The beguiling notion of a minimum income for all
Another attempt to convince us all of the merits of a universal basic income over in The Guardian. This is based on the experiment done in Dauphin in the 1970s. Some of us here very much like the idea but as we do so that means that we've also thought through the idea a little more than some others have:
But is this really an old-fashioned, leftist idea? I remembered reading about an old plan, something that has been proposed by some of history’s leading thinkers. Thomas More hinted at it in Utopia, more than 500 years ago. And its proponents have spanned the spectrum from the left to the right, from the civil rights campaigner Martin Luther King to the economist Milton Friedman.
It’s an incredibly simple idea: universal basic income – a monthly allowance of enough to pay for your basic needs: food, shelter, education. And it’s completely unconditional: not a favour, but a right.
The first problem with the proof being used here, that Dauphin experiment, is that it wasn't a universal basic income, was not ion fact a right to a certain income unconditionally. Rather, what was tested was a negative income tax. If you earn less than x then that income will be topped up to x. And there was a tax rate applied too, you only kept 50% of earned income over a certain level.
This is an important point because it mirrors the development of the idea itself. It was Milton Friedman who did a lot of the heavy lifting here. He started out with a universal basic income. And quickly realised that there was just no way to tax everyone enough to pay it out. So he moved to the negative income tax idea, that there's a minimum income, yes, but earned income counts against it in some manner.
That was still too expensive for the time and so it morphed into tax credits - the EITC over in the US being introduced at about the same time as this Dauphin experiment. The EITC arrived with us as working tax credits rather later.
And the reason is simply cost. The Dauphin guaranteed income was about $16,000 (in 2014 $) for a single person. Call that about £13,000 here today. To produce that as a universal basic income would cost about £650 billion, not that far off total government tax revenue today. Or 35 to 40% of GDP, that sort of number. Sure, we can subtract much of current welfare spending to get to the net cost but that's not the sort of amount that we think we can squeeze out of the economy in tax without beginning not to have much of an economy.
Which is why it turns up as working tax credits, something conditional, not something universal.
It is possible to construct it so that it is universal - but that means paying attention to the other part of UBI, basic. At a rate around the state pension, perhaps the state pension guarantee, say £150 a week per adult, then it could be done with the redirection of current spending rather than taxing everyone to heck and back. As Charles Murray showed in "In Our Hands", $10,000 a year for the rather richer United States could just about be done.
We can have universal and basic of substantial and directed but not substantial and universal. And of course this is before we get to the fantasies of the JRF and the like where everyone should have a "liveable" income.
Some of us here support a UBI, others don't. But it is still true that the number only stack up if great attention is paid to the basic part of it. If it's to be anything more than that most basic amount then the universal part has to go.
Is Ayn Rand still relevant 35 years on from her death?
Though she died in 1982, huge numbers of people still come to Ayn Rand through her novels The Fountainhead and Atlas Shrugged – and their lives are changed as a result. No wonder. These novels assert the nobility of using your mind to reach your full potential. They make self-belief cool.
Rand’s heroes are individualists who live by their own creative talents—existing for no one else, nor asking others to exist for them. They are rebels against the establishment and its ways. They do not conform to social norms, but stand by their own vision and truth: a vision built on their own values and a truth built on fact and reason, not on the false authority of others. They are the creative minds who discover new knowledge, who innovate, drive progress and consequently benefit all humanity.
But minds cannot be forced to think. Creativity, and therefore human progress, depends on people being free to think and act in pursuit of their own values. That is a powerful case for liberty, values, mind, reason, creativity, entrepreneurship, capitalism, achievement, heroism, happiness, self-esteem and pride. And against the life-destroying consequences of coercion, extortion, regulation, self-sacrifice, altruism, wishful thinking and refusing to use one’s mind.
Nowhere do Rand’s ideas change more lives than in her adopted United States, where her novels tap into the American ideals of self-reliance and individualism. In the early 1990s, a decade after her death, a survey by the Library of Congress and the Book of the Month Club rated Atlas Shrugged as the most influential book after the Bible. Today, Rand’s ideas are taught in colleges across America and discussed in academic and popular journals. Institutes and groups have been set up to promote her ideas.
