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Archive for the ‘Fiscal Policy’ Category

I shared yesterday an example of how a big tax increase on expensive homes led to fewer sales. Indeed, the drop was so pronounced that the government didn’t just collect less money than projected, which is a very common consequence when fiscal burdens increase, but it actually collected less money than before the tax hike was enacted.

That’s the Laffer Curve on steroids.

The purpose of that column was to share with my leftist friends an example of a tax increase that achieved something they desired (i.e., putting a damper on sales of expensive houses) in hopes of getting them to understand that higher taxes on other types of economic activity also will have similar effects.

And some of those “other types of economic activity” will be things that they presumably like, such as job creation, entrepreneurship, and upward mobility.

I now have another example to share. The New York Times is reporting that a Mexican tax on soda is causing a big drop in soda consumption.

In the first year of a big soda tax in Mexico, sales of sugary drinks fell. In the second year, they fell again, according to new research. The finding represents the best evidence to date of how sizable taxes on sugary drinks, increasingly favored by large American cities, may influence consumer behavior.

This is an amazing admission. Those first three sentences of the article are an acknowledgement of the central premise of supply-side economics: The more you tax of something, the less you get of it.

In other words, taxes do alter behavior. In the wonky world of economics, this is simply the common-sense observation that demand curves are downward-sloping. When the price of something goes up (in this case, because of taxes), the quantity that is demanded falls and there is less output.

And here’s another remarkable admission in the story. The effect of taxes on behavior can be so significant that revenues are impacted.

The results…matter for policy makers who hope to use the money raised by such taxes to fund other projects. …some public officials may be dismayed… Philadelphia passed a large soda tax last year and earmarked most of its proceeds to pay for a major expansion to prekindergarten. City budget officials had assumed that the tax would provide a stable source of revenue for education. If results there mirror those of Mexico, city councilors may eventually have to find the education money elsewhere.

Wow, not just an admission of supply-side economics, but also an acknowledgement of the Laffer Curve.

Now if we can get the New York Times to admit that these principle also apply to taxes on work, saving, investment, and entrepreneurship, that will be a remarkable achievement.

P.S. Leftists are capable of amazing hypocrisy, so I won’t be holding me breath awaiting the consistent application of the NYT‘s newfound knowledge.

P.P.S. Just because some folks on the left are correct about the economic impact of soda taxes, that doesn’t mean they are right on policy. As a libertarian, I don’t think it’s the government’s job to dictate (or even influence) what we eat and drink.

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In my never-ending strategy to educate policy makers about the Laffer Curve, I generally rely on both microeconomic theory (i.e., people respond to incentives) and real-world examples.

And my favorite real-world example is what happened in the 1980s when Reagan cut the top tax rate from 70 percent to 28 percent. Critics said Reagan’s reforms would deprive the Treasury of revenue and result in rich people paying a lot less tax. So I share IRS data on annual tax revenues from those making more than $200,000 per year to show that there was actually a big increase in revenue from upper-income taxpayers.

It has slowly dawned on me, though, that this may not be the best example to share if I’m trying to convince skeptical statists. After all, they presumably don’t like Reagan and they may viscerally reject my underlying point about the Laffer Curve since I’m linking it to the success of Reaganomics.

So I have a new strategy for getting my leftist friends to accept the Laffer Curve. I’m instead going to link the Laffer Curve to “successful” examples of left-wing policy. To be more specific, statists like to use the power of government to control our behavior, often by imposing mandates and regulations. But sometimes they impose taxes on things they don’t like.

And if I can use those example to teach them the basic lesson of supply-side economics (if you tax something, you get less of it), hopefully they’ll apply that lesson when contemplating higher taxes on thing they presumably do like (such as jobs, growth, competitiveness, etc).

Here’s a list of “successful” leftist tax hikes that have come to my attention.

Now I’m going to augment this list with an example from the United Kingdom.

