The IMF’s Dirigiste Tax Agenda, Part II

Yesterday’s column reviewed a new report from the International Monetary Fund and criticized that bureaucracy for celebrating how the world’s most-powerful governments are going to take more money from the private sector thanks to a corporate tax cartel.

But that’s not the worst part of the IMF document.

The report also asserts that low-income countries (LICs) can grow faster if they increase their fiscal burdens.

This is not April Fool’s Day. I’m not joking. The bureaucrats at the IMF apparently want readers to believe that higher taxes and more spending are a route to prosperity.

Let’s look at some excerpts from the report, which was authored by Ruud de Mooij, Alexander Klemm, and Christophe Waerzeggers.

Global revenue from the 2-pillar reform…might rise to around 0.4 percent of GDP in the longer term. If a proportional share of this revenue flows to LICs, this would provide a welcome contribution to their revenue objective. However, the impact is dwarfed by the…expenditure needs in LICs of nearly 16 percent of GDP (and a significant share of this will need to come from taxation)… Estimates…suggest a potential revenue increase in LICs of 8 percent of GDP. …compared with that in emerging market economies as an aspirational level…suggests a revenue potential of around 5 percent of GDP. …Several options present themselves to raise revenues in LICs, both in tax policy and revenue administration. …Some promising avenues in tax policy include: Value-Added Tax (VAT)…specific excises…on select products such as alcohol, tobacco, unhealthy foods, passenger vehicles, fuel, and carbon emissions. …Strengthening the progressive personal income tax… Making greater use of recurrent real property taxes.

Here’s a chart from the study which shows how much bigger the IMF thinks government should be in poor nations (the second column) compared to various potential sources of revenue (columns 1, 3, and 4).

For those not familiar with the jargon, “SDG” is the abbreviation for “sustainable development goals,” as defined by the United Nations.

And the UN now robotically asserts that more taxes are needed to government can boost growth with more spending (other international bureaucracies sing from the same songsheet).

I actually went to the United Nations a few years ago and explained why this “magic beans” theory of government-led economic development is wrong.

Simply stated, there are two parts of the world that have become rich and in both cases prosperity arose when government was far smaller than what the IMF and UN want us to believe is necessary.

• First, empirical data shows that some western nations became rich in the 1800s when fiscal burdens were trivially small.
• Second, some East Asian nations became rich after World War II when their fiscal burdens were very modest.

I’ll close by challenging folks from the IMF or UN (as well as other people who agree with their agenda) to answer this very simple question.

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The IMF’s Dirigiste Tax Agenda, Part I

Thanks in large part to the pro-growth agendas of Margaret Thatcher and Ronald Reagan, but also giving credit to policymakers in nations like Ireland and Switzerland, businesses (and their workers, consumers, and shareholders) have benefited from four decades of tax competition.

How much have they benefited?

As shown by this chart, average corporate tax rates have dropped by about half since the early 1980s.

Not everybody is happy that corporate tax rates have declined.

Politicians in high-tax nations have always resented tax competition and they have been working through left-leaning international bureaucracies to push for various forms of tax harmonization.

Unfortunately, they have been partially successful.

Over the past 20 years, the human right of financial privacy has been substantially eroded so that uncompetitive governments can track – and tax – money that migrates to low-tax jurisdictions.

As a result, politicians recently have been raising personal income tax rates.

And they want to also raise corporate income tax rates, which is why many pro-tax politicians (including Joe Biden) are supporting a global tax cartel on business income.

The International Monetary Fund has a new report praising this effort. Authored by Ruud de Mooij, Alexander Klemm, and Christophe Waerzeggers, it celebrates the fact that politicians will be diverting more money from the productive sector of the economy

P1 is estimated to reallocate about 2 percent of total profits of MNEs, mainly from low-tax investment hubs to other countries, raising global Corporate Income Tax (CIT) revenue by $12 billion. …P2 would raise global CIT revenues by 5.7 percent, which is before any behavioral responses by firms (Figure 1b). According to staff simulations, 18.5 percent of global profit of MNEs is taxed below 15 percent ($1.47 trillion in 2019). On average, the current tax rate on these profits is 5 percent, so that profits exceeding the substance-based income exclusion would be subjected to a average top-up tax of 10 percent. …An additional positive revenue impact from P2 could come from reduced competition over corporate tax rates, which could boost global CIT revenues by an extra 8.1 percent. …a 1 percentage point increase in the world average CIT rate will, on average, induce a country to raise its own rate by 0.6 percentage points. By putting a floor of 15 percent, the simulations above suggest that 18.5 percent of MNE profit will indeed face a higher CIT burden, implying that countries will feel less pressure to keep their own tax rates low. Using simulations of the tax competition model, we find that the average CIT rate would rise from 22.2 to 24.3 percent due to the global minimum tax. The associated boost in global CIT revenues would be 8.1 percent, exceeding the direct effect on revenue.

By the way P1 is Pillar 1, which is the proposal to give powerful nations a bigger claim on the taxable income of big companies. By contrast, P2 is Pillar 2, which is the proposal for a mandatory minimum tax of at least 15 percent on corporate income.

In other words, a tax cartel.

As you can see from this next chart, most of the additional revenue is the result of the scheme for a 15 percent tax cartel.

I’ll close with two observations about this depressing data.

First, the IMF’s own research shows that reductions in corporate tax rates have not resulted in lower revenues. But I guess they now want to ignore the Laffer Curve since politicians want to grab more money.

Second, we should all be outraged that IMF bureaucrats (including the authors of the paper cited above) receive tax-free salaries while pushing for higher taxes on the rest of us.

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The IMF, the Laffer Curve, and Supply-Side Economics

The Laffer Curve is a very straightforward concept.

It graphically illustrates why politicians are wrong if they think you can double tax revenue by doubling tax rates (or that revenues will drop by 50 percent if tax rates are cut in half).

Simply stated, you also have to look at what happens to taxable income.

In cases where taxpayers have a lot of control over the timing, level, and composition of their income, changes in tax rates may cause big changes in taxable income (or “tax base” in the jargon of economists).

None of this should be controversial. Even Paul Krugman agrees that the Laffer Curve exists.

Today, we are going to see that the pro-tax International Monetary Fund also admits there is a Laffer Curve.

Indeed, a new study authored by David Amaglobeli, Valerio Crispolti, and Xuguang Simon Sheng openly states that politicians should be very cognizant of the fact that some tax policy changes can have a big effect on the “tax base.”

This paper investigates the potential revenue impact of different tax policy changes using the Tax Policy Reform Database (TPRD)… Revenue responses to tax policy changes depend on many factors… However, one of most important factors is the nature of the tax policy change itself. For example, while a tax rate cut will directly lower revenue intake, it could also encourage more economic activity, hence expand the tax base. Estimating the revenue response to a tax policy change, therefore, requires granular information on the nature of this change, including on the tax instrument used (e.g., VAT or personal income tax), the type of change adopted (e.g., tax base, tax rate), and its timing and size.

Here are some of the findings.

We assess the impact of tax policy changes on tax revenues using Jordà (2005)’s local projections method. Our baseline results are based on tax shocks identified in the year when a tax change is announced. Our main empirical findings suggest that the revenue yield of tax policy changes varies significantly across taxes and types of changes, with tax rate changes generally having a more transitory revenue impact than tax base changes for most taxes. Specifically, base broadening changes in PIT, CIT, EXE, and PRO have on average a more significant and long-lasting impact on tax collection than rate changes. At the same time, rate hikes have relatively more significant effects on taxes in the case of VAT and SSC measures.

Most notably, the report finds tax increases hurt prosperity, especially higher marginal tax rates.

Gechert and Groß (2019) conclude that measures to broaden the tax base are less harmful to economic growth than tax hikes. Dabla-Norris and Lima (2018) find that during fiscal consolidations, tax base-broadening measures lead to smaller output and employment declines compared to measures to increase tax rates.

And we learn that it is very foolish to raise corporate tax rates.

Mertens and Ravn (2013) find that…increases in CIT are approximately revenue neutral for the United States. …Announcements of CIT increases are associated with a somewhat transitory rise in tax collection, suggesting that companies have quickly adapted their business to reduce the tax burden.

For wonky readers, here’s a chart from the study. Note how, in many cases, there’s not much difference in revenue between tax increases (blue line) and tax cuts (red lines).

P.S. One big takeaway is that there is not a single Laffer Curve. There are multiple Laffer Curves depending on the tax that’s being changed and the ability of taxpayers to change their behavior.

P.P.S. A less-obvious takeaway is that class-warfare taxes cause the most economic damage, meaning the most harm to ordinary people.

P.P.P.S. You can call it the “Khaldun Curve” if you prefer.

P.P.P.P.S. I have trouble deciding what evidence is most powerful, the views of CPAs or the data from the OECD?

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International Bureaucracies Push for More Poverty in Latin America

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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Learning a Lesson about Big Government from Barbados

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.

• First, the right kind of austerity produces growth rather than poverty.
• Second, government spending rarely acts as productive investment.

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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IMF Bailouts and Moral Hazard

One of the (many) unfortunate tendencies of politicians is that they focus on the short run (i.e., their upcoming reelection battles).

Why is this unfortunate? Because there are some policy changes that may be costly in the short run, but they are nonetheless very worthwhile because they generate big long-run benefits.

• Shifting to a system of personal retirement accounts means trillions of dollars of near-term “transition costs” in order to protect current retirees and older workers, but reform will solve the program’s long-term $40 trillion-plus unfunded liability.
• Messy fights over the debt limit create (almost certainly exaggerated) concerns about potential default, but that potential cost would be trivial compared to the long-run benefits of figuring out how to limit the growing burden of federal spending.
• When bad monetary policy causes a financial bubble or housing bubble, shifting to good monetary policy presumably will lead to short-run pain as markets adjust, but that’s far better than producing a 2008-style crisis by letting the bubble(s) expand further.

I offer the above examples because similar short-run and long-run tradeoffs exist when looking at what happens when the International Monetary Fund provides bailouts for profligate governments.

The Economist has an article that perfectly illustrates the IMF’s pernicious role.

The year was 1958. …Argentina turned to the fund for its first “standby arrangement”, a line of credit accompanied by a plan to stabilise the economy. …Sixty years later, in June 2018, Argentina was back for its 21st arrangement: a $50bn loan, later increased to $57bn, backed by the government’s promises to cut the budget deficit and strengthen the central bank in the hope of quelling inflation and stabilising the peso. The loan was the largest in the imf’s history. …Despite its size, the rescue failed to save Argentina from default and despair. …Foreign capital kept retreating, the peso kept falling and inflation kept rising. The evaluation speculates that the size of the imf’s loan may even have been “self-defeating”, eroding confidence rather than inspiring it.

Just in case you missed it, the article mentions that Argentina has received 21 different bailouts since 1958, which works out to be one bailout every three years (Professor Steve Hanke counts 22 bailouts, for what it’s worth).

In probably every case, IMF bureaucrats presumably thought a bailout was a way of minimizing economic pain (and they probably thought the same thing for dozens of bailouts provided to Haiti, Colombia, Peru, Honduras, Philippines, etc).

But what actually has happened is that politicians – in Argentina and elsewhere – have learned that it’s okay to pursue bad policy because there’s always another bailout.

In other words, IMF policy is a glaring example of “moral hazard.” By shielding politicians from the consequences of bad policy, the bureaucracy is actually encouraging those politicians to engage in additional bad policy.

To be blunt, the IMF is the arsonist rather than the firefighter.

The article in the Economist included this observation.

Conservative critics think the fund has been seduced by its dance partner, wasting public money in a futile battle.

My right-leaning friends are correct, but their criticisms are too mild.

It’s not just that the IMF is wasting money. It’s dampening growth by pushing policies that misallocate capital.

It’s not just that the IMF is engaging in a futile battle. It’s making problems far worse by enabling ever-more government.

Here’s what should have happened to Argentina in 1958 (and what should have happened in 2018, and what should happen when there’s pressure for yet another bailout).

• The investors who buy Argentinian government bonds should learn that lending to dodgy governments is a risky practice.
• The politicians in Argentina who spend excessively should learn that there’s a tipping point when they can no longer borrow.
• The interest groups in Argentina should learn that parasites also suffer when they kill their host animal by being too greedy.
• The voters in Argentina should learn that there are serious adverse consequences when you elect “Peronist” politicians.

Sadly, none of these lessons get learned so long as the IMF is standing by to provide never-ending bailouts.

So instead of some short-run pain, which is then offset by better long-run policy, we get bailouts that mask short-run pain and encourage more long-run damage.

The moral of the story? Shut down the IMF.

The sad reality? The IMF is getting more power.

P.S. To add injury to injury, the IMF usually insists that governments raise taxes in exchange for getting bailed out.

