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Posts Tagged ‘Supply-side economics’

Mark Perry of the American Enterprise Institute is most famous for his Venn diagrams that expose hypocrisy and inconsistency.

But he also is famous for his charts.

And since I’m a big fan of sensible tax policy and the Laffer Curve, we’re going to share Mark’s new chart looking at the inverse relationship between the top tax rate and the share of taxes paid by the richest Americans.

Examining the chart, it quickly becomes evident that upper-income taxpayers started paying a much greater share of the tax burden after the Reagan tax cuts.

My left-leaning friends sometimes look at this data and complain that the rich are paying more of the tax burden only because they have grabbed a larger share of national income. And this means we should impose punitive tax rates.

But this argument is flawed for three reasons.

First, there is not a fixed amount of income. The success of a rich entrepreneur does not mean less income for the rest of us. Instead, it’s quite likely that all of us are better off because the entrepreneur created some product of service that we value. Indeed, data from the Census Bureau confirms that all income classes tend to rise and fall simultaneously.

Second, it’s not even accurate to say that the rich are getting richer faster than the poor are getting richer.

Third, one of the big fiscal lessons of the 1980s is that punitive tax rates on upper-income taxpayers backfire because investors, entrepreneurs, and business owners will choose to earn and report less taxable income.

For my contribution to this discussion, I want to elaborate on this final point.

When I give speeches, I sometimes discover that audiences don’t understand why rich taxpayers can easily control the amount of their taxable income.

And I greatly sympathize since I didn’t appreciate this point earlier in my career.

That’s because the vast majority of us get the lion’s share of our income from our employers. And when we get this so-called W-2 income, we don’t have much control over how much tax we pay. And we assume that this must be true for others.

But rich people are different. If you go the IRS’s Statistics of Income website and click on the latest data in Table 1.4, you’ll find that wages and salaries are only a small fraction of the income earned by wealthy taxpayers.

These high-income taxpayers may be tempting targets for Alexandria Ocasio-Cortez, Elizabeth Warren, Bernie Sanders and the other peddlers of resentment, but they’re also very elusive targets.

That’s because it’s relatively easy – and completely legal – for them to control the timing, level, and composition of business and investment income.

When tax rates are low, this type of tax planning doesn’t make much sense. But as tax rates increase, rich people have an ever-growing incentive to reduce their taxable income and that creates a bonanza for lawyers, accountants, and financial planners.

Needless to say, there are many loopholes to exploit in a 75,000-page tax code.

P.S. There’s some very good evidence from Sweden confirming my point.

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Like most taxpayer-supported international bureaucracies, the Organization for Economic Cooperation and Development (OECD) has a statist orientation.

The Paris-based OECD is particularly bad on fiscal policy and it is infamous for its efforts to prop up Europe’s welfare states by hindering tax competition.

It even has a relatively new “BEPS” project that is explicitly designed so that politicians can grab more money from corporations.

So it’s safe to say that the OECD is not a hotbed of libertarian thought on tax policy, much less a supporter of pro-growth business taxation.

Which makes it all the more significant that it just announced that supporters of free markets are correct about the Laffer Curve and corporate tax rates.

The OECD doesn’t openly acknowledge that this is the case, of course, but let’s look at key passages from a Tuesday press release.

Taxes paid by companies remain a key source of government revenues, especially in developing countries, despite the worldwide trend of falling corporate tax rates over the past two decades… In 2016, corporate tax revenues accounted for 13.3% of total tax revenues on average across the 88 jurisdictions for which data is available. This figure has increased from 12% in 2000. …OECD analysis shows that a clear trend of falling statutory corporate tax rates – the headline rate faced by companies – over the last two decades. The database shows that the average combined (central and sub-central government) statutory tax rate fell from 28.6% in 2000 to 21.4% in 2018.

So tax rates have dramatically fallen but tax revenue has actually increased. I guess many of the self-styled experts are wrong on the Laffer Curve.

