July
17, 2003, 7:00 a.m.
Rise
of the Russian Model
Reagan-like
tax rates are revving up the ol’ Bear.
By Michael
T. Darda
hile
most global stock markets have been in the doldrums for most of the last
three years, Russian stocks have more than tripled in value since January
2001. During the same period, Russia's 20-year dollar bond yield has fallen
to 7 percent from 18 percent. This is no accident.
Russia's
complex and burdensome income-tax system was scrapped and replaced with
a 13 percent flat income-tax rate in 2001. Corporate tax rates were slashed
to 24 percent from 35 percent last year. The reforms resulted in a 33
percent boost in after-tax incentives on labor and a 17 percent rise in
the after-tax rate of return on corporate earnings. The combination amounts
to a 50 percent increase in the after-tax rate of return on labor and
business.
It should be no surprise
that if you tax labor and business less, there will be more labor and business
to tax. In short, the size of the tax base varies inversely with the height
of the tax rate. If the incentive change from tax cutting is big enough,
it actually could produce a net rise in tax revenues, which is exactly what
has happened in Russia.
Tax revenues in dollar
terms were up 19 percent last year and have shot up 50 percent since 2001!
Faster growth and more tax revenues have produced three consecutive years
of fiscal surpluses. This has reduced the government's overall external
debt to $112 billion in 2003, or just 34 percent of GDP.
Importantly, Russian
president Vladimir Putin is bucking the neo-Malthusian impulse to hoard
"government revenues" and instead plans to continue deploying surpluses
to buy down tax rates. Putin plans to slash the Value Added Tax (VAT) to
16 percent from 20 percent next year and reduce the Unified Social Tax (UST)
to 25 percent from 35 percent. Talk of a free-trade zone with former Russian
republics is also in the air.
Excellent pro-growth
tax polices have allowed the ruble to hold a more steady relationship with
the dollar. As a result, headline inflation has dipped below 15 percent
year-on-year from nearly 20 percent (YoY) at the beginning of last year.
Still, Russia's central bank is expanding the monetary base at nearly a
40 percent annualized rate, which works out to nearly six times the rate
of real economic growth. With gold and commodity prices close to all-time
highs in ruble terms, the central bank's liquidity policy should be tighter.
It is worth noting
that the Russian central bank's currency and gold reserves have risen to
nearly $65 billion. This means, if it wanted to, the central bank literally
could withdraw every ruble from circulation more than two times over. It
other words, there would be no technical impediment to stabilizing the ruble
at any level against the dollar, the euro, gold, commodities, or some combination.
With major tax cuts
taking place all over Eastern and Western Europe, across non-Japan Asia,
and in the U.S. and Canada, the global economy is poised for surprisingly
good growth in 2004. Unfortunately, Africa, Japan, and Latin America are
the odd men out when it comes to supply-side fiscal reforms. Monetary reflation
may save Japan from another year of stagnation, but Africa and Latin America
continue to be hobbled by the IMF's root-canal economic policies.
If political leaders
in Africa and Latin America took a quick look at the differences in their
economies (flat-lining) and Russia's (expanding at nearly a 7 percent annualized
rate) they would see quickly that the path to prosperity is not paved with
high tax rates and floppy currencies. Real wages are the lowest in countries
where tax rates on capital are the highest and currencies are the weakest.
Perhaps Vladimir Putin
could take a trip to Africa and Latin America to show political leaders
there how to get escape velocity from the IMF's failed policy framework
of loose money and tight fiscal policy. In order to go for growth, countries
need to have a currency that retains its purchasing power. Just as important,
it needs to pay, after tax, to work, invest, and innovate in the
above-ground economy. Lower tax rates and stable money worked for Reagan,
and now they are working for Russia. They can work for Africa and Latin
America, too.
—
Michael Darda is the chief economist of Polyconomics, Inc., an economic
forecasting firm located in Parsippany, New Jersey. He welcomes your comments
at mdarda@polyconomics.com.
<% dim printurl
printurl = Request.ServerVariables("URL")%> 
hile
most global stock markets have been in the doldrums for most of the last
three years, Russian stocks have more than tripled in value since January
2001. During the same period, Russia's 20-year dollar bond yield has fallen
to 7 percent from 18 percent. This is no accident. 
