A free-market agenda for the 2012 budget
50p Tax – It should go. It doesn't raise any money and it damages Britain's economic competitiveness. Dropping the 50p rate to 45p would be ineffective and wet. Any tax over 40p – to which national insurance must be added too – will produce lower long-term returns for the Treasury as investors conclude that Britain does not welcome them. Changing the rate to a new figure simple sends out the signal that Britain's tax system is in turmoil – while what investors want it stability. Reducing it all the way to 40p will send out a clear signal that Britain is open for business again.
We released a report last year calling for the 50p rate to be scrapped and arguing that it would lower tax revenue. Our director, Dr Eamonn Butler, recently wrote about this in the Mail on Sunday.
Mansion tax - There is a case for wholesale reform of Britain's land/property taxes, but the mansion tax is the wrong way to go. Tax policy should be driven by economics, not envy-fuelled class warfare. This taxing of wealth is essentially theft.
Personal Allowances - We are in favour of raising the personal allowance and have been arguing for this for years. Indeed, we would go further and ensure that people earning the minimum wage or less did not pay income tax at all.
Pensions - Further restrictions on contributing to private pensions would be a misstep by the Chancellor. Firstly, savers have already been hit hard by policies like QE. Secondly, given the demographic pressures of an ageing population, the government should be encouraging people to save more not less. Thirdly, savings create capital pools for investment, which drives economic growth – again, we need more savings, not less.
Sin taxes - Sin taxes are regressive: they hit the poorest hardest. Moreover, the revenue from existing sin taxes already far exceeds the costs to society of tobacco, alcohol, and so on. Any further taxation is just about money – whatever the government claims.
100 year or Perpetual Bonds - You would have to be mad to buy a 100 year or perpetual gilt, from this government or anyone else. The only way this could ever work is the government forced people to buy them (the most likely target of such a policy is the banks). But that's just a covert way to write off debt via inflation. It would be a dishonest cop-out, and another step along the road to permanently high debt and low growth.
General Anti-Avoidance Rule - The best way to ensure people pay their fair share of tax is to radically simplify the tax system by removing complex reliefs, allowances, and loopholes. Doing that would also allow you to lower headline rates. A 'general anti-avoidance rule' on the other hand, leaves far too much to bureaucratic discretion. It is a recipe for uncertainty, arbitrariness, and corruption. Our paper critiquing the GAAR can be viewed here.
The 50p tax must go
The Guardian reports today that George Osborne is "poised" to scrap the 50p tax in this Wednesday's budget:
Government sources say that from the outset the chancellor has seen a cut in the 50p rate as the headline-grabbing measure of the budget, and views it as the simplest single step he can take to show his commitment to an enterprise economy... The chancellor has, sources say, been intellectually persuaded of the case for a cut in the top rate, a move that will endear him to the Tory right.
There's no point in counting unhatched chickens, but if this is true, it is superb news. For one thing, the 50p tax hasn't even done the job its supporters claimed it would — it seems to have lowered tax revenue. The Institute for Fiscal Studies (the gold standard for this sort of thing) says this, as does the Treasury itself. Absurdly, the 50p tax rate's defenders justify it on moral grounds, as if high taxes are a necessary punishment for the crime of creating a lot of wealth.
Mind you, reducing the government's tax income is a good thing. The problem is that the 50p tax does that by making everyone else poorer. As our report last year showed, the 50p rate is a drag on growth. The 50p tax base is very small, at around 320,000 people, or 1% of the total number of taxpayers. But those 50p taxpayers are also extremely productive and valuable: that 1% pays around 28% of total tax revenue.
Squeezing a narrow base of highly wealthy people is a dangerous game. As our report showed, the 50p rate was driving high income earners abroad and into early retirement. Who can blame them? If the government was taking more than half of my income (when other taxes are taken into account) and I could afford to throw in the towel to spend more time with my family and friends, I would too. The upshot of that is that the rest of us lose their talent for wealth creation. No wonder job creation is so weak right now — the 50p tax smothers precisely the people we're depending on to start and invest in new businesses.
