Global Emerging Markets (GEMs) : Sweden

President Obama’s Tax Reform Proposal: Good Policy, Brilliant Politics

Charles Krakoff — Fri, 17 Dec 2010 15:02:00 GMT

In a move bold and radical by the standards of Washington political gridlock, President Obama yesterday called for comprehensive tax reform. In so doing, he has given Congressional Republicans the rope with which they may choose to hang themselves.

Everyone from Paul Krugman to Rush Limbaugh can agree that the U.S. tax code – weighing in at around 10,000 pages it is the third longest in the world, after India’s and Britain’s – is a mess, shot through with loopholes, incentives, and exemptions: $1 trillion worth each year, according to the President’s bipartisan deficit reduction commission, which released its preliminary findings a couple of weeks ago. The gist of the President’s remarks is that the tax code could be simplified by removing these loopholes, broadening the tax base, and lowering both corporate and personal income tax rates.

The United States now has the second highest headline corporate tax in the OECD group of wealthier nations. This doesn’t mean that the average corporation pays 35% of its income in taxes; exemptions and loopholes result in much lower effective rates for many companies, but not all. Companies that do not operate in favored industries will pay much higher taxes than those that do. Consider as an alternative Sweden and Denmark, those bastions of high taxation and the welfare state, which impose corporate tax rates of 26.3% and 25.0%, respectively. Or some of the newer members of the European Union, in a rush to raise investment and employment after the breakup of the Soviet Union. Poland, the Czech Republic, and Slovakia have corporate tax rates of 19%, Romania 16%, and Bulgaria 10%. China and Vietnam, both still under Communist rule, tax their corporations at 25%. Even Cuba – Cuba! – has a corporate tax rate of 30%, not that it has much in the way of corporate profits to tax. The corporate tax codes in these countries have far fewer loopholes and exemptions, of course, and all of these countries have high rates of value added tax, but most of them also have a wider base of taxpayers and a simpler tax regime perceived by most as reasonably fair. The U.S. cannot make such a claim.

One of my principal gripes with the President has been his insistence on trying to achieve fiscal balance by raising taxes on wealthier Americans, while at the same time increasing the proportion of Americans who pay no Federal income tax at all. As gratifying as it may be to impose confiscatory taxes on neurosurgeons and Wall Street bankers, it is impossible to reduce the deficit in this way. The numbers simply don’t add up. I have advised a fair number of governments in emerging and developing economies on tax reform, and the mantra has been, and remains: broaden the tax base and lower rates.

Broadening the tax base makes sense for all kinds of reasons. It gives more people a real stake in society and its governance, changing them from passive recipients of government benefits to active contributors, who may be less eager to vote for expenditures they will have to pay for. It also lowers the average burden on taxpayers, since with more contributors each one has to pay less. Broadening the tax base also means abandoning the obsessive focus on income tax in favor of multiple forms of taxation, which in turn allows us to lighten the tax burden on behavior we want to encourage (work, employment) and increase it on behaviors we want to discourage (carbon emissions, excessive indebtedness, overconsumption). It is possible to go too far in this direction and get deeper into the business of social engineering (ever-rising taxes on tobacco and alcohol and proposed surtaxes on sugary soft drinks, for example), but our government has been in the business of social engineering for some time. The mortgage interest deduction, the employer-provided medical insurance exemption, incentives to buy hybrid cars or solar water heaters, and tax breaks for oil drilling were all introduced to promote behaviors that politicians at one time or another considered virtuous and certain corporate interests favored.

The trouble is that what may once have been a perfectly justified social policy may become something else, but by then so many have come to depend on the resulting exemptions and subsidies that resistance to reform becomes entrenched. We have recently seen that our government’s compulsion to increase home ownership encouraged bankers to lend and people to borrow for houses they couldn’t afford. If renting instead of owning one’s home were less stigmatized in government policy and popular perception, the housing crisis would never have occurred. But home builders, real estate agents, and mortgage lenders have powerful lobbies that will pull out all the stops to block abolition of the mortgage interest deduction. Just about every other potential reform also has a well-funded opposing special interest group and lobbyists, who will fight hard to protect their benefits. You don’t get rid of a trillion dollars in tax breaks without upsetting a lot of people. You don’t introduce new taxes (a national carbon tax and/or a value added tax, for example) without upsetting an equal number of people, and not just no-tax Republicans.

