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Archive for the ‘Competitiveness’ Category

Since all economic theories – even Marxism and socialism – recognize that capital formation is a key to long-run growth, higher wages, and improved living standards, it obviously doesn’t make sense to penalize saving and investment.

Yet that’s exactly what happens because of double taxation in the United States, as can be seen by this rather sobering flowchart.

So how can we fix the problem? The best answer, particularly in the long run, is to shrink the burden of government spending so that there’s no pressure for punitive tax policies.

Good reform is also possible in the medium run. Policy makers could implement a big bang version of tax reform, replacing the corrupt internal revenue code with a simple and fair flat tax. That automatically would eliminate the tax bias against saving and investment since one of the key principles of the flat tax is that income gets taxed only one time.

That being said, there’s no chance of sweeping tax reform for the next few years (and maybe ever), so let’s look at some pro-growth incremental reforms that would reduce or eliminate the extra tax penalties on income that is saved and invested.

On the investment side of the ledger, any policies that lower or end the capital gains tax and the double tax on dividends would be desirable.

But let’s focus today on the saving side. And let’s start by explaining how a fair and neutral system would operate. Here’s what I wrote back in 2012 and I think it’s reasonably succinct and accurate.

…all saving and investment should be treated the way we currently treat individual retirement accounts. If you have a traditional IRA (or “front-ended” IRA), you get a deduction for any money you put in a retirement account, but then you pay tax on the money – including any earnings – when the money is withdrawn. If you have a Roth IRA (or “back-ended” IRA), you pay tax on your income in the year that it is earned, but if you put the money in a retirement account, there is no additional tax on withdrawals or the subsequent earnings. From an economic perspective, front-ended IRAs and back-ended IRAs generate the same result. Income that is saved and invested is treated the same as income that is immediately consumed. From a present-value perspective, front-ended IRAs and back-ended IRAs produce the same outcome. All that changes is the point at which the government imposes the single layer of tax.

The key takeaways are in the first and last sentences. All savings should be protected from double taxation, not just what you set aside for retirement. And that means government can tax you one time, either when you first earn the income or when you consume the income.

Our friends to the north can teach us some lessons on this issue.

Here are some excerpts from a column in the Wall Street Journal, authored by my colleague Chris Edwards and Amity Shlaes of the Calvin Coolidge Foundation.

Some Republicans are advocating a giant child tax credit, but there are more effective means for helping the middle class. One is a tax program already road-tested in the country whose populace most resembles our own, Canada. It’s called the Tax-Free Savings Account and TFSA, as most Canadians refer to it, is a roaring success. …what is this Canadian savings account? The nearest U.S. equivalent would be Roth Individual Retirement Accounts. With a Roth, workers pay taxes on earnings before they put their cash into the account. The money then grows tax-protected, and people pay no tax when they withdraw it.

But these accounts are much better than Roth IRAs.

Though these savings accounts were introduced only five years ago, 48% of Canadians have already signed up. That compares with only 38% of U.S. households owning any type of IRA—though IRAs have been around for decades….Roth accounts have numerous restrictions. You can’t open a Roth easily if your earnings are above certain limits: $191,000, for example, for a married couple filing jointly. You can’t withdraw cash whenever you feel like it, at least not without daunting penalties. …Canada’s TFSAs are like Roth IRAs—but supercharged. Citizens may deposit up to $5,500 after-tax each year, and all account earnings and withdrawals are tax-free. However, unlike Roth IRAs, funds can be withdrawn at any time for any reason with no penalties or taxes. Another feature: The annual limit on a contribution carries over from year to year if a citizen doesn’t reach it. So if a Canadian contributes $2,000 this year, he can put away up to $9,000 next year ($3,500 plus $5,500). There are other attractive features: Unlike in a Roth, there are no income limits for individuals contributing to a TFSA, and there are no withdrawal requirements at retirement.

In other words, the Canadian accounts are like unlimited or unrestricted Roth IRAs.

And because the government isn’t trying to micro-manage how people save, Canadians are very receptive. Chris adds some additional information in a post for Cato at Liberty.

…released new data confirming the popularity of TFSAs. In just the past year, TFSA account assets increased 34 percent, and the number of accounts increased 16 percent. In June 2014, 13 million Canadians held $132 billion in TFSA assets. Given that the U.S. population is about 10 times that of Canada, it would be like 130 million Americans pouring $1.3 trillion into a new personal savings vehicle. …In just five years, TFSAs have become the most popular savings vehicle in Canada, outstripping the Canadian version of 401(k)s.

