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"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice" - Adam Smith

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

Written by Sam Bowman | Thursday 14 February 2013

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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When is a potato chip not just a potato chip?

Written by Blog Editor | Thursday 14 February 2013

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

Written by Lydia Ellis | Wednesday 13 February 2013

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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Chart of the week: US trade balance

Written by Gabriel Stein | Tuesday 12 February 2013

Summary: The US trade deficit for December 2012 was the narrowest since January 2010

What the chart shows: The chart shows the US trade balance – exports minus imports – in millions of dollars.

Why is the chart interesting: US exports were surprisingly strong in December, rising by 2.1% from November, while imports fell by 2.7%. The data is important, both because it shows that the recent improvement in the US foreign balance continues, if erratically; and because it is likely to lead to a revision of the Q4 economic growth data. Last month the bureau of economic analysis said that the US economy shrank by 0.1% in Q4 2012. (Note that American growth numbers are given as the seasonally adjusted annualised rate of change from the previous quarter; in Europe, where the number is usually given as the quarterly change, the US number would have been -0.025%, ie, no change.) The unexpectedly strong trade numbers probably mean that this will be revised to show a small positive figure instead.

Chart and comments provided by Stein Brothers (UK), www.steinbrothers.co.uk.

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The inheritance tax of loss

Written by Dr Eamonn Butler | Monday 11 February 2013

The Health Secretary Jeremy Hunt plans that, from 2017, anyone with assets, including their home, worth more than £123,000 will be liable for the first £75,000 of their social care costs. They will also pay accommodation expenses of up to £12,000 a year. This, he says, will prevent people having to sell their homes when they need to move into residential care, which can be very expensive.

Meanwhile the Chancellor of the Exchequer, George Osborne, will say that the level at which inheritance tax becomes payable on estates will be frozen at £325,000 instead of being raised to £1m as the Conservatives had pledged before the election.

The care funding plans will benefit perhaps a fifth of the UK's pensioners: at present, people with much lower levels of assets are liable for their own care costs.

But then the money has to come from somewhere. Why should younger people, many of them starting out in life and trying to provide for their families on modest incomes, face higher taxes to support those who already own their homes?

After all, people in the UK see their homes as a form of saving. And it has been a much more reliable form of saving than having your money in the bank, where it is whittled down fast by inflation – inflation caused, of course, by the bad monetary policy of the authorities.

Governments have actually encouraged this form of saving too. Many of those benefiting from Jeremy Hunt's plans will have enjoyed tax relief on their mortgage interest payments for many years under the old MIRAS scheme. When they cashed in and moved up the property ladder, they would not pay the 28%-40% capital gains tax rates that have been levied on other kinds of assets like shares and bonds. Planning restrictions have ensured that house prices have kept on going. And so on.

If governments have encouraged people to save in their homes in these ways – using taxpayers' cash to fund the process – it is remarkable that they now maintain that people should not be expiated to cash in those assets when they need to. Yes, if you have to move into a residential care home it is a difficult time, but if you have saved in your home for a rainy day, it is a bit much to expect taxpayers then to hand you a very expensive umbrella so you can pass the home on to your kids.

...Who will then end up paying more inheritance tax on that asset – a 40% tax which breaks up capital (just at the time when we need capital to invest in economic recovery) and which encourages people to juggle their assets so as to avoid the tax. So big is the loss from this that the tax – though a nice earner for the government – has probably produced negative returns for the economy for the 100+ years of its history.

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Why we really should cut employers national insurance

Written by Tim Worstall | Sunday 10 February 2013

We've talked a lot around here about how the working poor should be lifted up entirely out of the income tax system. Get that personal allowance up to something like the full year, full time, minimum wage. And of course, national insurance would have to start at that point as well.

There's one bit that has been a little contentious though. I've argued that employers' national insurance must only start at that level too. The come back has been that, well, since employers pay that then why should they get a tax reduction when we want to increase the take home incomes of the working poor? Which is to ignore the whole idea of tax incidence. That employers hand over the money isn't in doubt. It's whether the workers' wages fall to account for it which is.

Fortunately we have an interesting paper to shine light on this question:

The choice between these alternatives hinges upon our views on who actually bears the tax burden. In the case of employer social contributions, they can be borne by firms (reducing their after-tax profits), they can be 'shifted backwards' to employees (reducing net wages of their workforce) or 'shifted forward' to consumers (increasing the price level of their products).

