A howler from the IPPR

The IPPR have a report out today calling for corporation tax to be hiked and employers’ national insurance contributions to be cut. You don’t have to read far in the report to spot an absolute howler.

From the report’s Executive Summary (emphasis my own):

“The corporation tax rate should be increased, and the proceeds used to fund a reduction in employers’ national insurance contributions (ENICs). We model a rise in corporation tax from 19 to 24 per cent, which would allow a reduction in ENICS from 13.8 to 11.8 per cent. This change will ensure that shareholders bear a greater portion of the burden of corporate taxation, allowing the proceeds to be passed on to workers through wage increases or additional employment. A higher rate of corporation tax would also raise the value of investment allowances, creating a larger incentive for investment. The changes would shift the burden of taxation away from less profitable businesses with high input costs onto more profitable ones”

Let’s put it to one side whether shifting taxation from businesses with high input costs to businesses with low input costs is a good idea. The idea that a higher rate of corporation tax increases the incentive to invest is categorically wrong.

Guys. It’s time for some optimal tax theory.

In the 1960s Dale Jorgenson and Robert Hall put together a framework for evaluating the effect taxes have on investment. It’s pretty straightforward. It sums up all the associated costs of capital such as taxes, depreciation and borrowing costs. If an investment can generate a return net of those costs then it’ll take place, if it doesn’t then it won’t be made.

The amazing thing about Hall and Jorgenson’s User Cost of Capital equation is that it lets you mathematically prove that the IPPR’s claim that higher rates of corporation tax will increase the incentive to invest is wrong.

Alan Cole (formerly of the Tax Foundation) in his paper Fixing the Corporate Income Tax, shows that raising the corporate tax rate increases the cost of capital.

“Hall and Jorgenson derive an expression for the price of capital, as follows:[10]

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“where c is the cost of capital services, q is the price of capital goods, r is the discount rate, delta is the rate of physical depreciation on the asset, k is an investment tax credit, z is the present value of the depreciation deduction on one dollar’s investment, and u is the tax rate. For the purposes of this analysis, we will concern ourselves with the relationship between z and u.

“The value of z under current law is greater than zero, but less than one. A value of zero would correspond to no deductions at all, whereas a value of one would correspond to a system where deductions for capital equipment were taken immediately. (This is also often known as “expensing.”)

“Recent Tax Foundation research found z to be 0.8714 in the U.S. in 2012, meaning that the present value of the depreciation deduction schedule for the average investment made in 2012 was only about 87 percent of the value of the actual investment.

With a value of 0.8714 for z, we find that the cost of capital increases as u increases. That is to say, a higher corporate rate (under current depreciation schedules) increases the cost of capital."

It’s true that as the net present value of capital allowances increases the effect that a higher rate has on the cost of capital falls (capital allowances also become increasingly expensive). If we allowed firms to immediately write-off capital investments (known amongst wonks as full expensing), then the corporate tax rate would have no effect whatsoever on investment, but at no point does a higher corporate tax rate increase the incentive to invest. The IPPR’s claim is simply false.

George Osborne’s 9 percentage point cut in corporation tax was funded in part by making depreciation schedules less generous (and in the case of industrial buildings scrapped them altogether).

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As a result, the UK’s Effective Marginal Tax Rate in 2016 was only 3% lower than in 2007. Osborne’s rate cuts were effective at attracting international capital, but failed to move the needle on domestic investment. Hiking corporation tax without expanding capital allowances (which is what the IPPR propose) would hit investment hard.

The coal-fired power plant you can’t get coal to

For over a decade, my country—Sri Lanka—followed a state-directed, debt-fueled model of infrastructure development. The results were mixed: just how mixed is illustrated by is the 900Mw coal-fired power plant in Norochcholai. It is regarded as a success: but read on.

The largest power plant in the country, Norochcholai was expected to transform the energy supply, producing reliable cheap power and freeing the country from the vagaries of the weather. Up to that point, the bulk of the country’s power was being provided by hydropower. 

