Topic: Tax and Budget Policy

Let Them Go Barefooted

Just about every American needs to buy socks every year, while a relatively tiny number of U.S. workers actually MAKE socks for a living. Yet the Bush administration may decide by this Friday whether to sock it to the many for the temporary benefit of one small and dwindling industry.

Under a provision of the Central American Free Trade Agreement approved by Congress in 2005, the Bush administration is weighing whether to impose special duties on socks imported from Honduras. According to today’s Wall Street Journal, the move would placate a particular lawmaker in Alabama with several sock factories in his district and a few other, mostly southern lawmakers whose votes may be necessary for upcoming trade deals the administration wants.

Has U.S. trade policy come to this? For the sake of a domestic sock industry that, by its own count, employs only 20,000 workers, the U.S. government would impose a temporary 13.5 percent tariff on the 8.3 percent of imported socks that come from the small neighboring democracy of Honduras—a country that entered into a free trade agreement with the United States only two years ago.

By design, the tariff would mean higher sock prices for the 300 million or so Americans who buy and wear socks. And the sock tax would fall disproportionately on lower-income families, who spend a higher share of their income on such staples as food and clothing.

The Bush administration should forget nose counting for future trade agreements if gathering votes means raising trade taxes on low-income Americans. If the administration wants to support free trade, it should resist any calls for higher tariffs.

Radical Economic Reform in Georgia

The nations of the former Soviet Union include some of the world’s most interesting free-market reformers. Estonia is famous for its laissez-faire approach, but Georgia deserves attention as well - and not just because I went to the University of Georgia (a different Georgia, I’ll admit, but let’s not get bogged down in details).  A few years ago, it implemented a 12 percent flat tax. But it still had a problem of a very high 20 percent payroll tax rate, so Alvin Rabushka reports that Georgia has lowered the combined 32 percent flat tax/payroll tax rate to 25 percent this year. But why stop there? According to the Wall Street Journal, Georgia now plans to lower the 25 percent tax rate to 15 percent over the next five years and also abolish the capital gains tax:

Newly re-elected Georgian President Mikheil Saakashvili wants to slash taxes, speed privatization, ease foreign-investment rules and tap international capital markets as part of a radical plan to shake up the economy of the Black Sea country, his prime minister said in an interview. “The state will basically do everything to support business and investments instead of standing in the way of it,” said Prime Minister Lado Gurgenidze… The government last week signed off on a proposal that would cut average income taxes to 15% from 25% over the next five years. Capital-gains taxes, currently at 20%, would be abolished altogether.

Will Hungary Join the Flat Tax Club?

Tax-news.com is reporting that Hungary’s governing coalition is considering a flat tax. Tax competition is probably the only reason why this conversation is taking place. The current government, after all, has a dismal fiscal record of higher taxes and higher spending. But four of Hungary’s bordering nations already have flat tax systems, meaning that the competitive pressure for reform must be growing more intense as time passes:

The office of Hungarian Prime Minster Ferenc Gyurcsany has confirmed that the government intends to reduce the tax burden by 0.5% of gross domestic product over the next two years. … Gyurcsany told Euromoney that the convergence plan allowed some room for tax cuts and for the overall tax burden to be cut to 37.6% of GDP by 2010. … [T]he governing coalition has begun to debate a number of tax proposals with the aim of sharpening the country’s tax competitiveness. According to the business daily Vilaggazdasag, four tax packages were under discussion by the governing Socialist Party and its junior coalition partner Free Democrats last Friday: one would cut the ‘tax wedge’ on labour from 29% to about 20%, but increase the top rate of VAT by 2% to 24% and abolish tax allowances; the second would reform the personal income tax system, applying the principle of ‘super grossing’; the third would reduce the tax burden on corporations; and the fourth would introduce a flat tax on personal incomes and/or corporate incomes and VAT.

Conservatism Revealed

What does it say about the Republican Party when the leading fusionist conservative in the field - Mitt Romney, darling of National Review and erstwhile heir to Ronald Reagan - runs and wins a campaign arguing that the federal government is responsible for all of the ills facing the U.S. auto industry, that the taxpayer should pony up the corporate welfare checks going to Detroit and increase them by a factor of five, that the federal government can and should move heaven and earth to save “every job” at risk in this economy, and that economic recovery is best achieved by a sit-down involving auto industry CEOs, labor bosses, and government agents armed with Harvard MBAs to produce a well-coordinated strategic economic plan? That is, what explains the emergence of economic fascism (in a non-pejorative sense) in the Grand Old Party at the expense of free market capitalism?

I have no answer. But it certainly explains the increasing migration of libertarians voters to the Democratic Party. They may be no better, but at least the Dems offer libertarians something in social and foreign policy circles that the Republicans don’t.

IMF Concludes Lower Tax Rates Can Yield More Tax Revenue

A new study from the International Monetary Fund looks at what happened in Russia after the 13 percent flat tax was implemented and concludes that there was a Laffer Curve effect. Indeed, the increase in taxable income was so large that it completely offset the impact of the lower tax rate. In other words, this was one of the rare cases of a tax cut “paying for itself” (in the vast majority of cases, lower tax rates generate revenue feedback, but the net result is still less money for government).

Interestingly, the study finds that the additional revenue materialized because people are more willing to obey the law when the tax rate is low, as theory would predict, but did not find an increase in labor supply, which theory also would predict This anomaly aside, it is still good news that the IMF recognizes that there is a Laffer Curve and that high tax rates are needlessly destructive:

Can tax rate cuts increase revenues?

…The Russian flat tax experiment is particularly interesting: after the introduction of flat taxes, and effective personal income tax rate cuts, tax revenues increased substantially and almost immediately. Furthermore, they increased much faster than labor supply and output. The paper explains how tax rate cuts can increase tax revenues through tax compliance spillovers in such a manner.

