Reflections on the coalition agreement

Non-business capital gains will be taxed at or near to the same rates as ordinary income, with generous exemptions for entrepreneurial business activities.

It isn’t entirely clear what this means but regardless, raising taxes on capital and investment when you are trying to encourage economic growth isn’t terribly sensible. The fact that this measure will only apply to non-business assets and will be subject to major exemptions may stop this tax hike being too damaging, but the devil is in the detail. Generally though, raising capital taxes is counter-productive – CGT is the tax that tends to exhibit the strongest laffer curve effects, and I’ve seen research suggesting that c.15% is the revenue maximising rate – more than that and you just change people’s behaviour.

Inheritance tax cut kicked into the long grass. Lib Dems allowed to abstain on transferable tax allowances for married couples. Air Passenger Duty will be charged on a per-plane, rather than per-passenger basis.

All this was expected. The transferable allowance is small beer, and the changes to Air Passenger Duty are, in themselves, unobjectionable. It is still my view that inheritance tax is unjust and ought to be abolished, but it is understandable that this is not seen as a priority.

An independent commission to review public sector pensions will be set up (accrued rights will be protected). The basic state pension will rise in line with earnings, prices or by 3.5% from April 2011 – whichever is highest.

Good that public sector pensions are being reviewed, but that may just be used as an opportunity to bury a potentially very unpopular issue. As for the state pension, I’m all in favour of dignity for the elderly and agree that the current state pension is rather pitiful. But the question is, are spending commitments like this affordable? And will the government introduce measures to shift the UK to a funded pension system, rather than a PAYGO one? We desperately need to address our long-term age-related liabilities, but I don’t see much sign of that happening at the moment.

A levy on the banks will be introduced.

One can see the argument here – without a levy, banks won’t have to pay any tax on their profits for a few years, because they have such gigantic accumulated losses to bring forward. But this isn’t a sensible way for taxpayers to ‘get their money back’ – what we want is for the government to be able to sell off their bank shares as soon as possible, hopefully at a profit. Bank bashing measures just make this more difficult. ASI fellow Miles Saltiel has a more detailed reaction to plans for a bank levy here.

Robust action to tackle unacceptable bonuses in the financial services sector will be undertaken.

This is ill-advised. The proposals the FSA made on financial sector services last year go far enough. Any additional measures amount to little more than economic populism, and are potentially quite damaging to Britain’s standing as an internationally competitive, major financial centre. It is also worth pointing out – again – that bonuses played no significant role in the financial crisis.

Detailed proposals to make the banking sector more competitive will be brought forward.

This is good news: the obvious place to start is to reduce barriers of entry into the banking sector, so that trusted consumer brands like Tesco can get involved, while also splitting up the nationalized mega-banks as they are returned to the private sector.

An independent commission will examine the case for separating retail and investment banking. It will report in a year.

This idea is worth looking at properly. Opinion among free market economists remains divided.

Responsibility for macro and micro-prudential financial regulation will be transferred to the Bank of England.

This is a good thing, and is something the ASI has called for in a series of reports and briefings on financial regulation. The point though is not just to change the name above the door, but to change the way financial regulation is done. The key is to focus on the big picture instead of box-ticking compliance. Ultimately, sensible monetary reform would be a far better guarantor of financial stability than improved regulation, but that’s a subject for another day.

The government will attempt to ensure the flow of credit to viable small and medium sized enterprises, possibly through a major loan guarantee scheme and net lending targets for the nationalizing banks.

Yes, viable SMEs need access to finance, but government involvement is troubling. Like it or not, the UK economy is hugely indebted and massively overleveraged. We won’t have a sustainable economic recovery until these imbalances have been addressed, and government intervention that has the effect of delaying necessary adjustments may end up causing more pain down the line.

There will be an annual limit on the number of non-EU economic migrants allowed to live and work in the UK.

Not sure about this – if people want to work and contribute, I say let them. The free movement of labour is really just an extension of free trade. Of course, there are legitimate social concerns about immigration, and security worries too – but is this the way to address them?

