Challenges to Fundamental Tax Reform

by Ryan Ellis

ON A SUNNY OCTOBER MORNING more than two decades ago, President Ronald Reagan signed into law the Tax Reform Act of 1986. The idea was a simple one, and it gained broad bipartisan backing: In exchange for the lowest income tax rates since before the New Deal, the income tax base would be broadened. Both wasteful, giveaway loopholes and (unfortunately) some useful pro-growth tax policies were discarded. The new 28 percent top tax rate on households and 34 percent tax rate on corporations were not only lower than they were in the days of the New Deal and the Great Society; they were lower than today’s 35 percent tax rate on both.

Where do proponents of low tax rates stand today, more than 20 years later? The outlook, it must be confessed, is grim. If Congress does nothing, individual tax rates are scheduled to rise across the board, from a range of 10 percent to 35 percent today up to a range of 15 percent to 39.6 percent in January 2011. Pressures that didn’t exist back in 1986—the imminent retirement of the Baby Boomers, exploding health care costs, a new Cold War against global jihadism—conspire to push tax rates even higher.

Those of us who dream of one day seeing a 15 percent flat tax or a national consumed income/sales tax behold these developments as a nightmare. Let’s begin by examining the challenges facing fundamental tax reform, and then propose a way out of the woods.

The Challenges

The Total Tax Burden. You can’t know where you’re going unless you know where you are, so examining the total tax burden as a percentage of the economy is a good place to start. Back in 1986, total government taxes took 26.8 percent out of gross domestic product. In 2007, the latest full year for which the Office of Management and Budget has data, the figure was 29.2 percent. What explains the backsliding? The tax man grew fatter in both state capitals (where taxes rose by a percentage point during the period), and Washington, D.C. (where taxes rose by 1.4 percentage points). Put simply, government got bigger.

And it’s only going to get worse. Put in rough terms, the Congressional Budget Office projects that federal spending will double over the next half century, growing by about 20 percentage points to 40 percent of gross domestic product. The biggest culprits will be Medicare (socialized medicine for the old), Medicaid (socialized medicine for the poor), and Social Security (socialized pensions for everybody).

Recently, Rep. Paul Ryan (R-Wis.) asked the CBO how high the top marginal income tax rate would have to go to finance all this new federal spending. The answer—to 88 percent—is so frightening as to be laughable. In response, Ryan has introduced a bill, which has been fully scored by government actuaries and bean counters, to keep government spending at its current level of 20 percent of GDP and to create an alternative tax system with a 25 percent top rate.

The Elephant in the Room: Health Care Spending. The pressure for higher tax rates is fueled in large part by the anticipated spending demands of the retiring Baby Boomer generation. The federal government’s two major health spending programs—Medicare and Medicaid—are projected to rise from a manageable 4.1 percent of GDP today to 18.6 percent of GDP in 2082, according to CBO. That share of GDP is almost equal to government’s total share today. It’s easy to see that government health care programs account for a large part of the projected increase in government spending to 40 percent of GDP.

Reforming health care is the way out of this mess. Cutting Medicare and Medicaid are not politically viable strategies. Nor is raising the top marginal tax rate to 88 percent, for that matter. The smart move is reform.

Medicaid has a relatively straightforward reform mechanism, and it can be found in Congressman Ryan’s “American Roadmap” reform plan Give states a choice: either accept a block grant of Medicaid funding, which will grow no faster than inflation plus population growth; or, free your residents to accept Medicaid as an individual voucher they can roll over into the working world. Either way, Medicaid is transformed from an open-ended entitlement to something resembling the reformed welfare program.

Medicare requires a little more surgery. Younger workers currently pay a 2.9 percent Medicare payroll tax. They should be given the option to save this in a Medicare Savings Account which would be invested in a preset 50/50 stock/bond mix. Upon retirement, these workers could purchase a medical annuity to give themselves a health insurance plan for life. For current and near retirees, Medicare should be turned into a voucher for this same purpose. Under such a plan, those who are poor and/or sick would get a relatively bigger voucher, and those who are wealthy and/or healthy would get a relatively smaller one. Seniors could thus craft a Medicare plan specifically to their needs—not what the government says they need.

For the rest of us, a combination of beefed-up health savings accounts, the ability to purchase health insurance across state lines, greater use of health information technology, and health care price transparency should do the trick. Reforming the tax code so that it no longer favors employer-purchased health insurance over individual health insurance would also help.

Unless tax reformers get the health care tiger back in the cage, any hope for fundamental tax reform remains a pipe dream.

