It's the liberty, not the spending, Stupid!

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There are times when quite wonderful, quite delightful, little papers happen to fall into our laps. This is one of them.

As we're all well aware there're a number of people out there claiming that the reason poor countries are poor is beause they don't tax enough. They don't do enough income redistribution, there's not enough government spending, they're not, in short, sufficiently like our own large government states to be able to develop.

And then along comes the World Bank to entirely destroy that contention:

Reviewing the economic performance -- good and bad -- of more than 100 countries over the past 30 years

Oooh, excellent, we're looking at reality then.

...new empirical evidence supporting the idea that economic freedom and civil and political liberties are the root causes of why some countries achieve and sustain better economic outcomes. For instance, a one unit change in the initial level of economic freedom between two countries (on a scale of 1 to 10) is associated with an almost 1 percentage point differential in their average long-run economic growth rates. In the case of civil and political liberties, the long-term effect is also positive and significant with a differential of 0.3 percentage point.

So economic liberty leads to economic growth and civil liberty leads to it as well, even if at a lower rate. But what about that government spending, those entitlements?

In contrast, no evidence was found that the initial level of entitlement rights or their change over time had any significant effects on long-term per capita income, except for a negative effect in some specifications of the model.

Ah, those go from no effect on growth to a bad effect on growth. The conclusion?

These results tend to support earlier findings that beyond core functions of government responsibility -- including the protection of liberty itself -- the expansion of the state to provide for various entitlements, including so-called economic, social, and cultural rights, may not make people richer in the long run and may even make them poorer.

Which leads us to our policy prescription. Yes, of course we should help and aid the destitute, feed the starving, clothe the naked. But beyond such emergency aid what we should really be doing is insisting that poor countries enact proper economic and civil liberties. That's the way they'll stop being poor.

Sounds a bit familiar actually. Take it away, Adam:

Little else is required to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes and a tolerable administration of justice.

Strange the way we have to keep repeating things we've known for 235 years really.

Tax simplification means a flat tax

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One of the more laudable attempts of the government to reduce bureaucracy is a drive towards tax simplification. Two highlights are the abolition of complicated reliefs (though the Taxpayers’ Alliance quickly observed that the benefit was undone by other meddling in the Budget); and the possible merger of National Insurance Contributions with Income Tax. This last one could be a red herring though – the government has only announced a consultation and many seriously doubt whether any Government would ever want to flag up the fact that the basic rate of tax is not 20p but 31p.

The big prize in the lottery is a flat tax. It both simplifies tax and raises revenue. The Coalition Agreement neither mentions, nor excludes it. But it does mention a drive towards more competitive, simpler and fairer taxes: a flat tax ticks all these boxes.

A flat tax would:

1. Increase revenue as the black economy will disappear; tax exiles will repatriate their fortunes; and instead of paying for expensive advisers the rich will simply pay the tax;
2. Increase the revenue as the economy will grow (as was the case when Thatcher and Reagan cut taxes);
3. Maintain a zero rate for those who are less well off by putting the threshold from which tax becomes payable at a high enough level;
4. Do away with a large chunk of the HM Revenue’s expensive administration

It’s win-win. It is not a handout to the rich: in countries where a flat tax rate was introduced the wealthiest people in society ended up paying a larger percentage of the total tax take.

The Government has the choice. By doing not very much, it can conserve the socialist dogmas of yesteryear. Or it can reform. Radically and irreversibly. I guess it takes guts and ambition to go down as leaders rather than followers.

Adele joins the low-tax club

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There's a small club of musicians and actors who've protested against absurdly high tax rates. The classic is George Harrison's Beatles song, Taxman – "Should five percent appear too small /  Be thankful I don't take it all". (That wouldn't sound out of place in most debates about tax today, sadly.) And, of course, there's Michael Caine's explanation of the Laffer Curve – "I left for eight years when tax was put up to 82 per cent. The newspapers said: "Michael Caine's leaving: let him go, the stupid, overpaid, loudmouth idiot, who cares where he goes?" Well, you didn't get 82 per cent tax from me for eight years." 

The newest member of this elite club is Adele, whose (rather good) song "Rolling in the Deep" you've probably heard ad infinitum in Radio 2. She's not pulling any punches:

"I'm mortified to have to pay 50%. Trains are always late, most state schools are s*** and I've gotta give you, like, four million quid? Are you having a laugh? When I got my tax bill in from [my album] 19 I was ready to go and buy a gun and randomly open fire."

A bit extreme, but I can't blame her for being frustrated. The Guardian is a lot sniffier – how dare she resent paying half her earnings for inefficient state services!