P.P.S. To be fair, the IMF recommends tax increases even in the years when bailouts aren’t needed, so at least the bureaucrats have a consistent (albeit nutty) message.

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The IMF, Special Drawing Rights, and Expanding the Burden of Government

At the risk of understatement, I’m not a fan of the International Monetary Fund.

My main objection is that the bureaucracy’s various policies – especially bailouts – make it easier for irresponsible politicians to expand the burden of government spending and increase deficits and debt.

Needless to say, that approach doesn’t work. The best evidence is that many governments wind up in a never-ending cycle of tax-spend-debt-crisis-bailout, followed by further rounds of tax-spend-debt-crisis-bailout.

Moreover, the net effect of these policies is to divert capital from the economy’s productive sector. So it’s the economic equivalent of a lose-lose policy.

When criticizing the IMF, I usually focus on how the bureaucrats relentlessly urge higher taxes. Indeed, I often complain about how the bailouts are provided only if countries agree to raise taxes (another lose-lose situation).

Today, though, I want to write about another bad IMF policy. Earlier this year, the bureaucrats (with support from the Biden Administration) allocated $650 billion of new Special Drawing Rights (SDRs) – sort of a version of IMF-created money.

You can learn about SDRs by clicking here and here, so I won’t bore people with a description of how they work.

For purposes of our discussion, what matters is that the IMF uses SDRs to enable more government spending.

And that’s not a recipe for prosperity, either for national economies or the global economy.

Earlier this year, Mary Anastasia O’Grady of the Wall Street Journal highlighted how SDRs are rewarding very dodgy governments in Latin America.

Nicaraguan dictator Daniel Ortega is jailing, killing and disappearing his political opponents. …At the International Monetary Fund, he’s a valued member. So too are the governments of socialist, deadbeat Argentina and of El Salvador, which every day slips further into arbitrary, authoritarian rule. These are some of the bad actors in the Western Hemisphere who received more “special drawing rights” from the IMF on Aug. 23 as part of a new $650 billion general allocation. …SDRs are created out of thin air but can be converted, on demand, into hard currency. …Treasury Secretary Janet Yellen, who led the charge for this new round of SDRs, claims the transaction is cost-free… In fact, the conversion of SDRs to dollars is a subsidized, perpetual loan. For poor countries the subsidy is above 90% of the loan value. …There was a time when large multilateral handouts were conditioned on attempts at good governance. Those days are gone.

In a column last month for the Wall Street Journal, D.J. Nordquist and Dan Katz also analyzed the impact of the IMF’s policy.

…the International Monetary Fund announced in August a new general allocation of special drawing rights equivalent to $650 billion. …All IMF members, even rogue nations, receive them, so Iran got some $5 billion and Belarus $1 billion. …The allocation added more than $17 billion to Russia’s record-high reserves…the IMF and other proponents justified the SDR allocation on grounds that its benefits outweighed the harms… But because of the IMF shareholding formula… Only 3% of the general allocation flowed to low-income countries. …the IMF publicly indicated it would collaborate with the World Bank and other international financial institutions to ensure that SDRs were put to productive uses… Unfortunately, the IMF appears to have fallen into a classic trap of international organizations: acting based on aspirations rather than binding agreements. …Public confidence in international financial institutions has been understandably shaken as a result of corruption investigations into the IMF’s emergency pandemic-relief loans, theft of World Bank assistance by elite government officials, and serious questions regarding inappropriate Chinese influence at the World Bank, the World Health Organization, and elsewhere.

I’ll close by noting that SDRs are a great deal for politicians and bureaucrats. They get more spending, all of which seems free. And since almost nobody understands how this racket works, there’s near-zero democratic accountability.

P.S. Shifting gears, here’s are some excerpts from an article on the IMF’s website. It has nothing to do with the SDR issue, but it is a window into the the IMF’s statist mindset. The bureaucracy is lauding an economist, Mariana Mazzucato, who argues for industrial policy.

Mazzucato has been stirring the pot in economics and public policy for nearly a decade. Her main message is that governments around the world need to seize their power to lead innovation for the betterment of humanity. …Government is for setting big goals, defining the missions necessary for achieving them, encouraging and investing in innovation, and governing the process so that the public benefits. …She made the case for rethinking the role of government in her 2013 book, The Entrepreneurial State: Debunking Public vs. Private Sector Myths. …“State capacity has really been hollowed out because of the narrow way that we think about the state,” she says. …That’s particularly evident in the United Kingdom and the United States, where political leaders defunded public health and devalued government itself, eroding public trust and government’s capacity to respond to crises, she says. …Mazzucato urged “citizens’ dividends” and government equity stakes in businesses linked to government funding.

As illustrated by this video, letting politicians distort the economy is a recipe for stagnation and corruption.

P.P.S. There are many good economists who work at the IMF and they often produce high-quality research (see here, here, here, here, here, here, here, here, here, and here). Sadly, their sensible analyses doesn’t seem to have any impact on the policy decisions of the organization’s top bureaucrats.

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Are Poor Countries Poor Because Rich Countries Are Rich?

A regular theme of these columns is that the economy is not a fixed pie. If Person A becomes rich, that doesn’t mean less income for Persons B and C.

Indeed, the evidence is very strong that successful entrepreneurs only capture a tiny fraction of the wealth they create.

And there’s also lots of data showing how average incomes can rise over time and how all segments of society tend to rise together.

My reason for revisiting this topic is a story in the Economist about the possibility of an “grossly uneven” recovery, as illustrated by this chart.

My knee-jerk reaction to this chart is that nobody should pay attention to economic forecasters for the simple reason that they have a terrible track record.

And IMF economists seems to be among the worst of the worst when they make predictions.

This may be because economists at the IMF have a mistaken Keynesian view of the economy.

Or it may simply reflect the fact that it’s basically impossible to make such predictions (if any economists actually had that ability, they would be billionaires).

But today’s topic isn’t the foibles of the economics profession.

Instead, I want to focus on this issue of whether rich countries should be blamed for being richer than poor countries.

Here’s some of what the Economist wrote.

Over the longer term, the economic recovery is projected to remain grossly uneven. That, the fund argues, reflects…variations in fiscal largesse. In 2020 rich and poor countries alike loosened the purse-strings to protect households and businesses from the impact of lockdowns. This year fiscal support in the rich world is projected to remain broadly as generous as it was last year, allowing time for the private sector to get back on its feet (and, some economists would argue, even leading to some overheating in America). Emerging markets, by contrast, have shrunk their budget deficits (adjusted for the economic cycle, and before interest payments). The result will be a two-speed global economy. Output in the rich world is expected to return to its pre-pandemic trend by next year, and then to rise slightly above it. For the rest of the world, however, gdp is expected to remain well below trend at least until 2025.

As you can see from the excerpt, the IMF is wedded to the Keynesian view that government spending supposedly is good for growth – notwithstanding all the real-world evidence to the contrary.

But I’m more interested in the two points that aren’t mentioned, both of which revolve around the strong link between economic liberty and national prosperity.

• First, rich countries tend to be rich because they have (or had) good economic policy.
• Second, poor countries fail to converge because they tend to have bad economic policy.

For what it’s worth, the IMF’s failure to grasp these two points may help to explain why the bureaucracy advises poor countries to make bad choices.

The bottom line is that the global economy is not a fixed pie. If there are “grossly uneven” growth rates in the world, the reason is that some nations don’t follow the prudent recipe for prosperity.

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The IMF Should Be Eliminated, not Expanded

I’m not a fan of the International Monetary Fund (IMF).

Since I work mostly on fiscal issues, I don’t like the fact that the bureaucracy is an avid cheerleader for ever-higher taxes (which is disgustingly hypocritical since IMF employees get lavish, tax-free salaries).

But the biggest problem with the IMF is that it promotes “moral hazard.” More specifically, it provides bailouts for irresponsible governments and for those who foolishly lend to those governments.

The net result is that bad behavior is rewarded, which is a recipe for more bad behavior.

All of which explains why some nations (and their foolish lenders) have received dozens of bailouts.

Oh, and let’s not forget that these endless bailouts also lead to a misallocation of capital, thus reducing global growth.

In an article for the New York Times, Patricia Cohen reports on discussions to expand the IMF’s powers.

Once narrowly viewed as a financial watchdog and a first responder to countries in financial crises, the I.M.F. has more recently helped manage two of the biggest risks to the worldwide economy: the extreme inequality and climate change. …long-held beliefs like the single-minded focus on how much an economy grows, without regard to problems like inequality and environmental damage, are widely considered outdated. And the preferred cocktail for helping debt-ridden nations that was popular in the 1990s and early 2000s — austerity, privatization of government services and deregulation — has lost favor in many circles as punitive and often counterproductive.

There’s a lot to dislike about the above excerpts.

Starting with the article’s title, since it would be more accurate to say that the IMF’s bailout policies encourage fires.

Multiple fires.

Looking at the text, the part about “extreme inequality” is nonsensical, both because the IMF hasn’t done anything to “manage” the issue, other than to advocate for class-warfare taxes.

Moreover, there’s no support for the empty assertion that inequality is a “risk” to the world economy (sensible people point out that the real problem is poverty, not inequality).

Ms. Cohen also asserts that the “preferred cocktail” of  pro-market policies (known as the Washington Consensus) has “lost favor,” which certainly is accurate.

But she offers another empty – and inaccurate – assertion by writing that it was “counterproductive.”

Here are some additional excerpts.

The debate about the role of the I.M.F. was bubbling before the appointment of Ms. Georgieva… But she has embraced an expanded role for the agency. …she stepped up her predecessors’ attention to the widening inequality and made climate change a priority, calling for an end to all fossil fuel subsidies, for a tax on carbon and for significant investment in green technology. …Sustainable debt replaced austerity as the catchword. …The I.M.F. opposed the hard line taken by some Wall Street creditors in 2020 toward Argentina, emphasizing instead the need to protect “society’s most vulnerable” and to forgive debt that exceeds a country’s ability to repay.

The last thing the world needs is “an expanded role” for the IMF.

It’s especially troubling to read that the bureaucrats want dodgy governments to have more leeway to spend money (that’s the real meaning of “sustainable debt”).

And if the folks at the IMF are actually concerned about “society’s most vulnerable” in poorly run nations such as Argentina, they would be demanding that the country copy the very successful poverty-reducing policies in neighboring Chile.

Needless to say, that’s not what’s happening.

The article does acknowledge that not everyone is happy with the IMF’s statist agenda.

Some stakeholders…object to what’s perceived as a progressive tilt. …Ms. Georgieva’s activist climate agenda has…run afoul of Republicans in Congress… So has her advocacy for a minimum global corporate tax.

It would be nice, though, if Ms. Cohen had made the article more balanced by quoting some of the critics.

The bottom line, as I wrote last year, is that the world would be better off if the IMF was eliminated.

Simply stated, we don’t need an international bureaucracy that actually argues it’s okay to hurt the poor so long as the rich are hurt by a greater amount.

P.S. The political leadership of the IMF is hopelessly bad, as is the bureaucracy’s policy agenda. That being said, there are many good economists who work at the IMF and they often produce high-quality research (see here, here, here, here, here, here, here, here, here, and here). Sadly, their sensible analyses doesn’t seem to have any impact on the decisions of the organization’s top bureaucrats.

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IMF Goes All-In for Class Warfare

The International Monetary Fund’s dogmatic support for higher taxes and bigger government makes it “the dumpster fire of the global economy.”

Wherever IMF bureaucrats go, it seems they push for high-tax policies that will weaken growth.

• That’s true in the United States.
• That’s true in Africa.
• That’s true in the Mediterranean.
• That’s true in South Asia.
• That’s true in Western Europe.
• That’s true in Eastern Europe.
• That’s true in the Middle East.
• That’s true in China.
• That’s true in Latin America.

Call me crazy, but I’m baffled that the IMF seems to think nations will grow faster and be more prosperous if politicians seize more money from the economy’s productive sector.

Unfortunately, the IMF has been especially active in recent months..

In a column for the U.K.-based Guardian, Larry Elliott writes about the IMF using the pandemic as an excuse to push for higher taxes.

…the IMF called for domestic and international tax changes that would boost the money available to expand public services, make welfare states more generous… “To help meet pandemic-related financing needs, policymakers could consider a temporary Covid-19 recovery contribution, levied on high incomes or wealth,” the fiscal monitor said. …Paolo Mauro, the deputy director of the IMF’s fiscal affairs department, said there had been an “erosion” of the taxes paid by those at the top of the income scale, with the pandemic offering a chance to claw some of the money back. “Governments could consider higher taxes on property, capital gains and inheritance,” he said. “One specific option would be a Covid-19 recovery contribution – a surcharge on personal tax or corporate income tax.”