Getting rid of the 50p rate is critically important to revive growth in the UK. If the Guardian's report turns out to be true, I'll be happy (and not just because we at the Adam Smith Institute called it last year). It'll mean better prospects for everyone.
Oh, and there was one other part of that report that caught my eye: "In return for supporting the measure the Lib Dems are pressing for a large increase in the personal allowance for those in work." If coalition means Tory-led tax cuts for the rich and Lib Dem-led tax cuts for the poor, then who knows? Maybe the future isn't as gloomy as we think.
New at AdamSmith.org: A critique of the "Tycoon Tax"
For many years, the boundary between acceptable and unacceptable plans to reduce a UK tax bill has been depicted by tax “avoidance” versus tax “evasion”, the former being acceptable and the latter not.
The General Anti-Avoidance Rule (GAAR) report (commissioned by the Government in December 2010 and published in November 2011) has chosen to up-the-ante by using avoidance for unacceptability, and combining it with “abuse” (i.e. “egregious” tax planning) thus dropping off “evasion” altogether. The document refers more than 40 times to “avoidance”, 18 times to “abuse”, 5 times to “egregious”, and 60 times to “reasonable”.
Apart from some unnecessary changes to current terminology, this may not matter were it not for the clear views of the author, Graham Aaronson QC: “My own approach … is based on the premise that the levying of tax is the principal means by which the state pays for the services and facilities which it provides for its citizens”.
This sentence, together with a belief that tax rates should be progressive according to income or wealth, encapsulates the whole ethos of the report. There is no question or worry as to who decides on what and how large these “services and facilities” are to be. There is no evidence that Mr. Aaronson understands that all taxes reduce aggregate living standards – irrespective of whether or not collection costs exceed tax revenue – as they often do in respect of higher rate taxes for the “wealthy”.
Government infrastructure spending won't stimulate growth
Next week the Chancellor will deliver a much-anticipated budget. With calls for tax cuts, tax rises and regulatory reform, the line between politics and economics will be a difficult one to tread. However, many commentators and politicians seem to be in agreement on one thing: that ‘infrastructure investment’ would be a boost to the economy, reinvigorating the construction sector and adding to the nation's productivity. Hence we have projects such as HS2 and £6 billion announced in the last year’s autumn statement for roads and other rail projects. These measures are supposed to create jobs in the short- and the long-term whilst bringing the country's transport infrastructure into the 21st century. In the US, too, President Obama has been keen to point to ‘shovel ready jobs’ available through government infrastructure spending.
We should all be worried when politicians start spouting platitudes about the highly unrealistic benefits of these projects. The great myth of the success Roosevelt’s New Deal no doubt lingers in the minds of policy makers. But the truth about government infrastructure is wildly different from the conventional wisdom.
It is a fallacy to believe that the government can allocate resources effectively to meet future economic needs, instead of entrepreneurs. What advocates of state infrastructure spending fail to grasp is that government cannot suddenly acquire the knowledge as to which parts of the UK’s infrastructure either needs repair, replacement or, indeed, which new projects should be undertaken. The economy is dynamic and never static. The government cannot predict what it will look like in 30 years time, whether there will be an increase of manufacturing jobs in the northeast or high tech in the midlands. This is simply not possible to anticipate into the next twenty or thirty years.
The argument commonly made for infrastructure spending is that it will have a kind of Keynesian multiplier effect. Private construction firms will be employed, idle resources will be put to use and money will start to circulate through the economy as people spend their newly earned wages. But this, again, is untrue. Government infrastructure drains the economy of resources and, even in the short term, stops resources from being used elsewhere. These decisions are difficult even for the private sector, which relies on price signals. Sometimes the private sector fails, sometimes it succeeds, but because it is the investor's money that is on the line it has a reason to act rationally. Government lacks the information to act wisely, and the incentives to act prudently.
In Japan, large government infrastructure projects have failed to lift the country out if its low growth high debt slump. In the UK, many cities have built tramlines, which have almost universally turned out to be loss makers and failed to promote growth.
Entrepreneurs, not state bureaucrats, will be best to judge whether a particular project is worth the risk. The history of white elephant infrastructure projects is one that seems to repeat itself with each new administration. Let us hope that the politicians fail to match their rhetoric with our money.
