Lessons Unlearned From Brazil’s Recession

As she was sworn in for her second term last week Dilma Rousseff publicly stated government spending would have to be cut. Yes, you read that right; the leader of the Workers’ Party just said her own administration is spending too much taxpayer money. It might be a day late and a few billion dollars short, but could it be Brazil’s president just had her Eureka moment?

ReaisYears of spending billions of dollars on stadiums and infrastructure for a 4-week event has left the Brazilian government with little to brag about. While the world has moved on to other things the World Cup’s relics lie mostly unoccupied in a land of poverty, police corruption and gang violence. After the artificial boom created by said event the bubble has definitively burst. Yet to hear one of South America’s most adamant cheerleaders of government intervention admit to it is remarkable to say the least.

Government figures show Brazil’s economy had already fallen into a recession before the World Cup even got underway. This year the central bank expects the economy to grow by a dismal 0.38 percent while inflation hovers north of 6.5 percent, well above the 4.5 percent target rate. Industrial production is forecast to expand by no more than 0.7 percent, with the country’s current account deficit widening to $78 billion. Predictable though the downturn may be, its sheer magnitude is forcing the Dilma administration to consider some rather uncharacteristic measures. Or is it?

The budgets of a few dozen ministries and some secretariats may be cut by one-third, reportedly amounting to some $700 million in savings, the new Finance Minister Joaquim Levy was quick to add expenses listed in the constitution will be unaffected – a constitution about as thick as Ayn Rand’s novel Atlas Shrugged, by the way. In addition taxes on imports, credit, cosmetics and fuel are set to be raised. To make matters worse, an income tax reduction already approved by Congress was recently vetoed by Dilma herself.

Naturally, the fact that Brazil’s tax burden of 36% of GDP is far higher than that of other middle-income countries cannot be allowed to keep failed economic policies from going full steam ahead. The logic on which excise taxes or protective tariffs on imported goods rest, i.e. that raising prices of certain goods discourages their consumption, suddenly loses all its validity when it comes to such activities as human labor or investment. Can Brazilians really be expected to keep working just as hard despite essentially working two out of five business days just to sustain a giant bureaucracy? Can a society really be expected to achieve any sort of meaningful growth when forty percent of its productivity is sucked out of it?

It is obviously too late to take all of the resources spent on the aforementioned projects and redirect them into the private sector, where they would have contributed to sustainable economic growth. It is not too late, however, to reverse the trend and stop adding fuel to the fire. Besides, imagine how much more expensive that fire will be considering rising fuel taxes!

As the famous quote attributed to Thomas Edison goes, “I have not failed, I’ve just found 10,000 ways that will not work.” The latter can also be said for the idea of taxing and spending one’s way to prosperity. Edison’s point, however, was that making mistakes can be useful if one learns from them. Unfortunately that message does not seem to have reached Brasilia.


If Not Budget Cuts, What Is Troubling Europe?

My previous blog post concluded that the widely reported budget cuts as part of  “austerity measures” that are supposedly being implemented across Europe are really not all they are being trumped up to be. Nonetheless, it seems we keep hearing about how times are tough for many Europeans. Rising crime rates and sharp increases in (youth) unemployment are just some of the problems facing several nations on the Old Continent as we speak.

TaxBut one might wonder: if governments are still running huge budget deficits (which are detrimental in the long run, of course, but keep the alleged “economy recovery” going for now) because spending is not going down much or at all, why do we see so many reports of people suffering? If it is not the slashing of government budgets, what is hampering a return to prosperity in Europe?

The answer is plain and simple: higher taxes. Francois Hollande, president of France, implemented a now infamous 75% tax on the highest tax bracket while also raising corporate tax and sales tax. On the other side of the Canal, the British government has raised taxes to record levels, with the amount of tax paid in Britain projected to soar by 15 percent in real terms by 2015-16.  “Kabinett Merkel II”, the second coalition government under Chancellor Angela Merkel, has brought German citizens the largest increase in taxes and social security contributions of the last 17 years. In The Netherlands tax hikes were introduced in the form of a redistributive overhaul of the income tax system and VAT going from 19 percent to 21 percent, among other things. In Ireland taxes (such as VAT and property taxes) already began to go up in 2010, when the country suffered a major blow as a result of the global financial crisis.

Spain introduced its set of tax hikes last year when Prime Minister Mariano Rajoy came to power; VAT went up by three percentage points to 21 percent while Spanish income tax rates were elevated to the point where they got to be among the highest in Europe. Italians face a similar fate with the sales tax now at 21 percent, a newly introduced housing tax (yes, you read that right) and an additional 3 percent levy on high incomes. Greece and Portugal were forced to jack up taxes in order to qualify for the EU-IMF bailouts. .

It doesn’t take an economist to figure out that such measures will wreak havoc and cause serious economic and societal upheaval. So next time somebody raises the argument that cutting government spending is bad for economic growth – because “look at what’s going on in Europe right now!” – you might want to kindly advise him or her to stop parroting the talking heads on TV and do some old-fashioned research before bothering you with such nonsense.

