The Pin Factory Blog

Will Hutton makes a good point here :

The state and market are in a symbiotic relationship of mutual need. Regulation delivers public good. And private markets and corporations are the better because of it.

Quite, absoutely no doubt about it, the only interesting question is exactly what form of regulation delivers the most public good. However, he does, in his examples, rather induce a fit of the giggles.

We now need a social-democratic Keynesian government.

This will make things better he thinks. As one of his examples he offers:

...an activist US government took over Continental Illinois bank in the Eighties.

I think that might be the first time I've heard Reagan's America described as being activist or social democratic, certainly the first time I've seen Paul Volker portrayed as a Keynesian. But then while all of that was going on I was merely an undergraduate at the university where Hutton is now a Governor, so what do I know? The thrust of the piece though seems to be that we should nationalise Northern Rock, just as Continental Illinois was taken over. He might even be right, but let's look at what actually happened way back when...

The situation was in fact eeriely similar. A bank with few retail deposits decides to expand by tapping the wholesale markets to borrow short and lend long. When those markets worry about the quality of lending, those wholesale funds can no longer be rolled over and the bank faces a liquidity crunch. Sound familiar yet? What do the authorities do? Well, first, they guarantee all deposits: yes, all, disregarding the previous statutory limits on deposit insurance. They extend assistance through the Fed's discount window. They guarantee to provide any liquidity needs Continental might have. (This is sounding, well, more recent, isn't it?) Then they fiddle around for a couple of months seeing whether anyone would like to take over the bank. That doesn't work, so then, well, do they nationalise it? In a sense I suppose, for the next part was that the Fed bought a chunk of the bank's bad loans ($4.5 billion) and then invested $1 billion in capital by purchasing preferred stock.

This gave them 80 percent of the equity and the bank survived, being taken over a decade later by another bank. With, for some time, continued liquidity support. 

No, I don't know whether this is the best solution for Northern Rock or not. I just rather like pointing out that Will Hutton is telling us all that we must be more socially democratic, more Keynesian, must follow the Continental Illinois path: when what we've been following for the past few months is exactly that Continental Illinois path, the one pioneered by the decidedly monetarist and free market America of the 1980s.

I'd like to propose a little test that we can use to judge the merit of any proposal for the spending of taxes, something I'm calling "The Lifeboat Test". As we all know there are some things that have to be done both collectively and with the powers of compulsion (at least in paying for them) that the State has available. There's also another set of things which do indeed need to be done collectively, but there is no real reason why we need the compulsion of taxation to pay for them. For as PJ O'Rourke pointed out, taxation is in the end extracted by the business end of a gun (don't pay it and they send you to jail: escape and they'll try to shoot you).

I'm using lifeboats as my test for they are indeed something that must be collectively provided but as is also apparent (this might puzzle some non-Brits: The Royal National Lifeboat Institution runs all lifeboats in the UK and it is entirely a private charitable institution. Other than the usual charitable tax concessions it receives no subsidy from taxes at all) that they can be provided both excellently and voluntarily. What I propose is that if something is more important than the lifeboats, we can consider whether tax money (that extracted by the gun, remember) might be used to pay for it. If it's less important then we can reject the idea of funding from taxation out of hand.

Gordon Brown is apparently considering the funding of political parties from taxation (that which is extracted at the barrel of that gun, remember):  

Mr Brown also sent a clear signal that he was prepared to consider a big increase in state funding for political parties.

So let us now apply our new test. The suggestion is that, by force, money should be removed from our pockets to pay for politicians to apply for their own jobs. Is paying for politicians to posture and preen in front of us more important than the lifeboats? No? I think not as well.

Good, State funding of political parties fails the lifeboat test and can therefore safely be rejected out of hand.

To enliven a Monday morning, what State spending (paid for by the taxes the government already forcibly removes from us at gunpoint) also fails the lifeboat test? 

The Guardian is rather patting itself on the back for having found out that many of the securitization vehicles used to get debts off the balance sheet for various banks are, shock, horror, set up as charitable trusts!

You can see their investigative reporting here and their Leader on the subject here. Netsmith linked to CityUnslicker last week where it was explained that the use of a charity in this manner was actually rather the point. For the securitization vehicle to be truly off balance sheet, it cannot be owned by the bank which is trying to get it off its balance sheet.

Indeed, this is such a horror of the capitalist marketplace, such a dire and dangerous abuse of charitable status, that Her Majesty's Revenue and Customs has a page telling you how to do it. If you ask them very nicely, I'm told that they will send you a CD explaining the system as well.

