New European Data: When Tax Competition Is Weakened, Politicians Respond by Increasing Tax Rates

I often argue that we need to preserve tax competition and tax havens in order to limit the greed of the political class.

Without some sort of external constraint, they will over-tax and over-spend, creating the kind of downward economic spiral already happening in some European nations.

Speaking of which, new evidence from Europe bolsters my case.

Back in 2009, facing pressure from the big G-20 nations, all of the world’s major low-tax jurisdictions – even Switzerland – acquiesced to the notion that human rights laws protecting financial privacy no longer would apply to foreign investors.

In other words, high-tax governments now have much greater ability to track – and tax – flight capital.

So how have they responded since that time? Well, look at this chart from the European Union’s new report on taxation trends. Tax rates have begun to increase, reversing a very positive trend (which began with the Reagan and Thatcher tax cuts, though this chart only shows data since 1995).

We can’t say, of course, that the increase in tax rates since 2009 is because tax competition was eroded. Just like we can’t say the reduction of tax rates in the preceding years was because of tax competition.

But we do know that simple economic theory tells us that monopolists are more likely to raise prices than firms in competitive markets. Likewise, governments are more likely to raise tax rates if they think taxpayers don’t have escape options.

And we also know that the proponents of higher tax rates, such as the statist bureaucrats at the Paris-based OECD, are also the biggest opponents of tax competition. The OECD even complained in one of its reports that tax competition “may hamper the application of progressive tax rates.”

Well, those international bureaucrats (who, by the way, get tax-free salaries) are getting their wish. Tax rates are increasing.

“Let them eat cake”

So the political class can breathe a sigh of relief.

But what about the people of Europe? Well, economic growth is almost non-existent and unemployment is at record levels.

However, you can’t make an omelet without breaking a few eggs. As a past representative of Europe’s political elite once remarked, “let them eat cake.”

Marie Antoinette eventually may have regretted her choice of words, but Europe’s current politicians are probably more clever and have contingency plans. When the you-know-what hits the fan and Europe descends into social disarray and economic chaos, ordinary people will be the ones at risk.

Unfortunately, the United States is on the same path, as shown by these sobering charts from the Bank for International Settlements (and also as illustrated by these very funny Michael Ramirez and Bob Gorrell cartoons).

For more information on the important liberalizing impact of tax competition, here’s the video I narrated for the Center for Freedom and Prosperity.

But remember that restraining fiscal burdens is not the only reason to preserve tax competition and tax havens. There also are very important moral reasons to support low-tax jurisdictions.

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Based on a Review of Studies Looking at the Impact of Taxes on Growth, Academic Research Gives Obama a Record of 0-23-3

How do you define a terrible team? No, this isn’t going to be a joke about Notre Dame foolishly thinking it could match up against a team from the Southeastern Conference in college football’s national title game (though the Irish win the contest for prettiest make-believe girlfriends).

I’m asking the question because a winless record is usually a good indication of a team that doesn’t know what it’s doing and is in over its head.

With that in mind, and given the White House’s position that class warfare taxation is good fiscal policy, how should we interpret a recent publication from the Tax Foundation, which reviews the academic research on taxes and growth and doesn’t find a single study supporting the notion that higher tax rates are good for prosperity.

None. Zero. Nada. Zilch.

Twenty-three studies found a negative relationship between taxes and growth, by contrast, while three studies didn’t find any relationship.

For those keeping score at home, that’s a score of 0-23-3 for the view espoused by the Obama Administration.

This new Tax Foundation report is also useful if you want more information to debunk the absurd study from the Congressional Research Service that claimed no relationship between tax policy and growth. Indeed, the TF report even explains that serious methodological flaws made “the CRS study unpublishable in any peer-reviewed academic journal.”

So what do we find in the Tax Foundation report?

…what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy. In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth.

And what does this mean?

…results support the Neo-classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages. Taxes on income and wages reduce the incentive to work. Progressive income taxes, where higher income is taxed at higher rates, reduce the returns to education, since high incomes are associated with high levels of education, and so reduce the incentive to build human capital. Progressive taxation also reduces investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.

To be blunt, the report’s findings suggest the Obama White House is clueless about tax policy.

…there are not a lot of dissenting opinions coming from peer-reviewed academic journals. More and more, the consensus among experts is that taxes on corporate and personal income are particularly harmful to economic growth… This is because economic growth ultimately comes from production, innovation, and risk-taking.

