The Pin Factory Blog

If we are throwing quangos into the bonfire, I'd like to fuel the flames with a couple of 'consumer protection' bodies. I figure that government agencies that aim to protect us from faulty goods and inadequate services do no such thing – and indeed, leave us more exposed to them because they tend to reduce competition in consumer markets.

One of the great myths about the free market is that something dire has to happen before producers change their ways. For a start, I just don't accept the fact that producers and sellers are deeply unethical and will gladly sell us dangerous products if it makes them a quick buck. Most people I know in business are as ethical as the rest of us and don't want to do any such thing, any more than they want to profit from selling drugs or guns. They want to make money by serving their customers.

And, being good businesspeople, they know that you do not make money by serving a customer only once. It costs money to search out customers and pitch your product at them. You don't want to have to do that over and over. No, what you want is customers who are so delighted with what you sell them that they come back to you over and over. Remember also that businesspeople work at the margin. If just a few customers don't like what you are selling and go to another supplier, that it your profit gone. If they tell their friends, that's even worse. Long before you've killed any customers or had to fight any lawsuits, you will have changed your ways. Choice is by far the most effective consumer protection imaginable.

For some reason, people assume that taking these same market principles into services like healthcare or schools, which are run by governments today, would mean an endless round of painful closures and particular schools or hospitals going out of business. It's true that most new businesses fail. Their owners simply misjudge the market, or do not have the right skills and resources to capture it. But once they are established, firms close much less frequently. They learn where the market is and how to serve it, and they adapt to serve the changing tastes of their customers.

If they sometimes get it wrong, or can't keep up with the changing nature of demand, then yes, they might have to close. But far more often, you find they merge with or are taken over by other firms. There is usually something of value in the business that is useful to another. If we commercialised or privatised schools and hospitals, I would not expect to see them closing down all over the place. Long before closure threatened, they would have changed, and for the better I would expect to see them improve and change and try to take on the competition, and if they could not stand the pace, others would step in and take them over and upgrade them. The service standards that were tolerated in the monopoly state system would simply no longer be tolerated, and service users would be far better protected, as consumers, than they are in the state monopolies today.

There's a small club of musicians and actors who've protested against absurdly high tax rates. The classic is George Harrison's Beatles song, Taxman – "Should five percent appear too small /  Be thankful I don't take it all". (That wouldn't sound out of place in most debates about tax today, sadly.) And, of course, there's Michael Caine's explanation of the Laffer Curve – "I left for eight years when tax was put up to 82 per cent. The newspapers said: "Michael Caine's leaving: let him go, the stupid, overpaid, loudmouth idiot, who cares where he goes?" Well, you didn't get 82 per cent tax from me for eight years." 

The newest member of this elite club is Adele, whose (rather good) song "Rolling in the Deep" you've probably heard ad infinitum in Radio 2. She's not pulling any punches:

"I'm mortified to have to pay 50%. Trains are always late, most state schools are s*** and I've gotta give you, like, four million quid? Are you having a laugh? When I got my tax bill in from [my album] 19 I was ready to go and buy a gun and randomly open fire."

A bit extreme, but I can't blame her for being frustrated. The Guardian is a lot sniffier – how dare she resent paying half her earnings for inefficient state services!

Robert Nozick used the example of basketballer Wilt Chamberlain to show that even a society that began with equal wealth would quickly become quite unequal:

Suppose that among the members of this [equal] society is Wilt Chamberlain, and that he has as a condition of his contract with his team that he will play only if each person coming to see the game puts twenty-five cents into a special box at the gate of the sports arena, the contents of which will go to him. Suppose further that over the course of the season, one million fans decide to pay the twenty-five cents to watch him play. The result will be a new distribution, D2, in which Chamberlain now has $250,000, much more than anyone else.

