Eurobonds: Just because you want to ignore economics does not mean that economics will ignore you

The game now is that everyone sits round the table, staring at Germany until it blinks. Eurozone leaders figure the only way to save the euro is for all 17 member nations to get together and issue 'eurobonds'. There are some big hitters among those who think this is a really good idea – people like the new President of France, Francois Holland, the Italian Prime Minister Mario Monti, and the European Commission President Jose Manuel Barroso.

Right now, when eurozone countries want to borrow money, they issue their own bonds, selling them to investors for cash and the promise of a return – a rate of interest paid each year over a specified period, say ten years. Sadly, it has become nigh impossible for the government of Greece to finance its spending this way, because investors figure that its promises to repay are so shaky they demand double-digit rates of interest – which is cripplingly difficult for Greek taxpayers to fund, making it even harder for the country to stay afloat. And there are precious few people prepared to take the risk that Greece will actually be able to repay them in anything like ten years from now.

So the plan is that the eurozone as a whole should step in and issue its own eurobonds. The promise to pay lenders interest and indeed to repay their principal at the end of the term would be collectively guaranteed by all 17 nations. So eurozone countries, including those in trouble such as Greece, Ireland and Portugal (and those who are likely to be in trouble soon, like Spain and Italy) could borrow at realistic rates of interest, without crippling themselves.

That is good news for the troubled countries, because it means that all countries in the eurozone would actually be able to borrow at the same interest rate.The snag is that any such country cannot actually pay its share of the interest and principal payments when they become due, the other countries would have to help them out. And the stronger countries are not exactly thrilled at this prospect.

Nor should they be. In the first place, the eurobond idea distorts the price mechanism. If you are lending to someone, the interest you get in return should reward not only your forbearance but the risk you run of not being repaid when you want your money back. Lumping risky and non-risky (well, less risky) countries together means that prices no longer reflect that risk. The risk is pooled. Specifically, the stronger countries are subsidising the risks that are being run by the weaker ones. And when you subsidise something, you generally get more of it. But who wants weak countries to live beyond their means and take a bigger risk of running out of money than they already have done? We had enough of that from the banks, thank you very much.

But the system builds in moral hazard for the over-spent, over-borrowed countries to do exactly that. Live beyond your means, and your richer cousins will underwrite your profligacy and pay people to keep lending to you. Act prudently, and you get hit for a bill from the imprudent nations.

When it comes down to it, of course, Germany has the broadest shoulders. France might think itself in the same league, but actually investors reckon that is a pretty bad bet too – all the more so now that it has a socialist president who figures that balancing the books is for the birds. The German public certainly can't see why they should pay for other people's profligacy. Germany and the other stronger countries would in fact find it more expensive to borrow themselves, because they would be sharing the cost of the weaker countries' borrowing too.

Will it happen, though? Yes, quite probably. The alternative is to let Greece slide out of the euro, followed probably by a number of others that just can't make the grade. That would be messy, and it would cost European banks a lot of money – urged on by regulators, the banks hold a lot of government bonds, which were always reckoned to be safe investments. Though now, patently, they are not. That purely financial concern is what is in George Osborne's mind. But the real concern of pretty much everyone else is a political concern: that the exit of any country marks a retreat from the EU idea of deeper and closer integration, the fear that the European Project would find itself on a falling tide. And that they find deeply shocking.

The euro was always a political rather than an economic venture. But, as my economist friend Richard Jeffrey of Cazenove Capital puts it: "Just because you want to ignore economics does not mean that economics will ignore you." It's painfully clear what the end will be. The only question is how long it will be postponed, and at what cost.

The morality of taxation

Eamonn Butler discusses the morality of taxation, which he wrote about for the Taxpayers' Alliance's excellent new report, The Single Income Tax.

Deficit spending won't save us

Scott Sumner had another must-read post on his blog, The Money Illusion, last week. (Sumner is also the author of our report, The Case for NGDP Targeting.) Contrasting “Country A” and “Country B”, he asked which one looked like it was implementing austerity and which one fiscal stimulus: Country A, with a deficit of 8.8% and 8.2% unemployment, or Country B, with a budget surplus of 2% and 7.3% unemployment.

