Topic: International Economics and Development

Flat Tax in Romania

Romania’s flat tax is generating results that would make French politicians delirious with joy — huge increases in tax revenue. Income tax collections jumped 44.7 percent in 2005, the year the flat tax was introduced. (Sadly, the increased revenue isn’t keeping pace with Romanian government spending; as the country works to meet the various conditions for EU membership, its budget deficit is growing, which has led to complaints from Brussels.)

Rather than learn from this “Laffer Curve” example, the high-tax nations that dominate the EU are complaining about Romania’s “harmful tax competition.” A Hungarian news service reports:

Romania increased spending on roads, railways, pensions and other areas last year, mainly in December, to bring standards closer to those in the EU, which it joined on January 1.

…The Finance Ministry said today the government boosted revenue to 31.8% of GDP last year from 30.3% the previous year, helping meet a key EU recommendation. EU Monetary Affairs Commissioner Joaquin Almunia said last year that budget revenue as a proportion of GDP was lower than in any EU nation and recommended the country increase it. Economic growth, which the government has estimated at about 8% last year from 4.1% in 2005, also stimulated revenue collection, the finance ministry said.

…Romanian government spending increased 25% last year in nominal terms and accounted for 33.5% of GDP, from 31.2% in 2005, the ministry said. Income tax collection rose 44.7% to 9.8 billion lei ($3.8 billion). Romania has said income tax revenue has consistently increased since January 1, 2005, when it introduced a flat tax of 16% on corporate and personal income, the lowest in eastern Europe. It replaced a corporate tax rate of 25% and a personal income tax rate of as high as 40%.

Rule-of-law and U.S. Competitiveness

Policies such as Sarbanes-Oxley are reducing America’s competitiveness, but an equally worrisome problem is the erosion of the rule-of-law.

Stability and equal treatment are among the characteristics of an advanced legal system. Unfortunately, America’s legal system is now riddled with uncertainty, since investors and companies have no way of predicting outcomes.

The New York Sun has a column noting how America’s justice system is now an obstacle rather than an inducement to international investment:

[T]he American share of global initial public offerings declined to 5% from 50% in the last five years. Foreign companies are being scared away in part, both reports conclude, by soaring costs of American law.

The highwater mark for securities lawsuits was reached in 2005, with over $9 billion in class action settlements. The zeal of American prosecutors in corporate scandals is also of a different order of magnitude. In 2004, government fines in America totalled $4.74 billion, over 100 times more than in Britain, which had a total of $40.48 million. Sarbanes-Oxley, the federal law that imposes higher accountability standards on corporate boards, has almost tripled auditing costs for small public companies.

Perhaps the most chilling parts of the Bloomberg-Schumer report are the surveys of foreign business leaders who suggest, overwhelmingly, that they no longer trust American law. For most of the last century, trust in American commercial and securities law was one of our greatest competitive advantages. Investors flocked to our markets because securities laws guaranteed transparency and honesty. American contract law was the gold standard for world business, in part because of a long tradition of judges rigidly applying guidelines of liability and damages.

Economist Douglass North received a Nobel prize in part for his work on the vital role of legal stability in economic prosperity. An “essential element of the concept of justice,” legal philosopher H.L.A. Hart observed, “is the principle of treating like cases alike.” That’s why law is the foundation of freedom — people know where they stand. They can act freely instead of looking over their shoulders all day long.

But that trust has now capsized. Companies are afraid that if a few employees out of thousands do something wrong — even if not material to the bottom line — the company faces the prospect of ruin. An indictment, not a conviction, could put a company out of business. Why roll the legal dice in America when legal systems in Britain and elsewhere focus on punishing the individual wrongdoer, not shooting everyone in sight?

It’s impossible to measure how much distrust of law has contributed to declining competitiveness. But the evidence is all around us. Just talk with foreign business leaders.

The main victims of this trend, however, are employees and their pension plans. Drying up of markets means that countless people lose job opportunities and that innovation moves offshore. Trust, once lost, is hard to regain.

