Faith-based economics

Tweet

 

It is an article of faith for the Conservative and Unionist Party that the answer to all problems is to cut taxes, by which they really mean taxes on income, whether personal (income tax) or corporate (corporation tax). So when inflation is high, the solution is to cut taxes so people have more money to pay the bills, and if there is deflation, the solution is to cut taxes so people have more money to spend. If the Tory Party is united, it’s time to cut taxes, and if it’s divided it can magically be reunited by cutting taxes. The possible inconsistency in arguing that the same solution can be applied to diametrically opposite problems can safely be ignored – we are, after all, talking faith not fact here.

What they never mention is the caveats and corollaries which come with tax cuts. The first, and most obvious, of those is that income tax cuts only benefit those who pay tax in the first place. Many of those who are struggling the most in the face of rising fuel and food costs are on incomes so low that they pay little or no income tax; a cut of 1% of nothing is still nothing. Conversely, those who pay the most £s in tax gain the most pennies back if the rate is cut – who would ever have expected that a Tory policy would provide its greatest benefits to the most well-off? The second is that another of their articles of faith (equally poorly grounded in fact) is that government expenditure must be limited by the amount of tax revenues received; tax cuts must therefore also lead to spending cuts. It is, again, not exactly a coincidence that those most impacted by cuts in government spending will be those least able to fund alternatives.

When it comes to corporate taxes, their argument is that businesses which retain more of their profit will have more money available to invest, and that investment drives growth. Whilst investment can indeed drive growth, the evidence that businesses with greater retained profits will invest that extra cash is not exactly overwhelming. Many will simply choose to give that money to their shareholders, in extra dividends or share buy backs, having effectively externalised the costs of the public services which they use by passing them on to the rest of us. If there were good investment opportunities available, which would produce a better return than keeping the money in the bank or returning it to shareholders, they would be making the investment anyway, and borrowing the money to do so. And it is often the businesses which are struggling, for whatever reason, which most need to invest in new products, equipment, or processes; businesses which make little or no profit do not benefit from cutting taxes on profits. The people who do are shareholders – who would ever have expected that a Tory policy would provide its greatest benefits to the most well-off?

There is another article of the Tory faith worth referring to here – and that is the infamous Laffer Curve. This purports to show that there comes a point where tax increases have a negative impact on government revenues because people are incentivised to find ever more creative ways of avoiding or evading tax. For those who follow the true faith, this ‘proves’ that tax cuts can lead, counter-intuitively, to increased government revenue. There is just one problem. There is no – zero, zilch, nada – empirical evidence to support the Laffer Curve theory. It's junk economics, especially in the way the Tories seek to apply it. Indeed, such research as has been done tends to support the rather more blindingly obvious, and completely intuitive, conclusion that a government which cuts tax rates will end up collecting less money.

It is, unfortunately, far from unique in the history of man and economics to discover that a government basing its economics on articles of faith rather than empirical facts ends up pursuing policies which somehow, miraculously and entirely coincidentally of course, end up benefiting its own supporters.

Tax competition and racing to the bottom

Tweet

There was a letter from the First Minister in the Western Mail on Saturday, talking about how devolving Air Passenger Duty would make a huge difference.  That part was nonsense, of course.  Devolving APD in itself makes no difference whatsoever; what might make a difference is changing the level of taxation.  Devolving the power might or might not lead to change in tax rates – that actually depends on taxation policy rather than directly on where that policy is decided.

But there was one line in the letter which particularly drew my attention, and that was where the First Minister said, with clear approval of the principle, “The UK government has already accepted the case that it is appropriate for there to be some tax competition following the devolution of tax powers.” 

Perhaps one should never expect consistency from politicians, but I seem to remember that that wasn’t always his position.  Let’s consider his views on the devolution of Corporation Tax, when he said “When it comes to corporation tax I am sceptical on this and if we have it devolved to Northern Ireland, Scotland, England and Wales, I think there is a genuine risk of a race to the bottom with everyone reducing corporation tax; that would be great for business, but hopeless for the public purse.”

