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Posts Tagged ‘Taxation’

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

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

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

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

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

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 …ours is a country with an outdated tax code — one that reflects the worst go-it-alone, imperialistic, America-first impulses.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

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

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

He elaborates.

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

Amen.

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

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

Professor Martinez points to the obvious solution.

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

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

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

Here are some of the highlights.

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

The WSJ makes three very powerful points.

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

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

Second, there is no dearth of corporate tax revenue.

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

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

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

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

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

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

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

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

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

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

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

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I’ve shared some interested rankings on tax policy, including a map from the Tax Foundation showing which states have the earliest and latest Tax Freedom Days.

There’s also a depressing table showing that the United States “earns” a lowly 94th place in a ranking of business-friendly tax system.

Heck, there’s even a map showing the states with the highest wine taxes, as well as a map showing which states have the lightest and heaviest tax burdens compared to income.

So I was very interested to see this table from the Tax Foundation revealing which countries have the most punitive regimes for penalizing success.

Portugal has the dubious honor of having the most progressive (i.e., discriminatory) tax system in the developed world.

I don’t think anyone is surprised to see France in second place, though I confess that I was not expecting to see pro-reform success stories such as Chile and Canada in the top five.

And I’m totally embarrassed that the United States is #8, worse than such garden spots as Greece, Mexico, and Belgium.

Though it’s important to understand that the Tax Foundation is relying on a narrow definition of progressivity.

One way to measure and compare the progressivity of income tax codes across countries is to express the level of income at which each country’s top tax bracket applies as a multiple of that country’s average income.

That’s a useful bit of information and it shows one aspect of progressivity, but it’s also a bit misleading since it implies that the Swedish tax system (with a top tax rate of 56.7 percent) is less progressive than the Slovakian tax system (with a top tax rate of 21.7 percent).

You won’t be surprised that I think a ranking that purports to show the burden of “progressive” taxation should include the top tax rate.

Speaking of which, this is why I like the Tax Foundation’s measure of progressivity on the state level.

The…table also shows the gap between the top marginal tax rate and the marginal tax rate on $25,000 of taxable income. …Twenty-one states and the District of Columbia have progressive rate structures that rise after $25,000. California, New Jersey, and Vermont have the most progressive rate structures by a wide margin.

Who could have guessed that California would be the worst state, though I’m not surprised to see New Jersey (the worst place to die) and Vermont (worst place for self reliance) have such poor ratings as well.

And is anyone even remotely shocked to see that states with no income taxes manage to avoid any problems with ‘so-called” progressivity? Not surprisingly, they also grow faster and create more jobs.

The moral of the story, at the very least, is that America needs a simple and fair flat tax.

And not the Obama or Hollande version.

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People pay every single penny of tax that politicians impose on corporations.

The investors that own companies obviously pay (more than one time!) when governments tax profits.

The workers employed by companies obviously pay, both directly and indirectly, because of corporate income tax.

And consumers also bear a burden thanks to business taxes that lead to higher prices and reduced output.

Keep these points in mind as we discuss BEPS (“base erosion and profit shifting”), which is a plan to increase business tax  burdens being advanced by the Organization for Economic Cooperation and Development (OECD), a left-leaning international bureaucracy based in Paris.

Working on behalf of the high-tax nations that fund its activities, the OECD wants to rig the rules of international taxation so that companies can’t engage in legal tax planning.

The Wall Street Journal’s editorial page is not impressed by this campaign for higher taxes on employers.

The Organization for Economic Cooperation and Development last week released its latest proposals to combat “base erosion and profit shifting,” or the monster known as BEPS. The OECD and its masters at the G-20 are alarmed that large companies are able to use entirely legal accounting and corporate-organization strategies to shield themselves from the highest tax rates governments try to impose. …The OECD’s solution to this “problem” boils down to suggesting that governments tax the profits arising from operations in their jurisdiction, regardless of where the business unit that earned those profits is legally headquartered. The OECD also proposes that companies be required to report to each government on the geographic breakdown of profits, the better to catch earnings some other country might not have taxed enough.

What’s the bottom line?

This is a recipe for investment-stifling compliance burdens and regulatory uncertainty…the result of implementing the OECD’s recommendations would be lower tax revenues and fewer jobs.

By the way, I particularly appreciate the WSJ’s observation that tax competition and tax planning are good for high-tax nations since they enable economic activity that otherwise wouldn’t tax place (just as I explained in my video on the economics of tax havens).

