Monday, 29 July 2013

Why Most Politicians Are Nationalists At Heart

So, listening to BBC News today we're told that the Government is sending out vehicles with "Go home or face arrest" posters on them. But don't panic - you only need worry if you're an immigrant here in the UK illegally. Now as someone who finds arbitrary geographical borders to be insufficient for discriminating against others, I do find the issue of illegal immigration difficult, because in most cases those in the UK illegally are desperate for help, or for a leg up to better employment prospects, so it doesn't sit easy with me that they are refused solely on grounds of bogus geographical distinction*. 

However, I don't deny that a democratically elected Government has to balance the national treasure chest against immigrant expenditure, nor do I deny that the Home Office needs to keep a check on who is entertaining the country.  What I’m fed up with, though, is the disingenuous ways that politicians associated with the main four political parties couch their language and try to foster prejudice.  Ed Miliband and Nick Clegg continually endorse doing all they can for low earners (what they sometimes call 'the poorest in society'), but they draw the line when the poorest are from outside the UK, because non-UK residents don't have votes to buy.  David Cameron and George Osborne claim to endorse free market economics, but their immigration policies not only often prevent foreign workers coming to the UK, they also interfere with British employers' ability to hire foreign workers.

But most disingenuously of all - many politicians try to appeal to UK citizens' sense of familial togetherness by subliminally encouraging them to prefer British over non-British, as though it's akin to a family sticking together. By the 'family' analogy they mean you've paid your taxes earned in the UK so you deserve the money to be spent on your roads, education, health, etc as opposed to it being spent outside the UK.  The family analogy, though, is bogus and disingenuous - existing mainly to invoke a nationalistic exclusivity against foreigners. 

We all know it's true that families and those closest to us are positively favoured and cared about more than strangers.  There's no shame in it - it's just how humans are made up. I care more about my girlfriend, family and close friends than I do about complete strangers (it would be a strange world if I didn't).  But that's nothing like nationalism, as the Government (and particularly Labour MPs) would have you believe.  While someone who loves their beloved, family and friends naturally cares more about them than complete strangers - a nationalist cares more about some strangers than others - the ones that happen to have been born in the same country as him.  There is as little virtue in caring more about strangers that happen to have been born in the same country as you than there is caring more about strangers that happen to have the same skin colour, gender or sexual orientation as you. 

As for redistribution of wealth within a society - the family analogy shows precisely why the argument is bogus.  I redistribute wealth all the time around those to whom I'm closest - I spend plenty of money on them, and that money transfers from my bank account to someone else's (a restaurant owner, a department store, a petrol station, etc).  The Government doesn't force me to redistribute that wealth (like it does with taxation), I do it voluntarily.  If society really were like one big family, then we wouldn't need to be taxed so heavily for roads, education, health, and so on - we'd voluntarily distribute that wealth (as we do with those closest to us) to see that total strangers have safe driving, good schools and a good NHS. That we don't have the same mindfulness of strangers shows precisely why we are not that much like one big family.  We all want to live at the expense of others when we choose to spend more on those closest to us than we do on complete strangers.  Nationalists want us to live at the expense of others by discriminating against one kind of complete stranger over another kind of complete stranger.  Most politicians associated with the four main parties also want us to join them in discriminating against one kind of complete stranger over another kind of complete stranger, because they want to buy the votes of those of us inside UK borders.  Most politicians employ all the rhetoric to have us believe they are inclusive, that they are espousers of the free market, and that they consider us to be one big societal family.  But most of their immigration rhetoric suggests to me that a lot of them are nationalists at heart.

* I’ve written before about how immigration benefits the UK. 

** Picture courtesy of London24.com

Wednesday, 24 July 2013

A Royal Welcome




We have a new Royal baby (third in line for the throne for anyone counting), and already the Internet is saturated with anti-royal, pro-republic blogs and posts, as well as some nice coverage too.  Now when it comes to debates about the Royal Family, I find I am not a strong Royalist nor am I anti-monarchy either.  I’ll cover the anti-royal objections in a moment, but I think it’s worth saying, first off, that in my view the Queen deserves a tremendous amount of praise and support for her 60+ years service.  I think she has conducted herself with a great deal of credit over the years - and in a time in which so many people undignify themselves just to get noticed in the faux-ironic world of celebrity-ism, it is wonderful to see a lady monarch (perhaps the most famous women in the world) conduct her affairs with such dignity and grace.

