Richard Rahn on Taxing and Growing

The Taxing of Nations,” by Richard Rahn, The National Interest, Spring 2005, ppg 112-118.

A very good article by a senior fellow at the Discovery Institute on taxes and growth.

On the harm of taxing capital:

Economists have long known that taxing capital is economically destructive. Nobel Prize-winning economist Robert Lucas, after carefully reviewing relevant economic studies, concluded in 2003 that reducing capital-income taxation from its current level to zero (using other taxes to support an unchanged rate of government spending) would result in overall welfare gains of “perhaps 2 to 4 percent of annual consumption [compounded] in perpetuity.”

On the importance of the birth rate on retirement savings

It is often said that demographics drive history and, to a considerable extent, the lower-than-replacement birth rates on the continent are at the root of the tax-rate war [attempts by “Old Europe” to force developing countries to raise their capital tax rates]. Starting in the 1960s, these countries built welfare states with generous retirement systems. Such systems are barely sustainable, even with rapidly growing populations. “Defined-benefit” systems are in essence Ponzi schemes that require the number of new workers to grow as fast, if not faster, than the retirees, because it is the taxes of the working population, not any sort of savings, that are used to finance the payments to retired workers. Europe is plagued with stagnant or falling populations, which means that the proportion of the elderly is increasing rapidly.”

On the pain Old Europe must go through before it can grow again

In Many countries are moving to a “defined-contribution” system, much as Child did a quarter century ago (and as President Bush is now advocating for the United States). In such a system, workers are required to invest a given percentage of their incomes in relatively safe investments, such as government bonds r high-grand corporate bonds and stocks. The Europeans have waited too long, however, to make the necessary changes without going through considerable pain. They cannot get out of the dilemma by raising taxes, because their current tax rates are already above the revenue maximizing point. Hence, any tax increase will further reduce economic growth. Because present growth is so low, tax increases will actually lead to less tax revenue over the long run. The European governments are then left with no alternative to to begin reducing real benefits. But the public is not yet willing to support politicians who tell them the unpleasant truth. As a result, reducing benefits is constantly postponed by the politicians.

On just how insane capital taxes can be in Europe — which leads to capital flight

Individually, most Europeans understand the reality they are facing. Thus, we find that Europeans have much of their income. The problem is that Europeans have few profitable domestic investment alternatives available to them — given that tax rates on capital income often approach or even exceed 100 percent when an adjustment for inflation is made . (For example, if you are French investor who received 4 percent on a capital investment before taxes, but are subject to a 50-percent-plus tax rate on that investment, while the inflation rate is 3 percent, the actual after-tax return is negative 1 percent.)

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