WORD ON THE STREET

Border adjustment would sock Florida with hugely higher insurance rates

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In recent years, Congress repeatedly has considered legislation that would have adversely and profoundly impacted disaster-prone states like Florida. Luckily, we were spared passage, over and over again. Unfortunately, a tax “reform” package supported by House Republicans and likely to be introduced soon may contain provisions that would do essentially the same damage.

Historically, these bills targeted reinsurance purchased by property insurers from affiliates located offshore. The key change would be to eliminate the U.S. subsidiary’s ability to write off the reinsurance costs from their corporate income. The measures long have been supported by a group of U.S.-based insurance companies, who sought to reduce competition they face from foreign insurers and reinsurers.

Damages from isolated incidents such as fires, thefts and hailstorms are normally paid directly by insurance companies. However, when a massive disaster like a hurricane strikes, reinsurance kicks in and covers the insurer’s losses beyond a pre-negotiated deductible. Changing the tax rules to punish international insurers would be particularly damaging for reinsurers, whose global scope allows them simultaneously to cover enormous risks like hurricanes in Florida and earthquakes in New Zealand, as they are uncorrelated and therefore unlikely to happen at the same time.

Given Florida’s vulnerability to hurricanes, the availability and affordability of reinsurance protection is critical to the state’s economic health and security. According to new research by the Brattle Group, the tax would raise home insurance premiums by 1.9 percent, or $282 million a year in added costs, and raise premiums for business insurance by 6.7 percent, or $367 million in added costs.

As President Donald Trump and House Republicans continue to discuss plans for corporate tax reform, Floridians should pay close attention to proposals for a “border adjustment tax,” which is pitched as a way to tax goods and services companies import, but not those they export. House Republicans have discussed adding this feature to their tax reform “blueprint” in order to dampen the immediate fiscal impact of reducing the federal corporate income tax rate.

The fear for Florida and other disaster-prone states is that financial services, including insurance and reinsurance, would be included in the definition of imported goods and services and thus subject to taxation. In 2011, the Florida Legislature became so concerned by the prospect of Congress enacting a proposal to tax the purchase of offshore reinsurance that it unanimously passed a memorial urging its rejection.

Indeed, Florida has a reason to be concerned about any proposal that taxes the purchase of reinsurance from offshore companies, as 91 percent of the state’s private reinsurance protection comes from such companies, along with 98 percent of the private reinsurance bought by the state-backed Citizens Property Insurance Corp.

According to the Brattle study, applying border adjustment to insurance and reinsurance would cut the amount of reinsurance available to the United States by between 20 percent on the low end and a whopping 80 percent on the high end. Across the country, regular consumers would have to pay $16.9 billion more to obtain the same basic insurance coverage they already have. Florida, which leads the country with $2.9 trillion of insured coastal property, would be hit the hardest.

There is, however, some good news. Most countries that have adopted a border adjustment tax system have zero-rated or altogether exempted financial services from such taxation. Congress should do the same.

Florida has among the highest property insurance rates in the nation, due in no small part to its vulnerability to hurricanes, as well as an increasingly litigious environment that the Legislature can and should address. The last thing it needs is for Congress to tax something that it relies on more than any other state.


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What the Wall Street Journal gets wrong about farming in 2017

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With the Farm Bill up for reauthorization in 2018 and legislative debate poised to heat up later this year, there’s been a lot of talk about the plight of the American farmer. A recent Wall Street Journal piece proclaimed that we’re on the brink of a major national farm bust, as a shrinking global grain market and low prices increasingly will drive small family farms out of business.

Citing research from the U.S. Department of Agriculture, the Journal predicts that farm incomes will drop 9 percent in 2017, “extending the steepest slide since the Great Depression into a fourth year.”

Declining farm incomes have not gone unnoticed on Capitol Hill. The House Agriculture Committee recently held its first hearing of the 115th Congress, titled “Rural Economic Outlook: Setting the Stage for the Next Farm Bill.” Chairman Michael Conaway, R-Texas, said in his opening remarks:

America’s farmers and ranchers are facing very difficult times right now… As we begin consideration of the next Farm Bill, current conditions in farm and ranch country must be front and center.

