Topic: Tax and Budget Policy

Another Defective IMF study on Inequality and Redistribution

IMF Warns on the Dangers of Inequality,” screams the headline of a story by Ian Talley in the Wall Street Journal. The IMF – which Talley dubs “the world’s top economic institution”– is said to be “warning that rising income inequality is weighing on global economic growth and fueling political instability.” 

This has been a familiar chorus from the White House/IMF songbook since late 2011, when President Obama’s Special Assistant David Lipton became Deputy Managing Director of the IMF.  It echoes a December 2012 New York Times piece, “Income Inequality May Take Toll on Growth,” and a January 14, Financial Times feature, “IMF warns on threat of income inequality.”  This isn’t news.

Talley writes, “The IMF … says advanced and developing economies need to raise more revenues through taxes, focusing on progressive taxation that moves more of the burden for social security, health care and other state benefits to the high-income earners.” That isn’t news either.  The IMF has an ugly history of advising countries to raise tax rates, with disastrous results.  The inequality crusade is just a new pretext for old mistakes.

New York Times Op-ed on Infrastructure

My op-ed in today’s New York Times has prompted numerous critical comments on the NYT website. Let me address some of them.

Some readers questioned the linked source for my statement that infrastructure spending in the United States is about the same level as in other high-income countries. This fact does need some explanation, but I didn’t have room to include it in the op-ed. The data I cited were emailed to me by the author of the linked OECD report. It is national accounts data on gross fixed investment. I charted the data here in Figure 2.

Some readers wondered about my definition of “infrastructure.” That word is often used loosely. The definition that makes sense to me is the broad one of gross fixed investment, which includes such items as government highways and private pipelines and factories. The data are available from BEA Table 1.5.5, where you can see that private investment—even aside from residential—dwarfs government investment.

One reader expressed a common view that in traveling abroad you often find nicer airports than in this country. I think that’s correct, and often those foreign airports are private or partly private, while ours are government-owned.

Numerous readers pointed to shortcomings of particular private companies, and some of those complaints are surely correct. Private companies often screw up, but my experience is that governments screw up more because of deep, structural incentive problems. Furthermore, private markets have the powerful built-in mechanism of competition to fix problems over time, whereas government shortcomings often go unaddressed. Where there is a lack of competition in private markets, policymakers should focus on opening entry to increase it.

Raise Minimum Wage, Kill Jobs

During his State of the Union address, President Obama announced that he intended to raise minimum wages to $10.10/hour for certain workers. Based on data from EU countries, it is clear that minimum wage laws kill jobs. I concluded that hiking the minimum wage will kill jobs in the U.S., too. Executives surveyed in the Duke University/CFO Magazine Global Business Outlook Survey agree.

Chief Financial Officers from around the world were interviewed and the majority of them concurred: a minimum wage increase from $7.25/hour to $10.10/hour would kill a significant number of jobs.

Here’s what the CFOs had to say:

Sweden, Spending Restraint, and the Benefits of Obeying Fiscal Policy’s Golden Rule

When I first started working on fiscal policy in the 1980s, I never thought I would consider Sweden any sort of role model.

It was the quintessential cradle-to-grave welfare state, much loved on the left as an example for America to follow.

But Sweden suffered a severe economic shock in the early 1990s and policy makers were forced to rethink big government.

They’ve since implemented some positive reforms in the area of fiscal policy, along with other changes to liberalize the economy.

I’m particularly impressed that Swedish leaders imposed some genuine fiscal restraint.

Here’s a chart, based on IMF data, showing that the country enjoyed a nine-year period where the burden of government spending grew by an average of 1.9 percent per year.

Swedish Fiscal Restraint

From a libertarian perspective, that’s obviously not very impressive, particularly since the public sector was consuming about two-thirds of economic output at the start of the period.

But by the standards of European politicians, 1.9 percent annual growth was relatively frugal.

And since Mitchell’s Golden Rule merely requires that government grow slower than the private sector, Sweden did make progress.

Real progress. It turns out that a little bit of spending discipline can pay big dividends if it can be sustained for a few years.

This second chart shows that the overall burden of the public sector (left axis) fell dramatically, dropping from more than 67 percent of GDP to 52 percent of economic output.

Swedish Spending+Deficit as % of GDP

By the way, the biggest amount of progress occurred between 1994 and 1998, when spending grew by just 0.27 percent per year. That’s almost as good as what Germany achieved over a four-year period last decade.

American Society as Chessboard

One of my favorite Adam Smith passages is:

The man of system … seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it.

Today, the men and women of system in the nation’s capital have a high regard for their ability to arrange the chess pieces of American society. There are 318 million individuals, 28 million businesses, 50 state governments, 89,000 local governments, and countless churches, charities, and other organizations in this great nation. Congress passes laws to intervene in the affairs of all of these people and groups, trying to impress its design.

But federal policymakers usually ignore, or fail to understand, the principles of motion in society. They impose minimum wages and health laws, and businesses cut hiring. They subsidize water, which exacerbates droughts. They subsidize flood insurance, which increases the damage from floods. They impose the world’s highest corporate tax rate, and they are shocked when corporations shift their profits abroad.

