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Archive for the ‘Europe’ Category

Regular readers know that I am a tireless advocate for tax competition, which exists when governments are encouraged to adopt better tax policy in order to attract/retain jobs and investment. In other words, I want governments to compete with each other because that leads to better policy, just as we get better results as consumers when banks, pet stores, hairdressers, and grocery stores compete with each other.

There is powerful evidence that tax competition has generated very good results in the past 30 years. Top personal income tax rates averaged more than 67 percent back in 1980, but thanks in large part to tax competition, the average top tax rate on individuals has fallen to about 41 percent. Corporate tax rates also have dropped dramatically, from an average of around 48 percent (this data is not as easy to pin down) in 1980 to 25 percent today. And we now have more than 30 flat tax nations today, compared to just 3 in 1980.

That’s the good news. The bad news is that greedy politicians don’t like being constrained by tax competition. Politicians didn’t lower tax rates because they wanted to. They only made their tax systems better because they were afraid that jobs and investment would escape to lower-tax jurisdictions. They resent the fact that tax competition makes it hard to engage in class-warfare tax policy.

That’s why many of these politicians are seeking to replace tax competition with some sort of tax cartel. They want to impose rules on the entire world that will make it hard for taxpayers to benefit from better tax policy in another jurisdiction. In effect, they want some form of tax harmonization, which would create an “OPEC for politicians.” And just as the real OPEC extracts more money from energy consumers, a tax cartel would grab more money from taxpayers.

One aspect of this battle is the way proponents of higher taxes try to demonize so-called tax havens. Many of these jurisdictions are very small, but the smart ones nonetheless defend themselves against the attacks coming from the world’s major welfare states. Here’s a good example. Tony Travers of Cayman Finance, the association representing the financial services industry in the Cayman Islands, recently spoke about the left’s campaign against low-tax jurisdictions.

Travers said he believed the widespread negativity was part of well organised and powerful public relations campaigns driven by onshore Treasury, and supranational and domestic regulatory bodies. British politicians such as Emma Reynolds and former Prime Minister Gordon Brown and even US President Barack Obama were, he said, examples of politicians that were “blame deflecting … and anxious to obfuscate the failures of their domestic regulatory systems … by suggesting that in some way it is the tax or regulatory system of the offshore financial centre that is at fault.” He claimed the problems they were trying to conceal by their demonisation of offshore centres had their source onshore. He described various socialist activist movements, such as the trade unions, major charities such as Oxfam, and Travers arch nemesis, Richard Murphy of the Tax Justice Network as the “Tax Taliban” .

This fight is occurring at all levels. A new scholarly study from the Instituto Bruno Leoni in Italy digs into the academic debate about tax competition. Written by Dalibor Rohác of London’s Legatum Institute, the report debunks the argument that tax competition somehow is economically inefficient.

The first common argument is that tax competition distorts the allocation of mobile factors of production across countries. The second argument recurrent in the literature says that tax competition can reduce tax revenue and endanger the stability of public finances. The troublesome feature of both of these arguments is that they start from the assumption of government benevolence and omniscience. For instance, the first argument presupposes that the initial allocation of capital between the two countries was optimal and that tax competition is driving it away from the optimum. Likewise, the second argument implicitly assumes that the initial amount raised in taxes corresponded to some well-defined social optimum and therefore that tax competition drives revenue below that optimal level. Hence neither of these arguments holds in the light of basic public choice theory which convincingly demonstrates that governments do have a tendency to overspend and overtax.

Rohác cleverly exposes the other side’s statist agenda. He explains that their main argument is based on the idea that different tax rates in different nations will lead to an inefficient allocation of investment. He then points out that there is a pro-growth way and an anti-growth way of dealing with this supposed problem.

…if the problem of capital misallocation is caused by differences in tax rates among countries, than introducing a maximal rate is a solution that would be equally appropriate. …tax competition might well offer a solution to the alleged problem of misallocation of capital caused by tax differentials. If tax competition was a “race to the bottom,” then the final outcome would actually be a tax rate harmonized across countries and harmonized at a rate of zero per cent, thus eliminating capital tax distortions altogether.

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I’ve written before about the upcoming breakdown of the European welfare state, and my fingers are crossed that American policy makers will learn the right lessons and restrain the size and scope of government before we suffer from the social chaos and disarray that is sweeping through nations as varied as Greece and the United Kingdom.

Some defenders of big government claim that Europe will be okay, but a column in the New York Times by Desmond Lachman and Dalibor Rohac provides some sobering analysis. Some of their analysis focuses on the inherent instability of the common European currency, which certainly is a contributing factor, but the key takeaway is that many European nations are going to default. In the short run, the resulting economic instability will have a negative impact on the United States, but the long-run impact could be positive if American lawmakers undo the profligacy of the Bush-Obama years and put the U.S. back on a sound fiscal path.