Existing tax rules have been a counterintuitive boon to high-tax countries because companies can shield themselves from the worst excesses of the tax man while still running R&D centers, corporate offices and the like—and hiring workers to staff them—in places like the U.S. and France.

The editorial also suggests the BEPS campaign against multinational firms may be a boon for low-tax Ireland.

All of which is great news for Ireland, the poster child for a low corporate tax rate.

The Ireland-based Independent, however, reports that the Irish government is worried that the OECD’s anti-tax competition scheme will slash its corporate tax revenue because other governments will get the right to tax income earned in Ireland.

The country’s corporation tax is under scrutiny due to the multinational companies locating here and availing of our low 12.5pc tax rate – or much lower rates in some cases. US politicians have accused Ireland of being a “tax haven”… The OECD, a body made up of 34 western economies, is drawing up plans to restrict the ability of multinationals to move their income around to minimise their tax bill. …a draft Oireachtas Finance Committee report on global taxation, seen by the Irish Independent, contains warnings that Ireland’s corporation tax revenues, which amount to €4bn every year, will be halved under the new system. …Tax expert Brian Keegan is quoted in the report as saying: “Some of the OECD proposals would undoubtedly, result in that €4bn being reduced to €3bn or €2bn. That is the threat.”

So which newspaper is right? After all, Ireland presumably can’t be a winner and a loser.

But both are correct. The Irish Committee report is correct since the BEPS rules, applied to companies as they are currently structured, would be very disadvantageous to Ireland. But the Wall Street Journal thinks that Ireland ultimately would benefit because companies would move more or their operations to the Emerald Isle in order to escape some of the onerous provisions contained in the BEPS proposals.

That being said, I think Ireland and other low-tax jurisdictions ultimately would be losers for the simple reason that the current BEPS plan is just the beginning.

The high-tax nations will move the goal posts every year or two in hopes of grabbing more revenue.

The end goal is to create a system based on “formula apportionment.”

Here’s what I wrote last year about such a scheme.

…the OECD hints at its intended outcome when it says that the effort “will require some ‘out of the box’ thinking” and that business activity could be “identified through elements such as sales, workforce, payroll, and fixed assets.” That language suggests that the OECD intends to push global formula apportionment, which means that governments would have the power to reallocate corporate income regardless of where it is actually earned. Formula apportionment is attractive to governments that have punitive tax regimes, and it would be a blow to nations with more sensible low-tax systems. …business income currently earned in tax-friendly countries, such as Ireland and the Netherlands, would be reclassified as French-source income or German-source income based on arbitrary calculations of company sales and other factors. …nations with high tax rates would likely gain revenue, while jurisdictions with pro-growth systems would be losers, including Ireland, Hong Kong, Switzerland, Estonia, Luxembourg, Singapore, and the Netherlands.

Equally important, I also pointed out that formula apportionment would largely cripple tax competition for companies, which means higher tax rates all over the world.

…formula apportionment would be worse than a zero-sum game because it would create a web of regulations that would undermine tax competition and become increasingly onerous over time. Consider that tax competition has spurred OECD governments to cut their corporate tax rates from an average of 48 percent in the early 1980s to 24 percent today. If a formula apportionment system had been in place, the world would have been left with much higher tax rates, and thus less investment and economic growth. …If governments gain the power to define global taxable income, they will have incentives to rig the rules to unfairly gain more revenue. For example, governments could move toward less favorable, anti-investment depreciation schedules, which would harm global growth.

Some people have argued that I’m too pessimistic and paranoid. BEPS, they say, is simply a mechanism for tweaking international rules to stop companies from egregious tax planning.

But I think I’m being realistic.Why? Because I know the ideology of the left and I understand that politicians are always hungry for more tax revenue.

For example, from the moment the OECD first launched its campaign against so-called tax havens, I kept warning that the goal was global information sharing.

The OECD and its lackeys said I was being demagogic and that they simply wanted “upon request” information sharing.

So who was right? Click here to find out.

Not that I deserve any special award for insight. It doesn’t (or shouldn’t) take a genius, after all, to understand the nature of government.

Let’s close with some economic analysis of why the greed of politicians should be constrained by national borders.

P.S. The OECD, with the support of the Obama Administration, wants something akin to a World Tax Organization that would have the power to disallow free-market tax policy.

P.P.S. And the OECD also allied itself with the nutjobs in the Occupy movement in order to push class-warfare taxation.

P.P.P.S. Your tax dollars subsidize the OECD’s left-wing activism.

