It is often baffling how some Budget measures cause outrage while others pass by barely noticed. We all remember the furore about the tax credit cuts. But how many people remember that the same cuts will be applied to Universal Credit, which is replacing tax credits? This week’s cut to the Personal Independence Payment (PIP) is another example. Jeremy Corbyn denounced it as punishing “the most vulnerable and the poorest in our society”. The ink had barely dried before Tory backbenchers made clear their disagreements with the Chancellor. But of all the cuts that the Conservatives have made to disabled people, the cuts to PIP may well be the most sensible. They are almost certainly the least damaging.
That we have something of a housing problem in the UK is obvious. That we should be doing something about it equally so. However, those who tell us that we should be building more council houses are wrong. Yes, obviously, build more housing to bring the price down (by releasing more land to build upon) but housing on council tenancies is just the wrong way to go:
This paper provides new evidence on the effects of moving out of disadvantaged neighborhoods on the long-run economic outcomes of children. My empirical strategy is based on public housing demolitions in Chicago which forced households to relocate to private market housing using vouchers. Specifically, I compare adult outcomes of children displaced by demolition to their peers who lived in nearby public housing that was not demolished. Displaced children are 9 percent more likely to be employed and earn 16 percent more as adults. These results contrast with the Moving-to-Opportunity (MTO) relocation study, which detected effects only for children who were young when their families moved. To explore this discrepancy, this paper also examines a housing voucher lottery program (similar to MTO) conducted in Chicago. I find no measurable impact on labor market outcomes for children in households that won vouchers. The contrast between the lottery and demolition estimates remains even after re-weighting the demolition sample to adjust for differences in observed characteristics. Overall, this evidence suggests lottery volunteers are negatively selected on the magnitude of their children’s gains from relocation. This implies that moving from disadvantaged neighborhoods may have substantially larger impact on children than what is suggested by results from voucher experiments where parents elect to participate.
This is over and above the well known finding that labour immobility reduces employment levels. And in the British housing market there's nothing so immobile as a council tenancy.
We're always going to have some form of housing subsidy for those who simply cannot manage themselves. But it should be a subsidy simply paid out, not the creation of estates of immobile people.
There is such a thing as a bad tax cut, and business rates relief for small businesses is one of them. Despite what the Chancellor claimed in his budget yesterday, reducing rates will likely be a tax cut for landlords, not businesses. Business rates are a tax on non-domestic property, paid by the occupier rather than the owner and based on the property's rentable value. Since they are paid by the renting business, most people assume it is businesses who lose out because of them.
George Osborne made a truly horrible decision in the Budget yesterday: the one about a sugar tax.
So today I can announce that we will introduce a new sugar levy on the soft drinks industry.
Let me explain how it will work. It will be levied on the companies. It will be introduced in two years’ time to give companies plenty of space to change their product mix.
It will be assessed on the volume of the sugar-sweetened drinks they produce or import.
There will be two bands – one for total sugar content above 5 grams per 100 millilitres; a second, higher band for the most sugary drinks with more than 8 grams per 100 millilitres.
Pure fruit juices and milk-based drinks will be excluded, and we’ll ensure the smallest producers are kept out of scope.
We will of course consult on implementation.
We’re introducing the levy on the industry which means they can reduce the sugar content of their products – as many already do.
It means they can promote low-sugar or no sugar brands – as many already are.
They can take these perfectly reasonable steps to help with children’s health
Of course, some may choose to pass the price onto consumers and that will be their decision, and this would have an impact on consumption too.
We understand that tax affects behaviour. So let’s tax the things we want to reduce, not the things we want to encourage.
It's not that taxing sugar is a particularly bad thing to do. There's other nice and desirable things that we tax like booze and insurance. Hey, got to get the revenue where you can.
Rather, what worries us is the monumental mountain of lies that the campaign for this tax has been built upon. Sugar consumption has been falling in recent decades even as the country gets ever porkier. It is therefore not sugar consumption driving the fact that we're all becoming lardbuckets. If that is so the tax won't achieve the stated goal.