Mr. Mauro, like most IMF bureaucrats, is at “the top of the income scale,” but he doesn’t have to worry that he’ll be adversely impact if politicians seek to “claw some of the money back.”

Why? Because IMF officials get tax-free salaries (just like their counterparts at other international bureaucracies).

Writing for the IMF’s blog, Mr. Mauro is joined by David Amaglobeli and Vitor Gaspar in supporting higher taxes on other people.

Breaking the cycle of inequality requires both predistributive and redistributive policies. …The COVID-19 crisis has demonstrated the vital importance of a good social safety net that can be quickly activated to provide lifelines to struggling families. …Enhancing access to basic public services will require additional resources, which can be mobilized, depending on country circumstances, by strengthening overall tax capacity. Many countries could rely more on property and inheritance taxes.  Countries could also raise tax progressivity as some governments have room to increase top marginal personal income tax rates… Moreover, governments could consider levying temporary COVID-19 recovery contributions as supplements to personal income taxes for high-income households.

Needless to say, the IMF is way off base in fixating on inequality instead of trying to reduce poverty.

Meanwhile, Brian Cheung reports for Yahoo Finance about the IMF’s cheerleading for a global tax cartel.

The International Monetary Fund (IMF) says it backs a U.S. proposal for a global minimum corporate tax. IMF Chief Economist Gita Gopinath said that the fund has been calling for international cooperation on tax policy “for a long time,” adding that different corporate tax rates around the world have fueled tax shifting and avoidance. “That reduces the revenues that governments collect to do the needed social and economic spending,” Gopinath told Yahoo Finance Tuesday. “We’re very much in support of having this kind of global minimum corporate tax.” …Gopinath also backed Yellen’s push forward on an aggressive infrastructure bill… As the IMF continues to encourage countries with fiscal room to continue spending through the recovery, its chief economist said investment into infrastructure is one way to boost economic activity.

Based on the above stories we can put together a list of the tax increases embraced by the IMF, all justified by what I call “fairy dust” economics.

• Higher income tax rates.
• Higher property taxes.
• More double taxation of saving/investment.
• Higher death taxes.
• Wealth taxes.
• Global tax cartel.
• Higher consumption taxes.

And don’t forget the IMF is a long-time supporter of big energy taxes.

All supported by bureaucrats who are exempt from paying tax on their own very-comfortable salaries.

P.S. I feel sorry for two groups of people. First, I have great sympathy for taxpayers in nations that follow the IMF’s poisonous advice. Second, I feel sorry for the economists and other professionals at the IMF (who often produce high–quality research). They must wince with embarrassment every time garbage recommendations are issued by the political types in charge of the bureaucracy.

P.P.S. But since they’re actually competent, they will easily find new work if we shut down the IMF to protect the world economy.

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The Economics of Taxation

As part of a video debate last year (where I also discussed wealth taxation, poverty reduction, and the inadvisability of tax increases), I pontificated on the negative economic impact of class-warfare taxation.

To elaborate, I’m trying to help people understand why it is a mistake to impose class-warfare taxes on high-income taxpayers.

Back in 2019, I shared data from the Internal Revenue Service confirming that rich taxpayers get the vast majority of their income from business activity and investments.

And since it’s comparatively easy to control the timing, level, and composition of that income, class-warfare taxes generally backfire.

Heck, well-to-do taxpayers can simply shift all their investments into tax-free municipal bonds (that’s bad for the rest of us, by the way, since it’s better for growth if they invest in private businesses rather than buying bonds from state and local governments).

Or, they can simply buy growth stocks rather than dividend stocks because politicians (thankfully) haven’t figured out how to tax unrealized capital gains.

Some of my left-leaning readers probably think that my analysis can be ignored or dismissed because I’m a curmudgeonly libertarian.

But I’m simply recycling conventional economic thinking on these issues.

And to confirm that point, let’s review a study on taxes and growth that the International Monetary Fund published last December. Written by Khaled Abdel-Kader and Ruud de Mooij, there are passages that sound like they could have been written by yours truly.

Such as the observation that taxes hinder prosperity by reducing economic output (what economist refer to as deadweight loss).

…public finance…theories teach us some important lessons about efficient tax design. By transferring resources from the private to the public sector, taxes inescapably impose a loss on society that goes beyond the revenue generated. …deadweight loss (or excess burden) is what determines a tax distortion. Efficient tax design aims to minimize the total deadweight loss of taxes. The size of this loss depends on two main factors. First, losses are bigger the more responsive the tax base is to taxation. Second, the loss increases more than proportionately with the tax rate: adding a distortion to an already high tax rate is more harmful than adding it to a low tax rate. Two prescriptions for efficient tax policy follow: (i) it is efficient to impose taxes at a higher rate if things are in inelastic demand or supply; and (ii) it is best to tax as many things as possible to keep rates low. …empirical studies on the growth impact of taxes…generally find that income taxes are more distortive for economic growth than taxes on consumption.

There are several parts of the above passage that deserve extra attention, such as the observation about elasticity (similar to the point I made in the video about why higher tax rates on upper-income taxpayers are so destructive).

But the most important thing to understand is what the authors wrote about how “the [deadweight] loss increases more than proportionately with the tax rate.”

In other words, it’s more damaging to increase top tax rates.

This observation, which is almost certainly universally recognized in the economics profession, tells us why class-warfare taxes do the most economic damage, on a per-dollar-collected basis.

The IMF study also has worthwhile observations on different types of taxes, such as why it’s a good idea to have low income tax rates on people.

Optimal tax theory emphasizes the trade-off between equity and efficiency. …This requires balancing the revenue gain from a higher marginal top PIT rate at the initial base against the revenue loss induced by behavioral responses that a higher tax rate would induce—such as reduced labor effort, avoidance or evasion—measured by the elasticity of taxable income. …high marginal rates cause other adverse economic effects, e.g. on innovation and entrepreneurship, and thus create larger economic costs than is sometimes assumed.

Very similar to what I’ve written.

And low income tax rates on companies.

Capital income—interest, dividends and capital gains—is used for future consumption so that taxes on it correspond to a differentiated consumption tax on present versus future consumption—one that compounds if the time horizon expands. Prudent people who prefer to postpone consumption to later in life (or transfer it to their heirs) will thus be taxed more than those who do not, even though they have the same life-time earnings. This violates horizontal equity principles. Moreover, it causes a distortion by encouraging individuals to substitute future with current consumption, i.e. they reduce savings. The tax is therefore also inefficient. A classical result, formalized by Chamley (1986) and Judd (1985), is that the optimal tax on capital is zero.

Once again, very similar to what I’ve written.

Indeed, the study even asks whether there should be a corporate income tax when the same income already is subject to dividend taxation when distributed to shareholders.

…capital income taxes can be levied directly on the people that ultimately receive that income, i.e. shareholders and creditors. So: why is there a need for a CIT? It is hard to justify a CIT on efficiency grounds. As explained before, the incidence of the CIT in a small open economy falls largely on workers, not on the firm or its shareholders. Since it is more efficient to tax labor directly than indirectly, the optimal CIT is found to be zero. …CIT systems…in most countries…create two major economic distortions. First, by raising the cost of capital on equity they distort investment decisions. This hurts economic growth and adversely affects efficiency. Second, by differentiating between debt and equity, they induce a bias toward debt finance. This not only creates an additional direct welfare loss, but also threatens financial stability. Both distortions can be eliminated by…cash-flow taxes, which allow for full expensing of investment instead of deductions for tax depreciation

Also similar to what I’ve written.

And I like the fact that the study makes very sensible points about why there should not be a pro-debt bias in tax codes and why there should be “expensing” of business investment costs.

I’ll close by noting that the IMF study is not a libertarian document.

The authors are simply describing the economic costs of taxation and acknowledging the tradeoffs that exist when politicians impose various types of taxes (and the rates at which those taxes are imposed).

But that doesn’t mean the IMF is arguing for low taxes.

There are plenty of sections that make the (awful) argument that it’s okay to impose higher tax rates and sacrifice growth in order to achieve more equality.

And there are also sections that regurgitate the IMF’s anti-empirical argument that higher taxes can be good for growth if politicians wisely allocate the money so it is spent on genuine public goods.

Politicians doing what’s best for their countries rather than what’s best for themselves? Yeah, good luck with that.

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The IMF’s Poisonous Fiscal Advice for China

I have mixed feelings about China’s economic policies.

During the 1950s, 1960s, and 1970s, China was horrifically impoverished because of socialist policies. According to the Maddison database, the country was actually poorer under communism than it was 1,000 years ago.

But there was then a bit of economic liberalization starting in 1979. As a result, there’s been a significant increase in living standards and a huge reduction in poverty.

That’s the good news. And I sometimes use China’s post-1979 growth as an example of how even a modest bit of pro-market reform can generate positive results.

The bad news, though, is that China is still a relatively poor nation. Living standards are not only far below American levels, but per-capita economic output is also much lower than the levels in other East Asian nations.

Why hasn’t China caught up?

In part, it takes time for poorer nations to economically converge with richer nations.

But the bigger problem is that convergence is not going to happen unless China engages in a lot more economic reform.

According to the most-recent edition of the Fraser Institute’s Economic Freedom of the World, China is in the bottom quartile, ranked #124 out of 162 nations.

If you look at the the details of China’s score, you’ll notice that it does poorly in all areas. But the nation’s lowest score is for fiscal policy (“size of government”).

So if the goal is to help China converge, the obvious place to start is by shrinking the size and scope of government.

But not according to the bureaucrats at the International Monetary Fund.

In a recent report, the IMF actually advised China to move fiscal policy even further to the left.

I’m not joking. Here are the relevant excerpts.

A combination of a permanent strengthening of the social safety net with reforms to broaden the tax base and increase progressivity would provide effective household support. This would include: Expanding significantly the coverage of unemployment insurance… These efforts would be more effective if complemented with hiring subsidies and programs. …there remains ample scope to further increase transfers… Tax reforms could help improve the progressivity of the tax system as well as meet additional financing needs to permanently expand the social safety net.

This is so misguided, I’m at a loss for words.

But fortunately, I don’t need to be locquacious because Mihai Macovei already wrote an excellent article, critiquing the IMF’s statist approach, for the Mises Institute.

The IMF argues…that a “reliable and effective social safety system” and a “reduction of the high household savings rate” would rebalance and make “resilient” China’s growth model. But why would high saving and low consumption impede sustainable growth? Both sound economic theory and historic experience refute the mainstream’s claim that China needs a big welfare state like those of modern Western economies in order to get richer. …China’s social safety nets are much less generous than in advanced economies, in particular in terms of unemployment benefits and pension income… The fact that China has not built a highly redistributive welfare system like in most advanced economies is illustrated primarily by the very limited role played by the personal income tax (PIT) in income redistribution. …Only people in the top income quintile are effectively paying an income tax… As a result, the Chinese budget collects only 1.2 percent of GDP from PIT, compared to more than 10 percent of GDP in the US. …All this prompts the IMF…to call China’s taxation system “regressive” and to call for more progressive income taxation and redistribution. …In reality, China’s lighter taxation system reduces less people’s incentives to work and save compared to other economies. At the same time, less welfare redistribution ensures higher workforce participation and less waste relative to the oversized and increasingly unsustainable social safety nets in modern advanced economies. …the mainstream criticism of China’s high savings propensity, lean welfare system, and reduced progressivity of taxation seems utterly misplaced.

Mihai is obviously very polite. I would use all sorts of bad words to describe the IMF’s recommendations, but he simply observes that the bureaucracy’s approach is “utterly misplaced.”

To be fair, not everything in the report is nonsense. The IMF is correctly skeptical of China’s industrial policy, and the bureaucrats also understand that protectionism is economically foolish.

But they have a blind spot on fiscal policy, perhaps because IMF bureaucrats get lavish, tax-free salaries and thus have no way of understanding the real-world impact of punitive laws.

Though at least you can give the IMF credit for consistency. The bureaucrats also pushed for higher taxes and bigger government in China in 2015 and 2018.

As you might expect, I take the opposite approach and always urge pro-market reforms for the country.

P.S. Since we’re discussing China, here’s an amazing example of media bias.

P.P.S. The Organization for Economic Cooperation and Development is another international bureaucracy advocating for bad fiscal policy in China.

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The IMF Urges Nations to Adopt Greek-Style Fiscal Policy

Bernie Sanders was considered a hard-core leftist because his platform was based on higher taxes and higher spending.

Elizabeth Warren also was considered a hard-core leftist because she advocated a similar agenda of higher taxes and higher spending.

And Joe Biden, even though he is considered to be a moderate, is currently running on a platform of higher taxes and higher spending.

