More Evidence against the Capital Gains Tax

The capital gains tax is double taxation, and that’s a bad idea (assuming the goal is faster growth and higher wages).

Let’s consider how it discourages investment. People earn money, pay tax on that money, and then need to decide what to do with the remaining (after-tax) income.

If they save and invest, they can be hit with all sorts of additional taxes. Such as the capital gains tax.

If you want to be wonky, a capital gain occurs when an asset (like shares of stock) climbs in value between when it is purchased and when it is sold.

But stocks rise in value when the market expects a company will generate more income in the future.

Yet that income gets hit by both the corporate income tax and the personal income tax (the infamous double tax on dividends).

So a capital gains tax is a version of triple taxation.

Now that I’ve whined about capital gains taxation, let’s see what happens when a country moves in the right direction.

Professor Terry Moon, from the University of British Columbia, authored a study on the impact of a partial cut in South Korea’s capital gains tax. His abstract succinctly summarizes the results.

This paper assesses the effects of capital gains taxes on investment in the Republic of Korea (hereafter, Korea), where capital gains tax rates vary at the firm level by firm size. Following a reform in 2014, firms with a tax cut increased investment by 34 log points and issued more equity by 9 cents per dollar of lagged revenue, relative to unaffected firms. Additionally, the effects were larger for firms that appeared more cash constrained or went public after the reform. Taken together, these findings are consistent with the “traditional view” predicting that lower payout taxes spur equity-financed investment by increasing marginal returns on investment.

There are several interesting charts and graphs in the study.

But this one is particularly enlightening since we can see big positive results for the firms that were eligible for lower tax rates compared to the ones that still faced higher tax rates.

Richard Rahn wrote about capital gains taxation late last year.

Here are some excerpts from his column in the Washington Times.

Would you vote for a tax that frequently taxes people at an effective rate of 100% or more, misallocates investment, reduces economic growth and job creation, often becomes almost impossible to calculate, and in many cases reduces, rather than increases, revenue for the government? …So-called “capital gains” are price changes most often caused by inflation, which, of course, is caused by incompetent or corrupt governments. …Some countries explicitly allow for the indexing of a capital gain for inflation. Other countries have no capital gains tax at all because they recognize what a destructive tax it is. …The current maximum federal capital gains tax is 23.8%. …“Build Back Better” (BBB) bill would push the top rate to 31.8%…and…citizens of states with high state income tax rates like California, New York, and New Jersey would find themselves paying destructive rates from 43 to 45%.

Needless to say, it is a bad idea to impose a 43 percent-45 percent tax on any type of productive behavior.

But it is downright crazy to impose that type of tax on economic activity (investment) that also gets hit by other forms of tax.

Let’s close with this map from the Tax Foundation. As you can see, some European nations have punitive rates, but countries such as Belgium, Slovakia, Luxembourg, the Czech Republic, and Switzerland wisely have chosen not to impose a capital gains tax..

P.S. For more information, I invite people to watch the video I narrated on the topic. And this editorial from the Wall Street Journal also is a good summary of the issue.

P.P.S. Biden wants America to have the world’s worst capital gains tax. To learn why that’s a bad idea, click here and here.

Read Full Post »

Market-Driven Growth and the Asian Tigers

I’m currently in Tanzania as part of a speaking tour in Africa. My remarks today largely repeated the message I gave to an audience last week in Nigeria.

So I won’t bother sharing anything from my presentation. Instead, I want to highlight some numbers from a presentation by Professor Ken Schoolland.

He shared some data showing how the “Asian Tigers” grew far faster than major Latin American nations between 1950 and 2000.

These are very impressive examples of convergence (as the Asian Tigers caught up with Latin America) followed by divergence (as the Tigers then continued to grow much faster).

I’ll be adding this data to my “anti-convergence club.”

But I also noticed that Professor Schoolland was sharing some old data from 1995.

So I went to the Maddison website and created some new charts based on the latest-available data.

