A Swiss miss on taxes

6818

a-swiss-miss-on-taxes

Question: What are the greatest threats to individual liberties, and hence prosperity? Answer: Government-protected monopolies and cartels. And government cartels are the worst. OPEC hasn't been good for consumers – when governments get together it's usually to rip off their citizens.

The Anglo-Swiss Tax Agreement threatens to create another government cartel. This is a very dangerous precedent. There’ll soon be no corner of the world where the assets of British citizens are safe from the tentacles of HMRC.

Natural tax competition incentivises governments to keep taxes as low, and hence individuals as free, as possible. If tax rates exceed those citizens are willing to tolerate, then increased evasion, avoidance and emigration will drive taxes down. Emigration is a key point here. Giving people a way out of an oppressive tax regime keeps governments accountable, and puts some ceiling on taxes. Competition works.

Furthermore, tax competition protects the world’s capital flows from government hands and disperses capital amongst enterprising individuals who – when all is said and done – grow the economy, create jobs and increase tax revenues. Taxing capital gains is a form of double-taxation, and is a direct tax on investment. We need more investment right now, not less.

Once the agreement is implemented, enterprising individuals will emigrate further away from Britain and just move their assets elsewhere. 34% of capital squirreled away in Swiss accounts looks attractive, especially when £125bn apparently awaits taxation. But the fact is that Switzerland only starts handing over the cash by 2013, by which time many will have already transferred his or her money to Singapore. It’s an anti-growth, unenforceable agreement. What is the point?

Taking the Austrian medicine

6816

taking-the-austrian-medicine

As more data trickle in, it is becoming pretty obvious that bad weather and a royal wedding are not enough to explain the UK's poor growth record. The problems are more profound. Specifically, the UK economy is highly dependent on consumption – government and household spending – and neither of those is looking very clever right now.

Government spending has of course hardly fallen in real terms so far, but after years of rapid rises, even a slowdown is enough to give everyone the jitters. As for households, those with savings (by and large the biggest spenders) are earning almost nothing on their deposits, and are cutting back. Sure, those with mortgages may be paying less interest, but they are still gloomy too because they know that their money-making house-price spiral has come to an end. The near-collapse of the banks gave householders a shock, and now they are fully aware (at last) that they have been borrowing too much. So they are simply cutting back and trying to reduce their indebtedness. Unfortunately, they have been hit by higher taxes such as the VAT increase, which means they have to cut back even further to make a dent on their debt.

Richard Jeffrey of Cazenove Capital thinks that quantitative easing in the UK and US has not helped, because it has fuelled rises in raw material and energy costs which again have added to household costs, and forced them to cut back their other spending even faster. And looking at that trend, it is no wonder that surveys are showing high levels of pessimism in the business sector. Customers just aren't spending, which in turn means that business has less money coming in to put into investment, which in turn means that their capacity to boost future productivity and growth is diminished.

Look on the bright side, though. As the Austrian School of economists remind us, a downturn follows a credit binge just as surely as a hangover follows an alcohol binge. A hair of the quantitative easing dog might make you feel better for a time, but makes the eventual hangover worse. Eventually, though, your body and your economy recover. You just have to nurse your head and see the process through. With calls for more quantitative easing being rebuffed, it looks like the US and UK authorities have decided to take the Austrian medicine rather than reach for the bottle again.

Throwing fuel on the banking bonfire

6812

throwing-fuel-on-the-banking-bonfire

I'm very skeptical of UK government plans to 'ring fence' or separate out the retail arms of the banks from their investment arms.

In the first place, if banks are broken up by politicians and regulators, you can be sure it will be a mess. They will be broken up in ways that simply don't work, and UK bank business will leach abroad.

Second, retail bankers need investment returns, and investment bankers need savers' cash. If you try to split them, they will do their darnedest to keep that symbiosis going. The only split that might work would be if the investment and retail banks were completely separate institutions, separately owned and capitalised.

Third, if you did split out the retail banks, it becomes 100% certain that if one of them failed, they would be bailed out by the taxpayer – which is part of the whole ring fencing deal. And 100% certain that such bailouts would be needed.

Of course, the argument is that retail banking is all safe, traditional, Captain Mainwairing stuff, so retail-only banks would never need a bailout anyway. Hence the calls to split them. However, given the certainty that the government would bail them out to protect retail customers, the new retail-only banks would have every incentive to behave riskily, generating big returns for their savers and offering borrowers fantastic mortgage deals.

