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Posts Tagged ‘Tax avoidance’

The value-added tax is a very dangerous levy for the simple reason that giving a big new source of revenue to Washington almost certainly would result in a larger burden of government spending.

That’s certainly what happened in Europe, and there’s even more reason to think it would happen in America because we have a looming, baked-in-the-cake entitlement crisis and many politicians don’t want to reform programs such as Medicare, Medicaid, and Obamacare. They would much rather find additional tax revenues to enable this expansion of the welfare state. And their target is the middle class, which is why they very much want a VAT.

The most frustrating part of this debate is that there are some normally rational people who are sympathetic to the VAT because they focus on theoretical issues and somehow convince themselves that this new levy would be good for the private sector.

Here are the four most common economic myths about the value-added tax.

Myth 1: The VAT is pro-growth

Reihan Salam implies in the Wall Street Journal that taxing consumption is good for growth.

Mr. Cruz has roughly the right idea. He has come out in favor of a growth-friendly tax on consumption… Rather sneakily, he’s calling his consumption tax a “business flat tax,” but everyone knows that it’s a VAT.

And a different Wall Street Journal report asserts there’s a difference between taxing income and taxing consumption.

…a VAT taxes what people consume rather than how much they earn.

Reality: The VAT penalizes all productive economic activity

I don’t care whether proponents change the name of the VAT, but they are wrong when they say that taxes on consumption are somehow better for growth than taxes on income. Consider two simple scenarios. In the first example, a taxpayer earns $100 but loses $20 to the income tax. In the second example, a taxpayers earns $100, but loses $20 to the VAT. In one case, the taxpayer’s income is taxed when it is earned and in the other case it is taxed when it is spent. But in both cases, there is an identical gap between pre-tax income and post-tax consumption. The economic damage is identical, with the harm rising as the marginal tax rate (either income tax rate or VAT rate) increases.

Advocates for the VAT generally will admit that this is true, but then switch the argument and say that there’s pervasive double taxation in the internal revenue code and that this tax bias against saving and investment does far more damage, per dollar collected, than either income taxes imposed on wages or VATs imposed on consumption.

They’re right, but that’s an argument against double taxation, not an argument for taxing consumption instead of taxing income. They then sometimes assert that a VAT is needed to make the numbers add up if double taxation is to be eliminated. But a flat tax does the same thing, and without the risk of giving politicians a new source of revenue.

Myth 2: The VAT is pro-savings and pro-investment

As noted in a recent Wall Street Journal story, advocates claim this tax is an economic elixir.

Supporters of a VAT…say it is better for economic growth than an income tax because it doesn’t tax savings or investment.

Reality: The VAT discourages saving and investment

The superficially compelling argument for this assertion is that the VAT is a tax on consumption, so the imposition of such a tax will make saving relatively more attractive. But this simple analysis overlooks the fact that another term for saving is deferred consumption. It is true, of course, that people who save usually earn some sort of return (such as interest, dividends, or capital gains). This means they will be able to enjoy more consumption in the future. But that does not change the calculation. Instead, it simply means there will be more consumption to tax. In other words, the imposition of a VAT does not alter incentives to consume today or consume in the future (i.e., save and invest).

But this is not the end of the story. A VAT, like an income tax or payroll tax, drives a wedge between pre-tax income and post-tax income. This means, as already noted above, that a VAT also drives a wedge between pre-tax income and post-tax consumption – and this is true for current consumption and future consumption. This tax wedge means less incentive to earn income, and if there is less total income, this reduces both total saving and total consumption.

Again, advocates of a VAT generally will admit this is correct, but then resort to making a (correct) argument against double taxation. But why take the risk of a VAT when there are very simple and safe ways to eliminate the tax bias against saving and investment.

Myth 3: The VAT is pro-trade.

My normally sensible friend Steve Moore recently put forth this argument in the American Spectator.

…a better way to do this…is through a “border adjustable”…tax, meaning that it taxes imports and relieves all taxes on exports. …The guy who gets this is Ted Cruz. His tax plan…would not tax our exports. Cruz is right when he says this automatically gives us a 16% advantage.

Reality: The protectionist border-adjustability argument for a VAT is bad in theory and bad in reality.

For mercantilists worried about trade deficits, “border adjustability” is seen as a positive feature. But not only are they wrong on trade, they do not understand how a VAT works. Protectionists seem to think a VAT is akin to a tariff. It is true that the VAT is imposed on imports, but this does not discriminate against foreign-produced goods because the VAT also is imposed on domestic-produced goods.

Under current law, American goods sold in America do not pay a VAT, but neither do German-produced goods that are sold in America. Likewise, any American-produced goods sold in Germany are hit be a VAT, but so are German-produced goods. In other words, there is a level playing field. The only difference is that German politicians seize a greater share of people’s income.

So what happens if America adopts a VAT? The German government continues to tax American-produced goods in Germany, just as it taxes German-produced goods sold in Germany. There is no reason to expect a VAT to cause any change in the level of imports or exports from a German perspective. In the United States, there is a similar story. There is now a tax on imports, including imports from Germany. But there is an identical tax on domestically-produced goods. And since the playing field remains level, protectionists will be disappointed. The only winners will be politicians since they have more money to spend.

I explain this issue in greater detail in this video, beginning about 5:15, though I hope the entire thing is worth watching.

Myth 4: the VAT is pro-compliance

There’s a common belief, reflected in this blurb from a Wall Street Journal report, that a VAT has very little evasion or avoidance because it is self enforcing.

…governments like it because it tends to bring in more revenue, thanks in part to the role that businesses play in its collection. Incentivizing their efforts, businesses receive credits for the VAT they pay.

Reality: Any burdensome tax will lead to avoidance and evasion and that applies to the VAT.

I’m always amused at the large number of merchants in Europe who ask for cash payments for the deliberate purpose of escaping onerous VAT impositions. But my personal anecdotes probably are not as compelling as data from the European Commission.

To give an idea of the magnitude, here are some excerpts from a recent Bloomberg report.

Over the next two years, the Brussels-based commission will seek to streamline cross-border transactions, improve tax collection on Internet sales… In 2017, the EU plans to propose a single European VAT area, a reform of rates and add specifics to its anti-fraud strategy. …“We face a staggering fiscal gap: the VAT revenues are 170 billion euros short of what they could be,” EU Economic Affairs and Tax Commissioner Pierre Moscovici said. “It’s time to have this money back.”

For what it’s worth, the Europeans need to learn that burdensome levels of taxation will always encourage noncompliance.

Though, to be fair, much of the “tax gap” for the VAT in Europe exists because governments have chosen to adopt “destination-based” VATs rather than “origin-based” VATs, largely for the (ineffective) protectionist reasons outlined in Myth 3. And this creates a big opportunity to escape the VAT by classifying sales as exports, even if the goods and services ultimately are consumed in the home market.

P.S. At the risk of being wonky, it should be noted that there are actually two main types of value-added tax. In both cases, businesses collect the tax, and the tax incidence is similar (households actually bear the cost), but there are different collection methods. The credit-invoice VAT is the most common version (ubiquitous in Europe, for instance), and it somewhat resembles a sales tax in its implementation, albeit with the tax imposed at each stage of the production process. The subtraction-method VAT, by contrast, relies on a tax return sort of like the corporate income tax. The Joint Committee on Taxation has a good description of these two systems.