Here’s my cut-and-paste copy of the table summarizing all the academic research.

So what’s the bottom line? The Tax Foundation report concludes with the following.

In sum, the U.S. tax system is a drag on the economy.  Pro-growth tax reform that reduces the burden of corporate and personal income taxes would generate a more robust economic recovery and put the U.S. on a higher growth trajectory, with more investment, more employment, higher wages, and a higher standard of living.

In other words, America would be more prosperous with a simple and fair system such as the flat tax.

Too bad the political elite is more focused on maintaining (or even exacerbating) a corrupt status quo, even if it means less prosperity for the nation.

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Do Higher Tax Rates Hurt Growth?

Because of Obama’s class-warfare tax hike and additional tax increases by kleptocrats at the state level, many successful taxpayers will now lose more than 50 percent of any additional income they generate for the American economy.

I discuss the implications of this punitive tax policy in this CNBC interview.

Normally, this is the section where I highlight certain points I made, or bemoan the fact that I failed to mention an important fact or overlooked a key argument. Today, though, I want to address the do-taxes-impact-growth issue raised by Robert Frank.

More specifically, I want to debunk the Congressional Research Service study that he indirectly mentioned about two minutes into the segment. This is the report that asserted that it doesn’t matter if we impose high tax rates on investors, entrepreneurs, small business owners, and other “rich” taxpayers.

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

The good news is that I don’t really need to debunk this CRS study because Steve Entin already has undertaken that unpleasant task. Writing for the Tax Foundation, Steve points out some rather fatal flaws in the CRS study.

The study makes no effort to determine the channels through which the tax changes ought to work to affect the economy, looks at the wrong measure of progress over the wrong time frame, and takes inadequate account of what other tax or economic events are occurring at the same time that might mask the results. …Other changes in taxes and other influences on the economy occurring at the same time can easily hide or counteract the effect of the top tax rate changes alone. It is often impossible to hold other things constant to allow one to see the impact of the single item one wants to assess. When these other influences are omitted from the model, the “missing variables” problem poisons the results. …one should look at the long-term change in the capital stock and the ultimate level of output, not the short-term rise in investment and the short-term change in the growth rate. If one looks only at the growth rate, and not at the level of GDP, one could conclude that the tax rate change has only a temporary benefit, when in fact it is permanently helpful. …Looking only at the amount of investment triggered in the year following the tax change misses the point. The same holds true in the opposite direction for a tax increase. It takes years to retire through attrition the excess capital made redundant by a tax increase. Looking only at the change in investment in the year after the tax cut, rather than the cumulative increase in the stock of capital over time, misses about 95 percent of the impact. You can’t predict this fall’s apple crop by counting the number of seedlings planted this spring. The CRS study omits important variables and poisons its results by not holding other factors constant. The variables it does examine are indirectly related to the relationship one should be studying, but the study does not follow them for long enough to get the whole picture. The study is as weak now as it was when it was first issued. Grade: F.

By the way, the Wall Street Journal pointed out that the author of the CRS study is not exactly dispassionate and neutral on these matters.

You won’t be surprised to learn that Mr. Hungerford has donated to the Obama campaign and Senate Democrats and worked as an economist at the White House budget office under Bill Clinton.

In closing, I did address the taxes-growth issue last year. I wasn’t debunking the CRS study, but I was exposing the errors in some very similar analysis by a writer for the New York Times.

Here’s the key passage from that post.

Yes, lower tax rates are better for economic performance, just as wheels matter for a car’s performance. But if a car doesn’t have an engine, transmission, steering wheel, and brakes, it’s not going to matter how nice the wheels are.

In other words, I was focusing on the fact that you can’t accurately and honestly examine tax policy without looking at the impact of other public policy issues.

I made that point in the CNBC interview, of course, though it’s unclear whether the message got through.

But I think the Clinton years and Bush years make my point. Bill Clinton was bad on tax policy in 1993, but was good on almost everything else (including a cut in the capital gains tax rate in 1997), whereas George W. Bush was okay on tax policy, but was bad on just about everything else.

So here are a couple of very simple questions.

1. Given what we now know about the increase in economic freedom under Clinton and the loss in economic freedom under Bush, is anybody surprised that the economy did better under Clinton than it did under Bush?
2. Does anybody think that the economy prospered under Clinton because he raised tax rates in 1993?
3. Does anybody think the economy was anemic under Bush because he lowered taxes in 2001 and 2003?