The plant was designed and built by the China National Machinery and Equipment Import and Export Corporation (CMEC) and partly financed by a loan from the EXIM bank. Controversy dogged the project from inception: the idea was first floated in the 1980s but environmental and other concerns stopped it from being built. In 2005 a positive environmental impact assessment from 1998 was dusted off and the agreement with CMEC signed.

However, Sri Lanka does not produce coal. So the plant was sited by the seashore to facilitate the unloading of coal. Naturally, a pier should have been built for ships to dock and unload. But this was never done. Under pressure from environmentalists, the site was shifted from the eastern deep water port of Trincomalee, to Hambantota in the south, before finally settling on the West coast—where the water is too shallow to accommodate a pier.  

This means that the ships that bring coal for the plant must now discharge their cargo mid-sea onto small barges that transport it to shore. Inefficient enough: but unfortunately, Sri Lanka is also a tropical country, subject to the monsoon. So for six months of the year, the waters are too choppy for the barges to operate. So the plant has to stockpile half a year’s supply of coal in the open, where of course it gets wet.

Since a change of Government in 2015 the two sides have traded allegations of corruption, poor design and the use of substandard materials in the project. CMEC have retorted by blaming breakdowns on the transmission lines and a lack of technical skills in Sri Lanka. The fact that all the instruction manuals for the power plant were written in Chinese may have contributed to some of the confusion evident among local engineers.

Remarkably, despite all these mistakes, plus teething troubles that led to many unexpected shutdowns, and more recent problems of pollution from coal dust and fly ash, the coal power plant remains one of the best Chinese projects. It does at least generate power at relatively low cost: when it was completed in September 2014, the President announced a 25% cut in the electricity tariff (with cuts in kerosene, petrol and diesel prices thrown in for good measure). As an example of a state-led infrastructure project, however—it is a classic.

Ravi Ratnasabapathy is a Fellow of the Advocata Institute, a free-market think tank in Colombo.

As George Monbiot doesn't understand the environment is a luxury good

Apparently there's some confusion out there in environmentalland about the environmental Kuznets Curve. All it is, really, is an observation that the environment is a luxury good. By this we do not, at all, mean that nothing need be done about it. Quite the contrary, we mean that only richer societies are going to do anything about it. Thus this is simply nonsense:

Pinker suggests that the environmental impact of nations follows the same trajectory, claiming that the “environmental Kuznets Curve” shows they become cleaner as they get richer. To support this point, he compares Nordic countries with Afghanistan and Bangladesh. It is true that they do better on indicators such as air and water quality, as long as you disregard their impacts overseas. But when you look at the whole picture, including carbon emissions, you discover the opposite. The ecological footprints of Afghanistan and Bangladesh (namely the area required to provide the resources they use) are, respectively, 0.9 and 0.7 hectares per person. Norway’s is 5.8, Sweden’s is 6.5 and Finland, that paragon of environmental virtue, comes in at 6.7.

Pinker seems unaware of the controversies surrounding the Kuznets Curve, and the large body of data that appears to undermine it.

Sadly, such is the state of economic knowledge out there that we've even got to step back and explain what a luxury or superior good is. It doesn't mean something which is better, nor has it the colloquial or vernacular implications of luxury, something only for the rich and leisured.

An inferior good is something we spend less of our income upon as our incomes rise - potatoes, say. A normal good is something we spend the same portion upon, a luxury something we spend a higher portion of those rising incomes on. Just about everything is any and all of the three at some income level.

That environmental Kuznets Curve doesn't say, necessarily at least, that a richer society will be a cleaner one. What it does say is that after a certain level of income (wealth, if you prefer) then a society will spend a rising portion of that increasing income on a clean environment. It refers not to what absolutely will happen but to the economic capability of what resources will be devoted. 