The outraged reactions we can expect to every tax loophole threatened with closure and every exemption set to be eliminated could be the key to the success of tax reform. The lobbyists will squawk and spend vast amounts of money no matter what. But if there is a widespread sense that everything is on the table, nothing is sacred, and the pain will be shared more or less equally, it’s just possible that everyone would agree to sit down together and thrash out the details. It’s a process that could take years, but could just work.

This is where President Obama could rescue his Presidency. Never the radical leftist some think he is, the President may be moving closer to the center as a result of Republican gains in the November mid-term elections. If he succeeds and gets the Republicans to work with him on tax reform, he wins – the more so if the process yields some results. But if, as so often happens, the Republicans manage to snatch defeat from the jaws of victory by refusing to work with the President in a self-destructive obsession to vanquish him, he also wins. The Republicans will stand revealed as the mad obstructionists he has accused them of being, and he could ride the wave of revulsion into a second term in the White House. If the Republicans were smart, they would get out in front on this, encouraging the President and the Congressional Democrats to work together with them on meaningful tax reform. If the President is smart, he will do likewise. Unfortunately, the Republicans show no recent evidence of smarts and are likelier to denounce the President’s proposal as a ploy. In that case, they risk going down in flames in 2012, in one of the greatest-ever reversals of political fortunes.

The Jobless Recovery and Other Paradoxes

Charles Krakoff — Wed, 24 Feb 2010 20:25:00 GMT

In yesterday’s New York Times Janet Yellen, President of the Federal Reserve Bank of San Francisco, is quoted as predicting a slow drop in the U.S. unemployment rate, now 9.7 percent, to 9.25 percent by the end of this year and 8.0 percent by the end of 2011. This is pretty anemic in view of her forecast of 3.5% GDP growth this year and 4.5% next year, a robust performance for a mature economy, though she attributes much of this growth to reduction in inventories rather than growth in sales. Ms. Yellen doesn’t foresee a return to peak economic performance and a corresponding drop in unemployment until 2013. The cause, she says, is clear: an increase in business efficiency and labor productivity, which she says, “is here to stay.”

One has to assume that Ms. Yellen’s prediction of stubbornly high unemployment takes account of Wednesday’s probable passage by the Senate of the $15 billion jobs creation package, which its supporters say will create tens of thousands of new jobs by providing an exemption from payroll taxes to employers who hire people who have been out of work for six months or more, as well as a $1,000 tax credit if those people remain employed for at least a year.

This development follows President Obama’s spirited defense last week of the stimulus package, which he claims has saved or created as many as two million jobs. Never mind any possible flaws in the calculation, and never mind that it is private business, not government, that creates jobs in the private sector. Let’s accept the President’s assertion that the stimulus package, which the Congressional Budget Office now estimates has cost $862 billion, has accomplished what he says. That works out to $431,000 per job created or saved, or about 10 years’ wages for the average employee. That’s a lot of money to save or create a job that could disappear as soon as the incentives expire.

Tax incentives to create jobs generally don’t work. In the late 1980s and early 1990s I helped the government of Botswana design incentives policies to attract foreign direct investment and create new jobs. Botswana’s incentives were as generous as they come: for qualified investments the government would pay 100% of a company’s wage bill in the first year of operation, declining in 20% increments over the following four years. The program initially was a great success, creating over 10,000 new jobs in garment production, automobile assembly, and other light manufacturing. The only problem was that most of these jobs disappeared as the incentives expired, creating a new set of social and economic disruptions. In the late 1990s, after one of the biggest beneficiary companies collapsed, the government realized the cost of the incentives had far outweighed any calculable benefits and scrapped the program entirely. Many other countries have had similar experiences.

By their very nature, incentives of this kind distort business decisions. Investment and employment decisions taken primarily for reasons of government grants or tax breaks instead of a sound business case may generate some short-term benefits, but at the cost of long-term competitiveness. Few people in the Obama Administration have any business experience, so they fail to grasp what is intuitively obvious to most businessmen.

It is impossible to save jobs in declining industries, and attempts to do so typically condemn those industries to a more complete demise. A hundred years ago, some 40 percent of the U.S. work force farmed for a living. Mechanization of agriculture, improved soil and crop management, better roads, and refrigeration changed everything. Today, less than two percent of the population works on the farm, but that small number of farmers produces far more food and feeds many more people at a far lower cost. Efforts to support farmers through subsidies, price supports, and tax incentives have done nothing to increase or even maintain agricultural employment, though they have enriched many large agro-industrial corporations.

