The world is in a danger zone. In 2008, many people said they did not see the turbulence coming. Leaders have no such excuse now. And dangerous times call for courageous people. Some developed country officials sound like their woes are just their business. Not so. I still think that a double-dip recession for the world’s major economies is unlikely. But my confidence in that belief is being eroded daily by the steady drip of difficult economic news. A crisis made in the developed world could become a crisis for developing countries. Europe, Japan, and the United States must act to address their big economic problems before they become bigger problems for the rest of the world. Not to do so is irresponsible. But I know well that acting on them means honest and difficult discussions with parliaments and publics. Delay will narrow choices and make them harder and more costly. All of us across developing and developed economies have a stake in how they handle it. – World Bank Group President Robert B. Zoellick, Sept 22, 2011.
The grim outlook for the world economy is putting huge pressure on political leaders to come up with lasting solutions to their country’s financial woes. The way in which they choose to respond could have a major long term global impact.
The temptation for some will be to resurrect failed socialist mantras based on class warfare and the politics of envy and greed – the notion that you can squeeze more out of wealthier citizens by increasing their marginal tax rate. While such policies can give the impression to voters that political leaders are being strong and decisive, they almost always mask the truth that higher tax rates usually lead to a reduction in the tax take and a weakening of the economy.
The reality is that when politicians are faced with a financial crisis, all too often politics gets in the way. With their eyes firmly fixed on the next election, leaders who want to do the right thing in bringing excessive government spending under control find it difficult to cut expensive and popular taxpayer-funded programmes that their voters rely on. Nor is it easy for politicians, who want to be seen to be doing something definitive, to simply leave it to the free market to boost economic growth.
With financial uncertainties plaguing so many economies right now, the way that leaders respond to these challenges represents a major junction in the road ahead. Politicians who take the wrong turn and push for higher taxes and more state control may well usher in a resurgence of socialism, which will ultimately result in economies sinking even further into the mire. What is needed now are politicians with the courage to do what is right – get their government spending under control, get their fundamentals in order, and then leave it to individuals and the free market to grow their economies out of recession.
It is also clear at times like this that our political leaders could learn a lesson or two from householders who know only too well that when times are tough they should borrow less, spend carefully, and pay down debt! Our elected representatives need to realise that ultimately, we did not vote them into office so they could be popular – we voted for them to do the right thing for the communities they represent.
Any government that spends more than it earns for extended period of time will go broke. And when they cede to the relentless demands of minorities and vested interest groups, their actions may well damage their entire society as everyone is forced to pick up the cost. Nowhere can this been seen more clearly than in Greece at the present time, where their debt-laden economy is not only in danger of collapsing under the weight of special interest concessions, but there is a real danger they could bring down the Euro as well. The 15 austerity measures demanded of Greece by the European Union, the European Central Bank and the International Monetary Fund as a condition of their next bailout includes sacking another 20,000 state employees, cutting or freezing state salaries, shutting down loss-making state organisations, speeding up privatisations, and reforming a taxation system that is plagued by political corruption and tax evasion.
It turns out that a major part of Greece’s woes were caused by the ill-fated dream of their politicians to create a “super state” following their entry into the European Union in 2001. This saw the rapid growth in the public sector with a doubling of wages and entitlements. The Greek school system for example is reputed to employ four times more teachers per pupil than Finland – the country with the highest rated education system in Europe. State largesse can be found everywhere, from people employed in more than 600 professions that have been designated as “arduous and perilous” – like pastry chefs, radio announcers and hairdressers! – who are entitled to retire at 50 with a state pension set at 95 percent of their last working year’s earnings, to the Greek shipping industry which has always been tax exempt.1
As the world watches to see whether an insolvent Greece can make the progress on the reforms demanded of it, the OECD has just published figures for the June quarter which shows growth amongst member countries has slowed to 0.2 percent. New Zealand’s growth is half of that at 0.1 percent down from 0.9 percent the quarter before. With our economy in a downturn and an election just around the corner, it is important to see whether the policies being promoted by the various political parties are likely to boost our productivity and growth in the face of the serious global outlook.
