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Wednesday, June 28, 2006

Curly Capitalist Question 8, ACT and Tax

Anonymous has a question on ACT's tax policy

Act has a 25% (near) flat tax policy. If Act came to power:
-in which areas would they cut spending?
-would they have budget deficits?


At the last election, ACT had a policy of a top rate of all forms of taxation of 25%
It was not a flat tax as all those paying less than 25% would continue on the lower rate.

At a 25% rate, ACT would cut no spending. In 2002, the McLeod Report stated that NZ could drop to a 25% flat rate tax with no loss of revenue whatsoever. Huge budget surpluses also give any responsible government plenty of room to cut taxes while maintaining all current services.

ACT now advocates a "Taxpayer's Bill of Rights". Essentially ACT commits to freezing government spending at current levels. No increases without a 75% parliamentary majority, (to allow for emergencies such as war or a major public health crisis).

No budget deficits would be run.

The effect of this would be to gradually and painlessly reduce the proportion of government expenditure, proportionate to private spending, as the economy expands.

The well known "Laffer Curve" would also come into play here. According to Laffer, high tax levels produce certain revenues for the state, but lower tax levels can produce even more.

Imagine if we were all taxed at 80%. The government would get lots of tax, (for a while) but economic growth would be slow and may even go backwards.

If we were all taxed at 20%, economic activity would rise dramatically, more businesses would start and expand, wages would be bid up and more tax would be paid. The government would get the same, or more revenue at 20% as at 80%.

Also people would be far wealthier and more able to afford private education, health etc and so would depend less on the state.

I'm quoting from memory here but I believe the famous Caragata Report stateded that if NZ had adopted a 28% flat tax after WW2, that by the mid '90s, this country would have been a staggering 250% richer.

Imagine that. Paying off your mortgage in six years, rather than 15.

Low flat taxes sound pretty damn good to me.

27 Comments:

Blogger Heine said...

I remember the Caragata report. I still have his book somewhere back home stored away. Very interesting and thought provoking report.

1:50 AM  
Blogger Rob Good said...

Sounds good to me too.... When is Rodney and the team going to ramp up the seriousness and get the ball rolling?

10:07 AM  
Anonymous Anonymous said...

What evidence do you have to suggest that NZ is to the right of the turning point in the Laffer curve?

2:59 PM  
Blogger Yacap said...

1] The Laffer curve is nuttiness. Obviously if the tax rate is very high, you won't get much tax money; equally obviously, if it's very low, you won't get much. That doesn't imply there's a smooth, predictable curve between the two endpoints, or a unique place for maximum "revenue"

2] More tax money in the government's hands is not a good thing

3] Taxation is immoral. People who do it need to be hanged. That is all.

3:09 PM  
Blogger Trevor Loudon said...

Anonymous. Silly question. The principle is straight forward. Levy tax at a low rate, the economy will grow and you will get plenty of revenue.

Drop a golf ball and gravity will pull it to the ground. Want proof of that too?

3:48 PM  
Blogger Trevor Loudon said...

Yacap-please explain the illogicality of the Laffer Curve.

I never said there was an ideal point or a smooth curve, that depends on each economies circumstances and the dynamism of the individuals within it.

Its a simple proposition, the best way to raise revenue stably and inflicting the least damage is to levy low rates across a wide base. Not rocket science.

In my heart I agree with your other two points, but I'm a member of ACT, not the Anarcho-Capitalist Revolutionary Front.

3:55 PM  
Anonymous Anonymous said...

"Anonymous. Silly question. The principle is straight forward. "

Yes, the principle is straight forward, but how could you get an estimate of the tax rate at the turning point of the curve?

When going from a National government to a Labour one in 1999, Labour raised tax rates slightly and the revenue increased.

So, what evidence do you have to suggest that NZ is to the right of the turning point in the Laffer curve?


"Levy tax at a low rate, the economy will grow and you will get plenty of revenue."

The Laffer curve is a static model not a dynamic model. It has government revenue on the y axis and average tax rate on the x axis. It doesn't involve growth, time or changes in G or t over time.