However, what will happen as a result of giving in to the misinformation being shouted from the rooftops is that every Single Issue Fanatic will now be concocting plans to bombard us, and more crucially the government, with demands for whatever absurdities they can conceive of imposing upon us. Whatever the actual merits of a sugar tax (none, but that's by the by) the caving in to the fanatics has just made future public policy worse.
Just not a good idea.
Commenting on today's Budget, spokesmen for the Adam Smith Institute said:
Today’s budget was disappointing. Growth forecasts have been lowered, and the Chancellor’s failure to deliver any kind of growth agenda in the last Parliament has left the British economy vulnerable to a global economic slowdown. Even more worryingly, he doesn’t seem to care. There was nothing major in this budget to boost investment, and far from simplifying the tax system the Chancellor announced a raft of new levies that will make it even more complicated and wasteful.
Mr Osborne seems so firmly focused on the politics of the budget that he seems to have ignored the economics of it altogether.
– Sam Bowman, Executive Director
Mr Osborne sounded a lot like Gordon Brown today
Nigel Lawson's budgets were models of clear-sighted vision. In every budget he cut taxes, simplified them, and abolished at least one altogether. A George Osborne budget seems more like one of Gordon Brown's, a patchwork quilt of little measures with no clear pattern to it.
– Madsen Pirie, President
The Chancellor’s deficit plan is in tatters
Mr Osborne’s deficit reduction plans for this Parliament always seemed improbable but lowered growth forecasts make this plain to see. At the current rate of cuts, he will now need to find £31bn of cuts or tax rises in the year 2019 alone to deliver his surplus. This is highly unlikely and it seems almost certain that he will end up breaking all three of his own fiscal rules. In all likelihood he does not expect to be in the job by then and doesn’t mind handing the problem to someone else.
– Sam Bowman, Executive Director
Cutting business rates for small businesses is a bad idea – and could Italify British businesses
Business rates are mostly a tax on landowners, not on firms. Even though firms write the cheques, when business rates are cut, rents rise in proportion, so firms are no better off, but landowners are. Reducing rates for small businesses only makes this problem even worse. Not only will rents rise across the board for all firms, big and small, there now is a large distortion in favour of smaller firms present in the rates system, akin to rules in slow-growing Eurozone states like France and Italy. Smaller firms are generally less productive than large firms, and by creating a large distortion in favour of inefficient small businesses the Chancellor is risking the "Italification" of British business.
– Sam Bowman, Executive Director
Corporation tax cuts are modest good news
Corporation tax is—as George Osborne said—one of our least efficient taxes, destroying huge amounts of economic activity for each pound it raises in revenue. Cutting it from its current rate to 17% by the end of the parliament will put upwards pressure on productive investment and on workers wages, though the move is small. Devolving the tax to Northern Ireland is also very welcome—currently there is a very strong incentive for firms to site themselves just across the border in the Republic of Ireland, purely in order to pay lower corporation tax. Equal corporation tax on either sides of the border would bring the UK more revenue, and increase efficiency by reducing arbitrary distortions on where businesses should locate.
– Ben Southwood, Head of Research
The soft drinks tax is the thin end of the wedge
A tax on sugary soft drinks is the first step on the road to fat taxes and sugar taxes more generally. It makes little sense to tax sugary drinks on their own, rather than sugar more generally – a couple of Mars bars are just as bad as a bottle of Coke – but the Chancellor probably reckons that the public won’t care if he only targets soft drinks. Once the tax is in place, he will follow the lead of other ‘sin taxes’ and raise it higher and higher, and impose it on more and more things. The costs of this tax will likely be passed on to consumers in the form of higher prices, so it will be regressive.
– Sam Bowman, Executive Director
Capital gains tax cuts are a return to normal
We should not exaggerate the chancellor's achievement with his capital gains tax cut, as he has only returned the main rate to the level enjoyed under New Labour, but it is nevertheless a step in the right direction. Reducing the returns to investment reduces investment, it's as simple as that, and most economists therefore oppose capital taxation. However, though the overall move is a step in the right direction, it also adds layers of complexity: lower rate taxpayers and entrepreneurs continue to pay lower rates, while housing and carried interest remains taxed at the old rate. Tax preferences for certain sorts of investment work against market signals, pushing cash towards areas it can do less good in.