Under the subtraction method, value added is measured as the difference between an enterprise’s taxable sales and its purchases of taxable goods and services from other enterprises. At the end of the reporting period, a rate of tax is applied to this difference in order to determine the tax liability. The subtraction method is similar to the credit-invoice method in that both methods measure value added by comparing outputs (sales) to inputs (purchases) that have borne the tax. The subtraction method differs from the credit-invoice method principally in that the tax rate is applied to a net amount of value added (sales less purchases) rather than to gross sales with credits for tax on gross purchases (as under the credit-invoice method). The determination of the tax liability of an enterprise under the credit-invoice method relies upon the enterprise’s sales records and purchase invoices, while the subtraction method may rely upon records that the taxpayer maintains for income tax or financial accounting purposes.

P.P.S. Another wonky point is that the effort by states to tax Internet sales is actually an attempt to implement and enforce the kind of “destination-based” tax regime mentioned above. I explain that issue in this presentation on Capitol Hill.

P.P.P.S. You can enjoy some amusing – but also painfully accurate – cartoons about the VAT by clicking here, here, and here.

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I recently wrote a primer on the issue of tax evasion, which is illegal. I made the elementary point that low tax rates and a simple tax code are the best (and only good) way of promoting high levels of tax compliance.

Now let’s shift to the related topic of tax avoidance, which is legal. Unlike evasion, there’s no civil disobedience and no breaking of laws with tax avoidance. It simply means that taxpayers are taking advantage of provisions in the tax code that help protect income from the government.

And we all do it.

All these things I do to lower my taxes are legal.

As Judge Learned Hand correctly opined, nobody has any obligation to deliberately overpay the government.

Tax avoidance also is moral. Tax codes are corrupt and governments waste money, so anything that reduces the flow of revenue to the public sector is helpful.

With that in mind, I want to offer a hearty defense of Mr. Cameron from the United Kingdom. But I’m not referring to David Cameron, the current Prime Minister. Instead, I want to defend Ian Cameron, his late father.

The Financial Times has a summary of what Cameron’s father did to protect against punitive taxation.

Mr Cameron’s father, Ian, was one of the founder investors. Blairmore was incorporated in Panama but based in the Bahamas. The idea was for investors to avoid an extra layer of tax because investors came from lots of jurisdictions and some, at least, would have faced double taxation if the fund had been based in a mainstream jurisdiction — firstly by the country where the fund operated, and then by the investor’s own country when he or she received his profits. …In 1982, when Blairmore was set up, offshore funds were more tax-efficient than UK funds, on which investors had to pay tax annually. …It is also possible that investors avoided paying stamp duty — a tax on the transfer of documents, including share certificates — by using bearer shares, which were exempt from the duty.

I also want to defend David Cameron’s mother, who is still alive and engaging in tax avoidance, as noted by a column in the U.K.-based Times.

He also admitted receiving a lump sum of £200,000 from his mother in 2011, eight months after his father died in September 2010. The handout, which came on top of a £300,00 legacy, could allow Mr Cameron to avoid an £80,000 inheritance tax bill if his mother lives until 2018.

This is perfectly appropriate and legitimate tax planning, and also completely moral and economically beneficial since death taxes shouldn’t exist.

Now let’s consider why David Cameron’s parents decided to engage in tax avoidance. To understand his father’s motives, let’s look at the history of British tax rates, as reported by the Institute for Fiscal Studies in a survey of the U.K. tax system released last November.

In 1978–79, there was a starting rate of 25%, a basic rate of 33% and higher rates ranging from 40% to 83%. In addition, an investment income surcharge of 15% was applied to those with very high investment income, resulting in a maximum income tax rate of 98%.

In other words, David Cameron’s father had to deal with a tax code that basically stole all his money above a certain threshold. Much of his income was earned when the top rate was 98 percent. And when he set up his offshore structures, even after Thatcher’s early reforms, his top tax rate could have been as high as 75 percent.

I frequent use “confiscatory” when talking about tax systems that grab, say, 50 percent of the additional income being earned by taxpayers, but I’m simply expressing outrage at excessive taxation. In the case of 1970’s-era England, even a leftist presumably would agree that word applies to a system that seizes 75 percent-98 percent of a taxpayer’s income (though some British statists nonetheless will applaud because they think all income belongs to the government and some American leftists also will applaud because of spite).

By the way, let’s not forget that David Cameron’s father was presumably also aware that there was lots of double taxation in the United Kingdom because of other levies such as the corporate income tax, death tax, and capital gains tax. So I shudder to think about the effective marginal tax rate that may have applied to him and other taxpayers in the absence of tax planning (maybe they paid more than 100 percent, like the thousands of unfortunate French taxpayers victimized by that nation’s wretched tax system).

The bottom line if that I’m very sympathetic to Cameron’s father, who was simply doing what was best for his family and what was best for the economy.

But I’m not exactly bubbling over with sympathy for the Prime Minister, who appears to be a puerile and shallow hypocrite. I’ve previously shared examples of his government browbeating taxpayers who don’t choose to needlessly give extra money to the government.

And now he’s caught is his own web of demagoguery.

Writing in the U.K.-based Sunday Times, Dominic Lawson has an appropriately jaundiced perspective.

Jimmy Carr must be laughing. In June 2012 the comedian was revealed by The Times as one of a number of showbiz folk to have invested in a scheme that had the effect of minimising the tax paid on their (typically volatile) income. Somehow unable to resist commenting on this story, David Cameron…told journalists that Carr’s behaviour had been “morally wrong”. …In other words: the people are angry and the prime minister wants to be with the pitchfork-waving crowd, not on the other side of the barricades. …now the PM is himself the subject of a whipped-up storm of fury… That is why, in my column of June 24, 2012 (“Cameron’s the clown in this Carr sketch”), there appeared these words: “The prime minister could not resist accusing Carr of ‘morally wrong’ behaviour, a piece of headline-grabbing he will have cause to regret.” …As a result, Cameron has now felt forced to become the first prime minister to make his tax details open to the electorate. It’s a sort of ritual humiliation, but one that will in no way appease those who regard the very idea of personal wealth as immoral. He should never have pandered to them.

Janet Daly of the U.K.-based Telegraph is similarly unimpressed with Cameron’s shallow posturing.

…there is a great mass of voters…who are very susceptible to the impression that Mr Cameron is a rich man who may possibly be a hypocrite when he denounces the tax-avoiding wealthy. …The Prime Minister and his Chancellor had put themselves in the forefront of the assault on “the rich”. This was the modern Conservative party…a major rhetorical revolution that took dangerous liberties with the vocabulary of what was being discussed. The Government began to obscure the difference between tax evasion, which is a crime, and tax avoidance…George Osborne invented a new category of sin called “aggressive tax avoidance”. This was a far nastier, more elaborate form of financial planning… Some kinds of tax avoidance are OK but other kinds are not, and the difference between them is, well, basically a matter of what kind of person you are – which is for the Government to decide. …Mr Cameron says…he has done nothing illegal or unusual… Nor, apparently, have most of the people whose private finances have been revealed to the world in the Panama Papers. …free societies should not create moral “crimes” that can put people beyond the pale when they have done nothing illegal. Mr Cameron may be about to conclude that himself.

By the way, Cameron and his people are not very good liars. Here are some more excerpts from the Times column I cited above, which explained how his mother is transferring assets to David in ways that will avoid the awful death tax.

