Auteur Archief: Dalibor Rohac

‘Robin Hood’ Tax Will Not Make Markets More Stable and Might Hurt Economic Growth

Dalibor Rohac

The Financial Transaction Tax (FTT), which is to be adopted in 2014 by 11 eurozone countries, has come under a lot of flak lately.

Most recently, Sir Mervyn King said he could not “find anyone in the central banking community who thinks it’s a good idea.”

Even the Italian government, initially committed to adopting an FTT, is now having second thoughts — particularly because the tax will affect secondary trading in government bonds.

An FTT might have unpleasant unintended consequences, damaging economic growth on the European continent and beyond.”

In stark contrast, Algirdas Šemeta, the European Commissioner for taxes, claims that the levy of 0.1% on equity and fixed income transactions and 0.01% on derivatives is a response “to the persistent demands of their citizens, who have long called for a harmonized FTT in Europe. The levy will ensure that the under-taxed financial sector finally makes a fair contribution to the public purse.”

Besides generating significant new revenues to cash-strapped European governments, “it should help to deter the irresponsible financial trading that contributed to the crisis we are in today,” says Mr. Semeta.

However, there is very little rationale for such claims.

If adopted, an FTT will not be a boon for public budgets — nor is it likely to prevent financial crises. Instead, it might have unpleasant unintended consequences, damaging economic growth on the European continent and beyond.

The proponents of the tax argue that an FTT will reduce speculative and irresponsible trading, which was allegedly behind both the financial crisis of 2008 and the sovereign crisis in Europe.

But even if one believes that the ability to trade instantly, at practically zero cost, has helped to spread the panic, an FTT is not going to help.

Growing Volatility

There is no evidence that an FTT would moderate market volatility — and attenuate sudden shifts of mood on financial markets.

A recent report by Anna Pomeranets from the Bank of Canada concluded that there have been instances when an FTT led to an increase in volatility — most significantly on the New York Stock Exchange and the American Stock Exchange, between 1932 and 1981, where increases in the FTT were associated with rising volatility, increased bid-ask spreads, and lower trading volumes.

Similarly, the idea that capital is under-taxed in current tax regimes is mistaken.

If anything, tax systems that rely on the taxation of income tend to tax savings more heavily than consumption.

An additional levy on financial transactions will further discourage individuals and firms from saving and investing. And because financial capital is among the most mobile factors of production, expect this effect to be strong — leading both to less investment and therefore lower productivity and less growth in Europe.

That investment is highly sensitive to taxation means that the tax is unlikely to yield much revenue either.

Because an FTT is applied to all transactions made with a given security, its effect is cumulative — hence the deceptiveness of the seemingly low tax rates.

But that means that its application will change the nature and frequency of financial transactions, leading to lower tax revenues than anticipated by its advocates.

Sweden’s Bad Example

After an FTT was introduced in Sweden in 1984, trading in long-term bonds declined by 85% and practically half of all the trading in Swedish stocks moved to non-Swedish markets.

The EU’s FTT directive tries to remedy this problem by being set up as an extraterritorial tax.

The transfer of any security will be taxed even if it takes places outside of the relevant jurisdiction, as long as the security is issued in the country that applies the FTT (the issuance principle) or if the investor is residing in the country that applies the FTT (the residence principle).

Such a solution, though, is much worse than the problem it purports to address.

Extraterritoriality is legally contentious.

The United Kingdom has already launched a legal challenge at the European Court of Justice, on the grounds that it harms countries that are not taking part in implementing it.

Legal issues aside, an extraterritorial tax is an attack on tax competition, reducing the incentives of governments that are not taking part in an FTT to improve their tax and institutional environments in order to attract capital flows.

Worse yet, an FTT may lead investors to leave Europe altogether, and invest and issue securities in friendlier jurisdictions.

The real losers in that process will be the citizens of the 11 European countries who signed up for this fool’s errand — including relatively poor economies such as Slovakia, Slovenia or Estonia.

Dalibor Rohac is a policy analyst at the Center for Global Liberty and Prosperity at the Cato Institute.


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European Integration or Disintegration?

Dalibor Rohac

First, there were only a handful of cranky Tory backbenchers and libertarian Nigel Farage who were receptive in the 2000s to the growing popular discontent over the way the European Union was being run. Seen as a fringe movement and part of British political folklore, few expected euroskepticism to get much traction.

