Deficit spending won't save us

Scott Sumner had another must-read post on his blog, The Money Illusion, last week. (Sumner is also the author of our report, The Case for NGDP Targeting.) Contrasting “Country A” and “Country B”, he asked which one looked like it was implementing austerity and which one fiscal stimulus: Country A, with a deficit of 8.8% and 8.2% unemployment, or Country B, with a budget surplus of 2% and 7.3% unemployment.

One of the countries is the UK, and one is Sweden. But, according to arch-Keynesian Paul Krugman, “Somebody has been practicing harsh spending-side austerity — and it’s not Sweden.” And, “Given that public investment is, you know, productive, [Britain] is almost surely a case of self-defeating austerity.”

But, of course, the deficit sizes tell a completely different story. In fiscal terms, deficits are what matter in the Keynesian framework, because they reflect the “extra” amount of money the government is adding to the economy. “Austere” Britain is Country A, with a 8.8% deficit; “stimulating” Sweden is Country B, with the 2% budget surplus. As Sumner asks,

If you are not a committed ideologue on either side, just look at the data provided up top.  Does Country A really look like savage austerity?  Does country B look like a country engaged in fiscal stimulus?

Sumner argues that Sweden’s success is thanks to a Central Bank that provided monetary stimulus back in 2009. There’s a large contingent of people who claim that the government’s cuts are hurting the economy, but seem completely ignorant of the fact that, in the Keynesian model, monetary expansion should be able to completely offset fiscal contractions.

That’s not a model I subscribe to, but the so-called “Keynesians” who seem to think that there exists some kind of “real” aggregate demand simply don’t know what they’re talking about. As Sumner says, “If monetary stimulus makes fiscal stimulus unnecessary (and it does), then why would Britain want to do fiscal stimulus?”.

There is another question here for the anti-austerity people to answer: if an 8% budget deficit isn’t enough to stimulate the economy, how big does it need to get? We already have a bigger deficit than any of the Eurozone basket-cases but, even if we set aside reality for a moment, I'd love to hear how big the anti-cuts crowd think the deficit would need to get before we have some growth.

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A report the government can't afford to ignore

Today the 2020 Tax Commission, a joint venture of the Taxpayers' Alliance and the Institute of Directors helmed by City AM's Allister Heath, releases its final report. The Single Income Tax (summary here) argues for a comprehensive tax reform that would see the state shrink from 50% to 33%, with many of the current taxes we have on income, inheritance, and transactions being replaced with a single rate of 30% on income from labour, interest and dividends, with a £10,000 personal allowance.

By eliminating things like National Insurance paid by employees and employers (the worst stealth tax of all), everyone's tax burden would fall, and the shift from transaction taxes like Capital Gains Tax and Stamp Duty would facilitate a more smoothly-functioning price system. Only flows of income would be taxed. Regrettably, VAT cannot be scrapped as long as we're part of in the EU Single Market.

The report also makes good nods to localism by calling for local authorities to be held responsible for raising 50% of their spending power themselves, through things like local income and sales taxes. With any luck, this sort of change would bring down the overall tax burden even more, as councils competed with their neighbours.

I've been browsing through my preview copy for the last week, and it's a masterpiece. It is the best report to come out of a British think tank in years, and I can only hope that it has the impact it deserves. For a government that seems to be asleep at the wheel, The Single Income Tax should be a loud wake-up call.

The economics they teach in Sussex

It pains me to have to admit this but this is from someone who purports to teach economics in a British university:

And in recent weeks we have heard many economists argue that growth in the eurozone will come from "structural reforms" that will make it easier to collect taxes, reduce red tape, and easier to hire and fire workers.

But growth requires investment. Companies invest to make profits and grow. Evidence shows those which invest more in new technology, human capital and research and development, and are located in countries where public spending in these areas is high, are able to produce more competitive and better value products.

It is the "but" that is painful.

The eurozone will grow only once weaker countries are allowed to make the strategic investments Germany has. There is much talk about the need for internal rebalancing, to increase the competitiveness of the deficit-burdened south relative to the surplus-blessed north, but this is a limited view. What is required is not that wages fall in Portugal, Italy, Greece, and Spain, but that they make investments that increase their productivity – an impossibility with austerity-driven policies.

