Sunday, March 14, 2010

On taxation II.

Although in the previous post I mentioned macroeconomic context of taxation as the topic of this follow up post, as a layman I do not want to claim to analyze the issue in depth. My aim is only to pick up some themes  - some frequently mentioned in the public discourse, some totally absent - I find intriguing, nothing more.

The whole problem is centered around the redistributive role and the distortive nature of the taxes in the economy. From this angle taxes serve to channel money (capital) from the economy and from certain parts of society to others. As a discretionary levy on income or capital they nature is to change the incentives of the free market and pulling or pushing the economy out of its natural balance. (However, as some functions of the state are considered as necessary - setting the rules, guarding property rights, carry out judiciary decisions etc. - and their exercising is only plausible with some state revenues to a certain extent this distortion is unavoidable. But the extent is disputable and disputed.)  The first issue to be discussed here is the redistribution, whether it is negative under the present circumstances - i.e. in the crisis and with the necessity of tight fiscal policy narrowing consumption as a driver of economic growth. It is a specific approach, far from claiming universal validity.

An appropriate starting point is the model of the last decade (or in case of the US even the last 25 years) Income and social differences has grown in many Western and ECE countries. In the US it is usually associated with the tax changes, preferring - at least relatively - those in the upper income and wealth categories and in ECE - especially in the last decade - it is a result of the foreign direct investment based growth. (Although the necessity to follow this path and the possibility to find a different growth model is a topic of frequent contradiction, for my post the existence of this model will suffice, and it is not a prejudice regarding the merits of this path.) Nevertheless, as the US economy is based on internal consumption and in the transition countries the long period of subdued consumption led to a widespread desire to acquire the goods neglected during the change. The result - to sum it up simply, thus a bit simplystically - was the growth of credit aimed at consumption as real income growth couldn't serve as the basis of increased consumption. 

But why it is a problem when the growing national income - as in almost every country long and protracted periods of growth characterized the last decade - is not redistributed heavily, thus leading to growing income differences? Leaving aside moral considerations and not claiming that it necessarily fits to every situation one issue was the sustainability of the growth path. It is usually presumed that people with lower income tend to consume more as the ratio of their revenues ad to an extent it is true for additional income as well. This is mainly based on the fact that they usually can not satisfy their needs and desires because they disposable wealth is not enough. To the contrary, those with higher incomes, although spending more nominally, can easily save a higher ration of their income as it is significantly higher than their needs. (It is worth to note that the propensity to consume is influenced by social behavior as well, either on individual level or in societies with higher savings rate the consumption ratio can be relatively low even in lower income categories.) In general higher income of people in lower strata is perceived as a more certain way to drive up consumption, while the opposite is rather advantageous for higher savings. But it also means that if cheap credit is available for everyone, those with relatively low income can afford consumption. However, if one considers sustainability, the latter case is more problematic, as to keep the same growth rate without providing higher incomes means the constant raise of outstanding credit based on the rise of asset values. Conversely, as soon as asset values decline a credit crunch can easily occur. Beyond this "practical" problems it is also a debatable issue whether asset values can rise indefinitely.

A usual counterargument assumes that the economy is a closed system in which revenues are either consumed or saved and saving lead directly to investment increasing production on the long run. Therefore the higher savings rate of upper income categories is not directly affecting growth, as what they save is equally productive as the consumption at the lower stages of the ladder. In a closed system where financial tools are destined to transmit resources from one segment of the society to the other directly it is probably true but, but it is not so easy to determine whether modern savings techniques results in this very straightforward relationship. Moreover, due to the reliance of these savings techniques on the creation of the money in the financial system in order to create profit (it is the very basis of a financial bubble) even the channeling of savings into production is questionable. Not to speak of the difficulties of identifying the destination of such savings in geographical terms. It is probable that savings from Budapest will land in production in Brasil and this uncertainty again reduces the validity of the above mentioned model. The system is far from being closed and the relationship between the sectors are less clear and direct - due to financial innovation and globalization - as it was once. (An important aspect, tackled below is the profitability, whether financial investment brings less, equal or more profit as investment in production.) 

