Why you might not want to lend your money to the government

The decision to call in part of the War Loan leads to this remarkable figure from FT Alphaville:

The Treasury highlighted that “the nation has paid £1.26bn in total interest on these bonds since 1927″.

They sound awful. But in fact the Treasury has been a hands-down winner from the bonds. It issued them in 1927 in exchange for a bunch of maturing First World War bonds it couldn’t easily repay (Winston Churchill was struggling to cope with his disastrous decision to return to the gold standard at the pre-war rate, and the economy was crumbling as a result). Since then inflation has annualised at 4.77 per cent a year, well above the coupon of 4 per cent.

The result has been that in real terms, HM Treasury sold its “Consols” for £100 each, and is buying them back for £1.82 each. The government definitely got the better side of this bargain.

That's the effect of inflation over the long term. Anyone who had £10,000 in those in 1927 would have been considered a rich and wealthy man (a house was perhaps £250 in those days) and today that amount is below the level of savings at which you can still receive certain poverty related benefits. So lending one's money to the government, the same government that can decide what the inflation rate is going to be, might not be the most sensible thing one can ever do.

At which point we can only express surprise at those who tell us today that bonds are how we should all be saving for our pensions. If this is the effect of inflation upon bonds then why on earth would we want to do that? We want, obviously, something that captures some part of the increasing wealth of the society, meaning equities or possibly property. But there really are people out there insisting that pensions savings must be done in bonds, even in gilts. And sadly, one of them was Chancellor at one point: as when Gordon Brown changed the rules about how pension funds could invest.

History tells us that's really not a very sensible way to be doing things despite how convenient it might be to the government.

How food banks trump the welfare state

On the face of it, the figures are damning. Food banks in Britain helped over 900,000 people last year, up around a third over the year before. It seems Britain has a real problem with food poverty. Our benefits system just isn’t coping. But, like so many media headlines, the truth is a lot more subtle. Nearly all food banks in Britain are run by a single Christian charity, the Trussell Trust. In the last few years it has found a niche, sharpened its act, and opened a lot more. So not surprisingly, care professionals have been sending more people along. It may not be that the underlying problem is getting worse, just that it is being better served.

Nor is it the government’s benefit reforms that explain the rise. Food banks were growing long before the measures were passed in 2013, and many of the reforms have not even been implemented yet. And by merging scores of benefits into a far simpler universal benefit, the reforms should hopefully help ensure that people do not in fact fall through the gaps in the over-complicated welfare net.

The underlying problem that food banks help solve is not food poverty, any more than it is shoe poverty, clothes poverty, electricity poverty or water poverty. It is the temporary crises that people sometimes get into when they are unemployed or on low pay. Around 60% of food bank users are once-only users. They hit a crisis and can’t afford the groceries; that is why care workers refer them.

Around 30% of them have problems because their benefits payment has not arrived in time, or they are being penalised for not showing up at interview, or they have simply filled in a form wrongly. And you can blame that on our over-complicated, bureaucratic, distant and unfeeling state benefits system. We spend £94bn a year on it, a seventh of all government spending (and the government spends a lot). If we devolved the process to local communities and voluntary groups, it would work much better.

No government can do much about the fact that food prices have risen nearly 35% since 2007. Well, actually, they could stop subsidising biofuels, which has diverted huge amounts of agricultural produce out of human mouths and into gasoline tanks. And they could do something about the fact that other essentials have been soaring in price too. Government-mandated to renewable energy adds about 15% to the fuel bills of businesses and private sector organisations, plus about 6% on the gas bills and 11% on the electricity bills of domestic customers. That is why poorer people run out of cash and economise by going hungry.

Nearly everyone in Britain is well fed – some too much so – because Britain is a peaceful, trading nation with an established rule of law. Our farmers are not afraid to plant crops in case they are stolen by thugs or invading armies. Our traders bring produce to us from all over the world. If you want to see chronic poverty, look at countries that do not have this thriving market system.

Because this market system makes us a rich country, we can afford to help people who run into problems. The biggest philanthropic sector on the planet is that of America, the world’s richest country. In fact, America, Canada, New Zealand all have large food bank movements. That is because they are rich, and because they have a strong sense of community too. In Britain, too much of that sense of community has been crowded out by our state bureaucracy.

It is actually good to see charities taking on these problems. The state is inevitably large and lumbering. Private charities are much better at tackling individual human issues, like families who run out of cash from time to time.

