I may have to rethink my support for Pigou Taxes

The standard economic reaction to an externality is to tax it so as to include it into the price system. We'll then get the appropriate amount of said externality, a balanacing of the costs and benefits of it. In economic terms the argument is well nigh unassailable but I am beginning to reconsider my support for the idea. For taxes, by definition, have to be imposed by politicians and there's almost no good idea that a politician cannot screw up.

The straw for the camel is Osborne's increase in the bank levy this budget.

The move to increase the bank levy – from a charge of 0.088 per cent on banks’ global balance sheets to 0.105 per cent from 2013.......The Treasury retained its goal of raising £2.5bn a year from the levy.

The thing is, the bank levy is not supposed to be a tax, a method of filling the Treasury. It's supposed to be, in theory it is, an insurance premium on those bank liabilities which are not already covered by some other deposit insurance scheme. If, for example, bank borrowings from the wholesale markets (these are not covered by other schemes and so pay the levy) fall then the revenue from the levy should fall: we citizenry are providing less insurance to the banks and thus should get lower premiums. Similarly, if such wholesale funding moves from overnight borrowings to 5 year bond issues, this is less risk and thus lower premiums should be charged (the system does differentiate between these two scenarios).

But here we have the Treasury targetting an amount to be received: and a Chancellor seeing the levy as a convenient place to raise revenues, not to set the appropriate insurance premium.

And I'm afraid that the more we see of entirely righteous Pigou Taxes the more we see of this behaviour. I pointed out in these very pages some years back that if we applied the Stern Review to petrol taxation then fuel duty should fall by 12 p a litre: since then it has risen another 5 or 6 p still using Stern as the justification. Air Passenger Duty was set (amazingly, by Gordon Brown) at the Stern level of some $80 per tonne Co2-e: it has been doubled at least since then purely for revenue purposes.

I've not really made up my mind as yet, just rethinking my position. But it could be that Pigou Taxation just won't work because of politics. In the same way that Keynesian economics doesn't because of politicians: even if the entire economic analysis is correct there is never the political will in the booms to put aside money for the busts. And so it is with Pigou Taxes. They are correct in theory, of that there's no doubt.

But giving a politician a justification for a new tax is like giving a child a loaded machine gun: noisy, dangerous and very definitely a very bad idea.

The injustice of minimum alcohol pricing

I’ve struggled to write something about minimum alcohol pricing today. It’s a hugely important issue, and one I care deeply about. But I can’t help but be angry at the people who've proposed it, and the government made up of supposed “conservatives” and “liberals” who plan on implementing it. It's anti-individualism at its worst.

The “evidence-based” arguments made for minimum alcohol pricing are, in fact, based on distortion and bad science. The policy is paternalistic, indiscriminate, and only hits people who are frugal or on lower incomes. Slippery slope arguments are common, for good reason. But they’re especially appropriate here.

The idea behind minimum alcohol pricing is that all drinks must cost at least a certain amount per unit of alcohol in them. The figure being used right now is 40p per unit. On that 40p figure, the price of cans of (say) Becks would go up to at least £1, bottles of wine up to about £3.70, and so on.

If that sounds harmless, it’s because the temperance lobby have a clever strategy. Most people won’t oppose the principle of minimum alcohol pricing at such a low price level, because it won’t affect what they like to drink. But once the principle of minimum alcohol pricing is in place, the minimum price will climb inexorably upward.

The politics of this are straightforward but effective: target the most marginal, “problem” group – in this case, binge drinkers – with a low minimum price to pass an apparently-trivial law.

Once it’s in place, raising the minimum price is like boiling a frog. Bring the heat up slowly and steadily and, before people know it, they’ll be in boiling water. It’s what happened with cigarette duties: now taxes account for over 80% of the price of a packet of fags.

The justifications for this are completely, utterly bogus. Britain does not have a drinking problem: as ASI fellow Chris Snowdon has pointed out, we drink less today than ten years ago, less than a hundred years ago, and far less than we did before that.

Internationally, we are in the middle of the table in the European rankings, behind France, Germany and Spain, and far behind the Czech Republic and Luxemburg.

But what about binge drinking? In fact, the definition of “binge drinking” has been warped beyond all recognition. Three pints of strong lager in a day counts as a “binge” for an adult man, according to official definitions. A woman drinking two large glasses of wine is “binging” as well.

