With the exception of a few top-notch thinkers such as Pierre Bessard and Allister Heath, there are very few people in Europe who can intelligently analyze public policy, particularly with regard to fiscal issues.
I don’t know if Fredrik Erixon of the Brussels-based European Centre for International Political Economy is even close to being in the same league with Pierre and Allister, but he has a very good article that correctly explains that government spending and the welfare state are the real fiscal problems in Europe.
Here are some excerpts from his Bloomberg column.
When it comes to overspending on social welfare, …Europe has no angels. Even the “good” Scandinavians, and governments that appeared to be in sound fiscal shape in 2008, …were spending too much and will have to restructure. …Greece, Ireland, Portugal and Spain…are in many ways different, but they have three important characteristics in common. …government spending in those nations grew at remarkably high rates. In Greece and Spain, nominal spending by the state increased 50 percent to 55 percent in the five years before the crisis started, according to my calculations based on government data. In Portugal, public expenditure rose 35 percent; in Ireland, almost 75 percent. No other country in Western Europe came close to these rates.
This is remarkable. Someone in Europe who is focusing on the growth of government spending. He doesn’t mention that the solution is a spending cap (something akin to Mitchell’s Golden Rule), but that’s an implication of what he says. Moreover, I’m just glad that someone recognizes that the problem is spending, and that debt and deficits are best understood as symptoms of that underlying disease.
In any event, Mr. Erixon also has the right prognosis. The burden of the welfare state needs to shrink. And he seems reasonably certain that will happen.
Europe’s crisis economies will now have to radically reduce their welfare states. State spending in Spain will have to shrink by at least a quarter; Greece should count itself lucky if the cut is less than a half of the pre-crisis expenditure level. The worse news is that this is likely to be only the first round of welfare-state corrections. The next decade will usher Europe into the age of aging, when inevitably the cost of pensions will rise and providing health care for the elderly will be an even bigger cost driver. This demographic shift will be felt everywhere, including in the Nordic group of countries that has been saved from the worst effects of the sovereign-debt crisis. …Europe’s social systems will look very different 20 years from now. They will still be around, but benefit programs will be far less generous, and a greater part of social security will be organised privately. Welfare services, like health care, will be exposed to competition and, to a much greater degree, paid for out of pocket or by private insurance. The big divide in Europe won’t be between North and South or left and right. It will be between countries that diligently manage the transition away from the universal welfare state that has come to define the European social model, and countries that will be forced by events to change the hard way.
I’m not quite so optimistic. While I agree that current trends are unsustainable, I fear that the “optimistic” scenario is for governments to semi-stabilize their finances with both taxes and spending consuming about 50 percent of gross domestic product.
That’s obviously far beyond the growth-maximizing size of government, which means European nations – on average – would be condemned to permanent economic stagnation. Some of the nations that have very laissez-faire policies in areas other than fiscal policy, such as the Nordic nations, might experience some modest growth, but that would be offset by permanent recession in nations that have both big government and lots of intervention.
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Don Moma,
Being an apologist for greedy Big Government is unseemly. Government is THE problem, not lower vs higher income tax rates.
Everything bad about modern government was thought out by the Founders. They knew that immorality was always simmering just beneath the surface. As Machiavelli wrote, “Men are bad unless compelled to be good.” Government, having no competition, has no compulsion to be good. So it becomes bad. Very bad.
Now we have people like you defending the coveting of your neighbors’ goods. For thousands of years that has been acknowledged to be immoral. But now, coveting your neighbors’ goods is Policy.
Every dime of increased revenue will be taken by bureaucrats, and they will still put their hands out for more. Tell us this: How much is enough? The top 5% of taxpayers pay most of the federal taxes. U.S. corporate taxes are among the world’s highest. And yet, it is never enough.
History clearly shows that when tax rates are reduced, government revenues increase. When that was pointed out to Obama in an interview, his lame response regarding his proposed tax increases was “fairness”. How is it fair for a small sliver of the population to pay the freight for most of the country? How is it fair to grow government to the point that it starves the private sector of capital? How is it fair that these same policies result in skyrocketing unemployment and real inflation in the double digits?
Being an apologist for Big Government puts you on the wrong side of the argument. Government is immoral. It will take every dollar it can get and always demand more, more, more. So how much is enough? Answer that.
@DonMoma
The world is a very differwnt place today than it was in the 1950’s, or even the 1980’s. Investment income – what people rightly call “jobs” – is going to Asia already. Raising tax rates would only add a push to China’s pull.
We need more than technocrat money grabbing. Tax reform is a necessity to bring down the cost of tax compliance. Regulation reform is also necessary to bring down operating costs. Entitlement reform is needed to bring down overall burden govt spending, and show investors we’re not just going to pull an Argintina and nationalize their investment.
Don Moma: what’s the point of having a tax rate in the 50-75% range if no one actually pays that rate because the tax system was so full of loopholes that anyone who paid the actual top rate was a buffoon. That was the real situation of the 50’s through the 70’s. As the author notes, very, very few people actually paid the top rate on the bulk of their earnings. A 75% rate rife with loopholes distorts markets because it drives capital based on tax avoidance rather than efficiency and growth. Studies show that the wealthy actually paid higher rates under Reagan than they did under Carter.
A couple other points: Levine shouldn’t blame the tax system for his lack of work ethic. plenty of rich people work late into life ie Jack Welch. Also, David Levine doesn’t seem to understand the double and sometimes triple taxation involved in the investment income he receives now. And, if he’s pining for the days of Johnson/Ford/Carter I worry he may be experiencing some early manifestations of dementia.
