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Archive for the ‘Underground Economy’ Category

Even though I’m a dull and straight-laced guy, that doesn’t mean I want the government to pester, harass, and persecute people for engaging in victimless crimes that I find distasteful.

Especially when interventionism and prohibition doesn’t work. To be blunt, the War on Drugs has been a costly failure (much like the War on Poverty).

Fortunately, it appears that more and more people are coming to the same conclusion – and many of them aren’t libertarians. For instance, I recently cited Mona Charen’s wise comments about the issue.

Even more remarkable are the statements from one of America’s leading evangelicals, Pat Robertson.

Here’s the key sections from an Associated Press report.

Religious broadcaster Pat Robertson says marijuana should be legalized and treated like alcohol because the government’s war on drugs has failed. The outspoken evangelical Christian and host of “The 700 Club” on the Virginia Beach-based Christian Broadcasting Network he founded said the war on drugs is costing taxpayers billions of dollars. He said people should not be sent to prison for marijuana possession. The 81-year-old first became a self-proclaimed “hero of the hippie culture” in 2010 when he called for ending mandatory prison sentences for marijuana possession convictions. “I just think it’s shocking how many of these young people wind up in prison and they get turned into hardcore criminals because they had a possession of a very small amount of a controlled substance,” Robertson said on his show March 1. “The whole thing is crazy. We’ve said, ‘Well, we’re conservatives, we’re tough on crime.’ That’s baloney.” …Robertson said he “absolutely” supports ballot measures in Colorado and Washington state that would allow people older than 21 to possess a small amount of marijuana and allow for commercial pot sales. Both measures, if passed by voters, would place the states at odds with federal law, which bans marijuana use of all kinds. While he supports the measures, Robertson said he would not campaign for them and was “not encouraging people to use narcotics in any way, shape or form.” “I’m not a crusader,” he said. “I’ve never used marijuana and I don’t intend to, but it’s just one of those things that I think: this war on drugs just hasn’t succeeded.”

Wow, not only for legalization, but “absolutely” supports ballot initiatives in Colorado and Washington. Kudos to Rev. Robertson for recognizing the human cost of the Drug War. As the old saying goes, not everything immoral should be illegal.

Here’s five minutes from Gov. Gary Johnson on the issue.

Very well stated. Legalization is common-sense conservatism. Too bad Gary Johnson didn’t get more attention early in the GOP race.

The Drug War doesn’t work, and it is the ultimate example of Mitchell’s Law since it has spawned bad policies such as asset forfeiture and anti-money laundering rules.

Time to “just say no” to big government.

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Leftists want higher tax rates and they want greater tax compliance. But they have a hard time understanding that those goals are inconsistent.

Simply stated, people respond to incentives. When tax rates are punitive, folks earn and report less taxable income, and vice-versa.

In a previous post, I quoted an article from the International Monetary Fund, which unambiguously concluded that high tax burdens are the main reason people don’t fully comply with tax regimes.

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy.

Indeed, it’s worth noting that international studies find that the jurisdictions with the highest rates of tax compliance are the ones with reasonable tax systems, such as Hong Kong, Switzerland, and Singapore.

Now there’s a new study confirming these findings. Authored by two economists, one from the University of Wisconsin and the other from Jacksonville University, the new research cites the impact of tax burdens as well as other key variables.

Here are some key findings from the study.

According to the results provided in Table 2, the coefficient on the average effective federal income tax variable (AET) is positive in all three estimates and statistically significant for the overall study periods (1960-2008) at beyond the five percent level and statistically significant at the one percent level for the two sub-periods (1970-2007 and 1980-2008). Thus, as expected, the higher the average effective federal income tax rate, the greater the expected benefits of tax evasion may be and hence the greater the extent of that income tax evasion. This finding is consistent with most previous studies of income tax evasion using official data… In all three estimates, [the audit variable] exhibits the expected negative sign; however, in all three estimates it fails to be statistically significant at the five percent level. Indeed, these three coefficients are statistically significant at barely the 10 percent level. Thus it appears the audit rate (AUDIT) variable, of an in itself, may not be viewed as a strong deterrent to federal personal income taxation [evasion].

Translating from economic jargon, the study concludes that higher tax burdens lead to more evasion. Statists usually claim that this can be addressed by giving the IRS more power, but the researchers found that audit rates have a very weak effect.

