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Posts Tagged ‘Economics’

Some folks on the right in Washington, generally known as reformicons (short for reform conservatives), want the Republican Party to de-emphasize marginal tax rate reductions and instead focus on providing tax relief to parents.

There are many leaders in this movement and, if you want to learn more about the tax proposals being discussed, I specifically recommend the writings of Robert Stein, James Capretta, James Pethokoukis, Ramesh Ponnuru, Yuval Levin, Charles Blahous, Jason Fichtner, and Reihan Salam (and I’m sure I’m unintentionally leaving off many other worthy contributions).

I explained last year what I like (and don’t like) about reform conservatism, but I haven’t specifically analyzed the tax agenda of the reformicons.

Time to rectify that oversight. The Wall Street Journal was kind enough to give me some space so I could share my thoughts on this topic.

I start by outlining the debate, albeit in simplified form because of space constraints.

There’s a policy debate among conservatives in Washington about the best way to cut taxes and reform the tax code. The supply-siders want to replicate the success of Reaganomics with lower marginal tax rates. But there’s also a camp who call themselves “reform conservatives” who want income tax credits or payroll tax cuts explicitly for the purpose of reducing tax liabilities for middle-class parents. The supply-siders argue that if you want to encourage more work, saving, investment and entrepreneurship, then it is a good idea to reduce marginal tax rates on productive behavior. …Those in the other camp…don’t necessarily disagree with the supply-siders. They note that it was important to lower marginal tax rates in 1980 when the top personal tax rate was a confiscatory 70%. But now that the top rate is “only” about 40%, they argue, lower tax rates won’t deliver nearly as much bang for the buck.

The reformicons are right. Dropping the top tax rate from 40 percent will help the economy, but the pro-growth effect won’t be enormous. At least not compared to what happened during the Reagan years when the top tax rate was slashed from 70 percent to 28 percent.

And, as this leftist cartoon suggests, many Republicans act as if across-the-board tax rate reductions are an elixir for every ill.

But can reformicons suggest a better way of cutting and/or reforming taxes?

I’m not convinced that their agenda of child-oriented tax relief is the right answer.

In my column, I note that many of their policies have already been implemented, yet there’s little if any evidence that these tax cuts have generated positive outcomes.

…reform conservatives say it’s time for new ideas. That’s a nice concept, but Republicans already have enacted many of their proposed policies. The child tax credit was adopted in the 1990s and expanded during the Bush years. The earned income credit also funnels a lot of money (in the form of tax relief or cash payments) to families with children, and that provision also has been significantly expanded over the years. These policies have worked, at least in the sense that households with children now face lower tax liabilities. There is little evidence, though, to suggest positive economic or social outcomes. Were families strengthened? Did the economy grow faster? Did middle-income households feel more secure?

The reformicons often argue that their tax proposals are politically more appealing.

That may be true, but that doesn’t mean they are political winners, particularly if reformicons are trying to appease the class-warfare left, which will simply argue that tax cuts targeted at families making less than, say, $100,000 will be even “fairer” if they are targeted at families making less than $50,000.

Or maybe targeted at households who pay no tax, which means more transfer spending through the tax code!

The tax-credit reformers also argue that their proposals are much less susceptible to class-warfare demagoguery that is the supply-side approach, since tax relief flows to lower- and middle-income voters. …But here’s the downside: Conservatives can bend over backward to appease the class-warfare crowd, but they can never outflank them. …Once conservatives have accepted the left’s premise that tax policy should be based on static distribution tables, they won’t have a ready answer for the left’s gambit.

But as far as I’m concerned, the real issue is how to raise take-home pay.

The reformicons want to make families more secure by reducing how much the IRS takes from their paychecks.

I certainly like the idea of boosting post-tax income, but I contend that it would be even better to focus on policies that increase pre-tax income.

The most commonly cited reason for family-based tax relief is to raise take-home pay. That’s a noble goal, but it overlooks the fact that there are two ways to raise after-tax incomes. Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important.

In other words, our economy is under-performing and that is the greatest threat to the financial security of families.

Folks on the left say it is the fault of “secular stagnation” and that the burden of government should be further expanded, but both reformicons and supply-siders agree that we’ll get far better results by focusing on tax cuts.

But which tax cuts?

I end my column with some glass-half-full analysis. The reformicons may not be thrilled by lower income tax rates and the supply-siders may not be excited by child-oriented tax cuts, but both camps are quite sympathetic to tax reforms that address the punitive double taxation of income that is saved and invested.

While the camps disagree on lower individual income tax rates vs. child-oriented tax relief, both agree that the tax code’s bias against capital formation is very misguided. The logical compromise might be to focus on reforms that boost saving and investment, such as lowering the corporate tax rate, reducing the double taxation of dividends and capital gains, and allowing immediate expensing of business investment. These reforms would have strong supply-side effects. And since more saving and investment will lead to increased productivity, workers will enjoy higher wages, including households with children.

To be sure, some critics will say this type of tax agenda is too “business friendly,” which is an indirect way of saying that average voters may not understand how they benefit from tax reforms that don’t have a big and fast impact on their paychecks.

So maybe the right answer is to rip up the entire tax code and replace it with a simple and fair flat tax.

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What do cigarettes and capital gains have in common?

Well, they both start with the same letter, so maybe the Cookie Monster could incorporate them into his favorite song, but I’m thinking about something else. Specifically, both cigarettes and capital gains tell us something important about tax policy, the Laffer Curve, and the limits of political bullying.

In both cases, there are folks on the left who disapprove of these two “c” words and want to penalize them with high tax rates.

But it turns out that both cigarettes and capital gains are moving targets, so the politicians are grossly mistaken if they think that punitive taxation will generate a windfall of revenue.

I’ve already discussed why it’s senseless to impose high tax rates on capital gains. Simply stated, people can avoid the tax by not selling assets.

This might not be an ideal way of managing one’s investments, and it certainly isn’t good for the economy if it discourages new investment and prevents people from shifting existing investments into more productive uses, but it’s very effective as a strategy for individuals to protect against excessive taxation.

We see something quite similar with cigarettes. People can simply choose to buy fewer smokes.

Michel Kelly-Gagnon of Canada’s Montreal Economic Institute explains why higher tobacco taxes are not a guaranteed source of revenue for the political class.

Tax increases do not in each and every case lead to increases in government revenues. …When taxes on the consumption of a good are too high, you can get to a point where taxable consumption decreases and government revenues diminish rather than increase. Or at any rate, they don’t increase as much as what would be expected given the tax increase. This phenomenon constrains government’s ability to levy taxes. …There have been numerous examples in Canada of excessive taxes having a negative impact on government revenues. As shown by my colleagues Jean-François Minardi and Francis Pouliot in a study published last January ., there’s been three “Laffer moments” when it comes to tobacco tax revenues in Quebec since 1976. Whenever the level of taxation exceeded $15 per carton, the proceeds of the tobacco taxes eventually diminished. These are no isolated incidents. Laffer shows that the theory is confirmed by the experience of Cyprus, Denmark, Germany, Great Britain, Greece, Ireland, Latvia, Portugal, and Sweden.

Here’s a chart from his column showing how tax revenue has dropped in Quebec when the tax burden became too onerous.

Michel then acknowledges that some people will be happy about falling revenue because it presumably means fewer smokers.

But that’s not necessarily true.

While it is true that some people are deterred from smoking by tax increases, this is not the case of all smokers. Some avoid taxes by buying contraband cigarettes. Tax increases have no effect on the health of these smokers.

And because the tax burden is so severe, the underground economy for cigarettes is booming.

The folks at Michigan’s Mackinac Center have some remarkable and thorough estimates.

Since 2008, Mackinac Center for Public Policy analysts have periodically published estimates of cigarette smuggling in 47 of the 48 contiguous states. The numbers are quite shocking. In 2012, more than 27 percent of all Michigan in-state consumption was smuggled. In New York, almost 57 percent of all cigarettes consumed in the state were also illicit. This has profound effects on the revenue generated by state (and sometimes local) government. …We estimate nationwide revenue losses due to cigarette smuggling at $5.5 billion, a statistic consistent with the Bureau of Alcohol, Tobacco, Firearms and Explosives’ $5 billion estimate for 2009.

Here are the numbers for each state.

If all this evidence isn’t enough for you, I also encourage a look at the impact of higher tobacco taxes in Ireland, the United States, and Bulgaria and Romania.

Heck, even the city of Washington, DC, serves as a perverse role model on the foolishness of over-taxation.

P.S. Since this column focuses on the Laffer Curve and tobacco taxation, I would be remiss if I didn’t point out that Art Laffer recently put together a Handbook of Tobacco Taxation – Theory and Practice.

P.P.S. Art implies, at least indirectly, that policy makers should set the tax rate on tobacco at the revenue-maximizing level. That is far better than having the rate above the revenue-maximizing level, to be sure, but it rubs me the wrong way. I will repeat to my final day on earth that the growth-maximizing tax rate is far superior to the revenue-maximizing tax rate.

P.P.P.S. I’m currently in Australia for a series of speeches on fiscal policy. But as you can see from this photo, the PotL and I managed to find time to act like shameless tourists.

Tourists in Oz

P.P.P.P.S. Since I’m imitating Crocodile Dundee in the photo, I should close by noting that Paul Hogan (the actor who played Crocodile Dundee) has been harassed by the Australian tax police.

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I shared a chart back in February that shows how long it takes to double GDP based on different growth rates.

For instance, if the economy grows only 1 percent per year, it takes 70 years before the economy doubles. Think Italy or some other decrepit European welfare state.

But if the economy grows 4 percent annually, the economy doubles in less than 20 years. I’d point to Hong Kong and Singapore as examples, but they grow even faster.

The key point is that long-run growth is the key to a more prosperous society.

And that’s why the relatively weak growth of the Bush-Obama years is so troubling. Moreover, CNBC reports that some policy makers fret that the economy could be facing a period of prolonged stagnation.

Is there something seriously wrong with the economy? It’s a scary prospect, and a concern that’s gotten louder and louder over the past year. In economic circles, it goes by the alliterative name of “secular stagnation.” And it’s a phrase that Fed watchers are likely to hear more and more in the months ahead. Recent comments by the vice chairman of the Federal Reserve, Stanley Fischer, indicate questions within the central bank about whether the slow growth that has followed the recent recession could reflect, or at least could potentially morph into, longer-term issues within the economy. …The theory of secular stagnation was first developed by Alvin Hansen, who wondered in the midst of the Great Depression whether diminishing investment opportunities in a maturing economy would stunt economic growth and permanently prevent full employment—at least in the absence of robust government intervention… These theories have found a new life in the aftermath of the so-called Great Recession, as the U.S. is experiencing (albeit to a much less dramatic degree) slow growth over a relatively long time period.

I agree and disagree.

I agree that something is wrong with the economy.

But I disagree with the Keynesian interpretation that the economy’s weakness is because of some mysterious malady that requires government intervention.

Indeed, the problems exist because politicians are doing too much. If we want faster growth and more jobs, we need government to get out of the way.

This Michael Ramirez cartoon is one way of thinking about the issue.

But if you want more substance, Larry Kudlow and Steve Moore have some very sound analysis, which has been reprinted at Townhall.com.

They start by looking at the present-day Keynesian view.

…today many leading economists are throwing up their arms in frustration and assuring us that 2 percent growth is really the best we can do. Barack Obama’s former chief economist Larry Summers began this chant of “secular stagnation.” It’s a pessimistic message, and it’s now being echoed by Federal Reserve vice chair, Stanley Fischer. He agrees with Summers that slow growth in “labor supply, capital investment, and productivity” is the new normal that’s “holding down growth.” …Americans seem to be buying into this dreary assessment. A new Wall Street Journal poll finds that three out of four Americans think the next generation will be worse off than this generation. So long, American Dream.

But the problem isn’t the economy. Or it wouldn’t be if it wasn’t for all the meddling.

Larry and Steve explain that the crowd in Washington deserves blame for the economy’s sub-par performance.

…secular stagnation is all wrong. It’s a cover up for mistaken economic policies that began in the Bush years and intensified during the Obama administration. It would be hard to conceive of a worse set of policy prescriptions than the ones Larry Summers and his Keynesian collaborators have conjured up. We’ve had bailouts, massive spending-stimulus plans, tax increases on “the rich,” Obamacare, rudderless monetary policy that has collapsed the dollar, the Dodd-Frank bill, anti-carbon policies, a vast expansion of the welfare state, and on and on. …The blame falls on the White House and the Fed, and the discredited Keynesian model that government spending, debt, and cheap money are the way to restore growth. …the architects of this colossal policy failure are the same people who promised they would rebuild the U.S. economy “for the long term,” as Barack Obama put it in 2009. But they’re now blaming the stagnant economy on structural problems beyond their control.

Amen.

Just look at the data from the Minneapolis Fed to see how weak the economy is today compared to previous business cycles.

Fortunately, it’s not that difficult to restore growth.

We learned in the 1960s and 1980s how fast the economy can get back on its feet when policy mistakes are reversed. …The secular-stagnation argument is just an excuse for liberal policy failures. Keynesianism should now be recognized as snake oil.

By the way, I’d add the 1990s to that list.

There were some good reasons to dislike President Clinton, but America enjoyed more economic freedom as a result of the policies implemented during his presidency.

As a fiscal policy wonk, I’m especially happy about the spending restraint of the Clinton years.

P.S. Here are some good cartoons about Obamanomics.

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With all the controversy over the failed and costly Obamacare program, it’s understandable that other entitlements aren’t getting much attention.

But that doesn’t mean there aren’t serious problems with Medicaid, Medicare, and Social Security.

Indeed, the annual Social Security Trustees Report was released a few days ago and the updated numbers for the government-run retirement program are rather sobering.

Thanks in part to sloppy journalism, many people only vaguely realize that Social Security is actuarially unsound.

In reality, the level of projected red ink is shocking. If you look at the report’s annual projections and then adjust them for inflation (so we get an idea of the size of the problem based on the value of today’s dollars), we can put together a very depressing chart.

How depressing is this chart? Well, cumulative deficits over the next 75 years will total an astounding $40 trillion. And keep in mind these are inflation-adjusted numbers. In nominal dollars, total red ink will be far more than $150 trillion.

That’s a lot of money even by Washington standards.

Just as worrisome, the trend is in the wrong direction. Last year, the cumulative inflation-adjusted shortfall was $36 trillion. The year before, the total amount of red ink was $30 trillion. And so on.