Her ideas are accelerating in other English-speaking countries too, such as the UK (where 20,000 Rand books are sold each year), Canada, Australia, New Zealand, South Africa and India, where English is widely spoken. Even Indian footballers and Bollywood stars acknowledge her influence on their lives.
Beyond the English-speaking countries, Sweden, a country of just 9.5m people, leads the world in Google searches for ‘Ayn Rand’. About 25,000 copies are bought each year in Rand’s native Russia, another 13,000 a year in Brazil, 6,000 in Spain and 1,000 each in Japan and Bulgaria. Even in China, some 15,000 Rand books are bought each year—a number which, given that country’s economic and intellectual awakening, can only increase.
All this gives Rand a significant impact on the political debate. In the United States, many of those she inspired rose into public office. Former US Federal Reserve chairman Alan Greenspan (1926-) was an early member of Rand’s inner circle. Supreme Court Justice Clarence Thomas (1948-) shows his new clerks The Fountainhead movie. Politicians such as former Congressman Ron Paul (1935-), his son, Senator Rand Paul (1965-) and House Speaker Paul Ryan (1970-) cite Rand as an influence. Even President Ronald Reagan (1911-2004) described himself as “an admirer of Ayn Rand.”
Nor is this only a US phenomenon. Annie Lööf (1983-), leader of Sweden’s Center Party and former Enterprise Minister, helped launch the Swedish translation of The Fountainhead, calling Rand “one of the greatest thinkers of the 20th Century.” Rand’s ideas were praised by the reformist Prime Minister of Estonia, Mart Laar (1960-), and influenced Australia’s Prime Minister Malcolm Fraser (1930-2015), along with many other past or current political leaders.
What other novels have had such an impact on events, more than half a century after their publication? And what other novelist?
If we're to deal with drugs let's deal with the actual problems of drugs
There are of course those out here who object to people doing as they wish - against the wishes of those doing the objecting. The rest of us are only worried about the effects of people following their own path upon our lives. The externalities of their actions, that fist swinging to hit our nose or not.
At which point this is a thoroughly good idea:
Police will give free heroin to addicts in a controversial bid to cut drug-related crime, The Mail on Sunday can reveal.
Durham Constabulary is the first force in the country to draw up detailed plans for the Class A drug to be handed to long-term users.
In an exclusive interview, Chief Constable Mike Barton told this newspaper that police money will be used to supply heroin to addicts to inject themselves twice a day in a supervised ‘shooting gallery’.
The force – rated the best in the country by watchdogs last week – will fund the programme from its already stretched budget.
Mr Barton admits the plan will attract criticism but insists it will reduce crime because the addicts will no longer have to steal to pay for their fix, and dealers will lose customers.
We have been saying this ourselves for a number of years now. The problem with drugs is not people getting high - their life to waste after all. It's the effects upon the rest of us of the illegality of their getting high. The disease spread by unclean equipment, the vast costs of the illegally trafficked drugs themselves, the crimes committed to pay for them.
Short-circuit that entire system by just giving the addicts the drugs. Pharmaceutically pure heroin is in fact rather cheap - rather cheaper than having police officers go out to investigate a rash of low level burglaries in fact.
We approve, mightily.
Book Review: What Next? by Daniel Hannan
If you are filled with pessimism by current affairs, and Brexit contributes to your anxieties, allow me to recommend a prescription to you. Daniel Hannan’s “What Next, How to get the best from Brexit” is an astonishingly good soother of the nerves.
Considered one of the masterminds behind Brexit, Hannan put forward the intellectual case for leave. His book last year, “Why Vote Leave?” quickly became a Sunday Times bestseller, swaying opinions across the country. In his next book, with a clear vision and ladles of optimism he provides a much-needed target for the future of the relationship between the UK and the EU.