For taxpayer advocates hoping for meaningful reforms in the next farm bill, this doom and gloom does not bode well. Instead of leading to reforms that help farms struggling to stay afloat, it will likely only result in more of the status quo. That means more taxpayer-funded subsidies flowing to wealthy agribusinesses, while small farms become increasingly obsolete.

It’s true that commodity prices are down and many farmers are struggling. But it’s also true that, relatively speaking, the farm economy is doing pretty well. As the Environmental Working Group points out in a response to the Journal piece, median farm household income is expected to grow in 2017. At $76,735, median farm household income is actually $20,000 more than the median income for all U.S. households. While there is certainly risk in starting a farm operation—as there is with any business in a market-based economy—the annual business failure rate is 14 times greater than the annual failure rate for farms.

The alarmists imply that struggling commodity farmers are being left out to dry, but that couldn’t be further from the truth. Not only are commodity farmers protected by the Agricultural Risk Coverage program, which triggers payments when revenues fall below an anticipated threshold, and the Price Loss Coverage program, which pays out when market-year average prices fall below what’s called the reference price, but they also have the option to purchase government-subsidized crop insurance with lavish coverage options. On average, the government subsidizes 62 percent of farmers’ crop-insurance premiums, regardless of the size of the farm operation.

Farmers also have the option to insure not only their projected yields, but also their revenue. Under the most extravagant federal crop insurance product, the “harvest price option,” farmers can cash in either the locked-in price at the time they planted or the current market price, whichever is higher. As we’ve said before, it’s the “crop insurance equivalent of your auto insurer surprising you with a new Cadillac Escalade after you’ve totaled your Toyota Corolla.”

The Wall Street Journal correctly notes that the consolidation of large, industrial-scale farm operations has driven many small farms out of business. But what it doesn’t mention is that our crony agriculture policy is likely driving much of that consolidation. An EWG analysis found that the top 10 percent of U.S. farms are getting more than 50 percent of the subsidies, with 26 farm operations receiving subsidies of $1 million or more. Congress should address this cronyism by putting a cap on the amount of premium support a single farm operation can receive and enacting a means test, so that farmers who are making high incomes cannot receive subsidies. This would help to level the playing field for small family farmers and ensure that our taxpayer dollars are not being spent to boost the incomes of mega-farm agribusinesses.

Accounts like the Journal article invoke nostalgia for the hard-working family farmer, but this sympathy will only be misplaced if lawmakers do not seize on this opportunity to craft a reformed farm bill that puts the interests of taxpayers and struggling farmers above those of the Big Ag lobby. As we look ahead to the next farm bill, let’s not allow dismal, exaggerated narratives distract us from the fact that our current farm-support system is not working and badly needs reform.


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A cyber mandate isn’t the way to address cyber-insurance takeup

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To improve cyber preparedness and help companies recover from cyberattacks, it’s essential that the takeup rate for cyber insurance continues to rise. The insurance capacity plainly exists to write virtually all of the risks for which the market currently seeks coverage. What’s missing is demand.

The federal government can play a role to bolster that demand, but prescriptive measures, like a cyber-insurance backstop or a cyber-insurance mandate, would have a negative impact on those efforts. A recently released paper from R Street Technology Policy Fellow Anne Hobson instead recommended that so-called “internet-of-things” vendors and contractors that do business with the federal government be held financially responsibility should a cybersecurity failure on their part result in costs to U.S. taxpayers.

Some have proposed the best way to accomplish this goal would be to require that federal vendors and contractors buy cyber insurance. It’s a proposal that has some attractive features. Insurance often has the benefit of forcing private actors to take account of their practices and reduce risks that otherwise would cause their premiums to rise or render them unable to obtain coverage at all.

But it’s important to remember that insurance exists to transfer risk. Whether it’s appropriate to buy cyber coverage to address directors and officers liability, or to deal with the potential for business interruption, is a decision each firm’s management team must make for themselves. The government has no special knowledge to know what’s right for every company with which it does business. What it can and should require is that taxpayers be protected from having risks directly or implicitly transferred to them as a result of those private risk-management decisions.

While firms could pursue other mechanisms to address their financial responsibility—from letters of credit to surety bonds to cash—most would find cyber insurance the most efficient means to transfer the risk of cyber-related liabilities. When it comes to risk management, private firms have a number of questions they must ask, including what risks they face, what strategies can be employed to mitigate those risks and whether it is more cost-effective to retain those risks, which will be borne by shareholders and creditors, or to transfer them to third parties like insurers. The key is to make clear that firms know they will be held liable for any risks they create for others—in this case, the government and individuals whose private data are entrusted to the government. There will be no bailout if things go wrong.

