Tax, the Family and Economics

Another evening, another lecture. Tonight I listened to Professor Harold James speak about Tax, the Family and Economics: The Global Dimension, though there seemed very little about the global dimension and a lot of general theory. Nonetheless it was an interesting lecture on what is a hot topic of the day, and if you are truly desperate you can apparently watch the whole thing on 18, Doughty Street (looking out for the back of a handsome head in the front row on the right, if the lights aren’t reflecting off it too sharply).

As the title would suggest, Professor James’s concern was how government policy impacts upon family relations. “Societies that do not reproduce are bad societies” he noted, echoing many other critics who have expressed concern about the fact that most Western European countries, as well as (especially) Japan, have birth rates below the replacement rate (which is just over two children per woman). The state’s impact upon the family is important because for James the family is one of the three essential elements of society: just as we have come to recognise that markets are necessary to enable us to satisfy our desires, and public policy is necessary for us to meet essential needs, so the family serves a vital purpose.

One of the main purposes he cited was the family’s unique ability to solve the question of inter-generational transfers. Lest we get bogged down in jargon (a habit I am trying to avoid), this is the question of to what degree any generation must consider the needs of the next: can we burn all the coal or should we leave some to our children; should we sacrifice our own economic growth because of concerns about the atmosphere our grandchildren will inherit; classically, to what degree should each generation pays for its predecessors’ pensions and its successors’ education? The family is uniquely placed to address these issues. Indeed, that is their main value (from an economic point of view).

Sadly, James argues, that role is being eroded. There are three sources of this erosion. The first is attitude and culture: we have come to see families as a commodity, much as we do houses and cars. We do not expect to be saddled with them forever; gone are the days when people really did marry “until death do us part”. We may all go into marriage hoping and believing that it is forever (otherwise, what’s the point?), but in the back of every bride or groom’s mind is the knowledge that these days we do have an emergency exit. We know full well that marriage need not be for life; if we change our minds, we can. As plain speaking Hungarian Prime Minister Ferenc Gyurcsany observed, "Every man whose wife grows old has earned a younger woman."

[And every man whose wife reads his blog would like to disassociate himself from any such sentiment.]

The welfare state has also undermined the family, because it has removed its main (economic) raison d’être. No longer do we need families to provide for our old age; this is provided by the state. For perhaps the first time in human history, one need not breed to ensure a comfortable dotage; the state will pick up the cost, and cheap immigrant labour will provide the daycare. This has skewed the cost-benefit analysis that (perhaps subconsciously) goes into the decision to reproduce. It can be no coincidence that it is the prosperous countries that see declining birth-rates, while the poor still need to produce large numbers of offspring to ensure that they will be looked after in the future. With (some of) the benefits removed, the opportunity cost appears greater. In (at least the back of) the minds of people in the developed world, the question has become whether one spends £166,000 on raising a child or whether more satisfaction would be achieve by buying a holiday villa near Paphos.

The third issue facing married couples is taxation. Fiscal influences shape decisions (in some cases, that is the point). Our tax system, for perfectly laudable reasons, emphasises helping the poorest and most needy. As a result, it tends to tax working couples hard while rewarding unemployed singles (especially parents). This has been exacerbated by tax credits, which see people paying very high marginal rates of tax if they return to work (because income tax is compounded by loss of benefits which between them erode most of the gain of earning extra money).

High taxes generally generate a rent-seeking and lobbying culture: a lot of time and effort is expended on trying to shape the system and exploit it as much as possible. What is more, because of the unintended consequences that all taxation creates, efforts are made to compensate for these effects that in turn make the system ever more Byzantine. The simplest way of reducing the harm taxes do is to simplify them and minimise them, but that is not government’s way. Instead it seeks to create new exemptions and benefits and tinker and re-jig the system until it is painfully complicated, while each new clause and every new tax does further harm.

It is interesting to see both how this has encouraged the legislation of gay marriage and what further impact this has had. One of the arguments for creating civil unions was to give homosexual couples the tax benefits as heterosexual couples (for example, giving them exemptions from inheritance tax when one partner dies and leaves wealth to the other). This has in turn created new demands from other groups that lived together – for example siblings, non-sexual partners, parents and children – that wish also to enjoy the same tax benefits. The system becomes ever more complicated.

