Greece Needs the Magic Formula to Become the Wealthiest Country in the Eurozone
March 26, 2015
(This item originally appeared at Forbes.com on March 26, 2015.)
If your only ambition is to go from terrible to mediocre — to get your country off the international business pages so it can suffer in anonymity — then you can perhaps argue that most things can remain the same, and all you need is a few small tweaks to the existing status quo. In actual practice this usually doesn’t work, and not even mediocrity is achieved, but the idea seems plausible.
But, if your ambition is a little higher, it soon becomes obvious that doing things mostly the same way will produce mostly the same results. I suggest that Greece’s new Syriza government should embrace the idea of becoming the wealthiest country in the eurozone – yes, wealthier than Germany – in perhaps twenty years. Even if they fail, the result would still probably be pretty good.
But, I think this is actually not so hard to accomplish at all, when you fully understand the Magic Formula. The Magic Formula is: Low Taxes, Stable Money. Yes, that’s the whole thing. Greece is already halfway there, as long as the euro remains tolerably stable (which, admittedly, might not be for very much longer).
Between 1950 and 1970, Japan’s nominal GDP increased by about sixteen times, as measured in gold-linked yen–and U.S. dollars, then also gold-linked. Between 1986 and 1996, South Korea’s GDP increased by five times as measured in U.S. dollars, which were reasonably stable during that time. Obviously, if you can quadruple your economy in ten years, and then do it again for another ten years, you end up with a sixteen-times increase in twenty years, just as Japan did. Alas, South Korea’s hot streak was cut short by Unstable Money in 1997, just as Japan’s was terminated by the “Nixon Shock” of 1971.
These things are not so uncommon. Even Mexico’s economy nearly tripled between 1960 and 1970, as measured in gold-linked U.S. dollars. The Mexican peso was, in those days, linked to the dollar (and thus gold) at an unchanging 12.5 pesos per dollar. Stable Money.
Between 1999 and 2008, a mere nine years, Russia’s economy expanded by over eight times in U.S. dollar terms, even as population declined by 3.5%. (Admittedly, the crisis base in 1999 was very low.) Note that mining production, including all minerals and energy resources, was only 9.3% of GDP in 2013.
Even at today’s depressed levels (down 24% in nominal terms since 2008), Greece’s per-capita GDP would have to increase by “only” 112% relative to Germany’s for Greeks to become wealthier than Germans. Even at the pokey pace of Mexico in the 1960s, this seems achievable in ten years, not even twenty.
What once seemed impossible now seems easy, doesn’t it? And if it’s easy, and also fun because getting wealthy is fun, then why not do it?
In 2013, soon-to-be Finance Minister Yanis Varoufakis wrote a “modest proposal” for Greece’s economic strategy, teaming up with lefty U.S. economist James Galbraith. The group identified four elements to Greece’s problems:
1) A sovereign debt crisis. Greece can’t pay its accumulated debt, so it won’t.
2) A bank crisis. A sovereign default, plus the natural bad-debt consequences of economic contraction, inevitably lead to bank insolvency.
3) A “crisis of under-investment,” which basically means a stinky private economy.
4) A social crisis, which they say is caused by the first three items. A 24% decline in nominal GDP tends to do that.
I don’t have much disagreement with any of these items. The main issue is the solutions. The sovereign debt crisis should be resolved ultimately with a default and debt restructuring that brings the net present value of the debt down to a manageable level perhaps around 50% of GDP, much as Russia did in 2000. The bank insolvency issue should be resolved through the normal channels of creditor seniority, with as little financial theft as possible – and no “bailouts,” “recapitalization” or other government expenditures. These are politically sensitive issues, so I can understand why Varoufakis is dancing around them a bit, but that’s the bottom line, and I think he knows it. (I go into these topics in much more detail in Gold: the Monetary Polaris, available here.)
The social crisis is correctly identified as the natural outcome of the other issues. In crisis times, you have to provide something to allow the least-well-off to get by somehow.