Once that is understood then the arguments against it disappear. We still get to have those lovely arguments about what should be done, which is the most important thing we should devote those resources to. We are, just as with GDP itself, just making an observation about the economic resources available. How they're deployed is another matter.

That's also where it all gets interesting of course, we ourselves arguing that a cleaner environment is indeed something worthwhile - because everyone else seems to think so, the true determinant - which is why we must be efficient in our deployment of those resources in cleaning it all up. Rather than killing off the industrial capitalism which provides the resources to do the cleaning....

A no-brainer inheritance tax cut

To most voters inheritance tax is profoundly unfair, even the Fabian Society thinks the tax is too toxic to save. Worst still, rather than cutting the rate or scrapping it altogether, ministers have instead carved out exemptions for family homes distorting investment into property. Beyond being widely perceived as unfair, the tax is also much less progressive than many suppose. Greg Mankiw points out that the incidence doesn’t just fall on fortunate heirs, but also on workers who don’t receive a bequest.

“The estate tax is a tax on capital. As such, one would naturally expect it to discourage capital accumulation. Now, put this together with the fact that a smaller capital stock reduces productivity and labor income throughout the economy and the implication is clear: the repeal of the estate tax would stimulate growth and raise incomes for everyone, even those who never receive a bequest.

“The average worker has little reason to know that his weekly paycheck is smaller because of the existence of the estate tax. He may never realize that he bears part of the burden of the estate tax.”

Of course, the tax does have supporters. They worry about powerful dynasties forming and consider heirs undeserving. But there’s one inheritance tax cut everyone should support.

Under the status quo, each pound bequeathed over £325,000 is taxed at a high 40%. At the same time to avoid double taxation, capital gains are forgiven at death. This is backwards. As the Institute for Fiscal Studies’ Mirrlees Review put it “There is no case for forgiveness of CGT on death.”

This creates a powerful incentive for individuals to hold onto an asset when they would be otherwise better off selling up and putting their money in more profitable opportunities elsewhere. Taxes that reduce the number of times an asset changes hands also tend to reduce liquidity and increase volatility.

The Treasury estimated in 2012-13 that forgiving capital gains at death costs the Exchequer around £490m a year (annoyingly they haven’t calculated it lately). Since then the rate has fallen from 28% to 20% and revenue has nearly doubled.

Politicians are understandably resistant to adding further taxes on families when loved ones pass away, but forgiving capital gains at death is a terribly inefficient way to do that. The solution is a no-brainer. Scrap the exemption and plow the funds into cutting the inheritance tax rate.

Regulation by result

Too many regulators are obsessed by process, telling businesses and individuals precisely what they must do. The concern should be with the results, not the process. It is process regulation to require that all motor vehicles be fitted with a particular type of catalytic converter. It is result regulation to specify the maximum output of various pollutants that will be permitted.

The former approach limits the technology to that which is known and approved, whereas the latter leaves space for ingenuity and creativity to devise different ways of achieving the stipulated result.

The UK’s forthcoming departure from the European Union gives us an opportunity to move away from the process regulation which has largely been favoured by the EU, and into result regulation to achieve equivalent outcomes.

The Prime Minister’s Mansion House speech referred to the possibility of the UK, post-Brexit, using other means to secure similar ends. In effect she was saying that the UK will not simply replicate EU rules in future, but will often use different methods to bring about similar intended outcomes.

We want the UK to be a hive of inventiveness and entrepreneurship in future, and one way of encouraging this is to allow creative minds space in which to produce and test new ideas. By specifying the results we want regulations to achieve, we are allowing innovators to experiment with novel and unknown ways of bringing those results about. These new ideas might be more efficient or less costly, and they might help create some of tomorrow’s new jobs.

400-600-600, but what about the people who obey the rules?

Public Health England has decided that we should all be eating on the 400-600-600 plan. 400 calories for breakfast and 50% more for each of lunch and dinner. Quite why all should be gaining more calories from solid food than any journalist has ever done we're not quite sure.

