The TaxPayers' Alliance - Economics 101

London losing its edge

A huge share of Britain's GDP, tax revenues and exports are dependent upon financial services and the continuing ability of London to attract investment in this vital industry.  It is one sector where we are a world leader.  Take a look at the WorldMapper map with countries' sizes adjusted to their share of the international finance and insurance market.  99% of world profits from this huge industry flow to Switzerland, Germany, Luxembourg and the UK - we are the leaders:

This is a highly mobile industry as it operates globally and can communicate effortlessly across the world.  If London ceases to be competitive we could lose our lead in this vital sector really quickly.  If that happens we will struggle to make up for the loss of most of the around £15 billion of tax revenues that London exports to the rest of the country every year rather than spending itself.  That's just tax revenues - our long-term prosperity would also seriously suffer.

With all that in mind the news, from the Financial Times, that our competitive position relative to New York and other financial centres is eroding should be extremely worrying:

"London is losing its status as the world’s leading financial centre and being overtaken by New York, according to a global survey of finance professionals.

The collapse of Northern Rock and the proposed tax crackdown on non-domiciled residents are making the UK less attractive to overseas businesses, according to the City of London Corporation, which commissioned the survey.

A separate survey, also commissioned by the City, said the UK tax system had lost its competitive edge over other financial centres. The UK had become increasingly unpredictable and uncertain, complex and unnecessarily aggressive in its approach to taxpayers, it found."

Hong Kong's tax cuts

Hong Kong is to implement massive tax cuts:

"Hong Kong's financial chief said Wednesday he will cut salary and corporate taxes and abolish duty on beer and wine after a booming economy pushed the city's budget surplus to a record high.  In his maiden budget speech, Financial Secretary John Tsang said he would increase spending on health services and introduce measures to bridge the widening wealth gap and reduce air pollution.

Duty on beer and wine -- currently at 40 percent -- will be cut with immediate effect.

Tsang estimated the budget surplus would reach a record 115.6 billion dollars (14.8 billion US) in the fiscal year to March, four and a half times the government's forecast and nearly twice as much as last year's figure.  The territory's fiscal reserves will reach 484.9 billion dollars, he said.  Tsang attributed the surplus to higher-than-expected tax revenues from the city's booming stock and property markets as well as company profits and salaries."

This combination of swelling reserves and surpluses and hefty tax cuts is possible thanks to the dynamic returns to Hong Kong's already low taxes and the returns of broader economic liberalism.  Over many years the territory has had low taxes and rapid economic growth has left it with an income per person higher than that in Western Europe or Japan.  It places first, year after year, in the Index of Economic Freedom.  For more on Hong Kong's liberal economic order see the first 1980 episode of the late Milton Friedman's classic Free to Choose.  That commitment to low taxes and free-market economics creates growth which brings with it revenues that can fund future tax cuts in an incredible virtuous circle.

Britain, unfortunately, is going in the opposite direction with increased taxes hurting the economic growth that builds prosperity for the future.  That's quite a price to pay for little result in the public services.

Forsyth On Funding Tax Cuts

Where to in a downturn?

When Lord Forsyth's Tax Commission reported 18 months ago, it called for tax cuts amounting to £21bn. Ed Balls and the BBC immediately savaged it: "same old Tories - same old destroying the NHS - same old killing babies and pensioners in the street" etc etc etc (eg see this blog). George Osborne hastily caved in, distancing himself from the Report, and pronouncing:

“We will not be promising reductions in taxation at the election. Any changes in taxes will be revenue-neutral.”

Yesterday Forsyth himself came back with an excellent speech at the IEA. The speech tackles head on the issue of how an incoming Tory government could fund such cuts.

First, he points out that cuts in tax rates do not necessarily mean proportionately smaller tax revenues. You don't have to believe in Voodoo Economics to understand the by now considerable evidence to show that lower tax rates increase GDP (see many previous blogs), which increases the tax base and naturally boosts revenues. There is also considerable evidence that lower rates generate less tax avoidance/evasion.

Forsyth quotes a number of US studies supporting these effects, including the work of surefire future Nobel laureate Prof Martin Feldstein. That concluded a 1 percentage point cut in personal marginal tax rates leads to an increase in taxable income by up to 2%. Which at current UK tax rates, suggests around two-thirds of the revenue foregone by cutting rates would be recouped via a revenue boost. And that's without considering longer term "dynamic" effects in lifting GDP growth.

