Thursday, 17 June 2010

20 questions for the next Labour leader - part 2

Having just watched the Newsnight debate between the five contenders for the Labour leadership, I have to confess that I am still not much the wiser. With Jeremy Paxman seemingly more interested in trying to get the candidates to talk about the past (e.g. Iraq, Gordon Brown's leadership) than the future, there was precious little time for the candidates to outline future policy changes. Paxman's attempt to try and get Ed Balls to knife Alistair Darling over his last budget was particularly emblematic of much that is wrong with the way politics is conducted inside the Westminster/media bubble. Then Michael Crick had the audacity to claim that Ed Miliband had underperformed because he had "..failed to put forward the kind of visionary ideas..." that he had outlined at previous hustings. Well of course he failed, Michael, because he wasn't given the opportunity. In fact none of the candidates were.

In a previous blog I outlined five of the top twenty questions that I think need to be addressed in this leadership debate. Only the first of these (why you?) and the last (civil liberties) were really addressed in the Newsnight debate. The issues of housing, inequality and the candidates' own policy priorities were largely ignored. Yet the previous debate hosted by the Fabian Society seemed to be much more policy oriented. As a result it is slowly becoming apparent that there are some distinct differences between the various candidates, but we will only be able to fully appreciate what these are when we find out where each candidate stands on a range of different issues. Many of these critical issues will be in policy areas where the last government was found wanting, both by its supporters and by the electorate as a whole.

6) Clearly electoral reform is one such issue. The media think this is only of relevance to political anoraks, but it is becoming clear that it is central to issues of social justice and inclusion. It also impacts on the way political parties position and differentiate themselves and hence on amount of choice voters are given at elections. This was one of the key policies that was addressed at the Fabian meeting. It now appears that most of the candidates are signed up to electoral reform. Ed Balls is even in favour of a written constitution, which brings me on the the next point.

7) Constitutional reform.
One area where the last government lost trust was over its refusal to grant the people a referendum on the Lisbon Treaty. So would a future Labour government grant a referendum on all future EU treaties? This question is even more important given the role that such treaties appear to be playing in forcing the UK government to contract out public services and possibly privatise the Royal Mail.

8) Then there is the euro. Given the current problems in the eurozone it is imperative that we know under what circumstances (if any) each candidate would countenance the UK joining the euro. It is also important that we find out to what extent they each understand the potential economic consequences of doing so. One of the biggest economic consequences of joining the euro would be in the effect it had on the UK financial sector.

9) So would any of the candidates be prepared to reform the banking system to make it more competitive and reduce the risk of another financial collapse? Are they prepared to break up big banks? What other financial measures would they introduce? And how would they prevent the most disadvantaged in society being excluded from access to bank services as banks seek to increasingly make customer pay annual fees for bank accounts?

Of course it is not only our banking system that is prone to excessive executive pay and a disproportionate bonus culture. The same is true of much of British industry.

10) So how would each candidate improve shareholder democracy and Company Law in order to reduce corporate fraud, tax evasion and avoidance, and excessive executive pay and bonuses?

11) How would they regulate takeovers in order to maintain market competition, improve consumer choice and protect British businesses and jobs from unfair competition and commercial predators? There is no doubt that the takeover of Cadbury by Kraft cost Labour many thousands of votes, both around Birmingham and elsewhere.

12) Wealth and Mansion Taxes.
Which candidates would support a Mansion Tax of the type outlined by Vince Cable? Such a tax is far more redistributive than income tax and could generate up to £20bn, as I pointed out a few months ago. That is nearly ten times the amount that inheritance tax currently generates. It is also far more than is currently generated by stamp duty and CGT.

So, twelve down and eight more to go.

Tuesday, 1 June 2010

How to prevent a Euromess

So, the euro is in turmoil. A crisis that started in Greece is now spreading to Spain, Portugal, and possibly even to France and Italy. However, as the Nobel prize-winning economist Paul Krugman pointed out on his New York Times blog a few months ago, the real story is in Spain, not Greece. This is partly because Spain is the much bigger economy. It is also because, for most of the first seven years of this millenium, Spain kept to the rules and maintained its budget deficit well with the 3% limit demanded by the Maastrict Treaty. In fact, over that period it actually ran a small cumulative budget surplus (see Paul Krugman's blog for details). That, though, did not save it from the effects of the credit crunch and the financial collapse of late 2007. Greece on the other hand is a totally different kettle of fish. Unlike Spain, it didn't even try to play by the rules, so it is hardly a surprise that it is in the economic mess that it is.

