The UK’s AAA Credit Rating – Downgrade to Come?

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Over the last two weeks, Westminster attention has focused almost exclusively on the great expenses debate - where relatively small sums of money have been involved in buying quixotic items, such as duck houses.

More importantly, though, financial markets were spooked last week by confirmation from Standard & Poors, a leading credit rating agency, that it had moved the UK’s AAA credit rating to ‘outlook negative’ – the first time that the UK’s top-tier rating has been questioned since 1978.

Given the prodigious debt figures outlined in last April’s Budget, this response is hardly surprising. Indeed, the Budget numbers are truly alarming.

Net public sector borrowing this year is forecast to soar to £175 billion, whilst public sector net debt is projected to reach a staggering £1,370 billion by 2013/14, compared with £527 billion in 2007/08.

To fund this burgeoning deficit, the Government plans to issue £220 billion of gilts during this financial year.

Whilst last Thursday’s gilts auction was successful in selling £5 billion of short-term debt, it is long odds-on that some gilt auctions over the next 18 months will fail - especially if the UK’s prized AAA credit rating is removed.

In short, UK spending and borrowing is veering out of control; hence, the deep concerns of credit rating agencies inter alia.

What is needed, above all, is a sustained effort to cut back public expenditure, where so much money is wasted. Imposing substantial across-the-board cuts - in real terms - would be a good starting point.

Otherwise, the UK’s ability to fund its massive deficits will be seriously compromised.

The alternative, of course, is to call in the IMF, which also stated last week that the UK needed to cut its debt more quickly than proposed in April’s Budget.

Local government takes lessons in deficit financing from the Great Depression

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There really ought to be a word for an unhappy coincidence. I am currently reading Taxpayers In Revolt: Tax Resistance During the Great Depression by David T. Beito. In it, he describes a pernicious practice that local governments used during the 1920s and 1930s to circumvent plebiscites capping government debt and limiting state and municipal taxes.

According to Beito:

By the end of the 1920s, local governments hit on the "tax-anticipation warrant" ... to evade the debt limit. For many vote-conscious politicians in the 1920s, the tax-anticipation warrant proved an irresistible temptation...

[P]oliticians had every reason to gamble that continued prosperity would ensure the safe retirement of the warrants or at least put off the final day of reckoning. In short, the tax-anticipation warrant seemed a foolproof method of financing the expansion of local government and at the same time circumventing tax resistance.

I read those words, written 20 years ago about an era 80 years ago, last night. This morning, in the Financial Times, I read these words, written presumably last night about right now:

Four of Britain's biggest city councils have called on the government to introduce a revolutionary scheme that would let them raise billions of pounds for regeneration schemes on the back of future tax revenue. This type of scheme was pioneered in the US where it is known as "tax increment financing"... The move by Newcastle, Liverpool, Manchester and Birmingham [would allow] local authorities ... to issue bonds that could be paid back using the increased tax base that - it is assumed - would be the direct result of improved infrastructure....

Tempting though it would be to remind these spendthrift municicrats that they have no way of knowing whether their cherished scheme has justified, let alone will justify, the investment, there remains the basic problem affecting all deficit financing: the ability of today’s service recipients to pass the cost of schemes they support onto tomorrow’s taxpayers.

This creates enormous moral hazard, especially as more mobile taxpayers can support municipal bonds that will be paid for by those who buy their houses, while they can sell up and move to lower-leveraged areas.

Being a firm believer in localism myself, I don’t believe that government should be allowed to prevent local authorities borrowing if they wish. Local voters should punish fiscally-lax councillors. But there needs to be protection for the homebuyer, caveat emptor notwithstanding. At the very least, vendors should be obliged to inform buyers of any outstanding liabilities that might impinge upon them through local taxation as a result of past profligacy. Thus property prices would be discounted to reflect wasteful “public" borrowing, and home-owning voters would be a bit more reticent about voting for deficit spending.

Hitting your wallets

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Policy Exchange have released a report entitled Hitting the Bottle that calls for the hiking up the price of most alcoholic drinks. The analysis behind this report is largely flawed as it is built upon the misplaced assumption that strong alcohol is the primary cause of alcohol abuse.