Consideration will be given to bringing forward the rise in the state pension age to 66, but it won’t happen before 2016 for men and 2020 for women. Rules requiring compulsory annuitization at 75 will be scrapped.

OK, but if we’re going to deal with our fiscal problems it would be better to raise the retirement age higher and sooner. Of course that may be a non-starter politically. Getting rid of compulsory annuitization makes sense – it may be the right option for some people, but it isn’t right for everyone. People ought to be free to act in their own best interests.

The Tory welfare-to-work plans will be implemented in full. The receipt of benefits will be made conditional on the willingness to work, and welfare-to-work providers will be paid according to how successful they are in getting back into work.

Excellent – the Wisconsin reforms finally make it to Britain!

The Tory school choice reforms will be implemented. Parents, teachers, charities, churches, companies, etc will be able to set up new schools, and they will receive taxpayer funding on a per-pupil basis. All schools will be given greater freedom over their curriculum.

This was by far the best and most developed policy the Conservatives had in their general election manifesto, so thank goodness it survived the coalition horse-trading. Michael Gove’s ‘supply side revolution’ has the potential to transform British schooling for the better. The only lingering concerns are will new schools be exempt from local authority approval, and will operators be allowed to make a profit (both of which are essential if the necessary numbers of new schools are going to be established)?

A ‘Freedom Bill’ or ‘Great Repeal Bill’ will be enacted. The ID card scheme, the national identity register, the next generation of biometric passports, and the Contact Point Database will be scrapped. Traditional civil liberties will be restored.

Music to my ears!

Fixed term parliaments will be established. This means that the next general election will be on the first Thursday of May in 2015, unless 55% of both Houses of Parliament vote to dissolve before then.

This is a probably a political requirement of coalition government – it prevents the Conservatives from trying to stitch up the Liberal Democrats by calling an election whenever it looks like they could get an overall majority. The downside of fixed election dates is that they tend to lengthen the campaign phase of the political cycle – something most of us could do without!

Legislation will introduce fewer and more equal sized parliamentary constituencies, and ensure a referendum on the Alternative Vote.

A fairer distribution of seats is an essential reform, and I’m relaxed about a referendum on the Alternative Vote. I still think the most important quality of an electoral system is that it allows you to change governments, rather than that it ‘accurately reflects the views of voters’ (which, as any public choice economist will tell you, would never happen anyway). Moreover, I suspect that the Alternative Vote would force politicians to cluster even more around the centre ground, and may drive politics to become even more shallow and personality-driven. So sticking with first-past-the-post would be my preference, but I’m open to persuasion. After all, the Alternative Vote doesn’t seem to have thrown up too many problems in Australia.

A committee will be set up to bring forward proposals on introducing a mainly or wholly PR-elected House of Lords, with members serving a single long term. This committee will report by December this year.

As it stands, the unelected House of Lords does a far better job of protecting our liberties than the elected House of Commons. Might that quality of the Lords be lost in the introduction of elections, especially if those elections are based on a party list system, leading to the Lords being stuffed full of party apparatchiks? Most likely, yes. On the other hand, there are clearly inadequacies with the current system and the impetus for change is strong. What matters is that any changes deliver a House of Lords that is more willing to stand up to government, better able to scrutinize legislation, and more effective at protecting liberty than the current one, and not less. How they might be done is a subject for another time, but this is clearly the test that any changes to our constitutional arrangements should be judged.

Voters will get the right of recall: a petition signed by ten percent of an MP’s constituents will trigger a by-election (assuming the MP was found to have engaged in serious wrongdoing).

Good, although this does seem a case of closing the gate after the horse has bolted. I can’t see the right of recall be used all that much in future (even if it would have been very useful during the expenses scandal). And of course, who judges whether an MP has been engaged in serious wrongdoing or not?

A House Business Committee will be put in charge of Parliament’s timetable, to ensure that the legislature is properly able to hold the executive to account.

This is an excellent idea. Over the past couple of decades the executive has come to utterly dominate the legislature. Any measures to reverse this trend are welcome.

A commission will be established to consider the ‘West Lothian question’.

