Tuesday, May 24, 2005

Why Are Europeans Destroying Their Economies?

Germany and France could easily reverse their economic death spirals, but they refuse to. So Chirac and Schroder are set to end their days as failures. Why this is happening is a mystery.

The fix is easy in theory and not hard in practice: cut taxes so as to increase tax revenue.

The theory behind this, developed by Art Laffer, is commonsense. Here's how it works:

1. If you tax something at 0%, you get no revenue.

2. If you tax something at 100%, you also get no revenue, since the activity becomes worthless to the folks you are taxing, and they do something else (if they can't move away, you get a revolution).

3. So, it follows that moving between a tax rate of 0% and a tax rate of 100%, there is a curve starting at a return of zero, rising, and then falling back to zero.

From this is follows that at some to-be-determined rate, you get the highest return - more than that means revenue drops because people avoid the activity (e.g. working), and less than that it drops because people are content to pay a higher rate (perhaps because this buys them cost-effective state services).

It also follows that if your tax rate is too high, cutting it will increase your revenues, and this is the theory behind the Reagan and Bush tax cuts. Here's the reality: in spite of all the pains afflicting the US economy since 9/11, and in spite of the Bush tax cuts so ahted by the Dimocrats, guess what happened to Federal tax revenue in the year to April 2005 (WSJ subsrciption required)?

Federal tax revenues increased by 13.6%

So, the only questions for Euro pols is, are their taxes too high? I have yet to talk to a European who doesn't think so. And >10% unemployment and stalled economies are surely indicators that something is broken.

So, all the Euro politicians have to do is cut taxes. Then they'll get more money to pay their army of pensioners, companies will expand & hire more so unemployment costs will drop, their deficits will fall below the level needed to stop the Euro collapsing, and people will have more of their own money to spend so be happier. Which means the pols will be re-elected.

Win-Win.

This is not a theory, it's what Maggie did for the Brits in 1979. Before then, the UK had been socialized to death, its economy overtaken by Germany, Italy and France and its population emigrating. Following 1979, there were a few rough years and many people had to change to more productive jobs. But since then the UK has been growing consistently, leaving the French and Italians in the dust and set to overtake the Germans in a few years.

So here are two question for social philosophers.

1. How bad does it have to get before the Europeans come to their senses and cut taxes?

2. If they never do, what is it that makes great nations destroy themselves?