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Posts Tagged ‘Economics’

The good news about China is that economic liberalization has produced impressive growth in recent decades, which has helped bring hundreds of millions of people out of poverty.

The bad news is that China started from such a low position that per-capita income is still quite low compared to rich nations.

So what does the economic future hold? Will China continue its upward trajectory?

That’s certainly possible, but it depends on the Chinese government. Will there be additional liberalization, giving the economy more “breathing room” to grow?

Not if the government listens to the bureaucrats at the International Monetary Fund. I wrote three years ago about an IMF study that recommended huge tax increases in China.

And now there’s another IMF report pushing for big tax hikes. Only instead of arguing that higher taxes somehow will produce more growth by financing a bigger burden of government (which – no joke – was the core argument in the 2105 study), this new report claims higher taxes will produce more growth by reducing inequality.

Here’s the basic premise of the paper.

…economic growth has not benefited all segments of the population equally or at the same pace, causing income disparities to grow, resulting in a large increase in income inequality… This is especially of concern as the recent literature has found that elevated levels of inequality are harmful for the pace and sustainability of growth… The paper discusses what additional policies can be deployed to improve equity in opportunities and outcomes, with particular focus on the role for fiscal policy.

But a key part of the premise – the blanket assertion that inequality undermines growth – is junk.

As I noted in 2015 when debunking a different IMF study, “..they never differentiate between bad Greek-style inequality that is caused by cronyism and good Hong Kong-style inequality that is caused by some people getting richer faster than other people getting richer in a free market.”

Let’s dig into the details of this new IMF study.

Here’s the problem, at least according to the bureaucrats.

Income inequality in China today, as measured by the Gini coefficient, is among the highest in the world. …Furthermore, the Gini coefficient has rapidly increased over the last two decades, by a total of about 15 Gini points since 1990.

And here’s the chart that supposedly should cause angst. It shows that inequality began to rise as China shifted toward capitalism.

But why is this inequality a bad thing, assuming rich people earned their money honestly?

When markets are allowed to function, people become rich by providing value to the rest of us. In other words, it’s not a zero-sum game.

Ironically, the IMF study actually makes my point.

…much of China’s population has experienced rising real incomes. …even for the bottom 10 percent incomes rose by as much as 63 percent between 1980 and 2015… This has implied that China reduced the share of people living in poverty immensely. Measured by the headcount ratio, the population in poverty decreased by 86 percentage points from 1980 to 2013 (see figure 6), the most rapid reduction in history.

And here’s the aforementioned Figure 6, which is the data worth celebrating.

Any normal person will look at this chart and conclude that China should do more liberalization.

But not the bureaucrats at the IMF. With their zero-sum mentality, they fixate on the inequality chart.

Which leads them to make horrifyingly bad recommendations.

…several reforms could be envisaged to make fiscal policy more inclusive, both on the tax and expenditure side. …revenues from PIT contribute only around 5 percent of total revenues, a much lower share than the OECD average of 25 percent. Increasing the reliance on PIT, which more easily accommodates a progressive structure, could allow China to improve redistribution through the tax system. …While the PIT in China already embeds a progressive schedule with marginal rates increasing with income from 3 to 45 percent, …redesigning the tax brackets would ensure that middle and high income households with higher ability to pay contribute more to financing the national budget… Property and wealth taxes remain limited in China. Such taxes are broadly viewed as progressive, because high-income households usually tend also to have more property and wealth. …Consideration should therefore be given to adopt a recurrent market-value based property tax.

And why do IMF bureaucrats want all these additional growth-stifling taxes?

To finance a larger burden of government spending.

China still lags other emerging economies and OECD countries in public spending on education, health and social assistance. …social expenditure will need to be boosted.

In other words, the IMF is suggesting that China should copy welfare states such as Italy and France.

Except those nations at least enjoyed a lengthy period before World War II when government was very small. That’s when they became relatively rich.

The IMF wants China to adopt big government today, which is a recipe to short-circuit prosperity.

P.S. I don’t think the IMF is motivated by animus towards China. The bureaucrats are equal-opportunity dispensers of bad advice.

P.P.S. The OECD also is trying to undermine growth in China.

P.P.P.S. There are some senior-level Chinese officials who understand the downsides of a welfare state.

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With the possible exception of a few extreme environmentalists, everyone agrees that robust long-run growth is a key to a better society.

