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“So does that mean I can sleep with your girlfriend?”, A blog about the leisure time deficit.

This blog deals with the notion that it is just to re-balance inequalities. There is a tendency in the press and in political commentary to suggest that wealth inequality is a bad thing, the implication being that individual wealth differences ought to be ironed out. To counter this view, this blog sets out why such a view is flawed without wider consideration and asks the question: Why is the inequality of wealth or income the only variable  that seems to be at issue – surely if one is upset about inequality, that must run across the spectrum of all human activity?

Imagine two boys, Bill and Ben. (This blog could quite easily be re-written Bina and Bella so should be read as gender neutral). Bill and Ben went to school together from the age of 4. Bill was a quiet hard working boy who didn’t socialise well. He spent his youth mostly in his room studying and preparing for exams. By the time he finished high school, his performance reflected his efforts and he won a place at a top university. He continued to work hard and eventually took a job at a demanding Management Consultancy firm. Although the hours were extremely long, Bill’s ambition led him to earn £120,000 salary for a 60 hour week. Bill never had anytime to meet anyone nor had anytime for leisure.

Ben was not a hard working boy. He loved to have fun and took every opportunity to ignore the pressures of work. Ben was, however, very good at partying. When Ben finished high school, he wasn’t able to win a place at university as he didn’t get the right grades. He still, however, managed to have great fun and was very successful finding girlfriends unlike his erstwhile classmate Bill. Ben eventually took a job on £15,000 p.a. for a 20 hour week – for the rest of the week, Ben preferred to take his time as leisure.

According to our political masters and left leaning socialistic inclined commentators for example:

http://www.independent.co.uk/voices/comment/how-the-tax-facts-get-in-the-way-of-the-tory-story-8229280.html

the richest should bear the “broadest shoulders bear the greatest burden. It isn’t however, clear why this should be the case and if it is the case why should it be restricted to taxing individual income?

In the case of Bill and Ben, HMRC would seek to confiscate around 40% of Bill’s income leaving him with a net take home of  around 60% of his gross salary. Ben, on the other hand only contributes around 14% of his income leaving him with 86% of his gross salary. Under the current Housing Benefit regime, however, Ben is also entitled to claim more than £12,700 in housing allowance which more or less doubles his net take home.

To review, Bill’s hard work, dedication and efforts lead the HMRC to take around 40% of his income. Ben’s relaxed approach to work and effort lead him to be awarded a 100% net pay rise. This is in the name of “equality and fairness”.

What the analysis doesn’t take into account is the amount of leisure time that the respective parties have enjoyed over their lifetime. Whilst Bill toils until beyond midnight for his company, Ben finishes work at around 3 in the afternoon and enjoys sitting in the pub with his friends. Ben has enjoyed a great social life.

Would Ben’s greater ability to, for example, find girlfriends not be an apt matter for the socialist to consider as something that ought to be equalised? Of course, it would be easy to counter this argument with the fact that interpersonal relationships are contingent upon a dynamic that isn’t apt for state intervention. This argument, however, falls rather flat when one considers that the leisure time that leads to the availability of a social life is measurable.

The principle that leisure time or “non working time” isn’t considered by the state is a travesty for incentive, hard word and entrepreneuralism in the UK and elsewhere. If “justice, fairness and equality” is the cry of the re-distributors, perhaps they ought to consider the leisure time deficit of those higher earners who pretty much give up their time to their work.

In Defence of Tax Avoidance

INTRODUCTION

Claiming that someone has committed an act of “tax avoidance” has now become the sort of insult previously reserved for bigots, racists and criminals. This post seeks to redress the latest assault on the “law abiding” and turn the tables on the accusers. I argue that “tax avoidance” is a perfectly acceptable activity and in fact our country would be positively harmed by those who sough to do otherwise. I realise this position might in the first instance seem a tough task, but in fact as this blog demonstrates – it is an easy argument and self evidently true.

The real villain that the press (and the current collection of political Muppetry) appear to have a problem with is the UK tax code and the phenomenal opportunities left for tax professionals in accounting and law to take advantage of. I propose two solutions to these problems – either reduce the complexity of the tax code or recruit/ enfranchise the experts to design tax law.

WHAT IS TAX AVOIDANCE

We have heard in recent times that sensible tax planning is fine, but “(aggressive) tax avoidance” is not. We are also told that whilst tax evasion is a criminal activity (typically carried out by those that don’t reveal to HMRC how much they have earned), tax avoidance is not, tax avoidance is perfectly legal. The question is therefore, why are we getting hot under the collar about something that is legal? Further, what is the use of the word “aggressive” doing in the debate?  Is it possible to “aggressively walk the dog” or “aggressively go for a jog”, how about the moral repugnance you might feel if someone were to “aggressively go shopping for milk?”.

The fact remains that people in the UK, at least for now, are only due to pay tax if Parliament has passed an Act which requires them to do so. We don’t have to pay more. The idea that the State or Crown is prohibited from taking your assets  in the form of tax at will was stopped in 1215 at Runnymede in a document known as the Magna Carta. In it, the State/ Crown promised it would only take your property (and liberty) if it followed due process of law. So, unless there is a law that allows the State to tax, you are legally entitled to keep your property. Simple – or so it should be.

The term tax avoidance came about as a result between a gap between what Parliament had actually said it was going to tax (in an Act of Parliament) and what some people feel Parliament meant to tax. This is a very interesting gap. In the UK when Parliament pass an Act (Statute Law), the Statute is typically written in general terms. The role of working out what the Statutes mean in practice is a matter for the Judiciary through the Courts. So in trying to work out whether a particular transaction is taxable, it is for the Judges to work out whether it complies with the Statute, or not. Typically HMRC will attempt to say that transactions are taxable (or not eligible for tax relief) and accountants/ barristers/ tax lawyers will try and argue the opposite. The Judges decide.

