FRIDAY GRAPH: TAX RATES AND TAX REVENUE

In a recent article Is ‘Tax the Rich’ Good Policy? (ODT 25 April 2011), I made the point that those in the top income brackets in New Zealand are already taxed relatively heavily by international standards.

I also noted that because cuts to high tax rates encourage economic growth and reduce tax avoidance, they may actually produce more government revenue.

And I quoted President John F Kennedy who said, when cutting US tax rates in the 1960s, “It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise revenues in the long run is to cut rates now.”

This chart from Mark Perry’s blog Carpe Diem illustrates these points.

 

As Perry comments:

The chart above shows the relationship over time (from 1979 to 2007) between: a) the top marginal income tax rate, and b) the share of total income taxes paid by the top 1%). In 1979 the top marginal income tax rate was 70% and 18.3% of the total taxes paid were collected from the top 1% of taxpayers. By 2007 the top tax rate was 35% (half of the 1979 rate), and the tax share of the top 1% had more than doubled to 39.5% (from 18.3% in 1979).

The historical record shows an inverse relationship between the highest marginal income tax rate and the share of taxes collected from “the wealthy.” It’s a relationship to keep in mind during the current tax policy debate, where Obama wants to increase tax revenues by raising tax rates for “the rich,” and Rep. Ryan alternatively suggests a cut in the top marginal rate to stimulate economic growth, which would likely increase tax revenues from the wealthy, and increase overall tax revenue.

Note that this is not a Laffer curve argument that tax cuts are self-funding.  Normally they aren’t.  However, the loss of revenue over time from cutting inefficient taxes is less than the initial static loss because they encourage economic growth and expand the tax base.

Note also that higher income people pay more – a lot more – even with a flat or proportional tax.  Leaving aside the likelihood in practice of more favourable treatment for those at the bottom, a person on $25,000 pays $2,500 in tax under a simple flat 10% rate whereas someone on $250,000 pays $25,000.

COMPULSORY SUPERANNUATION: A POLICY IN SEARCH OF EVIDENCE

This is an interesting article by Brian Toohey, a respected Australian financial journalist.

A school of thought in New Zealand has favoured the adoption of Australia’s compulsory superannuation regime.  But Toohey writes:

To this day, there is still no detailed policy report showing that net economic and social gains flow from forcing employees to hand over a growing slice of their salary to the richly rewarded fund managers in the nation’s booming financial sector.

The union movement in Australia strongly backed the scheme (which has boosted union influence in Australian economic life).  But Toohey writes:

Several younger union officials now say privately that they believe the majority of their members would be better off if compulsory super contributions were paid instead as a normal part of salaries, letting all employees decide how best to allocate their income over the course of their working life …  Some older union officials like to portray money diverted compulsorily to super as a free gift from employers. It is not. It is money that could otherwise be paid as wages – a point that the superannuation minister (and former Australian Workers’ Union secretary) Bill Shorten candidly acknowledges.

This is correct.  Like other non-wage labour costs (such as ACC levies), the initial incidence is on employers but the costs are ultimately borne largely by employees.  (In competitive markets firms have no choice but to shift the burden – they have to maintain returns which cover their cost of capital.)

Toohey reports on recent APRA figures which received wide coverage in Australia:

The Australian Prudential Regulation Authority recently released figures showing that the average nominal annual super fund return over the ten years to 30 June 2011 was a pathetic 3.3 per cent. Given that the average annual increase in the CPI over that period was 3.2 per cent, returns only beat inflation by the slimmest of margins. Australians would have been better off putting their money into government bonds and term deposits, or reducing their mortgage or upgrading their educational qualifications or those of their children.

A corollary of this finding relates to the impact of the scheme on economic growth in Australia.  Some people argue that a similar scheme here would boost growth in New Zealand.  I have never seen any account of Australia’s improved economic performance over the past 25 years that attributes it to compulsory superannuation.  Rather, the main explanation is the economic reforms initiated by the Hawke and Keating governments and carried on by John Howard.  These figures suggest why compulsory savings have not been a significant factor, at least over the past 10 years: the returns to the scheme have been poor and capital has been misallocated.

The Australian Productivity Commission has amplified this point as Toohey notes, saying:

Compulsory saving imposes a deadweight loss as it distorts decisions about which savings vehicles to use, as well as between consumption and savings.  In particular, younger people may be less able to invest in their preferred mode of savings (for example, owning their own home, which is a tax effective savings vehicle and offers social benefits).