Is it just to take half of Chamberlain's earnings in this example? Why should the state interfere in simple and just exchanges like this? Nobody could claim that Chamberlain doesn't deserve the money – people want to give it to him because they want to see him play. But, as with George Harrison and Adele, he'll end up much richer than any one person in the audience. There are lots of people out there who wonder why they have to cough up so much of the money they earn just to pay for late trains and bad schools. Welcome to the club, Adele.

Adventures in government stupidity are of course nothing new: but to raising the bar to sheer howling lunacy is more unusual. Even that toxic brew of special interests, bureaucrats and politicians rarely produce something that is outright insane.

Rarely, but not never:

Local authorities will put up the deposit to allow first-time buyers to get on the housing ladder, under a scheme unveiled today. The organisation behind the ‘local lend a hand’ initiative, Capita business Sector Treasury Services, says it will free up social and affordable housing by making it easier for people to buy their own homes. The initiative is initially being backed by Lloyds TSB, and has been piloted by five local authorities, but Capita hopes to get more lenders and councils on board as the scheme progresses.

The local authorities will lodge funds with the lender to cover the shortfall in a first-time buyer’s deposit. This can be up to 20 per cent of the mortgage, so for a typical 75 per cent loan to value mortgage, the buyer would only need to find a 5 per cent deposit. Available funds in each area will be capped, although the council shouldn’t incur any actual costs unless there are problems with the mortgage repayments.

So let us try and get this straight. The world's entire financial system is still reeling from its recent effort to walk straight off a cliff by lending money to people to buy houses they couldn't afford. This lesson having been learned, said financial houses no no longer being willing to lend to people without a substantial deposit, showing that they've some skin in the game, that you don't lend hundreds of thousands to people who have bupkiss, we now have the following bright political solution?

The taxpayers should subsidise these deposits so that when (no, not if) something goes wrong in the future the taxpayers have to pick up the bill? That, having seen what people buying houses they cannot afford does, we should insist that more people should buy houses they cannot afford?

This, this, is why we send our finest minds to Oxbridge so that they may rule over us all?

Somewhere up there the Goddess of Irony is weeping bitter tears into her nectar as not even she had thought of that one.

Look, it's terribly, terribly, simple. If local councils want local houses to be cheaper they should grant planning permission for more local houses. Supply and demand really does work you know and it is the planning permission itself which is the most expensive part of a house these days. No, not the land, not the building, but the chitty allowing you to build on that land. The council even makes a profit issuing permissions rather than losses on paying people's deposits.

With ideas at the above level of stupidity I fully expect both Ed Balls and George Osborne to announce next week that the way to close the deficit is to make cucumbers from Moonlight.

The news is that the rate of Capital Gains Tax is to be increased to around 40%. My hope is that the CGT allowance of £10,100 will remain, but I note that the Liberal Democrats have suggested reducing this to £1,000.

The previous Labour government sought to simplify CGT by removing taper relief and indexation. To compensate for the loss of these reliefs, the rate of CGT was reduced to 18%. It would be most unfair to now increase the rate of CGT without either rebasing the book costs for long held assets from 1982 values or reintroducing indexation relief to compensate for the effects of inflation. Otherwise, if a share price simply rises in line with inflation, the value remains the same, so on disposal the investor is taxed not on the gain but on the increase in price. Such tax is therefore an erosion of value and a wealth tax in disguise.

The timing of the proposed change remains uncertain. It is possible that the changes could start immediately, or they could be backdated to the start of this financial year, or they could take effect from 6th April 2011. Given the need for speed to address the country's economic problems, I expect action sooner rather than later.

Investors planning to make disposals would be wise to do so before the emergency budget, in case the proposed increase in CGT takes immediate effect. Remember that the same shares bought back within a month match against the sale leaving the original holding undisturbed. You could hedge your bets by selling just before the budget, see what happens and then decide whether to unwind your position by buying back within a month.

Given the Tory commitment to reward marriage I think it unlikely that any action will be taken to remove the free transfer of assets between spouses. You should ensure that assets are held by the partner on the lower tax rate, and make transfers accordingly. Similarly, make transfers so sales are made in the right name to maximise the use of CGT allowances.

