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Archive for the ‘Tax Competition’ Category

If I was a citizen of the United Kingdom, I would have voted to leave the European Union for the simple reason that even a rickety lifeboat is better than a slowly sinking ship.

More specifically, demographic changes and statist policies are a crippling combination for continental Europe, almost surely guaranteeing a grim future, and British voters wisely decided to escape. Indeed, I listed Brexit as one of the best things that happened in 2016.

This doesn’t mean the U.K. has ideal policies, but Brexit was a good idea precisely because politicians in London will now have more leeway and incentive to liberalize their economy.

Though I wonder whether Prime Minister May and the bumbling Tories will take advantage of the situation.

The Financial Times has a report that captures the real issue driving Brexit discussions. Simply stated, the European Union is scared that an independent U.K. will become more market-friendly and thus put competitive pressure on E.U. welfare states.

The EU is threatening sanctions to stop Britain undercutting the continent’s economy after Brexit…the bloc wants unprecedented safeguards after the UK leaves to preserve a “level playing field” and counter the “clear risks” of Britain slashing taxes or relaxing regulation. Brussels…wants…to enforce restrictions on taxation…and employment rights. …the EU negotiators highlight the risk of Britain ‘undermining Europe as an area of high social protection’…the UK is “likely to use tax to gain competitiveness” and note it is already a low-tax economy with a “large number of offshore entities”. …On employment and environmental standards, the EU negotiators highlight the risk of Britain “undermining Europe as an area of high social protection”.

In case you don’t have a handy statism-to-English dictionary handy, you need to realize that “level playing field” means harmonizing taxes and regulations at very high level.

Moreover, “employment rights” means regulations that discourage hiring by making it very difficult for companies to get rid of workers.

And “high social protection” basically means a pervasive and suffocating welfare state.

To plagiarize from the story’s headline, these are all policies that belong in a bonfire.

And the prospect of that happening explains why the politicians and bureaucrats in continental Europe are very worried.

…senior EU diplomats, however, worry that the political expectations go beyond what it is possible to enforce or agree. “This is our big weakness,” said one. Theresa May, the British prime minister, last year warned the EU against a “punitive” Brexit deal, saying Britain would fight back by setting “the competitive tax rates and the policies that would attract the world’s best companies and biggest investors”.

Sadly, Theresa May doesn’t seem very serious about taking advantage of Brexit. Instead, she’s negotiating like she has the weak hand.

Instead, she has the ultimate trump card of a “hard Brexit.” Here are four reasons why she’s in a very strong position.

First, the U.K. has a more vibrant economy. In the latest estimates from the Fraser Institute’s Economic Freedom of the World, the United Kingdom is #6.

And how does that compare to the other major economies of Europe?

Well, Germany is #23, Spain is #36, France is #52, and Italy is #54.

So it’s easy to understand why the European Union is extremely agitated about the United Kingdom becoming even more market oriented.

Indeed, the only area where the U.K. is weak is “size of government.” So if Brexit led the Tories to lower tax rates and shrink the burden of government spending, it would put enormous pressure on the uncompetitive welfare states on the other side of the English Channel.

Second, the European Union is horrified about the prospect of losing membership funds from the United Kingdom. That’s why there’s been so much talk (the so-called divorce settlement) of ongoing payments from the U.K. to subsidize the army of bureaucrats in Brussels. A “hard Brexit” worries British multinational companies, but it worries European bureaucrats even more.

Third, the European Union has very few options to punitively respond because existing trade rules (under the World Trade Organization) are the fallback option if there’s no deal. In other words, any protectionist schemes (the “sanctions” discussed in the FT article) from Brussels surely would get rejected.

Fourth, European politicians may hate the idea of an independent, market-oriented United Kingdom, but the business community in the various nations of continental Europe will use its lobbying power to fight against self-destructive protectionist policies and other punitive measures being considered by the spiteful political class.

P.S. Here’s a Brexit version of the Bayeux Tapestry that probably won’t be funny unless one is familiar with the ins and outs of British politics.

P.P.S. Here are some easier-to-understand versions of Brexit humor.

P.P.P.S. And here’s some mockery of senior politicians of the European Commission.

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During the Obamacare bill-signing ceremony, Vice President Biden had a “hot mic” incident when he was overheard telling Obama that “this is a big f***ing deal.”

And he was telling the truth. It was a big deal (albeit a wrong deal) from a fiscal perspective and a health perspective. And it also was a very costly deal for Democrats, costing them the House in 2010 and the Senate in 2014. But it definitely was consequential.

Well, there’s another “big f***ing deal” in Washington, and it’s what just happened to the state and local tax deduction. It wasn’t totally repealed, as I would have preferred, but there’s now going to be a $10,000 limit on the amount of state and local taxes that can be deducted.