But regular readers know I’m not fixated on deficits and debt. I’m much more worried about the underlying problem of too much spending. So let’s look at the annual data showing how much payroll tax will be generated by Social Security and how much money will be paid out to beneficiaries.

As you can see, the problem is not inadequate tax revenue. Indeed, revenues will climb to record levels. The problem is that spending is projected to increase at an even faster rate.

Once again, don’t forget that these are inflation-adjusted numbers. In nominal dollars, the numbers are far bigger!

Why is the program becoming an ever-larger fiscal burden? The answer boils down to demographics. Simply stated, we will have more and more old people and fewer and fewer younger workers.

So if we do nothing, we’ll be Greece in 20 or 30 years.

That’s not a happy thought, so let’s close on a humorous note. Here’s a joke about how Social Security works, and you can enjoy some Social Security-themed cartoons here, here, and here.

P.S. I’m confident that few people will be surprised to learn that Obama’s supposed solution to this mess involves a huge tax increase.

P.P.S. The real solution is personal retirement accounts. I think Australia is the best role model, but Chile also is a big success.

P.P.S. The good news is that the American people are quite sympathetic to personal retirement accounts.

P.P.P.S. Statists try to scare people by claiming private investments are too risky, but one of my Cato colleagues showed that workers would be better off even if they retired after a stock market crash.

P.P.P.P.S. By the way, Social Security is a really bad deal for blacks and other minorities with lower-than-average life expectancies.

P.P.P.P.P.S. In the interests of fairness, I’ll admit the biggest weakness in the argument for personal accounts is that we might not be able to stop politicians from confiscating the money at some point in the future.

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I’m a long-time proponent of the flat tax for three simple reasons.

1. It replaces the discriminatory “progressive” tax with a single tax rate at the lowest possible level, thus reducing the tax penalty on productive behavior.

2. It gets rid of all forms of double taxation, such as the death tax and capital gains tax, meaning economic activity is never taxed more than one time.

3. Other than a family-based allowance, it gets rid of all loopholes, deductions, credits, exemptions, exclusions, and preferences, meaning economic activity is taxed equally.

Some people say that these are also three reasons to favor a national sales tax.

My response is that they’re correct. In simple terms, a national sales tax (such as the Fair Tax) is like a flat tax but with a different collection point.

If you want more details, I often explain the two plans are different sides of the same coin. The only difference is that the flat tax takes of slice of your income as you earn it and the sales tax takes a slice of your income as you spend it. But neither plan has any double taxation of income that is saved and invested. And neither plan has loopholes to lure people into making economically irrational decisions.

Instead of class warfare and/or social engineering, both plans are designed to raise money is the least-damaging fashion possible.

So even though I’m mostly known for being an advocate of the flat tax, I have 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.

With this bit of background, you can understand why it caught my attention that an economics professor at the University of Georgia (Go Dawgs!) wrote a column for Forbes with the provocative title of “I Will Support The Fair Tax When Its Backers Tell The Truth”.

Professor Dorfman writes that “such a consumption tax has much to recommend it from an economic point of view” but then warns that he “cannot support the Fair Tax as long as its backers continue to make implausible claims for their proposed reform.”

So what are the implausible claims? Let’s check them out and see if his friendly criticism is warranted.

He first expresses skepticism about the claim that take-home pay will rise to the level of gross pay under a Fair Tax, particularly given the assertion that prices won’t rise.

…the odds are that your gross pay will shrink over time under the Fair Tax. …employers can offer workers lower pay because of the lower cost of living (same prices, but higher take home pay). Because workers evaluate pay offers based on the purchasing power of that pay, the same competitive forces that will lower prices after the removal of business taxes, will lead to lower pay for employees in the long run as the labor market adjusts.

I suspect Professor Dorfman’s critique is correct, but I don’t think it matters. Workers understandably care first and foremost about the purchasing power of their paycheck, and that won’t be negatively impacted.

The Professor than looks at whether the Fair Tax gets taxes the underground economy.

…let’s tackle the claim that the Fair tax will do a better job of collecting taxes on criminals, the underground economy, and those who underreport their income. The idea is that people may hide some of their income or that drug dealers and others in the underground economy do not report their income, but that everyone spends money so the Fair Tax will tax everyone. Unfortunately, this claim is not true… Retailers are just as capable of underreporting revenue and not sending in the corresponding Fair Tax as people are of underreporting their income. …The incentive to avoid such consumption taxes will only increase when the rate is four or five times what it is now. If you don’t believe consumption taxes suffer from collection problems, go ask Greece.

And he looks specifically at taxing criminal activity.

Another reason that the Fair Tax will not capture extra revenue from illegal activities is that it only switches which side of the transaction is missed by the tax system. Currently, while drug dealers may not report their income, the people who buy drugs are paying with after-tax income. Under the Fair Tax, the drug dealers will pay tax when they spend their drug profits. However, unless the drug dealer sends in the Fair Tax on their sales, the drug buyers will now avoid tax on their purchases. Under either tax system, one side of the underground transactions will be paying taxes and one will not.

I think Professor Dorfman is correct, particularly in his explanation that drug dealers and other criminals will not collect sales tax when they peddle their illicit goods.

And he’s also correct when he says that the Fair Tax won’t collect all taxes on legal products.

But that doesn’t mean the Fair Tax is somehow flawed. Indeed, it’s quite likely that the underground economy will shrink under a national sales tax since the incentive to evade tax (on legal products) is a function of the tax rate. So if we replace the punitive high-rate internal revenue code with a low-rate Fair Tax, there will be a higher level of compliance.

But not zero evasion, so Fair Tax supporters exaggerate if they make that claim.

The next point of contention is whether the IRS can be repealed under a Fair Tax.

…some agency needs to collect all the sales taxes, ensure retailers are sending in the full amount, and handle all the mechanics of the prebate. The prebate requires this federal agency to know everyone’s family size and have a bank account or other method of sending out the prebate each month. So while individuals will have less interaction with the federal tax agency, there will still be some. For retail businesses, their interactions with federal tax officials will be at least as much as now, if not more.

The Professor is right, though this may be a matter of semantics. Fair Tax people acknowledge there will be a tax collector (the legislation creates an incentive for states to be in charge of collecting the tax), but they say that the tax authority under their system will be completely different than the abusive IRS we have today.

Last but not least is the controversy over whether everyone benefits under a Fair Tax.

…while Fair Tax proponents often act like nobody loses under the Fair Tax that is simply not possible. If the Fair Tax is implemented in a revenue neutral manner (collecting the same amount of total revenue as all the taxes it replaces), and some people win then other people must lose. Poor people pay roughly no tax either way, so the Fair tax would be neutral for them. The very rich will assumedly pay less since they spend a lower percentage of their income and spend more overseas. Thus, the suspicion is that the middle class will be paying more. One other group pretty sure to pay more is the elderly. The elderly have paid income tax while earning income, and under the Fair Tax would suddenly pay high consumption taxes right when their income drops and their spending increases. In the long run, this is not a problem, but early in a Fair Tax regime, the elderly definitely are losers.

Once again, Professor Dorfman is making a good point (and others have made the same point about the flat tax).

My response, for what it’s worth, is that supporters of both the flat tax and national sales tax should not be bound by revenue neutrality. Especially if the revenue-estimating system is rigged to produce bad numbers. Instead, they should set the rate sufficiently low that the overwhelming majority of taxpayers are net winners.

And in the long run, everyone can be a net winner if the economy grows faster.

And that, as Professor Dorfman agrees, is the main reason for tax reform.

The Fair Tax really has much to recommend it. It is simpler than the current system. It causes fewer distortions in the daily economic decisions that people make. The main distortion it does introduce is positive: to encourage saving and discourage consumption which would make the country wealthier in the long run.

Though I would quibble with the wording of this last excerpt. I don’t think the Fair Tax creates a pro-savings distortion. Instead, it removes an anti-savings bias. Just like the flat tax.

Now let me add a friendly criticism that Professor Dorfman didn’t address.

Advocates of the Fair Tax correctly say that their proposal shouldn’t be implemented until and unless the income tax is fully repealed. But as I explain in this video, that may be an impossible undertaking.

To be blunt, I don’t trust politicians. I fear that they would gladly adopt some form of consumption tax while secretly scheming to keep the income tax.

P.S. Actually, what I really want is a very small federal government, which presumably could be financed without any broad-based tax. Our nation enjoyed strong growth before that dark day in 1913 when the income tax was imposed, so why concede that politicians today should have either a flat tax or Fair Tax? But that’s an issue for another day.

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Have you ever wondered why, in a hypothetical match-up, the American people would elect Ronald Reagan over Barack Obama in a landslide?

And have you ever wondered why Americans rate Reagan as the best post-WWII President and put Obama in last place?

There are probably a couple of reasons for these polling numbers, but I suspect one reason for the gap is that Reaganomics generated much better results than Obamanomics.

I’ve already made this point using data from the Minneapolis Federal Reserve Bank, but today we’re going to look at some updated information from Tom Blumer, who put together a strong indictment of Obama’s record for PJ Media.

He points out that both Reagan and Obama inherited very weak economies. But that’s where the similarity ends. Reagan pushed an agenda of free markets and small government while Obama doubled down on Bush’s statism.

The results, he explains, confirm that big government is the problem rather than solution.

Obama’s economic policy, with the help of a pliant Federal Reserve, has been built on the notion that massive deficit spending and easy money would bring the economy roaring back and “stimulate” job growth.  The former strategy was tried during the 1930s. It only succeeded in lengthening the Great Depression, as the nation’s unemployment rate never fell below 12 percent. The fact that Team Obama insisted on making the same mistakes, while at the same time unleashing the federal government’s regulatory apparatus to harass the economy’s productive participants, is enough to make reasonable people question whether this president and his administration have ever truly wanted to see a genuine recovery occur. On the other hand, five years of strong, solid and uninterrupted economic performance following a serious recession is how you create a positive economic legacy. Ronald Reagan’s post-recession economy — an economy which faced arguably greater challenges when he took office, particularly double-digit inflation and a prime interest rate of 20 percent — did just that.

Those are strong words, but I think the accompanying graphics are even more persuasive.

Here’s a chart comparing post-recession growth for both Presidents.

And here’s the data on jobs, including breakdown of private-sector employment gains.

And here are the numbers for median household income. Once again, Obama is presiding over dismal numbers, particularly when compared to the Gipper.

What’s especially ironic, as I explained back in March, is that rich people are the only ones who have experienced income gains during the Obama years.

So Obama claims that his class-warfare policy is designed to hurt the wealthy, but the rest of us are the ones actually paying the price.

Let’s look at one final chart.

These poverty numbers weren’t included in the article, but I think they’re worth sharing because you can see that both the poverty rate and the number of Americans in poverty fell once Reagan’s policies took effect in the early 1980s. Under Obama, by contrast, the best we can say is that the numbers aren’t getting worse.

One final point, I imagine that some leftists will argue that Mr. Blumer is being unfair by looking only at Reagan’s post-1982-recession numbers.

That’s a fair point…but only if you think that the recession was caused by Reagan’s policies. Like most economists, I disagree with that accusation. The recession almost certainly was an unavoidable consequences of inflationary monetary policy in the 1970s.

Indeed, Reagan deserves special praise for his willingness to endure short-term pain in order to address that problem and set the stage for future prosperity. Obama, by contrast, wants continued money printing by the Fed in hopes that easy money can cure problems caused by easy money.

As you might imagine, I’m skeptical about that approach.

P.S. Here’s some snarky humor comparing the Gipper with Obama. And if you liked the story of what happens when you try socialism in the classroom, you’ll also enjoy this video of Reagan schooling Obama.

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When major changes occur, especially if they’re bad, people generally will try to understand what happened so they can avoid similar bad events in the future.

This is why, when we’re looking at major economic events, it’s critical to realize that narratives matter.

For instance, generation after generation of American students were taught that the Great Depression was the fault of capitalism run amok. But we now have lots of evidence that bad government policy caused the Great Depression and that the downturn was made more severe and longer lasting thanks to further policy mistakes by Hoover and Roosevelt.

The history textbooks are probably still wrong, but at least there’s a chance that interested students (and non-students) will come across more accurate explanations of what happened in the 1930s.

More recently, the same thing happened after the financial crisis. The statists immediately tried to convince people that the 2008 mess was a consequence of “Wall Street greed” and “deregulation.”

Fortunately, many experts were available to point out that the real problem was bad government policy, specifically easy money from the Fed and the corrupt system of subsidies from Fannie Mae and Freddie Mac.

So hopefully future history books won’t be as wrong about the financial crisis as they were about the Great Depression.

I raise these examples because I want to address another historical inaccuracy.

Let’s go back about 100 years ago to the s0-called “progressive era.” The conventional story is that this was a period when politicians reined in some of the excesses of big business. And if it wasn’t for that beneficial government intervention, we’d all still be oppressed peasants working in sweatshops.

There’s just one small problem with this narrative. It’s utter nonsense.

Let’s look specifically at the issue of sweatshops. Writing for the Independent Institute, Ben Powell looks at the history of sweatshops and whether workers were being mistreated.

He starts with a bit of history.

Sweatshops are an important stage in the process of economic development. As Jeffery Sachs puts it, “[S]weatshops are the first rung on the ladder out of  extreme poverty”. …Working conditions have been harsh and standards of living low throughout most of human history. …Prior to the Industrial Revolution,  textile production was decentralized to the homes of many rural families or artisans, and output was limited to what could be produced on the  spinning wheel and hand loom. …Yarn spinning was mechanized in 1767 with the invention of the spinning jenny, and water power was harnessed shortly  thereafter. With these inventions and steam power later, large-scale textile factories that are similar to today’s sweatshops emerged. The conditions in these  early sweatshops were worse than those in many Third World sweatshops today. In some factories, workers toiled for sixteen hours a day, six days per week.

Then he looks at what actually happened in Great Britain, which is where sweatshops began.

Yet workers flocked to the mills. …sweatshop workers…were attracted by the opportunity to earn higher wages than they could elsewhere. In fact, economist Ludwig von Mises defended the factory system of the Industrial Revolution,…writing, “The factory owners did not have the power to compel anybody to take a factory job. They could only hire people who were ready to work for the wages offered to them. Low as these wage rates were, they were nonetheless more than these paupers could earn in any other field open to them.” …Mises’s argument is supported by historical evidence. Economist Joel Mokyr reports that workers earned a wage premium of 15 to 30 percent by working in the factories compared with other alternatives. The transformation of Great Britain during this time was dramatic. As economist and historian Donald McCloskey describes it, “In the 80 years or so after 1780 the population of Britain nearly tripled, the towns of Liverpool and Manchester became gigantic cities, the average income of the population more than doubled… Peter Lindert and Jeffery  Williamson similarly find impressive gains in the standard of living between 1781 and 1851. Farm labor’s standard of living went up more than 60 percent,  blue-collar workers’ standard increased more than 86 percent, and overall workers’ standard increased more than 140 percent. Along with this increase in  the standard of living came a decrease in the share of women and children working beginning sometime between 1815 and 1820.