The coming out of Nigel Lawson, former chancellor of the exchequer, seems to be a game–changer. Writing about leaving the European Union, the Tory peer concluded that “the economic gains would substantially outweigh the costs.” Lord Lawson was soon followed by two Cabinet ministers — Education Secretary Michael Gove and Defense Secretary Philip Hammond — who also indicated that they would favor Britain’s exit.

Finally, writing in Financial Times, columnist Wolfgang Munchau acknowledged that “[a] departure need not be a disaster if the terms are negotiated with skill” — a statement that only weeks ago would look out of place on the opinion pages of a newspaper that had traditionally embraced the euro and European integration with fervent enthusiasm.

For the first time in years, it seems that the British are willing to have an open discussion about the costs and benefits of EU membership, without running the risk of being labeled as political extremists.

While so far this shift has been mostly a British occurrence, it does not have to remain one — indeed, it should not. For many countries in Europe, the costs of being part of the EU are very salient — particularly for those that are part of the eurozone and are expected to contribute toward the bailouts of less–than–solvent countries on the eurozone’s periphery.

Neither should this shift be only, or predominantly, about a binary choice between being a part of the EU versus leaving it. While many small, open economies on the European continent might benefit from the common market, there ought to be space for an open–ended debate about the EU’s governance and its dysfunctions.

Instead of having such a debate, Europeans were long fed the mantra of ever–closer union. It was assumed that the EU’s problems would be solved by deeper integration and tighter policy coordination. The monetary union was a part of that process, as was the growing body of EU directives, regulating everything from privacy issues to mobile–phone roaming charges. At the onset of the crisis, a banking and fiscal union were proposed as fixes to the macroeconomic imbalances that were becoming apparent in the eurozone’s periphery.

Only a small group of politicians tried to challenge that consensus. With exceptions, euroskeptics were not a savory bunch, as they were dominated by groups such as the Front National in France or the True Finns. The more thoughtful skeptics were often embarrassed to express their concerns, for fears of being ostracized and lumped together with the likes of the French right–winger Marine Le Pen.

However, closer integration has not been delivered. In 2013, the EU economy is expected to contract by 0.1 percent, following a year of negative growth. Unemployment is at a record high, with youth unemployment in some countries hovering well above 50 percent. Instead of becoming an economic powerhouse, Europe is flailing.

Today, there seems to be an opportunity to have an adult conversation about what has gone wrong with the European project. British Prime Minister David Cameron can help to set the tone for that discussion, but other European leaders need to join in as well. Many areas are in a desperate need of change.

Take regulation. The European Commission estimates that the administrative burden that EU–wide legislation imposes on businesses is $160 billion — and that does not include the economic costs that regulation creates by distorting incentives to produce and innovate. Another overdue problem: agricultural subsidies. Some 38 percent of the EU budget for 2014 to 2020 — or $470 billion — is going to be spent on farm subsidies.

The list is much longer. The past few years have seen the creation of a permanent bailout fund for the eurozone’s members in fiscal distress, with very little in terms of a cost–benefit analysis to justify it. There is an ongoing, silent power grab by European institutions, which can be illustrated by a recent note by the European Commission in which the commission asks member states to subject their economic policymaking to EU control: “The Commission considers it important that national plans for any major economic–policy reforms are assessed and discussed at EU–level before final decisions are taken at the national level.”

For far too long, the thoughtful dissenters were being mocked into hiding. With the political equilibrium shifting in Britain, however, it is no longer possible to simply ignore the discontent with the direction taken by European political elites. Although the denizens of Brussels’ corridors of power may not realize it yet, the time to renegotiate the “social contract” guiding the Continent is now.

Dalibor Rohac is a policy analyst at the Center for Global Liberty and Prosperity at the Cato Institute.


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Europe between Planners and Searchers

Dalibor Rohac

In his 2006 book, The White Man’s Burden, William Easterly makes the distinction between “planners” and “searchers” in economic development. Planners like to believe they already have the answers to big questions of economic development, which they often see as simple engineering problems, waiting to be fixed by enlightened political elites.

In contrast, searchers display more humility both in the choice of questions they attempt to address and the answers they provide. Searchers try to address local, context-specific problems, instead of coming up with a “Grand Theory of Development,” and are willing to accept that answers might arise from the bottom up, through experimentation, and trial and error.

Although Easterly’s interest is in economic development, the distinction between planners and searchers is at the heart of many public policy disagreements. And in spite of appearances, the planners versus searchers dichotomy is not an ideological distinction. Some free-marketeers are keen on particular one-size-fits-all solutions (think about proponents of the gold standard), and there may well be people on the political left who understand the idea of context-specificity and local knowledge.