Here’s a chart Chris included in his blog post.

And he adds some more analysis on the importance of simple vehicles to protect against double taxation.

Everyone agrees that Americans don’t save enough, so why don’t we kick-start a home-grown savings revolution with a U.S. version of TFSAs? …Canada has now run the real-world experiment on such accounts, and it has succeeded brilliantly. TFSAs, or USAs, are a better way to handle savings in the tax code. Currently, many people are scared off by the complexity of U.S. savings vehicles and by the lack of liquidity in retirement accounts. TFSAs solve these problems.

I guess we’ll have to wait and see whether American policy makers pay attention and follow Chris’ sage advice.

P.S. I realize I’m being picky, but I wish the Canadians didn’t use the term “tax-free savings accounts.” After the all, the income is taxed before it gets put into the accounts. Though even a nit-picker like me realizes that it might be a bit awkward to call them “no-double-taxation savings accounts.”

P.P.S. I do like that Chris and Amity argued that the accounts would be better than big child tax credits, particularly since I also argued in the Wall Street Journal that there were better ways to help the middle class.

P.P.P.S. Canada also can teach us important lessons on other issues, such as spending restraint, corporate tax reform, bank bailouts, and privatization of air traffic control. Heck, Canada even has one of the lowest levels of welfare spending among developed nations.

P.P.P.P.S. No wonder the two most capitalistic places in North America are in Canada. And Canada ranks above the United States in the Economic Freedom of the World Index.

P.P.P.P.P.S. Though there are still plenty of statists north of the border, so I’m not sure it’s the best escape option for advocates of small government. Though I doubt leftists no longer see it as an escape option, which was the premise of this joke that circulated after the 2010 election.

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I’ve had ample reason to praise Hong Kong’s economic policy.

Most recently, it was ranked (once again) as the world’s freest economy.

And I’ve shown that this makes a difference by comparing Hong Kong’s economic performance to the comparatively lackluster (or weak) performance of economies in the United States, Argentina, and France.

But perhaps the most encouraging thing about Hong Kong is that the nation’s top officials genuinely seem to understand the importance of small government.

Here are some excerpts from a recent speech delivered by Hong Kong’s Financial Secretary. He brags about small government and low tax rates!

Hong Kong has a simple tax system built on low tax rates. Our maximum salaries tax rate is 15 per cent and the profits tax rate a flat 16.5 per cent. Few companies and individuals would find it worth the risk to evade taxes at this low level. And that helps keep our compliance and enforcement costs low. Keeping our government small is at the heart of our fiscal principles. Leaving most of the community’s income and wealth in the hands of individuals and businesses gives the private sector greater flexibility and efficiency in making investment decisions and optimises the returns for the community. This helps to foster a business environment conducive to growth and competitiveness. It also encourages productivity and labour participation. Our annual recurrent government expenditure has remained steady over the past five years, at 13 per cent of GDP. …we have not responded irresponsibly to…populist calls by introducing social policies that increase government spending disproportionally. …The fact that our total government expenditure on social welfare has remained at less than 3 per cent of our GDP over the past five years speaks volumes about the precision, as well as the effectiveness, of these measures.

And he specifically mentions the importance of controlling the growth of government, which is the core message of Mitchell’s Golden Rule.

Our commitment to small government demands strong fiscal discipline….It is my responsibility to keep expenditure growth commensurate with growth in our GDP.

Is that just empty rhetoric?

Hardly. Here’s Article 107 from the Basic Law, which is “the constitutional document” for Hong Kong

The most important part of Article 107, needless to say, is that part of keeping budgetary growth “commensurate with the growth rate of its gross domestic product.”

The folks in Hong Kong don’t want to wind up like Europe.

Last year, I set up a Working Group on Long-term Fiscal Planning to conduct a fiscal sustainability health check. We did it because we are keenly aware of Hong Kong’s low fertility rate and ageing population, not unlike many advanced economies. And that can pose challenges to public finance in the longer term. A series of expenditure-control measures, including a 2 per cent efficiency enhancement over the next three financial years, has been rolled out.

And, speaking of Europe, he says the statist governments from that continent should clean up their own messes before criticizing Hong Kong for being responsible.

I would hope that some of those governments in Europe, those that have accused Hong Kong of being a tax haven, would look at the way they conduct their own fiscal policies. I believe they could learn a lesson from us about the virtues of small government.