One of the countries is the UK, and one is Sweden. But, according to arch-Keynesian Paul Krugman, “Somebody has been practicing harsh spending-side austerity — and it’s not Sweden.” And, “Given that public investment is, you know, productive, [Britain] is almost surely a case of self-defeating austerity.”

But, of course, the deficit sizes tell a completely different story. In fiscal terms, deficits are what matter in the Keynesian framework, because they reflect the “extra” amount of money the government is adding to the economy. “Austere” Britain is Country A, with a 8.8% deficit; “stimulating” Sweden is Country B, with the 2% budget surplus. As Sumner asks,

If you are not a committed ideologue on either side, just look at the data provided up top.  Does Country A really look like savage austerity?  Does country B look like a country engaged in fiscal stimulus?

Sumner argues that Sweden’s success is thanks to a Central Bank that provided monetary stimulus back in 2009. There’s a large contingent of people who claim that the government’s cuts are hurting the economy, but seem completely ignorant of the fact that, in the Keynesian model, monetary expansion should be able to completely offset fiscal contractions.

That’s not a model I subscribe to, but the so-called “Keynesians” who seem to think that there exists some kind of “real” aggregate demand simply don’t know what they’re talking about. As Sumner says, “If monetary stimulus makes fiscal stimulus unnecessary (and it does), then why would Britain want to do fiscal stimulus?”.

There is another question here for the anti-austerity people to answer: if an 8% budget deficit isn’t enough to stimulate the economy, how big does it need to get? We already have a bigger deficit than any of the Eurozone basket-cases but, even if we set aside reality for a moment, I'd love to hear how big the anti-cuts crowd think the deficit would need to get before we have some growth.

A report the government can't afford to ignore

Today the 2020 Tax Commission, a joint venture of the Taxpayers' Alliance and the Institute of Directors helmed by City AM's Allister Heath, releases its final report. The Single Income Tax (summary here) argues for a comprehensive tax reform that would see the state shrink from 50% to 33%, with many of the current taxes we have on income, inheritance, and transactions being replaced with a single rate of 30% on income from labour, interest and dividends, with a £10,000 personal allowance.

By eliminating things like National Insurance paid by employees and employers (the worst stealth tax of all), everyone's tax burden would fall, and the shift from transaction taxes like Capital Gains Tax and Stamp Duty would facilitate a more smoothly-functioning price system. Only flows of income would be taxed. Regrettably, VAT cannot be scrapped as long as we're part of in the EU Single Market.

The report also makes good nods to localism by calling for local authorities to be held responsible for raising 50% of their spending power themselves, through things like local income and sales taxes. With any luck, this sort of change would bring down the overall tax burden even more, as councils competed with their neighbours.

I've been browsing through my preview copy for the last week, and it's a masterpiece. It is the best report to come out of a British think tank in years, and I can only hope that it has the impact it deserves. For a government that seems to be asleep at the wheel, The Single Income Tax should be a loud wake-up call.

Why a fat tax would be a terrible idea

When we scheduled the release of The Wages of Sin Taxes for 15th May, we did not guess that it would be sandwiched between the announcement of a 50p minimum price for alcohol in Scotland (Monday) and a new campaign for sin taxes on food and soft drinks (today). Writing in the British Medical Journal, two academics have just called for price hikes on sugar-sweetened beverages and ‘junk food’ as a way of dealing with Britain’s alleged obesity epidemic.

Obesity rates, like drinking rates, have not actually risen for ten years, but the same decade saw the medical profession gain an uncanny grip on the nation’s political process and they are in no mood to relinquish it. Taking a break from hassling smokers and drinkers, the mandarins of public health have taken the ‘next logical step’ and moved on to the general population.