Professor James’s argued that taxes should not be used to shape society. He did not (as I had expected) argue that taxes should be adjusted to support marriage or the family; merely that elements that discriminate against or penalise marriage or the family should be eliminated. Instead, tax policy should aim to be neutral as to marital and family status. By eliminating the imbalances that already skew these decisions, it would remove barriers that currently exist to marriage, co-habitation, responsible parenting and so forth. But it would not create the unintended consequences that follow from efforts to tinker with the system for the purposes of social engineering.

What Professor James did not recommend, though it was implied by his lecture and is what one would have expected from Politeia (which hosted the event), was that the easiest way to reduce the negative impact of complex taxation is to reduce and simplify the it. I wholeheartedly agree that taxation needs to be applied fairly and should not be used as a means of shaping society in the government’s image.

However, just as David B. Smith has noted that efficiency savings are almost impossible unless rates are reduced, so in the same way it seems likely that complexity is a result of high government taxation and spending, which leads to lobbying, rent-seeking and a belief that governments need to tinker to compensate for problems that are, at the end of the day, of their own making. Lower and simpler taxes would rectify these problems, and at the same time free individuals to spend their own money to meet their needs as they see fit. That alone would do more to help the family than any benefit or tax break.

It ain’t who you are, it’s who you wanna’ be

There is a joke about economists that I have come across twice in the last couple of weeks. Charles Murray opens his book In Our Hands (about which I will blog in due course) by telling us about three men stuck at the bottom of a pit, discussing ways to get out. When it comes to the Economist, he begins by saying “First, assume we have a ladder.” G. R. Steele began his lecture on Friedrich Hayek by criticising microeconomics for being too theoretical: the economist on the desert island imagines he has a tin opener. Last night Nobel Laureate Professor George Akerlof sought to provide one explanation for why homo economicus failed to fully explain human behaviour.

Akerlof’s lecture was entitled Economics and Identity, and began with a self-effacing admission that he had originally discounted identity, feeling that it had nothing to say about economics. Identity is summed up by desire, and desire is the basis of the utility function upon which economics is based.

Groan not! I will try to keep the rest of this jargon free.

Basically, the usual assumption is that I need something, that need can be weighed, it can be compared to my resources, and then I decide whether it is worth the cost. Is an mp3 player worth three day’s work? Is the view from the top of the mountain and the sense of personal achievement worth the gruelling climb? Usually, it is assumed that these are either objective, or that where they vary this is according to taste and that taste is as far as identity goes.

Professor Akerlof has come to think otherwise. He believes that our desires are fundamentally affected not just by who we are but by who we feel we ought to be. This creates a gap between what we want (which he quantified as “e”), and what we feel we ought to want (which he quantified as “e*”, and then spent the lecture repeatedly using the term “e-star” until it became quite irritating!). This gap has various negative outcomes, and dealing with (or exploiting) it should be a significant influence on public policy.

Some examples might help – though he was running out of his ill-managed time when he came to address the specific impact, and so chose to skip many of the examples (including, annoyingly, one entitled “Macroeconomics”, which is economic code for government meddling). One was education. For Akerlof, one of the greatest tragedies in America today is the underperformance of black Americans, and the resulting economic and social problems they face (and cause, in heightened criminality, for example). Interestingly, this is also a major concern for Murray, who has concentrated for some time on policies aimed at helping the “underclass” (not just black Americans but all those drop out within society).

Akerlof noted that American society is still influenced by an us-and-them mentality, and that this has a profound effect on inner-city black children. Within their schools cultures develop whereby they deliberately flout rules, reject a system which they believe is stacked against them anyway, perform badly at school and drop out of school early. Their identity is influenced by negative stereotypes and they begin to believe that they should behave in a certain way – even if this conflicts with their inner desire to behave in a different way. This is reinforced by socialisation and sanction: their peers disregard education, if they are too eager they are bullied, so they come to believe that they ought to want to stick two fingers (or rather – as they are American – one finger) up at the system.

It should be noted (though Akerlof failed to do so) that this is a generalisation – there are many children who resist the pull of the culture within their schools. However, economists tend to work in abstractions and aggregates.

