David Cameron's Foolish (or Cynical) Naivete about the Laffer Curve

Even though he's allowing the budget to grow twice as fast as inflation, some people seem to think the new U.K. Prime Minster is a fiscal conservative. I'm skeptical. Not only is spending rising much too fast (there are promises of more restraint in the future, but I'll believe it when it happens), but Cameron and the Tory/Liberal coalition government are increasing the value-added tax and increasing the capital gains tax. Perhaps worst of all, they are leaving in place the new 50 percent tax rate that former Labor Prime Minister Gordon Brown imposed in hopes that class-warfare policy would help him get elected. But as this Daily Telegraph story suggests, it is quite likely that the higher tax rate will lose revenue as productive people escape to Switzerland and other jurisdictions not influenced by the politics of hate and envy.

One-in-four hedge fund employees has already left London to move to Switzerland, which is said to have a more stable tax regime, according to consultancy Kinetic partners. Calculations by the company claim the UK could have already forgone about £500m in tax revenues, based on the 1,000 or so hedge fund managers it says have already left the country. ...High-profile departures this year include Alan Howard, founder of Brevan Howard, and Mike Platt, founder of BlueCrest Capital.

This story shows both the power of the Laffer Curve and the importance of tax competition. The greedy politicians in England doubtlessly resent the "brain drain" to Switzerland. Like their U.S. counterparts, politicians view taxpayers as serfs who are supposed to blindly produce more income for the ruling class to expropriate and redistribute.

While I'm obviously not a big fan of British fiscal policy, America is worse in one important way. At least British taxpayers have the liberty to leave without being raped by the U.K. tax authority. Once they leave the United Kingdom and make their home in Switzerland, they are no longer British taxpayers. Americans who want to move, by contrast, are unable to escape the punitive internal revenue code. Indeed, the United States is one of the few nations in the world to have exit taxes, an odious approach generally associated with loathsome regimes such as the Soviet Union and Nazi Germany.

Americans Voting with their Feet to Escape Obama Tax Oppression

The Financial Times reports that the number of Americans giving up their citizenship to protect their families from America's onerous worldwide tax system has jumped rapidly. Even relatively high-tax nations such as the United Kingdom are attractive compared to the class-warfare system that Obama is creating in the United States. I run into people like this quite often as part of my travels. They are intensely patriotic to America as a nation, but they have lots of scorn for the federal government. Statists are perfectly willing to forgive terrorists like William Ayres, but they heap scorn on these "Benedict Arnold" taxpayers. But the tax exiles get the last laugh since the bureaucrats and politicians now get zero percent of their foreign-source income. You would think that, sooner or later, the left would realize they can get more tax revenue with reasonable tax rates. But that assumes that collectivists are motivated by revenue maximization rather than spite and envy.

The number of wealthy Americans living in the UK who are renouncing their US citizenship is rising rapidly as more expatriates seek to escape paying tax to the US on their worldwide income and gains and shed their "non-dom" status, accountants say. As many as 743 American expatriates made the irreversible decision to discard their passports last year, according to the US government – three times as many as in 2008. ...There is a waiting list at the embassy in London for people looking to give up citizenship, with the earliest appointments in February, lawyers and accountants say. ...“The big disadvantage with American citizens is they catch you on tax wherever you are in the world. If you are taxed only in the UK, you have the opportunity of keeping your money offshore tax free.”

To grasp the extent of this problem, here are blurbs from two other recent stories. Time magazine discusses the unfriendly rules that make life a hassle for overseas Americans.