I’ve already explained why this is going to reverberate around the nation, putting pressure on governors and state legislators for better tax policy, and I augment that argument in this clip from a recent interview with Trish Regan.

The bottom line is that high-tax states no longer will be able to jack up taxes, using federal deductibility to spread some of the burden to low-tax states.

Let’s look at what this means, starting with a superb column in today’s Wall Street Journal by Alfredo Ortiz.

The great American migration out of high-tax states like New York and Illinois may be about to accelerate. The tax reform enacted last month caps the deduction for state and local taxes, known as SALT, at $10,000. …between July 1, 2016, and July 1, 2017, …high-tax states like New York, New Jersey, Connecticut, Illinois and Rhode Island either lost residents or stagnated. …When people move, they take their money with them. The five high-tax states listed above have lost more than $200 billion of combined adjusted gross income since 1992… In contrast, Nevada, Washington, Florida and Texas gained roughly the same amount. If politicians in high-tax states want to prevent this migration from becoming a stampede, they will have to deliver fiscal discipline.

Mr. Ortiz shows how some state politicians already seem to realize higher taxes won’t be an easy option anymore.

New Jersey’s Gov.-elect Phil Murphy campaigned on a promise to impose a “millionaires’ tax.” But the Democratic president of the state Senate, Steve Sweeney, said in November that New Jersey needs to “hit the pause button” because “we can’t afford to lose thousands of people.” His next words could have come from a Republican: “You know, 1% of the people in the state of New Jersey pay about 42% of its tax base. And you know, they can leave.” New York City Mayor Bill de Blasio may need to rethink his proposed millionaires’ tax. George Sweeting, deputy director of the city’s Independent Budget Office, told Politico in November that eliminating the SALT deduction would “make it a tougher challenge if the city or the state wanted to raise their taxes.” New York state Comptroller Thomas DiNapoli added: “If you lose that deductibility, I worry about more middle-class families leaving.” …the limit on the SALT deduction is a gift that will keep on giving. In the years to come it will spur additional tax cuts and forestall tax increases at the state and local level.

Though the politicians from high-tax states are definitely whining about the new system.

The Governor of New Jersey is even fantasizing about a lawsuit to reverse reform.

Murphy, a Democrat, said he has spoken with leadership in New York and California and with legal scholars about doing “whatever it takes”… Asked if that included a joint lawsuit with other states, Murphy said “emphatically, yes.” …Murphy said. “This is a complete and utter outrage. And I don’t know how else to say it. We ain’t gonna stand for it.”

Here’s a story from New York Times that warmed my heart last month.

…while Mr. Cuomo and his counterparts from California and New Jersey seemed dead-certain about the tax bill’s intent — Mr. Brown called it “evil in the extreme” — there were still an array of questions about how states would respond. None of the three Democrats offered concrete plans on what action their states might take.

They haven’t offered any concrete plans because the only sensible policy – lower tax rates and streamlined government – is anathema to politicians who like buying votes with other people’s money.

California will be hard-hit, but a columnist for the L.A. Times correctly observes tax reform will serve as a much-need wake-up call for state lawmakers.

…let’s be intellectually honest. There’s no credible justification for the federal government subsidizing California’s highest-in-the-nation state income tax — or, for that matter, any local levy like the property tax. Why should federal tax money from people in other states be spent on partially rebating Californians for their state and local tax payments? Some of those states don’t even have their own income tax, including Nevada and Washington. Neither do Texas and Florida. …federal subsidies just encourage the high-tax states to rake in more money and spend it. And they numb the states’ taxpayers. …Republican state Sen. Jeff Stone of Temecula put it this way after Trump unveiled his proposal last week: “For years, the Democrats who raise our taxes in California have said, ‘Don’t worry. The increase won’t matter all that much because tax increases are deductible.’” Trump’s plan, Stone continued, “seems to finally force states to be transparent about how much they actually tax their own residents.”

He also makes a very wise point about the built-in instability of California’s class-warfare system – similar to a point I made years ago.

Our archaic system is way too volatile. The nonpartisan Legislative Analyst’s Office reported last week that income tax revenue is five times as volatile as personal income itself. The “unpredictable revenue swings complicate budgetary planning and contributed to the state’s boom-and-bust budgeting of the 2000s,” the analyst wrote. During the recession in 2008, for example, a 3.7% dip in the California economy resulted in a 23% nosedive in state revenue. The revenue stream has become unreliable because it depends too heavily on high-income earners, especially their capital gains. During an economic downturn, capital gains go bust and revenue slows to a trickle. In 2015, the top 1% of California earners paid about 48% of the total state income tax while drawing 24% of the taxable income.