Dragon’s Teeth in the Current Tax Structure. In less than three years, the top marginal income tax rate will rise from 35 percent to 39.6 percent. The long-term capital gains tax rate will rise from 15 percent to 20 percent. The tax on qualified dividends will rise from 15 percent to 39.6 percent. The “death tax” will go from zero percent to 55 percent. The alternative minimum tax (AMT) will ensnare tens of millions of households. Put this together with some tax base broadeners that mostly affect families with children and CBO projects a 10-year tax increase of over $2 trillion. According to the Treasury Department, that’s an average tax increase of nearly $2,000 per year per family.

Make no mistake about it: Those who are opposed to fundamental reform of the entitlement programs view this impending tax increase as one of the key mechanisms for funding the doubling of federal government spending. According to CBO, federal revenues in this high-tax world would hit 20.3 percent of GDP by 2018—approaching the post-World War II high seen in 2000 and well above the modern average of 18.3 percent of GDP. We can expect these high tax rates to retard economic growth, drive down wages, and leave us all worse off.

Bad Ideas in Congress. There’s no shortage of new bad tax policy ideas to supplement these dragon’s teeth. For instance, Senator and presidential candidate Barack Obama (D-Ill.) recently proposed going beyond the scheduled capital gains tax hike and bringing the rate all the way back up to 28 percent. Rep. Charlie Rangel (D-N.Y.) has proposed a “surtax” on high- bracket taxpayers (70 percent of whom have small business income, according to the IRS) to pay for new spending. Senator and presidential candidate John McCain (R-Ariz.) and others believe that fighting global warming justifies a massive “cap and trade” regime on carbon dioxide emissions. This plan is essentially an excise tax on energy consumption and will amount to hundreds of billions of dollars in new taxes per year. By no means should tax reformers view the impending 2011 tax hike as the high water mark for confiscatory tax rates.

The Fight for Global Capital. When President Reagan signed the Tax Reform Act in 1986, he lauded the bill for creating one of the lowest corporate income tax rates in the developed world. At the time, the United States led the way in the fight for global capital. In the intervening 22 years, the rest of the world caught up. According to the Organisation for Economic Cooperation and Development, the United States now has the second-highest corporate income tax rate (35 percent) in the developed world, behind only basket-case Japan. The average corporate rate in Europe is only 25 percent.

Corporate profits are only the first layer of tax on capital. A second layer comes when corporate profits are distributed to shareholders (dividends), or reinvested into the corporation (which eventually translates into a capital gain). By raising the double-tax on dividends from 15 percent to 39.6 percent, and the double-tax on capital gains from 15 percent to 20 percent, policymakers will further drive capital offshore.

Government also takes a third bite at the apple: the death tax. If an investor purchases a stock after he pays a personal income tax rate of 39.6 percent and then sees a 35 percent bite in pre-tax corporate profits, a 20 percent bite in capital gains, and a 39.6 percent bite in dividends, he might be forgiven for thinking that the Viking raid of the IRS is over. But then he’s liable after 2011 for a 55 percent death tax on his remaining nest egg. The death tax, too, pushes capital toward developing nations—like China and India.

The heart of modern fundamental tax reform must begin here. High taxes on capital always and everywhere translate into lower wages and diminished living standards.

A Program for Tax Reform

Assuming health care spending can be gotten under control, below is a simple program for Tax Reform 2.0:

1. Cut the corporate income tax rate to 25 percent, in line with our European competitors. If defenders of static revenue scoring insist on paying for it, there’s plenty of central planning masked as tax expenditures in the corporate tax base.

2. Allow households to choose to opt into a simplified system. Rep. Ryan and others (including several of those who were presidential candidates on the Republican side) have proposed this step. Under this system, taxpayers could choose to keep their deductions and pay higher tax rates or opt into a system with lower rates and fewer deductions. The alternate system would be designed to raise the same amount of revenue with a broader base and lower tax rates.

3. Create simplified and consolidated tax-free savings accounts. There are over a dozen retirement and non-retirement savings accounts out there, from Roth IRAs to Coverdell ESAs. Putting all these together, combined with lower tax rates in a simplified alternate system, would be a big step forward. And this reform shouldn’t be politically difficult to enact, since it doesn’t even reduce government revenue.

4. Let businesses expense equipment and technology purchases the first year. Under current rules, these purchases must be slowly deducted, or “depreciated.” The first-year deduction or the several-year depreciation comes out to the same amount in the end, so there would be no reduction in government revenue. The resulting business investment, however, will spur economic growth and enhance productivity.

Mr. Ellis is Tax Policy Director at Americans for Tax Reform.