In a nation that has changed so much these past 60 years, it is worth remembering that the monarchy stands as a symbol for sovereignty and leadership – one that continues to reflect the Christian ethos of direction and willingness to serve others.  The cultural changes I mentioned are to do with attitudes and perspectives, not science, technology and industry (which obviously is better).  60 years ago young people seemed to have more respect for police and teachers, and there seemed to be a greater respect for our nation’s religion, traditions, laws and institutions.  I think one can see in the Queen a symbol of many of the qualities this country used to have in abundance before the wave of counterculture flowed into our nation.  That said, I don’t think we should grumble – there aren’t many countries that can say they have had a 1953-2013 as successful, progressive and peaceful as ours.  As Cecil Rhodes once said, to be English is to have been fortunate enough to have “won first prize in the lottery of life”.

What of the objections from the anti-royals – don’t they make some valid points? 
Not as far as I can see - I don’t think they make much sense.  The anti-royal, pro-republican diatribe I’ve seen written is largely focused on the financial cost of the monarchy to the nation, and the objection that monarchy is counter to democracy by devaluing the Parliamentary system.  I’ll deal with the cost in a moment, but on the latter; I don’t know why anyone would argue that the monarchy is counter to democracy by devaluing the Parliamentary system, because we have a democratically elected Parliament that acts (at least legally and formally) for the people, where any deference to the Crown produces Royal action under the advice of Parliament, so there is no undermining of democracy. The executive authority of the monarchy actually acts as guarantor against Parliamentary misuse of constitutional power (we all know what happened with Cromwell’s Republic), so those who want the State to be a republic ought to be careful what they wish for.  Moreover, if you want to throw in the ‘democracy’ trump card, it appears that democracy should favour a monarchy, as the most recent poll showed that between 70-80% of people are said to be in favour of the Royal Family, so it’s not as though popular opinion is being undermined. 

When I see, for example, the French equivalent with the political impartiality of the French Legion of Honour, the Presidential situation, and the continual jostling for positional power, I can’t help but think the British monarchy is not outmoded or elitist – far from it.  It seems like a breath of fresh air in comparison.  Personally I think the objections to the monarchy involve the raising of issues that do not directly affect very many people at all.  The truth is, I think, society is so vast and complex now that your life won’t be made any worse by having a monarchy, and it would be no better by living in a UK republic.  Conversely, it seems clear from the recent jubilee celebrations, William and Kate’s recent wedding, and now the arrival of a newborn that many people do derive immense pride and pleasure from the Royal Family – and long may it continue. 

I won’t deny that there is too much lionisation of public figures, too much media obsession, and a pretty stultifying celebrity adoration in too many pockets of our nation, but that’s not an argument against the monarchy, it is simply a reflection of the limitation of celebrity-ism, and the meagre rewards it actually brings people ensnared by it.

But what about the cost of the Royal Family? You can’t deny that the money could be better spent on nurses, teachers, etc.
Sure I can – that’s completely the wrong way to look at it.  The cost/benefit analysis of having a Royal Family should only be about whether the pros of monarchy outweigh the cons (which, by the way, factors in a lot more than just financial expenditure), not about the optimum number of nurses and teachers.  The cost/benefit analysis of whether there are too few nurses or teachers should only be about finding the optimum number of nurses and teachers, not about whether the pros of monarchy outweigh the cons*. 

It’s worth asking; just how much does the monarchy cost the taxpayer?  Well, estimates vary from £100 to £200 million per year (the most recent being £204 million, with possible costs being overlooked in that estimate).  Let’s be generous to the republicans and say it costs £300 million, and let’s even forget all the revenue the Royals bring into this country.  If we pretend we have a £300 million deficit, this means it costs every person in the country about £4.30 per year to have a Royal Family – which works out at slightly less than 1.2p per day per person.  With a 70-80% popularity rating in the polls, any true espouser of reflecting the democratic feeling ought to be happy with that, even if they find themselves in the 20-30% minority.

But there’s something else that’s overlooked by republicans.  If we took all the Royal assets and accumulative wealth, had a joint presidency/parliamentary system, and put all that money back into the economy, everyone would be better off, right?  Wrong.  Most of the Royal assets are in equity that is not currently injected into the economy.  If the Royals sold everything and put the equity in the banking system then everybody else in the UK would be worse off, not better.  You see, the mega rich people who hoard their wealth in stocks, bonds and international currency actually make us all financially better off by doing this, not worse off.  I think it is because most people don’t grasp this that they are forever having enthusiastic paroxysms about economic stimulus systems that state they will put more money in our banks and lighten the load of the mega rich. It’s nonsense!  Of course, it would be better if the mega rich hoarders injected that money into third world crises, but the republicans aren’t arguing that – they are wrongly arguing that Royal expenditure makes Britain ‘worse off’.

