Economics, Pethokoukis

More evidence that the EU’s tax hike austerity is failing

Wolfgang Munchau in the FT:

The deterioration in Italy’s debt sustainability will become much clearer next year, as we get more statistical evidence of the calamitous effect of austerity. The effects are already being felt before the 2013 budget kicks in. The tax burden on Italian families almost doubled this month – a result of the introduction of a new property tax system – which has had the immediate effect of killing off the pre-Christmas retail business. Confcommercio, an association of service companies, estimates a consumption fall of 13 percent.

Then we have the French Solution. That’s not working out so great, either:

France’s most famous leading man, Gérard Depardieu, has joined the flight of France’s wealthy to less tax-heavy destinations, establishing his residency in the Belgian border town of Néchin.

A local mayor told French and Belgian media that seeking a respite from high taxes was just one of Depardieu’s reasons for leaving his native country. “He wanted to find a home in Belgium to escape France’s taxes, but he could have also moved to Brussels,” Mayor Daniel Senesael told Belgium’s RTBF television on Sunday. “He wanted to leave Paris, its noisiness, and find a little bit of calm, peace and serenity.” ,,,

His self-imposed exile will make him one of the highest-profile celebrities to ditch France because of the country’s stiff taxes on high earners. French President François Hollande has made good on his campaign promise to tax revenues above €1 million at a rate of 75 percent.

While these two examples are of different tax phenomena — one a wealth tax, the other a superhigh tax on incomes — they both suggest that jacking up taxes in high-tax Europe is a self-defeating proposition. They also provide some real-world reality checks for those suggesting the U.S. has little to fear from dramatically higher taxes.

20 thoughts on “More evidence that the EU’s tax hike austerity is failing

  1. Talk about your epistemic closure…. Here is the self same Munchau com complaining in the self-same FT about Germany’s fuzzy headed lefties: “What is most infuriating is the SPD’s sheer inability to explain in a clear way why the chancellor [Angela Merkel] is wrong. The reason for this inability is that the party has bought into the same panoply of false crisis narratives. It bought into the lie about fiscal profligacy as the cause of the crisis, and the need for austerity to solve it.”

    Here is a terrific Economist article making an excellent case that it is not epistemic closure that causes Mr. P to seize on Munchau’s few lines on taxes rather than his real point. http://www.economist.com/blogs/democracyinamerica/2012/12/austerity-and-right

    “My feeling is that what we’re seeing here are inherent political weaknesses in the anti-austerity message itself. Asking voters to embrace that message means asking them to approve of the government borrowing money which will add to their repayment burden as taxpayers, and then spend that money on other people. In Europe’s case, you’re asking Germans and Dutch to take on more public debt in order to increase demand for Spanish, Greek and Italian exports. In America’s case, you’re asking well-off Americans to take on more public debt, and then spend the money on food stamps, unemployment insurance, and health care for poor people.”

    I can see the European reluctance. But Americans who aren’t willing to help Americans strike me as being unAmerican.

  2. Balancing a budget through a majority of tax hikes is doomed to failure. Historically, tax revenue as a percentage of GDP is rarely above 19.0%, regardless of the tax rate. In fact, since the Great Depression, it has never topped 20.9%. The reason for this is simple: taxes change people’s behaviors. People will move their wealth into tax havens, move themselves into tax havens, or simply decide to marginally reduce their work.

    So, if government revenues are not dependent on the tax rate, what are they dependent on? Growth. If you cannot gain a higher percentage of tax income per GDP, than your best course of action would be to pursue pro-growth policies. Taxes, by definition, are not pro-growth (this is a fact accepted by both the right and the left. However, it is selectively understood by both parties as well. A leftist, for example, will willingly acknowledge a tax on carbon reduces carbon emissions, but then refuse to acknowledge a tax on productivity will reduce productivity).

    What are pro-growth policies that can be pursued? Well, let’s look at the components of GDP:

    GDP = C+I+G+NX, where
    C = Private sector consumption
    I = Business Investment
    G = Government Spending
    NX = Net exports (exports – imports)

    Policies could fuel consumption through things like low interest rates or debt forgiveness. However, encouraging consumption that people cannot afford is a recipe for disaster (as we saw in 2008).

    Policies could target investment. However, mal-investment is just as bad.

    What about government spending? Well, if you are trying to raise revenues to fight the deficit, increasing spending isn’t really the way to go about it.

