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Posts Tagged ‘Taxation’

My long-running feud with the Paris-based Organization for Economic Cooperation and Development could be categorized as a fight over tax compliance.

The bureaucrats at the OECD say that financial privacy must be eviscerated and the fiscal sovereignty must be wiped out so that high-tax governments can track and tax money around the world.

My view is that pro-growth reforms like the flat tax would be a much better approach. With a simple and fair tax code that doesn’t impose extra layers of tax on saving and investment, the IRS no longer would need to know about our bank accounts or investment funds – regardless of whether they are based in Geneva, Illinois, or Geneva, Switzerland.

Though I view better compliance as a secondary benefit. My main goal is to have a tax system that doesn’t impose needlessly high levels of economic damage.

But let’s stick with the compliance issue. Writing for E21, Daniel Di Martino explains that the Italian government makes evasion and avoidance a preferable option because tax rates are too onerous.

Italy’s problem, similar to many of its southern-European neighbors, is an oppressively high tax burden, irresponsible welfare programs that encourage high measured unemployment and increase the debt, and high levels of regulation. …the share of average wages collected by the Italian government via income and social security taxes is among the highest in the OECD at 48 percent. In addition, Italy imposes a value-added tax of 22 percent on most goods and services, one of the highest in Europe. Plus, Italy’s corporate, capital gains, gift, and myriad other taxes are passed on to individuals and borne directly by workers. These high taxes lead to a growing shadow economy, where people underreport work to avoid paying taxes. …many estimates point to more than  $175 billion (€150 billion) in lost tax revenue.

So what’s the best way of addressing that nation’s huge shadow economy?

Simple, less government.

Instead of cracking down on tax evasion and the shadow economy, Italy’s new government needs to rethink long-standing policies to bring a real economic recovery. Taxes need to be lowered so more businesses open and already-existing businesses and individuals come out of the shadows, broadening the tax base and raising revenue. This would allow those in the shadow economy to expand their businesses. Additionally, the welfare state should be trimmed so that people do not have an incentive to stay unemployed and young Italians are less burdened by government debt. Moreover, Italy needs to become more competitive by slashing the number of regulations.

The Institut Economique Molinari in Belgium took a look at the same issue, but included data for all European Union nations.

Economic reasoning and international experience point invariably to common causes that consistently create obstacles to dealings in the official economy: prohibitions, compulsory levies and specific tax measures, as well as fastidious and complex regulations. …As noted by two specialists, “In almost all studies, one of the most important causes (…) is the rise of the tax and social security burdens.” The higher these burdens on labour relations and dealings in the official economy, the less profitable these dealings become and the greater the incentive to trade on the black market. …As long as taxes account for a high share of the final price, opportunities for profit are provided in the underground economy, which moves in on a long‐term basis and comes to account for a significant share of countrywide sales. …Increasing this tax burden can only increase the disconnection between the real production cost of goods and their price on the official market, to such a degree that consumers begin abandoning the official market on a larger scale.

So what’s the answer?

Definitely not more government.

Given the scope of the underground economy, public authorities generally suggest toughening the means of repression so as to collect more tax revenues. The justification for this repression remains the same: it would promote the transfer of all under ground activity to the legal market, thereby creating new tax revenues. Beyond the cost of this repression in terms of resources and bureaucratisation of the economy, this reasoning and the resulting forecasts are erroneous. Though certain activities may no longer be undertaken in the underground economy, they will not be undertaken in the official economy either — in part or even in whole, depending on the specific case — because of the burden of compulsory levies and regulations. …Increased repression by the public authorities, without any change in regulatory and tax frameworks, risks simply destroying economic activities and the associated revenues. The only long‐lasting solution for ending the underground economy consists of dealing with the causes that give rise to it and thus to free the official market from its fiscal and regulatory burdens. …there is no other choice but to lighten tax and regulatory burdens.

Let’s now cross to this side of the Atlantic Ocean.

In an editorial about the current and former Treasury Secretary and their Cayman investments, the Wall Street Journal highlighted hypocrisy. But the best part was the conclusion about bad government policy driving money away from America.