For Better Health Insurance, Let Consumers Buy Across State Lines

by J. Patrick Rooney and Dan Perrin

IN LAWRENCEVILLE, A TOWN in southern Illinois just nine miles from the Indiana border, with fewer than 6,000 residents in the 1940s, choices for shopping were limited. Across the border was the larger town of Vincennes, Indiana, which was three to four times the size of Lawrenceville. Everyone from Lawrenceville went to Vincennes to shop, where they were sure to find more choices and better prices. They would even go to Vincennes for groceries. If a person needed a suit, he or she went across the border to Indiana to buy it.

Pat Rooney, one of the co-authors of this article, grew up in Lawrenceville, Illinois. His family did what we have just described.

Today, when we want to buy something from another state, we do it without giving the matter a second thought. The Commerce Clause of the U.S. Constitution allows us this freedom. In this age of and eBay, we can buy most things across state lines.

But probably not health insurance.

Most people don’t realize that even today, in the 21st century, Americans cannot cross a state line to buy health insurance. Congress passed a law in 1945 declaring insurance not to be interstate commerce, shortly after the Supreme Court had determined that it was. At issue was the question of who should regulate health insurance—the federal government or the states—and Congress voted to vest regulatory power with the states.

But Congress can easily allow the cross-state purchase of insurance without assuming federal regulatory control of the industry. After all, we buy cars in other states. We get credit cards and mortgages in other states. We ought to be able to buy health insurance wherever we can get the best coverage and the best price.

Nothing Matters More

Why is this matter so important? Because it would enable people to buy health insurance where they could get the best buy—and therefore, be able to be insured. Individual health insurance rates differ among the states. State mandates are driving up the cost of health insurance unmercifully in states like New Jersey and New York. Nothing would help the consumers in these states more than letting them go beyond state borders to buy the insurance coverage they want for the price they can afford.

The beauty in this approach is that we don’t need to change the laws in New Jersey or New York or any other state. These states can continue to regulate the insurance companies that market in their states as much as they want to. And if the people of these states want to pay for all the benefits mandated by their state, they’re free to do so. But if the citizens want to pursue other options—get more choices and better prices—then they would be free to do that as well.

Roadblocks to Freedom

It turns out that many state insurance commissioners oppose giving their citizens such freedom. Why? Because they want to be able to tell the consumers in their state what health insurance coverage they can or cannot buy rather than let the consumers make their own choice.

The Blue Cross and Blue Shield Association is in league with this opposition. And why is that? Because there are several states, particularly in the Northeast, where Blue Cross is the dominant force in the health insurance market. Even if it’s an unaffordable market, it’s their market, and they want to keep it. Blue Cross and Blue Shield’s opposition to this bill is well known and understood in Washington, D.C.

This collusion between state regulators and large insurers is the same story of business trying to get government to protect its market share that has taken place throughout history. In 1908, Henry Ford began selling Model Ts at the low price of $825. Many other auto manufacturers were making cars at the time, but their vehicles were being sold at closer to $10,000. Knowing they couldn’t compete with the $825 price tag coming out of Detroit, manufacturers in neighboring states sought protection from their state legislatures. The legislators didn’t disappoint them: Several states pronounced the Model T unsafe and unfit to drive on their roads. Of course the charge was baseless, but the companies felt they needed such legislation to protect them from financial ruin.

Thankfully, the federal government finally stepped in and passed a law requiring all states to accept the Model T and any other vehicle that met the safety standards.

It’s time for history to repeat itself.

There is no reason why large insurance companies and their cronies in state government should be allowed to shut out legitimate competition from other states. It wasn’t right when the automakers did it in the early 20th century, and it isn’t right for the large insurance companies to do it today.

Marketplace freedom would be a freedom for customers, not for insurance companies. Customers would become free to buy health insurance across state lines.

Health Care Choice Act

The legislation that can achieve this progress is the Health Care Choice Act (H.R. 4460) introduced by Rep. John Shadegg (R-Ariz.). This bill allows people to buy health insurance that is approved and being sold in another state. The policy must conform to state law where the health insurance policy is filed, not to the state where the insurance purchaser lives.

The Health Care Choice Act protects consumers by ensuring a level of financial stability among the insurance companies and by ensuring an independent review mechanism for all who purchase coverage under the terms of this legislation.

What would the proposed legislation do for the insurance market? Well, what did it do for the automobile market?

Not in My Backyard

Critics say interstate commerce will create fly-by-night insurers operating in less regulated states that will take advantage of consumers.

“The best analogy for what to expect here is probably our experience with interstate banking,” the Wall Street Journal has said, “which has indeed resulted in operators moving to friendly climes like Delaware and South Dakota but which has also proven nothing but a boon to consumers. A national market has allowed the growth of big, financially stable institutions that have earned consumer trust.”

