Archive for the 'Taxes' Category

Oct 08 2012

Is Switzerland becoming a feudal state?

Switzerland “could become a feudal state” claims an economist. – swissinfo

One Zurich economist thinks so:

In Switzerland 71 per cent of the wealth is concentrated in the hands of just ten per cent of the population – a figure that economist Hans Kissling finds alarming.

Kissling tells swissinfo that the gap between the rich and everyone else is growing and that this could threaten traditional Swiss democracy and the economy. He makes a call for an inheritance tax for the wealthy.

Statistics show that the 300 richest people have become 40 per cent wealthier in the past eight years, whereas most of the population has a lower income than at the beginning of the 1990s

Kissling has nothing against wealth, he just thinks that if someone did not earn their wealth but inherited it instead, they should have to share a bit with the rest of society.

I call for a tax on very high inheritances, from SFr1 million ($900.000) upwards, and only on the excess value of that. I certainly don’t want people to think that they can’t pass on their family home to the next generation.

I’m only interested in trying to stop any creeping feudalisation, to avoid having huge clans like in South America, which threaten the economy and the political world

He’s most concerned that if the gap between rich and middle class continues to widen and the middle class of Switzerland don’t start benefiting from the country’s growing wealth, there could be a dangerous backlash against the free market system.

…the richest one tenth of a percent in Zurich – there are no full Swiss statistics – had 677 times more wealth than an average citizen in 1991. By 2003, 12 years later, the richest one tenth of a percent had 1,027 times more wealth. So the gap has really grown.

The middle classes, unlike the lower classes, have not benefited from any concessions, such as health insurance or childcare allowances. Here they have to use up all their assets before they receive any support. The lower classes have help from the beginning. This is why the middle classes are threatened

Discussion Questions:

  1. Why does a growing gap between rich and middle class threaten social stability in Switzerland?
  2. What threats do growing inequality pose to Economic growth?
  3. What are the benefits of an inheritance tax as a means to reduce wealth and income inequality? What are the arguments against such a tax?
  4. What other types of government policies could reduce the wealth and income inequality that exists in Switzerland?

13 responses so far

Oct 31 2011

Keynes versus Hayek 101 – the debate continues

The most important graph used in Macroeconomics today is almost certainly the Aggregate Demand / Aggregate Supply (AD/AS) model. This graph can be used to illustrate most macroeconomic indicators, including those objectives that policymakers are most interested in achieving:

The AD/AS model, on its surface, is a very simple diagram, showing the total, or aggregate demand for a nation’s output and the total, or aggregate supply of goods and services produces in a nation. It is very similar to the microeconomics supply and demand diagram, except that instead of comparing the quantity of a particular good to the price in the market, the AD/AS model plots the national output  (Y) against the average price level (PL). The model shows an inverse relationship between aggregate and price level, and a direct relationship between aggregate supply and price levels.
What makes this seemingly simple model so interesting, however, is that there are two wildly different opinions among economists on one of the its two primary components. Some economists, whom we shall refer to as Keynesians, believe that the AS curve is horizontal whenever aggregate demand decreases, and vertical whenever AD increases beyond the full employment level of output. On the other side of this debate is whom we shall refer to as the Hayekians who believe that AS is vertical, regardless of the level of demand in the nation. The two views of AS can be illustrated as follows.
Underlying the two models above are very different ideas about a nation’s economy. The Keynesian AS curve implies that anything that leads to a fall in a nation’s aggregate demand (either household consumption, investment by firms, government spending or net exports) will cause a relatively mild fall in prices in the economy but a significant decline in the real GDP (or the total output and employment in the nation). The neo-classical AS curve, on the other hand, being vertical (or perfectly inelastic), implies that no matter what happens to AD, the nation’s output and employment will always remain at the full employment level (Yfe).
Behind these two models of AS are two schools of economic thought, one rooted in Keynesian theories and one rooted in the theories of an intellectual rival and contemporary of John Maynard Keynes’, Friedrich Hayek. Keynes and Hayek were the most pre-eminent economists of their era. Both lived in the first half of the 20th century, and rose to prominence in between the two World Wars. Both economists saw the world fall into the Great Depression, but each of them formulated their own distinct theory on the best way to deal with the Depression. The episode of Planet Money below goes into some detail about the lives and the theories of these to most influential economists.