    Net exports? How about protectionist trade policies? Well, that is a huge problem. All one needs to do is look at the monster failure that the Smoot-Hawley Tariff was to realize that is a bad idea. Besides, NX is a red herring. Trade is beneficial both ways, to favor one side over the other is foolish. It is not the trade balance that determines a country’s well-being, but rather its trade volume. The more trade a country does, the better off they are (assuming the trade is reciprocal, but I cannot imagine a country would be dumb enough to ship all their goods overseas for nothing in return).

    So what exactly can be done? Well, remember that GDP is Gross Domestic Production. As Say’s Law tells us, Production proceeds consumption, so our economic policies should focus on production.

    Now what, exactly, is production? Production for the sake of production is an empty promise. Production is the generation of goods and services people are willing to consume. For example, we could spur production by creating a billion stagecoaches, but if no one wants them, what good is it? No, firms must produce goods and services consumers are willing to buy.

    But how do they know what consumers are willing to buy and how much they will buy? Prices! Prices convey local knowledge (that is, information known only to a few) to where it is needed. For example, if the price of apples is high, then firms know consumers want more apples. Firms will then produce more apples and less oranges.

    So, any policy that distorts prices is inherently anti-growth, as prices convey demand to suppliers. Policies that distort prices include (but are not limited to) price controls, regulations, minimum wage (prices for workers), interest rate manipulation (interest rates are the price for loans), tariffs, and occupational licenses.

    By reducing the distortions in the price information, we can prevent the misallocation of resources to unproductive means. Regardless of the intent of the policy, anything that distorts prices leads to mal-investment; a false boom is created, and it will subsequently burst. This is what we saw with housing in 2008 and what we will see in bonds sometime later this decade.

    If you really, and I mean really want to solve the debt problem, one needs to look beyond taxes. They will only help in the very short run. Look to the pro-growth policies outlined above.

    • One other pro-growth policy I touched on, but didn’t go into a lot of detail is trade.

      Voluntary trade is, by it’s definition, mutually beneficial. Anyone who believes that trade is merely a transfer of wealth, nothing more than a zero-to-negative sum game is a walking example of his own fallacy.

      Trade occurs between individuals all the time and it makes both of them better off. The geographic location of the traders is irrelevant. I live in New Hampshire. Whether I choose to buy my t-shirt from a sewer in Concord, Massachusetts, the Mid West, or Vietnam does matter protectionism is not only anti-growth, but a clear violation of my consumer right to choose. Protectionism is a bad policy choice to spur growth (in fact, the majority of protectionist arguments are not based on economic foundations. They are special-interest laden and are not much more than thinly-veiled xenophobia).

    • To mix asset prices and consumer prices is apples and oranges. We buy fruit because we are hungry,and, yes, low prices drive demand. We buy Internet stocks, farm land, tulips or spec houses because prices are high and getting higher at such a rate that greed trumps common sense. (Spare me the Austrian School lecture; Prehistory surely featured obsidian bubbles.)

      The Japanese bubble burst in 1991; What followed was a lost decade, followed by a second lost decade. Progrowth doesn’t cut it. What we need is pro-demand.

        • Nobody comes to the metaphorical negotiation table and says: “here is my money. I hope, at some point, you will produce something I want.”

          No, every trade involves goods produced. In order for trade to occur, both parties need to have produced something so that they can trade.

        • Companies are sitting on $1 trillikon in cash waiting for some sign of demand out there. I am not a purist., Spme times iproduction is the problem, Some times it is demand, Today it happens to be demand.

          • The demand is there. In record numbers, I might add. Retail Sales (excluding autos, adjusted for inflation) is a record $2.12 trillion for the 12-months ending in October. When you add in autos, it is a record $2.60 trillion

            No, firms are sitting on cash for more reasons than “lack of demand”, not the least of which is tax uncertainty. Businesses have been promised higher taxes for each of the past four years. They don’t know what their tax bill will be, so they are holding on to cash as an insurance policy.

            Additionally, many firms got burned in the credit crunch. Wanting to avoid such a problem should another recession occur, firms have built a nice nest egg (this is one of the reasons I suspect the recession late next year will be mild).

            Firms are holding on to cash, but lack of demand is not a reason why.

          • When one looks at the recent business climate in America, is it really any surprise businesses aren’t spending and investing their money?

            We didn’t know the legality of Obamacare until this past June. We still don’t know how much it will cost.

            Much of Dodd-Frank has yet to be written. Some 300 regulations of it will go into effect on Jan 1.

            When was the last time there was a federal budget with taxes laid out?

            Basel III could greatly affect lending and borrowing ability.