The Blue Cross Association says interstate commerce would jeopardize the risk pool (the overall pool of money that makes insurance possible by allowing the healthy to subsidize the sick). But the healthy are already out of the insurance pool in the high-cost, heavy- mandate states. “A larger national market can only improve matters,” the Wall Street Journal argues.

“Choice and competition are the great taskmasters that relentlessly deliver lower prices and higher quality to American consumers,” comments Sally Pipes of the Pacific Research Institute. “This is as true for automobiles as it is for artichokes, computers as it is for camping gear. The only exceptions are when government policies limit choice and thwart competition, which is exactly the case with individual health insurance based on the state in which they reside. It’s time to end the states’ monopolies.”

An Idea for the People

In the current monopolistic environment, millions of Americans are afraid to move, switch jobs, or start their own businesses for fear of losing their health insurance.

That fear would go away if they were allowed to shop nationwide for policies that would follow them wherever they went.

America’s policymakers must decide whom they’re going to serve: the special interests or the people. The special interests may not want change, but the people clearly do. A Zogby International poll has shown that 72 percent of Americans think people should have the option of buying a policy that is approved and available in another state. According to Zogby, “A majority of people in every sub-group—including at least two-thirds in most—supports this. Hispanics (86 percent) and African Americans (85 percent) are the most likely to be in support, as are four in five single adults and people with annual household income of $15,000-$24,999 and $35,000-$74,000.” Further, “more Republicans (20 percent) than Democrats (12 percent) or independent voters (13 percent) are opposed.”

The small-business community represents the largest portion of the uninsured population. In a recent National Federation of Independent Business member ballot, 80 percent of the members said that individuals and the self-employed should be allowed to purchase health insurance coverage across state lines.

J. Kevin A. McKechnie, the staff director of the HSA Council, part of the American Bankers Association, talks about mandates imposed on health insurance plans by states. Writes McKechnie: “[I]nvolving government in health care choices brings politics to the doctor’s office. That’s why dance therapy and hair replacement procedures are mandated as covered benefits in some states. They’re expensive, of dubious medical necessity, and arise less from considerations of public health than from good lobbying. If you think health care is expensive now, wait until the government makes it ‘free.’”

Let’s Get It Done

Just as it is with the case of health savings accounts, the Health Care Choice Act will not single-handedly fix all the problems in American health care, but it is the one reform that could accomplish much very quickly. It’s common sense. It’s long overdue. We need to get it done.

Until we modernize the sale of individual health insurance in America, the only affordable alternative for many is to establish residency in an affordable state, buy insurance there, then move back to the state in which they currently reside, while keeping the insurance they bought elsewhere. Consumers should be free to buy health insurance wherever they can get the best coverage for the best price.

Mr. Rooney is a pioneer in the development of health savings accounts and is the former CEO of Golden Rule Insurance Company. Rooney helped build Golden Rule into the largest seller of individual health insurance policies in the country. Mr. Perrin is President of the HSA Coalition. This article is excerpted from Rooney and Perrin’s book America’s Health Care Crisis Solved, © 2008 by J. Patrick Rooney & Dan Perrin, published by John Wiley & Sons, Inc.

3 Votes, 2 Years, 1 Cause: How Georgia Exploded on the School Choice Scene

by Jamie Self

THREE YEARS AGO, THE ONLY CHOICE Georgia students seemingly had was whether they wanted a rectangular pizza or to pack their own lunch. But in the span of one legislative term (two years), the state has emerged as an unlikely school choice pioneer with two major pieces of private school choice law—one voucher and one tax credit program—and a beefed up charter school law that takes the power of approving and funding a charter out of the hands of the local school boards.

And it’s about time.

As a state, Georgia graduates only about half of its high school students. Just this May, the state school system announced that about 40 percent of Georgia’s eighth graders could be held back because of failed test scores. Parents fumed. Teachers were enraged. The Atlanta Journal-Constitution editorialized that Georgia’s “middle school students statewide flunked the Criterion- Referenced Competency Tests (CRCT) more completely and in more numbers than adolescents are usually known to do anything.” For decades now, Georgia has hovered at or near the bottom of all national education rankings—from SAT scores to drop-out rates and all sorts of reading and math scores in between. Academics-wise, it seems that Georgia ranks high only in performing poorly.

You might presume that such a formula, combined with a Republican- dominated House, Senate, and Governor’s office would create the perfect storm for school choice trail-blazing. You would be wrong. The victories in Georgia have come by the skinniest of margins—the special needs bill by one vote, and the tax credit bill by two.

