Topic: International Economics and Development

A Grim Update on European Tax Policy

I wrote the other day that Americans, regardless of all the bad policy we get from Washington, should be thankful we’re not stuck in an economic graveyard like Venezuela.

But we also should be happy we’re not Europeans. This is a point I’ve made before, usually accompanied by data showing that Americans have significantly higher living standards than their cousins on the other side of the Atlantic.

It’s now time to re-emphasize that message. The European Commission has issued its annual report on “Taxation Trends” and it is–at least for wonks and others who care about fiscal policy–a fascinating and compelling document.

If you believe in limited government, you’ll read the report in the same way you might look at a deadly traffic accident, filled with morbid curiosity and fear that you may eventually suffer the same fate.

But if you’re a statist, you’ll read the report like a 14-year old boy with his first copy of a girlie magazine, filled with fantasies about eventually getting to experience what your eyes are seeing.

Let’s start by giving the bureaucrats some credit for self-awareness. They openly admit that the tax burden is very onerous in the European Union.

The EU remains a high tax area. In 2012, the overall tax ratio, i.e. the sum of taxes and compulsory actual social contributions in the 28 Member States (EU-28) amounted to 39.4 % in the GDP-weighted average, nearly 15 percentage points of GDP over the level recorded for the USA and around 10 percentage points above the level recorded by Japan. The tax level in the EU is high not only compared to those two countries but also compared to other advanced economies; among the major non-European OECD members for which recent detailed tax data is available, Russia (35.6 % of GDP in 2011) and New Zealand (31.8 % of GDP in 2011) have tax ratios exceeding 30 % of GDP, while tax-to-GDP ratios for Canada, Australia and South Korea (2011 data) remained well below 30 %.

The Miracle of Modern-Day Prosperity…and the Ideas and Policies that Made it Happen

Why are some nations rich and other nations poor? What has enabled some nations to escape poverty while others continue to languish?

And if we want to help poor nations prosper, what’s the right recipe?

Since I’m a public finance economist, I’m tempted to say a flat tax and small government are an elixir for prosperity, but those policies are just one piece of a bigger puzzle.

A country also needs sensible monetary policy, open trade, modest regulation, and rule of law. In other words, you need small government AND free markets.

But even that doesn’t really tell us what causes growth.

In the past, I’ve highlighted the importance of capital formation and shared a remarkable chart showing how workers earn more when the capital stock is larger (which is why we should avoid punitive double taxation of income that is saved and invested).

But that also doesn’t really answer the question. After all, if a larger capital stock was all that mattered, doesn’t that imply that we could get prosperity if government simply mandated more saving and investing?

There’s something else that’s necessary. Something perhaps intangible, but critically important.

More Companies Escaping America’s Masochistic Corporate Tax System

Last August, I shared a list of companies that “re-domiciled” in other nations so they could escape America’s punitive “worldwide” tax system.

This past April, I augmented that list with some commentary about whether Walgreen’s might become a Swiss-based company.

And in May, I pontificated about Pfizer’s effort to re-domicile in the United Kingdom.

Well, to paraphrase what Ronald Reagan said to Jimmy Carter in the 1980 presidential debate, here we go again.

Here’s the opening few sentences from a report in the Wall Street Journal.

Medtronic Inc.’s agreement on Sunday to buy rival medical-device maker Covidien COV PLC for $42.9 billion is the latest in a wave of recent moves designed—at least in part—to sidestep U.S. corporate taxes. Covidien’s U.S. headquarters are in Mansfield, Mass., where many of its executives are based. But officially it is domiciled in Ireland, which is known for having a relatively low tax rate: The main corporate rate in Ireland is 12.5%. In the U.S., home to Medtronic, the 35% tax rate is among the world’s highest. Such so-called “tax inversion” deals have become increasingly popular, especially among health-care companies, many of which have ample cash abroad that would be taxed should they bring it back to the U.S.