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I’m a big advocate of the Laffer Curve.

Simply stated, it’s absurdly inaccurate to think that taxpayers and the economy are insensitive to changes in tax policy.

Yet bureaucracies such as the Joint Committee on Taxation basically assume that the economy will be unaffected and that tax revenues will jump dramatically if tax rates are boosted by, say, 100 percent.

In the real world, however, big changes in tax policy can and will lead to changes in taxable income. In other words, incentives matter. If the government punishes you more for earning more income, you will figure out ways to reduce the amount of money you report on your tax return.

This sometimes means that people will choose to be less productive. Why bust your derrière, after all, if government confiscates a big chunk of your additional earnings? Why make the sacrifice to set aside some of your income when the government imposes extra layers of tax on saving and investment? And why allocate your money on the basis of economic efficiency when you can reduce your taxable income by dumping your investments into something like municipal bonds that escape the extra layers of tax?

Or people can decide to hide some of the money they earn from the grasping claws of the IRS. Contractors can work off the books. Workers can take wages under the table. Business owners can overstate their expenses in order to reduce taxable income.

To reiterate, people respond to incentives. And that means you can’t estimate what will happen to tax revenues simply by looking at changes in tax rates. You also need to look at what’s happening to the amount of income people are willing to both earn and report.

Which is why I’m interested in some new research from two Canadian economists, one from the University of Toronto and one from the University of British Columbia. They looked at how rich people in Canada responded when their tax rates were altered.

Here are some excerpts from the study, published by the National Bureau of Economic Research.

In this paper we estimate the elasticity of reported income using the sub-national variation across Canadian provinces. …Comparing across provinces and through time, we find that elasticities are large for incomes at the top of the income distribution… The provincial tax rates for high earners vary strongly across the country, ranging from a low of 10 percent in Alberta to a high of 25.75 in Quebec. …at the top of the income distribution…these taxpayers have access to substantial financial advice that may facilitate tax avoidance. …We pay particular attention to the categories for $250,000 and those that report income between $150,000 and $250,000 as that income range is the closest to the P99 cutoff on which we focus.

Interestingly, the economists state that upper-income taxpayers should be less sensitive to tax rates today because less of their income is from investments.

…the source of incomes among those at the top has shifted substantially over the last half century from capital income toward earned income. All else equal, this change would tend to make income shifting or tax avoidance more difficult now than in earlier times.

Yet their results suggest that the taxable income of highly productive Canadians (those with incomes in the top 1 percent or the top 1/10th of 1 percent) is very sensitive to changes in tax rates.

The third column has the results for the bottom nine tenths of the top one percent, P99 to P99.9. Here, the estimate is a positive and significant 0.364. Finally, the top P99.9 percentile group shows an elasticity of 1.451, which is highly significant and large. …our estimate of 0.689 for P99 is high, and 1.451 for P99.9 very high.

And because rich people can raise or lower their taxable income in response to changing tax rates, this has big Laffer Curve implications.

According to the research, the revenue-maximizing tax rate for the top 1 percent is 44.4 percent and the revenue-maximizing tax rate for the even more successful top 1/10th of 1 percent is 27.5 percent!

The magnitude of our estimates can be put into context by calculating the revenue-maximizing tax rate τ∗, which is the rate corresponding to the peak of the so-called ‘Laffer Curve’. At this point, an incrementally higher rate will raise no further net revenue as the mechanical effect of the tax increase will be completely offset by the behavioural response of lower taxable income. …Plugging a = 1.81 and e = 0.689 into equation (8) yields an estimate for τ∗ of 44.4 percent. In Figure 1, four provinces have a top marginal tax rate for 2013 under 44.4 percent and six provinces are higher. Using the P99.9 estimate of 1.451, the revenue maximizing tax rate τ∗ would be only 27.5 percent. If true, this would suggest all provinces could increase revenue by lowering the tax rate for those in income group P99.9.

By the way, you read correctly, the revenue-maximizing tax rate for the super rich is lower than the revenue-maximizing tax rate for the regular rich.

This almost certainly is because very rich taxpayers get a greater share of their income from business and investment sources, and thus have more control over the timing, level, and composition of their earnings. Which means they can more easily suppress their income when tax rates go up and increase their income when tax rates fall.

That’s certainly what we see in the U.S. data and I assume Canadians aren’t that different.

But now it’s time for a big caveat.