By the way, whoever edits the press releases for the OECD might want to consider changing “despite” to “because of” (writers at the Washington Post, WTNH, Irish-based Independent, and Wall Street Journal need similar lessons in causality).

Let’s take a more detailed look at the data. Here’s a chart from the OECD showing how corporate rates have dropped just since 2000. Pay special attention to the orange line, which shows the rate for developed nations.

I applaud this big drop in tax rates. It’s been good for the world economy and good for workers.

And the chart only tells part of the story. The average corporate rate for OECD nations was 48 percent back in 1980.

In other words, tax rates have fallen by 50 percent in the developed world.

Yet if you look at this chart, which I prepared using the OECD’s own data, it shows that revenues actually have a slight upward trend.

I’ll close with a caveat. The Laffer Curve is very important when looking at corporate taxation, but that doesn’t mean it has an equally powerful impact when looking at other taxes.

It all depends on how sensitive various taxpayers are to changes in tax rates.

Business taxes have a big effect because companies can easily choose where to invest and how much to invest.

The Laffer Curve also is very important when looking at proposals (such as the nutty idea from Alexandria Ocasio-Cortez) to increase tax rates on the rich. That’s because upper-income taxpayers have a lot of control over the timing, level, and composition of business and investment income.

But changes in tax rates on middle-income earners are less likely to have a big effect because most of us get a huge chunk of our compensation from wages and salaries. Similarly, changes in sales taxes and value-added taxes are unlikely to have big effects.

Increasing those taxes is still a bad idea, of course. I’m simply making the point that not all tax increases are equally destructive (and not all tax cuts generate equal amounts of additional growth).

P.S. The International Monetary Fund also accidentally provided evidence about corporate taxes and the Laffer Curve. And there was also a little-noticed OECD study last year making the same point.

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Steve Moore and Art Laffer are the authors of Trumponomics, a largely favorable book about the President’s economic policy.

I have a more jaundiced view about Trump.

I’m happy to praise his good policies (taxes and regulation), but I also condemn his bad policies (spending and trade).

And as you might expect, some people are completely on the opposite side from Moore and Laffer.

Writing for New York, Jonathan Chait offers a very unfriendly review of the book. He starts by categorizing Steve and Art (as well as Larry Kudlow, who wrote the foreword) as being fixated on tax rates.

The authors of Trumponomics are Larry Kudlow (who left in the middle of its writing to accept a job as director of the National Economic Council), Stephen Moore, and Arthur Laffer. The three fervently propound supply-side economics, a doctrine that holds that economic performance hinges largely on maintaining low tax rates on the rich. …Kudlow, Moore, and Laffer are unusually fixated on tax cuts, but they are merely extreme examples of the entire Republican Establishment, which shared their broad priorities.

For what it’s worth, I think low tax rates are good policy. And I suspect that the vast majority of economists will agree with the notion that lower tax rates are better for growth than high tax rates.

But Chait presumably thinks that Larry, Steve, and Art overstate the importance of low rates (hence, the qualification about “economic performance hinges largely”).

To bolster his case, he claims advocates of low tax rates were wrong about the 1990s and the 2000s.

In the 1990s, the supply-siders insisted Bill Clinton’s increase in the top tax rate would create a recession and cause revenue to plummet. The following decade, they heralded the Bush tax cuts as the elixir that had brought in a glorious new era of prosperity. …The supply-siders have maintained absolute faith in their dogma in the face of repeated failure by banishing all doubt. …they have confined their failed predictions to the memory hole.

If Chait’s point is simply that some supply-siders have been too exuberant at times, I won’t argue. Exaggeration, overstatement, and tunnel vision are pervasive on all sides in Washington.

Heck, I sometimes fall victim to the same temptation, though I try to atone for my bouts of puffery by bending over backwards to point out that taxation is just one piece of the big policy puzzle.

