New Zealand tax report and the Laffer Curve

Just been covering the Laffer Curve with my Yr 13 class and it was very apt that the Inland Revenue Department (IRD) published a report that shows wealthy New Zealanders pay much lower tax rates than other earners. Based on the 311 of the wealthiest New Zealand citizens, the data shows that the average person in this group pays 8.9% tax on their income which includes capital gains on investments.

Robin Oliver an expert in tax economics was interviewed on Radio New Zealand’s “Morning Report” programme this morning and he is suggesting that changes are needed to income tax thresholds to make them fairer. Looking at the current tax rates and thresholds in New Zealnd (see table below) the jump in the tax rate from 17.5% to 30% when you hit the income bracket $48,001 to $70,000 is significant and the assumption is that this is a high level of income which it may well have been 20 years ago. However looking at the cost of living today this is well below what could be considered an income which should be taxed 30%. Click here to listen to the interview.

Laffer Curve

The laffer curve (named after American economist Arthur Laffer) indicates the relationship between the tax rate and the revenue gained by the government. If you charge a high tax rate it is unlikely that you will encourage people into work and therefore the tax revenue for the government is a lot lower if taxes had been lower. The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.
Economists have long used the Laffer curve to justify tax cuts, including:

• Ronald Reagan in 1981 – resulted in lower revenues
• George W. Bush in 2001 – resulted in lower revenues.
• Donal Trump in 2017 – resulted in lower revenues

The Congressional Budget Office, a government watchdog, now reckons that US national debt will hit 95% of GDP by 2027, up from 89% two years ago before the tax cuts.

America (see graphic above) is not the only country that appears to be on the wrong side of Mr Laffer’s curve. A paper published in 2017 by Jacob Lundberg, estimates Laffer curves for 27 OECD countries. He found that only Austria, Belgium, Denmark, Finland and Sweden have top income-tax rates that exceed their revenue-maximising levels. However only Sweden could meaningfully boost revenue by cutting tax rates on high-income earners. Most countries, in other words, appear to have set their highest tax rates at or below the optimal rate suggested by the Laffer curve.

Source: The Economist – 19th June 2019 – Graphic detail

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Globalisation to slowbalisation – IMF

With the global economy experiencing supply chain pressures, inflationary problems, higher interest and geopolitical tensions are we seeing what the IMF call ‘slowbalisation’?

Part of this change has come about from the decoupling of the American, European and Japanese economies from China. This ultimately alters trade and investment flows around the global economy and will mean lower economic growth and less liquidity. For instance consider the restrictions on technology including complex microchips being placed by the US on China. Janet Yellen the US Treasury secretary referred to ‘friendshoring’ which means relocating production to countries that fall within the US economic sphere of influence. Apple’s announcement that it would begin sourcing sophisticated chips from North America is the signal that many global firms have been waiting for to begin reducing their exposure to China.

Furthermore as well as the impact of decoupling of trade with China, a shortage of labour will also add to production costs and will result in slower rates of growth. Labour force participation rates have dropped as less migrant workers coming into countries. This scarcity of labour will put further pressure on wages and ultimately inflation. To counteract the latter interest rates will continue to climb and this will lead to further problems:

The cost of financing economic expansion will become more expensive.
Firms that have lived off 0% interest rates and negative real rates (nominal interest rate – inflation) will face increasing problems on their balance sheets

In the medium term interest rates are determined by inflationary expectations and rates tend to move lower in periods of disinflation and higher in periods of inflation. The risk for all central banks and policymakers is if the rate of inflation goes above that of expectations there can be a further tightening cycle. Although recently we have seen a reduction in inflation, central banks need to maintain a level of tightness – high interest rates – so that inflation levels are within a country’s target range.

