Californian lefties don't understand percentages
The Daily Mail (who else?) reports that reality TV star Kim Kardashian has been used in a left-wing political ad in California, which argues for higher taxes on the rich. The Courage Campaign, which is apparently backed by the California Federation of Teachers, says:
"Millionaires like the Kardashians only pay a tiny bit more in taxes than a middle-class Californian."
They base this on the fact that Kardashian only pays a 10.3 percent tax on her income, whereas a 'middle-class' Californian would pay 9.3 percent.
But hang on a second. 10.3 percent of $12,000,000 comes to $1,236,000 in taxes. 9.3 percent of $47,000 comes to $4,371. In other words, Kim Kardashian pays $1,231,629 more in tax than Average Joe. Is that really only a 'tiny bit more'?
It's also worth noting that California already has the third-highest state income tax rate in the US, with only Hawaii and Oregon taxing their highest earners more. More broadly, the Tax Foundation says that California has the sixth-highest state and local tax burden in the US, and ranks 49th out of 50 states for its business tax environment. And despite all that, the state has been struggling to make ends meet since 2008.
The Courage Campaign might want to ask themselves whether Kim Kardashian is really the problem. Couldn't it be that, in fact, the Californian public sector has simply grown too large to be funded, even with some of the highest taxes in America? It's a story that will be horribly familiar to most European readers.
An alternative to tax avoidance
Nick Clegg and David Cameron have both been talking tough on tax avoidance, and trailing plans to introduce a general “anti-avoidance power” so that HMRC can ensure everyone pays “their fair share”.
As usual, Tweedledee and Tweedledum have proved themselves incapable of distinguishing between avoidance and evasion. But there’s a world of difference between the two. Evasion means not paying taxes you are legally obliged to pay. Tax avoidance means paying the lowest amount of tax permissible under the law. And what’s wrong with that? Should we voluntarily give the government more money to waste than we are legally obliged to?
It isn’t clear, moreover, what is meant by a ‘general anti-avoidance power’. To me, that sounds worryingly like granting bureaucrats a broad discretionary power to tell people they must pay more tax than the law requires them to. Such a power would a blatant affront to any concept of the rule of law.
Perhaps they have something more like the United States’ Alternative Minimum Tax (AMT) in mind. Simplifying somewhat, that would add up to the following – if your assessed tax liability is less than X percent of your income/profits, then you must pay taxes equalling that percentage instead.
That approach would certainly be more reasonable than allowing broad bureaucratic discretion. But how long would the AMT remain targeted at large companies with, as David Cameron put it, ‘fancy corporate lawers and the rest of it’? The smart money says not long: in all likelihood, an AMT would quickly become a stealthy way of raising taxes across the board. The Treasury would not be able to resist.
More to the point, once you’ve accepted the logic of the AMT, isn’t a better solution staring you in the face? If a simple, exemption and allowance free flat rate tax levied on income and profits works so well, why not just scrap the 900+ page tax code and use the ‘alternative’ system for everyone instead? It might upset a few lawyers, accountants, and special interests, but if you want people to pay their ‘fair share’, that’s the way to do it.
Let us assume that they're honest
Tim Taylor has a nice piece about the recent arguments over what the top tax rate could be to maximise revenue: where the peak of the Laffer Curve is that is. Various of the usual types have been jumping up and down in excitement at a paper that shows that it could be 76%. It isn't, it's 54%, that's the total tax rate including VAT, NI and income tax and, in what is really the great switch in the paper, that takes no account whatsoever of the changes in long term incentives, it looks only at the short term. Scott Sumner is incandescent about the paper, a point which Taylor addresses.