You may think that the regulators would stop such risky behaviour in a sector that is supposed to be low-risk. Forget it. If there is one certainty to come out of the 2007/8 crisis, it is that regulators are useless. There was plenty of regulation in place, but it wasn't enforced, or it proved counterproductive.

The only thing that will make banking safer is competition. There is no proper competition in banking today because banks have to be huge in order to afford the costs of all that useless regulation. To boost competition, and to overcome the too-big-to-fail problem, the answer is not to break up the banks but to make the banks' reserve requirements more onerous, the larger they are. The sector would then naturally become less concentrated, and competition would do the regulators' job. It might even split, sensibly, of its own volition. Job done.

Calculating the optimal progessive income tax

6804

calculating-the-optimal-progessive-income-tax

An interesting new paper from Peter Diamond and Emmanuel Saez, trying to calculate what would be the optimal top tax rate to have in a progressive income tax system. Worth taking seriously as one has a Nobel and the second is tipped to be an obvious choice in years to come.

The things that need to be balanced are that the poor like an extra £ of redistribution more than the rich hate losing an extra £ to taxation and there will be behavioural changes as a result of changes in taxation rates. So, the calculation is really, what's the top rate at which we can snaffle as much as we can off the rich to give to the poor without killing that rich goose that lays those golden eggs?

The answer?

As an illustration using the different elasticity estimates of Gruber and Saez (2002) for high income earners mentioned above, the optimal top tax rate using the current taxable income base (and ignoring tax externalities) would be *=1/(1+1.5 x 0.57)=54 percent while the optimal top tax rate using a broader income base with no deductions would be *=1/(1+1.5 x 0.17)=80 percent.

You can just see it now, can't you? Whoopee! Tax the rich more!

Well, actually, this research was done for the US but let's apply it to the UK. This is the top tax rate for the top 1% as well: roughly those who currently pay the 50% income tax rate in the UK situation. It's also not the income tax rate. It's the total marginal tax rate: so we must include national insurance as well, that 13.8% that employers nominally but workers actually pay at such income levels.

So, we've firstly got evidence that the 50 % income tax rate in the UK is above the optimal level for that with the NI takes us well over our calculated to be optimal level of 54%. We'd need to have a top income tax rate of some 42, 43%, for the total marginal rate to be at that optimal 54%.

So, this is good, isn't it? Cut taxes now!

There's also a much more important difference that we should note between the US and UK tax systems. A US citizen is taxed on global income in the US. If they leave the country they still pay US taxes (with a large tax free allowance, with credits for foreign taxes paid). So the only possible behavioural response for a US citizen to such high tax rates is to just earn less money.

For a UK citizen of course this is not true. We can work less, take more leisure, if we think the Treasury is taking too much off us, just as can the American. But we can also leave. In fact, we're signed up to the EU which guarantees that we can move. Also, it guarantees that you cannot discriminate between EU citizens on the basis of national origin. So a Brit living in France would pay tax just like anyone else living in France: it would not be possible for the UK Treasury to insist that income made outside the UK were to be taxed at some special UK citizen only rate.

This escape hatch means that the optimal top rates decline: by quite how much no one as yet knows but it is obvious that they do decline.

So this is even better. We need to really cut taxes now!

And as to that mooted 80% top marginal rate? If we had a broader tax base and no deductions? That ability to bugger off and thumb ones' nose at the Treasury still applies. Meaning that the up to date research from two of the world's finer economists tells us that UK income tax rates are too high.

As, of course, we here at the ASI have been telling you for decades.

Put away your wrenches

6801

put-away-your-wrenches

If the economy is a machine, then perhaps it can be tuned by skilled mechanics. If it is not a machine, perhaps those skilled mechanics will get things wrong. It is not surprising that progressives think in terms of the machine metaphor, while others of us do not think in those terms.

Arnold Kling

Efficiency won't cut it

6794

efficiency-wont-cut-it

Over at Cato-at-Liberty, Tad DeHaven gives us a taste of his recent testimony before a Senate committee:

Most Americans agree that waste, fraud, and abuse in government programs is a problem. A recent poll of likely voters found that those surveyed believe an average of 42 percent of every dollar spent by the federal government is wasted. The same poll also found that 60 percent of those surveyed believe that problems with the federal budget can be solved by simply eliminating waste, fraud, and abuse. In fact, 40 percent strongly agreed with this position…

However, most people know very little about the breakdown of the federal government’s $3.8 trillion budget, and many don’t accept that huge deficits are caused by programs that benefit them. For example, the same poll found that 49 percent disagreed that Social Security and Medicare are a major source of problems for the federal budget. Attempting to reduce waste, fraud, and abuse is fine, but it won’t solve our deficit-spending problem.