Hannan begins triumphally, lauding the efforts of the millions who made Brexit a reality – something for which he has campaigned most of his life – and tells the story of precisely what was happening behind the scenes during the campaign. This makes for reading that is rather fascinating. In roughly fifty pages, Hannan reveals goings on that may come across to some readers as quite shocking. Particularly noteworthy is the way he rubbishes Farage and Aaron Banks, in such a way that you feel you are becoming privy to little known gems of political truth. Hannan convincingly concludes that the duo was actually less interested in winning the referendum, and more interested in “using the referendum as a vehicle to promote UKIP in general and Nigel in particular”.
After the juicy gossip of the politics behind Brexit is dealt with, Hannan moves onto dealing with the European Trade area, and the technicalities surrounding it. Discussion of the relationships between states and the EU are chock full of jargon, but Hannan deals with what has come to be a somewhat impenetrable subject quite nicely. He first distinguishes between a free trade area and a customs union (giving examples along the way) and explains why we want to be a member of the former and not the latter.
As I read on, I thought that the book may as well be titled “Brexit for Dummies” as its treatment of the issues at hand are so straightforward and sensible. But I think that may do the book a slight disservice, as it by no means treats its reader as a dummy. Hannan has enormous amounts of reverence for the reader, articulated in his characteristically eloquent style in a chapter named “Populism Versus Democracy”. For those uninitiated to Hannan, it may come as a surprise that he mentions immigration very little. He cares most about sovereignty and deregulation, not only highlighting their importance in an increasingly globalised world, but also showing ways that Britain can achieve its goals in these areas.
All the time Hannan reminds us that Brexit is not an event, but rather, a process. He also reminds us that because the UK is totally unique in its position in Europe, it should not simply seek to emulate Iceland, or Switzerland, but rather get its own unique arrangement that is both as free market as possible as well as outside the political union.
On the single market Hannan emphasises that membership is not as simple as a binary choice – something you don’t hear often. Hannan describes it as more like an amalgam of lots of different things, some very attractive, that work to the benefit of the consumer and bring down prices, and some not so good, like the common external tariff.
This might be worrying to some. A criticism that can be made of Hannan’s optimism, is that he treats post Brexit arrangements like a cinema pick and mix, without the thought that Eurocrats may not be as sweet to the UK as he might like. But he maintains (and reasonably) that because in diplomacy decisions are made present in mutual interest, rather than grudges, an outcome will be achieved that is mutually beneficial. After all, no one wants to be poorer.
Hannan’s book is easy and fun to read, and gives the reader a realistic plan as we move forward, that will benefit not only the UK but Europe also.
Clearly all the important problems are solved then
We do tend to think that the world has a problem or two. Some of which are even amenable to political action as a solution. It appears that those who rule us are not quite so sure:
Yet Sainsbury's, Asda, Tesco and Waitrose all charge a flat 40p fee for deliveries based on the eight bags usually needed for an average online shop - but some shoppers say excessive bags are often used.
The law states that councils should fine supermarkets up to £20,000 because it means bags are being sold at below the 5p legal threshold - but anecdotally it appears this is not being applied, one Government source said.
Labour MP Mary Creagh, chair of the Commons Environmental Audit Committee, told MailOnline the situation was ‘ridiculous’ while Green co-leader Caroline Lucas says the 40p flat fee 'risks fatally undermining the gains from charging'.
£20,000 is a substantial amount of money. Very much more than a fine for truly criminal behaviour we would wager. And this over the use of "too many" plastic bags? And the effrontery to use the word "fatally" in connection with this again use of "too many" plastic bags?
Ourselves we think that this is simply displacement activity. Those politicians know that there are indeed real problems out there but they've not a scoobie as to how they might be solved. So off they go to do something, for something must be done of course. It's just that they apply that something to things trivial and or irrelevant rather than any actual problem that might be usefully solved.
In praise of tax havens
In a referendum that is historic for being the first of its kind, Ecuador has voted to ban all politicians from having assets in tax havens. To many this will come as good news, for the term “tax haven” often conjures an incredibly negative image. The hoo-ha made by politicians would have us think that they are the reserve of slimy Russian oligarchs and unctuous property tycoons. But they’re not all that bad. Here's why tax havens might be a force for good in the global economy.
Firstly, they promote good tax policy around the world. This is because tax havens promote tax competition between jurisdictions, and this puts pressure on politicians in nations with oppressively high taxes to lower tax rates and reform their tax codes – as we have seen between in Ireland and the EU.
