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Posts Tagged ‘Fiscal Policy’

Most people have heard of the Laffer Curve, which shows that there is a non-linear relationship between tax rates and tax revenues (for instance, doubling tax rates won’t produce a doubling of tax revenue because people and businesses will have less incentive to earn and report income).

There’s something similar on the spending side of the budget. I call it the Rahn Curve and it shows there is a non-linear relationship between government spending and economic performance.

The concept is not controversial, just like the concept of a Laffer Curve is not controversial.

What does trigger disagreement, however, is figuring out the shape of the curve, especially the growth-maximizing size of government (or, in the case of the Laffer Curve, the revenue-maximizing tax rate).

Much of the academic literature suggests that is maximized when government spending consumes about 20-plus percent of economic output.

But I’ve questioned whether these studies are correct, based on data limitations that are inherent when doing research based on post-WWII numbers.

Those numbers tell us interesting things (the East Asian tiger economies have been star performers and have relatively small spending burdens), but does that mean government should consume 20 percent of GDP when we know from history that Western nations grew rapidly in the 1800s and early 1900s when there was no welfare state and the public sector consumed only about 10 percent of economic output?

Given my interest in these issues, I was intrigued to see a new study on the Social Science Research Network. Authored by Hisham Mohamed Hassan of the University of Khartoum, it estimates the growth-maximizing size of government in Sudan.

The bad news is that the study is in Arabic. The good news is that there is an abstract in English. Here are some of the findings.

Policies related to the level of government spending are considered one of the most important economic issues, and aspects that drew particular attention of its impact on economic growth. This paper aims to determine the size of the government of Sudan, which is reflecting positively on the optimal allocation of the resources and the level of public spending that maximizes economic growth. In addition to testing whether there is a long-run relationship between the size of the government and economic growth in Sudan? The findings show that the relationship between government size and economic growth in Sudan is nonlinear (Armey) curve, the ARDL model shows that there is a short and long-run relationship between the size of the government and economic growth in Sudan. The optimal size of the Sudanese government, based on the share of public spending, should not exceed 11.17% of GDP.

Since I can’t read the full study, there’s no way of assessing the quality of the research and/or if the conclusions are only appropriate for Sudan, or also appropriate for other developing nations, or universally applicable to all countries.

But even if the results are not applicable to rich countries, the conclusions are very useful since they debunk the absurd notion (peddled by the IMF, OECD, and UN) that developing nations should have bigger governments.

P.S. For those interested, here’s my video explaining the Rahn Curve (or Armey Curve if you prefer).

P.P.S. You can watch other videos on this topic by clicking here, here, here, and here).

P.P.P.S. Interestingly, some normally left-leaning international bureaucracies have acknowledged you get more prosperity with smaller government. Check out the analysis from the IMFECBWorld Bank, and OECD.

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It is disappointing that the bureaucrats at the International Monetary Fund routinely advocate for higher taxes and bigger government in nations from all parts of the world (for examples, see here, here, here, here, here, and here).

It is disturbing that the IMF engages in bailouts that encourage bad fiscal policy by governments and reckless lending policies by financial institutions.

And it is disgusting that those IMF bureaucrats get tax-free salaries and are thus exempt from the damaging consequences of those misguided policies.

One set of rules for the peasants and one set of rules for the elite.

The latest example of IMF misbehavior revolves around the bureaucracy’s criticism of recently announced tax cuts in the United Kingdom.

A BBC report by Natalie Sherman and Tom Espiner summarizes the controversy.

The International Monetary Fund has openly criticised the UK government over its plan for tax cuts…In an unusually outspoken statement, the IMF said the proposal was likely to increase inequality and add to pressures pushing up prices. …Chancellor Kwasi Kwarteng unveiled the country’s biggest tax package in 50 years on Friday. But the £45bn cut has sparked fears that government borrowing could surge along with interest rates. …Lord Frost, the former Brexit minister and close ally of Prime Minister Liz Truss, criticised the IMF’s statement. …”The IMF has consistently advocated highly conventional economic policies. It is following this approach that has produced years of slow growth and weak productivity. The only way forward for Britain is lower taxes, spending restraint, and significant economic reform.” …Moody’s credit rating agency said on Wednesday that the UK’s plan for “large unfunded tax cuts” was “credit negative” and would lead to higher, persistent deficits “amid rising borrowing costs [and] a weaker growth outlook”. Moody’s did not change the UK’s credit rating.

So what should be done about the IMF’s misguided interference?

Writing for the Spectator in the U.K., Kate Andrews has some observations about the underlying philosophical and ideological conflict..

…the International Monetary Fund has weighed in on the UK’s mini-Budget, offering a direct rebuke of Liz Truss and Kwasi Kwarteng’s tax cuts. …its spokesperson said…‘Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture’… But this rebuke from the IMF is the kind of battle the Truss camp might be happy to have. …The IMF takes a political stance on inequality, viewing its reduction as a good thing in itself. Truss and Kwarteng reject this premise – summed up in the Chancellor’s statement last Friday when he called for the end of redistribution politics – and think it’s far more important to focus on ‘growing the size of the pie.’ The IMF’s ‘intervention’ is likely to become an example of the ‘Treasury orthodoxy’ that Truss was so vocal about during the leadership campaign: her belief that a left-wing economic consensus will not tolerate any meaningful shake-up of the tax code or supply-side reform.

Truss and Kwarteng are correct to reject the IMF’s foolish – and immoral – fixation on inequality.

All you really need to know is that the IMF publishes research implying it is okay to hurt poor people if rich people are hurt by a greater amount.

Let’s close by addressing whether tax cuts are bad for Britain’s currency and financial markets

Paul Marshall explained the interaction (and non-interaction) of fiscal and monetary policy in a column for the U.K.-based Financial Times.

Since 2010, the G7 policy framework has been one of tight fiscal and loose monetary policy. …This combination of fiscal austerity and monetary largesse has not been a success. Austerity has not prevented government debt ratios steadily climbing to historic highs. …Meanwhile quantitative easing has fuelled asset inflation for the super-rich and has more or less abolished risk pricing in financial markets. And…it has produced inflation which is still out of control. But now the global policy consensus is in the process of pivoting… A distinctive feature of the UK’s fiscal pivot is the emphasis on reducing the burden of tax on work and business. This is sensible. …the bigger problem for Liz Truss’s government is the Bank of England. It seems that the governor, Andrew Bailey, did not get the memo. Our central bank has been behind the curve since inflation first started to rise sharply in 2021. …The Bank of England effectively lost control of the UK bond market last Thursday when it raised interest rates by 50 basis points, instead of the 75bp that the US Federal Reserve and the European Central Bank raised by. Its timidity is now having an impact on both the gilt market and sterling. That is the essential context for the market reaction to the mini-Budget. Once you lose market confidence, it is doubly hard to win it back. …a more muscular stance from the BoE to underpin financial market confidence in the UK, even at the expense of some short-term pain.

He is right.

The Bank of England should be focused on trying to unwind its mistaken monetary policy that produced rising prices. That’s the approach that will strengthen the currency.

And Truss and Kwarteng should continue their efforts for better tax policy so the economy can grow faster.

But better tax policy needs to be accompanied by much-need spending restraint, which is what the United Kingdom enjoyed not only during the Thatcher years, but also under Prime Ministers Cameron and May.

P.S. The IMF also interfered in British politics when it tried to sabotage Brexit.

P.P.S. One obvious takeaway is that the IMF should be eliminated.

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I strongly supported Brexit in part because I wanted the United Kingdom to have both the leeway and the incentive to adopt pro-market policies.

Imagine my disappointment, then, when subsequent Conservative Prime Ministers did nothing (Theresa May) or expanded the burden of government (Boris Johnson).

Where was the reincarnation of Margaret Thatcher? Didn’t the Tory Party understand the need to restrain big government?

Perhaps my prayers have finally been answered. After jettisoning Boris Johnson (albeit for scandal rather than bad policy), the Tories elected Liz Truss to lead the nation.

And she appointed Kwasi Kwarteng to be Chancellor of the Exchequer (akin to U.S. Treasury Secretary). The two of them have just unveiled some major changes in U.K. fiscal policy.

Allister Heath’s editorial for the Telegraph has a celebratory tone.

…the best Budget I have ever heard a British Chancellor deliver, by a massive margin. The tax cuts were so huge and bold, the language so extraordinary, that at times, listening to Kwasi Kwarteng, I had to pinch myself to make sure I wasn’t dreaming, that I hadn’t been transported to a distant land that actually believed in the economics of Milton Friedman and FA Hayek. …The neo-Brownite consensus of the past 20 years, the egalitarian, redistributionist obsession, the technocratic centrism, the genuflections at the altar of a bogus class war, the spreadsheet-wielding socialists: all were blown to smithereens by Kwarteng’s stunning neo-Reaganite peroration. …All the taboos have been defiled: the fracking ban, the performative 45pc tax rate, the malfunctioning bonus cap, the previous gang’s nihilistic corporation tax and national insurance raids. The basic rate of income tax is being cut, as is stamp duty, that dumbest of levies. …Reforms of this order of magnitude should really have happened after the referendum in 2016, or after Boris Johnson became Prime Minister in 2019… Truss..has a fighting chance to save Britain, and her party, from oblivion.

The Wall Street Journal‘s editorial has a similarly hopeful tone while also explaining the difference between good supply-side policies and failed Keynesian demand-side policies.

This is a pro-growth agenda that is very different than the tax-and spend Keynesianism that has dominated the West’s economic policies for nearly two decades. …Mr. Kwarteng axed the 2.5-percentage-point increase in the payroll tax imposed by former Prime Minister Boris Johnson, and canceled a planned increase in the corporate income tax rate to 26% from 19%. …Kwarteng also surprised by eliminating the 45% tax rate on incomes above £150,000. The top marginal rate now will be 40%… A frequent complaint is that there’s no evidence tax cuts for corporations or higher earners will boost demand. Maybe not, but that’s also not the point. Britain doesn’t need a Keynesian demand-side stimulus. It needs the supply-side jolt Ms. Truss is trying to deliver by changing incentives to work and invest. A parallel complaint from the same crowd is that Ms. Truss’s policies—which they just said won’t stimulate demand—will stimulate so much demand the policies will stoke inflation. This has been the experience with debt-fueled fiscal blowouts since the pandemic, but Ms. Truss’s plan is different. She’s not throwing around money to fund consumption. She’s using the tax code to spur production.

The editorial concludes with a key observations.