Three other points:

• Capital gains arising within ISAs are free from CGT and this has just become significantly more valuable. It is therefore even more important that you utilise your ISA allowances.
• If gains are realised on sales to fund a SIPP contribution, the income tax relief on the contribution can offset the CGT arising.
• Capital gains arising from VCT investment are exempt from CGT so I suspect that there may be a revival of interest in this area.

Fred Robinson is a Private Client Partner at Killik & Co.
 

Sir Bob Geldof and Lord Bono can take the day off from their quest to eliminate African poverty today. A new report by the African Development Bank (PDF) shows that the African middle class is growing at a unprecedented rate, with almost 35% of Africa's population now being considered middle-class – an increase of almost 10% over the last thirty years. Measurements of living conditions are up across the board: electricity consumption has almost tripled since 1985, as has the continent's petroleum consumption. Although certain states in Africa, such as Liberia, continue to suffer from abject poverty, things are on the whole looking up.

Have the efforts of Elton John, Sting, Paul McCartney and other celebs finally started to pay off? Well, probably not – the report is distinctly lacking in references to celebrity activism. Instead, it says that the growth of this middle-class is due to social-economic opportunities provided by the private sector. Indeed, economic growth and an embryonic entrepreneurial spirit has led to formerly unheard-of levels of prosperity for many Africans who, instead of subsisting beneath the poverty line, are increasingly buying fridges, cars and televisions.

Sir Bob might argue that these changes were initially brought about by the West's aid generosity. Apparently not, as the report again states that macroeconomic policy changes are to thank for this upturn. In contract, over the last fifty years Africa gained little from $500,000,000,000 worth of poorly-structured aid that only encouraged aid-dependency.

Overwhelmingly, Africa needs trade, not aid. Trade was one of the key factors in the economic prosperity of the western world, and it can do the same in Africa. The current situation, however, denies Africa vital trading opportunities. The CAP impoverishes Africa. By having huge barriers to Europe's agricultural produce market, and therefore denying Africa the ability to trade in what they have a comparative advantage in, the CAP is plainly a raw deal. (Not to mention the fact that the CAP also costs each UK household £398 annually (PDF).)

While serious challenges no doubt lay ahead for Africa, notably HIV and its potentially devastating demographic impact, the route to Africa's long-overdue development is free trade, not another evening of banal comedy sketches, regardless of their benevolent intent. The current situation benefits only a small number of over-subsidised farmers, to the detriment of everybody else.

Britain’s international aid budget costs the equivalent of 22 days of national borrowing from international markets. By 2015, British Aid will have increased by 34.2% to £11.5 billion per annum. Including personal donations and state spending, Britain gives 0.8% of GDP in international aid. With state aid increasing, more people should ask: Why are average per capita incomes in Africa lower than 40 years ago after $1 trillion of aid being given over that period?

Aid infrastructure is somewhat responsible. British charities usually attempt to limit net administration costs to 10% (though they often exceed these targets). Reports from the World Bank and ActionAid respectively estimate that 40%-60% of international aid budgets are spent on consultants. Government bureaucracy diverts 5% of British, and 8.7% of European aid budgets respectively.

Most historical evidence shows that developing world aid recipients are more debt-laden, inflation-prone and likely to experience conflict and corruption. In Afghanistan, DfID was forced to stop aid-money after US intelligence found that £1 billion went missing through institutionalised corruption. Malawi’s president, the recipient of £93 million of direct aid, recently ordered an £8 million presidential jet.

President Kagame, recipient of £83 million of direct aid, recently purchased presidential jets worth £60 million. International aid has also contributed to Rwanda’s conflict with neighbouring Congo (in which 5 million people were killed) and prolonged Rwanda’s genocide. When $1.5 billion was donated to deal with a cholera epidemic in Rwanda, Hutu militias stole 60% to fund their crimes.