Probably the most sensible thing said about tax avoidance was the statement made by a Law Lord, Lord Hoffman who sat in the House of Lords decided on, among other things, tax cases:

“…tax avoidance in the sense of a series of transactions successfully structured to avoid a tax which Parliament intended to impose should be a contradiction in terms. The only way in which Parliament can express an intention to impose a tax is by a statute that means that such a tax is to be imposed. If that is what Parliament means, the courts should be trusted to give effect to its intention.”[1]

In the words of Lord Hoffman, tax avoidance is a contradiction in terms. It doesn’t actually mean anything…. why is there so much debate about the subject and where did the fuss come from?
AGGRESSIVE AVOIDANCE
The tax code is very complex. It currently runs to over 12,000 pages and appears to double every decade. Who is responsible for this extreme complexity? The answer is the people that pass new tax laws – i.e. politicians. As a result of the amazing complexity of the tax code there are many ways in which transactions can now be structured to minimise exposure to taxation.
How do the loopholes form? Although a politician might want to achieve a particular tax effect, due to the collective inadequacy of HMRC officials, politicians and the second rate consultation processes the law is badly drafted. In other words Parliament passes bad law. The loopholes that get created from this process are then exploited by some of the finest minds in the UK – e.g. senior tax solicitors at the Magic Circle (the top 6 law firms in the UK) are paid often in excess of £1-2 million p.a. The top paid tax barristers in the UK can command fees in excess of £5,000 per hour for advice.
On the other side of the fence at HMRC the starting salary for a tax inspector is £25,000 p.a. :
The system we have in tax argumentation is a little like Manchester City v Accrington Stanley. The only way in which Accrington Stanley can win the game is by cheating (apart from the once-in-a lifetime FA cup giant killing matches!). Cheating is exactly what HMRC try to do by simply moving the goal posts during and after the game and sometimes just after the goals have been scored.
Of course, to move the goal posts after a goal has been scored is a breach of the rule of law (as set out in the Magna Carta) but then HMRC don’t like losing so this is how the UK tax has tended to proceed since the famous case of Ramsay in 1982. In the Ramsay case the House of Lords decided that although what the tax payer had done was legal and worked within the Acts of Parliament, the Courts would still tax the transaction on the basis that Parliament hadn’t meant what it said. This grandly named “purposive jurisprudential analysis” of tax law has persisted ever since and makes tax planning difficult.
Tax professionals have become used to trying to work out “purposive analysis” since Ramsay – and arguably Ramsay isn’t a breach of the rule of law on the basis that the Courts underwrote that approach, not the executive (HMRC). Despite this, however, the latest assault on the rule of law is coming…
GENERAL ANTI AVOIDANCE RULE (GAAR)
George Osborne, a Conservative Chancellor, no less, has proposed introducing a rule in the next Budget which will almost certainly become law. The GAAR will say that HMRC will now be able to tax someone if they think the transaction undertaken is “unreasonable” – REGARDLESS OF PARLIAMENT. This change in the law is probably the biggest challenge to the rule of law since 1215, but the press have missed it. Probably because the technical detail is a bit too tricky and probably because they have become lost in the real debate and the implications. So we are clear here –
GAAR will allow HMRC to tax an individual or a business who operated in accordance with the law – when HMRC accept there was no tax – but tax them anyway because they don’t like the effect at a later stage – even acting against the law from Parliament!!!
 We are told that this will only apply to egregious/ aggressive tax avoidance, but as we have seen above, this expression simply means legal minimisation of tax. It is possible therefore that any tax planning might become a target for retrospective taxation including pensions planning, ISAs, VCT, EIS or any other form of activity that uses tax relief. Clearly not a rule that is going to promote investment, saving or business.
THE IMPACT OF TAXATION THROUGH THE MOB
As set out above – tax should always be a function of law. People should know in advance what tax is due before they act. Tax should never be retrospective i.e. imposed afterwards. This basic right is being undermined. Why? The answer lies in the fact that wealthy people are typically the recipients of tax planning and advice. There is now a consensus that the only people who will be affected by “anti-avoidance” provisions are the uber rich….
To abandon the rule of law, however, is a dangerous game to play. We don’t abandon the rule of law when it comes to the protection of Abu Qatada or other accused terrorists and for good reason. We value the law, we value the rules and we don’t believe that you can sustain and grow a modern economy without a sensible tax environment.
Starbucks, Google and Amazon have now found to their peril what happens when a nation wants to tax by mob rule. The implications of the disgraceful scene of a UK politician bleating on to business people that they should pay more than they legally have to was misunderstood. International businesses watching that scene who might have thought of the UK as a business friendly place will have been warned off. Businesses don’t typically withdraw with a fanfare, they quietly slip away, they don’t expand or recruit in unfriendly environments.
By attacking businesses and entrepreneurs through ex-post, retrospective taxation, by whining about the law that Parliament has passed, by endlessly complaining about success, we harm our own economic prospects. Good business maximises profits for shareholders – that is their function. A director of a company (under the Companies Act 2006) is employed solely to further the economic interests of a business. If they pay more taxation than is legally due to the State, they can be sued by their shareholders. If the shareholders want to make voluntary contributions to HMRC – that is fine, but we are in a bad situation where the directors feel they need to go above and beyond the law to comply with mob taxation and that is the state we are currently in.
The current anti-avoidance debate is having a harmful effect on the UKs ability to generate growth, jobs, wealth investment and encourage risk taking. The people we need to think about the UK as a place to do business must be looking at us in horror as we attack the very entities we need to grow our economy. As angry mobs sit outside shops in London complaining about the lack of tax being paid by organisations that contribute £100 millions to HMRC, the journalistic myopia is stunning. We are not only biting the hands that feed our state, we are snarling at those that might have done.
Starbucks employ more than 8,500 people in the UK and have contributed more than £160 million in tax.
See:  http://news.starbucks.com/article_display.cfm?article_id=709
We need more of these businesses in the UK, not less. We need to wake up and recognise who is paying the bills in this country – it certainly isn’t the feckless whingers outside the shops – or Richard Murphy.
SOLUTIONS
The solutions to the problem of “tax avoidance” are simple:
1. Work out how to hire very clever people to work at HMRC to close down loopholes. This will ensure that the laws Parliament think they are passing actually work. This might involve paying more money for the current advice, but at the moment we are in a “pay peanuts get monkeys” situation.
2. Simplify the tax code. This can be easily done by moving towards a flat rate tax system which has worked wonders for every country that has enacted it. Tax revenues have significantly risen and the costs of administering the tax system have been decimated. For those people worried about “relative poverty” which would potentially arise, see my last posting on the “Village of Billionaires”.
Our current political and civil service class – fronted almost exclusively by people with only a journalistic understanding of complexity is unlikely to change, but at least this post has provided the reasons for our current situation.

