Feel The Fear And Forego Child Benefit Anyway

The Inland Revenue is busy cleaning up part of Gordon Brown's poisonous legacy by clawing back Child Benefit payments made to households earning more than £50,000. Either you decline it, or you'll pay the equivalent in tax as a "Child Benefit Charge".

Given that you paid the government to pay you Child Benefit in the first place, you would be insane (or extremely passive aggressive), not to simply decline it. 

But if you do decide to hold onto the benefit undeservedly, the Child Benefit Charge means you know exactly which tax is being used to repay any Child Benefit you receive. Screwy, but it should teach you a lesson.

This also exposes Gordo's trick.

In paying child benefit to higher earners, Brown was trading on their greed, as well as their fear. He knew higher earners would feel justified in receiving the benefit because they already paid so much in tax and felt they should get something back. The stupidity of paying the government to receive a needless benefit would not dawn on them because it was all done indirectly, by stealth. There was no tax labelled "Child Benefit Charge", as there will be going forward (at least for undeserving recipients). As a result, he knew higher earners would struggle to believe that taxes would ever be reduced if they voted to restrict Child Benefit only to deserving families. The government would always find another sneaky use for the tax money.

The current government has had no alternative but to lift the lid on this nonsense. Public spending must be narrower and more targeted if the government is to spend less, get rid of the structural deficit, and release the tax drag on the economy.

Ideally we would seeer clear links between taxes and what they're used for - like crowdfunding public services.

Clearly income tax cuts are a long way off. But rather than shoot the current government as the messenger, we should blame Gordo and his Nude Labour cronies, including Balls and Milliband, for this predicament. None of those people must ever be allowed anywhere near the nation's coffers ever again.

Regions Unleashed...Eventually

Scrapping national public sector pay rates is great news at last for regional growth.  As mentioned previously, government spending is crowding out private businesses in the regions, and strangling their ability to compete nationally and globally.  Labour costs are a big component of this, and businessses should be allowed to base themselves in regions where lower local living costs mean workers don't need to charge as much for their services. 

This means the unions will need to be more flexible and do more work locally if they are to represent their members effectively. Instead, the likes of Brendan Barber, the Trade Union Council general secretary, would rather play on middle class fear and greed, suggesting this will “suck demand out of local economies, increase joblessness and worsen the North-South divide”. This is a bizarre claim. More civil servants will keep their jobs if the government can reduce its wage bill. Similarly, with local wages lower, businesses can afford to employ people who they otherwise could not. So this move means more jobs, not fewer.

But when? The gap between public and private sector pay in many regions is huge:

"In Wales, public sector workers are paid on average 18 per cent more than private sector workers doing the equivalent job. In Yorkshire and the Humber and the East of England the difference is 13 per cent, while in the North East the pay gap is 11 per cent." 

It could take many years for this difference to be removed.

Further, Faster, Narrower, More Targeted

Raising the personal tax allowance is a great idea. Too many low income earners are paying tax at the same time as receiving benefits - needlessly pouring tax money into the leaky Treasury bucket. But as ever, how to fund the tax break is the £64bn question.

This change brings the opporuntity to begin trimming many public spending programmes to make them more narrowly targeted. As a result, taxpayers will begin to trust the government to cut taxes rather than merely cut public spending.

Currently, there are many cases where the link between the burden of a tax and how the money is spent is unnecessarily indirect. This is no accident. As explained previously by Kristian Niemietz, the proponents of 'tax and spend' deliberately design policy and related spending programmes to favour a proportion of undeserving recipients without appearing to tax them directly. These are usually called 'universal' or 'comprehensive' programmes. This political strategy not only preys on greed amongst the 'sharp-elbowed' middle class, so that they'll welcome the policy behind the spending; but it also preys on their fear that abandoning the policy and cutting spending will not translate into lower middle class taxes. 

On that basis, the government only ever spends more, and either borrows or raises taxes to do so - a vicious circle we need to break.

Why Should Londoners Help Cut Regional Public Spending?

I confess that I spent a long time ignoring politics and politicians. I didn't even vote, to avoid encouraging them. I figured if I kept perfectly still they'd lose interest and move away. And for a while it worked - John Major's heroically quiet government nearly brought spending down to a reasonable figure of 35% of the UK's output. At that sort of level, the tax burden can be reduced, there's more money for private enterprise, output increases, the government gets more tax revenue at the same rate - everyone wins. Or at least the Australians and the Swiss do (source: OECD, hat tip IEA, p. 47).