The lesson to be learned from the experiences of these two countries is that the problems of the Eurozone are two-fold. Firstly, there are some countries that were admitted to the club (probably for political reasons) that were fiscally irresponsible and failed to obey the rules. In short, they probably shouldn't have been there in the first place. Then there were other countries, like Spain and Ireland, that generally obeyed the rules, but suffered from what Krugman terms asymmetric shocks. It is how the euro deals with these asymmetric shocks in the future that will ultimately determine whether the euro can survive in its present form. In my view, the measures so far proposed do not address the real issues, or provide any real solution. In order to understand how these asymmetric shocks can be prevented you need to understand their cause. In the cases of both Spain and Ireland, the primary cause was (surprise, surprise!) a massive property boom, driven in part by large speculative capital inflows, which then led to excessive local price inflation. So, no stable solution will be found unless it addresses the problems of capital flows, and local inflation in wages and house prices.

The problems in Spain started with the property boom. This led to massive inflows of cash into the economy that meant that Spain ended up running a massive current account deficit. This inflow of cash also stimulated the economy to such an extent that it caused inflation in local goods and services, and particularly in wages. The critical factor, however, is that the property boom ultimately led to a boom in GDP and thence to a huge increase in government revenues. So the government was able to spend more without either raising taxes, or borrowing to fund a deficit. The problem was, this extra spending then fuelled the boom in GDP even more, thereby exacerbating the underlying problem. However, because the economy was expanding and the government was still balancing its budget while its spending increased, few people saw the impending crisis looming. Unfortunately, when the property bubble burst, as it inevitably had to, government revenues collapsed with GDP, while government spending rose even further to fund the consequences of rising unemployment. The result is a massive deficit of over 12% of GDP. That, then is the history, as Paul Krugman outlined previously on his blog. The question for the euro though, is how could it all have been prevented?

Of course, it is patently obvious that central to this whole mess is the inflation in asset prices that occurred during the boom, mainly in housing and other real estate property. Now it has been argued by some at the Adam Smith Institute (ASI) that the flaw in the whole euro project is the common interest rate set by the European Central Bank, and it was this that caused the property boom because the bank rate was set too low. Unfortunately there are two major flaws to this argument.

For a start, the argument that housing booms are, or can be, effectively controlled by changing interest rates is not well supported by historical economic evidence. Governments and central banks are generally reluctant to raise interest rates in order to dampen house price inflation for fear of strangling economic growth or strengthening the currency too much. As I pointed out a few months ago, the only way to effectively control house price inflation is by controlling mortgage lending. Secondly, Britain and the USA suffered from their own housing bubbles without being in the Eurozone. They had the freedom to adjust their interest rates upwards to counter their own housing booms, but chose not to. Finally, it should also be remembered that the property booms in Spain and Ireland started long before either country joined the euro.

An alternative possible solution currently being touted is to go for greater fiscal integration in the EU. This is the approach that was suggested by the German government recently. Unfortunately, such a policy would reduce the ability of member states to run their own domestic affairs. It could lead to outside agencies (like the European Commission) telling member states how they should spend their own money. It would inevitably lead to greater tax harmonisation across the Eurozone (something favoured by Germany), together with a reduction in democratic accountability and plurality. It would also make the EU more like the USA. Of course one way the USA deals with fiscal imbalances between member states is to tax nationally and then redistribute money to the different states via federal grants. There is, though, no political appetite in the EU for a similar strategy.

The USA is also a more integrated economic region than the EU, with greater geographical movements of people. Paul Krugman has suggested that one solution to the Spanish problem, and asymmetric shocks in general, is an increase in "fiscal and labour integration". In other words to make the EU more like the USA. The problem with this is that there are deep structural barriers in Europe to the free movement of labour: language, culture, education and recognition of qualifications. In reality, it is far more likely that companies will move jobs to regions of low wages and high unemployment, than people will move between countries to find jobs.

There is, however, a third option that has so far been ignored. Rather than the EU taxing all citizens, as happens in the USA, it could tax all member governments in the Eurozone. The tax rate would be designed to counter the capital inflows that Spain enjoyed, and which led to its inflation rate exceeding the Eurozone average. By using this rate of surplus inflation in Spain as the figure of merit (i.e. the difference between local Spanish inflation and the Eurozone average), and calculating the tax due by applying that rate to the current value of Spanish GDP, such a measure would effectively counteract the effects that the capital inflows had in distorting the economy.