By way of background, there’s been a heated housing market in England, with strong demand leading to higher prices. The pro-market response is to allow more home-building, but the anti-developer crowd doesn’t like that approach, so instead a big tax on high-value homes was imposed.

And as the Daily Mail reports, this statist approach has been so “successful” that the tax hike has resulted in lower tax revenues.

George Osborne’s controversial tax raid on Britain’s most expensive homes has triggered a dramatic slump in stamp duty revenues. Sales of properties worth more than £1.5million fell by almost 40 per cent last year, according to analysis of Land Registry figures… This has caused the total amount of stamp duty collected by the Treasury to fall by around £440million, from £1.079billion to a possible £635.7million. The figures cover the period between April and November last year compared to the same period in 2015.

Our leftist friends, who sometimes openly admit that they want higher taxes on the rich even if the government doesn’t actually collect any extra revenue, should be especially happy because the tax has made life more difficult for people with more wealth and higher incomes.

Those buying a £1.5 million house faced an extra £18,750 in stamp duty. …Tory MP Jacob Rees-Mogg…described Mr Osborne’s ‘punitive’ stamp duty hikes as the ‘politics of envy’, adding that they have also failed because they have raised less money for the Treasury.

By the way, the fact that the rich paid less tax last year isn’t really the point. Instead, the lesson to be learned is that a tax increase caused there to be less economic activity.

So I won’t care if the tax on expensive homes brings in more money next year, but I will look to see if fewer homes are being sold compared to when this tax didn’t exist.

And if my leftist friends say they don’t care if fewer expensive homes are being sold, I’ll accept they have achieved some sort of victory. But I’ll ask them to be intellectually consistent and admit that they are implementing a version of supply-side economics and that they are embracing the notion that tax rates change behavior.

Once that happens, it’s hopefully just a matter of time before they recognize that it’s not a good idea to impose high tax rates on things that are unambiguously good for an economy, such as work, saving, investment, and entrepreneurship.

Yes, hope springs eternal.

P.S. In addition to theory and real-world examples, my other favorite way of convincing people about the Laffer Curve is to share the poll showing that only 15 percent of certified public accountants agree with the leftist view that taxes have no impact have taxable income. I figure that CPAs are a very credible source since they actually do tax returns and have an inside view of how behavior changes in response to tax policy.

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Back in 2009, I shared the results of a very helpful study by Pierre Bessard of Switzerland’s Liberal Institute (by the way, “liberal” in Europe means pro-market or “classical liberal“).

Pierre ranked the then-30 member nations of the Organization for Economic Cooperation and Development based on their tax burdens, their quality of governance, and their protection of financial privacy.

Switzerland was the top-ranked nation, followed by Luxembourg, Austria, and Canada.

Italy and Turkey were tied for last place, followed by Poland, Mexico, and Germany.

The United States, I’m ashamed to say, was in the bottom half. Our tax burden was (and still is) generally lower than Europe, but there’s nothing special about our quality of governance compared to other developed nations, and we definitely don’t allow privacy for our citizens (though we’re a good haven for foreigners).

Pierre’s publication was so helpful that I’ve asked him several times to release an updated version.

I don’t know if it’s because of my nagging, but the good news is that he’s in the final stages of putting together a new Tax Oppression Index. He just presented his findings at a conference in Panama.

But before divulging the new rankings, I want to share this slide from Pierre’s presentation. He correctly observes that the OECD’s statist agenda against tax competition is contrary to academic research in general, and also contrary to the Paris-based bureaucracy’s own research!

Yet the political hacks who run the OECD are pushing bad policies because Europe’s uncompetitive governments want to prop up their decrepit welfare states. And what’s especially irksome is that the bureaucrats at the OECD get tax-free salaries while pushing for higher fiscal burdens elsewhere in the world.

But I’m digressing. Let’s look at Pierre’s new rankings.

As you can see, Switzerland is still at the top, though now it’s tied with Canada. Estonia (which wasn’t part of the OECD back in 2009) is in third place, and New Zealand and Sweden also get very high scores.

