Taxing ourselves into prosperity Sinclair Davidson

Taxing ourselves into prosperity

Sinclair Davidson

RMIT University © 2010 Economics, Finance and Marketing 2

Gross Public Debt

0

20

40

60

80

100

120

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

% G

DP

Australia Euro-Area OECD


Structural Government Balance

-8.0 -7.0 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

% G

DP

Australia Euro-Area OECD


Australian Tax and Spend


US Tax and Spend


Euro-zone Tax and Spend

40

42

44

46

48

50

52

54

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

% G

DP

Receipts Outlays


OECD Tax and Spend

3536373839404142434445

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

% G

DP

Receipts Outlays


Questions

• It is quite clear that governments have been fiscally irresponsible.

– The data supports the that governments have been running long-term budget deficits.

– The level of public debt did not (generally) fall in the boom times and rise in the down times.

• The poor fiscal outcomes are NOT due to the Global Finance Crisis.

• Government has to get public finance onto a sustainable and responsible basis.

– That means balanced budgets in general.

– That means budget surpluses.

– That means either raising taxes or cutting spending.

• There is a question about high levels of public debt.

– Pay it off out of future growth.

– Inflate it away.


Krugman’s solution: Inflation



• Inflation is difficult to control.

• Inflation distorts the economy.

• A massive inflation would undermine Chinese savings.

• Inflation leads to inefficient ‘investment’.

–Gold.

• Krugman’s ‘solution’ involves aggregates and not specifics.



• Ludwig von Mises

–‘The assistance of inflation is invoked whenever a government is unwilling to increase taxation or unable to raise a loan; that is the truth of the matter.’

–‘It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of illusory or apparent profits.’

–‘The advocates of public control cannot do without inflation. They need it in order to finance their policy of reckless spending and of lavishly subsidizing and bribing the voters.’

–‘Inflation is the true opium of the people and it is administered to them by anticapitalist governments and parties.’


Growth accounting

• Where y = GDP growth

= net investment rate in capital stock

= growth rate in effective labour force

= productivity growth

= marginal productivity of capital

= output elasticity of labour

lky

kl


Growth accounting

• Five variables → taxation can impact growth in five ways

• Tax can impact the capital stock

– Tax affects investment rate and depreciation

• Tax can impact labour market

– Tax affects labour supply, hours worked, acquisition of educations & skills

• Tax can impact productivity growth

– Tax affects R&D decisions and venture capital choices

• Taxes also affect marginal productivity of capital by distorting investment away from highly taxed sectors

• Taxes also affect labour output by distorting employment away from high social output – high tax industry to lower output – lower tax industry


Growth accounting

• But we have to consider the impact of government spending.

• It is not clear that government spending adds as much value as taxation takes out of the economy.

• That implies that rigorous cost-benefit analysis needs to be passed before public spending is justified.

• “… though they may be in the highest degree advantageous to a great society, [they] are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals.” Adam Smith 1776.

– advantageous

– could never repay the expense


When Should Government Fund Activity?

Private

Funding

Private

Funding

Pri

vate

Ret

urns

Cost of Private Funds

Nobody should

Fund

Public Funding

(Arrow)

Cost of Public Funds

Public Return

Source: Adapted from Kenneth M. Brown (1998, pg. 45).


What is the cost of public funds?

• Cost of private funds scaled up by deadweight costs of taxation.–Deadweight costs of taxation may be very high!

–Henry Review–Corporate income tax 40%

–Personal income tax 24%

• The notion that government funding is ‘cheaper’ than private sector funding is simply wrong.


Taxation and Coercion

Public Good Yes No

Yes

Pay Tax

Disputed Territory

Coe

rcio

n

No

Free Rider Problem Private Economy


The Rahn Curve


The Laffer Curve


What is the relationship between Rahn and Laffer?


Can we spend our way out of trouble?

• No.

• Paul Krugman in the Age this morning.

– Now, we weren't supposed to find ourselves replaying the late 1930s. President Barack Obama's economists promised not to repeat the mistakes of 1937, when FDR pulled back fiscal stimulus too soon. But by making his program too small and too short-lived, Obama did just that: the stimulus raised growth while it lasted, but it made only a small dent in unemployment - and now it's fading out.

Just as some of us feared, the inadequacy of the administration's initial economic plan has landed it - and the nation - in a political trap. More stimulus is desperately needed, but in the public's eyes the failure of the initial program to deliver a convincing recovery has discredited government action to create jobs.


Can we spend our way out of trouble?


US Stimulus


US stimulus


Australian equivalent


Is government spending self-financing?

• No.

• Robert Reich

– The only sure way to bring that debt down and make it manageable in future years is to get the economy growing again — which requires that, in the short term, the government spend a lot of money (because consumers and businesses won’t).

• Lateral Economics

– So for every dollar the government spent, tax revenue to Australia’s governments rose by around 22.5 cents, leaving just 77.5 cents to be repaid. The total windfall to the budget – and to the community – of the additional tax revenue from the cash transfers is around $6.7 billion. This money and the production of all those people and all that capital kept in employment are the riches of good economic management – the only kind of free lunch we know of.


Is government spending self-financing?Suppose I walk up to you and forcibly take from your wallet $3636. That is roughly about the amount of the Federal Government's combined stimulus programs per head of population.

I immediately give you back $900 of this for you to spend on anything you want - cigarettes, clothing, computer games, fridges, handbags, mobile phones, tattoos, anything you care to buy. You could even deposit it straight back into your own bank account.

I then spend $2227 of your money on things that take my fancy.

Some lobbyist told me that throwing some of the money I've taken from you (let's call it what it is, a tax) towards housing insulation batts would somehow save the Earth. Someone else whispered in my ear that spending a fraction of the $2227 tax take on school gyms, at inflated rates, would help kids read, write, add and subtract. In fact, so many people are lobbying me to spend your money that I need more cash from elsewhere. I resolve this by borrowing even more currency, on top of your taxes.

I forgot to mention at the outset that 14 cents out of every dollar I spend is on my own administration costs.Julie Novak - The Courier Mail 23rd September, 2009


Did the Rudd Stimulus Packages work?

• No.

• If our package worked, why did everyone else fail?Figure One: Economic Growth and Stimulus

-7

-6

-5

-4

-3

-2

-1

0

1

-2 -1 0 1 2 3 4 5 6

Size of Stimulus (2008 - 2010 as % 2008 GDP)

GD

P G

row

th y

ear

to J

une

quar

ter

2009

%

Source: Size of St imulus OECD, GDP Growth Australian Financial Review 3 September, pg. 10








Conclusions

• Vulgar Keynesianism has failed. Again.

– This theory has been tried again and again and always fails.

• Government spending needs to be restrained.

• Economists have known this for a long time.

• Adam Smith

– Great nations are never impoverished by private, though they sometimes are by publick prodigality and misconduct.

– It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the œconomy of private people…. They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expence, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.

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Taxing ourselves into prosperity Sinclair Davidson