Taxes: best when broad

Here at the ASI we like taxes to be as predictable, as flat, as broad-based and as non-distortionary as possible—not to mention as low as possible. Until we've convinced everyone that we don't really need the government for most of the things it does now, we're going to need to raise revenue somehow. We want to do this in a way that reduces social welfare (and the economic activity that produces the goods to consume that produces the individual welfare that we sum to get social welfare) as little as possible.

Now we may sometimes need to use 'Pigovian' taxes—ones that discourage certain activities because they have negative outcomes on others—but most choices do not have substantial externalities. And in a society where property rights are clear and extensive, most substantial externalities will be priced in. For example, when roads are owned, their owners charge what we might call 'congestion charges': lots of problems arise only when some crucial good is un-owned and thus un-priced.

But generally we're just picking up revenue somewhere to pursue some government activity we view as worth the costs. Any non-Pigovian tax is going to reduce economic activity and welfare, but some more than others. For example, taxing investment into capital disincentivises most the activities which bring us greater productivity and wealth in the future. By contrast, if we could magically know, and tax, each individual's innate ability we wouldn't distort any decisions at all—because no decisions could change their tax liability.

The upshot of all of this is that broad-based consumption taxes are the best method of raising tax we can actually do. A 20% (or higher) tax on any good at any time leaves us as free to decide between options as no taxes, even though we have less in total to go round. By contrast any tax on capital or savings biases us in favour of current consumption over future consumption (and an income tax is partly a tax on savings).

The IFS tells us that scrapping all UK VAT exemptions would have raised £26-28bn in 2010-11 (since which we have grown substantially in real and nominal terms). In their view we could compensate everyone fully and still have £3bn left over.

A new job market paper from Bibek Adhikari at Tulane University in New Orleans takes this result further. Because VATs are usually implemented country wide, Adhikari builds 'synthetic controls'—essentially imaginary countries made up of weighted bits of other countries that didn't implement VATs—to properly test the effect of large-scale consumption taxation.

He finds that switching to consumption taxation leads to more capital invested per worker and higher total factor productivity (a measure of how good we are at using inputs), thereby raising output per head. In his words:

Five years after the reform, TFP of the treated group is 9.9 percent higher compared to the synthetic group and at its highest, the TFP of the treated group is 11.6 percent higher than the synthetic group.

So the ASI was right then!

There's a very slight problem with asteroid mining

Much excitement as the US decides that it's just fine if people go space mining. Which is interesting of course, for the UN rules say that while you're entirely free to go mining you're not to do it for a profit, it must be "for the benefit of all". Which slightly puts a damper on things. But there's another problem which the new US rules don't address: it's still not possible to own a deposit or resource up there. You are, now, under the new US rules, which the rest of the world doesn't recognise, allowed to explore, find and mine something, for that potential profit. But as soon as you start doing that then anyone else who can get there is entirely allowed to go mine that same deposit. That puts another damper on the economics of the adventure. However, as we've said around here before there's a rather more basic problem with the idea:

If that proposal is too large to take seriously, your horizons may have become too Earth-bound. The would-be asteroid miner Planetary Resources launched back in 2010. Its investors include Larry Page and Eric Schmidt of Google, whose bet on driverless cars sounded pretty silly a few years ago as well. While space mining remains a moonshot, with vast challenges for its pioneers, the potential rewards are stellar. One estimate suggests a single asteroid could contain more platinum than has ever been mined on Earth.

Mining asteroids to provide materials to build something in space sounds like a great idea given the cost of getting mass into space. Very early American houses were built, sometimes, of brick carried as ballast across the Atlantic: it didn't take long for people to realise that digging up some American clay and baking it was a more sensible idea. So it will be up there, use the resources there, not carry everything with us.

However, those starry eyed at the idea of those vast resources of platinum. What is the Earth bound price of platinum going to be if we double the amount that humanity has to play with? Somewhat lower than it currently is would be our prediction. And the elasticity of demand is, with respect to price, quite low for this metal. Meaning that a large increase in supply will lead to a very large decrease in price.

