El Salvador, Greece, and American Tax Dollars: The Destructive Impact of the IMF

The Europeans have just agreed to another bailout for Greece. That’s the bad news.

The good news is…well, there is no good news. Sarkozy, Merkel, and the other statists have once again failed to do the right thing and instead have decided to throw good money after bad and dig the debt hole even deeper.

But there is worse news. The IMF is financing part of the bailout and American taxpayers are “shareholders” in the IMF.

In other words, I’m helping to reward bad behavior and misallocate global capital. This doesn’t make me very happy – especially since the White House supports this misguided approach.

But this is business-as-usual for the IMF, and here’s a first-hand example.

I’m in El Salvador where I just finished two days of speeches, meetings, and interviews to discuss how the country should deal with its fiscal imbalance.

Discussing Mitchell's Golden Rule in El Salvador

My message is simple. El Salvador should reject tax hikes and instead put government on a diet by capping annual spending growth so the budget grows by 1 percent or 2 percent annually.

Ever single reporter responded by saying some variant of “but the IMF says we need to raise taxes.”

During the first interview, I simply said the IMF was wrong. During the second interview, I said El Salvador should refuse to let IMF bureaucrats in the country. After I heard the same IMF message the third time, I suggested shooting down any flight carrying IMF bureaucrats and their snake-oil economic advice.

The last comment was a joke, of course, but it does raise a fundamental question. Why are American taxpayers subsidizing an international bureaucracy that runs around the world urging higher taxes and bailouts?!?

To be fair, the IMF usually includes some good advice in their reports. If you read the fine print, the bureaucrats often recommend reductions in subsidies, red tape, government payrolls, and handouts.

But if you give politicians in any country a set of options, and higher taxes and/or bailouts are on the list, it doesn’t take a genius to realize that the good reforms will get ignored while the bad policies will be adopted.

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Greetings from El Salvador

I just gave a speech sponsored by the Chamber of Commerce about ideal fiscal policy. El Salvador, like many developing nations, has a small burden of government according to fiscal statistics. But that is largely because the government collects very little revenue thanks to pervasive tax evasion and a huge underground economy. I explained that there are two good ways to reduce tax evasion and one bad way to address the issue.

The bad way is to expand the size and power of the tax police. This approach may force people to be more honest about declaring their income, but it also will lead them to decide to earn less income. And since slavery is no longer legal, there’s no way for a government or its tax police to force people to produce.

The two good ways of reducing tax revenue, by contrast, are desirable even if there is no tax evasion.

The first option is lower tax rates. When tax rates are low, people have much less incentive to evade and avoid. But the best thing about low tax rates is that they encourage more national income. If El Salvador wants to become more prosperous, there is no shortcut. By definition, economic growth occurs when national income rises.

The second option is to reduce the size and scope of government so that it focuses on the provision of genuine public goods such as rule of law. There is good academic evidence that people are much more likely to pay tax when they perceive that they are getting something of value in exchange for their tax dollars. Income redistribution programs fail that test. The recipients feel they are getting something of value, of course, but they are not taxpayers. The people paying taxes to finance welfare, by contrast, correctly perceive that government is spending money improperly.

These lessons are very important for developing nations such as El Salvador, but they also apply in more developed nations. Greece shows what happens when a supposedly prosperous nation goes too far down the path of tax-and-spend. Unfortunately, the United States appears to be making the same mistakes.

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