For U.S. citizens, cutting ties with their native land is a drastic and irrevocable step. But as Overseas American Week, a lobbying effort by expatriate-advocacy groups, convenes in Washington this week, it's one that an increasing number of American expats are willing to take. According to government records, 502 expatriates renounced U.S. citizenship or permanent residency in the fourth quarter of 2009 — more than double the number of expatriations in all of 2008. And these figures don't include the hundreds — some experts say thousands — of applications languishing in various U.S. consulates and embassies around the world, waiting to be processed. While a small number of Americans hand in their passports each year for political reasons, the new surge in permanent expatriations is mainly because of taxes. ...expatriate organizations say the recent increase reflects a growing dissatisfaction with the way the U.S. government treats its expats and their money: the U.S. is the only industrialized nation that taxes its overseas citizens, subjecting them to taxation in both their country of citizenship and country of residence. ...Additionally, the U.S. government has implemented tougher rules requiring expatriates to report any foreign bank accounts exceeding $10,000, with stiff financial penalties for noncompliance. "This system is widely perceived as overly complex with multiple opportunities for accidental mistakes, and life-altering penalties for inadvertent failures," Hodgen says. These stringent measures were put into place to prevent Americans from stashing undeclared assets in offshore banks, but they also make life
increasingly difficult for millions of law-abiding expatriates. "The U.S. government creates conflict and abuses me," says business owner John. "I feel under duress to understand and comply with laws that have nothing to do with me and are constantly changing — almost never in my favor." ...Many U.S. expats report being turned away by banks and other institutions in their countries of residence only because they are American, according to American Citizens Abroad (ACA), a Geneva-based worldwide advocacy group for expatriate U.S. citizens. "We have become toxic citizens," says ACA founder Andy Sundberg. Paradoxically, by relinquishing their U.S. citizenship, expats can not only escape the financial burden of double taxation, but also strengthen the U.S. economy, he says, adding, "It will become much easier for these people to get a job abroad, and to set up, own and operate private companies that can promote American exports."

The New York Times, meanwhile, delves into the misguided policies that are driving Americans to renounce their citizenship.

Amid mounting frustration over taxation and banking problems, small but growing numbers of overseas Americans are taking the weighty step of renouncing their citizenship. ...frustrations over tax and banking questions, not political considerations, appear to be the main drivers of the surge. Expat advocates say that as it becomes more difficult for Americans to live and work abroad, it will become harder for American companies to compete. American expats have long complained that the United States is the only industrialized country to tax citizens on income earned abroad, even when they are taxed in their country of residence, though they are allowed to exclude their first $91,400 in foreign-earned income. One Swiss-based business executive, who spoke on the condition of anonymity because of sensitive family issues, said she weighed the decision for 10 years. She had lived abroad for years but had pleasant memories of service in the U.S. Marine Corps. Yet the notion of double taxation — and of future tax obligations for her children, who will receive few U.S. services — finally pushed her to renounce, she said. ...Stringent new banking regulations — aimed both at curbing tax evasion and, under the Patriot Act, preventing money from flowing to terrorist groups — have inadvertently made it harder for some expats to keep bank accounts in the United States and in some cases abroad. Some U.S.-based banks have closed expats’ accounts because of difficulty in certifying that the holders still maintain U.S. addresses, as required by a Patriot Act provision.

Say Goodbye to England

Okay, the title of this post is an absurd exaggeration, but I am not optimistic about the future of the United Kingdom. Government spending has exploded over the last ten-plus years (the largest expansion in the burden of government spending among developed nations), and this unsurprisingly has led to punitive class-warfare policies. I saved this article from the Daily Mail from a couple of months ago because I was curious to see whether predictions about talent fleeing London would prove accurate:

London will become the most highly taxed financial centre in the world when the new 50 per cent income tax rate for those earning £150,000 or more comes into force next month. Taxes will be higher than for financial workers living in the other key centres of New York, Paris, Frankfurt, Geneva, Zurich, Dubai and Hong Kong, KPMG calculated. The findings will raise fears that Labour's levies are driving businesses and bankers overseas and threatening Britain's competitiveness. ...Tullett announced last December that it will help employees move abroad if they want to avoid the top rate of tax, and Mr Smith said workers are already looking at relocating. Graeme Leach of the Institute of Directors said: 'The 50 per cent rate is a policy that should never have been announced. The indirect impact on entrepreneurial aspiration, business confidence and foreign investment is likely to be significant.

