Tag: economics

Nov 05 2010

Why the other ways don’t work

In my last blog post I calculated how to raise money for various things (getting rid of tuition fees, avoiding any benefit reductions and so forth) using income tax; originally the more ranty bit to be found in this post was included, but it was getting a bit long so I separated analysis and rant.

Since the election there’s been a great deal of discussion of cuts, largely this has been framed in terms of a cut to X being apocalyptic where X is some area supported by its interest group. There has been rather less focus on what should happen in place of such cuts, proposing an alternative area for increased cuts has generally been tried: “waste, foreigners in the form of international development, benefit scroungers, Trident“ are ever popular – each of these contributes about £1bn or so per annum in spending – the gap we’re trying to match is about £80bn per annum. There have been some proposals for increased taxes to be paid by “someone else”, an increase in VAT met with considerable opposition (VAT is the third biggest element of tax – the change would raise about £13bn per annum), as was an attempt to cut child benefit for higher rate tax payers, raising about £2.5billion per annum.

The favoured targets for increased taxes are “the rich” and “tax avoidance”. “The rich” are normally defined as “richer than me and the people I know”, which is a poor definition. Tax avoidance, according to an HMRC report under the last government the size of the tax gap – the sum of avoidance (legal) and tax evasion (illegal) was around £40bn per annum. This is disputed with Tax Research UK giving a figure three times larger at £120bn. It’s difficult to see exactly how they manage such a high estimate – it’s seems to be based around the size of the “shadow economy” – things like illegal working. Regardless of this actually collecting the money involved in the tax gap would appear to be difficult: as announced by Danny Alexander there’s a hope that spending £200million per year will result in a tax recovery of £7bn per year. There’s an implicit assumption in tax avoidance that again it’s “the rich” who are responsible but it seem clear from reading the HMRC document that successfully addressing the tax gap would probably impact quite broadly. For example, buying wine in Calais is a tax avoidance; as is paying the builder, decorator and so forth in cash; as is purchasing items in Hong Kong via ebay. The company I work for has changed the way it pays some of my pension contributions to reduce the tax paid – presumably this would count as a tax avoidance too.

Vodafone is in the news at the moment for a £6bn tax avoidance. The £6bn figure is as calculated by Private Eye and is described by HMRC as “an urban myth”; Vodafone appears to have made provision of £2.2bn to address this issue and ultimately paid £1.25bn. It’s worth pointing out that the £6bn figure, accrued over 10 years is typically compared by protestors with a *yearly* benefit cut of £7bn. This sort of presentation leads me to believe that the proposer is somewhere on the innumerate-dishonest scale and discount whatever else they are saying. Taking the Private Eye “high” estimate this is £600million per year, taking the difference between the amount actually paid and the “low” estimate it amounts to £100million per year. Vodafone appears to have paid around £1bn tax on profit in 2009 amounting to a rate of 25% in that year, so it is not true that they pay “no tax”. It’s also worth noting that Vodafone appear to have the legal upper hand in the situation, given a judgement in the European Court of Justice.

At one time Trident or its replacement were cited as a source of ready cash – again the presented cost of up to £100bn is for the entire lifetime of the system of up to fifty years or so i.e. between £1bn and £2bn a year, regardless of this the decision on Trident has been pushed into the future (i.e. beyond the next election). A more likely figure for the Trident replacement is £20bn, or at most £34bn. I’ve said previously that I consider Trident to be Cold War willy-waving but scrapping it is not a big impact – particularly if there is any sort of replacement.

A useful rule of thumb for all these situations seems to be:

  1. Check that tax gain and spending are being compared on the same time period.
  2. Divide quoted tax gain by at least three since that will get you back to a more generally accepted figure.

The latest wheeze is chasing George Osborne for a £1.6million tax bill. Referring to our list above, (1) is met admirably this bill would be payable once, on the death of his father. Experience suggests the figure of £1.6million is fanciful. David Mitchell puts this so much better than me here in the Observer. It’s not that I am in favour of tax avoidance I just see efforts to address the problem by individual harassment as pointless. What is needed, as Mitchell points out, are changes in the law so that tax avoidance becomes tax evasion and is then illegal. It’s ridiculous to expect people to pay tax that they don’t legally have to – it’s not what the great majority of the population do – why expect companies and the rich to do any different?