At least two consequences of this state of affairs have an impact on the considerations regarding the desirability of taxes and redistribution as a means to drive consumption. As the need to enhance competitiveness seems to grow instead of decreasing - due to the structural problems export is the favored way to create a current account surplus and cut down debt/to GDP ratio - wages can not be raised significantly (or only net wages through tax cuts, but the limitations of such measures to raise net income was the topic of my previous post) and it will limit the growth of consumption. If this driving force of the economic activity would need to be enhanced - and this is a matter of further consideration - the only feasible way seems to be redistribution as it would channel wealth from sectors of the respective societies where it is even not necessarily plays the role of being the source of investment to sectors where it could serve as a resource of consumption. (However, as the environment is rather inspiring deleveraging, getting rid of existing debts through savings it is far from being certain.) But beyond this - and probably more important - the validity of the model of government outcrowding is less plausible as it is treated in the public discourse. (This model relies on the assumption that private income is either consumed - that way poured into the economy - or saved - and the savings are directed by the financial institutions to the economy as sources of investment. The government's intervention - through collecting taxes - hijacks valuable resources and detours them. Although it is acceptable to a certain extent, if the government removes too much money from the private sector - especially if it happens through deficit spending covered by borrowing. In this case it usually assumed that less risky - and sometimes more profitable government bonds are more attractive to investors than company's bonds or savings accounts. Therefore the government collect and redistributes the money that would otherwise flowing swiftly into the economy. (The extensive taxation  has similar effects, as in this case the government directly expropriates the money it needs.) However, in the light of the globalization and the less than sure utilization of private savings as investment or domestic investment it is very doubtful. 

Firstly, as long as cheap credit flooded the world both the government and private sector was capable to draw on significant resources, irrespective of the prospects of return. No real outcrowding effect was detectable for example in Hungary, albeit one can ague that interest rates were higher than would have been without government imbalances. But - due to cheaper foreign currency denominated loans - private sector was capable to finance itself despite the huge volume of government sector borrowing. Secondly, nothing can ensure that savings not absorbed by government sector will be utilized by the private production sector. Even though some impact of government imbalances on the distribution of scarce resources can not be denied the original - and even today very popular - model of direct outcrowding seems less plausible. (Or, more precisely, it became pro-cyclical. While excess liquidity existed outcrowding was not a real issue. but after the collapse of the financial markets it reappeared in an enhanced form. But this time not the individual governments affected the economy, but those states that has the ability to borrow in their own currencies. Therefore, US government and Treasury bonds replaced ECE government bonds in the portfolios of investors.) But it means that the relationship is more refined as usually perceived and as a consequence it is dangerous to assume that reduction of government debt will result in a similar rise in private investment or consumption. (Especially as imbalances has to be dealt with and deleveraging is a universal phenomenon.)

This is not independent from the other important issue, how far taxes are distortive regarding economic activity and whether tax cuts in the EU are measures to release economic forces from their captivity or rather government subsidies that should be banned just as direct government subsidies are. The starting point is again the concept that taxation - even if it is undeniably necessary - is a distortion of the market, regardless of its extent. Even if better or worse tax systems can be conceived in this sense this idea clearly creates a binary opposition, taxation opposed to the tax free economy.  And if someone presumes market distortion as bad or at least disadvantageous taxation can not be seen as acceptable, only tolerable at best.  A tax free economy should be treated as better suited for optimal distribution of scarce resources than an economy with taxation. As a consequence any kind of change in the tax system is rather a redirection of this distortion, a change of who is affected positively and negatively but not the removal of negative effects in itself. But as long as distortion of the tax system exists why not to treat this redirection identically to the direct susbidies? It expresses preferences just as subsidies do, it forms obstacles in the development of certain industries - some of them would be in a more advantageous position without the taxation - while offering more favorable conditions for others. 

