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CF&P Foundation Paper Finds Proposed Wealth Tax Would Mean Loss of 1.8 Million Jobs

Wed, 08/12/2020 - 5:09am

For Immediate Release
Wednesday, August 12, 2020
202-285-0244
www.freedomandprosperity.org

CF&P Foundation Paper Finds Proposed Wealth Tax Would Mean Loss of 1.8 Million Jobs

(Washington, D.C., Wednesday, August 12, 2020) The Center for Freedom & Prosperity (CF&P) Foundation today published a new paper titled, “The Economic Effects of Wealth Taxes.” Authored by John Diamond and George Zodrow of Rice University, the paper considers the significant economic damage that would occur if lawmakers adopted a wealth tax of between 2 percent-6 percent. Such a plan, modelled after the proposal from Senator Elizabeth Warren, is likely to be part of next year’s post-election tax agenda.

Link to the paper: http://freedomandprosperity.org/2020/publications/the-economic-effects-of-wealth-taxes/

PDF: http://www.freedomandprosperity.org/files/White%20Paper/Diamond-Zodrow_Economic_Effects_of_Wealth_Taxes.pdf

Key findings from the paper:

A 2 percent annual tax on household wealth above $50 million and a 6 percent tax on household wealth over $1 billion would have the following effect on economic outcomes:

  • Long-run GDP decline of roughly 2.7 percent (relative to a steady state with no wealth tax) due to a decline in the capital stock of roughly 3.7 percent;
  • An immediate loss in hours worked of 1.1 percent, equating to approximately 1.8 million jobs, and a long-run loss in hours worked of 1.5 percent;
  • Initial decline in average annual household real wage income of about $2,500;
  • Explosive welfare state growth as transfers relative to GDP (excluding SS) increase by 70.1 percent;
  • Per-household wealth held by the top 0.25 falls by $3.7 million, and from lower-middle to upper-middle households, declines in lifetime wealth range from $440 to $49,660.
  • The lowest three lifetime income deciles are projected to be the beneficiaries of more redistribution spending, so they wouldn’t be net losers (other than increased dependency on government).

CF&P Chairman Dan Mitchell commented, “A wealth tax would shrink GDP, reduce annual household incomes and result in lost wages and American jobs. It would be very bad news for our economy and for families in all economic tiers.”

About the Center for Freedom and Prosperity Foundation

The Center for Freedom and Prosperity (CF&P) Foundation is a non-profit organization created in October of 2000 to advance market liberalization. The CF&P Foundation seeks to promote economic prosperity by educating the American people and elected representatives using original research and outreach.

For additional comments:
Andrew Quinlan can be reached at 202-285-0244, [email protected]

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Image credit: Pictures of Money | CC BY 2.0.

The Economic Effects of Wealth Taxes

Wed, 08/12/2020 - 4:45am
The Economic Effects of Wealth Taxes

[PDF Version]

August 2020

John W. Diamond and George R. Zodrow, Tax Policy Advisers LLC

Executive Summary

In this paper, we estimate the economic effects of the wealth tax proposed by Senator Warren using a computable general equilibrium model of the U.S. economy under the assumption that all revenues are used to increase income transfers (excluding Social Security payments) that accrue primarily to lower income groups. Our simulation of the Warren wealth tax estimates in the long run GDP falls by roughly 2.7 percent, as a result of decline in the capital stock of roughly 3.7 percent and in total hours worked of 1.5 percent, and aggregate consumption falls by 1.4 percent. Initially hours worked decline by 1.1 percent in a full employment economy; if instead labor hours worked per individual were held constant, this would be roughly equivalent to a loss of approximately 1.8 million jobs. Real wages decrease initially by 1.4 percent, but increase by 0.2 percent five years after enactment and by 1.3 percent in the long run. Together, the changes in real wages and the decline in hours worked imply that annual household real wage income on average across all wealth cohorts fall by $2,491 initially and by $1,129 five years after the reform. Five years after the reform, household real wage income falls by $4,487 for the lowest lifetime income group, by roughly $561 for the median household, and is unchanged for the top decile. In the long run, transfers relative to GDP increase by 70.1 percent, with most of the increase in transfers going to the bottom third of lifetime earners, whose average per-household transfer increases by $6,905. Per-household  wealth held by the top lifetime income group (the top 0.25 percent) falls by 6.3 percent ($3.7 million), and per-household wealth of the fourth through ninth income deciles declines by 0.9 percent (roughly $440) to 4.2 percent (roughly $49,660), while the per-household wealth of the bottom three income deciles increases by roughly 19.0 percent ($100) for the lowest income decile, 10.7 percent (roughly $500) for the second lowest decile, and 1.8 percent (roughly $350) for the third lowest decile.  

 

I. Introduction

A wealth tax is an individual level tax imposed on all or most forms of net wealth (assets less liabilities) typically above a fairly large exemption amount.  Although the United States currently does not have a broad-based wealth tax, Senator Bernie Sanders and Senator Elizabeth Warren each proposed a version of a wealth tax in the recent Democratic presidential campaign. In this paper, we begin by discussing the basic features of wealth taxation, the administrative concerns raised by the implementation of a new wealth tax, and its economic effects.[1]  We then turn to a description of the computable general equilibrium model we use to analyze the economic effects of a wealth tax in this study, followed by a description of our simulation results. A final section summarizes the results and suggests directions for future research.

II. The Structure of a Wealth Tax

A wealth tax is imposed on an annual basis and its base is net wealth, that is, the taxpayer’s total assets less total liabilities, including assets and liabilities held abroad.[2] In principle, all assets should be included in the wealth tax base at market values, such as stocks and bonds including those held in mutual funds, privately held businesses, housing and other real estate, liquid assets such as money market funds and savings deposits, and consumer durables.  In practice, many assets are exempted from taxation on either administrative grounds (e.g., consumer durables) or on political grounds. Loans should be subtracted from the base, but limits on the deductibility of loans are appropriate to the extent that some assets are not included in the wealth tax base. Wealth taxes are typically assessed only on wealth in excess of a significant exemption amount, both to simplify administration and compliance and to limit taxation to high-wealth taxpayers on equity grounds. The base is then subject to taxation under the wealth tax rate schedule, which may specify a single or “flat” rate or may involve a progressive tax rate structure.

The wealth tax proposed by Senator Warren is an example of a tax with a relatively simple progressive rate structure, as her plan would impose a 2 percent annual tax on household wealth in excess of $50 million and a 6 percent tax (up from a 3 percent tax rate in her initial proposal) on household wealth in excess of $1 billion. The Sanders wealth tax proposal is more complex. For married couples, it would impose a tax of 1 percent on households with wealth in excess of $32 million and increase in seven one percentage point increments to a top rate of 8 percent for households with net wealth in excess of $10 billion.[3] Both proposals assume a broad wealth tax base. In this paper, we model the economic effects of the Warren proposal; however, some preliminary results suggest that the economic effects of the two plans would be roughly similar.

Interestingly, the proposed top rates under these two proposals (6 percent and 8 percent) are quite high in comparison to other wealth taxes around the world – at least in the relatively few countries that utilize such taxes. Bunn (2019) notes that of the 36 countries in the OECD, only three (Switzerland, Spain, and Norway) currently have relatively broad-based wealth taxes, down from a high of 12 countries in 1996.[4]  Specifically, Norway imposes a wealth tax at 0.15 percent at the national level plus 0.70 percent at the municipality level for a total tax rate of 0.85 percent, Spain imposes a progressive wealth tax with rates that vary from 0.2 percent to 2.5 percent but that can be adjusted by its autonomous regions (with Madrid eliminating the tax entirely), and Switzerland has wealth tax rates that vary across its 26 cantons, ranging from 0.3 percent to 1.0 percent. Brülhart et al. (2017) note that the Swiss wealth tax is imposed on the upper middle class as well as the wealthiest households, given its relatively low exemption that was roughly equivalent to $107,000 in U.S. dollars in 2011.

As discussed by the Organisation for Economic Co-operation and Development (OECD) (2018), the countries that have eliminated their wealth taxes have done so for a variety of reasons. One overarching trend cited by OECD is a general movement toward lowering tax rates on high-income earners and on capital income; for example, the average top personal income tax rate in OECD countries declined from 65.7 percent to 43.3 percent in 2016, and the average statutory corporate income tax rate declined from 47 percent in 1981 to 24 percent in 2017. More specifically, OECD notes three primary reasons cited by countries for eliminating their wealth taxes. First, governments in these countries were concerned about the efficiency costs associated with wealth taxes, especially those related to capital flight in an era of increased capital mobility and increased access of wealthy taxpayers to tax havens.[5] Second, in practice net wealth taxes often failed to achieve their redistributive goals, primarily due to narrowly-defined tax bases coupled with pervasive tax avoidance and evasion which resulted in relatively low revenues, on the order of 0.2 to 1.0 percent of GDP.[6] Third, these countries were concerned about high administrative and compliance costs, especially when compared to these relatively low revenues.[7] In addition, wealth tax revenues in OECD countries have declined over time or at best remained constant, despite increasing levels of wealth since the 1970s.  Kopczuk (2013) notes that the relatively low revenues obtained from wealth taxes has made their elimination less problematic from a political perspective. Finally, as discussed below, the fact that relatively low wealth tax rates are equivalent to relatively high capital income tax rates has dissuaded some countries from using wealth taxes. For example, Boadway and Pestieau (2019) note that German courts held that the combined tax burden under the German income and wealth taxes could be no more than 50 percent of taxable income, and the wealth tax was ultimately held to be unconstitutional due to its confiscatory nature.

Another critical issue is the breadth of the base of a wealth tax. A broad base is desirable on both efficiency grounds so that the tax does not bias investment toward assets that receive preferential wealth tax treatment, and on equity grounds so that the tax does not provide differential treatment of individuals who have the same amount of wealth but choose to hold it in different forms. However, as under the income tax, a broad base may be difficult to achieve under a U.S. wealth tax, as political factors could easily result in exemptions or preferential treatment for wealth held in the forms of closely held businesses, farm assets, housing (partly on the grounds that housing is already subject to wealth taxation in the form of local property taxes), pension assets, collectibles such as fine art and antiques, and myriad other assets.

The experience with wealth taxation in Europe is not encouraging, with many exemptions such as those listed above, coupled with full deductibility of all loans in calculating net wealth which further reduces the tax base (Brumby and Keen, 2018; OECD, 2018). Saez and Zucman (2019) provide a counter argument: because the U.S. wealth tax would apply only to net wealth in excess of $50 million, preferential treatment of assets would be politically unpopular as it would benefit only highly wealthy individuals. This argument, however, clearly discounts the political power of such wealthy individuals – which, at least in some circles, provides one of the main arguments in support of a tax on large accumulations of wealth. Moreover, as noted above, creating a wealth tax bias favoring certain assets implies differential effective tax rates across assets which in turn creates resource misallocation and causes economic inefficiencies, a problem that has arisen in the context of European wealth taxes (OECD, 2018).

III. Administrative Concerns with a Wealth Tax

Much of the debate regarding the feasibility of a wealth tax centers on whether it can be administered effectively. Perhaps the most critical issue is valuation – under a wealth tax the market value of all assets subject to tax would have to be determined annually. Assets traded on national exchanges would be easy to value, as would holdings of cash. But experience with the estate and gift tax suggests that other assets, especially closely-held businesses, intangible assets, and collectibles such as fine art and antiques, are difficult to value and tend to be significantly under-valued; in addition, experience with the property tax suggests that accurate valuation may be problematical with real estate, including both residential and non-residential properties. Valuation problems would not be trivial – Batchelder and Kamin (2019) estimate that publicly traded assets account for only one-fifth of the taxable holdings of the top one percent of wealth holders. Valuing assets held abroad is also likely to be quite difficult. A second issue is evasion – taxpayers would have an incentive to hide assets, both domestic and foreign, and locating these assets would in many cases be quite difficult. Note that poor enforcement of a wealth tax creates its own economic distortions, as taxpayers are inefficiently encouraged to invest in assets that tend to be undervalued or hidden from the tax authorities. Finally, rules would have to be devised for the taxation of wealth held in trusts and family foundations.

The effectiveness of a wealth tax in the United States would depend on successful enforcement. Saez and Zucman (2019c) recommend increased reporting requirements for financial assets, valuing businesses using simple rules of thumb based on income or the book value of assets, and valuing artwork at its insured value. Additional resources for the aggressive enforcement by the IRS would be required, although such expenditures could be financed with some of the revenue from the wealth tax. The incremental increase in enforcement resources could be significant, as auditing the financial affairs of the very wealthy is highly complex; currently, the IRS processes about 4,000 estate and gift tax returns annually while collecting relatively little revenue. By comparison, roughly 75,000 returns would have to be processed under the Warren plan, and the analogous figure under the more sweeping Sanders plan would be 180,000 households. Moreover, these returns would have to be processed in an environment in which the taxpayers would have sizable resources to contest valuations, challenge legal interpretations, dispute other IRS claims, etc.

