Don’t kill off the only industry that provides loans for low-earners

Wonga’s decision to write off £220m worth of debt for 330,000 customers and “voluntarily” embrace new regulations will been seen by many as a form of social justice and an obvious defeat for the big, bad, payday-lending wolf.

Unfortunately, the Financial Conduct Authority’s attempt to further regulate the payday lending sector may end up harming low-income earners in need of a loan.

But first, we must distinguish between the payday lending industry and Wonga as a specific organization within that industry. Payday lenders offer customers quick and easy access to short-term cash flow. Though anyone with any income size could apply to Wonga for a loan, it is mostly used by people with low-incomes, as such earners struggle to get bank loans and credit cards, and payday loans are often cheaper than using an unauthorized overdraft.

Of course, there are risks associated with payday lending, as “companies are loaning to high-risk demographics, with usually low-income averages and bad credit scores.”* In order to stay profitable and protect themselves from bankruptcy, payday lending companies must factor defaults into their interest rates.

These interest rates –especially Wonga’s interest rates – tend to be the target of myths constructed by opponents of payday lending, who are either accidentally or intentionally analyzing the data badly. Most notably, critics attack Wonga for charging its customers close to an astronomical 6,000% interest rate.

That figure, however, comes from a legal quirk in British financial regulations that requires every business to express their interest rates as an annual rate. Wonga’s payday loan interest payments are capped at sixty days, so there is no scenario where anyone could come close to paying Wonga nearly 6,000% APR, as the company is forced to express as it’s annual rate.

Some of the criticisms leveled specifically at Wonga do have merit – indeed, their fake legal letter scandal from this past summer – which threatened customers with legal action if loans weren’t repaid – left everyone feeling uncomfortable with the industry.

Such behavior from any company is unethical, to say the least, and should be met with repercussions. But the FCA’s decision to crackdown on all payday lenders as a result of Wonga’s actions will drive almost all payday lenders out of business and leave Wonga to dominate the industry.

From today it has introduced new lending criteria to improve its decisions. That means it will be lending to fewer people and it is unlikely to be the only firm forced to do that, as the FCA said today: “This should put the rest of the industry on notice.

This new lending criteria, coupled with previous regulation tightening – bans on payday advertising in public spaces – and future proposed regulations – like a mandatory cap on costs for all short-term loans – reduces the entire industry’s profitability and forces smaller companies, that would otherwise compete with Wonga, out of the market.

Furthermore, other indirect financial regulations continue to ensure Wonga’s dominance in the loan market. Credit unions could become competitive payday lenders and compete with companies like Wonga, but their interest cap of 3% a month prevents them from properly competing in the market.

Yes, Wonga is facing a 53% fall in annual profits partly as a result of new controls set by the FCA, but other payday lender companies, that don’t have the ethically questionable history of Wonga, are looking to be cut out of the market all together.

Critics of payday loans will be overjoyed to hear that the payday lending industry is on the rocks, but those who actually use its services and benefit from the loans should be worried. Banks and credit card companies have priced these customers out of accessing loans, and with with less payday lenders offering their services to people with low incomes, a lot of people will find themselves with no options, no loan, and no way to pay rent.

While payday lenders are by no means the perfect system to deliver loans to low-income customers, they are currently the only realistic way for such people to get their hands on necessary loans.

*This gal.

UKIP is on the right track to beat low pay

Certain policies proposed by UKIP this morning remind us how far away the party platform is from a classically liberal agenda.

However.

In the kick-off to their party conference, UKIP has also announced that its general election manifesto will raise the personal allowance threshold by £3,500 pounds:

At its party conference, which has begun, UKIP will also promise to raise to £13,500 the amount people can earn before paying any income tax.

In a plan to win the “blue-collar vote”, Nigel Farage’s party will pledge to fund the changes by leaving the EU and cutting UK foreign aid by 85%.”

(At present, the) 40p rate is payable on income from £41,866 to £150,000, with the “additional rate” of 45% paid on anything over £150,000.

“Under UKIP’s plans, everyone earning between about £44,000 and £55,000 would pay income tax at 35p. Those earning more will pay 40p, with the additional rate scrapped. “

Despite other policy failings, UKIP’s commitment to raising personal allowance surpasses the coalition’s and should be heavily applauded.

This is the first policy of ‘party conference season’ that properly addresses the root of the cost-of-living crisis and provides a simple, effective solution to relieve the tax burden on low-income earners.

For years, the Adam Smith Institute has illustrated the pointlessness in taxing workers out of a living wage, to then compensate their low income with government handouts and benefits. The Labour party’s recent pledge to raise the minimum wage to £8 an hour threatens to put more young, unskilled workers out of jobs, while still taking away a substantial potion of income from anyone who happens to benefit from the small pay raise.

A hike in minimum wage is a symbolic gesture at best, that continues to tax away – or destroy – low-earner incomes. A raise in the personal allowance threshold, however, gets more money into the pockets of those earners, creating no dangerous side effects in the jobs market.

