Apr 2008 15

Even if you haven’t heard of Shire Pharmaceuticals or their ADHD drug, Adderall, which they describe as the "leading brand in the US market" you should still be very concerned at the possibility they might leave Britain due to high levels of tax, as is reported in City Am.  This is a FTSE100 firm, one of the biggest in the UK.  High tax rates won’t raise much revenue if firms like this one leave the country.

High levels of tax have hurt our international competitiveness but, although big companies have left before, this is usually hidden by the fact that it is new investment that goes elsewhere rather than existing companies in the UK leaving.  Now it is becoming more apparent than ever that Britain’s long term prosperity is being imperilled by an increasingly uncompetitive tax system.

Apr 2008 08

Tax evasion is rightly a crime and honest taxpayers should not have to subsidise a criminal minority.  Equally, there are sensible measures – such as simplifying the tax system – that can be taken to reduce the extent to which people can plan their way around tax (and reduce the advantages accorded to those with expensive accountants).

However, we don’t think that trying to blur the line between tax evasion (breaking the law in order to avoid paying tax) and tax avoidance (arranging your affairs, within the law, in a way that minimises your tax burden) is a good idea at all.  There are a number of reasons why, in practice and economic theory, such schemes turn out poorly whether you attempt to clamp down on anti-avoidance through a grand General Anti-Avoidance Principle or by encouraging the HMRC to become extremely aggresive (as has happened in recent years).

However, the basic problem is that the people who pay the highest price are never the rich foreigners that many on the left like to set up as bogeymen.  It is ordinary people.  Ex-cabbies starting up a business who haven’t done anything wrong but are bankrupted for 88p, for example.  This morning we found this 1909 election poster from the excellent collection at the Bodleian library which illustrates the basic problem pretty beautifully:

Tax_avoidance

Mar 2008 28

Dr. Terence Kealey (Vice Chancellor of Buckingham University) recently explained on Radio 4’s PM programme  that Ireland is now wealthier than the UK.  Indeed, Ireland’s per capita income is $38,504; the UK’s is $33,238.  It is probably for the first time ever that Ireland is wealthier than the UK.

In free market circles it has become common knowledge that the Celtic Tiger was created through tax cuts and cuts in regulation.  The usual counter-argument from the other side is that not the market, but EU subsidies caused the Irish boom.

I came across an article by Benjamin Powell  which explains how EU subsidies in fact did not help, but hindered Irish growth.  The article also makes an interesting comparison between EU countries which also received large amounts of subsidies, but who transformed into Tigers or Tiger Cubs.

Here’s the beef:

  • Dr. Powell found no link between economic growth rates and EU transfers. Over a period of time the Irish growth rates were highest when the EU subsidies were lowest.  At its highest level subsidies were 4 % of GDP.  Greece also received 4 % of GDP – but its growth rates were nowhere near Ireland’s.
  • Agricultural subsidies keep agricultural populations artificially high – when they would be more productive in other (urban) activities.
  • EU subsidies retard growth in another way: large number of people are employed in the business of obtaining the subsidies, rather than in more productive sectors.
Mar 2008 19

Did you know that 13% of UK adults face an effective marginal tax rate in excess of 70%? That is, for every additional £1 of income they get, the government will take at least 70p.

For 7% of adults it’s even worse: they face an effective marginal tax rate of 90% plus, meaning they lose at least 90p of every extra £1 they earn.

So who are these people? Mega-wedged investment bankers busily inflating more debt balloons down at the Wharf, perhaps? Rock stars? Undeserving plutocrats having their pips squeaked by our Socialist rulers?

Ah, no. Worst case for all of those high-rolling groups is a marginal tax rate of 41%. The only people who face 80, 90, 100% tax rates are the poor.

That’s because when they earn more, they not only have to pay tax, but they also face the progressive withdrawal of welfare benefits, such as housing benefit. Their Effective Marginal Tax Rate (EMTR) is consequently much higher.

The latest facts are set out in the Institute of Fiscal Studies’ Green Budget published in January. And here’s their overall summary showing how many people are on different Effective Marginal Tax Rates (EMTR):

It’s a depressing picture, and as we can see, Brown/Darling’s latest 2008 tinkering has actually increased the proportion of taxpayers on the top marginal rates.

