The contribution of the Greek shipping industry: I agree with Reuters

To celebrate the blog's 6th birthday I proposed to take suggestions for fact-checks from the audience on Twitter and Facebook. This is the first of the two winning fact-checks (a recommendation from my friend P.S.) and it deals with the contribution of shipping to the Greek economy.

The starting point for this fact-check is a Reuters special report, The Greek Shipping Myth, which cast doubt on the employment and GDP contribution figures cited by the Greek shipping industry (and echoed by much of the domestic and foreign press - eg the FT here). The core claim in this report is that the industry's contribution to the Greek economy is inflated because ELSTAT calculates the impact of shipping firms differently than the statistical agencies of other countries do - in particular, it includes in its calculations value added and employment that arise (and possibly stay) in other countries.

In brief: Reuters' claim is correct in its essence. Shipping contributes less to the Greek economy than the industry lets people believe, if by 'economy' one reads 'gross national income' or 'domestic employment'. It is also likely that it contributes a lot less to GDP than the industry claims, although without further input from ELSTAT on the 'domesticity' of its product this is very hard to assess. The treatment of shipping in Greek national accounts is not as unique as Reuters claims - to some extent, countries such as the UK and Cyprus also appear to record it in similar ways. It does, however, contrast sharply to the way in which German statisticians measure the industry, and which is completely aligned with Reuters' preferred approach.

'We're gonna need a bigger boat'

At the risk of flirting with conspiracy theories, it is worth explaining the context of the Reuters publication and the FT coverage cited above. The last few years have seen sustained pressure applied on Greek governments to raise taxes on the shipping industry. It's not just parts of the Greek left gunning for oligarchs that are behind this, either. The German shipping industry is said (see BBC article above) to be lobbying for a review of the taxation of Greek shipping and the IMF appears to have been mulling proposals for further taxation for some time. Parallel to this, the European Commission has recently submitted a set of proposals to Greece on reforming maritime tax; basically asking us to bring some activities out of scope of our tonnage tax system as niche sectors were looking like they were gaming the system.

There is a big obstacle to taxing the shipping industry further, as a forty-year old law (27/1975), given a kind of special status by direct reference in article 107 of the Greek Constitution of 1975, exempts any company that pays tonnage tax in Greece from paying any other corporation tax or capital gains tax on sales of vessels. The exemption even extends to individual shareholders; see more details on p 173 here. This is pretty heavy stuff; it means it's not just difficult to apply income tax to the shipping industry and its owners - it's virtually unconstitutional. The last Greek government got around this problem in 2013 by establishing a voluntary agreement with the industry for an additional levy, and then formalising aspects of this into law. This idea had originally been mooted in 2011, during negotiations on the second Greek bailout, and effectively means that Greek-owned shipping companies (regardless of flag) will have paid an additional EUR420m between 2014 and 2017 (and no less than EUR105m in any given year). It's a steep increase from the amount of tonnage tax receipts which bring in a risible EUR12m per year (in 2012; historical data available here under the 'EL' tab), but clearly this amount still looks relatively modest.

In short: there's a hell of a lot of money to play for; national statisticians are swimming with sharks and Reuters' claim is that they've long avoided being eaten but cutting a deal.

Shipping in the ocean of data

It's not easy to pin down shipping in national statistics. This is because the full suite of relevant sectors are only really identifiable at the 4-digit level of the European Union's revised standard industry classification (NACE rev. 2). The NACE rev. 2 codes we're potentially looking at are as follows:

C: MANUFACTURING
30.11: Building of ships and floating structures
30.12: Building of pleasure and sporting boats
33.15: Repair and maintenance of ships and boats.

H: TRANSPORTATION AND STORAGE
50.10 Sea and coastal passenger water transport
50.20 Sea and coastal freight water transport
52.10 Warehousing and Storage activities for transportation
52:22: Support activities incidental to water transportation

N: ADMINISTRATIVE AND SUPPORT SERVICE ACTIVITIES
77.34: Rental and leasing of water transport equipment

Even then, there is room for discretion. I would be careful, for example, about counting anything other than codes 50.20, 52.22 and 77.34 under 'shipping,' though I would count almost all of the rest as part of the 'maritime cluster.' Even then, I would be careful about including code 52.10: it's likely that warehousing support for shipping is only a small part of this activity, and it's impossible to disaggregate it further. The 'maritime cluster' sectors are a unit of sorts because they share skillsets and specialisms, not to mention historical, corporate and family ties. But it's fair to say that the industries of the broader cluster respond to completely different sources of demand - demand for yachts, ferry rides and cruises isn't really driven by the currents of world trade, except perhaps in the very long term. And you wouldn't really expect to tax these sectors by tonnage, would you?

There is a shortcut that researchers can and do use to get round all of this detail. NACE rev 2 code 50 (water transport) is a 2-digit sector and therefore a lot more statistics are publicly available for it; and intermediate demand for water transport from other industries is a half-decent proxy for shipping output, because it strips out demand for passenger travel and other non-trade related things.

Using Eurostat's supply and use tables here it's relatively easy to see what the top line is for 'water transport services.' Some EUR15bn per year, as of 2010, almost all of it from exports. These are the latest and only figures on intermediate consumption of shipping that are available to us, but happily they are not the only figures we can rely on.

A missing middleman?

Contrary to what the Reuters piece might have you think, Greece's ELSTAT does not publish regular releases specifically on the contribution of the shipping industry, the way it might do with say, manufacturing or services as a whole. It does, however, quietly prepare estimates of value added and employment in the industry for the purposes of compiling national accounts - which in turn feed into estimates of Greek GDP and productivity.