I don’t want to maximize revenue for the government. Not from the top 1/10th of 1 percent. Not from the top 1 percent. I don’t want to maximize the amount of revenue coming from any taxpayers. If tax rates are near the revenue-maximizing point, it implies a huge loss of private output per additional dollar collected by government.

As I’ve repeatedly argued, we want to be at the growth-maximizing point on the Laffer Curve. And that’s the level of tax necessary to finance the few legitimate functions of government.

That being said, the point of this blog post is to show that Obama, Krugman, and the rest of the class-warfare crowd are extremely misguided when they urge confiscatory tax rates on the rich.

Unless, of course, their goal is to punish success rather than to raise revenue.

P.S. Check out the IRS data from the 1980s on what happened to tax revenue from the rich when Reagan dropped the top tax rate from 70 percent to 28 percent.

I’ve used this information in plenty of debates and I’ve never run across a statist who has a good response.

P.P.S. I also think this polling data from certified public accountants is very persuasive.

I don’t know about you, but I suspect CPAs have a much better real-world understanding of the impact of tax policy than the bureaucrats at the Joint Committee on Taxation.

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

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

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

Here’s the methodology.

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

And here’s how the United States ranks.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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I’m a pessimist about public policy for two simple reasons:

1) Seeking power and votes, elected officials generally can’t resist making short-sighted and politically motivated choices that expand the burden of government.

2) Voters are susceptible to bribery, particularly over time as social capital (the work ethic, spirit of self reliance, etc) erodes and the entitlement mentality takes hold.

Actually, let me add a third reason.

The first two reasons explain why countries get into trouble. Our last reason explains why it’s oftentimes so hard to then fix the mess created by statism.

3) Once a nation adopts big government, reform is difficult because too many voters are riding in the wagon of dependency and they reflexively oppose good policy.

Or they’re riding in the party boat, but you get the idea.

Now that I’ve explained why I’m a Cassandra, let me try to be a Pollyanna.

And I’m going to be Super Pollyanna, because my task is to explain how Greece can be saved.

I’ll start by pointing out that government spending has actually been cut in recent years. And we’re talking about genuine spending cuts, not the make-believe cuts you find in Washington, which occur when spending doesn’t grow as fast as previously planned.

This chart, based on IMF data, shows that the budget increased dramatically in Greece from 1980-2009. But once the fiscal crisis started and Greek politicians no longer had the ability to finance spending with borrowed money, they had no choice but to reduce the burden of government spending.

This seems like great news, but there’s one minor problem and one major problem.

The minor problem is that there hasn’t been nearly enough structural reform of the welfare state in Greece. For long-run fiscal recovery, it’s very important to save money by reducing handouts that create dependency, while also shrinking the country’s bloated bureaucracy. By comparison, it’s less important (or perhaps even harmful) to save money by letting physical infrastructure deteriorate.

The major problem is that controlling government spending is just one piece of the puzzle. There are five major factors that determine economic performance, with experts assigning equal importance to fiscal policy, trade policy, regulatory policy, monetary policy, and rule of law.

Moreover, not only is fiscal policy just 20 percent of the puzzle, it’s also important to understand that spending is just part of that 20 percent. You also have to consider the tax burden.

And the progress Greece has made on the spending side of the budget has been offset by a bunch of destructive tax increases.

But there is a glimmer of hope because Greek politicians apparently realize that this is a problem.

Here are some excerpts from the Wall Street Journal’s coverage.

Greek Prime Minister Antonis Samaras promised tax-relief measures to help jump-start the country’s economy and boost the government’s popularity as it faces a series of political challenges in the months ahead. “The overtaxation has to end,” Mr. Samaras said Saturday during a speech.

It’s easy to see why there’s a desire to boost economic performance.

Since entering recession in 2008, Greece’s economy has shrunk by more than a quarter… This year, however, the country is expected to emerge from recession and post growth of 0.6%. But the recovery has yet to trickle down to ordinary Greeks who continue to face a jobless rate of more than 27% and higher taxes imposed during the past few years.

However, don’t get too excited. The Premier isn’t talking about sweeping reforms.

Instead, it appears that the proposed changes will be very minor.

In his remarks, the Greek premier announced a number of tax changes, including a 30% reduction in the levy on home heating oil and amendments to a new unified property tax that has been so far marred by errors and miscalculations in implementation.

Geesh, talk about rearranging the deck chairs on the Titanic.

Indeed, at least one of the tax cuts may be designed to bring in more money for the government. The New York Times, for instance, reports that the energy tax didn’t generate any extra tax revenue.