The obvious conclusion, as I’ve noted before, is that lower tax rates and tax reform are the best way to improve tax compliance – not more power for the IRS.

Incidentally, this new study also finds that evasion increases when the unemployment rate increases. Given his proposals for higher tax rates and his poor track record on jobs, it almost makes one think Obama is trying to set a record for tax evasion.

The study also finds that dissatisfaction with government is correlated with tax evasion. And since Obama’s White House has been wasting money on corrupt green energy programs and a failed stimulus, that also suggests that the Administration wants more tax evasion.

Indeed, this last finding is consistent with some research from the Bank of Italy that I cited in 2010.

…the coefficient of public spending inefficiency remains negative and highly significant. …We find that tax morale is higher when the taxpayer perceives and observes that the government is efficient; that is, it provides a fair output with respect to the revenues.

And I imagine that “tax morale” in the United States is further undermined by an internal revenue code that has metastasized into a 72,000-page monstrosity of corruption and sleaze.

On the other hand, tax evasion apparently is correlated with real per-capita gross domestic product. And since the economy has suffered from anemic performance over the past three years, that blows a hole in the conspiratorial theory that Obama wants more evasion.

All joking aside, I’m sure the President wants more tax compliance and more prosperity. And since I’m a nice guy, I’m going to help him out. Mr. President, this video outlines a plan that would achieve both of those goals.

Given his class-warfare rhetoric, I’m not holding my breath in anticipation that he will follow my sage advice.

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I’ve written several times about the foolish War on Drugs, which has been about as misguided and ineffective as the government’s War on Poverty.

So when I saw a news report about a couple of Swedes getting busted for smuggling 200-plus kilos of contraband into Norway, and then another story about a Russian getting caught trying to sneak 90 kilos of an illicit substance into the country, I wondered whether these were reports about cocaine or marijuana. Or perhaps heroin or crystal meth.

Hardly. Norway’s law enforcement community was protecting people from the horrible scourge of illegal butter.

Sounds absurd, but there’s been an increase in the demand for butter and high import taxes have created a huge incentive for black market butter sales. Here’s a video on this latest example of government stupidity.

I guess the moral of the story is that if you outlaw butter, only outlaws will have butter. Or perhaps butter is the gateway drug leading to whole milk consumption, red meat, salt, and other dietary sins. Surely Mayor Bloomberg will want to investigate.

By the way, the United States is not immune from foolish policies that line the pockets of criminals. Here’s a video from the Mackinac Center revealing how punitive tobacco taxes facilitate organized crime.

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While I’m usually a pessimist about public policy, there are a handful of issues where I think there’s positive momentum. School choice is one example and another is putting an end to the misguided war on drugs.

I’m somewhat optimistic on the drug war because more and more people, including conservatives, are realizing that government intervention isn’t working and is actually making things worse.

For example, here are some excerpts from a Mona Charen column, in which she praises Ron Paul for his leadership position on the issue.

Friedman was for legalization of all drugs, not just marijuana. It’s a position embraced by only one candidate for president, Ron Paul. …Paul deserves full credit for endorsing drug legalization. Friedman would approve. Governments in the United States, federal and state, spend an estimated $41.3 billion annually to prevent people from ingesting substances we deem harmful, though many unsafe ingestibles — you know the list — remain legal. Half of all federal prisoners are serving sentences for drug offenses, along with 20 percent of state prisoners. In 2009, there were 1.7 million drug arrests in the U.S. Half of those were for marijuana. As David Boaz and Timothy Lynch of the Cato Institute noted, “Addicts commit crimes to pay for a habit that would be easily affordable if it were legal. Police sources have estimated that as much as half the property crime in some major cities is committed by drug users.” Drug money, such as booze money during Prohibition, has corrupted countless police, Drug Enforcement Administration agents, border patrol agents, prosecutors and judges. Drug crime has blighted many neighborhoods. America’s appetite for drugs has encouraged lawlessness and violence in many neighboring countries, most recently in Mexico, where its drug violence is spilling north. Because illegal drugs are unregulated, their purity is unknowable — accounting for thousands of overdose deaths and injuries. Since we maintain drug prohibition to protect people from their own foolish decisions, those overdose deaths must weigh in the balance, too. Drug prohibition, Milton Friedman pointed out, keeps the price of drugs artificially inflated and amounts to a favor by the government to the drug lords. …Harvard economics professor Jeffrey Miron estimates that if drugs were legal and taxed, the U.S. and state treasuries would receive $46.7 billion in added revenue, while saving $41.3 billion in expenditures.

