Thursday, 25 July 2013

Laffer curve reflections (Detroit and Spain edition)

Tyler Cowan has some interesting observations on tax rates in (now bankrupt) Detroit - high rates, low revenue. Who would want to live there, given how easily you can move away by a few miles?

Problems for states are different - moving away is costly, though high-skilled people certainly can and do move to greener pastures when times get too awful. There is also another effect that comes from jacking up tax rates, which produces something like the Laffer-curve effect, but for different rates. Spain/Catalunya (some of the income tax here is regional) how has the 3rd highest income tax rates in the world, after Aruba and Sweden (and believe me, public services are not like in Sweden). Strikingly, actual tax revenue relative to GDP is one of the lowest in the OECD -- a full 9% less than the Netherlands, 7% less than Germany, and about on par with Switzerland, where tax rates on the same income are on average half.

This is another way of saying that taxation in Spain (and much of Latin Europe) is hugely distortionary - you have a small part of the economy that can be taxed, and the state squeezes out the last drop; and then there are vast parts where there is hardly an attempt to tax at all. Notary records of property values? much less than what people paid, no problem? No receipt for your purchase in the pharmacy? No problem. Italy introduced an obligation to carry the receipt within a certain distance of every shop to stop tax fraud... not here. The list goes on; all those cars with Andorra licence plates in Barcelona - do these guys really live there? I doubt it. And so, as rates have gone up, the incentive for people to switch from the (legal, efficient) part of the economy to the (untaxed, inefficient) part has gone up hugely. And guess what, it doesn't help with aggregate productivity.

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