At the very bottom, with the most oppressive tax systems, are Greece and Mexico (gee, what a surprise), followed by Israel and Turkey.

The good news, relatively speaking, is that the United States is tied with several other nations for 11th place with a score of 3.5.

So instead of being in the bottom half, as was the case with the 2009 Tax Oppression Index, the U.S. is now in the top half.

But that’s not because we’ve improved policy. It’s more because the OECD advocates of statism have been successful in destroying financial privacy in other nations. Even Switzerland’s human rights laws on privacy no longer protect foreign investors.

As such, Pierre’s new index basically removes financial privacy as a variable and augments the quality of governance variable with additional data about property rights and the rule of law.

P.S. When measuring the tax burden, the reason that America ranks above most European nations is not because they impose heavier taxes on rich people and businesses (indeed, the U.S. has a much higher corporate tax rate). Instead, we rank above Europe because they impose very heavy taxes on poor and middle-income taxpayers (mostly because of the value-added tax, which helps to explain why I am so unalterably opposed to that destructive levy).

P.P.S. Also in 2009, Pierre Bessard authored a great defense of tax havens for the New York Times.

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I don’t have strong views on global warming. Or climate change, or whatever it’s being called today.

But I’ve generally been skeptical about government action for the simple reason that the people making the most noise are statists who would use any excuse to increase the size and power of government. To be blunt, I simply don’t trust them. In Washington, they’re called watermelons – green on the outside (identifying as environmentalists) but red on the inside (pushing a statist agenda).

But there are some sensible people who think some sort of government involvement is necessary and appropriate.

George Schultz and James Baker, two former Secretaries of State, argue for a new carbon tax in a Wall Street Journal column as part of an agenda that also makes changes to regulation and government spending.

…there is mounting evidence of problems with the atmosphere that are growing too compelling to ignore. …The responsible and conservative response should be to take out an insurance policy. Doing so need not rely on heavy-handed, growth-inhibiting government regulations. Instead, a climate solution should be based on a sound economic analysis that embodies the conservative principles of free markets and limited government. We suggest…creating a gradually increasing carbon tax…, returning the tax proceeds to the American people in the form of dividends. And…rolling back government regulations once such a system is in place.

A multi-author column in the New York Times, including Professors Greg Mankiw and Martin Feldstein from Harvard, also puts for the argument for this plan.

On-again-off-again regulation is a poor way to protect the environment. And by creating needless uncertainty for businesses that are planning long-term capital investments, it is also a poor way to promote robust economic growth. By contrast, an ideal climate policy would reduce carbon emissions, limit regulatory intrusion, promote economic growth, help working-class Americans and prove durable when the political winds change. …Our plan is…the federal government would impose a gradually increasing tax on carbon dioxide emissions. It might begin at $40 per ton and increase steadily. This tax would send a powerful signal to businesses and consumers to reduce their carbon footprints. …the proceeds would be returned to the American people on an equal basis via quarterly dividend checks. With a carbon tax of $40 per ton, a family of four would receive about $2,000 in the first year. As the tax rate rose over time to further reduce emissions, so would the dividend payments. …regulations made unnecessary by the carbon tax would be eliminated, including an outright repeal of the Clean Power Plan.

They perceive this plan as being very popular.

Environmentalists should like the long-overdue commitment to carbon pricing. Growth advocates should embrace the reduced regulation and increased policy certainty, which would encourage long-term investments, especially in clean technologies. Libertarians should applaud a plan premised on getting the incentives right and government out of the way.

I hate to be the skunk at the party, but I’m a libertarian and I’m not applauding. I explain some of my concerns about the general concept in this interview.

In the plus column, there would be a tax cut and a regulatory rollback. In the minus column, there would be a new tax. So two good ideas and one bad idea, right? Sounds like a good deal in theory, even if you can’t trust politicians in the real world.