There's a problem here though, some people do actually obey the rules

Under its new ‘One You’ campaign, launched today, Britons are being encouraged to stick to 400 calories at breakfast, and 600 calories for both lunch and dinner.

Critics branded the daily allowance too low for growing children and close to war rations, but public health experts warned that obesity had now become ‘the norm’ and said most people were eating hundreds of extra calories each day.

Even with the significant decline in energy expended in this modern world 1600 calories a day isn't enough to sustain a healthy life long term.

PHE's underlying point is, well it's a claim at least, that everyone lies about how much they're eating., So, set the limit well under what is healthy, everyone lies, they'll be eating the right amount.

The problem being that not everyone does lie, disobey the rules. Different societies, different cultures, will have differing numbers of scoff laws of course, We'd not expect Italians and Germans to have the same incidence of jaywalking for example. We British tend to have more rule obeyers than many other cultures - perhaps not quite as many as the Germans but still.

Which is where PHE is making their mistake. They're noting that on average we lie, as with on average the population's number of legs is less than two. But knowing the number of legs is of no use to the provision of artificial limbs. So too that some lie is of no use in setting calorie targets. For some to many don't.

There will be those who follow this advice religiously and who therefore damage their health. Which really isn't what PHE should be doing, is it? It's the old grand delusion, treating us as a population to be managed rather than the individual humans we are. 

Time for roads to become part of the market economy

Politicians across the political spectrum are committed to cutting back carbon emissions to limit the damage of climate change. Today, the biggest area of disagreement is on how best to do it. Is it through markets or central planning?

The EU auctions off tradable permits to emit. In theory, this should allow market forces to find the most efficient way to cut back on pollution. In reality, few sectors are covered by the European Trading System. In most sectors, reducing emissions is up to each member state. The problem is that in sectors outside the scheme member states swap market forces for direct intervention.

Take my home country of Denmark for example. According to a newly released report, 38% of emission in non-ETS sectors in Denmark comes from transportation. Half of the emissions from transportation comes from passenger cars. It makes sense then to see cars a good starting point if we want to lower emission in the non-ETS sectors.

Besides polluting, cars are also noisy, cause congestion and wear and tear the roads. These are all negative externalities or, in other words, costs experienced by third parties. Externalities aren’t included in the price of consumption, so in order to have the consumer and producer take these into account and help limit the external costs encountered by third parties, countries try to put a price on the externality in one way or another. The principle being that you should pay for the cost you cause the rest of society. For example, in a world where externalities aren’t priced, the costs of driving are higher for the society than it is for the motorist. In other words, the motorist have no incentive to take the societal cost into account.

Neoliberals believe, rightly, that taxes shouldn't push morality. They shouldn't distort behaviour into what some think is arbitrarily right Instead, choices should be left to consumers provided they pay the full costs.

Denmark’s approach doesn’t take account of the actions of users but hits all purchasers straight away with high taxes–assuming negative behaviour later down the line. Danes pay a 150% registration tax of their cars and not less than three years ago, they were taxed at 180%. On top of that, there’s a six-monthly ownership tax of between roughly £55 and £2000 and of course VAT of 25%. Unsurprisingly, according to the report published by the Danish Economic Council, taxes on cars are too high. In fact, their calculations show that the taxation of petrol, diesel and electric cars are 120%, 70% and 50% percent higher than the external costs - shocker!

Taxes on passenger cars are therefore concentrated around the purchase and ownership of a car, which in itself doesn’t constitute a negative externality, and not around the externalities they produce. The taxes should therefore shifted to be as close to the source of the externality as possible. Since getting or owning a car is in itself not contributing to pollution or congestion, but the use of your car in peak hours on busy roads is, road pricing is preferable. With road pricing and taxes on fuel motorists can make an enlightened decision based on all the available information about the societal costs. Some will be willing to pay the price while others will find different alternatives. User fees will help cover the costs of maintenance and infrastructure.

