While 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 email@example.com.