Mr. Mnuchin served as director of Dune Capital, an investment firm he said he registered in the Caymans primarily to “accommodate nonprofits and pensions that want to invest through these off-shore entities.” By contrast, Mr. Lew was personallyinvested in the Citigroup Venture Capital International Growth Partnership II. You know, like that evil profiteer Mitt Romney, the subject of a now infamous Barack Obama campaign ad scoring Mr. Romney for profiting from money in offshore havens such as the Caymans. Mr. Lew’s Cayman company even used the same Ugland House building in the Caymans that President Obama so famously trashed as an “outrage” and “tax scam.” …The Democratic goal…seemed to be to get Mr. Mnuchin to admit that investors go to the Caymans to avoid American taxes. Mr. Mnuchin denied it but needn’t have been so shy. The Caymans have no corporate tax rate. The way to deal with the Caymans is not to punish investors who go there but to get rid of the regulations and high tax rates that send capital offshore.

But it’s not just market-friendly organizations that realize high tax burdens bolster the underground economy.

The International Monetary Fund released a study earlier this year on the shadow economy, which is defined as legal activities that are hidden from government.

The shadow economy includes all economic activities which are hidden from official authorities for monetary, regulatory, and institutional reasons. Monetary reasons include avoiding paying taxes and all social security contributions, regulatory reasons include avoiding governmental bureaucracy or the burden of regulatory framework, while institutional reasons include corruption law, the quality of political institutions and weak rule of law. For our study, the shadow economy reflects mostly legal economic and productive activities that, if recorded, would contribute to national GDP.

And what causes people to hide legal activity from government?

Here are some of the factors that drive the shadow economy according to the IMF.

In other words, people are less likely to comply when they have to endure bad government policy.

…in most cases trade openness, unemployment rate, GDP per capita, size of government, fiscal freedom and control of corruption are highly statistically significant.

And the number one bad government policy is high tax rates.

Let’s close by looking at the other side’s arguments.

Earlier this month, I revealed that the OECD finally admitted that it’s anti-tax competition project was motivated by a desire for class warfare and bigger government.

That’s terrible policy, but I give the bureaucrats in Paris credit for finally being honest.

By contrast, I’m not sure what to say about the bureaucrats in Brussels. The European Commission’s idea of an argument is this vapid video, which attempts to convince viewers that 20 percent of what they like is missing because government isn’t collecting more tax revenue.

In reality, of course, the money isn’t “missing.” It’s still in the private sector, where it actually is providing things that people like, rather than financing the stuff politicians like.

P.S. Speaking of vapid arguments from the European Commission, the bureaucrats actually created an online game designed to brainwash kids into supporting higher tax burdens.

P.P.S. The Wall Street Journal’s editorial mentioned Ugland House in the Cayman Islands. That’s the building that featured in some of Barack Obama’s dishonest demagoguery.

P.P.P.S. I’m still mystified that Republicans continue to send our tax dollars to Paris to subsidize the OECD. Actually, I’m not mystified. This is actually a good example of why they’re called the Stupid Party.

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I wrote last month about a new book from the Fraser Institute about demographics and entrepreneurship.

My contribution was a chapter about the impact of taxation, especially the capital gains tax.

At a panel in Washington, I had a chance to discuss my findings.

If you don’t want to watch an 11-minute video, my presentation can be boiled down to four main points.

1. Demographics is destiny – Other authors actually had the responsibility of explaining in the book about the importance of demographic change. But it never hurts to remind people that this is a profound and baked-in-the-cake ticking time bomb.

So I shared this chart with the audience and emphasized that a modest-sized welfare state may have been feasible in the past, but will be far more burdensome in the future for the simple reason that the ratio of taxpayers to tax-consumers is dramatically changing.

And it goes without saying that big-sized welfare states are doomed to collapse. Think Greece and extend it to Italy, France, Japan, and other developed nations (including, I fear, the United States).

2. Entrepreneurship drives growth – Capital and labor are the two factors of production, but entrepreneurs are akin to the chefs who figure out news ways of mixing those ingredients.

For all intents and purposes, entrepreneurs produce the creative destruction that is a prerequisite for growth.