Keynes believed in what we today call demand-management. The idea that through well planned economic policies, governments and central banks could intervene in a nation’s economy during periods of economic downturn to return the economy to its full-employment level, or the level of output the nation would be producing at if everyone who was willing and able to work was actually working. Keynes believed that aggregate demand was the most vital measure of economic activity in a nation, and that through its use of fiscal and monetary policies (changes in the tax rates, the levels of government spending, and the interest rates in the economy), the government and central bank could provide stimulus to a depressed economy and create demand for the nation’s resources that would help move a depressed economy back towards full employment.
Hayek and his disciples, on the other hand (sometimes referred to today as the supply-siders) had a different interpretation of the macroeconomy. Hayek was what many today refer to as a libertarian. He believed that the government’s best strategy for handling an economic downturn was to get out of the way. Any attempt by the government to influence the allocation of resources through “stimulus projects” would only reduce the private sector’s ability to quickly and efficienty correct itself. The free market, argued Hayek, was always superior to the government when it came to allocating resources towards the production of the goods and services consumers demanded, so why allow government to intervene in the economy at all. All a government should do, argued Hayek, was provide a few basic guidelines to allow the economy to function. A legal system of property rights, for instance. The government need not provide anything else. The free market would take care of health care, education, defense, security, infrastructure, and anything else the market demanded.
During depressions, Hayek believed that government could only make things worse by trying to intervene to restore full employment. At any and all times, government’s best action would be to lower taxes, reduce its spending on goods and services, and thereby encourage private entrepreneurs to provide the nation’s households with the output they demand. Any regulation of the private sector, including minimum wages, environmental regulations, workplace safety laws, government pensions, unemployment benefits, welfare payments, or any other measures by government to redistribute wealth or promote equality or social welfare would reduce incentives for individuals in society to achieve their full productivity and strive to maximize their potential output. By minimizing the government’s role in the economy, argued Hayek, a nation would be likely to recover swiftly from a 1930’s style Depression, and output can be maintained at a level that corresponds with full employment of the nation’s resources.
The graphs below show how the two competing ideologies view the effects of a fall in aggregate demand in the economy.
On the left we see the Keynesian model, which shows output (real GDP) falling with a fall in AD. The fall in output corresponds with a fall in employment, and therefore a recession (or Depression). To return to full employment, aggregate demand must move back to the right (or increase). To facilitate this, Keynes and his contemporaries believed that government should increase its spending, decrease taxes (to encourage households and firms to spend) and lower interest rates (to make saving less appealing). All that is needed, say the Keynesians, is a dose of stimulus to get back to full employment (Yfe).
In the Hayekian model, no government intervention is needed at all when aggregate demand falls. In fact, in an economy with very limited government, a fall in AD will have little or no effect on output and employment. Without minimum wages or laws making it difficult or expensive for firms to reduce wages or fire and hire workers, firms faced with falling demand will simply lower their employees’ wages and reduce the prices of their products to maintain their output. If there is no more demand for some products, those firms will shut down and their workers will go to work for firms whose products are still in demand, at whatever wage rate the market is offering. Wages and prices are perfectly flexible in the Hayekian view, because there is no government interfering, demanding workers for big government projects, competing wages up, enforcing a minimum wage, or paying unemployment benefits to those out of work: all policies that make it difficult for wages to adjust downwards during a recession. Without government intervention, wages and prices rise and fall with the level of demand in the economy, but output remains constant at its full employment level.
The two models could not be more different. In one (Keynes’) recessions will occur anytime demand falls below the level needed to maintain full employment. In the other (Hayek’s), recessions are impossible as long as government gets out (and stays out) of the way.
Which models is the right model? For most of the last 100 years, most Western economies have demonstrated more of the characteristics of the Keynesian model. As the last several years show, recessions certainly are possible. Wages and prices have NOT fallen as much as Hayek’s model suggest they should, and economic output has declined in many Western nations and remains below the levels achieved in 2007 in many places. Most economists would argue that this prolonged recession is likely due to a weak level of aggregate demand. And the economic policies of many Western nations have reflected the Keynesian belief that government can “fix the problem” through stimulus plans involving tax cuts, spending increases, and low interest rates.
But two years of Keynesian policies are now being reversed. US President Obama’s latest attempt at a Keynesian-style stimulus (his $447 billion “American Jobs Act”) has been rejected by the US Congress. Across Europe, government spending is being slashed and taxes are being raised, both policies that threaten to further reduce aggregate demand. Deregulation is the battle cry of the Republican Party in the United States one year before the next presidential election. Presidential candidates are promising to “cut taxes, cut spending and cut government”, which sounds like a Hayekian battle cry. Less government will lead to more competition, greater efficiency, more employment and a stronger economy, goes the thinking. Government cannot solve our problems, government is our problem.
This debate is not a new one. It has been going on since the 1930s when two scholars, one an Englishman from Cambridge, the other an Austrian at the London School of Economics, went toe to toe on the role of government in a nation’s economy. The two models of aggregate supply above survive to this day, and 80 years later, in the midst of what may be the second Great Depression, economists and politicians still haven’t figured out which theory is correct. Part of our problem is that in our Western democracies in which economic policies are determined by politicians who are often only in office for two to four years, we have not had the opportunity to truly put either economic theory to the test. Less than three years ago Barack Obama, freshly elected, embarked on the greatest experiment in Keynesianism since Franklin Roosevelt’s “New Deal”, which was widely credited with getting the US out of the Depression. Now, with another election looming, we have politicians promising to bring America back to economic prosperity in a truly Hayekian fashion, by “cutting, cutting and cutting”.