Britain has become the most important economic experiment in the developed world because Ms. Truss is the only leader willing to abandon a stale Keynesian policy consensus that has produced stagflation everywhere.

Here’s a tweet that captures the current approach, with “liberal” referring to pro-market classical liberalism.

This is the “Singapore-on-Thames” approach that I’ve been promoting for years. Finally!

In a column for Reason, Robert Jackman gives a relatively optimistic libertarian assessment of what to expect from Truss.

…will her arrival in Downing Street bring an end to the big-state, big-spending style of her predecessor? …Within the Westminster village, Truss has long been regarded as a torchbearer for liberty—a reputation that stretches back to her days working at various small-state think tanks. Since entering Parliament in 2010, she has been a member of the Free Enterprise Group… As trade secretary, Truss was responsible for delivering on the good bit of Brexit—jetting around the world to sign tariff-busting trade deals. She was good at it too, quickly securing ambitious agreements with Australia and Japan. …But will Liz Truss’ premiership put Britain back on track to a smaller state? Some things aren’t that simple. …Truss has long been an advocate of relaxing Britain’s punitive planning laws, which would make it easier to build much-needed homes and energy infrastructure.

As you might expect, the analysis from the U.K.-based Economist left much to be desired.

Liz Truss, Britain’s new prime minister, is now implementing Reaganomics…comprising tax cuts worth perhaps £30bn ($34bn) per year (1.2% of gdp)… The fuel that fiscal stimulus will inject into the economy will almost certainly lead the boe to raise interest rates… No matter, say Ms Truss’s backers, because tax cuts will boost productivity. Didn’t inflation fall and growth surge under Reagan? …Ms Truss’s cheerleaders seem to have read only the first chapter of the history of Reaganomics. The programme’s early record was mixed. The tax cuts did not stop a deep recession, yet by March 1984 annual inflation had risen back to 4.8% and America’s ten-year bond yield was over 12%, reflecting fears of another upward spiral in prices. Inflation was anchored only after Congress had raised taxes. By 1987 America’s budget, excluding interest payments, was nearly balanced. By 1993 Congress had raised taxes by almost as much as it had cut them in 1981.

By the way, the article’s analysis of Reaganomics is laughably inaccurate.

Meanwhile, a report in the New York Times, writtten by Eshe Nelson, Stephen Castle and , also has a skeptical tone.

But I’m surprised and impressed that they admit Thatcher’s policies worked in the 1980s.

Britain’s new prime minister, Liz Truss, gambled on Friday that a heavy dose of tax cuts, deregulation and free-market economics would reignite her country’s growth — a radical shift in policy… the new chancellor of the Exchequer, Kwasi Kwarteng, abandoned a proposed rise in corporate taxation and, in a surprise move, also abolished the top rate of 45 percent of income tax applied to those earning more than 150,000 pounds, or about $164,000, a year. He also cut the basic rate for lower earners and cut taxes on house purchases. …It is hard to overstate the magnitude of the policy shift from Mr. Johnson’s government, which just one year ago had announced targeted tax increases to offset its increased public spending… The chancellor’s statement in Parliament on Friday underscored the free-market, small-state, tax-cutting instincts of Ms. Truss, who has modeled herself on Margaret Thatcher, who was prime minister from 1979 to 1990. Thatcher’s economic revolution in the 1980s turned the economy around.

The article includes 11 very worrisome words.

…so far there has been no indication of corresponding spending cuts.

Amen. Tax cuts are good for growth, but their effectiveness and durability will be in question if there is not a concomitant effort to restrain the burden of spending.

Truss and Kwarteng also should have announced a spending cap, modeled on either the Swiss Debt Brake or Colorado’s TABOR.

P.S. In addition to worrying about whether Truss will copy Thatcher’s track record on spending, I’m also worried about her support for misguided energy subsidies.

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I celebrate when my friends on the left stumble into economic insights.

For instance, many of them sound like Milton Friedman when they pontificate in favor of higher tobacco taxes because they want people to smoke fewer cigarettes.

As a libertarian, I don’t think it’s government’s job to control our private lives, but I applaud when people understand that higher taxes on something will lead to less of that thing.

I get frustrated, of course, that they don’t apply that insight in other areas.

After all, if higher taxes on tobacco leads to less smoking, surely it is true that higher taxes on employment leads to less work.

Or less investment, less innovation, less entrepreneurship, etc, etc.

Let’s consider a new example of how this works in the case of sin taxes.

The New York Times has an article by Ted Alcorn about whether higher taxes on alcohol are an appropriate way of dealing with the damage caused by excessive drinking.

Here are some excerpts.

Oregon also has among the highest prevalence of problem drinking in the country. Last year, 2,153 residents died of causes attributed to alcohol, according to the Oregon Health Authority — more than twice the number of people killed by methamphetamines, heroin and fentanyl combined. …policies that experts consider most effective at curbing excessive drinking have been ignored. For example, even as alcohol-related deaths soared to record highs in the last few years, alcohol taxes have fallen to the lowest rates in a generation. …The U.S. Community Preventive Services Task Force, an independent group of experts, has endorsed measures to deter excess drinking, including raising the price of alcohol. …One way that governments can influence the price of alcohol is by taxing its producers or sellers, who pass the cost on to consumers. This is comparable to taxes on tobacco, which scores of studies show to be a powerful tool for reducing smoking. A large body of evidence shows that higher alcohol taxes are associated with less excessive drinking and lower rates of disease and injury deaths.

This all sounds reasonable.

Raise taxes and you save lives.

But it’s not that simple, as J.D. Tuccille explained in Reason a few years ago.

…you don’t need an outright ban on alcohol to fuel the production of bathtub gin and its equivalents. A new report shows that the same result has been achieved in many countries through the imposition of excessively high taxes… World Health Organization (WHO) research, published in 2014 (PDF), …”illicit and informally produced alcohol accounts for nearly a quarter of the alcohol consumed globally.” …What’s the attraction of drinking the local equivalent of bathtub gin when commercially produced products are widely available? “Unrecorded alcoholic beverages are generally less costly than recorded alcohol,” WHO dryly acknowledged in 2014. The IARD report goes into a bit more detail as to why that might be, noting that “these beverages are untaxed and outside of regulated production that can increase cost,” which means there “is often a significant price difference between illicit and legitimate products, driving demand.”

In other words, governments can impose lots of taxes on alcohol, but one consequence is to encourage the black market.

My two cents on this issues is that all taxes should be low, including so-called sin taxes. That is not because I’m oblivious to the damage of drinking, smoking, drugs, or sugar.

My opposition is driven by three factors.

  1. I don’t want politicians having more money to waste.
  2. Sin taxes will encourage problematic black markets..
  3. People should have the freedom to make dumb choices.

I’ll close by addressing a common counter-argument, which is that people who make dumb choices can impose costs on the rest of society.

But if people drive while drunk or stoned, focus on penalizing the people who make those bad choices so that they will have an incentive for more responsible behavior.

And if smokers and gluttons impose high costs on government health programs, maybe that’s yet another reason for restoring free markets in health care.

Simply stated, the answer almost always is less government rather than more government.

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Last month, I wrote an article comparing Switzerland’s admirable fiscal policy with the profligate tendencies of other European nations.

I included a chart showing that the burden of government spending in Switzerland is far below where it is in countries such as Belgium, Greece, and France – where the public sector consumes about 60 percent of economic output.

And then there are nations such as Germany, Spain, Sweden, Denmark, and Italy, where more than 50 percent of GDP is diverted to finance bloated budgets.

Given this background, I was not surprised to read an article in the New York Times about European politicians engaging in another spending binge.

Nationalizations. Subsidies. Cash handouts. Price caps. Profit taxes. …Governments are resorting to old-school solutions, …throwing vast amounts of money at the energy crisis engulfing the region… E.U. governments have already earmarked more than $350 billion to subsidize consumers, industry and utility companies; ministers met on Friday to narrow down their options for the bloc’s direct intervention in markets to grab excess profits, cap electricity prices and subsidize utilities companies. “Government intervention is back in vogue in a really big way,” said Mujtaba Rahman, Europe director at the consulting firm Eurasia. …The huge public spending is in addition to a nearly trillion-dollar stimulus package adopted over the past year to deal with the economic fallout from the pandemic, mostly through borrowing. …spending billions…may be the only way to keep voters on board with Europe’s strong support of Ukraine against Russia.

The fact that Europe “turns once again to big spending” surely must win a prize for least surprising headline.

What is surprising, though, is some of the mistakes in the article. The reporter, Matina Stevis-Gridneff, seems to think that Europe has been some sort of bastion of laissez-faire fiscal policy.

It’s back to 20th-century economics in Europe. …The standoff with Russia over Ukraine is upturning European economic orthodoxy at rapid speed with barely a peep of dissent at the European Union’s headquarters in Brussels, a bastion of neoliberalism that not so long ago imposed brutal austerity on its own members, most notably Greece, even after it became clear it was harmful. …The ballooning debt load would have normally caused an uproar in the bloc, where fiscal conservatism has dominated policy and politics for years. …Paolo Gentiloni, the top E.U. economic official, ..said that the E.U. would begin to consider changes to its stringent fiscal rules

I’m not sure which part of the above excerpt is most at odds with reality.

  • “A bastion of neoliberalism.” To be blunt, that’s wildly wrong.
  • “Brutal austerity.” To be blunt, that’s wildly wrong.
  • “Fiscal conservatism has dominated policy.” To be blunt, that’s wildly wrong.
  • “Stringent fiscal rules.” To be blunt, that’s wildly wrong.

Though, to be fair, Greece was forced to engage in real austerity for a few years last decade. Though that only happened after a lengthy period of profligacy.

And the Greek people suffered immensely because the government over-spent for so many years.

What’s tragic is that other European nations, led by Italy, almost surely will suffer Greek-style fiscal crises. And the European Central Bank is making a bad situation even worse.

P.S. My other “least surprising headline” columns can be found here, here, and here.

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Back in March, I explained that a spending cap is desirable, but noted that it’s important to set a limit that actually restrains government spending.

I made the same point as part of a recent speech to Hawaii’s Grassroot Institute.

My main point is that the goal of fiscal policy should be to control government spending, ideally by making sure it does not expand faster than the private sector.

That’s my Golden Rule.

The problem in Hawaii is that there’s a spending cap, but it’s set too high. Politicians are allowed to increase spending at the rate of growth of state income.

It’s far better to cap spending so that it increases no faster than population plus inflation.

Like the TABOR rule in Colorado.