Beyond these rather general considerations one can also ask whether tax modifications inside the EU can be justified? Even if one would argue that there are more market friendly and less market friendly tax systems and therefore modifications of the system reducing distortion can be designed (and it would be a serious counterargument to the above line of reasoning) it wouldn't eliminate a twofold problem inside a perceived common, single market, like the EU. Firstly, as even this counterargument would accept the possibility of tax modifications with negative effect on the economy (and serving as indirect subsidies), every single step would have to be judged individually from this perspective. Even though a common framework of taxation exists its effects are rather moderate, well reflected in the diversity of VAT system, even if the EU regulations set - nominally - a very strict limitations on their variations. But another problem - already tackled in one of my previous posts - persists: whether modification of the tax system is acceptable at all in a common and single market as the EU is usually seen? 

Every member state became a member of the economic community with a given architecture of its own national economy - brought in line with a set of regulations of the community - and joined this peculiar organization while it also had its own internal economic architecture. As soon as the integration was carried out - for example derogations were phased out - it was perceived to be part of this single common market. How far unilateral modifications of this internal architecture can be acceptable and when does this activity start to be contradicting to the idea of fair competition? The treaties are rather silent in this regard. They identify a series of fields were larger unity and conformity of the member states is expected an others were it is not desired rather arbitrarily? Why is it an aim of the EU to form a currency union - theoretically leaving no opt out for anyone - while tax systems are considered as almost exclusive territories of responsibility of national governments? It inconsequential at best. If the union is a given common market than every single unilateral deviation from the pre-existing conditions should be treated not only in the context of the respective member state, but in the context of the union as a whole. Favoring ones own country can be disadvantageous for others and such moves are considered as contrary to the idea of the common market in many cases. Why not in the case of taxes? Even in the case of tax cuts? Anyway, individual companies made decisions earlier according to given conditions and a deliberate change in these conditions undermine their reasoning, resulting in very real disadvantages that could not have been presumed.

Unfortunately not only the existence of the EU makes the practice of constant tax cuts a bit dubious from the perspective of a common market. Tax cuts can be interpreted as very direct subsidies for companies and their owners in the context of the difference between financial markets and investment into production sectors too. One of the reasons of the financial investments stronger appeal compared to investment into production (noteworthy is the growing share of financial companies from the GDP of the US in the last two decades) was the higher return on these asset classes. Seen from this angle tax cuts or tax rebates for companies are nothing else than premiums on this investment to make it competitive and attractive enough. But in essence it is the same as giving direct subsidies. The state gives public money to private companies in order to counter market forces' effect on their activity. Moreover, to the extent this assumption is true even the perceived results of such tax cuts and advantages - more investment in the private sector because of the higher return - can be questionable. If the tax advantage is just an investment premium to complement profit it is not certain that the additional income will be used this way. 

However, the matter seems to be complicated by the possibility to trade shares of individual companies on the markets. The rates of these shares are usually seen as a good reflection of their real market value, based on their activity. therefore on their real return in the form of excepted dividends. But it is not necessarily the case, it is an epistemological problem. Shares are traded as if they would reflect real activity, but it is not necessarily the case. In many individual cases it turned out that the company was capable to deceive the markets. (Remember the Enron.) Sometimes it is even beyond the individual companies and whole systems can fall victim of such practices, like the banking systems in Spain or ECE today, with their huge mortgages not written off or reduced to their real value (expectable return) rather kept overvalued in their books. In any case the possibility that the markets has only a chance to follow developments in companies and react to them with a lag - despite every kind of sophisticated means to evaluate their performances - because ultimately they have to rely on information supplied by those companies. And even if the markets are seemingly following real developments there is always a chance that their reaction is exagerrated. Who can really decide whether the volatility of oil prices in he last two-three years properly reflected the supply and demand and was not distorted by "speculation", the actions of market actors who only trade with virtual oil?