And that is even more painful for she seems to have missed that Germany has just spent and entire decade screwing down the wages of the workforce in order to increase productivity. Productivity being a measure of how much production you get out for how much you spend on labour going in.

But the real problem is that she is claiming that there is some either or calculation going on here. That *either* we increase productivity *or* we cut red tape. Which is an entire nonsense, of course. Cutting red tape, freeing up labour markets, shooting bureaucrats, these are productivity improvement measures. Just as much as (on the rare occasions they work) are making strategic investments driven by political aims. If you want to improve producitivty shouldn't you be doing both of the things that improve it?

What Air India tells us about state run and monopoly companies

A nice little story here about Air India. It illustrates the dangers of having either state run or monopolistic companies.

Some of the airline’s staggering losses are rooted in exceptionally generous staff benefits. Investigators discovered pilots insisted in staying in five star hotels in New York, Chicago and Mumbai during stop-overs instead of spending the night at cheaper airport hotels.

Significant losses in revenues are due to serving and retired pilots and crew taking business class seats ahead of paying customers. The practice was restricted in 2009 when its chief executive appealed to staff to co-operate and stressed there was no shame in traveling economy.

Despite the restrictions on staff using business class tickets, paying passengers were rejected to make way for Air India staff who were upgraded from economy seats. At one point, Air India’s business class ticket holders were shunted onto rival airlines — at Air India’s cost — because their own staff had occupied the seats.

The temptation for any group of insiders is to make use of that insiderdom to gain privileges. This is as true of CEOs as it is of airline pilots, as true of politicians as it is of scribblers for think tanks. It's simply human nature: when we talk about bureaucrats we call it public choice economics and when we talk about everyone else we call it the blindingly obvious.

The only cure we've got for this is competition: everyone needs to be put in fear of their livelihood about the success of the organisation. To consider that a business class airfare not paid by a customer makes that job more insecure: that the claim of a gargantuan pay deal for inhabiting the corner office makes losing that job more likely. And this really only can be done when the players in the marketplace are indeed playing in a market. One where such behaviour really does bring down a company and thus impose discipline on all others.

Which does pose problems with the politicians. For we've tried having competing governments in the Wars of the Roses and didn't like the result much. Perhaps we'll just have to revert to terminal violence in this difficult case?

The rotten state of our democracy

Parliamentary democracy – Britain’s great gift to the world – has gone bad. It has putrefied into brute populism. The 24-hour media cycle forces politicians to respond to every trifling issue and act on every interest-group demand, no matter how overblown. The more they do so, the more government pervades and controls citizens’ lives. Then, as the role and power of government expands to accommodate this widespread pervasion and control, the more largesse and patronage it has available to disperse, so the more supplicants it attracts and the bigger the political class that feeds off it.

In this downward spiral, principle is abandoned to pragmatism: politicians indulge every populist cause that might prolong their term in office, power accumulates unchecked, and the democratic rights and liberties of minorities – and of the mute majority – are trampled underfoot.

Politicians even seem to think that they can amend our very constitution by a simple majority vote in Parliament. Witness the remarks of UK Deputy Prime Minister Nick Clegg that a reform of the House of Lords does not need a referendum and the onus is on those who believe otherwise to make the case for it. That really is a breathtaking ignorance about the principles of democracy and the rule of law. There may be a lot wrong with the House of Lords, right enough. But by that argument, a majority in Parliament could at a stroke abolish any democratic institution, void any established civil right, and declare itself a dictatorship. As Ayn Rand put it:

Individual rights are not subject to a public vote; a majority has no right to vote away the rights of a minority; the political function of rights is precisely to protect minorities from oppression by majorities – and the smallest minority on earth is the individual.

Politicians' powers come from us. We might well be prepared to accept some curbs on our activities on the grounds that it will, on the whole, produce a better-functioning society. But none of us would willingly give a majority the power to exploit and abuse us. That is why we cook up complicated voting and parliamentary systems – not to choose and empower our representatives, but to limit them, to restrain them and to be able to get rid of them. Sure, a history full of accidents and entrenched power means that those institutions are far from perfect, but it should be up to the whole electorate to decide how they should be reformed. Allowing parliamentarians to design what parliament should look like is akin to putting the cat in charge of the cream jar.