But that’s only part of the problem. As I noted in my remarks, Hawaii politicians routinely waive even the overly permissive limit in their state.

At the risk of repeating myself, they should copy Colorado.

I also explained to the audience that a balanced budget is nice, but it shouldn’t be the goal of fiscal policy.

  1. From an economic perspective, the real problem is spending, regardless of whether outlays are financed by taxes or borrowing.
  2. From a practical perspective, balanced budget requirements are unsustainable because revenues rise and fall with the business cycle.
  3. From a political perspective, politicians can opt to comply by increasing the tax burden, particularly during an economic downturn.

I’ll add a fourth point. governments (such as Switzerland) with successful spending caps have a very good track record of budget surpluses. The same can’t be said for European nations that are supposed to comply with anti-deficit rules.

Not that Switzerland’s success should come as a surprise. If you fix the disease of excessive spending, that automatically should solve the symptom of red ink.

P.S. Here’s an explanation of Switzerland’s spending cap.

P.P.S. Here’s how a spending cap could solve the fiscal mess in Washington.

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Even though they ostensibly exist to promote economic growth, the International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) have an unfortunate track record of promoting higher taxes and bigger government.

Not that we should be surprised. IMF and OECD officials get very comfortable (and tax-free!) salaries, so they have a “public choice” incentive to reflect the wishes of the politicians who control their purse strings.

But understanding the incentives of international bureaucrats definitely does not mean we should give them a free pass when they push bad policy.

And that’s exactly what the IMF and OECD are doing in Latin America.

Consider, for instance, the new IMF report on “Tax Policy for Inclusive Growth in Latin America and the Caribbean.” The authors (Santiago Acosta-Ormaechea, Samuel Pienknagura, and Carlo Pizzinelli) apparently think those struggling nations will grow faster if there is a bigger burden of government.

…fiscal policy…is not progressive enough… This paper presents a detailed assessment of tax structures in LAC and outlines reform options to improve collection… Specific tax design features are then assessed, inspecting how the taxation of capital and labor can be improved…to both increase revenue and provide a more equitable tax structure… Evidence for LA7 countries shows that better PIT design could bring significant gains in collection and equity. … Potentially adverse growth impacts could be mitigated by providing well-targeted incentives to labor force participation of low-wage earners through an earned income tax credit… Increasing the tax burden on certain non-labor income sources (e.g., capital gains) would also raise PIT revenue and improve equity… Other untapped revenue sources should be considered more forcefully, including the taxation of immovable property, inheritance taxes, and environmental taxes.

As illustrated by Figure 1 from the report, one of the clear messages is that Latin American countries should be more like high-tax countries in Western Europe.

What the authors overlook, however, is that the (relatively) rich countries in Western Europe became rich when the burden of government was very small.

There’s never been a nation, anywhere in the world, or at any point in world history, that became rich by adopting big government.

Now let’s look at what the OECD recommends, as part of “Latin American Economic Outlook 2021: Working Together for a Better Recovery.”

The LEO 2021 provides tailored policy messages to help stakeholders take action and build forward better. …it highlights the need to learn from the pandemic and mainstream some of the social policy innovations adopted throughout the crisis to strengthen social protection systems and improve quality and accessibility of public services. …a set of tax policy options could increase revenues… there needs to be greater resource mobilisation…in most LAC countries, which in turn implies greater progressivity of the taxation system… the average tax-to-GDP ratio in the LAC region was 22.9% in 2019, considerably below the OECD average of 33.8%… Countries may need to consider additional ways of raising revenues… PIT is the principal factor behind the tax gap between LAC and the OECD, limiting not only potential revenues but also the redistributive power of the tax system… taxation of immovable property…and of individuals’ capital gains, should contribute to increasing revenues to finance the recovery and improve the progressivity of the taxation system. Other measures include wealth and inheritance taxes.

Table 1 from the report summarizes the “new social contract” that the OECD is advocating.

All you need to understand is that “strengthening social protection systems and public services” is bureaucrat-speak for more government spending and “developing fairer and stronger tax systems” is bureaucrat-speak for higher taxes and class warfare.

I’ll close by calling your attention to this video explaining the ideal fiscal policy for nations in the developing world.

But remember that fiscal policy is just one piece of the puzzle, so I also recommend this video and this video if you want a full understanding of the policies that are needed to create broadly shared prosperity.

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Back in 2009, I narrated a video about the downsides of class-warfare tax policy.

But if you don’t want to spend eight minutes watching the video (or 14 minutes watching this video), here’s a visual that summarizes why high tax rates discourage people from engaging in productive behavior.

The most important thing to understand is that a high marginal tax rate (i.e., the tax rate on earning more money) has a big effect on incentives to work, save, invest, and be entrepreneurial.

But how big is that effect?

Let’s review some new research from Professor Charles Jones.

The classic tradeoff in the optimal income tax literature is between redistribution and the incentive effects that determine the “size of the pie.” …However, what is in some ways the most natural effect on the size of the pie has not been adequately explored. …To the extent that top income taxation distorts…innovation, it can impact not only the income of the innovator but also the incomes of everyone else in the economy. …High incomes are a prize that partly motivates entrepreneurs to turn basic insights into a product or process that ultimately benefits consumers. High marginal tax rates deter this effort and therefore reduce innovation and overall GDP. …For example, consider raising the top marginal tax rate from 50% to 75%. …the change raises about 2.5% of GDP in revenue before the behavioral response. In the baseline calibration…, this increase in the top tax rate reduces innovation and lowers GDP per person in the long run by around 7 percent. …even redistributing the 2.5% of GDP to the bottom half of the population would leave them worse off on average: the 7% decline in their incomes is not offset by the 5% increase from redistribution. In other words, raising the top marginal rate from 50% to 75% reduces social welfare…the rate that incorporates innovation and maximizes the welfare of workers is much lower: the benchmark value is just 9%.

Here’s a table from the study showing how the optimum tax rate is very low if the goal is to help workers and society rather than politicians.

If you want more evidence, there’s a never-ending supply.

But if we want to be concise, start with this list.

Heck, higher tax rates can even hurt your favorite sports team.

P.S. Joe Biden wants people to think that it’s patriotic to pay more tax, though he exempts himself with clever tax planning.

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I don’t like shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, or green-energy pork.

But, as explained in this video clip, the insult added to injury is that the resuscitated “Build Back Better” is being sold as the “Inflation Reduction Act.”

If a private company said that candy bars help you lose weight or that it is okay to stick your hand under a running lawnmower, it would be dragged into court for false and/or dangerous advertising.

But when politicians make utterly dishonest claims about legislation, we have to grit our teeth and endure their lies.

The bottom line is that rising prices inevitably are a consequence of bad monetary policy.

That’s true in the United States, and that’s true elsewhere in the world.

So why, then, did Biden, Schumer, and Manchin decide to affix such an inaccurate label to their tax-and-spend package?

The answer presumably is political. Inflation is a problem for the incumbent party, so why not pretend the budget plan will somehow reduce inflation. Heck, if they could get away with it, they would probably call it the “Inflation Reduction and Cancer Elimination Act.”

But, to be fair, perhaps some of them actually believe a big-government plan will have an impact on inflation. For instance, the misguided but honest folks at the Committee for a Responsible Federal Budget released an endorsement letter from 55 supposed experts based on the assumption that higher taxes will lead to lower prices.

Here are some excerpts.

With inflation at a 40-year high…, we are writing to encourage you to pass legislation to reduce budget deficits in a manner that would help counter inflation… As President Biden has explained, “bringing down the deficit is one way to ease inflationary pressures.” …Given the current state of the economy, we believe passing deficit reduction would send an important message to the American people that their leaders are serious about tackling inflation.

There are two big problems with the letter.

First, it is based on Keynesian economics, which assumes higher prices are caused by excessive “aggregate demand” and that deficit reduction (whether from tax increases or spending restraint) can help by slowing the economy.

Yet this is the theory that also told us that it was impossible to have rising prices and rising unemployment, like we saw in the 1970s. And Keynesians also said we couldn’t have falling unemployment and falling inflation, like we enjoyed in the 1980s.

Second, even if one believes in the fairy tale of Keynesian economics, all of the alleged deficit reduction occurs in future years.

And even that is nonsense since every sentient adult knows that the massive expansion of the IRS’s budget is not going to generate a windfall of new tax revenue. And every honest person also knows that lawmakers plan on extending the new Obamacare handouts in the bill.

These tweets summarize why even Keynesians should realize the legislation is fraudulent.

P.S. It is very disappointing (but perhaps not entirely surprising) that former Indiana Governor Mitch Daniels signed the CRFB letter. And it also is disappointing that a couple of people from the American Enterprise Institute added their names as well. They all deserve the Charlie Brown Award.

P.P.S. As I noted in the video, deficit spending can lead to inflation if a central bank buys government bonds in order to help finance additional government spending (the crazy Modern Monetary Theory agenda). Perhaps I am being too charitable, but I don’t think that’s the reason for the Federal Reserve’s big mistake (though I fear it may be happening with the European Central Bank).

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I realize few readers are interested in small, faraway countries. But I periodically write about nations such as Jordan, Cyprus, Latvia, Vanuatu, Panama, and Pakistan because they offer important lessons – mostly negative, but sometimes positive – about fiscal policy.

Today, let’s see what we can learn from Barbados.

That island nation in the Caribbean wound up in fiscal trouble a few years ago and Abrahm Lustgarten of the New York Times wrote a lengthy article last week about that experience.

Here’s the situation as of 2018.

Barbados was out of money. It was so broke that it was taking out new loans just to pay the interest on the old ones, even as its infrastructure was coming undone. Soon the nation would have no choice but to declare itself insolvent, instigating a battle with the dozens of banks and creditors that held its $8 billion in debt and triggering austerity measures that would spiral the island into further poverty. …Mottley, the first woman to lead Barbados, had been working…to develop a plan that would restructure the country’s soaring debts in a way that would free up money to invest in Barbados’s economy.

While the preceding excerpts are mostly to illustrate what was happening, I can’t resist two editorial comments.

Now let’s get back to the story.

Prime Minister Mottley’s plan involved going to the International Monetary Fund, then headed by Christine Lagarde, for a bailout.

Mottley knew that banks and investors would work with her only if Barbados were participating in a formal I.M.F. program… Mottley wanted Lagarde to endorse an economic program that would still allow her to raise salaries of civil servants, build schools and improve piping and wiring for water and power. …No one was sure how Lagarde would respond. Would she trust Mottley to spend on Barbados first? …the director’s surprising reply: She was extremely supportive of what Mottley was proposing.