In reality, even if there is a correlation between the cost of alcohol and the amount that is drunk (although this is far from clear), there is certainly no proven correlation between the strength of alcohol and the harm resulting in drinking it. The most popular alcohols are medium to low strength lagers, not the more challenging and stronger ales and Belgian beers that this paper is suggesting need targeting. For example, Leffe Blonde will be in the highest rate of top-up tax set out by the authors; yet this is a premium beer usually drunk in moderation. People frontload on plentiful cheap and weak larger, not Duvel.

The authors of this report must be teetotallers; a partaker of alcohol would not offer as appeasement the fact that under their system low alcohol wines of less than 8.5% abv would be cheaper. Nobody I know has ever even heard of wine below 8.5% abv. Whereas the idea that “Government education campaigns on alcohol should promote ‘dry days’, including a focus on weekend abstinence" would be in equal parts mocked and ineffective.

There is only one recommendation in the report worth considering. This is that:

The costs of being admitted to hospital to sleep off alcoholic excess should not be covered by the NHS, but should be borne by the relevant individuals themselves. Patients admitted to hospital for less than 24 hours with acute alcohol intoxication should be charged the NHS tariff cost for their admission of £532.

Clearly this would lessen the running costs of the NHS, so our taxes would have to be cut in line with the amount passed on to the individuals (although oddly enough, the authors fail to mention this in their report).

In truth, cutting alcohol excess is not something that any government, with the best will in the world, is able to do through the manipulation of prices. All politicians can really do, is to take away the collectivization of responsibility and leave individuals to pay for the errors of their drinking habits. For the rest, I suggest they refer to Mill's Harm Principle.

Tea anyone?

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Two views from the Chicago Tax Day Tea Party.

Blog Review 973

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Ted Kennedy's always been anti-nuclear. Guess where the treatment that put his brain cancer into remission came from?

Another gobsmacking story of where your money goes.

One of those iconic moments in left wing folk history turns out to be a little different from what is generally assumed.

Didn't The Who do a song about this? Meet the new boss, same as the old?

The Beatles did one about this. Although not even George Harrison thought they would tax losing one's virginity.

A song that The Proclaimers didn't but should have written.

And finally, Baldrick's poetery is not possible to put to music.

The danger of inflation

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On sound monetarist principles I thought that quantitative easing – the Bank of England's euphemism for printing money – was a sensible policy. There was such a huge output gap – a growing number of unemployed people and a greater stock of underemployed productive capacity – that any new money would first go into boosting employment and productivity. Only when things had stabilized did we need to worry about the new money driving up prices.

There were, I thought, two possible dangers. One was that confidence would return as rapidly as it had disappeared, meaning that money would reappear from under people's mattresses and come back into the productive economy. With the Bank creating even more, that could over- egg the pudding and produce an inflation mess instead. The other was that, even if the new money worked as the Bank intended, and gradually stabilized the economy, it might not rein back in again quickly enough. After all, central bankers rather enjoy booms, and so do their political masters. So that would be another pudding over-egged, with similar results.

Since then, the economic situation has changed, and there now every danger that the Bank's (recently boosted) quantitative easing will indeed produce inflation. First, monetary aggregates are expanding, and prices haven't exactly fallen much, so the deflation dragon seems to be more of a gekko. Second, the output gap is big, but it has not grown as much as expected. The OECD says we've bottomed out, even George Soros says so. The reason, of course, is that we have borrowed so hard to stave off a collapse. Borrowing may stoke up future problems, but we seem to have bought our way out of a complete meltdown. We've been high on the drug of cheap credit for years, and instead of going cold turkey, we have bought ourselves a rehab course. It takes a lot longer, it might not be so effective, and the methadone of borrowing might have its own unpleasant effects, but at least we're not quivering and sweating on the floor.

You can argue whether that's the right policy – and I'd argue that it's highly dangerous – but the implications for quantitative easing must be clear. If this was largely a crisis of confidence, and confidence is now returning and the economy is reviving under its own steam, there is no point in stoking up the boiler yet further with new money. It can only lead to an explosion of inflation.