Phases in the graph

1. Industrialisation was prevalent in Europe and the USA and the advances in transposition reduced the costs for firms and encouraged trade.
2. WW1 and WW2 saw a very protectionist environment with trade becoming regionalised with trade barriers and the breakdown of the gold standard into currency blocs.
3. The post-war recovery and trade liberalisation encouraged growth in Europe, Japan and developing countries. The war had also stimulated a hugely expansionary fiscal and monetary policy which rendered the gold standard unsustainable. Floating exchange rates took over from those that were pegged to the US dollar.
4. In 2001 China became a member of the World Trade Organization (WTO) and there was the emergence of more free market economies with relaxed capital controls between countries. This was helped by the fall of the Berlin Wall and the integration of the former Soviet bloc.
5. “Slowbalisation” followed the global financial crisis in 2008 and the rising geopolitical tensions with protectionist policies being imposed by many countries.

Source:

IMF Blog – Charting Globalisation’s Turn to Slowbalisation After Global Financial Crisis

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Globalisation and geo-political tectonic plates

Below is another very good CNBC video which tackles the issues of globalisation and can it bring countries together? It goes right back to the 15th century and the Age of Discovery and mentions when globalisation really began in 18th century Britain with the industrial revolution. However more recently with more populist governments countries has become more protective of their industries of which the US China trade war being an example. This year the war in Ukraine has pushed international relations to breaking point.

2023 will most likely see a significant slowdown in the global economy and the reliance on global trade to function. IMF Chief Economist Pierre Olivier Gourinchas talks of ‘geo-political tectonic plates’ where rising commodity prices, supply chain problems, a refugee crisis and higher central bank interest rates have all pushed the plates (countries) further apart to form trading blocs.

The rise of China and other emerging markets has been the success of globalisation but it has also led to protectionist measures and rebalancing of power. Therefore as a country’s power increases there is a need to adjust the way we deal with this imbalance i.e. some countries economic development has not been matched with their financial and global institutional firepower which is patly due to the dominance of the US dollar. This is ironic as the US economy’s share of global output has declined. Worth a look especially when teaching trade and protectionism – see also the table on pros and cons of globalisation.

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World Cup Hosts, Winners and Political/Economic Systems

Keeping with the World Cup theme, I read a very interesting book a few years ago by Franklin Foer entitled “How Soccer Explains the World” in which he outlines that soccer is not merely a pastime but often an expression of the social, economic, political, and racial composition of the communities that host both the teams and their throngs of enthusiastic fans. I thought it worthwhile to look at the past hosts, winners of the World Cup and the political/economic system that prevailed in these countries at the time.

Source: The Thinking Fan’s Guide to the World Cup.

Command Systems not so successful.

According to Foer the Communist countries have the better of the results against the non-communist countries. Played 118 Won 46, Drawn 32, Lost 40. However a Communist country has yet to win the World Cup. He suggests that the reasons for this are as follows:

1. Coaches thought that science could provide the information to win games – i.e. evaluating teams on the number of passes, tackles, shots etc. This might work in athletics or gymnastics but doesn’t include the individual skill and risk-taking involved in winning games.
2. The harsh conditions of communism also meant that a lot of players defected to other countries that were more democratic.

Fascism as a driving force

The existence and adoration of a single, omnipotent leader is conceivably the best known characteristic of fascist governments. In Italy Benito Mussolini was always seeking to use popular culture in his quest to grasp authority and to convert Italian society, and sport was a key part of this strategy. Fascists took control of football in Italy and by the mid-1920s had proceeded to revolutionise the game, building stadiums all over the peninsula and creating a national team which was to dominate the international game for four years, winning two World Cups (1934 and 1938) and an Olympic gold medal.

Under leader Francisco Franco, Spain was also a fascist regime although it was described as an autocracy rather than a totalitarian state like those of Italy and Germany. This might explain why Spain’s fascist dictatorship endured from the 1940s into the 1970s. Franco was an avid Real Madrid supporter and, according to some, the regime provided decisive aid in the club’s signing of the best player of the fifties, the Argentine Alfredo Di Stefano, even though Barcelona had already agreed terms with him. Franco viewed the triumphs of Real Madrid and of the Spanish national team as in some way
his own.

However he did face serious opposition from the Basques and the clubs Athletico Bilbao and Real Sociedad were the only venues where the Basque people could express their cultural pride without ending up in jail. In the south of the country FC Barcelona was the heroic centre of the resistance to Franco’s military dictatorships. Their home ground, Camp Nou, provided an environment for Catalans to voice their strong disapproval of Franco’s military dictatorship.