As you can see, the Latin American nations were richer in 1950, but they have not enjoyed fast growth in the past 70 years.

By contrast, the Asian Tigers have enjoyed spectacular growth since 1950.

So not only are these nations much more prosperous than nations in Latin America, in most cases they have even surpassed European countries and Singapore is now richer than the United States.

Since I’m writing about the success of the Asian Tigers, let’s address the myth that they became rich because of industrial policy.

Sam Gregg of the Acton Institute examined this controversy in an article for Law & Liberty.

…what about some of the East Asian Tiger countries? Aren’t they proof that, when devised and implemented by wise governments guided by even cleverer experts, industrial policy can work? …There is, however, a wealth of evidence indicating that these policies produced similarly pedestrian outcomes in these countries. As for the Tigers, what primarily took them from the status of economic backwaters to first-world economies was economic liberalization and especially trade openness… Even the most devoted industrial policy advocates hesitate to present two of the Tigers, Singapore and Hong Kong, as industrial policy successes. They do nevertheless regard South Korea and Taiwan’s postwar histories as demonstrating why industrial policy should play a major role.

Gregg takes a close look at what actually happened in South Korea.

Beginning in 1954 and until about 1963, Korea’s government focused upon import-substitution industrialization policies… however,…economic growth in Korea only began taking off between 1963 and 1973 following a decisive shift towards export-orientated development and trade openness. …Industrial policy assumed a larger place in Korea’s economy in the mid-1970s. …Korea’s turn towards industrial policy in this period does not appear to have produced spectacular results. Economic growth during this period—whether in terms of GDP, trade, employment, manufacturing output, or exports in goods and services—was actually lower than what had been realized in the 1960s. …These results may help explain why Korea’s drift towards industrial policy was reversed, beginning in the late-1970s. …The overall result was a return to high growth throughout Korea’s economy.

And here’s his analysis of what happened in Taiwan.

…the Kuomintang government adopted an import-substitution approach to trade characterized by high tariffs and import quotas. The Taiwan Production Board oversaw the extensive use of industrial policy, especially through preferential loan-treatment… In the mid-1950s, key Taiwanese officials and their American advisors recognized that Taiwan could not keep going down this path. Hence in the late-1950s, decisions were made that re-orientated Taiwan’s economy towards competition and trade openness by, among other things, liberalizing imports and foreign investment rules as well as beginning a process of steadily removing export controls and gradually giving more and more exporters what amounted to a free trade status. As in Korea’s case, growth in Taiwan took off. …the general direction of Taiwan’s economy from 1958 onwards was away from industrial policy and tariffs and towards increasing integration into global markets. Like Korea, Taiwan underwent a limited return to interventionist policies in the mid-1970s, but, again, like Korea, this did not last.

The bottom line is that South Korea and Taiwan are not as rich as Hong Kong and Singapore and one reason they are lagging is that their governments tried to pick winners and losers.

But both those nations largely have abandoned industrial policy, so at least they recognized their mistakes.

P.S. A big issue at the conference is whether the “China Model” should be emulated. I shared some data showing why that would be a big mistake.

Read Full Post »

Why Did South Korea Diverge from Brazil?

Traditional economics, specifically convergence theory, tells us that poor nations should grow faster than rich nations.

I’m more interested, however, in why convergence often doesn’t happen, or only partially happens.

And I’m extremely interested in why we often see divergence, which occurs when two countries are at a similar level of development, but then one grows much faster than the other.

Let’s consider the example of Brazil vs, South Korea.  Otaviano Canuto has an interesting article, published by the Center for Macroeconomics and Development, that looks at how the two countries have diverged over the past 50 years.

Here’s the chart that depicts the dramatic difference.

The author analyzes many of the reasons that South Korea has enjoyed faster growth.

It’s especially worth noting that Brazil’s protectionism has been self-defeating.