You can see ELSTAT's breakdown of GDP components for 'water transport services' here. This roughly confirms the topline figure I cited above (15.8bn in 2010 but EUR12.8bn in 2014) and suggests that the industry contributed EUR5.7bn of value added in 2014, down from EUR6.6bn in 2010. ELSTAT provides the same figures on its own website here. Accounting for the sector's own demand for goods and services, in turn, produces this table, which suggests value added of EUR6.1bn in 2010.

That the two sets of figures are not identical is a little odd. They ought to be, yet you'll notice a difference of EUR460m in the industry's value added, as well as the fact that the water transport sector seems to buy almost no services (a puny EUR28m!) from itself. Now what could that be? It's rare, after all, for a broad (2-digit) industry to not use some of its own product as inputs. This to me is a first hint that there might be a missing middle-man in the GDP figures.

The impact studies

Unlike ELSTAT, the shipping industry and its observers in academia and think tanks are far from quiet about these estimates, and so the relevant figures have, in recent years, found their way into three widely-cited and to some extent overlapping assessments:

• The BCG Assessment of 2013 
• The IOBE assessment of 2013.
• The Oxford Economics Assessment of 2014.  

It is these studies that provide the chief lobby fodder of the industry, and they are genuinely loyal to the ELSTAT estimates. In fact, there is not much wrong with them at all. Like many 'impact' studies of course, they tend to bulk up their value added estimates with estimates of 'induced demand' and multiplier effects - ie value added in other industries that would not occur if it weren't for shipping. This tends to inflate the industry's contribution to a normally running economy, but might be a good approximation of what the country would miss out on if the entire industry were to decamp to other shores. This approach to impact assessment is not my main concern, or that of the Reuters investigation. Rather, I am concerned that Reuters may be right and that the core ELSTAT figures are probably wrong.

A Waste of Money at Reuters 

Reuters comes to this conclusion by looking at a sample of company accounts for the Greek offices of shipping companies - which account for only a fraction of the value added and employment claimed by the industry. This must have been a heroic effort - but also a wasted one, as ELSTAT had already done this work for them, The results can now be found in Eurostat's annual detailed enterprise statistics, and have two advantages: first, they go to enough detail to identify shipping extremely closely; second, they are limited to shipping enterprises registered in each member state.

• You can check out the service components of the maritime cluster here, along with their (very detailed) income, employment* and value added figures. 
• You may also want to add, for completeness, the activities of shipyards and dockyards, available separately here. 

*You need to be cautious and patient when it comes to the employment figures cited here. Unfortunately, quality control of the detailed enterprise statistics is relatively poor - on two occasions I've come across errors obvious to the naked eye, and shipping employment is one of them. Eurostat has a good record of acting on tip-offs about such errors but this is the holidays so it might take them a while to respond to my complaint.

Whatever the quality of the overall dataset, I believe there is no doubting the value added figures, which tally well with Reuters' estimates. The narrow shipping sector's value added (at factor costs) is barely EUR380m, based on output of EUR 735m. The broad maritime cluster produces a more respectable EUR936m of value added, on turnover of EUR2.2bn. Even this is miles away from the over EUR5bn that ELSTAT counts towards Greece's GDP. It's not just a question of inter-group transfers to companies outside Greece (like the ones, eg, that result in Starbucks' extremely low taxable income). If it were, then the top-line at least would presumably be the same regardless. It really looks like Reuters is right - the value added by shipping businesses registered abroad is being routinely included in the Greek GDP figures.

Then again, look again at the 2010 figures from enterprise stats - we may have our missing-middleman right there. At just over EUR400m, the sea freight sector's 2010 turnover from detailed enterprise statistics fits quite well into the gap between the two value added estimates for 'water transport' that we saw earlier - suggesting that the Greek-registered businesses (local management offices, in Reuters' article) produce nothing but intermediate inputs into an international industry that is somehow considered to be Greek in our annual accounts. Depending on whether the estimate is run top-down or bottom-up, they disappear into opaque group accounts, instead of being tallied up as intermediate inputs, which produces the two separate value-added estimates we saw earlier.

Whose billions?

But what of the other EUR5bn? Is that Greek domestic value added or is it foreign value-added? And if it is foreign value-added, does it give rise to Greek incomes? Consistent with Reuters' theory, it looks like ELSTAT treats all value added from firms of Greek beneficial ownership as domestic, and adds it to GDP. There may be some basis for this. The question of when a transaction can be said to arise in a country's territory and therefore to be domestic is not one of economics but of statistical convention, for which we turn to the wisdom of the ESA2010 manual:

Exports of goods occur without the goods crossing the country’s frontier in the following examples: (a) goods produced by resident units operating in international waters are sold directly to nonresidents in foreign countries. Examples of such goods are oil, natural gas, fishery products, maritime’s salvage; (b) transportation equipment or other movable equipment not tied to a fixed location; (c) goods after changing ownership, which are lost or destroyed before they have crossed the frontier of the exporting country; (d) merchanting, i.e. the purchase of a good by a resident from a non-resident and the subsequent resale of the good to another non-resident, without the good entering the merchant’s economy. Analogous cases occur for the imports of goods. 

Is Greece as unique in this treatment as Reuters alleges? It's easy to test this by comparing the contribution of water transport (remember, this is not quite 'shipping'!) to gross value added under the national accounts with its contribution under enterprise statistics. Here I'm keeping passenger transport in the calculation so that we're comparing 'water transport' with 'water transport' and can therefore isolate the effects of statistical treatment, country of registration and ownership structure.

The entire EU water transport sector makes about 26.5bn of value added under the detailed enterprise statistics approach (2013 figures here) but 34bn under the GDP approach (see here). Greece, the United Kingdom, Cyprus and Romania have enormous shipping sectors in their national accounts compared to detailed enterprise statistics, while Germany, Norway, Denmark, the Netherlands and Italy provide roughly the same figures under both datasets. Finally, Belgium, Portugal and Estonia seem to have larger shipping sectors in enterprise statistics than in their national accounts.

