by T. R. Reid
But the heavyweight players in this field, the three organizations that have the most clout in the realm of budgets and tax policy, are the World Bank, the International Monetary Fund, and the Organization for Economic Cooperation and Development.
These three institutions often work together on the same international problems (although they don’t always agree on the solutions). So it’s easy to confuse them. Even John Maynard Keynes, the British economist who was a central player in creating all three, said he always thought of the World Bank as a “fund” and the International Monetary Fund as a “bank.” In fact, though, their basic functions are somewhat different:
The World Bank, formally known as the International Bank for Reconstruction and Development, was set up in 1944 to finance the rebuilding of nations shattered by World War II. After a decade or so, with reconstruction and development moving along well in Europe, the bank turned its focus toward the planet’s poor countries, now generally called “developing countries.” It finances programs and projects to enhance economic growth and provides advice on spending, borrowing, and tax policy to the countries it supports.
The International Monetary Fund, or IMF, works with countries rich and poor to maintain what it calls an “orderly monetary system” for the world, a system in which all nations agree to follow common rules for currency exchange, cross-border taxation, and the like. It, too, provides advice on fiscal issues. The fund can also step in with loans to offset a financial crisis, as it did when several countries faced economic collapse in the Great Recession of 2008–9 and when Greece defaulted on its debts in 2015.
The Organization for Economic Cooperation and Development, or OECD, is a sort of exclusive club of countries, with membership restricted to the world’s richest nations. It currently has thirty-five members, ranging from the United States, the world’s leader in total wealth, to Chile and Mexico, the least wealthy of the wealthy. The OECD aims to get these successful nations to work together on common concerns like the environment, tax evasion, and financial fraud. It constantly issues reports and recommendations on financial and governance issues facing its member governments.
These international financial watchdogs all compile comparative data on national and international financial matters; when you see a listing, say, of the world’s richest countries, the source is probably one of these three. Such studies are invaluable to the harmless drudges (like me) who write comparative policy books on health care, taxation, and similar topics. The book you’re reading now probably couldn’t exist without the mountain of charts, tables, and rankings churned out every year by the World Bank and the OECD.
In addition, all three institutions provide advice to nations—big and small, “developed” and “developing,” democracies and dictatorships—on everything related to government finance. Which means they pour out a steady stream of reports and recommendations on tax policy. Their economists and accountants know what makes for an efficient and successful tax system and what makes for a bad one. While these organizations sometimes differ from each other on their economic nostrums—there was considerable argument in 2008–9 as to whether “austerity” or “stimulus” was the best medicine for recovery—all of them agree on the core framework that should underlie any national tax regime. When it comes to designing a country’s tax system, the World Bank, the IMF, and the OECD all preach the same sermon, relying on the same fundamental principle. This rule is not particularly complicated; it is easy to understand, although not always easy to implement. In fact, it’s so simple that the economists generally reduce the essential formula for good taxation to a four-letter word: “BBLR.”
That stands for “broad base, low rates.”
BBLR means that if the tax base—that is, the total amount of income, or sales, or property that can be taxed—is kept as large as possible, then the tax rate—that is, the percentage that people have to give to the government—can be kept low. Virtually all economists and tax experts agree that this is the best way to run a tax regime.
A broad-based income tax is one in which just about every penny a citizen earns during the year is taxable, without a bundle of exemptions, deductions, credits, allowances, and so on that reduce the taxable income. A broad-based sales tax is one in which sales tax has to be paid on every purchase, without exemptions for food, medical supplies, and so forth. A broad-based property tax is one that taxes the full assessed value of a home or building or piece of land.
To demonstrate, let’s imagine two citizens; we’ll call them Bill and Helen. Their economic circumstances are nearly identical, but they live in different states with different income tax rules.
