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Posts Tagged ‘Governemnt Spending’

I’m in Hong Kong for series of meeting and briefings on various economic and policy issues.

As you can imagine, I’m a huge fan of the jurisdiction’s simple 15 percent flat tax. It’s basically about as close to a pure flat tax as anyplace in the world. There is zero double taxation of income that is saved and invested.

That’s not an exaggeration. You don’t get double taxed on the interest you earn on your bank balances and other financial accounts. There’s no capital gains tax. There’s no death tax. And there’s no double taxation of dividends.

There are only a few deviations from a pure flat tax that even merit a mention. First, taxpayers with modest amounts of income don’t have to use the flat tax system. Instead, they can opt for a “progressive” tax system that has a top rate of 17 percent, but also has tax rates of 2 percent and 7 percent, and 12 percent.

Imagine, taxpayers getting to choose the system that works best for them, instead of the government forcing them into the system that requires the highest payment!

The other deviations are that businesses are not always allowed full expensing of business investment, and there also are a handful of deductions.

All things considered, though, Hong Kong gets almost everything right on tax policy, whereas the United States gets a majority of things wrong.

Oh, and I should mention that there are no payroll taxes in Hong Kong. Nor is there a value-added tax.

That’s all very impressive, but let’s actually focus on something that may be even more remarkable about Hong Kong.

It currently has a modest-sized government, with spending consuming less than 20 percent of economic output. That’s not as good as the United States 100 years ago, but it’s far better than where America is today.

That being said, Hong Kong has some major challenges. I’ve explained before that demographic changes will put pressure on fiscal policy in America, but demographic change is far more profound in Hong Kong.

As you can see from this data, it has the seventh-highest level of life expectancy in the world.

That’s good news, of course, but it does mean a lot of fiscal pressure, even for a jurisdiction that is justly famous for its very small welfare state.

But then you have to consider the fact that Hong Kong also has the fourth-lowest birthrate in the entire world.

In other words, Hong Kong faces a perfect storm of demographics. More and more non-working elderly over time, combined with fewer and fewer taxpayers to pull the wagon.

Given these unfriendly numbers, the Hong Kong government put together a working group to look at long-run fiscal issues.

In its recent report, the group presented a fiscal forecast that shows how the burden of government spending will slowly climb to nearly 24 percent of GDP over the next 25 years.

Here’s a chart showing actual data starting in the late 1990s and then projections until 2042.

To those of us from North America and Western Europe, where the overall burden of government spending, on average, consumes more than 40 percent of economic output, it seems like Hong Kong has a trivial problem.

But it’s still a problem and something has to change. Hong Kong could finance a bigger public sector by dipping into its large reserves (currently the jurisdiction has saved enough money to finance about two years of government spending) or by increasing the tax burden.

But hopefully Hong Kong will abide by Article 107 of its Basic Law (its constitution) and limit government spending so that it doesn’t grow faster than the private economy.

And there are some positive signs.

About 15 years ago, Hong Kong set up a system of private retirement accounts in order to create a self-funded source of retirement income.

Based on a recent government report on retirement income, here are some key features of this Mandatory Provident Fund (MPF) system.

The MPF System is an employment-based, privately-managed mandatory defined contribution system. …Employers are required under the Mandatory Provident Fund Schemes Ordinance (Cap. 485) to arrange for their employees aged 18 or above but under 65 to join… The MPF System has been implemented for 15 years only. …about 2.55 million employees are enrolled in MPF schemes, representing 100% of the employees required by law to join the schemes. This is a very high rate by international standards. In addition, another 210 000 self-employed persons are also scheme members. …An employer and an employee are each required to contribute 5% of the relevant employee’s income… As at end October 2015, MPF assets had increased to $594.2 billion, of which about $123.1 billion were investment returns.

Here’s a chart from the report, showing the cumulative growth of assets, based on both contributions and investment returns.