…the European Central Bank president, Jean-Claude Trichet, now keeps asserting that Europe’s sovereign debt crisis does not pose a significant threat to the overall European economy, let alone to the global economy.

American policymakers would do well to disregard Mr. Trichet’s sanguine remarks and brace themselves for a European economic tsunami that is all too likely to seriously derail the fragile U.S. economic recovery.

…over the past decade countries in Europe’s periphery have consistently not managed their public finances according to the arrangement’s rules. As a result, outsized budget and balance-of-payment deficits do not now simply characterize the Greek, Irish and Portuguese economies. Rather, more ominously, they also characterize Spain, which is aptly being described on Wall Street as being too big to fail yet also too big to save.

…European policymakers understand full well that a wave of sovereign debt defaults in Europe’s periphery would more than likely precipitate a full-blown European banking crisis, since European banks are the main holders of the $2 trillion in the periphery’s sovereign debt.

This suggests that European policy makers in the north will not lightly turn off the financing spigot that presently keeps the periphery afloat. However, judging by the crushing defeat handed Ms. Merkel in the May 2010 Westphalia state election, electoral considerations will likely make it all but impossible to indefinitely continue such financing.

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Here’s a new video from the Taxpayers Alliance in the United Kingdom exposing how left-wing environmental groups get funded by government handouts.

David Cameron supposedly is being tough on spending, but I’ve already revealed that overall spending is climbing at about twice the rate of inflation under his new budget. And I’m not holding my breath that he’ll reduce the taxpayer handouts shown in this video.

But we Americans can’t be smug because the federal budget also is riddled with all sorts of giveaways and subsidies to left-wing groups. Labor unions, AARP, and Planned Parenthood are just a few of the groups that have their snouts in the public trough. And I would be shocked to learn that environmental groups haven’t figured out how to scam taxpayers as well.

Back in the 1990s, GOPers had a campaign to “defund the left.” Whatever progress they made, though, had since been completely erased. As Republicans in the House try to figure out ways to restore fiscal sanity, eliminating handouts for left-wing groups would be a great place to start.

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The United States, Canada, and Switzerland are the only developed nations that have some degree of genuine federalism (Germany and Australia don’t count by my standards), and Switzerland is the only country where the central government is smaller than the local/regional governments. This is one of the reasons why Switzerland is so admirable, as partly explained in this Center for Freedom and Prosperity article on the Swiss tax system.

But perhaps other nations are learning from Switzerland’s success. The United Kingdom is devolving some power to Scotland, as reported by the Irish Times. This is just a small step, and it’s unclear how it will work since Scotland leans left and is heavily subsidized by England. But the value of federalism is that jurisdictions compete with each other and cross-regional subsidies are reduced. So if Scotland wants to use its new powers to make the wrong choices, at least only the Scottish people will suffer.

Scotland is to get substantial new powers to set its own income tax rates and win new rights to borrow money in phase two of the devolution of greater autonomy to the Scottish parliament.

The measures were described by Scottish secretary Michael Moore as the most significant transfer of financial power out of London since the formation of the UK more than 300 years ago, making Holyrood more accountable to voters.

…The proposals form the centrepiece of a new Scotland Bill drafted by the UK government, which will allow the Scottish government to increase or cut income tax rates by up to 50 per cent for basic rate taxpayers, and by 20 per cent at the highest rate.

The measures also go further than expected by offering the Scottish government much greater borrowing powers, and more quickly, than originally recommended by a cross-party commission on devolution chaired by Kenneth Calman.

…In addition, Holyrood will be allowed to introduce new, Scotland-only taxes, with Westminster’s approval, and have control over stamp duty and landfill tax. In all, the powers will give Holyrood control over about £12 billion or 35 per cent of its current spending: its block grant from the treasury, worth £29 billion a year, will be cut by an equal amount.

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Former Senator Phil Gramm had a column last week in the Wall Street Journal that deserves two blog posts. This first post highlights Gramm’s analysis showing that the U.S. has been very Keynesian compared to Europe, with numerous efforts to jump start the economy with deficit spending. But Senator Gramm hits the nail on the head, comparing America’s tepid recovery with the better performance across the Atlantic.

During the average recovery since World War II, gross domestic product (GDP) surpassed the pre-recession high five quarters after the recession began. It has never taken longer than seven quarters. Yet today, after 11 quarters, GDP is still below what it was in the fourth quarter of 2007. The economy is growing at only about a third of the rate of previous postwar recoveries from major recessions.

Obama administration officials such as Treasury Secretary Tim Geithner have argued that without their policies the economy would be worse, and we might have fallen “off a cliff.” While this assertion cannot be tested, we can compare the recent experience of other countries to our own.