“Economists generally agree,” they write, “that government intervention, including taxation, is justified when the market fails to provide the optimum amount of a good for society’s wellbeing.” Even if this dubious statement were true, there has never been a time when the market offered more choice in what we eat than drink than today. And, contrary to popular belief, it is much cheaper for a family to subsist on fresh fruit and vegetables than it is to eat out at McDonalds three times a day. For the spokespeople of public health, the problem is not that there is a lack of options, but that we plebs are not choosing the right ones.

Defining junk food is notoriously difficult. As Rob Lyons explains in his excellent book Panic on a Plate, a portion of McDonalds fries contains a quarter of an adult’s recommended intake of Vitamin C, while middle class favourites like olive oil, parmesan and pasta are rather fattening. A tax on “sugar sweetened beverages” will presumably leave apple juice and smoothies untouched, despite the fact that fruit juices are often sweeter and more calorific than Coca-Cola.

Whichever foods and drinks fall under the spotlight, it is unlikely that the new sin taxes will do anything except make the poor slightly poorer and George Osborne slightly chirpier. The record of fat taxes and soda taxes abroad is dismal. When academics assessed the effect of soda taxes in the USA, they found no evidence of a reduction in childhood obesity and concluded that "soft drink taxes are ineffective as an 'obesity' tax." Last year, a study claimed that a 10 per cent tax on sugar-sweetened beverages would lead to a 7.5 ml reduction in daily consumption, but this equates to just three calories a day. Since adult males require 2,500 calories per day to maintain a healthy weight, the impact on obesity rates would be somewhere below negligible.

Perhaps recognising this, the authors of the BMJ article insist that these taxes would have to be set at at least 20 per cent (in addition to the 20 per cent VAT). Such a rate would hit us all in the pocket, but it would still have an imperceptible effect on British waistlines. A 2007 study found that even a 100 per cent tax on “unhealthy foods” would reduce average body mass index (BMI) by less than one per cent (a reduction in BMI of just 0.2 points).

Although there is ample evidence that sin taxes of this kind do not work, we run the risk of accepting the medical establishment’s terms of debate by even discussing it. The real argument against this kind of state interference is that what we eat and drink is simply no one’s business but our own. As I show in The Wages of Sin Taxes, the claim that obesity is an economic time-bomb which forces the slim to pay for the sins of the fat is fallacious. Without that justification, the meddlers are exposed as the ugliest brand of paternalists. It is time to call these taxes what they are - fines for living in a way that displeases the British Medical Association. But since it is clear that these doctors won’t be happy until they can issue us with ration books, perhaps it time to remind these public servants who their masters are. 

The Wages of Sin Taxes: The True Cost of Taxing Alcohol, Tobacco and Other "Vices"

• “Sin taxes” on cigarettes and alcohol are designed to boost revenue, not improve public health
• Minimum alcohol pricing will exacerbate poverty and entrench inequality without discouraging binge drinking
• Most of the costs of drinking and smoking fall on individual consumers, not the public. There is no economic justification for increasing taxes on smokers and drinkers.

In a report released today, The Wages of Sin Taxes (Download PDF) by Christopher Snowdon, the Adam Smith Institute condemns the government’s decision to increase taxes on cigarettes and alcohol this year and to introduce minimum alcohol pricing.

The report argues that ‘sin taxes’ (taxes on commodities seen as harmful to health) are ineffective in reducing consumption and are not necessary for recouping lost revenue. The taxes are highly regressive and force the poor to pay for the government’s mishandling of public finances.

The taxes don’t work

Cigarette taxes are now so high that increases drive smokers to the black market instead of discouraging consumption or raising more revenue. Sin taxes are more likely to deter moderate users than heavy users, whose demand for cigarettes and alcohol is relatively inelastic.

A heavy smoker or an alcoholic is unlikely to reduce consumption because of a price rise, making sin taxes an unreliable way of reducing consumption or improving public health.

The victims of cigarette and alcohol duty

Sin taxes hit moderate and heavy users alike. Research has shown that previous rises in cigarette tax have made only 2.3% of smokers quit, with the other 97.7% just paying more in tax.

