The Mercedes Benz of state tax competition

State-to-state tax competition continues unabated: Georgia has successfully lured Mercedes Benz away from New Jersey, presumably with a very generous package of employer- and capital-friendly tax and other regulatory policies. Politicians everywhere run on jobs & growth. Tax competition is about seeking a temporary displacement to your jurisdiction at the expense of another. Temporary because you are only as good as your last tax break, zero is not the bottom, and excessive tax reductions are unsustainable.

Ireland: Oasis for American multinationals, desert for Irish workers

From last Sunday's NY times, opinion write Fintan O'Toole discusses life in Ireland, after it first gorged on a panoply of tax reforms meant to lure in multinationals, and then starved under austerity under financial crisis. Of note:

...Ireland has two economies: a global one dominated by American high-tech companies, and a domestic one in which most Irish workers have to make their living. The first is indeed booming. Not least because of those low corporate taxes, large global corporations find Dublin convivial for reasons other than its pubs and night life. The sheer scale of Ireland’s dependence on this kind of investment for its exports can be judged by the fact that Irish gross domestic product took a serious hit in 2013 when Viagra (which is made by Pfizer in County Cork) went off patent in Europe. Broadly speaking, however, the global side of the Irish economy has remained robust. 

But home is where the heartache is: in the domestic economy outside the gated community of high-tech multinationals. Outside Dublin, property prices are still falling. Wages for most workers have dropped sharply. Unemployment remains very high at 12.8 percent — and that figure would be higher if not for emigration. There’s always been a simple way to measure how well Ireland is doing: Go to the ports and airports after the Christmas vacation and count the young people waving goodbye to their parents as they head off to the United States, Canada, Australia or Britain, where they have gone to find work and opportunity. 

...[People in Ireland] are not convinced that the cruel scale of the punishment was necessary or that the nasty medicine has, in fact, worked. 

Behind both of these propositions looms the great contradiction in the supposed success story of Irish austerity. It was austerity only for citizens. Running parallel to all the cuts in public spending and all the calls for fiscal responsibility has been a program of spending so lavish that it makes a drunken sailor look stingy. 

The converse proposition is that when it comes to contributing to the mechanisms of the state--rule of law, infrastructure, educated workforce, etc etc, which fully support those multinational gated communities--the state looks primarily to workers to do the bulk of the heavy lifting, in the form of personal income taxes (41% at the top) and consumption taxes (23% on most goods). But Ireland is not alone in this political decision.

The story of feasts for corporations, famine for workers is a familiar one, and the trade off is supposed to be the positive externalities corporations bring. In other words, the political tradeoff that politicians think they are making goes as follows: we can give up our tax on corporate income if that lures more corporations into our jurisdictions which then hire our workers, whom we can then tax on their incomes and then again on their consumption, to pay for luring in more corporations, in a virtuous cycle. O'Toole's column strongly suggests that the externalities are not anywhere near what was expected or would be needed to continue the virtuous cycle.

The problem for the state is that the owners of corporate capital have received their benefit up front, but when they do not produce their side of the equation in exchange, there is no way for government to demand a refund.

Thus we can add Ireland's story to the multiple examples that exist in various iterations of it around the world, including for example the constant intra- and inter-state fights to lure in manufacturers, filmmakers, and sports teams. Maybe governments should be thinking about adding a carve-back clause to the fiscal bargain that creates oases for bargain-seeking multinationals, which would disgorge untaxed profits when it is clear a party to a tax incentive-fueled deal is not bringing what they said they would or could.

Speaking of austerity: Surprise for Quebec's Universities

Just in time for the holidays: the Quebec government has announced it will cut another $140 million from University budgets this year; schools will have to come up with the cuts by April--yes, in 4 months. That's on top of the rolled-back tuition increases, which represented about another $40 million. This is not a good surprise. It's especially harsh when the PQ is raising taxes all over the place and we all know into whose pockets some outlandish proportion of our taxes go. From the Montreal Gazette:

the PQ repeatedly promised to maintain funding to universities for this year despite cancelling the strongly opposed tuition hike that was to have gone into effect this fall. Universities have been waiting for compensation for about $40 million in lost revenues from the aborted increase.

The student protesters see this as an unintended consequence of their success:

Even the Fédération étudiante universitaire du Québec (FEUQ), which has suggested that universities are more mismanaged than underfunded, was shocked with what president Martine Desjardins called a “hasty” decision. 

“We talked about a redistribution of money, but we never wanted to see university budgets cut,” said Desjardins. “We’re shocked. We fear it’s services to students that will be cut, that students will have to pay the price again.”

I doubt the students alone will pay the price, but the juxtaposition of widespread & rampant corruption, steadily increasing taxes, and steadily increasing cuts to education reads like a serious governance crisis.

