Wednesday, January 21, 2009

Tax Policy

It has been a while..but I am back. Read and learn. I'll be more attentive hereafter, or at least until I run out of wisdom to share.

The debate on taxes between liberals and conservatives is insane. Lowering taxes serves everyone's objectives. The government realizes more revenue, and individuals keep more of what they make. Lower taxes create more incentive for investors, thus more economic activity, and it keeps capital in private hands versus under inefficient government control. Consequently more wealth is generated. Why are we arguing?

Over the last 50 years the jury (history) watched and heard both sides of the tax debate. They returned a unanimous verdict. Cuts help everyone. John Kennedy, Ronald Reagan and George W Bush lowered taxes and the economy skyrocketed every time. Herbert Hoover and FDR raised taxes and we had a depression. People say Bill Clinton raised taxes and the economy was great. That's true. But the marginal rate increases were modest, whereas his capital gains tax cut was substantial. Also the tech boom and his passage of NAFTA helped a lot.

There is a concern on the left that tax reduction dis-proportionately helps the wealthy, and it does. We can all agree that wealth creation in a capitalist system is top heavy. But capitalism still creates the greatest amount of wealth in every individual quintile of the income scale. If you are in the bottom 20% of earners, would you rather your income stagnate but remain proportional to someone in the top quintile, or would you rather earn more yourself and have the top earners gain disproportionally? I would care less about what was happening at the top so long as I was moving forward.

20 years ago Ireland's economy was one of the worst in Europe. They passed a law allowing artists to settle there and pay no taxes. Needless to say many people extended the meaning of artist (isn't a plumber creative?), and all of a sudden immigrants were coming from throughout Europe. The Parliament noticed that the economy was growing in a way they had never seen before, so they passed a general tax cut. Voila! There was more economic activity, more jobs, more net personal income, and more tax revenue. Since then they cut taxes 13 times. 13 times the economy grew, and 13 times the government realized more tax revenue. Ireland has gone from one of the worst economies in the EU to the second best, behind Luxembourg. Before the reductions they had 50,000 people a year leaving the country looking for work. Today they have 200,000 coming into the country looking for work.

Over the last 50 years Hong Kong has been the fastest growing of all western economies. They also have the lowest tax rate. In fact it even "favors the rich," in that it is a 16 percent flat tax. Still, the lowest rate among western economies not only produces the highest growth rate among them, but also produces the highest tax revenue per capita.

In about 1970 Communists won elections in Chile and nationalized industries and of course raised taxes. Needless to say the economy ground to a halt, there was high inflation, and despair ruled the country. Colonel Augusto Pinochet (head of the army) took control of the government, and his advisers (a group of free market economists from University of Chicago known as The Chicago Boys) had him privatize industry and lower taxes and regulations. There were huge job losses and more economic contraction at first, but within a couple of years the economy began to grow, and like Ireland, Chile became the economic miracle of their continent.

In 1945 Argentina had a standard of living higher than France. In the succeeding years the communists/ socialists took over, raised taxed and did all the things socialists do (including severely curbing personal freedoms). As a result the country went from vibrant growth to a stagnant second rate economy. Even France, with all its oppressive taxes, has grown faster and larger than Argentina.

The Heritage Foundation (a conservative think tank) and the Wall Street Journal compile statistics annually called the Economic Freedom Index. They quantify with a point value each area they think is important to the growth of an economy. The total point score gives an overall rating to each country gauging their economic freedom and growth potential. Taxes are the most important, but things like regulation, the judicial system, respect for private property, infrastructure etc are included. If you graph the ratings of each country, and placed it next to a graph of each countries economic growth, or per capita income, or living standard, or government revenue, or most anything we hope to get from our economy, you will see a mirror image. The higher the rating in the Economic Freedom Index, the higher the economic growth rate and overall prosperity.

Government is the problem, not the solution. Obviously we need government. We need a protector and an enforcer (police and armed forces). We also need a referee (settle disputes, insure transparency etc.). But mostly we need government to stay out of the way. Ironically, one might think lower taxes would starve the beast (government), but counter intuitively, lowering taxes actually produces more money. Eventually we will reach a point where the rate goes so low that revenue does begin to decline. Then we can argue. But please, not now..


Drew said...

This fits your comments rather well, especially when discussing the Chicago Boys... A little more Friedman would do us quite well these days... "I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible. The reason I am is because I believe the big problem is not taxes, the big problem is spending. The question is, "How do you hold down government spending?" Government spending now amounts to close to 40% of national income not counting indirect spending through regulation and the like. If you include that, you get up to roughly half. The real danger we face is that number will creep up and up and up. The only effective way I think to hold it down, is to hold down the amount of income the government has. The way to do that is to cut taxes.
o Interview by John Hawkins (16 September 2003)

Drew said...

Thought I would add this rant of mine as well...

As "we" bail out ourselves from ourselves with trillions in tax dollars, by way of the old tax and spend free ride, we do so at our own peril IMHO.

The revelation I have recently had is that where previously we would have seen these types of projects (Infrastructure funding) in the form of juicy pork filling the coffers of a piece of legislation, we now see this absolute waste of dollars turned into the form of an economic recovery plan which is rubber stamped by both sides of the aisle.

It is fascinating that the "Grande Plan" to stimulate and jolt the economy (from the incredible minds of the Obama administration) is to replace upper level jobs from the rags of companies such as Citi and Lehman with bridge building and road construction projects.

I personally do not know many recently laid off mortgage brokers and financial gurus lining the streets of Washington with their hands out begging to begin shoveling dirt to repair a bridge.

Where is the reinvestment into and recycling of the greatest resource in America, our intellectual capital through capitalism?

Why are we so quick to create a society in which Big Brother is the only major employer, because if you believe what Friedman said, and I do, then government will continue to increase at an unsustainable rate or at least a rate that I believe all conservatives and truly all people find despicable.

While some will make a fortune, and presumably already have, by using the government to line their pockets for the so-called "greater good", we will likely see ourselves fleeced to the point that we wake up one day in a place far different from the one whence we came.

I find it incredibly disturbing, not that a few inefficient car companies could go out of business, or that financial companies unwilling to admit to themselves the substantial risk they were involved in was ludicrous and unnecessary, because the is part of a free market system. What I find disturbing is how quick we are at ANY economic crisis, large or small, to say, "Please government, please help me..."

It (the free market)is not a happy go lucky warm and fuzzy place. The free market is though, the great equalizer because of it's uncanny ability to rid itself of those entities that are truly inefficient or the ones that don't function optimally.

While instead of facing a sharp downturn in the economy that in turn moves quickly back up and forward, our government bailout and increased intervention on all fronts will greatly slow any true, efficient LONG TERM recovery and growth and most likely lead us into a far worse off direction.

I am hoping that we can move in a better direction but it does appear that no matter where we end up, we will have arrived their on some really smooth roads.

Anonymous said...

Maybe Obama should sit around and play cards all day judging the gov and dreaming of ann