The Laffer Curve doesn't depend upon what you think is a fair tax rate

While scribbling elsewhere on Gerard Depardieu and his fleeing of the extortionate tax rates in France it occured to me that there's something rarely mentioned in this whole thing about where the peak of the Laffer Curve is. It's that that peak isn't determined by what you think is a fair rate of tax that they should pay is. Nor what the community in general, or democracy, politicians, think is a fair rate. It's determined by what those who have to pay the tax rate think is a fair rate.

And there's a lot of very interesting economics been done on what people do think is fair: take the ultimatum game for example. Two people, $100. One of them gets to decide how the two will split it. The other one can accept the split or reject it: on rejection neither of them get anything.

The logical policy is to accept any split at all from 1:99 on up. Hey, at least you'll get a whole dollar! But as it turns out people just don't react that way. As soon as the split starts getting worse than $40:$60 the rejection rate goes way up. The conclusion is that we're so tied up, we weird humans, about fairness that we will even punish ourselves in order to punish someone else we think is acting unfairly. There have also been experiments with both monkeys and apes (although with lovely pieces of fruit rather than useless pieces of paper) that lead to the same conclusion. All of us higher primates seem to be wired pretty much the same way: you try and rip me off and I'll take you down with me fella.

I've not seen this point explicitly made anywhere: although I assume that's to do with my lack of reading more than anything else. But if that sense of fairness is hard wired, then obviously it's also going to apply to those we're trying to tax. Which will mean that that peak of the Laffer Curve, that rate at which people bunk off, leave the country, reduce their work loads, lie or cheat the taxman, isn't determined by what we think is a fair rate to tax them. It's a result of what they think is a fair rate to tax them. Which, of course, could be a very different rate indeed from what we think is a fair rate.

Indeed, when we look at the family fortunes and incomes of those who advocate much higher tax rates we do indeed see all sorts of shenanigans going on to avoid those higher rates. The list of wills altered, trusts to hide from inheritance tax, personal service companies, dividend splitting and all the rest: even those who propose those higher taxes rates wriggle as if they think they are unfair when applied to themselves. That revealed preferences thing again: those who face those rates don't think they're fair.

And as I say, adding that unltimatum game into the mix does tell us something very interesting. It's not what we, or the left, think is a fair tax rate that matters. It's what the people paying the tax think is a fair rate that does. And as that game tells us, people start getting very unhappy with anything less than a 40:60 split. To the point where they will indeed give up income themselves in order to punish those offering such a measly share.

Why we don't want to equalise capital gains and income tax rates

This will sound a little odd, for we nromally say around here that we want to remove distortions in the tax system. One obvious such distortion being that capital gains and income are taxed at different rates, leading to everyone who can manage it shifting income over into capital gains. However, we don't want to rush off and try to equalise those rates. The reason being the following:

What we mean by "integrated" here is the combination of the corporation tax and the capital gains tax. A share goes up in value as the company makes more profits. But it's post tax profits that do this, not pre tax. So the higher the corporation tax the less the share price will rise: thus the lower the capital gain that the shareholder will receive.

We should thus look at the interplay of both taxes on the amount that the shareholder receives for putting their money at risk. Which is exactly what this "integrated" rate is. And that's with CGT at the current rate of 28%, not the income tax rate of 45% (the tippy top rate that is). So, if we moved CGT up to the marginal income tax rate then capital gains would be more heavily taxed than income because of that bite already taken by corporation tax. And that's absolutely not what we want to happen at all: for we know that capital taxation has higher deadweight costs than income tax anyway.

There is one way to do it though. If we abolish corporation tax altogether and simply tax dividends and capital gains as the income they are then we will indeed have equal rates for all types of income. Plus, what joys, all the spivs trying to dodge taxes through manipulation of the corporate tax system go out of business. And tens of thousands of our most highly paid lawyers and accountants have to do something productive with their lives.

What's not to like? Abolish corporation tax and then tax all income as income?

Hasn't that Washington Consensus done well?

Twenty and thirty years ago the general consensus was that pretty much nothing was going to help Africa. Sunk in Malthusian destitution as the various countries were, people really just couldn't see any manner in which the place could develop. Then there was this bright idea: hey, what if we told people and governments just to stop doing stupid things?

