New at AdamSmith.org: The global economics of corporate tax cuts
Jim Flaherty, Canada’s minister of finance, may well be exasperated. Speaking of the federal government’s plan for a national corporate tax of 25 per cent, the Minister affirmed that ‘we believe lower taxes create investment and jobs. I continue to encourage our provincial partners to follow our lead.’ Unfortunately, his counterparts remain to be convinced, with British Columbia and Ontario signalling their intentions to halt the downward trend.
How times have changed! ‘On New Year’s Day,’ reported Neil Reynolds, ‘Canada’s corporate tax rate — federal and provincial rates combined — fell to 25 per cent, giving Canada the lowest rate in the Group of Seven countries, and a more competitive economy on a global basis.’ (According to the 2012 Index of Economic Freedom, Canada’s federal rate of 15 per cent compares favourably with the United Kingdom’s 26 per cent.)
Flaherty could remind officials in the provincial treasuries of the global consequences of their actions, citing an economic truism published in The Wealth of Nations two-centuries-and-a-half ago.
Pensions redux
Remember pension tax simplification in 2006? At the time, it seemed like a reasonably good idea - reduce the patchwork of legislation built-up by successive governments to encourage retirement provision by simplifying the previous eight tax regimes into one single regime. But as with all national schemes, politicians can’t leave well enough alone and the tinkering with simplification began from day 1. And it just won’t stop – we can expect the Chancellor to fiddle some more come the March budget statement.
Throw in a history of scandals like Robert Maxwell, pension mis-selling and exorbitant fees and it’s little wonder normal folk are confused and suspicious, not to mention hugely reluctant to save.
But, lo on the horizon, rides Merryn Somerset Webb, editor-in-chief of Money Week and columnist for the Financial Times money supplement, with a battle cry to do away with the whole bloody mess.
In short, here’s her plan: “Abolish the pension system. Increase the annual ISA limit to somewhere around £30,000, with some kind of lifetime contribution limit included too. Make a big deal about how the money comes out entirely tax-free. Not having to pay tax on my income when I am old is an attractive option to me and I bet I am not alone.”
Ms Somerset Webb already anticipates some objections. Some will worry about liberated pensioners blowing it all in Las Vegas but she suggests a requirement to keep an age dependent minimum in the ISA. Others will cluck-cluck about the impact on public finances but Ms Somerset Webb suggests the Treasury “could amuse itself” with a one-off levy on all pension holdings to convert them into ISAs and believes the savings on pensions tax relief should compensate for the lack of income tax from ISA investments.
The proposal’s beautiful simplicity, of course, makes this a tough sell – there’s just too many vested interests keen on making things complicated: politicians who need fiddly toys, treasury officials aghast at losing buttons to push, financial advisors needing someone to advise, bankers flogging incomprehensible products.
And then there’s the problem with all proposals to simplify any tax regime – overwhelming inertia to undertake such efforts and an irresistible urge to keep changing the rules. How could savers be confident Mr Somerset Webb’s new regime would outlast their days on this planet? It was just a blink of the eye before tax simplification became a standing joke.
Still, Ms Somerset Webb has floated a brilliant idea and could be taken a step further - if we’re going to think big - by ending company sponsored and managed pension schemes. Employers would simply make contributions directly into an individual’s ISA account at some basic minimum rate, say 8%, or more if they want to attract and retain good staff. Companies would be freed from a tiresome cost and employees would benefit from a seamless and portable savings plan independent of their employer.
Could the nation cope with so much simplicity?
Selling the Rule of Law for £500m
On Radio 4’s Today Programme this morning, Exchequer Secretary to the Treasury David Gauke defended the introduction of retrospective tax law to make Barclays pay tax which it had avoided legally. “When we see something like this, behaviour which is unacceptable, we are willing to step in”, he said. There are always reasons to ditch rules which aren’t very convenient. But such reasons are rarely good enough. And certainly not when it is to scrape away the glue which keeps the law together: the Rule of Law.
Retrospective legislation – or Ex Post Facto law, as it is called in jargon – is unacceptable because it make coercive rules random at the behest of the rule maker. In The Constitution of Liberty, Hayek describes how some coercive action by government is acceptable, provided it satisfies three conditions: generality, certainty, and equality. Retrospective legislation fails on the certainty ground, and is therefore objectionable. Earlier, in The Road to Serfdom, he said:
“[The Rule of Law] means that the government in all its actions is bound by rules fixed and announced beforehand – rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances, and to plan one’s affairs on the basis of this knowledge.”
