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Less austerity will always mean more tax

Less austerity will always mean more tax

There is a great deal of discussion, following the election, of relaxing or even abandoning austerity.

There is an equal amount of confusion about this, because the same word is being used to describe two quite separate concepts.

The consequences of the government changing its policy on austerity are dramatically different, depending on which one it is.

One meaning of the word is what we might call “social austerity”. From any given pot of money available to a government, its supporters believe that, in general, tax cuts should be promoted rather than public spending increased. Opponents argue that public spending as a result has become underfunded. Local councils, education, and the NHS all need more money.

Social austerity can be relieved, as even the DUP and some Conservatives argue, by increasing spending appropriately, and funding it by increases in taxation. This was an important aspect of Labour’s manifesto, and the tragedy at Grenfell Tower has intensified the discussion around it.

The main risk is purely political. Are voters really and truly willing to pay more tax, rather than just wanting someone else to pay it?

There are some potential adverse economic consequences if the policy of higher taxation is pushed too far. Former French President Francois Hollande’s 75 per cent tax rate led to several hundred thousand skilled young people leaving France, mainly for the UK. If companies are taxed too heavily, they may choose to locate to another country. Both skilled labour and capital are geographically mobile.

But, within reason, social austerity could be relaxed without perhaps too many fears in this direction.

“Economic austerity” is quite a different matter. Opponents of this want to increase the gap between government spending and tax receipts – the so-called fiscal deficit. This is funded by issuing government bonds. So the deficit in any given year goes up, and the outstanding stock of government debt also rises.

Any relaxation of social austerity is paid for by higher taxes now. Any relaxation of economic austerity is paid for by borrowing more now.

But the debt has to be repaid at some point, and the interest payments on it must be met. So taxes in the future will be higher. Either way, less austerity means more tax.

John Maynard Keynes himself made it very clear that increasing public spending at a time of full employment would simply lead to more inflation. There are areas of the country where there probably are people registered as unemployed who genuinely do want to work – the Welsh Valleys, for example. But the rest of the UK is at full employment.

The number of people in employment is at an all-time high, at 32m. This has risen by 2.8m since 2010. Meanwhile the unemployment rate has fallen from 7.9 per cent in 2010 to just 4.6 per cent today.

Any major fiscal stimulus to the economy now would simply bid up wages, leading to higher costs and higher inflation.

The public mood on social austerity may have shifted. But the case for economic austerity is stronger than it has ever been.

As published in City AM Wednesday 21st June 2017

Image: People’s assembly by Peter Damian is licensed under CC by 2.0
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The UK could teach the Eurozone a thing or two about successful monetary unions

The UK could teach the Eurozone a thing or two about successful monetary unions

The Office for National Statistics (ONS) published last week some figures which show how a successful monetary union works in practice.

It is not obvious at first sight, from the dry heading: “regional public sector finances”.

The ONS collects information on the amounts of public spending and money raised in taxes across the regions of the UK. The difference is the so-called fiscal balance of the region.

Only three regions generate a surplus. In London, the South East and the East of England, total tax receipts exceed public spending. The capital has a healthy positive balance of £3,070 per head, followed by the South East at £1,667 per head.

Essentially, these two regions subsidise the rest of the UK. Public spending in the North East, for example, is £3,827 per person above the level of taxes raised in that region. In Wales, it is even higher at £4,545. No wonder that one of the first things Carwyn Jones, leader of the Welsh Assembly, said after the Brexit vote was: “Wales must not lose a penny of subsidy”.

The region which benefits most is Northern Ireland, which gets £5,437 per head more than it generates in tax. Scotland, to complete the picture, receives around half of that, at £2,824 per person.

There is a lot of debate around Brexit and the border between the North and the Republic of Ireland. There is even talk of reunification, but on these numbers the Republic would be mad to want it.

Essentially, the regions receive these subsidies because they are running deficits on their trade balance of payments. The exports of goods and services from the North East, for example, to the rest of the UK are much less than it imports. In balance of payments jargon, the subsidy it receives is a monetary transfer from the rest of the country, principally from London and the South East.

The ONS does not actually produce regional balance of payments statistics. But the fact that most regions receive these large transfers implies that they are just not productive enough to sustain their living standards by their own efforts.

All the regions are in the sterling monetary union. Those running trade deficits cannot devalue to try to improve their position. They must instead rely on subsidy.

Exactly the same principles apply in the Eurozone. The massive difference of course is that there is no central Eurozone government to make sure the weaker performing regions receive the necessary funding.

This is why President Macron and Chancellor Merkel announced they will examine changes to treaties to allow for further Eurozone integration. Even the hardline German finance minister, Wolfgang Schauble, said: “a community cannot exist without the strong vouching for the weaker ones”.

To be sustainable, a monetary union needs large transfers between its regions. London and the South East already put their hands deep into their pockets for the rest of the UK. Gordon Brown did get one thing spectacularly right. He kept us out of the Euro.