However, the plan that’s being promoted by Schultz, Baker, Feldstein, Mankiw, etc, doesn’t have two good ideas and one bad idea. They have the good regulatory reduction and the bad carbon tax, but instead of using the revenue to finance a good tax cut such as eliminating the capital gains tax or getting rid of the corporate income tax, they want to create universal handouts.

They want us to believe that this money, starting at $2,000 for a family of four, would be akin to some sort of tax rebate.

That’s utter nonsense, if not outright prevarication. This is a new redistribution program. Sort of like the “basic income” scheme being promoted by some folks.

And it creates a very worrisome dynamic since people will have an incentive to support ever-higher carbon taxes in order to get ever-larger checks from the government. Heck, the plan being pushed explicitly envisions such an outcome.

I’ve made the economic argument against carbon taxes and the cronyism argument against carbon taxes. Now that we have a real-world proposal, we have the practical argument against carbon taxes.

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When I debate one of my leftist friends about deficits, it’s often a strange experience because none of us actually care that much about red ink.

I’m motivated instead by a desire to shrink the burden of government spending, so I argue for spending restraint rather than tax hikes that would “feed the beast.”

And folks on the left want bigger government, so they argue for tax hikes to enable more spending and redistribution.

I feel that I have an advantage in these debates, though, because I share my table of nations that have achieved great results when nominal spending grows by less than 2 percent per year.

The table shows that nations practicing spending restraint for multi-year periods reduce the problem of excessive government and also address the symptom of red ink.

I then ask my leftist buddies to please share their table showing nations that got good results from tax increases. And the response is…awkward silence, followed by attempts to change the subject. I often think you can even hear crickets chirping in the background.

I point this out because I now have another nation to add to my collection.

From the start of last decade up through the 2009-2010 fiscal year, government spending in the United Kingdom grew by 7.1 percent annually, far faster than the growth of the economy’s productive sector. As a result, an ever-greater share of the private economy was being diverted to politicians and bureaucrats.

Beginning with the 2010-2011 fiscal year, however, officials started complying with my Golden Rule and outlays since then have grown by an average of 1.6 percent per year.

And as you can see from this chart prepared by the Institute for Fiscal Studies, this modest level of fiscal restraint has paid big dividends. The burden of government spending has significantly declined, falling from 45 percent of national income to 40 percent of national income.

This means more resources in private hands, which means better economic performance.

Though allow me to now share some caveats. Fiscal policy is only a small piece of what determines good policy, just 20 percent of a nation’s grade according to Economic Freedom of the World.

So spending restraint should be accompanied by free trade, sound money, a sensible regulatory structure, and good governance. Moreover, as we see from the tragedy of Greece, spending restraint doesn’t even lead to good fiscal policy if it’s accompanied by huge tax increases.

Fortunately, the United Kingdom is reasonably sensible, which explains why the country is ranked #10 by EFW. Though it’s worth noting that it gets its lowest score for “size of government,” so the recent bit of good news about spending restraint needs to be the start of a long journey.

P.S. The United States got great results thanks to spending restraint between 2009-2014. It will be interesting to see whether Republicans get better results with Trump in the White House.

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February 5 Addendum: For my left-wing friends and others who are bending over backwards to misread this column, saying nice things about Russia’s flat tax doesn’t mean (as noted below) that Russia’s overall economic policy is admirable. And it obviously doesn’t imply anything favorable about Russia’s dismal political system or Putin himself. I like the Russia flat tax for the same reason that I like trade liberalization in China and Social Security reform in Chile. Every so often, bad governments stumble upon a good policy and I think that’s laudable because I want people to have better lives. Sadly, I don’t think the Putin-Trump “bromance” will lead to a flat tax in the US, but that would be an unexpected and nice silver lining to that dark cloud.

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I’m obviously a big fan of a simple and fair flat tax.

In part, my support for fundamental reform is driven by my desire for a low rate, for no double taxation, and for the elimination of loopholes. Those are the economic reasons for reform.