For example, the data in Paul Krugman's blog shows that local inflation in Spain between 2000 and 2007 was on average about 4% more than in Germany (and the Eurozone average). At the same time the current account deficit varied between 4% and 10% of GDP. So, if the European Central Bank (ECB) were able to tax the Spanish government at a rate of 4% of GDP for that period, the Spanish government would then have been forced to pass on that tax to the population via tax rises, or spending cuts, in order to maintain its budget balance within the 3% Maastricht limit. Both of those measures would have acted as a dampener on economic growth in Spain, thereby counteracting the effects of the housing boom. Moreover, the tax revenues generated by such a measure, and thus acquired by the ECB, could then be used as bailout money for Spain in any future banking or economic crash. In fact such a policy would have resulted in Spain building up capital reserves at the ECB equivalent to around 25% of its GDP in the period up to 2007. That would have funded its current deficit for at least two years and thereby negated much of the economic crisis that it now finds itself in. This policy would therefore eliminate most of the potential for asymmetric shocks within the Eurozone while also providing the financial means to compensate for any shock should it ever occur.

There is, however, another issue that needs to be addressed if the euro is to work effectively, namely, how to regulate the banks. What this crisis also demonstrates is that EU member governments need adequate tools to be made available to them that allow them to regulate the lending policies of their local banks, and to the control the level of indebtedness of their own local populations. The problem is, the single currency zone of the euro and its single interest rate make that virtually impossible for any individual government. This though, is not just a problem with the Eurozone. It is also a problem that has its roots in how the European single market is constructed. You only have to look at the difficulties that Britain and the Netherlands had in regulating Icelandic and Irish banks to see that. As I have pointed out previously to those at the ASI, that can only be achieved if the EU allows member states to restrict lending of local banks to local customers, as at least used to happen in the USA.

The problems with the euro that I have described above, not only represent an important economic issue, but also an important political issue. The debate over whether Britain should ever join the euro may have been consigned to the cryogenic freezer now that Cameron is PM (given that the Tories will probably never agree to it), but it could still resurface as a major issue for the Labour Party, either in the forthcoming leadership contest, or in any future coalition with the Lib Dems. That is why it is important that the Labour Party has a coherent policy in this area. The question is, what should that policy be?

It is no secret that the issue of joining the euro strongly divided the last Labour government. It could also strongly divide the main leadership contenders. While large parts of British industry may be in favour of joining the Eurozone, that in itself is not sufficient justification. Moreover, part of the attraction of the euro is historical. It dates back to the 70's and 80's when Britain was a country of high inflation, and Germany was the epitome of monetary stability. That justification has now been rendered largely redundant. For the last twenty years Britain has enjoyed low inflation as well. In addition, because the Eurozone now includes fifteen countries, that is fourteen fewer currencies that British companies need to deal with, so the euro has already greatly simplified the problem of foreign exchange for British industry without the UK needing to join the euro, even if it has not completely eliminated it. What is clear, though, is that both the euro and the single market need substantial reform of the type I have outlined before Britain can even consider joining the euro. At the moment, that looks a long way off.

Saturday, 29 May 2010

20 questions for the next Labour leader - part 1

Last week Sunder Katwala of the Fabian Society posed the question on the Next Left blog site, "What are the difficult questions the leadership candidates need to answer?". The biggest surprise about this question is that no-one has asked it sooner. Many in the Labour Party who were unhappy with Gordon Brown's leadership may well have acted against him long before the last General Election if there had been a credible alternative candidate waiting in the wings. Unfortunately, one of the reasons that there was no credible alternative (even though there were plenty of potential candidates) was that no-one really knew what any of the possible leadership contenders stood for. The problem now is, we still don't.

There is a common misconception in the media that Labour lost the last election merely because of a failure of presentation, both in its policies and in the personality of its leader. I disagree. I believe Labour lost because it ran out of policy ideas and therefore appeared to many to be a spent political force. After 2001 it had exhausted the stock of policies it had built up in opposition, and any policies it came up with subsequently it had to invent on the hoof while running the country. Unfortunately most of them ended up sounding as though they were made up on the hoof. They lacked coherence and intellectual rigour, and alienated our core support. In fact many of them just didn't work. On top of that there was a total failure to address the issues that affected Labour voters the most (jobs, housing) or angered them the most (bankers bonuses, immigration, the economy). That is why before the Labour Party can choose a new leader, the members need to know where the candidates stand on the issues that matter to them.

Unfortunately, so far in this leadership campaign all we have seen is more of the same. It has been the same bland candidates with the same vacant policy agendas. So far the campaign has been about who has the looks to take on Cameron, and who can amass the biggest army of sycophantic backbench supporters. That is why Sunder is right to ask his question. I have already offered Sunder my initial answer on what those questions should be, but here I will outline my definitive top 20, starting with my top five. The rest will come later.

