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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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The Subtle Costs of a Mansion Tax

The Subtle Costs of a Mansion Tax

An exciting email pinged into my inbox at the end of last week. It was a link to the contents of the latest issue of the American Economic Association’s journal ‘Economic Policy’. For most people these are not usually as gripping as, say, a Ken Follett novel. But there, nestling amongst thickets of algebra, is an article entitled ‘Mansion Tax: the Effect on the Residential Real Estate Market’.

The authors, Wojcieck Kopczuk and David Munroe, are both members of the prestigious economics department at Columbia University in New York. The article contains its fair share of technical material, but the main points are conveyed by some straightforward charts. The paper describes a detailed analysis of residential real estate transactions since 2003 in New York City and in the neighbouring state of New Jersey.

The mansion taxes which they examine are nowhere near as punitive as the one envisaged by Ed Miliband. But the impact of the taxes is both dramatic and detrimental. A so-called mansion tax has been in force in New York since 1989 and in New Jersey since 2004. It applies not on an annual basis to the property, but simply to transactions of $1 million and over. The tax rate is 1 percent and is imposed on the full value of the transaction so that a $1 million sale is subject to a $10,000 tax liability, while a $999,999 transaction is not subject to the tax at all.

Not surprisingly, the tax distorts the distribution of pricing, so that there is a large bunching effect just below the $1 million threshold. A plot of the number of transactions in New York City against the price, not surprisingly, slopes downwards. There are a lot more sales of properties at, say, $500,000 than there are at £1.5 million. But there is a huge spike in the chart immediately below the $1 million tax threshold. The same result is shown for New Jersey. Here, the tax was introduced during the period for which the transactions data is available. And its impact was virtually instantaneous.

There is a large gap in transactions in price bands just above the threshold. But this is bigger than the excessive number of sales which take place below it. More sales are lost above the threshold than are gained below it. The tax causes the market to, as the authors put it, unravel. The market ceases to function properly, and trades which would otherwise have been undertaken by willing buyers and sellers do not take place at all. This is the real subtlety to the article. Mansion taxes create costs which are not at all obvious at first sight. The people who lose out can never be identified, for the simple reason that they are unable to carry out the transactions which they would have liked to. But their losses are nevertheless real.

Markets are often imperfect instruments. If left completely unchecked, they can create undesirable outcomes.  But Soviet-style diktats on markets can create costs for society which go beyond the immediately obvious.

As published in City AM on Wednesday 6th May

Image: Kensington & Knightsbridge – 79 by Kyle Taylor under license CC BY 2.0

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The 38 per cent tipping point on tax

The 38 per cent tipping point on tax

Ed Miliband’s proposal to tax non-doms more harshly may be good, populist politics. But does it make economic sense? At most, the yield will be around £1 billion, even if people do not alter their behaviour in response to the change in policy. The actual amount generated could even be negative if enough non-doms leave the country. Most commentators recognise this.

The history of tax wheezes dreamt up by governments is a litany of the eventual tax take falling short of its anticipated level because of changes in behaviour. In 1795, Britain was engaged in a titanic struggle for survival against revolutionary France. The sheer scale of the war put the public finances under unprecedented strain.  The then Prime Minister, Pitt, invented the Powder Tax.  Anyone wishing to buy powder for his wig had to register and pay a tax of a guinea (£1.05), a non-trivial amount in those days.  Wigs rapidly went out of fashion, and the tax yielded very little.  The diehards who persisted with wigs became known as ‘guinea pigs’, the origin of the modern phrase.

There does seem to be a limit to the amount of tax which British governments are able to raise.  Fifty years ago, a new Labour government, headed by Harold Wilson, had just come to power, determined to transform the British economy.  In the financial year 1964/65, the total amount of tax and National Insurance payments raised came to 36.2 per cent of GDP.  In the final year of office of this highly interventionist government, 1969/70, this figure had risen.  It had increased to the dizzy height of 37.4 per cent!  A government which by today’s standards was radical and left-wing felt able to put taxes up by all of 1 per cent of GDP.