But this needn’t mean a race to the bottom must occur. Havens encourage positive reform of the worst kind of taxes in our economy, because that is what they are primarily used to avoid – namely taxes on our savings and investments. These taxes discourage innovation, investment and saving in our country.
The ASI has in the past advocated a progressive consumption taxation policy that would only tax consumption, not investment, and more generally a simplification of the UK tax code. This would in the long run make our country a wealthier and more prosperous place for all, and the kind of tax competition encouraged by havens promotes such reform.
It’s not clear that countries are making any kind of Faustian pact by acting as ‘tax havens’. For one thing, places that are considered tax havens are generally nicer to live in. Switzerland and Liechtenstein, are both very desirable places to be, and both are considered tax havens in the academic sense of the term. In fact, data from the World Bank reveals that nine of the 13 richest jurisdictions in the world are in fact tax havens.
There is also a moral argument to be made for tax havens, though today it is largely irrelevant in the West. Millions across the world face hostility from their governments. From the Rohingya Muslims in Myanmar, to the ethnic Indians in East Africa, when you belong to a persecuted minority group, it makes sense to protect your family’s interests by putting your money somewhere the tentacles of the politicians cannot get to.
The kind of financial privacy laws that make tax havens so attractive to Swedish entrepreneurs who want to escape harsh taxation are the exact same laws that protect people from other forms of persecution.
Imagine you were a Jewish businessman in the Middle East. Being able to keep your assets safe in a tax haven might be the only thing between you and insolvency if your government decides to seize people’s assets illegally. Or, alternatively you might be a farmer in Zimbabwe (or any other banana republic dictatorship), a nation where on a whim the ruling powers could confiscate (or render valueless) your money. Being able to put your assets into a safer place could be the one thing that ensures your family has enough money to make it through the year.
However, ultimately, these arguments may just be moot points. For exactly what constitutes a tax haven is ambiguous and incredibly hard to define. This means that often legislating about them is difficult. Because of this, instead of trying to demolish and vilify low tax jurisdictions, perhaps we should just try and beat them at their own game.
Response to John Morgan on British Academia
John Morgan of the Times Higher Education has penned a short article criticising the report I wrote for the Adam Smith Institute on the political views of British academics. His article is titled, ‘Adam Smith Institute ‘lurch to the left’ report: flimsy figures’. I should begin by noting that I did not use the phrase “lurch to the left” anywhere in my report; rather, this was the phrase that several newspapers used in their write-ups.
Morgan criticises my report on the grounds that I compared figures from a self-selecting poll that asked about vote intention to figures from a systematically conducted poll that asked about party closeness. He apparently regards this comparison as totally illegitimate. My response to his criticism is twofold. First, as Morgan himself acknowledges, I noted the caveats pertaining to the comparison between the two sets of figures several times. For example, on p. 4 I wrote:
Relatively little good evidence is available on the political views of British academics.
And on p. 5 I wrote:
It is important to be aware that Halsey sampled his respondents differently to the THE, and posed a slightly different question, which means the comparison over time should be treated with a certain amount of caution.
Second, despite the fact that the data were collected differently and a slightly different question was posed in each case, comparing the two sets of figures arguably still provides some information about possible trends within academia. Of course, a 50-year repeated cross-section of academics would provide much more reliable information, but unfortunately this sort of survey has never been conducted. (My hunch is that the THE poll understates the current left-liberal skew in British academia, though admittedly I have no data to prove this.)
It is noteworthy that, according to data analysed by Sam Abrams, the sizable left-liberal skew in American academia has increased since the 1990s. This is consistent with Duarte et al.’s earlier finding that the left-liberal skew in social psychology increased dramatically over the 20th century. (More references related to trends in American academia can be found here.)
Nonetheless, even if the left-liberal skew in British academia hasn’t increased at all since 1990 (which seems unlikely), it would still be quite substantial today. Moreover, most of my report was dedicated to explaining why left-liberal views are overrepresented in the academy, and to exploring what consequences that overrepresentation may have had. Many academics I speak to readily acknowledge that there is a left-liberal skew. Indeed, it is an effect size of such large magnitude that it is almost too obvious to report.