Weekend notes
Detlev Schlichter is on typically forceful (and, yes, depressing) form over at Paper Money Collapse.
We should accept that deleveraging is ultimately unavoidable. If it comes with a period of deflation – so be it. But we will get neither. The system will be sustained at this stage of arrested collapse for as long as policymakers can get away with it. My outlook is that we will get even bigger central bank balance sheets (forget exit strategies! There is no exit!), we will get no sustained growth but inflation will creep higher.
The noisy advocates of easy money and of government stimulus always pretend to care for Europe’s unemployed youth. It is today’s youth that would have most to gain from a cleansing correction now, and it is those who already made their money and who sit on inflated assets and overstretched balance sheets that have most to gain from the central bank’s policy of extend and pretend. That is, until the whole thing goes pop anyway. Which won’t take too long.
In the meantime, the debasement of paper money continues.
Have you read his book yet? If not, get your copy here.
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Charles Murray's new book 'Coming Apart: The State of White America, 1960-2010' seems to be stirring up a lot of debate. His thesis, as I understand it, is that the gap between a new upper class and new lower class of Americans is growing, but that it has far more to do with diverging values, cultures and behaviours than economics. I haven't read it yet, but David Brooks says he'll be "shocked if there’s another book this year as important". For now, I just like Murray's comment to the FT on the race for the Republican nomination:
I am really unhappy with Obama. I really think he's terrible, but Romney and Santorum as the alternatives? Don't even think about Newt… I'm in despair. I mean, I'm a libertarian. I will take Romney over Santorum. And both of them over Newt. That's not a ringing endorsement, I know, but what can you say about such a field?
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On the other hand, for all his flaws (and they are many) Mitt Romney has at least said something exciting about tax - he plans to cut marginal rates by 20 percent across the board. As Fraser Nelson wrote in the Telegraph last week, Britain's Conservatives should take note. They won't win the next election by chasing opinion polls and running scared from the Left's renewed class warfare. They need to craft an aspirational agenda that is worth getting out of bed to vote for. As it is, all the Tory leadership is talking about is which taxes to raise to provide cover for scrapping the 50p tax rate (which isn't actually raising money anyway). They blame the Liberal Democrats, of course, but the real problem is that they are themselves completely unprincipled.
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In happier news, I was delighted to see the Wall Street Journal's Mary Anastasia O'Grady endorse the legalisation of cannabis on Fox News. Ever so gradually, the tide of opinion is turning against America's deadly, destructive, disastrous war on drugs. There is even talk that Colorado voters will approve a ballot initiative to legalise and regulate the production, sale and consumption of cannabis this November. Now there's something I could bring myself to vote for.
Why the 50p tax rate has to go
Eamonn had a very good piece in the Mail on Sunday yesterday, explaining why the 50p tax is bad news:
And although the Treasury has yet to release its formal study on the impact of a 50 per cent tax rate on growth, the early indicators are worrying; latest tax receipts from self-assessment forms – those used by the country’s richest – are down by half a billion pounds.
The total revenue from income tax payments came to £10.35 billion – £509 million lower than the previous year. Senior Treasury figures quietly let it be known that there had been ‘manoeuvring’ by well-off taxpayers to avoid the 50p top rate of income tax.
It is an example of what economists call the Laffer Curve, after the American economist Arthur Laffer, who discovered this simple truth: high tax rates actually bring in less money for the Treasury than lower ones, because they result in greater tax avoidance.
Is Britain good for business?
Is Britain good for business?
On Thursday I debated in the Cambridge Union alongside Damian Reece and Willie Walsh. The motion was that "This house believes Britain is no longer a capital for business." I asked for four facts to be entered in evidence.
The first was the 50 percent top rate of income tax which, according to the IFS, the ASI and the Treasury, raises no money and may even cost public funds. It is there simply to punish high earners and high achievers. Secondly I cited the 28 percent rate of Capital Gains Tax, pointing out that it motivates people to leave capital tied into yesterday's industries instead of freeing it up to invest in tomorrow's wealth and job-creating enterprises.