Again as we've said before, finding a bit of platinum up there would allow it to be sold down here for a high price, but a bit wouldn't cover the fixed costs of going. And finding a lot would depress the price possibly sufficiently that finding a lot wouldn't cover the price of going.

Doesn't mean we shouldn't go, doesn't mean we shouldn't go mining, but our slide rule tells us that mining for precious metals ain't gonna be the way to pay for it all. Rather an interesting twist on Adam Smith's diamonds and water paradox really: the truly valuable thing up there is likely to be the water that humans desperately need and is currently in very short supply.

Sadly, the IFS is wrong here

The IDS has a report out talking about how wealth is unequally distributed in the UK. And it's a good report, ticks all of the procedural boxes and emphasies one very important point. It's also entirely wrong.

The full extent of the wealth gap between Britain’s rich and poor has been laid bare by a thinktank report showing that 9% of households have no assets while 5% are worth in excess of £1.2m.

The study by the Institute for Fiscal Studies shows that the UK is a more unequal country when measured by wealth – the value of assets such as housing, pensions and shares – than it is when measured by income.

Obviously wealth inequality is higher than income: it's possible to have that negative wealth and we don't ever measure negative incomes. And the report (here) does emphasise an important point, that there's a life cycle to wealth. Generally, the young have no wealth, those on the verge of retirement are at the wealthiest they will be and then wealth declines as pensions are drawn down.

Except the report is still wrong. Because it doesn't include any of the things that we do to reduce the effects of wealth inequality. On pensions, for example, a private pension, or a public one earned from a job, is wealth: which it is. But the state pension is not wealth. and yet it's wealth in just the same sense that the other pension rights are.

Similarly, we count housing equity: but a lifetime tenancy at below market rents, like a council house, is also wealth and we don't count it.

The net effect of this is that all such reports (and we must emphasise that all such reports do work this way) measure the gross wealth inequality. It's as if we measured income inequality only by market incomes. And we don't, we measure income inequality after the influence of the tax and benefit systems. We ought to measure wealth inequality the same way but we don't.

After all, what we want to know is, should we be doing more here? And we cannot possibly even think about that until w know the situation after what we do do.

Time to pay for your own innovation mateys

We're approaching that time of the year when the Chancellor hands out the sweeties in the Autumn Statement. And so there's the usual calls for this or that sector to be given more sweeties. It is, as Mancur Olson said democracy degraded into, that time when the special interest groups get to carve up the flesh cut from the bodies of us taxpayers. And so we have industry making the ritual call, as predictably as pigs squealing at the sound of the swill bucket:

Manufacturers are set to unveil more gloom as their champions warn the Chancellor that the UK could be left in the industrial slow lane by cuts in support for innovation and exports.

"Cuts in support" equals less of our money.

Manufacturers are warning George Osborne that Britain risks squandering years of investment in hi-tech research and business support if he cuts support for innovation at the spending review next week.

"Innovation" is such a lovely word, isn't it? For we all like innovation and if government spends money on innovation then obviously we'll get more of it. Lovely! Mariana Mazzucato is right, the state can be entreprenurial.

Except of course that as with most academics at Sussex, she's not right, as Matt Ridley has pointed out:

In 2003, the Organization for Economic Cooperation and Development published a paper on the “sources of economic growth in OECD countries” between 1971 and 1998 and found, to its surprise, that whereas privately funded research and development stimulated economic growth, publicly funded research had no economic impact whatsoever. None. This earthshaking result has never been challenged or debunked. It is so inconvenient to the argument that science needs public funding that it is ignored.

In 2007, the economist Leo Sveikauskas of the U.S. Bureau of Labor Statistics concluded that returns from many forms of publicly financed R&D are near zero and that “many elements of university and government research have very low returns, overwhelmingly contribute to economic growth only indirectly, if at all.”

This is just Uncle Milton's four ways of spending money. If you're spending someone elses' money on someone else, as government does with innovation funding, not much will come of it. And if you're spending someone elses' money on yourself, as business does spending that tax innovation money, then the results are little better. But if you spend your own money on yourself, then efficiency and efficacy are the two prime targets and outcomes.

