FED INTERVENTION

Allan H. Meltzer explains why Fed should be taken away from investment banks (link):

"So what can taxpayers expect from an increase in the Fed's discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision – followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public. Investment banks don't need the Fed to regulate them. Some clear rules on capitalization would suffice."

THERE IS NOTHING WRONG WITH TAX HAVENS

One of the most interesting discussions among the economists and policy experts is a debate about the role of tax havens and offshore destinations that compete with other nations in the areas of taxes, regulation and investor protection. The opponents of tax havens believe that tax havens cause an enormous damage to the economies on the other side of the world since (in their opinion), tax havens are the fundamental reason for the lack of reinvestment and capital flight in onshore economies. The real reason why tax havens are prosecuted by governments is that governement agents seek the highest possible utility from tax revenues in the form of rent-seeking that would yield more power and revenue.

Taxes and Regulation

There are two reasons for high tax rates. One is that in case of high government spending, the structure of tax rates must be high enough to avoid excessive deficit spending that could impair domestic macroeconomic stability. First, the real threat to macroeconomic stability is not deficit but the size of government spending. Also, excessive deficit spending is a threat to domestic macroeconomic stability because of the so called crowding-out effect where high government spending crowds out investment in the private sector. The net outcome is higher interest rate that arises from an increased scarcity of investment that is caused by budget deficit and high government spending. Second, the basic assertion of the Laffer curve is that high tax rates produce a bulk of negative effect. For example, when Sweden had the highest marginal tax rate in the world excessing 80 percent, the net result had been a decreasing tax revenue and when marginal tax rate were reduced, tax revenue soared. However, the real aim of tax rate reduction is not the growth of government revenue but welfare and the right of taxpayers to use the disposable income they earn. Empirical evidence suggests that prudent macroeconomic discipline such as principles of low tax burden, limited spending and adherence of price stability by the central bank result in the improvement of conditions for economic growth and stabilization process regardless of asymmetric shocks. What about regulation? Government regulate for two reasons. First, to remove the negative effects of market imperfections and second, to insure public goods. However, predatory tax rates, the growth of tax burden and the regulation of the private sector are designed seek monopoly rents in an unregulated way. While sound regulation can certainly offset the sideblocks of negative externalities such as free-riding, excessive regulation is hampering the growth of real productivity which is essential to the standard of living and the quality of life.

Tax Havens

Dan Mitchell recently explained (link) the positive role of tax havens in a global economy. From a basic perspective, minimal tax burden in tax havens is a liberalizing force in the world economy since, given capital mobility and the fluidity of knowledge, destinations with higher corporate and personal income tax burden have no choice but to reduce tax rates on productive behavior. Flat tax revolution, that was initiated by Estonia in early 1990s, also helped reduce corporate tax rates in continental Europe and Scandinavia. Given the lack of data, there are hardly any empirical studies researching the impact of tax rate reductions on tax revenue. When Swedish economy faced an onerous macroeconomic instability marred by high inflation, low output growth, declining productivity growth and a sudden dramatic increase in the interest rate (to 500 percent overnight) by Riksbank, top marginal tax rate was 84 percent. Consequently, economic growth decline and public spending grew and shrank into deficit, pushing the real interest rate up, as explained by crowding-out effect (link). When the economy is on the line of potential output, expansionary fiscal policy boosted money demand which, in turn, induced the increase in the real and nominal interest rate. As a consequence, Swedish economy faced a declining investment. Firstly, because corporate tax rate was excessive and secondly, because crowding-out effect took place. Regarding tax havens, supply-side economic and tax policies induced the trend of lowering tax rates on all sources of productivity ranging from investment, savings and entrepreneurship to labor supply. Concerning regulation, high corporate tax rate and excessive regulation usually go hand in hand since the regulation of the private sector is mostly an implicit insurance against the loss of control and - hence - the loss of tax revenue that is needed to finance government spending.
Empirical observation

I took a closer view on the comparative analysis of tax havens and onshore jurisdictions that impose higher mandatory tax rates on corporate and personal income tax as well as more excessive regulation. I downloaded the data from World Bank's Governance (link) and used a correlation analysis tool to analyze related motions of corporate tax rate, the rule of law and regulatory quality on each of these variables. An important note is that it depends on what is meant by 'regulatory quality' since World Bank oftenly criticizes tax havens. Concerning governance, tax havens scored lower than Germany and Austria - countries with high and almost punitive corporate tax rate. Despite a shaddy and imperialist fiscal agression on Liechtenstein, Germany still enjoys an enormously high score on the rule of law and regulation. However, I did not take a detailed look at methodological details even though I can say that there are extreme bias towards what regulatory quality really is.