Brazil – 5 World Cup wins.

Brazil is the most successful country in terms of performances in the World Cup. Three out of their five World Cup wins have come about under military/fascist regimes. Also Argentina in the 1970s and 1980s achieved soccer’s golden prize under the watchful eye of the fascist generals. Since 1934, no fewer than seven World Cups have been won by countries with some form of fascist ideology.

Freedom House stated the 2018 tournament hosted in Russia was not ‘free’ with autocratic control by Vladimir Putin. Same can be said for Qatar where democratic elections or political parties do not exist. Freedom House states that “While Qatari citizens are among the wealthiest in the world, most of the population is made up of non-citizens with no political rights, few civil liberties, and limited access to economic opportunities.”

According to Franklin Foer, in spite of the common modern assertion that civilisation is in discord, football provides substance to the argument that a civilised world order is possible. But globalisation single-handedly cannot be seen to achieve this objective. In order to achieve a world environment where citizens have tolerance and respect for each other the institutions of a vivacious domestic liberalism must also be created and sustained.

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The New Corporation – Documentary

Following on from the very successful documentary ‘The Corporation’ comes ‘The New Corporation’. The Corporation​ examined an institution within society. THE NEW CORPORATION reveals a society now fully remade in the corporation’s image, tracking devastating consequences and also inspiring movements for change. Click on the link below to view screening options – The New Corporation

Gold prices – 9/11 to Qassem Suleimani

Over the years the store value of notes and coin hasn’t maintained its value like gold. Gold has been seen as a way to pass on the wealth of one generation to the next. What are some other reasons why gold goes up in price:

• The US dollar is seen as the reserve currency and when its value drops there tends to be move towards buying gold as security and this ultimately increases its price. After the GFC of 2008 the price of an ounce of gold went from approximately $1,000 to $1,900.
• Geopolitical uncertainty also sees people look to gold for relative safety – a good example was the drone strike that killed Qassem Suleimani, leader of the Quds Force of Iran’s Islamic Revolutionary Guard Corps. The price of gold rose around 3% one week after the event. The events of 9/11 saw gold rise by 6% – see Economist graphic.
• Gold is also very prevalent in the culture of some countries. India is one of the largest gold-consuming countries and it mainly used for jewellery.

Below is a clip from the Corporation Documentary where commodities trader Carlton Brown gives his reaction on the trading floor when the events of September 11 were unfolding. He talks of the price of gold ‘exploding’.

Future of capitalism

Below is CNBC video which looks at what capitalism is and the history behind it. It began in the 17th century in Europe and has spread to most parts of the world. Critics of the present form of capitalism argue that it harms the environment, increases inequality and slows economic growth. The video has some good data on inequality and discusses the fact that shareholder value is no longer the main priority of some firms.

Should Central Banks still be independent?

Video from CNBC looking at why central banks became independent and if it still should be the case – very informative and they use the Phillips Curve in their explanation. WIth the ongoing inflation problems in the 1970’s and 80’s it was thought that giving central banks independence of government control should be implemented. It was argued that policy makers would struggle to convince the public they were serious about containing inflation if politicians retained a say on setting interest rates. In 1989 New Zealand become the first country to introduce an independent bank with the 1989 – Reserve Bank Act. The mandate was to keep inflation between 0-2% but later changed to 1-3%.

With the GFC in 2008 it was central banks who slashed interest rates and implemented several rounds of quantitative easing to stimulate demand. However the GFC could have been prevented if central banks intervened to stop the biggest asset-bubble in history instead of focusing purely on keeping inflation low. Furthermore the European Central Bank were slow to act and the recovery was stymied. The fact that Germany is under the threat of deflation means that the ECB have cut interest into negative territory and are relaunch another round of quantitative easing – they are running out of options. Economists are focusing on fiscal stimulus – tax cuts and government spending. Therefore monetary and fiscal policy should be working together. According to Larry Elliott of The Guardian. central bank independence is a product of the neoliberal Chicago school of economics and aims to advance neoliberal interests. More specifically, workers like high employment because in those circumstances it is easier to bid up pay.

