Lib-Dem socialism is poisoning the coalition’s agenda

February 23, 2013

Those of us who hope the Liberal Democrats will reject socialism and embrace true liberalism have many reasons to be disappointed by this year’s party conference. Nick Clegg, for example, returned to his soak-the-rich “fairness” agenda with an attack on “tax avoidance”. He claimed avoidance costs the economy £42 billion a year and is “ethically wrong”. Indeed, it was implied that it was morally equivalent to benefit fraud. In a similar vein, Danny Alexander, Chief Secretary to the Treasury, talked of giving HM Revenue and Customs even more draconian powers – hardly a liberal approach to taxation.

It would appear that the Lib Dems’ moral compass is skewed by strong egalitarian beliefs, which are incompatible with both traditional conservatism and free markets. This would explain the notion that trying to protect private property from appropriation by the government is equivalent to stealing from other people. It would also explain the Lib Dems’ strong advocacy of redistribution, environmentalism and supranationalism  – key tenets of modern socialism.  

The egalitarian element within the coalition (which includes some Conservatives) is likely to hamper attempts at radical economic reform. The big reductions in benefit rates necessary to tackle welfare dependency are likely to be off limits; wealth-generating tax cuts for high earners will be out of the question; and businesses will be severely damaged by yet more environmental taxes and controls.

At least the scale of the budget deficit effectively prevents the egalitarians from pursuing more activist policies in pursuit of “fairness”. Nevertheless, the Lib Dems and their ideological allies from the left of the Conservative Party are likely to ensure that the details of the deficit reduction programme are determined primarily by misguided notions of equality rather than long-term considerations of economic efficiency.

21 September 2010, IEA Blog

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Fairness in benefits could save billions

February 23, 2013

A single claimant of Jobseeker’s Allowance or Income Support aged 18-24 receives £51.85 a week. This goes up to £65.45 for those aged 25 and over.

Tax credit and child benefit payments for a first child are significantly higher at £75 per week, while subsequent children will earn claimant households an additional £58 per week.

It would seem to be unfair that child-related benefits are paid at a higher rate than those for young adults. In particular, young adults may have to spend around a third of their income on utility bills, whereas families will enjoy the economies of scale resulting from shared living space, meals and transport etc. Moreover, it is inconsistent that the benefits system recognises economies of scale within families (hence the first child premiums) but not in its treatment of families vis-a-vis single households.

A fairer system would standardise first child payments at the young adults’ rate of £51.85 per week, with lower payments for additional children. This could be achieved in practice by halving the child element of child tax credits. The measure would have the additional advantages of improving work incentives and cutting billions from the annual £24 billion tax credits bill.

26 July 2010, IEA Blog

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Time to pull the plug on Eurostar?

February 23, 2013

The dismal economic returns on the Channel Tunnel Rail Link are a stark warning to supporters of a high-speed line to Scotland and the North of England.

The total cost of the link, now renamed “High Speed One” (HS1), is close to £10 billion in today’s money, when all the hidden subsidies and extras are included. And this figure does not include the substantial “deadweight” losses from the additional taxation required to fund the line. A commercial business would expect to make an annual return well above £500 million on such an investment, particularly since railways typically need to be substantially rebuilt after 30 or 40 years.

In this context, the return on HS1 is pitiful. Last year, the “investment recovery charge” levied on Eurostar was reduced by more than half to about £2,200 for each train service using the route. By my calculation, this adds up at most to about £40 million a year – a return of less than half of one per cent on the government’s original investment.

But even this return is questionable. Eurostar has made large losses during its sixteen year history and it remains to be seen whether the hidden subsidy of cut-price access charges will enable it to make sustained profits in the medium term. In other words, not just the infrastructure but the service itself has been heavily subsidised by taxpayers, meaning the overall economic return on HS1 has almost certainly been negative – even before inflation is taken into account. The local “Javelin” services to North Kent now using the line are also subsidised.