Second, tax cuts can be funded by containing the growth of public expenditure, and yesterday Forsyth suggested holding real growth to 1.5% pa during the first Parliament. He says:

"Matching Labour’s plans to increase spending by 2.1 per cent a year in real terms for the next three years was a mistake, but one which the Conservative Party is unlikely to have to implement as the Prime Minister will almost certainly go to the wire before calling a General Election. Far more important is whether any subsequent pledges to match the Government’s spending plans are made – if they are, they tie the Party into spending promises that could mean higher taxes or higher borrowing in a downturn."

We have long favoured the adoption of a third fiscal rule to contain the size of government (see eg here), so we wholeheartedly support Forsyth's call for an explicit upfront commitment. As he points out, 1.5% pa spending growth over a Parliament would almost certainly be enough to finance the whole of his proposed £21bn of tax cuts. And without destroying the NHS.

Finally, he takes a good whack at the slippery Mr Balls:

"Ed Balls is quite simply wrong – the price of not reforming our tax system is too great. Britain’s economy cannot continue to perform under the increasing burden of a higher, more complex, more uncertain and more unfair tax system. Political will and courage are now needed to grasp the nettle of reform."

PS ConservativeHome's spending campaign is getting more and more traction. Well done Tim and Sam- keep it up.

Lord Forsyth calls for lower spending growth

In an excellent speech yesterday at the IEA's State of the Economy conference Lord Forsyth, chairman of the Tax Reform Commission, used his speech (PDF, via ConservativeHome) to set out just how much could be achieved if spending growth was controlled: the ruinous economic effects of high taxes that we could avoid, the money we could return to the pockets of hard pressed taxpayers.  If spending growth was controlled at 1.5 per cent per annum we could afford the measures outlined in the Tax Reform Commission report; taking 2.5 million low paid people out of the tax system, a reduction in the basic rate of income tax to 20 per cent, a transferable tax allowance for couples with children, abolition of stamp duty on UK shares and the ending of inheritance tax (as part of a reform creating a short-term capital gains tax).

We have to hope that the major parties are listening and Lord Forsyth's excellent advice will be heeded.

More on the Laffer Curve from Dan Mitchell

Dan Mitchell, from the Centre for Freedom and Prosperity at the Cato Institute, provides evidence for the importance of dynamic effects on tax returns.

Northern Rock - the most expensive job creation scheme in history

Northern Rock's assets should be run down gradually, maximising value to taxpayers and minimising the scale of the potential loss. That much is clear. In this scenario, jobs at Northern Rock will have to be shed.

The Government has instead decided to try to keep Northern Rock going as a profitable business - never mind that it is a company with a busted brand, that would indeed be bust were it not for the £110 billion taxpayer guarantee.

There are 6,000 jobs at Northern Rock. The taxpayer liability per job is therefore a staggering £18.3 million. Should we really be risking so much for so few?

George Osborne wrong on historical public spending rises

In his speech to Policy Exchange on Friday, George Osborne said:

We can either: stick with our long term course; stick with the commitment I made to spending growth of 2.1% for the coming three years; review the final year when we know the state of the public finances; and understand that in an economic slowdown this will mean tight spending plans and difficult decisions about government priorities.

Or we can head off onto the margins of the political debate and reduce spending growth even further for the sake of a short term argument.

Never mind that it would probably be unachievable in a slowdown, when tax revenues fall and welfare spending rises. Never mind that it would be lower than anything Margaret Thatcher achieved during the economic turbulence she faced in her first parliament. At least, we are told, it will give us 'a dividing line'.

Here is the historical list of real terms public spending rises since 1970:

In bold are all the years when public spending growth was lower than 2.1 per cent in real terms. Note that public spending growth was lower than 2.1 per cent in every year of Thatcher's second parliament. In the first two years of her first parliament, spending growth was lower than 2.1 per cent, although the average in her first parliament was 2.3 per cent. Over the 18 years of Tory government, the average was 1.5 per cent. Note also that in the first three years of Brown as Chancellor, spending growth was lower than 2.1 per cent.

Now, is it really correct to say that 2.1 per cent per annum spending growth is tighter than under Thatcher?