An unprecedented jump in growth, for instance, is what enabled the western world to escape poverty, resulting in the famous “hockey stick” of modern prosperity.

Maintaining growth is an ongoing challenge for developed countries, to be sure, and it’s also vitally important to help developing nations grow and prosper.

Which is why policymakers should focus on the policies that generate good outcomes.

Libek, a think tank in Serbia, has released a study on this topic. They start by pointing out that we now have some good measures of economic liberty in various nations.

…the Economic Freedom in the World Index in 1996 by the Fraser Institute…was the first methodological tool that measured intrusion in functioning of the market process by government entities, either directly through government intervention or indirectly though regulation and market institutions. A similar index, Index of Economic Freedom, produced by the Wall Street Journal and the Heritage Foundation soon followed… Since this very successful tool was invented, it has been widely employed in empirical studies…, the most important were concerning the role of economic freedom in fostering economic growth. …empirical studies mostly concluded that there is a significant connection between economic freedom and economic growth.

Since I’m always citing the Fraser Index and the Heritage Index, I agree that these are very helpful sources of data.

And lots of academics also use those numbers.

So Libek took a close look at this wealth of empirical research.

Libek conducted a metastudy regarding economic freedom in December 2017, with the aim to reexamine the connection between economic freedom and economic growth in published empirical studies. …Using Google scholar mechanism…92 studies…consider the connection between economic freedom and economic growth. Out of these, a predominant majority of 86 studies (93.5%) finds a positive correlation or connection between them, while only 6 studies (6.5%) have less positive results. …This metastudy shows that empirical studies have predominantly found that economic freedom is associated with higher economic growth rates, while there is only one study claim otherwise and results of other 5 are less conclusive. This high rate of concurrence between economists is highly unusual, given the fact that economist tend to often disagree even among theoretically more accepted topics. Therefore, it is conclusively shown that higher level of economic freedom, ceteris paribus, leads to higher economic growth.

The folks at Libek have a big incentive to care about these issues because Serbia is a reform laggard.

Here’s a chart comparing economic freedom in Serbia with other European regions.

And here is why economic reform is so vitally important for the people of Serbia.

Serbia remains one of the poorest countries in Europe, measured by GDP, with just 5 000 euros per capita. These low growth rates do not provide a possibility for development and closing the gap with more advanced European economies. …A study estimated future economic gains through higher economic freedom (Gwartney and Lawson 2004) reporting that 1-point increase in economic freedom (measured on a 1 to 10 scale) would increase long term rate of economic growth for 1.24% of GDP. Therefore, if Serbia would increase its score from the current 6.75 to 7.75 points – the approximately current level of Austria or Germany, Serbian long-term growth rate would increase from the envisaged 2% in 2017 (and estimated by the IMF to stand at 3.5% in 2018 and 2019) to 5.25% in 2020 and afterwards. This growth rate would enable a fast income convergence with other European countries, with GDP level per capita doubling in 14 years.

Amen. Serbia has the capacity to “converge,” but that won’t happen without economic liberalization.

For non-Serbians, the parts of the Libek report that will be of greatest interest deal with examples of nations that are out-performing their neighbors.

The importance of economic freedom is well shown by the most important case studies from different continents: Chile (South America), Singapore and Korea (East Asia), and Botswana (Africa). In all these prominent cases, economic freedom propelled these societies to a high and sustainable economic growth which led them to prosperity, compared to their neighbors.

The report specifically looks at the long-run data for countries that have sharply diverged from regional competitors.

Let’s start by comparing Chile with the rest of South America. As you can see, Chile’s dramatic economic liberalization led to far higher levels of national prosperity.

Now let’s compare Botswana to the rest of Sub-Saharan Africa.

I did something similar back in 2015 and also earlier this year, so this remarkable data is impressive but not surprising.

Last but not least, let’s compare Singapore and South Korea to their neighbors.

Once again, we see a compelling link between economic liberty and economic outcomes.

This is dramatically evident when comparing South Korea and North Korea, but you also see remarkable numbers when comparing Singapore with the United States.

The lesson is not that nations need perfect policy (even Hong Kong has some statism). Instead, the message is that governments should strive to increase economic liberty – hopefully in big ways but even small reforms are helpful – so that there’s more “breathing room” for the economy’s productive sector.