Liberalism v GDP per capita

Martin Wolf in the FT wrote an interesting piece entitled ‘Liberalism will endure but must be renewed’. He states that liberalism is not a precise philosophy, it is an attitude. Liberals share a belief and trust in the capacity of human beings to decide things for themselves and express opinions and participate in public life.

Liberals share a belief that agency depends on possession of economic and political rights. As Martin Wolf stated ‘institutions are needed to protect those rights’ but liberalism also depends on markets to co-ordinate independent economic actors, free media to allow the spread of opinions, and political parties to organise politics. The graph below shows that economic growth and political freedom tend to go together as both depend on the rule of law. Liberal societies tend to be rich and rich societies tend to be liberal. Note that :

• New Zealand is one of the most liberal economies – approx 98 on the index – with its GDP per head being just over US$40,000.
• Singapore has a GDP per head over US$100,000 in relation to a Liberal Freedom index of approximately 72.
• Eritrea ranks as the lowest

Brexit and the EU explained

No doubt you are aware of the what is happening in the UK with regard to leaving the European Union – Brexit. Below is a very informative video from CNBC which explains the history of the UK when it entered the EEC (as it was formerly known) in 1973 under Ted Heath’s government to today where there is chaos as to the process of leaving the EU.

New Green Deal – more about politics than economics

In Unit 3 of A2 CIE economics course you will no doubt have come across externalities – see graphs below. In simple terms the cost to the consumer must also be accompanied by the external costs (referred to as externalities) which is normally not paid by the consumer. Externalities are common in virtually all economic activities. They are defined as third party (or spill over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid.

Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption. The study of externalities by economists has become extensive in recent years, not least because of concerns about the link between the economy and the environment.

This all seems very straight forward as you would assume the external cost (externality) of driving a car (emissions) would be added to the private cost of running the car (petrol etc). However carbon taxation is politically elusive as only 20% of global emissions are covered by schemes that put a price on carbon and only 1% of emissions subject to such schemes face a price as high as $40 per tonne of carbon dioxide. The Green New Deal proposes to a move to a 100% clean and renewable energy within a decade or two, and to zero net emissions by mid-century. Those who support the idea are sceptical about costs and funding as decarbonising the economy will require some serious capital.

For the Green New Deal to work it must mobilise a majority that are more passionate than the remainder. A carbon tax with a dividend may be appealing but the financial benefits are small when divided by the number of voters. Remember that an associated tax would encourage an aggressive response from wealthy fossils-fuel firms. A Green New Deal, in contrast, might promise sufficient goodies to organised interest groups, such as labour unions and domestic manufacturers, to gather a winning political coalition.

Some see the Green New Deal is something more radical. Roosevelt saw the Depression as both a threat to liberal democracy and the product of an economic system that put profits ahead of the welfare of the working man. Similarly, left-wing activists view climate change as the result of unbridled capitalism. They aim to solve it by redistributing economic and political power.

Source: The Economist – A bold new plan to tackle climate change ignores economic orthodoxy. 7th February 2019

US and China trade war and what it means.

Doing trade barriers with my NCEA Level 2 class and below is a good clip from Al Jazeera about the issues that are arising from it and who will lose the least from a trade war. The last ten years saw a marked improvement in trade between the United States and China. But Trump’s battle of the tariffs is threatening that. And there are fears of an all-out trade war. The U.S. is putting tariffs on 50 billion dollars worth of Chinese imports. The president says he wants a fairer trade with China. But Beijing’s fired back with a tit-for-tat response. It’s published a list of more than 600 American products it plans to hit with its own taxes. Is it a case of who blinks first in this economic brinkmanship? And what will it mean for global trade? The comments by Philippe LeGrain are particularly good.

The 3 heads of Donald Trump

Below is a great cartoon clip from the FT with Gillian Tett talking about the 3 heads of Donald Trump. With some excellent cartoon graphics she goes through each of the following:

1. The sensible serious Trump
2. The love to shock Trump
3. Sleezy, freewheeling, write my own rules, anti elitist Trump

One wonders which Trump will be more prevalent in his presidency? A lot of references to economics – animal spirits, NAFTA, tax cuts, corporate tax etc. As Gillian Tett points out ‘nobody really knows who he is’