As long as the markets can rely on money creation in order to acquire different assets and trade them the very existence of the capability of banks to create money consists the chance to drive a bubble, completely distorting prices, dissociating them from "real return". And the same bubble devalues the investment in other sectors than the financial. And if the rising stocks themselves provides return for investors - thorugh derivatives, transactions like swaps etc. - not the dividend of companies, making the relationship between real activity and investment return even loser. As long as this situation exists, investing otherwise is crazy, making such premiums as tax cuts inevitable to attract capital. 

A logical solution would seem a regulatory drive making financial assets less alluring and redirecting capital to other sectors. It would necessarily mean a devaluation of financial assets as well, because the expected return on them would immediately decline making their present value lower. Unfortunately it would mean a devaluation of those funds that will finance the pensions of the next generations, the life insurances of individuals etc. On the other hand one have to face the reality: if the growth of financial markets in the last years was the result of a bubble than excess liquidity has to exist in the system. Up to this moment this excess liquidity was not removed, rather moved between different entities. Central banks and governments stepped in and took over private debt (one of the embodiments of this excess liquidity) and transformed it to public debt. But it is not elimination. Could it be seriously hoped that the problems would be resolved without its removal from the system? At the moment the solution preferred by markets seems to be fiscal austerity, cutting wages (but not reducing the debt covered by those very wages) and prices not only in order to generate growth through export, but in order to reduce the public debt that was grown substantially by the takeover of private debt. The issue is whether it is the optimal solution in terms of distributing the pain between social actors (as there is hardly any painless way to resolve the problems) or inflation, restructuring and other alternatives would offer socially more acceptable ways out of this mire. It certainly deserves wise judgment and a broader horizon than that of the "experts" and "analysts". Unfortunately even broader than the horizon of the usual politicians.

Wednesday, March 10, 2010

On taxation I.

As the elections in Hungary in April draw nearer and the result seems pretty sure - at least regarding the person of the next prime minister - more and more speculation appears on the probable economic policy of the next government. Some of these are driven by curiosity and goodwill, others rather by pure and badly veiled self-interest, but one thing is common these are speculations as long as no elaborate program is published. (However, I'm sure that no one will really have any idea until the government will take over its responsibilities and initiates the first measures, but it is not my point here to denounce any party's campaign strategy.) But the issue of taxes has a key role in almost every attempt, usually in the well-known form of the tax cuts = strong growth causality. 

The idea certainly has a popular appeal and precisely because it is so easy to assume that nothing else is needed for living better than cutting taxes. Hand over less to the greedy paws of the state and in return even your future prospects for higher income will be enhanced immediately, it is the perfect populist perpetuum mobile. But beyond this rather simplistic approach the issue of taxes is at the core of almost every attempt to revive economic growth and ensure its sustainabilty and not only in Hungary. Either in the form of tax cuts or at least as a restructuring of the system, placing higher emphasis on property and consumption taxes and relieving a part of the burden on labor as a means to raise the employment rate and improve the employment rate. (The underlying reasoning is quite simple: the only obstacle of employing more people is the high cost of labor and the high taxes as they are disincentives on working, especially when they are accompanied by generous social benefits. Therefore as soon as taxes will lower employers will hire people and those who were earlier reluctant to work due to high taxes will flock to the gates of factories. Everyone can judge this reasoning and think of possible supportive or counterarguments.) May point is not to challenge this idea - although I'm reserved at best towards this simple argumentation - rather I would like to focus on other aspects of the tax issue, like the real effect of tax cuts on personal income - as it is always assumed that it is positive for everyone - and the real nature of the restructuring, the so called "whitening effect" or the macroeconomic role of tax cuts or even tax hikes. All of these from the perspective of a layman, of course and without the pretence of being comprehensive.

