Putin Tax: Back in the USSR

What did the Beatles mean by “I’m back in the USSR. You don’t know how lucky you are boys”? And why is the Club for Growth crowd arguing we should emulate Russian economic policy as in this tribute from Stephen Moore:

All over the world, from Estonia, to Albania, to Russia to Hong Kong, flat taxes are in vogue. The flat tax is being instituted to enhance economic growth, increase tax revenues and make tax codes fairer. Why not in the U.S. After all, isn’t the world topsy-turvy when Moscow, the onetime center of socialism, has a 13 percent top income tax rate compared to 35 percent in America, the land of the free? … I would suggest one politically viable way to overcome the special interest opposition to tax reform is adoption of a Freedom to Choose Flat Tax. The potential economic gains are gigantic for American workers and firms if the tax panel adopts this approach. For example, if the $200 billion a year compliance costs attributable to the tax code could be cut in half, the financial windfall to the nation would be larger than the value of all goods and services produced by every worker and business in the states of Maine, Vermont and New Hampshire combined. On top of that, Harvard University economist Dale Jorgenson estimated several years ago that if replacing the U.S. tax code with some kind of flat and simple consumption tax would increase economic growth by about 10 percent.

Before we turn to the real story in Russia, let me suggest two things. #1: having a dual system of taxation would likely increase compliance costs and #2: Moore misrepresents what Jorgenson and other economists have said when he claims reducing tax rates encourage rapid economic growth. The real message is that a fiscally neutral change in tax policy might provide a modest boost to savings assuming people consume less. The Reagan-Bush43 fiscal agenda seems to be to “give people their money back” so they can consume more. But even if the national savings rate is increased by a couple of percentage points, my Excel simulation model does not say that the growth rate rises by 10%. Rather, real income eventually increases by about 9% in a new steady state that occurs in a couple of centuries with the immediate boost to the growth rate being only 0.2%. Yet, Moore et al. continually misrepresent economic research by claiming a free lunch with a massive boost to the growth rate.

Mark Thoma noted:

Yes, let’s strive to emulate the economies of Estonia, Albania, and Russia – as the administration’s current economic policy seems to be doing …

Actually, the CIA sees the Russian economic scene thusly:

Economic growth slowed down in the second half of 2004 and the Russian government forecasts growth of only 4.5% to 6.2% for 2005. Oil, natural gas, metals, and timber account for more than 80% of exports, leaving the country vulnerable to swings in world prices. Russia’s manufacturing base is dilapidated and must be replaced or modernized if the country is to achieve broad-based economic growth. Other problems include a weak banking system, a poor business climate that discourages both domestic and foreign investors, corruption, and widespread lack of trust in institutions. In addition, a string of investigations launched against a major Russian oil company, culminating with the arrest of its CEO in the fall of 2003, have raised concerns by some observers that President Putin is granting more influence to forces within his government that desire to reassert state control over the economy.

With per capita income less than $10,000 and 25% of the population in poverty, why is the Club for Growth crowd arguing that Russia is a shining example of supply-side economics. It is true that real GDP growth was 5.1% in 2001, 4.7% in 2002, and 7.3% in 2003 but also note that real GDP grew by 6.3% in 1999 and 10% in 2000 before the reduction in income tax rates. And despite the strong growth since 1998, real per capita income may still be below its levels when the Soviet Union fell. If you are wondering why the Club for Growth blog discontinued comments, blame me for pointing out to Andrew Roth what Joseph Stiglitz wrote in his chapter “Who Lost Russia”. It seems Andrew considers it to be sneaky liberalism to point out something written by a Nobel Prize winning economist.

For sources on why Russia’s economy has seen such rapid growth since 1998, see the various reports from the World Bank. Their discussions note that Russia’s progress is attributable in part to restructurings that have undone some of the damage from the crony capitalism era and in part to rising petroleum prices, which is also discussed by Fiona Hill:

Looking carefully at Russia’s economic growth since 1997, there is a clear correlation between growth and the rise in world oil prices … In 1998, when world oil prices dipped to around $10 a barrel, this drop coincided with the worst of Russia’s economic crises and the collapse of the ruble. High oil prices and Russia’s oil production rebound after 1999 were good news for the Russian federal budget. Natural resources constitute around 80% of Russian exports and oil and gas account for 55% of all exports — making Russia’s budget particularly dependent on the energy sector. In fact, 37% of Russia’s budget revenues are provided by taxes on oil and gas. Recent research by the World Bank and the IMF has shown that each dollar increase in the price of a barrel of oil (Ural crude) raises Russia’s federal budget revenues by as much as 0.35% of GDP.

To his credit, Bruce Bartlett does not try to argue that the income tax change of 2001 increased economic growth and only notes an improvement in compliance as he points to an IMF analysis, which states:

there is no evidence of a strong supply side effect of the reform. Compliance, however, did improve quite substantially-by about one third according to our estimates-though it remains unclear whether this was due to the parametric reforms or to accompanying changes in enforcement.

Check out the report in its entirety to see what evidence there might be for a supply-side compliance effect – and while you do so, look at table 3 on page 16, which shows income tax revenues were 3.4% of GDP in 2003 (as compared to 2.4% in 2000) with total tax revenues being 36.6% of GDP (as compared to 36.9% in 2000). Imagine what a fiscally prudent liberal such as Alice Rivlin might do if total tax revenues (Federal, state, and local) were as high a percentage of U.S. GDP, that is, if we raised $4.4 trillion in taxes. We could easily fund public schools, better health care, and have better roads and still pay down government debt so as to protect our Social Security retirement. But Dr. Rivlin might also wonder if income tax revenues were a mere $0.4 trillion – how we would raise the other $4 trillion. Is Mr. Moore proposing we increase other forms of taxation that much?