Henry George

FATCA closes Americans’ Foreign Bank Accounts

Fred Foldvary Economics , , , ,

by Fred Foldvary

When the USA adopted the 16th Amendment to the Constitution a century ago, did the people understand that this would deprive Americans world-wide of foreign banking services? Americans thought that the income tax would just grab the money from the rich, but they did not understand that the income tax would tax everybody else more. All that is needed to equalize wealth without damage to the economy is to stop government subsidies, but this requires an economic sophistication that so far has eluded most people.

Inherently, an income tax yields an incentive to cheat, as the government depends on reporting. So the Internal Revenue Service has to monitor financial accounts to prevent tax evasion. Gradually, the IRS has extended its reach into accounts, first within the USA, and now into the foreign accounts held by American citizens.

No other country has imposed such costs and mandates on foreign accounts as the USA. So ironically the “land of the free” has the least economic freedom for its citizens abroad. The Foreign Account Tax Compliance Act (FATCA), enacted in 2010 requires foreign financial institutions to make reports on American accounts. Foreign financial institutions with American customers are required obtain a Global Intermediary Identification Number. FATCA requires foreign financial firms to identify their U.S. account holders, to disclose the account holders’ names, social security or other tax IDs, addresses, and the accounts’ balances, receipts, and withdrawals. For some accounts, the foreign bank is required to withhold some of the interest paid to the account, and send it straight to the IRS. This US law overrides the privacy laws of the foreign countries.

US law is thus legislating not only within US territory but throughout the whole world. If a financial firm does not comply, the IRS will tax 30 percent of its US-sourced income. The IRS is also busy laying out the legal infrastructure for enforcing this law with agreements with foreign governments for data sharing. Governments world-wide are signing on, because they too face the problem of tax evasion when they tax income that can hide.

FATCA does not just affect fat cats. Many foreign banks are now refusing to provide Americans with bank accounts and are closing the accounts of Americans, who are now also unable to obtain mortgages and insurance abroad. Americans are increasingly giving up their US citizenship in order to be able to work or retire abroad.

The US economy depends on international trade and global finance, with many Americans working abroad for US and foreign firms. Six million Americans live outside the territory of the USA. If Americans can no longer have foreign bank accounts, because the costs to the banks are too high, they will be so hampered that fewer Americans will be willing to live abroad, and this will hurt American enterprise.

Since the US government cannot directly impose laws on foreign lands, many foreign firms will sell their US affiliates and stop holding assets within the USA, thus putting themselves beyond the control of the US government. The overall cost to the US economy of FATCA may be much greater than the increase in tax revenue from reduced tax evasion. Also, those who seek to evade income taxes will find other ways. High taxes induce tax evasion, and enforcement drives evasion into other channels. How successful are US drug laws in stopping the smuggling in of drugs, and how successful have US immigration restrictions been at preventing illegal immigration?

Another consequence of greater reporting of American accounts is the increased risk of identity theft and theft of money from accounts. The greater the reporting, the greater the revelation of data that can be stolen.

It is no use seeking to repeal FATCA. The regulation of accounts, no matter how costly, follows from the income tax being, as Henry George put it, a tax on honesty. The taxation of wealth that can hide and flee requires strict and costly reporting and enforcement. The only effective remedy is to tax something that will not flee, hide, or shrink when taxed. A tax on land value cannot be evaded, and if that were the only tax, there would be no need to impose costs on finances.

Inequality Unexplained

Fred Foldvary Economics, Liberty , , , , , ,

There is a new economics documentary film that stars Robert Reich, former Secretary of Labor under President Clinton and now a professor at the Goldman School of Public Policy at the University of California at Berkeley. The film, Inequality for All,  directed by Jacob Kornbluth, won a U.S. Documentary Special Jury Award and has been shown nation-wide.

Unfortunately, Robert Reich has not explained why the US has had an increasing inequality of income. Neither in the film nor in his writings and interviews does he examine the cause. Without the elimination of the cause, there can be no remedy. As usual in documentaries of social problems, most of the film just describes and tells stories about the inequality.

Inequality for All is typical of welfare-state presentations in jumping to governmental responses that only treat the symptoms and effects. Reich advocates a higher minimum wage without any analysis what determines wages in a market economy.