How is a company to assess costs and gains before it makes an investment if greedy government can turn around at any given moment and ask for more? It is fundamentally unfair to hold a person to be in contravention of the law when the law did not exist when the alleged contravention occurred.
This is not the first time a greedy government has decided to outlaw behaviour after the facts. But there is even worse: leaving tax laws vague to give the taxman discretion to tax no matter what has been common practice in the UK for years.
Some have tried to legitimise the Treasury’s actions by pointing out that Barclays has signed a voluntary code of practice in which it promised not to use tax avoidance schemes. It was certainly silly of Barclays to do so, as tax avoidance is not illegal (tax evasion is); and by signing this code of practice it effectively harmed its shareholders. Its action may have been inspired by a fashionable public spirited sense of “corporate responsibility”. Barclays wouldn’t be the first corporate player to decide that it’s quite a good little idea to collaborate with coercive greedy government. Never mind the consequences for the entrepreneurs who arrive later.
You cannot opt out of the Rule of Law. Barclays' silly signature changes nothing to that simple fact. For the Treasury, £500 million of additional tax revenue is a sufficient reason to walk over legal certainty. Never mind the billions of pounds investment which will now walk out of the UK.
Wicked web
Oh what a tangled web we weave,
When first we practise to deceive
The tangled web that has become university funding in the UK is already throwing up early evidence of what a fraud the whole thing will prove to be.
In last week’s Times Higher Education, an article purports that students would be foolish to repay their loans early, even after the government’s scrapping of early-repayment penalties. It quotes Tim Leunig of CentreForum and a lecturer at the London School of Economics as saying graduates should think twice about paying off their debts early because most will never repay the full amount within 30 years, after which time arrears are written off.
He’s quoted as saying “Every penny of their early repayment is a gift to the government.” A gift to the government!!! That heavenly body showering us all with free goodies? What he really means is that failing to repay is a good kick in the ass to every hardworking taxpayer now stumping up the cash.
Putting yet another boot into the taxpayer is Liam Burns, president of the National Union of Students who’s quoted as saying “Ministers must come clean on student finance that those on low and middle income are not duped into chipping away at their outstanding debt.” Duped!!! Doesn’t he mean reneging on a promise?
So the government whips up a scheme for which it has no plans to fully collect unpaid debt, a teacher of our young advises against doing so and a student leader fans the flame of irresponsibility.
How morally bankrupt our body politic has become.
Debt reduction and economic growth
Here’s a letter I wrote to the Evening Standard last week. I’m not sure whether they published it or not.
Too many people believe we have a choice between debt reduction and economic growth – that we can have one, but not the other. Nothing could be further from the truth. In fact, debt is the greatest threat to our economic stability and debt reduction is the surest route back to economic health. Recessions are painful, but they also play a vital role in the business cycle: as the excesses of the boom years are unwound, as bad investments are liquidated and debts paid down, solid foundations are laid for real, sustainable growth in the future.
This has important implications. Firstly, it demands that George Osborne not only sticks with his deficit reduction plan, but actually goes further and faster. There is scope to do this. Remember, Labour raised spending by 60 percent while they were in office. The coalition government has so far reversed only the tiniest fraction of this. Secondly, the government must stop artificially stimulating borrowing and let the necessary private- and financial-sector deleveraging take place. History shows that growth returns once this process is underway, and not before. The Swedish experience of the 1990s is a good example of this in practice.
The Eurozone crisis paints a horrifying picture of what happens when debt spirals out of control, and Moody’s recent negative outlook warning shows that Britain is not immmune from the problems affecting the Continent. If we fail to reduce debt, the best we can hope for is Japanese-style stagnation. The worst case scenario – financial chaos and monetary collapse – is altogether less pleasant.
Perhaps I should have included a historical example of debt reduction going hand in hand with a return to economic health. One such occasion is the ‘forgotten depression’ of 1920, which Tom Woods writes about here:
The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent… Instead of "fiscal stimulus," Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third… By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.
Savage spending cuts
The chart above shows total UK public spending between 1997 and 2015 in constant 2005 £. Does that look like radical austerity to you?
This is hardly an original point, but it’s worth restating until people start to notice: Britain is not radically cutting public expenditure. As displayed on this chart, spending was £613bn in 2010 and £615bn in 2011; in 2012 and 2013 it will be £618bn, and in 2014 and 2015 it will be £617bn. Even in real terms, spending will be higher at the end of this parliament than it was at the beginning. It would be fair to characterize this as spending restraint, but it’s nothing more than that.