Hang on, I hear you object, if the mega rich man gave some of his wealth to feed the UK’s homeless, then that’s good for the economy, because the more the rich man spends the more the hungry have to eat.  Here’s what you are overlooking – the food that feeds the homeless people doesn’t just come out of thin air – it has to affect the economy somewhere.  If he feeds the homeless then the cost of that food is impacted in the rest of the economy – either others eat less or others pay more for their food.  I’m not saying it is not moral to feed the homeless – but the argument about spreading the wealth in the economy is mathematically wrong.  While the Royal assets are kept out of the economic system, almost everybody in the UK is better off.

In summary, I think the net pleasure of having a Royal Family outweighs the net negatives (public opinion evidently supports this view) – and I for one am proud of our Queen’s past 60 years and impressed with the legacy her sovereignty has left.  Long may she continue. 

* General tip here; in any analysis of costs and benefits, you need to ensure you’re getting the right answer to the right question, not the right answer to the wrong question, or (worse) the wrong answer to the wrong question.  Take a recent example – the Tory policy of capping benefits at £26,000 because “No one on benefits should receive more than someone working”.  That maxim is pretty sound to me, but it’s the wrong point to justify a benefit cap – the question of a benefit cap should be primarily about a proficient marginal tax rate associated with the withdrawal of benefits when a full or part-time job is acquired at a low wage by the householder, not about whether “No one on benefits should receive more than someone working” – because it misses the obvious permutation that 1) Benefit caps at a fairly arbitrary benchmark of £26,000 may not be socio-politically proficient and 2) No one on benefits should receive more than someone working are both prudent observations  .

** Photo courtesy of news.yahoo.com

Monday, 22 July 2013

Taleb, And Other Overrated 'Intellectuals'


Contrary to (often) popular opinion, I think most of our so-called 'world's great intellectuals' - Richard Dawkins, Stephen Hawking, Laurence Krauss, Steven Pinker, Paul Krugman, Steven Weinberg, AC Grayling (to name but a few) - are overrated. I don't find it all that surprising - humans tend to over-estimate the quality of public intellectuals, which then brings about further over-inflation from the many others that jump on the bandwagon of intellectual subservience.

But aren't they top contributors in their fields?

Yes, and their contributions - Richard Dawkins (biology), Stephen Hawking (physics), and so on - are immense.  But I didn't say they aren't proficient in their fields of expertise (though often I wish they would stay in their fields of expertise) - I said I think they are overrated, by which I mean I think there is an over-inflation of their general abilities, which isn't the same thing as saying they are not edifying in their specialised field. If you won £1 million but overestimated your windfall to the value of £10 million, you'd get a big shock when you went to pay for the £4 million house and £1 million car you'd set your heart on purchasing.  Those that do understand Richard Dawkins know they have a million pounds worth of biology; those who vastly overrate him believe they have ten million pounds of biology, religion, philosophy, cosmology, ontology, psychology and socio-political commentary.  That’s the principal difference.

Perhaps the most overrated of all, though, is Nassim Nicholas Taleb - author of the 2007 best-seller The Black Swan, in which he spends far too many pages talking about how improbable events are unpredictable due to being rare and seeped in unknown factors.  Not only is The Black Swan (to me) obvious and unoriginal, it stretches out about one chapter's worth of substantial material into a whole book, making the latter two-thirds seem (again, to me) execrably dull and repetitive. 

But perhaps the most noteworthy thing is that on several occasions I have seen Taleb referred to as ‘The greatest thinker of our time’ - which, unfortunately, judging by some of his television appearances, seems to be hype by which Taleb has also been swayed. Now here's the big irony; the kind of reasoning that is employed when conferring the adulation of ‘The greatest thinker of our time’ onto Taleb is the same kind of erroneous reasoning Taleb's book The Black Swan is set up to undermine.  In the first place, the popularity of the book occurred largely because of the financial crisis (with one caveat – see below) and the self-congratulatory claim by Taleb that he had predicted this 'black swan' event.  Ironically his bigger critics claimed that he couldn't really have predicted the financial crisis because 'black 'swans' are supposed to be high impact, low probability events that foil our expectations. 