Labour has made much of its programmes to make poverty history. But as the IFS analysis so clearly highlights, in time honoured tradition, their approach has weakened incentives for the poor to help themselves. The Joseph Rowntree Foundation summarises the key IFS findings for people of working age thus:

"Work incentives are most weakened through the withdrawal of means-tested benefits and tax credits, not through high rates of income tax. Over two million workers in Britain stand to lose more than half of any increase in earnings to taxes and reduced benefits. Some 160,000 would keep less than 10p of each extra £1 they earned.

Overall, reforms under the Conservatives acted to strengthen average work incentives whereas Labour’s reforms to date have weakened financial work incentives on average: since 1999, tax and benefit changes have increased the average EMTR by almost three percentage points."

Another IFS paper charts the history. To understand what’s happened, focus on the purple line: it shows the minimum effective marginal tax rate paid by the 10% of workers facing the very highest rates- they pay at least that much.

As we can see, under the Tories, the worst placed 10% of workers were those paying the 40% higher rate of income tax. Which is what we would expect. But since 1999, the worst placed 10% of workers are no longer those 40% income tax payers: rather, they are poor people facing crippling withdrawal rates on their welfare benefits.

This puts complaints about benefits scroungers into their proper perspective. No matter how much you and I may criticise them, for someone facing a 90% – or even a 70% – effective tax rate, working harder and longer is just not a rational option. And that feeling is reinforced when they hear tales of benefit recipients who’ve gone out to earn more, only to face later demands to repay hundreds of pounds in overpaid benefits: DWP’s systems are simply unable to keep track of their earnings in the context of Brown’s fearsomely complex benefits system.

Brown’s means tested benefits for pensioners have similarly undermined incentives to save for retirement. Just at the time when another of his master-strokes (dividend tax) put the boot in on our company pensions, his pension credit system has blown the incentive to save in a personal pension. Why bother, if the government will only grab the benefit by withdrawing its own payments to you?

The reality of Gordon Brown’s war on poverty is that by hugely expanding the scope and magnitude of means tested welfare benefits, he has made it much harder for the poor to earn their own way out of poverty. Even if they might want to. Despite all his talk about hand-ups replacing hand-outs, he has seriously reinforced long-term welfare dependency.

(See also this Telegraph article).

Mar 2008 19

An excellent article by Tim Montgomerie, editor of ConservativeHome, in the Guardian contains this priceless quote:

"The consensus on tax within the political establishment isn’t matched by the population at large. The same YouGov poll (pdf) that found strong support for David Cameron’s Conservatives found even greater support for tax reduction: 67% of all voters said that the government should tax less and spend less and 20% said the tax and spending mix was about right. Only 8% of Labour supporters want more tax and spend, but our political leaders are deaf to these new facts. They are still living in the 1990s, when voters thought Britain was underspending. I imagine Cameron, Brown and Clegg going home to watch This Life DVDs and to listen to Portishead. They are all out of step with the new mood of voters. Voters want a refund from a political establishment that has wasted much of the extra taxes that have been paid."

Mar 2008 17

Over the weekend, the Shadow Chief Secretary to the Treasury told the Sunday Telegraph:

"If we get into office and we deliver the efficiencies and we put the money in the bank, we put it by and then we go back to the electorate and we say not, ‘we would like you to believe that we will find these savings, that we will eliminate this waste’, but ‘we have actually done it, we’ve made the savings, we’ve got this money in the bank, now we are going to tell you how we will use that to cut your taxes in a way that is prudent and sustainable’…. It will be the great bonus of the second election. You go into government with a set of fully funded promises and during that first term of office, by delivering an efficiency programme, we will pile up the headroom to be able to offer reductions in taxation… When the money’s piled up in the pot, then you give it away in tax cuts."

It’s worth pointing out that Hammond also said in the same interview:

"Families were looking for some relief [in the Budget] and what they got was another hit. If you ask families the question, ‘do you feel your tax burden is too high or too low?’, I suspect invariably the answer will be too high."