Let’s close with some sage analysis from Deroy Murdock.

“Taxes should hurt,” Ronald Reagan once said. He referred to withholding taxes, which empower politicians to siphon workers’ money stealthily, before it reaches their paychecks. Writing the IRS a check each month, like covering the rent, would help taxpayers feel the public sector’s true cost. This would boost demand for tax relief and fuel scrutiny of big government. Like withholding taxes, SALT keeps high state-and-local taxes from hurting. In that sense, SALT is the opiate of the overtaxed masses. The heavy levies that liberal Democrats (and, inexcusably, some statist Republicans) impose from New York’s city hall to statehouses in Albany, Trenton, and Sacramento lack their full sting, since SALT soothes their pain. Just wait: Once social-justice warriors from Malibu to Manhattan feel the entire weight of their Democrat overlords’ yokes around their necks, they will squeal. Some will join the stampede to income-tax-free states, including Texas and Florida. …A conservative, the saying goes, is a liberal who has been mugged by reality. Dumping SALT into the Potomac should inspire a similar epiphany among the Democratic coastal elite.

He’s right. This reform could cause a political shake-up in blue states.

P.S. Since I started this column with some observations about the political consequences of Obamacare, this is a good time to mention some recent academic research about the impact of that law on the 2016 race.

We combine administrative records from the federal health care exchange with aggregate- and individual-level data on vote choice in the 2016 election. We show that personal experiences with the Affordable Care Act informed voting behavior and that these effects could have altered the election outcome in pivotal states… We also offer evidence that consumers purchasing coverage through the exchange were sensitive to premium price hikes publicized shortly before the election… Placebo tests using survey responses collected before the premium information became public suggest that these relationships are indeed causal.

Wow. Obamacare there’s a strong case that Obamacare delivered the House to the GOP, the Senate to the GOP, and also the White House to the GOP. Hopefully the Democrats will be less likely to do something really bad or really crazy the next time they hold power.

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The right kind of tax reform can help people directly and indirectly.

  • They benefit directly if reform reduces their tax burden and gives them more take-home income.
  • They benefit indirectly if reform increases growth and leads to additional pre-tax income.

For what it’s worth, I think the indirect impact is most important for family finances, and I discussed the potential benefits of faster growth in this recent interview on Fox Business.

But for today’s column, I want to focus on the final portion of the interview, when I pontificated on how limiting the state and local tax deduction is going to motivate some successful taxpayers to “vote with their  feet” and therefore put additional pressure on high-tax states.

And if we get lower tax rates at the state level, we can include that outcome as another indirect benefit of federal tax reform.

I’m leery of predictions, but I think this will happen. The bottom line is that high-income taxpayers – even before tax reform from Washington – have been escaping from states such as Illinois and California. Here are some fun facts from a recent column in National Review based on IRS data.

Last month, the Internal Revenue Service released the latest tax and migration numbers for 2015 and 2016. …the latest figures show that Florida is seeing an overwhelming influx of taxpayers from other states. In 2015 and 2016, the Sunshine State attracted a staggering net inflow of $17.4 billion in adjusted gross incomes. …the IRS is able to break down new residents by age groups. During the 2015–16 reporting period, nearly 70,000 tax filers between the ages of 26 and 35 moved into the state. That age group accounted for the biggest influx of new Florida residents, over ten thousand more than the 55-and-over category. …The states that lost the most net taxpayers in both dollar and percentage terms relative to their existing tax bases are Connecticut (–$2.7 billion) and New York (–$8.8 billion). What does this tell us? …the size of a state’s government matters. Florida’s per capita state spending is the lowest in the country… Connecticut, meanwhile, has the eighth highest per capita state spending, and New York ranks 15th. …New York has the second heaviest aggregate tax burden of any state, while Florida’s is the fourth lightest.

The Daily Caller combed through some new data from the Census Bureau.

Three Democratic-leaning states hemorrhaged hundreds of thousands of people in 2016 and 2017 as crime, high taxes and, in some cases, crummy weather had residents seeking greener pastures elsewhere. The exodus of residents was most pronounced in New York, which saw about 190,000 people leave the state between July 1, 2016 and July 1, 2017, according to U.S. Census Bureau data released last week. …Illinois lost so many residents that it dropped from the fifth to the sixth-most populous state in 2017, losing its previous spot to Pennsylvania. Just under 115,000 Illinois residents decamped for other states between July 2016 and July 2017. Since 2010, the Land of Lincoln has lost about 650,000 residents to other states on net… Illinois’ Democratic-dominated legislature has tried to ameliorate the situation with tax hikes, causing even more people to leave and throwing the state into a demographic spiral. Illinois experiences a net loss of about 33,000 residents in 2016, the fourth consecutive year of population decline. …California was the third deep blue state to experience significant domestic out-migration between July 2016 and July 2017, and it couldn’t blame the outflow on retirees searching for a more agreeable climate. About 138,000 residents left the state during that time period, second only to New York.