No, not some grand plan for how to develop, not earnest Fabians planning how the groundnut industry should work. But just, you know, stop doing the things that we know deter economic growth? And so was the Washington Consensus born. It's not actually a prescription, it's a series of rules of thumb. It's not even from Washington: if's from the experiences of various Latin American states. And it really is just a list of stupid things that you shouldn't so. Or perhaps the opposite of those stupid things that many had been doing. Have market determined exchange and interest rates, not purely invented ones. If you're going to have import restrictions make them general tariffs, not licenses or permits. Tax everything just a little bit, not one thing hugely. Public spending should be on those things that it does well: public health and primary school education. Protect property rights, allow foreigners to send their lovely capital in, regulate on environmental or safety grounds but not others. Essentially, just the basic Government Economics 101 stuff.

That consensus isn't anything official but it's just roughly what everyone thought the general advice should be around and about 1989. It gradually got implemented though the 90s in Africa (barring some horrors like Congo and Rwanda). So, what's the general outcome of governments not doing economically stupid things?

Hmm, that's pretty good actually:

As a starting point, Africa's economic growth sped up around 2000, and for the decade from 2000-2010, it was the second-fastest growing region of the world. If one counts a "consuming household" as a household with over $5000 per year in income, the number of African households in this category rose from about 59 million to 90 million over this decade.

In fact, given the deep despondency about even the possibility of development in Africa that's very good.

And it's an important lesson for us too. Indeed, I would argue that it contains the most important economic lesson it's necessary for us in hte rich world to understand, for our own sakes.

Yes, it's entirely possible that there are some bright ideas that government could do to make us wealthier. But much more important for our future wealth is not allowing the government to do the stupid things that will stop us ourselves making ourselves wealthier. And we can go through that list and see people already camapigning to do stupid things: exchange rates, what's the euro is not an invented and fixed rate? On interest rates we've endless fools stating that the government should just print money to "invest" at artificial rates. Capital controls are coming back into vogue: that'll stop the foreigners investing for a start,  as well as give us an artificial exchange rate. Everyone wants to tax the rich hugely, apparently crucial public spending in the UK now includes Newcastle's arts scene. And as Twain pointed out, while the legislature's in session no man's property is safe (there really are calls for the confiscation of second and empty houses for example, the forcible renting of them to social tenants through the local council is another idea out there).

Of course good ideas to make things better should be promoted. But the real battle is to stop them, as we've seen in Africa, doing the stupid things.

Ring-a-ring-a-fences

The Parliamentary Commission on Banking has reported this morning and, like most of the talk leading up to and since the Vickers Report, is pre-occupied by ring fencing.  Vickers, as you will recall, dealt with the demands for separating retail and investment banking by proposing that those banking groups involved in both should have separate subsidiaries for those sectors with no links between them.

Government discussions since then have been seen by some as, under pressure from the bankers, watering down the Vickers proposals.  The Parliamentary Commission, au contraire, claims that Vickers did not go far enough and the fences should be “electrified”, i.e. any infringement would lead immediately to full separation.  Sir John Vickers himself, in an email to the Today programme, quickly responded by saying that full separation would be an own goal.

What is weird about all this is that the financial crisis had little if anything to do with the lack of such separation.  Retail banks, like Northern Rock, and building societies created a bubble of huge unrepayable debts and, quite separately, banks packaged up those “assets” to conceal their true nature and then played pass the parcel with the packages.  Lehman Brothers was purely an investment bank.  The entities that created the crash were already separated and separating the other groups would do nothing to prevent a future crash.

What is even weirder is the failure to recognise that banking today is an international, if not fully global, market.  Financial solutions have to be found internationally.  The Basel group are doing their best to achieve that and we now have three “Accords”. They focus, quite sensibly, on ensuring banks are adequately capitalised for the businesses they run.  One can, and I have, criticised their proposals as an over-reaction which will penalise small businesses, but the point here is that the rest of world’s top regulators are not worrying at all about ring-fences.

Another part of the international dimension which the Parliamentary Commission fails to recognise is the EU involvement.  Uncertainty about that undoubtedly contributed to the Northern Rock crash as Professor Tim Congden and others, including Sir Mervyn King, have pointed out.  The UK is in course of handing financial regulation over to Brussels but what is for us to do and what for Brussels is unclear.  The only thing that is clear is that the EU’s interventions will damage the competitiveness of UK banks and increase the costs for taxpayers.

