Flat tax would be fairer

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Readers may already have seen coverage of The Effects of Taxes and Benefits on Household Income 2007/8, which was published by the Office of National Statistics earlier this week. Allister Heath wrote about it in City AM here, and Charlie Elphicke has done a briefing on it for the CPS here. The headline-making findings are that the poorest quintile of households pay a greater percentage of their gross income in tax than the richest (38.7% compared with 34.9%), and that their share of the total tax take has risen from 6.8% in 1996/7 to 7% in 2007/8 – despite an allegedly redistributive government being in power during that period. This is mostly down to rising indirect and stealth taxes, which tend to hit the poorest hardest. See the chart below for details:

Direct taxes Indirect taxes Total taxes Poorest 10.8% 27.9% 38.7% 2nd 14.1% 18.6% 32.7% 3rd 18.6% 15.9% 34.6% 4th 21.8% 13.7% 35.4% Richest 24.9% 10% 34.9%

No doubt these figures will lead some to conclude that the tax system needs to be made more progressive, and that the rich need to be stung with punitive higher-rate taxes to make the tax system 'fairer'. However, this would be completely the wrong approach. We already have a 'progressive' tax system, and yet it appears to achieve the opposite of what is intended. By contrast, replacing our current income tax, employees' national insurance contributions and council tax with a flat tax and a high personal allowance would make things much fairer. The figures below assume a tax-free personal allowance of £12,000, with all income above that taxed at 30%:

Direct taxes Indirect taxes Total taxes Poorest 0% 27.9% 27.9% 2nd 0.01% 18.6% 18.6% 3rd 15% 15.9% 30.9% 4th 20.7% 13.7% 34.4% Richest 25% 10% 35%

Now, I'm not saying that this is the ideal allowance/tax rate – I'm using simply using £12,000 and 30% to illustrate that a flat tax could leave the richest quintile paying the same percentage of their total income in tax, while greatly reducing the burden on lower-earners. Plainly, the UK's indirect tax burden would still leave the poorest quintile paying more tax than they should, but this would largely be addressed by existing cash benefits.  As it happens, the ONS statistics say some interesting things about benefits too, but that's a story for another day. You can download the complete set of ONS figures and tables here.

And now for something completely different

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The Austrians saw it coming

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In Thursday's Telegraph, Edmund Conway has a bash at the economics profession: "everyone is suffering" from the recession, he says, but "no one really foresaw precisely how this crisis would pan out."

The international financial system is a complicated beast, with countless actors, complex causal relationships, and multiple external influences and so, as he himself recognises, to make exact predictions would be "akin to providing an accurate weather forecast for every week of the following year." Nevertheless, despite his claims, there were those who did a pretty good job.

Peter Schiff, for example, not only predicted the housing crash in 2006:

Today's home prices are completely unsustainable… What's going to happen in 2007 is that… these sky-high real estate prices are going to come crashing back to earth.

But also the knock-on effects for the financial sector in 2007:

It's not just sub-prime… This is going to be an enormous credit crunch… The fundamentals are not sound… The worst is yet to come. Stay away from the financials – they're toxic.

And for the wider economy in 2008:

By November it'll be obvious that we're in a pretty big recession… it's not going to be months, it's going to be years.

Although in the minority, he was not alone. Economists across the world voiced similar concerns, but were ignored until too late. Almost all of them had one thing in common: they were followers of the Austrian Tradition, and inheritors of the ideas of F. A. Hayek.

Conway's criticisms don't properly apply to the profession as a whole, but rather to the prevailing economic orthodoxy, made up of those in comfy government posts and university seats, who happily sat back believing that there would be "no return to boom and bust" as the government blew up the housing bubble with easy credit.

Still, there's a really interesting point here: the crisis has damaged the reputation of economics, but at the same time thrown it open to new ideas and the return of old ones. Ideas that lie on the periphery of the discipline can now move to the troubled centre. We can, in Conway's words, "exhume once-sacrilegious figures such as John Maynard Keynes or Friedrich Hayek." Given the Austrian School's performance in predicting the current crisis, may I suggest we choose the latter?

What has become of the country of free Englishmen?

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Coming from a country haunted for decades by its totalitarian past, and being born at dawn on May 1st 1945, only a few hours after Hitler killed himself with a shot in his mouth, I have always had qualms with people telling me that Britain has become a police state. Even more so because I was so grateful for the sacrifice the British people made for my freedom, and because I eventually emigrated to this country. However, having experienced what happens if you cut yourself off from the number one state propaganda outlet, you get the impression those people are right. I dared to cancel my TV Licence in March this year because I was so bored, and because I get all I want from the internet anyway. Since then I keep getting scary letters from the TV Licensing Enforcement Division. Each of these letters assumes that I keep watching TV – they just don’t get it that there are people out there who think the value for money offered by the license fee is poor. Importantly, the letter indicates that equipment liable to pay the licence fee includes computers and mobile phones. Under the headline “Official Warning", suggestive of state action, the letter I received today went on: Our Enforcement Officers have now been authorized to visit your address in Gloucester Place. This is because we have no record of a TV Licence at Your address and you haven’t responded to previous letters. Indeed, I took the liberty not to bother with their previous letters and threw them away. The question emerges here: Does the state monopoly of the BBC really encompass all digital information gadgets such as mobile phones, blackberries and laptops? Thinking it through, surely that would mean they would be entitled to collect the licence fee worldwide from anyone who watches BBC broadcasts anywhere?