I’ve yet to see any figures on the “cut deficit through growth scheme”, a priori I’m dubious since the ability of government to influence growth seems marginal and any scheme would need to stretch out beyond the 10 years that even Labour were planning to cut the deficit in by which time using my state-of-the-art recession prediction algorithm we will have experienced another recession, and another addition to the deficit.

I’m uncomfortable with the idea that we should demand services (no tuition fees, protected benefits) but rather than seeking a way to contribute to paying for these services personally try to push the payment for them onto a small fraction of the population. If you demand more money for X but don’t expect to pay any more for it then frankly I don’t think you’re committed to the idea.

Oct 31 2010

Yields from income tax

This post is a tour of income tax and personal national insurance yields, it’s motivated by an interest in seeing how one might pay for a part of the reduction in the deficit through taxation. The reason for focusing particularly on income tax is that it yields a fairly large fraction of the total tax income (28.7% in income tax and 46.6% income tax and national insurance combined), as discussed in a previous post; this means that relatively large amounts of money are raised by relatively small changes when compared to other taxes. Furthermore it’s relatively easy to calculate: I can work out how much income tax I pay in a year but would struggle to tell you how much VAT I pay per year, the impact of a tax on insurance premiums the effect of a change on duty and so forth. Thirdly, it is the tax that is most transparently progressive, in the technical sense that the more you earn the greater the fraction of your income you pay in tax.
This calculation is based on a calculation of personal tax rates from wikipedia, this figure generates the tax rates programmatically and I simply translated the code to my computer language of choice – I thought about doing it in a spreadsheet but that turned out to be a bit brainbending. The second component of the calculation is the number of people in each income bracket: this information along with further information on incomes can also be found on wikipedia. Ultimately the data come from the HMRC. I’ve put these two bits of data together into a program which enables me to fiddle with tax rates, tax thresholds and so forth. It appears to be approximately correct since it matches roughly HMRC’s own figures on the effects of small perturbations to the tax system (pdf). This also tells you it’s possible to look this stuff up – but I find it more fun to calculate it myself! It’s also a good illustration of the general process of how to go about repeating someones calculations from literature sources: try to reproduce their graphs; try to match the summary numbers they produce.
This first figure shows the income and national insurance payable as a fraction of gross (total) pay as a function of pay. The thing I hadn’t appreciated intuitively is that the tax banding system gives quite a smooth increase in percentage tax take, this is because you only pay raised rates on the fraction of your income that lies above the threshold:
TaxRatesAsAFunctionOfIncome
Extending the horizontal scale out towards incomes of £1,000,000 and the rate tends to 50%. The next figure shows the distribution of incomes, in the UK:
PopulationAsAFunctionOfIncomeBand
You can see the same information in text form here. The area under this curve between points on the horizontal axis tells you the number of people in an income band. The median income in the UK is £26k per annum – half the population earn more than this, half less. About 1% of the population earns more than about £100k per annum. This final figure shows the amount that each income band pays according to the latest tax rates.
TaxPaidAsAFunctionOfIncomeBand
To summarise this final figure in tax bands, the 20% band accounts for about 57% of tax paid, the 40% band for 26% and the 50% band for 17%. These bands contain respectively 90%, 9% and 1% of the income tax paying population.
In case you’re curious my salary puts me close to the top of the basic rate tax band.
To apply the knowledge embedded in these graphs to some recent problems:
As a rule of thumb: 1p on basic gives about £4bn, 1p on upper rate gives £0.75bn, 1p on the new 50% band gives £0.31bn. The reason for this sharpish dropoff is that relatively few people are effected by the upper rate tax changes so to yield a large tax income the rates have to be changed by a relatively large amount.
Reducing the threshold of the 40% tax band to £40k from £43k yields about £3bn.
The £20billion cut in welfare benefits is equivalent to approximately 5p on the basic rate of income tax, taking it to 24.5% from 20%. This would cost me about £1700 per year.
Tuition fees cost about £7.5billion (based on 1.5 million students each requiring an average £5k tuition fees per year), this is about 2p on basic rate. This would cost me about £800 per year.
The £2.5billion income gained from cutting child benefit from those in the upper tax band could be paid for with an increase in the upper rate to ~43% from 40%. Although it seems the £2.5billion figure is dubious. I can’t help thinking simply increasing the upper rate by this amount, rather than a convoluted attempt at clawback would be simpler. This isn’t to say I support the idea of paying child benefit to all regardless of income, just that implementing withdrawal in this way is technically complicated. This tax rise wouldn’t cost me anything!
I’ve not seen anybody volunteering for these tax increases to support their favoured causes, rather they prefer a range of schemes of dubious value impacting other people to avoid the problem falling upon themselves – a subject for my next post.
Note
This modelling was done using Visual C# running under Windows 7, if you’re interested either in the code or in just the application then let me know in the comments below (or on twitter). There are a couple of minor bits of tidying I’d like to do before release. Please note that the application is “good enough for blogging work” and should not be considered an accurate tool for tax calculations – it’s a toy to help me understand things!