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A few days ago, I shared some academic research investigating whether economic crises lead to more liberalization (Naomi Klein’s hypothesis) or more statism (Robert Higgs’ hypothesis).

Given the dismal long-run outlook for the United States and most other developed nations, this is not just a theoretical issue.

Well, the good news is that the evidence shows that economic turmoil appears to be associated with pro-market reforms. At least with regard to regulatory policy.

Today, I’m going to share more good news. We now have some empirical research from two Danish economists showing that voters like good policy.

Here’s what Niclas Berggren and Christian Bjørnskov wanted to ascertain in their research

Since the early 1980s a wave of liberalizing reforms has swept over the world. While the stated motivation for these reforms has usually been to increase economic efficiency, some critics have instead inferred ulterior motives…with the claim that many of the reforms have been undertaken during different crises so as to bypass potential opponents, suggests that people will dislike the reforms and even be less satisfied with democracy as such. We test this hypothesis empirically, using panel data from 30 European countries in the period 1993–2015. The dependent variable is the average satisfaction with democracy, while the reform measures are constructed as distinct changes in four policy areas: government size, the rule of law, openness and regulation. …We moreover include a set of control variables, capturing economic circumstances, political institutions and features of politics.

In other words, we’ve seen considerable liberalization over the past 20-plus years. Were voters happy or unhappy as a result?

Here’s a way of visualizing what they investigated.

For what it’s worth, I’ve argued that Reagan showed good policy is good politics.

And the good news is that this research reaches a similar conclusion. Here are their main results.

Our results indicate that while reforms of government size are not robustly related to satisfaction with democracy, reforms of the other three kinds are – and in a way that runs counter to the anti-liberalization claims. Reforms that reduce economic freedom are generally related to satisfaction with democracy in a negative way, while reforms that increase economic freedom are positively associated with satisfaction with democracy. Voters also react more negatively to left-wing governments introducing reforms that de-liberalize. …the hypothesis of a general negative reaction towards liberalizing reforms taking the form of reduced satisfaction with democracy does not stand up to empirical scrutiny, at least not in our European sample.

Wonky readers may want to spend some time with this table, which shows the results of the statistical analysis

I’ll close with a couple of specific observations from the research, all of which deal with whether some reforms are more popular than others.

The good news is that voters are most satisfied when there’s less protectionism.

It turns out that the most immediately important type of reform here is liberalizations that increase market openness, such as reductions in protectionism and removal of obstacles to capital movements.

(Methinks the folks in the White House may want to reconsider their protectionist policies. It seems people understand that trade wars cause blowback.)

The bad news is that voters don’t seem to get excited about reforms to restrain government spending, whereas other types of pro-market reforms are popular.

Reforms that involve government size are rarely statistically significant; reforms that involve the other three reform areas typically are.

Though voters sometimes aren’t happy when government gets bigger, so I guess that’s partial good news.

Crises only seem to matter when government size increases, and then they make the effect on satisfaction with democracy much more negative.

Perhaps this is evidence that people recognize Keynesian “stimulus” schemes aren’t a good idea? I hope that’s the right interpretation. Heck, maybe this is yet another reason to stop sending tax dollars to subsidize the OECD.

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When I give speeches about modern welfare states, I’ll often cite grim data from the IMF, BIS, and OECD about the very depressing fiscal consequences of ever-expanding government.

And if I really want to worry an audience, I’ll augment those numbers by talking about the erosion of societal capital and explain it’s very hard to adopt necessary reforms once the work ethic and self-reliance have been replaced by a culture of dependency and entitlement.

I basically warn people that many western nations (including the United States) are doomed to suffer Greek-style fiscal collapse. Depending on the type of speech, this is where I sometimes share a slide suggesting that there are two possible outcomes once an economic crisis occurs.

  • Does a crisis caused by bad government lead to even more bad government, which is the pessimistic hypothesis in Robert Higgs’ classic, Crisis and Leviathan?
  • Or does an economic crisis force politicians to actually scale back the size and scope of government, which is the hypothesis in Naomi Klein’s The Rise of Disaster Capitalism.

I’ve generally sided with Higgs, though there obviously are cases – such as Chile – where bad statist policies were followed by sweeping economic liberalization.

But, based on new research from the International Monetary Fund, it may be that Klein has a stronger argument (which would be a depressing outcome for her, since she favors bigger government).

Here are some of the issues that the authors investigated.