Even the establishment media is noticing.

Here are excerpts from a recent report in the Mercury News.

A growing number of Bay Area residents — besieged by home prices, worsening traffic, high taxes and a generally more expensive cost of living — believe life would be better just about anywhere else but here. During the 12 months ending June 30, the number of people leaving California for another state exceeded by 61,100 the number who moved here from elsewhere in the U.S., according to state Finance Department statistics. The so-called “net outward migration” was the largest since 2011, when 63,300 more people fled California than entered. …”They are tired of the state of California and the endless taxes here,” said Scott McElfresh, a certified moving consultant. “People are getting soaked every time they turn around.”

And now that state and local taxes will no longer be fully deductible, this out-migration is going to accelerate. Which, of course, will mean added pressure for lower tax rates in states like New York and California. And New Jersey, Illinois, and Connecticut.

Here are some excerpts from a story from Yahoo Finance.

Wall Street tax expert Robert Willens, president of Robert Willens LLC, has never heard more discussion from wealthy New Yorkers about relocating to another state with a more favorable tax environment until now because of the GOP tax plan. “Everybody I speak to brings this up. Every NYC resident I speak to asks about the feasibility involved in doing it,” Willens, who regularly advises hedge fund clients on tax matters as it relates to investing, told Yahoo Finance. “I’ve been doing this more than 40 years, and never heard more discussion about relocating than recently.” …“He believes it will devastate NY (and, to a lesser extent, CA), primarily by ending or severely limiting the deduction of the very high state and local taxes. He estimated that his tax rate (and others [similarly] situated) will go from mid-30% to 56%, which will trigger a massive exodus from NY to places like Florida, which will crush the NYC (and therefore state) economy.” …Kelly Smallridge, the president and CEO of Palm Beach County’s Business Development Board, has seen an uptick in activity from CEOs looking to explore Florida since there’s no state tax on personal income. …The move from the northeast to Florida has been somewhat of a trend in recent years. In the last five years, 60 financial services firms have relocated to the Palm Beach area, Smallridge noted.

If you want to know what states are most vulnerable, the Tax Foundation’s map of state income tax burdens is a good place to start. Also, the Tax Foundation’s State Business Tax Climate Index is another measure of which states over-tax their citizens.

And here’s a survey of small business sentiment that shows which states are viewed as having unfriendly tax codes. Green is good and orange is bad.

And it’s also worth reviewing the evidence that already exists for tax-motivated migration.

Here’s a map showing the entire country and here’s a map showing the exodus from California.

Let’s close with this amusing cartoon strip.

Very clever. Sort of reminds me of these two cartoons (here and here) on the economic rivalry between Texas and California.

P.S. The folks at Redpanels, by the way, also have produced great cartoons on Keynesian economics, communism, the minimum wagebasic income, and infrastructure.

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When Ronald Reagan slashed tax rates in America in the 1980s, the obvious direct effect was more prosperity in America.

But the under-appreciated indirect effect of Reaganomics was that it helped generate more prosperity elsewhere in the world.

Not because Americans had higher income and could buy more products from home and abroad (though that is a nice fringe benefit), but rather because the Reagan tax cuts triggered a virtuous cycle of tax competition. Politicians in other countries had to lower their tax rates because of concerns that jobs and investment were migrating to America (Margaret Thatcher also deserves some credit since she also dramatically reduced tax rates and put even more competitive pressure on other nations to do the same thing).

If you look at the data for developed nations, the average top income tax rate in 1980 was more than 67 percent. It’s now closer to 40 percent.

And because even countries like Germany and France enacted supply-side reforms, the global economy enjoyed a 25-year renaissance of growth and prosperity.

Unfortunately, there’s been some slippage in the wrong direction in recent years, probably caused in part be the erosion of tax competition (politicians are more likely to grab additional money if they think targeted victims don’t have escape options).

But we may be poised for a new virtuous cycle of tax competition, at least with regards to business taxation. A big drop in the U.S. corporate tax rate will pressure other nations to lower their taxes as well. And if new developments from China and Europe are accurate, I’ve been underestimating the potential positive impact.

Let’s start with news from China, where some officials are acting as if dropping the U.S. corporate tax rate to 20 percent is akin to economic warfare.