1) The first question any potential leader should have to answer is the BIG one. It is this: "Why do you want to be leader? "
This is the question that Roger Mudd of CBS put to Ted Kennedy when he ran for US President in 1980. His failure to answer it effectively ended his presidential ambitions. For that reason alone, it is a question that deserves to be put to all leadership candidates. The events of the last ten years demonstrate that if a party is to avoid electoral stagnation, it needs to have a leader with a vision, not someone whose sole aim is to manage things a bit better, or is driven by his own hubris, vanity and lust for power and status. That is the underlying importance of this question.

2) The next question is one that I think follows on naturally from Q1. It is, what is YOUR big idea? What do you see as the fundamental structural problems in British society and what would you do to correct them?

Then we need to get into specifics regarding what a future leader would do if they became PM. If there are three issues that define the failure of the Blair/Brown years, then they are probably the housing crisis, the continuing rise in inequality, and the attack by the last government on civil liberties.

3) Housing
First we need to know if the candidates fully understand the role the housing bubble played in causing this current recession. Do they appreciate the effects that shortages of affordable housing have on distorting the labour market and reducing the mobility of labour? Do they recognise that inequalities in housing inevitably lead to inequalities in health, wealth and education? Do they understand that booming house prices lead to underinvestment in productive industry, and therefore to stagnating GDP and excessive private sector debt? Do they understand that housing booms always end in housing crashes, and that that always leads to recession, or worse? If so, we need to know how they plan to address these problems.
Would they support the building of more Council Houses, or social housing? And if so, how would they ensure that house building occurred in sufficient quantities? More importantly, how would they prevent future housing booms from occurring? I have already argued that control of house price inflation is essential to our future economic growth, and I have already outlined how such price stability could be achieved. If you don’t know the answer then I suggest you look here.

4) Inequality
Despite many noble initiatives, inequality in Britain grew (by some measures at least) under the 13 years of the last Labour government. If the Labour Party stands for anything, then it must be for the promotion of equality and fairness in all sectors of society. I doubt that anything in the last election campaign angered Labour voters as much as seeing David Cameron continually trying to present himself as the new champion of the poor and dispossessed. So any new Labour leader must outline how they would reduce inequality and make Britain a fairer country?

5) Civil Liberties
Despite incorporating the European convention on human rights into UK law, the last government's record on human rights and civil liberties was far from exemplary. Allegations of collusion in torture, extraordinary rendition, unlimited detention without charge and ID cards all made it look repressive and authoritarian. Worse still, it appeared more authoritarian and pro-establishment that the Tory Party. That is hardly a favourable position to be in for a party that claims to be the champion of the working man.
The question then for the leadership candidates (some of whom were associated with many of these illiberal policies) is this. Which should take priority under the law: the civil liberties of the individual, or the right of the state to maintain its own security? To claim (as many politicians do) that one must always try and balance civil liberties against the need for security seems to me akin to arguing that a country should always try to compromise between democracy and totalitarian rule. It can never be about balance or compromise. It is always about principles. It is about which of the two viewpoints should take priority, both in government policy, and under common law. It is also about the balance of power between the establishment and the people: the rulers and the ruled. That is why Labour should always be on the side of civil liberties, because it is about protecting the disadvantaged from abuse of power by the privileged.

These then are the first five questions I would put to the leadership candidates, but they are not the only ones. It remains to be seen, though, if we manage to get any satisfactory answers to any of them.

Saturday, 8 May 2010

Nick Clegg and the Tories - deal or no deal?

So who should Nick Clegg and the Lib Dems do a deal with? And what should they seek to get in return?

Clearly their first priority must be electoral reform. This is clearly their best opportunity yet to secure a set of reforms that could completely change the dynamic of British politics. Unfortunately, there are a number of major obstacles standing in the way that could prevent them from achieving this.

The first problem is this. On issues of policy (tax, electoral reform, Europe, the economy) the Lib Dems are much closer to Labour than the Tories, and so are most Lib Dem activists. Unfortunately, the same cannot be said for most Lib Dem voters, particularly those in many of the seats in the South of England where the Lib Dems are the main opposition to the Tories. So while most Lib Dem party members and MPs would be much happier forming a coalition with the outgoing Labour government, they could face a backlash from some of their voters and the Tory press if they did. David Cameron may not have won the election last Thursday, but there is no doubt that Gordon Brown lost it. Therefore Nick Clegg would be committing electoral suicide if he was seen to be supporting a Prime Minister who had been rejected by the voters.