Most basically, in a free market, ordinary workers are paid what economists call the “marginal product,” or what an extra worker contributes to output. If a worker adds $10 each hour to total output, then that is what he is paid, and that is what he is worth to the company. If the company pays him any less, say $8, that provides an opportunity for a similar company to offer $9 and get the $10 worth of output, so competition will drive the wage up to the worker’s contribution, his marginal product.

A minimum wage forces the firm to pay more than the worker’s marginal product. The firm will not hire a worker who costs more than he is worth. The reason that workers are not all dismissed is the law of diminishing returns. In a farm or factory, if there are only a few workers, each worker’s marginal product is high, because there is a lot of land and machines, and few workers. As workers are added, each extra worker contributes less extra output. Workers are hired up to the quantity for which the wage equals the marginal product.

The minimum wage acts like a tax on labor that forces the firm to reduce the number of workers employed to that level where the higher marginal product equals the required wage. In some cases, the firm will also respond by reducing benefits such as medical insurance such as by hiring part-time instead of full-time labor.

Many firms in competitive industries respond to the higher minimum wage as they would to a higher tax. They pass on some of the costs to the customers. The higher price reduces sales, production, employment, and income.

The minimum wage is lethal to the economy as it acts as an extra tax on employment on top of payroll taxes, unemployment taxes, workers insurance taxes, and the income tax on the profits of the firm. All these taxes reduce employment and reduce the take-home pay of the worker.

Henry George stated in his 1883 book Social Problems that “There is in nature no reason for poverty.” Poverty is caused not by any lack of natural resources but by human institutions that deprive workers of the ability to buy what they produce. The institution with the power to impose this intervention is government. The totality of restrictions, mandates, taxes, and subsidies reduces enterprise and takes away much of the product of labor. Then impoverished workers need the welfare state to provide the necessities of life.

The ideology of welfare statists makes them only think of governmental aid and reject the idea that governmental intervention is the source of the problem. They sneer at “free market fundamentalism.” They don’t understand the fact that taxes on labor redistribute wealth from workers to landowners as government taxes wages to pay for public goods that generate higher rent and land value. They don’t understand that the worker-tenant pays twice for the public goods of government, once by having half his wage taxed away, and a second time in the higher housing rental he pays because greater governmental services increase locational rents.

The effective remedy for poverty is to remove all punitive taxes and land-value subsidies. We can remove subsidies to the landed interests by having them pay back the rent generated by useful public goods such as roads, schools, and security. Without taxes on labor and enterprise, the cost of labor is lower to employers, while the worker’s take-home pay is higher. The replacement of wage taxes with land value taxes would reduce economic inequality while also increasing the productivity of the economy.

Of course the elimination of poverty also has to include better education, and that can be accomplished with vouchers, payments not to schools but to parents. A voucher is a ticket that a parent could use to send his children to the best schools. It provides an incentive for educators to produce better schools. It is not a panacea, because the home and neighborhood environment are also important, but it would shift the incentives towards better schooling.

It is not only unfortunate but astonishing that a leading professor of public policy who cares about the poor would not make the prosperity tax shift, replacing wage taxes with land value taxes, the core of his policy proposal. I suspect his response would be that while this is a good idea, it is politically unfeasible, while raising the minimum wage has political support. But the reason it is politically unfeasible today is precisely that leading reformers such as Robert Reich refuse to bring the effective remedy to public attention in the ultimately futile effort to advocate policies with the least current political resistance.

Much of the gains from economic growth and welfare get captured by higher rent and land value. Raising the minimum wage is futile because if all workers get a substantially higher minimum wage, their landlords will be able to raise their housing rentals by the amount of their greater ability to pay, and the landed interests will end up with the gains. Why do you think that housing costs have been escalating while wages stagnate?

Economic Rationality

Fred Foldvary Economics, Liberty , , , , , , ,

[Cross-posted at the Foldvarium]

The concept of rational action is a frontier of economic theory. The new field of behavioral economics combines economics and psychology to analyze actions that seem to be irrational. For example, people value health and long life, yet they smoke and eat unhealthy food. A related field, behavioral finance, examines psychological and emotional traits that prevent people from making wise investments. Perverse psychological biases include anchoring to past prices and facts, the bias of weighing recent events too highly relative to the more distant past, being overly confident in one’s abilities, and following the herd to a cliff.