3. The tax code discourages entrepreneurship – The bulk of my presentation was dedicated to explaining that double taxation is both pervasive and harmful.

I shared my flowchart showing how the American tax code is biased against income that is saved and invest, which discourages entrepreneurial activity.

And then showed the capital gains tax burden in developed countries.

The U.S. is probably even worse than shown in the above chart since our capital gains tax is imposed on inflationary gains.

4. The United States need to be more competitive – Last but not least, I pointed out that America’s class-warfare tax policies are the fiscal equivalent of an “own goal” (soccer reference for World Cup fans).

And this chart from my chapter shows how the United States, as of mid-2016, had the highest combined tax rate on capital gains when including the effect of the capital gains tax.

That’s the bad news. The good news is that the Trump tax cuts did produce a lower corporate rate. So in the version below, I’ve added my back-of-the-envelope calculation of where the U.S. now ranks.

But the bottom line is still uncompetitive when looking at the tax burden on investment.

And never forget that this ultimately backfires against workers since it translates into lower pay.

P.S. The Wall Street Journal produced an excellent description of why capital gains taxation is very destructive.

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Since I consider myself the world’s biggest advocate for tax competition and tax havens (even when it’s risky), I’m always on the lookout for new material to share.

So I was delighted to see a new monograph from the London-based Institute of Economic Affairs on the benefits of “offshore” financial centers. Authored by Diego Zuluaga, it explains why low-tax jurisdictions are good news for those of us laboring in less-enlightened places.

Offshore finance serves several purposes, the most salient of which is the efficient allocation of capital. Some of this activity is tax-related, aimed at raising after-tax investment returns. If it were not for offshore jurisdictions, much foreign investment would be vulnerable to double or triple taxation. Because, under such punitive rates of tax, some of this investment would not take place, the existence of offshore centres has real positive effects on economic activity alongside the (plausibly) negative impact on the tax revenue of individual countries. These welfare gains have been amply documented… Beyond their impact on aggregate investment, research shows that the existence of an OFC is associated with better economic outcomes in neighbouring countries. Contrary to the popular narrative, these jurisdictions are well-governed and peaceful. Who, after all, would wish to use intermediaries in places where investors were regularly expropriated or harassed? …It is difficult to imagine the process of globalisation that has taken place over the last fifty years, bringing hundreds of millions of people out of poverty, happening without the robust financial and legal framework which offshore jurisdictions provide for investment. It would be counterproductive, for both the developing and the rich world, to undermine their essential functions. …Clamping down on offshore centres…would make societies less productive and prosperous, and this effect would compound over time.

He provides some fiscal history, including the fact that government used to be very small in the industrialized world (indeed, that’s one of the big reasons why today’s rich nations got that way).

And he notes that low-tax jurisdictions became more important to global commerce as governments adopted dirigiste policies.

Before World War I, governments played only a small role in economic activity, rarely taking up shares of national income in excess of 15 per cent during peacetime. After the Great War, they took upon themselves ever larger fiscal and administrative functions, notably trade restrictions and capital controls. …In a context of punitive marginal tax rates, constrained capital movements…, OFCs were vital to the revival of cross-border trade and investment after World War II. Without stable intermediary jurisdictions with robust rule of law and low taxation, much international investment would have been too costly, whether because of the associated tax burden or the risks of expropriation and inflation.

Zuluaga notes that tax competition ties the hands of politicians.

Theory and evidence suggest that countries may have any two of free capital mobility, an independent tax policy and no tax competition (Figure 2). But they cannot have all three.

And here is the aforementioned Figure 2 from the report.

I wrote about a version of the tax trilemma two years ago and noted that there’s only a problem if a country has high taxes.

So I made the following correction.

Returning to the article, Zuluaga points out that low-tax jurisdictions have a much better track record in the fight against bad behavior than high-tax nations.

OFCs are neither the original source nor the ultimate destination of illegal financial flows. So long as there remain corrupt politicians, drug users and people willing to engage in terrorist acts, history suggests that some illegal financial activity will take place to make it possible. Furthermore, as we saw above, OFCs are as a rule far more compliant and transparent in their prevention of unlawful activities than onshore jurisdictions, including the United States and the United Kingdom.

