GOVERNMENT STIMULUS PACKAGE OFTEN JEOPARDIZE THE ECONOMIC WELL-BEING OF OUR CHILDREN AND GRANDCHILDREN
In "Government Debt" we saw the basics of how governments can finance debt, such as economic stimulus in times of crisis. The main conclusion of the article was that there is no free government money. Citizens always pay to finance debt be it through taxes or inflation. Moreover, we also saw that to finance debt governments can employ unused taxpayers' money, print money, or issue debt through bonds and bills. When they choose to finance debt (like rescuing broken companies or sending checks to their citizens) by issuing bonds and bills, these "loans" need to be repaid to the bond and bills buyers at the maturity date. In other words, to rescue businesses or send stimulus checks to citizens today governments take the promise to repay with interest the people funding these checks and rescues, at a future date. To pay these investors in the future, governments have a couple of options: increase taxes, cut spending, print money, or issue more debt. The first three options have negative effects on politicians' popular approval, so they tend to choose the last option, i.e. issue more debt through bonds and bills. In other words, the governments often pay bonds and bills of the past by selling more bonds and bills to be paid in the future, and once this second wave of bonds and bills expire they issue more bonds and bills, issuing future debt with more future debt. This is a very good mechanism for politicians as they look first and foremost to stay in power and most people do not understand how government finance debt. They think that government money is coming out of thin air, like Trump's $1200 Coronavirus checks, and are more likely to vote for the incumbent.
However, this politically smart strategy has multiple problems. The first problem is that countries with higher government debt grow slower. For example, on average, countries with debt levels that account for more than 90% of GDP have median growth rates 1% lower than those with debt lower than 90% of GDP (Reinhart and Rogoff, 2010). The second problem with this paying debt with more debt strategy is that the government is making future generations pay for the benefit of the current generation. In other words, we are jeopardizing the economic well-being of our children and grandchildren. Theoretically, it is possible to issue more debt once our children grow up to pay for previous debt and continue on this path forever. However, this strategy is not sustainable forever, and here is why: The third problem with this system is that buying debt with more debt is only possible to the extent that investors still want to buy government bonds and bills. If no one wants to buy governments bond and bills then issuing debt to finance debt is no longer an option and all debt issued from all previous generations must be paid at this time.
The best way to keep investors interested in government bonds and bills would be to increase government fiscal surplus. To expand its fiscal surplus, the government can implement 4 very hard policies, which are not always possible:
1 - Increase its labor force
2 - Increase taxes
3 - Cut government spending
4 - Increase worker productivity
(1) Increasing the workforce through baby booms or mass migration is hard to do. The fertility rate in most of the world has been falling for decades, despite increasing public benefits to having kids. Mass immigration tends to be highly unpopular, such as tax increases and cuts in government incentives (2 and 3). Even if a new tax does not directly affect you, such as wealth tax or tax on foreigners, it will most likely make you poorer. (4) Significant increases in productivity are probably the hardest of these choices since improving people’s level of education or developing new technologies (like computers) thorough research takes much more time and is more expensive than simply introducing labor into the markets, especially for a developed country (Acemoglu, 2009).
If the government debt is growing at a much faster pace than its credible ability to increase revenue, then investors (e.g. me, you, companies, foreign governments) will start to question the ability of the government to pay these debts without printing money. However, printing money without increasing the amount or quality of the goods and services in the economy leads to inflation, and inflation decreases the value of national currency in the long term. Therefore, no one will be willing to buy newer government debts, unless the government increases the interest rate paid on those debts. But if the government increases the interest rate paid, it will become harder and harder to increase taxes at the amount the government needs to pay the bond buyers. At this point, governments have to either (1) print money and generate inflation (e.g. Venezuela right now), (2) increase taxes and/or cut government spending (like Greece and Spain during The 2008 Crisis), or (3) default on bondholders (like Argentina during The 1998-2002 Argentine Great Depression).