Maybe you are thinking of some sort of macroeconomic theoretical growth model.

4:20 PM  
Anonymous Anonymous said...

"I'm quoting from memory here but I believe the famous Caragata Report stateded that if NZ had adopted a 28% flat tax after WW2, that by the mid '90s, this country would have been a staggering 250% richer."

Could you provide me with a link to a detailed description of the methodologies used in this report?

4:31 PM  
Anonymous Anonymous said...

I have just fit a regression model of annual real GDP per capita against time (1960-1998). There was an extremely strong linear relationship with respect to time and there was an R squared statistic of 0.9369.

After taking care of autocorrelation, the relationship with time became less strong but remained significant. There was a strong relationship between current and lagged (of order 1) real GDP per capita. The R squared statistic for the 2nd model was 0.9774.

Given that taxes varied over those 39 years, I think your theory that tax cuts lead to significant growth is very weak.

5:03 PM  
Blogger Trevor Loudon said...

Anon this is the name of the report. I'm sure a google search will give you what you want

Author: Patrick Caragata
Title: The Economic and Compliance Consequences of Taxation: A Report on the Health of the Tax System in New Zealand
Date of Publication: 1 August 1998

5:07 PM  
Blogger Trevor Loudon said...

Anonymous I think you're blinded by your own bullshit. I don't even know what the figures youre referring to mean. Go run a dairy for a year and then try to tell me that lower taxes don't lead to increased economic activity. Keep it simple man.

5:11 PM  
Blogger Yacap said...

Yacap-please explain the illogicality of the Laffer Curve.

The idea of the Laffer curve is that tax revenue is obviously zero at both ends (0% and 100% taxation), and non-zero at points in between, so Laffer assumes there's a curve that looks like a hump, therefore at some tax rate x revenue is maximized. That's what Anon above means about "how do you know we're to the right of the inflection point". There's no reason to think the curve looks anything like that, or is even stable from one day to the next.

My other complaint with proponents of the Laffer curve is that I assume that if they say "lower taxes to raise revenue" because they think we're to the right of the inflection point (assuming, arguendo, that the Laffer curve has some bearing on reality), then they'd also be in favour of raising taxes if they believed we were to the left of the inflection point. On the other hand, people who say "lower taxes because taxes are immoral" want to lower taxes regardless of any effect on government revenue - that's the good position.

5:55 PM  
Anonymous Anonymous said...

"Anonymous I think you're blinded by your own bullshit. I don't even know what the figures youre referring to mean."

You assume that it is bullshit yet you admit you don't understand the basics of regression modelling. Regression modelling is done by economists to test theories, make forecasts and find relationships between variables.


"Go run a dairy for a year and then try to tell me that lower taxes don't lead to increased economic activity. Keep it simple man."

How would running a dairy for a year give me an idea of the level of economic activity for the entire country?

12:56 PM  
Blogger Trevor Loudon said...

Fair enough anon. Your modelling tells me absolutely nothing as there is no mention of tax rates.

What are you trying to say? That there is no correlation between lowered tax rates and increased economic activity? Is that what you mean by saying my "case is weak"?

Running a dairy might make you understand that incentives or lack of, make a huge difference to economic decision making.

You don't need theorems to tell you that people work harder when they have incentives. Tax is a major disincentive to every business person I know. Maybe I haven't talked to the right people like you have.

You don't seem to understand this principle and neither does Michael Cullen.

That is what I mean being "blinded by bullshit". Using academic theorems to "disprove" what most small business people or investors could tell you for the asking.

BTW you're not Michael Cullen are you?

1:35 PM  
Blogger Yacap said...

Regression modelling is done by economists to test theories, make forecasts and find relationships between variables.

Real (Austrian-school) economists don't do that.

2:30 PM  
Blogger Deerhunta said...

Anon - All you have done is run a linear regression and come up with an high r2 value that shows that real GDP has increased linearly over time. Thats hardly rocket science mate.

10:57 AM  
Blogger Deerhunta said...