Why does public debate bear so little resemblance to this reality? In part, it’s down to the fact that the government is desperate to show bond markets that it is serious about deficit reduction, so that they can keep borrowing cheaply. This makes them dial up the austerity rhetoric, even when its not backed up by real spending cuts.
Another reason is the way the Treasury initially presented the coalition government’s austerity plan – as a recipe for £80bn in cuts. But these are cuts against a baseline of projected increases, not actual reductions in spending. Moreover, these are only ‘cuts’ in Departmental Expenditure Limits (DELs). Annually Managed Expenditure (AME), the other half of Total Managed Expenditure (TME), which includes social security, public sector pensions, debt interest payments, and European Union Contributions, would continue to rise.
And then there’s the fact that the public sector has grown so used to huge annual rises in spending that it struggles to cope without them. When you are accustomed to profligacy, fiscal restraint can be a shock to the system. Indeed, many of the promises made to public sector workers were based on the assumption that spending could grow by 7 or 8 percent a year indefinitely. Now that’s been exposed as a cruel lie, their union representatives are prepared to make a lot of noise about it.
But whichever way you slice it, there is no radical austerity, no savage spending cuts, no public sector apocalypse. Someone ought to tell Paul Krugman.
P.S. Apologies for the fact that my chart is titled ‘This’. For some reason, I couldn’t get ukpublicspending.co.uk to produce anything else!
When a council tax freeze is not a freeze
Councillor Colin Barrow, leader of Westminster Council, had a post on Conservative Home yesterday boasting about Westminster's council tax freeze:
Today Westminster’s Cabinet will confirm our intention to freeze our council tax for a record fifth year in a row, whilst at the same time responding to the concerns of our residents by putting an additional £2 million back in to street cleansing for the coming year.
Sounds good. Except that, in exchange for freezing council tax, Eric Pickles is offering councils a payment equivalent to a 2.5% rise in their council tax in exchange for freezing their rates. In other words, Westminster's council tax "freeze" has come at a cost to the rest of us that do not live in Westminster and might be facing rises in our own council tax. Eric Pickles's money is taxpayers' money, so this "freeze" is in fact a tax hike for everyone else so that Westminster council can look prudent.
There's a bigger point here than just the deceptive use of taxpayer money. That the central government can do this sort of trickery to allow councils to look prudent (and to avoid bad headlines for the government) points to a much deeper rot in the system. Councils only get about a quarter of their funds through council tax — the rest is from national taxes and centrally-collected and -allocated business rates. The idea is to use government to redistribute between rich and poor parts of the country. This bears the same zero-sum thinking of all redistributive taxation.
A much better approach would be to devolve fiscal, tax and regulatory powers to councils, so that the poor parts of the country can grow their way into prosperity. If the Barking and Dagenham Council could slash business regulation, it could stimulate business and attract investment to enrich its residents. If the plain people of Islington don't want laissez-faire, fine, but they shouldn't stop poorer places from enriching themselves by cutting back the state.
Alas, it's unlikely to happen. As long as councils are dependent on the central government for most of their funding, their "constituents" will not be council taxpayers but government pen-pushers. No wonder they're happy to boast about tax "freezes" that cost taxpayers even more money.
How charities and religion (should) solve the problem of social spending
At the beginning of January, the UK’s Charities Aid Foundation published a report on the World Giving Index. The ASI already covered this topic and the emphasis was how this index can recognize between-country differences in their respective levels of social capital.
One would expect that the outcome would see countries with strong egalitarian welfare states topping the list, as they have a much better sense of social capital developed than the 'ruthless' USA, where self-interest and greed allegedly drive the incentives of individuals.
Well, surprisingly (or not surprisingly at all), the US tops the list, followed by other Anglo-Saxon countries. As well as Ireland and the Netherlands, the USA, Australia, New Zealand, the UK, and Canada make up the top 7 in the list. And even though countries like Denmark (17), Sweden (40), Norway (32) or Germany (26) are ranked high enough, countries like France (80), Spain (83), Italy (104), Portugal (127) or Greece (151) apparently don't have any sense of social capital at all.
How does one explain these obvious differences between the Anglo-Saxon countries and the welfare state continental European countries? One paper provides a particularly interesting insight. A paper by Scheve and Stasavage (2006) uses religiosity to explain the difference in social welfare spending and redistribution between countries. Using a cross-country analysis they conclude that countries with higher levels of religiosity have lower levels of state welfare spending. They use this conclusion to explain the differences in between-country levels of redistribution.