– Ben Southwood, Head of Research
Raising the personal allowance is a good thing, but National Insurance thresholds have been left alone again
The Adam Smith Institute has campaigned for years to take the lowest-paid workers out of tax, and progress in raising the personal allowance is to be welcomed. But there has been no movement in National Insurance contributions, which are an income tax in all but name and kick in at much lower income levels than income tax now does – at just £8,060 per year. The Chancellor should target his income tax cuts on the poor and focus on raising National Insurance thresholds.
– Sam Bowman, Executive Director
The education changes will waste children's time and taxpayers' money
Announcing large, headline-grabbing education policy changes that were largely unrelated to funding in the budget would have been forgivable if there was evidence suggesting these moves would actually help much. But forcing kids to learn maths until 18, and stay in school until nearly 5pm, is going to cause lots of pain for little gain—Danish and Chinese evidence suggests that we'll see few if any benefits. Switching to an all-academy system, on the other hand, is probably a good move.
– Ben Southwood, Head of Research
(For the previous posting in this series, see here.) This posting goes through the Bank of England’s stress tests of UK banks’ leverage ratios – roughly speaking, their ratios of capital to leverage exposure. The banks perform poorly according to this test even under the very low 3% pass standard used by the Bank. Moreover, almost all banks fail the test under the higher minimum standards called for under Basel III when it is fully phased-in – and even those pass standards are much lower than they should be. These results confirm that the UK banking system is in very poor shape.
In an earlier posting, I suggested that the leverage ratio – the ratio of bank capital to its leverage exposure – is a better capital adequacy metric than capital ratios that use a denominator expressed in terms of Risk-Weighted Assets (RWAs). This is because the leverage exposure is a more reasonable and much less gameable measure than the RWA measure.
In this posting, I will go through the Bank of England’s second stress test – the test based on the Tier 1 leverage ratio, i.e., the ratio of banks’ Tier 1 capital to their leverage exposures. The definitions of these terms were explained here.
In this test, the Bank sets its minimum pass standard equal to 3%: a bank passes the test if its Tier 1 leverage ratio post the stress scenario is at least 3%, and it fails the stress test otherwise.
The outcomes for this stress test are given in Chart 1:
Chart 1: Stress Test Outcomes Using the Tier 1 Leverage Ratio with a 3% Pass Standard
(a) The pass standard is the bare minimum requirement (3%), expressed in terms of the Tier 1 leverage ratio - the ratio of Tier 1 capital to leverage exposure.
(b) The outcome is the Tier 1 leverage ratio post the stress scenario and post any resulting management actions. These data are obtained from Annex 1 of the Bank's stress test report (Bank of England, December 2015).
By this test, the UK banking system looks to be in pretty poor shape. The average outcome across the banks is 3.5%, making for an average surplus of 0.5%. The best performing institution (Nationwide) has a surplus (i.e., outcome minus pass standard) of only 1.1%, four (Barclays, HSBC, Lloyds and Santander) have surpluses of less than one hundred basis points, and the remaining two don’t have any surpluses.
You should also keep in mind that this 3% pass standard is itself a very low one. Despite its pretensions to impose tough new capital standards, Basel III still allows banks to fund up to 97% of their leverage exposure by borrowing and to have as little as 3% equity to absorb losses. Thus, if a bank has a leverage ratio of 3%, then it only takes only a loss equal to 3% of that leverage exposure to wipe out all its equity capital and render it insolvent.
Basel III’s minimum capital requirement is also way below the capital standards maintained by non-financial corporates, which only rarely have capital ratios below 30%.
In any case, the Basel 3% minimum requirement would not have helped had it been in place before the financial crisis: by 2007, UK banks’ average capital to asset ratios had fallen to just under 4% - still above the Basel III minimum, but not enough to prevent the collapse of the UK banking system. There is, therefore, no reason to expect that such a minimum capital ratio would protect the system in the face of a recurrence of the recent crisis.