A regression is NOT a model. A regression of data can show you what has happened in the past but cannot predict what will happen outside the parameters of the particular regression. For example what was the highest and lowest tax rate between 1960 and 1998 im don't know the figures but I doubt rates got anywhere near as low as 20%.

11:03 AM  
Anonymous Anonymous said...

" Fair enough anon. Your modelling tells me absolutely nothing as there is no mention of tax rates."

The R squared statistic gives the proportion of variation in the response variable explained by the explanatory variables. Both fitted models had real GDP per capita as the response variable. In the first model, time was the only explanatory variable. In the second model, real GDP per capita in the previous year and time were the explanatory variables. If tax rates had been reduced at constant rate over time, then it could be argued that real GDP per capita is increasing due to the tax cuts. A more plausible reason for the increase in real GDP per capita is improvements in technology.


"What are you trying to say? That there is no correlation between lowered tax rates and increased economic activity?"

Government spending also contributes to economic activity. Public goods, law and order spending and social services have an effect on economic activity.

Lower tax cuts would mean higher disposable incomes for many people and most likely it would result in higher levels of private consumption. The lower tax cuts would mean less revenue available for government spending (assuming the government doesn't change the level of surplus/deficit).


"Is that what you mean by saying my "case is weak"?"

No. I think your theory that tax cuts lead to higher economic growth uses valid arguments but empirically it is weak i.e. it lacks statistical evidence to back it up.


"Running a dairy might make you understand that incentives or lack of, make a huge difference to economic decision making."

I doubt that tax cuts would raise the level of effort or change the hours worked by a dairy owner. Tax cuts probably wouldn't have much effect on the sales revenue of the business. Cutting taxes would have little or no effect on the number of loaves of bread, bottles of milk, lollies, cigarettes etc bought at the dairy.


"You don't need theorems to tell you that people work harder when they have incentives. Tax is a major disincentive to every business person I know. Maybe I haven't talked to the right people like you have."

Incentives alone won't get people working harder. People also need the ability/opportunity to act on those incentives. For example tax cuts would create a greater incentive for an individual to become a high wage professional but if the tax cut means government spending in education is abolished, then there would be a reduced opportunity for that individual to take up training (unless that individual's parents can afford the fees).


"That is what I mean being "blinded by bullshit". Using academic theorems to "disprove" what most small business people or investors could tell you for the asking."

I didn't disprove your theory. I only showed that it was empirically weak. I fitted a regression model to real observations and altered the model to fit the data better. You on the other hand selectively use some economic theories while discard the rest. You have based your opinions on incomplete theories and treated those opinions as gospel truth. You even believed that:
1. Data was available that made the Laffer curve useful.
2. That NZ is currently to the right of the turning point on the Laffer curve.

4:30 PM  
Anonymous Anonymous said...

"Real (Austrian-school) economists don't do that."

Does that mean only unreal economists get jobs as forecasters or analysts?

4:54 PM  
Anonymous Anonymous said...

"A regression is NOT a model."

Regression is a technique for fitting a model to data.


"A regression of data can show you what has happened in the past but cannot predict what will happen outside the parameters of the particular regression. For example what was the highest and lowest tax rate between 1960 and 1998 im don't know the figures but I doubt rates got anywhere near as low as 20%."

Using regression models for forecasting has the assumption that the patterns modelled will continue into the near future. The further into the future the forecast is made, the less accurate it is likely to be. Fortunately new observations would usually be available before the far away forecasts are needed, so the model can be refitted to include those new observations.

It is very hard to tell what exactly would happen if taxes were to become extremely high or extremely low. So far tax rates have been quite varied (compare Muldoon's government to Shipley's) but if they were to have had a significant effect on the models, why were the R squared values for my models so high?

5:13 PM  
Blogger Yacap said...

Does that mean only unreal economists get jobs as forecasters or analysts?

For governments, yes, of course; why would they want to employ people who actually understood economics (human action), rather than mathematical "models" (good for physics; completely useless for economics)? The recommendations of anyone who understood economics would always be opposed to whatever the government wanted to do (unless it wanted to disassemble itself, but that's not very likely)

5:22 PM  
Anonymous Anonymous said...