Of course, the state could help in a very simple way. A large number of people referred to food banks are actually not those on benefits, but people on minimum wages. The government has pledged to take everyone on minimum wage out of tax, and about time too – it is absurd to tax people who are on the breadline. And yet we are still charging them and their employers another, hidden tax, namely National Insurance Contributions. Again, it’s crazy. If you want to help people in poverty­–and get people into the world’s best welfare programme, namely a paying job–you should be making work pay, which for many of the nation’s poorest, is appallingly not the case.

Being economically worth less does not mean you are worthless

I’ve just been on Channel 4 News discussing Lord Freud’s comments about letting people with disabilities choose to work for below the minimum wage. I haven’t watched it back but I gather from Twitter that I fluffed it a bit – unfortunately the producers put me up against two people without telling me, so I got flustered. 

The thing I said that upset people the most was that some people with severe disabilities or learning difficulties may be economically worth less than people without. (One of the people I was debating apparently thought I said ‘economically worthless’.) 

Lots of people have taken this to be a comment on the moral value of people with severe disabilities or learning difficulties. This is an error. The value of a person’s labour is equivalent to what others will pay them for a given amount of time, also known as their productivity. When Lord Freud talked about people not being ‘worth’ the minimum wage, this is what he meant.

It has absolutely nothing to do with how important they are as a person. Some very good people are unproductive because they are inexperienced, they don’t have economically-valuable talents, or they are disabled. Some very bad people are very productive because they did well in the lottery of life. Indeed this is something I care about very strongly, and it has led me to abandon beliefs I once held quite strongly in favour of mechanisms that would redress some of this imbalance.

Perhaps it was a bad choice of words to say ‘economic worth’ because many people are unaware of the above. I can understand that if you heard me say someone was ‘economically worth less’ (let alone ‘economically worthless’!) that you might think I was making some comment about that person’s value as a human being. I’m pleased, at least, that many people who disagree with me nonetheless give me the benefit of the doubt, and I hope I’d do the same.

I think Freud’s comments were motivated by a sincere desire to make disabled people’s lives better off by allowing those that want to work to do so, with their wages topped up by the taxpayer. Whether or not you agree that this is a wise move it does nobody any favours to suggest that anybody in this debate thinks people with disabilities are not valuable as human beings.

You can have cheap pensions and you can have interventionist pensions

But you cannot have cheap and interventionist pensions investment. That combination being what The Guardian is demanding:

Indexation keeps charges low – Nest is fantastically cheap. There are lots of good reasons to spread your investments over a diversified range of international companies, which Nest is doing. What’s more, in achieving returns of 10%-plus a year since launch, it hasn’t had to face too many awkward questions.

Nest is cheap, that's the way it has been designed. And the only way to have it that cheap is to be sticking the money into low and no load index funds. Any other system would mean having to cream off substantial parts of any likely return for those who do the managing to make the return. In fact, that's rather why Nest was first designed: to make it quite clear that there was a way of gaining pensions savings without having to pay over all of the gains to the Men In The City.

All of which is fine but it's entirely incompatible with this next demand:

Conventional City of London ideology is informing its investment decisions. Yet in Singapore, the country’s compulsory pension fund has been mobilised to held build local housing. Ottawa’s pension fund is extraordinarily interventionist. Given that we will be throwing hundreds of billions of pounds into a pension scheme for British workers, could we at least have a wider debate before sending half of it to Wall Street?

We've had that debate. And the answer was that we'd rather not send 2 and 20% to hedge fund operators, one or two percent to more traditional fund operators, for we've noticed that those fees almost inevitably eat up, and more, any extra performance they produce. And that's why all of these schemes for different methods of pension savings crash into a brick wall set up by reality. Yes, even these ideas that pensions should be in bonds to pay for infrastructure. The extra costs of managing the money, the extra costs of the requirement to have the people managing the money, are greater than the increased returns from having done so.

That's why indexation. For you can have pensions with cheap charges and you can have pensions with interventionist, active, management strategies, but you can't both pay for the activity and also have a cheap pension.

Do we need state children's services?

Our children need care and protection from abuse.  The question is whether the responsible bureaucracies give value for money, or indeed provide that care and protection at all.  Following each scandal, we are told that no one is to blame: the problem is systemic.  Then we are told that the bureaucracies will work better together in the future.  Then history repeats itself.  Rotherham should be a wake up call. In fact, the problem really is systemic and it needs a systemic solution. It is not a question of money. From 2001 to 2010 English and Welsh councils’ child social care expenditure nearly doubled from £4.7bn to £8.6bn at 2010 prices (while the number of under 15s fell slightly). Would anyone suggest that the quality and extent of childcare has doubled?

Of course the problem is hugely complex and there is no single, simple solution but surely one factor is the excess of bodies paddling in the same swamp: Local Authority children’s services, schools, doctors and hospitals, police and charities such as Barnardo’s and the NSPCC.  Each case is like Gerard Hoffnung’s performance by solo violin and massed conductors.