[1] Hoffman, L “Tax Avoidance” in British Tax Review No. 197 (2005) p203

A Village of Billionaires

Introduction

This post seeks to deal with the principle of “relative poverty” and demonstrate why the concept fails to have any moral value. The second issue this post deals with is the idea that the outcome of a “democratically elected” position isn’t necessarily “just”. Philosophers use the idea of a “thought experiment” to allow the reader to isolate a concept in order to think about it in a particular way. The example itself is less important than the concept it is seeking to analyse. 

A Village of Billionaires

There was a village that contained 20 families. Each family had an elected head who made decisions for their household in a committee. 10 of the families were billionaires, 10 of the families only had assets of £100 million. Each of the families lived in fabulous houses with swimming pools, tennis courts and vast living space. They had expensive cars on the drive way and their lifestyle was everything one would expect from a community with vast wealth. No-one was compelled to live in the village and each was free to leave if they so choose. Each family made an equal contribution to the common services that were available to the community such as roads, schools, street lighting, security and other services. A few miles outside the village lay another village with real poverty. There wasn’t enough food to eat, nor was there any basic medical or education provision.

The billionaire families in this community were the employers. They had made the families with assets of £100 million very rich. Their wealth derived from setting up businesses and taking risks with their own assets to create companies that made the other families wealthy. Despite this, the families with only £100 million felt they were “relatively poor”, after all their neighbours had 10 times their wealth.

As time went on, one of the Heads of a billionaire family died. He left his assets to his family who were another billionaire family in the community. This meant that now in the village there were 10 families with £100 million and only 9 billionaire families. At the following committee meeting a vote was proposed by a disgruntled head of a family with only £100 million. The vote insisted on the redistribution of wealth from the billionaires to the families that only had £100 million. The grounds for this proposal lay in the assertion that the families with only £100 million were relatively poor. Wasn’t it just that there was an equal distribution of wealth? Of course, there were no proposals for any wealth to leek outside the village to the other village where there were starving and dying children – that didn’t form part of the decision making. 

The vote was passed and fully in accordance with democratic principles – after all, the families with only £100 million were now in the majority. Shortly afterwards, the billionaire families decided to leave the village. Their business interests were closed and they set up a new village elsewhere.

Conculsions

It seems odd that for some people, the mere existence of a difference in income or asset levels makes them feel “something needs to be done” or that there had been an injustice. Perhaps the most surprising facet of those who cry “relative poverty” is the almost complete lack of empathy, compassion and drive to focus on absolute poverty as a counter balance to their claims for greater equality within their village. A village of billionaires shows the lie behind those claiming that inequality per se is something that should be addressed by State intervention. It seems absurd, for example that in the UK there are serious claims to prevent a cap on housing allowance in area where well off working families couldn’t afford to live.

Simon Hughes berated the government when they proposed to place a cap on housing benefit that had grown from £10 billion to £21 billion, suggested the cuts would be “hard hitting”:

http://www.bbc.co.uk/news/uk-politics-11616741

His concern about capping allowances, some in excess of £50,000 per year rent, appear both shallow, self serving and unethical in light of the claims of the starving and dying children in a village beyond our own. The “relative poverty” camp and its apologists have no moral claim to redistribution and their attempts at representing the poor need to be highlighted to give the lie to their position.

 It is often suggested that a decision reached by a democratic means is automatically just. The village of billionaires, however, demonstrates this isn’t necessarily the case. It also shows that decisions made in democratic forums can not only impose a tyranny of the majority on the minority but at the same time can negatively affect the majority also. The work of J.S. Mill in “On Liberty” provides a comprehensive account of negative and positive freedoms in this field. I am not suggesting that democratic decision making isn’t the most appropriate way to govern – far from it, I am however, suggesting that it doesn’t necessarily produce justice and freedom – two notions that in my view should always take precedence over majoritarianism. 

Government Deficits: The Basics – Why Voting For Labour or is the same as Turkeys voting for Christmas

There is a huge amount written on government deficits. Very little of it is clear, much of the data is confused and the underlying causes of the deficit are not really explained well. This post seeks to set out what a deficit is, how it happens and what can be done about it. This post also proposes a solution to the current debt crisis in both the UK  and abroad – namely by providing security for debts created by governments as a means to restrain uncontrolled political spending.

WHAT IS A GOVERNMENT DEFICIT

A deficit is the difference between the amount a government spends in a year and the amount it collects. Governments collect revenue from taxation (in all its guises) and spends money on a whole variety of projects, the largest areas in the UK being the welfare state including pensions, education and the health service.

There are two types of deficit. A cyclical deficit (which is ok) and a structural deficit (which isn’t). Dealing first with the cyclical deficit:

The government attempts to ensure that tax is collected and spent so that the books balance, however, during periods when the economy is doing very well, it is likely that the amount of tax collected will increase (given more people will buy more things hence increase VAT income for the government, buy more houses hence increase stamp duties, increase corporate profits and hence corporation tax, earn more money and therefore pay more in income tax). At the same time government spending typically reduces when the economy is doing well because fewer people will need to claim benefits in the form of unemployment allowances and houses allowances etc.

When the economy is doing badly, the reverse will happen and governments expect taxation receipts to fall and welfare benefits to rise causing their balance to go negative. This whole process is known as the economic cycle or business cycle. Governments, therefore try, or claim they are trying to balance the books over a cycle taking into account the natural ebb and flow or breathing of the economy. Governments are not really worried about creating a deficit when the economy is doing badly as this allows money from the State to flow into the economy when it is most needed, and governments are not troubled by taking too much out of the economy in the form of excessive tax receipts when the economy is doing well because it takes the steam out of a booming economy and allows the state to build up money for the next period of bad times. This process of allowing the government to take out and put in money counter-cyclically is known as automatic stablisation.