Which is why I want to focus on this next excerpt from Chait’s article. He is very agitated that the book praises the economic performance of the Clinton years and criticizes the economic performance of the Bush years.

A brief economic history in Trumponomics touts the gains made from 1982 to 1999, and laments “those gains stalled out after 2000 under Presidents George W. Bush and Barack Obama.” Notice, in addition to starting the Reagan era in 1982, thus absolving him for any blame for the recession that began a year into his presidency, they have retroactively moved the hated leftist Bill Clinton into the right-wing hero camp and the beloved conservative hero George W. Bush into the failed left-wing statist camp.

Well, there’s a reason Clinton is in the good camp and Bush is in the bad camp.

As you can see from Economic Freedom of the World (I added some numbers and commentary), the U.S. enjoyed increasing economic liberty during the 1990s and suffered decreasing economic liberty during the 2000s.

For what it’s worth, I’m not claiming that Bill Clinton wanted more economic liberty or that George W. Bush wanted more statism. Maybe the credit/blame belongs to Congress. Or maybe presidents get swept up in events that happen to occur when they’re in office.

All I’m saying is that Steve and Art are correct when they point out that the nation got better overall policy under Clinton and worse overall policy under Bush.

In other words, Clinton’s 1993 tax increase was bad, but it was more than offset by pro-market reforms in other areas. Likewise, Bush’s tax cuts were good, but they were more than offset by anti-market policies in other areas.

P.S. Chait complained about Moore and Laffer “starting the Reagan era in 1982, thus absolving him for any blame for the recession that began a year into his presidency”.

Since I’m a fan of Reaganomics, I feel compelled to offer three comments.

  • First, the recession began in July 1981. That’s six months into Reagan’s presidency rather than one year.
  • Second, does Chait really want to claim that the downturn was Reagan’s fault? If so, I’m curious to get his explanation for how a tax cut that was signed in August caused a recession that began the previous month.
  • Third, the recession almost certainly should be blamed on bad monetary policy, and even Robert Samuelson points out that Reagan deserves immense praise for his handling of that issue.

P.P.S. Bill Clinton’s 1993 tax hike didn’t produce the budget surpluses of the late 1990s. If you don’t believe me, check out the numbers from Bill Clinton’s FY1996 budget.

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The central argument against punitive taxation is that it leads to less economic activity.

Here’s a visual from an excellent video tutorial by Professor Alex Tabarrok. It shows that government grabs a share of private output when a tax is imposed, thus reducing the benefits to buyers (“consumer surplus”) and sellers (“producer surplus).

But it also shows that some economic activity never takes place (“deadweight loss”).

When discussing the economics of taxation, I always try to remind people that deadweight loss also represents foregone taxable activity, which is why the Laffer Curve is a very real thing (as even Paul Krugman admits).

To see these principles at work in the real world, let’s look at a report from the Washington Post. The story deals with cigarette taxation, but I’m not sharing this out of any sympathy for smokers. Instead, the goal is to understand and appreciate the broader point of how changes in tax policy can cause changes in behavior.

The sign on the window of a BP gas station in Southeast Washington advertises a pack of Newports for $10.75. Few customers were willing to pay that much. But several men in the gas station’s parking lot had better luck illegally hawking single cigarettes for 75 cents. The drop in legal sales and spike in black market “loosies” are the result of $2-a-pack increase in cigarette taxes that took effect last month… Anti-tobacco advocates hailed the higher legal age and the tax increase as ways to discourage smoking. But retailers say the city has instead encouraged the black market and sent customers outside the city.

Since I don’t want politicians to have more money, I’m glad smokers are engaging in tax avoidance.

And I feel sympathy for merchants who are hurt by the tax.