Just in case you think this speech is somehow an anomaly, let’s now look at some slides from a separate presentation by different Hong Kong officials.

Here’s one that warmed my heart. The Hong Kong official is bragging about the low-tax regime, which features a flat tax of 15 percent!

But what’s even more impressive is that Hong Kong has a very small burden of government spending.

And government officials brag about small government.

By the way, you’ll also notice that there’s virtually no red ink in Hong Kong, largely because the government focuses on controlling the disease of excessive spending.

Why is government small?

In large part, as you see from the next slide, because there is almost no redistribution spending.

Indeed, officials actually brag that fewer and fewer people are riding in the wagon of dependency.

Can you imagine American lawmakers with this kind of good sense?

None of this means that Hong Kong doesn’t have any challenges.

There are protests about a lack of democracy. There’s an aging population. And there’s the uncertainty of China.

But at least for now, Hong Kong is a tribute to the success of free markets and small government.

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I’m not a big fan of Obamanomics.

I don’t like the President’s class-warfare mentality on taxes. I don’t like his support for Keynesian spending policy. And I don’t like his costly expansions of government such as Obamacare.

Indeed, I even like mocking his reflexive statism.

That being said, I fully agree (albeit with some important caveats) with his observation that the United States generally is doing better than other nations.

Here are some blurbs from a Bloomberg report about the President’s remarks on that issue.

A month before congressional elections, President Barack Obama is making an appeal to American pride in promoting his economic policies, arguing that the U.S. is outpacing the recovery in other nations. …“The United States has put more people back to work than Europe, Japan, and every other advanced economy combined.” Obama said. …economies in Europe and Japan are sluggish. The recovery for the euro area – including France and Italy – stalled, with gross domestic product unchanged, from the first quarter to the second, according to Eurostat, the European Union’s statistics office in Luxembourg. Japan contracted by the most in more than five years, with GDP shrinking an annualized 7.1 percent, data from the government Cabinet Office in Tokyo show. …Jason Furman, the chairman of the White House Council of Economic Advisers…called Obama’s emphasis on the relative strength of the U.S. economy “useful context to compare to other countries that are facing similar challenges.”

I don’t know if the White House is correct on every specific claim, but it’s definitely true that the United States is out-pacing Europe.

Here are a couple of charts I found with a quick search. We’ll start with one comparing GDP performance. It’s not as up-to-date as the one I shared back in June, but it does a good job of showing how our cousins across the ocean are falling behind.

And here’s another chart I found showing how Europe also is lagging on employment.

And I can also say from personal experience, based on my trips to various conferences, that Europeans look at the American economy with envy. Heck, they even think 1 percent growth is a reason for celebration!

Which should give you an idea of how bad the outlook is in Europe.

After all, the United States is experiencing the weakest economic expansion since the Great Depression. Yet compared to European nations like France and Italy, we’re a powerhouse.

And this isn’t even a new development. After World War II, the European economies were converging with the United States. In other words, they were growing faster, which is what conventional economic theory predicts should happen over time.

But then, thanks the Europe’s shift to more statism in the 1960s and America’s shift to more freedom in the 1980s, the convergence stopped and America began to enjoy better performance. The data from recent years is just the latest bit of evidence.

Let’s now return to the central thesis of today’s post. As I said above, Obama is right that America is doing much better than most other nations.

But here’s the catch….and it’s a big one.

The President wants America to copy the policies that have caused economic stagnation in Europe!

Does he want higher tax rates? Yup.

Does he want more spending? You bet.

Does he want additional regulation? Yes.

Does he want increased intervention? Of course.

Does he want expanded welfare programs? Naturally.

In other words, when I read the article in Bloomberg, it was a very surreal experience. Is the President clueless? Or does he think we’re clueless? How could he brag about America out-performing Europe without realizing that he was attacking Obamanomics?

It was like getting a lecture on the merits of exercise from a guy who wants you to buy a big-screen TV and a lifetime supply of fast food. Or, better yet, check out these cartoons from Michael Ramirez, Glenn Foden, Eric Allie and Chip Bok.

By the way, I feel guilty about saying so many bad things about Europe, so let’s close with some reasonably clever anti-American humor from our European friends.

Here’s an image regarding culture.

And here’s one regarding…um…style.

P.S. Okay, maybe the Europeans have more culture and style, but Americans are more genuinely compassionate.