Finally, a wealth tax could encourage emigration and the renouncing of U.S. citizenship by the wealthy in order to avoid the wealth tax, which would be facilitated by the fact that most other OECD countries currently do not tax wealth. Although emigration has been problematical under several European wealth taxes, it seems less likely to be an issue in the much larger and more geographically isolated United States. In addition, both the Sanders and Warren proposals recommend an exit tax to discourage such tax-induced migration, which in principle could be applied retroactively to individuals who migrated while the tax was being discussed and enacted. Enforcement of these provisions, however, might also be difficult.

Ultimately, the key issue is the fraction of the wealth tax base that would be lost to undervaluation, other forms of tax avoidance, and tax evasion. Saez and Zucman (2019b) argue that the empirical evidence suggests that a 1 percent wealth tax would reduce reported wealth by 8 percent and then assume that a 2 percent tax would result in 15 percent reduction in reported wealth. Summers and Sarin (2019) suggest that this estimate is highly optimistic, seriously underestimating tax avoidance, evasion, and the exemptions that are likely to characterize a realistic wealth tax in the United States.[8] By comparison, the authors of the Penn-Wharton Budget Model (PWBM) (2019) analysis of the Warren wealth tax proposal review the empirical evidence and conclude that it implies a tax semi-elasticity of reported wealth of -13, that is, a one percent increase in the wealth tax rate is associated with a reduction in reported wealth of 13 percent, so that a flat rate 2 percent tax would reduce taxable wealth by 26 percent. In our analysis, we generally rely on the PWBM estimated wealth tax semi-elasticity. Note, however, that all of the existing empirical estimates are for relatively low rate taxes, and may not apply for taxes at rates as high as 2 and 3 percent — not to mention the 6 percent top rate envisioned under the Warren proposal or the 8 percent top rate under the Sanders plan. Indeed, the taxable income elasticity literature suggests that the sensitivity of taxpayers increases as tax rates increase, and also with income which provides the resources and often the flexibility to more effectively avoid or evade the tax. Moreover, Brülhart et al. (2017) find that the taxable wealth elasticity substantially exceeds the taxable income elasticity. Thus, avoidance and evasion are likely to create serious problems under a wealth tax, the magnitudes of which are difficult to estimate, especially for high wealth tax rates that are outside the boundaries of existing experience with the tax.

 IV. Economic Effects of a Wealth Tax A. Effects on Saving and Investment

A primary concern about a wealth tax is its effect on saving and investment. The most direct effect operates through the reduction in wealth of the affected taxpayers, including the reduction in accumulated wealth over time. Although such a reduction in wealth is, for at least some proponents of the wealth tax, a desirable result, the associated reduction in investment and thus in the capital stock over time will have deleterious effects, reducing labor productivity and thus wage income as well as economic output. This effect would to some extent be ameliorated by increased foreign investment in the United States (which would be accompanied by an increase in the trade deficit through the balance of payments); for example, Viard (2019) notes that the central estimate utilized by the Congressional Budget Office that 43 percent of reductions in domestic saving are offset by increased investment flows from abroad, with the range of estimates varying from 29 percent to 61 percent. The analogous figure in our model is 43 percent, very similar to the 40 percent figure used by PVBM (2019). A second offsetting effect would arise if wealth tax revenues were used for public saving or investment, e.g., in the form of reductions in the deficit and national debt, investment in public infrastructure, or investment in human capital accumulation. By comparison, this offsetting effect would not arise with expenditures on public consumption. Viard (2019, p.8) suggests that “very little of the revenue might be devoted to those purposes [public saving or investment]” and might instead be used to finance transfer programs; indeed, both the Warren and Sanders plans indicate that one of the primary ways their wealth tax revenues would be used would be to finance a new “Medicare for All” program. Our analysis follows the latter approach in assuming that wealth tax revenues are used solely to finance increases in transfer payments. Note, however, that the simulated macroeconomic effects of the wealth tax would be less negative if the revenues were instead used to finance reductions in the national debt or other public investments.

A wealth tax would also affect saving by changing the relative prices of current and future consumption. In the standard life-cycle model of household saving, a wealth tax effectively increases the price of future consumption by lowering the after-tax return to saving, creating a tax bias favoring current consumption and thus reducing saving. The magnitude of this response would depend on the sensitivity of the consumption of high-wealth individuals to such changes in relative prices, as well as the effective tax rate on saving, taking into account the potential for tax avoidance and evasion, which would reduce the effective tax rate and thus dampen the saving response. An offsetting effect arises, however, if some saving of high-wealth individuals is motivated by a desire to leave a bequest, defined broadly to include bequests to children and other relatives as well as charitable contributions. Such motives are sometimes modeled as implying a “target bequest,” that is, a bequest or a gift of a fixed magnitude determined by the taxable household.[9]  In this case, by both reducing wealth and reducing the after-tax return to remaining wealth, a wealth tax actually forces additional saving, since additional wealth accumulation is required to achieve the target bequest.

Our model includes both saving motives, as households are life-cycle savers but also have a fixed target bequest. The latter ensures that savings responses to changes in after-tax returns are muted, and thus addresses the long-standing criticism that savings responses in life-cycle models are unreasonably large (for example, see Ballard (2002) and Gravelle (2002)).

However, in our view, the standard life-cycle model with a target bequest does not capture well the likely responses of high-wealth households at the very top of the lifetime income distribution to the imposition of a wealth tax for two reasons. The first is that it seems unlikely that these households would dramatically curtail their consumption in order to finance a fixed target bequest. Indeed, the opposite result seems more likely: very high-wealth households might instead roughly maintain their pre-tax levels of consumption and thus their existing standards of living and instead reduce the target bequest by the amount of wealth tax paid. Such a result would be broadly consistent with empirical evidence suggesting that the wealth elasticity of consumption is relatively low, and that the consumption spending of high-wealth households is much less sensitive to changes in income and wealth than that of low-wealth households (see, for example, Carroll, et al., 2017).  Accordingly, in our analysis, we assume that in the aggregate, the target bequest is reduced by the amount of wealth tax revenue raised, so that the effects of the wealth tax on saving are limited to changes in after-tax rates of return and other general equilibrium effects.

Second, in the standard life-cycle model, a reduction in wealth will result in a reduction in demand for leisure (assuming that leisure is a normal good) and result in an increase in labor supply. Again, such a result seems unlikely for the very wealthy, whose labor supply is likely to be largely independent of the variations in wealth due to the wealth tax. Accordingly, we assume that the labor supply of the very wealthy households subject to the wealth tax is not affected by the tax, an assumption that is generally consistent with empirical evidence suggesting that income effects on labor supply are relatively small (McClelland and Mok, 2012). This is only true for the top 0.25 percent of households and relaxing this assumption has virtually no effect on aggregate estimates.

As noted above, another issue is that a wealth tax may distort the allocation of investment into assets for which enforcement is relatively poor or avoidance and evasion are relatively easy, which is likely to have a negative economic impact. For example, if tax avoidance, including under-valuation or tax evasion, is easier for collectibles or foreign investments, investments in such assets may increase at the expense of investments in the domestic private capital stock, reducing labor productivity and wages.  Note that our model does not capture these differential effects as all assets are taxed uniformly – although the effective tax rate is reduced by avoidance and evasion – and thus may understate the negative effects of a wealth tax on the domestic private capital stock and wages.

Finally, we should note that the apparently low tax rates under the typical wealth tax are misleading if they are compared to income tax rates imposed on capital income, and the capital income tax rates that are analogous to wealth tax rates are often in excess of 100 percent. To see this, note that a wealth tax is imposed each year on the stock of wealth (at some specific date), rather than on the flow of the income from that stock of wealth. As a result, a relatively low wealth tax rate is equivalent to a much higher capital income tax rate. For example, with a 1 percent wealth tax and a Treasury bond earning 2 percent, the effective income tax rate associated with the wealth tax is 50 percent; with a 2 percent tax rate, the effective income tax rate increases to 100 percent. In addition, as stressed by Mitchell (2019), these calculations do not take into account the taxation of interest income under the federal  income tax, which adds a second level of taxation at a top individual rate of 37 percent plus a net investment income tax of 3.8 percent, or taxation at the state level in those states that tax capital income under their personal income taxes.[10]

Moreover, Melly and Viard (2020) stress that the relatively high effective income tax rates obtained using the risk-free return on an asset such as a U.S. Treasury bill are also the relevant effective income tax rates for riskier investments that include a risk premium. The rationale underlying this argument is that in equilibrium the ex ante after-tax returns to safe investments should be equal to the ex ante after-tax returns to risky investments, and this can occur only if the tax applies solely to the safe return component of the total risky return.[11]

B. Distributional Effects of the Wealth Tax

A wealth tax with a large exemption would necessarily be highly progressive as it would directly affect only households with wealth in excess of the exemption – $50 million in the case of the Warren proposal – and thus apply only to very wealthy households.[12] Saez and Zucman (2019b) estimated that the Warren proposal, which would apply tax to households with wealth in excess of $50 million, would apply to 75,000 households or approximately 0.06 percent of all households, who hold approximately 10 percent of the total net wealth held by U.S. households, which they estimate to be $94 trillion in 2019. This estimate falls squarely in the middle of the range of four estimates of total net wealth of $86 trillion to $101 trillion (in 2016) cited by Holtzblatt (2019). Saez and Zucman estimate that a $50 million exemption would exempt slightly over 90 percent of this wealth, leaving a tax base of $9.3 trillion. A flat rate 2 percent wealth tax, ignoring any tax avoidance or evasion, would thus raise about $187 billion. They also estimate that a 1 percent surtax on wealth in excess of $1 billion – which characterized Senator Warren’s initial proposal – would raise an additional $25 billion from the 900 families at the top of the wealth distribution.

By comparison, Saez and Zucman (2019a) estimate that the Sanders proposal, which applies tax to households with wealth in excess of $32 million (for couples) would apply to 180,000 households or 0.15 percent of all households. They estimate the Sanders plan would raise $335 billion in 2019 under the assumption of a tax avoidance and evasion rate of 16 percent. However, the assumption that the avoidance and evasion rate would be the same under a wealth tax with rates as high as 8 percent as it would be under rates of 2 and 3 percent under the original Warren plan is implausible. On the other hand, with the tax semi-elasticity of -13 used by the PWBM authors, the wealth tax base of the highest wealth households would vanish entirely at a rate of 8 percent, an equally implausible result.  The general point is that it is impossible to predict how much avoidance and evasion would occur under such wealth tax rates, given the lack of empirical evidence on these high-rate elasticities, attributable to the fact that no country has ever tried to impose a wealth tax at anything approaching such rates.

Since under either proposal these households would bear most of the burden of a wealth tax, it would be highly progressive. A final assessment, however, would of course depend on the general equilibrium effects of the tax, including an analysis of how the revenues were spent.

V. The Diamond-Zodrow Model

This section provides a brief description of the model used in this analysis; for more details, see Zodrow and Diamond (2013) and Diamond and Zodrow (2015), and for the most recent parameter values used in the model, see Diamond and Zodrow (2020). The Diamond-Zodrow (DZ) model is a dynamic, overlapping generations, computable general equilibrium (CGE) model of the U.S. economy that focuses on the macroeconomic, distributional, and transitional effects of tax reforms. The model is thus well suited to simulating in considerable detail the economic effects of the implementation of the wealth taxes described above.

The DZ model is a micro-based general equilibrium model in which households act to maximize utility over their lifetimes, and firms act to maximize profits or firm value, with behavioral responses dictated by parameter values taken from the literature; these responses include changes in consumption, labor supply, and bequest behavior by households, as well as changes in the time path of investment by firms that take into account the costs of adjusting their capital stocks. Households and firms are characterized by perfect foresight. By construction, the model tracks the responses to a tax policy change every year after its enactment and converges to a steady-state long-run equilibrium characterized by a constant growth rate. As a result, the model tracks both the short-run and long-run responses to a tax policy change.

The overlapping generations structure of the model enables us to track the effects of policy reforms across generations and across income groups within each generation, rather than simply tracking the effects of reforms in terms of broad aggregate variables, and to analyze reforms like a wealth tax that affect only specific income groups. Specifically, each generation alive at any point in time includes 12 income groups that have differing but fixed lifetime wage profiles (we do not model human capital accumulation). Households are grouped by lifetime income deciles in each generation, with the tenth decile split into the top 0.25 percent (group 12) the next 0.75 percent (group 11), and the remaining 9 percent (group 10). In the case of the Warren wealth tax plan analyzed in this paper, the $50 million exemption implies that the tax affects only a small subset of the population, specifically, households with lifetime income in approximately the top 0.12 percent, all of whom are in the top lifetime income group.

