Posts Tagged ‘IMF’

Since there’s a big debate about whether there should be tax cuts and tax reform in the United States, let’s see what we can learn from abroad.

And let’s focus specifically on whether changes in tax policy actually produce “revenue feedback” because of the Laffer Curve. In other words, if tax rates change, does that incentive people to alter how much they work, save, and invest, thus changing the amount of taxable income they earn and report?

I’ve written about how the Laffer Curve has impacted revenue in nations such as France, Russia, Ireland, Canada, and the United Kingdom.

Now let’s go to Africa. In a column for BizNis Africa, Kyle Mandy of PwC explicitly warns that South Africa is at the wrong spot on the Laffer Curve.

At the time of the 2017 Budget in February, a number of commentators, including myself, warned National Treasury and Parliament that the tax increases announced in the Budget, particularly on personal income tax, would likely push tax revenues very close to the top of the Laffer curve, i.e. the point at which tax revenues are maximised and beyond which tax rate increases will actually result in a decrease in tax revenues.

Before continuing with the article, I can’t resist making an important point. The author understands that it is a bad idea to be on the downward-sloping part of the Laffer Curve. As he points out, that’s when tax rates are so punitive that “tax rate increases will actually result in a decrease in tax revenues.”

That’s correct, of course, but it’s almost as important to understand that it’s also a very bad idea to be at the “top of the Laffer Curve.” As noted in a study by economists from the Federal Reserve and the University of Chicago, that’s the point where economic damage is so great that a dollar of tax revenue can be associated with $20 of damage to the private sector.

Now that I got that off my chest, let’s look at some of the details in the article about South Africa.

The evidence…suggests that, in the current environment, South Africa has maximised the tax revenues that it can extract from its citizens and has possibly even gone past that point and is now on the downward slope of the curve. Why do I say this? The last few years have seen significant tax increases… These tax increases saw the main budget tax: GDP ratio increase from 24.5% in 2012/13 to 26% in 2015/16, primarily led by increases in personal income tax. However, since then the tax:GDP ratio has stalled at 26% in both 2016/17 and in the revised forecast for 2017/18. It is not unreasonable to expect that the tax:GDP ratio for 2017/18 may fall below 26% in the final outcome. The stalling of the tax:GDP ratio comes despite significant tax increases in each of 2016/17 and 2017/18 which were expected to deliver ZAR18 billion and ZAR28 billion of additional tax revenues respectively.

Once again, I can’t resist the temptation to interject. That final sentence should be changed to read “the stalling of the tax:GDP ratio comes because of significant tax increases.”

Mr. Mandy concludes his column by warning that the current approach is leading to bad results and noting that further tax hikes would make a bad situation even worse.

…the South African Revenue Service has acknowledged that it has seen a decline in levels of compliance. …So what does all of this mean for tax policy and fiscal policy generally? Simply put, National Treasury have been placed in an invidious position. Increasing taxes further in the current environment could be self-defeating and result in a decline in the tax:GDP ratio. This risk is particularly prevalent insofar as further tax increases in the form of personal income tax are concerned. Increasing the corporate tax rate would further dent investor confidence and economic growth.

The good news is that even South Africa’s government seems to realize there is a problem.

Here are some excerpts from a recent story.

Finance minister Malusi Gigaba has received President Jacob Zuma’s stamp of approval for an inquiry into tax administration and governance at the South African Revenue Service (Sars). According to the Medium-Term Budget Policy Statement (MTBPS), tax revenue is expected to fall almost R51 billion short of earlier estimates in the current fiscal year. …The probe also comes amid warnings that further tax hikes could be futile and may even result in a decline in the country’s tax-to-GDP ratio. …National Treasury has introduced various tax hikes over the past few years. The main budget tax-to-GDP ratio increased from 24.5% in 2012/13 to 26% in 2015/16, mainly as a result of higher effective personal income tax rates. But the tax-to-GDP ratio has subsequently stalled at 26% in 2016/17 and in the latest 2017/18 forecast and it is not inconceivable that the final outcome for the current fiscal year could fall below 26%… Gigaba seems to be aware of the dangers of additional tax hikes and warned in his MTBPS that it could be “counterproductive”.

I’m glad that there’s a recognition that higher taxes would backfire, but that’s not going to fix any problems.

The pressure for higher taxes will be relentless unless the South African government begins to control spending. The government should adopt a constitutional spending cap, which would alleviate budget pressures and create some “fiscal space” for lower tax rates.

But I’m not confident that will happen, particularly if the International Monetary Fund gets involved. Desmond Lachman, formerly of the IMF and now with the American Enterprise Institute, writes that the country is in trouble.

South Africa is in trouble. Per capita income has been in decline for several years and its economy is in recession for the second time in eight years. Unemployment remains at over 27%. Meanwhile, the rand is floundering on the foreign exchange market… In view of the favourable global economic environment, the country’s predicament is even more troubling. Interest rates have rarely been lower and capital flows to emerging markets have seldom been stronger. …If South Africa’s economy is performing poorly in this environment, it will probably struggle even more when central banks start to normalise their interest rate policies and when the global economic environment becomes more challenging.