U.S. tax cuts—the biggest passed since those during the presidency of Ronald Reagan three decades ago—have Beijing in a bind. Prominent in the new tax policy are generous reductions in the corporate tax and a rationalization of the global tax scheme. Both are expected to draw capital and skilled labor back to the United States. …In April, Chinese state-controlled media slammed the tax cuts, accusing the U.S. leadership of risking a “tax war”… On April 27, state-run newspaper People’s Daily quoted a Chinese financial official as saying, “We’ve made our stance clear: We oppose tax competition.” …Beijing has good reason to be afraid. …“Due to the tax cut, the capital—mostly from the manufacturing industry—will flow back to the U.S.,” Chen said.

While Chinese officials are worried about tax competition, they have a very effective response. They can cut tax rates as well.

…the Communist Party had promised to implement financial policy that would be more beneficial for the general public, but has not put this into practice. Instead, Beijing has kept and expanded a regime whereby heavy taxes do not benefit the people…, but are used to prop up inefficient state-owned enterprises… Chinese officials and scholars are considering the necessity of implementing their own tax reforms to keep up with the Trump administration. …Zhu Guangyao, a deputy minister of finance, said in a meeting that it was “indeed impossible” to “ignore the international effects” of the American tax cut, and that “proactive measures” needed to be taken to adjust accordingly. …a Chinese state-run overseas publication called “Xiakedao” came out with a report saying that while Trump’s tax cuts put pressure on China, the pressure “can all the same be transformed into an opportunity for reform.” It remains to be seen whether communist authorities are willing to accept a hit to their tax revenue to balance the economy and let capital flow into the hands of the private sector.

The Wall Street Journal also has a story on how China’s government might react to U.S. tax reform.

…economic mandarins in Beijing are focusing on a potentially… immediate threat from Washington— Donald Trump’s tax overhaul. In the Beijing leadership compound of Zhongnanhai, officials are putting in place a contingency plan to combat consequences for China of U.S. tax changes… What they fear is…sapping money out of China by making the U.S. a more attractive place to invest.

Pardon me for digressing, but isn’t it remarkable that nominally communist officials in China clearly understand that lower tax rates will boost investment while some left-leaning fiscal “experts” in America still want us to believe that lower tax won’t help growth.

But let’s get back to the main point.

An official involved in Beijing’s deliberations called Washington’s tax plan a “gray rhino,” an obvious danger in China’s economy that shouldn’t be ignored. …While the tax overhaul isn’t directly aimed at Beijing, …China will be squeezed. Under the tax plan now going through the U.S. legislative process, America’s corporate levy could drop to about 20% from 35%. Over the next few years, economists say, that could spur manufacturers—whether American or Chinese—to opt to set up plants in the U.S. rather than China.

It’s an open question, though, whether China will respond with bad policy or good policy.

Imposing capital controls to limit the flow of money to the United States would be an unfortunate reaction. Using American reform as an impetus for Chinese reform, by contrast, would be serendipitous.

The sweeping overhaul of the U.S. tax code, estimated to result in $1.4 trillion in U.S. cuts over a decade, is also serving as a wake-up call for Beijing, which for years has dragged its feet on revamping China’s own rigid tax system. Chinese businesses have long complained about high taxes, and the government has pledged to reduce the levies on them. …Chinese companies face a welter of other taxes and fees their U.S. counterparts don’t, including a 17% value-added tax. …Chinese employers pay far-higher payroll taxes. Welfare and social insurance taxes cost between 40% and 100% of a paycheck in China. World Bank figures for 2016 show that total tax burden on Chinese businesses are among the highest of major economies: 68% of profits, compared with 44% in the U.S. and 40.6% on average world-wide. The figures include national and local income taxes, value-added or sales taxes and any mandatory employer contributions for welfare and social security.

I very much hope Chinese officials respond to American tax cuts with their own supply-side reforms. I’ve applauded the Chinese government in the past for partial economic liberalization. Those policies have dramatically reduced poverty and been very beneficial for the country.

Lower tax rates could be the next step to boost living standards in China.

By the way, the Chinese aren’t the only ones paying attention to fiscal developments in the United States. The GOP tax plan also is causing headaches in Europe, as reported by CNN.

Germany, France, Britain, Spain and Italy have written to Treasury Sec. Steven Mnuchin… The letter argues that proposed changes to the U.S. tax code could give American companies an advantage over foreign rivals. …They said the provision could also tax the profits of foreign businesses that do not have a permanent base in the U.S. …The finance ministers said they opposed another measure in the Senate bill that could benefit American companies.