Cllr J P Floru: PUT FAT GOVERNMENT ON A DIET TO MAKE THE CAKE GROW

The British economic downturn did not start with the fallout of the credit crunch.  The foundation was laid in 1997, when Labour took power and started to carry out its ambitious programme.

The economic growth between 1992 and 1995 was very high. Since 1997 economic growth has never again reached the peaks of growth under Thatcher and Major and growth has declined steadily.

The size of government has risen to a staggering 44.7 % of GDP according to the latest economic figures. In 1997 it was 39 %. There is a direct link between the size of government and economic growth: the smaller the former, the larger the latter.

Gordon Brown’s public spending spree largely benefited the public-sector payroll, with poor productivity outcome.  NHS spending has almost tripled since 1997: from £32 to £92 billion.

To pay for it all, taxes continue to rise.  The tax take is the biggest in ten years.  Even that wasn’t enough, hence the steep rise in public borrowing,

Add to this a flood of new largely EU regulations (gold-plated by the Labour government), and we have a logical explanation of why the UK’s growth is slowing down.  Agreed, there is an international rise of prices for food, raw materials and fuel – but that is equal for all countries.  The reason why the UK is doing worse is its own government.  It is interesting to note that many non-doms who are fleeing the UK say that the new non-doms levy is “just the last straw”.

In this time of economic downturn we need tax cuts to make the pie grow again.  A substantial cut in corporation tax would do the trick.  This was, of course, what caused the steep rise in GDP growth in Ireland (wrongly described as The Irish “miracle” – there is nothing particularly miraculous about the link between tax cuts and economic growth).  There is no reason why the UK could not become the fastest growing economy in the world if it really wanted to.

Whereas in the medium term the Laffer effect would ensure a larger tax take as a result of GDP growth, in the short term the tax cuts could only be afforded by cuts in public spending.  The Conservative Party is far too timid on the subject.  A comment by Philip Hammond MP [against] a cut in public spending at a time of an economic downturn was profoundly unhelpful.  A pound spent in the public sector delivers a much smaller return than a pound spent in the private sector (kept in private hands as a result of tax cuts).  I cannot believe that 62 years after John Maynard Keynes’ death anyone still believes that public spending is needed to make the economy grow.

We like to blame Europe (I do),  but abandoning traditional Anglo-Saxon small government for continental big government was largely a choice made by Blair and Brown – not an imposition from Brussels.

Cllr JP Floru
Director of Freedom Alliance

Sources

2008 Index of Economic Freedom
The size and Functions of Government and Economic Growth, by James Gwartney, Robert Lawson and Randall Holcombe, Joint Economic Committee Study, April 1998.
Tories’ economic legacy has been squandered, by ruth Lea, The Daily Telegraph, 17 September 2007.
Tory row over tax and spending grows, by Jean Eaglesham, Financial Times, 5 February 2008
Barmy arguments from Philip Hammond on spending, by Corin Taylor, Taxpayers’ Alliance Website, 5 February 2008.
Tax ‘n’ spend: No way to run an economy, by  Ruth Lea, CPS,  2004.

Straight talking please Mr Osborne

Sometimes it's a wonder anyone bothers to vote these days. Why can't politicians stand up for what they believe in, and give it to us straight?

A classic example of this is today's FT report on George Osborne's speech later today on the principles of tax reform. Mr Osborne has said repeatedly (and rightly) that the Government's tax rises have been damaging to the economy. So why won't he come out and say that he will reduce them? Given that he won't, are we to believe that he is actually happy with the Government's tax rises? You'd be forgiven for being confused.

As the FT reports:

Mr Osborne will promise a “fundamental rethink” of the tax system to ensure a longer-term approach to fiscal changes that addresses the effects of taxes on issues such as climate change.

So what does "fundamental rethink" actually mean? Sounds like higher green taxes, lower taxes elsewhere, but no cut in the overall tax burden, when a cut in the overall burden of tax is the very think that Britain's economy needs. Some fundamental rethink!

Politicians who are afraid to address the high-tax, high-spending consensus should remember our YouGov poll last August, which found that 64 per cent think that the government spends too much and therefore taxes too much.

