Soft drinks tax slippery slope

With reports of 1,200 unnecessary deaths in a single NHS trust – some in the most cruel and inhumane circumstances – you might think that the clinicians trades unions might be keeping their heads down. But no. The umbrella organisation for medial practitioner groups is now calling for a tax on fizzy drinks. To combat obesity, they say.

To micro-manage our lives, more like. The average person gets about 2% of their calories from fizzy drinks, so even if a tax did make people drink less, it would have no noticeable effect on the weight of the nation.

Sure, some people drink a lot more sugary stuff. Will a tax dissuade them? International studies show that to make a measurable difference, the tax would have to be very large. People have strong favourites when it comes to food and drink, and they don't switch easily. A small tax would change nothing, and would just be a stealth tax. A large tax, the international studies show, simply prompts people to switch to other sugary drinks that are not taxed.

There are of course already non-sugary and low-calorie drinks on the shelves. If people don't buy them, that is their choice. Better labelling and better education might help people make more informed decisions, but we should not be trying to micro-manipulate peoples lives and choices.

You can imagine the bureaucracy of it. You would have to set up a quango to work out which drinks are 'sugary' enough to be taxed. Shopkeepers would need to account for the tax on some drinks but not others. If the tax is to fund diet education (as campaigners intend), then the Revenue has to separate it, the government has to set up yet other bureaucracies to spend it and monitor the spending, and so on. The money would buy nothing except more civil servants.

And as our report The Wages of Sin Taxes notes, a tax on soft drinks hits poor families the hardest. Groceries, food and drink, is a much larger part of their budget. But it would not make a scrap of difference to the middle-class campaigners, and NHS clinicians on indexed-linked pensions, who are advocating it.

Campaigners claim, of course, that children are most affected by sugary drinks as they consume more of them than adults. Well, if we really wanted to improve the lives of our children, we might pay off the national debt that saddles each of them with a £17,600 bill to pay off.

Denmark introduced a 'fat tax' a year ago but it was so unpopular that they scrapped it. It was meant to hit things like crisps and chips, but actually was applied to meat, yoghourt, even gourmet cheeses. German supermarkets did a roaring trade as Danes shopped abroad to escape the tax. Specialist businesses selling meat or cheese were badly hit.

There is a big difference between disapproving of how people run their lives and trying to run their lives for them. If I believe that someone is harming themselves, I will certainly tell them, explain why, and argue that they should change their ways. But if they want to live that way, I have no right to stop them.

And yet we listen patiently while political campaigners – and 'experts' who know nothing about economics – try to impose their own lifestyle standards on everyone else. It's soda today, what's it going to be tomorrow? Chocolate? Cake? Cheese? Bread? Milk? Spare us, please, to get on with our own lives. 

Horsemeat, moral panic and the failure of regulation

Is there anything more terrifying and dangerous to liberty than a 'moral panic'? I use the term in its sociological sense as the horsemeat saga fairly seems to fit the bill. One can almost write the script: a small finding, further investigations hit the front pages, the press become fixated and call for the heads of those responsible, government steps in, calls go out for a public enquiry and regulation or a toughening up of the rules and more spending on enforcement... In a few weeks the issue itself is largely forgotten except that the resultant regulations last forever. Worryingly, the scandal has also prompted attacks on international trade in food products and displayed the economic nationalism we see in this country with calls to eat only British meat.

The most puzzling feature of this particular saga and many others is the belief that additional regulation can solve the problem. In many ways, food was one of the first areas of the economy to be regulated under the Food Adulteration Protection Act of 1860, prompted by noticeably similar Victorian fears. In a curious and amusing echo of the banking crisis, we already have a regulator called the FSA, the Food Standards Agency (is the repetition of acronyms just coincidence, or a sign that we have so many quangos there aren't enough names?), which runs a Food Authenticity Programme. Although the FSA has been at the centre of the scandal, DEFRA also has powers in this area.

It is clear that there has been widespread adulteration of food products despite the presence of these institutions. Indeed, as with the banking crisis, it may be that regulation has encouraged it in various ways. Interestingly, a former bureaucrat at the FSA has suggested that the EU may be partially responsible owing to its ban on 'de-sinewed meat'. What is evident is that regulators will not prevent such events happening. Instead, as the ban on de-sinewed meat suggests, regulation will cause unintended consequences. Additional requirements for 'traceability' and more enforcement will increase costs for supplier which will be passed on and further drive up food prices for already hard-pressed low-income consumers, or it will promote cost-cutting and thus adulteration. Regulation will tend to drive smaller firms out of the marketplace, allowing room for monopolists to dominate the market. One should note that food industry lobby groups are usually happy to call for more regulation as well.