I have two responses. First, I actually agree with some of the complaints in the letter about selected provisions in the tax bill (see, for instance, Veronique de Rugy’s analysis in National Review about the danger of the BAT-like excise tax). We should be welcoming investment from foreign companies, not treating them like potential cash cows for Uncle Sam.

That being said, European officials are throwing stones in a glass house. They are the ones pushing the OECD’s initiative on “base erosion and profit shifting,” which is basically a scheme to extract more money from American multinational firms. And let’s also remember that the European Commission is also going after American companies using the novel argument that low taxes are a form of “state aid.”

Second, I think the Europeans are mostly worried about the lower corporate rate. German officials, for instance, have already been cited for their fear of a “ruinous era of tax competition.” And politicians at the European Parliament have been whining about a “race to the bottom.”

So I’ll give them the same advice I offered to China. Respond to Americans tax cuts by doing the right thing for your citizens. Boost growth and wages with lower tax rates.

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The late Mancur Olsen was a very accomplished academic economist who described the unfortunate tendency of vote-seeking governments to behave like “stationary bandits,” seeking to extract the maximum amount of money from taxpayers.

I’m not nearly as sophisticated, so I simply refer to this process as “goldfish government.”

Tax competition is a way of discouraging this self-destructive behavior. Politicians are less likely to over-tax and over-spend if they know that jobs and investment can migrate from high-tax nations to low-tax jurisdictions (borders can be a hassle, but they are beneficial since they presumably represent a limit on the reach of a government’s power).

This is why I’m a big fan of so-called tax havens.

I want politicians to be afraid that the geese with the golden eggs may fly away. This is one of the reasons why “offshore” nations play a very valuable role in the global economy.

But it’s important to realize that there’s also a moral argument for tax havens.

Ask yourself whether you would want the government to have easy access to your nest egg (whether it’s a lot or a little) if you lived in Russia? Or Venezuela? Or China? Or Zimbabwe?

Ask yourself whether you trust the bureaucracy to protect the privacy of your personal financial information if you lived in a country with corruption problems like Mexico? Or India? Or South Africa?

Here’s a story from France24 that underscores my point.

Turkish President Recep Tayyip Erdogan declared Sunday that businessmen who move assets abroad are committing “treason”, adding that his government should put an end to the practice. “I am aware that some businessmen are attempting to place their assets overseas. I call on the government not to authorise any such moves, because these are acts of treason,” Erdogan said in televised comments to party members in the eastern town on Mus.

Allow me to translate. What Erdogan is saying is “I don’t want escape options for potential victims of expropriation.” For all intents and purposes, he’s basically whining that he can’t steal money that is held offshore.

Which, of course, is why offshore finance is so important.

Professor Tyler Cowen elaborates in a Bloomberg column.

I’d like to speak up for offshore banking as a significant protection against tyranny and unjust autocracy. It’s not just that many offshore financial institutions, such as hedge funds registered in the Cayman Islands, are entirely legal, but also that the practice of hiding wealth overseas has its upside. …offshore…accounts make it harder for autocratic governments to confiscate resources from their citizens. That in turn limits the potential for tyranny.

Tyler looks at some of the research and unsurprisingly finds that there’s a lot of capital flight from unstable regimes.

A recent study shows which countries are most likely to use offshore banking, as measured by a percentage of their gross domestic product. …The top five countries on this list, measured as a percentage of GDP, are United Arab Emirates, Venezuela, Saudi Arabia, Russia and Argentina, based on estimates from 2007. In all of those cases the risk of arbitrary political confiscations of wealth is relatively high. …When I consider that list of countries, I don’t think confidential offshore banking is such a bad thing. …consider some of the countries that are not major players in the offshore wealth sweepstakes. China and Iran, for instance, have quite low percentages of their GDPs held in offshore accounts, in part because they haven’t been well integrated into global capital markets. …Are we so sure it would be bad for more Chinese and Iranian wealth to find its way into offshore banks? The upshot would be additional limits on the power of the central leaders to confiscate wealth and to keep political opposition in line.

So what’s the bottom line?

Simple. People need ways of protecting themselves from greedy government.

From the vantage point of Western liberalism, individuals should be free from arbitrary confiscations of their wealth, connected to threats against their life and liberty, even if those individuals didn’t earn all of that wealth justly or honestly. There is even a “takings clause” built into the U.S. Constitution. On top of these moral issues, such confiscations may scare off foreign investment and slow progress toward the rule of law.

By the way, the moral argument shouldn’t be limited to nations with overtly venal governments that engage in wealth expropriation. What about the rights of people in nations – such as Argentina and Greece – where  governments wreck economies because of blind incompetence? Shouldn’t they have the ability to protect themselves from wealth destruction?

I actually raised some of these arguments almost 10 years ago in this video from the Center for Freedom and Prosperity.

