Meet the new boss: same as the old
This little snippet makes me rather angry. Irate even:
Grant Thornton, the accountancy firm, says that if wages increase at the rate predicted by government economists there will be a record 5.5 million higher rate taxpayers by 2015.
Even if wages grow at a more conservative 2.5 per cent, more than 700,000 people will become higher or additional rate taxpayers in the same period.
At present, anyone earning more than £42,475 pays higher rate tax at 40 per cent, while those earning more than £150,000 pay additional rate tax at 50 per cent. The Chancellor announced a three-year freeze on tax thresholds last June. Mike Warburton, senior tax adviser at Grant Thornton, said the freeze, coupled with wage growth, would create twice as many higher rate taxpayers by 2015 as there were in 1997.
For governments of all stripes have been playing this little game all along. It's called "fiscal drag" and it's part of the pernicious hidden side of the tax system.
We're all pretty hot on knowing the rate of tax that we pay: it's a fairly easy thing to spot. What's much more difficult is figuring out how much of our income that tax rate is being applied to: more specifically, whether there's been a change over time. We can all see that tax rates have come down but if that rate is being applied to more of our income then it's not so clear cut, is it? And the specific point at issue here is the personal allowance and the tax bands.
Looking at historic tax rates and then feeding them though a prices and average wages calculator, we can see that in 1973 you started paying income tax when you earned £595 for the year. If that number had kept up with wages growth it would now be £8,700 a year: but it isn't, it's £7,475. So the poor are being sucked into the tax net simply by not updating the tax system properly.
It gets worse at the other end of the tax system though. You started paying the higher rate when you were earning £5,000 back then. If that was upgraded properly it would be £73,000 now. As above, it's a shade over £42,000 now. What was a tax band that affected the top 2 or 3% back then is about to become one that affects the top 20% of earners.
This process is terribly attractive to politicians, of course. For they get to tax ever more people ever more money without actually having to put up tax rates and take the political pain for having done so. But if we let it continue on for another generation we're going to get close to the paper round being more than the personal allowance and anyone working full time will be on higher rate tax as they're "rich". Even defenders of progressive taxation would blanch at that, wouldn't they?
We need to cut inflation down to size
Yesterday's inflation figures showed that the Consumer Price Index (CPI) measure of inflation in October dropped slightly to 5%, from 5.2% last month. CPI is the government's preferred measure, which does not take housing costs, such as mortgage repayments, into account. But those of us who still have mortgages to pay off might prefer to look at the more traditional Retail Price Index (RPI), which is even higher at 5.4%, down from 5.6%.
The Bank of England reckons that inflation is largely an effect of the falling pound, which makes imports more expensive, particularly the things it is hard to do without, such as fuel and food, which are largely imported. It is not helped by rising commodity prices as Asian countries bounce back from the slowdown and start building things again. They figure these pressure will ease, and when the VAT rise drops out of the calculations after it has been in place a year, the indexes will fall again, they say.
Well, they would say that, wouldn't they? It rather diverts attention from the £75bn of new money which the Bank 'printed' (in the form of Quantitative Easing) before expanding the programme to £200bn later that year and increasing it again recently to £275bn. And as we know, thanks to Milton Friedman, inflation is always and everywhere a monetary phenomenon. When you print too much money, it loses its worth.
So is that what is going on here? It's hard to say. The other folk who create money are the banks. Indeed, they can create it at the stroke of a pen, just by giving loans to their customers. The trouble for lots of their customers is that the banks have been more reluctant to do that recently, having had their fingers burnt by the crisis of 2007/8. So the Bank of England figures it is just replacing the money that the banks are no longer creating.
Maybe. For quite a long time through the noughties, the Bank had a target of 2% inflation which it failed to meet, month after month. And that was despite the fact that a strong pound and cheap imports from the likes of China meant that, if anything, prices should have been falling. The Bank stoked up a boom, and it was the inevitable bust of that boom that led to our present problems.
Yes, we need an big enough quantity of money around the place that banks and businesses have enough to lubricate the wheels of commerce. But you don't want to take risks with inflation. it is corrosive. When all prices are rising, it becomes harder to distinguish the 'signal' of real price rises and falls from the 'noise' of prices rising everywhere. How many people really know whether their house has gained or lost value, when the cost of living is rising so fast? How many entrepreneurs, for that matter, know if their investments are really paying off, after inflation is taken into account? They don't – and that is why inflation causes people to put their time, effort and money into the wrong things. That's a luxury we really can't afford in these times. We need to get inflation down. And fast.
Credit easing won't deliver growth
Upon observing gloomy reports of the UK economic growth figures last month (and with seemingly never-ending eurozone woes), panic has spreadthrough Westminster. The Conservatives are getting anxious and cannot seem to wait until their long term growth plan starts yielding its first results. The government wants to see higher growth immediately, as its popularity is decreasing at approximately the same rate as unemployment levels are increasing.