But where does the money end up?

Whether you think their view of domesticity of shipping product is right or wrong, it's worth noting that ELSTAT makes no claim as to whether this domestic product produces national incomes. The industry claims this, on the basis of GDP figures, as it shouldn't. This is a fine distinction that Reuters fails to make but it does point to the true villain.

I make this introduction because there is a difference between GDP and Gross National Product (not to mention GDP and Gross National Income), and I wouldn't expect the two to be identical in the case of Greece .[I spoke too soon; in 2013 they were. But they don't have to be]. If shipping value added arises within Greece's borders, then there's no reason not to count it towards GDP. If it then immediately leaves the country to swell the coffers of foreign firms, then it won't count towards GNI, but that does not make the GDP calculation incorrect. Clearly, industry lobbyists have an interest in conflating GDP contributions with GNP/GNI contributions, but it is the latter that would give their argument against further taxation weight with the Greek authorities. Hence Reuters, despite a light mixup in terminology, is essentially right to question the numbers. The argument, however, cuts both ways. If so little of the sector's value is created in Greece, on what basis would the Greek government tax it?

Still, the industry claims that the disputed EUR5bn of value added somehow finds its way back to Greece. But in what way? There is no massive net inflow of funds to Greek business in the 'water transport' sector that would account for this difference. You can see this for yourselves here - a trifling EUR40m at last count, and net outflows in most years. There is, to be sure, a huge flow of remittances and wages earned abroad into Greece - nearly EUR1bn on last count. Unfortunately, it's hard to know how much of this is attributed to the shipping industry, and even if all of it were money from shipping employees abroad it wouldn't account for the full EUR5bn anyway.

Or does the money return as private flows of savings, consumption and charitable donations? The industry's flow of charitable giving is unrecorded but clearly massive. A single shipping-family foundation, for example, has been responsible for about EUR900m of easily-traceable charitable giving in Greece over the last ten years, of which at least a third has come post-crisis. It is said that much of the Greek ambulance service runs on donations from the shipping industry, and that many individual charities have benefited.

Without much more transparency from the notoriously secretive shipping families, it is impossible to answer this question. My guess is that the contribution of shipping to Greek national incomes is overstated by something in the order of EUR3-4bn. It also reflects very poorly on ELSTAT that they are not able to answer a straightforward question on how their value added figures are derived, and that they provide two different estimates of value added in the water transport sector (one in I-O tables and one in the national accounts, never mind the one in enterprise statistics). At the very least a methodological note would be very useful. Like, yesterday.

UNDER-TAXING GREECE

Acknowledgement 5/1/2016: This post owes much to the thinking of A. Doxiadis and his book, Το Αόρατο Ρήγμα, on the structural characteristics of the Greek economy; as well as to conversations on tax with Gregory Farmakis. That's not to say either has endorsed the post of course. All errors etc are my own.

One of the stylised facts of the Greek crisis has been that Greece never truly overspent (barring perhaps 2009); if anything, it under-taxed. It's not hard to understand where this argument comes from - just compare revenue and spending as a % of GDP between Greece and the EU or the Eurozone average - the data are available here.

Clearly, in 1995 government spending in Greece was well below the EU average. It caught up quickly, but even so was still very close to the EU average around the 2005-7 period, especially after allowing for higher interest costs. Revenues, on the other hand, lagged the EU average by a persistent 4 percentage points each year since accession. On the face of it, it's more credible to look at Greece as a story of under-funding of the state than one of overspending.

Advocates of the under-funding hypothesis also point to the (unfortunately, now discontinued) dataset of tax by economic functions. This generally suggests that Greece has been taxing, eg., consumption more than the rest of Europe, while taxes on capital, once above the EU average, have fallen steadily and payroll taxes on employers have been persistently lower than the EU average (data here and here). Greek governments, the narrative goes, gave tax breaks to some industries, turned a blind eye to avoidance and evasion of social security contributions by others, then let taxpayers foot the bill.

This narrative eventually made its way, via the Trade Union movement, to the Greek Parliament's debt audit report - the definitive account of that kangaroo court that called itself the 'Debt Truth Committee.' It was one of the better-documented claims made in the report.
And it is wrong.

1. Greece is not what you think it is

Upset about Greece's low government revenues? Spare a thought for Tunisia's government, whose revenues are only ca. 24% of GDP- just over half the EU average. Is Tunisia's government under-funded? To be sure, it is less good at extracting tax from its population than the average EU country; but no one would dream of using an EU average as the yardstick for Tunisia.

Yet, by virtue of being an EU country, Greece is often benchmarked against the continent.The assumption is that Greece is a similar sort of country as its EU peers and the Greek state should rightfully expect similar revenues. If there is a difference in revenue, it is due to lower tax effort: a combination of lower tax rates or a lower level of tax compliance, which the state tolerates. In reality, this comparison is invalid. Greece may not be like Tunisia, but it is also not a mini-Germany, a mini-Spain or a large Portugal for that matter. It is structurally less well placed to yield large tax revenues.

The reasons are simple. All other things being equal, it's harder to tax the self-employed; of whom we have proportionately many more than other European countries. It's harder to tax the poor; of whom we also have more; and harder to tax retirees, of whom we also have more; finally, it's hard to tax chronically unprofitable micro-enterprises; of whom we also have more.