Tax cut is a popular promise as it is too easy to assume that the lower the taxes are, the higher one's net income is. In a narrow sense it is usually true - and people even tend to assume the same for so-called restructuring as lower tax rates has an immediate and direct effect on net income level, while the offsetting measures are many times hidden, not to speak of the tendency of the individual to take into consideration the positive perspectives and perceive the negative ones as applying only to others - but taken into account a series of direct consequences this assumption is highly questionable and certainly would need closer scrutiny. (Apart from those idealistic views that postulate a self-financing tax cut, the result of which is a stronger economic activity bringing even more revenues than the earlier system. But it is one of the basics of science that perpetuum mobile is impossible, so let's not deal with this nonsense.)

It is easier to assess the effects of the tax restructuring, as its aim is not to lower the overall level of taxes. The basic proposals - always based on study how the different types of taxes affect economic activity - advises lower taxes on labour costs (in general, not only lower income taxes, but lower social contributions paid by employers and employees as well) and higher ones on consumption (usually VAT, but other taxes connected to retail too) as less distortionary and on property. The effect of higher income is certainly imaginary for a lot of affected people, as the higher VAT immediately offsets a part of the raise in net income. But the effect is different for the different income categories, depending on the consumption/income ratio and the savings rate of the individuals. Those whose consumption makes a higher proportion of their net income will suffer more. It is hard to tell how far this measure can offset the results of income tax cuts, it can be different in every individual case and depends on the reactions as well - scaling back consumption can offer some relief - but the usual assumption is that the lower income categories are hit harder as the weight of basic goods and services (foodstuffs, energy, transport) is usually higher in their personal consumption basket and these are the ones where the possibility for considerable savings is the most restricted.

Not surprisingly a similar effect is detectable in the case of the property tax - in most cases a real estate tax - a favorite choice for many experts. The supporting arguments are usually practical ones - it is impossible to hide a house while it is easy to do it with income (so everyone is guilty of tax fraud, isn't it?), it is easy to tax them and it is in line with social justice as richer people tend to own more valuable properties. Albeit these arguments do not seem to be quite solid ones - for the market value of a real estate depends only in part, sometimes even marginally, on ones own activity - but my aim is to highlight its effect on the reality of income tax cuts. For most people their house is the only or the far most valuable piece of real estate their own and only a very few has capital return on them. (Beyond the advantage of not paying rent for their homes.) Therefore they can only service this tax from their income from work or labour (or in some cases from other incomes, however in case of many countries the wage is the dominant form of personal income for the bulk of the population.) As soon as the real estate is not used for some aim to yield return the property tax becomes in effect a hidden income tax. (Or even not so hidden if someone presume that it is a tax on the indirect income of being free of rental costs for housing.) But in both cases it is a tax levied on earnings and not on capital returns. Nevertheless it could have merits, for eyample a redistribution of wealth, bringing back capital to the economy etc., but it offsets income tax cuts and in a very arbitrary way. Due to the low influence on the market value of one's home, due to soaring real estate prices during boom years and protracted, many times incomplete correction in worse years. And due to the fact that in several ECE countries the ratio of real estate value to net income is probably higher than in many Western countries. It also means that the offsetting effects are different for everyone and only general assumptions and hypothesises can be put forward without a thorough analysis, but one can safely assume that a property tax can easily hit not only the lower income categories, but the middle-class, depending on the home value/income ratio. (The much advised solution to make a property tax deductible from the income taxes could eliminate the effect on the middle class, but wouldn't resolve the problem for lower middle class people and for those in the lower income categories. And selling one's home is also not necessarily a solution, because it would only capitalize a hidden income - the lack of home rental costs - in the form of a financial saving and the loss of income would only be avoided if the newly emerging rental costs would be covered by the return on this capital entirely.)