Aug 06 2010

An Englishman’s Home is his Castle

Corfe Castle*

Back to rant for the blog post, this time on housing.

A house is like a millstone around your neck, once you’re in it the reluctance to do anything that might cause you to move out is massive.

I’ve been somewhat itinerant since leaving university after my degree, I lived in Durham, in Cambridge and then in Poynton and now in Chester. It goes with the job, I’m sufficiently specialised that I need to travel to find work. For families containing two academics this leads to an even greater “two-body” problem; not every town or village needs a research scientist of my ilk. The downside of this is a degree of rootlessness and a lack of a handy family network. I’m not sure how common this rootlessness is across the population as a whole, it’s true for many of the people I know.

It was when I was house hunting in 2000 that I got some hint of the credit crunch, I’d gone off to see the financial advisor upstairs from my estate agent to ask about offset mortgages (having been mildly burnt on payment protection insurance, I was trying to work out the hitch on offset mortgages). We had a bit of a chat; after some reassurance on what I was trying to get he pointed out that I was ultra-cautious and if I wanted he  could get me a x4 joint salary mortgage. I’d done the sums on this, and frankly it was scary but clearly a lot of people were doing this.

People often have a go at estate agents but personally I think it’s the other punters that really fuck you up. Estate agents at least have to make some pretence of professionalism whilst the punter is free to do as they see fit and since they’re unlikely to have bought and sold more than a couple of houses they can either by malice or ignorance make your life miserable. The bank and the solicitor’s ability to find another little fee to slice off you on the way irritated me too. “Searches” caused me particular ire – it’s not like they actually went and “searched”, they got someone else to do an indexed retrieval, it’s not like they went rummaging anywhere for something lost. Searching for documents these days takes bugger all time and effort. It’s perhaps for this reason that I thought HIPS were a good idea, because I was pretty unimpressed by the system currently in place.

House price inflation is apparently the only good sort of inflation: no one is pleased if cars, carrots, or computers get more expensive every year but for houses it’s different. For those of us on the housing ladder this inflation is no problem, for those not on the ladder it is the sight of the bottom rung being wound up beyond reach. Compared to the 1950’s houses are about x4 more expensive in real terms today, they’re about twice as expensive in real terms as when we bought our first house, about 12 years ago.

The real point of this post was a mild bit of ranting about care for the elderly and the sale of houses. Houses appear to be sacrosanct, you can be sitting on a house worth half a million pounds but rather than sell that to pay for your care the expectation is that the State should provide. Personally I’m hoping for my parents to piss away the inheritance in their twilight years and leave nothing to me – this includes the house. This attitude to housing and inheritance seems to affect every strata of society:

Owners of country estates apparently expect the public to pick up the cost of maintenance. And in the news this week, council houses – I must admit I didn’t realise that council house tenancies were for life and potentially beyond. This strikes me as a nightmare for those responsible for the councils responsible for social housing provision, particularly given the ‘right-to-buy’ legislation. An obligation to provide housing for all is a good thing, the mechanism that via council houses, housing associations and housing benefit doesn’t look like a great way to do it. Actually, housing associations do look like a good idea to me. If you were a company with this obligation you’d want to make bulk arrangements with landlords, and you’d be fantastically nervous about handing over valuable assets for decades. 