Neoclassical economics often assumes that people are purely self-interested and always seek financial gain, and that therefore altruism is irrational, whereas as Adam Smith and Henry George wrote, human beings have two motivations: self interest and sympathy for others. Since people get satisfaction from serving others, it is incorrect to label altruism or actions based on subjective views of justice as “irrational.”

The Austrian school of economic thought has a different perspective on rationality. The Austrian economist Ludwig von Mises envisioned human action as inherently rational. A person has unlimited desires and scarce resources. Human beings economize, seeking maximum benefits for a given cost, or minimizing costs for a given benefit. At any moment in time, a person ranks his goals, ranging from most to least important. He chooses the resources to achieve the most important goal at some moment, then the second most, and so on, until his gains from trade have become exhausted. This is the inherent rationality of human action. Continue reading →

How to Extirpate Poverty

Fred Foldvary Economics, Liberty , ,

To “extirpate” means to complete eliminate, from the Latin word meaning to pull out by stem and root. To extirpate poverty means to eliminate its cause, so that it does not come back. Fundamentally, poverty comes from a low wage level, so we need to examine what makes a wage level low.

The wage level of an economy can be thought of as the wages paid to unskilled people. Those with greater skill and talent get higher wages, so some think that the solution to poverty is better education. But a stagnant economy also depresses the return to human capital, the extra wage for those who are more productive. In a thriving productive economy, even those with few skills are better off than skilled labor in a depressed economy. Indeed, in an unproductive economy, those with skills often find little market for their human capital.

The wage level of an economy is set by marginal labor, those who work at the least productive land in use. The classical “law of wages” says that when workers are mobile, the wage at the margin of production will set the wage level for the rest of the economy.

The margin of production has several edges. There is the horizontal extensive margin of land that is just barely worth using, land so unproductive it fetches no rent. There is the vertical extensive margin of the space above a city, into which taller buildings can rise, without increasing the site rent. There is also the intensive margin of adding more workers to land already being used. The wage at the intensive margin will equalize to that of the extensive margin. Workers are paid what they add to production, which is called their marginal product. Continue reading →

Government and Governance

Fred Foldvary Law, Politics , , , , , , , , , , ,

Policy debates typically center around the role of markets versus the role of governments. But this is a misleading distinction. Human society always has governance. Private organizations such as corporations and clubs have management, rules, and financial administration similar in function to those of government. The difference is that private governance is voluntary, while state-based government is coercively imposed on the people within some jurisdiction. So a central question is not whether the market or the government can best accomplish some task, but whether the governance shall be voluntary or coercive.

The Market-Failure Doctrine

Most economists would agree that we don’t live in the best of all possible worlds. But the doctrine of market failure found in most economics textbooks fails to distinguish between consensual and coercive governance as correctives. The prevailing theory asserts that while markets might provide private goods efficiently in a competitive economy, markets fail to provide the collective goods that people want. There are two basic reasons offered as to why markets are not sufficient. Markets can easily determine the demand for private goods, but how can we tell how much each individual wants of a collective good? We could ask people how much they are willing to pay, but how do we get a truthful answer? Free riders also are a problem. Once the collective good is provided, folks can use it whether they pay or not, so why pay?

So, the market-failure story goes, markets fail to deliver collective goods. Entrepreneurs lack incentive because they can’t get their customers to pay for the service the way they can get people to pay for individually consumed private goods. Continue reading →

Credit Booms Gone Wrong

Fred Foldvary Economics, History , , , , , , , ,

Recent research by economists Moritz Schularick and Alan M. Taylor have confirmed the theory that economic booms are fueled by an excessive growth of credit. They have written a paper titled “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870–2008“, published by the National Bureau of Economic Research.

A major cause of the Great Depression was a credit boom, as analyzed by Barry Eichengreen and Kris Mitchener in their paper, “The Great Depression as a credit boom gone wrong” (BIS Working Paper No. 137). Eichengreen and Mitchener cite Henry George’s Progress and Poverty as providing an early theory of booms and busts based on land speculation. They also credit the Austrian school of economic thought, which in the works of Friedrich Hayek and Ludwig von Mises, had developed a theory of the business cycle in which credit booms play a central role. Henry George’s theory of the business cycle is complementary to the Austrian theory, as George identified the rise in land values as the key role in causing depressions.