Keep in mind, though, that it takes 7.8 Hong Kong dollars to equal 1 U.S. dollar, so $594.2 billion is not nearly as large as it sounds.

In part, this is because the system isn’t yet mature. Workers have only been making contributions from 15 years, while a working lifetime is 40-45 years.

But there also are concerns that the level of mandatory saving is insufficient. Here’s additional language from the report, which cites the private retirement systems in Australia and Denmark.

There are views that the contribution rate or the maximum relevant income level should be raised to strengthen the retirement protection function of the MPF System. Take the privately-managed mandatory occupational contributory pension plans in Denmark and Australia as examples. In Denmark, employers and employees generally contribute a total of 9% to 17%. In Australia, only employers make contributions and the contribution rate will be raised progressively from 9% in 2013 to the present 9.5% and further to 12% in 2025.

I’m personally agnostic on the precise level of mandatory savings. My goal is simply to shrink tax-and-transfer entitlement programs, particularly before demographic changes lead to a larger burden of government spending.

And since I have great fondness for Hong Kong (how can you not get a thrill up your leg about a jurisdiction that routinely gets the highest score in Economic Freedom of the World?), I want it to remain a beacon for advocates of economic liberty.

P.S. Lest anyone think I’m being too fawning, Hong Kong has several policies that are misguided. Public housing is pervasive, there’s government-run healthcare, and one peculiar legacy of British rule is that only one piece of land is privately owned. Fixing these warts would make Hong Kong even more vibrant.

P.P.S. Another quirky feature of Hong Kong policy is that currency is issued by private banks. If you pull a $20 bill from your wallet, you’ll see that it was printed by HSBC, Standard Chartered, or Bank of China. Unfortunately, this isn’t because Hong Kong has a market-driven system of competing currencies. But it does have a currency board, which – by standards of government-controlled monetary systems – is one of the least-worst options. Of course, that means Hong Kong’s money is only as good as the currency to which it’s linked. And since the Hong Kong dollar is pegged to the U.S. dollar, that might be a cause for long-run concern.

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Remember the big debt limit fight of 2013? The political establishment at the time went overboard with hysterical rhetoric about potential instability in financial markets.

They warned that a failure to increase the federal government’s borrowing authority would mean default to bondholders even though the Treasury Department was collecting about 10 times as much revenue as would be needed to pay interest on the debt.

And these warnings had an effect. Congress eventually acquiesced.

I thought it was a worthwhile fight, but not everyone agrees.

The Government Accountability Office (GAO), for instance, recently released a report about that experience and they suggest that there was a negative impact on markets.

During the 2013 debt limit impasse, investors reported taking the unprecedented action of systematically avoiding certain Treasury securities—those that matured around the dates when the Department of the Treasury (Treasury) projected it would exhaust the extraordinary measures that it uses to manage federal debt when it is at the limit. …Investors told GAO that they are now prepared to take similar steps to systematically avoid certain Treasury securities during future debt limit impasses. …industry groups emphasized that even a temporary delay in payment could undermine confidence in the full faith and credit of the United States and therefore cause significant damage to markets for Treasury securities and other assets.

The GAO even produced estimates showing that the debt limit fight resulted in a slight increase in borrowing costs.

GAO’s analysis indicates that the additional borrowing costs that Treasury incurred rose rapidly in the final weeks and days leading up to the October 2013 deadline when Treasury projected it would exhaust its extraordinary measures. GAO estimated the total increased borrowing costs incurred through September 30, 2014, on securities issued by Treasury during the 2013 debt limit impasse. These estimates ranged from roughly $38 million to more than $70 million, depending on the specifications used.

I confess that these results don’t make sense since it is inconceivable to me that Treasury wouldn’t fully compensate bondholders if there was any sort of temporary default.

But GAO included some persuasive evidence that investors didn’t have total trust in the government. Here are a couple of charts looking at interest rates.

Both of them show an uptick in rates as we got closer to the date when the Treasury Department said it would run out of options.