Surely, it would be better to allow a more competitive and de-regulated marketplace, where consumers could choose whether they paid additional costs to guarantee the quality of their products and where market innovations could find more effective ways of policing?  Why is it that, whenever a crisis such as this occurs, calls for more regulation emerge despite (i) the failure of existing regulation (ii) the evidence that regulation may actually have contributed to the crisis and (iii) the effect of regulation will allow monopolistic behaviours and ultimately harm the consumer?

What free trade negotiations?

Oh well, it never was going to be very long before our rulers revealed themselves, once again, as the drooling nincompoops we all know them to be. This time the insight into their incompetence comes from their much ballyhooed decision to "negotiate" a free trade agreement between the European Union and the US.

The European Union and America are to open negotiations with the aim of creating the world’s biggest free trade area worth €86bn (£75bn) within two years.

I have a feeling that the Telegraph sub got lost among the zeros there. £75 billion is more like the value of free trade between Dorset and Somerset. Aside from that, yes, a free trade agreement would indeed be a good idea. But why anyone with two brain cells to rub together would take two years to "negotiate" one is beyond me. Declare unilateral free trade and be done with it. For, as I don't need to remind you but someone does need to remind the politicians, the value of trade is the imports we get to enjoy, not the exports we make.

Exports are simply the dreary drudge work we do in order to be able to afford those lovely imports. So, for the EU to "negotiate" a free trade area with the US is very simple. Just stop taxing EU citizens who purchase American goods by imposing tariffs upon them. Similarly, for the US to have free trade with the EU just means lifting those portions of the US Customs code that tax imports from Europe. There, all done. Extraordinarily simple, easy to achieve and yes, it would make us all richer to boot.

There are two possible reasons why this obviously elegant solution doesn't happen. The firsty requires us to believe that politicians are intelligent. In which case they realise that if we all realised how simple such things are then we wouldn't need, and wouldn't be willing to pay for, the politicians who currently do these things for us. Thus something simple like free trade must be made into a seemingly complex problem which will take years of hard work to sort out. Having met a number of the denizens of Westminster I am not willing to believe that politicians are that bright.

The second possibility is that they really are too dim to understand this trade thing. Perhaps they're trapped in the centuries old delusion that it is exports that make a country rich, not the consumption of the imports that trade makes possible. Which is rather where we came in: that drooling nincompoops thing. Having met a number of the denizens of Westminster I am willing to believe that.

I'm afraid that I cannot conceive of any other reasons at all why they think it necessary to "negotiate" about free trade. Simply declare it and get on with it. For it really is the imports that are the gains from trade, so all we have to do to gain from trade is to allow imports unencumbered. We could wrap this up by teatime for goodness sake, what is this years of negotiation needed?

Explaining that corporate cash glut

One of the standard tropes currently is that companies and corporates are just sitting on mounds of cash and not doing anything with it. And if you go and look at the balance sheets of the large corporations they most certainly are doing so. Quite why they are is a bit of a puzzle: and I was interested to see this as a contributary factor:

In addition, firms change: They hold fewer inventories and receivables...

Which brings me to one of my favourite tropes. There's a difference between structural change and cyclical change and it's essential that we note that difference. For example, we might note the relationship (whatever it is) between corporate cash holdings in 1980 and 1970 and subsequent corporate behaviour and then assume that the relationship will hold here in 2013. However, what if there has been some underlying structural change in the economy between 1980 and 2013?

And indeed there has been: we've got computing in a big way now.

It's long been said that we can see the impact of computers everywhere except actually in the economic statistics. We don't seem to be seeing the burst of growth that we would expect with the adoption of a major new technology for example. However, if you think about it, we can see the impact of computing in corporate balance sheets. For one of the things that the mass adoption of computers has caused (along with the shipping container) is just in time production. Everyone now holds very much less stock of anything. Of parts, of parts to make parts, of raw materials. Entire industries now operate on the basis that a customer has just bought something (the evidence being the bar code going through the till) so, about time to make another one then.