The “middle-income trap” has captured many developing countries: they succeeded in evolving from low per capita income levels, but then appeared to stall, losing momentum along the route toward the higher income levels… Such a trap may well characterize the experience of Brazil and most of Latin America since the 1980s. Conversely, South Korea maintained its pace of evolution, reaching a high-income status… The path from low- to middle- and then to high-income per capita corresponds to increasing the shares of population moved from subsistence activities to simple modern tasks and then to sophisticated ones. …South Korea relied extensively on international trade to accelerate their labor transfer by inserting themselves into the labor-intensive segments of global value chains… with the “helping winners and saving losers” of Brazil’s industrial policies…, the temptation to use surpluses to accumulate wealth in ways to maximize frontiers of interaction with the public sector prevails… Brazil’s long-standing high levels of trade protection and closure also favored such an option… The Brazilian economy pays a price in terms of productivity foregone because of its lack of trade openness.

As a big fan of trade, I obviously agree with this analysis.

But I also think that’s not the full story.

If you compare the scores the two countries get from the most-recent edition of Economic Freedom of the World, you’ll find that South Korea scores better on trade.

But you’ll also notice that there are much bigger gaps when looking at scores for size of government, legal system and property rights, and regulation (and the gaps for the latter two indices have existed for decades).

The bottom line is that there are many policy reasons why Brazil lags behind South Korea.

So if Brazil wants to break out of the “middle-income trap,” it needs to follow the tried-and-true recipe for growth and prosperity (what used to be known as the “Washington Consensus“).

P.S. And that means ignoring poisonous advice from the International Monetary Fund and Organization for Economic Cooperation and Development.

Read Full Post »

The Impressive Rise (and Potential Fall) of South Korea

When I give speeches on the importance of public policy, I frequently share data showing that pro-market nations are relatively prosperous when compared to countries with statist policies.

One of the most dramatic examples is South Korean prosperity versus North Korean deprivation.

It’s not that South Korea is perfect. After all, it only ranks #35 according to Economic Freedom of the World.

But that’s enough economic liberty to be in the “most free” category. And this helps to explain why South Korean living standards have climbed dramatically compared to the economic hellhole of North Korea (and you see something similar if you compare Venezuela and South Korea).

I’m definitely not the only person to notice the difference between the two Koreas. Here are some excerpts from one of Richard Rahn’s columns in 2017.

In 1960, South Korea and North Korea were similar in their poverty. Now, 50-plus years later, South Korea has a per-capita income more than 20 times that of North Korea, at approximately $38,000 per year, which is higher than that of Spain or Italy. South Koreans have gone from a per-capita income in 1970 that was about 10 percent of the average American to almost 70 percent today. …Koreans in both the North and South come from the same genetic stock, speak the same language, and occupy adjoining pieces of land with much of the same topography and limited natural resources. North Korea is the ultimate consequence of socialism, which always contains the seeds of its own destruction. Socialism goes against human nature, requiring its government to become increasingly authoritarian — North Korea being Exhibit A.

But Richard also warned that South Korea can’t rest on its laurels.

While economic growth per year averaged more than 9 percent from 1963 to 1990, it has now slowed down and last year was only 2.8 percent…a sharp drop from earlier decades. There is too much unneeded and counterproductive regulation, including the lack of ease of creating new businesses, barriers to imports and inward foreign investment. By any measure, South Korea has been a great success, but probably not as much as it could have been or can be if it followed more of a classic free trade and more limited-government model as practiced by Hong Kong and others. The country is increasingly exhibiting the disease of most other rich, developed democracies by allowing itself to be slowly seduced into the promise of more government services and attendant regulation, rather than the tougher and more competitive policies that created the wealth. Will South Korea avoid the stagnation of Japan and much of Europe? The jury is still out.

The jury may still be out, but there is growing evidence that South Korea is heading in the wrong direction because the nation’s relatively new President in increasing the burden of government.

Here are some passages from a report in the Japan Times.