            Retroactive taxes are a favorite of Congress (despite the fact they are blatantly illegal) making businesses fear any actions they take now will bite them later in the tax department.

            Talking with our clients, they all say the same thing “We’re busier than we have been in a long time, but we just can’t plan for the future. We have no idea what our taxes will be, what the new rules are, and what our legal obligations are.”

        • Asset prices are no different from consumer prices. If housing prices are high, for example, then it instructs contractors to build more houses. If Wal-Mart’s stock price is high, it instructs more entrepreneurs to build big-box stores.

          And if those prices are distorted, by say an overly generous housing policy or favorable equity policies, then resources are misallocated and we get bubbles.

          Now, this is not to say that a free-market would not have bubbles. Bubbles will happen, which is why recessions can be a good thing. A recession is the market mechanism for correcting misallocation of resources. But let’s not artificially create more bubbles, or create an environment where bubbles are more likely to happen. That is counter-productive.

          • The Chinese are dead serious about avoiding a real estate buibble: raising second-home downpayments to 60 percent; setting higher interest rates for mcmansions; taxing raw land profits at 60 percent.

            The problem is animal spirit. Overly generous housing policy? Seriousy? Japan is as homogenous and frugal as societies get. How do you explain 100-year mortgages there? The Chinese are right to try to avoid a bubble that sucks up wealth and then vaporizes it. Yes, try,

        • car sales and housing starts are back to Jan 08 and July 08 levels respectively . But the confidence fairy business is silly, as evidenced by the fact that confidence and sales started improving in September, well before a certain, seminal vote on economic.policy. Apple and Amazon are going full throttle. If demand was there, business would meet it, which isn’t to say that business has a right to be worried about dysfunctional govt.

          On housing bubbles, a little internal consistency might be nice. You say ours was caused by govt. policies. You say China may not be able to stop its bubble despite measures that would have AEI buffs redfaced and spitting (and I share that view.) So then you are in tacit agreement anyway that animal spirit IS a factor in economies.

          • Well, hang on. I didn’t say our housing bubble was caused by government policies. What I did say is government policies created an environment where the bubble was allowed to flourish. The government (by which I include semi-government agencies like Fannie and Freddie and the Fed) are hardly the sole cause of the housing bubble, but their actions did help perpetuate it.

            Regarding China, I am just not too sure how effective their policies will be. Government policies have both long term consequences and short term consequences. It is all too easy to look at the short term consequences and declare victory or defeat, while ignoring the long term consequences. Much is still to be seen in China.

            I do believe that the “animal spirits” play a part in the economy. People are people and they are prone to bouts of irrationality, even in the absence of government intervention. Look at the DotCom bubble, for example. It is precisely because of these animal spirits that I advocate that the government restrain itself in the economy and avoid price distortions. When a system is already prone to bubbles, do you really want to fuel that fire?

            I will tell you something: as you correctly noted earlier, I am an Austrian economist. However, my conversion is quite recent (about the last 3 years or so). I was a follower of Keynes. I understand and appreciate the Keynesian theories regarding economic activity and the role of the government. However, something never quite sat right. Keynes never addressed the problem of knowledge. He always assumed that the right knowledge in the right hands could achieve the right results. But that knowledge is spread out, decentralized, and localized. There is no possible way that a governing body could have the information needed to make proper economic decisions. There are approximately 330 million people in this nation. No way in Hell the government can make the right choice for 330 million, or even the majority. Besides, how do we know that the options they choose will not make somebody worse off than before? We do not.

            The problem with Keynes is that he sees everything in aggregate. A general glut. But not everything is in a sick. There are some segments of the economy that are healthy. By imposing a “one size fits all” cure, then the damage cannot be contained. The contagion of the bust may spread to healthy industries as resources are misallocated.

            I think Keynes was a great thinker, but he relies too much on the confidence theory. His policies require a nearly omnipotent government to be successful. Save God Himself, no one is omnipotent. Quite frankly, any policy that requires “the right people” is doomed to fail. We will not know whether or not the people chosen are “right” until it is far too late.

          • By the way, the first sentence of my last paragraph should read “…relies too much on the confidence fairy” not “confidence theory.”

            I really need to start proofreading my stuff.

  3. I have gone the other way, thinking, well, goodbye to the efficient market theory. But there is always the wisdom of crowds. Except that crowds seem particularly dumb lately, too. I do find comfort in game theory. Sooner or later, people realize that we are all in this together. Thanks for your reasoned, gracious responses. My apologies if I mine weren’t. Modulating is not one of my strengths.

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