The document argues that Europe's economic challenges stem from excessive taxation and spending by various nations rather than a singular 'European' issue. It criticizes proposals for tax harmonization and fiscal union as likely to worsen the situation, advocating instead for spending restraint to promote economic growth. The author cites historical examples to support the notion that countries can achieve fiscal balance by controlling government expenditure relative to GDP.

1. Harmonization vs.
Competition: Fiscal Union
vs. Decentralization
Free Market Road Show,
April 27, 2012

2. Defining the Problem
There is no “European” problem.
There is no “Eurozone” problem.
There is no “Euro” problem.
There is a problem of many nations taxing
too much and spending too much.
This is leading to anemic economic
performance.
International investors don’t trust some
nations to pay thir bills.

3. Making Bad Policy Even Worse
Proposals for tax harmonization and/or a
fiscal union will exacerbate the problems in
Europe.
No economic rationale for identical/similar tax
rates.
No economic rationale for fiscal transfers.
Look at the U.S., particularly in the past.
Look at Switzerland today.

4. Growth Matters…a Lot
Years Needed to Double Economic Output
7 percent growth
6 percent growth
5 percent growth
1 4 percent growth
3 percent growth
2 percent growth
1 percent growth
0 10 20 30 40 50 60 70 80

5. Definition of Good Fiscal Policy
Government spending should grow slower
than nominal GDP.
Over time, this reduces burden of public
sector.
Eliminates risk of higher taxes.
Deficits eventually disappear.
Debt shrinks as share of GDP.
Politicians don’t like this approach since they
can’t buy votes with other people’s money.

6. Size of Government Matters…a Lot
There is a “Rahn
Curve” relationship
between
government
spending and
economic growth
similar to the “Laffer
Curve” relationship
between tax rates
and tax revenue.

7. Big Government Inevitably…

8. …Erodes a Nation’s Social Capital

9. Demographics Is Fiscal Destiny
Ageing populations and welfare states are an
unstable combination.
Pay-as-you-go systems are Ponzi schemes.
Not enough future workers to support
redistribution programs.
Without reform, massive debt or massive tax
increases.
Probably both

10. Two Workers per Retiree

11. Increased Burden of Gov’t Spending

12. The Sovereign Debt Crisis
Greece was the tip of the iceberg
Ireland was phase two.
Spain and Portugal phase three.
Italy and Belgium phase four.
Japan in a special category.
Almost all other industrialized nations are on
this path.
Rare exceptions such as Australia, perhaps
Switzerland and even Sweden.

13. Where Is the Debt Tipping Point?
Rogoff and Reinhart say 90 percent of GDP is
the danger zone.
Depends on the nation.
Industrialized world has breathing room.
Greece got in trouble over 100 percent.
Japan still doing fine at 200 percent.
Spain and Portugal in trouble at less than 90
percent.

14. France – 400 Percent of GDP

15. Germany – 300-plus Percent of
GDP

16. Greece – 400 Percent of GDP

17. Ireland – 300 Percent of GDP

18. Italy – 250 Percent of GDP

19. Netherlands – 400 Percent of GDP

20. Japan – 600 Percent of GDP

21. Portugal – 300 Percent of GDP

22. Spain – 300 Percent of GDP

23. U.K. – 500-plus Percent of GDP

24. U.S. – 450 Percent of GDP

25. Implications for Tax Policy
Burden of government spending will increase
by at least 10 percentage points of GDP.
BIS model shows worse results, driven by
interest assumptions.
That won’t happen because it means an end
to Western civilization.
But what will happen?
In Europe, some nations will default and
leave the euro (so they can inflate).

26. Can Europe Tax to Prosperity?
Taxes on personal income averaged 9 percent
of GDP as of 2008.
VAT rates already average more than 20
percent.
Payroll tax rates also very high in most
European nations.
A reverse of trend of lower corporate rates is
almost certain.
But…

27. Revenge of the Laffer Curve?
Politicians can increase tax rates, but that
does not necessarily mean they collect more
tax revenue.
If economic growth slows, taxable income
also slows.
If incentives to avoid and evade rise, taxable
income slows even more.
America conducted a Laffer Curve experiment
in the 1980s.

28. Tax Rates, the Rich, and Revenue
In 1980, there were
116,800 rich people.
Those rich people
reported $36.2
billion of income to
the IRS.
They paid $19.0
billion of income tax
to the federal
government.

29. Tax Rates, the Rich, and Revenue
In 1980, there were By 1988, there were
116,800 rich people. 723,700 rich people.
Those rich people Those rich people
reported $36.2 reported $353.0
billion of income to billion of income to
the IRS. the IRS.
They paid $19.0 They paid $99.7
billion of income tax billion of income tax
to the federal to the federal
government. government.

30. What Should Be Done?
The answer is simple – just restrain the
growth of spending, as U.S. example shows.
If nominal revenue is projected to grow 7
percent each year, as CBO projects, red ink
can be reduced if spending grows by a lesser
amount.
A freeze balances the budget by 2017.
Letting spending grow by 2 percent each year
means fiscal balance in 2022.

31. Balancing the Budget with Spending Restraint
5,000
4,500
Current Spending
4,000
$Billions
3,500
Revenues (w/tax cuts)
3,000 Spending Freeze
1% Spending
2,500 2% Spending
2,000
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source:

32. Other Nations Have Reformed
Good fiscal policy does not require miracles,
just spending restraint.
If spending grows slower than nominal GDP,
good things happen.
Greater levels of fiscal restraint mean quicker
progress.
If spending grows faster than nominal GDP,
sooner or later a nation becomes Greece.
But sometimes nations do the right thing.

33. Ireland Restrains Growth of Spending and...
25
20
15
Billions
10
5
0
1985 1986 1987 1988 1989
Source: Economist Intelligence Unit

34. ...Burden of Government and Deficit Both Shrink
14 80
Budget Deficit
12
70
Government Spending as Share of GDP
10
60
Deficit as Share of GDP
8
50
Government Spending
6
40
4
30
2
0 20
1985 1986 1987 1988 1989
Source: Economist Intelligence Unit

35. New Zealand Restrains Growth of Spending and...
50
45
40
Billions
35
30
25
1990 1991 1992 1993 1994 1995
Source: Economist Intelligence Unit

36. ...Burden of Government and Deficit Both Shrink
5 55
4
Government Spending 50
Government Spending as Share of GDP
3
Budget Deficit as Share of GDP
2
Budget Deficit 45
1
0
40
1990 1991 1992 1993 1994 1995
-1
-2 35
Budget Surplus
-3
-4 30
Source: Economist Intelligence Unit

37. Canada Restrains Growth of Spending and...
450
400
Billions
350
300
1992 1993 1994 1995 1996 1997
Source: Economist Intelligence

38. ...Burden of Government and Deficit Both Shrink
10 65
Budget Deficit
8
Government Spending as Share of GDP
Budget Deficit as Share of GDP
6 55
4
Government Spending
2 45
0
1992 1993 1994 1995 1996 1997
-2 35
Source: Economist Intelligence Unit

39. Conclusion
Three challenges for Europe
Correctly identifying the problem – big
government is the disease. Deficits and
debt are symptoms.
Figuring out ways to “bend the cost curve”
of government spending.
Convincing voters that liberty is better than
dependency – particularly when
dependency means fiscal disaster.