He has the right description of the problem, but I’m worried about his proposed solution.

IMF assistance can hasten restoration of confidence. …An IMF programme would not be popular politically within South Africa but the government does not appear to have any realistic alternative.

Simply stated, the IMF has a very bad track record of pushing for higher taxes.

That doesn’t necessarily mean its bureaucrats will push for bad policy in South Africa, but past performance sometimes is a good predictor of future behavior.

For what it’s worth, the IMF is fully aware that the burden of government has been increasing. Here’s a blurb from the most recent Article IV report on South Africa.

During the past few years, the share of both revenues and expenditures continued its rising trend. The size of general government in South Africa is one of the highest among international peers at a similar level of development. Primary expenditures rose by 1.5 percentage points of GDP between 2012/13 and 2015/16, owing primarily to public enterprise-related transfers (0.8 percent of GDP, including a 0.6 percent of GDP equity injection for Eskom in 2015/2016) as well as relatively generous wage agreements combined with an increase in consolidated government employment (0.3 percent of GDP). In recent years, including the 2017 budget, higher personal income taxation has been the main tax  policy instrument to collect revenue combined with higher excise rates.

And here’s a section of the data table showing the expanding burden of both taxes and spending.

Unfortunately, the IMF never says that this growing fiscal burden is a problem. Instead, the focus is solely on the fact that spending is higher than revenue. In other words, the IMF mistakenly fixates on the symptom of red ink instead of addressing the real problem of excessive government.

So if the bureaucrats do an intervention, it almost certainly will result in bailout money for South Africa’s politicians in exchange for a “balanced” package of spending cuts and tax increases.

But the spending cuts likely will be either phony (reductions in planned increases, just like they do it in Washington) or will quickly evaporate. But the higher taxes will be real and permanent. Just like in most other nations where the IMF has intervened. Lather, rinse, repeat.

Speaking of misguided international bureaucracies, the Organization for Economic Cooperation and Development already has been pushing bad policy on South Africa. The bureaucrats even brag about their impact, as you can see from this Table in the OECD’s recent Economic Survey on South Africa.

The OECD is happy that income tax rates have increased and that there’s more double taxation on dividends, but the bureaucrats are still hoping for a new energy tax, expansion of the value-added tax, and more property taxes.

They must really hate the people of South Africa. No wonder the OECD is known as the world’s worst international bureaucracy.

I’ll close by noting that the country’s problems are not limited to fiscal policy. The country is only ranked #95 by Economic Freedom of the World. And it was as high as #46 in 2000.

Instead of pushing for higher taxes, that’s the problem the OECD and IMF should be trying to fix. But given their track record, that’s about as likely as me playing centerfield next year for the Yankees.

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I’m not a fan of the International Monetary Fund. Like many other international bureaucracies, it pushes a statist agenda.

The IMF’s support for bad policy gets me so agitated that I’ve sometimes referred to it as the “dumpster fire” or “Dr. Kevorkian” of the global economy.

But, in a perverse way, I admire the IMF’s determination to advance its ideological mission. The bureaucrats will push for tax hikes using any possible rationale.

Even if it means promoting really strange theories like the one I just read in the bureaucracy’s most recent Fiscal Monitor.

Welfare-based measures can help policymakers when they face decisions that entail important trade-offs between equity and efficiency. …One way to quantify social welfare in monetary units is to use the concept of equally distributed equivalent income.

And what exactly is “equally distributed equivalent income”?

It’s a theory that says big reductions in national prosperity are good if the net result is that people are more equal. I’m not joking. Here’s more about the theory.

…a welfare-based measure of inequality…with 1 being complete inequality and 0 being complete equality. A value of, say, 0.3 means that if incomes were equally distributed, then society would need only 70 percent (1 − 0.3) of the present national income to achieve the same level of welfare it currently enjoys (in which incomes are not equally distributed). The level of income per person that if equally distributed would enable the society to reach the same level of welfare as the existing distribution is termed equally distributed equivalent income (EDEI).

Set aside the jargon and focus on the radical implications. The IMF is basically stating that “the same level of welfare” can be achieved with “only 70 percent of the present national income” if government impose enough coercive redistribution.

In other words, Margaret Thatcher wasn’t exaggerating when she mocked the left for being willing to sacrifice national well-being and hurt the poor so long as those with higher incomes were subjected to even greater levels of harm.

Not surprisingly, the IMF uses its bizarre theory to justify more class-warfare taxation.

Figure 1.16 shows how the optimal top marginal income tax rate would change as the social welfare weight on high-income individuals increases. Assuming a welfare weight of zero for the very rich, the optimal marginal income tax rate can be calculated as 44 percent, based on an average income tax elasticity of 0.4… Therefore, there would appear to be scope for increasing the progressivity of income taxation…for countries wishing to enhance income redistribution.

