TCS Daily

Size Matters

By Johnny Munkhammar - January 24, 2006 12:00 AM

German Finance Minister Peer Steinbrück is urging new EU member states to raise taxes, since their currently low rates have "nothing to do with fair tax competition", he says. This kind of grandstanding harkens all the way back to Medieval times, when the Vatican was supposed to set a "fair price" for everything.

The German economy has been developing poorly for a number of years. Some recent tax reforms and structural changes in the business sector have helped, but still the situation is bad. Growth is low and unemployment is at record levels. Germany is having trouble competing. The finance minister obviously knows this. And he also seems to realize that high German taxes are partly to blame. But his solution is not for Germany to cut taxes radically. Instead, he wants his competitors to become less competitive.

Germany is a powerful country, especially in the EU arena. Steinbrück obviously wants to use that power to force new EU members to get rid of one of the main reasons for their success. Instead of lifting Germany, he wants to drag others down. Would he be happier if all European countries had the growth and unemployment levels of Germany?

If this is the definition of "fair", then let's have "unfair" tax competition. The fact that Steinbrück, like France's Nicolas Sarkozy, mixes up this issue with the EU budget turns his argument from bad to worse. Their tactics amount to blackmail: if the new members don't raise taxes, they will get less or nothing from the EU budget.

But, as we well know, EU agriculture policy is shameful and destructive. And most evaluations show that EU structural funds fail to achieve their goals. So giving up low taxes to get more of those funds is a bad deal. A better one would be to have free tax competition and a totally reformed EU budget. Not to mention a situation in which countries like Germany would try to compete instead of sabotaging their competitors.

To a large extent, this is all a symptom of the debate on the so-called "European Social Model" shared by most countries in Western -- "old" -- Europe. We created a highly uncompetitive model -- the core of which is a big state -- and now find it very hard to pursue reforms that take us away from it.

Politicians have defended the Model for decades and many voters now believe them. Thus, even if they have changed their minds, they find it hard now to give the opposite message to the citizens. And so many citizens -- in my country Sweden a majority -- are dependent on the state that any reduction in benefits can be resisted.

This is a system from which it is very hard to escape. Many politicians today probably curse their predecessors who introduced it. But as the problems get worse and little reform is achieved, politicians try to gain more support instead of challenging the old lies by blaming the problems on everything else: India and China, of course, and not to mention the US, but also our European neighbors. They compete "unfairly".

An increasingly common diversion now used to escape from reality is to say that the size of the state doesn't matter - that what matters is what you do with the big state. This idea seems to be shared by politicians as different as New Labour's Gordon Brown and Republican George W. Bush, with his current big government conservatism. Of course it matters what the state is doing, but sheer size is an essential aspect which is today so often overlooked. Naturally, politicians of all stripes like to have a big state at their disposal.

The size of the state matters for several reasons, one of which is the fact that everything the state does is founded upon forced and not voluntary financing. Another reason is that everything the state does follows the will of a majority and is based on collective, not individual, decisions.

It's also why the so-called social model makes Western Europe less competitive: First, the size of the state determines what tax pressure you have. High taxes make a country less competitive. And if the state and its public monopolies constitute a large share of society, there will be less space for all the forces of competition that create wealth.

The size of the state has long been the subject of political debate. But it is forgotten. Now, both left and right seem to love big government. But there is ground for optimism. The past year was one of discussions about a social model, but in denial of its antisocial effects and the need for reform. Steinbrück signaled that leading German politicians want to continue down that path in the coming year. But even in the worst scenario -- if he would succeed -- Europe cannot escape competition. The rest of the world, with an increasing number of extremely successful countries with free economies, will never be bullied into creating the same problems as Western Europe has.

We will have to compete, whether our politicians want it or not. And competition brings out the best, not the worst. That is why successful countries, not least in Eastern and Central Europe, will show the way.

Johnny Munkhammar is Director of Timbro, a free-market institute in Sweden and author of European Dawn -- After the Social Model (Timbro/Stockholm Network).


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