My only disagreement with Charen’s column is that Gary Johnson also wants to end the War on Drugs, so he should share some of the praise with Ron Paul.

And I suppose I should say that I don’t want the government to collect an additional $46.7 billion of revenue, but that’s a separate fiscal policy issue.

Ms. Charen continues with some very sensible cost-benefit analysis of legalization.

What is the downside to legalization? Friedman acknowledged the possibility that legalization might result in some increase in drug addiction. There was, after all, an uptick in alcoholism after Prohibition was repealed. But not all victims are created equal. The child, Friedman notes, who is killed in a drive-by shoot-out between drug gangs is a total victim. The adult who decides to take drugs is not. Let’s stipulate that some unknown number of Americans will become addicts after legalization, who otherwise would not have. We must ask whether the terrible price we are now paying — in police costs, international drug control efforts, border security, foregone tax revenue, overdose deaths, corruption and violence — is worth it.

This utilitarian argument is important. Libertarians traditionally rely on the moral argument that people should be free from government coercion so long as they’re not hindering the rights of others, and I certainly agree with that sentiment. But we could probably make more progress on this issue by also explaining that the costs of the drug war far outweigh any benefits.

And I suspect it also would help if we explained that legalization does not necessarily mean approval.

Ending the war on drugs does not mean endorsing drug use, any more than ending prohibition meant one had to be in favor of alcohol consumption.

Heck, you can be like me and be personally opposed to drug use and favor legalization. You can also favor private-sector sanctions against drug use and favor legalization.

When all is said and done, there are lots of reasons to favor legalization. Prohibition didn’t work in the 1920s and it isn’t working today. Too bad Ron Paul and Gary Johnson are the only candidates on the right side of this issue.

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One of my many frustrations of working in Washington is dealing with perpetual-motion-machine assertions. The classic example is Keynesian economics, which is based on the notion that you magically create additional economic activity by having the government spend money instead of allowing the private sector to decide how it gets spent (in an especially bizarre display of this thinking, Nancy Pelosi actually said that subsidizing unemployment was the best way to create jobs).

Another example of this backwards analysis can be found in the debate over the IRS budget. The President is resisting a GOP proposal to modestly trim the IRS’s gargantuan $12.5 billion budget and his argument is that we should actually boost funding for the tax collection bureaucracy since that will mean more IRS agents squeezing more money out of more taxpayers.

Here are some excerpts from an Associated Press report about the controversy.

Every dollar the Internal Revenue Service spends for audits, liens and seizing property from tax cheats brings in more than $10, a rate of return so good the Obama administration wants to boost the agency’s budget.House Republicans, seeing the heavy hand of a too-big government, beg to differ. They’ve already voted to cut the IRS budget by $600 million this year and want bigger cuts in 2012. …IRS Commissioner Doug Shulman told the committee Tuesday that the $600 million cut in this year’s budget would result in the IRS collecting $4 billion less through tax enforcement programs. The Democrat-controlled Senate is unlikely to pass a budget cut that big. But given the political climate on Capitol Hill, Obama’s plan to increase IRS spending is unlikely to pass, either. Obama has already increased the IRS budget by 10 percent since he took office, to nearly $12.5 billion. The president’s budget proposal for 2012 would increase IRS spending by an additional 9 percent — adding 5,100 employees. …Obama’s 2012 budget proposal for the IRS includes $473 million and 1,269 new positions to start implementing the health care law.

Unlike Keynesian economics, there actually is some truth to Obama’s position. The fantasy estimate of $10 of new revenue for every $1 spent on additional bureaucrats is clearly ludicrous, but it is equally obvious that many Americans would send less money to Washington if they didn’t have to worry about a coercive and powerful tax-collection bureaucracy that had the power to throw them in jail.

This is an empirical question, at least with regards to the narrow issue of whether more IRS agents “pay for themselves” by shaking down sufficient numbers of taxpayers. Reducing the number of IRS bureaucrats by 90 percent, from about 100,000 to 10,000, for instance, surely would be a net loss to the government since the money saved on IRS compensation would be trivial compared to the loss of tax revenue.

But that doesn’t mean that a reduction of 10,000 or 20,000 also would lead to a net loss. And it certainly does not mean that adding 10,000 or 20,000 more IRS agents will result in enough new revenue to compensate for the salaries and benefits of a bigger bureaucracy. Even left-wing economists presumably understand the concept of diminishing returns.