Note 1: In this example, I assume that your government is selling debts denominated in its own currency as the US does. The US only sells US dollar-denominated debts. However, sometimes governments sell debts denominated in foreign currency. If your government is selling foreign-denominated debts, its ability to pay bond buyers is even less credible because you cannot print foreign currencies (Eichengreen, 2011). Therefore, your ability to buy debts by issuing more debts is even smaller. According to estimates, for emerging markets, once debt denominated in foreign currency reaches 60% of GDP growth rates drop 2%, on average (Reinhart and Rogoff, 2010). Following this same thought, countries that can issue debt in their own currencies (especially the US) have potentially more to lose by misbehaving monetarily speaking. This happens since if their currencies become less credible in the future this can severely harm their ability to issue debt in the future compared to what they can do now (i.e. the exorbitant privilege).
Latin American decisions have relatively little power to shape their own future. Campello and Zucco (2016) studied 18 Latin American countries from 1980 to 2012 (i.e. 107 elections) and find that the strongest predictor of leaders reelection is external factors, such as the international interest rates and commodity prices. To a large extent, it does not matter how Latin American leaders perform in office. If the international scenario is favorable, they will win reelection. If it is not favorable, they will lose the election. Latin Americans are not able to account for the international context when voting and the economic performance of their country is highly influenced by external factors beyond their political leaders power (e.g. Calvo et al, 1993).
Many other historical factors support the argument that Latin American is a consequence of the international system much more than a result of their own choices. For example, supported by the US, most major Latin American countries had political right-wing dictatorships during the Cold War. Then, the collapse of the URSS created a democratization wave throughout the region (Gunitsky, 2014). After the end of the dictatorships, most states joined the then internationally favored economic right-wing wave led by the Washington Consensus. At this period, most Latin American countries opened their economy to international trade and foreign investment and embraced privatization and standard economic right-wing policies to fight inflation, e.g. Plano Real (Sargent and Wallace, 1975; Hunter, 2007). Later came the 1998 Asian Crisis, helping to spread economic chaos throughout the region, e.g. 1998-2002 Argentinian Great Depression, and paving the way to left-wing politicians. Around the 2000s, Lula, Cristina Kushner, Evo Morales, Hugo Chavez, among many other left-wing politicians were elected. The commodity boom as a result of China’s entrance in the WTO in 2001, reinforced the power of these left-wing politicians, who many won reelection (Levitsky and Roberts, 2011; Remmer, 2012). Later, came the 2008 Financial Crisis and consequent devaluation of commodity prices, leading to the fall of most of these left-wing leaders and election of right-wing politicians: Jair Bolsonaro, Mauricio Macri, Sebastián Piñera, Iván Duque Márquez, etc.
Obviously, there are exceptions like Venezuela’s that have entered a total state collapse after left-wing politicians refused to leave power or Chile which embraced right-wing economics during their dictatorial period and became much richer than the Latin American average. However, those are outliers. To a very large extent, Latin American countries mostly follow the external environment. On average, domestic factors, such as elections and the quality of political mandates, have relatively little power to shape Latin American’s future. Latin Americans are mostly at the hands of external factors and there is not much they can do to change it. Another suggestion of this literature, which echoes other major studies (e.g. Acemoglu et al, 2005), is that Latin Americans will almost certainly remain poorer than the US and Europe and highly unequal in our lifetime, regardless of how well people vote or how well politicians perform in office. Last but not least, these facts also indicate that Brazil is just another country in Latin American. This differs from most Brazilians' views who tend to give much more importance to local politics and behave as if Brazil was more or less different (read better) than the rest of Latin America.