As published in City AM Wednesday 31th May 2017

Image: Euro sign by Alex Guibord is licensed under CC by 2.0
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Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Elections create uncertainty. But we can be sure of one thing. Regardless of the result, during the course of the next Parliament, stealth taxes will rise. This week, we have a sharp rise in speeding fines. Even doing between 31 and 40mph in a 30mph zone can now land you with a penalty of 50 per cent of your weekly income.

Governments across the West are running out of ways to pay for the spending levels which the electorates appear to demand.

A key way in which public spending has been financed over the past 40 years has been through debt. Almost everywhere, the level of public sector debt relative to GDP has risen sharply.

A few years ago, the International Monetary Fund (IMF) published long runs of historical data on the public debt to GDP ratio for countries across the globe. The Bank of International Settlements (BIS) updates the ratio regularly.

In 1977, gross public debt in the United States was 39 per cent of GDP. In 2016, it was 98 per cent. Over the same period, the UK, using the IMF and BIS definitions, the rise was from 49 to 115 per cent of GDP. In France, the ratio went up from 15 to 115 per cent. Even in debt-wary Germany, there was an increase from 27 per cent in 1977, to 78 per cent in 2016.

There are different ways of defining public debt, and no two measures are the same. But regardless of how we put the figures together, the conclusion is clear.

Public sector debt has risen massively. The simple fact is that most governments in most years now routinely spend more than they dare raise in taxes. The resulting deficit has to be financed by issuing debt. But the limits are now being reached, a lesson the Greeks have learned so harshly in recent years.

Over the course of history, public sector debt, relative to the size of the economy, has been at much higher levels than it is now, with no apparent serious consequences. In 1946, for example, UK public debt was 270 per cent of GDP.

But in the past, governments with high debt levels typically did one of two things. They either defaulted, or they tried to pay it off. The left wing Labour government of Clement Attlee ran huge budget surpluses in the late 1940s, peaking at around £100bn a year in today’s terms.

Most debt used to be incurred as a result of war. In 1861, US public debt was less than 2 per cent of GDP. The Civil War bumped this up to 30 per cent. In the late 1810s, as a result of the Napoleonic Wars, the first truly global conflict, British debt was 260 per cent of GDP. It took decades to get it down to sustainable levels, but governments did succeed and pay it off.

In stark contrast, debt has been built up in the late twentieth and early twenty-first century to finance the services provided to voters. It is simply unsustainable.

As published in City AM Wednesday 26th April 2017

Image: Speed Trap by Peter Holmes is licensed under CC by 2.0
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Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

The shambles over the treatment of National Insurance has dominated the media’s reporting of the recent Budget. But only the previous week, Jeremy Corbyn made a complete horlicks of his tax return for the second year running.

The Bearded One makes a saintly fuss over making his tax affairs transparent. In 2016, he forgot to include his pensions in his return. This year, he seems to have entered his allowance as leader of the opposition as a benefit rather than as income.

The real scandal is not his gross incompetence. It is the amount he already earns in pensions and is set to receive in the coming years. It is not necessary to be an educational success to earn a lot of money. There are many prominent examples of this point. But, taking the population as a whole, there is a pretty good relationship between how well you do when in education and how much you earn in your career.

Corbyn left school with two grade Es at A level, and left what was then the North London Polytechnic without finishing his degree. His pensions, including his state pension and a pension from the Unison union, already amount to nearly £10,000 a year. When he retires as an MP, he is entitled to a further gold-plated pension which will pay out almost £50,000 annually, which analysis last year estimated would cost £1.6m to buy on the open market.

The leader of the opposition has spent his entire adult life outside the wealth creating sectors of the economy, insulated from market forces. And he will draw a pension which is more than the amount which the vast majority of full time employees are paid by actually working.

It is the continuing problem of public sector pay and pensions which the chancellor should be addressing, rather than fiddling around with the technicalities of National Insurance rates. The howls of anguish should not be from builders and plumbers, but from bureaucrats who find their gold-plated pensions and salaries cut. The public sector pay bill makes up around half of all total public spending, so this is the place to look to reduce the government’s deficit.

A new report by the Institute for Fiscal Studies (IFS) out this week acknowledged that, in raw terms, average hourly wages were about 14 per cent higher in the public sector than that in the private in 2015-16.

The IFS mounted the classic defence of high public sector pay, however, arguing that “after accounting for differences in education, age and experience, this gap falls to about 4 per cent”. In other words, public sector workers are more highly qualified, so their higher pay is justified.

But this takes no account of the outputs of the two sectors. In the old Soviet Union, value was measured solely on the basis of inputs such as the skills of the labour force, and we know what happened there.

A European Central Bank paper from 2011 illustrates the dangers. In Germany, public and private sector pay was more or less equal. In Portugal, Italy, Greece and Spain, public pay was between 20 and 50 per cent higher. Sharpen your axe Mr Hammond!

As published in City AM Wednesday 15th March 2017

Image: Seesaw by Rwendland is licensed under CC by 2.0
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Forget avoidance outrage: this is what we really think about tax

Forget avoidance outrage: this is what we really think about tax

Rather like a quantitative version of Hello! magazine, the Panama papers made headlines everywhere. Read all about the vast amount of money a particular celeb has got stashed away. Salivate, be titillated or be outraged, according to your fancy.