But not just higher statutory tax rates.

The bureaucrats also want more double taxation of income that is saved and invested. And wealth taxation as well.

Taxes on capital income play an equally important role in shaping the progressivity of a tax system. …An alternative, or complement, to capital income taxation for economies seeking more progressive taxation is to tax wealth.

The article even introduces a new measure called “progressive tax capacity,” which politicians doubtlessly will interpret as a floor rather than a ceiling.

Reminds me of the World Bank’s “report card” which gave better grades to nations with “high effort” tax systems.

Though I guess I should look at the bright side. It’s good news that the IMF estimates that the “optimal” tax rate is 44 percent rather than 100 percent (as the Congressional Budget Office implies). And I suppose I also should be happy that “progressive tax capacity” doesn’t justify a 100 percent tax rate.

I’m being sarcastic, of course. That being said, there is a bit of genuinely good analysis in the publication. The bureaucrats actually acknowledge that growth is the way of helping the poor, which is a point I’ve been trying to stress for several years.

…many emerging market and developing economies…experienced increases in inequality during periods of strong economic growth. …Although income growth has not been evenly shared in emerging market economies, all deciles of the income distribution have benefited from economic growth, even when inequality has increased. …Benefiting from high economic growth, East and South Asia and the Pacific region, in particular, showed remarkable success in reducing poverty between 1985 and 2015 (Figure 1.8). Likewise, a period of strong growth has led to a sustained decline in absolute poverty rates in sub-Saharan Africa and in Latin America and the Caribbean.

Here are two charts from this section of the Fiscal Monitor. Figure 1.7 shows that the biggest gains for the poor occurred in the emerging market economies that also saw big increases for the rich. And Figure 1.8 shows how global poverty has fallen.

I’m not saying, by the way, that inequality is necessary for growth.

My argument is merely that free markets and small government are a recipe for prosperity. And as a nation becomes richer thanks to capitalism, it’s quite likely that some people will get richer faster than others get richer.

I personally hope the poor get richer faster than the rich get richer, but the other way around is fine. So long as all groups are enjoying more prosperity and poverty is declining, that’s a good outcome.

P.S. My favorite example of rising inequality and falling poverty is China.

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As a general rule, the International Monetary Fund is a statist organization. Which shouldn’t be too surprising since its key “shareholders” are the world’s major governments.

And when you realize who controls the purse strings, it’s no surprise to learn that the bureaucracy is a persistent advocate of higher tax burdens and bigger government. Especially when the IMF’s politicized and leftist (and tax-free) leadership dictates the organization’s agenda.

Which explains why I’ve referred to that bureaucracy as a “dumpster fire of the global economy” and the “Dr. Kevorkian of global economic policy.”

I always make sure to point out, however, that there are some decent economists who work for the IMF and that they occasionally are allowed to produce good research. I’ve favorably cited the bureaucracy’s work on spending caps, for instance.

But what amuses me is when the IMF tries to promote bad policy and accidentally gives me powerful evidence for good policy. That happened in 2012, for example, when it produced some very persuasive data showing that value-added taxes are money machines to finance a bigger burden of government.

Well, it’s happened again, though this time the bureaucrats inadvertently just issued some research that makes the case for the Laffer Curve and lower corporate tax rates.

Though I can assure you that wasn’t the intention. Indeed, the article was written as part of the IMF’s battle against tax competition. As you can see from these excerpts, the authors clearly seem to favor higher tax burdens on business and want to cartelize the global economy for the benefit of the political class.

…what’s the problem when it comes to governments competing to attract investors through the tax treatment they provide? The trouble is…competing with one another and eroding each other’s revenues…countries end up having to…reduce much-needed public spending… All this has serious implications for developing countries because they are especially reliant on the corporate income tax for revenues. The risk that tax competition will pressure them into tax policies that endanger this key revenue source is therefore particularly worrisome. …international mobility means that activities are much more responsive to taxation from a national perspective… This is especially true of the activities and incomes of multinationals. Multinationals can manipulate transfer prices and use other avoidance devices to shift their profits from high tax countries to low, and they can choose in which country to invest. But they can’t shift their profits, or their real investments, to another planet. When countries compete for corporate tax base and/or real investments they do so at the expense of others—who are doing the same.

Here’s the data that most concerns the bureaucrats, though they presumably meant to point out that corporate tax rates have fallen by 20 percentage points, not by 20 percent.

Headline corporate income tax rates have plummeted since 1980, by an average of almost 20 percent. …it is a telling sign of international tax competition at work, which closer empirical work tends to confirm.

But here’s the accidental admission that immediately caught my eye. The authors admit that lower corporate tax rates have not resulted in lower revenue.

…revenues have remained steady so far in developing countries and increased in advanced economies.

And this wasn’t a typo or sloppy writing. Here are two charts that were included with the article. The first one shows that revenues (the red line) have climbed in the industrialized world as the average corporate tax rate (the blue line) has plummeted.