That all said, there are some welcome moves that Mr Osborne will announced today. Chief among them will be an Office of Tax Simplification, proposed by the Tax Reform Commission and designed to do to complex tax law what the National Audit Office is doing to government departments. The Tories would also require the Treasury to publish technical changes to the tax system in the autumn and set up a new parliamentary committee to scrutinise those changes. Hopefully this will insure no more CGT and non-dom chaos.

Tougher pensions reporting standards for companies - but what about the public sector?

Today's FT reports:

UK companies face having to add billions of pounds to their pensions liabilities under plans to be unveiled by the regulator to force them to use more realistic projections of how long workers will live after they retire.

The standard the Pensions Regulator is to propose next week is tougher than that used by 99.5 per cent of UK schemes and will increase stated liabilities for companies by 6 to 8 per cent, even for those already adopting the most prudent standard now in use. For roughly a third of all schemes, the increase in disclosed liabilities will be as much as 15 to 20 per cent and could force them to set aside more cash to fill shortfalls.

The regulator has the power to order weak companies to increase contributions to their final salary scheme. It also has the power to intervene on behalf of trustees if the regulator feels that companies are not putting in enough money to close gaps in their pension schemes.

There is nothing inherently wrong with this. Accurate reporting is, like the rule of law, essential to a well-functioning capitalist economy. But what about the public sector pension schemes? Unfunded public sector pension liabilities are anything from £530 billion (Treasury) to over £1 trillion (Neil Record's authoritative report for the IEA). They should be placed on the balance sheet immediately.

A thousand little Laffer Curves

Peter Franklin argues against the dynamic case for tax cuts, suggesting that if there is a Laffer Curve we are on the wrong side of it to get increased revenue when we cut taxes.

What needs to be remembered about the Laffer Curve is that it is an abstraction of a much more complex relationship between taxes and revenues.  It captures an essential truth that tax rises will not always increase revenue, and tax cuts will not always lead to a decrease.  However, it necessarily omits two crucial factors: time and the specific tax that is to be cut or raised.

Economic gains from tax cuts will often be felt over the medium to long term.  The European Central Bank studied the effects of growth in the state and found that a growth of 1 per cent in the size of the state led to a 0.13 per cent fall in economic growth.  Other studies have found effects at a similar order of magnitude.  That fall in economic growth won't mean a lot in the first year but over time becomes very significant.  Brown's spending splurge since 2000 may have left Britain's GDP almost £14 billion lower.

Different taxes will have different effects on the economy.  There is an ongoing debate over the kind of tax cuts most conducive to higher growth.  However, the conventional view is that the effects on growth will be at their largest when they affect incentives to work and invest in the United Kingdom.  Alistair Darling is retreating from taxing non-domiciles because it was expected that tax rise wouldn't increase revenue - even immediately.  A dynamic model (PDF) produced for the TaxPayers' Alliance by the Centre for Economics and Business Research suggested that pre-announced, phased cuts in corporation tax to the Irish level over 14 years would boost investment by 60 per cent and GDP by 9 per cent - and pay for itself within eight years.

The evidence that tax cuts and controlling spending will have a very positive effect on growth is quite well established.  Gains from increased growth quite quickly weaken and then overwhelm the effects on revenue of a tax cut.  Combine that with an easing of the burden on hard pressed taxpayers and the case for restraining growth in spending in order to cut taxes and unleash the dynamic potential of a low tax economy is incredibly strong.

Scrap fuel duty rises and Ken's attack on big cars

The Times reports that the accountancy firm Grant Thornton and a host of other organisations such as the AA, Chambers of Commerce and Freight Transport Association have called for a planned rise in fuel duty in the Budget to be scrapped.  We couldn't agree more.

Our report The case against further green taxes (PDF) set out, in chapter two, the case against ludicrously high fuel duty rates.

We set out how motoring taxes - charged on top of VAT - are set at between 40.9 and 3.6 times the global social cost of carbon dioxide emissions.  Each motorist is therefore paying between £548 and £743 per year beyond the cost of their emissions.

The only way that the fuel duty is justified is by focussing on all manner of other externalities, from noise to accidents to congestion.  Imagine if factories were taxed for noise they produced, if charity parachute jumps were taxed for the cost parachuting accidents imposes on the NHS, if we taxed first time buyers in order to reduce excess demand for homes instead of trying to ensure there is a greater supply (congestion is just an excess of demand for road space).  The proper response to small-scale, localised externalities is to regulate against dangerous or excessive levels; the proper response to congestion is to build more roads.