Shoukat Choudhry, the owner of the BP and four other gas stations in the city, says he does not see whom the higher taxes are helping. His customers can drive less than a mile to buy cheaper cigarettes in Maryland. He says the men in his parking lot are selling to teenagers. And the city is not getting as much tax revenue from his shops. Cigarette revenue at the BP store alone fell from $63,000 in September to $45,000 in October, when the tax increase took effect on the first of the month. …The amateur sellers say the higher cigarette tax has not been a bonanza for them. They upped their price a quarter for a single cigarette.

It’s also quite likely that the Laffer Curve will wreak havoc with the plans of the D.C. government.

Citywide figures for cigarette sales in October — as measured by tax revenue — will not be available until next month, city officials said. The District projected higher cigarette taxes would bring in $12 million over the next four years. Proceeds from the tax revenue are funding maternal and early childhood care programs. The Campaign for Tobacco-Free Kids says the fear of declining tax revenue because of black market sales has not materialized elsewhere.

Actually, there is plenty of evidence – both in America and elsewhere – that higher cigarette taxes backfire.

I would be shocked if D.C. doesn’t create new evidence since avoidance is so easy.

…critics of the tax increase say the District is unique because of how easy it is to travel to neighboring Virginia, which has a 30-cent tax, and Maryland, with a $2 tax. “What person in their right mind is going to pay $9 or $10 for a pack of cigarettes when they can go to Virginia?” said Kirk McCauley of the WMDA Service Station and Automotive Repair Association, a regional association for gas stations. …Ronald Jackson, who declined to buy a loose cigarette from the BP parking lot, says he saves money with a quick drive to Maryland to buy five cartons of Newport 100s, the legal limit. “After they increased the price, I just go over the border,” said Jackson, a 56-year-old Southeast D.C. resident. “They are much cheaper.”

An under-appreciated aspect of this tax is how it encourages the underground economy.

Though I’m happy to see (especially remembering what happened to Eric Garner) that D.C. police have no interest in hindering black market sales.

The D.C. Council originally set aside money from the cigarette tax increase for two police officers to crack down on illegal sales outside of stores. But that funding was removed amid concerns about excessive enforcement and that it would strain police relations with the community. On a Tuesday morning, Choudhry, the owner of the Southeast BP, stopped a police officer who was filling up his motorcycle at the BP station to point out a group of men selling cigarettes in his parking lot. The officer drove off without action. …On a good day, he can pull about $70 in profit. “Would you rather that we rob or steal,” said Mike, who said he has spent 15 years in jail. “Or do you want us out here selling things?”

Kudos to Mike. I’m glad he’s engaging in voluntary exchange rather than robbing and stealing. Though maybe he got in trouble with the law in the first place because of voluntary exchange (a all-too-common problem for people in Washington).

But now let’s zoom out and return to our discussion about economics and taxation.

An under-appreciated point to consider is that deadweight loss grows geometrically larger as tax rates go up. In other words, you don’t just double damage when you double tax rates. The consequences are far more severe.

Here are two charts that were created for a chapter I co-authored in a book about demographics and capital taxation. This first chart shows how a $1 tax leads to 25-cents of deadweight loss.

But if the tax doubles to $2, the deadweight loss doesn’t just double.

In this hypothetical example, it rises to $1 from 25-cents.

For any given tax on any particular economic activity, the amount of deadweight loss will depend on both supply and demand sensitivities. Some taxes impose high costs. Others impose low costs.

But in all cases, the deadweight loss increases disproportionately fast as the tax rate is increased. And that has big implications for whether there should high tax rates on personal income and corporate income, as well as whether there should be heavy death taxes and harsh tax rates on capital gains, interest, and dividends.

Some of my left-wing friends shrug their shoulders because they assume that rich people bear the burden. But remember that the reduction of “consumer surplus” is a measure of the loss to taxpayers. The deadweight loss is the foregone output to society.

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I’ve written about how taxes have a big impact on soccer (a quaint game with little or no scoring that Europeans play with their feet).

Taxes affect both the decisions of players and the success of teams.

Grasping and greedy governments also have an impact on football. Especially if teams play in Europe.