Towards legalisation?

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A report launched on Thursday by the UK Drug Policy Commission urges drug enforcement agencies to target the most harmful dealers, areas and activities, rather than simply aiming to reduce total supply.

The report must be praised for recognising the central flaw in the current drugs strategy – that “more enforcement generally does not lead to less availability because established drug markets are too resilient and adaptable." As long as demand exists, suppliers will find a way to get drugs to customers.

Crucially, the report also recognises that much of the harm associated with drugs is caused by the activities of suppliers – gang warfare, sexual exploitation, targeting of children, and dangerously impure drugs. Quite obviously, it is only because of the illegality of drugs that their supply is characterised by such criminal behaviour.

These insights are useful, but the report’s recommendations do not go far enough. Targeting the most harmful activities of drug criminals may alleviate the damage, but it will not solve the problem. Only by recognising that this is a war we cannot win, and by removing the drugs trade from the hands of gangsters can we really make a difference. Regulated legalisation is the best solution.

And as Tom pointed out in his post of yesterday, legalisation would also save a lot of money. Even allowing for the societal cost of heroin and crack use (potentially) doubling, the total saving would be at least £5bn.

More economic illiteracy

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In yet another startlingly display of the government’s economic illiteracy, Yvette Cooper has announced plans to dish out £1bn to 'create' jobs for 47,000 unemployed.

She would do well to ask herself one simple question: 'where will the money come from?' Of course, the answer is the taxpayer, either now or in years to come. The billion pounds that Cooper gives away will be taken from the pocket of the consumer and the tills of business. Consumers will spend less, and businesses will take on less staff – creating jobs in the public sector will inevitably destroy jobs in the private sector.

In reality, Cooper must have asked herself this question, and she (or at least her advisers) must know full well that there can be no sustained gain in employment from this scheme. Rather, they have their eyes on a political prize. The fabricated jobs are concentrated and obvious: photos of the newly-employed will find their way into government press releases and election manifestos, while the invisible losers, as many and as serious, will be left ignored.

Then there are the jobs themselves. These are positions that were deemed unnecessary even in the most prosperous (and profligate) years of the last decade, and yet it is now, when the country faces the greatest fiscal crisis of a generation, that the government decides that our money is well spent on dance assistants and tourism ambassadors. In the private sector, workers generate wealth, or they lose their job: in the public sector, there is no such discipline.

Having seen the government splash out more than a trillion pounds of our money to save the bankers, and collectively bearing a public debt of more than two trillion, it is all too easy to dismiss a billion as irrelevant. But we shouldn't - it's enough to pay MPs' expenses for a decade, exempt Dorset from income tax, or send a cheque for forty quid to every household in Britain.  This money should be given back to private individuals and private firms, who alone have the potential to bring about the economic growth that will get us out of this recession, and bring the unemployed back to work.

The cost-effectiveness of prohibition

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Back in April, the Transform Drug Policy Foundation published a paper comparing the cost effectiveness of the prohibition and the regulated legalization of drugs. I've only just got around to reading it, but I can confirm that it is an excellent piece of work.

The report finds that the total cost of prohibition of heroin and cocaine (the calculations focus solely on these two 'hard' drugs, since this is where the most extensive data is available) is £16.8bn per annum.

The benefits of prohibition depend on the extent to which prohibition decreases heroin and cocaine use – something for which there are no authoritative figures – and therefore reduces its health, social and economic costs. Depending on your assumptions here (the paper details four different scenarios), the estimated 'benefits' of prohibition range from £618m to –£309m.

This means that the total net cost of prohibition is somewhere between £16.2bn and £17.1bn.

The authors go on to compare this with a regulated legalization model under which heroin and cocaine would be freely available to buy from licensed pharmacies, with 10 percent of users (those with the most serious addiction problems) receiving diamorphine and cocaine by medical prescription. Depending on whether you assume that opiate and crack cocaine use would (a) go down by 50 percent, (b) stay the same, (c) go up by 50 percent, or (d) go up by 100 percent, the net cost of legalized heroin and cocaine under this model would be £3.2bn, £6bn, £8.8bn, or £11.6bn.

To put it another way, if opiate and crack use fell by 50 percent, we would save £14bn. If it didn't change, we would save £11bn. If it rose by 50 percent, we would save £8bn. And even if opiate and crack use doubled, we would still save £5bn, according to the authors' calculations. It is worth noting that this does not include any potential tax revenue that would be generated by drug legalization – something the authors believe would be small anyway, since drugs would be so much cheaper if the 'illegality premium' were removed.