The real key to health reform

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I often feel that the healthcare debate in the UK is so limited as to be pointless. It's not just that people only ever talk about 'reforming' the monolithic NHS, rather than admitting that it’s a relic of the Soviet-era central planning which is never going to provide the standards of healthcare that 21st Century consumers rightly expect. Rather, the problem is that even people willing to consider real change usually get bogged down obsessing about the wrong issue.

Discussion inevitably revolves around whether we should have national insurance, or social insurance, or private insurance. But what is completely missed is that it is the very over-reliance on third-party payment that causes most of the economic problems in healthcare, regardless of whether governments, non-profits or businesses are in charge.

The point is that while it makes sense to insure yourself against big-ticket, catastrophic health expenses that might (but hopefully won't) happen, it really isn't sensible to use insurance to pay for unavoidable, everyday occurrences (like having to go to the doctor every once in a while).

When you introduce third party payment into those situations, it causes a number of problems. Firstly, it introduces lots of administrative costs, which frequently exceed the cost of the treatment itself. Secondly, it gives both doctors and patients an incentive to maximize expenses – the patient because he's paid his dues and wants his money's worth, the doctor because he wants to increase his income. Thirdly, it blunts incentives to stay healthy, because that's what you've got insurance for. All this makes third-party payment the main reason why medical inflations runs at 8 or 9 percent a year, even when the wider economy is only running at 2 percent.

The key to successful healthcare reform is to get patients paying doctors directly for routine services, and returning insurance (of whatever sort) to its natural role. If you want a real-world example look at Singapore (where they get great outcomes for less than 4 percent of GDP). And if you want to know how it might work in the UK, have a look at this ASI report from 2001.

Free to choose what we tell you

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Anyone that has a vague understanding of the differences between Labour and the Conservatives on education policy knows that the latter have quite a different vision and remarkably better one. Despite some success with Academies, Labour are increasingly stuck in the mantra of a system that continues to fail children taught be the state, while the Conservatives are committed to creating a limited market in education.However, don’t be fooled into thinking that education will be liberated under the Conservatives. As Thatcher centralized while privatizing, Cameron’s Conservatives seem intent on offering choice within boundaries that in fact restrict. In much the same way that Labour has fermented education and its institutions to defend its socialistic vision of the world, the Conservatives will use education to promote theirs.

Claiming in ‘ Raising the Bar, Closing the Gap’ that “the only constraints on New Academies, and indeed on existing Academies, should be the curriculum requirements which apply to independent schools" is in reality a hefty weight around the necks of those educating and being educated. Like Labour, the Conservative Party will use the National Curriculum as tool with which to try to instil their view of the world into the minds of the children of this country. This is not freedom for schools and teachers, but the contiued politicization of education.

Take history for example. The Conservative's plan to force teaching with a focus on British history. Of course, you might think this is better than what we have now, but let parents, schools and teachers decide if that is the case. For my part, I would like to see a school teach the history of various battles for freedom throughout the ages; a fair amount of this would be British history, but rather a lot would not. Instead the Conservative Party want to “instill an appreciation of our national culture and nation’s past". No thanks.

1950: The end of fuel rations

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On this day in 1950 fuel rations ended thanks to trade with the United States.

Blog Review 972

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Much is made of the need to save local newspapers. There are those who say that maybe local governments, or central, might subsidise them. Here's evidence that there wouldn't be any point in having them if they were so subsidised.

That preference for the unions in the Chrysler bankruptcy. Congratulations Mr. President, you've just made finance more expensive for each and every unionised company.

Why we shouldn't use the Human Development Index as a measurement of anything other than how like Scandanavia a place is.

Politics is so often about squaring circles: and refusing to admit that circles cannot be squared.

Economists don't try brain surgery: so why do brain surgeons try economics?

A very confused Early Day Motion praising Polly Toynbee. She reveals her salary from The Guardian, but not her speaking fees, other freelance income nor her book royalties. We are urged, at her example, to reveal our total incomes.

And finally, where your tax money goes.