If the government simply wants its contractors to undertake cybersecurity measures, it can do that and, to an extent, it already has. It’s not only appropriate, but it’s absolutely essential that federal agencies vet the vendors and contractors with which they do business, and not offer contracts to those who practice poor cybersecurity hygiene. This should include examining vendors’ overall risk-management practices and taking as a positive sign that a given contractor has prepared for contingencies by obtaining insurance.

But as a technical matter, while it’s possible to require and define the scope of financial responsibilities that a government contractor holds to the agency with which it contracts, there is no magic formula to determine what kind and how much insurance every potential government contractor should get. Different firms of different sizes engaged in different kinds of activities that face different kinds of risks and operate under different contract terms all will have vastly different sorts of insurance needs.

The larger point here is that before you can enjoy the benefits of cyber insurance, which are many, you first must have a definable need for insurance. There is much to praise about how the underwriting process can act as a kind of cybersecurity audit. But the social benefits of cyber insurance do not, themselves, create the need for a cyber-insurance policy. First, you must have a risk that it actually would be prudent to transfer.


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Should we have a long-term budget for entitlements?

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Federal law treats Social Security, Medicare, Medicaid and other entitlements as “mandatory” spending programs, which means they are not subject to the annual appropriations process like the rest of the budget. These programs annually take on an ever-greater share of the federal budget — now almost 60 percent. They also are racking up huge unfunded long-term obligations, as the nonpartisan Congressional Budget Office has reported. The Government Accountability Office has chimed in by warning that entitlements are on an unsustainable growth trajectory.

So what to do?  Stuart Butler of the Brookings Institution and Maya MacGuineas of Committee for a Responsible Federal Budget suggest a long-term budget for entitlements. Doing this, they posit, would establish an “orderly pathway for helping to resolve inherent tensions” in current budgeting. Additionally, a long-term entitlement budget would “encourage Congress to make clear choices about long-term spending.” Presently, the auto-pilot growth of entitlements is crowding out spending on other priorities and fueling bruising budget fights.

The authors identify two steps to enact a long-term budget: designing a long-term budget plan and treating the plan as binding going forward (unless Congress takes steps to change it). For the initial design phase, Congress would need to map out a 25-year spending plan for major entitlement programs, as well as a funding plan to cover their costs (presumably by identifying specific taxes or revenue, savings, or by proposing a debt increase). The authors advocate that this long-term budget plan should also include tax expenditures, which, like entitlements, tend to grow inexorably.

CBO would then be tasked with publishing an annual 10-year “moving average” (based on the results of the previous five years and projections five years into the future) that would act as the baseline from which it would be determined if the budget was veering outside what the authors call the “corridors” of the long-term plan.

Congress would engage in quadrennial reviews of the long-term budget during the year after each presidential election. This formal review could be used to alter the long-term budget going forward, if Congress deemed it desirable. Once finalized, the budget timeline would be extended by another four years to create a new 25-year budget. Critically, revenue and entitlement levels that had been established during prior reviews would only be alterable by an act of Congress signed by the president.

In between these quadrennial reviews, agencies and Congress would have free rein to change revenues and entitlements, so long as the changes did not cause the long-term budget to diverge from the established corridors.

Once a plan is developed, Congress would vote to enact it, thereby creating a framework moving forward and teeing up the second element of the author’s proposal. That element requires the long-term budget plan to be the default budget for entitlement programs moving forward, and automatic procedures would be triggered if the spending plan failed to stay within the agreed-upon corridors.

The authors sensibly note that a long-term budget plan would be unlikely to survive if it required Congress to take proactive action to maintain it. Therefore, automatic enforcement mechanisms are necessary. The authors criticize the idea of using automatic triggers—modeled after mechanisms like the Medicare Sustainable Growth Rate—that would initiate cuts whenever the long-term plan veered outside the set corridors. As they point out, such proposals are politically difficult given their blunt nature of cutting expenditures across the board.