The alternative Lib Dem-Labour scenario is that a coalition between the two parties could be agreed, but with Gordon Brown stepping down as PM. But would Gordon Brown ever agree to that? I suspect not, but even if I'm wrong, who would replace him? No-one from within the Labour Party has the mandate, and a new leadership election would take too long. So how about if Nick Clegg were to be the new PM? That might be more popular with the electorate, but then the problem switches to the question of who would be his Chancellor of the Exchequer. The public would also want Vince Cable, but it is inconceivable that any coalition between the Lib Dems and Labour could be agreed with the Lib Dems holding both of the two top posts in Cabinet when they are by far the smaller party. And the alternative is that Gordon Brown might demand his old job back.

Finally there is the problem of stability. A Lib Dem-Labour coalition would still fail to command a majority in the House of Commons. It would need the additional support of the SDLP, the Greens, and either Plaid Cymru or the SNP or both in order to govern. Yet the greater the number of partners, the greater the risk of collapse. The question the Lib Dems should therefore be asking themselves is this. How long would such a coalition need to exist in order for it to deliver electoral reform in time for the next election? And how likely is it that it would happen? The doomsday scenario is that this coalition would collapse before any real reform could be enacted, and that at the ensuing general election the Tories went on to win decisively, with the Lib Dems routed. Electoral reform could then be off the political agenda for another generation.

So if a Lib Dem Labour coalition is fraught with difficulty and danger, how about a pact with the Tories? At first sight it is hard to see, though, how a pact between the Tories and the Lib Dems (whether in the form of a formal coalition or an informal one) could work given the massive differences in policy between the two parties and the mutual hostility of many of their respective MPs. Moreover, the Tories would never agree to electoral reform of the House of Commons. However there is one thing that the Tories could deliver that would be a total game changer - reform of the House of Lords.

David Cameron and the Tory Party claim to support a fully elected upper chamber, so now Nick Clegg needs to call their bluff. The outgoing Labour government has claimed that it was opposition from the existing Tory life peers and hereditary peers that blocked and delayed reform of the House of Lords in the final years of Gordon Brown's premiership. David Cameron on the other hand can deliver the necessary votes in the House of Lords needed to get reform through quickly. That should therefore be the price that Nick Clegg should demand for limited support of a minority Conservative government in the House of Commons. The critical factor here is speed. If reform of the House of Lords is not in place before the next general election, not just in legislation but in operation as well, it can always be repealed by a new (Tory) government in the House of Commons that may seek to break any promises and cancel any deals agreed previously. There is little honour in politics, particularly if it gets in the way of the exercising of unbridled power. However, once an elected House of Lords is up and running though, no House of Commons will be able to abolish it unilaterally. It would need a broad consent in The new House of Lords as well, and turkeys don't usually vote for Christmas. In short, once it is up and running, a directly elected House of Lords is here to stay. It is irreversible.

Now at first sight this might all seem like a small and insufficient concession for the Lib Dems to extract from the Tories given that most people see the House of Lords purely as a revising chamber. I believe, though, that reform of the House of Lords is the real key to total electoral reform in this country. It represents the small crack in the dam that will eventually bring down the whole structure. As the new House of Lords would be elected by PR, it would be more proportional, more democratic, and therefore more legitimate than the House of Commons. It could act as a block on extreme policies promoted by governments with Commons majorities but minority support from the electorate. In effect it would lead to coalition governments without the need to reform the voting procedure for the House of Commons, though that would surely follow. In short, it would totally change the rules of the game. That is why Clegg must seize the opportunity now. He may never get another chance.

Wednesday, 24 February 2010

Why is Labour afraid of a 'Mansion Tax'?

Is there a causal link between the British obsession with property ownership and the reluctance of our government to tax it? I can only think there must be, because I can't come up with any other reason why a Labour government would have failed to endorse Vince Cable's proposal for a 'Mansion Tax'.

Ever since Vince Cable announced his proposal it seems as though it has been subjected to a barrage of venomous criticism from all sides. Not surprisingly, most of this criticism has emanated from the small sect of people that would have the most to lose from this tax: those that make up the wealthy core vote of the Tory party and their cheerleaders in the right-wing press. Nor is it perhaps surprising that many Lib Dems also appear rather bewildered by it, given that it totally contradicts and undermines their currently stated opposition to that other established property tax: the Council Tax. What I really don't understand, though, is why those on the Left, and particularly most of the Labour Party have not enthusiastically embraced this tax policy. After all, it goes to the heart of what most socialists believe in and are striving for: a fairer and more equal society with a fairer and more even distribution of wealth. It targets extreme wealth, inherited wealth, and the idle rich. Moreover, because it targets fixed assets it is impossible to avoid. People and businesses can move between countries and tax jurisdictions: property can't. Personally, I only have one problem with this tax: it doesn't go far enough.