Thirdly I listed the current 25 percent rate of Corporation Tax, highlighting the fact that it is double the 12.5 percent levied in the Irish Republic. This, I said, is why Google and other firms chose Ireland rather than Britain for their European HQs.
Fourthly I identified the retroactive legislation announced to take a further £500m from Barclay's. For that relatively small sum we had sacrificed centuries of the rule of law and sent a clear message to foreign firms that even if they behaved within the law, the Treasury might change it afterwards to take more money from them.
In addition to those four facts, there was, I suggested, something else. It is a widely prevalent anti-business, anti-achievement culture, partly fanned by the media, in which success is disparaged. Business, which alone creates the wealth whose division is argued about, is derided every day in the media and in popular discourse, leaving politicians afraid to defend it.
For these reasons, I claimed, the Cambridge Union should regretfully and reluctantly conclude that Britain was no longer good for businesses. By a narrow 4-vote margin they agreed with me and did so.
A Suggestion in The Guardian I Agree With: A Fair Tax Commission
Yes, even The Guardian sometimes has sensible reader's letters to publish. And I wholeheartedly support this suggestion:
Surely it's time for Labour and others on the left to set up a Fair Tax Commission to examine the legitimacy of a more progressive tax system which shifts the burden to taxation of wealth, land and the grossly overinflated incomes which have become the hallmark of 21st-century capitalism;
I can't quite see why it is to be a thing of the left: Fair Taxes are the concern of us all. But given that we are all so concerned let us try to sketch out the various constraints within which such a Commission would be operating.
The first and most obvious is that it is obviously immoral that those working part time on minimum wage are paying income tax. Quite apart from the stupidity of taxing them then handing back tax credits there's the moral point. If this minimum wage is the minimum that it is legitimate to pay people for their labour then why is the bureaucracy getting a slice of it? We here at the ASI have been recommending for years that the personal allowance should rise to £12,000 a year. I would go further: if we are to have a minimum wage, something which we probably shouldn't but it's a political reality that we will, then the personal allowance for both income tax and national insurance should be that minimum wage for a full year full time job. If one moves then so does the other, link the two expressly and by law.
Secondly we almost certainly want to merge the income and NI systems anyway. The last benefit that relies upon NI is the state pension and that link is to be removed in upcoming legislation. There is no point in having this hidden income tax anymore: merge them.
We need to take note of this Laffer Curve thing. As Diamond and Saetz point out, given the existence of allowances (and yes, the ability of a UK citizen to leave the UK and thus not pay UK tax is just such an allowance) the peak of the Curve for all taxes on income is 54%. Yes, this includes even employers' national insurance (yes, I know, we've just abolished it up above) so that is the absolute top total tax rate we can have on incomes.
We also need to note the deadweight costs of taxation. Different taxes have different effects on future growth for the same revenue raised. We obviously want to have the least effects on future growth for whatever level of revenue. This means heavy on land and consumption taxes, light on income ones and probably best to do away with corporate and capital taxation altogether.
Now, if we're to set up a Commission to look at Fair Taxes then obviously, these are the sort of constraints that such a Commission should look at. Indeed, if there is to be such a Commission I'd happily take part so that it did look at these very points.
But the real importance of such a Commission would be that it would be an opportunity to force those on the left to understand a very basic point about progressive taxes and government. You cannot pay for Big Government with a highly progressive tax system. There just aren't enough rich people and they don't, collectively, have enough money to pay for everything. It's worth noting that the countries that do have substantially larger government than we do, the Nordics, have tax systems which are more regressive than our own one. That's the only way you can have both a Big State and also any hope of continued growth.
I, personally, am not averse to a system of governance that is paid for entirely by the rich. Quite happy for there to be a progressive taxation system: delighted in fact. For such a government would have to be considerably smaller than the one we have now.
And that would be the great value of a real Fair Tax Commission: bringing this indisputable point out into the open. Progressive taxation, the rich paying for it all, or and do note that it's or, Big Government. You can only have one of those two. So let's have the Commission and bring the point out into the open shall we?
Or if that all sounds like too much hard work and effort we could just get people to read the Mirrlees Review.