Taxes on cigarettes and alcohol are regressive and hit the poor hardest. The average smoker spends £1660 a year on cigarettes – 20% of the bottom 10%’s income. Sin taxes are the most regressive indirect taxes, as they tend to target products that are disproportionately consumed by the poor.

Minimum alcohol pricing is also deeply regressive, only affecting the cheaper drinks consumed by the poor. Punishing poor people for enjoying a drink or a cigarette exacerbates poverty and treats the poor like children who need to be controlled by the state.

The public cost of smoking and drinking

Taxes on cigarettes and alcohol have often been justified by studies that claim to estimate the “social cost” of these vices. These studies include intangible costs borne by individual consumers, such as “emotional distress”, lost years of life, and individual expenditures on cigarettes and alcohol. These are personal costs, not social costs. They also fail to include the economic benefits the alcohol and cigarette industry gives to the UK in terms of employment and government revenue. Most of these studies should be relegated to the bin of junk statistics.

In fact, smokers and heavy drinkers do not cost the state more. Though smokers may cost more during their working lives, but non-smokers require greater expenditure in pensions, nursing care and welfare payments. Chronic diseases associated with old age are far more expensive than the lethal diseases associated with smoking and alcoholism. Smokers and drinkers are not a burden on the state, and the myth of saints subsidising sinners should not be used to justify tax rises.

The appeal of ‘sin taxes’

Despite the fact they hurt the poor and do not change consumer consumption, sin taxes have always been popular with governments as a source of revenue.

Sin taxes and minimum alcohol pricing should be recognised for what they really are - stealth taxes and paternalism designed to control the poor.

Chris Snowdon, author of the report and Adam Smith Institute fellow, says:

“Campaigners for sin taxes and minimum pricing often claim that “healthy citizens” are forced to bear the cost of other people’s lifestyles. In fact, the evidence shows that smokers take less from the communal pot than the average Briton and the money raised from alcohol duty comfortably pays for any burden drinking places on public services. If the aim of policy is to make individuals pay their way, the government should slash the beer tax and subsidise cigarettes. We are not seriously suggesting the government does this, but if politicians insist on increasing taxes on these products, they should admit that the purpose is to raise revenue. Essentially the government is forcing the people who are least likely to live to extreme old age to pay for the escalating costs of an ageing population.

“As we show in the report, amongst EU countries there is no relationship between alcohol prices and alcohol related harm, nor is there an association between cigarette prices and smoking rates. The only significant effects that sin taxes have are to make the poor poorer and black marketeers richer.”

Does anyone remember 2002?

I certainly do. And I have to say that life wasn’t THAT different. I mean, I was revising for my GCSEs instead of a Masters, wore a school uniform every day and didn’t yet know how to drive, but overall, I’d be willing to wager that most people's lives aren’t that drastically different now than they were 10 years ago.

Crucially, the Government spent money on much the same things it does today – welfare, the NHS, defence, education, policing. It’s not like I am asking you to remember how things used to be in the 1920s when things were radically different.

Looking at Sam’s chart on Monday made me think of something.

In 2002, the UK Government was spending €442bn.

Last year, the government spent €739bn, and it seems likely that the figure in cash terms will be similar or higher in 2012.

It was conceded that the figures in that chart don’t account for inflation, so I have tried to do that myself below. I appreciate that this is a back-of-the-envelope way to do things, and I am not a trained economist, but I also think that my estimates of 4% annually and 3% annually are potentially on the high side, seeing as the Bank of England insist that inflation was kept under control for most of the last 10 years. (Even if quantitative easing may have left us in a situation where recent inflation is quite a bit higher than the “ideal” 2%)

Therefore I have a simple proposition: Return us to the level of spending we were at in 2002, adjusted for inflation and population growth.

Doing that would save, by my rough and ready calculation, between £68bn and £116bn. With that saving, we could abolish or drastically cut Employee Contributions to National Insurance, raise the Income Tax threshold to £12,500 (to correlate with a £6/hour minimum wage for a 40 hour week, so nobody on the minimum wage pays income tax), and abolish Inheritance Tax. If the inflation rate was at the lower end of my estimates, we’d still have a significant sum left over to reduce the deficit.