Ben then looks at the American experience. Once again, he finds that sweatshops allowed workers to earn more income than they could by staying on the farm.

And this was part of a process that enabled the United States to become much richer over time.

…workers flocked to the mills. At first, in the cities north of Boston it was mainly rural women and girls who left the farm to populate the early textile mills.  During the 1830s in Lowell, a woman could earn $12 to $14 a month (in 1830s dollars) and after paying $5 for room and board in a company boarding house  would have the rest left over for clothing, leisure, and savings. It wasn’t uncommon for women to return home to the farm after a year with $25 to $50 in a  bank account. This was far more money than they could have earned on the farm and often more disposable cash than their fathers had. …much like in Great Britain, living standards improved over time. In 1820, before the Industrial Revolution, annual per capita income in the United States stood at a little  more than $2,000. By 1850, it had grown by 50 percent to more than $3,000 and then doubled again by 1900 to more than $6,600. Along with the rise in  incomes came improvements in working conditions and greater consumption.

Eventually, of course, the sweatshops disappeared. But Ben explains that it was because of higher living standards rather than government intervention.

Sweatshops are eliminated mainly through the process of industrialization that raises a country’s income. The increased income comes from increased  worker productivity, which raises the upper bound of compensation. The increased productivity isn’t just in one firm, but in many firms and industries, and  thus workers’ next-best alternatives improve, raising the lower bound of compensation. As the economy grows, the competitive process pushes wages up.  Because health, safety, leisure, and so on are normal goods, workers demand more of their compensation on these margins as their total compensation increases. The result is the eventual disappearance of sweatshops.

Now let’s look at the broader issue of whether the “progressive era” was bad news for big business.

The answer is yes and no. Politicians imposed lots of legislation that was bad for the free market, but the crony capitalists of that era were big supporters of intervention.

Tim Carney elaborates in a column for the Washington Examiner.

Every American knows the fable of the Progressive Era and that “trust buster” Teddy Roosevelt wielding the big stick of federal power to battle the greedy corporations. We would be better off if more people knew the work of the man who dismantled this myth: historian Gabriel Kolko… His thesis: “The dominant fact of American political life” in the Progressive Period “was that big business led the struggle for the federal regulation of the economy.”

Here’s what really happened.

Many corporate titans in the early 20th Century, buying into the pervasive hubris of the day, believed that a state-managed economy was the inevitable end of a rational society—the conclusion of what Standard Oil’s top lobbyist Samuel Dodd called the “march of civilization.” Competition, in their eyes, was destructive redundancy. “Competition is industrial war,” James Logan of the U.S. Envelope Company wrote in 1901. “Ignorant, unrestricted competition carried to its logical conclusion means death to some of the combatants and injury for all.”  Steel baron Andrew Carnegie constantly strove to turn the steel industry into a cartel and keep prices high. Competition, however, always had a way pulling prices down. As Carnegie wrote in 1908, “It always comes back to me that Government control, and that alone, will properly solve the problem.” Kolko also showed how the socialists welcomed corporate-state collusion to advance monopoly as part of “progress.”

And, as Tim explains, it’s still happening today.

This has its echoes in contemporary progressive politics… When conservatives challenged Obamacare’s individual mandate, the White House had the backing of the insurance industry and the hospital lobby. After Obama won at the Supreme Court, liberal Bill Scher wrote in the New York Times that progressive victories historically flow from the Left’s alliances with Big Business. …Liberal scholar William Galston at the Brookings Institution explains the economics at play. “Corporations have sizeable cash flows and access to credit markets, which gives them a cushion against adversity and added costs,” he wrote in 2013, explaining why the big guys often welcome regulation.

In other words, big business often is the enemy of genuine capitalism and free markets.

Not only did the big companies, including insurance and pharmaceuticals, support Obamacare.

They’re now supporting the corrupt Import-Export Bank.

And they’re perfectly happy to support higher taxes, at least when the rest of us are being victimized.

They also supported the sleazy TARP bailout.

The moral of the story is not just the big business can be just as bad as big labor. The real moral of the story is captured by this poster.

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One of the worst things about working in Washington is that it’s so easy to get frustrated about the fact-free nature of political debates.

For instance, there’s now a big controversy about companies “re-domiciling” or “inverting” from the United States to lower-tax nations such as Ireland and Switzerland.

This should not be controversial. Unless, of course, you think businesses shouldn’t be allowed to move from California to Texas. Or from New York to Tennessee.

And even if you somehow think taxpayers don’t have the right to legally protect themselves from punitive taxation, there are two very stark facts that should guide the political debate.

First, the United States has the world’s highest corporate tax rate, which undermines job creation and competitiveness in America, regardless of whether there are inversions.

Second, the United States has the most punitive “worldwide” tax system, meaning the IRS gets to tax American-domiciled companies on income that is earned (and already subject to tax) in other nations.

This is why, as I explain in this video, that the politicians who are protesting against inversions are putting demagoguery above jobs.

One of the most important aspects of this debate, though, doesn’t involve the intricacies of corporate taxation. Instead, it’s a broader public finance point about whether it’s good public policy to disadvantage shareholders, workers, and consumers in order to give politicians more money to spend.

In my mind, that’s a no-brainer.

P.S. Kudos to Rand Paul for being one of the few politicians who is willing to publicly defend companies that engage in legal tax planning.

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I’ve had some fun over the years by pointing out that Paul Krugman has butchered numbers when writing about fiscal policy in nations such as France, Estonia, Germany, and the United Kingdom.

So I shouldn’t be surprised that he wants to catch me making an error. But I’m not sure his “gotcha” moment is very persuasive. Here’s some of what he wrote for today’s New York Times.

Gov. Jerry Brown was able to push through a modestly liberal agenda of higher taxes, spending increases and a rise in the minimum wage. California also moved enthusiastically to implement Obamacare. …Needless to say, conservatives predicted doom. …Daniel J. Mitchell of the Cato Institute declared that by voting for Proposition 30, which authorized those tax increases, “the looters and moochers of the Golden State” (yes, they really do think they’re living in an Ayn Rand novel) were committing “economic suicide.”

Kudos to Krugman for having read Atlas Shrugged, or for at least knowing that Rand sometimes referred to to “looters and moochers.” Though I have to subtract points because he thinks I’m a conservative rather than a libertarian.

But what about his characterization of my position? Well, he’s right, though I’m predicting slow-motion suicide. Voting for a tax hike isn’t akin to jumping off the Golden Gate bridge. Instead, by further penalizing success and expanding the burden of government, California is engaging in the economic equivalent of smoking four packs of cigarettes every day instead of three and one-half packs.

Here’s some of what I wrote.

I’m generally reluctant to make predictions, but I feel safe in stating that this measure is going to accelerate California’s economic decline. Some successful taxpayers are going to tunnel under the proverbial Berlin Wall and escape to states with better (or less worse) fiscal policy. And that will mean fewer jobs and lower wages than otherwise would be the case.

Anyhow, Krugman wants readers to think that California is a success rather than a failure because the state now has a budget surplus and there’s been an uptick in job creation.

Here’s more of what he wrote.

There is, I’m sorry to say, no sign of the promised catastrophe. If tax increases are causing a major flight of jobs from California, you can’t see it in the job numbers. Employment is up 3.6 percent in the past 18 months, compared with a national average of 2.8 percent; at this point, California’s share of national employment, which was hit hard by the bursting of the state’s enormous housing bubble, is back to pre-recession levels. …And, yes, the budget is back in surplus. …So what do we learn from the California comeback? Mainly, that you should take anti-government propaganda with large helpings of salt. Tax increases aren’t economic suicide; sometimes they’re a useful way to pay for things we need.

I’m not persuaded, and I definitely don’t think this counts as a “gotcha” moment.

First, I’m a bit surprised that he wants to brag about California’s employment numbers. The Golden State has one of the highest joblessness rates in the nation. Indeed, only four states rank below California.

Second, I don’t particularly care whether the state has a budget surplus. I care about the size of government.

Krugman might respond by saying that the tax hike generated revenues, thus disproving the Laffer Curve, which is something that does matter to supporters of small government.

But the Laffer Curve doesn’t say that all tax hikes lose revenue. Instead, it says that tax rate increases will have a negative impact on taxable income. It’s then an empirical question to figure out if revenues go up a lot, go up a little, stay flat, or decline.

And what matters most of all is the long-run impact. You can rape and pillage upper-income taxpayers in the short run, particularly if a tax hike is retroactive. In the long run, though, people can move, re-organize their finances, and take other steps to reduce their exposure to the greed of the political class.

In other words, people can vote with their feet…and with their money.

And that’s what seems to be happening in California. Take a look at how much income has emigrated from the state since 1992.

Next we have a map showing which states, over time, are gaining taxable income and which states are losing income (and I invite you to look at how zero-income tax states tend to be very green).

The data isn’t population adjusted, so populous states are over-represented, but you’ll still see that California is losing while Texas is winning.

And here is similar data from the Tax Foundation.

So what’s all of this mean?

Well, it means I’m standing by my prediction of slow-motion economic suicide. The state is going to become the France of America…at least if Illinois doesn’t get there first.

California has some natural advantages that make it very desirable. And I suspect that the state’s politicians could get away with above-average taxes simply because certain people will pay some sort of premium to enjoy the climate and geography.

But the number of people willing to pay will shrink as the premium rises.

In other words, this Chuck Asay cartoon may be the most accurate depiction of California’s future. And this Lisa Benson cartoon shows what will happen between now and then.

But I won’t hold my breath waiting for a mea culpa from Krugman.

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I’m currently in Asia, where I just finished a series of speeches about economic policy in China and Hong Kong.

These two jurisdictions offer very powerful lessons about the importance of economic policy.

Hong Kong is supposed to be Nirvana for libertarians. It holds the top spot in the Economic Freedom of the World rankings. It has an optional flat tax. It has a private retirement system. And based on IMF data, government spending “only” consumes 18.4 percent of GDP (compared to 38.6 percent of economic output in the United States and 54.4 percent of GDP in France).

In reality, Hong Kong is far from perfect. It may have a lot more economic freedom than other jurisdictions, but there is widespread government intervention in certain sectors, such as housing. And while a flat tax and spending burden of 18.4 percent of GDP sound good, let’s not forget that the western world became rich in the 1800s when there was no income tax and the public sector consumed less than 10 percent of GDP.

But when you rank countries on the basis of economic freedom, you don’t compare jurisdictions to a nonexistent libertarian utopia. You compare them to other nations. So Hong Kong gets the top spot. And that’s paying dividends. When you look at long-run comparisons with other nations, Hong Kong has grown faster and become more prosperous.

So what about China? This wasn’t my first visit to the country, but it was the first time I went to Shanghai, and it is a very impressive place. It’s obvious that China has enjoyed a lot of growth in the past few decades.

But just as you shouldn’t judge the United States by a visit to Wall Street, it would be a mistake to draw sweeping conclusions about China after a few days in Shanghai.

Indeed, average living standards for all of China are still far below American levels. Moreover, if you look at the Economic Freedom of the World rankings, China still has a lot of room for improvement. It ranks 123rd out of 152 nations, which is not only far below France (#40), but also Greece (#85), Haiti (#98), and Russia (#101).

That being said, China’s score is 6.22 out of 10, which is a vast improvement compared to where it was in 1980, when it had a score of only 4.00.

This has led to some wonderful outcomes. This chart (h/t: Mark Perry) shows the share of the world’s population living on less than $1 per day (blue line) and the share of East Asia’s population with the same level of deprivation (red line). A big reason the red line has fallen so dramatically is that severe poverty in China has largely disappeared.

The real question for China is the degree to which there will be ongoing improvement.

I think it would be good if China became more like Hong Kong and that this led to much higher living standards. Heck, I’d be happy if China became more like Taiwan or South Korea, both of which have become relatively rich nations by moving substantially in the direction of free markets and small government.

But I don’t think this will happen. In one of my speeches, I posed a series of questions, followed by some less-than-optimistic answers.

Is the financial system weak? (because of too much state control over capital flows and investment)

Is there too much cronyism? (with friends and relatives getting favorable access to business)

Will China’s demographics be a problem? (the one-child policy is not just tyrannical, but it also means China’s population is aging)

Is rapid growth sustainable? (in the absence of reforms to boost economic freedom)

Have stimulus plans led to malinvestment? (such as ghost cities and other boondoggles)

Since economists are lousy when they make predictions, it’s quite possible that I’m wrong and my pessimism is unwarranted. For the sake of the Chinese people, let’s hope so.

And what about Hong Kong? I suspect they’ll remain the freest economy in the world. After all, why wreck a good thing?

Then again, the United States was the world’s 3rd-freest economy as recently as 2001. Now, thanks to Bush-Obama statism, we’ve plummeted to 17 in the ranking.

But I doubt Hong Kong policy makers would be equally foolish.

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When people in other nations ask me for evidence in favor of low taxes, I often will ask them to compare the economic performance of a high-tax nation like France with the performance of a nation such as Switzerland with less onerous taxes.

If I’m asked by Americans, I generally suggest that they compare different states. For instance, I show them evidence that California has a much more punitive tax system than Texas. And when you look at all the available state rankings, it’s clear that there’s a big difference.

*Tax burdens as a share of state income.

*The State Tyranny Index.

*Mercatus State Fiscal Ranking.

*State Business Tax Climate Index.

*Tax Foundation’s Tax Freedom Day.

*State Freedom Index.

*Death Spiral states.

And I then ask folks to compare economic performance. There’s lots of evidence that Texas is growing much faster and creating far more jobs than California.

Heck, it’s almost as if California politicians want to drive successful people out of the Golden State (fortunately, the state’s politicians didn’t read Walter Williams’ satirical column about putting a barbed-wire fence at the border). And when upper-income taxpayers leave the state, that means taxable income and tax revenue also escape.

Though it’s worth pointing out that the case for low taxes isn’t based solely on comparisons of Texas and California. We know, for instance, that states with no income taxes generally outperform other states.

