The mouse that squeaked

Alan Reynolds
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Posted: Oct 16, 2003 12:00 AM

In "The Mouse That Roared," a 1959 Peter Sellers movie, the tiny country of Fenwick declares war on the United States in the hopes that it will quickly lose and then receive oodles of postwar aid. Replace Fenwick with Iraq, and you get a pretty good idea of what some people mean by "rebuilding" Iraq -- namely, a potentially endless transfer of funds from U.S. taxpayers to Iraq.

President Bush campaigned against "what's called nation building," yet nation re- building now appears to be the main rationale for keeping 116,000 U.S. soldiers in Iraq. What is ultimately required, however, is for Iraq to become economically self-sufficient. And that requires, above all, economic liberation -- getting the government out of meddling with peoples' lives except when it comes to protecting lives and property.

It seems fair for the United States to repair the damage caused by U.S. bombs. But too much help can be addictive and unhelpful. Like welfare, foreign aid can discourage productive effort and encouraging chronic dependency.

What Iraq needs most right now is not even democracy, desirable as that may be, but capitalism. Even Osama bin Laden dismissed Saddam Hussein as a "socialist apostate." And Iraq's foolish experiment with socialism even predates Saddam. A recent Congressional Research Service study notes that "government control of the economy tightened from one regime to the next;" adding that in 1989 Saddam "reimposed price controls, re-nationalized some state enterprises, and raised industrial and agricultural subsidies." Nearly everyone in Iraq thus became wholly dependent on a government with absolute and absolutely corrupting power.

Socialism was no more effective in Iraq than it was in, say, North Korea. Iraq's economy shrunk by half over the past three years, according to estimates from the World Bank. Average income in Iraq will be only about $450 to $600 per person by the end of this year, the World Bank estimates, down horrifically from $3,600 during the oil boom of 1980. Half the population is unemployed or barely employed, and the government employs 30 percent of those who do have jobs. Everyone gets a monthly food package, at a cost of $2 billion a year, thus discouraging many people from getting in the business of producing and distributing food, while discouraging others from bothering to work for their supper.

The idea of "rebuilding" Iraq is wrong. What Iraq was before the war does not need to be rebuilt. The old socialist Iraq needs to be completely demolished so a free economy can provide the means to prosperity. And not much hope should be placed on the U.S. occupation.

Several writers point to the Allied occupation of Germany and Japan after World War II as examples of occupation being conducive to economic recovery. But the "economic miracles" in Germany and Japan did not really begin until occupation ended.

In Germany, Finance Minister Ludwig Erhard raised the income threshold at which the Occupation's 50 percent tax rate applied from $500 a year to $2,200 on June 22, 1948, and to $5,000 in the following year. The income level at which the occupation's top tax of 95 percent applied was immediately raised from $15,000 to $63,000. The top rate itself was brought to down to 63 percent at $250,000 by 1955 and to 53 percent by 1958. Overtime was even tax-exempt in the early years, which means the marginal tax on extra work was zero.

The occupation of Japan lasted from Aug. 30, 1945, to April 28, 1952. As in Germany, occupation tax rates were brutally punitive, with at top tax rate of 86 percent applying at middling incomes. As soon as the occupation ended, Japan cut taxes in every year but one from 1952 to 1974. The income needed to fall into the 60 percent tax bracket was raised from 300,000 yen in 1949 to 3,000,000 in 1953. A tax on wealth was abolished in the same year. The top tax rate was soon cut to 55 percent, and interest income and capital gains became tax free.

Like every other "economic miracle," the remarkably fast recoveries of post-occupation Germany and Japan were largely the result of replacing bureaucratic austerity with bold supply-side tax policies.

The American occupation in Iraq may be more enlightened today. Yet there is an almost unavoidable tendency of military people to over-organize everything. And there is an equally unavoidable tendency among diplomatic people to shun dramatic change and minimize risk. Big problems need big solutions, and the most seriously liberating reforms are most likely to come from local political entrepreneurs with a personal stake in success.

A month ago, Iraqi Finance Minister Kamel Al-Gailani announced that the maximum tax rate on individual and corporate income will be 15 percent next year, and the maximum tariff on imports will be 5 percent. Although Iraq might be better off skipping income taxes in favor of a simpler sales tax or value-added tax, it is hard to complain too much about tax rates below 15 percent. Sadqiq Jafar, a writer with ameinfo.com, notes that under Iraq's 1982 Tax Law, corporate and individual tax rates approached 60 percent. That steep tax raised very little revenue, but it repelled foreign investment and provoked emigration of skilled people and their capital.

Unfortunately, the provisional government is still counting on oil (indeed counting on somehow doubling oil production next year) for nearly all government revenue. That oil revenue should instead flow to the people of Iraq, through privatization. Once empowered with shares, citizens might choose to sell some of those shares to foreign investors who could quickly develop the terribly neglected socialist oil fields. Alternatively, the quasi-government could at least offer 50-year leases on oil properties to foreign oil companies, collecting revenues in that way while not wasting all the booty in salaries and subsidies, as is done today.

Because of Iraq's urbanization and strong regional loyalties, it would be smart for the new constitution to form a federal republic. That means limiting central government functions to providing for the common defense, a common currency and a common market, and facilitating the private development of modern interstate highway, rail, power and communication systems. Provincial and city governments would need their own revenue sources, such as property and sales taxes.

My advice is just advice, to take or to leave. Occupation forces, on the other hand, can easily become too pushy. Rather than "rebuilding the old Iraq," the Iraqis themselves are going to have to build a new Iraq -- a process that requires more wisdom and less dependence on foreign aid. The Iraqis are the only ones who have the knowledge and incentive to get it right.