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There are valid moral and economic arguments against high-income inequality (e.g. Stiglitz, 2012). Moreover, assuming that no human race or ethnicity is super to another and a world where everyone has the same opportunities, there should not exist the abysmal economic inequalities that see today both within and across countries. (In this post I will focus on within-country inequality). However, the world we live in is far from equal. In the last 5000 years, no major equalization of income has happened by making the poorer better. A sustainable decrease in income inequality has only been achieved with mass warfare, complete revolutions, state collapse, and catastrophic plagues (Scheidel, 2017). When everybody loses everything, the rich as the ones who lose the most. Therefore, from a realist perspective, should governments even try to decrease inequality?
Assuming politicians' main goal is to make their citizens' lives better, a strong moral claim can be made that governments should at least try to decrease inequality. However, as one of the bases of political science research states, politicians' main goal, on average, is not to improve the lives of their citizens but to stay in power (Geddes, 1995). Politicians may try to improve the lives of their citizens if this helps them to take or maintain power. In other words, helping voters can be the means to the goal and not the goal by itself. This phenomenon can be seen throughout the world. For example, Africa is so poor, to a large extent, because politicians distribute taxes from the poor to the rich who are the ones with real power to maintain or elect a political leader (Bates, 1981). Corrupt politicians, like in Latin America, also leave millions in starvation for their to buy luxury goods and services. American and European governments are also not that far behind (See "The Morality of Legal Tax Avoidance" for a deeper discussion).
Therefore, if decreasing inequality by lifting the poor is virtually impossible and politicians do their best to stay in power, politicians will say they will decrease inequality in case the people who can put or maintain them in power want. But these people, on average, are not economic experts or political specialists. Therefore, politicians have great incentives to give citizens what they think will decrease inequality, like taxing the rich, but in reality, it will not. In the real world, taxing the rich is pretty much impossible. Taxes encourage highly skilled workers to migrate, create major collateral damages, have high implementation and enforcement costs, sometimes generate little revenue, and may make most of the society poorer. Between 1975 and 1986, for example, the US lost revenue trying to tax capital income (Gordon and Slemrod, 1988; Shoven, 1991). Wealth tax has been tried in dozens of countries and has failed miserably in virtually all of them (Boadway et al., 2010). Even if it is possible to lift the poor to make a highly unequal society, like the US or most Latin American countries, look like Europe this would take centuries of hard-fought political battles. And as John Keynes said, "in the long run we are all dead."
To some extent, governments cannot decrease inequality because they are the result of that inequality. Academically-speaking, political institutions and income inequality are endogenous (Acemoglu and Robinson, 2008). Most political leaders in unequal regions are only in power today because they somehow benefited from the system, be it through promising incentives to big firms in exchange of political incentives (like leaving tax loopholes open), spending their own millions in campaigns and buying their way into office, or being born in a rich family (e.g. Graetz and Shapiro, 2005). To some extent, politicians are the system, and to completely remodel the political system to solve inequality would be self-harming. I do not doubt that one or two politicians truly want to completely reform the political system. However, democratic governments have too many vetos to allow a handful of individuals within the system to deeply change it (Tsebelis, 2000). Major political change, such as the ones that can decrease inequality almost always comes from outside the country, i.e. external shocks (Gunitsky, 2014). Domestic factors, like elections, cannot solve income inequality.
In summary, from a realist perspective, politicians should claim that they will solve wealth inequality if the people who have the power to choose or maintain a political leader wants. And that is what politicians usually do. However, governments know that making places like America or Brazil as equal as Europe is not possible in our lifetime. In other words, politicians are self-interested, have incentives to play with voters' irrationalities (like incomplete information on inequality and taxation), and they are endogenous to the unequal system.
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Work is a fundamental part of wealth creation (e.g. Weber, 1958). Moreover, in a capitalist system, by making yourself better off you also make other people better off. For example, by expanding your company to make more money you are giving more jobs and making other people better even if you do not intend to do so, i.e. the invisible hand of Adam Smith. From basic economics, we know that by increasing taxation, individuals' incentives to work decrease. In an extreme case, if 100% of your income goes to the government, how much would you be willing to work? On average, the higher the tax rates, the lower is the desire for people to work. Similarly, the lower the tax rates, the higher are the incentives to work. As evidence of that, highly taxed Western European citizens tend to work fewer hours than richer places with lower income tax rates as the US (OECD), which has contributed to the European persistent low growth rates.