But the UK figures turned truly nasty during the noughties, and that certainly grabbed my attention. By 2009, Gordo and his cronies were spending an amount equal to about 50% the UK's output.  That left the UK in a terrible hole, and it's difficult to believe some hail Gordo as an economic saviour. Contrary to his own claim, he didn't put an 'end to boom and bust' - Mr Bust is alive and well and living high on his overdraft. And if you believe Osborne's plans for the greatest spending reduction since the invention of the stylus, he'll only cut national spending to 40% of GDP by 2015. 

But, for Londoners at least, the picture is a lot less depressing when you break down public spending by UK region. The rate of public spending has remained under 40% by regional GDP for London and the South East, while the rest of the country (bar the East at 45%) is way north, so to speak. In fact, public spending in the North-East peaks at a whacking 70% of regional GDP. England is cruising at 50%, while Scotland is at 60% and Wales and Northern Ireland are dragging around a millstone of government expenditure equal to 80% of their GDP  (source: HM Treasury, hat tip IEA, p. 57). 

As mentioned previously, the government is crowding out private businesses in the regions, and strangling their ability to compete, nationally as well as globally. Manufacturing seems to have been hit hardest, but even a local services business will have to compete with the public sector for administrative staff. And if those people don't want to work for the public sector, they may as well head to... London and the South East.

Funny that. And even funnier that Labour attacked Tory plans to reduce regional public spending. Far from risking a regional recession, the policy change was an opportunity for the regions to rid themselves of the cold dead hand of government.

Of course, bound up in this are national schemes that put public funds in the hands of middle-class people who shouldn't have been taxed to pay for them in the first place. You also see regional MPs resisting cuts to those programmes, preying on the middle class fear that they won't lead to tax cuts.

But people seem to be missing the competitive element to all this. Not only do London and the South East benefit from the flow of dissatisfied regional private sector workers and businesses. But there must also be a risk that London-based policy-makers won't persist in trying to administer medicine the regions don't want. I mean, it's hard to get the attention of Ministers and senior officials at the best of times. But when they're under the sort of pressure they are today, well, maybe they just won't get round to doing the regions a favour...

Trading On Greed and Fear In The Middle-Class

The ebbing financial tide is leaving many weird schemes high and dry - Madoff's ponzi, Icelandic savings accounts, Irish real estate, Greece, Californian municipalities, Royal Bank of Scotland... So we should expect to see at least a little of the same weirdness among the UK public accounts. 

Actually there's quite a lot, as you've probably guessed from the title of "Sharper Axes, Lower Taxes" and its cover design. And you can rely on the Institute of Economic Affairs to point it out in this fashion. The IEA is a research and educational charity whose "mission is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markts in solving economic and social problems." Street: "We give it to ya raw." Don't look for a juicy political manifesto from these guys. The Tea Party they are not. Look for pragmatic next steps and the odd yelp. The choice is yours to make.

But the thought that struck me most often while reading this book was not how the carpet at HM Treasury will cope with all the blood. It's that the font of all weirdness in the public accounts is the lethal cocktail of fear and greed whipped up for the middle class. 

This is perhaps best explained by Kristian Niemietz in the introduction to his chapter on welfare spending. Basically, a spending decision is more likely to be driven by the range of people who appear to benefit than the reality of who pays. This seems merely obvious at first, though not planned. But this is textbook stuff for politicians and public officials. First, they create a 'fiscal illusion' by simultaneously highlighting the benefits of a spending programme to the recipients - including as many (undeserving and greedy) middle class people as possible - and shrouding the costs in mystic runes of Whitehall jargon and indirect taxes (but Whitehall can't even count, so it's likely to get this wrong). This is why politicians are accused of having no apparent means of funding their promises. And it's why we have VAT, and taxes on alcohol, tobacco, gambling and driving around, and employer contributions and public sector borrowing. These costs are designed to be forgotten. Then, because "there is no direct link between any particular benefit and any particular tax", the middle class (most voters) will not only welcome the policy behind the spending, but later resist the abolition of the unduly expensive benefit, fearing that it will not translate into lower middle class taxes. "The benefit is certain; the tax reduction that could correspond with its abolution is not."