Serious child abuse of any form is a crime.  Where a teacher, doctor or any social worker believes that a crime may have been committed, or may still be in progress, then that should be reported to the police like any other possible crime. The police should investigate without fear, favour, concerns for being branded racist or other politically correct excuses for doing nothing – or passing the buck to social services.

The bigger question is then whether children’s services are necessary at all.  If the current Local Authority bureaucracies did not exist, what would we put in their place?

Rotherham demands a systemic solution and that in turn suggests we start with a blank page.

Clearly we need the youth justice system and adoption facilities alongside those offered by the voluntary sector (e.g. Barnardo’s).  But Local Authorities’ manifest incompetence in adoption suggests maybe that should be turned over to the voluntary sector and perhaps arrangements for fostering too.

If taxpayer value would be improved, as it is being for schools, by channelling taxpayer funding through the voluntary sector, then why not?  Equally well if something like the existing services can be radically rebuilt to give our children the protection they need, then so be it. But if we just go on tinkering and adding more boxes to tick, more Rotherhams could follow.

The Negative Income Tax and Basic Income are pretty much the same thing

I’ve been talking about the Negative Income Tax lately, and equating it with the idea of a Basic Income. I think most of the policies’ respective advocates would deny that they’re the same policy. In this post I’m going to outline why that’s incorrect and I’m happy to say that they’re basically the same thing. For the uninitiated, a Negative Income Tax is a form of welfare that replaces most existing welfare schemes with a single payment that supplements the income of the unemployed and low-paid. The payment is withdrawn as your earnings increase, ideally at a gradual enough rate that increasing your earnings (and hence reducing leisure time) is always worthwhile.

An example: a £5,000 basic payment at a 50% marginal withdrawal rate (this means that for every additional pound earned, the worker will receive 50p less in NIT payments). Someone with an income of zero would receive an NIT payment of £5,000, or just under £100/week. If they took a job that paid £5,000/year, they would receive a top-up of £2,500/year; that paid £7,500, a top-up of £1,250/year. Once they reached £10,000/year, they would receive nothing in NIT.

This idea was supported by Milton Friedman, among others, and has a reasonably strong pedigree on the right. Even libertarians who object to income redistribution in principle usually concede that a Negative Income Tax is the least bad form of welfare, because it is administratively simple and perverts incentives less than most welfare schemes. It is particularly appealing to many liberals and libertarians because it is unpaternalistic.

A Basic Income, on the other hand, is usually conceived as a flat payment to everybody irrespective of circumstance. This leads to a very big problem: assuming it replaces most forms of welfare as an NIT does, a basic income high enough for unemployed workers to subsist on would simply not be affordable to pay to everyone. A policy that ideally would be designed to help the poor ends up being a very expensive subsidy to people who do not need extra money.

Advocates of the Basic Income recognize this, and their solution is typically to use the tax system to ‘claw back’ the payment from relatively high earners. So everyone gets the money, but it is withdrawn according to earnings.

In practice, that’s more or less the same as a Negative Income Tax – the only difference is whether the withdrawal takes place at the ‘front’ of the payment (as with the NIT), or the ‘end’ (as with the Basic Income). Strange as it may seem, the policies advocated by Milton Friedman and the Green Party are the same in all but the technical detail.

But even if there is a surprising amount of agreement in terms of the kind of welfare we’d like to see, the detail may be more difficult to agree on. How much should a ‘basic income’ be? When should it begin to be withdrawn, and at what rate?

Questions like this are, I think, likely to be where what breaks up this (unholy?) alliance. But maybe not. Traditional policies like the minimum wage probably do more harm than good, and, rightfully, the question of how to improve the lives of the low paid does not seem to be going away. It will take compromise, but in the Negative Income Tax / Basic Income, we may have an answer.

Five intriguing papers I discovered this week II

As the second in a series, here are summaries of five interesting journal articles I read in the last week. All of these ones are new, although that may not always be the case. 1. "Very Long-Run Discount Rates" by Stefano Giglio, Matteo Maggiori and Johannes Stroebel

Giglio et al. use the difference between the prices of leasehold and freehold properties in the UK and Singapore to compute long-run discount rates. They find that over 100 years, the discount rate is 2.6%—whereas properties with 700-year or longer leases trade at par with freeholds. They point out that this 2.6% discount rate may have implications for climate change policy; the famous and influential Stern Review recommended using a 0% discount rate, which may justify much more extensive anti-CO2 measures now. Some slides explaining their findings are available here.