Yes, that is what we want to know. Who really pays these taxes?

The economic effects of social contributions are sensitive to both moderators representing basic economic institutions (which can be summarised in three 'models’: namely Anglo-Saxon, Continental-Mediterranean and Nordic) and the tax wedge definition – in particular, the inclusion of indirect taxes. Moreover, the impact of taxes on wages differs in the short as well as the long-term. In our preferred specification, the elasticity of wages to taxes is -0.70 in the default option, i.e. a non-Nordic economy in the long run. Therefore, workers bear 70% of taxes.

So, 70% of employers' national insurance is really paid by the workers in the form of lower wages.

Something which should give those living wage campaigners food for thought. If we now include employers' NI as well as income tax and employees NI then simply raising the personal allowance (to all three) to the full year, full time, minimum wage would give workers a larger post tax income than the living wage would.

All of which really makes me wonder why they don't in fact campaign for this. They are, after all, trying to make the working poor better off aren't they?

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Certainly securitisation increased risk taking: that's the darn point of it

Written by Tim Worstall | Saturday 09 February 2013

I thought this was an interesting little piece of research by the New York Fed.

There’s ample evidence that securitization led mortgage lenders to take more risk, thereby contributing to a large increase in mortgage delinquencies during the financial crisis. In this post, I discuss evidence from a recent research study I undertook with Vitaly Bord suggesting that securitization also led to riskier corporate lending. We show that during the boom years of securitization, corporate loans that banks securitized at loan origination underperformed similar, unsecuritized loans originated by the same banks. Additionally, we report evidence suggesting that the performance gap reflects looser underwriting standards applied by banks to loans they securitize.

However, the bit I missed in the subsequent discussion was the point that this is what securitisation is for: to allow greater risks to be taken. Not that I missed seeing what is there, I missed it because they don't mention it.

Just so that we all understand, securitisation is the idea of chopping up a loan or a pool of loans into bonds that can then be sold off to various different groups of investors. It's often associated with structuring the pool of loans: say, one group of investors takes the first 10% of losses, the next the next 20% and so on. But this structuring isn't necessary: securitisation is just the creation of the bonds that can be sold around.

And of course lending is, like any other form of provision of capital or debt to people, all about managing risk. There's the risk, after all, of absolutely any loan not being repaid. Further, there's a constraint as to how much banks can lend and to whom in the risk that is associated with any such loans. This constraint is something we'd rather like to find a way around, too.

We don't want the banks themselves to be taking more risks: but we would rather like those riskier projects to be able to find financing from somewhere. The economy would be a very boring and static place if no one did lend to anything that had any risk associated with it.

The answer thus is to make sure that these extra risks are not being carried by the banks. That they are spread out over some larger or different group of people. People who have both a greater appetite for risk and also a greater capacity to bear it. And that's exactly what securitisation does, is indeed the very purpose of it.

Finally, we find evidence that all loan investors, including banks, expect that securitized loans will perform worse. Banks appear to do so because they charge significantly higher interest rates on these loans than on the loans they don’t securitize. Institutional investors, who together with the originating bank and CLOs acquire the loans that banks securitize, follow the loan originator and choose to acquire a smaller stake in securitized loans.

And it appears that everyone was entirely aware of this greater risk: so much so that everyone took on a smaller portion of any one risk. Exactly and precisely what we desire to happen.

Our evidence that securitization led to riskier corporate lending is in line with similar findings unveiled by studies of the effects of securitization on mortgage lending. Taken together, these studies confirm an important downside of securitization.

This isn't a downside: this is the point, the very purpose. We're happy with greater risks being taken as long as those risks are distributed and laid off to those who can bear them. Which is what securitisation does.

One more thing:

While on average banks retain 26 percent of each syndicated loan they originate but don’t securitize, they retain only 9 percent of each loan they do securitize.

If the banks had held onto zero percent of the loans that they had securitised then there would have been zero financial crisis. If all of that risk had been passed on to the insurance companies, pension funds, individual investors, then we wouldn't have had highly geared banks falling over as they had to liquidate positions in bonds fast falling towards zero. And guess what the solution has been to this little point? Yup, you guessed it, laws that insist that banks must, must, hold onto a portion (usually 5%) of any securitisations that they originate. It's almost as if our rulers don't understand the world they rule. They're insisting on concentrating risk in exaclty the manner that caused the crisis instead of dispersing it in the manner that would have avoided it.