Moreover, we don’t need to rely on casual empiricism. Here are some of the results from a new study published by the Mercatus Center.

…this study uses the average tax rate as a practical approximation of the overall state tax burden. …The coefficient of average tax rate is negative and statistically significant in both models, suggesting that a higher tax burden as a share of income reduces state economic growth. …Elasticity of −2.6, for example, implies that a 1 percent increase in the tax rate decreases economic growth by 2.6 percent, not percentage points. …While the aforementioned income growth results are insightful, the impact of taxation on the level of income is also important. …income tax progressivity has a significant negative relationship with real GSP per capita. …An alternative way to measure economic activity is to look at the number of private firms that operate in each state. …The main conclusion from the two regression models is that only personal income tax progressivity seems to have a significant negative effect on the growth in the number of firms. … By voting with their feet, people send a clear signal about where they prefer to live and work. …an empirical analysis of migration may show, indirectly, how taxes affect the flow of economic activity across states. …state net immigration rate is negatively related to the personal income tax rate … The net immigration rate also seems to have a significantly negative correlation with the average tax rate and income tax progressivity.

These findings should not be a surprise.

It’s common sense that economic activity – and taxpayers – will flow to states that don’t punish people for creating wealth.

Let’s now circle back to the Texas-vs-California comparisons. Take a look at this remarkable chart put together by Mark Perry of the American Enterprise Institute.

As you can see, total employment in Texas has jumped almost 10 percent since 2008. In California, by contrast, total employment has increased by less than 2/10ths of 1 percent.

So you can see why this Lisa Benson cartoon is so appropriate.

Speaking of humor, this Chuck Asay cartoon speculates on how future archaeologists will view California. And this joke about Texas, California, and a coyote is among my most-viewed blog posts.

All jokes aside, none of this should be interpreted to suggest that Texas is perfect. There’s too much government in the Lone Star state. It’s only a success story when compared to California.

And even though California does worse than Texas in my Moocher Index, it’s worth pointing out that Californians are the least likely of all Americans to sign up for food stamps.

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Why do statists make so many mistakes with data? Paul Krugman, for instance, has butchered numbers when writing about fiscal policy in nations such as France, Estonia, Germany, and the United Kingdom.

But Krugman isn’t alone. We also have Thomas Piketty, who was lionized by the left after publication of Capital in the Twenty-First Century.

Ever since his book was published, various experts have called into question the veracity of Piketty’s numbers. Most recently, here’s some of what Alan Reynolds, my colleague at the Cato Institute, wrote about his data for the Wall Street Journal.

Thomas Piketty…remains a hero on the left, but the honeymoon may be drawing to a sour close as evidence mounts that his numbers don’t add up. …data are so misleading as to be worthless. They attempt to estimate top U.S. wealth shares on the basis of that portion of capital income reported on individual income tax returns—interest, dividends, rent and capital gains. This won’t work because federal tax laws in 1981, 1986, 1997 and 2003 momentously changed (1) the rules about which sorts of capital income have to be reported, (2) the tax incentives to report business income on individual rather than corporate tax forms, and (3) the tax incentives for high-income taxpayers to respond to lower tax rates on capital gains and dividends by realizing more capital gains and holding more dividend-paying stocks.

Alan lists some of specific problems that exist when you try to make sweeping assertions based on tax return data.

For example, interest income from tax-exempt municipal bonds was unreported before 1987—so the subsequent reporting of income created an illusory increase in top incomes and wealth. Since 1997, by contrast, most capital gains on home sales have disappeared from the tax returns of middle-income couples, thanks to a $500,000 tax exemption. …since the mid-1980s, most capital income and capital gains of middle-income savers began to vanish from tax returns by migrating into IRAs, 401(k)s and other retirement and college savings plans. Balances in private retirement plans rose to $12.4 trillion in 2012 from $875 billion in 1984. …When individual tax rates dropped from 70% in 1980 to 28% in 1988, this provoked a massive shift: from retaining private business income inside C-corporations to letting earnings pass through to the owners’ individual tax returns via partnerships, LLCs and Subchapter S corporations. …Although more frequent asset sales showed up as an increase in capital income, realized gains are no more valuable than unrealized gains so realization of gains tells us almost nothing about wealth. Similarly, a portfolio shift from municipal bonds, coins or cash into dividend-paying stocks after the tax on dividends fell to 15% in 2003 might look like more capital income when it was merely swapping an untaxed asset for a taxable one.

So what’s the bottom line?

Mr. Piketty’s premonition of soaring U.S. wealth shares for the top 1% finds no credible support in his book or elsewhere.

But let’s now conduct a thought experiment. What if Piketty’s data was right? Would that justify punitive class-warfare tax rates?

I’ve already explained that this would be the wrong approach.

And Diana Furchtgott-Roth of the Manhattan Institute cites some new academic research to make a similar point.

Meltzer and Richard show that using redistribution to ameliorate income inequality is not only ineffective, but worsens the problem that policy makers seek to cure. …Since workers’ productivity levels increase with the more they produce, and because higher taxes create disincentives to working, taxes lead to lower economic growth. …Higher tax rates that fund transfer payments hamper economic growth. That’s because they increase the number of people who depend on these payments and find it preferable not to work. There also is less learning-by-doing among those who work. …As taxes and transfers rise, hours of work and acquired skills decline, reducing economic growth. …it is this decline in hours worked for low-productivity workers that leads to more economic inequality — not the growth of technology nor the rent-seeking privileges of the rich, two causes cited by Piketty. Reduced effort by the rich in reaction to higher taxes comes at the expense of economic growth, which has the potential to raise everyone’s living standards and increase economic opportunity. …Meltzer and Richard show that the growth of government is the true driver behind inequality.

In other words, the supposed solution of ever-higher tax rates from folks such as Piketty (and Obama) would be harmful to the overall economy and be especially damaging to those with lower incomes.

If we want to help the poor, the goal should be to achieve faster economic growth by enabling capitalism and entrepreneurship.

In other words, copy Hong Kong and Singapore, not France.

Here’s the video I narrated for the Center for Freedom and Prosperity explaining why class-warfare tax policy is so misguided.

P.S. This isn’t the first time that Alan Reynolds has debunked Piketty.

P.P.S. These two pizzas tell you everything you need to know about how the left would define success.

P.P.P.S. And Margaret Thatcher exposed why their definition of success is absurd.

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Libertarians tend to like – or at least have a grudging respect for – the underground economy.

For instance, even if we’re personally very straight-laced, we don’t like government prohibitions against gambling, drugs, and prostitution. This is why we’re not upset when these things happen in spite of the laws enacted by the political class.

But this isn’t just about victimless crimes. We also dislike high taxes, so you won’t find libertarians shedding many tears when we read about tax avoidance and tax evasion in nations (such as France and Greece) with punitive tax systems.

Politicians tend to have a different perspective. They generally get very upset if we’re not following their societal diktats and acquiescing to their fiscal demands.

But now we’re suddenly seeing that some politicians have a new-found appreciation for the underground economy.

The New York Times reports that European nations want to add these activities to their estimates of GDP.

As of September, all European Union countries will be required to take fuller accounting of trade in sex, drugs and other underground businesses as part of an overhaul of economic measurements by Eurostat, the European statistics agency. The point of counting everything, including the wages of sin, is to get a more accurate reading of each country’s gross domestic product.

Sounds reasonable, right? Who objects, after all, to more accurate numbers?

But it’s always good to be suspicious of governments.

And why is suspicion warranted in this case? Well, it appears that this effort to re-measure GDP may give politicians more ability to spend.

With European Union governments obliged to reduce debt as a percentage of their economies, the changes are also expected to make growth rates from Spain to Sweden look better, possibly also making debt ratios seem rosier. …In Italy, Ireland, Portugal and Spain, …G.D.P. could increase by as much as 2 percent, Eurostat estimates, while Germany and France could see expansions of as much as 3 percent. Britain might show a gain of 3 to 4 percent, Eurostat said.

To elaborate, there are “Maastricht rules” in the European Union that (at least in theory) obligate governments to keep deficits from rising about 3 percent of GDP and to keep debt from climbing above 60 percent of GDP.

So if politicians and bureaucrats can figure out ways to make GDP appear bigger, that means they can have more red ink. Which means, of course, that they can spend more money.

So now it should be abundantly clear why governments have an incentive to add the underground economy to their GDP estimates.

But there’s one little problem with this approach. The whole purpose of the Maastricht rules was to keep nations from spending themselves into a fiscal crisis. The rules obviously didn’t work very well (perhaps because they focused on the symptom of red ink rather than the underlying disease of too much government spending), but there presumably would have been even more profligacy if they didn’t exist.

So what’s the point of adding the underground economy to GDP when that simply gives politicians more leeway to spend?

Indeed, the NYT article notes that some of the bean-counting bureaucracies in Europe are concerned that this new approach won’t work because there won’t be any new tax revenue to accompany the new spending.

Statistics agencies, though, say that whatever the improved ratios, debt will not be easier to service, because governments cannot collect taxes from illegal underground activity.

And just in case you don’t trust the New York Times, here’s a blurb from Money News making the same point.

No country is supposed to let their annual deficits exceed 3 percent of GDP or accumulated debt exceed 60 percent of GDP. Countries that don’t comply with the debt limits are to be penalized — 0.2 percent of GDP, plus a “variable component” that can range up to 0.5 percent of GDP annually as long as the breach continues. Boosting GDP helps lower the debt ratio.

The bottom line is that these changes will enable Europe’s politicians to postpone much-needed fiscal discipline.

In other words, they’ll have the ability to spend themselves deeper into a hole.

And as you can see from these sobering IMF, OECD, and BIS estimates, the hole is already enormous.

Not that America is any different. Our economy may be doing better (or less worse) today, but our future fiscal outlook is worse than many other nations thanks to a combination of poorly designed entitlement programs and changing demographics.

And just as is the case for Europe, counting our underground economy would not be a substitute for the reforms needed to save the nation.

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I’ve shared lots of data and evidence about the harmful economic impact of government spending.

Simply stated, budgetary outlays divert resources from more productive uses. And this results in labor and capital being misallocated, leading to less economic output.

The damage is even more pronounced when you look at how politicians finance the budget. Whether they use taxes or borrowing (or even printing money), there are additional distortions that hinder the private sector.

Today, we’re going to look at the economic impact of a particular type of government spending. A new working paper by two academics at the University of Miami has revealed a negative relationship between government consumption spending and economic growth.

But before digging into the details, what do public finance economists mean when they talk about “consumption spending”? At the risk of over-simplifying, it’s the part of the budget used to purchase goods and services. Everything from soldiers to housing and from jails to education.

It’s basically the so-called discretionary portion of the federal budget, minus “investment spending” (which would be things like roads).

Anyhow, here are some of the key findings.

This paper tests the Mundellian hypothesis that too much government spending reduces economic growth… In this paper, we analyze annual panel data from 1999 to 2011 for 31 OECD countries to examine the role of government spending in determining economic growth. In particular, we will focus our attention on government consumption spending on non-market goods such as defense and justice for collective consumption and its effect on growth in real GDP growth. …We find that government consumption spending on non-market goods signifi cantly reduces economic growth. A one percentage point increase in government consumption of non-market goods as a percent of GDP is associated with a 0.86 percentage lower growth rate in GDP. …This result is compatible with Barro (1990)’s fi nding for the Summers and Heston database, but suggests a stronger negative eff ect of government consumption on economic growth.

That’s a big number, which implies that we’re definitely on the downward-sloping portion of the Rahn Curve.

By the way, just in case you’re wondering why Obama’s “stimulus” was such a flop, the study also notes that “the 2009 American Reinvestment and Recovery Act envisaged less than 5% spending on public investment, and over 95% on consumption.”

In other words, Obama increased the type of government spending with the worst impact on the economy. Something to keep in mind when politicians, lobbyists, interest groups, and other insiders argue that there’s no need to cut back on discretionary spending.

But it’s also important to note that the study has some findings that may distress libertarians and small-government conservatives. It finds, for instance, that “government investment spending is positively related to growth.”

Also, it’s important to realize that the study is limited to only certain forms of discretionary spending. As the authors explain, they examine, “the impact of government consumption spending net of health, education and housing service.”

But even with those caveats, we have another strong piece of evidence that our economy would grow much faster if we reduced the burden of government spending.

And if you need more evidence on the harmful effect of government spending (either generally or specific types of outlays), allow me to call your attention to research even from normally left-leaning international bureaucracies such as the Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank.

And you can find similar findings in the work of scholars from all over the world, including the United States, Finland, Australia, Sweden, Italy, Portugal, and the United Kingdom.

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There have been many truly awful presidents elected in the United States, but if I had to pick my least favorite, I might choose Herbert Hoover.

I obviously have disdain for Hoover’s big-government policies, but I also am extremely irritated that – as Jonah Goldberg explained – he allowed the left to create an utterly bogus narrative that the Great Depression was caused by capitalism and free markets.

Indeed, the Center for Freedom and Prosperity produced a video demonstrating that the statist policies of both Hoover and Roosevelt helped trigger, deepen, and lengthen the economic slump.

Building on that theme, here’s a new video from Prager University that looks specifically at the misguided policies of Herbert Hoover.

Amen. Great job unmasking Hoover’s terrible record.

As I explained when correcting a glaring error by Andrew Sullivan, Hoover was a big-government interventionist. Heck, even FDR’s inner circle understood that the New Deal was simply an extension of Hoover’s statist policies.

In other words, FDR doubled down on Hoover’s awful record. And with awful results. We have a better understanding today of how the New Deal caused the downturn to be deeper and longer.

This Tom Sowell video is definitely worth watching if you want more information on that topic.

And here’s something else to share with your big-government friends. The Keynesian crowd was predicting another massive depression after World War II because of both a reduction in wartime outlays and the demobilization of millions of troops. Yet that didn’t happen, as Jeff Jacoby has succinctly explained. And if you want more details on how smaller government helped restore growth after WWII, check out what Jason Taylor and Rich Vedder wrote for Cato.

P.S. I’ve compared Bush and Obama to Hoover and Roosevelt because of some very obvious similarities. Bush was a big-government Republican who helped pave the way for a big-government Democrat, just as Hoover was a big-government Republican who also created the conditions for a big-government Democrat.

The analogy also is good because I suspect political and economic incompetence led both Hoover and Bush to expand the burden of government, whereas their successors were ideologically committed to bigger government. We know about Obama’s visceral statism, and you can watch a video of FDR advocating genuinely awful policy.