The Technology Strategy Board: dirigisme in action
Ever heard of the Technology Strategy Board (TSB)? The TSB is an NDPB sponsored by the BIS! Or, to put that in real terms and not public sector-speak, it is one of those arm’s length, alphabet soup agencies that spends huge amounts of taxpayer’s money in order to ‘stimulate’ economic growth. The TSB should be better known, however, as it serves to demonstrate so many of the problems of government intervention that one hardly knows where to begin.
Ostensibly, the TSB’s role is ‘to accelerate economic growth by stimulating and supporting business-led innovation.’ I don’t think that here it is necessary to get into the fallacies of Keynesian stimulus policies, of which this is one. The TSB has an annual budget of around £200million. It boasts that it has spent £1billion since its establishment in 2004 and has been allocated another £1billion to spend during the course of the present Parliament. Austerity indeed.
To my mind, those who advocate such stimulus will never be convinced of the case against them, no matter how much evidence is presented, because they are fundamentally pursuing non-economic agendas, albeit disguised as economic ones. These policies are dictated by ‘conscience’ as Paul Krugman revealingly tells us. The agendas may be ‘noble’ – equity – or ‘ignoble’ – self-advancement and political gains – but they are not fundamentally related to maximising economic growth and wealth-creation. It should be pointed out, however, that the TSB was created in 2004, at the height of an economic boom. Why, one wonders, does an economy which was clearly overheating need a Keynesian stimulus?
Leaving macroeconomics aside, therefore, let’s examine the TSB as an example of how dirigisme fails in reality. As Lew Rockwell argues (as have many before him), organisations like these are part of the ‘regulatory-industrial complex’. This complex is ostensibly erected by the state in order to provide benefit to the public. In the case of regulatory agencies this is ‘consumer protection’ whereas in the case of the TSB this is to stimulate innovation and create economic growth. As Rockwell points out, the strongest lobbyists for such agencies are actually existing large market occupants seeking to errect barriers to entry, in the form of compliance costs, to their more nimble competitors or to benefit from subsidies. We then end up with oligopolistic industries where, in the absence of competition, they can extract higher profits from consumers. This usually prompts further intervention in the form of ‘competition authorities’ which worsen the problem.
As reported in Private Eye No. 1308 information on the TSB’s grants had to be extracted under FoI requests (some of which is available on the website). ‘Iain Gray, the board’s £199,000 a-year chief executive, was previously general manager of Airbus UK. Funnily enough, the biggest single strategy board grant, of £9.8m, went to... Airbus UK’. Private Eye goes on to list some of the various large organisations that benefit from taxpayer largesse: Nissan, Rolls Royce, BAE, BMW, Ford and we can also add GSK and GE. Unsurprisingly, large organisations are adept at obtaining such grants, which are ostensibly intended for SMEs, because they are able to devote resources and lobbying beyond the reach of small enterprises. Effectively, the TSB is subsidising large market occupants with research funding which is not accessible to small firms and new entrants. This is public choice in action and it is destructive of public benefit.
Cheerleaders of such programmes will argue to the effect that SMEs and innovation are still being aided by the allocation of government (i.e. taypayer’s) cash. Here we have the age-old doctrine of ‘picking winners’. Even if the TSB were an entirely objective observer – which it evidently is not – how is it to know that such innovation is better than that it does not fund? Here we have the Hayekian knowledge problem in action. The only way to establish the viability of a particular good and a particular firm is to expose it to a free market. Further, as capital is being withdrawn from other areas of the economy via taxation and allocated to these purposes, how is the government to know that the capital would not have been employed more efficiently elsewhere. If you’re not convinced by Hayek, just look at the history of government investment schemes to see an evidence-based approach!
Here we have a clear case of what Adam Smith would call a ‘conspiracy against the public’. Unfortunately, such dirigisme is becoming increasingly likely as a policy choice as there is pressure to find additional sources of funding for small businesses. Such an approach is not only likely to fail but be counter-productive. So, here’s a policy solution; throw the TSB on the ‘bonfire of the quangos’ which will not only free up the hefty officials’ salaries but also £1billion of promised spending which is currently going into the pockets of large firms anyway. If we must ‘stimulate’ the economy, rather than reduce the deficit, use the £1billion to fund some tax cuts.