Relying on a new database of major past labor and product market reforms in advanced countries, we test a large set of variables for robust correlation with reform in each area. …structural reforms are notoriously difficult to implement…one of the most prominent hypotheses put forward in the literature, namely that crisis induces reform… we attempt to minimize value judgements and measurement error by employing a newly constructed “narrative” dataset of major reforms in four areas namely product market regulation (PMR) in network industries, EPL for regular workers, EPL for temporary workers, and unemployment benefit systems. … The large welfare costs of economic or financial crisis can break the deadlock over welfare-enhancing measures that could not be adopted otherwise due to conflict over their distributional consequences.

In short, they wanted to find out whether bad economic news (as captured by data on “GDP growth, deep recession, unemployment, crisis”) leads to pro-market reforms.

The answer is yes.

Our main result supports some form of the crisis-induces-reform hypothesis across all four reform areas. High unemployment, recession and/or an open economic crisis tend to be associated with a greater likelihood of reform. The effect is economically significant. For example, an increase of 10 percentage points in unemployment (as seen in several European economies in the aftermath of the Great Recession) is associated with an increase in the probability to undertake a major EPL reform for regular contract of about 5 percentage points — that is, about twice the average probability in the sample.

Here’s a chart from the report showing a big spike in deregulation in late 1990s/early 2000s.

And here’s a chart showing nations that took steps to cut back on unemployment subsidies.

Keep in mind, by the way, that some nations (such as Austria) may not have reformed because they never adopted bad policies in the first place.

Kudos to Denmark for implementing so much reform. And Greece wins a Booby Prize for failing to adopt desperately needed reforms.

I was also happy to see some results that bolster my argument in favor of jurisdictional competition as a tool to encourage better policy.

We also find evidence that outside pressure increases the likelihood of reform in certain areas. Reforms are more likely when other countries also undertake them.

Interestingly, it doesn’t appear that ideology plays a major role.

…we do not find any evidence for an ideological bias—there is no robust difference between left- and right-of-center governments’ propensity to undertake reform. …In the context of labor and product market reforms, while a reforming right-of-center government may face the combined resistance of the leftwing electorate, trade unions and other civil society groups, a left-of-center government will be less likely to be accused of pushing through reforms on ideological grounds and may therefore be more likely to succeed.

My two cents is that ideology can play a role (think Reagan and Thatcher, for instance), but that there are plenty of instances of putative right-of-center politicians making government bigger (Nixon and Bush, to cite US examples) and several instances of supposed left-of-center politicians overseeing pro-market reforms (Bill Clinton being the obvious example from America).

I’ll close with a very important caveat. The IMF study looked at regulatory policy. There are no lessons to be learned from this research about whether crises produce better fiscal policy.

For what it’s worth, based on all the post-financial-crisis tax increases that were imposed in Europe, I suspect that the Higgs hypothesis is still very relevant.

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I often discuss the importance of long-run growth and I pontificate endlessly about the policies that will produce better economic performance.

But what about short-term fluctuations? Where are we in the so-called business cycle? I don’t think economists are good at forecasting the ups and downs of the economy, but I did mention the factors that might contribute to a downturn in this interview with Dana Loesch.

Dana isn’t the only one interested in this topic.

The New York Times opined today about the state of the economy.

…the American economy has a lot more power…, and it’s making a lot of noise. …While Mr. Trump praised himself effusively…the stock market seemed unimpressed. …That’s because if you look down the line, there are few clear reasons to be so enthusiastic.

I suspect the editors at the NYT are somewhat motivated by a desire to make Trump look bad, but I don’t necessarily disagree with some of their analysis.

Though I think they are wrong on tax policy, which is the best thing that’s happened since Trump took office.

…the initial jolt of the Republicans’ $1.5 trillion tax cuts, mostly for corporations and the wealthy, is wearing off. Corporations have bought back $437 billion of their own shares, which leaves them that much less to invest in new production, or wages.

By the way, there’s nothing wrong with stock buybacks. It’s a way for companies to return profits to shareholders. And those shareholders generally then reinvest the money, so the NYT screwed up on that bit of analysis.

But they raise a very legitimate issue when looking at the impact of monetary policy.

Then there’s the flattening yield curve, which the St. Louis Federal Reserve’s president, James Bullard, warns could invert late this year if current conditions persist. That means short-term rates, such as those for two-year Treasury bonds, run higher than long-term rates, like the 10-year bond, a sign of pessimism that is a well-known red flag.