The good news is that Obama will never be as bad as FDR, no matter how hard he tries.

P.P.S. It’s also worth mentioning that a very serious downturn in 1921 was quickly ended in part thanks to big reductions in the burden of government spending. Your Keynesian friends will also have a hard time explaining how that happened.

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Back in 2010, I shared a remarkable chart showing how quickly economic output doubles in a fast-growth economy, but it also showed how long it takes for GDP to expand if an economy only grows 1 percent or 2 percent per year.

My main message was that nations should follow good policy because:

…even modest differences in economic growth can have a big impact on relative prosperity with a couple of decades.

But what’s really astounding – in a bad way – is that there used to be no growth. I recently posted a remarkable video from Learn Liberty that showed how the world was mired in poverty for century after century until growth exploded around 1800.

Now Don Boudreaux has a similar must-watch video for Marginal Revolution University.

The moral of the story is that poverty is, or at least was, the natural state of humanity.

But then something remarkable happened. The power of government was constrained and the vitality of markets was unleashed. The rest, as they say, is history.

And if you want to see a remarkable case study, the Fund for American Studies has its own great video showing how one nation went from misery to prosperity in just 100 or so years.

And to augment that video, here’s a chart from Wikipedia.

Just something to have in the back of your mind when some statist naively tells you the economy is a fixed pie and that successful entrepreneurs only become rich by making other people poor.

That’s simply not true.

Actually, allow me to revise my remarks. In the left’s fantasy world of taxes, bailouts, handouts, and cronyism, there is no growth and some people are able to use government coercion to become rich by ripping off others.

But in all likelihood, this satirical image shows the true impact of statism and redistribution.

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Obamacare resulted in big increases in the fiscal burden of government (ironically, it would be even worse if Obama hadn’t unilaterally suspended parts of the law).

The legislation increased government spending, mostly for expanded Medicaid and big subsidies for private insurance.

There were also several tax hikes, with targeted levies on medical device makers and tanning beds, as well as some soak-the-rich taxes on upper-income taxpayers.

These various policies are bad news for economic performance, but the damage of Obamacare goes well beyond these provisions.

Writing for Real Clear Markets, Professor Casey Mulligan of the University of Chicago explains that Obamacare contains huge implicit tax hikes on work and other forms of productive behavior.

…can we begin to take seriously the idea that the fiscal policies and regulations hidden in the Affordable Care Act are shrinking our economy? …Politicians and journalists use the term tax more narrowly than economists do, but the economic definition is needed to understand the economic effects of the ACA. …Withholding benefits from people who work or earn is hardly different than telling them to pay a tax. For this reason, economists refer to benefits withheld as “implicit taxes.” What really matters for labor market performance is the reward to working inclusive of implicit taxes, and not the amount of revenue delivered to the government treasury… The ACA…is full of implicit taxes. Many of them have remained hidden in the “fog of controversy” surrounding the law and their effects excluded from economic analyses of it.

In other words, his basic message is that the government reduces incentives to be more productive and earn more money when it provides handouts that are based on people earning less money.

Indeed, click here to see a remarkable chart showing how redistribution programs discourage work.

And speaking of charts, here’s one from Professor Mulligan’s article, and it shows the nation’s largest tax hikes based on what happened to the marginal tax rate on working.

Wow. No wonder we’re suffering from a very anemic recovery.

Professor Mulligan elaborates.

During a period that included more than a dozen tax increases, the ACA is arguably the largest as a single piece of legislation, adding about six percentage points to the marginal tax rate faced, on average, by workers in the economy. The only way to cite larger marginal tax increases would be to combine multiple coincident laws, such as the Revenue Acts of 1950 and 1951 and the new payroll tax rate that went into effect in 1950. Even with these adjustments, the ACA is still the third largest marginal tax rate hike during the seventy years. …Let’s not be surprised that, as we implement a new law that taxes jobs and incomes, we are ending up with fewer jobs and less income.

By the way, other academics also have found that Obamacare will lure many people out of the workforce and into government dependency.

The White House actually wants us to believe this is a good thing, as humorously depicted by this Glenn McCoy cartoon.

But rational people understand that our economic output is a function of how much labor and capital are being productively utilized.

In other words, Obamacare is a mess. It’s hurting the economy and should be repealed as the first step in a long journey back to market-based healthcare.

P.S. Mulligan’s chart also re-confirms that unemployment benefits increase unemployment. Heck, that’s such a simple and obvious concept that it’s easily explained in this Wizard-of-Id parody and this Michael Ramirez cartoon.

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I wrote the other day that Americans, regardless of all the bad policy we get from Washington, should be thankful we’re not stuck in a hellhole like Venezuela.

But we also should be happy we’re not Europeans. This is a point I’ve made before, usually accompanied by data showing that Americans have significantly higher living standards than their cousins on the other side of the Atlantic.

It’s now time to re-emphasize that message. The European Commission has issued its annual report on “Taxation Trends” and it is – at least for wonks and others who care about fiscal policy – a fascinating and compelling document.

If you believe in limited government, you’ll read the report in the same way you might look at a deadly traffic accident, filled with morbid curiosity and fear that you may eventually suffer the same fate.

But if you’re a statist, you’ll read the report like a 14-year old boy with his first copy of a girlie magazine, filled with fantasies about eventually getting to experience what your eyes are seeing.

Let’s start by giving the bureaucrats some credit for self-awareness. They openly admit that the tax burden is very onerous in the European Union.

The EU remains a high tax area. In 2012, the overall tax ratio, i.e. the sum of taxes and compulsory actual social contributions in the 28 Member States (EU-28) amounted to 39.4 % in the GDP-weighted average, nearly 15 percentage points of GDP over the level recorded for the USA and around 10 percentage points above the level recorded by Japan. The tax level in the EU is high not only compared to those two countries but also compared to other advanced economies; among the major non-European OECD members for which recent detailed tax data is available, Russia (35.6 % of GDP in 2011) and New Zealand (31.8 % of GDP in 2011) have tax ratios exceeding 30 % of GDP, while tax-to-GDP ratios for Canada, Australia and South Korea (2011 data) remained well below 30 %.

Here’s a chart from the report showing that taxes consume about 40 percent of economic output in EU nations. And while Americans correctly view the internal revenue code as very burdensome, taxes “only” consume about 25 percent of GDP in the United States.

EU Report Total Tax

Other nations with comparatively modest tax burdens include Canada (CA), Australia (AU), South Korea (KR), and Switzerland (CH).

But it’s important to understand that not all nations in the European Union are identical.

Just as there are high-tax states and low-tax states in America, there are high-tax countries and low-tax countries in Europe. Surprisingly, France was not the worst nation.

…the ratio of 2012 tax revenue to GDP was highest in Denmark, Belgium and France (48.1 %, 45.4 % and 45.0 % respectively); the lowest shares were recorded in Lithuania (27.2 % of GDP), Bulgaria (27.9 % of GDP) and Latvia (27.9 % of GDP).

I’m surprised, by the way, that Sweden isn’t among the highest-taxed nations. I guess they’ve made even more progress than I thought.

Now let’s drill down into the report and look at some of the specific data.

But you may want to stop reading now if you get easily depressed.

That’s because it’s time to look at a chart showing what’s happened to income tax rates. Specifically, this chart shows the average top tax rate on personal income, both for Eurozone (nations using the euro currency) and European Union nations.

As you can see, the average top tax rate has jumped by almost four percentage points for euro nations and by about two percentage points for all EU nations.

EU Report Personal Income Tax

This is very unfortunate. Tax rates were heading in the right direction when there was vigorous tax competition inside Europe. But now that high-tax nations have been somewhat successful in forcing low-tax jurisdictions to become deputy tax enforcers, that positive trend has halted and policy is moving in the wrong direction.

But not in all regards.

Tax competition also has been compelling governments to lower corporate tax rates. And while that trend has abated, you can see in this chart that politicians haven’t felt they have leeway to push rates higher.

EU Report Corporate Income Tax

Though I am very concerned about the OECD’s campaign to undermine corporate tax competition.

If they’re successful, there’s no doubt we’ll see higher corporate tax rates.

Let’s now look at some more depressing data. This chart shows that a continuation in the trend toward higher rates for value-added taxes (VATs).

EU Report VAT

I’ve warned repeatedly that the VAT is a money machine for big government and the EU data certainly supports my position.

But if you want evidence from other parts of the world, there’s some IMF data that clearly shows how politicians use the VAT to expand the burden of government.

Last but not least, let’s now draw some conclusions from all this information.

At the beginning of the column, I mentioned that Americans should not copy Europe because bigger government translates into lower living standards.

Simply stated, there’s a negative relationship between the size of government and economic performance.

So let’s look at another piece of data to emphasize that point. The bureaucrats at the OECD just did a report on the U.S. economy and they produced a chart showing that the current recovery is very anemic. We haven’t recaptured lost economic output, which normally happens after a downturn. Indeed, we haven’t even returned to normal growth levels.

But that’s not news to regular readers. I’ve shared powerful data from the Minneapolis Federal Reserve showing the failure of Obamanomics.

What is noteworthy, though, is comparing Europe to the United States. As you can see from these two charts, euro nations have flat lined. And if you look at the vertical scale, you can see that they were growing a lot slower than the United States to begin with.

Dismal European Economy

In other words, we’re not doing very well in the United States.

But compared to Europe, we’re Hong Kong.

Two final caveats: First, I always like to stress that economic performance is impacted by a wide range of policies. So while I think that rising tax burdens and higher tax rates are hurting growth in Europe, there are other factors that also matter.

Second, any analysis of fiscal policy should also include data on the burden of government spending. After all, a nation with a low tax burden will still suffer economic problems if there’s a large public sector financed by red ink.

And one big warning: Obama wants to make America more like Europe. If he succeeds, we can expect European-style stagnation.

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Why are some nations rich and other nations poor? What has enabled some nations to escape poverty while others continue to languish?

And if we want to help poor nations prosper, what’s the right recipe?

Since I’m a public finance economist, I’m tempted to say a flat tax and small government are an elixir for prosperity, but those policies are just one piece of a bigger puzzle.

A country also needs sensible monetary policy, open trade, modest regulation, and rule of law. In other words, you need small government AND free markets.

But even that doesn’t really tell us what causes growth.

In the past, I’ve highlighted the importance of capital formation and shared a remarkable chart showing how workers earn more when the capital stock is larger (which is why we should avoid punitive double taxation of income that is saved and invested).

But that also doesn’t really answer the question. After all, if a larger capital stock was all that mattered, doesn’t that imply that we could get prosperity if government simply mandated more saving and investing?

There’s something else that’s necessary. Something perhaps intangible, but critically important.

Deirdre McCloskey, in a video for Learn Liberty, says that ideas and innovation drive growth.

This is a great video for many reasons, but two points strike me as very important.

First, Deirdre is saying that economic liberty matters, but that modern prosperity also was enabled by a change in the culture. People began to appreciate and respect entrepreneurs. You could call this a form of social capital (and I think such cultural norms are critically important for a thriving society).

And entrepreneurs are the innovators who figure out ways of mixing capital and labor in ways that generate ever-larger amounts of economic output, so they play a critical role in boosting prosperity.

Second, she reminds us that poverty is the normal human condition and that the modern era truly is an amazing change. Indeed, I was so shocked by her numbers that I had to investigate to see if she was exaggerating.

She wasn’t. Using the Angus Maddison data set, I looked to see if Deirdre was right about world prosperity resembling a hockey stick.

Sure enough, there was an amazing increase in prosperity beginning about 1800, just as she explained. Indeed, she could have said that people lived on less than $2 per day for much of recorded history.

Here’s the data for world per-capita economic output over the past two thousand years.

Modern Prosperity

Wow. Unlike the make-believe hockey stick used by global warming alarmists, this one is real. And it shows that the economy definitely isn’t a fixed pie if the right policies – and the right attitudes – prevail.

So what’s the moral of the story?

Perhaps the most obvious lesson is that we should respect and appreciate entrepreneurs and other wealth creators.

Unfortunately, we live in an era where politicians would like us to believe that the economic pie is fixed and that it’s the job of government to re-slice the pie with class-warfare tax policy and lots of redistribution.

But when they re-slice the pie, they also change the size of the pie. And not in a good way.

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Imagine how weird it would be if the Cato Institute and Americans for Tax Reform praised Barack Obama for fiscal responsibility.

And think how inconceivable it would be for the Heritage Foundation and the National Taxpayers Union to applaud Tim “Turbotax” Geithner for economic stewardship.

But the Canadian version of that happened while I was at the conference of the World Taxpayers Association in Vancouver two weeks ago.

The event was organized by the Canadian Taxpayers Federation and the main speaker was Paul Martin of the Liberal Party, who served as Finance Minister from 1993-2002 and Prime Minister from 2003-2006.

And I should add, for context, that the Liberal Party in Canada is not a classical liberal party with a track record of free markets and small government.

But Paul Martin was honored because he was responsible, while Finance Minister, for one of the best records of fiscal restraint of any policy maker in recent history (click here for international comparisons).

I’ve pointed out that the burden of spending fell under Bill Clinton, and I’ve even acknowledged that the federal budget hasn’t grown much under Obama, at least once you get past his first couple of years.

But Paul Martin was far more frugal. And since Canada has a parliamentary system, there’s no ambiguity about who deserves credit. He restrained spending when his party had control.

What happened to generate the good results? For all intents and purposes, he imposed a spending freeze. And I’m talking a nominal spending freeze, not the kind of fake fiscal discipline you get when politicians make “cuts” off an inflated baseline.

And because the budget was successfully restrained, that addressed both the problem of too much spending and the symptom of red ink.

In his speech, Martin won me over when he bragged that the burden of government spending fell to its lowest point in 50 years.

And my man crush became even more pronounced when he said they allowed agencies to ask for more funds, but only if they identified offsetting cuts elsewhere.

What a novel concept! A government that actually looked at tradeoffs and prioritized outlays. Sort of like a household or business.

Paul Martin DiscussionI asked the former Prime Minister a couple of questions.

I was specifically interested in why the Liberal Party didn’t behave like other left-wing parties and raise taxes to enable bigger government.

Martin said there were some in his party who wanted that approach, but that there were two reasons for good policy.

First, enough people understood that Canada has a spending problem rather than a debt problem. And second, there was concern that financial markets would react poorly if policy makers simply pushed for higher taxes and ignored the size of government.