Government sources pushed back yesterday against claims that the arrangement was a tax dodge. …“Every year hundreds of thousands of parents give money to their children,” a No 10 source said. “To suggest that by giving money to the prime minister there is somehow a tax dodge is extraordinary.” A No 10 spokesman said: “This is in no way linked to tax avoidance and it would be wrong to suggest otherwise.”

This is bollocks, as the English would say. If there was no desire to avoid an unfair and pernicious tax, Cameron’s mother could have left him that money upon her death.

Instead, she made a gift for purposes of hopefully keeping any extra money if her family rather than letting the government grab it. David Cameron should proudly embrace this modest bit of tax avoidance.

It’s definitely what I would do if I ever get to the point where I had enough money to worry about the death tax. Sadly, I don’t expect that to happen because it’s not easy for policy wonks to earn large amounts of money.

But if I ever find a big pot of money that will be around after my death, I know that I’ll want my children and the Cato Institute to be the beneficiaries, not a bunch of greedy and wasteful politicians (sorry to be redundant).

Heck, I’d leave my money to my cats before giving it to the corrupt crowd in Washington.

P.S. Rich leftists often say they want to pay higher taxes, yet they change their tune when presented with the opportunity to voluntarily give more of their money to Washington.

P.P.S. Since I quoted Judge Learned Hand on tax avoidance, I’m almost certain to get feedback from my leftist friends about the quote by Oliver Wendell Holmes about taxes being the price we pay for civilization. Allow me to preempt them by noting that Justice Holmes made that remark when the federal government consumed about 5 percent of our economy. As I wrote in 2013, “I’ll gladly pay for that amount of civilization.”

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I’m hoping the “Panama Papers” issue will quickly fade from the news (as happened after a similar data theft from BVI in 2013)  for the simple reason that even left-leaning reporters will get bored when they discover it is mostly a story about internationally active investors legally using structures designed for cross-border investment.

Yes, statists have a broader agenda of trying to make tax avoidance somehow shameful and illegitimate. But I doubt they’ll make much progress since no rational person (not even Bono or Donald Trump) voluntarily pays more to the government than is legally required.

Instead, I’m hoping that advocates of economic liberty can use this non-controversy controversy to our advantage by explaining that good tax policy is the best way to encourage both growth and compliance.

I often explain, for instance, that the best way to “hurt” tax havens is for onshore countries to have lower tax rates and less double taxation.

But is it really possible to have a simple tax system that accomplishes all these things? Some folks say no. They argue that there are competing goals in tax policy and that lawmakers are in the unenviable position of having to choose among goals that are mutually inconsistent.

Indeed, a writer for The Economist has a column that purports to show the existence of a “trilemma.”

…the trilemma, under which three options are available, but only two at most can be selected. In this case, it is a simple tax system; independent national tax policies; and the existence of multinational companies and investors.

Here’s my amateur depiction of this supposed trilemma, which ostensibly allows only two out of the three goals to be achieved.

And why does the author think these three things can’t simultaneously exist?

…simple tax systems are the best; they do not distort behaviour. But countries also like to set their own tax policies… The existence of national tax policies also allows economies like Ireland to offer themselves as an attractive place to do business… But that freedom also means that multinational companies and investors can arrange their affairs so as to minimise their tax charge. Governments react to that possibility with a series of carrots and sticks; tax breaks to persuade companies to stay and regulations designed to close loopholes that multinationals try to exploit… This makes the tax system more complex.

This may sound superficially persuasive, but it’s wrong.

And it’s not just wrong in theory. There are real-world examples that show that the trilemma is false.

  • Hong Kong has a simple tax system, an independent national tax policy, and lots of multinational companies and investors.
  • The Cayman Islands has a simple tax system, an independent national tax policy, and lots of multinational companies and investors.
  • Switzerland has a simple tax system, an independent national tax policy, and lots of multinational companies and investors.
  • Estonia has a simple tax system, an independent national tax policy, and lots of multinational companies and investors.

So why is the author wrong?

For the simple reason that he omitted one word. The trilemma can be switched from false to true by adding “high” before “tax.”

To be fair, perhaps this is what the author actually meant since he writes at one point about the level of taxes needed to finance ever-expanding welfare states.

…a world of simple taxes, and independent tax policies, would probably undermine the tax base governments need to fund the welfare states

So there actually is a real lesson to be learned and a real trilemma to analyze. If nations have high taxes, they can’t also have simple tax systems that are appealing to companies and investors.

By the way, the author makes a very good point, noting that tax rates would be more punitive if politicians didn’t have to worry that jobs and investment could cross national borders.

…without…tax competition, one suspects the global tax take would creep higher and higher.

Actually, this is not something “one suspects.” It is a 99.9999 percent certainty. Heck, the OECD even admitted at the very beginning of its anti-tax competition project that the goal was to enable high tax rates and large fiscal burdens. Here’s what the (tax-free!) bureaucrats wrote on page 14 of their 1998 report about the impact of “harmful tax competition.”

Since I’ve pointed out that the OECD has an unseemly pattern of dishonest data manipulation, I feel compelled to give them credit for being uncharacteristically truthful in this instance.

P.S. Let’s take a look at some other trilemmas.

From what I can tell, the most famous trilemma in economics is the Impossible Trinity, which says you can’t simultaneously have fixed exchange rates, open capital flows, and an independent monetary policy. Instead, you have to pick only two of the three options. I try to steer clear of monetary policy issues, but this makes sense.

And it’s definitely true that you can spark an argument among libertarians by raising the possibility, as put forth by an economist from Sweden, that there is a trilemma regarding immigration policy. Is it really true that you can’t simultaneously have limited government, open borders, and democracy? Do you really have to pick two of the three options? For what it’s worth, I would change “democracy” to “majoritarianism.”

Though if you prefer non-policy trilemmas, there’s the one circulates in the business world. It hypothesizes that you can’t have a process for producing a product that is good, cheap, and fast. You have to pick two of the three options. I suspect this is true in the short run, but one of the great thing about capitalism is that markets over time generally make things cheaper, better, and faster.

Last but not least, while searching for good examples of trilemmas, I found this one about communism. It’s amusing, obviously, but can someone truly be both communist and intelligent? Maybe that was possible 100 years ago, before all the horrors that have been unleashed by communism, but is that possible today? Though maybe that’s the point of the trilemma. You can be a smart communist, but only if you actually understand that the system doesn’t work and you’re willing to make dishonest arguments. But, if that’s the case, are you really a communist, or are you some sort of sleazy, power-hungry opportunist?

P.P.S. For those who appreciate politically incorrect humor, here’s another trilemma that you may find amusing.

P.P.P.S. Returning to our original topic, I can’t resist sharing a blurb from this story about New Jersey’s fiscal problems.

The decision by billionaire hedge-fund manager David Tepper to quit New Jersey for tax-friendly Florida could complicate estimates of how much tax money the struggling state will collect, the head of the Legislature’s nonpartisan research branch warned lawmakers. …New Jersey relies on personal income taxes for about 40 percent of its revenue, and less than 1 percent of taxpayers contribute about a third of those collections.

Gee, what a surprise. A state that punishes success over time has less successful people.

But let’s now match this story to our aforementioned tax trilemma. I don’t know if New Jersey’s tax system is simple, but Tepper’s escape means we now have more evidence that high-tax policy is not compatible with attracting and retaining investors.

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I wrote a couple of days ago about the “Panama Papers” issue and touched on the key issues. I explained that this non-scandal scandal is simply another chapter in the never-ending war by high-tax governments against tax competition, fiscal sovereignty, and financial privacy.

Here are a few of the other points I made: .

