Same old, same old
A few weeks in the wide expanse of Arizona and Utah quickly cleared the brain of despondency about the state of the world. The horizons were limitless, the empty roads a joy to cruise and the sense of time and space humbling but satisfying. But returning to the fag end of the Lib Dem conference and the start of the more depressing Labour affair soon brought back that old despair. The Tories have been little better.
None of this is to say that America itself offers much hope. For like the ruling classes here and in the eurozone, they still don’t come clean on the fundamental reality that most western countries have been living far beyond their means for too long. To be sure, the Tea Party phenomenon cottoned onto it early but its very success attracted a ragtag collection of agendas that have little to do with fiscal sobriety but instead threaten derailing its original mission.
The crise du jour is now the fate of the euro and politicians are nervously dancing around the only realistic solution to save the currency – a formalized fiscal union that will see the richer nations funding the poorer ones. That’s what happens in a federal state and it’s what the US has been doing for decades through national programs like Social Security, Medicare and Unemployment Insurance. Canada has a more formalized mechanism of negotiated formulae that directly transfer funds from wealthier provinces to poorer ones. It’s done in the UK, too – money flows from England to Wales, Northern Ireland and Scotland.
The problem for the eurozone, of course, is that such formalized fiscal transfers are political dynamite. The rich don’t want to support the feckless and the poor don’t want to be bullied. The matter is compounded by the fact that time is fast running out. America and Canada built up their federal fiscal regimes from the bottom up over many decades, bit by bit. The eurozone has probably only a few weeks to do the same and the scheme will have to be imposed from the top down to make it happen.
But if the euro is to be saved that’s what must be done. Is that what the people want?
So much for the big picture where the problems conveniently drowned out further developments on the ground that will do little to spur economic growth. On Oct. 1, the minimum wage went up for young and old and agency workers were granted equal rights as full time staff. Neither measure will foster employment. While our leaders fret about grand numbers in the billions and trillions, they continue to nickel and dime the real economy into submission.
More QE will give us stagflation
Have you noticed how more and more economists are joining the Austrian School? Or at least accepting an Austrian explanation of why we are in such a financial hole and what to do about it?
The latest is Andrew Sentance, A very grand economist, being a former member of the Bank of England's Monetary Policy Committee. In the Financial Times the other day, he was contemplating the prevailing wisdom that the Bank of England would and should stimulate the economy with a further round of Quantitating Easing (printing money to you and me).
But, he noted, previous stimulus packages in both the UK and US have not exactly had the desired effect. They have not boosted growth: rather, they have produced only increased inflation. More of the same policy, he concludes, is likely to produce more of the same – the old stagflation we remember from the 1970s.
So what is to be done? His answer seems to be the Austrian solution of grit your teeth and let the economy sort itself out. We must expect a period of low growth while things adjust – as the Austrians say, over-optimistic investments made in the boom years have to be liquidated and resources redirected to projects that make more more sense in more normal times. And we need to make that adjustment easier: Sentance talks about ensuring labour markets are flexible, not burdening business with excessive regulation, keeping taxes as low and as enterprise-friendly as we can. Not much sign of any of that, though.
An EU financial transaction tax would be folly
You’d think that after a decade of creating one of the world’s biggest financial powder keg in living memory, the leaders of the EU would have a little humility about their plans to tax financial markets. Alas, not. Today’s outline of the financial transaction tax proposal by Jose Manuel Barroso confirms that they plan to throw more gunpowder onto the keg. We published a very good paper on the idea of the Tobin tax recently. A financial transaction tax, like a Tobin tax, would not raise any significant revenue and, crucially, would probably make markets more volatile.
First, a clarification: despite many reports to the contrary, this is not a Tobin tax in the true sense. A Tobin tax is a small tax on spot trades of foreign exchange – intended by James Tobin to reduce volatility in currency markets. But it is similar: the financial transaction tax would apply to stock, bond and derivatives exchanges. The impact will be less profound than a true Tobin tax would be, but most of the same principles apply.
Will it raise money? Probably not: the projections for revenues are based on market volume (ie, the total number of exchanges made) which would probably fall considerably. When Brazil tried a financial transaction tax (now abandoned) it didn’t raise much. Tobin himself rejected the idea that a Tobin tax would raise any money and explicitly distanced himself from groups that did.
I am constantly baffled by the failure of politicians to understand that trading funds can and will move country if the financial incentives are there. How many times have Europe’s leaders lamented cheaper competition from the Far East driving jobs out of the EU? Yet when those jobs are (far more lucrative) financial ones, they seem to think that no similar principle applies. It’s crazy for the EU to claim that it can raise €57 bn per annum without impacting the sector. (Mind you, the British government might be tempted to favour a Eurozone-only tax, as it would probably drive quite a few funds to the City of London.)