Robert Nozick used the example of basketballer Wilt Chamberlain to show that even a society that began with equal wealth would quickly become quite unequal:

Suppose that among the members of this [equal] society is Wilt Chamberlain, and that he has as a condition of his contract with his team that he will play only if each person coming to see the game puts twenty-five cents into a special box at the gate of the sports arena, the contents of which will go to him. Suppose further that over the course of the season, one million fans decide to pay the twenty-five cents to watch him play. The result will be a new distribution, D2, in which Chamberlain now has $250,000, much more than anyone else.

Is it just to take half of Chamberlain's earnings in this example? Why should the state interfere in simple and just exchanges like this? Nobody could claim that Chamberlain doesn't deserve the money – people want to give it to him because they want to see him play. But, as with George Harrison and Adele, he'll end up much richer than any one person in the audience. There are lots of people out there who wonder why they have to cough up so much of the money they earn just to pay for late trains and bad schools. Welcome to the club, Adele.

Could Britain be next for a pension tax?

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Ireland has joined the increasing number of EU states that have begun seizing or taxing private pension funds to plug their budget deficits. Under the Irish plan, a 0.6% tax will be levied against private pensions for the next four years, in order to fund a stimulus package. Note that this will be a tax on the capital itself, not the gains.

The plan is, of course, ludicrous: classic "gombeen economics", in the words of the Irish Times's commentator (gombeen is an Irish word for a corrupt wheeler-dealer), that will only make Ireland's situation worse. And stimulus packages are a Keynesian folly. At best they do nothing, at worst they bankrupt countries and lead to lost decades of stagnation. And the principle of raiding people's savings, made on good faith, to pay for a government project is immoral in and of itself. But, however much we might sympathise, that is Ireland’s challenge. The real danger is that we might see the same kind of thing over here.

From next year private sector workers will be automatically enrolled into a pension fund. A tax similar to the Irish levy wouldn't yield the government a huge amount, but it would plug a hole in its finances. If the recovery that the government expects doesn’t come through, it isn’t hard to foresee a “temporary” levy on pension pots. Like the Irish levy, it might start small. But remember: the first income tax was just 2%, and was originally introduced to fund the Napoleonic Wars. Small, temporary taxes have habit of sticking around and growing.

Even a tiny pension confiscation would have a seismic impact: just as the Irish government’s levy has broken the good faith in which Irish pension holders invested their money, so would the faith that Britain’s system relies on. It may be coincidence that pension contributions are being made mandatory at the same time that this is happening abroad, but the inability to disengage from private pensions would free the government’s hands to raid these funds. Such a tax would be deceitful, deter investment, and undermine people's ability to provide for themselves in their old age – yet another step away from self-sufficiency, towards dependence on the state.

How likely is this to happen? Sadly, it may be inevitable. Hungary, Poland, France and other EU states have carried out straightforward pension seizures, and a levy might be presented as a “lucky escape”. Yeah, right. Some might say, optimistically, that a pension tax would be politically unfeasible in Britain. But if a strong recovery doesn’t take place (and so far, growth figures have undershot the government’s projections), and the government continues to buckle to special interest pressure, the pensions nest egg might be too tempting to resist.

How to beat the national debt

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It's a commonplace that debt, even the national debt, is not a problem in and of itself. Nor is any specific or particular amount of debt a problem or not a problem. A €340 billion debt for the US's $14 trillion economy is a different beast from the €340 billion debt of Greece's very much smaller economy. What can be a problem is the amount of debt in relation to something else: that something else being the capacity to service it.

Our usual method of describing this is to mutter about the debt to GDP ratio. As reasonable rules of thumb, below 30% it's irrelevant, once it starts going over 60% we see future growth being constrained, above 100% something really must be done and over 150%, unless you're something very strange like Japan, you're bust.

So, in all our talk about how we're going to deal with the national debt yes, there's room for cutting spending so as to avoid adding to the debt and thus make everything more difficult. But there's also room to increase the size of the economy so as to reduce the ratio. No, not by simply borrowing more and splurging in some hope that the Keynesian Fairy will sprinkle growth dust. But a change in hte tax system.

Here's the growth, the extra growth, that could come from a simple change in the way we raise taxes:

Clean income tax is flat rate no allowances, standard flat is with an allowance, transition relief means don't do it all at once.

No, we're not raising any different amounts, we're raising the same amount of tax in a different way. This doesn't mean cutting anything, this is purely the extra growth we'd get by changing the method, not amount, of taxation. As you can see, simply changing the method of taxation could give us a lovely little bolus of growth, one that reduces the national debt as a percentage of GDP and thus reduces the overall problem we face.

We can still do all the other things, or not, as the mood takes us, but this is a free lunch, that rarity in economics. And free lunches, given their rarity, really should be eaten.

Why, yes, we at the ASI have been advocating a standard flat tax for a number of years. For, you know, it works.