Federal attempts to arrange state government policies bring surprises as well. Federal policymakers offer matching grants for Medicaid, and are surprised that it prompts rapid state spending growth and dubious schemes to boost payments. Federal policymakers provide state aid for schools, but states probably just substitute added federal funding for their own.

The latest lesson on society’s principles of motion regards food stamp aid. From the Washington Post:

Congress last month passed a revamp of agriculture and food policy that was supposed to save the U.S. government $8.6 billion in food-stamp costs over a decade. That may not happen, though, now that some states are finding a way to avoid the cuts.

New York, Connecticut and Pennsylvania are triggering extra nutrition spending by adding money to a home-heating subsidy tied to increased food-stamp aid. The move feeds needy families while thwarting spending-reduction goals … If more follow, the federal government would have to spend much of the $8.6 billion it planned to save, as states reduce spending on other programs to meet the new mandate.

“These federal cuts have made it harder for our state’s most vulnerable residents to put food on the table. The state has intervened on behalf of these low-income New Yorkers,” Gov. Andrew M. Cuomo (D) said in a statement Feb 25. “New York is stepping up to help families in need.”

How Much Tax Revenue from Legalized Marijuana?

Some marijuana legalizers push the argument that legalization will generate additional tax revenue. Opinions differ widely, however, on exactly how much revenue.

In mid-February, Colorado Governor John Hickenlooper predicted that the taxes, licenses, and fees on medical-plus-recreational marijuana would generate $134 million for the fiscal year starting in July.

In my 2010 Cato White Paper, I predicted that full legalization (federal and state) would generate roughly $55-60 million per year for Colorado.

Now just released data from Colorado for January, the first month of fully legal marijuana sales, show about $2 million from recreational marijuana and about $3.5 million for medical-plus-recreational marijuana.  The latter figure implies annual revenues of about $42 million.

This January figure may turn out to be misleading.  On one hand, the industry could grow over time, boosting revenues. On the other hand, initial hoopla over legalization may have inflated January sales.  And, longer term, sales in Colorado could decline if other states legalize or medicalize.

If the lower revenue numbers persist, does that weaken the case for legalization?

No: Increased tax revenue was never the main reason for legalization. Instead, the crucial goals of legalization are greater freedom for marijuana users and elimination of prohibition’s unintended consequences (crime, corruption, poor quality control, diminished civil liberties, restrictions on medical uses, and expenditure on enforcement).

Collecting revenue on legalized marijuana is perfectly sensible; it allows lower tax rates on everything else. But this appears to be a small effect, and it is not the main benefit of legalization in any case.

A Fiscal Lesson from Germany

Germany isn’t exactly a fiscal role model.

Tax rates are too onerous and government spending consumes about 44 percent of economic output.

That’s even higher than it is in the United States, where politicians at the federal, state, and local levels divert about 39 percent of GDP into the public sector.

Germany also has too much red tape and government intervention, which helps to explain why it lags other European nations such as Denmark and Estonia in the Economic Freedom of the World rankings.

But I have (sort of) defended Germany a couple of times, at least on fiscal policy, explaining that the Germans didn’t squander much money on Keynesian spending schemes during the downturn and also explaining that Paul Krugman was wrong in his column on Germany and austerity.

Today, though, I’m going to give Germany some unambiguous praise.

If you look at last decade’s fiscal data, you’ll see that our Teutonic friends actually followed my Golden Rule on fiscal policy for a four-year period.

Here’s a chart, based on IMF numbers, showing total government spending in Germany from 2003-2007. As you can see, German policy makers basically froze spending.

German Fiscal Restraint

I realize that I’m a libertarian and that I shouldn’t be happy unless the burden of spending is being dramatically reduced, but we’re talking about the performance of European politicians, so I’m grading on a curve.

By that standard, limiting spending so it grows by an average of 0.18 percent is rather impressive. Interestingly, this period of fiscal discipline began when the Social Democrats were in power.

And because the economy’s productive sector was growing at a faster rate during this time, a bit more than 2 percent annually, the relative burden of government spending did fall.

The red line in this next chart shows that the public sector, measured as a share of economic output, fell from almost 49 percent of GDP to less than 44 percent of GDP.

German Spending+Deficit as % of GDP

It’s also worth noting that this four-year period of spending restraint also led to a balanced budget, as shown by the blue line.

In other words, by addressing the underlying problem of too much government, the German government automatically dealt with the symptom of red ink.

That’s the good news.

The bad news is that the German government wasn’t willing to sustain this modest degree of fiscal discipline. The Christian Democrats, who took office in mid-2005, allowed faster spending growth beginning in 2008. As I noted above, the budget increases haven’t been huge, but there’s been enough additional spending that Germany no longer is complying with the Golden Rule and the burden of the public sector is stuck at about 44 percent of GDP.

The moral of the story is that Germany shows that good things happen when spending is restrained, but long-run good performance requires long-run spending discipline.

That’s why I’m a fan of Switzerland’s spending cap. It’s called the “debt brake,” but it basically requires politicians to limit spending so that the budget doesn’t grow much faster than inflation plus population.

And that’s why Switzerland has enjoyed more than a decade of good policy.

To see other examples of nations that have enjoyed fiscal success with period of spending restrain, watch this video.

The Canadian example is particularly impressive.