Topic: Tax and Budget Policy

Despite Losing Business to Flat Tax Neighbors, Hungarian Politicians Clinging to High Tax Rates

The Budapest Times has a feature story noting that many of Hungary’s neighbors have simple and fair flat tax system and wondering whether the nation can afford to retain a system base on high tax rates:

Bulgaria and Albania joined Russia, Slovakia, Romania and nine other Central and Eastern European countries by adopting a flat tax system at the beginning of the year. Four of Hungary’s seven neighbours have already chosen the flat tax option. In fact, flat tax is now the preferred system among the post-communist economies of Central and Eastern Europe. Is Hungary – already suffering the lowest rate of economic growth of the new EU member states – in danger of being left behind? …To western Europeans, this may sound like the utopian stunt of a madman, but in fact flat tax policies – until recently little more than a theoretical notion dreamt up by economists – have rapidly caught on in the developing economies of central and Eastern Europe since Estonia opted for the novel system in 1994.

In addtion to explaining how the flat tax improves tax compliance, the article notes that many companies are relocating in Slovakia because that country’s tax system is much more conducive to productive activity. The Hungarian fiscal system, by contrast, is very punitive:

With a flat rate of tax, regardless of how much a person earns, he pays the same proportion of his wage to the state. With progressive tax, a pay rise can lead to an increase in the percentage claimed by the government. …a simple, low-rate tax which is easy to collect and difficult to evade is likely to raise more money than a high-rate tax system that is full of loopholes and which nobody fully understands. …Compare Hungary with Slovakia. Hungary’s northern neighbour has opted for the purest of flat tax systems. Employers’ and employees’ income tax contributions are fixed at 19%, as is corporate tax and even VAT. Thousands of Hungarian companies have already relocated their headquarters to Hungarian-speaking southern Slovakia – not only are taxes lower, but accounting has been made child’s play. Hungarian employers must pay 16% income tax and 29% social security on payroll, while employees pay between 18% and 36% income tax plus a host of social and other contributions. The net result of this is that the government receives up to double what the employee takes home. 

Even though Hungary’s growth rate is sluggish and the nation is losing jobs and investment to other nations with better tax systems, the politicians are stubbornly refusing to join the flat tax revolution. This is bad news for Hungary’s workers:

The small, conservative opposition party the Hungarian Democratic Forum has long been calling for the adoption of a flat tax model. Party leader Ibolya Dávid argued last year, when the Czech Republic chose to follow its southern neighbour Slovakia into the flat tax world, that Hungary risks losing out in the battle for foreign investment and lagging behind if it does not follow suit. …Earlier this year, it was reported that two of four possible alternatives included the adoption of a flat tax model. However, last week Magyar Hírlap reported that the cabinet working group had ruled out any such move.

Will the UK Chase Away the Geese with the Golden Eggs?

Allister Heath has an excellent column in the Spectator explaining how Gordon Brown’s class-warfare policies will discourage successful foreigners from moving to the United Kingdom.

London will be hit particularly hard because the attack on “non-domiciled residents” will be augmented by higher capital gains taxes and policies to discourage British expatriates from spending too much time (and money) in the city.

But some people will benefit. Swiss realtors are probably delighted with Brown’s self-destructive proposals, since many highly-productive people will now be looking to relocate to tax-friendly jurisdictions:

[T]he Treasury now admits that 3,000 non-dom expats will leave Britain in April, when the changes, including a £30,000 annual poll tax, are due to kick in. This is a truly remarkable admission, of which far too little has been made. Given how hard all economies, including Britain, strive to attract high-net-worth investors and the highly skilled these days, it is difficult to fathom why any government in its right mind would wish suddenly to begin penalising those it has sought to woo for so long. What is most absurd about this is that the Treasury readily acknowledges, in the very same document laying out its tax hike plans, that ‘in an increasingly globalised economy it is crucial for the UK’s competitiveness that the UK continues to attract international talent to this country’.

…[T]he assault on the non-doms is going hand in hand with a hike in capital gains tax, a rise in corporation tax on small companies, and a crackdown on the 29,000 non-residents who commute most weeks from Monaco or the Isle of Man. All of these changes add up to a simple message to the skilled, hard-working and above all footloose international talent to which today’s Britain owes so much of its success: don’t bother coming here, we don’t value you any longer.

