More tax collection now in Greece isn’t so great!

I just had an email conversation with Greek macroeconomist Evi Pappa who is a Professor at EUI in Florence. 

She made a point about tax collection that I had, for some reason, not grasped, even though it’s blindingly obvious.

Right now, in the throes of an aggregate demand death spiral, cranking up tax collection on the mass of the population is not going to help.  Because it’s an increase in taxes!  [That’s the mental leap I made today!]  And will depress aggregate demand still further.  And, since they are in a single currency, there will be no compensating monetary policy loosening for them.

In the longer term, tax evasion is obviously vital to sort out.  But if that task has to be begun right now, the best thing would be to cut tax rates so that increased tax collection did not mean higher tax revenues.   In fact, in the short-term, cutting tax rates might actually help spread the custom of collecting and paying taxes more widely.  If think of tax evasion as a costly activity, then we might expect that, without changing the costs of tax evasion, cutting tax rates would lower the returns to tax evasion, and, hence increase taxes paid.  [h/t Pontus Rendahl at Cambridge for pointing this second rather basic point out to me].

Of course, a lot of Syriza’s rhetorical focus on this has been about extracting more revenues from the rich and super-rich.  Extracting that money would not depress demand much, because those individuals tend to have very low propensities to consume out of marginal income.  But if that can’t be done without the collateral damage imposed by much wider tax collection on the weight of lower and middle-income individuals, then better to postpone until the trajectory of the economy is more certain.

But try telling this to Greek’s creditors.

And we can make similar arguments about G.  That’s government spending.  The pensions and civil servant salaries that are the focus of so much outrage are the Greeks digging Keynesian holes and filling them.  And whatever the rights and wrongs of those payments six months ago, they are more needed now than before.

There’s an irony in the fact that the way the argument has played out between Syriza and the Eurogroup, which has led to renewed recession in Greece, and flight from Greek banks, has actually taken what is optimal from a politics-free perspective further away from what is politically feasible.

If there were no issues about sovereignty, moral hazard, tit for tat, credibility, etc, the best thing now would be for a much more generous package in the short-term, to counter the recession, relative to the situation last Summer.  However, Syriza’s own tactics, the ‘do what I say or I will blow my own brains out’ strategy, and Eurogroup’s probable increased scepticism about the Greek’s capacity to stick to conditions that would go along with any deal, mean that what they are prepared to offer is probably not more generous than before, and perhaps harsher.

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10 Responses to More tax collection now in Greece isn’t so great!

  1. Eleftherios Athanasiou says:

    What is happening with Greece has long departed from the economics sphere and has shifted to a politics agenda. The rectifying moves proposed and implemented actually contradict the main body of economic theory, especially during slumps even if one is a Keynesian aficionado or not. There was no monetary (it could not be done in the Eurozone as it is done in the US) nor fiscal expansion in terms of government spending or tax easing whatsoever. As a result, demand has continued to plummet. The debt to GDP ratio remains large and all that matters for the Eurozone’s elite in general and the Germans in particular is financial rationalisation.

    I do not know if this stems from the nightmare of hyperinflation which has been encoded to the German DNA, but austerity on the other hand does not seem to yield results. One could say, why Portugal and not Greece but unfortunately the two cases are not the same. Austerity can yield results eventually, but with tremendous social costs and this is something that the Greek people and the Greek government do not want to happen each for their own reasons. Germany on the other hand seems to want to set a rule, that economic naivety has long passed and that someone has to pay unfortunately, even if this a social deterioration in the short and medium run.

    What is leaving me skeptical however, is the urge of the Eurozone to defend its policies, while also promoting the idea that whatever is done, is done for the greater good. However not a single step has been taken in terms of foreign direct investments to address the anemic private sector performance of Greece (as it is done in the US). To top that, any talks of the Greek government with other countries (yes, even Russia) about possible investments are being translated as a political “casus belli” by the Eurozone administration. Not to mention the unprecedented pressure of debt repayment, while the thing that Greece needs in reality is a debt restructuring or at least an installment relaxation. It seems as if the Eurozone is united in good times and divided during bad.