But these are almost explicit implications of the tax restructuring approach, although not necessarily recognized by those who would be affected. (And the problem of the effect on different social categories still persists, it can easily turn out to bring advantages only to those in the higher income categories.) However, the income tax cuts has a very similar offsetting effect, as long as they are not self-financing (and I would dismiss this assumptions, at least in the short term, because I try to assess the immediate effect on income) or not financed from new sovereign debt issuance. So, one can assume that tax cuts are accompanied by spending cuts. If these are not confined to the laying off of unnecessary public administration personnel (a phenomenon certainly existing, but the extent of which - and conversely the extent of the savings offered by this usually popular move - is hard to guess)  the implications will be higher implicit or explicit costs for public services. (People will either be charged with a higher sum for these or will be obliged to buy them from private entrepreneurs instead receiving them from the state on a lower price etc.*) The first aspect of this offsetting effect is the inflationary one, higher explicit prices for public services will drive the CPI upwards and they will remain at that level even after their statistical effect faded in the next year. (However, some savings can be achieved at the personal level by not buying these services, because earlier everyone paid for them a usually lower individual price in the form of taxes, while from this moment only those would be charged with a higher one-time price than the tax was who effectively would use them. But again it is not easy to make estimates regarding this effect and apart from the case of significant cost savings due to higher efficiency - or because of a more depressed demand due to visible an higher prices - the aggregate sum spent on these services would remain equal, only its distribution would be different. But its analysis is far beyond the means and possibilities of this blog post.) However, beyond inflation one can assume another offsetting effect, the effect of almost compulsory saving. Scaling back the state (spending cuts) usually implies the emergence and reconfiguration of systems like pensions or health insurance on the basis of self-provision. Even if it won't be obligatory legally it would be hard to avoid paying these contributions, because the cost sparing accessibility of public services would depend on them in case of necessity (classic health insurance) or they could mean the difference between a pension barely higher than subsistence level and a decent sum. However it is not necessarily a meaningful investment in the future, as it is rather a forced consumption and obligatory saving. (A kind of "békekölcsön" or "hadikölcsön".) And it has very similar effects and probably would have the perception as paying taxes. At this point the negative effect is more probable on the lower income categories, as for the higher earners, who even vefore the tax cuts had enough income to save a considerable amount, it is a meaningful choice between different risk-reducing strategies and investment forms. In general I would hypothesize that the effect of tax cuts - due to almost compulsory savings - would be only really positive in higher income categories and could even mean a decline of freely disposable income in the lower categories. And certainly surprise many from the middle class.

However, toothpaste advertisers will certainly drew our attention to a possible source of higher revenues, the "whitening effect". It is usually assumed that lower taxes will inspire people to legalize their earlier grey or black incomes, because - as this reasoning assumes - their incentive to hide it was only the horrifying nominal or marginal tax rate. (The implicit assumption of the "whitening effect" is the existence of a highly effective tax administration that can detect tax evasion with a high certainty making this practice risky enough to convince earlier evaders to accept the lower tax rate.) Nothwithstanding the sorrowful fact that the highest estimates of grey economies in the EU are usually produced for low tax level countries (Hungary is of course overtaken in this sense by Romania, Slovakia, Estonia, Latvia, Bulgaria, one can imagine the mood of our experts etc.) the assumption is not in compliance with the basic assumptions of the idea that lower taxes generate more work and with higher labour input higher growth. The main argument behind the reasoning that low taxes = higher employment (more work and more employed) refers to the willingness to work more if the income is taxed more benevolently. The favorite tool of measuring the effects of the tax system is marginal tax rate, i.e. how much can someone retain from one unit of additional income. However, if one considers black economy properly, it means that a significant part of one's income is taxed with a zero rate, therefore the marginal tax of grey and black incomes is zero. So the advocates of the "whitening effect" (while relying on psychological arguments, usually abhorred from if they are used to doubt their economic models) at the end state that people - contrary to their basic premises - will be ready to do the same work with the same intensity if their marginal tax rate will be raised. (And not insignificantly, as any natural number is infinitely more than zero ;) ) Therefore it is highly improbable that people will legalize their untaxed income, or if they do then labour input will decline in the economy, generating less output as the marked raise of the marginal tax rate  is a strong disincentive for work. 