How does this influence policy. Akerlof cited examples of where schools have made strenuous efforts to overcome the negative culture within the school, and have as a result turned schools around. It requires good teachers and small class sizes, however (no surprise there!). Indeed, argued Akerlof, black children from inner-city schools derive more benefit from small class sizes than other groups. The public policy impact is that this suggests that efforts should be made to bring the best teachers to inner city school and reduce their class sizes – the exact opposite of what generally happens, where good teachers work in schools with excited and engaged pupils, and the money (private or public) ensures small class sizes.

There were other examples; education was just one. However, when all was said and done I was left wondering what was so novel about Akerlof’s suggestion. So homo economicus is nothing more than a flawed model. It’s hardly news. Poor kids from inner-city schools need better teachers and smaller class sizes. I can see why they gave him the Nobel Prize!

Akerlof has produced four publications on this subject so far, and promises more to come. It may be that they better explain the usefulness (or even utility!) of incorporating identity into economic modelling and public policy. Until he does, however, this remains nothing more than an intriguing idea.

POLL: Who would you choose in the second round of the French presidential elections?

Okay. This is a first, and it may all go horribly wrong, but...

It's poll time!!

And the question is this: Given that the choice is between an unreconstructed socialist with a winning smile and a right-wing moderniser who wants to liberalise the economy but stick it to immigrants, who would you choose in the second round of the French presidential elections?

Or, if you disagree with the analysis above, how about just telling us who you would support anyway.

Who would you support in second round of the French presidential elections
	Nicolas Sarkozy
	Segolene Royal
	I would rather emigrate
Free polls from Pollhost.com

For the record, I am aware that this may also prove an embarrassing indictment upon the amount of traffic this poll recieves, but I'm prepared to take that risk in the interests of... er... I don't know. Entertaining my regular reader, I guess.

It must be the internet: we’ve mentioned the Nazis!

An excellent post from Jonny Wright has encouraged me to break cover on the suggestion that the EU should ban holocaust denial throughout the Union’s 27 members. I probably don’t need to revise the background. Suffice to say that there are two questions: should one ban holocaust denial? And is it right that this should be legislated upon at an EU level?

I have written before on the subject of banning holocaust denial. There is something truly grotesque about the attempt by some pseudo-historians and anti-Semites to rub the extermination of millions out of the pages of history. If any false-theory or misguided belief deserves to be banned it is this.

But it doesn’t. No matter how distasteful holocaust denial may seem, it is as nothing compared to the dangers of legislating against people's freedom of speech. It is trite beyond belief to equate one’s opponents with the Nazis, but when one begins to impinge upon the fundamental freedoms upon which a liberal society is built, one takes a first step down a slippery and dangerous path. Freedom must also include the freedom to be wrong, and liberty requires tolerance of those whose views challenge or even disgust us.

Why, anyway, are we so afraid of this tiny minority of twisted fools, that we should seek to muzzle them with the full force of the state? If we are so sure of our truths, can we not defend them with evidence and reason, rather than legislating to protect them? Let the holocaust deniers shout from the rooftops; they just draw attention to an evil that might otherwise fade into the distance.

As for European-wide legislation, it is neither necessary nor warranted. There is no compelling reason why EU member-states need to harmonise their laws on freedom of expression (though if they happened to all adopt a policy of tolerance towards opinions with which they did not disagree, I would rejoice!). The EU remains – at least for now – an single economic market, onto which has been grafted a few additional competences such as justice and foreign affairs co-operation. We remain 27 nation-states, each perfectly capable of deciding for itself what laws need apply in its jurisdiction.

The EU recognises this: it has a principle called “subsidiarity” that says that decisions should be taken at the level nearest the citizen (a principle that might usefully be applied within nation-states!). Sadly, the EU has always treated the subsidiarity clause with contempt. Like all bureaucracies, the Eurocracy seeks constantly to expand its powers. To our shame, Liberal Democrat euro-parliamentarians are all too ready to assist that creeping arrogation of power.

Thus this proposed law is the worst of both worlds, and highlights the fact that the EU is not in practice a liberal institution. The EU exists to further the free movement of goods, services, capital and labour and so foster greater harmony and co-operation between nations. In the process it has expanded its responsibilities far beyond what is necessary to achieve these goals, taking decision-making – and thus power – ever further away from the citizen.