Depending on how you answer those questions, you may be qualified to work at the Congressional Research Service.

But if you understand that it’s important to look at the overall burden of government when measuring the impact of public policy on economic performance, then…well, I’m not sure whether I can promise anything other than you’ll have the satisfaction of knowing that you’re intellectually honest and economically literate.

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How the Welfare State Traps the Poor in Dependency, the British Version

Back in 2011, I linked to a simple chart that illustrated how handouts and subsidies create very high implicit marginal tax rates for low-income people and explained how “generosity” from the government leads to a tar-paper effect that limits upward mobility.

Earlier this year, I shared an amazing chart that specifically measured how the welfare state imposes these high implicit tax rates. Unbelievably, some people would be better off earning $29,000 rather than $69,000.

Simply stated, the multitude of redistribution programs are worth a lot of money, but you begin to lose those goodies if you begin to live a productive and independent life.

And since we know that rich people respond to high tax rates by declaring less income to the government, we shouldn’t be surprised that poor people also respond to incentives.

We also shouldn’t be surprised to learn that other nations have these same perverse policies. Here are some excerpts from a powerful piece for the UK-based Spectator.

…today’s Sunday Times magazine has a long piece asking whether there is a “fundamental difference in our attitudes to work”. It’s still one of the most important questions in Britain today: what’s the use of economic growth if it doesn’t shorten British dole queues? And should we blame these industrious immigrants; aren’t the Brits just lazy? …The quality of the British debate is so poor that we almost never look at this from the point of view of the low-wage worker. Every budget, the IFS will dutifully work out if it has been “fair” – ie, gives the most to the poorest. The LibDems will judge a budget by this metric. That’s a nice, easy, simple graph. But what about destroying the work incentive? Each budget and each change to tax should be judged on how many people are then ensnared in the welfare trap. I adapted the below (nasty, complex) graphs from an internal government presentation, which still make the case powerfully. The bottom axis is money earned from employer and the side axis is income retained. The graphs are complex but worth studying, if only to get a feel for the horrific system confronting millions of the lowest-paid in Britain today.

Here are the two charts. the author is correct. They are quite complex. But they show that there’s no much incentive to work harder, whether you’re a young person or a single parent.

After showing these amazing charts, the author makes some very powerful additional observations.

…if I was in a position of a British single mother I have not the slightest doubt that I would choose welfare. Why break your back on the minimum wage for longer than you have to, if it doesn’t pay? Some people do have the resolve to do it. I know I wouldn’t. …So let’s not talk about “lazy” Brits. The problem is a cruel and purblind welfare system which still, to this day, strengthens the welfare trap with budgets passed without the slightest regard for its effect on the work incentives on the poorest. …Meanwhile, the cash-strapped British government is still creating still the most expensive poverty in the world.

The final sentence in the excerpt really sums it up, noting that the government is “creating the most expensive poverty in the world.” Sort of like a turbo-charged version of Mitchell’s Law. The politicians create a few redistribution programs. Poverty begins to get worse. So then they add a few more handouts to address the problems caused by the first set of programs. Lather, rinse, repeat.

In other words, this poster applies in all nations.

P.S. If you want some real-world examples of the horrible impact of the British welfare state, you can see how the welfare state destroys lives, creates perverse incentives, and turns people into despicable moochers.

P.P.S. We have the same problems in America, and even leftists are beginning to admit this is bad for poor people. Heck, just look at this chart showing that the poverty rate was falling until the War on Poverty began.

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Dissecting Obama’s Record on Tax Policy

The folks at the Center for Freedom and Prosperity have been on a roll in the past few months, putting out an excellent series of videos on Obama’s economic policies.

• A look at the President’s failure to control government spending.
• A review of the Obama’s dismal track record on jobs and growth.
• A video showing how the auto bailout has been a costly mistake.

Now we have a new addition to the list. Here’s Mattie Duppler of Americans for Tax Reform, narrating a video that eviscerates the President’s tax agenda.

I like the entire video, as you can imagine, but certain insights and observations are particularly appealing.

1. The rich already pay a disproportionate share of the total tax burden – The video explains that the top-20 percent of income earners pay more than 67 percent of all federal taxes even though they earn only about 50 percent of total income. And, as I’ve explained, it would be very difficult to squeeze that much more money from them.