The business cycle is as old as the Bible (think Joseph in Egypt during the years of famine and the years of plenty). One has to be very weary of politicians who claim to have overcome them (Brown: “No more booms, no more busts’ – how eloquent from a man who created and resided over he biggest boom and bust in the UKs history). Surpluses and deficits that even each out over the economy cycle are unsurprisingly called cyclical deficits and surpluses. Sensible governments will recognise when the economy is in a cyclical upturn and save money for the inevitable slowing down. Government run by ignorant or short sighted politicians and civil servants will find themselves getting over exuberant and spend the money during the good times leaving the cupboard bear for the downturn.

When one of the ex-Labour Minister’s, Liam Byrne was thrown out of office, he left a note for the new Minister. It stated :”there isn’t any money left”. Gordon Brown, Ed Balls, Liam Byrne and the rest of the Labour administration had spent all of the money during the good times, leaving nothing in the pot for the bad times. Most of the old Labour team are seeking re-election. Be afraid. Be very afraid. It would be a little like voting for Fred Goodwin or Bob Diamond to sit on the remuneration committee of a bank. The Labour administration squandered more money between 1997 and 2010 than every other British government in history, combined. The notion that something had to be kept back was completely absent from their thinking as pay, employment rights and staffing in the public sector ballooned out of control. When the business cycle turned negative, as it has been doing for hundred of years, there was no saving for a rainy day.

STRUCTURAL DEFICITS

A structure deficit is a very different thing to a cyclical deficit. It is something to be concerned about and something that can’t be sustained over any period of time.

A structural deficit is a situation in which the amount of money being spent by government is greater than its tax receipts, even taking into account the economic cycle. A good way to think about this would be to compare it with a persons salary. Each month a person receives their salary in their bank account. From their salary, they have to pay their bills and the amount in their bank reduces and keeps reducing until they receive their next salary payment. If over time their bank balance keeps falling, even taking into account their salary – they are running a structural deficit. In other words they are spending too much money and need to change their habits.

THE BOND MARKET AND THE EURO CRISIS

So, what happens when someone spends more than they have? Well, they have to get someone to lend them the money. Governments are exactly the same. Whilst we as individuals might have to borrow money in the form of a loan or an overdraft, the government has to borrow the money from the bond market. In the UK, the government will issue bonds, known as “Gilts”. These bonds are loans that people are prepared to make to the UK government. If you add up all the money that the UK government owes, mostly in the form of gilts – you will get a handle on the national debt. We currently owe more than a trillion, that is:

£1,000,000,000,000!

For more numbers a good site is:

http://www.debtbombshell.com/

Lending to governments is a pretty safe thing to do. Or at least it was, to most governments. Following defaults (a default is where the person you lent to doesn’t pay you back) in Argentina and Russia along with an assortment of countries in Africa, investor confidence in government bonds became more restricted to G7 nations. After all, it wasn’t likely that the largest economies in the world would default.

The confidence of investors was well founded. Up until 1999, each of these nations were capable of simply printing currency to make good on the debts albeit with a potentially inflationary after taste. Following the establishment of the Euro a number of countries lost control of their currency, but not their ability to raise money in the bond market.

The socialist influence on politics across the Euro-continent from the period of 1997 through to 2012 represented a period of the most grotesque profligacy in history. A lesson in how not to run a country – our own brand of political fool came in the form of Balls, Byrne and Brown.

In short, these politicians ran systematic structural deficits. Their wasteful spending manifested itself in a whole host of ways – spraying their client groups (people who they wanted to vote for them) with money. There were huge rises in pay across the public sector, vanity building projects costing billions, huge increases in employment in the public sector and importantly significant reductions in pension ages. In Greece certain members of the public sector were able to retire on full pensions in their 40s – with the State happy to pay pensions for 40+ years on a working life of less than half of that figure. Of course, the entire enterprise was bound to collapse and it did.

The financial crisis discussed in the previous posting didn’t cause the government crisis that followed. It merely preceded it and acted as a catalyst for something that had to happen in any event at some stage. As the world economy started to tail spin, resulting from the financial crisis, socialist governments from Spain, to the UK to Greece began to realise they had nothing in reserve to cope with an economic downturn. They had spent the lot.

These governments began to do what they did best and borrow – from the bond market. The bond market, however, started to look at the capacity of these countries to be able to repay back the debt and this eventually turned into a full blown bond market panic. It was Greece that won the ugly contest out of the Euro-socialist line up. The term “PIIGS” was coined to pick out the countries who had been caught “swimming naked when the tide went out” i.e. had run out of money when the economy down turned. Portugal, Ireland, Italy, Greece and Spain were forced to either apply for a bailout from their EU partners or be presented with de facto budgets. In short, the governments of these countries had lost control of their countries like a common bankrupt looses control of their own finances. The northern Europeans, namely the Franco-German alliance had to dictate terms.

SOLUTIONS

The most obvious solution to a debt crisis is to ensure that politicians of any colour in any country are restrained from spending more than they receive. Of course, the danger here is that politicians will claim they are only running cyclical deficits – Brown, Balls and Byrne did exactly that. One solution to this, would be the prevention of governments from running a deficit during times when GDP is above a certain figure e.g. 1.5% (the reason this figure isn’t zero is due to the fact that there is a natural rate of GDP growth one would expect in an economy due to population growth and technological advances – there is much debate about this figure but is certainly a positive number). Once GDP rises to a certain level, if political spending implies a deficit, then spending cuts ought to automatically be put in place to ensure some funds are saved for a rainy day.

The second solution to incontinent political and civil service spending is to self impose limits on money that can be raised from the bond market. The bond market is without a doubt the most powerful group of investors on the planet. A US political advisor, James Carville once said he would like to come back as the bond market – so he could intimidate everyone!

The bond market, like any lending sensible “institution” is concerned with two things. The most important is faith that the borrower will give them their money back at some point. The second is that they receive a reasonable rate of interest for taking the risk as lender. When investors get worried, the simply won’t lend. This happened when various Euro-governments were shut out from the bond market and it could easily happen to the UK.