Implementation of the reform implies that these households are subject to the two-rate progressive wealth tax that characterizes the Warren plan; the reform is not anticipated. As noted above, a key factor in the analysis is the fraction of the wealth tax base that goes unreported due to tax avoidance and evasion. The PWBM (2019) approach in assuming a wealth tax semi-elasticity of -13 implies a 26 percent avoidance/evasion rate with a 2 percent wealth tax, and a 78 percent avoidance/evasion rate with a 6 percent wealth tax. However, since the 6 percent rate is far outside the range observed empirically and is thus quite uncertain, and a 78 percent avoidance/evasion rate is extremely high, we simply assume that the average avoidance/evasion rate is 30 percent. It is also worth noting that our model does not capture the efficiency costs associated with tax avoidance/evasion behavior.

The model includes considerable detail on business taxation, including separate tax treatment of corporate and pass-through entities, separate tax treatment of owner-occupied and rental housing, and separate tax treatment of new and old capital. The model includes explicit calculation of asset values before and after the enactment of a reform, which enter into the base of the wealth tax. We also model the progressive taxation of labor income for households at different income levels, capture differential taxation of different types of capital income (although we do not model differential capital income taxes across income groups), and model government expenditures, including government transfers and a pay-as-you-go Social Security system.

The model includes four consumer/producer sectors, characterized by profit-maximizing firms and competitive markets. The goods produced by these four sectors are: (1) a composite good C produced by the “corporate” sector, which includes all business subject to the corporate income tax; (2) a second composite good N produced by the “noncorporate” sector that encompasses all pass-through entities including S corporations, partnerships, LLCs, LLPs, and sole proprietorships; (3) an owner-occupied housing good H; and (4) a rental housing good R.

The model includes a simplified treatment of international capital flows and international trade. The allocation of mobile capital is determined by relative interest rates at home and abroad, and the reduction in investment due to the introduction of a wealth tax in the United States leads to capital inflows from abroad. Trade is assumed to satisfy a standard balance-of-payments constraint.

On the consumption side, each household has an “economic life” of 55 years, with 45 post-education working years and a fixed 10-year retirement, and makes its consumption and labor supply choices to maximize lifetime welfare subject to a lifetime budget constraint that includes personal income and other taxes as well as a fixed “target” bequest. As discussed above, households in the top lifetime income group are assumed to have fixed labor supply and to reduce their target bequest by the amount of the wealth tax. Given this model structure, there are 55 overlapping generations at each point in time in the model, and each generation includes the 12 lifetime income groups described above.

The government purchases fixed amounts of the composite goods at market prices, makes transfer payments, and pays interest on the national debt. It finances these expenditures with revenues from the corporate income tax, a progressive labor income tax, and flat-rate taxes on capital income. The model does not include public infrastructure.

All markets are assumed to be in equilibrium in all periods. The economy must begin and end in a steady-state equilibrium, with all of the key macroeconomic variables growing at the exogenous growth rate, which equals the sum of the exogenous population and productivity growth rates. Note that this is a critical assumption in that it implies that the imposition of a wealth tax cannot change the rate of economic growth in the model, which is exogenously specified.  Hansson (2010) examines wealth taxes in 20 OECD countries between 1980 and 1999 and estimates that a 1 percentage point increase in the wealth tax rate reduces the economic growth rate by between 0.02 and 0.04 percentage points. Thus, a wealth tax rate in the range of 2 to 6 percent as proposed under the Warren plan could potentially have significantly more negative medium and long terms effects than those simulated in this paper.

VI. Wealth Tax Simulation Results

In this section we describe the results of simulating the effects of the Warren wealth tax within the context of our computable general equilibrium model. As discussed above, the tax is imposed at a 2 percent tax on wealth in excess of $50 million, coupled with a 4 percent surtax on wealth in excess of $1 billion. We compare the macroeconomic effects of the policy change to the values that would have occurred in the absence of any changes — that is, under a current law long run scenario, which includes the permanent features of the Tax Cuts and Jobs Act enacted in 2017, including the corporate income tax rate cut to 21 percent, but does not include provisions like expensing and the personal income tax rate cuts that are currently scheduled to be phased out.

The wealth tax raises revenue equal to 1.1 percent of GDP in the first year of enactment and 1.35 percent of GDP in the long run, and is collected from households who are in the top 0.1 percent of the lifetime income distribution. The macroeconomic effects of the wealth tax are shown in Table 1. Because the wealth tax reduces the after-tax return to saving and investment and increases the cost of capital to firms, it reduces saving and investment and, over time, reduces the capital stock. Investment declines initially by 13.6 percent, then rebounds quickly, and declines by 4.7 percent in the long run. The total capital stock declines gradually to a level 3.5 percent lower ten years after enactment and 3.7 percent lower in the long run; the capital stock declines less than domestic investment because of an inflow of foreign capital in response to an increase in relative returns to capital, as described above. The smaller capital stock results in decreased labor productivity and an eventual decline in nominal wages, although price changes imply that real wages, which decrease initially by 1.4 percent, increase by 0.2 percent after ten years, fluctuate around that level, and ultimately increase by 1.3 percent in the long run. The demand for labor falls as the capital stock declines, and the supply of labor falls as households receive larger transfer payments financed by the wealth tax revenues which result in income effects that increase the demand for leisure and thus reduce labor supply. Hours worked decrease initially by 1.1 percent and decline by 1.5 percent in the long run. Recall that our model assumes full employment so that this decline reflects a voluntary reduction in hours worked, holding the labor force constant, in response to wealth-tax-induced changes in prices and incomes. However, if instead labor hours worked per individual were held constant, the initial decline in hours worked of 1.1 percent would be equivalent to a decline in employment of approximately 1.8 million jobs initially. The declines in the capital stock and labor supply imply that GDP declines as well, by 2.2 percent 5 years after enactment and by 2.7 percent in the long run. Consumption also declines, but by less than GDP since the declines in investment are disproportionately large and the declines in the capital stock occur gradually over time. Indeed, consumption increases initially by 4.4 percent, but then declines gradually, to a decrease of 0.7 percent ten years after reform and 1.4 percent in the long run. Similar declines in consumption are observed in the four sectors, although there is also a shift from owner-occupied housing to rental housing due to the increase in relative housing demands by lower-income individuals, who consume a disproportionate share of rental housing.

Transfers increase as the revenues from the wealth tax are used to increase government transfers (other than Social Security) in proportion to existing government transfers. Transfers relative to GDP increase by 54.8 percent initially (from a ratio of 4.1 to 6.3), by 60.1 percent ten years after reform, and by 70.8 percent in the long run. These increases are concentrated in the lower lifetime income groups, as 20 percent of the increase in transfers relative to GDP goes to the lowest income group (the bottom decile), 15 percent to the second lowest lifetime income group (the second lowest decile), and 13 percent to the third lowest lifetime income group (the third decile). This of course reflects a reduction in the wealth of the top lifetime income group, which experiences a reduction in net wealth of roughly 6.3 percent. The wealth of the fourth through ninth income deciles falls by 0.9 percent to 4.2 percent, while the wealth of the lowest three income deciles increases by roughly 19.0 percent for the lowest decile, 10.7 percent for the second lowest decile, and 1.8 percent for the third lowest decile.  Based on data from the Survey of Current Finances for 2016 and the long run change in wealth from the simulation, the changes in wealth in terms of today’s dollars and wealth holdings implies that the wealth per household of the highest income decile falls by roughly $3.7 million, and per household wealth of the fourth through ninth income deciles declines by roughly $440 to $49,660, while the per household wealth of the bottom three income deciles increases by roughly $100 for the lowest income decile, $500 for the second lowest decile, and $350 for the third lowest decile.

Table 1

Macroeconomic Effects of the Warren Wealth Tax

(Tax Rates of 2% and 6%, Revenue Finances Increased Transfers)

(Percentage changes in variables, relative to steady state with no wealth tax)

 

Variable           % Change in Year: 2020 2024 2029 2039 2069 LR GDP 0.4 -2.2 -2.5 -2.7 -2.6 -2.7 Total Consumption 4.4 0.2 -0.7 -1.3 -1.3 -1.4       Corporate Good 4.2 0.3 -0.6 -1.3 -1.2 -1.4       Noncorporate Good 4.2 0.3 -0.6 -1.3 -1.2 -1.4       Rental Housing 6.2 2.0 1.9 2.1 2.6 3.2       Owner–Occupied Housing 4.6 -0.6 -1.6 -2.3 -2.5 -2.8 Total Investment -13.6 -8.7 -6.8 -5.4 -4.8 -4.7 Total Capital Stock 0.0 -2.3 -3.5 -4.2 -3.7 -3.7 Real Wage -1.5 0.2 0.6 1.1 0.8 1.3 Total Employment (hours worked) -1.1 -1.3 -1.3 -1.3 -1.4 -1.5 Transfers (non-SS) / GDP 54.8 65.1 60.1 59.1 66.5 70.8 VII. Conclusion

Recent proposals for the introduction of a wealth tax, especially those put forth by U.S. Senators Elizabeth Warren and Bernie Sanders, have garnered considerable attention. Proponents of a wealth tax stress that in addition to raising revenue, the wealth tax has the advantage of reducing income and wealth disparities. Opponents stress that implementing a wealth tax would face formidable administrative and compliance problems and would have negative effects on saving and investment – problems that have resulted in many OECD countries dropping the tax, although three nations still utilize the tax. Of special concern are the relatively high tax rates under the two proposals – with top rates of 6-8 percent – which are significantly above those utilized in other countries.

In this paper, we focus on estimating the economic effects of the wealth tax proposed by Senator Warren using a computable general equilibrium model of the U.S. economy under the assumption that all revenues are used to finance increase in income transfer that accrue primarily to lower income groups. In particular, we provide an estimate of the trade-offs involved in imposing such a plan. For example, in the long run, transfers relative to GDP increase by roughly 70.1 percent (from a ratio of 4.1 to 6.9), with 48 percent of the increase in transfers going to the bottom 3 income groups, while GDP falls by roughly 2.7 percent, as a result of declines in the capital stock of roughly 3.7 percent and in hours worked of 1.5 percent, and aggregate consumption falls by 1.4 percent.  Wealth held by the top lifetime income group falls by 6.3 percent. Different observers will of course have very different views as to the desirability of making these tradeoffs, but our analysis hopefully sheds some light on the debate by providing an estimate of their magnitudes.

We conclude with a few caveats. In our view, dynamic, overlapping generations computable general equilibrium models of the type used in this analysis are one of the best tools available to analyze the economic effects of tax policy changes such as the wealth tax analyzed in this study; in particular, they provide a rich structure based on fundamental economic theory that captures many of the complex and interacting effects of potential tax reforms. Nevertheless, it is clear that the estimated effects of the wealth tax presented in this report reflect the results of a particular simulation within the context of a specific computable general equilibrium dynamic economic model. For example, as noted above, the model used in this analysis does not allow for the imposition of the wealth tax to change the rate of economic growth (although it does allow for changes in GDP relative to the steady state level).  If a wealth tax reduced the long run rate of economic growth, as suggested in the empirical analysis by Hansson (2010) cited above, a wealth tax rate in the range of 2 to 6 percent as proposed under the Warren plan could potentially have significantly more negative medium and long terms effects than described in this paper. On the other hand, our analysis assumes that wealth tax revenues are used solely to finance increases in transfer payments and assumes the very wealthy reduce their bequests in response to the wealth tax; the simulated macroeconomic effects of the wealth tax would be less negative if the revenues were instead used to finance reductions in the national debt or other public investments or if we assumed the very wealthy reduced consumption rather than their bequests.  More generally, the results of any study that attempts to model the effects of significant tax reforms in today’s highly complex and internationally integrated economy are at best suggestive, and this report is no exception. Such results depend on the details of the reform proposed and its model representation as well as a wide variety of structural assumptions in the model and the specific model parameters utilized in simulating the model. An analysis of the sensitivity of our results to variations in model structure, model assumptions, and parameter values as well as alternative wealth taxes is the subject of ongoing research.

Acknowledgements

This report was prepared with the financial support of the Center for Freedom and Prosperity (CF&P) Foundation.  The opinions expressed in this paper are those of the authors and should not be construed as reflecting the views of CF&P Foundation or any entity with which the authors are affiliated, including Rice University and the Baker Institute for Public Policy.

This study used the Diamond-Zodrow model, a dynamic computable general equilibrium model copyrighted by Tax Policy Advisers, LLC, in which the authors have an ownership interest. The terms of this arrangement have been reviewed and approved by Rice University in accordance with its conflict of interest policies.

[1]  In this paper, we draw on numerous recent articles that have examined the issues surrounding wealth taxation, including especially Viard (2019), as well as Holtzblatt (2019), and Li and Smith (2020).

[2]  An annual wealth tax should thus be distinguished from the estate and gift tax, which is a one-time tax imposed on the transfer of assets.

[3]  The tax thresholds for married couples under the Sanders plan are $32 million (1 percent), $50 million (2 percent), $250 million (3 percent), $500 million (4 percent), $1 billion (5 percent), $2.5 billion (6 percent), $5 billion (7 percent), and $10 billion (8 percent). These thresholds would be halved for single taxpayers.