The tax Vince Cable proposed was originally going to be set at a rate of 0.5% on the excess value of any property above a threshold of £1 million, and was expected to yield over £1bn in revenue. Unfortunately, Vince then appeared to lose his nerve and watered down his proposal by raising the threshold to £2 million. Presumably the Lib Dems were worried that the original proposal might lose them too many votes in their key marginal constituencies in and around London. As a result the tax is now worse than useless. Like Labour's 50% income tax band that I slated in my last post, this proposal doesn't raise sufficient revenue to make it politically worthwhile. It won't fill the fiscal black hole that we are currently staring into, nor will it either help rebalance the property market or contribute anything significant towards promoting greater wealth redistribution and a fairer system of taxation in this country.

Instead of a 0.5% tax above £2m, the tax rate should be set much higher and the threshold set much lower (and closer to the current Inheritance Tax threshold). In short, it should be set at a minimum of 2% on excess property values above £500k. Now that would be truly radical, and it would yield almost £10bn for The Treasury. If the tax were also to be levied on all second homes and buy-to-let properties below £500k, and all commercial land not already covered by business rates (such as speculative land banks etc.), the total could be closer to £20bn. Not only would such a proposal be both radical and progressive, it would also allow the Government to address the problem of the budget deficit without cutting services or raising taxes on income and consumption that could damage the fragile economic recovery.

Of course those that would be hit by this tax would claim it was both unfair and arbitrary. In fact it is neither. The rate at which this tax is set is consistent with existing property taxes. It is, therefore, the absence of this tax that is unfair. To understand why, we need to consider the other main property tax that is levied on the populus: Council Tax. It is the iniquity of this tax that demands the introduction of the Mansion Tax, and also helps determine the rate and threshold that should be imposed.

The average Council Tax in the UK is now nearly £1500, compared to the average property value of about £165k. For most people, this equates to a 0.9% tax on the asset value of the property they live in, irrespective of whether they actually own that property or not. Yet this tax is not levied in proportion to the actual house price, nor even the price back in 1991 when the last valuation took place. In fact, as the graph above illustrates, the relative burden of this tax falls disproportionately on those occupying houses valued in the lower bands (A-E) who would also be expected to have lower incomes and net wealth, while the rich end up paying a much lower rate of tax when measured either as a proportion of their income or their wealth (i.e. property value). This cannot be fair, and goes against all established principles of progressive taxation. It is because of this iniquity that the Mansion Tax is needed.

This then is the rationale behind such a tax. Currently most Council Tax payers (or at least those in bands A-E) are paying approximately 1% of the asset value of their property in tax each year. Yet coincidentally, this equates almost exactly to the amount they would pay in extra income tax (at 20%) from the typical maximum rental income (about 5% of asset value) that they could reasonably be expected to derive from that property. In other words, they are in effect being taxed on the potential income that the equivalent property investment might yield. So, applying the same principle to those living in more expensive properties (bands F-H), who are also likely to be higher rate (i.e. 40%) income tax payers, means that their tax rate should be 40% of the rental value (which in turn is 5% of the asset price), and this then equates to a property tax equal to 2% of the asset value. As for the level at which the threshold for this tax is set, well that should be determined by the point on the graph above at which the tax rate under the current system plateaus off in favour of the rich. This occurs at about band F/G, or 1991 property values of about £160k. Today these properties are valued at about £500k.

There are two main objections that critics of this tax usually try to raise to demonstrate, either its unfairness, or its impracticality.

The first objection is that the tax will prove far too difficult to collect because it is just not possible to value each property accurately enough, or the property values will change with time. If this were true, though, then surely the same problems should apply to the collection of Council Tax and inheritance tax, shouldn't they? So how is it that these taxes appear to work perfectly well? If it is possible to value a property for the purposes of levying Inheritance Tax upon it, then it should be equally possible to value the same property for the purpose of this Mansion Tax. Remember - the Inheritance Tax threshold is currently below the level at which I would propose levying the Mansion Tax. So every property that would be subject to the Mansion tax in the future is already potentially subject to Inheritance Tax now.

The second objection is equally spurious. It is based on a belief that all taxes should be based on the principle of a person's ability to pay. This in itself is a noble and just position to take. Unfortunately, those that seek to oppose wealth taxes like the Mansion Tax presume that one's ability to pay, as they define it, is determined solely by one's income, and not by one's accumulated wealth. Thus they invent the hypothetical case of a little old lady living alone in a vast mansion, with little or no income to support her, other than maybe her paltry widow's pension. This is supposed to highlight the gross unfairness of the tax. With little or no income, how can she pay the tax? An equally valid question though is, with no income how can she maintain the property at all, irrespective of whether it is taxed or not? How will she be able to pay for the roof to be mended, or the electrical wiring replaced, or the boiler repaired?