As it stands, the focus is not on internalising the externalities. Instead, it has become a question of ideology and being able to say that the Liberal government actually got through with liberal policies instead of handling the real problems. They’ve ended up lowering one tax only to raise another (as it was done last time when the registration tax was lowered). Taxes should have a purpose, to reduce the external costs imposed on society, this approach doesn’t solve that.

Road prices would make people aware of the costs they impose on others. They would then use roads more efficiently. Finding just the right price is difficult, however. The congestion charge in London, for example, was way too low and the price uniform, which meant motorists weren’t nudged towards off-peak hours and routes. A more ideal road pricing scheme would look similar to that of Singapore where they differentiate between time and place. GPS technology, proliferation of smartphones and apps are making it easier and easier to solve the cost issue of road pricing.

There is a pressing need to find a better way of funding roads and cutting emissions. As electric cars become commonplace, fuel duty receipts will shrink. The case for scrapping taxes on purchase and ownership, cutting taxes on fuel and instating road pricing will become irresistible.

We've come a long way from the days of pure socialism on parts of the continent, when prices were ignored in favour of ideology. Yet some hangovers remain. It’s been proven time after time that prices are the best way of allocating scarce resources. When a resource is free to use, it becomes overused because the consumer has no incentive to economise. It’s therefore high time roads become a part of the market economy as well.

We agree with the IPPR, let's abolish corporation tax

IPPR describe themselves as a progressive think tank which is why it's so wonderful to see them proposing a properly progressive idea - let's abolish corporation tax. This isn't, of course, what they think they are suggesting but it is that very thing. For they insist that all sources of income should be taxed at the same rate. Which means that, if dividends are to be taxed at normal income tax rates, we must not tax those same dividends at the level of the company

The rates and allowances for employee NICs and income tax should be
combined into a single tax schedule, and applied to all incomes on an
individual, annual basis. All income would be treated under the same rates,
irrespective of whether it was sourced from labour earnings, savings, trusts,
dividends or property rents. 

We're most certainly not averse to a merger of NI and income tax. We'd insist that when it does happen that employers' NI must be included - just so that all can see how not a low tax nation we are.

That still leaves that dividends point. Currently corporate profits pay corporation tax, dividends being paid out of that post-tax income. Whether tax is collected at the corporate or personal level is a second order consideration, we'd prefer, as here, at the personal. The current system deliberately reflects this reality, that's why there are those lower dividend tax rates at the personal level. So, we abolish those, tax as income purely and simply.

Therefore we must abolish the taxation at the corporate level, abolish that corporation tax charge. As we've been saying we should anyway for a long time now but it's nice to have progressives like the IPPR on board as well.

Alternatively, of course, they've just not understood their own proposal something which, frankly, wouldn't surprise either.

Yes, really, we should have a carbon tax

In fact, we should have had a carbon tax some time ago. This is not to say that all of the extreme predictions of the catastrophists are true. Rather, we know that the fools are going to do something here so let's do the one thing that would actually work. The proof of the carbon tax being:

Successive ministers and officials have kicked the issue of how to decarbonise heating down the road.

That’s partly because it has not yet become entirely clear which technological approach is best, be it electrification of heating, the use of greener gases such as hydrogen, district heating schemes, or some combination of all three.

We face uncertainty here, that proper, Knightian, uncertainty. This is not something where we can play the percentages nor the probabilities, we really just don't know. And we'll not know for some time therefore it is impossible to plan.

So, what should we do? Note that this isn't to agree that something must be done - we know that something will so that's what we're trying to influence. And if something is to be done in the face of this uncertainty, what is it?

We should get prices right - that's the carbon tax - and then sit back and see what happens. For once we have got prices right we can and should, as Hayek so often pointed out, use that great calculating machine of a market economy to tell us what the answer is.

As is so often true there are things just too important for us not to be using prices in markets to tell us what we should be doing.