[4]  In addition, Belgium imposes a tax on financial securities at a flat rate of 0.15 percent, Italy imposes a tax on foreign wealth, and the Netherlands imposes a presumptive income tax on wealth in lieu of taxing capital gains under its income tax. These taxes differ considerably from the broad-based wealth taxes under discussion in the United States.

[5] For example, in 2018 France replaced its wealth tax with a property tax on high-value real estate as part of a set of measures designed to reduce the taxation of relatively mobile capital income, with the government citing the need to attract foreign investment as a primary rationale; see “Speech by Bruno LeMaire, French Ministry of the Economy and Finance,” https://eaccny.com/news/chapternews/speech-by-bruno-la-maire-french-minister-of-the-economy-and-finance/.

[6]  For example, Sweden repealed its wealth tax in 2007 due to concerns about widespread evasion (Henrekson and Du Rietz, 2014) and emigration of high-wealth individuals (Edwards, 2019).

[7]  Rosalsky (2019) notes that the wealth tax in Austria was eliminated in large part due to the high cost of administering and enforcing the tax (https://www.npr.org/sections/money/2019/02/26/698057356/if-a-wealth-tax-is-such-a-good-idea-why-did-europe-kill-theirs).

[8]  Summers and Sarin (2019) argue that experience with the estate and gift tax suggests that far more wealth – on the order of 60 percent – would escape taxation; their revenue estimate for the Warren proposal is roughly $25 billion, in comparison to the Saez-Zucman (2019b) estimate of $212 billion. Saez and Zucman (2019d) argue that the Summers-Sarin estimate is far too low because it assumes that the exemptions and weak enforcement under the estate and gift tax would apply to the wealth tax. Note that the Saez-Zucman estimate implies that revenues would be roughly 1 percent of GDP – only the Swiss tax raises revenue on this scale although it imposes the tax on a much broader base including many upper middle class households, while wealth taxes raise much less in Norway (0.4 percent) and in Spain (0.2 percent) (Viard, 2019).

[9]  For example, see Fullerton and Rogers (1993). Other bequest motives may also be operative, including altruism toward one’s heirs, a “joy of giving” motive typically modeled by treating the bequest simply as another consumption good, or a “strategic bequest” motive, under which parents attempt to alter the behavior of their children by altering the promised bequest.

[10]  Recognizing this relatively high tax burden, Spain limits the combined income and wealth tax burden to 60 percent of taxable income.

[11]  Our model does not consider risk and uncertainty explicitly, although it does include an equity premium. On a related point, Kopczuk (2019) notes that a wealth tax may encourage risk-taking more than the alternative of capital income taxation because the taxation of wealth effectively allows full deductibility of losses, which is often difficult to achieve under capital income taxation. On the other hand, he also argues that wealth taxation tends to shift the tax burden from economic rents to safe returns, which is undesirable on efficiency grounds.

[12]  Note, however, that shifting of the wealth tax might reduce wages as described above, thus reducing somewhat the progressivity of the tax.

 

References

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Image credit: Pictures of Money | CC BY 2.0.

No Unconditional Handouts to the States

Tue, 08/11/2020 - 3:54am

Originally published by Inside Sources on August 10, 2020.

The biggest sticking point in negotiations between the White House, Senate Republicans and House Democrats over the next COVID-19 relief bill is the treatment of the CARES Act’s recently expired $600 in added weekly unemployment benefits.

But added unemployment benefits are not the only point of contention and — in the long run — the question of financial aid to the states is likely to prove the most consequential.

The sides are far apart on the question of aid to the states. In their bill, Democrats provided $1 trillion, roughly the entire amount that Republicans proposed in new spending, just for state, local and tribal governments.

Republicans proposed no new funds for states but offered more flexibility for use of funds leftover from the $150 billion allocated in the CARES Act. A new report from the U.S. Treasury Department’s Office of Inspector General shows that only about 25 percent have yet been spent.

State and local governments are taking on considerable responsibility in the fight against COVID-19, and for good reason, as they are closest to the problem and best positioned to quickly respond as conditions change.

It is thus understandable that Congress would consider some measure of financial support to state and local governments as part of the national effort to address the virus. But how states are permitted to spend any potential relief dollars is just as important to get right as the amount of aid they end up receiving.

Long before the arrival of COVID-19, many states were in dire straits financially.

Some, like New Jersey, Illinois and Massachusetts have taken on hundreds of billions of dollars in debt to finance large governments, while others make the hard decisions that lead to responsible and balanced budgets.

Some, like Wyoming, Alaska, California and North Dakota, even planned ahead and now have sizable “rainy-day” funds they can draw upon to fill budget gaps due to declining tax revenues during the pandemic.

And whereas some states responded to expected declines in tax revenue with furloughs and other spending cuts, Illinois continued its irresponsible ways by passing a budget with $2.4 billion more in spending than the previous year.

Is it right that the most responsible states should have to shoulder the added costs of supporting those that refuse to get their fiscal houses in order? Doing so would amount to a reward for failing to act responsibly.

Employee compensation accounts for half of all state and local spending, making unfunded pension liabilities a large part of the story when it comes to state financial mismanagement.

For decades, governments have failed to fully fund the often generous pension benefits for their employees, kicking the can down the road for future taxpayers to deal with. Unfunded liabilities of state pension plans now total roughly $5 trillion, according to U.S. Pension Tracker.

This is a problem that requires significant reforms. A condition free bailout of the states that allows governments to allocate federal dollars toward closing fiscal gaps caused by excessive spending — such as through state employee pension programs — would only serve to sap the political will necessary to make reform a reality.

To avoid this problem, Congress should scrutinize state requests for aid and provide only those funds necessary to help them address COVID-related challenges.

Or if being more generous is a necessary compromise, then funds should be conditioned on the adoption of fiscally responsible reforms that put pension programs on the path to sustainability, or that encourage the use of rainy-day funds to better prepare for the next crisis.

Will America Learn from Japan’s Fiscal Decline?

Mon, 08/10/2020 - 12:58pm

Compared to most of the world, Japan is a rich country. But it’s important to understand that Japan became rich when the burden of government was very small and there was no welfare state.

Indeed, as recently as 1970, Japan’s fiscal policy was rated by Economic Freedom of the World as being better than what exists today in Hong Kong.

Unfortunately, the country has since moved in the wrong direction. Back in 2016, I shared the “most depressing chart about Japan” because it showed that the overall tax burden doubled in just 45 years.

As you might expect, that rising tax burden was accompanied by a rising burden of government spending (fueled in part by enactment of a value-added tax).

And that has not been a good combination for the Japanese economy, as Douglas Carr explains in an article for National Review.

From 1993 to 2019, the U.S. averaged 2.6 percent growth, …far ahead of Japan’s meager 0.9 percent. …What happened? Big government happened… Japanese government spending was just 17.5 percent of the country’s GDP in 1960 but has grown, as illustrated below, to 38.8 percent of GDP today. …the island nation’s growth never recovered. The theory that government spending boosts long-term growth has failed… What government spending does is crowd out investment.

Amen. Japan has become a parody of Keynesian spending.

Here’s a chart from Mr. Carr’s article, which could be entitled “the other most depressing chart about Japan.”

As you can see, the burden of government spending began to climb about 1970 and is now represents a bigger drag on their economy than what we’re enduring in the United States.

Unfortunately, the United States is soon going to follow Japan in that wrong direction according to fiscal projections from the Congressional Budget Office.

Carr warns that bigger government in America won’t work any better than big government in Japan.

Rather than a problem confined to the other side of the world, Japan’s death spiral is a pointed warning to the U.S. The U.S. and Japanese economies are on the same trajectory; Japan is simply further along the big-government, low-growth path. …The United States is at risk of entering a Japanese death spiral.

Here’s another chart from the article showing the inverse relationship between government spending and economic growth.

Moreover, the U.S. numbers may be even worse because of coronavirus-related spending and whatever new handouts that might be created after the election.

The negative relationship of government spending with growth and investment holds with adjustments for cyclical influences such as using ten-year averages or the Congressional Budget Office’s estimates of cyclically adjusted U.S. government spending. CBO data highlight how close the U.S. is to a Japanese-style death spiral. …Of course, CBO’s recent forecast was prepared before the coronavirus shock and does not incorporate spending by a new Democratic government, so this dismal outlook is likely to worsen.

So what’s the solution? Can the United States avoid a Greek-style future?

The author explains how America can be saved.

Boosting growth means restraining government. Restraining government means reengineering entitlements… Economically, it shouldn’t be too difficult to do better. We have an insolvent, low-return government-retirement program along with an insolvent retiree-health program — part of a Rube Goldberg health-care system.

He’s right. To avoid stagnation and decline, we desperately need spending restraint and genuine entitlement reform in the United States.

Sadly, Trump is on the wrong side on that issue and Biden wants to add fuel to the fire by making the programs even bigger.

P.S. Here’s another depressing chart about Japan.

P.P.S. Unsurprisingly, the OECD and IMF have been cheerleading for Japan’s fiscal decline.

P.P.P.S. Japan’s government may win the prize for the strangest regulation and the prize for the most useless government giveaway.

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Image credit: victorpalmer | Pixabay License.

Being Libertarian

Sun, 08/09/2020 - 12:33pm

Back in 2018, I shared five images that capture what it means to be libertarian.

Let’s do the same thing today, except we’ll first start with a video that is interesting overall, but has some specific insights about libertarians from 5:45-7:20.

Now let’s look at our five new images.

We’ll start with the all-important point that there’s a big difference between wanting good things and thinking that government is the way to achieve good things.

Our second contribution shows the libertarian claim that they are the philosophical descendants of America’s Founders (even Alexander Hamilton).

Our third contribution is from Reddit’s libertarian page and it captures the movement’s laissez-faire spirit.

Next we have another reminder that government was the most dangerous entity in the 20th century (and presumably in all history).

Last but not least, here’s a powerful set of images that underscores the giant difference between legality and morality.

P.S. There’s another interesting video on Jonathan Haidt’s analysis of libertarians at the end of this column. And you can read more of his analysis here.

P.P.S. You can learn more about libertarian self-identification here and here.

Evidence from Italy: Less Regulation = More Jobs and Higher Earnings

Sat, 08/08/2020 - 12:26pm

There are all sorts of regulations, some of which affect the entire economy and some of which target certain sectors. Moreover, regulations vary widely since – depending on the example – they may tell people and business what to do, how to do it, when to do it, and who to do it with.

This is why it’s probably best to think of government red tape as an obstacle course that increases the difficulty of engaging in commerce.

An expensive obstacle course.

Some new research published by Italy’s central bank gives us an opportunity to understand the consequences of red tape.

The study, authored by Lucia Rizzica, Giacomo Roma, and Gabriele Rovigatti, looked at a real-world example of product market regulation (PMR) governing retail hours in Italy.

In this paper we focus on how the regulation of shops opening hours affects the relevant market size and structure. This dimension of PMR has traditionally been a controversial issue in the policy debate, as it involves social, political, economic, and even religious considerations. …we tackle these questions empirically and estimate the effects of full deregulation in shop opening hours on the level and composition of employment and on the number of shops and their size distribution…we focus on Italy and build a novel dataset of Italian municipalities 2007-2016, including their regulatory status, and exploit the variation provided by the staggered implementation at the municipal level of a deregulation reform enacted from1998 onwards.

Here’s a visual from the study, showing the variation over time in the number of municipalities with no regulation, medium regulation, and heavy regulation.

The good news is that Italy actually got rid of rules dictating when stores could be open and this gave the economists an opportunity to measure what happened.

Our estimates show that, in the context of a general contraction of the retail sector and of the economy as a whole, deregulating shops opening hours helped lowering the decrease in both the number of workers and establishments, with an estimated positive impact of about 3% and 2%, respectively. …On top of it, individual-based estimates show that the sector’s labor force structure changed towards a higher prevalence of employees over self-employed, together with a general increase in the number of hours worked and earnings of employees, especially of those with permanent contracts. Our results are robust to a number of checks… In Table 2 we present our baseline results. In columns (1)-(2) we report the estimates of the liberalization effect on the number of workers, and in columns (3)-(4) those on the number of plants in each municipality. …the resulting estimated effect of liberalization in the newly liberalized municipalities is a 3.4% increase in the number of individuals working in the wholesale and retail sector, and a 2.1% increase in the number of shops. …Finally, we show that the reform also had a positive effect on the activity of complementary services, such as restaurants and financial services and, overall, on total employment in affected areas.

For wonky readers, here’s the table mentioned in the above excerpt.

So what’s the bottom line?

…from a policy perspective, our results provide support to the idea that a more flexible regulation of the business environment boosts economic growth… We find no evidence that this leads to a worsening of employment conditions, on the contrary permanent dependent workers enjoyed an increase in their earnings.

It’s great to see that deregulation produced more jobs and higher earnings.

But one thing that we don’t find in the study, unfortunately, is any estimate of how deregulation also benefited consumers thanks to lower prices and greater convenience.

In other words, eliminating or reducing red tape is a win-win situation for just about everybody (with the only exception being the cronyists who gain undeserved advantages because of regulation).