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My colleagues Chris Edwards and Nicole Kaeding have just released the biennual Fiscal Policy Report Card on America’s Governors from the Cato Institute.

The Report Card is one of the Cato Institute’s most impressive publications since developments on the state level help illustrate the relationship between good fiscal policy and economic performance.

The top scores were earned by Pat McCrory of North Carolina and Sam Brownback of Kansas. Both have taken steps to significantly reduce marginal tax rates and restrain the burden of state government spending in their states.

Here are all the scores. Paul LePage of Maine and Mike Pence of Indiana also earned high marks, while the governors of Minnesota, Oregon, Delaware, Washington, Illinois, Massachusetts, Colorado, and Calfornia all received failing grades.

Here some of what Chris and Nicole wrote for National Review about the results of their research .

Let’s start with the good news.

Pat McCrory of North Carolina signed a bill replacing individual-income-tax rates of 6.0, 7.0, and 7.75 percent with a single rate of 5.75 percent. He also cut the corporate-tax rate from 6.9 to 5.0 percent and repealed the estate tax. Sam Brownback of Kansas approved a plan in 2012 replacing three individual-income-tax rates with two and cutting the top rate from 6.45 to 4.9 percent. The reform also increased the standard deduction and reduced taxes on small businesses. Brownback cut income-tax rates further in 2013.

Now for the not-so-good news.

…all eight governors earning an “F” were Democrats. …Jerry Brown of California and Pat Quinn of Illinois, for example, earned “F” grades for their large tax hikes.

If you look at the data on state spending, Governor Brownback of Kansas and Governor Bentley of Alabama both got high scores of 85, largely because per-capita spending fell during their tenure.

Governor Kasich of Ohio did the worst job on spending (why am I not surprised), getting a low score of 16 (Governor Abercrombie of Hawaii and Governor Hickenlooper of Colorado were the next lowest, both “earning” a score of 22).

Interestingly, the left is very anxious to undermine the achievements of America’s best governors.

I’ve previously defended the pro-growth reforms to unemployment insurance adopted by Governor McCrory of North Carolina.

And now let me take this opportunity to defend Governor Brownback of Kansas.

The New York Times is desperately hoping he loses his reelection bid since that might dissuade other state policy makers from enacting good reforms.

Mr. Brownback’s proudly conservative policies have turned out to be so divisive and his tax cuts have generated such a drop in state revenue that they have caused even many Republicans to revolt. …it is unsurprising that many Kansas Republicans have turned on Mr. Brownback. This is a state that once had a tradition of centrist Republicans, like former Senator Bob Dole… More than 100 current and former Republican elected officials have endorsed Mr. Davis.

The Wall Street Journal, however, points out that the anti-Brownback GOPers are largely sore losers.

…many of the “Republicans” on the list are in fact independents who long ago defected from the GOP. …six state Senators whom tea-party groups ousted in 2012 for obstructing tax and government reforms are supporting Mr. Davis.

What really matters, though, is that Governor Brownback’s reforms are designed to rejuvenate a state economy that has lagged its neighbors.

Here are some details from another WSJ editorial.

By liberal accounts Kansas is experiencing a major fiscal and economic meltdown like well, you know, Illinois. …But some early economic indicators suggest they may be producing modest positive effects. The danger is that a coalition of Democrats and big-spending Republicans will pull out the rug before the benefits fully materialize.

What are those benefits?

Well, it’s still early, but the preliminary results are positive.

Kansas has long trailed its neighbors in private job and economic growth. …All of Kansas’s surrounding states save Nebraska had lower top tax rates, and most also had lower unemployment. …Since the tax cuts took effect, the gap in job creation between Kansas and neighboring states has shrunk. Kansas’s rate of private job growth between January 2013 and June 2014 averaged 167% of that in Nebraska, 105% of Iowa and 61% in Oklahoma. That compares to 61%, 85% and 42%, respectively, between 2004 and 2012. While Kansas added jobs at a slower pace than Missouri this year, its private economy grew more than twice as fast as its eastern neighbor last year.

Statists are grousing about lower-than-expected revenues, but their command of the facts leaves something to be desired.

Tax-reform critics complain that revenues (as expected) declined this year and that receipts were $235 million—or about 4%—below the state’s estimate last year. However, predicting revenues was particularly challenging this year because federal tax changes encouraged investors to shift income to 2012 from 2013. Revenues missed the mark in numerous states including Iowa ($185 million; 3%), Missouri ($308 million; 4%) and Oklahoma ($283 million; 5%).