In putting together their economic policy, the Labour Party has gone back to its socialist roots to announce higher taxes on the “rich”. If they win November’s election, they have promised to increase the top tax rate from 33 cents in the dollar to 39 cents. In addition they will introduce a capital gains tax. To justify this increase in the top tax rate they say, “We need to ask the highest income earners to pay a little more income tax to help out. At the moment some New Zealanders are not paying their fair share and are leaving it to others to shoulder the burden.”
The Green Party has also jumped firmly onto the higher tax bandwagon. As well as wanting to introduce ecological taxes and water levies, the Greens will also campaign on introducing a capital gains tax and raising the top tax rate to 39 cents in the dollar: the “Concentration of income and wealth should be discouraged and the gap between rich and poor narrowed.” According to the Greens anyone who earns over $80,000 a year is classified as being “rich”.
Some commentators believe that US President Barack Obama’s announcement last week that raising taxes on high income earners will be a solution to their financial crisis, signals the start of his re-election campaign. Like the New Zealand Labour Party, he is couching his policy in the rhetoric of people doing their “fair share”. In a speech delivered at the White House on Thursday, the President used the words “fair” and “fairness” 10 times, claiming that asking the wealthiest Americans to “pay their fair share” was “the right thing to do”.2
This week’s NZCPR Guest is Professor Richard Epstein, a Senior Fellow at the Hoover Institute and Professor of Law at New York University, who offers a commentary How is Warren Buffett Like the Pope? in which he critiques recent comments along these same lines by no less than Pope Benedict XVI and financier Warren Buffett:
“The Pope was on his way to recession-torn Spain—to lead the Roman Catholic Church’s weeklong celebration of World Youth Day—when he denounced those nameless persons who put ‘profits before people’. Understanding the win/win concept would have taken the Pope away from his false condemnation of markets. It might have led him to examine more closely Spain’s profligate policies, where high guaranteed public benefits and extensive workplace regulation have led to an unholy mix of soaring public debt and an unemployment rate of 20 percent. It is a tragic irony that papal economics mimic those of the Church’s socialist opponents. The Pope’s powerful but misdirected words will only complicate the task of meaningful fiscal and regulatory reform in Spain and the rest of Europe. False claims for social justice come at a very high price.
“A similarly harsh verdict must be rendered on Warren Buffett, whose much discussed editorial in the New York Times foolishly condemns the very economic system that allowed him to flourish as an extraordinary investor. The wise pundits of the left insist, like Buffett, that higher tax brackets do not diminish earnings. That point is surely overstated, especially for capital gains. What’s driving the current decline is not that highly skilled people are unwilling to work. It is that employers are unwilling to hire. Fancy bankers, doctors, lawyers, and venture capitalists may be happy to work for less. But the people who hired them in good times won’t keep on hiring them in bad times when the economy slows. When the other side of the market falters, the incomes of the rich slide as well, and in ways that future tax increases will only accelerate. The government will not find a treasure trove of revenues by raising taxes on former millionaires and billionaires.”
A blind adherence to the socialist ideal that increasing the tax rate on the better off will generate more tax revenue totally ignores not only the reality of human behaviour but also the basics of economics. The point is that higher income earners, just like everyone else, are inclined to act in a rational manner to minimise their tax liability – especially if they perceive that the taxes they are being charged are unfair. The UK based Adam Smith Institute, which has comprehensively researched this issue has found that lower tax rates have a positive impact on work, output, and employment,
while higher taxes have the opposite economic effect by penalising participation in activities that are taxed.3 They conclude that the purpose of a tax system should be to raise revenue for the government not to punish hight income earners, and they offer evidence from the UK, US, France, Canada, India, Hong Kong and Russia that high top tax rates not only fail to produce increased public revenues, but they also injure economies. They make the point that taxpayers are wealth creators who, in general, don’t take kindly to spite.
In this increasingly mobile world, where smart countries are making themselves tax competitive in order to attract the brightest and the best wealth creators, politicians need to consider carefully whether their tax policies will do more harm to their country than good.