Special Needs Vouchers

In 2007, the first window of opportunity for school choice in Georgia was opened when Senate President Pro-Tem Eric Johnson decided to make a voucher for special needs students his signature bill for the session. The introduction of SB 10—or the Georgia Special Needs Scholarship Program—marked the first time any private school choice measure for K-12 students had been attempted in almost a decade. (In 1999, Senator Clay Land introduced what was called the Early Hope Scholarship, which would have provided vouchers to low-income students in poor-performing schools.) SB 10 gives special needs students a voucher in the amount the state spends on that child’s education that could be used to attend a private school of the parent’s choice.

As expected, the education establishment regarded the bill as an apocalypse and dug in with both feet. Despite Georgia’s perennial status as an educational bottom-feeder, the education establishment (the Georgia Association of Educators, the School Boards Association, the state PTA, and the Professional Association of Georgia Educators) still opined that more choice and opportunity was the sure pathway to educational demise. Protected by an apparent obliviousness to Georgia’s dismal status, the education establishment drove into the state capitol with their usual tactics of fear, misinformation, and local school power riding shotgun. They were again determined to protect the status quo without so much as a whiff of irony that the status quo was the heavyweight champion of failing kids.

A pro-school choice coalition (the Georgia Family Council, the Georgia Public Policy Foundation, The Archdiocese of Atlanta, the Catholic Conference, the Jewish Federation, Torah Day Schools, as well national groups such as the Alliance for School Choice and the Friedman Foundation) decided to respond with facts and parents—and a cameo from Barney the Purple Dinosaur. Numerous parents offered hours of “break your heart” testimony about how desperate they were for another educational opportunity for their struggling child, but couldn’t afford it. One such story came from a mom who would visit her son’s special needs classroom to find him propped in front of Barney videos all day. The Barneyfication of our education system was a turning point. Once she was able to move him to a private school, she explained, he was able to learn to read and advance academically like never before.

Such stories and testimony helped ease the bill through the Senate as expected. The House, we all knew going in, was the true battleground for this bill. No stone was left unturned. No angle went un-played. No story went untold. Still, on the last day of session, in the last hour of session, the bill was one vote short of passage. But in the shadow of a crushing, one-vote, near-miss defeat, the Speaker wielded his gavel. And in one slow-motion, hear-your-own-heartbeat, black-and-white moment of desperate suspense, he weighed in with the final vote necessary to pass SB 10 into law and bring hope and promise to Georgia’s students. (Note: Melodrama fully intended and warranted.)

A year later, almost 900 students with special needs are receiving scholarships from the state under the law. Not a single public school closed, lost money, or had to fire any teachers, which exposes the apocalyptic warnings of the education establishment for what they really were: a bunch of hot air.

Our next decision was whether to accept our win, take our foot off the gas, and regroup for future battles, or to go into overdrive, seize the momentum, and continue to smash through the gauntlet of entrenchments and school entitlements. Ultimately, we chose the latter.

At least two other trophies were within reach: easing the road for charter school implementation and tax credits for those giving to private school scholarship organizations.

Freeing Charter Schools from Local School Board Obstruction

Would it make sense to allow McDonald’s to decide whether a Wendy’s could open in the same neighborhood? Of course not. But that’s precisely the sort of power that local school boards had over prospective charter schools. Under Georgia law, charter school authorizations had to be approved by local school boards. The state school board could ultimately approve a charter, but without the local board’s approval, the charter school would receive less than half of the funding they would receive otherwise, making it nearly financially impossible for them to operate.

House Bill 881 removed the local school board’s ability to have the final say in whether a charter school opens up in the area by creating an independent authorizing board. The law also brought equality to the funding formula by allowing charters to receive their full allowable funding regardless of who approves the charter.

HB 881 passed the usually problematic House by a vote of 119 to 48. The ease of passage was a result of the fact that even legislators who oppose vouchers for private schools are often comfortable with the concept of providing choice within public education.

Tax Credits for Private School Scholarships

The more difficult win was HB 1133, the tax credit scholarship program. HB 1133 allows companies and individuals to receive a dollar-for-dollar tax credit for donations made to student scholarship organizations—nonprofits that give scholarships to current public school students who wish to attend a private school. Corporations can receive a credit for donations in an amount of up to 75 percent of their tax liability. Individual donations are capped at $1,000 or $2,500 for a married couple filing jointly. Overall, there is a statewide cap of $50 million. Again, a skinny vote ensued. With 92 votes in the House—one more than necessary—HB 1133 passed.

In response to the passage of HB 1133, Jeff Hubbard, state president of the Georgia Association of Educators, said: “This was a classic public versus private issue. We do not feel that public funds should be going to pay for private education.”