To illustrate how big the effect of these structural characteristics is, I wanted to focus on one example. Let's look at the components of market output that a government can reasonably expect to tax - the operating surpluses of financial corporations; the operating surpluses of non-financial corporations; the operating surpluses of organisations serving households; and the mixed income of households. You can find all of these figures here; unfortunately the figures are not expressed as % of GDP, which has to be done manually by comparing with these figures.

Once you run the figures, one set of numbers stands out - household mixed income. As pg 200 of Eurostat's ESA2010 manual explains, this is the income of self-employed people working in unincorporated businesses (ie not companies); it includes the income of business owners and their families. Hence the term 'mixed': these are part wages and part profits, and the two can only be separated arbitrarily.

Greece, as you might expect from my introduction, has the second-highest share of mixed income as a share of GDP in Europe, and had the highest bar none pre-crisis. But, whatever lazy journalists tell you, this structural issue is not common to all of the PIIGS countries. Greece stands alone amongst peripheral Euro countries in having its operating surpluses distributed in this way. At 23.7% of GDP in 2008, mixed household income as a share of total output was over three times higher than in Cyprus; more than twice as high as in Spain; nearly twice as high as in Portugal; and over 40% higher than in Italy. Spain was more or less on a par with Germany on this metric. In fact, to find economies similar to Greece's in their dependence on household mixed income, you need to go as far as Poland and Slovakia.





But what does this mean for tax? Well, there is a good correlation in Europe between mixed income as a share of GDP and the amount a government can raise from taxes on income and profits (data on this here). In fact, all of the high-tax/high spend Nordic economies have tiny mixed income contributions to GDP; while those with high mixed income contributions tend to be recent accession countries. The correlation isn't perfect of course, and I am guilty of cherry-picking; the correlation becomes less neat after 2008. I believe the reason for this is the increased tax effort of some economies over others during and after the crisis; as tax effort rose most amongst those countries with the lowest tax revenue, it makes sense for the correlation to weaken. In fact, in later years the curve tends to flatten as all countries apparently aim to raise at least 5% of GDP in income and corporation tax.

Now look very closely at the revenue/mixed income graph. First- it suggests that tax effort in Greece may, if anything, have been relatively high pre-crisis. In a slightly different study looking at structural influences on tax revenues, the World Bank's researchers have found much the same thing, although for completeness I should note their colleagues at the IMF and IGC have found the opposite.

Yet another way of approaching this would be to consider how far along the Greek laffer curve we were in 2010. As veteran readers know, we have an estimate of this from Trabandt & Uhlig (2012), who found that 2010 Greece could only increase its tax take by 2.4% of GDP by raising capital taxes before it started falling again. It could increase it by a maximum of 4.8% of 2010 GDP by also maximising labour taxes. True enough, Greece has never since managed to get to that peak, but even without a major recession it seems the best we could ever do would be to catch-up to the EU average.

Now the tax to mixed income graph we discussed earlier suggests that, if the mixed income contribution in Greece were to fall to where Spain's is (ie by 12 percentage points - which is to say, very substantially), we might expect income and corporation tax revenues to rise by a good 4% of GDP - incidentally the same margin by which our government revenues have chronically lagged those of the rest of Europe.

Does all of this not sound familiar? This over-reliance on self-employment and very small businesses is precisely the same distortion that is responsible for the bulk of Greece's lead over the rest of Europe in terms of hours worked per person. Isn't it time we reviewed this properly? I know you've heard it said a million times that small businesses are the backbone of the economy, and that entrepreneurs will save Greece/Europe/the world; I have worked in small business advocacy for years and I have some sympathy for this view. But not all self-employment is enterprising and not all small family businesses are small and family-run for the right reasons. A Greek self-employed pharmacist may be an entrepreneur; but some of their colleagues are also effectively civil servants with a profit margin. A Greek freelancer may be a flexible go-getter; or they may be an employee whom the employer doesn't want on their books so they can avoid national insurance contributions.

Here's a heretical proposal; why not adopt the change in mixed income as % of GDP as a simple indicator of structural change? Whether it is a good thing, I cannot say. But it is worth noting that, by this token, Spain, Croatia and Bulgaria are the star post-crisis reformers; much more so than Greece.

UPDATE 22/12: I've looked into why the mixed income of Greek households has fallen as a share of GDP here. In summary, and with the exception of construction and law firms, there is no evidence that this is a sign of 'reform' - Greece's mixed income-generating sectors are withering on the vine rather than formalising.

An ideological aside

I don't wish for readers to interpret the above as a suggestion that the Greek economy must be reformed into a shape that maximises tax revenue. Paying taxes is nobody's idea of the meaning of life or the purpose of economic activity. But we need to accept that the current setup leads to low revenues, almost inescapably. We can choose to accept a low-revenue, low-spend equilibrium; tax ourselves to the gills to achieve a high-spend, high-ttax equilibrium with very low output, or aim for a low-revenue, high-spend and high output equilibrium and accept the hardship that will surely come whenever the credit line next dries up. There is no other choice.

2. Tax revenue is not what you think it is

In addition to misunderstanding what kind of country Greece is, the discussion of Greek tax effort also ignores what tax revenues are, and why ours are different than many other EU countries'.

Tax revenue isn't just money the state takes. Some tax revenue is also money the state makes. It is a return on past public investment. By this I don't mean tax revenues resulting from fiscal multiplier effects, which should be small on a cyclical basis if the public finances are consistently well managed. I am referring to tax revenues resulting from the deepening of physical, social or human capital as a result of public spending.

Essentially, when a government invests productively, it builds public capital which in turn boosts the productivity of the private sector. Better roads and ports enable trade. A nation-wide electricity grid makes appliances more reliable and homes more valuable. A fibre-optic network brings more people within reach of their peers and of online retailers. More educated, informed, empowered or healthier people are both more productive and more demanding. Simply- and well-regulated industries are more trustworthy and productive. At the extreme, the state can sometimes build entirely new kinds of intellectual capital; it can become a venture capitalist of sorts, creating whole new fledgling industries for the private sector to explore - the premise, after all, of Mariana Mazzucato's Entrepreneurial State.