It is also fair to note that political beliefs probably play a role in these differences. Greg Mankiw is a Republican-leaning economist: he was chair of the Council of Economic Advisers in the George W. Bush administration and has been an adviser to Mitt Romney. On the other side, Peter Diamond is a Democratic-leaning economist: Barack Obama attempted to appoint him to the Federal Reserve Board of Governors, and when he was blocked by Republican senators, his name was rumored as a possibility for Obama's Council of Economic Advisers. To be clear, I'm not suggesting that either author would consciously shade his analysis to fit pre-existing political beliefs. But I do believe that when working through a complex model with a number of discretionary choices, we all have a tendency to come out with what seems a "reasonable" answer--which often happens to be not too far from our preexisting beliefs.
Sumner does indeed assume that: but I think that the causation goes entirely the other way around. It isn't that our pre-extant political beliefs make us pick the numbers which lead us to our desired solution. It's that our beliefs about what are the appropriate numbers help to determine our political beliefs.
In this example the numbers chosen by Diamond and Saetz do lead to what we might call a left wing solution. Much higher taxes on the rich. The sort of numbers that Sumner or I would put into the same equation would lead to a much more "right wing" solution, a lower peak for the Laffer Curve. The numbers we're talking about are things like the effect of higher taxes on the propensity to work and so on.
But I don't think that Sumner and I would put in lower numbers in order to get a lower Laffer peak: just as I don't think that our two lefty economists would do the opposite (I can think of plenty of people who would but not these two of this stature). Rather, I think that it's our prejudices about what these elasticities are which lead to our having right or left views on tax rates. Perhaps prejudices is too strong there: our inclinations as to what the numbers are given our own view of the world.
As an example, my marginal income comes from freelance writing. There are enough outlets that I can, if I need a bit more money, just write for more hours. Not go off to the pub, sit at the keyboard instead of taking the bike out for a spin. I know what my reaction to 70% tax rates would be: I'd shoot off on the bicycle and over the Portuguese hills and have a few pints when I came back. My output would decline and decline quite substantially. So I'm prepared to believe, primed to believe, that work effort is quite elastic as compared to tax rates. Other people might have very different ideas about life and the work life balance: no harm in that. They might be more swayed by prestige for example, or have always worked in jobs where income doesn't vary much with effort or hours (like a university professor for example). Thus, from their own experience, their own internal values, they're predisposed to believe that work effort, hours, have a low elasticity with respect to tax rates. Because people are more motivated by things other than post-tax income.
Of course, where we're trying to see what the effect on the entire economy is we're supposed to be inputting the numbers that apply to everyone else, not what apply to us alone. But where there is judgment, where there are choices as to what number to use, I really do think that it's our own opinions, our own experiences, of what these numbers are that then feeds through into our having right wing or left wing results.
I've rather over-egged this argument in order to get the point over. But I do think it to be true that it isn't that we choose economic models, or numbers to put into them, because we want to reach a conclusion that accords with our political ideals. Rather, our political ideals grow out of what we think those numbers are before we start to run them through the models. And I think this goes far beyond simple economic models as well. I, to use my favourite subject as an example once again, absolutely despise having to fill out paperwork. It is, I am certain, because of my hatred for having to do so that I am so vociferously opposed to a governance system that insists on people filling out paperwork all the time. I'm sure you can think of other examples of the same point: our own character, our own wants and desires, do get projected onto the world around us.
All of which is grist to the mill of the classically liberal world view of course. Those who wish to may, whatever consenting adults voluntarily choose to do. But the impositions upon such in what they must do or may not do have to be incredibly limited, for what must and may not be done is being determined by those internal prejudices of those doing the deciding rather than the free will of the participants.
Investment should be left to the private sector, not the government
Regarding the UK Chancellor’s last week’s autumn statement, if anyone had any doubts, one thing was made clear – the UK, much like the US, is embracing fully on a Keynesian path to recovery.
The government took the plunge to direct private sector investment decisions. It is calling on pension funds to invest into infrastructure projects and even putting in some money by itself, it is calling on businesses to hire more young people (introducing an age boundary and a waiting list boundary) and offering them money to do so, it is calling on banks to lend more money to businesses by offering guarantees for these loans thereby setting a stage for another asset bubble, it is underwriting mortgages and driving the housing supply and finally it is doing all this in hope of satisfying narrow interests and in hope of ensuring political success.