To solve the problem, governments would be well advised to only issue paper (bonds) that were asset backed – rather like a mortgage. Investors who were buying these bonds would then be prepared to lend at much lower rates of interest (given the reduced risk) and there would be a finite number of “securities” to lend against – given the finite amount of assets held by the government. There would be huge political pressure (as there is with a household mortgage) to get the debt paid off – rather than the current situation where the national debt is simply rising. Governments who hit the debt ceiling (the US has a self imposed ceiling unlike the UK) then decisions would have to be made in regards to cutting spending.

FINAL WORD

Without a doubt, the two largest problems for government spending are health and pensions. It would be possible to double health spending at any given moment in the cycle. Health represents an area through which we could channel unlimited spending. Most of this money would be spend keeping patients alive for incrementally longer periods. I am not advocating we don’t spend more and more money on the health service, but I do think it needs to be said that the amounts we spend in this regard are with due concern to what can be afforded – namely in regards to our national debt and budget deficits. It is currently political suicide to suggest health spending is somehow controlled – but one thing should be borne in mind which is that the majority of funds are spend on salaries, not on health care.

The second issue relates to pensions of civil servants, quasi-government officials, teachers, nurses, doctors and others in the public sector. The fact is we are living long. Retiring at 60 or 65 is no longer something the state should or ought to afford. If the pension age were increased to 70, the deficit would be wiped out in a stroke. We need some serious thinking on pensions reform – specifically linking the pension age with life expectancy – if we don’t we will end up like Greece.

I am aware that many socialist writers would say the solution is to increase the tax rate on the rich etc. However, government revenue is likely to actually fall if tax rates rise – due to the fact that few wealth creators are going to take additional risk, employ additional staff and add to GDP. I have written elsewhere on this blog on this subject and will continue to do so.

 

The death of Casino Capitalism – A Failure of Personal Reponsibility

This post examines the “2008 crisis” as discussed in worldwide media and argues that there wasn’t a single crisis but rather two distinct crises. This post looks at the first crisis which originated in the financial markets and destroyed more than £1 trillion of bank equity value. The origins of this crisis and the almost universal reaction raise interesting questions about personal responsibility, given that the majority of loss came from borrowers who simply didn’t have the money to pay back the funds they had borrowed. Rather than questioning the motives and responsibility of the borrowers – the focus turned on the lenders who had lost their money.

The second crisis was and still is a government budget crisis which has the capacity to destroy not equity value but the fabric of society and nation states – it will be discussed in the next posting. This crisis was ultimately derived from a short-sighted, power-greedy often pseudo-socialist agenda intent on grabbing power at any cost and increasing the benefits/ pensions/ working conditions etc of their voting group – even to the point of national humiliation and bankruptcy such as Greece. The gall of those UK politicians who steered our country to the brink, such as Ed Balls and Liam Byrne to continue in public office after the biggest and most dangerous spending splurge in British history is startling.

THE DEATH OF CASINO CAPITALISM

There has been much ink split on the incentive structures within investment banking. As an ex-Director of Lehman Brothers back in the late 90’s I had direct experience of the kinds of risks which back then were seen as acceptable.  Traders and management were entitled to a bonus based on their profits generated in each department. In the event massive losses occurred, many traders left the bank and started up elsewhere. Of course, this is easy to say and rather more difficult to effect. If a trader had been dismissed or left a bank as a result of losing several million US Dollars, it wasn’t a simple matter of finding another job. Investment banking wasn’t and isn’t the public sector (of which I also have experience as a teacher). Failure was punished quickly, efficiently and ruthlessly. Failed traders didn’t cause the financial crisis – arguably it was success that caused it. As traders proved themselves money makers, their bosses would grant ever larger position limits, granting them the ability to take great risk. This situation didn’t happen over a short period, rather it took many years for an individual to be given the capacity to take positions in markets that would create significant exposure.

I am aware of stories of huge losses racked up by Nick Lesson style traders – the billions lost in UBS, Sumitomo and other institutions that have employed failed traders. These losses, although painful for those involved didn’t however, have the capacity to create the sort of equity destruction of the 2008 period- in fact in all of those cases, the losses were not sanctioned by the bank – they arose as a result of fraud – something that can and does happen in all businesses – its just in these Lesson – cases the numbers are bigger. The real damage caused by the collapse in the financial sector related to huge management-sanctioned-risk.

Throughout the aftermath of the financial crisis politicians, regulators, protest groups and media commentators began to use the word “bankers” as a catch all expression to deride and castigate activity that led to the collapse in financial markets. The expression, however  was lazy, inaccurate and confused. Banking has served the UK and funded its public services for decades. It is one of most successful industries and pays its way handsomely. It employs 100,000’s of people, makes a massive contribution to tax revenue, facilitates businesses, funds mortgages and is the bedrock for our economy.  For the full detail on its phenomenal contribution to the UK see:

http://www.bba.org.uk/

Those calling for the castigation of “bankers” generally would feel rather sorry if our financial services sector collapsed and our economy began to resemble a backward, undeveloped economy incapable of providing even the most basic services, let alone a welfare state. It was interesting to see that after all the carping about “bankers bonuses”, the greatest loser from the shrinking of the City bonus pool was HMRC – there was an estimated £4 billion they didn’t collect in income tax following the crisis directly from the pool. That’s £4 billion that had to come from elsewhere. Whilst it remains the case that the CDO/CDS market led to the destruction of bank equity capital and caused a severe restriction on lending, those “bankers” count in the dozens. To see the castigation of a responsible industry that employs millions is crazy. So is a potential regulatory regime that may constrain an industry that was working well in all but a tiny number of cases.

The proposed “breaking up” of banks and the subsequent language of those unfamiliar with the industry may be in danger of damaging an important sector that we all need to work well. Some intellectually challenged commentators have even suggested that the government itself create a bank for lending – clearly something beyond its competence and something that would require the tax payer to take on commercial risk. Do we want untrained, unqualified Civil Servants deciding on whether you can have a mortgage, or whether you can borrow money for your business?