Moon Jae-in began his second full year as South Korea’s president with a reminder of what didn’t work in the first — namely his economic policies. …The self-styled “jobs president” has seen his once sky-high poll numbers tumble… Moon, a progressive, was swept into office in 2017 promising a reversal from the conglomerate-focused economic agenda of ousted President Park Geun-hye. But his plan to raise the minimum wage 11 percent disappointed… More than three-quarters of the 30 experts surveyed by Bloomberg News last month predicted that employment growth would slow this year, in part because of the wage hike. …In a speech at his news conference Thursday, Moon…pledged to improve the safety net…and fix what he described as “the worst forms of polarized wealth and economic inequality in the world.” …More than half of South Koreans surveyed in another Gallup poll last month said that the administration needed “to focus on economic growth, rather than income distribution.”

By the way, the article doesn’t even mention that South Korea faces a major demographic challenge.

It has a catastrophically low fertility rate, which means that the tax-and-transfer welfare state will become increasingly unaffordable as the ratio of workers to recipients shifts in the wrong direction.

Entitlement reform is the sensible answer to this problem (see Hong Kong, for example).

But that’s obviously not happening under President Moon. Indeed, he wants to make matters worse by expanding the welfare state.

Some people in South Korea realize that demographics are a problem for their nation.

The U.K.-based Express looks at their attempted solution.

Seoul’s Dongguk and Kyung Hee universities say the courses on dating, sex, love and relationships target a generation which is shunning traditional family lives. …as part of the course, students have to date three classmates for a month each. …The course has expanded to Kyong Hee university, which offers “Love and Marriage” classes and Inha university in Incheon, a specialist engineering college, where students can now sign up to lessons on prioritising success and love. In 2016 the number of marriages hit its lowest since 1977, according to data from the government agency Statistics Korea. …The crude marriage rate – the annual number of marriages per 1,000 people – was 5.5 last year, compared with 295.1 when statistics began in 1970. Seoul has spent about £50 billion trying to boost the birth rate.

I’m skeptical of this approach, regardless of how much money the government spends.

Policy makers should focus instead on things they can control, such as fiscal policy and regulatory policy.

And this is why South Korea’s lurch to the left is so disappointing. Politicians are making things worse rather than better.

Even the New York Times is reporting that Moon’s statist agenda isn’t working.

Under President Moon Jae-in, South Korea has raised taxes and the minimum wage in the name of economic growth. So far, it hasn’t worked out as planned. Growth has slowed, unemployment has risen and small-business owners…are complaining. …With his progressive policies, President Moon is trying to tackle some of the same economic problems that plague the United States and much of the developed world. They include a widening wealth gap, slower growth and stagnant wages. …South Korea’s troubles suggest the limits of the state in solving economic problems, especially without addressing the underlying structural issues. …After his election in May 2017, Mr. Moon undertook a sharp shift in economic policy. He supported higher wages, tighter restrictions on working hours and greater welfare spending, funded by tax increases on companies and high-income earners. …Mr. Moon has paid a steep political price for his agenda. His approval rating has plummeted from 84 percent in mid-2017 to 45 percent in the most recent Gallup poll. …The 2019 budget represents the sharpest increase in spending in a decade… The minimum wage has also gone up again for 2019, by 11 percent.

More taxes, more spending, more regulation, and more intervention. Who does Moon think he is, Barack Obama or Richard Nixon?

On a serious note, it surely says something that even the New York Times is forced to acknowledge that statist policies backfire.

Let’s close by looking at how South Korea’s economic freedom score has evolved over time. As you can see, there was a lot of economic liberalization between 1975-2005. That’s the good news.

The bad news is that economic liberty has declined since the mid-2000s.

The drop is modest, at least in absolute terms. But it’s also important (as I explained when looking at Italy) to look at relative competitiveness.

South Korea’s current score of 7.53 isn’t that much lower than its 7.67 score in 2006. But that slight drop, along with pro-reforms steps that other nations have taken, means that South Korea is now ranked #35 instead of #20.

And the current scores are based on policy in 2016, before Moon moved South Korea in the direction of more statism. This doesn’t bode well.