P.S. There’s lots of evidence that politicians raise tax rates when tax competition is weakened.

P.P.S. Which is why I’m very happy that Rand Paul is leading the fight against a scheme for a global tax cartel.

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When companies want to boost sales, they sometimes tinker with products and then advertise them as “new and improved.”

In the case of governments, though, I suspect “new” is not “improved.”

The British territory of Jersey, for instance, has a very good tax system. It has a low-rate flat tax and it overtly brags about how its system is much better than the one imposed by London.

In the United States, by contrast, the state of New Jersey has a well-deserved reputation for bad fiscal policy. To be blunt, it’s not a good place to live and it’s even a bad place to die.

And it’s about to get worse. A column in the Wall Street Journal warns that New Jersey is poised to take a big step in the wrong direction. The authors start by observing that the state is already in bad shape.

…painless solutions to New Jersey’s fiscal challenges don’t exist. …a massive structural deficit lurks… New Jersey’s property taxes, already the highest in the nation, are being driven up further by the state’s pension burden and escalating health-care costs for government workers.

In other words, interest groups (especially overpaid bureaucrats) control the political process and they are pressuring politicians to divert even more money from the state’s beleaguered private sector.

…politicians seem to think New Jersey can tax its way to budgetary stability. At a debate this week in Newark, the Democratic gubernatorial nominee, Phil Murphy, pledged to spend more on education and to “fully fund our pension obligations.” …But just taxing more would risk making New Jersey’s fiscal woes even worse. …New Jersey is grasping at the same straws. During the current fiscal year, the state’s pension contribution is $2.5 billion, only about half the amount actuarially recommended. The so-called millionaire’s tax, a proposal Gov. Chris Christie has vetoed several times since taking office in 2010, will no doubt make a comeback if Mr. Murphy is elected. Yet it would bring in only an estimated $600 million a year.

The column warns that New Jersey may wind up repeating Connecticut’s mistakes.

Going down that path, however, is a recipe for a loss of high-value taxpayers and businesses.

Let’s look at a remarkable story from the New York Times. Published last year, it offers a very tangible example of how the state’s budgetary status will further deteriorate if big tax hikes drive away more successful taxpayers.

One man can move out of New Jersey and put the entire state budget at risk. Other states are facing similar situations…during a routine review of New Jersey’s finances, one could sense the alarm. The state’s wealthiest resident had reportedly “shifted his personal and business domicile to another state,” Frank W. Haines III, New Jersey’s legislative budget and finance officer, told a State Senate committee. If the news were true, New Jersey would lose so much in tax revenue that “we may be facing an unusual degree of income tax forecast risk,” Mr. Haines said.

Here are some of the details.

…hedge-fund billionaire David Tepper…declared himself a resident of Florida after living for over 20 years in New Jersey. He later moved the official headquarters of his hedge fund, Appaloosa Management, to Miami. New Jersey won’t say exactly how much Mr. Tepper paid in taxes. …Tax experts say his move to Florida could cost New Jersey — which has a top tax rate of 8.97 percent — hundreds of millions of dollars in lost payments. …several New Jersey lawmakers cited his relocation as proof that the state’s tax rates, up from 6.37 percent in 1996, are chasing away the rich. Florida has no personal income tax.

By the way, Tepper isn’t alone. Billions of dollars of wealth have already left New Jersey because of bad tax policy. Yet politicians in Trenton blindly want to make the state even less attractive.

At the risk of asking an obvious question, how can they not realize that this will accelerate the migration of high-value taxpayers to states with better policy?

New Jersey isn’t alone in committing slow-motion suicide. I already mentioned Connecticut and you can add states such as California and Illinois to the list.

What’s remarkable is that these states are punishing the very taxpayers that are critical to state finances.

…states with the highest tax rates on the rich are growing increasingly dependent on a smaller group of superearners for tax revenue. In New York, California, Connecticut, Maryland and New Jersey, the top 1 percent pay a third or more of total income taxes. Now a handful of billionaires or even a single individual like Mr. Tepper can have a noticeable impact on state revenues and budgets. …Some academic research shows that high taxes are chasing the rich to lower-tax states, and anecdotes of tax-fleeing billionaires abound. …In California, 5,745 taxpayers earning $5 million or more generated more than $10 billion of income taxes in 2013, or about 19 percent of the state’s total, according to state officials. “Any state that depends on income taxes is going to get sick whenever one of these guys gets a cold,” Mr. Sullivan said.

The federal government does the same thing, of course, but it has more leeway to impose bad policy because it’s more challenging to move out of the country than to move across state borders.