Of course, advocates of high speed lines may point to “wider benefits” such as regeneration. Indeed, the expensive re-routing of the Channel Tunnel link through East London was supposed to boost the area’s economy (as well as to facilitate currently non-existent through trains to the North of England). However, state-funded regeneration tends to be a negative sum game. Resources are inefficiently transferred from some areas to others, while social problems are displaced rather than reduced. Moreover, if nebulous “wider benefits” arguments were used consistently as a rationale for taxpayer support, just about every business activity would be entitled to subsidies and almost the entire economy would become socialised.

After sixteen years of support, the government should stop subsidising train services to the continent. Taxpayers could receive at least some compensation if the high-speed line were sold off to the highest bidder with the proceeds used for tax cuts and (unlike in current proposals for its “privatisation”) no restrictions imposed on how the route is used. Perhaps an unsubsidised international service could just about cover maintenance costs, with the sunk capital effectively written off. But far better returns could almost certainly be achieved by shutting down the line and disposing of the assets – which include substantial plots of land, tunnels under London and the Thames, and large amounts of scrap metal.

22 July 2010, IEA Blog

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Making the country work again

February 23, 2013

Even Margaret Thatcher didn’t manage to dismantle Britain’s disastrous welfare system. Judging by the policy plans of the Lib-Con coalition, there is little reason to be optimistic that today’s leaders will be any more successful.The timid proposals on welfare are little more than an expansion of existing failed programmes.

It is unsurprising that welfare reform has presented such a problem for successive governments. The six million working-age adults who now receive out-of-work benefits – plus millions more over 60s receiving generous pension credits – comprise a large voting bloc. Labour would have risked losing its core support had it attacked benefit dependency.

Within the new administration, the rebranded, centrist Conservative Party will be wary of implementing policies perceived (wrongly) as an attack on the poor, while any major changes could face strong opposition from the Liberal Democrats’ hard-socialist left.

Nevertheless, the dire state of the public finances means the new government will have little choice but to make substantial cuts in welfare expenditure. Benefit payments now account for almost one in three pounds the government spends. Balancing the budget will be next to impossible unless welfare plays a proportionate role in the programme of cuts. In reality, the new adminstration may be forced to implement radical reform.

This represents a huge opportunity – not just to save money, but also to address many of the social problems associated with welfare dependency. Life on benefits not only encourages crime and anti-social behaviour; a growing body of research suggests that long-term claimants are more likely to suffer from poor physical health, low self-confidence, anxiety and depression. Studies have also linked worklessness to lower life expectancy. While one should be cautious about such findings, a convincing case can certainly be made that the benefits of employment are not just financial.

The negative effects of welfare dependency are amplified by its concentration in certain areas and among particular groups. On many social housing estates the majority of residents are reliant on benefits. Any sense of shame for relying on handouts has long since disappeared, replaced by an aggressive sense of entitlement. Worse still, the behavioural norms needed to hold down a job – honesty, reliability, good manners and so on – have been undermined. This catastrophic decline in standards will take generations to reverse. Eliminating the poisonous impact of the benefits system is, however, a necessary first step.

The key to reducing welfare dependency is removing the ‘poverty trap’. The current system means that for many claimants it is simply not worth doing low-paid work – at least not in the ‘formal sector’. Once additional work-related costs such as clothing, train tickets or petrol are factored in, someone working full time on the minimum wage will typically be just a few pounds a week better off. Because benefits are withdrawn as income increases, the effective pay rate can be less than £1 an hour.

Working may also mean losing the other perks given to those on welfare, including priority access to low-rent social housing. As a result of massive government subsidies, social properties are generally of superior quality to privately rented homes. Indeed, a high proportion have recently been refurbished with new kitchens, bathrooms and heating under the multi-billion-pound ‘Decent Homes Initiative’. It is almost as if claimants are being rewarded for their dependence on the state.

This approach has to change. Benefits, tax credits and other subsidies have produced close to a communist distribution for families earning less than the median wage. Yet welfare dependency will only be reduced when there is a big gap in living standards between those who work and those who do not.

A series of specific policy measures would push the system in the right direction. Child tax credits, for example, should be paid at a much lower rate to workless households to better reflect the additional costs of working. More can also be done to reduce the income tax burden on low-paid employees – the new government’s plan to increase personal allowances is a good start, though it would be far more effective if it were funded by benefit cuts rather than higher taxes on investment.