The better an investor the state is, and the more it allocates funds to investment rather than consumption, the more its tax revenue will tend to grow as a share of GDP, holding tax effort and state capacity constant. The share of its tax revenue that reflects returns on investment will grow, while the share of revenue that reflects coercion and rents will shrink. If, on the other hand, government spending fails to build valuable capital and improve productivity across the economy, then over time returns on public spending will fall as a share of GDP - forcing the state to increase its tax effort or its capacity just to stay still.

The right amounts, the wrong places

Is there reason to believe that this has happened to Greece in the run-up to the crisis? Yes. We invested broadly the right amounts, but got very little by way of returns. Government gross fixed capital formation was not low in the pre-crisis era, and with the exception of the year 2005 it was almost unwavering at ca. 3.5% of GDP (Eurostat claims that none of this was defence spending, by the way). That put us ahead of places like Norway or Sweden, but just short of Spain or Ireland and way behind Portugal.

The problem then was not the allocation of public spending between consumption and investment, but rather the quality of public investment and its complementarity with private investment.

• Both pre- and post-crisis, our welfare state has consistently given us the lowest social returns on investment among the OECD countries .
• Public investment in Greece was for years allocated based on regional voting patterns - and because of this decisions have remained stubbornly centralised. 
• A great deal of public spending is misdirected. Our own citizens suspected corruption was rife even pre-crisis, more so than in any other PIIGS country.
• Our spending on education, on the other hand, seems to have yielded consistently good returns. The Conference Board's Growth Accounting Database suggests we've got more growth out of skills since the 90s than any other developed country, bar Singapore. 

There are some very good long-term calculations for Greece, in two studies in particular. Kamps (2004) finds very strong returns on public investment between 1961-2001, more so than in other EU countries; but these are what are known as partial returns - ie they look at the returns on public spending without considering the losses from crowding out of, or by, private investment. Using data from 1960 to 2005, Alfonso and St Aubin (2008) confirm the finding of strong partial returns on public investment, but find negative total returns due the negative response of public investment to private investment. The actual, total effect of public investment in Greece was negative .

 A second ideological aside 

In discussing the money that government makes I do not pretend that all government spending builds capital; that all of it is efficient, or has high or even positive returns; or that the private sector would not, left to its own devices, have used the same funds better. All I am saying is that, undeniably, some tax revenue is a return on public investment.

Whither Syriza’s Wealth Tax?

Lost amidst the tumultuous coverage of Eurogroup meetings, negotiations, leaked documents and denials, the new Greek government’s plans for tax reform are slowly taking shape and are due to be announced in the early summer of 2015. One flagship fiscal policy, announced as far back as the Thessaloniki programme, is a wealth tax. We don't know much about it, but we do know that a) it will replace ENFIA b) it will not apply to primary residences c) it is likely to be levied almost exclusively against property, although other assets might follow d) it will most likely be a net wealth tax, i.e. levied against people's equity in their belongings.

This won’t be the first attempt by Greek governments to tax wealth of course  - the hated ENFIA may have actually hastened the downfall of the previous government, prompting the kind of people that core Syriza voters had once derided as ‘νοικοκυραίοι’ to join them in the party’s ranks.

Ironically, no more than a year ago, the Bundesbank itself proposed a wealth tax (as a one-off, high impact measure) for troubled Eurozone countries. The IMF also considered a recurring wealth tax (see pg 39 here), again only to suggest that one-off levies on wealth might work better. Cyprus, of course, got a brief taste of this medicine before moving on to a more traditional depositor bail-in. 

Towards a new Wealth Tax: Taking stock

According to the ECB’s Household Consumption and Finances Survey, it took a net 331,800 in assets to put a Greek household in the top 10% of the wealth distribution (see Table A2 here) in 2009. While the threshold must have fallen very significantly since then, some of the fall in e.g. property wealth should be reversed when the economy begins to recover. So, without access to more recent figures, I will assume that it would take a threshold of EUR300,000 to capture the top 10% of Greek households by wealth. Not a bad place to start counting ‘the rich’ if you’re looking to balance left-wing legitimacy with a decent revenue, and also a number often referred to in the past as Syriza's threshold for wealth taxation.

Next is the question of how much wealth these people have. The ECB’s 2009 figures aren’t much help here, but Credit Suisse’s 2014 estimate of D10 wealth in Greece (which allows for a fat tail uncaptured by surveys) is at 56% of ca. $1 trillion, nearly half of which is in turn owned by the top 1% (pp. 125-6 here). The tax base potentially covered by our wealth tax system is therefore around EUR494 billion gross in today’s rates, or EUR462 billion net (assuming the top 10%’s ratio of gross to net wealth has not changed since 2009). 

[Note: I started writing this post in January; 'today's rates' unfortunately refer to late January]

This is the top line and it’s huge. Like an entrepreneur mulling over their business plan, the new Greek government might be tempted to think – if we can get just a little bit of that…

Well we can get a little. We know because others have tried for years. Wealth taxes are far from new, but were a dying breed in the run-up to the crisis, with more and more OECD countries abandoning them from the mid-90s onwards. Here's why.