This may not be as dramatic as what happened when Reagan reduced tax rates on investors, entrepreneurs, and other upper-income taxpayers in the 1980, but it’s still a very dramatic and powerful example of the Laffer Curve in action.

And even in the developing world, we see that revenues (red line) have stayed stable in spite of – or perhaps because of – huge reductions in average corporate tax rates (blue line).

These findings are not very surprising for those of us who have been arguing in favor of lower corporate tax rates.

But it’s astounding that the IMF published this data, especially as part of an article that is trying to promote higher tax burdens.

It’s as if a prosecutor in a major trial says a defendant is guilty and then spends most of the trial producing exculpatory evidence.

I have no idea how this managed to make its way through the editing process at the IMF. Wasn’t there an intern involved in the proofreading process, someone who could have warned, “Umm, guys, you’re actually giving Dan Mitchell some powerful data in favor of lower tax burdens”?

In any event, I look forward to repeatedly writing “even the IMF agrees” when pontificating in the future about the Laffer Curve and the benefits of lower corporate tax rates.

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I don’t like international bureaucracies that push statist policies.

In a perverse way, though, I admire their brassiness. They’re now arguing that higher taxes are good for growth.

This isn’t a joke. They never offer any evidence, of course, but it’s now routine to find international bureaucrats asserting that there will be more prosperity if more resources are taken out of the private sector and given to politicians (see the 3:30 mark of this video for some evidence).

Christine Lagarde, the lavishly paid head of the IMF, is doubling down on this bizarre idea that higher tax burdens are a way to generate more growth for poor nations.

…we are here to discuss an equally powerful tool for global growth — domestic resource mobilization. …taxes, and the improvement of tax systems, can boost development in incredible ways… So today, allow me first to explain the IMF’s commitment to capacity development and second, to outline strategies governments can use to generate stable sources of revenue…the IMF has a third important development mission — capacity development.

Keep in mind that all of the buzz phrases in the preceding passages – “resource mobilization” and “capacity development” – refer to governments imposing and collecting more taxes.

Again, I’m not joking.

…the focus of our event today — enabling countries to raise public tax revenues efficiently.

And there’s plenty of rhetoric about how higher taxes somehow translate into more prosperity.

Resource mobilization can, if pursued wisely, become a key pillar of strong economy… For many developing countries, increased revenue is a necessary catalyst to reach the 2030 Sustainable Development Goals, and can be a driver of inclusive growth. Yet in some countries revenue remains stagnant, as the resources needed to enhance economic and civic life sit on the sidelines.

Wow, money that the government doesn’t grab apparently will just “sit on the sidelines.”

Lagarde’s entire speech was a triumph of anti-empiricism.

For instance, the western world went from poverty to prosperity in the 1800s when government was very small, averaging less than 10 percent of economic output.

Yet Lagarde makes an unsubstantiated assertion that today’s poor nations should have tax burdens of at least 15 percent of GDP (the OECD is even worse, arguing that taxes should consume 25 percent of economic output).

How significant is the resource problem? Developing countries typically collect between 10 to 20 percent of GDP in taxes, while the average for advanced economies is closer to 40 percent. IMF staff research shows that developing countries should aim to collect 15 percent of GDP to improve the likelihood of achieving stable and sustainable growth.

By the way, I should not that the IMF partnered with Oxfam, the radical left-wing pressure group, at the conference where her speech was delivered (sort of like the OECD cooperating with the crazies in the Occupy movement).

Moreover, her support for higher taxes is rather hypocritical since she doesn’t have to pay tax on her munificent salary.

I’ve also written about the various ways the IMF has endorsed higher taxes in the United States.

It’s also worth noting that the IMF boss thinks America should have a bigger welfare state as well. Here’s some of what she said about policy in the United States.

Policies need to help lower income households – including through a higher federal minimum wage, more generous earned income tax credit, and upgraded social programs for the nonworking poor. …There is a need to deepen and improve the provision of reasonable benefits to households… This should include paid family leave to care for a child or a parent, childcare assistance, and a better disability insurance program. I would just note that the U.S. is the only country among advanced economies without paid maternity leave at the national level.

The IMF even figured out a way to criticize the notion of lower corporate taxation in the United States.

The IMF…said that already highly leveraged U.S. companies may not be in a position to translate a cash-flow boost from U.S. Republican tax reform proposals into productive capital investments that can aid sustainable growth. Instead, the Fund said the slug of cash, which is likely to include repatriation of profits held overseas by multinational corporations, could be channelled into risks such as purchases of financial assets, mergers and dividend payouts. Such temptations would be highest in the information technology and health care sectors, according to the report. “Cash flow from tax reforms may accrue mainly to sectors that have engaged in substantial financial risk taking,” the IMF said. “Such risk taking is associated with intermittent large destabilising swings in the financial system over the past few decades.”

Basically, the bureaucrats at the IMF want us to believe that money left in private hands will be poorly used.