…There are 4.6% fewer people employed in the U.S. today than at the start of the recession. Euro zone countries have lost 1.7% of their jobs.

…This simple comparison suggests…that American economic policy has been less effective in increasing employment than the policies of other developed nations. …While the most recent quarterly growth figures are just a snapshot in time, it is hardly encouraging that economic growth in the U.S. (1.7%) is lower than in the euro zone (4%), U.K. (4.8%), G-7 (2.8%) and OECD (2%).

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The biggest long-term threat to fiscal responsibility is a value-added tax, as I’ve explained here, here, here, here, and here. So I’m delighted to see a growing amount of research showing that a VAT is bad news. Jim Powell has an excellent column at Investor’s Business Daily that makes a rather obvious point about the wisdom (or lack thereof) of copying the tax policy of nations that are teetering on the edge of fiscal collapse (this cartoon has the same message in a more amusing fashion).

Drums are beating in Washington for a value-added tax in addition to the “stimulus” taxes, health care taxes, energy taxes and other taxes President Obama has imposed and wants to impose on hard-pressed taxpayers.

Supposedly a value-added tax is a magic elixir for curing budget deficits and excessive debt. Quack remedy would be more like it. If it worked, you’d observe that countries with a VAT had budget surpluses and no debt problems. But almost every country that has a VAT is plagued with budget deficits and excessive debt.

… No surprise that the worst financial basket cases all have a VAT. Iceland has the highest VAT rates, but this didn’t prevent its financial crisis and the near bankruptcy of its government. Italy’s VAT rates are almost as high, and its debt exceeds its GDP. Financial crises are looming in Spain and Portugal, and of course they have a VAT.

Greece has a VAT, too, and when politicians ran out of money to pay government employees for more than a year’s worth of work every year, they rioted in the streets.  Great Britain has a VAT, and its government finances are in the worst shape since World War II — its budget deficit is expected to be bigger than that of Greece.

Moreover, the OECD has acknowledged that “(VAT) tax and transfer wedges have discouraged firms from offering employment and individuals from taking it, reduced employment and increased inequality.”

And a new study by Douglas Holtz-Eakin and Cameron Smith finds evidence that a VAT would lead to bigger government.

VATs provide a significant amount of revenue. …But do these significant revenues cause government spending to grow larger? Or is it the case that adoption of a VAT is evidence of the desire for a larger government so that the causal arrow runs from a taste for Leviathan to a VAT, and not the reverse? …we find a statistically significant dynamic relationship between the rate of VAT taxation and the size of government. Although no single study is definitive, this is the first rigorous evidence that a VAT causes government to grow larger. …countries that adopted a VAT did in fact experience, on average, a 29 percent increase in the size of government. …The estimated coefficient of 0.262 indicates that adopting a VAT is associated with larger government. This estimate is statistically significant. …our results shift the burden of proof to those who deny that VATs fuel increases in the size of the public sector.

This study jumps into a long-running chicken-or-egg debate in the academic literature about whether higher taxes lead to higher spending or whether higher spending leads to higher taxes. This causality debate is interesting, but I’m not sure it really matters. A VAT is a terrible idea if it triggers bigger government, and a VAT is a bad idea if it merely finances bigger government. But I suspect this study is correct. The key thing to remember is that Milton Friedman was right when he warned that “In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with.” This means that a VAT will allow more government spending and no reduction in deficits and debt, which is exactly what we see in Europe (and as Jim Powell noted in his column). Last but not least, this video summarizes the best arguments against a VAT.

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Jim Glassman has a thorough article in Commentary explaining that Europe is in deep trouble both because high tax rates discourage work and production and because excessive handouts encourage sloth and dependency. This should be a common-sense observation, but most politicians get votes by convincing voters they can have comfortable lives without producing. The inevitable result is what happened in Greece, though the negative effects of that debacle are being postponed (but also magnified) by the European bailout. Considering what’s happening, it’s hard to have any optimism about the long-term result. Here’s a long excerpt, but the whole article is worth reading since the same thing will happen in America if the Bush-Obama policies are not reversed.

Prosperity, it seems, can bring sloth, which in turn disrupts the virtuous cycle, though not immediately. There is a period, which I believe we are in right now, where the disruption is not apparent, where it can be obscured through government monetary and fiscal manipulation. But eventually, a simple rule will prevail: you can’t live well if you don’t work.

It is hardly surprising that work produces well-being, and if work diminishes, then well-being, even in the most advanced economy, will slow down, stop, or shift into reverse gear. “Decadence,” with its connotations of self-indulgence and decline, is not too strong a word for the response we have seen to economic success, especially in much of Europe, over the past few decades.

