Low Taxes Make 'Icelandic Tiger' Roar
Iceland a supply-side success
Over the last decade or so, Iceland has steadily moved away from being a poverty-stricken economic backwater, overly dependent on its fishery, to a more robust and vibrant 21st century economy where two-thirds of its GDP is made up of financial services, software development, communications and tourism. How did they accomplish such a turnaround? Simple, they reduced their tax rates and changed their policies towards non-foreign born workers.
Inspired by Ireland's Celtic Tiger, Iceland went the extra step and installed both low corporate taxes and simple, flat-rate taxes on individuals.
According to Globe and Mail columnist Neil Reynolds, Iceland's successes through economic liberalisation and tax reductions could definitely be a lesson (or model) for Canada --- not to mention New Brunswick. Read on:
Iceland's tax reduction lesson for Canada. - What's the best way to expand a welfare state, irrationally assuming for the moment that you want to expand a welfare state? Cut taxes.Why? indeed. I mean, what level-headed Canadian or New Brunswicker could possibly argue with the economic model of a country with less than half the population of New Brunswick (with similar ethnic homogeneity) that boasts its own national university, an elite symphony orchestra, a national museum, an opera and ballet company and its own stock exchange. Not to mention, a country that reads more books per capita than any other country in Europe.
Especially cut corporate taxes. You will collect less revenue every time you nick a dollar but you will have many more dollars to nick - and you will almost certainly find yourself with more tax revenue than you know what to do with. Iceland is a good example. Though tiny in population (with 280,000 people, it has only twice the population of Prince Edward Island), Iceland provides a compact manual to supply-siding your way to public sector expansion, a large-type Big Government for Dummies guidebook.
Iceland now collects far more revenue (as a percentage of gross domestic product) from a low corporate tax rate (18%) than it used to collect from a high corporate tax rate (50%). Thoroughly Nordic in its instincts, the country has used part of this windfall revenue to buy more government - even as other countries have cut back on government. In 1992, Iceland's government spending accounted for 32% of a stagnant GDP.
Now it accounts for 40% of an expanding GDP, a 25%increase in public sector share in 15 years. Iceland now buys marginally more government than Canada buys (39.5% of GDP) with cut-rate taxes on personal income and corporate profits - indeed with less than one-half the Canadian rates. However you split up Iceland's increase in national income, this small country's economic transformation in the past 15 years has made it a supply-side example to the world.
A basket-case economy in the 1980s, with an inflation rate that hit 100%, Iceland is now the fifth-richest country in the world (based on per capita GDP, adjusted for purchasing power, of $40,000 US). In the International Monetary Fund listing, the only richer countries are (tax haven) Luxembourg, (oil-rich) Norway, (low-tax) Ireland and the US (Canada ranks 10th with per-capita GDP of $35,600). Hannes Gissurarson, a professor of politics at the University of Iceland in Reykjavik and author of a forthcoming book on what he calls “Iceland's renaissance,” says the decisive factor in the country's success has been the elimination of high tax rates on income - whether personal or corporate.
In a paper co-written with US economist Daniel J. Mitchell and published this month by the Washington-based Cato Institute, Prof. Gissurarson says “Iceland's paradox” - lower tax rates, higher revenues - “documents a strong Laffer Curve effect.” Before Iceland lowered its rates on personal income and profits, he says, these taxes collected revenue equal to 9% of GDP. They now collect revenue equal to 18%.
Named for Arthur Laffer, the California economist who inspired Ronald Reagan's tax cuts in the 1980s, the Laffer Curve holds that there are two tax rates that will produce the same amount of revenue - one of them high, one of them low. A corollary is that, masochism aside, low rates are preferable to high rates. Iceland provides laboratory proof. It began cutting rates in 1992, incrementally reducing its taxation of “productive activity.” By the end of the decade, the rate on corporate income had fallen to 18% and the rate on investment income (dividends, interest, capital gains) had fallen to 10% (from 40%).
Though nominally high at 36% (down from 48%), Iceland's flat tax on personal income contains a universal deduction that protects significant income from any tax. (Iceland funds municipal spending through a separate income tax; the central government's flat-rate income tax is 22%.) Only two countries have lower tax rates on “productive activity” - Ireland (with its celebrated 12.5% rate) and Hungary (with a 16% rate). In Iceland, the impact has been remarkable. In 1998, the country's 40% rate on investment income produced 2% of government revenue; in 2006, its 10% rate produced 14% of government revenue.
Economic growth accelerated, averaging more than 4% a year for the past decade, more than 6% for the past three years. Prof. Gissurarson and Mitchell do not herald Iceland as a low-tax country; rather as a country that uses low tax rates to encourage saving and investment. On the other hand, it taxes consumption in the usual European manner with high (24%) sales taxes. Yet the two economists insist that Iceland's tax rate reductions are, beyond any doubt, “a supply-side success.”