No miracles

First, even when the tax base is wealth, taxes are paid out of income, and wealth taxes are thus constrained to some extent by the income of the wealthy. In some parts of the world (well, Germany) there is even a legal precedent of courts capping wealth tax as a share of actual income. In this context, the main function of wealth taxes is to marginally improve the fit between households’ tax liabilities and their tax-paying capacity, often by using wealth as a proxy for undeclared income. In countries like Greece, where high earners are notorious for tax avoidance, the appeal is undeniable. But large numbers of households, especially olders ones, can be asset-rich (or asset-comfortable) and cash-poor. A tragic example was one of the high-profile Greek suicides of 2012, a carer who twice insisted in his suicide note that he had ‘ample wealth, but no cash.’

Second, it's hard to pin down accurate valuations of wealth. Assets acquired in the (often remote) past may have appreciated enormously in value but, in the absence of a market sale, never been revalued accordingly. Taxpayers have no incentive to obtain independent valuations, especially under a wealth tax regime, But even if they wanted to obtain one, this will not always be possible since most of the assets that constitute wealth are highly illiquid and non-standardised. To name one example, the Spanish wealth tax system was known to consistently under-value property prices by around 70%.

Third, wealth taxes distort markets in significant ways as taxpayers seek to minimise liabilities; taxpayers can sell property and rent it back, lease yachts instead of owning outright, use equity release schemes to reduce their net equity in properties, and, of course, move their deposits (if counted as wealth) to another country.  This last option makes it hard for countries like Greece to levy any taxes on deposits unless they have the option of also implementing capital controls. I, for one, see no coincidence in the fact that Greek deposit flight accelerated following a series of news stories in January and early February claiming that Syriza was planning to tax deposits. While I cannot vouch for the quality of the sources cited by the press at the time, this plan chimed with a set of 2013 proposals made by one E. Tsakalotos, better known today as our Much More Agreeable Lead Negotiator with the Troika Institutions.

Finally, wealth taxes cost a lot to administer; they require a lot of high-quality information to run, when most states struggle to get even the basics right. Greece is struggling to get a register of property ownership together, let alone take stock of other assets.

So how much could we raise?

The tax yield from such exercises has varied across countries but as a rule it has been surprisingly small.  In Sweden, with a hundred years’ experience of wealth taxation and a vastly different tax culture to Greece’s, the wealth tax never raised more than 0.4% of GDP before being abolished. In France, it never raised more than 0.25% of GDP and in Spain it never raised more than 0.22% in recent history. The European Commission’s recent review of international wealth taxation found that revenues from net wealth taxes throughout Europe didn’t seem to exceed 0.5% of GDP in any country – about EUR1bn if applied to Greece. Historically, only small and very wealthy countries able to exercise capital controls seem to have achieved more – Switzerland probably owns the record at about 3.5% of GDP.

These examples are not entirely typical of what the Greek government could expect. Wealth taxes in other EU countries have generally focused on a narrower share of the population than the Greek government envisages and none have been implemented in the kind of struggle for survival the Greek government finds itself in. When the IMF used ECB data to calculate what might be raised on a recurring basis from a tax on the top 10%, they arrived at an estimate of around 1% of GDP across the EU (see pg 39 here). The closest equivalent to Greece might still turn out to be the case of Iceland, which reintroduced a net wealth tax in 2010, and originally set it to sunset out in 2014. We know exactly how much this raised – ca 0.9% to 1% of GDP in 2013 and 2014, despite the added support of capital controls.

That's the top-down approach. But a bottom-up estimate is also possible. My guess is that the pain threshold for such a tax is to cause taxpayers to pay as much as they would do if they had declared all income, but also not sell assets or eat into deposits, and also maintain their target ratio of liquid assets to income. If anyone is willing to try the math on this one, please leave a comment.

It’s hard to get to the liquid assets or the undeclared income of the top wealth decile in Greece, but extrapolating from the ECB’s figures for the four quartiles of the distribution back in 2009, I believe that their liquid assets might be around 3 times the group’s quarterly permanent household income (see Table 2 here for the data underlying my extrapolation). Additionally, we have estimates of unreported income by wealth quantiles from the groundbreaking work of Artavanis et al, who find that the top 10% by wealth under-report their income by ca. 50% (see Fig 1 here). That unreported income would also be part of the final tax base.

And how much would all of that that be?  Well even assuming the top 10% by wealth are also the top 10% by income (which they are definitely not) their liquid assets would not exceed 19% of Greece’s total annual household income, or ca. EUR42bn on 2013 figures, and their annual undeclared income would be around EUR28bn.

If pressed, I would say that an annual yield double that of the ENFIA income would be the best-case scenario in the medium-term, and on a very favourable set of assumptions. On balance, the risks are weighed to the downside, suggesting the wealth tax would have to be broadened, meeting fierce resistance along the way. But seriously, that's just me sticking my finger in the air. If you're willing to do the math, get in touch. 

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[1] Unlike other estimates, I am tempted to use the 2009 ratios from the ECB household consumption and wealth study, because I suspect wealthier households really do target liquid assets as a share of their annual income.

THOSE INEVITABLE EUROZONE CURRENT ACCOUNT IMBALANCES, REVISITED

Health Warning: See Manolis’ comment below and my response regarding the figures. By the looks of it, Eurostat didn't mess any figures up.

One of the core narratives employed in an attempt to explain the Eurozone crisis has always been a variant of the 'global imbalances' theme - the Euro peg puts member states on a treadmill, on which the weighted-average speed of the group sets the pace. If you can't keep up, you rack up current account deficits until you are unable to finance these and fall off. If you can keep up easily, you rack up current account surpluses at the expense of everyone else.

Since most of the trade carried out by Eurozone members is intra-Eurozone trade, the argument goes, it is impossible for everyone to achieve surpluses. The Eurozone treadmill is a zero-sum game, and unless you can lead the race, your best option is to exit.

Well the latest data can be found here, and they show that, at a price, current account deficits can come down within the Euro straitjacket. 