The poverty trap is a particular problem for those stuck on incapacity benefits. The incentives to move on to them are too strong and there are powerful reasons for claimants to hang on to these entitlements. But incapacity is a privately insurable risk. The government should not provide special benefits for those no longer able to work as a result of chronic health problems.

Perhaps most importantly, the perverse incentives associated with housing policy must be addressed. Social housing should be very basic – a last resort for the genuinely homeless rather than an aspiration for people trying to get accommodation on the cheap. This means paring down the £7 billion-a-year public housing subsidies and also reforming the £20 billion-a-year Housing Benefit system.

The latter is absolutely essential if work incentives are to be increased. Withdrawn at 65p for every pound earned, Housing Benefit is often the major reason why it is not worth working. Part of the solution is to ensure that a significant proportion of rent is paid from basic benefits such as Jobseeker’s Allowance and Income Support. In this way, tenants are encouraged to find low-cost accommodation and the negative impact of the subsidies is reduced. Moreover, the barmy rules that allow claimants to live in expensive areas such as Kensington and Chelsea should be phased out.

Yet reforming the benefit system is only part of the equation. The next government must also tackle other barriers to work. Key steps include abolishing the minimum wage, reining back employment law, and making it easier for the unemployed to relocate by liberalising the planning system. Indeed, by lowering the cost of housing and basic goods, a programme of deregulation across the economy would enable benefit rates to be cut without increasing poverty, giving a further boost to work incentives.

A policy of radical reform will clearly face stiff opposition from entrenched interests, including the bureaucrats that depend on bloated budgets within government. Small, incremental measures risk being obstructed and diluted, and the political will to push them through could easily dissipate. A more effective approach may be to undertake a fundamental rethink of the scale and scope of the benefits system. Certainly, only major changes will achieve a big reduction in welfare dependency within one parliament. A degree of consensus may even be possible. Many from the left are now joining the right in openly acknowledging the harmful effects of state handouts on the prospects of the poor.

The long-term aim should be to make work much more rewarding than life on benefits so that only a relatively small number of people in genuine need require assistance. At this stage, responsibility for their support could be returned to families, charities and community groups. Britain’s counterproductive experiment in state welfare could finally be wound up.

19 May 2010, a different version of this article was published in the Daily Telegraph

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The Conservatives should have stood firm on inheritance tax

February 23, 2013

The Conservatives have abandoned their manifesto commitment to raise the Inheritance Tax threshold as part of the coalition deal with the Liberal Democrats. This his highly regrettable.

Inheritance Tax is clearly unjust in the sense that it represents triple taxation. Tax is paid on the initial income, then on savings and then again after death, creating significant economic distortions. One result is the small army of tax advisers employed to minimise exposure to death duties; another is that resources are allocated in order to avoid tax rather to achieve the highest returns. Perhaps most importantly, the tax reduces incentives to save rather than consume, thus lowering investment and hampering the production of wealth.

Inheritance Tax raises about £3.5 billion per annum for the Treasury – a tiny proportion of the overall tax take. The Conservative plans to raise the threshold would therefore have cost relatively little. Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.

The Liberal Democrats’ alternative policy of raising personal allowances to benefit the low paid is worthwhile in order to improve work incentives by reducing the horrendous marginal withdrawal rates produced by benefits and tax credits. Nevertheless, given the fiscal crisis, the measure will have to be funded by tax rises elsewhere. If, as the reversal on inheritance tax suggests, this means higher taxes for the relatively wealthy, it may represent a transfer from those with low time preferences (entrepreneurs and savers) to those with high time preferences (low-income spenders). Accordingly, the economic benefits of this realignment of the tax system are far from clear.

12 May 2010, IEA Blog

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Is it worth voting?

February 23, 2013

With the opinion polls pointing to a close result and the prospect of a hung parliament, turnout is expected to be relatively high in today’s election. Yet for economists this presents a bit of a puzzle.

Given that the chance of any single vote being decisive is so small, particularly outside a handful of highly marginal seats, the individual act of voting is arguably irrational – especially since costs are incurred, such as time and effort wasted on the trip to the polling station.

