David R. Henderson

David R. Henderson

3/02/2009 @ 12:20PM

Will Obama And Gordon Brown Cook Up A Tax Cartel?

When President Obama and British Prime Minister Gordon Brown meet tomorrow, one of the main items on the agenda will surely be the economy and economic policy. I’m skeptical about pundits who predict what two government leaders will talk about, and I make no claims about my predictive ability. But there are policies I wish they would talk about and–if they are really Keynesians–that they should talk about, such as reducing the minimum wage. I would also like them to talk about why Britain faces a less dismal fiscal future than the United States because of some reforms that Margaret Thatcher initiated. Unfortunately, there are also policies that I fear they will talk about, such as forming a tax cartel.

Why should Obama and Brown, as good Keynesians, talk about abolishing or reducing the minimum wage? It goes back to the economic model that John Maynard Keynes presented in The General Theory of Employment, Interest and Money. Because Keynes’ best-known work is so unclear, there is a small cottage industry in economics that looks at what Keynes really meant. Although we still don’t know for sure, we do know what modern Keynesians mean. Most of them believe that wages are inflexible and that this causes problems. When “aggregate demand”–that is, the demand for goods and services–falls, the demand for labor falls but wages don’t. The result: higher unemployment. Modern Keynesians have agreed that if wages could fall quickly, there would not be a need for tax cuts or increases in government spending to raise aggregate demand: The lower wages would price workers into jobs. These Keynesians despair, though, about whether wages will fall quickly.

But there is one area where the government could get out of the way and let wages fall: the minimum wage. In the United States, the federal minimum wage is now $6.55 an hour and will rise to $7.25 in July. In Britain, the minimum wage ranges from (at current exchange rates), $5 an hour for those under age 18 to $8.11 an hour for those aged 22 or higher. For workers between age 18 and 21, there is a “development rate” of $6.75 an hour.

As economists have long known, and as Keynesian economist Paul Samuelson and the late Keynesian James Tobin have pointed out, the minimum wage destroys jobs for unskilled workers. Economists’ consensus estimate is that a 20% increase in the minimum wage destroys 2% to 4% of youths’ jobs. These job-destroying effects have been more severe for black youths. As Samuelson wrote in his 1970 textbook, Economics, about a proposal to raise the minimum to $2: “What good does it do a black youth to know that an employer must pay him $2 an hour if the fact that he must be paid that amount is what keeps him from getting a job?”

Moreover, notice the term “development” in the British minimum wage law. It’s both an explicit recognition that workers need time to develop their skills and an implicit recognition that setting the wage too high will price out vulnerable unskilled workers. What about workers who “develop” more slowly? The British government’s answer: tough.

Last month, President Obama said he would listen to alternate plans for creating jobs. Here’s one: Reduce the U.S. minimum wage by 25%. This would create jobs for 400,000 to 800,000 youths. And the cost to the government would be zero.

I also wish they would talk about how to reduce the growth of spending on government Ponzi schemes, more commonly known in the United States as Social Security. President Obama could learn a lot from British reforms that Prime Minister Margaret Thatcher made in the 1980s. Before then, the Basic State Pension (BSP) was indexed to wages. Over long time periods, real wages rise, which means that wages rise faster than prices. Mrs. Thatcher indexed the BSP to prices, thus reducing the rate of growth of expenditures in this government program. President Obama would achieve a lot by indexing Social Security benefits to prices instead of to wages.

My guess, though, is that Gordon Brown sees that President Obama has destroyed, in a little over five weeks, the economic legacy that President Reagan in the early 1980s and President Clinton with the Republican Congress of the mid-1990s worked so hard to achieve. Reagan reduced taxes as a percent of GDP, and Clinton and Congress reduced government spending as a percent of GDP. President Obama admits, in his own budget, that government spending will grow from its current level of 21% of GDP in fiscal year 2008. It is projected to be 27.7% in FY 2009 and 24.1% in FY 2010. Gordon Brown may be seeking political cover for the same “turnaround” in Britain.

And while they’re at it, they might discuss a global tax cartel. Various European governments want to “harmonize taxation,” their euphemism for agreeing to keep tax rates high so that high-income workers and investors have less incentive to seek out countries with low tax rates. This high-tax strategy is hampered by small countries, often former British colonies, that have the gall to keep tax rates low. In the past few years, the OECD has pushed vigorously to blacklist such countries, with the idea of imposing sanctions on them. In their book, Global Tax Competition, Cato Institute economists Chris Edwards and Daniel J. Mitchell write that Gordon Brown “has a long track record of undermining the interests of the U.K. territories that are on the OECD blacklist.”

Edwards and Mitchell also point out that in 2000, when Lawrence Summers was President Clinton’s Treasury secretary, he claimed that tax competition among governments was “the dark side to international capital mobility.” Fortunately, with the Clinton administration on its way out, Summers put little effort into supporting the OECD’s anti-tax-competition agenda. But now Summers is President Obama’s main economic adviser. In case you think Summers has forgotten his agenda, he hasn’t. In a paper published in January, Summers and co-author James Hines recognized that the increasingly global economy makes people and capital more mobile and, therefore, will make government hesitant to increase corporate and individual tax rates. But they identified a way to avoid this problem: reduce tax competition between countries. They wrote:

“International agreements have the potential to play significant roles in these strategies. It is already the case that governments cooperate in international settings such as the World Trade Organization to promote international trade and investment, and bilateral and multilateral tax agreements and initiatives serve the function of facilitating tax enforcement and avoidance of double taxation of international income. Doubtless governments will come to rely more heavily on international agreements in the years to come, but it remains to be seen whether they will accelerate or offset the recent trend in the direction of expenditure taxation.”

It does remain to be seen. Will the meeting on Tuesday be the opening round in a discussion of a tax cartel? If it is, will we find out?


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