But let’s assume that the White House is correct and that more IRS agents would be a net plus from the government’s perspective. The Administration would like us to reflexively endorse a bigger and more aggressive IRS, but public policy should not be based on what is a “net plus” for the government.

There are two ways to promote better tax compliance. The Obama approach, as we’ve read above, is to expand the size and power of the IRS. Up to a point, this policy can be “successful” in extracting additional money from the productive sector of the economy.

The alternative approach, by contrast, seeks better compliance by lowering tax rates and reforming/simplifying tax systems. This course of action boosts compliance by making evasion and avoidance less attractive. People are much less likely to cheat if the government isn’t being too greedy, and they’re also more likely to comply if they think there is less waste, fraud, corruption, and favoritism in the tax code.

Let’s now put this discussion in context. Obama wants more IRS agents in large part to enforce his new scheme for government-run healthcare. Yet that’s a perfect example of what I modestly call Mitchell’s Law – politicians doing one bad thing (expanding the IRS) only because they did another bad thing (enacting a health care bill that made the tax code even more convoluted and punitive).

So instead of making the IRS bigger in response to a bad healthcare law, why not repeal that bad law and shrink the size of the IRS? Even better, why not junk the entire tax code so we can replace the IRS with a system that is honest and fair?

And if these big steps are not immediately feasible, at least cut the IRS budget so that awful laws are enforced in a less destructive manner.

This Center for Freedom and Prosperity video has additional details about the national nightmare we call the IRS.

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In the private sector, no business owner would be dumb enough to assume that higher prices automatically translate into proportionately higher revenues. If McDonald’s boosted hamburger prices by 30 percent, for instance, the experts at the company would fully expect that sales would decline. Depending on the magnitude of the drop, total revenue might still climb, but by far less than 30 percent. And it’s quite possible that the company would lose revenue. In the public sector, however, there is very little understanding of how the real world works. Here’s a Reuters story I saw on Tim Worstall’s blog, which reveals that Bulgaria and Romania both are losing revenue after increasing tobacco taxes.

Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead. Criminal gangs and impoverished Roma communities near borders with countries where prices are lower — Serbia, Macedonia, Moldova and Ukraine — have taken to smuggling which has wiped out gains from higher excise duties. Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third. …Overall losses from smuggling will probably outweigh tax gains as Bulgaria struggle to fight the growing black market, which has risen to over 30 percent of all cigarette sales and could cost 500 million levs in lost revenues this year, said Bezlov at the Center for the Study of Democracy. While the government expected higher income from taxes in 2010 it has already revised that to the same level as last year. “However, this (too) looks unlikely at present,” Bezlov added. Romania, desperately trying to keep a 20 billion-euro International Monetary Fund-led bailout deal on track, has a similar problem after nearly doubling cigarette prices in 2009 then hiking value added tax. Romania’s top three cigarette makers — units of British American Tobacco, Japan Tobacco International and Philip Morris — contributed roughly 2 billion euros to the budget in taxes in 2009, or just under 2 percent of GDP. They estimate about a third of cigarettes in Romania are smuggled and say this could cost the state over 1 billion euros.

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Regular readers know that I am a big supporter of international tax competition as a mechanism to limit the greed of the political elite. Unfortunately, the statists are having some success in their efforts to undermine the fiscal sovereignty of low-tax jurisdictions. Even the Swiss have been forced to weaken their human rights policy of protecting financial privacy. So does this mean the politicians from high-tax nations will get more money to spend? Probably not. One reason is that “better” enforcement of high tax rates on saving and investment will have the same economic impact as an increase in tax rates. This, of course, will mean less saving and investment, which translates into slower growth and a smaller tax base. Another reason is that restrictions on the ability to shift economic activity across border to escape oppressive taxation will lead many people to find domestic strategies as a substitute means of protecting their income and assets. An article by a Romanian academic explains further and notes that low-tax jurisdictions will continue to enjoy better economic performance.