The move towards mass ownership of housing is relatively recent – mainly post-war in the UK (see page 12 here), and around Europe home ownership rates are broadly comparable, there are a couple of anomalies. I guess the reason for this is that home ownership fulfils a deep need for security, and literature and recent history reveal plenty of evil landlords.

I suppose the general point I’m making here is that we all want to pass on an inheritance, this is a very natural feeling but the effect of this desire impacts those that are still living and don’t benefit from an inheritance. I actually quite like Billy-Gotta-Jobs proposal on taxing all houses as capital gains on death, as a way of cooling house price inflation.

Update: as supergoonybird points out in the comments, BillyGottaJob’s proposal is actually for capital gains tax on *all* house sales – not just on death. This is a radical idea – but certainly one that strikes in the right place.

*Corfe castle because it’s close to where I was born and lived until I was 18. Image from here.

Jul 01 2010

A brief return to politics – the Budget

Following on from my pre-Budget “Sceptical look at the economy“, I thought I’d return to politics and the Budget.

The financial position seems to be largely what was expected before the election and the size of the proposed cuts seems consistent with the scale of cuts in Spain, Greece and Ireland.

What I would have done? I suppose I prevaricated in my last post on what I would have done in the recent Budget. To be a bit more explicit: I would have put probably something like 3p on basic rate tax, lifted the lower threshold of basic rate and brought down the threshold to the higher rate. And looked to cutting something like 15% across government spending with no ring-fencing. I may have put up capital gains tax a bit more at the higher rate and not reduced corporation tax – but to be honest these measures don’t bring in much cash anyway. As for benefit cuts, I’d probably have gone for means-testing things such as child benefit, winter fuel allowance and so forth. My impression is this would approximately fill the appropriate gaps (but I haven’t done any calculation).

But then nobody voted for me, and the Liberal Democrat experience is if you offer the voting public an increase in income tax they say how great this is, and how they’d really love you to spend the money where you’ve said you’ll spend it, and then vote for someone else who has promised not to raise income tax. Of the national parties the Green Party manifesto was the only one to imply they would not make any cuts, but increase overall taxation to cover the structural deficit; electorally the Green Party didn’t do that well in the General Election with about 1.0% of the vote.

As it stands the Budget was somewhat different from my preferred option. There are a few mitigating factors but I’m not convinced that VAT rises are a good way to raise tax (it has been suggested that they are better than income tax rises because they do not fall on essentials and they are “voluntary” to a degree, which income tax rises most definitely are not). It seems rather notable that there was much symbolic “dipping of the hands in the blood” by Nick Clegg, Danny Alexander and Vince Cable, you’d have though the Tories would have been a bit more forthcoming about defending a budget in which they were the majority partner and which largely matched their electoral commitments.

The Labour Party has started pointing out that this is a very political Budget, that’s true, and so was their idea of defering cuts into next year. For the Opposition this has the positive political benefit of not needing to be clear about what you would do until well after the General Election (and not even then) and allows you free-reign to criticise cuts by the incoming government without proferring an alternative because obviously you’d be doing this next year when things would have become magically better.

I’ve come to the conclusion that macroeconomics is almost entirely about politics, and the vehemence with which economic opinions are presented leads me to believe that everyone realises they don’t actually know what they’re talking about and that by shouting loudly they can get away with it. Presumably MP’s and ministers feel they have learnt to run the economy through the odd lecture course on the infamous Politics, Philosophy and Economics undergraduate degree course at Oxford. It seems notable that prior to the election the global consensus appears to have been for “economic stimulus” and after it is for “deficit reduction” (with the exception of the US). I’m not clear how this has happened, because I can’t believe it’s entirely driven by the UK election.