In 2004, the year he won the Nobel Prize, Edward Prescott, an economist at the Federal Reserve Bank of Minneapolis, published a paper titled “Why Do Americans Work So Much More than Europeans?” The data were stunning. Prescott found that the average output per adult between 1993 and 1996 in the United States was 75 percent greater than in Italy, 49 percent greater than in the United Kingdom, and 35 percent greater than in France and Germany. “Most of the differences in output,” he wrote, were “accounted for by differences in hours worked per person and not by differences in productivity.”

…Prescott showed that these differences are of fairly recent origin. During the period from 1970 to 1974, Europeans—including the French, Germans, and British—generally worked more than Americans. At that time, however, Europeans were less productive than Americans, so their overall output per person was about the same as it was in 1993-96: around one-third below the U.S. level. So, as Europeans became more efficient (producing more goods and services per hour of work), they cut back on their hours, choosing leisure over work. And the gap has widened. By the time Prescott won his Nobel Prize, Americans were working 50 percent more than the French.

…In his paper, Prescott fingered the culprit: high taxes. “The surprising finding,” he wrote, “is that this marginal tax rate [difference between Europe and the U.S.] accounts for the predominance of differences at points in time and the large change in relative labor supply over time.” Taxation rates on the next euro of income became so high that people were discouraged from working—especially with the enticements of early retirement.

But this explanation is incomplete. Why are taxes so high in Europe? Certainly not to maintain a strong defense but rather to pour money into a welfare state that provides lavish support to retirees, perennial students, and others who aren’t working. In other words, Europeans have chosen to have workers support non-workers in their leisure.

…A financial crisis can pull the covers away to give us a clear look at what’s underneath, and the current crisis has exposed Europe as a fool’s paradise. “The fundamental cause of the financial crisis,” wrote the George Mason University economist Tyler Cowen on his blog, Marginal Revolution, “is people and institutions thinking they are more wealthy than they are.”

…The same with nations. Europe supported its welfare state with borrowed money, a practice that can be perfectly healthy as long as both welfare state and debt are modest and loans can be serviced by diligent workers. Europe, however, is not nearly as wealthy as it thought it was, or as wealthy as its national way of life indicated.

Take Greece. …Greece joined the European Union in 1981 and the eurozone—the continent’s monetary union—in 2001. Since the second event, especially, Greece has been behaving as if it were truly rich. The secret was borrowed money. At the end of 2009, the country had a public debt equivalent to 114 percent of its GDP. That’s on top of the 3 percent of GDP that the European Union contributes as direct aid each year. Meanwhile, Greece consistently violated the EU’s rules for minimum deficit and debt levels. The Greeks, however, lived better and better, with an official retirement age of just 58. Only three-fifths of adult Greeks under age 64 were in the work force.

…Default can impose needed fiscal discipline on a government. But in an age of financial magic and euro-solidarity, default for a European nation is not a burden that has to be borne—at least not yet. On the brink of not being able to pay its debts earlier this year, Greece was bailed out with $100 billion in loans from the 15 other eurozone countries and about $50 billion from the International Monetary Fund. This year, the Greek government will make interest payments amounting to 15 percent of GDP on its loans (the U.S. pays less than 3 percent). With Portugal and Spain and perhaps Italy heading for similar trouble, Europe announced it would guarantee debts up to $955 billion.

There are two problems with such bailouts. First, they do little or nothing to end the leisure-seeking practices, encouraged by high marginal tax rates and labor regulations, that led to the near-defaults in the first place. Greece may promise austerity as a condition for being saved, but don’t count on delivery. Second is the matter of moral hazard—the tendency of insurance against calamity to provide an incentive toward behavior that produces calamity.

I warned of the dangers of moral hazard during the current financial crisis in an article in this magazine last year, and, unfortunately, we are seeing those predictions being realized. Much pain was caused by the crisis, but much was mitigated as well by government policies that kept profligate banks and other businesses alive that should have disappeared—and, of course, Washington took the occasion of the crisis to increase the size of its own welfare state. What the eurozone nations have done in bailing out Greece and pre-bailing Portugal and the others is to introduce a heaping helping of moral hazard that may seem nourishing at first but that inevitably will cause severe indigestion, or worse.

…While the United States is not Europe, many of our states clearly have aspirations in the same decadent direction. With high marginal tax rates and regulations that discourage work, California this year is running a deficit of $20 billion, and a recent study found that the pension shortfall for government workers is $500 billion. Investors were recently paying about $300,000 to buy credit default swaps—that is, an insurance policy—on each $10 million in California municipal bonds. That’s a rate 50 percent higher than on bonds issued by Kazakhstan. As a monetary union, the United States may face a decision similar to that of the eurozone nations: should the federal government bail out California? If it does, we will have entered a fool’s paradise on this side of the Atlantic as well.

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