Morgan also criticises my report on the grounds that I made claims about the impacts of left-liberal overrepresentation for which I provided no empirical evidence. He writes,
Using a self-selecting survey as a rough guide to possible voting patterns in a forthcoming election is one thing. It is another to conflate that survey with totally separate data and use this flimsy base to make sweeping judgements, as Carl does in suggesting that growing “ideological homogeneity” has led to “the trend towards curtailments of free speech on university campuses” or that it “has arguably led to systematic biases in scholarship”. There is no evidence in his report that this is true [emphasis added].
While reasonable people can disagree about the validity of comparing two sets of figures from different sources, on this point I would claim that Morgan is simply wrong. I discussed numerous previous papers that have investigated the impacts of the academy’s left-liberal skew. One important such paper is titled, ‘Political Diversity Will Improve Social Psychological Science’ by Duarte et al. Another is titled, ‘How Ideology Has Hindered Sociological Insight’ by Chris Martin. Yet another is titled, ‘A Social Science without Sacred Values’ by Winegard and Winegard. Yet another is titled, ‘Microagressions and Moral Cultures’ by Campbell and Manning. For other references, please see Section 5 of my report. Morgan may well disagree with these authors’ claims, but it is simply false to say that I cited no evidence.
According to Morgan, my “wafer-thin report looks like an attempt to import a US-style campus culture war into the UK.” It strikes me as odd to use the word “import” here, given that––from what I can tell––a “US-style campus culture war” already seems to be raging pretty fiercely at British universities. Just in the last few years, there have been heated controversies about: no platforming (e.g., here, here and here), trigger warnings (e.g., here, here and here), micro-aggressions (e.g., here and here), decolonising curricula (e.g., here, here), and other identity politics issues (e.g., here, here, here and here).
In summary, I would disagree with Morgan that comparing two sets of figures from different sources is futile, especially given the paucity of available data. I would reject his claim that my report provided no evidence as to the impact of left-liberal overrepresentation on scholarship and free speech. And I would note that he does not dispute that fundamental fact that British academia has a sizable left-liberal skew, which is an interesting phenomenon in need of explanation.
Good ideas take time to come to fruition
Alistair Darling tells us that perhaps the time has come for us to have proper road pricing:
Over a decade ago, as transport secretary, I backed plans for road pricing, unsuccessfully. This time, there’s a better chance, not least because the ubiquity of smartphones has solved many of the technological issues. Even so, success will depend on getting the politics right, which means gradually bringing in a scheme, over ten years or more, but laying the groundwork now.
We would not back the use of a smartphone itself as the mechanism but the ubiquity (and cheapness) of the technology does indeed make it much easier. Which is why we backed the idea back when Darling was in office, why people were identifying the idea with us as far back as 1989. A fuller exposition of the idea is here.
At heart the idea is terribly simple. Road space is a scarce resource, scarce resources must be allocated in some manner. Economics tells us that normally - although not always - the best method of allocating a scarce resource is by price. Thus let us allocate the scarce resource of road space by price.
This is of course open to the accusation that the rich will get all of the benefit, only they will be able to afford to drive their Rollers through Hyde Park. Yet this is not actually how this works. Lighter traffic volumes, constrained by that price, makes all other forms of transport in the area more efficient. Bicycles flow more freely, buses are faster, even the air breathed by pedestrians kills them more slowly.
The benefits of road pricing flow only partially to those who still drive, the majority to everyone else who isn't driving.
Madsen Pirie of this parish insists that our job is to be off there howling in the wilderness over some idea or other and then to turn up a decade later when everyone agrees with our previous lunacy as the accepted wisdom. It's obviously a pity that this has taken three decades so far (and Alan Walters was arguing for it as far back as the 50s) but perhaps we'll get there all the same.
Short-termism: steady on now
A lot of recent economic problems have been put down to short-termism. Many accounts of the financial crisis held that loan originators and mortgage investors knew they were taking on a lot of risk, but were under pressure from "quarterly capitalism"—the need to present a strong bottom line to investors every financial quarter. Many people ascribe some of "secular stagnation"—slow growth around the world since the financial crisis, and persistently low interest rates—to an unwillingness of firms to invest for the long run in their business, choosing to give the money back to their stockholders through buybacks and dividends instead.
