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Archive for June 8th, 2010

I gave a speech in Hungary about two weeks ago and now the government has announced a big step in the direction of better fiscal policy. According to Reuters, “Hungary’s new government plans to introduce a flat personal income tax of 16 percent from 2011, as well as a 15 percent cut in public sector wages.” Those are the headline initiatives, but the fiscal reform package includes other good policies. Here’s a blurb from The Economist.

After a three-day emergency cabinet meeting over the weekend, Viktor Orban, the prime minister, announced the government’s new economic programme this afternoon. The battered forint quickly jumped almost 2% in response. …The introduction of a 16% flat personal income tax is a daring move, and could have important repercussions beyond balancing the state’s books. Unemployment, or at least that element of it which is declared, is nudging 12%, and one reason is Hungary’s cumbersome bureacracy and heavy tax burden. Now Mr Orban has announced that corporation tax for companies with annual profits of less than 500m forints will be reduced from 19% to 10%. Ten more small and bothersome taxes are set to be abolished altogether.

A few years ago, when several nations each year were adopting the flat tax, I arbitrarily decided that this rock classic would be the theme song of the tax reform movement. Any better suggestions?

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Art Laffer has a compelling column in yesterday’s Wall Street Journal, where he makes the case that future tax rate increases will cause considerable economic damage because people have an incentive to maximize income this year to take advantage of current tax rates – resulting in an artificial drop in economic activity next year. In effect, this will be a reverse version of the experiment in the early 1980s, when entrepreneurs and investors had an incentive to postpone economic activity since Reagan’s tax rate reductions were phased in over several years. I am reluctant to endorse Art’s prediction that the “economy will collapse,” since even good economists are lousy forecasters. But we certainly will see a large degree of tax planning, which will lead to less revenue than expected next year. And the higher tax rates will inhibit growth, though it is impossible to predict whether this means 2.1 percent growth instead of 2.3 percent growth, for instance, or 0.5 percent growth instead of 0.6 percent growth.

On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. …the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. …Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there’s always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere. …if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be. …In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn’t take effect until Jan. 1, 1983. Reagan’s delayed tax cuts were the mirror image of President Barack Obama’s delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%. But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don’t work until they take effect. Mr. Obama’s experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011. …The result will be a crash in tax receipts once the surge is past. If you thought deficits and unemployment have been bad lately, you ain’t seen nothing yet.

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I’m on my may to El Salvador to give a speech about the principles of good fiscal policy and I stopped off in Panama for a luncheon speech sponsored by the Fundacion Libertad about the dangers of excessive government spending.  I have two observations based on my day of discussions.

First, Panama has a very large banking sector, in part because it is a tax haven and in part because it is a “dollarized” economy. But Panama, like Canada, did not have any sectoral problems during the financial crisis. Why? Because unlike the United States, there are no policies to subsidize housing. There is no Fannie Mae, no Freddie Mac, and no Community Reinvestment Act. So even though there has been a housing boom in Panama City that has since cooled off, this did not lead to significant problems since banks had no government-created incentive to make zero-downpayment loans or offer loans to people with inadequate income and assets.

Second, Panama is a safe haven for oppressed people in Latin America. Many people from unstable regimes such as Venezuela have fled to Panama – or at least moved their money to Panama - to protect their families. Other people from places such as Ecuador and Argentina have moved their money to Panama to guard against expropriation and theft by corrupt governments. And others from nations like Mexico have placed their money in Panama because of rampant crime and kidnapping in their home nations – often triggered when corrupt bureaucrats in national tax offices sell information to criminal gangs. Putting money in Panama minimizes these terrible risks because so-called tax havens have strong human rights policies that protect financial privacy. But for many Latin Americans, the goal is not to protect against punitive taxation, but rather to guard against thuggish and incompetent governments. These are some of the issues highlighted in this video about “The Moral Case for Tax Havens.”

For taxpayers from North America and Western Europe, tax havens are an important safety valve to guard against bloated and wasteful government. For taxpayers in most other parts of the world, though, tax havens can mean the difference between life and death. So every time you hear greedy politicians like Barack Obama and Nicolas Sarkozy attack tax havens, remember that they are willing to put people’s lives at risk to promote their big government agenda.

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