Zuluaga concludes with a warning about how the attack on tax havens is really an attack on globalization. And the global economy will suffer if the statists prevail.

…an ominous alliance of revenue-greedy politicians, ideological campaigners and rent-seekers has emerged in recent years. Gradually, but relentlessly, they aim to dismantle the liberal financial order of which free capital movement is a fundamental component. …the alliance’s real goal: to eliminate tax competition and constrain the movement of capital in order to bring it under their control. The consequences of this effort would be long-standing and go far beyond a few tiny offshore financial centres.

Excellent points. I strongly recommend reading the entire publication.

Though I’m not sure Zuluaga and I agree on everything. His article notes, seemingly with approval, that offshore jurisdictions largely have agreed to help enforce the bad tax laws of onshore nations. Yet that’s a recipe for the application of more double taxation on income that is saved and invested, which he acknowledges is a bad thing.

In other words, I think financial privacy is a good thing since predatory governments are less likely to misbehave if they know taxpayers have safe (and confidential) places to put their money. Now that privacy has been weakened, however, anti-tax competition folks at the OECD are openly chortling that there can be higher taxes on capital.

The bottom line is that tax competition without privacy is not very effective. I wonder if Zuluaga understands and agrees.

Another IEA author, Richard Teather, got that key point.

In a 2005 monograph, he explained the vital role of financial privacy.

Although the country of residence may theoretically impose taxes on foreign income, it can only do so practically if its tax authorities have knowledge of that income. It is therefore common for tax havens to have strong privacy laws that protect investors’ personal information from enquirers (including foreign tax authorities). The best-known of these was Switzerland, which introduced banking secrecy to protect Jewish customers from Nazi confiscation, and there remains a genuine strong feeling in many of these countries that privacy is about more than just tax avoidance.

But I’m digressing. Since we’ve looked at one U.K.-based defense of low-tax jurisdictions, let’s also look at some excerpts from a column by Matthew Lynn in the London-based Spectator.

He makes a very interesting point about how so-called tax havens are basically the financial equivalent of free zones for goods.

…in a globalised economy, offshore finance plays an important role, enabling money to move across borders relatively easily. Rather oddly, a lot of the media seem to have decided that while it is fine for people and goods to move around the world, having a bank account or an investment in a different country makes you virtually a criminal. …The world already has an extensive network of free ports, tax-free zones where goods in transit can be processed or temporarily stored without having to pay local tariffs. There are an estimated 3,500 of them across 135 countries, facilitating the movement of goods around the world. They have helped trade grow hugely over the past couple of decades. Offshore centres…are now mainly financial ‘free ports’ — places where cash can easily be parked and transferred as it moves around the world.

He also makes a very important observation about how the theft of data leading to the Panama Papers and Paradise Papers revealed very little illegal behavior.

…one of the interesting things about the leaks is not how much wrongdoing they expose, but how little. Take last year’s Panama Papers scandal, for example. …For all the drama, it was pretty small beer. The reason? All the data revealed might have been interesting, and made for some lurid headlines, but very few people turned out to be breaking any laws. In only a handful of cases were taxes being evaded or money-laundered.

Which is a point I’ve made as well.

And here’s his conclusion.

…it turns out that offshore centres are used by just about everyone. Most pension funds use them, including those looking after the savings of the politicians queuing up to condemn them. They are part of the infrastructure of globalisation, as much as the container ships, airports and fibre optic cables. It is ironic that many of the same people who proudly describe themselves as citizens of the world think that applies to everything except money.

Amen. Once again, this is really a fight about globalization. Or, to be more accurate, a fight between good globalism and bad globalism.

To wrap up, here’s the video I narrated for the Center for Freedom and Prosperity on the economic benefits of tax havens.

P.S. I’ve previously cited other tax haven-related research and analysis from the United Kingdom, most notably from Allister Heath, Dan Hannan, Philip Booth, Godfrey Bloom, and Mark Field.

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Better economic performance is the most important reason to adopt pro-growth reforms such as the Tax Cuts and Jobs Act of 2017.

