Flattened By The Flat Tax?

Following Alex, more opinion polls seem to be showing that Merkel will struggle to get a majority in partnerhip with the FDP. At the same time voices are being raised within the CDU suggesting that the principal responsibility for this debacle lies with the Professor from Heidelberg.

Some indication of why flat tax ideas might impact so negatively on German voters is offered by the Financial Times this morning in a leader commenting on similar proposals from within the UK Conservative Party:

Some things, though, never seem to change. One of them is an abiding belief, defied by the outcome of the last three elections, that political salvation rests in the promise of tax cuts. George Osborne, the shadow chancellor and close ally of Mr Cameron, has thus proposed a new commission to consider a “flat tax”. All the current income tax rates and allowances would be swept away, replaced with a single, low rate and a high starting threshold. Mr Osborne is among the smartest of the young MPs in the so-called Notting Hill set. But sometimes even the modernisers inhabit a parallel political universe.

The economics of the flat tax are at very best dubious. A £10,000 income tax threshold combined with a single rate of 20 per cent, would leave a £50bn hole in the public finances. You have to have an awful lot of faith in supply side economics to believe it would be filled by an explosion of enterprise. The economists, though, can be left to argue among themselves. As much as some Tories see it as a panacea, the politics of a flat tax is electoral suicide.

So apart from the distributive consequences, the principal objection to the flat tax is the potential hole it would leave in public finances: ie how are you going to pay? On one theory a subsequent boom could generate significant income. Of this the FT has its doubts, the German Electors clearly have more than doubts, and I personally think everyone is doubting with good reason.

Now, in fairness to Angela Merkel, she claims not to be exactly proposing a flat tax, but then, in order to explain herself she has to lead off the not-especially-economically-literate voter into an enormously complicated debate about marginal tax rates and tax thresholds. Whatsmore, she can hardly blame people for imagining that what she is talking about is some version of Reaganomics and the impact of the Laffer Curve since she deliberately selected a section of Ronald Reagan’s 1980 election speech to use as the basis for her closing remarks in the TV debate with Schröder. Here’s what Reagan said:

“I think when you make that decision, it might be well if you would ask yourself, are you better off than you were four years ago? Is it easier for you to go and buy things in the stores than it was four years ago? Is there more or less unemployment in the country than there was four years ago?””And if you answer all of those questions yes, why then, I think your choice is very obvious as to whom you will vote for. If you don’t agree, if you don’t think this course that we’ve been on for the last four years is what you would like to see us follow for the next four, then I could suggest another choice that you have.”

and here’s a translation of the Merkel version:

“Dear voters, in two weeks you will make your decision about the election. Perhaps answering a few questions will help you to make your decision: Is our country better off than seven years ago (when Schroeder came to power)? Is growth higher? Is unemployment lower? Do we have less bureaucracy? Are our pensions and health care better?””If you can answer yes to all of these questions, then I think you have probably already decided who you will vote for. But if you have any doubt, if you do not want things to carry on as they are, then you have a choice.”

Of course it was the SPD opposition who drew this to the attention of Der Spiegel, and since that time they have used the ensuing controversy to make a lot of the running in the debate. But you have to ask yourself the question, who the hell was it who was advising Merkel to do this, and what was their objective since it hardly seems to have pushed her nearer to the Chancellorship?

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

7 thoughts on “Flattened By The Flat Tax?

  1. Personally, I’m always deeply sceptical of any public finance proposal that’s dependent on huge predicted windfalls or huge savings in “waste” to find fifty billion quid the proposal will by definition lose…

  2. As a child of the Reagan revolution, I don’t think there can be a lot of people who question the wisdom of the supply-side approach to taxation more than I do. I was the kid who found out that ketchup was the vegetable in his school lunch. But, since I don’t think Merkel actually has any intention whatsoever of really trying Reaganomics on Germany, it’s not immediately relevant.

    What I might propose, were I, say, Oskar Lafontaine, would be that I’d vote for a flat tax if the weath tax were tripled and its many loopholes closed. (I assume Germany’s wealth tax has loopholes that minimise its effect, since all wealth taxes seem to work that way.) But that would actually be an openly redistributionist policy, and would serve to kill any backing for it on the right.