The lower rates produce faster economic growth, which produces an expanding tax base, which produces “healthy” rises in revenues. High tax rates are counterproductive - whether judged from an economic or ideological perspective. Yet Canada clings to them, champions them. Why?
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Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do.
The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay. And so
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
"I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!"
"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"
"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"
"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
David R. Kamerschen , Ph.D.
Professor of Economics University of Georgia
For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible.
How about those who know its bullshit?
For Iceland, the simple reality is that it lowered taxes for two simple reasons: aluminum and geo thermal energy.
Since the country has an abundance of geothermal energy, AND an abundance of aluminum, manufacturing has shot up. That then let the government lower taxes, because dozens more manufactureres were being set up.
Geothermal is a constant reliable source of energy. And this is applicable becuase once again it applies to NB Power and the big question of whether its better to have tax subsidized power to export, or whether to keep the power to lower rates so that manufacturers, industry, and people want to go there.
Alcoa is currently building more mines, and is having a heyday of it. Obviously when you HAVE lots of companies, you can lower taxes.
But again, tax 'rates' mean nothing. We can't find out how much NB corporations pay, but we know that its ONLY 3% of the budget. The budget is about 6 billion, which means all the Irvings, UPS's, and McCains and their little stringalong companies pay only $180 million. Thats ALL corporate tax. That's every single corporation.
Now, we can also mention that that corporate tax rate has been lowered for about the last decade. At NO time has it risen. You've got to be a special kind of stupid to buy that "companies will pay less taxes but your government but you'll have more money!". They forgot to add "Act now, our operators are standing by!"
That again, brings us back to our concrete example, where small business tax was dropped to 1.5%. Did that produce more companies paying more money into the government? Not at all, in fact, as predicted, it had the OPPOSITE effect.
As for Iceland, read the OECD report and you'll find its far from peachy. Educational levels are generally lower than in Canada, and the economy is prone to radical swings. Inflation is about double canada's, and those tax savings are marginal.
However, there is definitely something to be said for 'taxing sales' rather than income. It's far from conclusive but its definitely been shown to work at the lower pay scales. But that's true of any economy, if you want the economy to grow, put more money into the hands of people who spend it.
The wealthy DO NOT spend it, they 'invest it', and they usually invest it elsewhere, partly of course because in NB there are few places TO invest it.
But this is what was said to the liberals when they made the bonehead move of DECREASING the gas tax, then of course raising the income tax. To me, and this is just opinion, that pretty much illustrates who affects public policy in the province.
That goes for all kinds of things. If you want more investment on renewable energy, just give lots of rebates or tex credits because money talks. Across the board tax cuts ONLY work if you first have the resources. Last time I checked there was no aluminum mining going on in NB and no dependable low cost power.
For anybody reading this, just because somebody points out something another country has done doesn't mean it will have the same impact here, particularly when it is a result of another factor.
Thanks for your comment Dr. Kamerschen. I guess the only thing I can add to this arguement is that by removing tax brackets, people will not be penalized for choosing to work harder. Moreover, the flat tax would simplify the system as it would put an end to progressive rates.
Furthermore, by eliminating the individual tax on capital source income, the flat tax would stimulate future savings and investment. Not to mention, the proposal achieves simplicity, economic efficiency, and fairness — the traditional measures of effective taxation — while also collecting higher revenues to fund essential government programs.
Also, the flat tax reduces tax evasion, by lowering the opportunity cost of
avoiding taxes. So therefore #10 could be much happier and less likely to claim part of his earnings overseas.
Mikel, this is your first and only warning. Please refrain from using profanity on this blog. If you have any questions, or are confused about the rules, then I encourage you to revisit the FAQs on the sidebar.
Next time your comment will be deleted.
There is no such thing as a 'flat tax', all that means is LOWER taxes for the wealthy. You don't need a 'flat tax' to cut out loopholes, all you need is the political desire to close loopholes. In other words, IF you tell all the rich people "look, we'll lower your tax rate so you don't have to use the loopholes-either way you won't pay any more tax, in fact you'll pay less".
Then of course you'll get all kinds of support. The support you WONT get is of course from the poor people who know damn well that its far more likely that a flat tax would be implemented WITH all the tax loopholes.
However, its the 'ideology' that sells, so we hear claims that 'the rich won't be punished'. Sure, the head of NB Power works SO much harder than that single mom who does two jobs to make ends meet. By all means we must make sure people like them know they are properly rewarded.
That, of course, is balderdash. Anybody who knows anybody in an executive position knows damn well they work far less, thats a 'reward' of climbing the ladder. Although we should note that political connections often have as much to do with it.
Work has never been correlated with income. Is JD Irving working so much harder than a refinery worker because he's spending time with bankers organizing loans? Of course not, its just DIFFERENT work, and if anything it isn't nearly as difficult, just ask the family of that refinery worker who DIED.
How much the rich actually put in is of interest, as well as whether its equal to what they are getting out. The Irvings, of course, packed up and moved to Bermuda.