Both Taleb and his fiercest critics have got their reasoning wrong here. The critics are wrong in denying that the financial crisis was predicable, but Taleb and his proponents are wrong in calling the financial crisis a 'black swan' event.  If the financial crisis really were a black swan event then Taleb is hoisted by his own petard because the black swan events in the book that earned him the title ‘The greatest thinker of our time’ are those events of which we do not know the probability. 

In the second place, the further irony is that it is actually the fortuitousness of the book's impact that is the black swan event, not any propitious timing or expertly executed foresight. Consider that Taleb's 2001 book Fooled by Randomness contained more or less the same underlying arguments as The Black Swan but made hardly any impact at all at the time of its release.

If we want to be super-critical towards his most fervent admirers (the ones that ascribed the success of his book to the occurrence of the financial crisis) – the book makes repeated allusions to the butterfly effect, which is the biggest indicator that one cannot necessarily make such simple causal ascriptions.  The whole wisdom of the butterfly effect is that a butterfly flapping its wings in India can start a causal chain that eventuates in a hurricane in the USA a few years later.  But to realise this one has to realise that from the standpoint of the hurricane observer the causal chain is prohibitively untraceable, with so many other causal factors remaining beyond the sphere of human observation.  Therefore, ascribing the success of The Black Swan to the financial crisis means necessarily selecting out one palpable link on the causal chain and disregarding the other links - which is the very thing being counselled against.  

The flip side to there being lots of overrated public intellectuals whose fame is as much about for fortuitous and serendipitous events as it is intellectual proficiency is that there are going to be lots of underrated, largely undiscovered talents awaiting the break that will give their abilities the recognition they deserve.  Maybe some of you are cases in point - in which case, go make yourself known - the world might be awaiting the discovery of whatever talent you have to offer. 

* Picture courtesy of cityofsound.com

Saturday, 13 July 2013

Economic Foolishness: The Truth About Bankers' Bonuses & Government Subsidies



If you’re looking for an area in which the most nonsense is spoken by the most people on any one subject, a good candidate has to be the financial crisis and the spurious ideas surrounding caps on bankers’ bonuses and Government bail-outs. You’ll hear politicians talking about how the banks needed more regulation, how bankers’ salaries and bonuses need capping, and how they were reckless in focusing on narrow, short-term visions rather than the supposedly preferred long-term incentives. The politicians are confused; they've got it wrong here on just about every level – but just as bad, they’ve not offered any example of a reasoning process to lead them to this conclusion, they’ve just assumed that because there was a financial crisis that this must mean bonus caps and more regulation will make things better. They won’t, they will make things worse.  Of course, the majority of the electorate also think that bonus caps and more regulation will make things better, so our MPs don't really have much of an incentive to understand where they're going wrong.  Unlike politicians, I will give you a clear and accurate reasoning process that demonstrates why bonus caps and more regulation won't make things better.

What politicians want to propose is that bankers’ deals are constrained by revoking bonuses if the borrower defaults or the deal collapses. They think that with the threat of bonus revocation bankers will be less reckless – but they have their reasoning backwards, they will actually be more reckless.  Let me first explain why it is incorrect to say that senior bankers have very narrow, short-term visions.  A significant proportion of bankers' bonuses are commensurate with the share prices of the bank (they are paid either in shares or in cash), where those share prices are determined by forecasted profits. If a banker undertakes disproportionately risky deals to obtain short-term profits then the forecasts will likely predict much bigger losses in the future, which means share prices will immediately drop.  Hence, managers paid in shares cannot afford to risk the narrow vision.

The banking risks that brought about the financial crisis were down to excessive gambling because the credit markets and stock markets didn't factor in those risks. Had this failure not happened, banks would have seen a rise in the cost of capital and a drop in share prices much sooner, giving the natural incentive for bankers to reduce the risk voluntarily to maximise their variable pay.  