This would make it drastically cheaper to hire new staff, and would let people on low and middle incomes keep more of their own money, creating big incentives to work. It would also abolish one of the least popular taxes.

Most reasonable people intuitively know that life wasn’t that much worse in 2002, if it was worse at all. If we could have 2002 levels of government spending, along with all the benefits above, I reckon most people would vote for it.

The Bennites strike back

Tim Worstall made himself (more) unpopular with Compass last week by pointing out that their idea of creating a form of national socialism rather resembled the sort of economy favoured by National Socialists. In a think piece entitled ‘Progressive Protectionism’, Colin Hines espouses a system in which countries “rebuild and re-diversify their economies by limiting what goods they let in and what finance they choose to enter or leave the country.” This happens to be much the same policy favoured by the British National Party. Hines has responded by calling this a “libellous smokescreen” and I have no wish to poke this particular hornet’s nest, other than to say that while ‘Progressive Protectionism’ is certainly unoriginal, it borrows less from Herr Hitler than from Mr Benn.

In 1976, Tony Benn came up with his ‘Alternative Economic Strategy’, of which Hines’ scheme is a virtual carbon copy. As described by Dominic Sandbrook in the latest volume of his monumental history of post-Churchillian Britain, Benn believed he could save the British economy by cutting the country off from foreign competition.

“The premise of the so-called Alternative Economic Strategy was that, in a globalized world, Britain could only reboot its stalled economy by temporarily cutting itself off from external pressures. Under this strategy, the government would introduce stringent controls on foreign imports and the flow of capital, effectively throwing up a protectionist barrier to stop too many foreign goods getting in. Behind this trade wall, they could adopt a properly socialist policy, with full employment, steadily rising wages, booming demand and hence a resurgent manufacturing sector, all under the direction of a souped-up National Enterprise Board.”

This was justifiably viewed as economic lunacy by the rest of Jim Callaghan’s Cabinet (who were hardly a band of Randian objectivists). They understood that such an anachronistic policy would lead to international retaliation on a grand scale which would further cripple British industry. In addition to violating various free trade agreements, including EEC membership, Benn’s “siege economy” was almost certain to lead to mass unemployment, severe deflation and shortages of essential imports. In the long term, it would stifle innovation and savagely curtail economic growth.

The only significant difference between Benn’s ruse and that of Hines is that the latter believes in turning the whole EU, not just the UK, into one large protectionist bloc. It is a matter of debate whether that would make the policy more or less disastrous, but disastrous it would surely be. “Benn’s alternative strategy would probably have been a catastrophe,” Sandbrook writes. “For one thing, he consistently refused to accept that a siege economy would probably annihilate what was left of British manufacturing. What was more, he seemed completely indifferent to the importance of financial discipline and international confidence, as if he could just wish away the new world of global competition and fluctuating exchange rates... in Benn’s imagination the rest of the world appeared as a sinister conspiracy of American bankers, European moneylenders and multinational corporations, plotting to undermine British socialism.” Benn, he concludes, “remained a little Englander to the last.”

After politely listening to Benn’s protectionist fantasies, Callaghan rejected the Alternative Economic Strategy in its entirety, but the scheme remained popular with many on the left of the Labour party and it was eventually incorporated into the 1983 election manifesto, famously described by Gerald Kaufman as the “longest suicide note in history”. Michael Foot’s crushing defeat in that election forced the party to abandon many of its most reactionary and economically illiterate ideas, of which the Alternative Economic Strategy was surely one. It seems that there are some who think it is time for a revival, but if resurrecting policies from Labour’s most dismal period of opposition qualifies as “progressive” then this much abused word no longer has any meaning.

Cardinal Keith O'Brien's misplaced faith in the Robin Hood Tax

Cardinal Keith O’Brien, the head of the Catholic Church in Scotland, has called for the government to introduce a “Robin Hood Tax”. This is hardly a surprise. O'Brien's expertise is in the field of faith and the supernatural, which is just where support for the “Robin Hood Tax” comes from. (Incidentally, this isn't the only dumb political statement the Cardinal has made in recent weeks.)