—Bill Broad lives in a state that has adopted a broad-based definition of income. He works for Galactic Airlines, earning $75,000 per year, plus assorted benefits: the company pays $1,000 per month for his health insurance; the company contributes $200 per month to his 401(k) retirement plan; the company pays for his parking fees at the airport where he works, which is valuable because parking would cost $20 per day if he had to pay for it. Bill owns a house in town, with mortgage interest payments of $2,000 per month. He sends his kids to private school, at a cost of $9,000 per year. He donates $50 per month to his church, and $500 each year to the United Fund campaign. The property tax on his house comes to $4,500.
Under the broad-based tax regime in his state, everything Bill receives from his employer is counted as income; that’s $75,000 in wages, plus $12,000 in health insurance premiums, plus $2,400 in retirement contributions, plus the value of the company-paid parking, which comes to $5,000 per year. Add it all up, and Bill’s gross income is $94,400. That’s also his taxable income, because his state doesn’t give any deductions for mortgage payments, property tax, charitable contributions, or education expenses. The state income tax rate is 10%, so Bill pays $9,440 in taxes.
—Helen High lives in a state that offers a generous assortment of income tax exemptions, credits, and deductions and makes up for them by imposing high tax rates. She, too, works for Galactic Airlines. She earns the same annual salary as Bill ($75,000); she gets the same $1,000-per-month insurance policy, paid for by the company. She gets the same $200 retirement contribution each month, and the company provides her free parking at the airport. Helen, too, has a mortgage on her house, with $2,000 of interest payments monthly. She, too, has kids in private school, at a cost of $9,000 per year. Just like Bill Broad, she donates a total of $1,100 each year to church and charities. And she, too, pays property tax of $4,500 per year.
Under the narrow-based tax rules where Helen lives, her salary counts as income, but her employer’s contributions to her health insurance and 401(k) plan do not. She is not taxed on the value of the free parking her company provides. She gets a deduction for the interest on her mortgage payment and additional deductions for her tax payments and charitable contributions. She gets a credit for her children’s educational expenses. So when Helen reaches the “taxable income” line on her tax return, the total, after all those exemptions and deductions, is $52,500. In order to get the same amount of revenue that Bill Broad paid—$9,440—the state will have to tax Helen High’s income at a rate of 17.98%. In other words, the tax rate has to be set nearly 80% higher to offset all the tax preferences that slashed Helen’s “taxable income.”
Because both taxpayers end up providing the same amount of revenue, what’s the difference? Why does it matter whether somebody is taxed at 10% or 17.98%, as long as government gets the revenue it needs?
First, nearly all economists believe that tax should be a “neutral” factor when people and corporations are making business decisions. An economy works best if financial decisions are based on sound business principles; if tax considerations influence the decision, they distort the economics. If International Widgets decides to buy a $20 million industrial robot, it should do so because that acquisition makes business sense—that is, this new tool will increase our profit�
��and not because there’s a big tax break for investing in robots. If some millionaire is looking for a bank to hold her life savings, she should look for the most trustworthy bank, rather than depositing her money in the Cayman Islands in order to hide it from the IRS. If a big U.S. tractor company decides to move the headquarters of its spare-parts business to Switzerland, that should happen only if Switzerland is an important hub of the parts business, not because Switzerland has rock-bottom corporate tax rates.
This is where low rates come in. If the rate is low, it’s less likely to influence personal and financial decisions; that is, the tax will be “neutral.” If the tax you owe is only 10% of your income, it’s probably not worth your while to pay a lawyer to design some complex tax haven scheme, or to move a whole branch of your company to a low-tax country. But if the tax man is going to take 17.9% or 35% or (in France) 75% of your income, then the lawyer’s complex scheme can save you serious money. The economist John Maynard Keynes was a famous advocate of progressive taxes, but he warned that higher rates run the risk of “making skillful evasions too much worthwhile.”2 High tax rates prompt people to spend money on the tax lawyers and finance wizards who design those skillful evasions. For the lawyers and the finance guys, this is a boon. But for the overall economy, it’s a significant loss. The money these taxpayers spent on legal fees and complicated financial constructions could have been invested in ways that would grow the national economy or solve social problems.