That levy, which was introduced in 2012, raised the tax on heating oil 450 percent. But it has failed to bring in additional revenue and has led to environmental damage as Greeks turned to burning wood for heat.

I guess it’s progress that both the Greek government and the New York Times are acknowledging the Laffer Curve, but this is a perfect example of why it’s important to be on the growth-maximizing point of the curve rather than the revenue-maximizing point.

So why am I expressing a tiny sliver of optimism when the Greek government’s tax agenda is so timid?

Well, there’s at least some hope of bigger and more pro-growth reforms.

He also announced a reduction to a so-called solidarity tax on income, the size of which is to be determined when the state budget for 2015 is drafted in October. The changes would be part of a “road map” for lowering taxation with cuts to the property tax, income tax and corporate tax to come later, he said. “Overtaxation may have been necessary, but now it must stop,” he said.

And the Greek press is reporting further details indicating that the government wants to reduce marginal tax rates

Samaras said that it his ultimate aim to reduce the top income tax rate to 32 percent and for business to pay no more than 15 percent.

If these policies actually took place, then I suspect Greece’s economy would enjoy robust growth.

Particularly if policy makers also dealt with the major problem of excessive regulation (see here and here to get a flavor of the awful nature of red tape in Greece).

In other words, any nation can prosper if good policy is adopted.

Including Greece, though I must admit in closing that I suspect that there’s a less-than-15-percent chance that my optimistic scenario will materialize. And if you read this Mark Steyn column, you’ll understand why the pessimistic scenario is much more likely.

P.S. Click here and here for two very funny (or sad) cartoons about Obama and Greece. And here’s another cartoon about Greece that’s worth sharing.

P.P.S. Click here and here for some amusing Greek policy humor.

P.P.P.S. The IMF also has admitted that Greece is on the wrong side of the Laffer Curve.

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I’ve already shared a bunch of data and evidence on the importance of low tax rates.

A review of the academic evidence by the Tax Foundation found overwhelming support for the notion that lower tax rates are good for growth.

An economist from Cornell found lower tax rates boost GDP.

Other economists found lower tax rates boost job creation, savings, and output.

Even economists at the Paris-based OECD have determined that high tax rates undermine economic performance.

And it’s become apparent, with even the New York Times taking notice, that high tax rates drive away high-achieving people.

We’re going to augment this list with some additional evidence.

In a study published by a German think tank, three economists from the University of Copenhagen in Denmark look at the impact of high marginal tax rates on Danish economic performance.

Here’s what they set out to measure.

…taxation distorts the functioning of the market economy by creating a wedge between the private return and the social return to a reallocation of resources, leaving socially desirable opportunities unexploited as a result. …This paper studies the impact of taxation on the mobility and allocation of labor, and quantifies the efficiency loss from misallocation of labor caused by taxation. …labor mobility responses are fundamentally different from the hours-of-work responses of the basic labor supply model… Our analysis builds on a standard search theoretic framework… We incorporate non-linear taxation into this setting and estimate the structural parameters of the model using employer-employee register based data for the full Danish population of workers and workplaces for the years 2004-2006. The estimated model is then used to examine the impact of different changes in the tax system, thereby characterizing the distortionary effects of taxation on the allocation of labor.

They produced several sets of results, including a look at the additional growth and output generated by moving to a system of lump-sum taxation (which presumably eliminates all disincentive effects).

But even when they looked at more modest reforms, such as a flat tax with a relatively high rate, they found the Danish economy would reap significant benefits.

…it is possible to reap a very large part of the potential efficiency gain by going “half the way”and replace the current taxation with a ‡at tax rate of 30 percent on all income. This shift from a Scandinavian tax system with high marginal tax rates to a level of taxation in line with low-tax OECD countries such as the United States increases total income by 20 percent and yields an efficiency gain measured in proportion to initial income of 10 percent. …a transition from a Scandinavian system with high marginal taxes to a system along the lines of low-tax OECD countries such as the United States. This reduces the rate of non-employment by around 10 percentage points, increases aggregate income by almost 20 percent (relative to the Scandinavian income level), and gives an efficiency gain measured in proportion to income of 9.9 percent. Thus, almost 80 percent of the efficiency loss from marginal taxation (9.7% divided by 12.4%) would be eliminated by shifting from a Scandinavian tax system to the system of a low-tax OECD country according to these estimates.