…Tax lawyers are starting to warn their clients seeking to relocate to Britain that the current volley of tax hikes is likely to be merely the thin edge of a much more punitive wedge. Brown’s attack on the non-doms could easily become Brown’s very own Sarbanes-Oxley, the ultra-onerous piece of post-Enron legislation in America which chased away hundreds of companies to more welcoming shores. But what is most distressing to non-doms currently based in the City, and to many of those considering moving here, is that the Tories support an almost identical policy.

Stimulus: Kindergarten Keynesianism

It is very curious that some top economists are pushing the Bush/Pelosi $100 billion stimulus giveaway.

  • For years, these same economists told us that more savings is good for the economy. Now they are saying that more consumption is good.
  • For years, these same economists have lambasted the budget deficit. Now, they support blowing a new $100 billion hole in the federal budget.
  • Finally, many economists have long complained that Americans are shopoholics and have far too much credit card debt. Now stimulus-supporting economists are demanding that Americans spend, spend, spend!

It is surprising that anyone takes economists seriously anymore.

Anyway, stimulus proponents say that mailing $100 billion of cash to families will cause the nation’s output to grow. Yet this simple Keynesian chart illustrates that the result will be higher prices, not more output.

The stimulus causes the aggregate demand curve to shift to the right, as proponents suggest. That moves us along the aggregate supply curve, which I believe should be drawn vertically in this case. The result is that prices jump up from P1 to P2, but output does not rise.

Stimulus proponents would argue that the aggregate supply curve should be sloped, at least in the short run. In that case, the figure would show a temporary bump upwards in output.

But that seems unlikely to me. Keynesian theories about why output might increase usually rely on imperfections in markets or information. Producers get fooled into increasing their output for a while, before the errors are worked out and output falls back to its long-term level.

But that wouldn’t seem to be the case here. Let’s say the rebate checks get mailed out in May and June. A U.S. cigarette producer may notice a slight uptick in sales in those months as smokers spend their government checks. But cigarette producers probably watch the news and they will know that this is just a temporary blip. As such, they won’t add any new workers or buy any new machines.

So output would stay pretty fixed, while prices would adjust upward slightly to clear markets. But I don’t claim to be a Keynesian expert, so if one of our Keynesian readers wants to tell me where I’m wrong, I’d be happy to hear it. Until then, I remain convinced that the Bush/Pelosi scheme is crack-pot.

Stimulus Package Is Welfare, Not Tax Cuts

The Bush administration’s propaganda sheet on the ridiculous stimulus package claims that it includes $100 billion in individual “tax rebates” or “tax relief.” The sheet goes on to claim that the relief is “not federal spending that would have little impact on the economy.”

In fact, the $100 billion is simply extra spending; it is a giant one-time welfare program. To pay for it, the government will borrow an added $100 billion, which will impose $100 billion of higher taxes on future generations.

Suppose there was a Democrat in the White House and she proposed $100 billion in cash hand-outs to families. She could structure it exactly the same way as Bush has, but call it a “Family Food and Health Care Supplement.” The minority GOP would probably denounce it strongly as wasteful welfare, which it would be.

But, as we have seen dozens of times since 2001, because the political operators in the White House call themselves Republicans and conservatives, many members of the Republican party appear to be going along with this nonsense.

The $50 billion business tax relief (capital expensing) is a little different. As a temporary break, it makes no sense. If businesses just pull some of their 2009 investment into 2008 to get the break, it just means we’ll have an investment slump next year. All we will have done is, once again, screw around with corporate business plans instead of making permanent reforms to help companies compete in the global economy. 

I’m a supporter of making capital expensing a permanent part of tax law. But enacting expensing temporarily, as we did a few years ago, just makes politicians think of it as a gimmick to be enacted every two years before an election.       

Background on Mortgage Markets

I asked colleague Alan Reynolds a question about mortgages today, and he replied with what I think are some useful points that usually don’t appear in the crisis-obsessed media. Here are what Alan believes are the rough stylized facts:

  • Most foreclosures are prime, not subprime.
  • Half of subprime mortgages are fixed, not ARMs.
  • The vast majority of recent subprime loans were for refinancing, not buying. As house appraisals went up, some just borrowed all the phantom equity and spent it.
  • About 96% of all mortgages are paid on time. Most of the rest are late, but not in default.
  • The main reason for default is that home prices fell in some areas, leaving more owed on the mortgage than the house is worth.
  • Serious delinquency (2-3 months late in payments) is much more common than foreclosure, partly because deals are being renegotiated. The media often confuse numbers of late payers with numbers of actual defaults.
  • Most foreclosures of ARMs happened before the rate adjusted, not after. Often within one year. This was often due to borrower fraud – lying about income and assets. When the house or condo could not be quickly flipped at a profit, those with zero down just stopped paying.
  • Very few subprime borrowers qualified for the lowest teaser rates – most paid about 7% or so from the start, so far as I can tell.
  • The adjustments on ARMs are limited, and with rates now falling some adjustment will be down rather than up.

