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Fiscal Lessons From Europe’s Crisis

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A lot may be learned by studying the current fiscal crisis in Europe.

What policies caused today’s fiscal and economic situation in Europe?

What behaviour exacerbated the problem?

What can others learn so as to avoid getting into the same difficulties? 

This short video does an excellent job summarizing 5 simple lessons from the European fiscal crisis [4]. It is in layman’s language and well worth your time.


This linked article by Dan Mitchell [5] discusses the video and some valid points, including:

1. Higher taxes lead to higher spending, not lower deficits. Miss Morandotti looks at the evidence from Europe and shows that politicians almost always claim that higher taxes will be used to reduce red ink, but the inevitable result is bigger government. This is a lesson that gullible Republicans need to learn – especially since some of them want to acquiesce to a tax hike as part of the “Supercommitee” negotiations [6].

2. A value-added tax would be a disaster. This was music to my ears since I have repeatedly warned [7] that the statists won’t be able to impose a European-style welfare state in the United States without first imposing this European-style money machine for big government.

3. A welfare state cripples the human spirit. This was the point eloquently made by Hadley Heath of the Independent Women’s Forum in a recent video [8].

4. Nations reach a point of no return when the number of people mooching off government exceeds the number of people producing. Indeed, Miss Morandotti drew these two cartoons [9] showing how the welfare state inevitably leads to fiscal collapse.

5. Bailouts don’t work. This also was a powerful lesson. Imagine how much better things would be in Europe if Greece never received an initial bailout [10]. Much less money would have been flushed down the toilet and this tough-love approach would have sent a very positive message to nations such as Portugal, Italy, and Spain about the danger of continued excessive spending.

For me, some of the other key issues raised in the video are:

Governments Want to Grow

If you give someone money they will spend it.

Government agencies want to grow and do so through higher budgets. And those budgets are financed by the taxpayers.

Note that the same is true for companies, especially when they form divisions into cost centres. Except, of course, the budgets are not financed by taxpayers.

A manager’s power (and compensation) is usually tied to the size of their division or group. This motivates them to continuously grow their unit. In profit centres, there is a linkage between spending and the return on capital employed. But as a cost centre, this often just means spending more money. As they are not assessed on profitability, often the correlation between improved service levels and increased budget is questionable.

In a company, over time wasteful spending bankrupts the company. Banks will not lend more money. Creditors will not extend terms. Investors will not subscribe for additional equity. These are the safeguards in place to try and ensure that a manager’s desire to grow his department is kept in check.

But in government, it is different. If government needs more money, they can print more (note that this is a cost to citizens). Or they can arbitrarily force investors (i.e., taxpayers) to invest more in government through higher taxes. As such, the requirement to closely watch spending to avoid financial distress is not strong.

And the results are evident. Look at your local news wherever you live. How much wasteful spending do you see? How much spending is in the form of crony capitalism, that is money being syphoned to special interest groups and/or supporters? How much money is spent to promote social goals, not to actually create employment, grow the economy, reduce debt, etc?

If most governments followed the laws and practices applicable to business, they would be bankrupt. But the ability to collect more and more revenues staves off the inevitable.

Government Grows Through Taxation

In theory, I do not have a problem with value added taxes (VAT). The issue is that they seldom, if ever, are neutral (in that the replace an existing tax so the consumer at the end of the day pays the same amount). Yes, they are often touted as neutral, but it never works that way in actuality. As global government spending continues to expand and there is a limit to what may be taken in income taxes, governments will rely further on VAT.

In the same vein are other taxes on non-income. We see this going on in Europe with the proposed tax on financial transactions. They are often not called “taxes”, but they are. “Surcharges” for air travel in many countries. Increasing “fees” for licenses. The list of revenue enhancers is seemingly endless. You can find many more examples in your region.

As the ability to generate government revenue from income taxes falls (see video discussion on Laffer Curve [11]), governments will need to raise their ever growing revenues from other sources. So look for expansions in these hidden taxes over the coming years.

Social Welfare State Cannot Continue in its Present Form

The social welfare state is essentially a Ponzi scheme. Those reaping the benefits are financed by those working today. And given the current demographic trends, it is unsustainable.

The problem is that there are more and more people living off the state and less people paying into the system. This is a huge issue for many countries, regions, and municipalities both today and in the near future. And there are few ways to deal with it.

You can reduce benefit payments and/or restrict eligibility. You can increase revenues to finance programs by raising taxes on contributors. You can increase immigration to raise the labor pool and number of contributors. Or you can reduce government services in other areas and shift resources to social welfare. All of these have their pros and cons.

Compounding this problem with the social welfare state is the high percentage of people reaping the benefits [12]. In many countries, we are at the point where near majorities of the voting population are net recipients of government spending. They have no interest in reducing benefits, bringing in more immigrants when unemployment is high, nor lessening other services. As a result, governments are loathe to do anything substantive other than increase taxes if they wish to remain in power.

To me, it is obvious that serious reforms will take place in social welfare. Yes, governments continue to try and kick the can down the road for future governments to deal with. The irresponsibility of these actions is staggering.

But the day of reckoning is almost here. Many local, regional, and national governments are already or close to bankruptcy. It is not just Greece. Look at Italy, Spain, and Portugal. And not just Europe. Countries like Argentina are suffering [13]. In the U.S., many states are in financial crisis [14]. Even cities are not immune [15].

I think the main social welfare reforms will come primarily by tightening eligibility for future recipients. That means increased age requirements, reduced benefit payouts in general, ways and means testing so that some people will not be eligible for any payments, etc. Perhaps higher tax rates on payments from personal deferred tax programs to “recover” taxes not paid while money accrued in the tax deferred accounts.

Whatever the specifics, changes will be made in the next few years. I fully expect that you will not receive the same level of government pension, health care, etc. as is paid out today.

As such, it behooves young and middle age adults to save for their own retirement needs.

Hey, if I am wrong, you will have even more capital to spend on a fantastic retirement. And when I am right, and I will be right on this, you will be better prepared than others who ignore this at their own peril.