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It's time to end big government's grip on our prisons

Written by Sally Yarrow | Friday 08 February 2013

Ben Gummer MP has an interesting article in the Daily Telegraph today calling for reform in the UK’s prison system. We have twice as many men and women incarcerated in England and Wales as there were in the mid-1990s. In short, our prisons aren’t working. Spending on prisons has continued to rise to close to £4bn, while reoffending rates have stayed the same. Ben Gummer argues that now is the time, during this period of austerity, to finally address the issue and bring real reform to the penal system.

In his article, Ben Gummer argues for:

‘…the need to re-connect victims and communities with sentencing, to make punishment more local and purposeful, and to remove as far as possible the impersonal and failing bureaucracy of the state. For many criminals, prison is just another welfare dependency, and we might challenge its over-use on those grounds alone.’

He also points out that prisons often fail to rehabilitate prisoners and treat the root causes of criminal behaviour. Bad prisons’ ‘failure to tackle mental health, profound psychological disorder, drug and alcohol addiction and moral vacuity, is in itself a crime on society’s part. We put people behind walls and then forget about them. That is wrong.’

Ben Gummer raises some important issues in his article. Unfortunately for far too long it has been implicitly accepted that sending people to prison is an effective way of tackling crime. A fascinating paper released by the Howard League for Penal Reform this week undermines this assumption, showing that prison’s effect in deterring people from committing crime can be overestimated, while reconviction statistics highlight the failure of the penal system to reintegrate convicts in society.

A one-size-fits-all approach to the penal system isn’t working. The state doesn't have the knowledge necessary to determine a single ideal imprisonment system, despite the highly centralized nature of our criminal justice system.

As the ASI's Sam Bowman argued in an event with the Howard League this week, we should learn from free markets. Central government cannot run prisons and criminal justice any better than it can run hospitals and schools. It is only through experimentation and a more localised approach to punishment that we can discover effective ways to solve our current prison problem. 

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Article: Blame bailouts for huge budget deficits

Written by Vuk Vukovic | Friday 08 February 2013

Among Keynesian economists there is a resilient opinion on how the current large budget deficits shouldn’t be thought of as a serious problem to the economy, since they are ultimately a result of a depressed economy. Here's Paul Krugman:

“It’s true that right now we have a large federal budget deficit. But that deficit is mainly the result of a depressed economy — and you’re actually supposed to run deficits in a depressed economy to help support overall demand. The deficit will come down as the economy recovers: Revenue will rise while some categories of spending, such as unemployment benefits, will fall.”

Disregard for a moment the key issue regarding this type of opinion - which is that in a depression a government is supposed to run large deficits in order to jump-start a recovery. Let's for now focus only on the argument that a deficit is a result of a depressed economy. What Krugman and the like have in mind when they make this claim is the following; because of the crisis and the credit crunch many businesses fail and consequentially unemployment rises. This creates pressures on the budget deficit, since revenues fall as many businesses are bankrupt and are not paying taxes (on both profits and employee taxes), and on the other hand many new unemployed put pressure on the expenditure side, as the government has to pay out more unemployment benefits.

This is all true. All the combined effects of the credit crunch will almost always result in an increased budget deficit. But they will never be so big to make the deficit rise above 10% of GDP as it did in the UK, Ireland or Spain (to mention only a few). Something else was at hand here.

This 'something else' was large government bailouts of fallen banks.

Continue reading.

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Chart of the week: European household savings rates

Written by Gabriel Stein | Thursday 07 February 2013

Household savings rates are unchanged or headed in the wrong direction. That is bad news for the euro area.

What does the chart show: The chart shows household savings rates as % of disposable income up to Q3 2012, by country.

Why is the chart interesting: Within the euro area, as globally, part of the cause of the Great Recession was an imbalance between excess savers and excess spenders. This needs to rebalance – spenders need to save more and savers need to spend more. But, the chart shows that savings in Spain and Italy are on a downward trend, whereas in Germany, France and the Netherlands they are broadly flat. This implies that the underlying problems in the euro area are far from solved.

Chart and comments provided by Stein Brothers (UK), www.steinbrothers.co.uk

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