Even small increases in economic growth – especially if sustained over time – can translate into meaningful improvements in living standards.

But there are several reasons why it won’t be easy to “prove” that last year’s tax reform boosted the economy.

And there are probably other factors to mention as well.

The takeaway is that the nation will enjoy good results from the 2017 tax changes, but I fully expect that the class-warfare crowd will claim that any good news is for reasons other than tax reform. And if there isn’t good news, they’ll assert this is evidence against “supply-side economics” and totally ignore the harmful effect of offsetting policies such as Trump’s protectionism.

That being said, some of the benefits of tax reform are already evident and difficult to dispute.

Let’s start by looking at what’s happening Down Under, largely driven by American tax reform.

The Australian government announced Monday that the Senate will vote in June on cutting corporate tax rates after an opinion poll suggested the contentious reform had popular public support. …Prime Minister Malcolm Turnbull’s conservative coalition wants to cut the corporate tax rate by 5 percent to 25 percent by 2026-27… Cormann said the need to reduce the tax burden on businesses had become more pressing for future Australian jobs and investment since the 2016 election because the United States had reduced its top corporate tax rate from 35 percent to 21 percent. “Putting businesses in Australia at an ongoing competitive disadvantage deliberately by imposing higher taxes in Australia … puts Australian workers at an oncoming disadvantage and that is clearly the point that more and more Australians are starting to fully appreciate,” Cormann told reporters. Cormann was referring to a poll published in The Australian newspaper on Monday that showed 63 percent of respondents supported company tax cuts.

Wow.

What’s remarkable is not that Australian lawmakers are moving to lower their corporate rate. The government, after all, has known for quite some time that this reform was necessary to boost wages and improve competitiveness.

The amazing takeaway from this article is that ordinary people understand and support the need to engage in tax competition and other nations feel compelled to also cut business tax burdens.

All last year, I kept arguing that this was one of the main reasons to support Trump’s proposal for a lower corporate rate. And now we’re seeing the benefits materializing.

Now let’s look at a positive domestic effect of tax reform, with a feel-good story from New Jersey. It appears that the avarice-driven governor may not get his huge proposed tax hike, even though Democrats dominate the state legislature.

Why? Because the state and local tax deduction has been curtailed, which means the federal government is no longer aiding and abetting bad fiscal policy.

New Jersey’s new Democratic governor is finding that, even with his party in full control of Trenton, raising taxes in one of the country’s highest-taxed states is no day at the beach. Gov. Phil Murphy…has proposed a $37.4 billion budget. He wants to raise $1.7 billion in new taxes and other revenue… But some of his fellow Democrats, who control the state legislature, have balked at the governor’s proposals to raise the state’s sales tax and impose a millionaires tax. State Senate President Steve Sweeney has been particularly vocal. …Mr. Sweeney previously voted for a millionaire’s tax, but said he changed his mind after the federal tax law was passed in December. The law capped previously unlimited annual state and local tax deductions at $10,000 for individual and married filers, and Mr. Sweeney said he is concerned an additional millionaire’s tax could drive people out of the state. “I think that people that have the ability to leave are leaving,” he said.

Of course they’re leaving. New Jersey taxes a lot and it’s the understatement of the century to point out that there’s not a correspondingly high level of quality services from government.

So why not move to Florida or Texas, where you’ll pay much less and government actually works better?

The bottom line is that tax-motivated migration already was occurring and it’s going to become even more important now that federal tax reform is no longer providing a huge de facto subsidy to high-tax states. And that’s going to have a positive effect. New Jersey is just an early example.

This doesn’t mean states won’t ever again impose bad policy. New Jersey probably will adopt some sort of tax hike before the dust settles. But it won’t be as bad as Governor Murphy wanted.

We also may see Illinois undo its flat tax after this November’s election, which would mean the elimination of the only decent feature of the state’s tax system. But I also don’t doubt that there will be some Democrats in the Illinois capital who warn (at least privately) that such a change will hasten the state’s collapse.

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I’ve written dozens of columns about the Laffer Curve and its implications.