P.S. While I’m glad that Italy got rid of rules limiting retail hours, the country – as measured by the World Bank – still has a lot of needless red tape.

OECD Research Acknowledges Big Benefits from Federalism

Fri, 08/07/2020 - 12:10pm

Largely because of my support for jurisdictional competition, I’m a big fan of federalism.

Simply stated, our liberties are better protected when there’s decentralization since politicians are less like to over-tax and over-spend when they know potential victims of plunder have the option of moving across a border.

Indeed, I cited some academic research back in 2012 which showed that there as less economy-weakening redistribution in nations with genuine federalism (see, for instance, how Vermont politicians were forced to backtrack when they try to impose government-run healthcare).

Now let’s look at some additional scholarly evidence. A study published by the OECD, authored by Hansjörg Blöchliger, Balázs Égert and Kaja Fredriksen, investigates the impact of federalism on outcomes in developed nations.

Here are the key findings from the abstract.

This paper presents empirical research on the potential effects of fiscal decentralisation on a set of outcomes such as GDP, productivity, public investment and school performance. The results can be summarised as follows: decentralisation, as measured by revenue or spending shares, is positively associated with GDP per capita levels. The impact seems to be stronger for revenue decentralisation than for spending decentralisation. Decentralisation is strongly and positively associated with educational outcomes as measured by international student assessments (PISA). While educational functions can be delegated either to sub-central governments (SCG) or to schools, the results suggest that both strategies appear to be equally beneficial for educational performance. Finally, investment in physical and – especially – human capital as a share of general government spending is significantly higher in more decentralised countries.

Here’s some detail from the body of the paper about the pro-growth impact of decentralization (especially when sub-national governments are responsible for raising their own funds).

Across countries, sub-central fiscal power, as measured by revenue or spending shares, is positively associated with economic activity. Doubling sub-central tax or spending shares (e.g. increasing the ratio of sub-central to general government tax revenue from 6 to 12%) is associated with a GDP per capita increase of around 3%. …Revenue decentralisation appears to be more strongly related with income gains than spending decentralisation. This empirical finding may reflect that “true” fiscal autonomy is better captured by the sub-central revenue share, as a large part of sub-central spending may be mandated or regulated by central government. … the estimated relationship never becomes negative and is not hump-shaped, i.e. “more decentralisation always tends to be better”.

The part of “more decentralisation always tends to be better” is a good result.

But it’s also a sad result since the United States has moved in the wrong direction in recent decades.

Though we’re still less centralized than most nations, as you can see from this chart from the OECD study.

Kudos to Canada and Switzerland for leading the world in federalism.

Here are some additional details from the study. I’m especially interested to see that the authors acknowledge how jurisdictional competition helps to explain why nations with federalism perform better.

Decentralised fiscal frameworks can raise TFP through an increase in the efficiency and productivity of the public sector… Public sector productivity is influenced by competition between SCGs and inter-jurisdictional mobility. Most SCGs aim at attracting and retaining mobile production factors, in order to promote investment and economic activity. They can do so by using fiscal policy, among other instruments. Since firms are choosing their location based on where they expect the highest returns on investment, and since returns depend (partly) on public inputs, SCGs have an incentive to raise the productivity of their public sector. SCGs may also try to improve the relationship between taxation and public service levels, by lowering taxes… The more decentralised a country, the stronger these competitive forces could be. Competition and inter-jurisdictional mobility could be weakened by large intergovernmental transfer systems, in particular fiscal equalisation.

As a aside, it’s rather ironic that that the professional economists at the OECD produce rigorous studies (here’s another one) showing the benefits of jurisdictional competition while the political appointees push for anti-growth policies such as tax harmonization.

Let’s close by looking at the study’s estimates of how nations would enjoy more prosperity by shifting in the direction of decentralization.

…an assessment of what a country might gain in terms of higher GDP if it moved to the benchmark of the most decentralised country. To be more specific, the gains were calculated for each federal country if it moved tax decentralisation to the level of Canada, and for each unitary country if it moved tax decentralisation to the level of Sweden (Figure 6). Further decentralisation could potentially be associated with an average increase of GDP of around 1% to 2% for federal countries and 3% to 4% for unitary countries, with values for more centralised countries being larger.

Here’s the accompanying chart.

Since the U.S. still has some federalism, our gain isn’t very large, but nations such as Austria, Belgium, Slovakia, Ireland, Luxembourg, and the United Kingdom could get big boosts.

P.S. I didn’t focus on the findings about better educational outcomes in decentralized nations. But I can’t resist pointing out that this is an additional reason to abolish the Department of Education.

P.P.S. Here’s a video discussing how Switzerland benefits from federalism.

P.P.P.S. And here’s what scholars from the Austrian school of economics wrote about federalism.

Warren Harding’s Anti-Keynesian Solution to a Deep Economic Downturn

Thu, 08/06/2020 - 12:58pm

We did not get good policy during the economic crisis of the 1930s. Indeed, it’s quite likely that bad decisions by Herbert Hoover and Franklin Roosevelt deepened and lengthened the Great Depression.

Likewise, George Bush and Barack Obama had the wrong responses (the TARP bailout and the faux stimulus) to the economic downturn of 2008-09.

But people in government don’t always make mistakes. If we go back nearly 100 years ago, we find that Warren Harding oversaw a very rapid recovery from the deep recession that occurred at the end of Woodrow Wilson’s disastrous presidency.

In a column for the Foundation for Economic Education, Robert Murphy has a very helpful tutorial on what happened.

…the U.S. experience during the 1920–1921 depression—one that the reader has probably never heard of—is almost a laboratory experiment …the government and Fed did the exact opposite of what the experts now recommend. We have just about the closest thing to a controlled experiment in macroeconomics that one could desire. To repeat, it’s not that the government boosted the budget at a slower rate, or that the Fed provided a tad less liquidity. On the contrary, the government slashed its budget tremendously… If the Keynesians are right about the Great Depression, then the depression of 1920–1921 should have been far worse. …the 1920–1921 depression was painful. The unemployment rate peaked at 11.7 percent in 1921. But it had dropped to 6.7 percent by the following year and was down to 2.4 percent by 1923. …the 1920–1921 depression “purged the rottenness out of the system” and provided a solid framework for sustainable growth. …The free market works. Even in the face of massive shocks requiring large structural adjustments, the best thing the government can do is cut its own budget and return more resources to the private sector.

Writing for National Review, David Harsanyi points out that there are many reasons why Warren Harding should be celebrated over Woodrow Wilson.

Wilson was one of the most despicable characters in 20th-century American politics: a national embarrassment. The Virginian didn’t merely hold racist “views;” he re-segregated the federal civil service. He didn’t merely involve the United States in a disastrous war in Europe after promising not to do so; he threw political opponents and anti-war activists into prison. Wilson, the first president to show open contempt for the Constitution and the Founding, was a vainglorious man unworthy of honor. Fortunately, we have the perfect replacement for Wilson: Warren Harding, the most underappreciated president in American history… Harding, unlike Wilson — and most of today’s political class, for that matter — didn’t believe politics should play an outsized role in the everyday lives of citizens. …Where Wilson had expanded the federal government in historic ways, creating massive new agencies such as the War Industries Board, Harding’s shortened term did not include any big new bureaucracies… Wilson left the country in a terrible recession; Harding turned it around, becoming the last president to end a downturn by cutting taxes, and slashing spending and regulations. Harding cut spending from $6.3 billion in 1920 to $3.3 billion by 1923.

Walter Block, in an article for the Mises Institute, explains that what happened almost 100 years ago can provide a good road map if President Trump wishes to restore prosperity today (especially when compared to the disastrous policies of Hoover and Roosevelt).

…let us look back a bit at some economic history regarding recessions and depressions… The depression in 1921 was short lived—maybe not a V, but at least a very narrow U. …Happily, during the 1921 depression, the government of President Warren G. Harding did not intervene…and the entire episode was over not in a matter of weeks (the V) or years (a fattish U), but months (a narrow U). The Great Depression, which stretched from 1929–41 (a morbidly obese U) stemmed from identical causes. …But Presidents Herbert Hoover and Franklin D. Roosevelt “fixed” this by propping up heavy industries whose extent was overblown by the previous artificially lowered interest rates, in an early “too big to fail” paroxysm. The Smoot-Hawley Tariff added insult to injury, and put the kibosh on any early recovery. …I now predict the sharpest of Vs, but if and only if, all other things being equal, the Trump administration cleaves to market principles. …So, Mr. President, embrace the free enterprise system, attain a V, a very narrow and sharp one, and the prognostication for November will be significantly boosted.

Professor Block’s analysis is very sound…except for the part where he speculates that Trump will do the right thing and copy Harding.

Given Trump’s awful track record on spending, it would be more accurate to speculate that I’ll be playing in the outfield for the Yankees when they win this year’s World Series.

Suffice to say, though, that it would be great to find another Warren Harding. Here’s a chart based on OMB data showing that he actually cut spending (and we’re looking at genuine spending cuts, not the make-believe spending cuts that happen in DC when politicians boost the budget by less than previously planned).

According to fans of Keynesian economics, these spending cuts should have tanked the economy, but instead we got a boom.

P.S. By the way, something similar happened after World War II.

P.P.S. Back in 2012, I shared some insightful analysis from Thomas Sowell about Harding’s economic policy.

P.P.P.S. Harding also lowered tax rates.

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Image credit: National Photo Company Collection, Library of Congress | Public Domain.

The Case Against the Public Option

Wed, 08/05/2020 - 12:53pm

Even though Joe Biden has embraced a very left-wing agenda, I suspect many of the items on his wish list are designed to placate Bernie-type activists who have considerable influence in the Democratic Party.

As such, I don’t think Biden will push “Medicare for All” if he’s elected. But I fear he may support a “public option” that is less radical but still misguided.

The strongest argument in the video is that a government-created competitor to private insurance companies will be much more expensive than politicians are promising.

This is what always happens with government programs (see MedicareMedicaid, and Obamacare) because politicians have a never-ending incentive to buy votes with other people’s money. And it will happen with any new program.

But I think the video overlooks an argument that would be even more politically effective, which is the fact that a public option would slowly but surely begin to strangle employer-based health insurance.

Simply stated, vote-buying politicians will deliberately under-price the cost of the public option. And the presence of a subsidized and under-priced government health plan will make employer-based policies less attractive over time – especially since the subsidies almost certainly will expand.

However, people generally like their employer-based health plans and presumably will be skeptical of any plan that threatens that system (and it’s probably safe to assume that health insurance companies will have an incentive to educate people about that likely outcome).

By the way, it’s not my intention to defend the employer-based system, which largely exists because of a foolish loophole in the tax code. As far as I’m concerned, that system is a convoluted and inefficient mess that has contributed to the health care system’s third-party payer crisis.

What we need is a restoration of free markets in health care.

But with the public option, the best-case scenario is that many people over time will get pushed from the top line of this image to the bottom line.

And that’s also the worst-case scenario since no problems will be fixed, but overall costs will be even higher thanks to greater government involvement.

For what it’s worth, some advocates of the public option claim it can actually save money by lowering reimbursement rates to doctors and hospitals. That could happen in theory, but exploding costs for MedicareMedicaid, and Obamacare show that it doesn’t happen in reality.

The bottom line is that more government intervention in health care won’t solve the problems caused by existing levels of government intervention in health care (a tragic example of Mitchell’s Law). Which is why I fear that the public option ultimately would be a slow-motion version of Medicare for All.

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Image credit: Pictures of Money | CC BY 2.0.

Subsidized Unemployment and Societal Capital

Tue, 08/04/2020 - 12:28pm

In early June, I pontificated about the upside-down incentives that are created when government pays people more to be idle than they could get by working.

This is a real-world concern because the crowd in Washington earlier this year approved a $600-per-week bonus for people getting unemployment benefits.

And that resulted in many people getting far more from benefits than they could get from employment. In some cases, even twice as much.

Anyhow, that bonus expired at the end of July, which has triggered a debate on whether to renew the policy.

In her Washington Post column, Catherine Rampell argues that super-charged benefits don’t discourage employment.

State benefits, on average, cover about 40 percent of the typical worker’s lost wages…  Given the extraordinary economic crisis, federal lawmakers wanted to “top up” state benefits so that workers would get close to 100 percent of their lost wages. …So Congress passed a $600 weekly supplement because it seemed about the right amount to make the average worker whole. …a majority of unemployed workers received more in benefits than they earned in their most recent paychecks. …this prompted concerns that the benefits themselves might slow down the recovery, discouraging people from returning to work because being on the dole was too darn comfortable. …five…recent studies…concluded the…$600 federal supplement does not appear to have depressed job growth. …Yes, at some point, …fears about work disincentives may materialize, as the economy recovers and job opportunities become more plentiful. We’re nowhere near that point now.

The Wall Street Journal also opined on this topic, specifically debunking one of the studies cited by Ms. Rampell.