Largely as a result of the past 30 years of innovation and investment in information technology, our economy is undergoing a similar shift now, in which manufacturing requires fewer and fewer people to produce more, higher-value goods. For the most part, this is a good thing. If productivity doesn’t increase, neither can wages and living standards.

I have seen garment factories with over a thousand sewing machine operators under a single roof, but these facilities are in Haiti and the Dominican Republic and China, and no incentives will ever bring them back to the United States. My great-grandparents worked in the sweatshops of New York’s Lower East Side, but those jobs went, first to South Carolina, and later to other countries, but they were replaced by better, higher-paying occupations. It can be an otherworldly experience to visit a modern factory, in which a handful of workers with digital controls can run a vast production flow. Any attempt to increase the number of employees with tax credits and other incentives would find few takers, but to the extent that it succeeded it would make these plants less competitive and put the entire enterprise at risk.

This is not an argument for the government to do nothing at all. The Oklahoma sod-busters who moved to California during the Great Depression and the Dust Bowl eventually found jobs in higher-value agriculture and emerging industries like aerospace, without much government assistance but not without wrenching dislocations and horrible suffering. No one wants to see a 21^st century repeat of The Grapes of Wrath. So what should government do?

The first thing is to remove some of the huge barriers to investment and employment in existing Federal laws. Writing in his blog, Mickey Kaus, hardly a Rush Limbaugh conservative, points to the Davis-Bacon Act, which requires workers hired on Federally-funded contracts to be paid the “prevailing wage” in the relevant county as determined by the Federal government. One of the centerpieces of the stimulus package was funding for “weatherization” of homes, but since it was launched the program has weatherized only 22,000 houses, largely because the Feds spent most of 2009 trying to establish the prevailing wage for weatherization work in more than 3,000 U.S. counties.

Davis-Bacon has been around since the 1930s, and was introduced to “stabilize” the construction industry by protecting white northern workers from being undercut by cheaper black migrants from the South. The Obama Administration is now presiding over a big expansion in the scope of Davis-Bacon to many additional jobs not previously covered. Moreover, the “prevailing wage” is set not in reference to actual wages as reported by the Labor Department’s Bureau of Labor Statistics but by its Wages and Hours Division, which uses a formula based on what the prevailing wage would be if all applicable jobs were unionized. According to some studies, this adds 22 percent to the actual prevailing wage. Kaus reports that the city of Portsmouth, New Hampshire turned down stimulus package money for construction of a new water treatment plant because the application of Davis-Bacon would have added $2.3 million to its $17.3 million cost. Ideally, Davis-Bacon would be repealed entirely, but with a President and a Democratic majority in both houses of Congress, who depend on labor union support, the likelihood of this happening is nil.

There are plenty of other examples of wrong-headed policies, including one of the highest corporate tax rates in the world, which is so riddled with special tax breaks and loopholes as to make a mockery of any claim to transparency and fairness. Many countries have found that a lower tax rate combined with elimination of most special exemptions generates more revenue with fewer distortions. Another example is the Obama Administration’s determination to impose taxes on overseas operations of U.S. corporations even before profits are remitted, which no other country does. Unfortunately, in the current political environment and under the current administration, neither of these anti-competitive policies stands any real chance of reform.

Finally, there is the “vision thing.” Barack Obama came to power promising a new approach to policy and politics, but in almost everything he has done he has proven himself a thoroughly conventional politician. His approach to technological change and its effect on the composition of industry is to award grants to companies trying to develop batteries for electric cars, while at the same time he has spent over a hundred billion dollars of taxpayers’ money to preserve jobs, wages, and benefits at GM and Chrysler. In an industry that has to cut its production capacity by at least a third just to survive, this makes no sense at all.

What we need instead is a set of policies that can help workers dislocated by technological transformation, globalization, and other fundamental changes to adapt to the requirements of the new economy. Rather than spend huge sums on vain efforts to preserve jobs destined to vanish, some fraction of that money could be spent on helping workers find new jobs and acquire the skills needed to succeed in them. Instead of trying, as the U.S. and some European countries do, to use incentives and penalties to prevent companies from shedding jobs, we should instead focus on the redundant workers themselves, as most Scandinavian countries and the Netherlands do. In Denmark, when two large meat packing plants closed with a loss of over 1,500 jobs, the national “workbusters” program shifted into gear, providing about €400,000 in assistance to complement financial contributions by the former employer, to detect vacant jobs and new job opportunities and to promote the laid-off workers to potential new employers. The company, with government assistance, published a leaflet, which it sent to 500 companies in the region, outlining the skills and ambitions of the former employees and providing information on the program and other employers’ experiences with it. Within 10 months, 98 percent of them had found new jobs, at a cost of around $350 per person.

