lauré (another inspecteur des finances!) to make it easier to tax value added in the presence of the lengthening value chains of the post-war boom (and of widespread cheating on income taxes). VAT was soon adopted by all developed countries in the world except for the US, which continues to rely upon a distortion-prone sales tax system.