Instead, they propose establishing a commission similar to the Defense Base Realignment Commission (which was established in the late 1980s to identify and close unnecessary military bases) that would act as the default enforcement mechanism to maintain the long-term budget. This would mean that, in the event the long-term budget started to careen outside the guardrails (for example, entitlement spending started to rise more than anticipated), the commission would be able to engage in the necessary course-correction actions to keep the long-term budget within the corridors (for example, by cutting spending or identifying more revenues for funding).

This commission would be jointly selected by Congress and the president, and its recommendations would be final — unless Congress took action to override it. This could be done by a congressional “super committee” that could develop an alternative method and package to maintain the long-term budget’s proper trajectory. The super committee’s alternative would then be considered on an expedited up-or-down vote in Congress and would replace the commission’s plan if approved.

In their paper, the authors address a few other points regarding their proposal, including some counterarguments to the idea. They note, for example, that it might be wise to allow the automatic-enforcement mechanisms (the commission and super-committee process) to be suspended during a certified recession. They also suggest the importance of setting an explicit fiscal objective that the long-term budget would be trying to help achieve, in an effort to discourage overpromising by politicians. Finally, the authors acknowledge that, while one Congress cannot legally bind future Congresses, the legislature is empowered to establish congressional procedures that can work to shape future congressional behavior and politics.

Congress has struggled mightily in recent years to carry out the fantastically complex annual budget and appropriations processes. A new process is needed, one that both reduces the steps that need to be completed each year, reduces the realm of conflict and soberly confronts fiscal reality. As such, Butler’s and MacGuineas’ proposal is a welcome effort to tackle a problem that too long has been unaddressed.


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How the federal government could lead by example in cyber insurance

The takeup rate of cyber insurance is rising, but the market’s growth to date has been uneven. Anne Hobson, a technology policy fellow at the R Street Institute, may have a solution to that problem. She proposes that the federal government, as a high-profile cyber target and large user of connected devices, is well-positioned to address the uniformity problems currently afflicting cyber-insurance policies by introducing a financial responsibility requirement for some of its most vulnerable vendors and contractors.

In a new paper, Hobson takes stock of the risks presented by growth of the so-called “internet of things.” The “things” are objects, hitherto unconnected, that are now being networked for our convenience. Each of these objects has the ability to send or receive data, often to do both, and is, as a result, susceptible to breach and malicious misuse.

She reasons that, beyond outright ignorance of the existence of cyber insurance, the principal reason firms fail to carry coverage is that the policies are both complex and nonstandard. Thus, while there is reason to believe the takeup rate will continue to climb as the market grows, a step taken to introduce some level of uniformity to the market may speed that process further.

But finding a benign way to introduce greater uniformity to cyber-insurance offerings is challenging, particularly given that the long-predicted rapid growth of the cyber-insurance market is now meaningfully underway.

Nigel Pearson, global head of fidelity at Allianz Global Corporate & Specialty recently noted that “the cyber market is growing by double-digit figures year-on-year, and could reach $20 billion or more in the next 10 years.” His prediction was echoed by similarly bullish analysis from Allied Market Research. Allied projects the cyber-insurance market will reach $14 billion in written premium in five years, by 2022.

Despite those developments, growth has been uneven. While firms in some sectors, particularly large firms in financial services, are now more likely than not to carry some level of cyber insurance, the vast majority of small and midsize businesses do not. The risk for such firms is large and growing. In fact, according to Hartford Steam Boiler, 60 percent of small and midsized businesses that experience a cyber attack go out of business within six months.

Hobson argues that prescriptive regulations establishing cybersecurity standards would do more harm than good for firms of all sizes, but that federal agencies can help encourage the fast-developing cyber-insurance market by insisting that internet-of-things contractors be held financially responsible for any liabilities created for taxpayers as a result of cyber-attacks on their products or services.

The rationale for such a requirement is twofold. First, it is important to insulate taxpayers from the costs associated with a breach. In Hobson’s own words:

In the case of a cyber-attack or data breach that stems from the insecurity of a contractor or vendor’s system, the contracting agency…could have to expend resources on a host of ancillary costs, which can include DDoS mitigation services, forensic investigations, user notifications and data recovery. Rather than pass such costs onto the taxpayers, agencies and government purchasing agents should assert in contractual language their right to subrogate these liabilities from the contractor or vendor.