Finally, Alan notes that there is a lot of misinformation out in the media about mortgages, much of it coming from the Center for Responsible Lending which, in turn, received a lot of cash from John Paulson who just made $3-4 billion by shorting mortgage-backed securities during the panic and hype about “subprime.”

Carter, Reagan and the Poor

My colleague Tom Firey is right on the mark with his nearby blog post dissecting a recent Paul Krugman column on the supposed myths of the Reagan economic record. Allow me to pile on.

Krugman wrote in a January 21 column for the New York Times that the economic record of President Reagan was one of failure. The Reagan years did encompass a recovery from a steep recession, he acknowledges, but then, “By the late 1980s, middle-class incomes were barely higher than they had been a decade before — and the poverty rate had actually risen.”

Let’s bore in on the poverty numbers and the operative phrase “a decade before.”

As everyone knows, Reagan was in office for exactly eight years, from January 1981 to January 1989. To compare his last full year in office (1988) to “a decade before” would take us back to 1978, a period that would include the last two years of Jimmy Carter’s single term. Those two years, it turns out, were absolutely brutal for America’s poor.

The last half of Carter’s tenure was marked by double digit inflation, record high interest rates, and a sputtering economy that fell into recession in the first half of 1980. That stagflationary mix caused the poverty numbers to soar. From 1978 to 1980, according to the Census Bureau, the number of Americans living below the poverty line rose by 4.8 million and the poverty rate jumped from 11.4 to 13.0 percent.

The poverty rate continued to climb under Reagan as the nation labored through a steep recession in 1981-82, a recession largely caused by the Federal Reserve Board’s efforts to slay the Carter-era inflation. After peaking at 15.2 percent in 1983, the rate declined steadily through the rest of Reagan’s time in office. By his last year in office, the poverty rate was exactly the same—13 percent—as it was in Carter’s last year in office. That’s nothing to crow about, but neither is it an increase or an obvious sign of failure.

To compare the last year of Reagan’s presidency to 1978 has the effect of saddling the Reagan record with the last half of the Carter presidency—a neat statistical trick worthy of the current presidential campaign season.

There Krugman Goes Again

In his Monday columnNew York Times writer Paul Krugman claims to (borrowing the headline) “Debunk… the Reagan Myth,” arguing that Ronald Reagan’s economic policies “did fail.” (The column does not mention that Krugman worked for Reagan’s Council of Economic Advisers in 1982–1983.)

In fact, Krugman devotes precious little space to examining (or debunking) Reagan’s economic policies or their performance. The column is mostly a lament that Americans view Reagan positively and that Democrats have not challenged (and may even share) that opinion.

Krugman’s criticisms comprise just seven of the column’s 37 sentences (and three of the seven are throwaway lines). Here they are verbatim:

For it did fail. The Reagan economy was a one-hit wonder. Yes, there was a boom in the mid-1980s, as the economy recovered from a severe recession. But while the rich got much richer, there was little sustained economic improvement for most Americans. By the late 1980s, middle-class incomes were barely higher than they had been a decade before — and the poverty rate had actually risen.

[T]here wasn’t any resurgence [in productivity growth] in the Reagan years.

Like productivity, American business prestige didn’t stage a comeback until the mid-1990s….

In short, Krugman makes four criticisms: Reagan’s policies resulted in (1) stagnant middle-class incomes, (2) an increase in the poverty rate, (3) stagnancy in productivity growth, and (4) stagnancy in “American business prestige.”

Are those claims true and do they show that Reagan’s economic policies “did fail”? Let’s look at the data. (Hyperlinks connect to the relevant federal data sets.)

MIDDLE-CLASS INCOME   To determine the course of middle-class income over Reagan’s presidency, let’s examine the U.S Census Bureau’s Current Population Reports on median real income over time. That is, let’s look at inflation-adjusted family income and household income for families/households that are in the exact middle of all U.S. families/households.