This chart, for instance, shows a log-linear relationship between corporate income tax and regulatory quality. Considering trend line - estimated by a polynomial of second degree, countries with higher corporate income tax also have sounder regulation. But, if you take a closer look, it can be seen that trend line declines slightly in the area where there is a high concentration of countries (France, Spain, Belgium, Germany...). From WB's data, a curious reasearcher would conclude that higher taxes are good and tax havens have a tighter regulatory quality. However, the relationship in the chart is intuitive since R-square is 0,0436 which means that the variation of the independent variable explains only 4,36 of the variation of the dependent variable.


This chart(log-linearization of the relationship between corporate tax rate and the rule of law) shows that countries with high corporate income tax rate also have comparatively decreased rule of law. Again, it all depends on what is meant under the rule of law. For example, if offshore services are legally recognized in Cayman Islands, and if World Bank's governance methodology treats that as irresponsible, then Caymans will receive a lower score on the rule of law. As you can see, Iceland has the highest rule of law and a modest corporate tax rate (16 percent down from 18 percent). Interestingly, Netherlands Antilles are a tax haven more in terms of regulation and information disclosure than in terms of taxes since 34 percent corporate tax rate seems to be highly sensitive to the rule of law. In fact, many so-called tax havens have a higher rule of law than continental countries. For instance, Cayman Islands have a higher rule of law than Spain, Singapore has a higher rule of law than Germany, Belgium and France etc.

As a conclusion, tax havens are the force of liberalization in the global economy and when surveys (such as WB's) are conducted, it's good to review the methodology and measurement of particular indicators. There are bias everywhere.

Rok Spruk is an economist.

IS SLOVENIA'S HEALTH-CARE SYSTEM SUSTAINABLE?

Institute for Economic Research in Health Care (INERHC) issued a thorough economic analysis and review of Slovenian health-care system (link). Previously, the institute issued a publication in which institute's experts analyzed the financial sustainability of government-mandated health-care system in Slovenia (link).

BEST PLACES FOR DOING BUSINESS

Forbes.com recently published its annual global research (link) on the attraction of particular countries on doing business from macroeconomic and microeconomic point of view. According to Forbes, the best place for doing business is Denmark, followed by Ireland, Finland, United States and United Kingdom. Among top 10 there are also Sweden, Canada, Singapore, Hong Kong and Estonia.

CDS IN ICELAND

In Forbes, there is a brief article (link) on credit default swap in Iceland in the wake of credit crunch and external shocks that affect macroeconomic stability.

LESSONS FROM ARGENTINA

THE QUALITY OF BUSINESS LOCATION: THE CASE OF SWISS CANTONS

Credit Suisse recently published a research paper (link) where it's been shown that Swiss cantons with lower tax burden and improved regulatory environment are therefore more attractive as locations for doing business (link). Cantons Zug, Zurich and Obwalden got the highest score. Although tax rate structure in Zurich is not among the lowest in entire Switzerland, Zurich's high score can be explained by the fact that there's a high-quality access to demand linkages that certainly boosts the quality of Zurich as business location despite relatively high personal and corporate tax rates. In more distant cantons, tax competition certainly plays a bigger role since creating a business environment friendly oriented towards incentives to work, save and invest is a primary tool that boosts the locational quality of the region regarding economic outlook and the quality of the particular environment for doing business.

KENNEDY TAX CUTS IN 1960s

Here is how JFK explained the benefits of tax reductions that he implemented in 1960s.