Second, greater adoption of cyber insurance would help to improve cybersecurity itself, as it would align security incentives. As firms go through the cyber-insurance underwriting process, they are made to audit their cyber vulnerability and to address problems as they are uncovered. For their part, insurers have every reason to ensure that firms maintain a vigilant cyber defense. Thus, each party has an independent pecuniary incentive to foster an effective ongoing cyber defense.

Congress is eager to improve the nation’s cybersecurity preparedness. But instead of a cyber-insurance backstop for large risks, or a prescriptive set of security requirements for small firms to follow, Hobson concludes that the best thing that it can do is set an example as a market participant. By taking a modest step, Congress can both expand the universe of firms with cyber insurance and bolster the nation’s cyber preparedness. That’s a win-win.

CTA previews Innovation Policy Day at SXSW

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The Consumer Technology Association welcomed R Street Tech Policy Fellow Anne Hobson to take part in a recent Facebook Live panel to preview the Innovation Policy Day programming CTA will be hosting at the upcoming SXSW festival in Austin, Texas. Hobson’s comments focus on augmented reality (AR) and virtual reality (VR), the roles these emerging technologies will play a role in improving people’s lives, and the concerns they have raised in such policy areas as cybersecurity, privacy, intellectual property, e-commerce, free expression and health and safety. Video of the panel is embedded below.

Ian Adams on KVOI in Tucson

R Street Senior Fellow Ian Adams and Mike Shaw of KVOI in Tucson, Arizona, to discuss the REINS (Regulations from the Executive in Need of Scrutiny Act) Act and what it means for re-balancing the distribution of power between the legislative and executive branches of government. The half-hour segment also focused on NHTSA’s decision to clear Tesla of any wrongdoing stemming from a recent fatal accident involving its autopilot system, as well as President Donald Trump’s use of a mobile device which might, in fact, be hacked already.

The full show is embedded below.

Transportation regulators are determined to stretch their powers to the limit

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Since 2008, the freight-railroad industry has contested an effort by two federal regulators to rebalance the relationship between freight-rail operators and Amtrak. The issue is one of control and timing.

Amtrak, which is government-funded but operates as a for-profit corporation, predominantly runs its many passenger rail routes over lines owned by freight-railroad companies. Even though freights own most of the lines, Congress has historically granted preference to Amtrak trains, meaning that freight trains must generally yield to Amtrak trains if their routes conflict. Even with this priority, however, Amtrak has proven remarkably poor at running its trains on time. Amtrak, in turn, has blamed its poor performance on the freights, arguing that they do not sufficiently prioritize Amtrak trains along their routes.

In an effort to rectify Amtrak’s lagging performance, Congress passed the Passenger Rail Investment and Improvement Act of 2008, which ordered the Federal Railroad Administration and Amtrak to promulgate joint metrics and standards to measuring the performance and quality of intercity passenger trains. Under PRIIA, the metrics are used to investigate substandard performance and, in some situations, may be used to award Amtrak damages if freight railroads are found to be the true cause of Amtrak’s poor performance.

While the statute required the FRA and Amtrak to promulgate the performance metrics, it charged a different federal agency, the Surface Transportation Board, with undertaking any such investigations into laggard performance. This framework drew a constitutional challenge from the freight-rail operators. Because the law empowered FRA and Amtrak to come up with the performance metrics together, the freight railroads argue the law violates the so-called “non-delegation doctrine.” That doctrine prohibits Congress from delegating its legislative powers to other entities, particularly private entities. Given that Amtrak is managed as a for-profit corporation, the rail industry argues that it qualifies as a private entity.

The rail industry initially won on this argument at the D.C. Circuit Court of Appeals, which agreed that PRIIA’s delegation of metric-setting power to a quasi-private entity like Amtrak was an unconstitutional delegation of Congress’ powers. On appeal to the Supreme Court, though, the tide turned. The high court held that Amtrak was, in fact, a government entity rather than a private entity. As a result, Congress enjoyed more leeway in delegating its power to Amtrak.

The drama didn’t end there. The D.C. Circuit revisited the case and again struck down the metric-setting section of PRIIA. This time they struck it down on alternative grounds—namely, that the law violates due process because it allowed Amtrak effectively to act as a regulator in a market in which it had “skin in the game.” In other words, Amtrak was competing as an economic actor with the freight railroads, while also having power to regulate and impact the conduct of its competitors.