Wow, I wish the average Republican had the same sophisticated understanding of fiscal policy.

No wonder Canada got such good results. They imposed austerity on the public sector, rather than trying to squeeze the private sector (a distinction that seems to escape Paul Krugman).

To give you an idea of what Paul Martin accomplished, here’s a video prepared by the Canadian Taxpayers Federation, which features laudatory comments by representatives of major market-oriented think tanks.

At the risk of stating the obvious, I don’t think there will ever be a video like this about Obama.

Very well done, even though I think it focused too much on red ink and not enough on the real accomplishment of spending restraint.

My Cato colleague, Chris Edwards, has produced some very good data on what’s happened to the burden of government spending in his home country.

For further information on that topic, here’s my video on international examples of spending restraint. Canada, you’ll notice, is one of the prominent case studies.

P.S. If you know any Keynesians, you can have some fun by asking them why Canada’s economy grew when the burden of government spending was reduced.

P.P.S. It’s also very impressive that Canada has one of the lowest levels of welfare spending of any developed nation.

P.P.P.S. No wonder Canada now ranks above the United States for economic freedom and the freest jurisdiction in North America is actually a Canadian province.

P.P.P.P.S. To end on a humorous note, Canadians should fortify their border to avoid an influx of American leftists.

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When the new Tory-led government came to power in the United Kingdom, I was rather unimpressed.

David Cameron positioned himself as a British version of George W. Bush, full of “compassionate conservative” ideas to expand the burden of government.

But even worse than Bush, because Cameron also jacked up taxes when he first took office, including big increases in the capital gains tax and the value-added tax.

But I must admit that policy in recent years has moved in the right direction, at least with regard to corporate taxation.

Writing for the U.K.-based Telegraph, Jeremy Warner remarks that business activity has significantly strengthened.

A survey by EY, published on Monday, showed that the UK is continuing to pull away from the rest of Europe in terms of Foreign Direct Investment (FDI). The UK secured nearly 800 projects last year, the highest ever, accounting for around a fifth of all European FDI, far in advance of any other country. …Such investment is in turn helping to fuel Britain’s economic recovery… Go back 10 years and it was all the other way; companies were scrambling to leave the country and domicile somewhere else. It is perhaps the Coalition’s biggest unsung achievement that it has managed to reverse this flow.

So why has the United Kingdom experienced this economic rebound?

Lower corporate tax rates are key, Warner explains.

…it has done so largely through the tax system, where it has been as good as its promise to make the UK the most competitive in the G20. By next year, Britain will have the equal lowest headline rate of corporation tax – along with Russia and Saudi Arabia – in this eclectic group of economies, as well as at 20pc the lowest by some distance of the G7 major advanced economies. Other G7 countries range from 25pc to a crushing 38pc and 39pc in France and the US. …Britain has also halted the double taxation of repatriated foreign profits and the taxation of controlled foreign subsidiaries.

So the 20 percent corporate tax rate has yielded good results.

Now let’s connect the dots.

More economic activity means more income for taxpayers.

And more income means a bigger tax base.

Which means…can you guess?…yup, it means revenue feedback.

In other words, we have another piece of evidence that the Laffer Curve is very real.

…Reducing corporation tax has reversed the outflow of corporate head office functions, and doing so has substantially added to overall employment, output, income tax, national insurance and VAT receipts. Dynamic modelling by the UK Treasury has shown that lower tax rates are helping to drive a higher overall tax take. The “Laffer curve” lives. …Let business profit from its own enterprise. It’s amazing how effective this principle can be in generating growth, and yes, taxes, too.

If you want more evidence about the Laffer Curve, here’s one of the videos I narrated.

Warner points out, by the way, that the United Kingdom should not rest on its laurels.

If modest reductions in the corporate tax rate are good, then deeper cuts should be even better.

If comparatively minor changes like these to the competitiveness of the tax system can have such dramatic effects, just think what more serious, root and branch tax reform might achieve. In Singapore, the headline rate is 17pc, in Hong Kong 16.5pc and in Ireland just 12.5pc. There’s a way to go.

Though if The U.K. keeps moving in the right direction, that may arouse hostility and attacks from countries with uncompetitive tax systems.

Indeed, the statists at the European Commission have just launched an investigation of three countries for supposedly under-taxing companies.

Here are some blurbs from a report in the Wall Street Journal.

European Union regulators are preparing to open a formal investigation into corporate-tax regimes in Ireland, Luxembourg and the Netherlands… The probe by the European Commission, the EU’s executive arm, follows criticism in Europe of low tax rates paid by global corporations… The probe is likely to consider whether generous corporate-tax regimes in Ireland, Luxembourg and the Netherlands amount to illegal state aid. …The EU’s tax commissioner, Algirdas Semeta, has warned that the region “can no longer afford freeloaders who reap huge profits in the EU without contributing to the public purse.”

This is remarkable.

In the twisted minds of the euro-crats in Brussels, it is “state aid” if you let companies keep some of the money they earn.

This is horrible economics, but it’s even worse from a moral perspective.

A subsidy (or “state aid”) occurs when the government taxes money from Person A and gives it to Person B. But it’s a perversion of the English language to say that a subsidy takes place if Person A gets a tax cut.

By the way, this perverse mentality is not limited to Europe.

The “tax expenditure” concept in the United States is based on the twisted notion that a tax cut that results in more money in your pocket is economically (and morally) equivalent to a spending handout that puts more money in your pocket.

P.S. The United Kingdom also provides us with powerful evidence that the Laffer Curve plays a big role when there are changes in the personal income tax.

P.P.S. Notwithstanding a bit of good news on corporate tax, I’m not optimistic about the U.K.’s long-run outlook. Simply stated, the nation’s political elite is too statist.

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Regular readers know that good fiscal policy takes place when government spending grows slower than the private economy.

Nations that maintain this Golden Rule for extended periods of time shrink the relative burden of government spending, thus enabling more growth by freeing up resources for the productive sector of the economy and creating leeway for lower tax rates.

And when countries deal with the underlying disease of too much spending, they automatically solve the symptom of red ink, so it’s a win-win situation whether you’re a spending hawk or a so-called deficit hawk.

With this in mind, let’s look at some interesting new research from the Heritage Foundation. They’ve produced a report entitled Europe’s Fiscal Crisis Revealed: An In-Depth Analysis of Spending, Austerity, and Growth.

It focuses on fiscal policy over the past few years and is an important contribution in two big ways. First, it shows that the Keynesian free-lunch approach is counterproductive. Second, it shows that the right kind of fiscal consolidation (i.e., spending restraint) generates superior results.

Here are some excerpts from the chapter by Professor Alberto Alesina of Harvard of Veronique de Rugy of the Mercatus Center. They look at some of the academic evidence.

The debate over the merits of austerity (the implementation of debt-reduction packages) is frustrating. Most people focus only on deficit reduction, but that can be achieved in many different ways. Some ways, such as raising taxes, deeply hurt growth… The data show that austerity has been implemented in Europe. However, with some rare exceptions, the forms of austerity were heavy on tax increases and far from involving savage spending cuts. …spending-based adjustments are more likely to reduce the debt-to-GDP ratio, regardless of whether fiscal adjustments are defined in terms of improvements in the cyclically adjusted primary budget deficit or in terms of premeditated policy changes designed to improve a country’s fiscal outlook. …Other research has found that fiscal adjustments based mostly on the spending side are less likely to be reversed and, as a result, have led to more long-lasting reductions in debt-to-GDP ratios. …successful fiscal adjustments are often rooted in reform of social programs and reductions in the size and pay of the government workforce rather than in other types of spending cuts. …tax increases failed to reduce the debt and were associated with large recessions. …growing evidence suggests that private investment tends to react more positively to spending-based adjustments. For instance, data from Alesina and Ardagna and from Alesina, Favero, and Giavazzi show that private-sector capital accumulation increases after governments cut spending.

The basic message of the Alesina-de Rugy chapter is that bad outcomes are largely unavoidable when nations spend themselves into fiscal trouble, but the damage can be minimized if policy makers impose spending restraint.

The Heritage Foundation’s Salim Furth is the editor of the report, and here’s some of what he wrote in Chapter 3, which looks at what’s happened in recent years as countries dealt with fiscal crisis.

Tax austerity is very harmful to growth, while spending cuts are partially replaced by private-sector activity, making them less harmful. …Estimating growth effects on private GDP, the difference between tax and spending multipliers grows predictably. A two-dollar decline in private GDP is associated with every dollar of tax increases, but spending cuts are associated with no change in private GDP.  …fiscal consolidation that relied 60 percentage points more on spending cuts was associated with 3.1 percentage points more GDP growth from 2009 to 2012, when average growth was just 3.3 percent over the entire period. In other words, a country that had a fiscal consolidation composed of 80 percent of spending cuts and 20 percent of tax increases would grow much more rapidly than a country in which only 20 percent of the consolidation was spending cuts and 80 percent was tax increases. The association is slightly stronger for private GDP.

Salim then cites a couple of powerful examples.

…the difference between Germany’s 8 percent growth from 2009 to 2012 and the 1 percent growth in the Netherlands is largely accounted for by Germany’s cut-spending, cut-taxes approach and the Netherlands’ raise-spending, raise-taxes approach. The U.K. and Italy enacted similarly-sized austerity packages, but Italy’s was half tax increases while the U.K. favored spending cuts. Neither country excelled, but over half of the gap between the U.K.’s 3 percent growth and Italy’s negative growth is explained by Italy’s tax increases.

By the way, it’s not as if Germany and the United Kingdom are stellar examples of fiscal restraint. It’s just that they’re doing better than nations that traveled down the path of even bigger government.

Regarding supposed Keynesian stimulus, Salim makes a very important point that more government spending seems positive in the short run, sort of like the fiscal version of a sugar high.

But that sugar high produces a bad hangover. Nations that try Keynesianism quickly fall behind countries with more prudent policy.

Government spending boosts GDP instantly and then crowds out private spending slowly. The incentive effects of taxation may take effect over several years, but they are permanent and especially pronounced in investment. If anything, this recent crisis shows how brief the short run is: Countries whose spending-focused stimulus put them one step ahead in 2010 were already two steps behind in 2012.

There’s a lot more in the report, so I encourage readers to give it a look.

I particularly like that it emphasizes the importance of properly defining “austerity” and “fiscal consolidation.” These are issues that I highlighted in my discussion with John Stossel.

Another great thing about the report is that it has all sorts of useful data.

Though much of it is depressing. Here’s Chart 2-9 from the report and it shows all the countries that have increased top marginal tax rates between 2007 and 2013.

Portugal wins the booby prize for the biggest tax hike, though many nations went down this class-warfare path. Including the United States thanks to Obama’s fiscal cliff tax increase.

The United Kingdom is an interesting case. It raised its top rate by 10 percentage points, but then cut the rate by 5 percentage points after it became apparent that the higher rate wasn’t collecting any additional revenue.

We should give credit to the handful of nations that have lowered tax rates, several of which replaced discriminatory systems with simple and fair flat taxes.

Though it’s also important to keep in mind where each nation started. Switzerland lowered it’s top rate by only 0.4 percentage points, which seems small compared to Denmark, which dropped its top rate by 6.7 percentage points.

But Switzerland started with a much lower rate, whereas Denmark has one of the world’s most punitive tax regimes (though, paradoxically, it is very laissez-faire in areas other than fiscal policy).

Let’s look at the same data, but from a different perspective. Chart 2-10 shows how many nations (from a list of 37) raised top rates or lowered top rates each year.

The good news is that tax cutters out-numbered tax-hikers in 2008 and 2009.

The bad news is that tax increases have dominated ever since 2010.

Many of these post-2009 tax hikes were enabled by a weakening of tax competition, which underscores why it is so important to preserve the right of jurisdictions to maintain competitive tax systems.

And don’t forget that tax policy will probably get even worse in the future because of aging populations and poorly designed entitlement programs.

Let’s close with some more numbers.

Here’s Table 2-5 from the report. It shows changes in the value-added tax (VAT) beginning in December 2008.

The key thing to notice is that there’s no column for decreases in the VAT. That’s because no nation lowered that levy. Practically speaking, this hidden form of a national sales tax is a money machine for bigger government.

But you don’t have to believe me. The International Monetary Fund unintentionally provided the data showing that VATs are the most effective tax for financing bigger government.

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There’s an old saying that there’s no such thing as bad publicity.

That may be true if you’re in Hollywood and visibility is a key to long-run earnings.

But in the world of public policy, you don’t want to be a punching bag. And that describes my role in a book excerpt just published by Salon.

Jordan Ellenberg, a mathematics professor at the University of Wisconsin, has decided that I’m a “linear” thinker.

Here are some excerpts from the article, starting with his perception of my view on the appropriate size of government, presumably culled from this blog post.

Daniel J. Mitchell of the libertarian Cato Institute posted a blog entry with the provocative title: “Why Is Obama Trying to Make America More Like Sweden when Swedes Are Trying to Be Less Like Sweden?” Good question! When you put it that way, it does seem pretty perverse.  …Here’s what the world looks like to the Cato Institute… Don’t worry about exactly how we’re quantifying these things. The point is just this: according to the chart, the more Swedish you are, the worse off your country is. The Swedes, no fools, have figured this out and are launching their northwestward climb toward free-market prosperity.

I confess that he presents a clever and amusing caricature of my views.

My ideal world of small government and free markets would be a Libertopia, whereas total statism could be characterized as the Black Pit of Socialism.

But Ellenberg’s goal isn’t to merely describe my philosophical yearnings and policy positions. He wants to discredit my viewpoint.

So he suggests an alternative way of looking at the world.

Let me draw the same picture from the point of view of people whose economic views are closer to President Obama’s… This picture gives very different advice about how Swedish we should be. Where do we find peak prosperity? At a point more Swedish than America, but less Swedish than Sweden. If this picture is right, it makes perfect sense for Obama to beef up our welfare state while the Swedes trim theirs down.

He elaborates, emphasizing the importance of nonlinear thinking.

The difference between the two pictures is the difference between linearity and nonlinearity… The Cato curve is a line; the non-Cato curve, the one with the hump in the middle, is not. …thinking nonlinearly is crucial, because not all curves are lines. A moment of reflection will tell you that the real curves of economics look like the second picture, not the first. They’re nonlinear. Mitchell’s reasoning is an example of false linearity—he’s assuming, without coming right out and saying so, that the course of prosperity is described by the line segment in the first picture, in which case Sweden stripping down its social infrastructure means we should do the same. …you know the linear picture is wrong. Some principle more complicated than “More government bad, less government good” is in effect. …Nonlinear thinking means which way you should go depends on where you already are.

