The problem with "austerity" plans: Europe should cut spending AND cut tax rates

Rioters have been throwing Molotov cocktails and chunks of rock at police and setting buildings on fire in Greek cities to protest the latest round of "austerity measures" demanded by European lenders and agreed to by Greek leaders.

While we of course do not condone such violence (the perpetrators of which are most likely dead-set against capitalism and entrepreneurship as well as the rule of law which makes the beneficial effects of capitalism and entrepreneurship possible), we also believe that they are correct in their perception that the austerity measures will crush Greece and doom the Greek economy for decades.

It's not that "austerity" in the form of greatly reduced government spending is wrong -- in fact, as we have discussed many times previously such as in this post from 2010, Greece spends an unsustainable amount of money on pensions and medical benefits for retirees, who can retire with 80% of their "pensionable salary" plus medical benefits for the rest of their life, and who retire at an average age of 58. As Steve Forbes noted in an article we linked to in this post, it was not until 2010's debt problems that Greece finally decided to stop giving mandatory annual bonuses equivalent to an additional two months' pay to all government bureaucrats, but that even then the country did not eliminate a single public-sector civil servant job.

So a reduction of excessive spending (the general meaning conveyed by the word "austerity" in normal usage) is certainly necessary if Greece wants to be able to pay its debts in the future.

However, European "austerity" measures always include severe tax-rate increases at the same time, and the austerity measures being forced onto Greece are no different. Despite the fact that Greece already had much higher tax rates than its neighbors (a top income-tax rate of nearly 50%, compared to flat taxes of 10% in neighboring Bulgaria and Albania, as Steve Forbes pointed out in his article), the latest rounds of austerity demanded still more growth-killing taxation. This BBC article describing the tax-rate increases Greek leaders accepted at the end of last year lists the following:
  • An increase in the existing "value-added tax" (VAT), such that the existing 19% rate will increase to 23%.
  • An increase in the VAT assessed on all restaurants and bars, which were previously forced to charge 13% value-added tax, and will now have to charge 23%.
  • A "solidarity levy" of between 1% and 5% on all households, depending upon income, to be increased two more times during 2012 (as Daniel Heninger explains in an opinion piece in today's Wall Street Journal, Europe often calls wealth taxes "solidarity taxes," saying "France has the world's most famous wealth tax. They call it 'the solidarity tax,' which is the Gallic equivalent of the Obama 'fair share.'")
  • An increase in property tax rates.
  • A 33% increase in excise taxes imposed on fuel, cigarettes, and alcohol (this would be in addition to the VAT taxes which were already assessed on all the layers of production of those goods before they reached the end consumer).
  • A reduction or elimination of many existing tax exemptions.
  • "Luxury levies" on yachts, swimming pools, and cars.
  • And, in addition to all of the above, "special levies on profitable firms, high-value properties and people with high incomes."
If those calling for these increased tax rates really think they will actually increase the amount of taxes that the Greek government will collect, they are ignorant of economics. These new tax rates will only serve to further stifle economic growth in Greece and drive most of those who would try to start a business there into other countries instead. Amazingly, those are just the "austerity" measures Greece accepted at the end of 2011 -- they recently agreed to additional austerity.

Austerity measures that radically cut spending and radically cut tax rates would be much better for Greece and for any modern welfare state, including California and the rest of the US as well. Cutting tax rates is one of the most important ways to encourage innovation, entrepreneurship, and economic growth -- and encouraging those critical activities is the best way to create a healthy economy and a country that can pay the interest and principal on its borrowing. If you want to enable an individual borrower to pay back his debts in the future, you don't tell him to cut down on his spending while simultaneously making it impossible for him to get a job.

We have written about the importance of pro-growth policies in solving government debt problems many times in the past, such as in this important previous post. We can only conclude that European leaders may not be reading this blog. If you know any of them, you should perhaps consider sending them a link to today's post. It might not be a bad idea to send it to a few US leaders as well.