The fact is that this hypothetical old lady is just that: hypothetical. She doesn't exist because no-one with an ounce of common sense would ever take on the responsibility of the upkeep of such a property without having sufficient excess capital to maintain both the property and their own lifestyle. If though, by some one-in-a-million chance this old lady did exist then there would still be many ways for her to pay. She could sell her home, and downsize, by acquiring a smaller and cheaper property. The capital profit could then be used as income. Alternatively she could re-mortgage and use the capital lump sum to fund her lifestyle.

In effect this argument against this Mansion Tax actually reduces to one in favour of the landed gentry being allowed to live beyond their means. Contrast that with the outcry that would emanate from the same right-wing voters if a group of penniless squatters were to take over a property and expect to live in it tax-free.

The plain fact is that this Mansion Tax is both fair and necessary. With the UK's wealth now estimated to be in the region of £6 trillion, and an astonishing 55% or more of that accounted for by unproductive residential property, it is obvious that we need to rebalance our economy. We need a taxation regime that encourages people to invest in productive assets, not unproductive ones, and the Mansion Tax would do just that if its scope were extended to cover buy-to-let investments and other private property portfolios.

To put it simply, the Mansion Tax is the missing link in our tax system that would do far more to reduce inequalities of wealth than the 50% income tax rate or Inheritance Tax will ever do. It will also raise far more revenue than both these taxes combined, and could even replace them. It is also supported by both Polly Toynbee of The Guardian, and Martin Wolf of The Financial Times.

If we are serious about trying making Britain a more equal and less economically divided society, then the issue of wealth inequality in this country needs to be addressed. With the wealthiest 10% of Britons now owning more of this country's assets than the remaining 90% put together, and with that disparity widening further with each passing year despite the efforts of the current government, something needs to change. Up until now government tax policy has focussed obsessively on revenue raised from income and consumption. Yet, as I pointed out in my previous post, by using higher tax bands for income tax as its preferred method of wealth redistribution, this government actually risks damaging the wider economy by reducing the amount of entrepreneurial activity within the economy. Rather than taxing liquid wealth, the government would be better served by taxing accumulated idle wealth, and by far the largest and least-taxed component of that wealth is property.

Moreover, this tax, unlike many others (such as the recently announced disastrous rise in National Insurance or the abolition of the 10% income tax band) has no electoral downside for Labour. It will have no impact on Labour's core vote, and it will be invisible to swing voters in marginal constituencies, as neither group will be targeted by the tax. Nor does it have the negative economic consequences that recent rises in National Insurance and Income Tax could have, particularly in the midst of a deep recession, by reducing consumption and demand within the economy, and thereby endangering jobs and the speed and scale of the recovery. Instead it targets dead money: money that would otherwise either remain idle and unproductive, or would be used to boost speculative asset prices such as property values; i.e. the same asset prices that caused this very recession in the first place. In fact this tax would target the ill-gotten gains of those that made the most money during the last credit boom, and whose earnings and increase in wealth we now know were both in large part undeserved because they were based on fictitious or inflated profits in the financial sector during the economic boom years.

Sunday, 14 February 2010

Why the 50p tax rate is bad politics and bad economics

The issue of tax has long been a thorny issue for the Labour Party, due in large part to the suspicion that it was the one single issue that cost it both the 1987 and 1992 elections. Hence Tony Blair's pledge before 1997 not to raise income tax in the first term of a Labour government. However, last year Alistair Darling did indeed announce an intention to raise income tax for those earning over £150k by introducing a new 50% tax band for those high earners. The intention of the tax seemed clear: to increase wealth redistribution and to make Britain a fairer and more equal society. There is just one problem with this proposal. Any objective analysis of it suggests that it will probably fail miserably to achieve any of its aims. In short, it is a rubbish policy.

This 50% tax targets a miniscule proportion of the population, it is too easy to avoid, and so it will raise virtually no extra money. In fact by encouraging tax avoidance, it may even reduce the overall tax receipts by also decreasing the number of 40% tax payers in the economy. In addition, the level and threshold at which it is set are so arbitrary that the signals it sends out are entirely negative. To put it simply, if the Government can tax at 50% today, then why not 66% or 90% tomorrow? With no logical reason to doubt that the tax rate could go even higher in the near future such a policy completely destroys any confidence in Labour's future tax plans. Instead it raises the spectre of the bad old days of the 1970's and Dennis Healey's pledge to "tax the rich until their pips squeak." It therefore destroys confidence in the Government without even having the positive compensating effect of raising significant amounts of extra money. So, instead of a win-win scenario, we have a lose-lose one. Brilliant!