It hardly needs to be said that the “Robin Hood Tax” (or financial transaction tax, to give it its correct, non-adolescent name) is a sham. No, it would not raise £20bn in revenue, as its supporters claim – that number is based on a static analysis that supposes, wrongly, that the tax wouldn’t affect behaviour.

In fact, it would affect behaviour a great deal, by crippling financial traders’ ability to engage in high-volume, low-margin trades that give volume to markets and help it to adjust quickly to new real-world information. A “small” 0.05% tax adds up to be quite substantial as you make several trades a day, as these traders do.

Most likely, a financial transaction tax would drive many traders overseas – to Zurich, Wall Street, Singapore, or somewhere else. That’s what happened in Sweden when that country tried the tax: within less than a decade of the tax’s implementation, trading for over 50% of Swedish equities had moved to London. Futures and options trading virtually ceased in Sweden altogether.

Advocates of the tax in Sweden claimed it would raise 1.5bn kroner per year (approximately £330m in current figures). In reality, it raised just 50m kroner (£11m in current figures), or one thirtieth of what was promised. The advocates of the “Robin Hood Tax” today are spinning the same fraud, and their numbers are worthless.

The “Robin Hood Tax” is, basically, a case of charities misusing their organizations for political purposes. It has nothing to do with charity, and everything to do with the left-wing agenda those charity employees want to advance. It’s a huge shame to see organizations like Oxfam and others misappropriated by the hard left to give PR heft to this silly idea.

The "Robin Hood Tax" is faith-based economics at its worst. But if Cardinal O’Brien really wants to help the poor, there’s plenty he could do himself. The Catholic Church is one of the richest organizations in Britain. They say charity begins at home. If O’Brien wants the government to get richer, waiving his church’s tax-exempt status would seem like a good place to start.

The return of the recession

So it’s official: Britain has double-dipped. Is anyone really surprised?

Of course, today’s number are relatively insignificant in statistical terms, and there is every chance that the Office of National Statistics will revise them a few months down the line. So we shouldn’t put too much faith in the details of today’s announcement or try to draw lessons that aren’t there to be drawn.

But it has been obvious right from the start that this was not your average, run-of-the-mill, cyclical downturn. The financial crisis and the recession that followed it was and is the result of severe, deep-seated structural problems in Western economies. And Britain has bigger structural problems than most.

Put simply, we are addicted to debt and constant monetary expansion. This has eroded our capital base and undermined our productive capacity, and has skewed the economy disastrously towards those sectors that thrive on credit and easy money: namely housing, finance, and big government. The boom years inflated huge bubbles in these sectors; the bust years have revealed how much of that growth was unsustainable, or even illusory.  

The situation we are in now can be summarized as follows. The economy remains heavily distorted: the prices of houses and financial assets are artificially inflated by government policy; banks which would have failed in the market have been kept on life support; gigantic, hugely inefficient public sectors are being sustained by money-printing and growth-sapping taxation. The savings needed to support investment aren’t there, and we’re weighed down with one of the highest levels of public-private debt in the industrialized world.

The astonishing thing is that every single one of those distortions is consciously, willfully being pursued by the government as a matter of policy. Quite frankly, it is surprising we aren’t doing worse than we are.

Not that there is all that much governments can do to create growth in situations like this. Yes, tax cuts and deregulation would give the private sector a sorely needed boost. And yes, reforming / privatizing / abolishing the public sector (as appropriate) would do wonders for Britain’s productivity. But what really matters is what governments don’t do. They have to allow the mistakes of the boom years to be unwound. They have to let markets adjust. They have to let new patterns of sustainable specialization and trade develop spontaneously, without bureaucratic interference.

That is a process – and it takes time. But unless we go through it, we won’t be returning to robust, real growth any time soon. The road we are on leads to a zombie economy. It’s time we took a different one.