WHY DID THE CRISIS HAPPEN

In short, the real collapse in banking took place because people borrowed money they couldn’t afford to borrow. Banks were unable to get their money back and as a result those people who had invested in banks had to pay for the losses. When the crisis struck in 2008, there has never been a greater incidence of wealth distribution from rich to poor in human history and it took place in a matter of months. Shareholders of banks were systematically wiped out with share prices falling almost uniformly by more than 90% and in some cases 100% (Northern Rock). This equity loss (in excess of £1 trillion) had to cover the losses on property loans that had gone sour – in other words the shareholders (and in some cases the bond holders) had to cover the losses on investments made by people who couldn’t afford it.

Of course, this wasn’t a socialist nirvana, those people who had borrowed the money and found themselves unable to pay it back were not happy about the outcome – they suffered too. The UK government to date hasn’t lost money by involving itself in the equity of banks such as Lloyds and RBS, nor has it lost a penny investing the assets of Northern Rock or Bradford and Bingley. In fact, it is likely the government will probably find itself sitting on a significant profit in years to come providing they don’t mismanage their investment and destroy the sector with ill conceived and reactionary policies. Since September 2012 the UK governments shareholdings have doubled in value as the world economy begins to thaw and the pseudo-Socialist deranged spending of southern Europe is controlled by calmer voices in the EU and in Germany in particular.

The technical complexity that allowed sub-prime borrowers access to funding is without a doubt a story of intrigue. The best account of it I have read is by Michael Lewis in “The Big Short”, but I would like to focus not on Collaterised Debt Obligations (CDOs) and Credit Defaut Swaps (CDSs). The derivative structuring departments of investment banks merely respond to demand in the market – they don’t in the words of Jack Nickleson – make the odds, they just deal the deck. Instead I would like to focus on who is responsible. There can be little doubt of the ingenious methods used by bankers at Deutsche Bank, Goldmans and other investment houses. They were experts in facilitating lending agreements between those wanting to borrow and those wanting to lend. That is, after all, the principle function of a bank. Investment banks just deal with more complicated arrangements. There is also little doubt that some of the institutions that ended up buying these loans make mistakes by relying on the rating agencies to give the loans a clean bill of health (AAA in some cases). The reality, however, is that the man-in-the-street isn’t getting involved in trading subordinated, sub-prime syndicated debt. The investment bankers who bought and sold these securities were simply part of a system that allowed demand to meet supply in ever more ingenious ways. The ultimate question, in my view has to be who was responsible for the debt in the first place.

WHO IS RESPONSIBLE?

The analysis that followed almost uniformly, however, placed the blame for the consequences of the disaster on those that lent and lost, rather than those that borrowed who couldn’t pay back. This is interesting analysis as it tends to move responsibility away from the individual and on to those who ultimately take the loss.

Taking that analysis a step further, one has to ask how far this sort of thinking ought to stretch? Is the cigarette vendor responsible for the smoker? Is the barman responsible for the drinker? Is the fast food operator or pizza restaurant  responsible for the diner? Clearly in all three situations there is a potentially bad outcome. The smoker can get lung cancer, the drinker can get sclerosis and the diner can become obese. Clearly, the buyer doesn’t intend for those things to happen – but are we saying that the seller bears responsibility for doing so?

Many would argue that the bankers – who supplied the funding for people to buy property – were aware of the fact that this couldn’t be paid back? I would suggest this is self-evidently false on the basis that the people that lost the most in this scenario were the lenders, not the borrowers. But a more fundamental question is do we want to look to the State and ultimately politicians to decide upon how we conduct our lives? Do we want Parliament to tell us what we can borrow, what we can eat, where we can go, what we can do?

At some stage there appears to have been a disconnect between the extent to which individuals bear responsibility and the extent to which that responsibility is borne by those that allowed them to make the decision. My view is that the notion of personal responsibility has shifted too far from individual choice and we are in danger of creating a society that seeks to blame others for their errors. Nick Cohen, in his book “Waiting for the Etonians” tells a story of a young woman who had borrowed too much on her credit card. He implies her debt and subsequent inability to pay it back were the fault of those that lent it to her. The temptation was simply too much. She had to have those clothes, she had to have that holiday, she had to buy those consumer electronics. It was their fault, not mine!

If we value freedom, we need to distinguish between those things we are happy to take responsibility for and those things we don’t. I realise that many will suggest that the State is necessary in many of our decisions. The fact that there is massive information asymmetry (i.e. sellers know much more about what they are selling than the buyer) is an important consideration. I am not suggesting for a moment that our food, for example doesn’t conform to safety standards, nor am I suggesting that a sensible Health and Safety regime isn’t required. I am however, suggesting that greater balance is needed.

If we want people to be free to buy a house with borrowed money (in the form of a mortgage), we must accept that the value of the house might fall and the value of the debt might exceed the equity put into the house. If we don’t want people to be free to do that, we need to radically intervene in the economy and start to allow the State to act like our parents – constantly reminding us to only spend what we can afford etc.

I for one don’t want inept, inexperienced, incompetent politicians telling me that I can’t do things that contain ANY risk. I suggest this goes for the majority. To those that want a completely anticipated risk free life, where the State makes all their decisions for them, I would suggest they grow up and start taking responsibility for their decisions.

Richard Murphy: Useful Idiot or Dangerous Fool? A Masterclass in Misunderstanding Basic Economics

Introduction

Richard Murphy describes himself as the UK’s number 1 economics blogger, but his work is so poor that as an ex-economics teacher, I would struggle to give him a grade D for his understanding of the subject. This blog will focus on “Economic Myths”, a Chapter in his book The Courageous State. In this chapter Richard explains we are ruled by “frightened politicians who are pulling the state to pieces”. Richard describes the real enemy of the peace as anyone who thinks the market is a good way to allocate resources within an economy as opposed to the (Courageous) State. Helpfully Richard points out that “detail matters because if it is wrong then the big narratives are also likely to be wrong”. So providing reasons why Richard has the detail wrong would help convince him that his big narrative is also wrong. It should be noted that Richard is funded by a variety of Trade Unions and is interested in reducing “poverty”, although it would appear that “poverty” for Richard is relative (see my previous posting on “Fairness and the Elephant in the Room”).

