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Posts Tagged ‘Fiscal Policy’

Remember when Paul Krugman warned that there was a plot against France? He asserted that critics wanted to undermine the great success of France’s social model.

I agreed with Krugman, at least in the limited sense that there is a plot against France. But I explained that the conspiracy to hurt the nation was being led by French politicians.

Simply stated, my view has been that the French political elite have been taxing the nation into stagnation and decline and there is every reason to think that the nation is heading toward a severe self-inflicted fiscal crisis.

But it turns out I may have been too optimistic. Let’s look at some updates from Krugmantopia.

We’ll start with a report from the Financial Times, which captures the nation’s sense of despair.

…if the country’s embattled socialist president was hoping for some respite from what has been a testing year, he can probably think again. … the French economy barely expanded during the second quarter of this year after stagnating in the first. …the result will make it all but impossible to achieve the government’s growth forecast for 2014 of 1 per cent… Bruno Cavalier, chief economist at Oddo & Cie, the Paris-based bank, says one reason is the huge constraint on disposable income posed by France’s tax burden, which has risen from 41 per cent of GDP in 2009 to 45.7 per cent last year – one of the highest in the eurozone.

The government has responded by rearranging the deck chairs on the political Titanic.

French President Francois Hollande dissolved the government on Monday after open feuding among his Cabinet over the country’s stagnant economy. …France has had effectively no economic growth this year, unemployment is hovering around 10 percent and Hollande’s approval ratings are sunk in the teens. …Hollande’s promises to cut taxes and make it easier for businesses to open and operate have stalled, in large part because of the divisions among his Socialist party.

For what it’s worth, Hollande’s commitment to tax cuts and deregulation is about as sincere and genuine as my support for the Florida Gators.

After all, he’s the guy who imposed a new top tax rate of 75 percent (which he said was “patriotic”)

And that’s just the personal income tax. When you add other taxes to the mix, you get a system that is so onerous that more than 8,000 households paid more than 100 percent of their income to the French government!

No wonder successful people are escaping to other nations.

By the way, if you’re wondering why Hollande is appointing new people to his government, it’s because some of his ministers were complaining that so-called austerity was inhibiting Keynesian spending policies that would make government even bigger!

Austerity measures being pursued by France and elsewhere in the euro zone are quashing growth, FrenchEconomy Minister Arnaud Montebourg was quoted saying on Saturday… The outspoken minister, a fierce critic of budget austerity, is known for frequent attacks on big business and the European Commission, which he accuses of strangling economic recovery with its prioritization of deficit reduction. …While not as strident as the comments by Montebourg, French Finance Minister Michel Sapin similarly argued for moderated deficit reduction in an interview published in Italian newspaper La Repubblica. “The euro zone is at risk of getting stuck in a spiral of weak or negative growth. We absolutely must slow down the rate of deficit reduction,” Sapin was quoted as saying.

In other words, the French policy debate is between the far left and the crazy left.

Which is why this dour assessment from across the English Channel probably understates the depth of the problem.

Since Francois Hollande was elected President in 2012, French GDP per capita has fallen. Its economy is expected to grow by just 0.7 per cent this year. …the country now looks set for stagnation – with its unemployment rate entrenched above 10 per cent (and youth unemployment double that). …the problems are obvious. The French government accounts for a massive 57.1 per cent of the economy in state spending and transfers. The tax burden is so high at 57 per cent for French employees (the sum of income, payroll taxes, VAT, and social security contributions as a proportion of the gross employment cost)… The World Economic Forum says that France is near the worst performer on a host of measures: positioned 130 out of 148 countries for its regulatory burden, 134 for the tax rates on profits, 135 on cooperation in labour-employer relations, and 144 on hiring and firing practices. …No wonder investors have voted with their wallets. FDI into France is estimated to have fallen by 95 per cent in the last decade.

Wow. No wonder the French people are so glum about the economy, as reported by the EU Observer.

…in France, the eurozone’s second biggest economy, eight percent felt the country’s economy was good. …Only 34 percent feel the jobs crisis has peaked compared with 60 percent who are bracing themselves for a darker economic future.

Which raises a good question. If the French people are so pessimistic about the future, why do they keep electing socialists?!?

Particularly when they tell pollsters they support smaller government!

Last but not least, we have a story from the New York Times about the mind-boggling regulation and protectionism that , mostly because it illustrates the pervasive statism that is strangling France.