Want to know who else is climbing on the economically suicidal bandwagon of higher taxes and higher spending? You probably won’t be surprised to learn that the pro-tax International Monetary Fund just published its World Economic Outlook and parts of it read like the Democratic Party’s platform.

Here are some of the ways the IMF wants to expand the burden of government spending.

Investments in health, education, and high-return infrastructure projects that also help move the economy to lower carbon dependence… Moreover, safeguarding critical social spending can ensure that the most vulnerable are protected while also supporting near-term activity, given that the outlays will go to groups with a higher propensity to spend their disposable income… Some fiscal resources…should be redeployed to public investment—including in renewable energy, improving the efficiency of power transmission, and retrofitting buildings to reduce their carbon footprint. …social spending should be expanded to protect the most vulnerable where gaps exist in the safety net. In those cases, authorities could enhance paid family and sick leave, expand eligibility for unemployment insurance, and strengthen health care benefit coverage…social spending measures…strengthening social assistance (for example, conditional cash transfers, food stamps and in-kind nutrition, medical payments for low-income households), expanding social insurance (relaxing eligibility criteria for unemployment insurance…), and investments in retraining and reskilling programs.

And here’s a partial list of the various class-warfare taxes that the IMF is promoting.

Although adopting new revenue measures during the crisis will be difficult, governments may need to consider raising progressive taxes on more affluent individuals and those relatively less affected by the crisis (including increasing tax rates on higher income brackets, high-end property, capital gains, and wealth) as well as changes to corporate taxation that ensure firms pay taxes commensurate with profitability. …Efforts to expand the tax base can include reducing corporate tax breaks, applying tighter caps on personal income tax deductions, instituting value-added taxes.

Oh, by the way, if nations have any rules that protect the interests of taxpayers, the IMF wants “temporary” suspensions.

Where fiscal rules may constrain action, their temporary suspension would be warranted

Needless to say, any time politicians have a chance to expand their power, temporary becomes permanent.

When I discuss IMF malfeasance in my speeches, I’m frequently asked why the bureaucrats propose policies that don’t work – especially when the organization’s supposed purpose is to promote growth and stability.

The answer is “public choice.” Top IMF officials are selected by politicians and are given very generous salaries, and they know that the best way to stay on the gravy train is to support policies that will please those politicians.

And because their lavish salaries are tax free, they have an extra incentive to curry favor with politicians.

P.S. I wish there was a reporter smart enough and brave enough to ask the head of the IMF to identify a single nation – at any point in history – that became rich by expanding the size and cost of government.

P.P.S. There are plenty of good economists who work for the IMF and they often write papers pointing out the economic benefits of lower taxes and smaller government (and spending caps as well!). But the senior people at the bureaucracy (the ones selected by politicians) make all the important decisions.

 

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The International Monetary Fund, Negative-Sum Economics, and the Eighth Theorem of Government

At the risk of understatement, I’m not a fan of the International Monetary Fund (IMF).

The international bureaucracy is the “Johnny Appleseed” of moral hazard, using bailouts to reward profligate governments and imprudent lenders.

The IMF also is infamous for encouraging higher tax burdens, which is especially outrageous since its cossetted employees are exempt from paying tax on their lavish salaries.

In recent years, the IMF has been using inequality as a justification for statist policies. Most recently, the lead bureaucrat at the IMF, Kristalina Georgieva, cited that issue as a reason for governments to impose higher taxes to fund bigger welfare states.

…inequality has become one of the most complex and vexing challenges in the global economy. Inequality of opportunity. Inequality across generations. Inequality between women and men. And, of course, inequality of income and wealth. …The good news is we have tools to address these issues… Progressive taxation is a key component of effective fiscal policy. At the top of the income distribution, our research shows that marginal tax rates can be raised without sacrificing economic growth. …Gender budgeting is another valuable fiscal tool in the fight to reduce inequality…. The ability to scale up social spending is also essential… A cornerstone of our approach to issues of economic inclusion is our social spending strategy.

What’s especially remarkable is that the IMF has claimed that the punitive policies actually will lead to more growth, in stark contrast to honest people on the left who have always acknowledged the equity-efficiency tradeoff.

The economics editor at the left-leaning Guardian, Larry Elliott, is predictably delighted with the IMF’s embrace of Greek-style fiscal policy.

Raising income tax on the wealthy will help close the growing gap between rich and poor and can be done without harming growth, the head of the International Monetary Fund has said. Kristalina Georgieva, the IMF’s managing director, said higher marginal tax rates for the better off were needed as part of a policy rethink to tackle inequality. …The IMF managing director, who succeeded Christine Lagarde last year, said higher taxes on the better off…would help fund government spending to expand opportunities for those “communities and individuals that have been falling behind.” …Georgieva said the IMF recognised that social spending policies are increasingly relevant in tackling inequality. …She added that many less well-off countries needed to scale up social spending.

Ironically, the IMF actually has admitted that this approach is bad for prosperity.

It has produced research on something called “equally distributed equivalent income” to justify lower levels of income so long as economic misery is broadly shared.

I’m not joking. You can click here to see another example of the IMF embracing poverty if it means the rich disproportionately suffer.

In other words, negative-sum economics. Though Margaret Thatcher was more eloquent in her description of this awful ideology.

At first, this column was going to be a run-of-the-mill anti-IMF diatribe.

But as I contemplated how the people fixated on inequality are willing to treat the poor like sacrificial lambs, it occurred to me that this is a perfect opportunity to unveil my Eighth Theorem of Government.

P.S. Here are my other theorems of government.

• The “First Theorem” explains how Washington really operates.
• The “Second Theorem” explains why it is so important to block the creation of new programs.
• The “Third Theorem” explains why centralized programs inevitably waste money.
• The “Fourth Theorem” explains that good policy can be good politics.
• The “Fifth Theorem” explains how good ideas on paper become bad ideas in reality.
• The “Sixth Theorem” explains an under-appreciated benefit of a flat tax.
• The “Seventh Theorem” explains how bigger governments are less competent.

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The IMF Proposes a Giant Global Energy Tax

I’m not a big fan of the International Monetary Fund for the simple reason that the international bureaucracy undermines global prosperity by pushing for higher taxes, while also exacerbating moral hazard by providing bailouts to rich investors who foolishly lend money to dodgy and corrupt governments.

Six years ago, I complained that the bureaucrats wanted a giant energy tax, which would have diverted more than $5,000 from an average family’s budget.

That didn’t go anywhere, but the IMF hasn’t given up. Indeed, they’re now floating a new proposal for an enormous global energy tax.

To give credit to the IMF, the bureaucrats don’t mince words or disguise their agenda. The openly stated goal is to impose a giant tax increase.

Domestic policies are thus needed to give people and businesses greater incentives (through pricing or other means) to reduce emissions…international cooperation is key to ensure that all countries do their part. …The shift from fossil fuels will not only transform economic production processes, it will also profoundly change the lives of many people and communities. …Carbon taxes—charges on the carbon content of fossil fuels—and similar arrangements to increase the price of carbon, are the single most powerful and efficient tool… Even so, the global average carbon price is $2 a ton… To illustrate the extra effort needed by each country…, three scenarios are considered, with tax rates of $25, $50, and $75 a ton of CO2 in 2030.

The IMF asserts that the tax should be $75 per ton. At least based on alarmist predictions about climate warming.

What would that mean?

Under carbon taxation on a scale needed…, the price of essential items in household budgets, such as electricity and gasoline, would rise considerably… With a $75 a ton carbon tax, coal prices would typically rise by more than 200 percent above baseline levels in 2030… The price of natural gas…would also rise significantly, by 70 percent on average…carbon taxes would undoubtedly add to the cost of living for all households… In most countries, one-third to one-half of the burden of increased energy prices on households comes indirectly through higher general prices for consumer products.

Here’s a table from the publication showing how various prices would increase.

The bureaucrats recognize that huge tax increases on energy will lead to opposition (remember the Yellow Vest protests in France?).

So the article proposes various ways of using the revenues from a carbon tax, in hopes of creating constituencies that will support the tax.

Here’s the table from the report that outlines the various options.

To be fair, the microeconomic analysis for the various options is reasonably sound.

And if the bureaucrats embraced a complete revenue swap, meaning no net increase in money for politicians, there might be a basis for compromise.

However, it seems clear that the IMF favors a big energy tax combined with universal handouts (i.e., something akin to a “basic income“).

A political consideration in favor of combining carbon taxation with equal dividends is that such an approach creates a large constituency in favor of enacting and keeping the plan (because about 40 percent of the population gains, and those gains rise if the carbon price increases over time).

And other supporters of carbon taxes also want to use the revenue to finance a bigger burden of government.

Last but not least, it’s worth noting that the IMF wants to get poor nations to participate in this scheme by offering more foreign aid. That may be good for the bank accounts of corrupt politicians, but it won’t be good news for those countries.

And rich nations would be threatened with protectionism.

Turning an international carbon price floor into reality would require agreement among participants…participation in the agreement among emerging market economies might be encouraged through side payments, technology transfers…nonparticipants could be coerced into joining the agreement through trade sanctions…or border carbon adjustments (levying charges on the unpriced carbon emissions embodied in imports from nonparticipant countries to match the domestic carbon tax).

I’m amused, by the way, that the IMF has a creative euphemism (“border carbon adjustments”) for protectionism. I’m surprised Trump doesn’t do something similar (perhaps “border wage adjustment”).

For what it’s worth, the bureaucracy criticized Trump for being a protectionist, but I guess trade taxes are okay when the IMF proposes them.

But let’s not digress. The bottom line is that a massive global energy tax is bad news, particularly since politicians will use the windfall to expand the burden of government.

P.S. Proponents sometimes claim that a carbon tax is a neutral and non-destructive form of tax. That’s inaccurate. Such levies may not do as much damage as income taxes, on a per-dollar-collected basis, but that doesn’t magically mean there’s no economic harm (the same is true for consumption taxes and payroll taxes).

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The IMF, State Capacity, and Spurious Correlation

The International Monetary Fund is infamous for its advocacy of higher taxes.

Heck, it’s not merely advocacy. The international bureaucracy uses bailout money as a tool to coerce politicians into approving higher tax burdens.

This is so reprehensible that I’ve referred to the IMF as the “Dumpster Fire of the Global Economy” and called it the “Doctor Kevorkian of Global Economic Policy.”

The bureaucrats also are quite inventive when it comes to rationalizing tax increases.

For instance, a new report from the IMF suggests that a minimum tax level is critical for achieving rapid growth and development.

Is there a minimum tax to GDP ratio associated with a significant acceleration in the process of growth and development? We give an empirical answer to this question by investigating the existence of a tipping point in tax-to-GDP levels. We use two separate databases: a novel contemporary database covering 139 countries from 1965 to 2011 and a historical database for 30 advanced economies from1800 to 1980. We find that the answer to the question is yes. Estimated tipping points are similar at about 12¾ percent of GDP. For the contemporary dataset we find that a country just above the threshold will have GDP per capita 7.5 percent larger, after10 years. The effect is tightly estimated and economically large.

Here’s a depiction of the IMF’s perspective.

At some level, there is a correlation between prosperity and taxation. For instance, some poor nations in the developing world are so corrupt and incompetent that they are incapable of collecting much tax revenue.

But that doesn’t mean higher taxes would somehow make those nations richer. After all, correlation does not imply causation (i.e., crowing roosters don’t cause the sun to rise).

Professor Bryan Caplan of George Mason University points out the methodological shortcomings is the “state capacity” theory.

In recent years, many social scientists…have fallen in love with the concept of “state capacity.” …To my mind, this is scarcely better than saying, “Good government is good; bad government is bad.” Matters would be different, admittedly, if the state capacity literature showed that good government is the crucial ingredient required for success.  But researchers rarely even try to show this.  Instead, they look at various societies and say, “Look at how well-run the governments in successful countries are – and look at how poorly-run the governments in unsuccessful countries are.”  The casual causal insinuation is palpable. …why not just ditch your premature focus on “state capacity” in favor of an open-minded exploration of social capacity?  Good government might be the crucial ingredient for success.  But maybe good government is a byproduct of wealth, trust, intelligence, freedom, or some cocktail thereof. …While good social outcomes all tend to go together, the state capacity literature fails to show that government is the crucial factor that makes all the others possible.

Two other scholars from George Mason University, Professor Peter Boettke and Rosolino Candela, address the issue in an academic study.

This paper reconceptualizes and unbundles the relationship between public predation, state capacity and economic development. …we argue that to the extent that a causal relationship exists between state capacity and economic development, the relationship is proximate rather than fundamental. State capacity emerges from an institutional context in which the state is constrained from preying on its citizenry in violation of predefined rules limiting its discretion. When political constraints are not established to limit political discretion, then state capacity will degenerate from a means of delivering economic development to a means of predation.