That’s a strange theory, but the oddest part of this report is that the IMF actually argued that a small repatriation holiday in 2004 somehow caused the recession of 2008 (almost all rational people put the blame on the Federal Reserve and the duo of Fannie Mae and Freddie Mac).

The report noted that past major tax changes typically were followed by increases in financial risk-taking, including the tax reforms in 1986 and a corporate tax repatriation “holiday” in 2004. In both cases, these led to leverage buildups that were followed by recessions, in 1990 and 2008. …inflation and interest rates could rise more sharply than expected. This could increase market volatility and raise debt service costs for already-stretched corporate balance sheets, the IMF said. …”Tighter financial conditions could lead to distress” for weaker firms, the IMF said, noting that resulting losses would be borne by banks, life insurers, mutual funds, pension funds, and overseas institutions.

But the U.S. isn’t special.

The IMF wants higher tax burdens everywhere. Such as the Caribbean.

Over the past decade, governments in the Caribbean region have introduced the value-added tax (VAT) to modernize their tax system, rapidly mobilize revenue… VAT…has boosted revenues, the VAT has not reached its potential. …The paper also finds that although tax administration reforms can boost revenues, countries have just started… These reforms need to intensify in order to have a more significant impact on compliance and revenue.

Writing for the Weekly Standard, Irwin Stelzer has a very dim assessment of the International Monetary Fund’s actions.

He starts with some background information.

The original vision of the IMF was as an agency attending to global stability… Along with the World Bank, the agency was created at an alcohol-fueled conference of 730 delegates from 44 nations, convened 72 years ago in Bretton Woods, New Hampshire. No matter that the delegates from one of the important attendees, the Soviet Union, did not speak English: Harry Dexter White, the head of the U.S. delegation, was a Soviet agent who kept Moscow informed of the goings-on. …Today’s IMF includes 189 nations, has some 2,700 employees and an annual budget in excess of $1 billion, almost 18 percent of which comes from U.S. taxpayers.

He then points out that the IMF has a bad habit of putting dodgy people in charge.

In 2004 Rodrigo Rato took the top chair and served until 2007, when he resigned to face trial in Spain for a variety of frauds involving over 70 bank accounts, and the amassing of a €27 million fortune in a web of dozens of companies. Sr. Rato was succeeded by Dominique Strauss-Kahn… Strauss-Kahn did a reasonable job until arrested in New York City on charges of imposing himself on a hotel maid whose testimony proved so incredible that all criminal charges were dropped. But DSK did settle her civil suit for a reported $1.5 million… Madame Christine Lagarde, former French finance minister, took over as managing director. …Lagarde now faces a criminal trial in France for approving a 2008 arbitration decision award of £340 million to a major financial supporter of then-president Nicolas Sarkozy that was later reversed by an appeals court.

And he notes that these head bureaucrats are lavishly compensated.

…her job…pays $500,000 per year, tax free, plus benefits and a $75,000 allowance to be paid “without any certification or justification by you, to enable you to maintain, in the interests of the Fund, a scale of living appropriate to your position as Managing Director.” The salary is twice the take-home pay of the American president, who must pay taxes on his $400,000 salary… Vacations and sick leave follow generous European standards.

Last but not least, he points out that IMF economists have a lousy track record.

All of which might be money well spent if the IMF had been reasonably successful in one of its key functions—forecasting the outlook for the international economy. …one can’t help wondering what is going on in the IMF’s highly paid forecasting shop. A study of the 189 IMF members by the Economist finds 220 instances between 1999 and 2014 in which an economy grew one year before sinking the next. “In its April forecasts the IMF never once foresaw the contraction looming in the next year.” The magazine’s random-number generator got it right 18 percent of the time.

If all the IMF did was waste a lot of money producing inaccurate forecasts, I wouldn’t be overly upset.

After all, economists seemingly specialize in getting the future wrong. My problem is that the IMF pushes bad policy.

Let’s close with a defense of the bureaucracy.

Desmond Lachman of the American Enterprise Institute argues that the IMF is needed because of future crises.

A number of recent senior U.S. Treasury nominations, who are known for their antipathy towards the International Monetary Fund, seems to signal that President Trump might want to have a smaller IMF. Before he yields to the temptation of trying to downsize that institution, he might want to reflect on the fact that there is a high probability that during his term he will be confronted with a global economic crisis that will require a large IMF… It is generally not a good idea to think about downsizing the fire brigade on the eve of a major conflagration. In the same way, it would seem that President Trump would be ill-advised to think about reigning in the IMF at a time when there is the real prospect of a global economic crisis during his term of office.

I actually agree with much of what Desmond wrote about the possibility of economic and fiscal crisis in the near future.

The problem, though, is that the IMF is not a fire brigade. It’s more akin to a collection of fiscal pyromaniacs.

P.S. In the interest of fairness, I want to acknowledge that we sometimes get good analysis from the IMF. Economists from that bureaucracy have concluded (two times!) that spending caps are the most effective fiscal rule. They also made some good observations about tax policy earlier this year. And IMF researchers in 2016 concluded that smaller government and lower taxes produce more prosperity. Moreover, an IMF study in 2015 found that decentralized government works better.