2. "Is the stock market just a side show? Evidence from a structural reform" by Murillo Campello, Rafael P. Ribas, and Albert Wang

Campello et al. look at a 2005 reform that, in a staggered 16-month basis and after a trial, allowed $400bn worth of Chinese equity, previously untradable, to be bought and sold. Using "wrinkles" in the roll out that provide quasi-experimental tests, they find that firm profitability, productivity, investment and value all improved substantially. "Policies that ease restrictions on [capital] markets may have positive effects" runs the final line of their conclusion—quelle surprise!

3. "Social security programs and retirement around the world: Disability insurance programs and retirement" by Courtney Coile, Kevin S. Milligan and David A. Wise

These three authors add to the burgeoning literature proving that those on the edge of retirement respond to incentives just like anyone else. This shouldn't really be a surprise, but the heavy flow of publications adding evidence in this direction suggests that maybe there was once a bizarre consensus in the other direction. Coile et al. show that delaying eligibility to pensions, increasing the stringency of disability insurance programs, and other welfare reforms for older people have "very large" effects on how much labour they decide to supply. Not exactly shocking, but certainly important in ageing societies.

4. "What Happens When Employers are Free to Discriminate? Evidence from the English Barclays Premier Fantasy Football League" by Alex Bryson and Arnaud Chevalier

In this nifty and quirky paper the authors try and isolate "taste-based" racial discrimination, by looking if fantasy football players pick footballers differently based on their race, controlling for "productivity" (i.e. their expected points tally). They find no evidence of taste-based discrimination here, suggesting that much of the apparent discrimination found in other studies (e.g. studies of fake CVs where different ethnicities see different acceptance rates even when they have similar qualifications and experience) could be statistical. That is, since employers cannot directly observe productivity (unlike in fantasy football), and since different ethnicities have different productivity distributions, certain ethnicities are on average less valuable to employers. Of course, it might be that people exercise taste-based discrimination as well when they have to interact regularly with the group/race/ethnicity in question—fantasy football is much more at arms length.

5. "The Role of Publicly Provided Electricity in Economic Development: The Experience of the Tennessee Valley Authority, 1929–1955" by Carl Kitchens (ungated)

The most fun kind of research to read is one that confirms a niggling view you've had for a while, but one that nevertheless overturns a happy consensus. The Tennessee Valley Authority is a classic example of "enlightened" central planning, targeting a hard-up area with massive coordinated infrastructural investment and widely believed to have delivered substantial benefits. But if these dams and systems were really such good investments wouldn't private companies have got around all the barriers to such an investment already? There are some cases where I suppose that sort of basic argument doesn't hold, but it's a pretty good first approach to any area, and it turns out the TVA is one of them. Kitchens newly-published paper finds "that the development of the TVA during its first 30 years did not cause manufacturing, retail sales per capita or electrification to grow any faster in areas receiving TVA electricity than in other areas in the Southeast."

How much does Will Hutton actually know about pensions?

Yes, it's a Monday morning so we've the weekend's Will Hutton column to pick through if we so with. And I have to say that it's a real doozy. We might hope for just a little better than this from someone who wants to tell us all how we should live our own lives, how the country should be run. He wants to talk about the new pension rules:

Meanwhile, insurance companies will lose a great part of the £11bn inflow they have been using to support long-term investment. To date, that has been invested in company and government bonds. But with more energy, imagination and drive, it could have been a rich source of long-term capital for British infrastructure projects – had the instruments been developed in which the insurance companies could have invested. Even as it was, the government has managed to coax the companies into coming up with £5bn a year on infrastructure over the next five years. But now an important source of the funding – annuity inflows – will evaporate.

The annuity inflows were not a large part of the financing of this market. For in one of his acts of financial repression (yes, that is the technical term for it) Gordon Brown insisted that annuioties should be largely funded by gilts. The pension funds which built up over the years, yes, these could be and are invested in some micture of bonds and equities and infrastucture projects and so on. But it's the very switch from those funds into hte annuities that reduces the amount available for such investments. But that pales beside this ludicrous misunderstanding:

But it is not "their money" and we all live in a society whose members' decisions profoundly affect each other. Mr Webb, I assume, would not make this remark about individuals being free, as neighbours, to play offensively loud music, or free not to bin their household rubbish or free to refuse to school their children. Being free to binge your lifetime savings, which taxpayers have helped create, falls into the same category. Every citizen in these island pays higher taxes than they otherwise would to compensate for the lack of tax coming from tax-sheltered pensions. The contributions to build up personal pension funds are allowable against tax and the funds, once acquired, pay no capital gains tax and no income tax on dividends. Up to 40% of the value of any pension fund is thus created through the construction of a watertight tax-free zone. We should care if the resulting money is spent on a Lamborghini: a chunk of the car belongs by right to taxpayers.