It’s not just Medtronic. Here are some passages from a story by Tax Analysts.

Teva Pharmaceuticals Inc. agreed to buy U.S. pharmaceutical company Labrys Biologics Inc. Teva, an Israeli-headquartered company, had an effective tax rate of 4 percent in 2013. In yet another pharma deal, Swiss company Roche has agreed to acquire U.S. company Genia Technologies Inc. Corporations are also taking other steps to shift valuable assets and businesses out of the U.S. On Tuesday the U.K. company Vodafone announced plans to move its center for product innovation and development from Silicon Valley to the U.K. The move likely means that revenue from intangibles developed in the future by the research and development center would be taxable primarily in the U.K., and not the U.S.

So how should we interpret these moves?

Big Blow for Argentina in Holdouts Case

Today, the U.S. Supreme Court inflicted a major blow to Argentina in its decade-long legal struggle with some of its creditors since it defaulted on its debt in 2001—the largest sovereign default in history.

While in 2005 and 2010 most of Argentina’s creditors settled to swap their old bonds with heavily discounted new bonds, a group of holdout creditors challenged Buenos Aires in the courts. In October 2012, the U.S. Court of Appeals for the Second Circuit sided with plaintiffs to rule that Argentina must treat all its creditors equally and pay owners of defaulted bonds that were issued under New York law. Today, SCOTUS rejected Argentina’s appeal to that ruling. Buenos Aires now faces three options:

  1. Comply with the ruling and pay the holdout creditors the $1.33 billion it owes them. Argentina can afford this. According to the most recent estimates (June 6), the country has $28.6 billions in Central Bank reserves. Paying the holdouts would send a strong signal that Argentina is willing to play by the rules and honor its debts. However, the government of Cristina Fernández de Kirchner has made a political crusade out of its struggle against the holdouts (whom she calls “vultures”). Unfortunately, most voices in the opposition share her distaste for paying the holdouts.
  2. Ignore the ruling. If it does so, Argentina will be legally prevented from paying the other 93% of creditors that agreed to the previous bond swaps of 2005 and 2010 because the ruling requires Argentina to pay holdouts along with those who accepted the swaps. If this happens, Argentina would enter into a technical default. The economic consequences are uncertain. The central government is already mostly shunned out of international markets. But Argentine provinces and businesses could face a more difficult time servicing their debts.
  3. In an effort to avoid a technical default, Argentina could offer the bondholders who agreed to the 2005 and 2010 debt swaps new bonds issued under Argentina’s jurisdiction. Thus, the bondholders would face a terrible choice: either they stick to their U.S.-issued bonds and risk an almost certain default, or accept Argentina’s offer of new bonds issued under the “protection” of its shaky legal and political institutions. The chants of “Argentina, Argentina!” in the chambers of Congress in 2001 when the country opted for defaulting should be in the bondholders’ minds when considering this option.

Clearly, the best option for Argentina’s long-term economic prosperity is the first one. But it requires the country’s political class to swallow its pride and agree to play by the rules. That would be a first in a very long time.

Tax Exiles Flee America: Blame the Greedy Politicians

The U.S. government is driving some of its most productive citizens abroad.  The only beneficiaries are countries such as Singapore and Switzerland, which offer sanctuary to Americans fleeing avaricious Uncle Sam.

Three years ago Eduardo Saverin, one of Facebook’s founders, joined 1780 other Americans in renouncing their citizenship.  Heading overseas allowed him to reduce the federal government’s take when his company went public.

Just 231 people gave up their citizenship in 2008.  Last year the number was 2999.  The first three months of 2014 was 1001, up from 679 for the first quarter of last year. 

Tax flight is not an option for most people.  However, the rich have more choices internationally.  And they increasingly are telling Uncle Sam goodbye.

So are big corporations, such as Pfizer, which is seeking to buy the British pharmaceutical company AstraZeneca.  The acquisition would allow Pfizer to move its headquarters to the United Kingdom, which employs a “territorial” tax system, with taxes collected only where the income is earned, in contrast to Washington’s worldwide levy. 