The government is centrally planning the country’s development. And they are doing so through populist policies, higher spending and more borrowing, despite all the warnings from the Office for Budget Responsibility (OBR) on the adverse effect this will have on output. The call for cuts is still strong but so is the call for more spending and more borrowing. The deficit and debt goals are prolonged another 2 years than initially planned. No wonder, since the policies the Chancellor came up with will only widen the national debt and increase the budget deficit. What is the point of calling plan A (or plan A plus) austerity, when it is clear that the UK is using a fiscal stimulus.
It is worrying that the current government would rather resort to populism and cronyism to create a seemingly good picture of the economy then to keep its long-term goals. The bond markets aren't punishing the UK yet, but they will do so soon enough. The policies imposed by the Chancellor resemble all those policies that led the peripheral eurozone nations into severe debt troubles. The UK is nothing like these economies some would say and would be right. But it is only a matter of time before it becomes like them if allowed to continue with a centrally planned investment and ‘growth’ scheme.
The worst outcome will be in the perception the UK government will create. Once it fails in its policies to restore growth, the Keynesian response will be it was because it crippled the recovery by cuts and that the plea towards austerity didn’t boost spending or the aggregate demand. The fiscal austerity aimed to reduce the national debt and budget deficit will be blamed for UK’s failure and a lost decade or two. But it will be exactly the opposite. Reckless spending in the Brown period and incompetence and lack of courage to change the public’s opinion on the welfare state and continuance with populist policies during the current government will mark the reasons of a lost decade in Britain.
The lessons of the financial crisis in 2008 and the current eurozone sovereign debt crisis haven’t been learnt. The fallacy that a centrally planned economy can lead to prosperity and creating value still persists in the minds of the decision makers. Government steering of private sector investment leads to the creation of artificial demand and it leads to the creation of asset bubbles. The solution to these previously created problems cannot be applying the same policy as before, it must rest on other virtues, it must focus on creating value. And only the private sector can create value. Therefore, the government must do everything to clear the way and remove any burdensome regulation and taxes in order to encourage the private sector to do so. Confidence in the economy is best restored if it’s a healthy, private sector led economy, not a government run behemoth. If UK policymakers are unable to see this, they should resign with immediate effect before they poison an entire generation with dogmatic thinking.
The good, the bad and the ugly in the autumn statement
THE GOOD
1. UK’s commitment to eliminating its deficit remains credible. However, the growth figures that the initial deficit reduction plan was based on now look overly optimistic, which means that cutting the deficit will almost certainly require additional cuts to current expenditure before the next election. But so long as the government commits itself to eliminating the deficit by reducing expenditure – and not threatening growth by raising taxes – we should be able to avoid a Euro-style meltdown.
THE BAD
2. Spending on infrastructure is an accountancy trick. It might boost GDP numbers, but it won’t do much for the real economy – in fact, it might make things worse. A recession is a period where investors reallocate their capital and people reskill to produce things that consumers want to buy. Infrastructure spending delays this, by creating unsustainable demand for skills that the private sector doesn't want. That might make the economy appear to be improving in the short term, but in the long term it gives mixed signals about where people should reskill and move, and makes sustainable recovery even tougher to achieve.
3. The lack of pro-growth tax cuts is worrying. If the last year has proved anything, it is that economic growth won’t come from nowhere. Entrepreneurs are paralysed by employment and business regulation, with high taxes making retirement a more attractive option than reinvestment for many successful businesspeople, and credit markets are reluctant to lend in such a sclerotic business environment. If the Chancellor wants to make the Eurozone crisis into an opportunity for Britain, he should be trying to make Britain the best place in Europe to do business. That means cutting taxes and regulation across the board.