…the Los Angeles Chargers and Tennessee Titans traveled across the Atlantic to play a game in London’s Wembley Stadium. …Players spoke of the burdens of traveling so far to play a game, especially the team from California that had to cross eight time zones. Players also spoke out about the tax nightmare they faced when they got to the UK. …players talked ahead of time to their CPAs to determine the tax hit they’d take for the privilege of such a long road trip… Great Britain…levies high taxes on athletes who visit for an athletic match. Teams from California — the Raiders, Chargers, and Rams — already face the highest state income tax in the nation with a top rate of 13.3 percent. Of course, players also have to pay federal income tax. …To top it all off, those players who receive one of their 16 paychecks in London pay a 45 percent tax on a prorated amount based on the number of days they spend in the country. Bottom line: Players on California teams could end up paying 60 percent or more in income taxes for that game check. …For non-resident foreign athletes, HM Revenue and Customs (HMRC) reserves the right to tax not only the income they earn from competing in the match but a portion of any endorsement money they earn worldwide.

No wonder some of the world’s top athletes don’t want to compete in the United Kingdom.

And what about the NFL players, who got hit with a 60 percent tax rate for one game?

Those players are lucky they’re not Cam Newton, who paid a 198.8 percent tax for playing in the 2016 Super Bowl.

Last year’s tax bill also impacts professional football in a negative way. The IRS has decided that sports teams don’t count as “pass-through” businesses, as noted by Accounting Today.

Two major sports franchises might soon be on the auction block following Microsoft Corp. co-founder Paul Allen’s death last week. But a recent Internal Revenue Service rule could cut the teams’ sales prices. Allen died with no heirs and a $26 billion estate, including the National Football League’s Seattle Seahawks… The teams together are worth more than $3 billion, according to the Bloomberg Billionaires Index. …the IRS said in August that team owners would be barred from the write-off — one of the biggest benefits in the law — that allows owners of pass-through entities such as partnerships and limited liability companies to deduct as much as 20 percent of their taxable income. …Arthur Hazlitt, a tax partner at O’Melveny & Myers LLP in New York who provided the tax structure and planning advice for hedge fund manager David Tepper’s acquisition of the Carolina Panthers, estimates the IRS rules could spur potential bidders to offer at least tens of millions of dollars less.

Gee, what a surprise. Higher tax burdens lower the value of income-producing assets.

Something to keep in mind next them there’s a debate on whether we should be double-taxing dividends and capital gains.

Or the death tax.

Let’s close with a report from Bloomberg about some new research about the impact of taxes on team performance.

The 2017 law could put teams in states with high personal income tax rates at a disadvantage when negotiating with free agents thanks to new limits on deductions, including for state and local taxes, according to tax economist Matthias Petutschnig of the Vienna University of Economics and Business. Petutschnig’s research into team performance over more than two decades shows that National Football League franchises based in high-tax states lost more games on average during the regular season compared to teams in low or no-tax states. That’s because of the NFL’s salary cap for teams, according to Petutschnig; if they have to give certain players more money to compensate for higher taxes, it reduces how much they pay other players and lowers the team’s overall talent level. “The new tax law exacerbates my findings and makes it harder for high-tax teams to put together a high-quality roster,” Petutschnig said.

Here’s a chart from the article.

And here are more details.

A player for the Miami Dolphins or Houston Texans, where no state income taxes are levied, “was always going to come out a whole lot better than somebody playing in New York,” said Jerome Glickman, a director at accounting firm Friedman LLP who works with professional athletes. “Now, it’s worse.” …a free agent considering a California team compared to a team in Texas or Florida would need to make 10 percent to 12 percent more to compensate for his state tax bill, said NFL agent Joe Linta… the Raiders — who will eventually move to Las Vegas in no-tax Nevada — have often made the case that unequal tax rates create an uneven playing field. Quarterback Jimmy Garoppolo’s five-year $137.5 million contract with the San Francisco 49ers will mean an additional $3 million tax bill under the new tax law… Garoppolo would have saved $2 million in taxes under the new code had he instead signed with the Denver Broncos in lower-tax Colorado.