This research deserves to be taken seriously. It's high time we had a mature and rational debate about drug legalization in the UK.

For more on the problems with prohition, I'd highly recommend the IEA's Prohibitions, edited by John Meadowcroft. The picture above is from the NORML Foundation.

Directionless banking policy

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"Pathetic." "Ridiculous." "Stage-managed." Utterly fake." "Desperate." "Absurd." "Utterly inconsistent." "Hypocrisy." "Disgraceful muddle."

Those are a few of the phrases Alistair Heath used to describe the government's banking policy in an excellent City AM editorial yesterday. He's right not to pull any punches: the Chancellor's demand that the major UK banks increase their lending really doesn't make a lot of sense, other than as a media stunt.

As Heath says, do we really want the banks to lend at the same levels they did in 2006-7, at the height of what is now recognised as a completely unsustainable boom? Surely it's a good thing that banks like Northern Rock are "no longer growing at a crazy rate by imprudently borrowing on the money markets"? 

Moreover, it's not just that the supply of credit has fallen, in part because "many foreign banks (such as the Icelandic lenders) have quit Britain". Demand has fallen too – a point made in our recent book, The Recession. As Heath points out, there's still plenty of mortgage credit available, it's just that people have finally developed more realistic attitudes towards investing in property (i.e. prices don't just go up). And that's a good thing.

The trouble is, ultimately, that the government doesn't know what it is doing. They can't decide whether stabilizing the banks is the priority, or whether more debt is needed to 'stimulate' the economy. So they attempt to require the banks both to sort out their balance sheets and hold more capital, and try to get them to lend more at the same time. In their desperation to paint the Tories as a "do nothing party", the government is running around doing anything and everything it can think of, without a rational set of guiding principles.

This kind of incoherent policymaking is not just ineffective, but actually damaging. Businesses and consumers don't know what to expect next, and economic activity slows as a result. What markets need desperately if they are to recover is stability. Sadly, this government seems singularly incapable of providing it.

Subsidizing housing

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Property developers will be pleased by Housing Minister John Healey’s announcement that 270 developments have been shortlisted for government assistance totalling £925m. £419m of this takes the form of five-year loans (presumably at lower rates than offered by the commercial banks), while £339m will go towards affordable housing, and £166m be given as direct grants to developers.

Healey’s declared aim is to “help build the homes the country needs." One would think that a shortage of homes would sort itself out – that demand would push up prices, and developers would be able to make a profit on constructing new homes. On these 270 projects at least, that doesn’t seem to be true: since the housing slump, the projects need government help to make them viable. At more than £40,000 per home (22,400 are to be constructed), the scheme is an expensive way of building homes that cost more to build than people want to pay for them.

Perhaps the logic is that we need to provide more affordable housing (although only a third of the proposed homes fall into this category). But if that really is the idea, then surely the best way is not to subsidise loss-making developments, but to give grants to consumers who could not otherwise afford homes. Rather than a Soviet-style central government department determining where and how homes should be built, it should be left to the decisions of consumers and developers operating in a free marketplace – it is they who know best.

Healey boasts that the scheme will “create 20,000 jobs on housebuilding sites", ignoring the fact that government funding for these jobs must found from somewhere. It is perhaps the only merit of the plan that it is to be funded from cuts elsewhere, but nevertheless the money given to house-builders must eventually come from the taxpayer, either now or in the future. The scheme will not create jobs – it will take wealth from the productive areas of the economy, to subsidise the unproductive activities of private builders.

Now, it is true that in the long term we face a shortage in housing supply – the rate of building new homes just isn’t keeping up with the demand generated by a growing population and dividing households. But government handouts (and generous loans) are resolutely not the answer. Rather, if government is serious about tackling the housing shortage, it must address the heart of the problem: the stifling and illogical planning laws and politicisation of the planning process that hold back developers from pursuing really beneficial projects.

A safe pair of hands?

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News that Sir Win Bischoff, formerly chairman of Citigroup, is taking over as chairman of Lloyds Banking Group does not exactly inspire confidence. After all, Citigroup needed a massive bailout from the US government in November 2008, receiving $45bn under the TARP scheme and receiving government guarantees on another $306bn of assets. Those figures exceed even those of AIG – the posterboy for mismanagement and incompetence on Wall Street. So clearly Sir Win is just the man to run Britain's biggest and (arguably) most troubled bank...

I'd prefer we adopted the approach advocated by Tim Ambler and Keith Boyfield in our recent publication, Regulatory Myopia: "If any financial company is rescued by the government, the directors should be treated as for bankruptcy: i.e. they should be disqualified with pro rata loss of bonuses and pension rights". The City's current failure-free merry-go-round just gives capitalism a bad name.