So, devolution of taxes that he wants to cut would lead to healthy tax competition; devolution of taxes that he doesn’t want to cut would lead to a race to the bottom.  There is nothing wrong with taking a political view as to which taxes should be cut, held the same, or increased – that’s an entirely legitimate way of enabling people to compare and contrast political parties and programmes.  It is not, however, a sound or principled basis for deciding where taxation powers should reside. 

‘Tax competition’ and ‘race to the bottom’ are just two different ways of describing the same thing.

Taxes, grants, and photo-opportunities

Tweet Yesterday’s Western Mail carried this story about the Ford engine plant in Bridgend.  The company received a £12 million grant from the Welsh Government a little under two years ago, and is now seeking a further £15 million in aid, with the implied suggestion that it may yet decide to build its new engine elsewhere.  Part of the justification for seeking further aid is that the company’s Europe, Middle East and Africa region is expected to report an annual loss of around $1.2 billion when results are published on Thursday, although globally the company is expected to show an overall pre-tax profit of $6 billion (around £4 billion).

I’m not in a position to know whether, or to what extent, the company does its intergroup accounting in such a way as to ensure that profits end up in the places where the tax bills is lowest, and losses in the places where state aid is easiest to come by.  Perhaps they don’t, although they’d be something of an exception amongst the big multinationals if they did not endeavour to optimise their advantages from international differences in approach.

I also don’t know whether the Labour Government in Cardiff will accede to the request for another £15 million.  I’d be surprised, though, if they rejected the request out of hand given the potential consequences.  It’s easier to claim credit for ‘saving’ jobs than it is to risk those jobs.  And although the government happens to be Labour, it doesn’t seem likely that any of the opposition parties would put their heads above the parapet to query the wisdom of paying £15 million to a company which is making a £4 billion annual profit, for similar reasons.

By curious coincidence, the same edition of the paper contained a letter from a Labour Councillor in Blackwood, Nigel Dix.  (Scroll down here.)  He attacks the Tories, Plaid, UKIP, and the SNP for proposals to reduce corporation tax.  Leaving aside the rather pathetic attempt to brand all four parties with the same brush as “parties of the right” seeking to “transfer wealth to the rich”, his argument is that a reduction in tax will “simply result in multi-national companies contributing even less than they currently do”.  That point is a valid one to make as a description of the overall global result, although it skips over the fact that a transfer of taxable profit to a lower tax regime might actually lead to a higher tax take for an individual exchequer.

But what, ultimately, is the fundamental difference between a tax cut (bad) and a grant (good)?  They are both ways of giving money to companies in essence.  There are arguments for and against both; each has its advantages and disadvantages, but either way there is an effective transfer of funds from the taxpayer to the private company.

Personally, I’m a little agnostic on the question of corporation tax reductions for companies.  I don’t really see it as a question of it being right-wing or left wing; that depends on the accompanying policies.  In isolation, then certainly it is, like a cash grant, simply a rebalancing of finance between the public purse and the private purse in a way which is damaging to the public purse.  But if accompanied by measures to prevent the use of clever accountancy tricks to shift the profit from where it is made, and to properly tax any money taken out of companies in high salaries and dividends, then allowing companies to retain more of their profits with little option but to reinvest them could be an engine for job creation.

I suspect though that Labour will continue to cling to a regime of higher tax and then give the money out in grants.  The photo-ops for ministers are much better that way.

Entrepreneurs and managers

Tweet

The Government claim – of course – that their budget was ‘business-friendly’, and therefore likely to boost economic growth.  The aim is not unreasonable; but is their claim really true?

Certainly, there’s a good argument for reducing the level of corporation tax.  Leaving profits in companies to allow for reinvestment and taxing the money more heavily when it is taken out in salaries, dividends and share options should theoretically enable businesses to invest more, and is, in principle, something that I support.