I'd love to get my hands on the statistics showing just how many people are at the different income levels and how much each level contributes to the budget. No surprise, that's information that is very hard to come by, I can't even find it at Statistics Canada. We do know that New Brunswick has the highest differential between rich and poor in the country.
So absolutely, you can do like the above and make changes and HOPE that maybe rich people will contribute more. Again, we just saw during this 'cash crisis' that taxes on investment income went down, and that the tax increase was LOWEST on those with the highest income. Or, you can simple make the legislation FORCE them to. If you can't do it through income because of loopholes then do it through taxing the resources with which they make their money. If you look at the people with money in New Brunswick I suspect there are VERY few that are simply going to pack their bags and go elsewhere. Certainly the Irvings, with their hopes on another refinery wouldn't want to send that kind of message. 'Hoping' the rich will pay more really hasn't paid off very well so far.
Not so. A flat tax would also help the largest group of them all, the middle class. You're talking blatant income redistribution mike (not that out tax system isn't set up that way now but you're hinting at something more far reaching. Different jobs and different skill levels pay different wages based on the market. It's called capitalism. You're suggesting communism that has been an enormous failure in the world.
Huh? That has nothing to do with communism, or else I explained it badly. In the past budget, the tax increase of the middle class was much higher than those whose income was over 110 thousand. You simply make that increase the same for everybody. That has nothing to do with 'redistributing income'. You are simply saying that EVERYBODY has to pay more taxes because we've got no money.
You'll note that even 'flat tax' advocates base the whole thing on 'getting rid of loopholes' and 'making taxes simpler'. What does that tell you? Either way it simply comes down to how much tax you pay. IF the loopholes that are closed amount to the same as the decreased tax rate, what is the difference? There is no difference, the amount of tax paid is the same.
As for 'simplicity', well, the canadian tax system to the person paying is already remarkably simple, there aren't nearly the deductions that americans have, and of course the wealthy don't do their own taxes.
For the middle class, it makes no difference at all, almost by definition. It all depends what the tax level is set at. If its set at the most common level, then obviously for those people there is no change at all. For the people who paid a higher tax than whatever the flat tax rate is at, then all it means is that you've lowered the tax. The only people its 'simpler' for is accountants, but of course its mostly software that does the calculations anyway.
So how about this, what if the flat tax rate were set at 60%? Are you better off or worse? Well, since its way higher than what you pay then OF COURSE youre worse off.
Proponents, of course, say it should be lower, which means the same thing as just 'lowering taxes'. Keep in mind you guys probably aren't millionaire's and probably aren't super rich or you wouldn't be crying about this. The real tragedy is that its the VERY rich who have had the hugest decreases in taxes since the mid nineties. You guys always forget that when you claim the NDP is going to 'raise taxes' to pay for stuff. That's true, but its not YOUR taxes they want to raise, its the people who are becoming millionaires and billionaires.
To try to butter it up some more they say things like 'oh, we'll get rid of loopholes though'. Well, again, you can BELIEVE that if you want, but ask any tax accountant in Alberta if there are any loopholes and they'll send you the list.
Just like the small business tax or the Iceland scenario, the ONLY way it makes more government money is IF more people move into the system to take advantage of it.
For Iceland its easy, there are hardly any people and they have huge resources (relatively).
Like I said, there is zero evidence that more will move in, and I suspect the governments position is that when, and if, new companies set up shop that they simply 'tailor make' a solution for them like they did for the potash company to make it worth their while.
So its no coincidence that its mostly fiscal conservatives, the guys who simply want lower taxes, who talk about flat taxes. It's pretty obvious though that a 'system' of taxation has less to do with it than the details.
That's not communism, thats straight out basic economics 101.
Enjoy your blog...and the annecdote from Anonymous at 1:21 should be read by all...but thought you should know it wasn't Kamerschen (see//www.snopes.com/business/taxes/howtaxes.asp)
This comment has been removed by the author.
Thanks duepreparation. Btw, where are you emailing from in Fredericton?
For the record, it just looks like an anonymous story about "tax cuts for the rich" that seems to get a different professor's name, like Kamerschen or Davies, attached to the bottom of it. Typical of blogosphere trolls who like to steal other ppls identity to get a point across.
Iceland ranks in the top half in math and reading comprehension amongst all OECD countries.
"Since the late 1990s, the government has considerably raised expenditure on education, which is now among the highest in the OECD relative to GDP. Nonetheless, Iceland continues to have one of the largest shares of those in the working age population who have not attained upper secondary or higher qualifications, and educational achievements of 15-year olds are not outstanding relative to the country’s advanced state of economic development. This is all the more unsatisfactory because spending per student in the compulsory education sector exceeds the OECD mean considerably, even after controlling for differences in per capita GDP. Measures to improve outcomes include curriculum adjustments and an enhancement of teaching evaluation and quality."
-OECD 2006 report
Iceland also has free tuition and universal medical and social security, and very low social security payments into the system, again, easy to do when you have a small population with lots of resources.
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