Why Taxing “The Rich” Is A Bad Idea

 “Government is the great fiction through which everybody endeavors to live at the expense of everybody else.”
Claude Frédéric Bastiat

If you were to ask people if they should be protected from those who would take their money or property by force, most of them would likely respond in the affirmative. However, when that same principle is applied to the State, the immorality of forcibly taking from someone what is rightfully his or hers is suddenly lost on a lot of people. So it is with the redistribution of wealth through taxation.

The idea of the State playing Robin Hood by taking from the rich to give to the poor seems to be gaining traction across Europe and North America, as evidenced by the election of such socialists as Hollande (France), Schmidt (Denmark), Di Rupo (Belgium) and Mister “You didn’t build that” Barack Obama in recent years. The common theme in their policies is the redistribution of wealth through taxation; they believe that it is only fair that rich people should have to surrender part of their wealth to the State so that it can take care of the poor. At the same time, the fact that those wealthy people that happen to be well-connected are exempt from those policies is often conveniently omitted.

Those that argue for a progressive tax code (i.e. the higher your income, the higher your taxes) like to appeal to people’s emotions by using the aforementioned fairness argument, based on a misinterpretation of the equality principle which holds that all human beings are equal and should therefore be treated equally under the law. They like to leave out the latter and apply this misinterpreted rip-off version of the equality principle to income, arguing that the government should redistribute income earned by “rich” people to the poor. But who gets to decide who “the rich” are? That decision is invariably arbitrary; for what person A may call “rich” person B may call “normal”. To the poor, most people around them seem to be rich, whereas middle-class people will perceive a smaller percentage of people rich. In other words, it all depends on one’s subjective perception of wealth.

Nonetheless, the sentiment from which the aforementioned socialist ideas sprang is understandable. The financial and economic crisis of 2008 exposed the system of crony capitalism – also known as a corporatocracy – that we find ourselves in today, which has manifested in the form of bailouts, humongous executive bonuses and large-scale fraud. These excesses, however, happened precisely in those well-connected industries and corporations mentioned before, where government guarantees opened the floodgates for reckless policies with no downside risk [1]. In other words, government intervention was the problem all along. Unfortunately though, some people have, with the help of the mainstream media, leaped to the conclusion that the free market is to blame. Consequently, their solution is more government regulation to curb the greed supposedly inherent in capitalism. .

Against this backdrop, the recent uptick in the popularity of socialist policies can be easily explained. In addition, most people will agree that it was immoral that the “fat cat bankers” used their political clout to get a third party – the government – to reward their reckless policies by bailing them out. But if it is immoral and greedy for the bankers to get the government to prop them up, why is it not immoral and greedy for voters to use the government to do the same for them? How can one justify having the government intervene on his or her behalf to forcibly take money from some people to give it to other people? Why do some standards of morality apply to some people while other standards of morality apply to other people?

Aside from the morality issue though, there are practical reasons why taxing the so-called rich is an inherently flawed idea. Let’s first look at how people get rich. Most rich people weren’t born that way, they became rich for a reason. Most of them set up their own business making products or offering services to satisfy an unfulfilled demand – creating jobs and happy customers in the process.. Admittedly there are some rich families that have chosen to invest their money in land or real estate to maintain rather than grow their level of wealth. But they form the exception to the rule; just as rich celebrities like Paris Hilton that simply live off of the money that was already owned by the family, form the exception. Businessmen will continue to invest money to take advantage of opportunities at hand. Given their experience with making the most out of such opportunities, their investments are a lot more likely to pay off than the investments of less seasoned (business) people.

Second, the rich are more likely to invest any additional money they have at their disposal in a business than spend it on luxury goods, generating benefits for the economy through increased employment. Poor people, on the other hand, will almost certainly spend it on basic necessities, creating no additional economic benefit for society as a whole.

However, there is more to the story than just increased employment. Evidently some of the wealth is not invested in businesses. But let’s say Steve Jobs’ wealth had been redistributed to the poor, preventing him from investing the required capital and designing innovative electronic devices that improved the quality of our lives. Or how about the inventors of the washing machine, the dryer, the computer, the television set, the radio or the car? If it wasn’t for capitalism, what incentive would there have been for anyone to work hard to invent something to improve the life of the common man? Surely no one would argue that we are not better off because of these home appliances, iPhones, laptops, tablets and the like, or that we would have been better off if their prices had been higher due to taxation.

People of a socialist persuasion hold the belief that there is a fixed “pie” of wealth of which we all get a piece. Accordingly, they assume that when the rich get richer, the poor must inevitably get poorer. The truth is, however, that the rich get richer only by enlarging the “pie”, not by somehow stealing it from other people. The rich get rich only in and through society. The only entity that’s in the business of taking people’s money at gunpoint is the State. Which is why we need to restrict its power to arbitrarily redistribute wealth and instead let the free market run its course. For not only does the free market have the best track record of improving the lot of the common man, it is also the most moral instrument imaginable to achieve this goal.

[1] See also: Johnson, S. & Kwak, J. (2011). 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. New York: Random House USA Inc.