By the way, other scholars have reached similar conclusions, so Professor Petutschnig’s research should be viewed as yet another addition to the powerful body of evidence about the harmful effect of punitive tax policy.

P.S. I think nations have the right to tax income earned inside their borders, so I’m not theoretically opposed to the U.K. taxing athletes who earn income on British soil. But I don’t favor punitive rates. And I don’t think the IRS should add injury to injury by then taxing the same income. That lesson even applies to royalty.

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As illustrated by this video tutorial, I’m a big advocate of the Laffer Curve.

I very much want to help policy makers understand (especially at the Joint Committee on Taxation) that there’s not a linear relationship between tax rates and tax revenue. In other words, you don’t double tax revenue by doubling tax rates.

Having worked on this issue for decades, I can state with great confidence that there are two groups that make my job difficult.

  • The folks who don’t like pro-growth tax policy and thus claim that changes in tax policy have no impact on the economy.
  • The folks who do like pro-growth tax policy and thus claim that every tax cut will “pay for itself” because of faster growth.

Which was my message in this clip from a recent interview.

For all intents and purposes, I’m Goldilocks in the debate over the Laffer Curve. Except instead of stating that the porridge is too hot or too cold, my message is that it is that changes in tax policy generally lead to more taxable income, but the growth in income is usually not enough to offset the impact of lower tax rates.

In other words, some revenue feedback but not 100 percent revenue feedback.

Yes, some tax cuts do pay for themselves. But they tend to be tax cuts on people (such as investors and entrepreneurs) who have a lot of control over the timing, level, and composition of their income.

And, as I said in the interview, I think the lower corporate tax rate will have substantial supply-side effects (see here and here for evidence). This is because a business can make big changes in response to a new tax law, whereas people like you and me don’t have the same flexibility.

But I don’t want this column to be nothing but theory, so here’s a news report from Estonia on the Laffer Curve in action.

After Estonia raised its alcohol excise tax rates considerably in 2017, Estonian daily Postimees has estimated that the target of the money the alcohol excise tax would bring into state coffers could have been missed by at least EUR 40 million. …Initially, in the state budget of 2017, the ministry had been planned that proceeds from the alcohol excise tax would bring EUR 276.4 million, but last summer, it cut the forecast to EUR 237.5 million.

I guess I’ll make this story Part VII in my collection of examples designed to educate my friends on the left (here’s Part I, Part II, Part III, Part IV, Part V, and Part VI).

But there’s a much more important point I want to make.

The fact that most tax increases produce more revenue is definitely not an argument in favor of higher tax rates.

That argument is wrong in part because government already is far too large. But it’s also wrong because we should consider the health and vitality of the private sector. Here’s some of what I wrote about some academic research in 2012.

…this study implies that the government would reduce private-sector taxable income by about $20 for every $1 of new tax revenue. Does that seem like good public policy? Ask yourself what sort of politicians are willing to destroy so much private sector output to get their greedy paws on a bit more revenue. What about capital taxation? According to the second chart, the government could increase the tax rate from about 40 percent to 70 percent before getting to the revenue-maximizing point. But that 75 percent increase in the tax rate wouldn’t generate much tax revenue, not even a 10 percent increase. So the question then becomes whether it’s good public policy to destroy a large amount of private output in exchange for a small increase in tax revenue. Once again, the loss of taxable income to the private sector would dwarf the new revenue for the political class.

The bottom line is that I don’t think it’s a good trade to reduce the private sector by any amount simply to generate more money for politicians.

P.S. I’m also Goldilocks when considering the Rahn Curve.

P.P.S. For what it’s worth, Paul Krugman (sort of) agrees with me about the Laffer Curve.

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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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