Moreover, one can only vote for a crude package of proposals, which in practice is likely to be changed significantly when it comes to implementation. The political process is extremely inefficient at responding to individual preferences compared with the fine differentiation of markets.

Worse still, various authors from the rational choice school (for example, Olson and Stigler) have shown that policy tends to be determined by special interests rather than the preferences of voters. The “logic of collective action” means that small concentrated groups have a far stronger incentive to commit resources to lobbying politicians and bureaucrats than large dispersed groups such as general taxpayers.

Special interests also engage in “agenda manipulation” to frame policy debates in particular ways and exclude perspectives that are detrimental to their cause. Indeed, Schumpeter went as far as to suggest that politicians and interest groups “are able to fashion and, within very wide limits, even to create the will of the people.” While this may be going too far, a strong case can certainly be made that such strategies further undermine the notion that voting “makes a difference.” (And in some cases, elite interests may simply ignore the wishes of voters, as with the ratification of the Lisbon Treaty).

So why do people continue to vote in large numbers? One hypothesis is that voters find it difficult to calculate probabilities and therefore don’t realise their individual vote is unlikely to make any difference. Another idea is that people vote because they value the preservation of the wider democratic process – they act out of duty and/or altruism. Neither explanation is very satisfactory from a rational choice perspective.

6 May 2010, IEA Blog

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Banning ‘meow-meow’ would be counterproductive

February 23, 2013

The heavily publicised deaths of two teenagers in Lincolnshire who took mephedrone (known as “meow meow”) has led to calls for the drug to be banned. Shadow Home Secretary Chris Grayling has stated there is a “very strong case” for banning meow meow, while Lord Mandelson has stated that its legality will be considered “very speedily, very carefully”. It would appear that little has been learnt from the failure of prohibitions imposed on other recreational drugs and that scant regard is being given to the principle of self ownership – if individuals own their bodies then they must be free to harm themselves.

There is strong evidence from previous prohibitions (heroin, cocaine, ecstasy and so on) that banning mephedrone will only increase the harm it causes. Worryingly, the “forbidden fruit effect” means that outlawing the substance may actually add to its allure for drug takers. For consumers the fact that a drug is prohibited arguably advertises its potency.

As John Meadowcroft has pointed out, prohibition “makes risky behaviour even more risky”. A ban will clearly drive meow meow further into the black economy, placing its distribution into the hands of criminal gangs. It will also criminalise otherwise law-abiding users and heighten health risks as the precise contents or quality of the drug are difficult to determine. And while meow meow is not thought to be anything like as addictive as heroin or crack, there is a danger that prohibition will push prices up and encourage users to commit crime to fund their activities. At the very least, significant law enforcement resources will be wasted on a crackdown that achieves little.

The rise in popularity of meow meow presents an opportunity for a change of direction on drugs policy. Rather than banning the substance, policymakers should remove any regulatory barriers that prevent its legal trade. In this way, the criminal element would be driven out, reputable brand names would develop and users would be confident about what they were consuming. This approach could then be rolled out to other illegal drugs such as cannabis, speed and ecstasy.

17 March 2010, IEA Blog

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How to cut Britain’s £20 billion Housing Benefit bill

February 23, 2013

The cost of Housing Benefit (HB) has exploded over the last five years, rising from £13.5 billion in 2004/05 to £20 billion in 2009/10. This is a cause for deep concern, not just because HB is a major burden on taxpayers, but also because it produces severe disincentives for workless people to enter employment.

The benefit is withdrawn at a rate of 65p for every pound earned above a certain amount. For many claimants it is the main reason that it is not worth starting low-paid work. This withdrawal of HB is normally in addition to the withdrawal of benefits and labour market taxes that have to be borne at the margin.

The Housing Benefit trap is particularly pernicious in high rent areas such as London. The capital receives 26% of HB payments although accounting for 12% of the UK’s population. This may partly explain why parts of London have some of the highest rates of worklessness in the country despite the wide range of employment opportunities.