More importantly, transaction taxes actually increase the volatility they’re designed to reduce. Tim Harford once gave a good analogy for this. Imagine if you were charged for using an ATM – rather than taking out £20 or £50 whenever you needed it, you might save up your withdrawals until you absolutely needed to, and then take quite a lot of money in one big go. Irregular, large withdrawals would increase the fluctuations in your cash reserves (and the ATM’s) and increase volatility.
Markets exist to factor information into prices. Taxes on exchanges act as a blindfold on them, reducing the number of exchanges that can take place at the margin. If a trade is taxed, it makes some trades with a low expected yield unviable. Traders wait to make their trades – that means fewer and bigger trades. The impact of this tax won’t be as bad as a Tobin tax would be, but it’s a bad step nonetheless. But I’m sure the leaders proposing it know that. Their agenda is a political one: to buy enough time and political capital by appearing “tough” on markets for them to pass more EU bank bailouts.
The moral case against the 50p tax has to be made
The great tax debate has been thrust back to the top of the political agenda, and about time too. The economic argument against Britain’s 50p top rate of income tax is convincing. As 20 leading economists told the Financial Times earlier this month, there is no evidence that the increased top rate has managed to raise any new revenue for the exchequer.
Crucially, its detrimental effect on the UK’s competitiveness impacts most upon middle and lower-income earners. The FT’s letter made this abundantly clear: ‘the economic damage it causes means it is against the interests even of ordinary workers who don’t pay it’.
The numbers, quite simply, do not add up. Yet as strong as this case may be, there is an even more persuasive justification for abolishing the 50p top rate – one that has largely been ignored so far. Regardless of economics, it is the utterly compelling moral argument that should win the day.
According to KPMG (£), one of the ‘big four’ professional services firms, the average top rate of tax across the European Union is 37.5%, while the richest Americans pay 35% of their income in tax. By contrast, those earning over £150,000 in the UK can expect to pay a marginal tax rate of 52% (50% on their income and an extra 2% in national insurance).
This disparity is grossly unfair. What right does the state have to take over half of an individual’s earned income away from them? None. Is there any evidence that our governments should be trusted to spend a greater proportion of our money? History suggests otherwise.
The case for cutting tax is not just a pragmatic economic argument. It raises other fundamental questions about the morality of how we run our society, and of the role that government should play in the lives of individuals. This year's Tax Freedom Day shows that Britons have to work a staggering 149 days in a year just to pay their taxes. Tim Farron could not have been more wrong at the Liberal Democrat party conference last week. For a western liberal democracy founded on defending the freedom of the individual, this is morally abhorrent.
So far the focus of discussions by politicians and pundits alike has been on economics and whether tax cuts make financial sense. Now it is time for that focus to shift onto the morality of tax; this is the argument that will end the great debate once and for all.
Alexander Wickham is a freelance journalist and Politics finalist at the University of Bath. He writes for the Huffington Post and the student magazine Political Promise.
What growth agenda?
With all the marching and political grandstanding against "cuts" that we've seen so far this year, it's easy to forget that the UK's deficit is still as big as Greece's, and government spending accounts for 50.1% of all GDP. As a superb piece by Julian Harris in Monday's City AM showed, there hasn't been anything in the way of cuts yet:
This year, the first six months saw another £7.5bn nominal rise in total public sector spending (which excludes the effects of financial sector interventions). When inflation is taken into account, this does amount to a decline – of 0.43 per cent, compared to 2010.
Yes, total public sector spending, even in real terms, was just 0.43 per cent lower than last year – and still 3.9 per cent higher, in real terms, than in Labour’s final full year in power (2009).
By the end of the current fiscal year, the government’s officially recognised debt – which does not even include many eye-watering, massive liabilities – will top one trillion pounds. It has already reached the equivalent of 61.4 per cent of British GDP. Little wonder that last month’s level of public sector net borrowing – £15.9bn – was an all-time record high for August, despite the government clawing in £2.24bn more in tax than during the same month last year.
Net borrowing has reached £51.5bn in the financial year to date, only slightly down from borrowing of £55.3bn at the same point in last year’s cycle. The billions aren’t going quite as far as they used to, thanks to inflation, but this still looks more like topiary than axe-swinging. The government remains on track to pile more than another £120bn onto the public debt by the end of the year, with some economists doubting if the annual deficit will be cut at all.