Alexandre Chartier and Benjamin Gaignault work off Apple computers and have no intention of ever using the DVD player tucked in the corner of their airy office. But French regulations demand that all driving schools have one, so they got one. Mr. Chartier, 28, and his partner, Mr. Gaignault, 25, are trying to break into the driving school business here… But they are not having an easy time. The other driving schools have sued them, saying their innovations break the rules. …their struggle highlights how the myriad rules governing driving schools — and 36 other highly regulated professions — stifle competition and inflate prices in France.

And what are these rules and regulations, other than the bizarre requirement to own a DVD player?

“The system is absurd,” said Mr. Koenig, who was a speechwriter for Christine Lagarde when she was the French finance minister. …he has been campaigning for changes, including calling for an overhaul of the written test, which he says goes far beyond making sure that a person knows the rules of the road. Instead, he said, it seems intended to trip students up with ridiculous questions, such as: If you run headlong into a wall, would you be safer if you were in a tank or in a car? (The answer: a car, because it has air bags.) …Some studies have concluded that the French are probably paying 20 percent more than they should for the services they get from regulated professions, which include notaries, lawyers, bailiffs, ambulance drivers, court clerks, driving instructors and more. …Francis Kramarz, an economist who has studied the French licensing system, says that barriers to getting a license are so high that about one million French people, who should have licenses, have never been able to get them. …Mr. Kramarz said that it often costs 3,000 euros, or about $3,900, to get a license. But others said the average was closer to 1,500 to 2,000 euros.

Gee, isn’t big government wonderful!

The statists say it helps the less fortunate, but it seems the poor are the ones most hurt by regulations that push the cost of getting a license to $2,000 or above.

P.S. In an uncharacteristic expression of mercy, President Hollande has announced that he wants to limit the fiscal burden so that no taxpayer has to surrender more than 80 percent  of their income to the government.

P.P.S. No wonder Obama will never make America as bad as France, regardless of how hard he tries.

P.P.P.S. Here’s the best-ever cartoon about French economic policy, though this cartoon deserves honorable mention.

P.P.P.P.S. Even the establishment, as indicated by stories in Newsweek and the New York Times (as well as The Economist and the BBC), is noticing that the French economy is dismal.

P.P.P.P.P.S. No matter how much I mock France, there are places in Europe with even worse economic policy.

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It’s remarkable to read that European politicians are agitating to spend more money, supposedly to make up for “spending cuts” and austerity.

To put it mildly, their Keynesian-based arguments reflect a reality-optional understanding of recent fiscal policy on the other side of the Atlantic.

Here’s some of what Leonid Bershidsky wrote for Bloomberg.

Just as France’s and Italy’s poor economic results prompt the leaders of the euro area’s second and third biggest economies to step up their fight against fiscal austerity, it might be appropriate to ask whether they even know what that is.

An excellent question. As I’ve already explained, austerity is a catch-all phrase that includes bad policy (higher taxes) and good policy (spending restraint).

But with a few notable exceptions, European nations have been choosing the wrong kind of austerity (even though Paul Krugman doesn’t seem to know the difference).

As a result, the real problem of bloated government keeps getting worse.

Government spending in the European Union, and in the euro zone in particular, is now significantly higher than before the 2008 financial crisis. …Among the 28 EU members, public spending reached 49 percent of gross domestic product in 2013, 3.5 percentage points more than in 2007.

Here’s a chart showing how the burden of government spending has become more onerous since 2007.

As you can see, all the big nations of Western Europe have moved in the wrong direction.

Only a small handful of countries in Eastern Europe that have trimmed the size of the public sector.

Bershidsky does explain that the numbers today are slightly better than they were at the peak of the economic downturn, though not because of genuine fiscal restraint.

The spending-to-GDP-ratio first ballooned by 2009, exceeding 50 percent for the EU as a whole, and then shrank a little… That, however, was not the result of government’s austerity efforts: Rather, the spending didn’t go down as much as the economies collapsed, and then didn’t grow in line with the modest rebound.

Here are some examples he shared.

I suppose France deserves a special shout out for managing to expand the size of government between 2009 and 2013. That’s what you call real commitment to statism!

The article also cites an example that is both amusing and tragic, at least in the sense that there’s no genuine seriousness about reforming hte public sector.

Even when spending cuts are made…, the whole public spending system’s glaring inadequacy is not affected. …The ushers at the Italian Parliament, whose job is to carry messages in their imposing gold-braided uniforms, made $181,590 a year by the time they retired, but will only make as much as $140,000 after Renzi’s courageous cut. If you wonder what on earth could be wrong with getting rid of them altogether and just using e-mail, you just don’t get European public expenditure.

I particularly embrace Bershidsky’s conclusion.

