Transcript OECD - Konzervativizmus

How to Finance
the State
May 18, 2010
Free Market Road Show
Two Major Issues
What is the
appropriate role of
government?
The classical liberal
vision of small
government.
Or the welfare state
vision of large
government.
How should
government be
financed?
Broad-base and lowrate system
designed to
minimize distortions.
Or a tax code as a
tool of social policy.
What Should Government Do?
There are certain core functions of government
- including national defense, legal system, and
public safety.
The more governments stray from these core
functions, the less likely they are to be
competent in any area.
The more governments stray from these core
functions, the higher the tax burden.
This means less growth.
Government Spending and Growth
If government spending is zero, presumably
there will be very little economic growth because
enforcing contracts, protecting property, and
developing an infrastructure would be very
difficult. Some government spending is
necessary to uphold the rule of law.
Government spending reduces growth, however,
when the public sector becomes too large,
leading to punitive tax rates and misallocation of
labor and capital.
The “Rahn Curve”
There is a “Rahn
Curve” relationship
between government
spending and
economic growth
similar to the “Laffer
Curve” relationship
between tax rates
and tax revenue.
Empirical Estimates of the Rahn Curve
Academic studies generally find that the
growth-maximizing level of government is 17
percent-23 percent, though a European
Central Bank study put the figure as high as
30 percent.
Every single western nation spends above the
growth-maximizing level in these studies.
Because of data limitations, the actual
growth-maximizing level of spending
presumably is lower than shown in the
studies.
What About Wealthy Welfare States?
Don’t Europe’s welfare states show that big
government is not an impediment to growth?
No. They became rich because they used to
have small public sectors and laissez-faire
policy (indeed, still have laissez-faire policy).
Government expanded after they became
wealthy and could afford anti-growth policies.
A nation (or state) can tolerate one percent
growth once it is rich. But a poor nation (or
state) will never become rich with one
percent growth.
Burden of Government Used to be Small
50
Expenditures as a percent of GDP
45
Sweden
40
UK
35
US
30
Japan
25
Germany
France
20
15
10
5
0
1870
1913
1920
1937
Source: Tanzi and Schuknecht, "Reforming Government: An Overview of Recent Experience,"
1960
What Have We Learned?
Fiscal Policy is just one of many variables that
impact economic performance.
Government spending for “public goods” can
contribute to better economic performance,
but most types of government spending
reduce growth.
The growth-maximizing level of government
spending is probably less than 20 percent of
economic output.
What is Good Tax Policy?
Tax Income at one low rate, ideally far lower
than 20 percent.
Define the tax base correctly, taxing Income
only one time.
Tax all income alike, since neutrality ensures
economic criteria rather than tax provisions
determine resource allocation.
Tax only income earned inside national
borders, the common-sense notion of
territorial taxation.
Why Have a Low Tax Rate?
The marginal tax rate – the burden on the
next increment of income – must be kept low.
A low marginal tax rate rewards productive
behavior. People will work more, save more,
and invest more.
Incentives to hide, shelter, under-report
income are lower when the marginal tax rate
is reasonable.
Research indicates that the marginal tax rate
should be no higher than 20 percent.
Why Tax Income Only One Time?
Many nations impose multiple layers of tax
on income that is saved and invested.
This is the wrong definition of the tax base.
Taxes on interest, dividends, capital gains,
and inheritances are examples of the
discriminatory treatment of capital.
This is a self-destructive policy since it harms
the activity – capital formation – that all
economic theories agree is necessary for
economic growth and rising living standards.
Why Loopholes Are Bad Policy
Special provisions in a tax code are
economically inefficient because they lure
people into decisions that only make sense for
tax reasons.
Exemptions, deductions, credits, and other
preferences create opportunities for corruption.
High tax rates and double taxation increase
incentives for taxpayers to seek loopholes. Low
rates make special provisions less attractive.
Territorial Taxation
The good-fences-make-good-neighbors
approach to tax policy.
If economic activity occurs inside America’s
borders, America should tax it.
If economic activity occurs inside Germany’s
borders, Germany should tax it.
The opposite approach – worldwide taxation
– necessarily causes headaches and usually is
a source of conflict.
The Flat Tax Is the Answer
A low tax rate.
No double taxation of income that is saved
and invested.
Neutrality, meaning no special preferences of
special penalties.
Territorial, so taxpayers can compete on a
level playing field.
Simplicity – two postcards.
The Barack Obama Flat Tax
What did you
make last year?
Send it in
Growing List of Flat Tax Nations
30
0
1987
1992
1997
2002
2007
2008
2009
A Word of Caution
No flat tax system fully satisfies the
theoretical ideal of one tax rate, no double
taxation, and no loopholes.
Some jurisdictions, such as Hong Kong,
Estonia, and Slovakia, have remarkably good
systems.
Others are less impressive, and others are too
obscure to make meaningful assessments.
Responding to Critics
Opponents of tax reform argue that high tax
burdens on saving, investment, and assets
prevent an “unfair” concentration of wealth.
No evidence for this hypothesis.
These policies diminish economic growth and
capital formation, and this primarily hurts
lower-income people.
Opponents fail to realize that the goal is
upward mobility and economic expansion, not
simply new ways to divide an existing pie.
Growth, Not Redistribution
Compassion is not defined by seizing and
spending someone else’s money.
It is far more compassionate to create a
society that gives people the opportunity to
get a good job that pays a good wage.
In the U.S., there is dramatic income mobility
as many rich people lose wealth and many
poor people climb out of poverty.
Winston Churchill defined socialism as the
equal sharing of the misery.
Conclusion
High tax rates are bad for growth.
High tax rates increase tax avoidance and tax
evasion.
High tax rates do not raise much revenue –
and may reduce revenue.
High tax rates on saving and investment are
especially damaging to economic
performance.
Special preferences are economically
inefficient and morally corrupt.