Thoughts on Flat Taxes

Written for the RENUA flat taxes event today.

When all the little economists are in short pants, we learn the principles of public finance. Governments have to tax households and firms in order to provide services the market won’t, like libraries, street lighting, and national defense, as well as redistributing income from the rich to the poor as an aid to social solidarity. Taxes are a necessary evil. All taxes induce distortions to people’s behaviour. Some distortions, like the plastic bag tax, are clearly good. They make almost no one worse off and make lots of people better off. Recurrent taxes on property are in fact the least distortive to long run GDP per capita we have. While a site value tax would have been perfect, the LPT does a similar if suboptimal job.

Some taxes are highly distortionary, such as a very low corporation tax rate, or a very high income tax rate. These make lots of people better (and worse) off and damage important incentives. An efficient tax structure would deliver the funds to power public services with the minimum of distortions to individual and collective incentives. The theory of public finance has come around to the view that marginal taxes are not the most important thing to worry about, in information-opaque systems, the average tax rate should be relied on most heavily. The all-in tax rate for personal income tax & employee social security contributions is 52% here, relative to 46% on average across the OECD.

Perhaps more importantly, the ability to balance the average tax rate with a corruption-resistant tax structure through which taxes are collected and disbursed is a major asset of any public finance structure.  Important results have now been established showing the spread of corruption is quite badly affected by the ease with which the variables which determine the tax base can be manipulated by those in power. If we worry about the Noonan-end of the tax gathering element first, then, two principles which therefore make sense are simplicity and certainty with respect to the tax system.

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November Exchequer Returns

Available here.

The Euro Debate and the Abuse of Language

Defenders of the Eurozone’s initial design, subsequent management and purported reform invariably refer to the system as a ‘monetary union’. So do academic commentators including the authors of the recent Vox piece on the origins of the crisis. Whether intended or unconscious, this is an abuse of language.

Monetary unions do not experience selective bank closures, the re-introduction of exchange controls or the numerous other manifestations of financial fragmentation that have occurred before and after the Eurozone ‘reforms’. Germany is a monetary union. In 1974 the Herstatt Bank collapsed in Cologne and several banks based in Dusseldorf went down in the recent crisis. Both cities are in Nordrhein Westfalen, but there was no closure of bank branches in the state nor were exchange controls introduced by the state authorities on either occasion. Interest rates in Nordrhein Westfalen did not detach from rates elsewhere in Germany nor did bank deposits flee the state.

When the Continental Illinois Bank went under in 1984, at the time the largest-ever US bank failure, the state of Illinois was not expected to handle the fall-out. In the recent crisis the state of Delaware, home to lehmans, and the state of North Carolina, home to Wachovia, were similarly spared. The USA is also a monetary union and there is federal responsibility for bank supervision, bank resolution and the protection of bank creditors.

The Eurozone in contrast was established in 1999 as no more than a common currency area, with a ‘central bank’ responsible only for monetary policy in the aggregate, in pursuit of an inflation target. To describe it as a ‘monetary union’ is to deny that there is any distinction between a common currency area and a monetary union. If the Eurozone really was a monetary union in 2008 the history of the crisis would have been very different.

Language matters. In his 1946 essay (Politics and the English Language) George Orwell put it like this:

‘The great enemy of clear language is insincerity. When there is a gap between one’s real and one’s declared aims, one turns as it were instinctively to long words and exhausted idioms, like a cuttlefish spurting out ink. In our age there is no such thing as “keeping out of politics.” All issues are political issues, and politics itself is a mass of lies, evasions, folly, hatred, and schizophrenia. When the general atmosphere is bad, language must suffer.’

The danger is that relentless description of the Eurozone as a monetary union deflects attention from the awkward truth that it is not, and from the political unwillingness to make it so.

It has finally happened

It was way back in April 2009 that Barry Eichengreen and I first compared the world industrial output collapses of 1929 and 2008. The situation looked pretty alarming at that stage, but it turned out that we were a good leading indicator of recovery: the world economy started turning around almost immediately afterwards, thanks to a coordinated reflationary macroeconomic policy response. Then 2010 happened, reflation turned to austerity in Europe, and the global recovery slowed, to the point where at times it seemed to be petering out almost altogether.

And in August of this year, the inevitable happened: measured in terms of industrial output, our current recovery was overtaken by that of the interwar period. Pretty dismal stuff. Let’s hope that we can at least avoid the famous 1937-38 double dip, visible at the end of the interwar series.

 

 

Exchange rates

Paul Krugman suggests that exchange rates might matter for economic performance here.

On Ireland and exchange rates, one could add that, because of our large trade exposure to non-Eurozone markets, we  benefitted from an unusually large nominal depreciation in 2014-15 (which translated into a substantial real depreciation) (slides 8 and 9 here). I doubt this is unrelated to the employment boom we have enjoyed since then.