The authors also confirmed that lower tax rates would generate revenue feedback. In other words, the Laffer Curve exists.

We may also use the reform experiment to compute the marginal excess burden of taxation as described above. When measured in proportion to the mechanical loss of tax revenue, we obtain an estimate of 87 percent. …this estimate also corresponds to the degree of self-financing of the tax cut. Thus, the increase in tax revenue from the behavioral response is 87 percent of the mechanical loss in tax revenue.

Too bad we can’t get the Joint Committee on Taxation in Washington to join the 21st Century. Those bureaucrats still base their work on the preposterous assumption that taxes have no impact on overall economic performance.

Since we just looked at a study of the growth generated by reducing very high tax rates, let’s now consider the opposite scenario. What happens if you take medium-level tax rates and raise them dramatically?

The Tax Foundation looks at precisely this issue. The group estimated the likely results if lawmakers adopted the class-warfare policies proposed by Thomas Piketty.

Piketty suggests higher taxes on the wealthiest among us. He calls for a global wealth tax, and he recommends establishing a top income tax rate of 80 percent, with a next-to-top income tax rate of 50 or 60 percent for the upper-middle class. …This study…provides quantitative estimates of what his proposed tax rates would mean for capital formation, jobs, the level of income, and government revenue. This study also estimates how Piketty’s proposed income tax rates would affect the distribution of income in the United States.

Piketty, of course, thinks that even confiscatory levels of taxation have no negative impact on economic performance.

Piketty claims people (or at least the upper-income people he would tax so heavily) are totally insensitive to marginal tax rates. In his world view, upper-income taxpayers will work and invest just as much as before even if dramatically higher taxes reduce their after-tax rewards to a fraction of what they were previously. …Piketty’s vision of the world strains credulity.

When the Tax Foundation crunched the numbers, though, its experts found that Piketty’s proposal would be devastating.

Under Piketty’s 55 and 80 percent tax brackets, people in the new, ultra-high tax brackets will work and invest less because they will be able to keep so little of the reward from the last hour of work and the last dollar of investment. …As the supplies of labor and capital in the production process decline, the economy’s output will also contract. Although it is only people with upper incomes who will directly pay the 55 and 80 percent tax rates, people throughout the economy will indirectly bear some of the tax burden. For example, the average person’s wages will be lower than otherwise because middle-income workers will have less equipment and software to enhance their productivity, and wages depend on productivity. Similarly, people throughout the economy will have fewer employment opportunities and will lose desirable goods and services, because businesses will grow more slowly and be less innovative.

The magnitude of the damage would depend on whether the higher tax rates also applied to dividends and capital gains. Here’s what the Tax Foundation estimated would happen to the economy if dividends and capital gains were not hit with Piketty-style tax rates.

These are some very dismal numbers.

But now look at the results if tax rates also are increased on dividends and capital gains. The dramatic increase in double taxation (dwarfing what Obama wanted) would have catastrophic consequences for overall investment (the “capital stock”). This would lead to a big loss in jobs and a dramatic reduction in overall economic output.

The Tax Foundation then measures the impact of these policies on the well-being of people in various income classes.

Needless to say, upper-income taxpayers suffer substantial losses. But the rest of us also suffer as well.

…the poor and middle class would also lose. They would suffer a large, but indirect, tax burden as a result of the smaller economy. Their after-tax incomes would fall over 3 percent if capital gains and dividends retain their current-law tax treatment and almost 17 percent if capital gains and dividends are taxed like ordinary income.

And since I’m sure Piketty and his crowd would want to subject capital gains and dividends to confiscatory tax rates, the 17 percent drop is a more realistic assessment of their economic agenda.

Though, to be fair, Piketty-style policies would make society more “equal.” But, as the Tax Foundation notes, some methods of achieving equality are very bad for lower-income people.

…a reasonable question to ask is whether a middle-income family is made better off if their income drops 3.2 percent while the income of a family in the top 1 percent drops 21.0 percent, or their income plummets 16.8 percent while the income of a family in the top 1 percent plummets 43.3 percent.

Of course, if Margaret Thatcher is correct, the left has no problem with this outcome.

But for those of us who care about better lives for ordinary people, this is confirmation that envy isn’t – or at least shouldn’t be – a basis for tax policy.

Sadly, that’s not the case. We’ve already seen the horrible impact of Hollande’s Piketty-style policies in France. And Obama said he would be perfectly content to impose higher tax rates even if the resulting economic damage is so severe that no additional revenue is collected.

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