If the Government was going to raise the tax rate for high earners, it should at least have done so based on some underlying guiding principle. That principle should be one of equality or fairness. The questions then become, how can we justify such a higher rate of income tax for higher earners, and what should it be?

Historically, government expenditure has tended to hover around 40% of GDP, at least in recent decades. In the light of this one could reasonably argue that anyone who is paying less than 40% of their income in tax is clearly not paying their fair share. At first sight that might appear to encompass the majority of the population who only pay income tax at 20%. However, that argument doesn't account for the additional 11% they pay in National Insurance (soon to increase further), Council Tax (which averages out at another 4%) and the VAT and other consumption taxes that they pay on most other basic costs including transport, food and clothing. So in practice a person on an average income (which is currently about £25k) pays significantly more than 40% of their total income in tax, almost all of which is unavoidable.

As the average Briton is clearly being taxed at a rate that is greater than the overall taxation ratio of 40%, it is therefore only fair that those on higher incomes should also be expected to be taxed at an overall tax rate that is commensurate with the ratio of Government expenditure to GDP as well. However, any additional income that the richest 10% of the population earn in excess of the average household income (currently about £45k) is predominantly disposable income. It is income that is above and beyond that which is required to cover most daily living expenses. Therefore, it seems only reasonable that this should be taxed at the same overall ratio as the national average. That seems to me to be the justifiable rationale behind imposing a higher tax rate for the top earners in society, and perhaps why it has been set at 40% for most of the last few decades. However, there is now a problem. The current recession means that the ratio of Government expenditure to GDP is increasing above 40%, while tax receipts are declining. With public sector net borrowing (PSNB) predicted to exceed £175bn this year, and the bond markets getting increasingly nervous about the scale of our national debt, politicians need to come up with credible policies to tackle this problem. However both the solutions advanced so far have a dark side.

On the one hand is the spectre of tax rises, as exemplified by the recent announcement by Alistair Darling to raise National Insurance contributions, for both individuals and employers. This, though is a tax on both jobs and consumption, both of which could slow any economic recovery. On the other hand the Tories are baying for spending cuts. Yet this also risks prolonging the recession by increasing government spending on benefits even more while reducing government procurement and economic consumption. What is needed is a 'third way' that reduces the deficit without taxing jobs and reducing revenues from consumption. That way is to tax surplus wealth, and one such source is the disposable income of higher earners. I would therefore argue that rather than introducing a new 50% tax rate that benefits no-one, the Government should have raised the existing 40% rate.

My reasoning is this. Given that the ratio of Government expenditure to GDP has now increased to nearly 44% for this financial year (2009-10), and is expected to remain at such a level for the foreseeable future, and tax receipts have plummeted to only 33% of GDP due to the recession, gradually raising the upper tax rate from 40% to 44% would have represented a far better policy than the introduction of a new 50% rate. Not only would it have been fairer, it would have been based on a clear and transparent principle that would have reassured the public that such rates were not arbitrary and vindictive. It would have also raised ten times as much in tax as the 50p rate (£10bn versus £1bn). As such it would have made a significant impact on our underlying budget deficit (currently estimated at about £50bn), while having little or no adverse effect on either levels of employment or consumption (due to it being targeted at the disposable income of the affluent that would normally be invested in assets and savings). It would also be far less prone to the problems of tax avoidance as it is highly unlikely to cause a mass exodus of higher rate tax-payers from the country.

So the essence of this tax policy is this. Rather than having a fixed 40% tax band, or introducing a new 50% band, the current 40% band should 'float' with its level set by the current ratio of government spending to GDP. Under the current financial circumstances we find ourselves in that would mean gradually increasing the rate from 40% to about 44%.

There would of course still be great howls of protest from those with salaries in the top decile of the earnings league who would be the most affected by the raising of this tax level. However, these are to a large extent the very people who enjoyed the largest percentage growth in their earnings during the boom years, earnings that we now know (or at least suspect) were, in a large measure, based on fictitious or inflated profits, particularly in the financial sector. In which case, these were, in large part, salary rises that were unearned.

These are also the people who, more than any other sector of society, invested those earnings in the property bubble that caused the boom and the resulting crash in the first place. So, given that many of them were the largest beneficiaries of the credit boom, and partially responsible for it, isn't it fair that they should also be the ones who should contribute most towards restoring the economic stability of the country? Given that they are also the only ones with the spare cash to do so shows that they also have the means to do so. And if they don't like this policy? Well, they can always vote for a party that will promise to slash public spending in order to keep it below 40% of GDP. But then don't most of them do that already?