A large number of studies have shown that giving more wealth to heirs and the value of money itself are major incentives to continue to work (Carrol, 2000; Reiter, 2004; Francis, 2009). This benefit of giving more wealth to your heirs is sometimes known as the "joy-of-giving" and "warm glow" (Andreoni, 1990). Most likely, personal consumption and joy-of-giving affect the desire to work, and taxes decrease the incentives for both. Supporting this idea is the fact that 45% of the people with children consider bequests (i.e. financial gifts) to be important, while 21% without children think the same (Laitner and Juster, 1996). In other words, although having a child significantly increases the importance of bequests, it cannot explain the 55% of the people who think that bequests are not important even if they have kids. In these same lines, the wealth of individuals continues to grow after they are diagnosed with a terminal illness, but intergenerational tax avoidance strategies are especially pronounced when they are about to die (Kopczuk, 2007). In summary, the joy of giving and money itself probably incentivizes people to work.
Thus, the decrease or removal of taxes can create major economic benefits for society. Even the removal of taxes on the wealthy, such as wealth tax, estate tax, and inheritance tax, can potentially make the whole society better off. Not to mention that these taxes on the rich encourage emigration and capital flight, barely collect taxation, create huge collateral damages for societies, and end up indirectly taxing everyone. The problem of inequality is not on wealth distribution itself. However, even if it was, wealth distribution cannot be solved by implementing a tax on the rich. Inequality becomes a problem when the rich have more political power than the poor, although everyone has one vote. In other words, inequality is a problem of weak political institutions and should be solved with political reform rather than higher taxes.
Nothing is free. Even if you are not paying directly for it, you may be paying it directly, or someone else is. In the case of "free" college tuition, all residents of a country pay for university through taxes. That is part of the reason why many Europeans have to pay up to 50% of their salaries in taxes, while in the US this number is more like 25%, on average (Flora, 1983; Saez and Zucman, 2019). In other words, under a "free" college system, your parents are paying for your tuition since you are born. There is no free university. Additionally, the people who go to the university tend to be from higher social classes. Consequently, if the whole society is paying through taxes for free college tuition (or student debt forgiveness) and mostly the richer classes go to university, then you are redistributing money from the poor to the rich (e.g. Looney, 2019). No country in the world has more than 60% of the population with a college degree, even the countries that have "free" universities for decades. Therefore, even if "free" university increases the percentage of poor people going to university, a free college policy will always redistribute money from the poor to the rich. And, as we already saw previously, taxing mostly the rich is not a possibility.
Another important point is that "free" education seems to decrease the quality of teaching and research. Regardless on how you rank universities (such as based on international prestige, average graduate salary, professor to student ratio, global awards received by staff, number of research citations), most of the top universities in the world are the US and most of the top universities in Europe are in the UK. The US has the most expensive schools in the world and the UK has the most expensive in Europe. This is no coincidence. Many of the best European professors move to the US due to much higher post-tax salaries and research stipends. As evidence of that, most European Nobel winners have spent a good part of their lives working in the US. The opposite almost never happens. Moreover, as Professor Luigi Zingales from the University of Chicago (who is Italian) points out, the US had the best pre-college education of the world even compared to other developed countries. After basic education was made public, Americans clearly lost such led on pre-college education. Last but not least, the lack of tuition decreases incentives for students to graduate. In places, like Spain and Italy, is it normal to see people who take 8-10 years to finish their college degrees. In the US, this almost never happens.
There is no doubt that university tuition paid by all taxpayers has some benefits. However, college is never free and taxpayer-funded universities create major collateral damages for society. The statement that many people make saying that "free" college education is always better is not clear at all.