That leaves the “crisis of under-investment.” Varoufakis offers a dubious state-funded investment scheme that would likely be a laughable failure. The basic problem is that Greece provides an absolutely terrifying environment for capital – because of the probability of sovereign default and bank “bail-in”; because of the risk of monetary catastrophe if Greece somehow stops using the euro; because of the disastrous high-tax “austerity” policies rammed through by the IMF and other foreign groups with a long history of destroying everything they touch; because of the hideous tax system and other business-unfriendly elements; because of all the potential catastrophes summed up in the phrase “the next Venezuela”; and because the present left-leaning government hasn’t come up with any good ideas besides this:
“The Investment-led Recovery and Convergence Programme (IRCP) will be cofinanced by bonds issued jointly by the European Investment Bank (EIB) and the European Investment Fund (EIF). The EIB has a remit to invest in health, education, urban renewal, urban environment, green technology and green power generation, while the EIF both can co-finance EIB investment projects and should finance a European Venture Capital Fund, which was part of its original design.”
You could ask any one of the thousands of Greek businesspeople fleeing for Bulgaria, and they would name a list much like mine. This presents another fine opportunity, however: those Greek businesspeople would probably be happy to flee back to familiar Greece just as quickly, if the business environment was more attractive than Bulgaria’s. As investment and employment surged, the “social crisis” would disappear.
Hong Kong has a 15% flat income tax, no sales taxes or VAT, no payroll taxes, and no taxes on capital gains, dividends or inheritance. Nevertheless, the government is able to provide all the familiar developed-world services including universal healthcare, a welfare system, a public rail system, and public universities. The government has no debt and a long history of running budget surpluses.
That is perhaps a little too much for Greece to embrace at one go. Thus, for Greece, I suggest a 15% flat tax, and the existing VAT of 23% (perhaps lowering it eventually). The addition of the VAT to what amounts to the Hong Kong model should produce much more revenue/GDP, which is perhaps appropriate for Greece, at least in the first instance.
That’s it. The VAT is more than enough burden on the lower incomes. That’s why I would eliminate Greece’s 44% combined payroll tax, and all other junk taxes. True, the 15% flat income tax rate is higher than Bulgaria’s 10%, but I think Greek businessmen would appreciate not having to pay Bulgaria’s 17.9% employer-paid payroll tax, which is combined with another 12.9% paid by employees.
The “flat tax” idea is basically a product of U.S. political realities. When the idea was developed in the 1980s, and popularized in the 1990s, the U.S. had combined payroll taxes of about 12%-13%. Sales taxes were imposed on the state level, and in the range of 8%-10%. These were not terribly high, compared to proposed flat tax rates of perhaps 18%.
The U.S. Federal government had no Federal sales taxes or VAT, so that could not be included in Federal-level regulation. The Federal payroll taxes were “earmarked” for existing Social Security and Medicare programs, and thus considered untouchable, even if this “earmarking” was always something of a fiction.
However, as this U.S.-style flat tax idea was adopted by governments especially in post-Soviet Eastern Europe after 2000, it was merged with European-style payroll tax systems like Bulgaria’s 30.8% combined, and VATs like Bulgaria’s 20% rate. Countries enjoyed enormous economic benefits nevertheless; but this was certainly not a Hong Kong-style idealized “low tax” environment. A sense of imbalance and unfairness remained. Why were the lowest-earning members of society paying 30.8% of their first dollar of earnings in payroll taxes, and then, when they tried to spend that money, paying another 20% of VAT, plus all the other junk taxes, while business owners were paying 10%?
Good question. I think that is why the flat-tax ardor has dimmed somewhat in Europe, with Albania, for example, ditching its 10% flat tax for a system with a 23% top rate.
That is why I see a top-to-bottom tax reform as necessary for Greece, including the elimination of all payroll taxes. Employees would get an immediate increase in after-tax income of 19%–even 52% if employers pass along their tax savings. That tends to make one politically popular. More importantly, employers and employees would be able to cooperate together without paying enormous sums to the government. The natural result is more people looking for work in the private sector, more employers providing it – and a disappearance of the “social crisis.”
Wealthier than Germans. Twenty years? I doubt it would take that long, especially when thousands of German businessmen start to flee for business-friendly Greece.