To emphasis the fact that this is a genuine play on greed and fear in the middle class and not some kind of whacky conspiracy theory, Kristian points out that those who advocate "a drastic expansion of the British welfare state" call this effect "middle-class buy-in":

"while narrowly targeted policies will fail to draw on the strength of middle-class political pressure to defend welfare, policies with wider coverage actively recruit the sharp elbows of the middle class." The Solidarity Society: why we can afford to end poverty, and how to do it with public support. Fabian Society, 2009

This is why Richard Murphy recommends universal social benefits and comprehensive pensions for all, and national pay deals for local workers. The comfy middle class soak up the benefit but don't see the cost, leaving those on lower incomes to bear the reality of stagnating growth, fewer jobs and the lost chance to use their lower local living costs to compete in, say, manufacturing.

These tactics are a particularly insidious form of disease the only cure for which is the rapidly growing and seemingly unquenchable thirst for sunlight that is the subect of this blog. There is no substitute for obtaining people's informed consent to public expenditure. So it was certainly worth wading through "Sharper Axes, Lower Taxes" and I'll be featuring more from it. That's not to say I agree with every suggested chop, but I'll be doing my best to hunt out the fiscal illusions and suggest the pragmatic choice.

Role of The State: Part 2

In Part One of this post, I covered Warwick Lightfoot's book on the state of the UK's finances, Sorry, We Have No Money, which provides a useful context for Richard Murphy's The Courageous State. Another useful lens through which to view this book is Tim Harford's The Undercover Economist. Yet another is Michael Lewis's Boomerang: The Meltdown Tour... I think you're getting the picture.

Richard Murphy's thesis is that we need 'a new way of economic thinking' because the 'neoliberal' belief in the power of free markets is misplaced and has caused successive governments to retreat in a 'cowardly' fashion from areas where the state should intervene unashamedly. Richard argues that the 'cowardly' state is doing a poor job of providing public services like education, care for the elderly and so on, whereas a 'courageous state' would not.

Richard's proposed alternative model rests on the primary economic objective that the state should  enable people to achieve their ‘potential’ in terms of four groups of needs: 'material', 'emotional', 'intellectual' and 'purpose'. To do that, Richard recommends universal social benefits, a higher minimum wage, a 35 hour week, protecting union rights, reintroducing “industry wage boards” that replicate national collective pay bargaining, extra tax relief for employing people, free higher education, more social housing, removing any market element from the NHS, care for the elderly, youth services and ‘comprehensive payment of earnings-related pay-as-you-go pensions for all in society because no other form of pension provision eventually makes sense financially or economically.” He would claw back universal benefits and pension payments from people on higher incomes via 'negative tax allowances'.

To try to pay for all this, Richard suggests raising more tax revenue from progressive taxes, especially on higher incomes, capital gains, inherited property, land values, advertising and removal of deductions for business interest payments over £50k. Richard would also raise the corporate tax rate, but grant deductions to “those who add value by creating employment in the community or by providing training in society” rather than “the speculator or the company that survives on technology alone when so much of that technology will almost certainly be directed at excess consumption.” He would provide further incentives to charity and recycling shops, over and above their existing tax-free status. The minimum wage should be lifted - with additional increments for more expensive locations, like London, rather than reductions in line with local costs and labour market conditions.

Clearly this book does not represent a short or medium term solution for today's economic problems. It's more of a plea for a different mindset in the longer term. As a solution for the short term, it lacks any acknowledgement of our basic fiscal constraints that Warwick Lightfoot explained, or how the recommendations would operate within them:

• Countries should aim to limit public spending to around 30 - 35% of GDP to avoid slowing the economy and reducing the absolute amount of tax raised;
• Tax receipts in the UK have averaged around 38 per cent of GDP over the last twenty years and have never exceeded 40%.
• Only a deficit of up to 2.5% of GDP can be financed sustainably;
• As government borrowing competes with private sector borrowing any new spending proposal to generate benefits at least 25% greater than the explicit financing costs involved.