Most Americans understand intuitively that if people make more money by not working, fewer people will work. Then there are politicians and economists who want to pass out more money while claiming that disincentives to work are irrelevant. …a study by Yale economists…purportedly finds the $600 federal enhancement to jobless benefits hasn’t affected the incentive to work. …Yet the study excluded part-time workers and those who hadn’t been working at a business in their sample last year. In other words, the study focused on workers with more loyalty to their employers. …Notably, states with more generous unemployment benefits for low-wage workers generally have had larger declines in labor-force participation. In Kentucky the lowest-paid 25% of unemployed workers on average have made 216% of what they did working. The state’s labor-force participation has declined 4.8 percentage points since February. …If you subsidize not working, you get less work.

In this Rampell vs. WSJ debate, I’m more sympathetic to the latter.

When the big fight over extended unemployment benefits during the Obama years was finally resolved, it showed that people are significantly more likely to find jobs when they’re no longer getting paid for not working.

This doesn’t mean that it will be easy (especially in an environment where there is still uncertainty about the coronavirus), or that we shouldn’t have sympathy for people facing pressure to find jobs after losing their previous positions.

But if we want prosperity and rising living standards, there’s really no alternative.

I’ll close with another excerpt from Ms. Rampell’s column. She cites an economist who found that some people went back to work even though they received less money than they were getting from the government.

Evercore ISI economist, Ernie Tedeschi, …observed that in June, around 70 percent of unemployment recipients who resumed working had been receiving more from benefits than their prior wage — yet nonetheless returned to work.

This is largely good news since it shows that America still enjoys a high degree of societal capital (work ethic, desire to earn rather than get handouts, etc).

But this underscores why we shouldn’t erode that valuable form of capital by making people feel like chumps for doing the right thing (a point I emphasized earlier this year when criticizing Elizabeth Warren’s dependency agenda).

Otherwise we wind up with the real-world version of this satirical Wizard-of-Id cartoon.

P.S. Speaking of satire, Nancy Pelosi actually argued that paying people not to work was a form of stimulus.

P.P.S. Here are a couple of anecdotes, one from Ohio and one from Michigan, about the perverse impact of excessive unemployment benefits during the last downturn.

P.P.P.S. If you want more academic literature on the relationship between government benefits and joblessness, click here and here.

P.P.P.P.S. Last but not least, prominent economists on the left (including Paul Krugman) actually agree the unemployment benefits encourage joblessness.

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Image credit: Steven Depolo | CC BY 2.0.

Greece Needs to Expand its Experiment with Supply-Side Economics

Mon, 08/03/2020 - 12:35pm

There’s a reason that Greece is almost synonymous with bad economic policy. The country has endured some terrible prime ministers, most recently Alexis Tsipras of the far-left Syriza Party.

Andreas Papandreou, however, wins the prize for doing the most damage. He dramatically expanded the burden of government spending in the 1980s (the opposite of what Reagan and Thatcher were doing that decade), thus setting the stage for Greece’s eventual fiscal collapse.

But Greek economic policy isn’t a total disaster.

Policy makers in Athens are trying a bit of supply-side tax policy, at least for a limited group of people.

The U.K.-based Times has a report on Greece’s campaign to lure foreigners with low tax rates.

“The logic is very simple: we want pensioners to relocate here,” Athina Kalyva, the Greek head of tax policy at the finance ministry, said. “We have a beautiful country, a very good climate, so why not?” “We hope that pensioners benefiting from this attractive rate will spend most of their time in Greece,” Ms Kalyva told the Observer. Ultimately, the aim is to expand the country’s tax base, she added. “That would mean investing a bit — renting or buying a home.” …The proposal goes further than other countries, however, with the flat tax rate in Greece to apply to other sources of revenue as well as pensions, according to the draft law. “The 7 per cent flat rate will apply to whatever income a person might have, be that rents or dividends as well as pensions,” said Alex Patelis, chief economic adviser to Kyriakos Mitsotakis, the prime minister. “As a reformist government, we have to try to tick all the boxes to boost the economy and change growth models.”

Here are excerpts from a Reuters report.

Greece will offer financial incentives to encourage wealthy individuals to move their tax residence to the country, part of a package of tax relief measures… Greece’s conservative government is keen to attract investments to boost the recovering economy’s growth prospects. …The so-called “non-dom” programme will offer qualified wealthy investors who opt to shift their tax residence to the country a flat tax of 100,000 euros ($110,710) on global incomes earned outside Greece annually. “The tax incentive will run for a duration of up to 15 years and will include the benefit of no inheritance tax for assets outside Greece,” a senior government official told Reuters. One of the requirements to qualify will be residing in Greece for at least 183 days per year and making an investment of at least 500,000 euros within three years. …Investments of 3 million euros will reduce the flat tax to just 25,000 euros. There will also be a grandfathering clause protecting investors from policy changes by future governments.

By the way, Greece isn’t simply offering a flat-rate tax to wealthy foreigners. It’s offering them a flat-amount tax.

In other words, because they simply pay a predetermined amount, their actual tax rate (at least for non-Greek income) shrinks as their income goes up.

And since tax rates matter, this policy is luring well-to-do foreigners to Greece.

That’s good news. I’m a big fan of cross-border tax migration, both inside countries and between countries. And I’ve specifically applauded “citizenship by investment” programs that offer favorable tax rates to foreigners who bring much-needed investment to countries wanting more growth.

But I want politicians to understand that if low tax rates are good for newcomers, those low rates also would be good for locals.

But here’s the bad news. Fiscal policy in Greece is terrible (ranked #158 for “size of government” out of 162 nations according to the latest edition of Economic Freedom of the World).

What’s especially depressing is that Greece’s score has actually declined ever since the fiscal crisis began about 10 years ago.

In other words, the country got in trouble because of too much government, and politicians responded by actually making fiscal policy worse (aided and abetted by the fiscal pyromaniacs at the IMF).

And the bottom line is that it’s impossible to have overall low tax rates with a bloated public sector – a lesson that applies in other nations, including the United States.

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Image credit: Pedro Szekely | CC BY-SA 2.0.

Why Elon Musk’s EV Credits Need to Go

Fri, 07/31/2020 - 12:21pm

Originally published by RealClearEnergy on July 30, 2020.

Over the last week, the media has reported that Elon Musk’s Tesla is making money hand over fist. In reality, however, like Musk’s aerospace company SpaceX, Tesla is using fists – the government’s – to take money from the taxpayers.

To avoid going into the red, Tesla leverages government mandates requiring the production of electric cars to mulct other car companies that don’t make EVs – or enough of them – into buying “credits” from Elon in lieu of doing so.

Essentially, other car companies must choose between diverting capital into unprofitable electric cars or diverting money into Elon Musk’s pockets.

It’s cheaper and easier to do the latter than to expend the even larger sums it would take to design, tool, and manufacture their own electric cars, which they’d then have to try to sell without losing money again. Their dealers don’t want cars they can’t get enough people to buy to make it worthwhile – even with the incentive of thousands of dollars of other people’s money (tax credits) thrown in as part of the deal. It looks bad to have what amounts to electrified Azteks just sitting there, collecting dust and taking up valuable floor space that could be used to display cars that people want to buy – and do – without being paid off to buy them.

No one wants to be the automotive Goodwill store.

One analyst notes that Tesla’s reported profits “are more than accounted for by $1 billion in regulatory credits sold to other carmakers during the 12 months (up to) June.” (italics mine). But these credits would never have been bought absent the government mandate. According to Morningstar’s David Whiston, “Tesla had a pre-tax loss of $278 million excluding $428 million regulatory credit revenue.” This is how Tesla makes – or rather, takes – its money. But that’s not how it’s reported.

The analyst went on to state that Tesla “… is only able to earn this income because rivals haven’t gotten their act together yet on building enough electric vehicles and have to buy credits to satisfy emissions regulators.”

Gotten their act together?

EV apologists makes it sound like a car company only wanting to build what people are willing to buy at a price that makes it worth making is a disreputable thing. And that’s the problem with electric cars – they are not worth it for most manufacturers; at least presently. If they were, the government would not need to impose production quotas. There are no production quotas for iPhones – and Apple doesn’t need to get the government to strong-arm Samsung to buy “credits” from them in order to stay in business. But car companies that make what people want to buy – and what is profitable to sell – are shamed for not viewing the government as their customer like Tesla does.

Tesla “earns” this money in the same way as the IRS. The difference is that Tesla is a privately-owned company using the same offer-you-can’t-refuse methods. Elon Musk is on track to pocket another couple of billion for this very reason, something only possible because of his silent partner, the government. It’s easy making money when you can simply take it.

But as the aforementioned analyst also notes, “this good fortune won’t last forever” – because, eventually, the other car companies will “get their act together” – meaning, they’ll cave into the regulatory pressure and build the required number of electric cars. Perhaps nothing but electric cars – as VW has publicly said it will do by 2025, after being practically crucified by the government for selling millions of 50 MPG (at only about $22,000) diesel-powered cars that people jostled in line to buy. Which they can no longer buy – because the government outlawed them.

At any rate, once VW builds nothing but electric cars, they will no longer have to pay Elon to build electric cars. However, someone will still have to pay for all these government mandated EVs, which are currently impossible to sell for a profit without someone else taking a loss. Nissan, for example, has been bled for “selling” its Leaf electric car. It frequently only leaves the showroom floor when its new owner’s receive tax credits to the tune of several thousand dollars, and the window stickers of all the other cars on the floor increase to offset the loss.

The only reason Nissan builds the Leaf at all is to meet the regulatory requirements. It would probably be cheaper – and easier – to line Elon’s pockets, as GM, Toyota and other car companies have been doing. But it will get a lot more expensive for everyone when all you’re able to buy is an electric car, and it’s no longer possible to use the government to make someone else pay for it.

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Image credit: Maurizio Pesce | CC BY 2.0.

Understanding “Public Goods”

Fri, 07/31/2020 - 12:17pm

I wrote last month about “anarcho-capitalists” who think we don’t need any government because markets can provide everything.

Most people, though, think that there are certain things (such as national defense and the rule of law) that are “public goods” because they won’t exist if they’re not provided by government.

Academics tell us, if we want to be rigorous, that there are two characteristics that define public goods.

  1. They are goods that people won’t buy because they can reap the benefit without paying (economists say this means the good is “non-excludable” while normal people refer to this as the free-rider problem).
  2. They are goods that can be universally shared since one person’s consumption of the good doesn’t limit another person’s consumption of the good (economists say such goods are “non-rival”).

That’s a bit wonky, so let’s consider the example of national defense.

In a world with bad countries (or, to be more accurate, a world with nations governed by bad people), there’s a risk or external aggression. Since most people wouldn’t want to be conquered – and presumably mistreated – by foreign aggressors, national defense is valuable.

But how would it be provided in the absence of government? Maybe Bill Gates and Jeff Bezos would have an incentive to cough up some cash since they have a lot of wealth to protect, but most people (including most rich people) might figure that someone else would cover the cost and they could enjoy protection for free.

This two-part series from Marginal Revolution University explains public goods, using the example of asteroid defense. Here’s an introductory video.

And here’s a follow-up version that has a bit more detail.

I’m writing about this wonky issue because the debate over public goods, at least in some quarters, also is a debate about the size of government.

Consider this image of supposed public goods.

It shows all sorts of activities where governments today play a role, but most of those things aren’t actually public goods since they can be – and sometimes are – privately provided (see examples for fire protectionmoneyroadseducationhealthair traffic control, and parks).

In other words, as Professor Tabarrok noted in the second video, something isn’t a public good just because it’s currently being handled by government.

Indeed, let’s look at the classic example of lighthouses, which often are cited as an example of something that absolutely must be provided by government. Yet scholars have found that the private sector led the way (before being supplanted by government).

For a more prudent view of public goods, Ronald Reagan’s FY1987 budget included a set of principles to help guide whether the federal government should play a role in various areas.

Those six principles could even be boiled down to one principle: Always opt for the private sector whenever possible.

I’ll close by identifying the bureaucracies in Washington that provide genuine public goods. As you can see, much of the federal government (Department of Housing and Urban DevelopmentDepartment of EducationDepartment of EnergyDepartment of AgricultureDepartment of Transportation, etc) doesn’t qualify.

To be sure, I’m using a broad-brush approach with this image. Some of the bureaucracies that I crossed out do a few things that qualify as public goods (such as nuclear weapons research at the Department of Energy), and the bureaucracies that didn’t get crossed out do lots of things (such at veterans health care) that should be in the private sector.

The bottom line is that much of the federal government isn’t needed, based on what’s a genuine public good. And for much of America’s history, at least prior to the 1930s, Washington was only a tiny burden because it was only involved in a few areas, such as national defense.

Though it’s worth noting that government could – and should – be much smaller even using an expansive definition of public goods and the role of government.

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Image credit: Frank Schulenburg | CC BY-SA 4.0.

Tax Increases Will Generate More Spending, More Debt, and Less Prosperity

Thu, 07/30/2020 - 12:58pm

Because of changing demographics and poorly designed entitlement programs, the burden of government spending in the United States (in the absence of genuine reform) is going to increase dramatically over the next few decades.