In fact, there is a place for both. Hayek once famously wrote, “this is not a dispute about whether planning is to be done or not,” but rather a dispute about whether it “is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.” Individuals, firms, and governments do—and should—plan. A problem arises, however, when the limits of planning are not recognized and when it is expected that the planner always has a correct answer to any policy question.

We’ve yet to see the final bill for the ideological blindness of European planners.”

Hayek devoted his life to explaining the pitfalls of one instance of such hubris—the command economies of the Soviet Union and Eastern Europe. While in no way commensurable with the atrocities of communism, the ideological commitment of European political elites to the European integration project may well enter history books as yet another illustration of such bloated self-confidence.

Europe has a long-standing “planning” tradition, which the European integration process has mirrored. This intellectual undercurrent encompasses the belief that governments should play an important role in the economy, but more importantly the belief that European countries need to move towards a political union. A corollary is the notion—implicit in European policy debates—that Europe’s problems require a common European response.

Though initially prompted by an ambition to enlarge markets and preserve peace in Europe in the late 1980s, economic and political integration became a one-way street. The Maastricht Treaty, signed in 1992, stipulated that a single European currency would be created—famously without devising any mechanism for leaving the monetary union.

From then on, the European Union has been on a unidirectional track towards becoming a political union. The Lisbon Treaty, which became effective after Czech President Václav Klaus begrudgingly signed it into law in November 2009, cemented this trend by moving from unanimity to qualified majority in several important policy areas and empowering the European Parliament, among other features. At the same time, however, a sovereign debt crisis began to unfold in the European periphery.

Europe’s response to the crisis reflected the planning mentality of its leaders. Rather than recognizing that the monetary union—instead of being the promised catalyst of prosperity—contributed to accumulation of fiscal and external imbalances in the periphery and trying to find ways to go back, politicians insisted that there was nothing flawed with the existing institutional structure that more political unification could not fix.

Instead of a prudent devolution, Europe got more planning and a “whatever-it-takes” attitude—bailout funds have been created to shield ailing banks and governments from markets and closed-door European summits have become the principal venue where decisions over Europe’s financial future are made. A full fiscal union, unthinkable until recently and still unpalatable to voters in countries like Germany, is now being entertained as a perfectly respectable, though slightly premature, option.

As often happens whenever ideology is confronted with unpleasant facts, Europeans also face a cognitive dissonance between the promise of a better functioning, more closely integrated union, and the ongoing economic mess—which is arguably getting worse, not better. If planning is not working all that splendidly for us, maybe it’s time to let searchers give it a try.

The economic and financial problems that the construction of the Eurozone generated are not historically unprecedented. Governments and firms often found themselves in too much debt in the years predating the creation of the Euro. And there had been mechanisms for dealing with such situations—not just the political fiat we’ve seen in the past four years.

A searcher would thus point out that we might want to try local procedures, such as bankruptcy. True, financial panics are not pretty, and have costs for the real economy, but that is not a reason for treating financial institutions as too big to fail, but rather, as Paul Seabright argues, to develop mechanisms that can determine seniority of different claimants without necessarily prompting everyone to go withdraw their cash out of banks simultaneously.

Similarly, it has not been unusual for governments to enter and leave different monetary arrangements at will, especially if it turns out that an unrealistic exchange rate is contributing to a chronic macroeconomic malaise—as it may have in the case of Argentina in the late 1990s. While European politicians, with their planning mentality, have taken orderly departures of individual countries from the Eurozone off the table, there exist a wealth of examples of countries that have successfully dealt with such problems in the past, such as Czechoslovakia (in 1919 and in 1993).

In short, a searcher’s approach towards solving current economic problems in the Eurozone would readily recognize complexity and involve looking for bottom-up, country-specific solutions without necessarily endorsing any specific political vision for Europe from the outset. Yet, that is not the approach by those believe that they have the answer—i.e. more and deeper integration—regardless of the problem they are trying to address, and regardless of economic reality. We’ve yet to see the final bill for the ideological blindness of European planners.

Dalibor Rohac is a policy analyst at the Cato Institute in Washington, D.C.


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Fixing Egypt’s Subsidy Nightmare

Dalibor Rohac

With gas at $1.73 a gallon, no wonder Cairo’s traffic is a nightmare. And with bread at less than a cent apiece, it’s no surprise that the city’s sidewalks are lined with discarded pitas. By using subsidies, governments in the Middle East and North Africa ensure that everyone, including the poorest, have access to basic consumer goods at an affordable price. But energy and commodity subsidies are becoming an increasingly heavy drain on public resources, while bringing only very small benefits to those in need.

