TCS Daily

Supply-Side Swiss

By Joshua Livestro - January 27, 2004 12:00 AM

In a recent contribution to National Review Online, Jerry Bowyer attacked the Bush tax cuts package for not doing enough to lower the tax burden of the rich. If the reality of the tax cuts had lived up to the rhetoric of its opponents, Bowyer explains, the economic recovery would have taken off much quicker and much more strongly than it did: "It wasn't until May of last year, when 'the rich' were dealt into the game, that the weak recovery strengthened."

Articles like that are bound to get on the nerves of those who share the sentiments of the 1970s British Labour Party Chancellor Denis Healy, who famously claimed that the purpose of any income tax system should be to "squeeze the rich till the pips squeak." But if this is enough to get them worked up, what would they make of the recently implemented reform of personal income tax in the Swiss canton of Schaffhausen? Because towards the end of last year, the local Parliament there decided to introduce a new income tax that has as its cornerstone the principle of regression. In other words: the more money you make, the less tax you pay. As of the first of January 2004, in the canton of Schaffhausen, it actually pays to get rich.

Instead of flying into a Howard Dean-like rage, though, tax addicts would do well to consider the merits of the Schaffhausen measures before rejecting them in a knee-jerk fashion. No sane person, after all, could oppose a system of taxation that is morally sound and economically efficient -- which is precisely what these measures are all about. The morality of it is easy enough to explain. It is after all fairly widely accepted that working hard and saving for a rainy day both constitute morally good behavior. Any tax system that claims to have its basis in morality would therefore have to encourage precisely those activities. Whatever else they might like to say about it, the taxaholics would have to admit that the Schaffhausen income tax does exactly that -- and does it in spades. Who wouldn't want to go out and work, work, work, if every extra Swiss Franc earned will be taxed less than the previous one?

The economic case for a regressive system of income tax is linked to the moral case for it. It is a case first made by the American economist Arthur Laffer. Laffer shot to fame in the early 1980s, when, as a member of President Reagan's Economic Policy Advisory Board, his Laffer Curve theory (developed in the early 1970s) provided the public justification of the Reagan tax cuts. The basis of his theory was that a high tax rate might in fact lead to lower government revenues than a lower tax rate because of a flight of capital and labor into the black economy. Whereas punitive rates of taxation encourage tax evasion, substantially lower rates could actually have the opposite effect of tempting people back into the official economy. Ironically (or as libertarians might say, perversely) lower rates could thus lead to an increase in government revenues. According to Laffer's theory, a sufficiently large tax cut would almost certainly be self-financing.

Laffer was proved right in spectacular fashion in the 1980s when Reagan's radical tax-cutting measures led to one of the longest sustained economic booms in American history, with rising private and corporate incomes also leading to higher tax receipts. That didn't stop left-wing academics from castigating Laffer's ideas, claiming they were anything from ridiculous to immoral. The mere fact that they were actually right didn't seem to bother them much. But as Bruce Bartlett observed in a recent column on, academia has gradually come round to Laffer's position, in turn convincing policy makers in institutions like the IMF and the World Bank that supply-side tax policies might hold the key to the economic development of the world's poorest nations.

And what works in Pakistan or Southern Africa will certainly work in Schaffhausen. The local administrators in Schaffhausen are not just optimistic about this, they're banking on it. Unafraid to count their chickens before they are hatched, they are confidently predicting that the new income tax will lead to new streams of revenue for the canton. They have even gone so far as to express the hope that high earners would be tempted to relocate to Schaffhausen. So if you're traveling through Switzerland this summer, don't be surprised if you come across a road sign saying "You are entering Schaffhausen. Millionaires welcome here."


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