So Hammond’s answer to the following questions would presumably be: Do you think taxes are too high? "Yes". So will you cut them? "No, well, maybe in 2014".

What utter rubbish!

Mar 2008 13

People might be forgiven for thinking it is just the largest and most polluting cars that are going to face increased tax with the big boost to Vehicle Excise Duty today.  This report, from the BBC News website, suggests that Darling has raised taxes on "high-polluting" cars:

"In his first Budget Mr Darling raised taxes on high-polluting cars, alcohol and cigarettes and announced new tests for incapacity benefit claimants."

In fact, new TaxPayers’ Alliance research reveals that a heavy majority of the different car models in current production will face increased taxes under the new charging structure, even compared to the 2008-09 rates:

  • 88 per cent of cars will pay more under Darling’s new charging structure.
  • 2 per cent of cars will pay the same under Darling’s new charging structure.
  • 9 per cent of cars will pay less under Darling’s new charging structure.

The higher rate in the first year, the "showroom tax", will apply to most cars – with only a small number paying less in the first year:

  • 72 per cent of cars will pay more in the first year than in subsequent years.
  • 22 per cent of cars will pay the same in the first year as in subsequent years.
  • 6 per cent of cars will pay less in the first year than in subsequent years.

To find out how much you will have to pay for your car download our spreadsheet with details of every model in production:

Download the TaxPayers’ Alliance Vehicle Excise Duty Database (XLS, 2.5MB)

Notes

  1. Fuel economy data is drawn from the official VCA Car Fuel Database.
  2. Data on the new charging structures is from table A8 in the Budget.
Mar 2008 04

How progress happens

So what should we make of the schools lottery fiasco? Brighton’s attempt to impose Marxist-Leninist principles on school place allocation (originally blogged here) has backfired spectacularly, with an outright reduction in the proportion of kids getting their first choice secondary school. It’s reportedly declined from 84% to 78%, so more than one-in-five kids won’t get their top choice.

The first point to make is that this reflects a national crisis. The Guardian has surveyed local authorities and reports:

"Up to 120,000 of the 560,000 families expecting to receive an offer of a secondary school place in the post this morning will be disappointed as local authorities across the country report fewer pupils being offered their first choice of school.

Islington saw one of the biggest falls, with 59% getting their first preference – down nine percentage points from 68% last year. Barking saw a drop from 73.5% to 71.5%; Hammersmith from 62% to 60%; and Westminster from 69% to 66%." (See also the Times survey here).

Second, this is yet another example of our politicos promising the earth but not having the faintest clue what that might actually entail. Blair was constantly banging on about school choice, but as teachers union boss John Dunford says, the reality is quite different:

"Parents’ expectations are wrongly being raised by the political rhetoric of parental choice when in fact all parents are able to expect is to express a preference of which school they attend."

Obviously Dunford has an axe – the teaching unions never wanted parental choice in the first place. But in highlighting the gulf between rhetoric and reality he points to the nub of the problem.

Far too much of this debate suggests choice is a consumer benefit. Parents can choose which school their kids should go to, just like they’re able to choose which family car they’ll drive. Whoopee!

But according to the polls, most parents don’t want choice per se: hardly surprising, given how time consuming and stressful the whole nasty business can be (even when you’re armed with a private school cheque book). What parents actually say they want is "good local schools". And that’s the key point.

Choice is not something people necessarily enjoy exercising. But choice is a vital condition for driving progress. Unless people can actively choose between the good and the not so good, there’s generally no way for society to work out which is which (leave it to the commissars to decide? you’re not serious).

Of course, there is a key second condition for progress, which is real competition among suppliers. In the real world, that means when consumers in 1972 chose the Datsun Cherry over the Austin Allegro, there were consequences. The Japanese owned reliable car manufacturers thrived and expanded, and the shoddy British owned ones disappeared. But eventually the Japanese set up British manufacturing facilities and Britain’s exports hit all-time highs. Kind of idea.

It’s no good parents having the "right" to choose the good schools if there is no real competition among the schools and no consequences for them. All that happens is more and more parents have their choices over-ruled, and angst levels explode (sorry about that Tamsin- you’ve now been rejected by your first three choices, so Bash Street it is).