Tort reforms limiting damages don’t get close to the heart of the problem. American justice has a deeper flaw — it no longer reliably distinguishes right from wrong. Instead, decisions are made on an ad hoc basis, jury by jury, without predictable boundaries.

Hong Kong to Lower Flat Tax?

Thanks to strong growth, which is in part due to a tax system that minimizes the burden on productive activity, Hong Kong leaders are considering reducing the flat tax to just 15 percent.

Tax-news.com reports:

Donald Tsang has pledged to cut Hong Kong’s individual and corporate income taxes if re-elected as the Special Administrative Region’s Chief Executive next month. Tsang officially announced that he would seek election to a second term of office last week and said that one of his key policies would be to return some of Hong Kong’s fiscal surplus back to the population through a “gradual” reduction in salary and profit taxes to 15%.

Dutch Tax Haven Pressures Greedy Governments

The New York Times has a thorough article today detailing how both individuals and companies are using the Netherlands as a haven for productive activity.

This is good news for all taxpayers. The rich directly benefit, since greedy politicians are unable to seize as much of their money. And the rest of us benefit, since this puts downward pressure on tax rates as governments try to keep the geese that lay the golden eggs from flying away.

[L]ast August, according to details disclosed in documents maintained by the Handelsregister, the trade registry of the Netherlands, Promogroup helped the three [Rolling Stones] performers set up a pair of private Dutch foundations that will allow them to transfer assets tax-free to heirs when they die. Other Dutch shelters that Promogroup has arranged for the three have already paid off handsomely; over the last 20 years, according to Dutch documents, the three musicians have paid just $7.2 million in taxes on earnings of $450 million that they have channeled through Amsterdam — a tax rate of about 1.5 percent, well below the British rate of 40 percent.

The rock powerhouse U2 has transferred lucrative assets to Amsterdam, as have other pop singers and well-known athletes….

While old-school, offshore tax havens — the warm ones with tropical fish, off-the-shelf holding companies sporting post-office-box addresses, and scant regulation or transparency — still attract money, they are largely patronized, tax lawyers and entertainment bankers say, by hedge funds and private equity firms looking to protect lush trading profits from taxes. But for earnings derived from intellectual property such as royalties, the Netherlands has become a tax shelter of choice.

Many of the world’s multinational corporations, like Coca-Cola, Nike, Ikea, and Gucci, have set up holding companies here in recent years to take advantage of tax shelters nearly identical to the ones that the Rolling Stones and U2 use.

The Netherlands is home to almost 20,000 “mailbox companies,” Dutch shorthand for corporate shells set up by foreign companies and wealthy foreigners who use them to relieve taxes on royalties, dividends and interest payments….

Globally, some 1,165 companies use Dutch tax shelters to reduce or eliminate taxes on royalties and patents.

Not surprsingly, international bureaucracies and left wing groups despise tax havens — precisely because tax competition makes it more difficult to increase the size of government. The story in the Times elaborates, including completely unsubstantiated accusations that low taxes somehow facilitate dirty money:

Some experts see a darker side to the emergence of the Netherlands as a sought-after tax shelter. In 2000, the Organization for Economic Cooperation and Development, based in Paris, black-marked the country as one of the world’s top five industrialized tax havens for promoting “treaty shopping” for low-tax jurisdictions.

…In its report last fall, SOMO, the research group, said…that “tax haven features of the Netherlands also facilitate money laundering and attract companies with a dubious reputation.”

Endorsing the U.S. Trade Complaint Against China

On Friday, the U.S. Trade Representative initiated a formal challenge of various Chinese tax programs within the dispute settlement system of the World Trade Organization. It was only the third formal challenge of Chinese policies since that country joined the WTO in 2001.

Specifically, the United States alleges that Chinese tax policies that encourage production for exportation and that discourage the use of imported materials and components in the production process constitute subsidies that harm U.S. interests and violate the obligations China undertook when it joined the WTO in 2001.

I have been critical of the administration’s various trade policy errors of commission and omission over the years. Last week I lamented U.S. trade representative Susan Schwab’s failure to articulate the broad case for trade.  Today, I have only kudos for the USTR. Not only was the United States well within its rights to bring this case, it was the right thing to do, politically and economically. 