As liberals we can be proud of our support for the Union, but that support must not blind us to its faults. We must not become partisans for the Union against our principles or the wishes of our countrymen. If we are going to fight to keep Britain in the Union, we must fight twice as hard to keep the Union liberal. If we fail in that, we will fail the British people twice over: we will saddle them with an illiberal institution; and when eventually it becomes to much to bear, we will share the blame for Britain’s withdrawal.

How a beautiful illusion is born from a fatal conceit

At his inaugural lecture, Professor G.L.S. Shackle gave a brief outline of what was required to be a “complete economist”:

“To be a complete economist, a man need only be a mathematician, a philosopher,
a psychologist, an anthropologist, a historian, a geographer, and a student of
politics; a master of prose exposition; a man of the world with the experience
of practical business and finance, an understanding of the problems of
administration, and a good knowledge of four or five languages. All this in
addition, of course, to familiarity with the economics literature itself.”

Few, understandably, live up to this demanding standard. One of those who came closest to doing so was Friedrich Hayek, at least according to G. R. Steele, Lecturer in Economics at Lancaster University Management School. Steele was launching his new book, The Economics of Friedrich Hayek, at Policy Exchange.

In fact, as Steele freely admitted, the book was about far more than economics, as Hayek was far more than an economist: indeed, he is recognised and taught in politics, sociology, philosophy and psychology, but economics courses usually ignore him; an essay on him by Steele was rejected by one (unnamed) economics journal on the grounds that their readers would not be interested in the history of economics (if only the same excluded tracts on Keynes!).

Hayek took a dim view of both Micro- and Macro-economics: the former a mathematical extraction that ignores social and institutional contexts, assumes perfect knowledge and rational behaviour, and sees no value in entrepreneurship; the latter a rationale for intervention based on broad measures which politicians could then seek to influence ( a view which the politicians were surprisingly keen to embrace!). For him, economics was a subset of a broad theory of human action founded upon social theory and psychology, and needed to reflect the fallible, partial and dispersed nature of knowledge.

This was the basis for Hayek’s defence of freedom and the market economy. No policy maker, no bank of civil servants, no computer in the basement, can ever capture the extent and subtlety of the knowledge that resides within each individual actor, and so can never improve upon the judgements of individuals exercising “particular knowledge [in a specific] time and place”. Steele might have added Lionel Robbins’ observation that economics is the interaction of scarcity and desire, so that individuals must assess for themselves what a commodity (car, medicine, an hour of one’s time) is worth. Thus Hayek realised that central planning – the second guessing of millions of citizens operating independently – was both a “beautiful illusion” and a “fatal conceit” that would destroy productivity, efficiency, liberal institutions, the rule of law, and ultimately civilisation itself. It is a big claim, and was the subject of Hayek’s most famous book.

Why, then, was (and, even more surprisingly, is) socialism so popular, particularly among the educated middle-classes. Hayek’s explanation was acerbic: “One’s initial surprise at finding that intelligent people tend to be socialists diminishes when one realises that, of course, intelligent people will tend to overvalue intelligence …” It flatters us to believe that we can exercise a guiding hand over something as vast and chaotic as the economy – itself nothing more than the expression of our wishes and our capabilities. It lets us play at being Olympians, shaping the lives and fortunes of mortal men far below. In fact there is only one hand that can truly guide the economy, an invisible hand subject to no single will.

Socialists have no “understanding of economic processes”: the price system and the mechanisms of the market leave them cold. Socialists fail to allow the vast amount of dispersed and tacit information to express itself, and so the economies they guide underperform. This in turn encourages them to seek to break through the torpor with ever more authoritarian measures: in Britain it was price controls, which destroyed industry; in China it was a concentration on the production of steel to the exclusion of food, which destroyed lives.

In 1974 Hayek was awarded (half) the Nobel Prize for economics. In his acceptance speech, he noted that he would have advised against creating such a prize, which would “tend to accentuate the swings of scientific fashion”, though in his case “the selection committee has brilliantly refuted [this fear] by awarding the prize to one whose views are as unfashionable as mine are.”

He was more worried, however, by the effect it may have on the recipients themselves, and their impact upon public policy: “the Nobel Prize confers on an individual an authority which in economics no man ought to possess… I am not sure that it is desirable to strengthen the influence of a few individual economists by such a ceremonial and eye-catching recognition of achievements… [The committee should,] on conferring the prize, remind the recipient of the sage counsel of one of the great men in our subject, Alfred Marshall, who wrote: ‘Students of social science, must fear popular approval: Evil is with them when all men speak well of them’.” Such acclaim was never granted to Hayek himself.