And here’s some analysis from Reason.

While The New York Times denounces as “ruinous” the Kansas tax cut, it is sitting in a state, New York, with a top rate of 8.82 percent. If all the government spending paid for by those high taxes were the panacea that the Times claims it is, you might expect New York to have a lower unemployment than Kansas. But check the numbers, and Kansas’s seasonally adjusted unemployment rate for June was a low 4.9 percent, while New York’s was 6.6 percent. “Ruinous,” indeed.

Given the high stakes, it will be very interesting to see whether Brownback is reelected next month.

Same with Scott Walker of Wisconsin (who, by the way, earned a B), who got national attention for his efforts to rein in the privileged position of state bureaucrats and Pat Quinn of Illinois (who got an F), who attracted a lot of attention for his destructive tax hikes.

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Most of us will never be directly impacted by the international provisions of the internal revenue code.

That’s bad news because it presumably means we don’t have a lot of money, but it’s good news because IRS policies regarding “foreign-source income” are a poisonous combination of complexity, harshness, and bullying (this image from the International Tax Blog helps to illustrate that only taxpayers with lots of money can afford the lawyers and accountants needed to navigate this awful part of the internal revenue code).

But the bullying and the burdens aren’t being imposed solely on Americans. The internal revenue code is uniquely unilateral and imperialistic, so we simultaneously hurt U.S. taxpayers and cause discord with other jurisdictions.

Here are some very wise words from a Washington Post column by Professor Andrés Martinez of Arizona State University.

Much of his article focuses on the inversion issue, but I’ve already covered that topic many times. What caught my attention instead is that he does a great job of highlighting the underlying philosophical and design flaws of our tax code. And what he writes on that topic is very much worth sharing.

The Obama administration is not living up to its promise to move the country away from an arrogant, unilateral approach to the world. And it has not embraced a more consensus-driven, multipolar vision that reflects the fact that America is not the sole player in the global sandbox. No, I am not talking here about national security or counter-terrorism policy, but rather the telling issue of how governments think about money — specifically the money they are entitled to, as established by their tax policies. …ours is a country with an outdated tax code — one that reflects the worst go-it-alone, imperialistic, America-first impulses. …the…problem is old-fashioned Yankee imperialism.

What is he talking about? What is this fiscal imperialism?

It’s worldwide taxation, a policy that is grossly inconsistent with good tax policy (for instance, worldwide taxation is abolished under both the flat tax and national sales tax).

He elaborates.

The United States persists in imposing its “worldwide taxation” system, as opposed to the “territorial” model embraced by most of the rest of the world. Under a “territorial” tax system, the sovereign with jurisdiction over the economic activity is entitled to tax it.  If you profit from doing business in France, you owe the French treasury taxes, regardless of whether you are a French, American or Japanese multinational.  Even the United States, conveniently, subscribes to this logical approach when it comes to foreign companies doing business here: Foreign companies pay Washington corporate taxes on the income made by their U.S. operations. But under our worldwide tax system, Uncle Sam also taxes your income as an American citizen (or Apple’s or Coca-Cola’s) anywhere in the world. …Imagine you are a California-based widget manufacturer competing around the world against a Dutch widget manufacturer. You both do very well and compete aggressively in Latin America, and pay taxes on your income there. Trouble is, your Dutch competitor can reinvest those profits back in its home country without paying additional taxes, but you can’t.

Amen.

Indeed, if you watch this video, you’ll see that I also show how the territorial system of the Netherlands is far superior and more pro-competitive than America’s worldwide regime.

And if you like images, this graphic explains how American companies are put at a competitive disadvantage.

Professor Martinez points to the obvious solution.

Instead of attacking companies struggling to compete in the global marketplace, the Obama administration should work with Republicans to move to a territorial tax system.

But, needless to say, the White House wants to move policy in the wrong direction.

Looking specifically at the topic of inversions, the Wall Street Journal eviscerates the Obama Administration’s unilateral effort to penalize American companies that compete overseas.

Here are some of the highlights.

…the Obama Treasury this week rolled out a plan to discourage investment in America. …the practical impact will be to make it harder to make money overseas and then bring it back here. …if the changes work as intended, they will make it more difficult and expensive for companies to reinvest foreign earnings in the U.S. Tell us again how this helps American workers.