With both the Liberal-Democrat and Conservative Party Conferences ahead of us, we can only hope both party leaders will continue to embrace an increase in personal allowance and match UKIP’s threshold; or maybe even one-up them. (National Insurance cuts, anyone?)

Sometimes it’s the little things that matter in tax systems

A little story that helps to explain why the Greek economy is in the depths that it is:

But as happens so often in Greece, the bureaucrats had other plans. In a country where you are viewed favorably when you spend money but are considered a criminal when you make it, starting a business is a nightmare. The demands are outrageous, and include a requirement that the business pay taxes in advance equal to 50 percent of estimated profit in the first two years. And the taxes are collected even if the business suffers a loss.

I recall something similar from time in California: you must put up a bond for the amount of sales tax that you will be collecting in the future. Plus a fee for the privilege of opening a business in that great state.

This just isn’t a sensible manner in which to be running a tax system. Yes, of course, tax must be collected for there are things that we really do need government to do (even if not as many as they attempt to do). And it’s probably a good idea to have certain measures in the tax law to make sure that people don’t dodge said righteously due taxes. But to add to the capital requirements for starting a business in this manner is simply ludicrous. It’s a difficult enough, and expensive enough, enterprise at the best of times. Rather better, therefore, to leave the possibility of avoidance there in the process of leaving some room for a business to even start.

Our own dear HMRC seems to have cottoned on to this point: it’s no secret at all that many new firms bolster working capital by delaying PAYE tax payments to the Treasury. It’s not exactly desirable in the scheme of things but when looked at in the round better that such companies survive their growth pangs than that HMG gets its money on the nail.

Of course we should have a more progressive tax system

The Guardian is getting very het up about the fact that we don’t seem to have a very progressive tax system:

These last two charts suggest that while redistribution of income does happen, it’s mainly due to receipt of benefits by the poor instead of progressive taxation.

There’s a reason why we don’t have a more progressive system too. Which is that there’s a limit to how much you can tax incomes and capital returns before you manage to completely cease all economic growth (or, in the extreme, all economic activity). Which means that if you then still want to stuff ever more gelt and pilf into the maw of the State then you’ve got to tax consumption, sins and other things, those consumption taxes inevitably being regressive taxes.

And we’re around and about at those limits of income and capital taxation. The Treasury certainly believes we are: they’ve said that income tax at 45% (plus employers’ NI etc) is the peak of the Laffer Curve, capital gains tax at 28% is similarly at that peak.

At which point we find that we thoroughly agree with The Guardian: we too believe that the UK tax system should be made more progressive. And given that we cannot increase taxes on incomes any further and that consumption taxes are regressive, this means that the only way to do so is to reduce the income taxes on the poor. So, as we’ve said around here before, the personal allowance for both income tax and NI (yes, employees’ and employers’) should be raised to, at the very minimum, the equivalent of the full time full year minimum wage. Or around £12,500 at present.

This would make The Guardian happy as it would make the tax system more progressive. It would also mean having to shrink the size of the State which would make us doubly happy. What’s not to like?

Well of course we should reform inheritance tax

Another report into inheritance tax and another observation that it doesn’t actually do what it says upon the tin:

People with estates worth many millions are able to avoid the brunt of inheritance tax through complex schemes, including moving the cash offshore or investing in agricultural land and small business shares. Those avenues are closed to “moderately well–off” people whose only assets are their home and pension, Mr Johnson said.

It’s just about possible to see that the great plutocratic fortunes should be broken up every generation or so to prevent the fossilisation of society: if that’s something you tend to worry about which we don’t very much. But to have a taxation system which attempts to do this and then doesn’t is obviously entirely dysfunctional.

Our current system manages to tax the small capital of the bourgeois while leaving those plutocrats untouched. We therefore really rather do want to change that taxation system.

This is not, I hasten to add, the official ASI line here, rather being a personal musing. But I take it as a given that we don’t actually want to tax the petit and haute bourgeois accumulations of capital. Far from it, we’d much prefer to see modest estates cascade down the generations. For reasonable amounts do provide freedom and liberty. In that currently fashionable phrase, enough to do anything but not enough to do nothing. It’s also, even if you do worry about the plutocrats, not how much money is left that is the problem but how much money is received. Someone leaving a few billions to be spread among thousands is very different from a few hundreds of millions being left to just one.

So I would muse that we might want to move to a system something like the following. It is the receipt of an inheritance which is taxable, not the leaving of one. Further, there’s a substantial lifetime exemption from having to pay tax on receiving one or many. Several millions perhaps: that need to still do something amount.

Alternatively, of course, we could just move the entire taxation system over to being a consumption tax. In that manner we don’t actually mind who has what amount of capital nor where it came from. We just tax people when they spend with the capital or the income from it. and given that that’s the general trhust of the Mirrlees Report there’s good academic backing for the plan.