They cite Mancur Olson’s work on “political bandits” to understand the limited conditions that would be necessary for there to be a causal relationship between taxes and growth.

Olson’s famous distinction between a “stationary bandit” and a “roving bandit” provides an illustration of our point regarding the emphasis placed on initial conditions. Olson provides a powerful argument for understanding how the self-interest of a revenue-maximizing ruler will align with the political conditions necessary for wealth maximization, not only for himself, but also for his subjects. In a world of roving banditry, a political ruler will have little incentive to invest in fiscal technologies required for regular taxation and judicial technologies that secure property rights and enforce contracts. Only when a bandit has settled down will he or she be incentivized to invest in the provision of public goods that encourage individuals to accumulate wealth, rather than concealing it from predators. However, by Olson’s own admission, his stationary bandit argument is a necessary, though not a sufficient condition for taming public predation.

Their conclusion is that constitutional constants on government are needed to ensure taxes aren’t a tool for additional predation.

In unbundling the relationship between state capacity and economic development, we have distinguished between the protective state, the productive state and the predatory state. To the extent that expansions in state capacity are consistent with economic development, this is because a credible commitment to a set of rules that constrain political discretion have been established. …Fundamentally, economic development requires a protective state from which state capacity emerges as a byproduct. If, however, political constraints are not established to limit political discretion, then state capacity will degenerate from a means of delivering economic development to a means of predation.

Professor Mark Koyama of George Mason University also has written wisely on this topic.

I’m not an academic, so I have a much simpler way of thinking about this issue.

When the IMF (and other bureaucracies) assert that higher taxes are good for growth, I explain that it’s all based on fairy dust or magic beans.

P.S. In a perverse way, I admire the IMF. The bureaucracy’s rationale for existence (dealing with fixed exchange rates) disappeared decades ago, yet the IMF managed to reinvent itself and is now bigger and more bloated than ever.

P.P.S. You won’t be surprised to learn that IMF bureaucrats receive tax-free salaries while pushing for higher taxes on everyone else.

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Four Things to Understand about the Taxation of International Businesses

A few years ago, I put together a basic primer on corporate taxation. Everything I wrote is still relevant, but I didn’t include much discussion about international topics.

In part, that’s because those issues are even more wonky and more boring than domestic issues such as depreciation. But that doesn’t mean they’re not important – especially when they involve tax competition. Here are some comments I made in March of last year.

The reason I’m posting this video about 18 months after the presentation is that the issue is heating up.

The tax-loving bureaucrats at the International Monetary Fund have published a report whining about the fact that businesses utilize low-tax jurisdictions when making decisions on where to move money and invest money.

According to official statistics, Luxembourg, a country of 600,000 people, hosts as much foreign direct investment (FDI) as the United States and much more than China. Luxembourg’s $4 trillion in FDI comes out to $6.6 million a person. FDI of this size hardly reflects brick-and-mortar investments in the minuscule Luxembourg economy. …much of it is phantom in nature—investments that pass through empty corporate shells. These shells, also called special purpose entities, have no real business activities. Rather, they carry out holding activities, conduct intrafirm financing, or manage intangible assets—often to minimize multinationals’ global tax bill. …a few well-known tax havens host the vast majority of the world’s phantom FDI. Luxembourg and the Netherlands host nearly half. And when you add Hong Kong SAR, the British Virgin Islands, Bermuda, Singapore, the Cayman Islands, Switzerland, Ireland, and Mauritius to the list, these 10 economies host more than 85 percent of all phantom investments.

That’s a nice list of jurisdictions. My gut instinct, of course, is to say that high-tax nations should copy the pro-growth policies of places such as Bermuda, Singapore, the Cayman Islands, and Switzerland.

The IMF, however, thinks those are bad places and instead argues that harmonization would be a better approach.

…how does this handful of tax havens attract so much phantom FDI? In some cases, it is a deliberate policy strategy to lure as much foreign investment as possible by offering lucrative benefits—such as very low or zero effective corporate tax rates. …This…erodes the tax bases in other economies. The global average corporate tax rate was cut from 40 percent in 1990 to about 25 percent in 2017, indicating a race to the bottom and pointing to a need for international coordination. …the IMF put forward various alternatives for a revised international tax architecture, ranging from minimum taxes to allocation of taxing rights to destination economies. No matter which road policymakers choose, one fact remains clear: international cooperation is the key to dealing with taxation in today’s globalized economic environment.

Here’s a chart that accompanied the IMF report. The bureaucrats view this as proof of something bad

I view it as prudent and responsible corporate behavior.

At the risk of oversimplifying what’s happening in the world of international business taxation, here are four simple points.

1. It’s better for prosperity if money stays in the private sector, so corporate tax avoidance should be applauded. Simply stated, politicians are likely to waste any funds they seize from businesses. Money in the private economy, by contrast, boosts growth.
2. Multinational companies will naturally try to “push the envelope” and shift as much income as possible to low-tax jurisdictions. That’s sensible corporate behavior, reflecting obligation to shareholders, and should be applauded.
3. Nations can address “profit shifting” by using rules on “transfer pricing,” so there’s no need for harmonized rules. If governments think companies are pushing too far, they can effectively disallow tax-motivated shifts of money.
4. A terrible outcome would be a form of tax harmonization known as “global formula apportionment.” This wouldn’t be harmonizing rates, as the E.U. has always urged, but it would force companies to overstate income in high-tax nations.

Why does all this wonky stuff matter?

As I said in my presentation, we will suffer from “goldfish government” unless tax competition exiss to serve as a constraint on the tendency of politicians to over-tax and over-spend.

P.S. Sadly, America’s Treasury Secretary is sympathetic to global harmonization of business taxation.

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The IMF’s Brexit Analysis: Predictably Shoddy and Politicized

Back in 2016, I wrote “The Economic Case for Brexit.”

My argument was based on the fact the European Union was a slowly sinking ship, both because of grim demographics and bad public policy.

Getting in a lifeboat can be unnerving, but Brexit was – and still is – better than the alternative of continued E.U. membership.

But not everyone shared my perspective.

The BBC reported that year that Brexit would produce terrible consequences according to the International Monetary Fund.

Christine Lagarde said she had “not seen anything that’s positive” about Brexit and warned that it could “lead to a technical recession”. …The IMF said in a report on the UK economy that a leave vote could have a “negative and substantial effect”. It has previously said that such an outcome could lead to “severe regional and global damage”. The Fund said a Brexit vote would result in a “protracted period of heightened uncertainty” and could result in a sharp rise in interest rates, cause volatility on financial markets and damage London’s status as a global financial centre.

Yet none of these bad predictions were accurate.

Not right away and not in the three years since U.K. voters opted for independence.

Not that we should be surprised. The IMF has a very bad track record on economic forecasting. And the forecasts are probably especially inaccurate when the bureaucrats, given the organization’s statist bias, are trying to influence the outcome (the IMF was part of “Project Fear”).

But a history of bias and inaccuracy hasn’t stopped the IMF from continuing to interfere with British politics. Here are some excerpts from a story earlier this week.

Boris Johnson has been warned that a No Deal Brexit is one of the biggest risks facing the global economy. In a broadside against the new Prime Minister’s ‘do or die’ pledge to leave the European Union at the end of October with or without a deal, the International Monetary Fund said a chaotic departure could cause havoc across the world. …No Deal is one of the gravest threats to international economic performance, the IMF said. …Eurosceptics have long criticised the IMF for anti-Brexit rhetoric and it has been one of the loudest opponents of No Deal, saying in April that it could trigger a lengthy UK recession.

I was both disgusted and upset when I read this story.

I don’t like when the IMF subsidizes bad policy with bailouts, and I also don’t like when it promotes bad policy with analysis.

Fortunately, I don’t need to do any substantive number crunching because Professor Steve Hanke of Johns Hopkins University has a superb Forbes column on this exact issue.

No sooner than Boris Johnson put his foot over the threshold of 10 Downing Street, the International Monetary Fund (IMF) offered its unsolicited advice… In a preemptive strike, the Philosopher Kings threw cold water on the idea of a no deal, asserting that it would be a disaster. …such meddling is nothing new for the IMF. Indeed, a bipartisan Congressional commission (The International Financial Advisory Commission, known as the Meltzer Commission) concluded in 2000 that the IMF interferes too much in the domestic politics of member countries.

Professor Hanke is perplexed that anyone would listen to IMF bureaucrats given their awful track record.

…the IMF’s ability to…thrive…is quite remarkable in light of the IMF’s performance. As Harvard University’s Robert Barro put it, the IMF reminds him of Ray Bradbury’s Fahrenheit 451 “in which the fire department’s mission is to start fires.” Barro’s basis for that conclusion is his own extensive research.  His damning evidence finds that: A higher IMF loan participation rate reduces economic growth. IMF lending lowers investment. A greater involvement in IMF programs lowers the level of the rule of law and democracy. And if that’s not bad enough, countries that participate in IMF programs tend to be recidivists. In short, IMF programs don’t provide cures, but create addicts.

This is why I’ve referred to the IMF as the “dumpster fire” of the world economy and also called the bureaucracy the “Dr. Kevorkian” of international economic policy.

By the way, here’s Professor Hanke’s table of the IMF’s main addicts.

I wrote just two weeks ago about the IMF’s multiple bailouts of Pakistan, the net effect of what have been to subsidize bigger government.

Let’s close with more of Professor Hanke’s analysis.

The original reason for its creation has completely vanished.

The IMF, which was born in 1944, was designed to provide short-term assistance on the cheap to countries whose currencies were pegged to the U.S. dollar via the Bretton Woods Agreement. …But, in 1971, when President Richard Nixon closed the gold window, the Bretton Woods exchange-rate system collapsed. And, with that, the IMF’s original purpose was swept into the dustbin. However, since then, the IMF has used every rationale under the sun to reinvent itself and expand its scope and scale. …And, in the process of acquiring more power, it has become more political.

Sadly, he is not optimistic about shutting down this destructive – and cossetted – bureaucracy.

The IMF should have been mothballed and put in a museum long ago. After all, its original function was buried in 1971, and its performance in its new endeavors has been less than stellar. But, a museum for the IMF is not in the cards. …About all we can do is realize that the IMF is a political hydra with an agenda to serve the wishes of the political elites who allow it to grow new heads.

P.S. Here’s my explanation of how the U.K. can prosper in a post-Brexit world.

P.P.S. Here’s some academic research explaining how E.U. membership has undermined prosperity for member nations.

P.P.P.S. If you want Brexit-related humor, click here and here.

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Pakistan: A Case Study of IMF Malfeasance

I’ve labeled the International Monetary Fund as the “dumpster fire” of the world economy.

I’ve also called the bureaucracy the “Dr. Kevorkian” of international economic policy, though that reference many not mean anything to younger readers.

My main complaint is that the IMF is always urging – or even extorting – nations to impose higher tax burdens.

Let’s look at a fresh example of this odious practice.

According to a Reuters report, IMF-supported tax increases are provoking economic strife in Pakistan.

Markets and wholesale merchants across Pakistan closed on Saturday in a strike by businesses against measures demanded by the International Monetary Fund… Markets and wholesale merchants across Pakistan closed on Saturday in a strike by businesses against measures demanded by the International Monetary Fund. …Prime Minister Imran Khan’s government..is having to impose tough austerity measures having been forced to turn to the IMF for Pakistan’s 13th bailout since the late 1980s. …Under the IMF bailout, signed this month, Pakistan is under heavy pressure to boost its tax revenues.

I’m not surprised the private sector is protesting against IMF-instigated tax hikes.

We see similar stories from all over the world.

But what really grabbed my attention was the reference to 13 bailouts. Good grief, you would think the IMF bureaucrats would learn after five or six attempts that they shouldn’t throw good money after bad.

That being said, I wondered if the IMF was pushing for big tax hikes because they had demanded – and received – big spending cuts in exchange for the previous 12 bailouts.

So I went to the IMF’s World Economic Outlook Database to peruse the numbers…and I discovered that the IMF’s repeated bailouts actually led to big increases in the burden of spending.

The IMF’s numbers, which go back to 1993, show that outlays have tripled. And that’s after adjusting for inflation!

Looking closely at the chart, I suppose one could argue that Pakistan was semi-responsible up until the turn of the century. Yes, the spending burden increased, but at a relatively mild rate.

But the brakes definitely came off this century. Enabled by endless bailouts from the IMF, Pakistan’s politicians definitely aren’t complying with my Golden Rule.

I’ll close with one final point.

The IMF types, as well as others on the left, actually want people to believe that Pakistan should have a bigger burden of government spending.

According to this novel theory, the public sector in the country, which currently consumes more than 20 percent of GDP, is too small to finance the “investments” that are needed to enable more prosperity.