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BEYOND THAT, A TAX SYSTEM studded with preferences—exclusions, exemptions, accelerated depreciation, intangible drilling credits, and so on—is a complicated tax system. Getting rid of all those loopholes so that all income is treated the same way makes the whole business of taxation easier for both the taxpayer and the tax collector. If dividends you received from a “Subchapter S” partnership (whatever that means) were taxed the same as all other income, you wouldn’t have to dig through the verbal jungle of IRS Form 1065 to figure out how much of the dividend is an “unrecaptured section 1250 gain” (whatever that means). If there’s no deduction for contributions, charities don’t have to produce a certified receipt for each donation, and the contributor doesn’t have to track down the nine-digit Tax ID Number of each charity she wants to support.
Getting rid of the complications also makes it easier for the tax agency to check a tax return or to perform an audit. And a broader tax base makes the system feel fairer. If deductions, credits, and such are strictly limited, the average wage earner won’t have that sneaking suspicion that rich people have their own special escape clauses to cut their tax burden.
The principle of BBLR applies to other types of taxes as well. Consider a state sales tax. Let’s say the total of retail sales in a certain state is $1 billion per year. If the state’s sales tax applies to every purchase, without any exemptions, the sales tax base will be the entire $1 billion. With a sales tax of 9%, the state will take in $90 million in sales tax revenue. But if the sales tax exempts food, medicine, children’s clothing, and newspapers—these are the common exceptions—the sales tax base is only $500 million. To bring in the same $90 million of revenue, the state would have to double its sales tax rate to 18%. And all those exemptions make the process difficult for retailers, who have to figure out on every sale which items are tax exempt and which are not.
For all these reasons, there is broad consensus among economists and tax experts that a broad tax base, making it possible to lower the rates, is the gold standard for the design of any revenue system. When President George W. Bush appointed a blue-ribbon commission in 2005 to write a new, improved tax code—the President’s Advisory Panel on Federal Tax Reform—the advisers’ main suggestion was a BBLR approach. In response, each of the predictable interest groups complained loudly about the proposed elimination of its favorite credits and deductions; the plan went nowhere. When President Barack Obama appointed a blue-ribbon commission to find ways to cut the deficit—it was officially the National Commission on Fiscal Responsibility and Reform, but everybody called it “Simpson-Bowles”—that group, too, recommended a BBLR tax reform. In response, each of the predictable interest groups complained loudly about the proposed elimination of its favorite credits and deductions; the plan prompted extensive debate but never got to a vote in Congress.
Because economists are usually not unanimous about anything, it’s downright strange to see the virtually universal endorsement of the BBLR principle by academics, tax-reform advocates, think tanks around the world, and the three big international financial organizations. Yet there are a few dissenters. One is Professor James R. Hines, an economist at the University of Michigan. He acknowledges the benefits of a simplified tax system with low rates. But he says it’s fairer if the law gives special breaks to taxpayers in special circumstances, like parents or the chronically ill or corporations that have to make large capital investments. Yes, this makes taxes more complicated, the professor concedes, but “good policy is messy.” Professor Hines also argues, tongue in cheek, that it’s probably better if Congress fritters away a lot of time writing tax loopholes. If all exemptions and preferences were eliminated, he says, “the only tax policy role of Congress would be to choose tax rates. Should we worry about what Congress might do with all the extra time?”3
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THE OECD PUBLISHES A broad variety of reports and proposals on financial topics, but one of its perennial bestsellers is a 160-page guidebook called Choosing a Broad Base–Low Rate Approach to Taxation.