The whole piece is essential reading. The bottom line is that the government is still spending like there's no tomorrow, and Britain's growth rates are abysmal.
As I wrote yesterday, the problem isn't austerity, but a failure to make it easier to do business in Britain. George Osborne may have put forward a reasonably convincing plan to cut the deficit (though it seems unlikely that he will eliminate it by 2015), but he and Vince Cable have failed utterly to promote wealth creation in Britain. The Coalition has done pretty well at accountancy, but terribly at economics.
What's to be done? Supply-side reforms like Madsen's would be a good start – let all firms register their employees as self-employed to cut through volumes of regulation and avoid some national insurance. Significant tax simplification should be on the agenda: abolish all tax breaks for everything, and use the money saved to reduce the overall tax burden – particularly for income and corporation taxes. Favouring one sector over another, or one type of firm over another, is ineffective tinkering and hostage to the realities of political lobbying. It distorts the economy and wastes money.
There are other things that can be done – it's not rocket science, but the economy can't be expected to grow with the state as big as it is. Tax cuts and deregulation are needed, and until a pro-market growth agenda that delivers reforms like those is put forward, the government cannot expect a decent recovery. There ain't no such thing as a free lunch.
Companies don't pay corporation tax. Never, not a single penny
One of the more annoying things we hear from the left side of the political aisle is that "companies must pay more tax". Given that companies do not pay tax, ever, cannot pay tax, ever, this is of course the call of the ignorant. But explaining how it is that companies, while they definitely hand over the cheque, do not actually carry the burden of a tax is difficult and can be complex.
So now that I've found this excellent and simple explanation of how this all works out I'll point you to it. Here.
Do note a couple of other things that come with this argument. For example, the Financial Transactions, or Robin Hood, Tax that is so popular among the economic mouth breathers suffers from exactly the same problem. Yes, sure, it would be lovely to "make the banks pay" but it just won't be them that does, they're companies, they cannot. It will be us the consumers who pay the tax.
One little point about that paper though: I'm afraid that in proposing their alternative tax system they've forgotten something that we here in Europe learned a long time ago. They want to impose a sales tax of 17.5% (of goods value, or 15% of tax and goods value). I'm afraid that doesn't really work because, shocking as I know everyone will find this news, not everyone is entirely and openly 100% honest.
Which means that there's a limit to how high you can make a consumption tax if that tax is levied just at the final point of retail sale. And 17.5 % is, I would suggest, very much above that limit. In order to be able to have such a high rate you need to make it a VAT: so that it accumulates at each stage along the production and distribution chain, lowering the temptation not to collect it at that final point.
But, the reason I draw your attention to the paper is that the first couple of pages give a very clear and excellent description of how and why it is that it isn't the company that pays corporation tax. It's largely (and even more so in a smaller more open economy like the UK) the workers that do.
A political battle that we must win
Cuadrilla Resources has reported their huge gas find near Blackpool. And it is huge, just enormous:
And it's a whopper: 200 trillion cubic feet. Recoverable reserves will be less, perhaps considerably so: but to put it in perspective, the Groningen field, at 100 TCF, completely transformed the Dutch economy** in the '60's and 70's and will last to 2080. The largest North Sea gas field discovery to date - the Troll field in Norwegian waters - was about 50 TCF recoverable, and has been supplying France, Belgium and Germany since the mid '90s, with many more productive years to come.
The reason this is important? It completely changes the economics of renewables and climate change. Yes, gas is a fossil fuel, yes, there are emissions, but they're a lot lower than coal. We've already got most of the country piped for gas delivery and this new cheap and above all local source can just be pumped into that system.
It simply makes windmills an irrelevance: quite apart from the massive difficulty we'd have with the variability of wind power if we did build out the proposed system. Which is why, of course, Greens like Caroline Lucas are squawking:
Instead of caving in to fierce industry lobbying, the government should follow the example of France and others by agreeing a moratorium on new shale gas exploration, at least until the environmental and health effects are fully understood.
Why should we stop looking around for shale gas just because we're uncertain about the effect of exploiting it? Sounds very odd: until you consider that Blackpool isn't the only place in the UK with shale gas underneath it. Find a few more fields, see that we've got a century of more of energy under our feet and, well, standing between 60 million Brits and cheap and clean heat and power is unlikely to do a political career much good. Thus the call to ban the exploration, so that we never do manage to find out how much we've got.
And that's the political battle we've got to gird ourselves up to win: we really mustn't let the greens (and Greens) impose an exploration ban. This is going to be difficult though: Chris Huhne has been heard spouting off about people lighting their tap water in the film Gasland. Except of course that has been happening for decades longer than frakking has been done, it's an entirely natural (even if worrying) occurence.