As Chris points out, the number of diseases defined as “alcohol related” has tripled in the last 25 years. When you change the meaning of words to suit your purposes, you can “prove” anything.

Minimum alcohol pricing is outrageously regressive, as are all “sin taxes”, only really affecting the behaviour of people who can’t afford expensive booze. In some ways this is Victorian-style paternalism, but the temperance movement of the 19th Century was about self-help and personal choice. Today’s anti-alcohol “health campaigners” are more akin to the American Prohibitionists. For them, the state is the ultimate weapon with which to impose morality on the masses.

And this, really, is why I hate minimum alcohol pricing so much. It’s puritanical fascism. That fear that someone, somewhere, may be having fun can finally be eliminated using the power and violence of the state.

All of the “evidence” in the world shouldn’t undermine the basic value we place on individual liberty. The case for minimum alcohol pricing is extraordinarily weak as it is, but nothing should undermine the right to choose our own poison.


Hayek's death, 20 years on

“All political theories assume, of course, that most individuals are very ignorant. Those who plead for liberty differ from the rest in that they include among the ignorant themselves as well as the wisest."

“It is because freedom means the renunciation of direct control of individual efforts that a free society can make use of so much more knowledge than the mind of the wisest ruler could comprehend”

FA Hayek, The Constitution of Liberty. 

Hayek died twenty years ago today. His profound insights into economics and social philosophy might be more important than ever.

The perils of a state run banking system

An near endless number of loons are insisting that we must have greater State direction of bank lending in this country. We've even loons light in the current Government insisting that this should be so: to say nothing of the true loons further left whose mantra seems to be "Forward to Five Year Planning!".

One little story from a place where they really do have state directed banking:

Banks prefer to lend to state-owned enterprises, sometimes because they are urged to do so but also because it is safer: if it runs into problems, the debt will be restructured and they will not be penalised.

Not that that is going to surprise anyone: one group of bureaucrats is always going to be ready to lend to another group of bureaucrats. But then what happens?

"Fundraising" from private lenders is illegal in China, but also commonplace........Official interest rates for savers are so low – negative in real terms – that lending illicitly is much more attractive than putting your money in the bank.

OK, markets will out, there's a demand for investment opportunities, a demand for financing, outside what those state owned banks are willing to do.

So, what happens next?

Now 31, Wu's fortunes have changed dramatically. She is on death row, facing execution for fraud and raising money outside the banking system.

They shoot you.

It's certainly a fairly severe reaction to market competition, isn't it? But in the end that is what has to happen. Not the shooting, but the punishment. For if a functioning free market outperforms the inevitably incompetent state bureaucrat run banks the the state will inevitably take action against that market that is showing them up to be the incompetents they are.

It's an extention of PJ O'Rourke's point, that we should never allow the people with all the money to also be the people with all the guns. And given that government has all the guns we really shouldn't be allowing them to control the money as well.

ASI budget coverage highlights

The Adam Smith Institute appeared on a variety of TV, radio, print and online news sites commenting on Osborne's announcements both pre and post speech. Below are some of the highlights:

  • Dr Eamonn Butler on the Jeff Randall Show, Sky News discussing the expected changes in taxes.
  • Dr Madsen Pirie on the Today Programme arguing against government intervention in business and for less regulation and taxes.
  • ASI Fellow Alex Singleton on the Jeremy Vine Show defending the need to scrap the 50p tax rate.
  • Sam Bowman on Al Arabiya TV giving his reaction to Osborne's announcements.
  • Dr Madsen Pirie writes in City AM an entrepreneur's wish list for the budget.
  • Sam Bowman writes in the New Statesman on his dream budget proposal: legalising and taxing drugs.
  • Sally Thompson writing on Politics.co.uk on the need to reduce the tax burden and simplify the tax system to generate growth.
  • Tom Clougherty's criticises the tax hike on cigarettes in The Sun.
  • The ASI's reaction to the 50p tax rate and lowering of the 40p tax threshold feature in the Daily Mail and Daily Telegraph and ConservativeHome.