So, yes, let's increase the amount of innovation in UK companies. We would even like to increase the efficiency and efficacy of such spending. Which means reducing to zero the ineffective taxpayer funding of it all and telling companies to fund their own research and work themselves.

Garett Jones vs. Bryan Caplan on immigration

Garett Jones, one of my favourite economists, has a new book out, Hive Mind, about how the IQ of your compatriots is more important in determining your life outcomes than your own IQ. Since the IQs of people in the developing world is recorded as lower than the IQs of people in the developed world, this means that mass immigration could worsen our lives by lowering average IQ, since this feeds through to lower social trust and worse institutions.

This would reduce the value of open borders as a policy regime. But Bryan Caplan, famous libertarian advocate of more liberalised migration laws, disagrees, and they debate this issue here, in what I think is a very high quality and interesting tussle.

Yes of course Thomas Piketty is wrong, why do you ask?

It was obvious from the moment of publication that Thomas Piketty was wrong. Simply because the world just does not resemble his dystopia of a capitalist plutocracy. The much more interesting work has been picking apart his assumptions and arguments to work out why he is wrong. Our own opinion is that it's an entirely political work. Standard optimal taxation theory states that we shouldn't be taxing capital or capital incomes (rents are another matter). This is unacceptable to certain political types therefore an argument, any argument, for taxing capital and capital incomes must be constructed. The End, Finis.

However, that detailed work of why he's wrong continues. As with this reported by Branko Milanovic:

But then suppose that capitalists decide to spend some of their r on fancy cars and yachts. There would be a split between the rate of return on capital (which is still r), and the rate at which capital grows (which will be now equal to r*=sr where s is the average saving rate out of capital income). It is then very clear that if capital does not increase as fast as output, the share of capital income in total net output (Piketty’s alpha) may not increase. It is at its most obvious if we assume that s=0. Then capitalists spend their entire income, the capital stock does not grow at all, and if the growth rate of output (g) is positive, the capital/output ratio will go down, and Piketty’s alpha will decline. Notice that all of this happens while r>g still holds in the background (on the production side).

If capitalists spend some of their income from capital then while the return to capital can be more than the growth of the economy, it does not necessarily follow that capital will ever increase sa a portion of that economy. Simply because some of that return is consumed, not spent. And it seems a reasonably logical idea that people would consume some of the income from their capital. No point in being rich if you don't have hot and cold running redheads Ferrari Testarossas after all.

As it happens the empirical evidence is that said capitalists do in fact spend some part of their income, do not save it all. And they spend a sufficient amount of it that capital is not becoming an ever greater part of the economy. Piketty is wrong, it ain't happening.

All of which accords with the general advice given to people with savings in fact. Sure, you want to reinvest some of your returns because there's this thing called inflation. Meaning that some part of your current returns are in fact illusory, and you need to reinvest some part of those returns to make sure that your income in the future is the same, in real terms, as you've got now. But once you're managing that, sure, go buy that redhe sportscar.

That is, capital maintenance and the best living standard possible compatible with that is how the rich, just like everyone else, seem to act. Thus capital doesn't ever concentrate.

Does welfare reduce poverty?

Does welfare reduce poverty? That might seem like a stupid question. Welfare is basically giving money to the badly-off. Of course, there are lots of glitches in the system which make it less efficient and effective than it could be and limit its potential (see the ASI's latest paper for more on that). But it still targets those in need reasonably well, even if it could do better. However this may not be true for all groups. Harvard's George Borjas, among the world's experts on the economics of immigration, finds in a new working paper that in one specific case welfare did not increase recipient incomes and reduce poverty.

The Personal Responsibility and Work Opportunity Reconciliation Act of 1996, the major Clinton-era bipartisan welfare reform, slashed federal spending on welfare benefits, cutting especially immigrant eligibility for major payments. Many, but not all, states decided to cushion their immigrant populations from the blow, making this a natural experiment. We can look at the difference between immigrant populations in states that did and didn't cushion them to discover whether cutting hit those who used to get it, or whether it induced extra waged labour to make up the gap?

In practice Borjas finds that the entirety of the loss in reduced welfare benefits is made up by extra earnings from working in the labour market. In fact, more than the entirety is made up, and cutting welfare actually reduced poverty for the most-affected immigrant groups.