PEOPLE USUALLY DO NOT UNDERSTAND THE DIFFERENCE BETWEEN ECONOMIC RIGHT AND LEFT AND POLITICAL RIGHT AND LEFT
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The economic spectrum is relatively well defined. Right-wing economists usually prefer less government interference in the economy, while left-wing economists tend to prefer more government interventions. No major right-wing economist says that governments should not exist or that free markets are perfect. Right-wing economists (also known as freshwater economists or neoliberals) are just more skeptical that governments can make the situation better than freer markets. In other words, they often believe that the medicine (government intervention) is frequently worse than the disease (free-market inefficiencies). Similarly, no major left-wing economists will claim that the government should run the whole economy and there should be no kind of free-market. They are just less skeptical of the possibility of governments making people's life worse than they are. In the end, economics is a much more uniform field than people sometimes believe. For example, virtually major economists agree that the government should intervene on collateral damages, such as pollution and monopolies, and that private companies are more productive than public ones. The differences usually arise in how much the government should intervene in the economy and in which way.
The political spectrum is much messier. The political right-wing is supposed to favor the elites, while the political left-wing is supposed to favor the masses. However, what is good for elites in one country may not be good for elites on the other. The same goes for the masses. Therefore, it is very hard to generalize the political right and left on a global scale. Moreover, issues like international trade are not right or left. Although free trade can make a minority fraction of the population worse off, it makes the society as a whole better off, i.e. elites AND masses. Virtually, all major economists from both economic wings agree with that statement. The fact that sometimes the majority of a nation dislikes free-trade is partially a consequence of lack of knowledge on economics (Rho and Tomz, 2017), or as Nobel Laureate Simon Hebert called it, bounded rationality (1955; 1979). Similarly, liberalizing gay marriage, euthanasia, abortion, prostitution, or weed, do not intrinsically benefit elites more than masses, or vice versa. Hence, none of these debates should belong to the right or left political spectrum. (Politicians sometimes label themselves right or left to increase their chances to maintain or gain power, although they may not be right or left. For more on that check "Politicians and Equality Promises")
Moraya Consulting is an economic right-wing institution but it does not align with any political spectrum or most features that many people characterize as political right or left.
The cost of implementing new taxes and enforcing them is usually very high. There are multiple examples of governments expending more capital trying to implementing and enforcing the tax than the amount they manage to collect. For example, from 1975 to 1986 the US net result from trying to tax capital was a loss of revenue (Gordon and Slemrod, 1988; Shoven, 1991). This creates a paradox. Theoretically, governments are supposed to tax people to make their citizens better off. However, if they use taxpayers' money to get more taxes and end up collecting less money than the amount they spent, the goal to collect such taxes is questionable for the beginning.
Capital income taxation, specifically, can be relatively easily collected by forcing national financial intermediaries (like bank and brokerages) to report their clients earning and implementing flat withholding taxation on those gains. However, governments cannot force financial intermediaries abroad to report their clients, which encourages illegal tax evasion to foreign countries. Today, the only country seriously trying to force foreign financial intermediaries to report their clients is the US through the so-called Foreign Account Tax Compliance Act (FATCA). However, by doing that the US has deprived its citizens of opening accounts in most of the best financial institutions in the world, as these institutions do not want to spend a large part of their revenue to comply with FATCA. Additionally, FATCA has spiked American renunciation rates. To the best of my knowledge, currently, no country in the world has more citizenship renunciation per year than the "land of the free." Once Americans renounce their citizenship and they no longer have any financial ties to the US, there is nothing else Uncle Sam can do to tax these individuals. Furthermore, countries abroad can hide the personal information of clients and decrease barriers for tax evaders to attract more foreign investment (Gravelle, 2009). Some scholars go as far as to say that no capital income tax will survive in an open economy (Razin and Sadka, 1991).