The World According to Murphy

Under the heading “The Fundamental Flaws in Neoliberal Thinking” Richard makes the following points about Neoliberal thinking:

1. The markets always know best. Any intervention in the process is sub-optimal.

2. All government intervention is sub-optimal (as it is not market based).

3. Tax is a bad thing as it takes choice away.

4. The statement “the world is measurably probabilistic” (Skidelsky) means: “The result is that these economists think that the future is entirely predictable.”

5. “That human beings when engaging in the market place are omniscient – they can clairvoyantly foretell everything that might happen and how likely it is to occur and when”.

Richard then tries to explain why the 2008 financial crisis took place under the heading “Putting all this in context, or why we’re in a mess right now”  he makes the following points:

6. “The assumptions underpinning neoclassical economics are quite absurd… they bear no relationship to reality… we know they don’t work”.

7. Alan Greenspan (ex-Chairman of the US Federal Reserve) and Lord Turner (ex Head of the FSA) admitted mistakes in regulating – they relied on neoliberal economics – a quasi religious belief which was “precisely why we had a crash”.

8. “Bankers were sure neoliberal economics was right because they were the winners”

Finally Richard provides some concluding comments:

9. Economics became difficult because it started using Maths rather than “plain English”. 

10. Richard says he has a problem with Maths when it “flatly contradicts the word we observe”.

The statement “the world is measurably probabilistic” (Skidelsky) means: “The result is that these economists think that the future is entirely predictable.”

11. Business don’t know how to maximise profits so any theory that suggests they do is flawed.

12. Business’s don’t increase sales up to the last point where a profit is made (marginal cost theory) – as this doesn’t take into account overheads, so he says “I kid you not: the whole edifice of neoliberal economics and the mantra so often repeated that business is more efficient than government is made on this type of logic.”

13. The post war period was really successful in the UK, economic policy was largely determined by the government and the abandonment of government intervention and control led to our terminal decline into market based solutions.

Why RIchard has gone wrong

The world is complex. One of the ways we seek to understand it is to simplify things in order to understand them. Economics students learn that a “model” is a tool for understanding how relationships work. Models are a guide. So for example, students are taught that when things get cheaper (prices falling) usually more people will buy them (demand will increase). Its not always true, but generally this sort of understanding works well enough to understand the relationship between prices and demand. If one were to find a situation where a price increase led to an increase in demand, this wouldn’t invalidate the general principle that generally falling prices lead to increasing demand. One good example of this would be goods that are desirable because they are expensive (i.e. high value luxury goods that are prestigious because few people can afford them).  Richard, sadly has missed the point of modelling and believes that because he has found a situation in which the market has “failed”, firstly markets are bad at allocating resources and secondly the government would is much better. It is difficult to see how the second thing follows from the first in an ex-Soviet, ex-Eastern Bloc world, but there it is. The following is a short lesson on how the world really works and why we need to be careful of fools like Richard…

Why Markets Work Best and What Neo-Liberals Really Think

There are two reasons why markets are better at allocating resources (i.e. deciding who gets what, when, how, and for how much) This does not mean that neo-liberals really think that markets are the only solution or that they always work best. The two reasons are known as “consumer sovereignty” and “productive efficiency”. I will de-jargonise. 

Consumer sovereignty simply means that markets are best at working out what people want. They do this because if the market produces something that people don’t want, they won’t buy it. If the market produces something that people do want, then producers will know this (because people will buy it) and make more of it. So we end up with produces making stuff that people want.

The second thing that markets do well is something known as “productive efficiency” – this means that producers (firms, companies etc)who make things are in competition with each other to supply the things that we want. The producers who make better stuff at cheaper prices are the ones who will survive, the ones that make expensive poorer quality stuff will go bankrupt. A good example of this might be the Betamax/ VHS video competition or the development of the ipod versus the CD market. So we end up with the best stuff at the lowest prices.

In summary, the “market” will supply consumers with the stuff that they want at the best prices. Simple really – not offensive and rather intuitive. So, what goes wrong…

Sometimes the Market Fails

Very few pro-market thinkers (including the poster boys of libertarianism such as Friedman and Nozick) believe that the market is the only solution to how an economy ought to be organised. Richard gets confused on this point and effectively sets up a row with the “right” that no-one on the right is attempting to argue with. 

The market is likely to fail in a number of circumstances such as failing to take into account third party costs (e.g. pollution, environmental damage). The market is also likely to under produce certain goods such as state education, health, roads, police, army and the courts. The market is likely to over produce undesirable goods such as drugs and prostitution.

Good economics recognises the limitations of the model being proposed. Clearly the market doesn’t have the solution in all cases and for situations such as market failure – the government is of course the most appropriate mechanism for determining allocation. 

The government, however, is not the best a working out what consumers want and is most certainly not the best at working out how to produce it. One only has to think of the food queues of the old Soviet Union to work out the implications of allowing politicians to work out what we as a nation want. 

Murphy and Other Fools

The reason people like Murphy are dangerous is because they do actually have influence. They don’t realise they are wrong. They don’t really understand the world and they get easily confused. In order to highlight the extend of his failure to understand the world I would like to focus on three statements taken from above:

4. The statement “the world is measurably probabilistic” (Skidelsky) means: “The result is that these economists think that the future is entirely predictable.”

Is something entirely predictable if it is measurably probabilistic? Of course it isn’t nor does any sensible economist think that is the case. Does the world have to deal with probability when making economic decisions – of course they do but that doesn’t mean to say they think it is entirely predictable. A good example of the use of probability in business is the world of insurance. In order to work out what your premium ought to be for your car, there will be a team of actuaries trying to work out the appropriate chances of an incident and the costs of that incident. Do they think the future is entirely predictable? No, they don’t – would they describe the world as measurably probabilistic – yes they would. Murphy’s alternative to using probability theory isn’t set out in his Chapter on Economic Myths, although presumably he would rely on government for working out what is likely to happen in the future – after all – who needs actuarial sciences when we have John Prescott, Harriet Harman, Ed Balls, Gordon Brown and Liam Byrne – they all did a lovely job predicting what was going to happen.