The Austrian business cycle theory

At the (sadly now closed) Mises Economics Blog, Art Carden has a good short primer on the Austrian business cycle theory:

Calculation: People appraise and bargain for goods and services in markets. Prices are the coordinators that tell people the most effective ways in which resources can be deployed. Interest rates are determined by the interaction of firms’ demands for investable resources and households’ willingness to save. Holding investment demand constant, changing interest rates indicate changes in households’ preferences for future versus present consumption. A rising interest rate indicates a reduction in the supply of saving (and an increasing demand for present versus future consumption) while a falling interest rate indicates an increase in the supply of saving (and an increasing demand for future versus present consumption).

Suppose people decide to save more. They will reduce their present consumption in order to save more for future consumption. The prices of goods for immediate consumption will fall, and the prices of investment goods will rise. Wages will fall at the point of immediate consumption, but they will rise for people farther back in the structure of production.

How do people know what to produce? When I’m 64, I might want birthday greetings, bottles of wine, or both. Enter profits and losses. Profits and losses tell firms whether they are choosing wisely with respect to what they produce. Firms that correctly anticipate what best satisfies households’ wants will be rewarded with profits while those that incorrectly anticipate what households want will be punished with losses. This is the essence of “an economy working right,” to borrow from F.A. Hayek via Garrison.

Miscalculation: When the government manipulates the money supply, the market’s signals are distorted. In Tim Harford’s book The Undercover Economist, he points out that competitive markets produce a “world of truth” in which prices reflect households’ preferences and firms’ costs of production. The Austrian theory gives us an example of a way in which prices are systematically lying. Entrepreneurs’ and managers’ appraisals are incorrect as a result of credit expansion. What looks like equilibrium isn’t, and the gap between real saving and the quantity of investable resources demanded is masked by new money. To use Professor Garrison’s term, the gap is “papered over.”

Things look great during the boom phase of the business cycle because consumption and investment are both increasing. They are increasing to unsustainable levels, though: during the credit expansion, firms initiate investment projects that cannot be realized given household savings. The structure of production is fundamentally distorted as prices, interest rates, and wages do not reflect households’ preferences. As credit expansion cannot continue forever without causing hyperinflation, miscalculations that led to malinvestments are eventually revealed.

Recalculation: If the economy is left to its own devices, miscalculations will be corrected and malinvestments will be corrected by a process of recalculation. Firms and households fix their mistakes, and resources are reallocated. Prices that are consistent with the economy’s underlying fundamentals of tastes, technology, and resource availability emerge and guide people toward what Arnold Kling has called “patterns of sustainable specialization and trade.” In other words, physical capital, human capital, and social capital are invested in lines of production that do not compromise a society’s ability to provide for its future wants.

Watching the budget yesterday, it struck me how unreal politics has become. George Osborne proudly mentioned his "credit easing" policy. Roger Garrison (quoted above) might call this "papering over" the gaps in the British economy, and he'd probably be right. It's as if the last ten years never happened. 

The rest, which we discussed in detail yesterday, sounded to me like papering over gaps in a fundamentally cracked economy that still needs to go through that crucial "recalculation" phase. Osborne invoked Adam Smith's canons of taxation, too, and he is supposed to have a great deal of respect for Smith's work. Very well — at least he's singing from the right hymn sheet, even if the tune's all wrong. It's too much to hope for an Austrian conversion from the Chancellor, but maybe in between his Theory of Moral Sentiments reading sessions, he'll find the time to read some Hayek, Mises, Art Carden or Roger Garrison too.

A free market take on the 2012 budget

Generally positive on tax…

• Cutting the 50p tax rate to 45 percent is a step in the right direction, but the Chancellor should have scrapped this altogether. The danger is that the 45p will become a permanent rate. The government should commit to scrapping this new top rate tax before the next election.

• Raising the personal allowance to £9,025 is also very welcome. The government should raise its target from £10,000 to £12,400, which would lift minimum wage earners out of tax altogether.

• The government’s commitment to merging income tax and national insurance is very encouraging. Britain’s tax code is absurdly complex and tax simplification should be one of the government’s top priorities.

• The ‘tax receipt’ idea could make a big difference. By making spending more transparent, people will be better able to hold the government to account for its fiscal policies. With a bit of luck, these tax receipts could sow the seeds of a small government revolution as more people realise how wasteful government spending really is.

• The additional cut in corporation tax is a good, pro-growth measure that will boost Britain’s economic competitiveness. But it should go further – competing with large countries is not enough anymore, and a corporate tax rate higher than 20% is still too high. Furthermore, the new and/or expanded allowances and tax credits the chancellor announced will increase complexity and run against the general theme of tax simplification.