"For governments, yes, of course; why would they want to employ people who actually understood economics (human action), rather than mathematical "models" (good for physics; completely useless for economics)?"

You are confusing theoretical models with fitted regression models.

Theoretical models tend to be used only for teaching purposes. Most of them are useful for conveying some particular economic concept but aren't useful in modelling actual economies e.g. the Laffer curve.

Regression modelling is when a model is fitted to a set of observations, usually via the ordinary least squares method. The simplest regression model example is a straight line of best fit to points on a 2D scatter plot. In this situation you know that the line of best fit would have the structure of:

y=mx+c

where m is the slope and c is the intercept.

There would be a data set of observed y and x values. m and c values are chosen that minimise the sum of the squared residuals.

A residual is equal to an observed y value minus the corresponding fitted y value on that straight line.

After doing diagnostics on the model, the model might be changed then refitted, in order to fit the data more closely.


"The recommendations of anyone who understood economics would always be opposed to whatever the government wanted to do (unless it wanted to disassemble itself, but that's not very likely)"

Do you think that the vast majority of people who have studied or taught economics don't understand it?

5:59 PM  
Blogger Yacap said...

You are confusing theoretical models with fitted regression models.

I'm not. You're confusing models with reality.

There would be a data set of observed y and x values.

Why would there be? Observed values of whatever may or may not be interesting, as a demonstration of theory in action, but it's utterly unrelated to economics.

Do you think that the vast majority of people who have studied or taught economics don't understand it?

Yes. Probably 99.9% of people who have studied or taught economics understand it far less than your average ten-year-old.

(Here's a nice quote from an interview with Peter Schiff on the Financial Sense Newshour last week, when asked about being taught economics: "you get brainwashed; they wring the common sense out of you; I mean probably somebody that has no education in economics whatsoever has got a better chance of understanding economics than someone that's got a degree from Harvard in economics, 'cos they have to unlearn everything they learned just to get back to zero" -- full programme here; at about 39 minutes)

8:02 PM  
Blogger Trevor Loudon said...

Right on yacap. If anon is an example of a student of economics, I'll just stick to being a student of reality.

8:51 PM  
Anonymous Anonymous said...

Trev,

I based my views about tax cuts and economic growth on observations in reality yet you base your's on theory alone. Your theory used valid arguments but:
1. There are opposing theories that use valid arguments.
2. Methods based on observations in reality show your theory to be weak.

Trev, you used to say that you liked economics because it is like physics (for prediction and optimisation). You got that wrong for both your definition of economics and the comparison to physics.

Now that yacap has come along, you have changed your tune to economics being wrong and you being are a student of reality.

You rubbished my regression models yet you admitted that you don't understand what I did. You say that my regression models are bad because you don't understand them, yet you accept Caragata's dodgy calibration model as gospel truth and you didn't understand what he was doing.

Trev, you aren't a student of reality; you are a student of incomplete theory, half truths, fallacies and free market utopian theology. You only accept reality when it doesn't counter the assertions you have made in support of your extreme political ideology.

3:30 PM  
Blogger Yacap said...

Economics isn't wrong. Your "version" of economics is wrong.

1. No, there are not "opposing theories that use valid arguments", any more than there is "opposing mathematics that uses valid arguments" in which 2+2=5 on alternate Wednesdays (i.e., if you get that result, you're doing something wrong)

2. If observation of reality doesn't bear out correct theory, then there's something wrong with your observation (or you're attempting to apply the theory to circumstances where it doesn't apply). In praxeology (of which economics is a subset), theory always beats observation - (a) the theory is known to be correct, and (b) you can only interpret your observations, whatever they are, through the lens of theory.

Read Human Action ASAP. (Won't be easy; like Schiff said, you'll have to unlearn everything you thought you knew)

Anybody who calls himself an economist who hasn't read (and understood) Human Action is lying and knows nothing about economics, guaranteed!

7:36 PM  
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