There are other drawbacks with compulsory savings.  Toohey notes that fees paid to fund managers and administrators now amount to about $18 billion a year.  Last year it was reported that around $10 billion in superannuation accounts had gone missing – the owners of the lost accounts could not be tracked down.  The legislation backing the scheme has been endlessly tinkered with – over 2000 amendments to it had been made at last count – and further amendments are currently being debated.

Perhaps considerations such as these led the recent Savings Working Group not to recommend a compulsory savings scheme for New Zealand.

The Spirit Level 2

The Sunday-Star Times and journalist Anthony Hubbard in particular appear to have embarked on a crusade against inequality in New Zealand, motivated by the 2009 book The Spirit Level by British academics Richard Wilkinson and Kate Pickett (neither of whom are statisticians or economists).

To read the Sunday Star-Times you would never know that the book has been subject to devastating criticisms.

I had a lengthy blog on the book on 22 December, citing several references.

I also wrote this article which appeared in the Sunday Star-Times of 30 January.

For a biting short summary of some of the criticisms, see this article titled ‘If you want something trashy to read on the beach, I’ve got a recommendation’ by Toby Young in The Spectator of 14 August 2010.

Young refers to a paper by Peter Saunders published by the London think tank Policy Exchange which can be found here.

Saunders writes that the message of The Spirit Level, that redistribution is the cure of most social ills:

… has received an enthusiastic reception from politicians and pundits on the left who believe The Spirit Level offers a rational, evidence-based justification for the radical egalitarianism to which they have long been emotionally committed. However, careful evaluation and analysis shows that very little of Wilkinson and Pickett’s statistical evidence actually stands up, and their causal argument is full of holes.

He goes on to say:

In this report, Wilkinson and Pickett’s empirical claims are critically re-examined using (a) their own data on 23 countries, (b) more up-to-date statistics on a larger sample of 44 countries, and (c) data on the US states. Very few of their empirical claims survive intact.

And Saunders sums up:

This report shows that The Spirit Level has little claim to validity. Its evidence is weak, the analysis is superficial and the theory is unsupported. The book’s growing influence threatens to contaminate an important area of political debate with wonky statistics and spurious correlations. The case for radical income redistribution is no more compelling now than it was before this book was published.

According to a chart in the Sunday Star-Times, Australia comes just under New Zealand on the measure of inequality used.  There seems to be little political support in that country for the kind of redistributive measures advocated by Wilkinson and Pickett: the emphasis is, correctly in my view, on economic reform to lift all incomes.

I agree with Toby Young that the book “belongs in the trash pile”. Others are free to disagree, but if they do it is dishonest not to acknowledge the criticisms and engage with them.

A Perspective on Ireland’s Economy

Philip Lane is Professor of International Macroeconomics at Trinity College Dublin.  He is also a managing editor of the journal Economic Policy, the founder of The Irish Economy blog, and a research fellow of the Centre for Economic Policy Research.  His research interests include financial globalisation, the macroeconomics of exchange rates and capital flows, macroeconomic policy design, European Monetary Union, and the Irish economy.

Last week he visited New Zealand as a guest of the Treasury, the Reserve Bank, and Victoria University.  During his visit he presented this guest lecture on the troubled Irish economy, drawing on his recent report to the Irish Parliament’s finance committee on ‘Macroeconomic Policy and Effective Fiscal and Economic Governance’.

Some highlights from his talk (also reported here by Brian Fallow in the New Zealand Herald) were:

  • Ireland’s is a real depression: 15% fall in GDP 2007-2010
  • The Celtic Tiger 1994-2001 was no mirage
  • The domestic bubble (2003-2007) was partly the result of Ireland’s membership of the Eurozone, which produced interest rates that were too low for a booming economy.  When it burst, the problems were compounded by the global crisis
  • The banking crisis followed.  The excessive government guarantees to subordinated and senior bondholders were a major mistake (although bank shareholders were punished)
  • This precipitated the fiscal crisis, with successive austerity budgets and ultimately the EU/IMF bailout
  • Ireland has ‘bitten the bullet’ with cuts to public spending, wages, the minimum wage and welfare (although the cuts return most payments to around 2006 levels).  This amounts to an ‘internal devaluation’ given the fixed currency, and has boosted prospects for the real economy
  • The consensus in Ireland is to return to the core principles of the ‘Celtic Tiger’ era.