One of the things that really has been hollowed out of the economy is the piles of, months worth of usage there used to be, of stocks sitting around and doing nothing, just waiting to be used. Which is where those cash balances at companies come in: the money that used to be used to finance such stocks is now not doing so. Therefore it is sitting in bank accounts. At some point everyone will work out that this is a structural change, it's not just a turn of the cycle, and the money will be returned to shareholders. At which point we'll have corporates running on what we would, in the past, have considered to be a very capital light manner. Which is great, because it frees that capital up to go and do other things.

I don't claim that this is the only cause of corporate cash piles of course. But I do insist that it is one of them. That everyone now holds much less stock and work in progress is indeed one of the reasons why corporate balance sheets are brimming with cash.

 

Bubble trouble

The US Department of Justice's lawsuit against Standard and Poor's is misguided, says our legal writer Lawsmith. It was the market's confidence in the ratings agencies that was at fault, not the agencies themselves.

Last week, Standard & Poor's, the rating agency, was sued by the U.S. Department of Justice (USDoJ) in a Los Angeles federal court for “knowingly and with intent to defraud, devis(ing), particpat(ing) in, and execut(ing) a scheme to defraud investors in (residential property securitisations) and CDOs, including federally insured financial institutions... and to obtain money from these investors by means of material false and fraudulent pretenses, representations, and promises and the concealment of material facts.”

Even to persons legally trained, this is weighty stuff. One of the most amusing ways I know to frighten an unschooled junior lawyer is to sit him or her down in front of a structure diagram of a securitisation, a jumbled mess of agreements, parties, cashflows, security arrangements, and hedging – and then change slides to display a CDO, a securitisation of securitisations, a stacked jumble of jumbles. (Instant fun.) Despite the visuals, however, such transactions are conceptually very simple: one takes assets that throw off a steady stream of income (such as residential mortgages), models the cashflows arising from them, and creates debt instruments which match the payments from the assets with the payments on the notes. Those notes or bonds are then sold, with the seller recouping the capital value of the assets in the present in exchange for investors' acquiring the future flows of income.

As such, securitisation is a remarkably versatile funding tool: one can quite literally put a chicken sandwich into a securitisation, and emerge on the other side with investment-grade debt. This is achieved through a process called “tranching,” where certain classes of debt receive higher payments of interest but absorb losses first, allowing the more senior pieces to be sold as relatively safer assets. So, for example, with a structure that issues £100 million in notes – £40m “B” and £60m “A” – if there is a shortfall of £30 million, the junior “B” tranche is wiped out by 75%, whereas the position of the senior debt is unaffected.

This is where rating agencies come in. Each agency appointed on a particular transaction assesses how these transactions have been structured by the banks and determines, on the basis of a pre-published (and public) set of criteria, their reasoning for arriving at their conclusions. Based on the amount and quality of credit enhancement for a given deal, they issue ratings to the more senior classes of debt which represent the rating agency's opinion as to the probability of default on a given piece – the better the rating, the lower that probability is.

USDoJ asserts that, as the sub-prime crisis began to unfold over the course of 2007, S&P rated 30 CDOs backed, in whole or in part, by non-prime (low-income borrower) RMBS collateral, and that “S&P knowingly disregarded the true extent of the credit risks associated with those non-prime RMBS tranches in issuing and/or confirming ratings for CDOs with exposure to those non-prime RMBS tranches.” One of these, the complaint points out, was “NovaStar ABS CDO I,” a $374 million transaction comprised of securities which were backed by subprime residential loans and issued in 2006 (76%), 2005 (18%), and 2007 (5%). S&P rated $277 million of the notes issued by the deal as AAA, or the lowest probability of default; however, the deal imploded. The result, as put by the Justice Department, was “near total losses to investors,” who were for the most part federally-insured banks.

This is an example of one small part of a wider evil which requires a $4bn lawsuit to be put right. The nitty-gritty of legal arguments – which does not bear repeating here – hinges on whether S&P's statements on these deals were actionable misrepresentations or protected speech under the US Constitution. The more important question, though, is this: is this a case that should have been brought in the first place?

From a jurisprudential standpoint, the only relevant consideration is that the statute upon which the claim is based has never been used before for this purpose (suggesting that this alleged social ill was not what the drafters of FIRREA 1989 had in mind).

In terms of economic substance, a slightly closer look at NovaStar shows that USDoJ falls very wide of the mark. As of late 2006, the company was a reasonably reputable originator of residential mortgage loans: as reported by the New York Times, NovaStar “boasted 430 offices in 39 states... fast becoming one of the top 20 home lenders in the country,” a “Wall Street darling” with “shares trading at $30 (in 2003), up from $9.50 in late 2002.” It would go higher, eventually soaring to $70 per share: “between 2004 and 2007, for instance, the company raised more than $400 million from investors,” eventually attaining a market value of $1.6 billion, with loan origination to sub-prime borrowers reaching $600 million per month.