The proposition is not without caveats however.  If the investment simply flows abroad to lower wage economies, then the businesses will still benefit, but the benefit to the rest of the UK economy is rather less clear.  And I’m not at all sure that a relatively small cut of 1p hasn’t been massively over-hyped in terms of its potential effect.

It will certainly benefit the larger businesses paying £millions in CT, but it won’t make that large a difference to the smaller and medium sized companies which are the real engine of growth in employment opportunities.  And many of those larger companies are currently sitting on large cash piles anyway – it’s not lack of cash which is holding back investment so much as lack of worthwhile investment opportunities.

Then there’s the second part of their ‘business-friendly’ agenda – the reduction of the top rate of tax from 50p to 45p.  The argument is that this reduction in tax for those earning over £150,000 will help and encourage entrepreneurs.  I’m unconvinced.

Whilst there certainly are some entrepreneurs on very high salaries, £150,000 is a salary of which most entrepreneurs can only dream; the level of tax which they’d pay on it is tomorrow’s problem, not today’s.  In fact, the majority of people in the UK economy earning that level of salary aren’t entrepreneurs at all, they’re rent-seeking managers.  Increasing their take-home pay doesn’t have any obvious connection with boosting growth.

That perhaps underlines my issue with the way that the UK Government is using the term ‘business-friendly’.  Creating a climate where businesses can grow and thrive, providing jobs as well as goods and services, isn’t at all the same thing as increasing the net rewards of the people running those businesses.  It’s more than a little disingenuous to conflate the two in the way that the government are doing.

Competitive spirals

Tweet

The Welsh Government seems to be a little bit confused as to what it thinks when it comes to devolving Corporation Tax.  According to the Business Section in Friday’s Western Mail, it was being ruled out pretty firmly, but Adrian Masters reveals a rather different stance on the issue in Government statements.

I’m still convinced that it could and should be devolved, but I have considerable sympathy with Carwyn Jones’ concern about a “competitive spiral to the bottom”.  It is a real potential danger.

The extent to which we need to worry about it depends though on what we really mean when we talk about ‘creating’ jobs.  It’s a word much-loved by politicians, particularly if they can claim that their actions have done the ‘creating’, but far too often what they actually mean is ‘moving’ jobs.

If the jobs are genuinely extra ones, then a lower rate of CT in one part of the unitary state can indeed be a significant factor in helping industries to decide where to ‘create’ those jobs.  And that makes it a valid approach from a unionist, not just a nationalist, perspective. 

Holtham’s recommendation for a rate of CT which varied according to the gap between ‘regional’ GVA and the ‘national’ average is a mechanism which anyone could support, regardless of their views on the constituonal position of Wales.  (And indeed, it’s something which Wales might even want to consider internally, in order to boost the prospects of places like Ynys Môn, rather than concentrate all new jobs in South-East Wales.)

If the jobs are not extra, and are merely being moved from an area of high CT to an area of low CT, then whilst it might have some positive effect by spreading economic prosperity and jobs more evenly (not to be sneezed at as an objective in itself), the net fiscal effect would be an overall loss to the Treasury with no overall total increase in economic prosperity to show for it. 

But, rather then seeking to oppose the idea as a result of such concerns, surely it would be better if our First Minister applied a little thought to the question of how we combine the power over CT with other actions so as to ensure that we target the genuine creation of new jobs?

The missing promise

Tweet

There was some talk a couple of weeks ago that the Tories’ manifesto had been sent to London to be censored, so as to eliminate any commitments with which the UK Party was unhappy.  Not having seen the drafts, it’s difficult for outsiders to spot what is missing, obviously.

There is, though, one glaring omission, I thought when I read it.  The party’s economic commission, under Dylan Jones-Evans, produced a report not long ago with a number of recommendations in it.  There was no doubt in my mind, from the way that Dylan presented it, and from my own reading of it, that the one single proposal seen as being most important was the variation of Corporation Tax.

However, it is nowhere to be found in the published document.  It means that the party is putting forward an economic policy which its own commission would recognise as being less than optimal.