Fine, as long as the issue doesn’t get kicked into the long grass. I think the time has come for England to have its own Parliament.

The Calman Commission’s proposals will be implemented, and the Welsh will be offered a referendum on further devolution.

As I’ve written before, the Calman Commission’s proposals are a complete dog’s breakfast that would do very little to increase Scotland’s fiscal autonomy or to encourage more prudent expenditure. A much better idea would be to keep National Insurance and VAT as UK taxes, and devolve everything else to Holyrood. As for greater devolution in Wales: no objections here.

An agreement on limiting donations and reforming party funding will be pursued, with the aim of removing ‘big money’ from politics.

When they say big money, I have a funny feeling the mean trade union money – i.e. Labour money. But party politics aside, I’m not convinced the further regulation of political donations is either necessary or desirable. And under no circumstances would I be willing to contemplate state funding of political parties (which would further insulate our political class from the real world). Unfortunately this is likely to be the direction in which banning ‘big money’ would take us.

Power will be radically devolved to local government, which will be given greater financial autonomy. There will be a full review of local government finance.

This is good stuff, but I’ll believe it when I see it. Now that they have finally got their hands on a bit of central power, the Liberal Democrats may cool about giving that power away to local authorities. And I suspect the Tories will be very wary about making any changes to local government finance – the words ‘poll tax’ don’t provoke happy memories. If decentralization does go ahead, the government should start abolishing the regional tier of government and redistributing its powers to the local level. The next step is to give local authorities real policy freedom in the areas they are responsible for. Then they should be made as fully self-financing as possible.

A high-speed rail network will be established, the third runway at Heathrow will be canceled, and no new runways at Gatwick or Stansted will be allowed. We won’t get any new nuclear power stations, but we will get lots of new environmental legislation.

It’s a shame to finish on a negative, but this has the main area of concern in the coalition agreement – a great multitude of sins are being proposed under the cover of ‘making Britain a low carbon economy’. Most of them are likely to increase prices for consumers, encourage more businesses to rent-seek rather than engage in entrepreneurial activity, and significantly decrease our energy security. High-speed rail is likely to cost a lot and fail to deliver corresponding benefits, while not allowing new runways is likely to make life even more difficult for British travelers.


An emergency budget will be held within 50 days, and will announce £6bn of cuts in the current financial year, and outline a deliverable long-term plan for “significantly accelerated reduction in the structural deficit”, mainly through spending cuts. A full spending review will be initiated, and will report in the autumn. Full strategic and defence reviews will be held at the same time. However, NHS spending will increase in real terms every year, the target to spend 0.7% of GDP on overseas aid will remain in place, and a significant ‘pupil premium’ for disadvantaged pupils will be introduced.

This is good, but is it enough? I appreciate that cutting public spending in-year is tricky (like a big ship, government takes a while to change direction) but I am sure that bigger year-1 savings are both possible and desirable, given the state of the UK’s public finances and the disaster unfolding elsewhere in Europe. Moreover, saying you will significantly accelerate deficit reduction is not the same as pledging to eliminate the budget deficit over the course of the parliament, which is the promise I hoped the new government would make. And it is disappointing to see that NHS and international development spending is still ring-fenced – there should not be any sacred cows. Nevertheless, this is a step in the right direction and it is the job of organizations like the Adam Smith Institute to drag the government towards real fiscal responsibility.

Reductions will be made to the Child Trust Fund and tax credits for higher earners.

Good – the Child Trust Fund is a pointless gimmick, and when money is tight it makes sense to target resources on the most needy.

There will be a substantial increase in the personal allowance from April 2011, with stated longer-term objective of raising it to £10,000.

Excellent – the ASI has been pushing for this for ages, and it is great to see steps being taken in this direction.

That means no increase in the thresholds for employee NI (as Tories originally pledged), but the increase in the thresholds for employer NI will go ahead as planned.

Well, that’s a bit of a disappointment, but the rise in the income tax personal allowance more than makes up for it. Stopping the rise in employers’ contributions is the really important bit, so it’s good that didn’t fall by the wayside in negotiations. Cont'd...