Austerity? What austerity?
Recently a lot of attention has been given to the case against British austerity. It has been blamed for the inability of the UK economy to pull itself out of border-line recession. Krugman, DeLong, Baker and many others attack it claiming that contractionary expansion makes no sense, while on the other hand Sumner and Boudreaux tend to overturn the argument by claiming there is no austerity in the UK. And opposing to both of these views, UK Chancellor George Osborne surprisingly claims it is working.
Who is right? Well, one thing is certain, Britain isn't experiencing any form of robust economic growth, so whatever policy is done by the government clearly isn't working.
The UK government is leading an ambiguous recovery policy which is, unsurprisingly, producing ambiguous results. It is sending wrong signals to the private sector. When it is trying to subsidize, this yields no effects as the people expect it to cut further. When it is trying to build high-profile infrastructural projects, it isn't working as the anticipated costs are much higher than the benefits. When it’s trying to make banks increase lending, it creates less competition in banking making the price of credit still too high. Any intervention it’s trying to make is yielding no positive outcomes. Surprise, surprise.
Austerity or expansion?
The UK had the one of the strongest fiscal stimuli (relative to the size of its economy) in the world as a response to the crisis, during the premiership of Gordon Brown. The result was making the situation much worse with a rising public debt and the third highest budget deficit in the world behind only Greece and Egypt in 2011, and behind Greece and Iceland in 2010. This comparison is striking since these countries were doing much worse than the UK at the time and were countries with highly unstable economies – Iceland before the restructuring, Greece whenever, and Egypt after a year-long revolution which saw the downfall of a dictator and an inability to consolidate ever since.
So the argument of Keynesians is that this wasn’t enough, and that Britain is crippled with austerity. The media is supporting the former view as well. Britain is running the hardest austerity policy in Europe and this is resulting in terrible growth performance and the inability to start up the recovery. However, Britain is far from austerity. Yes, some painful cuts have been made, tuitions were rising, unions were hit, wages in the public sector are stagnant, a lot of public sector workers have been laid off, but what does the government do with this saved up money? It "invests" in credit easing, housing subsidies, the youth contract and infrastructural projects. On the other hand, it's guiding private sector investment and centrally planning credit, it announces an increase of the minimum wage, abolishing of the default retirement age, more regulation after claiming to remove regulation, the 50p tax rate and so on. None of these policies are policies aimed at growth. They are all part of a Keynesian response to the crisis.
After all, if one would just observe the spending data for the UK, it is still increasing, both relatively (as percent of GDP) and absolutely.
As a comparison, during the Thatcher government, spending as percentage of GDP went down from 46% in 1981 (where it stands currently) to 34% by the end of 1989. The New Labour government(s) simply reversed that trend. To be fair, it took the Thatcher government two years to see spending to GDP rapidly decrease, so one might say to give the current government a chance. However, according to the announced policies which haven’t all even kicked in yet, I highly doubt the outcome will be the same.
The outcomes of the Thatcher government then and the Coalition government now are very likely to produce different results. In the 1980s, Thatcher removed some of the economy's dependency on the government and was able to increase competitiveness in the private sector. The current government is in fact looking to increase this dependency, and yet it naively expects the private sector to step in and grow on its own.
The initial call for austerity in the UK was a necessary solution for an economy left in dire straits after the previous government’s response to the crisis. They needed to avoid the peripheral eurozone scenario and a possible sovereign debt crisis. They have succeeded in doing so and have sent positive signals to foreign investors. But now they need to be brave enough to send similar signals to the domestic economy. Continuing with the cuts is futile if the dependency on the government isn't removed. Having subsidies for youth hiring, housing, banks or businesses won’t remove this dependency.
One does not simply enforce austerity without clearing the way for the private sector to grow again on the principles of competition and an unconstrained business environment. This crucial assumption still hasn't been made in Britain. Until we don’t see signs of reducing business and consumer dependency on the government and until we don’t see signs of more competition and less regulatory constraints to foster economic growth, the current situation will extend itself even further than projected.