Needless to say, I don’t like bailouts. And a bailout that enables more government spending seems especially foolish.

But I like to check the numbers before making sweeping pronouncements.

And while I am very skeptical of IMF bailouts, I like that the international bureaucracy has an extensive database with economic and fiscal numbers. Including fiscal data for Barbados going back to 1994.

So let’s see whether Barbados somehow was being hurt by inadequate levels of government spending.

But it turns out that total government spending today is more than four times greater than it was in 1994.

And if we look at government spending as a share of gross domestic product, we can see that government has nearly doubled in size.

To be fair to Ms. Mottley, the politicians in office from 1994-2008 were the most profligate.

But none of that changes the fact that government is far bigger today than it was in the recent past. So the notion that Barbados needs a bigger government budget is nonsense.

Sadly, the reporter did not bother to share any of these numbers. Indeed, in a story that ran more than 10,000 words, there were only 50 words that even hinted at the real problem.

…a mixture of poor management and corruption had eroded the country’s economy. …the country had developed a “dysfunctional” fiscal culture in which government agencies and departments took loans and negotiated deals without consulting the central bank, accumulating sprawling debt… The country’s response was to print more money and borrow more.

I’ll close by observing that Barbados never would have gotten into trouble if it had a Swiss-style spending cap. If government spending had been allowed to grow only 3 percent each year starting in 1994, Barbados would be enjoyed a huge budget surplus today.

P.S. Ironically, economists at the IMF have written in favor of spending caps on multiple occasions. Too bad the political hacks in charge of the bureaucracy don’t pay attention to that research.

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One of the best things about 2021 was the fact that Congress did not approve Joe Biden’s economically debilitating plan to raise taxes and expand the welfare state.

His so-called Build Back Better plan was a very bad mix of class-warfare tax policy and redistributionist spending policy.

But one of the worst things about 2022 may be the reincarnation of a slimmed-down version of Biden’s plan.

Simply stated, the “slimmed-down version” of a terrible piece of legislation is bad news – even if it is possible to envision something even worse.

The Wall Street Journal‘s editorial on the package illustrates why it is bad news that Senator Joe Manchin is trying to rescue Biden’s statist agenda.

As the economy slouches near recession, Majority Leader Chuck Schumer and West Virginia Sen. Joe Manchin…unveiled a tax-and-spending deal that they call the Inflation Reduction Act. Is their aim to reduce inflation by chilling business investment and the economy? …A more accurate name would be the Business Investment Reduction and Distortion Act since that will be the result of its $433 billion in climate and healthcare spending, and $615 billion in new taxes and drug price-control “savings.”

The editorial highlights four terrible provisions.

First, there’s a big tax hike on American companies, with the biggest tax hike on firms that make new investments.

…the 15% minimum tax on corporate book income…will slam businesses whose taxable income is lower than the profits on their financial statements owing to the likes of investment expensing.

For all intents and purposes, politicians would be creating a second type of corporate income tax.

Heavy compliance costs for the business community, of course, but the rest of us probably care more about the estimated loss of 218,000 jobs according to the National Association of Manufacturers.

Second, there are corrupt “green energy” provisions that will degrade America’s energy efficiency and security.

…the bill’s $369 billion in climate spending, most of which is corporate welfare. …All of this will steer private investment into green energy at the cost of reduced investment in fossil fuels. Wind and solar subsidies are already creating distortions in power markets that make the electric grid less reliable and energy more expensive. The expansion of subsidies will compound these problems.

If you want to know why this is bad, just remember Solyndra.

Third, the legislation imposes back-door price controls on the pharmaceutical industry.

The bill will require the Health and Human Services Secretary to “negotiate” Medicare prices—i.e., impose price controls—for dozens of drugs. But the $288 billion in putative savings are fanciful. Manufacturers will hedge potential future losses by launching drugs at higher prices. …The bill will also discourage investment in innovative treatments that could reduce future healthcare spending.

For those of us who value the development of new drugs to fight problems like cancer and Alzheimer’s, this is very bad news.

Fourth, a very corrupt internal revenue service is rewarded for its bad behavior.

Speculative revenue of $124 billion will also come from an $80 billion boost for the IRS. Most of this will finance more audits. The rich can afford more tax lawyers, but middle and upper-middle class Americans will be inclined to settle IRS claims, however meritless, lest they spend even more to defend themselves.

P.S. I can’t resist sharing one final bit of information.

If you peruse the Joint Committee on Taxation’s analysis of the bill, you’ll find that Joe Biden is breaking his promise not to raise taxes on people making less than $400,000 per year.

Not that anyone should be shocked. I have repeatedly explained that the big spenders need to pillage lower-income and middle-class household if they want to finance bigger government.

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Yesterday’s column analyzed some depressing data in the new long-run fiscal forecast from the Congressional Budget Office.

Simply stated, if we leave fiscal policy on auto-pilot, government spending is going to consume an ever-larger share of America’s economy. Which means some combination of more taxes, more debt, and more reckless monetary policy.

Today, let’s show how that problem can be solved.

My final chart yesterday showed that the fundamental problem is that government spending is projected to grow faster than the private economy, thus violating the “golden rule” of fiscal policy.

Here’s a revised version of that chart. I have added a bar showing how fast tax revenues are expected to grow over the next 30 years, as well as a bar showing the projection for population plus inflation.

As already stated, it’s a big problem that government spending is growing faster (an average of 4.63 percent per year) than the growth of the private economy (an average of 3.75 percent per years.

But the goal of fiscal policy should not be to maintain the bloated budget that currently exists. That would lock in all the reckless spending we got under Bush, Obama, and Trump. Not to mention the additional waste approved under Biden.

Ideally, fiscal policy should seek to reduce the burden of federal spending.

Which is why this next chart is key. It shows what would happen if the federal government adopted a TABOR-style spending cap, modeled after the very successful fiscal rule in Colorado.

If government spending can only grow as fast as inflation plus population, we avoid giant future deficits. Indeed, we eventually get budget surpluses.

But I’m not overly concerned with fiscal balance. The proper goal should be to reduce the burden of spending, regardless of how it is financed.

And a spending cap linked to population plus inflation over the next 30 years would yield impressive results. Instead of the federal government consuming more than 30 percent of the economy’s output, only 17.8 percent of GDP would be diverted by federal spending in 2052.

P.S. A spending cap also could be modeled on Switzerland’s very successful “debt brake.”

P.P.S. Some of my left-leaning friends doubtlessly will think a federal budget that consumes “only” 17.8 percent of GDP is grossly inadequate. Yet that was the size of the federal government, relative to economic output, at the end of Bill Clinton’s presidency.

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The Congressional Budget Office has released its new long-run fiscal forecast. Like I did last year (and the year before, and the year before, etc), let’s look at some very worrisome data.

We’ll start with projections over the next three decades for taxes and spending, measured as a share of economic output (gross domestic product). As you can see, the tax burden is increasing, but the spending burden is increasing even faster.

By the way, some people think America’s main fiscal problem is the gap between the two lines. In other words, they worry about deficits and debt.

But the real problem is government spending. And that’s true whether the spending burden is financed by taxes, borrowing, or printing money.

So why is the burden of government spending projected to get larger?

As you can see from Figure 2-2, entitlement programs deserve the lion’s share of the blame. Social Security spending is expanding as a share of GDP, and health entitlements (Medicare, Medicaid, and Obamacare) are expanding even faster.

Now let’s confirm that the problem is not on the revenue side.

As you can see from Figure 2-7, taxation is expected to consume an ever-larger share of economic output in future decades. And that’s true even if the Trump tax cuts are made permanent.

Having shared three charts from CBO’s report, it’s now time for a chart that I created using CBO’s long-run data.

My chart shows that America’s main fiscal problem is that we are not abiding by fiscal policy’s Golden Rule. To be more specific, the burden of government is projected to grow faster than the economy.

So long as the burden of government is expanding faster than the private sector, that’s a recipe for higher taxes, more debt, and reckless monetary policy.

All of those options lead to the same bad outcome.

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Adding to already voluminous research in the area (including studies from AustraliaCanadaGermany, and the United Kingdom), I wrote yesterday about a new study showing that lower corporate tax rates produce more economic growth.

Not that these results should be a surprise.

Anyone with a basic understanding of economics realizes that taxes discourage the activity that is being taxed (something politicians understand when they discuss levies on tobacco).

And the higher the tax, the greater the damage.

Today, let’s revisit the 2017 Trump tax cuts, particularly the reduction in the corporate tax rate.

The International Monetary Fund has published new research on the issue, looking specifically at the impact of cross-border investment. Here are some excerpts from the study, which was written by Thornton Matheson, Alexander Klemm, Laura Power, and Thomas Brosy.

The 2017 Tax Cuts and Jobs Act (TCJA) sharply reduced effective corporate income tax rates on equity-financed US investment. This paper examines the reform’s impact on US inbound foreign direct investment (FDI) and investment in property, plant and equipment (PPE) by foreign-owned US companies. …We find that both PPE investment and FDI financed with retained earnings responded positively to the TCJA reform, but FDI financed with new equity or debt did not. …the increase in PPE investment after TCJA was driven by general economic growth. In regressions of FDI financed with retained earnings, however, tax coefficients were robust to inclusion of macroeconomic controls. As the literature predicts, EATRs have a greater impact on cross-border investment than EMTRs.

These results are interesting, but not overwhelming.

So why am I citing this research?

Because of the following chart, which shows two very important and very desirable results of the 2017 tax bill.

  • First, we see lower average tax rates and lower marginal tax rates for the three types of business financing on the right.
  • Second, we can see from “EMTR debt finance” on the left that the legislation significantly reduced the tax code’s bias for debt.

Here’s the chart, with the blue bars representing pre-2017 tax rates and the orange bars showing today’s tax rates.

The bottom line is that the 2017 law moved tax policy in the right direction. In a big way.

We got lower rates and moved closer to neutrality.

And I say that as someone who has no problem criticizing some of the other policies we got during that era.

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Here is the argument why corporate tax rates should be as low as possible.

In an ideal world, there would be no corporate income tax (or any income tax).

But I’ll gladly accept any movement in the right direction, which is why the reduction in the corporate tax rate was the crown jewel of Trump’s 2017 tax plan.

The bad news is that Biden wants to undo much of that progress.