Inferring what the voting public want from elections and opinion polls is always a tricky business but the evidence seems to be they’re happy with the Budget and it’s pretty much what they expected. I suspect the reason for this is that the majority of them will be in the private sector and over the past few years the companies they work in would have laid people off, been on pay freezes and, over a longer period, treated employees less generously in pension terms but this largely hasn’t happened in the public sector. The same opinion poll shows fairly good support for maintaining the state pension whilst “cutting benefits for those of working age”. 

The Office of Budget Responsibility is pretty upfront in saying it’s estimates for GDP growth are subject to large uncertainty (see p10 of this report, and also Annex A on how figures are derived – hat-tip to Christopher Cook for that). The biggest problem seems to be that recession are utterly unpredictable. I’d be interested to see similar analysis for unemployment figures – can’t help thinking they’re not going to be good.

My useful pieces of contextual information for the day: UK employed population is about 30million, of which about 5million are in the public sector.

Jun 16 2010

A sceptical look at the economy

This blog post was written partly because I’d got fed up with hearing about how all cuts were evil, without hearing an alternative plan. It has ended up more a collection of interesting data sources, and some mild ranting.

First to define some terms: The gross domestic product (GDP) is a measure of the total economic output of the country. It’s handy because we can use it to compare any other number we come up with to see how big they are. £1billion may sound like a lot, but the GDP is £1.5trillion, so £1billion is a less than 0.1% of GDP.

The debt is the total amount of money that the state owes; the deficit is the annual gap between what the state takes in taxes and what it spends. A debt is sustainable in the long term but running an annual deficit above a certain size, for a period, is not sustainable. The deficit can be divided into two components: a cyclical component which goes up and down with current economic conditions and a structural component which is on top of this. The structural component is the bad bit. There is some dispute over the validity of this division since economic cycles are not easy to define.

As Mr Micawber says in David Copperfield: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

I’m a big fan of the Guardian’s government spending chart (see the image at the top of page), it’s a rather pretty way of seeing where government spending goes. For the year 2008/9 the total spending is £621bn, in this year the Treasury gets an enormous, anomalous amount in financial stabilisation (18%) – this will not recur in future years. Beyond this there’s the Department of Health, spending about 18%, Department of Work and Pensions (22%) with the largest fraction of this going on the state pension, Department for Children, Schools and Families (10%). The key point here is that a very large chunk of the money spent is spent on things that people very vocally want (schools, health care, state pensions).

The figures for where tax comes from are perhaps a little surprising, extracting the data from table 1 in this report by the Institute for Fiscal Studies. The major chunks are shown in the piechart below:

The “other” category is made up of various minor indirect taxes (tobacco, alcohol etc) and capital taxes (3%). The surprising thing to me was the relatively low level of corporation tax. There seems to be evidence of tax avoidance by corporations amounting to something in the region of £10bn, but this would only be roughly 1.6% of the tax take.

By the way, as a physicist, I look down on piecharts!
The total tax take of around 36% of GDP puts the UK roughly in the middle of the OECD table of taxes, with countries like New Zealand and Germany taking very similar levels of tax, France, Italy and Finland taking rather more (at around 44%) and countries like Ireland, Switzerland and the United States taking rather less at ~30%. The full OECD data is here, and wikipedia has a sortable list for all the countries of the world. An interesting exercise is to consider this list, and think in which countries you might want to live.
Of income tax the top 1% of earners pay nearly 25% of all income tax, you can see the full breakdown in this article on the BBC website. Put another way, the 40% tax band covering perhaps 15% of tax payers provides nearly 40% of income (here). This does exclude National Insurance contributions though. I was surprised by these figures, I’d assumed that the relatively small number of higher tax rate payers would result in a much lower total take.

The net result of these incomings and outgoings is that we had a national debt of 68.1% of GDP at the end of 2009, and a total deficit of 11.4% of GDP. (According to the Office of National Statistics). According to the newly formed Office of Budget Responsibility  (table 4.5) the national debt (which they call net debt) is 53.5% this year and the deficit (net borrowing) is 11.1% of which 8.8% is structural. 