Even if one dismisses this conclusion as absurd (I wouldn't be sure, people are usually not flocking to legalize their incomes even with lower tax rates as long as they are not really deterred by the high risk of being punished for tax evasion, but in this case - as it recently happened in Germany when someone offered for sale a CD with the alleged data of alleged tax-evaders - they usually do it on very unfavorable terms - i.e. high tax rates - as well) the extent of the cut in the income tax rates to unearth hidden incomes is not easy to estimate and certainly depends on the total income/grey income ratio. Because the higher one's illegal income as a ration of the total income is the lower his/her effective tax rate calculated on this total income is. Therefore only a more pronounced cut can bring enough incentive to legalize income. One can hypothesize that people with only occasional grey earnings will more readily pay some tax with a smaller cut (although it is not entirely consistent with the marginal tax incentive idea), while those who are in fact employed as grey workers - either entirely paid under the table or having officially a lower salary than they are receiving - will be convinced only by a very marked step on this route. This is not entirely hypothetic, as the main aim of these cuts is usually to convince the latter category- who are also conceived as the potential source of significant additional budget revenues. (Besides these rather automatic considerations one can also refer to the problem of labour costs beyond the income tax, social contributions and especially those that are paid for by the employer. Even in case of a significant tax cut these elements of labour cost can easily deter employers to offer a legal full salary, they can instead offer a splitting of the gains from the tax cuts - higher official salary with the same or slightly higher net income -, what would also be in fact a higher taxation of these grey incomes.) 

Anyway, one can safely conclude that tax cuts in themselves won't bring more freely disposable income for everyone. (It is important to note that one's income can nominally be higher, but with inflation, higher personal spending and almost compulsory savings the freely disposable income, the part of one's earnings that can be distributed freely into different consumption goods or directed into investment etc. can be even lower than before and ultimately this is what counts in assessing whether one is better or worse off after the tax cuts.) The effect of tax cuts can hardly be assessed in general, it should rather be done with the analysis focusing on different social groups, even though the macroeconomic effects are easier to grasp. But maybe for the individuals their personal fate has a precedence over macroeconomics, however shortsighted it be.

(So much for today, I will continue the analysis of the macroeconomic peculiarities in the next post.)

*There is always the possibility of magical savings due to higher efficiency of private providers, but the empirical evidence for this is controversial at best, therefore I won't make an attempt to guess its extent.

Democracy victorious

Our Moldavian very European democrats are in action. Instead of complying with the current constitution and dissolve parliament after the failure of electing a new president, they decided to create a new one. Not that I had any illusion and I'm sure that for those who thought of them as the champions of democracy it will even be a  reassurance in their blind faith. However, the nasty communist did not attempt this move. Maybe they were so rotten in their souls that they couldn't even think of this  extraordinary democratic solution for a constitutional impasse and went to the polls (to the polls, oh, what a dictatorship!) again instead.

Tuesday, March 9, 2010

Political economy of the West - updated

I always tried to avoid being boring and repetitive (however the resulting decline of posts can only help in the latter, but unfortunately enhances the former) but one of my permanent assumptions mentioned on this blog is that contrary to the popular - and evidently self-interest driven - portrayal of Eastern politicians their are not different from their Western peers. A very few of these people is the proverbial knight of public interest as opposed to the individual or group interest and unshakable champion of meaningful reforms delivering better results for everyone in the long term. It is quite instructive to take a look at Germany.

Germany is obviously a Western country, where the social democrats were ousted from power last September and their place as junior partner in a coalition besides the christian democrats was taken over by the liberals. For many - among them fro the respective parties - it was the realization of a dream coalition, much awaited for 11 years, since Helmut Kohl lost an election in 1998. Some commentators embedded the events into a grand narrative of overall decline of the left, predicting a loss of power for Great Britain's Labour for this May (once a certainty, now not so sure) and imagined an EU almost without leftist governments. Others (and the same commentators as well) pointed out that the electoral result of the liberals, an all time high, almost 15% is a sign of a strong desire for profound change in Germany. Especially, as the party run on a program with a very market-friendly agenda: tax cuts (self-financing ones, of course through stronger economic activity), health care reform, deregulation were the key points, but at the same time they emphasized a modified approach to the social systems, a more friendly one, in order to erase their stigm being the party of "social coldness" (soziale Kaelte). As the conservatives were always perceived as a market oriented party many awaited rapid changes.

