The Financial Crisis and the Outlook for Free-Market Reform

1. The Financial Crisis and the Outlook for Free-Market Reform Presentation to the International Leaders Summit, Brussels, December 8, 2009

2. Three Main Questions • 1. Who or what caused the financial crisis? • What happened to the tiger economies of Ireland and Eastern Europe? • Will tax competition survive the OECD, EC, G-20, IMF, UN, etc?

3. Global Financial Crisis • Worldwide drop in asset values, combined with heavy leverage, has crippled banks. • No nation with a significant financial services sector is immune. • Iceland’s economy collapsed. • Economic forecasts are uniformly grim, though the so-called experts failed to predict the downturn, so they probably are the least likely to correctly predict the recovery.

4. Who Deserves the Blame? • In the U.S., the problem was largely created by government policy mistakes. • Easy-money policy by Federal Reserve. • Corrupt system of subsidies from Fannie Mae and Freddie Mac. • So-called affordable-lending rules that extorted banks into making bad loans. • Preferences for debt in the tax code. • The result: A bubble that now has collapsed.

5. The Misguided Bailout • The federal government should not bail out any private companies. • Bailouts reward the people who make mistakes. • Bailouts create moral hazard. • Bailouts hinder the necessary and desirable reallocation of resources. • Paulson’s incoherence added to the crisis. • No hope and change with Obama

6. What Should Happen? • President Reagan did nothing after the huge stock market crash in 1987. • The market quickly recovered and the economy enjoyed strong growth. • If taxpayers are on the chopping block, the approach used during the S&L bailout is far preferable to what is happening now – paying healthy institutions to absorb bankrupt ones. • Bad investments must be liquidated.

7. What Will Happen? • Mitchell’s Law: Bad government policy leads to more bad government policy. • Politicians will increase financial regulation, perhaps even creating more systemic risk with global, one-size-fits-all, rules. • In the short run, the financial crisis is an excuse to substantially increase the burden of government spending. • The return of Keynesianism.

8. Lessons from the Tiger Economies • Critics almost seem happy that pro-market tiger economies have stumbled. • Has the free-market model failed? • Let’s compare the three big continental welfare states – France, Germany, and Italy – with five tiger economies – Estonia, Ireland, Latvia, Lithuania, and Slovakia.

9. The Tiger Economies Boomed… • From 1995-2007, the five tigers enjoyed rapid growth and per capita GDP grew, on average, by more than 190 percent according to IMF data. • During the same period, the big three welfare states expanded less than 54 percent (data adjusted for PPP, but not inflation).

10. The Collapse of the Tigers… • According to IMF projections, the tiger economies will shrink by an average of more than 9 percent between 2007 and 2010. • The big 3, by contrast, will grow by about ½ of 1 percent during the same period. • Is this the end of the tigers and an indictment of free markets?

11. The Tigers Will Rebound • Based on IMF projections for the 2007-2014 period, the tigers will enjoy almost as much growth (11 percent) as the big 3 welfare states (13.9 percent). • Looking solely at the 2009-2014 period, the tigers (22.3 percent) will outperform the big 3 (15.3 percent).

12. The Tiger Model is Correct • Over the 20-year period (1995-2014), the tigers will enjoy nearly three times as much growth (219 percent) as the big 3 (75 percent). • Long-run economic growth is the key. • The only accurate criticism of the tigers is that their upward trajectory is more volatile.

13. What About Wealthy Welfare States? • Don’t Europe’s welfare states show that big government is not an impediment to growth? • No. They became rich because they used to have small public sectors and laissez-faire policy (indeed, still have laissez-faire policy). • Government expanded after they became wealthy and could afford anti-growth policies. • A nation (or state) can tolerate one percent growth once it is rich. But a poor nation (or state) will never become rich with one percent growth.

14. Growth is the Best Option • You can’t redistribute without first producing. • It is better to be a poor person in a rich nation than a middle-income person in a poor nation. • Rich nations can afford redistribution, and the accompanying tepid growth. • Poor nations will never become rich if they adopt welfare state policies.

16. What is Being Maximized? • Is the goal wealth maximization or equality of outcomes? • Incomes are more widely dispersed in the US than in most European nations. • But poor people in the US almost always have more income and higher living standards than poor people in Europe. • In the long run, higher growth rates will increase relative prosperity of poor Americans.

17. The Tax Competition Battle • For more than one decade, high-tax nations have been persecuting low-tax jurisdictions, particularly so-called tax havens. • Led by international bureaucracies such as the OECD, there is an attempt to create a global tax cartel to hinder the flow of jobs and investment from high-tax nations to low-tax jurisdictions. • An “OPEC for politicians” is a bad idea.

18. The CEN Ideology • The various anti-tax competition initiatives share a common theme – they are motivated by an ideological belief in the theory of capital export neutrality (CEN), which holds that all tax planning (avoidance or evasion) must be eliminated. • Other than tax law professors and international bureaucrats, there is very little support for this theory.

19. Asked why he robbed banks, Willie Sutton remarked, “that’s where the money is.” Some – if not most – politicians have the same attitude about taxpayers. There Is a Simpler Explanation

20. Tax Harmonization • Proponents of CEN believe in tax harmonization, either explicitly or implicitly. • Explicit tax harmonization is not an immediate threat, though the EC in the past has sought to require minimum corporate tax rates. • Implicit harmonization is a real threat, in the form of demands for “information sharing” and the push for worldwide (rather than territorial) taxation.

21. Territorial vs Worldwide Taxation • The CEN ideology would prefer explicit tax harmonization, but worldwide taxation is a backdoor method of achieving the same goal. • Worldwide taxation means that the a company is taxed by its home nation on all income, regardless of where it is earned. • Territorial taxation is the common-sense notion of only taxing income earned inside national borders.

22. Obama’s Anti-Tax Haven Proposal • The Administration has proposed to make life more difficult for taxpayers utilizing low-tax jurisdictions. • This is not good news for Switzerland, but it is not a major issue for multinationals. • Indeed, it may not be a big issue for anyone. • After talking about collecting $100 billion more revenue every year, the White House proposal is estimated to collect $8.7 billion over 10 years.

23. More than 12,000 companies are registered at Ugland House, and Obama says it is “either the biggest building in the world or biggest tax scam in the world.” Demagoguery vs Reality

24. Cayman Islands vs. Delaware

25. What Does Adam Smith Say? • An inquisition into every man’s private circumstances, and an inquisition which, in order to accommodate the tax to them, watched over all the fluctuations of his fortunes, would be a source of such continual and endless vexation as no people could support…. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could…

26. Adam Smith…Continued • …either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country would so far tend to dry up every source of revenue both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour would necessarily be more or less diminished by its removal.—Adam Smith, An Inquiry into the Nature & Causes of the Wealth of Nations, 1776.

27. Even OECD Economists Admit… • OECD economists have written that “the ability to choose the location of economic activity offsets shortcomings in government budgeting processes, limiting a tendency to spend and tax excessively.” • OECD economists note that “legal tax avoidance can be reduced by closing loopholes and illegal tax evasion can be contained by better enforcement of tax codes. But the root of the problem appears in many cases to be high tax rates.”

28. Conclusion • Government is causing major problems around the worlds – and using the problems as an excuse for even more government intervention. • The bailouts mean more government interference – on a permanent basis. • The Keynesian “stimulus” schemes mean more government spending – on a permanent basis. • The world needs havens so that people can escape and there is discipline for government.