So, not unusually, British chattering classes are dancing around playing ring-a-ring-a-ring-fence when the rest of the world gets on with regulating the real financial market.  It is truly astonishing that this Commission should choose to focus its entire attention on the area that matters least.  The consequence of adopting their suggestions, as Vickers himself seems to be pointing out, can only be that we will hobble our own financial sector at great cost to the economy and the British taxpayer.

But, but, people invest in order to get their profits back in their own pockets!

The US has a high corporation tax rate. The US also doesn't charge that tax to profits made outside the US and kept outside the US. Therefore, obviously, US corporations keep the profits they make outside the US outside the US. You know, that first great secret of economics, incentives matter?

Back a few years a temporary solution was suggestedL bring back the profits and we'll charge you only a teensie rate: many did. Again, incentives matter. Now there's vast mountains of money sitting offshore and perhaps that low tax trick might be tried again. Mebbe: but a common argument against it is the following:

ABSTRACT: This paper analyzes the impact of the Homeland Investment Act of 2004, which provided a one-time tax holiday for the repatriation of foreign earnings and thereby reduced the cost to U.S. multinationals of accessing a source of internal capital. Lawmakers and lobbyists justified its passage by arguing that it would alleviate financial constraints. This paper’s results indicate that repatriations did not lead to an increase in domestic investment, domestic employment or R&D—even for the firms that appeared to be financially constrained or lobbied for the holiday. Instead, estimates indicate that a $1 increase in repatriations was associated with a $0.60-$0.92 increase in payouts to shareholders—despite regulations stating that such expenditures were not a permitted use of repatriations qualifying for the tax holiday. The results indicate that U.S. multinationals were not financially constrained and were reasonably well-governed. The fungibility of money appears to have undermined the effectiveness of the regulations.

Note that this is used as an argument against the tax holiday, not in favour of it. when obviously it's an argument in favour of it.

The basic error is to think that investment is something only done by companies with the money that they have internally: thus the shock at the idea that shareholders might get some of their own money back. When in fact, all the really important investment in hte economy is actually done by individuals in new businesses: not by old ones ploughing back in their profits.

No, obviously, the amount of new investment is very much smaller than the amount of reinvestment. But that's not what I mean. The things that really change economies, that bring in the new disruptive technologies, are the entry and exit from the marketplace of firms. Which by definition means the creation of new firms able to do the entering (and exit of those going bust of course). And who are the people most likely to invest in a business from the outside? Clearly, those who have already shown that they will do so by virtue of the fact that they hold equity in a business or two.

At present there's some vast amount of money offshore in those corporations. $1.2 trillion, $1.7, estimates vary. Assuming that it is a good idea that this money leaves the Bahamas or wherever and gets injected into the US economy (which I think it probably is) then this argument about dividends is piffle. The very fact that it is likely to be paid out in dividends is the very reason why it's a good idea. For putting it into the hands of investors increases the chances that it will be invested in new businesses: the long run lifeblood of economic growth.

Note to the TUC: Your own opinions? Fine: but you're not allowed your own facts

Now we all know that the past 30 years has been the triumph of neoliberlaism, where we who own capital get to trample the faces of the workers into the dust. Stealing the bread from the mouths of children and cackling gleefully as we do so. Something which the TUC would like to bring to our attention in this report. Where they use this little chart.

Which is interesting, don't you think? The profit share has risen, the wage share fallen, QED, we're screwing the workers.

Except, except, those numbers don't actually look right to me. For this is something that has been looked at repeatedly in recent months. Here's a different attempt at protraying the same information:

As you can see, the decline in the labour share is the same. But instead of a rise in the profit share being the cause we've a rise in mixed income (essentially, the self-employed and as there's more of them why not) and a rise in taxes minus subsidies: that's largely I believe the rise in VAT over the time period.

It's actually quite important for us to work this out of course. If the labour share has fallen because us capitalists are stealing it all then that's one thing. Perhaps Hurrah! and perhaps Boo! depending which side you see yourself on. If it's simply a result of a rise in self-employment then it doesn't really matter either way. And if it's as a result of a rise in taxes well, the prescription will obviously be to lower taxes. So we'd really rather like to know which of these two sets of numbers is correct.