As we can see from this Bloomberg article, it appears that the feckless big-government policies of all the major parties are driving productive investors and entrepreneurs to jurisdictions with better tax law. Switzerland seems to be the biggest beneficiary. As you read the details below, one thing to keep in mind is that at least Brits are free to emigrate. The U.S. government imposes repugnant Soviet-style exit taxes designed to ransack successful people who want the freedom to move someplace with more liberty:

...more than 100 bankers, hedge fund managers and wealthy retirees are gathered on a cold March night to plot their escape from Britain. Swiss government officials and Geneva-based financial advisers have come to London to lure rich residents with glowing descriptions of the country’s low taxes, safe streets, private-banking options and convenient ski weekends. ...Next door, an overflow crowd of 50 more attendees enjoys wine and canapes as they watch the presentation on closed- circuit televisions in a mahogany-lined library, which includes a chart showing the prevalence of English as a language for doing business in Switzerland. A JPMorgan Chase & Co. banker who declined to be identified confides he’s planning to relocate next year. His main complaint: higher U.K. taxes, a theme the Swiss delegation has pounced upon. “Some people think it’s morally wrong to be working for the government for more than half the year,” says Jonathan Ivinson, a Geneva-based tax partner at international law firm Hogan & Hartson LLP... London’s highest earners must now pay a 50 percent tax on incomes above 150,000 pounds ($227,200) that came into force on April 6, replacing a 40 percent top rate. ...During the campaign, both Brown and Cameron said they backed additional curbs on the U.K. financial industry -- including a bank transaction levy -- and agreed that Britain’s dire financial state would lock in higher tax rates for the foreseeable future: ...As the taxman’s take grows larger, Switzerland is shaping up as the most-welcoming alternative for British exiles. Light- touch regulation and the willingness of cantons, as regional governments are called, to negotiate special tax rates for both individuals and businesses have prompted at least 30 London hedge fund managers to consider moving to Geneva in the past year, says Shelby du Pasquier, a Geneva-based partner at Lenz & Staehelin, a Swiss law firm. Investment management and advisory services aren’t regulated in Switzerland, apart from anti-money laundering rules, and the federal government and several cantons last year reduced taxes on dividend payments for entrepreneurs, including owners of hedge fund firms, he says. ...Geneva has already attracted some of London’s top talent. Alan Howard, co-founder of Brevan Howard Asset Management LLP, Europe’s largest hedge fund firm, has rented office space in Geneva for 60 traders relocating from London. ...BlueCrest Capital Management Ltd., Europe’s third-largest hedge fund firm, has opened a Geneva office for as many as 70 traders and analysts who have worked in London on its two biggest funds. They’re being joined by BlueCrest co-founder Michael Platt and Leda Braga, manager of the $9 billion BlueTrend fund, according to people familiar with the firm’s transitional plans. ...The departures of those principals prove that the threat to London’s prominence as a financial center is real, says Stuart Fraser, head of policy at the City of London Corporation, which runs the financial district. ...U.K. top tax rates will exceed those in Germany and France for the first time since 1989, according to a study by accounting firm KPMG. A banker earning 1 million pounds a year in London will now take home less than his counterparts in Frankfurt, Hong Kong, New York, Paris, Singapore and Zurich, KPMG says. “The U.K. has abandoned one of its key principles when it comes to tax, which is predictability,” says Bertrand des Pallieres, founder of SPQR Capital LLP, a London-based hedge fund firm with about $700 million in assets as of April. He left the U.K. last year and opened an office in Geneva after the new tax rate was announced. It’s not only funds looking at leaving. Broker Tullett Prebon said in December it would allow its 700 employees in London to move to “more certain tax regimes.” Several of Tullett Prebon’s major desks are now planning to move key personnel, the company says. ...London Mayor Boris Johnson estimates that up to 9,000 bankers, hedge fund managers and private-equity executives could leave the city, according to a letter he sent to the Labour government in January. ...Marcel Jouault is working to make sure that agitated Britons wind up in Pfaeffikon, a village on the shore of Lake Zurich. Pfaeffikon’s 11.8 percent corporate tax rate and 19 percent personal income levy are both Switzerland’s lowest, helping the village lure funds that handle about $100 billion in investments, according to hedge fund research firm Opalesque Ltd.

