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Archive for the ‘Sweden’ Category

I know exactly how Ronald Reagan must have felt back in 1980 when he famously said “There you go again” to Jimmy Carter during their debate.

That’s because I endlessly have to deal with critics who try to undercut the Laffer Curve by claiming that it’s based on the notion that all tax cuts “pay for themselves.”

Now it’s time for me to say “There you go again.”

Reuters regurgitated this misleading trope about the Laffer Curve last year, issuing a report about how the head of the Congressional Budget Office supposedly disappointed “devotees” of “Reaganomics” by saying that tax cuts are not self-financing.

The…Republican-appointed director of the Congressional Budget Office delivered some bad news…to the party’s “Reaganomics” devotees: Tax cuts don’t pay for themselves through turbocharged economic growth. Keith Hall, who served as an economic adviser to former President George W. Bush, made the pronouncement… “No, the evidence is that tax cuts do not pay for themselves,” Hall said in response to a reporter’s question. “And our models that we’re doing, our macroeconomic effects, show that.” His comment is at odds with lingering economic theory from the 1980s.

Well, I’m a “devotee of Reaganomics.” So was I disappointed?

Nope. I largely agree with the CBO Director on this topic.

But I think he should have included two caveats.

First, while there are some politicians (both now and also back in the 1980s) who blindly act as if all tax cuts are self-financing, Reaganomics was not based on that notion.

Instead, proponents of the Reagan tax cuts simply argued reforms would lead to more growth – and therefore more taxable income. And, on that basis, it was a slam-dunk victory.

Interestingly, the report from Reuters quasi-admits that Reaganomics wasn’t based on self-financing tax cuts, noting instead that the core belief was that revenue generated by additional growth would result in “less need” (as opposed to “no need”) to find offsetting budget cuts.

Stronger economic growth generated by tax cuts would boost revenues so much that there is less need to find offsetting savings.

The second caveat is that not all tax cuts (or tax increases) are created equal. Some changes in tax policy have big effects on incentives to work, save, and invest. Others don’t have much impact on economic activity because the tax system’s penalty on productive behavior isn’t altered.

In a few cases, it actually is possible for a tax cut to be self-financing. But in the vast majority of cases, the real issue is the degree to which there is some amount of revenue feedback. In other words, the discussion should focus on the extent to which the foregone revenue from lower tax rates is offset by revenue gains from increased taxable income.

Let’s now look at a real-world example from Sweden to see how politicians are blind to this common-sense insight. The left-wing coalition government in that country indirectly increased marginal tax rates (by phasing out a credit) for some high-income taxpayers this year. The experts at Timbro have examined the potential revenue impact. They start with a description of what happened to policy.

To finance their reforms, …the marginal tax rate for some 400,000 people working in Sweden – e g doctors, engineers, accountants/auditors and others in high income brackets – will be increased by three percentage points to 60 per cent. …it is also necessary to take into consideration payroll tax… Under current rules, the effective marginal tax rate is 75 per cent for high earners. After the phase-out it rises to 77 per cent.

Amazingly, the Swedish government assumes that taxpayers won’t change their behavior in reaction to this high marginal tax rate.

Decades of economics research show that if you raise income tax, people will reduce their working time, put in less effort on the job and engage in more tax planning. When the government calculated the expected increase in revenue of SEK 2.7 billion from the earned income tax credit’s phase out, it failed to take changes in behaviour into consideration because revenue and expenses in the budget are calculated statically.

The folks at Timbro explain what likely will happen as upper-income taxpayers respond to the higher marginal tax rate.

The amount of revenue generated from a tax hike depends on how people change their behaviour as a result. … High elasticity means that salary earners are sensitive to changes in taxation, and that they are very likely to alter their behaviour with certain types of reforms. Examples of this are increasing or decreasing hours worked, switching jobs, or starting a company to enable more tax-planning options. …Elasticity of 0.3 is often used in international literature (e g Hendren, 2014) as a reasonable estimate of the mainstream for this area of research. Piketty & Saez (2012) state that most estimates of elasticity are within the range of 0.1 and 0.4. They conclude that 0.25 is “a realistic mid-range estimate” of elasticity.

So what happens when you apply these measures of taxpayer responsiveness to the Swedish tax hike?

With zero elasticity, i e a static assessment, the revenue increase from phase-out of the earned income tax is assessed at SEK 2.6 billion. That is in line with the government’s estimate of SEK 2.7 billion. … all revenue disappears already at a low, 0.1, level of elasticity.

And when you look at the more mainstream measures of taxpayer responsiveness, the net effect of the government’s tax hike is that the Swedish Treasury will have less revenue.

In other words, this is one of those rare examples of taxable income changing by enough to swamp the impact of the change in the marginal tax rate.