source: http://www.beaumontenterprise.com/

 

4 responses so far

Sep 23 2011

Fiscal stimulus, the Swiss way

Parliament gives green light to government economic boost plan. – swissinfo

In the last two weeks, both my countries, America and Switzerland, have put forward stimulus packages aimed at helping their economies avoid entering a second recession. The US American Jobs Act, announced by President Obama to the US people two weeks ago today, will provide relief to American businesses and households mostly in the form of tax cuts. Some new spending on infrastructure, primarily schools and transportation, is provided, as is continued relief for unemployed Americans.

The chart below shows how the American Jobs Act plans to spend the proposed $447 billion. 

Clearly, the largest single category of spending proposed by the AJA is in the form of tax cuts for American households and firms (a combined 54.8% of the total). The purpose of tax cuts, of course, is to provide households with more disposable income with the hope that household consumption will increase, thereby increasing demand for goods, services, and ultimately labor, which would bring down unemployment. Businesses will also enjoy a cut in the taxes they pay when employing workers, so the costs to firms that hire new workers will be lower if the bill is passed. Extending benefits to workers who are already unemployed makes up a relatively small component of the American stimulus plan, while infrastructure and education spending, both which contribute to the long-run growth potential of the US economy, make up less than a third of the $447 billion package.

Let’s now look at the Swiss stimulus package, approved by the Swiss parliament today following a debate that lasted just seven hours. (For comparison, the American Jobs Act will require months of deliberation and when it is ultimately passed will likely have been completely modified by the American congress). The chart below shows where the $950 million of spending announced by Switzerland will be spent.

The biggest difference, as can be seen, is that a full 57.5% of the Swiss stimulus comes as relief for unemployed Swiss workers, compared to just 14% of America’s package. The 24.4% spent on research and development will go towards “a research and innovation programme, helping to translate ideas into successful business plans.” The subsidies for Switzerland’s tourist industry will come in the form of low-interest loans to businesses in the hotel and travel industry, which has been adversely affected by the recent appreciation of the Swiss franc, which has reduced tourism in Switzerland as Europeans and others have found it more expensive to travel to the country in recent months. Tourism is one of the largest sectors in the Swiss job market, so the spending on unemployment benefits will bring direct relief to individuals affected by that industry.

To compare the two country’s stimulus packages (America’s is only in the proposal stage, while Switzerland’s has been approved and will begin being implemented soon), is a study in two different economic philosophies. One major difference is the obvious lack of tax cuts in the Swiss plan. Such cuts were proposed by the conservative party in Switzerland, but the country’s finance minister, supported by the center-left party, argued that “tax policy should not be shaped by the current monetary situation.” She is referring to the fact that Switzerland’s stimulus in needed in response to the strong Swiss franc, not due to any underlying problems in the Swiss economy. The Swiss plan targets relief directly at those industries affected by the strong currency, tourism and high skilled manufacturing, which stands to benefit from increased spending on R&D. 

The US plan, on the other hand, includes over $240 billion (almost 55% of the total) in tax cuts, which while they do increase households’ disposable incomes, do very little to guarantee an increase in total spending in the economy. The last two rounds of stimulus in the United States, the 2009 American Recovery and Reinvestment Act, and the 2008 tax rebate program under George W. Bush, both included significant tax cuts to Americans (all of the Bush stimulus was a tax refund). Neither of these packages produced much growth for the United States, although the ARRA likely prevented unemployment from rising higher than it would have without a stimulus.