The banking sector needs more competition, not more regulation

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Hector Sants of the FSA, the UK financial regulator, has warned banks that future dividend and bonus payments will be scrutinised for their potential impact on risk. Actually, it is the FSA that is the biggest risk factor in UK. Frankly, the body is not fit for purpose. It's rule-driven tick-box approach missed everything that was going wrong in the finance sector in 2007, and it is no more useful today. What's needed is real reform of the banking sector, and the introduction of a lot more competition, which is by far the best regulator and the best friend of customers – not more rules and inept rulemakers.

This might actually happen. The Independent Commission on Banking reckons in its interim report that the promotion of competition should be a core function of banking regulation. In other words, we should have a proper economic regulator, which looks at the structure of the industry and tries to make it as competitive as possible. Much of our trouble is that the huge expense of the tick-box regulation means that banks have had to grow big in order to afford it, and competition has largely disappeared.

It is interesting that scores of US banks fail every year. That is manageable, because they are all small. In the UK, by contrast, there is an implicit guarantee (and, up to the first £85,000 of your savings, an explicit guarantee), that the government will bail the banks out. That's not healthy for any business. You can run a pretty shoddy firm if you know that the taxpayers will pick up your debts.

Another idea of the Commission is to separate out retail banking, so if people really do want to make sure their money is safe, they can find somewhere to go. That makes sense too. If we had proper competition, it would already have happened. But like any insurance, government guarantees encourage risk-taking, with its associated high profits.

The question is how you achieve such restructuring. We certainly don't want Vince Cable in hobnail boots forcibly breaking up the banks as he sees fit. We can let the market do it. Making the stringency of banks' reserve requirements proportional to their size would favour the creation of smaller banks and would properly reflect the greater systemic risk which is generated by the bigger ones.

In Brazil, retail and investment banking licences are quite separate, and if you stray from one line of business to the other you get put in jail – which seems to work pretty well. But again, I think we can use the market rather than this top-down approach. Simply requiring banks to offer demonstrably safe deposit accounts – or even making them tell customers just how risky their accounts were – would achieve the retail-investment separation quite naturally. 

America is borrowing itself into a black hole

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I'm sure we can all relate to this scenario: you stroll up to the cash point and put your card in, only to be confronted by a message reading 'insufficient funds'. You ring up the bank to get to the bottom of this and, to your horror, you are told that you are $14,294,000,000,000 in red. What is the solution to this conundrum - tighten the purse-strings? Start going to Lidl instead of Waitrose? Scale back the foie-gras consumption? Of course not: the most sensible option is to borrow some more money. After all, if you owe money you may as well borrow so more to cover the gap. What could possibly go wrong with that?

To any normal person this should, quite rightly, sound like insanity. To the Obama Administration, however, it’s a way of life. Yesterday, with the issuing of $72,000,000,000 worth of notes and bonds, after which each US citizen owes $46,000, the US government finally reached its legally-binding borrowing limit. President Obama was soon on TV calling for the borrowing-ceiling to be raised. On CBS he claimed:

"If investors around the world thought that the full faith and credit of the United States was not being backed up, if they thought that we might renege on our IOUs, it could unravel the entire financial system."

Maybe he is right, although S&P's once-inconceivable downgrading of America's debt outlook to 'negative' last month shows confidence is already waning. Even more ominously, as early as November last year the Chinese rating agency Dagong downgraded America's debt from AA to A+. With mounting concerns over the infeasibility of US debt levels, what is Obama's solution? More borrowing. More debt.

And where does all this money go? Into either the immediate black-hole of government entitlements spending or into propping up companies destined to failure. A mere $600billion was rolled off the presses for the Keynesian nightmare of QE2. $50billion was pumped into the over-unionised General Motors to produce more poorly-built cars destined for the scrap-heap. With Obama unwilling to face the realities of America's precarious fiscal position and his ill-fated anticipation of being able to purely grow out of this economic dilemma, it seems there will be no end in sight.

If I were an American taxpayer I know the course of action I would prefer: take the medicine, and take it now. Facing up the realities of fiscal illusions may be painful but it will happen eventually. If only that would be sooner rather than later.

Poking holes in America's debt ceiling

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The Americans, in an attempt to bring their public finances under control, have an absolute 'debt ceiling' – they can't legally borrow more than that. Last year it was set at the eyewatering level of $14.3 trillion, after dozens of increases since 1940. Well, the bad news is that the US economy hit its head on that ceiling yesterday. Worse yet is that there's going to be some fudging on the issue: Treasury Secretary Tim Geithner has found a way to put off the crunch date until August.

One should never underestimate the power of fudging in politics. Whatever mast you tie yourself to, there is always some way of slackening the knots just a tad. The same will no doubt happen with Greece, which was given a Eurozone bailout to buy time to sort out its finances. Yet its finances remain visibly unsorted: Greece's national debt is expected to hit 157.7% of GDP this year.