The reality is that when politicians push for increased fuel duty they are doing so not in order to save the planet but in order to squeeze more money out of hard working taxpayers.  Ken's proposed increase in the Congestion Charge rate for 4x4s and other big cars is exactly the same.  The only difference is that the Congestion Charges wastes almost all of the money it raises:

"Conservative councillor Phil Taylor challenge's TfL's assertion that congestion charging is generating substantial surpluses. He says: "TfL's own statement of accounts show that the cumulative surplus generated from the start of the scheme until the end of the last financial year was only £189.7 million.

"This amount has barely covered the original scheme's set up costs of £161.7 million.  Pretty much all of the £677.4 million collected in the first three and a bit years of operation of the scheme has been spent on out of control set up and running costs."

The additional charge for big cars is just Ken Livingstone playing class warrior.  Making very productive people who contribute a huge amount to the capital's economy feel unwelcome.

Fuel Duty increases and increased congestion charging both unfairly single out motorists who already pay VAT on petrol and when buying new cars.  They also impose a burden on the rest of the economy by making road haulage - the main way in which goods are moved around the country - more expensive.

If politicians accepted how weak the case for further green taxes is and stopped or reversed increases in fuel duty then they could reap the rewards electorally.  Look at this graph, from our report on green taxes:

 

Those consuming the most petrol, and hence, paying the most fuel duty are middle class commuters.  An electoral constituency well worth appealing to.  Our polling has shown that most people are pretty cynical about green taxes and think they are just a revenue raising measure.  63 per cent agreed with the statement: “Politicians are not serious about the environment and are using the issue as an excuse to raise more revenue from green taxes.”  Bashing cars won't improve a politician's image.

Increasing fuel duty is both a bad idea and makes no political sense.  Alistair Darling should give motorists a break.

Re-think on non-doms

Today's Times reports that Alistair Darling may re-think his plans to tax non-doms:

The Treasury is understood to be looking at possible concessions after a wave of protests raised fears of an exodus of wealth-creating foreigners from the City.

Officials were examining the detail of the proposals and looking at ways of “making clarifications”.

The Times understands they are considering introducing provisions to assure non-doms that the Treasury’s aim was not to pry into their world-wide tax affairs, but only to tax the earnings they bring to Britain.

If so, this climbdown is a sensible move. But what a way to make tax law. And how much damage will have been caused to the Government's relationship with overseas wealth creators, who will surely now regard Britain with more distrust than ever before? 

Non-dom tax plans will lose money

Well, who on Earth didn't see this coming?

"The Treasury is expecting to raise an extra £800 million a year by 2010 from a £30,000 annual tax on wealthy non-doms, as part of an effort to cut public sector borrowing.

But the study warned that the non-dom plan will cost the Government £2.1 billion in lost tax receipts due to "capital flight", in which wealthy individuals leave the UK and take their money with them. Even the Treasury has admitted that 3,000 of the wealthiest non-doms could leave the UK as a result of the tax plans.

According to tax experts at the Society of Trust and Estate Practitioners, non-doms pay £7.16 billion in tax annually. The society has calculated that the departure of the richest would cost Mr Darling more than £2.1 billion."

If you place a new tax on a group with the financial means to live anywhere they choose, who often work in industries that are used to communicating globally, they'll move.  Their companies will relocate so that they don't have to pay more to attract the best staff.  This will put a dent in tax revenues that can easily outweigh the revenue gains from higher rates.  The effect will be exacerbated if you explicitly threaten further tax rises - as the Government did (PDF, Para 5.81).

The Government will pay a price for their shallow populism bashing non-doms.  They'll find it harder than expected to balance the books.  The price British, domiciled, taxpayers are asked to pay will be far higher if London's position as a financial centre is imperiled.

"Elegant retreat" very welcome

Today's Telegraph gives a very welcome report that the Conservatives may not match Labour's spending plans beyond 2010-11:

David Cameron is prepared to drop his pledge to match Labour's spending increases after the next election to pave the way for tax cuts under a Conservative government, The Daily Telegraph can disclose.

The Tory leader, under mounting internal pressure to stretch his party's lead over Labour, has conceded that it could be impossible to deliver tax cuts if he sticks to Gordon Brown's commitments.