The Horn of Africa crisis owes some origins to international aid. In 1980s Ethiopia, £90 million of aid was used to lure starving villagers into state camps, from where 600,000 were deported and at least 100,000 died. Using British and Russian aid, Somalia embarked upon a territorial conflict with Ethiopia, which neither nation could afford. Today, warlords rule most of Somalia, expropriating up to 80% of aid that goes there.

The great paradox of international aid is that resources meant to alleviate humanitarian suffering often perpetuate it. Western living standards can only be exported through free trade and more open migration laws.

Free trade gives poorer countries a competitive advantage to exploit, so they can trade their way to prosperity. Instead of giving dictators money to disperse, enterprising citizens earn the money themselves. Governments can still rob their people, but have to allow at least some commerce to take place to do so.

As Sam has argued, more open immigration rules in the West would allow developing nations’ inhabitants to learn from and experience Western market practices. Along with their earnings, they can return these ideas back to their home countries (where trading opportunities would encourage growth). Meanwhile, Western nations would benefit from better growth and higher tax revenues. Peaceful economic exchange would be a lot better for everyone than paying warlords and dictators to oppress their own people.

One of the most interesting sites to come out of Africa recently is African Liberty  which blows open the traditional Western metropolitan elite consensus about how to help people in the continent.

It's refreshing stuff. My eye was drawn to the piece about the 'ambitious UN centrist plan' to get half the world's children into school (free schools, of course, paid for by governments) by 2015. Part of this is Ghana's programme to feed all schoolchildren at taxpayers' expense – a ploy to increase the enrolment figures. That, say the authors, means higher taxes on parents who would gladly ensure their children are properly fed, with less money then available to fix the problems of dilapidated classrooms, out-of-date textbooks and poorly paid teachers.

And the delightfully-named Rejoice Ngwenya, writing from Harare, gives a sharp taste of what life has become like in Zimbabwe:

My day starts with a fire in the gazebo to warm a bucket of bathing water. Electricity is usually down and with a water system that collapsed six months ago, running water is a thing of the past. Zimbabwe National Water Authority has a repertoire of excuses why the precious liquid deserted my home. I have stopped asking. Water bills do come, but there are no penalties for ignoring them... Forget eggs and a cup of tea. They are not on my menu if the preceding day I had no access to at least six United States dollars. My breakfast is therefore limited to a bowl of corn meal porridge with peanut butter, and boiled sweet potatoes!

Then there are pieces arguing that the Aid industry has become – well, just that, a self-justifying industry – and that its critics, the people who believe in opening up markets rather than sending aid to entrenched governments – are in fact its best friends. Challenging stuff.

There is a lot to be said for the wisdom that can come with age. Looking back at how little I knew just three years ago - before I joined the ASI - it is shocking to think how little I knew. Go back a bit further and the trite nonsense that I was spouting at university makes me shudder. At least I was not alone; the place was choc-a-bloc with students, whose grasp of the real world was limited in many weird and wonderful respects. This was not helped by the fact that the majority of academics were living in Never Land. Ignorance ruled.

It therefore does not surprise me that Opinionpanel Research have found that after the first two leaders’ debates, half of students were planning to vote Lib Dem. This is not a criticism of the Lib Dem policies overall (which are not markedly worse than the Conservative ones), but on the specific Lib Dem policy that many students like: vowing to scrap university fees over six years. In effect, a policy to redistribute money from those that will never benefit from higher education to those will.

The fact that most students are of the left, and so should be opposed to regressive taxation, makes the issue perverse, and worryingly I ‘d suggest it goes beyond ‘turkeys not voting for Christmas’. After all, they have already paid (or not). Despite the easy access students have to credit, somehow 'free' higher education has come to be seen as a right. It is time for the debate against subsidised higher education to enter the popular debate. The question is: Are any politicians brave enough to face down the historically riotous students? Perhaps they should, most are too lazy to vote.