Perhaps it is already too late. Even the much-feted US constitution has been unable to prevent politicians expanding their role, their power and their budgets. It seems we have overthrown the tyranny of monarchs, only to enslave ourselves under a new tyranny of elected dictatorships. And the trouble is that we ourselves connive in this tyranny. We demand favours and subsidies for our pet causes, one after another after another. And – in a sort of political version of Say's Law – government simply expands to meet that demand.

The West shook off the control of the old aristocratic class through a worldwide wave of revolutions. We need a new worldwide wave of revolutions – constitutional revolutions – to save ourselves from the new tyranny of the political class. As I explain in my primer on public choice economics, we need voting systems that prevent interest-group capture of the policy agenda. Rules to stop minorities being exploited. Limits on what politicians can do. Curbs to end political careerism. Ceilings on government’s power to spend, borrow and print money.

And we need a revolution in understanding: reminding ourselves and the likes of Nick Clegg and other MPs that democracy is not merely the dictatorship of the majority, but the vital mechanism by which dictatorship of can kind can be thwarted.

Another glass of doublethink?

As you may have noticed, we've been pretty preoccupied with the nanny state this week. With Monday's minimum alcohol pricing announcement in Scotland, Tuesday's release of "The Wages of Sin Taxes", Chris Snowdon's excellent debunking of the arguments for sin taxes, and yesterday's call by British Medical Association writers to bring in a "fat tax" on fatty foods (not that anyone can agree on what those are), it seems that there's hardly a single bit of fun someone in power doesn't want to discourage with a tax or price floor.

It's all very dispiriting, but what's striking is how economically sound it all is. These paternalists might have no regard for individual liberty; they might have a puritan's appreciation of the power of a bottle of wine to lubricate human relationships; they might even long for two extra years in a care home in Kent. And you have to admire their pragmatism in stamping out the things they disapprove of — generally speaking, poor people living unhealthy lifestyles. They grasp the fundamental law of economics that incentives matter.

But in in proposing things like taxes on Coca-Cola are price floors for alcohol, the puritans have given the game away. They've accepted free market logic that contravenes all the other things they tend to support.  If taxing Coca-Cola makes people drink Coca-Cola less, then taxing work via the income tax must make people work less. If a price floor for alcohol makes people drink less booze (binge drinkers' low price elasticities of demand notwithstanding), then the price floor for labour we call the National Minimum Wage must make firms hire fewer people.

Even the infamous "pasty tax", which I oppose – there's no such thing as a good tax rise, in my book – is criticised by many on the left as a tax on "working class food". What is a minimum price floor on alcohol, if not an attack on "working class booze"?

The elite that wants to impose its lifestyle on the rest of us may be using this sort of thinking for evil, but more people accepting the logic of economic thinking is generally a good thing. Not many people actively want more unemployment or less productivity. With any luck, it will turn out that not many people actively want to be told by their betters how to eat and socialize either.

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Brace yourselves, there’s another bank holiday coming

Last year in the UK there was a lot of fuss about the Royal Wedding in economic and political circles.

Some claimed that the economy saw stagnant growth because of the extra bank holiday for the Wedding. An extra bank holiday was, apparently, the reason the second quarter of 2011 had negative growth (-0.1%, see graph below). According to these people, the extra day off for the Diamond Jubilee will probably be why the UK will have a negative growth in Q2 2012 too.

If only the British were working on these days off, everything would have been different. Instead of a -0.3% drop, the UK could have grown by, say, 3% that quarter. What a missed opportunity. (Note: the 3% was an estimate based on no data at all, just my personal opinion, which makes it as imprecise as any forecast you could see that blames things like the Royal Wedding for a re-occurring recession.)

I’m waiting for the next logical step from UK policymakers – to make the people work on Saturdays and Sundays in order to mitigate the effects of the Royal events. That ought to make the economy grow.

In fact, I have an even better proposal. Since we’re in a recession, why not make every week a 7-day working week for everyone! First, it would ease the inequality pressure a bit, and second it would spur growth well over the previously estimated 3%. If you want a Chinese-style bounce back of a 9% growth, than working weekends is the way to go.

