The Irish bank bail out that happened yesterday illustrates the rock and hard place governments are under. Americans might gaze across the pond and think that this is a European problem. However, several of the indigenous American states are teetering on the brink of financial disaster, and the US government itself is trodding down the same prickly path.
Governments have a choice. Grow the economy or tax their constituents into submission.
In a recent poll the BBC found some interesting data. Most people in the world believe that their government doesn’t spend their tax dollars wisely. While cultures are different, human behaviour is relatively the same. Digging down into the data, certain countries populace are OK with a tax increase to solve economic problems while others are not. For example, 33% of British citizens favour a tax increase. Only 8% of the French do. Contrasting those two countries, the French already have a high amount of public welfare spending. The appetite to tax and spend more on it is not there.
In the United States, only about 20% of the population favours an increase in taxes to cover economic shortfalls. Roughly 70% of the population wants to see a cut in government services. This data would indicate that politicians have the political capital to cut budgets without raising taxes.
Dan Henninger echoes that same point in his Wall Street Journal column today. The US and its sovereign states can choose to grow, or raise taxes. Raising taxes will only lead to a death spiral of economic disaster. Politicians must make the choice to cut.
Some of these choices should be really easy. Why is the Post Office a public entity? Do we need public television or public radio anymore? Why not privatize bus service in cities? Changing public pensions from defined benefit to defined contribution and raising retirement ages to a reasonable number should be simple.
Others are much more difficult because of the emotion involved. Everyone wants clean water and clean air. Everyone wants to take care of the mentally handicapped. How we do it though is open to discussion. There are ways to accomplish these goals and be economically efficient at the same time.
On the tax side, there are a lot of things government can do. Merely extending the Bush tax cuts is not enough. How about ending the capital gains tax? The cap gains tax doesn’t just tax dividends. It taxes hourly wages. It taxes capital equipment. Ending it would raise employment, make companies more productive, incent companies to buy new equipment, and to build new plants across America.
Ending capital gains would also put a tough decision in front of the Chief Financial Officers(CFO) of America. Currently, cash is building up on balance sheets in corporate America. CFO’s are not reinvesting in property, plant and equipment because the net present value (NPV) of doing so is negative. Instead, they are buying back stock. A poor use of corporate funds because it doesn’t reward long term shareholders. The CFO’s are also looking to buy other companies. Hence, we have seen a rise in mergers and acquisitions in the latter half of this year. A suspension of capital gains would allow that cash to flow directly to shareholders in the form of a dividend. That cash would be reinvested into the economy. Ending capital gains is a catalyst and incentive for growth.
Instituting a flat tax is also something that government can do to incentivise growth. Rates are too high. Why not a tax of 15%-20%, with no write offs for anything. Let people decide what to do with their money without any influence from the government. Free to choose is a productive concept.
Lowering corporate taxes is also good policy. Currently, corporations are engaging in tax arbitrage. The US corporate tax rate is 35%, when the rest of the world is at 18%. Why not lower rates 10% to 25%? There is a lot of advantage for companies to do the bulk of their business in the US. Property rights and case law are strong incentives. The US corporate tax rate can be slightly higher than the rest of the world because of all the advantages. This is not a race to the bottom.
The other place that the US needs to examine very closely is regulatory policy. Over the past number of years, regulatory policy has engaged in “regulatory creep”. This is a hidden tax on doing business in the US. George Stigler received a Nobel Prize for his analysis of how government regulation increases the cost of doing business. Correct regulation that aligns economic growth with good public outcomes is good policy. Currently in the US, our regulatory system misaligns incentives and so businesses choose to go elsewhere.
There are some tough choices to make. They need to be made soon. Politicians of all stripes have kicked the can down the road for too long. The day of financial and economic reckoning is coming.