2. There aren’t enough rich people to fund big government – The video explains that stealing every penny from every millionaire would run the federal government for only three months. And it also makes the very wise observation that this would be a one-time bit of pillaging since rich people would quickly learn not to earn and report so much income. We learned in the 1980s that the best way to soak the rich is by putting a stop to confiscatory tax rates.

3. The high cost of the death tax – I don’t like double taxation, but the death tax is usually triple taxation and that makes a bad tax even worse. Especially since the tax causes the liquidation of private capital, thus putting downward pressure on wages. And even though the tax doesn’t collect much revenue, it probably does result in some upward pressure on government spending, thus augmenting the damage.

4. High taxes on the rich are a precursor to higher taxes on everyone else – This is a point I have made on several occasions, including just yesterday. I’m particularly concerned that the politicians in Washington will boost income tax rates for everybody, then decide that even more money is needed and impose a value-added tax.

The video also makes good points about double taxation, class warfare, and the Laffer Curve.

Please share widely.

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How Redistribution Creates a Poverty Trap

I’ve beaten up on Newt Gingrich for his views on global warming and his attack on the Ryan budget plan, but I’m completely on his side in the faux controversy about whether it is racist to call Barack Obama the “food stamp president.”

This story from ABC News should worry everybody, regardless of whether the people getting trapped in government dependency are white, black, brown, yellow, or green with yellow polka dots.

Congress is under pressure to cut the rapidly rising costs of the federal government’s food stamps program at a time when a record number of Americans are relying on it. The House Appropriations Committee today will review the fiscal year 2012 appropriations bill for the Department of Agriculture that includes $71 billion for the agency’s “Supplemental Nutrition Assistance Program.” That’s $2 billion less than what President Obama requested but a 9 percent increase from 2011, which, critics say, is too large given the sizeable budget deficit. A record number of Americans — about 14 percent — now rely on the federal government’s food stamps program and its rapid expansion in recent years has become a politically explosive topic. More than 44.5 million Americans received SNAP benefits in March, an 11 percent increase from one year ago and nearly 61 percent higher than the same time four years ago.

Most people focus on the huge burden that the food stamp program imposes on taxpayers, which surely is significant, but there is another economic cost that is equally worrisome, and it applies to all income redistribution programs. Whenever the government gives people money simply because their incomes are below a certain level, that creates a poverty trap. More specifically, because people lose benefits for earning more income, they are penalized with very onerous implicit marginal tax rates for climbing the economic ladder.

This isn’t intuitive, so here’s a back-of-the-envelope hypothetical example. Let’s assume you are a low-income person who wants a better life and you have a chance to earn an additional $1,000. How much better off will you be, and will it be worth the costs you might incur (non-pecuniary costs such as the loss of leisure and pecuniary costs such as commuting and child care)?

To answer that question, let’s assume your official tax burden on that additional income is 10 percent for federal income tax, 15 percent for payroll tax, and 5 percent for state income tax. You may not even be aware of the employer portion of the payroll tax, so let’s drop that to 7.5 percent (actually 7.65 percent, but let’s keep this simple). And while state taxes are deductible, the vast majority of people with modest incomes don’t utilize itemized deductions. So the marginal tax rate on this additional income, depending on what assumptions you want to make, is between 20 percent and 25 percent.

So if you earn an additional $1,000, your disposable income only increases by about $750-$800. Is that worth it? Maybe, but maybe not, depending on the costs you incur to earn that income. In any event, the marginal tax rate is rather steep for a low-income person, you may be thinking.

But it gets worse. Let’s say that you lose $15 of government handouts for every $100 of additional income your earn. So when you earn $1,000 of income, you only keep $750-$800, but you also have to give up $150 of goodies from the government – meaning your effective disposable income only rises by $600-$650.

This means that your implicit marginal tax rate on earning more money is actually somewhere between 35 percent and 40 percent. In other words, your marginal tax rate is at least as high as the tax rate on rock stars and professional athletes.

Here’s a chart showing the number of food stamp recipients. It certainly looks like America is becoming a food stamp nation. But if you want to see an even more disturbing image, look at the second chart in this article from the Mises Institute. You’ll see that my hypothetical example dramatically understates the marginal tax rate on people trying to join the middle class. As a taxpayer, I don’t like the cost of the food stamp program. As an economist, I hate the high marginal tax rates caused by income redistribution programs.

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