New Jersey, however, can’t set up guard towers and barbed wire fences at the border, so it will feel the effect of bad policy at a faster rate.

P.S. I used to think that Governor Christie might be the Ronald Reagan of New Jersey. I was naive. Yes, he did have some success in vetoing legislation that would have exacerbated fiscal problems in the Garden State, but he was unable to change the state’s bad fiscal trajectory.

P.P.S. Remarkably, New Jersey was like New Hampshire back in the 1960s, with no income tax and no sales tax. What a tragic story of fiscal decline!

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I shared some academic research last year showing that top-level inventors are very sensitive to tax policy and that they migrate from high-tax nations to low-tax jurisdictions.

Now we have some new scholarly research showing that they also migrate from high-tax states to low-tax states.

Let’s look at some of the findings from this new study, which was published by the Federal Reserve Bank of San Francisco. We’ll start with the issue the economists chose to investigate.

…personal taxes vary enormously from state to state. These geographical differences are particularly large for high income taxpayers. …the average tax rate (ATR) component due solely to state individual income taxes for a taxpayer with income at the 99th percentile nationally in 2010…in California, Oregon, and Maine were 8.1%, 9.1%, and 7.7%, respectively. By contrast, Washington, Texas, Florida, and six other states had 0 income tax. Large differences are also observed in business taxes. …Iowa, Pennsylvania, and Minnesota had corporate income taxes rates of 12%, 9.99%, and 9.8%, respectively, while Washington, Nevada, and three other states had no corporate tax at all. And not only do tax rates vary substantially across states, they also vary within states over time. …If workers and firms are mobile across state borders, these large differences over time and place have the potential to significantly affect the geographical allocation of highly skilled workers and employers across the country.

Here’s a map showing the tax rates on these very successful taxpayers, as of 2010. Many of these states (California, Illinois, New Jersey, and Connecticut) have moved in the wrong direction since that time, while others (such as North Carolina and Kansas) have moved in the right direction.

Anyhow, here’s more information about the theoretical issue being explored.

Many states aggressively and openly compete for firms and high-skilled workers by offering low taxes. Indeed, low-tax states routinely advertise their favorable tax environments with the explicit goal of attracting workers and business activity to their jurisdiction. Between 2012 and 2014, Texas ran TV ads in California, Illinois and New York urging businesses and high-income taxpayers to relocate….In this paper, we seek to quantify how sensitive is internal migration by high-skilled workers to personal and business tax differentials across U.S. states. Personal taxes might shift the supply of workers to a state: states with high personal taxes presumably experience a lower supply of workers for given before-tax average wage, cost of living and local amenities. Business taxes might shift the local demand for skilled workers by businesses: states with high business taxes presumably experience a lower demand for workers, all else equal.

And here’s their methodology.

We focus on the locational outcomes of star scientists, defined as scientists…with patent counts in the top 5% of the distribution. Using data on the universe of U.S. patents filed between 1976 and 2010, we identify their state of residence in each year. We compute bilateral migration flows for every pair of states (51×51) for every year. We then relate bilateral outmigration to the differential between the destination and origin state in personal and business taxes in each year. …Our models estimate the elasticity of migration to taxes by relating changes in number of scientists who move from one state to another to changes in the tax differential between the two states.

So what did the economists find? Given all the previous research on this topic, you won’t be surprised to learn that high tax rates are a way of redistributing people.

We uncover large, stable, and precisely estimated effects of personal and business taxes on star scientists’ migration patterns. …For the average tax rate faced by an individual at the 99th percentile of the national income distribution, we find a long-run elasticity of about 1.8: a 1% increase in after-tax income in state d relative to state o is associated with a 1.8 percent long-run increase in the net flow of star scientists moving from o to d. …To be clear: The flow elasticity implies that if after tax income in a state increases by one percent due to a personal income tax cut, the stock of scientists in the state experiences a percentage increase of 0.4 percent per year… We find a similar elasticity for state corporate income tax… In all, our estimates suggest that both the supply of, and the demand for, star scientists are highly sensitive to state taxes.

Wonky readers may appreciate these graphs from the study.

For everyone else, the important lesson from this research is that high tax rates discourage productive behavior and drive away the people who create a lot of value.

Two years ago, I shared some research showing that entrepreneurs flee high-tax nations to low-tax jurisdictions. Now we know the some thing happens with top-level inventors.

And let’s not forget that it’s even easier for investment to cross borders, which is why high corporate tax rates and high levels of double taxation are so damaging to U.S. workers and American competitiveness.

P.S. I don’t expect many leftists to change their minds because of this research. Some of them openly admit they want high tax rates solely for reasons of spite. Sensible people, by contrast, should be even more committed to pro-growth tax reform.

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