It is of course illegal not to declare assets and income held abroad, but the fact that some people are driven to this extreme suggests that in some countries taxes have reached unacceptably high levels. In exactly the same fashion, people are also driven to hide some of their economic activity from the tax man, giving rise to the well known phenomenon of the underground economy. In fact, tax evasion is as old as taxes themselves, and the best way to minimize it is to levy reasonable taxes. International tax evasion and the local underground economy provide the two main escape routes. In modern democratic times, they also set implicit limits to the growth of government. They are both illegal, but the local shadow economy is now so widespread that governments know that they cannot enforce compliance without becoming hugely unpopular (suggesting that high taxes are, in fact, not as widely accepted by the population as some would like to think). Limiting international tax competition looks a much easier bet. However, if high-tax countries are successful in stopping the shift of savings to tax havens by enforcing transparency and information exchange, they will displace, but not halt, tax evasion and fiscal competition. The underground economy, both local and international, will grow. In the meantime, wealthy people and their assets will continue to move from high to low tax environments. Over time, the economically more attractive places will still enjoy much higher rates of economic growth.

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In an amusing coincidence, Secretary of State Hillary Clinton and I were both in Latin America this week offering fiscal policy advice. But it won’t surprise you to know that Mrs. Clinton’s suggestions are radically different than the advice I provided. She spoke in Ecuador and, according to an AFP report, said it was time for “the wealthy across the Americas to pay their ‘fair share’ of taxes in order to eliminate poverty and promote economic opportunity for all.” She also claimed that “her appeal to overhaul tax systems did not amount to ‘class warfare’ and was instead a recognition that the ‘winner-take-all-approach’ was a drag on progress.” The AFP story concludes with Mrs. Clinton asserting, “We can’t mince words about this. Levels of tax evasion are unacceptably high,”

By contrast, in my remarks to the Fundacion Libertad in Panama and in my speech to the Chamber of Commerce in El Salvador, I explained that academic research shows that better tax compliance is best achieved by lowering tax rates and eliminating inefficient and corrupt spending programs so that taxpayers have more confidence that their money is not being wasted. But let’s touch on something even more important than economics. I also made a moral argument about the danger of giving national tax authorities too much power and information – especially in a region where governments oftentimes are the source of oppression, expropriation, and tyranny. Simply stated, there are some things that are more important than obeying tax laws. This Center for Freedom and Prosperity video explains that so-called tax havens are an extremely important refuge for people who are subject to persecution and other forms of government malfeasance.

Let’s consider some Latin American examples. Imagine a political dissident in Venezuela. Hugo Chavez has turned that country into a thugocracy and opponents of his sinister regime are vulnerable to having their assets expropriated (and worse). Thankfully, many Venezuelans are able to protect themselves from socialist tyranny by putting their money in Cayman, Panama, or Miami (the U.S. is a tax haven for non-U.S. people). But if Mrs. Clinton got to make the rules, tax havens would no longer exist and Chavez would be empowered.

Or what about families in Mexico, who rightfully are afraid that if they keep their money in the country and report it on their tax returns, corrupt bureaucrats in the national tax office will sell their names to criminal gangs and suddenly their children will be kidnapped and they will have to deal with the horror of getting a ransom note accompanied by a child’s finger. Fortunately, many Mexicans can guard against this horrific possibility by placing their assets in Cayman, Panama, or Miami. But in Mrs. Clinton’s ideal world, those options would not exist and many more people would experience the nightmare of vicious crime.

And consider the plight of Argentinians. A few years ago, the nation’s venal government stole the private pension assets of the people. This is in addition to radical currency devaluations that have wiped out a big chunk of people’s savings. Prudent Argentinians have avoided these forms of back-door thievery by moving funds to Cayman, Panama, and Miami. In the Orwellian world envisioned by Mrs. Clinton, however, tax havens wouldn’t exist and governments would have carte blanche to engage in bad policy.

This is not the first indication of Mrs. Clinton’s government-über-alles mindset as Secretary of State. Let’s remember that she urged class-warfare tax policy for Pakistan and more recently said Brazil was a role model for soak-the-rich tax policy (a strange assertion since the top tax rate there is only 27.5 percent). If nothing else, at least we can give her credit for being consistent.

But if I have to choose between Mrs. Clinton’s consistent statism and protecting the liberty and freedom of oppressed and persecuted people, it’s no contest. Politicians and senior government appointees all over the world act as if folks in the private sector are nothing more than serfs and peasants who have an obligation to pay ever-higher tax burdens, so we should be happy that so-called tax havens offer a refuge – even if we don’t live in failed states such as Venezuela, Mexico, and Argentina. Actually, since Obama is trying to turn us into Greece, maybe this issue will be important for Americans even sooner than we think.

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