That bad outlook will get even worse thanks to all the coronavirus-related spending from Washington.

This is bad news for America since more of the economy’s output will be consumed by government, leaving fewer resources for the private sector. And that problem would exist even if all the spending was magically offset by trillions of dollars of unexpected tax revenue.

Many people, however, think the nation’s future fiscal problem is that politicians will borrow to finance  that new spending. I think that’s a mistaken view, since it focuses on a symptom (red ink) rather than the underlying disease (excessive spending).

But regardless of one’s views on that issue, fiscal policy is on an unsustainable path. And that means there will soon be a fight between twho different ways of addressing the nation’s grim fiscal outlook.

  • Restrain the growth of government spending.
  • Divert more money from taxpayers to the IRS.

Fortunately, we now have some new evidence to help guide policy.

new study from the Mercatus Center, authored by Veronique de Rugy and Jack Salmon, examines what actually happens when politicians try to control debt with spending restraint or tax increases.

Here’s what the authors wanted to investigate.

Fiscal consolidation can take two forms: (1) adopting a debt-reduction package driven primarily by tax increases or (2) adopting a package mostly consisting of spending restraint. …What policymakers might not know is which of these two forms of consolidation tend to be more effective at reining in debt levels and which are less harmful to economic performance: tax-based (TB) fiscal consolidation or expenditure-based (EB) fiscal consolidation.

Here’s their methodology.

Our analysis focuses on large fiscal consolidations, or consolidations in which the fiscal deficit as a share of GDP improves by at least 1.5 percentage points over two years and does not decrease in either of those two years. …A successful consolidation is defined as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes places or by at least 3 percentage points two years after the adjustment. …Episodes in which the consolidation is at least 60 percent revenue increases are labeled TB, and episodes in which the consolidation is at least 60 percent spending decreases are labeled EB.

And here are their results.

…of the 45 EB episodes, more than half were successful, while of the 67 TB episodes, less than 4 in 10 were successful. …The results in table 2 show that while in unsuccessful adjustments most (74 percent) of the changes are on the revenue side, in successful adjustments most (60 percent) of the changes are on the expenditure side. In successful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by 1.50 percent. By contrast, in unsuccessful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by less than 0.35 percent. From these findings we conclude that successful fiscal adjustments are those that involve significant spending reductions with only modest increases in taxation. Unsuccessful fiscal adjustments, however, typically involve significant increases in taxation and very modest spending reductions.

Table 2 summarizes the findings.

As you can see, tax increases are the least effective way of dealing with the problem. Which makes sense when you realize that the nation’s fiscal problem is too much spending, not inadequate revenue.

In my not-so-humble opinion, I think the table I prepared back in 2014 is even more compelling.

Based on IMF data, it shows nations that imposed mutli-year spending restraint and how that fiscally prudent policy generated very good results – both in terms of reducing the spending burden and lowering red ink.

When I do debates at conferences with my left-wing friends, I almost always ask them to show me a similar table of countries that achieved good results with tax increases.

Needless to say, none of them have ever even attempted to prepare such a list.

That’s because nations that repeatedly raise taxes – as we’ve seen in Europe – wind up with more spending and more debt.

In other words, politicians pull a bait-and-switch. They claim more revenue is needed to reduce debt, but they use any additional money to buy votes.

Which is why advocates of good fiscal policy should adamantly oppose any and all tax increases.

Let’s close by looking at two more charts from the Mercatus study.

Here’s a look at how Irish politicians have mostly chose to restrain spending.

And here’s a look at how Greek politicians have mostly opted for tax increases.

It goes without saying (but I’ll say it anyhow) that the Greek approach has been very unsuccessful.

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Image credit: Martin Jacobsen | CC BY-SA 3.0.

Comparing Living Standards: The United States vs European Countries and other Developed Nations

Wed, 07/29/2020 - 12:35pm

My view of the U.S. economic policy often depends on whether I’m writing about absolute levels of laissez-faire or relative levels of laissez-faire.

If my column is about the former, I generally complain about excessive spendingpunitive taxationsenseless red tapeeasy-money monetary policy, and trade protectionism.

But if I’m writing about relative levels of economic liberty, I often turn into a jingoistic, pro-American flag-waver.

That because – with a few exceptions such as SingaporeHong KongNew Zealand, and Switzerland – the United States enjoys more economic freedom than other nations.

And because of the relationship between policy and prosperity, this means that Americans tend to have much higher living standards than their counterparts in other nations. Even when compared to people in other developed countries.

(Which is why it’s so disappointing that many American politicians want to make the U.S. more like Europe.)

Let’s examine some data. In a column for National Review, Joseph Sullivan compares recent increases in living standards for major nations.

If you want to answer questions about how economic wellbeing for individuals in a country has evolved, the actual change in the value of real GDP per capita may tell you more than the rate of its change. Why? Individuals buy goods and services with dollars and cents — not the rates of change that economists, politicians, and pundits tend to focus on when it comes to growth. …By this metric, between 2016 and 2019, economic growth in the U.S. was the best in its class. …The U.S. surpasses…its peers…by no small margin. It bests the silver medalist in this category, Finland, by $1,100. That is almost as big as the $1,160 that separates the runner-up from the peer country that comes in dead last, Sweden.

Here’s the chat from his article.

The key takeaway is that Americans started the period with more per-capita GDP and the U.S. lead expanded.

That’s one way of looking at the data.

2017 report from the Pew Research Center also has some fascinating numbers about the relative well-being of the middle class in different nations.

…the middle class in a country consists of adults living in households with disposable incomes ranging from two-thirds to double the country’s own median disposable household income (adjusted for household size). This definition allows middle-class incomes to vary across countries, because national incomes vary across countries. …That raises a question: What shares of adults in Western European countries have the same standard of living as the American middle class? …When the Western European countries the Center analyzed are viewed through the lens of middle-class incomes in the U.S., the share of adults who are middle class decreases in most of them. …In most Western European countries studied, applying the U.S. standard shrinks the middle-class share by about 10 percentage points… Applying U.S. incomes as the middle-class standard also boosts the estimated shares of adults who are in the lower-income tier in most Western European countries… Overall, regardless of how middle class fortunes are analyzed, the material standard of living in the U.S. is estimated to be better than in most Western European countries examined.

The main thing to understand is that there’s a big difference between being middle class in a rich country and being middle class in a not-so-rich country.

And if you peruse the chart from the Pew Report, you’ll notice that a lot of middle-class Europeans would be lower-income if they lived in the United States.

And if you looked at the issue from the other perspective, as I did last year, many poor Americans would be middle class if they lived in Europe.

Let’s augment that analysis by looking at a graphic the Economist put together several years ago. It’s based on the OECD’s Better-Life Index, which is a bit dodgy since it includes measures such as the Paris-based bureaucracy’s utterly dishonest definition of poverty.

That being said, notice that the bottom 10 percent of Americans would be middle class (or above!) if they lived in other nations.

I’ll close with the data on Actual Individual Consumption from the OECD, which are the numbers that (I believe) most accurately measure relative living standards between nations (indeed, I shared data from this source in 20102014, and 2017).

As you can see, the United States easily surpasses other industrialized nations, with a score of 145.9 in 2017 (compared to the average of 100).

My final observation is that all this data is contrary to traditional convergence theory, which assumes that poor nations should grow faster than rich nations.

In other words, Europe should be catching up to the United States.

Indeed, that actually happened for a couple of decades after World War II, but then many European nations expanded welfare states in the 1960s and 1970s, while the U.S. for more economic freedom under both Ronald Reagan and Bill Clinton in the 1980s and 1990s.

And since policies diverged, convergence stalled.

The bottom line is that rich nations can consistently out-perform poor nations if they have allow more economic freedom.

P.S. Not only do ordinary Americans have a big edge over their European counterparts, they also enjoy much lower taxes.

Canada’s Fiscal Policy Has Been Deteriorating Under Trudeau, Even Before Coronavirus

Tue, 07/28/2020 - 12:30pm

Back in 2011, CF&P released this video citing four nations – Canada, Ireland, Slovakia, and New Zealand – that achieved very good results with multi-year periods of genuine spending restraint.

Today, let’s focus on what’s been happening with government spending in Canada.

As explained in the video, America’s northern neighbor enjoyed a five-year period in the 1990s when government spending increased by an average of just 1 percent annually, with most of that progress occurring when the Liberal Party was in charge.

This fiscal probity – an example of my Golden Rule before I even invented the concept – paid big dividends.

The overall burden of government spending, measured as a share of economic output, declined substantially.

And because Canadian lawmakers dealt with the underlying problem of too much spending, that automatically solved the symptom of red ink.

That’s the good news.

The bad news is that Canada’s current prime minister, Justin Trudeau, has been spending a lot of money.

Jon Hartley, in an article for National Review, looks at his fiscal policy.

In June, Fitch downgraded Canada’s sovereign debt, revoking its prized AAA status. …Canadian finance minister Bill Morneau recently revealed that Canada’s projected 2020 deficit is now C$343 billion, a whopping 16 percent of GDP. …The Trudeau government now finds itself in a quandary over how to get to grips with its increased government spending. …This won’t be the first time that Canada has had to wrestle with its federal debt… Perhaps unsurprisingly, there has been speculation that the Trudeau government is now looking to institute a controversial federal housing-equity tax on primary residences… Canada now has high middle-class tax rates and, if federal and provincial taxes are combined, a top marginal tax rate of over 53 percent in the most populous province, Ontario. …Simply printing money to pay for Canadian sovereign debt is probably not on the cards either. …What’s lacking for now is any obvious policy path to return the country to economic normality and restore a semblance of control to the nation’s finances.

This is helpful analysis, especially when thinking about how Canada will try to climb back out of the fiscal hole caused by the coronavirus.

But I think it’s more revealing to see Trudeau’s track record before the virus.

So I went to the database for the IMF’s World Economic Outlook, which was released late last year before the disease wreaked havoc with government finances.

Here’s the data showing the spending burden has grown almost twice as fast under Trudeau (2016-2020) as it did in the previous five years (2011-2015).

Since Canada has a federal system, this data includes spending increases by sub-national governments. So it’s not clear how much Trudeau should be blamed compared to his predecessor.

But surely we can conclude that fiscal policy has deteriorated during his reign.

Also, the IMF data for the Trudeau years is preliminary. But since we want to see what was happening before the coronavirus, these numbers are actually the ones we want to use.

The bottom line is that Canada was moving in the wrong direction before the coronavirus and the spending burden has jumped dramatically since the disease hit.

This does not bode well for Canada’s long-run economic health.

P.S. Notwithstanding fiscal deterioration under Trudeau, Canada is still a surprisingly pro-market country, ranked #8 in the world. Moreover, it has some very sensible policies involving school choicewelfare reformcorporate tax reformbank bailoutsregulatory budgeting, the tax treatment of saving, and privatization of air traffic control.

P.P.S. Here’s my early assessment (from 2016) of Trudeau’s agenda, and here’s what I wrote last year about his misguided tax policy.

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Image credit: Renegade98 | CC BY-SA 2.0.

Donald Trump Is No Ronald Reagan

Mon, 07/27/2020 - 12:39pm

Way back in January of 2017, I predicted for a French TV audience that Donald Trump would be a big spender like George Bush instead of a small-government conservative like Ronald Reagan.

Sadly, I was right.

crunched the numbers earlier this year and showed that Trump has been a big spender, no matter how the data is sliced.

Perhaps most shocking, he’s even allowed domestic spending to increase faster than it did under Bill Clinton, Jimmy Carter, and Barack Obama.

That’s a terrible track record, especially compared to Reagan’s impressive performance (by the way, these calculations were made before all the coronavirus-related spending, so updated numbers would make Trump look even worse by comparison).

Anyhow, I’m looking at this issue today because of a recent story in the Washington Post.

The Reagan Foundation just told the Trump people to stop using the Gipper’s likeness in their fundraising appeals.

The Ronald Reagan Presidential Foundation and Institute, which runs the 40th president’s library near Los Angeles, has demanded that President Trump and the Republican National Committee (RNC) quit raising campaign money by using Ronald Reagan’s name and likeness. …What came to the foundation’s attention — and compelled officials there to complain — was a fundraising email that went out July 19… The solicitation offered, for a donation of $45 or more, a “limited edition” commemorative set featuring two gold-colored coins, one with an image of Reagan and one with an image of Trump. …Proceeds from the coin sales went to the Trump Make America Great Again Committee, a joint fundraising operation that benefits both the Trump campaign and the RNC. …In the 1990s, both Reagan and his wife Nancy signed legal documents that granted the foundation sole rights to their names, likenesses and images. …the RNC accepted the foundation’s demand regarding the fundraising emails.

It’s unclear why the Reagan Foundation made the request.

For what it’s worth, I hope officials were motivated at least in part by disappointment with Trump’s anti-conservative record on government spending (and also on trade).

Simply stated, Trump is no Reagan.

While I’m a big fan of the Gipper, I don’t pretend he had a perfect track record. But I think it’s correct to say that his goal was to advance liberty by shrinking government, even if there were occasional detours.