Ellenberg then points out, citing the Laffer Curve, that “the folks at Cato used to understand” the importance of nonlinear analysis.

The irony is that economic conservatives like the folks at Cato used to understand this better than anybody. That second picture I drew up there? …I am not the first person to draw it. It’s called the Laffer curve, and it’s played a central role in Republican economics for almost forty years… if the government vacuums up every cent of the wage you’re paid to show up and teach school, or sell hardware, or middle-manage, why bother doing it? Over on the right edge of the graph, people don’t work at all. Or, if they work, they do so in informal economic niches where the tax collector’s hand can’t reach. The government’s revenue is zero… the curve recording the relationship between tax rate and government revenue cannot be a straight line.

So what’s the bottom line? Am I a linear buffoon, as Ellenberg suggests?

Well, it’s possible I’m a buffoon in some regards, but it’s not correct to pigeonhole me as a simple-minded linear thinker. At least not if the debate is about the proper size of government.

I make this self-serving claim for the simple reason that I’m a big proponents of the Rahn Curve, which is …drum roll please… a nonlinear way of looking at the relationship between the size of government and economic performance. And just in case you think I’m prevaricating, here’s a depiction of the Rahn Curve that was excerpted from my video on that specific topic.

Moreover, if you click on Rahn Curve category of my blog, you’ll find about 20 posts on the topic. And if you type “Rahn Curve” in the search box, you’ll find about twice as many mentions.

So why didn’t Ellenberg notice any of this research?

Beats the heck out of me. Perhaps he made a linear assumption about a supposed lack of nonlinear thinking among libertarians.

In any event, here’s my video on the Rahn Curve so you can judge for yourself.

And if you want information on the topic, here’s a video from Canada and here’s a video from the United Kingdom.

P.S. I would argue that both the United States and Sweden are on the downward-sloping portion of the Rahn Curve, which is sort of what Ellenberg displays on his first graph. Had he been more thorough in his research, though, he would have discovered that I think growth is maximized when the public sector consumes about 10 percent of GDP.

P.P.S. Ellenberg’s second chart puts the U.S. and Sweden at the same level of prosperity. Indeed, it looks like Sweden is a bit higher. That’s certainly not what we see in the international data on living standards. Moreover, Ellenberg may want to apply some nonlinear thinking to the data showing that Swedes in America earn a lot more than Swedes still living in Sweden.

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The title of this post sounds like the beginning of a strange joke, but it’s actually because we’re covering three issues today.

Our first topic is corporate taxation. More specifically, we’re looking at a nation that seems to be learning that it’s foolish the have a punitive corporate tax system.

By way of background, the United States used to have the second-highest corporate tax rate in the developed world.

But then the Japanese came to their senses and reduced their tax rate on companies, leaving America with the dubious honor of having the world’s highest rate.

So did the United States respond with a tax cut in order to improve competitiveness? Nope, our rate is still high and the United States arguably now has the world’s worst tax system for businesses.

But the Japanese learned if a step in the right direction is good, then another step in the right direction must be even better.

The Wall Street Journal reports that Japan will be lowering its corporate tax rate again.

Japan’s ruling party on Tuesday cleared the way for a corporate tax cut to take effect next year… Reducing the corporate tax rate, currently about 35%, is a long-standing demand of large corporations. They say they bear an unfair share of the burden and have an incentive to move plants overseas to where taxes are lower. …Business leaders want the rate to fall below 30% within the next few years and eventually to 25%… The Japan Business Federation, known as Keidanren, says tax cuts could partly pay for themselves by spurring investment. Japan’s current corporate tax rate is higher than most European and Asian countries, although it is lower than the U.S. level of roughly 40%.

If only American politicians could be equally sensible.

The Japanese (at least some of them) even understand that a lower corporate rate will generate revenue feedback because of the Laffer Curve.

I’ve tried to make the same point to American policymakers, but that’s like teaching budget calculus to kids from the fiscal policy short bus.

Let’s switch gears to our second topic and look at what one veteran wrote about handouts from Uncle Sam.

Here are excerpts from his column in the Washington Post.

Though I spent more than five years on active duty during the 1970s as an Army infantry officer and an additional 23 years in the Reserves, I never fired a weapon other than in training, and I spent no time in a combat zone. …nearly half of the 4.5 million active-duty service members and reservists over the past decade were never deployed overseas. Among those who were, many never experienced combat. …support jobs aren’t particularly hazardous. Police officers, firefighters and construction workers face more danger than Army public affairs specialists, Air Force mechanics, Marine Corps legal assistants, Navy finance clerks or headquarters staff officers.

So what’s the point? Well, this former soldier thinks that benefits are too generous.

And yet, the benefits flow lavishly. …Even though I spent 80 percent of my time in uniform as a reservist, I received an annual pension in 2013 of $24,990, to which I contributed no money while serving. …My family and I have access to U.S. military bases worldwide, where we can use the fitness facilities at no charge and take advantage of the tax-free prices at the commissaries and post exchanges. The most generous benefit of all is Tricare. This year I paid just $550 for family medical insurance. In the civilian sector, the average family contribution for health care in 2013 was $4,565… Simply put, I’m getting more than I gave. Tricare for military retirees and their families is so underpriced that it’s more of a gift than a benefit. …budget deficits are tilting America toward financial malaise. Our elected representatives will have to summon the courage to confront the costs of benefits and entitlements and make hard choices. Some “no” votes when it comes to our service members and, in particular, military retirees will be necessary.

The entire column is informative and thoughtful. My only quibble is that it would be more accurate to say “an expanding burden of government is tilting America toward financial malaise.”

But I shouldn’t nitpick, even though I think it’s important to focus on the underlying problem of spending rather than the symptom of red ink.

Simply stated, it’s refreshing to read someone who writes that his group should get fewer taxpayer-financed goodies. And I like the idea of reserving generous benefits for those who put their lives at risk, or actually got injured.

Last but not least, I periodically share stories that highlight challenging public policy issues, even for principled libertarians.

You can check out some of my prior examples of “you be the judge” by clicking here.

Today, we have another installment.

The New York Times has reported that a mom and dad in the United Kingdom were arrested because their kid was too fat.

The parents of an 11-year-old boy were arrested in Britain on suspicion of neglect and child cruelty after authorities grew alarmed about the child’s weight. The boy, who like his parents was not identified, weighed 210 pounds. …In a statement, the police said that “obesity and neglect of children” were sensitive issues, but that its child abuse investigation unit worked with health care and social service agencies to ensure a “proportionate and necessary” response. The police said in the statement that “intervention at this level is very rare and will only occur where other attempts to protect the child have been unsuccessful.”

So was this a proper example of state intervention?

My instinct is to say no. After all, even bad parents presumably care about their kids. And they’ll almost certainly do a better job of taking care of them than a government bureaucracy.

But there are limits. Even strict libertarians, for instance, will accept government intervention if parents are sadistically beating a child.

And if bad parents were giving multiple shots of whiskey to 7-year olds every single night, that also would justify intervention in the minds of almost everybody.

On the other hand, would any of us want the state to intervene simply because parents don’t do a good job overseeing homework? Or because they let their kids play outside without supervision (a real issue in the United States, I’m embarrassed to admit)?

The answer hopefully is no.

But how do we decide when we have parents who are over-feeding a kid?

My take, for what it’s worth, is that the size of kids is not a legitimate function of government. My heart might want there to be intervention, but my head tells me that bureaucrats can’t be trusted to exercise this power prudently.

P.S. I guess “bye bye burger boy” in the United Kingdom didn’t work very well.

P.P.S. But the U.K. government does fund foreign sex travel, and that has to burn some calories.

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Our leftist friends have decided that income inequality is a scourge that must be addressed.

That might be a noble goal if they were motivated by a desire to improve the lives of the less fortunate.

Based on their policy proposals, though, it appears that the main goal is to punish the so-called rich. And they’re so fixated on that objective, Margaret Thatcher pointed out, that they’re willing to make the poor worse off.

And what’s especially bizarre is that rich leftists are among the biggest cheerleaders for these policies. Heck, I’ve even debated some of these limousine liberals, as you can see here and here.

But maybe their feelings of self-loathing and guilt are justified. After all, it seems that statist policies are actually associated with higher degrees of income inequality.

Let’s see what Steve Moore and Rich Vedder discovered when they looked at evidence from the states. Here are excerpts from their column in the Wall Street Journal.

Our state-by-state analysis finds that the more liberal states whose policies are supposed to promote fairness have a bigger gap between higher and lower incomes than do states that have more conservative, pro-growth policies. …According to 2012 Census Bureau data (the latest available figures), the District of Columbia, New York, Connecticut, Mississippi and Louisiana have the highest measure of income inequality of all the states; Wyoming, Alaska, Utah, Hawaii and New Hampshire have the lowest Gini coefficients. The three places that are most unequal—Washington, D.C., New York and Connecticut—are dominated by liberal policies and politicians. Four of the five states with the lowest Gini coefficients—Wyoming, Alaska, Utah and New Hampshire—are generally red states.

Steve and Rich then look at some specific comparison and some specific issues.

Texas is often regarded as an unregulated Wild West of winner-take-all-capitalism, while California is held up as the model of progressive government. Yet Texas has a lower Gini coefficient (.477) and a lower poverty rate (20.5%) than California (Gini coefficient .482, poverty rate 25.8%). Do the 19 states with minimum wages above the $7.25 federal minimum have lower income inequality? Sorry, no. States with a super minimum wage like Connecticut ($8.70), California ($8), New York ($8) and Vermont ($8.73) have significantly wider gaps between rich and poor than those states that don’t. What about welfare benefits? …In general, the higher the benefit package, the higher the Gini coefficient. States with high income-tax rates aren’t any more equal than states with no income tax.

So what’s the bottom line?

The conclusion is nearly inescapable that liberal policy prescriptions—especially high income-tax rates and the lack of a right-to-work law—make states less prosperous because they chase away workers, businesses and capital. …When politicians get fixated on closing income gaps rather than creating an overall climate conducive to prosperity, middle- and lower-income groups suffer most and income inequality rises. …John F. Kennedy had it right that a rising tide lifts all boats. It would be better for low- and middle-income Americans if growth and not equality became the driving policy goal in the states and in Washington, D.C.

Speaking of rich, guilt-ridden leftists, Michael Moore is getting divorced and the fight with his soon-to-be ex is resulting in some revelations about the immense wealth of this anti-capitalist crusader.

Here are some eye-catching details from a story in the UK-based Daily Mail.

According to Celebrity Worth, Moore has $50m in assets. …the Torch Lake mansion…put a spotlight on his wealth and opened him up for ridicule because he has so often criticized the rich in his films. …The home, which was completed years ago, is believed to cost in the neighborhood of $2m. …The lake house isn’t their only home. They own a total of nine properties in Michigan and New York. Their Manhattan condo was created through ‘the combination of three separate units,’ according to The Smoking Gun. …Together Moore and Glynn own ‘multiple substantial residences and multiple companies,’ including Dog Eat Dog Films, the production company behind films Roger & Me and Bowling for Columbine.

Nine properties, including a lakefront mansion and a three-units-combined-into-one Manhattan condo?!?

Who knew bashing the rich was such a lucrative gig.

Geesh, I’m a defender of the top 1 percent and I only have a house in Virginia.

I’m obviously doing something wrong.

P.S. While rich leftists say they want higher taxes, they’ve been exposed on camera as complete hypocrites.

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In previous columns, I’ve explained why a wealth tax is a very bad idea. And I’ve also pontificated on why leftists are wrong to pursue policies of coerced equality.

So it goes without saying that I’m a big fan of a new Wall Street Journal column by John Steele Gordon.

He writes that the anti-wealth ideology animating the political elite is based on a fundamental misunderstanding of how large fortunes are generated.

He starts by pointing out that many of today’s richest people earned their money as a result of the microprocessor, a technological development that has dramatically improved the lives of ordinary people.

The French economist Thomas Piketty, in his new book “Capital in the 21st Century,” calls for an 80% tax on incomes over $250,000 and a 2% annual tax on net worth in order to prevent an excessive concentration of wealth. That is a monumentally bad idea. The great growth of fortunes in recent decades is not a sinister development. Instead it is simply the inevitable result of an extraordinary technological innovation, the microprocessor… Seven of the 10 largest fortunes in America today were built on this technology, as have been countless smaller ones. …no one is poorer because Bill Gates, Larry Ellison, et al., are so much richer. These new fortunes came into existence only because the public wanted the products and services—and lower prices—that the microprocessor made possible.

He then points out that this is actually a consistent pattern through history.

New technologies make us better off, and also create riches for those who most effectively bring those new developments to consumers.

Whenever a new technology comes along that greatly reduces the cost of a fundamental input to the economy, or makes possible what had previously been impossible, there has always been a flowering of great new fortunes—often far larger than those that came before. …The full-rigged ship that Europeans developed in the 15th century, for instance, was capable of reaching the far corners of the globe. …The Dutch exploited the new trade so successfully that the historian Simon Schama entitled his 1987 book on this period of Dutch history “The Embarrassment of Riches.” …Before James Watt’s rotary steam engine, patented in 1781, only human and animal muscles, water mills and windmills could supply power. But with Watt’s engine it was suddenly possible to input vast amounts of very-low-cost energy into the economy. Combined with the factory system of production, the steam engine sparked the Industrial Revolution, causing growth—and thus wealth as well as job creation—to sharply accelerate. By the 1820s so many new fortunes were piling up that the English social critic John Sterling was writing, “Wealth! Wealth! Wealth! Praise to the God of the 19th century! The Golden Idol! The mighty Mammon!” In 1826 the young Benjamin Disraeli coined the word millionaire to denote the holders of these new industrial fortunes. …before the railroad, moving goods overland was extremely, and often prohibitively, expensive. The railroad made it cheap. Such fortunes as those of the railroad-owning Vanderbilts, Goulds and Harrimans became legendary for their size. …Many of the new fortunes in America’s Gilded Age in the late 19th century were based on petroleum, by then inexpensive and abundant thanks to Edwin Drake’s drilling technique. Steel, suddenly made cheap thanks to the Bessemer converter, could now have a thousand new uses. Oil and steel, taken together, made the automobile possible. That produced still more great fortunes, not only in car manufacturing, but also in rubber, glass, highway construction and such ancillary industries.