There's definitely something hinky going on between the two sets of numbers. Both do sum to 100, as they must. My problem is that the TUC's numbers just refer to "ONS figures from the Blue Book" while the second set actually tell us which specific figures are being used (The relevant series used here are CGBZ, DTWM, CGBX, CMVL and YBHA.). And I'm afraid I'm not enough of an economist (nor statistician) to work out what hinkiness is being perpetrated here.

So I throw it open to you: what is it that the TUC has done to give us this decidedly non-standard view of how income shares have changed over the decades?

A libertarian defence of 'social justice'

The economics of Christmas

George Monbiot has cannily saved himself a few quid by flagging up his intention to scrimp on Christmas presents this year. Conveniently dropping the narrative of Austerity Britain for a moment, Monbiot has gone back to his ‘Bring on the Recession’ phase, complaining that since our “every conceivable want and need has been met” we shouldn’t waste our money buying our nearest and dearest Terry the Swearing Turtle for Christmas. “Bake them a cake,” he suggests, “write them a poem, give them a kiss, tell them a joke, but for God's sake stop trashing the planet to tell someone you care.”

So it’s a satsuma in a stocking for poor Mrs Monbiot and all the little Monbiots, as they gather environmentally sustainable winter fuel for their socialist household. But perhaps the anti-consumerism miserablists have a point. Christmas is a time when resources are misallocated and unwanted tat is exchanged. According to one study, the average recipient values their gifts at ten per cent less than their market price. That may be an underestimate. Of the roughly £8.5 billion spent on yuletide gifts in Britain last year, £2.4 billion’s worth—more than a quarter—were unwanted.

In strict economic terms, the most efficient gift is cold, hard cash, but exchanging equivalent sums of money lacks festive spirit and so people take their chance on the high street. This is where the market fails. Buyers have sub-optimal information about your wants and less incentive than you to maximise utility. They cannot always be sure that you do not already have the gift they have in mind, nor do they know if someone else is planning to give you the same thing. And since the joy is in the giving, they might be more interested in eliciting a fleeting sense of amusement when the present is opened than in providing lasting satisfaction. This is where Billy Bass comes in.

But note the reason for this inefficient spending. Resources are misallocated because one person has to decide what someone else wants without having the knowledge or incentive to spend as carefully as they would if buying for themselves. The market failure of Christmas is therefore an example of what happens when other people spend money on our behalf. The best person to buy things for you is you. Your friends and family might make a decent stab at it. Distant bureaucrats who have never met us - and who are spending other people’s money - perhaps can’t.

So when you open your presents next week and find yourself with another garish tie or an awful bottle of perfume, consider this: If your loved ones don’t know you well enough to make spending choices for you, what chance does the government have?

The Benefit-Industrial Complex

Anyone following the progress of the government's “Universal Credit” welfare reform program will know that (1) its signature provision is the creation of the so-called Benefit Cap limiting the amount of benefits that any one person or family can claim in a given week to £350 or £500, respectively.

Lesser known is (2) that “under Universal Credit, the default position will be that all housing costs for both social and private sector tenants” – currently paid out as a single, discrete benefit but soon to be subsumed within the benefit cap – are to be paid directly to claimants, whereas previously it was paid directly to claimants' landlords.

That the second of these proposals should be controversial is a little surprising, considering the fact that paying one's rent is the sort of thing most people will do for a substantial majority of their working lives. So I was puzzled to see Mark Easton, BBC News' Home Editor, excoriating the government, and accusing it of being “secretive*... on a matter that affects the lives of hundreds of thousands of the most vulnerable people in Britain”: the proposal to, in his words, “force social housing tenants to pay their own rent”.

Easton's objections followed three lines. First, he argued, social landlords' business plans rely on suffering only 2% aggregate arrears; such plans would be thrown into disarray if Housing Benefit claimants are given responsibility for managing their own affairs (which, he argues, would increase monthly arrears to as much as 30%). Second, he continued, existing social tenants have “little or no experience of monthly budgets,” get their benefit in cash weekly, and therefore are not predisposed to – or capable of – managing their own finances. Finally, he concluded, many have not chosen to access banking facilities or do not have regular access to the internet, both of which are necessary to use the new Universal Credit regime.

The capacity argument has been invoked frequently in relation to the Universal Credit – Shelter, for example, made representation during the public consultations preceding the 24 November Report of Session on Universal Credit that there is “considerable apprehension as to how many social tenants will manage their incomes”.