As they show in Figure 1. (pg 259 of the paper) European welfare states (such as Sweden, Denmark, France, Germany, Norway etc.) experience traditionally high levels of social spending (measured as a % of GDP) while simultaneously religious beliefs (measured by the importance of God in a person’s life) are not very high (averaging between 4 and 5 on a 1 to 10 scale). On the other hand, countries in which religious beliefs play an important role (between 7,5 and 8,5 on the same scale) in an individual’s everyday life (such as the US, Ireland, Canada, Portugal) the level of spending tends to be much lower, 5 to 10 percent on average, thus strengthening their initial hypothesis. Therefore religion could act as a substitute for an inadequate level of state funded social insurance.
But why are then churches and charities so much more involved in countries with lower levels of welfare spending? Does the importance of God influence people to be more cooperative and thus engage in charitable activities? Or is religious awareness, as in the case of the UK, irrelevant to the fact that people are more charitable?
Consider the implication of inter-church competition to explain the reasons behind why churches in some countries offer more services to replace government welfare programs. One should look at the difference between countries with one dominant religion and one dominant church and those with many churches (with same or different religious beliefs) and observe that in countries with multiple churches there exists a certain level of competition between them. In these cases offering services such as child day care may be a way to attract more people to their church. Observing this the government has less incentive to invest into the provision of these services.
There may exist a reverse causality in this case – it’s not due to the fact that the government decided to lower social spending that the churches have increased the level of services they offer, but quite the opposite – it is due to the competition between churches to lure more and more people in that signals to the government to lower their social spending levels. Charitable donations can be tracked in the same direction; due to the fact that more people tend to privately solve the coordination problem in the demand for social insurance, there is less need for the state to step in and provide it.
If this is indeed true, it should act as a signal to countries such as the UK or Ireland to lower their welfare spending, since private incentives and charitable organizations are likely to take over from the government and provide services such as child day care, private schools, hospital care, retirement homes, homeless shelters, soup kitchens etc. The Salvation Army does just that, as do many other UK organizations. Perhaps it isn't quite sure how much the private sector can 'offload' the government in its welfare spending, but it should be given a chance to do so, particularly in the Anglo-Saxon countries where social capital is undoubtedly very high.
Return on investment for government projects
One of the principal claims made to support various government projects is that they will offer a positive return on investment (RoI). From one perspective, levels of RoI are scrutinised as part of the cost/benefit analysis and consultation process on major projects and form part of the ‘business case’ for such projects (presumably the term ‘business case’ is used to distinguish such discussion from non-financial issues involved in any project). The same is true when subsidies are given.
For a full discussion Mark Pennington’s Robust Political Economy is excellent reading and is, naturally, quite correct. If governments are going to spend vast sums of taxpayer’s money on public projects it is only right that they are not loss-making; especially when the project is not a pure public good (not that this excuses the Ministry of Defence for wasting money!). Government departments’ projections and performance are scrutinised by the National Audit Office and Parliament itself.
Unsurprisingly, predictions of RoI are frequently over-ambitious and even without hindsight can be called into question. While large transport infrastructure projects are à la mode it’s worth recalling the Channel Tunnel but I’m sure everyone has their favourite; the South Sea scheme, groundnuts, Concorde, the Millennium Dome, the Edinburgh tram etc etc etc. It is to be remembered that plenty of other countries’ governments also have a strong record in this sort of thing so it is not simply British incompetence. This should all be borne in mind when governments and lobbyists put forward favourable RoI as a justification for projects as diverse as HS2, the Olympics or UK film funding.
Nonetheless, although predictions of RoI are often optimistic, or downright fraudulent, there is a bigger epistemological question at stake here. For instance, in the case of film funding: “For everyone [sic.] £1 ... invested, British films are reckoned to generate £5 at the box office”. To which the response must be “How much would the £1 have earned if it were left in private hands?” Clearly this question cannot be answered, even if we approximated it using the average RoI for every £1 invested throughout the economy (also, one wonders, if films are such a profitable investment, why aren’t private investors falling over themselves to get into the industry?). Proponents of projects fail to recognise that they are making a counterfactual claim by using RoI and are assuming knowledge that they cannot possibly possess.
This ‘knowledge problem’ was most famously expressed by F.A. von Hayek in his article ‘The use of knowledge in society’ (although I think Hayek was discussing the dispersed nature of knowledge rather than the impossibility of it as in these instances). Of course, there may be other reasons for pursuing a government spending project, hence we now have the concept of ‘Social Return on Investment’, but these will likewise be subject to incentive problems, as Public Choice theory demonstrates*.