The Government's regulatory proposals are a disaster, and tangible evidence that they don't understand economics.  Here's why the regulatory proposals will increase recklessness not decrease it. Suppose we take the state's advice and award variable pay when profitable ventures are completed instead of at the point of making them - it's pretty clear why that won't help things. Consider corporate lenders A and B who each lend out £1 million to 2 identical clients on a 4 year plan. With Government regulations, any bonuses A and B procure on the deal should be deferred until the 4 year period is up, subject to the loans being fully paid off. If A's client defaults within that time period then most politicians think A should receive no variable pay. Here's the problem; how on earth can this improve A's decision-making? At the time of lending, the known risks presented by the 2 clients were factored in to the deal. It is a combination of varying factors way beyond the lender’s foresight that client 1 turns out to be one of the few that ends up defaulting. The risk is taken at the point of the loan, not at any time thereafter - so it is ludicrous to try to improve initial analyses by basing variable pay on unforeseeable future circumstances.

Such a proposal does not adjust risks, it adjusts unforeseen consequences - so it would be crazy to evaluate financial restitution based on such factors, because it increases bankers' incentives to heighten risks. If they have to wait for the culmination of repayment you'll see a huge increase in risky deals because a great proportion of loan deals are low probability of high loss, so lenders might as well make more deals, particularly as the cost of huge losses won't be incurred by bankers' themselves but by bail-outs.  The way to incentivise bankers to calculate the risk more diligently when making loans is to have them bear the cost of that risk at the time of making the decision by imposing a banker's insurance premium for the risk that that decision engenders (this is how banks insure using buffers for capital, where a premium for every loan can still be weighed).

Suppose the lender was paid variable pay equal to 10% of his contribution, where "contribution" means the interest margin he earns from the loan minus the premium charged to insure against the risk of the loan defaulting - the banker will have an incentive to only make the loan if the interest margin is greater than the cost of the risk-insurance. The bankers' role would be to calculate these loans using a risk analysis, and make the ones that seem economically viable, enjoying their bonuses on the profits, and bearing the costs on the losses. If you underestimate the risks then the insurance premiums will be too small, and there will be excessive lending - but this issue isn't solved by changing variable pay and bonuses, it is solved by improving the calibration of risks in the first place.

Next, most politicians think that high-paid, big-gambling bank managers are the real failure of corporate governance. They are not - it is the other way around - it is low-paid, risk-averse bank managers that are failing the system. Firstly, managers tend to take fewer risks than shareholders (despite most people thinking the reverse is true), as most shareholders have diversity in stocks that are not correlated with each other, so all the eggs are not in one corporate basket. Managers on the other hand more often have all their managerial eggs in the basket of the company for whom they work, so if their company fails they'll lose their salary plus any company shares they own.

In a healthy system then, big bonuses, therefore, have the positive effect of increasing appetite for risk - which is a good thing because if risks pay off then appreciation of equity increases hugely, whereas if the risks don't pay off, the most the shareholders can lose is the value of the shares they bought (in other words, a few eggs in their basket). That is why shareholders benefit from risk, and why they want managers whose appetite for risk is voracious (the best way to achieve this is if when it comes to shares owned in companies managers have diverse portfolios).  

Ah, but I’ll bet you have a burning question; what stops the risk culture going out of control and becoming a culture of recklessness?  What stops (or should stop) companies engaging in crazy lending is that a company's creditors (either a single investor or another company) have a claim on the services of the company taking risks, by providing something (a property or service) under the contractual agreement.  As creditors don't share in the company's profits they don't gain from their company's risks - which is reflected in the risk premium agreed by the first and second parties (it is the increasing cost of borrowing that places constraints on corporate leverage and other risky ventures). This ought to make it crystal clear why Government bail-outs and guarantees are mostly a terrible idea - and why they only increase the incentive for risk-taking. Put it this way, if you stake your house on a deal and it goes wrong you're going to be hugely out of pocket and asking a friend for lodgings. If you stake your house on a deal and it goes wrong but is under guarantee by the Government, you get another house at the taxpayer's expense. It's pretty obvious which deal is going to elicit the most careful analysis before it is finalised.

And the last point, a mother would be foolish if she kept buying her young son lots of cakes and chocolate and then complained that he’d got fat.  But if a boy wants lots of sugar he cannot be blamed for accepting his mother’s sweet subsidies.  Similarly, a company's executive who rejects Government subsidies does something irresponsible because he drives down the value of his company's shares. Given that a Government's guarantee of bank deposits severely reduces the risk premium that banks must pay on their debt capital, it is clear that these kinds of bail-outs are unadvisable, and bad for the general public, who as taxpayers benefit much better when markets are left alone. When the Government acts as a creditor they won't often demand higher interest rates commensurate with risk-taking, which is why it is better when non-Government creditors incentivise against foolish risk-taking by reining in recklessness. To prove the point, here's a fact you may not know - in the past 35 years, of all world's largest financial institutions that have failed, over 90% of them have creditors that suffered no significant loss due to Government bail-outs. This basically amounts to a Government subsidised risk encouragement, by removing or depleting the standard market risk-taking discipline that creditors charge.  It's a shame politicians that think this way are in charge of our country.