The 1969/70 level is almost the highest ever recorded over the past five decades in the UK, being fractionally higher in the recession of the early 1980s at 37.6 per cent.  Gordon Brown controlled domestic policy in Britain from 1997 onwards.  The tax manual doubled in size thanks to the huge number of new schemes Brown introduced.  But when he was booted out by the electorate just after the end of the tax year 2009/10, tax and social security receipts were only 34.5 per cent of GDP.

Elected authorities at all levels in the UK seem to be reluctant to increase tax beyond a certain point.  The Scottish Executive has had the power to raise the basic rate of income tax by up to 3p in the pound.  But despite the fact that the body has always been controlled by parties of the Left, Labour and the SNP, neither has used the power.  Local authorities can hold referenda to put up council tax, but they don’t.

The 38 per cent threshold is not an immutable physical law.  But no UK government of whatever persuasion in the past 50 years has been either willing or able to raise more tax than this as a percentage of GDP.  This sets clear limits to the ambitions of any government during the next Parliament.

Paul Ormerod

As published in City Am on Wednesday 15th April 2015

Image: “Look after the pennies and the pounds will look after themselves” by Tristan Martin under license CC BY 2.0. 

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Corporate tax is getting easier to avoid. Time to abolish it.

Corporate tax avoidance is once again prominent in the news. When Jean-Claude Juncker, the new European Commission president, was prime minister of Luxembourg, the country seems to have operated as a vast tax shelter. Leaked documents have revealed that special tax arrangements were agreed by his country with over 300 multi-national companies.

 

Getting a handle on the scale of corporate tax avoidance across the world is tricky. A detailed study has just come out in the latest issue of the top ranked Journal of Economic Perspectives, by Gabriel Zucman of the London School of Economics. His focus is on American companies. Zucman’s thorough analysis of balance of payments statistics and corporate filings shows that US companies are moving profits to Bermuda, Luxembourg, and similar countries on a large and growing scale. About 20 percent of all US corporate profits are now booked in such havens, a tenfold increase since the 1980s. Over the most recent 15 years, the effective rate of tax on the profits of US firms has fallen by one-third, from around 30 per cent down to 20 per cent. And about two-thirds of this can be attributed to an increase in shifting profits to low-tax jurisdictions. In money terms, the loss in revenue is some $175 billion, over 1 per cent of the total size of the American economy.

 

It is of course the most dramatic examples which hit the headlines. But if the effective rate is some 20 per cent, and a few massive companies are paying very little tax at all, many American companies must in fact paying tax rates on profits which are close to the nominal rate of 35 per cent. Although Zucman does not repeat his detailed exercise for the UK and Europe, a clear implication of the paper is that a qualitatively similar outcome obtains here. In other words, most firms operate in a way which most people would regard as being fair and reasonable. Blanket condemnations on the lines of Ed Miliband’s ‘zero-zero’ speech are wholly at odds with reality.

That said, there are undoubtedly serious problems with corporate tax regimes across the developed world. The increasing complexity of the legislation offers many opportunities for ingenious but perfectly legitimate avoidance schemes, such as Google’s “double Irish Dutch sandwich” described by Zucman. We can go down the route of trying to get greater international consensus on the treatment of tax, and steps have certainly been made in this direction. But it is a long and arduous process with no guarantee of success.

The simplest solution is to abolish corporate taxes on profits and to tax consumption instead. Ultimately, the tax burden can only fall on individuals. Taxing profits creates the illusion amongst the electorate that there is a free lunch. But someone, somewhere, pays. Higher corporate taxes might lead, for example, to lower dividends or lower wage increases. Companies might squeeze suppliers harder or cut back on investment. Tax needs to be transparent, so people can really decide what value they get out of it.

 

As published in City AM on Tuesday 18th November
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