My favorite may be the one that pointed out why it generally is misguided to raise tax rates even if the government would collect more revenue (i.e., don’t give politicians $1 if it means reducing the private economy by $5).

And I’m always reminding people that the goal is to maximize growth rather than revenue.

I’ve even written about how the Laffer Curve relates to issues as diverse as sex and ISIS.

But I haven’t paid much attention to the history of the issue. Now, thanks to some great research from Nima Sanandaji, we can investigate that topic.

…the Laffer Curve has been used by supporters of low taxes around the world to reinforce their ideas. …it has helped to inspire a downward shift in taxation. Ronald Reagan’s administration introduced massive changes, which dropped the marginal tax rate to 28 percent. …even the proponents of high tax policy are aware of Laffer’s warnings: there is a limit to how high taxes can be raised.

All that’s true.

Reagan’s lower tax rates did produce a windfall of tax revenue from the rich.

And even folks on the left admit that the revenue-maximizing tax rate is below 100 percent, so they acknowledge the Laffer Curve is real.

But what many people don’t know is that the concept of the Laffer Curve existed long before Art drew his famous curve on a napkin.

Nima points to the example of Ibn Khaldun.

…Laffer’s theory was far from new. …Laffer has himself explained that he didn’t invent the curve, but took it from Ibn Khaldun, a 14th-century Muslim, North African philosopher. …Born in 14th-century Tunisia, Khaldun was a prominent scholar and one of the founders of economics and social sciences. Khaldun believed that a just government should only, in accordance with Islamic law, impose low taxes. …However, rulers tend to increase the tax to benefit themselves. High taxes hurt commerce and trade. When tax rates are raised to pay for a bloated government, it will finally cause the tax base to shrink so much that the government cannot meet its obligations. …at this point the state would often implode under its own weight, leading to a period of chaos and the rise of a new state.

Here’s Khaldun’s most famous statement on tax rates and tax revenue.

By the way, there were plenty of people between Khaldun and Laffer who understood why punitive tax rates are foolish, including Alexander Hamilton and John Maynard Keynes(!).

P.S. Perhaps because they’re exposed to the real-world impact, America’s CPAs also understand the Laffer Curve is very real.

P.P.S. Nima has just written a fascinating new book, The Birthplace of Capitalism – The Middle East, which can be ordered here.

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I’ve written over and over again that changing demographics are a very under-appreciated economic development. I’ve also written about why entrepreneurship is a critical determinant of growth.

But I never thought of combining those topics. Fortunately, the folks at the Fraser Institute had the foresight to do just that, having just published a book entitled Demographics and Entrepreneurship: Mitigating the Effects of an Aging Population.

There are chapters on theory and evidence. There are chapters on specific issues, such as taxes, regulation, migration, financial markets, and education.

It’s basically the literary equivalent of one-stop-shopping. You’ll learn why you should be concerned about demographic change. More important, since there’s not much policy makers can do to impact birthrates, you’ll learn everything you need to know about the potential policy changes that could help nations adapt to aging populations.

This short video is an introduction to the topic.

Let’s look at just a few of the highlights of the book.

In the opening chapter, Robert Murphy offers a primer on the importance of entrepreneurship.

…there is a crucial connection between entrepreneurship and economic prosperity. …There is a growing recognition that a society’s economic prosperity depends…specifically on entrepreneurship. …Two of the top names associated with the theory of entrepreneurship are Joseph Schumpeter and Israel Kirzner… Schumpeter famously invoked the term “creative destruction” to describe the volatile development occurring in a capitalist system… Kirzner has written extensively on entrepreneurship…and how…the alert entrepreneurial class who perceive these misallocations before their more complacent peers, and in the process earn pure profits… Schumpeter’s entrepreneur is a disruptor who creates new products first in his mind and then makes them a reality, whereas Kirzner’s entrepreneur is a coordinator who simply observes the profit opportunities waiting to be grasped. …If the goal is maximum economic efficiency in the long run, to provide the highest possible standard of living to citizens within the unavoidable constraints imposed by nature, then we need bold, innovative entrepreneurs who disrupt existing modes of production by introducing entirely new goods and services, but we also need vigilant, alert entrepreneurs who spot arbitrage opportunities in the existing price structure and quickly move to whittle them away.