But I also am very much motivated by the moral case for tax reform. It offends me that we have 70,000-plus pages of special favors for the friends and contributors of politicians. I value the rule of law, so I want everyone in America to play by the same rules.

And I confess that I’m jealous that other nations have adopted this common-sense reform while we’re still stuck with a punitive and unfair internal revenue code.

But the silver lining to this dark cloud is that we can learn from the experiences of other nations.

A recent report looks at what’s happened in Russia following the introduction of the flat tax.

On December 23, 2016, in his annual end-of-year press conference, Russian President Vladimir Putin said that despite his “many doubts” at the initial stage of introducing a flat 13-percent personal income tax in 2001, tax reform in Russia has been a major success. …Putin claimed that in 2001, when the tax reform was introduced, he was “concerned that the budget would lose revenue, because those who earn more would have to pay less.” He said he was also concerned “whether social justice would be ensured and so on.” However, as the reform gained traction, “personal-income tax collection has increased – pay attention – seven times,” Putin said. …Daniel Mitchell, a senior fellow at the Cato Institute, told Polygraph.info that two factors contributed to a significant increase in personal income tax revenue: “the low rate made tax evasion and avoidance much less attractive, and increased incentives to earn income.”

I appreciated the chance to talk to the reporter and get quoted in the story, but I am naturally suspicious about the claims of government officials. So I wondered about Putin’s claim about a seven-fold increase in income tax receipts.

I know there were good results in the first few years after reform. I authored a study for the Center for Freedom and Prosperity last decade, and there was data at the time showing an impressive increase in revenues from the personal income tax. That data certainly bolstered the argument for tax reform.

But we now have almost another full decade of data. Has the Russian flat tax continued to produce good results? Is the low tax rate continuing to encourage both the earning of income and reporting of income?

To answer these questions, I had my intern cull through various IMF Article IV consultation reports on Russia to get up-to-date data on personal income tax receipts in Russia. And what did I learn? Was Putin wrong?

Yes, Putin’s claim of a seven-fold increase in tax receipts was completely misleading. There was actually a 10-fold jump in personal income tax revenue.

In other words, the flat tax is a success. In today’s Washington, you would say the Russian government is winning bigly.

But there are caveats.

  • Russia has experienced significant inflation, at least compared to the United States. So if you factor out increases in the price level, personal income tax revenues are “only” about three times higher today than they were before the flat tax was implemented.
  • Moreover, a flat tax is not a panacea. Notwithstanding the good results it has delivered, Russia has an unimpressive ranking of #102 from Economic Freedom of the World. In other words, there’s still a long way to go if Russia wants to become a rich nation.

But these caveats don’t change the main conclusion, which is that the Russian flat tax works. Just as it works in Hong Kong. And just as it works in Jersey. It works wherever it is tried.

Let’s look at another example. Writing for Forbes, Fahim Mostafa explains that the Hungarian flat tax also has been a big success.

A fair number of Eastern European nations have…chosen this system of taxation over its progressive counterpart. Among the latest to join this club is Hungary, replacing progressive rates from 17% to 32% with a flat tax of 16% on income effective from 2012 onward… There is reason to believe that the implementation of this system has largely benefited the Eastern European nation. …The results from the following years have been remarkable. Total government revenue in 2015 (the last year for which OECD data is available at this time) stood at 23.8% higher than the maximum prior to the flat tax reform… According to the OECD, public debt in Hungary has been decreasing steadily since 2011. Increased revenues allow for this debt to be paid. …The flat tax has boosted consumption in Hungary, greatly increasing taxes collected from sales. Total tax revenue has shot up despite the massive cuts made to income tax. Politicians seeking to implement this policy in their own nation would do well to point out the example of Hungary.

I’ll add two comments.