This argument is probably honestly made out of concern for humanity and backed by evidence. That it also makes it morally appropriate to burden the taxpayer for the market risk of landlords in the Housing Benefit tenant market arising from failure on the part of welfare beneficiaries to manage their finances is another question, especially when we consider the practical character of the libertarian reply.

Human beings have paid rent with reassuring frequency for millennia and statutory frameworks have regulated these payments since 1772 – 1772 B.C.E., that is (cf: the Code of Hammurabi, sections 50 and 51). Furthermore, the internet access required by Universal Credit is available free of charge at public libraries and for a small fee on mobile phones and at internet cafes around the country. The internet is used daily by billions of people of all ages, creeds and nations, and with highly variable degrees of intelligence. It is no stretch to say that able-bodied adult British claimaints of sound mind should be able to combine these two competencies and pay their bills.

Politically, Easton's concern for social landlords and their businesses is more interesting. Trials of the beneficiary-pays system have shown that the increase in arrears has made letting to DWP tenants uneconomic, and the reform means that private sector landlords “will pull out” of the benefit claimant housing market (at page 93) – a problem amplified from the perspective of local authorities who are duty-bound to find housing for these persons and “increasingly... have to advise people to look for housing in the private sector.”

What is left unsaid by Easton is the scale of the private sector's involvement in welfare provision relating to housing. It is vast. In Northern Ireland alone, the Select Committee's report notes, “we think ['think?'] there are 60,000 private landlords who currently receive payment of Housing Benefit direct – about £250,000,000 a year” – £4,100 per landlord, or £148.00 for every man, woman and child in Northern Ireland. While I do not have exact figures to hand, if this were extrapolated on a per-capita basis nationally, the level of private sector benefit realised would rise to nearly £10 billion – roughly 45% of the total Housing Benefit bill, and nearly 1% of GDP, roughly equal in heft to the 2012 Olympic Games.

Viewed thus Housing Benefit is less a welfare program than a national industry, operating on the scale of value-added giants like automobile manufacturing (£54bn) or defence (£45bn) and capable of distorting the market to the detriment of the working taxpayer. As a component of income allocated towards housing, Housing Benefit has long outstripped private wages. As a subsidy it disrupts the supply of property for private renters, providing what is in effect a national minimum rent while driving up rents for non-beneficiaries in the process, thus striking the propertyless taxpayer from three directions.

And as a safety net it fails too – while senior editors of the BBC and Labour MPs invoke in the system's defence the inability of its beneficiaries to demonstrate the financial acumen of a Bronze Age Babylonian tenant farmer, the Commons Work and Pensions Committee report on the subject states, matter-of-factly, that “many benefit claimants will never be able to take up or return to work.” When the question of whether Britain can continue to afford its welfare state is an open one, this is clearly the wrong approach.

Quite irrespective of the relative merits of welfare provision, the existing system is ripe for reform. The government's efforts to date are a welcome first step.

*  So secret, in fact, that his article was published a full two days (24 November) after a report published by the House of Commons Work and Pensions Committee on the subject (22 November), and after months of public consultations with interested parties. But I digress.

The Benefit-Industrial Complex

Housing benefit is a national industry, says Preston Byrne. In this article he argues that it sustains a national minimum rent and drives up rental costs for everyone.

Anyone following the progress of the government's “Universal Credit” welfare reform program will know that (1) its signature provision is the creation of the so-called Benefit Cap limiting the amount of benefits that any one person or family can claim in a given week to £350 or £500, respectively.

Lesser known is (2) that “under Universal Credit, the default position will be that all housing costs for both social and private sector tenants” – currently paid out as a single, discrete benefit but soon to be subsumed within the benefit cap – are to be paid directly to claimants, whereas previously it was paid directly to claimants' landlords.

That the second of these proposals should be controversial is a little surprising, considering the fact that paying one's rent is the sort of thing most people will do for a substantial majority of their working lives. So I was puzzled to see Mark Easton, BBC News' Home Editor, excoriating the government, and accusing it of being “secretive*... on a matter that affects the lives of hundreds of thousands of the most vulnerable people in Britain”: the proposal to, in his words, “force social housing tenants to pay their own rent”.

Read this article.