Today, let’s look at some new academic evidence on the issue. A new study from the National Bureau of Economic Research, authored by Professors James Cloyne, Joseba Martinez, Haroon Mumtaz, and Paolo Surico, finds that lower corporate rates are especially beneficial for long-run prosperity.

We use…post-WWII U.S. data on output, taxes, productivity and R&D spending to estimate the dynamic effects of income tax changes…and focus on personal and corporate income tax changes separately. …In Figure 1, we present our first set of main results. The figure contains two columns. On the left, we show the IRFs to a reduction in the average corporate tax rate. On the right, we show the results for a reduction in the average personal tax rate. …The first row in Figure 1 reveals that, following a shock to corporate and personal income taxes, the average tax rates decline temporarily. …The second row in Figure 1 shows the impulse response functions for the percentage response of real GDP. … Looking at the first column it is clear that, despite the transitory nature of the corporate tax reduction, there are very persistent effects on real GDP, whose short-run increase of 0.5% persists throughout the ten year period shown in the figure. In other words, the corporate income tax cut has disappeared after 5 years, but the effect on the level of economic activity is still sizable and significant after 8 years. …A similar picture emerges for productivity, as shown in the third row of Figure 1. Both tax rate cuts boost productivity on impact, with the size of the initial response to a personal income tax cut being much larger than for a cut to corporate taxes. On the other hand, the effects of corporate tax cuts grow over time and remain significant even after 10 years.

Here’s the aforementioned Figure 1 from their research.

I’ll conclude by noting that permanent tax cuts are much better than temporary tax cuts.

But if taxes are being cut, regardless of duration, the goal should be to get the most bang for the buck. And there’s plenty of evidence (from the United States, AustraliaCanadaGermany, and the United Kingdom) that lowering corporate tax rates is a smart place to start.

P.S. It’s unfortunate that Biden wants a higher corporate tax burden in the United States. It’s even more disturbing that he wants a global tax cartel so the entire world has to follow in his footsteps. But he apparently does not understand the topic.

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If Joe Biden’s bungled economic policy is any indication, the GOP may wind up controlling Washington in the not-too-distant future.

If so, I hope Republicans rekindle their interest in the kind of genuine entitlement reform discussed in this interview.

But I’m not sure whether to be optimistic or pessimistic.

On the plus side, the GOP supported pro-growth entitlement reform during the Obama years.

On the minus side, the party largely punted on the issue once Trump took over.

To be sure, punting is the easy route from a “public choice” perspective. Politicians like offering freebies to voters and many voters like getting handouts.

However, that approach means America’s economy is weakened by an ever-growing burden of federal spending and eventually is plunged into fiscal crisis.

And that’s based on the programs that already exist. Joe Biden wants to expand the welfare state with even more entitlements!

The Wall Street Journal editorialized about the downside of making America more like Europe last October.

The result of…expanded entitlements is likely to be reduced incentives to work and invest, slower economic growth, lower living standards, and less fiscal space for essential public goods like national defense. That’s the lesson from Europe’s cradle-to-grave welfare states… Europe’s little-discussed secret is that its cradle-to-grave welfare states are financed by the middle class via value-added and payroll taxes. The combined employer-employee social security tax rate is 36% in Spain, 40% in Italy and 65% in France. Value-added taxes in most European economies are around 20%. There simply aren’t enough rich to finance their entitlements.

Amen. I’ve repeatedly warned that a European-sized welfare state would mean European-sized taxes on lower-income and middle-class Americans.

And what’s remarkable (and discouraging) is that some politicians in the U.S. want to expand entitlements even though many European governments now realize they made big mistakes and need to scale back.

The irony is that some European governments have tried to reform their tax and welfare systems to become more competitive. Germany and Sweden over two decades reformed their welfare and labor policies. …Other European governments are also pushing welfare-state reforms. French President Emmanuel Macron has passed pension reform and cut the corporate tax rate to 26.5% from 33% in 2017… Greece is pulling out of its debt trap with Prime Minister Kyriakos Mitsotakis’s tax, pension and regulatory reforms.

For what it’s worth, I’m happy about these reforms, but I fear many European nations are in the too-little-too-late category.

Why? Because the demographic outlook is deteriorating faster than reform is happening. In other words, most of them are probably destined to suffer Greek-style fiscal crises.

But if (or when) that happens, maybe American politicians will finally wake up and realize we need good reforms to prevent Social Security, Medicare, and Medicaid from causing a similar collapse on this side of the Atlantic Ocean..

Hopefully that epiphany will take place before it is too late for the United States.

P.S. For those who are interested in the history of fiscal policy, John Cogan of the Hoover Institution wrote about pre-20th-century entitlements earlier this year.

Here are excerpts from his column in the Wall Street Journal.

The history of U.S. entitlements is a 230-year record of continuous expansion… The first major entitlement, Revolutionary War disability benefits, was initially restricted to members of the Continental Army and Navy who were injured in battle and survivors of those killed in wartime. Eligibility was then expanded, first to state militia soldiers, then to veterans whose disabilities were unrelated to wartime service, and eventually to virtually all people who served during the war regardless of disability. Civil War disability pensions followed the same…process, except on a far grander scale. Pensions were initially confined to U.S servicemen who suffered wartime injuries and survivors of those killed in battle. Eventually they were extended to virtually all union Civil War veterans regardless of disability. …Congress followed the same liberalizing process with 20th-century entitlements.

If this excerpt doesn’t satisfy your curiosity, here’s Cogan discussing the topic for 46 minutes.

P.P.S. Not all entitlement reform is created equal.

P.P.P.S. Here an informative chart if you want to know whether to blame defense spending or entitlement spending.

P.P.P.P.S. I always argue in favor of a Swiss-style spending cap, which presumably would force politicians to address America’s entitlement problem.

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I’ve written a few columns that explain tax principles, but this video from the Tax Foundation may be the best place to start if you have friends or colleagues who need to learn the basics.

As part of the article that accompanies the video, the Tax Foundation explains that not all taxes are created equal. In other words, some taxes impose more damage than other taxes.

And this chart from the article is a nice summary of the three types of tax, along with the potential damage caused by varying ways of collecting tax.

As a general rule, this chart is totally accurate.

Corporate income taxes, gross receipts taxes (mentioned here), and wealth taxes do a lot of economic damage on a per-dollar-collected basis.

But I want to add a caveat to the first column.

As currently designed, there’s no question that the personal income tax and the corporate income tax are very bad taxes.

But it is possible to dramatically reduce the damage imposed by those levies. For instance, the personal income tax could be largely defanged if the current system was repealed and replaced by a simple and fair flat tax.

Likewise, it’s possible to reform the corporate income tax (full expensing, territoriality, no double tax on dividends, etc) so that it does comparatively little damage.

By the way, I’m sure the experts at the Tax Foundation would agree with these observations, so I’m augmenting rather than criticizing.

And since I’m doing some augmenting, another observation is that the first two taxes on the bottom row generally are very similar, at least with regard to their economic impact (and also similar to a properly designed individual income tax).

Here’s some of what I wrote in a column back in 2012.

…anything that expands the “tax wedge” between pre-tax income and post-tax consumption is going to impose similar levels of economic harm. Here’s a simple example. If I earn $100, does it matter to me if the government takes $25 as I earn that income (either with a payroll tax or income tax) or as I spend that income (either with a sales tax or value-added tax)? Is there any reason that my incentives to earn and produce will be altered by shifting from one approach to the other?

I explain that the answer is no. My incentive to earn income is affected by my ability to use income to enjoy consumption. But if taxes take a big bite, I’ll have less reason to be productive, regardless of how politicians collect the tax.

For what it is worth, I’ve used Belgium as an example to explain why shifting from payroll taxes to sales taxes, or vice-versa, is not a recipe for greater prosperity.

P.S. Those who want more advanced primers on taxes and growth should click here and here.

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Back in May, I pointed out that it is absurd for Joe Biden to claim credit for lower deficits. This Reason video elaborates, noting that red ink is (temporarily) falling solely because the orgy of pandemic spending is ending.

Serious budget people, regardless of their ideology, know this is true.

Almost everything Biden has done since taking office has expanded the burden of government.

For instance, he pushed through a so-called stimulus scheme, followed by a boondoggle-filled infrastructure plan.

Both of which are captured in this chart from Brian Riedl.

By the way, it would be better if the chart focused on how the spending burden has increased. After all, deficits should be viewed as the symptom. The real disease is excessive government.

That being said, either type of chart would look far worse if Biden had been able to convince Congress to approve $trillions of additional spending as part of his “build back better” proposal.

One final point is that Biden also has added to the fiscal burden of government with the pen-and-phone approach.

The Congressional Budget Office estimates that Biden has added $532 billion of extra spending via executive orders and other unilateral decisions.

P.S. I have no doubt Trump and many other politicians of both parties also would be taking credit for falling deficits if they were in Biden’s position. After all, politicians are probably the least ethical people in the nation. And Washington brings out the worst of the worst.

P.P.S. There is a risk that a slimmed-down version of Biden’s “build back better” plan is being resuscitated. That would be bad news for the economy. Not as bad as the original version, to be sure, but it’s crazy to enact anti-growth proposals with the economy teetering on the edge of recession (especially since some of the specific provisions are so misguided).

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Last month, I shared a chart from a study published by the European Central Bank.

It showed which European nations were in the unfortunate position of facing big future spending increases (the vertical axis) combined with already-high levels of government debt (the horizontal axis).

The bottom line is that Italy, Portugal, France and Belgium face a very difficult fiscal future.

And Estonia (at least relatively speaking) is in the best shape.

Today we are going to augment those ECB numbers by looking at some data from the OECD’s recent report on Estonia.

Here’s a chart showing how the burden of government spending is going to increase in various nations between now and 2060.

Slovakia, Spain, Norway, and the Czech Republic have the biggest problem.

Lithuania is in the best shape, surprisingly followed by Greece (I assume because that nation already hit rock bottom, not because of good policy).

I also highlight the United States, which will have to face the challenge of above-average spending increases.

But if you want to know which nation will be the next to suffer fiscal collapse, you also need to know whether (or the degree to which) it has the capacity – or “fiscal space” – to endure a bigger burden of government spending.

James Capretta addressed that topic in an article for the Bulwark.

Which governments have exercised budgetary restraint in recent years, even while confronting sequential global crises? Which have been more profligate? And what do the differences portend for their differing abilities to handle an era when servicing debt may be more expensive than it has been in many years? …Accuracy…requires assessing both assets and liabilities. …The Organization for Economic Cooperation and Development…’s most comprehensive measure of fiscal resilience is the “financial net worth” of the reporting countries, which includes the main sources of accumulated liabilities (especially public debt) along with financial assets owned by governments.