An "elegant retreat" has been discussed at the highest level of the party after intense pressure from MPs and grassroot supporters for more eye-catching policy initiatives, particularly on tax...

The latest evidence from a batch of recent polls shows that the Conservatives' lead has halved from nine points to four.

The party needs a double-figure advantage to have any chance of a majority at the next election.

Thatcherite Tory MPs blame the slip on Mr Cameron's failure to build on the popularity of last October's announcements to raise the threshold on inheritance tax to £1 million and scrap stamp duty for first-time buyers...

...they agreed in 2006 to match Labour's massive increases in spending until 2010-11.

Now, however, with the economy in the doldrums, the Tory leadership realises that if it renews the pledge beyond that time, into a period when they could be back in power, it would wreck any prospect of tax cuts.

Quite right. Matching Labour's spending plans was always economic lunacy. Taxpayers will be hoping that at least one party will be able to offer relief from the record tax burden at the next election. As our YouGov poll of 2,000 adults found in August last year, 64 per cent believe that "the government spends too much and therefore taxes too much". The votes are there to be won.   

Predictable effect of tax rises on non-doms

From today's FT:

Digby Jones, the trade and investment minister, has warned that plans for a tax crackdown on non-domiciled foreigners living in the UK threaten London’s role as a world finance centre...

Lord Jones said the tax changes made it harder for him to sell Britain as a destination for skilled foreign workers and inward investment.

The minister, who said he was not consulted on the change, added: “I can give you five reasons as to why you should invest in Britain before you go and invest anywhere else in Europe. But maybe there were seven and now there are five.”...

Lord Jones had been frequently asked about the tax changes on trips to India and the Gulf. He feared they had reduced the attractions of Britain as a destination for skilled people.

“It has caused people to say ‘Does this mean you don’t want us?’,” he said, adding that there was a danger such changes meant the UK would lose its “badge as the place to come and bring your skill and work hard in the developed world“.

“I don’t want to be in the position where one morning we wake up and people are saying ‘Digby: no matter how good you are at doing what you do, the product isn’t as good as it was’.”

What do you expect if you raise taxes on the most internationally mobile group of people? It is legitimate to worry about the rich executive paying a lower rate of tax than the cleaner, but the answer is not to raise taxes on the executive, but cut them for the cleaner. It's a shame that the main politicial parties are so addicted to spending that they will choose the economically damaging course of action.

Photo by Flickr User .Martin. used under a Creative Commons License.

Barmy arguments from Philip Hammond on spending

From today's FT:

Mr Hammond argued on Monday night it made no economic sense to advocate cutting public spending when the economic cycle was in a downturn. “At any time, the proposal that we should cut back the growth in public spending more harshly than Margaret Thatcher did is pretty odd.” He said that if the idea was “an extraordinary one last summer, it’s quite a barmy one now ... It’s not a sensible approach at this point in the cycle”.

Mr Hammond's assertions are wrong on so many counts that it's hard to know where to start!

1. It's not clear that in a small open economy with high capital mobility (like the UK), fiscal policy has much impact on demand. Monetary policy is far more effective. Note that the US, which is currently preparing a fiscal stimulus package, is a less open economy than the UK, and that therefore fiscal policy will have more impact across the Atlantic. That said, if you believe in Ricardian Equivalence, then borrowing to stimulate the economy will fail - in this scenario the best thing is to restrain spending and enact supply-side tax cuts (in the long run surely the right thing to do).

2. If you do accept that fiscal policy can play a role in supporting an economic recovery in the UK, at least in the short-term, which Mr Hammond's statement imples, then the relevant question is the fiscal stance as a whole. Assuming the economy grows at 2 per cent, then freezing public spending and cutting taxes by 2 per cent would create the same fiscal position as growing spending at 2 per cent and leaving taxes at their current level. It would therefore be entirely plausible to cut public spending in a downturn, provided that taxes were also reduced.

3. In terms of their effects on the economy, public spending and taxes are very different. The public sector is far less productive than the private sector, so a pound spent in the public sector will have less economic benefit than a pound of tax cuts - a very simple rule to remember and backed up by mountains of evidence showing that higher public spending and higher taxes have a negative impact on economic growth. While far from perfect, the US fiscal plan does at least stimulate the economy by providing tax rebate cheques rather than extra spending on government programmes. The lesson is therefore that if you want to pursue counter-cyclical fiscal policy, then cut taxes rather than increase spending. In the long run, that will benefit the economy far more, and given the dynamic effects of tax reductions, you won't be borrowing quite as much as you thought anyway.