The federal government is expected once again to appeal that ruling to the Supreme Court. In the meantime, another related skirmish has broken out. While the non-delegation dispute was working its way up and down from the Supreme Court, the Surface Transportation Board stepped in and declared its authority to define PRIIA’s metrics and standards. As laid out above, PRIIA clearly awarded the power to define metrics—such as on-time performance to the FRA and Amtrak—while it reserved the powers of investigation and enforcement to the STB. But since the FRA/Amtrak version of the regulations are tied up in court, the STB claims it has the power to step into the fray and define its own metrics.

Unsurprisingly, this development sparked another court case by the freight-rail industry—this one in the 8th U.S. Circuit Court of Appeals—arguing that the STB usurped powers not granted to it by the law. At stake in this case is the proposition that, just because a protracted legal battle has halted the implementation of a law, another regulator is not suddenly empowered to fill the gaps.

The best option would be for Congress to step in again and fix the statutory defect and clarify whether the FRA or the STB has metric-setting power (and at the same time, clarify that Amtrak does not have such power). Either way, the drama surrounding this controversy is just one more demonstration of federal agencies pursuing creative methods to implement regulations and accrue power—even in the face of seemingly clear statutory language and court decisions to the contrary. If their power to do so is affirmed, both regulated industry and Congress have something new to fear.


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The administration’s bad start on civil asset forfeiture

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It appears that President Donald Trump has officially taken a position on civil asset forfeiture. This week, the president offered to help “destroy” the career of a Texas state senator who was supporting reform with the state’s asset forfeiture laws (he later claimed that he was joking.)

Joke or not, the threat came during an exchange with Rockwall County Sheriff Harold Eavenson, who told the president: “We’ve got a state senator in Texas that was talking about introducing legislation to require conviction before we could receive that forfeiture money.” Eavenson went on to say that the Mexican cartels would “build a monument to [the unnamed senator] in Mexico if he could get that legislation passed.”

The particular bill Eavenson was referring to is co-sponsored by state Sens. Konni Burton, R-Fort Worth, and Juan “Chuy” Hinojosa, D-McAllen, with the goal to reform civil asset forfeiture in Texas. The two senators championed this reform effort because of the inherent injustices associated with the asset-forfeiture process.

Because such seizures are civil, a victim of forfeiture does not have access to appointed counsel and the standard of proof is typically “preponderance of the evidence,” much lower than the criminal standard of “beyond a reasonable doubt.” Maybe most egregious, the practice has encouraged a policing-for-profit mentality where officers pursue much-needed funds via the forfeiture mechanism, rather than acting as administers of peace—protecting and serving. This mentality has increased the tension between the police and the policed.

A pillar of President Trump’s campaign (and now his presidency) has been the populist defense of “the little guy.” It is mind-boggling that he would defend a practice that targets his base. The rich elite can afford lawyers, but the little guy cannot.

The Supreme Court has performed legal somersaults defending forfeiture without charge or conviction. Thus, federal courts continue to hear cases with titles like United States v. Articles Consisting of 50,000 Cardboard Boxes More or Less, Each Containing One Part of Clacker Balls.

But the legislation in question here is a state bill. Federalism, according to the GOP’s official platform, is “the foundation of personal liberty.” The platform goes on to say:

Federalism is a cornerstone of our constitutional system. Every violation of state sovereignty by federal officials is not merely a transgression of one unit of government against another; it is an assault on the liberties of individual Americans.

It seems reasonable, then, that the state of Texas should decide what is right for the state of Texas, without interference or threats from the federal executive. The notion that the president would use his bully pulpit to “destroy” duly elected state senators because a sheriff with a shiny star on his chest bitched about having his toys taken away is a Nixonesque abuse of power.


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Neeley addresses press conference on ‘Conservative Texas Budget’

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R Street Southwest Region Director Josiah Neeley joined with Texas state Sen. Don Huffines, R-Dallas, and other members of the Conservative Texas Budget Coalition at an Austin press conference to unveil a proposed 2018-19 state budget that includes significant tax and spending reforms, capping spending at no more than $218.5 billion, eliminating the state’s costly business margins tax and enacted structural reforms to property taxes. Video of the press conference is embedded below.

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