We simply mustn't let them ban exploration or cheap energy in favour of their damn windmills.
UK bailing out France, not Greece
So, the eurozone and the IMF are putting together a £1.7 trillion fund to save Greece (and for that matter Portugal and Ireland) and stave off a default. Right?
It's the politics which are the problem
One of the great unknowns is why tax systems are so appallingly bad. We try to tax corporations, bodies that are physically incapable of actually paying tax, tax the returns to wealth generating capital, tax the poor far too heavily: it cannot be that each and every politician ever elected is an entire and complete loon, there must be something else going on. And indeed there is:
There is often a gap between the prescriptions of an “optimal” tax system and actual tax systems, some of which can be neither efficient economically nor efficient at redistributing income. With a focus on personal income taxes, this paper reviews the political economics literature on tax systems and reforms to see whether political mechanisms allow us to better understand why tax systems look the way they look. Finally, we exploit a database of reforms in labour taxation in the European Union to check the determinants of all reforms, on the one hand, and of targeted reforms, on the other hand. The results fit well with political economy theories and show that political variables carry more weight in triggering reforms than economic variables. This shed light on whether and how tax reforms are achievable. It also explains why many reforms that seem economically optimal fail to be implemented.
While they don't quite phrase it like this the problem is that there are a sufficiently large number of loons with the vote for politicians to have an incentive to both propose and maintain absurd tax systems. They get voted for which is all they care about.
Just as an example, here's a quote from Polly Toynbee:
Yes, it's interesting that many LDs are leaving themselves wiggle-room on 50p tax. It may be that mansion taxes and others would bring in more from the rich - but I think it would be political suicide to lower the top rate - until we are a far more equal society. It would become the totemic policy.
She doesn't care whether the 50 p rate actually raises any money, whether a lower rate would raise more, what possible damage might be being done to longer term entrepreneurialism and wealth generation. No, only that anyone trying to abolish it could be castigated as only aiding the rich for we're too unequal a country (she doesn't even seem to care that you don't use the tax system to create equality anyway, you use the benefits system for that. The UK's tax system is already more progressive than Sweden's, just as an example).
That's why we end up with appalling tax systems, because the people who influence policy on tax systems simply don't care about tax systems: they're following the voices in their heads about politics instead.
Growth forecasts no surprise
It should be no surprise that the IMF has cut its world growth forecasts. We had it coming. In the UK, the Office of Budget Responsibility's growth forecasts always looked wildly optimistic – 1.8%, they were predicting back in november. Now the IMF says UK growth will be a mere 1.1% in 2011, and 1.6% in 2012. Even that, I figure is on the optimistic side, and the IMF admits there's 6:1 odds of us going negative.
It's not just the eurozone crisis. It's odds-on that the euro will split asunder. Either Greece, and then other spendthrift peripheral countries, will be forced out – or Germany and its more economically solid neighbours might just leave them to it. There's little chance that Greece, which in the last twelve month has not sold one state asset or fired a single civil servant, will actually knuckle down to the latest 'austerity' package. Trying to save the euro by issuing a 'eurobond' looks a forlorn hope too – it would take years of treaty negotiations to establish. Setting up some 'European Monetary Fund' could be done more quickly, but taxpayers in the more solid countries like Germany would likely be rather grumpy about chipping in money just to keep bailing out the spendthrifts.
Nor is it 'low demand' caused by government cutbacks. Britain's public sector 'cuts' have amounted to just 0.7% in real terms this year, which hardly amounts to a 'reckless' slashing of public 'investment'. You can argue that the government should be stimulating growth by boosting its spending if you like – but where will the money come from? If it comes from borrowing, that just makes our debt hold deeper, which will not ease any business person's fears. The UK is already on track to add £126bn to its borrowing this year, which must alarm investors. And our households are the most indebted in Europe. If more spending is paid for through taxation, then we will all have less left in our pockets to spend, and businesses will get even gloomier. If it comes by printing money, well, that is the way to make our money even more worthless, that is, to more inflation. Inflation is already killing UK growth. People on fixed incomes are seeing their wages buying 5% less than they did last year. No wonder growth is slowing.
No, we are at last feeling the hangover after our twenty-year cheap-money borrowing and spending boom. I'm afraid that we just have to go through the pain of it. When we do, the economy will be much better 'balanced', though without the need for politicians to 'rebalance' it – people will just write off overambitious investments and start putting their effort and money into more realistic ones. But the fact that we are in for some quite unavoidable pain should come as a surprise to nobody.