In times of slow growth, rising unemployment, no signs of recovery and record low consumer and investor confidence comes an idea that is supposed to alter the financial sector by decreasing the role of banks in the economic recovery and leaving it up to the government to kick start lending – not via fiscal stimulus, but something very similar and yet very unconventional – credit easing.
Credit easing implies the government buying corporate bonds from small and medium-sized businesses and therefore providing them with enough money to start investing and hiring again. It is supposed to be a swift way to deliver credit to businesses and start up economic growth in the short run until the long run stabilization reforms start to yield their expected effects. The idea comes as somewhat revolutionary for the system where the government wishes to create a market for loans and bonds of small and medium-sized businesses (SMBs) thereby removing the dependency of the SMBs on the banks.
Since George Osborne, who made the proposal, hasn’t yet found a way to enforce it, several ideas emerge on how this is supposed to be done; (i) buying loans and bonds directly from the SMBs by a government agency; (ii) buying SMB loans from the banks (either by the government or by private investors via government subsidies), securitizing them and selling them off to private investors; (iii) buying the banks’ corporate bonds and thereby reducing their funding costs and creating an incentive for banks to increase lending; (iv) offer a government guarantee on SMB loans increasing confidence for the banks to increase lending to the SMBs.
The first proposal implies a simple fiscal stimulus to certain businesses who found themselves in problems and need recapitalization. The problem arising, among many others, is adverse selection. There is no way for a government bureaucrat to possess enough information to determine which companies should get the necessary funding and which companies will have the strength to invest it in potentially prosperous projects.
With rising uncertainty surrounding the world economy, it is questionable why would the firms start increasing production and start hiring again if they anticipate more contraction in the future and higher taxes due to unsustainable deficit and debt levels. It is more likely that both businesses and consumers use this money to pay off their debts rather than increase hiring or production. The stimulus in the form of bond purchases can only result in a type of social transfer from the government to politically prominent firms that found themselves in trouble.
The second proposal has similar implications to the quantitative easing policy, where someone is supposed to artificially clean the riskier loans off the banks’ balance sheets. There is an additional clause to securitize these risky loans and sell them off as “safe” assets. The government will be the middleman that pools the securities together and gives them a government guarantee giving the security a high rating. These sorts of securities will soon enough become a desirable asset and their demand will increase. An increasing demand will yield more and more securities and more and more credit to businesses – an effect that is in theory a good one.
However, due to an increasing demand for these low risk securities it is very likely that the banks will start to decrease lending standards and offer loans to high-risk business projects. Knowing the typical regulatory train of thoughts, I dare to say the regulators will encourage banks and other institutions to fill up their assets with these securities in order to re-capitalise themselves and become safer (see Basel I and II and the recourse rule).
Needless to say, this will create an artificial demand for business loans which could lead to an even more dangerous bubble than the mortgage loan bubble as it’s eventual burst will impact the businesses directly. Creating an asset bubble to bring an economy out of a recession proved to be disastrous so far (remember Fed in 2001). Let’s not repeat the same mistake for Britain.
In conclusion, credit easing will undermine the government’s credibility in trying to pursue a long term credible growth path, the very basis upon which their austerity plan can work. By committing to balancing the budget in order to keep its deficit cut promise, the Treasury will send signals to investors that the growth plan is credible and that the government isn’t looking for short-term fixes but rather a long-run stabilization path. Even though the European debt market will influence the UK recovery substantially, more uncertainty and more asset bubbles isn’t a proper incentive for growth and it never will be.
Making taxes more app-arent
How much tax do you pay to get the money to buy everyday goods and services? The answer might surprise you. When you buy something at the shop, HMRC take away Value Added Tax and then some more for things like petrol, tobacco and alcohol through special duties. But even before you have the money to buy what you need, you first have to earn it and here too the Government takes another cut. Fortunately, the TaxPayers' Alliance has released 'Tax Buster', a great little smartphone app today that does all the calculations for you.
One of the biggest problems with the tax system is the amount of effort you need to invest just to understand exactly what we pay in which taxes. So a tool that shows, for any product you buy, how much extra you'd have to earn to pay for the Income Tax and National Insurance, and takes into account the effect employers' National Insurance and Corporation Tax have on driving down earnings. Forget the 20% 'basic rate' of tax. On most ordinary goods and services, typical taxpayers with average incomes pay over 50% tax. On tobacco, alcohol and fuel, the percentages are higher still. Play around with the app yourself. It certainly provides half an hour of compulsive (if rather depressing) fiddling as you enter the details of the various products you've bought recently and Tweet and Facebook the results to your friends.