From 1981 to 1988 (which roughly corresponds with Reagan’s tenure), median real family income grew 11.1 percent while real household income grew 10.3 percent. Those growth rates are in the top third of the 30 eight-year periods from 1968–1975 to 1998–2005.

To be fair, Krugman did not speak of middle-class income over Reagan’s tenure, but instead compared middle-class incomes of “the late 1980s” with the decade before. So we look at the data again and find that, in 1986, despite two recessions (1980, 1982) in the intervening years, median family income was 10.7 percent higher than a decade ago and median household income was 10.3 percent higher. The following year, median family income was 11.8 and 11.0 percent higher than a decade before. (The gains were smaller in 1988.)

In contrast, income growth during Bill Clinton’s administration only eclipsed Reagan’s 1986 and 1987 numbers once: at the height of the tech bubble in 2000, family income was 12.3 percent higher than a decade previous (however, household income was lower than Reagan’s 11.0 percent). Further, the George W. Bush administration eclipsed those numbers in three straight years — in 2001, 2002 and 2003, both family and median income gains over the preceding decade were higher than the best Reagan or Clinton numbers. Curiously, Krugman does not credit G.W. Bush with being more successful, economically, than either Reagan or Clinton.

POVERTY   Krugman is correct that the poverty rate was higher at the end of Reagan’s term than it was “a decade before” in 1978. However, the poverty data show much more that Krugman doesn’t discuss.

In 1978, 9.1 percent of families and 11.4 percent of individuals in the United States were living below the poverty line. The year marked the penultimate in a previously unprecedented span of years (beginning in 1972) where the poverty rate for families fell below 10 percent. However, both rates began climbing in 1979, preceding the onset of the twin recessions of 1980 and 1982. Poverty topped out at 12.3 percent for families and 15.2 percent for individuals in 1983.

From there, though, poverty under Reagan moved downward steadily, reaching 10.4 percent for families and 13.0 percent for individuals in 1988. Both rates fell further in the first year of the George H.W. Bush administration. However, neither rate would be that low again until 1997, the year after welfare reform passed Congress. The poverty rate for families would not duck below 10 percent again until the last two years of the Clinton administration and the first three years of the George W. Bush administration.

PRESTIGE   On this point, I cannot challenge Krugman. He gives no evidence to support this claim, and I know of no data sets that measure “prestige.”

PRODUCTIVITY GROWTH   Krugman is correct that the data show productivity growth under Reagan was around 1.4 percent a year, not much higher than the previous period 1973–1979 (1.2 percent) and a little less than the subsequent period 1990–1995 (1.5 percent). Those numbers are all considerably lower than the 2.8 average annual increase for 1947–1973 and the 2.5 percent for 1996-2000.

Krugman does not mention the productivity rate for 2000–2006; at 2.7 percent, productivity growth is even higher under the George W. Bush administration than it was in the best of the Clinton years. Again, curiously, Krugman does not credit G.W. Bush with being even more successful economically than Reagan or Clinton.

This raises a question: If the average productivity growth rate increased over the last five years of the Clinton administration, and that growth continued (at a slightly higher rate) through the first five years of the G.W. Bush administration, then does policy (or politics) have much to do with productivity? The recent spurt in U.S. productivity seems the product of cheap computers and Americans’ special talent for using them, not the machinations of Washington, D.C. More broadly, significant increases in productivity growth have much more to do with stochastic innovation than White House actions (except, perhaps, Al Gore’s creating the Internet).

KRUGMAN CONSIDERED   This leads to a broader question: How much credit can any president take for economic growth that occurs during his presidency?

To be sure, Reagan deserves some credit for improving on the economic trends of the 1970s, but credit should also go to Gerry Ford and Jimmy Carter for taking the first steps toward deregulation, and to Paul Volcker and the Fed for tamping down inflation. Likewise, the economic success of Clinton and George W. Bush owe some debt to Reagan (and, in W’s case, to Clinton) and much to Alan Greenspan (not to mention Silicon Valley). If the United States successfully combats the current economic slowdown, the credit should go to Ben Bernanke and his Fed colleagues, not to any stimulus package cobbled together by the White House or Capitol Hill.

Economic policies are intended to have long-term effects (though those policies can have some immediate effects). But economic conditions are only partly the product of economic policies — they are products of many different decisions by many different economic actors, most of whom are not elected. Politicians receive far too much credit and blame for current economic conditions.

Krugman’s claims about the Reagan record are misleading and, in the case of middle-class income, outright false. But more significantly, the concept underlying Krugman’s column is facile.