The secret behind NovaStar's short-lived success was that the firm originated loans which, in hindsight, a reasonably prudent mortgage lender would not have, with low-quality security and to low-quality borowers. “One NovaStar loan on a property in Ohio totalled $77,500 even though the average sales price for the neighbourhood was $31,685, and the same house had been purchased two months earlier for $20,000,” reported the Times, and virtually anyone – “even... a corpse, the joke went” – could obtain one. NovaStar employed accounting methods that “gave the company lots of leeway in how it valued the loans held on its books,” such as one which “allowed it to record immediately all the income that a loan would generate over its life,” even if the mortgage had decades to run until maturity. As a result, virtually the entire market misapprehended NovaStar's business, including its securitisation business, until the subprime bubble was well into the throes of its (widely unexpected and spectacular) collapse.

When one considers that it is not a rating agency's mandate to perform investor due diligence, but rather to look at the stated characteristics of the income flows presented to it and “assess the likelihood, and in some situations the consequences, of default – nothing more or less,” one understands that if garbage data go in, whether by dint of fraud or endemic asset mispricing, garbage conclusions will invariably come out. It is this which should colour USDoJ's claims when being viewed by objective observers.

The credit enhancement involved in obtaining a AAA rating should, according to USDoJ, “on average, be able to withstand economic conditions similar to those of the Great Depression,” a roughly 1% probability of default. Most of the time the rating agencies get this right: the default rate of AAA-rated notes in structured finance transactions has, in the last thirty years, barely exceeded 0.5%, and even then only reached that historically unusual high in 2008.

But sub-prime RMBS was different, and this was not the fault of the rating agencies. Investors everywhere lost money as a result of the sub-prime crisis because they failed to conduct proper due diligence and were caught up in the largest speculative property mania in history – one which was US-government-fuelled at that. The U.S. federal government was left with considerable additional egg on its face after it then had to bail out these banks with these toxic assets on their books. But, if this lawsuit is to be believed, the primary responsibility for these losses should lie with S&P, which has allegedly perpetrated a massive fraud for its own material gain.

Recent rhetoric emerging from the populist left has capitalised on the suit, with financially illiterate commentators asserting that the rating agencies' giving AAA ratings to toxic assets was “tantamount to a massive betrayal of America.” This is plainly absurd. Many people and institutions made bad calls in the run-up to the great recession. It does not follow that it is appropriate to sue organisations which made a profit throughout, simply because they had no skin in the game. Nor will it do anything to protect the American taxpayer from being the guarantor of last resort, a precarious position in which the American people remain: not despite the role of their government, but because of it.

Article: Bubble trouble

Last week, Standard & Poor's, the rating agency, was sued by the U.S. Department of Justice (USDoJ) in a Los Angeles federal court for “knowingly and with intent to defraud, devis(ing), particpat(ing) in, and execut(ing) a scheme to defraud investors in (residential property securitisations) and CDOs, including federally insured financial institutions... and to obtain money from these investors by means of material false and fraudulent pretenses, representations, and promises and the concealment of material facts.”

Even to persons legally trained, this is weighty stuff. One of the most amusing ways I know to frighten an unschooled junior lawyer is to sit him or her down in front of a structure diagram of a securitisation, a jumbled mess of agreements, parties, cashflows, security arrangements, and hedging – and then change slides to display a CDO, a securitisation of securitisations, a stacked jumble of jumbles. (Instant fun.) Despite the visuals, however, such transactions are conceptually very simple: one takes assets that throw off a steady stream of income (such as residential mortgages), models the cashflows arising from them, and creates debt instruments which match the payments from the assets with the payments on the notes. Those notes or bonds are then sold, with the seller recouping the capital value of the assets in the present in exchange for investors' acquiring the future flows of income.

Continue reading.

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The 10p rate is a flawed tax cut, but a tax cut nonetheless

Robert Halfon MP’s campaign to reintroduce the 10p tax now appears to have been a success. After David Cameron’s hint that it would be introduced in the next budget and Ed Miliband’s announcement today that Labour would reintroduce it after the election, it seems inevitable that it will be a part of the next budget.

