As published in City AM Wednesday 12th December 2018Read More
The income tax system in the UK is highly progressive.
Not many people know that, to use a catch phrase attributed, rightly or wrongly, to the great actor Michael Caine.
The top one per cent of earners contribute 27 per cent of all income tax receipts. To put it in context, just 300,000 people pay nearly three times as much in total as the bottom 15m taxpayers. Despite all the political rhetoric about tax avoidance, high earners cough up a very large amount of money to the Exchequer every year.
Under the Labour government of the 1970s, the highest marginal tax rate was no less than 98 per cent. But the top one per cent of earners paid only 11 per cent of all income tax.
Jeremy Corbyn and shadow chancellor John McDonnell pledged in their manifesto to raise around another £15bn a year in tax from this group. In addition, corporation tax on profits would allegedly raise a further £19bn.
The realism of Labour’s costings as a whole was called into serious question at the time by people such as Paul Johnson at the Institute for Fiscal Studies.
A paper published in the latest American Economic Review produces strong evidence that it is purely wishful thinking to imagine that anything like these amounts could be raised. In the modern world, both skilled labour and capital are highly mobile. There would simply be movement out of the UK altogether.
The authors, Enrico Moretti and Daniel Wilson of Berkley and the San Francisco Federal Reserve Bank, carry out a very detailed statistical analysis of the impact of the different state income tax rates in the US on where highly skilled people choose to work.
Personal taxes vary enormously across the American states. In California, for example, the average tax rate arising on top earners which is due solely to state rather than federal taxation is eight per cent. In contrast, in Texas (and eight other states) it is zero. Over the period of the study – 1977 to 2010 – rates have also varied substantially within individual states.
Moretti and Wilson compile an impressively detailed set of data on individuals they describe as ‘star scientists’, defined as those scientists who are very prolific in generating patents. They examine the location decisions of some 260,000 individuals during the period they analyse.
Their conclusion is unequivocal: “we uncover large, stable, and precisely estimated effects of personal and corporate taxes on star scientists’ migration patterns”. Essentially, steep taxes drove away high-achievers.
Tax rates are important not just to individuals in choosing where they want to work. The different corporate tax rates levied by individual states affect where companies such as Microsoft and General Electric locate their most productive and innovative researchers.
There are of course many factors which determine where people and firms decide to locate. But the idea that innovative people will simply sit around en masse and wait to be fleeced is pure fantasy. There may be little chance of the current Labour leadership understanding the real world, but the electorate needs to.
As published in City AM Wednesday 5th July 2017
Image: Jeremy Corbyn and John McDonnell by Rwendland is licensed under CC BY-SA 4.0Read More
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 2.0Read More
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 2.0Read More
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