Switzerland’s plan includes no tax cuts, instead it offers direct support to particular industries in the form of government spending, and helps unemployed workers continue to spend and contribute to aggregate demand by maintaining their incomes during their period of unemployment. Switzerland’s stimulus, it could be argued, is more of a demand-side fiscal stimulus than America’s, which, due to its large tax cuts, places more of the responsibility for increased aggregate demand on the private sector. However, the 31% of the American plan that goes towards school and transportation infrastructure, and the 14% that goes towards continued unemployment benefits, should have positive demand-side effects, and should help increse employment and output in America if the bill is passed.

Discussion Questions:

  1. What is meant by the claim that Switzerland’s stimulus package is more of a demand-side policy than the United States’? How will the various types of spending in the Swiss plan contribute to the country’s aggregate demand?
  2. Another difference between the two plans is how they will be paid for. In Switzerland, “the money is to be taken from an expected 2011 budget surplus,” while the US budget for 2012 is expected to have a deficit of around 10% of the country’s GDP. How does the budget situation in the two country’s impact the ability to use fiscal expansionary fiscal policy to promote the macroeconomic objective of full employment?
  3. Which is more likely to have a direct expansionary effect on aggregate demand, tax cuts of a certain size or government spending of the same size? Explain your answer.

51 responses so far

Jan 17 2011

Market Failure and Bullets

Should hunters switch to ‘green’ bullets? – CNN.com

Chis Rock once said,

“We don’t need gun control, we need bullet control. I think a bullet should cost $5,000, cause if a bullet cost $5,000 there would be no more innocent bystanders.”

Chris Rock may not have had market failure in mind when he wrote this joke, but he unknowingly demonstrated a perfect example of a case in which the over-consumption of a particular good results in spillover costs on third parties not involved in the original transaction (the “innocent bystanders”). In economics, this is known as a negative externality of consumption, and is considered a market failure because without some kind of government intervention, too much of the harmful good will be produced and consumed: in this case, too many bullets are consumed causing harm to society.

I always thought Chris Rock’s idea of taxing bullets was a good idea, but never thought I’d find a real example of such a solution to market failure, until now. Although the bullets in the article below are those used by hunters, whereas Chris Rock’s bullets are probably those used by gangsters, the economic concepts underlying the market failures are similar.

Three years ago, Phillip Loughlin made a choice he knew would brand him as an outsider with many of his fellow hunters:

He decided to shoot “green” bullets.

“It made sense,” Loughlin said of his switch to more environmentally friendly ammo, which doesn’t contain lead. “I believe that we need to do a little bit to take care of the rest of the habitat and the environment — not just what we want to shoot out of it.”

Lead, a toxic metal that can lower the IQs of children, is the essential element in most ammunition on the market today.

But greener alternatives are gaining visibility — and stirring controversy — as some hunters, scientists, environmentalists and public health officials worry about lead ammunition’s threat to the environment and public health.

Hunting groups oppose limits on lead ammunition, saying there’s no risk and alternatives are too expensive…

Lead bullets cause harm to the environment and possibly to human health. The private consumption of these bullets exceeds what is socially optimal, while “green” bullets, on the other hand, are under-consumed by private individuals. There are two market failures occurring here, and they can be illustrated as follows:
When markets fail, government action is sometimes necessary to achieve a more socially optimal allocation of resources. The bullet market represents a market failure because too many harmful lead bullets are being consumed while not enough environmentally friendly “green” bullets are being consumed.

The graphs above show the impact of corrective taxes and subsidies in resolving these market failures. Whether or not governments will pursue such corrective policies has yet to be seen. A couple of states, however, appear to already understand that market failures require government intervention.

Last year, California banned lead bullets in the chunk of the state that makes up the endangered California condor’s habitat. The large birds are known to feed on scraps of meat left behind by hunters. Those scraps sometimes contain pieces of lead bullets, and lead poisoning is thought to be a contributor to condor deaths.

Arizona, another condor state, gives out coupons so hunters can buy green ammunition. Utah may soon follow suit.

Discussion Questions:

  1. Why don’t all states simply ban the use of lead bullets by hunters? Is this solution socially optimal?
  2. Besides corrective taxes and subsidies, how could government reduce the demand for lead bullets and increase demand for “green” bullets?
  3. How will Arizona’s use of coupons demonstrate a market-based approach to externality reduction?
  4. And this one is from the authors of the Environmental Economics blog: “Do you think the deer care which kind of bullets the hunters use?”

18 responses so far

Oct 24 2010

What does a good IB Economics Commentary look like?

It’s that time of the IB Economics course when I get to start teaching my year one students to write the dreaded Internal Assessment Commentaries. For their first IA, my students are writing a commentary on an article relating to Section 2.1 and 2.2 of the IB course, on supply, demand, market equilibrium and elasticities.