Corporation Tax and Payroll Tax: the stealthiest taxes of them all

Imagine, if you will, a society made up of two types of citizen: the taxpayers and the voters. Taxpayers cannot vote, and voters do not pay tax. What will the result be? It seems fairly obvious that voters will vote for high taxes to pay for public services from which they will benefit at the expense of the taxpayers. Such a society would quickly fall apart, as the taxpayers agitated for more representation and refused to pay “taxation without representation”

Such a society would seem anathema to us, nowadays. Which is surprising, because we live in such a society. In one respect, devolution has created such a situation: Scottish voters choose representatives that will implement policies – say, free care for the elderly – that will be paid for in part by non-Scottish British taxpayers who have no control over the decision. This is a dangerous situation that is undoubtedly contributing to the loss of faith in the Union among English voters.

However, there is an older and more fundamental form of this: the taxation of companies. Companies do not have a vote, and yet they are taxed on their income, and required to pay additional taxes when employing staff. This seems a rather clear example of “taxation without representation” – it is true that the owners have votes, but they only have as many votes (one each) as non-owners, and consequently are being taxed in a manner additional to that of their non-company-owning fellow voters. If there was a tax on people over 2m in height, we would consider this arbitrary and unfair. A tax on business-ownership is ignored.

To be clear, it is not as if the income that owners derive from their investments is not taxed. Share dividends are subject to income tax at the same rate as salaries. However, when companies turn a profit they have to pay Corporation Tax before paying dividends, which are then subject to Income Tax. This double taxation can only be justified by treating the company as a legal entity distinct from its owners – it is taxed in its own right. But this legal status does not stretch to being permitted to vote.

Socialist economists and policy makers would probably argue that it is only reasonable to tax businesses, as they are the products of capital and that to exempt capital from taxation when the other “factors of production” (land and labour)
are taxed would represent an unfair tax exemption for rich investors (and poor investors, but socialists tend to ignore them!). This is certainly true, and it is not my intention here to suggest that capital should not be taxed. However, there is no justification for taxing it twice: if capital or profits are taxed when earned, they should not be re-taxed when they are paid out. This “double taxation” (distinct from the double taxation that arises when people and capital operate in different jurisdictions) is unfair and ultimately should be ended.

Ironically, those who support business taxes (and here I add in payroll taxes, such as employers’ National Insurance contributions) are actually harming UK consumers more than UK business. After all, the inevitable consequence of business taxes is that they will drive up prices. If tomorrow a Chancellor of the Exchequer announced a 5 per cent rise in corporation taxes, it is not going to result in Tesco generating commensurately less profits next year. The board may take the decision to absorb part of the cost of the additional taxes as a public relations stunt, but ultimately they are going to hand the extra costs down to customers. The same is true of payroll taxes.

The real danger in this is that the tax is therefore invisible. Consumers are aware of the 17.5 per cent VAT they pay on most goods, and most receipts even explicitly state the amount of VAT paid – next time you are looking at you wage slip in despair and your eye flicks enviously over the part that says how much tax you’ve paid, remember also to get those old receipts out of your wallet and factor in the bit at the bottom. This is only (or rather, less than) half the story, however, as the 82.5 per cent of your bill that isn’t VAT includes other business taxes, without which your supplier would be able to (and due to competition would be obliged to) charge lower prices.

Thus Corporation and Payroll Taxes are the ultimate stealth tax: the Chancellor sells them to us on the grounds that they are levied on businesses, and so we are led to believe that they are free money – taken from “someone else”, a faceless organisation with no vote; in fact, they are taken from us every time we open our wallets and purses. Our Income Tax bill confronts us regularly; our VAT bill every time we spend; but taxes on business slip in under the radar, taking money for the state disguised as money for the supplier.

This is ultimately damaging, as visible taxes have more obvious impact and so teach us to exercise more fiscal discipline. If our receipts also told us how much Corporation Tax we were paying, and if we received larger gross salaries but paid higher National Insurance (i.e. the employer contribution was instead factored into our salaries and personal contribution) we would have a more honest view of how much tax we paid. While we were at it, it would be nice if there were a means of quantifying the number of jobs foregone because payroll taxes made marginal employment (i.e. jobs which are only barely going to generate more revenue than they cost – usually the lowest paid jobs) unviable, thus driving up unemployment for the poorest and least skilled. Only then would we have an honest idea of the costs and effects of the policies our leaders are perusing, and for which many of us have voted.