Given this data, the GAO argues that it would be best to eviscerate the debt limit.

The bureaucrats propose three options, all of which would have the effect of enabling automatic or near-automatic increases in the federal government’s borrowing authority.

GAO identified three potential approaches to delegating borrowing authority. …Option 1: Link Action on the Debt Limit to the Budget Resolution …legislation raising the debt limit to the level envisioned in the Congressional Budget Resolution would be…deemed to have passed… Option 2: Provide the Administration with the Authority to Increase the Debt Limit, Subject to a Congressional Motion of Disapproval… Option 3: Delegating Broad Authority to the Administration to Borrow…such sums as necessary to fund implementation of the laws duly enacted by Congress and the President.

So is GAO right? Should we give Washington a credit card with no limits?

I don’t think so, but I’m obviously not very persuasive because I actually had a chance to share my views with GAO as they prepared the report.

Here are the details about GAO’s process for getting feedback from outside sources.

…we hosted a private Web forum where selected experts participated in an interactive discussion on the various policy proposals and commented on the technical feasibility and merits of each option. We selected experts to invite to the forum based on their experience with budget and debt issues in various capacities (government officials, former congressional staff, and policy researchers), as well as on their knowledge of the debt limit, as demonstrated through published articles and congressional testimony since 2011. …we received comments from 17 of the experts invited to the forum. We determined that the 17 participants represented the full range of political perspectives. We analyzed the results of the forum to identify key factors that policymakers should consider when evaluating different policy options.

Given the ground rules of this exercise, it wouldn’t be appropriate for me to share details of that interactive discussion.

But I will share some of my 2013 public testimony to the Joint Economic Committee.

Here’s some of what I told lawmakers.

I explained that Greece is now suffering through a very deep recession, with record unemployment and harsh economic conditions. I asked the Committee a rhetorical question: Wouldn’t it have been preferable if there was some sort of mechanism, say, 15 years ago that would have enabled some lawmakers to throw sand in the gears so that the government couldn’t issue any more debt? Yes, there would have been some budgetary turmoil at the time, but it would have been trivial compared to the misery the Greek people currently are enduring. I closed by drawing an analogy to the situation in Washington. We know we’re on an unsustainable path. Do we want to wait until we hit a crisis before we address the over-spending crisis? Or do we want to take prudent and modest steps today – such as genuine entitlement reform and spending caps – to ensure prosperity and long-run growth.

In other words, my argument is simply that it’s good to have debt limit fights because they create a periodic opportunity to force reforms that might avert far greater budgetary turmoil in the future.

Indeed, one of the few recent victories for fiscal responsibility was the 2011 Budget Control Act (BCA), which only was implemented because of a fight that year over the debt limit. At the time, the establishment was screaming and yelling about risky brinksmanship.

But the net result is that the BCA ultimately resulted in the sequester, which was a huge victory that contributed to much better fiscal numbers between 2009-2014.

By the way, I’m not the only one to make this argument. The case for short-term fighting today to avoid fiscal crisis in the future was advanced in greater detail by a Wall Street expert back in 2011.

P.P.S. You can enjoy some good debt limit cartoons by clicking here and here.

 

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Since I’ve written several times that the United States will face a fiscal crisis if entitlement programs aren’t reformed, you won’t be surprised to see that I repeat those points in this CNBC debate.

But I’m not happy with my performance.

Not because my leftist opponent grabbed more air time (mostly because the host started challenging him, which also happens periodically when I’m on Kudlow’s show), but because he gave me a giant opening to completely destroy his arguments and I failed to seize the opportunity.

He kept arguing that America is more dynamic and innovative than Europe, which generally is true, but then he argued that we should copy Europe’s fiscal policy by increasing the burden of government spending.

I think the points I made to wrap up the debate were fine, but I would be much happier with my performance if I had pointed out this huge hole in his position.

As shown in this amusing and clever poster, you don’t solve the problems created by government with more government.

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