P.P.S. On the other hand, I was greatly amused in 2014 when the IMF took two diametrically opposed positions on infrastructure spending in a three-month period. And I also think it’s funny that IMF bureaucrats inadvertently generated some very powerful evidence against the VAT.

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Since I’ve referred to the International Monetary Fund as both “the Dumpster Fire of the Global Economy” and “the Dr. Kevorkian of Global Economic Policy,” readers can safely conclude that I’m not a fan of the international bureaucracy. My main gripe is that senior bureaucrats routinely make the mistake of bailing out profligate governments (often as a back-door way of bailing out banks that foolishly lent to those governments), and they compound that mistake by then insisting on big tax hikes.

But as I’ve noted when writing about international bureaucracies, the professional economists who work for these organizations often produce very good work.

And that’s true even for the IMF. The bureaucracy published a study a few years ago entitled “The Size of Government and U.S.–European Differences in Economic Performance” and it has some useful and interesting conclusions. Here are some excerpts, along with my observations. We’ll start with the question the authors want to answer.

How much of a drag is the modern welfare state on economic performance? … One standard approach has been to estimate the disincentive effects of taxes and deduce that lower taxes would imply higher welfare. However, in the context of modern democracies, this argument begs the question why voters prefer an inferior economic outcome (a higher tax burden) instead of voting for parties that would minimize taxes.

Actually, we don’t need to “beg the question.” We get bad policy because voters get seduced into voting for politicians who promise to pillage the “rich” and give goodies to everyone else. And since voters generally don’t understand that this approach leads to “an inferior economic outcome,” the process can continue indefinitely (or until the ratio between those pulling the wagon and those riding in the wagon gets too imbalanced).

But I’m digressing. Let’s get back to the main focus of the study. The authors note that Europe isn’t converging with the United States, which is what standard economic theory says should be happening.

The academic debate over the long-term failure of European countries to catch up with U.S. economic performance also points to the need for a better assessment of the economic effects of large governments. Over the last three decades, European countries have not made inroads in closing a gap in per capita income vis-à-vis the US. …This paper focuses on…the role of the size of the public sector… The literature studying the impact of government on economic performance is large. Theory has focused on welfare effects—stressing the distortionary impact of taxation and government spending… observed government sizes generally tend to be too large, thus depressing welfare in many countries, or actual policies depart from allocationally optimal ones, especially in the “Rhineland-model” European economies.

And here are some of the results.

… a higher tax wedge results in lower hours worked. Moreover, the equation can be used to predict hours worked as a function of the tax wedge. …based on these calibrations, and using the welfare measure described in Appendix II, the steady-state welfare effects of varying the size of government can be analyzed. Table 2 provides the results of two such thought experiments: (i) to cut the marginal tax rate by five percentage points and (ii) to adopt U.S. taxation levels (in both accompanied by offsetting changes in spending), with the welfare change measured in the incremental consumption equivalent of the tax cuts. For example, had Belgium between 1990–99 cut marginal income tax rates by five percentage points, it would have reaped a welfare gain equivalent to 7⅓ percent of aggregate consumption (or of 21 percent if it had adopted US tax levels). These are large potential welfare gains from cutting back government.

Here’s a table from the study showing the theoretical gains from lowering tax rates, either by 5-percentage points, or all the way down to American levels.

But the authors note that their model is incomplete, with some countries doing better than what’s implied by their fiscal systems.

The basic model has considerable difficulties in accounting for labor supply in very high-tax countries, which it frequently underpredicted (e.g., the Nordic countries, excluding Norway…). …One group comprising Sweden and Denmark… Both countries are often singled out as countries with large government, but, as seen in the previous, both also have higher than predicted labor supply in the baseline model.

The study tries to explain such differences by considering whether some governments spend money in an effective manner on “active labor market policies” that produce higher levels of labor supply.

Perhaps that’s a partial explanation, but I think there’s a much simpler way of making sense of the data. The Nordic nations, as I’ve repeatedly written, have strongly pro-market policies once fiscal policy is taken out of the equation.

So if you just look at fiscal policy, they should be way behind the United States. But since they are more market-oriented than America in other areas (trade, rule of law, regulation, and monetary policy), that shrinks the gap.

That being said, I’m not going to be too critical of the IMF study since it does reach a very sensible conclusion.

…the size of government does play a significant role in explaining lower European labor supply…the size of European governments appears to imply large welfare costs. …Moreover, government policies that do not directly increase the size of government, e.g., regulation, are observed to also impart significant costs.

By the way, don’t assume this IMF study is an outlier. When economists at international bureaucracies are free to do real research without interference by their political masters, it’s not uncommon for them to produce sensible results.

Last but not least, here’s the video I narrated on the “Rahn Curve” and the growth-maximizing size of government.

Now if we could just get Hillary Clinton and Donald Trump to understand this research, we’ll be in good shape (actually, since those two are poster children for the theory of Public Choice, who am I kidding?).