Imposing a lottery to allocate the good school places is both an act of desperate failure, and a block on future progress. There are no consequences for the poor schools because they get their places filled anyway. There is no driving incentive to improve. And next year we will be right back in the same place, with probably even fewer children getting their first choices.

At this point, somebody usually says "ah yes, but if you allow choice and competition among schools, you will create a lot of waste- school places aren’t like water, you can’t turn them on and off just like that, and underperforming schools would get left with loads of empty places we’d still have to pay for."

And there is some truth in that. Choice and competition is a messy, and in some respects wasteful, process. You do get pockets of oversupply developing alongside pockets of shortage. It all seems a bit random and chaotic.

The problem is, that’s the only way we ever make progress. As Eric Beinhocker describes in his outstanding book The Origin of Wealth (see here), progress has always depended on large dollops of randomness and wasteful dead-ends.

But it also depends on something else. The randomness has to be contained in a structure that can somehow recognise and react to its results. Just having the randomness alone doesn’t do it.

As Beinhocker highlights, evolution works through differentiation, selection, and amplification. That’s how we made it out of the primordial soup in the first place, and that’s how all our economic and material progress has come about ever since.

Which is why the latest economic thinking about how we get richer places heavy emphasis on evolutionary behavioural processes rather than intelligent design engineering processes. There is no grand masterplan, and systems that work on that basis are systems that are doomed to underperformance and ultimate extinction.

A school place lottery has the randomness all right. But it will do nothing whatsovever to improve Britain’s schools.

Whatever their rhetoric may say, when it comes to schools, none of Britain’s mainstream politicians has yet convinced us they’re prepared to abandon their primitive faith in intelligent design.

Feb 2008 29

London

A huge share of Britain’s GDP, tax revenues and exports are dependent upon financial services and the continuing ability of London to attract investment in this vital industry.  It is one sector where we are a world leader.  Take a look at the WorldMapper map with countries’ sizes adjusted to their share of the international finance and insurance market.  99% of world profits from this huge industry flow to Switzerland, Germany, Luxembourg and the UK – we are the leaders:

97

This is a highly mobile industry as it operates globally and can communicate effortlessly across the world.  If London ceases to be competitive we could lose our lead in this vital sector really quickly.  If that happens we will struggle to make up for the loss of most of the around £15 billion of tax revenues that London exports to the rest of the country every year rather than spending itself.  That’s just tax revenues – our long-term prosperity would also seriously suffer.

With all that in mind the news, from the Financial Times, that our competitive position relative to New York and other financial centres is eroding should be extremely worrying:

"London is losing its status as the world’s leading financial centre and being overtaken by New York, according to a global survey of finance professionals.

The collapse of Northern Rock and the proposed tax crackdown on non-domiciled residents are making the UK less attractive to overseas businesses, according to the City of London Corporation, which commissioned the survey.

A separate survey, also commissioned by the City, said the UK tax system had lost its competitive edge over other financial centres. The UK had become increasingly unpredictable and uncertain, complex and unnecessarily aggressive in its approach to taxpayers, it found."

Feb 2008 28

Hongkong Hong Kong is to implement massive tax cuts:

"Hong Kong’s financial chief said Wednesday he will cut salary and corporate taxes and abolish duty on beer and wine after a booming economy pushed the city’s budget surplus to a record high.  In his maiden budget speech, Financial Secretary John Tsang said he would increase spending on health services and introduce measures to bridge the widening wealth gap and reduce air pollution.

Duty on beer and wine — currently at 40 percent — will be cut with immediate effect.

Tsang estimated the budget surplus would reach a record 115.6 billion dollars (14.8 billion US) in the fiscal year to March, four and a half times the government’s forecast and nearly twice as much as last year’s figure.  The territory’s fiscal reserves will reach 484.9 billion dollars, he said.  Tsang attributed the surplus to higher-than-expected tax revenues from the city’s booming stock and property markets as well as company profits and salaries."