In Egypt, the middle classes, the well-off and big business are the biggest beneficiaries of the subsidy system. A typical better-off Egyptian receives roughly twice the amount in subsidies as a genuinely poor one. At the same time, subsidies to fuels and food account for almost one-third of the total government budget, or over 10 percent of the country’s GDP. Thus the subsidy issue is the key to solving Egypt’s public-finance problems.

Yet reform is a daunting task. For Egyptians, subsidized commodities are an essential part of the perceived social contract between the citizens and the state. Egyptians have traditionally had little say in public affairs and could never expect much from their government (other than taxes, onerous bureaucracy and a constant hassle). When President Sadat attempted to cut bread subsidies in 1977, violent nationwide riots ensued. The same thing happened thirty years later, following a hike in food prices in 2008.

Making subsidy reforms popular will require compensating the losers—not only the poorest segments of the population.”

So far, attempts to address the subsidy problem have been shambolic. In October 2012, Prime Minister Hisham Kandil announced that the government was planning a gradual reform of energy subsidies. The proposal suggests setting a cap on how much cheap fuel and cooking gas each household can purchase, with each Egyptian household to have access to only two cylinders of fully subsidized butane (used for cooking); further consumption would be subsidized only partially to discourage pervasive leakage to the black market.

The proposed reform helps address one of the problems: subsidized commodities are available to everyone, regardless of their income or wealth. Wealthier Egyptians buy more cooking gas, gasoline or electricity than poorer ones. Thus the bulk of the spending on subsidies ends up benefiting the rich.

At the same time, a cap on purchases won’t solve the deeper problem with subsidies. As anyone who has received an unwanted yet expensive Christmas present from a distant uncle can attest, transfers of commodities are a clumsy way of making people better off. “If only he gave me cash!” tends to be a common reaction, especially when the gift comes without a return receipt.

Similarly, receiving cheap commodities instead of cash, Egyptians often end up with an abundance of goods they either don’t need or don’t value much, resulting in waste and black markets. Imposing a cap or trying to direct the subsidies at poorer families does not change the fact that it is much cheaper to help people by giving them money than by handing out stuff.

Egyptian policymakers need to study other countries that tried to deal with the subsidy problem in the past. In the 1990s, various Arab countries, including Jordan, Yemen, and Tunisia, reformed their food-subsidy programs. Jordan started by first limiting the availability of ration coupons to low-income groups and then by gradually replacing them with cash transfers. By 1999, food subsidies had been replaced by payments from the National Aid Fund.

Policymakers in Yemen followed a similar route and brought down a food-subsidy budget that accounted for 7 percent of GDP in 1996 to zero within three years. However, targeting cash at needy people has proven to be much more difficult than in Jordan, which may explain the return of the subsidy problem in the 2000s.

Finally, Tunisians tried something different. Instead of replacing subsidies with cash transfers, they eliminated subsidies on higher-quality goods that were consumed mostly by the middle classes and the rich, while keeping subsidies on inferior products bought mostly by poor people.

The best option is to simply turn the subsidy system into a temporary stream of unconditional cash transfers to every Egyptian, eliminating the distortions of in-kind redistribution, such as the bloated network of various middlemen, licensed bakers, gas distributors and flour dealers. That has the potential to demonstrate the benefits of cash redistribution and create a wide constituency for future reforms.

Egypt finds itself in a tough place. The military has a firm hold on power. The radical Islamists are challenging the Muslim Brotherhood’s dominance in the political arena. The country is in a state of latent civil unrest. It is no wonder few Egyptian politicians are willing to entertain radical reform. Yet that is exactly what is needed to get the Egyptian economy back on track.

Making subsidy reforms popular will require compensating the losers—not only the poorest segments of the population. After all, the poorest are not necessarily the ones who are most likely to show up in Tahrir Square. While broad compensation would limit immediate fiscal gains from reform, it could be executed rapidly, without first instituting a complex system of means testing.

Very often, economists advising governments recommend carefully timed and gradual reforms, since they create few painful dislocations in the economy. But such an approach ignores the political reality of the country. A plan by Egypt’s government that extends over many years will not be seen as credible if the government has only a tenuous political mandate and faces deep domestic divisions.

This does not mean that the government can’t do anything. By putting in place a reform that is swift and encompassing and makes nearly everyone better off, Egyptian political elites would not only do a service to the Egyptian people—they would also strengthen their own bargaining position in the competition for political power.

Dalibor Rohac is a policy analyst at the Cato Institute in Washington, D.C.


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