Yet if this theory is accurate, why is Pakistan’s economy stagnant when there are prosperous jurisdictions with smaller spending burdens, such as Hong Kong, Singapore, and Taiwan?

And if the theory is accurate, why did the United States and Western Europe become rich in the 1800s, back when governments only consumed about 10 percent of economic output?

This video tells you everything you need to know.

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IMF Research Shows Higher Business Taxes Reduce Likelihood of Firm Survival

The International Monetary Fund is one of my least favorite international bureaucracies because the political types who run the organization routinely support bad policies such as bailouts and tax increases.

But there are professional economists at the IMF who do good work.

While writing about the mess in Argentina yesterday, for instance, I cited some very sensible research from one of the IMF’s economists.

Today, I’m going to cite two other IMF scholars. Serhan Cevik and Fedor Miryugin have produced some new research looking at the relationship between firm survival and business taxation. Here’s the basic methodology of their study.

While creative destruction—through firm entry and exit—is essential for economic progress, establishing a conducive ecosystem for firm survival is also necessary for sustainable private sector development… While corporate income taxes are expected to lower firms’ capital investment and productivity by raising the user cost of capital, distorting factor prices and reducing after-tax return on investment, taxation also provides resources for public infrastructure investments and the proper functioning of government institutions, which are key to a firm’s success. …the overall impact of taxation on firm performance depends on the relative weight of these two opposing effects, which can vary with the composition and efficiency of taxation and government spending. … In this paper, we focus on how taxation affects the survival prospects of nonfinancial firms, using hazard models and a comprehensive dataset covering over 4 million nonfinancial firms from 21 countries with a total of 21.5 million firm-year observations over the period 1995–2015. …we control for a plethora of firm characteristics, such as age, size, profitability, capital intensity, leverage and total factor productivity (TFP), as well as systematic differences across sectors and countries.

By the way, I agree that there are some core public goods that help an economy flourish. That being said, things like courts and national defense can easily be financed without any income tax.

And even with a very broad definition of public goods (i.e., to include infrastructure, education, etc), it’s possible to finance government with very low tax burdens.

But I’m digressing.

Let’s focus on the study. As you can see, the authors grabbed a lot of data from various European nations.

And they specifically measured the impact of the effective marginal tax rate on firm survival.

Unsurprisingly, higher tax burdens have a negative effect.

We find that the tax burden—measured by the firm-specific EMTR—exerts an adverse effect on companies’ survival prospects. In other words, a lower level of EMTR increases the survival probability among firms in our sample. This finding is not only statistically but also economically important and remains robust when we partition the sample into country subgroups. …digging deeper into the tax sensitivity of firm survival, we uncover a nonlinear relationship between the firm-specific EMTR and the probability of corporate failure, which implies that taxation becomes a detriment to firm survival at higher levels. With regards to the impact of other firm characteristics, we obtain results that are in line with previous research and see that survival probability differs depending on firm age and size, with older and larger firms experiencing a lower risk of failure.

For those that like statistics, here are the specific results.

Here are the real-world implications.

Reforms in tax policy and revenue administration should therefore be designed to cut the costs of compliance, facilitate entrepreneurship and innovation, and encourage alternative sources of financing by particularly addressing the corporate debt bias. In this context, the EMTR holds a special key by influencing firms’ investment decisions and the probability of survival over time, especially in capital intensive sectors of the economy. Importantly, the challenge for policymakers is not simply reducing the statutory CIT rate, but to level the playing field for all firms by rationalizing differentiated tax treatments across sectors, capital asset types and sources of financing.

There are some obvious takeaways from this research.

• First, it’s a very good idea to lower corporate tax rates.
• Second, it’s a good idea to treat all businesses the same.
• Third, it’s a good idea to treat debt and equity alike.

For what it’s worth, this IMF study basically embraces the sensible principles of business taxation that you find in a flat tax.

Too bad we can’t convince the political types who run the IMF to push the policies supported by IMF economists!

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The Macro Damage of Trade Taxes

In a video I shared two months ago included a wide range of academic studies showing that government-imposed trade barriers undermine economic prosperity.

Not that those results were a surprise. Theory teaches us that government intervention is a recipe for economic harm. And we certainly have painful history showing the adverse consequences of protectionism.

When I debate the issue, I like to cite real-world examples, such as the fact that the nations with the lowest trade barriers tend to be very prosperous while protectionist nations are economic laggards.

No wonder there’s such a strong consensus among economists.

Today, we’re going to add to pro-trade consensus.

A new study from the International Monetary Fund investigates the macroeconomic impact of trade taxes. Here’s the basic outline of the methodology.

Some economies have recently begun to use commercial policy, seemingly for macroeconomic objectives. So it seems an appropriate time to study what, if any, the macroeconomic consequences of tariffs have actually been in practice. Most of the predisposition of the economics profession against protectionism is based on evidence that is either a) theoretical, b) micro, or c) aggregate and dated. Accordingly, in this paper, we study empirically the macroeconomic effects of tariffs using recent aggregate data. …Our panel of annual data is long if unbalanced, covering 1963 through 2014; more recent data is of greater relevance, but older data contains more protectionism. Since little protectionism remains in rich countries, we use a broad span of 151 countries, including 34 advanced and 117 developing countries.

And here are the results.

Our results suggest that tariff increases have adverse domestic macroeconomic and distributional consequences. We find empirically that tariff increases lead to declines of output and productivity in the medium term, as well as increases in unemployment and inequality. … a one standard deviation (or 3.6 percentage point) tariff increase leads to a decrease in output of about .4% five years later. We consider this effect to be plausibly sized and economically significant… Why does output fall after a tariff increase? …a key channel is the statistically and economically significant decrease in labor productivity, which cumulates to about .9% after five years. …Protectionism also leads to a small (statistically marginal) increase in unemployment…we find that tariff increases lead to more inequality, as measured by the Gini index; the effect becomes statistically significant two years after the tariff change. To summarize: the aversion of the economics profession to the deadweight losses caused by protectionism seems warranted; higher tariffs seem to have lower output and productivity, while raising unemployment and inequality. … there are asymmetric effects of protectionism; tariff increases hurt the economy more than liberalizations help.

These graphs show the main results.

The simple way to think about this data is that protectionism forces an economy to operate with sand in the gears. Another analogy is that protectionism is like having to deal with permanent and needless road detours. You can still get where you want to go, but at greater cost.

The bottom line is that things simply don’t function smoothly once government intervenes.

Lower growth, reduced productivity, and higher unemployment are obvious and inevitable consequences, as shown in the IMF study.

And while I don’t worry about inequality when some people get richer faster than other people get richer in a genuine free market, it’s morally disgusting for politicians to support protectionist policies that are especially harmful to the poor.

P.S. Everything in the IMF study about the damage of trade taxes also applies to the economic analysis of other forms of taxation. Indeed, deadweight losses presumably are even higher when considering income taxes. So the IMF deserves to be castigated for putting politics above economics when it pimps for higher taxes.

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The Bigger the IMF, the Greater the Risk of Profligacy, Debt, and Crisis

I’m not a big fan of the International Monetary Fund and I regularly criticize the international bureaucracy for its relentless advocacy in favor of higher taxes.

But that’s not what worries me most about the IMF.

To be sure, higher fiscal burdens undermine economic vitality, and I regularly warn that such policies will reduce an economy’s potential long-run growth rate.

That being said, tax increases generally don’t threaten macroeconomic stability.

If we’re looking at policies that can trigger short-run crises, I’m more concerned about the IMF’s bailout policies. For all intents and purposes, the IMF subsidizes “moral hazard” by reducing the perceived cost (to financial institutions) of lending money to dodgy governments and reducing the perceived costs (to governments) of incurring more debt.

Why not take more risk, after all, if you think the IMF will step in to socialize any losses? In other words, when the IMF engages in a few bailouts today, it increases the likelihood of more bailouts in the future.

That’s the bad news. The worse news is that the bureaucrats want a bigger figurative checkbook to enable even bigger future bailouts.

The good news is that the U.S. government can say no.

But will it? The U.K.-based Financial Times reported a few days ago that the United States might support an expansion of the IMF’s bailout capacity.

The Trump administration has left the door open for a US funding boost to the IMF, calling for a “careful evaluation” of the global lender’s finances to make sure it has enough money to rescue struggling economies. …The IMF — led by Christine Lagarde, a former French finance minister — is hoping to get its members to increase the fund’s permanent reserves… This year, the Trump administration has been among the most enthusiastic supporters of the IMF’s $57bn loan package to Argentina— its largest in history.

The next day, the FT augmented its coverage.

The IMF is set to embark on a major fundraising drive…the success of Ms Lagarde’s campaign is highly uncertain, with potentially profound consequences not only for the fund but for the global economy. …supporters of the fund say there are many possible scenarios in which it would be essential. If a recession and financial crisis were to hit in the coming years,central bankers may well struggle to find monetary remedies… a US Treasury spokesman left the door open to new possible contributions from America to the IMF. …Optimists point to a surprise decision by the Trump administration in April to support a $13bn boost to World Bank resources… there is still scepticism of the IMF among his top lieutenants at the Treasury department, including David Malpass, the undersecretary for international affairs. …Even if they were on board, economic and national security hawks at the White House who disdain multilateralism as a loss of sovereignty could be an additional obstacle, not to mention Republican lawmakers on Capitol Hill. The previous IMF quota increase, pushed by the Obama administration — which raised America’s permanent commitment to the fund to about $115bn — finally scraped through Congress in 2016, after a half-decade delay.

I was very saddened a couple of years ago when the GOP Congress agreed to expand the IMF’s bailout authority, especially since a similar effort was blocked in 2014 when Democrats still controlled the Senate.

The issue today is whether the Trump Administration will repeat that mistake.

Back in 2012, I stated that the IMF issue was a “minimum test” for Republicans. Well, the issues haven’t changed. Everything I wrote then still applies today.

I hope Trump does the right thing and rejects expanded bailout authority for the IMF for the sensible reason that it’s foolish to subsidize more borrowing by badly governed nations.

But I’m not picky. I’ll also be happy if Trump says no simply because he’s miffed that the IMF attacked him (accurately but unfairly) during the 2016 campaign and dissed his tax plan earlier this year.

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Identifying (and Preventing) Future Greek-Style Fiscal Collapses

Way back in early 2011, I wrote about the likelihood of various nations suffering a Greek-style meltdown. After speculating on the importance of debt burdens and interest payments, I concluded that

…which nation will be the next domino to fall? …Some people think total government debt is the key variable…that’s not necessarily a good rule of thumb. …Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe… The moral of the story is that there is no magic point where deficit spending leads to a fiscal crisis, but we do know that it is a bad idea for governments to engage in reckless spending over a long period of time. That’s a recipe for stifling taxes and large deficits. And when investors see the resulting combination of sluggish growth and rising debt, eventually they will run out of patience.

As I noted earlier this year, it’s not easy to predict the point at which “investors no longer trust that they will receive payments on government bonds.”

Though that would be useful information, which is why a new study from the International Monetary Fund could be very helpful. The researchers look at how to measure fiscal crisis.

The literature on fiscal crises and on early warning indicators is limited, although it has expanded in recent years. Most of the past literature focused on sovereign external debt defaults alone …the canonical fiscal crisis is a debt crisis, when the government is unable to service the interest and or principle as scheduled. … It is important to note, however, that fiscal crises may not necessarily be associated with external debt defaults. They can be associated with other forms of expropriation, including domestic arrears and high inflation that erodes the value of some types of debt. …a fiscal crisis is identified when one or more of the following distinct criteria are satisfied: …Credit events associated with sovereign debt (e.g., outright defaults and restructuring). …Recourse to large-scale IMF financial support. …Implicit domestic public default (e.g., via high inflation rates). …Loss of market confidence in the sovereign.

The goal is to figure out the conditions that precipitate problems.

…The objective of this paper is to better understand the structural weaknesses that make countries prone to entering a fiscal crisis. …We use two of the more common approaches to build early warning systems (EWS) for fiscal crises: the signal approach and logit model. …event studies indicate that a fiscal crisis tends to be preceded by loose fiscal policy (Figure 3.1). In the run-up to a crisis, there is robust real expenditure growth.

Some of the obvious variables, as noted above and also in Figure 3.1 (the dashed vertical line is the year a crisis occurs), are whether there’s a rising burden of government spending and whether the economy is growing.

For readers who like wonky material, the authors explain the two approaches they use.

In order to construct early warning systems for fiscal crises, we adopt two alternative approaches that have been used in the literature. We first use the signal approach, followed by multivariate logit models. …The signals approach involves monitoring the developments of economic variables that tend to behave differently prior to a crisis. Once they cross a specific threshold this gives a warning signal for a possible fiscal crisis in the next 1-2 years. …Logit model…early warning systems…draw on standard panel regression…with a binary dependent variable equal to one when a crisis begins (or when there is a crisis). …The main advantage of this approach is that it allows testing for the statistical significance of the different leading indicators and takes into account their correlation.