I touched on some of these topics in this interview with Neil Cavuto.

Let’s look at what some others have written on this issue.

Veronique de Rugy of the Mercatus Center looks at some reactions from onshore politicians, which range from illogical to extremist.

The French finance minister, for instance, already put Panama back on the list of countries that aren’t sufficiently willing to help enforce onerous French tax law. That’s despite France’s removal of Panama from its list of uncooperative states and territories in 2012 after reaching a bilateral agreement on precisely that issue. President Barack Obama, on the other hand, recognizes that most of the activities reported in the stolen pages are legal. As such, he wants to do something that might be even more radical than what France has done. He proposes making it illegal to legally reduce one’s tax burden. Falling back on some generic and zero-sum concept of tax fairness, he told reporters that we “shouldn’t make it legal to engage in transactions just to avoid taxes” and that he wants to enforce “the basic principle of making sure everyone pays their fair share.”

So France wants to punish Panama, even though Panama already has agreed to help enforce bad French tax laws. Meanwhile, President Obama reflexively wants to punish taxpayers who have the temerity and gall to not voluntarily over-pay their taxes (an issue where Donald Trump actually said something sensible).

As an economist, Veronique highlights the most important issue (assuming, of course, one wants more prosperity).

If you want more global trade and more global investments, international bureaucracies such as the Organisation for Co-operation and Economic Development and governments around the world shouldn’t make it harder to operate international businesses and engage in cross-border investment and business.

Then she looks at discouraging developments from her home country.

For years, France has punished its entrepreneurs and businesses with high taxes and terrible laws. As a result, last year alone, some 10,000 French millionaires called it quits and moved abroad. However, rather than reform its tax laws and streamline its government, it wants to put its grabby hands on some cash… But it won’t work in the long run. France and other high-tax nations can try very hard to destroy tax competition, financial privacy and the sovereignty of countries with better tax structures, but they still won’t be able to afford their big and broken welfare states. …That’s the real financial scandal.

Amen. This is a simple matter of math and demographics.

The Wall Street Journal also has opined on the controversy, wondering about the fact that some folks on the left are fixating on legal tax avoidance.

The papers…purport to document the dealings of the Mossack Fonseca law firm, which appears to have helped wealthy clients establish shell companies in Panama, a rare remaining bastion of bank secrecy. …The fact that an individual created such a company, or opened bank accounts in Panama, is not proof of any wrongdoing… That’s not stopping the media from jumping to conclusions, many are oddly focusing on tax avoidance.

There’s a reason for the fixation on tax avoidance, of course. Politicians realize that they need to demonize legal tax if they want to impose big tax hikes by shutting down loopholes (both the real ones and the fake ones).

In any event, the editors agree that the real issue from Panama Papers is the presumably dodgy accumulation of assets by politicians.

The mistake now would be to narrow the focus prematurely, zeroing in on tax avoidance that is a hobbyhorse of the political class but in this case is a distraction. The real news here are the incomes and far-flung bank accounts of the political class.

The WSJ is right.

I touch on that issue in this interview with CNBC, explaining that it should be a non-story that international investors use international structures, but hitting hard on the fact that politicians so often manage to obtain a lot of wealth during their time in public “service.”

The bottom line is that if we’re going to have a crusade for transparency, it should focus on government officials, who have a track record of unethical behavior, not on the investors and entrepreneurs who actually earn their money by using capital to boost growth.

I should have dug into my files and provided a few examples of the hypocritical American politicians who have utilized tax havens. Such as…ahem…the current Secretary of the Treasury.

Speaking of hypocrisy, Seth Lipsky of the New York Sun identifies another strange example of double standards, in this case involving privacy.

The New York Times…defended Apple when the iPhone maker refused to help the FBI break into the iPhone that had been used by the Islamist terrorists who slew 14 innocent people in San Bernardino. It even praised Apple for refusing to help. Yet it’s joining in the feeding frenzy over what are coming to be known as the Panama Papers…calling for major investigations into money laundering and tax evasion.

I was sympathetic to Apple’s legal argument, even though I also wished the company would have helped the FBI (albeit without giving the government any details that could have been used to create a backdoor into all of our iPhones).

But Mr. Lipsky is right that the privacy-loving defenders of Apple have a remarkably inconsistent approach to the issue.

Where were most of the do-gooders…when the FBI was frantically trying to gain access to the infamous iPhone? It might be able to tell us to whom the killers had been talking and whether they were planning more attacks. …Apple…got cheered by all the right people. The Gray Lady…praised Apple for refusing to help. …So why are the do-gooders who are so protective of iPhone data when it belongs — or relates — to terrorists nonetheless so delighted about the disclosure of data when the data belong to the rich? Or relates to their property? Property rights, it seems, just don’t interest the do-gooders. They don’t believe individuals have a right to property or to due process before their stuff is taken.

This is a great point.

What it basically shows is that leftists (“do-gooders” to Seth) have more sympathy for medieval butchers who kill innocent people than they have for over-burdened taxpayers who actually want to preserve their money so it is used to promote prosperity rather than to fatten government budgets.

By the way, I can’t resist sharing another excerpt.

…tax havens can serve a benign purpose. They put pressure on law-abiding governments to keep taxation within non-abusive limits, something that is increasingly rare in the age of socialism.

Bingo. This is why everyone – especially those of us who aren’t rich – should applaud low-tax jurisdictions.

Just imagine how high taxes would be if politicians thought all of us were captive customers!

Let’s look at one final interview on the topic. But I’m not sharing this BBC interview because I said anything new or different. Instead, I want to use this opportunity to grouse about media bias. You’ll notice that I was out-numbered 2-to-1 in the discussion (3-to-1 if you include the host).

But I’m not upset I was in the minority. That’s so common that I barely notice when it happens.

What did irk me, though, was the allocation of time. Both statists got far more ability to speak, turning a run-of-the-mill example of bias into an irritating experience.

On the other hand, I did get to point out that the OECD bureaucrat was staggeringly hypocritical since she urges higher taxes on everyone else when she (like the rest of her colleagues) gets a tax-free salary. So maybe I should be content having unleashed that zinger.

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Hillary Clinton and Bernie Sanders are basically two peas in a pod on economic policy. The only difference is that Sanders wants America to become Greece at a faster rate.

Folks on the left may get excited by whether we travel 60 mph in the wrong direction or 90 mph in the wrong direction, but this seems like a Hobson’s choice for those of us who would prefer that America become more like Hong Kong or Singapore.

Consider the issue of taxation. Clinton and Sanders both agree that they want to raise tax rates on investors, entrepreneurs, small business owners, and other “rich” taxpayers. The only difference is how high and how quickly.

Scott Winship of the Manhattan Institute has a must-read column on this topic in today’s Wall Street Journal.

He starts by speculating whether there’s a rate high enough to satisfy the greed of these two politicians.

Here is a question to ask Hillary Clinton and Bernie Sanders: What is the best tax rate to impose on high-income earners…? Perhaps they think it is 83%, a rate that economists Thomas Piketty and Emmanuel Saez hypothesized in 2014… Or maybe it is 90%, which Sen. Sanders told CNBC last May was not out of the question.

He then points out that there were very high tax rates in America between World War II and the Reagan era.

…the U.S. had such rates in the past. From 1936 to 1980, the highest federal income-tax rate was never below 70%, and the top rate exceeded 90% from 1951 to 1963. …The discussion of these rates can easily create the impression that the federal government collected far more money from “the rich” before the Reagan administration.

