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A Plan for Europe – Interview with Thomas Colignatus (Part 2)

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Thomas Colignatus
Personal website: http://www.dataweb.nl/~cool/

Plan for Europe: http://mpra.ub.uni-muenchen.de/33476/

NOTE: This is the second and final part of the interview. In case you missed the first part check the following link: A Plan for Europe – Interview with Thomas Colignatus (Part 1)

Thomas Colignatus is a Dutch econometrician (1954). All his works can be found in his personal website. In September 2011 he drafted a plan for Europe, to deal with the political, economic and institutional flaws of the European Union and its constituent member-states. The plan is titled “High Noon at the EU Corral. An economic plan for Europe, September 2011“. __It uses standard economic theory but also has some new insights. It shows that political decision makers have more options than commonly thought. The plan is rather long and at points technical. Can it work? An interview may highlight its key aspects and may allow the broader public to grasp the plethora of ideas found in it.

The interview consists of two parts. Feel free to post or send (see contact info) any comments you may have regarding the ideas of Thomas Colignatus, either if that is to shed more light to some aspects of his plan or to clarify some of his points. Part 1 dealt with the Economic Supreme Court and the National Investment Banks. This Part 2 deals with functional finance and monetary stability.

Start of Part 2

-Protesilaos Stavrou: Thomas, you have this rather complex story about stagflation, minimum wages, tax void, dynamic marginal tax rate, VAT, and other aspects. Can you somehow compress this in single clear statement ?

Thomas Colignatus: One can always try. It is important to see how we got into this crisis, apart from issues of governance and investments. This is the prong of stagflation and taxation and social insurance. Everyone now sees that the financial system is badly managed but the labour market, taxes and social insurance are a disaster too. The basic problem was and is known under the name of stagflation, which means a high state of unemployment and high inflation. It has been with us since about 1965 and the finance of the Vietnam War by means of debt. Governments have been trying to understand the causes of stagflation and guessing at its cure. Old approaches were vulgar Keynesianism and monetarism.

The US government since the Reagan presidency tried deregulation of markets including the finance sector – let us call this ‘neoliberal economics’. This seemed to work and the policy was copied by other governments that wanted their sectors to be competitive. It however only repressed stagflation. The 2007+ shock to the financial system forced stagflation into the open again, and with a vengeance. The shock has been cushioned by the rise of national debts but governments now seem to run out of options. Re-regulating banks might cause massive unemployment. This can only be avoided by a reorganisation of taxation and social insurance and minimum wages.
-PS: This is standard. The IMF and all governments want lower marginal taxes, flexible labour, reduction or abolition of the minimum wage. They have been trying for this for the last 30 years.

TC: Except that they do not take account of the tax void and the dynamic marginal tax rate. By pursuing their policies these governments have been creating the very stagflation that they were trying to solve. Been shooting themselves in the feet.

-PS: One step at the time. What is a tax void ?

TC: The tax void is the difference between gross minimum wage costs and net minimum income. These taxes including premiums are only collected exactly at the level of the minimum wage but they have no meaning below it. There they exists on paper but are not collected since people cannot work below the minimum wage. Hence these taxes can be abolished for free. Thus it is possible to reduce the minimum wage to gross = net. See the diagram or the “Don’t tax sweat” memo.

-PS: That is curious. Why would government levy taxes that they cannot collect, and that raise the minimum wage costs such that more people become unemployed ?

TC: The dominant tax theory is that lower marginal rates increase incentives. To reduce marginal rates you want to broaden the tax base and reduce exemption or shift to VAT that has no exemption. There are social premiums for unemployment and health insurance that have no exemption. But the lower exemption, the higher the tax at the minimum wage, and the higher the minimum wage must become to allow for a decent level of living. And the higher the tax void. The problem is that tax theorists determine a policy but without co-ordination about the labour market and social norms. The solution lies in the simple formula that X ≥ B, which means that tax exemption X should be at least as high as the minimum level of living B. The minimum wage can be M = B = X, or gross = net = exemption. Also VAT affects the wage costs, in Holland it is 19% but it rather should be 1%. Social and health insurance would also have an exemption.

-PS: This is quite revolutionary.

TC: A pure matter of logic, that other econometricians may want to check, see here. Please note my “Definition & Reality” methodology here. Economic analysis has much uncertainty and running regressions generates coefficients with some error too. Instead, I look at the definitions in the model and see what conclusions can already be drawn from those. The conclusions are as strong as the definitions of taxation and social subsistence. As said, the problem is that tax theorists determine a policy but without co-ordination about the labour market and social norms.