    Therefore, I strongly believe that it is not about economics anymore. It is about politics, mistrust and power games.

    • Tony Yates says:

      Thanks for these insights into the political background. I think it’s worth bashing away at the economics nonetheless, in the hope that somehow this can influence the power plays in the negotiations.

  2. Someone says:

    Greece is on the wrong side of the Laffer Curve!

  3. pontus says:

    I think Evi is definitely right. And as tax evasion is a costly activity, the right thing to do is to lower taxes and simultaneously crack down on evasion, leaving revenues unchanged.

  4. Paideia says:

    I tried to figure out what the Greek tax revenue as a share of GDP was, and my clumsy calculation got me to around 30 or so percent.

    There are two things at work here: one is way in which taxes are collected. From what I understand, Greece relies on self-reporting and a non-electronic system. This need not be a problem per se though. Great Britain defeated Napoleon in no small part due to their ability to maintain and finance the Royal Navy even as Bonaparte dominated the entire continent, outnumbering the Brits by more than 5:1 in people. Voltaire, I believe (or it was Smith, can’t recall) that English productivity was probably 3 times what is was in France, and it was due to superior taxation schemes (the optimal vector, if you please). From Findlay and Rourke’s “Power and Plenty”, we know that tax-revenue as a share of national income in the UK was about 20% around 1800. Napoleon could barely manage 13%, yet the average French peasent was destitute compared to his British colleague.

    The other thing is that Nordic countries can raise at least 50% of their national income in tax revenues and still enjoy high-level prosperity. What gives?

    Clearly, there is a cultural challenge inherent to Greece that goes beyond simple macroeconomic understanding. Northern European cultures probably enjoy some combination of more honest citizens, more efficient tax-schemes, and more transparency.

    I don’t know if this has been explored, but I could imagine a reason for Greece’s poor situation is the general uncertaininty and the inability of average people navigate so complex and regulated an economy as theirs. Nordic economies are by international standards not heavily regulated, although they are heavily taxed. The US is not heavily taxed, but very heavily regulated. I imagine the propensity to use regulation rather than taxation as a policy tool is a feature of Latin and Southern European economies for various cultural reasons. I can easily imagine a situation in which regulation confers much larger competitive advantages for firms and raises barriers to entry more than subsidies or taxation might, thereby retarding Schumpterian creative destruction.

    Based on these unscientific scribblings, my inclination is that Southern European cultures are incapable of competently managing a modern welfare state that requires large bureaucracies (and bureaucratic efficieny requires very upright types).

    The solution for them is the negative income tax proposed (not Friedman’s original idea, although he is credited with it). Abolish all bureaucracy except defence and justice system, slash taxes to a single flat rate on all income whether derived from capital or labor and parcel out in equal shares to all citizens (not immigrants, of whom Greece has many). I would guess Greece could tolerate a flat tax of perhaps 25% and not much more. 6% would be required for debt service (at current nominal GDP assuming interest rate of 2% p.a. for 50 years, this would fall as GDP grows), 3% for externeal and internal security, and the remaining 16% would give your average Greek a direct transfer €3000 a year. A family of four would have €12,000 a year.

    This would suit Greek culture well. Women would probably drop out of the monetary economy and provide the welfare services through civil society and familiy institutions, and men would be free to specialize in the monetary economy. Assuming most regulation was abolished, as well, with a flat tax of 25%, no corporate income tax, starting a business in Greece would become very attractive.

    • Eleftherios Athanasiou says:

      Resorting to unconventional tax policies based on the excuse of cultural features is a rather defeatist view in my opinion. Not that there aren’t differences between cultures among European countries (this is one of the main roadblocks of a true EU Monetary Union) but, why not invest to a cultural reversion rather than accepting your “nature”, even though it has not led you anywhere?

