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.

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:

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."

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.

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.

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.

Dan Mitchell, from the Centre for Freedom and Prosperity at the Cato Institute, provides evidence for the importance of dynamic effects on tax returns.

Northern Rock’s assets should be run down gradually, maximising value to taxpayers and minimising the scale of the potential loss. That much is clear. In this scenario, jobs at Northern Rock will have to be shed.

The Government has instead decided to try to keep Northern Rock going as a profitable business – never mind that it is a company with a busted brand, that would indeed be bust were it not for the £110 billion taxpayer guarantee.

There are 6,000 jobs at Northern Rock. The taxpayer liability per job is therefore a staggering £18.3 million. Should we really be risking so much for so few?

In his speech to Policy Exchange on Friday, George Osborne said:

We can either: stick with our long term course; stick with the commitment I made to spending growth of 2.1% for the coming three years; review the final year when we know the state of the public finances; and understand that in an economic slowdown this will mean tight spending plans and difficult decisions about government priorities.

Or we can head off onto the margins of the political debate and reduce spending growth even further for the sake of a short term argument.

Never mind that it would probably be unachievable in a slowdown, when tax revenues fall and welfare spending rises. Never mind that it would be lower than anything Margaret Thatcher achieved during the economic turbulence she faced in her first parliament. At least, we are told, it will give us ‘a dividing line’.

Here is the historical list of real terms public spending rises since 1970:

In bold are all the years when public spending growth was lower than 2.1 per cent in real terms. Note that public spending growth was lower than 2.1 per cent in every year of Thatcher’s second parliament. In the first two years of her first parliament, spending growth was lower than 2.1 per cent, although the average in her first parliament was 2.3 per cent. Over the 18 years of Tory government, the average was 1.5 per cent. Note also that in the first three years of Brown as Chancellor, spending growth was lower than 2.1 per cent.

Now, is it really correct to say that 2.1 per cent per annum spending growth is tighter than under Thatcher?

The British economic downturn did not start with the fallout of the credit crunch.  The foundation was laid in 1997, when Labour took power and started to carry out its ambitious programme.

The economic growth between 1992 and 1995 was very high. Since 1997 economic growth has never again reached the peaks of growth under Thatcher and Major and growth has declined steadily.

The size of government has risen to a staggering 44.7 % of GDP according to the latest economic figures. In 1997 it was 39 %. There is a direct link between the size of government and economic growth: the smaller the former, the larger the latter.

Gordon Brown’s public spending spree largely benefited the public-sector payroll, with poor productivity outcome.  NHS spending has almost tripled since 1997: from £32 to £92 billion.

To pay for it all, taxes continue to rise.  The tax take is the biggest in ten years.  Even that wasn’t enough, hence the steep rise in public borrowing,

Add to this a flood of new largely EU regulations (gold-plated by the Labour government), and we have a logical explanation of why the UK’s growth is slowing down.  Agreed, there is an international rise of prices for food, raw materials and fuel – but that is equal for all countries.  The reason why the UK is doing worse is its own government.  It is interesting to note that many non-doms who are fleeing the UK say that the new non-doms levy is “just the last straw”.

In this time of economic downturn we need tax cuts to make the pie grow again.  A substantial cut in corporation tax would do the trick.  This was, of course, what caused the steep rise in GDP growth in Ireland (wrongly described as The Irish “miracle” – there is nothing particularly miraculous about the link between tax cuts and economic growth).  There is no reason why the UK could not become the fastest growing economy in the world if it really wanted to.

Whereas in the medium term the Laffer effect would ensure a larger tax take as a result of GDP growth, in the short term the tax cuts could only be afforded by cuts in public spending.  The Conservative Party is far too timid on the subject.  A comment by Philip Hammond MP [against] a cut in public spending at a time of an economic downturn was profoundly unhelpful.  A pound spent in the public sector delivers a much smaller return than a pound spent in the private sector (kept in private hands as a result of tax cuts).  I cannot believe that 62 years after John Maynard Keynes’ death anyone still believes that public spending is needed to make the economy grow.

We like to blame Europe (I do),  but abandoning traditional Anglo-Saxon small government for continental big government was largely a choice made by Blair and Brown – not an imposition from Brussels.

Cllr JP Floru
Director of Freedom Alliance

Sources

2008 Index of Economic Freedom
The size and Functions of Government and Economic Growth, by James Gwartney, Robert Lawson and Randall Holcombe, Joint Economic Committee Study, April 1998.
Tories’ economic legacy has been squandered, by ruth Lea, The Daily Telegraph, 17 September 2007.
Tory row over tax and spending grows, by Jean Eaglesham, Financial Times, 5 February 2008
Barmy arguments from Philip Hammond on spending, by Corin Taylor, Taxpayers’ Alliance Website, 5 February 2008.
Tax ‘n’ spend: No way to run an economy, by  Ruth Lea, CPS,  2004.