There is no rational justification for European governments to insist on higher spending levels than in 2007. The post-crisis years have shown that in Italy, and in the EU was a whole, increased reliance on government spending drives up sovereign debt but doesn’t result in commensurate growth. The idea of a fiscal multiplier of more than one — every euro spent by the government coming back as a euro plus change in growth — obviously has not worked. In fact, increased government interference in the economy, in the form of higher borrowing and spending as well as increased regulation, have led to the shrinking of private credit.  …Unreformed government spending is a hindrance, not a catalyst for growth.

Amen.

Politicians will never want to hear this message, but government spending undermines economic performance by diverting resources from the the economy’s productive sector.

Here’s my video on the theoretical evidence against government spending.

And here’s the video looking at the empirical evidence against excessive spending.

P.S. Other Europeans who have correctly analyzed Europe’s spending problem include Constantin Gurdgiev and Fredrik Erixon.

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I’m in Australia for Consilium, an annual conference which is hosted by the Centre for Independent Studies.

I spoke on fiscal policy and pontificated on the need for nations to restrain government spending.

That’s an important message (at least in my humble option), but I thought it was more interesting to learn more about the tax and spending policies of Australia’s current government, which is led by the supposedly right-of-Center Liberal Party (Aussies still use “liberal” in the European sense of classical liberalism).

Unfortunately, I learned that the Australian Liberals (like British Tories) need some remedial work on fiscal policy.

Prime Minister Abbott and his team, for instance, have proposed to increase Australia’s top tax rate. Here’s some of what’s been reported by the Australian Financial Review.

The Abbott government’s deficit tax means top earners will face a 49 per cent marginal tax rate, the eighth ­highest among developed countries. …. Australia already holds one of the highest personal income and company tax rates in the OECD. The 30 per cent corporate tax rate and 45 per cent personal income tax rate are higher than the average of 25.32 per cent for companies and 41.51 per cent for individuals. A personal tax increase will worsen the impact of “bracket creep”. …a higher income tax rate could also make Australia less competitive globally.

And the AFR also reports that a visiting scholar has thrown cold water on the idea of mimicking European fiscal policy.

Professor Prescott, who won the Nobel Prize for ­economics in 2004, …said that at 49 per cent the top marginal tax rate would hurt growth and the government should redouble its efforts to bring down expenditure instead. “It’s too high,” said Professor Prescott, who has written on the negative impact of increased taxes on economic growth in Europe. “You’re killing the goose that lays the golden egg.” …Lamenting “as sad” the standard of public and academic debate over budget deficits – both here and abroad – Professor Prescott said the focus should be on productivity and ­government spending. “What matters is expenditure. To spend is to tax and to tax is to depress.”

So why is an ostensibly right-of-center government copying Obama’s class warfare tax policy?

Beats me, though I’m told it’s because the politicians in Canberra (the nation’s capital) thinks this will appease the left and show “fairness.”

I imagine that strategy will be a flop, just like the first President Bush didn’t win any friends when he capitulated to a tax hike in 1990.

In any event, the Australian Taxpayers’ Alliance warns that the tax hike may lose revenue because of Laffer Curve effects.

“The idea of increasing the top marginal tax rate in Australia is unlikely to raise any revenue, and may actually decrease government revenue due to a shrinking in the tax base, as high-income people reduce their labour supply, investment, innovation and tax compliance,” said John Humphreys, the deputy director of the Australian Taxpayers Alliance and an economics lecturer at the University of Queensland. …“Based on mainstream estimates of the high-income elasticity of taxable income, it is fairly straight forward to calculate the tax rate that will raise the maximum amount of revenue, and in Australia that is about 45%. If tax is increased beyond that level, then it is unlikely to raise revenue, and may actually cause a drop in revenue.…” The modeling by Humphreys is due to be published in Policy Journal in the coming months.

I’m skeptical about the finding that the revenue-maximizing rate for the personal income tax is 45 percent, particularly when there is very rigorous analysis suggesting that 20 percent is much closer to the mark.

But I definitely agree that pushing the rate to 49 percent will backfire on the Australian government.

And the folks at the ATA do make the very sound point that politicians shouldn’t try to set the top rate at the revenue-maximizing level regardless.

“There is no logical argument for increasing marginal tax rates about the revenue-maximising level, and indeed there is no good argument for having tax rates anywhere near the revenue-maximising level since those taxes raise very little money but cause significant economic damage.”

Amen. Indeed, allow me to call your attention to some very impressive academic work on this issue.

Now let’s shift to the spending side of Australian fiscal policy.