Numbers without context are meaningless: a priori I have no idea how these numbers for debt and deficit compare to the past. However, help is at hand: this report shows how they have varied over the past 100 or so years. I’ve copied the key figure for national debt below:

At the end of the second world war the UK had a national debt of around 250% of GDP, much larger than our current debt (and even our predicted debt over the next few years). Interestingly we see in the same report (figure 1) that the deficit is rarely negative (i.e income greater than expenditure), hovering around 2% (i.e. still a deficit) debt is still paid off via growth in the economy and inflation.

I suppose the purpose of all of this preamble is a discussion of cuts, or if you prefer tax increases. Prior to the election everyone seemed to agree on the size of the gap to be filled but none of the parties managed to fill more than 25% of the gap, as evidenced in this report by the Institute of Fiscal Studies, the Guardian’s data blog had a nice breakdown of the measures proposed by the three main parties. The major political point of departure was when cuts should start (not if cuts would start), and my view prior to the election was that whoever won broadly similar levels of cuts would be made although there was some evidence that the balance between taxation and cutting would be different depending on party but since none of them revealed (or had) much of their plan it’s rather difficult to say.  It is a very minority view that no cuts are required, although I see the unions are trying that one out today along with threats if there are any cuts.

YouGov,  for the Sunday Times, helpfully asked the public:

“The government has asked for public advice on where it should cut public spending. Which, if any, of the following areas do you think should be targeted for cuts? Please tick up to three”. 

And the public demonstrated that if you ask a stupid question, you get a stupid answer (or, being generous to the public, if you ask a question without providing contextual information you get a stupid answer). I considered trying to find a fancy way of presenting this information, but in a nutshell: by far the most popular area for cuts (61%) is in international aid whose total budget is 0.8% of total spending (i.e. pretty much the smallest bit of the budget you can find).

To be fair to the public, many of them will be working in the private sector and will have variously experienced pay cuts (or at least freezes), reduced working, redundancies, budget reductions and frozen recruitment and they may well be feeling it’s someone else’s turn.

You can experiment with cuts yourself with this handy tool from the FT, have a play and think about how you’d stand up and justify the cuts you’ve made. To paraphrase Polly Toynbee: “Don’t be young, old, vulnerable, one of our brave boys, sick etc”.

The alternative to cuts are tax increases, but nobody seems keen to talk about them. Prior to the election there was a report stating that the deficit was equivalent to about 6p on the basic rate of income tax. Proposals to raise tax were normally described as a “Tax on jobs” or “Death tax”, which is unhelpful to say the least. Another popular idea is to tax the bankers, one option here is the Tobin or Robin Hood Tax which puts a small tax (typically fractions of a percent) on every financial transaction, because there are very many of these transactions potentially the amount raised could be large this would seem to require international coordination and it isn’t clear where the money raised would be spent (climate change, international aid, fund for future bank collapses have all been suggested). The banking sector contributes approximately £70bn to GDP, or 6.8%. The structural deficit isn’t about any money spent rescuing banks though, it’s about an ongoing gap between spending and taxation.

My personal view is that we should be talking about taxation, and where the balance between cuts and increased taxation should lie (currently it looks like 80/20 cuts to taxes). There should be some discussion of where tax rises are best levied : “on someone else” isn’t really a proper answer. Income tax seems like the best place to me, probably at basic rate with uplift of the lower threshold to protect some of the least well off, but possibly lowering the threshold to the upper tax bracket. In the longer term making the public sector more flexible to economic hardship would be nice, this time there seems to have been much more flexibility in how companies have approached recession – not necessarily painless, but better than losing your job. One element of this could be variable pay in the public sector (or bonuses as we colloquially call it) this provides two things to an employer: the ability to vary pay when income to the company is poor and some decoupling of current salaries from pension entitlements (since bonuses are typically not counted towards pension payments).

So to end on a happy note: I propose bonuses for the public sector!

* Update: hat-tip to AlexConner who pointed out that it is Mr Micawber not Uriah Heep who is responsible for the quote from David Copperfield.