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I must be perversely masochistic because I have the strange habit of reading reports issued by international bureaucracies such as the International Monetary Fund, World Bank, United Nations, and Organization for Economic Cooperation and Development.

But one tiny silver lining to this dark cloud is that it’s given me an opportunity to notice how these groups have settled on a common strategy of urging higher taxes for the ostensible purpose of promoting growth and development.

Seriously, this is their argument, though they always rely on euphemisms when asserting that politicians should get more money to spend.

  • The OECD, for instance, has written that “Increased domestic resource mobilisation is widely accepted as crucial for countries to successfully meet the challenges of development and achieve higher living standards for their people.”
  • The Paris-based bureaucrats of the OECD also asserted that “now is the time to consider reforms that generate long-term, stable resources for governments to finance development.”
  • The IMF is banging on this drum as well, with news reports quoting the organization’s top bureaucrat stating that “…economies need to strengthen their fiscal frameworks…by boosting…sources of revenues.” while also reporting that “The IMF chief said taxation allows governments to mobilize their revenues.”
  • And the UN, which has “…called for a tax on billionaires to help raise more than $400 billion a year” routinely categorizes such money grabs as “financing for development.”

As you can see, these bureaucracies are singing from the same hymnal, but it’s a new version.

In the past, the left agitated for higher taxes simply in hopes for having more redistribution.

And they’ve urged higher taxes because of spite and hostility against those with high incomes.

Some folks on the left also have supported higher taxes on the theory that the economy’s performance is boosted when deficits are smaller.

But now, they are advocating higher taxes (oops, excuse me, I mean they are urging “resource mobilization” to generate “stable resources” so there can be “financing for development” in order to “strengthen fiscal frameworks”) on the theory that bigger government is the way to get more growth.

You probably won’t be surprised to learn, however, that these reports from international bureaucracies never provide any evidence for this novel hypothesis. None. Zero. Zilch. Nada. The null set.

They simply assert that governments will be able to make presumably wonderful growth-generating “investments” if politicians can squeeze more money from the private sector.

And I strongly suspect that this absence of evidence is deliberate. Simply stated, international bureaucracies are willing to produce shoddy research (just look at what the IMF and OECD wrote about the relationship between growth and inequality), but there’s a limit to how far data can be tortured and manipulated.

Especially when there’s so much evidence from real scholars that economic performance is weakened when government gets bigger.

Not to mention that most sentient beings can look around the world and look at the moribund economies of nations with large governments (such as France, Italy, and Greece) and compare them with the better performance of places with smaller government (such as Hong Kong, Switzerland, and Singapore).

But if you read the aforementioned reports from the international bureaucracies, you’ll notice that some of them focus on getting more growth in poor nations.

Perhaps, some statists might argue, government is big enough in Europe, but not big enough in poorer regions such as sub-Saharan Africa.

So let’s look at the numbers. Is it true that governments in the developing world don’t have enough money to provide core public goods?

The answer is no.

But before sharing those numbers, let’s look at some historical data. A few years ago, I shared some research demonstrating that countries in North America and Western Europe became rich in the 1800s and early 1900s when the burden of government spending was very modest.

One would logically conclude from this data that today’s poor nations should copy that approach.

Yet here’s the data from the International Monetary Fund on government expenditures in various poor regions of the world. As you can see, the burden of government spending in these areas is two or three times larger than it was in America and other nations that when they made the move from agricultural poverty to middle class prosperity.

The bottom line is that small government and free markets is the recipe for growth and prosperity in all nations.

Just don’t expect international bureaucracies to share that recipe since one of the obvious conclusions is that we therefore don’t need parasitical bodies like the IMF, OECD, World Bank, and UN.

P.S. Unsurprisingly, Hillary Clinton also has adopted the mantra of higher-taxes → bigger government → more growth.

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I’m not a fan of the International Monetary Fund. The bureaucracy was created in 1944 to manage and coordinate the system of fixed exchange rates created as part of the 1944 Bretton Woods agreement. But once fixed exchange rates disappeared, the over-funded bureaucracy cleverly adopted a new rationale for its existence and its main role now is to bail out insolvent nations (what that really means, of course, is that it exists to bail out big banks that foolishly lend money to profligate third-world governments).

As part of this new mission, the IMF acts like the Pied Piper of tax hikes. The bureaucrats parachute into nations, refinance and restructure the debt of those countries, and insist on a bunch of tax increases in hopes that more revenue will then be available to service the new debt.

Needless to say, this is not exactly a recipe for growth and prosperity. The private sector in these countries gets hammered with tax increases, the big banks in rich nations get indirect bailouts, and the real problem of bloated government generally is left to fester and metastasize.

This is why I’ve referred to the IMF as the Dr. Kevorkian of the global economy. But the bureaucracy is bad for other reasons. It also has decided that it should grade all nations on their economic policies and it routinely uses that self-assigned authority to recommend big tax hikes all over the world. Including lots of tax increases in the United States.