But seriously, when forecasters of economic activity design their models they never stop to think beyond the one-non-working-day parameter. Didn’t anyone consider the amount of tourists that came to London for the Royal Wedding, and that will arrive for the Diamond Jubilee? People have stayed in London for more than a week in those days. The hotels were full and made a bundle. The airline companies made money, Transport for London made money (the tourists did need to buy tickets amid the congestion they’ve temporarily caused), shops sold more stuff, tourist attractions sold more tickets, and some money even went to the non-taxpaying parts of the economy. A lot of money was left in the country and will be left during the next couple of months.

Using event like the Royal Wedding to justify a double-dip recession can only be done by those hiding their own incompetence for being unable to achieve a recovery.

In the end, it’s not how many days in a week people work, it’s how much value an economy can create. This is where the UK is lagging behind. And it won’t fix it with giving businesses extra money but by giving them an equal, unconstrained opportunity to compete and succeed. And it certainly won’t fix it by abolishing Royal events that can actually attract people to come and spend their money in this country.

As soon as you know it, the Olympics could be called off because it could cause massive delays to people coming in and out of work. What a tragedy for the economy. I’m guessing it will cause a massive amount of stress making the people perform sub-par throughout those 8 weeks. It’s no telling what this could do to the economy. Brace yourselves, not because of the Eurozone collapsing, rising energy prices or a hidden threat of inflation – no – brace yourselves because there’s a Diamond Jubilee coming.

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Why a fat tax would be a terrible idea

When we scheduled the release of The Wages of Sin Taxes for 15th May, we did not guess that it would be sandwiched between the announcement of a 50p minimum price for alcohol in Scotland (Monday) and a new campaign for sin taxes on food and soft drinks (today). Writing in the British Medical Journal, two academics have just called for price hikes on sugar-sweetened beverages and ‘junk food’ as a way of dealing with Britain’s alleged obesity epidemic.

Obesity rates, like drinking rates, have not actually risen for ten years, but the same decade saw the medical profession gain an uncanny grip on the nation’s political process and they are in no mood to relinquish it. Taking a break from hassling smokers and drinkers, the mandarins of public health have taken the ‘next logical step’ and moved on to the general population.

“Economists generally agree,” they write, “that government intervention, including taxation, is justified when the market fails to provide the optimum amount of a good for society’s wellbeing.” Even if this dubious statement were true, there has never been a time when the market offered more choice in what we eat than drink than today. And, contrary to popular belief, it is much cheaper for a family to subsist on fresh fruit and vegetables than it is to eat out at McDonalds three times a day. For the spokespeople of public health, the problem is not that there is a lack of options, but that we plebs are not choosing the right ones.

Defining junk food is notoriously difficult. As Rob Lyons explains in his excellent book Panic on a Plate, a portion of McDonalds fries contains a quarter of an adult’s recommended intake of Vitamin C, while middle class favourites like olive oil, parmesan and pasta are rather fattening. A tax on “sugar sweetened beverages” will presumably leave apple juice and smoothies untouched, despite the fact that fruit juices are often sweeter and more calorific than Coca-Cola.

Whichever foods and drinks fall under the spotlight, it is unlikely that the new sin taxes will do anything except make the poor slightly poorer and George Osborne slightly chirpier. The record of fat taxes and soda taxes abroad is dismal. When academics assessed the effect of soda taxes in the USA, they found no evidence of a reduction in childhood obesity and concluded that "soft drink taxes are ineffective as an 'obesity' tax." Last year, a study claimed that a 10 per cent tax on sugar-sweetened beverages would lead to a 7.5 ml reduction in daily consumption, but this equates to just three calories a day. Since adult males require 2,500 calories per day to maintain a healthy weight, the impact on obesity rates would be somewhere below negligible.

Perhaps recognising this, the authors of the BMJ article insist that these taxes would have to be set at at least 20 per cent (in addition to the 20 per cent VAT). Such a rate would hit us all in the pocket, but it would still have an imperceptible effect on British waistlines. A 2007 study found that even a 100 per cent tax on “unhealthy foods” would reduce average body mass index (BMI) by less than one per cent (a reduction in BMI of just 0.2 points).

Although there is ample evidence that sin taxes of this kind do not work, we run the risk of accepting the medical establishment’s terms of debate by even discussing it. The real argument against this kind of state interference is that what we eat and drink is simply no one’s business but our own. As I show in The Wages of Sin Taxes, the claim that obesity is an economic time-bomb which forces the slim to pay for the sins of the fat is fallacious. Without that justification, the meddlers are exposed as the ugliest brand of paternalists. It is time to call these taxes what they are - fines for living in a way that displeases the British Medical Association. But since it is clear that these doctors won’t be happy until they can issue us with ration books, perhaps it time to remind these public servants who their masters are. 