The cost to Canadians of pension splitting

We had a lively discussion over Lisa Philipp's paper today, during which a question arose regarding the cost of pension splitting to the budget, i.e., how much does pension splitting cost as a matter of tax expenditure analysis?  Note for non-Canadian readers, the pension splitting issue is as follows: Canada has individual filing only, no joint filing.  But for various reasons, in 2007 Canada introduced what amounts to joint filing with respect to private pension income, i.e., one spouse can deduct and the other include up to half of an annual pension income stream (some restrictions apply)--this is not for a federal pension income but strictly for income generated from private retirement savings.  A ready answer to the TEA question was not immediately found, but I've since had a look at the Tax Expenditures and Evaluations 2011 Report, found the data and made this handy chart:

So we can see that pension income splitting created a $840 million hole in the budget in 2007 and it has increased since then to about $925 million.   In class someone pointed out that pension splitting rule incidentally increased the value of a related tax benefit, namely the pension income credit, i.e., the amount of pension income a taxpayer is allowed tax-free (currently $2,000).  Sure enough the TEA report explains in fn 39: "The introduction of pension income splitting in 2007 increases the number of individuals claiming the Pension Income Credit and thus increases the value of this tax expenditure (i.e. spouses who previously did not have pension income)".  Putting the two pension benefits together yields this:

So we can see the cost of the credit increased by about $110 million in 2007, dropped a bit in 2009 and by 2011 was again about $100 million higher than it was in 2006.  It therefore seems plausible to attribute about $100 million of the credit's cost to the pension splitting rule, bringing the total TEA cost of the latter to about a billion per year.

That is about 0.4% of the total annual budget (which is currently about $245 billion) or about 4% of the annual budgetary deficit (currently about $26 billion).  Not huge perhaps, but not to be dismissed as nothing, either, especially when we know there is scant policy here: this is a straight up tax giveaway for Canadians with private pensions, i.e., higher income retirees.  Political pandering?  A quick scan of the TEA list shows it is in the league, TEA cost-wise, of the working income tax benefit and the medical expense tax benefit.  I am now very curious how many Canadians share the pension splitting benefit, both alone and in comparison to other tax expenditures.  I don't know how to find that though, so will leave the discussion right here.

On austerity

On the pain in Spain, and in Greece and in the Czech Republic and in the Netherlands...

And here is an interview with Amartya Sen on austerity and democracy:

Question: Professor Sen, do you have the impression that economists and economic policy makers are learning the right lessons from the most severe economic and financial crisis since the Great Depression? 

Answer: I don’t think that at all. I’m quite disappointed by the nature of economic thinking as well as social thinking that connects economics with politics. 

What’s going wrong? 

Several features of policy making are worrying, particularly in Europe. The first is a democratic failure. An economic policy has to be ultimately something that people understand, appreciate and support. That’s what democracy is all about. The old idea of “no taxation without representation” is not there in Europe at the moment. 

...If you are living in a southern country, in Greece, and Portugal and Spain, the electorates views are much less important than the views of the bankers, the rating agencies and the financial institutions. One result of European monetary integration, without a political integration, is that the population of many of these countries has no voice. Economics is de-linked from the political base. That I think is a mistake and it goes completely against the big European movement that began in the 40s and fostered the idea of a democratic, united Europe. . .

Will Developed Countries Learn to Tax?

In 1963, Nicholas Kaldor published a paper in Foreign Affairs about the ongoing fiscal problems of poor countries, entitled “Will Underdeveloped Countries Learn to Tax?“   It turns out Kaldor should have aimed this advice at his own country, as the rich world, confident in its fiscal advice to the poor throughout the 60s through the 90s, was busy eroding its own ability to finance the needs of the prosperous state and now must take its own medicine, to no one’s liking.

As Kaldor stated it:

… [t]he importance of public revenue to the underdeveloped countries can hardly be exaggerated if they are to achieve their hopes of accelerated economic progress. Whatever the prevailing ideology or political color of a particular government, it must steadily expand a whole host of non-revenue- yielding services-education, health, communication systems and so on-as a prerequisite for the country’s economic and cultural development. These services must be financed out of government revenue. Besides meeting these needs, taxes and other compulsory levies provide the most appropriate instruments for increasing savings for capital formation out of domestic sources. By providing a surplus over recurrent expenditure, they make it possible to devote a higher proportion of resources to building up capital assets.

In a paper recently posted on NBER, Swiss economist Charles Wyplozs contemplates the chronic undertaxation self-imposed in rich countries, and comes to the same conclusion as Kaldor: Countries need revenues to build up a state that fosters economic growth and not catastrophic ruin.  They fail in this miserably because of political malfunction — every special interest group vies for favors and every politician vies for reelection by granting them.  This leads to what Wyplozs called a deficit bias.  Of course, we in the tax world know this problem and even have a poem for it, sometimes attributed to Senator Long:

Don’t tax you, don’t tax me, tax the fella behind the tree.

We also all know that there is no fella behind the tree, so of course Wyplozs is right, every democracy will gravitate to an undertaxation situation because every democratic legislature has a K street and an upcoming election.  The difficulty of course is that there is no reasoning with special interest groups or politicians, and even as the deficit bias rears its ugly head and threatens to topple the whole structure, we still hear the ancient mating call for tax cuts and incentives to boost the competitiveness of insert-your-constituency-name-here and a loving response from Congress.

So, will developed countries learn to tax?  Wyplozs seems to think there is potential if societies can figure out how to get a combination of good rules and good institutions in place to help governments reject “all favors, carrying out spending and transfers purely on the basis of welfare principles exactly as the mythical benevolent dictator would do.”   As a lawyer, I like the idea of a system of rules and institutions that carry out this public service in a way that incorporates the ideas of human freedom and representation in government.  As a realist, I know that such a system is a mythical creature, something like a “confidence fairy.”  Some might call it the “rule of law” fairy.  But perhaps, unlike the confidence fairy, the rule of law fairy is worth chasing.  With few alternatives, we can do little but continue to express our belief in it in hopes that somewhere, it can come to life and do good things.