When the Swedish energy company Vattenfall retrenched some 450 workers the company, with government support, set up an internal support organization to which each of the employees was reassigned to “work” full-time on finding new employment. Each person was assessed and assigned a tutor to develop a plan for training for a new trade or for self-employment or to pursue additional education. The company published a job journal on the company’s intranet to help workers find new jobs within the company, while all new internal recruitment requests had to go through the redundancy pool to identify a possible match. The program also topped up the salaries, at least temporarily, of those workers who accepted lower-paid jobs within or outside the company. The cost? About $20 million, or $50,000 per worker. A lot of money to be sure, but much less than the $400,000 in the Obama stimulus package.

These are not panaceas, and may not be applicable in all cases. But they are indicative of a flexible and innovative approach to unemployment that takes into account structural changes in the national and global economy and seeks sustainable solutions instead of quick fixes. Some may argue that the American system of government makes this kind of approach exceptionally hard, but even now President Obama may still have enough political capital to get something done. If he took on Davis-Bacon he would achieve the kind of bipartisanship he claims to want. But that would take extraordinary political courage and leadership of a kind the President so far has not exhibited.

I'll Take Sweden: Socialism, Free Markets, and the Nanny State

Charles Krakoff — Thu, 01 Oct 2009 20:36:00 GMT

In the eyes of many Americans, “Sweden” is shorthand for everything we don’t want America to become. It’s a tradition that goes back some way. In the 1965 movie I’ll Take Sweden, Bob Hope is an executive whose company sends him to Sweden, and he takes his teenage daughter, played by Tuesday Weld, largely to get her out of the clutches of her dead-end, guitar-playing boyfriend, played by Frankie Avalon, whom she wants to marry. Long story short, Tuesday falls in love with a suave Swede, only to find he has some strange ideas about premarital sex. Enter Frankie, who has traveled across the sea to try to win his girl back. He breaks his guitar over the degenerate Scandinavian’s head, and takes Tuesday back to America and married life in a trailer park, with Dad beaming proudly.

Opponents of President Obama’s proposed health care reform, massive deficit spending, takeover of the banking and automotive industries, and other “statist” excesses defend their position by saying those things are fine if you want America to become like Sweden, but we don’t, thank you.

John Stewart’s Daily Show ran a series a few months ago reporting on the horror that is modern day Sweden. The show’s ace investigative reporter went around interviewing people of all walks of life, from former members of ABBA to business executives, doctors, government officials, and factory workers, all of whom professed satisfaction with their lives and with the way Swedish society is organized. The reporter concluded that there had to be some kind of Invasion of the Body Snatchers thing going on, with most Swedes’ brains having been taken over by an alien life form that made them unaware how miserable they really are.

The only thing wrong with this picture is that it’s not really true. It is true that Sweden was an early adopter of the sexual revolution, the Swedes enjoy mixed saunas and sensible cars, and Sweden has colonized much of the world with Ikea, which for all its commercial success looks like something a state bureaucrat with fascist leanings might have invented.

Oh, and it is a welfare state. Sweden does provide benefits to the unemployed and it gives all its citizens free health care and education, and taxes them pretty highly in return. The combined income and social security tax for high earners is over 48% (including mandatory pension contributions), but that is not too far from the U.S. where earners in the top 5% can pay as much as 40%, depending on income taxes in their home state. And Sweden’s corporate tax rate is only 28%, compared to the 35% U.S. corporate tax rate and average effective combined Federal and state rate of 39.3%.

Sweden is far from being the statist, socialist nightmare that many Americans imagine. The government last week announced deep cuts in personal income taxes “to stimulate the economy,” together with planned reforms to improve the business climate and create incentives to start companies.

It may be their Lutheran heritage that has imparted to the Swedes some common sense and a work ethic. The maximum $1,650 after-tax monthly employment benefit is hardly lavish, and in most cases it expires after 300 days. The government offers retraining, employment subsidies and reduced employer social contributions to encourage companies to hire the unemployed, with additional enticements such as lower minimum wages and flexible contracts for hiring people under 25. Similar youth employment incentives proposed two years ago in France, drew hundreds of thousands of students into the streets in protest.