City traders need price controls to keep their drinks bills down

When commentators mythologise about evil capitalists charging unfair prices for their goods, they usually juxtapose them with some (economically) poor unfortunate who is unable to exercise choice and so is obliged to part with more of their hard-earned and scanty resources than is fair.

Outside the exercise of monopoly provision of essential services, there is little truth behind these claims. One must eat and drink, and one must be clothed, sheltered and warm. But one does not need a mobile telephone, so no matter how high the prices of mobile telephony, no purveyor of telephones or air-time can “gouge” the poor consumer: if one does not believe the price worth paying, one simply does not buy.

Nonetheless, the image of the poor consumer is an emotive one (“There but for the Grace of God go I”), and is often used to justify government intervention in pricing. Where natural monopolies obtain, regulators oversee prices, but since time immemorial there have been calls for price controls on goods that are freely traded in the market. Both the last years of the Ancien Regime and early Revolutionary France were rocked by battles over whether food prices should be capped; Britain and America experienced rent control (and wages control) in the middle of the last century.

Misguided though these policies are, food and shelter are at least essentials, and the supposed beneficiaries poor. But wine critics know little of poor people, and have their own constituencies (and their own livers) to worry about. Thus the call by wine critics cited in The Times today for a cap on the mark-up restaurants can charge for wine does leave a rather sour and flat taste in the mouth, lacking any overtones of oak or so much as a hint of summer fruits.

Price controls to protect the rich from being exploited are rather futile. Swillers of 1964 Petrus Pomerol Bordeaux operate in the ultimate luxury market. They are more than capable of determining whether an additional £2,900 a bottle is worth paying for dinner at the Dorchester Grill as opposed to Gordon Ramsay’s establishment down the road.

Fortunately, the call will fall on deaf ears. For one thing, it is too reminiscent of the Conservatives introduction and maintenance of the Corn Laws to protect the incomes of rich landowners. But more significantly, it exposes all the stupidities of price controls in any market.

Good wines have been laid down for a long time. Thus those who bought early benefit from their foresight. The owners of the Dorchester note that one could not buy bottles as cheaply as Mr. Ramsey is now able to sell them. He has made a shrewd investment. If the Dorchester were required to sell at a lower price, they might be unable to make any profit at all, and so would simply not sell the wine. Thus supply would fall. In more immediate products a similar problem exists: if one caps rental prices, fewer houses are made available for rent; if one caps sale prices, fewer are built.

In fact, the whole system is based on the assumption that there is a natural and fair price for a product. There is not, or at least if there is it is the price at which both seller and buyer are satisfied. Every purchase is an example of individuals happily swapping one resource (ultimately their labour) for another, and outside the essentials there is always an element of choice. Prices are dictated by supply and demand. Any attempt to interfere with that – to require that prices be kept lower or higher – will merely reduce either supply or demand. Some of us may choose to buy Fair Trade tea and coffee, but if all tea and coffee were elevated in price to ensure a larger income for farmers, consumers would simply drink less tea and coffee, either undermining the benefits of the elevated price or forcing some farmers our of the industry altogether.

Martin Isark may argue that excessive mark-ups “It discourages experimentation and dampens enthusiasm for trading-up”, but capping the mark-up to “£10 a bottle for most wines”, as Malcolm Gluck suggests, is likely to squeeze the middle out of the market. Restaurants will only keep cheaper wines on which they can make a good profit, and very expensive wines that do not fall foul of the new regulations. Thus trading up will be even more difficult, as a large chasm will open up in the middle that it is not worth restaurants servicing.

Ironically, the city traders who have been blowing record bonuses recently know all this. It is not they that are calling for price controls. They are probably getting their full £2,900 worth of value from the exclusivity that results from being able to pay vastly more than other people for an identical product. No genuinely poor people are suffering here. But perhaps the “relatively poor” – which in this case means wine critics struggling on mere five and six figure salaries – will have to accept that enjoying a 1982 Le Montrachet Bouchard Pere & Fils over dinner is simply not worth the price.