Murphy describes in the chapter how there was a period of time when the economics profession didn’t properly appreciate the vital role of entrepreneurs.

But that fortunately has changed and academics are now paying closer attention. He cites some of the recent research.

An extensive literature documents the connection between entrepreneurship and economic growth. The studies vary in terms of the specific measure of entrepreneurship (e.g., small firms, self-employment rate, young firms, etc.) and the size of the economic unit being studied. …Carree et al. (2002) look at 23 OECD countries from 1976 to 1996. …They “find confirmation for the hypothesized economic growth penalty on deviations from the equilibrium rate of business ownership… An important policy implication of our exercises is that low barriers to entry and exit of businesses are necessary conditions for the equilibrium seeking mechanisms that are vital for a sound economic development” …Holtz-Eakin and Kao (2003) look at the birth and death rates of firms across US states, and find that this proxy for entrepreneurship contributes to growth. Similarly, Callejón and Segarra (1999) look at manufacturing firm birth and death rates in Spain from 1980 to 1992, and conclude that this measure of “turbulence” contributes to total factor productivity growth. …Wennekers and Thurik (1999) use business ownership rates as a proxy for “entrepreneurship.” Looking at a sample of 23 OECD countries from 1984 to 1994, they, too, find that entrepreneurship was associated with higher rates of employment growth at the national level.

In a chapter on taxation, Seth Giertz highlights the negative impact of taxes on entrepreneurship, particularly what happens with tax regimes have a bias against saving and investment.

High tax rates discourage both consumption and savings. But, for a given average tax rate, taxes on an income base penalize savings more heavily than taxes on consumption. …a consumption tax base is neutral between the decision to save versus consume. By contrast, an income tax base results in the double taxation of savings. …three major features of tax policy that are important for entrepreneurship. First, capital accumulation and access to capital is essential for innovation to have a big impact. Despite this, tax systems generally tax savings more heavily than consumption….Second, the tax treatment of risk affects incentives for entrepreneurship, since entrepreneurship tends to entail high risk. …progressivity can sometimes discourage entrepreneurship. This is because tax systems do not afford full offsets for losses, making progressivity effectively a tax increase. …Third, tax policy can lead entrepreneurial activity to shift from productive toward unproductive or destructive aims. Productive entrepreneurship tends to flourish when the route to great wealth is achieved primarily through private markets… High taxes reduce the rewards from productive entrepreneurship. All too often, smart, talented, and innovative people are drawn out of socially productive endeavours and into unproductive ones because the private returns from devising an innovative tax scheme—or lobbying government for special tax preferences—are greater than those for building the proverbial better mousetrap.

In a chapter I co-authored with Brian Garst, Charles Lammam, and Taylor Jackson, we look specifically at the negative impact of capital gains taxation on entrepreneurship.

We spend a bit of time reminding readers of what drives growth.

One of the more uncontroversial propositions in economics is that output is a function of labor (the workforce) and capital (machines, technology, land, etc.). Indeed, it is almost a tautology to say that growth exists when people provide more labor or more capital to the economy, or when—thanks to vital role of entrepreneurs—labor and capital are allocated more productively. In other words, labor and capital are the two “factors of production,” and the key for policymakers is to figure out the policy recipe that will increase the quantity and quality of those two resources. …In the absence of taxation, people provide labor to the economy so long as they value the income they earn more than they value the foregone leisure. And they provide capital to the economy (i.e., they save and invest) so long as they value future consumption (presumably augmented by earnings on capital) more than they value current consumption.

And we highlight how entrepreneurs generate the best type of growth.

this discussion also helps illustrate why entrepreneurship is so important. The preceding analysis basically focused on achieving growth by increasing the quantity of capital and labor. Such growth is real, but it has significant “opportunity costs” in that people must forego leisure and/or current consumption in order to have more disposable income. Entrepreneurs, by contrast, figure out how to increase the quality of capital and labor. More specifically, entrepreneurs earn profits by satisfying consumer desires with new and previously unknown or underused combinations of labor and capital. In their pursuit of profit, they come up with ways of generating more or better output from the same amount of labor and capital. This explains why we have much higher living standards today even though we work far fewer hours than our ancestors.