The detailed sources of Greece's adjustment can be seen here. It's mostly down to an improved goods balance, while a reduced net income balance is a distant second. 

'That's a recession for you' I hear some readers snort. Since Greece is in a deep downturn, imports must be falling and therefore the goods balance is improving. Except that's not the case. Looking at the goods balance in detail (data here), reveals the following:

And since better economists than me occasionally read this blog, a puzzle for you. Can you explain what happened to Greece's income debits in 2012 (data here)?

To my regret I was originally unable to, but my reader Manolis spotted the difference - Greek government interest payments. These fell by 2.2 percentage points as a share of GDP between 2011 and 2012 (see p 51 here), so they can probably account for most of the 2.7 percentage points loss of income debits during this period (data here).

My original guess, which I will keep up for historical reasons, was that the change had something to do with tax reform, since income debits spiked in mid 2002, following what was then called the 'mother of all tax reforms'. I theorised that the 2002-3 reforms had forced companies to change the way they used offshore companies to avoid tax, sending an increasing amount of money 'abroad.' I also thought that regulatory uncertainty around the tax reforms of 2012 might have momentarily stopped this flow of income. In fact, following Manolis' contribution, I would still offer my conspiracy theory to anyone trying to understand the remaining 0.5% drop.

For details of the 2002 reforms, and the pre-reform environment, see p. 26 onwards here and the image below:

THE GREECE VS. ICELAND COMPARISON YOU HAVEN'T HEARD ABOUT

Source is this paper from the Paris School of Economics, which is well worth reading in its own right.

Summary: Between 2007 and 2011, Greek deposits in tax havens nearly tripled. Icelandic deposits in tax havens fell to almost zero. And that's really all I need to say here.

UPDATE:  Turns out I do need to add something.

A VERY DIFFERENT VIEW OF THE FAILED GREEK STATE

I love Google Scholar.

Like all things hyperlinked, Google Scholar's number one unintended attribute is that it makes serendipity not just possible, but inevitable. You look for X, you find Y along the way.

Tonight I found myself looking, for the umpteenth time, for and at papers explaining Greece's record of Total Factor Productivity Growth after the 50s, as part of my efforts to expand this article. If you'd like to follow that thread, the best I found for you tonight was this paper on the incomplete convergence of Total Factor Productivity between Greece and other European countries.

Anyway, as I was leaping, monkey-like, from citation to citation with about 30 tabs open, I stumbled onto this paper, a review of about 60 years of productivity growth in Europe. In itself, it seemed to me like  the EU-KLEMS stuff I've read so much of, only a little out-of-date. I know I'm doing some solid researchers a great disservice in saying this but hey, it's my evening, I demand something slightly more interesting.

Then suddenly I stumbled on this phrase, which sounded eerily familiar:

"Harrison (2002) considers a game between the Dictator (D) and the Producer (P) to investigate when it will pay both parties to maintain a high coercion, high effort with monitoring equilibrium."

I love that phrase: 'high coercion, high effort with monitoring equilibrium' - it implies there's an opposite equilibrium involving low coercion (well, by the standards of an abstract Dictator), low effort and monitoring. And that, my friends, sounds a little like Greece.

You see, Greece is a paradox of both over- and under-regulation, where an overbearing, omnipresent state coexists with a truckload of employer misconduct, poverty, rent-seeking, anticompetitive practices and cronyism. You can't call it socialism because profits (often in fact rents) are widely tolerated and the state's safety net was full of holes in the best of times. You can't call it capitalism, because price signals are either supressed or hopelessly distorted by state intervention. So here's my hunch: the low-coercion, low effort and monitoring equilibrium that Harrison blames for the collapse of the Soviet Union is in fact also responsible for the failure of the Greek State, which, despite undisputedly democratic elections, remained unreconstructedly authoritarian in its function except where it was forced by outside stakeholders (usually the EU) and the threat of a popular backlash to act otherwise.

Harrison (2002) is in fact this paper and I urge you to read it. Some of it is game theory; most is in fact economic history illustrated by facts, figures and equations. Harrison, as we've seen, set up a game with two agents: the producer and the dictator.

"The dictator maximises a payoff made up by the value of rents less his costs and losses, while producers maximise their income received in wages and bonuses and appropriated through theft, less the costs of effort and punishments."  

In the Greek case, for 'producers' read 'businesses and the self-employed' - the mix of 'wages' and 'bonuses' would be different to what Harrison expected under this reading but I doubt this changes much. For 'Dictator' read, of course, the State, but in a broader sense, reflecting the particular social classes and interests that hold the State captive for a particular period of time. Output theft relates to entrepreneurs' failure to render the tax and social contributions and regulatory compliance expected by the State, whether through avoidance (legal) or evasion (illegal). Of course calling these things 'output theft' is not the libertarian view of tax, but it definitely fits the authoritarian view quite well. For a quick analysis of how regulation is a tax, I would refer you to pg 14 here. You might argue that Harrison doesn't have regulation in mind when speaking of Dictator's rents, but actually he does - just check out page 21 here.

"The dictator sets coercion high or low by deciding whether or not to monitor. Without monitoring the dictator cannot stop producers stealing output. The dictator raises coercion by monitoring output, which efficiently eliminates stealing, but monitoring is costly and is a deduction from their rents. When output is monitored, high output can be rewarded and low output punished."

"Output depends on both effort and the scale of punishments. Producers decide whether effort is to be high or low. When effort is low, the value of output is positive and the producer cost of effort is zero. When effort is high and has a positive cost, the value of output is raised by the value of effort. Output depends also on the scale of punishments, because firing and forced labour reallocate workers towards employments of lower intrinsic productivity. Output is high when effort is high, low when effort is low and low output is unpunished, and lower still when low output is punished. (Because planners know who is being punished, the dictator can discriminate between the output loss arising from low effort and that arising as an indirect cost of the punishments he has imposed, so he does not try to punish the latter twice." 