But there are a few negatives on tax too…

• Raising tobacco duty by 5% above inflation is petty, vindictive, and possibly self-defeating. Such taxes are already extremely regressive, hitting the poorest the hardest. Moreover, high levels of tobacco duty are already encouraging smuggling and counterfeit cigarettes. Cigarette smugglers will be very pleased at today’s duty hike.

• Reducing the 40p rate threshold will mean that only basic rate taxpayers will benefit from the personal allowance rise. Up to 300,000 people will now find themselves upper rate taxpayers as a result. This will hit single-earner families particularly hard.

• The General Anti-Avoidance Rule is a bad idea. It leaves far too much latitude for bureaucratic discretion. It adds another layer of complexity on our labyrinthine tax code. And it is an affront to the rule of law. Radically simplifying taxes is a much better way of ensuring people pay their fair share.

• Raising Stamp Duty Land Tax on homes worth more than £2m is a politically-motivated sop to the Liberal Democrats. Taxes like stamp duty are damaging because they discourage transactions and gum up markets. They also raise very little revenue.

The budget is weakest where it strays into industrial policy…

• Was the tax credit for animation, video games, and high-end TV production designed just so the Chancellor could make his ‘Wallace & Gromit’ joke? These are unquestionably attractive, wealth-creating industries, but the government should not be picking winners and advantaging politically-favoured businesses over less fashionable ones like this.

• In promising to fund superfast broadband in 10 British cities, the government is creating a role for itself where it just isn’t needed. Over the past two decades, the private sector has delivered (and continues to deliver) a vast digital infrastructure at virtually no cost to the taxpayer. It is hard to think of a better example of something the state should simply stay out of.

• The Chancellor’s call for increased airport capacity in the South East is a good thing, but it is worth remembering that the politically-motivated rejection of such airport capacity has been explicit government policy up until now.

• The various credit, business, and construction support schemes contained in the budget are misguided, and will do little except preventing markets from adjusting to changed economic circumstances, as they must if we are to return to robust, sustainable growth. Nevertheless, these schemes are probably small enough to be dismissed as pointless gimmicks rather than serious market distortions.

The macro outlook is worse than the chancellor is letting on…

• The growth forecasts the chancellor announced still look implausibly optimistic. The public sector, financial industry, and housing/construction sectors all boomed unsustainably in the 2000s, and must probably contract further as the economy rebalances. We are weighed down by debt, and the deleveraging process has barely started. So in the absence of significant and radical supply-side measures to boost growth in the rest of the economy, it is hard to see how these forecasts can be met. And that’s before you even consider the sizeable downside risk posed by the eurozone crisis and our still-fragile banks.

• The government’s borrowing costs are low not because of the chancellor’s fiscal rectitude, but rather because the Bank of England is directly intervening in the gilts market to reduce borrowing costs via quantitative easing, and because things in the eurozone are even worse than in Britain. The economy may be getting better, but the overall macro-economic picture remains far worse than the chancellor is likely to admit. 

• Finally, it is worth remembering that for all the talk of austerity Britain, the government will still borrow £126bn this year. That’s £14.5m an hour, every hour, all year long. 

Can the budget breathe life into the economy?

It is worth remembering that no chancellor, however enlightened, can really be said to breathe life into the economy. Believing otherwise gives rise to all kinds of hubristic policies, which do little more than redistribute wealth from one area of the economy to another. In fact, all the chancellor can do is create the conditions in which the wealth-creating private sector can grow and prosper. This is the yardstick by which the forthcoming budget should be judged.

So what can we hope for from the chancellor? What can he do to help Britain’s beleaguered wealth-creators? Step one is to cut taxes. And here, perhaps we can be more optimistic than usual. All the indications are that the 50p tax rate is set to be cut to 45 percent. The chancellor ought to go further and faster, since cutting marginal rates for higher-earners has a history of boosting growth without significantly impacting revenues. But this is a start, and it sends a clear message that Britain is open for business. Raising the personal allowance, and leaving a bit more cash in every worker’s pocket, is a good move too.