And here’s what we say about the counterproductive impact of capital gains taxation, particularly when combined with other forms of double taxation.

…the effective marginal tax rate on saving and investment is considerably higher than the effective marginal tax rate on consumption. This double taxation is understandably controversial since all economic theories—even Marxism and socialism—agree that capital is critical for long-run growth and higher living standards. …capital gains taxes harm economies in ways unique to the levy. …entrepreneurs play a vital role in the economy since they figure out more efficient ways to allocate labor and capital. …The potential for a capital gain is a big reason for the risk they incur and the effort they expend. Thus, the existence of capital gains taxes discourages some entrepreneurial activity from ever happening. …the capital gains tax is more easily avoidable than other forms of taxation. Entrepreneurs who generate wealth with good ideas can avoid the levy by simply choosing not to sell. This “lock-in effect” is not good for the overall economy… Most governments do not allow taxpayers to adjust the value of property for inflation when calculating capital gains. Even in a low-inflation environment, this can produce perverse results. …taxpayers can sometimes pay tax even when assets have lost value in real terms. …Capital gains taxes contribute to the problem of “debt bias,” which occurs when there is a tax advantage for corporate investments to be financed by debt instead of equity. …Excessive debt increases the probability of bankruptcy for the firm and contributes to systemic risk.

We then cite a lot of academic studies. I strongly encourage folks to peruse that section, but to keep this column manageable, let’s close by looking at two charts that reveal how some nation – including the United States – have uncompetitive tax systems.

Here are long-run capital gains tax rates in developed nations.

By the way, even though the data comes from a 2018 OECD report, it shows tax rates as of July 1, 2016. So not all the numbers will be current. For instance, I assume Macron’s reforms have mitigated France’s horrible score.

Speaking of horrible scores, here are the numbers showing the combined burden of the corporate income tax and capital gains tax. Sadly, the United States was at the top of this list as of July 1, 2016.

The good news is that the recent tax reform means that the United States no longer has the world’s most punitive tax system for new investment.

Though keep in mind that the United States doesn’t allow investors to index capital gains for inflation, so the effective tax rate on capital gains will always be higher than the statutory tax rate.

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I almost feel guilty when I criticize the garbled economic thoughts of Pope Francis. After all, he was influenced by Peronist ideology as a youngster, so he was probably a lost cause from the beginning.

Moreover, Walter Williams and Thomas Sowell have already dissected his irrational ramblings on economics and explained that free markets are better for the poor. Especially when compared to government dependency.

But since Pope Francis just attacked tax havens, and I consider myself the world’s foremost defender of these low-tax jurisdictions, I can’t resist adding my two cents. Here’s what the Wall Street Journal just reported about the Pope’s ideological opposition to market-friendly tax systems.

The Vatican denounced the use of offshore tax havens… The document, which was released jointly by the Vatican’s offices for Catholic doctrine and social justice, echoed past warnings by Pope Francis over the dangers of unbridled capitalism. …The teaching document, which was personally approved by the pope, suggested that greater regulation of the world’s financial markets was necessary to contain “predatory and speculative” practices and economic inequality.

He even embraced global regulation, not understanding that this increases systemic risk.

“The supranational dimension of the economic system makes it easy to bypass the regulations established by individual countries,” the Vatican said. “The current globalization of the financial system requires a stable, clear and effective coordination among various national regulatory authorities.”

And he said that governments should have more money to spend.

A section of the document was dedicated to criticizing offshore tax havens, which it said contribute to the “creation of economic systems founded on inequality,” by depriving nations of legitimate revenue.

Wow, it’s like the Pope is applying for a job at the IMF or OECD. Or even with the scam charity Oxfam.

In any event, he’s definitely wrong on how to generate more prosperity. Maybe he should watch this video.

Or read Marian Tupy.

Or see what Nobel Prize winners have to say.

P.S. And if the all that doesn’t work, methinks Pope Francis should have a conversation with Libertarian Jesus. He could start here, here, and here.

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