The WSJ makes three very powerful points.

First, companies that invert still pay tax on profits earned in America.

…the point is not to ensure that U.S. business profits will continue to be taxed. Such profits will be taxed under any of the inversion deals that have received so much recent attention. The White House goal is to ensure that the U.S. government can tax theforeign profits of U.S. companies, even though this money has already been taxed by the countries in which it was earned, and even though those countries generally don’t tax their own companies on profits earned in the U.S.

Second, there is no dearth of corporate tax revenue.

Mr. Lew may be famously ignorant on matters of finance, but now there’s reason to question his command of basic math. Corporate income tax revenues have roughly doubled since the recession. Such receipts surged in fiscal year 2013 to $274 billion, up from $138 billion in 2009. Even the White House budget office is expecting corporate income tax revenues for fiscal 2014 to rise above $332 billion and to hit $502 billion by 2016.

Third, it’s either laughable or unseemly that companies are being lectured about “fairness” and “patriotism” by a cronyist like Treasury Secretary Lew.

It must be fun for corporate executives to get a moral lecture from a guy who took home an $800,000 salary from a nonprofit university and then pocketed a severance payment when he quit to work on Wall Street, even though school policy says only terminated employees are eligible for severance.

Heck, it’s not just that Lew got sweetheart treatment from an educational institution that gets subsidies from Washington.

The WSJ also should have mentioned that he was an “unpatriotic” tax avoider when he worked on Wall Street.

But I guess rules are only for the little people, not the political elite.

P.S. Amazingly, I actually found a very good joke about worldwide taxation. Maybe not as funny as these IRS jokes, but still reasonably amusing.

P.P.S. Shifting from tax competitiveness to tax principles, I’ve been criticized for being a squish by Laurence Vance of the Mises Institute. He wrote:

Mitchell supports the flat tax is “other than a family-based allowance, it gets rid of all loopholes, deductions, credits, exemptions, exclusions, and preferences, meaning economic activity is taxed equally.” But because “a national sales tax (such as the Fair Tax) is like a flat tax but with a different collection point,” and “the two plans are different sides of the same coin” with no “loopholes,” even though he is “mostly known for being an advocate of the flat tax,” Mitchell has “no objection to speaking in favor of a national sales tax, testifying in favor of a national sales tax, or debating in favor of a national sales tax.” But as I have said before, the flat tax is not flat and the Fair Tax is not fair. …proponents of a free society should work towardexpanding tax deductions, tax credits, tax breaks, tax exemptions, tax exclusions, tax incentives, tax loopholes, tax preferences, tax avoidance schemes, and tax shelters and applying them to as many Americans as possible. These things are not subsidies that have to be “paid for.” They should only be eliminated because the income tax itself has been eliminated. …the goal should be no taxes whatsoever.

In my defense, I largely agree. As I’ve noted here, here, here, and here, I ultimately want to limit the federal government to the powers granted in Article I, Section 8 of the Constitution, in which case we wouldn’t need any broad-based tax.

Though I confess I’ve never argued in favor of “no taxes whatsoever” since I’m not an anarcho-capitalist. So maybe I am a squish. Moreover, Mr. Vance isn’t the first person to accuse me of being insufficiently hardcore.

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I’ve complained over and over again that America’s tax code is a nightmare that undermines competitiveness and retards growth.

Our aggregate fiscal burden may not be as high as it is for many of our foreign competitors, but high tax rates and poor design mean the system is very punitive on a per-dollar-raised basis.

For more information, the Tax Foundation has put together an excellent report measuring international tax competitiveness.

Here’s the methodology.

The Tax Foundation’s International Tax Competitiveness Index (ITCI) measures the degree to which the 34 OECD countries’ tax systems promote competitiveness through low tax burdens on business investment and neutrality through a well-structured tax code. …No longer can a country tax business investment and activity at a high rate without adversely affecting its economic performance. In recent years, many countries have recognized this fact and have moved to reform their tax codes to be more competitive. However, others have failed to do so and are falling behind the global movement. …The competitiveness of a tax code is determined by several factors. The structure and rate of corporate taxes, property taxes, income taxes, cost recovery of business investment, and whether a country has a territorial system are some of the factors that determine whether a country’s tax code is competitive.

And here’s how the United States ranks.