On Sunday, David Willetts, the universities minister, claimed that a graduate tax is “by far the best option to go for in tough times” when looking to ensure university teaching and research funding is maintained.

Presently, non-medical undergraduate students from middle-income backgrounds pay between 15 and 30% of the costs of their degrees. Taxpayers and university endowments pay the rest and subsidise interest on student loans. This means that undergraduates pay far less than the full cost of their university education. When people can buy something for much less than it actually costs, they tend to buy too much of it. Since 1980 the proportion of people going to university has more than doubled. Many students have gone to university but gained degrees which will not increase their future income; at the same time they have spent three years out of the job market losing a small fortune in forgone wages. A ‘double-cost’ for the students and taxpayers.

Replacing student fees and loans with a graduate tax goes too far in the opposite direction. If the tax is implemented as simply as possible, an individual will pay an additional flat rate (say 3 to 5%) on top of their income tax if they go to university. A tax like this would distort the higher education market by encouraging people not to go to university and so avoid the tax altogether. This could impact especially badly on school leavers from poorer backgrounds.

When university-leavers go into graduate jobs the tax would encourage them to work less hard so they pay less in tax. UCU estimates that a graduate tax of 5% would leave the average secondary school teacher about £46,000 worse-off over 25 years. People could end up paying much more than the value of their university education in graduate taxes over their lifetime, discouraging them from going to university. This would mean too few people go to university, decreasing their future earnings and holding back economic growth.

Additionally, people may go to university, enter high-paying jobs and then emigrate to avoid paying the tax. The Student Loans Company has had a tough time getting loan-repayments from emigres so enforcing a graduate tax internationally will be difficult at best. The result would be a state which pays for most of the university education of high-earning emigres, but which cannot recoup the money and whose policies (by causing the emigration of high-earners) decrease future economic growth.

A more complex graduate tax could be implemented, one where different percentages of income are paid according to university attended, degree taken and income earned. This might lead to a better- targeted tax but it would have much higher administrative costs and would cause even more distortion in the higher-education and job markets.

In fact, the idea of a graduate tax needs to be scrapped and instead Willetts should enact James Stanfield's proposals set out in The Broken University.

According to a commission set up by the Scottish Labour Party, in order to reduce alcohol consumption, a “floor price” for alcohol should be introduced together with a levy on alcohol retailers. Its report also suggests a limit on the number of licences available for retailers and a halt to the sponsorship of sporting events. However, under scrutiny these suggestions may be ineffective.

A minimum price for alcohol aims to raise the price of the “loss leaders”, i.e. drinks that are priced below cost (in order to attract customers), hence the minimum price will be set at/below the market price. Therefore a minimum price will not reduce the actual alcohol consumption, since it will only reduce the excessive demand for alcohol. Moreover, retailers will just switch the “loss leaders” to drinks that cost more than the minimum price, and price these drinks less than their costs while still charging more than the minimum price.

Even if levies and minimum pricing do manage to raise the price of alcohol, they will hit sensible drinkers as well as binge drinkers. Although binge drinkers are more sensitive to price changes, it will be the sensible, drinkers who will have to reduce their consumption. For binge drinkers, alcohol is an every-day necessity with few or no substitute, a Giffen good, to put it in economic jargon. A rise in the price of alcohol will mean that alcoholics will have to reduce the consumption of other goods in order to maintain their budget for alcohol, and as a result their alcohol consumption will not decrease. In contrast, alcohol is a normal good for sensible drinkers, and a rise in the price of alcoholic drinks will reduce their ability to purchase. Hence levies and minimum pricing would not be an effective or fair solution.

Limiting the number of licences will reduce the availability of alcoholic drinks, making them more expensive and harder to buy. Again this will hit sensible drinkers the hardest, for the reasons stated above. It may well encourage black markets to grow, increasing the cost of policing without reducing alcohol consumption.