And since we’re dealing with turbo-charged examples of the Laffer Curve, let’s look at what my colleague Alan Reynolds shared about the “huge across-the-board increase in marginal tax rates…Herbert Hoover pushed for” in the early 1930s.

Total federal revenues fell dramatically to less than $2 billion in 1932 and 1933 – after all tax rates had been at least doubled and the top rate raised from 25% to 63%.  That was a sharp decline from revenues of $3.1 billion in 1931 and more than $4 billion in 1930, when the top tax was just 25%. …Revenues fell even as a share of falling GDP –  from 4.1% in 1930 and 3.7% in 1931 to 2.8% in 1932 (the first year of the Hoover tax increase) and 3.4% in 1933. That illusory 1932-33 “increase” was entirely due to less GDP, not more revenue.

Roosevelt’s additional tax increases in the mid-1930s didn’t work much better.

The 15 highest tax rates were increased again in 1936, dividends were made fully taxable at those higher rates, and both corporate and capital gains tax rates were also increased…  Yet all of those massive “tax increases”…failed to bring as much revenue in 1936 as was collected with much lower tax rates in 1930.

The point of these examples is not that governments wound up with less money. What matters is that politicians destroyed private-sector output as a consequence of more punitive tax policy.

And that’s why the tax increases that generate more tax revenue are almost as misguided as the ones that lose revenue.

Consider Hillary Clinton’s tax-hike plan. The Tax Foundation crunched the numbers and concluded it would generate more revenue for the federal government. But I argued that shouldn’t matter.

she’s willing to lower our incomes by 0.80 percent to increase the government’s take by 0.46 percent. A good deal for her and her cronies, but bad for America.

At the risk of repeating myself, we shouldn’t try to be at the revenue-maximizing point of the Laffer Curve.

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I’m in Sweden today, where I just spoke before Timbro (a prominent classical liberal think tank) about the US elections and the implications for public policy.

My main message was pessimism since neither Donald Trump nor Hillary Clinton support genuine entitlement reform.

But I’ve addressed that topic many times before. Today, motivated by my trip, I want to augment my analysis about Sweden from 10 days ago.

In that column, I highlighted some research from Professor Olle Kranz showing that Sweden became a rich nation during a free-market era when government was relatively small. And as you can see from his chart (I added the parts in red), this is also when per-capita economic output in Sweden caught up with – and eventually surpassed – per-capita GDP in other advanced countries.

Then Sweden began to lose ground. Some of this was understandable and inevitable. Sweden didn’t participate in World War II, so its comparative prosperity during the war and immediately afterwards was a one-time blip.

But the main focus of my column from last week was to show that Swedish prosperity began a sustained drop during the 1960s, and I argued that the nation lost ground precisely because statist policies were adopted.

In other words, Sweden enjoyed above-average growth when it relied on policies I like and then suffered below-average growth when it imposed the policies (high tax rates, massive redistribution, etc) that get Bernie Sanders excited.

Today, let’s build upon Professor Kranz’s analysis by extending his calculations. He did his research in the early part of last decade, and we now have many years of additional data that can be added to the chart.

But before doing that, it’s worth noting that the years of additional data basically coincide with a period of market-oriented reforms in Sweden. A study from the Reform Institute in Stockholm explains some of what happened, starting with the stagnation caused by the era of big government.

The seventies and eighties saw Sweden’s tax burden rise from an average European level to the world’s highest. The public sector expanded vastly. All facets of the welfare system were made more generous in international comparison. Meanwhile, labour market regulation increased… Throughout these years, Swedes’ individual after-tax real income stagnated, private sector job creation ceased, and public debt spiralled higher. This culminated in a severe economic crisis in the early 1990s. By then, Sweden had fallen to 14th place in the GDP per capita rankings of OECD countries.

That’s the bad news.

The good news is that this economic misery led to market-oriented reforms.

When the onset of the financial crisis coincided with election of a market-oriented centre-right government in 1991, the reform process began in earnest. Most emphasis at the time was placed on reforms that opened significant sectors in the economy to greater competition. Moreover, an important feature of these regulatory reforms was that the crisis spurred local authorities to implement less burdensome regulation. …significant changes were introduced to the tax system, macroeconomic policy framework, and social insurance system. …every aspect of the Swedish economy has changed due to implementation of reforms. …public sector employment has declined.

To be sure, none of the means Sweden became Hong Kong. It is currently ranked only #38 by Economic Freedom of the World, and its score only improved from 6.92 in 1990 to 7.46 today, hardly a huge jump.

But we nonetheless can now check whether this period of modest reform yielded any dividends. And, looking at an updated and extended version of Professor Kranz’s chart, there certainly seems to be a clear relationship between pro-market policy and Swedish prosperity.

Call me crazy, but it seems like there’s a lesson here about the right recipe for growth.