The good news is that the Abbott government isn’t proposing big increases in the burden of government spending.

The bad news, however, is that there doesn’t seem to be any commitment to a short-term or long-term effort to shrink the public sector.

Here’s a chart, based on IMF data, looking at what’s happened to Australian government spending over the past 20-plus years. The purple-ish line is nominal government spending (left axis) and the blue line is government spending as a share of economic output (right axis).

Australia Spending

In the long run, the trend of the blue line is the most important variable.

Unfortunately, the burden of government spending has climbed since the late 1980s. It’s still much lower than the burden of spending in places such as France, but the line is moving in the wrong direction.

On the other hand, if you look at the data since 2000, you could accurately say that Australian policy makers have succeeded in keeping the burden of spending from climbing above 34 percent of GDP (there was some foolish stimulus spending beginning back in 2009, but it didn’t lead to a permanent expansion in the size of government).

But let me share some remarkable data showing Australia’s missed fiscal opportunity. If you look at the IMF’s annual government spending and do the calculations, you’ll find that government spending since 1988 has grown by an average of 6.8 percent each year.

Since nominal GDP also has increased at a good pace, the actual burden of government has “only” risen from about 30 percent to 34 percent of economic output.

But imagine if Australian policy makers had merely imposed some version of Mitchell’s Golden Rule and limited spending so that it grew by, say, 3 percent annually.

If they had engaged in that modest level of fiscal restraint, the burden of the public sector today would be only about half its current size. In other words, government spending in Australia would be less than 17 percent of economic output, which would be even better than Hong Kong and Singapore.

This explains why I’m so fixated on expenditure limitations. You can make big progress over just a couple of decades if politicians somehow can be convinced to restrain the rate of growth of government spending.

Or, as the people of Switzerland figured out, you can enjoy that progress if you impose a spending limit on the politicians.

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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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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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Since I’m an economist, I generally support competition.

But it’s time to admit that competition isn’t always a good idea. Particularly when international bureaucracies compete to see which one can promote the most-destructive pro-tax policies.

For instance, I noted early last year that the bureaucrats at the Organization for Economic Cooperation and Development (OECD) were pushing a new scheme to increase the global tax burden on the business community.

Then I wrote later in the year that the International Monetary Fund was even more aggressive about pushing tax hikes, earning it the label of being the Dr. Kevorkian of the world economy.

That must have created some jealousy at the OECD, so those bureaucrats earlier this year had a taxpalooza party and endorsed a plethora of class-warfare tax hikes.

Now the IMF has responded to the challenge and is pushing additional tax increases all over the world.

For example, the bureaucrats want much higher taxes on energy use, both in the United States and all around the world.

This chart from the IMF shows how much the bureaucracy thinks that the tax should be increased just on coal consumption.

The chart doesn’t make much sense, particularly if you don’t know anything about “gigajoules.” Fortunately, Ronald Bailey of Reason translates the jargon and tells us how this will impact the average American household.

The National Journal reports that the tax rate would be $8 per gigajoule of coal and a bit over $3 per gigajoule of natural gas. Roughly speaking a ton of coal contains somewhere around 25 gigajoules of energy, which implies a tax rate of $200 per ton. …The average American household uses about 11,000 kilowatt hours annually, implying a hike in electric rates of about $1,100 per year due to the new carbon tax. Since the average monthly electric bill is about $107, the IMF’s proposed tax hike on coal would approximately double how much Americans pay for coal-fired electricity. A thousand cubic feet (mcf) of natural gas contains about 1 gigajoule of energy. The average American household burns about 75 mcf of natural gas annually so that implies a total tax burden of $225 per residential customer.

To be fair, the IMF crowd asserts that all these new taxes can be – at least in theory – offset by lower taxes elsewhere.

…we are generally talking about smarter taxes rather than higher taxes. This means re-calibrating tax systems to achieve fiscal objectives more efficiently, most obviously by using the proceeds to lower other burdensome taxes. The revenue from energy taxes could of course also be used to pay down public debt.

Needless to say, I strongly suspect that politicians would use any new revenue to finance a larger burden of government spending. That’s what happened when the income tax was enacted. That’s what happened when the payroll tax was enacted. That’s what happened when the value-added tax was enacted.

If you think something different would happen following the implementation of an energy tax, you win the grand prize for gullibility.

But let’s give the IMF credit. The bureaucrats are equal opportunity tax hikers. They don’t just want higher taxes in the United States. They give the same message everywhere in the world.

Here are some excerpts from an editorial about Spanish fiscal policy in the Wall Street Journal.