However, even looking at the longer term, I'm uncomfortable with the premise that the straightforward achievement of personal potential should be our primary economic driver for a 'new way of thinking'. Limiting our primary needs to 'material', 'emotional', 'intellectual' and 'purpose' overlooks our physical potential, notwithstanding the importance we attach to health and wellbeing. Richard is also a little unfairly dismissive of a purist form of free market economics, since economists only deal in models, which are imperfect (unlike mathematical theories), as Emanuel Derman has explained. In fact, a great deal of economic debate focuses on how to deal with market failures, as Tim Harford discusses in The Undercover Economist. Those failures tend to arise from suppliers leveraging scarcity or ignoring externalities associated with their activities ("a harm suffered or benefit enjoyed by some third party that isn’t reflected in a market transaction", e.g. the true cost of smoking). Asymmetry of information is another challenge, as is the overriding requirement for fair outcomes, particularly in relation to the vulnerable. So I'd have thought that any advancement on free market thinking ought to encompass those sorts of concerns in its central premise. Simply starting with the idea of enabling everyone to achieve their 'potential' is a model that begs the same questions as traditional economic thinking about whether this achievement comes at the expense of another person or is 'unfair' and so on.

I'm also uncomfortable with the idea that we should pour more tax revenue into a state that is 'cowardly' and inefficient. Richard does not say how this would improve public sector productivity, and Warwick Lightfoot points out that 30 years of attempts to improve efficiency have failed. Surely we need to see improvements in the way the state currently spends our money before giving it extra - even if we could pay it more within the fiscal constraints mentioned above.

Unfortunately, the more I get into the detail of Richard's recommendations, the more anxious I become for the future they would yield.

I worry about the statement that "There is little or no evidence that business people are motivated by eventually realising substantial capital gains: entrepreneurial activity is a lifestyle choice that genuine entrepreneurs take irrespective of taxes." The first part might be true - perhaps the 4.3 million sole business proprietors in this country are self-employed merely for the income, rather than the chance of selling for the capital gain that would fund their retirement. Perhaps, too, they prefer the lifestyle of answering to customers rather than a boss. But I know from personal experience that we are not in business 'irrespective of taxes'. At some point it becomes impossible to work any more hours or increase prices, and if that does not pay the bills one can only reduce costs. A person in that position will not generate any additional tax revenue, and may ease off and contribute less.

Richard's rationale for a 35 hour week is somewhat instructive here. He says we are working too long because we are either trying to do 'the government's job' of lifting ourselves out of poverty or “to consume more goods that [we] really do not need.” But the vast majority of those who work harder to earn more aren't among the relatively few fat cats. We work harder because we don't believe the government can keep us out of poverty, or pay off our mortgages by the time we retire, or provide better healthcare or a better education for our kids. As Richard says, we are already providing our own private solution for the ways in which he says the state is 'cowardly'. So is it 'fair' to expect us to pour even more money into that leaky public sector bucket knowing it will bring no improvement?

Richard also complains that “the UK has one of the lowest ratios of staff employed in small companies in the developed world”. I guess he's pointing to the fact that about 4.3m of our 4.5m businesses are owner-operated. He seems to be saying that the failure of these individuals to band together is somehow "the major impediment" to "staff"' having the opportunity to “join in the ownership of their enterprise to take a share of the profit when appropriate, and to eventually reach positions of senior management.” Richard says these people should be obliged to operate limited liability partnerships rather than to be allowed to operate as sole director/shareholder of a limited company. Or is he saying these 4.3m people should close up shop and seek employment with the remaining 200,000 businesses in the hope of one day rising to the level of senior management? This holds the same irony as the Mexican fisherman story.

But is 'employment' really the right model for everyone?

Richard says the 'courageous state' is one that “recognises trade union rights” (he advises the Trade Union Congress on tax issues.)  Apparently unions are essential to “health and safety, paid holidays, equal pay, protection from dismissal… collective bargaining, protection in industrial disputes, and representation in the workplace.” That may be true of the 60% of public sector workers they represent, but only for a far smaller proportion of private sector workers. The result has also been that public sector workers are 14% better off in terms of pay and pensions than private sector workers. And research shows the premium is much larger in some areas. The unions are pushing for an even greater premium, as we've learned from recent strikes. And while I have no idea of Richard's politics (he's equally damning of recent Labour and Conservative/coalition governments) it's no coincidence that the unions finance and control the Labour Party. The more public sector workers there are, and the better paid they are, the more votes there will be for the Labour Party.