I don’t know what the numbers would be in a UK poll, but I suspect they wouldn’t prove too dissimilar. At the very least, British respondents would likely echo the same basic sentiment: that government is wasteful, and that all the spending cuts you need can be delivered through simple ‘efficiency savings’.

Unfortunately, it just isn’t true: yes, there is significant scope for cutting government waste, but in the end waste is an inherent part of government. It’s in the nature of the beast, and there’s only so much you can do to stop it. More importantly, however much waste you find is going to be insignificant in the grand scheme of things: compared with, say, providing universal cradle-to-the-grave welfare, a lack of efficiency really isn’t costing us that much.

Ultimately, there’s one surefire way to cut spending and restore fiscal sanity, and that’s to shrink the state. Put simply, government should do less, individuals should do more. There’s no way around that fact.

The Enron accounting of Private Finance Initiatives

6789

the-enron-accounting-of-private-finance-initiatives

The Treasury Select Committee (TSC) has recently directed its fire at PFI deals – and not before time. PFI became widely adopted in the early 1990s and has expanded remorselessly ever since. In essence, it is a procurement initiative for large capital projects that seeks to combine the Government’s low cost of borrowing with the private sector’s ability to deliver far more efficiently.

In recent years, it has been widely adopted in financing NHS, transport and education projects. However, as the TSC has pointed out, PFI has several ‘stings in its tail’.

First, PFI has been regularly used to side-step government expenditure targets. Secondly, many PFI projects, particularly those where the private sector input is high, are accounted for off-balance sheet. Hence, the TSC has estimated that a further £35 billion – no mean sum – has effectively been added to the UK’s burgeoning national debt. Thirdly, because of the hire purchase element of many PFI deals, the pay-back period is often very extended and highly expensive.

Advocates of PFI – many of whom work on public procurement projects – argue that PFI has significant advantages including cheaper financing. Whilst 10-year gilt yields are close to record lows currently, it is very debatable whether the cost of capital for PFI deals is markedly cheaper.

In any event, the Government should not use PFI financing to circumvent public expenditure budgetary controls. Nor should it use PFI unless the case is quite compelling – a scenario that seems to have applied to few projects since 2000.

More generally, over the next decade, the Government should clean up its own balance sheet so that investors can be reassured that Enron-style financial accounting techniques are not being adopted.

Aside from some £35 billion of PFI liabilities, this would also extend to accounting for the massive c£1 trillion public sector pension liability. But unwinding outstanding PFI liabilities would be a good start.

Mises on the causes of the crisis

6788

mises-on-the-causes-of-the-crisis

The excitement about toppling Col Gadaffi is understandable, but a distraction from our real troubles. I have significant reservations about the intervention, but he was a brute and it's good to see the end of him. In the long run, though, the ongoing financial crisis will probably prove to be much more important to our lives. We shouldn't lose sight of it. We may be witnessing the start of a double-dip recession, or even the end of the beginning of another Great Depression.

What happened? The Mises Institute blog has posted a fabulous speech by Ludwig von Mises this week. Given in 1931, Mises spoke on "The Causes of the Economic Crisis" (PDF, pp. 155–182). Then, as now, a secondary economic crash pushed the world deeper into recession. It was avoidable, but not by the time it became apparent to the world. Sometimes you cannot undo the mistakes of the past. Massive malinvestments caused by central banks "underbidding interest rates" (in Mises's terms) can only be undone through business failure, however painful. Bailing businesses out simply prolongs the pain.

As usual, Mises is on the money here:

The severe convulsions of the economy are the inevitable result of policies which hamper market activity, the regulator of capitalistic production. If everything possible is done to prevent the market from fulfilling its function of bringing supply and demand into balance, it should come as no surprise that a serious disproportionality between supply and demand persists, that commodities remain unsold, factories stand idle, many millions are unemployed, destitution and misery are growing and that finally, in the wake of all these, destructive radicalism is rampant in politics.

The periodically returning crises of cyclical changes in business conditions are the effect of attempts, undertaken repeatedly, to underbid the interest rates which develop on the unhampered market. These attempts to underbid unhampered market interest rates are made through the intervention of banking policy—by credit expansion through the additional creation of uncovered notes and checking deposits—in order to bring about a boom. The crisis under which we are now suffering is of this type, too. However, it goes beyond the typical business cycle depression, not only in scale but also in character—because the interventions with market processes which evoked the crisis were not limited only to influencing the rate of interest. The interventions have directly affected wage rates and commodity prices, too. . . .