After reading a dozen or so out of my 38 students’ first drafts, I began to realize that what many of them needed was a clearer idea of what a good IB Economics commentary should look like. So I went back through past years’ commentaries and decided in the end just to write a sample commentary myself.

As you know, I do a lot of economics writing, so I thought this would be a breeze; I’d bust out a 700 word commentary modelling to my students what a top IA should look like. Well, I did it, but it proved to be much harder than I thought it would be. Why? Because after my first draft I was at 1100 words! The word limit, as IB students know, is 750, so I proceeded to spend as much time as it took me to write figuring out how to get it down to within the word limit.

Well, I did it. Below is my sample commentary for year one IB students. I do owe some credit to a past student of mine, Maren, whose article I stole and whose own commentary I adapted to write this one.

First, here’s the link to the article:

Where is Switzerland’s Cheapest Place to Live? – SwissInfo

And my commentary:

Introduction of theory:
Demand, supply and elasticity are basic economic concepts that when applied to different markets can help governments and individuals make informed decisions about things as basic as where to live and how to collect taxes.

Connection to article:
Recently, Credit Suisse conducted a survey and determined that Switzerland’s most expensive canton is Geneva, while the cheapest place to live is Appenzell Inner Rhodes, (AIR)

Analysis:
Demand is a curve showing the various amounts of a product consumers want and can purchase at different prices during a specific period of time. Supply is a curve showing the different amounts of a product suppliers are willing to provide at different prices. Equilibrium price and quantity are determined by the intersection of demand and supply. Price elasticity of demand (PED) indicates the responsiveness of consumers to a change in price, and is reflected in the relative slope of demand.

In the graph below, the markets for housing in Geneva and AIR are shown.

Demand for housing in Geneva (Dg), is high because of the many employment opportunities there. In addition, Geneva’s scarce land means supply of housing is low, resulting in a high equilibrium rent (Rg). Demand for housing in Geneva is inelastic, since renters in Geneva are less responsive to changes in rent compared to AIR, perhaps due to the perceived necessity of living close to their work.

Demand for housing in AIR (Da) is low, but supply is high due to the abundance of land. AIR is a rural canton with few jobs, therefore fewer people are willing and able to live there than in Geneva. Since living in the countryside is not a necessity, demand is relatively elastic, or responsive to changes in rent. The lower demand and greater supply make the AIR’s equilibrium rent relatively low.

The effect of a tax on property is a shift of the supply curve to the left and in increase in rents as landowners, forced to pay the canton a share of their rental incomes, raise the rent they charge residents.

In Geneva, property taxes are high, but this has little effect on the quantity demanded.

Geneva’s property tax shifts the supply of housing leftwards, as fewer landlords will be willing and able to supply properties to renters when the canton taxes rental incomes. However, the decrease in quantity demanded is proportionally smaller than the increase in the price caused by the tax, since demand for housing in Geneva is highly inelastic, or unresponsive to the higher price caused by the tax.

Renters in AIR are far more responsive to higher rents caused by property taxes, perhaps because living in AIR is not considered a necessity and there are more substitutes for rural cantons to live in. Renters in Geneva do not have the freedom to live in one of Switzerland’s many rural cantons, and are therefore less responsive to higher rents resulting from cantonal taxes.

Evaluation:
A tax decrease in AIR could lead to a significant increase in the number of people willing to live there, since renters are highly responsive to lower taxes. To some extent, housing in AIR and Geneva are substitutes for one another. Lower taxes in AIR would make living there more attractive, and subsequently the demand for housing in Geneva would fall putting downward pressure on rents there. People would move to AIR, attracted by lower rents, and commute to work in the cities. According to the article, this is already happening:

The disparity in the amount of disposable income… has increased the trend of people moving cantons for financial reasons… Economic necessities had led to an increase… of people moving address and opting to commute into work”.

There are many determinants of demand for housing in Switzerland, the primary one being location. High rents in Geneva are explained by the high demand for and the limited supply of housing. On the other hand, residents in AIR enjoy much lower rents, due to the weak demand and abundant land. Cantons should take into consideration the PED for housing when determining their property tax levels. Raising the tax Geneva will have little effect on rentals but could create substantial tax revenue. On the other hand, reducing taxes in AIR may attract many households away from the city to the countryside, drawn by the lower rents and property taxes.

Applying the basic principles of demand, supply and elasticity to Switzerland’s housing market allows households and government alike to make better decisions about where to live and how much to tax citizens.

Note: To see the full commentary including a cover page and highlighted article, click here

46 responses so far

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