A Recipe for Recession

This news that Germany is planning on raising its value-added tax next year from 16 percent to 19 percent (the largest increase in the VAT’s forty years) is a terrible idea.

Terrible.

And, the fact that Japan is considering a similar tax hike is equally worrisome.

Investors Business Daily spells it out nicely today:

“...At the same time that taxes are going up, central banks — from Frankfurt to Washington to Tokyo to Beijing — are raising interest rates or otherwise clamping down on money-supply growth. If this trend of higher taxes and tighter credit continues, it could mean a massive slowdown, if not an outright recession, in the world's major economies.

We're not trying to be alarmist. Right now, conditions are very positive. But data show the world is already overtaxed. As a matter of efficiency, countries perform best when government's tax take is relatively small — about 20% of GDP. Above that level, economies start to suffer. Repeated studies bear this out.

Perhaps the most famous, by Harvard economist Martin Feldstein, found that high rates of taxation cost countries more than $1 in output for each dollar of added taxes imposed. Likewise, World Bank studies of dozens of economies going all the way back to 1983 find pretty much the same thing....”

A combination of tight money and tax hikes is a formula for recession. On the other hand, tight money and lower tax-rates is a tried and true growth formula--the Reagan model. History bears this out.

With investor tax cuts extended until 2010, and tighter money from the Fed, the U.S. is still on the right path for now. But Congress still needs to make these pro-growth tax cuts permanent.