    The question I would ask myself, if I were a German voter, is whether or not Merkel’s political advisors once she’s in office are likely to be any better than her election advisors? When you mess up as stupendous a lead as she enjoyed a few months ago, it has to lead you to question the competence of her team. Certainly, it seems to me that the Chrisitan Democrats have offered every reason to vote against the likes of Stoiber and Schönbohm.

  3. The point of the flat tax argument is not so much what the rate or the threshold should be, but that a simple tax regime is better than a complex one. If you don’t like the thought of a £50bn hole in the finances then you could reduce the threshold or increase the rate. Alternatively if you think you are on the right hand side of the Laffer curve you could reduce the rate and increase the threshold. And it’s worth remembering that increasing tax rates is just as likely to reduce the tax take as to increase it.

  4. “but that a simple tax regime is better than a complex one”

    I think virtually everyone would be prepared to vote for that. The problem comes when you get down to the actual simplifications, that’s where all the arguing starts.

    In particular since for demographic structural reasons major areas of expenditure in most EU countries are set to increase more rapidly than revenue as things stand.

    So since virtually no-body especially wants to raise taxes (partly for reasons which you indicate) significant cuts are on the order of the day anyway. So there is tremendous pressure for any simplification to be revenue neutral. But for the flat income tax to be revenue neutral you would need a very low threshold which again would be politically unacceptable for the revenue burden which would fall on the lowest earning groups.

    So the compromise is to go for a much higher threshold, and then what?

    Again the big issue in Germany is precisely the non-wage costs that employers have to pay for each extra person employed. These in-principal are easier to address, but you still have to find ways of funding them: Merkel has been proposing a 2% increase in VAT, but this, of course will hit an already weak domestic demand, and again Kirchhof understandably doesn’t like this idea.

    I’m not clear whether this is in fact linked with the tax proposal but Kirchhof seems to have been proposing pension reductions (which may be necessary anyway), and again the CDU seems to have run away from this completely.

  5. Surely the point, Edward, is that there are hyper-greedy people in every country. Those in Britain and Germany look in envy at what has been achieved in the US and would like to get their hands on some of that plutocrat action. If what it takes to get their is lying (first to politicians, about how a proposal will be received and then to the voters), well, you can’t make an omelette without breaking eggs.

    The more interesting question, really, is not why was this proposed but why the voters in these countries reject it. Possibilities include
    * bizarre US culture that has individuals believing that they’re likely to be millionaires soon, so they should create a society that coddles millionaires
    * a supine US press that doesn’t inform voters of the implications of political choices
    * a corrupt US political process that has both parties simply presenting slightly different faces of plutocracy.

    I’d love to see a serious analysis of this issue.

  6. Maynard, some more background from this Globe and Mail article:

    “The flat-tax concept has been discussed seriously by more governments in the past year than it ever has before — but a lot of it will depend on what happens in Germany this weekend,” Stuart Adam, a senior research economist with the Institute for Fiscal Studies, said in an interview yesterday. “A negative vote will probably prevent any other wealthy nation from bringing up the idea any time in the foreseeable future.”

    There is a big difference, some economists note, between the way a flat tax is perceived by middle-class voters in the comparatively poor new democracies of the east, and in the well-off welfare states of Western Europe and North America.

    “In the West, this is often seen as letting the rich pay less tax than they did before,” Mr. Adam said. “In the poorer countries of the East, it is seen as making the rich pay any tax at all, which they didn’t do before . . . So it may never be popular in rich countries.”

    The movement began in 1994, when the government of Estonia, desperate to rebuild an economy after communism’s fall, decided to adopt an idea that had previously been the preserve of academic economists and fringe politicians. Shortly after introducing a flat tax, Estonia’s economy boomed. Fellow Baltic countries Latvia and Lithuania soon followed, succeeded by Russia in 2001 with a flat tax rate of 13 per cent. The last two years have seen a tidal wave of flat-tax conversions: Serbia, Ukraine, Georgia and Romania have outdone one another to introduce lower rates, and Greece, Hungary, Poland and the Czech Republic are in the midst of flattening their taxes.

  7. Germany has no wealth tax at all. Or rather the current code has been judged unconstitutional and thus unenforcable. But as it has not been formally repealed the states may not pass wealth tax statues on their own.
    While the code was enforced the administration of the tax cost 50% of revenues generated by it.

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