But rich people aren’t fatted calves awaiting slaughter. They generally are smart enough to figure out ways to avoid high tax rates. And if they’re not smart enough, they know to hire bright lawyers, lobbyists, and accountants who figure out ways to protect their income.

Which is exactly what happened.

The effective tax rates actually paid by the highest income earners during the 1950s and early ’60s were far lower than the highest marginal rates. …In the 1960s, for example, the average rate paid by the top 0.1% of tax filers—the top 10th of the top 1%—ranged from 26.5% to 29.5%, according to a 2007 study by Messrs. Piketty and Saez. Even during the 20 years after the Reagan tax cuts, the top 10th of the top 1% paid an average rate of 23.7% to 33%—essentially the same as in the 1960s.

Gee, sounds like Hauser’s Law – a limit on how much governments can tax – is true, at least for upper-income taxpayers.

And Winship provides some data showing that high tax rate are not the way to collect more revenue.

When average tax rates went up from 27.6% in 1965 to 34% in 1975, revenues went down, from 0.6% to 0.5% of the sum of GDP plus capital gains. When average tax rates declined to 23.7% over the second half of the 1970s and the ’80s, tax revenues from the top went up, reaching 0.8% of GDP plus capital gains in 1990. …in the early 1990s, Presidents George H.W. Bush and Bill Clinton raised average tax rates at the top, and revenue from the top 0.1% eventually skyrocketed. But the flood of revenue overwhelmingly reflected not the increase in rates but the stock market’s takeoff… Consider: If the higher top tax rates had caused the growth in revenue, then revenues should have fallen when Mr. Clinton cut the top tax rate on capital gains to 20% from 28% in 1997. But revenues from the top 0.1% kept pouring in.

And if you want more detail, check out the IRS data from the 1980s, which shows that rich taxpayers paid a lot more tax when the top rate was dropped from 70 percent to 28 percent.

That was a case of the Laffer Curve on steroids!

No wonder some leftists admit that spite is their real reason for supporting confiscatory tax rates on the rich, not revenue.

But what if the high tax rates are imposed on a much bigger share of the population, not just the traditional target of the “top 1 percent”?

Well, even hardcore statists who favor punitive tax policy admit that this would be a recipe for economic calamity.

Mr. Piketty said, “I firmly believe, that imposing a 70% or 80% marginal rate on large segments of the population (say, 25% of the population, or even 10%, or even a few percentage points) would lead to an economic disaster.” In other words, sayonara increased tax revenue.

Heck, even the European governments with the biggest welfare states rarely impose tax rates at those levels.

And when they do (as in the case of Hollande’s 75 percent tax rate in France), they suffer severe consequences.

Which is why the real difference in taxation between the United States and Europe isn’t the way the rich are taxed. Government is bigger in Europe because of higher tax burdens on the poor and middle class, specifically onerous value-added taxes and top income tax rates that take effect at relatively modest levels of income.

In other words, the rich already pay the lion’s share of tax in the United States. But not because we have 1970s-style tax rates, but because the tax burden is relatively modest for lower- and middle-income people.

Which brings us to Winship’s final point.

Proposals to soak the rich by raising their tax rates are unlikely to yield the revenue windfall that Mr. Sanders or Mrs. Clinton are dangling before voters. Leveling with the American people means…admitting that they will have to raise the money from tax hikes on middle-class voters.

Though he “buried the lede,” as they say in the journalism business. The most important takeaway from his column is that the redistribution agenda being advanced by Clinton and Sanders necessarily will require big tax hikes on the middle class.

Indeed, the “tax-the-rich” rhetoric they employ is simply a smokescreen to mask their real goals.

Which is why I included that argument in my video that provided five reasons why class-warfare taxation is a bad idea.

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I’m never surprised when politicians make absurd statements, but I’m still capable of being shocked when other people make outlandish assertions.

Like the leftist policy wonk who claimed that capitalism is actually coercion, even though free markets are based on voluntary exchange. Or the statist columnist who argued people aren’t free unless they’re entitled to other people’s money, even though that turns some people into unfree serfs.

Now I have another example of upside-down thinking. It deals with the “inversion” issue, which involves American-chartered companies choosing to redomicile overseas.

A column in the Huffington Post implies that Pfizer is some sort of economic traitor for making a sensible business decision to protect the interests of workers, consumers, and shareholders.

Pfizer…wants to turn its back on America by claiming to be an Irish company through an offshore merger, giving it access to Ireland’s low tax rates. The change would only be on paper. The company would still be run from the United States, enjoying all the benefits of being based in America—such as our taxpayer-supported roads, public colleges, and patent protections—without paying its part to support them.

There’s a remarkable level of inaccuracy in that short excerpt. Pfizer wouldn’t be claiming to be an Irish company. It would be an Irish company. And it would still pay tax to the IRS on all U.S.-source income. All that changes with an inversion is that the company no longer would have to pay tax to the IRS on non-U.S. income. Which is money the American government shouldn’t be taxing in the first place!

Here’s more from the article.

Pfizer could walk out on its existing U.S. tax bill of up to $35 billion if its Irish tax maneuver goes forward. That’s what it already owes the American people on about $150 billion in profits it has stashed offshore, much of it in tax havens.

Wrong again. The extra layer of tax on foreign-source income only applies if the money comes back to the United States. Pfizer won’t “walk out” on a tax liability. Everything the company is doing is fully compliant with tax laws and IRS rules.

Here’s another excerpt, which I think is wrong, but doesn’t involve misstatements.

When corporations dodge their taxes, the rest of us have to make up for what’s missing. We pay for it in higher taxes, underfunded public services, or more debt.

The “rest of us” aren’t losers when there’s an inversion. All the evidence shows that we benefit when tax competition puts pressure on governments.

By the way, the author wants Obama to arbitrarily and unilaterally rewrite the rules .

President Obama can stop Pfizer’s biggest cash grab: that estimated $35 billion in unpaid taxes it wants to pocket by changing its mailing address. There are already Treasury Department rules in place to prevent this kind of overseas tax dodge. As now written, however, they wouldn’t apply to Pfizer’s cleverly-crafted deal. The Obama Administration needs to correct those regulations so they cover all American companies trying to exploit the loophole Pfizer is using. It already has the authority to do it.

Needless to say, Pfizer can’t “grab” its own money. The only grabbing in this scenario would be by the IRS. Since I’m not an international tax lawyer, I have no idea if the Obama Administration could get away with an after-the-fact raid on Pfizer, but I will note that the above passage at least acknowledges that Pfizer is obeying the law.

Now let’s look at some analysis from someone who actually understands the issue. Mihir Desai is a Harvard professor and he recently explained the reforms that actually would stop inversions in a column for the Wall Street Journal.

Removing the incentive for American companies to move their headquarters abroad is a widely recognized goal. To do so, the U.S. will need to join the rest of the G-7 countries and tax business income only once, in the country where it was earned. …Currently, the U.S. taxes the world-wide income of its corporations at one of the highest rates in the world, but defers that tax until the profits are repatriated. The result is the worst of all worlds—a high federal statutory rate (35%) that encourages aggressive transfer pricing, a significant restriction on capital allocation that keeps cash offshore, very little revenue for the Treasury, and the loss of U.S. headquarters to countries with territorial tax systems.

In other words, America should join the rest of the world and adopt a territorial tax system. And Prof. Desai is right. If the U.S. government stopped the anti-competitive practice of “worldwide” taxation, inversions would disappear.