Madrid last month cut corporate and personal tax rates, simplified Spain’s personal-income tax system and vowed to close loopholes. That’s good news… So leave it to the austerity scolds at the International Monetary Fund to call for tax increases. …Specifically, the Fund wants Spain to raise value-added taxes, alcohol and tobacco excise taxes, tourism taxes, and various environmental and energy levies: “It will be critical to protect the most vulnerable by increasing the support system for them via the transfer and tax system.”

Gee, I suppose that we should be happy the IMF didn’t endorse higher income taxes as well.

The good news is that the Spanish government may have learned from previous mistakes that tax hikes don’t work.

Rather than heed this bad advice, Prime Minister Mariano Rajoy and Finance Minister Cristobal Montoro are cutting government spending and eliminating wasteful programs to reduce pressure on the public fisc. Public spending amounted to 44.8% of GDP in 2013, which is still too high but down from 46.3% in 2010. The government projects it will fall to 40% by 2017.Madrid has also made clear that it believes private growth is the real answer to its fiscal woes. …In other words, economic growth spurred by low taxes and less state intervention yields more revenue over time. If Mr. Montoro can pursue the logic of that insight, there’s hope for Spain’s beleaguered economy.

I’m not overly confident about Spain’s future, but it is worth noting that, according to IMF data, government spending has basically been flat since 2010 (after rising by an average of about 10 percent annually in the previous three decades).

So if the politicians can maintain fiscal discipline by following my Golden Rule, maybe Spain can undo decades of profligacy and become the success story of the Mediterranean.

Let’s hope so. In any event, we know some Spanish taxpayers have decided that they’re tired of being fleeced.

We have one final example of the IMF’s compulsive tax-aholic instincts.

Allister Heath explains that the bureaucracy is pushing for a plethora of new taxes on the U.K. economy.

The IMF wants an increase in the VAT burden.

…the IMF wants to get rid or significantly reduce the zero-rated exemption on VAT, which covers food, children’s clothes and the rest. While it is true that the exemptions reduce economic efficiency, ditching them would necessitate a big hike in benefits and a major uplift in the minimum wage, which would be far more damaging to the economy’s performance and ability to create jobs for the low-skilled. It’s a stupid idea and one which would destroy any government that sought to implement it, with zero real net benefit. It would be a horrendous waste of precious political capital that ought instead to be invested in real reform of the public sector.

And an increase in energy taxes.

The report also calls for a greater reliance on so-called Pigouvian taxes, which are supposed to discourage externalities and behaviour which inflicts costs on others. It mentions higher taxes on carbon and on congestion as examples. But what this really means is that the IMF is advocating a massive tax increase on motorists, even though there is robust evidence which suggests that they already pay much more, in the aggregate, than any sensible measure of the combined cost of road upkeep and development, pollution and congestion.

And higher property taxes.

It gets worse: these days, one cannot read a document from an international body that doesn’t call for greater taxes on property. This war on homeowners is based on the faulty notion that taxing people who own their homes doesn’t affect their behaviour, which is clearly ridiculous. This latest missive from the IMF doesn’t disappoint on this front: it calls for the revaluation of property for tax purposes, which is code for a massive increase in council tax for millions of homes, especially in London and the home counties.

Understandably, Allister is not thrilled by the IMF’s proposed tax orgy.

The tax burden is already too high; increasing it further would be a terrible mistake. The problem is that spending still accounts for an excessively large share of the economy, and the political challenge is to find a way of re-engineering the welfare state to allow the state to shrink and the private sector to expand. The model should be Australia, Switzerland or Singapore, countries that boast low taxes and high quality services.

And I particularly like that Allister correctly pinpoints the main flaw in the IMF’s thinking. The bureaucrats look at deficits and they instinctively think about how to close the gap with tax hikes.

That’s flawed from a practical perspective, both because of the Laffer Curve and because politicians will respond to the expectation of higher revenue by boosting spending.

But it’s also flawed from a theoretical perspective because the real problem is that the public sector is far too large in all developed nations. So replacing debt-financed spending with tax-financed spending doesn’t address the real problem (even if one heroically assumes revenues actually materialize and further assumes politicians didn’t exacerbate the problem with more spending).

Here’s a remedial course for politicians, international bureaucrats, and others who don’t understand fiscal policy.

P.S. Wise people have speculated that international bureaucrats are quick to urge higher taxes because they don’t have to pay taxes on their lavish salaries.

P.P.S. This isn’t the first time the IMF has proposed massive tax hikes on energy consumption.

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