THE UGLY
4. Credit easing is a deeply misguided policy that utterly ignores the lessons of the last decade. Packaging together small business borrowing into a government-backed security gives a false illusion of safety to investors. If and when some of those businesses start to fail en masse, bonds that looked completely safe are revealed to be worthless, creating financial havoc. It’s a re-run of the US subprime mortgage policies that led to the 2008 financial crisis. All credit easing does is set us up for another crash in a few years time.
Dr Madsen Pirie, President of the Adam Smith Institute, adds:
“It is good that 'Plan A' to cut the deficit is now 'Plan A-star,' stressing the importance of growth as well. The measures are small beer compared to the things that could really lead to growth. We must be careful not to tread in Gordon Brown's footsteps, trumpeting small-scale schemes by loud announcements.
What is needed is for government to be serious about removing the obstacles to growth posed by high taxation and over-regulation. Small businesses, which provide two-thirds of all new jobs, want to hear that their tax burdens will fall, and that they will be freed from many of the regulations designed for large firms.”
A guaranteed mistake
I rejoice in UK Business Secretary Vince Cable's ability to believe in two contradictory things at the same time. One is that the banks should strengthen themselves by putting more money into reserves. The other is that they should lend more to small businesses in order to kick-start economic recovery. The logical problem, of course, is that money which the banks keep in their vaults isn't then available to lend out to businesses – or anyone for that matter.
In his Autumn Statement (or soon after), Chancellor George Osborne is expected to resolve this dilemma by providing government guarantees on loans that the banks make to certain businesses. It parallels his announcement last week that the government would provide guarantees on loans made to first-time house buyers.
Guarantees are cheap. You don't have to shell out the money unless things go wrong. That doesn't stop them being immoral and counterproductive. With the government guaranteeing 95% mortgages, and with interest rates so low, I wonder how many people will be seduced into taking out home loans which – when interest rates rise – they won't be able to afford. Encouraging such sub-prime mortgages is surely immoral. And taxpayers bailing out banks when such loans go wrong…well, haven't we been here before?
The business loan guarantees being planned by George Osborne pose the same moral hazard. And they are bad for business, too. Sure, credit is tight. Curiously, that might be because interest rates are too low, not too high. Why would anyone lend money when the interest they earn doesn't even keep pace with our 5.2% RPI inflation rate? Inasmuch as the new guarantee scheme encourages businesses to borrow – which might be marginal, given the gloom that infects nearly all businesses right now – it will encourage people to make more bad investments. It's surprising, but business failures are lower at the moment than they have been in decades: it's simply cheap credit that is propping them up.
Some time, businesses have to grit their teeth and write off all the over-optimistic investments they made during the Brown Bogus Boom years. Then perhaps their investment cash can be put into things that have a better prospect of returning a profit. Painful, but better than living in a fantasy world underwritten by taxpayers. But giving them cheap credit, and more of it, just prolongs the the illusion, and the slow agony.
Bank-bashing for pensioners
What’s more satisfying than bashing bankers to help pensioners? There is something to the Occupy movement’s outrage at the rewards enjoyed by the banking industry but the hue and cry for higher bonus and income taxes and a financial transactions tax misses the point.
The ASI has already explained why a financial transaction tax, aka Robin Hood or Tobin tax, is simply wrong and we won’t go over the details. Suffice to say that bankers are too smart to actually pay it. They’ll either move elsewhere or pass on the tax (like any other corporate tax) to their customers, ie. pensioners and other savers.
A more promising route for dealing with seemingly high-flying bankers is to figure out why they make so much money in the first place, not how to tax it after they’ve made it.
Step forward, David Norman, chief executive of TCF Investment. In an open letter to Prime Minister Cameron, Mr Norman calls for “an urgent and holistic review of the UK retail fund sector.” His literal bottom line is that the retail fund industry is ripping off savers through a complex and opaque system of fees and hidden charges.