That’s a lesson other nations seem to be learning. There’s only a small handful of countries with worldwide tax systems and that group is getting smaller every year.

Japan in 2009 and the United Kingdom in 2010 shifted to a territorial tax regime and lowered their statutory corporate rates. The U.K. did so to stop companies from moving their headquarters abroad; Japan was primarily interested in encouraging its multinationals to reinvest foreign earnings at home.

Professor Desai closes with a broader point about how it’s good for the American economy with multinational firms earn market share abroad.

…it is mistaken to demonize the foreign operations of American multinationals as working contrary to the interests of American workers. Instead the evidence, including research by C. Fritz Foley, James R. Hines and myself, suggests that U.S. companies succeeding globally expand at home—contradicting the zero-sum intuition. Demonizing multinational firms plays to populist impulses today. But ensuring that the U.S. is a great home for global companies and a great place for them to invest is actually the best prescription for rising median wages.

Amen. You don’t get higher wages by seizing ever-larger amounts of money from employers.

This is why we should have a territorial tax system and a much lower corporate tax rate.

Which is what Wayne Winegarden of the Pacific Research Institute argues for in Forbes.

…why would a company consider such a restructuring? The answer: the uncompetitive U.S. corporate income tax code. Attempts to punish companies that are pursuing corporate inversions misdiagnose the problem and, in so doing, make a bad situation worse. The problem that needs to be solved is the uncompetitive and overly burdensome U.S. corporate income tax code. The U.S. corporate income tax code puts U.S. companies at an unsustainable competitive disadvantage compared to their global competitors. The corporate income tax code in the U.S. imposes the highest marginal tax rate among the industrialized countries (a combined federal and average state tax rate of 39.1 percent), is overly-complex, difficult to understand, full of special interest carve-outs, taxes the same income multiple times, and taxes U.S. companies based on their global income.

Mr. Winegarden also makes the key point that a company that inverts still pays tax to the IRS on income earned in America.

…a corporate inversion does not reduce the income taxes paid by U.S. companies on income earned in the U.S. Following a corporate inversion, the income taxes owed by the former U.S. company on its income earned in the U.S. are precisely the same. What is different, however, is that the income that a company earns outside of the U.S. is no longer taxable.

Let’s now return to the specific case of Pfizer.

Veronique de Rugy of the Mercatus Center explains in National Review why the entire inversion issue is a classic case of blame-the-victim by Washington.

Almost 50 companies have chosen to “invert” over the last ten years. More than in the previous 20 years. …there are very good reasons for companies to do this. …for American businesses operating overseas, costs have become increasingly prohibitive. …Europe now sports a corporate-tax rate below 24 percent, while the U.S. remains stubbornly high at 35 percent, or almost 40 percent when factoring in state taxes. …it’s the combination with America’s worldwide taxation system that leaves U.S.-based corporations so severely handicapped. Unlike almost every other nation, the U.S. taxes American companies no matter where their income is earned. …So if a U.S.-based firm does business in Ireland they don’t simply pay the low 12.5 percent rate that everyone else pays, but also the difference between that and the U.S. rate.

Veronique explains why Pfizer made the right choice when it recently merged with an Irish company.

That’s a sensible reason to do what Pfizer has done recently with its attempt to purchase the Irish-based Allergan and relocate its headquarters there. The move would allow them to compete on an even playing field with every other company not based in the U.S. Despite the impression given by critics, they’ll still pay the U.S. rate when doing business here.

And she takes aim at the politicians who refuse to take responsibility for bad policy and instead seek to blame the victims.

…politicians and their ideological sycophants in the media wish to cast the issue as a moral failure on the part of businesses instead of as the predictable response to a poorly constructed corporate-tax code. …Clinton wants to stop the companies from moving with an “exit tax.” Clinton isn’t the first to propose such a silly plan. Lawmakers and Treasury officials have made numerous attempts to stop businesses from leaving for greener pastures and each time they have failed. Instead, they should reform the tax code so that businesses don’t want to leave.

Let’s close with an observation about the Pfizer controversy.

Perhaps the company did make a “mistake” by failing to adequately grease the palms of politicians.

Consider the case of Johnson Controls, for instance, which is another company that also is in the process of redomiciling in a country with better tax law.

Brent Scher of the Washington Free Beacon reports that the company has been a big donor to the Clinton Foundation, which presumably means it won’t be targeted if she makes it to the White House.

Hillary Clinton has spent the past few months going after Johnson Controls for moving its headquarters overseas, but during a campaign event on Monday, her husband Bill Clinton said that it is one of his “favorite companies.” …He described Johnson Controls as “one of my favorite companies” and praised the work it had done in the clean energy sector during an event in North Carolina on Monday. …Johnson Controls has contributed more than $100,000 to the Clinton Foundation and also partnered with it on numerous projects over the past eight years and as recently as 2015. Some of the Clinton Foundation projects included multi-million commitments from Johnson Controls. Bill Clinton pointed out in his speech that his foundation has done business with Johnson Controls—something that Hillary Clinton is yet to mention.

For what it’s worth, the folks at Johnson Controls may have made a wise “investment” by funneling money into the Clinton machine, but they shouldn’t delude themselves into thinking that this necessarily protects them. If Hillary Clinton ever decides that it is in her interest to throw the company to the wolves, I strongly suspect she won’t hesitate.

Though it’s worth pointing out that Burger King didn’t get attacked very much by the White House when it inverted to Canada, perhaps because Warren Buffett, a major Obama ally, was involved with the deal.

But wouldn’t it be nice if we had a reasonable tax code so that companies didn’t have to worry about currying favor with the political class?

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Why do many people engage in civil disobedience and decide not to comply with tax laws?

Our leftist friends (the ones who think that they’re compassionate because they want to spend other people’s money) assert that those who don’t obey the revenue demands of government are greedy tax evaders who don’t care about society.

And these leftists support more power and more money for the Internal Revenue Service in hopes of forcing higher levels of compliance.

Will this approach work? Are they right that governments should be more aggressive to obtain more obedience?

To answer questions of how to best deal with tax evasion, we should keep in mind three broad issues about the enforcement of any type of law:

1. Presumably there should be some sort of cost-benefit analysis. We don’t assign every person a cop, after all, even though that presumably would reduce crime. Simply stated, it wouldn’t be worth the cost.

2. We also understand that crime reduction isn’t the only thing that matters. We grant people basic constitutional rights, for instance, even though that frequently makes is more difficult to get convictions.

3. And what if laws are unjust, even to the point of leading citizens to engage in jury nullification? Does our legal system lose moral legitimacy when it is more lenient to those convicted of child pornography than it is to folks guilty of forgetting to file paperwork?

Now let’s consider specific tax-related issues.

I’ve written before that “tough on crime” is the right approach, but only if laws are legitimate. And that leads to a very interesting set of questions.

4. Is it appropriate to track down every penny, even if it results in absurdities such as the German government spending 800,000 euros to track down 25,000 euros of unpaid taxes on coffee beans ordered online?

5. Or what about the draconian FATCA law imposed by the United States government, which is only projected to raise $870 million per year, but will impose several times as much cost on taxpayers, drive investment out of American, and also causing significant anti-US resentment around the world?

6. And is there perhaps a good way of encouraging compliance?

The purpose of today’s (lengthy) column is to answer the final question.

More specifically, the right way to reduce tax evasion is to have a reasonable and non-punitive tax code that finances a modest-sized, non-corrupt government. This make tax compliance more likely and more just.