First, the same caveats I applied to Russia apply to Hungary. The country is ranked #57 from Economic Freedom of the World, so it’s great that there’s a successful flat tax, but a lot more reform is needed for Hungary to become a role model for overall market-friendly reform.

Second, the author should probably make a change to the column. Instead of writing that “tax revenue has shot up despite the massive cuts,” it might be more accurate to write that “tax revenue has shot up because of the massive cuts.”

Yes, every so often you can find examples of nations being on the downward-sloping portion of the Laffer Curve, either because tax rates are ridiculously high (the U.S. before Reagan) or because a nation is developing or transitioning and needs low tax burdens to boost growth and encourage compliance.

It’s never my goal to boost revenue for governments, of course, but there’s surely a lesson to be learned about the benefits of low tax rates when both taxpayers and the government wind up with more money.

P.S. If we really want to learn from other places about the ideal tax system, we should check out Bermuda, Monaco, and the Cayman Islands.

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I’m glad that Donald Trump wants faster growth. The American people shouldn’t have to settle for the kind of anemic economic performance that the nation endured during the Obama years.

But does he understand the right recipe for prosperity?

That’s an open question. At times, Trump makes Obama-style arguments about the Keynesian elixir of government infrastructure spending. But at other times, he talks about lowering taxes and reducing the burden of red tape.

I don’t know what’s he’s ultimately going to decide, but, as the late Yogi Berra might say, the debate over “stimulus” is deja vu all over again. Supporters of Keynesianism (a.k.a., the economic version of a perpetual motion machine) want us to believe that government can make the country more prosperous with a borrow-and-spend agenda.

At the risk of understatement, I disagree with that free-lunch ideology. And I discussed this issue in a recent France24 appearance. I was on via satellite, so there was an awkward delay in my responses, but I hopefully made clear that real stimulus is generated by policies that make government smaller and unleash the private sector.

If you want background data on labor-force participation and younger workers, click here. And if you want more information about unions and public policy, click here.

For today, though, I want to focus on Keynesian economics and the best way to “stimulate” growth.

The question I always ask my Keynesian friends is to provide a success story. I don’t even ask for a bunch of good examples (like I provide when explaining how spending restraint yields good results). All I ask is that they show one nation, anywhere in the world, at any point in history, where the borrow-and-spend approach produced a good economy.

Simply stated, there are success stories. And the reason they don’t exist is because Keynesian economics doesn’t work.

Though the Keynesians invariably respond with the rather lame argument that their spending schemes mitigated bad outcomes. And they even assert that good outcomes would have been achieved if only there was even more spending.

All this is based, by the way, on Keynesian models that are designed to show that more spending generates growth. I’m not joking. That’s literally their idea of evidence.

Since you’re probably laughing after reading that, let’s close with a bit of explicit Keynesian-themed humor.

I’ve always thought this Scott Stantis cartoon best captures why Keynesian economics is misguided. Simply stated, it’s silly to think that the private sector is going to perform better if politicians are increasing the burden of government spending.

But I’m also amused by cartoons that expose the fact that Keynesian economics is based on the notion that you can become richer by redistributing money within an economy. Sort of like taking money out of your right pocket and putting it in your left pocket and thinking that you now have more money.

Expanding on this theme, here’s a new addition for our collection of Keynesian humor. It’s courtesy of Don Boudreaux at Cafe Hayek, and it shows the Keynesian plan to charge the economy (pun intended). You don’t need to know a lot about electricity to realize this isn’t a very practical approach.

Is this an unfair jab? Maybe, but don’t forget that Keynesians are the folks who think it’s good for growth to pay people to dig holes and then pay them to fill the holes. Or, in Krugman’s case, to hope for alien attacks. No wonder it’s so easy to mock them.

P.S. If you want to learn more about Keynesian economics, the video I narrated for the Center for Freedom and Prosperity is a good place to start.

P.P.S. And if you like Keynesian videos, here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek. And even though it’s no longer the right time of year, here’s the satirical commercial for Keynesian Christmas carols.

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