Weekly Economics Lesson: High Taxes Are a Recipe for Reduced Competitiveness

Politicians understand the economic impact of taxation when it serves their interests. They often brag about raising tobacco taxes to discourage smoking. It's not their business to dictate private behavior, of course, but they are right about higher taxes leading to less smoking (they also lead to more cigarette smuggling, but that's a separate issue). Those same politicians, however, conveniently forget about the economic effect of taxes when they impose high tax rates on work, saving, investment, and entrepreneurship. Or maybe they simply don't care. But as is explained in the Wall Street Journal, taxes on productive behavior matter a lot. More than one million people have escaped New York this decade, and punitive taxes clearly have played a role in this brain drain to other states:

Between 2000 and 2008, the Empire State had a net domestic outflow of more than 1.5 million, the biggest exodus of any state, with most hailing from New York City. The departures also have perilous budget consequences, since they tend to include residents who are better off than those arriving. Statewide, departing families have income levels 13% higher than those moving in, while in New York County (home of Manhattan) the differential was even more severe. Those moving elsewhere had an average income of $93,264, some 28% higher than the $72,726 earned by those coming in. In 2006 alone, that swap meant the state lost $4.3 billion in taxpayer income. Add that up from 2001 through 2008, and it translates into annual net income losses somewhere near $30 billion. ...no single reason can be fingered for a million migrants seeking their fortunes across state lines, but one place to start is New York's notorious state and local tax burden. According to the Tax Foundation, between 1977 and 2008, New York has ranked first or second in the country for its state-local tax burden compared to the U.S. average. In the years considered by the Empire Center study, New York's state and local tax burden ranged between 11% and 12% of income. The peak year for taxes, 2004, was followed by the peak year for departures—as New York lost nearly 250,000 people to other states in 2005. And that's before another big tax hike this year. That pattern is consistent with the annual migration patterns, showing that highly taxed and economically lackluster states were most likely to end up in residents' rear view mirrors. According to the annual study by United Van Lines, states like New York, New Jersey, Michigan and Illinois have been big losers in recent years. ...Liberals continue to insist that they can raise taxes ever higher without any effect on behavior, but the New York study is one more piece of evidence that this is a destructive illusion.

Many Talented Foreigners No Longer See America as the Place that Rewards Achievement

While there is considerable disagreement regarding the value of low-skilled immigrants (especially with regards to whether illegals deserve amnesty), almost everybody agrees that the United States is a big beneficiary when highly skilled workers, investors, and entrepreneurs from around the world come to America. So it is a bit troubling that USA Today is reporting that many Indians and Chinese are deciding that they can achieve more by going back home. It is too soon to make sweeping pronouncements about the public policy implications of this demographic shift, but this preliminary evidence of a reverse "brain drain" certainly suggests that the big-government policies of Bush and Obama have made the American economy less vibrant and less dynamic:

More skilled immigrants are giving up their American dreams to pursue careers back home, raising concerns that the U.S. may lose its competitive edge in science, technology and other fields. "What was a trickle has become a flood," says Duke University's Vivek Wadhwa, who studies reverse immigration. ..."For the first time in American history, we are experiencing the brain drain that other countries experienced," he says. Suren Dutia, CEO of TiE Global, a worldwide network of professionals who promote entrepreneurship, says the U.S. economy will suffer without these skilled workers. "If the country is going to maintain the kind of economic well-being that we've enjoyed for many years, that requires having these incredibly gifted individuals who have been educated and trained by us," he says. ...Multinational companies that belong to the American Council on International Personnel tell Executive Director Lynn Shotwell that skilled immigrants are discouraged by the immigration process, she says. Some can wait up to a decade for permanent residency, she says. "They're frustrated with having an uncertain immigration status," she says. "They're giving up."