Gordon then concludes by warning against class-warfare tax policy, since it would discourage the risk-taking that necessarily accompanies big investments in new technology.

Any attempt to tax away new fortunes in the name of preventing inequality is certain to have adverse effects on further technology creation and niche exploitation by entrepreneurs—and harm job creation as a result. The reason is one of the laws of economics: Potential reward must equal the risk or the risk won’t be taken. And the risks in any new technology are very real in the highly competitive game that is capitalism. In 1903, 57 automobile companies opened for business in this country, hoping to exploit the new technology. Only the Ford Motor Co. survived the Darwinian struggle to succeed. As Henry Ford’s fortune grew to dazzling levels, some might have decried it, but they also should have rejoiced as he made the automobile affordable for everyman.

My only complaint about Gordon’s column is that he didn’t have the space to emphasize a related point.

All of the large fortunes that he discusses were not accumulated at the expense of those with less money.

In other words, the economy was not a fixed pie. Capitalism made everybody better off. Some just got richer faster than other people got richer.

P.S. I wrote the other day about the VA scandal and emphasized that the problem was not inadequate spending.

I want to revisit the issue because Professor Glenn Reynolds makes a very important point about greed in a column for USA Today.

People sometimes think that government or “nonprofit” operations will be run more honestly than for-profit businesses because the businesses operate on the basis of “greed.” But, in fact, greed is a human characteristic that is present in any organization made up of humans. It’s all about incentives. And, ironically, a for-profit medical system might actually offer employees less room for greed than a government system. That’s because VA patients were stuck with the VA. If wait times were long, they just had to wait, or do without care. In a free-market system, a provider whose wait times were too long would lose business, and even if the employees faked up the wait-time numbers, that loss of business would show up on the bottom line. That would lead top managers to act, or lose their jobs. In the VA system, however, the losses didn’t show up on the bottom line because, well, there isn’t one. Instead, the losses were diffused among the many patients who went without care — visible to them, but not to the people who ran the agency, who relied on the cooked-books numbers from their bonus-seeking underlings. …that’s the problem with socialism. The absence of a bottom line doesn’t reduce greed and self-dealing — it removes a constraint on greed and self-dealing.

Amen.

Greed is always with us. The question is whether greed is channeled in productive ways. In a free market, greedy people can only become rich by providing the rest of us with valuable goods and services.

In statist systems, by contrast, greedy people manipulate coercive government policies in order to obtain unearned wealth.

And that choice has big consequences for the rest of us, as illustrated by this satirical image.

P.S. Here’s a cartoon from Robert Ariail that sums up how Washington will probably deal with the mess at the Veterans Administration.

Sort of reminds me of this Gary Varvel cartoon.

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I haven’t spent much time writing about Thomas Piketty’s inequality book for the simple reason that my goal is economic liberty, not equality.

That being said, I think that Piketty is fundamentally misguided even if the goal is helping the poor. Simply stated, long-run growth is the best way of reducing poverty and boosting living standards. Piketty, by contrast, focuses on redistribution – even though this would require punitive taxation, thus undermining growth and hurting the less fortunate.

This is very obvious when we look at economic performance in market-oriented nations and compare it to economic performance in countries where government plays a bigger role.

Most recently, I showed how Poland is out-pacing Ukraine.

I’ve compared South Korea and North Korea.

The data for Chile, Argentina, and Venezuela is very powerful.

I’ve shown how Singapore has eclipsed Jamaica.

And we can see that Hong Kong has caught up with the United States.

As I often remark in my speeches, I’d much rather be a poor person in a jurisdiction such as Hong Kong or Singapore rather than in a “compassionate” country such as France.

France might give me lots of handouts, but I’d remain poor. In a free-market society, by contrast, I could climb out of poverty.

Anyhow, let’s return to Piketty’s thesis about the rich benefiting from capital accumulation. All sorts of scholars have called into question his theoretical model and his empirical data, but I don’t even care if Piketty’s right. In a free society, the worst thing that happens is that the rich get richer faster than the poor get richer.

That’s why we should concentrate on what we can do to boost growth.

And there is one economic reform that is good for growth, but would be especially beneficial for lower-income people. Merrill Matthews of the Institute for Policy Innovation, in a column for Forbes, makes a powerful case for Social Security reform.

He starts with the essential insight that policy makers should focus on helping the poor, not penalizing success.

French economist Thomas Piketty wants to attack the issue of income inequality by redistributing the wealth of the highest earners. Wouldn’t a better solution be to increase the wealth of the lowest earners?

Merrill says we should make it easier for the overall population to become capitalists.

…instead of taxing that success even more than we already do, which discourages capital development and investment, Washington can help lower- and middle-income workers acquire capital so they too can partake in those higher returns.

He then points out that workers are forced to participate in a Social Security system that imposes very high taxes in exchange for rather meager benefits.

Eugene Steuerle and Caleb Quakenbush of the Urban Institute publish an annual estimate of how much workers at different income levels and marriage status pay into Social Security and Medicare and how much they can expect to receive in benefits. Their 2013 report estimates that a single male worker earning the average income of $44,800 (in 2013 dollars) turning 65 in 2015 can expect to receive $287,000 in Social Security benefits. However, that worker paid in $337,000, for a net loss of about $50,000. Both estimates assume a growth rate of 2 percent, which happens to match Piketty’s projection of long-term GDP growth. That disparity between contributions and benefits declines significantly for women, who tend to live longer. A single female worker would have paid in the same amount, $337,000, but could expect to receive $314,000.

Now we get to his proposed reform.

…what if workers were able to put that same amount of money—their 12.4 percent Social Security (FICA) tax; $5,555 in Stererle’s example—into a personal retirement account that could be invested in broad-based equities?

With personal retirement accounts, ordinary workers can generate big nest eggs.

Using an interest calculator, a $5,555 annual contribution over 40 years at 6 percent grows to about $970,000. Factor in that wealth and income inequality largely evaporates. …if the left is really concerned about income inequality, the best way to end it is wealth creation, not redistribution. Replacing Social Security’s financially struggling system with personal retirement accounts would create real wealth for millions of working Americans.

As you can imagine, I heartily concur. Here’s the video I narrated on the topic for the Center for Freedom and Prosperity.

By the way, if you think the stock market is too risky, particularly after the recent financial crisis, one of my Cato colleagues produced a thorough study showing that people who retired right after the market fell still would have been better off with personal accounts.

P.S. If you want to understand why class-warfare tax policy will backfire, another one of my colleagues dismantled the work of Piketty and others.

P.P.S. You can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke, though I’m not sure we should laugh considering that tens of millions of Americans will suffer when the system no longer can afford to pay promised benefits.

P.P.P.S. Obama’s supposed solution would be an even bigger move in the wrong direction.

P.P.P.P.S. Last but definitely not least, watch Margaret Thatcher destroy the left’s position on income distribution.

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I’m in Vancouver, Canada, for the biennial meeting of the World Taxpayers Associations.

I gave a speech on why tax competition is a valuable force to constrain the greed of the political class, but warned the audience that high-tax governments and international bureaucracies are using financial protectionism to coerce low-tax jurisdictions into weakening their good policies.

But regular readers know that I pontificate far too often on that topic, so today’s column is instead about a presentation by Michael Walker, who was the founding Executive Director at Canada’s Fraser Institute.

Michael’s great contribution to the world was the creation of the Economic Freedom of the World Index, which he developed working with scholars such as Milton Friedman.

I’ve cited the EFW Index many times, particularly to bemoan how America’s score has deteriorated during the Bush-Obama years.

Today, though, we’re going to look at global trends in economic freedom, using some of the slides from Michael’s presentation. And the good news, as you can see from the green line in this first chart, is that there was a significant increase in economic freedom between 1980 and 2010.

EFW Economic Freedom(1)

The blue line, by the way, shows how much nations differed. A higher blue line means more variation (in other words, some nations with very good scores and some with very bad scores), while a lower blue lines means that nations are converging.

To really understand what’s happening, however, it’s important to look at the component parts of the EFW Index. As I wrote back in 2012:

…a country’s economic performance is governed by a wide range of policies.

Indeed, the research suggests that there are five big factors that determine prosperity, and they’re all equally important.

Rule of law and property rights

Sound money

Fiscal policy

Trade policy

Regulatory policy

So let’s look at what’s been happening in each of these areas. Keep in mind, as we look at the following charts, that 10 is the best score.

We’ll start with fiscal policy. As you can see, policy was moving in the wrong direction from 1970 to 1985, then we got two decades of pro-growth changes, but now policy is again trending in the wrong direction.

EFW Size of Government

We’re still better off than we were 30 years ago, but I’m afraid scores will continue to decline because tax rates are now heading in the wrong direction and the burden of government spending is rising in many nations.

Now let’s look at the regulatory data. The trend may not be dramatic, but it is positive. The green line is gradually rising, showing that governments are easing red tape and reducing intervention.

EFW Regulation

Moreover, there’s no sign that policy is moving in the wrong direction, at least on a global basis.

Shifting to trade, we have perhaps the biggest success story in global economic policy. Between 1980 and 200, there was a dramatic increase in the freedom to trade.

EFW Free Trade

We also see some progress on monetary policy, both in that it stopped moving in the wrong direction in 1975 and then moved in the right direction beginning in 1995.

EFW Sound Money

Though I confess some skepticism about this measure. Central banks have created a lot of problems with excess liquidity, but they generally escape blame so long as easy-money policies don’t result in higher consumer prices.

This brings us to our final category. Property rights and the rule of law are very important for market economies, but unfortunately we’ve seen no long-run improvement in these key measures. Positive change between 1975 and 1995 is offset by movement in the wrong direction at other times.

EFW Rule of Law

Indeed, if we look at this next chart, which measures the distribution of scores for each category in 2010, you’ll see that nations get their lowest scores on rule of law and property rights.

EFW Five Factors

This aggregate data, while very useful, does not tell the entire story. If you look at various regions, you’ll discover that “first world” nations tend to get decent scores on rule of law and property rights while developing nations get poor scores.

Indeed, this is why the blue line in the rule of law/property rights chart is so much higher than it is for other categories. Simply stated, this is one area where there hasn’t been much convergence.

Which is a big reason why many developing nations are economic laggards, even if they get reasonably good scores in other categories.

Here’s a final chart that emphasizes that point. It shows nations that get the best scores on the size of government (left column), but then shows that many of them get very poor scores for rule of law and property rights (right column).

The fiscal burden of government is very low in nations such as Lebanon and Bangladesh, for instance, but these jurisdictions don’t attract a lot of investment or enjoy much growth because government fails to provide the right environment.

EFW Size of Government vs Rule of Law Challenge

All of which shows why Hong Kong, Singapore, and Switzerland deserve special praise. They have strong rule of law and property rights while simultaneously maintaining reasonable limits on the fiscal burden of the public sector. No wonder they are ranked first, second, and fourth in overall economic freedom.

And it’s worth noting that a few other nations deserve honorable mention for getting good fiscal policy scores while doing a decent job on the rule of law and property rights, specifically Bahamas (#39), Chile (#11), Mauritius (#6), and United Arab Emirates (#5).

By the way, the United States only got a 6.4 for size of government and a 7.1 for rule of law and property rights. No wonder America is only #17 in the overall rankings.

Back in 2000, when the United States ranked #3, we got a 7.0 for size of government and a 9.2 for rule of law and property rights.

So now you now know why I complain so much about Bush and Obama. And you especially know why I’m so concerned about the erosion of the rule of law under Obama.

P.S. A Spanish academic has developed some fascinating historical data on non-fiscal economic freedom, which is very helpful in understanding how the western world has managed to remain somewhat prosperous even though the fiscal burden of government increased dramatically in the 20th Century.

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On many occasions, I’ve explained that economic output is a function of how much labor and capital are productively utilized.

This is why I relentlessly criticize policies that undermine GDP growth by hindering the use of these “factors of production.”

That’s a bit of economic jargon, but it helps to explain why we shouldn’t be discriminating against capital by double taxing income that is saved and invested.

And it helps to explain why we shouldn’t be discouraging labor by subsidizing unemployment and idleness.

But it’s time to issue a very important caveat. The goal of policy should be economic freedom, not maximizing GDP.

There’s nothing wrong with people choosing to be out of the labor force – so long as they’re not expecting taxpayers to pay their expenses.

Many women, for instance, may want to be at home with children, particularly during their younger years.

Moreover, some older workers may want to retire early.

So while I think it’s bad news that labor force participation has dropped under Obama, there’s more than one possible way to look at that data when you factor in the voluntary choices of some segments of the potential workforce.

But it’s very difficult to give any sort of optimistic or positive spin to these numbers from the Senate Budget Committee. They show a very worrisome trend among prime-working-age men.

These are people who should be in the labor force.

Here’s what John Hinderaker at Powerline wrote about these sobering figures.

An unprecedented number of men–one in six–between the ages of 25 and 54, what should be their prime earning years, are either unemployed or out of the work force entirely.

Here’s the breakdown.

One in eight, the highest proportion since record-keeping began in 1955, are out of the labor forceAnother 2.9 million men in the 25-54 age group haven’t given up–they are still in the labor force–but are currently unemployed.

And here are the consequences.

…the damage done to a generation of American men (and women too, of course) will not easily be undone. Those who missed a chunk of what should have been their most productive years, or departed the labor force entirely, will suffer from Obamanomics for the rest of their lives. The damage being done by our current, inept economic policies is literally incalculable.

Here’s another chart, this one comparing idleness among men in 2007 and 2014.

So how do we fix this problem, keeping in mind that this is not a partisan issue since the bad trend started under Bush?

The big-picture answer is free markets and small government.

In other words, you create jobs by having Washington get out of the way.

P.S. Over the years, the President has made some remarkable statements.

  • In my video on class warfare, I noted that Obama said in 2008 that – for reasons of “fairness” – he wanted to raise the capital gains tax even if the government lost revenue.
  • A couple of years ago, he arrogantly remarked that “at some point you have made enough money.”
  • In 2011, the President was complaining about bank fees and asserted that, “you don’t have some inherent right just to, you know, get a certain amount of profit…”
  • And in 2012, Obama made his infamous “you didn’t build that” statement, which generated some very amusing political cartoons.

With these statements in mind, here’s some Obama humor.

No substantive policy message, I’ll admit, but still funny. Sort of like this t-shirt, this Pennsylvania joke, this Reagan-Obama comparison, this Wyoming joke, this Bush-Obama comparison, this video satire, and this bumper sticker.

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