Combined with the gradual reductions in corporation tax that we already know about, these moves make for an encouraging pro-growth tax agenda. But more needs to be done. Firstly, the chancellor must avoid the temptation to give with one hand and take with the other – so no new stealth taxes, and no more populist assualts on ‘the rich’.  More importantly, the chancellor needs to realize that Britain’s treatment of capital and investment is uncompetitive and economically damaging. Taxes on savings, dividends and capital gains should be reduced immediately, and ultimately eliminated altogether.

That is likely too much to hope for now. But there are other, politically easier things the chancellor could announce on Wednesday. Chief among these is a concerted effort to deregulate the UK economy, systematically reducing barriers to market entry, cutting costly red-tape, and boosting competition. The trouble is such campaigns have been announced countless times before, but the regulatory burden has just kept growing. This time, we need more than rhetoric.

Two areas are worth particular attention. Firstly, it is rumoured that the budget will contain early details of a new regulatory framework for the flourishing internet and technology industries. It is vital that this framework is the very epitome of ‘light-touch’ and does not stand in the way of innovation, growth and job creation. Sadly there are already indications the chancellor’s announcements will fail this test. Secondly, the chancellor ought to build on David Cameron’s recent call for more private investment in the road network by signalling the government’s intention to radically liberalize the planning system and free the private sector to invest in (and charge for) new infrastructure.

Cutting taxes, reducing regulation, and encouraging investment – these are the three most crucial things the chancellor’s budget can do to help the private sector breathe life into the UK economy. But there is also a broader point to be made. Britain’s financial crisis and recession was no random event – it was the product of the credit-fuelled boom that preceded it. Years of easy money distorted the economy, creating unsustainable booms in finance, property and the public sector, and left us weighed down with debt. Thanks to bailouts, quantitative easing, and record-breaking budget deficits, those problems are still with us. We haven’t allowed the economy to adjust, and that is significantly damaging our growth prospects. Such problems will take time to unwind, but for now, the chancellor must find the strength to eschew popular but counter-productive policies like credit easing and housing market stimulus. Doing otherwise risks the long-term zombification of the British economy – the very opposite of what the chancellor wants to achieve.


A tale of two minimum prices

Consider two propositions. Firstly, that a minimum price on a unit of alcohol will reduce alcohol consumption by making cheap booze less affordable. Secondly, that minimum wage laws increase the price of a unit of labour, but do not lead to greater unemployment. 

These two statements are logically inconsistent and yet many people are able to hold both simultaneously. Some people take the opposite view: that minimum pricing won’t work, but that the minimum wage destroys jobs. They, too, seem to believe that employers respond differently to higher costs than drinkers.

There would be less disagreement if the minimum wage was raised to £50 an hour and the minimum price was set at £20 a unit. Clearly, there is a point at which the price exceeds what people are willing to pay. The only question is whether 50p a unit – as demanded by the ever-demanding British Medical Association – reaches that point. If 50p proves ineffective, we can surely expect campaigns for a 60p, 70p and 80p unit price in the years ahead.

Demand for alcohol is often inelastic, most obviously for alcoholics, but so is demand for labour. If a supermarket chain wishes to open a new store, it will have to employ shelf-stackers. The minimum wage might compel this employer to spend more on labour costs than would otherwise be the case, but at £6.08 an hour, it is unlikely to plunge him into bankruptcy. He might have to find savings elsewhere, but the store will still open. 

The situation might be different for the sole trader who is offered a contract to make a thousand widgets. The contract can be fulfilled, but only by taking on staff. If he pays £5.50 an hour, there is just enough profit to make the job worthwhile, but at £6.08 the margin is too tight. Deciding that the job is not worth the hassle, he turns down the contract and it goes to a company in China. We cannot know how often decisions like this are made, but it is doubtful that they are never made at all. The demand for labour may be relatively inelastic, but it is not totally rigid.

The minimum pricing of alcohol differs from the minimum pricing of labour only insofar as it is explicitly aimed at reducing consumption. The unintended consequence of the minimum wage is the intended consequence of minimum pricing and vice versa.

Ultimately it is a moral question. We might accept the loss of a few jobs for the higher goal of ensuring a higher wage for the low-paid, just as we might accept that forcing the majority to pay more for their beer is a price worth paying if a few problem drinkers cut down their consumption. The economics remain the same in both cases, but there is one significant distinction. Whereas the minimum wage compels supermarkets to give low-income workers more money, minimum pricing compels poor consumers to give supermarkets more money. No matter how noble the intention, that would be a peculiarly ignoble consequence.