The United States provides a good example of an uncompetitive tax code. …the United States now has the highest corporate income tax rate in the industrialized world. …The United States places 32nd out of the 34 OECD countries on the ITCI. There are three main drivers behind the U.S.’s low score. First, it has the highest corporate income tax rate in the OECD at 39.1 percent. Second, it is one of the only countries in the OECD that does not have a territorial tax system, which would exempt foreign profits earned by domestic corporations from domestic taxation. Finally, the United States loses points for having a relatively high, progressive individual income tax (combined top rate of 46.3 percent) that taxes both dividends and capital gains, albeit at a reduced rate.

Here are the rankings, including scores for the various components.

You have to scroll to the bottom to find the United States. It’s embarrassing that we’re below even Spain and Italy, though I guess it’s good that we managed to edge out Portugal and France.

Looking at the component data, all I can say is that we should be very thankful that politicians haven’t yet figured out how to impose a value-added tax.

I’m also wondering whether it’s better to be ranked 32 out of 34 nations or ranked 94 out of 100 nations?

But rather than focus too much on America’s bad score, let’s look at what some nations are doing right.

Estonia – I’m not surprised that this Baltic nations scores well. Any country that rejects Paul Krugman must be doing something right.

New Zealand – The Kiwis can maintain a decent tax system because they control government spending and limit government coercion.

Switzerland – Fiscal decentralization and sensible citizens are key factors in restraining bad tax policy in Switzerland.

Sweden – The individual income tax is onerous, but Sweden’s penchant for pro-market reform has helped generate good scores in other categories.

Australia – I’m worried the Aussies are drifting in the wrong direction, but any nations that abolishes its death tax deserves a high score.

To close, here’s some of what the editors at the Wall Street Journal opined this morning.

…the inaugural ranking puts the U.S. at 32nd out of 34 industrialized countries in the Organization for Economic Co-operation and Development (OECD). With the developed world’s highest corporate tax rate at over 39% including state levies, plus a rare demand that money earned overseas should be taxed as if it were earned domestically, the U.S. is almost in a class by itself. It ranks just behind Spain and Italy, of all economic humiliations. America did beat Portugal and France, which is currently run by an avowed socialist. …the U.S. would do even worse if it were measured against the world’s roughly 190 countries. The accounting firm KPMG maintains a corporate tax table that includes more than 130 countries and only one has a higher overall corporate tax rate than the U.S. The United Arab Emirates’ 55% rate is an exception, however, because it usually applies only to foreign oil companies.

The WSJ adds a very important point about the liberalizing impact of tax competition.

Liberals argue that U.S. tax rates don’t need to come down because they are already well below the level when Ronald Reagan came into office. But unlike the U.S., the world hasn’t stood still. Reagan’s tax-cutting example ignited a worldwide revolution that has seen waves of corporate tax-rate reductions. The U.S. last reduced the top marginal corporate income tax rate in 1986. But the Tax Foundation reports that other countries have reduced “the OECD average corporate tax rate from 47.5 percent in the early 1980s to around 25 percent today.”

This final excerpt should help explain why I spend a lot of time defending and promoting tax competition.

As bad as the tax system is now, just imagine how bad it would be if politicians didn’t have to worry about jobs and investment escaping.

P.S. If there was a way of measuring tax policies for foreign investors, I suspect the United States would jump a few spots in the rankings.

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When asked about the most worrisome statistic for a nation, I don’t say it’s the top marginal tax rate, even though I think class-warfare taxation is very poisonous for long-run economic performance.

Nor do I say it’s the burden of government spending relative to private economic output, even though the size of the public sector gives us a good idea of the degree to which labor and capital are being poorly allocated.

I don’t even say that a nation’s score in the Economic Freedom of the World index is the most important number, even though that’s the best and most comprehensive measure of the quality of a country’s economic policy.

My answer, for what it’s worth, is that a nation is doomed when a majority of its people decide that it is morally and economically okay to live off the labor of others and want to use the coercive power of government to make it happen.

For lack of a better term, we can call this a country’s Dependency Ratio, and it’s a measure of eroding social capital. To what degree, in other words, has the entitlement mentality replaced the work ethic and the spirit of self reliance?

But before continuing further, I want to provide two important caveats.

1) The Dependency Ratio is not the percentage of households that get money from the government. That’s an important number, to be sure, but it includes people who get money but don’t have an entitlement mentality. A good example is that Social Security recipients in America get checks from Uncle Sam, but only because they had no choice but to pay into the system and did not have the freedom to use that money instead for a personal retirement account. In many if not most cases, they don’t see themselves as part of a “takers” coalition.