Going back to our stress test, you have an easy exam with a very low pass standard, and yet the UK banking system barely scrapes through, if even that.
It is also curious that the two weakest banks hit the pass standard right on the nose: had the stress been even a smidgeon more severe, they would have failed the test. It is almost ‘as if’ the stress test had been deliberately engineered to ensure that the adverse scenario was as adverse as it could possibly be without actually pushing any bank over the edge.
To be clear: I am not suggesting that the good folks at the Bank would even dream of fixing their stress test to produce such an outcome. But I am saying is that it is quite a coincidence to get not just one but two banks whose post-stress outcomes just happen to come out to be exactly equal to the pass standard.
Be all this as it may, the Bank’s assessment was much more upbeat than any Jeremiad of mine. Regarding the five best-performing banks (i.e., the ones that actually got a surplus) it reported that the PRA Board had judged that the “stress test did not reveal capital inadequacies” for these banks and saw no need to mention that their surpluses were rather on the small side – 0.3% for Barclays, 0.4% for Santander, 0.7% for HSBC, 0.9% for Lloyds, and only 1.1% for the star of the class, the Nationwide.
As for the two dunces that got surpluses of exactly zero in the leverage ratio test, the PRA Board carefully noted that their capital positions remain above the threshold CET1 ratio of 4.5% and meet the leverage ratio of 3%”. Nice choice of words.
Despite their capital inadequacies, these two then got off with of a slap on the wrist from the PRA and their capital plans were approved.
The Bank’s overall assessment was then this:
The stress-test results suggested that the banking system was capitalised to support the real economy in a global stress scenario which adversely impacts the United Kingdom, such as that incorporated in the 2015 stress scenario.
Personally, I would have slightly re-edited this statement to read as follows:
The stress-test results suggested that the banking system only just managed not to fail the test under the 2015 stress scenario and obviously we cannot draw any conclusions about whether the banking system would have passed the stress test under any other stress scenarios that we did not consider.
It might also have pointed out that the banking system would have failed the stress test if the stress scenario had been more adverse or if the hurdle had been even a little higher.
There is another problem as well. The 3% pass standard assumed in this test took no account of the additional leverage ratio requirements that will be phased-in under Basel III: these are the additional leverage ratio requirements corresponding to the Counter-Cyclical Capital Buffer and Globally Systemically Important Institutions Buffer. If we include these to their maximum possible extent under fully phased-in Basel III, then we get the outcomes shown in Chart 2:
Chart 2: Stress Test Outcomes Using the Tier 1 Leverage Ratio with the Potential Maximum Basel III Pass Standard
(a) Author’s calculations based on information provided by the Bank of England’s ‘The Financial Policy Committee’s review of the leverage ratio” (October 2014) based on the assumption that the pass standard is the potential maximum required minimum leverage ratios under fully-implemented Basel III.
(b) The outcome is expressed in terms of the Tier 1 leverage ratio - the ratio of Tier 1 capital to leverage exposure - post the stress scenario and post any resulting management actions. These data are obtained from Annex 1 of the Bank's stress test report (Bank of England, December 2015).
If the earlier outcomes reported in Chart 1 were bad, these are disastrous: the overall average shortfall is 0.85%, only one bank (Nationwide) scrapes through the test with a surplus of under 0.1% and the other six banks fail.
It gets worse, too: it turns out that even these outcomes are still overly optimistic.
More on this in the next posting.
 See P. Alessandri and A. G. Haldane, “Banking on the state,” November 6, 2009, chart 2, p. 24.
 Quotes from Bank of England, “Stress testing the UK banking system: 2015 results,” pp. 9-10.
 And if we applied those other adjustments too, then we would get an even higher average shortfall, i.e., 0.85% + 3.5% – 1.89% = 2.46%. Ouch!