TAX RATE REDUCTION IN GIBRALTAR

Tax-news.com recently reported that Gibraltar's government eventually decided to slash the corporate tax rate from 33 percent to 12 percent by the beginning of 2010 (link).

ARGENTINA'S PUBLIC DEBT SHOT UP TO 56 PERCENT OF THE GDP

From FT:

"Argentina’s debt levels are now higher than they were when it crashed into the biggest sovereign debt default in history in 2001, and a worsening crisis of confidence in the government has brought the spectre of a new default closer, a report to be published next week says. Despite a radical restructuring just three years ago, public debt has reached $114.7bn (€74.4bn, £59bn), or 56 per cent of gross domestic product, compared with $144.2bn, or 54 per cent of GDP, in 2001 – at a time when Argentina’s economy was much larger – according to the paper. Martín Krause and Aldo Abram, directors of the Argentine Institutions and Markets Research Centre at Eseade business school and the report’s authors, also found that if the amount owed to bondholders who did not accept the 2005 restructuring and are suing to recover their money is included, Argentina’s overall debt rises to $170bn, or 67 per cent of GDP. “We’re not teetering on the brink of default but if we continue down this path, with this level of [social] conflict, we could get there,” Mr Abram told the FT. Many developed countries, including Italy and Japan, have higher ratios of debt to GDP but Argentina’s higher borrowing costs and rocky institutional record make it harder to secure credit. “The worry is not the amount, it’s that we won’t have access to credit,” Mr Abram said. The six-month-old government of Cristina Fernández, the president, has been struggling to resolve a conflict with farmers after it imposed a sliding scale of export tariffs on key agricultural exports in March. The unrest has spread to truck drivers, who have mounted roadblocks to demand an end to the farm dispute, which has disrupted grains transportation. Their action has caused fuel shortages and will put further pressure on inflation, which the government is widely accused of trying to conceal with doctored data. Meanwhile, the government must this year find $14.6bn for debt servicing, plus $11.8bn next year and $10.5bn in 2010. However, the threat of legal action by bond holdouts bars Argentina from international capital markets whilst it remains in default with the Paris Club of creditor nations, to which it owes $6.6bn. Argentina has increasingly turned to Hugo Chávez, the Venezuelan president, who has bought $6.4bn in bonds in the past three years. But its international financial isolation is costly – Buenos Aires has had to pay Venezuela interest rates of up to 13 per cent, yet it cancelled its low-cost International Monetary Fund debt and the Paris Club debt only costs 5.3 per cent, Mr Krause said. By contrast Brazil, which had a far worse debt profile than Argentina in 2001, recently achieved investment grade and sold a 10-year bond at 5.3 per cent."

PRICE CONTROLS DON'T SOLVE RELATIVE SCARCITY: THE CASE OF MEXICO

Financial Times reports that Mexican government decided to impose food price controls in response to an increase in food prices. It will be interesting to see the situation when the laws of supply and demand take place.

INFLATION IN ASIAN ECONOMIES

Financial Times has a brilliant analysis regarding inflationary pressures and the surgence of macroeconomic instability in Asian export-driven economies (here).

REGULATION AND ENTREPRENEURSHIP

Kevin Hassett of the American Enterprise Institute recently published in article (link) in which he explained why there is a negative correlation between high regulation of entry and entrepreneurship. Two economists, Silvia Ardagna and Annamaria Lusardi examined survey data collected from 150,000 individuals in 37 different countries and showed that the amount of opportunity entrepreneurs is the highest in countries where there is less regulation of entry. For example, the United States has the highest share (8 percent) of opportunity enterpreneurs and the fewest regulatory entry barriers, after Canada and Denmark. On the other side, Spain, France, Belgium and Slovenia have the lowest share of opportunity enterpreneurs and unsurprisingly many regulatory barriers of entry.

CHILE'S ECONOMIC MIRACLE

OECD - ECONOMIC OUTLOOK 2008

AUSTRALIA'S ECONOMY GROWS FAST

In the latest quarter, Australia's economy grew 0,6 percent - twice as fast as the economists forecasted - continuing 17 years of rapid economic expansion. Economy's growth records may force the central bank to raise interest rate to curb inflationary pressures (link).