Of course, private investors have to make a similar assumption of knowledge with similar constraints on that knowledge. The key differences are, however, that private projects are undertaken at the risk to the individual(s) concerned and without the constraint of Public Choice effects. A private scheme that fails to generate sufficient RoI will be liquidated or sold on to someone who can generate a profit or – if undertaken for reasons other than profit - will be run at a loss. Government schemes that fail to make a profit simply incur greater charges on the public purse.
To most readers of the ASI blog, I expect, these points will be so commonplace as to be hardly worth mentioning. However, as we hear such claims made every day in favour of x project and y subsidy and go unquestioned it seems worth re-iterating. It is beholden on us to remember that rationalisation of government spending based on claims of positive RoI is not simply occasionally fallacious but always and entirely specious.
*For a full discussion, Mark Pennington’s Robust Political Economy. It is excellent reading.
Want a stagnant economy? Then keep the 50p tax!
David Cameron said today that he will not scrap the 50p tax rate, because “it would be unpopular”; because “the broadest shoulders should do more”; and because it would not be appropriate now that the economic situation has deteriorated. Let us dissect the arguments one by one.
Cameron approaches the argument from the wrong end. He wants to balance the books. But these are the books of a socialist state. This government is spending the most money any government has ever spent in the UK. Arguably, a government which merely seeks to finance such an excessive state is not Conservative. The question is not whether 50p raises money; or whether it is popular. The question is: will this 50p rate produce growth and therefore prosperity for all?
Of course 50p is popular with a majority in the land: they are not paying it. Something is not right because it is supported by the majority. It is possible that expelling hundreds of thousands of immigrants would be popular with a majority. It is possible that banning travellers would be popular with a majority. It is possible that expropriating anyone who owns more than, say, £500,000, would be popular. Democratic majority rule must always be subject to rules which limit what the state is allowed to do. In effect: limiting coercion by the state to an absolute minimum. Key in the limits to government stands the protection of private property rights – the ownership of one’s body and the fruits of one’s labour. Property must not be made subject to majority rule because it is of enormous benefit to all – including those who don’t own anything.
Private property (including the fruits of one’s labour) does not need protecting because of a “belief”, but because it advances society and therefore civilisation as a whole. Pay, profit, and resulting wealth shows which behaviour should be imitated and which shouldn’t: go out to work, or stay in bed? It shows which methods are the most effective, thereby leading to innovation and progress. It sends signals to everybody else as to which goods and services are required where and when: when the Soviet Union abolished private property it resulted in long queues and shortages. Accumulation of property and capital allows investment. Exclusive products become mass produced because wealthy people pay too much for them initially. Countries with no respect for private property stagnate or decline. Is it a coincidence that this government coerces us through taxes to part with the biggest share of our private property ever; while at the same time its country produces no growth whatsoever?
Should the biggest shoulders do more? They already do, of course. When I last checked, shoulders were situated on top of a body that can walk away. This is precisely what is happening in the City right now. Those biggest shoulders are moving to Switzerland and Dubai and Singapore and Hong Kong – and the rest of us will eventually have to pay for the shortfall in tax take. HMRC enthusiastically reports that the 50p brought in hundreds of millions in the first year. Presumably, it takes a while before people start fleeing. Perhaps the 50p payers even hang around for a bit longer while Osborne dangles the prospect of the future abolition of the 50p in front of them? What the increased revenue does not show is how much tax take is not achieved because those high-end employees never arrive on our shores; or because entrepreneurs decide to invest outside of the UK. What that increased revenue does not show is what harm it does to the economy. This government of the 50p is also the government of no growth. Countries which slashed their taxes always experienced a high growth as a result. 50p tax seems to be part of an Agenda for No Growth.
It is said that we could not cut the 50p, because the economic situation has deteriorated. Has anyone in Osborne’s department ever wondered whether the one does not (in part) cause the other?
In this whole debate one very strange argument popped up. According to The Telegraph. “Ministers are also thought to believe that the decision effectively to extend the public sector pay freeze until 2015 has postponed the removal of the 50p rate”. Perhaps they mean to say that everybody should tighten the belt. To me and mine a public sector pay freeze comes not even close to approaching effective measures to reduce the size and therefore the cost of our bloated state. How about firing half of all the public sector employees so we can cut taxes to jump start the economy? Firing half of our public sector employees would have the added advantage that there would be fewer around to harm our economic endeavors with their rules and regulations.
Demanding that people part with 50p in tax is excessive. Add to this social security contributions, VAT, stamp duty, fuel tax, flight tax, and a myriad of other taxes, and you reach levels of 70 or 80% of taxation. Such taxes are not characteristic of a free people.