Though I would add that we wouldn’t be in the position of having to raise rates if the Fed hadn’t pushed rates artificially low in the first place (the same mistake they made last decade, by the way).

In other words, the best way of avoiding “tight money” is to not engage in periods of “easy money.”

The NYT editorial also looks at consumer spending, which is fine if the goal is to see whether retailers are happy. But if the issue is whether the economy is doing well, it’s much more important to see whether personal income is rising or falling.

Consumers were in a spending mood this spring, an attitude that won’t necessarily continue. …A recent Reuters analysis found that the bottom 60 percent of income-earners have been fueling their spending, and thus the economy’s, by using their savings or credit cards. They almost have to, because wage growth is expanding at a disappointing 2.7 percent annual clip.

I fully agree with this excerpt about trade. Assuming he wants to run for reelection, Trump is being very foolish to push for more protectionism.

…consider the administration’s effort to apply the sledgehammer to the economy’s toes via a trade war and ensuing tariffs on imported steel and aluminum, among other products. …Not only have the tariffs contributed to $1 billion in higher costs for General Motors, they are now contributing to rising prices of everything from Cokes to vacuum cleaners as companies pass along those costs to consumers.

Last but not least, I don’t necessarily agree that expansion have to end. After all, the economy is largely capable of self-correcting.

But a “business cycle” is probably inevitable so long as government has so much power to intervene.

None of these issues by themselves will put the brakes on an economy that is powering along with a 3.9 percent unemployment rate. But the friction is building. …economic expansions — and this one is in its 10th year — eventually run out of gas. …Mr. President, while you like to take credit for positive economic trends that are well beyond your control, you will own the downside, too.

For what it’s worth, I think misguided monetary policy usually deserves blame for short-run economic instability.

I mentioned in the interview that the central bank is trying to “normalize” interest rates. I hope the Fed is successful, though I worry that financial markets (and housing markets) have become dependent on easy money and will take a hit.

I’ll close by pointing out that the pundit class is focusing on whether the economy is growing faster under Trump than it grew under Obama.

I don’t care about that contest. I’m much more interested in whether we can get the kind of free market-driven prosperity we enjoyed under Ronald Reagan or Bill Clinton.

We didn’t get that growth during the Obama years.

And given Trump’s schizophrenic approach to policy, I don’t have high hopes we’ll average 3 percent-plus growth during his tenure.

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I don’t like the tribal nature of American politics, in part because I get criticized for not playing the game.

I tell both groups that I care about public policy rather than personal or partisan loyalty. Not that this explanation makes either group happy.

Today, I’m going to give a “thumbs up” to the President for what he’s doing about car mileage regulations. Which means the first group will be happy and the second group will be irritated.

To be more specific, the Trump Administration is proposing to ease up on the CAFE (corporate average fuel economy) rules. The Obama Administration, working with California environmentalists, proposed to make these regulations far more costly. Trump’s people basically want to freeze the car mileage mandate at the current 37-miles-per-gallon level.

Here’s a look at the history of the CAFE standards.

Sam Kazman of the Competitive Enterprise Institute explained earlier this year why these regulation impose high costs. And deadly costs.

The federal government’s auto fuel economy standards have for decades posed a simple problem: They kill people. Worse, the National Highway Traffic Safety Administration has covered this up. …To call it a coverup isn’t hyperbole. CAFE kills people by causing cars to be made smaller and lighter. While these downsized cars are more fuel-efficient, they are also less crashworthy. …A 1989 Harvard-Brookings study estimated the death toll at between 2,200 and 3,900 a year. Similarly, a 2002 National Academy of Sciences study estimated that CAFE had contributed to up to 2,600 fatalities in 1993. …The Insurance Institute for Highway Safety, which closely monitors crashworthiness, still provides the same advice it has been giving for years: “Bigger, heavier vehicles are safer.”

The Trump Administration apparently was listening to Sam, and has decided to block future increases in the CAFE mandate.

Environmentalists are predictably upset, but the Wall Street Journal opined on this topic a couple of days ago and explained why it is good news.

