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How Greece Could Overtake Germany

Tax rates up, tax receipts down? This 'austerity' doesn't work...
I HAVE asserted that Greece really isn't going to solve its problems until the government creates a healthy environment for private business, writes Nathan Lewis of New World Economics in this article first published at Forbes.
This mostly means tax reform, with much lower rates. Yes, you could name a dozen other factors that help, but what we find in practice is that, if taxes are low, then things tend to work out well no matter what the situation is regarding these other factors.
We also find that these other factors also tend to improve along the way, because any government that is serious enough to engage in major tax reform is also serious enough to address other issues that arise.
If taxes are high, not only does this depress private enterprise in the first instance, no matter what the other factors may be, but it also sets in motion a trend toward corruption that makes all other effective reform impossible.
That's why the Magic Formula is only four words: Low Taxes, Stable Money. If you have the Magic Formula, the other stuff tends to get solved over time. If you don't have the Magic Formula, you can try to fix everything else on your hundred-item wish list of reforms, and you will probably fail – or, even if you didn't fail, it still wouldn't matter.
Nevertheless, governments are afraid. Mostly, they are afraid of a major decline in tax revenue. Oddly, this often follows a long period in which taxes are continually raised ("austerity"), and continually produce a decline in tax revenue. The Greek government's tax revenue was €67.5 billion in 2013, down from €81.4 billion in 2008. It looks like it fell another 3% or so in 2014. You would think that someone worried about a decline in tax revenue would not keep doing that, over and over.
Observant people have seen the same thing happen again and again throughout history. Here's John Maynard Keynes in 1933:
"Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance, than an increase, of balancing the Budget. For to take the opposite view to-day is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more; – and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss."
Here's the great Arab genius Ibn Khaldun, who was a high minster in several North African states, writing on the topic in the 14th century:
"The rulers may, mistakenly, try to remedy this decrease in the yield of taxation by raising the rate of taxes...This process of higher tax rates and lower yields (caused by the government's belief that higher rates result in higher returns) may go on until production begins to decline owing to the despair of business men, and to affect population."
Greece's population peaked at 11.19 million in 2009, and was 10.99 million in 2014. So, don't do that. Rather, do what US president John F. Kennedy, inspired by the example of Germany's Ludwig Erhard, suggested in 1963:
"It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenue in the long run is to cut the rates now. The experience of a number of European countries and Japan has borne this out."
Ah, but there's that hedge – "given sufficient time to gather the fruits." Meaning "the long run".
Certainly one should expect a reduction in tax revenue for at least a short period of time? Isn't there some pain to go along with this gain? It seems reasonable.
But, we find that is not the case at all. Tax revenue tends to rise immediately. This was the case after the Kennedy tax cut of 1964 and Coolidge tax cut of 1925; it was the case in Japan and Germany during the 1960s; it was the case after the Reagan and Thatcher tax reforms in the 1980s; and it has been the case among the European flat-taxers in more recent years. (I document all these examples in my book Gold: the Once and Future Money.)
At the beginning of 2008, Bulgaria introduced its 10% flat tax system – a 10% rate on corporate profits and individual income. This replaced a 15% corporate tax rate in 2007 (down from 40% in 1997) and a top personal income tax rate of 25% (down from 50% in 1996).
Bulgaria's VAT rate remained unchanged at 20%. However, payroll tax rates fell from 43.6% combined in 2007 to 31.7% combined in 2008. They are 31.4% today.
For 2008, total tax revenue rose 14.7% compared to 2007. Corporate tax revenue rose 22%. Individual income tax revenue rose 9%. Payroll tax revenue rose 10%. The government ran a budget surplus that year, as it had for the previous five years as well.
This followed the pattern of Bulgaria's experience since 1998. Despite all the reductions in tax rates noted above, tax revenue never shrank. (The Bulgarian Lev has been linked with a currency board to the Deutschemark and then the Euro since 1997.) Indeed, between 1998 and 2008, total tax revenue grew by 207% – more than tripling in a decade. (It has since stagnated somewhat, reflecting difficulties throughout Europe.)
Government debt/GDP fell from 77.6% in 1999 to 13.7% in 2008. Tax revenue, as a percentage of GDP, was 34.8% in 1998. In 2008, after the flat tax implementation, it had risen to 38.3%.
One of the surprising things we find is that, not only does nominal tax revenue tend to increase, but the revenue/GDP ratio remains amazingly stable or even rises, despite a barrage of tax reforms.
Bulgaria's experience mirrors that of Russia. After sovereign default in 1998 and restructuring the defaulted sovereign debt in 2000, Russia's government embarked on a program of renewal, powered by a major tax reform program. Russia's implementation of its 13% flat income tax at the beginning of 2001 is well known. However, that was just one part of a program which included a reduction of the VAT to 20% from 23% in 1999, a reduction in the corporate tax rate to 24% from 35% in 2002, a reduction of the VAT to 18% in 2004, a reduction in combined payroll tax rates to 24% from 35.6% in 2004, the elimination of inheritance and gift taxes in 2005, the reduction of the tax rate on dividend income to 9% from 15% in 2008, and the reduction of the corporate tax rate to 20% in 2009.
The Russian government's tax revenue increased 46% in 2001, 40% in 2002, 27% in 2003, 26% in 2004, 23% in 2005, 32% in 2006, and 36% in 2007. Tax revenue/GDP was 31.4% in 2000, and 31.6% in 2008.
During all of these years, 2001-2008, the Russian government ran a budget surplus, reaching an astonishing 10% of GDP in 2005. The former defaulter's debt/GDP ratio is now 11%. (Unfortunately, Russia's hot streak ended with the 2008-2009 financial crisis, which prompted the government to raise payroll taxes to 34% from 26% in 2010.)
Alas, the example of some European flat-taxers, such as Bulgaria, has been marred by the continuation of very high payroll and VAT taxes. I suggest eliminating payroll taxes altogether – perhaps phased in over a few years – as high VATs around 20% are certainly more than enough burden for the lower incomes to bear. Although some might think this is "extreme," I would argue that maintaining a 20%+ payroll tax on top of a 15%+ VAT would seem very "extreme" to someone from Hong Kong, which has no payroll or VAT/sales taxes at all. Greece's present VAT of 23% is similar to the US payroll tax of about 13% and average sales taxes of about 10%. Nobody in the US thinks this is a "low tax" situation, especially for lower incomes.
When governments begin to see that major tax reform is actually a means to create much more tax revenue, in the "long run" but even immediately, while also resolving the major problems of society (notably the 26% unemployment), then their prior fears dissipate like so much delusion. They begin to grasp the alchemical laws of economic creation and destruction. There is actually nothing to lose, and everything to gain. It is all just as Confucius said 2,500 years ago: a healthy economy produces healthy government finances, so if you concentrate on the healthy economy, everything else just works out.
This level of leadership also tends to produce very long political careers, such as Lee Kuan Yew in Singapore, or the Liberal Democratic Party in Japan during the 1950s and 1960s.
I think Greeks should aim to become more wealthy than Germans in twenty years. Wouldn't that be fun?

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

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