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The Wages of Sin Taxes: The True Cost of Taxing Alcohol, Tobacco and Other "Vices"

  • “Sin taxes” on cigarettes and alcohol are designed to boost revenue, not improve public health
  • Minimum alcohol pricing will exacerbate poverty and entrench inequality without discouraging binge drinking
  • Most of the costs of drinking and smoking fall on individual consumers, not the public. There is no economic justification for increasing taxes on smokers and drinkers.

In a report released today, The Wages of Sin Taxes (Download PDF) by Christopher Snowdon, the Adam Smith Institute condemns the government’s decision to increase taxes on cigarettes and alcohol this year and to introduce minimum alcohol pricing.

The report argues that ‘sin taxes’ (taxes on commodities seen as harmful to health) are ineffective in reducing consumption and are not necessary for recouping lost revenue. The taxes are highly regressive and force the poor to pay for the government’s mishandling of public finances.

The taxes don’t work

Cigarette taxes are now so high that increases drive smokers to the black market instead of discouraging consumption or raising more revenue. Sin taxes are more likely to deter moderate users than heavy users, whose demand for cigarettes and alcohol is relatively inelastic.

A heavy smoker or an alcoholic is unlikely to reduce consumption because of a price rise, making sin taxes an unreliable way of reducing consumption or improving public health.

The victims of cigarette and alcohol duty

Sin taxes hit moderate and heavy users alike. Research has shown that previous rises in cigarette tax have made only 2.3% of smokers quit, with the other 97.7% just paying more in tax.

Taxes on cigarettes and alcohol are regressive and hit the poor hardest. The average smoker spends £1660 a year on cigarettes – 20% of the bottom 10%’s income. Sin taxes are the most regressive indirect taxes, as they tend to target products that are disproportionately consumed by the poor.

Minimum alcohol pricing is also deeply regressive, only affecting the cheaper drinks consumed by the poor. Punishing poor people for enjoying a drink or a cigarette exacerbates poverty and treats the poor like children who need to be controlled by the state.

The public cost of smoking and drinking

Taxes on cigarettes and alcohol have often been justified by studies that claim to estimate the “social cost” of these vices. These studies include intangible costs borne by individual consumers, such as “emotional distress”, lost years of life, and individual expenditures on cigarettes and alcohol. These are personal costs, not social costs. They also fail to include the economic benefits the alcohol and cigarette industry gives to the UK in terms of employment and government revenue. Most of these studies should be relegated to the bin of junk statistics.

In fact, smokers and heavy drinkers do not cost the state more. Though smokers may cost more during their working lives, but non-smokers require greater expenditure in pensions, nursing care and welfare payments. Chronic diseases associated with old age are far more expensive than the lethal diseases associated with smoking and alcoholism. Smokers and drinkers are not a burden on the state, and the myth of saints subsidising sinners should not be used to justify tax rises.

The appeal of ‘sin taxes’

Despite the fact they hurt the poor and do not change consumer consumption, sin taxes have always been popular with governments as a source of revenue.

Sin taxes and minimum alcohol pricing should be recognised for what they really are - stealth taxes and paternalism designed to control the poor.

Chris Snowdon, author of the report and Adam Smith Institute fellow, says:

“Campaigners for sin taxes and minimum pricing often claim that “healthy citizens” are forced to bear the cost of other people’s lifestyles. In fact, the evidence shows that smokers take less from the communal pot than the average Briton and the money raised from alcohol duty comfortably pays for any burden drinking places on public services. If the aim of policy is to make individuals pay their way, the government should slash the beer tax and subsidise cigarettes. We are not seriously suggesting the government does this, but if politicians insist on increasing taxes on these products, they should admit that the purpose is to raise revenue. Essentially the government is forcing the people who are least likely to live to extreme old age to pay for the escalating costs of an ageing population.

“As we show in the report, amongst EU countries there is no relationship between alcohol prices and alcohol related harm, nor is there an association between cigarette prices and smoking rates. The only significant effects that sin taxes have are to make the poor poorer and black marketeers richer.”