On health care, Sweden’s single-payer system came under intolerable stress in the 1980s, with rising costs and growing waiting lists for medical procedures. The government devolved substantial power to county councils, and gave them freedom to introduce market-based reforms, which most have done. Hospitals have been privatized and the market share of private medical practitioners is on the rise. Many kinks still need to be worked out, but Stockholm, which has been most aggressive in introducing market-oriented reforms, has shown impressive results.

Still and all, Sweden is socialist, isn’t it? And that has to be a bad thing, right?

In a word, no. Sweden is a leader in privatizing public pensions. Though mainly state-owned corporations historically accounted for about one fourth of the market capitalization of the Stockholm Stock Exchange, the government has privatized or plans to privatize most of its crown jewels, including the stock exchange itself, the Apoteket pharmaceutical distribution monopoly, the former alcohol manufacturing and distribution monopoly Vin & Sprit, and major state-owned telecoms, real estate, and financial firms. Industry itself has always been overwhelmingly in private hands, and Sweden has a lot of world-renowned companies for a country of only nine million people, including Volvo, SKF, Ericsson, Skanska, Electrolux, Sandvik, Atlas Copco, Ikea, and H&M.

In the 1990s Saab and Volvo sold their passenger car divisions to General Motors and Ford, respectively, while holding on to their lucrative truck, heavy equipment, and aerospace operations. This past spring, as GM teetered on the edge of bankruptcy, and the U.S. government started crafting its takeover of GM and Chrysler, the Swedish government firmly rejected the idea of a Saab bailout. “The Swedish state is not prepared to own car factories,” said Maud Olofsson, the Minister of Enterprise. The World Economic Forum ranks Sweden the fourth most competitive economy in the world, just behind Switzerland, the United States, and Singapore.

Sweden went through its own financial and banking crisis in the early 1990s when a real estate bubble collapsed, GDP dropped by 5%, total employment fell 10%, and the central bank briefly jacked up interest rates to 500% to prevent a run on the krona. The state took over a fourth of the country’s banking assets to save the banking system, at a cost of 4% of GDP. In 1994 the budget deficit stood at 15% of GDP. The government quickly restored the banks to private ownership, cut government spending, and introduced liberal economic reforms that enabled the economy to rebound quickly and to capitalize on the emerging IT and telecoms boom. From a 2008 budget surplus of 2.5% of GDP, this year’s expected budget deficit is 2.2% of GDP, and is forecast to widen to 3.4% in 2010 before returning to balance. Not bad for the worst global financial and economic crisis since the Great Depression, and an awful lot better than America’s projected deficit of 13.1% of GDP this year and 9.6% next year, not to mention the boom years of 2001 to 2008, when the Bush Administration ran average annual deficits of more than 4% of GDP.

Sweden is not perfect. The nanny state sticks its nose into too many corners of personal life. An eight-year-old boy in Lund had his birthday party invitations confiscated at school when he failed to invite two of his classmates. This violated rules on “inclusion.” Government has launched an investigation of parents who use the family computer to access porn sites, which their kids might then be able to access. In the 1970s Sweden, the home of former heavyweight champion Ingemar Johanssen, banned boxing as too violent for the pacific society it had become. TV advertising is banned from programs targeting under-12s, while movies with even a hint of violence get a rating that bans under-12s from watching, even if accompanied by their parents. Toy guns –even water pistols – were outlawed. Alcohol taxes are among the highest in the world, and you can see the unhealthy consequences on the overnight duty-free “booze cruises” from Stockholm to Helsinki, which end with bleary-eyed Swedes (and Finns), still drunk, stumbling onto the pier, their shoes encrusted with vomit. But e-commerce, home DVD players, the end of internal border controls in the EU, and a general feeling that things had gone too far have started to win some battles with the nanny state. You can buy toy tanks and bazookas now, and in 2007 the ban on boxing was repealed.

As the U.S. government, first under George W. Bush and now under Barack Obama, becomes ever more statist, and as Americans accept eavesdropping on telephone conversations, bans on trans fats ,and proposals to tax soft drinks as something governments have every right to do, Sweden – never anywhere near as socialist as popular imagination would have it – has steadily moved in the opposite direction. Our paths will cross, if they haven’t already done so. One can only be grateful that when Americans realize the limits of state intervention in our personal and economic affairs we will have the Swedish model as a guide to start putting ourselves back on the right track.