* Photo courtesy of debtonation.org

Monday, 8 July 2013

The Best Way To Get More Tax From Corporations Is To Stop Taxing Them



Hot on the agenda in recent times surrounding the World Leaders’ convention has been whether there is a tenable solution Governments can put in place to have global tax regulations that stop companies avoiding tax.  People are asking whether there can be such a thing on a world scale, as such an achievement would be unprecedented in terms of global economics.  As anyone who knows the history of attempted international coalescences would know, this is a very tricky situation to administer - particularly given the vast differences in the countries that would be involved in this kind of globalised tax system.  How on earth could we ever get so many different nations (with frequently changing Governments) to agree on, and proficiently oversee, such a complex system?  And even if we could, is it right to revert to potentially despotic measures to get places like Switzerland, Cyprus, Luxembourg and Ireland to conform, when such tax havens have self-governing national autonomy, and the good economies and high employment as a result of low income tax? Given the relationship between taxpaying and the positive impact on developing countries that need to be lifted out of the mire, I'm happy to assume that these measures are to be supported - so how, then, can such a complex and intractable system be achieved?

A bit of general advice, whenever you want to find the best solution, the first thing to do is identify the problem that needs solving, and make sure that that is the problem you are actually solving. The problem is twofold; firstly, that the whereabouts of a company's profits in a global economy is hard to keep a track of; and secondly, that it is often hard for outside authorities to identify what a company's profits amount to. From what I can gather from every time an MP speaks on this issue, their central focus is on refining the system to scour the market for companies' unpaid taxes and surreptitious distortions of the balance books.  I think this is a misjudged method of tackling the problem - not because it is the wrong thing to do, but because in the first place such an endeavour is probably going to end up being as costly as the tax they'd hope to recover; and in the second place I doubt whether a body of world authorities would have the competence (and synergy of thought) to achieve their aims.  And to add weight to the problem, tax avoiding companies hire economists that can show them how to find loopholes in Governments' tax policies, so these companies are adept at staying one step ahead of the authorities (these economists are often ex-treasury consultants who helped advise on the original policies, and are ideally equipped to understand profits and business practices a lot better than politicians).

So what's the best solution?  My view is, if the problem is to do with how hard it is to keep track of the whereabouts of a company's profits, and how difficult it is to identify what a company's profits amount to, the best thing to do is to ditch corporation tax altogether.  Here's why.  It's a great myth that corporations pay tax. Corporations don't pay tax - only individuals pay tax.  The cost of corporation tax is borne by customers (with increased prices of goods or services), employees (with decreased wages) or shareholders (with lower dividends).  Corporations pay tax only in the sense that the cheque or debit is written in the name of the company. If the cost of taxes ultimately falls on individuals, then it makes sense to have tax policies that are only focused on individuals, and scrap all the payments in the name of corporations.

This to me is an obvious solution to the aforementioned problems, because unlike profits in a global economy, the locations of personal incomes and expenditure are relatively transparent, so the Government might as well focus predominantly on taxing dividend income (shareholders profits), earnings (through income tax) and sales (through consumption tax).  The Government already does this anyway, but to a much less judicious level due to the corporate tax, so it wouldn’t be too hard or too costly to administer.  In actual fact, as far as Government income is concerned, taxing earnings and taxing consumption are more or less interchangeable; you can tax the money as it is being earned or you can tax it as it is being spent.

The obvious question is; if this idea is as good as I’ve made it sound, why don’t the Government follow the model and recover billions of pounds of tax that’s currently being avoided?  I’ll wager that the answer is twofold.  In the first place, such a policy is risky – not because it is a bad policy, but because a lot of the electorate have got the wrong idea about its demerits, which means the Government considers it a potential vote loser.  When you hear the rhetoric of those sceptical about ditching corporation tax, they usually say something along the lines of this;

Wouldn't the danger of scrapping corporation tax be that the companies (shareholders) would simply guard against their losses by increasing prices and lowering wages, meaning that the workers and consumers are getting penalised while the wealthier shareholders are hardly affected because they passed all the tax on to workers and consumers?