Free trade purists might disagree, arguing that if China wants to subsidize its exports to the United States, Americans should write the Chinese thank you letters for financially supporting our consumption. And accordingly, we shouldn’t intervene if the Chinese want to squander their resources that way. I think that argument holds water up to a point — a point that we are well beyond and where the costs of the status quo outweigh its benefits. 

Yes, we benefit as consumers from subsidized Chinese production, but only until the consensus for a liberal trading order collapses. At that point, retrograde protectionism threatens not only the benefits of that subsidized consumption, but the benefits of trade more generally, and the conditions that make relatively freer trade possible. Furthermore, the U.S. trade relationship with China is wealth-creating in both countries without need of subsidization. Safeguarding continuation of the flow of the benefits of trade to both countries by expecting China (and the United States) to play by the established rules seems a reasonable compromise to me.

The rules-based trading system has been remarkably successful at promoting trade and investment, and its continued success depends upon adherence to its rules and respect for its institutions — particularly by the world’s large economies.

China has demonstrated that it doesn’t respond well to bilateral threats — if for no other reason than its desire to avoid the appearance of being bullied. China knows what its obligations are. But it also knows that one of the many benefits of its membership in the WTO is that its policies are above board unless and until the dispute settlement body of the WTO finds against them. If China wants to drag its feet with respect to compliance and reform, bringing cases against China within the WTO might become fashionable.  

We are already witnessing a deterioration of support for trade and its institutions in the United States precisely because of perceptions that policymakers are doing too little to enforce the existing rules. I don’t advocate knee-jerk invocation of our rights to dispute settlement — there is plenty of room for deliberation and consultation (which is perpetually in play under the radar). 

To the extent that Friday’s actions serve as a release valve for some of the political pressure that has been building in Congress for unilateral actions against China, it is already a success. By bringing the case through formal WTO channels, Congress will see that there are, in fact, alternatives to dangerous, unilateral sanctions. In that sense, this case could reduce the likelihood that Congress intervenes and mucks everything up and it could actually improve long-term prospects for the U.S.-China trade relationship.

EU vs. Gas-guzzlers

The commissioners of the European Union endlessly preach about the need for carbon taxes and costly regulations that will reduce the quality of life for regular people. But those same commissioners get driven around in low-mileage vehicles. Fortunately, they are getting attacked for this hypocritical attitude.

Sadly, the embarrassment will have little impact. American politicians — including President Bush — want to force Americans into smaller (and more dangerous) cars, yet periodic efforts to require them to live by the same rules have proved fruitless.

The EU Observer reports on the controversy in Brussels: 

EU commissioners are finding themselves under scrutiny to see if they are putting into practice the green values that Brussels is increasingly preaching, with most of the 120-strong fleet of officials cars comprising gas-guzzling, C02-emitting giants.

…[T]he vast majority of the 27 commissioners use the standard-issue vehicles such as Audis or Mercedes — high on security features but rather lower on environment friendliness — to be ferried here and there across Brussels; sometimes even the few hundred metres between commission buildings.

…A commission spokesperson said, “It’s an individual decision for commissioners what their service car should be but as a general rule, the commissioners choose cars that are functional and safe for what they are doing.”

A French Global Warming Tax Against the U.S.?

Al Gore has a new ally in his fight for new taxes and regulations to limit carbon emissions. The New York Times reports that, for all intents and purposes, Jacques Chirac is blackmailing the United States: 

President Jacques Chirac has demanded that the United States sign both the Kyoto climate protocol and a future agreement that will take effect when the Kyoto accord runs out in 2012.

He warned that if the United States did not sign the agreements, a carbon tax across Europe on imports from nations that have not signed the Kyoto treaty could be imposed to try to force compliance.

Trade lawyers have been divided over the legality of a carbon tax, with some saying it would run counter to international trade rules. But Mr. Chirac said other European countries would back it. “I believe we will have all of the European Union,” he said.