Many in the free market movement have expressed their dismay at this. The CPS’s Ryan Bourne has argued convincingly that it would be better to raise the personal allowance more instead of introducing a new band of tax, primarily on the grounds of simplicity.

I agree with him, but I am still pleased that the government is going for the 10p rate. Where I differ is that I do not see the reforms as being a case of either/or. The personal allowance will be raised to £10,000 – as I argued in my paper Just Rewards last year, it should be pegged to at least the minimum wage level – but it seems unlikely to be raised beyond that.

George Osborne is unlikely to see a raise beyond £10k as being worth the reduction in revenue – raising the personal allowance was a Lib Dem policy before the election, and it would be hard for the Conservatives to claim special credit for raising it even further. This proposal essentially allows the Conservatives to claim credit for something – taxing low-income earners less – that they should have been for all along. The effect is basically the same.

I am not really convinced that the addition of another tax band will be significantly complicating. The length of Tolley’s Tax Guide, a rough but useful guide to tax code complexity, has doubled since 1997 – not because there are extra bands (you could fit a hundred different bands on a single page) but because of the number of special exemptions and loopholes created by government to favour certain groups over others. This, it seems to me, is the real meat in the tax simplification sandwich.

I would love to see a “simple tax” proposal to scrap all the complications in income tax but preserve two different tax rates, so that the argument over tax simplification former was not bound up in the (quite different) argument over whether we should have a single band of tax or not. (Incidentally, if you’re a tax expert and you might be interested in writing this, get in touch.)

It is hard to object in principle to the idea that taxing a billionaire causes less harm to him than taxing a hospital porter at the same rate does to the porter. Indeed, anyone who believes in a tax free personal allowance and a single flat rate of tax, in effect, is acknowledging that principle as well. This isn’t to say that the practical arguments for a single rate of tax – the incentive effects and the political impetus for lower taxes created by putting all taxpayers onto the same band – aren’t very strong, just that there are good arguments in the other direction, too.

There are good arguments against the 10p rate, but most are based on an assumption that the alternative would be a further rise to the personal allowance, rather than the status quo. Alas, because of the politics, I think it’s 10p or nothing. That’s why I’ll support it – it’s a flawed tax cut, but it’s a tax cut nonetheless.

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Book review: Heavens on Earth – How to Create Mass Prosperity

For those who, after five years of austerity (and rising deficit), despair about how to create growth, Heavens on Earth is indispensable bedtime and boardroom reading. In it, JP Floru investigates eight countries which have transformed their economies to create lasting high growth.  In different times and places the methods used to make the switch from scarcity to plenty have been remarkably similar. At times it is surprising: who would think that there are great correlations between the Industrial Revolution in Britain, 2013 Communist China, post-World War II America and Pinochet-era Chile? 

“If Julius Caesar had met George Washington in 1760, he would have found the world barely changed. He would have been served food prepared by slaves in a stately home. The average age would have been twenty-eight to thirty-five. Just 250 years later he would have heard talk of missions to Mars...” So what happened? The book brings these arguments to life throughout with such insights.

Meet “Sideline Stan”, the New Zealand Minister of Labour who systematically refused to intervene in social conflicts. Meet Hong Kong’s John Cowperthwaite, who sent statisticians arrived from Whitehall on the first plane back: statistics would only be used to interfere and harm the economy. At the same time Heavens on Earth explains the main economic concepts which are relevant today: the Laffer Curve, Austrian economics, the wisdom of Adam Smith (no coincidence: JP Floru is a Fellow of the Adam Smith Institute) and the workings of Keynesian economics (or rather: why they do not work).

Although well-known existing ideas and quotes are used, at times the book is highly original: “Regulatory Failure Spiral” is the common enough situation of governments trying to rectify failing regulations with more failing regulations. The “Holy Trinity of Profligate Government: taxing, printing and borrowing” is extensively identified and lambasted. As said before, the links between highly different economic cultures may seem surprising. Some may also be surprised to learn that concern for the poor permeates the book. Poverty is not just a state in which people exist, it has to be created: it is created by economic oppression and only free markets can free the poor.

Heaven on Earth’s sub-title: “How to Create Mass Prosperity?” is laid out in chapter 9 but I won’t give the recipe away. The book is thorough, enlightening and fun, and a must-read in times like these.

Heavens on Earth – How to Create Mass Prosperity by JP Floru is published by Biteback and available on Amazon. The official ASI launch party is in Westminster on 18 March.

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