Taxing capital incomes – are we doing it the right way?

About fifteen years ago, the new Secretary of the Treasury, Dr Caralee McLeish, was part of a World Bank team that put together a dataset measuring the regulations and taxes that small businesses face in different countries. In conjunction with Price Waterhouse, this group (including an extremely famous Harvard economist) worked out the taxes paid by a standardised 20-person business in its first two years of operation, as well as the taxes its employees pay. 

The authors then used this data to ascertain if there was a consistent relationship between the taxes and regulations that businesses in each country face and the amount of investment taking place in each country. There was: the countries with lower tax rates and less onerous regulations tended to have more investment and more foreign investment. The data were considered so useful that the exercise is now repeated annually. One of the original papers by this group of authors, “The effect of corporate taxes on investment and entrepreneurship” (published in 2010) has been cited more than 750 times. 

New Zealand has low levels of capital for a country of its income level and quite high corporate taxes. 

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Winners and losers of the past five years

In his evidence to the Treasury Select Committee on the Summer Budget 2015, George Osborne opined that:

…distributional analysis is helpful. It helps inform the debate, and … shows how money is allocated by Government around the different income quintiles of society.

HM Treasury’s draft results have now been published. They show that low income households suffered the smallest pre-tax fall in income Read more

George Osborne explains Summer Budget 2015

The first reckoning for any Budget is when the Office for Budget Responsibility releases its estimates of the fiscal and economic impact of the measures. The second is when the Chancellor appears in front of the Treasury Select Committee and explains the reasoning behind the Budget. George Osborne’s Summer Budget appearance happened yesterday and shed light on a number of his more controversial fiscal policies. This is my summary of his answers, presented without comment. Read more

Why doesn’t NZ need a fiscal rule?

I’ve been pointed to a very useful review of NZ’s fiscal policy that explains how the country manages so well with neither a fiscal rule nor a fiscal council. The NZ government is required by law to maintain ‘prudent levels’ of public debt but, beyond that, it is left to individual governments to decide what that means. Accountability and scrutiny is achieved largely through transparency and “broad social consensus on fiscal responsibility” and, so far, that has largely worked. The weakness identified by the review is that the government pursues time-inconsistent policy and saves too little in booms to offset the expenditure in recessions. The UK, despite a series of fiscal rules, suffers from similar problems.

The review considers whether a numerical fiscal rule might help and makes the point that

..it might weaken the Government’s ‘ownership’ of the debt target, and its preparedness to save revenue windfalls…  It might create incentives for governments to comply with the rule through policies that would weaken other parts of the balance sheet.

In other words, once there is a rule then the game is compliance with the letter, not the spirit, and that can actually weaken fiscal governance. Read more

Alesina on austerity: round 2

Alberto Alesina has returned to the fray with a new paper that shows how tax rises are far more damaging than tax cuts. With a new dataset covering the recessionary years, this is the most up-to-date evidence on fiscal consolidation available. Importantly, they are unable to discern evidence that the ZLB caused the effects of fiscal policy to be greater. Of course, this isn’t the final word and it’s only one piece of evidence, but I’ll be reading it closely over the next few days.

Fiscal adjustments based upon cuts in spending appear to have been much less costly, in terms of output losses, than those based upon tax increases. The difference between the two types of adjustment is very large. Our results, however, are mute on the question whether the countries we have studied did the right thing implementing fiscal austerity at the time they did, that is 2009-13.

Fiscal rules, growth and the ZLB

Yesterday I wrote that the consequence of a fiscal rule with a short horizon has been austerity, which delayed the UK’s economic recovery. Of course, that analysis misses a very important element of the recent recession, which is that the UK’s monetary policy was at the ZLB. That greatly increased the effect of fiscal policy on GDP in a way that wouldn’t happen in normal times. It’s also why Portes and Wren-Lewis recommend that any fiscal rule be suspended during periods where monetary policy is at the ZLB. So why am I really worried about a growth cost that is only realised in very unusual circumstances?

If the ideas about secular stagnation turn out to hold water then we may be hitting the ZLB far more often in the coming decades. Even if that doesn’t eventuate, real interest rates have been trending down for a long time, which has led some people to recommend a higher inflation target to avoid the ZLB in future. The upshot is that, unless there are changes to the standard monetary policy regime–flexible targeting of 2 per cent inflation–high fiscal multipliers and fiscal activism may become a regular occurrence. If it does then the government’s fiscal rule had better work during those times, too.