And here’s a chart showing how developed nations (with the exception of oil-rich Norway) have been spending themselves into a fiscal ditch.

Here are some of Capretta’s observations.

Among the twenty-seven OECD countries that reported data every year from 1995 to 2020, the average deterioration in their net financial position, weighted by population size, was equal to 48 percent of GDP. …Several countries stand out for the steepness of their declines. Japan’s net financial position was -20 percent of GDP in 1995, and in 2020 it was -129 percent of GDP—in other words, in just 25 years it worsened by over 100 percent of the country’s annual GDP. Similarly, the United Kingdom experienced a serious deterioration, with a net financial position in 2020 equal to -109 percent of GDP. In 1995, it was -26 percent. …France, Greece, Italy, and Spain are regularly criticized for their uneven approaches to fiscal discipline. The OECD data showing a substantial deterioration of their net financial positions over the last quarter century provides more evidence that each of these countries needs to take further steps to lower the risk of a fiscal crisis in future years.

The United States obviously is not in good shape, though I think the OECD’s methodology is imperfect.

Yes, America will have to deal with a fiscal crisis if we don’t figure out a way of controlling spending, but I suspect many other countries will reach that point before the U.S. (with Italy quite likely being the next to go belly up).

P.S. At the risk of repeating advice from previous columns, genuine entitlement reform is the only solution to America’s long-run spending problem, ideally enforced by a Swiss-style, TABOR-style spending cap.

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Echoing remarks earlier this month to a group in Nigeria, I spoke today about fiscal economics to the 2022 Africa Liberty Camp in Entebbe, Uganda.

During the Q&A session, I was asked to specify the ideal amount of government spending. I addressed that issue in an April interview while visiting Spain.

You’ll notice that I didn’t give a specific number in the above video. Just like I didn’t give a specific number to the audience in Uganda.

That’s because there is not an exact answer. The only thing we can definitively state is that government in most nations should be far smaller than it is today.

This is illustrated by the “Rahn Curve,” which I discussed both in the interview and in my speech today.

What is the Rahn Curve? Here’s some of what I wrote back in 2015.

…it shows the non-linear relationship between the size of government and economic performance. Simply stated, some government spending presumably enables growth by creating the conditions (such as rule of law and property rights) for commerce. But as politicians learn to buy votes and enhance their power by engaging in redistribution, then government spending is associated with weaker economic performance because of perverse incentives and widespread misallocation of resources.

And here’s a visual depiction of the Rahn Curve. The upward-sloping part of the curve shows that spending on genuine public goods is associated with more prosperity. But once government budgets exceed a certain level, additional spending means weaker economic performance.

In the above graph, I show that growth is maximized when government consumes about 15 percent-20 percent of economic output.

But I actually think prosperity would be maximized if government was a smaller burden, perhaps about 5 percent-10 percent of GDP.

In 2017, I explained the appropriate role of government in a libertarian society. My analysis was based on my “minarchist” views, which imply government only spends money for national defense and rule of law.

By contrast, my anarcho-capitalist friends would say we don’t need any government.

Meanwhile, moderate libertarians (or conservative Republicans) might be amenable to having state and local governments play a role in education and infrastructure.

The bottom line is that I think growth would be maximized if government consumes – at most – 10 percent of economic output (which was the size of government in the 1800s when the Western world became rich).

But I will be happy with any progress (particularly since government is projected to become an even bigger burden if left on autopilot).

If you want to watch more videos related to the Rahn curve, there are many options.

P.S. Here’s my response to a critic from the left.

P.P.S. Interestingly, some normally left-leaning international bureaucracies have acknowledged you get more prosperity with smaller government. Check out the analysis from the IMF, ECB, World Bank, and OECD.

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As part of a conference organized by the Face of Liberty International in Nigeria, I reviewed realworld evidence to explain the recipe needed for poor nations to become rich nations. With an emphasis on fiscal policy, of course.

I think much of what I said is common sense backed by hard data.

Indeed, the evidence is so clear that I put together a never-answered-question challenge back in 2020 (which built upon an earlier version from 2014).

Why is it “never-answered”?

Because my left-leaning friends have never been able to provide an example, either now or at some point in the past, of a poor nation becoming a rich nation by imposing higher taxes and a bigger burden of government spending.

Yet supposed experts in economic development for decades have pushed foreign aid in failed efforts turn poor countries into rich countries.

More recently (and even more preposterously), international bureaucracies like the OECD, UN, and IMF have been arguing that higher taxes and bigger government are needed to promote economic development.

For all intents and purposes, my argument is based on the fact that western nations became rich in the 1800s and early 1900s when they had very low taxes and very small governments.

And if you don’t have 20 minutes to watch the above video, the most important charts come from a column I wrote back in 2018.

The first chart shows that there was a stunning reduction in poverty in western nations over a 100-year time period.

And the second chart shows that this near-miraculous improvement occurred before those nations had welfare states or any other forms of redistribution spending.

P.S. Rule of law (rather than arbitrary rule by kings, chiefs, emperors, and dictators) is a necessary prerequisite for growth. And weak rule of law is an even bigger challenge in the developing world than bad advice from international bureaucracies.

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I’ve already shared the “feel-good story” for 2022, so today I’m going to share this year’s feel-good map.

Courtesy of the Tax Foundation, here are the states that have lowered personal income tax rates and/or corporate income tax rates in 2021 and 2022. I’ve previously written about these reforms (both this year and last year), but more and more states and lowering tax burdens, giving us a new reason to write about this topic.

The map is actually even better than it looks because there are several states that don’t have any income taxes, so it’s impossible for them to lower rates. I’ve labelled them with a red zero.

And when you add together the states with no income tax with the states that are reducing income tax rates, more than half of them are either at the right destination (zero) or moving in that direction.

That’s very good news.

And here’s more good news from the Tax Foundation. The flat tax club is expanding.

I prefer the states with no income taxes, but low-rate flat taxes are the next best approach.

P.S. According to the Tax Foundation, New York and Washington, D.C. have moved in the wrong direction. Both increased income tax burdens in 2021. No wonder people are moving away.

P.P.S. If I had to pick the states with the best reforms, I think Iowa and Arizona belong at the top of the list.

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America’s fiscal future is very grim, largely because of an ever-expanding burden of entitlement spending.

To see the magnitude of the problem, let’s peruse the Budget and Economic Outlook, which was released yesterday by the Congressional Budget Office has some.

Most people are focusing on how deficits are going to climb from $1 trillion to $2 trillion-plus over the next 10 years.

That’s not good news, but we should be far more worried about the fact that the burden of government spending is growing faster than the private economy. As a result, government will be consuming an ever-larger share of national output.

The budget wonks who (mistakenly) focus on red ink say the problem is so serious that we need higher taxes.

They look at this chart, which is based on CBO’s baseline forecast (what will happen if taxes and spending are left on autopilot), and assert we have no choice but to raise taxes.

They point out that the annual deficit in 2032 will be almost $2.3 trillion and that it’s impossible cut spending by that much.

Needless to say, it would be a near-impossible political undertaking to cut $2.3 trillion in one year (though it would fulfill libertarian fantasies).

But what if, instead of kicking the can down the road, policymakers imposed some sort of overall spending cap to avoid a giant deficit in 10 year.

This second chart displays that scenario. I took CBO’s baseline (autopilot) numbers and assumed that spending could only increase by 1.4 percent annually starting in 2024.

As you can see, that modest bit of fiscal discipline completely eliminates the project $2.3 trillion annual deficit in 2032.

In other words, there is no need for any tax increase.

Especially since politicians almost certainly would respond to the expectation of additional revenue by increasing spending above the baseline (as would happen with Joe Biden’s so-called Build Back Better scheme).

I’ll close by noting that there’s no need to fixate on whether the budget is balanced by 2032. What matters is trend lines.

It’s not good for government to grow faster than the private economy in the long run. And it’s not good for deficits and debt to climb as a share of economic output in the long run.

Both of those outcomes can be avoided if we have some sort of spending cap so that outlays grow slower than the private sector.

The stricter the cap, the quicker the progress.

  • I prefer actual cuts (a requirement to reduce nominal spending each year).
  • I would be happy with a hard freeze (like we had for a few years after the Tea Party revolt).
  • As noted above, a 1.4 percent spending cap balances the budget by 2032.
  • But we would make progress, albeit slow progress, even if the spending cap allowed the budget to grow by 2.0 percent of 2.5 percent per year.

P.S. I start the spending cap in 2024 because spending is not projected to grow by very much between 2022 and 2023. That’s not because today’s politicians are being responsible, however. It’s simply a result of one-time pandemic emergency spending coming to an end. But since that one-time spending has a big impact on short-run numbers, I delayed the spending cap for one year.

P.P.S. The blue revenue line has a kink in 2025 because the baseline forecast assumes that many of the Trump tax cuts expire that year. If those tax cuts are extended or made permanent, revenues would be about $400 billion lower in 2032. As such, balancing the budget by that year would require a spending cap that allows annual outlays to increase by less than 0.9 percent per year.

P.P.P.S. President Biden is bragging that the deficit is falling this year, but that’s only because the one-time pandemic spending is coming to an end.

P.P.P.P.S. A spending cap is a simple solution, but it would not be an easy solution. In the long-run, it would require genuine entitlement reform.

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Earlier this year, I pointed out that President Biden should not be blamed for rising prices.

There has been inflation, of course, but the Federal Reserve deserves the blame. More specifically, America’s central bank responded to the coronavirus pandemic by dumping a lot of money into the economy beginning in early 2020.

Nearly a year before Biden took office.

The Federal Reserve is not the only central bank to make this mistake.

Here’s the balance sheet for the Eurosystem (the European Central Bank and the various national central banks that are in charge of the euro currency). As you can see, there’s also been a dramatic increase in liquidity on the other side of the Atlantic Ocean.

Why should American readers care about what’s happening with the euro?

In part, this is simply a lesson about the downsides of bad monetary policy. For years, I’ve been explaining that politicians like easy-money policies because they create “sugar highs” for an economy.

That’s the good news.

The bad news is that false booms almost always are followed by real busts.

But this is more than a lesson about monetary policy. What’s happened with the euro may have created the conditions for another European fiscal crisis (for background on Europe’s previous fiscal crisis, click here, here, and here).

In an article for Project Syndicate, Willem Buiter warns that the European Central Bank sacrificed sensible monetary policy by buying up the debt of profligate governments.