In Borjas's words:

The evidence presented in this paper strongly suggests that, at least in terms of officially measured poverty rates in immigrant families, the welfare state is not a panacea. For these families, welfare contributes to poverty.

Now, I am sceptical as to whether this is widely applicable. There may well be differences between immigrant groups and natives of similar socioeconomic status—for example, first generation immigrants are widely perceived as having a stronger work ethic. They may also have lower savings to run down, credit to run up, or family ties to rely upon. It may be more credible that the authorities will let them endure real economic hardship—whereas the hardship of others may be more visible and salient for voters and welfare authorities. So this finding probably does not apply to native welfare recipients.

These points are why the ASI, and myself, favour a generous but simple welfare system: the negative income tax. But the finding is certainly interesting. In at least some cases, welfare does not reduce poverty, and may even increase it.

Will Hutton's quite right here, of course he is

Sure, we could have done all of these things, we could even do them now:

Britain, for example, could have had a brilliant civil nuclear industry, a vibrant aerospace sector, the fastest growing windfarm industry, clusters of hi-tech business all over the country – and a hi-tech steel industry. Instead it is no better than a mendicant subcontractor. It does not have a share stake in Airbus, while France and China are building our nuclear power stations. Our green industries, once the fastest growing in Europe, are shutting. Only banks and hedge funds are protected and nurtured in a vigorous, uncompromising industrial policy, but they don’t buy much steel. They are the “we” behind which even ultra-libertarian Sajid Javid will throw the awesome weight of the state. Scunthorpe, Redcar, Teesside and the West Midlands are not; they can go hang.

And for once the Observer's subs have got the heart of the matter correct:

There is no need for the laws of supply and demand to destroy our industries

The point is though, that while we could have done all of these things we didn't want to do all of these things nor do we want all of those things to have been done. For we actually want what is produced to be so as a result of the interplay of supply and demand.

Do not forget Adam Smith: the sole point and purpose of all production is consumption. Supply is, in a very general sense indeed, determined by the resources available and the technologies we know about to transform them. Demand is, well, that's us. And so we want what is produced, that supply within those twin constraints of resources and technology, to be determined by the accumulated desires of us all, which is that demand.

Hutton talks about both steel and football. And if it costs more to produce Accrington Stanley than people are willing to support their demand for Accrington Stanley with then it's not just that the club should close it's that we desire that the club should close, as it did. Similarly with steel: if those resources combined with that technology are a net loser to our society then we'd prefer that those resources go off and combine with some other technology to produce something that is a net addition of value to our society.

Hutton is entirely right that we can ignore both supply and demand and construct the economy according to other metrics. Perhaps the personal desires of the head of an Oxbridge college for example. But the point is that we don't want to do that. We actually desire the economy to be run on the basis of supply and demand precisely because demand is what we all want. Not, say, what the head of an Oxbridge college wants.

Yes, we like this idea from Liam Fox

An interesting idea. For we do indeed know that there're problems with using GDP as the sole guide to how the economy is doing. It doesn't measure distribution for example, counts cleaning up pollution as positive (which it is) but not the original pollution as negative and so on. It also suffers from a grave problem in the way that it measures government activity. It's this which Fox thinks we should address:

We have long been fixated on the concept of GDP growth as the determinant of economic wellbeing, particularly in the political arena. Yet, there is a difference between GDP and wealth creation and it is the latter that ultimately determines our national prosperity. We create wealth when we turn an individual’s idea into a good or a service for someone else to buy. Consider the Keynesian idea of burying £5 notes in bottles in mineshafts and having the private sector dig them up, or Krugman’s proposal to stage a fake alien invasion to boost anti-alien defence spending. Both would boost GDP, but neither would add to worthwhile economic activity. There are better ways to measure whether policies are conducive to wealth creation. If we take total government expenditure out of GDP calculations, then the resulting measure, Gross Private Product (GPP), gives us a much better idea of worthwhile economic activity.

We would most certainly agree that GPP is a useful figure for us to be looking at.