10. Richard says he has a problem with Maths when it “flatly contradicts the word we observe”.

This statement is interesting as it has overtones of the pre-Enlightenment movement. If the maths contradicts the world we observe, either we have the maths wrong or our observations will be wrong. The maths itself is never wrong. In fact, most scientific discoveries, particularly in astro and theoretical physics leap forward when the maths indicate our understanding of the world is incorrect. Think of Einsteins Theory of Relativity disproving Newton (the maths did the work here),  think of how Galileo worked out how the Earth wasn’t the centre of the Universe. In short, Maths scares people and it might be difficult but it can’t be “wrong” – people can be wrong. The use of maths in economics, finance and commerce has been so useful and globally significant that an attack on its use could only be flagged up by the sort of fool who lacks an appreciation of its power.

11. Business don’t know how to maximise profits so any theory that suggests they do is flawed.

This last statement typifies Murphy’s stupidity, beautifully. Economic theory doesn’t state that businesses will maximise profits. Economic theory indicates that businesses will try and maximise profits. The difference ought not to be subtle, but it clearly is too much for Murphy. Every business decision is fraught with many variables, many of those variables will be uncertain. Mistakes, errors, greed, miscalculations are all part of the economic backdrop in the world we live. No-one has access to the future and no-one but Murphy is suggesting we do. The only thing market theory suggests is that rational people will at least try and maximise utility (i.e. the best outcome in accordance with however that is defined for them – and for business that is typically profit) in all situations.

Conclusions

My hope this blog clears some things up in respect to libertarian economic thinking. One has to beware anyone who thinks that government is going to be better than the market at determining what it is we want. After all, we are the market and very few who think about it want their needs supplied and determined by politicians and bureaucrats. 

Fairness and the Elephant in the Room

The Elephant in the Room suggests the calls for “fairness and equality” are really the language of self interest.

How much more should we give non-pension welfare benefit claimants this year? This posting considers the way the debate is framed and calls into question the use of the term “fairness”. The only reasonable outcome for a successful moral argument on the re-distribution of wealth from our current position is an increase in the overseas development budget. Not an argument I am currently hearing from Labour or renegade LibDems. Their motives are based on advocating for their client groups i.e. those on welfare, unions and the public sector to improve their financial position – in order to retain/ regain power – i.e. their arguments may sound moral but are just as economically self-interested as those calling for tax reductions.

By way of summary, benefit claimants might receive money from the government in the form of tax credits, job seekers allowance, maternity pay, sick pay. All of these benefits increased at a rate of 5.2% this year. A stark figure when one considers the state of the economy, the size of the deficit and the fact that most working people where happy to keep their job, let alone lobby for a pay increase of 5.2%. The argument falls to whether increases in benefits should increase (not be cut, slashed, decimated or sacrificed) by 1% or around 2.2% (roughly the rate of CPI). So for someone on jobseekers, the debate revolves around 9 pence per day relative to an income of around £57 per week.

The debate is typically – but not always – framed by re-distributors suggesting “pain should be shared”, “all must make sacrifices”, “its unfair that the people who caused the crash should suffer” etc. We have seen demonstrations by teachers, nurses, anti-capitalists and others complain that they are “suffering”. Is any of this true? Is any of this reasonable?

Looking at the facts, the public sector hasn’t at any stage considered the possibility of pay cuts since the events of 2008. Growth in public sector spending has in fact increased. A lot. So what is the tenor of the complaint? It is true there have been a number of job losses in the public sector, but there has also been an awful lot of hiring in the public sector. The debate appears to be coalescing not around the notion of a fair distribution of tax revenue but around redistribution in general. We have heard many times politicians indicate equality between the increasing of tax and the giving of payments. They are not the same thing (see my earlier blog on the difference between giving and taking). 

The question to be asked then is what underpins a fair distribution? The emotive argument about providing for others certainly has moral merit, but why would the provision of benefits to others be necessarily restricted to people within national borders? Surely the elephant in the room is the argument that a fair distribution must dictate the following:

If re-distribution is going to take place, the most deserving are the most in need.

The most in need surely can’t be classified as people who are provided with a free education, free heath service, financial payments each week, free housing (and if they are lucky in places like Chelsea and Hampstead) etc. The most in need must include the 5 million children that die each year of diaherra, those staving to death, those children who parents have been killed in conflict, those children who have been born with aids in states that don’t have a developed health system, those children who don’t live with security of access to water?

If a moral argument about fairness of re-distribution is raised by the left, why is the moral argument directed towards people who, in the standards of the world we live in, are in the top 5% – even if they are on welfare benefits. Surely, the only logical argument for increases in welfare payments on grounds of fairness of distribution must only be valid if they are directed towards an increase in the overseas development budget? The extra 9 pence per day, would after all save a child’s life by purchasing oral rehydration sachets.

http://rehydrate.org/ors/index.html

 If a moral argument about justice and fairness are raised about re-distribution on grounds of equality (I am thinking here about some proto-communist writers such as Richard Murphy among many other “liberal press” scribblers), surely the real needy must be first in line? Shouldn’t they be advocating for a slashing of welfare benefits and a re-allocation to the overseas development budget? One has to wonder why they don’t, after all, the philosophical underpinnings of their moral voice are not state constrained (such as Rawls in “A theory of Justice” or Murphy/Nagel in “The Myth of Ownership”). In the allocation of scare resources and on their current argument, the UK liberal left prefer to provide free housing in Knightsbridge rather than feeding staving children. Is that a moral argument – it doesn’t look like one to me.

I suppose the greatest embarrassment for the argument for equality is that those who are victoriously arguing for it are most likely to be economic beneficiaries –  providing of course that their notion of “equality” and “relative poverty” places them in a position to be recipients rather than donors. I would be far more open and willing to listen to arguments for equality if this meant those advocating it were not potential economic winners from their successful argument. The fact that in the overwhelming majority of circumstances, they are – only serves as evidence that Milton Friedman’s “rational agent” theory is still alive and kicking in 2013. Until I hear the mainstream left start to argue for redistribution towards international aid and away from the welfare budget – they are every bit the neo-classical, neo-liberal self interested agents as described in economic theory. 

How embarrassing…