The result: something completely different. After their first 100 and a few days in power the coalition seems to be nothing else then the scene of endless brickering, conflicts, their party leaders - except the chancellor, Angela Merkel - attacking each other at every opportunity despite the efforts to bring peace. Moreover, it turned out that the key proposal of the liberals are not so welcome by their partners as they expected. In some cases on practical grounds: with a huge debt burden taken during the most severe phase of the crisis the conservatives are reluctant to pledge themselves to the requested tax cuts s they are not convinced of the myth of self-financing tax-cuts. In other cases the difference is one of principles: the smaller - Bavarian - conservative party opposes vehemently the idea of the introduction of a single lump-sum fee for health insurance for everyone, independent of their income etc. (The liberals idea is to compensate the obvious social disadvantages - people with lower income paying higher fees in proportion of heir income than people with higher income and/or more property - through the tax or the social system. It is not only contrary to their proposals regarding a simpler tax system, but probably would be mor expensive than the present system of direct state contributions to the individual helth insurance institutes as compensation of their losses. According to some estimates of the Ministry of Finance it would cost about 17 billion euro yearly, while the present system required "only" 8-9 billions last year.) The Bavarians announced that it is for them an issue of life and death, they can't accept any from of a lump sum fee.

Although these are not the only contested issues (for example a huge debate on the so-called Hartz IV system, a social assistance system for long term unemployed broke out recently) maybe even so much is enough to illustrate the depth of the problems. The first reaction was - beyond the inevitable surprise - some commentaries on Merkel, whose sympathy for ideas of social democratic origin was underestimated by her liberal partners - followed the conclusion. However, it was rather a reflection of the popular mood of the Germans, who rapidly withdrew their support from the liberals (they lost a half of their voters during this period) not only because of the above mentioned problems, but because they soon became suspicious of clientelist politics. (In a package of tax cuts they pressed for lower VAT for hotels and restaurants but it was soon revealed that the respective business has no intention to pass it to the costumers - i.e. lower its prices - and informations surfaced on huge donations to the party from hotel owners.) Their reaction was somehow confused: raising the pressure on their partners regarding tax cuts - irrespective of the situation of the budget - and health reform. (The story is very similar to the story of the Hungarian liberals from 2006, the series of similarities extends even to the continuous reference to the sanctity of the coalition agreement - a text with sufficiently opaque and vague formulations in this regard.) Even after opinion pollsters shared the results of their surveys with the public: no one really expected them to deliver the exact promises they made, especially not the tax cuts, thought not too much credible by everyone - rather changes in the relationship of the sate and its citizens, a field where they didn't even had at the end a single idea.

What can be the conclusion of this familiar story? (Familiar from Hungary, a coalition rapdily loosing the support of the population - according to the last poll more than three fifth of Germans considers this coalition an alliance of parties that do not fit to each other - and politicians misreading the signs sent to them from the public and struggling to keep power in a key province in the country at the elections in May.) Not the too easy prediction of inevitable failure of the government, rather the necessary caution for every politician. First, ideas popular in opinion poll can easily turn out to be unpopular when not only the bright side, but the trade offs has to be faced. Secondly, it is dangerous to be carried away by someone's own zeal and think that the people are enthusiastic about the same points of their program as they themselves. Thirdly, despite the dire situation of the left, these societies didn't make a u-turn and embraced the anglo-saxon type of free-market capitalism. They are rather not only divided in this sense, but clearly looking for solutions to preserve as much from the welfare state as can be. Not very insightful conclusions, but as in ECE politicians instinctively or consciously accepting them are portrayed as villains, maybe not is not completely useless to point them out.

It was a long time ago I posted something and it seems the topic was almost the same as this post. However, this one was written in a bit different genre. Not too much difference, but some justification. ;)