Mr. Hubbard, and those in his camp, perpetually miss the point. This is not a debate over public versus private (much less a classic one). This is a debate about educating our children, by whatever means it takes to get the job done. This is an understanding that, despite doubling per-student spending since 2004, we have seen very little return on our investment. This is about finally saying enough is enough. We are not satisfied standing by to watch thousands of students graduate each year unprepared for college or the workplace and to watch as thousands of other students fail to graduate at all.

A $50 million cap on the tax credit scholarship program represents less than one-half of 1 percent of total education spending by the state. Perhaps we can diversify with such a small percentage and just see what sort of return we get.

Lessons Learned: Advice to Anyone in Another State Who Sits Where We Did Three Years Ago

● A Republican majority does not necessarily make it easy to pass school choice legislation. In Georgia, Republicans control both chambers of the legislature and the executive branch, and, still, school choice legislation passed by the skinniest of margins.

● You must have a champion with political capital—and the will to use every bit of it for choice. Here in Georgia, Sen. Eric Johnson was willing to make school choice his signature issue and was willing to use his position as President Pro Tem to make trades and cash in favors to help choice bills succeed.

● Be careful in making concessions to your bill hoping to gain the support of the education establishment. Such compromises can weaken your bill without gaining you any votes. In our case, often the school board associations or state PTA would ask that we tweak school choice bills in some way that would make it more palatable for them. But not a single such compromise actually gained us any support in the long run.

● Know your allies. Know your opponents. And, in both cases, look beyond your usual suspects. You may find non- traditional partners such as the business community, anti-tax advocates, or parents in various special needs advocacy groups.

● Tap into the vast knowledge of those who have gone before you. There are numerous school choice programs in a handful of states. Learn all you can from the people there before starting out. It will save you much time, energy, and money to have an understanding of what has worked and what hasn’t elsewhere.

● Parents are the key. If you involve them early, parents will go to great lengths to secure a better future for their children. They are the best messengers to the legislature and the media. Bill design is boring, but important. Again, talk to national choice advocates and get legal help. A well-written bill will withstand court challenges and will be easier to pass and implement.

● There is more than one school choice argument. Know them, and match your message to your audience. For some, the idea of free markets and competition is fundamental and all you need to say. For others, the social justice message—the horror that lower income, predominately minority communities are trapped in cycles of poverty due to generations of educational failure—will ring truer.

● Have thick skin. You will be personally accused to trying to undermine all of public education to the great harm of all children (and maybe even puppies and kittens). Be prepared, and forgo name calling. What you are doing will bring hope to those most in need.

Ms. Self is Director of Government Affairs for the Georgia Family Council.

Entrepreneurship Remakes the Business Degree: The Acton MBA Makes Students Think About Their Calling in Life

by Bryan O’Keefe

JEFF SANDEFER HAS THE REFLECTIVE AIR of a college professor, but his calm demeanor masks an entrepreneur’s impatience. When Sandefer sees an opportunity, he takes it; when something is broken, his instinct is to fix it. That entrepreneurial impulse led Sandefer to start his first business at the age of 16, and has since propelled him to found a number of highly successful oil and gas enterprises. When Sandefer started teaching in the MBA program at the University of Texas, his old entrepreneurial impatience kicked in.

“Most people came to business school because they were not happy with their lives,” Sandefer recalls. “I found that they would go through an MBA program, take a high-paying job, and then a couple years later discover they were even unhappier than before.” There has to be a better way, he thought. That realization led him to help fund and, with the aid of three colleagues from the University of Texas, develop a new MBA program, the Acton School of Business. And a better way it’s proving to be. The Princeton Review recently ranked Acton the #6 “classroom experience” in the country, and Acton’s faculty was ranked #5 in the nation.

In contrast to the standard MBA model— a two-year program in a university setting, taught by academics and geared toward graduating students into a few, select fields—Acton emphasizes entrepreneurship, hard work, accountability, and a search for the student’s true calling in life.

Acton’s students hail from all walks of life, from recent college graduates to executives at publicly traded corporations. “All of our students share common traits. They want to change the world, and they are incredibly hard workers. You don’t survive the Acton MBA unless you’re willing to work hard,” says Sandefer.

Acton is not for the faint of heart. Its MBA program condenses the usual two-year course of study into a single year, and students are expected to put in 90+ hours of work per week. Classes are taught by business owners and entrepreneurs who bring their real-life experience to the classroom. Instructors do not lecture; instead, they lead their students through case studies with a series of rigorous questions. “To be on the faculty at Acton, you must run a company while you teach,” says Sandefer. “And when you do teach, you are required to follow the purest of pure Socratic Method.”

