Transcript OECD

Harmonization vs.
Competition: Fiscal Union
vs. Decentralization
Free Market Road Show,
April 27, 2012
Defining the Problem
There is no “European” problem.
There is no “Eurozone” problem.
There is no “Euro” problem.
There is a problem of many nations taxing
too much and spending too much.
This is leading to anemic economic
performance.
International investors don’t trust some
nations to pay thir bills.
Making Bad Policy Even Worse
Proposals for tax harmonization and/or a
fiscal union will exacerbate the problems in
Europe.
No economic rationale for identical/similar tax
rates.
No economic rationale for fiscal transfers.
Look at the U.S., particularly in the past.
Look at Switzerland today.
Growth Matters…a Lot
Years Needed to Double Economic Output
7 percent growth
6 percent growth
5 percent growth
1
4 percent growth
3 percent growth
2 percent growth
1 percent growth
0
10
20
30
40
50
60
70
80
Definition of Good Fiscal Policy
Government spending should grow slower
than nominal GDP.
Over time, this reduces burden of public
sector.
Eliminates risk of higher taxes.
Deficits eventually disappear.
Debt shrinks as share of GDP.
Politicians don’t like this approach since they
can’t buy votes with other people’s money.
Size of Government Matters…a Lot
There is a “Rahn
Curve” relationship
between
government
spending and
economic growth
similar to the “Laffer
Curve” relationship
between tax rates
and tax revenue.
Big Government Inevitably…
…Erodes a Nation’s Social Capital
Demographics Is Fiscal Destiny
Ageing populations and welfare states are an
unstable combination.
Pay-as-you-go systems are Ponzi schemes.
Not enough future workers to support
redistribution programs.
Without reform, massive debt or massive tax
increases.
Probably both
Two Workers per Retiree
Increased Burden of Gov’t Spending
The Sovereign Debt Crisis
Greece was the tip of the iceberg
Ireland was phase two.
Spain and Portugal phase three.
Italy and Belgium phase four.
Japan in a special category.
Almost all other industrialized nations are on
this path.
Rare exceptions such as Australia, perhaps
Switzerland and even Sweden.
Where Is the Debt Tipping Point?
Rogoff and Reinhart say 90 percent of GDP is
the danger zone.
Depends on the nation.
Industrialized world has breathing room.
Greece got in trouble over 100 percent.
Japan still doing fine at 200 percent.
Spain and Portugal in trouble at less than 90
percent.
France – 400 Percent of GDP
Germany – 300-plus Percent of GDP
Greece – 400 Percent of GDP
Ireland – 300 Percent of GDP
Italy – 250 Percent of GDP
Netherlands – 400 Percent of GDP
Japan – 600 Percent of GDP
Portugal – 300 Percent of GDP
Spain – 300 Percent of GDP
U.K. – 500-plus Percent of GDP
U.S. – 450 Percent of GDP
Implications for Tax Policy
Burden of government spending will increase
by at least 10 percentage points of GDP.
BIS model shows worse results, driven by
interest assumptions.
That won’t happen because it means an end
to Western civilization.
But what will happen?
In Europe, some nations will default and
leave the euro (so they can inflate).
Can Europe Tax to Prosperity?
Taxes on personal income averaged 9 percent
of GDP as of 2008.
VAT rates already average more than 20
percent.
Payroll tax rates also very high in most
European nations.
A reverse of trend of lower corporate rates is
almost certain.
But…
Revenge of the Laffer Curve?
Politicians can increase tax rates, but that
does not necessarily mean they collect more
tax revenue.
If economic growth slows, taxable income
also slows.
If incentives to avoid and evade rise, taxable
income slows even more.
America conducted a Laffer Curve experiment
in the 1980s.
Tax Rates, the Rich, and Revenue
In 1980, there were
116,800 rich people.
Those rich people
reported $36.2
billion of income to
the IRS.
They paid $19.0
billion of income tax
to the federal
government.
Tax Rates, the Rich, and Revenue
In 1980, there were
116,800 rich people.
Those rich people
reported $36.2
billion of income to
the IRS.
They paid $19.0
billion of income tax
to the federal
government.
By 1988, there were
723,700 rich people.
Those rich people
reported $353.0
billion of income to
the IRS.
They paid $99.7
billion of income tax
to the federal
government.
What Should Be Done?
The answer is simple – just restrain the
growth of spending, as U.S. example shows.
If nominal revenue is projected to grow 7
percent each year, as CBO projects, red ink
can be reduced if spending grows by a lesser
amount.
A freeze balances the budget by 2017.
Letting spending grow by 2 percent each year
means fiscal balance in 2022.
Balancing the Budget with Spending Restraint
5,000
4,500
Current Spending
$Billions
4,000
3,500
Revenues (w/tax cuts)
3,000
Spending Freeze
1% Spending
2% Spending
2,500
2,000
2011
Source:
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Other Nations Have Reformed
Good fiscal policy does not require miracles,
just spending restraint.
If spending grows slower than nominal GDP,
good things happen.
Greater levels of fiscal restraint mean quicker
progress.
If spending grows faster than nominal GDP,
sooner or later a nation becomes Greece.
But sometimes nations do the right thing.
Ireland Restrains Growth of Spending and...
25
Billions
20
15
10
5
0
1985
Source: Economist Intelligence Unit
1986
1987
1988
1989
...Burden of Government and Deficit Both Shrink
80
Budget Deficit
Deficit as Share of GDP
12
70
10
60
8
50
Government Spending
6
40
4
30
2
0
20
1985
Source: Economist Intelligence Unit
1986
1987
1988
1989
Government Spending as Share of GDP
14
New Zealand Restrains Growth of Spending and...
50
Billions
45
40
35
30
25
1990
1991
Source: Economist Intelligence Unit
1992
1993
1994
1995
...Burden of Government and Deficit Both Shrink
5
Budget Deficit as Share of GDP
4
Government Spending
3
50
2
Budget Deficit
1
45
0
-1
1990
1991
1992
1993
-2
Budget Surplus
1994
1995
40
35
-3
-4
Source: Economist Intelligence Unit
30
Government Spending as Share of GDP
55
Canada Restrains Growth of Spending and...
450
Billions
400
350
300
1992
Source: Economist Intelligence
1993
1994
1995
1996
1997
...Burden of Government and Deficit Both Shrink
65
Budget Deficit
8
6
55
4
Government Spending
2
45
0
1992
1993
-2
Source: Economist Intelligence Unit
1994
1995
1996
1997
35
Government Spending as Share of GDP
Budget Deficit as Share of GDP
10
Conclusion
Three challenges for Europe
Correctly identifying the problem – big
government is the disease. Deficits and
debt are symptoms.
Figuring out ways to “bend the cost curve”
of government spending.
Convincing voters that liberty is better than
dependency – particularly when
dependency means fiscal disaster.