The Trump Administration’s deregulation is improving consumer choice and reducing costs… Its proposed revisions Thursday to fuel economy rules continue this trend to the benefit of car buyers… Obama bureaucrats were acutely blind—perhaps willfully so—to economic and technological trends in 2012 when they set a fleetwide average benchmark of 54.5 miles a gallon by 2025. …Americans prefer bigger cars, which makes it harder for automakers to meet the escalating Cafe targets. …As prices rise to meet the new standards, consumers would also wait longer to replace their cars. The average age of a car is approaching 12 years, up from about 8.5 in 1995. Newer cars are more efficient and safer, so longer vehicle turnover could result in more traffic fatalities… Thursday’s Trump Administration proposal to freeze—not roll back—fuel economy standards at the current 2020 target of 37 miles a gallon. …Automakers also want to duck a prolonged legal tussle with California, which received a waiver from the Obama Administration under the Clean Air Act in 2013 to establish its own emissions standards and electric-car mandate. The proposed Trump standards would apply nationally.

Holman Jenkins of the WSJ also weighed in on the issue, pointing out that undoing Obama’s expansion of CAFE mandates will have no impact on the earth’s climate.

…the effect on climate change would be zero. The Obama White House at the time exaggerated by a factor of two the Environmental Protection Agency’s estimate of the effect on total emissions over the lifetime of the cars involved. It doesn’t matter. Two times nothing is still nothing. …Let’s remember the truth of Mr. Obama’s fuel-economy rules. He did not wander the balconies of the White House gazing far into the future when he drafted the 2021-25 fuel economy target of 54.5 miles a gallon. His flunkies, as documented in a House investigation, simply were looking for a impressive-sounding number to serve the administration’s political interests at the time. …in undoing Mr. Obama’s policies, Mr. Trump is doing nothing to hurt the climate.

Myron Ebell of the Competitive Enterprise Institute also wrote on the topic and noted that Trump’s policy will save about 1,000 lives each year.

…the administration has struck a blow for consumer choice that will be good news for drivers planning or hoping to buy a new car in the next decade. That’s because the mileage mandate is one of the main causes of rapidly rising vehicle prices. …Meeting ever more stringent fuel economy standards is driving up new vehicle prices. Sticker shock is thereby causing a lot of people to hang on to their current cars. The average age of all cars on the road is now at an all-time high of over 11-1/2 years. …Freezing CAFE standards will make new cars more affordable for millions of Americans and also allow many of them to buy bigger and hence even safer new models. How much safer will be hotly debated. The Transportation Department concludes that the proposed changes will prevent about 1,000 traffic fatalities a year. …For many people, fuel economy will still be the most important factor in choosing a new car. The good news for them is that the Trump administration’s action will in no way prevent them from buying a model that gets great gas mileage. The good news for everyone else is that the choice of models will be much wider than if the CAFE standard remained 54.5 mpg.

By the way, this isn’t simply a matter of saving lives.

After all, we theoretically could save thousands of lives by simply banning automobiles. In the world of sensible public policy, we make trade-offs, deciding if achieving a certain goal is worthwhile when looking at all the costs and all the benefits.

So it’s theoretically possible that a policy that leads to more premature deaths might be acceptable.

But CAFE fails even on that basis. As Marlo Lewis explained a few years ago, the policy both kills people and imposes net financial costs.

The bottom line is that Donald Trump just improved his grade on regulation.

Back in April, I gave him a B+ on regulation. But then he did something foolish in June that (if I recalculated) would have dropped him to a B. Now he’s probably back at a B+ because of the change to the CAFE rules.

Given what he’s doing on trade, he needs to boost his other grades as much as possible!

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In the past few years, I’ve bolstered the case for lower tax rates by citing country-specific research from Italy, Australia, Germany, Sweden, Israel, Portugal, South Africa, the United States, Denmark, Russia, France, and the United Kingdom.

Now let’s look to the north.

Two Canadian scholars investigated the impact of provincial tax policy changes in Canada. Here are the issues they investigated.

The tax cuts introduced by the provincial government of British Columbia (BC) in 2001 are an important example… The tax reform was introduced in two stages. In an attempt to make the BC’s economy more competitive, the government reduced the corporate income tax (CIT) rate initially by 3.0 percentage points with an additional 1.5 percentage point reduction in 2005. The government also cut the personal income tax (PIT) rate by about 25 percent. …The Canadian provincial governments’ tax policies provide a good natural experiment for the study of the effects of tax rates on growth. …The principal objective of this paper is to investigate the effects of taxation on growth using data from 10 Canadian provinces during 1977-2006. We also explore the relationship between tax rates and total tax revenue. We use the empirical results to assess the revenue and growth rate effects of the 2001 British Columbia’s incentive-based tax cuts.