What would we do without the fearless investigative journalists at The Guardian speaking truth to power, as they do? 

Fraser Nelson had an excellent piece on the Spectator's Coffee House blog yesterday, arguing that the UK economy is in "a far worse condition than Gordon Brown makes out... his skill [as chancellor] was not in managing the economy well, but in making people believe it had been managed well."

Indeed.

As Fraser points out, most developed countries have had better growth than the UK since 1997, and Britain has actually been the worst economic performer in the English-speaking world. So much for the miracle economy! And thanks to Brown's wasteful public spending we have the biggest deficit in Western Europe, at a point in the economic cycle when we should really have a surplus. Government borrowing has placed a heavy burden on future generations. Inflation is making a comeback. Millions of Britons are economically inactive and dependent on state benefits. The list goes on...

What should be done? I believe overhauling the welfare system is the most urgent task facing the country – done correctly it would reduce spending and increase economic growth, by getting people off handouts and into productive work, as well as having an important social impact. Our recent report Working Welfare provides a handy guide to reform.

Alongside that we need to bring public spending under control, making public services more efficient and cutting government waste (£101 billion of which was recently identified by the Taxpayers' Alliance). Add in a few juicy tax cuts to boost enterprise and strengthen incentives, and you've got a recipe for real economic success.

Doesn't sound that hard, does it?

The Prime Minister still likes to crow over making the Bank of England independent when he was chancellor. He is keen to take credit for every success, but when the fan gets clogged his McCavity alter ego is assumed. In any case, recent occurrences have shown the Bank's independence to be purely cosmetic: they are culpable when inflation targets are missed, but when they try to avoid moral hazard by not bailing out Northern Rock, the Treasury takes over.

What the Northern Rock debacle has illustrated is the weakness of Brown's tripartite system of financial regulation (divide and rule) where the boundaries are blurred and the Treasury maintains close control. This kind of regulation is a feature of the government's approach to everything from the NHS to quangos – and it doesn't work. Everyone who is anyone in the City knew Northern Rock was in trouble months before it collapsed through the most normal of banking failures: borrowing short and lending long. Why did the situation get so out of hand?

Another failing was highlighted by the Bank of England's decision not to inject liquidity into the markets over the summer, as the European Central Bank and the US Federal Reserve chose to. As James Harding put it in The Times:

Was this because it was not sufficiently in touch with the financial markets? Was it because the Financial Services Authority knew what was needed but, under Gordon Brown’s model of tripartite regulation, did not have the authority to make it happen? Was it because the Bank is mandated to meet inflation targets but, unlike the Fed, does not have an equal responsibility for nurturing growth?

All in all, the former chancellor may deserve more blame than credit for his handling of the country's financial stability. And there may be harder times ahead. As Sir Samuel Brittan wrote last week, stagflation may, once again, be on the horizon.

According to reports in yesterday's Financial Times, the government are finally going to heed our advice and put the Tote (the state-owned betting company) up for auction. As we have consistently argued, from our influential 2004 report At Odds With Taxpayers to the present day, this is the only fair and straightforward method of finding out what the Tote is actually worth, and getting good value on the sale for UK taxpayers.

The government's original plan was to simply sell the Tote to the racing industry and the Tote's management at a knockdown price - "for the good of racing". However, the ASI challenged the government through a formal complaint to the European Commission's Competition Directorate, which twice ruled that the government's backroom deal with the racing industry would constitute an illegal use of state aid.

In any case, the racing industry and the Tote's management have only managed to muster £330 million, well short of the £400 million valuation placed on the Tote by PWC, the accountancy firm.

However, if the Treasury now goes ahead and auctions off the Tote, the price realised may be north of £500 million, according to our City sources. That is good news for UK taxpayers, and good news for racing too - since the government plans to give something back for 'the good of racing'.

However, it is worth remembering that horse racing as a sport and business has never been more prosperous. It would be far better to put the revenue raised towards cutting some taxes and maintaining some sports grounds, so that British kids can get some more exercise.

In a speech in Beijing this week, shadow chancellor George Osborne signalled his intention to announce proposals to slash corporation tax in the New Year. Saying a Tory government would offer a "sustained programme of lower taxation" and promising to reduce the tax burden on companies and individuals in every Budget as chancellor, he pointed to Ireland as an example of the correct response to an "intensely competitive global environment". Ireland's corporation tax is 12.5 percent.