This combination of swelling reserves and surpluses and hefty tax cuts is possible thanks to the dynamic returns to Hong Kong’s already low taxes and the returns of broader economic liberalism.  Over many years the territory has had low taxes and rapid economic growth has left it with an income per person higher than that in Western Europe or Japan.  It places first, year after year, in the Index of Economic Freedom.  For more on Hong Kong’s liberal economic order see the first 1980 episode of the late Milton Friedman’s classic Free to Choose.  That commitment to low taxes and free-market economics creates growth which brings with it revenues that can fund future tax cuts in an incredible virtuous circle.

Britain, unfortunately, is going in the opposite direction with increased taxes hurting the economic growth that builds prosperity for the future.  That’s quite a price to pay for little result in the public services.

Feb 2008 27
Where to in a downturn?

When Lord Forsyth’s Tax Commission reported 18 months ago, it called for tax cuts amounting to £21bn. Ed Balls and the BBC immediately savaged it: "same old Tories – same old destroying the NHS – same old killing babies and pensioners in the street" etc etc etc (eg see this blog). George Osborne hastily caved in, distancing himself from the Report, and pronouncing:

“We will not be promising reductions in taxation at the election. Any changes in taxes will be revenue-neutral.”

Yesterday Forsyth himself came back with an excellent speech at the IEA. The speech tackles head on the issue of how an incoming Tory government could fund such cuts.

First, he points out that cuts in tax rates do not necessarily mean proportionately smaller tax revenues. You don’t have to believe in Voodoo Economics to understand the by now considerable evidence to show that lower tax rates increase GDP (see many previous blogs), which increases the tax base and naturally boosts revenues. There is also considerable evidence that lower rates generate less tax avoidance/evasion.

Forsyth quotes a number of US studies supporting these effects, including the work of surefire future Nobel laureate Prof Martin Feldstein. That concluded a 1 percentage point cut in personal marginal tax rates leads to an increase in taxable income by up to 2%. Which at current UK tax rates, suggests around two-thirds of the revenue foregone by cutting rates would be recouped via a revenue boost. And that’s without considering longer term "dynamic" effects in lifting GDP growth.

Second, tax cuts can be funded by containing the growth of public expenditure, and yesterday Forsyth suggested holding real growth to 1.5% pa during the first Parliament. He says:

"Matching Labour’s plans to increase spending by 2.1 per cent a year in real terms for the next three years was a mistake, but one which the Conservative Party is unlikely to have to implement as the Prime Minister will almost certainly go to the wire before calling a General Election. Far more important is whether any subsequent pledges to match the Government’s spending plans are made – if they are, they tie the Party into spending promises that could mean higher taxes or higher borrowing in a downturn."

We have long favoured the adoption of a third fiscal rule to contain the size of government (see eg here), so we wholeheartedly support Forsyth’s call for an explicit upfront commitment. As he points out, 1.5% pa spending growth over a Parliament would almost certainly be enough to finance the whole of his proposed £21bn of tax cuts. And without destroying the NHS.

Finally, he takes a good whack at the slippery Mr Balls:

"Ed Balls is quite simply wrong – the price of not reforming our tax system is too great. Britain’s economy cannot continue to perform under the increasing burden of a higher, more complex, more uncertain and more unfair tax system. Political will and courage are now needed to grasp the nettle of reform."

PS ConservativeHome’s spending campaign is getting more and more traction. Well done Tim and Sam- keep it up.

Feb 2008 27

In an excellent speech yesterday at the IEA’s State of the Economy conference Lord Forsyth, chairman of the Tax Reform Commission, used his speech (PDF, via ConservativeHome) to set out just how much could be achieved if spending growth was controlled: the ruinous economic effects of high taxes that we could avoid, the money we could return to the pockets of hard pressed taxpayers.  If spending growth was controlled at 1.5 per cent per annum we could afford the measures outlined in the Tax Reform Commission report; taking 2.5 million low paid people out of the tax system, a reduction in the basic rate of income tax to 20 per cent, a transferable tax allowance for couples with children, abolition of stamp duty on UK shares and the ending of inheritance tax (as part of a reform creating a short-term capital gains tax).

We have to hope that the major parties are listening and Lord Forsyth’s excellent advice will be heeded.

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