PJ O'Rourke once asked perhaps the most interesting question we can ask about government. Namely, when are we done? When have we passed all the laws that need to be passed and we can fold the tent and quietly creep away? When have we addressed all those problems that can be addressed by legislation and thus have no need to support a class of legislators? He didn't know the answer to that but we now do: we have reached that point. We're done:
The traditional summertime sound of the ice cream van chime has, for decades, been music to the ears of pensioners, as well as children, who duly venture outside for a weekly treat. But a city council's decision to ban vendors from pausing on the street for longer than 15 minutes has caused great upset amongst the elderly, who fear they won't make it to the van in time. The crackdown has been branded "ridiculous" and prompted more than 65 people, many of them pensioners, to write to town hall chiefs, warning that they are too frail to adhere to such a time limit. Previously, ice cream vans were allowed to remain static for 20 minutes but could stay as long as they liked if they had a queue. The new rules mean that they must leave their spot within 15 minutes, only staying an extra quarter-of-an-hour maximum if there are people waiting. If they breach the 30-minute limit, they face having their licence to trade revoked.
Pensioners have been writing in to point out that, given the NHS' ability to perform hip replacements, it can take them 30 minutes to get to the van. But our objection is not to what this rule is, it's to the existence of the rule at all. This is clearly and obviously something that can be left to the market unadorned to solve. After all, the point of the ice cream van is that it is mobile: it goes to where the customers are. If there are none it will move on: if there're lots it will stay longer. This is what we want: our aim is always to at least attempt to increase the consumption opportunities of the population and "stay if you've got customers, move if you don't" obviously maximises that, our goal.
This regulation is not just therefore ridiculous (seriously, that grown adults working on the taxpayers' money, even dream of the idea that the parking time of an ice cream van needs regulating?) it is counter-productive, it takes us further away from our aim of maximising the people getting what the people want. We have therefore reached Peak Government, we have solved all possible problems and are now left meddling where there is no need to.
Which, while the thought that anyone tried to regulate Mr. Whippy is depressing, is actually a cheerful message, isn't it? For now we have ahead of us the pleasant task of firing the politicians given that their predecessors have already managed to complete the necessary tasks.
The simple existence of a set of parking time regulations for ice cream vans proves that this is so.
When the Financial Conduct Authority sets out to be helpful, as its latest Financial Advice Market Review does this week, it is hard to know whether to laugh or cry. The strategic problem is that its own regulatory approach is causing the market which it is supposed to protect and grow, to fail. The strategic solution would be to abolish the FCA but it is Osborne’s baby and he will not do that. So the new FAMR shows the advisers and their clients how to do their business in another market beyond the FCA’s clutches. It is all a bit subtle: financial “advice” is regulated but financial “guidance” is not. The government’s Money Advice Service, for example, is not regulated no matter what rubbish it may advise. The FCA wants the Treasury to make the distinction more explicit and advisers to understand how they can exploit that. Advisers should be “navigating the boundary between providing helpful guidance based on a customer’s circumstance (such as a financial ‘health check’ prompting customers to think about their financial needs and priorities) and [not] straying into an implicit personal recommendation.” (p.28). It is OK to talk about X (must be nameless, wink, wink, nudge, nudge) who has very similar circumstances and wisely adopted course Y provided one does not actually recommend Y to the client.
And the FCA will now offer “new guidance to support firms who wish to offer 'streamlined advice' on a limited range of consumer needs." This should include, it says, "a series of illustrative case studies highlighting the main considerations firms need to take into account when developing such models.” “Streamlined” advice is, of course, guidance, not advice. (p.35). Terminology is a problem as the FCA also refers to this category as ‘simplified’ or ‘focused’ or ‘basic’ advice. “Nudges” and “rules of thumb,” in case you were wondering, are guidance, not advice.
The FCA makes the distinction that, following guidance, it is the client who decides the course of investment whereas, according to them, the client always follows advice. This is a non-difference as the decisions are always made by the client in both cases.