The problem isn’t taxes. It’s spending. You cannot tax the super-rich enough to make a meaningful difference in US revenues. You can confiscate the total wealth of the top 1% and the US government would burn through it in a year. There’s not enough money there. Not enough people make “$1.2 million”. You always end up taxing the middle class, because that’s where the money really is.
That said, like the author of this blog, I am not hard core on never raising taxes. If there was a grand bargain of real government reform and spending cuts, not just reductions in the increases, I would support a modest increase in taxes. But that’s never what is offered. It’s all to fund more and more government which will never have enough money.
You should look at Fidelity.com today. An article is presented where another rich person is calling for iincreased taxes on the rich, claiming historical data sugeests that a tax rate of 50%-70% is the optimal point on the Laffer curve. Interested in your response. Article attached:“I was a kid in the 1950s,” says David Levine. “And the whole time, the top marginal tax rate was 87 percent. Not many people paid that much. Only three baseball players — Ted Williams, Joe DiMaggio and Willie Mays — got there. But it was 87 percent.”
Most people, of course, do not mark major life events by the top marginal tax bracket at the time. But David Levine isn’t most people. Levine is the former chief economist for the investment-management firm Sanford C. Bernstein. He is, as you might expect, a very rich man. But he’s one of those rich guys who, like Warren Buffett, is begging the government to raise his taxes.
Levine has been following federal tax policy for most of his adult life. “My main job was to forecast the economy,” he shrugs. “So taxes are tremendously important to that. And tax policy changes are tremendously important.” And, to him, those changes mostly went the same way: cutting taxes on people, like Levine and his friends, who didn’t need tax cuts, as the working class struggled.
He brandishes a table that tells the whole story: John F. Kennedy brought the top tax rate down to 70 percent. Ronald Reagan brought it to 50 percent, and then to 28 percent. Levine still sounds offended. “I was making seven figures,” he says. “They lowered my marginal tax rate to 28 percent. And the median American, he was paying a 15 percent marginal tax plus his payroll taxes plus the employer’s share of his payroll taxes, which comes out of his income. So he was paying, all in all, about 27.9 percent. And I was paying 28 percent.”
“Under George H.W Bush and Bill Clinton it gets raised a bit more to 39.6 percent,” Levine continues. “But then George W. Bush comes in and cuts it to 35 percent and lowers the rate on qualified dividends to 15 percent. And by now I’ve retired. I’m living off investments. All my income is coming from qualified dividends. And so I’m sitting there in the 15 percent tax bracket. And I use the maximum charitable deduction every year. So my actual tax rate has been 7 percent every year since 2007!”
It would be one thing, Levine says, if the economy had performed so much better after taxes on the rich were cut. But it didn’t. Some of the fastest economic growth of the post-war period came in the 1950s, when the top tax rate was above 80 percent. The slowest growth came in the 2000s, when the top tax rate was 35 percent. So the fastest income growth for the top 1 percent has come under the low-tax regimes, while the fastest income growth for the median American came when taxes on the richest Americans rose.
Correlation is, of course, not causation. As Doug Holtz-Eakin, a conservative economist who squared off against Levine on a panel at the Tax Policy Center, argues, the post-World War II era was good for the United States. We had a kind of global monopoly that allowed us to live large and share the wealth. But that monopoly is gone, and there’s no tax regime that can bring it back.
But the flip side of that is also true. To hear many Republicans talk, you would think that the slightest tweak to the tax rates of the very richest Americans would grind the economy to a halt. In this telling, the “job creators” would go galt and refuse to make profitable investments because the extra money they would make would be taxed at 40 percent rather than 35 percent. Or they would hide so much of their income that the tax wouldn’t raise any money anyway.
But when economists think about the role taxes play in a person’s decision to work, they think about two things. There’s the “substitution effect,” where higher tax rates make you work less, because you keep less of every extra dollar you earn. But there’s also the “income effect,” in which higher tax rates make you work more, because you need to earn more to be able to live how you want to live, or retire when you want to retire. The question is, which dominates.
Levine, who retired before he turned 50, is an example of the income effect winning out. “There’s no question you would have gotten more out of me if you’d taxed me more,” he says. “Think about it. You’re 40 years old, making a ton of money. But you’ve only been making it for a little while. And you’re looking at a life expectancy of 40 more years. Of course you’re going to work more years if taxes are higher! To make the money you need, you need to keep working.”
In a recent paper, economists Emmanuel Saez, Thomas Piketty and Peter Diamond looked closely at the evidence on high-income taxation. “The question we were asking is where is the point where the Laffer curve” — which tries to estimate when higher taxes lead to less revenue, either due to evasion or slower growth — “hits the maximum revenue,” says Diamond, who won the 2011 Nobel prize in economics. “You don’t want to be beyond that. But we argue you would like to be fairly close to that. Taking revenue from people making $1.2 million is better than taking it from other groups.”
The answer, they find, is somewhere between 50 and 70 percent. Above that, you begin to lose more revenue than you raise. “So instead of the current Washington fight between Bush and Clinton tax rates, let’s think of the fight being between the Johnson/Ford/Carter tax rates and the tax rate we had after Reagan’s initial cut,” Diamond says, with a laugh.
His numbers don’t look right to me. It is true that government as share of GDP has grown significantly in recent years, just as you would expect under austerity. But the data I have from Eurostat points to much less dramatic increases than this fellow reports.