So it seems the employment relationship works just fine for the public sector and at least one of our major political parties. But the adverse impact on the regional competitiveness of the private sector is another story. Local businesses can't hope to lure many staff from the public sector. Richard would address this in part by restoring “industry wage boards” to replicate national collective bargaining in the private sector. In other words, he advocates union-style pressure being applied to force regional businesses to pay their employees more. This must result in higher prices, further reducing demand for regional output, and hastening the decline of regional economies. On the other hand, Warwick Lightfoot suggests local competitiveness could be restored if public sector pay and pensions were reducd by 2% of GDP nationally - about £30bn or 17% overall in line with local costs and labour market conditions. The latter option seems logical to me. Richard would also help the regions by giving local authorities more powers, taxation rights and encouraging the issue of municipal bonds (doubtless backed by a bank guarantee and ultimately the taxpayer). So local businesses would not only be competing with the local authority for staff, but would also be paying higher taxes and competing against the local authorities for finance. Municipal bonds wouldn't be a great investment on that basis. The local economy would never generate the taxes to pay the promised return on the bonds, leaving local investors out of pocket and calling on the bank guarantee - and ultimately the taxpayer.

Richard justifies his proposed tax on advertising (other than local media job ads "and such other announcements") because he says advertising is a "pernicious" and “continual process of artificially manufactured dissatisfaction”. He rightly assumes that such a tax would increase the cost of such advertising and inflate the cost of any items advertised. But Richard does not explain why this inflation is desirable, or why the reduction in demand for the higher priced goods would help businesses pay their employees more, and thereby increase income tax revenue. He does not acknowledge the possibility that the reverse would actually occur and overall tax revenue could fall due to lack of demand for goods and downsizing. Richard would tax the production of luxury goods, even if that were to destroy those industries (“so be it,” he says, “this is a price worth paying”). Richard would ban advertising to children, but does not explain the impact this is likely to have on children’s TV programming, for example. He believes the media generally does not behave well enough to 'deserve' advertising revenue, but there are deserving elements that could receive government funding in return for impartiality or public service: please buy more lipstick, if you can afford to, so we can send more BBC staff to cover the Greek riots.

All this conjures up images of a fairly desolate future - I certainly don't see the funding of romantic comedies anywhere in Richard's plans.

But, ultimately, I'm most repelled by the notion that we should automatically rely on the state for our wellbeing. This encourages an 'entitlement culture' in which we are preoccupied with our rights but ignorant of our duties, as I've pointed out before. In turn, this allows us to cast ourselves as passive victims of our institutions - on which we lay the blame for crisis after crisis. Yet each crisis reminds us that all our economic problems ultimately fall on each of us as an individual, whether as a taxpayer, employee or aspiring benefits recipient.

If I were asked to suggest 'a new way of economic thinking' the premise would be one that encourages each of us to behave as an active participant in a society of our own making and under our own control and to acknowedge that each of us bears ultimate responsibility for the wellbeing of others. Such a premise would be that each of us is obliged to secure everyone else’s long term welfare, not just our own.

On that basis, the role of the state would be to enable each of us to fulfil our own fundamental obligation to secure everyone's welfare, not to deliver it for us. 

The Role Of The State: Part 1

The Christmas break finally allowed me to read various books that I knew were going to require some clear days, a rich diet, plenty of sleep and a deep sense of panic about our economic plight.

Amidst the pile were Warwick Lightfoot's Sorry, We Have No Money and Richard Murphy's The Courageous State. I read them in that order, but I also think the first provides a better context for the second, so I'll get to Richard's book in my next post.

Warwick Lightfoot's book provides a very helpful overview of public sector finances, reflecting his previous economic advisory roles at the heart of government.  It also explains a key problem that is destroying regional competitive advantages. 

First, it's worth extracting some basic fiscal rules that have emerged through economic experience:

• Public expenditure needs to be paid for through taxation, either directly in the short term or indirectly by repaying public borrowing over the longer term. Tax is a 'deadweight cost' or inefficiency in the economy, so countries should aim to limit public spending to around 30 - 35% of GDP (more on GDP shortly). Try to tax/spend more than that, and the economy slows down and reduces the absolute amount of tax actually raised;
• Tax receipts in the UK have averaged around 38 per cent of GDP over the last twenty years and have never exceeded 40%.
• A deficit of up to 2.5% of GDP can be financed sustainably;
• Govt borrowing competes with private sector borrowing and can crowd it out or drive up borrowing costs. As a result, the US Office of Management and Budget, for example, requires any new spending proposal to generate benefits at least 25% greater than the explicit financing costs involved. 