All attempts to emerge from the crisis by new interventionist measures are completely misguided. There is only one way out of the crisis: Forgo every attempt to prevent the impact of market prices on production. Give up the pursuit of policies which seek to establish interest rates, wage rates and commodity prices different from those the market indicates. This may contradict the prevailing view. It certainly is not popular. Today all governments and political parties have full confidence in interventionism and it is not likely that they will abandon their program. However, it is perhaps not too optimistic to assume that those governments and parties whose policies have led to this crisis will some day disappear from the stage and make way for men whose economic program leads, not to destruction and chaos, but to economic development and progress.

Treating too much debt with more debt or giving reckless banks a bailout is economic homeopathy. There's no post-hoc cure to long-term foolishness. Eventually, you have to pay the piper, and resolve to take the steps necessary to avoid that situation in future. The only solution to our current crisis is to weather the storm.

There may be certain types of monetary central planning that are less bad than others, but all are still least-bad ways of doing something the government should have no involvement in. If we're serious about avoiding a repeat in a couple of years, we need to start thinking seriously about how to abolish central banks. It isn't the symptoms we need to fight, it's the disease.

The resurgence of inflation

6781

the-resurgence-of-inflation

One of the most potent economic lessons of the last century was the dreadful impact of inflation, most dramatically demonstrated in Weimar Germany in the 1920s. The UK’s last serious encounter with seemingly uncontrollable inflation was back in the 1970s when the rate reached 26.9%. Such high levels of inflation, though holding undoubted attractions for debtors, seriously distort the equilibrium of the economy. Moreover, once ingrained in the system, inflation is very difficult to eradicate.

In recent months, the Bank of England’s anti-inflation stance has been remarkably laid back, especially given the MPC’s remit on controlling general price levels. Tuesday’s CPI figures were not good. Inflation reached 4.4% in July and may exceed 5% shortly, especially since three major ingredients – food, utilities and transport – all have further price increases in the system. Worldwide agricultural prices continue to rise, whilst the ‘big six’ utility companies are pushing through double-figure price increases, primarily due to higher input costs and massive investment requirements. Furthermore, July’s CPI figure, to which many rail fares are linked, will cause the latter to rise by some 8%.

High inflation seriously dissuades saving; it particularly impacts retired people. Although they may not shout too loudly about it, the reality is that, since the financial crisis in 2008 and the subsequent recession brought about ultra-low interest rates, returns to savers have been minimal. Many will argue that raising interest rates now will damage the UK’s already lacklustre growth rate. Perhaps so. The basic lesson, though, is never lose control of public borrowing as happened under the previous Government. Similar comments apply to inflation.

After the huge borrowing splurge of the last decade, it will take many years – perhaps even a decade - to re-create an economy, based on high growth, low borrowing and minimal inflation. Despite the weak economy, rising inflation should not be regarded, as is so often the case, as tomorrow’s problem.

A small step to a big improvement

6775

a-small-step-to-a-big-improvement

The government has correctly realized it cannot spend its way out of debt. It has not, however, paid sufficient attention yet to the supply side, to helping create the right climate and conditions for economic growth. The debt, big though it is, will look smaller in a larger economy.

There is one simply supply side measure that could boost growth rapidly. It is to make life easier for small businesses so they can be established, grow and expand, and create the new jobs that will cut unemployment and dependency.

The record of small businesses is there for all to see. Companies with fewer than 100 employees create roughly two-thirds of all new jobs. Yet life is by no means easy for them. These firms, which account for nearly half of all employment in the UK, have to spend time calculating PAYE tax returns and National Insurance for their employees, when they would rather be out generating more business and creating more jobs. And they have to cope with a swathe of regulations that take time to comply with and hamper their ability to expand.

The one big supply side measure to unleash them would be to allow those who work for small businesses to be registered as self-employed. The employers would not then face the burdens of paperwork. They would not have to cope with statutory sick pay, holiday pay, maternity and paternity leave and a host of other regulatory requirements. Big firms can set up departments to deal with this, but the small employer who hires a handful of people gets bogged down in a quagmire of costly red tape.

Of course the Treasury will resist. They have spent 20 years trying to force self-employed people into 'employed' status so they can collect tax from them more readily. The Chancellor should force his Treasury to look at the supply side. New jobs mean people being paid wages and spending money, some of it in High Streets. They mean people coming off benefit. They mean a growing economy and a broader tax base.

Small businesses could simply send the names and contact details of their staff to HM Revenue and Customs, and pay their staff as self-employed people under contract. It would be a simple reform, and one that could give the economy a jump start where it matters most – in the sector that creates the new jobs and growth.