2) From a practical perspective, the Dependency Ratio is a good concept, but I’m not aware of a methodologically sound way to calculate a nation’s entitlement mentality. And there’s definitely not good data for purposes of doing international comparisons (though this polling data suggests that the problem is much more severe in nations such as France than it is in the United States). So you have to rely on imperfect proxy measures, such as the share of households getting payments, the size and cost of the bureaucracy, and overall social welfare spending.

I’ve shared all these thoughts because they give the necessary background for today’s main topic, which is South Africa’s dismal economic future.

Take a look at this very depressing chart that appeared in my Twitter feed. It shows what has happened over the past five years in South Africa’s labor market.

This isn’t good news. The number of bureaucrats has risen dramatically while there’s been no growth in the number of people working in the economy’s productive sector.

If this trend continues, it’s only a matter of time before South Africa suffers economic collapse. You can’t have an ever-growing class of people living off a non-growing pool of taxpayers.

However, I realize that the chart only shows five years of data, so it could present a misleading view of trends in the country, particularly if there are policy reforms in other areas that might offset the damage of expanding bureaucracy.

So let’s look at other economic sources to confirm whether South Africa is moving in the wrong direction.

I mentioned above that the Economic Freedom of the World has the best data on the quality of a nation’s economic policy. Here’s South Africa’s performance.

The good news is that South Africa enjoyed a big jump in economic freedom between 1990 and 2000, which isn’t too surprising since the morally abominable Apartheid regime relied on heavy levels of government intervention. Ending that system was a key step in economic liberalization.

But the bad news is that there’s been no improvement since that time. Indeed, South Africa’s score has declined. The fall in the absolute score is minor, but bigger problem is that the nation’s relative score has suffered a big drop. If you look at the blue bars on the bottom, you can see that South Africa had the world’s 36th-freest economy in 2003, but it’s now down to having the world’s 88th-freest economy.

In other words, other nations have moved policy in the right direction while South Africa has been stagnant.

Since I’m a fiscal policy economist, I also looked at what’s been happening to the burden of government spending in South Africa.

As you can see, this chart (based on IMF data) shows that government outlays (left axis) have jumped significantly since the turn of the century.

And since government grew faster than the private sector (violating the Golden Rule), the overall burden of government spending increased (right axis) even when measured as a share of economic output.

I don’t know if the additional spending has been used to pay for additional bureaucrats, social welfare programs, infrastructure, education, or the military.

I suspect all of the above, which helps to explain why South Africa’s fiscal policy score from Economic Freedom of the World has dropped from 6.45 to 5.45 (on a 1-10 scale) since 2000.

More important, I also suspect that the net result is to have lured lots of additional people into government dependency.

That doesn’t bode well for South Africa’s future.

P.S. On a different topic, we have a couple of updates on the politicized and corrupt behavior at the IRS.

First, we have another case of misplaced email messages. Here’s an excerpt from an AP report.

On Friday, the IRS issued a report to Congress saying the agency also lost emails from five other employees related to the probe, including two agents who worked in a Cincinnati office processing applications for tax-exempt status. …The IRS blamed computer crashes for all the lost emails.

Gee, how convenient.

I wonder if the IRS will allow me to claim lost data next time I have a tax dispute?

Second, it’s understandable that the IRS is anxious to hide its internal communication because what does get released shows a partisan and malevolent bureaucracy.

The day that former Internal Revenue Service official Lois Lerner publicly apologized for using “inappropriate criteria” to delay tax exemptions for Tea Party groups, she told her colleagues that they were being “beaten up by the press for all the wrong reasons.” …The documents show Lerner’s efforts to persuade Treasury auditors that there was no institutional bias at the IRS, the agency’s attempts to head off a damaging investigation with a pre-emptive apology, and Lerner’s pep talk to her staff after the apology. …The idea for a public apology to head off the audit came at least a month before. Lerner was set to give a speech at Georgetown University and was “begging” for some newsworthy information, IRS chief of staff Nikole Flax said in an e-mail. “We may want to use it to burst a bubble,” said then-acting IRS commissioner Steven Miller in response. He later joked that Lerner could use the speech to “apologize for undermanaging.”

Amazing. The bureaucrats laughed about their efforts to terrorize people and distort the political process.

The only real solution is sweeping tax reform so the IRS loses almost all its power.

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