The story was covered heavily by the Guardian, the in-house newspaper of the metropolitan liberal elite. But the popular reaction was not quite what they were hoping for. Many people seem to regard the revelations contained in the Panama documents as just the way the ultra-rich and powerful are meant to behave. Rather like Conservative MPs and sex scandals, tax evasion and foreign dictators seem to go together quite naturally.

John McDonnell, the shadow chancellor, demanded an immediate and full public inquiry in the House of Commons. He could perhaps consult Yanis Varoufakis, one of his economic advisers, who of course was so successful in running the economy during his time as Greek finance minister.

Or the Left could more usefully ponder a fundamental principle in economic theory, the concept of so-called revealed preference. Economists attach relatively little value to surveys of opinion. This extends far beyond political opinion polls, though these serve to illustrate the point. In the 1980s, for example, survey after survey showed large majorities in favour of higher public spending financed by higher taxation. Yet the electorate consistently returned Margaret Thatcher to power when they had to make an actual decision.

Just because voters dislike tax avoidance by global companies and the super-rich, it does not mean that they themselves want to pay any more tax. We saw this in the general election last year, where there was a decisive swing away from Ed Miliband’s Labour to the tax-cutting Conservatives in the marginal constituencies of England and Wales.

Economists believe that it is only by their actions that people reveal what their preferences really are. Faced with a hypothetical question, their answers are unreliable, so we observe what they genuinely think by the decisions they make. The Journal of Economic Perspectives had a symposium on this question in one of its 2012 issues. The discussions are technical, but the top MIT econometrician Jerry Hausman summed it up neatly when he wrote: “what people say is different to what they do”.

The plain fact is that we have data going back over 50 years on the total amount of tax which governments are able to levy on the British people. Regardless of who has been in power, no government has been able to lift the percentage of national income which goes in tax above the 38 per cent mark. This includes all taxes: income, capital, corporation and the rest.

Politicians have to understand the wishes of the electorate if they themselves want to stay in power. Gordon Brown might have doubled the size of the tax manual when he was in power, but the tax take was if anything slightly low when he was booted out in 2010, at 34.9 per cent of GDP.

For all the fine sentiments expressed in surveys and the outrage over tax dodging, the revealed preference of the British electorate is to keep taxes low.

As published in CITY AM on Wednesday 20th April 

Image: Taxes by Got Credit is licensed under CC BY 2.0

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Why a sugar tax would be a big fat failure: People are too smart for central planners

Why a sugar tax would be a big fat failure: People are too smart for central planners

Government ministers have bowed to pressure. They have published the report by Public Health England (PHE) which calls for a tax of up to 20 per cent on sugary drinks and foods.  If the tax reduced sugar intake in line with the recommendations, it is claimed that more than 77,000 deaths could be prevented in the next 25 years.  PHE must be gifted with unusual powers of clairvoyance to be able to see the future with such precise accuracy.  Better get the staff transferred to the Treasury or the Bank pronto, so they can predict the next economic crisis!

Lurking in all such projections is the little word ‘if’.  It is this tiny word which is the downfall of so many grandiose plans of social engineering.  The public may simply not believe the message, at least not in sufficient numbers to make much difference.  Hardly a week goes by without some academic berk or pompous official proclaiming that something we have enjoyed since time immemorial is a mortal threat to our health.  The latest is the pronouncement from the World Health Organisation that bacon sandwiches and sausages are as dangerous as smoking.  Such statements are often contradicted at some point in the future.  Car owners, for example, were actively encouraged to switch from petrol to diesel, but the latter is now regarded as the devil incarnate.

The fundamental difficulty is that ordinary people are much smarter and more creative in their reactions to changes in incentives than planners give them credit for.  During the UN Climate Change conference in Copenhagen in 2009, the city council wanted to curb prostitution.  They sent postcards to hotels and delegates urging them not to patronise the city’s sex workers.  The members of the Sex Workers Interest Group responded by offering free sex to anyone who could produce both their delegate card and one of the postcards sent by the Mayor.  They faced the choice of a much reduced income if the Mayor’s strategy was complied with, or a normal income reduced by the occasional free service.

Taxes on sugar are altogether less exotic.  If the price goes up, less will be consumed.  That is the opening chapter of many economic textbooks.  But reality can be much more complex.  Different states in America have different levels of tax on cigarettes.  Jerome Adda and Francesca Cornaglia of University College London took advantage of this to examine how smokers responded to different tax rates in a 2006 paper in the American Economic Review.  The higher the rate of tax, the fewer cigarettes smoked.  So far, so good.  But higher rates led smokers to switch to brands with higher tar and nicotine yields.  In addition, smokers increased their intensity of smoking by smoking right down to the butt.  Such behaviour further increases tar and nicotine consumption, and leads to even more dangerous chemicals being inhaled.

Obesity is undoubtedly a serious problem.  But the idea that a simple tax on sugar will solve the problem is a pure fantasy of the mindset of the central planner.

Paul Ormerod 

As published in City AM on Wednesday 28th October 2015

Image: Coca Cola, Share a Coke by Mike Mozart licensed under CC BY 2.0

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