…major central banks have engaged in aggressive low-interest-rate and asset-purchase policies to support their governments’ expansionary fiscal policies, even though they knew such policies were likely to run counter to their price-stability mandates and were not necessary to preserve financial stability. The “fiscal capture” interpretation is particularly convincing for the ECB, which must deal with several sovereigns that are facing debt-sustainability issues. Greece, Italy, Portugal, and Spain are all fiscally fragile. And France, Belgium, and Cyprus could also face sovereign-funding problems when the next cyclical downturn hits.

Mr. Buiter shares some sobering data.

All told, the Eurosystem’s holdings of public-sector securities under the PEPP at the end of March 2022 amounted to more than €1.6 trillion ($1.7 trillion), or 13.4% of 2021 eurozone GDP, and cumulative net purchases of Greek sovereign debt under the PEPP were €38.5 billion (21.1% of Greece’s 2021 GDP). For Portugal, Italy, and Spain, the corresponding GDP shares of net PEPP purchases were 16.4%, 16%, and 15.7%, respectively. The Eurosystem’s Public Sector Purchase Program (PSPP) also made net purchases of investment-grade sovereign debt. From November 2019 until the end of March 2022, these totaled €503.6 billion, or 4.1% of eurozone GDP. In total, the Eurosystem bought more than 120% of net eurozone sovereign debt issuances in 2020 and 2021.

Other experts also fear Europe’s central bank has created more risk.

Two weeks ago, Desmond Lachman of the American Enterprise Institute expressed concern that Italy had become dependent on the ECB.

…the European Central Bank (ECB) is signaling that soon it will be turning off its monetary policy spigot to fight the inflation beast. Over the past two years, that spigot has flooded the European economy with around $4 trillion in liquidity through an unprecedented pace of government bond buying. The end to ECB money printing could come as a particular shock to the Italian economy, which has grown accustomed to having the ECB scoop up all of its government’s debt issuance as part of its Pandemic Emergency Purchase Program. …the country’s economy has stalled, its budget deficit has ballooned, and its public debt has skyrocketed to 150 percent of GDP. …Italy has had the dubious distinction of being a country whose per capita income has actually declined over the past 20 years. …All of this is of considerable importance to the world economic outlook. In 2010, the Greek sovereign debt crisis shook world financial markets. Now that the global economy is already slowing, the last thing that it needs is a sovereign debt crisis in Italy, a country whose economy is some 10 times the size of Greece’s.

Mr. Lachman also warned about this in April.

Over the past two years, the ECB’s bond-buying programs have kept countries in the eurozone’s periphery, including most notably Italy, afloat. In particular, under its €1.85 trillion ($2 trillion) pandemic emergency purchase program, the ECB has bought most of these countries’ government-debt issuance. That has saved them from having to face the test of the markets.

And he said the same thing in March.

The ECB engaged in a large-scale bond-buying program over the past two years…, as did the U.S. Federal Reserve. The size of the ECB’s balance sheet increased by a staggering four trillion euros (equivalent to $4.4 billion), including €1.85 trillion under its Pandemic Emergency Purchasing Program. …The ECB’s massive bond buying activity has been successful in keeping countries in the eurozone’s periphery afloat despite the marked deterioration in their public finances in the wake of the pandemic.

Let’s conclude with several observations.

So if politicians won’t adopt good policies and their bad policies won’t work, what’s going to happen?

At some point, national governments will probably default.

That’s an unpleasant outcome, but at least it will stop the bleeding.

Unlike bailouts and easy money, which exacerbate the underlying problems.

P.S. For what it is worth, I do not think a common currency is necessarily a bad idea. That being said, I wonder if the euro can survive Europe’s awful politicians.

P.P.S. While I think Mr. Buiter’s article in Project Syndicate was very reasonable, I’ve had good reason to criticize some of his past analysis.

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More than 10 years ago, I narrated this video showing how the United States benefited from spending restraint under both Ronald Reagan and Bill Clinton. Since today’s topic is Clinton’s policies, pay attention starting about 4:00.

If you don’t have time to watch the video, I hope you will at least pay attention to this chart, which appeared near the end (about 6:00).

It shows what happened to domestic spending (entitlements plus discretionary) as a share of economic output during the Reagan years, the Clinton years, and the 2001-2010 period under Bush and Obama.

Reagan was the runaway champion, but it’s worth noting that the burden of domestic spending also declined during the Clinton years.

But it wasn’t just that Bill Clinton was good on spending. Good things happened in the 1990s in other areas as well, especially trade.

In a column for the Wall Street Journal, Bill Galston defends Clinton’s “neoliberal” record.

… critics often mark the Clinton administration as the moment when establishment Democrats capitulated to the ideology of the unfettered market. Poor and working-class Americans paid the price, they charge… The historical record tells a different story. …During eight years of the Clinton administration, annual real growth in gross domestic product averaged a robust 3.8% while inflation was restrained, averaging 2.6%. Payrolls increased by 22.9 million… Unemployment fell from 7.3% in January 1993 to…4.2% at the end of President Clinton’s second term. Adjusted for inflation, real median household income rose by 13.9%. …During the administration, federal spending as a share of GDP fell from 21.2% to 17.5%… What about the poor? The poverty rate declined during the Clinton administration by nearly one quarter, from 15.1% to 11.3%, near its historic low. And it declined even faster among minorities—by 8.1 percentage points for Hispanics and 10.9 points for blacks. …In sum, during the heyday of neoliberalism, Americans weren’t forced to choose between high growth and low inflation or between aggregate growth and fairness for the poor, working class and minorities.

Why did we get these good results?

Because overall economic freedom increased during the Clinton years. And when the burden of government is reduced, that creates more opportunity for upward advancement for everyone in society.

By the way, I’m not arguing in today’s column that Bill Clinton deserves all the credit. There’s little doubt that the Republican landslide in 1994 played a big role in many of the subsequent pro-market reforms (such as welfare reform, the 1997 tax cut, etc).

But I will say that Bill Clinton at least was amenable to pro-market compromises, which is not what we saw during the Obama years (and I doubt we will see a shift to the center from Biden if Republicans win Congress this November).

P.S. Republicans were able to impose some fiscal discipline on Obama after the Tea Party landslide of 2010

P.P.S. For those who want more details, click here for a detailed examination of the fiscal policy performance of various modern presidents.

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As part of my (reality-based) opposition to a value-added tax, I testified to the Ways & Means Committee back in 2011.

My primary argument against the VAT is that it would enable a bigger burden of government spending.

I frequently share this chart, for instance, that shows that the nations in Western Europe were quite similar to the United States back in the 1960s, with government budgets that consumed about 30 percent of economic output.

That was before they enacted VATs.

But once European politicians got that new source of revenue, the spending burden diverged, with the welfare state becoming a much larger burden in Western Europe than in the United States.

In other words, the VAT was a money machine for big government.

That argument is just as accurate today as it was back in 2011.

For today’s column, however, I want to focus on what I said in the last minute of my testimony (beginning about 4:00).

I pointed out that VAT supporters are wrong when they claim that adoption of this new tax would enable reductions in the income tax.

And if you peruse my written testimony, you’ll see that I included several charts showing how tax burdens changed between 1965 and 2008. In every case, I showed that European politicians actually increased the burden of income taxes after they enacted their VATs.

Is that still true?

Of course.

Here’s an updated version of the chart showing that the overall tax burden dramatically increased after VATs were imposed.

In the United States, by contrast, the overall tax burden only increased during this time period from 23.6 percent of GDP to 25 percent of GDP.

Still bad news, but nowhere near as bad as Western Europe, where the overall tax burden jumped by more than 13 percentage points.

Now let’s peruse the updated version of the chart showing what happened to taxes on income and profits.

As you can see, European governments definitely did not use VAT revenues to lower other taxes.

In the United States, by contrast, the tax burden on income and profits only increased during this time period from 11.3 percent of GDP to 11.6 percent of GDP.

Still bad news, but nowhere near as bad as Western Europe, where the tax burden on income and profits jumped by nearly 5 percentage points.

Now let’s peruse the updated version of the chart showing what happened to taxes on corporations (this chart is especially important because there are very naive people in the business community who think that they can avoid higher taxes on their companies if they surrender to a VAT).

As you can see, governments in Europe have been grabbing more money from corporations since VATs were imposed.

In the United States, by contrast, the tax burden on corporations actually decreased during this time period from 3.9 percent of GDP to 1.3 percent of GDP.

By every possible measure, the value-added tax is a big mistake (as even the IMF inadvertently shows).

Unless, of course, politicians first get rid of the income tax – including repealing the 16th Amendment and replacing it with an ironclad prohibition against any future income tax.

But that’s about as likely as me playing the outfield for the New York Yankees in this year’s World Series.

P.S. I mentioned at the very end of my testimony that we did not have clear evidence from other nations that subsequently adopted VATs. In the case of Japan, we now do have data showing how the VAT is financing bigger government.

P.P.S. Some VAT advocates actually claim the levy is good for growth. That’s a nonsensical claim. VATs drive a wedge between pre-tax income and post-tax consumption. What they really mean to say is that VATs don’t do as much damage, on a per-dollar-raised basis, as conventional income taxes (with punitive rates and double taxation).

P.P.P.S. You can enjoy some good anti-VAT cartoons herehere, and here.

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Since I’m a big fan of spending caps, I’m very happy to be in Zurich as part of the Free Market Road Show.

Switzerland’s spending cap (called “the debt brake“) is probably the best system in the world. It does have an escape clause for emergencies, so the government did increase spending during the pandemic.

But as this chart illustrates, Swiss lawmakers were much more responsible than their American counterparts. Over the past few years, IMF data shows that the national debt (as a share of GDP) increased by about 3.4 percent in Switzerland compared to 12.8 percent in the United States.

Even more amazing, Switzerland is now quickly restoring spending restraint.

Indeed, as reported by Le News, Switzerland already is going to be back to fiscal balance by the end of this year.

The Covid-19 pandemic plunged Switzerland’s budget into the red in 2020 and 2021. The federal government expects to return to normality with a balanced budget in 2022. …In 2022, the federal government expects to spend CHF 0.6 billion less than it collects. …the government is aiming for an ordinary operating surplus of CHF 1 billion. Past budget surpluses may also be applied to the accumulated deficit to bring the accounting into line with the debt brake rules.

If you want to know why there such quick progress, one of the big banks, Credit Suisse, recently analyzed the nation’s fiscal status and explained how the debt brake requires future spending restraint to compensate for the emergency spending during the pandemic.