…This paper shows that endogenous tax compliance responses can be responsible for the massive increase in tax revenues. The key intuition is that tax regimes are prone to spillovers, as the aggregate behavior of taxpayers determines how much time the tax authority can dedicate to the individual taxpayer. In a way, tax evaders protect each other by tying down the tax authority’s limited capacity. Hence, small cuts in the tax rates can lead to much larger changes in the behavior of taxpayers — most importantly, it can make them much more likely to declare their incomes honestly. These spillovers can lead to increasing tax revenues.

…taxpayers evade less tax payments when the tax rate is lower… evasion increases with the tax rate.

…Three cases could be highlighted. First, countries with high official tax rates and relatively weaker tax authorities, such as some of the transition economies, might benefit from tax rate cuts and improving compliance. Second, the model might be also relevant for countries with high tax rates, even if tax enforcement seems to be strong in absolute terms. Third, low tax countries which have particularly weak tax enforcement could also think about improving tax compliance via tax rate cuts.

It’s Not My Fault They’re Kissing

My friend Blake Hounshell (he’s actually a friend, not “my friend” in the Washington sense) has a post up at FP Passport observing President Bush’s and Saudi dictator King Abdullah’s latest canoodling. In that post, Blake argues that

if you’re a gasoline-consuming American, you’re deeply complicit in this marriage, too. So laugh all you want at Bush, but he kisses Saudi cheek for thee—just as U.S. presidents have done for decades.

To which I would respond “baloney!” There’s nothing about the fact that we–or Europe, or China, or Japan–consume oil that mandates that we play kissy-poo with Abdullah or anybody else. There are a few theories why we would want to kiss up to the Saudis, and none of them hold water. The first is that the Saudis, who control 25% of the world’s proven oil reserves, make production decisions based on political relationships rather than economic considerations, and therefore when we kiss up to them, we increase the likelihood that they’ll make production decisions that are in our interests (and in contravention of their own). Like now, for example, the president is pleading that OPEC members increase production so as to tamp down the price of gasoline in the U.S.

As my colleague Jerry Taylor is wont to point out, however, “no amount of ‘get tough’ rhetoric or ‘pretty please’ diplomacy has ever affected OPEC production decisions, despite what American politicians would have you believe.” So that theory needs reworking.

There’s also the belief that we need to keep a close relationship with the Saudis to shore up our position in the region and resume the pursuit of our *ahem* traditional goal in the region of “promoting stability.” But this theory, too, leaves a lot to be desired. Our traditional posture in the Middle East has essentially amounted to a transfer payment from U.S. taxpayers to the Saudi Royal Family and the oil companies it runs. (Kuwait and the GCC countries, too.) Essentially we cover a substantial amount of the cost that it takes to defend these countries from prospective predators. But one has to ask “What would the Arabs do in the absence of an American security commitment?” 75% of the Saudi government’s revenue comes from oil. 45% of the country’s GDP comes from oil. Are we to assume that, absent a U.S. security commitment, the Saudi royal family is just going to cower in a defensive crouch and leave that money on the table for any rogue actor in the region to swoop in and take? Seems unlikely. The royal family seems much more interested in preserving itself and expanding its wealth than that.

To the contrary, it seems more likely that they would spend more, and get more serious about defending themselves from outside threats. Now, one could make the argument at this point that the Arabs in recent years have not proved themselves to be particularly formidable opponents on the battlefield, which is persuasive to a point. But even if, say, Iran made the remarkably rash move of launching a war against Saudi Arabia, Saudi’s defense budget dwarfs Iran’s and Saudi’s military technology is decades ahead of Iran’s. Even if they were to begin losing a conventional conflict against (hypothetically, again) Iran, standoff forces like long-range U.S. bombers could zoom in to restore the status quo ante without batting an eyelash.

So I’m left wondering why, exactly, it’s American gasoline consumers who are forcing U.S. presidents to suck up to Abdullah and the Saudi Royal Family. Any theories are hereby welcomed. In the meantime, please do give a read to Eugene Gholz’s and Daryl Press’s Policy Analysis titled “Energy Alarmism: The Myths that Make Americans Worry about Oil” for much more detail, and data that informed my arguments above.

Ethanol Program Milks Consumers Dry

Have you noticed how the price of milk has shot up in the past year? A big chunk of the blame lies with Congress and the ethanol program.

In its effort to promote the fantasy known as “energy independence,” the U.S. Congress favors the ethanol industry with a 51-cent-per-gallon exemption from the federal gasoline tax, and a 54-cent-per-gallon tariff on imported ethanol. By artificially stimulating the domestic ethanol industry, the program has created an insatiable demand for corn, driving up feed grain costs for dairy farmers, leading to higher prices for milk.

I’ve often disagreed with Sen. Chuck Schumer (D-N.Y.) on trade issues, especially his threat to slap tariffs on imports from China, but on this issue, the senator has positioned himself as the American consumer’s best friend. According to a story this week in the New York Daily News:

“Ethanol has increased the average American’s grocery bill $47 since July,” said Sen. Chuck Schumer, citing figures from Iowa State University.

Schumer (D-N.Y.) is pushing for an immediate end to the 54-cent-per-gallon tariff on ethanol imports as a way to increase the supply of the federally mandated fuel additive, reduce pressure on the corn market and bring down milk prices.

“Bring the cheaper ethanol in, reduce the price of corn, and then reduce the price of milk,” he said.

The senator is on to something. While were at it, let’s eliminate remaining U.S. tariffs on imported shoes, clothing, sugar, rice, cheese and, yes, milk.