P.S. The 16 countries in the comparison are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Japan, Sweden, Switzerland, the United Kingdom, and the United States.

P.P.S. If you’re so disposed, you can watch my speech in Stockholm on Timbro’s Facebook page. If you prefer YouTube, the folks at CEPOS in Denmark saw the same speech (I only oppose wasteful forms of recycling) and they posted it yesterday.

P.P.P.S. If you’re interested in more information about market-oriented reforms in Sweden, check out Lotta Moberg’s video and Johan Norberg’s video.

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Sweden punches way above its weight in debates about economic policy. Leftists all over the world (most recently, Bernie Sanders) say the Nordic nation is an example that proves a big welfare state can exist in a rich nation. And since various data sources (such as the IMF’s huge database) show that Sweden is relatively prosperous and also that there’s an onerous fiscal burden of government, this argument is somewhat plausible.

A few folks on the left sometimes even imply that Sweden is a relatively prosperous nation because it has a large public sector. Though the people who make this assertion never bother to provide any data or evidence.

I have five responses when confronted with the why-can’t-we-be-more-like-Sweden argument.

  1. Sweden became rich when government was small. Indeed, until about 1960, the burden of the public sector in Sweden was smaller than it was in the United States. And as late as 1970, Sweden still had less redistribution spending than America had in 1980.
  2. Sweden compensates for bad fiscal policy by having a very pro-market approach to other areas, such as trade policy, regulatory policy, monetary policy, and rule of law and property rights. Indeed, it has more economic freedom than the United States when looking an non-fiscal policies. The same is true for Denmark.
  3. Sweden has suffered from slower growth ever since the welfare state led to large increases in the burden of government spending. This has resulted in Sweden losing ground relative to other nations and dropping in the rankings of per-capita GDP.
  4. Sweden is trying to undo the damage of big government with pro-market reforms. Starting in the 1990s, there have been tax-rate reductions, periods of spending restraint, adoption of personal retirement accounts, and implementation of nationwide school choice.
  5. Sweden doesn’t look quite so good when you learn that Americans of Swedish descent produce 39 percent more economic output, on a per-capita basis, than the Swedes that stayed in Sweden. There’s even a lower poverty rate for Americans of Swedish ancestry compared to the rate for native Swedes.

I think the above information is very powerful. But I’ll also admit that these five points sometimes aren’t very effective in changing minds and educating people because there’s simply too much information to digest.

As such, I’ve always thought it would be helpful to have one compelling visual that clearly shows why Sweden’s experience is actually an argument against big government.

And, thanks to the Professor Deepak Lal of UCLA, who wrote a chapter for a superb book on fiscal policy published by a British think tank, my wish may have been granted. In his chapter, he noted that Sweden’s economic performance stuttered once big government was imposed on the economy.

Though the Swedish model is offered to prove that high levels of social security can be paid for from the cradle to the grave without damaging economic performance, the claim is false (see Figure 1). The Swedish economy, between 1870 and 1950, grew faster on average than any other industrialised economy, and the country became technologically one of the most advanced and richest in the world. From the 1950s Swedish economic growth slowed relative to other industrialised countries. This was due to the expansion of the welfare state and the growth of public – at the expense of private – employment.57 After the Second World War the working population increased by about 1 million: public employment accounted for c. 770,000, private accounted for only 155,000. The crowding out by an inefficient public sector of the efficient private sector has characterised Sweden for nearly half a century.58 From being the fourth richest county in the OECD in 1970 it has fallen to 14th place. Only in France and New Zealand has there been a larger fall in relative wealth

And here is Figure 1, which should make clear that what’s good in Sweden (rising relative prosperity) was made possible by the era of free markets and small government, and that what’s bad in Sweden (falling relative prosperity) is associated with the adoption and expansion of the welfare state.

But just to make things obvious for any government officials who may be reading this column, I augment the graph by pointing out (in red) the “free-market era” and the “welfare-state era.”

As you can see, credit for the chart actually belongs to Professor Olle Krantz. The version I found in Professor Lal’s chapter is a reproduction, so unfortunately the two axes are not very clear. But all you need to know is that Sweden’s relative economic position fell significantly between the time the welfare state was adopted and the mid 1990s (which presumably reflects the comparative cross-country data that was available when Krantz did his calculations).

You can also see, for what it’s worth, that Sweden’s economy spiked during World War II. There’s no policy lesson in this observation, other than to perhaps note that it’s never a good idea to have your factories bombed.

But the main lesson, which hopefully is abundantly clear, is that big government is a recipe for comparative decline.

Which perhaps explains why Swedish policymakers have spent the past 25 years or so trying to undo some of those mistakes.

Addendum on November 3, 2016: A Swedish researcher kindly sent me a clear copy of Professor Kranz’s chart, so the axes are now very clear.

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