Asked whether Ireland would raise the 12.5% tax rate on inward investment, Professor Lane’s answer was, “never, ever”.

His account of Ireland’s rise and fall contrasts starkly with those of critics who saw Ireland’s predicament as a failure of ‘the neoliberal model’.

An example is this article by New Zealand journalist Alison McCulloch (‘Folly of Tiger is a warning for New Zealand’, New Zealand Herald, 24 April 2010).

I wrote this article in reply but the Herald declined to publish it.

Friday graph: why Ireland is broke

This is a graph courtesy of the Institute of Public Affairs in Melbourne, an impressive Australian thinktank.

It comes from the Irish government’s own 140 page ‘National Recovery Plan‘ published last week.

It is amazing reading.

  • From 2000 to 2009 average public sector salaries increased 59%
  • In 2004, 34% of income earners were exempt from tax. In 2010, 45% were exempt
  • In 2007 property taxes generated 6.7 billion euros.  In 2010 that figure will be 1.6 billion
  • In 2009 interest on government debt was 8% of tax revenues.  In 2014 it will be 20%.

Naysayers try to tell you that the Celtic Tiger was a myth and that free-market policies brought the Irish economy down.

The truth is exactly the opposite.  Liberalisation caused the Irish economy to surge until a return to big government crushed it.  Membership of the eurozone, poor banking regulation and the government guarantee of bank depositors and creditors were also major factors.

I wrote this article on Ireland recently (Otago Daily Times, 5 November 2010).

Watch British MEP Dan Hannan talking about it in the European Parliament below:

Going beyond national standards

Last year I wrote this article, ‘Two Cheers for National Standards’ (Otago Daily Times, 17 July 2009).

I supported the government’s move to introduce standards for literacy and numeracy at primary and intermediate schools, saying:

Such a move is long overdue.  In 1998, the Education Forum, comprising educationists and business sector representatives, published a report Policy Directions for Assessment at the Primary School Level, authored by Professor Alan Smithers, a distinguished British education adviser.

The Forum stated that “it is strongly in favour of national assessment in primary schools.  It fully recognises that accurate information and feedback have a major part to play in improving education performance.”

In effect, the state school system is an enormous government monopoly (which would benefit from competition).   We can’t expect it to perform well without objective performance data.

The article went on to talk about ‘league tables’, judging schools as opposed to students, the flawed outcomes-based curriculum, and the problem of consistent assessment of standards.

I concluded by saying:

Finally, standards are no silver bullet for upgrading education.

Perhaps the most important reform would be moves towards greater parental choice and competition in the system, and greater school autonomy.

Teacher quality (including teacher training, professional development and certification) is also vital, as is how better teachers are rewarded and under-performing teachers dealt with.

But the government’s national standards initiative deserves two cheers.

A recent video from the Cato Institute in Washington helped extend my thinking (the section I’m referring to starts from 5 minutes 30 seconds into the clip).

It was a talk on national education standards by former high school teacher Rep. Rob Bishop (the section I’m referring to starts from about 5 minutes 30 seconds into the clip).

He began by talking about the endless series of education initiatives aimed at dealing with America’s under-performing public schools – the War on Poverty, A Nation at Risk, No Child Left Behind, and now the Obama administration’s Race to the Top.

As with so many fads and fashions in education, none has worked, or worked well.  As Bishop says, the most common reaction of any public school teacher is to think, “This too shall pass”.

He goes on to emphasise the limitations of standards and testing: “education is a subjective area, it is not an objective area.”  Moreover:

You cannot define a good school, you cannot define a good teacher, you cannot define a good education, but you know when you see it.  And as long as parents are satisfied, that ought to be the concept.

Bishop comes down on the side of parental choice – giving parents the freedom to decide where they want to send their children and rewarding schools and teachers accordingly.

He recounts a familiar objection to school choice raised by a state legislator in Georgia:

He said this idea of empowering parents may work but it won’t work in my district because the parents are too dumb.  I thought, but I did not have the guts to say, ‘they elected you didn’t they?’  I am totally opposed to that premise.  Parents are not too dumb.  Parents do care about their kids.  And even if you accepted the premise that parents are too dumb to make these decisions, the state is a poor replacement for the parent.

As far as I’m concerned those are killer arguments.

Going beyond national standards and introducing school choice – funding schools at the different levels (primary, intermediate, secondary) on the same basis according to enrolments – is the next logical education reform.  Two reports by an Inter-Party Working Group released early this year advocated such a move.