About 50 firms have moved their headquarters over the last three decades, half of them since 2008.  Last month the Obama administration decried the practice and proposed to increase the share of foreign ownership required for inversions.

Traditionally the entrepreneurial and productive wanted to come to America.  Many still do.  But the choice is no longer so clear-cut. 

Obama Understands the Improving State of Humanity

On Wednesday, President Obama stated an irrefutable fact: the state of humanity is better than any time before. He said,

…if you had to choose any moment to be born in human history, not knowing what your position was gonna be, who you were gonna be, you’d choose this time. The world is less violent than it has ever been. It is healthier than it has ever been. It is more tolerant than it has ever been. It is better fed than it has ever been. It is more educated than it has ever been. Terrible things happen around the world every single day but the trend lines of progress are unmistakable.

This is merry news, especially since he is helping to spread the message of Cato’s new website, HumanProgress.org. And who could help to spread it faster than the leader of the free world?

His understanding of the reasons for improvements in human well-being is unclear, though he seems to imply that people, left to their own devices, will try to improve their lot:

(T)he trend lines of progress are unmistakable. And the reason is because each successive generation tries to learn from previous mistakes and push us, the course of history, in a better direction.

The President is correct in recognizing that progress is most commonly realized when people are left free to pursue their enlightened self-interest. Consider the following examples:

Life expectancy and economic freedom were both higher in Venezuela than in Chile in the 1970s. As Venezuela became less economically free and Chile became more economically free, Chile caught up with Venezuela and eventually overtook it. Today, life expectancy in liberal Chile is higher than in socialist Venezuela.

Life expectancy and economic freedom were both higher in Venezuela than in Chile in the 1970s. As Venezuela became less economically free and Chile became more economically free, Chile caught up with Venezuela and eventually overtook it. Today, life expectancy in liberal Chile is higher than in socialist Venezuela.

Consider also China’s reforms: As China embraced free market policies, its poverty rate has plummeted.

Consider also China’s reforms: As China embraced free market policies, its poverty rate has plummeted.

Obama did his young audience a service in teaching them that the world is the best it has ever been. These massive improvements were the result of no one’s intention, other than the intention to better one’s own life through free markets. Look no further than North and South Korea, East and West Germany, and Taiwan and pre-reform China for evidence of the power of free markets to create sustainable development.

Paul Martin: The Bill Clinton of Canada, Only Much Better

Imagine how weird it would be if the Cato Institute and Americans for Tax Reform praised Barack Obama for fiscal responsibility. And think how inconceivable it would be for the Heritage Foundation and the National Taxpayers Union to applaud Tim Geithner for economic stewardship.

The Canadian version of that happened while I was at the conference of the World Taxpayers Association in Vancouver two weeks ago.

The event was organized by the Canadian Taxpayers Federation and the main speaker was Paul Martin of the Liberal Party, who served as finance minister from 1993 to 2002, and then as prime minister from 2003 to 2006. I should add, for context, that the Liberal Party in Canada is not a classical liberal party with a track record of free markets and small government.

But Paul Martin was honored because he was responsible, while finance minister, for one of the best records of fiscal restraint of any policymaker in recent history (click here for international comparisons).

I’ve pointed out that the burden of spending fell under Bill Clinton, and I’ve even acknowledged that the federal budget hasn’t grown much under Obama, at least once you get past his first couple of years. But Paul Martin was far more frugal. And since Canada has a parliamentary system, there’s no ambiguity about who deserves credit. He restrained spending when his party had control.

What happened to generate the good results? For all intents and purposes, he imposed a spending freeze. And I’m talking a nominal spending freeze, not the kind of fake fiscal discipline you get when politicians make “cuts” off an inflated baseline. Because the budget was successfully restrained, that addressed both the problem of too much spending and the symptom of red ink.