The Dictator's Handbook (16 page)

Needless to say, people want to be sleek and satisfied and not lean and apprehensive. That is why they remain loyal. A heavy tax burden emphasizes the differences between being rich and poor—in or out of the coalition. At the same time, the resulting revenues fund spoils for the lucky few, leaving little for everyone else. Further, the misery such heavy taxes inflict on the general population makes participation in the coalition even more valuable. Fearing exclusion and poverty under an alternative leadership, supporters are all the more fiercely loyal. They will do anything to keep what they have and keep on collecting goodies. Gerard Padró i Miguel of the London School of Economics has shown that the leaders of numerous African nations tax “too” highly (that is, beyond the maximum revenue point) and then turn around and provide subsidies to chosen groups. This may be economic madness, but it is also political genius.
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Democrats tax heavily too and for the same reason as autocrats: they provide subsidies to groups that favor them at the polls at the expense of those who oppose them. We will see, for instance, that Democrats and Republicans each use taxation when they can to redistribute wealth from their opponents to their supporters. So democratic governments also have an appetite for taxation but they cannot indulge that appetite to the extent autocrats can. Since their numbers are small, an autocrat can easily compensate his essential backers for the tax burden that falls on them. This option is not available
to a democrat because his number of supporters is so large. Tax rates are therefore limited by the need to make coalition members better off than they can expect to be under alternative leadership. On the campaign trail, US president George H. W. Bush told the American people, “Read my lips, no new taxes.” Yet, budget shortfalls left him scrambling for revenue. The result was more taxes. In the wake of the First Gulf War, just eighteen months earlier, Bush had approval ratings of over 90 percent. But a declining economy and his broken promise on taxes led to his ouster in the 1992 election. While all leaders want to generate revenue with which to reward supporters, democratic incumbents are constrained to keep taxes relatively low. A democrat taxes above the good governance minimum, but he does not raise taxes to the autocrat's revenue maximization point.

The relationship between regime type and taxation can be seen in the recent history of Mexico. Mexico's first free election came in 1994, and the incumbent party, the Partido Revolucionario Institucional (PRI), lost nationally for the first time in 2000. As can be seen in
Figure 4.1
, onset of competitive elections (and of democratization) marks the start of the decline in government revenue as a percentage of gross domestic product (GDP). As the size of the winning coalition enlarged, Mexico's tax rates followed suit by declining, just as they should when politicians need to curry favor with many instead of a few. For instance, the highest marginal tax rate in Mexico in 1979, with the PRI firmly in control, was 55 percent. As the PRI's one-party rule declined, so did tax rates. By 2000, marking the first truly free, competitive presidential election, Mexico's highest tax rate was 40 percent.
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Members of any autocrat's small coalition also dislike paying taxes, but they readily endorse high taxes when those taxes are used to funnel great wealth back to them. This was just the case in Bell, California. City Manager Robert Rizzo raised property taxes. The city council could have stopped such increases, but had they done so, the city could not have afforded their bloated consultancy fees. Suppose for simplicity that Rizzo's coalition was composed of 1 percent of Bell's 36,000 residents. For every dollar increase in tax per person, Rizzo would have had up to $100 of services and payments he could transfer
to each coalition member. Had his coalition been composed of half of Bell's residents, each dollar increase in tax would provide only $2 per coalition member for transfers and services. It is easy to see why the coalition would sooner endorse higher taxes in the former setup than the latter.

 

FIGURE 4.1
Mexico's Tax Take and Democratization

Nevertheless, to most of us who live in democracies, the idea that our taxes are actually less than in other systems might sound frankly absurd. If you live in New York City, as we do, you pay federal, state, and local taxes (as well as social security, Medicare, and sales tax). If you earn a reasonably good income, then income taxes suck up about 40 percent of your earnings. By the time you factor in sales, property, and other taxes, a reasonably wealthy New Yorker will have paid more than half her income in tax—hardly a low figure. European democracies, with their extensive social safety nets and universal health care, can tax at even higher rates. In contrast, some autocracies don't even have income taxes. But the comparison of average tax rates is misleading.

At the income levels taxed in much of the world's poor autocracies, the tax rate in Europe and the United States is zero. We have to compare taxes at given income levels, not across the board, since most income tax systems are designed to be progressive, taxing higher incomes at higher rates than lower incomes. By looking at how much tax has to be paid at a given income level across countries we get close to comparing apples to apples and oranges to oranges. In the United States, for example, a couple with one child and an income under about $32,400 pays no income tax. If their income were, say, $20,000 they would
receive
$1,000 from the federal government to help support their child. In China, a family with an income of $32,400 is expected to pay about $6,725 in income tax.
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Further, even when nominal rates are low, autocracies have high implicit taxes—if you have something valuable then it simply gets taken.
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It's worth remembering that the wealthiest man in China and the wealthiest man in Russia are both currently in prison.

In 2004, Mikhail Khodorkovsky was the wealthiest man in Russia and the sixteenth wealthiest man in the world. He made his money building up Yukos, an oil company founded in the privatization wave in Russia in 1993. Yukos was the largest nonstate oil company in the world and accounted for about 20 percent of Russian oil production. Khodorkovsky, who had initially been close to the government, spoke out about Putin's autocratic rule of Russia and he funded several opposition political parties. In 2003, he was arrested on fraud charges and subsequently convicted. The Russian government accused Yukos of tax evasion. According to Yukos, the tax take claimed by Russia from Yukos was substantially higher than that levied on other oil companies and, in some years, exceeded gross revenue. These enormous tax burdens forced Yukos into bankruptcy. With the end of his first eight-year sentence, Khodorkovsky, apparently still seen as a liability by the Russian government, was recently given a second sentence for embezzlement and money laundering.