4. Even under Mr Hammond's own logic - that we can't cut spending growth faster than Mrs Thatcher because we're in a downturn - his case against cutting spending growth is weak. Mrs Thatcher came in during a downturn much more severe than the one at the moment, and therefore even under Mr Hammond's logic, had less room to cut spending than today.

The great danger for the future is that if the Conservatives stick to their plans to increase spending by 2 per cent per annum, and if the economy grows more slowly (as looks likely), taxes or borrowing will have to increase. Raising taxes in a downturn is the worst possible thing to do, while accepting increased borrowing makes the pain of fiscal adjustment worse in the future. In addition, the state would be consuming a higher proportion of GDP - another negative consequence of failing to restrain spending.

If the Tories are serious about forming the next government, they have to offer voters an alternative to the failed high spending, high tax consensus of the Labour years. Criticising calls for spending restraint as "barmy" implies that Tory policy will be no different to Labour policy, and that tax reductions will not be forthcoming. It also reveals a massive contradiction in the Tory stance. The Shadow Treasury team has rightly criticised rising taxes under Gordon Brown and rightly pointed out their economic costs. So will the Tories cut taxes then?! It seems as though the answer is "no".

Jeremy Leggett attempts to bend the logic of peak oil to secure more subsidies for renewables

The Guardian are still allowing Jeremy Leggett space to lobby on behalf of his industry - those renewable companies making big profits on the back of the Renewables Obligation that pushes up energy prices.  His new article is about peak oil.

First, he accuses oil firms of profiteering because Shell and ExxonMobil are making big profits.  That's a bit rich coming from a renewables executive (see link above) and only part of the picture.  Not all big oil companies are enjoying soaring profits.  Just today British Petroleum announced dissapointing figures.  That means all the rest of Leggett's rhetoric about oil firms pocketing the cash rather than investing in new exploration is a little empirically weak.

From then on he starts arguing that peak oil is going to ruin us and lambasting complacent economists:

"Economists tend not to see the problem. As the oil price goes up, they assume more cash will be available for exploration, the oil majors will duly explore, and they will find more oil."

It is reasonable to assume that oil exploration spending will increase with a higher oil price - and that does appear to have happened.  In just one year, from 2004 to 2005, oil exploration budgets increased by 31 per cent.  Leggett argues this kind of statistic is misleading:

"Moreover, the International Energy Agency has described recent apparent increases in exploration spend as "illusory" because of inflation in costs in the far-flung places where the industry is now forced to look for new oil."

So they are spending more money looking for oil.  It's just that those colossal amounts of money are being spent to find oil in increasingly remote and challenging places to drill, where oil production hasn't been nationalised - most of the world's productive oil fields are off limits.

Of course, oil won't magically appear from the ground when the majors increase investment.  While there is still a lot of oil there - rising prices are still dependent upon OPEC holding down supply - it will be increasingly difficult to meet rising demand. While that contradicts the straw man assumption set up by Leggett - that economists think oil production will always rise to meet demand - it doesn't really create the need for panic he seeks to establish. The economy is filled with rational actors who don't want to pay higher energy bills who have plenty of other ways to respond to rising fuel prices.

If incentives to discover more oil - high oil prices - don't create an increased supply then resulting high energy prices will create other incentives.  Incentives to use energy more efficiently; to seek out new economical sources of power; to shift towards other existing sources of power such as nuclear.  All this will be done without subsidy.  That means there isn't a need for new taxes and Government attempting to pick winners.  Shortages in a particular resources encourage innovation, economy and substitution.  That is why economists do not expect high oil prices to create a long term crisis, although there may well be costs in the short term.

Those short term costs will be larger if the rise in energy prices is faster and smaller if it is slower.  It is more costly to adapt to rising prices more quickly.  What that implies is that the correct policy response to peak oil would actually be to do everything we can to slow rises in energy prices - and give the economy longer to adapt - that would imply dumping measures like the Renewables Obligation.  That way we could replace subsidies now with a more gradual rise in energy prices.  That would allow time for market incentives to encourage investment in alternative sources of energy that aren't subsidy junkies like wind farms.