Then they crunch a bunch of numbers.

Here’s what they find using the signal approach.

…current account deficit, degree of openness, use of central bank credit to finance the deficit, size of the fiscal (overall or primary) deficit and pace of expansion in public expenditures—all these increase the probability of a future crisis.

And here’s what they conclude using the logit approach.

The results, by and large, highlight similar leading indicators as the signals approach… The probability of entering a crisis increases with growing macroeconomic imbalances due to large output gaps and deteriorating external imbalances. The results also indicate a role for fiscal policy, via public expenditures growth. … high expenditure growth could contribute to a deterioration in the current account and a large output gap, making the fiscal position vulnerable to changes in the economic cycle.

The bottom line is that both approaches yield very similar conclusions.

Our results show that there is a small set of robust leading indicators (both fiscal and non-fiscal) that help assess the probability of a fiscal crisis. This is especially the case for advanced and emerging markets. For these countries, we find that domestic imbalances (large output or credit gaps), external imbalances (current account deficit), and rising public expenditures increase the probability of a crisis. …Our results suggest that indeed fiscal variables matter. Strong expenditure growth and financing pressures (e.g., need for central bank financing) can help predict crises.

Some of this data is reflected in Figure 5.2.

And here’s the bottom line, starting with the claim that governments are being semi-responsible because we don’t actually see many fiscal crises.

…we find that some types of vulnerabilities are consistently relevant to explain fiscal crises. This raises the question why governments do not act as they see signals. In large measure they do, as crises among advanced economies are rare. Still, the occurrence of crises may reflect overly optimistic projections about the future… Our results show that a relatively small set of robust leading indicators can help assess the probability of a fiscal crisis in advanced and emerging markets with high accuracy. …countries can reduce the frequency of fiscal crises by adopting prudent policies and strengthening risk management. Fiscal crises are more likely when economies build domestic and external imbalances. This calls for avoiding excessively loose polices when domestic growth is above average. For fiscal policy, this means avoiding procyclical increases in expenditures.

The key takeaway is that spending restraint is a very important tool for avoiding a fiscal crisis.

Yes, a few other factors also are important (central bankers should avoid irresponsible monetary policy, for instance), but some of these are outside the direct control of politicians.

Which is why this new research underscores the importance of some sort of spending cap, preferably enshrined in a jurisdiction’s constitution like in Hong Kong and Switzerland.

P.S. While there haven’t been many fiscal crises in developed nations, that may change thanks to very unfavorable demographics and poorly designed entitlement programs.

P.P.S. I hope the political decision makers at the IMF read this study (as well as prior IMF studies on the efficacy of spending caps) and no longer will agitate for tax increases on nations that get into fiscal trouble.

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Class-Warfare Taxes Are Most Harmful to Prosperity

When I write about the economics of fiscal policy and need to give people an easy-to-understand explanation on how government spending affects growth, I share my four-part video series.

But. other than a much-too-short primer on growth and taxation from 2016, I don’t have something similar for tax policy. So I have to direct people to various columns about marginal tax rates, double taxation, tax favoritism, tax reform, corporate taxation, and tax competition.

Today’s column isn’t going to be a comprehensive analysis of taxes and growth, but it is going to augment the 2016 primer by taking a close look at how some taxes are more destructive than others.

And what makes today’s column noteworthy is that I’ll be citing the work of left-leaning international bureaucracies.

Let’s look at a study from the OECD.

…taxes…affect the decisions of households to save, supply labour and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues…investigating how tax structures could best be designed to promote economic growth is a key issue for tax policy making. … this study looks at consequences of taxes for both GDP per capita levels and their transitional growth rates.

For all intents and purposes, the economists at the OECD wanted to learn more about how taxes distort the quantity and quality of labor and capital, as illustrated by this flowchart from the report.

Here are the main findings (some of which I cited, in an incidental fashion, back in 2014).

The reviewed evidence and the empirical work suggests a “tax and growth ranking” with recurrent taxes on immovable property being the least distortive tax instrument in terms of reducing long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes. …relying less on corporate income relative to personal income taxes could increase efficiency. …Focusing on personal income taxation, there is also evidence that flattening the tax schedule could be beneficial for GDP per capita, notably by favouring entrepreneurship. …Estimates in this study point to adverse effects of highly progressive income tax schedules on GDP per capita through both lower labour utilisation and lower productivity… a reduction in the top marginal tax rate is found to raise productivity in industries with potentially high rates of enterprise creation. …Corporate income taxes appear to have a particularly negative impact on GDP per capita.”

Here’s how the study presented the findings. I might quibble with some of the conclusions, but it’s worth noting all the minuses in the columns for marginal tax, progressivity, top rates, dividends, capital gains, and corporate tax.

This is all based on data from relatively prosperous countries.

A new study from the International Monetary Fund, which looks at low-income nations rather than high-income nations, reaches the same conclusion.

The average tax to GDP ratio in low-income countries is 15% compared to that of 30% in advanced economies. Meanwhile, these countries are also those that are in most need of fiscal space for sustainable and inclusive growth. In the past two decades, low-income countries have made substantial efforts in strengthening revenue mobilization. …what is the most desirable tax instrument for fiscal consolidation that balances the efficiency and equity concerns. In this paper, we study quantitatively the macroeconomic and distributional impacts of different tax instruments for low-income countries.

It’s galling that the IMF report implies that there’s a “need for fiscal space” and refers to higher tax burdens as “strengthening revenue mobilization.”

But I assume some of that rhetoric was added at the direction of the political types.

The economists who crunched the numbers produced results that confirm some of the essential principles of supply-side economics.

…we conduct steady state comparison across revenue mobilization schemes where an additional tax revenues equal to 2% GDP in the benchmark economy are raised by VAT, PIT, and CIT respectively. Our quantitative results show that across the three taxes, VAT leads to the least output and consumption losses of respectively 1.8% and 4% due to its non-distorting feature… Overall, we find that among the three taxes, VAT incurs the lowest efficiency costs in terms of aggregate output and consumption, but it could be very regressive… CIT, on the other hand, though causes larger efficiency costs, but has considerable better inequality implications. PIT, however, deteriorates both the economic efficiency and equity, thus is the most detrimental instrument.

Here’s the most important chart from the study. It shows that all taxes undermine prosperity, but that personal income taxes (grey bar) and corporate income tax (white bar) do the most damage.

I’ll close with two observations.

First, these two studies are further confirmation of my observation that many – perhaps most – economists at international bureaucracies generate sensible analysis. They must be very frustrated that their advice is so frequently ignored by the political appointees who push for statist policies.

Second, some well-meaning people look at this type of research and conclude that it would be okay if politicians in America imposed a value-added tax. They overlook that a VAT is bad for growth and are naive if they think a VAT somehow will lead to lower income tax burdens.

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The IMF Proposes (again) to Sabotage China’s Economy

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

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

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

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

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

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

Here’s the basic premise of the paper.

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

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

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

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

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

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

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

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

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

Ironically, the IMF study actually makes my point.

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

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

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

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

Which leads them to make horrifyingly bad recommendations.

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

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

To finance a larger burden of government spending.

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

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

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

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

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

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

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

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The IMF’s Reprehensible Campaign for Continued Poverty in Sub-Saharan Africa

A couple of months ago, I thought I did something meaningful by sharing six separate examples of the International Monetary Fund pressuring sub-Saharan African nations to impose higher tax burdens. This was evidence, I suggested, that the IMF had a disturbing agenda of bigger government for the entire region.

I didn’t imply the bureaucrats were motivated by racism. After all, the IMF has pushed for higher taxes in the United States, in China, in Latin America, in the Middle East, and in Europe. (folks who work at the IMF don’t pay taxes on their own salaries, but they clearly believe in equal opportunity when urging higher taxes for everyone else).

Nonetheless, I thought it was scandalous that the IMF was systematically agitating for taxes in a region that desperately needs more investment and entrepreneurship. And my six examples were proof of a continent-wide agenda!

But it turns out that I wasn’t exposing some sort of sinister secret. The IMF just published a new report where the bureaucrats openly argue that there should be big tax hikes in all sub-Saharan nations.

Domestic revenue mobilization is one of the most pressing policy challenges facing sub-Saharan African countries. …the region as a whole could mobilize about 3 to 5 percent of GDP, on average, in additional revenues. …domestic revenue mobilization should be a key component of any fiscal consolidation strategy. Absent adequate efforts to raise domestic revenues, fiscal consolidation tends to rely excessively on reductions in public spending.

Notice, by the way, the term “domestic revenue mobilization.” Such a charming euphemism for higher taxes.

And it’s also worth pointing out that the IMF openly urges more revenue so that governments don’t have to impose spending restraint.

Moreover, the IMF is happy that there have been “substantial gains in revenue mobilization” over the past two decades.

Over the past three decades, many sub-Saharan African countries have achieved substantial gains in revenue mobilization. For the median sub-Saharan African economy, total revenue excluding grants increased from around 14 percent of GDP in the mid-1990s, to more than 18 percent in 2016, while tax revenue increased from 11 to 15 percent. …Two-thirds of sub-Saharan African countries now have revenue ratios above 15 percent, compared with fewer than half in 1995. …the region still has the lowest revenue-to-GDP ratio compared to other regions in the world. The good news is that there are signs of convergence. Over the past three decades, the increase in sub-Saharan Africa’s revenue ratio has been double that for all emerging market and developing economies.

To the bureaucrats at the IMF, the “convergence” toward higher taxes is “good news.”

However, there is some data in the report that is genuine good news.

In most regions of the world, there has been a trend in recent years toward reducing rates for the CIT and the personal income tax (PIT). In sub-Saharan African countries, the average top PIT rate has been reduced from about 44 to 32 percent since 2000, while average top CIT rates have been reduced by more than 5 percentage points during the same period.

Here are two charts showing the decline in tax rates, not only in Africa, but in most other regions.

By the way, the IMF bureaucrats appear to be surprised that revenues went up as tax rates went down. I guess they’ve never heard of the Laffer Curve.

Despite this decline in rates, total direct taxes (PIT and CIT) as a percentage of GDP have been trending upward.

But the IMF obviously didn’t learn from this evidence (or from the evidence it shared last year).

Rather than proposing lower tax rates, the report urges a plethora of tax hikes.

Successful experiences in revenue mobilization have relied on efforts to implement broad-based VATs, gradually expand the base for direct taxes (CIT and PIT), and implement a system to tax small businesses and levy excises on a few key items.

Wow. I don’t know what’s worse, claiming that tax increases are good for growth, or pushing higher taxes in the world’s poorest region.

Let’s close by debunking the IMF’s absurd contention that bigger government would be good for Africa.

I suppose the simplest response would be to share my video series about the economics of government spending, especially since I cite a wealth of academic research.

But let’s take an even simpler approach. The IMF report complained that governments in sub-Saharan Africa don’t have enough money to spend.

The good news, as illustrated by this chart (based on data from the bureaucracy’s World Economic Outlook database), is that the IMF is accurate about relative fiscal burdens.

The bad news is that the IMF wants us to believe that a low fiscal burden is a bad thing. The bureaucrats at the IMF (and at other international bureaucracies) actually want people to believe that bigger government means more prosperity. Which is why the report urges big tax hikes.

But you won’t be surprised to learn that the IMF doesn’t provide any evidence for this bizarre assertion.

Though I’ve had folks on the left sometimes tell me that bigger government must be good for growth because rich nations in the western world have bigger governments while poor nations in Africa have comparatively small governments.

If you want to get in the weeds of public finance theory, the IMF bureaucrats are misinterpreting Wagner’s Law.

But there’s no need to delve into theory. When people make this assertion to me, I challenge them to identify a poor nation that ever became a rich nation with big government.

It’s true, of course, that there are rich nations that have big governments, but all of those countries became rich in the 1800s when government was very small and welfare state programs were basically nonexistent.

So let’s take the previous chart, which supposedly showed too little spending in sub-Saharan Africa, and add another column (in red) showing the level of government spending in North America and Western Europe in the 1800s.

The obvious takeaway is that African nations should cut taxes and reducing spending. The exact opposite of what the IMF recommends.

In other words, the IMF’s agenda of bigger government and higher taxes is a recipe for continued poverty.

But keep in mind that fiscal policy is just one piece of the puzzle. As explained in Economic Freedom of the World, a nation’s prosperity also is affected by regulatory policy, trade policy, monetary policy, and quality of governance.