The fact that dividends and interest are often taxed differently and capital gains are also only taxed once gains are realized is a problem because it creates ways to legally avoid and facilitate illegal evasion. For example, investors can buy stocks in a no-income-tax jurisdiction while they are residents of a high tax state and realize those gains only after they are the fiscal residence of a no-income-tax state. In that way, they will most likely be tax-free, legally (For more check capital gains). Important studies suggest that dividends and interest should be taxed at the same rate and at accrual rather than when realized (Diamond and Mirrlees, 1971). However, financial intermediaries usually do not even have the information necessary for such a tax system to be implemented. And even if it could be possible, the taxation of non-realized investments would generate collateral damages in the whole economy (e.g. the price of all capital assets would drop and many sectors of the economy would develop slower) and raise morality questions (e.g. why should one be taxed for something they are not extracting monetary benefits?).
Several countries - such as Australia, Japan, France, Italy, and Sweden - have tried to prevent their citizens to invest abroad by implementing controls. However, capital controls are costly, hard to enforce, and discourage legit international investments (Gros, 1990; Gordon and Jun, 1993). Big economies trying to manipulate prices by controlling foreign investments also decrease the wealth of the world, on average, as it leads to a non-efficient global allocation of resources (see The "Their Tax" Fallacy). Due to the former reasons, virtually all countries have abandoned the capital controls practice. Some people also request for the so-called carryover basis of capital gains tax after death, so that the heir continues to be responsible for the appreciation of the asset, like stocks, during his ancestor life. If governments cannot even tax capital gains during one lifetime, many scholars have questioned the ability of the state to enforce a tax that can go on for theoretically infinite generations (Kopczuk, 2013).
The same major implementation and enforcement costs can be seen in many other taxes. For example, individuals and firms have avoided consumption taxes (sales tax, VAT, use tax) by buying goods online in low consumption tax jurisdictions. Countries can tax VAT at international borders but those are very costly, so the practice has been abandoned in many borders, like within the European Union (Gordon and Hines, 2002). Partially also due to low cost-benefit wealth tax and the estate tax have been eliminated by countries like Canada, Australia, and Sweden (Boadway et al, 2010; Schmalbeck, 2001). Figure 1 shows that intergenerational taxes never account for even 1 % of national GDP in the G7 economies and they are hard to enforce. Wealth tax, specifically, is very hard to be implemented. Virtually no government has decent wealth information about its citizens. Therefore, the first step to implement a wealth tax would be to collect data on the wealth of all residents, keep an annual track of that wealth, and monitor wealth transfer. Otherwise, individuals can simply move their wealth to family members (Brown, 1991). Additionally, a wealth tax would encourage wealthy individuals to reallocate their capital in items that are hard to assess value (like human capital, works of arts, rare paintings, ancient sculptures). Consequently, the wealth tax would also decrease the value of other assets in the economy that they possessed (like properties, stocks, and bonds), making most of the society worse off. Studies have questioned the capacity of wealth tax to fight income inequality (McCaffery, 1994). Not to say that it creates inefficiencies in the free-market price mechanism.
New taxes or increases in old taxes create severe collateral damages, or as economists like to say, "externalities." For example, increasing taxes on foreign investors encourage individuals residing abroad to reallocate their assets in other countries. In a small economy, which is a price-taker on international markets, these taxes on foreigners must be burden by domestic workers since output prices cannot increase to offset the new tax. In other words, as Nobel Laureates James Mirrlees and Peter Diamond (1971) point out, local workers pay for the tax on foreigners. Wealth tax also makes most of the society worse off because it decreases the value of many assets in the economy, such as houses, bonds, and stocks (Check The "Their Tax" Fallacy).