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

I don’t blame people from France for evading confiscatory taxation. I don’t blame people in corrupt nations such as Mexico for evading taxation. I don’t blame people in dictatorial nations such as Venezuela for evading taxation. But I would criticize people in Singapore,Switzerland, Hong Kong, or Estonia for dodging their tax liabilities. They are fortunate to live in nations with reasonable tax rates, low levels of corruption, and good rule of law.

Let’s elaborate on this issue.

And we’ll start by citing the world’s leading expert, Friedrich Schneider, who made these important points about low tax rates in an article for the International Monetary Fund.

…the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… Several studies have found strong evidence that the tax regime influences the shadow economy. …In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points.

With this bit of background, let’s look at the magnitude of non-compliance.

The Wall Street Journal reports on the history of dodging greedy governments.

Tax evasion has been around since ancient Mesopotamia, when the Sumerians were cheerfully working the black market. …The Romans were the most efficient tax collectors of all. Unfortunately Emperor Nero (ruling from A.D. 54 to 68) abandoned the high growth, low-tax policies of his predecessors. In their place he created a downward spiral of inflationary measures coupled with excessive taxation. By the third century, widespread tax evasion forced economically stressed Rome to practice expropriation. …Six hundred years later, during the Heian period (794-1185), Japan’s aristocracy acted in a similar manner and with similar consequences. …China’s Qing Dynasty (1644-1912) waged a harsh war against the tax-dodging gentry.

These same fights between governments and taxpayers exist today.

In a column published by the New York Times, we got some first-hand knowledge of the extraordinary steps people take to protect themselves from taxation in China.

In China, businesses have to give out invoices called fapiao to ensure that taxes are being paid. But the fapiao — the very mechanism intended to keep businesses honest — is sometimes the key to cheating on taxes. …My company would disguise my salary as a series of expenses, which would also save me from paying personal income tax. But to show proof of expenses, the accountant needed fapiao. It was my responsibility to collect the invoices. …But evading taxes in China was harder than I expected because everyone else was trying to evade taxes, too. …Though businesses are obligated to give out fapiao, many do not unless customers pester them. They are trying to minimize the paper trail so they too can avoid paying taxes on their true income. …some people are driven to buy fake invoices. It’s not hard; scalpers will sell them on the street, and companies that specialize in printing fake fapiao proliferate.

The author had mixed feelings about the experience.

I couldn’t figure out whether what I was doing was right or wrong. By demanding a fapiao, I was forcing some businesses to pay taxes they would otherwise evade. But all of this was in the service of helping my own company evade taxes. In this strange tale, I was both hero and villain. To me, tax evasion seemed intractable. Like a blown-up balloon, if you push in one part, another swells.

Meanwhile, Leonid Bershidsky, writing for Bloomberg, reviews what people do to escape the grasping hand of government in Greece.

In gross domestic product terms, Greece has the second biggest shadow economy among European Union countries without a Communist past…unreported revenue accounts for 23.3 percent of GDP, or $55.3 billion. …Had it been subject to taxes — at the prevailing 40 percent rate — the shadow economy would have contributed $22 billion to the government’s coffers.

Bershidsky cites some new academic research.

…researchers used loan application data from a big Greek bank. …The bank…regards the reported income figure as a fiction, as do many other banks in eastern and southern Europe. As a result, it uses estimates of “soft” — untaxed — income for its risk-scoring model. Artavanis, Tsoutsoura and Morse recreated these estimates and concluded that the true income of self-employed workers in Greece is 75 percent to 84 percent higher than the reported one.

Greek politician have tried to get more money from the shadow economy but haven’t been very successful.

Even the leftist government of former Prime Minister Alexis Tsipras, which came up with unworkable schemes to crack down on tax evasion — from using housewives and tourists to inform on small businesses to a levy on cash withdrawals — failed.

Bershidsky notes that some have called for indirect forms of taxation that are harder to evade.

The researchers suggest the government should sell occupation licenses through the powerful professional associations: a harsh but effective way to collect more money.

Though his conclusion rubs me the wrong way.

The shadow economy — and particularly the contributions of professionals — is an enormous potential resource for governments.

At the risk of editorializing, I would say that the untaxed money is “money politicians would like to use to buy votes” rather than calling it “an enormous potential resource.” Which is a point Bershidsky should understand since he wrote back in 2014 that European governments have spent themselves into a fiscal ditch.

Now let’s shift to the academic world. What do scholars have to say about tax compliance?

Two economists from the University of Rome have authored a study examining the role of fiscal policy on the underground economy and economic performance. They start by observing that ever-higher taxes are crippling economic performance in Europe.

…most European economies have been experiencing feeble growth and increasing levels of public debt. Compliance with the Stability and Growth Pact, and in particular with the primary deficit clause, has required many governments to raise taxes to exceptional high levels, thus hindering business venture and economic recovery.

And those high tax burdens don’t collect nearly as much money as politicians want because taxpayers have greater incentives to dodge the tax collectors.

…between a country’s tax system and the size of its shadow economy is a two-way relationship. …there exists a positive relationship between the dimension of the tax burden on economic activity and the size of the informal economy. …various tax reform scenarios, recently advocated in economic and policy circles as a means to promote growth, such as…ex-ante budget-neutral tax shifts involving reductions of distortionary taxes on labor and business compensated by an increase in the consumption tax or counterbalanced by decreases of government spending. We will see that all these fiscal reforms give rise to a resource reallocation effect from underground to official production or vice versa and have rather different implications in terms of output, fiscal solvency and welfare.

The authors look at the Italian evidence and find that lower tax rates would create a win-win situation.

Our main results can be summarized as follows. …the dimension of the underground sector is substantially decreased by fiscal interventions envisaging sizeable labor tax wedge reductions. Finally, all the considered tax reforms have positive effects on the fiscal consolidation process due to a combination of larger tax revenues and positive output growth. …consider the case in which the decrease of the business tax is met by a public spending cut…an expansionary effect on output, consumption and investments, and, despite the overall reduction of tax revenues, the public-debt-to-output ratio falls. However, we notice that the expansionary effects are…magnified on consumption and investments. In this model, in fact, public spending is a pure waste that crowds out the private component of aggregate demand, therefore it comes as no surprise that a tax cut on business, counterbalanced by a public spending reduction, is highly beneficial for both consumption and investments. …the underground sector shrinks.

The benefits of lower tax rates are especially significant if paired with reductions in the burden of government spending.

When the reduction of the business tax, personal income tax, and employers’ SSC tax rates are financed through a cut in public spending…we observe positive welfare effects… The main difference…is that consumption is significantly higher…due to the fact that this reform leaves the consumption tax unchanged, while public spending is a pure waste that crowds out private consumption. …all the policy changes that lower the labor tax wedge permanently reduce the dimension of the underground sector. Finally, all the considered tax reforms positively contribute to the fiscal consolidation process.

Let’s now look at some fascinating research produced by some other Italian economists.

They look at factors that lead to higher or lower levels of compliance.

…a high quality of the services provided by the State, and a fair treatment of taxpayers increase tax morale. More generally, a high level of trust in legal and political institutions has a positive effect on tax morale. …two further institutional characteristics that are likely to negatively affect an individual’s tax morale: corruption and complexity of the tax system.

By the way, “tax morale” is a rough measure of whether taxpayers willingly obey based on their perceptions of factors such as tax fairness and waste and corruption in government.

