Rand Paul’s Economic Freedom Zones

Are you tired of high taxes? Then move to Liberland.

Liberwhatnow?

A self-professed Libertarian politician from the Czech Republic says he has created a new, sovereign country on the Croatian-Serbia border where citizens decide their own tax burden, property and individual rights are respected and the national motto is “Live and Let Live.” Vít Jedlička, a member of the Conservative Party of Free Citizens, recently appointed himself president of the Free Republic of Liberland, a “micronation,” located on the banks of the Danube River in a 2.7-square-mile patch of what he says is unclaimed territory. Jedlička says neither neighboring nation claimed the land when they established their borders following the breakup of Yugoslavia, and claims international law allows his claim.

While this sounds like a pie-in-the-sky idea concocted by some idealist libertarian, it is actually more serious than that. The land patch Mr. Jedlicka has claimed is four times bigger than Monaco, a well known freedom zone in otherwise heavily statist Europe, and almost exactly the same size as Gibraltar. In other words, at least in terms of territory “Liberland” is big enough to give its residents a fair chance.

But regardless of whether Mr. Jedlicka ever manages to create Liberland, his idea is presents a theoretical and political challenge to statists and libertarians alike. Government involvement in our lives, our families and our businesses has reached such a level that it is almost unimaginable that unabridged freedom is almost unimaginable. Big government has become a way of life.

The best way to shake up the conventional-wisdom image of big government as a given structure in our society is to do what Mr. Jedlicka is suggesting: to carve out a chunk of land and allow it to compete with big-government nations as a libertarian jurisdiction.

Better still: we don’t have to go to such extremes as Mr. Jedlicka does in order to allow libertarian ideas to compete with statism. We can take the “Liberland” vision and translate it into a practical, actionable model here in the United States. In fact, Senator Rand Paul has already taken a step in that direction:

Twenty-five counties in Kentucky, most of Detroit, and many of America’s large cities suffer from chronically high unemployment. Government stimulus packages haven’t worked because they insist on picking winners and losers. I propose a stimulus that simply leaves more money in the hands of those who’ve earned it. Economic Freedom zones – areas of reduced taxes – are different than a government stimulus. Economic Freedom Zones encourage businesses and individuals which the market has already selected. Only one out of ten small businesses succeed. Consumers vote every day on which businesses succeed. Reducing taxes in economically depressed areas is a stimulus that will work because the money is returned to businesses and individuals who have already proven that they can succeed.

The theory behind the idea is that there is a defined set of obstacles that stand in the way of entrepreneurship, jobs creation and rising prosperity; if those obstacles are removed the zones will thrive and lift their residents out of poverty and despair.

There is nothing wrong with this theory. In fact, there is a lot of support for it from experiences around the world over the past several decades. Commonly these areas are called Special Economic Zones, simmply because the term “economic freedom zone” hints that the economic success of those zones has something to do with economic freedom.

In reality, most Special Economic Zones have been created as a tool for providing businesses with more favorable conditions than are otherwise offered in a country. The original recipe for a Special Economic Zone was the removal of trade barriers and generally lower taxes; over time some zones have added financial incentives – also known as corporate welfare – and preferential treatment based on, for example, the geographic origin of investing companies. These measures are contradictory to the principles of economic freedom.

Senator Paul’s model is not aimed at providing preferential treatment within the zone, nor does it come with corporate welfare (a spending practice the senator opposes). He has instead taken a step back to the original concept and proposes that select cities and counties in the United States should be favored by:

  • Reduced individual and corporate income taxes to a flat five percent;
  • Cut the payroll tax by a total of four percent;
  • Elimination of some federal regulations;
  • Vastly expand Section 179 expensing (allowing businesses a deduction for production inputs such as tools); and
  • Suspend the capital gains tax.

The idea of jurisdictional competition with economic freedom zones side by side with the big-government economy is inspiring. However, there are at least three issues that Senator Paul should consider in moving forward with his idea:

1. The duration of the zone itself. The advantages offered by Senator Paul’s zones will benefit small businesses with high mobility and low fixed costs of operation. These are companies that can take immediate advantage of lower taxes, especially if they are labor-intensive. But if the zones do not last more than a few years, these companies will be ready to move to where post-zone economic conditions are better. If this happens, the revitalization may turn out to be temporary. Larger, more long-term oriented businesses require lasting beneficial economic conditions, in other words that the freedom zones gain permanent status.

2. Jurisdictional overlap. Senator Paul’s proposed zones would be entirely federal in nature. Since the federal government is an intrusive entity in the economy, it carries some promise of success that this would be a federal project. At the same time, there is a significant risk that states and local governments would try to get their share of the prosperity generated by the zones. A lower corporate income tax could, for example, be countered by a higher state income tax, just as a lower income tax in a city could be countered by an increase in the local income tax. In other words, to maximize the likelihood of success Senator Paul’s proposal must incorporate reciprocity agreements with other jurisdictions: no counter-measures by states, cities, counties and townships.

3. Venture capital supply. Senator Paul’s model creates better economic conditions and it is reasonable to expect a surge in entrepreneurship within the zones. At the same time, there can be no significant improvement in economic conditions without supply of venture capital. Since a major problem in impoverished areas is the lack of local venture capital, it is important that Senator Paul’s model is constructed in such a way that outside venture capitalists will consider supporting new and growing businesses in the zones.

This last point is perhaps the most crucial one. The type of funding can make a big difference, as exemplified by the revitalization of this neighborhood in Cleveland.

Senator Paul’s idea is not complete as it stands today – it needs to address the issues presented here – but it is definintely worth taking seriously.