The IMF even tries to interfere with American elections. Just recently, the chief bureaucrat of the organization launched a not-too-subtle attack on Donald Trump.

Though in this case, which involved trade barriers, the IMF actually is on the right side (the bureaucracy generally has a pro-tax bias, but the one big exception is that it favors lower taxes on global trade).

Anyhow, the IMF’s Managing Director warned that additional protectionist taxes on global trade threaten the global economy. And even though she didn’t specifically mention the Republican nominee, you can see from the various headlines I’m sharing that reporters put 2 + 2 together and realized that Ms Lagarde was criticizing Trump.

And he deserves condemnation. The post-World War II shift to lower trade taxes has been a big victory for economic freedom (indeed, tariff reductions have helped offset the damage caused by increasingly bad fiscal policy over the past several decades).

Nonetheless, there is something quite unseemly about an international bureaucracy taking sides in an American election (who do they think they are, the IRS?). Especially since American taxpayers underwrite the biggest share of the IMF’s activities.

Let’s look specifically at an analysis of the IMF’s actions from the UK-based Guardian.

The managing director of the International Monetary Fund, has launched a thinly veiled attack on the anti-free-trade sentiments expressed by US presidential candidate Donald Trump… Lagarde made it clear she strongly opposed the Republican candidate’s policies, which include higher US tariffs and a barrier along the border with Mexico. …“There is a growing risk of politicians seeking office by promising to ‘get tough’ with foreign trade partners through punitive tariffs or other restrictions on trade…” She added that throughout history there had been arguments about trade. “But history clearly tells us that closing borders or increasing protectionism is not the way to go…”

By the way, while I agree with her comments on trade, her comments about a “barrier along the border with Mexico” reek of hypocrisy.

Christine Lagarde criticises his policies including plans for…a US-Mexico border wall.

Those who have visited the IMF’s lavish headquarters can confirm that there is a very heavily guarded barrier separating the IMF from the hoi polloi and peasantry of Washington.

Call me crazy, but a bureaucracy with lots of security to prevent unauthorized people from entering its building is in no position to lecture a nation for wanting security to prevent unauthorized people from crossing its borders. And I say this as someone who generally favors immigration.

But let’s set that issue aside. There’s actually a very serious sin of omission in the IMF’s analysis that needs to be addressed.

The international bureaucracy (correctly) opposes trade taxes and wants to build on the progress of recent decades by further reducing government-imposed barriers to cross-border economic activity. As noted above, this is the right position and I applaud the IMF’s defense of lower tariffs and expanded trade.

That being said, the level of protectionism has fallen significantly in the post-World War II era. In other words, trade taxes already are reasonably low. Yes, it would be better if they were even lower (ideally zero, like in Hong Kong).

My problem (or, to be more accurate, one of my problems) with the IMF is that the bureaucracy acts as if the world economy is hanging in the balance if there’s some sort of increase in the currently low tax burden on trade.

Yet what about the tax burden on behaviors that actually generate the income people use to purchase goods from other nations? Top tax rates on personal income average more than 40 percent in the developed world, dwarfing the average tariffs of trade.

And the burden on income that is saved and invested is even higher because of double taxation, which is especially destructive since all economic theories – including Marxism and socialism – agree that capital formation is a key to long-run growth and higher living standards (i.e., the ability to buy more goods, including those produced in other nations).

So here’s the question that must be asked: If it is bad to have very modest taxes on the share of people’s income that is used to buy goods produced in other nations, then why isn’t it even worse to have very onerous taxes on the productive behaviors that generate that income?

In other words, if the IMF is correct (and it is) to criticize Trump for threatening to increase the modest tax rates that are imposed on global trade, then why doesn’t the IMF criticize Hillary Clinton for threatening to increase the rather harsh tax rates that are imposed on working, saving, and investment?

Maybe Madame Lagarde’s army of flunkies and servants (one of the many perks she gets, in addition to a munificent tax-free salary) can explain that sauce for a goose is also sauce for a gander.

By the way, I can’t resist addressing one final aspect to this story. The Guardian‘s report notes that Lagarde wants to offset the supposedly harmful impact of trade by further increasing the size and scope of government.

…the solution was for governments to provide direct financial support for those with low skills through higher minimum wages, more generous welfare states, investment in education and a crackdown on tax evasion.

Wow, that’s a lot of economic illiteracy packed into one sentence fragment.

Now you understand why I refer to the IMF as the dumpster fire of global economics.

P.S. While the IMF likes to push bad policy for the United States, the bureaucracy’s proposals for China are akin to a declaration of economic warfare.

P.P.S. The IMF’s flip-flop on infrastructure spending reveals a lot about the bureaucracy’s inner workings.

P.P.P.S. While the IMF often produces sloppy and dishonest research, every so often the professional economists on the staff slip something  useful past the political types. Though my all-time-favorite bit of IMF research was the study that inadvertently showed why a value-added tax is so dangerous.

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