Sometimes it’s a wonder anyone bothers to vote these days. Why can’t politicians stand up for what they believe in, and give it to us straight?

A classic example of this is today’s FT report on George Osborne’s speech later today on the principles of tax reform. Mr Osborne has said repeatedly (and rightly) that the Government’s tax rises have been damaging to the economy. So why won’t he come out and say that he will reduce them? Given that he won’t, are we to believe that he is actually happy with the Government’s tax rises? You’d be forgiven for being confused.

As the FT reports:

Mr Osborne will promise a “fundamental rethink” of the tax system to ensure a longer-term approach to fiscal changes that addresses the effects of taxes on issues such as climate change.

So what does "fundamental rethink" actually mean? Sounds like higher green taxes, lower taxes elsewhere, but no cut in the overall tax burden, when a cut in the overall burden of tax is the very think that Britain’s economy needs. Some fundamental rethink!

Politicians who are afraid to address the high-tax, high-spending consensus should remember our YouGov poll last August, which found that 64 per cent think that the government spends too much and therefore taxes too much.

That all said, there are some welcome moves that Mr Osborne will announced today. Chief among them will be an Office of Tax Simplification, proposed by the Tax Reform Commission and designed to do to complex tax law what the National Audit Office is doing to government departments. The Tories would also require the Treasury to publish technical changes to the tax system in the autumn and set up a new parliamentary committee to scrutinise those changes. Hopefully this will insure no more CGT and non-dom chaos.

Today’s FT reports:

UK companies face having to add billions of pounds to their pensions liabilities under plans to be unveiled by the regulator to force them to use more realistic projections of how long workers will live after they retire.

The standard the Pensions Regulator is to propose next week is tougher than that used by 99.5 per cent of UK schemes and will increase stated liabilities for companies by 6 to 8 per cent, even for those already adopting the most prudent standard now in use. For roughly a third of all schemes, the increase in disclosed liabilities will be as much as 15 to 20 per cent and could force them to set aside more cash to fill shortfalls.

The regulator has the power to order weak companies to increase contributions to their final salary scheme. It also has the power to intervene on behalf of trustees if the regulator feels that companies are not putting in enough money to close gaps in their pension schemes.

There is nothing inherently wrong with this. Accurate reporting is, like the rule of law, essential to a well-functioning capitalist economy. But what about the public sector pension schemes? Unfunded public sector pension liabilities are anything from £530 billion (Treasury) to over £1 trillion (Neil Record’s authoritative report for the IEA). They should be placed on the balance sheet immediately.

Peter Franklin argues against the dynamic case for tax cuts, suggesting that if there is a Laffer Curve we are on the wrong side of it to get increased revenue when we cut taxes.

What needs to be remembered about the Laffer Curve is that it is an abstraction of a much more complex relationship between taxes and revenues.  It captures an essential truth that tax rises will not always increase revenue, and tax cuts will not always lead to a decrease.  However, it necessarily omits two crucial factors: time and the specific tax that is to be cut or raised.

Economic gains from tax cuts will often be felt over the medium to long term.  The European Central Bank studied the effects of growth in the state and found that a growth of 1 per cent in the size of the state led to a 0.13 per cent fall in economic growth.  Other studies have found effects at a similar order of magnitude.  That fall in economic growth won’t mean a lot in the first year but over time becomes very significant.  Brown’s spending splurge since 2000 may have left Britain’s GDP almost £14 billion lower.

Different taxes will have different effects on the economy.  There is an ongoing debate over the kind of tax cuts most conducive to higher growth.  However, the conventional view is that the effects on growth will be at their largest when they affect incentives to work and invest in the United Kingdom.  Alistair Darling is retreating from taxing non-domiciles because it was expected that tax rise wouldn’t increase revenue – even immediately.  A dynamic model (PDF) produced for the TaxPayers’ Alliance by the Centre for Economics and Business Research suggested that pre-announced, phased cuts in corporation tax to the Irish level over 14 years would boost investment by 60 per cent and GDP by 9 per cent – and pay for itself within eight years.

The evidence that tax cuts and controlling spending will have a very positive effect on growth is quite well established.  Gains from increased growth quite quickly weaken and then overwhelm the effects on revenue of a tax cut.  Combine that with an easing of the burden on hard pressed taxpayers and the case for restraining growth in spending in order to cut taxes and unleash the dynamic potential of a low tax economy is incredibly strong.