For there's more to it than just some ideas and plans of government not being very sensible, even if they do push the GDP numbers up. We have a basic problem about how to include government in GDP. Which is that we measure GDP at market prices: but there's no market prices for much of what government provides. Thus we have to fall back on simply arguing that the value of what government provides is the amount of money that government spends on that provision. Yes, even we think that a criminal justice system is a good thing to have, adds greatly to the general wealth. Government spending on diversity advisers possibly loss so.

One implication of this is that if we decide to pay civil servants more then the economy grows. Because we are counting the output of the civil servants as being the same as the input we pay them to provide it. So, we do indeed need to change how we view at least some parts of the GDP figures, and looking to GPP seems like a good idea to us.

Stripped, of course, of all that chest beating about it being only the Tories what done it.

Liam Fox is on the wrong road to sensible money

Shockingly, I find myself agreeing more with the most recent output from firebrand communist John McDonnell than committed free marketeer Liam Fox. In an FT article, McDonnell clarifies his views on the Bank of England: calling Bank independence "sacrosanct" (in contrast to his earlier utterances); arguing for QE to include purchases not just of gilts but a wider range of private assets; arguing for a higher inflation target to avoid the Zero Lower Bound (ZLB) problem; reaffirming the case for 'people's QE'; and considering nominal GDP targeting.

Let me say that people's QE has been tried, and it failed utterly. This shouldn't be surprising. Markets are better at investing than government bureaucrats, whether by 'investing' we mean 'buying financial instruments' or 'investing in physical and human capital'.

We don't need a higher inflation target to beat the ZLB on nominal interest rates because the central bank has tools other than interest rate manipulation (which I've argued it should get out of entirely).

We don't need to buy a range of assets because portfolio balancing works just fine—again, let the market choose where to put newly-created money, at least until we run out of gilts—then buy foreign currency, not any particular asset.

But I think nominal GDP targeting is a very interesting idea, at least if you target levels, especially market forecasts of levels, and especially if you reduce the discretion the rate-setting monetary policy committee has in reaching it. It is as close as you can get to a neutral monetary policy while you still have a central bank, and mimicks what you'd see with a free banking system.

By contrast I think that Liam Fox's speech to the Institute of Economic Affairs labours under a huge number of misapprehensions and offers few interesting steps forward for monetary policy.

Among Fox's claims that don't add up:

1. That higher inflation leads to lower real pay—false. This is obviously true for a given level of nominal pay, but nominal pay is not fixed any more than any other price is, so if price inflation rises, wage inflation does too. Real wages move towards real productivity—both logically (otherwise firms could poach each others' workers and make easy profits), and in the data.
2. That higher inflation hurts savers or investors—again false. While there may be nominal rigidities in labour markets ("sticky wages") there are few in capital markets. Fund managers and banks are not fooled by nominal values—they move their money around to get real returns. Thus we get the Fisher Equation—extra inflation is simply added to savers' and investors' returns.
3. "Central banks have been the government's lender of first resort"—this is simply not true, central banks buy bonds on the after market at the market rate, not from government directly. What's more, central banks don't hold particular high shares of the stock of government debt right now—there is a lot more out there to hold.
4. More government scrutiny should be applied to central bank actions—does Fox really have faith in committees, the executive, or worse, elected representatives, to do better? The suggestion is essentially to politicise monetary policy.
5. QE only boosts asset prices—false.
6. It's bad if QE (considered alone) led to wider wealth inequality—a strange view to take.
7. That low real interest rates have anything to do with central bank policy—Fox might want to take a look at the trend of risk-free rates over time and across the world. He might also want to look what happens to market rates (i.e. the rates at which 99.9% of capital is lent at) when central banks loosen policy.

What's shocking about all this is that Fox and I share a huge range of views, whereas McDonnell and I agree on almost nothing.

Fox and I are both free marketeers who want a stable macro policy that leaves markets and the price system as free as possible to determine the important micro goings-on in the economy. Fox points to Friedrich Hayek for inspiration, but I think Hayek's views would be closer to mine, as would those of Milton Friedman. This is not to say that others wouldn't share Fox's perspective—Murray Rothbard and Ludwig von Mises come to mind—but I hope he will consider my alternative free market view.