Cry For Thee, Argentina

Those who are blithely assuming that the American economy will be able to raise taxes to redeem the bonds held by the Social Security Trust Fund (not to mention to come up with the money for Medicare's promises) ought to ponder the dynamic described in this McKinsey Quarterly report:

Argentina’s residential-construction sector is a prime example of the way tax evasion and regulatory barriers distort competition and hinder productivity. As a rule, it is far more cost-effective to build large-scale housing developments consisting of standard homes than to build the same number of customized homes, because the large-scale developer achieves economies of scale. Thus in a normal housing market, only affluent families can afford to buy plots of land and build customized houses. It is therefore a startling anomaly that some 85 percent of single-family homes in Argentina—not a particularly prosperous country—are custom-built. By stark contrast, in the far wealthier United States, 75 percent of all single-family homes are built in large-scale developments of 20 or more units.

A market distortion is clearly at work: in Argentina, a unique house costs no more to build than a standard one, though the labor productivity of a house in a large-scale development is double that of a single-plot house. Why are the normal laws of the market reversed? The answer is that by evading the value-added tax, or VAT (21 percent on materials and 10.5 percent on construction work), and labor taxes (around 20 percent on top of wages), small firms developing single-plot houses can compete equally with—or even outgun—large-scale developers who pay taxes.

The theoretical cost of building an average single-plot home in Argentina breaks down as follows: land, 14 percent; general-contractor profit and administrative expenses, 17 percent; project management, 3 percent; materials, 29 percent; labor and labor taxes, 22 percent; and other taxes such as VAT, gross-income taxes, and stamp taxes, 15 percent. In reality, however, smaller companies, which are harder for the tax authorities to track, can usually cut the overall cost to the tune of some 18 percent by evading their VAT, gross-income taxes, and stamp taxes completely and by paying, on average, no more than 50 percent of the labor taxes they owe. Small build-ing firms typically declare only the proportion of their wage bill that they would pay under the required minimum wage. The rest they pay, in cash, under the table.

By spreading the architect’s fee over a large number of houses, purchasing materials in bulk, and using equipment capacity more efficiently, the big developers can cut their overall costs by 19 percent. But their costs are only about equal to those of single-plot builders when tax evasion is taken into account....

The same thing happens in the Argentine food processing industry, as small firms and individuals find ways to evade onerous taxes.

Similarly, in the United States, since roughly the end of World War II, under a variety of tax codes (with top marginal rates as high as 90% and as low as 28%) the Federal government has taken in only about 18-1/2% of GDP in revenues.

There is a limit to what Government can collect, and that bodes ill for the promises the government has been making to Baby Boomer potential retirees. No matter how many I.O.Mes it writes to itself.