An “A” for Accountability

The school holds instructors responsible for their classroom performance, a practice nearly unheard of in a higher education system dominated by tenured faculty. Acton professors are paid a relatively low base salary—but, with good student evaluations, they can earn bonuses of up to $30,000. (To guard against faculty bribing students with high marks, Acton requires that professors grade on a bell curve, with equal numbers of As and Fs, and that student evaluations be conducted before the final grades are given.) The evaluation results are made public, and the lowest-rated professor is not invited back to teach again.

“It’s a very free market approach,” says Sandefer. “It’s a powerful model because it holds everyone accountable.” Moreover, the Acton MBA program is pioneering a novel financial aid system: Successful graduates pay no direct tuition. Students front the funds for their first semester. If they make it through, they are reimbursed for the first semester costs and are awarded a fellowship funded by a business leader for their second semester.

At the end of the program, each student writes a letter to the donor who funded his or her fellowship. In the letter, the students evaluate the entire Acton MBA program. If they believe the program has lived up to its promises, they are asked to donate 10 percent of their salary until they have paid back the cost of the fellowship. If, however, the student is willing to tell the donor that the program failed to meet expectations, the student can walk away, owing the school nothing. Financial support from outside donors is thus directly linked to aid for students—and to accountability for the school as a whole.

“Acton is the only school where students graduate and do not pay any tuition. And the system we use makes it easy to see if we are delivering,” notes Sandefer. He hastens to add that “100 percent of those who have graduated under the fellowship program have agreed that the school fully delivered on its promises.”

A Real Vocational School

Perhaps the most innovative aspect of the program involves its efforts to help students discover their deeper purpose in life. Lord Acton, for whom the school is named, famously remarked: “To be able to look back on one’s past life with satisfaction is to have lived twice.” That insight goes to the heart of the Acton MBA.

“Our students are not worried about their first job out of business school. We want them to consider where they will be in 20, 30, 40 years. It should be a hero’s journey, where they find their calling,” says Sandefer.

For that reason, the school does not participate in traditional business school recruiting programs. Instead, students are expected to decide where precisely they want to work. Then the school does its best to land those exact positions for its students. “We don’t have a system where 1,000 recruiters come to campus and students just take whatever job is offered,” says Sandefer. “The students have to be very thoughtful about what they want to do. And then we call the CEO of that company for them.” While the program emphasizes entrepreneurship, many students will work for an established company to gain experience in a specific area before they start their own business. “The first job after Acton is just the first ‘stepping stone’ towards a calling,” adds Sandefer. “Unlike most MBA programs, where students will go into consulting, investment banking, or middle management, our students’ ‘stepping-stone jobs’ are as varied as the callings.”

Reinventing the MBA

The entire Acton approach has excited higher education donors who lament the lack of accountability, widespread inefficiencies, and lack of purpose common in today’s Ivory Tower. “The Acton MBA is a great alternative to the traditional university model. It shows you can have a high-quality, accountable education for less cost than what higher education usually offers,” says David Weekley, chairman of David Weekley Homes and an Acton MBA donor. “It also causes students to think about why and not just what. The students are thinking broadly and deeply about the society around them. They are learning about how to be great in business, and how to be great in life, too.”

Weekley appreciates that the program holds students and faculty equally responsible for their performance. “The fact that they vary compensation based on student evaluations is highly unusual in higher education. In the business world, we are graded by our customers every day. With tenure, your compensation is unrelated to work you do with students. The Acton MBA is a very democratic system and ensures accountability for students and teachers.”

Other donors echo that sentiment. “There’s some accountability in higher education, but for what?” asks Alex Cranberg, chairman of Aspect Energy and another Acton supporter. “Professors are held accountable for how often they’re cited, or for the amount of research grant money they bring in. But there’s very little accountability for actual student achievement. I’m impressed that at Acton both students and faculty are graded on a curve. Few schools—if any—are doing the same thing.”

Cranberg is likewise pleased that Acton employs teachers with real-world achievements, not just book smarts. “Higher education’s infatuation with credentials has made it blind to opportunities to use professional people that are equally, or even more, impressive. We should be focusing on teachers with achievements, not just credentials.” He agrees with Weekley that the program instills a sense of purpose in its students. “The students are urged and taught how to set out a path in life as opposed to just allowing a path to be set out for them. The Acton MBA makes the student figure out who they really are.”

Weekley says that letters received from the fellowship students he has sponsored reveal how profoundly the program affects its students. “People usually have two or three seminal points in life. For our students, Acton is clearly one of them. These letters are heartfelt, and students always talk about how this experience has changed their lives.”