In the long run the scope for high coercion depends positively on the dictator’s return from high effort, the cost to the dictator of not monitoring, and maximum feasible or credible punishments, and negatively on the costs of effort and monitoring. It also depends positively on the excess of the dictator’s discount factor over that of producers. The more the dictator is orientated towards the long run, the more he will pay to sustain coercion in the present; the more producers are orientated towards the short run, the less they will sacrifice to persuade the dictator to abandon coercion. 

So how does the system collapse? For Harrison the two key variables are the cost of monitoring the economy and the Dictator's reputation. He argues that post-industrial economies are much harder to monitor than agrarian or industrial ones, making it unsustainable for the command economy to maintain a high-monitoring equilibrium. Some reforms can, of course put things back on track rather than undermine the Dictator - but in Greece's case the reforms would have had to increase tax administrative capacity - which never worked. In fact, even to this date the reaction to every effort at increasing the State's capacity to monitor is staggering, as the IMF's most recent review of the Greek bailout reveals:

To cut a long story short, here is a summary of Harrison's findings:

• The system remains stable right up to the point of collapse.
• Command economies can secure stable high output through artificial incentives, under given historical circumstances.
• Coercion can be legitimate socially but not legally. Authority that rests on coercion cannot make binding commitments. Rather, the credibility of commitments rests on the Dictator’s reputation, which is fragile and may be lost if coercion is relaxed once. The absence of binding commitments results in a time-consistency problem for central planners.
• In exercising coercion the dictator is rationally secretive. Both the dictator and producers may exploit information asymmetries to shift payoffs in their favour. Specifically, the dictator will conceal monitoring and punishment costs, and producers will exploit the difficulty of observing effort to overstate its subjective costs and secure improved rewards.
• Command economies may be undermined by adverse trends in monitoring costs. Changes in the means and complexity of production can raise the costs of monitoring producers. When monitoring becomes unprofitable, the dictator will abandon high coercion.
• Command economies may also be undermined by bad policy. Too much and too little coercion are both destructive. Too much means overreliance on penalties. Too little means tolerating rent–seeking and erosion of the dictator’s reputation. Both can undermine the profitability of monitoring.
• Command economies can be undermined by economic reforms. Moreover, the cycle of reforms and counterreforms can harm the dictator’s reputation.
• The dictator’s surrender, not workers’ resistance, triggers the system’s collapse.

  

YOU SHALL NOT HAZ!

Dear readers,

I've waited a long time for a juicy academic paper to come along that discusses the state and prospects of the Greek economy and have come up with the occasional gem now and then. But I think I found a real good one the other night.

Through this discussion on VoxEU.com, I became aware of a new working paper by Matthias Traband of the Fed (yuk!) Board of Governors and Harald Uhlig of the University of Chicago which tries to answer a very fundamental question: how much can sovereigns tax before they reach their maximum tax take?

This question is based on the Laffer Curve hypothesis: if zero effective tax rates produce no government revenue, and 100% effective tax rates also produce no government revenue (as all economic activity ceases), then there must be a point in between where the economy is taxed as much as it possibly can be; further increases in headline tax rates will simply reduce the government's tax take by providing disincentives towards work and investment. I know many readers on the Left will resent the idea of the Laffer curve: filthy neoliberals telling them what they can and cannot do, as though the world were not infinitely malleable to their political preoccupations! And true enough the Laffer curve is hardly as fixed and stable as it looks on a blackboard. Today's Laffer curve is tomorrow's laughingstock.

But the core insight is undeniable - no government anywhere in the world taxes its citizens and businesses above a certain point, as they implicitly know that beyond a certain point they will only end up hurting themselves.

Anyway, I strongly urge you to read the Traband and Uhlig paper, as it specifically calculates two core variables to any future model of the Greek economy - the maximum sustainable interest rate and the maximum sustainable tax take. As p. 26 indicates, the highest interest rate Greece could have sustained back in 2009 was 7.4%. I'm pegging this to 2009, as the 2010 calibration uses 2009 figures and is therefore completely useless in our case. This indicates that, although the Greek state is insolvent, the actual interest rate imposed by our creditors is currently just about sustainable. More importantly, the highest amount by which we could sustainably increase tax revenues to GDP compared to 2009 was 4.8%, on top of the 37.9% we were getting in 2009 - so essentially 42.7%.

This is important because the tax revenues assumed by the IMF's debt sustainability report  are 41% of GDP - a sustainable figure as it turns out. However, it also means that, barring a fundamental shift in the structure of the Greek economy, 42.7% is the maximum amount of primary government spending we can sustain. It's the limit to the size of the state.

How do we get there is the question. Traband and Uhlig show that taxing capital alone can only provide an additional 2.4% of GDP and take us to 40.3%. Taxing labour alone would only provide 4.4% of GDP and take us to 42.3%, which is sustainable but sub-optimal. Whatever happens, we'll have to rely more on labour taxes than capital taxes. And whatever happens, it's simply not possible for the Greek state to sustainably grow to more than that 42.7% of GDP. People should bear a realistic calibration of the Laffer curve in mind before they make comparisons between Greece and other European countries - the argument is often made that the Greek state is not too big, given that the EU average for government spending is higher than ours. The simple answer is, that's their Laffer Curve; not ours.

In the words of LOL-Gandalf, YOU SHALL NOT HAZ!

THINGZ FALLZ APART, TEH CENTRE NO CAN HOLDZ

Breaking news: The Greek Treasury Minister in charge of revenue has just quit, citing personal reasons.