But both of these are wrong. Far from being short-termist, US investment bankers were so convinced their own banks had good financial strategies that they invested heavily in their own firms. And they weren't alone: practically everybody—regulators, ratings agencies, government-sponsored enterprises and banks—believed that US housing was on the up. The investment turned out to be foolish, but it was ignorance and poor guesswork, not inevitable upshot of bad bets.
And there is no reason why society should always do new investment through existing firms. Would it have been better to try and invent smartphones through existing camera companies like Kodak? Would on-demand video have turned out better if Blockbuster, not Netflix, had been the first big player? There is a reason that young entrepreneurs and start-ups have grown to dominate some businesses, creatively destroying older players in the process. Young firms are nimbler and more flexible and manoeuvrable.
This is why buybacks and dividends—ways that firms return money to shareholders—are not necessarily any bad thing, or any indication of worrying short-termism among business. It doesn't necessarily mean lower investment overall; mostly that investment will just be happening in different places.
Now to some extent, this is just conjecture: it makes sense that households would switch investment from one venture to another when companies divest cash. But a new paper from Charles Wang at Harvard Business School, and Jesse Fried at Harvard Law, strongly supports my thesis with empirical data. (Hat tip to Jose Ricón's wonderful third links post for bringing the paper to my attention.)
Wang and Fried look at the capital flows data—the huge outflows from S&P 500 firms to their shareholders that worry so many commentators—and find that these are balanced by gigantic flows into investment, but in other ways and areas. As well as buying some stock back, firms issued more. They also funded investment with new borrowing. On top of that, stockholders used much of the cash coming out to invest in non-S&P 500 firms.
During the period 2005-2014, S&P 500 firms distributed to shareholders more than $3.95 trillion through stock buybacks and $2.45 trillion through dividends. But S&P 500 firms absorbed, directly or indirectly, $3.4 trillion of equity capital from shareholders through share issuances.
We show that while S&P 500 firms are net exporters of equity capital, public firms outside of the S&P 500 are net importers of equity capital. During the period 2005-2014, they absorbed $520 billion of equity capital, or about 16% of the net shareholder payouts of S&P 500 companies.
Public firms engaged in approximately $800 billion of net debt issuances, equal to 32% of the $2.50 trillion in net shareholder payouts. When a firm borrows $X and issues a dividend of $X, there is no reduction in the firm’s assets.
What's more, Wang and Fried caution that even this much smaller number likely does not represent firms missing out on investment opportunity due to a self-destructive urge to give their owners money.
Firstly, net income, the denominator in this equation, is calculated after R&D spending—but firms spend a huge sum on that (around the size of 25-30% of net income itself) before we get to this point. Simply including R&D may balance the scales entirely. Secondly, firms do not need to spend out of cash, and can easily—and often do—issue more equity or debt. Thirdly, cash in the hands of investors does not all go into consumption—it may go into IPOs, private equity, venture capital, or crowdfunding.
The paper is devastating to the simplistic case that buybacks, driven by myopic short-termism, hurt growth, which should always have seemed silly. In 1900 should we have worried if Standard Oil gave money to its investors, because they might just consume it all, and not invest in the companies of the future? Capitalism proceeds by constant entrepreneurial rearrangement of the structure of production—big existing firms are sometimes as bad at picking winners as the government.
Why Lord Lawson's right about tax reform
Ex-Chancellor Lord Lawson appeared on Sky News yesterday and backed abolishing Corporation Tax and replacing it with a 'Trump style border-tax'. Perhaps he read the ASI's 2017 Budget Wishlist where I called for exactly the same thing.
This might all sound rather surprising. Indeed, reading Sky News' write-up, which makes reference to Trump using the tax to make Mexico pay for the wall, you might think that Lawson was advocating a tariff. Far from it. He was actually backing the House Republican corporate tax reform plan, which effectively abolishes Corporation Tax as we know it, and replaces it with a kind of sales tax like VAT (with a few caveats).