That's all very encouraging stuff, and clearly the Conservatives have been emboldened by the popularity of their inheritance tax plans (only millionaires will pay). And corporation tax is a good place to start, given its importance to the UK economy. Even after the 2007 budget has come into force, Britain's headline rate will be 28 percent – 8 percent higher than the OECD average. In a globalized economy, that really matters because companies (and people) can easily relocate to lower tax jurisdictions, taking jobs and capital with them. So if the UK wants to remain competitive, lowering corporation tax is a must.

It isn't just a matter of international comparisons though. Corporation tax is inherently a bad thing, and the less of it we have the better. Reducing corporation tax would create stronger incentives for hard work, innovation and enterprise, increase business investment and, ultimately, lead to higher GDP. Indeed, according to the Taxpayers' Alliance's dynamic model for the UK economy, if we cut corporation tax rates to Irish levels by 2016, GDP would be 8.7 percent higher than it otherwise would have been by 2021. Total employment would be boosted by 8.7 percent and disposable income would be 13.5 percent higher. Economic growth would actually deliver a high overall tax rate too, so everyone wins.

Of course, the Irish 12.5 percent may be a little too much to hope for, even at Christmas. But the Conservatives' own Tax Reform Commission, headed by Lord Forsyth, proposed an immediate cut to 25 percent, with the aim of getting to 20 percent over time. That would certainly be better than a lump of coal.

My true love sent to me: two turtle doves. In the original it seems that the turtle doves represent the Old and New Testaments of the Bible.

Pigeon fanciers are outraged after HM Revenue & Customs (HMRC) left pigeon racing out of the official list of sports, and they are asking the Queen, who is patron of the Royal Pigeon Racing Association (RPRA), to get this ruling reversed. Why so many ruffled feathers about something apparently so trivial?

Well, it's all about money. Premises used for 'sports' are exempt from the rates, a local-authority tax. Under MHRC proposals to introduce rates on sports clubs and village halls, groups can formally apply for dispensation from HMRC for 80% relief and then to their local authority for a 20% reduction. So pigeon fanciers now face paying rates on their sheds, though officially recognized sports such as yoga, arm-wrestling and trampolining are still exempt.

Doesn't it all speak volumes about just how silly and bird-brained all these tax rules are?

Paul Krugman makes a point about the US mortgage market :

The WSJ reports that homeowners whose mortgages are bigger than their houses are worth are starting to walk away from their houses, even if they could afford the mortgage payments.

This will have some Brits, those with memories of the early 90s and negative equity, rather scratching their heads, for you can't walk away here. If you owe more than the house is worth and it is sold, or foreclosed upon, you still owe the bank that gap. This is something that is generally not true in the US: most mortgages are non-recourse (and thus Jingle Mail: posting the keys back to the bank and loading up the pick up truck). That is, they are secured against solely the property, there is no recourse to the general income of the borrower nor other of their assets (this is subject to a number of qualifications, it depends State by State and usually is only true for primary mortgages).

What this means in the grander scheme of things is that what happened to consumer spending in the UK in those 90s is not a good guide to what might happen to it in the US in the coming year or two as the bubble unravels. Similarly, given that it is the lender that has to eat such losses in the US, nor is what happened to the banks here. We can also take this a stage further and point out that whatever happens in the US in the coming year or two will not be a good guide to what might happen here if there is a large fall in house prices.

I agree this is a slightly geeky point but watch out for those commentators who fail to grasp it: the differences in the mortgage contracts are sufficiently large that the effects of negative equity upon consumer spending (and thus the wider economy) could be wildly different. 

The Tax Justice Network have a nice little graph here . Their contention is simple: the more of GDP that the government takes in tax then the lower the rate of child poverty. We can thus justify massively higher taxes because we're doing it for the children. I questioned their US figure of 22% of children in poverty because the usual one (US Census) is 12% or so. Here's the definition of poverty that they are using:

Share of children 17 years and under living in households with equivalized disposable income less than 50% of median income; Society at a Glance: OECD Social Indicators, 2005, p.57.

This, of course, is not a measure of poverty, this is one of inequality (or relative poverty, if you prefer). As long as we remember this crucial distinction, the TJN are of course quite correct. The outcomes from the market allocation of incomes can strike some as unfair and different societies seem to have different takes on how much of this they wish to remedy. That remedying done by greater taxation on higher income earners and the single, the money being given to lower income earners with children. This lowers the number of children living in such relative poverty. All of this is, I would hope, obvious, along with the corollary that the less redistribution the closer to the market allocation of incomes we shall be.

All of which means that what the TJN graph actually shows us is that in places where you have less redistributive taxation and spending then you have less redistributive taxation and spending. Something which isn't, if I might be frank with you, a finding which is either surprising or shocking.