For instance, Holman Jenkins noted in his Wall Street Journal column that Reagan always had the right long-run goals even when he made short-run comprises on trade that were unfortunate.

Reagan slapped import quotas on cars, motorcycles, forklifts, memory chips, color TVs, machine tools, textiles, steel, Canadian lumber and mushrooms. There was no market meltdown. Donald Trump hit foreign steel and aluminum, and the Dow Jones Industrial Average fell more than 600 points… The real difference is that Reagan’s protectionist devices were negotiated. They were acts of cartel creation… This was unattractive but it wasn’t a disaster, and Reagan’s protectionism quickly fell away when a global upswing began. …Mr. Trump wants a spectacle with himself at the center. …His confused and misguided ideas about trade are one of his few long and deeply held policy commitments.

And if you need more evidence, look at what Reagan said about trade herehere, and here.

Can you imagine Trump giving such remarks? Or even understanding the underlying principles?

There are also important differences in the populism of Trump and Reagan, as explained by Jonah Goldberg of the American Enterprise Institute.

…there are different kinds of conservative populism. Until recently, right-wing populism manifested itself in the various forms of the tea party, which emphasized limited government and fiscal restraint. That populism…is very different from Trump’s version. …Reagan’s themes and rhetoric were decidedly un-Trumpian. The conservative populist who delivered “A Time for Choosing” used broadly inclusive language, focusing his ire at a centralized government that reduced a nation of aspiring individuals to “the masses.” …Reagan’s populist rhetoric was informed by a moderate, big-hearted temperament, a faith in American exceptionalism… He warned of concentrated power that corrodes self-government.

I’ll close with the observation that Trump has enacted some good policies, especially with regard to taxes and red tape.

The bottom line is that I’m not trying to convince anyone to vote for Trump or to vote against Trump.

Instead, I simply want people to be consistent and principled advocates of economic liberty instead of blind partisans.

As explained in my Ninth Theorem of Government.

In other words, I don’t care if you’re an enthusiastic supporter of Trump. Just don’t let that support lead you to somehow rationalize that wasteful spending and protectionism are somehow good ideas.

And I don’t care if you’re an enthusiastic never-Trumper. Just don’t let that hostility lead you to somehow decide that tax cuts and deregulation are bad ideas.

P.S. In my speeches over the past few years, I’ve run into many people who tell me that Trump must be good because the media hates him the same way they hated Reagan. It’s certainly true that the establishment press has visceral disdain for both of them. I’ll simply point out that media hostility is a necessary but not sufficient condition for determining whether a Republican believes in smaller government.

Democratic Socialism Doesn’t Work Any Better than Totalitarian Socialism

Sun, 07/26/2020 - 12:27pm

When I write about socialism, I often point out that there’s a difference between how economists define it (government ownershipcentral planning, and price controls) and how normal people define it (lots of taxes, redistribution, and intervention).

These definitions are blurry, of course, which is why I created a “socialism slide” to show how countries oftentimes are an odd mix of markets and government.

But one thing that isn’t blurry is the evidence on what works. Simply stated, there is less prosperity in nations with big government compared to nations with small government.

And it doesn’t matter whether socialism is the result of democracy or tyranny.

Kristian Niemietz is with the Institute of Economic Affairs in London. He explained for CapX that mixing democracy with socialism doesn’t fix anything.

Mention the economic failures of the former Eastern Bloc countries, or Maoist China, or North Vietnam, or today, of Cuba or Venezuela or North Korea, and the answer will invariably be: “But that was a dictatorship! That’s got nothing to do with me, I’m a democratic socialist!” …“[S]ocialism means ‘economic democracy’… But the…economic failures of socialism never had anything to do with a lack of democracy. Democratisation improves many things, and is desirable for many reasons. But it does not, in and of itself, make countries richer. …The empirical literature on this subject finds no relationship either way between economic development, and the system of government. …If socialists want to make the case that democracy was the magic missing ingredient… How exactly would democracy have closed the economic gap between East and West Germany, or North and South Korea, or Cuba and Puerto Rico, or Maoist China and Taiwan, or the People’s Republic of Angola and Botswana, or Venezuela and Chile?

Meanwhile, Kevin Williamson pointed out in National Review that post-war socialism in the United Kingdom failed for the same reason that socialism fails anywhere and everywhere it is tried.

History counsels us to consider the first adjective in “democratic socialist” with some skepticism. …the socialism that reduced the United Kingdom from world power to intermittently pre-industrial backwater in the post-war era was thoroughly democratic. …In the United States, we use the word “democratic” as though it were a synonym for “decent” or “accountable,” but 51 percent of the people can wreck a country just as easily and as thoroughly as 10 percent of them. …The problems of socialism are problems of socialism — problems related to the absence of markets, innovation, and free enterprise… Socialism and authoritarianism often go hand in hand (almost always, in fact), but socialism on its own, even when it is the result of democratic elections and genuinely democratic processes, is a bottomless well of misery. …rights — property rights and the right to trade prominent among them — also find themselves on the wrong side of majorities, constantly and predictably. But they are…necessary for a thriving and prosperous society. Socialism destroys societies by gutting or diminishing those rights. Doing so with the blessing of 50 percent plus one of the population does not make that any less immoral or any less corrosive.

Thankfully, Margaret Thatcher saved the United Kingdom from socialism.

But other nations haven’t been so lucky. Democratically elected governments adopted socialism in Greece and Argentina, but neither country found a savior to restore economic liberty (or maybe voters didn’t want to reverse the failed policies).

What about the United States? Will we vote ourselves into socialism?

Given the wretched track records of WilsonHooverFDRNixonObama, etc, I’m tempted to say that we’ve been doing that for more than 100 years.

But I don’t want to be unduly pessimistic. America hasn’t slid too far down the socialism slide. Indeed, we’re actually ranked #6 in the world for economic liberty.

That’s the good news. The bad news is that there are lots of proposals for additional bad policy and plenty of politicians clamoring to move in the wrong direction.

To see what that might mean, I’ll close with some polling data that the Washington Examiner shared earlier this year. Here are things that might happen if socialists (however defined) get power in the United States.

And here are things that the American people say would qualify as socialism.

Ugh, that’s a recipe for the Venezuela-fication of the U.S. economy.

P.S. For what it’s worth, notwithstanding his statist platform, I think Joe Biden only intends to incrementally go down the slide (whereas Bernie Sanders would have greased the slide for a rapid descent).

Minneapolis vs. Capitalism

Sat, 07/25/2020 - 12:18pm

recently speculated whether Seattle should be considered the worst-governed city in the country.

Though there’s lots of competition for that honor from places like San FranciscoDetroitNew York City, and Chicago. And John Stossel makes a compelling case for Minneapolis in this new video.

As I’ve previously noted, statist policies are never a good idea, but they’re especially foolish when adopted by local or state governments.

Why? Because it’s relatively easy for productive people to escape bad policy by moving across borders.

And that happensA lot.

Yet the folks in Minnesota – at least if the anti-capitalism comments in the video are any indication – must not care whether the geese with the golden eggs fly away.

To learn more, let’s take a look at the Washington Post story referenced in the Stossel video.

Authored by Tracy Jan, it looks at all the big-government policies imposed by local and state government.

The Twin Cities…and…progressive policies… Taxes, for decades, have been redistributed from wealthy suburbs to poorer communities to combat inequality — an effort bolstered in recent years by raising state income taxes on the rich. The result: more money for schools, affordable housing and social services in lower-income neighborhoods. …Minnesota’s progressive reputation was cemented nearly five decades ago… Gov. Wendell Anderson…worked with the Republican-controlled legislature to pass…a redistributive tax policy introduced in 1971 that required wealthy communities in the Twin Cities region to share their commercial property tax revenue with the poorest areas. Income and sales tax revenue from rich suburbs across the state also was shared with less-affluent cities and rural communities to fund schools, police and housing. …It would be the beginning of a suite of policies that over subsequent decades increased investments in housing, schools and small businesses in disadvantaged communities. …more state aid poured into poor communities in 2013, when then-Gov. Mark Dayton raised taxes on the wealthiest Minnesotans. The Democrat…campaigned to “Tax the Rich!” — saying everyone should pay their “fair share” to keep society “functional.” The income tax rate, already fairly high for top income earners compared with other states, increased from 7.85 percent to 9.85 percent for individuals making more than $150,000.

I fully agree with Stossel that the story’s headline is hopelessly biased, though that’s usually the fault of editors rather than reporters.

But let’s set that aside and focus on the details in the report.

What conclusions are warranted? The reporter can’t resist making a silly assertion that growth isn’t part of the solution (she’s obviously not familiar with Census Bureau data).

Those enduring disparities…highlight the flawed premise…that economic prosperity is a remedy for racial inequality.

Though she does acknowledge that the mess in Minneapolis poses a challenge for the left’s argument that big government is the answer.

…progressive policies ha[ve] not translated into economic equality. Instead, the wealth gap between Minneapolis’s largely white population and the city’s black residents has deepened, producing some of the nation’s widest racial disparities in income, employment and homeownership. …The shortcomings have given rise to an urgent debate about where Minneapolis went wrong and what measures would bring better results. …The typical black family in the Twin Cities earned $39,851 in 2017, lower than the median income for African Americans nationally… A quarter of black households lived in poverty, five times the poverty rate for white households. …the outcome for black residents in Minneapolis and St. Paul…undercuts the liberal argument that spending on progressive policies can create systemic change. …Black residents…are worse off today by some measures than they were 20 and 30 years ago, even as the fortunes of their white counterparts held steady or improved, according to census data. …Despite a slew of programs to help first-time home buyers, only a quarter of black residents in the Twin Cities own their homes…much lower than the national black homeownership rate of 42 percent.

I’ll make four points in response to this story.

First, there is no substitute for growth, and – as Stossel observed in the video, but as Ms. Tan doesn’t seem to appreciate – we shouldn’t care if some groups get rich faster than other groups.

Second, stronger growth not only explains why average living standards in the United States are higher than in other nations, but also why the average low-income person in America does better than the average middle class person in many other countries.

Third, the only effective and successful way to achieve long-run growth is with free markets and small government, but Minnesota doesn’t fare well in rankings of economic liberty (see herehere, and here) and Minneapolis scores poorly when cities are ranked.

Fourth, the redistribution programs from both local and state governments doubtlessly have trapped many poor residents in dependency, especially since there are high implicit marginal tax rates if they seek self-sufficiency and financial independence.

The bottom line is that Minneapolis has poor governance, as does the entire state of Minnesota, but the politicians will have to try harder to achieve worst-in-nation status.

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Image credit: Doug Kerr | CC BY-SA 2.0.

OECD Data: Higher Tax Rates Don’t Necessarily Mean Higher Tax Revenue

Fri, 07/24/2020 - 12:55pm

I participated in a debate yesterday on “tax havens” for the BBC World Service. If you read last month’s two-part series on the topic (here and here), you already know I’m a big defender of low-tax jurisdictions.

But it’s always interesting to interact with people with a different perspective (in this case, former Obama appointee David Carden and U.K. Professor Rita de la Feria).

As you might imagine, critics generally argue that tax havens should be eliminated so politicians have greater leeway to increase tax rates and finance bigger government. And if you listen to the entire interview, that’s an even bigger part of their argument now that there’s lots of coronavirus-related spending.

But for purposes of today’s column, I want to focus on what I said beginning at 49:10 of the interview.

I opined that it’s reasonable to issue debt to finance a temporary emergency and then gradually reduce the debt burden afterwards (similar to what happened during and after World War II, as well as during other points in history).

The most important part of my answer, however, was the discussion about how revenues didn’t decline when tax rates were slashed beginning in 1980.

Let’s first take a look at what happened to top tax rates for 24 industrialized nations from North America, Western Europe, and the Pacific Rim. As you can see, there’s been a big reduction in tax rates since 1980.

In the interview, I mentioned OECD data about taxes on income and profits, which can be found here (specifically data series 1000). So let’s see what happened to revenues during the period of falling tax rates.

Lo and behold, it turns out that revenue went up. Not just nominal revenues. Not just inflation-adjusted revenues. Tax revenues even increased as a share of gross domestic product.

In part, this is the Laffer Curve in action. Lower tax rates meant better incentives to engage in productive behavior. That meant higher levels of taxable income (the variable that should matter most).

For what it’s worth, I suspect that the lower tax rates – by themselves – did not cause tax revenue to rise. After all, there are many policies that determine the overall vitality of an economy.

But there’s no question that there’s a lot of “revenue feedback” when tax rates are changed.

The bottom line is that the folks advocating higher tax rates shouldn’t expect a windfall of tax revenue if they succeed in imposing class-warfare tax policy.

P.S. For the folks on the left who are motivated by spite rather than greed, it doesn’t matter if higher tax rates generate more money.

P.P.S. Interestingly, both the IMF and OECD have admitted, at least by inference, that lower corporate tax rates don’t result in lower tax revenues.

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Image credit: geralt | Pixabay License.

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