P.S. I’m not expecting South Korea to become another Hong Kong or Singapore, but it should at least seek incremental progress rather than incremental deterioration. Taiwan is a good example of that approach.

July 29, 2021 Addendum: Here’s a chart showing that both South Korea and Taiwan have easily out-performed the world average in recent decades.

The key question, of course, is whether they will follow the right policies and get continued good performance in the future.

Read Full Post »

Capitalism Rules, Socialism Drools

I don’t care whether it’s called socialism, fascism, or communism, statism is evil and destructive. And going partway down that path with “democratic socialism” may avoid brutality, but the end result is still economic misery.

In hopes of getting this point across, I utilize everything from humor to theoretical analysis.

But my favorite approach, based on decades of experience with one-on-one meetings, public speeches, and private briefings, is to share cross-country comparisons. Such real-world evidence seems to be most persuasive.

So it’s time to add to that collection.

Let’s go back to 2011, when Catherine Rampell was with the New York Times and she wrote a column about a book by World Bank economist Branko Milanovic. She focuses on a powerful visual.

My favorite part of the book was this graph…on the vertical axis, you can see where any given ventile from any country falls when compared to the entire population of the world. …take a look at America. Notice how the entire line for the United States resides in the top portion of the graph? That’s because the entire country is relatively rich. In fact, America’s bottom ventile is still richer than most of the world: That is, the typical person in the bottom 5 percent of the American income distribution is still richer than 68 percent of the world’s inhabitants. …America’s poorest are, as a group, about as rich as India’s richest.

Here’s the graph that grabbed her attention.

I agree with everything Ms. Rampell wrote about that graph, but let me expand the focus by explaining why this is yet another piece of evidence for the proposition that policy makers should focus on growth rather than (in)equality.

From a leftist perspective, the ideal line for such a graph is horizontal because that represents complete income equality. And they naturally think that statist policies are more likely to produce an outcome closer to that redistributionist ideal (hence, their support for politicians such as Obama, Clinton, and Sanders).

But the graph shows why they are so wrong to support ever-larger government.

For instance, ponder the question of which nation produces better outcomes for poor people? Obviously, per-capita output for all income levels is higher in the United States, but the gap is especially huge for those with low incomes.

There doubtlessly are many reasons for the output gap in the chart, but one logical explanation is that the overall burden of government is much lower in the United States (#16 in the economic freedom rankings) than in China (#111), India (#114), and Brazil (#118).

By the way, some people may say it’s unfair to compare the United States with nations from the developing world. But the entire point of this comparison is that these other countries aren’t part of the “first world” in part because their economic policies are characterized by statism rather than capitalism.

But for those who want comparisons among developed nations, I’ve reviewed evidence from the United States and Europe on many occasions and the results always show that the relatively more market-friendly policies in the United States produce higher levels of prosperity than the more statist policies of Europe.

And if you want a more apples-to-apples comparison involving one of the most successful European nations, consider this chart showing the relative prosperity of different income levels in the United States and Sweden.

The bottom line is that it’s very difficult to find any evidence to suggest that any group of people enjoys more prosperity in a nation with a larger burden of government.

Which is why I’m still waiting for a leftist to successfully respond to my two-question challenge (and they actually only need to give an answer to one of the questions).

Another good way of determining whether markets work better than statism is to see how fast nations grow over time.

James Pethokoukis of the American Enterprise Institute shares a chart from Max Roser showing long-run changes in per-capita economic output for South Korea and Venezuela.

The amazing takeaway is that Venezuela was about three times richer than South Korea about fifty years ago, but now that ratio is almost reversed.

This is an amazing ratification of the all-important principle that sustained differences in growth have an enormous impact on a nation’s long-run prosperity.

And it shows that nations from the developing world can experience “convergence” and join the first world if they adopt good policies.

They don’t even need great policies. The key is simply to keep the burden of government at modest levels so the private sector has room to grow.

P.S. For those wondering about my juvenile title, I probably watched Homeward Bound: The Incredible Journey over 100 times when my kids were young and I’m borrowing a very appropriate line from that film.