One should not mock as there is a genuine attempt, in all the muddle, to shift finance advice from regulated bureaucracy to a mass market. The FCA is excited by the idea of “robo-advice,” allowing the consumer to provide her details and options to her tablet, or whatever, and receive an investment plan back. Banks and the other big players, who can see competitive advantage over the independent professionals, are equally excited. And because banks’ computers are never wrong, this will be “guidance,” not “advice.” Importantly, it could become value for money for the consumers currently locked out by the FCA.
Yet another report from Oxfam shouting about the iniquities of inequality, the way in which tax havens rob governments of their rightful dues and....well, you get the story, you've heard it screamed at you often enough. But the real point to pick up from this is how unimportant that issue of tax havens actually is:
In a report titled End the Era of Tax Havens, Oxfam said wealthy people funnelling cash to “secrecy jurisdictions” such as the Cayman Islands and Bermuda were contributing to the wealth divide.
It said the Treasury was losing around £5bn a year from British “tax-dodgers” holding more than £170bn in tax havens.
It also highlighted the impact on the global wealth gap, saying governments are thought to be losing £120bn, with the world’s poorest regions missing out on £43bn.
£120 billion certainly sounds like a lot of money. But is it actually? In comparison to what?
The global economy is around $70 trillion, global tax revenues are some $23 trillion. Being generous with exchange rates we might say that the tax dodging (not that we accept the sum itself but let's work with what we're being given) is 1% of government budgets. So, who thinks that the world would be just peachy if governments had another 1% of revenue? How many problems does anyone really think this will solve? No, serious question.
Then think about the effort being being applied here. If 1% really is an important number then why not apply that same effort, or possibly less as it might actually be easier, in making governments just that 1% more efficient at what they do? We would have that same lovely outcome of making the world a better place but we'd have expended a great less energy in getting there. Odd then that the people shouting most about the havens aren't the people shouting about the efficiency with which the money is used really.
Leave aside all of the other arguments about tax and havens. Is 1% actually an important number?
First, Help to Buy, now Help to Save. What will be the next headline-grabbing, vote-seeking but yet fiddling, complicated, expensive and ultimately destructive policy from the UK government? Help to Buy helped to buy votes (at taxpayers' expense) by subsidising house purchases. As UK house prices were rising fast, it was almost universally popular. Not in the Adam Smith Institute of course: we explained its damaging consequences on the blog. By adding further to the demand for housing, but doing nothing to increase supply (such as easing the UK's suffocating 1940s planning policies), the scheme simply stoked prices further.
Under Help to Save, around 3.5m people on universal credit or working tax credits who save up to £50 a month will receive a cash bonus of 50% of their savings after two years. Then they can save for another two years, with the same deal.
That amounts to a cash gift of £1200 from taxpayers. Not that many of the 3.5m will get that amount: £50 a month is a huge amount for people on benefits to save – indeed, half of UK adults have less than £500 set aside for emergencies.
Of course, if interest rates were not kept artificially low by the Bank of England (in concert with other people's central banks), saving might be more attractive. And if there were not so much onerous regulation on hiring and firing, more people on benefits would be able to get a job, and move on to a better one. Help to Save looks like a measure to plaster over the cracks opened up by earlier ones.
And think about the administrative complexity of the scheme. The UK's tax code is already nearly the world's longest, and its welfare code is pretty dense too: but here we are, adding another couple of dozen pages. Just think about the rules, and the staff, you need to create and manage even a trifling scheme like this. First, you have to identify those who qualify – and check their bona fides. Which means rules, documents and civil servants. Then you have to check what they are saving, so you need access to their account – or are you setting up a special account for them? Ditto. You need to check that the two-year and then four-year schedule has been met. Ditto. Then you need to pay over the cash, so you need to raise payments, dispatch them, make sure it is all done correctly, deal with mistakes and complaints.... Ditto.
It does not take much reflection to see that this scheme – and countless others like it – will occupy a sizeable civil-service task force, probably in several centres throughout the country, and that the cost of the scheme could well be a significant proportion of the intended benefit. Are there not cheaper and easier ways to help poorer families? Like taking them out of National Insurance entirely?