There's another nit to pick – despite it being described by some as 'Trump' style, we don't actually know if he supports it. He seems to use the term border tax interchangeably to mean either an protectionist tariff or the border adjustment that's part of Ryan's plan.
The main objective of the Ryan plan is to replace the current system of corporation tax, which discourages investment lowering long-run GDP. That’s why economists like Alan Auerbach and Larry Kotlikoff (as well us at the ASI) are backing the plan.
The Ryan plan contains three major changes to the status quo.
1. It lets you deduct the full cost of capital investment immediately. In order to calculate their taxable corporations currently have to work through a plethora of complex rules and depreciation schedules. The Ryan plan simplifies this by allowing for the immediate full expensing of capital investment.
This is why it's known as a Cash Flow Tax, instead of navigating depreciation schedules and deducting interest costs – firms simply pay tax on their cash flow (Revenues-Expenses).
Beyond saving on paperwork, this has two major benefits. First, it will increase investment, boosting productivity and ultimately workers' wages. When Estonia brought in a Cash-Flow Tax, they saw investment surge compared their neighbours. The Tax Foundation points out that "between 2000 and 2004, Investment growth in Estonia was 39 percentage points faster than neighboring Latvia and Lithuania."
Second, it fixes one of the biggest and most pernicious distortions that exists in both the UK and US tax systems – the debt equity bias. The status quo treats investments funded through debt much more favourably than investments funded by raising money from investors (equity). This is a problem because debt (and not equity) tends to attract government bailouts.
2. It's Border-Adjusted. In other words, the taxes are paid based on where the final transaction happens - in tax jargon it's 'destination based'. As I mentioned before under this system firms calculate how much tax they pay by subtracting their expenses from their revenue. But border-adjustment complicates that slightly.
Imported inputs no longer count as deductible expenses and exports no longer count as taxable revenue. This is typically the most controversial part of the proposal. Its opponents have painted it as a protectionist move that will push up costs at shops like Walmart and hit ordinary Americans hard. If they were right, the tax would be a terrible idea. But I (and many other economists) think they’re mistaken.
It's worth looking at why you'd want to make a tax border-adjustable. It's all about the base . The tax base, that is. It shifts the tax base from domestic production to domestic consumptionIf it’s implemented then companies will never be able to reduce their tax bill by moving overseas, effectively giving America the lowest corporate tax rate in the world—zero. That makes the US incredibly attractive for foreign investment.
It’s nuts to attack firms for following the rules of the current system, but where there is a problem with tax avoidance—Base Erosion and Profit Shifting—the solution is fixing the underlying rules. Dylan Matthews over at Vox has a really nice explanation:
"Right now, the US taxes companies on their profits, both those earned in the US and those earned abroad that are brought back into America. But because foreign profits aren’t taxed until they’re brought back to the US, companies have a big incentive to make US profits look like foreign profits to avoid taxes.
For example, suppose that a car company — let’s just call it, uh, General Motors — makes $1 billion in profit manufacturing cars in the US and selling them domestically and exporting them to subsidiaries abroad. That would normally subject it to about $350 million in taxes, since the US has a 35 percent corporate tax rate. But GM could instead have its foreign subsidiaries pay $1 billion less for the cars they buy from the US branch of the company. That wipes out GM’s US profits, leaving it with no US tax liability and shifting the profits to the subsidiaries abroad. If those subsidiaries are in countries with a low or nonexistent corporate income tax, that could wind up being a very good deal.
Same goes for companies that import goods. Imagine a company — call it Chiquita Banana — that has subsidiaries in Latin American countries, buys up bananas from banana farmers, and then sells them to the US branch for resale. Suppose it, too, makes a $1 billion profit doing this. It could then just have its Latin American subsidiaries charge $1 billion more for the bananas, leaving the US branch with no profits and shifting them to Latin America."
Border-adjustment makes schemes like these redundant. Why undercharge a foreign subsidiary when your exports already don't count as taxable revenue? And why overcharge for imported inputs when you can't deduct your imports as costs.
So why are people opposed?