It’s not much use parents learning that their children are not achieving national standards if all they can do about it is complain to the school or stand for the board of trustees.

The real way to empower them is to provide them with the option of ‘exit’ as well as ‘voice’: to send their child to another school.  Isn’t that the option people as consumers have in practically every other area of their life?

The ‘Climategate’ Scandal Should Not Be A Surprise

An article I wrote for the Otago Daily Times published today:

Terence Kealey, Vice-Chancellor of the University of Buckingham in Britain, is an interesting and iconoclastic scholar.

A scientist (biochemist) himself, his book The Economic Laws of Scientific Research challenges the idea that science is a public good requiring government subsidies.

Last month I heard Professor Kealey speak at an academic conference in Australia.  His topic was the ‘Climategate’ scandal at the Climatic Research Unit of the University of East Anglia.  Subsequently, other global warming claims have been shown to be flawed, such as the disappearance of glaciers in the Himalayas predicted in the last IPCC report.

Kealey’s basic point was: Why should we be surprised about all this?  The assumption that scientists are always dispassionate seekers after truth is naïve, he argued.

Kealey reminded those who claim a scientific consensus about human-induced global warming of a similar consensus about eugenics – the science of controlled breeding – in the first half of the twentieth century.

We think of eugenics today as one of modern science’s most horrible perversions and associate it with Hitler and Nazism.  But eugenics ideas were once persuasive, as Kealey showed with quotes from well-known authors:

H G Wells (1901): “The swarms of black and brown and dirty-white and yellow people have to go.  It is their portion to die out and disappear.”
D H Lawrence (1921): “Three cheers for the inventors of poison gas.”

And the appalling George Bernard Shaw (1933): “Extermination must be put on a scientific basis if it is ever to be carried out humanely and thoroughly … if we desire a certain type of civilization and culture, we must exterminate the sort of people who do not fit into it.”

Such ‘scientific’ beliefs are dead today, but as Max Planck put it, “A new scientific truth does not triumph by convincing its opponents and making them see the light but rather because its opponents eventually die and a new generation grows up that is familiar with it.”

Kealey illustrated the lengths to which some scientists will go in order to silence ‘sceptics’ by a historical event involving Pythagoras (of the Theorem).
Pythagoras was a good scientist and he revered ‘rational’ numbers (whole numbers or whole fractions).  He believed that whole numbers underpinned the universe, from music to the movement of the planets.

But Pythagoras had a student called Hippasus who discovered that the square root of 2 is not a ‘rational’ number.  It is in fact an ‘irrational’ number and Hippasus showed that irrational numbers can never be definitively calculated.  This proof upset Pythagoras and he asked Hippasus to retract it.  But Hippasus refused, so Pythagoras had him drowned.

Kealey wryly commented, “I think Pythagoras went too far; I think that scientists should desist from killing each other or even from telling outright falsehoods.  But, like advocates in court, scientists can nonetheless be counted on to put forward only one very partial case … and no one should expect a scientist to be anything other than a biased advocate.”

Such partiality has long been a feature of the global warming debate.  One early proponent, the late Stephen Schneider, is notorious for saying, “To capture the public imagination, we have to offer up some scary scenarios, make simplified dramatic statements and little mention of any doubts one might have.  Each of us has to decide the right balance between being effective and being honest.”

Former US Vice-President Al Gore made that approach into an art form.  His film An Inconvenient Truth was found by a British court to contain nine significant errors in a context of “alarmism and exaggeration”.

In a leaked email, Climate Research Unit director Professor Phil Jones, referring to two papers that apparently falsified his work, wrote:  “I can’t see either of these papers being in the next IPCC report.  [New Zealand-born scientist] Kevin Trenberth and I will keep them out somehow – even if we have to redefine what the peer-group literature is!”

Here at home serious questions have been raised about the reliability of NIWA’s posted domestic temperature record – leading NIWA’s board to acknowledge the need to clarify the matter and publish the results.    

The integrity of climate science has taken a hit with Climategate and its sequels.  Scientific academies have been insisting on greater honesty and transparency.

Of course many reputable scientists continue to see a material risk of dangerous manmade warming.  I believe their case needs to be taken seriously – most scientists are honest.  But those in that camp should be the first to denounce exaggerated and erroneous claims by scientists that undermine confidence in their concerns.

On global warming it is nonsense to claim that “the science is settled”.  Scepticism about science is always in order – indeed it is the essence of scientific inquiry.