Looking from the other perspective, in a frictionless market where foreign taxes are not fully tax deductible at home, an increase in capital income tax in foreign investors increases investments in other countries. Therefore, governments have incentives to implement capital income tax rates lower than the market or not implement capital income taxes at all. Out of the 20 richest countries and territories in the world, the vast majority do not tax foreign portfolio investors. These financial incentives are especially significant in small economies (Bucovetsky, 1991; Wilson, 1991), which helps to make international tax loopholes almost impossible to close. The same happens with labor income tax. Workers, especially highly skilled ones, move to countries with lower tax rates. When Denmark, for example, implemented preferential tax rates for the wealthy the percentage of high earning foreigners doubled (Kleven et al, 2014).
Individuals also often prefer to buy goods and services in countries with low consumption taxes (like sales tax or VAT) and low taxes on imports (i.e. tariffs). Brazilians and Argentinians, for example, often wait to buy laptops and cell phones once they travel to the US because it is much cheaper there. Another evidence of that, is the crescent use of online stores, such as Alibaba and Amazon, to the purchase of goods with better prices abroad. Different capital gains tax rates between countries also encourage individuals to move abroad before realizing their gains. In some situations, an individual can work to lose money because a wealthy individual's after-tax labor income at home can be lower than their labor plus capital income tax duties. Therefore, these rich people would be richer living in a no income tax country than working in their high tax home country (see working to lose money). Many countries with low taxation are now legally selling their permanent visas and passports looking to attract even more capital from countries with high taxes.
Thus, taxes create great proven collateral damages, such as incentivizing the exportation of capital and workers and decreasing domestic well-being. Moreover, the way governments use these taxes is usually highly inefficient, if not straight corrupt or immoral.
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Nobel Laureate James Mirrlees (1982) and others (e.g. Piketty and Saez, 2012) have established that high tax rates encourage emigration. Within-countries, it has been shown, for example, that wealthy Americans emigrate to low-tax states to legally avoid taxes such as estate tax, inheritance tax, and sales tax (Bakija and Slemrod, 2004). Similarly, Swiss people emigrate to cantons with lower income tax rates (Liebig et al, 2007; Kirchgassner and Pommerehne, 1996).
Internationally, the same happens. Strong empirical evidence has been shown, for example, that preferential tax rates for high earners in Denmark have double the number of wealthy foreigners relative to lower-paid foreigners in this Scandinavian country (Kleven et al, 2014). Even soccer stars have been shown to move according to tax rates. As Kleven et al. (2013) have indicated, top domestic players are more likely to stay in their home country, foreign players are more likely to immigrate, and teams tend to be better, in places where top tax rates are low. When UK top marginal tax rates increased to 50%, even the legendary Arsenal manager Arsene Wenger said in 2009: “With the new taxation system [...] the domination of the Premier League will go, that is for sure”. And he was not wrong. In the 5 years before the implementation of the new taxation, English teams had reached the UEFA Champions League Final five times, and in the 7 years after the implementation of the increased top marginal tax rate, no English teams reached the final of this same tournament. Supposedly, Cristiano Ronaldo's partial reason to move from Manchester United to Real Madrid was due to this new English tax, while in Spain he could enjoy the so-called "Beckham Law." According to the Beckham Law, special foreign workers only needed to pay a flat 24% income tax (rather than the normal 43% required by high earning Spaniards) and are exempt from foreign-source taxation, i.e. territorial taxation.
Individuals accumulating wealth through capital income taxation are especially sensitive to taxation since capital is much more mobile than labor (e.g. Young and Varner, 2011). In other words, individuals living mostly of capital gains can simply move their fiscal residence and investments in a no-tax jurisdiction to be tax-exempt. For example, multi-billionaire Eduardo Saverin chose to emigrate from the US (and renounce US citizenship) to go live in Singapore, where the government only tax residents from income made domestically. Therefore, if Eduardo has his $9.4 billion (as of 2019) invested in a no-tax jurisdiction, like the Cayman Islands or the Bahamas, he can be fully tax-exempt, legally. On the other hand, if most of one's income comes from labor (like soccer players) this individual not only needs to move to a low tax jurisdiction but also probably needs to find a job in this low-tax country. Even if this individual can work remotely from a low-tax country, most countries tax labor income at the source, regardless of fiscal residence.