HOW WOULD EMERGING MARKETS SURVIVE MACROECONOMIC CRISIS

Bloomberg discusses how emerging markets would survive an economic crisis (link).

AGEING POPULATION IN JAPAN

From WSJ's Real Time Economics (link):

"Japan’s finance minister, Fukushiro Nukaga, suggested a way to alleviate the country’s strained finances as its population ages rapidly: Work till you’re 70. Japan is already the world’s oldest big nation, and between 2005 and 2020, the number of Japanese aged over 65 is forecast to rise to about 36 million from 26 million. Meanwhile, the number of working age Japanese will shrink to 74 million from 84 million. That is already hurting economic growth, and is expected to have an even greater effect in the future. Japan’s productivity — a measure of how much each worker produces — will rise a healthy 2.2% a year between 2009 and 2013, according to a forecast by the Organization for Economic Cooperation and Development. But the shrinking workforce will strip 0.7 percentage point from that, leaving the country with just 1.5% annual growth. “We are at a historic turning point,” Mr. Nukaga told a news conference Wednesday. While output growth is slowed, more people are living off pensions. Japan over recent years has already introduced some changes designed to make its pension system workable. Between 2000 and 2025, the age at which men can receive their full pension is being raised from 60 to 65. (The changes affect women five years later.) Pension premiums paid by workers are rising. This still isn’t enough however. Other ways to alleviate the problem, he said, could include allowing a greater number of foreign workers in Japan, which has traditionally not allowed large-scale immigration."

CUTTING THE CORPORATE TAX BURDEN

Greg Mankiw (link) recently wrote an article (link) published in The New York Times (link) discussing the possibility of a cut in the corporate tax rate as recently proposed by the economic advisers of John McCain. While John McCain has some doubtful and economically questionable proposals, such as the extension of gas-tax holidays, his economic advisers recently proposed a cut in the federal corporate tax rate from 35 percent to 25 percent. While the suggested proposal has been harshly criticized by economists such as Brad DeLong (link), the proposal deserves an open discussion about the consequences of the corporate tax rate.

The most frequent mistake that has been grasped repeatedly by the mainstream media and intellectual elites is that corporate tax is actually paid by the corporation itself. Despite the soundness of the argument, it is false. Corporations are likely to be tax-collectors than taxpayers. Why? For example, if you own equities and securities, than corporations shift the burden to consumers, hired labor and stockholders. An increase in the corporate tax rate potentially reduces capital investment. In turn, a corporation levies the burden by cutting total costs of labor and services. Consequentially, corporate equities and stocks are hampered by a higher relative weight on potential returns. Also, a significant amount of empirical research, including Randolph's 2006 study (Congressional Budget Office), has confirmed that the major share (70 percent) of the corporate tax burden is beared by the labor force. Researchers at Oxford University (Arulampalan, Devereux, Maffini) examined the effect of the corporate tax in 50,000 European companies in nine European countries. They found that, in the long run, a $1 increase in the tax bill reduces the real wage at the median by 92 cents.

The opposition to the cut in corporate tax rate often includes arguments such as the loss of tax revenue and the reduction of real wages. However, none of these arguments is based on empirical observations. In the short run, there are numerous static assumptions claiming that the revenue may fall precisely. However, the reduction in corporate tax burden would result in a stronger and less volatile stock market. In turn, that would boost capital investment respectively which would lead to higher productivity growth. A basic consequence of productivity increase is the increase in real wages and a drop in consumer prices. True, part of rhe revenue loss may be covered by an increase in other taxes such as gasoline taxes. But have there been any confident estimates showing that the revenue may really decline?

An additional and truly important measure to decrease the corporate tax burden is lowering government expenditure, both in absolute in relative terms. According to experience, the net effect of lower government spending is an increase in the growth of real productivity as well as stronger stock market that would boost investment and reduce volatility of the stock market itself. Also, lower government spending would result in higher output growth as well as it would have significantly positive welfare effects on prices, wages and employment.