      Moreover, the problematic Greek culture is a result of a plethora of economic and political mistakes as well as historical reasons which cannot be accounted to “the South cannot be taxed effectively” generalities, as in many cases the Greek people did not have a say on policies regarding their country.

      On this basis, and taking into account the fact that now Greece, more than ever, cannot conduct its own monetary or fiscal policy, a negative income tax regime would be highly unlikely to get a positive vote from the other European countries. Firstly, this kind of approach has never been implemented in totality (therefore it does not have a sound empirical body) and secondly, I think that this loose anti-bureaucratic path you are proposing does not come in line with the austerity policy, monitoring – heavy doctrine that is promoted by Germany and the North in general.

      Not to mention the costs emerging from the moral hazard side of such a scheme.

      • Paideia says:

        Changing culture takes hundreds if not thousands of years. We need to find a more practical solution.

        I don’t see how moral hazard would be a problem compared to whatever challenges there are today. I’m advocating a lower tax rate and less bureaucracy. Anyone who’s worked in any organization, public or private, is familiar with the dynamics of Parkinson’s Law.

        The reason Northern countries are wealthy is not because of large and powerful bureaucracies. That defies common sense. They are wealthy in spite of these. The bureaucrats of the North are just less rent-seeking type than your typical Latin-Hellenistic civil servant – the deadweight loss from bureaucracy is less dire.

        I’m not advocating abolishing the public financing of certain necessary goods, just abolishing public production. The demand for many services of the welfare state is constant – education, healthcare, etc. Consumers/taxpayers don’t care who makes them, they just care they get the best deal for their money and they have access to these services. There is no need for public production, merely public financing. A bureaucrat is not going to spend his time innovating his way to a better deal for taxpayers for the obvious reason he will not reap any rewards for that effort. Therefore, any creativity/productivity gains take place in the private sector, which is what we see every day. The public sector may then, if it’s especially efficient, implement some of those gains, but they will never come close to rate of creativity that private entrepreneurs do.

        So: abolish the public production of welfare goods, and move to a system of public financing, but private production, where taxpayers keep their consumer surplus, and producers keep their producer surplus. This will generate the kind of incentives we want to see more of. Simply put, the negative income tax.

      • Eleftherios Athanasiou says:

        The notion that northern countries’ bureaucrats are rent-seeking avert reminds me of Montesquieu’s theory about climate and geography, which is quite amusing. But I will simply disagree. What defines people and their culture is related to deeper historical, economic and political reasons rather than sentiment driven blanket statements.

        Onto the negative income tax. Some points:

        1) As you eloquently put it, consumers/taxpayers just care to get the best deal for their money and have access to services. Why exactly won’t they react the same way knowing that they will receive a subsidy if they work less? There should be tax reforms and aggressive anti-tax evasion policies, not doubtful practices.

        2) Earlier, I mentioned that negative income tax schemes have a very limited empirical background. However, even the existing evidence is rather disheartening. Negative income taxes actually made people reduce their working hours as a response to the negative income tax.

        3) You could say that the negative income tax theory has indeed been implemented to some extent in the form of the earned income tax credit scheme (EITC) enacted in 1975 in the US. However, what started as a supplementary program aiding the poor has become a sluggish public machine which actually has increased state dependencies as people are targeting welfare packages.

        4) What wage plateau is fair? If the wage cap for the negative income tax is 1000 euros, is it fair for the person earning 995 and not fair for another person earning 1002 euros?

        5) In Greece’s case, how on earth would this be financed?

        To summarize, a negative income tax would actually increase public state dependencies, increase public financing and inflate people’s incentives to free ride. I’m not saying that the solution is more taxes. On the contrary, Greece needs less taxes but most importantly it needs to find the processes that will minimize tax evasion and the culture around it.

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