And nations in sub-Saharan Africa generally score even lower in those areas than they do for fiscal policy. So while those countries should reduce their fiscal burdens, it’s probably even more important for them to address other policy mistakes.

To end on an upbeat note, here’s a video from Reason about how free markets can help bring prosperity to Africa.

I also recommend this video from the Center for Freedom and Prosperity since it does a great job of debunking the argument that higher taxes and bigger government are a recipe for prosperity.

And this video about Botswana is a good case study of how African nations can enjoy more prosperity with market-oriented policy.

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IMF’s High-Tax Agenda Will Undermine Growth in Sub-Saharan Africa

If you were exempted from taxation, you’d presumably be very happy. After all, even folks on the left do everything they can to minimize their tax payments.

Now imagine that you are put in charge of tax policy.

Like Elizabeth Warren, you obviously won’t volunteer to start paying tax, but what would you recommend for other people?

Would you want them to also enjoy tax-free status, or at least get to experience a smaller tax burden? Or would you take a malicious approach and suggest tax increases, comforted by the fact that you wouldn’t be affected?

In this theoretical scenario, I hope most of us would choose the former approach and seek tax cuts.

But not everybody feels the same way. The bureaucrats at the International Monetary Fund actually do receive tax-free salaries. Yet instead of seeking to share their good fortune with others, they routinely and reflexively urge higher taxes on the rest of us. Here are some articles, all from the past 12 months, that I’ve written about the IMF’s love affair with punitive taxation.

• Last June, I wrote about the IMF pushing a theory that higher taxes would improve growth in the developing world.
• Last July, I wrote about the IMF complaining that tax competition between nations is resulting in lower corporate tax rates.
• Last October, I wrote about the IMF asserting that lower living standards are desirable if everyone is more equally poor.
• Also in October, I wrote about the IMF concocting a measure of “fiscal space” to justify higher taxes across the globe.
• Last November, I wrote about the IMF publishing a study expanding on its claim that equal poverty is better than unequal prosperity.
• This February, I wrote about the IMF advocating more double taxation of income that is saved and invested.

Needless to say, I especially don’t like it when the IMF urges higher taxes in America.

But I think everybody should have more freedom and prosperity, so I also don’t like it when the IMF pushes tax hikes elsewhere. I don’t like it when the tax-free bureaucrats advocate higher taxes on an entire region. I don’t like it when they push a high-tax agenda on big countries. I don’t like it when they urge tax increases on small countries.

What upsets me most of all, however, is that the IMF is trying to punish very poor nations is sub-Saharan Africa.

This came to my attention when I saw a Bloomberg report about the IMF recommending policy changes in Ivory Coast. At first glance, I thought the IMF was doing something sensible, supporting faster growth and higher income.

Ivory Coast must improve its tax system if the world’s biggest cocoa producer wants to maintain economic growth of at least 7 percent, the International Monetary Fund said. Jose Gijon, the resident representative for the Washington-based lender, said in an interview in the commercial capital of Abidjan Wednesday. “…if it wants to become an emerging country and for that, it needs higher income.”

But I found out that the bureaucrats wanted higher income for the government.

“The key for Ivory Coast is revenue…The government needs to create sufficient fiscal space…”

Unsurprisingly, local politicians like the idea of getting more loot.

The government seeks to gradually increase its tax revenue to 20 percent of gross domestic product from 15.9 percent now, Prime Minister Amadou Gon Coulibaly said in 2017.

How sad. Ivory Coast (now usually known as Côte d’Ivoire) is a very poor country, with living standards akin to those of the United States in 1860. Yet rather than recommend the policies that allowed the United States and other western nations to become rich, such as no income tax and very small government, the IMF wants to fatten the coffers of a corrupt and ineffective public sector.

Here’s something else that is sad. This seems to be the advice the IMF gives to all nations in sub-Saharan Africa.

Consider this story from Kenya.

Kenyans should brace themselves for higher taxes after the Government caved in to the International Monetary Fund’s (IMF) demands. …It made the commitment to the IMF in a letter of intent that spells out a raft of measures that are likely to eat into consumers’ pockets. …The sectors to be hit include agriculture, manufacturing, education, health, tourism, finance, social work, and energy. …The Government hopes to squeeze an extra Sh40 billion in taxes from these sectors. This is likely to have a ripple effect by pushing up the cost of goods and services… The Government intends to increase income tax by over Sh100 billion in the financial year 2018/19.

We also have the IMF’s perverse approach to “tax reform” in Nigeria.

The International Monetary Fund (IMF) has advised Nigeria to embark on a full Value Added Tax (VAT) reform. …The lender’s Mission Chief for Nigeria, African Department, Mr Amine Mati, …said government must raise taxes… In addition, government should also increase taxes on alcohol and tobacco and broaden VAT.

The bureaucrats also want more tax revenue in Tanzania.

The International Monetary Fund (IMF) Deputy Managing Director, Tao Zhang has hailed Tanzania for managing to boost tax collection… The visiting IMF leader said it was vital to mobilise more…public resources by strengthening tax collection… “it is crucial to mobilise more…public resources within Tanzania, especially by strengthening tax collection…” he said at a public lecture he gave in Dar es Salaam yesterday.

The IMF is even using a $190 million bribe to advocate higher taxes in Ghana.

Ghana needs to improve revenue collection…to achieve its fiscal targets, the International Monetary Fund said. …“Fiscal consolidation has to be revenue-based,” Koliadina told reporters in the capital, Accra. …A positive outcome of the fifth and sixth reviews of the program will lead to the IMF disbursing $190 million to Ghana, Koliadina said.

Last but not least, let’s look at the IMF’s misguided advice for Botswana.

The Government of Botswana should seek to strengthen its revenue base…, the International Monetary Fund has said. …”The authorities agreed that there is a significant potential to boost domestic revenues through tax administration and tax policy reforms that could…provide additional funding for future fiscal expenditures,” the report stated.

Higher taxes to finance bigger government? Wow, talk about economic malpractice.

Since Botswana has been one of the few bright spots in Africa, I hope lawmakers tell the IMF to get lost. But I worry that politicians will be happy to take the IMF’s bad advice.

How tragic.

These are the only nations I investigated, so I guess it’s possible that there’s a sub-Saharan nation where the IMF hasn’t recommended higher taxes. Heck, it’s even theoretically possible that the bureaucrats may have suggested lower taxes somewhere on the continent (though that’s about as likely me playing pro football next season).

I’ll simply note that the IMF openly admits that it wants higher taxes all across the region.

Tax revenues play a critical role for countries to create room in their budgets to increase spending on social services…raising tax revenues is the most growth-friendly way to stabilize debt. More broadly, building a country’s tax capacity is at the center of any viable development strategy…we see potential in many countries of sub-Saharan Africa to raise tax revenues by about one percent of GDP per year over the next five or so years. …Since building the capacity to collect more from personal income taxes takes time, in the next few years VAT and excise taxes likely offer the biggest potential for additional revenue. For example, recent studies by the IMF indicate a revenue potential of about 3 percent of GDP from VAT in Cape Verde, Senegal, and Uganda, and ½ percent of GDP from excises for all countries in sub-Saharan Africa. …It is also important to consider newer sources of revenue, such as property taxes. …Raising revenues is often a politically difficult task. But the current economic junction in sub-Saharan Africa together with sustained development needs creates an imperative for action now.

I’m almost at a loss for words. It’s mind-boggling that anybody could look at policy in sub-Saharan Africa and conclude that the recipe for growth is giving more money to politicians.

And I’m equally flabbergasted that the IMF openly claims that bigger government is good for growth. Unsurprisingly, the bureaucrats never try to justify that bizarre and anti-empirical assertion.

For those who are interested in genuinely sensible information on how poor nations can become rich nations, I strongly recommend this video from the Center for Freedom and Prosperity.

P.S. Back in 2015, to mock the pervasive statism at the Organization for Economic Cooperation and Development, I created a fake fill-in-the-blanks/multiple-choice template. A similar exercise for the IMF would only require one short sentence: “The nation of __ should raise taxes.”

P.P.S. In other words, this cartoon is very accurate.

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The International Monetary Fund Doubles Down on a Pro-Tax Agenda

The worst-international-bureaucracy contest is heating up.

In recent years, the prize has belonged to the Paris-based Organization for Economic Cooperation and Development for reasons outlined in this interview. Indeed, I’ve even argued that subsidies for the OECD are the worst expenditure in the federal budget, at least when measured on a damage-per-dollar-spent basis.

But the International Monetary Fund stepped up its game in 2017, pushing statism to a much higher level.

• In June, I wrote about the IMF pushing a theory that higher taxes would improve growth in the developing world.
• In July, I wrote about the IMF complaining that tax competition between nations is resulting in lower corporate tax rates.
• In October, I wrote about the IMF asserting that lower living standards are desirable if everyone is more equally poor.
• Also in October, I wrote about the IMF concocting a measure of “fiscal space” to justify higher taxes across the globe.
• In November, I wrote about the IMF publishing a study expanding on its claim that equal poverty is better than unequal prosperity.

And the IMF is continuing its jihad against taxpayers in 2018.

The head bureaucrat at the IMF just unleashed a harsh attack on the recent tax reform in the United States, warning that other nations might now feel compelled to make their tax systems less onerous.

IMF Managing Director Christine Lagarde said the Trump administration’s $1.5 trillion tax cut could prompt other nations to follow suit, fueling a “race to the bottom” that risks hemming in public spending. …It also will fuel inflation, she said. “What we are beginning to see already and what is of concern is the beginning of a race to the bottom, where many other policy makers around the world are saying: ‘Well, if you’re going to cut tax and you’re going to have sweet deals with your corporates, I’m going to do the same thing,”’ Lagarde said.

Heaven forbid we have lower tax rates and more growth!

Though the really amazing part of that passage is that Ms. Lagarde apparently believes in the silly notion that tax cuts are inflationary. Leftists made the same argument against the Reagan tax cuts. Fortunately, their opposition we ineffective, Reagan slashed tax rates and inflation dramatically declined.

What’s also noteworthy, as illustrated by this next excerpt, is that Lagarde doesn’t even bother with the usual insincere rhetoric about using new revenues to reduce red ink. Instead, she openly urges more class-warfare taxation to finance ever-bigger government.

The IMF chief’s blunt assessment follows an unusually public disagreement between the fund and President Donald Trump’s administration last fall over an IMF paper arguing that developed nations can share prosperity more evenly, without sacrificing growth, by shifting the income-tax burden onto the rich. Competitive tax cuts risk holding back governments in spending on anything from defense and infrastructure to health and education, Lagarde said.

What makes her statements so absurd is that even IMF economists have found that higher taxes and bigger government depress economic activity. But Ms. Largarde apparently doesn’t care because she’s trying to please the politicians who appointed her.

By the way, keep in mind that Ms. LaGarde’s enormous salary is tax free, as are the munificent compensation packages of all IMF employees. So it takes enormous chutzpah for her to push for higher taxes on the serfs in the economy’s productive sector.

But it’s not just Lagarde. We also have a new publication by two senior IMF bureaucrats that urges more punitive taxes on saving and investment.

Although Thomas Piketty has famously proposed a coordinated global wealth tax of the wealthiest at two percent, there are now very few effective explicit wealth taxes in either developing or advanced economies. Indeed between 1985 and 2007, the number of OECD countries with an active wealth tax fell from twelve to just four. And many of those were, and are, of limited effectiveness. …This hot topic of how tax systems can assist in addressing excessive increases in wealth inequality was discussed at the regular IMF-World Bank session on taxation last October. …some among the very rich recognize some social benefit from being taxed more heavily (for instance, Bill Gates’ father). Perhaps then there is more that can be done to foster that sense of social responsibility… The exchange of tax information between countries is a powerful tool…and perhaps ultimately game-changing approach to the taxation of the wealthy…we do see good cause to be less pessimistic than even a few years ago.

Once again, we can debunk the IMF by….well, by citing the IMF. The professional economists at the bureaucracy have produced research showing that discriminatory taxes on capital are very bad for prosperity.

But the top bureaucrats at the organization are driven by either by statist ideology or by self interest (i.e., currying favor with the governments that decide senior-level slots).

The bottom line is that perhaps the IMF should be renamed the Anti-Empirical Monetary Fund.

And with regards to worst-international-bureaucracy contest, I fully expect the OECD to quickly produce something awful to justify its claim to first place.

P.S. I’m not a fan of the United Nations, but that bureaucracy generally is too ineffective to compete with the IMF and OECD.

P.P.S. The World Bank also does things I don’t like (as well as some good things), but it generally doesn’t push a statist policy agenda, at least compared to the nefarious actions of OECD and IMF.

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South Africa’s Failing Experiment with Higher Taxes

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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The IMF’s Creative New Rationale for Higher Tax Rates

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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