Sunday, March 14, 2010

More on taxes and tax avoidance . . . and prosperity

I was working in the yard on Saturday and, as I usually do when working outside, I listened to a few lectures--at high speed.

The series I was listening to came from the November Sovereign Society Offshore Advantage Academy meeting in Los Cabos, Mexico.

One of the speakers, Dan Mitchell, Senior Fellow and Chairman for Freedom and Prosperity at the CATO Institute, got talking about tax policy and tax avoidance.

Remember my post on tax avoidance as a civic good back in December? Miller made much the same point about the value of tax competition. As it has become easier for people to move around the world; as the world has become more "open," tax rates in many countries have actually fallen.

Miller noted that, on average, top income tax rates have dropped 26 percent over the last 20 years or so. Corporate tax rates have dropped by more than 20 percent on average. Moreover, there have been significant reductions in double taxation. As Miller put it, "Globalization is making it easier for the geese that lay golden eggs to escape oppression."

And, said Miller, all of these are good things.

He showed a number of graphs that demonstrate the differences that an average annual shift of just one percent in growth can produce over a few years' time.

As I've also been reading in the last couple of days in Phil Town's book Payback Time, you can calculate how quickly a certain percentage rate will double the underlying value by dividing 72 by the average rate of growth (or inflation or interest . . .). It's called the Rule of 72.

For example: Suppose you are making $35,000 a year today. At 3% inflation, how long will it take before you need to be making $70,000 a year . . . just to remain even with your current income?

Divide 72 by 3: there's your answer. In other words, at 3% average inflation, it will take 24 years before you need to be making $70,000.

But suppose inflation ratchets up just a couple of percent. Let's make it a 5% rate of inflation. Divide 72 by 5 and you're looking at a salary of $70,000 to break even within about 14 years.

Seven percent inflation? 10 years. Ten percent inflation, 7 years.

Pretend you're facing no inflation but the economy grows at 3% per year? --Participants in your economy will, on average, be twice as wealthy 24 years from now as they are today.

Push your economic growth two percent higher? --You're twice as wealthy in 14 years.

Two percent lower (as America's government is threatening to do with its confiscatory tax policies): at 1% average growth rate per year (discounting inflation!), America will take 70 years to become twice as wealthy as it is today.

Miller noted that it is these (apparently) small percentage differences that have made dramatic differences in economic prosperity on the world's stage--just in the space of our own lifetimes (or a little longer).

Argentina, which was the 10th most prosperous country in the world on a GDP per capita basis as late as 1949, had fallen to 50th by 1992 . . . while Hong Kong, in the same time, rose from about 53rd to 10th!

Or take Ireland and France. In 1975, the per capita income (as calculated by dividing Gross National Product by population) in Ireland was about $8,000; in France, it was just over $15,000--almost twice as high. The two countries maintained a nearly equivalent nominal disparity in income till about 1990 . . . and then Ireland started catching up. Between 1990 and 1995, Ireland's rate of growth remained consistent with where it had been in the previous five years; France, meanwhile, slowed down a bit. And then, right about 1995, Ireland took off. In five years, the average income in Ireland rocketed from approximately $18,500 to a bit over $30,000 . . . while France's average income plodded along, growing from about $23,000 to not quite $26,000. In 2004, France sat at an average of about $27,000, while Ireland was a bit over $35,000--a huge disparity brought about by a small percentage difference in growth rates over a few years' time.

And what can make these kinds of differences?

Often: tax policies of the government. As Miller noted, "A smaller burden of government translates into more opportunity and higher living standards."

Consider: Based on a Rule of 72 calculation, the U.S. economy has been growing at an average of between 2% and 3% per year for the last 50 years . . . during a time when the government, on average, consumed about 20% of everything our economy produced.

"Today, the burden of the federal government is more than 27 percent of GDP," Miller said, "up from 18.5 percent when Clinton left office.

"Because of Social Security, Medicare, and Medicaid, federal spending is projected to jump from 22 percent-plus of GDP today to 45 percent to 67 percent of GDP after the baby boom generation is fully retired." Meanwhile, "State and local governments will consume – at a minimum – another 15 percent of GDP."

Socialism, anyone? Poverty, anyone?

Miller noted that politicians understand how taxes work as incentives (or disincentives) in other areas of life: "We want to decrease the number of people who smoke. Let's raise taxes on cigarettes." Why don't they understand that the same thinking applies to income?

If you want people to be motivated to produce, you don't raise taxes on income!

"High tax rates reduce incentives to engage in productive behavior, meaning less work, saving, investment, and entrepreneurship. This means less taxable income."

Miller illustrated the reverse of this "equation" with the real-world example of Reagan's policies.

  • In 1980, there were 116,800 rich people.
  • Those rich people reported $36.2 billion of income to the IRS.
  • They paid $19.0 billion of income tax to the federal government.
Under Reagan, tax rates were dropped and . . . by 1988 . . .

  • There were 723,700 rich people.
  • Those rich people reported $353.0 billion of income to the IRS.
  • They paid $99.7 billion of income tax to the federal government.
Want to see the principle operating in reverse?

Yesterday afternoon, after listening to Miller's presentation in the morning, I bumped into this article about "Maryland's Mobile Millionaires" from the Wall Street Journal:
Illinois Governor Pat Quinn is the latest Democrat to demand a tax increase, this week proposing to raise the state's top marginal individual income tax rate to 4% from 3%. He'd better hope this works out better than it has for Maryland.

We reported in May that after passing a millionaire surtax nearly one-third of Maryland's millionaires had gone missing, thus contributing to a decline in state revenues. The politicians in Annapolis had said they'd collect $106 million by raising its income tax rate on millionaire households to 6.25% from 4.75%. In cities like Baltimore and Bethesda, which apply add-on income taxes, the top tax rate with the surcharge now reaches as high as 9.3%—fifth highest in the nation. Liberals said this was based on incomplete data and that rich Marylanders hadn't fled the state.

Well, the state comptroller's office now has the final tax return data for 2008, the first year that the higher tax rates applied. The number of millionaire tax returns fell sharply to 5,529 from 7,898 in 2007, a 30% tumble. The taxes paid by rich filers fell by 22%, and instead of their payments increasing by $106 million, they fell by some $257 million.
What's going on? Is it just the lousy economy? No. No way.

People cheating on their taxes? Not likely.

Read the article for an analysis.

The same thing can happen--as it has--on the international stage.
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