What they mean is, if corporation tax is ditched and individuals associated with the companies pay more tax through the extra taxing of income and sales, then that extra expenditure will come from the reduction in staff wages and in increased prices on goods as shareholders won't want the losses to come from their dividends. Here’s what they are missing.  Except where a company enjoys a monopoly (which is rare in this day and age), shareholders of any company cannot decide what prices to charge for their goods or services, nor can they decide their labour rate either. These prices are determined by supply and demand of the goods, services and labour concerned, not by shareholders.  Further, if corporation tax is abolished, salaries and dividends will be higher not lower, and prices will be lower (with consumption being higher).  The Government can automatically recoup what it has lost from corporation tax in extra income tax and sales tax without having to radically change the system. Whether they recoup less, more or the same depends on whether personal income, tax rates and VAT are higher or lower than corporation tax rates, and on the effect of ditching corporate tax on aggregate employment and consumption.

A second reason why the Government may be furtive about this policy is that many low earning consumers may think they are going to be hit hardest.  They have it in their heads that if corporation tax is abolished then individuals associated with the company (primarily customers) are going to pay more to make up for what the Government is now not getting, which means more on consumption tax. They are worried about average earning Joe who ends up paying more for his goods, because relatively speaking average Joe is getting hit harder than richer people on this consumption tax because a few pounds extra on goods prices for him has a greater effect than on the wealthiest who will hardly notice.

Not only do they fail to realise that if the lost tax is transferred to earning and consumption then the rich will get hit hardest (because they earn and consume more), they also fail to realise how switching tax within a corporation to individuals affects the situation.  Let’s use a simple illustration to show what happens.  Suppose the Government gets £1 million from a corporation in corporation tax. If the Government didn’t get it, either someone else would get that £1 million, or several other people would get a share of it. For simplicity, suppose the £1 million would all go to a single shareholder (let’s call him Bob) in dividends. If the Government taxes Bob’s dividend at 45%, then the Government has £450,000, even without changing tax rates. Now the Government can increase taxes on dividends to make up the £550,000 it has lost.  Bob is now no worse off than when there were corporation taxes and lower taxes on dividends, and the Government is no worse off because it still gets its £1 million.  But the world is altogether better off because corporate taxes being more avoidable have higher deadweight costs for the Government than individual income taxes. That is to say, they dampen economic activity and waste resources on unproductive avoidance efforts (usually in the form of accountants).  

The third and final reason why I think the Government won’t ditch corporation tax is a pretty ugly reason, but undoubtedly true, at least to a great degree.  The Government is primarily concerned with how it can buy votes – and many of the people that bear the cost of corporation tax are foreigners who have no power to vote, so they are ideal people on whom to impose a cost.  You can see from the reaction to non-UK citizens using our NHS how pervasive this national prejudice really is.  Once we jump these three Government hurdles, there is no logical reason why we can’t see the abolition of corporation tax. 

I said earlier that taxing income and taxing consumption is pretty interchangeable, so which is preferable as a primary source of Government income?  Well given that higher earners spend proportionally less of their income on consumption, the ratio of tax obligation diminishes as wealth grows, so it is important that higher earners still pay proportionally more tax on their earnings, and low earners are taxed at a much lower rate (in both cases the Government recoups these tax losses when people spend their money on consumption – but this kind of economy is much more mobile and faster growing than a tax system that discourages earning and spending). 

The general rule of thumb with taxation is that when the Government taxes something it results in less of it.  For example, higher tax on savings discourages saving; higher tax on earnings discourages work, and higher tax on consumption discourages spending.  That’s why I favour taxing consumption over earnings, because consumption tax yields higher employment and formation of capital, which increases a nation’s economic growth.  This has a positive corollary effect; if when the Government taxes something it results in less of it, then higher taxes on the things we want less of (or things that we like but know are bad for us) will bring about a reduction of those things.  So I’m all for much higher tax on cigarettes, alcohol, gambling, pollution and use of natural resources that degrade the environment (I draw a distinction here between taxes related to genuine degradation of the environment, which are mostly progressive, and green taxes, which are mostly regressive and unjustified – that’s another future Blog post)

The upshot, though, is it is possible to have a much better tax system that closes the loopholes being exploited in tax avoidance – and this will put an end to the deadweight losses associated with corporation tax, and it will help spread the money to developing countries in which many of these multinational companies make so much of their money. 

 

* Picture courtesy of tax.donut
 

 
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