"GDP", or gross domestic product, is worth a separate explanation. It's the market value of all final goods and services produced within a country in a given period. There are 3 methods of determining it, which should all reach the same result. But it's worth considering that the figure is gross, so it includes wasteful or otherwise harmful expenditure, as Tim Harford explains in The Undercover Economist - like shoddy building work that needs to be repaired. So, I guess a fall in GDP due to a decline in harmful output could be seen as a good thing, but the economy is still smaller. Therefore we should still reduce the absolute amount of public expenditure by keeping it below 35% of GDP.  

Warwick Lightfoot explains that, above 35% of GDP, the marginal benefit from extra public spending drops sharply. I wonder whether this helps to explain why the EU, and Eurozone in particular, appears to be struggling to derive benefit from increasing EU public expenditure? It would seem tough to mirror the success of, say, the US when the timing of US federation meant that it's taxpayers captured the upside of the surge public sector spending from quite low levels during much of the 20th century, whereas EU came in after member states had already exhausted the marginal economies.

At any rate, how do the UK's finances stack up?

In 2009 public expenditure reached 48% of GDP from a low of about 37% in 1997-99. The structural or permanent budget deficit was about 7% of GDP and public borrowing was about 11% of GDP in 2009-10. The current government had aimed to bring public spending down to just under 40% and public borrowing down to about 1% in 2015-16.  Public spending of just under 40% will still be too high, and continue to act as a drag on economic growth. Further work will be needed to remove structural inefficiencies in the years beyond. Unfortunately, public sector productivity fell between 1997-07, while private sector productivity increased. The public sector faces fewer penalties for failure and has few effective incentives to use capital efficiently. None of the many efficiency measures of the past 30 years has worked.

It's important to understand that public expenditure is also a critical factor in local and regional development, and helps explain why local production capacity has been lost to other regions and countries. New Labour's solution to regional decline was to decentralise government, increasing the share of public sector expenditure as a share of the local economy - well beyond the proportion of 48% of national GDP.  That differential is largely explained by the fact that staff have been employed on wages and salaries agreed on a national basis with public sector unions (which account for 60% of public sector workers). That union activity has ensured that public sector workers enjoy a 14% pay and pension premium nationally. But the difference is disproportionately larger in communities outside London and the South East. So regional private sector employers face overwhelming competition for employees from the public sector. To compete on pay, private businesses have to charge more for their products, which means they lose out to competitors who don't face the same pay costs. Higher regional public sector pay also has local inflationary effects that mean it's less attractive for private sector workers to live and work in the regions. Inevitably, the regional private sector businesses close and those who wish to work in the private sector head to London and the South East - or to overseas production centres. Warwick Lightfoot estimates that public sector pay and pensions should be reduced by 2% of GDP nationally - about £30bn or 17% overall. But clearly this needs to take place on a regional or local basis if regional competitiveness is to be restored.

Meanwhile, social security payments put benefits recipients on a par with low income earners. So-called 'working' tax credits are paid to people who work 16 hours a week, but is progressively withdrawn for additional hours worked, so people don't take the perceived risk of working longer hours. Centrally determined tax credits also work harder against regional or local employers. Potential savings in remedying this situation are estimated at £30bn from a social security budget of £195bn (however, spending on older people also needs to be given higher priority, as we have no additional tax-raising capacity to fund our 'pay-as-you-go' liabilities on an ageing population).

So to restore regional - and therefore national - competitiveness, Warwick Lightfoot suggests that public sector remuneration and social security must be reduced in line with local costs and labour market conditions. Shifts towards local rather than national taxation would also enable localised competition.

The last time we were in this mess, in the 70's, public borrowing peaked at 9% of GDP, but none of the factors like high inflation, North Sea oil or public asset sales are there to help us now. My conclusion from Warwick's book is that reducing public sector pay and pensions and social security to working people in line with local pay and cost of living is one of the few options left to us to deliver the cuts needed to boost inward private investment that will power us out of the current malaise and set up a sustainably high standard of living.