Governments are aware of such a threat of capital flight and emigration from highly skilled workers and consequently have been decreasing taxes on high earners. Between 2003 and 2008, for example, France decreased its top income tax rate from 48.1% to 40% and Germany from 48.5% to 45% (Simula and Trannoy, 2011), and many states have implemented preferential tax treatment for high earners (e.g. Liebig, 2004). More recently, many rich countries have put their permanent visas and passport for sale to the wealthy. As we already saw in a previous post, taxing the rich is almost impossible.
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Individuals care first and foremost to their own interest, and second to fairness. Therefore, most people use the "fairness" argument to their own benefit and care relatively little about what is fair or not.
Some people claim it is "fair" to tax the rich more than the rest of the population, which I am not saying it is necessarily wrong. However, the fact that the world is divided by countries is probably the biggest unfairness of all. The average income of the poorest countries in the world is literally more than 100 times higher than that of the richest countries in the world (Rodrik et al., 2004). Just by looking at their country of birth, one can predict a person's income with highly significant precision (Roemer, 2000). Being born in a rich country is not a skill or merit, it is pure luck. Therefore, it cannot be fair that only a limited amount of people can enjoy such benefits. On the other hand, there are no major movements from citizens of the richest countries in the world trying to finish with their countries' borders and opening their countries to all the poorest citizens of the world. If anything, the trend is in the opposite way. Citizens from rich countries try to restrict entrance to their country as much as possible. In other words, the tax "fairness" argument can be claimed that it used mostly to self-interest rather than to make society as a whole better, which is contraction to the argument itself.
From a tax perspective, there are also great hypocrisies. For example, it makes no sense in terms of fairness to tax citizens who live abroad the whole year and consequently do not enjoy most benefits provided by their home country government. However, regardless of their lack of connections and the time they spend in the US, American citizens continue to be taxed. Not surprisingly, the number of US citizens renouncing their citizenship, i.e. giving up on being Americans, is on its all-time high (United States Treasury). From the best of my knowledge, no country in the world has more citizen renunciations per year than the US. This fact that the US has been taxing people who live and work abroad with wide-acceptance (or at least indifference) from the vast majority of the US population is a great contradiction for people who call for an increase in tax duties on the rich because it is “fair.” If people really cared about tax fairness, they would be making massive protest walks all over the country to take down the US citizenship-based taxation. However, there are no major anti-citizenship-based taxation street movements in US cities. What we see, on the other hand, are major movements to increase the tax on the rich.
Additionally, I also have never seen a large sample study demonstrating that poor people supporting a progressive tax system (i.e. the more you earn the more you pay in tax), continue to support a progressive tax system once they become rich. Thus, it is possible to argue that on average “fair” taxation advocates care for fairness mostly if “fair” makes them better. On average, individuals do not seem to care about "fair" taxation if it does not improve their quality of life. It is hard to defend "fairness" from a moral perspective when the "correct" morality only applies once it benefits you. In a perfect political system, where the rich do not have political advantages over the poor, the fairest tax system is possibly a flat tax (i.e. everyone pays the same amount of tax regardless of the income), as the 2013 Nobel Laureate Eugene Fama claims.
However, the political system is not fair. From a more realist and monetary perspective, it is virtually impossible to tax the rich. Creating high marginal tax rates on the rich encourages migration and capital flight (e.g. Mirrlees, 1982; Piketty and Saez, 2012; Kleven et al, 2013; 2014). The optimal taxation system is probably more toward a regressive system (i.e. the more you earn, the less you pay), such as the Swiss tax system which employs a only small lump-sum tax on the rich.
There are also questions if more money will make all people better off. See "Money and Happiness".