And that measure of morale naturally varies across countries.

…we examine how people from different countries react to varying tax rates and levels of efficiency. …We focus our analysis on three countries: Italy, Sweden and UK. …these three countries show differences concerning the two institutional characteristics we are focused on. Italy and Sweden show a high tax burden while UK shows a low one. Whereas, Sweden and UK can be considered efficient states, Italy is not.

By the way, I don’t particularly consider the United Kingdom to be a low-tax jurisdiction. And I don’t think it’s very efficient, especially if you examine the government-run healthcare system.

But everything is relative, I guess, and the U.K. is probably efficient compared to Italy.

Anyhow, here are the results of the study.

Experimental subjects react to institution incentives, no matter the country. More specifically, tax compliance increases as efficiency increases and decreases as the tax rate increases. However, although people’s reaction to changes in efficiency is homogeneous across countries, subjects from different countries react with a different degree to an increase in the tax rate. In particular, participants who live in Italy or Sweden – countries where the tax burden is usually high – react more strongly to an increase in the tax rate than our British subjects. At the same time, subjects in Sweden – where the efficiency of the public service is high – react less to tax rate increases than Italian subjects.

So low tax rates matter, but competent and frugal government also is part of the story.

In all 3 countries, higher tax rates imply lower compliance. This is in line with experimental evidence: as Alm (2012, p. 66) affirms: “most (but not all) experimental studies have found that a higher tax rate leads to less compliance” and “The presence of a public good financed by voluntary tax payments has been found to increase subject tax compliance”. …The stronger negative reaction of Italian subjects to an increase in the tax rate may be due to the fact that in everyday life they suffer from high tax rates combined with inefficiency and corruption. …In fact, in the final questionnaire, 67.5% of Italian participants state that people would be more likely to pay taxes if the government were more efficient (vs 34.4% and 30.3% in UK and Sweden respectively) and 54.6% would comply with their fiscal obligations if they had some control over how tax money were spent (vs 30.8% and 25.8% in UK and Sweden respectively)… No way to impose a high tax burden on citizens if the tax revenue is wasted through inefficiency and corruption.

Here’s one additional academic study from Columbia University. The author recognizes the role of tax rates in discouraging compliance, but focuses on the impact of tax complexity.

Here’s what he wrote about the underlying theory of tax compliance.

The basic theoretical framework for tax evasion was derived…from the Becker model of crime. This approach views tax evasion as a gamble. …when tax evasion is successful, the taxpayer gains by not paying taxes. In other cases, tax evasion is uncovered by tax authorities, and the taxpayer has to pay taxes due and fines. The taxpayer compares the expected gain to the expected loss. …This approach highlights a number of factors that determine whether and to what extent taxes are evaded. These are: the magnitude of potential savings (which, on the margin, is simply equal to the tax rate)… This model therefore highlights…natural policy parameters that can affect evasion. …the marginal gains from tax evasion could be reduced by imposing lower marginal tax rates.

Interestingly, he doesn’t see much difference between (illegal) evasion and (legal) avoidance.

The ideal compliance policy should target both tax avoidance and tax evasion. While there is a legal distinction between the two, from the economic point of view the difference is less explicit. Both types of activity involve a loss of revenue and both involve a loss of economic welfare.

He then brings tax complexity into the equation.

…the appropriate extent of tax enforcement critically depends on the underlying tax structure. In particular, the role of complexity in the tax system as a factor influencing the size of the tax gap, as well as legal but undesirable tax avoidance, are highlighted. Two principal implications of tax complexity are stressed here. First, complexity permits additional ways to shield income from tax and, consequently, complexity increases the overall cost of taxation. … Reasonable simplification can more adequately combat tax evasion and avoidance than traditional enforcement measures.

Here are some of his findings.

Tax avoidance is a function of ambiguity in the tax system. …Administrative investment in enforcement becomes more important when the tax system is more distortionary. One way to reduce the need for costly tax enforcement is to reduce distortions. … Higher complexity induces tax avoidance and other types of substitution responses. A tax system that allows for many different types of avoidance responses is likely to cause stronger behavioral effects and therefore higher excess burden. …Shutting down extra margins of response can be loosely summarized as expanding the tax base by eliminating preferential treatment of some types of income, deductions, and exemptions. …One of the consequences of complexity is that it makes it difficult for honest taxpayers to fulfill their obligations. …The bottom line is that complexity makes relying on penalties a much less appealing approach to enforcement. …From the complexity point of view, itemized deductions add a multitude of tax avoidance and evasion opportunities. …They stimulate avoidance by introducing extra margins with differential tax treatment.

Sounds to me like an argument for a flat tax.

Incidentally (and importantly), he acknowledges that greater enforcement may not be a wise option if the underlying tax law (such as the code’s harsh bias against income that is saved and invested) is overly destructive.

…tax avoidance—letting well enough alone—may be a simple and practical way of addressing shortcomings of an inefficient tax structure. For example, suppose that, as much of the optimal taxation literature suggests, capital incomes should not be taxed, or should only be taxed lightly. In that case, the best policy response would be cutting tax rates imposed on capital income. If it is not politically feasible to pursue such policies explicitly, a similar outcome can be accomplished by reducing enforcement or increasing avoidance opportunities in this area. …The preferred way of dealing with compliance problems is fixing the tax code.

Amen. Many types of tax evasion only exist because the politicians in Washington have saddled us with bad tax policy.

And when tax policy moves in the right direction, compliance improves. Consider what happened in the 1980s when Reagan’s reforms lowered the top tax rate from 70 percent to 28 percent. Rich people paid five times as much to the IRS, in large part because they declared 10 times as much income.

But it’s very unlikely that they actually earned 10 times as much income. Some non-trivial portion of that gain was because of less evasion and less avoidance.

Simply stated, it makes sense to comply with the tax system when rates are low.

Let’s close by addressing one of the ways that leftists want to improve compliance. They want to destroy financial privacy and give governments near-unlimited ability to collect and share financial information about taxpayers, all for the purpose of supposedly bolstering tax compliance.

This agenda, if ultimately successful, will cripple tax competition as a liberalizing force in the global economy.

This would be very unfortunate. Tax rates have fallen in recent decades, for instance, largely because governments have felt pressure to compete for jobs and investment.

That has led to tax systems that are less punitive. And politicians really can’t complain about being pressured to lower tax rates since these reforms generally led to more growth, which generated significant revenue feedback. In other words, the Laffer Curve works.

There’s even some evidence that tax competition leads to less government spending.

But these are bad things from a statist perspective.

This helps to explain why politicians from high-tax governments want to eviscerate tax competition and create some sort of global tax cartel. An “OPEC for politicians” would give them more leeway to impose class-warfare tax policy and buy votes.

The rhetoric they’ll use will be about reducing tax evasion. The real goal will be bigger government.

I’m not joking. Left-wing international bureaucracies such as the Organization for Economic Cooperation and Development have justified their anti-tax competition efforts by asserting that jurisdictional rivalry “may hamper the application of progressive tax rates and the achievement of redistributive goals.”

I suppose we should give them credit for being honest about their ideological agenda. But for those who want good tax policy (and who also understand why that’s the right way to boost tax compliance), it’s particularly galling that the OECD is being financed with American tax dollars to push in the other direction.

P.S. I don’t know if you’ll want to laugh or cry, but here are some very odd examples of tax enforcement.

P.P.S. Here’s more evidence that high tax rates and tax complexity facilitate corruption.

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