P.P.S. For those who want more information about South Korean growth, check out this comparison of that country with its northern neighbor.

P.P.P.S. And for those who want to learn more about Venezuela’s lack of growth, see how that country compares to Chile and Argentina.

Read Full Post »

Long-Term Growth and the Corrosive Impact of Obamanomics

One of my goals is to convince people that even small differences in long-run growth can have a powerful impact on living standards and societal prosperity.

In other words, the economy is not a fixed pie. The right policies, such as free markets and small government, can create a better life for everybody.

And bad policy, needless to say, can have the opposite impact.

Very few people realize, for instance, that Argentina was one of the world’s 10-richest nations at the end of World War II, but interventionist policies have weakened growth and caused the country to plummet in the rankings.

Hong Kong, by contrast, had a relatively poor economy at the end of the war, but now is one of the globe’s most prosperous jurisdictions.

If you want more examples, check out this chart showing how North Korea and South Korea have diverged over time.

Or how about the chart showing how Chile has out-performed other major Latin American economies.

This comparison of living standards in the United States and Europe also is very compelling.

Here’s a simple guide to highlight the difference between weak growth and strong growth. It shows how long it takes a nation to double economic output depending on annual growth.

As you can see, a nation with 1 percent growth (think Italy) will have to wait 70 years before the economic pie doubles in size.

But a nation that grows 4 percent or faster each year (think Singapore) will double GDP in less than 20 years.

So why am I plowing through all this material?

My answer is simple, but depressing. I’m worried that the United States is becoming more like Europe. During the Bush-Obama years, we’ve seen big increases in the size and scope of government, and it’s no surprise that we’re now suffering from anemic economic performance.

That’s the first point I made in this interview with Michelle Fields of PJTV.

Much of the material in the interview will be familiar to regular readers, but a few points deserve some emphasis.

I say that America becoming more like Europe isn’t the end of the world, but I should elaborate. What I meant is that we can survive 2 percent growth instead of 3 percent growth. We could even survive 1 percent growth.

But if we continue on the current path of ever-growing government and combine that with an aging population and poorly designed entitlement programs, then we will see the end of the world. At least in the sense of fiscal crisis and economic collapse.

All the points I make about jobs, employment, labor force participation, unemployment insurance and disability are simply different ways of saying that it’s not good for the economy when politicians continuously make dependency more attractive than work.

If you want to know more about why the so-called stimulus was a failure, my article in The Federalist is a nice place to start.

The libertarian fantasy world of a small central government is a very good goal, but it’s still possible to make significant progress if politicians follow Mitchell’s Golden Rule.

P.S. You may recognize the host because she narrated a very good video for the Center for Freedom and Prosperity. Michelle explained how the big-government policies of Hoover and Roosevelt deepened and extended the Great Depression.

She also exposed rich leftists as complete hypocrites in this interview.

P.P.S. Since I mentioned above that South Korea has far surpassed North Korea, I should share this powerful nighttime picture of the Korean peninsula.

Gee, maybe capitalism is better than statism after all.

Unless, of course, you think there’s something really nice about North Korea to offset South Korea’s economic advantages.

Such as malnutrition or enslavement. Or a small carbon footprint, which led some nutjobs to rank Cuba far above America.

Read Full Post »

The Brutal Impact of North Korean Statism

One hopes that the dictator of North Korea suffered greatly before he died. After all, his totalitarian and communist (pardon the redundancy) policies caused untold death and misery.

But let’s try to learn an economics lesson. In a previous post, I compared  long-term growth in Hong Kong and Argentina to show the difference between capitalism and cronyism.

But for a much more dramatic comparison, look at the difference between North Korea and South Korea. Hmmm…, I wonder if we can conclude that markets are better than statism?

And if you like these types of comparisons, here’s a post showing how Singapore has caught up with the United States. And here’s another comparing what’s happened in the past 30 years in Chile, Argentina, and Venezuela.

Read Full Post »