Sigh. The tax benefits that pensions savings get is not actually a waiving of tax. It is only tax deferral. It is true that you do not pay tax on the money you put into your pension fund. But it is also true that you do pay tax on any pension that results from that saving. And it's absolutely true that if you cash out your pension to the extent that you can afford a Lamborghini then you'll be paying at least the higher rate on most of that cash. Quite possibly the 45 p rate on some of it too.

That I pay tax upon my money in 2015 rather than in 1985 gives the taxpayers no claim over my car now, does it?

It's not just that assumption he's making there, that if you don't get taxed then taxpayers own part of you and your possessions. It's that he simply doesn't seem to be aware that pensions taxation is all about deferral, not the simple non-taxation of the income at all. And as I say, these are the people we're supposed to get our ideas from about how to run the country?

Osborne's Surprise

The most exciting part of George Osborne's fifth budget came as a total surprise.  This was the complete overhaul of the pensions system, and it achieved two of the Adam Smith Institute's long-term objectives: simplification combined with tax reduction. 

The previous rules, complicated and cumbersome, arose from the Treasury's lack of trust in people's ability to manage their own affairs competently.  The Treasury tried to micro-manage how pension pots should be drawn upon.  They limited the amount that could be taken in cash, and capped the amount that could be drawn in annual income to a small amount, with a punitive 55% tax on anything in excess. 

The Treasury's concerns were twofold.  They didn't want high earners to use pension pots to circumvent income tax, and they didn't want people drawing so much that they had insufficient left to support them and might become a burden on the state.  People were compelled at one stage to buy an annuity, despite the poor value these have represented.

Osborne's bold budget has introduced the revolutionary idea that people are better at judging their own interests than Treasury officials are.  At a stroke he has given them the choice of how much to draw and when to draw it, and abolished the 55% rate.  Anything they do withdraw will be taxed at their marginal rate.  Significantly, the Chancellor pointed out that those on his side of the House know that lower tax rates can sometimes bring increased revenue, and he expects it will happen in this case.

Saving for retirement has suddenly been made more attractive, and since much of this saving is in equities, it means more investment will be available to create and sustain jobs and to boost growth.  It also means that fewer people will choose to be dependent on the state in their old age.

The Chancellor has expressed his confidence that people will behave responsibly and with due regard for their own interest.  Bravo.  It is an admirable sentiment and one that should be adopted in other Departments.  The ASI will be encouraging them to do so in the months ahead.

I find myself agreeing with Richard Murphy

I think I'm going to need to take a little lie down. I find myself in agreement with Richard Murphy on something. Even that it's only partial agreement is disturbing. He says:

I have read a lot about what fairness is of late. I have come to the conclusion that there is no objective answer to that. Whatever one person thinks is fair is, apparently, acceptable to at least someone, somewhere. That is why it comes to fairness majority opinions matter. On the welfare cap I have no doubt the majority will consider what is being proposed to be profoundly unfair if they realise just who is affected.

As to the definition of fairness, yes, he's correct: for this is the point of Adam Smith's linen shirt. That you cannot afford one does not make you poor. But if you live in a society where not being able to afford a linen shirt marks you as being poor then yes, in that society you are poor. So, what we all, collectively, think of as being fair is indeed what is fair in our society. And that is a malleable thing. We used to, vilely, think that it was just fine to hang people for stealing a loaf of bread to take but just one example from our past.

However, I disagree entirely with the idea that people are going to think that the benefits cap is indeed unfair. It is, after all, set at around median household income and we do, most of us, think of the welfare system as a safety net and not something that should provide a better than average lifestyle.

But we can go further than this. It was most amusing watching the reactions to the initial part of the benefits cap, the limitation on the amount of housing benefit that anyone could claim. The number was announced as being £400 and everyone exploded in outrage. What? You can't rent a rabbit hutch on that amount per month! The next turn of the news cycle brought the clarification that this wasn't a monthly limit, this was a weekly one. At which point the outrage exploded again: what, you mean people have been getting more than £20k a year, tax free, in subsidy for their rents? But, but, that's more than I earn!

We British have alwasy prided outselves on our sense of fair play: possibly in error. And we do indeed have ideas about what is fair within our own society and the definition of what is fair should properly be judged on what we collectively think is so. But recent experience tells me that the idea of a benefits cap is something that most of us will describe as fair. Simply because most of us do think that the welfare system is a safety net, nor either something that should provide a substantial lifestyle nor an exercise in social and economic re-engineering.