Tax Buster is available from the App Store for iPhone users while other smartphones can use the online webapp version. For more information, visit the app's website at www.tpaTaxBuster.co.uk.
Hanging London out to dry: The impact of an EU Financial Transaction Tax
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Our new report, released today, assesses the impact of a Financial Transaction Tax (aka Robin Hood Tax) on Britain's economy. The results are eye-watering – it would destroy the City's derivatives trading sector, hit Britain's growth and ramp up market volatility. The executive summary is below:
1) The European Commission has proposed a Financial Transaction Tax (FTT) on all securities traded with at least one party within the European Union. A tax of 0.1% would be applied to shares and bonds trades and 0.01% to derivatives trades, including over-the-counter derivatives, of which London is a world centre.
2) The EC’s impact assessment projects a 1.76% hit to long-term (20-year) growth across the EU. This would amount to a £25.58 billion cost to the UK economy over this period, and a £185 billion cost to the total European Union economy (2010 prices). This is based on a direct application of the cost to Britain’s economy. The true figure is likely to be far greater, because of Britain’s disproportionately large financial sector (and especially its derivatives trading sector).
3) The EC impact assessment also projects up to a 90% decline in derivatives trading if its proposed Financial Transaction Tax is implemented. The City of London is the centre of global over-the-counter derivatives trading, accounting for nearly half (45.8%) of all global interest rates derivatives turnover. This would adversely and disproportionately hurt the London economy, and would destroy a socially-valuable financial activity that it integral to the modern British economy.
4) Contrary to some supporters of the FTT, the tax would increase market volatility. There is no empirical support for the idea that the FTT would reduce volatility. Indeed, by making transactions more costly, the tax would make markets less responsive to new information and more prone to violent lurches up and down. Academic models of the tax have been inconclusive at best.
5) The FTT would reduce market liquidity in all securities markets. 40% of the London Stock Exchange’s volume is based on high-volume, low-margin transactions, which would be wiped out by the FTT, making markets far more illiquid. Markets’ ability to incorporate new information into asset prices would be undermined.
6) Unemployment would rise if an FTT was introduced. At the margin, the FTT would mean less investment and less output. The tax, if implemented in 2014 as proposed by the EC, would slow down an economic recovery and reduce capital investment. The EC’s long-run projection for this is a 4.5% reduction in investment.
7) If the FTT was only introduced in the EU or G20, many traders currently operating in the UK would relocate to places like Hong Kong, Singapore or Zurich. There is little scope for a worldwide FTT – even types of trades that are affected in a minor way by the FTT would likely move en masse to other jurisdictions that would flourish as FTT-free zones.
Charities and the Robin Hood Tax
Have you ever given money to Oxfam thinking, "Gee whiz, I hope some of this goes on support for the Robin Hood tax campaign!"? Me neither. I doubt many people do. The phenomenon of charities like Oxfam, Médecins Sans Frontières, The Salvation Army and others supporting the Robin Hood Tax is bizarre. Most people give to charity thinking that their money will go on doctors for poor people, food for starving people, shelter for homeless people, or the like. They would be surprised – and, I expect, angry – to find out that the charity they are donating to is a supporter of the Robin Hood Tax campaign.
In the interests of people who want to give money to charity without supporting the Robin Hood Tax, here is a list of the more prominent charities that support the campaign (I've emboldened some of the most prominent ones):
- Action for Global Health
- ActionAid
- Barnardo's
- Bond
- CAFOD
- Chartered Society of Physiotherapy
- Christian Aid
- Christian Medical Fellowship
- Church Action on Poverty
- Comic Relief
- Concern Universal
- Health Poverty Action
- International HIV/AIDS Alliance
- Oxfam
- Pump Aid
- Restless Development
- Save the Children UK
- SCIAF
- Stop AIDS Campaign
- TB Alert
- The British Dietetic Association [I had never heard of these guys, but I thought it was funny]
- The Salvation Army
- UNICEF UK
- Water Aid
Now, are there a lot of people who donate to The Salvation Army with the intention of supporting the Robin Hood Tax? Probably not. When I give to charity, I want to help people who are less fortunate in life than me, not support crackpot, celebrity-backed economic cyanide masquerading as "tax justice". Fake Charities monitors charities that get money from the government.
In future, I'll only be giving to charities like these, which (as far as I'm aware) do not support anything like the Robin Hood Tax:
- Kiva.org
- SpecialEffect
- St Mungo's
- Combat Stress
- Deworm the World
- Stop TB Partnership
- Great Ormond St Hospital
There are plenty of others (leave suggestions in the comments). Charity should mean charity, nothing else.
Regional Fund: Coalition's job plan destroys jobs
By handing out cheques to selected companies, the Coalition expects to create or protect 201,000 jobs. Even though three quarters of bidders were disappointed, the government promised to dole out £950 million.