Mr Norman is continuing a crusade whose beliefs were spelled out in a paper published over a year ago. It detailed all the charges borne by saversfrom the upfront Annual Management Charge down through admin fees, FSA fees, stamp duty and trading costs, to name just some. He has calculated that an average UK stock market fund investment of £100,000 over 20 years at 7% a year will generate £227,695. Of this total, though, £159,272 goes on all the various charges, not to the saver. (A Robin Hood tax would simply be another component in this overall bill.)
Now, Mr Norman’s figures may be extreme and he has been challenged on many of them by Mark Dampier, head of research at Hargreaves Lansdown. Of course, the two would differ: TCF markets itself as a low-cost investment provider while Hargreaves Lansdown is introducing a new monthly fee on index tracker funds.
All of this is way beyond the comprehension of most so Mr Norman has a solution: “The publication and wide communication of sound research into the total cost impacts on funds would empower self-motivated consumers and act as a standard to hold adviser recommendations to account. It should be an imperative for FSA to publish tables of Total Costs of Ownership (TCO) for all funds sold in the UK.”
For free and open market types like us, a thorough review of the sector may be a good idea as long it does lead to price transparency to foster competitive markets - the only sure route to the best quality at the lowest possible price. The risk is the unintended consequences of letting politicians start poking about. For the government, it really doesn’t require much except a bit of “nudge” work. But will they be able to stop there?
In the meantime, can we persuade the Occupy movement to swap their logo from “I am the 99%” to “I am the TCO”?
Reusing chewed-up ideas on the housing market
On Monday, David Cameron announced a new policy on housing designed to partially underwrite mortgage loans for first time buyers in order to make it easier for them to buy and own a house. The idea is to make new buyers provide only a 5% deposit for buying a new home, instead of up to 20%, which the banks are demanding now. It is supposed to make the “homeownership dream” a reality for young people. The government and the construction firms will together underwrite a part of the loan creating an incentive to the banks to relax lending standards. This is aimed to help 100,000 new possible homebuyers who are excluded from the market due to high loan-to-value ratio’s.
The PM cleverly offered a caveat to potential critics by saying this policy won’t result in another asset bubble like it did in the US, since it is only focused on people buying new houses. It is supposed to create jobs in the construction industry as well as making it easier to own a home.
This essentially means that no matter what the current supply of housing is in the UK, because the government is worried with low rates in housing construction, it is willing to distort the housing market by increasing the supply of new homes.
The policy such as this one comes closest to the Community Reinvestment Act (CRA) instituted in the US, more particularly its amendment in 1995. For those unfamiliar with the CRA, it forced the banks to offer more loans and weaker lending standards to underprivileged groups in the society (minorities for example). It was a popular political move that was guided under the idea that everyone is entitled to a home, and if they can’t provide it by themselves, the government should do it instead.
As an effect, encouraging homeownership added to an artificial created demand for housing in the US which combined with a few other presumptions led to the boom and bust of the housing market. Houses became available to many of whom were unable to afford them, underwritten by the government controlled enterprises. Lending standards were decreasing due to short run interests of the politicians to remain in power. A populist policy such as “let’s make more people own a home” sounds good to the median voter, and may even win some favours for the politician in power, but its effect can only be an artificial demand and suboptimal provision of an asset.
I do understand the difficult situation the PM and his Chancellor are finding themselves in as their growth strategy isn’t delivering any results. I might understand the political need for a politically motivated act that will create a (temporary) artificial boost in housing and build some new homes for the people. However, it seems that every move they make to boost short-run growth further undermines their long-run growth path. Every new populist policy will simply detach them from their fiscal stabilization goal and make the UK more vulnerable to outside shocks of investor sentiment. I fail to see how increasing spending via credit easing programs or subsidizing homeownership can overturn a deficit. There will be no aggregate demand created either, since household incomes are locked-in and it is unlikely for the people to start spending on houses all of a sudden. The effects cannot be immediate, they can only distort the economy in the long run. It all sounds more like an expensive political trick used to buy votes.
Haven’t they learned anything from the eurozone sovereign debt crisis? A welfare state used to fund populist policies to finance political self-preservation leads to disaster.