Not quite the policy conclusion Leggett had in mind?

Photo by Flickr User neilharmer used under a Creative Commons License.

The human cost of wind power vanity projects

Today the Financial Times reports on the poor performance of the Renewables Obligation in encouraging wind farms: "The amount of new wind capacity added in 2007 was less than three-quarters of that built the year before."  This is despite subsidies that make wind farms massively profitable:

"Under the current regime, and thanks in part to high power prices, wind turbines can pay for themselves within about five years, out of a working life of at least 20 years.

In its energy white paper last year the government described the RO as the “primary mechanism” for meeting its goals of reducing fossil fuel dependency. However, Andrew Wright, managing director of markets at Ofgem, the electricity regulator, told the Financial Times: “The RO is a very expensive way of providing support for renewables.”

Peter Atherton, head utilities analyst at Citi Investment Research, said: “It’s a bonanza. Anyone who can get their nose in the trough is trying to."

The problem is that wind farms are getting stuck in the planning system.  Now, it is important at this stage to note that they aren't just facing the same "not in my back yard" opposition that many industrial developments do.

Part of the problem with windpower is that each turbine has a very low capacity and, as such, you need massive numbers of them - covering a huge amount of land - to get the kind of power you would get from a small number of conventional or nuclear power plants.

As such, wind farms are poor value in two ways:  They are poor value for money as you need to provide a lot of subsidy to produce a relatively small amount of capacity.  However, they are also poor value for environmental disruption as you need to ruin a lot of landscapes in order to produce a relatively small amount of capacity.  The Government have offered a massive subsidy that has meant it is unnecessary for wind power to offer good value for money.  However, they have not found a way of absolving wind farms of the need to provide good value for their geographical footprint - because of that large footprint the planning system is proving particularly difficult to traverse for wind power.

It would be bad enough if the Renewables Obligation, the largest source of subsidy to wind power, were merely expensive - a waste of every taxpayers' money.  However, as it functions by obligating energy companies to obtain a certain share of the energy they provide from renewable sources - thereby increasing the cost of electricity - it has particularly pernicious social consequences.  The poor spend a significantly larger proportion of their income on electricity than the rich (graph from the TaxPayers' Alliance report The Case Against Further Green Taxes):

The poor could, in theory, be compensated for the additional bill created by the Renewables Obligation with some sort of additional benefit - an increase in the Winter Fuel Allowance, for example.  However, benefits are a poor subsitute for keeping your money in the first place.  When a Government policy creates an uncertain burden - it is hard to know exactly what the Renewables Obligation will cost people, how much it will raise utility bills - compensation will often be insufficient, slow to arrive and otherwise poorly targetted.

In this particular case the burden of regulation is likely to be not just unwelcome but actually lethal.  In 2006-07 there were 23,900 excess deaths in the winter (PDF).  These are predominantly the elderly suffering in the cold and making it more expensive for them to keep warm seems almost certain to increase the number of deaths.  Poor pensioners - forced to try and cut corners by, among other things, higher council tax bills - should not be forced to choose between a more pressing struggle to make ends meet and the dreadful risks of living in a cold home.

An additional financial burden upon the poorest and deaths among the elderly are a high price to pay for a failing attempt to encourage slight increases in the amount of renewable power we use.

Photo by Flickr User wdrwilson used under a Creative Commons License.

The Laffer Curve explained

A new video from the CATO Institute in Washington gives an excellent explanation of the Laffer Curve, which showed that, in certain circumstances, cuts in tax rates could increase tax revenue. You can watch the video here.

Tories are wrong to match government spending plans

ConservativeHome's ongoing campaign to persuade the Conservative Party to abandon promises to match the Government's spending plans should be applauded. The Sun today has it absolutely right on the Tory position:

"TORIES blame Gordon Brown for digging a £9bn “black hole” in public finances.

Every family in Britain will have to stump up £360 a year to plug the gap, they say.

But hang on, aren’t these the same Tories who rashly vowed to match Labour spending for six more years?

Presumably that means raising taxes too, just as they say Labour must. Where else can they find £9bn?

If the Tories intend to fight the next election on a tax and spend agenda, they really have lost the plot."

With the three main politicial parties promising to tax and spend the same amount overall, taxpayers are currently being asked to choose between different revenue-neutral packages. This is not good enough.