From time to time the newspapers print a story that illustrates the problem. Last month the Evening Standard looked at the case of a mother of six receiving HB to rent a £2 million house in St John’s Wood, at a cost of £6,400 a month. Once other benefits such as Child Tax Credits and Income Support are factored in, as well as Income Tax and National Insurance, it’s clear she would have to earn in excess of £150,000 a year to be better off in work.

Such perverse incentives, as well as the clear injustice of such cases, provide strong arguments for reform of the system both to reduce public spending and address high levels of welfare dependency.

A simple first step would be to phase in a requirement for HB claimants to pay a proportion of their rent out of their basic benefits (such as Income Support). This would act as a deterrent to those exploiting the system to live in luxury homes in exclusive areas and would encourage tenants to seek out low-cost accommodation.

A second measure would be to reform the “local connection” criteria which in effect provide claimants with an entitlement to live in a particular area, no matter how expensive. Councils should be far freer to house homeless families in low-cost areas. At the very least, they could be housed in cheaper areas within a short commute of the borough in question (for example, Westminster Council could house people in Barking and Dagenham).

The long-term solution to the Housing Benefit problem lies, however, in the liberalisation of planning and building regulations that prevent the supply of ultra-low-cost accommodation. A liberal approach to land use could finally bring an end to this costly, complex and counterproductive system.

15 March 2010, IEA Blog

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The economics of airport security

February 23, 2013

Around 235 million passengers passed through Britain’s airports in 2009. Most of those – both arriving and departing – will have experienced significant delays due to security checks. While estimating the value of travellers’ time is an inexact science, the cost is likely to run into several billion pounds annually, particularly given the disproportionate number of high-earners who fly frequently.

There are also other costs, even more difficult to quantify. The high level of hassle and perceived unfriendliness may damage the reputation of the UK as a good place to do business or a welcoming holiday destination.Yet delays are likely to increase further with the introduction of controversial full-body scanners following the recent terrorist incident on a plane bound for Detroit.

The current approach would appear to be based on the politicians’ mantra of ‘something must be done’ rather than any sensible assessment of transport risks. Terrorism is insignificant in terms of death and injury. In the UK alone, for example, close to 3,000 people die on the roads every year. Low-cost road safety measures could be a far better use of resources than extra airport security. (Indeed, at the margin, longer airport delays may incentivise travellers to use their cars instead – actually costing lives.) There is also inconsistency in the policy towards different modes of transport, with next to no security on the trains or London Underground despite a similar risk of terrorist carnage (this is not an argument for stricter security controls on land transport).

A better long-term approach might be to give primary responsibility for air security to the airlines and airports. These firms would have a direct financial interest in improving the travel experience of their customers. Passengers could choose between high-delay, lower-risk and low-delay, higher-risk companies, according to their own subjective preferences. Airlines should also be free to set up ‘trusted flyer’ schemes to allow certain passengers to circumvent time-consuming and humiliating checks.

13 January 2010, IEA Blog

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Snow chaos – could private roads do better?

February 23, 2013

The current cold snap has led to widespread disruption on Britain’s roads. Much of the network has been left untreated as local authorities have struggled to cope and many routes have been blocked by uncleared snow or abandoned vehicles.
Is there a solution to the transport chaos that descends on the UK whenever temperatures drop below freezing and a few inches of snow fall? There are good reasons to believe that privatising the road network would produce far stronger incentives to keep traffic flowing.

Under current arrangements trunk roads and motorways are managed by the Highways Agency and the rest of the network by local authorities. While their staff undoubtedly work hard to respond to disruption as it happens, the financial incentives for these organisations to resolve this recurring problem in the long term are very weak. Taxpayers fund their activities whether or not they perform well.

By contrast, profit-seeking private road owners – heavily dependent on tolls for their income – would have very strong incentives to keep the roads clear. Nightmare scenarios, such as motorists being stuck overnight in their cars in freezing weather, could do immense damage to the reputation of private road companies and their brand names. Moreover, the possibility of costly insurance claims from accidents caused by poor road conditions would provide a further incentive for owners to ensure their infrastructure was adequately cleared and gritted.

7 January 2010, IEA Blog

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