As state money does not grow on trees, it has to be raised elsewhere. Thereby destroying other jobs. The only thing we see is displacement: jobs are taxed away to subsidise the government's favourites. Nick Clegg, for example, who is the MP for Sheffield Hallam, announced the new plan while visiting Sheffield Forgemasters - which will benefit from the government's profligacy.
When governments pick winners, they invariably end up picking losers. This stems from the classical Hayekian knowledge problem: millions of decisions by people are infinitely better placed to allocate funds to guarantee maximum returns, than bureaucrats from Whitehall are. Investment decisions should be left to those who are best placed to assess them: the parties concerned. They are driven to success by risking their own money on their own projects. Let's make sure we follow up on the "success" of the winners in today's cash bonanza. It will make for a splendid disaster book in about five years time.
The government will hand over £1 to the private companies for every £5 of investment the companies can find privately. It is to be expected that most projects were planned a long time ago and would have been gone ahead anyway. And if they would not have happened without the government's cash, then they should not be subsidised, as the market had determined that it was not a sound investment.
One would have thought that after the disastrous bank-and country bailouts the government would have been wisened up enough by now not to gamble with taxpayers' money in this way.
It looks as if this year Wesminster's Father Christmases will fill company stockings with presents the companies paid for themselves.
Slouching towards stimulus
Peter Boettke has a short post on political parties, where he quotes Luigi Zingales from the start of the Great Recession:
If Keynesian principles and education are the cause of the current depression, it is hard to imagine they can be the solution. Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription.
Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good. And they tell consumers, who are affected by severe spending problems, that consuming is good, while saving is bad. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington.
It's depressing to think that it's this straightforward, but when you see headlines like this it's difficult to disagree. If even an "austerity" government is swallowing Keynesian silliness about government spending "kickstarting" the economy (even for PR reasons), it's pretty clear that we're in trouble. I wrote about the recalculation view of recessions recently:
The policy implications of this perspective are quite signficant. Forget trying to "stimulate" your way out of a recession through spending or printing money – all you'll be doing is creating another type of false, unsustainable demand. You'll do the most damage if the stimulus is aimed at the unemployed, the people who need to retrain to cope with the real economy the most: reskilling takes time, and will be put off if there's some public works project nearby that will hire you instead. Even taking up unemployed people's time has an opportunity cost; justification for "stimulus" programmes ignore this.
It's the "unsustainable" that's key there – governments could reinflate the bubble, or inflate another one somewhere else, through fiscal or monetary policy. But we don't want to do that, because it's not sustainable and diverts resources from where there is real demand. The Coalition's "kickstart" for the economy is bad news: it's the wrong thing to do economically, and it suggests that the government is slouching towards Keynesianism again.
Increased rewards for top CEOs
It is good news that the rewards for Britain's top CEOs have increased substantially on the previous year. Although this has been depicted as a 'pay' increase, in fact most of it is made up of performance-related rewards such as shares and share options. Only a tiny fraction of it relates to salaries.
It is good news for Britain that our top executives have been delivering the goods with a substantially improved performance. This bodes well for the viability and competitiveness of UK businesses in the future, which in turn will improve the prospects for employment here. They have gained performance-related rewards by improving the results on the previous, poor year.
It is also a good thing that in an international economy, Britain can offer the kind of rewards that attract and retain the high business achievers. Far from criticizing or curtailing these incentives, we should be seeking to make them even more attractive by removing the disincentive of the 50 percent top income tax band.
The really angry 53%
There’s a lot of really angry people out there. The assorted collection of Occupy Wall Street-types around the world are getting all the media attention. Nobody’s quite sure what they really want or what would make them fold away their spiffy tents. Something about socking it to the 1% of the population in order to satisfy the other 99%.
Well, now there’s another percentage movement underway – The 53%. Launched earlier this month in the U.S., it’s a grass roots bunch purporting to represent the 53% of Americans who actually pay federal taxes. Their website is just a collection of individual testimonials in a photograph about working hard, saving and eschewing handouts to the other 47%. Like this.
If the Occupy crowd are hoping to do for the Democrats what the Tea Party movement did for The Republicans, then The 53% have just upped the ante.
Here in the U.K., HMRC estimates there were 30.2 million income tax payers in 2010 in a country of some 62.3 million people as just reported by the ONS so any such movement here would be The 48%. But they’ll have to be flexible on the name. HMRC forecasts 29.9 million tax payers for 2012 while the ONS forecasts annual population growth of 500,000, putting the number of people in the UK in 2012 at 63.3 so the movement would need to change its name to The 47%.
What are the chances of a British The 48%? Well, as the Lib Dems’ Chris Huhne so clearly warned the Conservatives last month (“We need no tea party tendency in Britain), not much. Right?
What about The 47%? Or The 46%? Or the 45%.....