An expansion of money and credit reduces interest rates and induces a greater production and purchase of long-duration capital goods and land. The most important investment and speculation affected is real estate. Much of investment consists of buildings and the durable goods that go into buildings as well as the infrastructure that services real estate. Much of the gains from an economic expansion go to higher land rent and land value, so speculators jump in to profit from leveraged speculation. This creates an unsustainable rise in land value that makes real estate too expensive for actual uses, so as interest rates and real estate costs rise, investment slows down and then declines. The subsequent fall in land values and investment reduces total output, generates unemployment, and then crashes the financial system.

We can ask whether this theory is consistent with historical evidence. One strand of evidence is the history of the real estate cycle, which has been investigated by the works of Homer Hoyt, Fred Harrison, and my own writings. Another strand is the history of credit booms, as shown by Schularick and Taylor, who assembled a large data set on money and credit for 12 developed economies 1870 to 2008. They show how credit expansions have been related to money expansions, and how financial innovations have greatly increased credit. Because economic booms are fueled by credit expansion, Schularick and Taylor note that credit booms can be used to forecast the coming downturn.

Followers of Henry George have focused on the real estate aspect of the boom and bust, while the Austrian school has focused on credit, interest rates, and capital goods. A complete explanation requires a synthesis of the theories of both schools, but these recent works on credit booms have not recognized the geo-Austrian synthesis. In order to eliminate the boom-bust cycle, both the real side (real estate) and the financial side (money and credit) need to be confronted.

Current Austrian-school economists such as Larry White and George Selgin have investigated the theory and history of free banking, the truly free-market policy of abolishing the central bank as well as restrictions on banking such as limiting branches and controlling interest rates. In pure free banking, there would be a base of real money such as gold or a fixed amount of government currency. Banks would issue their own private notes convertible into base money at a fixed rate. The convertibility and the competitive banking structure would provide a flexible supply of money along with price stability. The banks would associate to provide one another with loans when a bank faces a temporary need for more base money, or a lender of last resort.

Both the members of the Austrian school and the economists who have studied credit booms have not understood the need to prevent the land-value bubble by taxing most of the value of land. That would stop land speculation and eliminate the demand for credit by land buyers.

But the credit-bubble theorists have not understood that financial regulation and rules for central banks cannot solve the financial side of credit bubbles. Credit booms always go wrong. As the Austrians have pointed out, there is no scientific way to know the correct amount of money or the optimal rates of interest. Only the market can discover the rate of interest that balances savings and borrowing, and only the market can balance money supply with money demand.

Thus the remedy for the boom-bust cycle is both land value taxation and free banking. Land speculation would not be as bad without a credit boom, but will still take place as land values capture economic gains and land speculators suck credit away from productive uses. But also, a credit boom with land-value taxation will still result in excessive construction and the waste of resources in fixed capital goods, reducing the circulating capital need to generate output and employment, as Mason Gaffney has written about.

Economic bliss requires both the public collection of rent and a free market in money.

[Editor’s note: this essay first appeared on Dr. Foldvary’s blog, the Foldvarium, on April 4 2010]

North Dakota or Bust!

Brandon Christensen Current Events, Economics, Links , , ,

An excerpt from co-editor Fred Foldvary’s Progress Report:

In theory, productive public goods increase land rent because the supply of land is fixed. There can also be a rise in wages from more public goods, but that would be temporary. If labor becomes more productive in a location, that attracts labor from areas where wages are lower for the same skills. The increase in the labor supply will drive wages back down to normal. But the total supply of land in some region cannot expand, so the increase in rent sticks.

Just as territorial benefits raise land values, costs to landowners reduce the rent they keep, and so capitalize land value down. If the public goods are paid for by public revenue from land rent or site values, then the rise in land values would be limited. If governmental public goods are paid by labor and enterprise, then the rentalization and capitalization are implicit subsidies to landowners, at the expense of taxed labor and enterprise.

Economists have found evidence of the generation of higher land values from greater public goods. We now have an excellent case study: North Dakota.

Read the whole thing here. I’ve never been to North Dakota, but if it’s anything like South Dakota I might be tempted to settle there someday. Just kidding! California is the best state to live in, even with our terrible, fascistic-like government.

I am still having trouble wrapping my head around the concept of land value taxing, though. Someday I’m going to have to spend a couple of days with a copy of Henry George’s Progress and Poverty and see what I can figure out.