Opponents worry this will impose a huge tax increase on importers. In essence, they object that this is a protectionist measure aimed at deterring overseas trade. Indeed, with supporters like Trump describing it as a big border tax, it's hardly surprising many people have got that idea.
But it turns out that almost all economists believe that the border-adjustment won't have any effect on the overall balance of trade.
Simultaneously taxing imports and and effectively subsidising exports by letting firms exclude export revenue from their taxable income should cause the US dollar to appreciate to the amount that'd make it trade neutral.
The import tax would raise the cost of imports and cause fewer imports to be demanded. This means that foreigners are getting fewer dollars, increasing scarcity and driving up the value of the dollar. At the same time, the export subsidy side of things would make US goods cheaper, the US would then sell more goods overseas and this would drive up the demand for the dollars you need to pay for them.
Martin Feldstein, who served as President Ronald Reagan's top economic advisor (and long overdue for a Nobel Prize), explained it an article for the Wall Street Journal:
"Since a border tax adjustment wouldn't change U.S. national saving or investment, it cannot change the size of the trade deficit. To preserve that original trade balance, the exchange rate of the dollar must adjust to bring the prices of U.S. imports and exports back to the values that would prevail without the border tax adjustment. With a 20% corporate tax rate, that means that the value of the dollar must rise by 25%.
With a 25% rise in the value of the dollar relative to foreign currencies, the $80 net price of U.S. exports would rise in the foreign currency to the equivalent of 1.25 times $80, or $100, and therefore back to the initial price. Similarly, the 25% rise in the value of the dollar would reduce the real import price to the U.S. retail customer back to $125/1.25, or $100, as it is without the border tax adjustment."
Now there are admittedly a few concerns here.
Some are worried that the currency adjustment wouldn't happen immediately and would hurt American importers in the meantime. I'm sceptical of that fear. For example, look at the Mexican Peso the morning after Trump was elected or the pound after the Brexit vote. Big currency moves can be priced in even before a policy change has been formally announced.
Others are concerned that the currency wouldn't fully adjust because of the third element of the Ryan plan.
3. It'd make wages a fully deductible expense. So far there's very little to differentiate the destination-based cash-flow tax I'm describing to a VAT. But the wage deduction is what sets it apart. It'd allow firms to fully deduct wage costs from their taxable income, which they can't under the current system. This makes the proposal more progressive than a similar VAT.
It's essentially equivalent to a big cut to payroll taxes like national insurance or social security. Indeed, economists at the (truly excellent) Tax Foundation looked at the distributional impact of the plan and found that it's more progressive than existing corporation tax set-up. This is because part (about 25% in their example, maybe more according to ASI research) of the burden of corporation tax falls upon labour and corporation tax deters new investment which depresses productivity lowering wages.
But the wage deduction is probably the biggest obstacle overall. First, some have argued that it'd make it hard to past the WTO. The WTO allows border adjustments for indirect taxes like VATs but doesn't for direct taxes like corporation tax. Without the wage deduction it'd be very straightforward to get it passed the WTO, but with it another nation might argue that it distorts trade in a way that a VAT doesn't. If the WTO were run by economists this argument would get short shrift, but sadly lawyers still run the world and this could become a hiccup. It'd hardly be the end of the world as the US could simply replace the wage deduction with a big-league cut to payroll taxes and push it through.
Second, some have argued that the wage deduction would impede the currency adjustment because wages are deductible for domestic production but not imported inputs. I'm sceptical of this argument because the wage deduction wouldn't cancel out the effect of large payroll taxes that hit domestic producers but not necessarily importers. And I doubt that those objecting to this move would object to an economy wide wage-subsidy as protectionist.
That's it, in a (rather large) nutshell. I think Lawson and the House GOP are right to back this move. It removes large impediments to investments within the corporate tax system, it'll boost GDP and wages, and effectively gives the US (and Britain if we follow) most competitive business tax system in the world.
It’s really important for us in the UK to follow this debate, for two reasons. The first is because after Brexit we need to make our tax system as efficient as possible to encourage growth. But the second is because if the US does go ahead with this reform plan then we will have little choice but to follow suit if we want to remain competitive.