-PS: Still, I can imagine that lower marginal tax rates generate so much incentives and growth, such that we can afford some more unemployment at the bottom of the labour market.

TC: I have said so myself and I have called for research into this. The culture of unemployment at the bottom of the labour market comes with bad health, crime, bad education, the banlieu around Paris, bloated bureaucracies for subsidies and so on. Do we really want this or is it a result of wrong policy that creates the tax void ? Secondly, how do we calculate the marginal tax rate ? Economics is about optimality and thus we look at marginal values. The usual marginal tax rate is the statutory rate, but there is also the dynamic marginal rate that arises from changes over time. If you have a piece of a cake, and if both grow at the same rate, then the share in the cake remains the same. A person who pays 40% tax on average, when exemption is high and with a statutory rate of 60%, may continue to pay only 40% when exemption rises over time as well. When I look at regressions then the average rate is much more important than the statutory marginal. If you allow another formula, let us use taxes T and income Y and the difference operator Δ to calculate the changes of taxes and income. The rule is that ΔT / T = ΔY / Y ↔ ΔT / ΔY = T / Y, which means that if taxes grow as fast as income, with ΔT / T the rate of change, then the dynamic marginal tax rate ΔT / ΔY is the same as the average tax T / Y, and conversely. This formula should be presented to everyone who speaks about marginal tax rates, to clarify that it need not be a problem to have a high level of exemption X = B.

-PS: Wow. You really want to state this in an interview ?

TC: It is the missing link in the discussion on taxes, incentives, stagflation. The policy to reduce exemption caused unemployment and thus a shift of the Phillipscurve in the relation to wages and inflation. If you don’t take this into account then you do not understand what has been happening since 1965. Take the recent IMF report page 63. They present The Netherlands as a guiding example for the rest of Europe. Their facts are correct but they are only part of the story and their analysis is wrong. The true analysis is that Holland creates mass unemployment via its tax void and partly hides it in subsidies to get people from the labour force, and it partly exports this unemployment by a systematic export surplus. In the last decade Germany has been copying the Dutch example. Germans call it a “miracle” but it is a disaster for the eurozone since Southern Europe is pushed into debt. It is typical that Hans-Werner Sinn in his rescue plan mentions the balance of payment crisis but does not put part of the blame on Germany itself. We also see an IMF (a) that wants all countries to become surplus exporters with somewhere some magic deficit hole, (b) that treats countries like Greece and Ireland as single phenomena and that does not see that it should send alarm squads to Holland and Germany. Those countries should raise their wages. I would say to the IMF: look deeper into that tax formula, see DRGTPE.

-PS: This is already a long and heavy interview and we still have to deal with monetary stability.

TC: The quick and easy solution is to refer to my original article that triggered your interest. The EFSF was invented since they apparently did not want to rethink the ECB and wanted to extend from the eurozone to all 27 members. However, it is better to rethink the ECB and the system of central banks. Economic theory and financial markets are at ease with a well defined Central Bank. These patchwork inventions of these last years only generate instability, and they are an invitation to hedge funds to test them.

The current EFSF is an off-balance risk vehicle where governments accept all kinds of risks but they keep those out of the budget so that nomally they are closer to the SGP targets. It is fancy bookkeeping again but with the huge risk of what happens when events turn sour. Slovakia still has to vote on it and I hope that they kill it; see what Richard Sulik has to say except from some rhetoric.

-PS: And what about Greece ? I tended to like the idea of eurobonds.

TC: Eurobonds kill the market signals about national budgets. One would rather keep those. Can you imagine the stupidity of Basel III and the bank stress tests that government bonds are considered risk free ? These authorities make such a grave error and now they want the populations of the afflicted countries to suffer ?

I propose to think differently. Greece and Italy can be restored to 100% debt to GDP ratios and bank equity can be enlarged by monetary means. The fun thing is that printing money hardly costs anything. Inflation is a worry but the authorities have been neglecting the inflation in capital goods and assets, and my proposal is to make a clean break, and kill the money overhang over time. Greece and Italy were invited in the eurozone, this invitation comes with some responsibility, and if Germany and Holland, and indeed all countries, adjust their tax policies and create their Economic Supreme Courts and National Investment Banks then we are back in full employment under stable prices like in the 1950s. That was not a freak accident but came about by economic conditions.

-PS: Thomas, thank you for this interview. You have surely given something to think about.

—End of Interview—
See Part 1 of the interview