HOUSING BUBBLE SPREADS ACROSS EUROPE

This article was written by Martin Rojko, a real estate analyst and frequent guest writer at Capitalism & Freedom.

According to indicators used for measuring a housing price bubble, residential property values were inflated last year in many european countries. Morgan Stanley´s and Global Property Guide´s data indicate, that market distortion is in Spain, Ireland, Baltic states, Netherlands, Denmark, Czech republic, Great Britain. As these data were gathered in 2006, it´s more than probable more markets join now a bubbled group including Slovakia.

According to TREND calculations the price of mostly selling apartment (one-bedroom, 60 m2 livable area) were equaled to eight-year disposable household income in Bratislava area. Although numbers (not only) such these should be counted carefully, sticking out income and price is a matter of fact. Also another indicator of rental property yields signals the bubble. While a few years ago an owner in Bratislava could make 10% or more from an apartment, now it is approximately 5% (less than mortgage interest in banks). It is the result of doubling apartment prices and stabilising rents.

A long history of western developed markets suggests a normal yield of around 10 – 12%. Property gets cheap when yields approach 15 – 20%. Numbers lower than 6-8% mean overvaluation. According to ECB note house prices in euro zone are overvalued by 15 to 25% by this indicator from their historical averages.

The second indicator, price-to-income ratio, tells how many years of pretax annual earnings are necessary for a household to purchase a house. The historical rule of thumb is that one annual income indicates undervalued properties, two and three annual incomes normal valuation, and four and more annual incomes overvaluation and bubble territory.

This situation has clear solution. To bring the ratio of prices to rents and incomes back to fair value, both must rise sharply or prices must fall. Housing prices now fall in Ireland, Latvia, Estonia, Spain and Great Britain.

We can often hear some experts said that european countries haven´t so crazy lending standards as in the USA and that´s why there´s no danger to afraid of a bubble. It´s a clear misunderstanding. Subprime mortgages don´t create a bubble although it can boost it. Look at Great Britain, Ireland or Spain. There haven´t been much relaxed bank´s lending conditions (especially comparing to the USA), so why the current turmoil? Because home prices are not justified by fundamentals – income, and rents. The bubble is reality.

Now the question stands whether it will burst and harm the whole economy or slowly blowing-out. Considering three mentioned countries I see the greatest danger in Spain. First, there is a huge home supply at prices which people simply can´t afford to pay. Currently cca 650 000 unsold units. Developers will be forced to decrease price maybe 30% down to sell them. But in the meantime many firms get to financial problems and go bankrupt. Second, Spain has the highest construction sector share on GDP in Europe (nearly 18 %). When developer, building firms have troubles, banks and whole economy have also. Of course, government interferes and pumps subsidy package to the economy, but this step only postpones clearing of the market.

There´s another (empirical) point we must be aware of. It is a tight correlation between US and euro area housing prices. The latter following the former with a lag of about two years. US started to decline in 2006, so maybe this year eurozone is in order.

But what about emerging euro countries? Well, as mentioned above the bubble exists in many of them. One thing is clear. Prices are rising slower than in previous years, in some markets (Estonia) they are heading downward with mild heavy impact on a part of mortgaged buyers. They have stabilized in polish Warsaw (been for 9 months cca on the same level) and start to stabilize in Bratislava. While up to day growth was driven in most part by foreign investors, they are now (also due to so called “mortgage crisis”) away. Developers thus hope domestic buyers will continue, but prices are too high for middle classed society (as largest pool of potential clients), because they are set-up still for wealthy and investors.

Now the question is whether incomes will rise so quickly that homes will sell at this level or prices should go down. I think second alternative is the most probable (and not because of I´m not living in my own). And the sooner sellers realize this, the lesser will be impact of bursting bubble in later times. The opposite side of a coin is firms are misguided by monetary policy of central banks, which manipulate interest rate according to their needs, while a real value of the money (or better said the means of payment) can be much higher (see US). And another question here arises (when not talking of abolition), whether one central bank for many differently phased markets is the best way to cope with problems.

Martin Rojko, author is a reporter in TRENDreality.sk (real estate server of business weekly TREND) and runs a blog vlastnictvo.blogspot.com