With strikes and demonstrations protesting against budget cuts, there are really only two likely outcomes: Greece defaulting on its debts, so that its creditors don't get all their money back; or more bailouts, coming principally from the only Eurozone country that can afford them, Germany. As for real budget reform in Greece, dream on.

You would think that fudging along cannot work forever, and I am sure it can't. But as Adam Smith observed, 'there is a great deal of ruin in a nation'. And a great deal of fudging seems to be possible before the inevitable disaster happens. Trouble is, the more fudge you have covered yourself in, the harder the clean-up afterwards. 

The Rally Against Debt

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Tomorrow (Saturday, May 14th), a Rally Against Debt will be held in London. The idea is to use the tactic used by the TUC, National Union of Students and other special interest groups. Where those groups marched for directly self-interested reasons – to oppose public sector cutbacks in the TUC’s case, and to demand that taxpayers pay for their tuition in the NUS’s case – the Rally Against Debt is essentially motivated by good old-fashioned dislike of big government.

Sadly, some have drawn Tea Party comparisons. This is neither enlightening nor particularly insightful. It seems a strange point of reference to use, since we’ve had so many protests of our own over here. The only remarkable thing about this is that being in favour of cuts tends not to be a position held by single interest groups, which are the main actors in most protests. If I was cynical, I would think the Tea Party comparisons are intended as a smear.

I must confess that I’m not a huge fan of marches of any kind in a democracy. I don’t see the point in a march against cuts if the intent is to change government policy, because even a highly successful march will only field a fraction of the electorate. Even with half a million squeaky wheels marching down Whitehall, it may very well be the case that the grease is needed elsewhere. And, in a democracy, marches are always heavily skewed towards special interest groups – a case of dispersed losses and concentrated gains.

A few people who stand to gain a lot from a government policy – typically the recipients of a spending programme of some kind – will be a lot louder than the many, many people who have to pay for it. But their loudness tells us nothing about the best policy to implement. (Inevitably, someone will say that taxing people less heavily is morally equivalent to spending more. I wonder if these people feel the same way when their houses are burgled – after all, the burglar gains as much as they lose, so there’s no loss, using their logic.)

All that said, if the victims of the “dispersed losses” are prepared to take a stand against special interests, then great. The deficit and debt are the pressing issues of the day. The idea that greed caused the financial crisis is incorrect, but it may very well cause the next one – a debt crisis caused by public sector greed. I’m glad that some people are taking a stand against that.

Rally Against Debt

Where: Old Palace Yard (Opposite Parliament)

When: 11am – 2pm. Saturday, 14th May.

Time to let the housing bubble burst

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The housing market is, almost certainly, a bubble. As the graph of inflation-adjusted house prices above (taken from HousePriceCrash.co.uk) shows, there has been a steady rise in the real cost of a home over the past fifteen years. Like most other bubbles, it is a product of sustained government policies designed to privilege a special interest group – in this case, homeowners.

Government after government has tried to keep the bubble inflated to avoid their wrath. The more people throw their life’s savings into housing, the more the pressure on government grows to protect these investments. The consequences for the rest of the country have been ruinous: increased cost of rents, urban sprawl, inflation and a shortage of affordable homes. The poor – who are also the least electorally engaged, and so less important to politicians of all stripes –have been especially hard-hit.

In an ordinary industry, the huge demand for housing would provoke a big increase in homebuilding, including at the lower end of the market. But the supply side of the housing sector is tightly bound by the planning system. The planning laws in this country are a classic case of NIMBYism. Increasing the supply of homes in an area will reduce the cost and value of homes already there, so local authorities have no incentive to ease regulations to increase supply. Such is the flaw in democracy – established groups can use government to restrict competition and enrich themselves.

So, rather than tackling the supply side of housing and trying to create more homes, the government throws money at the demand side. But this only makes the problem worse. Shared equity schemes and artificially-cheap credit, created by the Bank of England, all lead to increasing prices without a corresponding increase in supply. Home buyers depend heavily on borrowed money, so the political pressure on the government to keep the price of money low is enormous. And the higher prices grow, the greater the pressure is to make borrowing cheap. This whole mechanism entirely divorces interest rates from their true function, which is to reflect the supply and demand of money – ie, savings and borrowing. This disrupts relative prices (and thus the structure of production) across the whole economy, and fuels the bidding war over houses.

If government’s protection of house prices was removed – most importantly, the planning system that depresses supply and the artificially cheap credit that inflates demand – the supply of houses that people want to live in would rise and house prices would fall. Homeowners should not be able to use government to protect their investments at everybody else’s expense. With a looming housing crisis and house prices at an all-time high, it's time to let the bubble burst.