As part of the pandemic response, the Federal Council approved fiscal measures of over 70 billion Swiss francs… As a result of the debt brake, this deficit should be offset in the immediate following years. …the Federal Council announced that it would classify the majority of the fiscal measures as extraordinary spending. Under the law, this can be paid back more slowly – specifically, within six years. Additionally, with the escape clause, the Federal Assembly has the option of extending the repayment deadline even further in special cases.

Another international bank, ING, also issued a report about the country’s spending cap and actually expressed concern that the level of government debt is too low.

The main cause of Switzerland’s low indebtedness is a mechanism introduced by the Confederation to stabilise the federal debt: “the debt brake”. Enabled in the Constitution since 2003, with a population approval rate of 85% in 2001, the rule has strong legitimacy and many cantons have introduced similar models. The principle: public spending should not exceed revenues over a full economic cycle. The formula allows for a deficit during a recession, offset by surpluses during an expansion period. …the implementation of this system has resulted in a significant debt reduction, rather than just stabilisation. This is because the rule is applied asymmetrically and expenditure tends to be overestimated each year, while revenue is systematically underestimated. …every budget surplus is greeted with a self-congratulatory round of applause on the sound management of public finances.

Here’s a chart from the article showing on government debt began to decline once the spending cap was implemented. By contrast, debt in other industrialized nations has continued to climb.

Keep in mind, by the way, that this chart was before the pandemic.

Given Switzerland’s more prudent approach, the gap between the two lines is even higher today.

P.S. If you want a more in-depth discussion of how Switzerland’s de facto spending cap operates, there’s a very good article in the Swiss Journal of Economics and Statistics. Authored by Tobias Beljean and Alain Geier, the 2013 study has a lot of useful information.

…the success is not just visible in figures – it is also evident in the way that the budget process has changed. The debt brake has turned the budget process upside down. Previously, spending intentions were submitted by individual government offices, and it was very difficult to make changes to a large number of budget items during the short interval between the first consolidated budget plan (largely influenced by government offices) between April and the final budget proposal in June. More problematic still, the finance minister faced the potential opposition of six “spending” ministers, who were each looking for support to get their policy proposals into the budget. The budget process is now essentially a top-down process, in which targets are set at the beginning of the process and then broken down to individual ministries and offices. …One key aspect is the fact that the debt brake sets a clear target for the deficit and expenditure. …the (risk-averse) administration tends to plan its spending cautiously so as to not exceed the limit of the credit item. Hence, actual outcomes are mostly below spending limits and are not compensated for by occasional overspending and supplementary credits. The consequence for overall spending is a systematic undershooting of expenditure with respect to the budget. … This “revenue brake” and the “debt brake” taken together now result in a framework similar to an expenditure rule, as it is rather difficult to meet the requirements of the debt brake through revenue-side measures – at least in the short term.

P.P.S. You can also read a couple of good summaries (here and here) from the Swiss government’s Federal Finance Administration.

P.P.P.S. Hong Kong also has a spending cap, and Colorado’s Taxpayer Bill of Rights is a spending cap as well. You can click here to watch informative video presentations about the various spending caps.

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During the debate about the Trump tax plan, proponents made three main arguments in favor of reducing the federal corporate tax rate from 35 percent to 21 percent.

  1. A lower rate would be good for workers, consumers, and shareholders.
  2. A lower rate would boost American competitiveness.
  3. A lower rate would produce some revenue feedback for the IRS.

The last item involves the “Laffer Curve,” which is a graphical representation of the non-linear relationship between tax rates and tax revenue.

Put in simple terms, entrepreneurs, investors, and business owners have more incentive to earn money when tax rates are modest.

High tax rates, by contrast, discourage productive behavior while also giving people a bigger incentive to find loopholes and other ways of avoiding tax.

This does not mean that lower tax rates produce more revenue, though that sometimes happens.

The main takeaway is the most modest observation that lower tax rates will lead to more taxable income, which means some revenue feedback.

In other words, tax cuts don’t lose as much revenue as predicted by simplistic models (and tax increases don’t generate as much revenue as predicted).

I’ve shared many, many realworld examples of this phenomenon.

And here’s another. Look at how corporate tax revenues in the United States are increasing at a faster rate than projected.

The chart comes from Chris Edwards, and he helpfully explains what has happened.

The revenue surge came as a surprise to government economists. The chart…compares the new Office of Management and Budget March 2022 baseline projections to prior baseline projections from the OMB in May 2021 and the Congressional Budget Office in July 2021. …congressional estimators figured that the government would lose an average $76 billion a year the first four years… Corporate tax revenues were down from 2018 to 2020, but then soared in 2021. Revenues in 2021 of $372 billion (with a 21 percent tax rate) are 25 percent higher than revenues in 2017 of $297 billion (with a 35 percent tax rate). …we’re learning that a lower corporate tax rate is consistent with strong corporate tax revenues. …lower rates…broaden bases automatically through reduced tax avoidance and higher economic activity. Other nations have learned the same lesson. Keeping the corporate tax rate low is a winner for businesses and workers, but it can also be a winner for government budgets.

The Wall Street Journal has a new editorial on this topic. Here are some relevant excerpts.

…the 2017 tax reform that cut corporate tax rates…has been a winner for the economy and federal tax coffers. …Corporate revenue was supposed to fall to historic lows as a share of the economy. Big business supposedly got a windfall and government was robbed. It hasn’t turned out that way. …the big news now is that more corporate tax revenue is flowing into the Treasury at record levels even with the lower rate. …In June 2017, before tax reform passed, CBO predicted corporate tax revenue of $383 billion in fiscal 2021. But in April 2018, after reform passed, CBO lowered its estimate to $327 billion.

So what happened in the real world?

Actual corporate income tax revenue in 2021 was $372 billion—nearly as much at a 21% rate as CBO expected at the 35% rate that was among the highest in the world. Fiscal 2022 is turning out to be even better for the Treasury. Corporate tax revenue for the first six months was up 22% from a year earlier to $127 billion. …What accounts for this windfall for Uncle Sam…? …the Occam’s razor policy answer is that corporate tax reform worked as its sponsors predicted: Lowering the rates while broadening the base by eliminating loopholes created incentives for more efficient investment decisions that paid off for shareholders, workers and the government.

Notice, by the way, that corporate tax revenues have increased faster than projected in both the 2017 forecast and the 2021 forecast.

All of which shows that I may have been insufficiently optimistic when I wrote about this issue last year.

P.S. The goal of tax policy (either in general or when looking at business taxation) is not to maximize revenue for politicians, but rather to maximize prosperity for people. Indeed, if better tax policy leads to a lot of revenue feedback, that’s an argument for further reductions in tax rates.

P.P.S. Both the IMF and OECD have research showing that lower corporate tax rates do not necessarily lead to lower corporate tax revenues.

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Whether they are based on 10 questions or 144 questions, I can’t resist taking quizzes that supposedly identify one’s political or economic philosophy.

The good news, according to various quizzes, is that I’m 92 percent minarchist and only 6 percent communist.

Today, we are going to take a quiz prepared by the Committee for a Responsible Federal Budget. It is designed to determine fiscal priorities. You can click here to answer the 21 questions.

As is often the case with online tests and quizzes, I’m frustrated by the sloppy wording of certain questions.

Question #8 asks if we should spend more or less on interest. I answered “less,” of course, but the only way to make that happen (other than default) is to change policies so that the government borrows less money.

I imagine 99 percent of people who take the quiz will also answer “less,” but those results mean nothing without follow-up questions about whether they want less spending or higher taxes.*

Question #17 asks if we should spend more or less on seniors or children. Like any sensible libertarian I want to spend less on both categories, so how do I answer?

Question #19 asks if we should spend more or less on seniors or welfare. Once again, the correct answer is to spend less on both categories, so there’s no logical way to respond.

For what it’s worth, I opted to spend less on both children and welfare for the simple reason that – in my libertarian fantasy world – it would take longer to implement reforms to replace Medicare and Social Security.

Given the inadequate wording of the quiz, I’m not surprised I got these strange results.

Notwithstanding what the top panels says, I don’t want to spend more on so-called public investment, regardless of whether that means infrastructure or research and development.

With regards to the bottom panel, I do want to spend less on children. Or, to be more accurate, I want the government to spend less on children so that families will have greater ability to spend more on children.

I’ll close by stating that I much prefer the CRFB quiz I took last year. The questions were better designed and it gave me very accurate results (i.e., I’m a “minimalist” who is “in favor of smaller government”).

*On paper, tax increases reduce debt and therefore reduce interest costs. In the real world, higher taxes lead to weaker economic performance and a larger burden of spending, thus producing more debt and higher interest costs.

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I wrote a few days ago about Biden’s plan to impose punitive double taxation on dividends.

But that’s not an outlier in his budget. As you can see from this table from the Tax Foundation, he wants to violate the principles of sensible fiscal policy by having high tax rates on all types of income.

What’s especially disappointing is that he wants tax rates in the United States to be much higher than in other developed nations.

At the risk of understatement, that’s not a recipe for jobs and investment.

The Wall Street Journal editorialized about Biden’s taxaholic preferences.

Mr. Biden…is proposing $2.5 trillion in new taxes that would give the U.S. the highest or near-highest tax rates in the developed world. …The biggest jump is in taxes on capital gains, as the top combined rate would rise to 48.9% from 29.2% today. That’s a 67% increase in the government’s take on long-term capital investments. The new top rate would be more than 2.5 times the OECD average of 18.9%. Nothing like reducing the U.S. return on capital to get people to invest elsewhere. Mr. Biden would also lift the top combined tax rate on corporate income to 32.3% from 25.8%. That would leap over Australia and Germany, which have top rates of 30% and 29.9% respectively, and it would crush the 22.8% OECD average. …Mr. Biden would also put the U.S. at the top of the noncompetitive list for personal income taxes, with multiple increases that would put the combined American rate at 57.3%. Compare that with 42.9% today and an average of 42.6% across the OECD.

The WSJ‘s editorial contained this chart.

The United States would be on top for corporate tax rates if Biden’s plan is adopted (which actually means on the bottom for competitiveness).

The bottom line is that Biden wants the U.S. to have the highest corporate rate, highest double taxation of dividends, and highest double taxation of capital gains.

To reiterate, not a smart way of trying to get more jobs and investment.

P.S. The “good news” is that the United States would not be at the absolute bottom for international tax competitiveness.

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