The Acton program has a relatively small class, currently set at 22, with a planned expansion to 35 next year. But Sandefer has larger aspirations. “We are trying to find a way to spread this across the country in different types of graduate schools, including business schools, engineering programs, and even law schools,” says Sandefer. “I truly hope that donors who are thinking about writing checks to higher education look at what we have done and examine ways to make that gift effective.”

Both Weekley and Cranberg believe that higher education and its donors would be wise to adopt Sandefer’s approach. “A lot of entrepreneurs have an interest in supporting higher education. They want to inspire people,” says Cranberg. “But anybody looking to support entrepreneurship would do well to look at traditional programs, understand why the Acton MBA is different, and learn from that comparison.” “My hope is that this can become a whole new model for higher education,” Weekley concludes. “It’s proven to be a successful formula. A forward-looking university would be wise to make this a reality on campus.”

Mr. O’Keefe is Associate Director of the Center for College Affordability and Productivity. This article is reprinted from Philanthropy magazine, March/April 2008.

Forces for Good: The Six Practices of High-Impact Nonprofits

by John Blundell

WHAT’S THE BEST BOOK you’ve ever read on nonprofit management? Having been with trade associations and educational charities for over 30 years now, I am often asked that question.

Well I now have a brand new answer, namely Forces for Good: The Six Practices of High-Impact Nonprofits by Leslie R. Crutchfield and Heather McLeod Grant, published by Jossey-Bass.

Leslie and Heather have solid nonprofit experience. Heather was also with McKinsey and Company, and this whole book is a project of the Center for the Advancement of Social Entrepreneurship at Duke University in North Carolina. Leslie is with Ashoka, a group I have long much admired.

The authors began by selecting a dozen top-performing nonprofits. The book is long on methodology, and it is hard to dispute any of it. Out of their research came this stellar group. I will not list their names (as most will not be known to you) but rather their fields: hunger relief (two organizations fell in this category); federal and state budget analysis; national service, youth leadership; environment; museums, science education; housing; conservative public policy; Hispanic interests; housing and economic development; education reform; and youth leadership, housing, and job training.

Those labels are not completely satisfactory, but they’ll have to do given space constraints.

So, What Did I Learn?

I read page 18 again and again. It is the page that summarizes six myths of nonprofit management:

1. Perfect Management: “Some management is necessary, but it is not sufficient to explain … high levels of impact.”

2. Brand-Name Awareness: “A few hardly focus on marketing at all.”

3. A Breakthrough New Idea: Tweaking an old idea is often just as good as the big new one.

4. Textbook Mission Statements: “Most of them are too busy living it” to be endlessly rewriting mission statements.

5. High Ratings on Conventional Metrics: Rating agencies can measure overhead but not impact. Hear, hear!

6. Large Budgets: Size and impact do not correlate. How true! So there are the myths.

Now for the Six Best Practices

1. Advocate and Serve: If you start as an advocacy group, you will add services and vice versa; and there are synergies, so the more you do of both, the greater the total impact.

2. Make Markets Work: How wonderful to read these words in a nonprofit text! Self interest trumps altruism. It’s more than that.

3. Inspire Evangelists: Volunteers and donors are more than cheap labor and a source of money. They can be made into evangelists.

4. Nurture Nonprofit Networks: Really high-impact groups build networks, advance their whole field (not just their niche), and see so-called competitors as allies who are to be helped. If only I could bottle up this section alone and beat some people over the head with it. There are some naïve people who just do not understand this point and have an ultimately futile and, in the meantime, highly damaging mental model.

5. Master the Art of Adaptation: “[L]isten, learn and modify … based on external cues … .”

6. Share Leadership: “[S]hare power in order to be a stronger force for good … distribute leadership … cultivate a strong second- in-command, build enduring executive teams with long tenure, and develop highly engaged boards … .”

On the face of it, some of this could be quickly described as banal. But the richness of this book lies in chapters 2 through 7, which examine these six themes with wonderful illustrations from all the top 12 performers.

Chapters 8 and 9 cover “Sustaining Impact” and “Putting It into Practice”; the latter contains “What to Do” lists that will keep your staff and board arguing to positive effect all day and all night.

This book struck a lot of chords for me. Obviously one does not agree with all it says, but so much of it was so good that it goes to the “must tell all my mates to read it” bracket and scores overall A++.

Now if you want to know the best book on fundraising, try Relationship Fundraising: A Donor-Based Approach to the Business of Raising Money by Ken Burnett.

Dr. Blundell is Director General of the Institute of Economic Affairs. This article is reprinted from Association Management Quarterly, Spring 2008.