“In general,” the guide says, “tax reforms that broaden tax bases and lower rates should reduce the extent to which tax systems distort work, consumption, and investment decisions, increasing output and enabling improvements in social welfare.” Governments may think they have good reason to create provisions giving tax breaks to particular groups, but the OECD economists beg to differ. “Whatever the reason, tax provisions entail a loss of government revenues, which necessarily means that other taxes have to be higher than otherwise. . . . These higher rates may create additional efficiency losses, adverse effects on income distribution, and administrative and compliance costs.”4
Many countries, rich and poor, have moved in the direction of BBLR. Among them are Canada, Great Britain, and Germany, which have eliminated exemptions and credits at various times to broaden the tax base and lower rates. As we’ll see shortly, the United States took a big leap toward BBLR some thirty years ago. But then the lobbyists pushed (successfully) to get their preferred exemptions back into the U.S. tax code; this narrowed the tax base, so rates had to go up to bring in the same amount of revenue.
When I asked the economists at the World Bank, the IMF, and the OECD which countries have the best tax system, they agreed on a prime candidate. New Zealand, they all told me, is Exhibit A for demonstrating the merits of the broad-based, low-rate approach. The academic literature supports this conclusion. “The New Zealand tax system stands out in comparative perspective,” concluded a 2012 study in the Journal of Public Policy. “Over the last three decades, New Zealand arguably moved further than any other advanced economy in neo-liberal tax reform, i.e. in the direction of low rates, broad bases, and neutral taxation. . . . The top rates on labor income in New Zealand are extraordinarily low by international standards. . . . The [sales tax] rate also remained relatively low by international standards.”5
It’s not really surprising that New Zealand followed the economists’ advice. This island nation has been a policy leader for decades among the world’s rich democracies. The Economist magazine noted that “New Zealanders have a right to be smug” at international meetings, because so many of their governmental innovations have been copied around the world.
New Zealand was the first nation on the planet to let women vote (in 1893). It has given new meaning to the term “paying with plastic”; the nation’s currency is printed on waterproof, tear-resistant plastic, with transparent windows in the middle of the
bill. The money doesn’t wear out, it’s almost impossible to counterfeit, and it floats if you drop it in a river. As a result, the Kiwis have sold this monetary innovation to dozens of countries. (Kate Sheppard, the proto-feminist who led the world’s first successful campaign for women’s suffrage, is on New Zealand’s plastic $10 bill.) While other nations ponder the idea of privatizing the post office, New Zealand already has competing public and private postal services, with mailboxes of different colors side by side on the street. (I tried both systems and found the government delivery a little cheaper and just as fast.)
The nation has also been a leader in dealing with the indigenous population. As early as 1840, when white colonial settlers around the world—including the U.S. Cavalry—were waging war on the aboriginal residents of their new lands, the British pioneers who came to New Zealand signed a treaty recognizing members of the Maori tribe as equal citizens. (American Indians didn’t become U.S. citizens until 1924.) The Maori language has been an official language since the birth of the nation. All government agencies print their documents in English and Maori. The Inland Revenue Department—also known by its Maori name, Te Tari Taake—provides both English and Maori versions of Form IR3, the local equivalent of Form 1040.
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A GREEN MOUNTAINOUS ISLAND NATION with almost no manufacturing, New Zealand might seem to be an unlikely candidate for membership in the OECD, an organization limited to the world’s richest industrialized democracies. But the Kiwis have built an advanced, prosperous, industrialized democracy—without heavy industry. They’ve done it by promoting a vigorous business of “adventure tourism” that lures rock climbers, windsurfers, snowboarders, bungee jumpers, and the like from all over the world, and by exporting the fruits of their farms and forests—primarily dairy products, timber, wool, and wine. To compete with much larger agricultural nations, New Zealand promotes its products as “100% pure,” containing nothing artificial or genetically modified. The point is made emphatically on the label of a beer called Steinlager Pure, a delicious brew and a successful export found all over Asia. “You are holding in your hand one of the purest beers anyone can make,” the label declares. “No additives. No preservatives. Sourced from the purest place on earth, New Zealand.”