His Chinese counterpart, Huang Guangyu, also known as Wong Kwong Ku, fared little better. Starting with nothing but $500 and a street cart, Guangyu created Gome, the largest electrical retailer in China. He was repeatedly ranked as China's richest individual—until
he was sentenced to fourteen years in prison for bribery. It is likely that he was guilty since bribery is commonplace in Chinese business dealings. It is also likely that he and others who have been prosecuted for corruption in China were “chosen for political reasons.”
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In autocracies, it is unwise to be rich unless it is the government that made you rich. And if this is the case, it is important to be loyal beyond all else. As we noted, it is quite possible that Guangyu and Khodorkovsky were both guilty of fraud and bribery. That is the nature of business in their respective countries. Even so, many others were surely guilty of the same crimes and yet walk free today. What singled them out was that they did not support the government and they had enormous wealth. White farmers in Zimbabwe suffer a similar fate. Robert Mugabe's government seizes their land. The cover for these seizures is land redistribution to poor blacks who were dispossessed under colonial and white minority rule. The reality is much different. The land invariably ends up in the hands of cronies, none of whom are farmers. When the new owners invariably allow the land to fall into disuse, the farmers lose their investments, farm workers are evicted from their houses, and Zimbabwe, once a huge agricultural exporter, becomes hungrier. But on the other side of the ledger, Robert Mugabe is still in power.

Democrats are less inclined to rewrite the rules and seize wealth. Tempting though extra revenue is, it comes at the cost of lost productivity to the masses. In Shakespeare's
Merchant of Venice,
the heroine, Portia, disguises herself as a judge and adjudicates at the trial between Antonio, who pledged his person as security on a loan, and Shylock, who demands his pound of Antonio's flesh when Antonio does not pay in time.
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Bassanio, Antonio's friend (and Portia's husband), offers to pay many times the debt due and when Shylock refuses, he appeals to the mercy of the court: “And I beseech you, Wrest once the law to your authority: To do a great right, do a little wrong. . . .”

But Portia recognizes the sanctity of the law: “It must not be; there is no power in Venice Can alter a decree established: 'Twill be recorded for a precedent, And many an error by the same example, Will rush into the state: it cannot be.'”

The many messages of the
Merchant of Venice
are complicated and controversial, but one message, epitomized by the passage just quoted
(but not the reversal in the enforcement of contracts just a bit later in the play) reminds us that rule of law is essential to successful commerce. As one examination of the demands of commerce as seen in the
Merchant of Venice
makes clear both for Venice and in general, “Contract does not require friendship, but it does require a degree of trust that the market is well-regulated or that the institutions of contract enforcement are appropriately strong.”
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Democrats need resources so they can reward their coalition, but they can't take too much or they risk alienating those very same supporters. Similar concerns shape how taxes are collected. Leaders want to collect taxes in a “fair” or at least transparent way. Few US citizens would regard the Internal Revenue Service (IRS) as a transparent tax authority, but it is at least governed by rules (albeit an awful lot of them) and enforced by an independent judiciary. As for all the rules and exceptions that make the US tax code so complicated, these inevitably result from politicians doing what politicians inevitably do: rewarding their supporters at the expense of everybody else. This is why sheaves of pages in the tax code are dedicated to farmers—a crucial coalition for some politicians, who need to receive their rewards if their senators and representatives are to remain in power.

Autocrats can be less transparent. As we saw in the case of the unfortunate Messrs Khodorkovsky and Guangyu, when the opportunity arises autocrats will grab whatever they can. Yet even as they work without the constraint of being bound by people's feelings, autocrats face real issues in the realm of collecting taxes. High taxes will inevitably drive people to hide their work and profits. This makes monitoring their income difficult. Furthermore, the large bureaucracy required to run a comprehensive tax system, such as the one in the United States, can be prohibitively expensive. To put this in context, the US's Internal Revenue Service spends about $38 per person, or about 0.5 percent of the IRS take, on collecting an average of $7,614 in tax per person.
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This is fine in a nation with per capita GDP of
$46,000, but in nations with incomes of only $1,000 per year, such a cost of collecting taxes would be about 23 percent of the revenue. Further, setting up a large bureaucracy makes an autocrat beholden to those who run it. The first rule of office holding is to minimize the number of people whose support you need. To avoid becoming a slave of their own tax collectors, autocrats often use indirect taxation instead. With indirect taxes, the cost of the tax is passed on to someone other than the person actually paying it. For instance, sellers pay sales taxes to municipal governments but sellers pass the cost on to buyers, making sales taxes indirect.

Agricultural marketing boards are a common indirect means of taxing poor farmers in autocracies. In principal such organizations are designed to fulfill a similar function as the European Union's Common Agricultural Policy (CAP). The CAP guarantees farmers minimum prices for their goods—thus it provides a benefit to the farmers. In many democracies, as in the United States, rural areas are overrepresented electorally. Given the desire to rule with as few supporters as possible, it should be of little surprise that democrats often include farm groups in their coalition and reward them accordingly.
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