And here are the headline results.

The results of this paper indicate that higher taxes are associated with lower private investment and slower economic growth. Our analysis suggests that a 10 percentage point cut in the statutory corporate income tax rate is associated with a temporary 1 to 2 percentage point increase in per capita GDP growth rate. Similarly, a 10 percentage point reduction in the top marginal personal income tax rate is related to a temporary one percentage point increase in the growth rate. … The results suggest that the tax cuts can result in significant long-run output gains. In particular, our simulation results indicate that the 4.5 percentage point CIT rate cut will boost the long-run GDP per capita in BC by 18 percent compared to the level that would have prevailed in the absence of the CIT tax cut. …The result indicates that a 10 percentage point reduction in the corporate marginal tax rate is associated with a 5.76 percentage point increase in the private investment to GDP ratio. Similarly, a 10 percentage point cut in the top personal income tax rate is related to a 5.96 percentage point rise in the private investment to GDP ratio.

The authors look specifically at what happened when British Columbia adopted supply-side tax reforms.

…In this section, we attempt to gauge the magnitude of the growth effects of the CIT and PIT rate cuts in BC in 2001… the growth rate effect of the tax cut is temporary, but long-lasting. Figure 2 shows the output with the CIT rate cut relative to the no-tax cut output over the 120 years horizon. Our model indicates that in the long-run per capita output would be 17.6 percent higher with the 4.5 percentage point CIT rate cut. …We have used a similar procedure to calculate the effects of the five percentage point reduction in the PIT rate in BC. …The solid line in Figure 3 shows simulated relative output with the PIT rate cut compared to the output with the base line growth rate of 1.275. Our model indicates that per capita output would be 7.6 percent higher in the long run with the five percentage point PIT rate cut.

Here’s their estimate of the long-run benefits of a lower corporate tax rate.

And here’s what they found when estimating the pro-growth impact of a lower tax rate on households.

In both cases, lower tax rates lead to more economic output.

Which means that lower tax rates result in more taxable income (the core premise of the Laffer Curve).

The amount of tax revenue that a provincial government collects depends on both its tax rates and tax bases. Thus one major concern that policy makers have in cutting tax rates is the implication of tax cuts for government tax receipts. …The true cost of raising a tax rate to taxpayers is not just the direct cost of but also the loss of output caused by changes in taxpayers’ economic decisions. The Marginal Cost of Public Funds (MCF) measures the loss created by the additional distortion in the allocation of resources when an additional dollar of tax revenue is raised through a tax rate increase. …if…government is on the negatively-sloped section of its present value revenue Laffer curve…, a tax rate reduction would increase the present value of the government’s tax revenues.

And the Canadian research determined that, measured by present value, the lower corporate tax rate will increase tax revenue.

…computations indicate that including the growth rate effects substantially raises our view of the MCF for a PIT. Our computations therefore support previous analysis which indicates that it is much more costly to raise revenue through a PIT rate increase than through a sales tax rate increase and that there are potentially large efficiency gains if a province switches from an income tax to a sales tax. When the growth rate effects of the CIT are included in the analysis, …a CIT rate reduction would increase the present value of the government’s tax revenues. A CIT rate cut would make taxpayers better off and the government would have more funds to spend on public services or cut other taxes. Therefore our computations provide strong support for cutting corporate income tax rates.

Needless to say, if faced with the choice between “more funds to spend” and “cut other taxes,” I greatly prefer the latter. Which is why I worry that people learn the wrong lesson when I point out that the rich paid a lot more tax after Reagan lowered the top rate in the 1980s.

The goal is to generate more prosperity for people, not more revenue for government. So if a tax cut produces more revenue, the immediate response should be to drop the rate even further.

But I’m digressing. The point of today’s column is simply to augment my collection of case studies showing that better tax policy produces better economic performance.

P.S. The research from Canada also helps to explain the positive effect of decentralization and federalism. British Columbia had the leeway to adopt supply-side reforms because the central government in Canada is somewhat limited in size and scope. That’s even more true in Switzerland (where we see the best results), and somewhat true about the United States.

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